text:
    Laurence Arnold Tanzer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81355.
    Promulgated February 1, 1938.

      John W. Townsend, Esq., for the petitioner.

      Daniel A. Taylor, Esq., for the respondent.
   OPINION.

Kern :

Since no question is raised by respondent as to the validity of the gift of the securities to petitioner from his wife, the sole question is whether the gift of the securities in question and their ultimate sale by petitioner constituted a transaction entered into for profit within the meaning of section 28 (e) (2) of the Kevenue Act of 1932, set out in the margin. Other sections of the Kevenue Act of 1932 which are pertinent to the decision in this case, to wit, sections 113 (a) (2), 101 (b), 101 (c) (2), 101 (c) (6), 101 (c) (8), 101 (c) (8)) (B), and 111 (a), are also set out in the margin.

Where ordinary investment property is acquired by gift from a donor who has purchased it as an investment, and this property is later sold by the donee, the ultimate sale by the donee is part of a transaction entered into for profit unless the conduct of the donee furnishes evidence to the contrary. Yol. 3, Paul and Mertens, Law of Federal Income Taxation, p. 279, par. 26.49. The original acquisition of the property later becoming the subject of the gift was for investment reasons, the purpose being to obtain a satisfactory return on the money invested, together with an assured repayment of the money or a subsequent sale of the property at a profit, and is therefore to be regarded as a transaction entered into for profit. R. W. Hale, 32 B. T. A. 356; affd., 85 Fed. (2d) 819. Where the subsequent sale is made by the donee, it has been considered by Congress as a part of a transaction begun by the original acquisition of the property by the donor and in the Revenue Acts from 1921 to 1932, inclusive, the basis for determining gain or loss from the sale of the property by the donee has been the same as it would have been in the hands of the donor, i. e., the cost to the donor. Because of the fact that such provision of the revenue acts applied to the determination of both gain and loss on the part of the donee, and not to gain alone, and gifts and subsequent sales by the donee were made similar to the one involved in the instant case, the Revenue Acts of 1934 and subsequent years provide that in determining loss to the donee the basis shall be either that provided for in prior revenue acts or the fair market value of the property at the time of the gift, whichever is lower. Sec. 113 (a) (2), Revenue Act of 1934; Report of the Senate Committee on Finance on the Revenue Act of 1934, p. 33. Since the original acquisition of investment property by the donor is a transaction entered into for profit, and since under the Revenue Act of 1932 the basis for determining gain or loss from a sale by the donee would be the same as it would have been to the donor, we must conclude that Congress intended to treat the sale of property by the donee as part of a transaction begun by its purchase by the donor; therefore, we must conclude that a .sale of such property by the donee is a transaction entered into for profit. On the other hand, where the property acquired by gift or inheritance is not ordinary investment property but was acquired by both donor and donee for personal use or enjoyment, and there was no thought at the time of its acquisition by either of its ultimate disposition, the sale of such property by the donee made long after its acquisition is not part of a transaction entered into for profit. Juliet P. Hamilton, 25 B. T. A. 1317. In the instant case the property acquired consisted of investment securities, originally purchased by petitioner’s wife as an investment, which the donee at the time of acquisition expected ultimately to sell and did sell a short time thereafter. Therefore, the transaction must be considered as one entered into for profit even though one of the purposes motivating the donor in making a gift, of such property and the donee in accepting and subsequently selling the property given was to make available to the donee a capital loss for income tax purposes.

Reviewed by the Board.

Judgment will be entered for the petitioner.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (e) Losses by Individuals. — Subject to the limitations provided in subsection (r) of this section, in the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—
      *******
      (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or
      *******

       SBC. 113. ADJUSTED BASIS EOR DETERMINING GAIN OR LOSS.
      (a) Basis (Unadjusted) of Property. — The basis of property shall be the cost of such property; except that—
      *******
      (2) Gifts after December 81, 1920. — If the property was acquired by gift after December 31, 1920, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift. If the facts necessary to determine such basis are unknown to the donee, the Commissioner shall, if possible, obtain such facts from such donor or last preceding owner, or any other person cognizant thereof. If the Commissioner finds it impossible to obtain such facts, the basis shall be the fair market yalue of such property as found by the Commissioner as of the date or approximate date at which, according to the best information that the Commissioner is able to obtain, such property was acquired by such donor or last preceding owner.
      SEC. 101. CAPITAL NET GAINS AND LOSSES.
      *******
      (b) Tax in Cash of Capital, Net Loss. — In the case of any taxpayer, other than a corporation, who for any taxable year sustains a capital net loss (as hereinafter defined in this section), there shall be levied, collected, and paid, in lieu of all other taxes imposed by this title, a tax determined as follows: a partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner as if this section had not been enacted, and the total tax shall be this amount minus 12% per centum of the capital net loss; but in no case shall the tax of a taxpayer who has sustained a capital net loss be less than the tax computed without regard to the provisions of this section.

        (c) Definitions. — For the purposes of this title—
      *******
      (2) “Capital loss” means deductible loss resulting from the sale or exchange of capital assets.

        *******

      (6) “Capital net loss” means the excess of the sum of the capital losses plus the capital deductions over the total amount of capital gain.

        *******

      (8) “Capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the iaxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business. For the purposes of this definition—
      *******
      (B) In determining the period for which the taxpayer has held property however acquired there shaU be included the period for which such property was held by any other person, if under the provisions of section 113, such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person.
      SEC. 111. DETERMINATION OF AMOUNT OF GAIN OR LOSS.
      (a) Computation of Gain ok Loss. — Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b), and the loss shall be the excess of such basis over the amount realized.


source: Caselaw Access Project

author: Sternhagen:

license: Public Domain

text:
    T. I. Stoner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81922.
    Promulgated February 1, 1938.

      Arnold F, Sohaetzle, Esq., for the petitioner.

      Harold I). Thomas, Esq., for the respondent.
   OPINION.

Sternhagen:

Petitioner contends that the special tax bills and sewer tax warrants are obligations of a political subdivision of a state, and therefore that the interest is exempt from tax by clause (A), section 22 (b) (4), Revenue Act of 1932. The bills and warrants were, in accordance with municipal ordinance, issued to contractors in payment for improvements. The special tax bills were payable by the city commissioner of finance and revenue and the sewer tax warrants by the county treasurer, from collections made under special assessments against the specific properties benefited by the improvements, and were secured by a lien on such properties. In all respects here material they are similar to the special tax bills considered in Standard Investment Co., 36 B. T. A. 156, and, as in that case, the interest on them was properly included in petitioner’s taxable income.

Petitioner argues that these obligations can not be distinguished from the municipal bonds the interest on which was held exempt in Michael Poritarelli, 35 B. T. A. 872 (on review, C. C. A., 7th Cir.) and Carey-Reed Co., 36 B. T. A. 36 (on review, C. C. A., 6th Cir.). Those decisions were based, however, on the legislative sanction which had attached to the consistent administrative rulings treating the interest on such bonds as tax-exempt and repeated reenactments of the provisions of section 22 (b) (4). There was no such consistent and well known practice in regard to special tax bills and warrants. While it is true that O. D. 447 and O. D. 491 were revoked and interest on the bonds held taxable in G. C. M. 16961, XV-2 C. B. 179 (1936), this reversal was made after the proceeding of Michael Pontarelli, supra, had been instituted, and was hence of no avail to the Commissioner in that proceeding.

Judgment will be entered for the respondent.

       SEC. 22.-GROSS INCOME.
      * * * * * * *
      (b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title:
      * * * * $ * *
      (4) Tax-Free Interest. — Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; * * *

       O. D. 447, 2 C. B. 03 (1920) ; O. D. 491, 2 C. B. 93 (1920) ; I. T. 2074, 1II-2 C. B, 79 (1924).

       See O. D. 999, 5 C. B. 102 (1921), and I. T. 1606, II-l C. B. 69 (1923), revoked-by G. C. M. 13469 (1934).


author: Mellott :

text:
    Frederick L. Leckie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86565.
    Promulgated February 1, 1938.

      Arthwr E. Peter silge, Esq., for the petitioner.

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

Mellott :

The Commissioner determined a deficiency in petitioner’s income tax for the year 1934 in the amount of $867.29. In an amended answer which he, as'respondent, filed in the instant proceeding he not only denied that he had erred in determining the deficiency but alleged that he had erred in not increasing petitioner’s net income by the addition of $3,004 as a capital net gain. He accordingly asked for an increased deficiency. Petitioner, in his reply, admitted that such capital gain was realized. Effect will be given to this admission in a recomputation under Eule 50.

The sole issue for determination is whether or not the respondent erred in disallowing the deduction from gross income of $4,610.35 as a bad debt. In the notice of deficiency it is stated that said amount was disallowed because a bondholders’ committee, acting for the holders of bonds issued by the Morgan Properties Co., had “acquired the properties of [the company] in pursuance of a plan of reorganization, hence under section 112 (b) of the Revenue Act of 1934 no loss is recognized.”

