author: Black :

text:
    Huey & Philp Hardware Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92801.
    Promulgated October 24, 1939.

      Alvin H. Lane, Esq., for the petitioner.

      J. L. Backstrom, Esq., for the respondent.
   OPINION.

Black :

The only issue involved in this proceeding is whether petitioner is entitled to a deduction for a bad debt which it alleges it ascertained to be worthless and charged off during the taxable year. There is no issue as to the amount of the debt or that it was charged off during the taxable year. Petitioner originally claimed $53,741.15 as the amount of the bad debt, but now concedes that this figure should be reduced to $49,504.72.

The respondent has denied the deduction on two grounds: First, that the purchase of the real estate at foreclosure sale by the hardware company and its subsequent transfer to two newly organized corporations, the Magna Eealty Co. and Griffin Eealty Co., was all part of a plan for the reorganization of the realty company and that all the above named corporations were parties to such reorganization and that petitioner is, therefore, not entitled to the deduction which it claims; second, that even if there were no reorganization of the realty company, nevertheless the fair market value of the property in question was far in excess of what petitioner paid for it at the foreclosure sale and petitioner, therefore, did not ascertain its debt against the realty company to be worthless, as it claims.

We shall take up respondent’s first ground for disallowing the deduction. It is respondent’s contention that petitioner sustained no loss within the purview of section 112 (b) (3) of the Revenue Act of 1934. It is respondent’s contention that the $70,000 demand note executed by the Huey & Philp Realty Co. to petitioner (described in our findings of fact) was a “security” within the meaning of section 112 (b) (3) of the Revenue Act of 1934.

Section 112 (b) (3) of the Revenue Act of 1934 provides:

* * * 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.

The reorganization provisions of the Revenue Act of 1934 relied upon by the respondent are printed in the margin.

The respondent cites the following authorities in support of his contention that there was a reorganization: Burnham v. Commissioner, 86 Fed. (2d) 776; certiorari denied, 300 U. S. 683; Tiscornia v. Commissioner, 95 Fed. (2d) 678, 682; Commissioner v. Kitselman, 89 Fed. (2d) 458; certiorari denied, 302 U. S. 709; Commissioner v. Newberry Lumber Co., 94 Fed. (2d) 447; Commissioner v. Freimd, 98 Fed. (2d) 201; Karl B. Segall, 38 B. T. A. 43; E. P. Raymond, 37 B. T. A. 423; Frances M. Averill, 37 B. T. A. 485. To these authorities may be added Frederick L. Leckie, 37 B. T. A. 252.

We shall not attempt to review each of the above authorities but we have read and carefully considered them. In substance they hold that, where the bondholders of a corporation which has defaulted in its bonds form a protective committee and agree upon a plan to purchase the property of the defaulting corporation at a foreclosure sale and transfer it to a new corporation organized as a part of the plan of reorganization, in exchange in whole or in part for the new corporation’s stock or bonds or debentures, such transactions constitute a reorganization and gain or loss is to be recognized only to the extent provided in section 112.

In the first place, we doubt if the $70,000 demand note of petitioner against the realty company dated June 10, 1934, secured by a second mortgage and foreclosed upon in November 1935, can be held to be a “security” within the meaning of section 112 (b) (3), cited above. Cf. Pinellas Ice & Cold, Storage Co. v. Commissioner, 287 U. S. 462. Marjorie Fleming Lloyd-Smith, 40 B. T. A. 214.

But even if we assume that the $70,000 demand note in question was a “security” within the meaning of the quoted statute, in order for the transactions in question to be within the nonrecognition provisions of the statute in question, and the authorities above cited, petitioner must have purchased the property at foreclosure sale and transferred it to the newly organized corporations in exchange for their capital stock or securities, all as a part of a plan of reorganization previously agreed upon.

In the instant case there is no evidence of any plan to reorganize the realty company. On the contrary, certain of petitioner’s officers who were in control of its affairs at the time of the foreclosure sale testified that there was no plan of reorganization; that the hardware company simply realized that it had a loss on the realty company and under the then set-up, the loss would in all probability continue to increase; and that the hardware company decided to foreclose its second lien and purchase the property at $20,000 if no one bid the property in at a higher price than that and take its loss by charging off the remainder of its debt as a bad debt. These officers testified that at the time of the foreclosure sale, there had been no plans made to organize two new corporations and transfer the purchased property to them; that these plans were agreed upon and consummated after the foreclosure sale.

There is no evidence in the record to the contrary, such as minutes of the corporations or letters to stockholders outlining a plan of reorganization. Therefore, we conclude from the evidence that the real estate in question was not purchased by petitioner at foreclosure sale as part of a plan to reorganize the realty company, but was simply a sale and must be so treated. As a further reason for coming to this conclusion, aside from the reasons which we have already stated, petitioner apparently did not exchange the property purchased at the foreclosure sale for the stock of the two newly organized corporations. Apparently each of these two newly organized corporations was organized with a capital stock of $1,000 paid in cash by petitioner.

Subsequently the real estate on which the Minnesota Mutual Life Insurance Co. held a first mortgage lien was conveyed to the Magna Realty Co. for $850 in cash and $9,150 deferred payments secured by a second mortgage and subject to the first mortgage held by the Minnesota Mutual Life Insurance Co. In the same maimer and for the same consideration, petitioner conveyed to the Griffin Realty Co. the real estate upon which the Praetorians held a first mortgage lien.

It is not necessary for us to decide whether the conveyance to the two newly organized corporations by petitioner of the real estate purchased by it at foreclosure sale was one in which gain or loss is recognized or is one in which gain or loss is postponed, either because of the reorganization provisions of section 112 of the Revenue Act of 1934 or of section 112 (b) (5) of the same act. Apparently there was neither gain nor loss to petitioner in these transactions with the two newly organized corporations in any event, because it appears to have conveyed the properties to the newly organized corporations for exactly what it paid for them at the foreclosure sale. But we have not that question before us.

As we have already stated, the only question which we have before us to decide is whether or not petitioner is entitled to the deduction of a debt which it alleges it ascertained to be worthless in the taxable year and charged off. In line with what we have said above, we hold that it is so entitled unless it is precluded from doing so by reason of the second reason assigned by the Commissioner in his deficiency notice.

The statute which authorizes a taxpayer to take a deduction for a debt ascertained to be worthless and charged off in the taxable year is section 23 (k) and is so familiar that it need not be quoted. Article 23 (k)-3 of Regulations 86, dealing with the phase of the question which we have here to decide, is in part printed in the margin.

The petitioner contends that, under the doctrine promulgated by the Supreme Court of the United States in Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216, the sale price at foreclosure is conclusive proof as to the fair market value of the property at the time of sale, and that no independent inquiry as to fair market value of the property at such time is permissible. We do not think the Supreme Court went as far in the Midland Mutual Life Insurance Co. case as petitioner contends, but we do not think it is necessary for us to decide how far it went in this respect.

At the hearing, evidence was admitted from both parties as to the fair market value of the property in question. Upon a weighing of that evidence we have found that the fair market value of the property in question at the time of sale was the $20,000 which petitioner bid for it, plus the amounts of the outstanding first mortgages against it. We consider that it is unnecessary to discuss this evidence in detail. It is simply an ordinary instance where witnesses differ in their opinion as to value and it is unnecessary to believe that any of them testified in bad faith. We simply conclude that the usual, presumption that the bid price at the duly advertised public sale represented the fair market value of the property at that time, coupled with petitioner’s evidence at the hearing as to value, discharges its burden of proof in that respect and justifies our above finding as to its fair market value. Therefore, petitioner’s basis for gain or loss on the future sale or exchange of the property was the purchase price paid for it at the foreclosure sale.

Petitioner will, of course, not be entitled to have any of the $49,-504.72 that is charged off as a bad debt carried forward as a part of its cost basis of the property, as would have been the case if we had held that the transactions showed a reorganization and petitioner could not take its bad debt deduction because of section 112 (b) (3). Petitioner is now getting a deduction for this $49,504.72 bad debt loss and as a matter of course can not use it as a part of the cost of the real property purchased at the foreclosure sale for the purpose of determining gain or loss or depreciation on the property in the future. We, therefore, hold that petitioner is entitled to a deduction of $49,504.72 as a debt ascertained to be worthless and charged off during the taxable year.

Decision will be entered, wider Bule 50.

       Sue. 112. (g) Definition of Reobganization. — As used in this section and section 113—
      (1) The term “reorganization” means * * * (B) the acquisition by one corporation in exchange solely ior all or a part of its voting stock: of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. * * *
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.

      (h) Definition of Conteol. — As used in this section the term “control” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

       * * * If mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. In addition, if the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. * * *


source: Caselaw Access Project

author: Lbeci-i :

license: Public Domain

text:
    Benjamin R. Britt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91568.
    Promulgated October 24, 1939.

      Robert A. Littleton, Esq., for tbe petitioner.

