text:
    Peninsula Properties Co. Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103564.
    Promulgated June 10, 1942.

      Clyde C. Sherwood, Esq., and John V. Lewis, Esq., for the petitioner.

      Harry R. Horrow, Esq., for the respondent.
   OPINION.

Kern:

The first issue for our disposition is whether the respondent correctly determined that petitioner realized ordinary income in the amount of $148,653.04 during the fiscal year 1936 as the result of a settlement of an account with Miller and Monroe jointly. The facts reveal that petitioner had become indebted in the amount of $182,-188.06 to the individuals. During the fiscal year this credit was offset by the transfer to the individuals of 500 shares in the Aptos Corporation. This stock had been carried on-the books of petitioner at a Amine of $100,000. Petitioner reported the difference between the total debt and the $100,000 stock paid as ordinary income.

Respondent’s determination is based upon the assumption that the stock was not worth $100,000, but only $33,535.02. Our findings of fact, hoAvever, show that the 500 shares, which constituted Aptos’ total issue, were worth $100,000 when issued. This conclusion is sufficient to dispose of respondent’s primary contention.

There is, however, a secondary issue still to be disposed of. Petitioner, by amendment to its petition, claims that it erred in reporting the $82,188.06 difference as ordinary income; and that it should be found to be capital gain which may be offset by any capital losses suffered by petitioner within the fiscal year. Respondent and petitioner have already stipulated that petitioner suffered a capital loss in excess of the deduction claimed on its return upon the dissolution of the Improvement Co. Petitioner had erroneously reported this amount as a bad debt. Respondent argues that this amount is deductible only to the extent of $2,000, however, by virtue of the capital loss provisions of the revenue acts and, since petitioner has not established any capital gains to act as offsets, that the balance of this loss can not be taken into account for income tax purposes. Petitioner, on the other hand, in its amended petition claims that the $82,188.06 gain was a capital gain and when balanced against the $115,102.48 loss results in a net capital loss of $32,914.42, which amount is deductible to the extent of $2,000. If petitioner prevails, the result will be, in effect, the removal of the $82,188.06 figure from petitioner’s taxable income.

If the transaction whereby the two individuals acquired the stock from petitioner is to be regarded as a sale or exchange of the stock in return for the extinguishment of its preexisting debt in the sum of $182,188.06, then the difference between the cost to petitioner of the stock and the amount of its liability thus discharged must be regarded as capital gain. Petitioner was not a dealer in securities and did not hold the stock primarily for sale to customers in the ordinary course of its business. Therefore, it must be considered as a capital asset. Chemical Bank & Trust Co. v. United States, 21 Fed. Supp. 167; 85 Ct. Cls. 651.

If a capital asset is transferred in consideration for the extinguishment of a liability of the transferor in an amount less than the cost basis to the transferor of the asset so transferred, the resulting loss to the transferor is a capital loss within the meaning of the_revenue act. Rogers v. Commissioner, 103 Fed. (2d) 790; certiorari denied, 308 U. S. 580. Conversely, where the capital asset so transferred is held at a basis less than the amount of the transferor’s debt extinguished by such transfer, the resulting gain to the transferor must be considered as a capital gain. In each case the transaction is treated as if the transferor had sold the asset for cash equivalent to the amount of the debt and had applied the cash to the payment of the debt. See E. F. Simms, 28 B. T. A. 988; Carlisle Packing Co., 29 B. T. A. 514.

Respondent, however, contends that the transaction here involved should be considered as having been, in reality, two transactions. According to his construction petitioner transferred the Aptos stock, as to which its cost basis was $100,000, in satisfaction of $100,000 of the claim of Miller and Monroe, and then in a later and separate transaction Miller and Monroe gratuitously forgave the balance of petitioner’s obligation to them. Thus, as respondent interprets the facts, there was a transfer’ which might have resulted in capital gain or loss, buc which resulted in neither, since the amount received was exactly equivalent to the cost basis of the asset transferred; and this was followed by the gratuitous forgiveness of the remainder of the indebtedness of petitioner, which resulted in the receipt of ordinary income. In support of this contention respondent points out that petitioner, on its books, treated the excess of the debt extinguished over the cost basis of the Aptos stock as miscellaneous income, and that petitioner treated it in its return as ordinary income. Respondent also relies upon part of an answer of one witness who was a party to the transaction, who referred to the transfer of the Aptos stock as a part payment of petitioner’s indebtedness. We do not agree with respondent’s interpretation of the facts. A careful consideration of all of the facts and circumstances disclosed by the record compels us to the conclusion that the transaction should be treated as one transaction, not two; that petitioner transferred the Aptos stock, a capital asset, to Monroe and Miller in return for their forgiveness of its debt to them of $182,188.06.; and that, since petitioner’s basis as to this stock was $100,000, it realized a gain thereby in the sum of $82,188.06, regardless of what the fair market value of the stock was; and that this was a capital gain against which could be offset capital losses.

The second main issue raised is whether respondent erred in failing to exclude from petitioner’s taxable income for the fiscal year 1936 the sum of $40,997.30 representing the portion of an indebtedness ..of $52,247.30 to the Pacific States Construction Co. of which petitioner was relieved by a compromise settlement within the taxable year for the lesser sum of $11,250. Petitioner reported the $40,997.30 as ordinary income on its return, but now claims the amount should not have been included because, it alleges, petitioner was insolvent at the time and did not thereby become solvent. The endeavor of petitioner to prove insolvency is not successful. Miller testified that in his opinion the assets were worth over a hundred thousand dollars less than the liabilities. He also read into the record certain figures from sheets he had prepared after examination of the corporation’s books. According to his testimony the books disclosed the value of the assets as of the close of the fiscal year 1936 to be $976,994.78, and the liabilities on the same date to be $1,313,444.78. By the close of the next year the assets had fallen to $884,668.48 and the liabilities to $1,179,965.52. The change in these figures was, according to Miller’s testimony, occasioned by purchases of land by Aptos and other brokers. When questioned as to whether the value of the assets was calculated with regard to fair market value of the properties held, Miller said that'the figures were based on cost from 1925 to 1927. He then went on to say that the financial depression had greatly lessened the value of the properties, so that, in his opinion, the cost figures actually exceeded any fair market value of the lands.

Were it not for one of the exhibits introduced by petitioner without limitation to its application, we might have concluded that petitioner had established a prima facie case of insolvency. But this exhibit sets forth the sales by Aptos within the fiscal year 1937 of certain lands transferred by petitioner to Aptos at cost. The date of the transfer of this property to Aptos is not shown on the exhibit, but from the testimony it appears that it was not all transferred at once. The land was transferred to Aptos at cost, therein stated to be $254,910.90. As a result of hundreds of sales to the public during the fiscal year 1937, gross profits in the amount of $286,729.42 were realized, or over 100 percent. On only three transactions with the public were losses sustained, amounting to $1,353; and on two other sales made not to the public but to Miller and Monroe, large losses in the amount of $86,636.27 resulted. In these sales to Miller and Monroe. however, it is extremely dubious whether fair market value was ever taken into consideration or that the sales price is indicative of fair market Amine. Thus Ave see that, Avhile Miller claims that the properties in the hands of the petitioner were not worth cost, some considerable part, of them had a fair market value of twice that amount, as the sales records disclose. We do not know from the testimony ghen Avliat properties comprised the petitioner’s assets in the fiscal years 1936 or 1937. While there is much testimony about transfers of property to Aptos, no dates were given from which we can determine the holdings of petitioner at the times material to a finding of insolvency. Upon the facts shown by the record, we can not reach the conclusion that petitioner was insolvent at the time of the compromise, August 31, 1935, and conclude, therefore, that the $40,997.30 saved to petitioner by the compromise of this claim constituted ordinary taxable income to petitioner.

The third main issue, Avhich was raised in part by amendment to the pleadings at the hearing, concerns the transaction involving the 56 bonds. In the cases of Miller and estate of L. G. Monroe, the respondent has claimed that the individuals received taxable income in excess of that reported by them as the result of using Monroe & Miller, Ltd., in the transaction as a “middle-man.” Now, as an alternative to this content ion, respondent argues that the petitioner realized taxable income in the amounts of $56,000 and $16,380 representing, respectively, the principal amount of the bonds received from Monroe & Miller, Ltd., retired during the fiscal year 1937, and the accrued interest thereon. The amount of $16,380 was included in respondent’s original determination of deficiency; as to the $56,000, the issue was raised for the first time at the hearing. Bespondent fails to advance any tenable theory for this position and introduces no proof to sustain such a conclusion. The burden of proof is upon the respondent as to any new issues raised in his answer in this case with regard to the taxability to petitioner of the $56,000 principal of the bonds. However, it is not necessary to decide even this phase of this issue on a basis of failure of proof, since the petitioner has introduced corporate records to show credits received by Monroe & Miller, Ltd., from petitioner in the full amount of the principal and interest of the bonds transferred, and there was testimony that these credits were paid off. Upon the facts disclosed by the record, we conclude that the petitioner paid out the equivalent of what it received, and that petitioner realized no taxable income by virtue of the transaction.

Decision will be entered wider Rule 50.


source: Caselaw Access Project

author: Sternhagen:

license: Public Domain

text:
    Harry B. Golden, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106802.
    Promulgated June 10, 1942.

      Nathaniel Golden, Esq., for the petitioner.

      T. G. Riston, Esq., for the respondent.
   opinion.

Sternhagen:

The Commissioner determined a deficiency of $593.79 in petitioner’s income tax for 1938, by taxing 50 percent of the gain received in 1938 in an installment of the sale price of shares of stock sold by petitioner in 1936. The facts are all stipulated and need not be specially found. The return was filed in Boston, Massachusetts.

