author: Morris

text:
    Appeal of ARTHUR B. GROVER.
    Docket No. 1159.
    Submitted May 6, 1925.
    Decided January 30, 1926.
    An agreement construed to be a contract of sale of land. The vendee had an equitable interest in the land and the contracts of sale arising therefrom, the value of which is to be taken into consideration in determining future gains or losses thereon.

      Robert H. Montgomery, J. Marvin Haynes, and Leland T. Ather-ton,, Msgs., for the taxpayer.

      Lawrence Graves, Esq., for the Commissioner.

      Before Marquette and Moeeis.
    This appeal is from the determination of a deficiency of $6,097.27 in income tax for the years 1917 to 1920, inclusive, arising from adjustments made by the Commissioner increasing the amount computed to be the taxpayer’s distributive share of the income of Grover and Layman, a partnership.
    BINDINGS OB FACT.
    The taxpayer is an individual residing in the City of New York.
    He is and was during the years 1909 to 1920, inclusive, a member of the partnership of Grover and Layman. The other members of the partnership were Charles A. Layman and Bedford P. Thiebaud. The partnership is and was, during the years mentioned herein, engaged in the business of buying real estate, improving and dividing it into lots, and selling them.
    Some time in the year 1909, the partnership entered into negotiations with the Edgewood Improvement Association, of New Orleans, La., hereinafter called the Association, for the purchase of a certain tract of land, containing 1,462 lots, owned by the Association and located in the City of New Orleans, and offered to pay therefor $250,000, in annual installments of not less than $30,000 each, over a period of eight years, the deferred payments not to bear interest. The Association agreed to sell the lots in question to the partnership for $250,000, payable over a term of years, deferred payments not to bear interest, but was unwilling to convey to the partnership the legal title to the lots unless it would make a down payment of not less than one-fourth of the purchase price. As the partnership needed all its available resources to develop and market the lots in the event that it acquired them, it was unable at that time to make a substantial down payment and give a mortgage for the balance of the purchase price. It suggested to the Association that the Association accept annual payments on the purchase price of the lots and retain the legal title to the lots as security for the payment of the entire purchase price; that, in lieu of a down payment, the partnership would expend on, the lots whatever amount of money would be required to develop and market them, and that the members of the partnership would market and sell the lots in the same manner as if they held the legal title thereto. The Association agreed to the terms suggested by the partnership and authorized its president to enter into a contract to sell the lots to the partnership for $250,000, and, -on March 10, 1910, the partnership and the Association, by its president, made and entered into a written contract of which the provisions material here are, in substance, as follows:
    The Association constituted the partnership its agent to sell the real estate involved and granted to it the sole and exclusive right to sell the same for a period of eight years, and agreed that, during that time, it would.not sell said real estate or any part thereof, or permit or suffer it to be sold, except through the partnership. The partnership was to offer the lots for sale and was to fix and determine the price at which they were to be sold, such selling price to be sufficiently large so that 90 per cent thereof would be equal to $250,000. The partnership agreed that, by the use of its own funds, it would stake and number the 1,462 lots contained in the tract of land and would use its own funds to advertise the sale of the lots, and that it would provide special trains for prospective purchasers on sales days, employ agents, and otherwise aggressively push the sale of the lots. The partnership also agreed to pay all city and State taxes for the years subsequent to the year 1911, to reimburse the Association for taxes to be paid by it for the years 1910 and 1911 — subsequently determined to be the amount of $8,608.85 — and to pay the Association each year '90 per cent of all collections from sales. If 90 per cent of the collections from sales in any one year should be less than $30,000, the partnership was to make good the deficit. The Association agreed that, upon the payment to it by the partnership of the amount of $250,000, plus taxes for the years 1910 to 1911, it would convey to the partnership all unsold lots and assign to it all amounts remaining uncollected on lots theretofore sold, and that thereupon the interests of the Association in the real estate and uncollected balances should cease and terminate. If in any year the partnership should fail to make the minimum payment of $30,000, it was to forfeit all rights under the contract. The payments, however, were always made.
    The written instrument of March 10, 1910, although in form a contract creating the relation of principal and agent between the Association and the partnership, was intended by the parties thereto to be in fact a contract for the sale by the Association of the lots therein described for $253,608.85, payable in installments, the Association to retain the legal title to the lots until the entire amount of the purchase price should have been paid.
    Pursuant to the contract of March 10, 1910, the partnership at its own expense improved and advertised the lots referred to at a cost of more than $7,500, and between March 1Ó, 1910, and March 1, 1913, it sold 966 lots, the contract of sale in each case providing that, in the event of default in payment by the purchaser, the right of resale should revert to the partnership. A few sales were also made outright. On these 966 contracts of sale and outright sales, there was collected prior to March 1, 1913, the amount of $122,281.80, of which amount 90 per cent, or $110,-053.61, was paid to the Association, leaving a balance of $143,555.24 due to the Association on March 1, 1913, under the contract of March 10,1910.
    On March 1, 1913, there were outstanding 966 contracts for the sale of lots, on which payments were being made and on which there was unpaid the amount of $258,870, and there were 481 lots of the 1,462 lots referred to unsold and not under contract to be sold. The value of the outstanding contracts of sale on March 1, 1913, was $225,977.13, and the fair market value of the unsold lots at that time was $197,008.48.
    During the years 1910 to 1916, inclusive, the amount spent by the partnership in improving and selling the lots referred to exceeded the 10 per cent of the collections from sales, which it retained under the contract of March 10, 1910.
    During the year 1917, the partnership completed the payment of the amount of $253,608.85, due by it to the Association under the contract entered into by them on March 10, 1910, and the Association on May 1, 1918, conveyed to the partnership all the lots then unsold and assigned to it the uncollected balances outstanding on the contracts theretofore made for the sale of the lots.
    The partnership continued to sell lots and to make collections on contracts of sale during the years 1917 to 1920, inclusive. It made returns of income for those years, but the evidence does not disclose how it computed its profits arising from such sales and collections. The Commissioner, however, upon audit of the partnership returns, determined that the amounts collected by the partnership in those years, on the contracts of sale of the lots involved, represented compensation for services rendered by the partnership under the contract of March 10, 1910, and that they were income to the partnership when received. He adjusted the partnership income and the taxpayer’s distributive share thereof accordingly.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, under Eule 50.
   OPINION.

Morris

: The solution of the question presented by this appeal depends upon the construction to be placed on the contract entered into on March 10, 1910, by and between the Edgewood Improvement Association and the partnership of Grover and Layman, outlined in tbe findings of fact. The taxpayer contends that, regardless of the form of the written instrument, it was intended by the parties thereto to be a contract for the sale by the Association to the partnership of the lots therein described, and that the partnership had, on March 1, 1913, an interest in the unsold lots and outstanding contracts of sale, which should be taken into consideration in determining the partnership income for the years 1917 to 1920, inclusive, arising from the sale of the lots and the collections on the contracts. The taxpayer also urges that, even if the contract of March 10, 1910, be construed as merely creating the partnership the agent of the Association to sell the lots in question, the partnership acquired, in addition to the power to sell the lots, an interest therein and in all contracts of sale thereof, and that the interest so acquired had a value on March 1, 1913, Avhich must be considered in computing the partnership income in subsequent years. The Commissioner contends that the contract of March 10, 1910, created the partnership the agent of the Association to perform certain services for which payment was to be made upon completion, and that the partnership did not on March 1, 1913, have any interest in the lots and sales contracts involved herein.

Even if the Commissioner’s construction of the contract of March 10,1910, be correct, which, for the reasons hereinafter set forth we do not think is the case, his determination of the partnership income for the years 1917 to 1920, inclusive, is, nevertheless, incorrect. The services rendered by the partnership were completed in the year 1917, and the unsold lots and outstanding contracts of sale were conveyed to it by. the Association in the year 1918. Therefore, if the contract was only for services to be performed by the partnership and to be paid for on completion, it follows that the compensation for such services was income to the partnership in the year 1917 or the year 1918, depending on whether it kept its books on the cash receipts and disbursements basis or the accrual basis. If its books were kept on the accrual basis, the unsold lots and outstanding contracts of sale were income to the partnership in the year 1917, to the extent of their fair market value at the time the partnership completed the services under the contract of March 10, 1910. If the partnership’s books were kept on the cash receipts and disbursements basis, the partnership received income in the year 1918, to the extent of the fair market value of the unsold lots and outstanding contracts of sale, at the time they were conveyed or assigned to it by the Association.

The evidence in this appeal establishes that the partnership agreed to purchase and the Association agreed to sell to it certain lots for $253,608.85, payable over a term of years. The Association was, however, unwilling to convey the legal title to the lots unless it received a substantial initial payment, which the partnership was unable to make at that time. The partnership therefore suggested to the officers of the Association that the Association retain the legal title to the lots as security for payment of the purchase price, that it .accept and receive annual payments thereon of not less than $30,000 ■cash, and that the partnership, in lieu of the down payment, would enter upon and improve, advertise and market the lots at its own expense in the same manner as if it held legal title thereto, substantially all of the amounts derived from the sale thereof to be turned •over by the partnership to the Association and credited upon the agreed purchase price of $253,608.85 for the entire tract. The Association agreed to the terms proposed by the partnership and instructed its president to enter into a contract of sale to carry out those terms. The result was the written instrument herein referred to as the contract of March 10, 1910. The partnership, under that contract, immediately entered upon the lots and improved, advertised .and sold them at its own expense. As the selling price of the lots was collected, 90 per cent thereof was turned over to the Association and applied on the amount for which the Association had agreed to sell the entire tract to the partnership. The payment of the entire amount of $253,608.85 was finally completed by the partnership in the year 1917 and the Association.shortly thereafter conveyed to the •partnership the legal title to the lots remaining unsold and also assigned to it all outstanding contracts of sale.

