author: Smith: Tbammell,

text:
    Acacia Park Cemetery Association, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 30210.
    Promulgated December 7, 1932.

      Leonard L. Cowan, Esq., for the petitioner.

      Arthur Camdujf, Esq., for the respondent.
   OPINION.

Smith:

In this proceeding the petitioner contends that the cost of the lots in each of the two sections to its cemetery was $100,000 greater than the amount allowed by the respondent in the determination of profits upon the sales. If this contention be denied, the petitioner contends that 10 per cent of the amount received from sales was received by it in trust and hence was no part of petitioner’s net income.

We are of the opinion that there is no merit in the petitioner’s contention that the cost of the lots sold was inclusive of an amount to be paid in by lot purchasers to provide for perpetual care. The cost of the land and improvements was not enhanced by the fact that the petitioner was to provide perpetual care. While we have held, under certain conditions, that the cost of improvements and additions legally bound to be made by contract when lots in a real estate development are sold may be added to the cost of the lots (Milton A. Mackay, 11 B. T. A. 569; Birdneck Realty Corp., 25 B. T. A. 1084), it does not follow that future ordinary expenses and upkeep may be so treated. Expenses are deductible when paid or incurred. Even when it is known that expenses will be incurred in a subsequent year, it is not a ground for allowing a deduction in a previous year. The petitioner’s contention upon this point is not sustained.

It is necessary to consider the petitioner’s alternative contention that a portion of the sale price was received by the petitioner in trust and accordingly that a portion of it did not represent taxable income.

The Board has held in a number of cases that, where lots in a cemetery are sold with the provision that a portion of the sale price is to be set aside in a separate fund and the income used for perpetual care, the amount thus set aside is not taxable income. Los Angeles Cemetery Assn., 2 B. T. A. 495; Greenwood Cemetery Assn., 2 B. T. A. 910; Metairie Cemetery Assn., 4 B. T. A. 903; Inglewood Panic Cemetery Assn., 6 B. T. A. 886. A court has held to the same effect in Portland Cremation Assn. v. Commissioner, 31 Fed. (2d) 843. In the last named case the court stated:

It is true that a mere honorary obligation which one may perforin or not at his will does not create a trust. But a trust may be created by parol, and its creation does not depend on the use of particular words of trust. Chicago, etc., Ry. Co. v. Des Moines, etc., Ry. Co., 254 U. S. 196, 208, 41 S. Ct. 81, 65 L. Ed. 219. It may be inferred from facts and circumstances. Thus the owner and donor of personal property may create a perfect trust by Ms unequivocal declaration in writing or by parol that he himself holds such property in trust for purposes named. 26 R. C. L. 1182. And any words which indicate with sufficient certainty a purpose to create a trust will be effective in so doing. Gutch v. Fosdick, 48 N. J. Eq. 353, 22 A. 590, 27 Am. St. Rep. 473; Foulds v. Dillon, 231 Mich. 509, 204 N. W. 733. While the petitioner here may be said to have had control of the money which it had placed in the maintenance fund, diversion of that fund for corporation purposes or any purpose other than that designed by its promise to maintain the same, and the specific resolution of its board of directors to devote to that purpose 20 per centum of its receipts from sales, might be enjoined by a suit in equity as a violation of the trust agreement. The crucial question is, Did the petitioner’s patrons possess the right to protect themselves and demand the preservation of the fund which the petitioner had covenanted with them to maintain and by its resolution had set apart for maintenance? That question is by the authorities answered in the affirmative. * * *

On brief the petitioner admits that the precise question presented for determination by this proceeding, so far as the published reports indicate, has never before been directly presented to this Board or the Federal courts; that in cases heretofore decided the question has been whether or not the fund set aside is a trust fund and, if so, whether under the peculiar facts in the case the funds were received in trust or placed in the trust fund.

So far as the record before us shows, there was never any corporate resolution adopted by the petitioner’s stockholders or directors relative to the creation of a trust fund to provide for perpetual care. The president of the corporation testified, with reference to the establishment of a perpetual care fund in 1922, that:

Our arrangement was tbat we would establish a $100,000 fund for the first 25% acres we opened up, and that, in selling lots, we were to set aside 10 per cent on the 25% acres, to be sold at a minimum price or an approximate price of at least $155 a lot, which would figure up to approximately $975,000, and 10 per cent of that was to be set aside, making a minimum) of approximately $100,000 for the first 25 acres.

He instructed salesmen that they might inform prospective purchasers that a perpetual care fund was to be set up and that 10 per cent of the amounts received were to be placed in such fund. Two salesmen of the petitioner testified that they were so instructed and that they advised prospective purchasers that 10 per cent of the amounts paid in on their lots would be set up in a perpetual care fund. The president testified that the $100,000 perpetual care fund was not set up as originally contemplated, for the reason that:

We needed the money for improvements necessary, that we were putting in, and we decided that, any time under the construction period, or any time during that time, as long as we had available lots for sale, that that fund would he intact, and that the proceeds from the sale would be charged and put in, up to the entire amount.

He further testified that 725 lots had been set aside for this purpose.

From a consideration of the entire evidence we are of the opinion that it does not establish the fact that any part of the amounts paid in by the lot purchasers was received by the petitioner in trust. The contract of sale provided that each lot should receive perpetual care. In 1924 a comparatively small amount was deposited with a trustee, the income of which was to be used for the perpetual care of the cemetery as distinguished from the care of lots sold, but only so far as necessary. Any excess of the income which might be received from such fund was available to the petitioner for any corporate purpose. The record does not show that any liability for perpetual care was recognized in the keeping of the petitioner’s books of account, or that any action was taken by its stockholders or board of directors recognizing such liability. In this situation we are of the opinion that the petitioner has failed to establish that the money was received in trust, and that the proceeding at bar involves a situation substantially the same as was considered in Springdale Cemetery Assn., 3 B. T. A. 223, and Mt. Plymouth Corp., 25 B. T. A. 1201. In the last named case the facts were that a corporation selling lots from a tract in Florida gave assurance that each lot owner would for 21 years have the privileges of a golf course and club house in the tract, and stated that $100 of the price of each lot would be used to maintain such golf course and club house. We held that no trust existed in respect of the $100 received from the sale of each lot and that such $100 was within the corporation’s gross income.

Reviewed by the Board.

Judgment will be entered under Rule SO.

Tbammell,

dissenting: I agree that the portion of the purchase price of each lot which it was represented would be set aside for perpetual care should not be added to the purchase price of the lots, but can not agree that the entire selling price of the lots should be included in income.

The Commissioner in his determination has excluded from taxable income in each of the years here involved such amounts as were actually set aside in a trust fund by the petitioner, upon the ground that such amounts were received impressed with the trust for perpetual care. The question here is whether the amounts received by the petitioner which were to be placed in such fund but were not actually placed there are to be excluded from income. In the sale of lots the contract provided, The purchase price hereof shall include perpetual care,” and salesmen represented to purchasers that a fund would be set up for this purpose and that 10 per cent of the purchase price of each lot would be set aside in a trust fund to be used exclusively for perpetual care. In my opinion, if a stated portion of the amounts received from the sale of lots was impressed with a trust, the petitioner received such amounts in trust, and if it did in fact commingle it with its other funds and did not set up a trust fund as agreed, that is a question of liability to lot owners on the part of the petitioner, with which we are not here concerned. If the petitioner should have misappropriated money received in trust and did not segregate it as agreed, the lot holders undoubtedly had their remedy. With this remedy, or whether the lot owners cared to exercise or resort to a remedy, we are not here concerned. With respect to the duty to keep trust property separate, the Tentative Draft No. 2 of the Restatement of the Law of Trusts of The American Law Institute, on p. 97, sec. 174, states as follows:

The trustee is under a duty to the beneficiary to keep the trust property separate from his individual property and ordinarily to keep it separate from other property not subject to the trust, and so far as it is reasonable he should see that the property is designated as property of the trust.

See also Lannin v. Buckley, 256 Mass. 78; 152 N. E. 71. However, I know of no authority to the effect that, if a trustee violates his duty as trustee, the trust is destroyed or there is no trust.

