author: Leech :

text:
    Sand Springs Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 65848, 69409.
    Promulgated October 23, 1934.

      J. S. T. Ivins, Esq., and F. E. Toungman, Esq., for the petitioner.

      P. A. Bayer, Esq., for the respondent.
   OPINION.

Leech :

In these consolidated proceedings, petitioner asks rede-termination of deficiencies in income tax proposed for the calendar years 1929 and 1930, in the respective amounts of $5,685.64 and $4,192.35.

The common error assigned to both deficiencies is the disallowance by respondent of petitioner’s asserted deduction of alleged interest payments on its bonds outstanding during those yéars. Petitioner also assigns error in the petition filed at Docket No. 65484, in the amount of depreciation allowed it by respondent for 1929.

From the records of this Board in Docket Nos. 32438 and 32439, included in this record by stipulation, as well as other formal oral stipulations, we summarize the facts necessary for an understanding of the single present issue.

Petitioner was incorporated in 1911 under the laws of Oklahoma. In 1912 it issued its 25-year first mortgage bonds in the sum of $300,000, bearing interest at the rate of 6 percent per annum and secured by a deed of trust dated July 1, 1912, covering all of its properties, rights, and franchises. These bonds were outstanding during all subsequent years, including the years 1929 and 1930, involved in these proceedings. The petitioner paid interest to the bondholders each year in the total amount of $18,000, and claimed such interest as a deduction from income in its income tax returns.

After auditing the income and profits tax returns of the petitioner and other companies with which it was affiliated for the fiscal years ended June 30,1918, to June 30,1923, inclusive, the respondent determined tax deficiencies, resulting from the disallowance of this deduction for interest, among other adjustments. The notice of deficiency in each instance states this was “ for the reason that it is the opinion of this office that the amount paid to the Sand Springs Home was in the nature of a gift and not deductible.” Petitioner appealed from respondent’s determination of deficiencies for those years, assigning, among other errors, “ the addition to net income of the Sand Springs Eailway Company of $18,000 each taxable year, representing interest paid upon outstanding bonds of the Sand Springs Eailway Company.” The facts alleged in each petition to support that assignment were:

Throughout all of the taxable years under consideration, the Sand Springs Railway Company had outstanding bonds, secured by a mortgage upon its property and franchises in the principal sum of $300,000, which bonds carried interest at the rate of 6 per cent per annum.
During each of the taxable years under consideration, the Sand Springs Railway Company paid interest upon said bonds, amounting to $18,000. Such interest was deducted by the Sand Springs Railway Company from its gross income in the computation of its net income for each of said taxable years, but said deduction was disallowed by the Commissioner, who increased the net income of the Sand Springs Railway Company accordingly.

Eespondent’s answer put petitioner upon proof thereof.

The Board then disallowed the asserted interest deduction (Sand Springs Railway Co., 21 B. T. A. 1291), upon which final decision was entered January 5, 1932. That decision has not been disturbed by review or otherwise.

Later, respondent disallowed similar asserted deductions in determining deficiencies for 1929 and 1930 against the same taxpayer, the deficiency notice, in at least one instance, stating the reason therefor to have been the absence of proper consideration in the .issuance of the bonds upon which the disputed alleged interest was paid. The pending proceedings resulted. Petitioner herein assigns the identical error assigned in the petitions relating to the deficiencies for the years redetermined by this Board in Sand Springs Railway Co., supra. It now alleges the existence of proper consideration for the issuance of these same bonds, as a fact, in support of the present assignment of error.

At the hearing, petitioner made formal proffer of specific evidence for the purpose of proving “that the bonds of the Sand Springs Eailway Company to which reference has been made, were issued for adequate, valid and sufficient consideration.”

In addition to having formally pleaded res judicata, respondent objected to the admission of such evidence on the ground that “this question having been previously decided by the Board, the issue is res juáücata and the petitioner is estopped from bringing further evidence on the same question.”

' The Board reserved its ruling thereon. Counsel for petitioner then stipulated that in the event this objection was sustained, subject to an exception, no further evidence would be offered on either pending issue unless such ruling were later reversed, and that our decision should be entered upon the present record approving the disputed deficiencies as proposed. Thus, no proof was offered on the depreciation issue.

The respondent argues that our decision in Sand Springs Railway Co., supra, is conclusive of the issue presently presented, though the causes of action are different, since the issue and facts litigated in both proceedings are the same. Petitioner contends that the rule of res judicata does not apply here, because the present controversy is based upon different causes of action, and only the matters actually litigated and decided in- the prior proceeding are res judicata here. It argues that the only matters which are res judicata here are (1) that the petitioner is not entitled to the deductions claimed for the years involved in the prior proceedings, and (2) that bonds of a corporation, not shown to have been issued for consideration, did not constitute an “ indebtedness ” within the meaning of the applicable revenue acts which would entitle a corporation to deduct the interest paid upon such bonds.

The doctrine of res judicata is so well fixed in the law that no useful purpose could be served here by further discussion. Cromwell v. County of Sac, 94 U. S. 351, 352, 353; New Orleans v. Citizens Bank, 167 U. S. 371; Southern Pacific Railroad Co. v. United States, 168 U. S. 1; United States v. Moser, 266 U. S. 236; Tait v. Western Maryland Railway Co., 289 U. S. 620, 623; Mary Haller, 26 B. T. A. 395; Chasrles P. Leininger, 29 B. T. A. 874; Portage Silica Co., 29 B. T. A. 881; Edwin J. Marshall, 29 B. T. A. 1075.

Our inquiry, therefore, is as to the propriety of its application in bar of the pending proffer of evidence.

Since the parties to both proceedings are the same, but the causes of action different, the decision in the former cases is a bar here, if, and-only if, “the point or question to be determined in the latter action is the- same as that litigated and determined in the original action.” Tait v. Western Maryland Railway Co., supra.

It is true that the fact of proper consideration for the issuance of the bonds now pleaded and sought to be proved by the pending proffer, was neither pleaded nor proved by evidence in the earlier action. Petitioner there, specifically waived the materiality of that fact and rested its position solely upon the legal proposition, that, regardless of whether there was proper consideration for the issuance of the bonds, it was entitled to deduct the amounts paid as interest thereon. Petitioner now argues that its action .in this .earlier proceeding was practically a demurrer to the fact of consideration, and that decision thereon could not, .therefore, estop it here. That legal position might be sound if the factual premise existed. Cf. Gould v. Evansville & Crawford Railway Co., 91 U. S. 526.

The ^rules' of practice of the Board do not permit a technical demurrer. However, our discretionary practice of considering decisive points of law involved in proceedings before hearing evidence on the facts, in proper cases, upon formal motion therefor, has the same effect. Conrad Hardware Co., 8 B. T. A. 512; Henry M. Leland, 8 B. T. A. 974; Greylock Mills, 9 B. T. A. 1281; A. J. DeMay & Co., 10 B. T. A. 455; Maple Coal Co., 10 B. T. A. 1336; Chadbourne & Moore, Inc., 16 B. T. A. 961; Greylock Mills, 18 B. T. A. 75; Greylock Mills v. White, 63 Fed. (2d) 866; Tex-Penn Oil Co., 28 B. T. A. 917.

Petitioner did not avail itself of this procedure, but went to trial on the merits.

The issue then before the Board was not the validity of the reason for his action which the respondent gave in the statements accompanying the notices of deficiencies. Edgar M. Carnrick, 21 B. T. A. 12; Reuben H. Donnelley Corporation, 26 B. T. A. 107; affd., 35 Fed. (2d) 910; certiorari denied, 281 U. S. 735. Instead, the issue presented and decided was, whether respondent’s action in disallowing, for the years there involved, a deduction of alleged interest on a particular issue of the petitioner’s bonds was proper for any reason. John I. Chipley, 25 B. T. A. 1103; Richard L. McCann, Administrator, 30 B. T. A. 102.

That is the pending issue, except that the disallowance involved is for later years. This difference is not controlling here. Tait v. Western Maryland Railway Co., supra; New Orleans v. Citizens Bank, supra.

The provisions of the respective revenue acts applicable to both cases are identical. Section 234 (a) (2), Bevenue Act of 1921, and section 23 (b), Kevenue Act of 1928. The parties are the same. The facts and circumstances surrounding this same issue of bonds, including the consideration therefor, have been constant since the bonds were issued. The mere failure of the petitioner to plead or prove any then existing and material fact in the earlier proceeding, would not seem to exclude it from the res therein adjudicated. New Orleans v. Citizens Bank, supra.

However, though neither pleaded nor proved by evidence in the earlier case, the existence of proper consideration for the issuance of the bonds was there specifically considered and decided. The Board, in its opinion, in the prior case, definitely discussed that-very question of fact. After noting the statement of counsel for petitioner waiving its materiality and contending solely upon the issue of law, the Board assumed the absence of such consideration and, then, established tire materiality of that fact in the decision of the issue by disallowing the proposed deduction upon that assumption of lack of proper consideration. Sand Springs Railway Co., supra; cf. Larsen v. Northland Transportation Co., 292 U. S. 20.