At the hearing, two members of the partnership, and also the president of the Association, who executed the contract of March 10, 1910, on behalf of the Association, testified that it was intended by the parties to that contract to provide thereby for the sale by the Association to the partnership of the lots described therein for $253,608.85, the Association to retain title thereto merely as security for the payment of the purchase price. Counsel for the Commissioner objected to the admission of this testimony on the ground that the instrument is free from any ambiguity and speaks for itself and that its terms can not be varied or changed by parol evidence. We think the testimony is competent and admissible. As this Board has said heretofore, in the Appeal of Converse & Co., 1 B. T. A. 742:

The rule against varying or contradicting writings by parol evidence obtains only in suits between and is confined to parties to the writing- and tbeir privies and has no operation with respect to third persons nor even upon the parties themselves in controversies with third persons. Sigua Iron Co. v. Greene, 88 Fed. 207; O’Shea v. New York, C. & St. L. R. Co., 105 Fed. 559; Mitchell v. McShane Lumber Co., 220 Fed. 878.

From the evidence in this appeal, we are of the opinion that it was intended by the parties to the instrument of March 10, 1910, to contract for the sale to the partnership of the lots in question for the sum of $253,608.85, and that the partnership on March 1, 1913, had an equitable interest in the lots, which at that time had not been conveyed to third parties, and in the outstanding contracts of sale.

In view of what we have hereinabove said, there only remains for determination the question as to the value on March 1, 1913, of the interest of the partnership in the lots and sales contracts referred to. The evidence clearly shows, to our mind, that on that date there were 481 of the 1,462 lots involved herein unsold or not under contract of sale to third parties and that these lots had a fair market value at that time of $197,008.48. The fair market value of the outstanding contracts of sale, on which payments were being made, is shown by the evidence to have been $225,977.13 on March 1, 1913. The partnership at that time still owed the Association, under the contract of March 10, 1910, the amount of $143,555.24. The value of the partnership’s interest in the lots and sales contracts was, therefore, $279,430.37 on March 1, 1913, and that value should be taken into consideration in computing the partnership income for the years 1917 to 1920, inclusive, arising from the sale of the lots and collections on the contracts, and the taxpayer’s distributive share of the partnership income should be adjusted accordingly.


source: Caselaw Access Project

author: Littleton:

license: Public Domain

text:
    Appeal of PHILIP T. STARCK, Executor, Estate of PHILIP A. STARCK.
    Docket No. 4051.
    Submitted December 12, 1925.
    Decided January 30, 1926.
    A transfer of stock, under circumstances disclosed by the evidence, three years and three months prior to the donor’s death, held, not to have been made in contemplation of death.

      A. M. Frumberg, Esq., for the taxpayer.

      John F. Greaney, Esq., for the Commissioner.,
    Before Littleton, Smith, and Tetjssell.
    This is an appeal from the determination of a deficiency in estate tax, amounting to $122,903.98, arising from the increase in the value of the gross estate by the inclusion therein of $1,260,096.93, representing the value of 1,357 shares of the capital stock of the P. A. Starck Piano Co., alleged to have been transferred by the decendent to his son and two daughters on January 8, 1919, in contemplation of death.
    FINDINGS OF FACT.
    Philip T. Stark is the regularly appointed, qualified, and acting executor of the estate of Philip A. Starck, who died March 21, 1922, a resident of Chicago, Ill.

      Philip A. Starck and his son, Philip T. Starck, became engaged in the piano business in a small way in 1898. Sales of pianos increased rapidly and in 1906 the business was incorporated. .Shortly thereafter the corporation began the manufacture of its own pianos. At the date of organization .the capital stock consisted of 2,000 shares of the par value of $100 each, of which 1,990 shares were issued to the decedent and 10 shares to the son, Philip T. Starck, the former being made president and the latter treasurer of the company. The by-laws of the corporation gave to the treasurer equal powers with the president in the management of the business. The president and the treasurer worked in complete harmony, with the result that the business continued to grow and, many years prior to the decedent’s death, a number of branch houses had been established in various cities.
    Philip A. Starck was active, jovial, and of an optimistic temperament. He was fond of entertaining in his home and each year took several weeks’ vacation in Florida, California, or Europe. With the exception of occasional attacks of indigestion and headache over a period of about 16 years prior to his death, the decedent had never suffered from illness. He was indiscreet, however, in the matter of his diet, persisted in eating rapidly, and refused to obey his physician’s advice as to his diet. On March 4, 1918, although he was not seriously ill, he went to a hospital in Chicago, pursuant to his physician’s advice, for treatment, where he remained until March 28, 1918. He regarded his ailment as inconsequential. The doctor who had been his physician for a period of about 26 years éxplained that the stay at the hospital was for the purpose of forcing the decedent to rest and to diet. With the exception of those whom he informed of his stay at the hospital, his personal and business acquaintances did not know that he had been there. Thereafter, as had been the case before, his general health was good and, with the exception of receiving treatment for occasional attacks of indigestion, he did not at any time consult his physician. Until the date of his death he was active in the conduct of the business. During 1918 he made a will, and in one of the provisions thereof devised to his son 52 per cent of the stock, owned by him in the P. A. Starck Piano Co.
    On January 8, 1919, the decedent, being the owner of 1,857 shares of stock of the P. A. Starck Piano Co., transferred 520 shares thereof to his son Philip T. Starck, 419 shares to his daughter Lillian Starck, and 418 shares to his daughter Gladys M. Starck. The value of the 1,857 shares at the time of the transfer was $1,260,096.93. The transfer was absolute and all income derived from the stock so transferred was received and has been reported by the donees in their individual income-tax returns.

      The executor did not include in the estate-tax return the value-of said shares of stock as a part of the gross estate of the decedent. The Commissioner determined that the transfer was made in contemplation of death and, accordingly, on March 7, 1924, assessed, the deficiency of $122,903.98, whereupon the executor filed a claim for the abatement of this amount, which claim was denied in its entirety by the Commissioner on April 24, 1925.
    Philip T. Starck, although a material factor in the upbuilding of the business, owned but a small percentage of the stock of the corporation, the 10 shares owned by him in 1906 having been increased by purchase from time to time to 130 shares of the 2,000 shares outstanding on January 8, 1919, the remainder being owned by Philip A. Starck. During the period from 1906 to 1919 the son had married, purchased a home, and was rearing a family of four children. During 1917 he became dissatisfied with his interest in the corporation since, with the increase and expansion of the business, he was assuming greater responsibility in the management of it, and demanded of his father that he be given additional shares of stock, threatening to sever his connection with the business unless this was done. Thereupon, Philip A. Starck promised to adjust the stockholdings but delayed doing so until January 8, 1919, at- which time he transferred to Philip T. Starck 520 additional shares. At the same time he transferred 419 and 418 shares, respectively, to his two daughters and retained 500 shares. At. the time of the transfers the decedent did not contemplate death within the reasonably near future. The primary purpose of the transfers was to reward his son for his services and a desire to have his daughters independent during his lifetime. He also had in mind in making the transfers a saving in the matter of Federal income taxes upon dividends received. At the time of the transfers the decedent contemplated retiring, but did not do so, and continued his activities in the conduct of the business substantially as he had before the transfers. In 1922, the decedent, with his two daughters, went to Los Angeles, Calif. While there he planned the establishment of a branch house in that city and the arrangements had proceeded to the point of the employment of a branch manager when, on March 31, 1922, the decedent suddenly died of heart disease at the age of 61.
    DECISION. ■
    The deficiency determined by the Commissioner is disallowed.
   OPINION.

Littleton:

The question presented in this appeal is whether the transfer of the stock by the decedent to his children on January 8, 1919, was made in contemplation of death, within the meaning of section 402 of the Revenue Act of 1918, which provides that the value of the gross estate shall be determined by including the value at the time of death of all property of the decedent to the extent o £ any interest therein of which the decedent has at any time made a transfer, or with respect to which he has at any time created a trust, in contemplation of death, except in the case of a tona fide sale for a fair consideration in money or money’s worth.

The transfers here involved were made more than three years before the death of the decedent, and the presumption in the statute with respect to transfers made within two years prior to death does not arise.

In determining whether a transfer is made in contemplation of death, the Board must look to the expressions of the decedent, to the outward visible acts and circumstances surrounding a transfer of property prior to death. So far as the transfer of the 520 shares of stock to Philip T. Starck is concerned, it might well be said, under the evidence, that this transfer was for a fair consideration in money or money’s worth, since it appears that the decedent’s motive in making the transfer of stock to his son was in recognition of the valuable services rendered by him over a period of years and in compliance with the demand of the son that his interest in the business be increased.

There have been presented to this Board opposing pictures of practically the same state of facts. The executor portrays the decedent as physically strong, healthy, optimistic, and an energetic man both before and after his stay at the hospital in Chicago and the transfers of the stock in question; that for three years after the transfer of stock he continued his activities as he had for several years before, and that, although he had occasional attacks of indigestion and headache as a result of hearty eating, he regarded these ailments lightly and was not influenced by them in any way in making the transfers of the stock in question. The Commissioner, on the other hand, portrays the decedent as a man suffering for many years from severe headaches, serious stomach trouble, and heart disease, necessitating his going to a hospital for a period of 24 days and, in addition, spending a considerable portion of his time at health resorts; that his health was such in 1918 that he made his will and, in 1919, transferred the stock to his son and daughters in contemplation of death; and that, thereafter, he gradually declined in health until his death from heart disease on March 31, 1922.

