author: Arttndell :

text:
    William Fleming, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95061.
    Promulgated January 7, 1941.

      B. B. Garmon, Esq., and Harry G. Weelcs, Esq., for the petitioner.

      Stanley B. Anderson, Esq., and James L. Bachstrom, Esq., for the respondent.
   OPINION.

Arttndell :

The issues in this proceeding have been enumerated at the outset and will be considered hi the order there set forth.

Issue No. 1.

We are called on here to say whether petitioner may apply the whole of the proceeds received during the taxable year 1935 under the Haddaway Oil Payment to the cost of that payment as claimed by him or may thus apply only the portion representative of cost and report the residue as taxable income as claimed by the respondent. The petitioner concedes on brief that the issue here is substantially the same as that presented in T. W. Lee, 42 B. T. A. 1217. In that case contrary to the contentions of both parties in the instant case, we held that the basis of oil payments which represented an economic interest in the oil properties to which they applied, as evidenced either plainly by an assignment to the payee of the oil interest out of which the payments were to be made or more remotely by other factors, must be recovered through depletion. Accordingly, we held that proceeds received under such oil payments must be included in taxable income, with appropriate deductions for depletion. The disposition of the present case is governed by that holding. In the situation before us there was an assignment of the interest from which the payments were to be made and accordingly no close question arises as in T. W. Lee, supra. It is clear that petitioners had an economic interest in the oil payment recoverable only through depletion.

Accordingly, petitioner must include in income the entire amount of the proceeds received during the taxable year under the oil payments and is not entitled to the allowance for the return of cost made by the respondent.

Issue No. #.

The question here is whether the petitioner, trustee, is entitled to deduct the entire depreciation and depletion that may be allowed on the trust income for the taxable year where the pertinent provisions of the trust instrument do not direct whether the trustee or the beneficiary shall take the deduction, and the distribution of the income is placed entirely in the discretion of the trustee. The respondent claims that under section 23 (1) and (m) of the Revenue Act of 1934 allowance for depreciation and depletion must be divided, in the absence of specific trust provisions, between the trust and the beneficiary on the basis of the amount of income distributed and retained in that year. The petitioner contends that, properly interpreted, the statute awards the allowance only to those to whom the trust income is “al-locable” under the trust instrument and that in the present case the income was in the first instance allocated entirely to the trustee. Distributions made thereafter in his discretion, argues the petitioner, do not alter this result.

The statute when properly read in the light of the circumstances attendant on its enactment does not support petitioner’s view. Prior to the Revenue Act of 1928 it was held in the case of a trust, the income of which was currently distributable, that the allowance for depreciation and depletion might not be deducted by the beneficiary but only by the trust, even though it retained no income against which the deduction might be applied. See United States v. Blow, 77 Fed. (2d) 141; Charles F. Grey, 41 B. T. A. 234, 242. The following provision was thereupon added to section 23 (k) and (1) of the Revenue Act of 1928 and made applicable to both depletion and depreciation deductions:

In the case of property held in trust the allowable deduction [for depreciation and depletion] shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provision, on the basis of the trust income allocable to each.

The purpose of this change in the law was to eliminate the “considerable hardship” which was imposed on the beneficiaries under prior law and to secure to them their fair portion of these allowances in proportion to the income distributable to them. See Senate Report No. 960, Revenue Act of 1928, (70th Cong., 1st sess.) p. 20. See also Sue Carol, 30 B. T. A. 443, 447, 448; Sada G. Wilson Blake, 39 B. T. A. 793.

The force of these facts in the instant case requires the apportionment of the allowance here in question between the trust and the beneficiary. The single factor which stands out against it is the uncontrolled power in the trustee to determine the amount of income to be distributed in any year. This placing of the trust income under the control of the trustee does not, however, constitute the allocation contemplated by the statute. The theory of the petitioner that the income is in the first instance allocable in toto to the trustee is not decisive of the question. That is true in all cases where a trustee receives and distributes income, in that it must first go to the trustee before it can be distributed to the beneficiaries. In view of its purpose to insure a fair portion of the allowance to the beneficiary, the statute properly goes beyond the act of placing the funds in a position for distribution and takes account of the distribution itself.

The argument of the petitioner consists principally in a request that the allowance here in question be governed by his bookkeeping practice, but, against what we deem the plain direction of the statute, his position may not be sustained.

Respondent’s method of computing the allowance is accordingly affirmed.

Decision will he entered under Rule 50.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions :
      ****** *
      (1) Depreciation. — A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property ■and shall be allowed to the life tenant. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each.
      (m) Depletion. — In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; * * *. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each. * * *


source: Caselaw Access Project

author: Mellott :

license: Public Domain

text:
    Amelia Solomon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97937.
    Promulgated January 7, 1941.

      W. A. Seifert, Esq., W. W. Booth, Esq., R. L. Kirkpatrick, Esq., and A. G. Wallerstedt, O. P. A., for the petitioner.

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

Mellott :

Petitioner contends that a complete and irrevocable gift, of the trust corpus was made on October 9, 1928, vesting an estate,, measurable in value, in a named class of beneficiaries, and the only-right of which she divested herself on May 10, 1935, was the right to demand that the income be paid to her for life; that she, in 1928, contributed only approximately one-third of the trust corpus, her son, H. Alfred, having contributed the other two-thirds; and, if she is determined to have made a gift of trust corpus in 1935, that the-gift, at most, was of only one-third. These contentions will be considered in the order stated.

According to the trust instrument petitioner and her husband “delivered to and deposited with” the trustee securities which, on the date of the death of the husband, had a fair market value of $375,996.46. They reserved the right “to modify, alter, amend or extend the terms” of the trust, “in whole or in part and to change the beneficiaries.” The gift, therefore, was not complete until this power terminated or was relinquished. Burnet v. Guggenheim, 288 U. S. 280; Porter v. Commissioner, 288 U. S. 436; Estate of Sanford v. Commissioner, 308 U. S. 39. Petitioner attempts to distinguish the instant proceeding from the Sanford case upon the ground that she and her husband reserved only the power to designate which of a class should have the corpus of the trust upon its termination, whereas, she says, the donor in the cited case could designate any beneficiary other than himself. We can not spell out of the trust instrument before us any such limitation as petitioner contends exists; and it may be pointed out that in the Sanford case the great grandchildren of the settlor— descendants per stirpes of the named grandchildren who were the life beneficiaries — constituted a “class” just as much as the “living lawful issue” of the children of petitioner and her husband.

No useful purpose would be served by discussing at length petitioner’s argument upon the first portion of the contention now under consideration. It is sufficient to state that, in our opinion, the settlors, so long as both lived, could have designated anyone other than themselves to receive the corpus of the trust, under the broad powers retained. We, therefore, hold that no estate, measurable in value, passed to their grandchildren upon the creation of the trust. The remaining portion of petitioner’s first contention will be considered later.

Over the objection of counsel for the respondent petitioner was permitted to introduce certain evidence tending to prove her contention that she, in 1928, contributed only approximately one-third of the trust corpus, her son, H. Alfred, contributed two-thirds and her husband, Max, contributed nothing. Upon brief she states that it makes no difference, as she views the case, whether it be held that the son or the husband made the contribution. It is essential, however, that determination be made whether she contributed more than one-third.

Notwithstanding the evidence introduced by petitioner, we are of the opinion and have found as a fact that she and her husband each contributed 50 percent of the corpus. This conclusion is based upon many factors, some of which will be specifically referred to later. But first the evidence relied upon by petitioner to prove that her son, H. Alfred, contributed two-thirds of the securities to the corpus of the trust will be summarized.

The evidence consisted of the testimony of H. Alfred and an accountant; pages from a ledger in which had been entered descriptions of securities, dates purchased, prices paid and kindred information — but not by whom purchased; bank books showing the deposits of income received; pages from a memorandum book kept by II. Alfred; several checks written by petitioner, H. Alfred or Max Solomon; and two memoranda prepared by the accountant in collaboration with H. Alfred, based partially upon an analysis of the exhibits referred to above and partially upon information furnished by H. Alfred. One memorandum purports to list “Securities Contributed by H. Alfred Solomon” and the other “Securities Contributed by Amelia Solomon.”