Petitioner’s waiver as to the fact of proper consideration had the effect of admitting its absence in the premises, regardless of whether or not that waiver was inadvertent or erroneous where, as there, the question of fact to which it was directed was then before the Board. Tait v. Western Maryland Railway Co., supra. Neither the propriety of the consideration of that fact as then present for determination nor the assumption of the absence of proper consideration at the issuance of the bonds which followed, upon which assumption the issue was then decided, can be questioned now. This Board had competent and exclusive jurisdiction of that controversy (section 274, Revenue Act of 1926) and the decision therein, remaining undisturbed, is final and conclusive. New Orleans v. Citizens Bank, supra; Wobber Brothers, 31 B. T. A. 133.

We hold that the decision of this Board in Sand Springs Railway Co., supra, is res judicata of the present proceedings. New Orleans v. Citizens Bank, supra; Larsen v. Northland Transportation Co., supra; Tait v. Western Maryland Railway Co., supra.

The objection oí respondent is sustained and an exception noted to petitioner.

Upon the record, as well as in accordance with the formal stipulation in reference thereto,

Reviewed by the Board.

Decision will be entered for the respondent.

Smith dissents.

       Sec. 234. (a) That In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
      * * * * * * *
      (2) All interest paid or accrued within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry on obligations or securities (other than obligations of the united States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this title;

         SEC. 23. DEDUCTIONS PROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *»***•»
      (b) Interest. — All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the united States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exenapt from taxation under this title.


source: Caselaw Access Project

author: Black:

license: Public Domain

text:
    San Jacinto Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71143.
    Promulgated October 23, 1934.

      Thomas Watters, Esq., for the petitioner.

      John D.'Kiley, Esq., for the respondent.
   OPINION.

Black:

In this proceeding the Commissioner has determined a deficiency against petitioner for the year 1930 of $1,392.29.

In the petition several errors have been assigned. These errors will be separately stated and ruled upon later in this opinion. An agreed statement of facts has been filed, which is incorporated herein by reference. Only such part of the facts will be stated in this opinion as seems necessary to an understanding of the issues to be decided.

The petitioner was during the taxable year a corporation organized under and by virtue of the laws of the State of Texas, with its home office in the city of Beaumont, Texas.

It was a stock company doing business usual to that of a life insurance company operating on the legal reserve, level premium plan. The petitioner kept its books and records and filed its Federal income tax return on the basis of cash receipts and disbursements.

With these preliminary statements, we will now state and rule upon the issues as raised by the pleadings.

(a) Is the petitioner entitled to deduct depreciation- upon furniture, fixtures, and equipment which it owned and used in its business, regardless of whether used in the production of underwriting or investment income, or is petitioner’s deduction restricted in this respect to the ratio that investment income bears to gross income? The petitioner contends that it is entitled to a depreciation deduction on furniture and fixtures and equipment, regardless of the use to which the property is devoted, and that its deduction therefor is not restricted, as the respondent contends, to only so much of the whole amount of depreciation on these things as its investment income bears to gross income.

In Rockford Life Insurance Co. v. Commissioner, 292 U. S. 382, decided since briefs were filed in this proceeding, this issue was decided by the Supreme Court adversely to the contention of petitioner and in harmony with the contention made by respondent. On this issue respondent is sustained.

(b) The same depreciation question is raised with reference to automobiles owned by petitioner and used in its business in both the investment and underwriting departments. On this issue the determination of the respondent is sustained on the strength of the authority cited under (a).

(c) Is the petitioner entitled to a deduction from gross income for real estate taxes paid by it during the taxable year upon property which it had sold prior to the taxable year, but upon which it had ‘ncurred a liability for such taxes during the period of' its ownership? On this point the facts have been stipulated as follows:

Prior to the taxable year 1929, the petitioner acquired a certain property located at the corner of Fannin and Orleans Streets, Beaumont, Texas, known as the San Jacinto Life Building. The building was owned by petitioner in fee simple from a date prior to the first of the taxable year 1929 to April 30, 1929. During the period from January 1 to April 30, 1929, the petitioner occupied a part of this building for home office purposes, and thereafter the petitioner occupied a part of-said premises as a tenant only.
On April -30, 1929, the petitioner sold the property to the San Jacinto Building Company.
On January 1, 1929, state, county and municipal taxes were assessed against said property in the amount of $25,832.50 and became a lien thereon from and after the date of said assessment. No part of such taxes was assessed against local benefits of a kind tending to increase the value of said property. -On January 30, 1930, petitioner paid said real estate taxes in the amount of $25,832.50.
Subsequently, to-wit, January 30, 1930, .petitioner was paid, the amount of $17,221.66 by the purchaser of the property, such payment being a suin equal to the ratable proportion of the taxes for the full’ year, based on the ownership of such property by the purchaser thereof, from May 1, 1929 to December 31, 1929.
Such payment was made in accordance with an agreement entered, into at the time of the sale of said property by the petitioner and represented a part of the consideration agreed to be paid by the purchaser.
No part of said taxes above referred to has been allowed to the petitioner as deduction from gross income.

Respondent disallowed all of the $25,832.50 as a deduction, giving as a reason for his action, “ The taxes in question are disallowed in accordance with the provisions of section 203 (b) of the 1928 Act.” Section 203 (b) reads as follows:

(b) Rental value of real estate. — No reduction shall be made under subsection (a) (6) and (7) of this section on account of any real estate owned and occupied in whole or in part by a life insurance company unless there is included in the return of gross income the rental value of the space so occupied. * * *

With reference to the applicability of section 203 (b), petitioner says in its brief: “ It is conceded that no rental income was reported from this building by the petitioner during the taxable year, for the very apparent reason that there was no such income, the property having passed out of the possession of the- petitioner prior to the beginning of the taxable yean”

We think petitioner’s contention that it is entitled to a deduction for this $25,832.50 taxes paid in 1930 is untenable. It has been stipulated that petitioner did not include in its gross income for 1929 the rental value of the space which it occupied in said building during the period of time from January 1 to April 30, 1929. This fact will be found in the stipulation, paragraph 4, which.-we give under point (d) to be hereafter discussed.

It must be remembered that the deduction for real estate expenses, including taxes, provided by section 203 (a) (6) of the Revenue Act of 1928, when applied to a home office building owned by an insurance company, should be read in connection with section 203 (b), already quoted, which puts a limitation upon the allowance of these deductions. That limitation has been approved by the Supreme Court in Helvering v. Independent Life Insurance Co., 292 U. S. 371. Petitioner contends this limitation does not apply in the instant case because it had disposed of the building prior to January 1, 1930, the year in which the taxes in question were paid; it was not the owner of the building in 1930; and there was no rental value of space which it would be obliged to return as income before it could claim the benefit of the deduction for taxes and other real estate expenses provided by section 203 (a) (6).

This argument is not convincing. It is true that, under the laws of Texas, liability for city, school, state, and county taxes accrues against the owner of property on January 1 of each year and the taxpayer does not have to pay the taxes until prior to February 1 of the following year (Texas Coca-Cola Bottling Co., 30 B. T. A. 736), but we do not see where that affects in any way the limitation provided by section 203 (b).

Suppose that while petitioner was the owner of this office building in 1929, occupying space in it for its own- use, it had incurred certain liabilities for expenses in the upkeep and maintenance of the building, such for example as heating and lighting and had not paid these expenses until 1930, would it be contended that petitioner would be entitled to take a deduction for these expenses from 1930 gross income, notwithstanding it has been admitted that petitioner did not return as income the rental value of the space which it occupied during the time such expenses were incurred ? We think not. And we think the same reasoning would apply as to taxes.

Petitioner urges in support of its contention our decision in Missouri State Life Insurance Co., 29 B. T. A. 401, but we do not see where that case is in point. In the latter case we held that taxes which had accrued prior to the acquisition of the real estate by the insurance company but which were actually paid by the insurance company while it was the owner of the real estate in question, were not deductible because the taxes were not those of the insurance company but were the taxes of those who owned the land at the time the taxes accrued. If the taxes involved in the instant case were taxes on farm lands which petitioner owned in 1929, when the taxes accrued, but sold in that year, we think Missouri State Life Insurance Co., swpra, would be an authority in support of petitioner’s contention that it is entitled to the deduction for taxes paid in 1930, notwithstanding it was no longer the owner of the property. The mere fact that it had sold the property and was no longer the owner of it in the year when the taxes were properly paid, would not deprive it of the deduction.

It would be sufficient to meet the measure of the statute if petitioner was the owner of the property at the time the tax liability legally accrued. Undoubtedly the same rule would apply to a home office building owned by an insurance company in which it occupied space for its own use, if it were not for the limitation contained in section 203(b). But, as already stated, we believe that section deprives petitioner of the deduction claimed. As to this issue, we sustain respondent.

