author: Mellott:

text:
    J. E. Houston, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53802.
    Promulgated October 18, 1935.

      J. E. Houston, Esq., pro se.

      Paul D. Page, Esq., for the respondent.
   OPINION.

Mellott:

Under the above facts, are the amounts paid to petitioner exempt from the payment of the Federal income tax?

Much has been written by the courts and by this Board upon the rather vexing question.involved herein. The rule is well settled and not difficult to understand, though its application has sometimes given difficulty.

Petitioner claims that he was an “ employee ” of a political subdivision of the state and that his services were rendered in connection with the exercise of an essential or usual governmental function. It is axiomatic that one claiming immunity from the imposition of a tax must bring himself clearly within the exemption. Has petitioner done so?

Under substantially similar facts we have frequently held that taxpayers were not entitled to immunity from the Federal income tax. George H. Gabel, 25 B. T. A. 60; Charles M. Haft, 20 B. T. A. 431; Richard F. Burges, 25 B. T. A. 1191; Edwin, J. Raber, 20 B. T. A. 975; Walter G. Winne, 27 B. T. A. 369; Milo R. Maltbie, 31 B. T. A. 614; D. Frederick, Burnett, 31 B. T. A. 1092. The “ polestar ” which has guided us chiefly has been, the case of Metcalf & Eddy v. Mitchell, 269 U. S. 514. See also Helvering v. Powers, 293 U. S. 214; Lucas v. Reed, 281 U. S. 699; Commissioner v. Murphy, 70 Fed. (2d) 790; Burnet v. McDonough, 46 Fed. (2d) 944; and Haight v. Commissioner, 52 Fed. (2d) 779; certiorari denied, 285 U. S. 537.

Petitioner attempts to distinguish his case from Haight v. Commissioner, supra. In that case the court held the mere fact that the taxpayer was required to report to the general attorney from time to time as to what had been done did not “ show that the General Attorney exercised any detailed control as to what should be done, and how it should be done, which is essential to the relationship of employer and employee.”

Petitioner has not only failed to show any substantial difference between his case and that of the petitioner in the Haight case, but, under cross-examination, brought himself clearly within the rules enunciated, and the reasoning applied, in that case.

Q. As a matter of fact, your services were secured on account of your familiarity with the matters, were they not, and your special qualifications to handle them?
A. They told me that.
Q. As a matter of fact, it was for the benefit of your judgment and your discretion and your skill that the Sanitary District obtained your services.
A. They said that that was so.
Q. As a matter of fact, you did the same work that you previously did, did you not?
A. The same character of work, yes sir. And in addition other work.

The facts show that petitioner was not furnished office space, although the sanitary district maintained an office in Peoria, where the major portion of his work was being performed. He maintained his own private office and was free to engage, and did engage, in work other than rendering services to the sanitary district, for which he received sums equal to, or in excess of, those paid by the sanitary district. The sanitary district apparently was simply another client.

The record fails to show that the general attorney exercised any control whatever as to what should be done, how it should be done, or even when it should .be done. The only showing in that connection was, as testified by the petitioner, that he “ reported to the General Attorney from time to time.” That circumstance was not considered sufficient in the Haight case, supra, to establish the relationship of employer and employee and we do not believe tliat it should be deemed sufficient in this case.

We hold that petitioner was not an employee of the sanitary district engaged in rendering services in connection with the exercise of an essential or usual governmental function, and that he is not entitled to immunity from the Federal income tax upon the sums received.

Reviewed by the Board.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Leech:

license: Public Domain

text:
    Arthur J. Morris, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 64246.
    Promulgated October 22, 1935.

      James A. Vaughan, Esq., for the petitioner.

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

Leech:

This proceeding seeks redetermination of a deficiency of $34,769.61 for the calendar year 1929. The error assigned is the action of respondent in including in petitioner’s income for the year in question the income of five trusts created by him in favor of his wife and four daughters.

The facts are stipulated and only a brief statement of such as are necessary for an understanding of the issues will be made here.

Petitioner, at the time of the occurrence here involved, was, and is now, a resident of the State of New York. On July 1, 1926, he executed five trust instruments by which he conveyed to himself and his secretary, as trustees, five separate lots of securities. The trust instrument in each instance was substantially the same, except as to the beneficiary. The trust in each case was created for the term of five years, at the end of which time the property was to be recon-veyed to the grantor. In each instance the property was transferred to the trustees to hold “ In Trust to receive all the income thereof and after paying therefrom all lawful charges and expenses including compensation of the Trustees as hereinafter provided, to pay or apply the net income or such part thereof as the Trustees may determine upon, from such trust estate arising each year in substantially equal monthly instalments, or in such other instalments as may be deemed advisable by the Trustees ” to or for the beneficiary. The trust in each case was executed in, and the trust estates were at all times located in, the State of New York. In the case of each trust it is not disputed that gains arising from the sale of securities would not be subject to distribution but would, under the law of New York, be accumulated as part of the corpus and only the income from investments be subject to distribution to the beneficiaries. It was provided, however, in each trust, with respect to the distributable income, that “ nothing herein shall prevent the said Trustees from paying out to the beneficiaries herein contemplated only part of said income and accumulating the balance for the purpose of increasing the principal of said trust fund in such manner and in such amounts as to the Trustees may seem proper.” No power of revocation was reserved.

Upon the expiration of five years or upon the death of the beneficiary, whichever should first occur, the trustees were, under each trust, “ to pay over the principal of said trust estate as it shall then exist with all gains and increase of capital, if any, in fee simple to the Donor if he is living.”

Eeturns were filed for each of the five trusts for the calendar year here involved, reporting the net income received by each. The parties hereto are agreed as to the amount of the income received, the portion in each case represented by profit from sale of the trust corpus and the part representing the current investment income of the trust. The disputed deficiency here arises from respondent’s action in including the total income of each trust for the year in question, in petitioner’s income as taxable to him.

Respondent contends that the income in question, whether that represented by gains on disposition of capital assets of the trusts or the investment income realized by the trust estates, was taxable to petitioner under section 167 of the Revenue Act of 1928, for the reason that petitioner was vested with discretion to hold or accumulate such income for future distribution to himself. Petitioner’s position is that, as to the income represented by gains upon the sales of capital assets, the trustees had no such discretion but were required by law to accumulate such income, and, consequently, section 167 of the Revenue Act of 1928 is not applicable. As *to the investment income of each trust, petitioner argues that, notwithstanding the authority reserved to the trustees to accumulate such income as an addition to the corpus, the beneficiary in each case obtained a vested right to such income under New York law and could have enforced its distribution to her had petitioner attempted to withhold it. As to this income it is insisted that the trustees, in fact, had no authority, in the exercise of their discretion, to accumulate it for later distribution to petitioner. Actually, all of the income of this character was distributed by the trustees in each year to the several beneficiaries.

In reference to the income consisting of gains upon sales of assets included in the corpus of the several trusts, section 167 of the Revenue Act of 1928 is not applicable. Preston R. Bassett, 33 B. T. A. 182.

With respect to the investment income of these five trusts which was distributed to the several beneficiaries, we have given careful consideration to the argument of petitioner’s counsel, that the specific reservation in the trust instrument of the power in the trustees to accumulate this income for the purpose of increasing the corpus distributable to the grantor, was without effect under the laws of New York. Examination has been made of the authorities submitted by counsel and we are unwilling to conclude that under the decisions of the courts of that state, petitioner’s wife and daughters would be held to have a vested interest in this income and be entitled to enforce its distribution to them if accumulation were attempted by the trustees. The intent of the grantor of these trusts appears to be clear that these beneficiaries are to receive only such amounts as the trustees, in the exercise of their discretion, distributed to them. The record does not disclose whether the beneficiaries were of age nor is it indicated that the trust was, in any instance, for the purpose of maintenance of the beneficiary. We recognize the rule in New York State that, where the trust is created for the purpose of maintenance and the intent is clear that the income is to be used for that purpose, an attempt to limit the right of the beneficiary to receive that income, embodied in provisions granting discretion of the trustees to withhold, is, under some conditions, disregarded where the result reached by such construction does not violate the intent of the grantor that the beneficiary shall receive the entire income. Hill v. Guaranty Trust Co., 163 App. Div. 374; 148 N. Y. S. 601; In re Bavier, 164 App. Div. 358; 149 N. Y. S. 728; Curtis v. Curtis, 184 App. Div. 274; 171 N. Y. S. 510; Curtis v. Curtis, 185 App. Div. 391; 173 N. Y. S. 103; Bankers Trust Co. v. Moy, 148 Misc. 38; 265 N. Y. S. 77. The cases cited by counsel for petitioner fall within this general class, but it does not appear to us that the instant case is controlled by them. Each trust instrument here discloses that the intent of the grantor was not to give a vested interest to these several beneficiaries in the income as realized by the trustees, but only in such part of that income as the trustees, in their discretion, might distribute. It is apparent from a consideration of all of the trust provisions, that the purpose of the grantor was to retain control of the trust income to the extent of applying it for his own benefit, if he so desired.

