author: Van Fossan :

text:
    A. P. Giannini, Petitioner, v. Commissioner of Internal Revenue, Respondent. Clorinda A. Giannini, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 87128, 87127.
    Promulgated August 15, 1940.

      Andrew F. Burke, Esq., Harry Friedman, Esq., and George H. Foster, Esq., for the petitioners.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Van Fossan :

The first issue is essentially one of fact. Briefly it may be outlined thus: Early in 1925 a committee was appointed to determine the proper compensation of the petitioner for his services as president of Bancitaly, of whose stock of 5,200,000 outstanding shares he and his family interests owned only 10,446 shares. Prior thereto petitioner had received no compensation for services from Bancitaly. The committee recommended to the directors on June 27, 1927, that from January 1, 1927, the petitioner should receive, in lieu of salary, 5 percent of the yearly net profits, with a guaranteed minimum of $100,000. From January 1 to July 22, 1927, that percentage amounted to the sum of $445,704.20, which, on November 30, 1927, was credited to his account, offset by certain advances and in-debtednesses debited to him by Bancitaly.

On repeated occasions during 1927 the petitioner unequivocally refused to accept any compensation for his services rendered during that year in addition to the $445,704.20 already credited, although such further compensation was estimated by petitioner to amount to $1,500,000. Upon his refusal, and adopting a suggestion made by petitioner, the Bancitaly directors decided to donate the $1,500,000 to the University of California for the establishment of the Giannini Foundation of Agricultural Economics, so named in honor of the petitioner. That action was predicated on1 their belief that the foundation would be of great use to the public in general and would benefit Bancitaly specifically because of the farmers’ loans held by its subsidiary, and also on their desire to pay tribute to the petitioner. The regents of the University of California accepted the gift with observations commendatory to the petitioner.

All proposals and negotiations relating to the donation were carried on exclusively between Bancitaly and the regents. The petitioner’s participation in the transaction was confined solely to his suggestions relating to the nature and purpose of the contribution and to his expression of satisfaction “if the corporation should be so minded.”

In 1928 it was found that the $1,500,000 estimated to be the amount of the petitioner’s compensation for 1927 which he had refused to accept, would not be reached from Bancitaly’s net profits. However, Bancitaly paid to the regents the full amount of its offer, with the approval of the petitioner, who assumed responsibility for the miscalculation. The deficiency, $142,392.60, at petitioner’s suggestion was charged to the petitioner on Bancitaly’s books on July 19, 1928, and was paid from compensation from Bancitaly earned by him subsequent to January 20, 1928.

Upon and subsequent to the petitioner’s refusal to accept the $1,357,607.40 representing his percentage of net profits earned from July 23, 1927, to January 20, 1928, neither he nor his wife received any part of that sum by way of cash, credit, or other method of payment or allocation to them and they had no right, title, or interest therein.

The respondent’s position seems to be based on the assumption that the petitioner directed and compelled Bancitaly to make the donation, an act which, the respondent asserts, was wholly ultra vires. He argues that in January 1928 the petitioner was entitled, to receive the $1,357,607.40 as a part of his compensation and, therefore, the diversion of that sum to the University of California constituted, in reality, a gift by petitioner.

We are of the opinion, and have found asi a fact, that the petitioner unqualifiedly refused to accept any compensation for the year 1927 in excess of the $445,704.20 credited to him on1 November 30, 1927, and covering the period from January 1 to July 22, 1927. His first refusal was made shortly after the net earnings of Bancitaly for that period were tentatively ascertained and he repeated that refusal at numerous times thereafter. His refusal was subject to no condition or contingency and relieved Bancitaly of any obligation to pay petitioner the sum in question. The amount in excess of the $445,-704.20, thereafter belonged to Bancitaly to dispose of as it saw fit.

There is nothing in the record in any way impugning or discrediting petitioner’s testimony and his exposition of the matter is fully and .adequately corroborated by the unrefuted statements of disinterested witnesses and by the records of Bancitaly and of the regents of the University of California. We have no reason to doubt that he declined absolutely to accept the excess compensation for the period from July 23, 1927, to the end of the year. Bancitaly accepted Ms decision as final and treated the excess as its own on its books and in' its subsequent actions.

It is elemental that an individual may refuse to enforce a right, forswear a debt due him, or relinquish a claim. After such action it is equally basic that Ms debtor retains full possession and ownership of the thing renounced. It is obvious also that no one is compelled to accept compensation or payment for services or goods. When he refuses to do so he can not be charged with the amount so refused and abandoned, as an item of income. Under no theory of constructive receipt can it be compensation within the meaning and definition of income.

It matters not that the suggestion to make the donation to the University of California came from petitioner. The offer was made by Bancitaly and all details were carried on' by its officers and agents. The petitioner took no part whatever in the negotiations or in the completion of the gift. The respondent challenges the right of Bancitaly to make such a donation. We are not concerned with that phase of the matter. It has no bearing on our question.

The respondent further argues that there is m> difference between the $1,857,607.40 refused by the petitioner and the $142,892.60 required to complete the $1,500,000, the latter slum being charged to him by Bancitaly and ultimately paid by him out of compensation later earned and credited to him on Bancitaly’s books.

The two amounts are in wholly different categories and are not comparable. The first was never paid to petitioner but was donated by Bancitaly to the University. The item of $142,392.60 was paid by Bancitaly but was ultimately assumed and paid by petitioner out of other earnings. The petitioner felt morally responsible for his inaccurate calculation or estimate of Bancitaly’s probable profits for 1927 and, therefore, personally made good the deficiency. Such sequential action on his part had no effect on that part of the compensation for 1927 which he had previously renounced and in which he had abandoned all interest.

The second issue presents an unusual situation. The petitioner received from the Giannini Co. during the year 1928 the sum of $78,749.50 pursuant to the action of its board of directors dated January 28, 1929, wMch in turn referred to the original agreement created by its action1 on January 25, 1926. Both the petitioner and the respondent agree that the amount should be included in the petitioner’s income for 1928, but both designate and term the question an issue in the present case. As is frankly stated by the petitioner’s counsel, we are asked to construe the so-called “profit-sharing contract,” in order that its effect upon the sharing of losses thereunder in subsequent years may be determined.

We do not have the later years before us and, hence, confine ourselves to approving the action of the respondent. There is no controversy over the respondent’s determination as to the instant year. Whether or not the petitioner later sustained losses under his agreement with the Giannini Co. and the tax effect of such losses, if sustained, must await decision when, if ever, the later years are before us.

Decision will be entered under Bule 50.


source: Caselaw Access Project

author: Murdock:

license: Public Domain

text:
    Edwin P. Shattuck, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97268.
    Promulgated August 15, 1940.

      Wendell Davis, Esq., for the petitioner.

      Leonard A. Spalding, Esq., for the respondent.
   OPINION.

Murdock:

The petitioner contends that he “held” for more than one year within the meaning of section 117 (a) of the Revenue Act of 1934, an interest in the $75,000 face value of Erie & St. Lawrence notes, since his firm became the owner of the notes on December 4, 1933, “subject only to an option for their repurchase by the [McDou-gall-Duluth] Company.” He argues that the substance, though not the form, of the transaction of November 1933 was to pay and satisfy the fee by transfer of title to the notes subject only to an option for their repurchase for $70,000 up to May 1, 1934. The substance of the transaction was, as we see it, the same as the form, in so far as ownership of the notes is concerned. They were to remain and they did remain the property of the McDougall-Duluth Co. until May 1, 1934, when it failed to pay its note and the Erie & St. Lawrence notes then became the property of Shattuck, Bangs & Davis to satisfy in full the debt due them. Prior to May 1, 1934, the partnership held the notes as pledgee, not as owner subject to an option. The words of the agreement, the book entries, and the intent of McDougall-Duluth Co. all support that conclusion. The case of Tex-Penn Oil Co. v. Helver ing, 300 U. S. 481, so strongly relied upon by the petitioner, is distinguishable, since there the writings were contrary to the facts, whereas here there is no such difference. The period of holding for the purpose of section 117 (a) did not include the period during which the partnership had possession of the notes as pledgee.

The petitioner argues, as an alternative, that his firm acquired on December 4, 1933, such dominion over and benefits in the Erie & St. Lawrence notes as would start the holding period of section 117 (a), even though it did not acquire full title. His point is that his firm gave consideration for the notes at that time, received possession of the negotiable notes, received a power of attorney coupled with an interest, and collected the interest on the notes, all of which shows that the firm had a property right in the notes from December 4,1933. The possession which the firm received was that of pledgee. The necessity for and the purpose of the power of attorney, as well as the collection of the interest, are all sufficiently explained in the findings of fact. The firm had no dominion over or benefits in the notes inconsistent with ownership of the notes in the McDougall-Duluth Co. up to May 1,1934.

The period from December 4, 1933, to May 1, 1934, would have a dual or contingent character under the petitioner’s alternative theory. It would be a period of holding by the petitioner’s firm if the firm finally acquired the notes, but it would be a period of holding by the McDougall-Duluth Co. if the latter paid its note and took possession of the Erie & St. Lawrence notes. The act does not provide for any such method of measuring the period of holding. It does enumerate in séction 117 (c) certain situations under which the period of ownership by others shall be added to that of the taxpayer, but none of those provisions applies here. The fact that there are such provisions is an indication that Congress did not intend any other exceptions to the general rule. I. T. 1378, I-2 C. B. 26, is not applicable here, nor is W. H. Hay, 25 B. T. A. 96. The petitioner cites no authority which directly leads to the conclusion he would have us reach. We find no error in the action of the Commissioner.