      D. D. Smith, Esq., for the respondent.
   OPINION.

Lbeci-i :

The first question involves the proper basis for computing petitioner’s gain on the redemption of the United Carbon Co. stock held by him. The transactions, as a result of which petitioner acquired this stock, appear in the findings of fact. In a proceeding brought by United Carbon Co. to redetermine deficiencies in its income tax for 1925, the Circuit Court of Appeals, reversing the Board’s decision at 32 B. T. A. 1000, held that no reorganization had occurred within section 203 (b) (4) of the Revenue Act of 1926 by reason of these same transactions. United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. This decision resulted from the court’s view that, since the values of the shares of certain of the transferors before the exchange differed substantially from the respective values of the stock received from United Carbon Co. in the exchange, the condition of section 203 (b) (4) of the Revenue Act of 1926 had not been met.

Although alternative grounds for holding that a statutory reorganization had resulted were urged before the Board and by it were disregarded because of the conclusion it reached (see 32 B. T. A. 1000, 1008), the Commissioner abandoned these • alternative grounds on appeal, and the Circuit Court confined itself to the question there presented. Since fes judicata has not been pleaded by petitioner here, we can not even consider whether the United Carbon Co. case is decisive of all questions that might have been raised. Baker v. Spokane Savings Bank, 71 Fed. (2d) 487; Murrell v. Stock Growers' National Bank of Cheyenne, 74 Fed. (2d) 827; Reserve Natural Gas Co. of Louisiana, 15 B. T. A. 951.

The United Oarbon Oo. case, then, stands for the proposition that the transactions engaged in, during 1925, by Liberty Carbon Co., 11 corporations and a partnership, on one hand, and United Carbon Co., on the other, did not constitute a reorganization within section 203 (b) (4) of the Revenue Act of 1926. We now consider whether there was a reorganization under other sections of the 1926 Act, to wit, section 203 (b) (3) and section 203 (h) (1) (A). If petitioner acquired his stock in United Carbon Co. as a result of such a reorganization, then its basis will be the same as in that of the property exchanged therefor. The basis of the preferred stock, thus received, will be the allocated cost of the Liberty Carbon Co. stock exchanged therefor, rather than the fair market value of the Liberty Carbon stock on the date of the exchange. Revenue Act of 1926, sec. 204 (a) (6).

Attacking this point, petitioner argues that the condition of section 203 (h) (1) (A) has not been met for the reason that United Carbon Co. did not acquire “substantially all” the properties of Liberty Carbon Co. in exchange for stock. It is argued that while assets of a cost of $213,856.02 were exchanged for stock, other assets costing $105,017.38 were retained by Liberty Carbon Co. However, the record shows that, of the assets not transferred for stock, inventory valued at $79,539.43 was transferred to United Carbon Co. for cash. In other words, Liberty Carbon Co. parted with approximately 92 percent of its property in exchange for stock and cash.

Such a percentage is high enough to satisfy the statute. Gross v. Commissioner, 88 Fed. (2d) 567; Milton Smith, 34 B. T. A. 702.

Petitioner, however, contends, in effect, that we must segregate the transaction into two parts — the transfer of property, costing $213,-856.02, in exchange for stock; and the transfer of inventory, costing $79,539.43, for $79,539.43 in cash. There is no merit in this position. In Helvering v. Minnesota Tea Co., 296 U. S. 378, the taxpayer transferred all of its assets to a corporation in exchange for 18,000 shares of the transferee’s stock and $426,000 in cash. In holding that a reorganization had resulted under section 112 (i) (1) (A) of the Revenue Act of 1928 (worded identically with section 203 (h) (1) (A) in the 1926 Act), the Court said:

* * * Also, a large part of the consideration was cash. This, we think, is permissible so long as the taxpayer reserved an interest in the affairs of the transferee which represented a material part of the value of the transferred assets.

There can be no question but that the interest received by Liberty Carbon Co. in United Carbon Co. represented a “material part” of the value of the transferred assets. By a simple calculation, it is seen that the United Carbon stock received by Liberty Carbon Co. in the exchange here represented at least 73 percent of the value of the Liberty Carbon assets transferred. That percentage constituted a “material” part of the value of those transferred assets. G. & K. Manufacturing Co. v. Helvering, 296 U. S. 389; Nelson Co. v. Helvering, 296 U. S. 374; Millicent Turle Roelker, 39 B. T. A. 967.

We conclude that a statutory reorganization resulted, under sections 203 (b) (3) and 203 (h) (1) (A) of the 1926 Act, when Liberty Carbon Co. transferred 92 percent of its assets to United Carbon Co. in exchange for stock and cash.

In view of our conclusion that the first issue must be resolved against petitioner, we do not need to consider the affirmative defense of estoppel raised in respondent’s answer.

There remains to be decided the question of whether the gain realized by petitioner on the redemption of his preferred stock by United Carbon Co. in 1934 is taxable to the extent of 40 percent on the theory that it resulted from the sale of a capital asset held for more than 5 but less than 10 years or whether it is taxable, in full, as a distribution in partial liquidation. Revenue Act of 1934, sec. 115 (c).

Petitioner urges that since $110 per share was the price paid, the stock could not have been reacquired by the company in liquidation, dissolution, or winding up, because paragraph (e)' of the provisions on the back of the certificates mentioned $107 as the per share price to be paid in that event. The price of $110, he contends, was paid pursuant to paragraph (b), and indicates a straight purchase. If this be the case, he argues, William, A. Smith, 38 B. T. A. 317, is controlling.

But, in the Smith case, all the elements of a sale were present. The reacquired stock was not retired, but was held in the treasury of the corporation subject to reissuance. The last sentence of paragraph (b) of the stock certificates, involved here, provides that preferred stock purchased or redeemed or discharged shall not be reissued. The redemption, in other words, was to be complete. It is proper to presume, therefore, that that procedure was followed when petitioner’s stock was reacquired in 1934. United States Bank v. Dandridge, 12 Wheat. 64. This factual distinction prevents, in our opinion, the application of the Smith case here.

Section 115 (i) of the Revenue Act of 1934 defines “amounts distributed in partial liquidation” to mean “a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.” To be a partial liquidation it is not necessary that the corporation be planning a cessation of business or be in the process of final liquidation or that all of the preferred stock be retired at once. Commissioner v. Quackenbos, 78 Fed. (2d) 156; Commissioner v. Cordingley, 78 Fed. (2d) 118. In Salt Lahe Hardware Co., 27 B. T. A. 482, holding that amounts paid to redeem outstanding preferred stock constituted amounts distributed in partial liquidation, the Board said: “As set forth in the statute, section 201, supra, [the counterpart of section 115 (i) in the 1934 Act], a partial liquidation takes place whenever a corporation distributes money or assets in complete cancellation or redemption of a part of its capital stock. No particular portion is mentioned, nor is the the word ‘part’ in any way limited. Whether the amount so redeemed be all of a series or class, or only a part thereof, apparently makes no difference under the definition adopted by Congress.” See also Dill Manufacturing Co., 39 B. T. A. 1023.

Petitioner further contends that United Carbon Co. redeemed this stock out of profits, .rather than capital, and that section 115 of the 1934 Act deals only with distributions which effect a change in the capital structure of the corporation. Implicit in this is the view that a distribution of profits can not be a partial liquidation. The decision of the Supreme Court in Helvering v. Chester N. Weaver Co., 305 U. S. 293, concludes the petitioner in that position. This cancellation of this stock did reduce its capital. When United Carbon Co. reacquired its stock, it canceled it, and could not reissue the shares acquired.

Petitioner also intimates that United Carbon Co. was obligated to acquire the stock by the contract appearing on the back of each stock certificate, and that a compliance with this obligation was not a liquidation of the stock. The factual premise is not correct. But even if it were, the conclusion that the acquisition and cancellation of this stock was a partial liquidation, would still follow. Chester A. Souther, 39 B. T. A. 197.

Thus, since the money paid for the stock constituted a distribution in partial liquidation, it follows that 100 percent of the gain realized by petitioner from the redemption of his preferred stock in 1934 is taxable. Revenue Act of 1934, sec. 115 (c). Helvering v. Chester N. Weaver Co., supra. As previously indicated, this gain is equivalent to the difference between the amount received for the stock in 1934 and the allocated cost of the Liberty Carbon Co. stock exchanged therefor in 1929.

Decision will be entered under Rule SO.

       Sac. 203 (b)(4). 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.

       Sue. 203 (h)(1). The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation) * * *


author: Smith:

text:
    Swastika Oil and Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90861.
    Promulgated October 24, 1939.

      M. J. Eporrer, Esq., and Marry G. Kinne, Esq., for the petitioner.

      E. Q. Sievers, Esq., for the respondent.
   OPINION.

Smith:

This proceeding is for the redetennination of an income tax deficiency of $7,319.83 and an excess profits tax deficiency of $2,625.45 for the fiscal year ended October 31, 1935. Petitioner alleges that the respondent erred in including in its income an amount of $53,146.52 which it received during the taxable year in settlement of a contested lawsuit, and in disallowing the deduction of bad debts in the amount of $2,665.51.

Petitioner is a corporation, engaged in the production and sale of oil and gas in Muskegon County, Michigan.

