text:
    Central Loan and Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82565.
    Promulgated May 24, 1939.

      Thomas B. Roberts, Esq., and Charles P. M. Allen, O. P. A., for the petitioner.

      Hugh Brewster, Esq., and A. M. Wilding-White, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined a deficiency in petitioner’s income tax for the year 1932 in the amount of $4,346.05. The sole question is: “Must $121,499.56, received by petitioner as a refund of state taxes paid by its predecessor in prior years, be included in its gross income?”

We find the facts to be as stipulated. Briefly, they are as follows:

Petitioner, an Iowa corporation, was formed in 1929 for the purpose of liquidating the assets received by it in a nontaxable reorganization from its predecessor, the Central Trust Co. One of the assets consisted of a claim against Polk County, Iowa, for a refund of taxes paid under protest in 1921, 1922, and 1923. Petitioner and its predecessor each kept its books and made its income tax returns on the basis of.cash receipts and disbursements. A portion of the taxes paid in each of the j^ears was ultimately determined by the courts to be refundable and in 1932 petitioner received $121,499.56 from Polk County. This amount was shown in its income tax return for that year but was not included in gross income. The taxes paid, the portion refunded, the portion which resulted in a benefit to the taxpayer in the year paid, and the portion which did not result in any benefit to it are as shown in the following schedule:

Both parties concede that the taxpayer had the full benefit of the deduction from gross income of the amount paid in 1922 in that said deduction decreased its Federal income taxes for that year. They differ as to the interpretation to be placed upon the facts stipulated with reference to the other years, petitioner contending that they show no benefit was derived from the deduction claimed in either 1921 or 1923 and respondent contending that no such inference can be drawn and that therefore the question should be resolved on the assumption that actual benefit was derived in each of the years.

A careful analysis of the stipulation convinces us that no benefit was derived by the taxpayer from the deduction in 1923. The gross income appears to have been only $281,166.82 while the net result of the operations for the year appears to have been a loss of $1,142,-116.26. As to the year 1921 the operations appear to have resulted in a loss of $19,809.95 after the deduction of $32,486.44 for taxes, $27,313.49 of which was refunded during the taxable year. We are at a loss to understand why the parties did not see fib to put the income tax returns in evidence; for without the information which they contain it is difficult to ascertain whether, as contended by petitioner upon brief, “they would have shown a substantial loss without the benefit of any deduction for said taxes” or whether, as contended by respondent, they would have shown an income subject to tax in excess of the income as disclosed by the balance sheet after due consideration had been given to the fact that some of the deductions shown on the balance sheet may not have been allowable in. computing taxable income. In. this state of the record we think it must be assumed, for the purposes of this proceeding, that full benefit of the deduction was derived in the year 1921. We have made such assumption in preparing the above schedule.

The adjustments made by the Commissioner, which resulted in the deficiency for the year in issue, may be summarized as follows:

Net income (loss) shown on return_ (.$50,426.68)
Add: ($121,499.56 refund of taxes, $94.46 not in issue, less deductions concededly correct $4,680.86) — net addition to income_ 116,913.16
Adjusted net income- 66,486.48'
Less statutory net loss from 1931_ 34,878.88
Balance subject to tax- 31,607.65

It is apparent that there will be no deficiency in tax if only the amounts representing refunds of taxes paid in the years 1921 and 1922 are included in gross income for the year 1932. The issue may be resolved, therefore by determining whether or not the amount representing a refund of the taxes paid in 1923 should be included.

Numerous cases have been decided by the courts and this Board involving the general question of the inclusion in gross income of amounts representing recoveries by a taxpayer of amounts previously deducted from income for losses, expenses, bad debts, taxes, etc. The leading case is Burnet v. Sanford & Brooks Co., 282 U. S. 359; but many others are set out in the recent Board case of Estate of William H. Block, 39 B. T. A. 338. Collectively they enunciate and apply the rule that where “the amount recovered had been deducted previously to offset income, it should be reported as a part of gross income for the year in which it was recovered.” The reason for the rule is stated thus:

Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs. No other system would be practical in view of the statute of limitations, the obvious administrative difficulties involved, and the lack of finality in income tax liability, which would result.

Cf. Dixie Margarine Co., 38 B. T. A. 471, and Charles W. Nash, 34 B. T. A. 675; affd., 88 Fed. (2d) 477.