Decision will be entered, for the respondent.


author: Black:

text:
    Kurtz Bros., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100187.
    Promulgated August 16, 1940.

      Pressly B. Baldridge, Esq., for the petitioner.

      William, A. Schmitt, Esq., for the respondent.
   OPINION.

Black:

Petitioner contends that the alleged interest which it collected from various political subdivisions of the State of Pennsylvania is exempt from taxation under section 22 (b) (4) of the Internal Eevenue Code, Title 26, which is printed in the margin.

Petitioner contends that the provision of the statute in question that “Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof” shall be exempt from taxation, is broad enough to include interest which a taxpayer receives on open account from a political subdivision of a state. Petitioner contends that the words “the obligations” mean not only bonds, debentures, and the like, but also open accounts, and cites in support of such contention, among other cases, Commissioner v. Meyer, 104 Fed. (2d) 155, and Kings County Development Co. v. Commissioner, 93 Fed. (2d) 33.

In Commissioner v. Meyer, supra, the court affirmed the decision of the Board, and held that interest on notes issued by a municipality in connection with the purchase of land by it was exempt from tax under section 22 (b) (4) of the 1934 Act, overruling the Commissioner’s contention that the notes were not the kind of obligations covered by the statute because they were not executed in the exercise of the borrowing power of the municipality, like authorized bonds which are issued and sold for the purpose of borrowing money.

In Kings County Development Co. v. Commissioner, supra, the court reversed the Board and held that interest received in 1930 from the Tulare Lake Basin Water Storage District on deferred payments in purchase of real estate, not represented by bonds or other securities of the district, was exempt from income tax under section 22 (b) (4) of the Revenue Act of 1928. The court held that Congress did not intend to limit the exemption as to interest on obligations of a state or political subdivision thereof only to interest on such obligations as are evidenced by some particular form of obligation, but that the exemption applies equally to an obligation evidenced by an ordinary written agreement of purchase and sale, in which the political subdivision agreed to pay interest. Neither of the above cited cases goes so far as to hold that interest paid by a political subdivision on an open account would be exempt from income tax because it was interest paid on an obligation of the state or political subdivision thereof. The court in Commissioner v. Meyer, supra, in discussing the meaning of the word “obligations”, as used in the statute, said:

It is manifest that the word “obligations” in the statute was not intended to extend to every obligation which included the payment of interest but only to those obligations which were created in the exercise of the borrowing power. See Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 55 S. Ct. 50, 79 L. Ed. 211. But where credit is obtained in consideration for a promise to pay money in the future, together with interest on that money, there is no valid ground for making a distinction between Interest paid on bonds duly issued and interest paid on notes duly delivered.

Again, the court said in the concluding paragraph of its opinion, speaking of the obligation of the village of Suffern to pay interest on its notes executed and delivered to Meyer:

* * * Its obligations were “issued” within the above regulations when its notes were delivered to the respondent to obtain credit on obligations incurred under its borrowing power. Such circumstances bring the interest paid on the notes within the scope of the above statute and mate it exempt from taxation. Kings County Dev. Co. v. Commissioner, 9 Cir., 93 F. 2d 33; Norfolk Nat. Bank v. Commissioner, 4 Cir., 66 F. 2d 48.

In the instant case there were no promissory notes executed by the political subdivisions of Pennsylvania upon which they agreed to pay interest to the creditor, as there was in the Meyer case, nor was there any written agreement to pay interest on the deferred payments, as there was in the Kings County Development Co. case, supra.

In the instant case we simply have a situation where certain townships and school districts of the State of Pennsylvania purchased certain goods and merchandise from petitioner on open account. These accounts were apparently not paid when due, whereupon petitioner sent invoices for interest to these several townships and school districts. The invoices for interest were paid to the extent of $1,196.57.

Under such circumstances, we do not think it can be said that the interest was paid upon “the obligations of a State, Territory, or any political subdivision thereof” within the meaning of the statute. There is no evidence that any of these townships or school districts had executed in the exercise of their borrowing power any written agreement with petitioner that they would pay interest on their past due accounts. Some of them were invoiced with interest at 4 percent per annum and some were invoiced with interest at 6 percent per annum. This difference in interest rate is not explained. There is no evidence that this was done pursuant to any written agreement between petitioner and the respective debtors but was done according to the decision of petitioner. The word “obligations” as used in the statute, we think, means some kind of a written instrument executed by the state or a political subdivision thereof, in the exercise of its borrowing power. The statute was intended to exempt from taxation interest paid upon such an obligation.

For the reason that the evidence does not show that the alleged interest involved in this case was paid pursuant to obligations executed and delivered by the respective political subdivisions in the exercise of their borrowing power, we hold that the amount in question is not exempt from taxation.

Decision wül be entered, for respondent.

       (4) TAx-rp.EE interest. — Interest upon (A) the obligations of a State, Territory, or any political subdivisión thereof, or the District of Columbia; or (B) obligation of a corporation organized under Act of Congress, if such corporation is an instrumentality of the United States; or (C) the obligations of the United States or its possessions, * * * In the case of obligations of the United States issued after September 1, 1917 (other than postal sayings certificates of deposit) and in the case of obligations of a corporation organized under Act of Congress, the interest shall be exempt only if and to the extent provided in the respective Acts authorizing the issue thereof as amended and supplemented, and shall be excluded from gross income only if and to the extent it is wholly exempt from the taxes imposed by this title.


author: Smith:

text:
    L. B. Hirsch, Petitioner, v. Commissioner of Internal Revenue, Respondent. Max S. and Clementine Hirsch, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95782, 98539.
    Promulgated August 20, 1940.

      Robert T. Jacob, Esq., and Samuel B. Weinstein, Esq., for the petitioners.

      Edward 0. Adams, Esq., for the respondent.
   OPINION.

Smith:

These proceedings, consolidated for hearing, involve deficiencies in income tax and penalties for 1935 and 1936 as follows:

The questions in issue are:

(1) Whether the redemption by a corporation of a portion of its capital stock in cancellation of the indebtedness of two of its stockholder-officers, the petitioners L. B. Hirsch and Max S. Hirsch, in 1935, was essentially equivalent to a taxable dividend; and whether the failure of L. B. Hirsch to report the transaction in his return for 1935 constituted fraud.

(2) Whether one of the petitioners, Max S. Hirsch, is entitled to a bad debt deduction in 1935 in respect of a loan which he had made to his brother-in-law in a prior year.

(3) Whether the petitioner, Max S. Hirsch, is entitled to interest deductions in 1935 on life insurance policy loans, where such interest was not paid in cash in that year but was added to the principal amount of the loans.

(4) Whether the petitioner, L. B. Hirsch, is entitled in 1935 and 1936 to an exemption of $2,500 as head of a family and credits of $1,200 for three dependents; and whether in claiming such exemption and credits in 1936 the petitioner incurred the 5 percent negligence penalty which the respondent has asserted for that year.

The several contentions of the petitioners will be considered separately.

Issue 1.

(a) Surrender of stock in payment of indebtedness to corporation, whether essentially equivalent to a taxable dividend, (b) Fraud penalty for failure to report transaction in return.

Facts. — Petitioners Max S. Hirsch and Clementine Hirsch are husband and wife and filed joint income tax returns for 1935 and 1936. Petitioner L. B. Hirsch is a brother of Max S. Hirsch. All are residents of Portland, Oregon.

During 1935 and 1936 Max S. Hirsch and L. B. Hirsch were president and vice president, respectively, of the Hirsch Weis Manufacturing Co., a corporation engaged in the business of manufacturing and selling work clothes, canvas materials, and related products, with its principal place of business at Portland.

The Hirsch Weis Manufacturing Co., hereinafter sometimes referred to as the company, was organized under the laws of the State of Oregon in 1912, with an authorized capital stock of $100,000, divided into 1,000 shares of common stock of a par value of $100 each. Of the original stock issue, Max S. Hirsch subscribed and paid for 600 shares; L. B. Hirsch, 160 shares; Clara Behrens, sister of Max S. and L. B. Hirsch, 40 shares; H. A. Weis, 100 shares, and E. A. Gerst, 100 shares.

On or about December 20, 1920, the authorized capital stock of the company was increased to $700,000 (7,000 shares of $100 par value each) and a 500 percent stock dividend was declared and paid. At or about that time 7 shares were issued to a son of Max S. Hirsch, 34 shares to a nephew, and 12 shares to a niece.

The stockholders and the number of shares of stock held by each on December 21, 1920, and on December 20, 1935, were as follows:

Max S. Hirsch has been president and general manager of the company since incorporation. For a number of years prior to 1935 he and L. B. Hirsch borrowed large sums of money from the company, some on open account and some on promissory notes. It was the practice of both stockholders to give their promissory notes to the company, bearing interest at the rate of 6 percent per annum, for amounts of money borrowed. They paid the amounts with interest from time to time out of dividends received from the company. On May 6,1932, Max S. Hirsch owed no money on notes to the company. On May 6, 1932, he borrowed $2,500 from the company, giving his promissory note therefor. He owed $47,100 to the company on Ms notes at January 1, 1935. He paid $6,000 in cash on March 1, 1935, which left him owing a balance of $41,100.