On April 19, 1929, petitioner and J. D. Wrather entered into a contract, to which there were several supplements, whereby Wrather agreed to build an oil refinery in the vicinity of lands covered by certain oil and gas leases which the petitioner owned. It was proposed that a corporation would be organized to operate the refinery. Petitioner agreed to sell to Wrather or the corporation at a certain price and for a period of two years (extended by supplemental agreement to three years) a minimum quantity of oil if and when produced at its wells. It was further agreed that when the earnings of the refinery should become equal to the cost of its construction, which by supplemental agreement was fixed at $75,000, 35 percent of the corporation’s capital stock would be assigned to the petitioner without further consideration.

The proposed corporation was organized May 17, 1929, under the name of Michigan Central Refining Co., with a capital stock of $300,000, consisting of 30,000 shares of the par value of $10 per share. Thereafter, Wrather assigned to the corporation all of his interest in and obligations under the contract of April 19, 1929, in exchange for 30,000 shares of the capital stock of the corporation.

The refinery was completed during 1929 and was operated by the Michigan Central Refining Co. until about April 30, 1930. On or about that date the directors and principal stockholders of the company fraudulently conveyed and assigned, without adequate consideration, all of the company’s assets to another corporation, the Roosevelt Oil Co., which they had organized for that purpose without petitioner’s knowledge or consent. Thereafter, the refinery was moved to Mt. Pleasant, Michigan, where it was operated by the Roosevelt Oil Co., and the Michigan Central Refining Co. was dissolved.

On May 19, 1931, petitioner entered suit against the Michigan Central Refining Co., its individual stockholders and directors, the Roosevelt Oil Co., and others, alleging that the conveyance of the assets of the Michigan Central Refining Co. to the Roosevelt Oil Co., and the dissolution of the former company, were false and fraudulent and invalid; that it (the petitioner) was entitled to 35 percent of the capital stock of Michigan Central Refining Co. and 35 percent of the profits of that company in accordance with the contract of April 19, 1929.

On January 23, 1935, the Circuit Court of Muskegon County, Michigan, handed down an opinion in which it upheld substantially the petitioner’s allegations. The court decreed that the dissolution of the Michigan Central Refining Co. and the sale of its assets were null and void and ordered that the company be reinstated and that there be assigned to it all of the assets of the Roosevelt Oil Co. It was further ordered that there be issued to the petitioner 10,480 shares, and to others, as the defendants might direct in writing, 16,470 shares of the capital stock of the Michigan Central Refining Co., and that an accounting of the profits of that company and the Roosevelt Oil Co. be made to determine the amount thereof to which petitioner was entitled under the contract of April 19, 1929. The final decree of the court was entered February 28, 1935.

In its opinion the court said :

It appears clear that at the time of the fraudulent sale of the Refinery’s assets to Roosevelt, the defendant Wrather’s account for the erection of the Refinery equipment at Muskegon had been paid down to $39,000.00, hy reason thereof plaintiff was entitled to one-half of the capital stock in the Refinery, in accordance with the Swastika-Wrather contract, and that after the fraudulent sale and subsequent to the removal of the Refinery equipment to Mt. Pleasant, the Refinery under the name of Roosevelt Oil Company, paid to Wrather his entire account for the erection of the refinery equipment at Muskegon.

The court further said:

It is also my opinion that since the sale of the Refinery, it, operating under the name of Roosevelt Oil Company, has made a large profit which the defendants Wrather and Caldwell have been and are attempting to conceal from Plaintiffs and its representatives, and Warren and Kinne, and plaintiff Swastika, and Warren and Kinne are entitled to an accounting thereof and therefor.

The defendants prepared to take an appeal to the higher court but later agreed to settle the case out of court. Pursuant to such agree-meat the petitioner in September 1935 received a cash payment of $80,000 in full settlement of its claims. Petitioner had incurred legal expenses of $26,853.48 in connection with the suit, leaving a net recovery of $53,146.52.

Petitioner keeps its books upon the accrual basis and makes its income tax returns on the basis of a fiscal year ending October 31.

In his deficiency notice the respondent included the amount of $53,146.52 in petitioner’s gross income for the taxable year ended October 31, 1935. The petitioner contends that the amount did not represent taxable income but was “a compensation for injury to capital.” In support of its contention the petitioner cites, among other cases, Gould v. Gould, 245 U. S. 151; United States v. Safety Gar Heating & Lighting Co., 291 U. S. 88; Saunders v. Commissioner, 29 Fed. (2d) 834; Heiner v. Hewes, 30 Fed. (2d) 787; and Farmers’ & Merchants’ Bank of Catlettsburg v. Commissioner, 59 Fed. (2d) 912.

Those cases, we think, are not authority for petitioner’s contentions in the instant case. In Farmers’ & Merchants' Bank of Catlettsburg v. Commissioner, supra, which petitioner submits is identical in principle with the instant case, it was held that an amount received by the Farmers’ & Merchants’ Bank of Catlettsburg, Kentucky, in settlement of an action against the Federal Reserve Bank for damages resulting from injury to its business, did not constitute taxable income. The court pointed out in its opinion that:

The fund involved must he considered in the light of the claim from which it was realized and which is reflected in the petition filed in its action against the Reserve Bank. We find nothing therein to indicate, with the certainty required in the statement of a cause of action, that petitioner sought reparation for profits which petitioners’ misconduct prevented it from earning in 1925. * * * Petitioner not only did not insist upon the restoration of anticipated profits as a matter of fact, but based its claim for damages upon an alleged tortious injury to the good will of its business, and we can see no legal distinction between compensation for destruction of or damage to incorporeal or intangible property, such as good will, and similar compensation for damage to tangible property. Compare Harris & Co. v. Lucas (C. C. A.) 48 P. (2d) 187, syl. 5.

In the instant case the action brought by the petitioner was, in substance, an action to recover the income and the shares of stock to which it was entitled under its contract with Wrather, of which it had been deprived by the fraudulent acts of the defendants. In other words, the petitioner here did seek “reparation for profits” which the defendants’ misconduct had “prevented it from earning.” The distinction, we think, is a vital one. Under petitioner’s contract with Wrather, and with the Michigan Central Refining Co. as as-signee, it was entitled to certain profits of the refinery if and when earned. There can be no question that such profits would have been taxable to the petitioner if they had been timely received by it in accordance with the terms of the agreement. The fact that the receipt of such profits by the petitioner was postponed until a later year by the fraudulent acts of others does not affect their nature as taxable income.

In United States v. Safety Car Heating & Lighting Co., supra, the Supreme Court pointed out the distinction between a “contested claim for profits which if prosecuted effectively would ripen into income” and a suit based upon “an injury to capital, with the result that the recovery is never income, no matter when collected.”

Petitioner’s claim against the Michigan Central Befining Co. and others was, undeniably, a claim for profits rather than a claim for loss of or injury to capital, as the distinction has been made by the courts.

We are of the opinion, further, that the amount received by the petitioner is taxable to it in the year 1935 when petitioner’s right to the recovery was fixed by the court and became definite in amount. As the Court further said in United States v. Safety Car Heating & Lighting Co., supra:

* * * Claims existing unconditionally before March 1, 1913, being tbus excluded from tbe tax, tbe plain meaning of tbe regulation is that conditional or contingent claims, tbougb they may have bad an inchoate existence before March 1, 1913, are to be taxed when they are shorn of their conditional or contingent quality and become unconditional or absolute. So far as the problem to be solved depends upon the intention of the Congress in the enactment of the statute, the result is hardly doubtful.

In North American Oil Consolidated v. Burnet, 286 U. S. 411, the Supreme Court held that income which was earned in 1916 but impounded by a receiver pending the outcome of litigation and actually paid to the taxpayer in 1911, was taxable income to the petitioner in 1917. See also H. Liebes & Co. v. Commissioner, 90 Fed. (2d) 932, and cases therein cited.

The fact that petitioner kept its books and accounts upon the accrual basis does not alter the result, for, as said by the court in H. Liebes & Co. v. Commissioner, supra:

* * * income accrues to a taxpayer, when there arises to him a fixed or unconditional right to receive it, if there is a reasonable expectancy that the right will be converted into money or its equivalent.

In the instant case there was no time prior to the decision of the court establishing petitioner’s right to the recovery when the petitioner had a fixed or unconditional right to the income and a reasonable expectancy that the right would be converted into money or its equivalent.

The remaining issue involves the right of petitioner to a loss or bad debt deduction of $2,665.51. A portion of that amount, $889.32, represents tbe balance of a deposit in a closed bank and tbe remainder, $1,776.19, represents bad debts, botb of wbicb amounts the petitioner ascertained to be worthless and charged off in its return.

The evidence of record is convincing that the balance of the bank account as well as the debts in question were worthless and uncollectible at the close of petitioner’s taxable year and the amount claimed is therefore deductible in its entirety.

Decision will Toe entered, under Bule 50.


author: Leech :

text:
    Estate of Wilton J. Lambert, Deceased, by Elizabeth G. Lambert, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92119.
    Promulgated October 24, 1939.

      George B. Fraser, Esq., for the petitioner.