Eespondent argues that the question of benefit is immaterial and says that “if the taxes were deductible but were not deducted, that omission can not be given any consideration in the year of refund, or at all, after the statute of limitations has run against the taxpayer, without in effect circumventing the statute of limitations.” We do not agree with this contention. If the deduction has not been claimed in a prior year the rule is not applicable. Its basis is that there has been a recovery of some amount “deducted previously to offset income.” While the question of actual benefit may not heretofore have been made a prerequisite to the inclusion in gross income of the amount recovered, inferentially it has been a controlling factor. Thus, in Houbigant, Inc., 31 B. T. A. 954; affd., 80 Fed. (2d) 1012; certiorari denied, 298 U. S. 669, in holding that the amount recovered as a refund of customs duties must be included in income, it was pointed out that the taxpayer had claimed and been allowed “the deduction of the full amounts” in computing its taxable income for the prior years. In Victoria Paper Mills Co., 32 B. T. A. 666; affd., 83 Fed. (2d) 1022, it was said that “since the amount received on the judgments * * * represented a refund of taxes for prior years which had been deducted * * * in its income taxes for those years, the entire amount * * * is taxable to the petitioner” in the year received; while in Chevy Chase Land, Co., 34 B. T. A. 150, it was said “If * * * the refunds * * * represent * * * payments in prior years, for which it received credit in computing net income, then the refund constitutes taxable income to petitioner.” Cf. Grace M. Barnett, 39 B. T. A. 864. We think it is very material that no actual benefit was derived by the taxpayer through a deduction from its gross income in the year 1923 of the taxes paid in that year. If such amount was not deducted to offset income, as the facts indicate and as we have found, then the amount received in the taxable year should not be included in gross income for that year.

Respondent’s contention that the taxability of the refund should be made dependent upon whether the saving in tax in the year the deduction was claimed equals or exceeds the tax assessed in the year the refund is made is likewise unsound. While it may be true that this particular taxpayer effected a saving in tax in the year 1922 in excess of the amount of the present deficiency, the next case coming before us may present an entirely different picture. To apply any such test as that suggested would abrogate or circumvent the statute of limitations far more than to apply the rule of the cited cases. The view which we have taken accords with the view expressed by the General Counsel of the Treasury Department in G. C. M. 18525, C. B. 1937-1, p. 80, and G. C. M 20854, 1939 Int. Rev. Bul. No. 9, p. 2, on a question somewhat analogous, namely, a bad debt. Therein it is stated that the amount subsequently collected on account of a bad debt is not required to be included in gross income for the year of receipt unless it had been allowed as a deduction for income tax purposes in whole or in part in a prior year.

Reviewed by the Board.

Judgment will be entered for the petitioner.


source: Caselaw Access Project

author: TURNER:

license: Public Domain

text:
    C. L. Gransden & Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90134.
    Promulgated May 24, 1939.

      Ward H. Peale, Esq., and William 0. Rowland, G. P. A., for the petitioner.

      Edward O. Adams, Esq., for the respondent.
   OPINION.

TURNER:

This proceeding involves deficiencies in income and excess profits taxes for the calendar year 1934 in the respective amounts of $1,552.40 and $563.42. The only question presented is whether certain losses sustained by the petitioner resulting from the surrender of its vendee’s interests in two contracts to purchase real property, in consideration of the vendor’s cancellation of its debts under the contracts, constituted ordinary losses or capital losses.

The facts have been stipulated and as stipulated are adopted as our findings herein. Only those facts necessary to an understanding of the discussion of the issues are set forth.

The petitioner is a Michigan corporation, with its princpal office at 1214 Eighteenth Street, Detroit, Michigan.

Detroit Traot.

On November 18,1924, William B. Thompson, as vendor, and Henry Klotz, as vendee, entered into a contract for the sale of land and buildings situated in the city of Detroit, Michigan. The contract recited a down payment in the sum of $400, and the vendee agreed to pay the balance of $8,350 in monthly installments of $75 each. The vendee agreed to keep the buildings insured for the benefit of the vendor and to pay all taxes and assessments against the premises. It was mutually agreed that if the vendee failed to pay such tax assessments and insurance premiums, the vendor might pay same and any sums so paid would be a further lien on the land payable by the vendee to the vend- or, and if proceedings were taken to enforce the contract in equity, after default by the vendee, the entire amount owing thereon would be due and payable forthwith.

The contract provided that no assignment or conveyance by the vendee would create any liability on the vendor until a duplicate thereof was delivered to the vendor; further that the vendee should have possession of the premises after the execution of the contract and while not in default on his part in carrying out the terms thereof, and if the vendee failed to perform the contract or any part thereof the vendor, immediately after such default, had the right to declare the contract void and retain whatever might have been paid thereon and be entitled to immediate possession of the premises. The contract also provided that “The covenants shall bind the heirs, assigns, and successors of the respective parties.”

On February 11,1926, Henry Klotz and his wife, Christiana Klotz, as vendors, and petitioner, as vendee, entered into a land contract wherein the former agreed to sell to the latter the property referred to in the above contract of November 18, 1924. This contract recited a down payment of $1,000, and the vendee agreed to pay the balance of $11,000 in monthly installments of $75 each.

