author:
Smiti-i : McMahon,
      TukneR,

text:
    General Outdoor Advertising Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 66511.
    Promulgated July 25, 1935.

      Jamies L. Bohr, Esq., and Malcolm O. Law, Esq., for the petitioner.

      Harry F. Morton, Esq., for the respondent.
   OPINION.

Smiti-i :

1. The first question presented by this proceeding is whether petitioner is entitled tp deduct from its gross income of 1929, $199,-222.34 paid out for attorney fees and other expenses in connection with an equity suit instituted by the United States against the petitioner and others under the Sherman Anti-Trust and Clayton Acts which resulted in the entry of a consent decree. Petitioner claims the right to the deduction under section 23 of the Revenue Act of 1928, which, so far as material, provides:

SEO. 2 3. DEDUCTIONS PROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *

In the litigation referred to the United States made the following substantial charges against the petitioner:

(a) that petitioner was part of a combination and conspiracy to restrain interstate trade and commerce, and to monopolize and attempt to monopolize such commerce; (b) that petitioner itself was an illegal combination and unlawful monopoly and that it should be dissolved; (c) that contract of August 24, 1925 between petitioner and National Outdoor Advertising Bureau, Inc., was illegal; (d) that options to purchase stock of the National Outdoor Advertising Bureau, Inc., wore illegal; (e) that petitioner violated the law in entering into contracts for outdoor advertising display to be executed on plants owned by others; (f) that National Outdoor Advertising Bureau, Inc., granted preferences, priorities, etc., to petitioner; (g) that petitioner granted preferences, priorities, etc., to the National Outdoor Advertising Bureau; (h) that petitioner illegally refused to sell advertising space; (i) that petitioner and Foster & Kleiser Company had an illegal understanding as to the division of territory between them; (j) that petitioner and others maintained illegal price agreements; (k) that election of George W. Kleiser to petitioner’s Board of Directors was illegal; (1) that Foster & Kleiser Investment Company was part of an illegal community of interest between Foster & Kleiser Company and petitioner; (m) that voting trust agreement of February 26, 1925, under which petitioner’s stock was trus-teed, was illegal; (n) that petitioner’s contract for the acquisition of P. & H. Morton Advertising Company was illegal; and (o) that Outdoor Advertising Association of America was part of an illegal monopoly.

Before the suit was instituted representatives of the petitioner and of the United States Department of Justice had had many conferences with respect to the application to it of the Sherman Anti-Trust and Clayton Acts. The petitioner was whiling to agree that under the construction placed upon those acts by the Department of Justice certain of its contracts were illegal; also that the court might enter a decree that the petitioner be enjoined from doing certain things provided for in the contracts. It was not, however, willing to admit that all of the charges made against it by the Department of Justice were well grounded — -hence, the suit. Voluminous testimony was taken in the trial of the case. While the case was on hearing counsel for the United States and for the petitioner agreed to the entry of a consent decree, which was later entered by the court. Many of the charges made by the United States, particularly the serious charges, were not established by the decree. The decree established, however, that the contract of August 24,1925, between the petitioner and the National Outdoor Advertising Bureau, Inc., was illegal. The petition in the proceeding charged with respect to this contract:

* * * Under this contract, which is now in full force and effect, the Bureau was constituted the agent of the General Company [petitioner] to solicit contracts for national outdoor advertising to be executed upon the plants owned or operated by the General Company, and, at the option of the Bureau, to be executed upon plants not owned or operated by the General Company. The contract further provides that all advertising contracts procured or obtained by the Bureau to be performed by the General Company shall forthwith be assigned by the Bureau to the General Company. In the practical operation of this contract more than 90 per cent of all of the contract for outdoor advertising obtained by the Bureau are assigned to the General Company.
In addition, the General Company and the Bureau have agreed in this contract not to compete in the solicitation of national advertising from specified advertisers, the names of which are appended to the contract, but which are changed from time to time by mutual agreement between the General Company and the Bureau.
With the exception of the General Company itself, the Bureau (including so-called members thereof) is the largest single agency in the United States for the solicitation of national outdoor advertising. The combined volume of business obtained by the General Company and the Bureau represents about 80 per cent of the total volume of national outdoor advertising business in the United States.
The contract between the General Company and the Bureau is now in operation and will continue for an indefinite period by virtue of the provision therein for automatic renewal until cancelled by written notice, and even on the giving of such written notice the contract shall not terminate until five years from the end of the year in which notice of a desire to terminate is given.

The parties were enjoined from further carrying out this agreement or any similar agreement, except that operations under it might be continued until November 1, 1929, for the purpose of making necessary changes and adjustments in the business operations of the parties incident to the voiding of the contract. Options to purchase stock of the National Outdoor Advertising Bureau, Inc., were declared null and void. The election of George W. Kleiser as a member of the board of directors of the petitioner was declared in violation of the Clayton Act and Kleiser was perpetually enjoined from holding that office. The decree also provided that certain acts, if performed, would be in violation of the law and petitioner was enjoined from doing any such acts.

The petitioner contends that the greater part of the far-flung charges made against it by the United States were not substantiated; that as a result of the litigation the petitioner was not required to refrain from doing anything which it had not agreed to refrain from doing prior to the entry of the consent decree; that it was necessary for the petitioner to defend itself from the grave charges made against it by the United States; and that the attorney fees and expenses paid in connection with the litigation were ordinary and necessary expenses within the contemplation of the taxing statute.

The question of what constitutes ordinary and necessary expenses was before the Supreme Court in Welch v. Helvering, 290 U. S. 111. The Court there said:

* * * Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack. Cf. Kornhauser v. United States, 276 U. S. 145, 48 S. Ct. 219, 72 L. Ed. 505. * * *

In Mrs. A. B. Hurt et al., Executors, 30 B. T. A. 653, we stated:

We have consistently held since Sarah Backer, 1 B. T. A. 214, that where a suit is directly connected with or results “ proximately ” from a taxpayer’s trade or business, attorney fees and costs incurred therein are deductible as ordinary and necessary business expenses under the statute. The rule adopted in that case was approved in Kornhauser v. United States, 276 U. S. 145, and has since been followed in innumerable other cases. The Court in that ease, reviewing certain departmental and Board rulings, spoke with approval of the allowance of a deduction of legal fees incurred by a physician in the defense of a suit for malpractice, the deductibility of similar expenses incurred in defending an action for damages by a tenant injured upon the taxpayer’s farm, and fees expended in the defense of a patent infringement suit. Speaking of legal fees being “ ordinary and necessary,” tbe Court said “ it was an ‘ ordinary and necessary’ expense, since a suit ordinarily and, as a general thing at least, necessarily requires tbe employment of counsel and payment of bis charges.”

In Commissioner v. Continental Screen Co., 58 Fed. (2d) 625; affirming 19 B. T. A. 1095, the question before the court was whether attorney fees paid by a corporation for services in representing the corporation before the Federal Trade Commission were legally deductible from gross income as ordinary and necessary expenses. The court held that they were. It stated:

* * * we have no doubt as to the correctness of the board’s decision. The proceeding before the Trade Commission was undoubtedly an “ action ” against respondent which was “ directly connected with ” or which “ proximately resulted ” from its business. To respondent’s board of directors the situation was ominous. The life of the business was endangered. Under such circumstances respondent followed the very natural and ordinary procedure suggested by the vital necessity of the situation. It employed counsel to protect its interest and agreed to pay for their services. Any other course upon the part of itsi board of directors would have been unusual and would, no doubt, have subjected them to well founded criticism by its stockholders.

In Foss v. Commissioner, 75 Fed. (2d) 326, the question was as to whether Foss, a stockholder in two corporations, was entitled to deduct from gross income certain counsel fees. Minority stockholders in one of the companies filed a bill in equity against Foss in the Federal Court in New Jersey alleging that he and certain others were in combination to waste the assets of the company and divert its business to another company and to violate the Sherman AntiTrust Act. The District Court found in favor of the plaintiffs; it enjoined Foss and his associates from doing the illegal acts specified and also in voting their stock in the Blower Co. On appeal the Circuit Court of Appeals for the Second Circuit vacated the last part of the order and allowed Foss and his associates to vote their stock. Foss paid his personal counsel for services in this litigation $5,000 in 1920, and $32,479 in 1921. He contended that these payments were proper deductions from his gross income in those years. The Commissioner refused to allow them. In the course of its opinion the Circuit Court of Appeals for the First Circuit stated:

We entertain no doubt that the counsel fees in question were an ordinary and necessary expense of that business. The test is stated in Kornhauser v. United States, 276 U. S. 145, in which it was said, “Where a' suit or action against a taxpayer is directly connected with or, as otherwise stated, proximately resulted from his business, the expense incurred is a business expense,” ete. Sutherland, J., at page 153. The litigation was plainly an outgrowth of the business activities in which Foss was engaged. He was brought into the suit, not as the government contends, simply because of his stock ownership in the Blower Co., but because of his stock ownership and business activity in the Sturtevant Co. and the Blower Co. It was his business activities in those connections which exposed him to the suit. Under such circumstances counsel fees are a deductible expense as was expressly held in the Konihauser case. See, too, Commissioner v. Continental Screen Co., 58 Fed. (2d) 625 (C. C. A. 6); Commissioner v. Peoples Pittsburgh Trust Co., 60 Fed. (2d) 187.