L. B. Hirsch owed no money on notes to the company during 1928 or on January 1, 1929. He borrowed $4,000 on Ms note on February 5, 1929. At December 14, 1935, he owed the company on notes $14,186.18.

The total indebtedness of officers and employees to the company on December 31, 1934, was $54,859.44, nearly all of which was owed by the two principal stockholders, the petitioners herein.

On December 20, 1935, Max S. Hirsch’s total indebtedness to the company amounted to $58,010.51, of which amount $41,100 was represented by his promissory notes, $13,123.10 was on open account, $1,287.41 was accrued interest, and $2,500 was represented by the note of a third party which he had assumed. The indebtedness of L. B. Hirsch to the company at that time was $14,186.18, all of which was represented by promissory notes.

Prior to June 1934 the company had made a practice of borrowing operating funds from the local banks at the normal interest rates of 5 to 6 percent. In 1934, however, it began selling its commercial paper through brokers as a means of financing its business operations and was able to secure funds at the much lower interest rates of 1 or 1¾ percent.

The brokerage concern which was marketing the company’s commercial paper requested an audit of the company’s books by a firm of certified public accountants. In making such audit of the company’s books for 1934 the auditors in charge of the examination, after consultation with the brokerage firm, recommended that as a protection to the company’s financial rating the loans of the stockholders appearing in the company’s books be liquidated.

On or shortly prior to December 21, 1935, the directors of the company, after discussing the matter informally, decided that Max S. Hirsch and L. B. Hirsch should pay off their indebtedness to the company in whole or in part by turning in 10 percent of their stock at its par value of $100 per share. The other stockholders were to have the same privilege, that is, of turning in 10 percent of their stockholdings at $100 per share. Accordingly, on December 21, 1935, Max S. Hirsch surrendered 500 of his shares of stock and L. B. Hirsch surrendered 100 of his shares in partial liquidation of their loans. Twenty-six shares were turned in by two other stockholders during 1935 and in subsequent years additional shares were turned in by other stockholders under the same arrangement.

In the company’s books closing journal entries were made under date of December 31, 1935, showing a debit of $62,600 to “Treasury Stock” and a credit of a like amount to “General Ledger,” with the notation “To take up charges from General Ledger.” Also there was a debit to “Capital Stock” of $62,600 and a corresponding credit to “Treasury Stock,” with the notation “To show cancellation of Stock.”

No minutes of the informal meeting of the directors held on or about December 21, 1935, were made at that time but several years later the following minutes dated December 21, 1935, were prepared and posted in the company’s books:

Be It Remembered, that at 8 P. M. Dec. 21, 1935 at the office of the company, Front & Burnside, a special meeting of the Directors of the Hirsch Weis Mfg. Go. was held, at which all directors of said corporation were present.
The president called attention to the indebtedness to the corporation of L. B. Hirsch and Max S. Hirsch and stated that there was no other way at this time or in the near future that this indebtedness be paid by either debtor excepting to sell to the corporation, part of their respective holdings of shares in the corporation.
After a great deal of discussion, it was moved, duly seconded, and carried that said L. B. Hirsch and Max S. Hirsch sell to the corporation, 10% of its shares of stock in the corporation at a par value of $100.00 per share, giving the same privilege to each and every stockholder who desires to take advantage of it now or anytime in the future — that is 10% of their holdings in the corporation, as of Dec. 21, 1935.
As 10% of the holdings of shares of stock in the corporation of said Max S. Hirsch would not pay the complete indebtedness with interest and a certain note of John Sehibel that said Max S. Hirsch assumed, it was moved, seconded and carried that the corporation buy from said Max S. Hirsch an additional 4% or a total of approximately 14% of said Max S. Hirsch holding of shares of stock in the corporation which would then pay the complete indebtedness to the corporation with interest as well as the note referred to.
There being no further business to come before the Board of Directors, there was a motion made, seconded and carried to adjourn.
Max S. Hirsch,
President
H. A. Weis,
Treasurer

The net earnings and dividends of the company over the period 1913 to 1935, inclusive, were as follows:

The balance sheets of the Hirsch Weis Manufacturing Co., as shown by its income tax returns for 1934 and 1935, at December 31, 1933, December 31,1934, and December 31, 1935, show the following:

In his income tax return for 1935 Max S. Hirsch reported the surrender of his stock in payment of his indebtedness to the company as a capital transaction. The respondent has determined m his deficiency notice that the transaction constituted a redemption or cancellation of such stock by the company “at such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to the distribution of a taxable dividend within the meaning of section 115 (g) of the Eevenue Act of 1934.”

Petitioner L. B. Hirsch did not report the transaction in his return and for his failure to do so the respondent has asserted a 50 percent fraud penalty under section 293 (b) of the Revenue Act of 1934.

The redemption of stock in these proceedings was at such time and in such manner as to make the redemption essentially equivalent to the distribution of a taxable dividend.

The failure of L. B. Hirsch to report the redemption in his return was not due to fraud with intent to evade tax.

Opinion. — Section 115 (g) of the Revenue Act of 1934 provides:

SBC. 115. DISTRIBUTIONS BY CORPORATIONS.
*******
(g) Redemption of Stock. — If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

The respondent has determined that the redemption of its stock by the Hirsch Weis Manufacturing Co., as described above, was essentially equivalent to the distribution of a taxable dividend within the meaning of the statute. He has further determined that the petitioner, L. B. Hirsch, filed a false and fraudulent return for 1935 by reason of his failure to report the transaction in his income tax return for that year.

The first question for consideration is whether the redemption of a portion of the shares of stock of the two petitioners in December 1935 was “at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend.” The petitioners argue that it was not; that the certified public accountants who were auditing the books of the company for 1934 (apparently during the year 1935), at the instance of the brokerage concern engaged in marketing the company’s commercial paper, recommended the liquidation of the debts owed to the company by its principal stockholders; that the stockholders were not in funds for the repayment of the loans; and that the only way in which the indebtedness could be liquidated was to surrender some of their stockholdings for redemption.

In this connection it should be noted that the redemption of the shares of stock by the company did not operate to increase the surplus or undivided profits of the company. The debts owing to the company by the principal stockholders were carried on the company’s books of account as “Notes Receivable” and “Accounts Receivable.” The net effect of the redemption was to reduce the -ratio between current assets and current liabilities. Even if, from the broker’s standpoint, the financial statement of the company was improved by reducing the amounts owed to the company by the principal stockholders, the relation of current assets to current liabilities was rendered less favorable.

The evidence shows that during the depression years 1930 to 1934, inclusive, the principal stockholders borrowed large amounts from the company. The company paid no dividends during these years. What use was made of the funds borrowed is not shown by the evidence. It appears, however, from an inspection of the income tax return of Max S. Hirsch for 1935 that he was interested in investing in securities wholly unrelated to the company’s business. In 1935 he sold securities which he had purchased in 1934 and 1935 at a cost of $12,460.70. It may be that the petitioner Max S. Hirsch’s investments could not be sold to advantage in 1935 and his debts paid to the company. But it is clear that the two principal stockholders of the company borrowed from the company at a time when the company needed the money in its business operations; for it was under the necessity of borrowing large amounts of money from banks and upon its commercial paper through brokers. Through the redemption of the shares the two principal stockholders received assets of the corporation of a value of $60,000. The financial condition of the company was weakened by the redemption.

In J. Natwick, 36 B. T. A. 866, the Board said:

Without deciding whether the question presented here is purely one of fact or a mixed question of fact and law, we are of the opinion that the respondent is correct in maintaining in this case that his determination under this, as under other provisions of the statute, carries a presumption of correctness which must be overthrown by a preponderance of the evidence on the part of the petitioner. We said in George Hyman, 28 B. T. A. 1231, at page 1233: “From such facts it is just as conceivable that the redemption and cancellation were essentially equivalent to a dividend as it is that they were not; and, since the respondent has determined that they were, and the burden of proof is on petitioner, we can not affirmatively find that it was not.”

Although, it may not be said in these proceedings that there was any relation between the declaration of the 500 percent stock dividend in 1920 and the redemption of the shares in 1935, we think that the evidence supports the determination of the respondent that the redemption of the shares was essentially equivalent to the distribution of a taxable dividend. His determination is therefore sustained.

The fraud issue arises from the failure of the petitioner, L. B. Hirsch, to report in his income tax return for 1935 the redemption of 100 shares of his Hirsch Weis Manufacturing Co. stock. His defense is that he did not consider that he had any taxable gain on the transaction, since .the shares of stock surrendered to the company were worth as much or more than the consideration received for them, that is, the cancellation of $10,000 of his indebtedness to the company.

L. B. Hirsch’s income tax return for 1935 was made up by an attorney, Robert T. Jacob, who also acted as tax adviser for Max S. Hirsch and for the Hirsch Weis Manufacturing Co. Jacob testified that he made up the return from figures which the taxpayer read off to him out of a notebook in which he kept a record of items of income and deductions and that the taxpayer made no mention of having surrendered any stock of the Hirsch Weis Manufacturing Co. in that year, and that he did not learn of that until he saw the report of the examining revenue agent. Jacob further testified that he made up the 1935 return of Max S. Hirsch and reported therein a capital gain on the shares which he surrendered.

In our opinion the evidence does not show that the omission by L. B. Hirsch of the transaction in question from his income tax return for 1935 was due to fraud with intent to evade tax. Since the burden of proof with respect to the fraud issue rests upon the respondent, the assessment of the fraud penalty is not sustained.