The facts indicate, however, that the funds were actually used for perpetual care as provided in the contract, but that they were commingled with the general funds of the petitioner, except with respect to the small amount of trust to the extent of $6,500 set up in 1924.

I think that the facts in this case, on account of the provision contained in the contract with the lot purchasers, the - representations made by the salesmen of the lots, and the published literature with respect to the perpetual care fund, are of such a character as to impress a definite proportion of the funds received from lot owners with a trust. It was clearly understood by the purchasers of lots that 10 per cent of the total purchase price of each lot was to be devoted to a trust fund. When they paid their money in, they paid it with these facts and representations before them. It seems clear that they would have had a remedy to have enjoined the misapplication of the specified portion of the fund to any other use than for perpetual care if they had seen fit to do so, or they could have had any other remedy afforded to a beneficiary for the failure on the part of a trustee to perform his duty according to the trust agreement.

I think that this case is governed by our decision in the case of the Los Angeles Cemetery Assn., 2 B. T. A. 495; Greenwood Cemetery Assn., 2 B. T. A. 910; Metairie Cemetery Assn., 4 B. T. A. 903; Portland Cremation Assn. v. Commissioner, 31 Fed. (2d) 843; Inglewood Park Cemetery Assn., 6 B. T. A. 386.

In the Inglewood Park Cemetery Assn, case the facts were that salesmen employed by the petitioner were instructed to call the attention of all purchasers of lots to the provision relating to perpetual care. Each deed conveying title to lots contained a perpetual care guarantee that 25 per cent of all receipts from the sale of lots was transferred to the perpetual care fund at the end of each month. The perpetual care fund was deposited in a special bank account designated “ Trust Fund for Perpetual Care.” It is to be observed in that case that the amount when received by the petitioner was commingled with its own funds and that a portion of the receipts from the lot sales was not transferred to the trust fund until the end of each month. Certainly the transfer to a fund after the receipt thereof is not sufficient in and of itself to create the trust relation or to impress a trust upon the fund at the time of its receipt. If a taxpayer sets up a trust fund of its own funds which it had previously received, clearly this would not be sufficient to impress a trust thereon retroactively, but we held in that case that a portion of the funds received was impressed with the trust and did not constitute income when received. If it was impressed with a trust at the time received, the trust relation is then established and whether at the end of the month it is set aside into a special trust fund would add no strength to the trust relationship. In the case at bar there were representations made and the contracts of sale were substantially identical with the representations and contracts of sale in the Inglewood Park Cemetery Association.

In the case of Los Angeles Cemetery Assn., supra, reliance was placed on a provision of the California Civil Code to the effect that any cemetery corporation or association under contract for the perpetual care of certain lots in the cemetery is expressly forbidden to use the funds received for the perpetual care for any other purpose. There is a similar statute in Illinois, to wit, ch. 21, ¶ 51, sec. 4 of Cahill’s Illinois Revised Statutes, relative to cemetery associations, in effect during the taxable years, as follows:

¶51. Trust fund.] §4. Tlie board of directors of such cemetery society, or cemetery association, or the trustees of any public graveyard, may set apart such portion, as they see fit of the moneys received from the sale of the lots in such cemetery or graveyard, which sums shall he kept separate from all other assets as an especial trust fund, and they shall keep the same invested in safe interest or income paying securities, for the purpose of keeping said cemetery or graveyard, and the lots therein, permanently in good order and repair, and the interest or income derived from such trust fund shall be applied only to that purpose, and shall not be diverted from such use.

In the case of Evergreen Cemetery Assn. of Chicago, 21 B. T. A. 1194, we held that amounts received by the petitioner in that case for perpetual care were received in trust and were not to be included in taxable income. Our opinion in that case was based upon “ The representations made by the petitioner in its advertising matter, contracts and deeds as to the perpetual care fund,’ taken in connection with the positive and uncontradicted testimony of the treasurer of the fund touching the same * * In that case, however, the fund was actually set up. We have similar or even stronger representations and more specific statements and clearer testimony in this case with respect to the paying in of a definite portion of the price of each lot.

In the Portland Cremation Assn. case, supra, decided by the Circuit Court of Appeals, the court said: “ In the case at bar the representations went no further than to say that a portion of the purchase price would he placed in a maintenance fund.” The court further said:

In short, the decisions of the Board of Tax Appeals seem to narrow the question here involved to this: That, in case the taxpayer specifies in its representations to purchasers that its covenant to maintain is backed by a permanent fund to be created by placing aside either all or a named portion of the purchase price received on each sale, the fund will be a trust fund, but, if in the representations to purchasers the portion of the money so received and so to be set aside is left unspecified, there will be no trust or obligation enforceable in equity but only a contract, breach whereof will be remediable only by an action at law. This seems to us an unsubstantial distinction. We cannot agree that the fund so set aside by the petitioner here is not essentially a trust fund. The deeds it gave to purchasers contained a covenant to the grantee and his heirs that the petitioner would maintain the niche or vault forever. All sales were made with the representation that said covenant was guaranteed by a permanent maintenance fund and that a portion of the purchase price paid by each purchaser would be placed in that fund, and that the fund could not and would not be used for any other purpose. [Italics ours.]

The court held on the facts in that case that the money was received in trust and was not to be included in the taxpayer’s income. It is to be observed that the court placed its decision on the “representations that a portion of the purchase price would be placed in a maintenance fund.”

The court further said, “And any words which indicate with sufficient certainty a purpose to create a trust will be effective in so doing.”

In the case of Spring Canyon Coal Co. v. Commissioner, decided by the Circuit Court of Appeals, Tenth Circuit, 43 Fed. (2d) 78, the petitioner corporation had set aside out of its funds a reserve for the payment of workmen's compensation insurance. The court held that amounts added to that reserve fund were to be included in taxable income. The court further said, “the present case is not analogous to a trust set up by an employer to assist employees in sickness or old age, where he is under no obligation so to do; neither is it governed by Portland Cremation Association v. Commissioner, * * * where a cemetery corporation, in consideration of the purchase of a lot, agreed to pay a portion of the price into a perpetual maintenance fund.”

The situation presented in this case is materially different from the case of Springdale Cemetery Assn., 3 B. T. A. 223, and similar cases where a reserve fund is set aside for perpetual care of lots. When the money from the sale of lots is not impressed with a trust when received, it is not important that a reserve is set up or that a trust is afterwards set up. The setting up of a reserve out of income does not affect income and makes no income exempt. Nor does the creation of a trust out of income already received, if the income when received was not impressed with a trust, relieve the tax burden which falls on the income received. But, if when some money is received a portion of it is impressed with a trust, a different situation exists. Such portion so impressed is not income, and it remains impressed with the trust regardless of whether it is improperly commingled with other funds.

Nor do I think that it is important that the trust fund here was not mandatory under the Illinois statute, but was merely permissive. Manifestly trusts can be created by the voluntary action of the parties. As a rule trusts are so created. I can not agree in this respect with the language of the Springdale case, supra, which distinguishes a mandatory from a permissive trust.

Nor do I think it is of importance whatever that the board of directors and the stockholders took no formal action. There can be no doubt, it seems to me, that the corporation is bound by representations of its authorized officers, which statements are corroborated by published literature, especially when concededly the corporation was permitted by law to do the very things which it was represented would be done. Lack of authority certainly would have been no defense if the corporation had been sued as a trustee by lot owners.

From a consideration of the evidence in this case apd the authorities, it is my opinion that 10 per cent of the amount received as the selling price of each lot was impressed with a trust for perpetual care when received, and should not be included in the taxable income of the petitioner.


source: Caselaw Access Project

author: Murdock:

license: Public Domain

text:
    Otto H. Kahn, Addie W. Kahn, and Gilbert W. Kahn, Trustees, Residuary Estate of Abraham Wolff, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54767.
    Promulgated December 7, 1932.
   OPINION.

Murdock:

The Commissioned determined a deficiency of $8,961.39 in the petitioners’ income tax liability for the year 1927. The Commissioner determined that the estate realized a profit of $435.40 upon the liquidation of 34 shares of New York Railways Participation Corporation voting trust certificates. A loss of $38,064.09 had been claimed on the return on account of the liquidation of these shares. The only issue is as to the basis for gain or loss which these shares take under the Revenue Act of 1926. The facts were stipulated, but need not be set out in full.

