author: Kern:

text:
    Estate of George H. Letz, Sr., Deceased, George H. Letz, Jr., Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99940.
    Promulgated December 16, 1941.

      R. L. P. Wallace Esq., and Joseph W. Zeller, Esq., for the petitioner.

      Olay O. Holmes, Esq., for the respondent.
   OPINION.

Kern:

As previously stated, the sole issue for our determination is whether the Commissioner correctly included within the taxable income of decedent for the period January 1 to February 25, 1936 (the date of his death), the total of certain amounts credited to decedent on the books of the Letz Manufacturing Co. prior to January 1, 1936, which credits were evidenced by negotiable notes payable on demand then held by decedent. As set forth in our findings of fact, part of this amount was attributable to back salary and interest thereon and the remaining $1,500 was by reason of a credit inherited from the estate of decedent’s sister.

At all times, except for a period of a few months in 1935, the amounts of these notes were subject to decedent’s demand for payment. The testimony of the manager of the Port Authority Branch of the National City Bank and John H. Letz, a responsible officer of the Letz Manufacturing Co., as supplemented by the books of that company, has convinced us that the notes held by decedent were at all times worth their face amount and could have been paid by the company on decedent’s demand at any time up until the date of his death, except for a short restricted period in 1935 not deemed material.

Petitioner, therefore, urges us to find that the various amounts credited to his decedent were constructively received by him in tne years when first credited to his account. This doctrine of constructive receipt is of importance only where taxpayers keep their books and report their income on a cash receipts and disbursements basis. If a certain income is made subject to his unqualified control within a taxable year, we say that that income was received by the taxpayer within the taxable year even though not reduced to possession until a later date. In tbe instant case the decedent could have had receipt upon demand. The corporation was solvent. Therefore, if the respondent had determined that decedent had constructively received from the corporation the amounts called for by the several notes in the years of their respective issue, we would have perforce sustained such a determination. John A. Brander, 3 B. T. A. 231; Chester M. Curry, 3 B. T. A. 237; John I. Chipley, 25 B. T. A. 1103; Corliss v. Bowers, 281 U. S. 376.

However, because of the latent equitable character of this doctrine of constructive receipt, we doubt whether under the circumstances of this case, petitioner can invoke its application. Alice H. Moran, Executrix, 26 B. T. A. 1154; affd., 67 Fed. (2d) 601.

We do not labor this point, for we feel that there has been mode than constructive receipt by decedent of the amounts evidenced by the notes. By a long standing regulation taxpayers are required to include in income notes received by them in payment for services to the amount of their fair market value. Regulations 94, article 22 (a)-4, which does not differ materially from prior regulations, provides as follows:

Notes or other evidences of indebtedness received in payment for services constitute income to the amount of their fair market value. A taxpayer receiving as compensation a note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as of the time of receipt the fair discounted value of the note at such time. Thus, if it appears that such a note is or could be discounted on a 6 percent basis, the recipient shall include such note in his gross income to the amount of its face value less discount computed at the prevailing rate for such transactions. If the payments due on a note so accounted for are met as they become due, there should be included as income in respect of each such payment so much thereof as represents recovery for the discount originally deducted.

The theory of this and similar regulations is that the taxpayer receiving a note having a fair market value has actually received as income something of value equivalent, to the extent of that value, to cash, which is just as includible in his income as cash would be. Estate of William B. Pratt, 7 B. T. A. 621. Its receipt is not a fiction, to be used as a juridical tool for the accomplishment of an equitable result, but is a factual reality.

In the instant proceeding, when notes payable to decedent or his order on demand were issued, representing credits on account of salary payable to him, decedent had not only constructively received the income but must be treated as having actually received cash to the extent of their fair market value, which we have found to be the face amount thereof. Estate of William B. Pratt, supra; Roswell Magill on “Taxable Income”, pp. 156, 157. The evidence discloses that the original negotiable demand notes were all issued prior to the taxable year, and, consequently, the amounts in question were properly in-cludible in decedent’s taxable income prior to the taxable period here before us.

Thus it is clear that decedent should have reported as income those credits in the years in which they first became subject to his unfettered command. This he did not do except in two instances, and those particular credits are not in issue. Since the amounts were properly taxable to the decedent prior to 1936 and all facts relative thereto were open to the Commissioner’s agents prior to 1936, the petitioner argues that section 42 of the Eevenue Act of 1936 has no applicability here. That section reads as follows:

SEO. 42. PERIOD IN WHICH ITEMS OE GROSS INCOME INCLUDED.
* * * In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period. [Emphasis ours.]

Whether or not petitioner is taxable depends upon the construction and effect of the italicized words of the statute. Thus it becomes necessary to ascertain the meaning of those words. The entire last sentence of section 42, set forth above, is relatively new. Section 42 of the 1934 and 1936 laws repeats the provision contained in the 1918 and subsequent laws that items of gross income shall be included in the return for the year in which the taxpayer receives them, unless, under his method of accounting, they should properly be accounted for as of a different period; and then adds the new matter set forth above. The section is one primarily concerned with accounting. The purpose behind and the reason for the addition of this new sentence to section 42 is probably best set forth in the report of the House Ways and Means Committee, 73d Cong. (1934), 2d sess., H. Kept. 704, p. 24, wherein it is stated that the courts have held that income accrued to a decedent on the cash basis prior to his death is not income to the estate, and under the law as it then existed, unless such income be taxable to the decedent, it would escape income taxation altogether. The Committee reported that section 42, therefore, had been drawn to require the inclusion in the income of a decedent of all amounts accrued up to the date of his death regardless of the fact that the taxpayer may have kept his books on the cash basis. Since no further purpose is attributed to the proposed addition in the subcommittee reports or the reports of the Senate Finance Committee or the Conference Committee, we conclude that the new matter was intended to apply to only one situation, that is, where income was accruable in the broad sense of the word by a decedent, who was on a cash basis, prior to his death, but was reduced to possession only after his death. Our interpretation of this section is substantiated by the words of the section itself: “if not otherwise properly includible in respect of such period or a prior period.”

^Respondent argues that the rationale of Helvering v. Enright, 312 U. S. 636, is that the intention of Congress in enacting section 42 was “to reach all income earned during the life of a decedent that would otherwise escape the income tax,” citing Helvering v. McGlue, 119 Fed. (2d) 167. The interpretation placed upon this quotation is unwarranted. When properly construed, in the light of its context, the words of the court, supra, should read “all income earned during the life of a decedent but not received by him * *

The words of the section itself preclude such an interpretation. It refers only to “amounts accrued.” Obviously, amounts received are not “amounts accrued.” Here, as we have shown, decedent actually received the items of income in years prior to his death. Section 42 further limits its application to “amounts accrued * * * if not otherwise properly includible in respect of * * * a prior period.” As we have shown, the items of income here involved were properly includible in decedent’s income in periods prior to the taxable period in which the date of his death fell.

Where the words of a tax statute limit its applicability it can not be argued that untoward circumstances make it applicable to the specific circumstances under which the lawmakers provided that it should be impotent.

There is a further point of controversy between the parties. The Commissioner included the amount of $35,707.04 in the decedent’s income tax return for the taxable period before us as representing the total of salary and interest credited to decedent on the company’s books on his death which had not been previously included in taxable income of the decedent. Petitioner claims that the total amount of salary and interest credited to decedent on the company’s books at his death which had not been previously included in income of decedent is not $35,707.04 but $31,456.71. We have concluded from the evidence that the total amount credited to decedent by the company on his death was $51,974.06, of which amount $1,500 was inherited by decedent and $3,096.68 represented decedent’s share in a certain bond issue which was transferred to the company. It appears that the respondent does not seek to include these latter two amounts within the unreported income claimed to give rise to the asserted deficiency, for respondent’s brief states that the issue involves only accrued salary and interest. The parties have agreed that income tax has already been paid on salary and interest in the amount of $15,920.67, included in the total amount credited to decedent at the time of his death. The bookkeeper for the company having testified that these were the only credits outstanding in decedent’s favor on the company’s books at his death, we conclude that respondent’s total is erroneous and accept the figures as proven by petitioner and set forth in our findings of fact. Since we have already determined the law to be in petitioner’s favor, however, this rejection of respondent’s determination is of no importance.

Reviewed by the Board.

Decision will he entered under Rule SO.

Sterni-iagen, Arundell, Black, Mellott, and Opper dissent.


source: Caselaw Access Project

author: Arundell : Murdock, Sternhagen, Harron,

license: Public Domain

text:
    Caroline Rosenheim, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104497.
    Promulgated December 17, 1941.

      Milton Rindler, C. P. A., for the petitioner.

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

Arundell :

Petitioner has moved to dismiss this proceeding on the ground that we lack jurisdiction.

Prior to May 22, 1933, petitioner resided at 2 West 86th Street, New York, N. Y. On May 22, 1933, petitioner moved from 2 West 86th Street to 225 Central Park West, New York, N. Y., where she has since resided. From May 22, 1933, to date, she has had no other residence or business address in New York, N. Y. Petitioner’s Federal income tax returns for the years 1935 to 1939, inclusive, which were filed with the collector for the third district of New York, showed her correct address, namely, 225 Central Park West, New York, N. Y. The collector for the third district of New York addressed a letter to her under date of March 7, 1938, at 225 Central Park West.

On June 7, 1940, respondent sent by registered mail a letter addressed to petitioner at 2 West 86th Street, New York, N. Y., reading in part as follows:

You are advised that the determination of the income tax liability of the Tobacco Products Corporation of New Jersey, 15 Exchange Place, Jersey City, New Jersey, for the taxable year ended December 31, 1935, discloses a deficiency of $3,051,085.43, income tax, as shown in the statement attached. $6,427.75 of the amount of the income tax deficiency, plus interest as provided by law, will be assessed against you as a transferee of assets of said Tobacco Products Corporation of New Jersey.