H. Alfred testified that his father during his lifetime had engaged in the scrap iron and steel business and had been very successful; that when his father had any excess profits which he did not need in his business he either bought bonds or made a gift to his wife in cash; that in 1922 petitioner gave him approximately $500,000 in securities; that his father gave him approximately $40,000 or $50,000 in securities in 1922, 1923, and 1924; that he lived at home with his parents until 1930; that he was present when his father and mother signed the trust agreement in 1928; that he delivered most of the securities mentioned in the trust agreement to the trustees; that he got these securities from safety deposit boxes held jointly in the names of his mother and father and himself; that he kept the books and records for his mother and father and himself, showing the ownership of such securities; and that after his father’s death he had reason to trace the ownership of all of the securities held under this trust. When asked the reason for doing so, he replied:

After Dad’s death the Government assessed inheritance tax on the entire corpus of this trust, so, on advice of counsel, we decided to go to the books of records and make up a list of securities to show the Government the ownership of the securities; who owned the securities, and that Dad never contributed anything to the trust.

The accountant testified that in February 1934 he assisted H. Alfred in the preparation of a list of the securities which were deposited with the trustee in October, 1928; that later, prior to the execution of the instrument by petitioner and H. Alfred in 1935, the list was revised to determine definitely the ownership of the securities; that the witness examined principal and income books kept by H. Alfred; that the principals of petitioner and H. Alfred were kept in one book; that being informed that H. Alfred had received about $500,000 in securities from his mother in 1922, he attempted to trace the securities to find if any of them went to the trustees in 1928; that after locating the securities in the principal book, he made an investigation to determine who received the income from them prior to 1928 by tracing the income from the securities to the bank account in which it had been deposited; and that he thus determined that, of the securities originally deposited in the trust, one-third belonged to petitioner and two-thirds to H. Alfred. He also testified that he was not a lawyer. Petitioner was not called as a witness and the testimony set out above was the only evidence bearing upon this phase of the proceeding.

According to the memoranda prepared by the accountant the securities transferred to the trust on October 9, 1928, cost $382,207.79. Securities costing $23,567.36 appear to have been paid for with checks signed by Max Solomon; securities costing $93,081.31 with checks signed by petitioner; and securities costing $96,866.56 with checks signed by H. Alfred. The accountant was unable to determine whose checks were issued to pay for the remaining securities, the total cost of which was $178,692.56. It is interesting to note, however, that he included in the list of “Securities Contributed by Amelia Solomon” securities which were paid for by checks signed by H. Alfred Solomon totaling $19,711.61, and securities having an aggregate cost of $62,956.79 as to which no evidence was adduced showing who had purchased them. He also included in the list of “Securities Contributed by H. Alfred Solomon” securities which were paid for by checks signed by Max Solomon totaling $23,567.36, by petitioner totaling $11,318.26, and securities having an aggregate cost of $115,735.77, as to which no evidence was adduced in the hearing before us to show who had purchased them. It is apparent, therefore, that the accountant’s determination as to who was the contributor or owner of each security transferred to the trust in 1928 was not based upon checks issued in payment for the securities at the time of their purchase. From an examination of the schedules and his testimony, we are satisfied that his determination was based primarily upon the fact that the income from the securities listed on the H. Alfred schedule, during the period subsequent to their acquisition and prior to the transfer in trust, had been deposited in a bank account in the name of H. Alfred and recorded as his income in the books which he kept.

We are not convinced from the evidence that H. Alfred, on October 9, 1928, was the owner or contributor of any of the securities transferred to the trust on that date. The schedule, which petitioner contends shows the securities contributed by H. Alfred, lists 35 securities purchased between May 1918 and December 1927. H. Alfred appears to have been born in 1900, so he, during this period, was between 18 and 27 years of age. Ten of the securities were purchased prior to 1923 and the remainder subsequent thereto at a total cost of $257,776.34. Of this amount, securities costing $77,154.95 were paid for with checks signed by IT. Alfred, $41,318.26 by checks signed by petitioner, and $23,567.36 by checks signed by Max Solomon. It will be noted that securities costing $115,735.77 are not accounted for. For aught that appears in this record they may have been purchased either by petitioner or her husband. At any rate, the evidence is far from sufficient to prove that H. Alfred acquired the ownership of the securities costing $180,621.39 ($257,776.34 — $77,154.95); and his testimony that he received gifts of securities from his parents in 1922, 1923, and 1924 is not helpful in view of his failure to identify the securities received. Moreover, the mere fact that IT. Alfred received the income from some of the securities during the period subsequent to their purchase and prior to the execution of the trust does not necessarily indicate that he was the owner of them. It is not unusual for parents to give their child or children income from securities, and at the same time retain the ownership of them.

But even if it be assumed that H. Alfred became the owner of some of the securities prior to their transfer in trust, we are not convinced that he did not surrender such ownership to one or both of his parents prior to the execution of the agreement on October 9, 1928. He was present when his mother and father executed the agreement. According to his testimony, he took the securities from safety deposit boxes held jointly in the names of his mother and father and himself and delivered them to* the trustee. He knew that his mother and father were assuming dominion and control over them and irrevocably transferring title to them to a trustee, reserving only the right to modify and amend the trust instrument and to change the beneficiaries of income and principal. Why did he remain silent when this was being done? He kept the books and records from which he says ownership can be traced. If they now show that he was the owner of two-thirds of the securities transferred to the trust they must have reflected this ownership on October 9, 1928. As the keeper of these books, and the person who delivered the securities to the trustee, he must have been aware of the fact, if it were a fact, that his securities were being transfered by his parents to a trust over which he was to have m> control, two-thirds of the income of which was to be paid to his brother and sister. If he intended to be a contributor to this trust, why did he not insist that his name appear as such on the trust instrument? And why did he permit his father’s name to appear as a contributor if in fact his father made no contribution whatsoever ? if he were an undisclosed contributor of two-thirds of the trust corpus, why did he permit his parents to punish him by depriving him of any income from the securities deposited with the trustee from November 24, 1930, to November 23, 1932 ? The record does not contain the answer to these questions. A reasonable inference from all of the facts seems to be either that he did not own two-thirds of the securities on October 9, 1928, or, if he did, that he surrendered such ownership to one or both of his parents on that date. At any rate, upon the evidence before us, we can not find as a fact that H. Alfred, after October 9,1928, had any interest in the trust other than as stated therein. Our conclusion is that the only contributors to the trust corpus on October 9, 1928, were the individuals named in the trust instrument, viz., the petitioner and her husband, and we have made a finding to that effect.

When we come to deterlnine the fractional proportion contributed to the trust by petitioner and her husband, the evidence set out above serves both to confound us and to confirm our opinion that they contributed approximately equal amounts. Our conclusion is strengthened by the language of the trust instrument; the joint dominion and control which petitioner and her husband exercised over the property prior to the creation of the trust; their treatment of the income from the trust and especially their withdrawal of H. Alfred’s share; the practice of the husband of expending his excess profits in the purchase of bonds or giving cash to his wife to be so expended; the fact that the securities were contained in safety deposit boxes to which each had access; and the presently stipulated fact that “one half of the corpus * * * was included by the Commissioner * * * in the gross estate (of the husband) subject to federal estate tax and tax paid ■thereon.” It has accordingly been found as a fact that petitioner and her husband each contributed 50 percent of the corpus of the trust -on October 9, 1928.

Respondent starts with the premise that petitioner and her husband each contributed 50 percent of the corpus to the trust in 1928. Nevertheless he argues that “the quantum of the gift (made by petitioner in 1935 when she relinquished the retained powers) was the entire principal.” This may be considered in conjunction with the contentions of petitioner heretofore referred to but not discussed.