The petitioners, or former trustees of the same estate, acquired $150,000 par value of Metropolitan Street Railway Company 4 per cent bonds in 1904 at a cost of $143,155.28. On March 14, 1912, these bonds were exchanged, pursuant to a plan of reorganization, for the following bonds of the newly organized The New York Railways Company: $37,500 par value first refunding mortgage bonds having a fair market value at the date of the exchange of $30,750, and $112,500 par value 5 per cent adjustment mortgage income bonds having a fair market value at the date of the exchange of $61,875. The estate used first refunding mortgage bonds of the par value of $3,675 to repay the principal and interest on a loan, and retained $33,825 par value of these bonds. During March, 1912, after the exchange above mentioned, the estate purchased for cash $175 par value first refunding mortgage bonds for $143.06 and thereafter held $34,000 par value, of the first refunding mortgage bonds. In 1925, pursuant to a plan of reorganization of The New York Railways Company, the estate exchanged the $34,000 pa,r value of first refunding mortgage bonds for bonds of the new company having a fair market value at the time of the exchange of $7,984.90, and 34 shares of The New York Railways Participation Corporation voting trust certificates having a fair market value at the time of the exchange of $9,690. In 1927 the estate received a final liquidating dividend on these 34 shares. The total of dividends received was $14,849.16. The Commissioner, in determining the deficiency, used $27,879.56 as a basis for gain or loss on the securities received in the 1925 reorganization. This basis was made up of $143.06, the cost of $175 par value of bonds purchased in March, 1912, and $27,736.50, the fair market value at the date of the 1912 exchange of $33,825 par value of first refunding mortgage bonds received in the exchange which took place at that time. He then allocated this basis between the bonds and shares received in the 1925 exchange in proportion to the fair market value of each. In this way he determined that the basis for gain or loss on the 34 shares was $15,284.56.

The petitioners disagree with the Commissioner only with respect to the effect which the 1912 reorganization exchange had upon the basis for gain or loss of the securities acquired in that exchange. They apparently concede that if the Commissioner’s theory of the effect of the 1912 reorganization and exchange is correct, the profit determined by the Commissioner is correct. In other words, they make no other attack upon the Commissioner’s figures or method of computation. They contend that the securities acquired in the 1912 reorganization exchange took the same basis which the property exchanged had, to wit, original cost in 1904, because the securities held before and after the 1912 exchange were essentially the same. They concede that if the final disposition of the securities in question had occurred prior to 1924, Marr v. United States, 268 U. S. 536, would have fully supported the Commissioner’s determination, and, further, if disposition had occurred in any of the years 1918 to 1923, inclusive, the present contention could not be reconciled with John J. Radel Co., 5 B. T. A. 250, and St. Louis Union Trust Co., Executor, 14 B. T. A. 323. They point out that the Revenue Act of 1926, in providing for the basis of property acquired before March 1, 1913, makes no reference to reorganization exchanges. They call attention to the difference in certain provisions of the Revenue Acts of 1918 and 1921 as opposed to corresponding provisions of the Revenue Acts of 1924 and 1926 and argue inferentially that Congress, in the two latter acts, intended to provide for no change of basis in any reorganization exchange, regardless of date They say that if there is any doubt about drawing such an inference, the reports of Congressional Committees must be examined for the Congressional intent and there one will find that Congress was referring to types of exchanges and was not making any division with regard to dates.

We find no justification in the acts for the petitioners’ view. The provisions of the 1926 Act are clear. The words used therein permit of no doubt as to how the profit in this particular case should be computed. Section 204(a) (6) was unnecessary and pointless if the property received takes the basis of that given up in all exchanges of this type. The presence of subparagraph (6) in section 204(a), and the absence of any similar provision in section 204(b), clearly shows that Congress intended different results, depending upon whether the exchange in which the property was acquired took place before March 1, 1913, or after February 28, 1913. If after February 28, 1913, the old basis carried through, but if before March 1,1913, the property acquired took a new basis different from that of the property exchanged. Here one exchange was after February 28, 1913, and the basis did not change. But another exchange was in 1912 and the basis changed at that time. Cf. Marr v. United States, supra.

Section 202(a) provides that the gain from the disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized. Section 204(a) has to do with property acquired after February 28, 1913, and provides that the basis for such property shall be cost, except that if the property was acquired upon an exchange described in subdivision (b), (d), (e) or (f) of section 203, the basis shall be the same as in the case of the property exchanged * * This latter provision applies to the 34 shares, since they were acquired upon a nontaxable exchange of the kind described in section 203(b)(2). Thus, the property acquired by the petitioner in the 1925 exchange takes the basis of the property exchanged. The property exchanged was $34,000 par value of first refunding mortgage bonds. So far, the parties may not be in disagreement. But the petitioner apparently contends that* in determining the cost basis for this $34,000 par value of bonds, section 204(a) (6) again applies as does section 203(b) (2), so that these bonds acquired in the 1912 exchange take the cost basis of the bonds given in that exchange. Thus, he gets back to the original cost of- the bonds. However, the bonds of $34,000 par value which we are now considering were not acquired after February 28, 1913. Consequently, section 204(a) has no further application. These bonds were property acquired before March 1, 1913, and therefore section 204(b) applies. Section 20.4(b) provides that the basis for determining gain or loss on the disposition of property acquired before March 1, 1913, shall be the cost of such property or the fair market value of such property as of March 1, 1913, whichever is greater. The parties agree that cost is greater than March 1,1913, value. The cost of $175 par value of these bonds is $143.06. The remainder of these bonds, having a par value of $33,825, were acquired in the exchange which took place in March, 1912. Their cost to the petitioner was the fair market value at the •date of the exchange of the property given in exchange for them. John J. Radel Co., supra; St. Louis Union Trust Co., Executor, supra; John Glackner Realty Corp., 11 B. T. A. 151; Alden Anderson, 19 B. T. A. 371; Peter Doelger Brewing Co., 22 B. T. A. 1176; Reliance Investment Co., 22 B. T. A. 1287; Rice v. Commissioner, 47 Fed. (2d) 99. The parties have not stipulated the value of this property. They have stipulated, however, that the first refunding mortgage bonds had a fair market value at the date of this exchange of $820 for each $1,000 bond. The Commissioner has used this value as cost, apparently assuming that the property given in exchange had the same value as the property received. The petitioner makes no objection to the use of this value if his own theory is rejected. We find no error in the Commissioner’s determination of the profit from this transaction.

The parties have stipulated that the petitioner has made a payment of a part of its tax not shown as a credit in the notice of deficiency.

Judgment will be entered imder Rule 50.


author: Black:

text:
    American Equitable Assurance Company of New York, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44332.
    Promulgated December 8, 1932.

      LeRoy B. Isermann, Esq., and Wendell P. Barber, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Black:

At the hearing and by brief counsel for the respondent based his entire contention as to the transferee liability of petitioner upon the contract liability, if any, of the petitioner to pay the tax in question, resulting from its assumption of certain debts and liabilities of Norwegian Atlas in the contract of May 25, 1926. Respondent contends that petitioner’s agreement to pay the tax involved in this proceeding was a part of the very consideration for the assets which it received from the Norwegian Atlas. In Wolf Mfg. Industries, Bankrupt, etc. v. United States, 56 Fed. (2d) 64, the court said:

We have observed that the only consideration for the transfer of the corporate assets to the trustees was the agreement by the latter to pay the debts and discharge the liabilities of the corporation, and that the property received in trust was to he devoted first of all to the discharge of such debts and liabilities. Upon such written contract, under the statutes of Illinois and Indiana, actions are barred in 10 years. Within that time the Government filed its claim in the court of bankruptcy, showing that there had been legally established a tax liability against the corporation in the sum claimed.
Both Illinois and Indiana recognized the rule that third persons for whose benefit a contract is made may bring action thereon. (See Commercial v. Kirkwood, 172 Ill., 563; Dean v. Walker, 107 Ill. 540; Chicago Title & Trust Co. v. Central Trust, 312 Ill. 396; Hess v. Lackey, 191 Ind. 107; Tinkler v. Swaynie, 71 Ind. 562; Ransdel v. Moore, 153 Ind. 393.) And despite what may be the rule in various other Commonwealths, the same rule has long abided in the Federal courts. (See Hendrick v. Lindsay, 93 U. S. 143; Princes Amusement Co. v. Wells, 271 Fed. 226 (C. C. A. 6, certiorari denied, 254 U. S. 701); Gibson v. Victor Talking Machine Co., 232 Fed. 225; Barker v. Pullman, 124 Fed. 555 at 567; Blackmore v. Parkes et al., 81 Fed. 899 (C. C. A. 6); In re Dresser, 135 Fed. 495 (C. C. A. 2); Millett v. Omaha Bank, 30 Fed. (2d) 655 (C. C. A. 8). It follows that the Government, having established the legal liability of the corporation, was entitled to file and have allowed its claim in the bankrupt estate of the parties who assumed and agreed to pay such liabilities. Furthermore, it was the court’s duty, sitting as a court in equity, to treat the property of the bankrupt as a trust fund for the benefit of the creditors of the corporation according to their respective priorities.