This letter was in due course returned to respondent undelivered by the postal authorities. On July 1,1940, this same letter was delivered to petitioner at her residence, 225 Central Park West, New York, N. Y., by an employee of the United States Bureau of Internal Revenue.

On August 31, 1940, petitioner filed with this Board a petition for redetermination of her liability as transferee of the assets of the Tobacco Products Corporation of New Jersey. In her petition, petitioner alleged that this Board was without jurisdiction to consider the cause on the merits on the ground that respondent did not send to petitioner a “proper notice of deficiency.” Petitioner alleged in the petition that she had not received a notice of transferee liability from respondent via the postal authorities, and that respondent’s letter had been delivered by hand.

On March 10,1941, petitioner filed a motion to dismiss the proceeding for lack of -jurisdiction of the Board to hear and determine the issues raised. The motion was based upon petitioner’s contention that the letter notifying petitioner of transferee liability was not sent by registered mail, as required by law.

The applicable provisions of the statute are section 272 (a) and section 311 (a) (1) and (e) of the Revenue Act of 1938. The pertinent portions of these provisions of the statute are set forth in the margin.

Petitioner contends that the letter which she received on July 1,1940, was not delivered by the United States postal authorities, and, accordingly, was not such a notice as would give the Board jurisdiction of this proceeding. In his memorandum of authorities filed at the hearing respondent stated that his “position is specifically this: That the important element' of the statutory procedure in obtaining jurisdiction of the Board of Tax Appeals is the determination of a deficiency by the Commissioner and the receipt of the notice of that deficiency by the taxpayer.”

The early case of Henry M. Day, 12 B. T. A. 161, is in point with this one on the facts. In that case the Commissioner sent a notice of deficiency to the taxpayer’s former address despite the taxpayer’s having filed documents showing another address. The notice was returned and was then delivered to the taxpayer by an employee of the collector. On motion of the respondent we dismissed for lack of jurisdiction, stating:

There is a vital difference, however, between a mailing and a manual delivery. The one is definitely provided for by the statute and is the notice of deficiency which gives us jurisdiction. The other is not provided for by the statute and it may well be that Congress intended, in providing for notice in a certain manner, i. e., by registered mail, to exclude all other forms as the condition precedent to our jurisdiction.

In John A. Gebelein, Inc., 37 B. T. A. 605, we held that we had no jurisdiction of a proceeding based upon a notice not sent by registered mail. In Estate of Charles Schmalstig, 43 B. T. A. 433, we reiterated the necessity of a registered mailing of the notice to the taxpayer as one of the prerequisites of our jurisdiction.

In the instant proceeding respondent sent the notice of transferee liability to petitioner’s former address by registered mail. We are of the opinion that respondent’s action fell short of compliance with the statute. The statute comprehends delivery, or at least an honest attempt to effect delivery, to the taxpayer at his last known address. We have construed the statute as requiring the Commissioner to notify the taxpayer by registered mail. It seems obvious that a letter received by the taxpayer other than by registered mail is not a notification of the taxpayer by registered mail.

Respondent relies upon Dilks v. Blair, 23 Fed. (2d) 831; Kay Manufacturing Co., 18 B. T. A. 753; Daniel Thew Wright, 34 B. T. A. 84; Bankers Trust Co., Trustee, 24 B. T. A. 10; and Whitmer v. Lucas, 53 Fed. (2d) 1006. In none of these was delivery effected by hand or in any way other than through registered mail. These cases, therefore, are not authority for the proposition that manual delivery, or any delivery other than by registered mail, is sufficient compliance with the statute.

Respondent also relies heavily upon Tyson v. Commissioner, 66 Fed. (2d) 160. That case is the only one cited by him which involves a nonregistered notice. There, however, the court sustained our dismissal of the proceeding for lack of jurisdiction on the ground that the letter which was sent to the taxpayer was not a notice of deficiency. In view of its holding in the Tyson case, the court’s language in the course of its opinion regarding the effect of registration can be accorded little weight.

Respondent argues that, in any event, such defects as might appear in the mailing of the notice were cured by the filing of the petition. We can not agree. In her petition, petitioner raised the question of jurisdiction and set forth the facts upon which she based her allegation. In this petitioner followed the procedure adopted in DeForest Hulburd, 27 B. T. A. 1123, and approved by the Supreme Court in Hulburd v. Commissioner, 296 U. S. 300. There the petitioners in their petition raised the question of whether they were the proper parties to receive a notice of transferee liability. The Supreme Court said that when the matter was raised by petition “the remedy available to the Commissioner was obvious and ample.” Here, as in the Hulburd case, the petitioner has not ignored the defect, but on the contrary has steadily insisted that there was no proper notice of deficiency.

Although respondent makes no point that the notice was sent to petitioner’s last known address, we are of the opinion that it was not. The respondent is required to exercise reasonable diligence in ascertaining the proper address to which to mail the notice. Welch v. Schweitzer, 106 Fed. (2d) 885. Here respondent mailed the notice to an address at which petitioner had not resided for more than seven years prior to the mailing. The fact that petitioner filed personal income tax returns for the years 1935 to 1939, inclusive, with the collector of the same district in which petitioner’s former address was located is an indication that respondent devoted little effort to the determination of petitioner’s last known address. Despite the fact that respondent’s dealings with petitioner prior to the letter which she received July 1, 1940, were as taxpayer and not transferee, it would seem that respondent should be held to a more strict standard of diligence.

Since a petition must be filed with this Board within 90 days after the notice of deficiency is mailed (section 272 (a) (1), Internal Revenue Code, the potential dangers of a holding that the Commissioner may dispense with notification by registered mail are obvious. In a case where the registered notification is returned undelivered to the Commissioner and the manual delivery to the taxpayer occurs after the 90 days have nearly run, the taxpayer’s right of petition to this Board would be seriously impaired. Such a right has been said to be a valuable one. Russell v. United States, 278 U. S. 181; Percy N. Powers, 20 B. T. A. 75.. Moreover, it is at least doubtful whether we might have the power to extend the statutory period. Stebbins v. Helvering, 121 Fed. (2d) 892.

The motion of petitioner is granted and, accordingly, the proceeding must be dismissed.

Reviewed by the Board.

An order of dismissal will be entered.

Murdock,

concurring: The Commissioner does not contend that the first notice was sent to the “last known address” of the taxpayer. His point, as explained in the majority opinion, is that receipt of the notice by the taxpayer is sufficient. The taxpayer, under the circumstances of this case, was under no burden to show that the address to which the notice was sent was not the address last known to the Commissioner. The Commissioner makes no contention that it was the last known address. He refers to it merely as a “former address.” For these reasons I think the majority opinion is correct.

Sternhagen,

dissenting: Since the petition was filed within ninety days after the notice of liability was sent to the transferee by registered mail at her last known address, the Board must hear and determine the transferee liability. The prevailing opinion seems to take it for granted that 2 West 86th Street was not the last known address, and that the registered notice of June 7 was not the statutory notice. It then discusses the ineffectiveness of the later notice delivered by hand, and, finding that such notice was not sent by registered mail, as the statute requires, it holds that jurisdiction is wanting.- All the discussion of the ineffectiveness of the second notice is beside the point of jurisdiction. If that notice were the only notice, the authorities leave no doubt of the correctness of a dismissal of a petition based upon it. But the first notice was sent by registered mail and can not be disregarded.

It has not been shown that at the time the registered notice was sent 2 West 86th Street was not the then last known address of the transferee. Her individual income tax returns have nothing to do with this question, for it was not as an individual taxpayer that the petitioner was being addressed. She was being addressed as a transferee of the assets of the Tobacco Products Corporation of New Jersey, and presumably with whatever information the Commissioner had on hand the notice was sent to the last known address of such transferee. It is not reasonable to say that the Commissioner must check such information against the address of persons having the same name who may have filed individual tax returns in the same collection district, ascertain that such person is the transferee in question, and send the notice of transferee liability to the present address of such taxpayer. The statute makes no such onerous requirement. Even though there may be instances in which a transferee who has moved will find himself in difficulty, this is not such a case, and there is no reason to decide it as if it were.

The motion to dismiss should be denied.

Smith, Mellott, Arnold, Keen, and Opper agree with this dissent.

Harron,

dissenting: I believe respondent’s delivery of the transferee notice constitutes substantial compliance with the statute. If it is true that the notice which was mailed was not sent to the “last known address”, nevertheless the error was corrected and delivery was actually made to the last known address. It seems to me to be highly technical to hold that because the notice which had been mailed was later delivered (by hand) to the correct address, the statute is not met. There is no question here about the date from which started the ninety-day period within which a petition with this Board could be filed. The determination of the question at issue should not be affected by a deflection in the direction of some other question not present. To decide the question at issue in respondent’s favor does not predetermine a future decision of any other question. But, if the other question were also presented here, I believe it would not be illogical or outside the scope of a fair application of the statute to say that the date of delivery by respondent’s employee is that date from which the ninety-day period begins to run.

       SEC. 272. PROCEDURE IN GENERAL.
      (a) Petition to Board of Tax Apmals. — li in the case of any taxpayer, the Commissioner determines that there is a deficiency in respect of the tax imposed by this title, the Commissioner is authorized to send notice of such deficiency to the taxpayer by registered mail. Within ninety days after such notice is mailed (not counting Sunday or a legal holiday in the District of Columbia as the ninetieth day), the taxpayer may file a petition with the Board of Tax Appeals for a redetermination of the deficiency. * * *
      SEC. 311. TRANSFERRED ASSETS.
      (a) Method of Collection. — The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this title (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting claims and suits for refunds) :
      (1) Transferees. — The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this title.