In support of Ms disallowance of the expenses here in question the respondent relies upon Burroughs Building Material Co., 18 B. T. A. 101; affd., 41 Fed. (2d) 178; Gould Paper Co., 26 B. T. A. 560; affd., 72 Fed. (2d) 698. In the first mentioned case the court held that the counsel fees paid by a taxpayer in defense of prosecution for violation of a price-fixing statute were not deductible as ordinary and necessary expenses. In Gould Paper Co. v. Commissioner, supra, the court said:

The cost of defending the proceedings against the petitioner and its president in 1917 are deductible, if at all, because they were ordinary and necessary expenses of the petitioner’s business. Part of these expenses were incurred in defending a criminal action against the president and part in defending both the petitioner and its president in an action in equity. The effect of membership in an organization known as the News Print Manufacturers Association was a part of the issue. We considered at some length the question here presented in Burroughs Bldg. Material Co. v. Commissioner, 47 Fed. (2) 178, and reached the conclusion that a taxpayer could not deduct such expenses as these when incurred in its own, behalf. As to the part expended in behalf of its president the petitioner has even less reason to claim a deduction.

The petitioner seeks to distinguish the present proceeding from the above mentioned cases upon the ground that in Burroughs Building Material Co. v. Commissioner, supra, the question was as to whether fines, court costs, and attorney fees in connection with an indictment under a state statute prohibiting price-fixing agreements where the taxpayer pleaded guilty were deductible from gross income. The petitioner submits that there is no such issue in this case. Petitioner further submits that in the Gould Paper Co. case there was, first of all, a criminal proceeding, and, second, that the taxpayer was adjudged as having participated in an unlawful combination in restraint of trade, whereas there are no such facts which obtain in this case.

We are of opinion that the distinction sought to be made is a valid one. The suit brought against this petitioner by the Department of Justice quite clearly had as its objective the development of a series of rules for the government of the industry. The petitioner was of the opinion that it was not violating the Sherman Anti-Trust andl Clayton Acts by anything it did. In fact it claimed that those acts did not apply to it. The court did not find that the petitioner had participated in an unlawful combination in restraint of trade in violation of the Sherman Anti-Trust Act. The consent decree stated that a certain agreement which the petitioner had entered into with another corporation was illegal and the petitioner was enjoined from further operating under the agreement, except for a season. The decree also set forth that certain acts would, if performed, violate the law and such acts were enjoined, but there is no finding that the acts were committed.

It is not lightly to be assumed that Congress intended to exclude from ordinary and- necessary expenses of operation attorney fees paid in the regular course of business. The Board and the courts have held, in many instances, that taxpayers may not deduct, as ordinary and necessary expenses, fines and the costs of litigation where the taxpayer has been found guilty of violating laws. But the reason for the disallowance of such deductions has generally rested upon the ground that they were not proximately connected with the taxpayer’s business, or that to allow the deductions would be against public policy. Neither of such reasons obtains in this case.

In our judgment the $199,222.34 paid or accrued by the petitioner upon its books of account in 1929 is a legal deduction from gross income as an ordinary and necessary expense. ;

2. and 3. The respondent in his deficiency notice held that the General Outdoor Managers Securities Corporation was affiliated with the petitioner during the year 1929 within the purview of section 141 of the Revenue Act of 1928, and that its net loss of $197.85 for 1929 should have been included in the consolidated return filed by the petitioner. He disallowed a deduction in the sum of $68,100 actually paid by the petitioner and claimed to have been incurred by it as additional compensation for its managers and executives. The petitioner contends that the amount which should have been deducted is $70,200, since that was the amount which it had obligated itself to pay to the General Outdoor Managers Securities Corporation for 4,680 shares of that corporation’s capital stock. The two questions, first, as to affiliation status, and, second, as to the deductibility of the $70,200, will be considered together.

Section 141 (d) of the Revenue Act of 1928 defines an “ affiliated group ” to be:

* * * one or more chains of corporations connected through stock ownership with a common parent corporation if—
(1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and
(2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations. * * *

Article 713 of Regulations 74 requires that “A consolidated return must include every domestic corporation which is a member of the affiliated group.”

The respondent argues that since under the plan for the organization of the General Outdoor Managers Securities Corporation the petitioner was to subscribe and pay for 5,000 shares of stock of that company at $40 per share, which shares were to remain the sole property of the petitioner, and since from the date of organization of the corporation in April 1929 to December 31, 1929, the petitioner was the legal owner of all of the outstanding shares of the General Outdoor Managers Securities Corporation, the two corporations were affiliated during the period in question.

The petitioner contends that there was no affiliation between General Outdoor Advertising Co. and General Outdoor Managers Securities Corporation, upon the ground that the shares of stock of the latter corporation were not beneficially owned by the petitioner, but by the participants in the plan, citing Handy & Harmon v. Burnet, 284 U. S. 136. We are of the opinion, however, that the principle invoked by the Supreme Court in Handy & Harmon v. Burnet is not applicable here. Under the agreement between the petitioner and the General Outdoor Managers Securities Corporation the shares of the latter company subscribed for and paid by the petitioner were to “ remain its sole property.” Also, under the plan, if the employment of the participant was terminated for cause resulting in loss to the petitioner, the participant was to receive such sum as might be fixed by petitioner’s board of directors at not less than $25 per share.

We are furthermore of the opinion that the payment of the $70,200 in question by the petitioner in 1929 was not intended as additional compensation paid for the services of its managers and executives. The corporation was organized with other objects in view. We sustain the respondent’s disallowance of the claimed deduction. Cf. S. Naitove & Co., 8 B. T. A. 589, 596; affd., 32 Fed. (2d) 948; Horn & Hardart Baking Co., 19 B. T. A. 704.

4. The last question in issue is whether the respondent erred in determining and computing a taxable gain of $532,140.60 on the transfer by the petitioner in 1929 of certain of its assets to the Central Outdoor Advertising Co. for stock in that company.

Section 112 of the Revenue Act of 1928 provides, so far as material, as follows:

(b) Exchanges solely in Ickid.—
***** * *
(5) Transfer to corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to Ms interest in the property prior to the exchange.
* * * * * ♦ #
(j) Definition of control. — As used in this section the term “control” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

The evidence shows that the four transferor corporations were “ in control ” of the Central Outdoor Advertising Co. immediately after the exchange because they owned 80 percent of all the stock issued by the Central Outdoor Advertising Co. The question raised by the respondent is whether the stock of the new company was issued substantially in proportion to the interest of each corporation in the property prior to the exchange. He submits that the figures set up on the books of the new corporation show the net value of the assets (assets less liabilities) transferred to the Central Outdoor Advertising Co. by the respective companies, and that based upon these book values the percentages of the interest of each company in the property transferred, prior to the exchange, and the percentages of the stock received by each of the companies are as follows:

The respondent submits that from the foregoing table it can readily be seen that there were considerable discrepancies in the ratio of stock issued to the interest of each recipient in the property exchanged ; that the petitioner received 9 percent less stock of the total issued than its interest in the property transferred; that the Packer Co. received 7 percent more stock than the value of its assets entitled it to; and that the Bond Co. and Toledo Co. together received 2 percent of the stock in excess of their contribution of assets. The respondent further submits that the fair market value of the shares of Central Outdoor Advertising Co. at the date of receipt by the transferors was $30 per share, instead of $16.30 per share as claimed by the petitioner.

The evidence shows that the allocation of the stock was made to the transferor corporations in exact proportion to the values placed upon the assets conveyed by the several transferor corporations; that the persons who were responsible for the determination of the amounts of the stock to be issued were thoroughly conversant with the properties to be conveyed to the new corporation; that they took all of these factors into account in making the allocation; and that the allocation of the shares of stock to them was mutually satisfactory. The evidence further shows that thereafter accountants were employed to determine the values of the assets received from the several corporations for the purpose of making entries upon the books of. account of the new corporation. We have set forth in our findings the basis which the accountants used. That basis was in no wise related to the basis used by the several transferor corporations in their negotiations for the determination of the amount of stock to be issued to each by the Central Outdoor Advertising Co.

From a consideration of the entire evidence we are of opinion that the respondent’s contention upon this point is without merit. Cf. Ared Corporation, 30 B. T. A. 1080. The amount of the stock and securities received by each of the transferor corporations was substantially in proportion to its interest in the property prior to the exchange. The petitioner realized no taxable gain from the exchange. The contention of the petitioner upon this point is sustained.

In view of the conclusion which we have reached upon this point, it is not necessary to determine the fair market value of the shares of Central Outdoor Advertising Co. at the date of receipt by the petitioner.

Reviewed by the Board.

Judgment will be entered under Rule 50.

McMahon,

concurring: The cases cited by the Board (and Citron-Byer Co., 21 B. T. A. 308; Peoples-Pittsburgh Trust Co., et al., Executors, 21 B. T. A. 588; affirmed in Commissioner v. Peoples-Pittsburgh Trust Co., 60 Fed. (2d) 187; and Lawrence A. Wagner, 30 B. T. A. 1099, and cases therein cited) disclose that in a proceeding before the Board, where it appears from a conviction in a criminal court or from an adjudication with a finding in a civil court, or from undisputed proof which would justify such a conviction or finding, that acts in contravention of laws subjecting offenders thereunder to fine, imprisonment, or both, or to restraining orders of a tribunal of competent jurisdiction, have been committed in the operation of a business, expenses incurred or paid in a defense against formal complaints or charges before or by a court or governmental agency of competent jurisdiction based on such acts are not allowable as deductions because such allowance would be contrary to sound public policy; and, on the other hand, where such conviction, finding or undisputed proof is not established, deductions of this character are allowable. No such conviction, finding or undisputed proof has been established in this proceeding.