In 1936 petitioner, having for more than ten years owned 65 shares of stock, sold them for $74,231.25. The gain was $69,897.92. Less than 30 percent of the sale price was received in the year of sale; the rest was to be paid in installments over a period of five years. The petitioner elected, as he had the right to do, to use the installment method for reporting the profit. In 1938 the portion of the profit received was $18,640.80, and the petitioner reported 30 percent of this amount as the taxable profit. He relied upon the Revenue Act of 1936, section 117 (a), which was in effect when the sale was made. The Commissioner, acting under the Revenue Act of 1938, section 117 (b), determined that 50 percent of the gain received that year was taxable.

The Commissioner’s determination is sustained. The tax upon income received in 1938 is controlled by the taxing statute in effect in that year. The law in 1936 provided that upon a sale of property held for more than ten years only 30 percent of the gain would be taxed. If petitioner had elected to be taxed in that year upon the entire gain from the sale, he would have been permitted to take into account only 30 percent of the gain. He chose, however, to spread the tax over the period of installments; and, in doing so, he took the risk that the rate of tax might change or that the proportionate amount of capital gain to be taken into account might change upward or downward. There is nothing to indicate that the Congress enacting the 1936 statute intended that the rate or the percentage should be fixed for the future, even if it had that power. Cf. Snell v. Commissioner, 97 Fed. (2d) 891.

Decision will be entered for the respondent.


author: Disney:

text:
    S. B. Heininger, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106518.
    Promulgated June 10, 1942.

      Samuel W. Witwer, Jr., Esq., for the petitioner.

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

Disney:

The present proceeding involves income taxes for the calendar years 1937 and 1938. The Commissioner determined deficiencies in the respective amounts of $10,816.62 and $4,359.39. The petitioner urges error as to the major portion of the amounts. The questions presented are whether certain amounts received by the petitioner were properly added to gross income, and whether certain attorney fees were deductible as ordinary and necessary expenses of business. The income tax returns involved were filed with the collector for the first district of Illinois at Chicago, Illinois. The greater portion of the facts have been stipulated, as follows:

1. The petitioner, S. B. Heiningek, was a resident of Chicago, Illinois, at the time of the filing of the petition herein. Petitioner now resides at Athens, Wisconsin. The returns for the periods here involved were filed with the Collector of Internal Revenue for the First District of Illinois, at Chicago, Illinois.
2. On December S, 1940, th'e respondent mailed to petitioner a notice of deficiency in federal income taxes for the years 1937 and 1938, a true and correct copy of which is attached as Exhibit A to the petition herein.
3. The taxes in controversy are income taxes for the calendar years 1937 and 1938, and the deficiencies asserted are in the amounts of $10,816.62 and $4,359.39, respectively.
4. During the years from about 1926 to 1939, the petitioner was a licensed dentist in the State of Illinois. His principal work since about 1932 was the making of artificial dentures, commonly known as false teeth, for customers living outside of the City of Chicago wh'o did not personally visit petitioner’s office. Before said dentures were made for a customer, petitioner required from and there was forwarded to him from such customer a payment of $2.00 generally designated by the petitioner and hereinafter for convenience referred to as “deposit”. Said dentures, when completed for said nonresident customers, were mailed or shipped to them, C. O'. D., for the amount of petitioner’s respective charges less the $2.00 “deposit”. For various reasons some of the “deposits” were returned to said clients and the dentures ordered by them were not furnished by the petitioner. For years prior to the year 1937, the petitioner consistently followed the practice of entering said “deposits” in his books of account as gross receipts when received, against which he entered as offsets thereto when returned the amounts of the “deposits” returned, and reflected the difference as gross income in his income tax returns for those years.
5. Petitioner’s books of account for the years 1937 and 1938 recorded aforesaid “deposits” and said “deposits” returned and gross income as set forth in paragraph 4, supra. On December 31, 1937, the petitioner credited to a “deposit account” an item of $20,503.60 representing “deposits” on orders which had not been filled or completed. Of said amount, $3,656.60 represented “deposits” received during the period prior to January 1, 1937, and $16,937.00 represented “deposits” received during the year 1937. Said item of $20,593.60 was deducted from petitioner’s gross income arrived at as set forth, supra, in his income tax return filed for the year 1937. On December 31, 1938 the petitioner credited to said “deposit account” an item of $6,900.63 representing “deposits” received during the year 1938. During the year 1938 the petitioner completed, mailed and/or shipped dentures on which deposits in the amount of $13,823.94 had been made in prior years and which were included in the said item of $20,593.60. On December 31, 1938 said “deposit account” was charged with said item of $13,823.94 and gross receipts for 1938 were increased in a like amount, leaving in said “deposit account” as of January 1, 1939 the amount of $13,670.29 ($20,593.60 minus $13,823.94 plus $6,900.63) representing deposits on orders for dentures unfilled as of that date. In petitioner’s income tax return for said year 1938 the aforesaid item of $13,823.94 was included in gross income and the said item of $6,900.63 was deducted from gross income.
In the respondent’s final determination of the petitioner’s tax liability for said year 1937, as evidenced by his notice of deficiency, a copy of which is attached to the petition herein as Exhibit A, the respondent disallowed as a deduction the said item of $3,656.60 and included in gross income the said item of $16,937.00. The petitioner concedes that the respondent’s action in disallowing the said deduction of $3,656.60 was proper and in the final determination herein of petitioner’s tax liability for the said year, said deduction should be disallowed.
In the respondent’s final determination of the deficiency herein for the said year 1938, as evidenced by his notice of deficiency, a copy of which is attached to the petition herein as Exhibit A, the respondent eliminated from gross income the said item of $13,823.94 and included in petitioner’s gross income the said item of $6,900.63.
6. Petitioner’s income tax returns were at all times filed on the cash receipts and disbursements basis. The petitioner never applied for nor received permission from the Commissioner of Internal Revenue to change his method of accounting or filing his income tax returns employed for years prior to 1937.
7. On September 22, 1937 a citation was issued by the Solicitor of the Post Office Department, charging that petitioner was engaged in conducting a scheme for obtaining funds through the mails by means of false and fraudulent practices, in violation of 39 U. S. C. A., Sections 259 and 732. Shortly thereafter petitioner appeared before the United States Post Office Department, answered said charges and employed attorneys to render legal services to petitioner in resisting the issuance of the so-called “Fraud Order” under said Statute. During 1937 petitioner paid attorneys’ fees and other legal expenses in connection with said proceedings, amounting to $7,060.99; said payments were reasonable in amount.
8. On February 19, 1938, and after a hearing under the aforesaid citation, the Postmaster General of the United States issued a so-called “Fraud Order,” forbidding the Postmaster at Chicago, Illinois, to pay any money orders drawn to the order of petitioner, and instructing said Postmaster to return all mail addressed to the petitioner to the senders, marked “Fraudulent”. Thereafter, on February 25, 1938, petitioner filed suit in the District Court of the United States for the District of Columbia against James A. Farley, Postmaster General, and on that date said Court entered an order directing the Postmaster General to hold all mail addressed to petitioner until the further order of the Court.
9. On June 6, 1938, the District Court of the United States for the District of Columbia granted to petitioner a permanent injunction, restraining the Postmaster General of the United States from enforcing the aforesaid “Fraud Order” or otherwise proceeding in accordance with the terms of said “Fraud . Order”. Thereafter the Postmaster General appealed said case to the Court of Appeals for the District of Columbia, and on April 17, 1939 that Court reversed the Order of the District Court for the District of Columbia and remanded the cause with instructions to dissolve the injunction and to dismiss the Bill of Complaint. The opinion of the said Court of Appeals is reported at 105 Fed. 2d 79, of which this Board may take judicial notice. Thereafter, in the October Term, A. D. 1939, petitioner applied to the Supreme Court of the United States for a Writ of Certiorari to review the judgment of the United States Court of Appeals, which Petition for Certiorari was denied.
• 10. A copy of the Bill of Complaint filed by the petitioner in said District Court including a copy of the aforesaid “Fraud Order” attached thereto as “Exhibit A”; a copy of the Answer thereto; a copy of the Restraint Order entered by tbe said District Court; a copy of tbe Court’s opinion; and a copy of tbe Court’s order of permanent injunction are set forth in “Exhibit A”, as labeled therein, which is attached hereto and made a part hereof.
11. Pursuant to mandate of the aforesaid Court of Appeals, the said District Court entered an order dissolving the aforesaid injunction and dismissing the aforesaid Bill of Complaint. Said order is now final and in full force and effect.
12. During the year 1938 petitioner paid to attorneys for legal services in prosecuting his injunction suit in the District Court of the United States for the District of Columbia, and defending the aforesaid appeal of the Postmaster General to the Circuit Court of Appeals for the District of Columbia, and in applying to the Supreme Court of the United States for Writ of Certiorari, fees and legal expenses aggregating $29,530.58; said payments were reasonable in amount.

We find tbe facts to be as stipulated. In addition, from evidence adduced, we further find:

The petitioner on receiving an inquiry by mail customarily mailed a portion of wax called “first impression” material with an order blank and catalogue of prices and instructions as to how to use the wax. The customer would return it with an impression of the teeth, and was then furnished with material for a second impression. If this was satisfactory, the upper plate was made. If not satisfactory, further material was sent to get a better impression. If upon a fourth effort a satisfactory impression was not secured the procedure was discontinued and the deposit mailed back to the customer. If finally satisfactory, the upper plate was finished and sent c. o. d. for the price of the upper plate only, with wax for an impression for the lower plate, which in like manner was finished and sent c. o. d. The petitioner’s gross receipts from the dental business in the year 1937 were $287,582.82 and in 1938 were $150,168.27. Refunds made in 1938 were $27,349 and for the year 1937 were $38,062.08. The petitioner had only one bank account, upon which he drew to pay operating expenses and refunds which were made whenever customers asked for them, whether before or after the completion of the dentures, if the customer was not satisfied. This was pursuant to a written statement included in the order blank used, to the effect that satisfaction was guaranteed or the customer’s money would be refunded after a trial of the teeth of 60 days.