These five trusts are the creation of this petitioner. In them he has sought to reserve powers, to himself, with respect to the trust income which, if effective, make such income taxable to him under the applicable revenue act. He now asks that we determine that, had the question of his powers as trustee under these various trusts been submitted to a New York court, its decision would have denied him the right to exercise the powers reserved. It is quite true that if these trust instruments had been submitted to the state court and reformed by the elimination of those sections granting discretionary power to the trustees, such decision would be binding on us. Freuler v. Helvering, 291 U. S. 35. The trusts, however, have not been construed by the New York courts. It does appear that the provisions in the trust instruments reserving the right in the trustees to accumulate investment income for future distribution to petitioner violate section 16 of the New York Personal Property law. This fact, however, in our opinion, does not mean that a judicial construction of the instruments would hold the primary beneficiaries entitled to trust income withheld by the trustees.

This result would follow, only, if the court’s decision voided, not only the provisions authorizing the accumulation, but also the discretionary power of the trustees to determine the amount distributable to the primary beneficiaries. But the intent of the grantor here is so clear that the trustees should have this power, that no legal reformation of this present instrument would ignore it. The result, then, would be merely to accelerate the next eventual estate, the vested remainder, and hold the remaindermen entitled now to distribution of that portion of the income unlawfully accumulated by the trustees. In re Donchain's Estate, 199 N. Y. S. 107; In re King’s Estate, 200 N. Y. S. 829; In re Kohler, 231 N. Y. 353; 132 N. E. 114; In re Hazelton’s Will, 196 N. Y. S. 333. As petitioner holds that vested remainder interest under each of the trusts, the result to him, in liability for tax upon this income, would be the same. He would have the right, as trustee, to withhold the income from distribution to the primary beneficiaries, in which event it would be distributable and thus taxable to him.

Upon the present record we hold that the disputed income derived from the investment of the trust assets is taxable to petitioner.

Judgment will be entered under Bule 50.

       Sec. 167. Income for benefit of grantor. — Where any part of the income of a trust may, in the, discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution ” deduction), such part of the income of the trust shall be included in computing the net income of the grantor.

       § 16. Validity of directions for accumulation of income. An accumulation of th*> income of personal property, directed by any instrument sufficient in law to pass sucb property is valid:
      1. If directed to commence from the date of the instrument, or the death of the person executing the same, and to be made for the benefit of one or more minors, then in being, or in being at such death, and to terminate at or before the expiration of their minority.
      $ A if ‡ * * *
      3. All other directions for the accumulation of the income of personal property, not authorized by statute, are void. In either case mentioned in subdivisions one and two of this section a direction for any such accumulation for a longer term than the minority of the persons intended to be benefited thereby, has the same effect as if limited to the minority of such persons, and is void as respects the time beyond such minority.


author: Black :

text:
    American Gas & Electric Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62604.
    Promulgated October 22, 1935.

      William H. Harding, Esq., and H. G. Kilpatrieh, Esq., for the petitioner.

      Henry A. Goa>, Esq., for the respondent.
   OPINION.

Black :

The Commissioner has determined a deficiency in income tax for the calendar year 1929, amounting to $20,791.47. The only issue is whether the petitioner and five other domestic corporations which are taxable under section 13 of the Kevenue Act of 1928 may file a consolidated income tax return for the calendar year 1929 where their common parent was an insurance company, taxable under section 204 of the same act. The facts were stipulated and there were two exhibits filed. These are a part of the record and need not be copied in this report. The material facts of the stipulation are that the petitioner is, and during the year 1929 was, a corporation duly incorporated, organized, and existing under the laws of the State of Maryland. All the stock of the petitioner and the other five domestic corporations (each of which was subject to the tax imposed by section 13 of the Kevenue Act of 1928) was owned during the taxable year by the American Equitable Assurance Co. of New York, a domestic stock fire insurance corporation which was subject to the tax imposed by section 204 of the Kevenue Act of 1928.

For the year 1929 the six corporations (including the petitioner) which were subsidiaries of the insurance company filed a consolidated return in which, and in the forms 851 and 1122 filed in connection therewith, petitioner was named as parent of the group. The insurance company filed a separate return of its income for 1929 and did not join in the consolidated return filed by the subsidiaries. On form 1122 the various subsidiary corporations named the petitioner as the parent corporation. On form 851 the petitioner, as parent, reported the amount of capital stock of each corporation outstanding and by whom it was owned. Then followed this statement :

All of the above mentioned Companies are Subsidiaries of the American Equitable Assurance Company of New York and all of the issued and outstanding capital stock is owned by the American Equitable Assurance Company of New York, but our understanding is that we cannot file a report for the Insurance Company including these Subsidiary Companies which do not do an insurance business; therefore we have selected one of the Subsidiary Companies as a Parent to the Subsidiary Group.

The respondent’s deficiency notice dated January 13, 1932, from which this appeal is taken, set forth a deficiency of $20,191.47, disallowed affiliation of the companies, and computed the tax liability of the petitioner and each of the corporations joining in the consolidated return for the year 1929 upon the basis of separate returns.

The petitioner and the respondent further stipulated that if the petitioner is not entitled under the statute to file a consolidated return with the American Bank & Trust Co. Shares, Inc., American Industrial Securities Corporation, American Mercantile Securities Corporation, Keserve Securities Corporation of America, and Central Union Securities Corporation, then the deficiency of $20,791.47 in income tax determined against the petitioner for the year 1929 is correct, but if the petitioner is entitled to file such consolidated return with said corporation there is no deficiency in income tax against petitioner.

In Corner Broadway-Maiden Lane, Inc., 29 B. T. A. 762, the Board held, in a case very similar to this, that a consolidated return was improper. That decision has been reversed by the Second Circuit in Corner Broadway-Maiden Lane, Inc. v. Commissioner, 76 Fed. (2d) 106. In its opinion the Circuit Court of Appeals distinctly decided that such a group of corporations is an affiliated group within the meaning of section 141 (d) of the Eevenue Act of 1928, and such was the decision of the Board in Travelers Indemnity Co., 81 B. T. A. 507. This latter case was decided by us after our decision in the Corner Broadway-Maiden Lane, Inc., case. Therefore it seems now to be settled that a domestic insurance company which is taxable under the provisions of section 204 of the Eevenue Act of 1928 can be the common parent of other domestic corporations which are taxable under the provisions of section 13 of that act. Although in his deficiency notice the Commissioner seems to have relied solely on his contention that a domestic fire insurance company which is taxable under section 204 cannot be the common parent, within the meaning of section 141, of other domestic corporations which are taxable under section 13, yet in the brief filed by his counsel he calls attention to article 18 of Eegulations 75, which reads in part as follows :

Ap.t. 18. Eailobe to Comply with Regulations.—
****** *
(b) Parent Incorrectly Designated in Consolidated Return.
If a consolidated return includes a corporation as the parent and such corporation was not (under the provisions of section 141 of the Act) the parent, the tax liability of each corporation included in the return will be computed in the same manner as if separate returns had been filed, unless, upon application, the Commissioner approves the making of a consolidated return, or unless under article 11 a consolidated return is required for such year.

Eespondent thus relies upon petitioner’s failure to comply with the foregoing regulation as another reason why the consolidated return should he disregarded and the tax should be computed to each corporation separately. This same regulation was quoted and relied upon as a basis in part for our decision in Corner Broadway-Maiden Lane, Inc., supra, but the Circuit Court of Appeals reversed our application of it and held that it was not applicable to the situation which we had before us in that case. We see no substantial difference between the situation which existed in the Corner Broadway-Madden Lane, Inc., case and the one we have here. In that case the common parent corporation, which was an insurance company, did not file the consolidated return, just as the common parent corporation in the instant case did not file the consolidated return.

Of course, the logical explanation of that appears to be that under the Commissioner’s regulations the real common parent corporation in each case was not permitted to file a consolidated return because the Commissioner had distinctly provided in his Kegulations 75, article 2 (b), that no domestic insurance company would be recognized as a common parent of an affiliated group.

In the Corner Broadway-Maiden Lane, Inc., case the Lawyers Trust Co., the corporation filing the consolidated return, did not designate itself in the return as the parent corporation, whereas in the instant case petitioner did designate itself as the parent corporation.. Thus there is that difference. However, it is plain that this designation was made because the corporations included in the consolidated return had interpreted the Commissioner’s regulations to mean that none but a common parent corporation would be allowed to file the consolidated return and that under the regulations, the real common parent, the American Equitable Assurance Co., would not be permitted to file the consolidated return.

Therefore, petitioner was selected to file it, but in doing so gave the Commissioner full information that it was only designated as the parent corporation as a matter of form and that the real common parent of the group was the insurance company.