The stipulation does not indicate the reason 50 percent of the fair market value of the trust corpus on the date of the husband’s death was included in his gross estate. We assume that it was because of section 302 (d) of the Revenue Act of 1926, under which the estate tax is imposed upon the value of the interest “of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend or revoke * * Cf. Porter v. Commissioner, supra. By a parity of reasoning, the other 50 percent would probably have been includable in the gross estate of petitioner if, peradventure, she had died simultaneously with her husband or if the death of both had occurred under such circumstances that it was impossible to ascertain which died first. We are not called upon to decide this question, nor need we express an opinion as to the correctness of including any portion of the corpus in the gross estate of the deceased husband. Our question is: Did petitioner’s relinquishment of the power to modify, alter, and amend the terms of the trust subject all, one-half, or none of the corpus to the gift tax under Title III of the Revenue Act of 1932?

Section 501 (a) of the Revenue Act of 1932 imposes the tax “upon the transfer * * * by any individual, * * * of property by gift.” It seems to be clear that Congress intended to impose the tax upon the donor just as it intended to impose the estate tax under section 302 (d), supra, upon the transferor. This is apparently the view taken by the respondent in the promulgation of his regulations; for in article 3 of Regulations 79,1936 Ed., it is stated: “* * * the tax is a primary and personal liability of the donor, is an excise upon his act of making the transfer, is measured by the value of the property passing from the donor * * *. As to any property * * * of which the donor has so parted with dominion and control as to leave in him no power to cause the beneficial title to be revested in himself, the gift is completed.” (Italics ours.) Congress evidently intended to tax — perhaps could only constitutionally tax — the vhlue of the property passing from the donor. This seems to be the substance of the regulation. What, then, passed from petitioner? She says only a life estate in the property contributed by her. Respondent says all of the property comprising the corpus on May 10, 1935.

Having decided that no complete gift of the corpus was made in 1928, we think it is reasonable to hold, and we do hold, that petitioner made a gift when she, in 1935, relinquished the retained power. Burnet v. Guggenheim, supra; Estate of Sanford v. Commissioner, supra. This comes literally within section 501 (c) of the Revenue Act of 1932. We do not agree with respondent’s contention, however, that all of the property then comprising the corpus became subject to the gift tax.

The property contributed to the trust by petitioner’s husband became, upon his death, subject to the exercise by her of a general power. If she had not relinquished it the value of the property at the time of her death would have been includable in her gross estate under section 302 (f) of the Revenue Act of 1926. Nevertheless we do not believe that her relinquishment of the power in 1935 subjected that portion of the property to a gift tax against her.

Section 302 (f), supra, first became a part of the revenue act in 1919. Prior thereto the department, by regulation, had required all property passing under a general power of appointment to be included in the gross estate of the decedent “appointor.” In United States v. Field, 255 U. S. 257, the Supreme Court held the regulation to be invalid and that the interest there in question, not having been the property of the decedent appointor at the time of her death nor subject to distribution as part of her estate, was not taxable under section 202 (a) or 202 (b) of the Revenue Act of 1918. The Court pointed out that “it would have been easy for Congress to express a purpose to tax property passing under a general power of appointment exercised by a decedent had such a purpose existed.” Since it had not done so the court applied the “accepted canon that the provisions of (tax imposing) acts are not to be extended by implication.” Gould v. Gould, 245 U. S. 151.

It need not be determined in this proceeding whether Congress has the power to subject to the gift tax property passing through the relinquishment, by one other than the donor, of a power given to him by the donor. It is sufficient to point out, as the Supreme Court did in the Field case supra, that Congress has not endeavored to subject such a transaction to the gift tax. Moreover, it is also not without significance that the Department has promulgated no regulation attempting to subject the relinquishment of such power to the gift tax, as it has done in connection with the estate tax. Indeed it is doubtful if such a power is either a property right or an interest in property, cf. Farmers Loan & Trust Co. v. Bowers, 29 Fed. (2d) 14, 17, a prerequisite, it would seem, to including it in “property transferred by gift.”

We are of the opinion and hold that one-half of the presently stipulated value of the corpus of the trust on May 10, 1935, and no more, should be included in the total amount of gifts made by petitioner during the year 1935.

Decision will be entered under Rule SO.

       (c) The tax shall not apply to a transfer of property in trust where the power to revest in the donor title to such property is vested in the donor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such property or the income therefrom, but the relinquishment or termination of such power (other than by the donor’s death) shall be considered to be a transfer by the donor by gift of the property subject to such power, and any payment of the income therefrom to a beneficiary other than the donor shall be considered to be a transfer by the donor of such income by gift.

       (f) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will, or (2) by deed executed in contemplation of, or intended to take effect in possession or enjoyment at or after, his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth; * * *


author: Arttndell:

text:
    F. F. Hardesty, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. F. F. (Eula P.) Hardesty, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of R. A. Elliott, Deceased, Emma C. Elliott, and Cecil H. Tolbert, Independent Executors, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. E. Caddie (R. A.) Elliott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94925, 94926, 94928, 94929.
    Promulgated January 7, 1941.

      Harry G. Weeks, Esq., and R. B. Gammon, Esq., for petitioners.

      8. B. Anderson, Esq., for the respondent.
   OPINION.

Arttndell:

The issues in this proceeding have been enumerated at the outset and will be considered in the order there set forth.

Issue No. 1.

We are called on here to say whether the petitioners, F. F. Hardesty and his wife, may apply the whole of the proceeds received by them during the taxable year 1935 under the Haddaway oil payment to the cost of that payment as claimed by them, or may thus apply only the portion representative of cost and report the residue as taxable income as claimed by the respondent. The petitioners concede on brief that the issue here is substantially the same as that presented in T. W. Lee, 42 B. T. A. 1217. In that case, contrary to the contentions of both parties in the instant case, we held that the basis of oil payment# which represented an economic interest in the oil properties to which they applied, as evidenced either plainly by an assignment to the payee of the oil interest out of which the payments were to be made- or more remotely by other factors, must be recovered through depletion. Accordingly, we held that proceeds received under such oil payments must be included in taxable income, with appropriate deductions for depletion.

The disposition of the present case is governed by that holding. In the situation before us there was an assignment of the interest from which the payments were to be made and accordingly no close question arises as in T. W. Lee, supra. It is clear that petitioners had an economic interest in the oil properties in question and they must therefore recoup their cost of the oil payment through depletion.

Accordingly, petitioners must include in income the entire amount of the proceeds received during the taxable year under the oil payments and are not entitled to the allowance for the return of cost made by the respondent. They are, however, entitled to appropriate deductions for depletion. ■

Issue No. 2.

The question for decision under this issue is whether any of the intangible development and drilling costs incurred by the Hardesty-Elliott Oil Co., a partnership, in drilling the four wells, as described above, on the Kichter “A” and “B” leases may be deducted as a business expense from the income of the partnership in computing the income distributable and taxable to petitioners.

Petitioners raise a preliminary question, contending that the issue as it relates to the Kichter “A” lease is not properly before us, since it was not raised in the original pleadings or amendments thereto, but is an affirmative issue raised by the respondent for the first time on supplemental brief. The situation as to this is somewhat unusual. The petitioners by amended petition squarely raised the issue in allegations that “respondent erred in failing and refusing to allow as a deduction * * * the said intangible drilling and development costs totaling $10,727.34 and $7,768.75 respectively.” These allegations were denied by the respondent’s answer to the amendment. Consequently, the petitioners err in their statement that the issue was not raised by the pleadings. In the petitioners’ first brief filed in these proceedings they say that “the issue presented by the amended petitions with respect to drilling costs on the Kichter ‘A’ lease is hereby waived.” Therein they recognize that they raised the issue which they now say was never raised by the pleadings. As the petitioners have waived the issue, perhaps it would be sufficient to say that the issue should be decided for the respondent on the waiver. But the respondent asks for decision on the merits, and the petitioners have filed a reply brief arguing the question at length, apparently not desiring to have it decided on their waiver. In this posture of affairs we think the question properly before us for decision on the merits and we prefer to so dispose of it.

As the cases now stand as to this issue, the respondent has not allowed deductions for the cost of drilling wells on the Richter “A” and “B” leases for the reason that they constitute, in his view, the capital cost of the interests in the leases which were acquired thereby and must, therefore, be capitalized. The principal argument of the petitioners in reply is that the drilling and development of the leases in question did not constitute “consideration” for the interests acquired by the Hardesty-Elliott Oil Co. in the leases and that as ordinary intangible development and drilling expenses they are deductible on the authority of article 23 (m)-16 of Regulations 94.