1. We first consider the question whether the Commissioner erred in including in petitioner’s gross income amounts received by petitioner as deposits upon dental work ordered from him by mail, under a written agreement, embodied in the order blank used by the customer, that his money would be refunded in case of dissatisfaction. The petitioner of course has the burden of showing respondent’s action to be error. Petitioner in substance contends that there was, in each of the taxable years, when the deposits were received, no certainty that the contracts would be completed, perhaps pai’ticularly in 1938, in September of which year the Post Office citation was issued, that the money had not been earned, and the deposit was earnest money held in suspense; therefore the amounts did not constitute income. The respondent on his part in effect argues that the money had been received without restriction as to disposition or use, and was therefore gross income.

We note at once that one element of the petitioner’s argument has no factual basis in the record: though he argues, on brief, that in the taxable year “As yet, he had done no work and performed no services Avhereby he earned the deposit”, the record does not bear out such statement. Indeed, immediately prior to the above quoted language, he had stated that nothing had been done prior to the close of the year “other than to secure either a preliminary or final impression or to commence preparation of the first plate” — which shows on its face that at least some work had been done, something earned. This may well have reasonably been as much as or more than the $2 deposit here involved. The record does not tell us what proportion that amount bore to the fee for the finished product. Moreover, the evidence, by stipulation, is simply that on December 31, 193T, the deposits credited to the “deposit account” by the petitioner (and which were not returned as gross income by him) were “on orders which had not been filled or completed.” Likewise the amounts left in the deposit account on December 31,1938, were those “representing deposits on orders for dentures unfilled as of that date.” An exhibit refers to the deposits on hand at the close of each year as “on orders not completed as yet.” This constitutes all the evidence on the point. Obviously this is no showing that the $2 deposits had not been earned during the year, merely because orders had not been “filled” or “completed.” The burden being upon the petitioner, we hold that no showing is made that the deposits had not been earned during the respective taxable years. Yet the petitioner seems to recognize this point of fact as decisive, for on reply brief he says:

The question before this Board is whether petitioner did anything in the respective years of receipt whereby he became entitled to the deposits, as earnings. Here the facts operated to place the status of the deposits, as earnings, in suspense throughout the respective years of receipt. * * *

Shortly after this appear the statements quoted above to the effect that the deposits had not been earned at the end of the year. We consider it clear that there is no showing that the deposits had not been earned. The only question, then, is the effect of an agreement to return them in case of dissatisfaction. That agreement covered not only the $2 deposits, but the entire amount received, and no claim is made that the petitioner’s argument applies to more than the $2 deposits, the balance being returned as income. The argument could, when limited, as we have limited it, to the effect of the written agreement to return in case of dissatisfaction, be applied to petitioner’s entire income with equal logic.

The petitioner cites Webb Press Co., Ltd., 3 B. T. A. 247. That case involved a contract for sale of a cotton compress, where title was retained until acceptance, which did not occur until the next year, so that we held the money received in advance to be income in the following year. The case is of little help here, where there is no title retention and no question of acceptance. Here the customer merely has a right to return of his money if dissatisfied. Bourne v. Commissioner, 62 Fed. (2d) 648, also cited, is a similar case, where there was advance payment or “earnest money” on a contract to sell real estate, where title did not pass and deed was not delivered until a later year, in which it was held the payment constituted income. We think such cases do not control here, where there is found only agreement to refund, not a retention of title or a contract not accepted. The same in effect is true of Virginia Iron, Coal & Coke Co. v. Commissioner, 99 Fed. (2d) 919; and Reginald Denny, 33 B. T. A. 738, involved a loan, neither paid nor received as income. Here, we think, the $2 was both so paid and received. It was deposited by the petitioner in his only bank account, subject

to his check and disposition, and, in our opinion, it was, as we said in D. H. Byrd, 32 B. T. A. 568, 572, “subject only to an unliqui-dated contingent liability.” It was received “under a claim of right and without restriction as to its disposition.” North American Oil Consolidated v. Burnet, 286 U. S. 417; Brown v. Helvering, 291 U. S. 193. The petitioner seeks to distinguish these two cases, cited by the respondent, by the suggestion that there was no earning in the taxable year. We have above noted that there is no such proof in the record. The contract to refund was in effect that this would be done if there was dissatisfaction after a trial of 60 days. Such agreement, in our opinion, does not demonstrate that gross income does not include money received upon the contract. That the petitioner might discontinue business because of the fraud order does not require a different conclusion. On this point the respondent is not shown to have erred.

2. Was there error in refusing deduction of attorney fees paid in connection with the fraud order issued by the Postmaster General and finally unsuccessful effort to obtain a permanent injunction against it? The respondent cites that line of cases which holds, in sum, that expense for attorney fees is not ordinary and necessary if paid to defend, unsuccessfully, a criminal case, where there is conviction, or expense of paying fines. The petitioner seeks to distinguish the situation herein from that involved in such cases, on the ground that here remedies afforded him by the law were asserted, and that there was no judicial determination of wrongdoing or admission of illegality. Here the Solicitor of the Post Office Department issued a citation for fraud order, under a statute so authorizing if he has evidence satisfactory to him that any person is engaged in conducting any scheme or device for obtaining money or property through the mails by means of false or fraudulent pretenses, representations, or promises. Petitioner unsuccessfully expended money in 1937 for attorney fees in resisting the citation issued. The Postmaster General in 1938 issued the fraud order, the petitioner secured a permanent injunction in the United States District Court against the order, but upon appeal there was reversal, the Circuit Court of Appeals specifically holding that the sole question before it was whether there was substantial evidence before the Postmaster General warranting the issuance of the fraud order, that his conclusion was presumptively correct, that the judgment of the court could not be substituted for that of the Postmaster General, and that there was substantial evidence before the Postmaster General; therefore the reversal. In 1938 the petitioner expended moneys for attorney fees to secure the injunction, and to defend the appeal and unsuccessfully apply to the Supreme Court of the United States for certiorari. The amounts expended are stipulated to be reasonable. Are they allowable as ordinary and necessary expense of trade or business ?

After careful consideration of this somewhat novel question we have come to the conclusion that the petitioner is not entitled to the deduction claimed. National Outdoor Advertising Bureau v. Helvering, 89 Fed. (2d) 878, in our opinion governs this case. There a bill in equity was filed by the Attorney General of the United States to enjoin certain matters which he thought unlawful. A consent decree in equity issued forbidding the acts, but not finding that they had been committed. The Board of Tax Appeals considered that, since there was no evidence of commission of criminal acts and since the decree had been directed to acts in the future, expenses incurred in defense of the suit should be deducted. Upon appeal the Circuit Court, reversing the Board, said:

* * * if ⅛ ⅛ never necessary to violate the law in managing a business, it cannot be necessary to resist a decree in equity forbidding violations, except in cases where an injunction is unjustified. * * *

Herein also we find proceedings not under the criminal statutes, the first, resistance to a “fraud order” citation by the Postmaster General, and the second, an injunction proceeding by the petitioner to enjoin such order after its issuance. Though here there was no consent involved in the fraud order or the final opinion denying injunction, nevertheless there was a holding by the Postmaster General that the practice complained of existed, and a sustention thereof by the Circuit Court. It is as if in the National Outdoor Advertising case there had been a decree of injunction on the merits, without consent. We think that opinion is based upon the fact of decree, and not the consent. The court seems to be of the opinion that if a decree of injunction is justified where there is a contention of unlawful practice, the expense is not deductible as ordinary and necessary expense. That the practices herein complained of by the Postmaster General were unlawful is demonstrated by examination of the Federal statutes: The fraud order was issued under sections 259 and 732 of Title 39," U. S. Code Annotated. The part thereof pertinent here is:

Tlie Postmaster General may, upon evidence satisfactory to Mm * * * that any person or compány is conducting any other scheme or device for obtaining money or property of any kind through the mails by means of false or fraudulent pretenses, representations, or promises * * * [act to bar the use of the mails or forbid payment of money orders, etc.]

The language is the same in the two statutes. But the same expression is the gist of a criminal statute. Section 338 of Title 18, U. S. Code Annotated, provides that:

Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises * * ⅜ shall ⅜ ⅜ * place * * * any letter ⅝ * * in any post office * * * shall be fined not more than $1,000 or imprisoned not more than five years, or both.

In other words, the use of the mails in any scheme for obtaining money or property by means of false or fraudulent pretenses, representations, or promises is ground for barring from the mails, and for criminal prosecution. Though no criminal prosecution is suggested in the proceeding, it is apparent that the ground for the fraud order was the unlawful character charged to the practices of the petitioner. Use of the mails for lawful purposes would be no logical basis for a fraud order. We therefore think that injunction against unlawful practices appears here just as in the National Outdoor Advertising case. That case certainly stands for the principle that a criminal case and conviction therein is not a necessary base for denial of deduction of legal expenses involved, but that a civil proceeding involving injunction against practice forbidden by law, unsuccessfully defended, calls for such denial. The reversal of the Board’s view in that case, in our opinion, requires denial of the petitioner’s contention here, as is shown by the fact that deduction of expense was allowed by the court in so far as the defense was successful. We cited the National Outdoor Advertising case in Textile Mills Securities Corporation, 38 B. T. A. 623, 631. The proceeding in which the legal expenses are involved need be only civil,, such as injunction. Such proceeding here appearing, we conclude and hold that the respondent did not err in denying the claim of deduction for legal expenses in either year.

Decision will be entered for the respondent.


author: Opper:

text:
    Fowler Brothers & Cox, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101054.
    Promulgated June 16, 1942.

      George E. H. Goodnar, Esq., for the petitioner.

      Frank M. Thompson, Jr., Esq., for the respondent.
   OPINION.