Under these circumstances the Commissioner was not misled. Only the income and deductions of corporations which were affiliated under section 141 were included in the consolidated return and none of the group was left out except the insurance company, and this was because of section 141 (e), which provides that “An insurance company subject to the tax imposed by section 201 or 204 shall not be included in the same consolidated return with a corporation subject to the tax imposed by section 13.” Under these circumstances we think there has been a substantial compliance with the law and the Commissioner would not have the right, by reason of anything said in article 18 (b) of his Kegulations 75, to throw out the consolidated return which was filed and compute petitioner’s tax for the taxable year on the basis of a separate return. On this point compare the latter part of the court’s opinion in Corner Broadway-Maiden Lane, Inc. v. Commissioner, supra. It is plain that, on the theory that a domestic insurance company can be the common parent of an affiliated group within the meaning of section 141, (and we so decide in this proceeding, following the authorities which we have cited), some parts of the Commissioner’s regulations are contrary to the statute.

Decision will be entered for the petitioner that there is no deficiency.


author: Murdock: Smith,

text:
    Marjory Taylor Hardwick, Petitioner, v. Commissioner of Internal Revenue, Respondent. Elizabeth Taylor Ely, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76545, 76546.
    Promulgated October 22, 1935.

      Virgil T. Moore, Esq., for the petitioners.

      Arthur Carndu/f, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined deficiencies in income tax for the year 1930 as follows: Marjory Taylor Hardwick (Docket No. 76545), $4,932.88; and Elizabeth Taylor Ely (Docket No. 76546), $5,183.66. The only issue between the parties is whether the Commissioner erred in disallowing to each petitioner a loss on the sale of stock of the Tubize Chatillon Co. which they made in 1930 to the Anelma Corporation. The facts have been stipulated.

Each petitioner owned in 1930, 1,500 shares of the stock of the Tubize Chatillon Co. (hereinafter called Tubize) having a basis for gain or loss of $19,950. Roland L. Taylor, the father of the petitioners, owned 90,606 shares of the stock of Tubize. The petitioners and their father caused the Anelma Corporation (hereafter called Anelma) to be organized shortly prior to December 30, 1930. Each of the petitioners subscribed for 50 shares of the stock of Anelma and paid $5,000 therefor to the corporation. They received appropriate stock certificates. Their father subscribed for 2,960 shares of that stock. He paid $296,000 to the corporation for his stock and received appropriate certificates. No other shares of Anelma were issued or outstanding. The petitioners and their father made a written offer on December 30, 1930, to Anelma to sell their shares of Tubize stock to Anelma at $3.25 per share. That was the market price of the stock on the New York Curb Exchange at the close of business on December 29, 1930. Anelma accepted the offer. The sellers delivered 93,606 shares of Tubize stock to Anelma. The latter paid each of the petitioners $1,815 and paid Taylor $294,469.50. The Commissioner disallowed the loss which the petitioners claimed on account of the sale of their Tubize stock to Anelma. He explained that the loss was disallowed because “the transaction falls within the provisions of section 112 (b) (5) of the Revenue Act of 1928.”

Section 112 (b) (5) of the Revenue Act of 1928 provides:

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in; exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but 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.

It is at once apparent that the above section does not cover the present case. The petitioners did not transfer Tubize stock to Anelma solely in exchange for stock or securities in that corporation. The parties have stipulated that the petitioners sold their Tubize stock to Anelma for cash. The petitioners have thus made out a prima facie case entitling each of them to deduct as a loss $15,075, the difference between the amount realized by each from the sale and the basis which the stock had in the hands of each petitioner.

There may be bona fide sales between a corporation and its stockholders which will give rise to gain or loss. David Stewart, 17 B. T. A. 604; Fruit Belt Telephone Co., 22 B. T. A. 440; Edward Securities Corporation, 30 B. T. A. 918; A. S. Eldridge, 30 B. T. A. 1322; A. B. Glancy, Inc., 31 B. T. A. 236; Budd v. Commissioner, 43 Fed. (2d) 509; Commissioner v. Van Vorst, 59 Fed. (2d) 677; Jones v. Helvering, 71 Fed. (2d) 214; certiorari denied, 293 U. S. 583. If there was any fraud connected with the organization of this corporation or any lack of bona fides in the sale, such facts may not be inferred from this record, but should have been alleged and proved by the Commissioner. David Stewart, supra; Corrado & Galiardi, Inc., 22 B. T. A. 847; Budd v. Commissioner, supra; Edward Securities Corporation, supra. Full face value must be given to these transactions in accordance with the stipulation of the parties. Furthermore, the fact should be noted that the sales were at market value, which indicates that there was a real loss and that no undue advantage was taken by reason of the fact that the sellers controlled the purchaser corporation. There is no reason to infer that Anelma was created solely for the purpose of making this purchase. It owned the Tubize stock and had a cash balance after the transaction. It may liave continued and it may have had many other transactions. The inference that it was created solely for the purpose of this particular sale can not be fairly drawn from the record. The respondent has stipulated that the petitioners purchased their stock of Anelma for cash. It can not be said that there was no substance to that purchase. Edward Securities Corporation, supra; Helvering v. Gregory, 69 Fed. (2d) 809; affd., 293 U. S. 465; J. Hampton Hoult, 24 B. T. A. 79; dismissed, 59 Fed. (2d) 1055; Minnie C. Brackett, Administratrix, 19 B. T. A. 1154; affirmed without opinion by the Seventh Circuit April 21, 1931. Apparently the Commissioner would argue that in substance each of the petitioners exchanged $125 in cash and her Tubize shares for 50 shares of Anelma stock. But the stipulation shows that the facts are otherwise. The general rule of section 112 (a) applies to this transaction. Minnie C. Brackett, Administratrix, supra; J. Hampton Hoult, supra; James E. Wells, 29 B. T. A. 222. None of the exceptions contained in section 112 applies. Cf. William H. Mullins, 14 B. T. A. 426. This would perhaps be more clear to the Commissioner if the sale here in question had been made at a profit. Under such circumstances he would probably not argue that the gain would not be recognized because the transaction fell within section 112 (b) (5). Cf. Minnie C. Brackett, Administratrix, supra.

Reviewed by the Board.

Decision will he entered wider Bule SO.

Smith,

dissenting: Section 112 (b) (5) of the Revenue Act of 1928 specifically provides that, where “ property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation ”, no gain or loss shall be recognized.

The substance of the transaction involved in these proceedings is that the petitioners and their father transferred shares of Tubize Chatillon Co. stock and cash to the Anelma Corporation in exchange for all of the shares of that company. The cash and shares paid in to the Anelma Corporation by the petitioners constituted property.” The number of shares received by each was substantially in proportion to his or her interest in the property prior to the exchange. In my opinion the petitioners sustained no deductible loss from the transaction.

In Weiss v. Stearn, 265 U. S. 242, it was stated that “ when applying the provisions of the Sixteenth Amendment and income tax laws enacted thereunder we must regard matters of substance and not mere form.” I think the above cited rule is applicable in these proceedings- The petitioners, with their father, owned all the shares of stock of the Anelma Corporation. All of the assets of that corporation at the close of December 30, 1930, had been contributed by the petitioners and their father. I do not regard the payment of $4,875 to the corporation by each of the petitioners and the payment by the corporation to the petitioners of the same amount of money on the same day as anything more than form. The deficiencies found by the respondent should be approved.

ARUndell, Mellott, and Arnold agree with this dissent.


text:
    Ida Stephenson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62825.
    Promulgated October 22, 1935.

      M. J. Arnold, Esq., and B. S. Oozby, Esq., for the petitioner.

      P. A. Bayer, Esq., and R. B. Gannon, Esq., for respondent.
   OPINION.

Black :

Petitioner’s only contention is that the respondent erred in adding to her net income the above described net amount of $55,328.01. She contends that the three items of income and the deduction making up this net amount were the income and deduction of the estate of L. L. Stephenson, deceased, and were correctly reported by petitioner as independent executrix on the fiduciary return, form 1041.

The respondent’s position is contained in the opening statement and oral argument of his counsel, made in place of a brief. In his opening statement counsel said:

Of course, it is our position that the petitioner and her husband owned certain property as community property. When the husband died she was the sole beneficiary named in the will, and having first of all one-half of the community property, and having inherited the second half, subject to any debts, I assume that she owned the entire property, and that the income from the property is the income of the petitioner.

In support of the above stated position, counsel for the respondent in his oral argument cited as authority articles 3662, 3449, and 3436 of Vernon’s Annotated Texas Statutes, and Parks v. Knox, 61 Tex. Civ. App. 493; 130 S. W. 203. These articles are as follows:

Aar. 3662. (3593) (2220) (2165) Where there is no child.
Where the husband or wife dies intestate, or becomes insane, having no children, and no separate property, the common property passes to the survivor, charged with the debts of the community; and no administration thereon or guardianship of the estate shall be necessary.
Art. 3449. (3376) (2009) (1956) Administration under will.
The administration of an estate under a will shall in all respects be governed by the provisions of the law respecting the administration of intestates’ estates, except where it is otherwise provided by law or by the provisions and directions of the will.
Art. 3436. (3362) (1995) (1942) Testator may provide that no action he had in court, eto.
Any person capable of making a will may so provide in his will that no other action shall be had in the county court in relation to the settlement of his estate than the probating and recording of his will, and the return of an inventory, appraisement and lists of claims of his estate.