We have previously passed on the general question which is thus framed. It arises here, as in several former instances, where the taxpayer in the execution or assignment of an oil lease or a deed to oil property agrees to drill a certain number of wells on the leased or acquired premises. We have held in this situation that, where it is clear that the drilling constitutes consideration for an interest in the land or lease, the drilling and development costs so incurred must be capitalized. See State Consolidated Oil Co., 19 B. T. A. 86; affd., 66 Fed. (2d) 648; certiorari denied, 290 U. S. 704; Nunn-Stubblefield Oil Co., 31 B. T. A. 180. The Circuit Court of Appeals in affirming the former case noted the argument of the taxpayer that authority to deduct such drilling costs as business expense was found in article 223 of Regulations 62, which corresponds to article 23 (m)-16 of Regulations 94, relied on by petitioners here. The court in answering that argument held that this provision of the regulations applied only to expenses incurred on land which the taxpayer owned or had theretofore leased and was “not intended to apply to one who drills a well upon land in performance of a contract to purchase an interest therein.”

The issue presented thus resolves itself into the question of whether, in the circumstances of each of the two leases and agreements before us, the development and drilling which the Hardesty-Elliott Oil Co. was obligated to perform may properly be regarded as the consideration for the interests acquired in the leases. This requires a separate consideration of each lease and its pertinent agreement.

The terms of the instrument of assignment by which the Hardesty-Elliott Oil Co. acquired a three-quarters interest in the Richter “A” lease expressly provide that the assignee shall drill two wells on the leased premises, under certain conditions, “as part of the consideration for this assignment and the rights hereby granted.” It must, therefore, be assumed that the parties to the agreement regarded the outlays to be made by the Hardesty-Elliott Oil Co. in drilling as the quid pro quo for the assigned interest in the lease. This is a factor of prime significance in making the determination which we are called on to make and, unless contradicted by the circumstances surrounding the agreement, may be accepted as conclusive. See United States v. Sentinel Oil Co., 109 Fed. (2d) 854, where it was agreed by the parties that the drilling was the consideration for the lease involved. Such contradiction is not to be found in the fact that the assignment was completed before the drilling was begun. While this factor has been thought to be of significance by the Commissioner as set forth in G. C. M. 10686, C. B. XI-2, p. 257, his views have now been altered as shown by G. C. M. 22224 (July 23, 1940). The petitioners concede on brief that no argument in their favor may be founded on the time of the assignment of the lease. From an interpretation of the whole instrument it seems plain that the drilling operations were directly attributable to the requirements of the assignment and constituted a part of the consideration therefor. In this situation, and in view of the fact that no other circumstance attendant on the execution of the assignment which might alter this conclusion have come to our notice, it must be held on the authority of Nunn-Stubblefield Oil Co., supra, State Consolidated Oil Co., supra, and United States v. Sentinel Oil Co., supra, that the costs of drilling and developing the Richter “A” lease must be capitalized. Compare Edwards Drilling Co., 35 B. T. A. 341; affd., 95 Fed. (2d) 719; Cook, Drilling Co., 38 B. T. A. 291; and F. H. E. Oil Co., 41 B. T. A. 130, 134, cases in which the deduction of drilling costs as business expense is allowed since it is held that the interest acquired did not constitute an interest in the land.

Petitioners urge, however, that Nunn-Stubblefield Oil Co., supra, is distinguishable from the instant case in that there the transaction involved an exchange of the drilling operations for the lease, the transferor of the lease retaining merely an overriding royalty interest and in no way participating in the operation of the lease. In the present case, on the other hand, it is contended that the arrangement contemplated constituted a joint venture in which the drilling operations were contributed by petitioners as their share in the venture. Therefore, it is said, the petitioners became the owners of a three-quarters interest in the venture by virtue of the agreement, and the drilling which took place thereafter was thus done on a lease owned at least in part by the petitioners. In this guise, it is contended, the situation falls within the situation contemplated by article 23 (m)-16 and petitioners are thus entitled to deduct the three-fourths of the expense in proportion to their ownership.

We do not regard this interpretation of the assignment agreement as the true one. The object of the assignor in entering into the contract, as is made plain by the provisions placing in the assignee’s hands the whole management of the lease and the disposition of the oil and gas, was to secure the development of the lease by another, ■retaining to himself a share in the profits, if any, resulting from the oil and gas produced. The whole cost of the development was to be borne by the assignee, without risk of the loss of any money to the assignor. It is true the assignor agreed to pay a portion of the operating expenses after the wells were drilled and had begun to produce, but this by provision of the agreement was to be subtracted from the gross proceeds of the oil to which the assignor was entitled. The situation differs therefore only slightly from the royalty arrangement agreed on in Nunn-Stubblefleld Oil Co., supra, and for our purposes here that difference is without significance. The principal fact remains that the assignee received an interest in the lease in consideration of His agreement to drill on the leased premises; this requires capitalization of the drilling expense without regard to the fact that thereafter the proceeds of the oil were to be divided and the expenses borne by both parties to the agreement.

The question raised by the provisions of the Eichter “B” lease and the accompanying “Development Contract and Escrow Agreement” presents a somewhat closer issue. The provisions of the agreement are plain enough as to the drilling of the first well on the Eichter “B” lease. It is expressly stated to be “in consideration of the covenants and agreements set out in said oil and gas lease.” This conclusion, moreover, is bolstered by the escrow provisions which expressly render the delivery of the lease dependent on petitioners’ meeting this requirement. As to the second well, however, the result is less plain. It was to be drilled after the delivery of the lease and the failure to drill it was to result only in the forfeiture of the $10,000 bond as liquidated damages. These factors, however, we deem insufficient to make any distinction between the first and second wells. United States v. Sentinel Oil Co., supra. In that case it was held that the time of the transfer to the taxpayer-driller of the interest which was to be transferred in connection with the drilling was not determinative of whether the drilling constituted consideration for the transfer. The significance of the liquidated damages provision in its application to the second well is paled by the fact that it applies equally to the performance of all other provisions of the agreement, including the drilling of the first well..

A significant feature of the agreement relative to the Eichter “B” lease which in our opinion compels the conclusion that the drilling of both wells constituted consideration for the lease is the form in which the agreement was executed, separate and apart from the lease itself and in lieu of the payment of any consideration in cash at the time of executing the lease. This factor also answers petitioners’ argument that in the more usual oil and gas lease the prime or only consideration is the royalties agreed to be paid. In this case we have more than a simple oil lease; there is a separate agreement under which petitioners assume obligations for the discharge of which they are to receive full and free title to the lease. The costs thus incurred by them are plainly consideration for the lease and must be capitalized.

Decision will be entered under Rule 50.


author: Hill :

text:
    Carl M. Britt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95566.
    Promulgated January 7, 1941.

      Tom F. Carey, O. P. A., for the petitioner.

      Wilford F. Payne, Esq., for the respondent.
   OPINION.

Hill :

Some of the issues raised in the pleadings have been settled by agreement of parties. These issues relate to the year in which certain deductions should be taken and certain accounts included in gross income. Petitioner kept his books and returned his income -on the cash receipts and disbursements basis, and it is now agreed that the deductions in question are properly allowable from gross income for the year in which actually paid, and the items of income are includable for the year in which actually received. The facts necessary to make the adjustments are set out hereinabove, and wiil be reflected in the recomputations under Eule 50. If such adjustments result in an increase of the deficiency for the year 1936, respondent has timely made claim therefor, and same will be allowed.

The remaining issues submitted for decision involve (a) the amounts of the deductions allowable on account of depreciation of petitioner’s buildings, machinery, and equipment, and (b) whether or not petitioner is entitled to any depletion deductions on the basis of income derived from the milling of tailings or chats.

For the year 1935, petitioner claimed a deduction of $4,932.50 and for 1936 a deduction of $4,388.62 for depreciation on the theory that the buildings, machinery, and equipment had a depreciable basis of $20,000 when acquired. Kespondent, using the same rate of depreciation, allowed the amounts of $1,125 and $1,013.62, respectively, on the theory that at the time of acquisition by petitioner the assets had a ■depreciable basis of $5,000 and at the beginning of the taxable year 1935 had a basis of $4,500.