TukneR,

dissenting: I am unable to agree with the conclusion reached in the majority opinion in respect of the deduction claimed for attorney fees. The facts show that they were paid for legal services rendered in the defense of certain acts of the petitioner which were admitted in a consent decree to have been illegal, and, in my opinion, the rule laid down in Burroughs Building Material Co. v. Commissioner, 47 Fed. (2d) 178, should be applied.

Van Fossan and Seawell agree with this dissent.


source: Caselaw Access Project

author:
McMahon:
      Turnee,

license: Public Domain

text:
    National Outdoor Advertising Bureau, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 65252, 70999.
    Promulgated July 25, 1935.

      Wilton H. Wallace, Esq., and E. F. Golladay, Esq., for the petitioner.

      Nathan Gammon, Esq., and P. A. Sebastian, Esq., for the respondent.
   OPINION.

McMahon:

The first question presented for determination is whether the petitioner is exempt from Federal income tax under section 103 (12) of the Revenue Act of 1928, set forth in the margin.

In Garden Homes Co., 26 B. T. A. 441; affirmed on this point in Garden Homes Co. v. Commissioner, 64 Fed. (2d) 593, in construing a similar section of the 1926 Act, the Board stated:

It seems to us that by the inclusion of the word “ like ” it was intended that such rule of construction should be applied, thus limiting the associations exempt from taxation under such section to farmers’, fruit growers’ and other associations of “ like ” kind, nature or character.

The Circuit Court stated in part:

* * * In construing corresponding sections of the Revenue Acts of 1916 and 1918, the Treasury Department said (I. T. 1312; C. B. 1-1, p. 263) “In framing the Statute, Congress appears to have had in mind, agricultural, fruit growing, and similar occupations. Under the doctrine of ejusdem generis the term ‘ like associations ’ should be confined to pursuits similar to farming and fruit growing.” The subsequent re-enactment of that statutory provision requires that the administrative construction be considered as having been adopted by Congress. * * * ■ *

In our opinion this proceeding is governed in principle by Garden Homes Co., supra. To the same effect are Stanford University Bookstore, 29 B. T. A. 1280, 1283; Hills Mercantile Co., 22 B. T. A. 114, 118, South Carolina Produce Association v. Commissioner, 50 Fed. (2d) 742, affirming 19 B. T. A. 1028; Riverdale Co-operative Creamery Association v. Commissioner, 48 Fed. (2d) 711. Anything to the contrary in Northwestern Drug Co., 14 B. T. A. 222, cited by petitioner, was not necessary to the Board’s decision therein that petitioner was not exempt, and is not in accord with the rule of statutory construction also stated therein that a taxing statute granting an exemption from taxation must be strictly construed and all doubts resolved in favor of the Government.

In our opinion the petitioner is not an association exempt from taxation under section 103 (12) of the Revenue Act of 1928.

Furthermore, the surplus accumulated by the petitioner can not be considered “ a reasonable reserve for any necessary purpose ” which is authorized under section 103 (12). The auditor of petitioner testified that in his opinion the surplus of $156,295.98 at the end of 1928, $142,783.36 at the end of 1929, and $221,484.32 at the end of 1930, were reasonable reserves; that no special reserve had been set up on petitioner’s books as a reserve for bad debts; and that petitioner regarded the “ surplus as a reserve against the bad debt account.” The present president of petitioner, who was vice president and general manager in 1928,1929, and 1930, testified that in his opinion the surplus built up by petitioner in 1929 and 1930 was too low, that the surplus was created as a reserve for the purpose of paying bills promptly in case the collections were not made promptly and to meet unusual or unexpected losses which might arise from failure of its members to pay their accounts, which petitioner felt called upon to pay to plant owners to maintain its credit. He testified that the petitioner had had losses but “Fortunately they have been very small.” He further testified that ■ ordinarily collections from its members were made prior to payment to plant owners and that the petitioner usually received money before it was paid out. There is no testimony as to what portion or percentage of the annual billings to members was uncollectible or what portion or percentage of the annual billings of plant owners to petitioner for advertising of its members petitioner was required to pay without reimbursement therefor. The surplus at the end of 1929 was approximately 24 percent of the accounts receivable and at the end" of 1930 it was approximately 70 percent of the accounts receivable. There is no testimony which would reasonably justify the setting up by petitioner of a reserve for bad debts upon such basis. The president also testified that the commissions earned by the petitioner currently had been sufficient to take care of emergencies “because we have been able to acquire the surplus which we have enjoyed without retaining more than 6%%”

In any event, the petitioner has failed to show that the surplus constituted a reasonable reserve for any necessary purpose.

The petitioner claims that in 1928 and 1929 it sustained statutory net losses deductible in part in 1929 and 1930. Whether petitioner sustained statutory net losses in 1928 and 1929 is dependent upon the determination of whether the sums of $23,564.03 and $43,787.36 claimed as legal expense deductions in 1928 and 1929, respectively, are “ ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Sec. 23, Revenue Act of 1928.

It is contended by the petitioner that the suit brought against it and others was not a criminal suit and did not involve the indictment of anyone, that no proposal was made that penalties be asserted against it or anyone else, that petitioner voluntarily offered to abandon and cancel the contract between it and the General Co. and to eliminate the exclusive agency feature from its stock option agreements before suit was brought, and that the expenses involved were ordinary and necessary expenses incurred in carrying on its business.

A similar issue was presented in General Outdoor Advertising Co., Inc., 32 B. T. A. 1011. That company incurred or paid attorney fees and other expenses as. a codefendant with the petitioner herein in the same suit involved here. We are here concerned with the same court decree. Upon similar determinative facts, we held that such attorney fees and other expenses paid or incurred by that company in defending itself in such suit were deductible from its gross income. Upon the whole record and the authority of our holding in that case, we hold that the amount of $23,564.03 incurred in 1928 and the amount of $43,787.36 incurred in 1929 by the petitioner, as heretofore set forth, constitute ordinary and necessary expenses incurred in carrying on a trade or business within the purview of section 23 of the Revenue Act of 1928.

In view of our holding in this respect, the petitioner sustained a statutory loss of $13,848.75 in 1928 which is allowable as a deduction in computing the net income of petitioner for 1929. The net income for 1929 as adjusted by respondent is $25,399.46. In view of our holding, a net loss will result for 1929, the amount of which is allowable as a deduction in 1930.

The remaining question to be determined is whether the difference between the book value of automobiles used in petitioner’s business and the amount allowed therefor in an exchange for new automobiles is allowable as a loss deduction.

The petitioner contends that section 112 (b) (1) of the Revenue Act of 1928 is not applicable, as the automobiles while used in the business were not in any sense held “ for productive use ” and that the transaction was a simple purchase and sale.

It is apparent from the record that the transaction constituted an exchange and not a separate sale of the old automobiles and a separate purchase of the new automobiles. Hew automobiles were purchased and the old automobiles were turned in as a part of purchase price of the new automobiles. The automobiles were used by petitioner’s inspection service department, which department was essential to the most important activity of petitioner, in fact the activity upon which its entire, business rested. This was the gathering of information relative to space suitable for outdoor advertising and the personal inspection of all available advertising space throughout the United States so as to be able to perform and render the service for which it was paid. The automobiles were the means employed by petitioner for such purpose and if not directly, at least indirectly, were instrumental in the production of petitioner’s income. The transaction is therefore within section 112 (b) (1) of the 1928 Act and the action of the respondent in disallowing the loss of $1,202.02 claimed by the petitioner is approved. See W. H. Hartman Co., 20 B. T. A. 302; Graves, Cox & Co., 27 B. T. A. 546; and George E. Hamilton, 30 B. T. A. 160; I. T. 2356, C. B. VI-1, p. 168; I. T. 2419, C. B. VII-1, p. 231; and I. T. 2573, C. B. X-1, p. 215.

Reviewed by the Board.

Decision will be entered wader Rule 50.

Turnee,

dissenting: I am unable to agree with the conclusion reached in the majority opinion in respect of the deduction claimed for attorney fees. The facts show that they were paid for legal services rendered in the defense of certain acts of the petitioner which were admitted in a consent decree to have been illegal, and, in my opinion, the rule laid down in Burroughs Building Material Co., v. Commissioner, 47 Fed. (2d) 178, should be applied.

Van Fossan and Sea well agree with this dissent.

       SEC.. 103. EXEMPTIONS FROM TAX ON CORPORATIONS.
      The following organizations shall be exempt from taxation under this title—
      * * * * * >K *
      (12) Farmers’, fruit growers’, dr like associations organized and operated on a cooperative basis (a) for the purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the Quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, If the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers uho market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonble reserve for any necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, and may purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor' producers does not exceed 15 per centum of the value of all its purchases.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      (b) Exchanges solely in Mni.—
      (1) Pbopbkty held poe PHODDCTiyE dsb oe ihvbstment. — No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other praperty-held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.


author: Trammell:

text:
    Millar Brainard, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56985.
    Promulgated July 25, 1935.