Under the above articles the respondent contends that no administration of the decedent’s estate was necessary or in fact took place; that therefore there was no “ Income received by estates of deceased persons during the period of administration or settlement of the estate ” as that clause is used in section 161 (a) (3) of the Revenue Act of 1928; that there was no net income of an estate to be computed under section 162, no tax to be paid by the fiduciary under section 161 (b), and no return to be filed under section 143, all of the Revenue Act of 1928; that the three items of income and the one item of deduction for interest paid that were reported on form 1041 should have been reported in petitioner’s own individual return; and that, under section 23 (c) of the Revenue Act of 1928 and article 154 of Regulations 74, petitioner was not entitled to deduct on her own individual return the state inheritance and Federal estate taxes paid in the total amount of $55,328.01.

Petitioner is not contending that she is entitled to deduct the state inheritance and Federal estate taxes amounting to a total of $55,328.01 in her individual income tax return. She concedes that under section 23 (c), supra, such taxes are “ allowed as a deduction only to the estate.” She merely contends that certain income which the respondent has determined to be her income was in fact and in law the income of the estate, so that the estate would have income from which such taxes could be deducted.

Since the decedent herein died testate rather than intestate, since he was not insane, and since he and the petitioner had two minor children and an adopted daughter at the time of his death, we fail to see wherein article 3662, supra, is at all applicable to this case. Of course, it is the respondent’s contention that, since article 3449, supra, provides that except for certain stated provisions the administration of an estate under a will shall be governed by the “ law respecting the administration of intestates’ estates ”, it is the last clause of article 3662 that is applicable here. We doubt very much the correctness of this contention for the reason that the estate here in question was being administered by an independent executrix. See Stevenson v. Roberts, 25 Tex. Civ. App. 577; 64 S. W. 230, 234. In that case the court, after quoting in full article 3449 (then art. 2009, Rev. Stat.), said:

It is doubtful if this provision was intended to apply to independent executors. It appears rather to be intended ¡to apply to a judicial administration by an administrator under the will, or by an executor without independent powers.

In any event, we are clearly of the opinion that there was an “ administration ” of the decedent’s estate within the meaning of that term as used in section 161 of the Revenue Act of 1928. Todd v. Willis, 66 Tex. 704; 1 S. W. 803; Garrett J. Donnelly et al., Executors, 31 B. T. A. 577. In the Todd case the Supreme Court of Texas said:

We have no doubt that the management of the estate of a deceased person, and the disposition of property by executors acting under a will which withdraws the estate from the general control of a probate court, is to be deemed, within the meaning of the law, an “ administration.”

We have examined Parks v. Knox, supra, and find nothing therein which is contrary to our holding in the Donnelly case, supra, which was exactly in point with the instant case.

It only remains for us to decide whether the estate of L. L. Stephenson, deceased, was in process of administration until at least the close of December 31, 1929, and whether the three items of income and one item of deduction for interest paid were the income and deduction of the estate or the income and deduction of petitioner in her individual capacity.

We think the evidence clearly shows that the estate was in process of administration until at least the close of December 31, 1929. At that time the lawsuits in causes numbered B-47878, 33796, and 8585 were still pending and the $100,000 in bonds deposited in escrow on April 17, 1929, by Ida Stephenson individually and as independent executrix of her deceased husband’s estate had not then been released and were not in fact released until about April 4, 1930. We therefore find as a fact that the estate of L. L. Stephenson, deceased, was in process of administration or settlement until at least the close of December 31, 1929.

We come now to the more troublesome question of fact as to whether the evidence offered by petitioner proves that the three items of income and one item of deduction for interest paid were in fact the estate’s income and deduction rather than petitioner’s. The respondent has determined that the net amount of these four items, namely, $55,328.01, was taxable to petitioner in her individual capacity, and the burden of showing otherwise is on the petitioner. Wickwire v. Reinecke, 275 U. S. 101.

The theory of petitioner is that there was an estate in process of administration during the taxable year (and on this point we have sustained petitioner); that the property which was owned by L. L. Stephenson and his wife, Ida Stephenson, prior to his death was community property in which each owned a one-half interest and upon the death of L. L. Stephenson, his estate continued to own his one half of the property and Mrs. Stephenson owned her one half; that during the taxable year petitioner, in her individual capacity and as independent executrix of her husband’s estate, partitioned the property, distributing one half thereof to herself and one half to the estate; that she returned on her individual income tax return the income from the one half of the property which was distributed to her as an individual and on the fiduciary return which she filed for the estate she reported the income from the property which was partitioned to the estate; and that, after giving effect to certain deductions, the remainder of the income partitioned to the estate, amounting to $19,357.63, was distributed, to petitioner as the sole beneficiary of the estate and returned by her on her individual income tax return.

There seems to be no doubt that under the laws of Texas an independent executor has the right to make such a partition. The case of Parks v. Knox, supra, holds as follows:

Being authorized by will to administer independently of the probate court, the executors could determine for themselves when they would surrender their rights and powers over the estate to the distributees.
Where executors are empowered to act independently of the probate court, they may close the administration, or surrender all or any portion of the property to the heirs or devisees, without the formality of judicial sanction, and the same legal consequences follow.

Was there such a partition made as the petitioner claims? We do not think the evidence is sufficient to establish such a partition. The stipulation which has been filed does not show any partition. The only witness who testified concerning the alleged partition was E. G. Hendrix, accountant and business manager of both the estate and petitioner. He testified: “We assigned certain of those properties to her (Mrs. Ida Stephenson as an individual) and certain of them to the estate.” On cross-examination the following questions and answers of the witness relating to the above testimony appear:

Q. How was that done?
A. By segregating them and keeping them separate in the books.
Q. In other words, the only segregation as I understand it, is on this book which you have in your lap at the present time, is that right?
A. Segregation of the properties, yes sir.
Q. Did anybody else know anything about that besides you and Mrs. Stephenson ?
A. No, and the attorney.
Q. So that when you have been referring to partitions here during your direct examination, what you meant was that an account was opened in this book in which certain assets were listed as being estate assets, is that right?
A. Correct.

From, a careful review of all the evidence we conclude that what was actually done was substantially this: The estate was a large estate, thoroughly solvent, and there was no need for the independent executrix to retain in the estate all the decedent’s interest in the community property, so she distributed certain of the property, bonds, notes, etc., to herself as an individual. This she had a right to do, being the sole legatee and devisee under the will. The income from the property thus distributed is not in controversy here. Certain other of the community property was not distributed during the taxable year. The estate owned a one-half interest in this property and Mrs. Stephenson owned the other half.

The instant case is distinguishable from that of Garrett J. Donnelly et al., Executors, supra. In that case the decedent, A. M. Donnelly, and his wife, Catherine, owned as community property 5,373% shares of stock in the Eastland Oil Co. After Donnelly’s death, the stock was divided and certificates were issued for 2,686% shares to Catherine Donnelly and 2,686% shares to her as executrix of the estate of A. M. Donnelly, deceased. Under those circumstances we held that the dividends on the 2,686% shares belonging to the estate were not taxable to Catherine Donnelly in her individual capacity. As we have already pointed out, we can not hold under the evidence in this case that there was any such definite partition of the assets as there was in the Donnelly case. Therefore the resulting taxation is not the same.

We therefore find as ultimate facts that the item of interest amounting to $30,379.71, reported -as item No. 2 on form 1041, was the total interest received between January 19, 1929, and December 31, 1929, on community property or on the investment of the proceeds from such property owned by decedent and his wife at the time of his death and in which the estate still owned a one-half interest; that the item of dividends, amounting to $44,300.64, reported as item No. 7 on form 1041, was the total dividends received between January 19, 1929, and December 31, 1929, on community property or on the investment of the proceeds from such property owned by decedent and his wife at the time of his death and in which the estate still owned a one-half interest; that the item of other income amounting to $8.65, reported as item No. 8 on form 1041, was one half of an insurance dividend received between January 19, 1929, and December 31, 1929, on community property owned by decedent and his wife at the time of his death; and that the other one half of the insurance dividend just referred to was reported by petitioner in her individual return, form 1040. Ho evidence was offered with respect to the item of interest paid in the amount of $3.36, reported as item No. 10 on form 1041.

The conclusions we reach from the findings set forth in the previous paragraph are that the respondent erred in increasing petitioner’s net income taxable at normal and surtax rates by one half of $30,379.71, plus one half of $44,300.64, plus $8.65, or a total amount of $37,348.82. The evidence offered by petitioner proves to our satisfaction that this total amount of $37,348.82 was properly the income of the estate of L. L. Stephenson, deceased. Under sections 161, 162, and 143 of the Revenue Act of 1928, we think petitioner, as independent executrix, was not only entitled, but was required by law, to file a return for the estate and report therein the said amount of $37,348.82, from which she was entitled to take allowable deductions.