In September 1934 petitioner acquired the assets in question from the Pioneer Co. in satisfaction of his claim against the company in the amount of $20,000. The corporation owed petitioner $3,305.73 for money advanced, and the balance of the consideration paid by petitioner for the assets represented a credit of $16,694.27 which D. L, Larsh, president and principal stockholder of the corporation, had •caused to be transferred, as a gift, from his account to petitioner’s account on the corporation’s books. The assets then had a salvage value of not less than $20,000.

The basis for depreciation in respect of the property here involved is the basis for determining gain upon sale or other disposition, section 114 (a), Eevenue Acts of 1934 and 1936, and such basis is cost, except that, in the case of the property acquired by gift after December 31, 1920, the basis is the same as it would be in the hands of the donor, section 113 (a) (2).

So much is agreed to by the parties. But respondent argues that, since the corporation was indebted to Larsh in an amount in excess of $100,000, and its assets were worth only about $20,000, the credit of $16,694.27 transferred by Larsh to petitioner’s account had a value in Larsh’s hands of only approximately 20 cents on the dollar, and petitioner’s basis is the same; also the indebtedness of $3,305.73 owing by the corporation to petitioner for money advanced by him to it, which he exchanged in part for the assets, likewise had a value of not more than 20 cents on the dollar, since the basis is cost and cost is the value of the thing exchanged. Hence, respondent contends that petitioner’s total basis at the time of acquisition of the assets was less than $5,000, the basis upon which respondent computed the depreciation deductions allowed by him.

We are unable to agree with respondent’s contention on this point. The records show that, in substance and effect, Larsh agreed to subordinate to petitioner’s claim so much of the indebtedness owing by the corporation to Larsh as was in excess of $16,694.27 and that petitioner should be permitted to purchase the corporation’s assets, worth $20,000, in satisfaction of his aggregate credit of $20,000. Pursuant to such agreement, the credit was transferred by Larsh and the assets were acquired by petitioner. Therefore, at the time of the transfer the credit was worth fa.ce value in Larsh’s hands, and at the time of the acquisition of the assets, petitioner’s total credit also was worth face value.

Respondent argues further, in an apparent effort to justify his action in disallowing the deductions claimed by petitioner, that petitioner did not use in his business all of the assets acquired from the corporation. In reply, petitioner contends that he is entitled to deduct depreciation on all of the assets for the reason that they were all purchased for business purposes, and were held for such future use, although a portion temporarily was not used during the taxable year. We pass discussion of the point on its merits. Respondent did not determine the deficiency on the basis that only a part of the assets were used in petitioner’s business, and no proof was offered in respect of the portion not used. The point was raised for the first time in respondent’s brief. This Board will not consider issues of fact not raised by the pleadings. D. N. & E. Walter Co., 10 B. T. A. 620, 630; Americam Industrial Corporation, 20 B. T. A. 188, 202; North American Coal Corporation, 28 B. T. A. 807, 831; Coosa Land Co., 29 B. T. A. 389, 394; Jamieson Associates, Inc., 37 B. T. A. 92, 118.

Respondent’s action on the first issue is reversed.

The second issue presented for decision is whether or not petitioner is entitled to percentage depletion on the basis of income derived from the milling of lead and zinc ores, known as tailings or chats, which petitioner had not mined or extracted from the earth, but processed, under a royalty contract, from ores theretofore milled and deposited on the surface of the land. Precisely the same question, under facts not distinguishable from those of the instant case, was decided adversely to petitioner’s contention by the United States Circuit Court of Appeals for the Tenth Circuit in Atlas Milling Co. v. Jones, 115 Fed. (2d) 61.

In its opinion the court pointed out that the statute authorizes, as a matter of grace, an allowance for depletion in the case of “mines” and that the word “mines” as so used is limited to natural deposits and does not include a tailings dump deposited on the surface of the land, consisting of a residue of ores that has been severed and milled. In an opinion rendered on rehearing of the same case on October 14,1940,115 Fed. (2d) 64, the court adhered to the conclusion reached in its former opinion.

In our opinion the court in the cited case correctly decided the question we have here. Accordingly, we hold that petitioner is not entitled to any deduction for depletion in either of the taxable years.

Decision will be entered under Rule 50.


author: Turner:

text:
    Lowell H. Chamberlain and Gertrude M. Chamberlain, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96410.
    Promulgated January 7, 1941.

      W. Z. Proctor, Esq., for the petitioners.

      Gene W. Reardon, Esq., for the respondent.
   OPINION.

Turner:

This proceeding is brought for redetermination of a deficiency in income tax for the calendar year 1934 in the amount of $1,377.18, which arises in greater part from respondent’s disallowance of the deduction claimed for taxes paid on certain real property inherited by Lowell II. Chamberlain from his father on the death of tbe latter on March 14, 1933. The question at issue is whether petitioner may properly deduct real property taxes for the year 1933. paid by him in 1934 when it is shown that he did not become the owner of the property until March 14, 1933, the date of his father’s death.

The facts have been stipulated and as stipulated are adopted as our findings of fact.

Petitioners are Lowell H. Chamberlain, hereinafter referred to as the petitioner, and Gertrude M. Chamberlain, husband and wife, who reside at 3520 Grand Avenue, Des Moines, Iowa. They filed a joint income tax return for the calendar year 1934.

On March 14,1933, Davis S. Chamberlain, a resident of Des Moines, died, leaving a will by the terms of which all of his real estate which was located in Polk County, Iowa, was devised and bequeathed to his only child, the petitioner, Lowell H. Chamberlain. This will was duly admitted to probate on April 14, 1933, in the District Court of Iowa in and for Polk County and the estate of Davis S. Chamberlain was administered upon and closed and the executor discharged in that court as provided by the laws of the state.

Under the applicable Iowa laws the real estate devised to petitioner passed to him immediately on the death of his father on March 14, 1933. All claims and costs of administration were fully satisfied without recourse to this real estate.

Local city and county taxes for the year 1933 in the amount of $11,960.49 were assessed and levied against the real estate thus inherited by petitioner, in accordance with the laws of Iowa, and were paid by the petitioner in 1934. These taxes were assessed and the receipt for payment made out in the name of the decedent, Davis S. Chamberlain. They were entered by the auditor of Polk County, Iowa, upon the county tax list which was delivered to the county treasurer on or before December 31,1933, for collection. They became due and payable on January 1, 1934, and in each instance the amount of the tax equaled the product of the assessed value of the real estate multiplied by the established tax rate.

The parties have joined issue on the question whether petitioner may deduct from his income the 1933 property taxes paid by him on realty inherited from his father on March 14, 1933. The deduction from gross income of such taxes is allowed by section 23 (c) of the Kevenue Act of 1934, but under the decisions only the owner of the property on the date on which the tax accrues may avail himself of the allowance. Carl K. Lifson, Administrator, 36 B. T. A. 593; affd., 98 Fed. (2d) 508; Patrick Cudahy Family Co., 36 B. T. A. 1147; affd., 102 Fed. (2d) 930; First Bond & Mortgage Co., 27 B. T. A. 430; Texas Coca-Cola Bottling Co., 30 B. T. A. 736; California Sanitary Co., Ltd., 32 B. T. A. 122; Gatens Investment Co., 36 B. T. A. 309. Cf. Commissioner v. Coward, 110 Fed. (2d) 725. So much the petitioner admits and the question resolves itself into a consideration of the time at which, under Iowa law, the taxes in question accrued or became an obligation outstanding against the land.

In some cases involving the question here we have had to deal with statutes whereby the tax becomes a lien on the land on a date specified in the statute. Gatens Investment Co., supra; Theodore Plestcheeff, 35 B. T. A. 508; affd., 100 Fed. (2d) 62. In those cases we have held that the tax became due when the lien attached. In other cases, the statute has failed to specify the date on which the lien or obligation arises and we have made an examination of the whole taxing process, seeking the time at which the tax became fixed and certain as an obligation. Thus we held in Henry J. Burchell, Jr., Executor, 41 B. T. A. 55; affd., 115 Fed. (2d) 681, that the accrual date of the tax ■was the time at which the state warrant attached. In M. P. Klyce, Administrator, 41 B. T. A. 194, the date on which the tax became due and payable was held to be the accrual date under Alabama law. In Texas Coca-Cola Bottling Co., supra, we held that the date of listing the land for assessment was the time at which the taxes levied thereon accrued.

