author: Tkijss3dll :

text:
    Leighton Supply Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5744.
    Promulgated May 26, 1927.
    Inventobies. — A merchandise inventory taken as of December SI, 1920, and priced according to manufacturers’ printed price list of June and July, 1920, is not an inventory at cost or market whichever is lower as of December 31, 1920. The petitioner’s revision of such inventory based upon actual knowledge of market prices as of December 81, 1920, was properly used as a basis for computing gross merchandise gain for the year 1920.

      W. W. Ross, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in the amount of $6,239.04 for the calendar year 1920, proposed to be assessed by the respondent in his letter dated May 26,1925,

      The petitioner alleges that the respondent erred in not accepting the petitioner’s revised inventory of $510,596.25 upon the basis of cost or market whichever is lower as at December 81,1920, instead of the original inventory of $529,604.85.
    FINDINGS OF FACT.
    The Leighton Supply Co. was incorporated in 1909 and since that time has been engaged at Fort Dodge, Iowa, in the business of wholesaling plumbing, heating, mill, and well supplies. Since the organization of the petitioner, E. I. Leighton has been secretary-treasurer and general manager of the entire business. He either made or had direct supervision over all purchases and sales.
    It has alwaj^s been the custom of the petitioner to take inventory during the latter part of December of each year. The actual counting and listing of all merchandise in stock was completed as soon as possible after December 31 and then the clerks, under Leighton’s supervision, applied the cost or market, whichever was lower, and the necessary extensions to arrive at the inventory value of the various articles. In pricing the articles, the clerks used the printed price lists of manufacturers, less discounts allowed jobbers, and the computing was done by comptometer operators. Inventories were usually completed during the latter part of January or the first part of February, after which the necessary entries were made upon the books as of December 31 of the year for which the inventory was made.
    For the year 1920, the taxable year here in question, the petitioner followed its regular custom of taking inventory. In pricing articles on hand on December 31, 1920, the clerks used the printed list of prices and discounts which had prevailed during June and July, 1920, for that was their only source of such information. The inventory amounting to $529,604.85 was completed shortly after the first of February, 1921, and the said amount was entered upon the books for the purpose of making a preliminary report to the stockholders although Leighton knew at the time that the inventory values were too high. Leighton’s instructions to his assistants were to complete the inventory upon the available information as to the values and afterwards he would make such changes as were necessary, and in accordance with his own knowledge of the prevailing market conditions and values as of December 31,1920.
    From the middle of July, 1919, to approximately the middle of July, 1920, the market was quite stable and market values remained about the same. In July or August of 1920, there began a serious slump in the market, caused by the banks calling loans, and that condition continued through the first months of 1921. Toward the close of 1920 market conditions became chaotic, jobbers and retail dealers had excessively large inventories (as did the petitioner) which could not be disposed of, and manufacturers had to cut their prices to make sales. However, the manufacturers did not revise their printed price lists as of June, 1920, for they could not foretell how far prices would drop nor how long the slump would last, but instead offered their merchandise for sale at greater discounts.
    The petitioner usually purchased merchandise in carload lots on which manufacturers usually allowed larger discounts from list prices than were allowed on purchase of smaller quantities. During December, 1920, many representatives of various manufacturers came to Leighton’s office at the petitioner’s place of business and quoted sale prices on various articles handled by petitioner and endeavored to secure orders from petitioner. Because of these quotations of prices by various manufacturers, Leighton had knowledge of the current market of December, 1920, and it was because of that knowledge that he desired to revise the inventory after all the mass of detail work had been completed by his clerks. The true market values were not used in making the original inventory because Leighton desired to secure more information as to market conditions and values as of December 31, 1920.
    Leighton, upon receiving the original inventory from his clerks, immediately made the necessary revisions or corrections as to a portion of the inventory in accordance with his definite information as to market values on December 31, 1920. Those corrections reduced the inventory as follows:

      Leighton knew at that time that other items in the inventory not reduced were priced higher than the prevailing market values as of December 31, 1920, but as to those items Leighton did not have definite information or quotations and he considered that it would consume too much time to secure such information covering the large number of items included in the unrevised inventory and on many items of which manufacturers did not put out printed price fists. Based upon the corrected inventory the petitioner sustained a loss during 1921 of approximately $118,000.
    The revised inventory was entered upon the books as of December 31, 1920, and in the petitioner’s income and profits-tax return for 1920 the inventory was reported as $510,596.25. A revenue agent examined the petitioner’s books and reported the inventory for 1920 as $529,604.85, which was adopted by the respondent.
   OPINION.

Tkijss3dll :

The sole issue in this proceeding is whether the original or the revised inventory is the proper one to adopt in computing the taxable income of the petitioner for the year 1920. The Commissioner adopted the original inventory and takes the position that it was based on market values as at December 31, 1920, and that the revised inventory is based on market values as of February 15, 1921, after a further decline in the market. The petitioner claims that the revised inventory is based on market values as of December 31, 1920.

In the findings of fact we have set out a schedule showing the reduction in the inventory in dollars and cents and have not attempted to set out the schedule contained in the record showing the original and revised discounts used by the petitioner for they are too voluminous, as they vary to some extent as to the various and numerous articles.

The petitioner in its income-tax return for 1920 reported its inventory at $510,596.25 and in-its petition claims that the revised inventory of that amount is the proper one to adopt in determining its taxable income. However, the record before us establishes a revised inventory in the amount of $510,741.73.

Leighton’s uncontradicted testimony as to market conditions and values as at December 31, 1920, is convincing. However, to further establish the petitioner’s contention there has been submitted the testimony of several disinterested and well qualified witnesses, who sold plumbing and other supplies to the petitioner.

One witness, who since 1910 has been the sales manager of a textile belting company of Chicago, Ill., testified that his concern had to revise its discounts on belting shortly after October, 1920, because of the demoralized condition of the market and that the values used by the petitioner in its revised inventory on belting were the fair market values as of December 31, 1920. This witness also testified that prices continued to drop during the first months of 1921 requiring further revisions in discounts.

Another witness, an officer in a company which for many years has manufactured lavatory fixtures, testified that such fixtures were sold during the latter part of 1920 at most any price the manufacturers could get. He further testified that the petitioner in its revised inventory as to such fixtures used prices on which his company was offering to sell such articles.

Another witness, the sales manager, of a malleable iron company for 25 years, testified that by December 31, 1920, the market was in a most chaotic condition. This witness gave a statement showing the discount rates as of December 31, 1920, on iron fittings as used by the petitioner in its revised inventory, were the equivalent of his companies’ discount rates at that time.

Another witness, general sales manager of the Y. & K. Co., testified that petitioner in its original inventory used the Y. & K. Co.’s list prices and discounts, but that due to market conditions market prices were 15 per cent less on December 31, 1920, which was a lower value than that used by petitioner in its revised inventory.

The secretary and treasurer of a company manufacturing lead products testified that many contractors who had been dealing with the Government had large stocks of lead goods on hand and were compelled to dispose of such stock at any price in the fall of 1920. He testified that the values on lead goods as used by petitioner in its revised inventory represented the fair market value on December 31, 1920.

The sales manager, for the past 20 years, of a company manufacturing boilers and radiators, testified that the company’s list prices did not represent the true market values on December 31, 1920, but that the values used by petitioner in its revised inventory on radiation products did represent such values.

The sales manager of a company which sells pneumatic pressure tanks testified that the company’s list prices did not represent market values on December 31, 1920, because of the rapid decline in prices at that time, that discount terms were made across the desk by salesmen and that the values used in petitioner’s revised inventory on pneumatic tanks were the correct market values on December 31, 1920.

We are convinced by the testimony and record in this proceeding that the petitioner was conservative in revising its inventory for 1920, and that as to that portion of the inventory which was revised the petitioner used the fair market values as of December 31, 1920, as quoted to it by the representatives of the manufacturers it had been dealing with.

The revised inventory in the amount of $510,741.73 is the proper one to adopt in computing the petitioner’s taxable income for the year 1920. See Appeal of California, Canneries Co., 2 B. T. A. 109, and the Appeal of Summit Wholesale Grocery Co., 1 B. T. A. 1040.

Order of redetermination will he made upon 15 days'1 notice, pursuant to Rule 50, and judgment will he entered in due course.


source: Caselaw Access Project

author: Trussell:

license: Public Domain

text:
    Raymond Guarini and Domenico Candela, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7342.
    Promulgated May 26, 1927.
    Private Bankers. — Additions to capital and reserves required by state statutes governing private bankers, although set aside from current earnings, can not be deducted from the income of a banking partnership distributable to the partners.