Thus it seems clear that in such a case the Government has a cause of action against the purchaser of assets who assumes the liability for taxes of the transferor, which it may assert in a proper proceeding in court.

Section 280 of the Revenue Act of 1926, as has been often said by the Board and the courts, creates no new liability, but simply gives to the Government the right to enforce, by the methods provided therein, an existing liability which it may have at law or in equity against the transferee. Petitioner in its brief, in arguing against its own liability in the instant case, cites certain Board and court cases where it was held that the respondent had not sustained the burden of proof put upon him by the statute to show the liability of the transferee. An examination of these cases will show that they were cases where the respondent failed to show the insolvency of the transferor or the value of the assets transferred and matters of that sort which were necessary elements of his case. These were all cases where the respondent relied entirely upon an equitable liability against the transferor, based on the trust fund doctrine. None of these cases were such as we have in the instant case, where there was a contractual agreement on the part of the transferee to pay the tax. Therefore, we do not believe the cases cited by petitioner are in point to sustain the contention which it makes.

In the third paragraph of the contract of May 25, 1926, quoted in our findings of fact, the petitioner agreed to assume and pay every obligation, insurance or otherwise, of the Norwegian Atlas, now outstanding and known or unknown, which had arisen against it in connection with its business transacted through its United States branch, and in the tenth paragraph of the contract it agreed “ to pay all taxes, Federal, state or otherwise, if and when determined, for all years prior to the year 1926,” except for the first five months of the year 1926, which Norwegian Atlas agreed to pay. This we think creates a liability on the part of the petitioner to the United States which it may enforce by a proper court action, and, being such a liability, it may be enforced against petitioner under section 280 of the Revenue Act of 1926. ■ Petitioner is a transferee of the property of the taxpayer, the Norwegian Atlas, and the value of the property is far in excess of the tax involved in this proceeding, and a part of the very consideration for the property which petitioner received from the transferor was an agreement to pay the taxes involved in this proceeding. At least that is the construction which we place upon the meaning of the contract between petitioner and the Norwegian Atlas.

The question of the enforcement of a purely contractual liability was before us in Reid Ice Cream Corp., 24 B. T. A. 823, in which the petitioner entered into a contract with the taxpayer by which the petitioner transferee bought out another corporation under a contract which provided that the purchaser should assume the liabilities of the seller as of a certain date and subsequent liabilities incurred in the ordinary routine of business. Following the sale, the seller distributed the entire purchase money to its stockholders. The tax return of the seller showed a tax liability resulting from the profits of the sale, which the respondent proposed to assess and collect from the purchaser, Reid Ice Cream Corporation, under section 280, basing his action on the promise to assume- and pay the liabilities of the seller. We sustained the contention of the respondent and held that the taxes in question were included in the contract and that a purely contractual liability of the transferee could be enforced under section 280. We adhered to the same general rule in Richards & Hirschfield, 24 B. T. A. 1295.

Reid Ice Cream Corp., supra, was reversed in Reid Ice Cream Corp. v. Commissioner, 59 Fed. (2d) 189, but not upon the ground that a contractual liability could not be enforced under section 280. The court held that the Board was in error in holding that the contract involved in that proceeding was broad enough to cover the taxes which resulted from the sede itself. The court said in part:

Where as in the instant case, a corporation sells its business, the properties sold are the only transferred assets and there is no claim against those transferred assets so far as the income tax on any profit on the sale is concerned. That claim arises only on the payment of the price and relates only to the price received and not in any sense to the transferred assets, and, again:
Here there was no taxable fund until after the sale, and the petitioner never partook of a taxable fund because no tax liability arose except upon receipt by the seller of the purchase price. That, and not the assets sold, constitutes the taxable fund. There could not be any claim against the transferred assets. Therefore section 280 creates no liability; it is remedial and presupposes a liability for the enforcement of which it is designed to furnish a remedy..

The opinion of the court, as we construe it, does not conflict with the rule announced by us in Reid Ice Cream Corp., supra, and Richards & Hirsehfield, supra, to the effect that where the purchaser assumes by contract the payment of taxes already existing, as part of the consideration for the transferred assets, and fails to pay that part of the agreed consideration, collection of such taxes may be enforced under section 280. Therefore, we hold that petitioner is liable as a transferee under the provisions of section 280 of the Revenue Act of 1926.

Limitations. — Petitioner pleads and relies on the 4-year statute of limitations. The return of the Norwegian Atlas was filed July 3, 1923, and the notice of deficiency was mailed July 2, 1927, which was within four years. Within 60 days thereafter a petition was filed with this Board seeking a redetermination, which proceeding was dismissed by order of the Board on June 11, 1929, for lack of jurisdiction. The petition had been filed in the name of Norwegian Atlas, but was signed by an official of American Equitable as the successor of the United States Branch of Norwegian Atlas. The 60-day notice to petitioner was mailed March 15, 1929.

Section 280(b) (1) expressly provides that, “ The period of limitation for assessment of any such liability of a transferee or fiduciary shall be as follows: (1) Within one year after the expiration of the period of limitation for assessment against the taxpayer.”

Section 277 (b) of the Revenue Act of 1928, as amended by section 504 of the Revenue Act of 1928, expressly provides that the period during which the Commissioner is prohibited from making an assessment or instituting distraint or proceedings in court, or while a proceeding in respect of the deficiency is pending before this Board, and 60 days thereafter, shall not be counted in considering the running of the statute of limitations.

In view of these statutes, it is clear that the statute had not run in the instant proceeding, because the deficiency notice to petitioner was sent before the dismissal of the Norwegian Atlas proceeding. Wayne Body Corp., 22 B .T. A. 401. Cf. Wells-Elkhorn Coal Co., 27 B. T. A. 198.

Norwegian Atlas Deductions. — Petitioner claims the right to go into the merits of the deductions which were claimed by Norwegian Atlas and disallowed by the respondent. Petitioner has this right. Wayne Body Gory., supra. Relative to this matter, the burden of proof is on the petitioner. Petitioner contends that respondent should allow as a deduction from gross income of Norwegian Atlas in 1922 the amount of these reinsurance claims, aggregating $74,115.41, either as losses or bad debts. While it is true that all three reinsurers were placed in liquidation in 1921, the books of Norwegian Atlas at the close of 1922 showed the aggregate of $74,115.41 as reinsurance receivable, and it does not appear that these claims were ascertained to be worthless and charged off during the taxable year. On the contrary, it is vigorously argued by petitioner in this proceeding that these claims were valuable assets retained by Norwegian Atlas, out of which the United States could and should have collected the tax in controversy instead of enforcing it against the petitioner under section 280. In addition it may be observed that it is alleged in the petition that “ Subsequent to the filing of its 1922 tax return, the Norwegian Company collected a substantial proportion of these dividends, no part of which has been received by petitioner.” In the evidence of Wendell P. Barker, general counsel and vice president of the petitioner, it is stated, “ I know that the company today possesses certain assets in the United States in the shape of certain claims or dioses in action which they are today endeavoring to enforce and I know that since this contract was signed they have taken down and collected a substantial sum of money in connection with these claims which was reserved from this contract.”

This allegation of the petition and evidence quoted is incompatible with a theory of either a loss or worthless debt in 1922, and we sustain respondent in disallowing these claimed deductions.