The petition alleges that the respondent erred in disallowing the amount claimed and in holding that the bonds were not ascertained to be partially -worthless; that he erred in holding that the committee acquired the properties “in pursuance of a plan of reorganization in such manner as to prevent the recognition of loss under section 112 (b) ”; and that he “erred in holding that a partial bad debt deduction cannot be allowed if the holders of the bonds evidencing said debt participate in a plan of reorganization by means of which they acquire the properties of the debtor which were mortgaged to secure the debt.”

All of the facts were stipulated. A summary will be sufficient for present purposes.

In November 1926 petitioner paid $5,000 for $5,000 par value bonds of the Morgan Properties Co. (hereinafter called the Morgan Co.). The bonds were secured by a mortgage covering all of the properties of the Morgan Co., consisting of two parcels in Ohio and one in New York. The Morgan Co. leased all of its properties to the Morgan Lithograph Co. (hereinafter called the Lithograph Co.), the agreed rental being an amount equal to the interest .on the bonds, the annual maturities of the bonds, and taxes and operating expensesXof the Morgan Co. The Lithograph Co. sustained losses from its operations for each of the four years ending June 30, 1929, to June 30, 1932, inclusive, and failed to pay the rental maturing August 1, 1932. The Morgan Co. defaulted' in the payment of principal and interest due on its bonds August 15,1932.

The bondholders’ protective committee (hereinafter called the committee) was formed December 1, 1932. On January 5, 1933, petitioner deposited Ms bonds with the committee. Ultimately 9T percent of the $1,280,000 outstanding bonds were so deposited. The Union Trust Co. of Cleveland was the designated depositary of the bonds. All depositing bondholders assented to the provisions of the bondholders’ protective agreement.

On June 3, 1933, the United States District Court at Cleveland, Ohio, appointed a receiver for the Lithograph Co. upon the application of one of its creditors. The trustee for the bondholders filed a claim for the rent due the Morgan Co. and received three dividends, totaling $86,043.71, in 1934. Nondepositing bondholders received their shares of this sum in cash, while the shares of the depositing bondholders were paid to the committee.

Under date of July 1,1933, the committee adopted a “plan of readjustment” and forwarded copies thereof to all bondholders on July 6, 1933. Bondholders assented to the plan by depositing their bonds with the committee, or by permitting them to remain with the committee if they had already been deposited. In accordance with the provisions of the plan the following steps were taken:

On January 12,1934, the committee caused the trustee for the bondholders to commence foreclosure proceedings. On June 4, 1934, the Payne Avenue plant of the Morgan Co. located in Cleveland, Ohio, was sold at public sale pursuant to the foreclosure decree. The committee bid $75,250 and its bid was accepted.

On June 5, 1934, the committee organized an Ohio corporation knoAvn as Industrial Properties, Inc. On July 11,1934, the committee assigned to this corporation the $1,235,000 principal amount of the bonds which had been deposited with it pursuant to the plan and also its bid at the foreclosure sale. Most of the sum bid at the foreclosure sale, or $69,145.29, was paid by a credit in that amount endorsed on the deposited bonds, the balance of the debt represented by the bonds remaining uncanceled. The difference between the sale price and the amount credited on the bonds (which difference was for court costs and other cash requirements of the foreclosure), was paid in cash out of the funds received by the committee in connection with the claim for rent due from the Lithograph Co. All of the capital stock of the new corporation, Industrial Properties, Inc., was received by the committee and held by it during the year 1934 for the benefit of the depositing bondholders.

On November 30, 1934, the second parcel of Ohio property of the Morgan Co., was sold at a public sale, pursuant to the foreclosure decree. Industrial Properties, Inc., was the purchaser, the price bid being $30,000, of which $27,096.32 was paid by a credit in that amount endorsed on the deposited bonds. The balance of the debt represented by the bonds remained uncanceled and the difference between the sale price and the amount credited on the bonds was paid in cash out of the proceeds of the claim for rent.

Industrial Properties, Inc., leased the first mentioned property for two years to a corporation formed to continue the business of the Lithograph Co. This corporation was given the option to purchase the property under lease for $500,000 at any time while the lease was in effect. The last mentioned property was leased to an Ohio corporation engaged in the business of producing continuous business office forms printed on paper.

The New York property could not be sold for enough to produce any substantial return to bondholders, and this situation existed prior to December 31, 1934. Following the receipt of an offer from Laundered Service, Inc., a New York corporation, in June 1935, the committee caused foreclosure proceedings to be instituted on the New York property covered by the mortgage. At the foreclosure sale in December 1935, Industrial Properties purchased this property for $46,000. It applied the deposited bonds in part payment of the purchase price, leaving the balance of the debt represented by the bonds uncanceled. It paid in cash taxes of approximately $18,060, and also court costs in connection with the foreclosure. Industrial Properties, Inc., immediately transferred this property to Laundered Service, Inc., for $45,000, of which $15,000 was paid in cash and the balance was represented by a bond secured by a purchase money mortgage.

Under date of October 1, 1936, the committee wrote a letter to the depositing bondholders, including petitioner, advising them of the action theretofore taken pursuant to the plan. The letter stated that the committee, in accordance with the plan, would distribute the capital stock of the new corporation to holders of certificates of deposit on the basis of one share for each $100 principal amount of bonds deposited with the committee and that the new corporation contemporaneously would pay a dividend of $2 per share. Petitioner surrendered the certificate of deposit which had been given to him when his bonds were turned over to the depositary and on October 19, 1936, received 50 shares of the capital stock of Industrial Properties, Inc., and $100 in cash representing dividends at the rate of $2 per share.

Nondepositing bondholders have received cash distributions totaling $154.5873 per $1,000 bond, representing their proportional interest in the amounts received through sale of the properties and on the claim for rent filed in the receivership of the Morgan Co. Of this sum they received $127,928 per $1,000 bond during 1934.

Petitioner is one of the partners in the firm of Duncan, Leckie, McCreary, Schlitz & Hinslea, attorneys, of Cleveland, Ohio, which represented the trustees for the bondholders under the trust mortgage and prosecuted the Ohio foreclosure action, including the sale of the two Ohio properties owned by the Morgan Co. The facts with respect to the condition of the Morgan Co. were known to these attorneys (including petitioner) in 1934. Petitioner determined in 1934 that the debt represented by the bonds was partially worthless, made a partial charge-off of $4,610.35 in 1934, and claimed a bad debt deduction of this amount in his income tax return for that year. This deduction was disallowed by the respondent.

At the hearing both parties made reference to the case of Irene O. Kitselman, 33 B. T. A. 494, which had been reversed by the United States Circuit Court of Appeals for the Seventh Circuit in Commissioner v. Kitselman, 89 Fed. (2d) 458, and upon brief it is discussed at length. At the time of the hearing application had been made to the Supreme Court for a writ of certiorari but the writ had been neither denied nor granted. Respondent, having prevailed in the Circuit Court and the facts in the instant proceeding being somewhat analogous to those in that case, relies upon the decision of the court. Petitioner, while admitting that an affirmance by the Supreme Court, of the decision of the court in the Kitselman case would have been decisive of the present controversy, nevertheless urges that the Board give further consideration to the question since the denial of the writ, which has subsequently occurred, 302 U. S. 709, is not tantamount to a decision by the Supreme Court upon the question decided. In other words, he relies upon the decision of the Board. The Board has therefore made a careful reexamination of the whole question, and has given due consideration to the argument and authorities cited by both parties, including the opinions of the court and the Board in the Kitselman case.

In the Kitselman case the Board held that there was not an exchange of stock or securities within the meaning of section 112 (b) (3) of the Revenue Act of 1928 since, under the view then held by the Board, there was not a reorganization within the definition of that term in section 112 (i). The Circuit Court, having before it the group of cases decided by the Supreme Court December 16, 1935, especially Helvering v. Minnesota Tea Co., 296 U. S. 378; G. & K. Manufacturing Co. v. Helvering, 296 U. S. 389; and Helvering v. Watts, 296 U. S. 387, reversed the decision of the Board and held that there was a reorganization. It held, citing the above cases, that bonds are securities within the meaning of the statute and that they, but not mere short term notes, represent sufficiently definite, material, and substantial interest to satisfy the implicit requirement of a “continuitjr of interest.” Cf. Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U. S. 462; Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937. The Circuit Court of Appeals for the Ninth Circuit, in Lilienthal v. Commissioner, 80 Fed. (2d) 411, has held under the same section of a later revenue act that collateral trust bonds of a corporation, which were exchanged for stock, are securities within the meaning of such section. The Board has made a similar holding in Kaspare Cohn Co. Ltd., 35 B. T. A. 646 (on appeal to the Ninth Circuit) and Lucien H. Tyng, 36 B. T. A. 21. There is no difference in principle between those cases and the case at bar, though in them stock was exchanged for bonds while in the instant case bonds were exchanged for stock. But the statute (sec. 112 (b) (3), supra) in each instance refers to “stock or securities.” It seems, therefore, that the court was fully justified in concluding that the bondholders had effectuated a statutory reorganization and that a similar holding should be made in the instant proceeding.