Opper:

The first issue is the deductibility of an assertedly worthless debt consisting of the balance of petitioner’s deposit in a closed bank. Simultaneously there was owed to the bank by petitioner a note at least as large as the unpaid deposit. The record does not succeed in clarifying the facts to our satisfaction, but it does appear that from the beginning efforts had been made on petitioner’s behalf to offset the one debt against the other, which if successful wouldj. of course, be tantamount to a collection of petitioner’s deposit in full. Up to and including the tax year these efforts had been unavailing. But the matter was still in abeyance, petitioner was still claiming, and the bank’s receiver still denying the validity of petitioner’s contention. No definitive action had as yet been taken by either party to the controversy.

In tbe following year petitioner dissolved and transferred assets ■and liabilities to a successor corporation with a similar name, and ■apparently similar officers and stockholders, but even at that time the matter was still in dispute. One of the points which remains in ■obscurity on the whole record, although the attention of petitioner’s •counsel was directed to it at the hearing, is the treatment of the •deposit on this transfer. We do not know whether it was included ■among the assets turned over to the new company and if so what was paid for it, and. if not when or for what consideration it was .subsequently transferred. It is clear, however, that eventually it must have been obtained by the successor, for several years later the new company was successful in offsetting the deposit against the note liability which it had assumed, a result which seems to us to have been possible only on the assumption that the same entity was in a position to operate as both debtor and creditor.

Passing the point that no evidence appears upon which a determination of the financial condition of the debtor bank and of the collectibility of the deposit from the bank’s assets can be independently weighed by the Board, see Higginbotham-Bailey-Logan Co., 8 B. T. A. 566; Eastern New Jersey Power Co., 37 B. T. A. 1037, it is .■apparent from the record that there was no new development in the tax year respecting the ability of the bank to pay, which constituted the ground for the exercise of judgment by petitioner’s officers in that year in charging off the deposit or ascertaining any impossibility of collecting it. In answer to the question, “Did conditions in general look worse in 1937 than they did in 1933?” petitioner’s president testified “No, they did not * * * they looked better.” i.What apparently induced the 1937 charge-off, if that can be told from this record, was that petitioner’s president “talked to some three nr four attorneys around our town there about it and they didn’t think it was possible for us to ever get it offset.” This, as the later •events show, was erroneous advice, and in fact petitioner and its successor did not follow it; for, as we have already indicated, the •claim was never abandoned and petitioner’s successor was able a few years later to accomplish the settlement. If therefore the determinative factor relied upon to single out the tax year for the charge-off was the assumption founded upon advice received in that year that no offset would eventuate, the conclusion must be that there ■could have been no ascertainment of worthlessness at that time since in fact the debt was, and later proved to be, entirely collectible. Mayer Tank Manufacturing Co. v. Commissioner (C. C. A., 2d Cir.), 126 Fed. (2d) 588.

There is some suggestion that since the ultimate collection redounded to the benefit of petitioner’s successor and since the transfer •of petitioner’s .assets and its liquidation had intervened, the debt proved to be worthless as far as petitioner was concerned. There are-numerous objections to any reasoning of that nature. The one that we think is sufficient is that if the transfer of assets and the liquidation and dissolution which took place in a subsequent year were what deprived petitioner of the eventual payment of the debt, petitioner’s-loss would have to be claimed in the year when the transactions said, to be responsible for it took place and not in the tax year before us.

There was no bad debt in 1937 nor in fact at any time. Petitioner’s claim of worthlessness therefore can not be sustained and. respondent was correct in disallowing it.

The next question is whether a deduction for officers’ salaries not recorded on the books, nor claimed in petitioner’s return, nor paid, during the tax year, may now be allowed as a deduction. Without-disposing of his other contentions, it seems to us respondent’s action, must be upheld on the elementary ground that petitioner was on the-cash basis and can not be permitted to deduct items not paid during, the tax year.

It is true that petitioner asserts it was actually upon the accruaL basis but the only foundation for this assertion is that prior to petitioner’s withdrawal from active business, many years before, it had conformed to that description. For five successive years, including' the one before us, its returns contained a statement that they andi its books were based on cash receipts and disbursements. This statement is borne out by the admitted failure to show on the books of account or the return itself any item of salaries during the tax year,, a procedure which would, of course, be entirely understandable only-if the cash basis were used, since if salaries were due they were not actually paid.

We sustain respondent * * * in denying the deduction * * * a& salary ⅜ * * for we are not satisfied that petitioner’s accounts were kept on an accrual basis so that this item was properly accruable in that year. While petitioner’s chief witness testified that the accounts were so kept, that testimony is in conflict with the statement sworn to on the return that thfe-accounts were kept on a basis of cash receipts and disbursements. This variance was not explained at trial; furthermore, the details of the return itself indicated that the statement thereon is correct. Consequently, we have relied upon it and found as a fact that petitioner’s accounts were kept on the cash, basis. The salary, therefore, is not deductible as an expense until paid’,. [Memphis Memorial Park, 28 B. T. A. 1037, 1044; affirmed per curiam (C. C. A., 6th Cir.), 84 Fed. (2d) 1008.]

Tlie attempt to convert these returns into accrual basis computations on the ground that respondent’s consent to a change from the prior-method of reporting was never obtained, Regulations 94, art. 41-2, must likewise fail. Respondent’s consent can be implied from his acceptance of a changed method of reporting, without rejection or other indication of his nonacquiescence. Rossin & Sons, Inc. v. Com missioner (C. C. A., 2d Cir.), 113 Fed. (2d) 652. The disallowance of the claimed deduction is approved.

.We are next confronted with the question whether petitioner is entitled to a dividends paid credit both for computing its undistributed surplus tax and its personal holding company tax. Petitioner distributed the sum of $10,000 in the tax year in the course of its liquidation. It is now settled that the fact that this was a distribution in liquidation rather than a dividend taxable to the stockholders does not- of itself eliminate its use in computing the dividends paid credit. Melvering v. Credit Alliance Corporation, 316 U. S. 107. The provision of the Revenue Act however which authorizes this result (section 27 (f)) is limited in application to “the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913.” The function of this phrasing is discussed in Helvering v. Credit Alliance Corporation, supra:

* * * The line drawn in all of the revenue acts between profits accumulated Ibefore the enactment of the first income tax act and after that date for distinguishing capital and income furnishes the reason for the insertion of the «clause in subsection (f). Section 27 deals with a credit to the distributing corporation and the phrase finds its proper office in limiting the amount of the distribution in liquidation which may be considered a dividend from earnings or profits as distinguished from one composed of capital.

In the present case the distribution in question was one of a series which up to the close of the tax year had failed to complete the return óf the capital account. It appears from the evidence, moreover, that when the liquidation was terminated there had still been no distribution out of petitioner’s earnings or profits. Since we are dealing with distributions in partial liquidation, the provisions of 115 (c) rather than necessarily those of 115 (b) formulate the test to be applied. Foster v. United States, 303 U. S. 118. We are therefore not commanded to view these as distributions of the most recently accumulated «earnings and profits, if from other circumstances we can determine whether they are properly chargeable to capital account; for, if so, section 115 (c) expressly excludes them from treatment as dividends both under 115 (c) and under 27 (f). Reed Drug Co., 44 B. T. A. 573.

In this case we know that accompanying the payment to the stockholders was a cancellation and reissuance of the capital stock resulting an a reduction of the capital account on the books of the company and of the shares outstanding in the hands of the stockholders. This is the most persuasive evidence that the distributions here in question were properly chargeable to capital account. William D. P. Jarvis, 43 B. T. A. 439; affd. (C. C. A., 4th Cir.), 123 Fed. (2d) 742. They .are not, therefore, to be treated as dividends nor as a ground for permitting a dividends paid credit under section 27 (f). The remaining questions can be disposed of without difficulty. Petitioner’s assertion of error in the computation of the specific credit permitted by section 14 (c) (1) must be rejected on the authority of Sportwear Hosiery Mills, 44 B. T. A. 1026. Although not expressly conceding the legal conclusion, petitioner’s admissions of fact make it clear that it is a personal holding company subject to the provisions of section 351. And it explicitly withdraws any controversy relating to the penalty for failure to file a personal holding company return.

Decision will be entered for the respondent.


author: Smith:

text:
    John P. Elton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 108403.
    Promulgated June 16, 1942.

      Ernest W. McCormick, Esq., and John C. Parsons, Esq., for the petitioner.

      Charles P. Reilly, Esq., and Martim, I. Lore, Esq., for the respondent.
   OPINION.

Smith:

The principal issue presented for decision is whether the distribution of cash received by the petitioner from the Colonial Trust Co. is taxable in full as an ordinary dividend or is to be-treated as a distribution in partial liquidation of the company. If there was a complete cancellation or redemption by the corporation, of a part of its stock the distribution was in partial liquidation of the corporation as defined in section 115 (i) of the Revenue Act of 1938, unless the cancellation or redemption was essentially equivalent to the distribution of a taxable dividend within the meaning of section 115 (g). The petitioner contends that the distribution in question was in partial liquidation of the company and resulted in a capital loss to him on the basis of the actual cost of shares of stock which he identifies as having been redeemed. The respondent contends that in the event we find there was a partial liquidation of the corporation the gain or loss must be computed upon the basis of the average cost of all of the petitioner’s stock in the trust company and not upon the basis of the actual cost of shares claimed to have been redeemed.

On all of the evidence, we hold that the Colonial Trust Co. did in fact completely redeem and cancel a part of its stock in 1939. The respondent’s argument that there was no partial liquidation of the corporation because it did not in any way curtail its business activity and was not in the process of winding up its affairs is without merit. Commissioner v. Quackenbos, 78 Fed. (2d) 156; Benjamin, R. Britt, 40 B. T. A. 790. The pertinent facts are that the corporation called in and canceled 5,000 shares, or one-half of its total outstanding stock, for the amount of $1,100,000 in cash, which it charged entirely to its capital and surplus accounts. The amount of $220 per share which was distributed was approximately equivalent to the fair market value of the shares redeemed. This fact distinguishes the instant case from Lida E. Malone, 45 B. T. A. 305, in which the amount distributed to the stockholders in cancellation of a part of the stock bore no reasonable relation to the fair market value of the stock redeemed and did not return to those stockholders the proportion of the assets of the corporation to which those shares of stock would entitle them. The distribution plainly comes withia the very letter of the statute and, being in partial liquidation of the corporation, is to be treated as in part or full payment in exchange for the stock in accordance with the provisions of section 115 (c).