B. A. Winterburn, secretary of the P. A. Starck Piano Co., testified concerning a conversation with the decedent, as follows:

In 1917 I was offered a position with another concern, and I went to Mr. Starck and told him my intention to leave and he asked me why; I told him I thought it was better for me; that I had a chance to get into this other concern and become a stockholder in the company and he told me at the time— he told me to stay — he said his holdings in the P. A. Starck Piano Company were too large, and that he was going to make some division of his stock; that Mr. P. T. Starck had been so helpful in building the business and had been so much help to him in looking after the branch stores and general business of the company, that he felt that it was no more than right he should have a larger interest in the business than he had at that time, and another thing, living expenses were getting higher and P: T’s family was growing and it was his intention to make some division of his holdings at that time. * * ⅜
Q. Did Mr. P. A. Starck say anything to you about desiring to see his children enjoy this property during his lifetime?
A. Yes. He said that his son and daughters were entitled to enjoy a part of the money that he had made, and that he wanted to divide it up so that they could enjoy it, while he was living, and so that he could see them enjoy it, and that was also one of the reasons for dividing his stock.

Philip T. Starck testified that during 1917 he had several conversations with the decedent relative to a division of the stock and that finally, in the latter part of 1917, he stated to the decedent that unless he was given additional stock he would withdraw from the business, whereupon the decedent stated:

I want you to be satisfied with the business. You have been working hard. You have got a big family. He said, I am going to fix this thing up as soon as I possibly can now, so that everything will be all right.

This witness further testified that at the time of the transfers—

He [the decedent] told me he wanted me to have a substantial interest in the business. He said, “ I. will turn over a certain amount of stock to you, and I will turn over a certain amount to the girls, so that they will be independent, and each one can take care of their own. A great many men who have made a success in life wait until they die, then their children will get the money and have a good old time with it, and the man that made the money don’t have the pleasure of seeing their children have a good time. I want my children to have a good time while I am alive. I want to see them enjoy this money. I want them to have this money just like it is their own, so that they can do with it what they want. I want them to have a nice house, with a nice automobile, and have parties and friends, and I am having the pleasure with them.” That is just the conversation we had.

That the purpose of the decedent, and the cause which moved him to make these transfers, was to reward his son for faithful services and at the same time to provide for the independence of his two daughters during his lifetime, is established by the testimony of a number of the decedent’s personal friends and business associates. It is shown that as far back as 1911 the decedent had discussed the matter of transferring certain of his stock to his son and daughters, and, also, the question as to whether it should be given to them direct or placed in trust.

As to the decedent’s health, his physician for a period of more than 25 years prior to the transfers testified that he had never suffered from any serious illness and described him as a human dynamo.

Webster’s Unabridged Dictionary defines “ contemplation ” as the act of looking forward to an event as about to happen; expectation; act of intending, purposing, or considering, hence, intention; consideration; etc.

An act may well be performed in contemplation of death at some time in the future and yet not be in contemplation of death within the meaning of that phrase as used in the statute. The intention of Congress in the enactment of section 402 of the Revenue Act of 1918 was to provide for the inclusion in the gross estate of the value of any property concerning which the decedent made 'a transfer, except for a fair consideration in money or money’s worth, in contemplation of death within a reasonable time in the near future, as distinguished from the general expectation of death entertained by everyone.

In Shwab v. Doyle, 269 Fed. 321, the Circuit Court of Appeals said:

On principle, and without present reference to authority, the ultimate question concerns the motive which actuated the grantor; that is to say, whether or not a specific anticipation or expectation of her own death, immediate or near at hand (as distinguished from the general and universal expectation of death some time), was the immediately moving cause of the transfer.

In Meyer v. United States, 60 Ct. Cls. 474, 483, the Court of Claims said:

If it be said that there need not be a conviction that death is imminent, there must be at least a belief that it is to be expected in the very near future, rather than in the usual course of events, and in this state of mind, in this belief, in the near approach of death, must be found the motive for the conveyance if it is properly to be characterized as made in contemplation of death.

In Spreckels v. State, 30 Calif. App. 363, the court said:

A reasonable and just view of the law in question is that it is only where the transfer of property by gift is immediately and directly prompted by the expectation of death that the property so transferred becomes amenable to the burden; or, as counsel for the respondents with singular aptness states the proposition: “ It is only when contemplation of death is the motive without which the conveyance would not be made that a transfer may be subjected to the tax.” That is, the expectation of death must be the direct, specific, and Immediate animating cause of the transfer.

In State v. Pabst, 139 Wis. 561, the court said:

It is manifest that they [the words] were intended to cover transfers by parties who were prompted to make them by reason of the expectation of death, and which, in view of that event, accomplished transfers of the property of decedents in the nature of a testamentary disposition. It is therefore obvious that they are not used as referring to that expectation of death generally entertained by every person. The words are evidently intended to refer to an expectation of death which arises from such a bodily or mental condition as prompts persons to dispose of their property and bestow it on those whom they regard as entitled to their bounty.

In tlie case of Rea v. Heiner, 6 Fed. (2d) 389, the District Court for the Western District of Pennsylvania stated:

There is a common agreement that the words “ contemplation of death,” mean not the general knowledge of all men that they must die; that it must be a present apprehension, from some existing bodily or mental condition or impending peril, creating a reasonable fear that death is near at hand; and that, so arising, it must be the direct and animating cause, and the only cause, of the transfer. If this apprehension, so arising, is absent, there is not that contemplation of death intended by the statute, especially when another adequate motive actuating the gift is shown.
Applying these legal principles to the case in hand, I reach without difficulty the conclusion that the gifts in question made by Mrs. Oliver were not made in contemplation of death. Her sound condition, mentally and physically ; her active participation in important affairs; her expressed belief that she'would live to a very old age; the preparation she was making for extensive improvements on her farm and at her home in Canada — all these, in connection with the animating motives for the transfer hereinbefore found to exist, conclusively rebut and overcome the presumption of the statute.

See, also, Conway’s Estate, 72 Ind. App. 303; Rosenthal v. People, 211 Ill. 306; State Street Trust Co. v. Stevens, 209 Mass. 373; Commonwealth v. Fenley, 189 Ky. 480; In re Spaulding’s Estate, 63 N. Y. S. 694; In re Palmer’s Estate, 102 N. Y. S. 236, 240; Vaughan v. Riordan, 280 Fed. 742.

In our opinion the evidence in this appeal does not justify the conclusion that the transfers of the stock were made in contemplation of death, within the meaning of the statute. On the contrary it appears from the evidence that the decedent was strong and active .until the date of his death, and that he regarded his ailments inconsequential, and, with the exception of about three weeks’ treatment in a hospital in 1918, he was never under the regular care of a physician. The decedent’s motive in making the transfers appears to have been for the purpose of rewarding the son for his services, of providing for the independence of his daughters during his lifetime, and of reducing the Federal income tax, rather than in the expectation of death within the reasonably near future.


author: Smith

text:
    Appeal of THE TOPEKA TENT & AWNING CO.
    Docket No. 3440.
    Submitted July 17, 1925.
    Decided January 30, 1926.
    1. One of four partners purchased the nineteen-thirtieths interest held by two partners, paying therefor an amount in excess of nineteen-thirtieths of the book value of the tangible assets of the partnership. Held, that the amount paid in excess of nineteen-thirtieths of the book value does not accurately measure nineteen-thirtieths of the value of certain rights in a patent owned by the partnership plus a one-half interest in certain rights in a Canadian patent owned by one of the vendor partners.
    2. A stockholder of a corporation owning 1,435 out of 1,500 shares of stock outstanding and entitled to receive royalties from the corporation upon a certain patent owned by him, waived in 1918 his rights to receive further royalties. Held, that the value of the right so waived may not be included in the computation of invested capital.

      Harry W. Golmery and George Elliott, Esqs., for the taxpayer.

      Benjamin H. Saunders, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Tkussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1919 in the amount of $2,976.69. The appeal is based upon seven allegations of error on the part of the Commissioner in determining the deficiency.
    FINDINGS OF FACT.
    The Topeka Tent & Awning Co. was originally organized as a partnership in 1901. It first had three partners; later four. On November 1, 1917, the members of the partnership were William Schick, owning a nine-thirtieths interest; B. W. Carter, owning a ten-thirtieths interest; F. A. Anton, owning a ten-thirtieths interest, and J. G. Stoneback, owning a one-thirtieth interest.
    On March 7, 1911,- a patent was issued to F. A. Anton on a lateral arm for awnings and, on November 30, 1912, Anton entered into a contract with the partnership reading in part as follows:
    For a valuable consideration and $1.00 in hand paid by the party of the second part [The Topeka Tent & Awning Company] to the party of the first part [F. A. Anton], the receipt of which is hereby acknowledged, and for the •consideration mentioned in other paragraphs herein, the party of the first part hereby grants and sells to the party of the second part, their heirs and assigns, the rights and privileges pertaining to said patent as named hereafter, namely, the exclusive right to manufacture and market said articles in the United States and territories thereof, said article being covered under patent No. 086,120, and known as Anton’s Lateral Arm.