If, however, the Circuit Court erred in holding in the Kitselman case that a statutory reorganization had been effected — which we do not intimate — and if we are wrong in making a similar holding here, which carries with it, as it does, a holding that section 112 (b) (3)1 of the Revenue Act of 1934 is applicable, respondent must nevertheless prevail. Section 112 (b) (5) is clearly applicable and under it no finding need be made that there was a reorganization. It provides that no gain or loss shall be recognized if property is transferred lo a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation. Petitioner and a majority of the bondholders, in 1933, transferred their bonds to the committee; but they remained the equitable owners of them. When, in 1934, the committee transferred the property and bonds held by it in trust for the bondholders, to the new corporation in exchange for all its stock, the committee held such stock as trustees for the bondholders and they, through their trustees, were in control of the new corporation. The plan contemplated that the stock of the new corporation would be “distributed or exchanged * * * pro rata among the depositing bondholders”, and this was subsequently carried out. It seems clear, therefore, that the exchange in 1934 came squarely within section 112 (b) (5) and hence no gain or loss is to be recognized.

At first blush it might seem, inasmuch as petitioner determined in 1934 that the debt represented by the bonds was partially worthless and charged off a portion of his investment in such bonds, that the amount should be allowed as a deduction from his gross income. But not so. His investment in 1934 was that of an equitable owner in the property held by the committee as trustee for him and the other bondholders. We have no evidence from which we can determine the value of such ownership or his aliquot part in it; but we are satisfied that it, even in 1934, had a greater value than he woidd have us ascribe to it. Clearly it had at least as much value as a similar amount of bonds owned by a nondepositing bondholder. Such bondholders realized, during 1934, more than 12y2 percent of their investment. If petitioner had kept his bonds and hence had been a nondepositing holder, he would not have sustained a loss equivalent to that which he charged off. But he did not do so. He participated in the reorganization and exchanged his bonds for stock of the new corporation. It is obvious that he and the other bondholders represented by the committee felt, and we believe justifiably, that in so doing they would be able to minimize, if not entirely eradicate, their loss; for the reorganized Lithograph Co. was given the option of purchasing, for $500,000, the property which the committee had bid in for $75,250. In addition, the property had been leased to the reorganized company at $10,000 for the first year, $15,000 plus current taxes for the second year, with the option of extending the lease for three years at a rental of $25,000 for the third year and $30,000 for each of the fourth and fifth years, and the first year’s rent luid been paid.

The new company liad also acquired tlie second parcel oí Ohio property prior to the end of 1934 and a mortgage note in the face amount of $13,000, secured by a first mortgage on a residence in Lakewood, Ohio, all for $30,000, the deposited bonds having been applied in part payment thereof. This property was leased for a period of five years, ending April 30, 1940, at an annual rental of $7,500 for each of the first two years, $8,000 for the third year and $9,000 for the fourth and fifth years, with the option to the lessee of renewing the lease for an additional period of five years at a rental to be agreed upon, but not to exceed $12,000, and to purchase the property at an amount equal to ten times the annual rental then current. The committee and the new company also had a substantial interest, as the holder of 97 percent of the outstanding bonds, in the property located in blew York.

In a letter written by the committee to the depositing bondholders under date of October 1, 1936, it was stated that the new corporation then had on hand the following cash and properties:

1. Cash $37,640.63.
2. The Payne Avenue property, leased, to Morgan Lithograph Corporation.
3. Tlie East 30th Street property leased to Bonnar-Vawter Eanform Company, Inc.
4. A purchase money note in the face amount of $60,000 executed by Morgan Lithograph Corporation, secured by a chattel mortgage on equipment and machinery sold to that corporation and located in the Payne Avenue plant, Cleveland, Ohio.
5. A bond in the face amount of $30,000 executed by Laundered Service, Inc., secured by a purchase money mortgage on the Elmhurst, New York, Property, the unpaid balance of principal upon which is $29,500.
6. A defaulted note in the face amount of $13,000 secured by a first mortgage on a dwelling on West 117th Street in Lakewood, Ohio, upon which foreclosure proceedings are pending.

The total amount of the indebtedness of the new corporation was stated to be not in excess of $11,500. In that year petitioner received a cash dividend of $100 upon his stock in the corporation.

While the value of petitioner’s interest in the corporation in 1936 is no criterion by which the value of such interest in 1934 can be determined, it is nevertheless obvious, even if the situation as it existed in 1936 be ignored, that such interest had a value greater than that reported by him. If, therefore, we are in error in concluding that section 112 (b) (3) or (b) (5) precludes the allowance of the claimed deduction, the deficiency determined by the Commissioner must be approved for failure of the petitioner to establish the portion of the debt which was worthless.

Reviewed by the Board.

Judgment will be entered under Rule 50.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) General Rule. — Upon the sale or exchange of property the entire amount of gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock foe stock on eeoeganization. — No gain or loss shall be recognized if stock or securities in a corporation, a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      *******
      (5) Teanspee to coepoeation conteolled by teanspeeoe. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
      * * * * * * *
      (g) Definition of Reoeganization. — As used in this section and section 113—
      (1) The term “reorganization” means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock; of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (G) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred * * *.


author: Tyson :

text:
    Asa R. Blish, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83241.
    Promulgated February 1, 1938.

      Asa R. Blish pro se.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Tyson :

The respondent determined a deficiency in income tax for the calendar year 1938 in the amount of $1,294.09. The determination is based upon (1) the disallowance of a bad debt in the amount of $300, of taxes paid on cigarettes in the amount of $43.80, and a reduction in the cost of maintaining an automobile for business purposes in the amount of $258.77; and (2) the inclusion in the income of petitioner of $200 as bond interest and $9,340.60 as profit from the sale of commodities.

The sole error assigned by petitioner is the inclusion in his income, of the $9,340.60 profit from the sale of commodities, which amount, he alleges, should not have been so included, because of the fact that his losses during the same year from transactions in stocks more than equaled his gains from the purchase and sale of commodities. At the hearing and on brief, however, petitioner conceded that the gains from his transactions in commodities exceeded his losses from his transactions in stocks by $98.58.

The petitioner is an individual, residing in New York, and was not a dealer in securities, but was working for a salary during the taxable year. During the year Í933 he bought and sold, through Farroll Brothers, Chicago, Illinois, brokers, stocks and also commodity futures ; that is to say, with regard to commodity futures, he purchased and sold contracts to accept and make future deliveries of grain. During that year he realized a gain of $9,340.60 on his transactions in commodity futures and incurred a loss of $9,242.02 on his transactions in stocks. He failed to report in his income tax return for 1933 either the gain from his transactions in commodity futures or the losses sustained on his transactions in stocks.

As stated, no error was assigned as to any of the items embraced in the deficiency notice, except as to the respondent’s inclusion in income of the profit from the sale of commodity futures, and no evidence was adduced at the hearing with regard to the other items. Consequently, the determination of respondent as to these other items is approved.

There then remains for consideration the sole question of whether or not the petitioner has the right to deduct from his gross income the loss on his sales of stock in the amount of $9,242.02, which is less than his gain of $9,340.60 on his purchases and sales of commodity futures, under section 23 (r) (1) of the Revenue Act of 1932, which reads as follows:

SEC. 23. DEDUCTIONS EROM GROSS INCOME.

* * * * * * *
(r) Limitation on Stock Losses.—
(1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not capital assets (as defined in section 101) shall he allowed only to the extent of the gains from such sales or exchanges (including gains which may he derived by a taxpayer from the retirement of his own obligations).
* * * * * * *
(t) Definition of Stocks and Bonds. — As used in subsections (r) and (s), the term “stocks and bonds” means (1) shares of stock in any corporation, or (2) rights to subscribe for or to receive such shares, or (3) bonds, debentures, notes, or certificates or other evidences of indebtedness, issued by any corporation (other than a government or political subdivision thereof), with interest coupons or in registered form, or (4) certificates of profit, or of interest in property or accumulations, in any investment trust or similar organization holding or dealing in any of the instruments mentioned or described in this subsection, regardless of whether or not such investment trust or similar organization constitutes a corporation within the meaning of this Act.

Petitioner contends that he is entitled to deduct his loss on sales of stocks from his gain on purchases and sales of commodity futures, on the ground that through various purchases of commodity futures he obligated himself by contract to make or accept future deliveries of grain, that through his various sales of those commodity futures he relieved himself of such obligations at a profit, and that those transactions constituted “the retirement of his own obligations” within the meaning of the last parenthetical clause of section 23 (r) (1), supra.