      John E. Hughes, Esg., for the petitioner.

      Hartford Allen, Esg., for the respondent.
   opinion.

Trammell:

This proceeding is for the redetermination of a deficiency in income tax for the year 1928 in the amount of $34,121.64. The issue is whether “ respondent erred, by adding to petitioner’s income the sum of $147,620.18 for alleged profit on stock trading.” In the deficiency letter respondent made the following explanation of his action:

The increase in income is due to transferring profits reported by your wife, mother and children, which you assigned to them upon the sale of the securities. You are advised that in as much as the assignment of these gifts took effect after the sale, the profit realized thereon is taxable to you.

In December 1927 the petitioner, having decided that conditions were favorable, contemplated trading in the stock market during 1928. He consulted a lawyer and was advised that it was possible for him to trade in trust for his children and other members of his family. Petitioner thereupon discussed the matter with his wife and mother, and stated to them that he declared a trust of his stock trading during 1928 for the benefit of his family upon certain terms and conditions. Petitioner agreed to assume personally any losses resulting from the venture, and to distribute the profits, if any, in equal shares to his wife, mother, and two minor children, after deducting a reasonable compensation for his services. During 1928 petitioner carried on the trading operations contemplated and at the end of the year determined his compensation at slightly less than $10,000, which he reported in his income tax return for that year. The profits remaining were then divided in approximately equal shares among the members of his family, and the amounts were reported in their respective tax returns for 1928. The amounts allocated to the beneficiaries were credited to them on petitioner’s books, but they never got the cash, except petitioner’s mother, to a small extent.

It is a well established general rule that' a valid and enforceable trust in personal property may be created by parol, James H. Torrens, 31 B. T. A. 787, 796, and this is the law in Illinois, John H. Stevens, 24 B. T. A. 52, and cases therein cited. But it is unnecessary, we think, to attempt to determine here whether an enforce' able parol trust may be established in personal property not owned by the trustor at the time" of the declaration of the trust but which is to be acquired in the future, for the reason that if a valid1 trust was not created by this petitioner until after he had earned the profits in question, clearly he is taxable thereon, and if a valid trust was created prior thereto we reach the same conclusion under the facts of this case.

If the petitioner made a gift in trust of the res which thereafter produced income, the income is not taxable to him, but if the subject matter of the trust consisted merely of an assignment of future profits, the amount is properly taxable to petitioner, and the incidence of the tax fell before the trust was created1. Lucas v. Earl, 281 U. S. 111. The question presented, then, is purely one of fact, which we must determine from the evidence in the record before us.

Petitioner testified that he told his wife the trust “ would be in the securities, the stocks or bonds”, which would be purchased; and again on cross-examination he testified that the transactions themselves constituted a trust for the benefit of his family; that he declared “ an interest in the stock, the securities purchased and sold ”; and still again that his “ securities trading ” was a trust for the members of his family. However, in a sworn statement dated February 4, 1931, addressed to the Commissioner, protesting the proposed assessment" of additional tax, the petitioner stated:

In December 1927, taxpayer anticipated considerable profits during the coming year from dealing in stocks and decided tlien and there that said profits should constitute a trust for his mother, his wife and his two children. * * *
Accordingly, in December 1927, taxpayer declared that all profits made by him from defiling in stocks for the taxable year 1928, less a reasonable amount to be determined by him as compensation for managing the trust, should constitute a trust for the benefit of his mother, his wife and his two minor children and should be credited and eventually paid to them; the respective shares of each of them to be determined after the close of the year 1928.

From the whole record we think that petitioner intended to give in trust to the members of his family only the profits that might be derived from his stock market operations during 1928, It seems obvious that he never intended to give, and certainly he did not in fact give, the securities purchased and sold nor the capital employed in his market trading. The securities were purchased solely for the purpose of reselling at .a profit, and it was only in the profits that the members of petitioner’s family received any benefit or distributive share. All losses were to be borne by the petitioner, and if there had been no profit, his family would have had no interest of any kind whatever in the account.

After the close of the year, petitioner determined an amount which he considered reasonable compensation for his services, and the remaining profits, computed without reference to losses on certain specific transactions, were credited on his books to the respective members of his family, in approximately equal amounts. Thus, whatever may have been petitioner’s intention, it was only the profits which were in fact given by him in the way of credits, but even those credits, for reasons not disclosed by the record, were never paid to his family in cash, except in the case of petitioner’s mother, who received to a limited extent the amount credited to her. The corpus representing securities or the proceeds from the sale thereof were not distributed to the members of petitioner’s family.

In the circumstances disclosed, we are of the opinion that petitioner’s declaration of trust in December 1927 amounted to no more than an assignment of profits or income to be earned in the future. The fact that petitioner declared in 1927 that whatever profits he might derive from trading on the market in 1928 he would hold in trust for the benefit of. the members of his family is immaterial and can not affect or lessen his liability for tax thereon. T. J. Rogers, 15 B. T. A. 638. The assignment of a bare right to income does not relieve the assignor of tax liability thereon. Rose v. Commissioner, 65 Fed. (2d) 616.

In Milton A. Holmes, 21 B. T. A. 584, we held that a certain trading account carried with a brokerage firm in 1924 under the designation “ Milton A. Holmes No. 3 ” was the separate property of the petitioner’s wife, and that the income therefrom was therefore not taxable to the petitioner. The facts of that case, however, clearly distinguish it from the present proceeding. No gift was involved. The evidence established that the brokerage account was opened and operated by petitioner for and at the request of his wife, and the brokerage firm was so informed. Prior to opening the account it was agreed and understood that any losses sustained should be borne solely by the wife, and that any profits derived should be her property. It further appeared that the petitioner’s wife owned securities and cash in excess of $19,000 which she authorized her husband to use to protect the trading account against possible losses. The account was at all times treated as the separate property of the wife, and the income was in fact paid over to her in subsequent years.

In the case at bar, all losses were to be borne by the petitioner; under the declaration of trust the members of his family had an interest only in such profits, if any, as might be derived, and hence their interest did not attach until and after the profits were derived. On the facts presented, and for the reasons indicated, we hold that the income in controversy is taxable to the petitioner as a part of his gross income for 1928.- Respondent’s action is approved.

Judgment will be entered for the respondent.


author: McMahon :

text:
    Herman J. Sternberg, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 55758.
    Promulgated July 26, 1935.

      David Baron, Esq., for the petitioner.

      Bernard D. Daniels, Esq., O. A. Ray, Esq., and T. M. Mather, Esq., for the respondent.
   OPINION.

McMahon :

The first question presented is whether the petitioner is entitled to deduct, in the calendar year 1928, an amount of $19,-170.73 as a debt ascertained to be worthless and charged off. Leó M. Geissal, who was office manager of the petitioner and had charge of petitioner’s books and records, and the petitioner himself, each testified that this amount represented “ advances ” made to the Cache River Dredge Co., which was a joint venture composed of the petitioner as an individual and A. Y. Wills & Sons, a corporation. It is not clear just what these witnesses meant by the word “ advances.” However, considering the evidence as a whole, we can not conclude that the amount constituted loans which would give rise to an indebtedness. The records of the petitioner show that this amount was the excess of the amounts paid by petitioner from September 4, 1919, to March 3, 1924, to or for the Cache River Dredge Co. over the amounts received by him from such company during the period from December 23, 1919, to January 25, 1924. The account in the records of the petitioner in which this item appears is headed “ Cache River Dredge Company, Investment Account,” and the evidence shows that the payments were made to the company for the purpose of financing the purchase of equipment needed on the job. The evidence further shows that the agreement between the petitioner and the Cache River Dredge Co. provided that the moneys paid to that company by the petitioner should be repaid out of the receipts of the joint venture. It is also shown by the evidence that the agreement of joint venture provided that the petitioner and A. V. Wills & Sons should each furnish half the funds and equipment and receive half the profits. There is no evidence as to how much money or equipment was furnished by A. Y. Wills & Sons and there is nothing to show that the amount paid in by the petitioner amounted to more than his share of the amount to be contributed. In short, there is no proof to show that any portion of the amount advanced by petitioner was on behalf of A. Y. Wills & Sons, giving rise to a debt from A. V. Wills & Sons to the petitioner. Nor do we see how it can be reasoned under any circumstances that there was a debt owing from the joint venture to the petitioner. Petitioner himself was one of the two parties to the joint venture upon an equal basis. We can not assume that the amounts paid were not for and on behalf of the petitioner in accordance with the agreement of the joint venture. It should be noted that this was not a partnership. The United States Circuit Court of- Appeals for the Seventh Circuit so held in an action between this petitioner and the trustee in bankruptcy for the estate of A. Y. Wills & Sons (29 Fed. (2d) 235). It is our opinion that the amount of $19,170.73 did not constitute a debt owing to the petitioner but constituted the portion of his investment in the joint , venture which had not been returned to him. It follows that the petitioner is not entitled to take the amount of $19,170.13 as a bad debt reduction in the year 1928.