Decision will he entered for the respondent.


author: Lansdon :

text:
    C. S. Denman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 38030, 44028.
    Promulgated December 8, 1932.

      A. F. Schaetzle, Esq., for the petitioner.

      J. B. Johnston, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has asserted deficiencies in income tax for the years 1925, 1926 and 1927, in the respective amounts of $68.33, $128.94 and $775.18. The only issue is whether all or any part of the petitioner’s salary as a manager of the municipally owned waterworks of the City of Des Moines is exempt from Federal income tax. The two proceedings were duly consolidated for hearing.

Petitioner is an individual residing in Des Moines, Iowa, where he is the manager of the municipally owned and operated waterworks of that city. In each of the years here involved he received an annual salary of $8,000, which was paid to him by the city through the trustees of the waterworks system.

The City of Des Moines owns, maintains and operates a waterworks system through a board of trustees under authority conferred by the General Assembly of the State of Iowa. It furnishes all the water used by the city and its inhabitants. Water supplied to private purchasers is metered and a flat charge based on the mileage of mains is made for that consumed by the city. Prior to municipal ownership, water was supplied to the City of Des Moines by a private corporation.

The essential governmental activities of the republic are not taxable by the states and the corresponding activities of the states are not taxable by the republic. McCulloch v. State of Maryland, 4 Wheat, 316; Weston v. City Council of Charleston, 2 Pet. 449; Collector v. Day, 11 Wal. 113, 127; Indian Motorcycle Co. v. United States, 283 U. S. 570. Any difficulty in the application of the principle arises from the necessity of differentiating between functions that are essentially and usually governmental in character and those which are proprietary.

Petitioner here contends that the supplying of water to the city and its inhabitants is an essential governmental function that has now become usual throughout the republic, and in his brief calls attention to evidence adduced in this proceeding that a very large proportion of the cities of the United States own and operate waterworks systems. This contention is not in harmony with the decisions of the courts and of the Board. In Flint v. Stone Tracy Co., 220 U. S. 107, the Supreme Court said:

It is no part of the essential governmental functions of a State to provide means of transportation, supply artificial light, water and the like. These objects are often accomplished through the medium of private corporations, and, though the public may derive a benefit from such operations, the companies carrying on such enterprises are, nevertheless, private companies, whose business is prosecuted for private emolument and advantage. For the purpose of taxation they stand upon the same footing as other private corporations upon which special franchises have been conferred.
The true distinction is between the attempted taxation of those operations of the States essential to the execution of its governmental functions, and which the State can only do itself, and those activities which are of a private character. The former, the United States may not interfere with by taxing the agencies of the State in carrying out its purposes; the latter, although regulated by the State, and exercising delegated authority, such as the right of eminent domain, are not removed from the field of legitimate Federal taxation.

In Blair v. Byers, 35 Fed. (2d) 326, the United States Circuit Court of Appeals, in a case in which an attorney employed and paid by the trustees of the Des Moines Municipal Water Works sought to have salary received therefrom exempted from Federal taxation, the court said:

Glearly the government is not prohibited from taxing the instrumentalities of a state or a political subdivision of a state, when these are employed in the exercise of a proprietary function. The Supreme Court, in South Carolina v. United States, 199; U. S. 437, 26 S. Ct. 110, 116, 59 L. Ed. 261, 4 Arm. Cas. 737, held that: “The exemption of state agencies and instrumentalities from national taxation is limited to those which are of a strictly governmental character, and does not extend to those which are used by the state in the carrying on an ordinary private business.”

In the Byers opinion supra, the court relied on Stone Tracy Co., supra, and also the following from City of Winona v. Botzet, 169 Fed. 321:

In the City of Winona v. Botzet, 169 F. 321, 333, 23 L. R. A. (N. S.) 204, this court decided that: “ The power of a city to construct and operate waterworks is not a political or governmental, but a private or corporate, power, granted and exercised, not to enable it to control its people, but to authorize it to furnish to itself and to its inhabitants water for their private advantage.”

In a very recent proceeding, T. P. Wittschen, 25 B. T. A. 46, in which the attorney of a California utility district sought tax exemption for the salary received therefrom, there is a full discussion of all the questions here involved. We think that the result reached in that proceeding is controlling here.

As an alternative, petitioner contends that, even if we should hold that supplying water to inhabitants by a municipally owned waterworks is a proprietary function, nevertheless, the supplying of water to the city itself for flushing sewers and streets and for use in the school and other public buildings is an essential and usual governmental function. In this connection the evidence shows that an average of about 40 per cent of all the water pumped by the Des Moines Water Works in the taxable years was used by the city. On this showing petitioner contends that at least 40 per cent of his salary should be exempt from Federal income tax. We can not adopt this theory. Whether water is sold to inhabitants or to the city, the nature of the transaction is the same. It is a function that is not essentially governmental.

Decision will be entered for the respondent.


author: Marquette :

text:
    Crossett Western Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46278, 63823.
    Promulgated December 8, 1932.

      Robert T. Jacob, Esq., for the petitioner.

      W. E. Davis, Esq., for the respondent.
   OPINION.

Marquette :

The principal question in these proceedings is whether the petitioner and the Gales Creek Logging Company were entitled to file consolidated returns for 1924 and subsequent years by reason of affiliation. Despondent determined with respect to the year 1924 that there was no showing of a disproportion in the inter-company accounts such as would warrant the consolidation of accounts under section 240 (d) of the Revenue Act of 1924. That section reads as follows: *

In any case of two or more related trades or businesses * * * owned or controlled directly or indirectly by the same interests, the Commissioner may and at the request of the taxpayer shall, if necessary in order to malre accurate distribution or apportionment of gains, profits, income, deductions, or capital between or among such related trades or businesses, consolidate the accounts of such related trades or businesses.

The evidence here presented shows a close business relationship between the two companies, joint purchasing • of supplies, frequent exchange of equipment and of employees’ services, and that both companies used the same accounting system. But that is not sufficient, we think, to prove, that a proper apportionment of gains, profits, income, deductions, or capital between the two companies could not be made without consolidating the accounts. Respondent has in fact made such apportionment without consolidation, and petitioner has failed to sustain the burden of showing that respondent’s determination was erroneous.

The Revenue Act of 1924 also provides that:

Sec. 240. (a) Corporations which are affiliated within the meaning of this section may, for any taxable year, make separate returns or, under regulations prescribed by the Commissioner, with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is granted, by the Commissioner.
* * & * * * *
(e) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the voting stock of the other or others, or (2) if at least 95 per centum of the voting stock of two or more corporations is owned by the same interests. * * *.

The Revenue Acts of 1926 and 1928 contain the same provisions.

At the close of the year 1924, eleven of the twenty-eight persons holding all of petitioner’s capital stock owned 21.472 per cent of the Logging Company’s voting stock. Another 72.701 per cent was owned by petitioner itself, while the remaining 5.827 per cent was owned by seven persons holding none of petitioner’s stock. Manifestly, there was no affiliation of the first class, for petitioner did not own 95 per cent of Logging Company stock until November, 1928. Then, did the same interests own the required amount of stock in both companies for affiliation of the second class? We think not.

The statute requires such common holdings to amount to at least 95 per cent. That is, not less than 95 per cent of stock in both companies must be held by the same interests before the benefit of the statute may be invoked.

In the present case, unless we regard petitioner as of the “ same interests ” as its stockholders, there is not even an approximation of meeting the statutory requirement.

The petitioner asks us to treat the ownership of its stock by groups, rather than by individuals, and to consider its own holdings of Logging Company stock as being proportionately owned by the persons composing the various groups. On that basis, for 1924 we have stockholdings as follows:

As a matter of record, however, the Logging Company stock was held, 1.853 per cent by two members of Group A, 3.999 per cent by five members of Group B, 1.817 per cent by one member of Group C, and 17.086 by the eight members of Group D, five of whom held none of petitioner’s stock. Petitioner, itself, a separate entity, owned 72.701 per cent of the Logging Company stock. Substantially similar results obtained until November 15, 1928, although the personnel of the above groups, and their respective stockholdings, varied somewhat from year to year.