Pretermitting, because unnecessary to decision, consideration of the question of whether or not the kind or character of his obligations claimed to have been retired by petitioner was such as to bring them within the meaning of the last parenthetical clause of section 23 (r) (1), supra, it is nevertheless true that, whatever may have been their kind or character, it is not shown in this record that the obligations were retired at less than their face amount. This being true, no gain is shown to have been derived by petitioner from the retirement of the obligations incurred in his commodity transactions within the purview of the last parenthetical clause, since that clause-treats only of such gains as result from the retirement by a taxpayer of his own obligations at less than their face amount.

If aid is needed to support this interpretation of the meaning of the last parenthetical clause of section 23 (r) (1), supra, it is amply supplied by the legislative history of its incorporation in the Revenue Act of 1932. Prior to the passage of the Revenue Act of 1932 there was no provision in existing law corresponding to section 23 (r). When the enactment of section 23 (r) was under consideration by the Senate the parenthetical clause here discussed was inserted as an amendment thereto, except for the change hereinafter mentioned made by the Conference Committee.

The amendment as adopted by the Senate was agreed to by the Conference Committee of the Senate and House, with the exception that the word “his” was inserted in lieu of the word “its” preceding the last two words in the parenthetical clause of “own obligations”. The parenthetical clause as so agreed to by the Conference Committee, was enacted into law and appears in the Revenue Act of 1932.

From the explanation of the purposes of the amendment as made on the floor of the Senate when it was adopted, it clearly appears that it was intended and designed by Congress to meet the situation presented by the opinion in the case of United States v. Kirby Lumber Co., 284 U. S. 1, in which opinion it was held that the taxpayer had realized taxable gains through the retirement of its own obligations by the purchase thereof for an amount less than the amount of the obligations.

We conclude that the respondent properly included in petitioner’s income his gain from purchases and sales of commodity futures and that there may not be allowed as a deduction, to the extent of any part of such gain, the amount of petitioner’s loss on sales of stocks, since it was not shown that the gain was derived from “the retirement of his own obligations” within the meaning of section 23 (r) (1), supra. Accordingly, the respondent’s determination is approved.

Decision will be entered for the respondent.

       Mr. REED. Mr. President, X offer the amendment which X send to the desk.
      The VICE PRESIDENT. The amendment will be stated.
      The Chief Clerk. In the committee amendment, on page 32, following the word “exchanges,” in line 13, * * * it is proposed to strike out the period and insert in parentheses as follows: “(including gains which may be derived by a taxpayer from the retirement of its own obligations.)”
      *******
      Mr. REED. Just a word in explanation.
      The Finance Committee had decided, rather drastically, that the deduction of losses should be limited to the amount of gains in securities that the taxpayer realizes during the tax year. With that decision I make no quarrel. Last November, however, the Supreme Court of the United States decided, in the Kirby Lumber case, that where a corporation bought its own bonds at less than par, it realized a taxable profit. If that is a gain, as the Supreme Court has decided, it is only justice that it should be allowed to be considered as a gain in offsetting against losses in that year.
      The amendment * * * simply provides that that gain may be taken into consideration in the same way that gains from dealing in somebody else’s stocks or bonds are taken into consideration.
      * * * * sH * *
      The VICE PRESIDENT. The question is on agreeing to the amendment offered by the Senator from Pennsylvania to the amendment of the committee.
      The amendment to the amendment was agreed to.
      The amendment, as amended, was agreed to.
      [Congressional Record, 72d Cong., 1st sess. — Senate (May 31, 1932), volume 75, part 10, p. 11631.]

       In lieu of the matter proposed to be inserted by the Senate amendment insert the following:
      (r) Limitation on Stock Losses.—
      (1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not capital assets (as defined in section 101) shall be allowed only to the extent of the gains from such sales or exchanges (including gains which may be derived by a taxpayer from the retirement of his own obligations).
      *******
      [Conference Report (H. R. 10236), Revenue Bill, 1932.]


author: Black : Sternhagen,

text:
    Terrace Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80584.
    Promulgated February 1, 1938.

      Lucien H. Boggs, Esq., for tbe petitioner.

      P. A. Bayer, Esq., and J. M. Morcmsld, Esq., for the respondent.
   OPINION.

Black :

Petitioner in its brief states the points upon which it relies, as follows:

1. The Commissioner has not met the burden of proof which devolves upon him to establish prima facie liability upon petitioner as a transferee.
2. The property conveyed by the original taxpayer to the petitioner was a homestead. Under the constitution of Florida a homestead is not a mere right of personal exemption, but a peculiar qualified estate in land of such character as not to be distrainable for Federal taxes even had title continued to stand in the original taxpayer, in other words the Government lost nothing by the transfer.

If petitioner is correct in point 1, tlien we need go no further. One of the essential things which the Commissioner must prove to fix transferee liability in equity upon a transferee of assets is that the transfer was either made while the transferor was insolvent or else resulted in insolvency of the transferor, or, in the case of a corporation, was one of a series of distributions in liquidation which resulted in its insolvency. See Kinnett-Odom Co., 19 B. T. A. 1124; Samuel Keller, 21 B. T. A. 84; affd., 59 Fed. (2d) 499; Eliza J. Wray, 24 B. T. A. 94. There is no contention made by the Commissioner in this proceeding that petitioner was liable at law as a transferee of the assets of Aycock, such as that petitioner by contract assumed and agreed to pay the liabilities of Aycock, including the taxes in question. The allegations of the Commissioner affirmatively pleaded in his answer would only establish a liability in equity.

An examination of our findings of fact will show that the Commissioner has met his burden of proof of showing all elements of transferee liability except one, and that is that the transfer of the assets in question by Thomas J. Aycock and his wife to petitioner on July 12, 1938, was made while he was insolvent or else rendered him insolvent. The record is silent on that point. There can be no question but that if Aycock was insolvent at the time the transfer in question was made to petitioner, Terrace Corporation, or if such transfer rendered him insolvent, such transfer was a fraud upon his creditors and the Government would have a right to proceed against petitioner as a transferee. An insolvent debtor can not make an effective transfer as against his creditors of his property to a corporation which he forms, in exchange for its capital stock (and for the purposes of this discussion we will treat all of the stock of petitioner as having been issued to Aycock or his nominees). First National Bank of Chicago v. Trobein Co., 59 Ohio St. 316; Allen v. French, 178 Mass. 539. It seems equally well settled that a solvent individual who is not rendered i/nsol/omt thereby, may freely convey his property to whomever he pleases, no actual fraud being shown. Coaldale Coal Co. v. State Bank, 142 Pa. 288; 21 Atl. 871. Cf. McDonald v. Williams, 174 U. S. 397; Hollins v. Brierfleld Coal & Iron Co., 150 U. S. 371.

Was Aycock insolvent at the time he made the transfer in question or was he rendered insolvent thereby? It is that question which we are unable to answer from the facts which have been proved. It is respondent’s contention in his brief that all the evidence, when taken together, makes out a prima facie case of transferee liability and that if, at the time of the transfer of assets in July 1933, Thomas J. Aycock was still solvent and had other assets left which were subject to the payment of his debts, the burden was upon petitioner to show that fact.

An examination of respondent’s answer filed in this proceeding-shows that he affirmatively alleged all the facts which were necessary to make out a prima facie case of petitioner’s transferee liability, but these allegations were denied by petitioner in its reply, which was duly filed. It was therefore the burden of the Commissioner to prove these facts at the hearing. He proved them all satisfactorily by a stipulation of facts which was filed except as to the insolvency of Aycock at the time of the transfer or that the transfer itself resulted in his insolvency.

As to this vital matter petitioner points out that the conveyance in question was made July 12, 1933, and that there is nothing in the stipulated facts to show that Aycock was insolvent at the time of the transfer or that the transfer itself resulted in his insolvency; that, while it is true that the stipulation of facts shows that “The deficiencies determined by the Board for the years 1925, 1928 and 1929 were assessed against Thomas J. Aycock, Jacksonville, Florida, on respondent’s March, 1934, list in the respective amounts of $9,859.82, $123.92 and $301.53, plus interest as provided by law, and that such amounts remain outstanding and are unpaid; that the respondent has diligently proceeded in an attempt to collect said amounts from Thomas J. Aycock without avail and has issued a warrant of distraint to enforce collection of said amounts from said Thomas J. Aycock and after diligent search has been unable to locate any property of said Thomas J. Aycock out of which collection of said taxes could be effected,” nevertheless, these facts are insufficient to show that Aycock was insolvent at the time of the transfer, July 12, 1933, or that the transfer itself rendered him insolvent. Petitioner concedes that the stipulated facts show that Aycock was insolvent from and after the assessment of deficiencies against him in March 1934, but contends that these facts fall short of showing that Aycock was insolvent on July 12, 1933.