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

Leech :

To recapitulate, petitioner contends that legal fees owing to decedent, accrued at the time of his death, in the amount of $56,-873.88, are not includable in gross income of decedent for the period in 1935 ending in his death, under the Revenue Act of 1934, section 42, the pertinent part of which is quoted in the margin. In the alternative, she seeks the deduction of expenses in the amount of $4,213.05, incurred in connection with the collection of those accrued fees. In addition, petitioner claims the right to deduct the sum of $1,690.13, i. e., the stock assessment of $1,717.87, paid in 1936, less interest of $27.74, accruing after decedent’s death, an alleged loss of $9,166.30, on decedent’s annuity contract, which is the difference between the adjusted cost of the contract on the date of his death, and its discounted value on that date; an alleged loss of $2,845.85 in the TJter-mehle case, resulting from the overpayment in that controversy, plus expenses of $3,500, incurred in defending that suit; the sum of $200, paid in settlement of the Oliver claim, plus expenses of $300 incurred in defending it; and the sum of $25,000, paid in settlement of the Allen claim, plus expenses of $9,225.86 incurred in defending it. These contentions present the five issues which are discussed in the order stated.

First Issue.

Petitioner does not contest the action of respondent in taxing the accrued fees of decedent, on the ground that any of the items included therein were uncollectible, nor does any evidence denying the collectibility appear in the record. See American Cigar Co., 21 B. T. A. 464; affd., 66 Fed. (2d) 425; certiorari denied, 290 U. S. 699; Corn Exchange Bank v. United, States, 37 Fed. (2d) 34. She attacks that action for the reason, alleged in the petition, that the sums aggregating the disputed fees were earned and owing to decedent long before 1935 and, in addition, argues that section 42 of the Revenue Act of 1934, upon which respondent supports his action, is unconstitutional.

Respondent asks us to find that these fees were earned and owing to decedent and were thus accrued to him during the period, in 1935, preceding decedent’s death. Petitioner opposes this finding. The petition alleges and the answer denies that the fees were earned and owing to decedent before 1935. No evidence was offered on that point. So, we have made no finding.

However, we think the fact as to when these accounts receivable were earned and accrued, is immaterial. It was stipulated, and has been found as a fact, that the entire amount in dispute was accrued at the date of decedent’s death. The controlling statutory provision reads: “ * * * amounts accrued up to the date of his death.” Petitioner’s decedent was on the cash basis. None of these fees had been included in income before the taxable year. This is exactly the situation to which Congress intended the pertinent provision of section 42, supra, to apply. Lillian O. Fehrman, Executrix, 38 B. T. A. 37. The effect of that provision, together with its complement in section 43, infra, was merely to place decedent on the accrual basis of accounting for the period of the year, 1935, in which he died.

Thus, the total gross income for the part of the year which ended by his death is income actually received plus income accruable, and his total deductions are those to which a taxpayer on the cash basis is entitled, plus those to which a taxpayer on the accrual basis is entitled. Herder v. Helvering, 106 Fed. (2d) 153. Receivables properly “* * * accrued up to the date of his [decedent’s] death,” regardless of when they first became accruable, and which have not yet been reflected in income of a prior period because of his use of the cash system of accounting, are to be included in his gross income for the part of the year preceding death. On the other hand, under the last sentence of section 43, infra, all obligations of decedent properly “* * * accrued up to the date of his [decedent’s] death,” irrespective of when they acquired that status, are deductible. This is subject to the provision “if not otherwise properly includible [allowable] in respect of such period or a prior period,” which means, of course, only, that there may not be duplication of income or deductions.

Section 42 of the Revenue Act of 1934, supra, therefore, clearly supports the disputed action of respondent. Herder v. Helvering, supra; Lillian O. Fehrman, Executrix, supra.

However, petitioner urges that this section is unconstitutional when tested by the Fifth Amendment, and that its application would deprive decedent’s estate of property without due process of law. The reasoning advanced is not wholly clear but seems to be, in substance, that the section (1) constitutes double taxation, and (2) is arbitrary and capricious in that it unreasonably discriminates against taxpayers who die. The constitutional challenge of section 42, supra, does not seem to us considered or answered in the reported cases.

Double taxation is not, per se, violative of the Fifth Amendment. Hellmich v. Hellman, 276 U. S. 233; Fort Smith Lumber Co. v. Arkansas, 251 U. S. 532; Packard Motor Car Co. v. United States, 69 Ct. Cls. 570. But here there is no double taxation in any legal sense. Cf. Bull v. United States, 295 U. S. 247. The only tax imposed directly on the disputed accrued fees is the income tax authorized by section 42, supra. See Eisner v. Macomber, 252 U. S. 189; Doyle v. Mitchell Brothers Co., 247 U. S. 179. The estate tax, to which these accruals may be subject under section 302 of the Revenue Act of 1926, as amended, is not a tax on such accruals, but is an excise tax imposed upon their transfer, which is only measured by the value of the property so transferred at decedent’s death. Knowlton v. Moore, 178 U. S. 41. That is not constitutionally objectionable. As the Supreme Court said in the Bull case, supra: “The same sum of money in different aspects may be the basis of both forms of tax.”

That the section under attack is arbitrary and capricious because it unreasonably discriminates against taxpayers on the cash basis who die, is likewise without merit, particularly in view of its complement, section 43. The cash system of accounting is one that has a proper use only where there is a future period for taxing income received subsequently to the period in which the right to receive accrues. It is only because of the existence of such future period that the taxing of the property represented by the accrual is postponed until the actual period of collection. Thus, where a taxpayer, reporting on a cash basis and deferring the inclusion of receivables acquired in one year until the future period of their collection, dies, the possibility of the existence of such future period ceases. One of the conditions supporting the use of the cash system is, therefore, then eliminated and such system becomes no longer applicable to correctly reflect income. Section 42, supra, merely makes reasonable provision for this condition. See Lillian O. Fehrman, Executrix, supra.

Taxing persons who die, in this particular way, is not an unreasonable discrimination. The application of this provision is certain to all such taxpayers. In the Social Security Act, Title IX, Congress singled out for tax purposes the employers of eight or more persons, and in the same act (Title VIII), exempted from such tax agricultural labor, domestic service, and civil service. By section 233 of the Revenue Act of 1921, foreign corporations were exempted from tax on the income received on the sale abroad of goods bought in this country. The Act of Congress of August 2, 1886, as amended by section 3 of the Act of Congress of May 9, 1902, imposed an excise on artificially colored oleomargarine, to the exclusion of artificially colored butter. The Supreme Court held all these discriminations reasonable and not arbitrary or capricious. Steward Machine Co. v. Davis, 301 U. S. 548; Helvering v. Davis, 301 U. S. 619; Barclay & Co. v. Edwards, 267 U. S. 442; McCray v. United States, 195 U. S. 27.

Second Issue.

Since we have affirmed respondent in the first issue, the contention of the petitioner that the expenses incurred by her in ascertaining and collecting the accrued fees, thus taxed, are deductible, under section 43 of the Revenue Act of 1934, must be answered. It is argued that these fees are one of the costs of producing this income, composed of the accrued fees, and that, if these fees are to be taxed under section 42, supra, the deduction of the necessary expenses of the estate in reducing these fees to possession, must be allowed.

This contention overlooks the fact that we are not concerned here with administrative expenses of the estate. Our consideration is limited to income, on the one hand, and deductions on the other, which had already accrued to decedent at his death.

Deductions are a matter of legislative grace, and the conditions prescribed by Congress as prerequisites to their allowance must be strictly observed. New Colonial Ice Co. v. Helvering, 292 U. S. 485. The petitioner may well be entitled to the disputed deductions in computing the net estate of decedent subject to estate tax. But none of them constitute obligations owed or accrued by decedent at his death, and, consequently, are not deductible under section 43, supra.

Third Issue.

The assessment on decedent’s 80 shares of stock in the Federal-American National Bank & Trust Co. was made July 5, 1934, during decedent’s lifetime, and was paid February 5, 1936, after his death. No deduction could have been taken in decedent’s 1934 return, because he was then on the cash basis. Section 43 of the 1934 Act, supra, expressly removes this disability for the final taxable period of decedent’s life, because the assessment was not properly includable in any prior period.

We, therefore, hold that this deduction is allowable. Jamieson Associates, Inc., 37 B. T. A. 92; Central National Bank of Cleveland, Administrator, 35 B. T. A. 489.

Fourth Issue.

Decedent paid $46,067.40 for his annuity contract, on December 27, 1934. During his life he received $1,800 on this contract, in accordance with its terms, leaving an unrecovered cost at the date of his death amounting to $44,267.40. On August 6, 1935, the discounted value of the annuity was $35,101.10. Petitioner claims that the difference between the unrecovered cost and the discounted value, or $9,166.30, is a deductible loss to decedent because (1) he entered into this transaction for profit and (2) the respondent has ruled that petitioner, who as an individual is the beneficiary under the contract from and after decedent’s death, must report this identical sum as income, which, she says, will be unjust if a corresponding deduction is not allowed decedent. The respondent’s ruling in this connection is neither cited nor set out in full, no allegation thereof is made in the petition, and it has not been put in evidence. In any event, since petitioner in her present representative capacity and as an individual, is two separate taxable entities, we do not deem any sucb ruling material.