The petitioner contends in the alternative that of the amount of $19,170.73, the amount of $11,834.23 should be allowed as a loss in the year 1927 and the amount of $7,336.50 should be allowed as a deduction for a bad debt in the year 1928. However, we see no logical reason for splitting up this amount of $19,170.73 in the manner urged. In our opinion, as hereinabove emphasized, the amount of $19,170.73 represented the excess of the amounts invested by petitioner in the joint venture over and above the amounts which he received therefrom. A loss of this type is deductible in the year in which it is sustained. The real question here is as to the amount and year of the loss sustained, if any; and this depends upon the peculiar circumstances involved in this proceeding. John Thatcher & Son, 30 B. T. A. 510, 513.

It was in 1924 that the Cache Biver Drainage District directed the joint venture to cease operations and apparently at that time petitioner was “out of: pocket” $19,170.73. However, it was not in that year that the loss was sustained, because there remained a reasonable possibility that the district would be able to raise funds for the original contract to be performed. The evidence shows that the court did permit the district to issue further bonds and thereby raise money. In other words, until it was definitely determined that there would be no completion of this enterprise by the joint venture it could not be reasonably determined whether petitioner had sustained a loss upon the venture as a whole, which is the test. Nor can it be reasonably said that the fact that A. V. Wills & Sons went into bankruptcy in 1926 gave rise to a loss by the petitioner. In our view there still remained the possibility that the work might be continued. However, when in 1927 the district entered into a new contract, that with the petitioner individually, to construct a complete drainage system, it became a certainty that performance by or in behalf of the joint venture would not be continued and that the petitioner would not receive his half of the unpaid $2,000 representing the percentage retained by the drainage district until the completion of the job. In our opinion it was in 1927 that petitioner sustained his loss. However, we can not find that the full amount of his loss was $19,170.73. Petitioner still had pending in the courts a claim for $7,336.50 against A. Y. Wills & Sons. If this amount were collected it would reduce his loss in the joint venture by that amount. See Birdsboro Steel Foundry & Machine Co. v. United States, 3 Fed. Supp. 640, and cases cited therein. We accordingly bold that in the computation of the petitioner’s net income for the year 1927, or as contended by the petitioner, his net loss for that year, the petitioner is entitled to deduct the amount of $11,834.23 as a loss.

The question next arises as to whether the petitioner is entitled to deduct the amount of $7,336.50 in the year 1928. In our opinion the petitioner, upon whom rests the burden of proof, has failed to adduce sufficient evidence that he sustained a loss in this amount in 1928. There is no proof whatever as to the amount of the assets or liabilities of the bankrupt, A. Y. Wills & Sons. All we know is that the petitioner claimed this amount as a preferred claim before the District Court, the bankruptcy court; that the master in bankruptcy found for the petitioner; that the bankruptcy court approved the allowance of the claim but denied to it any preference; and that thereafter the United States Circuit Court of Appeals for the Seventh Circuit on November 22, 1928, affirmed the decision of the District Court (29 Fed. (2d) 235). The petitioner apparently contends that if this claim had been held to be a preferred claim he would have received -the full amount thereof. However, there is no proof to show how much of the claim could have been or was paid out of the bankrupt’s estate after the decision of the Circuit Court of Appeals holding that it was not a preferred claim. We are not at liberty to assume that the claim was either wholly or partly worthless. We accordingly hold that the amount of $7,336.50 is not deductible as a loss in the year 1928. For the same reasons the petitioner is not entitled to deduct this amount as a bad debt in the year 1928.

The petitioner also contends that- he sustained a statutory net loss for the year 1927 in the amount of $60,316.19, which he is entitled to carry forward to the year 1928. In arriving at this amount of net loss the petitioner treated the amount of $11,834.23 referred to above as deductible in 1927.' This, as pointed out above, was proper, and any net loss resulting from the allowance of this deduction in 1927 may be allowed as a deduction in computing the net income for the year 1928, in accordance with section 117 (e) of the Revenue Act of 1928. In arriving at such amount of net loss the petitioner also eliminated from income an amount of $53,391.84 which had been included by him in his return for the year 1927. This amount represents the final amount paid to' the petitioner as damages for breach of contract by Drainage District No. 7 of Poin-sett County, Arkansas. Payment was effected by paying petitioner $272.96 in cash and $38,000 in certificates of the district, and by crediting the district with an amount which it had advanced to petitioner at a prior time. The certificates were taken by petitioner at par and were fully redeemed. This payment was made to the petitioner in 1927, pursuant to a judgment of the United States Circuit Court of Appeals for the Eighth Circuit rendered in that year (16 Fed. (2d) 598). We see no reason for holding that this whole amount was not income to the petitioner in 1927. Amounts received in settlement of an action for damages are income in the year in which received. Banta Refrigerator Co., 15 B. T. A. 1038; and Armstrong Knitting Mills, 19 B. T. A. 318. We accordingly hold that the amount in question should not be excluded from income of the petitioner for the year 1927.

Each of the parties refers us to section 212 (b) of the Revenue Act of 1926 and article 36 of Regulations 69, promulgated under the Revenue Act of 1926, as to each issue.

In our opinion the provisions of article 36 have no application here. In the case of work done for the Cache River Drainage District the petitioner was not operating under the contract. The long term contract was held by A. V. Wills & Sons. Petitioner was operating under the agreement of joint venture with A. V. Wills & Sons. Furthermore, even if these were long term contracts, in neither case was the contract “ finally completed and accepted ” as required by this provision of the regulations. In the case of the work done for Drainage District No. 7 of Poinsett County, Arkansas, the income received by the petitioner was in reality damages for breach of contract. However, if it were considered income from a long term contract it was not income prior to 1927 for the reason that it was not until 1927 that it was “ determined ” as required by the regulations.

Decision will be entered under Rule 50.

       (e) Net loss for 192G or 1927. — If for the taxable year 1926 or 1927 a taxpayer sustained a net loss within the provisions;of the Revenue Act of 1926, the amount of such net loss shall be allowed as a deduction .in .computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.

      (b) The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *

       Art. 36. Long-term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term “ long-term contracts ” means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following bases:
      *******
      (b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. * * *


author: Sea well:

text:
    R. Lawrence Coughlin and Evelyn W. Coughlin, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76106.
    Promulgated July 30, 1935.

      R. Lawenee Coughlin, Esq., and Joseph Molitoris, Esq., for the petitioners.

      I. Graf, Esq., for the respondent.
   'OPINION.

Sea well:

There is no provision in the Revenue Act of 1928 specifically exempting from income tax the compensation received by the petitioner. To obtain the exemption claimed the petitioner must show that he is an officer or employee of a political subdivision of the Commonwealth of Pennsylvania. Commissioner v. Modjeski, 75 Fed. (2d) 468; Jeremiah Wood, 31 B. T. A. 1141.

The concession of counsel for the respondent that the districts were engaged in the exercise of an essential governmental function makes it unnecessary to discuss their governmental character. See Helvering v. Powers, 293 U. S. 214, in which the Court made the test “usual governmental functions” instead of “essential governmental functions.” The petitioner claims that he was an officer or employee of the respective districts during the taxable years, and not an independent contractor, as contended by the respondent.

There was express statutory authority for the appointments received by the petitioner as attorney for the districts. 62 Purdon’s Pennsylvania Statutes, sec. 211; 24 Purdon’s Pennsylvania Statutes, •sec. 216. In each case the appointment was for a term of one year. The Board of directors of the poor district could have terminated the services of the petitioner at any time, but the right of removal in the school directors was available only upon a showing, after hearing, if demanded, of “ incompetency, intemperance, neglect of duty, violation of any of the school laws of this Commonwealth, or other improper conduct.” 24 Purdon’s Pennsylvania Statutes, sec. 341.

The duties of the petitioner were continuous and embraced all the ordinary legal services required by the districts. The respective boards of directors had the right to demand all of the petitioner’s time for the rendition of services within the scope of his employment. The fact that they did not utilize all of his time and that the petitioner conducted a private law practice during his spare time is not controlling. Neither is it fatal to the petitioner’s claim that he relied on his own ability as a lawyer to carry out duties assigned him. Burnet v. Livezey, 48 Fed. (2d) 159; Robert Carey, 31 B. T. A. 839; Robert P. Bay, 28 B. T. A. 1169. There was present at all times the right to control the petitioner’s activities, which distinguishes an employee from an independent contractor. Metcalf & Eddy v. Mitchell, 269 U. S. 514.

The cases of Burnet v. Livezey, supra, and United States v. Butler, 49 Fed. (2d) 52, involved facts strikingly similar to those here. There the courts concluded that the taxpayers were employees and that the compensation they received for services rendered as attorneys for county commissioners in the case of Butler, and the Public Service Commission of West Virginia in the case of Livezey, was immune from tax. See also Jeremiah Wood, supra, in which a like ruling was made respecting an attorney to the Town Board of Hempstead, New York. We reach the same conclusion here with respect to the compensation the petitioner received each taxable year from the poor district and the school district. The fact that in addition to his salary the petitioner received fees for abnormal work is not material. United States v. Butler, supra; George H. Harlan, 30 B. T. A. 804.

Reviewed by the Board.

Decision will be entered under Rude 60.

SternhageN, Morris, McMahoN, and Matthews dissent.


author: Seawell :

text:
    Grass Creek Oil & Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75928.
    Promulgated July 31, 1935.

      L. A. Parker, for the petitioner.

      Dean P. Kimball, Esq., for tlie respondent.
   OPINION.