(d) Is the petitioner entitled to a deduction from its taxable income for the year 1930 of the amount of a net loss sustained during the preceding taxable year ? On this point the facts have been stipulated as follows:

1. It is agreed that the amount of “ net loss ” as shown by the return, being $30,654.26, should be reduced by deducting therefrom the sum of $2,813.03 received by petitioner in the taxable year 1929 as interest on tax-exempt securities and reported in Item 5 of said return.
2. It is stipulated and agreed that in the taxable year 1929, the petitioner owned certain furniture, fixtures, automobile and equipment costing $33,529.39, and used by the petitioner in the conduct of its business. On account thereof, the petitioner deducted as a part of Item 12 of its amended income tax return, “ Exhibit A”, the sum of $3,759.26 as depreciation thereon, of which amount the respondent has disallowed the sum of $3,175.86.
It is agreed that if the United States Board of Tax Appeals and/or the court should hold that the petitioner is entitled to depreciation on said furniture, fixtures, automobile and equipment, without regard to the department in which the said furniture, fixtures, automobile and equipment are used, then petitioner is entitled to deduct from gross income the full amount of $3,759.26, hereinabove referred to.
The ratio of petitioner’s investment income to gross income for the taxable year 1929 was 18.12%, and it is agreed that if the United States Board of Tax Appeals and/or the court should hold that the petitioner is entitled to depreciation on said furniture, fixtures, automobile and equipment, only to the extent that such furniture, fixtures, automobile and equipment are used in the production of investment income, then, based upon such ratio, the petitioner’s correct deduction from gross income for depreciation upon the said furniture, fixtures, automobile and equipment is the sum of $681.18.
3. As hereinabove set forth, under (c) above, the petitioner owned in fee simple during the period from January 1, 1929, to April 30, 1929, a certain office building in the city of Beaumont, Texas, which it occupied in part during such period for home office purposes. The book value of the said building on the date of sale, April 30, 1929, was the sum of $1,202,410.60.
4. It is stipulated and agreed that the rental value of the space occupied by petitioner was for the said period January 1, 1929, to April 30, 1929, the sum of $4,000.00. The petitioner did not, however, report in its amended income tax return, “ Exhibit A”, the rental value of the space it occupied in the amount of $4,000.00, as hereinabove set forth, although the petitioner did report as Item 3 of its amended income tax return, “ Exhibit A”, $33,564.16 as rents received from tenants.
5. It is agreed that in computing the “ net loss ” for 1929, the petitioner deducted from gross income, taxes in the sum of $23,533.50 and other real estate expenses in the sum of $22,154.71, being Items 10 and 11 of “ Exhibit'A ”. All of the said amounts pertained to and were disbursed in connection with the ownership of the said home office property. No part of the said taxes was assessed against local benefits of a kind tending to increase the value of the property, and no' part of the other real estate expenses was paid out for new buildings or for permanent improvements or betterments made to increase the value of the said property. The petitioner also deducted the sum of $9,827.79 as a part of Item 12 of “ Exhibit A ”, representing the depreciation deduction .upon said home office building.
6. It is agreed that if in order to be entitled to deductions on account of taxes, real estate expenses and depreciation, all in connection with its home office property and building, as hereinabove set forth, the petitioner must include in its return of gross income the rental value of the space which it occupied, and that such rental value shall not be less than a sum which in addition to rentals received from other tenants shall provide a net income (after deducting taxes, depreciation and all other expense) at the rate of four per centum per annum of the book value of the said building at the end of the taxable year, then it is agreed that the petitioner did not sustain a net loss in the year 1929 to carry forward into the taxable year 1930.
7. It is further agreed that if the petitioner is entitled to deduct from gross income in the year 1929 its disbursements on account Of taxes, depreciation and other expense as hereinabove referred to, without reporting as income the rental value of the space which the petitioner occupied, computed as herein-above set forth, then it is agreed that the petitioner’s net loss for the taxable year 1929 to be carried forward into the year 1930 is the sum of $27,841.23; provided, however, that should the United States Board of Tax Appeals and/or the court hold that the petitioner is entitled to depreciation on furniture, fixtures, automobile and equipment, only to the extent that such said furniture, fixtures, automobile and equipment, are used in the production of investment income, then the net loss for the taxable year 1929 to be carried forward into the year 1930 is the sum of $24,763.15.

We hold that petitioner is not entitled to carry forward a “ net loss ” for the year 1929, because there was no net loss under the facts stipulated (see especially paragraph 6 of the above. stipulation), when interpreted in the light’of recent Supreme Court decisions. Helvering v. Independent Life Insurance Co., supra; Rockford Life Insurance Co. v. Commissioner, supra.

(e) Is petitioner entitled to a deduction from taxable income in the amount of $3,000, which amount constitutes the specific exemption provided by section 203 (a) (9) of the Revenue Act of 1928, for domestic life insurance companies?

It has been stipulated that the petitioner has not heretofore been allowed the specific exemption from net income of $3,000 which is allowed by section 203(a) (9) of the Revenue Act of 1928 to domestic life insurance companies whose net income (computed without the benefit of said section) is $25,000, or less. In the event that petitioner’s net income for the taxable year as determined by a recompu-tation under Rule 50 is $25,000, or less (computed without the benefit of section 203(a)(9), then petitioner will be entitled to á specific exemption of $3,000 as provided by section 203 (a) (9) of the Revenue Act of 1928.

Reviewed by the Board.

Decision will 5e entered under Rule 50.


author:
ARtjndell:
      Murdoch,

text:
    George P. Pitkin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 65173.
    Promulgated October 23, 1934.

      Robert N. Anderson, Esq., and J. Nelson Anderson, Esq., for the petitioner.

      Harold Allen, Esq., for the respondent.
   OPINION.

ARtjndell:

This controversy relates to income taxes for the year 1929 in the amount of $3,989.05. The only issue involved,is whether or not the petitioner received a taxable dividend of $37,785.54 from the City National Bank & Trust Co., a corporation, in 1929.

The main facts are stipulated, but some oral testimony was introduced at the hearing showing the following situation: The petitioner, a resident "and citizen of the State of New Jersey, was, prior to March 4, 1928, one of a group owning 82.1 percent of the .stock of the City National Bank & Trust Co., a New Jersey corporation, hereinafter referred to as the Bank. These stockholders collectively owned 86.87 percent of the stock of another New Jersey corporation known as the Bankers’ Securities Co., hereinafter referred to as the Securities Co. The Securities Co. was a stockholding company and owned more than 51 percent of the stock of seven banks.

On March 4, 1928, the State of New Jersey enacted legislation making it unlawful for corporations, other than New Jersey banks and trust companies, to own more than 10 percent of the stock of more than one other banking corporation, except in cases where the entire capital stock of all corporations involved should be held by the same stockholders in equal ratios.

After passage of the above mentioned legislation, the stockholders of the Bank and the Securities Co. deemed it to their interests to realign and change their corporate affiliations, which, according to the stipulations made a part of this record, was carried out in the following manner:

Upon the passage of this act it became necessary to take steps to bring the Securities Company within the exception, if it was to continue to do business. Accordingly, a plan was devised and approved by the stockholders and directors of both the Bank and the Securities Company, whereby the capital stock of the Bank was increased from $100,000 to $200,000, by the issuance of 1,000 additional shares. The new shares were sold to the old stockholders, in proportion to the old shares held, for $250 per share, and, in accordance with the plan, the Bank then declared a special dividend of $100 per share on each of the 2,000 shares which dividend was paid on July 30, 1029.
In accordance with the agreement with the stockholders, the dividend was paid, not to the stockholders, but to a committee of the stockholders of the Bank, which, in accordance with the agreed plan, organized a new corporation, the City National Company, with an authorized capital stock of $200,000, and the committee purchased the entire issue for the stockholders of the Bank, using the dividend money for the purchase. When this was accomplished, both the Bank and the City National Company had outstanding stock of $200,000, and each stockholder held stock in each of the two corporations in the same relative proportion.
The stock of the Bank and of the new corporation was turned over to trustees, who issued depository receipts therefor and it was understood and agreed that no stock in the new corporation could be sold unless a like amount of Bank stock was sold, and vice versa.
It was intended that the new corporation (the City National Company) would purchase the assets of the Securities Company for a sum not less than $184,800 and then to liquidate the Securities Company and pay each stockholder $120 per share. There were holders of 25 shares of the Securities Company stock, however, who objected and prevented the plan from being carried out in that manner, so instead of purchasing the assets of the Securities Company, the City National Company purchased 1,503 shares of the Securities Company stock out of the total of 1,540 shares outstanding. Of the 37 shares, not purchased, 12 were qualifying and the other 25 were owned by the objectors.

Included in their stipulation the parties have set forth a table showing the Bank’s financial situation on certain dates and indicating how this transaction was treated in the books of the Bank. This table and statement of the transactions follows:

The petitioner, as the owner of 193 shares of the Bank stock, was entitled to purchase, and did purchase, another 193 shares for $250 per share in accordance with the plan of reorganization, so that on July 30,1929 (the date on which the dividend was paid) he was the owner of 386 shares, and his share of the dividend was $38,600.

The respondent has determined that at the time the special dividend was declared and paid the Bank had earnings in its surplus and undivided profits accounts equivalent to 97.89 percent of the $200,000 distributed and that such amount was taxable to the stockholders. In the notice of deficiency respondent determined that 97.89 percent of the $38,600 received by petitioner, or $37,785.54, was taxable to him as a corporate dividend.