In this contention we think petitioner must be sustained. It may well be that respondent could have proved that the transfer which Aycock and his wife made to petitioner on July 12, 1933, was made while he was insolvent or that the transfer itself rendered him insolvent, but he did not prove it and we know of no authority for us to supply by inference what respondent has failed to prove. The statute places the burden of proof to show transferee liability upon respondent and that means that he must prove all elements which are necessary to make out a prima facie case. He has not made out in the instant case such a prima facie case and there is no obligation upon the transferee to go forward with his defense until respondent has done so.

It is undoubtedly true that if respondent had proved that Aycock was insolvent at the time he and his wife made their conveyance of the homestead property to petitioner, or immediately thereafter, the petitioner would not be heard to claim that it was an innocent purchaser for value. The rights of an innocent purchaser for value would not be a valid defense available to petitioner, a transferee corporation, under such circumstances. Clark v. Walter T. Bradley Coal Co., 6 App. D. C. 437; Roberts v. Hughes, 86 Vt. 76; 83 Atl. 807.

But, as we have already pointed out, a transferee does not have to enter upon his defenses until the complaining creditor has made out a prima facie case, and the trouble in the instant case is that respondent has not proved that Aycock was insolvent when he made the transfer nor has he proved that such conveyance resulted in Ay-cock’s insolvency. What respondent has proved is that Aycock was insolvent seven or eight months afterwards, at the time the deficiencies were assessed against him in March 1934, and has continued so thereafter. It is true that the stipulation shows that the Commissioner has issued a warrant of distraint against Aycock and has found no property.

This is equivalent to a return of an execution nulla bona against the debtor and is sufficient to prove that the creditor has exhausted his remedies against the debtor transferor (one of the necessary elements to prove in establishing transferee liability in equity), but the weight of authority seems to hold that the return of an execution nulla bona against the debtor, several months after the alleged fraudulent transfer, is not sufficient to prove that the debtor was insolvent at the time of the transfer or was rendered insolvent thereby. Cf. American Feature Film Co., 24 B. T. A. 18.

In this latter case the facts showed that the taxes against the taxpayer transferor had not been paid and that distraint warrants had been issued against him and returned nulla bona. Nevertheless we said, “These facts do not prove insolvency immediately after the alleged distribution [citing cases].”

Respondent seems to assume in his argument that if he has proved Aycock insolvent after March 1934, when the judgment for the deficiencies in income taxes was rendered against him by the Board of Tax Appeals, this proof relates back and is sufficient to make out a prima facie case that Aycock was insolvent immediately after the conveyance in question — July 12, 1933 — and that if he had sufficient property left with which to pay his debts, that would be a fact which petitioner would have to prove. We do not understand the weight of authority to support such a rule, though there is some minority authority to that effect. The Supreme Court of Indiana, in Nevers v. Hack, 138 Ind. 260; 37 N. E. 791, stated what we believe to be the rule followed by the majority of the courts on this question. The court in its opinion stated, in part, as follows:

* * * It is the settled law in this state that it must be both alleged and proven, before an alleged fraudulent conveyance can be avoided, that at the time of the conveyance, and at the time the suit is brought, the debtor did not have enough property left, subject to execution, to pay his debts. Pence v. Croan, 51 Ind. 336; Sherman v. Hogland, 54 Ind. 578; Evans v. Hamilton, 56 Ind. 34; Bentley v. Honkle, 57 Ind. 374; Romine v. Romine, 59 Ind. 346; Deutseh v. Korsmier, Id. 373; Price v. Sanders, 60 Ind. 310; Whitesel v. Hiney, 62 Ind. 168; Spauling v. Myers, 64 Ind. 264; Nohle v. Hines, 72 Ind. 12; Broker v. Kelsey, Id. 51; and many other cases too numerous to cite. Counsel for appellant concedes this to be the law in this state, but contends that, if the insolvency of the debtor be established or proven to exist at the time the suit is brought to avoid the conveyance, that carries with it the presumption that such insolvency existed prior to that time, and extends bach to the time when the conveyance was made, and cites, in support of that proposition, Lee v. Lee, 77 Ind. 251. That ease — and perhaps some others, among which are Bruker v. Kelsey, supra, and cases there cited — holds that a return of an execution nulla bona shortly before the suit is brought may be sufficient, prima facie, to prove that the grantor did not have property, at the time the suit is brought, subject to execution, sufficient to pay his debts. But none of them holds that such return is sufficient to prove that he did not have sufficient property at the time the conveyance was made. In support of the contention that such return is sufficient, we are referred to Strong v. Lawrence, 58 Iowa, 65, 12 N. W. 74, and Carlisle v. Rich, 8 N. H. 44, both of which hold that “where it is found that a debtor is insolvent at the time the judgment is rendered, and is unable to respond to the amount recovered, his insolvency will be considered as extending back beyond a voluntary conveyance of his property made during his indebtedness, unless the contrary be shown.” This doctrine virtually puts the burden of proof upon the wrong party. It, in effect, amounts to saying to a party charged with a fraudulent conveyance, “You must prove yourself innocent before the party preferring the charge is required to prove anything.”

Cf. Field v. Otero, 255 Pac. 785.

It should be kept in mind that in a transferee proceeding insolvency must be proved at two basic dates: (1) At the time of the transfer of the property; (2) at the time the creditor brings his action to subject the property in the hands of the transferee to the payment of his claim. The first is necessary in order to show that the conveyance was a fraud on the transferor’s creditors. The second is necessary in order to show that the primary debtor is unable to respond to the creditor’s demand and therefore a resort to a secondary liability is justified.

If insolvency is shown at the first period the presumption would be that it continued to the second period, in the absence of a showing to the contrary, for where a showing is once made that insolvency exists it is presumed to continue until the contrary is shown. But a showing of insolvency at the second period does not relate back to the first period and establish insolvency at the first period. That we think is the weakness of respondent’s position as it relates to the evidence which we have before us in the instant case. The only way that we can make a finding that Aycock was insolvent at the time of the conveyance in question, or was rendered insolvent thereby, is to relate back the evidence as to the period of March 1934 and thereafter. And this, for reasons which we have already stated, we do not think we may do.

In addition to the authorities cited above, we think the instant case is controlled by our decision in Annie Troll, 33 B. T. A. 598. In that case we said:

Upon the foregoing facts, which we find, we are called upon to determine the liability of petitioner as transferee. The burden of proof is upon the respondent to show that petitioner is liable as a transferee. Title IX of the Revenue Act of 1924, as amended by section 602 of the Revenue Act of 1928. This burden includes the burden of showing that the transfer of the assets to the transferee rendered the transferor insolvent, or that the transferor was insolvent at the time of the transfer. Charles B. Behr, 30 B. T. A. 1291; petition to review dismissed, Commissioner v. Behr, 74 Fed. (2d) 1011; Willard H. Ashton, 28 B. T. A. 582; Florence McCall, 26 B. T. A. 292; Eliza J. Wray, 24 B. T. A. 94; American Feature Film Co., 24 B. T. A. 18; Samuel Keller, 21 B. T. A. 84; affd., Commissioner v. Keller, 59 Fed. (2d) 499; Joseph A. Steinle, Administrator, 19 B. T. A. 325; and Phil Gleichman, 17 B. T. A. 147.
# * * * * * *
Richard Wunsch, deputy collector, testified that at the time he filed the notices of tas lien on July 2 and 3, 1930, he made efforts to locate some assets of Charles Troll, but that he was unsuccessful. It is to be noted that the testimony of this witness is not directed toward proving what assets or liabilities Charles Troll had at the date in question, the controlling date, March 1, 1930, but to dates more than four months later, and therefore, it is not sufficient to prove insolvency on March 1, 1930, the date of the transfers in question here. * * *

On the strength of the foregoing authorities we sustain petitioner’s point 1 and hold that respondent has failed to make out a prima facie case of transferee liability against petitioner as the transferee of the assets of Thomas J. Aycock. This being so, it is unnecessary to rule on petitioner’s point 2.

Reviewed by the Board.

Decision will be entered thd$ petitioner is not liable as transferee of the assets of Thomas J. AycoeJc.

Sternhagen,

dissenting: I think the Commissioner has proved enough to establish prima facie that petitioner is liable in equity for the unpaid deficiencies of the transferor. While there is still the possibility that the transferor was, after conveying his residence to the corporation, the owner of assets sufficient to satisfy the deficiencies, this could have been shown by the petitioner, which was Ms privately created corporation; and I think it fair and not a violation of the rules of evidence to require the petitioner to go forward with evidence to show it or suffer the reasonable inference that the transferor retained nothing with which his tax liability could he satisfied.

There is no need here to import all the technique of setting aside fraudulent conveyances. The question is one of equitable liability. The individual taxpayer, while his deficiency was being litigated in the Board, set up a new corporation to which he transferred his residence and took all its shares, one directly and five to his nominees, members of his family. The corporation was not an innocent stranger. It knew all that the taxpayer knew. So far as this record shows, its shares continued to be owned by the same persons. Without more, there is ground for equitable liability. Seven or eight months later, the taxpayer transferor was found to be insolvent. This, taken with all the earlier circumstances, should establish the liability sufficiently to require rebuttal. What such rebuttal might have been to be effective need not be suggested; but since the transferee has preferred to rest with none at all, the case against it should be held to be established.