        *******

      (eV Address for Notice of Liability. — In the absence of notice to the Commissioner under section 312 (b) of the existence of a fiduciary relationship, notice of liability eB-forceable under tbis section in respect of a tax imposed by this title, if mailed to the person subject to the liability at bis last known address, shall be sufficient for tbe purposes of this title even if such person is deceased, or is under a legal disability, or in tbe case of a corporation, has terminated its existence.


author: Hill :

text:
    George P. Skouras, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles P. Skouras, Petitioner, v. Commissioner of Internal Revenue, Respondent. Spyros P. Skouras, Petitioner, v. Commissioner of Internal Revenue, Respondent. Florence L. Skouras, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 103609, 103610, 103611, 103618.
    Promulgated December 17, 1941.

      Louis M. Weber, Esq., for tbe petitioners.

      Henry O. Glarh, Esq., for the respondent.
   OPINION.

Hill :

Prior to 1985 the Skouras Brothers Securities Co., a partnership of which the first three petitioners herein were members, acquired $600,000 principal amount of 6% percent convertible gold notes of Fox Metropolitan Playhouses, Inc., at a cost of $95,833.18. During the taxable year 1935, as a result of the reorganization of the corporation under section 77-B of the Bankruptcy Act, the partnership realized a gain upon the exchange of its convertible gold notes for certain securities of the new corporation and $120,000 in cash. Petitioners reported in their income tax returns their respective distributable shares of such gain to the extent only of the cash received by the partnership pursuant to section 112 (c) of the Revenue Act of 1934, on the theory that the 77-B reorganization resulted in nontaxable transfers within the meaning of section 112 (b) (5), or was a nontaxable reorganization within the meaning of section 112(g) (1) (C) of the 1934 Act, quoted supra.

Upon audit of petitioners’ returns, respondent held that the transaction constituted neither nontaxable exchanges nor a reorganization within the statute and that the entire amount of gain realized was subject to tax, and he computed the deficiencies upon the basis of a value of 67% for the new notes exchanged for the old, and a value of 6% for the class B stock. These valuations were called in question by petitioners, but from a careful consideration of all the evidence, we are unable to conclude that respondent’s bases do not reflect fair market value. We have, therefore, found as a fact that at the time of the exchange the securities had a fair market value in the amounts stated, and on this point we find for respondent.

The principal issue for decision is whether or not, under the facts set out hereinabove, the transaction constituted nontaxable transfers or a reorganization, within the purview of the taxing statute.

It is not necessary for a transaction to constitute a reorganization within section 112 (g) (1) in order to be a nontaxable transfer within section 112 (b) (5), but the same transaction may constitute both such transfer and reorganization. Claude Neon Lights, Inc., 35 B. T. A. 424, 439.

To constitute a nontaxable transfer, it must appear that “property” was transferred to a corporation by one or more persons by prearrangement solely in exchange for stock or securities of the transferee corporation, and that immediately after such exchange the transferors collectively were in control of the corporation through ownership of not less than 80 percent of the voting and all other classes of stock (sec. 112 (h)). Also, in the case of an exchange by two or more persons it must appear that the amount of stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. However, coownership of transferred property is not essential, and the several transfers need not be effected simultaneously if pursuant to a prior arrangement; nor is control of the new corporation required to be vested in the transferors in proportion to their interests in the property prior to the exchange; this latter requirement pertains only to the total value of stocks and securities received. F. L. G. Straubel, 29 B. T. A. 516; cf. Edwin L. Dana, 36 B. T. A. 231; Portland Oil Co. v. Commissioner, 109 Fed. (2d) 479; certiorari denied, 310 U. S. 650, affirming 38 B. T. A. 957.

It is, furthermore, now well settled that money is “property” within the meaning of that term as used in section 112 (b)(5). Halliburton v. Commissioner, 78 Fed. (2d) 265; Claude Neon Lights, Inc., supra; Portland Oil Co. v. Commissioner, supra. In the Halliburton case the court remarked:

We think it is clear that the statute comprehends a situation such as presented in the instant case where certain persons transfer to a corporation certain property and property rights, other than money, while others transfer money only, and stock in the corporation is issued in exchange for such transfers.

The facts of the present proceedings bring them squarely within the foregoing rules, which have been applied in many similar cases. Those facts, briefly summarized, show that Fox Metropolitan Playhouses, Inc., the old corporation, was insolvent and a reorganization proceeding under section 77-B of the Bankruptcy Act was duly instituted. A plan of reorganization was submitted to the court, and, in the order confirming the plan and directing that it be carried out, the court stated that the debtor corporation was insolvent and hence acceptance of the plan of reorganization by its stockholders was not requisite to confirmation. Pursuant to the plan as carried out, a new corporation, Metropolitan Playhouses, Inc., was organized, with an authorized capital stock consisting of class A and class B shares. The holders of the Qy2 percent convertible gold notes of the old corporation received, in exchange for each $1,000 principal amount of such notes, one 5 percent debenture in the principal amount of $550 and four shares of class B stock of the new corporation, plus $200 cash. The voting rights of the class A stock were subject only to the limited rights of the class B stockholders to elect not more than three of the nine directors of the new corporation. By direction of the bankruptcy court, the assets of the old corporation were transferred to the new, but neither the old corporation nor its sole stockholder, Fox Theatres Corporation, received any recognition in the reorganization.

United Artists paid $425,000 cash for one-half of the class A stock and the other half of such stock was placed in escrow with the bank under an option agreement, which apparently finally resulted in the acquisition of the stock by United Artists.

Thus, in any event, the noteholders of the old corporation transferred property (convertible gold notes) to the new corporation in exchange for stock and securities (all of the authorized and issued class B stock and 5 percent debentures), plus cash. The mortgaged assets of the old corporation were transferred by order of the court to the new corporation, and constituted the security behind the 5 percent debentures. United Artists transferred property (money) to the new corporation in exchange for 50 percent of the authorized class A stock, which was all of the issued and outstanding stock of that class. A certificate for the remainder of the authorized class A stock was from its incipiency in escrow under an option agreement which forestalled its delivery until and unless such option should be exercised. It appears, therefore, that immediately after consummation of the transaction, the transferors collectively were in control of the new corporation through ownership of 100 percent of its issued class A and class B stocks, which comprised the only two classes of stock authorized.

The noteholders owned all of the equity in the properties of the old corporation, and it was those properties which gave the new corporation substance. Although the properties were not transferred to the new corporation directly by the bondholders, nevertheless they were transferred to the new corporation by order of the court solely for the benefit of the noteholders, and this circumstance, together with the fact that United Artists transferred money to the new corporation in exchange for stock, brings the transaction within section 112 (b) (5), if the amounts of the securities received by the transferors were substantially in proportion to their respective interests in the properties prior to exchange, which latter point will be discussed below.

In respect of the transfer of the mortgaged property of the old corporation to the new corporation under order of the court in the 77-B reorganization, the present proceedings are not distinguishable on the facts from Commissioner v. Cement Investors, Inc., 122 Fed. (2d) 380. In that case it was held that the bondholders for whose benefit the transfer was ordered and made were transferors of the property within section 112 (b) (5). The court in its opinion said:

The holders of Industrial’s bonds were entitled to a satisfaction of their indebtedness from the mortgaged property, or a statutory substitute therefor under § 77 B. They had acquired equitable rights in the property and were entitled to have it disposed of under a plan fair and equitable to them. * * * Since no equity remained in the properties for the preferred and common stockholders, the properties passed under the jurisdiction of the court empowered to make fair and equitable disposition thereof for the benefit of the bondholders. In the exercise of that jurisdiction the bankruptcy court ordered the equitable rights and interests of the bondholders in the properties to be transferred to the Colorado Corporation in exchange for stock and bonds of that corporation. Pursuant to the order, all of the assets of Industrial and the Colorado Company were transferred to the Colorado Corporation. In substance, Industrial’s bondholders were the transferors.
*******
Hence, the property was transferred to the Colorado Corporation solely in exchange for stock and securities of such corporation and immediately after the transfer the bondholders, the transferors, were in control of the Colorado Corporation, owning all of its stock, and no gain or loss should be recognized by reason of the provisions of § 112 (b) (5).

The only remaining question which, merits consideration is whether or not the amount of securities received by each transferor was substantially in proportion to his interests in the property prior to the exchange. Petitioners on brief present an elaborate argument to demonstrate such proportionate interest, but their discussion involves analysis of a number of complex factors, including fair market values of stocks, securities, and assets extremely difficult to appraise. Without attempting a detailed analysis of such factors, we are convinced from the record that the statutory requirement on this point has been met. In respect of the money exchanged for class A stock by United Artists, a corporation which theretofore had had no interest in the old company, it seems self-evident that the stock received in exchange was substantially in proportion to the interest of United Artists in the money prior to such exchange. There is nothing in the record to suggest that the purchase of this stock by United Artists was at a price other than its fair value.

In respect of the class B stock and 5 percent debentures received by the noteholders of the old corporation in exchange for the 6% percent convertible gold notes, it seems equally apparent that the new securities received in exchange were substantially in proportion to the interest of each in the old notes prior to the exchange, since each received, on the basis of $1,000 principal amount of the old notes, precisely the same amount of new securities and cash, and the mortgaged assets behind the old notes were transferred to the new company and constituted the security for the new debentures under the same mortgage lien. Furthermore, it appears that the plan of reorganization was worked out to the satisfaction of the various adverse and conflicting interests, each striving to drive the best possible bargain,r and was consummated under the direction and with the approval of the bankruptcy court.