The petitioner concedes that $50,000 of the Bank’s profits were distributed in the special dividend, and that to the extent that the $38,600 received by him shared in said sum, it may be properly taxed. He contends, however, that except as to the $50,000, the entire special dividend constituted a return of capital, and, therefore, was not taxable as income within the rule laid down in Eisner v. Macomber, 252 U. S. 189, and other cases cited.

The respondent relies upon section 22(a) and section 115(a) and (b) of the Bevenue Act of 1928.

Beginning with the Bevenue Act of 1917 it has been the intent of Congress, as expressed in the successive taxing statutes, to remove from, corporations the power to designate from what year’s profits dividends should be deemed to be paid or the particular fund from which disbursement of dividends is made. Douglas v. Edwards, 269 U. S. 204. The application of the statute cannot be circumvented by a resolution declaring a distribution out of some fund other than earnings. Albert J. Gifford, 18 B. T. A. 795; affd., sub nom Leland v. Commissioner, 50 Fed. (2d) 523; McCaughn v. McCahan, 39 Fed. (2d) 3.

The design of the statute is to subject to tax distributions to stockholders so long as the corporation making the distributions has earnings realized subsequent to March 1, 1913. But the statute should not be given an interpretation so broad as to go beyond its obvious purpose and to bring about an entirely artificial result. In this case there was no intention on the part of the petitioner and the other stockholders of the Bank to increase the latter’s surplus and to turn over to the Bank for its own use the entire $250,000 paid in. This money was paid to the Bank for the very definite purpose of accomplishing the reorganization of the Securities Co., which reorganization was made necessary by a recent act of the legislature of New Jersey. Thé Bank was a conduit of $150,000 of the money rather than a recipient in its own right, as it was well and definitely understood by all parties when the money was paid to the Bank that it would forthwith be used for the purpose for which it was paid. All the details had been agreed to in writing before a single dollar was paid in to the Bank by its stockholders. The underlying principle, in this proceeding is not unlike that in Weaver v. Commissioner, 58 Fed. (2d) 755. In that case it was stipulated that the stockholders of a corporation, in order to increase its working capital, paid in to it $100,000. They received no stock for the amount so paid in and a verbal understanding existed among them that at some future time the contributed sum would be returned to them. Three years later the whole amount ivas returned to the stockholders in the exact sums originally contributed. The Commissioner treated the amounts paid to the stockholders as dividends and the Board sustained his action. The court, after examining into the record in the Weaver case, reached the conclusion that the stockholders became creditors of the corporation when they made their payments and the amounts paid back to them were in reality in payment of loans and not dividends. It is equally true in the instant case that the amounts paid out by the Bank, exclusive of the $50,000 admittedly paid out of undivided profits, did not represent a dividend, but the repayment by the Bank of sums intrusted to. it'in order that it might use them as directed. The facts here are in some respects more favorable to the taxpayer than they were in the Weaver case, where the sum contributed was used in the business of the corporation for nearly three years. Here the money paid in represented cash out of the stockholders’ pockets, while in the Weaver case it was largely made up of sums then appearing on the corporate books as credits to the stockholders’ individual accounts from prior years’ earnings and profits of the corporation. Under this interpretation of the facts we do not reach the point where the sums paid in by the stockholders to the extent of $150,000 ever in fact became a part of the permanent funds of the Bank, however they were accounted for on the Bank’s books. Of the $200,000 paid to the stockholders only $50,000 was in fact a dividend, the balance being a return of money loaned for a specific purpose. Petitioner concedes the taxability of the $50,000 and we agree with him that the balance was not a dividend.

Eeviewed by the Board.

Decision will be entered under Rule 50.

Murdoch,

dissenting: Section 115 of the Revenue Act of 1928 provides that the term “ dividend ” means any distribution made by a corporation to its shareholders out of its earnings or profits accumulated after February 28, 1918, and it also provides, for the purpose .of the act, “every distribution is. made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits.” The City National Bank & Trust Co. distributed $200,000 of money belonging to it at a time when it had earnings or profits accumulated after February 28, 1913, amounting to at least $180,822.04. It seems clear to me that the distribution in question was a dividend within the provisions of the statute to the extent of $180,822.04.

Sternhagen, Matthews, and Leech agree with this dissent.

         SEC. 22. GROSS INCOME.
      (a) General definition. — “ Gross income ” includes gains, profits, and income derived from * * * dividends * * *.
      SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      (a) Definition of dividend. — The term “ dividend ” when used in this title (except in section 203(a)(4) and section 208(c)(1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
      (b) Source of distributions. — For the purposes of this Act every distribution 'is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after-the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 113.


author: Goodrich:

text:
    Selma Wertheimer and Fidelity Trust Company, Co-Executors, Estate of Morris S. Wertheimer, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 48006.
    Promulgated October 23, 1934.

      /Samuel Kaufman, Esq., for the petitioners.

      Thomas F. Callahan, Esq., for the respondent.
   OPINION.

Goodrich:

Respondent has determined against petitioners’ decedent, Morris S. Wertheimer, a deficiency in income tax for 1926 in the amount of $4,943.60. At trial he admitted error in including capital gains of $10,924.06 in Wertheimer.’s income for 1926. Accordingly, upon settlement, that item will be eliminated from income as disclosed by the deficiency notice.

Of the issues raised by the pleadings, two remain for our decision — first, whether Wertheimer sustained a loss of $53,445.60, deductible from bis income for 1926, upon liquidation of his stock of A. Guckenheimer & Bros. Co.; and, second, whether Wertheimer, as a beneficiary of a trust, may deduct from his income for 1926 the amount of $19,973.85, being his pro rata share of a loss claimed to have been sustained by the trust upon its disposition of shares in the same Guckenheimer Co. To some extent, the issues are related, for both Wertheimer and the trust of which he was a beneficiary disposed of their shares in the same transaction. It is for us now to determine whether that transaction gave rise to a loss deductible from income in 1926.

The facts are not in dispute. The case was submitted upon an agreed statement of counsel, which, together with the several stipulations on the trial record, we adopt as our findings of fact. For the purposes of this report, a briefer statement will suffice.

On June 17,1921, Morris Wertheimer owned 801 shares of stock of the A. Guckenheimer & Bros. Co., a Pennsylvania corporation; the estate of his father, Samuel, owned 3,803 shares. The cost of Morris’ stock is unknown and undeterminable and the parties agreed that we may assume the cost to be the same as its March 1,1913, value, which was $84.30 a share. Samuel Wertheimer died on May 3, 1915, leaving his stock, then worth $57.24 a share, in trust upon certain conditions which were subsequently fulfilled, so that in June 1921 Morris had a one-seventh interest therein.

On June 17, 1921, the company had 14,403 shares outstanding. On that day it purchased from its stockholders ratably 2,876 shares of its own stock, paying therefor $229,260 in cash, and property to the value of $69,706.56, or a total of $298,966.56. Of Morris’ shares, 160 were thus redeemed, leaving him 641, and of the estate’s shares, 660 were redeemed, leaving 2,643.

On the same day all of the stockholders of the Guckenheimer Co., including Morris and the estate of Samuel Wertheimer, transferred to three trustees all of the cash and properties received by them in purchase of their shares and the 11,527 shares of the company still outstanding. At the same time the company transferred to the trustees $101,530.12 which represented a reserve for payment of its liabilities exclusive of Federal income and profits taxes.

These transfers were made in connection with the consummation of a sale of all of the stock of the company to outside interests, and under a trust agreement between the stockholders and the trustees, the purpose of which was to assure, as the proposed purchasers demanded, the payment of all existing liabilities of the company. The trustees were unrestricted as to the sale of the stock, and the agreement provided that they should hold the funds from the sale, as well as the funds transferred to them by the old stockholders, to invest and reinvest; to discharge all liabilities of the corporation, including state and Federal tax liabilities; to pay over the income of the fund pro rata to the beneficiaries; and ultimately to distribute any residue after all liabilities had been met. Accounting by the trustees was waived by the old stockholders until all the liabilities had been settled and paid, and they agreed to accept as final and conclusive all acts of the trustees done in the administration of the trust.

In another agreement between the trustees for the stockholders and the proposed purchasers, also under date of June 17, 1921, the trustees agreed to sell and the purchasers to buy the 11,527 shares of stock of the Guckenheimer corporation then outstanding; the trustees agreed to pay all liabilities of the corporation, including Federal and state tax liabilities, for all periods up to and including June 30, 1921; and to hold the purchase price and make no distribution to their cestm que trustent until all the corporation’s debts had been discharged. The agreement provided further that the trustees could conduct any proceedings or litigation pertaining to the determination, assessment, reassessment, and restatement of Federal or state taxes in the name of the corporation, and in the event the corporation should receive any amount as a refund or credit on account of any Federal or state taxes levied or assessed for any period prior to June 30, 1921, the purchasers would cause the corporation to pay over to the trustees such refund or credit, and if the corporation failed to pay the amount of any refund or credit to the trustees, the purchasers agreed to pay over or transfer such amount to them.