Mellott agrees with this dissent.


author: Hill :

text:
    Fontaine Fox, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78834.
    Promulgated February 4, 1938.

      Frank J. Albus, Esq., and E. V. McKeown, Esq., for the petitioner.

      J. R. Johnston, Esq., for the respondent.
   OPINION.

Hill :

Petitioner, relying on the contract between Reynard and the Bell Syndicate, contends that the amount received by Reynard from the Syndicate constituted income to Reynard; that it was properly reported by Reynard in its returns and no portion of it was income taxable to him. The respondent’s position is that his determination is correct and can be sustained on either of two grounds — first, that Reynard was a mere dummy and its identity should be ignored, and, second, that since the $104,000 paid by the Syndicate was compensation for the creative efforts of petitioner it is taxable to him under the rule of the decision in Lucas v. Earl, 281 U. S. 111.

The income in question, having been received by Reynard pursuant to its contract with the Bell Syndicate, is taxable to Reynard under the applicable act unless there is a special situation requiring that it be taxed to petitioner. The rule regarding a corporation and its stockholders as separate taxable entities was stated in New Colonial Ice Co. v. Helvering, 292 U. S. 435, as follows:

As a general rule a corporation and its stockholders are deemed separate entities and this is true in respect of tax problems. Of course, the rule is subject to the qualification that the separate identity may be disregarded in exceptional situations where it otherwise would present an obstacle to the due protection or enforcement of public or private rights. * * *

Here all the contracts regarding the use of the cartoons for syndication purposes and extending over a number of years were between Reynard and the Bell Syndicate. While petitioner signed them, it was in his capacity as president of Reynard and not in his personal capacity. Such other business transactions as Reynard had, involving considerable sums in investments in real estate, stocks, and bonds, were carried on in its name. Federal and state tax returns were filed for it from, the time of its organization. And even before this Board it contested respondent’s determination of its tax liability for the fiscal years ended March 31,1930, and 1931, as appears at 30 B. T. A. 451. In addition its contest of respondent’s determination of its tax liability for the year ended March 31, 1932, is involved in Docket No. 78835. Respondent’s determination there is based on an inclusion in the income of Reynard of a portion of that involved here.

In fact down to the instant proceeding Reynard’s separate identity has been generally respected by petitioner and has been recognized by all who had dealings with it. Respondent’s position in respect to disregarding its separate entity is not entirely consistent with his determination. If Reynard’s identity is to be disregarded for the purpose of including in petitioner’s income the amount it received from the Bell Syndicate, it would seem that it should be disregarded for the purpose of including in petitioner’s income all other items of income received by Reynard as well as its deductions, including security losses. This respondent has not done nor asked in his answer to have done.

Respondent contends that, since the income from the Bell Syndicate contract resulted from the personal efforts of petitioner, it is income of the petitioner within the intendment of the income tax laws, and asks us to find that this was such an exceptional situation as to warrant the disregard of Reynard’s separate identity to that extent. He cites no decision, comparable in facts, and we know of none, in which such action has been taken.

We do not think the facts here warrant disregarding Reynard as a separate entity.

Nor do we think they fall within the purview of the decision in Lucas v. Earl, supra. In that case the question was whether an attorney was taxable for the whole of his salary and fees earned by him in the tax years or only upon one-half, by reason of an agreement with his wife by which his earnings were to be received and owned by them jointly. The court was of the opinion that the case turned upon the construction of the taxing act. It said: “The statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the same when paid from vesting even for a second in the man who earned it.” This was deemed to be the meaning of the statute as to compensation for personal service and the husband who earned the income was held to be subject to the tax. See Blair v. Commissioner, 300 U. S. 5.

Respondent admits that there was no contractual relationship existing between petitioner and the Bell Syndicate and that no assignment of future earnings was involved in any of the contracts. This being true, we fail tp see where Lucas v. Earl, sufra, has any application. Petitioner produced certain cartoons for Reynard. For these it paid bim a stipulated compensation, which was taxable to the petitioner as, such. For the use of the cartoons for syndication purposes the Bell Syndicate paid Reynard a stipulated minimum amount, which was taxable to Reynard as income arising from the use made by it. of the cartoons.

With respect to the royalties of $9,482.30 paid by R K O, Qeorge Borgfeldt & Co., and Fred A. Wish, Inc., fpr the use in their respective businesses of certain characters created by petitioner, he contends that, having assigned his contracts with those corporations to Rey-nard on April 1, 1932, and thereby having transferred all of his rights under them to Reynard, such rights became its property and the subsequent income therefrom was its income. The parties have not discussed in their briefs the question of petitioner’s right to enter into the contracts in view of the contract he had with Reynard. We therefore assume that he had such right.

It is well settled that an assignment of income does not relieve the assignor of the tax thereon. Lucas v. Earl, supra; Burnet v. Leininger, 285 U. S. 136. But where an income producing property is assigned or transferred the income subsequently arising therefrom is not taxable to the assignor. Blair v. Commissioner, supra; Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 286 U. S. 565; Hall v. Burnet, 54 Fed. (2d) 443; certiorari denied, 285 U. S. 552; Commissioner v. O'Donnell, 90 Fed, (2d) 907. Riere the rights petitioner had under the contracts with the three corporations constituted property. Cf. Hall v. Burnet, supra. When he transferred the contracts to Reynard these rights became its property and whatever income thereafter arose from them was income to if and not to petitioner. Respondent takes, the position that Lucas v. Earl, supra, is applicable on the ground that this was. an assignment of contract interests, arising out of the performance by petitioner of services in the past. The contracts between petitioner and the three corporations were for the privilege of using certain characters or cartoons in the business of the respective corporations and not for the services of petitioner. So far as the record shows, petitioner has never been in the employment of any of them. But, conceding- that the contracts, were connected with the past services of petitioner, the rule in Lucas v. Earl, supra, would not be applicable, as it applies only to the assignment of future earnings and not to the assignment of .assets resulting from past earnings. Matchette v. Helvering, 81 Fed. (2d) 73; certiorari denied, 298 U. S. 677.

Reviewed by the Board.

Decision will be entered for the petitioner.

        Pullman Car Co. v. Missouri Pacific Ry. Co., 115 U. S. 587, 596-597; Donnell v. Herring-Hall-Marvin Safe Co., 208 U. S. 267, 273; United States v. Delaware L. & W. R. Co., 238 U. S. 516, 527-529; Cannon Mfg. Co. v. Cudahy Co., 267 U. S. 333; Klein v. Board of Supervisors, 282 U. S. 19, 24.

        Klein v. Board of Supervisors, 282 U. S. 19, 24; Dalton v. Bowers, 287 U. S. 404, 410; Burnet v. Clark, 287 U. S. 410, 415; Burnet v. Commonwealth Improvement Co., 287 U. S. 415, 418-420.

        United States v. Lehigh Valley R. Co., 220 U. S. 257. 272-274; Chicago, M. & St. P. Ry. Co. v. Minneapolis Civic Assn., 247 U. S. 490, 500-501; Southern Pacific Co. v. Lowe, 247 U. S. 330, 337-338; Gulf Oil Corp. v. Lewellyn, 248 U. S. 71.


author: Arundeul:

text:
    Chester A. Sheppard, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87430.
    Promulgated February 4, 1938.

      G. D. Phillips, Esq., for the petitioner.

      W. W. Kerr, Esq., for the respondent.
   OPINION.

Arundeul:

The first question for consideration is whether the amount of $13,402.26 claimed by petitioner as interest for the 144 days that he operated the Texas Gilmore properties is deductible from gross income. Section 23(b) of the Revenue Act of 1932 allows a deduction for “interest paid or accrued within the taxable year on indebtedness,” with certain exceptions not here material.

Petitioner states the question involved here as being whether or not he had an obligation under the agreement of the certificate holders to pay or cause to be paid the interest on the indebtedness represented by the old trust certificates and says that the answer lies on the construction to be placed on that agreement. It is argued that the agreement contemplated that the indebtedness represented by the trust certificates should be kept alive.

The statutory provision allowing deduction for interest on indebtedness means interest on an obligation of the taxpayer claiming it; payments made on obligations of others do not meet the statutory requirement. These fundamentals have often been stated. Colston v. Burnet, 59 Fed. (2d) 867, affirming 21 B. T. A. 396; Automatic Sprinkler Co. of America, 27 B. T. A. 160; Helen B. Sulzberger, 33 B. T. A. 1093. Turning to the agreement here, it is impossible to find therein any obligation on the part of the petitioner to pay interest on the obligations of the Texas Gilmore Co. The essence of the agreement in so far as it relates to this question is, as stated in petitioner’s reply brief, that if the property was purchased by the trustees, the trustees would cause to be issued through a newly formed corporation new certificates of indebtedness including accrued interest. This, we think, is a complete answer to petitioner’s claim. His obligation in this matter was only to cause to be issued by the new corporation certificates evidencing indebtedness taken upon itself and not indebtedness of the trustee. The trustee undertook no obligation of indebtedness or to pay interest.