On October 29,1926, the principal balance remaining unpaid under the contract of February 11, 1926, having been reduced by monthly payments to an amount equal to the balance remaining unpaid under the contract of November 18,1924, Henry Klotz and his wife executed and delivered to petitioner an assignment of the last mentioned contract. This assignment recited a balance owing upon said contract in the amount of $6,107.08, “which the said assignee and grantee assumes and agrees to pay.” Thereafter petitioner made the monthly payments thereon to the vendor, William B. Thompson, the last payment being made in December 1932.

On December 15, 1934, petitioner, being in default, delivered to Thompson the two land contracts above referred to and also a quitclaim deed running from Henry Klotz and his wife to petitioner. On that date Thompson executed an instrument acknowledging receipt of the contracts and quitclaim deed, and also the sum of $250 paid by petitioner, in consideration of which Thompson released petitioner from any claim of any nature regarding the sale of the property.

Depreciation allowed or allowable on the property from the date of purchase to December 31, 1933, amounts to $1,225, and from January 1 to December 31,1934, amounts to $143.75.

As a result of the foregoing transactions petitioner sustained a loss in the sum of $7,411.51, computed as follows:

Cash principal payments on purchase_$8, 530.26
Cash payment_ 250. 00
8, 780.26
Less depreciation_ 1, 368. 75
Loss;--- 7,411.51

In its income tax return for the year 1984 petitioner deducted as an ordinary loss on account of the foregoing transactions the sum of $7,130.26.

Flint Tract.

On September 17,1929, Marcia Webb Dort et al., as vendors, and the petitioner herein, as vendee, entered into a land contract -wherein the former agreed to sell to the latter a lot and building situated in the city of Flint, Genesee County, Michigan. The consideration recited was $28,000, payable $2,800 upon execution of the contract and the balance in monthly installments of $250 each, including interest at 6 percent.

Prior to January 24, 1934, petitioner made cash payments on the principal of the purchase price in the aggregate amount of $5,808.91, and also disbursed in cash the amount of $5,770.93 for additions and betterments to the property.

On January 24, 1934, petitioner, being in default, entered into a written agreement with the vendors whereby he surrendered and assigned all his right, title, and interest in the contract and the property described therein, and the vendors released him from any further liability under the contract. In further consideration of that release petitioner agreed to pay an amount equal to all taxes due and accrued on the property. There is nothing in the record however to indicate that the said taxes were so paid by petitioner. The agreement also provided that petitioner would have the right to remain in possession of the property as a tenant.

Depreciation allowed or allowable on the property from the date of purchase to December 31, 1933, amounts to $4,400, and from January 1 to January 24,1934, amounts to $58.06.

Prior to 1934 petitioner accrued on its books interest on the property in the amount of $710 and taxes in the amount of $631.74, and deducted such amounts so accrued from income in its income tax returns. These accruals were never paid and were canceled upon the execution of the release above referred to.

As a result of the transactions above described petitioner sustained a loss in the amount of $5,780.04, computed as follows:

Cash principal payments on purchase-$5, 808. 91
Cash payments on additions and betterments- 5,770.93
11,579.84
Less:
Depreciation_,-$4, 458'. 06
Accrued interest_ 710. 00
Accrued taxes_ 631. 74
-$5, 799. 80
Loss___ 5,780.04

In its income tax return for 1934 petitioner deducted as an ordinary loss on account of the foregoing transactions the sum of $6,138.10.

The respondent has determined that the losses sustained by the petitioner in the two land contracts heretofore described constituted capital losses and has reduced the deduction to the sum of $2,000.

The respondent contends that petitioner’s surrender of its vendee’s interests in the two land contracts in consideration of the vendors’ cancellation of its debts thereunder constituted sales or exchanges of capital assets within the meaning of section 117 of the Revenue Act of 1934, and that the losses sustained by petitioner were capital losses. Petitioner contends that there was no sale or exchange of a capital asset, but that “petitioner merely relinquished its right to require a conveyance from the vendor, and the latter relinquished his right to requite further payments by the petitioner upon the purchase price.”

We think the question here presented has already been decided by us in Betty Rogers, 37 B. T. A. 897; affd., 103 Fed. (2d) 790, and recently followed in Harold R. Smith, 39 B. T. A. 892. In the latter case we held that, where a taxpayer entered into contracts to purchase real property on the installment basis and after making certain payments thereon he surrendered his vendee’s interest in the contracts and the property to the vendor in consideration of the vendor’s cancellation of his debts under the contracts, the transactions constituted sales or exchanges of capital assets and the losses sustained by the vendee of his investment in the properties were capital losses. On that point the instant case is indistinguishable and the limitation prescribed by section 117 (d) of the Revenue Act of 1934 is applicable. In addition, however, to the loss of its investment in the Detroit tract, the petitioner sustained a further loss of $250, being an amount paid to the vendor in cash. The facts show that this payment was not a part of petitioner’s investment in the said real estate, but, together with its interest in the real estate, constituted the consideration for release from further liability under the contract. It was a money payment as partial consideration for a release from a money liability and with respect to such payment in money we are unable to spell out a sale or exchange. To the extent of $250 the loss should be allowed as an ordinary loss.