We next examine the facts in this case to determine whether section 115 (g) is applicable. The application of this provision of the law in any case depends entirely upon the particular facts. McGuire v. Commissioner, 84 Fed. (2d) 431. There is no question that the stock in the instant case was all issued for bona fide business reasons. More than one-half of the total paid therefor was paid in 1929. It appeared entirely probable at that time that there would he a substantial increase in the demand for loans from the bank, to meet which additional funds were required. Soon after the stock was issued, however, the business depression struck and in the ensuing years the bank found itself with more capital than it could use profitably. For this reason it decided to return some-of it to its ..stockholders.

The distribution in 1939 was made for sound business reasons and "was not a step in an apparent plan to distribute earnings in a manner which would save taxes for the stockholders, as in Randolph v. Commissioner, 76 Fed. (2d) 472. The stock was not redeemed at the •request of stockholders requiring financial assistance, as in Flanagan v. Helvering, 116 Fed. (2d) 937. It is true that the corporation did have earnings which accrued after February 28, 1913, in excess of the amount distributed, as did the taxpayer in Goldstein v. Commissioner, 113 Fed. (2d) 363. In the instant case, however, there is adequate and satisfactory explanation for the time and manner of the distribution, whereas such explanation was lacking in the Goldstein case. On the facts of this case we hold that the cancellation «and redemption of its stock by the Colonial Trust Co. was not essentially equivalent to the distribution of a taxable dividend within the meaning of section 115 (g). Commissioner v. Champion, 78 Fed. (2d) 513.

The final question is whether gain or loss to the petitioner is to be computed upon the basis of the actual cost of the shares which he designated for redemption or upon the average cost of each share «of stock owned by him. If the Colonial Trust Co. had merely elected to retire one-half of its outstanding shares at $220 per share and the petitioner had surrendered the certificates which he did surrender for the cancellation of 105 shares, no question could arise but that the petitioner would be entitled to use the cost of those shares as the basis for computing gain or loss upon the cancellation. We do not think the fact that the company elected at the same time to reduce the par value of the remaining 5,000 shares from $100 •to $25 per share and for the issuance therefor of 20,000 shares of the new stock has any bearing upon the question of the right of the petitioner to designate the certificates which were to be canceled. In Helvering v. Rankin, 295 U. S. 123, the Supreme Court held that a person having a margin account with a broker and making purchases and sales might designate to the broker the shares of stock which he wished sold as those purchased on a certain date. This-was held to be a sufficient identification of the shares to warrant the computation of gain or loss upon the cost of the shares thus-identified. The Court specifically pointed out that certificates for shares provide the ordinary means of identification but that that was not the only possible means. In this proceeding 'the certificates to be canceled were specifically designated. We see no reason why the petitioner should not be permitted to use the cost of the 105 shares covered by the certificates designated for redemption as the-, basis for the computation of the gain or loss upon the redemptiont of such shares.

Decision will be entered, under Rule 50.


author: Kern:

text:
    Kenneth S. Battelle, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Esther C. Battelle, Deceased, Kenneth S. Battelle, Administrator, and K. S. Battelle, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104655, 104656.
    Promulgated June 16, 1942.

      Louis Janin, Esq., for the petitioners.

      Arthur L. Hurray, Esq., for the respondent.
   OPINION.

Kern:

The issues involved in these proceedings have already been •set forth. The first, and main issue, is whether respondent erred in ■disallowing, as ordinary business deductions, the net losses sustained by the petitioner in 1936 and 1937 from transactions in commodity futures. The respondent classed those losses as losses from the sale •of capital assets, allowable only to the extent of $2,000 in each of the two taxable years.

The petitioner, in insisting that respondent has erred in limiting these losses, relies upon T. H. Banfield, 42 B. T. A. 769, and Ben Grote, 41 B. T. A. 247. These cases do not, however, support the petitioner’s position. In the Banfield case, supra, the issue in question was for the first time raised in respondent’s amended answer, and therefore respondent had the burden of proof with regard to this issue. Our decision in that case was not on its merits, but to the effect that the respondent had failed to sustain this burden. Moreover the case was later reversed on this point, Commissioner v. Banfield, 122 Fed. (2d) 1017.

The Grote case, supra, however, is a decision on the merits involving futures transactions, and at first blush appears controlling of the issue herein presented. The decision of the Grote case is that losses sustained in hedging transactions are not capital losses subject to the deduction limitations of section 117 of the Kevenue Acts of 1934 and 1936. We shall follow the rule of the Grote case. Having accepted this general rule, the material issue, therefore, is whether any or all of this petitioner’s losses were suffered as the result of hedging transactions. This being largely a factual question, it must necessarily be answered in each case upon the peculiar facts presented.

The term “hedging” has, for years, defied concise and exact definition. In Commissioner v. Farmers & Ginners Cotton Oil Co., 120 Fed. (2d) 772 (C. C. A., 5th Cir., 1941), reversing 41 B. T. A. 1083 (certio-rari denied, 314 U. S. 683), the court gave the following definition of the term:

A hedge is a form of price insurance, it is resorted to by business men to avoid’ the risk of changes in the market price of a commodity. ' The basic principle o£ hedging is the maintenance of an even or balanced market position.

This description of hedging is not sufficiently detailed and exclusive' to be used as a complete guide in all factual inquiries without the addition of such further necessary and material qualifications as the facts of the individual case require.

Viewing the facts of the instant proceeding in the light of the1 court’s definition of hedging in the Farmers & Ginners Cotton Oil Co., case, supra, we have concluded that the transactions, with the exception of those in cotton futures in the year 1936, which are discussed' infra, do not constitute hedges. None of the 1936 wheat futures-transactions, most of which called for deliveries in May, July, and September, are shown to have been a hedge. There was neither any wheat on hand nor in the ground against which to hedge, and petitioner did not plant any wheat until November of that year, whereas all the transactions were initiated in the early part of the year and called for deliveries before any wheat planted by petitioner could be-harvested. Likewise, none of petitioner’s 1937 cotton futures transactions can be considered as a hedge for the reason that the petitioner never once established a short position but, on the contrary, maintained a long position throughout two and one-half months' of that, year. Petitioner’s futures transactions in corn, which commodity market, as that of rye, also, has been through custom of the trade used for the hedging of barley, for which there is no active futures market, do not appear to us to have been hedging transactions. While he never assumed a long position, it will be noted that petitioner’s first three-short positions were maintained for the unreasonably short periods of four, eight, and three days, respectively, which rapid change of position is not consistent with the basic principle of hedging unless the-market during those few days may have taken an unusually sudden drop to the point where the petitioner could have suspected it to be at-a low. We have no evidence of such market condition and, without such evidence, we must conclude that this rapid and sporadic action was speculation. It is also pertinent to note that petitioner’s final and largest transactions, although the short position was thei’ein maintained for a period of three and one-half months, were entered into-subsequent to the disposition of all barley on hand or in the ground and were for a December delivery, although petitioner’s 1937 crop had not yet been planted and could not be expected to be ready for harvest, until at least six months after that date. Petitioner’s two intermediate-transactions, though possessing many of the attributes of hedges when viewed as isolated transactions, can not be so considered in view of the general speculative aspect of the com futures transactions in 1936, regarded as a whole.

Petitioner’s cotton futures transactions in 1936 were, however, of a different nature. There was never an assumption of a long position. The short position assumed by petitioner in January of that year was never fully offset until July, when it is apparent from, the figures in evidence that the price per bale had dropped to a. very low level. Petitioner planted his crop in the early part of 1936 and anticipated harvest in October. He did not short himself in a greater amount than he might reasonably have anticipated harvesting. Although a short position was assumed prior to planting, and at a time when no cotton remained on hand, there was always-the reasonable anticipation of the 1936 crop, which was planted sometime in the early part of the year and was harvested on or about the dates upon which delivery was called for by these futures contracts. The fact that a taxpayer does not have the commodity on hand at the time he assumes the short position does not preclude him from correctly terming it a hedge so long as he shows his purpose was to offset the production risk of a commodity he expects to have on hand for sale.

His maximum 1936 short position in cotton was 600 hales, assumed in April. His fall harvest yielded 471 bales. The only transaction in 1936 in cotton futures which appears at all questionable-is the 200 bales short position assumed October 9, 1936, and offset the following day. This isolated transaction is unexplained, but, in view of the petitioner’s general scheme of transactions, we conclude that these 1936 cotton futures transactions were hedges. We conclude that while petitioner’s activities on certain commodity futures markets were speculative, his transactions in cotton were not.

Viewing petitioner’s numerous transactions on the corn and rye futures markets in 1937, we conclude that they did not constitute hedges against his barley crop.

Petitioner was “in” and “out”, “long” and “short”, throughout the year. Pie never maintained any short position for longer than eleven days and the relinquishment of his sporadic short positions was never correlated with the sale of any of his crop. In addition, he continued to engage in futures transactions after the sale of all barley on hand and at a time when no new crop was planted and, so far as the evidence discloses, these transactions called for delivery on dates long prior to any anticipated future barley harvest. These 1937 futures transactions in corn and rye were not hedges and we so hold.

The sole remaining futures transactions are the 1937 wheat transactions, wherein petitioner did his most active business. Here, again, petitioner was “in” and “out”, “long” and “short” and for the first time assumed straddle positions, i. e., the assumption of a short position and a long position, both at the same time, without first offsetting the short position. The effect of these straddle operations was that the petitioner’s net straddle position was “long” during two-thirds of the taxable year. TIis crop was in the ground or on hand at all times during the year. As has already been indicated, we are not disposed under these circumstances to agree with an argument by the taxpayer that any of such transactions were intended to be hedges.