Issue 2.

Bad Debt Deduction.

Facts. — In 1925 Max S. Hirsch, hereinafter in this issue referred to as the petitioner, loaned to his brother-in-law, Leo W. Seller, $15,000 to invest in a business of manufacturing house dresses. The business was organized at or about that time at Seattle, Washington, by Seller and Sol Garde under the name of the Garde-Seller Co. Petitioner’s loan was evidenced by Seller’s promissory note and was secured by his stock in the company. Interest on this note was paid regularly to September 1, 1930. In 1932 the Garde-Seller Co. (then known as the Leman-Seller Manufacturing Co.) became insolvent and was placed in liquidation in June of that year. Seller turned over all of his share of the proceeds from the liquidation to the petitioner to apply against his note. Liquidation of the Leman-Seller Manufacturing Co. continued for several years, due to a number of accounts receivable being among the assets. From 1932 to 1934, inclusive, the following proceeds from the liquidation were received and applied against the note:

1932_$4,155.00
1933, first half year- 1, 050. 00
1933, second half year_ 268. 84
1934, Jan. 1 to Apr. 4_ 10. 00
1934, Apr. 5 to July 25_ 36. 92
1934, July 26 to Oct. 15_ 10.00
Total. 5,530. 76

JSTo further payments on principal or interest were ever received by the petitioner.

On May 9, 1934, the law firm in charge of the liquidation of the Leman-Seller Manufacturing Co. wrote to the petitioner stating that the only remaining assets of the company were “collection items of uncertain value.” On November 9, 1935, the petitioner wrote the following letter to one of the attorneys in the liquidating firm:

Noy. 9, 1935.
Mr. Edward G. Dobrin,
c/o Bogle, Bogle & Gates,
6th Floor Central Bldg.,
Seattle, Wn.
Dear Mr. Dobrin:
On May 9, 1934 you advised me that there was some remaining assets of uncertain value which Mr. Schermer agreed to describe in a letter to you and to divide the net recoveries three-eighths and five-eighths as collected.
I have never heard about these remaining assets up to date, either about all of them or any part so I would appreciate it if you would investigate and advise if there is any possible chance for any additional recoveries.
My loss in advancing or loaning money to Mr. Seller is not yet ascertained and as I wish to do so by the first of the year so that I can take my loss into consideration when making up my income tax statement, I would appreciate it if you would write me in detail.
Be kind enough to word your letter in such a way that the Federal State and Tax Commission do not question the deduction of my loss nor do they take a position that this loss should have been charged off the year previous.
I am sure you will understand to what I refer and thank you in advance.
With kindest personal regards, I am
Yours truly,
MSH: MD

The following reply to the above letter was received by the petitioner under date of December 10, 1935:

Seattle
December 10, 1935.
Mr. Max S. Hirsch,
67 West Burnside Street,
Portland, Oregon.
Dear Sir:
On May 9, 1934 we advised you that the only remaining assets of Leman-Seller Manufacturing Company are collection items of uncertain value which Mr. Schermer agreed to describe in a letter to us and to divide the net recovery three-eighths and five-eighths as collected.
Mr. Schermer has failed to give us the letter requested and although often requested to do so, has failed to give us any report. We wrote to him in this connection without response from him, under dates of October 12,1934, January 15, 1935, February 26, 1935, March 26, 1935 and August 17, 1935.
Under the circumstances, we believe that you may consider that no further recovery will be forthcoming.
Yery truly yours,
[Signed] Boque, Bogle & Gates.

After the liquidation of the Leman-Seller Manufacturing Co. was begun in 1932, Seller worked as a traveling salesman until the latter part of 1935, when he suffered a slight stroke. He was able to return to his' work after several weeks but never fully regained his health. His net earnings in 1934 and up to the time of his illness in 1935 were from about $2,400 to $2,800 per year. He had no property in either year out of which his indebtedness to the petitioner might-have been paid.

The petitioner knew or had reason to believe that the unpaid balance of Seller’s indebtedness to him at the close of 1934 was uncollectible.

Opinion. — In his deficiency notice the respondent determined that no deductible loss was sustained by the petitioner in 1935 on account of the worthlessness of the unpaid balance of Seller’s indebtedness, but did not state any specific grounds for the disallowance of the deduction claimed in the petitioner’s return. In these proceedings, however, the respondent makes the contention, among others, that the debt became worthless in 1934 and therefore may not be availed of as a deduction in 1935. We think that the evidence bears out this contention. The loan to Seller was made for the purpose of establishing him in business. As petitioner well knew, it was subject to the hazards of the business. The business failed in 1932 and was completely liquidated by the end of 1933, except for a few doubtful accounts from which only small recoveries were subsequently made. The evidence shows no grounds for any reasonable expectation on petitioner’s part that any further substantial recovery of the debt would ever be made.

That the petitioner himself was apprehensive about his right to claim the deduction in 1935, as against a prior year, is indicated by the letter which he wrote to the liquidating agents on November 9, 1935.

A deduction for a worthless debt must be taken in the year when the taxpayer ascertains, or reasonably should ascertain, that the debt has become worthless. Avery v. Commissioner, 22 Fed. (2d) 6.

The evidence before us fails to overcome the presumptive correctness of the respondent’s determination that the petitioner is not entitled to any deduction on account of the worthlessness of the debt in question in 1935.

Issue 3.

Interest ded/uction — interest on life insurance policy loans added to principad amount of loans.

Facts. — In his income tax return for 1935 L. B. Hirsch, referred to in this issue as the petitioner, claimed an interest deduction of $491.46, which, the respondent disallowed on the ground that the interest was not actually paid by the petitioner in 1935 and is therefore not deductible in petitioner’s return for that year, which was made on the cash basis.

At the hearing it was stipulated that $78.08 of the amount of interest claimed as a deduction in 1935 was paid by the petitioner in 1936 and is deductible in his return for that year. In the redeter-mination of the deficiency for 1936 under Rule 50 the $78.08 payment of interest will be allowed.

The $491.46 represents interest on loans which the petitioner had obtained on two life insurance policies from the insuring companies. The interest on the loans was not actually paid in cash by the petitioner in 1935, but was added to the principal amount of the loans. The policies had cash reserves sufficient to cover the resulting increase in the loans.

From these facts it is plain that there was no actual payment of the interest in dispute by the petitioner in 1935. The petitioner merely increased his indebtedness to the insurance companies by having the interest obligation carried over into the principal indebtedness. Petitioner actually paid out nothing in cash.

Opinion. — In Eckert v. Burnet, 283 U. S. 140, the Court held that a bad debt deduction was not allowable to a taxpayer on the cash basis who had given his promissory note in settlement of his liability as endorser of the notes of the corporation in which he was interested. In its opinion the Court said:

* * * For j-jjg pUrp0ge of a return upon a cash basis there was no loss in 1925. As happily stated by the Board of Tax Appeals the petitioner “merely exchanged his note under which he was primarily liable for the corporation’s notes under which he was secondarily liable, without any outlay of cash or property having a cash value.” A deduction may be permissible in the taxable year in which the petitioner pays cash. The petitioner says that it was definitely ascertained in 1925 that the petitioner would sustain the losses in question. So it was, if the petitioner ultimately pays his note. So was the tax considered in United States v. Mitchell, 271 U. S. 9, 12, 46 S. Ct. 418, 70 L. Ed. 799, but it could not be deducted until it was paid.

In United States v. Mitchell, 271 U. S. 9, it was field that taxes are deductible by a taxpayer on the cash basis in the year when paid. “It was not the purpose of the Act”, the Court said, “to permit gross income actually received to be diminished by taxes or other deductible items disbursed in a later year, even if accrued in the taxable year.” To the same effect is Helvering v. Price, 309 U. S. 409, holding that losses likewise are deductible by a taxpayer on the cash basis in the year when payment is made. The same rule was applied to interest deductions in Massachusetts Mutual Life Ins. Co. v. United States, 288 U. S. 269. See also Barto Co., 21 B. T. A. 1197; Oscar G. Joseph, 32 B. T. A. 1192; S. E. Thomason, 33 B. T. A. 576; dismissed (C. C. A., 7th Cir.), April 29, 1937; Fred W. Leadbetter, 39 B. T. A. 629.

The respondent correctly disallowed the interest deduction of $491.46 claimed by the petitioner in his 1935 return.

Issue 4.

(a) Personal exemption as head of fa/mily. (b)\ Credit for dependents, (e) Negligence penalty.

Facts. — In his returns for 1935 and 1936 L. B. Hirsch, referred to in this issue as the petitioner, claimed a personal exemption of $2,500 as head of a family and a credit of $1,200 for three dependents. The respondent in his deficiency notice allowed the petitioner a personal exemption of only $1,000. and disallowed the credit for dependents. In addition the respondent asserted a 5 percent penalty for 1936 amounting to $9.04, on the ground that the petitioner was negligent in claiming the exemption and credit referred to. The negligence penalty has not been asserted for 1935 for the reason, as respondent states in his brief, that the larger 50 percent fraud penalty has been asserted for that year.

The petitioner is unmarried. Since 1922 he has resided continuously at 1115 S. W. King Avenue, Portland, Oregon, with his sister, Eda H. Low, her husband, Julius Low, and their daughter, Barbara. The persons named were of the ages hr 1935 of about 55, 60, and 15 years, respectively.