      Gerald Morrell, Esq., for the petitioners.
    A. R. Marrs, Esq., for the respondent.
    On August 19, 1925, the Commissioner issued a deficiency letter to Raymond Guarini, in which there were asserted deficiencies in income taxes for the year 1919 of $228.58, for the year 1920 of $2,415.59, and for the year 1921 of $55.20, and on the same date he issued a deficiency letter to Domenico Candela asserting deficiencies in income taxes for the year 1919 of $244.53, for the year 1920 of $2,046.13, and for the year 1921 no deficiency.
    The issue presented for consideration here is whether a partnership carrying on business as private bankers may reduce the amount of partnership gains distributable to the partners by additions to the amounts required by the state law. to be maintained as statutory reserves and capital including the amounts required to be assigned to the superintendent of banks under the provisions of the laws of the State of New York governing the conduct of the banking business.
    Neither petitioner has complained of the adjustment of tax liability for the year 1921.

      FINDINGS OF FACT.
    During the years here in question the petitioners were partners carrying on a private banking business in New York City under the name and style of Guarini & Candela.
    For the year 1919 the partnership reported gross gains and profits from the said banking business in the amount of $41,051.52, and a net income, after the usual deductions of $25,549.58. For the purpose of showing the net taxable income available for distribution to the partners, they added the amount of premiums paid for life insurance; deducted nontaxable interest on Liberty bonds and municipal bonds and $4,054.66 required by the New York banking law to be set aside and maintained as an addition to the statutory surplus. The Commissioner made an adjustment for depreciation, which is not here in question, and restored the said sum of $4,054.66 to taxable income distributable to partners.
    For the year 1920 the partnership reported gross income from banking operations $60,027 and net income, after the usual deductions, of $50,177.
    During this year, under the requirements of the New York banking law, the partnership transferred to its capital account $20,000, and to its surplus account, required to be maintained under the said laws, $18,953.12, and reduced the amount of gains distributable to partners in the total sum of $38,953.12. The Commissioner made some adjustments for depreciation and interest exempt from tax, which are not here in question, and restored the said item of $38,953.12 to the amount of partnership gains and profits distributable to the partners.
   OPINION.

Trussell:

The Revenue Act of 1918, section 218 (a), provides:

That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year * * *.

The record of this case establishes the fact, which also appears to be admitted, that the amounts here in controversy were a part of the gains and profits of a banking partnership during the respective years 1919 and 1920, and although agreeing that the said amounts were partnership gains and profits, petitioners contend that such amounts should not be treated as taxable income of the partners because the state statutes require them to add such amounts to their fixed capital and surplus, and that, therefore, these amounts were not distributable to the partners. This line of reasoning may seem to have an element of plausibility but we are convinced that it is wholly unsound. The statutory requirements regarding the capital and surplus of a banking partnership may require additions to such capital and surplus from time to time and make it necessary for the partners to furnish such funds. The statutory requirement, however, is not that such additions to capital and surplus be taken out of current earnings, in fact such additions may be supplied from any other source, and the state statutory requirements would have to be complied with even though the business produced no gains and profits. We take it also to be true that when this partnership took from its current gains and profits the amounts here in controversy it did, in fact, first distribute such amounts to the partners, who thereupon paid in such amounts to the fixed capital and surplus of the partnership, and that the amounts in question were, therefore, distributed during the year in which they were earned, and there is no provision in any taxing statute permitting the deduction of such additions to capital or surplus from gross income.

The deficiencies in income taxes for the several years here wider consideration are redetermined to be as follows• Raymond Guarini, for 1919, $228.68; 1920, $2,4.15.59; 1921, $55.20; Domenico Candela, for 1919, $244-53; 1920, $2,046.13; 1921, no deficiency, and judgment will be entered accordingly.


author: Tkammell :

text:
    Geo. Feick & Sons Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8796, 13767, 18644.
    Promulgated May 26, 1927.
    Amounts credited to the officers of the petitioner corporation and not withdrawn by them held to be liabilities of the corporation and not a part of its invested capital.

      Ben Jenkins, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
    These are proceedings for the redetermination of income and profits taxes for the calendar years 1919, 1920, and 1921, in the amounts of $873.90, $1,351.12, and $2,509.26, respectively.
    The deficiences arise from the action of the respondent in excluding from invested capital for the years involved, amounts left in the business by the officers of the corporation representing salaries and dividends credited to the respective officers on the books of the corporation in excess of the amounts actually drawn by them. The three proceedings were consolidated for the purpose of hearing and decision.
    For 1920 and 1921 the petitioner alleges as error the action of the respondent in prorating and deducting from invested capital the taxes for prior years in an amount alleged to he in excess of the true tax liability for such prior years.
    FINDINGS OF FACT.
    The petitioner is an Ohio corporation with its principal office at Sandusky. It was organized the latter part of 1916 or the first part of 1917 and took over the personal business of George Feick, Sr., who had carried on the business theretofore as an individual.
    George Feick, Sr., transferred to the corporation, at the time of its organization, tangible assets of the value of $20,000. George Feick, Jr. and Emil Feick, sons of George Feick, Sr., contributed $2,000 each and capital stock was issued in the amount of 150 shares to George Feick, Sr., and 50 shares each to George Feick, Jr., and Emil Feick. Of the 150 shares issued to George Feick, Sr., one qualifying share each was issued to Minnie K. and Olga O. Feick, wife and daughter, respectively, of George Feick, Sr.; and George Feick, Sr., contributed another $1,000 in cash, making $5,000 contributed in cash in addition to the $20,000 in tangible assets paid in by him at the time of the organization of the corporation.
    At the time of organization of the corporation, it was agreed that all the salary which was to be allowed George Feick, Jr., and Emil Feick, and also all dividends which might accumulate on the stock owned by them as well as on the stock owned by George Feick, Sr., would be credited to them on the books of the corporation but would not actually be withdrawn in excess of $20 per week to George Feick, Jr., and $25 per week to Emil Feick. George Feick, Sr., did not draw any salary. The agreement was that they would wait and “leave all of the assets that could accumulate, leave them in the business for awhile, so we would not have to borrow money to relieve the burden at that time. All dividends were to be added to the business.”
    At the end of the year there was a directors’ meeting and at that meeting it was determined what amount should be credited to each of the accounts and each of the individuals paid income tax upon the amount so determined and credited to each of them on the books. The corporation kept personal accounts for each of the individuals. The amounts -were set up on the liability side of the balance sheet as being amounts due the officers and stockholders. The records of the corporation contained no entry to .the effect that items of accumulated salaries and dividends were to be kept in the business. The agreement on this matter was oral between the three individual officers. The amounts shown on the books to be due to each were credited to the accounts of the individuals and were not represented by notes, and no interest was paid on the amounts.
    Up until December 31, 1918, there had been accumulated $13,818; to December 31, 1919, $26,522; to December 31, 1920, $44,106, representing accumulated dividends and undrawn salaries which had been credited to the above-named individuals on the books of the corporation.
    In its income and profits-tax returns for the calendar years 1919, 1920, and 1921, petitioner included all amounts of the credits to its stockholders above mentioned in its invested capital.
    Upon auditing the income and profits-tax returns, the respondent disallowed the above amounts and excluded the same from invested capital.
   OPINION.

Tkammell :

The question is whether the amounts of accumulated salaries and dividends which had been credited to the stockholders and which had not been drawn by them for the respective years involved, constituted a part of the invested capital of petitioner.

In order to determine this question, we must decide whether the amounts so credited represented borrowed money in the hands of the corporation or whether it represented assets paid in by the stockholders. If the amounts were borrowed money, it is clear that they can not be included in invested capital. In our opinion, from all of the evidence, the amounts credited by the corporation to its stockholders, represented indebtedness of the corporation. The fact that the corporation retained and used the money in its business when it represented a liability, does not constitute such amount a part of its invested capital. We are not convinced that the stockholders contributed the amounts credited to them to the corporation. There appears to have been no agreement on the part of the stockholders, either among themselves or with the corporation, that they would at no time withdraw the amounts. In our opinion, the decision of this case is controlled by prior decisions of the Board. See Appeal of Kelly-Buckley Co., 1 B. T. A. 1154; Appeal of Consolidated Electric Lamp Co., 1 B. T. A. 616; Appeal of Electrical Supply Co., 1 B. T. A. 658; Appeal of Wm. H. Davidow Sons Co., 1 B. T. A. 1215; Appeals of Roshek Brothers Co., 2 B. T. A. 260; 794; and upon the authority of those decisions we hold that the amounts credited to the officers represented borrowed money. No question is raised as to whether funds were available out of which to pay the dividends credited to the stockholders.

On the question of computation of invested capital of the petitioner for the calendar years 1920 and 1921, it is not shown that the respondent committed error in the proration and exclusion from invested capital of the prior years’ taxes.