Assuming that the annuity contract was purchased for profit (see Helvering v. Louis, 77 Fed. (2d) 386), the position of petitioner is unsound. As originally issued, it provided that the Mutual Life Insurance Co. would pay decedent $900 every three months during his life; if he should die before the sum of the payments equaled the premium, then the company would continue the payments to petitioner, as his widow, until the sum of them, plus a smaller final payment, equaled the premium. The result to decedent of the interruption of payments to him, caused by his death, was that the interest or profit on the original investment, which otherwise would have been received by decedent, was not realized because the contract bound the company to repay to decedent’s widow only the principal amount of the premium. The propriety of the deduction of this interrupted interest or profit as a loss to decedent is the issue here.

The answer is apparent on the statement of the question. Failure to receive expected profits does not support a deduction. Warren Service Corporation, 39 B. T. A. 856; Henry G. Taylor, 34 B. T. A. 241; John F. Blanchard, 17 B. T. A. 1271; Frank F. Nicola, 1 B. T. A. 487.

Moreover, since the annuity was not payable to decedent over a fixed period (see George M. Cohan, 11 B. T. A. 743), but was payable throughout his life, there is no basis, established here, for a deduction. Helvering v. Louis, supra. Decision on this issue will be for respondent.

Fifth Issue.

Petitioner claims the right to deduct expenses incurred in paying and settling litigated claims against the decedent, under section 43 of the Revenue Act of 1934, supra. Each one of the suits in question was commenced in 1936, almost a year after decedent’s death. Liability was denied in each case. It is true that these causes of action were founded on occurrences in decedent’s lifetime, but there were no liquidations of the amounts due the claimants until two years after his death. In no case was the decedent’s liability fixed and determined at his death. At that time there was no basis existing for an accrual of any part of any of the items involved. United States v. Anderson, 269 U. S. 422; Lucas v. American Code Co., 280 U. S. 445; Crown Cork & Seal Co. v. United States, 4 Fed. Supp. 525. Thus, these contested payments were not “accrued up to the date of his death.” It follows that petitioner may not deduct the payments and expenses in connection with these claims against decedent’s estate.

In one of the actions against decedent, the Utermehle case, an investigation showed that the decedent had overpaid the claimant instead of being indebted to her. It is noted this overpayment could not be recovered because the claimant was judgment-proof. There is no evidence that this debt was ascertained to have become worthless prior to the date of the death of the decedent. In fact, the proof is to the contrary, for the overpayment was not discovered until after the suit had been filed against decedent’s estate in 1936. Herder v. Helvering, supra. But a debt which is not ascertained to have become worthless by a decedent until the time of his death or after-wards, may not be deducted upon his final return under section 43. Herder v. Helvering, supra. On that point, this case is controlling here. The deduction of any amount due decedent’s estate by reason of such overpayment is therefore denied.

Decision will he entered under Rule 50.

       SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.
      * * * In the ease oí the death of a taxpayer there shall be Included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.

       It should be noted, however, that this is the result, always, for the first period of accounting upon a change of basis from the cash to the accrual system. William Hardy, Inc. v. Commissioner, 82 Fed. (2d) 249, and Barbas v. Woodworth (Dist. Ct., Mich., Jan. 31, 1939).

       SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN.
      * * * In the case of the death of a taxpayer there shall be allowed as deductions and credits for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior period.


author: StbRnhagen:

text:
    Graham Sumner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92988.
    Promulgated October 24, 1939.

      Graham Sumner, Esq., pro se, and Charles F. Mclsaac, Fsq., for the petitioner.

      Sidney U. Hilcen, Esq., for the respondent.
   OPINION.

StbRnhagen:

The Commissioner determined the deficiency by treating the income from the trust securities as taxable to the petitioner. He held that despite the declaration of trust the petitioner retained such attributes of ownership of the securities as to justify taxing him. If the deficiency is correct, it must be on this broad ground, because we find nothing in the terms of the instrument or the evidence to bring the case within either section 166 or 167. From the standpoint of legal form, the petitioner transferred property in trust, himself the trustee, to collect and distribute the income therefrom to another for a prescribed period until the trust was by its terms to end. He retained no power to revest any part of the trust property in himself during the trust period, and at the end thereof, although the property was revested in the settlor, the revesting was by virtue not of a power retained or vested in him but of the termination of the trust in accordance with its terms. Phebe Warren McKean Downs, 36 B. T. A. 1129. None of the income of the trust was retained or accumulated for the settlor at any time. It was all to be distributed to the beneficiary.

But the inapplicability of section 166 or 167 is not decisive, Douglas v. Willcuts, 296 U. S. 1. The troublesome question is whether, after the creation of the trust, the petitioner’s control and dominion over the res is so substantially the same as it had been while he was unqualified owner as to justify taxing him irrespective of the trust. Practically speaking, the only effect of the trust was to require him to transfer the year’s income to his wife. In all other respects his relation to the trust property was the equivalent of ownership. If the duration of the trust were very much longer than a year, he might be relieved of the tax upon the income, Corning v. Commissioner, 104 Fed. (2d) 329; Clifford v. Helvering, 105 Fed. (2d) 586 (certiorari applied for) ; Henry A. B. Dunning, 36 B. T. A. 1222; dismissed, 97 Fed. (2d) 999; Jay C. Hormel, 39 B. T. A. 244 (on review C. C. A., 8th Cir.), and he might also be free from tax if the corpus had consisted of real property with a more formal evidence of transfer in trust and the creation of a new estate. United States v. First National Bank of Birmingham, 74 Fed. (2d) 360. But here we have the minimum indicia of a separation of individual and trustee ownership. We think it is insufficient to support any distinction from the decision in Du Pont v. Commissioner, 289 U. S. 685. That case went up on two grounds, the second ground expressing the unanimous view of the Court, as follows:

The provisions of these deeds would require a determination in favor of the government, though Burnet v. Wells had been decided the other way. * * * Here the grantor did not divest himself of title in any permanent or definitive way, did not strip himself of every interest in the subject-matter of the trust estate. During a term of three years, the trustee was to apply the income to the preservation of the policies, and while thus applying the income was to hold the principal intact for return to the grantor unless instructed to retain it longer. The situation in its legal effect would not be greatly different if the trusts had been created for a month or from day to day. One who retains for himself so many of the attributes of ownership is not the victim of despotic power when for the purpose of taxation he is treated as owner altogether.

Certainly there are as slight a divestiture of title, as much command over the disposition of the trust, a retention of as many attributes of ownership, here as there were in that case. See Burnet v. Wells, 289 U. S. 670. The Court, without referring to sections 166 and 167 or their prototypes in earlier statutes, held that the practical effect of the trust was so negligible as to leave the income taxable to the settlor even though the trust period was three years. We see no escape from the controlling effect of that decision upon the present case. See Benjamin F. Wollman, 31 B. T. A. 37; William C. Rands, 34 B. T. A. 1107; dismissed, 101 Fed. (2d) 1018; Estate of A. G. O'Laughlin, 38 B. T. A. 1120 (on review C. C. A., 7th Cir.).

The Commissioner correctly held the trust income taxable to the petitioner.

An attempt was made by petitioner to claim deductions if the trust income be held taxable to him. But they were not pleaded, the respondent properly objected to evidence about them because he was uninformed and not prepared on the subject, and they were not proven at the hearing but only referred to as a claim. They are therefore not judicable in this proceeding.

Decision will be entered under Rule 50.


author: Smith.

text:
    Estate of Ida B. Stone, Deceased, Continental Illinois National Bank and Trust Company of Chicago and Lillian Falker, Administrators, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91163.
    Promulgated October 25, 1939.

      Edward Blackman, Esq., for the petitioners.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Smith.

The question for our determination is whether the attorney fees which the decedent paid out in 1934 in defense of the tax claim asserted by the tax authorities of Pike County, Illinois, are deductible from her gross income as an ordinary and necessary business expense.

The taxing statute authorizes the deduction from gross income in computing net income of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Sec. 23 (a), Revenue Act of 1934.

The respondent has disallowed the deduction of the attorney fees in question on the ground that they were paid in defense of an action against the decedent as a distributee of her brother’s estate; that the cost of defending the tax claim “in no way depended upon whether or not you were operating a business, but involved a question concerning your right to receive the assets of the estate” of the deceased brother. In his deficiency notice the respondent refers to article 24-2 of Begulations 86, which states that the cost of defending or protecting title constitutes a part of the cost of the property and is not a deductible expense.

In support of their contention that the amount paid for attorney fees is a legal deduction from gross income, the petitioners argue that the decedent was during the taxable year engaged in a trade or business and that that business consisted of the active management of the decedent’s various properties. We have found as a fact that she was engaged in such trade or business. But we are of the opinion that this finding is immaterial to the issue presented.

The question here is whether the attorney fees paid by the petitioners’ decedent in 1984 were paid “in carrying on any trade or business.” The deduction can be allowed only if it falls fairly within the provisions of the statute. Lindley v. Commissioner (C. C. A. 2d Cir.), 2 Fed. Supp. 807.