Seawell :

This proceeding' was instituted to redetermine a deficiency of $264.76 in income tax for 1931. The sole issue is whether income derived from the sale of oil and gas produced from land of the State of Wyoming is exempt from tax. The facts were stipulated.

In 1908 the State of Wyoming filed with the United States Government, pursuant to a right granted by Federal statutes, its selection of the N. y2 NE. *4 of sec. 19, T. 46 N., R. 98 W. of the sixth principal meridian, hereinafter referred to as the tract, in lieu of a tract of like dimensions located in section 16. The tract thus relinquished was part of the lands granted to the State of Wyoming by the act for the admission of Wyoming, approved July 10, 1890, which granted sections 16 and 36 of every township for the support of the common schools.

In 1913 R. W. Harrison and others made a placer mining location covering the tract. On June 16, 1914, they leased the tract to B. H. Hopkins for a term of at least 25 years for the development of oil, gas, and other minerals from the land, reserving to themselves a one-tenth royalty. Thereafter the lease was assigned by Hopkins to the Greybull Refining Co. On July 24, 1914, Harrison and the others conveyed to the petitioner, a Montana corporation, all of their claims, rights, and interest in the tract, including their rights under the lease to Hopkins. In 1915 the petitioner, as the successor to Harrison and the others, filed an application for a patent to the tract. At the same time the State of Wyoming was claiming title to the tract. The 'United States was also contesting the claim of the State of Wyoming to the lien selection on account of the oil discovery on the tract after the selection was filed.

On May 19, 1916, the petitioner and the Greybull Refining Co. amended the lease of June 16, 1914, to effect a reduction of the royalty on oil, gas, and other minerals produced from the land from 10 percent to 8 percent. The agreement also provided for a reduction of the royalty to 6 percent in the event of a determination that the State of Wyoming or any person or corporation other than the petitioner had title to the tract, and either the petitioner or the Greybull Refining Co., its successors and assigns, maintained leasehold rights from the State of Wyoming or any person or corporation other than the petitioner in or to the tract for the whole or any part of the term of the lease.

On May 24, 1916, the State of Wyoming leased the tract to the Greybull Refining Co. for a term of 5 years, subject to a royalty of 10 percent of all oil and gas produced from the land. At the same time the parties entered into a further agreement providing that:

* * * in the event that the Grass Greek Oil and. Gas Gompany, its successors and assigns, shall be adjudged the owner of said land, then the Greybull Refining Company guarantees for itself and for the Grass Creek Oil and Gas Go. and their successors and assigns, to pay to the State of Wyoming a royalty of ten percent (10%) upon all the crude production of oil and gas produced from the said land during the time the said premises are operated and production therefrom is marketed by said companies, their successors and assigns * * *.

On June 30, 1917, the Greybull Refining Co. assigned to the Midwest Refining Co. all of its interest in the lease of June 16, 1914, from Harrison and the others and the lease of May 24, 1916, from the State of Wyoming, together with the accompanying agreement. Under the assignments the assignee assumed the obligations set forth in the state lease and accompanying agreement and any renewals thereof.

Litigation prosecuted under the claim of the State of Wyoming for an unlimited patent to the tract resulted in a decision on March 28, 1921, in favor of the state. State of Wyoming v. United States, 255 U. S. 489. As a result of the decision the claim made by the petitioner in 1915 for a patent for the tract was rejected.

Thereafter, in 1921, 1923, and 1928, the State of Wyoming gave the Midwest Refining Co. leases for the production of minerals from the tract. The lease executed in 1928 was for a term of five years from March 2, 1928. In each of the leases the lessor reserved a royalty on all oil and gas produced from the tract.

In 1931 the petitioner received from the Midwest Refining Co., pursuant to provisions of the lease dated June 16, 1914, as amended May 19, 1916, the sum of $6,508.20 for oil and gas produced from the tract.

In Fox Film Corporation v. Doyal, 286 U. S. 123, the Court said:

Tlie principle of the immunity from state taxation of instrumentalities of the Federal Government, and of the corresponding- immunity of state instru-mentalities from Federal taxation — essential to the maintenance of our dual system — has its inherent limitations. It is aimed at the protection of the operations of government (McCulloch v. Maryland, 4 Wheat. 316, 436), and the immunity does not extend “ to anything lying outside or beyond governmental functions and (heir exertions.” Indian Motocycle Co. v. United States, 283 U. S. 570, 576, 579. Where the immunity exists, it is absolute, resting upon an “entire absence of power” (Johnson v. Maryland, 254 U. S. 51, 55, 56), hut it does not exist “ where no direct burden is laid upon the governmental instrumentality, and there is only a remote, if any, influence upon the exercise of the functions of government.” Willcuts v. Bunn, 282 U. S. 216, 225.

We fail to find anything in the stipulated facts in this proceeding from which to conclude that the payment of the income in question created a direct burden upon instrumentalities of the State of Wyoming.

At all times after June 30, 1917, including the taxable year, the Midwest Refining Co. was obligated by agreement to pay royalties on minerals produced from the tract to both the petitioner and the State of Wyoming. The obligation was assumed at a time when doubt existed as to the real owner of the tract and was the price the company had to pay to insure continuation of its right to develop the property, irrespective of whether the petitioner or the State of Wyoming was held to be the owner of the tract. None of the agreements between the State of Wyoming and the Midwest Refining Co. entered into after the Supreme Court rendered its decision concerning title to the land contained a provision for the payment of royalty to the state in the event the petitioner or any of its successors and assigns was adjudged the owner of the tract. Equity regarded the state as the owner of the selected tract at all times after the statute as to the lien selection had been complied with. State of Wyoming v. United States, supra.

None of the income in question was derived from a contract to which the State of Wyoming was a party. All of it was received under provisions of the lease of June 16, 1914, the lessor rights of which the petitioner acquired on July 24, 1914, as amended on May 19, 1916, by agreement between the petitioner and the Greybull Refining Co., assignor of the Midwest Refining Co.

The obligation to pay the royalty in controversy was thus one to which the State of Wyoming was not a party, directly or indirectly. The agreement was one which concerned only the petitioner and the Midwest Refining Co. and was not entered into in the exercise of any function of the State of Wyoming. The source of the income claimed to be exempt from tax on account of constitutional restrictions was not from operations under a lease with the state, but between the petitioner and the Midwest Refining Co., private corporations acting in their private capacity.

In Wanless Iron Co., 29 B. T. A. 834; affd., 15 Ted. (2d) 779, Wanless, an individual, acquired a lease from the State of Minnesota, for the production of iron ore from state school land on a royalty basis of 25 cents per ton for all ore removed. The lessee assigned the lease to the Wanless Iron Co. and thereafter it subleased portions of the land to others. Each of the subleases made provision for payment of the royalty of 25 cents per ton directly to the State of Minnesota, as required by the lease issued to Wanless, and in addition thereto, a sum of money per ton to the Wanless Iron Co. The income received from the sublessees was held to be taxable, the court saying:

In the instant case, the source ol the income sought to be taxed was not operations carried on under the state lease, but under a contract or lease between the petitioner, a private corporation, and certain other private individuals. or corporations. These contracts were not assignments of the original lease (Craig v. Summers (Minn.) 49 N. W. 742), but were subleases, and as has been observed, contain terms differing from those of the original lease. They are distinct, separate contracts, to which the State of Minnesota is not a party, and the tax here is measured by the net income of the taxpayer arising from its operations in a private capacity for private gain. The sub-lessees agree to pay the petitioner royalties, and it thus obtained a profit from the sublessees’ operation of the mines.

A like conclusion was reached by us in Hobart Iron Co., 29 B. T. A. 855, based upon similar facts.

In Atlas Life Insurance Co., 29 B. T. A. 750, the petitioner, as-signee of a long-term lease bn a lot of the board of education of Tulsa, Oklahoma, erected a home office building on the lot at its own expense and thereafter derived income from the rental of space in the building. The improvements were to- remain the property of the lessee until the termination of the lease unless covenants of the lease were breached prior thereto. In agreeing with the Board that the rental income was subject to tax, in a decision rendered June 17, 1985 (78 Fed. (2d) 166), the court said:

Here the rental is based upon the appraised value of the land and not upon the improvements; and the income- claimed to be exempt is derived from the building, the property of the Insurance Company, and not from the land, the property of the Board of Education. ' •

Here, as already pointed out, the income claimed to be immune from taxation was derived from property rights in a contract entered into between private corporations, operating in such capacity.

We do not think taxation of the income in controversy would place any direct burden upon the State of Wyoming. Accordingly, we hold that the income of $6,508.20 in question is subject to tax.

Decision will be entered for the respondent.


author: TuRner :

text:
    Olympic Refining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50329.
    Promulgated July 31, 1935.

      Arthur J. Hair, Esq., and George E. Walling, Esq., for the petitioner.

      J. H. Teatman, Esq., for the respondent.
   OPINION.

TuRner :

The first question presented for our determination is whether or not the Barham Well No. 1 was properly classified by the respondent as an association, taxable under the income tax statute as a corporation for the years 1924, 1925, and 1926, and, if so, whether the petitioner herein is transferee of said Barham Well No. 1 within the-meaning of .section 280 of the Revenue Act of 1926. If these issues are determined for the respondent, it will then be necessary to consider the questions raised by the petition to the effect that the statute of limitations had run prior to August 15, 1930, the date on which the notice of deficiency herein was mailed by the respondent.