The home in which the petitioner, his sister, her husband, and their daughter resided was purchased by the petitioner and for personal reasons deeded to Ms sister as a gift in 1922. In 1932 or 1933 the property was mortgaged to secure a loan to the petitioner of $10,000, which petitioner subsequently paid off.

During the years 1935 and 1936 the petitioner contributed about $350 or $400 per month to the general expenses of maintaining the household in which he and the others resided. In addition he paid the medical bills of different members of the household and contributed to the educational expense of Barbara.

In 1929 or 1930 Julius Low suffered an eye affliction, which resulted in a permanent impairment of his eyesight. Since that time he has conducted a small business of selling wines and cigars on a commission basis to his friends and acquaintances in Portland. He has no office and no established place of business. His earnings amount to about $400 or $500 per year. In his return for 1935 the petitioner reported $463.42 as income earned by Julius Low in that year.

During 1935 and 1936 the petitioner, his sister, Eda H. Low, and her husband, Julius Low, owned all the stock of the Hirsch Investment Co., a corporation organized in 1911 with, a capital stock of $20,000 (200 shares of a par value of $100 each), which was later reduced to $5,000 (50 shares of a par value of $100 each). At December 31, 1935, the petitioner owned 27.5 shares, Julius Low 18.75 shares, and Eda H. Low 3.75 shares of the Hirsch Investment Co. stock. The principal asset of the corporation was a parcel of improved real estate consisting of a one-story concrete building which was rented. The financial condition of the corporation as at December 31, 1935, was as follows:

The accounts receivable included $20,688.71 owed to the corporation by L. B. Hirsch, $1,031.70 owed by Julius Low, and $6,387.92 owed by the stockholders jointly and charged to “Stockholders Joint Account.” The last stated amount of $6,387.92 represented moneys withdrawn from the corporation’s funds by the stockholders and used by them, in whole or in part, for general household purposes. The net earnings of the corporation as reported in its income tax returns were $869.78 in 1935 and $979.52 in 1936.

At the close of 1935 the petitioner was indebted to his sister, Eda H. Low, in the amount of $9,241, on which amount interest was credited for that year.

Opinion. — The respondent’s contentions are that the petitioner was not the head of a family and that he had no dependents in 1935 or 1936, entitling him to the exemption and credit which he claimed in his returns for those years. The pertinent provisions of the statute are found in section 25 (b) (1) and (2) of the Revenue Acts of 1934 and 1936, and are as follows:

SEC. 2 5. CREDITS OF INDIVIDUAL AGAINST NET INCOME.
* * * * * * *
(b) Credits toe Both Normal Tax and Surtax. — There shall be allowed for the purposes of the normal tax and the surtax the following credits against net income:
(1) Personal exemption. — In the ease of a single person, a personal exemption of $1,000; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided .between them.
(2) Credit for dependents. — $400 for each person (other than husband or wife) dependent upon and receiving his chief support from the taxpayer if such dependent person is under eighteen years of age or is incapable of self-support because mentally or physically defective.

Prior revenue acts have contained similar provisions. Consistent with prior regulations, the Commissioner has ruled, in article 25-4 of Regulations 86, that:

A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal' obligation. * * *

In John H. Watson, Jr., 38 B. T. A. 1026, we held that a taxpayer who was unmarried and lived with his mother and who, by reason of his mother’s residence with him, paid out approximately $5,000 per year for household expenses, was not entitled to the exemption of $2,500 as the head of a family, since the mother had ample means of support and had a substantial income of her own. See also Louise C. Ball, 16 B. T. A. 785, and John H. Rudiger, 22 B. T. A. 204.

On the other hand, we held in Alfred E. Fuhlage, 32 B. T. A. 222; affd., per curiam, 79 Fed. (2d) 998, that a taxpayer who was unmarried and who maintained a home in which he supported his unmarried sister who had no income or means of support of her own was entitled to the status of head of a family.

The evidence here is that neither the petitioner’s sister nor Julius Low nor their daughter Barbara was solely dependent upon the petitioner for support during either of the years involved. Besides Julius Low’s earnings, which amounted to between $400 and $500 per year, he and his wife owned nearly half of the Hirsch Investment Co. stock, the book value of which at December 31, 1935, was over $57,000. In addition, petitioner’s sister owned the residence in which they all lived, it having been conveyed to her by the petitioner as a gift in 1922, and the petitioner owed her a personal indebtedness of over $9,000.

While the evidence shows that the petitioner generously contributed to the expenses of the household in which they all resided and perhaps enabled his sister and her husband and their daughter to maintain higher living standards than they might have been able to maintain otherwise, it does not show that those persons, or any of them, were dependent upon him for their chief support or that in petitioner’s relationship to them he occupied the status of “head of a family”, within the meaning of the statute and the regulations.

Although our conclusion is that the petitioner is not entitled to the exemption of $2,500 as head of a family or to any credit for dependents in 1935 and 1936, we do not think that the claim for such exemption and credit in his returns affords any ground for the assessment of the negligence penalty for 1936. The claims at least are colorable and are in the nature of those commonly asserted by taxpayers conscientious in their own endeavor to return the taxes justly due the Government and advised in the preparation of their returns by competent and reliable tax attorneys. The assessment of the negligence penalty is therefore not sustained.

Decisions will he entered under Bule 50.


author: Leech:

text:
    Bessie B. Hopkinson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97014.
    Promulgated August 20, 1940.

      Herman Goldman, Esq'., and Milton J. Levitt, Esq., for the petitioner.

      Conway N. Kitchen, Esq., for the respondent.
   OPINION.

Leech:

The issues for decision are (1) whether payments, made under the contract between Hopkinson and the Eubber Co. and received by petitioner as beneficiary of the trust of which the contract formed the corpus, are ordinary income or capital gain in the hands of petitioner, and (2) whether payments made by the trustee for legal services are includable in petitioner’s net income under section 162 (b) of the Eevenue Act of 1934.

Petitioner contends that, since payments under the contract between her deceased husband, Ernest Hopkinson, and "United States Eubber Co. were capital gains as to her husband, they are also capital gains to her as beneficiary of a trust,, the corpus of which, as a result of an assignment from Hopkinson to the trustee, comprises the said contract. In his deficiency notice respondent took the position that the payments under the contract were royalty payments rather than payments of consideration for the sale of a capital asset, and hence were taxable as ordinary income. On brief, he does not press this contention, but instead urges that, since there was no sale or exchange by petitioner or the trustee, she is not entitled to the percentage provisions of section 117 of the Eevenue Act of 1934.

We think it is clear that Ernest Hopkinson sold his patents and patent applications to the Rubber Co. in 1930 and that all payments received by him under the contract of sale resulted from the sale of capital assets, were not royalties, and were, so far as he was concerned, taxable at capital gain rates. As petitioner aptly says in her brief: “It is obvious that the parties to the 1930 agreement intended to effect a sale of the inventions covered thereby. The language of the agreement, the designation of the parties and the desire to terminate the then existing license agreement, make this conclusion inescapable. It is bolstered up by the fact that in addition to the general assignment of the patents provided for by the 1930 agreement, the patents were individually assigned by HopkiNSON and the assignments were recorded in due course. It is impossible to conceive of what else could have been done or provided for which would have more clearly indicated the intention of the parties to the contract and which would have more definitely characterized the nature of the transaction covered thereby.” See Samuel E. Diescher, 36 B. T. A. 732; affd., 110 Fed. (2d) 90; certiorari denied, 310 U. S. 650; Rotorite Corporation, 40 B. T. A. 1304; Helvering v. Elbe Oil Land Development Co., 303 U. S. 372; Littlefield v. Perry, 88 U. S. 205; Rude v. Wescott, 130 U. S. 152; Herzog v. Heyman, 151 N. Y. 587; 45 N. E. 1127; Dalzell v. Fahys Watch Case Co., 138 N. Y. 285; 33 N. E. 1071. See also Kiesau Petroleum Corporation, 42 B. T. A. 69. As far as Ernest Hopkinson was concerned, moreover, such payments were taxable to him in the years received. Burnet v. Logan, 283 U. S. 404.

The question remains, however, as to whether petitioner is entitled to treat receipts under the contract as capital gains. It is to be noted at the outset that she is entitled to the percentage provisions, if the trustee is. Arthur Letts, Jr., 30 B. T. A. 800; affd., 84 Fed. (2d) 760; McNaghten v. United States, 17 Fed. Supp. 509.

The portions of section 117 of the 1934 Act which are here relevant are set out in the margin.1 The dispute really centers about the meaning of the words in subsection (b), “property held by the taxpayer.” Is petitioner to be denied the benefit of the percentage, provisions because neither she nor the trustee sold the patents and patent applications, but only became entitled to the proceeds of the sale after it was made through the assignment of the contract ?

Eesearch has disclosed no case in point, although there are intimations in United States v. National City Bank of New York, 21 Fed. Supp. 791, to the effect that a trustee in somewhat similar circumstances might compute gain at capital rates. We think, however, that the scheme of the revenue acts and certain analogous doctrines entitle petitioner to treat the payments under the contract as capital gains. Section 117 '(c) (2) provides that in determining the period for which a taxpayer has held property however acquired there shall be included the period for which the property was held by any other person, if under section 113 such property has the same basis in whole or in part in the taxpayer’s hands as it would have in the hands of such other person. Under section 113 (a) (3), if the property was acquired after December 31, 1920, by a transfer in trust, the basis is the same as it would be in the hands of the grantor. In passing upon the effect of an earlier counterpart of section 117, section 206 of the Revenue Act of 1921, the Court in Helvering v. New York Trust Co., 292 U. S. 455, enunciated the rule (which was subsequently embodied in section 117 (c) (2) of the 1934 Act) that the donee was deemed to have held the stock for the length of time it had been held by the donor, and for the purpose of computing gain on the sale of such stock was considered “as Turning assumed the place of the trustor.” (Emphasis supplied.) The Court also held:

* * * In respect of tlie legislative purpose to lessen hindrance caused by high normal and surtaxes, there is no distinction between gains derived from the sale made by an owner who has held the property for more than two years and those resulting from one by a donee whose tenure plus that of the donor exceeds that period.