In Iowa the date on which the tax becomes a lien on the realty or an outstanding obligation against the land is not specified by statute. Under the Iowa statute all property is listed and valued by the assessor beginning on the second Monday in January of each year (secs. 7106, 7115, Iowa Code, 1935) and the rolls or lists so made must be delivered to the local boards of review on or before the first Monday of April or May, dependent on the population of the community in which the land is situated. (Sec. 7122.) These boards hold sessions for correction of assessments one month after receipt of the assessment rolls. (Sec. 7129.) County boards for the adjustment of aggregate township valuations meet each year in June (sec. 7137) and a state board to adjust aggregate county valuations holds its annual session in July. (Secs. 7140, 7141.) The levy of the taxes, once the valuation process is completed, is made by the county board of supervisors each year at their September session, at which time the applicable rate of tax is determined. (Sec. 7171.) The county auditor is charged with the preparation of the tax list from the assessment rolls and the delivery thereof to the county treasurer on or before December 31 of the year for which the tax is levied. (Secs. 7145, 7147.) Taxes thus levied are due and payable between January 1 and March 1 of the year following the year for which they are levied (sec. 7210) and become delinquent, unless payment is to be made in installments, on April 1. (Sec. 7211.) itealty taxes are made by statute a lien on the land on which they are levied (sec. 7202), but no date is fixed' for the attachment of such lien except as between vendor and purchaser, in which case it attaches on December 31 of the tax year. (Sec. 7204.)

The decisions of the Iowa Supreme Court in construing the statute speak plainly of the date, on which real property taxes arise as an obligation outstanding against the land. In Gates v. Wirth, 181 Ia. 19; 163 N. W. 215, it was held that the tenant per aiotre vie of certain land did not become obligated to pay 1913 taxes assessed against the realty when his estate terminated on August 15, 1913. The court concluded that the taxes did not arise as a claim against the land and its owner until the levy in September, when the remainderman was in possession. Accordingly, judgment was given for the life tenant in the suit of the remainderman to recover for the 1913 taxes which he had paid. The reasoning of the court is made plain in the following excerpt from its opinion:

* * * The duty to pay, in order to discharge the land, as between title owners, rests, generally speaking, on the owner of the land at the time the annual tax to be levied is actually ascertained, fixed and levied, and this obligation to pay in no event arises until the work of the board of supervisors was completed, in September. This is the first time that the specific annual tax for the year became a lien upon the property, and this is the first time that an obligation rested on anyone to discharge the tax in order to free the land from the burden.
It follows, therefore, that, inasmuch as the estate of the life tenant in this case expired before any levy of taxes had been made for that year, before the burden of taxes for that year was imposed upon the real estate in question that he was under no obligation to discharge the taxes for that year for the benefit of the remainderman. The tax in question did not come into existence as an enforcible claim against the land until the remainderman came into possession of the land, freed from the burden of the life estate. The amount of the tax was not and could not be ascertained and determined until after the expiration of the life estate. No lien for the taxes for that year rested upon the land until after the expiration of the life estate. No tax was due until after the expiration of the life estate. * * *

This decision is supported by Iowa Wesleyan College v. Knight, 207 Ia. 1238; 224 N. W. 502, wherein it was held that land which was assessed for taxation on January 1, 1924, was exempt from taxation for that year when it was purchased by an educational institution on January 11 following. The 1924 taxes, it was held, did not arise through assessment, but attached on the date for levying the tax, which date was after the exempt institution had become the owner.

The Commissioner, in G. C. M. 9793 (1931), C. B. X-2, p. 142, has ruled that the accrual date of Iowa real property taxes is January 1 of the year at which time assessment is directed. To support his ruling he cited First Congregational Church of Cedar Rapids v. Linn County, 70 Ia. 396; 30 N. W. 650, which, in a situation substantially similar to that in love a Wesleyan College v. Knight, supra, reached a contrary conclusion. In this circumstance, however, we think the more recent decision of the state court must be regarded as controlling. The other cases cited by the Commissioner deal with the situation in which a vendor remains in possession of the property on January 1 of the year succeeding that for which tases are levied and in those cases it is held that, since by statute the lien is made to arise on December 31 of the tax year, the vendor must pay the taxes which arose while he was in possession. Relying on these cases,, the Commissioner concludes that the taxes became an obligation outstanding against the land on January 1 of the year for which they are levied. It is to be noted, however, that the January 1 with which these decisions deal is that of the succeeding year, the date on which the taxes are payable. They thus lend no support to the conclusion here sought by the Commissioner.

From the foregoing examination of the Iowa statutes and the decisions of the supreme court of that state, we conclude that the real property taxes in question accrued in September 1983, when they were levied by the board of supervisors and when the amount of the tax was finally determined. Petitioner was, accordingly, the owner of the land at the time they became an obligation against the land and he is entitled to a deduction from gross income for their payment. Dependent upon our conclusion on the issue just decided, the parties have stipulated the amounts proper for entry of decision and in entering the decision effect will be given to that stipulation.

Decision will he entered on the basis of the conclusion stated and the stipulation of the parties.


author: Smith:

text:
    Columbia River Paper Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97740.
    Promulgated January 7, 1941.

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

      B. H. Nehlett, Esq., for the respondent. .
   OPINION.

Smith:

This is a proceeding for the redetermination of a deficiency in income tax for 1936 of $4,195.50. The petitioner alleges that in the determination of the deficiency the respondent erred in failing to allow it a credit under the provisions of section 26 (c) of the Revenue Act of 1936 of the full amount of its adjusted net income for that year.

This proceeding has been submitted to the Board upon the basis of the pleadings, a signed stipulation of facts (incorporated herein by reference), and seven exhibits. They may be briefly summarized as follows:

The petitioner is a corporation incorporated under the laws of the State of Washington in January 1923. During the year 1936 it had an authorized and outstanding common capital stock of $2,000,000, divided into. 20,000 shares of the par value of $100 each. Under its charter it was also permitted to issue up to $750,000 preferred stock with cumulative dividends thereon of 8 percent per annum. At December 31, 1936, it had outstanding 6,804% shares of preferred stock. No dividends have been paid on the preferred stock since April 1, 1932. The dividends in arrears on such stock at December 31, 1936, amounted to $258,571.

As of April 1, 1927, the petitioner issued $1,000,000 first mortgage 6 percent bonds which matured serially. On September 20, 1932, bonds of this issue were outstanding in the amount of $800,000. On that date the petitioner entered into a written contract with the trustee for its bonds and the bondholders for an extension of the maturity date of some of the bonds. This written contract provided in part as follows:

This agreement of acceptance and authorization, as aforesaid, is made upon consideration of the punctual and complete performance by said Columbia Biver Paper Mills of its covenants and obligations as set forth in said Supplemental Indenture, and which said obligations include the following:
(1) To pay interest upon this and all other bonds tbe maturities of which are so extended, at the rate of per annum, during the period from October 1, 1932, to and including September 30, 1936;
(2) To neither declare nor pay any cash dividends prior to April 1, 1937, unless:
(a) It shall have retired, by purchase, or as otherwise provided in said Mortgage or Trust Deed of April 1, 1927, from the date hereof to the date of the declaration of said dividend, said outstanding bonds of an aggregate face value at least equal to the aggregate amount of bonds that would have matured except for the extension of maturities ;
(b) The current assets after the payment of said cash dividends shall exceed a sum equal to three times the then current liabilities.

Article VI of the supplemental indenture provided as follows:

The Company hereby covenants that it will pay no cash dividends prior to April 1, 1937, unless:

(a) It shall have retired, by purchase, or as otherwise provided in said Mortgage or Trust Deed of April 1, 1927, from the date hereof to the date of the declaration of said dividend, said outstanding bonds of an aggregate face value at least equal to the aggregate amount of bonds that would have matured except for the extension of maturities.
(b) The current assets after the payment of said cash dividends shall exceed a sum equal to three times the then current liabilities.