Judgment will be entered for the respondent.


author: Teammell:

text:
    Kenilworth Plantation, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6541.
    Promulgated May 26, 1927.

      Isom J. Guillory, Esq., and E. Barrett Prettyman, Esq., for the petitioner.

      J. Arthur Adams, Esq., for the respondent.
   Teammell:

This is a proceeding for the redetermination of a deficiency for 1919 in the amount of $10,858.87. The deficiency arises from the action of the Commissioner in determining the profits arising from the sale set out in the findings of fact upon a basis other than the installment basis.

The facts set out below, including the amount of the profit to be reported by the petitioner for 1919, are all stipulated.

FINDINGS OE PACT.

The petitioner on June 23, 1919, sold property, both real and personal, for $115,000 less a commission paid for the sale in the sum of $5,750, and received in payment therefor $10,000 in cash and 16 promissory notes running for a period of five years. The first note, which was for $30,000, matured January 1, 1920, and was paid during that month. The other 15 notes, of $5,000 each, matured as follows:

3 Notes on January 1, 1921
3 Notes on January 1, 1922
3 Notes on January 1, 1923
3 Notes on January 1, 1924
3 Notes on January 1, 1925

The profit derived from the sale of the property mentioned above' was $24,944.03. The amount of the profit to be reported by the petitioner for 1919 is $2,169. The petitioner reported its income on the calendar year basis.

Judgment will be entered on 10 days’ notice, under Bule 50.


author: TRAmmell:

text:
    I. J. Adelson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4666.
    Promulgated May 26, 1927.
    The petitioner and his wife were not partners during the years involved and the' income-tax returns of the petitioner for those years in which he claimed that his wife was a partner were false and fraudulent.

      Perry W. Shrader, Esq., for the petitioner.

      G. H. Ourl, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for 1919, 1920, and 1921, in the amounts of $540.37, $696.06, and $273.12, respectively. The question involved is whether the petitioner and his wife, Anna Adelson, were partners during the taxable years involved.
    The issue raised by the pleadings as to the deductibility of an alleged loss was withdrawn by the petitioner at the hearing. At the hearing, after all the evidence had been introduced, the respondent asserted the fraud penalty.
    FINDINGS OP PACT.
    The petitioner is an individual residing in Kansas City, Mo. In the latter part of 1913 or the early part of 1914, he started in the jewelry business, opening a store under the name of Adams Jewelry Co. For some time prior thereto, the petitioner’s wife, Anna Adel-son, together with another person had operated a restaurant in Kansas City, and prior to the opening of the Adams Jewelry Co. store the restaurant had been destroyed by fire and the petitioner’s wife had received 50 per cent of the insurance money, which was between $800 and $1,000. She turned over this money to the petitioner. The petitioner had approximately $600 of his own money. He took his wife’s and his own money and purchased a stock of goods when the Adams jewelry store was opened. The petitioner’s wife helped the petitioner in the store.
    In 1917 the petitioner started another store under the name of the Bennett Jewelry Co. The second store was operated by a partnership composed of Nathan and Albert Levenson and the petitioner. Albert Levenson had a 20 per cent interest, Nathan Levenson had a 30 per cent interest, while the petitioner had a 50 per cent interest. In 1919 a third store was opened which was operated as a partnership, under the name of Adelson, Chambers Jewelry Co. The petitioner and J. L. Chambers were partners.

      The petitioner conducted the Adams Jewelry Co. store as if it were operated by him as an individual. He stated in the financial reports to the banks and signed affidavits that he was the sole proprietor of that store.
    There was no agreement either oral or written between the petitioner and his wife in any of these businesses that the petitioner’s wife was a partner therein.
    The income-tax returns for 1919, 1920, and 1921, in which the petitioner claimed that his wife was a partner with him in the Adams Jewelry Co., the Bennett Jewelry Co., and the Adelson Chambers Co. were false and fraudulent.
   OPINION.

TRAmmell:

The only question involved in this proceeding is whether the petitioner and his wife were partners in the Adams Jewelry Co., the Bennett Jewelry Co., and the Adelson Chambers Co., during the years involved.

There is testimony to the effect that the petitioner’s wife let the petitioner have from $800 to $1,000 of her own funds when he started the Adams Jewelry Co. We are not convinced, however, that a partnership existed in that store or in either of the other stores. There is evidence that Mrs. Adelson went to the various stores and devoted some of her time there, but the partners of the petitioner in the Bennett Jewelry Co. and the Adelson Chambers Co. did not consider that they had entered into any agreement with Mrs. Adel-son with respect to a partnership. Jess Chambers, one of the partners in the Adelson Chambers Co. was asked:

Q. What interest did you have in the business?
A. A half interest.
Q. Who owned the other half interest?
A. Mr. Adelson.
Q. Was anything ever said to you about Mrs. Adelson being a partner in the business?
A. There was never any mention made of it. I took it for granted she was interested with him in the business.
Q. Why did you take it for granted?
A. On the conduct of Mrs. Adelson in our store.
Q. Just explain that to the Court, please.
A. She would occupy a good deal of time there and she would always be delving into the affairs of the business, financial part of it, and I always had little combats with her regarding my method of operation and her method of operation, and I was always left to presume that she had interest in it through her conduct.

He testified on cross examination as follows:

Q. ITrom the time you formed this partnership you and Mr. Adelson talked over the situation and arranged the business, didn’t you?
A. Yes.
Q. And all that yon know about your sister having any interest in it was just from her actions thereafter, is that all you know about it?
A. No, immediately on our conversation, upon our becoming partners, it was talked over in Mr. Adelson’s home when they lived on Newman Boulevard; she was called into the conversation, and I never had any idea she was putting any money in the business. Of course, at that time, if X had thought she was, I would have made some definite arrangement * * *.

He also testified as follows:

Q. Did you ever have any memorandum of partnership written?
A. No.
Q. Who signed the lease?
A. Mr. Adelson and myself.
Q. Signed it as individuals or partners?
A. I imagine as a partnership.

Albert H. Levenson, a member of the partnership of the Bennett Jewelry Co., testified that Mrs. Adelson was interested in that store “ because she’d come in and look around the place,” and also testified as follows:

My impression was she used to come into the store there and she would walk around, and if she saw we were busy she asked no questions, but would get behind the counter, and lots of times I asked her advice on the business and she handled cash, and Mrs. Adelson was in quite a few times and talked over the different ways in running the stock, and that is what made me think that Mrs. Adelson had an actual interest in the business.

The witness knew nothing of any partnership agreement in which Mrs. Adelson was a partner. The partnership agreement in which he was a partner was made with Adelson.

The petitioner filed an affidavit with the Bureau of Internal Revenue in which he stated that the Adams Jewelry Co. store was a sole proprietorship. He made statements to the banks and to the commercial agencies that he was the sole owner of that store and held himself out to the public as being the sole owner thereof.

With respect to the partnerships, the Adelson Chambers Co. and the Bennett Jewelry Co., in which the petitioner was a partner with others, it seems that if the petitioner’s wife had in fact been a member of these partnerships the other members thereof would have known the fact.

A partnership can not be formed except by agreement between the parties, yet Levenson and Chambers testified that the only reason that they considered Mrs. Adelson a partner was from the manner in which she came in the stores and conducted herself. From this conduct they testified that they considered that she was interested in her husband’s interest in the partnership, not that they had entered into a partnership with her. Chambers testified that if he had known that Mrs. Adelson (his sister) was putting any money into the business in which he was going into partnership with Adelson, lie would have made some definite arrangement. In other words, it appears from his testimony that he did not know that Mrs. Adclson was to be a partner, and that if she was to be one, the arrangements would have been different so far as he was concerned.

When the returns of the Adams Jewelry Co. store were filed foi 1.919, 1920, and 1921, it appears that they were filed as partnership returns on the advice of an attorney, although it appears that for years prior thereto the thought did not occur to Adelson to file partnership returns for that store.

Th respondent, after the testimony was all in, asserted the fraud penalty under section 274 (e) of the Revenue Act of 1926. See Appeal of Fred Ascher, 2 B. T. A. 1257.

Upon consideration of all of the testimony, we are convinced that the petitioner’s wife was not in fact a partner with him in any of the business enterprises herein set out, and that the returns in which he claimed that a portion of the income from these businesses belonged to his wife as a partner were false and fraudulent.

The fraud penalties should, therefore, be imposed for the years involved.

Judgment will he entered for the respondent on 15 days’ notice, under Rule 50.


text:
    Farmers Co-operative Grain & Livestock Co., Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5564.
    Promulgated May 26, 1927.