      The party of the second part agrees to pay to the party of the first part, his heirs and assigns, a royalty of fifty cents for each arm manufactured and sold previous to this time and during the life of said patent, except as hereinafter provided.
    The party of the second part shall have the privilege to manufacture, use and sell Anton’s Lateral Arms to the extent of equipping awnings which may be manufactured and sold by them without paying any royalty for arms soused and sold, it being also understood that all Anton’s Lateral Arms so-manufactured, used and sold previous to this time to come under this provision.
    A royalty of fifty cents per arm is to be paid in each and every case when only the arms are sold, the party of the first part, however, agrees herewith to refund such royalties received from the party of the second part on any accounts of sales of Anton’s Lateral Arms terminating in lost accounts.
    On November 8,1917, the partnership was dissolved. F. A. Anton purchased the nine-thirtieths interest of William Schick in the partnership for $31,500 and the ten-thirtieths interest of B. W. Carter in the partnership and his one-half interest in certain rights in-Canadian patent No. 142,263, dated August 13, 1912 (the Canadian patent on Anton lateral arms), for $40,000. ‘ As a part of the consideration for the payment of $31,500 to him, Schick agreed “not to engage in the manufacture and sale of tents and awnings, or other articles which are usually manufactured and sold by tent and awning companies (except such articles and lines of business as the undersigned is now engaged in) in Shawnee County, Kansas, for the period of five years from this date.” As a part of the consideration of $40,000 paid to Carter, he agreed “ not to engage in the manufacture and sale of tents and awnings, or other articles which are usually manufactured and sold by tent and awning companies, in Shawnee County, Kansas, for a period of five years from this date.” These transactions resulted in a new partnership with F. A. Anton owning a twenty-nine-thirtieths interest and J. G. Stoneback a one-thirtieth interest. In addition, Anton agreed to assume all liabilities of the partnership, including the 1917 excess-profits tax, which. amounted to $7,746. This partnership acquired the rights of the predecessor partnership in respect of the United States patent on Anton lateral arms and also acquired the one-half interest in the rights in the Canadian patent theretofore owned by B. W. Carter as an individual.
    The taxpayer was incorporated on March 15, 1918, retaining the same name, The Topeka Tent <⅞ Awning Co., which had been used by the partnership prior to 1918. It was agreed that the corporate organization was to begin as of January 1, 1918. The taxpayer has elected to be taxed as a corporation for the' entire calendar year 1918. At January 1, 1918, the partnership books showed tangible assets of $58,553.92. The opening balance sheet of the corporation was as follows:

      1018 Assets ■ 1918 Liabilities
    Jan. 1. Merchandise_$40, 054.81 Jan. 1. Capital stock_$150, 000. 00
    Merchandise and tools_ 516. 89 Surplus_ 8, 553. 92
    Furniture and fixtures _ 336.90
    Truck_ 410. 00
    Accounts receivable _ 14,159.13
    Insurance prepaid- 72.10
    Gates and patterns _ 1, 312. 50
    Gash_ 1, 091. 59
    Patents_ 75, 000.00
    Royalty_ 25, 000. 00
    158, 553.92 158, 553. 92
    The intangible assets included good will and the rights of the predecessor partnership (composed of Anton and Stoneback) in the United States and Canadian patents on Anton lateral arms.
    The capital stock of the corporation was divided into $50,000 par value common stock and $100,000 par value preferred stock. Of this amount $143,500 was issued to F. A. Anton, $5,000 to J. G. Stoneback, and the remainder, $1,500, in equal shares to three other persons to conform with the State laws, which required at least five incorporators and directors.
    On the organization of the corporation the stockholders desired to retire the preferred stock at the rate of $10,000 per year. In order that the corporation might have earnings sufficient to accomplish such purpose, Anton, who was the principal stockholder, decided to relieve the taxpayer from payment to him of the 50 cents royalty on each Anton lateral arm sold. At a meeting of the board of •directors of the corporation held April 8, 1918, the following resolution was adopted:
    On call of the president, F. A. Anton, the Board of Directors of the Topeka Tent and Awning Company met at the office of the company, 304 Kansas Avenue, Topeka, Kansas, on the above date.. Directors present were: F. A. Anton, Fred. L. Ackerman, Jr., John G. Stoneback and Earl Akers.
    President Anton reported that he met Revenue Officer H. M. Breidenthal of the Wichita Internal Revenue Department who so kindly assisted us and advised us in the reorganization and incorporation, and that he had quite a visit with him in the bank. The conversation had with Mr. Breidenthal convinced President Anton that apparently it was an impossibility to find anybody that could give positive information pertaining to the late laws passed affecting, reorganization, and the laws passed were such puzzles that no one could give a positive. interi>retation of the laws, since the interpretation of some of these laws might seriously interfere* with the plans made previously and decided upon. President Anton explained at length some of the problems that might confront us in the future, and to assist the corporation in carrying out the plans agreed on at and before the incorporation and recorded in minutes of the stockholders meeting March 20th, 1918. We made some generous •offers.
    Directors Aker’s move which was seconded by Director Ackerman, Jr., and ■carried unanimously.

      “ Be it resolved that whereas it appears that it may not be permissible by law to set up invested capital for the intangible for the purpose of depreciation of the intangible in keeping with the value and depreciation of the intangible thus providing the means of retirement of the preferred stock as planned and,
    “ Whereas it is advisable to carry out the original plans of providing means for the retirement of the preferred stock and,
    “ Whereas laws with which no one seems to be familiar might prevent the setting up of invested capital or sufficient invested capital for the purpose of depreciation it is hereby,
    “ Resolved that the Directors of the Topeka Tent and Atoning Company accept the offer of F. A. Anton to waive his Royalty Rights on United States Anton Lateral Patents, and his half interest in Royalty Rights on Ganada Anton Lateral Patents, and on account of reorganization and incorporation being made March 15 as of January 1, 1918 refund to the Topeka Tent and Awning Company the Royalty received by him from them for the months of January, February, March and April amounting to $1,054.50, providing, however, that this wañver and refun/d shall not be construed as a transfer for pro-fit to him, and further providing that this waiver is granted and this refund is made for the sole purpose of enabling the Topeka Tent and Awning Company to set up a valuation in harmony with the value of this intangible of the waiver and the .refund made by him in cash for the purpose mentioned heretofore and for the further purpose of the depreciation to provide means for the retirement of the preferred stock and father providing that if it should be found later impossible to carry out this provision because it is not permissible by law, then this waiver and this refund shall be null and void for the reason that the consideration has failed, and further providing that in case of such failure all Royalty paid to F. A. Anton for the months of January, February, March and April 1918 amounting to $1,054.50 and refunded to Topeka Tent and Awning Company as well as all Royalty that would be due F. A. Anton from the Topeka Tent and Awning Company, had no Waiver of paying royalty been granted and no refund been made shall at once become due and owing to him together with interest at 6 per cent per annum until paid and be it further provided that the Topeka Tent and Awning Company shall keep accurate accounts of all Arms manufactured and sold as provided in the original Royalty Contract by the Topeka Tent and Awning Company, a co-partnership and F. A. Anton for the purpose of assisting to establish a value of the intangible of the Royalty Contract for depreciation purposes, or in case the waiver of the Royalty Contract and the refunding heretofore mentioned for the reason stated has become inoperative, then the Records kept by Topeka Tent and Awning-Company on all Arms manufactured and sold under the old Royalty Contract can be easily ascertained and settlement for moneys owing F. A. Anton together with interests be made and paid in full.” (Italics ours).
    Pursuant to this resolution, Anton refunded to the corporation $1,054.50 royalties which had been paid him upon Anton lateral arms sold by the taxpaj^er during the months of January, February, March, and April. On and after April 8, 1918, the taxpayer became possessed of the rights of the predecessor partnership in the United States and Canadian patents on Anton lateral arms and was also relieved from the payment of any royalties to Anton in respect of them. However, Anton still owned a one-half interest in the so-called shop rights of the Canadian patent. For this interest Anton was paid $2,500 by the taxpayer on May 9, 1918. From the last-named date the taxpayer had the exclusive rights in the manufacture and sale of Anton lateral arms without the payment of any royalty under both the United States and Canadian patents.
    From April 8, 1918, to the close of the year 1924, no credits were placed on the books of the taxpayer corporation showing any liability to Anton for royalties but accounts were kept to record the number of Anton lateral arms sold. No royalties were paid to Anton by the corporation until the close of the year 1924, when the Commissioner decided that the taxpayer was not entitled to any invested capital in respect of the value of the right to receive a royalty relinquished by the resolution of the board of directors dated April 8, 1918, quoted above.
    The taxpayer is, and during the year 1919 and for many years prior thereto was, a manufacturer of tents, awnings, canvas products, automobile tops, and articles made out of fabrics; also a manufacturer of camp furniture and the Anton lateral arm. One of the most important assets of the taxpayer was its patent license to manufacture and sell Anton lateral arms. The Anton patent is a basic one and the taxpayer’s competitors in the awning business must purchase lateral arms from it. The number of such arms sold from 1911 to 1919, inclusive, was as follows:
    1911. 2,427 1916. 8, 066
    1912. 3, 690 1917. 7,181
    1913. 5,724 1918. 4,483
    1914. 4,778 1919. 7,130
    1915. 5,314
    The Anton lateral arm represents the largest single item of sale of the taxpayer at the present time, and in 1917 it represented around 50 per cent of the volume of the business. The following table shows gross sales of the taxpayer and its predecessor, the number of Anton lateral arms sold, the gross sales of arms, and the, gross sales less arm sales:

      The net profits for the calendar years 1908 to 1924, inclusive, and the net value of the tangible assets from 1909 to 1917, inclusive, are shown by the following:

    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, in accordance with Rule 50.
   OPINION.

Smith

: The questions involved in this appeal are: (1) The amount of invested capital to be allowed on certain intangible assets of a partnership paid in to the taxpayer corporation for shares of its capital stock; (2) the amount which may be included in invested capital representing the value of certain intangible-assets, consisting of rights to receive royalties donated to the corporation by one F. A. Anton; (3) the amount to be deducted from gross income for exhaustion of intangibles; and (4) the right of the taxpayer to special consideration under section 328 of the Revenue Act of 1918.