We hold that the transaction in controversy constituted transfers within section 112 (b) (5), supra, and hence did not give rise to gain recognizable for tax purposes in excess of the cash received by the transferor noteholders. The respective shares of such cash distributable to petitioners by the partnership were reported in their returns, and are not involved here. This conclusion renders it unnecessary to consider whether or not the transaction also was a nontaxable reorganization within the meaning of section 112 (g) (1), supra.

On the issue submitted for decision, respondent’s determinations are disapproved.

Decisions will he entered under Rule 50.


author: Opper: Smith,

text:
    Falmouth Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Tar Products Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Dockets Nos. 104454, 104455.
    Promulgated December 17, 1941.

      John E. MaOlure, Esq., for the petitioners.

      'William A. Schmitt, Esq., for the respondent.
   opinion.

Opper:

Respondent determined the following deficiencies in petitioners’ income tax liability for the year 1936:

The single issue in each proceeding is whether a dividend, declared during the tax year, is taxable to petitioners who are on the accrual basis. All the facts in each proceeding have been stipulated and as so stipulated are hereby adopted as our findings. The stipulation in its entirety is as follows:

1. The Petitioner,, Tar Products Corporation, .was incorporated under the laws of the State of Rhode Island on July 2, • 1920, with its principal office at the Industrial Trust Building, Providence, Rhode Island, but with its general office in the Koppers Building, Pittsburgh, Pennsylvania. The returns for the year here in question were filed with the Collector of Internal Revenue for the 23rd District of Pennsylvania.
2. On December 1, 1936, the- Petitioner owned 57,940 shares of common stock of Brooklyn Union Gas Company, a domestic corporation. On October 22, 1936, the said Brooklyn Union Gas Company declared a cash dividend of 75 cents a share, payable on January 2, 1937, to stockholders of record at the close of business on December 1, 1936.
3. The total dividend payable on the. said 57,940 shares of common stock on January 2, 1937, amounted to $43,455, and the dividend check was delivered to the general post office at Brooklyn, New York on December 31, 1936, for delivery to the stockholder on January 2, 1937, and was actually received on January 2, 1937, at the petitioner’s principal office in Providence, Rhode Island.
4. On December 22, 1936, the Petitioner transferred the foregoing common stock and other property to Esmont Company, a Delaware corporation, for all of its capital stock.
5. The said dividend of $43,455 was reported as 1937 income by Esmont Company and taxes paid thereon. Said taxes so paid have neither been credited nor refunded by the Respondent.
6. The Respondent, in determining the deficiency, added the said dividend to the taxpayer’s 1936 income.
7. At all times material, the taxpayer kept its books and made its tax returns on the accrual basis of accounting.

This proceeding was originally determined by a memorandum opinion, but the form which the disposition of the matter now takes makes appropriate some amplification of what was there said.

The case was designed to raise a specific question. Counsel in drafting the stipulation “knew what the legal question, the sharp legal issue was and we attempted to frame the issue consistent with the facts so that there would be no mistake about that.” The question, stated in terms of petitioners’ contention, is “that dividends are income only when the cash or. other properties are un-qualifiedly made subject to the demands of the stockholder, irrespective of the method of accounting; and that this rule is adopted as an exception to both the accrual and cash bases.”

Respondent’s regulations contain a provision of long standing that “A taxable distribution made by a corporation to its shareholders shall be included in the gross income of the distributees when the cash or other property is unqualifiedly made subject to their demands.” Regulations 94, article 115-1. It is this statement upon which petitioner relies. The regulation was apparently inspired by Revenue Act of 1921, section 201 (e). But both statute and regulation show that they are statements of the constructive receipt doctrine obviously limited to cash, basis accounting. In Cecil Q. Adams, 20 B. T. A. 248, 245, this Board had occasion to review the legislative history of section 201 (e). It said in referring to the background for the failure to include a similar provision in the 1924 Act:

* * * The report of the Ways and Means Committee and that of the Finance Committee state that this broad provision was inserted in place of the narrow one contained in section 201 (e) of the Revenue Act of 1921, and that it is the rule which would be followed without an express statutory provision. But the sentence was stricken from the bill by an amendment and the House Managers made this comment:
Amendment No. 43. The House bill provided that items of gross income should be considered to be received in the taxable year in which they are unqualifiedly made subject to the demands of the taxpayer. This provision was designed to require dividends, bond interests, and salaries, such as drawing accounts, to be included in income when subject to demand by the taxpayer even though not actually received in cash by him. Since this is the rule which is and should be followed in such cases in the absence of a statutory provision, the Senate amendment strikes out the provision and the House recedes.

See also Mary Miller Braxton, 22 B. T. A. 128.

Confirmation of a similar conclusion as to the regulations appears from related provisions, particularly article 41-2, providing “A method of accounting will not, however, be regarded as clearly reflecting income unless all items of gross income and all deductions are treated with reasonable consistency. * * * A taxpayer is deemed to have received items of gross income which have been credited to or set apart for him without restriction”; and article 42-3, entitled “Examples Of Constructive Keceipt”, which includes the statement that “Dividends on corporate stock are subject to tax when unquali-fiedly made subject to the demand of the shareholder.”

We think it evident therefore that these references to dividends were not intended to distinguish that form of income from others such as interest and drawing accounts, but merely to give effect to the recognized principle of constructive receipt. That doctrine can have no application to an accrual basis taxpayer whose liability to tax results not from turning his back upon income which he can receive for the asking, John A. Brander, 3 B. T. A. 231, but from the right to receive the income regardless of its immediate availability. Spring City Foundry Co. v. Commissioner, 292 U. S. 182. “The doctrine of constructive, receipt here involved implies complete dominion of the property in question and therefore goes far beyond the mere accrual of the right to such property.” Cox Motor Sales Co., 42 B. T. A. 192. “Unless this doctrine of constructive receipt is kept within the penumbra of actual receipt it will invade the field, of accrual accounting, and this should not be permitted.” I. M. Cowell, 18 B. T. A. 997.

We are accordingly of the opinion that the regulation upon which petitioners place exclusive reliance is without relevance to the present facts. It does not alter the result that to a taxpayer “on the accrual basis dividends will be taxable ordinarily in the year in which they are declared”, Mertens “Law of Federal Income Taxation”, 1939 Cumulative Supplement, 248 (note), on the theory that income is accruable for tax purposes when the right thereto becomes fixed, Archer Maynard Campbell, 6 B. T. A. 60, and that dividends by their declaration become a corporate liability, Helvering v. McGlue's Estate (C. C. A., 4th Cir.), 119 Fed. (2d) 167; Estate of Lewis Cass Ledyard, Jr., 44 B. T. A. 1056, 1066, citing Archer Maynard Campbell, supra; at least under the apparently applicable New York law. Estate of Henry W. Putnam, 45 B. T. A. 517. Certainly we can not say that dividends are automatically to be treated as in a class apart from other income, or that they are necessarily to be reported only when subjected to the command of the shareholder, alike in accrual and cash basis systems. On the narrow question presented to us we must hold in the negative.

Be viewed by the Board.

Decision will be entered for the respondent..

Smith,

dissenting: The rule of the Board in this case is contrary to the regulations of the Commissioner, which' have stood for more than 20 years.

By the Bevenue Acts of 1916 and 1917 “dividends” are defined to mean “any distribution made or ordered to be made by a corporation.” By the Bevenue Act of 1918 and all subsequent revenue acts the term “dividend” has been defined to mean “any distribution made by a corporation to its shareholders or members.” By article 1541 of Begulations 45 (1920 Ed.) it is provided: “The mere declaration of a dividend is not a distribution.”

Under all of the revenue acts it has been important to determine when a dividend became taxable income of the stockholder. For the rates of tax upon net income have varied from year to year. And under the Bevenue Act of 1918 dividends declared but not paid were held to be includible in the invested capital of the declarer up to the “date when the dividend is payable.” See article 858 of Begulations 45.

The Commissioner’s regulations early provided that dividends were includible in the gross income of a stockholder when they were made available to him. Article 1541 of Begulations 62, promulgated under the provisions of the Bevenue Act of 1921, provides in part: “A taxable distribution made by a corporation to its stockholders or members shall be included in the gross income of the distributees when the cash or other property is unqualifiedly made subject to their demands.” This regulation, with unimportant changes in phraseology, has been in effect from the Revenue Act of 1921.

In the prevailing opinion it is stated:

* * * The regulation [quoted above] was apparently inspired by Revenue Act of 1921, section 201 (e). But both statute and regulation show that they are statements of the constructive receipt doctrine obviously limited to cash basis accounting. * * *

I can not subscribe to this view. In my opinion the rule was prompted by more fundamental considerations, among which are (1) that a dividend is defined by the income tax acts as a “distribution made” by a corporation and that no distribution takes place from a mere declaration of the dividend; (2) that stockholders often do not know the date of the declaration of a dividend; (3) that in ordinary commercial accounting practice stockholders both on the cash and the accrual basis take into income dividends as of the date of payment ; (4) that on sales of shares of stock between the date of declaration and the record date for closing the books the purchaser receives the dividend and the gain reported on the sale is the excess of the sale price over the cost; and (5) that for some years corporations paying dividends have been required to file information returns showing the amounts of dividends distributed to each stockholder, which information returns have been used by the Commissioner for the purpose of verifying the returns of the stockholders.