Decision mil Toe entered under Buie 50.


author: MoRRis:

text:
    Leo Propper, Petitioner, v. Commissioner of Internal Revenue, Respondent. Bernard Kahn, Petitioner, v. Commissioner of Internal Revenue, Respondent. Samuel Kahn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 57672, 57673, 57806.
    Promulgated October 23, 1935.

      John E. Hughes, Esq., Norman P. S..Schloss, Esq., and Ohairles Kurz, G. P. A., for the petitioners.

      Ralph E. Smith, Esq., for the respondent.
   OPINION.

MoRRis:

There is no dispute over the cost basis to be used in the determination of gain or loss to these petitioners growing out of the transaction set forth hereinabove. Nor is there any dispute respecting inclusion of the cash, bonds, and real estate in such determination. Hence, the only question for our determination is whether or not the shares of the Delaware corporation, some under a 5-year restriction and some under a 90-day restriction upon sale, to the extent of their value as we find it from the record, should be included in the determination of gain or loss under section 112(c) of the Revenue Act of 1928, which both parties agree is controlling, differing only in the interpretation of the terms thereof.

Seo. 112. (a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) Exchanges solely in kind.—
Hi H* ❖ H* H* Hj H*
(3) Stock for stock on reorganization. — 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.
* Hi * * * * *
(c) Gam from exchanges not solely m kind.-—
(1) If an exchange would, be within the provisions of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
‡ sjt ‡ ‡

The parties are in agreement that the transaction in dispute falls within the exception to the general rule laid down in section 112, supra, but “What the petitioners challenge is the method of computation.” The petitioners argue that the “Respondent computes the gain by deducting the cost or other basis of the old stock from the total proceeds, including in the proceeds the new stock in the reorganized company. Then respondent applies the limitation referred to, in determining the taxable gain. Petitioners, on the other hand, contend that if the gain is to be effectively limited to the proceeds, other than the new stock, the stock must be excluded from the computation altogether, such exclusion being necessarily implied by the limitation, and by the statutory policy of permitting stock in reorganizations to be received without the recognition of gain.”

Under the general rule of section 112, gain or loss is recognized upon every sale or exchange. Certain exceptions to that rule are set forth and, under (b) (8), if the exchange of stock is “solely” for stock, no gain or loss shall be recognized. The statutory exception is modified where the exchange is not restricted to the exchange of stock for stock but involves money and other property, and in subdivision (c) of section 112 we find provision for the recognition of the gain, but in an amount not in excess of the sum of the money and the fair market value of the other property. The gain in such a transaction is necessarily the difference between the cost or other basis of the old stock and the fair market value of all the proceeds received in exchange therefor. The value of the new stock is used merely as a means of comparison under the statute, that is, to determine by such comparison what the actual profit is in order to then determine whether such profit is more or less than the limitation placed upon the amount of profit to be taxed. The interpretation contended for by the petitioner would render the limitation meaningless, for, if the fair market value of the new stock does not enter into the computation, the gain could not possibly exceed the sum of the cash and the fair market value of the other property.

The petitioners argue that, in any event, the 46,400 shares should be excluded from the determination, since because of the 5-year restriction placed upon their sale they had no fair market value, or if they had any fair market value such was not more than $100,000.

The respondent has determined a value of $21 a share and his determination is prima facie correct until overcome by preponderating evidence. To sustain the burden of proof the petitioners have relied upon expert testimony, from which we may, if satisfied with the conclusions drawn, find that (1) the stock had no fair market value whatsoever, or that (2) its fair market value was merely nominal ”, varying from $1.50 to $3 a share.

The majority of the witnesses testified that the stock had no fair market value whatsoever and the others more or less reluctantly testified to a nominal value, both groups giving as the principal reason for their conclusions the fact that the stock was restricted. A similar proposal was made in T. W. Henritze, 28 B. T. A. 1173, where we rejected the contention that stock containing a restrictive clause was without fair market value, saying:

A contractual obligation assumed by the recipient of shares not to exercise an owner’s right of sale does not as a matter of law establish the absence of fair market value. Newman v. Commissioner, 40 Fed. (2d) 225; rehearing denied, 41 Fed. (2d) 743; certiorari denied, 282 U. S. 858; Henry B. Parker, 11 B. T. A. 1336, 1350; H. H. Champlin, 28 B. T. A. 264; Tex-Penn Oil Co., 28 B. T. A. 917. The restrictive provisions, although stamped upon the share certificates are not inherent attributes of the shares. Between the corporation and the shareholder exist all of the normal legal incidents of such a relation. The restriction deprives the shareholder of none of his rights qua shareholder and adds nothing to either the rights or duties of the corporation. Held, for example, by a trustee prohibited by the trust to sell, they would nevertheless have full market value. Like any other property, such as land, buildings or chattels, they may have substantial fair market value despite a local or temporary obstacle to their cash realization by the one who happens to own them at a given time.
The very purpose of the restriction in this instance is shown by the evidence to be for the protection and enhancement of value rather than its destruction. The hypothesis of fair market value is the existence of willing seller and willing buyer, and it is a manifest anomaly to attempt an ascertainment of what a willing seller would take in respect of property which by reason of a voluntary contractual inhibition he has made himself unwilling to sell. Oould it be said, for example, that one who receives as compensation for services a marketable railroad bond, with the agreement with his employer that he will not sell it for a year, has received nothing of fair market value? Cf. Harry B. Hurd, 12 B. T. A. 368; H. L. Carnahan, 21 B. T. A. 893. Instances of wide diversity come to mind which would make the statute incredibly vulnerable. It has been held in other connections that taxpayers may not, by private contracts or definitions, determine their income tax liability. Lucas v. Earl, 281 U. S. 111; Mitchel v. Bowers, 15 Fed. (2d) 287; certiorari denied, 273 U. S. 759; Phelps v. Commissioner, 54 Fed. (2d) 289; certiorari denied, 285 U. S. 558. And the doctrine is, we think, applicable to a contractual restriction upon the sale or disposition of income received. The petitioners’ point, therefore, that because of the restrictive clause upon the shares they were without fair market value, is rejected.

We must, therefore, reject the contention that these shares had no fair market value. See also Tex-Penn Oil Co., 28 B. T. A. 917.

Nor can we, upon the record, sustain the contention that only a nominal value should be assigned. Nearly all of the witnesses were reluctant to attach any fair market value to the restricted shares, notwithstanding the unrestricted shares were selling on the New York Curb Exchange at $33 a share. Their sole reason for assigning only a nominal value was substantially the same reason that they gave for declaring that the shares had no fair market value whatsoever. Three bank officials testified that the stock had no “ collateral ” value for loan-making purposes. Obviously this testimony is of little assistance in determining the fair market value. Another witness, a “ statistician ” and “ customers’ man ”, testified that the 46,400 shares, subject to restriction, sold in bulk, all or none, would bring about $100,000 irrespective of what the balance sheet of the company might have shown at that time. In other words, his testimony was influenced by the restriction exclusively upon sale. So that we can give very little credit to this witness’ testimony. One witness, a stock broker, testified to a value of from $2 to $3 a share, subject to the restrictions. While admitting that other factors than the restriction placed upon the stock, such as the ability of the officers of the corporation, the state of their health, the stability of the concern itself, and the condition as shown by the balance sheet, should be considered, he admitted that he knew nothing about those factors. His answer, he further admitted, was based purely upon the restriction. Considering all of the testimony of the witnesses, giving full force and effect to their experience and fitness to testify upon the subject matter in controversy, we are of the opinion that the evidence adduced' fails to overcome the correctness of the respondent’s determination, which we find ourselves impelled to sustain.

The petitioners appear to have abandoned the third issue. At any rate there is no evidence from which we can determine the amount of surplus available for dividends, which is quite necessary if the respondent’s determination of that issue is to be answered. Cf. John S. Woodard, 30 B. T. A. 1216.

Judgment will he entered u/nder Rule 50.


author: Smith :

text:
    Security Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57090.
    Promulgated October 24, 1935.

      Olaude I. Parker, Esq., and John B. Millikan, Esq., for the petitioner.

      Ralph E. Smith, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of deficiencies of $93,353.10 and $106,111.80 in income tax for the years 1927 and 1928, respectively.

The question in issue is whether profit which was derived by a member of an affiliated group from the sale of stock of another member of the group, where the stock in question was acquired in the form of stock dividends and the sale did not break the affiliation, is taxable.

The facts are contained in a signed stipulation of the parties. They may be briefly summarized as follows: The Security Trust & Savings Bank (hereinafter sometimes referred to as the bank) is a California corporation, organized in 1889. The petitioner, Security Co., is a securities affiliate of the bank. It is a California corporation, incorporated December 18, 1922, with its principal place of business at Los Angeles. It was incorporated “ for the purpose of engaging in certain undertakings which are closely connected with and incidental to, but not technically within, the field of banking activities.” It was affiliated throughout the years 1927 and 1928 with the bank and with the bank filed consolidated returns for those years, and tax liability has been computed by the respondent upon a consolidated basis.