1. Of the intangible assets paid in to the corporation as of January 1, 1918, by the partnership composed of Anton and Stoneback, the Commissioner has allowed invested capital as follows:

For nine-thirtieths of the partnership intangibles purchased by Anton from Schick_$15,741.50
For ten-thirtieths of the partnership intangibles purchased by Anton from Carter_ 17,490. 55
-7- $33,232. 05
For one-half Interest in shop right and royalty in Canadian lateral arm patent purchased by Anton from Carter_ 5, 000.00
38,232.05
Twenty-five per cent of stock outstanding_ 35,000. 00

The taxpayer contends that by this computation the Commissioner has not allowed the inclusion in invested capital of any amount representing Stoneback’s one-thirtieth interest and Anton’s ten-thirtieths interest in the partnership intangibles; in other words, that the Commissioner has allowed for partnership intangibles only nineteen-thirtieths of the amount that should be allowed, and that the taxpayer is entitled to include in invested capital the value of the eleven-thirtieths interest in the intangibles paid in to the taxpayer corporation for shares of stock by Anton and Stoneback.

The evidence in this appeal shows that Anton acquired Schick’s and Carter’s interests in the old partnership, which was dissolved on November 8, 1917, at a cost in excess of their pro rata shares of the hook value of the tangibles of the partnership. The book value of the tangibles of the partnership at January 1,1918, was $58,553.92. The value was substantially the same at November 8, 1917, the date upon which Anton acquired Schick’s and Carter’s interests in the partnership, and at January 1, 1918. Their nineteen-thirtieths interest in the partnership tangibles was, therefore, on that date $37,084.15. Anton paid Schick $31,500 for a nine-thirtieths interest and Carter $40,000, of which $35,000 was for his interest in the partnership assets and $5,000 for his interest in the Canadian patent. Anton paid Schick and Carter $31,500 plus $35,000 cash for their interests in the partnership, a total of $66,500. This amount is $29,415.85 in excess of their pro rata shares of partnership tangibles at January 1, 1918. In addition, Anton agreed to pay all liabilities of the partnership, including the excess-profits tax liability for 1917, which proved to be $7,746. Since Schick and Carter were liable for nineteen-thirtieths of this amount of tax, their nineteen-thirtieths interest in the partnership intangibles at November 8, 1917, was sold for $34,321.95, and, upon the basis of that sale, the total value of such intangibles was $54,192.08. The partnership composed of Anton and Stoneback acquired these intangibles plus the one-half interest of Carter in the Canadian patent, which had a value of $5,000. The total value of the intangibles of the partnership paid in to the corporation by the partnership was, therefore, by this computation, $59,192.08.

The taxpayer claims the right to include in invested capital in respect of these intangibles a greater, amount than has been allowed-by the Commissioner by reason of the fact that the intangibles had a greater cash value. We do not, however, perceive any error committed by the Commissioner upon this point. He has applied the 25 per cent limitation imposed by section 326 (a) (5) of the Revenue Act of 1918, and has permitted the inclusion in invested capital of the greatest amount possible.

2. The taxpayer further claims that it is entitled to an increase in invested capital over the amount allowed by the Commissioner by reason of the fact that on April 8, 1918, Anton, who was entitled to receive royalties from the taxpayer in respect of Anton lateral arms manufactured and sold by it, relinquished the right (provided the value could be included in invested capital), and that the value of the right thus acquired by the corporation was “ from $49,700 to $89,850 or a fair average cash value of $65,275.” The claim of the taxpayer upon this point is an unusual one. The evidence is to the effect that the taxpayer desired to redeem its preferred stock at a rate of $10,000 per annum and was afraid that the profits from the business might not permit this to be done. Anton therefore waived his right for a season to receive royalties from the corporation. This was a property right of unquestioned value. The amount which would have been paid by the taxpayer to Anton during 1918, if he had not waived his right to receive royalties, was $3,529.50 and the average amount which he would have received during the next few years was in excess of that amount. Although of unquestioned value, may that value be included in invested capital?

Section 331 of the Revenue Act of 1918 provides that in the case of the change of ownership of property, after March 3, 1917, if an interest or control in such property of 50 per cent or more remains in the same persons, or any of them, then the property received from the previous owner shall not, for the purpose of determining invested capital, be allowed a greater value than would have been allowed under Title III of the Revenue Act of 1918 in computing invested capital of such previous owner if the property had not been so transferred, and that, if the previous owner was not a corporation, then the value of the property so transferred shall be taken at its cost at date of acquisition. The evidence does not show that Anton paid anything for this right to receive a royalty. He was an owner of more than 90 per cent of the outstanding stock of the corporation at the date when he waived his right to receive royalties. After the waiver of such right to the corporation, he unquestionably still had more than a 50 per cent interest in the right waived. Section 331 is a complete bar to the claim of the taxpayer upon this point.

3. The Commissioner has determined that the taxpayer is entitled to deduct from gross income of the year 1918, $3,721.84 for exhaustion of the taxpayer’s rights in the United States and Canadian patents on Anton lateral arms. This deduction is based upon a determination by the Commissioner of a value for those rights of $38,232.05. The taxpayer claims that in his determination of the value of such rights the Commissioner has not taken into account the value of Anton’s and Stoneback’s original eleven-thirtieths interest in them. It is the taxpayer’s, contention that the interests of the last two individuals were worth $19,239.60, and that therefore the basis which'should be used for determining the depreciation allow-anee upon such rights in the patents acquired from the previous partnership is $57,471.65.

The taxpayer also contends that it is entitled to deduct an additional $250, representing exhaustion on $2,500, the cash payment made by it on May 9, 1918, for Anton’s interest in the shop rights of the Canadian patent. Upon this last point the Commissioner admits error if it be found that the taxpayer is entitled to deduct any amount whatever in respect of the exhaustion of such shop right.

The taxpayer and the Commissioner have assumed that the amount paid by Anton for Schick’s and Carter’s interests in the partnership which terminated on November 8, 1917, in excess of their pro rata shares of the tangible assets, represents the amount paid for their rights in the United States and Canadian patents. In other words, they have assumed that the only intangible of value possessed by the partnership was its right in the United States patent on Anton lateral arms.

We think that the taxpayer’s contention upon this point is not well founded. The Topeka Tent & Awning Co. had been in existence as a partnership for many years and had done a large business with awning manufacturers throughout the United States. The sales of Anton lateral arms prior to 1918 were only about one-third of the total sales of the concern. In its brief the taxpayer claims that the net profits on arms and the total net profits for the years 1910 to 1923, inclusive, were as follows:

The taxpayer did not keep books of account which showed net profits on sales of arms separately from the total net profits, and we can make no finding that the profits on the sales of lateral arms were what they are claimed to have been. But even upon the assumption that the figures presented by the taxpayer are correct, it appears that only about one-half of the net profits of the concern are attributable to such sales. The partnership was doing a profitable business even prior to the date of the issuance of the United States patent on Anton lateral arms. The good will of the partnership was undoubtedly valuable. It is not subject to an exhaustion deduction under the provisions of the Revenue Act of 1918. The Commissioner found that the fair value of the rights in the United States and Canadian patents possessed by the partnership, which was dissolved on November 8, 1917, pins the corporation’s one-half interest in the license of the Canadian patent, all of which patent rights became property of the partnership composed of Anton and Stoneback and which were turned in to the corporation, had a value at January 1,1918, of $38,232.05. No evidence has been adduced before us which proves that the cash value was in excess of that amount.

With respect to the computation of the exhaustion allowance based upon a value of $38,232.05, the taxpayer alleges that the correct amount of that exhaustion deduction is $3,823.20. This is based upon the assumption that the patents from which the rights issued had a life of 10 years from January 1, 1918. The facts are, however, that the United States patent had a life of 10 years, 2 months, and 7 days from that date and the Canadian patent an even longer life. No evidence is before us which proves that the Commissioner’s computation of the exhaustion allowance with respect to the patent rights acquired from the predecessor partnership is in error.

The Commissioner admits that he made no deduction from gross income of the year 1919 of any amount representing an exhaustion of any part of the $2,500 paid by the taxpayer on May 9, 1918, for Anton’s one-half interest in the shop right in the Canadian patent. He also admits that the taxpayer may be entitled to a deduction for the exhaustion of this interest in the patent. The appeal of the taxpayer upon this point is therefore sustained.

4. By the agreement between Anton and the taxpayer, dated April 8, 1918, Anton waived his right to receive a royalty of 50 cents on each lateral arm sold by the taxpayer. Had it not been for this agreement, the taxpayer would have paid Anton royalties of $3,529.50 for the year 1919 and even larger amounts for subsequent years. The taxpayer contends that Anton’s right to receive royalties, if the value of the right may not be included in invested capital for the year 1919, is revived and that the taxpayer under its contract with Anton owes him the $3,529.50 in question, and that such amount is a legal deduction from the taxpayer’s gross income for the year 1919.

We are of the opinion that there is no merit in this contention. The language of the agreement of April 8,1918, is ambiguous. Even though the corporation be liable to Anton for the payment of any royalties in respect of lateral arms sold during the year 1919, such liability accrued not during the year 1919 but at some later date, when it was determined by the taxing authorities that the claim of the taxpayer with respect to the inclusion in invested capital of the value of the so-called gift to the taxpayer should be denied. Our conclusion is that the taxpayer is not entitled to deduct or exclude from the gross income of 1919 any amount in respect of royalties for that year.