If somehow there can be spelled out of the agreement an obligation of the petitioner for interest while he operated the properties, we would still be forced to the conclusion that no deduction would be allowable. The petitioner, it must be remembered, was operating the properties as trustee for the certificate holders who were the beneficial owners. Under such circumstances, if there was any liability for interest it would be a liability on the part of the certificate holders to pay interest to themselves. The statute clearly does not comprehend any such liability.

While we do not have the question of deductions by the new corporation, it is worthy of note that when the new corporation wTas brought into being by the certificate holders, they did not place upon it an unconditional liability for interest for the period here involved. Under the coupon set out in the findings of fact, payment for that period was solely in the discretion of the directors of the new corporation.

We accordingly hold that the petitioner did not incur liability for interest during the period that he operated the properties and that lie is not entitled to the deduction claimed.

The record on the depreciation issue is confusing. It appears that the petitioner computed and claimed depreciation in his return on a basis of $490,763.07 and at a rate of 8% percent. The deficiency notice states the depreciation has been allowed at the same rate, which indicates that the respondent used a lower basis than the petitioner. The assignment of error in the petition attacks only the amount disallowed as a deduction and does not indicate whether the petitioner complains of the basis or the rate used by the respondent. From the facts alleged in the petition, it appears that the petitioner questions the rate and not the basis. The disoussion at the hearing and in the briefs is along the line that the basis is in issue.

The evidence is insufficient to establish error in either the rate or the basis. The only evidence directed to the rate is the testimony of the petitioner that in his opinion a fair rate for depreciation is 10 percent. No facts are given upon which we can test the soundness of his statement. The evidence as to the basis is that the petitioner used the figure set up on the books of the Texas Gilmore Co. as depreciated cost. Whether or not that was actual depreciated cost we do not know. In this state of the record it is unnecessary to inquire whether the petitioner’s proper basis is cost to him or cost to the former owners.

Decision will be entered for the respondent.


author: Smith:

text:
    Robert S. Eaton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81350.
    Promulgated February 4, 1938.

      Frank J. Maguire, Esq., for the petitioner.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

Smith:

The sole question presented by this proceeding is whether the petitioner is liable to income tax upon the dividends paid upon 5,000 shares of the capital stock of the Norwich Pharmacal Co. standing in his name. The petitioner contends that, by reason of the fact that he entered into the agreement with his wife on June 1, 1932, by which she was to receive all of the income of the partnership up to $25,000 per year, and inasmuch as the dividends on the 5,000 shares set aside for the alleged partnership amounted in 1932 to less than $25,000, he is not liable to income tax in respect of them.

All of the income tax acts from the Bevenue Act of 1913 have provided that partnerships shall not be subject to income tax as entities but that the members of the partnership shall account annually for their shares of the net earnings of the partnership. In Burke-Waggoner Oil Association v. Hopkins, 209 U. S. 110, the Supreme Court said: “The term partnership as used in these sections obviously refers only to ordinary partnerships.” In section 181 of the Revenue Act of 1932, it is stated: “Individuals carrying on business in partnership shall be liable to income tax only in their individual capacity.”

* * * The requisites of a partnership are that the parties must have joined together to carry on a trade or adventure for their common benefit, each contributing property or services, and having a community of interest in the profits. * * * [Meehan v. Valentine, 145 U. S. 611, quoted in Schumacher v. Davis, (Dist. Ct., E. Dist. of N. Y.), 1 Fed. Supp. 959.]

See also George M. Cohan, 11 B. T. A. 743; affd., 39 Fed. (2d) 540; Harry C. Fisher, 29 B. T. A. 1041.

Was the alleged partnership of B. S. Eaton & Co. an “ordinary” partnership within the meaning of the applicable income tax act? We are of the opinion that it was not. The wife contributed no property, labor, or services to the alleged partnership. The petitioner was to receive no part of the income unless the income in any year exceeded $25,000, which was far in excess of the amount actually received. The petitioner, therefore, did not have any interest in the profits actually realized. Furthermore, the alleged partnership carried on no business whatever during its life. It was never seriously expected that it would. The arrangement was merely one by which a part of the petitioner’s income was to be made available to the wife for the payment of expenses, the principal part of which was the husband’s expenses.

In Corliss v. Bowers, 281 U. S. 376, it was said:

But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed — the actual benefit for which the tax is paid. * * * Still speaking with reference to taxation, if a man disposes of a fund in such a way that another is allowed to enjoy the income which it is in the power of the first to appropriate it does not matter whether the permission is given by assent or by failure to express dissent. * * *

Although B. S. Eaton & Co. was in form a partnership, it was not such in substance. It was only a means by which the petitioner might avoid the payment of income tax on a portion of his income, which was to be used in the major part for his own benefit. In Humphreys v. Commissioner, (C. C. A., 2d Cir.), 88 Fed. (2d) 430, it was held that a partnership existed between the taxpayer and his wife. In that case, however, the wife contributed the original capital for the partnership and the partnership was clearly engaged in the carrying on of a business. We are of the opinion that, in any case where a partnership exists within the contemplation of the taxing statute, the partner must either contribute capital or services to the partnership and must have a community of interest in the profits. Such was not the case here.

The respondent did not err in taxing to the petitioner the dividends paid upon the 5,000 shares of Norwich Pharmacal Co. stock which constituted the capital of the alleged partnership.

Judgment will he entered for the respondent.


author: Smith :

text:
    King County Insurance Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88016.
    Promulgated February 4, 1938.

      Tracy E. Griffin, Esq., and Harold L. Scott, O. P. A., for the petitioner.

      B. M. Coon, Esq., and C. W. Carhart, Esq., for the respondent.
   OPINION.

Smith :

The questions presented by this proceeding are (1) whether the petitioner wTas a business league exempt from income tax for 1931 and 1933, and (2) whether, if not exempt, the delinquency in filing returns for those years was due to a “reasonable cause.”

Section 103 of the Revenue Acts of 1928 and 1932 provides:

The following organizations shall be exempt from taxation under this title—
*******
(7) Business leagues, chambers of commerce, real-estate boards, or boards of trade, not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

There can be no question but that the petitioner qualifies as a business league exempt from income tax for 1931 and 1933, the taxable years involved in this proceeding, unless it is barred from such exemption by reason of the fact that it acted as agent in writing insurance policies on so-called “public business.” The respondent contends that by reason of this fact the petitioner engaged in business for profit and is accordingly barred from exemption. The evidence shows, however, that the members wTaived their commissions upon this public business in favor of the association in order to provide additional revenue for the petitioner’s expenses and because it was deemed in the public interest that there should be no competition on the part of the members in the writing of policies upon municipally owned properties. The members nevertheless were required to pay dues or advances, which were rebated only in part upon the receipt by the association of the commissions upon the public business.

In Waynesboro Manufacturers Association, 1 B. T. A. 911, the Board stated the requirements of this same provision of the taxing statutes, but under a prior law. We there pointed out that it was the intention of Congress to exempt from income tax organizations such as the petitioner, provided they were (1) not organized for profit, and (2) no part of the net earnings inured to the benefit of any private stockholder or individual. An organization to be exempt under this provision of the statute must meet both conditions of the exemption.

Quite clearly the petitioner was not organized for profit. That was not the purpose of the organization. Nor, in our opinion, was it operated for profit during the taxable years 1931 and 1933, notwithstanding that, through an appointed agent, it wrote so-called “public business” policies. The income from this source served merely to reduce the amount of the dues which otherwise would have had to be contributed by the members.

The evidence shows, too, that no part of the net earnings ever inured to the benefit of any private individual. The income from the public business, as above stated, merely served to reduce the amount of the dues. No member ever received, ever expected to receive, or ever had any possibility of receiving, back from the petitioner in any year an amount greater than or even equal to his advances to the petitioner for such year.

Exemption from income tax by a business league is not forfeited by the receipt of incidental income from transactions or operations which would be taxable by a corporation engaged in business for profit. In Crooks v. Kansas City Hay Dealers' Association, 37 Fed. (2d) 83, it was held that the mere fact that an association of this character may receive some income and use that income to carry on its work is no proof that it is organized for the sake of profit. See also Santee Club v. White (C. C. A., 1st Cir.), 87 Fed. (2d) 5.

We are of the opinion that the receipt by the petitioner of commissions on “public business” which served only to reduce the amount of dues payable by the members does not bar the petitioner from classification as an exempt association.