The losses sustained on these transactions discussed above are allowable in each of the two years only to the extent of $2,000 plus the gains from such sales or exchanges, under section 117 (d) of the Kevenue Act of 1936. The 1936 cotton futures transactions, however, we have held were not speculative transactions but were hedges and, accordingly, the losses sustained on these particular transactions are not so limited, but are allowable in full.

There is one further series of transactions still to be dealt with. In 1937 petitioner bought and accepted delivery of wheat produced by others and resold this wheat at a net loss of $15,046.96. Applying the definition of capital assets contained in section 117 (b) of the Revenue Act of 1936 to this wheat so acquired by the taxpayer, we conclude that this was not the purchase and sale of a capital asset. Section 117 (b) specifically excludes from its definition of capital assets:

Stock in trade of the taxpayer or other property of a kind which would properly be included in th¡e inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

This wheat, of which the taxpayer took delivery with the intention of resale, falls within the latter exception as set forth above.

Therefore, we hold that the losses sustained on the sale of the wheat purchased by the taxpayer are not limited by section 117 (d), but are allowable in full.

The final issue for our determination deals with petitioner’s right to deduct as business expenses the selling commissions on the transactions outlined above. Since petitioner was not a dealer with regard to contracts for future purchases and sales, these expenses should be considered as part of the cost when computing gain or loss. Spreckels v. Helvering, 315 U. S. 626. We, accordingly, disallow the deduction qua expenses of the selling commissions on those futures transactions here involved.

Decision will be entered under Rule 50.


author: Mellott:

text:
    Baboquivari Cattle Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103848.
    Promulgated June 16, 1942.

      Lloyd Fletcher, Jr., Esq., and John W. Townsend, Esq., for the-petitioner.

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

Mellott:

The Commissioner made several adjustments to the net income shown by petitioner’s returns for 1937 and 1938 and determined deficiencies in income tax in the respective amounts of $795.60 and $424.46. The sole error charged in the petition is the inclusion in gross income of $3,586.89 for 1937 and $3,247.74 for 1938, these being the amounts received from the United States under the Soil Conservation and Domestic Allotment Act. All of the facts have been stipulated, admitted in the pleadings, or shown in documents received in evidence without objection and are found accordingly.

Petitioner, an Arizona corporation engaged in the operation of a cattle ranch and keeping its books upon the accrual basis, filed its-returns with the collector of internal revenue for the district of Arizona. The ranch comprises 57,200 acres of land in Pima County,. Arizona, 45,880+ being owned by the state, 4,000 by the United States, and 7,319+ by petitioner. During the taxable years the land owned by the state was held by petitioner under grazing leases duly executed under the laws of Arizona for terms of from five to ten years and the land owned by the United States was held by petitioner under the provisions of the Taylor Grazing Act of June 28,1934 (48 Stat. 1296), as amended. The land is in a hot, semiarid region in the watershed of the Gila River, a tributary of the Colorado River. The major portion of the rainfall occurs during three summer months and because of climatic and geographical conditions the lands owned or held by petitioner and surrounding lands are subject to substantial erosion.

During the taxable years petitioner constructed or rebuilt on the ranch some dirt reservoirs and earthen tanks, constructed a rubble masonry dam, built two miles of drift fence, deepened a well, and developed a spring or seep. Before these improvements were undertaken a range grazing examiner, working in conjunction with the Pima County Range Conservation Committee, had made a survey of petitioner’s ranch and a report recommending that the improvements be made. The first report was approved by the committee on or about July 16,1937. On that date the committee advised petitioner in writing: “Upon notification by you * * * that one or more of these recommended improvements have been completed, the County Committee will inspect same and upon approval, will submit to you an application to be signed for benefit payment.” The letter also advised petitioner, in accordance with the Soil Conservation and Domestic Allotment Act, supra, and the regulations issued thereunder: “Number of animal units 2325 which times $1.50 per head, wrill enable you to earn a maximum payment of $3,487.50.” Substantially the same procedure was followed in 1938, the total allowance, computed upon the number of acres and number of animal units, being $3,247.74.

Upon completion of a portion of the work in 1937 the contemplated notification was given, application was filed and approved, and payment was authorized and made to petitioner in the amount of $3,586.89. Upon completion of the remainder of the work in 1938 payment was made in the amount of $3,247.74. The cost of the work in each year exceeded the amounts received by petitioner from the United States. In petitioner’s books of account the cost of the improvements was not charged to profit and loss, but was treated as a capital item and carried into an asset account entitled “Improvements under Federal Aid.” The amounts received by petitioner in the taxable years were treated as credits to capital surplus. In its returns of income the amounts were shown as carried upon petitioner’s books; but neither was included in its gross income. The Commissioner added each of them to the net income reported.

All of the improvements in 1937 were made upon land owned by the State of Arizona and held by petitioner under lease. Of the total amount received by petitioner in 1938, $899.10 (in the language of the stipulation) “represented reimbursements or payments for improvements made on land owned outright by the petitioner, $2,348.64 on land owned by the State of Arizona, and none on land owned by the United States Government.” While we have found all of the facts to be as stipulated, we think it is more accurate to say that benefit payments were received by petitioner in the amounts shown above for carrying out the range improvement practices recommended by the range examiner and approved by the Pima County Agricultural Conservation Association in accordance with the regulations prescribed by the Secretary of Agriculture under the Soil Conservation and Domestic Allotment Act, supra. So much, then, for the basic facts.

The Act of April 27,1935, (49 Stat. 163) directed the establishment of an agency in the Department of Agriculture to be known as the “Soil Conservation Service” and provided that the Secretary of Agriculture should assume all obligations incurred by the Soil Erosion Service prior to its transfer to the Department. Congress “recognized that the wastage of soil and moisture * * * resulting from soil erosion, is a menace to the national welfare” and declared its policy to be “to provide permanently for the control and prevention of soil erosion and thereby to preserve natural resources, control floods, prevent impairment of reservoirs, and maintain the navigability of rivers and harbors, protect public health, public lands and relieve unemployment * * *.” It therefore authorized the Secretary of Agriculture to conduct surveys, investigations, and research relating to the character of soil erosion and the preventive measures needed, to carry out preventive measures, and:

(3) To cooperate or enter into agreements with, or to furnish financial or other ■aid to, any agency, governmental or otherwise, or any person, subject to such ■conditions as he may deem necessary, for the purposes of this Act.

As a condition to extending any benefits under the act to lands not owned by the United States the Secretary of Agriculture was authorized to require: (1) the enactment and reasonable safeguards for the enforcement of state and local laws imposing suitable permanent restrictions on the use of the lands and otherwise providing for the prevention of soil erosion; (2) agreements or covenants as to the permanent use of such lands; and (3) contributions in money, services, materials, or otherwise, to any operations conferring such benefits. He was also authorized to secure the cooperation of any governmental agency, to continue employees of the organization theretofore established for the purpose of administering the provisions of the act with relation to the prevention of soil erosion, and to expend the funds theretofore appropriated for such purpose.

The excerpts from the report of the Senate Committee on Agriculture and Forestry shown in the margin indicate the magnitude of the problem and the reason for the enactment of the legislation.

The Soil Conservation Act was amended February 29, 1936, by the-addition of several new sections and it became the “Soil Conservation and Domestic Allotment Act.” (49 Stat. 1148.) The most substantial change was through the addition of sections Y and 8. Section Y,. as explained in Report No. 19Y3 of the House Committee on Agriculture, Y4th Cong., 2d sess., provided for Federal grants to the states to enable them to carry out plans developed by them to effectuate anyone or more of the following purposes:

(1) Preservation and improvements oí soil fertility;
(2) Promotion of the economic use of land;
(3) Diminution of exploitation and of unprofitable use of national soil resources ;
(4) Provision for and maintenance of a continuous and stable supply of agricultural commodities adequate to meet domestic and foreign consumer requirements at prices fair to producers and consumers; and
(5) Reestablishment and maintenance of farmers’ purchasing power.

Each state was left free to accept or refuse the benefits and it was-contemplated that no citizen of a state should have any relation, contractual or otherwise, with the Federal Government.

As a temporary expediency the Secretary of Agriculture, under-section 8, was given power to make payments of grants or other aid' to agricultural producers determined by him to be fair and reasonablé-in connection with the effectuation of the purposes specified in section Y, measured by: (1) the treatment or use of their land or a part thereof for soil restoration, soil conservation or the prevention of erosion; (2) changes in the use of their land; (3) a percentage of their normal production of any one or more agricultural commodities designated by the Secretary equaling the percentage of the normal national production of such commodity or commodities required for domestic consumption; or (4) any combination of the above. In determining the amount of any payment or grant measured by (1) or (2) the Secretary was required to take into consideration the productivity of the land affected by the farming practices adopted during the year with respect to which the payment was made. He was authorized to utilize county and community committees of agricultural producers, the agricultural extension service, and other approved agencies in carrying out the provisions of the act, but he was specifically denied the power “to enter into any contract binding upon .any producer or to acquire any land or any right or interest therein.” In administering section 8 the Secretary was required in every •practical way to encourage and provide for soil conserving and soil ■rebuilding practices rather than the growing of soil depleting commercial crops. To carry out the purposes of sections 7 and 8 there was authorized to be appropriated for any fiscal year an amount not :in excess of $500,000,000.