5. The taxpayer claimed that, by reason of abnormalities in income and invested capital for the year 1919, it is entitled to special consideration under the provisions of section 328 of the Revenue Act of 1918. In our opinion, there were abnormalities, both of income and of invested capital, which entitle the taxpayer to such consideration. The taxpayer has not submitted any evidence as to comparatives. By reason of such failure, the determination of the Commissioner under the provisions of section 328 will be final. Appeal of H. T. Cushman Manufacturing Co., 2 B. T. A. 39.

6. The taxpayer has alleged error on the part of the Commissioner in rejecting a claim for credit of $119.63, originally claimed for 1919. It has, however, offered no evidence in support of its claim.


author: Smith:

text:
    Appeal of ANDERSON & GUSTAFSON.
    Docket No. 1556.
    Submitted October 26, 1925.
    Decided January 30, 1926.
    A partnership which purchases an undivided one-half interest in an invention and writes it off as a loss during the year 1917, but which subsequently sells its interest in the invention, is not entitled, under the circumstances herein stated, to deduct from the gross income reported in its income-tax return for 1917 the amount of the investment in the invention.

      Fayette B. Dow and Willis Crane, Esgs., fo,r the taxpayer.

      B. G. Simpich, Esq., for the Commissioner.
    Before Smith, Littleton, and TRUssell.
    This appeal is from the determination of a deficiency in profits tax for the year 1911 in the amount of $16,260.31.
    FINDINGS OF FACT.
    In 1911, John A. Anderson and C. A. Gustafson were members of a copartnership with principal office at Chicago, Ill. In March, 1916, Ivan Engstrom solicited the taxpayers’ financial assistance in developing, patenting, and preparing for market a check-writer and adding machine. Engstrom estimated that the expense would be about $2,500 or $3,500 and that the machine could be prepared for market in from four to six months. The taxpayer entered into an arrangement whereby it purchased tools, dies, and other materials necessary to make a working model and draw plans, paid attorneys’ fees for applications for patents, and, in addition, advanced Eng-strom $30 weekly for his living expenses while the work was in its experimental stages. In the early part of 1911, the two members of the taxpayer partnership had advanced the total amount which Engstrom estimated would be necessary,-but. on further conference with Engstrom were advised that, on account of the peculiar conditions existing in the labor market, his first estimate would have to be raised considerably, and, due to inability to have tools and dies made promptly a working model of the machine could not be completed before another three or four months had expired. After the advances made by the taxpayers had grown to several times the amount originally estimated, Anderson and Gustafson made a thorough investigation of the device which Engstrom was working upon. They consulted with some of the manufacturers of check protector devices, and a, representative of one of the most successful concerns, after an examination of the device, stated to the taxpayers that “he would not give five cents for the device.” As a result of their investigations, Anderson and Gustafson reached the conclusion that the practicability of marketing the machine was very doubtful. Accordingly, they advised Engstrom that they would discontinue their arrangement. On September 30, 1917, they ceased advancing money for the enterprise and thereafter endeavored to dispose of their interest in the device, but without success. At the end of the calendar year 1917, they charged off the amounts advanced as a total loss.
    Engstrom was still confident that he had a machine of merit and immediately tried to interest new capital. On May 12, 1918, he came to the taxpayers with four or five individuals, whom he said he had succeeded in interesting in his machine provided they could get the taxpayers’ one-half interest on notes. They would not pay the taxpayers anything in cash but agreed to furnish cash to Eng-strom to complete another model. The taxpayers then sold their one-half interest in the patent application for $10,000 in notes, running from four months to a year (which notes were subsequently paid), and a royalty of 25 cents on each machine which might thereafter be manufactured and sold. The purchasers financed Engstrom to the extent of building 54 machines which were put in banks and other establishments on trial. None were ever sold and the taxpayers never received any royalties thereon.
    In 1917, the taxpayer partnership contributed $100 to the American Red Cross and claimed the amount paid as a deduction from gross income in the excess profits tax return filed. The deduction of this amount and of the claimed loss of $15,955 upon advances to Engstrom were disallowed by the Commissioner.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, in accordance with Rule 50.
   OPINION.

Smith:

The taxpayers claim the right to deduct from gross income, in a partnership tax return filed for the year 1917, $.15,955, representing the cost to the partnership of a one-half interest in an invention and patent application made by one Engstrom; also the right to a deduction of $100 contributed to the American Red Cross.

In their petition the taxpayers do not specify the proyision of the statute which entitles them to claim a deduction of a loss of $15,955. It was not contended at the hearing that it was an ordinary and necessary expense, but it was contended that the amount which had been spent was upon an invention which the taxpayers determined was worthless at the close of 1917. Ro contention was made that Engstrom was in any way obligated to pay them' back the amount expended by them, either in advances to himself for labor performed or for the cost of constructing the check writer and adding machine. The Board finds no basis for the allowance of the amount as a debt ascertained to have been worthless and charged off within the year. The losses which a partnership may deduct from gross income are those “ * * ⅜ actually sustained during the year, incurred in his business or trade, * * * when such losses are not compensated for by insurance or otherwise.” Section 5 (a), Revenue Act of 1916. We think that the evidence in this cáse does not show that the taxpayers actually sustained a loss during the. year 1917 in respect of the investment made in Engstrom’s invention. Engstrom succeeded in May, 1918, and eventually the taxpayers realized $10,000 cash from their interest in the invention. Whatever loss was sustained from the investment was in the year 1918 and not in 1917.

In the income-tax return for the year 1917 the taxpayer claimed the deduction of $100 as a contribution to the American Red Cross, which deduction was disallowed by the Commissioner. The partnership return was made under the provisions of the Revenue Act of 1917. In section 206 of that Act, Congress has specifically allowed to a partnership, in computing its net income for excess-profits tax purposes, the same deductions to which an individual is entitled in computing his net income for income tax purposes under the Revenue Act of 1916, as amended by the Revenue Act of 1917. Under the Revenue Act of 1916, as amended, an individual is entitled to deduct, in computing his net income, contributions or gifts actually made within the year to corporations or associations organized and operated exclusively for charitable purposes. The American Red Cross is such an organization. Therefore, the taxpayer was entitled to deduct from gross income for the year 1917 the $100 in question.


text:
    Appeal of HIGHLAND AMUSEMENT CO.
    Docket No. 5316.
    Submitted December 3, 1925.
    Decided January 30, 1926.

      Benjamin H. MeKindless, Esq., for the taxpayer.

      F. 0. Graves, Esq., for the Commissioner.
    Before Phillips and Tkammell.
    Taxpayer appeals from the determination of deficiencies in income and profits taxes for the years 1919, 1920, and 1921, in the sum of $2,644.03, arising, in part, from the disallowance by the Commissioner of the total amount claimed by the taxpayer as deductions for payments of salaries to its four officers for services performed.
    FINDINGS OE FACT. '
    The taxpayer is a Maryland corporation, with its office at Baltimore, and during the years in question was engaged in the operation of a vaudeville and moving-picture theatre in Baltimore. It had capital stock of 400 shares, held equally by four individuals, who were also officers and directors of the taxpayer. During the years in question each of such persons was active in the conduct of the theatre and rendered services in connection with its operation and management which required him to devote an average of from three to five hours each day to this work. In 1921 one of such officers and stockholders died, whereupon the work about the theatre was reassigned in order to provide employment for his widow, who thereafter rendered services to the taxpayer daily. Each of such persons was paid $26 per week, and during each of the years in question taxpayer paid to such officers and stockholders $5,200. The services performed by such stockholders were necessary to the efficient operation of the theatre and the amounts paid were reasonable compensation for the services rendered.
   DECISION.

The deficiencies, if any, should be computed by allowing as deductions, in each of the years involved, $5,200 as compensation for services rendered taxpayer by its officers and stockholders. Einal determination will be settled on 10 days’ notice, under Bule 50.


author: Maequette:

text:
    Appeal of A. J. SCHWARZLER CO.
    Docket No. 667.
    Submitted February 4, 1925.
    Decided January 30, 1926.
    Where a taxpayer owns tbe fee title to land and erects improvements thereon, the cost of such land and improvements may not be abandoned and written off as a loss while the taxpayer retains . title thereto.