That same day, June 17, 1921, the trustees sold all the stock for $492,779.25 in cash or its equivalent. In January 1926 they made payment of respondent’s final determination of the company’s income and profits tax liability for the four fiscal years ending June 30, 1921, a matter which had been in dispute continuously since 1922. The trustees annually filed tax returns during the period of administration, including the year 1926, but had reported neither profit nor loss upon their sale of the stock in 1921.

On January 21,1926, the trustees had on hand $589,355.05 and had paid all the liabilities of the company. They then distributed pro rata to the beneficiaries, the old stockholders, $480,000. Of this distribution Morris received $26,654.40, and his father’s estate received $110,112, Morris’ share thereof being $10,924.06. The trustees and the beneficiaries agreed that an attempt should be made to secure a refund of the amount paid the Government in discharge of its claim against the company for taxes and that the balance of the funds should be retained by the trustees to meet the expenses incident thereto. Subsequently, the trustees brought suit for refund, iipon which decision was handed down by the trial court in A. Guckenheimer & Bros. v. Heiner, U. S. District Court, Western District of Pennsylvania, May 12, 1934.

Petitioners claim a deduction of $53,445.60 from the 1926 income of their decedent as a loss sustained upon liquidation of his Gucken-heimer stock and also a deduction of $19,973.85 as Morris’ share of the loss similarly sustained by his father’s estate. As we see it, that is a misstatement of the issue. There was no liquidation of stock in 1926, for that was sold in 1921. If petitioners are entitled to any deduction for a loss sustained in 1926, it is on the theory that the trust was terminated in that year and petitioners’ decedent then received, either actually or constructively, his pro rata share of the trust corpus, which was less than the amount of his contribution to the original trust fund.

Respondent denies the claimed loss upon the grounds that the trust was in fact a mere selling agency; that the sale of the stock was a closed and completed transaction in 1921, and that the loss, if any, was sustained then, and not in 1926. Petitioners contend that the agreement created a valid trust; that neither gain nor loss was sustained by the stockholders in 1921 upon either the creation of the trust or the sale of the stock by the trustees; that the trust was terminated in 1926 and a loss then sustained, being the difference between the amount distributed and the basis of their interest in the trust corpus.

In our view of the case, we need not decide whether the trust agreement created a selling agency or a valid, continuing trust, nor need we pass on the 1921 transaction. Even assuming, as petitioners contend, that a valid trust was created and that, upon its termination, petitioners may deduct any loss sustained, still no deductible loss was sustained in 1926, for the trust was not then terminated.

In 1921, when the trust was created, petitioner’s decedent and the other stockholders of the Guckenheimer Corporation transferred cash and stock to the trustees for an interest in the trust fund after the settlement and payment of the corporation’s liabilities then existing. In January 1926 these liabilities had all been paid, and it is petitioners’ contention that this event fixed the termination of the trust and entitled them to a loss deduction. But the distribution made in 1926 was not the final distribution and accounting. The trustees, authorized by the beneficiaries, retained a large sum of money, over $100,000, to finance an attempt to secure a refund of Federal taxes.

This agreement by the beneficiaries to postpone complete distribution did not create a new trust. The pursuit of a refund did not occasion any fundamental change in the duties imposed on the trustees by the provisions of the original trust indenture to settle and pay the liabilities of the Guckenheimer Corporation. Equity implies such powers in trustees as are reasonably necessary to the discharge of the duties assigned by the instrument creating the trust. Mills v. Connor, 135 N. E. 616; 104 Ohio St. 409. The power to institute proceedings for a refund may therefore be implied from the duty conferred on the trustees to settle liabilities. The Federal tax liability was not “ settled ” by the payment of the amount demanded by the Commissioner, for the former stockholders, through their trustees, still disputed his determination. Perhaps it is not yet settled, notwithstanding the decision of the trial court.

However that may be, it is evident that the trust, either as created by the original trust indenture, or as later orally extended by the beneficiaries, was continued beyond the year 1926. Its complete liquidation was postponed, and there was no final distribution and accounting in that year. In order for the loss claimed by petitioners to be deductible, it must be evidenced by a closed and completed transaction. United States v. White Dental Mfg. Co., 274 U. S. 398; Mastin v. Commissioner, 28 Fed. (2d) 748, affirming 7 B. T. A. 72; Brewster v. Orr, 19 Fed. (2d) 230; Deeds v. Commissioner, 47 Fed. (2d) 695, affirming 14 B. T. A. 1140; Reese Blizzard, 16 B. T. A. 242; Whitney Realty Co., Ltd., 29 B. T. A. 453. There was no such transaction in 1926; respondent was not in error in denying the deductions claimed.

What we have said applies as well to the loss claimed to have been sustained by the trust estate of Samuel Wertheimer, in which'Morris had a one-seventh interest. Eespondent’s denial of the deduction of Morris’ proportion of that loss was correct for a further reason. It is well settled that losses upon property held in trust are deductible, if at all, by the trust estates, and not in proportionate shares by the beneficiaries thereof. T. Rosslyn Beatty, 28 B. T. A. 1286; George W. Balkwill, 25 B. T. A. 1147; Henri Chouteau, 22 B. T. A. 850; Estate of William H. Hotchkiss, 16 B. T. A. 1334; Cora S., Stern, 14 B. T. A. 444.

Eeviewed by the Board.

Judgment will be entered under Rule 50.

      As to modification of a trust agreement by consent c£ all parties in interest, see 65 C. J. 340.


author: Adams:

text:
    Plains Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 48977, 65492, 67197.
    Promulgated October 25, 1934.

      George 8. Atkinson, Esq., for the petitioner.

      John D. Kiley, Esq., and R. B. Gannon, Esq., for .the respondent.
   OPINION.

Adams:

These proceedings were consolidated for hearing and involve deficiencies in the amount of $202.98 for the calendar year 1927, $1,860.28 for the calendar year 1929, and $315.58 for the calendar year 1930.

The facts are stipulated as follows:

1. The petitioner is a corporation organized, existing and operating under the laws of the State of Texas, with its principal office at San Angelo, Texas.
2. The petitioner was chartered under the laws of the State of Texas in April, 1927, for the purpose of the purchase, subdivision and sale of real property.
3. Prior to the incorporation of petitioner, Charles Dorsey and J. M. Crews became acquainted with G. I. Dorrance. Charles Dorsey and J. M. Crews were men of financial means and G. I. Dorrance was a man experienced in city -real estate subdividing, who had been successful in “putting on” two or more of such projects. During the month of April, 1927, Dorsey, Crews and Dorrance verbally agreed to “ put on ” a real estate subdivision within or near the city of San Angelo, Texas. It was also verbally agreed among them that Dorsey and Crews would furnish the money and purchase the land; that Dorrance would give his time, skill and services to the carrying out of the project, and that the net profits, after payment of cost of land and expenses, were to be divided fifty percent to Dorsey and Crews and fifty percent to Dorrance.
4. Dorsey, Crews and Dorrance selected 100 acres of land within or near the city of San Angelo, Texas, for subdivision purposes. Dorsey and Crews purchased such land at an investment to them of $20,000.00, and then, to limit their (Dorsey and Crews) individual liability as to loss, caused the Plains Realty Company, the petitioner, to be organized, and conveyed such land and their interest in the agreement to it, in exchange for all its ($20,000.00 par value) stock, Dorrance receiving only two qualifying shares which he immediately endorsed back to Dorsey and Crews.
5. In order to make some written record ol the agreement between G. I. Dorrance on the one hand, and Charles Dorsey and J. M. Crews or the Plains Realty Company on the other hand, the substance of the agreement was set forth in the minutes of the first meeting of The Board of Directors of the Plains Realty Company, which minutes are set out in full as follows:
The first meeting of the Board of Directors of Plains Realty Co. held at the First National Bank in the city of Childress, Childress County, Texas, at 4 o’clock, P. M., on the 6th day of April, A. D. 1927.
G. I. Dorrance was chosen as temporary chairman and J. M. Crews was appointed temporary Secretary of the meeting.
Directors present G. I. Dorrance, Chas. Dorsey and J. M. Crews.
All the directors being present, on motion duly made and carried, the Board proceeded to the election of officers of the corporation to serve for the ensuing corporate year and until the election and taking of office of their successors.
The following were elected:
G. I. Dorrance_President
Chas. Dorsey_Vice President
J. M. Crews_ Secretary-Treasurer
TJ. S. Weddington_Asst. Secretary.
The permanent officers of the corporation then took charge of the meeting.
On motion duly made and carried it was ordered that no officer should receive a salary for services.
A form of stock certificate having been presented for approval was by motion adopted as the form of stock certificate of the corporation.
On motion the Treasurer was instructed to open a bank account with the First National Bank of Childress, Texas, for the deposit of funds belonging to the corporation, such funds to be withdrawn only by check of the corporation signed by the Treasurer, except when otherwise authorized by the Board of Directors.
On motion the Secretary was directed to procure a Seal, bearing the words, Plains Realty Co., Childress, Texas.
On motion it was ordered that the Secretary file the Charter with the County Clerk of Childress County, Texas, for public record.
Whereas one of the purposes for which this corporation was organized, is the purchase and sale of real estate, or the purchase, sub-division and sale of real property. And whereas this company is the owner of certain lands consisting of about one hundred acres situated near San Angelo, Texas, which they desire to subdivide for sale as city property.
It is hereby ordered that G. I. Dorrance be and is hereby appointed Manager of the subdivision and sale of said property.
That Mr. Dorrance proceed at once to San Angelo, have property surveyed and subdivided, streets marked and graded, preparatory to offering for sale, prepare and submit to the Board of Directors plans of subdivision and improvements, and plans and terms of sales.
The Board of Directors reserves the right to approve or reject plans for improvements involving the expenditure of large sums of money such as the erection of buildings, paving streets, laying of sidewalks and kindred improvements.
All necessary expense incurred in the subdividing and selling of said property shall be chargeable to and paid from the funds of the company except Mr. Dorrance shall take care of his own personal expense.
For the purpose of carrying out the plan of subdividing and sales, as above set out, Mr. G. I. Dorrance is hereby authorized to check on the company’s funds for any amount desired not to exceed $1,000.00 at any one time and shall render to the Board of Directors a monthly statement showing in detail the expense incurred and money expended.
As compensation to Mr. G. I. . Dorrance for the management and sale of said property, it is further ordered that the money or other property derived from sales or,- otherwise shall first be .applied to .the payment of the necessary expenses incurred in the conduct of said business, then to the liquidation of indebtedness, if any, and the return of the invested capital, the remainder, if any, shall then be divided at the ratio of one-half to Mr. G. I. Dorrance and one-half remain with the company, that is Mr. Dorrance shall receive one-half of the net gains, from the sale of the land, as above set out.
(Signed) J. M. Ceews (Signed) G. I. Doe-babtoei
Secretary President
6. The net profits fróm the sale of lots, computed on the installment basis, were entered in the petitioner’s ledger in the manner following:
On December 31, 1927, entire net profits on installments in 1927, to the amount of $5,704.94, were credited to surplus account on petitioner’s books.
On December 31, 1928, one-half of the above profits or $2,852.47 were charged to the surplus account and credited to an account entitled “ Due; G. I. Dor-rance ”. At the close of the years 1928, 1929 and 1930 one-half of the net profits on installments were credited to the surplus account and one-half to the account entitled- “ Due G. I. Dorrance ”.
The amounts of the above items and dates charged are shown in the following summary under (a) and (b).
(a) Credits to Surplus Account
12/31/27 Net profits installments 1927_:_$5, 704. 94
12/31/28 50% transferred “ Due G. I. Dorrance ” account_ 2, 852.47
Leaving . a- balance_$2,852.47
12/31/28 50% net profits year 1928-*_ 15,042. 47
12/31/29 50% net profits year 1929_ 6, 533. 71
12/31/30 50% net profits year 1930- 3,188. 02
(b) Credits to “Due (?. I. Dorrance” Account
12/31/28 50% net profits year 1927- 2, 852. 47
12/31/28 50% net profits year 1928_15,042. 47
12/31/29 50% net profits year 1929_ 6, 533. 71
12/31/30 50% net profits year 1930_ 3,186. 02
'7. The petitioner on its original return for the year 1927-reported 100% of the net profits (computed on the installment plan) from the sale of lots. It, however, on March 15, 1929, filed an amended return for the year 1927 on which it deducted one-half of such profits as “ Salary for G. I. Dorrance for 1927 as per contract ”. On its return for the year 1928 the petitioner reported all profits from sales and collection of installments as gross income but in determining its net income it deducted under Schedule O, as compensation to G. I. Dorrance, President, (time devoted to business, all) an amount equal to one-half the net profits' from such sales and collections.
On its returns for the years 1929 and 1930, the petitioner reported all profits from sales of lots and collection of installments (computed on the installment plan) as gross income, but in determining its net income it deducted as “ Salary- — officer—G-. I. Dorrance ” an amount equal to one-half of the' net profits from such sales and collections.
8. The amounts deducted on the returns as salary to G. I. Dorrance for the years 1927 to 1930, inclusive, equal respectively, the amounts shown as 50% net profits on the account “Due G. J. Dorrance” set forth in paragraph 6 (b) above.
The books of the petitioner do not reflect any payments made or authorized to officers as salaries during any year.
There were no deductions taken on any of the petitioner’s returns as officers’ salaries except those enumerated in paragraph seven as compensation to G. I. Dorrance, and which equal 50% of the net profits as shown in paragraph 6 (b) above.
None of the amounts deducted as salary to Dorrance on the tax returns or shown in paragraph 6 (b) as credits “Due G. I. Dorrance” were paid to G. I. Dorrance during any of the years 1927 to 1930, incl.
9. Mr. G. I. Dorrance reported on his individual income tax returns for years 1927 to 1930, inclusive, as salary, the amounts shown in paragraph 6 (b) above, and the Commissioner determined his taxes accordingly.
10. The Commissioner in determining the petitioner’s taxable income for each of the years 1927 to 1930, inclusive, disallowed the deduction of 50% of the profits deducted as salary of G. I. Dorrance, and held that the entire profits of the venture constituted income of the petitioner.
11. The books and records of the petitioner for all years under consideration were kept on the installment sales basis by calendar years. The petitioner’s balance sheet as at December 31, 1927, follows:
Assets :
Cash in bank_ $2,167. 40
Due on sales contracts_ 116,092.00
Stocks and bonds_ 300.00
Office equipment-349.25
Water lines Westland Park (To be purchased by West Texas Utilities Co_ 2, 588. 05
Unsold lots Westlahd Park_' — :_■_ 8,772.43
Westland Place: Real Estate__$10,250.00
Improvements- 1, 886. 63 12,136. 63
Deferred Expenses : Salesman’s commissions. 1,184. 94
$143, 590.70
Liabilities :
Notes payable, bank-- $6,000. 00
Land mortgage payable, Westland Park- 11, 755. 33
Land mortgage payable, Westland Place_ 2, 690.45
Advances, Dorsey and Crews_ 5,437. 22
Deposit on lots- $15.00
Salesmen’s commissions payable- 1,184.94
Gross profit on installment contract uncollected.- 90, 802.82
$117,885.76
Capital :
Capital stock_$20,000. 00
Net profit 1927_ 5,704.94
- $25,704.94
$143,590.70
At December 31, 1930, the total expenses, monies borrowed and capital invested in the project had not been returned in cash to the petitioner corporation or to the aforesaid Crews & Dorsey.

The sole question before us is whether petitioner is entitled to deduct from its gross income, for the years before us, the amounts credited on its books to G. I. Dorrance as compensation under the terms of the agreement evidenced by resolution of its board of directors.

We do not agree with petitioner’s contention that a partnership existed between it and Dorrance. The title to the land was retained by petitioner, and, under the terms of the agreement, Dorrance was appointed general manager of the subdivision and sale of the property and was to receive, as compensation for his services, one half of the net profits from the enterprise. He had no proprietary interest in the property and no proprietary interest in the profits as profits. The extent of his interest was that his compensation was to be measured by “ one-half of the net gains from the sale of the land ”, as set out in the agreement.

There was no provision that he was to share the losses, if any, and the resolution of the board of directors does not evidence an intention to form a partnership. Cf. Meehan v. Valentine, 145 U. S. 611; Sugg v. Hopkins, 11 Fed. (2d) 517. Under such circumstances we do not think that a partnership existed, which, unless authorized in petitioner’s charter, would have been in violation of the state laws; or that there was an attempt to form a partnership, which would require the same rules as to accounting as if a legal partnership had been formed. See Corralitos Co. v. Mackay, 31 Tex. Civ. App. 316; 72 S. W. 624; Millers Indemnity Underwriters v. Patten, 238 S. W. 240.

In support of his determination the respondent calls our attention to Sugg v. Hopkins, supra; Naitove & Co. v. Commissioner, 32 Fed. (2d) 949; Block & Kohner Mercantile Co. v. United States, 37 Fed. (2d) 877, and contends that in the taxable years before us all the events had not occurred from which could be determined the liability of petitioner to pay Dorrance any amount and that such liability could not be ascertained until the completion of the project. We do not agree with this contention, and we think the cases cited may be distinguished from the instant case on their facts and are not controlling here.

It is admitted, that the petitioner kept its books on the accrual basis and reported its income from the sale of lots in its real estate development on the installment sales basis. Under this method it accrued and credited on its books as a liability to Gr. I. Dorrance one half of the net profits applicable to installments paid during the taxable years on properties sold. It made its tax returns for 1927, 1929, and 1930 upon the basis upon which its accounts were kept,.claiming as an expense the amounts so credited to Dorrance. An examination of petitioner’s balance sheet as of December 31, 1927, shows due on sales contracts, $116,092, and gross profits on installment contracts uncollected, $90,802.82. The balance sheets at the close of 1929 and 1930 show a similar situation. At the close of 1927 the amount of gross profits from installment sales, uncollected, was approximately twice as large as all other liabilities. At the close of 1929 the amount of gross profits uncollected plus the total amount credited to Dorrance and the accumulated surplus was five times as large as all other liabilities, and approximately the same ratio existed at the close of 1930.