In his deficiency notice the respondent has stated that the reason for the disallowance of the deduction of the attorney fees is that their payment “in no way depended upon whether or not you were operating a business.” We think that this fact is evident. The tax authorities of Pike County, Illinois, claimed that for a long period of years the decedent’s brother, from whom Ida B. Stone inherited a large amount of property, owed back personal property taxes and that his estate was liable therefor. The claim was made against petitioners’ decedent because she as residuary legatee had received the assets of the estate of her brother. The claim would have been made against her regardless of whether she was carrying on a trade or business. She was, of course, under the necessity of protecting her property. We think it is a far stretch of the language of the statute to say that the attorney fees paid in 1984 by the petitioners’ decedent in resisting the tax claim constituted “ordinary and necessary expenses * * * in carrying on any trade or business.”

In Hutchings v. Burnet (App. D. C.), 58 Fed. (2d) 514, the facts were that the taxpayer inherited valuable ore lands with leases thereon. Afterwards a suit was brought against the taxpayer and other heirs by one Gamble, who claimed to be the owner of a one-fourth interest in the testator’s estate. This suit was successfully defended and in 1925 the taxpayer paid $19,089.82 as attorney fees incurred in the case. Deduction therefor was disallowed by the Commissioner, whose action was sustained by the Board. In affirming the Board’s decision the court said:

It is clear that the transactions which caused appellant to pay the several attorneys’ fees in question were not part of any trade or business carried on by her, but were separate transactions affecting only her personal interests and estate. The ore lands in which appellant acquired an interest were under royalty leases when her interest accrued, and she had no part in operating the property. She simply received her share of the royalties as and when they became payable. Moreover, the attorneys’ fees in question were not paid for services rendered in connection with the operation of the ore lands or other property of appellant, but in cases requiring only a defense of her title to such property. The cost of defending her title to property under such circumstances does not constitute a deductible expense under the statute. Commissioner of Internal Revenue v. Field (C. C. A.) 42 F. (2d) 820.

In Brawner v. Burnet (App. D. C.), 63 Fed. (2d) 129, the question presented was whether payments in settlement of a suit by the deceased partner’s wife asserting claim to partnership assets and for attorney fees in connection therewith were deductible from gross income as expenses paid or incurred in carrying on a trade or business. The expenditures involved were made by the surviving partner in the compromise of the case, which did not relate to ordinary management or control of the business in which the taxpayer was then engaged, which was the buying and selling of milk, but related solely to the taxpayer’s title to the assets of the business, the purpose for payment to the widow of the deceased partner being to secure to taxpayer the proprietary interest in the business. The attorney fees were held not deductible from gross income.

In White v. Commissioner (C. C. A., 9th Cir.), 61 Fed. (2d) 726, the question presented was whether moneys paid by a partnership in settlement of claims against one partner while a member of a previous partnership are deductible from gross income. The court pointed out that, while deductions from income for ordinary and necessary expenses should be broadly construed to facilitate business generally, deductible business expenses must bear some reasonable relation to such business. To the same effect are Bindley v. Commissioner, supra; Stuart v. Oommissioner (C. C. A., 1st Cir.), 84 Fed. (2d) 368; Dorr v. United States (U. S. Dist. Ct., Mass.), 18 Fed. Supp. 92; R. E. Nail et al., Executors, 27 B. T. A. 33.

In support of their contentions that the attorney fees paid by the petitioners’ decedent are deductible from gross income, the petitioners cite Kornhauser v. United States, 276 U. S. 145. The issue there was whether a law partner was entitled to deduct from gross income legal expenses paid by him in defending a suit brought against him by a prior partner. The court held that they were legal deductions from gross income because they were “directly connected with, or * * * proximately resulted from” the taxpayer’s business. In the instant proceeding we can not find that the attorney fees paid were directly connected with or proximately resulted from the carrying on of a trade or business by the petitioners’ decedent. They were not, as in that case, paid for the protection or recovery of income. See Kales v. Commissioner (C. C. A., 6th Cir.), 101 Fed. (2d) 35.

The petitioners also cite L. B. Reakirt, 29 B. T. A. 1296; affirmed, per curiam (C. C. A., 6th Cir.), 84 Fed. (2d) 996. The taxpayer in that case was found to be engaged in the real estate and investment business. In connection with that business he paid attorney fees in resisting an illegal attempt by a city to condemn and acquire certain of his property. We held that the attorney fees paid were legal deductions from gross income, since they were paid as an incident to his business. That case is distinguishable from the proceeding at bar upon its facts.

In Commissioner v. Chicago Dock & Canal Co. (C. C. A., 7th Cir.), 84 Fed. (2d) 288, the taxpayer contested a benefit assessment growing out of street widening and expended $9,000 for attorney fees and $600 for witness fees. The court said:

* * * The attorneys’ and witness fees were not paid for the purpose of defending the title to the real estate, but were paid solely to test the validity of an assessment made by the city involuntarily, in so far as the company is concerned. * * * The Board correctly decided that these expenditures were an ordinary and necessary business expense * * *

There was no question in that proceeding but that the attorney and witness fees were directly connected with the business carried on by the taxpayer.

The petitioners argue that if these attorney fees had been paid by Ida B. Stone’s brother during his lifetime or by his estate during the process of administration they would be legal deductions from gross income. They then argue that if so deductible they are likewise deductible by the petitioners’ decedent when paid by her in 1934. Assuming that they would be deductible if paid by the decedent’s brother during his lifetime, or by his estate during the process of administration, we do not think it follows that they are likewise deductible as a business expense by the petitioners’ decedent. The facts simply are that the petitioners’ decedent as residuary legatee of her deceased brother’s estate received property of a value of approximately $1,900,-000 upon the distribution of the estate. The petitioners’ decedent paid the attorney fees to protect her right to hold those assets freed from the claim of the tax authorities of Pike County. This, we think, was a personal expense which was in no wise connected with the carrying on of a trade or business by the petitioners’ decedent.

Reviewed by the Board.

Decision will he entered for the respondent,


author: Leech:

text:
    Hummel-Ross Fibre Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93077.
    Promulgated October 25, 1939.

      Frrnh J. Albus, Esq., and James H. Rindfleisch, G. P. A., for tlie petitioner.

      R. M. McMillan, Esq., for the respondent.
   OPINION.

Leech:

Eespondent disallowed petitioner’s deduction of $18,186.67 as accrued interest. He did not question in his deficiency notice, nor has he since questioned, either the fact or the propriety of the accrual of this amount as interest. Both are apparently conceded. He supports the disallowance only on the ground that, though this interest was properly accrued, it was never paid, but, after its accrual, it was forgiven and canceled during the taxable year.

The Eevenue Act of 1934 is controlling. Section 23 (b) provides that, in computing net income, “All interest paid or accrued within the taxable year on indebtedness * * *” is deductible.

It is clear that payment of accrued interest is not a necessary premise to its deduction under the quoted section. The contention that petitioner’s liability or obligation to pay the accrued interest was forgiven and so canceled during the tax year is not supported by the evidence. We think this record discloses conclusively that the obligations evidenced both by the bond and interest coupon, were both, in fact, transferred to petitioner, for one consideration, i. e., preferred stock. We have so found as a fact.

But that exchange occurred after the right to deduct the admittedly properly accrued interest was complete, under the quoted statutory provision.

It may be observed that respondent has not attempted to tax gain to petitioner on this exchange. The reason, obviously, is that, though petitioner’s satisfaction of the bond and the then accrued interest obligations, by transfer of its preferred stock, may have resulted in a realized gain to petitioner in the sum of the difference between the then fair market value of the stock and the amount of those obligations — the realization of gain here is immaterial. The exchange in which that transfer occurred was a statutory reorganization under section 112 (g) (1) of the Eevenue Act of 1934, and petitioner was a party thereto, since the reorganization consisted of a recapitalization of petitioner. Wesley V. E. Terhune, 40 B. T. A. 150, and cases cited therein. The exchange was an essential part of that reorganization and the plan including it. Consequently, gain, even if thus realized, was not recognized. Eevenue Act of 1934, sec. 112 (b) (3).

Decision twill be entered u/nder Bule 50.

         This is not so, however, under the Revenue Act of 1937. By virtue of an amendment contained in section 301 of that act, no deduction of accrued interest, under section 23 (b), is permissible “If not paid within the taxable year or within two and one half months after the close thereof.”

         See United States v. Kirby Lumber Co., 284 U. S. 1; Commissioner v. AutoStrop Safety Razor Co., 74 Fed. (2d) 226.


author: Murdock; Sternhagen, Leech,

text:
    William R. Kenan, Jr., and Lawrence G. Haines, Trustees Under the Will of Mary Lily (Flagler) Bingham, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94985.
    Promulgated October 26, 1939.

      Arthur A. Ballwntine, Esq., and George E. Oleary, Esq., for the petitioners.

      Thomas H. Lewis, JA, Esq., for the respondent.
   OPINION.

Murdock;

The Commissioner determined a deficiency of $365,-687.12 in the income tax of these petitioners for the year 1935. The petitioners assign as error the action of the Commissioner in including in income an item of $603,447.06 to represent the taxable portion of alleged gains of $1,991,316.75 resulting from the payment in securities of a bequest of $5,000,000 under the will of Mary Lily Bingham to Louise Clisby Francis. The facts have been stipulated and the stipulation is adopted as the findings of fact.