Does a taxpayer derive taxable income from the declaration of a dividend? Since by the statute a dividend, is defined as a distribution and since under the Commissioner’s regulations the mere declaration of a dividend does not amount to a distribution, clearly a taxpayer is not taxable in respect of dividends declared but not received.

In Montgomery’s Income Tax Procedure (1920), p. 450, it is stated:

* * * Very few stockholders have available or trustworthy information as to when dividends are declared. Their records show only the receipts of dividends.
In view of the definite statements in articles 31 and 1541 [Regulations 45] taxpayers should assume that the date of the receipt of a dividend is the date as of which it should be reported.

There is no suggestion in the statement made by this accounting authority that a taxpayer on the accrual basis is- to report dividends differently from one upon the cash basis.

I am informed and believe that it is ordinary commercial accounting practice for stockholders on the accrual basis, as well as those on the cash basis, to take into income dividends as of the date of payment or of receipt. That is strictly in accordance with regulations of the Commissioner which have been in effect for more than 20 years, and I think that this is the rule generally followed by all taxpaying stockholders. .

If the rule of the Board as enunciated in the majority opinion is the correct rule, then a taxpayer on the accrual basis may be required to include in income dividends which he has not received and may never receive. Assume, for instance, that a man on the accrual basis owns shares of stock on which dividends of $1,000 are declared on December 20, 1931, payable on February 1, 1938, to stockholders of record on January 15, 1938. Assume that he sells the shares of stock on January 2, 1938, at a profit. The -entire amount of that profit represented by the difference between the sale price and the cost may be taxable as capital gain. By the rule of the Board in this case such a taxpayer is required to include in his income for 1937 the $1,000 dividend which he has not and never will receive and clearly in 1938 is taxable upon his full capital gain. Was such a result ever contemplated by the Congress?' It surely was not contemplated by the regulations.

Undoubtedly, however, the most important consideration for the regulation was to enable the Commissioner to verify the tax returns of stockholders by the information returns of dividend payments made by a dividend paying corporation. This check will not be possible under the rule announced by the Board in this case.

That the Commissioner’s regulations were intended to apply to all stockholders, whether on the cash receipts and disbursements basis or on the accrual basis is apparent from his action with respect to the Board’s opinion in the case of Archer Maynard Campbell, 6 B. T. A. 60. The question presented by that proceeding was whether a taxpayer keeping his books of account upon the accrual basis and “consistently” including in gross income dividends according to the date of declaration could make his income tax returns upon the basis of his books of account. The Commissioner held that he was not entitled to accrue the dividend according to the date of declaration, but must wait until the dividend was paid to him or was made un-qualifiedly subject to his demands. The Board held, however, that his books of account correctly reflected his income. The Commissioner published his nonacquiescence to the rule. The only possible ground for such nonacquiescence was that it was contrary to his regulations. It should be noted, however, that the Board did not lay down the rule which is laid down in this case, that because the taxpayer was on the accrual basis he was required to include in his gross income dividends declared on his shares of stock. All that we held or intended to hold was that his books of account kept “consistently” upon the basis on which they were kept correctly reflected his net income. That is a far cry from a ruling that a taxpayer keeping his books upon the accrual basis must include in gross income dividends which have been declared upon his shares of stock, regardless of the date of payment.

In United States v. Woodward, 256 U. S. 632, it was held in connection with an estate tax payment that the word “accrued” means “became due.” In United States v. Anderson, 269 U. S. 422, the Court pointed out that in the Woodward case it did not have before it the question as to the correct basis of reporting where books of account were kept on some basis other than the cash basis. It stated that the purpose of section 13 (d) of the Revenue Act of 1916 was to permit taxpayers keeping accounts upon some basis other than that of actual receipts and disbursements to make returns upon the basis of such books of account unless that basis did not clearly reflect their income.

It is apparent from a careful study of the opinion of the Supreme Court in United States v. Anderson, supra, that it was not the intention of the Court to lay down any hard and fast rule as to what should constitute items of income and items of deduction where taxpayers kept their books of account and made their returns upon the accrual basis. This fact has also been recognized from the first by the Commissioner’s regulations. Under the law and under his regulations, taxpayers selling personal property on the installment basis and keeping their books so as to reflect income upon collections from such sales are permitted to report on that basis, and corporations keeping their books on, a completed contract basis are permitted to report on that basis.

It is the practice of most large corporations, such as the Brooklyn Union Gas Co., to declare dividends payable as of a certain date to stockholders of record of an intervening date. Where a taxpayer keeps its books of account by consistently accruing dividends as of the date of declaration or of the record date or of the payment date, the books of account may correctly reflect income. By permitting corporations to make their income tax returns upon the basis of their books, it was not the intention of Congress to “straight jacket” corporations on the accrual basis and make them accrue income on a different basis from that which they have consistently followed.

In Montgomery Tax Handbook (1941), p. 294, the following occurs:

When Do Dividends Accrue? Sec. 19.115-1, Reg. 103, suggests that dividends do not accrue before they are payable to the distributees, i. e., “when the cash or other property is unqualifiedly made subject to their demands.” * * * In Campbell (6 B. T. A. 60) the Board held, under the 1921 Act, as to language in iliat Act similar to tbe quoted language in Sec. 19.115-1, Reg. 103, that in the case of a taxpayer on the accrual basis a dividend declared in the taxable year but not payable until the following year was to be included in income of the taxable year. It is to be assumed in such cases that the “record date” must fall within the taxable year.

This indicates that the author was of the opinion that the Commissioner’s regulations now in effect require the accrual of dividends according to the date “when the cash or other property is unqualifiedly made subject to their demands.” It is to be noted, however, that he assumes that in such case the “record date” must fall within the taxable year. There is nothing in the majority report to support that proposition.

It is also pertinent to note that in Avery v. Commissioner, 292 U. S. 210, the Court interpreted the regulations of the Commissioner consonant with the views herein expressed.

In my opinion the Commissioner’s regulation which requires taxpayers to take into gross income dividends when unqualifiedly made subject to the stockholders’ demands is not ambiguous. It applies to all stockholders, regardless of the basis of accounting used by such stockholders.

By many Supreme Court decisions it has been held that a regulation of tbe Treasury Department, which interprets a statute in force for many years during which the Congress has passed successive income tax acts which did not abrogate the regulation, has the force and effect of law. See Helvering v. Reynolds Tobacco Co., 306 U. S. 110. That is the situation here.

I am further of the opinion that the fact that a dividend is declared by a corporation and that the corporation thereby becomes obligated to pay the dividend does not make the stockholder on the accrual basis the recipient of a taxable dividend from the date of declaration. Where a lessor demises property for a term of years, the lessee to pay the rental monthly, it can not be said that the lessor derives taxable income from the date the lease is executed of all rentals to be received in the future. No more can it be said that a stockholder on the accrual basis derives taxable income from the mere declaration of a dividend where his consistent practice has been to report them as accrued when made unqualifiedly subject to his demands, which ordinarily is on the date for payment.

The Commissioner’s regulations for a period of more than 20 years have consistently provided that dividends are to be taken into income when made unqualifiedly subject to the demand of the stockholder. Such a regulation has the force and effect of law.

I respectfully note my dissent.

ARNOLD and Hill agree with this dissent.

       In the consolidated proceeding of Falmouth Co. the following appears in place of paragraphs 4 and 5 :
      “The Petitioner reported the said dividend of $37,500.00 as taxable income on its 1937 return and paid taxes thereon. Said taxes so paid have neither been credited nor refunded by the Respondent.”

       Respondent’s counsel at the hearing.

       Petitioners’ reply brief.

       (e) For the purposes of this Act, a taxable distribution made by a corporation to its shareholders or members shall be included in the gross income of the distributees as of the date when the cash or other property is unqualifiedly made subject to their demands.


author: Arnold :

text:
    Zimmerman Steel Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103784.
    Promulgated December 17, 1941.

      Charles Blair, Esq., B. 8. Damis, C. P. A., and L. 8. Mwrohie, C. P. A., for the petitioner.

      Angus R. Sharmon, Jr., Esq., for the respondent.
   OPINION.

Arnold :

The respondent disallowed the deduction of accrued interest taken by petitioner in 1936 and 1937. His reason for so doing, as stated in the statement attached to the deficiency notice, was that there was no reasonable expectancy in 1986 and 1937 that the accrued interest would be paid by petitioner.

The petitioner contends on brief that the absence of reasonable expectancy of payment is an affirmative defense, and, not having been pleaded by respondent, he can not avail himself of such defense.

In the petition it is alleged that the respondent erroneously failed to allow proper deduction from gross income for 1936 and 1937 interest accrued on notes' and advances payable to the Bettendorf Co. The respondent denied error in this respect. The issue is petitioner’s right to the interest deduction. The burden of pleading and proof to establish its right to the deduction claimed is upon the petitioner. Brown v. Helvering, 291 U. S. 193; Welch v. Helvering, 290 U. S. 111; Burnet v. Houston, 283 U. S. 223. The reasons given by the respondent for his action “do not constitute or confine the issues.” James P. Gossett, 22 B. T. A. 1279, 1284; affd., 59 Fed. (2d) 365; rehearing denied, 60 Fed. (2d) 484; John I. Chipley, 25 B. T. A. 1103; Standard, Oil Co., 43 B. T. A. 973 (on appeal, C. C. A., 7th Cir.).