In our opinion the petitioner’s theory does not correctly interpret the statutory requirements. It is elementary that property owned by a corporation is not the property, pro rata, of the corporate shareholders unless and until distribution is made. The Supreme Court, in Handy & Harman v. Burnet, 284 U. S. 136, held that the “ same interests ” within the meaning of the revenue acts, are “ the beneficial owners in like proportions ” of stock of the corporations involved. The court further said:

It would require very plain language to sliow tliat Congress intended to permit consolidated returns to depend on a basis so indefinite and uncertain as control of stock without title, beneficial ownership or legal means to enforce it. Control resting solely on acquiescence, the exigencies of business, or other considerations having no binding force, is not sufficient to satisfy the statute.

Although the court was there considering a statute which provided for affiliation when “ substantially all ” the stock of the corporations was owned or controlled by the same interests, we think the words above quoted are definitely applicable here. The stock of the Logging Company owned by petitioner was not owned by petitioner’s individual stockholders. Lacking, as they did, all the necessary elements laid down by the Supreme Court, title, beneficial ownership, or the legal power to enforce it, we certainly can not say that petitioner’s stockholders were also the owners, pro rata of the Logging Company stock owned by petitioner. We therefore sustain the respondent’s determination that there was no affiliation of petitioner and the Logging Company by reason of common ownership of the stock of the two companies.

On November 15, 1928, petitioner had acquired more than 95 per cent of the Logging Company stock. For that calendar year the two companies filed consolidated returns, but respondent required the Logging Company to file one return as a separate corporation for the period January 1 to November 15, 1928, and also a return as an affiliate with the petitioner from November 16 to December 31. Eespondent contends that each part of the calendar year for which he required return to be filed constitutes a taxable year with respect to carrying forward deductible losses.

The Revenue Act of 1928, section 48, provides in part that:

“ Taxable year ” includes, in the case of a return made for a fractional part of a year under tlie provisions of this title or under regulations prescribed by the Commissioner with the approval of the Secretary, the period for which such return is made.

That wording is identical with like provisions in the Revenue Acts of 1924 and 1926, section 200 (a).

Under that provision each portion of the year of affiliation becomes a taxable year with respect to the allowance of net loss deductions and, where then existing corporations are affiliated during a fiscal or calendar year, separate returns may be required for the period prior to affiliation and a consolidated return for the subsequent period. See Tolerton & Warfield Co., 23 B. T. A. 892; Automatic Fire Alarm Co., 13 B. T. A. 1195; Green River Distilling Co., 16 B. T. A. 395. In the present case petitioner filed a consolidated return for the entire year of 1928, which was disallowed with respect to the period January 1 to November 15. Respondent allowed a consolidated return for the remainder of the year and there is no complaint on that score. The circumstances bring this proceeding squarely in line with the decisions above cited and we sustain the respondent’s determination on that point.

By article 41 (c) of Regulations 75, it is provided, respecting the year 1929 and subsequent years, that:

A net loss sustained by a corporation prior to the date upon which its income is included in the consolidated return of an affiliated group * * * shall he allowed as a deduction in computing the consolidated net income of such group in the same manner, to the same extent, and upon the same conditions as if the consolidated income were the income of such corporation. * * *

The petitioner contends that under the above provision of Regulations 75 the net losses of the Logging Company for the years 1927 and 1928 are deductible in computing consolidated net income for the year 1929; that in no other way can the full privileges of that provision be enjoyed.

In our opinion the contention is not valid. It disregards the fact that under section 48 of the controlling statute, supra, each taxable portion of the year 1928 became a taxable year. If there is any conflict between the statute and the regulations interpreting it, the latter must yield. But we- think they are not conflicting in his instance. The provision of Regulations 75 upon which petitioner relies is but one paragraph of several, all dealing with the general subject of net losses of affiliates sustained during taxable years. The paragraph immediately following the one in question provides that any period of less than twelve months for which either a separate return or a consolidated return is filed shall be considered as a taxable year. It is clear to us that the specific paragraph relied upon by petitioner can not be treated as isolated and independent, but must be considered in connection with, and as a part of the whole regulation respecting net loss deductions by affiliated groups. Under section 117 of the Revenue Act of 1928 net loss deductions are limited to losses occurring in the two taxable years immediately preceding that for which the deduction is to be made.

In Woolford Realty Co. v. Rose, 286 U. S. 819, corporation A suffered net losses for each of the years 1925, 1926 and 1927. Corporation B had net gains for the year 1927, and in that year the two companies became affiliated. The court held that A’s net losses for 1925 and 1926 could not be deducted from the combined income of A and B for the year 1927. See, also, Riley Stoker Corp., 26 B. T. A. 749. Those decisions are applicable here, so far as the year 1928 is involved, but not to the year 1929, because of changes in the law. It does not appear that respondent has violated the principles followed in those cases in computing the deficiency for the year 1929. In our opinion that determination should be sustained.

Decision will be entered for the respondent.


text:
    The Western Union Telegraph Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 48955, 48956.
    Promulgated December 8, 1932.

      Paul E. Lesh, Esq., for the petitioner.

      E. A. Tonjes, Esq., and A. H. Fast, Esq., for the respondent.
   OPINION.

Murdock:

In the case of Gold & Stock Telegraph Co., 26 B. T. A. 914, we held that the entire rental for the years 1920 and 1921, provided for in the agreements which Western Union Telegraph Company had with Gold & Stock Telegraph Company and Pacific and Atlantic Telegraph Company of the United States, was income to the lessors. In the present proceedings similar questions are raised in regard to rental under these two leases for the year 1926. On this point we adhere to our prior decision and the cases therein mentioned, without further discussion.

There is no contention in this case that the petitioner is liable in law under any contract or agreement for the taxes in controversy. The question whether the petitioner is liable in equity as a transferee of property of these taxpayers in respect of the tax imposed upon the taxpayers for this year remains. Section 280 created no new liability. Phillips v. Commissioner, 283 U. S. 589. The term “ transferee ” includes a distributee. Sec. 280 (f). In proceedings before the Board the burden is upon the Commissioner to show that a petitioner is liable as a transferee of property of a taxpayer. See section 602 of the Revenue Act of 1928.

The petitioner relies very strongly upon United States v. Western Union Telegraph Co., 50 Fed. (2d) 102, and Harwood v. Eaton, 59 Fed. (2d) 1009, as well as upon two decisions of the courts of New York cited in these two Federal court cases. We digress, therefore, so that our consideration of the present cases may be had with a proper appreciation of these cases and their effect, or lack of effect, upon the question which we must decide. The New York cases to which we refer are Bowers v. Interborough, Rapid Transit Co. and Peabody v. Interborough, Rapid Transit Co. The Bowers, case was first decided by Judge Gavegan of the Supreme Court of New York County, 201 N.Y.S. 198, and affirmed by the Appellate Division, First Department, without opinion, 202 N.Y.S. 917. Thereafter, the Peabody case came before Judge Ford of the Supreme Court of New York County, 209 N.Y.S. 376, was affirmed without opinion by the Appellate Division, First Department, 209 N.Y.S. 893, and was finally affirmed without opinion by the Court of Appeals, 240 N. Y. 708; 148 N.E. 768. One must look, apparently, to the opinion of Judge Gavegan for the rationale of these decisions. We are unable to perceive how these two cases have any bearing upon the question before us. In each, individual stockholders of a lessor corporation brought suit against the lessee to require it to pay them amounts which the lessee had agreed and guaranteed to pay directly to the stockholders of the lessor corporation. Decisions in favor of the rights of the individual stockholders to sue the lessee directly were based upon the presence in the lease of what was termed a “guaranty.” Judge Gavegan, in his opinion, merely interpreted the provisions of this guaranty and held that it was an undertaking additional to the agreement to pay the rent to the lessor, intended to give the stockholders additional rights and remedies, and, whereas the failure to pay the rent was a breach affecting the stockholders indirectly, the guaranty was an undertaking running directly to them. Cases such as Beveridge v. New York Electric Ry. Co., 112 N. Y. 1; 19 N.E. 489, and Flagg v. Manhattan Ry. Co., 10 Fed. 413, were distinguished on the ground that in those cases there was no express agreement with or direct obligation to the stockholders. The present petitioner, like Bowers and Peabody, is a stockholder in the lessor companies, but, unlike Bowers and Peabody, it is also the lessee and so-called guarantor. It may legally occupy the dual position of lessee and stockholder in the lessor. But a paradoxical situation arose in so far as it purported to make any guarantee on the stock which it held itself. So long as it held shares of stock in the lessor companies, its so-called guaranty, in relation to those particular shares of stock, was vacuous. Therefore, in deciding the present case, we can obtain no benefit from the Bowers and Peabody cases. For the reasons already given, we should likewise disregard the two Federal court decisions in so far as they rely upon the two New York cases.