Between September 20, 1932, and December 31,1936, the petitioner had retired by purchase or otherwise outstanding bonds of an aggregate face value of not to exceed $130,500 principal amount. Under the terms of the original indenture of April 1, 1927, and the supplemental indenture, there would have matured between September 20,1932, and December 31, 1936, bonds of an aggregate face value of $160,000.

In its income tax return for 1936 the petitioner reported a net income of $21,991.18. The respondent has determined that the adjusted net income is in the amount of $23,091.15. Petitioner does not contest the correctness of the determination of the respondent as to the correct adjusted net income.

The only question for the Board’s determination is whether the petitioner is entitled to a credit under section 26 (c) (1) of the Keve-nue Act of 1936 of $23,091.15, the amount of its adjusted net income for 1936. That section provides in material part as follows:

(c) CONTRACTS Restricting Payment of Dividends.—
(I) Prohibition on payment of dividends. — An amount equal to tbe excess of tbe adjusted net income over tbe aggregate of tbe amounts which can be distributed within tbe taxable year as dividends without violating a provision of a written contract executed by tbe corporation prior to May 1, 1936, which provision expressly deals with tbe payment of dividends. * * *

In his brief the respondent states:

True, indeed, as of December 31, 1936, tbe petitioner bad not retired a sufficient number of its bonds to overcome tbe restrictions imposed upon tbe payment of cash dividends by the Supplemental Indenture of September 20, 1932, but this restriction applies only bo cash dividends, leaving open the right to declare a dividend in another form, some other form. Obviously, under such circumstances tbe provisions of tbe law and tbe regulations have not been met.

The reference made to the regulations above is to article 26-2 (5) of Regulations 94, which provides in material part as follows:

(6) Prohibition on payment of dividends. — The credit provided in section 26 (c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend—
■(I) in one form (as, for example, in stock or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, or
(2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable year) without violating such provision—
then the amount is one which, under section 26 (c) (1), can be distributed within the taxable year as a dividend without violating such provisions.

It is the respondent’s contention in this case that the petitioner could have distributed its earnings for 1936 to its preferred stockholders either in kind or in the form of bonds or of shares of preferred stock. We agree with the respondent that if a dividend could have been paid by the petitioner during 1936 in any form other than cash the petitioner has not brought itself within the letter of section 26 (c) (1) of the taxing statute.

We are of the opinion, however, that in the circumstances of this case the petitioner could not have made any distribution to its stockholders except in the form of cash. The preferred stockholders were entitled to an annual dividend equaling 8 percent on the par value of their stock. Only a cash dividend would satisfy such requirement.

Under the petitioner’s bylaws the petitioner could have paid no dividend of any kind upon its common stock until the arrears in dividends upon the preferred stock had been cleared up. We think it clear that the arrears in preferred stock dividends could have been cleared up only by cash distributions. Since the petitioner could not during 1936 have paid any cash dividends without violating the provisions of the written contract, we think that the petitioner is entitled to credit under section 26 (c) (1) of the statute which it claims.

It is not plain from the record why the word “cash” was inserted before the word “dividends” in the written contract. We think, however, that it is obvious that the phrase “cash dividends” was understood by the contracting parties to describe the only kind of dividends which the petitioner might in any event pay. There is no reason to assume otherwise.

It can not be doubted that the supplemental agreement executed by the petitioner on September 20, 1932, “expressly deals with the payment of dividends” as provided in section 26 (c) (1) of the statute and, since in our opinion that was a complete bar to the petitioner’s payment of any dividends in 1936, the action of the respondent in disallowing a credit of the adjusted net income of the petitioner for 1936 under section 26 (c) (1) of the statute is reversed.

Keviewed by the Board.

Decision will be entered under Rule 50.


author: Disney:

text:
    Brockway Glass Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100367.
    Promulgated January 9, 1941.

      Omar G. Olds, Esq., for the petitioner.

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

Disney:

The parties present for consideration two questions: (1) Whether the petitioner is entitled to credit, under section 26 (c) (2) of the Revenue Act of 1936, in the amount of $23,160.31, instead of $5,000 allowed by the Commissioner; (2) whether capital stock value declared in an original return can be increased in amended return for error alleged in the value first declared. We shall consider the issues separately, in that order.

1. Was the petitioner entitled to credit for more than the $5,000 allowed by the respondent, under the language of the trust indenture and the terms of the above statute?

The statute involves a credit; it is, therefore, to be strictly construed. Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. Under it the petitioner is entitled to credit for an amount equal to earnings and profits of the taxable year which is required to be paid within the taxable year in discharge of a debt “to the extent that such amount has been so paid.” The requirement, however, must be “by a provision of a written contract * * * which provision expressly deals with the disposition of earnings and profits of the taxable year.” (Italics supplied.) The petitioner contends, and the respondent denies, that above the $5,000 allowed by the Commissioner earnings and profits of the taxable year were required to be paid, and that this requirement was by a provision which expressly deals with the disposition of such earnings and profits of the year. The question seems to be one of first impression. Respondent cites no authority and petitioner none, except general authority on statutory construction.

The indenture provided that the petitioner would each year reserve out of earnings and not distribute by dividend $5,000 for the purpose of providing a reserve sufficient to meet the payment of $50,000 of bonds last maturing. The petitioner stresses this purpose, and argues that under section 27 (a) (4) of the Revenue Act of 1938 there would be no doubt about the allowance of credit, since therein credit is given for “Amounts used or irrevocably set aside to pay or to retire indebtedness of any kind, if such amounts are reasonable with respect to the size and terms of such indebtedness”, and that the provision of the 1938 Act simply expresses the intent which we should impute to section 26 (c) (2) of the Revenue Act of 1936. We are not impressed by that argument. The language of section 27 (a ) (4) of the Revenue Act of 1938 is in this respect the same as in section 351 (b) (2) (B) of the Revenue Act of 1936 (as amended by section 355 (b) of the Revenue Act of 1937). The Act of 1936 applied to personal holding companies. Petitioner is not shown to be such. The presence of the language in section 351 of the 1936 Act indicates, we think, that only a personal holding company was given the privilege of a credit for “Amounts used or set aside to retire indebtedness” and not limited to an amount covered by a contractual provision expressly dealing with the earnings and profits of the taxable year. We think the language of the 1938 Act does not help the petitioner. We find nothing in the committee reports thereon to indicate mere clarification of the intention of section 26 (c) (2) of the Revenue Act of 1936. Nor do we think that the purpose of the bond indenture to provide moneys with, which to pay the last $50,000 of bonds is materially helpful here. The question is, in sum, whether the contract required more than $5,000 of the earnings and profits of the taxable year to be paid on the bonds. The petitioner points out the power of the trustee to take action to protect the bondholders, and the letter it wrote demanding, in effect, the reservation from earnings of the taxable year the amount of $23,160.31, the amount for which credit is asked. It is obviously true that the trustee could have foreclosed because of the plain default of the petitioner in failing to reserve $5,000 per year out of its earnings. But could it, under the indenture, have required the petitioner to reserve more than $5,000 earnings in the taxable year ? After careful consideration of the contract and the statute, we think it could not have done so. The contract, as to any one year, requires a reservation of $5,000 only. There is here involved only one year. The trustee might conceivably have enjoined the payment of dividends of $5,000 in each of the earlier years. But this was not done. We think it could not enjoin payment of dividends above $5,000 in the taxable year, any more than it could have done so in one of the earlier years. The contract, in other words, did not require reservation of earnings, by a provision expressly dealing with the disposition of earnings or profits, above $5,000 per year. No paragraph or provision of the contract, save “Item 9” — as to the $5,000 per year — can be said to deal expressly with disposition of earnings and profits. Tire other provisions of the bond indenture are general, such as are not unusually found, and no express control over disposition of earnings or profits is bestowed upon the trustee. The provision requiring payment of the bonds in the taxable year did not expressly deal with the disposition of earnings and profits. In G. B. R. Oil Corporation, 40 B. T. A. 738, 744, construing the section here examined, we said:

The general purpose of section 26 (e) (2), it seems to us, is to give, a credit where a dividend paid! credit cannot be secured. In other words, the basic intent of Congress seems to have been to include in the provision only contracts which inevitably require in their performance a drawing on current earnings, thus removing current earnings as a source of dividend payments. * * *

We think the petitioner was not, by the contract here relied upon, prevented from paying dividends above $5,000 in the taxable year, and therefore not deprived of dividends paid credit. We conclude and hold that the respondent did not err in limiting credit to $5,000 under section 26 (c) (2).