Under date of January 14, 1937, the Secretary, pursuant to the authority vested in him under section 8 of the act promulgated regulations under which payments would be made to farmers, tenants, xanch operators, sharecroppers, etc., in the State. of Arizona. A ranch operator was defined to be “a person who as owner, cash tenant, •or share tenant operates or a person who acts in similar capacity in tthe operation of a ranching unit.” A ranching unit was “all range .'land which is used by the ranch operator as a single unit in producing Tange live stock with farm machinery, work stock and labor, sub-stantially separate from that of any other range land.” A range 'building payment was stated to mean “a payment for the carrying ■out of approved range building practices” and a range building ¡allowance was defined as “the largest amount for any ranching unit ■which may be earned as a range building payment on such ranching •unit.” Animal unit was defined as “one cow, one horse, 5 sheep, 5 ¡goats or the equivalent thereof” and grazing capacity or range land was stated to mean “that number of animal units which such land will sustain on a twelve-month basis over a period of years without injury to the range forage, tree growth or watershed.” (Western ."■Region Bulletin, No. 101, Arizona, sufra.)

Under part IV of the regulations the rates and conditions of range ‘building payments were set out. As particularly applicable to the presently stipulated facts they were: 15 cents per cubic yard of fill •or excavation for constructing earthen pits or reservoirs with ade-cúate spillways; $1 per linear foot for drilling or digging a well; ■$50 for digging out a spring or seep and protecting the source from trampling; 30 cents per rod for constructing cross fences or drift fences; and 3 cents per linear foot for the establishment of fire guards. Under section 2 of part IY of the regulations the range building allowance for any ranching unit was to be “equal to $1.50 times the grazing capacity of the range laud in the ranching unit.”

Application for range building payments could be made only by ranch operators and payments were to be made only upon application filed with the county committee. The grazing capacity for each. ranching unit was to be established only upon a report submitted by the range examiner who, in examining the range and making his report thereon, was required to take into consideration: (a) composition, palatability, and density of growth; (b) climatic fluctuations; (c) distribution and character of watering facilities; (d) topographic and cultural features; (e) classes of live stock; (f) presence or absence of rodents and poisonous plant infestations; and (g) previous use.

The regulations were amended June 3, 1937 (W. R. B. No. 101, Arizona, Supplement I, supra), to provide that payment be made for carrying out on range land in 1937 such range building practices as were approved by the county committee for the ranching unit prior to their institution, provided the payments did not exceed the range building allowance for the ranching unit. They were further amended under date of July 23, 1937 (W. R. B. 101, Arizona, Supplement II, Federal Register, July 27, 1937, p. 1554), in particulars not presently important.

Rather extended reference has been made to the act and regulations under which the payments in issue were made for two reasons: First, because this is the first proceeding before the Board in which the taxability of such payments has been in issue; and second, because, notwithstanding the stipulation of the parties to the effect that the payments were “reimbursements or payments for improvements made on land owned outright by petitioner * * * or by the State of Arizona”, we feel that they were nothing but benefit payments for carrying out approved range improvement practices recommended by the range examiner and approved by the county conservation committee. With this background and acting upon the assumption that our question is essentially whether benefit payments are income to the recipient, we give consideration to the several contentions made by petitioner upon brief, though not in the order presented by it.

May the payments be construed to be gifts and therefore exempt from taxation under section 22 (b) (3) of the Revenue Act of 1936? Petitioner urges that they should be, pointing out that the Secretary of Agriculture had no power under the act to “enter into any contract binding upon any producer”, that the United States received no direct consideration in goods or services for the payments made, and that the act itself refers to the payments as “grants.” The only case cited is United States v. Hurst, 2 Fed. (2d) 73. In that case the United States District Court for the District of Wyoming followed Union Oil Co. v. Smith, 249 U. S. 337, which recognized that a locator and discoverer of mineral rights upon vacant lands of the United States had a possessory right in the land, capable of conveyance, inheritance or devise, and held that the acquisition of such a right under the United States statutes partook “more of the nature of a gift than that of any other method of acquiring title to property known to the law.” It also held that if Congress had desired to exclude from its exemption of gifts any particular kind it would have so declared.

It may be assumed for present purposes that the conclusion of the Court was correct under the facts before it; but we do not believe that the payments now in issue can be construed to be gifts. Under the Soil Conservation and Domestic Allotment Act it was not intended that the Government should make “a voluntary transfer of real or personal property without any consideration”, “a donation”, “a present”, or that it should “voluntarily bestow something of value without expectation of return.” The very theory of the legislation was that the Government and the landowner or tenant should cooperate in preventing soil erosion, the Government intending, not to bind a landowner or tenant to make any particular improvement, but to give him a “benefit payment”, if earned, after inspection of the completed work and signing of the required application. The fact that the work was required to be performed voluntarily and that the Secretary of Agriculture was without power to enter into any binding contracts with the owner or operator before the completion of the work, is not sufficient, in our judgment, to make the payments mere gifts. We hold, therefore, that the amounts in issue may not be excluded from gross income under section 22 (b) (3), supra.

The taxation of the payments to it, says the petitioner, would fro tanto reduce the benefits granted by the Soil Conservation and Domestic Allotment Act and thus defeat the very purpose of Congress. This, it contends, “argues strongly that the payments were not intended by Congress to be subject to taxation as income.” The only cases cited in support of this contention are those holding that tax-imposing statutes are to be construed strictly against the Government and all .doubt resolved in favor of the taxpayer. Gould v. Gould, 245 U. S. 151; Crooks v. Harrelson, 282 U. S. 55. In our judgment the cited cases are not applicable. Petitioners assertion that this is a case where there is a presumption against the taxability of the amounts received is not supported by any authorities, nor does it point to any specific statute allowing an exemption from tax. The act under which the payments were made was passed while the income tax laws were in full force and effect. It must be presumed that Congress was aware of their provisions. Since it did not see fit to incorporate in the act a provision exempting benefit payments, the conclusion that it intended them to be taxed is inescapable. Cf. Pacific Co. Ltd. v. Johnson, 285 U. S. 480; Sun-Herald Corporation v. Duggan, 73 Fed. (2d) 298; United States v. Stewart, 311 U. S. 60.

The briefs of the parties are largely devoted to a discussion of the rule enunciated by the Supreme Court in Edwards v. Cuba Railroad Co., 268 U. S. 628, and its applicability to the stipulated facts. Stated •generally, it is that a contribution to the capital assets of a railroad •company in order to induce construction and oper'ation of railroads for the service of the public, does not constitute income to the recipient within the meaning of the Sixteenth Amendment. The cited case has been followed many times by the courts and this Board. In Liberty Light & Power Co., 4 B. T. A. 155, citizens of a community, desiring to obtain electric sendee, transferred to the taxpayer transmission lines which they had constructed. In Texas & Pacific Railway Co. v. United States, 52 Fed. (2d) 1040; affirmed on another issue, 286 U. S. 285, and Kauai Railway Co., Ltd., 13 B. T. A. 686, contributions were made to railroad companies by business concerns for the construction of spur or side tracks and for other construction work. In Chicago & Northwestern Railway Co. v. Commissioner, 66 Fed. (2d) 61; certiorari denied, 290 U. S. 672, the taxpayer received an allowance from the Government for undermaintenance of its railroad during Federal control. In Frank Holton & Co., 10 B. T. A. 1317, property to be used as a factory •was conveyed to the taxpayer to induce it to locate in that city, and in Arkansas Compress Co., 8 B. T. A. 155, contributions of land and cash •were made to the taxpayer to induce it to erect and operate cotton compresses and warehouses. In each case it was held that the taxpayer was not in receipt of taxable income. See also Great Northern Railway Co., 8 B. T. A. 225; affd., 40 Fed. (2d) 372; certiorari denied, 282 U. S. 855; Baltimore & Ohio Railroad Co., 30 B. T. A. 194; Decatur Water Supply Co. v. Commissioner, 88 Fed. (2d) 341; Valley Waste Disposal Co., 38 B. T. A. 452; and Detroit Edison Co., 45 B. T. A. 358 (on appeal, C. C. A., 6th Cir.).

- But while the rule of the cited case has been followed many times, it has been found to be inapplicable to many payments made by the sovereign to a taxpayer. The Court of Claims, in Texas & Pacific Railway Co. v. United States, supra-, citing a number of cases decided by this Board in which it was held that amounts received by railroad companies under the provisions of the Transportation Act to make good an operating deficit for the six-month period after termination of Federal control were income (Gulf, Mobile & Northern Railroad Co., 22 B. T. A. 233; affd., 293 U. S. 295, and others), came to the game conclusion, though the railroads were relying upon Edwards v. Cuba Railroad Co. The Supreme Court affirmed, saying — “The sums * * * were not subsidies or gifts.” Texas & Pacific Railway Co. v. United States, supra. See also Continental Tie & Lumber Co. v. United States, 286 U. S. 290. The amounts paid to railroad companies as just compensation for the taking and use of their properties during Federal control were also held to be income (Kansas City Southern Railway Co. v. Commissioner, 52 Fed. (2d) 372; certiorari denied, 284 U. S. 676, affirming on this point 16 B. T. A. 665), although the taxpayers relied upon the rule of the Cuba Railroad Co. case. In Burke-Divide Oil Co. v. Neal, 73 Fed. (2d) 857; certiorari denied, 295 U. S. 740, the amount received from the United States through the Secretary of the Interior, representing the taxpayer’s equitable portion of an amount which had been accumulated and impounded pending termination of litigation in connection with oil and gas claims which, in good faith, had been developed in the bed of the Bed Biver, was held to be income. Under somewhat similar facts the same conclusion was reached in Obispo Oil Co. v. Welch, 85 Fed. (2d) 860, the case, however, being reversed by the Supreme Court (301 U. S. 190) upon other grounds. In Marine Transport Co. v. Commissioner, 77 Fed. (2d) 177, affirming Marine Transport Co., 28 B. T. A. 566, it was held that an award made to the petitioner by the Mixed Claims Commission on account of the destruction of a schooner in 1917 was not, as. contended by it, a gratuity or bounty but compensation for property destroyed. Payment of the sum of $23,000 by the State of Maryland to a ferry company was held, in Helvering v. Claiborne-Annapolis Ferry Co., 93 Fed. (2d) 875, to be compensation for operation of the ferry and hence includable in gross income. A shipping company, which had received a very favorable contract for the carrying of the mails and which had agreed to impound a portion of its earnings to be expended for additional vessels, was required to include m income the amounts impounded during the taxable years, notwithstanding its contention that they were either parts of a Government subsidy useable only for capital purposes or not income within the definition in Eisner v. Macomber, 252 U. S. 189. Lykes Bros. Steamship Co., 42 B. T. A. 1935; affd., 126 Fed. (2d) 725. Edwards v. Cuba Railroad Co., was cited and relied upon in each of the cited cases but found to be inapplicable.