In Erle Gerard, 28 B. T. A. 236, we considered very carefully the question as to whether or not Barham Well No. 1 was properly classified as an association, taxable as a corporation for the year 1923 under section 2 of the Revenue Act of 1921 and articles 1502 and 1504 of Regulations 62. We concluded that Barham Well No. 1 was an association within the meaning of the statute, and regulations for the year 1923, and our finding on this point has since been affirmed by the United States Circuit Court of Appeals for the Ninth Circuit, 75 Fed. (2d) 542. We have very carefully considered the evidence in the record in this case and are convinced that the same ruling should obtain for the years 1924, 1925, and 1926, and-feel that nothing can be added to the discussion in Erle Gerard, supra, on this point.

In that case we did not have .before us the question as to whether or not the petitioner is a transferee of Barham Well No. 1 within the meaning of section 280 of the Revenue Act-of 1926, but we did decide that the petitioner purchased the shares of the unit holders and not the assets of the association, and we find nothing in the record of this case to cause a change of our views on the nature of the transaction. The facts here show that, upon the acquisition of the various units or shares of Barham Well No. 1 by the petitioner the property of the former was taken over and merged with other property and operations of the petitioner. On, these facts, it is clear that the petitioner became the transferee of Barham Well No. 1 within the meaning of section 280, supra.

Having determined that the petitioner is a transferee of Barham Well No. 1, it becomes necessary to consider and dispose of the contention that the .period within which the deficiencies herein involved could be assessed against and collected from the petitioner had expired prior to August 15, 1930, the date on which the deficiency letter herein was mailed.

Under section 277 (a) of the Revenue Act of 1924 and section 277 (a) (2); of the Revenue Act of .1926, it is provided that income taxes for the calendar year 1924 must be assessed within four years after the return was filed. Under section 277 (b) of the Revenue Acts of 1924 and 1926, however, it' is provided that where a deficiency notice has been mailed under subdivision (a) of section 274 of those acts and a petition has been filed with the Board, the running of the statute of limitations on the making of assessment is suspended until the decision of the Board has become final and for 60 days thereafter. Section 280 (b) ' (1) of the Revenue Act of 1926 provides that assessment of liability of a transferee must'be made within one year, after the expiration of the period of limitation for assessment against the taxpayer. With reference to the years 1925 and 1926, the statutory provisions:.are the same, except that the period within which income taxes must be assessed against the-taxpayer is three years from the date of the filing of the return instead of four years allowed for 1924.

The petitioner takes the position that-neither ’of the petitions filed in respect of the deficiencies determined against Barham Well No. 1 for the years 1924,1925, and 1926 effected--the suspension of the running of the statute of limitations. With reference to 1924, it is claimed that Leeper had previously, on or about March 1, 1927, disposed of all his right, title, and interest in and to the- said Barham Well No. 1, and had no authority whatever to 'file- a petition in its behalf. With reference to 1925,-the petitioner relies on the fact that Walker S. Clute was never at any time a unit holder or trustee of Barham Well No. 1, and that he likewise was without any authority to file a petition. If these petitions did suspend the running of the statute of limitations until their final disposition and for a period of sixty days thereafter, it would not be- necessary to trace in detail the various dates which might otherwise affect or mark the running of the statute of limitations, since we have found- as a fact that the petitions were not finally disposed of until 1932, which -was more than a year after the deficiency notice herein was mailed to the petitioner. In our opinion the filing, of these petitions did suspend, the running of the statute of limitations. American Equitable Assurance Co. of New York v. Helvering, 68 Fed. (2d) 46.

Decision will be entered for the respondent for deficiencies in the amounts .shown by the deficiency letter, plus interest as provided'by law. - -


author: Sternhagen:

text:
    Thomas J. Ingram, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56943.
    Promulgated July 31, 1935.

      FloydI F. Toomey, Esq., and A. G. ~W alter stedt, Esq., for the petitioner.

      James R. Johnston, Esq., for the respondent.
   OPINION.

Sternhagen:

The respondent set aside a closing agreement with the petitioner and determined a deficiency of $11,046.70 for 1927, together with a 5 percent negligence penalty of $552.34. The petitioner relies upon the closing agreement for a decision that there is no deficiency or penalty.

It is not suggested that the closing agreement is on its face lacking in any essential to its validity under section 606(a) or (b), Revenue Act of 1928, but the controversy turns upon the question whether there has been such “ a showing of fraud or malfeasance, or misrepresentation of a material fact” as to support the statutory exception to the rule that the agreement shall be final and conclusive and shall not be set aside or disregarded.

The respondent argues that since, in the deficiency notice, it is said that “ the Secretary of the Treasury has approved the setting aside of the final closing agreement entered into for the year 1927 ”, this must be taken as an ofiicial factual determination of fraud or malfeasance, or misrepresentation of a material fact; and upon this proposition is superimposed the doctrine that since any ofiicial factual determination in respect of the deficiency is presumed to be correct, the burden of proof is thus cast upon the petitioner to prove otherwise. In other words, the respondent, by merely setting aside a closing agreement, would require the petitioner to establish, by a preponderance of evidence, the negatives of fraud, malfeasance, and misrepresentation of a material fact; and this, although in the notice of deficiency the Commissioner omitted any express determination of fraud, malfeasance, or material misrepresentation in' the making of the closing agreement, but expressly stated that “ the understatement of tax for the year 1927 is attributable to negligence ”, and added the 5 percent penalty. In these circumstances, we think that the taxpayer may fairly expect the Government to prove the exceptional fact which will support setting aside the closing agreement. There is no reason to interpret the statute as requiring him in the first instance to negate every possibility of fact or inference which might support the abrogation of the agreement. Clearly, as to fraud, the burden is expressly placed upon the Commissioner. As to malfeasance or misrepresentation, the statute is silent as to the burden. But the only rule consistent with the general statutory purpose of finality in closing agreements is that he who seeks to set one aside under the exception must prove; the fact upon which the exception is conditioned.

But the respondent argues as if an understatement in the return (treated by him in this case as fraudulent) meets the exception. He marshals his evidence not s.o much to prove fraud or misrepresentation in the agreement as to prove culpable understatement in the return. This, we think, is unsound. It is conceivable that a tax liability including penalty for a fraudulent return may be consciously closed by an agreement under section 606. Where, as here, after the recital of a categorical figure of tax liability there is an agreement that such liability shall be final and conclusive, there must be a showing of infirmity in the agreement itself. A faulty return, even though fraudulent, is, while not without significance, not alone determinative. Needless to say, this rule is reciprocally applicable whether the agreement is sought to be abrogated by the taxpayer who has agreed to pay too much or by the Commissioner who has agreed to too little.

The evidence in the present proceeding we think is insufficient to support a finding necessary to set aside the agreement. We can not find fraud, malfeasance, or misrepresentation of a material fact in the making of the agreement. It is true; and admitted by the taxpayer, that upon his return gross income was understated. The petitioner testified that the omission was unintended, and, from the facts and circumstances in evidence showing how the books were kept and. the return made, we find no reason to doubt either the honesty or the credibility of this testimony. Even the revenue agent who finally discovered the error reported to the Commissioner that there was ño evidence of fraud or. malfeasance, that the taxpayer “ is a man of the highest type of business integrity- ”, that all books and records were unhesitatingly produced, and that there was in his opinion no warrant for a fraud investigation. But the respondent argues that this still leaves the omission in the return and the nondisclosure at the time of the closing agreement within the statutory term of “ misrepresentation of a material -fact.” His argument would treat misrepresentation as synonymous with mistake. While there is a subtle question of language in the distinction between a-mistaken or erroneous statement and a misrepresentation, this must be resolved to promote the purpose of the statute.- Obviously the use of the word misrepresentation denotes something mo.re deliberate or more conscious -than mere error or mistake. Otherwise the entire rationale of a closing agreement would be lost. Congress intended that innocent mistakes should be buried in a closing agreement. Bankers’ Reserve Life Co. v. United States, 42 Fed. (2d) 313; Aetna Life Insurance Co. v. Eaton, 43, Fed. (2d) 711; Wolverine Petrolcum Corporation v. Commissioner, 75 Fed. (2d) 593. This still leaves an ample field for protection against an agreement founded in trickery or deception. While we make no attempt to define the boundaries of the “ misrepresentation of a material fact ” prescribed by the statute, we hold that it is at least exclusive of mere incorrect, erroneous, or mistaken statement, Wolverine Petroleum Corporation v. Commissioner, supra. Phoenix Insurance Co., 29 B. T. A. 291. Cf. G. C. M. 7549, IX C. B, 164.

The evidence in the present proceeding, in our opinion, discloses no more than an erroneous omission of certain items of income from the taxpayer’s return, and, as to the agreement, it discloses no more than an innocent willingness to enter into such an agreement. Whether the agreement was sought by the taxpayer or by the Government does not clearly appear, although the indications point more to the Government as the proposer than to him.

In view, therefore, of the, existence of the closing agreement and of, the nonexistence of facts sufficient to support its setting aside, we hold that there is no deficiency and no penalty for 1927, and reverse the respondent’s determination. , .

Judgment will he entered for the petitioner.