      R. A. Wolfe for the petitioner.

      J. Arthur Adams, Esq., for the respondent.
   TRAmmell:

This is a proceeding for the redetermination of a deficiency in income and profits taxes for the fiscal year ended May 31, 1920, in the amount of $3,185.97. A deficiency was asserted by the respondent in the amount of $8.10 for the fiscal year ended May 31, 1919, notice of which was given the petitioner in the deficiency notice of July 11, 1925, but no proceeding for the redetermination thereof was instituted.

The petitioner is a Kansas corporation, having its office at Lewis. The errors assigned in the petition are: That the amount of wheat on hand, as set forth in the inventory in the balance sheet prepared by the petitioner, was overstated approximately 900 bushels and was invoiced at $2.60 and $2.65 per bushel, when the actual cost was only $2.55 per bushel; that the corn was also invoiced for more than it cost and the lumber was invoiced at current market prices instead of cost or market, whichever was lower, resulting in an overstatement of approximately $2,500 in the lumber inventory.

It is the contention of the petitioner that the inventories prepared by it at the end of its fiscal year 1920 were overstated both in quantity and in price. Certain books were introduced in evidence but no error was pointed out therein. On the other hand, the person who was manager of the business during the year involved and who was subpoenaed as a witness by the respondent, testified that the inventories were correctly taken and correctly priced. There was no evidence introduced from which we could find that the inventories were incorrectly made.

Judgment will be entered for the respondent.


author: Lansdon :

text:
    F. E. Heath, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6015.
    Promulgated May 27, 1927.
    1. Petitioner sold an interest in a dairy property -to an employee more tlian a year prior to March 1, 1913, and another certain interest to a second employee more than a year subsequent thereto, and more than a year prior to March 1, 1913, bought and leased certain dairy cattle and dairy facilities from a corporation not engaged in the dairy business. Held, that the sale and purchase prices so received and paid did not constitute a true measure of the fair market value of such property.
    2. Petitioner acquired a herd of dairy cattle at different dates prior and subsequent to March 1, 1913, and by elimination, breeding and purchase maintained the standard of such herd, which was sold in 1919. Held, that in the light of the evidence adduced in this proceeding there was no accrued depreciation at date of sale.
    3. Depreciation on physical property of the petitioner, other than herd of dairy cattle, determined by the Commissioner approved, except as modified by a stipulation.
    4. The community income involved in this proceeding was properly determined to be the taxable income of the petitioner, United States v. Robhins, 269 U. S. 315; Appeal of D. Cerruti, 4 B. T. A. 682.

      Everett S. Layman, Esq., for the petitioner.

      George G. "Witter, Esq., for the respondent.
    The Commissioner has found a deficiency in income and profits tax for the year 1919 in the amount of $6,156.20. The controversy arises from diverse computations of gain from the sale in 1919 of certain dairy ranches and of the stock and equipment thereof, made by the petitioner and the Commissioner. The main issue relates to the depreciation of a dairy herd acquired in part prior to March 1,1913, and in part subsequent thereto.

      Depreciation of plant and equipment is also involved. Tbe sale was made on tbe installment plan and there is no dispute as to tbe Commissioner’s method of computing tax liability on tbe payments made.
    BINDINGS OF FACT.
    The petitioner is an individual citizen of the United States and of the State of California, who is engaged in the dairy business near the City of Berkeley. In 1907 he leased the Pleasanton No. 1 Ranch for dairy purposes from George Davis, who reserved a one-third interest. He at once erected buildings on the leased land at a cost of $17,000. About four months after the lease was signed Davis died, and his widow put her son in the place of the deceased. Some six months later he sold his interest to Mrs. Davis for $25,000. In 1911 the Davises sold the ranch and dairy to the Spring Valley Water Co., which bought the property for the sole purpose of securing the water thereon and promptly offered to lease the dairy privileges and sell the buildings, appurtenances and cattle. The petitioner leased the property and bought, for $20,100 cash, 280 head of cattle and all the dairy buildings and equipment. He set to work to improve the plant and dairy herd, buying and installing new machinery, buying cows when he found good small herds for sale at reasonable prices, and buying pure bred cattle. He disposed of the bulls then on hand and bought pure bred sires. When he had any cattle for sale there was a demand for them among neighboring dairymen because of the high reputation of the Pleasanton Dairy.
    In March, 1912, petitioner sold a one-third interest in the ranch to John Wipfli, one of his foremen on another ranch, for $12,500, making the latter a partner in the business. The terms of the sale were $2,500 cash and $10,000 to be paid from the profits of the business as they accrued.
    In June, 1913, petitioner leased Pleasanton Dairy No. 2 from the Spring Valley Water Co. and took possession in October of the same year. He immediately plowed and graded between 280 and 300 acres of land and seeded it to alfalfa; built several houses, sheds and barns; sunk wells and then in March, 1914, put dairy stock on it. In the latter part of the year he sold forty-two one hundred and twenty-sevenths of this dairy to Wipfli.
    In 1916 he sold ten one hundred and twenty-sevenths of both dairies to one Gwerder, another foreman, for $10,000. The parties agreed that after the sale to Gwerder, the petitioner still owned seventy-five one hundred and twenty-sevenths of the combined properties. In 1919 the petitioner sold his remaining interest in the combined properties for $85,000 and other considerations, and received in that year as a first installment on such sales price the amount of $7,456.14. According to the terms of this sale the purchase price was to be paid from the profits of the business. The vendees agreed to deliver all the milk to the vendor at his retail dairy headquarters in Berkeley and allow him a differential of 2 cents per gallon under the regular wholesale prices during a period of 20 years or such part of that time as a certain contract that the dairymen should pay that amount into the Retail Milk Dealers’ Association remained in force. The Milk Dealers’ Association contract was rescinded a short time prior to the hearing of this case.
    " The March 1, 1913, value of the cattle on Pleasanton Dairy No. 1 was:

    Later in 1913 petitioner purchased 20 cows at $85 per head and in 1915 he added to the herd 7 purebred cows for which he paid $2,700, increasing the total value and cost to $53,800.
    Payments for Pleasanton Dairy No. 2, were made as follows:

    The bulls purchased were all pure bred and of the best dairy types. The old were disposed of and new purchased somewhat more frequently than once in two years. All the best of the heifer calves were retained and the herds were thus replenished and brought to a higher standard from year to year. The average cost of bringing a calf to maturity was $119, and the average sale price or salvage value of cows no longer useful for dairy purposes was $40.
    All receipts from the sales of cattle for beef, veal, and other purposes and the sale of milk and all disbursements and losses for and from the herds and in the production and sale of milk were reported in the tax returns from year to year. Some depreciation was reported for several years and disallowed and afterwards a part of it allowed. No allowance was asked or made for exhaustion, wear and tear of the herd after 1915. Allowances were made for losses of cattle by death.
    The parties stipulated correct rates of depreciation for certain groups of physical assets, other than dairy cattle, as follows: buildings, 5 per cent; machinery, wagons, and harness, 10 per cent; ice plant and equipment, 10 per cent; horses, 16% per cent.
   OPINION.

Lansdon :

In computing the gain resulting from the sale in 1919 of the properties involved in this proceeding, the respondent relies for value at March 1, 1913, (1) on the price paid the Spring Valley Water Co. for the lease and herd on Pleasanton Dairy, Eanch No. 1, prior to March 1, 1913; (2) on the price at which certain interests in the two properties were sold to Wipfli and Gwerder in 1912,1914, and 1916, and (3) on his theory that the dairy herds were subject to depreciation from 1913 for animals acquired before that date and from date of acquisition for animals acquired subsequent thereto. We shall discuss these contentions in the order set forth.

The evidence is conclusive that the Spring Valley Water Co. purchased the property known as Pleasanton Dairy Eanch No. 1, solely for the purpose of securing the water thereon and the water rights pertaining thereto. This company is engaged in the business of selling water to the people and City of San Francisco. It sold the dairy herd and dairy appurtenances which it purchased from the Davises at a price that we can not regard, in all the circumstances, as a true measure of the fair market value of such property at the date of sale.

The petitioner was engaged in the dairy business on a large scale. The properties in question represented only a part of his interests in such industry. He testified that he did not have time to give proper personal attention to all his properties and that he sold the interests to Wipfli and Gwerder, his employees at the time, for a price much below actual value for the purpose of securing the interested services of reliable men in the operation of the property. It is not unusual for men with large business interests to dispose of shares of their property to trusted employees at less than actual value for the purpose alleged here. We are convinced that the prices received from the sale of the several interests to Wipfli and Gwerder did not accurately reflect the fair market value of the properties at the dates of such sales.