In the preceding paragraphs reference has been made to practically all of the cases in which Edwards v. Cuba Railroad Co. has been cited or discussed. They indicate that the doctrine has been sparingly applied. It has been pointed out above that the payments in issue were made for cooperating in the soil conservation program. They were denominated “benefit payments.” They were made under the same law and regulations that payments were made for refraining from raising cotton or sugar beets, for devoting a portion of the acreage to the raising of leguminous crops, taking steps to eradicate rodents and noxious weeds, furrowing on the contour, withholding land from grazing, or following out other approved practices-for building up the soil and preventing erosion. It is true that the Government had not bound the landowners, by contract, to perform any of the practices; but it, by its regulations and adoption of the program, held out to them the incentive that payment would be made if the practices were followed out. In other words, the Government was in somewhat the same situation that a private individual would be under an outstanding offer of purchase or sale at a given price. It told the landowners what was desired and agreed to pay those who complied with the established practices. Petitioner complied and received the payments. They, in our judgment, were-income. Cf. Salvage v. Commissioner, 76 Fed. (2d) 112.

The bookkeeping entries made by petitioner following receipt of the payments are not determinative, if they have any significance whatever in the instant proceeding. No doubt its capital improvements were enhanced in value; but so would they have been if petitioner had elected, for instance, to expend money in eradicating rodents or noxious weeds, planting leguminous crops, furrowing on the contour, or following most any of the approved practices. We can not believe Congress ever intended that all such payments should be wholly exempted from tax. Nor are we persuaded that a different rule should be applied because, as suggested by petitioner, the United States “admits responsibility for the conditions which necessitate the rehabilitation work.” This is no doubt a real justification for the expenditure by the Government; but it does not justify a failure to tax one who is enriched, thereby.

At the risk of unnecessarily extending this discussion it may be pointed out that if the payments to petitioner are not taxed as income in the year of receipt it will receive even more favorable treatment than will be received by manufacturers of essential war materials and commodities, who are cooperating with the Federal Government in the present emergency. They, under Title III— Amortization Deduction, Second Revenue Act of 1910 (sec. 124, I. R. Code) and articles 19.124-1 to 19.124-9, Regulations 103, as amended by T. D. 5016, may amortize, over a 60-month period, the cost of facilities constructed by them for the manufacture of essential war commodities; but in determining the adjusted basis of such facilities all amounts received “in connection with * * * [their] agreement to supply articles for national defense, though denominated reimbursements for all or a part of the cost of an emergency facility, are not to be treated as capital receipts but are to be taken into account in computing income * * * (Art. 19.124 — 6, Regulations 103.) In petitioner’s returns of income it included, in its depre-ciable assets, “Improvements under Federal Aid $6978.52” and deducted as depreciation, a portion thereof based on the estimated life of the property. The claimed deduction has been allowed. It is apparent, therefore, that petitioner will recover, through amortization, depreciation and obsolescence, its total capital investment in the property. If the amounts received from the Government are not included in income, it, in effect, will have a double deduction. In the absence of specific legislation, it should not be assumed Congress intended that recipients of benefit payments be singled out for such preferential treatment.

The Commissioner, in our judgment, committed no error in including the amounts in issue in petitioner’s income. Since this is the only adjustment contested,

Decision will be entered for the respondent.

Reviewed by the Board.

       Aet of April 27, 1935 (49 Stat. 163), as amended by Act of February 29, 1936 (49 Stat. 1148).

       Western Region Bulletin No. 101, Arizona, Federal Register Feb. 26, 1937, p. 345; W. R. B. Arizona Supp. I, Federal Register, June 5, 1937, p. 1141; W. R. B. 101, Arizona Supp. II, Federal Register July 27, 1937, p. 1554.

       Recognizing that, unless soil erosion can be controlled on farm, grazing, and forest lands, the prosperity of the united States cannot be permanently maintained, the bill provides for the coordination of all Federal activities with relation to soil erosion.
      Heretofore, soil-erosion control has been among several groups in the different Departments. The present bill coordinates all of these groups and places the control under the Secretary of Agriculture. Experiences of recent storms, both flood and wind, •demonstrate the necessity to prevent wastage of soil, the conservation of water, and the control of floods. The silting of reservoirs, the maintaining of the navigability of rivers and harbors, the protection of public lands, all justify Federal responsibility for the carrying out of a national erosion-control program.
      Vast areas of agricultural lands are threatened with abandonment and the occupants thereof are daily increasing the numbers on Federal relief rolls to the extent that this problem alone warrants an extensive Federal erosion-control program.

        The aid authorized in this subsection will be necessary because, in general, the owner-of private lands cannot bear the entire cost of controlling the erosion thereon. He has-neither the technical knowledge nor the financial resources. Over tremendous areas, land' destruction has proceeded to the point where it would be impossible to persuade or force the owners to assume the entire burden of control, nor would it be just to do so. Fundamentally, they have not been responsible for the erosion which has occurred. In the* disposal of the public domain, settlers were encouraged to acquire the public lands and to cultivate them. With the transfer of ownership went no restrictions, instructions, or advice as to methods under which the land should be used in order to protect it from erosion.
      Acting in good faith, the settlers used their land in the light of the- best information available. Since it was not the initial fault of the settler that his land became subject to erosion, it would not be right to require him to bear the entire burden of repairing-damage done or of preventing future damage. Furthermore, the interest of the Nation-in Controlling erosion far exceeds that of the private landowners. An individual may destroy his land, move away, obtain a position somewhere else, accumulate capital, andpurchase new land. For the Nation, land destroyed is land gone forever. This drain on the national resource is not immediately fatal, but, if the destruction continues unchecked,, the time will come when remaining land resources will be insnfficent to support our population on an adequate standard of living. The cost to the Nation of such changes would be incalculable. Moreover, erosion directly threatens vast Federal investments in dams and channels and annually requires the expenditure of large sums for dredging operations. The only practical method of eliminating these hazards and costs is to* control the erosion on private lands, and it would not be equitable to require the owner of these lands to make expenditures for the protection of Federal investments.


author: Leech:

text:
    David S. Brown, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105121.
    Promulgated June 16, 1942.

      Charles 8. Fettreteh, Esq., for the petitioner..

      C. C. Holmes, Esq., for the respondent.
   OPINION.

First Issue.

Leech:

Respondent contends that the taking of property by condemnation and the payment of just compensation therefor is not a sale or exchange within the meaning of section 117 (a) of the Revenue Act of 1936, and gain thus realized is accordingly taxable as ordinary income, and not as capital gain. This position is without merit. Commissioner v. Appleby Estate, 123 Fed. (2d) 700, affirming 41 B. T. A. 18; Seaside Improvement Co. v. Commissioner, 105 Fed. (2d) 990; certiorari denied, 308 U. S. 618; Henry A. Kieselbach, 44 B. T. A. 279; affirmed on this issue, 127 Fed. (2d) 359; Hawaiian Gas Products, Ltd., 43 B. T. A. 655. See also Helvering v. Hammel, 311 U. S. 504.

Second Issue.

At all events, respondent argues that the amount added to the condemnation award because of the lapse of time between the taking of the condemned property and payment therefor, designated as interest, is taxable as ordinary income and not as capital gain. The Second Circuit Court of Appeals in two cases, Seaside Improvement Co. v. Commissioner, supra, and Commissioner v. Appleby Estate, supra, and the Board in Henry A. Kieselbach, supra, and Hawaiian Gas Products, Ltd., supra, decided against that view. Despite the reversal ■of the Kieselbach case on this point by the Third Circuit Court of Appeals in Commissioner v. Kieselbach, supra, we feel constrained to maintain our position. Respondent is therefore reversed. Commissioner v. Appleby Estate, supra; Seaside Improvement Co. v. Commissioner, supra; Hawaiian Gas Products, Ltd., supra.

Third Issue.

Petitioner urges that the cost basis of the improvements taken in the condemnation include his depreciated basis for structural additions made to the premises in 19Í9 after the acquisition of the property by the petitioner, and demolished subsequently to make way for the building on the property when condemned.

Granting that the petitioner would be entitled to prevail if any basis to him for these additions made to the building in 1919, which were demolished in 1930, was established by the record (see Commissioner v. Appleby Estate, supra; Seaside Improvement Co. v. Commissioner, supra; Helvering v. Hammel, supra), that premise of fact is wholly wanting here. The only witness called had never seen the building except cursorily in passing it occasionally and had never been inside of it. His “estimate” of the cost of the 1919 additions and their value, as well as all his other testimony, was based wholly upon records in an office in the municipal government in the city of New York.. Under any circumstances, this testimony, we think, is wholly insufficient to establish the basis required. Respondent is affirmed on this issue. Burnet v. Houston, 283 U. S. 223.

Fourth Issue.

In computing the gain realized by petitioner, respondent deducted from the value of the building on the premises when acquired on June 16, 1913, depreciation at the rate of 5 percent from that date to September 17, 1931, when it was demolished for the purpose of erecting the new garage thereon. Petitioner claims that the proper rate to have been used was 3 percent per annum. The only witness on this point was the witness called by the petitioner, whose testimony has just been discussed. We think the testimony of that witness was not sufficient to establish error in the rate used by the respondent. Respondent is therefore affirmed.

Decision will be entered u/nder Bule SO.