Decision will be entered under Rule 50.


author: Mellott:

text:
    Estate of Charles Schimmel, Deceased, Mary Schimmel and Abram Q. Schimmel, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81991.
    Promulgated May 24, 1939.

      Don W. Stewart, Esq., and O. B. Martin, O. P. A., for tRe petitioners.

      Arthur Oamdwff, Esq., and Wm. G. Rwymann, Esq., for the re-pondent.
   OPINION.

Mellott:

TRe respondent determined a deficiency in petitioner’s income tax in tRe amount of $2,387.55 for tRe calendar year 1932. Two issues were raised by tRe pleadings, one of wRicR, involving depreciation on furniture and fixtures, was abandoned by tRe petitioner.

TRe question to be decided is: “Under the laws of Nebraska, when do general city taxes on real estate in cities of the metropolitan class (Omaha) accrue?”

TRe proceeding was submitted upon the following stipulation of facts.

Stipulation op Facts.
During the calendar year 1932 the petitioner was a resident and taxpayer of the State of Nebraska and was the owner and operator of the Blackstone Hotel in the City of Omaha, County of Douglas and State of Nebraska. Said city was during said year and for several years prior and subsequent thereto a city of the metropolitan class as defined by the laws of the State of Nebraska.
During the year in issue, and for several years prior and subsequent thereto the petitioner kept his books of account and filed his Federal income tax returns on the accrual basis. For the calendar year 1932 the petitioner duly filed his Federal income tax return and deducted from his taxable income the amount of $14,211.64 under “Schedule A-6, Occupation Expense, Real Estate & Personal” as described in his said return. The petitioner computed said amount so deducted and claimed as follows:
He carried on his books of account a reserve account for taxes accrued. On December 31, 1931 this account bore a credit of $2,600. During the year 1932 he credited and entered on said account as tax expense $1,150 for the month of January, $1,150 for the month of February and $1,250 each for the remaining ten months of 1932 or a total of $14,800 additional credits, thus making the total credits entered in said account for said year, $17,400. During the said year, he entered as debits to said account taxes paid in 1932 in the total amount of $14,311.64, “credit to taxes expense, $588.36,” and credit balance of $2,500 thus balancing said account as of December 31, 1932. The debits to said account in respect of taxes paid were as follows:
Apr. 30, 1932 Payment of 1931 county real estate taxes- $2,421.52
July 1, 1932 Payment of 1932 city real estate taxes- 10,380.76
July 1, 1932 Payment of 1932 city personal taxes- 1,280. 04
July 1, 1932 Payment of 1932 city intangible taxes- 16.33
Nov. 28, 1932 Payment of 1932 county personal taxes- 203. 03
Nov. 28, 1932 Payment of 1932 county intangible taxes- 9. 96
$14,311.64
In his Federal income tax return the petitioner deducted from taxable income the above amount of $14,800 (being credits accrued as monthly charges to tax expense as stated above) less $588.36, which had been credited to tax expense in 1931, thus arriving at the amount deducted of $14,211.64. The Commissioner disallowed $2,054.02 thereof and allowed as a deduction for taxes in said year, $12,157.62 which he computed as follows:
Taxes accrued, and paid i» 1982
November 28, 1932 — Payment county personal taxes_$203.03
November 28, 1932 — Payment county intangible taxes- 9.96
Taxes accrued m 1982 hut paid in 1933
Date of Payment Date of Accrual
April 28, 1933 April 1, 1932, 1932 County Real Estate taxes_ $2,243.10
June 30, 1933 April 1, 1932, 1933 City Personal taxes_ 823.43
July 31, 1933 April 1, 1932, 1933 City Real Estate taxes_ 8,878.10
Total allowed by Commissioner_$12,157. 62
It is agreed that the Commissioner in determining the deficiency here in issue allowed as a deduction in 1932 the 1933 City Personal and Real Estate taxes paid in 1933 and did not allow as a deduction in 1932 any of the 1932 City-Personal and Real Estate taxes paid in 1932.
It is further agreed that Section 514 of Chapter 14 of the Compiled Statutes of Nebraska, 1929, provide that city taxes shall be assessed and levied a year in advance of the year in which they are paid and that in respect of the laws of Nebraska in effect during the year 1932 in the city of Omaha, Nebraska the city real estate and personal taxes were assessed and levied a year in advance of the year in which they were paid, the assessment being made on April 1, of each year for the following year. City real estate and personal taxes were levied in the year before the year in which they became due. City real estate taxes became a lien on May 1 of the year in which they were due, being the year after the year of assessment and levy. City personal taxes became a lien on November 1 of the year in which they were levied, being the year before the year in which they were due. City real estate and personal taxes became due on May 1 of the year after the year they were assessed and levied and became delinquent on July 1 or two months after they were due.
In respect of the laws of Nebraska in effect during the year 1932 County and State real estate taxes were assessed and levied during the current tax year and became due on November 1 of tlie current tax year, and became a lien on December 1 of tbe current tax year but did not become delinquent until May 1 of tbe following year.
Accordingly, in determining tbe deficiency bere in issue tbe Commissioner determined that tbe petitioner was on tbe accrual basis and that bis County Real Estate taxes for 1982, assessed and levied and which were a lien on his property in 1932 but which were not paid until April 28, 1933 were deductible from 1932 taxable income; and be further determined that petitioner’s 1933 City personal and real estate taxes which were assessed and levied and which became a lien as to personal taxes in 1932 and as to real estate taxes in 1933 but which were not paid until June 30,1933 and July 31,1933, respectively, were deductible from 1932 taxable income.