Mary Lily Bingham died on July 27, 1917. She left a will in which she placed her large residuary estate in trust. The will provided in item seventh that the trustees should pay a certain amount annually to Louise Clisby Wise until she reached the age of 40, “at which time or as soon thereafter as compatible with the interests of my estate, they shall pay to her the sum of Five Million ($5,000,000.00) Dollars.” The will provided in item, eleventh that the trustees, in the case of certain payments, including that of the $5,000,000 under item fifth, should have the right “to substitute for the payment in money, payment in marketable securities of a value equal to the sum to be paid, the selection of the securities to be substituted in any instance, and the valuation of such securities to be done by the Trustees and their selection and valuation to be final.”

Louise Clisby Wise became 40 years of age on June 28, 1935. Her name at that time was Louise Clisby Wise Francis. The trustees decided to pay her the $5,000,000 partly in cash and partly in securities. They paid her as follows:

Cash_$1,029, 003.46
Securities, value on July 28, 1935- 3, 949, 661.71
Accrued interest on bonds delivered- 21,334.83
5,000,000.00

Most of the securities delivered had been acquired by the trustees as a part of the estate of the decedent at her death. Those securities had a value of $1,268,541.05 at that time and a value of $3,240,062.50, or an increased value of $1,971,521.45, on July 28, 1935. The Commissioner determined that the distribution resulted in a gain to the extent of the increase in value and that 30 percent or $591,456.44, was taxable to the trust under section 117 of the Eevenue Act of 1934. A portion of the securities delivered had been purchased by the trustees on June 15, 1931, and their value on July 28, 1935, exceeded their cost by $19,511.71. The Commissioner determined that 60 percent, or $11,707.03, of that excess was taxable to the trust under section 117. The remainder of the securities transferred were purchased by the trustees on April 29, 1935, and their value on July 28, 1935, exceeded their cost by $283.59. The Commissioner determined that the difference was taxable gain of the trust.

The three items just mentioned total $603,447.06, and the Commissioner added that amount to the income of the petitioners as “additional capital gain” and taxed it as such in computing the deficiency. He explained that the distribution constituted a final disposition resulting in taxable gain to the trust under section 111 of the Eevenue Act of 1934.

The petitioners reported the accrued interest of $21,334.83 as income, except to the extent that such interest was exempt, and the Commissioner made no change as to that interest in determining the deficiency.

Section 111 provides that “the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the” basis, and the amount realized “shall be the sum of any money received plus the fair market value of the property (other than money) received.” The Commissioner, in article 111-1 of Eeg-ulations 86, interpreted the section to mean that any gain realized from “the conversion of property into- cash, or from the exchange of property for other property differing materially in kind or extent” would be income. The court said in First Savings Bank of Ogden v. Burnet, 53 Fed. (2d) 919, that the phrase “other disposition of property” relates only to such other dispositions as are like sales. The petitioners point out that the trustees were not required to negotiate with the beneficiary and merely distributed the securities pursuant to the directions of the testator as expressed in the will. They argue that the transaction did not resemble a sale, the trust realized nothing in money or other property from the distribution, and, consequently, it realized no gain under the statute.

The case of Suisman v. Eaton, 15 Fed. Supp. 113; affirmed, per curiam, 83 Fed. (2d) 1019; certiorari denied, 299 U. S. 573; rehearing denied, 299 U. S. 621, is in point. The decedent in that case left his residuary estate in trust and the trustee was to pay $50,000 to each of the children of the deceased when he or she became 25 years of age. There was no mention in the will of payment in securities or other property. One child, Minerva, became 25 in 1924. The trustee, with her consent and the consent of the other children, transferred to her, in full satisfaction of her legacy, shares of stock worth $50,025 and received $25 in cash. The trustee filed a return and reported a profit from the transaction. The trustee contended in the suit that the transaction was not a sale or other disposition of property giving rise to taxable gain. The court held that the daughter acquired an equitable right under the will to receive $50,000 in cash upon attaining the age of 25, but no right to any specific assets; the satisfaction of her rights by the transfer of the securities was a “sale or other disposition” of the securities within the meaning of section 202 of the Revenue Act of 1924; the property received (the amount realized) by the trust “was the discharge of the corpus from Minerva’s equitable right to receive $50,000 therefrom”; the value of that property was $50,000; and the trust realized a taxable gain of the excess of $50,000 over the basis of the securities.

The present case differs from the Suisman case in that here the beneficiary had no right to demand cash but had to take the securities. In other respects the cases are quite similar. The bequest in each was fixed at a definite amount in money. There was no bequest of specific securities in either. The Bingham bequest gave the beneficiary an equitable right to receive $5,000,000 in cash or its equivalent on June 28, 1935, but no right to any specific assets. Her rights, like those in the other case, were a charge upon the corpus of the trust. The trustee had to part with either that amount of cash or securities worth that amount. The discharge was no less important to the trust than it would have been had there been no authority to pay the bequest in securities. Thus, the reasoning of the Suisman case would apply as follows: The discharge of the trust obligation represented by her rights was worth $5,000,000 to the trust, the trust in disposing of the securities realized $3,949,661.71 therefrom, and the excess of that amount over its basis for the securities was gain realized from the “sale or other disposition” of the securities. We hold, upon authority of the Suisman case, that the disposition was within section 111. Furthermore, the increase in value of the securities was realized by the trust and benefited the trust to the full extent, since, except for that increase, it would have had to part with other property in its corpus. The disposition of these assets freed other assets of the trust from the charge of the bequest and the estate made a clear gain. Cf. United States v. Kirby Lumber Co., 284 U. S. 1.

Cases cited by the petitioners involving dividends paid in kind are not helpful. Where a corporation declares a dividend in a certain amount and later discharges its pecuniary obligation by the distribution and acceptance of property, it realizes gain or loss upon the disposition of the property. Callanan Road Improvement Co., 12 B. T. A. 1109; Bacon-McMillan Veneer Co., 20 B. T. A. 556. But if the declaration provides for payment in kind, no pecuniary obligation is created and no gain or loss results. Helvering v. General Utilities & Operating Co., 296 U. S. 200; Commissioner v. Columbia-Pacific Shipping Co., 77 Fed. (2d) 759; First Savings Bank of Ogden v. Burnet, supra. The declarations in the latter group of cases mentioned specific securities and to that extent were more analogous to a specific bequest than to the bequest involved in the present case. An estate has no gain or loss from the distribution of property specifically bequeathed, but the situation is quite different where it discharges an obligation measured in money. Any change in the value of assets specifically bequeathed affects only the beneficiary, but a change in the other case affects the estate rather than the beneficiary.

We are not unmindful of the change in section 113 (a) (5) of the Bevenue Act of 1934 from the corresponding provision of earlier acts. The acts just prior had provided that the basis in the hands of a beneficiary of personal property acquired by general bequest was the fair market value of the property at the time it was distributed to the beneficiary. The provision applied, for example, to any personal property received by a residuary legatee. Section 113 (a) (5) of the Bevenue Act of 1934 provides that the basis for all property “acquired by bequest, devise, or inheritance” shall be its fair market value “at the time of such acquisition.” The petitioners argue that the beneficiary in this case will have to take as her basis the same basis which the trust has had, and if she sells the securities she will be taxed upon the same gain which is being taxed to the trust. Although such a result might be undesirable and not intended, nevertheless, it is not unconscionable. Cf. Ernest M. Bull, Executor, 7 B. T. A. 993; Shaffer v. Carter, 252 U. S. 37. The tax would fall upon two different taxpayers. Furthermore, the beneficiary may have acquired the securities within the meaning of section 113 (a) (5) on June 28, 1935, in discharge of a pecuniary bequest rather than at the death of the testator. Certainly those securities not owned by the testator must have been “acquired” later. The beneficiary received a bequest of $5,000,000 in cash which could be paid in an equivalent of securities and did not receive a bequest of any securities. Her acquisition of the securities was unlike that of a residuary legatee or heir whose title relates back to that of the testator and who is affected by any change in value of the property. There is reason to give the latter taxpayers the basis of value at the date of death of the testator. The situation of the beneficiary here is quite different and perhaps her basis is the value of the securities when she acquired them in satisfaction of her claim against the trust for cash or its equivalent. Perhaps then for the first time they were appropriated for such use and then for the first time she acquired any interest in them. This, of course, is not the occasion to decide what her basis is, but the application of section 113 (a) (5) is not obvious.

Eeviewed by the Board.

Decision will be entered for the respondent.

Sternhagen,

concurring: Since the Suisman decision has been affirmed by the Circuit Court of Appeals to which this proceeding would go on review and certiorari has been twice denied, it gives authoritative support to the present decision. But I can not refrain from expressing a doubt of the soundness of treating the distribution by a trustee at the appointed time as being a “sale or other disposition” of the distributed assets in consideration for value consisting of the discharge of his duty to distribute.

Leech,

dissenting: The petitioning trust was created to carry out the testamentary wishes of the decedent. The bequest to Louise Clisby Francis was not pecuniary, it seems to me. It was a legacy of money or securities in the alternative. The purpose, I think, obviously, was to avoid the creation of a money obligation, and to protect the estate and, possibly, the market for these securities, by making the legacy thus alternative. The choice of that alternative was left to the trustees of the testamentary trust. They chose and it thus became a legacy of securities. In my opinion, the petitioner therefore “realized” no gain under section 111 of the Eevenue Act of 1934, in the transfer of securities to Louise Clisby Francis. Cf. Helvering v. General Utilities & Operating Co., supra.