Since the petitioner was exempt from income tax it was, of course, not required to file income tax returns. But in any event the delinquency in filing returns was due to a reasonable cause, even if the petitioner might be held to be taxable. The respondent was therefore in error in determining delinquency penalties.

Judgment of no deficiencies will be entered.


author: Harron :

text:
    Charles W. Deeds, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 84663, 87383.
    Promulgated February 4, 1938.

      George H. Day, Esq., for the petitioner.

      H. F. Noneman, Esq., for the respondent.
   OPINION.

Harron :

The only issue is whether the petitioner is entitled to the exclusion from the total value of conveyances by gift to each donee in each taxable year of $5,000 under section 504 (b), Eevenue Act of 1932. Petitioner made gifts to two donees in each taxable year involved but the question is whether they were gifts of future interests.

The Eevenue Act of 1932 provides in section 504 (b) the following:

(b) Gifts Less Than $5,000. — In the ease of gifts (other than of future interests in property) made to any person by the donor during the calendar year, the first $5,000 of such gifts to such person shall not, for the purposes of subsection (a), be included in the total amount of gifts made during such year.

The exemption from gift tax of $5,000 on gifts to any particular donee in a taxable year is expressly not allowed by the statute in the case of gifts of future interests. Explanation is given in the Congressional Committee Eeports (Eeport No. 655, p. 41; Eeport No. 708, p. 29; 72d Cong., 1st sess.), as follows:

The exemption being available only in so far as the donees are ascertainable, the denial of the exemption in the case of gifts of future interests is dictated by the apprehended difficulty, in many instances, of determining the number of eventual donees and the values of their respective gifts.

The respondent contends that petitioner is not entitled to the claimed gift deductions because the gifts made in the taxable years were gifts of future interests. Petitioner contends that the gifts constituted gifts of present interests in property.

The respondent at the outset of his brief states “that the Board has in effect decided this question against the respondent in Thomas E. Wells, 34 B. T. A. 315, affirmed, 88 Fed. (2d) 339”, but states that the respondent “desires to save the point and is pursuing the matter further.”

The respondent claims first that the beneficiaries of the trusts did not take present interests because he argues that possession and enjoyment of the property are postponed until a future date. This conclusion is based upon the fact that neither the property conveyed to the trust nor the income from it was as a matter of right immediately subject to the unqualified demands of the beneficiaries but rather, until the beneficiaries reached the age of 30, any distribution out of income or principal was subject to the sole discretion of the trustee. The respondent next claims that the transfers can not be regarded as gifts of present interests to the trust as an entity since the trustee acquired no beneficial interest and the gifts were not to him but to the children. He cites Burnet v. Guggenheim, 288 U. S. 280, for the proposition that the gift tax statute is not aimed at every transfer of legal title without consideration, but only at transfers that have the quality of a gift. He concludes that it is necessary to consider the equitable rather than the legal interest transferred to determine whether there was a gift of a future interest in property.

In the Wells case, supra, the same arguments were advanced varied only by the slightly different terms of the trust in that case. In the Wells case there were transfers by gift to three irrevocable trusts each created for the benefit of one named minor child. The terms of each trust were that income should be accumulated until the beneficiary should reach 21 or should die before that age; after reaching 21 the income should be paid to the beneficiary until he reached the age of 30 or until the death of his mother, who was the trustee, and upon either of these events the corpus plus the accumulation should be paid over to the beneficiary in fee. In the case of the death of any beneficiary before the time of distribution the trust corpus was to go to his issue or in default of issue to the other children of the grantor. It was there held that although possession of the trust property was postponed there was present enjoyment thereof by the beneficiaries inasmuch as it was being administered and the income was being accumulated for their sole use and benefit. This conclusion was reached, even though, as in the present case, the trust property was not immediately subject to the demands of the beneficiaries, as a matter of right. The case at bar can be said to be an even stronger case for the conclusion that there is present enjoyment by the beneficiaries, because of the power in the discretion of the trustee at any time before the beneficiaries reach the age of 30 to apply for the benefit of or pay over to the beneficiaries the income and/or principal, while in the Wells case nothing could be distributed to the beneficiaries until they reached 21. In this case the beneficiaries were living and immediately upon the execution of the trusts, as soon as the trusts realized income, it could be paid to or applied for the maintenance of each beneficiary.

As to the second argument of the respondent, set out above, the Board in the Wells case agreed that the trustee, alone, can not be considered as the donee of the gift because the transfer to him does not have the quality of a gift since he has no beneficial use of the property, citing Burnet v. Guggenheim, supra. However, the Board concluded that the trust considered as an entity embracing the trustee as well as the beneficiaries, which entity is defined as a person in the tax statute and has long been treated by the tax statute as having a separate existence, could be considered the donee of the gift. The Board concluded, therefore, as an alternative ground of its decision, that if the trust as an entity be regarded as the donee, it received a present interest in the property, being the entire interest with which • the donor parted. The Board’s decision was affirmed in Commissioner v. Wells, 88 Fed. (2d) 339, which placed primary emphasis on this latter ground of the Board’s decision.

The present proceeding is not distinguishable in principle from the Wells case. Considering the donee, in the case of each gift, to be the trust, a legal entity composed of both trustee and beneficiary, the trust received the “complete property” or all of the grantor’s right, title, and interest in the property conveyed by gifts. All title and interest went out of the grantor at the time of the gifts. Eeceiving the entire title, the trust, therefore, as an entity, received a present interest in the property. This “trust entity” theory has been adopted as an alternative ground of decision in the subsequent cases of Commissioner v. Krebs, 90 Fed. (2d) 880, and Noyes v. Hassett, 20 Fed.Supp. 31. See also Seymour H. Knox, 36 B. T. A. 630.

However, considering the beneficiary alone under each trust as the donee of the gift, there is present the question whether the interest received by him at the time of the gift was a present or future interest. In the case of each trust, one named living beneficiary had the entire beneficial interest throughout the duration of the trust. His interest in the property conveyed to the trustee began immediately upon the conveyance of the property; all income was to be accumulated or applied for the use and benefit of the beneficiary or paid over to him in the discretion of the trustee until the beneficiary reached the age of 30. In the discretion of the trustee the principal could also be applied for his benefit until he reached the age of 30. At the age of 30 the beneficiary was entitled to receive all the income of the trust for the rest of his life; and in the discretion of the trustee, one-half of the corpus and accumulations could be paid to him upon reaching the age of 30. Other distributions of the trust principal could be made during the remainder of the beneficiary’s life, in the discretion of the trustee. Under the terms of each trust it ceases to exist upon the death of the beneficiary and he or she may exercise a power of appointment by will over whatever principal, if any, may remain at that time. Thus, throughout the duration of the trust, the beneficiary has the sole beneficial interest and it began immediately upon the creation of the trust without any beneficial interest intervening. Since this interest of the beneficiary began immediately upon the conveyance to the trust, the beneficiary of each trust took a present interest in the property conveyed. Therefore the $5,000 exclusion from the value of the gifts to each trust is allowable in each taxable year.

This conclusion is in accord with the well considered opinion of Judge Brewster in Noyes v. Hassett, supra, which case is rather closely in point on its facts. In that case, gifts were made to irrevocable trusts each created for the benefit of a different minor child of the grantor for the child’s life, with a special power of appointment by will over any remainder of principal or accumulated income held by the trust at the time of the beneficiary’s death. The trustees had discretion during the respective beneficiaries’ lives to pay over the net income quarterly or oftener to the beneficiaries, or in their discretion, either to accumulate the income for future distribution, or add it to the corpus of the trust. The trustees also had power to make any payments to the beneficiaries from principal which they should deem for the best interests of the beneficiaries. The court held that despite “the contingencies arising from the discretionary powers conferred upon the trustees”, the interests taken by the beneficiaries were not “future interests” and that therefore the $5,000 exclusion was allowable. The case at bar is an even stronger case for allowing the exclusion because of the greater rights of the beneficiaries and the corresponding limitations on the discretion of the trustee. It is even closer to the interest created in the Wells case, supra, as regards the beneficiaries’ ultimate power over any accumulations, since the beneficiaries here have a general power of appointment over anything remaining in the trust under which they can appoint to their estates, if they so desire.

We are of the opinion that under the terms of the trusts in the instant case the beneficiaries received at the time the property was conveyed to the trusts by the petitioner, present interests in that property. The petitioner is therefore entitled to the exclusions claimed from the yalue of the gifts each year to two separate donees as allowed by section 504 (b).

Decision would be entered for petitioner except for errors he appears to have made in stating the total values of the gifts made in each year. In 1934 petitioner returned the gift tax upon the basis of total value of gifts of $186,912.50 whereas the total value corrected by respondent appears to be $185,968.75. In 1935 petitioner returned the gift tax upon the basis of total value of gifts of $315,212.50 whereas the total value corrected by respondent appears to be $314,525. It would follow that since petitioner reported tax in each year upon an erroneous base, his computation of tax must be in error.

Decision will he entered vmder Bule 50.