The Revenue Acts of 1928 and 1932 each provide:

Seo. 23. Deductions from gross income. — In computing net income there shall be allowed as deductions:
* * * * * * *
(c) Taxes 6enebai.lt. — Taxes paid or accrued within the taxable year. * * *

The question is whether the general city real estate taxes in the amount of $10,380.76, which petitioner contends accrued in 1932, should be deducted from gross income for 1932, or whether the amount of $8,878.10, which the respondent determined to be the amount that accrued in that year, should be deducted. This question may be resolved by determining when such taxes accrue under the laws of Nebraska.

The pertinent provisions of the Compiled Statutes of Nebraska, 1929, are the following:

1A-514. Certification for Levy. The city council shall annually certify to the county clerk of the county in which the city is located, by resolution, the number of mills which the city desires to be levied on each dollar, as taxation for all municipal purposes for the ensuing year, upon all taxable property within the limits of the city * * *. The certification required herein shall be made before the County Board of Equalization shall have made its tax levy of each respective year. * * *
14-548. Lien of Taxes and Assessments. All general municipal taxes upon real estate shall be a first lien upon the real estate upon which it is levied * * *. The lien of all general municipal taxes levied on personal and real property shall be governed by the general revenue laws of this state. * * *
14r-549. Delinquent Taxes. All general taxes on personal and real property in such city levied under this act, shall become due May 1st and delinquent on July 1st of the year following the levy and shall draw the same rate of interest as the general taxes of the county and state. * * *
77-203. Real Property Taxes, Constitute First Lien. Taxes on all real property shall be a first lien thereon from and including the first day of December of the year in which they are levied until the same are paid, except general city taxes on real property within the corporate limits of cities of the metropolitan class, which shall be a first lien thereon from and including the first day of May following the levy, until the same are paid. * * *
77-204, Personal Property Taxes, Constitute First Lien. Taxes assessed upon personal property shall be a first lien upon the personal property of the person to whom assessed from and after the first day of November of the year in which they are assessed, until paid. * * *
77-1008. Same, State Levy, Rate, When Transmitted to County Cleric. On or before the second day of August in each year the state board shall transmit to the county clerk of each county a statement of the rate of taxation required for the general state tax, the state school tax and any other general or special taxes, as directed to be levied and collected by the state board.
77-1601. Real Property, Assessment, Classification, Real Estate Classification Boards. All real property in this state subject to taxation shall be assessed on the first day of April, 1926, and every fourth year thereafter, which assessment shall be used as a basis of valuation for taxation until the next regular assessment, except as hereinafter provided. * * *
77-1605. Additional Lands and Improvements, Includes in Return, Decreased Values. Bach assessor shall annually, at the time of taking the list and valuation of personal property, also take a list of all real property that shall have become subject to taxation since the last previous listing of the property in the county, with the value thereof, and of all buildings and all other improvements of any kind. * * *
77-1801. County Tax Levy, Procedure, Limitations, Appeals. The County Board of Equalization shall adjourn from time to time until the action of the State Board of Equalization and assessment shall have been had and certified to the County Clerk, and, on the last day of sitting as a board of equalization, the county board shall levy the necessary taxes for the current year. * * *
77-1907. Taxes, When Delinquent, Interest. On the first day of December of the year in which taxes shall have been assessed, all unpaid personal taxes, shall become delinquent and shall draw thereafter interest at the rate of ten (10%) per cent per annum, which interest shall be collected the same as tax so due. On the first day of May of the year after which taxes shall have been assessed, all unpaid taxes upon real property shall become delinquent, and such delinquent taxes shall thereafter draw ten (10%) per cent interest, which interest shall be collected the same as the tax so due. * * *

Eespondent’s ruling (I. T. 2849, XIY-1 C. B. 60) as to the date of the accrual of real and personal property taxes in the State of Nebraska has been examined. It refers to the date of the accrual of real estate taxes generally, but makes no specific reference to “general city taxes on real property within the corporate limits of cities of the metropolitan class.” It is not in issue in this proceeding and, since it has not been passed upon by the courts or by this Board, no opinion will be expressed as to its correctness. We must determine when general city real estate taxes accrue and to do so the state statutes must be examined in the light of previous court and Board decisions.