      A. B. Sinclair, G. P. A., for the taxpayer.

      Benjamin H. Saunders, Esq., for the Commissioner.
    Before Ivins, KoRner and Marquette.
    This is an appeal from the determination of a deficiency in income and excess profits taxes for the year 1919 in the amount of $17,062.82. The deficiency arises from the disallowance by the Commissioner of an alleged loss of $90,257.88, claimed by the taxpayer to have been sustained in that year in connection with certain real estate owned by it.
    FINDINGS OF FACT.
    The taxpayer is a corporation, organized under the laws of the State of New York some time prior to the year 1909, and it is, and has been since its organization, engaged in buying real estate in New York City, erecting apartment and store buildings thereon, and selling them.
    In the year 1909, the taxpayer purchased for $47,500 the entire city block in New York City, bounded by One hundred and sixty-seventh Street, Clay Avenue, One hundred and sixty-eighth Street, and Teller Avenue. The land was a steep hillside, the street level of Teller Avenue being about 40 feet higher than that of Clay Avenue. It proceeded to divide the land so acquired into 28 lots, 13 of them fronting on Clay Avenue and 15 on Teller Avenue, and to erect buildings on the 18 lots on Clay Avenue and on the lot on the corner of Teller Avenue and One hundred and sixty-seventh Street. The fronts of the lots built upon were at street level and building on them was much easier and less expensive than upon the lots facing on Teller Avenue, for, although some excavation was necessary to bring the rear of the lots down to grade, the buildings could be erected on ordinary foundations, while, on the Teller Avenue side, it would be necessary to build foundations from below the grade of Clay Avenue up to the grade of Teller Avenue and to do a great deal of filling.
    While the taxpayer was constructing the buildings on Clay Avenue and the building on the corner of Teller Avenue and One hundred and sixty-seventh Street, it also constructed, at a cost of about $70,-000, the lower part of a foundation wall for back walls of buildings that might thereafter be erected on Teller Avenue. This wall extended vertically from below the level of the back yards of the Clay Avenue buildings to a line 25 feet to 35 feet above that level. The material excavated in grading the Clay Avenue lots was filled in on the Teller Avenue side of the wall, which was about 13 feet nearer Teller Avenue than was the back line of the Clay Avenue lots. The Clay Avenue buildings and the rear foundation wall on the Teller Avenue property were constructed between the years 1909 and 1913.
    The erection of buildings on the Teller Avenue lots would, to a large extent, cut off the light from the rear windows of the Clay Avenue buildings, as the tops of the Teller Avenue buildings would be about 50 feet above the roofs of the buildings on Clay Avenue. For this reason, and on account of the much higher cost of building on Teller Avenue, the taxpayer, when it had completed the foundation wall mentioned, decided to defer further building on the Teller Avenue lots until a later date. About this time, or a little later, subways were constructed on Jerome Avenue, which attracted prospective purchasers away from the Teller Avenue property of the taxpayer and to property in the vicinity of the subway, and a large hospital was erected on the block west of Teller Avenue, with a high blank retaining wall facing the taxpayer’s Teller Avenue lots and cutting off the light therefrom, as well as presenting an unattractive view to any building that might be erected thereon. The foundation wall erected by the taxpayer at the rear of the Teller Avenue lots crumbled, falling down in several places. These changes occurred prior to the year 1917, and, on account of them, it was apparent to the taxpayer, and was so decided by its officers, that further building operations on the Teller Avenue lots would be a losing venture, and that it would be cheaper to let them remain as they were, and to purchase lots in other localities for any other building operations the company might thereafter undertake.
    The Teller Avenue lots were taxed by the City of New York separately from the lots on which buildings had .been constructed by the taxpayer, and the taxpayer, from the time it acquired them, never paid any taxes or assessments thereon, but allowed the taxes and assessments to accumulate with interest. In the year 1917, the City of New York caused its tax lien on these lots to be sold for arrears in taxes, and, in the absence of other bidders, bid them in, but this sale was later canceled. In the year 1919 there were accumulated liens for taxes, assessments, and interest against the Teller Avenue lots amounting to $19,106.13. At that timp. the market value of those lots had decreased, for the reasons above stated, to less than the amount of the liens against them.

      The cost to the taxpayer of the entire block of land purchased in 1909 was $47,500, and the value of the Teller Avenue lots was one-fifth of the value of the entire block, or $9,500.
    The taxpayer, in the year 1919, sold the lots on Clay Avenue and the lot at the corner of Teller Avenue and One hundred and sixty-seventh Street, together with the buildings thereon. At the same time, it attempted to abandon the Teller Avenue lots, and charged off on its books the cost of the lots and of the foundation wall thereon as a loss in the year 1919. In its income-tax return for that year, it treated the whole business described above as one transaction, deducting from the price realized upon the sale of the buildings and the land upon which they were situated the aggregate cost of all the land and the cost of the buildings and the Teller Avenue foundation wall, and reported the difference as income. The Commissioner, in auditing the return, held that the dealings with the buildings and land under them constituted one transaction which was completed, and that the acquisition of the Teller Avenue lots and erection of foundations thereon constituted anpther transaction which was not completed. Of the purchase price of the land, he attributed $20,725 to the Teller Avenue lots, and of the construction costs he attributed $69,532.83 to the Teller Avenue foundations. The sum of these amounts he deducted from the cost of land and buildings sold, increasing net income by $90,257.83, and determined a deficiency in tax of $17,062.82.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, under Bule 50.
   OPINION.

Maequette:

The taxpayer claims the right to deduct the cost of a parcel of land purchased in the year 1909', and a foundation wall erected thereon between the years 1909 and 1913, as a loss in the year 1919, upon the ground that the property was abandoned as worthless in that year. The Commissioner denied the loss, upon the ground that it was not a realized loss, as the title to the property was still vested in the taxpayer and no loss had been sustained within the meaning of the law. The taxpayer alleges that it abandoned the property in 1919 and wrote it off on its books as having no value.

Section 234(a) (4) of the Revenue Act of 1918 authorizes, as deductions in computing net income, “Losses sustained during the taxable year and not compensated for by insurance or otherwise.” The testimony produced tends to show that the property in question had decreased in value, due to changes in the neighborhood, that it was not desirable as a building site, and that taxes had been permitted to accumulate against it until they equaled or exceeded its then value. Assuming all this to be true, the taxpayer did not sustain a loss in the taxable year.

It is well settled that title to real property can not be lost by abandonment alone. 1 Corpus Juris, 10. In 1 Ruling Case Law, p. 2, section 2, it is stated:

The characteristic element of abandonment is a voluntary relinquishment of ownership, whereby the thing so dealt with ceases to be the property of any person and becomes the subject of appropriation by the first taker.

In the case of East Tennessee Iron & Coal Co. v. Wiggin, 68 Fed. 446, 449, Judge Lurton, who delivered the opinion of the court, said:

Precisely what is meant by “ an abandoned ” legal title is hard to define. If it is the valid legal title, it is inconceivable how it can be abandoned.

Here there is no question but that the legal title to the property attempted to be abandoned was in the taxpayer, and remained in it until after the taxable year in question. It could exercise dominion over it to the exclusion of everyone else, and it is difficult to conceive how it could sustain a loss with respect to the property and still have the property to deal with as its own. True, the value of the property may have declined by reason of changed conditions and the taxpayer’s neglect to pay taxes thereon. In fact, every piece of property upon which taxes are permitted to accumulate and which is located in a neighborhood which has become undesirable, necessarily suffers a diminution in its mar bet value, but it has never been held that a taxpayer could deduct as a loss the diminution in value of land the title to which is still retained, and the difference is one of degree only. Losses from dealing in real or personal property, growing out of the ownership thereof, are deductible only when ascertained and determined upon an actual, completed, and closed transaction during the taxable year, and are not sustained through the mental processes by which a taxpayer determines that the property is worthless and charges it off on its books, while it still retains the title to the property itself.

The taxpayer has treated the purchase of the tract of land described in the findings of fact, the sale of a part thereof, and the alleged abandonment of the balance as one transaction, but its own actions show conclusively that such was not the case, for the reason that, when it sold part of the land and the houses erected thereon, it retained to itself the land the cost of which it now seeks to write off through an attempted abandonment. When the houses were sold, a gain or loss accrued to the taxpayer, measured by the difference between the cost and selling prices of the buildings and the land upon which they were situated. This constituted one transaction. Likewise, a gain or loss would accrue upon the remaining part only through a sale or other disposition thereof, which would constitute another and different transaction. The taxpayer seeks to complete this latter transaction by a book entry, based upon its own estimate of the value of the land. The purpose of the attempt to write off the value of the property not sold as worthless in the taxable year was to obtain a deduction which would in part offset the gain realized on the property sold and thus reduce the tax thereon. It may be that the equity of the taxpayer in the unsold lots was of little value because of the accumulated taxes,'but we think that a loss is sustained, within the meaning of the law, only when it is a realized loss and is evidenced by a completed and closed transaction.

We are, therefore, of the opinion that a taxpayer may not deduct as a loss the cost of real estate and improvements, the title to which it retains; yet, even if we were to hold that the title to real estate could be abandoned and the cost thereof written off as a loss, we do not think the taxpayer would be entitled to deduct, in the year 1919, the cost of the lots and foundation wall involved herein. The taxpayer permitted taxes to accumulate against the property from the year 1909 to the year 1917, and in the latter year permitted it to be sold for taxes; and, if we were to recognize that it could and did, in fact and in law, abandon the property, we would be constrained, to hold that such abandonment occurred not later than the year 1917.

The evidence produced in this appeal establishes that the taxpayer in 1909 paid $47,500 for the parcel of land bounded by One hundred and sixty-seventh Street, One hundred and sixty-eighth Street, Olay Avenue and Teller Avenue, and that the value of the lots on Teller Avenue, because of their contour and unfavorable condition for building, had a value of only one-fifth of the value* of the entire tract. Therefore, $9,500 of the cost of the entire parcel of land should be allocated to the Teller Avenue lots and the remainder to* that part of the land which the taxpayer sold in the year 1919. In other respects, the determination of the Commissioner is approved.


author: Steknhagen:

text:
    Appeal of UNION COLLIERIES CO.
    Docket No. 1612.
    Submitted August 31, 1925.
    Decided February 3, 1926.
    Tbe cost of coal-mining machinery and equipment held not deductible as ordinary and necessary expenses.
    An alleged bad debt held not deductible.

      William A. Seifert and Hale Hill, Esqs., for the taxpayer.