The entire outstanding capital stock of the petitioner has at all times been held by trustees for the benefit of the stockholders of the bank, and throughout the years 1927 and 1928 each outstanding certificate representing a share or shares of the capital stock of the bank was endorsed as follows:

Under the terms of a certain Trust Agreement dated July 1, 1922, between the Security Trust & Savings Bant, party of the first part, and J. S'. Sartori and others as Trustees, party of the second part, and William H. Allen, Jr., and others as stockholders of the said bant, parties of the third part, the registered holder of the share or shares of stoct of the Security Trust & Savings Bant represented' by this certificate of stoct is the owner of a beneficial interest in the capital stoct of the Security Company, a corporation organized pursuant to said agreement, from time to time held by the Trustees under said agreement rateably with all other stoctholders of the said bant who have a beneficial interest in the capital stoct of the said Security Company; the said beneficial interest is transferable only by the transfer on the boots of the said bant of the shares of stoct represented by the within certificate of stoct, and any transfer of said stoct carries with it a proportionate beneficial interest in the stoct of the Security Company.

Under the declaration of trust the original capital of the petitioner was provided by a special dividend from the bank, to which the stockholders waived claim. The declaration of trust further provided that:

* * * any other or further special dividends, whether cash dividends, or stock dividend's, which may be in the future declared by the Board of Directors of the said bank for the purpose of supplying additional capital or surplus of the Security Company, may likewise be paid to the said trustees, and to this end the stockholders hereby assign and transfer to the trustees all their right, title and interest in and to said other or further special dividends declared for such purpose, and do empower and’ direct the bank to pay any such dividend or dividends to the trustees for such purpose.

In conformity with the provisions of the trust agreement, the bank declared and distributed several stock dividends, among which the following only are involved in the proposed income tax deficiencies for the years 1927 and 1928:

Date of distribution Shares distributed
December 28, 1925_2, 500
April 1, 1927_2,250
May 2, 1927_5,000

These stock dividend shares of the bank were issued to the aforesaid trustees after first endorsing thereon the legend set out above and the trustees immediately transferred such stock dividend shares to the petitioner. The petitioner in turn issued shares of its capital stock to the trustees, in whom the legal title to such shares of petitioner has at all times been vested in conformity with the provisions of the trust agreement.

During 1927 and 1928 petitioner sold certain of the stock dividend shares of the bank (endorsed with the legend provisions referred to). The stipulation provides :

If the sale by petitioner, as a member of the affiliated group, of shares of the capital stock of its affiliate, the Security Trust & Savings Bank (with aforesaid legend endorsed thereon) which shares were received by petitioner pursuant to the trust agreement dated July 1, 1922', was such a transaction as gave rise to the receipt of taxable income, then the amount thereof for each of said years is as follows:
For the year 1927_$645, 275. 30
For the year 1928_ 650,151. 36

Taxable profit in the amount of $217,934.75 was reported by petitioner for the year 1927 with respect to the sale of Security Trust & Savings Bank stock, endorsed as aforesaid, a part of which represented profit on shares purchased from and sold to the public, and a part profit on the sale of the stock dividend shares.

Certain issues raised by petitioner have been settled by stipulation of the parties. The petitioner admits liability for income tax upon the profit realized by it from the sale of shares of stock of the bank purchased by it from the public, and by it sold to the public.

It is the contention of the petitioner herein that the sale fcy it of the stock dividend shares of its affiliate, the Security Trust & Savings Bank, was a capital transaction in the stock of another member of the affiliated group, and therefore, could result in no taxable income. In support of this contention it cites United Drug Co. v. Nichols, 21 Fed. (2d) 160; Farmers Deposit National Bank, 5 B. T. A. 520; H. S. Crocker Co., 5 B. T. A. 531; Interurban, Construction Co., 5 B. T. A. 529; Liberty Agency Co., 5 B. T. A. 118; Baker-Vawter Co., 7 B. T. A. 594; John Scowcroft & Sons Co., 18 B. T. A. 532; Ohio Central Telephone Co., 28 B. T. A. 96.

The Board cases mentioned above were cited upon the theory that an affiliated group constitutes a unit which for income tax purposes is to be regarded as a single taxpayer. Since the decision of the Circuit Court of Appeals for the Seventh Circuit in Commissioner v. Van Camp Packing Co., 61 Fed. (2d) 596, this Board has reversed its position upon this subject. Thus, in James McCutcheon & Co., 30 B. T. A. 1177, this Board said:

Inasmuch as under more recent decisions, as indicated above, affiliated corporations filing a consolidated return are not to be treated as one and the same taxpayer, but as taxpayers retaining their separate identities, and as not all dealings by the corporation in its capital stock are to be considered purely as capital transactions resulting in neither taxable gain nor deductible loss, it appears that the basis upon which our decisions in the Scowcroft and Van damp cases were reached can not be sustained.

See also Founders General Corporation, 30 B. T. A. 1256. In Founders General Corporation v. Commissioner, 79 Fed. (2d) 6, the court observed:

That the business unity which is the basis of affiliation does not permit corporate identities to be ignored as a general rule is clearly established. See Helvering v. Post & Sheldon Corp., 71 Fed. (2) 930; Commissioner of Internal Revenue v. Liberty Nat. Co., 58 Fed. (2) 57. The affiliation makes the group which files of right a consolidated return a tax computing unit but leaves the individual corporations the taxpayers. Woolford Realty Co. v. Rose, 286 U. S. 219; Commissioner v. Ben Ginsburg Co., 54 Fed. (2) 238. There would be little substance to this distinction, if for tax purposes the stock of a parent when owned by its subsidiary were to be treated, in disregard of the actual fact, the same as though it were the capital stock of the subsidiary. On the contrary, common ownership of the business by means of the requisite amount of stock ownership by the same interests to produce an affiliated group ordinarily cuts no deeper than to make taxable income computable by the elimination of certain intercompany transactions ,in determining both the profit and loss of the taxpayers to arrive fairly at the net taxable income of each. The parent’s stock is property in the hands of the subsidiary in every practical sense as much when acquired directly from the parent as it is when, acquired by the subsidiary from: outside sources. * * *

In tlie instant case it is clear that the stock dividend shares in the hands of the petitioner constituted property owned by it. It is stipu-latedL that when it sold some of these shares to the public in 1927 and 1928 it realized profits therefrom of $645,275.30 in 1927 and $650,-151.36 in 1928. Our only question is whether those profits are to be recognized for income tax. We can not see that they stand upon any different plane from profits realized from the sale to the public of any other species of property.

The petitioner points out that the Circuit Court of Appeals for the Second Circuit in Founders General Corporations. Commissioner, supra, reversed our decision entered pursuant to our opinion in Founders General Corporation, supra, and relies upon the court’s opinion in support of its contentions. The taxable year involved in that case was a fiscal year ended November 29,1928. In the course of its opinion the court stated :

* * * when Congress provided in See. iiS (2) [(a)] (12) oí the 1928 Act that the “ basis in case of property acquired by a corporation during any period, in the taxable year 1929 or any subsequent taxable year, in respect oí which a consolidated return is made by such corporation under section 141 of this Act shall be determined in accordance with regulations prescribed under section 141 (b)” the Commissioner treated such stock as this as “property” and provided in T. R. 75: Art. 34 (a) (1) (b) that the basis should “be determined and adjusted in the same manner as if the selling corporation and the issuing corporation had never been members of an affiliated group.” Even under the regulations in force during this taxable period the amount the petitioner obtained upon the sale of the stock it acquired directly from its parent in excess of what it paid the parent for that stock would be taxable income but for one thing. That circumstance is that for stock obtained from the parent there is no cost basis from which profit can be computed.
In the hands of the parent, its capital stock has no cost basis. There can be no gain or loss to it upon the original issue and sale of its own stock. See Art. 66 of T. R. 74. When the petitioner acquired the stock from its parent its basis for determining gain or loss upon its sale became that of the parent. See, Art. 603 of T. R. 74; Sec. 113 (12) of the Revenue Act of 1928 (C. 852, 45 Stat. 791). The stock, therefore, had no cost basis in the hands of the petitioner. Eor this reason the apparent profit derived by the petitioner cannot be recognized for taxation since it cannot be computed as a profit under the law and regulations then existing.

The Board is not in the same quandary in this case which the court was in in that. We have no question of a base for the purpose of computing the profits. Those are stipulated. The case is not strictly in point.

We conclude that the stipulated profits from the sales of the stock dividend shares in 1927 and 1928 are liable to income tax.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Black: Smith,

text:
    Foye Lumber & Tie Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67607.
    Promulgated October 24, 1935.