There are other reasons why the Western Union Telegraph Co. case is not direct authority here. It was a suit by the Government to impress a lien for taxes due for the years 1917 to 1920 from the North Western Telegraph Company upon funds in the possession of the Western Union Telegraph Company, which, by agreement, the latter paid to the shareholders of the former. The court held that no lien could be impressed upon the payments in the hands of the lessee. Our question is a different one. Here the Government contends that, since the payments have constructively passed through the lessor and into the hands of its stockholders, the petitioner is liable as a stockholder-transferee for the tax imposed upon the lessor. Furthermore, the report does not show that Western Union was a stockholder of North Western, whereas in our cases Western Union was not only the lessee and guarantor, but also owned a majority of the stock of the lessor corporations. The Harwood decision, to which we have had reference, was on a demurrer. The case has been decided on the merits since the preparation of this report. 59 Fed. (2d) 1009. It may or may not be distinguishable, but at least it differs from our cases in that Harwood was simply a stockholder, not also lessee, and the lease made no mention of dividends. There is no indication in the report that Western Union was a stockholder of the Empire and Bay State Telegraph Company. We must, therefore, decide the present cases without giving undue regard to the two cases just mentioned.

The respondent contends that the petitioner is liable in equity under what he calls the “ trust fund theory.” The liability of a transferee in equity may arise in various ways, and it is unfortunate that one or all of these ways was ever called the “ trust fund theory.” The alleged liability here does not result from a distribution to stockholders of the amount paid in for their stock, nor from a situation where a corporation transfers its assets for stock without proper provision for its existing debts, as sometimes arises in connection with consolidations or mergers. Cf. Fostoria Milling & Grain Co., 11 B.T.A. 1401. The petitioner, as a stockholder, has received or retained property of the taxpayer. Under municipal law, is the petitioner liable, to the extent of the property received, for taxes of the taxpayer which were imposed by Federal law for the year 1926?

There is a distinction between transfers by a going solvent corporation and those made by a corporation when it is insolvent or when it becomes insolvent as a result of the particular transfer in question. Courts have said that property transferred under the latter circumstances is a trust fund for the benefit of creditors, who may take it from the hands of the transferee to the extent of the property received or the debt, whichever is smaller; that is, that an equitable lien in favor of creditors attaches to the property of the corporation. Hollins v. Brierfield Coal & Iron Co., 150 U. S. 371; McDonald v. Williams, 174 U. S. 397; In re Feckheimer Fishel Co., 212 Fed. 357. See also Wood v. Dummer, 3 Mason 308, where the words “ trust fund ” were first used in this connection. A reason sometimes given for such a rule is that the transfer amounts to a fraud, either actual or constructive, upon those to whom the corporation is obligated. But on one ground or another courts have attempted persistently to give equitable relief to those having a superior right to corporate property. Cf. Bailey v. Hornthal, 154 N. Y. 648; 49 N. E. 56. Application of the rule depends upon the meaning which attaches to the word “ insolvent ” as used therein. This word has several different meanings. Toof v. Martin, 80 U. S. 40. The Bankruptcy Act of 1898 specifies that it means an excess of debts over the aggregate of the debtor’s property when the latter is fairly valued. Some courts have held that this is the general and usual meaning. Marvin v. Anderson, 111 Wis. 387; 87 N. W. 226; Grumsfeld v. Brownell, 12 N. M. 192; 76 Pac. 310. However, the word need not be so narrowly defined in connection with transferee liability. It may also mean an inability to meet obligations as they mature in the regular course of business by means of available assets or a legitimate use of credit. Cf. Toof v. Martin, supra; Hayden v. Chemical National Bank, 84 Fed. 874; Brower v. Harbeck, 9 N. Y. 589, 594; Baker v. Emerson, 38 N. Y. S. 576; Lodi Chemical Co. v. Charles H. Pleasants Co., 54 N. Y. S. 668; French v. Andrews, 30 N. Y. S. 796. Another definition is that a debtor has no property which a creditor can reach by legal process for the satisfaction of his debt. The latter rule is sometimes stated as a rule of evidence, i. e., proof that there is no property which a creditor can reach, is evidence of insolvency on the part of the debtor. Terry v. Tubman, 92 U. S. 156; Bartlett v. Drew, 57 N. Y. 587; Fletcher Cyclopedia Corporations, vol. 8, §§ 5008-9.

The petitioner contends that each lessor was a solvent going concern when it entered into the lease with Western Union; the taxes in question had not accrued and were not even contemplated; the transfers were made at those times by the lessor corporations to their stockholders and did not render the corporations insolvent; at least the evidence does not show any insolvency at those times; the stockholders of the taxpayer companies derived their rights to receive the payments from these leases; these rights came to partial fruition in 1926 without any further act upon the part of the taxpayers; thus, the Commissioner has failed to show that the petitioner is liable as a transferee for the 1926 taxes. The taxes for the year 1926 had first to accrue before any transferee liability could arise. The Commissioner relies upon transfers in 1926 and early 1927, resulting from the distribution of the rental payments for 1926. Moreover, he may be able to follow the income of the taxpayers even if there was no technical transfer of this property. Cf. Hatch v. Morosco Holding Co., 50 Fed. (2d) 128. We know that taxes for the year 1926 were assessed, payment was demanded, warrants for distraint were returned unsatisfied, and the entire assessments remain unpaid. Yet these circumstances do not show that the taxpayers were insolvent when the 1926 rental was distributed. Determination and assessment of and distraint for the 1926 taxes took place long after the 1926 rentals were discharged. Thus, the time element robs these facts of any importance which they might have otherwise in showing insolvency when the 1926 payments became due. However, the contract was carried out as to later years and later rentals retained by Western Union, as a stockholder, exceeded the amount of the deficiencies.

Although the case of United States v. Western Union Telegraph Co., supra, is not directly in point, nevertheless that opinion indicates that the Government has no remedy at law. Counsel for the present petitioner makes no contention that the taxpayers had any property which the Government could reach by legal process for the satisfaction of the taxes due it. Cf. United States v. Fairall, 16 Fed. (2d) 328; Rensselaer & S. R. R. Co. v. Irwin, 249 Fed. 726; certiorari denied, 246 U. S. 671. The stipulation shows that the property of the taxpayers is not being managed by and is not in the possession of the taxpayers; it has been intermingled with that' of Western Union; and at no time has either taxpayer had in its possession property of any description upon which the Government might levy to enforce payment of any Federal income taxes which might be due. In the light of the facts as stipulated, the decision in the Western Union case, supra, and the petitioner’s brief, we are justified in holding, for the purpose of this case, that the taxpayers at no time had property which the Government could reach by legal process for the satisfaction of the tax liability of the! two taxpayers for the year 1926. The taxpayers have not met their tax obligations and without the rent payments they apparently had no way to pay their income taxes, had they desired to pay. In short, if they are to be tested by either of the two latter definitions of insolvency given above, they were insolvent.