Section 202 of the Eevenue Act of 1918 provides as follows:

Sec. 202. (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall he—
(1) In the case of property acquired before March 1, 1913, the fair market price or value of such property as of that date; and
(2) In the case of property acquired on or after that date, the cost thereof; or the inventory value, if the inventory is made in accordance with section 203.

Section 214 of the Act is in part as follows:

Sec. 214. (a) That in computing net income there shall be allowed as deductions :
*******
(8) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business * * *.

The petitioner has proved that there was no diminution and that on the contrary there was a continuous and very appreciable increase in the actual productive capacity of the herd from year to year during the whole period of his ownership, and contends that this clearly evidences that the respondent erred in including accrued depreciation of such herd as a factor in computing gain from the sale thereof.

The facts here indicate an accounting procedure by the petitioner that is equivalent to making annual additions to a reserve for depreciation and simultaneously charging all the cost of maintaining the standard of the herd against such reserve. The effect' was the measurement of annual depreciation by the cost of replacements for each year. There was, therefore, no accrued depreciation at date of sale and the respondent erred in making such deduction from the basic cost of the property. Compare the result reached here with Haugh & Keenan Storage & Transfer Co. v. Heiner, 20 Fed. (2d) 921, and with our decisions, Appeal of Cleveland Home Brewing Co., 1 B. T. A. 87; Appeal of Russell Milling Co., 1 B. T. A. 194; Appeal of Rub-No-More Co., 1. B. T. A. 228; Appeal of Hamilton Manufacturing Co., 3 B. T. A. 1045; Appeal of Western Star Milling Co., 5 B. T. A. 109.

From the evidence adduced at the hearing, we are not able to make any definite findings of fact as to the cost, the useful life, or the value at the date of sale of the plant assets and irrigation facilities of the petitioner. Subject to certain stipulations of the parties which we have incorporated in our findings of fact, we approve the action of the Commissioner in computing depreciation on the property, other than the dairy herd, involved in this transaction and in including such depreciation as a factor in his determination of gain realized from the sale of an interest in such property in the year 1919.

It is alleged in the petition that under the laws of California the gain involved was a part of the income of a marital community, one-half of which should be taxed to Laura Heath, wife of the petitioner. The Commissioner denied this allegation in his answer to such petition. At the hearing neither party referred to this point or adduced any evidence in respect thereof. The entire deficiency is determinable against the petitioner. United States v. Robbins, 269 U. S. 315; Appeal of D. Cerruti, 4 B. T. A. 682.

Judgment will be entered on BO days’ notice, pnder Bule 50.


text:
    Appeal of Troy Manufacturing Co.
    Docket No. 6585.
    Promulgated May 27, 1927.
    1. At the time of the entry of the United States into the World War, taxpayer was engaged in the manufacture of automobile bodies. It immediately remodeled its plant and engaged in the manufacture of aeroplane parts for companies making aeroplanes for the United States. At the close of the war, the demand for aeroplane parts ceased- Taxpayer found that the demand for open-car bodies had been lessened by that for closed bodies and early in the year 1919, finding that it could not sell its plant or secure contracts for manufacturing anything for which it was suitable, leased it for a small rental. After deciding to go out of business it wrote down the book value of its depreciable assets to the alleged capitalized value -of the net annual rental received from the lease. Seld, that the amcunt so written off was not deductible from gross income under .the provisions of section 234 (a) of the Revenue Act of 1918.
    2. Where a taxpayer has erroneously written off one of its liabilities, and reported an equal amount as income; the amount so reported is not taxable.

      Oarroll Sprigg, Esq., and John E. Smart, G. P. A., for the petitioner.

      George G.,Witter, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income and profits taxes for the year 1919, amounting to $58,306.90. The deficiency arises from the disallowance by the Commissioner of petitioner’s claim for the deduction of $87,682.25 on account of obsolescence of petitioner’s plant at Troy, Ohio, and his refusal to permit petitioner to eliminate from its taxable income $6,081.21 reported in its return for that year on account of a liability erroneously written off at the close of the year.
    FINDINGS OF FACT.
    During the taxable year, the petitioner was an Ohio corporation organized in, 1909 and having its principal plant and offices at Troy, Ohio. Its capital stock consisted of 100,000 common- and 50,000 preferred, all issued and outstanding prior to January 1,1919.

      Prior to the entry of the United States into the World War, the petitioner’s sole business consisted of the manufacture of small, low-priced automobile bodies for open cars under contract with several other companies.
    Almost immediately following the declaration of war by the Congress of the United States, the petitioner abandoned the manufacture of automobile bodies, remodeled its plant and devoted all its facilities to the production of aeroplane parts for companies engaged in the manufacture of aeroplanes for the Government of the United States.
    On the cessation of hostilities the demand for aeroplanes in large quantities ceased. In the meantime the prevailing styles of automobiles had changed or were rapidly changing from the open to the closed cars, and the demand for open-car bodies had greatly decreased. The leading automobile producers had so increased and improved their facilities that the large plants were manufacturing their own cars complete. The petitioner’s plant was not suited to the production of closed or of the new models of open-car bodies, or to quantity production of car bodies of any style. A careful survey convinced its directors that without very extensive changes in its plant, the taxpayer could not compete with other existing larger and more up-to-date concerns, and that the business outlook was not such as to justify the changes necessary to conform its facilities to the progress in the art of building car bodies. Its officials, therefore, decided to abandon and did abandon all business operations. On February 1, 1919, they leased it to one of the company’s stockholders who had been superintendent and general manager for the taxpayer. The lease was for a period of three years at $10,000 per year gross rental. Payment of taxes, insurance and other charges left the corporation about $4,000 per year net income from the property. Concurrent with this transaction and a part of it, petitioner purchased the $22,000 of stock owned by the lessee, paid him therefor par value in cash and also released him from all responsibility as coindorser of certain company paper.'
    The lessee acquired the property for use in any manufacturing business promising profitable returns. He first considered the production of parts of aeroplanes and other machines and vehicles. After an extensive search for business he secured some contracts for building automobile bodies. He then formed the Troy Body Corporation, turned the lease in for stock, made necessary banking connections, organized an operating personnel and engaged in the production of open-car bodies. This company was unsuccessful. A receiver was appointed and about four years after beginning operations it was liquidated as a bankrupt. The lessee several times offered the taxpayer $50,000 for the property m question.- 1ms offer was always refused and counter offers to sell to the lessee for $125,000, $100,000, and $75,000 were made and all such offers of sale were declined.
    After the execution of the lease, the lessee immediately went into possession. Petitioner did not, however, abate ,its efforts to sell. Its officials had, prior to the execution of the lease, sought buyers in Chicago, Detroit and other large cities. The following notice appeared in, the Cincinnati Commercial Tribune for Saturday, April 26, 1919:
    Foe Sam
    On Satdeday, May 3, 1919, at 3 o'clock p. m., for the purpose of liquidation, the plant and equipment of the Troy Manufacturing Company, at Trpy, Ohio, will be offered for sale upon the following terms and conditions; Sealed bids will be received up to and including 10 o’clock a. m., on said date, each bid to be accompanied by a certified check for $1,000.00, as a guarantee of good faith of said bid. All bids will be opened at time stated and property sold to the highest bidder. Terms cash.
    The Troy Manufacturing Company, Troy, Ohio.
    Prior to December 31, 1918, the petitioner acquired tangible capital assets which at that, date were carried.on its books in the amount of $221,434.91, against which at that date there was a depreciation reserve of $33,752.66. The depreciated book value of such assets at December 31, 1918, was $187,682.25.' The assets in question and the respective original book values at such date were real estate, $9,100; buildings and equipment, $165,436.84; machinery and tools, $42,465.68; office furniture and fixtures, $4,432.39. The principal building is a brick structure upon which the Commissioner has allowed depreciation at the rate of 3 per cent per annum. There is also a wooden factory building upon which depreciation at the. rate of 4 per cent per annum has been allowed. The alleged residual values of these buildings after deducting “closing depreciation” as hereinafter described were respectively $50,000 and $8,900.
    During the year 1918 the Dayton Wright Aeroplane Co. billed and shipped material to petitioner for the manufacture of aeroplane parts. Proper credit for these materials was made on petitioner’s books at the time of their receipt. At the end of the year it was discovered that such materials to the value of. $6,081.21, properly billed, but for which no invoices had been received, were covered by petitioner’s inventory. The value was, therefore, carried as a liability. When, at the end of the year 1919, no invoices from the aeroplane company had reached petitioner, its secretary and treasurer wrote the liability for these goods off its books and reported the amount as income in its return for 1919. Afterward, it restored the liability to its books and requested allowance therefor in the settlement of its taxes for 1919. The Commissioner has refused to comply with its request.
    In its income and profits-tax return for 1919 the petitioner deducted $95,164.25 from gross income on account of exhaustion, wear, and tear of its plant and equipment. Of this amount $7,482 was on account of “ ordinary depreciation ” and $87,682.25 was designated as “ closing depreciation ” the effect of which was to write down the depreciated cost of the plant and equipment from $187,682.25 to $100,000. The deduction for ordinary depreciation was computed on residual values resulting from the deduction claimed for closing depreciation. The following explanation was attached to the return:

      *Note as to Closing Depreciation

    The Troy Manufacturing Company was originally engaged in the manufacture of Automobile bodies, being established since 1909 at Troy, Ohio. From October 1917 to December 1918 the plant was given over entirely to the manufacture of airplane parts on orders from various companies holding government contracts. After the signing of the armistice the orders in progress were can-celled, final settlement thereof being made January 31, 1919. The company was then left with its former business gone and with a more or less obsolete plant on its hands in an undesirable location and it was therefore considered by the management to be poor policy to attempt to carry on any future manufacturing operations at the Troy plant. The plant was therefore advertised for public sale on May 3rd, 1919, .but without success, and several attempts were also made to sell it privately for the sum of $100,000.00.
    The best that could be done was to rent the entire plant, including machinery, equipment and fixtures, to the Troy Body Company, on a three year lease from the 31st of January 1919 at a gross rental of $10,000.00 out of which the Troy Manufacturing Company had to pay all taxes and insurance, besides suffering the loss through wear and tear of the plant and equipment.
    For the above reasons therefore it is submitted that the deduction of $87,682.25, caused through the reduction of the plant to a fair value of $100,000.00, is a proper deduction according to Article 170 of Regulations 45 (Revised) and that $100,000.00 represents a generous valuation, especially if compared with the net income realized on a rental basis, which is less than $4,000.00 after deducting all charges.
    Upon audit of such return the Commissioner disallowed “ excessive depreciation ” in the amount of $80,256.22, allowed $2,000 on account of amortization in the taxable year, refused to comply with the petitioner’s request that the company’s liability on account of goods received by it from the Dayton Wright Aeroplane Co. amounting to $6,081.20 be considered in the computation of its taxes, made other adjustments, and determined the deficiency now in controversy.
   OPINION.

Lansdon :

The parties agree that the depreciated book value of the real estate and machinery, consisting of the plant at Troy, Ohio, less the reserve for depreciation, was $187,682.25 at the signing of the Armistice in November, 1918, and at January 1, 1919. Early in January, 1919, the petitioner ascertained that the business of manufacturing- aeroplane parts, for which its plant had been remodeled in 1917, had practically ceased to exist. It believed also that the styles of bodies for automobiles and the methods of manufacturing the same had been so changed during the war that there was no longer a profitable field for the use of its plant in that line. It found no opening either for profitable employment or sale of the plant, and, therefore, claimed a deduction of $87,682.25 as “ closing depreciation or obsolescence ” in its income and profits-tax return for 1919. The Commissioner disallowed the claim and allowed only a reasonable rate of depreciation on the alleged residual value of the plant. The petitioner has appealed from these determinations of the Commissioner. If this deduction is allowable it must be based on one or the other of the following provisions of the Revenue Act of 1918:

Sec. 284. (a) That in computing- the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * * * # 5 N *
(4) Losses sustained during the taxable year 'and not compensated for by insurance or otherwise;
*******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

The petitioner’s contention that it is entitled to a deduction from gross income for the taxable year as obsolescence will be considered first. The assets here in question consisted of buildings and factory and office machinery, equipment, and fixtures. As the record discloses that none of this property was used in the trade or business of the petitioner during the year 1919, it is obvious that the alleged obsolescence, if any, occurred prior to the taxable year. If there was a progressive loss of value due to the causes alleged by the petitioner that loss culminated in obsoleteness at the date of the alleged abandonment of the property for the purposes for which it was acquired and is not deductible as obsolescence from the gross income of 1919.

The petitioner further contends that if the deduction claimed can not be allowed as obsolescence, it should have relief under the provisions of 234 (a) (4) of the Revenue Act of 1918 cited sufra. It proved that early in January it ceased manufacturing operations and that thereafter it never used its plant or equipment for any production purposes and that subsequent to that date its only business activities consisted in the liquidation of its assets. It made many unsuccessful attempts to sell the property, which it repeatedly offered for $100,000 and in one instance for $75,000. A sale appearing to be impossible, it leased the plant and equipment for a term of three years at an annual rental of $10,000, out of which it was required to pay taxes, insurance and the expenses of all external repairs. Do these facts establish the petitioner’s contention that on account of unexpected changes, the property during the taxable year was reduced to a salvage value not in excess of $100,000 and thereby sustained a loss in the amount of $87,682.25 ? If there was such a loss do the facts bring it within the provision of the law which allows deductions from gross income on account of losses sustained during the taxable year and not compensated for by insurance or otherwise?

In support of its alternative contention the petitioner relies on the provision of the law cited above and on the Commissioner’s administrative interpretation of that provision, set forth in Regulations 45 as follows:

Art. 170. Closing depreciation account. — If the use of any property in the business is permanently discontinued, although no sale or other disposition of the property has taken place, a determination of any gain or loss may be made; but any deduction in respect of any loss thereon must be disclosed in the taxpayer’s return for the year in which the determination is made and a full statement of the facts and the basis upon which the computation is calculated must be attached to the return. Upon a sale or other disposition of the property, the consideration received shall be compared with the amount of the estimated salvage value used in computing the gain or loss as above provided, and the amount of the difference shall be treated as a gain or loss, as the case may be, of the year in which the sale or other disposition was made. See Articles 141-145.
Art. 143. Loss of useful value. — When through some change in business conditions the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in the business, he may claim as a loss for the year in which he takes such action the difference between the cost or the fair market value as of March 1, 1913, of any asset so discarded (less any depreciation sustained) and its salvage value remaining. This exception fo the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property must be prematurely discarded, as, for example, where an increase in the cost of or other change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Any loss to be deductible under this exception must be charged off on the books and fully explained in returns of income. * * *

The petitioner asserts that it has proved facts that bring it squarely within the provisions of section 234 (a) (4) of the Revenue Act of 1918 as interpreted by the Commissioner in the articles of the Regulations here quoted. It has written off its books a loss which it has measured and determined by capitalizing the earning power of the balance of assets carried forward. In its income and profits-tax return for 1919 it deducted the amount of the loss so determined and “made an explanation of the facts and the basis upon which the computation is calculated.” It avers that it accepted the regulations as its guide in this procedure and as the only guide under which it could make a return that truly reflected its income for the taxable year. The proof of loss and the petitioner’s explanation thereof did not convince the Commissioner and the deduction was not allowed.

We have given careful consideration to the evidence adduced by the petitioner and are not convinced that the facts warrant or that the law permits the deduction claimed. The obsolescence, if any, due to change in the art of automobile body building affected only the machinery. Some of the machinery was transferred to a body-manufacturing plant in another city, in which the petitioner was a stockholder, and some of it was transferred to and used by the lessee of the property, the Troy Body Corporation. The manager of the lessee testified that he was unable to make any profits because the machinery was out of date. This is not convincing. If the Troy Body Corporation could have secured business it may be assumed that it would have replaced any obsolescent or obsolete machinery with up-to-date equipment, especially as it had the use of a plant of large value at a rental that is alleged to have bepn little more than nominal. The buildings, making up the greater part of the value of the assets in question, were regarded by the lessee as suitable for and useful in a business identical with that which the petitioner had discontinued and that was conducted by the lessee for several years thereafter. There is no evidence that such buildings sustained loss of useful value in 1919 in the amount claimed bv the petitioner.

The loss sustained, if any, seems to have been in the nature of a shrinkage of value. Such losses can be taken as deductions from gross income only when they have been realized by the sale or other disposition of the property. We are not convinced that the lease of the property for an annual rental alleged to represent only a moderate return on the so-called residual value of $100,000 is disposition thereof that comes within any provisions of law authorizing the reduction of income by the deduction of losses sustained during a taxable year. The action of the Commissioner in disallowing the amount of $87,682.25 as a deduction from the gross income of the petitioner as for the year 1919, is approved.

It appears from the evidence that the petitioner took ordinary depreciation on only the alleged residual value of the assets in question. Since we have disallowed the deduction reducing the property to a value of $100,000, it follows that the amount of ordinary depreciation for the taxable year should be computed not on such residual value, but upon the book value of such assets, which the parties agree was $221,434.91. As there is no dispute as to the normal useful life of any of the property involved we leave this adjustment to be made under Kule 50.