At the hearing counsel for petitioner in his opening remarks stated in part that it was the position of petitioner (1) that even if there was no reasonable expectancy of paying the interest, it would still be deductible because the petitioner was on an accrual basis and (2) that the petitioner denied that there was no reasonable expectancy that the interest would be paid. A stipulation of facts was entered into. In addition, counsel for petitioner adduced oral testimony bearing particularly on the question of whether there was a probability that the interest would be paid. No question was raised by the petitioner at the hearing as to any defects in pleading on the part of the respondent. Obviously, the petitioner had been fully and completely advised prior to the hearing as to respondent’s reason for. the disallowance of the interest deduction. • It can claim no detriment to its cause on that score.

Section 23 of the Revenue Act of 1936, in so far as applicable herein, provides that in computing net income there shall be allowed as a deduction “All interest paid or accrued within the taxable year on indebtedness.” If accounts are kept on an accrual basis, a deduction is to be taken in the year in which it is incurred, although payment is not presently due and although the amount has not been definitely ascertained. Brown v. Helvering, 291 U. S. 193. The books of petitioner were kept on an accrual basis. The Bettendorf Co. made various cash advances to petitioner over a period of many years. The amounts of such advances remaining unpaid each year from 1923 to 1937, inclusive, together with the interest due thereon, are set forth in our findings of fact.

The interest for 1936 and 1937 on such advances was $46,954.17 and $49,301.90, respectively, and these amounts were entered on the books of petitioner as accrued interest payable. There is no dispute about these facts. They were stipulated. Apparently the respondent does not question the legal liability of petitioner to the Bettendorf Co. for the advances and interest thereon or the amount of the obligation, or that petitioner kept its books on an accrual basis and was therefore entitled to make its returns on that basis. He contends, however, that the right to accrue an expense carries with it an expectation that it will be paid, and that the petitioner is not entitled to deduct the interest to arrive at net income, since it failed to show that during 1936 and 1937 there was a reasonable expectancy that the interest would or could be paid. In Helvering v. Russian Finance & Construction Corporation, 77 Fed. (2d) 324, the court stated:

The basis of the accrual system of accounting is that obligations incurred in the normal course of business mil be discharged in due course. United States v. American Can Co., 280 U. S. 412 * * *. This is a necessary assumption. * * * When books are kept on an accrual basis, a presently existing obligation which, in the normal course of events, the taxpayer is justified in believing he must fulfill, may be accrued. [Emphasis supplied.]

As to income items a similar rule is applied. The rule is that a taxpayer on an accrual basis is not required to report as income in his return an amount which he may never receive. In Corn Exchange Bank v. United States, 37 Fed. (2d) 34, it is stated:

* * * A taxpayer, even though keeping his books upon an accrual basis, should not be required to pay a tax on an accrued income unless it is good and collectible, and, where it is of doubtful collectibility or it is reasonably certain it will not be collected, it would be an injustice to the taxpayer to insist upon taxation.

To the same effect are Commissioner v. Brown, 54.Fed. (2d) 563; American Central Utilities Co., 36 B. T. A. 688; American Fork & Hoc Co., 33 B. T. A. 1139; Atlantic Coast Line Railroad Co., 31 B. T. A. 730; affd., 81 Fed. (2d) 309; certiorari denied, 298 U. S. 656. Principles pertaining to the accrual of income should also be applied to deductions. See Paul and Mertens, Law of Federal Income Taxation, § 11.75.

This rule was relied upon by the Bettendorf Co. and it did not accrue on its books or report the accrued interest payable to it from the petitioner as income in 1936 and 1937. It may be pointed out that the Bettendorf Co. relied upon the same rule for 1929 and 1930, claiming that the interest for such years was not reportable as taxable income because uncollectible. The Board as to those years on the facts presented held otherwise. Bettendorf Co., 34 B. T. A. 72. E. J. Bettendorf was president of both companies and he .and his brother owned a majority of the common stock of both. As president of the Bettendorf Co. he testified that, although the payment of the interest had not been forgiven, it was not accrued on the company’s books “because there was some doubt whether the full realization of the debt would be achieved.” As president of petitioner he testified that he entertained hopes that it would be able to pay the debt some day. It seems to us that in view of the evidence such hope or expectation of the payment of the debt and especially the accrued interest in 1936 and 1937 was founded on wishful thinking rather than on fact. From 1923 to 1937, inclusive, except 1928, 1929, and 1930, the petitioner operated at a loss each year as disclosed by its books. In 1935 the liabilities of petitioner (other than stock liability) exceeded its assets by the amount of $133,807.57. This excess of liabilities over assets increased in 1936 and 1937, in which latter year- the excess was over $193,000. At the end of 1935 the total indebtedness to the Bettendorf Co. amounted to $835,229.90, whereas the total assets as shown in petitioner’s balance sheets amounted to only $778,911.91. At the end of 1935 its total liabilities, other than stock liability, were $912,719.48. At the end of 1936 the total indebtedness to Bettendorf Co. was $882,-185.07 and the total assets were $765,766.91. At the end of 1937 the total indebtedness to Bettendorf Co. was $931,485.97, whereas the total assets were $780,501.08. Its total liabilities at the end of 1936 and 1937, other than stock liability, were $944,113.50 and $973,688.04, respectively. The petitioner is still operating, but whether it operated at a profit or a loss in 1938 to 1940, inclusive, does not appear from the evidence. Apparently it had no surplus funds, since the last payment on the indebtedness was made by petitioner during 1929. E. J. Bettendorf testified that the petitioner’s books of account showed a profit of $40,792.77 for the first four months of 1941 before deduction of Federal taxes. The showing of a profit in the first quarter of 1941 is no positive indication that the petitioner’s operations for that year will result in a profit for the year or that it can or will actually pay any part of its indebtedness. Bettendorf also testified that during the first four months of 1941 the petitioner operated at full capacity and that $24,000 of its sales represented purchases from the Bettendorf Co. If it then operated at capacity its profits will probably not increase substantially. Payments, if any, which might be made in 1941 by petitioner would undoubtedly be applied by the. Bettendorf Co. to the indebtedness accrued on its books in years prior to 1936 and 1937. The evidence does not, in our opinion, justify a belief that the interest accrued in 1936 and 1937 would ever be paid and certainly not in due course. Undoubtedly accounting practice required that the petitioner enter its liabilities on its books of account and show them in its balance sheets in order to reflect clearly and fairly its financial status. We are not, however, concerned herein with accounting practice. The question is petitioner’s right to the deduction claimed, which is governed by a Federal revenue statute. There is no inconsistency in- the determination of the respondent that petitioner had taxable income and his claim that it had no expectancy of paying the interest accrued in 1936 and 1937. Unless its assets were worth substantially more than shown on its books of account, its assets, plus the income determined by the respondent were substantially less than the amount of its total liabilities at the end of 1935.

Furthermore, it appears that beginning in 1927 the Bettendorf Co. accepted each year a note for $1 for the amount entered instead of renewal notes showing both the advances and accrued interest thereon, and in 1936 and 1937 did not accrue any interest on its books. These facts strongly indicate a forgiveness of the interest on the part of the Bettendorf Co., notwithstanding the statement of its president to the contrary. Under all the facts and circumstances it is our opinion that the interest accrued on the books of petitioner for 1936 and 1937 in the respective amounts of $46,954.17 and $49,-301.90 was not properly deductible within the meaning of section 23 of the Revenue Act of 1936', since there was no reasonable expectation of such obligation being discharged in the normal course of business. Cf. Lamm Lumber Co., 45 B. T. A. 1.

In Panhandle Refining Co., 45 B. T. A. 651, which also involved the right to interest deductions for 1936 and 1937 by debtor taxpayer engaged in the oil business, payments in large amounts on the indebtedness had been made by taxpayer to its creditor each year from 1919 to the close of 1937, the creditor accrued the interest on its books as income, the condition of taxpayer’s business was improving, its properties had doubled in value by 1936, increased in value in 1937, and at the time of hearing were in still better condition and of greater value, and its potential earnings were curtailed by proration or a limitation on production then in effect. As therein stated there was obviously no uncertainty as to payment. The case is therefore distinguishable.

The action of respondent in disallowing the items as deductions in 1936 and 1937, respectively, is therefore approved.

Reviewed by the Board.

Decision will he entered for the respondent.

Smith, Leech, Disney, and KeRN dissent.


author: Smith:

text:
    Securities Company of New Jersey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105049.
    Promulgated December 18, 1941.

      John A. Gonlin, G. P. A., for the petitioner.

      B. E. Transue, Esq., for the respondent.
   OPINION.

Smith:

In the determination of the deficiency the respondent included in the taxable income for 1937 “the fair market value of 18,018 shares of capital stock of New Jersey Realty Co. received during the taxable year 1937”, which value he “determined to be 12y2 cents a share at the time of receipt.”

In the petition it is alleged:

Respondent was in error in considering as a dividend tlie receipt by petitioner of 875 shares in reorganization, which respondent has otherwise officially held to have been a tax-free reorganization within the year 1937.

In the answer to the petition this allegation of fact is denied.

In the signed stipulation of facts filed in this case is the following paragraph:

A plan of reorganization occurred June 1, 1937, wherein the shareholders of Fidelity Union Title & Mortgage Guaranty Co. received shares in a new corporation, New Jersey Realty Co., which exchange respondent has recognized as a tax-free reorganization.

The 18,018 shares of capital stock of the New Jersey Realty Co. received by the petitioner in 1937 consisted of 875 shares received on the reorganization “which exchange respondent has recognized as a tax-free reorganization”, and 17,143 'shares of that stock received as a dividend.- Accordingly, we have two questions presented relative to the 18,018 shares of stock, the first of which is whether 875 shares were received by the petitioner in 1937 as a result of the tax-free exchange and, second, the fair market value of the 17,143 shares received as a taxable dividend.