That distribution of securities occurred solely by authority of the will of Mary Lily Bingham. Consent of the recipient was not obtained. It was not a requisite. That fact, I think, effectively distinguishes this case from Suisman v. Eaton, supra, and renders inapplicable the rule applied in United States v. Kirby Lumber Co., supra.

TukneR agrees with this dissent.


text:
    C. A. Sporl & Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90354.
    Promulgated October 31, 1939.

      Arthur A. Moreno, Esq., and F. W. Gaudin, Esq., for the petitioner.

      Joe D. Hughes, Esq., and William P. Blahe, Esq., for the respondent.
   OPINION.

Smith:

This proceeding is for the redetermination of deficiencies in income and excess profits taxes for 1933 of $4,885.66 and $1,244.49, respectively. The question in issue is whether the petitioner sustained a deductible loss of $39,100 in 1933 on the sale to its president, Cyprian A. Sporl, Sr., of $46,000 par value second mortgage bonds of the Shipside Storage Co.

C. A. Sporl & Co., is a Louisiana corporation, with its principal office in New Orleans. It is engaged in the insurance brokerage business. Upon its organization it took over the business of a predecessor partnership.

One of its principal customers was the Jahncke Dry Docks, Inc., a Delaware corporation organized in 1922. The petitioner placed many policies of insurance for the Jahncke Dry Docks, Inc., charging that company with the full amount of the premiums thereon. Under its contracts with the insurance companies the petitioner was required to remit to them the premiums called for in the policies, less commissions, at varying rates for different types of insurance.

In September 1931 the petitioner was a general creditor of the Jahncke Dry Docks, Inc., in the amount of $70,935.58. On or about September 8, 1931, the Jahncke Dry Docks, Inc., informed its general creditors that it could not immediately pay the full amount of its indebtedness to them; that it contemplated selling its dry dock and ship repair equipment, and also its wharf, and expected to raise enough funds from the sale to pay off a part of its first mortgage bonds, leaving a balance of only $300,000; that it would then have on hand enough cash to pay its general creditors about 20 cents on the dollar; and that it would then issue second mortgage bonds bearing 6 percent interest for the balance of the creditors’ claims. Petitioner was advised that if this proposition was not acceptable to its general creditors there was nothing left for the company to do except permit a foreclosure of the first mortgage, which would entirely wipe out the equity of the general creditors.

On September 18, 1931, the petitioner wrote to the Jahncke Dry Docks, Inc., as follows:

Replying to your letter dated Sept. 8, 1931, we hereby agree to the plan proposed therein and will accept in settlement of our unsecured claim against your Company, after crediting the cash which will be paid to us out of free assets, mortgage bonds as set out in your letter. This agreement shall not become effective until similar agreements are executed by the holders of at least ninety (90%) per cent in principal amount of the ordinary claims against your Company.

Shortly thereafter the petitioner’s officers were orally advised that more than 90 percent of the general creditors had accepted the proposition and that the contemplated plan of settlement would be carried into effect. On October 13, 1931, the petitioner received $14,235.58 cash under the plan. The name “Jahncke Dry Docks, Inc.” was then changed to “Shipside Storage Co., Inc.,” and that company, pursuant to the plan, issued $233,400 of 6 percent mortgage bonds dated January 1,1932, and in February 1932 delivered $56,100 par value of the bonds in fulfillment of its agreement. It also at about the same time paid the petitioner interest upon $56,100 of its claim from October 13,1931, to December 31,1931.

Upon receipt of the bonds the petitioner turned over to the insurance companies $10,100 of the bonds to settle a like amount of their claim against the petitioner. The bonds were accepted by the insurance companies at their par value.

On December 26, 1933, the petitioner sold the balance of the Ship-side Storage Co. second mortgage bonds which it then had on hand, consisting of 46 bonds of a par value of $1,000 each, to C. A. Sporl, Sr., its president, for $6,900. This was the fair market value of the bonds at that time. The bonds had first been offered for sale through a reputable broker, but the broker was unable to receive any offers for them.

In its income tax return for 1933 the petitioner claimed the deduction of a loss of $39,100, which the respondent disallowed upon the ground that the bonds were not capital assets and therefore the loss on their sale was not deductible under the limitation of section 23 (r) of the Eevenue Act of 1932. This section of the statute reads in part as follows:

SEO. 23. DEDUCTION'S FROM GROSS INCOME.
In computing net income there shall he allowed as deductions:
(r) Limitation op Stock Losses.—
(1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not capital assets (as defined in section 101) shall be allowed only to the extent of the gains from such sales or exchanges (including gains which may be derived by a taxpayer from the retirement of his own obligations).

Section 101 (c) (8) provides in part:

(c) Definitions. — Dor the purposes of this title—
(8) “Capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business. * * *

The respondent raises the question as to whether the sale of the bonds by the petitioner to its president was at the fair market value, but the evidence conclusively shows that it was. The issue must, therefore, turn on whether the bonds were held by the petitioner for the statutory two-year period. The period for which the bonds were “held” dates from the time that they were acquired by the petitioner, McFeely v. Commissioner, 296 U. S. 102. To come within the two-year period essential to their classification as capital assets the bonds which the petitioner sold on December 26, 1938, must have been acquired on or before December 26, 1931. It is the contention of the petitioner that it acquired the bonds in October 1931, upon the execution of the creditors’ agreement, although the bonds were not issued by the Shipside Storage Co. until after January 1, 1982.

* * * As between tbe parlies, * * * tbe question of whether or not title has passed to tbe buyer, and, if so, when, depend upon tbe intention of tbe parties manifested at tbe time of tbe transaction or tbe making of the bargain. * * * [55 c. J., sec. 531.]

See also Charles C. Hanson, 23 B. T. A. 590. Cf. R. A. Shillinglaw, 32 B. T. A. 1235; affd., 99 Fed. (2d) 87.

A case somewhat like this (but having a different issue) is Fordyce v. Helvering, 76 Fed. (2d) 431, where an exchange agreement was to become effective when a certain amount of stock was deposited or upon a declaration by one of the companies that the plan was effective. A declaration was made on November 13, 1929, and the court held that to be the basic date even though the stock to be given in exchange was not required to be delivered until a later date.

We have no doubt from a consideration of all of the evidence that it was the intention of the parties concerned that after October 13, 1931, the petitioner was not a general creditor of the Shipside Storage Co. in the amount of $56,700; that it had definitely obligated itself to receive in lieu thereof second mortgage bonds of the Shipside Storage Co. of a par value of $56,700. We think that the date of acquisition of these bonds related back to the date when the contract was entered into between the parties. The loss sustained by the petitioner upon the sale of the $46,000 par value of the bonds was $39,100. That loss was sustained upon a sale of capital assets and the limitation upon the deduction of losses imposed by section 23 (r) of the statute does not apply.

The reason given by the respondent in his deficiency notice for disallowing the loss is as follows:

It is held that the loss occurred in 1932 at the time when delivery was made to you of the bonds in question, which, according to the records of the corporation issuing them, were worth less than face value. Your protest, executed October 26, 1935, paragraph 3, affirms that you accepted the said bonds in the year 1932; accordingly, the Bureau holds that the revenue agent correctly disallowed the loss as having occurred in the year 1933.
In addition to the above and relative to your contention that the loss was sustained in 1933, your attention is called to the following:
I. No evidence has been furnished as to the 1933 fair market value of the bonds, or that the sale was for a fair market price.
II. Losses from the sale of bonds which are not capital assets are deductible only to the extent of the gains from such sales. Section 23 (r) of the Revenue Act of 1932.

At the hearing of this proceeding the petitioner submitted evidence to overcome points raised by the respondent in his deficiency notice. The income tax returns of the petitioner for 1932 and 1933 were submitted in evidence and they show that those returns were made upon a cash receipts and disbursements basis. By virtue of this fact the respondent contends that the petitioner has not shown the cost to it of the $46,000 second mortgage bonds sold to its president on December 26, 1933, and that therefore the petitioner is not entitled to the deduction of the claimed loss.

It is true that the petitioner has not met or attempted to meet this contention of the respondent. We do not know whether the petitioner included in its gross income of 1931 or 1932 the $56,700 of second mortgage bonds which it received from the Shipside Storage Co. We think, however, that the bonds constituted taxable income of the petitioner either in 1931 or 1932. They were accepted by the petitioner in satisfaction of its claim against the Shipside Storage Co. If they were not so included, the $6,900 received upon the sale in December 1933 constituted additional taxable income of 1933. The respondent has not so contended.

Since the issue as to the cost to the petitioner of the bonds in question, as distinguished from their value at the date of receipt, was not raised by the respondent in the deficiency notice, and since the evidence shows that the $56,700 face value of bonds were received by the petitioner in exchange for an open account of equal amount, we are of the opinion that the cost of the bonds to the petitioner was $56,700.

The entire deficiencies for 1933 result from the disallowance of the claimed loss of $39,100.

Decision of no deficiency will loe entered.