       SEO. 606. CLOSING AGREEMENTS.
      (a) Authorization. — The Commissioner (or any officer or employee of tile Bureau of Internal Revenue, including the field service, authorized in writing by the Commissioner) is authorized to enter into an agreement in writing with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal-revenue tax for any taxable period ending prior to the date of the agreement.
      (b) Finality of agreements. — If such agreement is approved by the Secretary, or the undersecretary, within such time as may be stated in such agreement, or later agreed to, such agreement shall be final and .conclusive, and, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact—
      (1) the case shall not be reopened as to the matters agreed upon or the agreement modified, by any officer, employee, or agent of the united States, and
      (2) in any suit, action, or proceeding, such agreement, or any determination, assessment, collection, payment, abatement, refund, or credit made in accordance therewith, shall not be annulled, modified, set aside, or disregarded.

         Sec. 601. [Amending sec. 907 (a) of Revenue Act of 1924.] * :: * In any proceeding involving the issue whether the petitioner has been guilty of fraud with intent to evade tax, where no hearing has been held before the enactment of the Revenue Act of 1928, the burden of proof in respect of such issue shall be upon the Commissioner.


text:
    Nora C. Todd, Conway L. Todd, and A. Richard Todd, as Executors of the Last Will and Testament of Libanus M. Todd, Late of the City of Rochester, Monroe County, New York, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76108.
    Promulgated July 31, 1935.

      Clarence P. Moser, Esq., for the petitioners.

      O. W. Swecker, Esq., for the respondent.
   OPINION.

Sea well:

Under the Revenue Act of 1928, section 161 (b), it is provided in reference to the income of a trust:

(&) Computation and payment. — The. tax shall be computed upon the net income of the estate or trust, and shall be paid by the fiduciary, except as provided in section 166 (relating to revocable trusts) and section 167 (relating to income for benefit of the grantor). * * *

Sections 166 and 167, referred to, are as follows:

SEO. 166. REVOCABLE TRUSTS.
Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.
SEO. 167. INCOME FOR BENEFIT OF GRANTOR.
Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution” deduction), such part of the income of the trust shall be included in computing the net income of the grantor.

These sections of the revenue laws have been so frequently considered by the Board and the courts that there would appear to be few new questions of law for interpretation. In this proceeding only a rather unusual question of fact is presented. When the fact is correctly analyzed and applied to the named statutes, a proper result should be fairly obtained, and the question involved herein correctly answered with small difficulty. The sole question has to do with the place and meaning of the exception found in paragraph eleventh of the trust instrument set out in the findings of fact. The grantor of the trust in the first part of paragraph eleventh made certain reservations of power to himself, which upon analysis may be stated as follows: In a general way, (1) “to change or modify the terms and conditions of the trust instrument in any respect or particular, and in any way he may see fit ”; and, in a special way, (2) “ to change the Beneficiaries, or their shares in the trust fund ”, and (3) “to terminate the trust by (a) directing that the principal thereof be distributed to the Beneficiaries mentioned in the trust, or (b) to others to be designated by the Donor.” After thus stating the powers reserved to himself he added these words: “ Except that the Donor does not reserve the right to revoke the gift made by this Indenture.” An exception is defined to be “ a clause in a deed by which the lessor excepts something out of that which he granted before by the deed.” Bouvier’s Law Dictionary. That which is excepted must be a part only; if everything granted is excepted the exception is void. For example, decedent reserved the power to change the instrument. Suppose he had inserted an exception like this: Except I do not reserve the power to change the instrument. The exception would have been void. But if he, after reserving the power to change the beneficiaries, had inserted an exception like this: Except the change of beneficiaries shall not be made in any way which will permit any part of the corpus or income of the trust to revest to the grantor, it would not have been void. This is the sort of exception which the decedent did not make. “ The gift ” which decedent did not reserve the right to revoke must be understood to mean the corpus of the trust which he had by the “ indenture ” conveyed to the trustees in trust. Express power to change the beneficiaries was reserved, generally and specifically, and without limitation. Under such powers the decedent could at any time within the taxable year have made himself a beneficiary of the income or even of the corpus of the trust upon dissolution.

In Kaplan v. Commissioner, 66 Fed. (2d) 401, the court said:

* * * We see no occasion for refinement of construction against the government. We think the statute [section 219 (g), Revenue Act of 1924, same as section 167, Revenue Act of 1928] means that if under any circumstances or contingencies any part of the accumulated income might inure to the benefit of the grantor such portion of the income is taxable to him.

Moreover, under the reserved powers, even if the exception is given the meaning insisted upon by petitioners’ counsel, the decedent could have directed the trustees to apply the income of the trust to the payment of premiums upon policies of insurance on the life of the grantor without revoking the gift to the trustees.

It seems evident from any view of the matter that the trust was revocable during the taxable year and the income could have been used for the grantor’s benefit. See Edward E. Bradley, 27 B. T. A. 280; Malcolm W. Greenough, 29 B. T. A. 315; affd., 74 Fed. (2d) 25.

Reviewed by the Board.

Judgment will be entered for the respondent.

Black and Trammell dissent.


author: Smith :

text:
    Samuel Insull, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret A., Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent. Samuel Insull, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 68001-68003, 68503-68505.
    Promulgated August 1, 1935.

      Lawrence Graves, Esq., for the petitioners.

      Alim H. Pierce, Esq., and Irving M. Tullar, Esq., for the respondent.
   SUPPLEMENTAL OPINION.

Smith :

In our opinion promulgated in the above entitled proceedings on February 14, 1935, 32 B. T. A. 47, we held that the proceeds received by the petitioners from the sale of rights received by the petitioners in August 1930 to subscribe for additional shares of the common capital stock of Insull Utility Investments, Inc., constituted ordinary gains and not capital net gains.

The facts bearing upon this point are fully covered in the written stipulation of facts filed by the parties. Prior to December 27, 1928, the date upon which a charter for Insull Utility Investments, Inc., was obtained under the laws of the State of Illinois, the petitioners were the owners of large blocks of stock utility companies operating in the city of Chicago and its immediate vicinity. Most of such shares had been held by the petitioners for a period of more than two years prior to December 27, 1928. Upon the organization of Insull Utility Investments, Inc., the petitioners turned in their shares of stock to Insull Utility Investments, Inc., for shares of preferred stock, first series, and common stock .of that company. Such exchange constituted a nontaxable exchange under the provisions of the Revenue Act of 1928.

Subsequent to the organization of Insull Utility Investments, Inc., the petitioners received, small stock dividends upon their shares of stock in that company. On August 30, 1930, Insull Utility Investments, Inc., issued rights to the holders of its common and preferred stock of record on November 30, 1930, to subscribe for additional shares of its common stock at $50 per share'on or prior to September 15, 1930. The petitioners did not exercise those subscription rights, but on September 13, 1930, exchanged them for common stock of the Corporation Securities Co., which at that date had a stipulated value of $23 per share. The petitioners and the respondent have treated this exchange as the equivalent of a sale. The question for decision by the Board is whether the proceeds from the exchange or sale of the rights constituted capital gain or ordinary income.

In our opinion (32 B. T. A. 47) we sustained the contention of the respondent that the gains were ordinary income and not capital net gains.

In Bradley W. Palmer, 32 B. T. A. 550, we held that where a person received subscription rights on shares of stock which he had held for more than two years and did not exercise such rights but sold them, the proceeds of the sale constituted capital net gain and not ordinary income. The question is raised whether a like conclusion should be reached here, where the facts are that the stockholder had not held the shares of stock of Insull Utility Investments, Inc., for a period of two full years, but the period of such holding added to the period of holding the shares of public utility companies exchanged for shares of stock of Insull Utility Investments, Inc., in a nontaxable transaction amounted to more than two full years.

If the subscription rights sold on September 13,1930, were received on capital assets of the petitioners, the net proceeds frGm the sale constitute capital net gain within the meaning of section 101 of the Revenue Act of 1928. Bradley W. Palmer, supra.

“ Capital assets ” are defined in section 101 (c) (8) of the Revenue Act of 1928 as meaning:

* * * property held by tbe taxpayer for more than two years * * *
(A) In determining the period for which the taxpayer has held property received on an exchange there shall be included the period for which he held the property exchanged, if under the provisions of section 113, the property received has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in the hands as the property exchanged.

We have held in our opinion (82 B. T. A. 47) that the shares of stock of Insull Utility Investments, Inc., were received by the petitioners in January 1929, in a nontaxable exchange. See section 118 (a) (8) of the Revenue Act of 1928. It therefore follows that, where the period of holding by the petitioners of the shares of stock of Insull Utility Investments, Inc., added to the period for which shares of stock of other companies exchanged for those shares amounted to more than two years, the holdings of the petitioners of shares of stock of Insull Utility Investments, Inc., constituted capital assets. This is the situation except as to a very small number of the shares of Insull Utility Investments, Inc., stock held by the petitioners. As to the proceeds from the sale of rights identifiable with shares purchased upon the exercise of rights within two years from September 13, 1930, such proceeds are taxable as ordinary income.

This supplemental opinion is substituted for our supplemental opinion promulgated April 30,1935, 32 B. T. A. 567, and modifies our opinion promulgated February 14, 1935, 32 B. T. A. 47.

Reviewed by the Board.

Judgment will be entered under Rule 60.