      Willis D. Nanee, Esq., for the Commissioner.
    Before SteRnhagen and Lansdon.
    This is an appeal from the determination of a deficiency of $91,-346.12 in income and profits taxes for 1918. The taxpayer claims the right to a deduction of amounts paid for rails, cars, motors, machinery, switches, and frogs, as ordinary and necessary expenses, and also of an amount alleged to be a bad debt deductible within the year.
    FINDINGS OE PACT.
    The taxpayer is a Pennsylvania corporation, organized in March, 1915, to mine and sell coal. Throughout 1918 it owned and operated three mines, all of which are located in Pennsylvania, and are designated as Mine No. 1, Mine No. 2, and Mine No. 3. Mines Nos. 1 and 2 are drift mines in the Pittsburgh seam. Their development was begun in the latter part of 1915. In 1918 there was installed in Mine No. 1, one mining machine, which cost $2,785.41, and in Mine No. 2, one mining machine, which cost $2,785.48. In both mines there were 17 pit cars, which cost $3,183.33. There were also used, in 1918, in Mine No. 1, ties, rails, spikes, switches, and frogs, which cost $7,343.78; and in Mine No. 2, $9,808.46. These amounts were all charged to operating cost in 1918.
    The net tons produced were as follows:

    The muxiber of men employed in the two mines were as follows:

      The reason for the purchase and use of additional equipment in the mines after January 1, 1918, was that, as the mine work proceeded further from the opening or tipple, more track and equipment was necessary to bring out the coal and maintain production.
    Accidents are so frequent in mining, such as the covers falling in, that it is not possible to determine accurately the life of light rails, ties and similar equipment. Heavy rails which are used on the main line of haulage will last longer than light rails. Cars are frequently repaired, and are used more than a year, except when lost or destroyed in an accident. Mining machines will, with ordinary repairs, last more than a year. Those purchased in 1918 for use in Mines Nos. 1 and 2 were used until the mines were exhausted, and were then rebuilt. Switches have a life of more than one year, when subjected to ordinary wear and tear.
    The taxpayer filed a claim for an amortization deduction for the taxable year, which included the amortization of some of the same properties which are now sought to be included in the deduction for ordinary and necessary expenses. The Commissioner allowed a deduction for amortization, but not upon all the properties or in the full amount claimed.
    On April 2, 1917, the taxpayer executed a written agreement with Benjamin Mcoll, giving him the exclusive agency for the sale of its coal (with exceptions not here material), the expenses of sale to be borne by the agent, the compensation being 3 per cent of the selling price f. o. b. mines. Other portions of the agreement are as follows:
    Sixth. All sales are to be made for the account of the Company, in such amounts, for such deliveries and at such prices as shall be from time to time approved by it, and shall be invoiced to the purchaser in the name of Union Collieries Company, B. Nieoll & Co., Agent, and payment for the same shall be made to the said agent by the purchasers thereof, and this condition as to payment shall be stated on the contracts of sale. The invoices shall indicate that the Agent is Sales Agent for the Company, and the Corporate name of the Company shall appear thereon.
    Seventh. The Agent hereby guarantees to the Company all accounts for coal sold by the Agent under the terms of this agreement, and the Agent agrees to mate payment to the Company on the 25th day of each month for all coal delivered to the purchasers thereof during the preceding month, less the commissions to which the Agent shall be entitled on dr in respect to the coal so delivered. While the Agent guarantees to the Company all accounts for coal delivered under this agreement, it is expressly agreed that the Agent shall not be held responsible for any claims made by customers on account of the quality of the coal shipped, shortage in shipments, or any other claims arising or alleged to have arisen on account of any act or omission of the Company, nor shall the Agent be required to pay for coal in any case where the obligation of the purchaser to pay for the .'same shall be in dispute on the ground that the Company has failed to carry opt the covenants and conditions in the sales contract or contracts' approved by it. And in the event that the Agent shall have made payment for coal before such dispute shall have arisen, the Agent may withhold payment of the amount in dispute from moneys of tie Company thereafter coming into the Agent’s possession, until such dispute shall have been adjusted. The Agent shall in no event be liable for payments for coal sold to purchasers in ease the Coal Company shall release the liability of the purchasers to pay for coal by reason of breach of the sales contract or contracts, or otherwise. Said payments shall be based upon the weights of coal furnished by the Company to the Agent from the railroad weights at the scales nearest to the loading point of said coal. The moneys payable by the Agent under this paragraph are in so [sic] sense advances, but are payments for coal delivered by the Company.
    Eighth. If at any time during the existence of this agreement, the Agent is unable to sell all the coal produced by the Company from its mines at prices not less than those last theretofore fixed by the Company, the Company shall have the right to sell so much of said coal as the Agent is unable to sell, and, for such coal so sold by the Company, the Agent shall not be entitled to commissions, nor shall the Agent be obliged to guarantee the accounts for coal so sold by the Company. The inability of the Agent to sell the coal produced by the Company at any given time or from time to time shall not affect the right of the Agent to sell said coal thereafter during the life of this agreement (in accordance with the provisions thereof.) It is understood and agreed, however, that the price or prices for which the Company’s coal shall be sold by the Agent shall be fixed by the Company from time to time and the Agent shall be advised at his Pittsburgh Ofiice by such authority in such manner as may be arranged by the Company, and the Company shall not at any time offer for sale, or sell any coal (as to which the Agent is herein constituted the Sales Agent of the Company) at a lower price or on other terms than that at which the Agent has been last theretofore authorized by the Company to sell the same.
    In 1917 the taxpayer shipped coal covered by this contract, and at the end of 1917 there was an unpaid balance of the price of such coal amounting to $25,873.99,. The taxpayer discussed this unpaid balance with Nicoll frequently in 1917 and 1918, but Nicoll denied liability and refused to pay at that time. At a meeting of the directors of the taxpayer on February 24, 1919, the following resolution was adopted:
    Resolved, that whereas the Board of Directors have been advised that there is scarcely a possibility of the Company being able to collect its claim against B. Nicoll & Company, carried on the books of the company at $25,873.99,
    Therefore, be it resolved that the said amount of $25,873.99 be charged to the profit and loss account of the company as a loss.
    The amount of $25,873.99 was actually charged off the books of account after 1918, at the time in 1919 when the books were closed for 1918.
    The following collections were subsequently made on this account :
    Sept. 80, 1919_$6, 624. 55
    Mar. 11, 1920___ 4,912.10
    Sept. 24, 1920-■_ 8,046.73
    Nov. 3, 1920--- 4,422.03
    24,005. 41

      The amounts recovered in 1919 and 1920 were included in the taxpayer’s returns of taxable income for those years.
    The coal which was covered by the $25,873.99 was required by the Government to be shipped and was shipped to a pool maintained at the Lower Lake ports. Coal from this pool could only be shipped upon the authorization and direction of the pool management. Some of the shippers had taken more coal from the pool than they were entitled to, and this left too little for the rest. Mcoll refused to pay the bill because, he said, he had not received his proper share of the coal in the pool. The taxpayer’s counsel said the amount was uncollectible from Mcoll. The taxpayer continued to ship coal upon Mcoll’s order, under the contract during 1918. All coal was paid for, except the disputed coal in the pool. The payments were subsequently made for this coal because, through the efforts of the pool management, those who received more coal than they were entitled to paid for it.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Steknhagen:

The taxpayer, relying upon article 222, Regulations 45, urges that, in 1918, its Mines Nos. 1 and 2 had reached their normal production, and therefore the expenditures for cars, motors, machines, rails, ties, switches and frogs, when made, were properly deductible as ordinary and necessary business expenses. The argument is similar- to that considered in the Appeal of Bruin Coal Co., 1 B. T. A. 83, and Appeal of Winifrede Coal Co., 1 B. T. A. 566, the former being relied upon by the taxpayer and the latter by the Commissioner. These decisions indicate the difficulty of regarding the article as an authoritative construction of the statute. Under it, the deductibility of any item, after a mine has reached “the development stage,” depends first upon whether it is to be called a major item ” or a “ minor item.” This Board must apply the statute directly to the facts and may not insert into the statute a classification which is not there expressly or by clear implication. When the statute provides for the deduction of ordinary and necessary expenses, the Board will determine whether, all things considered, the expenses in question are such, and this determination should not be made to depend alone upon whether they are major or minor items. Such an inquiry would only inject into the problem an additional question no simpler than the primary question. The article also adds, as a factor of deductibility, that the item is “ necessary to maintain the normal output.” We think this is unauthorized and, to the extent that the opinion in Appeal of Bruin Coal Co., 1 B. T. A. 83, adopts this criterion, it is overruled. In the Winifrede Appeal the properties in question, including mining machines, which are also in issue here, had a useful life of several years, and the Board held them to be capital items and their cost not deductible as expenses.

In the present record, the taxpayer’s engineering witness testified that all of the items in question would last more than a year, except for an accident, such as the collapse of the roof of the mine. It also appears that some of this property was used in Mines Nos. 1 and 2 until those mines were exhausted in 1922. The machines were thereafter rebuilt. Some of the cars were used in Mine No. 3. In such circumstances, it is our opinion that their cost should not be deducted so as to reduce taxable net income of the year of purchase, merely because they may serve to maintain production at its existing level. Like all other items of property used in the business of a taxpayer, they are subject to exhaustion, wear and tear, and obsolescence, and if, in a proper case, such exhaustion be measured by the units of production, this would be a normal method of recovering the initial outlay during the period of useful life. The loss by casualty is expressly provided for by a deduction when it occurs, just as the amortization deduction has already been provided for.

We are of opinion, also, that the deduction of the alleged bad debt was properly disallowed by the Commissioner. Whether there ever was a debt on this account owing by Nicoll is doubtful. From the contract it would seem that Nicoll’s liability for the purchase price of coal was only a secondary liability, if any. We need not determine that question. Nicoll denied liability.- But the coal had been shipped, and the Fuel Administration distributed it through the coal pool of the Lower Lake ports. Just what this was, or how it operated, does not clearly appear, and we can not determine to whom the taxpayer could rightfully look for responsibility for proper delivery. We are told that it could not look to the United States, while, at the same time, it is said that the United States sequestered the coal. However, it was never supposed that the coal was lost. Apparently, the administration of the pool involved some temporary confusion until deliveries and liability could be traced. This was done and the amount was paid almost entirely in little more than a year — not a long time under the circumstances.