2. Was the petitioner bound by its declaration of value on its capital stock tax return, or may it amend the declaration as to value after time for filing has expired1? The first filing was on July 31, 1936, the value declared $750,000; the second was on April 3, 1937, the declared value $1,250,000. The latter return, with additional amount of tax and penalty and interest remitted therewith, was returned by the Commissioner about June 28, 1937, with the advice that the amended return was not acceptable. Petitioner’s time to file capital stock tax return for the period July 1, 1937, to August 31, 1937, was extended to September 15, 1937, on June 20, 1937, and on September 15, 1937, the petitioner filed a capital stock tax return for the year ended June 30, 1937, declaring a value of $1,394,024.43 and paid the tax. About August 30, 1938, the Commissioner informed petitioner that the value was established at $750,000 by the return filed July 1, 1936, and the value for the year ended June 30, .1937, had been determined to be $894,024.43.

The petitioner’s contention on this issue is, in effect, that its first return was grossly erroneous, that the amended return was its first return as required by section 105 of the Revenue Act of 1935, and that the act, if applied to petitioner herein, is contrary, to the Fifth Amendment to the Constitution of the United States. The principal authority relied upon is Haggar Co. v. Helvering, 308 U. S. 389. The Supreme Court in Riley Investment Co. v. Commissioner, 311 U. S. 55, involving amendment of a return with reference to depletion under section 114 (b) (4) o^ the Revenue Act of 1934, distinguished the case from the Haggar Co. case, supra, and held that the return was not a “first return” because it was filed after the expiration of the statutory period for filing the original return. In William B. Scaife & Sons Co., 41 B. T. A. 278, we pointed out that the Saggar Co. case, supra, involved and emphasized the fact of amendment of capital stock tax return prior to expiration of time for filing the return, and concluded that, since in the Soaife case the amendment was submitted after expiration of the period for filing, the valuation could not be changed. We held the same in Maine Central Transportation Co., 42 B. T. A. 350, following the Soaife case. We find nothing in the present record to justify a different conclusion. The element of error in the first return was considered in the Soaife case. The contention that the statute is unconstitutional has been variously rejected. The cases so holding include Allied Agents, Inc. v. United States, 88 Ct. Cls. 315; 26 Fed. Supp. 98; Chicago Telephone Supply Co. v. United States, 87 Ct. Cls. 425; 23 Fed. Supp. 471; certiorari denied, 305 U. S. 628; Scaife & Sons Co. v. Driscoll, 94 Fed. (2d) 664. We conclude that the act is not shown to be unconstitutional, and that petitioner has not shown error by the1 Commissioner in the determination of excess profits tax liability.

Decision will T>e entered for the respondent.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the ease of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—

        * * * * * * *
      (c) Contracts Restricting Payment op Dividends.—

        * t «< # * # «
      (2) Disposition op profits op taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. ITor the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings* and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.


author: Leeoh:

text:
    William H. Joseph, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ben Levy, Petitioner, v. Commissioner of Internal Revenue, Respondent. Louis Streicker, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 96036, 96037, 96038.
    Promulgated January 10, 1941.
    TF. M. Haag, Esq., for the petitioners.

      6r. E. Brooks, Esq., for the respondent.
   OPINION.

Leeoh:

It appears that the only issue presented by the notice of deficiency and the pleadings is the deductibility of certain individual gambling losses sustained by the petitioners from their distributive shares of income from a gambling partnership, in computing the petitioners’ net income. Consequently no other issues can be considered. Popular Priced Tailoring Co. v. Commissioner, 33 Fed. (2d) 464; Elmore L. Potter, 18 B. T. A. 549.

Section 23 (g) of the Revenue Act of 1936 provides that “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.”

Section 181 of the Revenue Act of 1936 provides that “Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.”

Section 182 provides that “There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year.”

Section 183 provides that “The net income of the partnership shall be computed in the same maimer and on the same basis as in the case of an individual.” That the deductions sought by these petitioners are allowable within the above-cited sections has been settled by the case of Jennings v. Commissioner, 110 Fed. (2d) 945, as to which the Supreme Court has recently denied certiorari, 311 U. S. 704. See also Neuberger v. Commissioner, 311 U. S. 72. We, therefore, hold that petitioners are entitled to the contested deductions.

Decisions will te entered wader Rule 50.


author: Murdock :

text:
    Robert L. Rooke, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98112.
    Promulgated January 10, 1941.

      Victor E. Cappa, Esq., for the petitioner.

      Arthur W. Carnduff, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $7,870.34 in the income tax of this petitioner for the calendar year 1935. The facts have been stipulated.

The petitioner, during the entire year 1935, was the life beneficiary of three trusts. The trustee of each trust was to receive and collect the rents, profits, and income of the trust property and, after paying charges and expenses, was to pay the net amount remaining to this petitioner during his life. The remainders went to certain individuals and charities. The petitioner was one of the trustees of each trust. Each trust owned and held some stock in two foreign personal holding companies and reported in its original return on Form 1040, as dividends received, its pro rata share of the undistributed adjusted net income of those two companies. The trusts did not actually receive and, of course, did not distribute to the petitioner any of those amounts. The petitioner did not report any of the amounts as a part of his income. The trusts reported the amounts under section 351 (d) of the Revenue Act of 1934, which is as follows:

(d) Payment op Surtax on Pro Bata Shares. — The tax imposed by this section shall not apply if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire pro rata shares, whether distributed or not, of the “adjusted net income” of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of earnings or profits for such taxable year shall, if distributed to any shareholder who has so included in his gross income his-pro rata share, be exempt from tax in the amount of the share so included.

The Commissioner has included all of the aforesaid amounts in the income of this petitioner and has given the following explanation:

The trust instruments relating to these trusts provide for the distribution of all of the income to you as the life beneficiary.
The examination further disclosed that during the taxable year the above-named trusts were the owners,of all of the outstanding capital stock of two-foreign personal holding companies, namely:
(1) Canadian Merchandise Holdings, Ltd.
(2) Dome, Ltd.
In accordance with the trustees’ interpretation of the provisions of Section-351 of the Revenue Act of 1934, the trusts included in gross income reported-on their income tax returns for the year 1935 their pro-rata shares of the undistributed domestic net income of the aforesaid personal holding companies-for the year 1935.
Inasmuch as the trust agreements provide that the income of the trusts are-to be distributed to you as the life beneficiary, and since, under the provisions, of Section 351 (b)-l of the Revenue Act of 1934, you, as the beneficiary of the-trusts, are considered to be the owner of the capital stock of Canadian Merchandise Holdings, Ltd., and Dome, Ltd., the Bureau holds that the pro-rata shares of the undistributed domestic net income of these holding companies-reported by the trusts do not constitute taxable income to the trusts, but should be included as such in your return.
Adjustments have been made accordingly.

Section 351 (b) (1), mentioned by the Commissioner, provides in part that, for the purpose of determining the ownership of stock in. a personal holding company, stock owned by a trust shall be considered as being owned proportionally by its beneficiaries. We need not-decide here whether the Commissioner could tax a corporation under section 851 (a) where a trust-stockholder rather than the beneficiary-had reported under (d). But, if (d) is not complied with, the alternative is to impose the tax on the corporation under (a), and the Commissioner may not force a beneficiary to report under (d) where he has not chosen to do so. Cf. Zaida Clay, 40 B. T. A. 562; Estate of Daniel C. Bleser, 41 B. T. A. 643.

Decision will he entered under Ride 50~