See also McFeely v. Commissioner, 296 U. S. 102, and Macy v. Helvering, 82 Fed. (2d) 183.

There is thus discernible a Congressional intent to treat a donee as standing for income tax purposes in the shoes of the donor, explicit in regard to basis and holding period, and inferential as to capital gains. Decisional analogies are to be found in the cases of installment sales, where, upon the sale of an installment obligation, the purchaser of that obligation is required to report income in the same manner as the vendor, Wobbers, Inc., 26 B. T. A. 322; Portland Oil Co. v. Commissioner, 109 Fed. (2d) 479, and in the case of a reorganization, where the earnings of a predecessor corporation retain their character as earnings in the hands of the recipient company, Commissioner v. Sansome, 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667.

In contemplation of law, every payment made by the Rubber Co. was, as we have pointed out, part of the purchase price of a sale of capital assets. The character of these payments in the hands of the recipient was not changed by the fact that the recipient took under an assigned right. Petitioner assumed the duty and obligation of reporting income arising out of the contract. R. E. Nail et al., Executors, 27 B. T. A. 33; Swartz, Inc. v. Commissioner, 69 Fed. (2d) 633; Nelson v. Ferguson, 56 Fed. (2d) 121; Commissioner v. O’Donnell, 90 Fed. (2d) 907. We conclude that she likewise received from the assignor the right to report that income at capital rates.

The second issue is whether in computing the net income of the trust subject to taxation in the hands of petitioner the inclusion of $7,500 paid by the trustee for legal fees is proper. It has been held that where the tax liability of the income beneficiary is in issue, rather than the liability of the trustee, and the trust instrument requires the trustee to pay the particular expenses out of trust income, the income beneficiary is taxable only with respect to the net amounts actually distributed to him, regardless of whether as to the trustee the deduction in question is allowable. Augusta Bliss Reese, 29 B. T. A. 565; Gertrude Thompson, 40 B. T. A. 891; Mary Helen Cadwalader, 27 B. T. A. 1078. Without deciding, therefore, whether the trustee was entitled to this deduction, upon the authority of the foregoing cases we sustain petitioner and hold that she is taxable only in respect of the amounts actually distributed to her. In reaching this conclusion we have not neglected respondent’s argument to the effect that some of the legal services related to petitioner’s right to assign her interest to her children and the resulting tax liabilities, and hence she constructively received a part, if not all, of the $7,500 fee. We think that the tax status and assignability of all interests under the trust were of equal interest to the trustee and fell within the class of objects for which the trustee was specifically authorized to procure legal assistance. Respondent is concluded, therefore, by Augusta Bliss Reese, supra.

Decision xoill be entered for the petitioner.
      SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
      *******
      (b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a bind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.
      (c) Determination of Period foe Which Held. — For the purpose of subsection (a)—
      *******
      (2) In determining the period for which the taxpayer has held property however acquired there shall be included the period for which such property was held by any other person, if under the provisions of section 113, such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person.


text:
    Miller & Paine, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94968.
    Promulgated August 20, 1940.

      H. A. Mihills, G. P. A., for the petitioner.

      Angus B. Shannon, Jr., Esq., for the respondent.
   OPINION.

Black:

As we understand the contention of petitioner, it is in substance that the transfer of stock in the New Jersey corporation for stock in the New York corporation was one in which no gain or loss was recognized because it was one which falls squarely within the provisions of section 112 (b) (3) of the Revenue Act of 1934, which reads:

(3) Stock por Stock on Reobuanizatton. — No gain or loss shall be recognized. if stock or securities in a corporation a party to' a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

Petitioner further contends that the receipt by the creditors of the New Jersey corporation, petitioner being one of them, of stock in the New York corporation in exchange for the notes which these creditors held against the New Jersey corporation was a separate transaction and was not an exchange of property for stock within the meaning of section 112 (b) (5), but was simply a paying off by the New York company of indebtedness which it had assumed of the New Jersey corporation, and that, inasmuch as only $10 was paid for each $100 indebtedness the balance of the debt was worthless, and petitioner had the right to charge oh during the taxable year $25,650 of the indebtedness of the New Jersey corporation to petitioner, which it did not collect and to deduct it in determining net income.

Among other authorities which petitioner cites in support of its contention are Hale v. Helvering, 85 Fed. (2d) 819, affirming 32 B. T. A. 356, and Bingham v. Commissioner, 105 Fed. (2d) 971. We think these authorities do not support petitioner’s contention. In the Hale case there was a compromise by the creditor of his debt for less than face value and the court held that this action of the creditor in accepting in cash a lesser amount than the full face value of his note was not a “sale or exchange” of his note, so as to bring the loss suffered by the creditor within the capital loss provisions of the statute. To somewhat the same effect is the Bingham case above cited.

If there had been a paying off of petitioner’s debt in cash at 10 cents on the dollar, doubtless petitioner would be correct in its contentions under the authorities cited. It should be remembered, however, that section 112 (b) (5), upon which the Commissioner relies in this proceeding, does not deal with the paying off of debts in cash. It deals with the “transfer to corporation controlled by transferor.” In other words, it deals with a situation where the transferor instead of receiving cash retains an interest through stock ownership in the property which he has transferred. If that interest amounts to a control by the transferors of the transferee corporation as control is defined in the statute, then no gain or loss is to be recognized, assuming that the other conditions provided in the statute are met.

In the instant case there can be no question but that the creditors of the New Jersey corporation, including petitioner, transferred their notes against that corporation to the New York corporation and received in exchange therefor solely stock in the New York corporation. In other words, they did not receive payment of their debts, but exchanged their debts for a continuing interest in the new corporation. This is the sort of transaction where no gain or loss is recognized, provided the conditions required by section 112 (b) (5) of the Revenue Act of 1934 are met. Cf. Rockford Brick & Tile Co., 31 B. T. A. 537.

While petitioner firmly contends that section 112 (b) (5) is not applicable and that the facts simply show the compromise of a debt at less than face value and therefore Hale v. Helvering, supra, and Bingham v. Commissioner, supra, govern, nevertheless petitioner contends that, even if section 112 (b) (5) is held to be applicable, the conditions which it prescribes are not met with in the instant case. Petitioner points out that 112 (b) (5) requires that “in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.” Certainly in the instant case each of the creditors fared the same. Each was given one share of stock in the New York corporation of the par value of $10 for each $100 of his indebtedness. But, says petitioner, the 852 shares of stock of $10 par value in the new corporation which the stockholders of the old corporation received in exchange for their 1,375 shares of $100 par value must be considered in determining whether all who transferred their property to the New York corporation received stock of the new corporation in proportion to their interests in the property prior to the exchange. We agree with petitioner that this 352 shares of stock must be considered, but we do not agree with petitioner that there is anything in the facts which shows that these stockholders fared any better or any worse in the exchange than the creditors who exchanged their notes for stock. Petitioner in its argument points out that the noteholders exchanged $100 of indebtedness for $10 par value of stock, whereas each stockholder exchanged four shares of $100 par value in the New Jersey corporation for $10 par value of stock in the New York corporation. Petitioner cites, in support of its contention that there is a substantial disparity in this treatment, United Carbon Co. v. Commissioner, 90 Fed. (2d) 43.

Petitioner, in making its comparison to show disparity in the proportions of the stock received by the old stockholders and the creditors, uses cost basis of the property. It assumes that each share of stock costs $100, its par value, and that each $100 of indebtedness costs $100. Even if we assume that the record which we have before us shows these respective costs, which it does not, we point out that it is not the cost of property which is transferred to a transferee corporation in exchange for its stock that determines whether or not section 112 (b) (5) is applicable. It is the value of the property at the time it is transferred to the corporation which is used in the comparison to determine whether or not each transferor has substantially received his correct proportion of stock. Cost of the assets transferred is not material in making that comparison. Value at the time of transfer is the important thing. An examination of United Carbon Co. v. Commissioner, supra, upon which petitioner relies, will show that the court reached its decision that section 112 (b) (5) did not control by comparing the values of the respective properties at the time of transfer with the values of the shares of stock in United Carbon Co. which each transferor received. The court, after making this comparison, reached the conclusion that there Avas a very substantial disparity as to the proportions received bjT the several transferors and therefore section 112 (b) (5) was not controlling. Cf. Gladstone Corporation, 37 B. T. A. 174; Commissioner v. Lincoln-Boyle Ice Co., 93 Fed. (2d) 26.