The sales upon which the profits were based had already been made and it could be reasonably ascertained not only that there would be profits, but the amount of the profits. Such profits were determined and ratably apportioned to payments made during the taxable years and returned by the petitioner as income.

The respondent does not question the basis upon which the income was reported nor the allocation of the profits to the respective years, but argues-that the amounts credited to Dorrance may not be deducted as an expense because they cannot be sufficiently ascertained. We are not impressed with this argument. We think under all the facts of the case petitioner could reasonably determine in the respective years not only that Dorrance would receive compensation, but the amounts of such compensation, and that such amounts were properly accrued and deducted from the gross income as expenses properly attributable to the process of earning the income reported during the respective periods. Cf. American National Co. v. United States, 274 U. S. 99; United States v. Anderson, 269 U. S. 422. The petitioner’s contention is sustained.

Reviewed by the Board.

Decision will be entered under Rule 50.

Black, AruNdele, and Leech dissent.


author: Aeundell :

text:
    C. George Armstrong, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 58400.
    Promulgated October 25, 1934.

      Frederick G. Bowherder, G. P, A., for the petitioner.

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

Aeundell :

This proceeding involves, a deficiency in income tax in the amount of $9,760.61 for the year 1928. The deficiency was computed on the theory that the cash received by petitioner for his class A stock of the Chelmsford Co. exceeded the basis by $79,593.09, and that that sum represented taxable gain. In the petition filed the basis used by respondent was alleged to be erroneous. By amended answer respondent alleges that the total consideration received by petitioner on the exchange exceeded the basis by $193,433.17 and that the entire amount thereof represents taxable income. The basis of Chelmsford Co. stock was stipulated, leaving for decision two questions — first, whether there was a reorganization which would limit the taxable gain to petitioner on an exchange of stock for stock and cash, and, second, whether the exchange of two classes of stock should be treated as separate exchanges or one.

According to the stipulated facts, on December 20, 1928, the Chelmsford Co. had outstanding these three classes of stock: class A preferred, $25 par, 19,370 shares; first- preferred, $100 par, 1,130 shares; class B, no par, 25,018 shares. The class A preferred and first preferred were preferred in the distribution of assets up to the par value of the stock and accumulated dividends before any distribution could be made to class B stockholders. Petitioner owned Chelmsford Co. stock as follows:

On November 28, 1928, the Chelmsford Co. entered into an agreement with Canada Dry Ginger Ale, Inc. (hereinafter called Canada Dry), whereby the Chehnsford Co. agreed to transfer all its assets to Canada Dry in exchange for 4,473 shares of capital stock of Canada Dry and $606,250 in cash, that amount of cash being the liquidating value of the Chelmsford class A preferred and first preferred stocks. It was further agreed that the Chelmsford Co. was to distribute to its stockholders, in liquidation, the cash and Canada Dry stock to be received from Canada Dry; further, that the Chelmsford Co-. was to dissolve. Canada Dry agreed to assume the liabilities -of the Chelmsford Co., with certain exceptions not here material.

The agreement was carried out on December 20,1928. On the same date the Chelmsford Co. distributed to the holders of its class A preferred and first preferred stocks, in cash, the liquidating values thereof plus accumulated dividends. On the same daté it distributed to its class B stockholders a dividend of -86.722 cents per share in cash and the Canada Dry stock pro rata. At the same time the stockholders of the Chelmsford Co. surrendered their stock to' that company; The above related' actions were duly authorized and approved by formal votes of the Chelmsford Co. directors and stockholders, and it was further formally voted to dissolve the Chelmsford Co. and it was dissolved on or about December 31, 1928.

In the distribution of December 20, 1928, petitioner received the following cash and stock of Canada Dry:

In the agreement between the Chelmsford Co. and Canada Dry it was stated that Canada Dry proposed to organize á new corporation, all of whose stock it was to own, to take over the assets and conduct the business of'the Chelmsford Co. Immediately after acquisition of the Chelmsford Co.’s assets, Canada Dry transferred them to a newly organized corporation, the Chelmsford Ginger Ale Corporation, in which Canada Dry owned all of the capital stock.

On December 20, 1928, following consummation of the transaction with the Chelmsford Co., Canada Dry had outstanding 508,858 shares of stock. The 4,473 shares of stock issued to the Chelmsford Co. were purchased in the open market by Canada Dry between November 28 and December 20, 1928, at a value [so stipulated] of $80 per share.

The fair market value of the Canada Dry stock acquired by petitioner on December 20, 1928, was $76,125 per share. Petitioner keeps his records and files his income tax returns on the cash receipts and disbursements basis.

We think it beyond serious dispute that the transaction between the Chelmsford Co. and Canada Dry constituted a reorganization within the meaning of section 112 (i) (1) of the Revenue Act of 1928. It was an acquisition by one corporation of “ all the properties of another corporation ” in which a substantial part of the consideration was represented by stock which went to the old stockholders, thereby maintaining a continuity of stock interest. The transaction at least “ partakes of the nature of a merger.” Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U. S. 462. The respondent originally determined that there was a reorganization and computed the deficiency accordingly. To support his present position he argues that so large a portion of Chelmsford stock was “ sold ” as to preclude the transaction from being treated as a reorganization. This does not appear to be the case. The stock was not sold. It was turned in, the holders of the preferred receiving the liquidating value thereof, and the holders of common stock receiving part cash and part stock of Canada Dry. Nor is it material that Canada Dry transferred the Chelmsford Co.’s asests to another corporation. Tulsa Oxygen Co., 18 B. T. A. 1283; First National Bank of Champlain, 21 B. T. A. 415. Canada Dry was a “ party to a reorganization ” and petitioner received its stock in exchange for his common (class B) stock of Chelmsford, hence the recognition of his gain is limited by the provisions of section 112 (c) (1) of the 1928 Act.

The respondent earnestly urges that the liquidation of the preferred stock and the exchange of class B for stock and cash should be treated as a single transaction and the consideration treated as a lump sum. We cannot agree with this view. The preferred stocks were essentially different from the class B and they were treated differently in the reorganization. Had the petitioner owned but one class it would be difficult, to say the least, to apply to him the method proposed by the respondent. We had a similar situation in A. W. Leonard, 21 B. T. A. 549, in which we held that the different classes of stock should be treated as separate properties, saying in part:

Prior to the reorganization each petitioner owned two distinct classes of property, namely, common stock and preferred stock. Under the provisions of the revenue act, each had a separate basis upon which to compute gain or loss. If either or both were sold, profit would be computed upon such separate basis

The rule of the Leonard case is applicable here. The cases cited by respondent are distinguishable. In Elizabeth Bruce, 30 B. T. A. 80, two parcels of the same kind of stock were involved. We held that the disposition of the two parcels was part of one reorganization transaction and should be treated as but a single exchange. First Seattle Dexter Horton National Bank et al., Executors, 27 B. T. A. 1242, likewise involved but one class of stock.

We accordingly hold that the cash received by petitioner upon the surrender of his preferred stock cannot be used as a measure of the gain on his class B stock. No loss is claimed on the preferred stock and we do not pass on that matter. We further hold that the gain on the class B stock may not be recognized in an amount in excess of the cash received, $16,994.95.

Decision will be entered wider Bule 50.


author: MtjRdock : Adams,

text:
    Courtenay D. Allington, Petitioner, v. Commissioner of Internal Revenue, Respondent. Leslie E. Allington, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 53411, 53412.
    Promulgated October 25, 1934.

      Lawrence A. Mccsselink, Esq., for the petitioners.

      Owen W. 8weaker, Esq., for the respondent.
   OPINION.

MtjRdock :

The Commissioner early established the rule that “ when shares of stock in a corporation are sold from lots purchased at different-dates and at different prices and the identity of the lots can not be determined, the stock sold shall be charged against the earliest purchases of such stock.” Art. 58, Regulations 74; Towne v. McElligott, 274 Fed. 960. Section 115(c) of the Revenue Act of 1928 provides that amounts distributed in partial liqúidation of a corporation shall be treated as in part or full payment in exchang'd for the stock and the gain shall be determined under section 111. The petitioners do not attack the rule nor claim that it does not apply to stock canceled in liquidation of a corporation: They contend that their shares canceled can be identified and the first in, first out rule does not apply. The Commissioner has held that the ■ identity of the shares canceled can not be determined and his determination must be approved unless the petitioners have produced evidence showing the identity of the shares canceled.