In support of its claim that an amount of $6,081.21 included in its income and profits-tax return on account of a liability resulting from the receipt of materials not paid for should be deducted, the petitioner relies on the evidence of a single witness, who was its secretary and treasurer at the time of the transaction, and the making of the entries that are now alleged to have been erroneous. The witness testified that the amount represented the value of materials for the construction of aeroplane parts received from the Dayton Wright Aeroplane Co. during the prior year that had not been invoiced to it at the end of the year although the bills of lading therefor had been received.

The petitioner kept its books of account and' made its income and profits-tax returns on the accrual basis. No invoice of the material was ever received from the aeroplane company and it -was, therefore, impossible for the petitioner to accrue the cost of the merchandise. It received the materials, which were taken into its assets at the memorandum value of the parts and supplies at the date received. Since the petitioner never received an invoice for such materials and has never made any payment on the alleged value of such consignment, it is evident that it received and carried into its inventory merchandise in the amount of $6,081.21 for which it showed no corresponding liability, thus increasing its showing of income beyond the true income by that amount.

The writing off of this liability was bad bookkeeping; but there does not appear to have been any intention to defraud either the Government or the creditor. The amount written off was not a gain and was not income, and the United States is not entitled to tax it as such.

Judgment will be entered on 10 days’ notice, under Rule 50.


author: Littleton :

text:
    James D. Bronson and George H. Prince as Surviving Trustees under a Trust Created by C. N. Nelson, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7702.
    Promulgated May 27, 1927.
    Tlie decedent during his lifetime and on or about August 9, 1917, transferred practically all of his property, consisting principally of stocks and other securities, to a New York bank as trustee, such trust instrument providing for the distribution of the corpus of the trust after his death by three individuals. Decedent died on May 24, 1923, and left a will in which was incorporated the provisions of the trust instrument theretofore executed. In the will decedent appointed the three individuals as executors and trustees of his estate. The will was not probated but the estate was administered and settled by the individuals designated by the decedent in conformity with the provisions of the will and the trust. The three individuals performed the usual and customary services in the administration of the estate and for such services between the date of death and the date on which they took over the property of the estate as trustees, they determined and paid themselves on May 19, 1924, reasonable compensation of $10,000 each, and also paid reasonable attorneys’ fees for services rendered in the administration of the estate in the total sum of $30,000. Held, that under the provisions of section 403 (a) (1) of the Revenue Act of 1921, these amounts were proper deductions from the value of the gross estate in determining the value of the net estate for the purpose of the tax.

      Francis D. Butler, Esq., and Pierce Butler, Jr., Esq., for the petitioners.

      John F. Greaney, Esq., for the respondent.
    The Commissioner determined a deficiency in estate tax under the Revenue Act of 1921 in the amount of $12,328.75, of which approximately $8,400 is in controversy. The petitioners claim that certain payments, totaling $30,000 to trustees and $30,000 to attorneys, for services rendered in the administration and settlement of the estate of. C. N. Nelson, are deductible as administration expenses in ascertaining the value of the net estate for the purpose of the estate tax.
    FINDINGS OE FACT.
    Some time prior to August 9, 1917, Charles N. Nelson, a resident of the State of New York, incorporated his business under the name of C. N. Nelson, Iñc. The articles of incorporation provided for 10,000 shares of common stock. In exchange for such stock Nelson transferred practically all of his property of the value of approximately $3,000,000 to the corporation. On August 9, 1917, he transferred all of his interests in the corporation to certain persons named in the deed, in trust, reserving to himself all the income therefrom, together with the right to alter or revoke the trust instrument at will. The trust deed provided for the care of the property and distribution of the proceeds arising therefrom to Nelson during the remainder of his life and after his death until the death of all of his descendants named therein, and for the final disposition of the property on the death of the last surviving beneficiary thereunder.
    Coincident with the execution of the trust deed the decedent made and subscribed to his last will and testament and incorporated therein the trust deed, which constitutes 12 of the 14 pages of his will. Aside from the disposal of property not covered by the trust, the provisions for the disposition of the estate on testator’s death remained as provided for by the deed of trust. He bequeathed the property not included in the trust to his wife, with a provision that if she should not survive him, then his executors named in the will should convert this remainder into money or such interest-bearing obligations as they should deem safe and wise, and pay, transfer and deliver the same to Kobert S. Davis, James D. Bronson, and George H. Prince, as trustees, or their successor or successors, and thereupon all monies so paid and all property so transferred and delivered should merge into and become a part of the principal of the trust fund and properties thereinbefore mentioned, and theretofore or by the will vested in said trustees, as thereinbefore recited, and should be held, invested, treated and distributed as such.
    The trustees under the deed were authorized to alienate the whole or any part of the property covered thereby and required to reinvest the proceeds at interest during the continuation of the trust period. The executors of the will were authorized to sell the whole or any part of the testator’s property and to execute and deliver all writings necessary to pass title thereto.
    Three codicils to the will were made for the purpose of incorporating therein the amendments to the deed of trust executed October 15, 1917, December 23, 1919, and June 17, 1921, and bear the respective dates of such amendments. None of these six instruments make any change in the originals material to the decision of the issue here involved. The amendment executed October 15, 1917 was reexecüted May 10,1920. An amendment to the deed of trust, executed June 22, 1920, contains the following provision:
    Now, Therefore, I, the said Charles N. Nelson, do hereby revoke the appointment of the said Kobert S. Davis, James D. Bronson, and George H. Prince as trustees of said trusts, and do hereby nominate and appoint Bank-e>'s Trust Company of New York, of the State of New York, sole trustee of said trusts, to hold said office until my death. Upon my death, the said Bankers Trust Company shall cease to hold the office of trustee, and I hereby nominate and appoint the said Kobert S. Davis, James D. Bronson and George H. Prince, as trustees of said trusts from and after the date of my death. The property now forming the said trust estate shall he forthwith transferred by the present trustees to the new trustee herein named, and, upon my death, the new trustee or its successors shall forthwith transfer the trust estate to said Kobert S. Davis, James D. Bronson and George H. Prince, their survivor or survivors, successor or successors, as the case may be, as trustees.
    Nelson died May 24, 1923. By virtue of the will, Davis, Bronson, and Prince, designated as executors and trustees, immediately came into possession of the estate of the approximate value of $3,000,000. Although they were the executors named in the will, they decided not to probate the will. They proceeded forthwith to marshal the assets of the estate, to determine and pay debts, charges, etc. They at once employed counsel. They inventoried and.valued the entire property, about half of which consisted of common stock of corporations and bank stocks not listed. The decedent had investments totaling about $150,000 in the Bahama Islands and in California which were practically a failure and the valuation of these investments was very complicated. Davis, Bronson, and Prince ascertained and paid the funeral expenses, debts and charges against the estate, prepared Federal income and estateTax returns and New York transfer-tax returns, and paid such taxes. During the administration of the estate at least one of the trustees was compelled to rearrange his personal business affairs for a period of one year in order to perform the duties required of him in connection with the settlement of the estate. Davis, .Bronson, and Prince performed the aforementioned services, and such other services as were required under the will and trust instrument, within two years after the death of Nelson, for which they allowed and paid themselves reasonable compensation of $10,000 each, or a total of $30,000, and in addition determined, allowed and paid the attorneys employed for services during- the same period in connection with the settlement of ■the estate reasonable fees, totaling $30,000. These amounts were paid on May 19, 1924. Thereafter Davis, Bronson, and Prince held the property as trustees under the trusts created and received each $500 per annum compensation.
   OPINION.

Littleton :

There is no controversy as to the facts in this proceeding nor is there any dispute concerning the reasonableness of the fees paid for the services performed.

The value of the decedent’s gross estate transferred at death by specific devise and bequests, and in trusts, was $2,899,093.09. Davis, Bronson, and Prince took possession of this estate upon the death of Nelson under the appointment in the will. They, as well as the attorneys employed by them, did a great deal of work in marshaling this estate, valuing assets, determining and paying debts, claims, taxes, etc., in the settlement of the estate prior and preparatory to taking over and administering the property conveyed in trust. During the period for which the fees in controversy are claimed, these gentlemen were not merely acting as trustees under a trust. They were administering and settling the estate in the same manner as regularly appointed executors or administrators would. That they did not see fit to probate the will and obtain letters testamentary as executors we think makes no difference in the matter of allowance of the fees as deductions from the gross estate under section 403 of the Revenue Act of 1921. The laws of the State of New York, the jurisdiction under which this estate was administered, permit and. make allowance for expenses of this character.

Section 285 of the New York Surrogate’s Court Act provides in part that—

On the settlement of the account of any executor, administrator, guardian or testamentary trustee, the surrogate must allow to him his just, reasonable and necessary expenses actually paid by him, * * * and in addition thereto the surrogate must allow to such executor, * * * for his services in such official capacity, and if there be more than one, apportion among them according to the services rendered by them respectively: * * * The value of any real or personal property, to be determined in such manner as the surrogate may direct, and the increment thereof, received, distributed or delivered, shall be considered as money in mating computation of commissions. But this shall not apply in case of a specific legacy or devise.