In the instant case we have no evidence whatever as to the value of the notes of the NeAv Jersey corporation at the time they were transferred to the New York corporation. Likewise we have no evidence as to the value of the shares of stock of the New Jersey corporation which were transferred to the New York corporation. In the absence of such evidence we can only presume that each $100 of indebtedness at the time of transfer had a value of $10 when it was exchanged for a share of stock in the New York corporation having a fair market value of $10. Likewise we can only presume that each four shares of stock in the New Jersey corporation had a fair market value of $10 when they were exchanged for shares of the New York corporation on a basis of four shares of the New Jersey corporation for one share of the New York corporation of a fair market value of $10. If that be true, and in the absence of evidence as to value we have no right to assume that it is not true, then the proportion of stock in the new corporation which each transferor received Avas substantially the same proportion as the value of the property which he transferred to the new corporation. Certainly no one can successfully contend that the transferors of the property were not in control of the corporation after the transfers Avere made. They owned 100 percent of the stock of the New York corporation. It seems to us that the only possible contention as to why section 112 (b) (5) does not control would be that the respective transferors did not receive stock in the new corporation which was substantially in proportion to the interest which they each owned in the property at the time it was transferred to the new corporation. As we have already pointed out, we think there is no evidence in the record from which we can conclude that the interests were not substantially proportionate.

Therefore, we think section 112 (b) (5) is controlling. Cf. Snowden v. McCabe, 111 Fed. (2d) 743. Petitioner can not be allowed the loss in 1934 which it claims. It will have to take its loss in the year 1936, when it sold the stock in the New York corporation at $10 per share. Respondent is sustained.

Decision will be entered for respondent.


author: Mtjedock:

text:
    Mother Lode Coalition Mines Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98500.
    Promulgated August 20, 1940.

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

      Oonway N. Kitchen, Esq., for the respondent.
   OPINION.

Mtjedock:

The petitioner makes three arguments to support its claim for a percentage depletion deduction for 1935. One is that its election made on its 1933 return under the Revenue Act of 1932 was a continuing valid election to claim percentage depletion under section 114 (b) (4) of the Revenue Act of 1934. Another is that its amended return for 1934 was timely filed and constituted the “first return” under the Revenue Act of 1934, so that the election made therein to take percentage depletion for 1934 and subsequent years was an effective election under section 114 (b) (4) of the Revenue Act of 1934. The other argument is that the 1935 return was the “first return” within the meaning of section 114 (b) (4), since no depletion deduction upon a percentage basis was allowable for 1934.

The Board has held that the 1934 Act, in section 114 (b) (4), required a new election by taxpayers as to whether or not they desired percentage depletion for 1934 and subsequent years. Dorothy Glenn Coal Mining Co., 38 B. T. A. 1154; C. H. Mead Coal Co., 38 B. T. A. 1163; reversed on other grounds, 106 Fed. (2d) 388. Thus the election made by this taxpayer in its return for 1933 does not constitute the election required by the Revenue Act of 1934.

The Supreme Court has held, in Haggar Co. v. Helvering, 308 U. S. 389, that the term “first return,” as used in section 215 (f) of the National Industrial Recovery Act, “means a return for the first year in which the taxpayer exercises the privilege of fixing its capital stock value for tax purposes, and includes a timely amended return for that year.” The timely amended return in that case was filed within the time fixed by statute (and an extension thereof) for filing the. return. The Court was not influenced by a later regulation providing that the value declared in the original return could not be changed by an amended return filed within the statutory limits. There is a reference in the opinion to Mead Coal Co. v. Commissioner, 106 Fed. (2d) 388, wherein the Circuit Court of Appeals for the Fourth Circuit held that an amended return for 1934, electing percentage depletion and filed before the return for 1935 was due, was sufficient to support a deduction of percentage depletion for 1934. See also Del Mar Addition v. Commissioner, 113 Fed. (2d) 410. The Board, in William B. Scaife & Sons Co., 41 B. T. A. 278, interpreted the Haggar decision as recognizing only an amended return filed within the time for filing the return for the period and held that one filed thereafter was ineffective. The Circuit Court of Appeals for the Ninth Circuit, in Riley Investment Co. v. Commissioner, 110 Fed. (2d) 655, made a similar interpretation of the Haggar decision and expressed disapproval of the test of timeliness given in the Mead case. The petitioner in the Riley case was engaged in mining gold. It had exhausted its cost basis for depletion and claimed no deduction for depletion on its return for 1934. It filed an amended return on March 3, 1936, electing and claiming percentage depletion. The court held that the amended return was not timely and did not entitle tbe taxpayer to percentage depletion. The opinion contains a discussion of several of the points urged by the present petitioner. The Board held in Walter C. Hill, 41 B. T. A. 245, that an amended return, filed after the return for the next year was due, was ineffective for making an election of percentage depletion under section 114 (b) (4).

The amended return of the present petitioner for 1934 was filed on May 29, 1939, more than four years after the time for filing the return for 1934, more than four months after it learned that its percentage depletion for 1935 might be disallowed, more than three months after the deficiency notice for 1935 was mailed, and after the petition in this case was filed. It was not timely filed and was not the first return for 1934 within the meaning of section 114 (b) (4). Riley Investment Co. v. Commissioner, supra; Walter C. Hill, supra. Cf. William B. Scaife & Sons Co., supra. The conclusion is also supported by Mead Coal Co. v. Commissioner, supra.

The remaining argument of the petitioner is that its return for 1935 was its “first return” within the meaning of section 114 (b) (4) of the Revenue Act of 1934, since it was the first return under that provision in which it was entitled to any deduction for percentage, depletion. This argument is based upon the conclusion that no deduction for percentage depletion was allowable for 1934. The petitioner merely points to the net loss for 1934. The net loss shows that a deduction for percentage depletion in 1934 would not have reduced taxes for 1934 but it does not show that such a deduction was not allowable under the statute.

Section 114 (b) (4) allowed a deduction of 15 per centum “of the gross income from the property during the taxable year” but not to “exceed 50 per centum of the net income * * * from the property” excluding depletion. The terms “gross income from the property” and “net income from the property” are not necessarily synonymous with the terms “Gross Income” and “Net Income” appearing on the return. Cf. Consumers Natural Gas Co., 30 B. T. A. 1263; affd., 78 Fed. (2d) 161; certiorari denied, 296 U. S. 634. See Regulations 86, article 23 (m) -1, defining gross and net income from the property. The record shows that the petitioner had gross income from the property which would support a deduction for percentage depletion and it fails to show that there was no net income from the property for 1934. Not all deductions shown upon a return are necessarily deductible in determining net income from the property, since only those are deductible which are attributable or properly allocable to the mineral property and process upon which the depletion is claimed. Regulations 86, art. 23 (m)-1. Cf. Vinton Petroleum Co. of Texas, 28 B. T. A. 549; affd., 71 Fed. (2d) 420; Consumers Natural Gas Co., supra; Ambassador Petroleum Co., 28 B. T. A. 868; Houston Production Co. v. United States, 4 Fed. Supp. 715; Brea Canon Oil Co., 29 B. T. A. 1134; affd., 77 Fed. (2d) 67; certiorari denied, 296 U. S. 604; Greensboro Gas Co., 30 B. T. A. 1362; affd., 79 Fed. (2d) 701; certiorari denied, 296 U. S. 639.

Tbe record does not show whether or not the petitioner had other properties in 1934, or what part of the taxes might be deductible in computing net income from the property upon which depletion is being claimed. The same is true of the item “N. Y. General Expense.” “Selling Commission” and “Delivery Expense on Refined Copper” are not further explained. We may not assume, in the absence of proof, that those items are deductible in their entirety, or in any particular part, in the computation of “net income from the property.” The same and more may be said in regard to the large item of “Shutdown Expense.” The meager description given of that item strongly suggests that it is not all deductible in determining net income from the property for 1934. The copper sold in 1934 was mined previously. Should the entire shutdown expense be charged against 1934 sales? Did the petitioner refine its copper, and, if so, what allocation of income and deductions would that require.

The petitioner has failed to show that it would not have been entitled to any percentage depletion deduction for 1934 under section 114 (b) (4) and the main support of its third argument must fall. Furthermore, there is language in the Dorothy Glenn Coal Mining Co. case, supra, and in Kehoe-Berge Coal Co., 41 B. T. A. 282, which may mean that the election must be made for 1934 and that no election made in a later return will do, where the property was owned in 1934 and an election could have been made upon the return for that year.

The legislative history of the provision and its effect upon taxpayers situated like the present one has been fully considered and discussed in prior opinions cited herein. Since this petitioner did not make the election required by section 114 (b) (4), it may not have any deduction for percentage depletion for 1935.

Decision will be entered for the respondent.

       SEC. 111. BASIS FOR DEPRECIATION AND DEPLETION.
      *******
      (b) Basis foe Depletion.—
      (4) * * * A taxpayer making Ms first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or .of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section.


author: AeuNdell :

text:
    George W. Covington and Kate Ellis Covington, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98283.
    Promulgated August 21, 1940.

      C. M. Trammell, Esq., and Carl J. Batter, Esq., for the petitioners.

      Donald P. Moyers, Esq., for the respondent.
   OPINION.

AeuNdell :

The respondent has limited to $2,000 for each year the amount of deductible loss sustained by the petitioner in trading in futures contracts. The petitioner claims the losses are deductible in full. He originally included brokers’ commissions and excise taxes in the amounts claimed as losses. By amendment to the petition the commissions and taxes are segregated and claimed, respectively, as expense and tax deductions.