Relative to the first question, we have no information as to the 875 shares except that the respondent has recognized them as having been received in a tax-free reorganization. It was apparently the intention of the parties to stipulate that the 875 shares in question were received in a tax-free reorganization. We therefore sustain the petitioner in its contention that the 875 shares were received in a tax-free reorganization and were improperly included by the respondent in taxable income.

Relative to the second point, the petitioner contends that the stock of the New Jersey Realty Co. had no fair market value when received by it in 1937. It contends that that corporation had a very large bonded indebtedness; that at the end of its first seven months of operation it had incurred an operating loss of $154,517.60, with no provision made for interest on its more than $8,000,000 of outstanding bonds; and that the evidence of a sale of only 2,157 shares of stock in 1937 at prices ranging from 12% cents per share to 25 cents per share in 1937 is no criterion of the value of a block of 17,143 shares.

It is to be noted, however, that the few sales that were made in 1937 were at a price of 12% cents or more per share; that the petitioner placed these shares upon its books of account at a value of 12% cents per share; and that the respondent has determined that that was their fair market value at date of receipt. In our opinion the evidence submitted by the petitioner does not overcome the presumption of the correctness of the respondent’s determination that the 17,143 shares had a fair market value at the date of receipt of 12% cents per share. We accordingly approve his determination.

In its petition to this Board the petitioner alleges error on the part of respondent as follows:

Omission to privilege as “credit” for computation of surtax under Section 14 and surtax under Section 351 the amount restricted as to dividend disbursement and set aside by petitioner to retire its outstanding bonded indebtedness.

On brief petitioner abandoned its claim for credit in the computation of tax due under section 14. Thus, there remains only the question whether petitioner is entitled to a deduction in the computation of personal holding company surtax. The applicable provision of the statute is section 351 (b) (2) (B) of the Revenue Act of 1936, as amended by section 355 of the Revenue Act of 1937, which provides in part as follows:

SEO. 355. UNDISTRIBUTED ADJUSTED NET INCOME.
For the purposes of this title the term “undistributed adjusted net income” means the adjusted net income (as defined in section 856) minus—
*******
(b) Amounts used or irrevocably set aside to pay or to retire indebtedness of any hind incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness.

With regard to this section the Senate Finance Committee reported as follows:

The word “irrevocably” is added to protect the revenue, so that amounts may not be set aside for retirement of debt, and deductions secured, although finally such amounts are never used to retire the indebtedness. [Senate Finance Committee Report, 75th Cong., 1st sess., S. Kept. 1242.]

At the close of the year 1937 petitioner’s board of directors duly resolved to set aside and use its entire profits for that year to pay and retire its outstanding bonded indebtedness. Thereafter, entries were made in petitioner’s general journal as of December 31, 1937, and with reference to the resolution, debiting to surplus and crediting to an account entitled “Provision for Retirement of 6% bonds November 1, 1942” the amount of $9,963.43. The petition raises the question whether the resolution and book entries entitle petitioner to the deduction under section 355 (b).

The statutory language is unmistakable and clear in meaning and we have no difficulty in applying it to the facts. The ordinary meaning of the word “irrevocable” is that the action referred to is incapable of being recalled or revoked; past recall. Webster’s New International Dictionary, 2d Ed. Unabridged. The evidence shows that the amount which petitioner claims to have set aside irrevocably actually remained completely subject to its dominion and control. No consideration was furnished for its action in making the resolution or credit by any other party. It does not appear that the profits in question were actually ever used to retire the bonds, nor were they in fact deposited in a sinking fund for that purpose. The book entries were entirely under the control of the petitioner and the credit could have been removed from its books at will. Under these circumstances it can not be said that petitioner irrevocably set aside its profits to retire its indebtedness.

It is also well to note that this case is distinguishable from Atlantic Land, Co., 43 B. T. A. 74. In that case we held that unrestricted book credits of a declared dividend to the accounts of individual stockholders constituted actual payment of the dividend within the meaning of section 27 (a) of the Revenue Act of 1936. In the instant ease the bondholders, or the trustee for the bondholders, could not have withdrawn any part of the amount alleged to have been set aside by petitioner. In no way can the book credit in the instant case be construed to have constituted a “payment” and the case is therefore not controlled by the rule of Atlantic Land Co., supra. We hold that the resolution of the board of directors and the book entries made with regard to that resolution do not entitle petitioner to a deduction under the provisions of section 355 (b) of the Revenue Act of 1937.

During the taxable year petitioner deposited with the Merchants & Newark Trust Co., as trustee for its bondholders, 10,000 shares of the capital stock of the Fidelity Union Trust Co. This deposit was made in accordance with the provisions of the indenture dated September 28, 1937, which expressly stated that the stock was to be deposited as additional security for the bonds, the maturities of which were thereby extended to October 1, 1947. The shares of stock deposited had a fair market value of $350,000. Petitioner contends that the deposit constituted an irrevocable setting aside of an amount to pay or retire its indebtedness within the purview of section 355 (b), supra, and claims that it is therefore entitled to the statutory deduction in computing its Title IA undistributed adjusted net income. The respondent relies npon article 355-2 (b) of Regulations 94, contained in chapter XXXV (A) added by Treasury Decision 4791, 1938-1 C. B. 83. That regulation provides in material part as follows:

(b) Amounts used or irrevocably set aside. — The deduction is allowable, in any taxable year, only for amounts used or irrevocably set aside in that year. The use or irrevocable setting aside must be to effect the extinguishment or discharge of indebtedness. * * *

The question thus presented appears to be one of first impression here. It is not necessary for us to pass upon the validity of the respondent’s regulations at this time. Those regulations may neither add to nor detract from the force and effect of the statute. We shall satisfy ourselves as to the applicability of the statutory provisions in the instant case.

It is clear from the original trust indenture, dated October 1, 1927, which provided for the issuance of the bonds as to which the deposit of additional security was made, that the bondholders were to have no recourse against the security except in the event of default in payment by the petitioner. Furthermore, title to the security was to remain in petitioner’s name until such default. After default in payment the stock was to be transferred to the trustee only if the trustee requested the action. It does not appear that a transfer of title to the trustee was ever made. The petitioner retained the right to receive all dividends on the stock and was entitled to all rights to subscribe declared upon it.

The petitioner also retained all voting rights in the stock. The original indenture further provided that, when the whole amount of principal and interest due on the bonds was paid and the company had performed all of its obligations under the indenture, then all interest of the trustee in the shares of stock would revert to petitioner.

These provisions of the original indenture were not modified or revoked by the 1937 extension agreement but, on the contrary, were expressly continued in effect. Thus, the petitioner, which is enjoying all the incidents of ownership, except that of free disposition, in the stock in question and may ultimately regain its complete interest therein, now claims that the stock was irrevocably set aside to pay or retire its bonded indebtedness. The fallacy in petitioner’s contention is at once apparent.

It does appear that the deposit of the stock was irrevocable in that petitioner could not voluntarily recall it. That alone, however, does not satisfy the conditions of the statute. The statute requires that an amount be irrevocably set aside to fay or retire an indebtedness. The agreements under which the deposit of security was made contemplated that petitioner would make the payments and that thereafter the security would be returned to it. The case is clearly one in which the amount set aside may never be used to retire the indebtedness. As indicated by the language of Senate Report 1242, supra, the statute permits no deduction in such cases.

The respondent is sustained on this issue.

Decision will be entered under Bule 50.


author: Smith: Murdock,

text:
    The Louisa Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104402.
    Promulgated December 18, 1941.

      J. 8. Seidman, Esq., and A. S. Fedde, G. P. A., for the petitioner.

      R. H. Transue, Esq., for the respondent.
   OPINION.

Smith:

The question presented is whether the petitioner is entitled to deduct from its adjusted net income for 1937, admittedly $158,594.80, the undistributed profits tax paid by the petitioner in 1937 in the amount of $10,387.42, for the purpose of determining the amount of the income upon which the personal holding company surtax is imposed.

At the hearing of this proceeding counsel for the respondent stated:

The Commissioner takes the position, while the sum of $10,000. [$10,387.42] may have been turned over to the Collector of Internal Revenue, merely the sum of five thousand-odd dollars [$5,909.68] constituted the payment of tax. The excess was mere deposit which the taxpayer might as well have put in a bank account with six percent interest. He is only entitled to the net amount of this deduction under this section. * * *

The petitioner; submits that since it made its tax return for 1937 on the cash receipts and disbursements basis it is entitled to deduct from its adjusted net income for 1937 the full amount of the undistributed profits tax for 1936 paid by it in 1937, viz., $10,387.42, and not merely the amount of its correct undistributed profits tax for 1936, viz., $5,909.68.