The rule uniformly followed in determining when a taxpayer on the accrual basis may accrue taxes for income tax purposes was laid down by the Supreme Court of the United States in United States v. Anderson, 269 U. S. 422, in the following language:

* * * In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. * * *

This Board and the courts have applied the rule in a number of cases involving the accrual date for real property taxes assessed and levied by states, counties, and municipalities. Under the laws of some states it has been held that such date is the date when the taxes have been assessed and, under the particular statutes, have become a lien upon the property. California Sanitary Co., Ltd., 32 B. T. A. 122; First Bond & Mortgage Co., 27 B. T. A. 430; Cloguet Co-operative Society, 21 B. T. A. 744; Leamington Hotel Co., 26 B. T. A. 1004; Texas Coca-Cola Bottling Co., 30 B. T. A. 736; Carl K. Lifson, Administrator, 36 B. T. A. 593; affd., 98 Fed. (2d) 508; H. H. Brown Co., 8 B. T. A. 112; Crown Willamette Paper Co., 14 B. T. A. 133; Gatens Investment Co., 36 B. T. A. 309. Under the laws of Wisconsin real estate taxes have been held to accrue on December 2, the date of the delivery of the tax roll by the tax commissioner to the city treasurer of Milwaukee, on which date the tax lien attaches, although the taxes had been assessed on May 1. Securities Co. of Milwaukee v. United States (U. S. Dist. Ct., E. Dist. Wis.), Dec. 1936; appeal dismissed on stipulation of parties, 91 Fed. (2d) 1022; Commissioner v. Patrick Cudahy Family Co., 102 Fed. (2d) 930, affirming 36 B. T. A. 1147. Under the laws of Maine taxes have been held to accrue on June 30 when they become due, although under the statutes they are made payable on December 10. Klauber Embroidery Works, 11 B. T. A. 779. Under the laws of Ohio, real estate taxes have been held to accrue on April 2, when the lien attaches, although the amount of the assessment is not determined until December, Walsh-Maguire Co. v. Commissioner, 97 Fed. (2d) 983; while under the laws of Washington real estate taxes have been held to accrue on March 1, the date the tax lien attaches, although they are not due and payable until February of the following year. Grand Hotel Co., 21 B. T. A. 890; cf. Theodore Plestcheeff, 35 B. T. A. 508; affd., 100 Fed. (2d) 62.

A study of the above cited cases indicates that, in every instance where taxes have been held to have accrued prior to the date when they became due, the tax lien had attached and become a charge against the property at the time of the assessment or levy, and the liability of the owner of the property had then become fixed. In other words, the “liability of the taxpayer to pay it” had arisen or the property itself had been definitely charged with its payment.

Section 77-1601 of the Compiled Statutes of Nebraska, supra, provides that all real property in the state shall be assessed on the first day of April 1926, and every fourth year thereafter, and that this assessment shall be used as a basis for valuation. It seems, therefore, that there would be no assessment in April 1931. Assuming, however, that the parties correctly stipulated that there was an assessment in 1931, such assessment apparently consisted in merely valuing the property to be taxed to the end that such valuation might be used as a basis for the apportionment of the tax. The parties agree that the tax was levied in 1931, although they disagree as to the date when the levy was made, respondent contending that it was April 1 and petitioner contending that it was on or after August 2, 1931. While we lean toward the latter view, a decision to that effect is unnecessary, since both parties concede that it was made in 1931. It consisted of fixing the rate at which the real property in the city was to be taxed.

But under sections 14 — 549 and 17-203 of the Nebraska statutes set out supra, “general city taxes on real property within the corporate limits of cities of the metropolitan class” are made “a first lien thereon from and including the first day of May following the levy.” The recent decision by the Supreme Court of Nebraska in Chicago & N. W. Ry. Co. v. Bauman, 132 Neb. 67; 271 N. W. 256, indicates quite clearly that such levy must have been made in August, rather than in April; but, even if made in April, no lien attached until May 1 of the next year. This is recognized by respondent, he stating upon brief that “the lien on Nebraska land did not attach to property within corporate limits of cities of the metropolitan class * * * until one year and one month following assessment.”