      Robert B. Hamer, Esq., for the petitioner.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Black:

In support of its assignment of error, petitioner relies upon Harris & Co. v. Lucas, 48 Fed. (2d) 187, which it contends was not overruled by the Supreme Court’s decision in Welch v. Helvering, 290 U. S. 111. The Commissioner in support of his dis-allowance of the claimed deduction relies entirely upon the decision of the Supreme Court in Welch v. Helvering, supra.

The applicable statute is section 23(a), Eevenue Act of 1928, which provides:

In computing net income there shall be allowed as deductions:
(a) Expenses. — All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *.

There can be no doubt, we think, from the facts which have been stipulated, that the $2,000 payment which the petitioner made in the taxable year to the Omaha National Bank was a necessary expense. It seems quite clear that petitioner could not have procured the particular loan which it sought without the making of this $2,000 payment and it also seems clear that this loan was absolutely necessary to the carrying on of its business. Thus the “ necessary ” provision of the statute is fulfilled. And if the court’s decision in Harris & Co. v. Lucas, supra, upon which petitioner relies, laid down the correct rule, then it seems unquestionable that the petitioner would be entitled to the deduction which it claims, for the court in that case said:

It is evident that the words “ ordinary ” and “ necessary ” in the statute are not used conjunctively, and are not to be construed as requiring that an expense of a business to be deductible must be both ordinary and necessary in a narrow, technical sense. On the contrary, it is clear that Congress intended the statute to be broadly construed to facilitate business generally, so that any necessary expense, not actually a capital investment, incurred in good faith in a particular business, is to be considered an ordinary expense of that business. This in effect is the construction given the statute by the Treasury Department by the courts.

Thus it will be seen that the substance of the Circuit Court’s opinion in the Harris & Co. case was that “ any necessary expense, not actually a capital investment, incurred in good faith in a particular business, is to be considered an ordinary expense of that business.”

The Supreme Court in Welch v. Helvering, supra, in construing an identical provision of the 1926 Act, gave a contrary construction to the statute from that which the Circuit Court had given it in the Harris & Co. case, for the Supreme Court decided that a business expense, to be deductible under this provision of the statute, must not only be a necessary but also must be an ordinary expense. On that point it said:

We may assume that the payments to creditors of the Welch Company were necessary for the development of the petitioner’s business, at least in the sense that they were appropriate and helpful. McCulloch v. Maryland, 4 Wheat. 316, 4 L. Ed. 579. He certainly thought they were, and we should be slow to override his judgment. But the problem is not solved when the payments are characterized as necessary. Many necessary payments are charges upon capital. There is need to determine whether they are both necessary and ordinary.

And then the Court went on to hold that payments made by a grain commission agent (secretary of a bankrupt corporation engaged in grain business) to the corporation’s creditors for the purpose of strengthening his individual standing and credit and reestablishing business relations with the corporation’s former customers, were not deductible from his income as “ ordinary and necessary expenses.”

While there are some differences in the nature of the facts and circumstances surrounding the $2,000 payment which petitioner made in the instant case to the bank from those in connection with the payments which Welch as an individual made to creditors of the defunct E. L. Welch Co. in the Welch v. Helvering case, nevertheless we do not think these differences would justify our attempting to draw a distinction and reach a contrary conclusion from that which was reached in the Welch case. We think that under the doctrine laid down by the Supreme Court we must affirm the Commissioner in his disallowance of the claimed deduction.

Petitioner further claims that the $2,000 payment which it made to the bank should be treated as a commission paid to secure the loan of $5,000 and therefore should be allowed as a deduction on that ground, lío citation of authorities is necessary to support the right of a business to deduct commissions properly paid in the borrowing of money in the regular course of its business. But, as we construe the facts which have been stipulated, the case we have here is not one of that kind.

The W. J. Foye Lumber Co. was a Nebraska corporation which in 1923 became insolvent and was liquidated and the liquidation paid 50 percent of the claims of creditors. One of these creditors was the Omaha National Bank and after liquidation was completed it still held an unsatisfied claim against the liquidated corporation amounting to approximately $30,000. The Foye Lumber & Tie Co. (petitioner here) was organized in 1925. It needed credit to operate its business and sought to obtain a line of credit from the bank. The bank refused unless the petitioner agreed to pay the bank, if and when its profits would justify it, in addition to interest and principal on the new loans, cash payments to amount to approximately 10 percent of the peak loan accommodations made in any one year, such payments to be made because of the losses which the bank had sustained upon the liquidation of the W. J. Foye Lumber Co. Loans were made by the bank to petitioner under this agreement in the years 1925, 1926, 1927, 1928, 1929, and 1930, but petitioner made no payments to the bank on account of the bank’s losses on the liquidated corporation.

On March 3, 1930, petitioner applied to the bank for a loan of $3,000, but the bank refused unless petitioner would pay $4,000 under its agreement, which the bank claimed was in default. Petitioner notified the bank that it would be impossible to make such a payment and finally the bank agreed to loan petitioner $5,000 provided it would make the bank a payment of $2,000, and it has been stipulated “ that said $2,000 was the first and only payment made by petitioner to said bank, pursuant to said arrangement.” Under these circumstances we do not think it can be held that this $2,000 payment was a commission relating only to the $5,000 loan which was made, but that it was a payment made which related not only to the $5,000 loan which was made March 3, 1930, but to the loans which the bank had made to petitioner in prior years and for the making of which petitioner was under certain obligations to the bank, which we have already set out.

While, as we have stated, the $2,000 payment was necessary, we do not think that under the circumstances stated, it was “ ordinary ” within the meaning of the applicable statute.

Reviewed by the Board.

Decision will be entered, for the respondent.

Smith,

dissenting: In support of its conclusion that the petitioner is not entitled to deduct from gross income of the fiscal year ended July 31, 1930, the $2,000 bonus paid in obtaining a loan of $3,000, the Board relies upon Welch v. Helvering, 290 U. S. 111. I do not think that case stands for the proposition for which it is cited. In that case Welch made payments upon debts of a corporation which had failed and of which he had been the secretary. He made these payments “ in order to reestablish his relations with customers whom he had known when acting for the Welch Company and to solidify his credit and standing.” Welch made them of his own volition. The evidence does not show that they were made in the earning of net income. The Supreme Court in the above cited case observed:

* * * Now, what is ordinary, though there must always be a strain pf constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack. * * *

I am of the opinion that the payment of $2,000 made by the petitioner during the fiscal year ended July 31, 1930, does not fall in the same category as the payments made by Welch. As shown by the stipulated facts, the petitioner was in a tight place. It had to secure a loan of $3,000 in order to continue in business. If the bank had charged it interest of $2,000 for the loan, can it be doubted that the payment of the $2,000 would be a deductible expense? Cf. Jones Syndicate v. Commissioner, 23 Fed. (2d) 833.

I do not think that it can be doubted that under the opinion of tbe Board tbe petitioner is required to pay income tax upon an amount of net income greater by $2,000 than the petitioner received from the conduct of his business. I can not believe that it was the intention of Congress that the term “ ordinary and necessary ” expenses should be so narrowly construed as to deny to a taxpayer the deduction of an amount which a taxpayer has paid to secure a loan to carry on his business. Cf. Kornhauser v. United States, 276 U. S. 145.

TRAmmell and Arttndell agree with this dissent.


text:
    John B. Hittell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70820.
    Promulgated October 24, 1935.

      John B. Hittell pro se.

      Paul D. Page, Esq., for the respondent.
   OPINION.

Mellott:

In this proceeding the petitioner contests the respondent’s determination of a deficiency in income tax in the amount of $301.26 for the calendar year 1930. The sole issue presented for our decision is whether the respondent erred in including in the petitioner’s taxable net income for the year 1930 compensation amounting to $6,600 which he received from the Board of Local Improvements of the city of Chicago in that year.

The facts were stipulated, and we adopt the stipulation as our findings of fact. For the purposes of this report, the following summary will suffice.

The petitioner, a resident of Chicago, Illinois, during the year 1930, was employed as chief street engineer of the Board of Local Improvements of that city. He had held this position continuously since December 31, 1913, his appointment being under the classified civil service of the city of Chicago. His duties were to examine estimates and plans for street improvements, inspect construction and examine various materials entering into street and alley paving, design pavements and their appurtenances, make assignments of paving inspectors, handle correspondence pertaining to this work, and attend conferences between the board and other city departments. His entire time was devoted to these duties and during the year in question he received an annual salary of $6,600. The deficiency here in dispute results from his failure to report this compensation as income in his Federal income tax return for the year 1930.