The respondent’s limitation of the losses to $2,000 is based on his holding that the futures contracts bought and sold by the petitioner were in the nature of capital assets within the meaning of section 117 (b) of the Revenue Act of 1936, and, therefore, were subject to the provisions of section 117 (d) of the Revenue Act of 1936. The petitioner contends that in his trading in futures there was no property “held” by him and there was no sale or exchange of property. It is argued that as there was no delivery of the commodities the petitioner never acquired or held a physical asset; the contracts themselves were not property rights because there was no immediate right to exercise.

The evidence in this case is that the petitioner was obligated under his contracts and the rules of the exchanges to agree to make or take delivery of the commodities. But in practice the petitioner rarely either made or took delivery; in the years before us he did not do so in any instance. He closed out his contracts before delivery date by executing through his brokers “set-off” contracts, that is, contracts to buy or sell commodities in quantities equivalent to those specified in the contracts under which he was then obligated. Set-offs were cleared through the clearing house association of the exchange and the petitioner paid or received the net amount owing by or to him when the contracts were set off against each other.

The exchange rules provide that futures contracts shall be presumed to be made in the form set out in the findings. According to Meyer’s Law of Stock Brokers and Stock Exchanges, § 32 (b), contracts in this form are not physically executed, and the only written memoranda actually signed are the “contract slips” exchanged by the brokers. The contract slips confirm the oral contracts made on the floor of the exchange. The contract slips, when signed, constitute binding contracts. Commodity Exchanges, by Baer and Woodruff, p. 77. Using the contract slips as their basis, the brokers make a daily report to the clearing house association of the exchange. Upon the filing and acceptance of the brokers’ reports the clearing house assumes responsibility for completion of the contracts and is substituted as seller to all buyers and as buyers to all sellers. Commodity Exchanges, supra, p. 77; Future Trading, by Hoffman, p. 203; Hedging in Grain Futures, United States Department of Agriculture, Circular No. 151, p. 15. The bylaws of the Chicago Board of Trade Clearing Corporation, as reported in Future Trading, supra,, are specific on this point in the folio-wing provision:

Buyers and sellers of commodities on change for future delivery may tender their contracts for clearance to the clearing house, and if the clearing house accept the same, the buyer shall be deemed to have bought such commodity from the clearing house, and the seller shall be deemed to have sold such commodity to the clearing house. Such substitution, shall be effective in law for all purposes. The original buyers and sellers shall be released from their obligations to each other, and the clearing house shall be deemed to have succeeded to all the rights, and to have assumed all the obligations of the original parties to such contracts.

So much for the mechanics of handling commodity futures. Considering the petitioner’s several arguments, we think that under any view it must be concluded that he held property within the meaning of the statutory definition of capital assets. Some authorities take the view that in dealing in futures the contracts are bought and sold. In Future Trading, supra, p. 11, it is'said that “in' dealing in futures one is dealing not in the actual commodity but in claims on or contracts for the commodity.” Accepting this approach, it would seem to follow that petitioner’s losses were capital losses, as contracts are unquestionably property. Another view is that the contract slips evidencing the purchases and sales “constitute bought and sold notes.” Bibb v. Allen, 149 U. S. 481. Under this view the contracts are nothing more nor less than dioses in action, and are of course property, ¿iltill another view is to treat future dealings as carrying out the igrigiiial intent to make or take delivery and to ascribe to set-offs tné effect of delivery. In Chicago Board of Trade v. Christie Grain & Stock Co., 198 U. S. 236, the Court said:

* * * We must suppose that from the beginning as now, if a member had a contract with another member to buy a certain amount of wheat at a certain' time and another to sell the same amount at the same time, it would be deemed unnecessary to exchange warehouse receipts. We must suppose that then as now, a settlement would be made by the payment of differences, after the analogy of a clearing house. This naturally would take place no less that the contracts were made in good faith for actual delivery, since the result of actual delivery would be to leave the parties just where they were before. Set-off has all the effects of delivery. * * * [Italics added.]

In Lyons Milling Co. v. Goffe & Carkener, 46 Fed. (2d) 241, it is said that set-off is “in legal effect ¿ delivery.”

It is obvious that if delivery were made it would be in fulfillment of a contract of purchase and sale of property. And if set-off has all the effects of delivery the gain or loss therefrom should, we think, have the same character as a gain or loss from actual delivery.

There is testimony in the record that the petitioner did not actually sign any contracts in his dealings in futures. This we presume was intended to establish that he had no contracts that were bought and sold. He was, however, represented by his brokers and the contracts they made were his, whether or not he signed them. For reasons given above, we hold that the petitioner’s losses from trading in futures were losses incurred in the sale or exchange of capital assets and are limited under the provisions of section 117 (d).

The next question is whether brokers’ commissions are deductible. Under the authorities selling commissions paid by one engaged in the trade or business of buying and selling securities are deductible as business expenses, Neuberger v. Commissioner, 104 Fed. (2d) 649, whereas commissions on purchases are not deductible, Helvering v. Winmill, 305 U. S. 79.

The commissions paid on commodities transactions differ somewhat from those on securities. On securities transactions a commission is payable on both a purchase and sale. On commodities transactions the commission is not payable upon a purchase or a sale, separately, but only upon the consummation, that is, on delivery of the commodity or upon the closing out by a matching sale or purchase. The evidence is to the effect that had the petitioner initiated a transaction through one broker and closed it out through another he would have had to pay a commission to each. It was the practice to initiate and to close through a single broker, who was paid but one commission.

These differences between securities and commodities transactions are not enough to warrant a different treatment of the commissions. Upon the evidence here it would seem that a part of the commission was paid for the purchase and part for the sale under each contract. The question then is as to the allocation to be made in order to determine the amount deductible as selling commissions. The burden is on the petitioner to show what portion of the total commissions was paid for selling. There is no evidence directly on this point, and perhaps none could be offered because of the fact that the payments were made as lump sums to cover two transactions. Whether the brokers made any division between purchases and sales does not appear. Thus the best that we can do is to make an estimate and in so doing we may properly bear heavily on the petitioner. Cohan v. Commissioner, 39 Fed. (2d) 540. There is nothing to indicate that any more than one-half of brokers’ services in any transactions was devoted to sales. Therefore, wTe hold that one-half, and no more, of the total commissions paid may be deducted as attributable to sales.

The tax deductions conceded by the respondent will be allowed on recomputation.

Decision will be entered, under Rule 50.

         (b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable .year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.


text:
    Estate of Richard Hemmons Halsey, Lilian Johnson Halsey, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96404.
    Promulgated August 21, 1940.

      Jonathan Grout, Esq., for the petitioner.

      Davis Hashin, Esq., for the respondent.
   OPINION.

Murdock:

The theory upon which the Commissioner determined the deficiency was that the alleged transfer was an incomplete gift, inasmuch as Mabel did not know what was in the envelope and did not accept a gift of the certificates. However, it appears that she did accept the envelope and its contents with full intent to keep it as her own. She had thereafter continuous possession of the shares and was free to do with them as she pleased. The decedent clearly intended to make a gift; he was competent; the sister was competent, and accepted; and there was a transfer of title with complete relinquishment by the donor of dominion and control of the property. Cf. Max R. Bardach, 32 B. T. A. 517, 520. The gift was complete on August 16, 1933. Cf. Nelson A. Elsasser, Executor, 12 B. T. A. 681.

The respondent, by amended answer, has attempted to support his determination upon a wholly different theory — that of contemplation of death. The evidence shows that the transfer was made within two years of the date of death. The respondent cites section 302 (c) of the Revenue Act of 1926, as amended, providing that such a transfer is presumed to have been made in contemplation of death unless the contrary be proven. The only affirmative argument advanced by the respondent is that the decedent consulted a lawyer about a will, learned that he could give a) part of his property to his sister and the rest would go to his wife in the absence of a will, and then delivered the shares to his sister in contemplation of death. The evidence does not support this argument. The decedent did not mention such matters to the attorney. Almost a year later, on his fourteenth wedding anniversary, he executed his will and gave it, together with a beautiful letter, to his wife. The facts do not show that the transfer was made in contemplation of death. But the respondent contends that the statute requires the petitioner to prove that the transfer was not in contemplation of death. The decedent was only 54. He was extremely active in his business and enjoyed excellent health. He had no expectation of death within the reasonably near future. The respondent concedes these facts and relies, as above stated, upon the visit to the lawyer to show a testamentary motive. The stock was not paying dividends but it was worth about $37,000. The gift tended to equalize the distribution of the estate of their father among Julian, Mabel, and the petitioner, and to give substantial financial assistance to a widowed sister who was much in need of it. While the evidence pertaining to the transfer is not as clear and convincing as might be desirable, nevertheless, the reasonable conclusion to be drawn from the entire record is that the transfer was not made in contemplation of death.

The respondent, also by way of amended answer, raises the point that the transfer was one intended to take effect in possession or enjoyment at or after the death of the donor. The decedent made an absolute transfer of the certificates, permanently parted with possession, and never again exercised any dominion or control over or benefited from the shares. The sister received possession and thereafter retained it. She was free to use them as she saw fit. Her possession and enjoyment was immediate and was so intended.

The respondent contends finally that, in any event, the amount of the settlement should be included in the gross estate. No such issue was raised by the pleadings and it may not be raised in the respondent’s brief. The facts in regard to the suit and settlement are inadequate for a decision of such an issue. If there is anything, other than the fact of settlement, to show that the estate had a lawful and valuable claim at the date of death in respect to the shares, the respondent should have pleaded the facts and introduced evidence to establish them.

Decision will ~be entered for the petitioner.