' Courtenay D. Allington relies principally upon his testimony that he knew of the Commissioner’s first in, first out rule and intended to have canceled his lot of 47 shares in its entirety and 10.33 shares from his lot of 100 shares in order to realize a minimum gain for tax purposes. He argues that the certificate for .47 shares would not have been turned in by him if he had not intended to have those shares canceled. But the method used by him in reporting his gain on his income tax return made shortly afterward does not indicate that such was his intention. On the contrary, it indicates that he had no such intention. Furthermore, the petitioner filed an original petition and two amended petitions, and only in the amended petition filed on the day of the hearing does-he suggest.and pray for a recomputation based upon thé cost of the 47 shares and the 10.33 shares. There may have been a different reason- for turning in all outstanding certificates. The name of the corporation was changed on October 5, 1928, and the corporation may have desired to issue new certificates bearing the new name. This point was not called to the.attention of the witness and it may be that there was no such change made. Still, for some reason, all certificates were turned in, 39 percent of the stock was canceled, and new certificates were issued. If the witness intended that all of his 47-share lot should be canceled and only 10.33 shares of his 10:0-share lot, he never did anything to see that his wishes were carried out. A mere intention to sell certain shares is riot sufficient to identify the shares actually sold. Skinner v. Eaton, 34 Fed. (2d) 575; affd., 45 Fed. (2d) 568; certiorari denied, 283 U. S. 837; A. D. Geoghegan, 31 B. T. A. 93; Mary E. Horner, 28 B. T. A. 360; affd., 72 Fed. (2d) 407; Mickler Holding Co., 29 B. T. A. 300; Gommissioner v. Merchants & Manufacturers Fire Insurance Co., 72 Fed. (2d) 408; Snyder v. Commissioner 73 Fed. (2d) 5, affirming 29 B. T. A. 39. The petitioner simply turned in both certificates and the impossibility of determining which particular shares were canceled and which were reissued in the new certificate is obvious. The shares went into hotchpotch and all identity was lost. The application of the Commissioner’s rule under such circumstances seems entirely warranted. The rule is .fair and reasonable. Snyder v. Commissioner, 54 Fed. (2d) 57, affirming 20 B. T. A. 778; Skinner v. Eaton, supra; Burdett Stryker, 21 B. T. A. 561; Towne v. McElligott, supra; Commissioner v. Merchants & Manufacturers Fire Insurance Co., supra. It has been used for many years. The petitioner’s remaining shares carry the remaining cost. The Commissioner might have adopted a rule of averaging the cost of all shares, but he did not, and, since the rule he adopted is a reasonable one, we can not reject it and apply another in its place. Skinner v. Eaton, supra. Cf. David Stewart, 17 B. T. A. 604.

The record is not as complete in regard to Leslie E. Allington as it is in the case of Courtenay D. Allington. However, counsel do not seem to be in dispute in regard to the facts and seem to agree that there are no material differences in the facts in the two cases.

Reviewed by the Board.

Decisions will be entered for the resfondent.

Adams,

dissenting: This appeal presents only one question for determination: Were the shares of stock surrendered by petitioners susceptible of identification, and, if so, was the testimony sufficient to identify them so as to take them out of the first in, first out rule ?

I think it valuable in the consideration of this question to further examine the facts presented upon the hearing. Courtenay D. Alling-ton testified that he was vice president of Harris, Small & Co. at the time the liquidating dividend was declared and, at that time, he owned 147 shares of capital stock of the company, 100 shares having been purchased in 1925 at a cost of $100 per share, and 50 additional shares in 1926 at a cost of $416.81 per share; that these two holdings were originally represented by two certificates, one for 100 shares, the other for 50 shares; that in 1927 he sold 3 of his shares so owned and turned in to the company his 50-share certificate, which was canceled and a new certificate for 47 shares was issued to him; that when the liquidating dividend was declared, he understood that had he at that time had a certificate just equaling the 39 percent provided for, it would only have been necessary for him to turn in such certificate for cancellation in order to comply with the resolutions declaring the dividend and that the same would have been canceled, leaving his other certificate intact, but, the 47-share certificate not being sufficient to make up the 39 percent required, he turned in both certificates so that the 39 percent might be taken by first exhausting the 47-share certificate, and the remainder would then be taken from the 100-share certificate and a new certificate issued him.

Kespondent’s counsel, in cross-examining this witness, propounded to him the following questions:

Q. You testified that you turned in your forty seven share certificate and then you were forced to turn in the one hundred share certificate for the reason that the fifty share certificate, or rather, the forty seven share certificate did not make up the liquidating dividend. Now, isn’t it a fact that this company required you to turn in all your stock? ' You could not turn in thirty nine percent ; you had to turn all of it in, is that correct?
A. No, I don’t think so.-
Q. But, under the resolution, as you understand it, didn’t it require you to turn in all your stock to the corporation?
A. No, I had to turn in thirty nine percent of it.
In answer to another question propounded by counsel for the respondent, witness said:
A. If I had happened to have a certificate for exactly thirty nine per cent of my total holdings, I could have turned in that certificate and no other. That is my understanding.

The witness testified further upon cross-examination:

Q. Well, as a matter of fact, you did turn in all your shares, and did you know, yourself, what shares were cancelled?
A. I do 'for my own, yes sir, because I was vice president of the company. I actually did it. I signed certificates. I turned in my forty seven shares first. [Emphasis supplied.]
Q. What do you mean — just a minute ■ there. What do you mean, you ‘ turned it in first?
A. Well, I had sold previously three shares, and, as I say, I was familiar with the first in and first out rule, and the three shares I sold from my fifty share certificate, being my high priced stock, to save on my taxes. Well, when this liquidating dividend came, I figured on turning in my forty seven share certificate first, taking all I could out of that, and taking the balance out of the one hundred shares, because at the time I did that I considered-that I was going to be able to do just the same as I had in the sale of the stock, if I could identify my certificates, I could take my forty seven shares, the $416 stock.

Witness further explained he made his income tax return for that year in so far as this transaction was concerned, upon the advice of a certified public accountant and that on the return he showed that the stock disposed of for the liquidating dividend was to be taken m so far as possible out of the 47-share certificate, the last purchased.

It was established at the hearing that the new certificates were signed by the petitioner, Courtenay D. Allington.

I think the undisputed facts in this case show that petitioners have so identified the shares sold as to take the transaction out of the first in, first out rule. It is recognized that mere intention is not controlling, but that something else must have been done, that something else must have happened which served to identify the particular shares turned in as those which were to be applied to the liquidating dividend.

Petitioner had the right to decide which shares of stock he would turn in on the liquidating dividend.

What could he have done in addition to what he did do to identify the shares actually turned in for the purpose of meeting the liquidating dividend? He might have written a letter to himself as vice president of the company charged with the duty of reissuing this stock, directing himself as such vice president so to handle the transaction. This he did not do and this, it seems to me, was entirely unnecessary. He might have given verbal instructions to the company as to how he wanted the transaction handled, but, he being the company for the purpose of reissuing stock, it would seem quite strange to say that he would have to give himself specific instructions.

A question so similar to. this that it seems identical in all of its elements has been passed on recently by the General Counsel’s office in G. C. M. 11Y43, XII-2Y-6264 (Internal Revenue Bulletin, July 3, 1933). In this memorandum, question 3 requested an opinion as to which shares were sold when the taxpayer sold 100 shares of stock and turned in two certificates, one being for 98 shares and the other for 588 shares. The 98-share certificate was acquired after the 588 shares. In the opinion it was said:

Question No. 3 relates to the case where A sold 100 shares, turning in certificate No. P — ■ and a certificate representing all the other shares owned, and inquiries which shares were sold. It is known that the 98 shares represented, by certificate No. P— represent lots 5 to 8, inclusive, and the other certificate must therefore represent the 588 shares contained in lots 1 to h, inclusive. It is arguable that, since A has turned in all his certificates, none of the shares sold can he identified as coming from any particular lot, and that consequently all the 100 shares should be presumed to have been sold from lot 1. This argument would be much stronger if certificate No. P — , as well as the other certificate, had represented 100 or more shares, or if each certificate had represented less than 100 shares. But certificate No-. P — , in fact contained less than 100 shares, while the other certificate contained more than 100 shares, and if A had desired to sell all the shares from the latter certificate he would not have needed to turn in certificate No. P — . Therefore, the most reasonable presumption is that A was selling all the shares represented by certificate No. P — , and making up the balance of t shares from the other certificate. Accordingly this office is of the opinion that all of lots 5 to 8, inclusive had been sold together with. 2 shares from lot 1. (Compare Cleveland, Trust Co. v. Commissioner, supra; Howbert v. Penrose, 38 Fed. ,(2d) 577; M. J. Scanlon v. Commissioner, 21 B. T. A. 1120.) [Emphasis supplied.]

The above opinion suggested two exceptions — (1) in case good evidence was introduced that A did not intend to sell any particular shares; or, (2) his only purpose in turning in both certificates was to have all of his remaining shares represented by one certificate. The case here cannot be brought within either of these exceptions if we are to regard the undisputed testimony upon the hearing. Allington testified he did not think the resolution required him to turn in all of the stock, but only 39 percent, and, if he had happened to have a certificate for exactly 39 percent of his holdings, he could have turned in that one only.

Similarly, there is no support for the suggestion that the certificates were both turned in for convenience. The undisputed testimony shows that the shares of all stockholders except the Allingtons were represented by single certificates. ■

It seems clear that, if Allington had intended to take the liquidating dividend out of the 100-share certificate, only one certificate would have been surrendered. His cross-examination developed that he was aware of the income tax consequences of the sale from one lot or the other. In order to save taxes, he had on a previous occasion sold part of his high priced stock, and he intended to do the • same thing in relation to the liquidating dividend.

Entertaining these views, I respectfully dissent.

Black and Seawell agree with this dissent.