Section 41 of the Revenue Act of 1936 provides in material part as follows:

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. * * *

Section 356 of the Revenue Act of 1936, added by section 1 of the Revenue Act of 1937, provides in part as follows:

For the purposes of this title the term “adjusted net income” means the net income with the following adjustments:
(a) Additional Deductions. — There shall be allowed as deductions—
(1) Federal income, war-profits, and excess-profits taxes paid or accrued during the taxable year to the extent not allowed as a deduction under section 23; * * *

In Eckert Packing Co., 42 B. T. A. 1000, we said:

A taxpayer is not entitled to deduct the amount of tax paid in a given year if, prior to the final determination of his tax liability for such year, the amount paid is refunded or recovered. Bergan v. Commissioner, 80 Fed. (2d) 89; Leach v. Commissioner, 50 Fed. (2d) 371; Inland Products Co. v. Blair, 31 Fed. (2d) 867; Bohemian Breweries, Inc. v. United States, 27 Fed. Supp. 588; Joseph V. Horn, 23 B. T. A. 1131; Philip C. Brown, supra. [10 B. T. A. 1122); and see Lehigh Valley Coal Sales Co., 15 B. T. A. 1401. Similarly, a taxpayer is not entitled to deduct the amount of tax accrued in a given year, if, prior to the final determination of his tax liability for such year, the amount accrued is ascertained to be excessive, and then he is entitled to deduct only the correct amount of tax. See Elsie S. Eckstein, 41 B. T. A. 746, in which the Board stated in part as follows (p. 751) :
* * * In any event, however, we have consistently held that where in a given year a taxpayer takes a deduction which, prior to the final determination of his income tax liability for such year, is ascertained to be excessive only the correct amount will be allowed in the final determination of his income tax liability. Inland Products Co., 10 B. T. A. 235; affd., 31 Fed. (2d) 867; Mary W. Leach, 16 B. T. A. 781; affd., 50 Fed. (2d) 371; Joseph V. Horn, 23 B. T. A. 1131; J. B. Jemison, 18 B. T. A. 399; Beacon Coal Co., 9 B. T. A. 280; Producers Fuel Co., 1 B. T. A. 202.

Cf. E. B. Elliott Co., 45 B. T. A. 82; Security Flour Mills Co., 45 B. T. A. 671.

Although, in several of the cases above cited the taxpayers kept (heir books of account and made their income tax returns upon the accrual basis, that was not true in Mary W. Leach, 16 B. T. A. 781; affd. (C. C. A., 1st Cir.), 50 Fed. (2d) 371. The taxpayer in that case was on the cash receipts and disbursements basis. In 1922 the taxpayer paid a large estate tax. She claimed the deduction from her gross income of 1922 of the full amount of the estate tax paid. In 1928 she recovered a large part of the estate tax paid. The court held, affirming the Board, that the taxpayer was entitled to deduct from her gross income of 1922 only the unrefunded portion of the estate tax paid.

We think that the rule applied by the court in Leach v. Commissioner, supra, has equal application to the proceeding at bar. The year 1937 is the year with which we are concerned. That is the year in which the petitioner paid the undistributed profits tax for 1936. To the extent that the payment of the tax was in excess and has been refunded, the petitioner is not entitled to the deduction thereof. This is in accordance with the respondent’s determination.

Reviewed by the Board.

Decision will he entered for the respondent.

Murdock,

dissenting: This case further demonstrates the error of the rule established in the Elliott case, 45 B. T. A. 82.


author: Van Fossan :

text:
    Estate of Jay R. Monroe, Deceased, E. F. Britten, Jr., and W. G. Zaenglein, Executors, Petitioners, et al.
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 98216, 100249, 100952, 100953, 100960, 100961, 100962, 100963, 101429.
    Promulgated December 18, 1941.

      Edwin Bruce Hallett, Esq., and Kenneth Garread, Esq., for the petitioners.

      Arthur W. Garndwff, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Charles Pinnell; Estate of George Garrabrant, by Margaret C. Garrabrant, Executrix, and Margaret C. Garrabrant, Individually; J. Charles O’Brien; Charles Day Moulton; Louis McCloud and Minnie E. McCloud; Harry H. Thomas and Bessie J. Thomas, his wife; James C. Elms and Estate of Grace W. Elms, by James C. Elms, Alfred H. Corwin and Earl S. Johnson, Executors; Estate of John G. Zeller, Deceased, John E. Zeller and Savings Investment and Trust Company, Executors; and Estate of Abilene P. Zeller, his wife, Deceased, John E. Zeller and Savings Investment & Trust Company, Executors.

   •OPINION.

Van Fossan :

In their tax returns each of the petitioners claimed a deduction as a bad debt of the difference between the amount paid in cash for debenture bonds of the Elbamon Co. in 1931 and the amount received in 1935' in final distribution of its assets in complete liquidation.

As fully appears above, the Savings Co. was in financial difficulty because of the shrinkage in value of its assets. In order to eliminate from the Savings Co.’s holdings certain stocks in eleven leading New York City banks, which it was compelled by the New Jersey bank examiners to sell or to carry at a greatly reduced valuation, the petitioners and ten other directors of the Savings Co. organized the Elba-mon Co. The nineteen stockholders paid in cash $6,400 for their stock and also bought for cash at par debenture bonds of Elbamon totaling $633,600. Elbamon then borrowed $100,000 from the Savings Co. and, with the proceeds of the loan and the cash paid for its stock and bonds, bought the bank stocks for $737,626.96, the original cost price. Such stock had a market value of $172,489.60 at the time.

During 1932 and 1933 Elbamon sold the bank stock for $207,152.33 and reinvested the proceeds in industrial, public utility, and railroad securities. During its existence Elbamon concluded 127 transactions in securities.

In November 1932 H. E. Wilier was made president of the Savings Co. He insisted that Elbamon, which had been construed to be an affiliate of the Savings Co., cease functioning and be dissolved. After much objection from the stockholders they acceded to his demands and Elbamon was dissolved in February 1935. Its assets were distributed in July 1935, each stockholder-bondholder receiving 7.42+ percent of his investment as his final liquidating distribution.

Eespondent originally disallowed the deductions for failure of taxpayers to submit substantiating evidence. On brief he maintains that they are not allowable either as bad debts or losses and, in the alternative, argues that, if allowable as losses, the deductions are limited by sections 23 (j) and 117 of the Eevenue Act of 1934.

Petitioners, on brief, rely chiefly on the case of Robert Gaylord, Inc., 41 B. T. A. 1119. The reliance which petitioners place on the Gaylord case is obviously misplaced. The deduction in that case was allowed as an ordinary and necessary business expense of a corporation on facts differing greatly from those here present. Here the taxpayers are individuals and on the record it could not be held by any stretch of reason that the purchase of the bonds was an ordinary and necessary expense of their several trades or businesses.

The purchase of debenture bonds is usually motivated by investment considerations. It contemplates normally a situation in which there is a purchase at market price with reasonable expectation of profit either from interest or appreciation in value. The mere statement of the facts in the present cases suggests an abnormal situation. Nineteen persons paid $6,400 for Elbamon’s stock. These stockholders paid $633,600 for Elbamon income bonds when that company had no assets. The bonds were not secured by a mortgage or otherwise. Elbamon borrowed $100,000 from the Savings Co. and pledged all of its assets (including the bank stock to be acquired). At this point Elbamon had $740,000 in cash. Elbamon then paid $737,626.96 for the bank stocks, admittedly worth but $172,489.60. Thereafter, assuming as we must the priority of the rights of the Savings Co. as the pledgee of the assets over the rights of the bondholders, the debenture bonds had but $74,862.64 worth of assets behind them. The value of the debenture bonds, qua bonds, at the time of the purchase, could not have been in excess of the value .of its assets thus marshalled. This wide disparity between price and value suggests that the excess of the purchase price was not paid for an investment. The only reasonable inference is that the excess of price was paid for some other purpose. See Majestic Securities Corporation v. Commissioner, 120 Fed. (2d) 12, in which it was observed:

* * * It is clear from the stipulated facts that at the time the securities were acquired from the bank their market value was much less than their original cost and that the assets of the bank were depreciated proportionately. When the relation of petitioner’s stockholders to the bank and their resulting interest in the bank’s financial condition are considered in connection with this fact it is a reasonable inference that the payment of the excess over market value was for the purpose of improving the condition of the bank. If this be true the excess was paid “for a purpose other than the acquisition of the securities”, and such excess did not represent a part of the cost.

The reasoning of this case is pertinent here. The “other purpose” in the instant cases was to provide Elbamon with funds so that it in turn might relieve the Savings Co. of its investment in the stocks of several New York banks, the write-down or disposition of which stocks had been ordered by the bank examiner. Thus, looked at as an investment in Elbamon, the excess can not be said to be part of the cost of the debentures. It was a contribution or gift, with no reasonable expectation of recovery. If the corporate entity of Elbamon be overlooked, the excess might be said to be a contribution to the Savings Co., which company is still in existence. In neither view can petitioners find comfort. Thus it is that the excess expenditure can form no part of a bad debt deduction.

The question remains whether the bondholders are entitled to deductions in an aggregate amount measured by the difference between a cost equal to the net amount of Elbamon’s assets ($74,862.64) at the time of purchase and the amount received in liquidation ($47,499.88).

It would seem that such a deduction should be allowed. The corollary of the holding in Majestic SecwiUes Corporation, supra, is that to the extent that the payment was not a gift or contribution, i. e., in so far as it represented a payment for the bonds themselves and not for some other purpose, it was a true' cost of the bonds. This cost we find to be $74,862.64, the amount available to the bondholders if liquidation had taken place in 1931.

A further question arises however: Are petitioners limited by the provisions of section 117 respecting capital gains and losses? The answer to this question depends on whether petitioners come within the scope of section 117 (f). We have found as a fact that the bonds were, in the language of the statute, issued “in registered form.” We also hold that there was a “retirement” of the bonds within the meaning of that term in the cited section. See McClain v. Commissioner, 311 U. S. 527, where the Court observed, “it is plain that Congress intended by the new subsection (f) to take out of the bad debt provisions certain transactions and to place them in the category of capital gains and losses.” This holding requires the application of the provisions of section 117 to the deductions here involved. To the limited extent above indicated the deductions are allowed.

Decisions will be entered under Rule 50.

         SEC. 117. CAPITAL GAINS AND LOSSES.
      *******
      (f) Retirement of Bonds. Etc. — For the purposes of this title, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.