This is a mandatory provision, that such expenses as are here involved must be allowed when the court is supervising the administration of the estate. The court has no discretion in the matter of allowing such expenses except perhaps as to the reasonableness thereof and that feature is not involved in this proceeding and if it were this Board could determine the reasonableness of the amount. Una Libby Kaufman, Executrix, 5 B. T. A. 31.

The Commissioner allowed deductions amounting to $97,994.71 from the value of the gross estate and determined thereby that the value of the net estate transferred was $2,801,098.92 and the total tax upon the transfer to be $273,653.85. Davis, Bronson, and Prince in administering the estate made an estate-tax return showing a tax of $261,325.10, which was paid. The Commissioner contends as a justification for his action in disallowing the $60,000 that while “ there is no question but that executors’ commissions and attorneys’ fees fall within the classification of £ administration expenses,’ as used in the Federal statute herein previously quoted, provided such commissions and fees are actually incurred, expended, and approved by the Surrogate in connection with the administration of the estate by the executors, but, in cases like that of the estate herein considered where there was no administration by' the executors, and no final accounting to the Surrogate by the executors, as such, and no final order by the Surrogate fixing the amount of the executors’ commissions and attorneys’ fees, it is difficult to see under what theory the deductions may be allowed in computing the Federal estate tax.” And, further, he contends that “ assuming that the services performed by the' trustees partook of the nature of the services usually performed by executors, the deductions claimed will still be not allowable for the reason that no final account has been, or will be, presented for the consideration and approval, or disapproval, of the Surrogate. The same is true with respect to the fees paid to the attorneys by the trustees.” Finally the Commissioner insists “ that under the construction placed upon the section referred to [403 of the Revenue Act of 1921] in his regulations [article 36, Regulations 63], it is not believed that the amounts claimed are deductible. There was no administration upon the estate whatever in the probate courts, and consequently the expenses involved are not determined to be administration expenses within the meaning of the law.” In his Regulations 63, article 36, the Commissioner states that:

Tlie amount deductible as executor's or administrator’s commissions is such amount as has actually been paid or which at the time the return is filed it is reasonably expected will be paid, but no deduction will be allowed if no commissions are to be collected. Where the amount of the commissions has not been fixed by decree of the proper court, the deduction will be allowed on the final audit of the return provided: (1) That the Commissioner is reasonably satisfied that the commissions claimed will be paid; (2) that the amount entered as a deduction is within the amount allowable by the laws of the jurisdiction wherein the estate is being administered; and (3) that it is in accordance with the usually accepted practice in said jurisdiction in estates of similar size and character. Where the comnrssions claimed have not been awarded by the proper court the Commissioner on final audit may disallow the deduction in part or in whole, as the circumstances in his judgment justify, subject to such future adjustment as the facts may later require. If the deduction is allowed in advance of payment and payment is thereafter waived, it shall be the duty of the executor to notify the Commissioner.

We think that in so far as this regulation undertakes to restrict the allowance of administration expenses to those items which have been fixed and awarded by a decree of a proper court, it is a too narrow construction of the Act and should not be followed.

■ We think that by section 403 (a) (1) of the Revenue Act of 1921 Congress intended that the value of the gross estate should be reduced by the amount of such usual and customary expenses incident to the administration and settlement of estates as are permitted and authorized by the laws' of the jurisdiction under which such estate is administered and settled without specifically naming thfni, The language of the section is broad and should be given a liberal interpretation. The section does not provide that such amounts may be deductible only when fixed and approved by a decree of some court of the jurisdiction, as the Commissioner would have us interpret it, but such amounts as are allowed, permitted or authorized by the laws. The Surrogate’s Court Act, section 285, as amended by chapter 649, Laws of 1923, provides a sliding scale of commissions for testamentary trustees and under this schedule the fees of the trustees here would amount to approximately $60,000 instead of $30,000, as actually paid and claimed. What does “ administration ” mean ? Its ordinary meaning in connection with estates of deceased persons is the holding and management of property during the period before distribution, the collection of assets, ascertainment and payment of debts and taxes. Probate proceedings are not essential to this purpose. If an administrator is appointed by a court he performs the above services and distributes the property in accordance with the intestate laws. If an executor is appointed he is granted letters testamentary. He performs the same services and distributes in accordance with the will. Here the trustees perform the same services and make distribution in accordance with the trust deed. The only reason that can be given for determining that these amounts do not fall within the term is that no formal probate of the will was had. We think that is not enough. The amount here involved was an administration expense.

In the Appeal of Samuel E. A. Stern, et al., Executors, 2 B. T. A. 102, the Board held that in allowing deductions from the gross estate in computing estate taxes, Congress did not intend that determination of the tax should await final settlement of the estate and a reduction to absolute certainty of all claims against it, and that deductions for executors’ commissions might be based upon a reasonable estimate of the amount allowable by the lex domicilia and it is not essential that such commissions be first allowed by order of court or paid. Compare Appeal of Grace M. Knox, et al., Executors, 3 B. T. A. 143; Appeal of Henry Riffel, 3 B. T. A. 436; Appeal of Salina Bell, Executrix, 3 B. T. A. 1172; Mrs. Browning Coleman Moore, Executrix, 5 B. T. A. 255; William W. Mead, et al., Executors, 6 B. T. A. 752.

The statute refers to expenses “ allowed by the laws of the jurisdiction ” not those expenses fixed and awarded by a decree of a probate court. The Board is of the opinion that the amount of $60,000 claimed was a proper deduction from the value of the gross estate in determining the net estate for the purpose of tax, and that the Commissioner erred in not allowing such deduction.

Judgment will 5e entered on 15 days’ notice, under Bule 50.


text:
    Ware River Railroad Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8712, 19054.
    Promulgated May 27, 1927.
    The amount of the Federal tax upon the income of the petitioner paid by its lessee constitutes income to the petitioner for the year in which such tax became due and was paid.

      Robert H. Davison, Esq., for the petitioner.

      A. H. Murray, Esq., for the respondent.
    Proceeding Docket No. 19054 relates to a deficiency of $649.02 for the calendar year 1919 and proceeding Docket No. 8712, relates to deficiencies of $643.29 and $463.27 for the calendar years 1920 and 1921, respectively. The issues in both cases are the same and the proceedings were consolidated for hearing and decision.
    The Commissioner held that the tax upon the petitioner’s income paid by its lessee under the terms of the lease constitutéd additional income. Petitioner claims first that Federal income and profits tax payable by a lessee does not constitute additional income to the lessor; secondly, that Federal income and profits tax payable by a lessee does not constitute additional income to the lessor in the taxable year during which the income on which such tax was earned, was received. The facts are found as stipulated.
    Petitioner is a Massachusetts corporation with principal office in Boston. During the years 1919, 1920, and 1921 it kept its books and rendered its income and profits-tax returns on the accrual basis. During the years in question the railroad property of the taxpayer was leased to the Boston & Albany Railroad Co. and by it to the New York Central Railroad Co. under an instrument of lease which contained among other things the following provision: “And said second party doth further covenant and agree to pay all taxes, which during said term may be assessed upon said first party, its railroad and the stock of its stockholders * *
    Pursuant to the foregoing provision of the lease the New York Central Railroad Co. paid in the year 1919 taxes on the income of the taxpayer for the year 1918 in the sum of $6,438, of which sum, however, the Director General of Railroads bore or assumed one-sixth; the said New York Central paid in 1920 for Federal taxes on the income of the taxpayer for the year 1919 the sum of $6,490.14, of which sum the Director General of Railroads bore or assumed one-fifth; and paid in the year 1920 for Federal taxes on the income of the taxpayer for the year 1920 the sum of $6,482.84, of which sum the Director General bore one-fifth of the portion of the taxes attributable to the months of January and February, or one-fifth of one-sixth of the aforementioned sum.
   OPINION.

Littleton :

The decision of the issues presented in these proceedings is governed by the Board’s decision in the Appeal of Providence & Worcester Railroad Co., 6 B. T. A. 1186, in which it was held that amounts representing Federal taxes assessed against the lessor and paid by the lessee under the terms of the lease constituted additional income to such lessor in the nature of compensation for the use of property in the year in which such tax became due and payable. The fact that the Director General of Railroads bore a portion of the tax assessed against the petitioner has no bearing upon the question whether the amount paid to petitioner by the New York Central Railroad Co., lessee, was income to it.

Judgment will be entered on 15 days’ notice, wider Rule 50.