The courts of Nebraska have held that a real estate tax creates no personal liability against the owner of the land (Toy v. McHugh, 62 Neb. 820; Kelley v. Wehn, 63 Neb. 410; City of Beatrice v. Wright, 72 Neb. 689). We have pointed out above that the statutes provide that the taxes here involved did not become due or a lien against the property of petitioner until May 1, 1932. It is apparent, therefore, that neither the assessment nor the levy of these taxes laid any charge upon either the person or the property of petitioner until May 1, 1932. In our opinion, if he had disposed of his Omaha city real estate subsequent to April 1, 1931, and prior to May 1, 1932, he would not have been liable for the taxes assessed and levied in 1931.

Being of the opinion that the event which determined petitioner’s liability for Omaha city real estate taxes was his ownership of the property on May 1,1932, when such taxes became due and a first lien upon it, we hold that the respondent erred in determining that such taxes were not accruable and deductible in computing his taxable income for 1932.

Judgment will be entered imder Rule 50.


author: OppeR:

text:
    Mississippi River and Bonne Terre Railway, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84282.
    Promulgated May 24, 1939.

      James M. Chaney, Esq., for the petitioner.

      W. H. SeJúwatha, Esq., and J. T. Porter, Esq., for the respondent.
   OPINION.

OppeR:

Petitioner, an ahnost wholly owned subsidiary of the Missouri-Illinois Railroad Co., resists respondent’s determination of a deficiency as to it, which is the result of certain adjustments made by respondent in the net income of petitioner’s parent corporation. Petitioner and its affiliate filed consolidated returns.

The issues are three: First, whether under the circumstances respondent was entitled to assert against this petitioner, which had, by itself, no taxable net income, a deficiency arising as a result of the net income of its parent; second, whether the loss on the sale of a building owned by petitioner but leased under a long term general lease to its parent was deductible either by the parent or by petitioner ; and, third, whether items of depreciation on the leased property generally may be deducted by either this petitioner or the parent lessee. For convenience of discussion the issues stated will be treated in inverse order.

In our view the precise question raised as to depreciation has been ruled upon. In Atlantic Goast Line Railroad Co., 31 B. T. A. 730, both the lessor and lessee were before the Board in a consolidated proceeding. It was determined that the lessee there was not entitled to deduct for depreciation because it had no capital investment in the property or the lease, and that such deductions were not available to the lessor because the obligation of the lessee was to redeliver the property at the end of the lease in its original condition. The decision was affirmed at 81 Fed. (2d) 309, certiorari being denied, 298 U. S. 656.

Petitioner objects to the result so reached on the ground that “from every principle of right and justice, allowance for this depreciation should be made to one or to the other member of the affiliated group. The cars and other units of equipment are depreciating each year, exactly the same as are similar units of equipment owned by any other railroad where no lease is involved.” A similar contention in Atlantic Coast Line Railroad Co., supra, was characterized as “more apparent than real” and answered by a quotation from Terre Haute, Indianapolis de Eastern Traction Co., 24 B. T. A. 197, 212, as follows:

“And the lessee, when it makes good the loss, is entitled to deduct the entire amount so expended either in the year in which made (if an ordinary repair), or (if a capital item), over the life of the property replaced or remaining term of the lease, whichever is shorter. In that manner the lessee will have returned to it its entire cost of maintaining the property which it is entitled to deduct, and tlie lessor, at the end of the term, will receive back its property or its equivalent in value in as good a condition and value as when leased.”

It is urged further that the cases cited are distinguishable on two grounds. First, because petitioner is almost wholly owned by the lessee; and, second, because the terms of the lease require that the lessor reimburse the lessee for expenditures of maintaining the property.

To support the first distinction petitioner cites Southern Pacific Co. v. Lowe, 247 U. S. 330. In cur view, however, the doctrine of that case is inapplicable here. There, as the Supreme Court’s opinion points out, “The Central Pacific and the Southern Pacific were in substance identical because of the complete ownership and control which the latter possessed over the former as stockholder and in other capacities, While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control. And, besides, the funds represented by the dividends [the ownership of which was the subject of dispute] were in the actual possession and control of the Southern Pacific as well before as after the declaration of the dividend.” [Emphasis added.]