The Government, seeking payment of income taxes, is not like a creditor of a corporation who extended credit with full knowledge of the lease agreement. Cases involving rights of such a creditor are not in point. Debts are obligations for the payment of money founded upon, contract, express or implied. Taxes are imposts levied for the support of the Government. Taxes operate in invitvm. Meriwether v. Garrett, 102 U. S. 472, 513. They are of a higher nature than debts. United States v. McHatton, 266 Fed. 602. Stockholders “ do not occupy the position of strangers, who have taken for value, in good faith, and without notice of corporate obligations either fixed or potential.” United States v. Updike, 8 Fed. (2d) 913; certiorari denied, 271 U. S. 661. Cf. Pierce v. United States, 255 U. S. 398. The two New York decisions discussed above had to do with the rights of stockholders under a lessee’s guarantee and their remedies against the lessee. But the rights of stockholders to the property of their corporation are entirely different. Cf. American Telegraph & Cable Co. v. United States, 61 Ct. Cls. 326. A corporation can not directly or indirectly distribute its assets among its stockholders nor allow stockholders to withdraw its assets, except in the payment of dividends out of profits and after lawful obligations have been met. Bartlett v. Drew, supra. The right to contract is not absolute in all matters. Knoxville Iron Co. v. Harbison, 183 U. S. 13. The lease agreements were legal and effective for many purposes and no doubt gave the stockholders certain rights even as against the corporations. Cf. Scovill v. Thayer, 105 U. S. 143. But the rights of the stockholders to corporate property at all times were subject to a superior potential right on the part of the Government to impose taxes upon the corporation and collect those taxes from the income of the corporation. Cf. Louisville & Nashville R. R. Co. v. Motley, 219 U. S. 467; Knox v. Lee, 12 Wall. 457, 550, 551. When the Constitution was amended and income taxes imposed upon the corporations, the right of the Government to collect such taxes from corporate property took precedence over the right of the stockholder to continue to receive that property.

The varying definitions of insolvency, the diversity in reasoning which shades of difference in cases have elicited, and the controversy which has raged in regard to the “ trust fund doctrine,” indicate the improbability of any satisfactory all-inclusive general rule covering equitable liability. Yet, despite conflicting reasoning in opinions and texts, the decision of actual cases has not been so difficult. Therefore, in the final analysis, we must seek the decision of this case in its particular facts. These corporations have parted with their property and have gotten nothing in return which the Government can take for taxes. Instead, the consideration for the use of the properties under the agreement is to be paid directly to the stockholders, as if the corporations had been paid and had declared divi-¿lends. If the corporations had sold their properties at a taxable profit, the proceeds of the sales, paid by agreement to the stockholders, could be followed for the purpose of collecting the tax on the sale. Cf. United States v. McHatton, supra. So here, since no remedy is available at law to the Government, we think equity under the local law would follow the income from the properties into the hands of the stockholders and make it liable for the tax, because the stockholders have this property which ought to be applied to the payment of taxes of their corporation. Cf. Bartlett v. Drew, supra. We, therefore, hold that there is a liability in equity on the part of this stockholder to pay these taxes of the corporations from its retained share of the payments which have become due since the obligation to pay the taxes accrued. Cf. United States v. Updike, supra; United States v. Armstrong, 26 Fed. (2d) 227.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: Love :

text:
    Times-Picayune Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 48892, 49539.
    Promulgated December 9, 1932.

      Esmond Phelps, Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent.
   OPINION.

Love :

The sole question here involved is whether or not the annual payment by petitioner of $6,000, in the manner and for the purposes disclosed in our findings of fact, is deductible from gross income as an ordinary and necessary expense item, under section 234 (a) of the Revenue Act of 1926 (which is the same as section 23 (a) of the Revenue Act of 1928).

The evidence in the case clearly justifies the conclusion that petitioner was not actuated in making the payments herein described by philanthropic or charitable motives. It was a clear, cold-blooded business proposition on the part of the petitioner’s board of directors. They expected to get returns of value in dollars and cents. In their judgment it was a sound business proposition, and subsequent history seems to have proven the wisdom of their action.

While it is true that, when the question here involved is to be decided each case must to a very large extent be viewed separately and decided on its own merits, and no effort be made to lay down a general rule, yet we believe it may be safely stated that when the board of directors, in the exercise of their sound, conservative judgment, decide that an expenditure óf a sum of money will bring actual money returns to the corporation, though such returns may come to the corporation through indirect channels, we believe that such expenditures are within the purview and spirit of the statute and should be allowed as deductions. We believe such to be the clear import declared by the court in the case of Harris & Co. v. Lucas, 48 Fed. (2d) 187. In that case, the court, among other things, said:

It is evident that the words “ ordinary ” and “ necessary ” in the statute are not used conjunctively, and are not to be construed as requiring that an expense of a business to be deductible must be both ordinary and necessary, in a narrow, technical sense. On the contrary, it is clear that Congress intended the statute to be broadly construed to facilitate business generally, so that any necessary expense, not actually a capital investment, incurred in good faith in a particular business, is to be considered an ordinary expense of that business. This in effect is the construction given the statute by the Treasury Department and the courts.
While the Treasury Department has held as a general rule that only expenditures commonly recognized as operating expenses are deductible, the rule has been applied with great liberality, and practically any reasonable expenditure that has benefitted the business has been allowed to be deducted as an expense * * *.
*******
Of course, each case depends for decision upon its own facts, and it would be impossible to formulate a uniform rule to govern all cases. Generally speaking, business men should be free to exercise their ingenuity in devising methods of increasing business. This rebounds to the benefit of the government by creating more taxable income. Considering the above stated examples, it would seem clear by analogy that petitioner was entitled to deduct the amounts paid to its former creditors. It was under no legal obligation to make the payments, and they were made entirely to promote the business by restoring its credit with the wholesalers from whom it purchased goods.

Practically to the same purport is the case of American Rolling Mills v. Commissioner, 41 Fed. (2d) 314. Also Corning Glass Works v. Lucas, 37 Fed. (2d) 798; Rodeo-Vallejo Ferry Co., 24 B. T. A. 936, 941; Old Mission. Portland Cement Co., 25 B. T. A. 305.

Since the issuance of the deficiency notices here involved, the Commissioner has liberalized his policy with respect to such questions as here under consideration. See I. T. 2653, Internal Revenue Bulletin No. 44, dated October 31,1932, p. 6.

The deficiencies should be redetermined and the payment made by petitioner to Tulane University for each of the years 1927 and 1928 allowed as an expense deduction from gross income.

Judgment will l)e entered wider Rule 50.


author: Smith:

text:
    Edward E. Bradley, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56168.
    Promulgated December 9, 1932.

      G. Hadlai Hull, Esq., for the petitioner.

      C. G. Holmes, Esq., for the respondent.
   OPINION.

Smith:

In addition toi the principal issue the petitioner also alleged error with respect to the taxability of alleged capital gains upon sales of securities by the trustee, but no evidence has been offered regarding such sales and we have no basis upon which to make any determination with respect thereto.

The petitioner contends that the trust was established in 1923 for the purpose of providing for the dependent members of his family, and that he had no intention of ever designating himself as a beneficiary of the trust. He asserts that he has never received any of the income in question, the amount of which is not in dispute, and that the respondent has erroneously taxed this income to him under section 219 (h) of the Revenue Act of 1926. The petitioner submitted a statement of the income and disbursements of the trust fund for the purpose of showing to whom the income was paid. From this statement it appears that a considerable portion of the income in each year was added to the principal, and that the beneficiaries designated by the petitioner to share in his bounty each year received only such amounts as he deemed necessary for their support. It is to be noted that none of these persons was designated in the trust instrument as a beneficiary; Although the petitioner claims that the trust was established to take care of his dependents, and the facts show that he had other income more than ample in amount to provide for himself and wife, she nevertheless received the largest share of the distributed income during the taxable years.

The respondent’s action in taxing the income of this trust to the petitioner is sustained. There is nothing in the trust instrument to prevent the petitioner from designating himself as' the beneficiary. The petitioner had the right to dispose of the income of the trust as he saw fit, and during the taxable years before us designated the recipients of his bounty. The instant proceeding is controlled by Corliss v. Bowers, 281 U. S. 376, 378, wherein the Supreme Court said:

* * * if a man disposes of a fund in such a way that another is allowed to enjoy the income which it is in the power of the first to appropriate it does not matter whether the permission is given by assent or by failure to express dissent. The income that is subject to a man’s unfettered command and that he is free to enjoy at his own option may be taxed to him as his income, whether he sees fit to enjoy it or not. * * *

See also Grace Whitney Hoff, 20 B. T. A. 86. Cf. S. A. Lynch, 23 B. T. A. 435; Charles Kaplan, 26 B. T. A. 379; Sydney R. Bliss, 26 B. T. A. 962.

Judgment will be entered for the respondent-