Section 9 of Article IX of the Constitution of Illinois, adopted in 1870, authorizes the general assembly of the state.' to vest the corporate authorities of cities and villages with poAver to make local improvements by special assessment or special taxation. Under an act of the General Assembly of the State of Illinois, approved April 10, 1872, in force July 1, 1872, to be found in Cahill’s Illinois Revised Statutes, 1927, p. 312, the City Council of Chicago was authorized to “ lay out, to establish, open, alter, widen, extend, grade, pave or otherwise improve streets, alleys, avenues, sidewalks, wharves, parks and public grounds, and vacate the same.” The power so given to the city council, when all or a portion of the cost thereof is to be paid by special assessment, is exercised in the maimer provided for in an act approved by the General Assembly of Illinois on June 14, 1897, entitled “An Act concerning local improvements ”, to be found in Cahill’s Illinois Revised Statutes, 1927, p. 323 et seq. The Board of Local Improvements of the city of Chicago was created under that act. The act conferred upon it the power to originate schemes for local improArements, to be paid for by special assessment or special tax either with or without a petition, and charged it with the responsibility of causing an estimate of the cost to be made, conducting public hearings after notifying the owners of the property involved, and preparing an ordinance for submission to the city council. After the passage of the ordinance by the city council, the board was authorized by the act to receive bids, make the necessary contracts, fix the time for the commencement and completion of the work, and do any other act, expressed or implied, pertaining to the execution of the work, all of which was required to be done under the direction and to the satisfaction of the board. The board was also given the power to appoint an attorney, an engineer, and such assistant attorneys, engineers, clerks, inspectors, etc., as should be necessary to carry into effect the purposes of the act. The act further provided that the costs and expenses of maintaining the board be paid by the city out of its general fund.

The question to be decided in this proceeding is whether petitioner was engaged in the performance of an essential governmental function. His employment is not denied.

The Revenue Act of 1928 (secs. 21 and 22 (a)) taxes income derived from “ compensation for personal service * * * derived from any source whatever.” The petitioner’s claim to exemption is not based upon any provision contained in this act. It rests upon the well established principle, resulting from our dual form of government, that “the instrumentalities, means and operations, whereby the states exercise the governmental powers belonging to them are * * * exempt from taxation by the United States.” Ohio v. Helvering, 292 U. S. 360, and cases cited therein. Whether any particular activity of an agency or instrumentality of a state is governmental, and thus immune from Federal taxation, “ is a question which compels consideration of the nature of the activity.” Helvering v. Powers, 293 U. S. 214.

In support of his contention that the functions performed by the Board of Local Improvements with respect to streets are not essentially governmental, the respondent cites Lyons v. Reinecke, 10 Fed. (2d) 3; Weightman v. Corporation of Washington, 1 Black. 39; District of Columbia v. Woodbury, 136 U. S. 450; Naumburg v. City of Milwaukee, 146 Fed. 641.

In Lyons v. Reinecke, supra, the Circuit Court of Appeals for the Seventh Circuit had before it the question of whether compensation received by a real estate expert for work incident to the condemnation of property for street improvements of the city of Chicago was exempt from Federal income tax. Action had been brought in the District Court of the United States for the Eastern District of Illinois to recover tax claimed to have been illegally extracted from him for the year 1920. The District Court sustained a demurrer to his declaration and such ruling was sustained by the Circuit Court.

The court, referring to the general rule that pleadings are to be construed most strongly against the pleader, held that the declaration was so indefinite and uncertain that it failed to show what work the pleader had been employed to do, or what work he did for the money received. It held that the facts, as pleaded by him, did not show whether his employment was such as to bring him within or leave him without the rule under which the compensation so received would be exempt.

The cases of Weightman v. Corporation of Washington, supra, Distinct of Columbia v. Woodbury, supra, and Naumburg v. City of Milwaukee, supra, also relied on by the respondent, all involved the negligent performance by a city of its duty to maintain and repair highways. Whether a city in maintaining and repairing highways or streets is engaged in a governmental or proprietary capacity need not here be decided, as the maintenance and repair of streets is not a local improvement and is not one of the functions performed by the Board of Local Improvements. Crane v. West Chicago Park Commissioners, 153 Ill. 348; 38 N. E. 943.

The Board of Local Improvements of the city of Chicago is “ an arm or agency of the municipal government.” People v. Faherty, 306 Ill. 119; 137 N. E. 506. “ The powers, duties, and functions of the Board * * * are confined to investigating, recommending, and supervising such [local] improvements. * * * The power to make such improvements is vested * * * in the corporate authorities.” People v. City of Rock Island, 271 Ill. 412; 111 N. E. 291.

The courts of Illinois have held that “ local improvements ” include the opening, grading, and paving of streets and alleys, curbing and guttering of streets, laying sidewalks, the construction of lateral, local or district sewers, the laying of lateral water mains, etc. City of Chicago v. Law, 114 Ill. 569; 33 N. E. 855; Palmer v. City of Danville, 154 Ill. 156; 38 N. E. 1067; Gray v. Town of Cicero, 175 Ill. 459; 53 N. E. 91; Enos v. City of Springfield, 113 Ill. 65; Payne v. Village of South Springfield, 161 Ill. 285; 44 N. E. 105.

In the instant proceeding it is unnecessary to decide whether or not dll the functions performed by the Board of Local Improvements are governmental, as the petitioner’s duties were confined to streets. If the board, as an adjunct of the city of Chicago, is performing an essential governmental function when it originates a scheme for the improvement of a street, estimates its cost, conducts public hearings, prepares an ordinance for submission to the city council, and, after the ordinance is passed by the city council, makes the necessary contracts and supervises the execution of the work, the petitioner’s salary as an employee of this board is exempt. On the other hand, if this function is proprietary or nongovernmental, his salary is subject to taxation by the Federal Government. Helvering v. Powers, supra.

A street has been defined to be a highway free for all, maintained not for private gain, but for public benefit, Carlin v. City of Chicago, 104 N. E. 905, 907; 262 Ill. 564; a public highway within an incorporated municipality, People v. Kyle, 173 N. E. 75, 76; 341 Ill. 31; a public thoroughfare or highway established for the accommodation of the public generally, Slaughter v. Meridian Light & Ry. Co., 48 So. 6, 9; 95 Miss. 251. While every street is a highway, every highway is not a street. City of Wooster v. Arbenz, 116 Ohio St. 281; 156 N. E. 210; Debolt v. Carter, 31 Ind. 355, 367. “ The fundamental idea of a street is not only that it is public, but public for all purposes of free and unobstructed passage, which is its chief and primary, but by no means sole, use.” Dillon—Municipal Corporations, 4th Ed., sec. 683, p, 811.

In Atkin v. Kansas, 191 U. S. 207, Atkin entered into a contract with. Kansas City to construct a pavement on Quindaro Boulevard in that city, and in the performance of the work required under the contract employed one George Reese and permitted him to work more than eight hours per day. Atkin was prosecuted and sentenced under the Kansas eight-hour law. He appealed to the Supreme Court .of the United States, contending that the provisions of the law deprived him of his liberty and property without due process of law. In the course of its opinion the Supreme Court said:

Tlie improvement of the Boulevard in question was a work of which the State, if it had deemed it proper to do so, could have taken immediate charge by its own agents; for, it is one of the functions of government to provide public highways for the convenience and comfort of the people. Instead of undertaking that work directly, the State invested one of its governmental agencies with power to care for it. Whether done by the State directly or by one of its instrumentalities, the work was of a public, not private, character. [Italics ours.]

See also United States v. King County, Washington, 281 Fed. 686, 688.

We are of the opinion that the above quoted excerpt from the decision of the Supreme Court in Atkin v. Kansas is controlling of the issue here presented. The powers, duties, and functions with respect to streets conferred upon the Board of Local Improvements by the statute under which it was created are incidental to, and a part of the work of, providing streets for the comfort and convenience of the people of the city of Chicago, and are essentially governmental. In performing these functions the board acted through its agent or instrumentality, the petitioner. He was its chief street engineer, a position which came under the classified civil service of the city of Chicago. His employment, which had continued for 15 years, required all of his time, and he received an annual salary.

We are convinced that petitioner was an employee of an agency of the State of Illinois engaged in the performance of an essential governmental function. The respondent reached the same conclusion under a similar state of facts. In Solicitor’s Opinion 145, 1-2 C. B. 75, he said:

The board of local improvements of tlie city is a board existing under tlie local improvement act of the State of Illinois, the members of which are appointed by the mayor and confirmed by the city council. * * * This board is an agency of the city, and its expenses, all except such as are involved in the actual construction of the improvements, are paid out of the general corporate fund of the city (citing cases) * * *. The affidavits * * * clearly and specifically indicate that the board of local improvements not only had the right to, but also actually did, direct and control the manner and means whereby the services of the taxpayers in question were performed * * *. Such affidavits also clearly establish that the board of local improvements retained and exercised the right to control the manner and means whereby the work * * * was carried on. The employment has been continuous and such, continuous employment was contemplated. The services to the city have also been practically exclusive of all other work. You are accordingly advised that the services performed by the taxpayers in the course of their employment * * * were the services of employees of a political subdivision of a State and compensation received by them in such employment is not subject to Federal income tax.

It follows that the compensation received by petitioner is exempt from the Federal income tax.

Judgment will be entered for the petitioner.