Here the separate identity of the two corporations has been meticulously preserved, not only as to their separate existence, but as to their reciprocal rights and obligations. The indenture of lease which gives rise to the present question is a printed document covering 27 pages and dwelling with repeated emphasis upon the several rights and liabilities of the parties. It is even provided (article three, section 3) that “The Lessor, at the expense of the Lessee, shall and will during the continuance of this lease, subject to the provisions of Section 7 of Article 5 hereof, maintain, and, if necessary, from time to time, renew, its existence and organization as a body corporate, in due form of law * * The section referred to (article five, section 7) permits the consolidation or merger of the lessor and the lessee. But the very presence of that provision negatives the intention of the parties that they be regarded as already merged for practical purposes. It is further stipulated in the “habendum” clause that the lease shall not operate to grant or demise “any other right, privilege or franchise which is or may be necessary to fully preserve the corporate existence or organization of the Lessor.” And (section 1, article two) it is also provided that the lessee will pay the lessor the sums necessary “for the maintenance of its corporate organization, including the salaries of any necessary officers or compensation of its Board of Directors and for other expenses of administration * * *.” We can not disregard for the purposes of this proceeding the separate corporate organization of the parties which they themselves have so carefully preserved and emphasized. The income tax returns for the relevant years were not made as one organization but as two. For all that appears some advantage may have been anticipated in this respect by petitioner and its affiliate. In any event, these corporations have chosen to operate separately in so far as the relationship here material is concerned, and no assumption that in certain instances the existence of corporate entities may be disregarded seems to us to require that for the benefit of the corporation itself we overlook a separation upon which in their own relations both parties have been insistent.

Nor are we able to concur in petitioner’s contention that a construction of the lease places upon it the cost of upkeep of the property. The provisions are essentially similar to those appearing in Atlantic Coast Line Railroad Co., supra. With reference to sections 11 and 12 of article two of the present lease, quoted at length in our findings of fact, petitioner itself concedes in its brief “* * * if the lessee should regard the replacement of the equipment as essential to the maintenance of the value of the property for lessor’s purposes (as would appear most natural), and return the property at the expiration of the lease with equipment in as good condition as that found at the beginning of the lease, lessor would, under the provisions of the lease above quoted, sustain no damage by reason of the annual depreciation.”

Petitioner contends, however, that other provisions, particularly section 9 of article three, require that repairs and replacements be made at the expense of the lessor. We can not agree. Examination of the lease makes it apparent that the section last mentioned refers only to additions and extensions and not to maintenance or replacement of existing properties. In the earlier section the obligation of the! lessee is spoken of as “retiring, replacing or renewing.” No similar words are used in section 9, but the reference there is to “additions, betterments, improvements and extensions” and to the acquisition or construction of “new or additional lines of railway.” And it is only for the latter class of expenditures that the lessor is required to reimburse the lessee, presumably on the theory that such extensions and betterments become the lessor’s property, as would appear to follow from the general statement at the beginning of section 9 that such action is “for the account of the Lessor.”

Most significant of all is the reimbursement provision itself, which states that the lessee is to be repaid “For all capital expenditures made by the Lessee with respect to the demised property for any of the purposes heretofore enumerated in this Section 9 or in Sections 5, 6 or 8 of this Article Three or in Section 5 of Article Two or in Section 4 of Article Five hereof * * There is no reference to sections 11 and 12 of article two, which are the sections requiring the lessor to maintain the demised property.

Being unable to conclude that the lease requires the lessor to sustain the expense of maintaining the property in its original condition, we can not follow the petitioner to the conclusion that in this case the economic loss resulting from depreciation falls on the lessor; and, that being so, we see no ground for distinguishing the cases cited above.

It does not follow from what has been said, however, that petitioner is not entitled to a deduction for the loss occasioned upon the sale of its building. It is true this also was covered by the lease. But “no use was contemplated” for it and it was sold at an admitted loss. We think this issue is controlled by the principle of Commissioner v. Providence, W. & B. R. Co., 74 Fed. (2d) 714, affirming a memorandum decision of this Board. There (page 716), “Although the assignee is bound generally to maintain the leased property in good condition and to return equal value at the end of the term”, there was an exception for “such portions and parcels of the real estate and property not required by the lessee for railroad purposes.” Here also the lessee is given power “to sell, lease or otherwise dispose of any part of the demised property” with the proviso “in every case that the exercise of any of the rights above set forth in the judgment of the lessee shall not decrease the value of the demised property as a whole for railway purposes.” And in the event of a sale the proceeds “shall be applied by the lessee at its option either to a reduction of any outstanding obligations or indebtedness of the lessor or to betterments or improvements upon or additions to the demised property” for which under other provisions of the lease the lessor was obligated to pay.

Speaking of the property sold in the Providence, W. & B. R. Co. case, supra, the court said: “When they were sold the only proceeds the respondent could ever receive were limited to the sale price and the only obligation of the assignee was to account to the respondent for that. The difference between that and the cost which the respondent had paid was an absolute loss.” We think the same conclusion follows here.

This is not inconsistent with our holding on the previous issue, but in effect follows logically from it. To quote again from Commissioner v. Providence, W. & B. R. Co., supra:

This loss occurred entirely in the year when the property was sold in accordance with the sixth paragraph of the lease. While the generators remained a part of the leased property, the assignee’s obligation to return equal value at the termination of the lease continued and prevented any deduction by the respondent for depreciation. Weiss v. Weiner, 279 U. S. 333. * * * During this time no lessening in the value of the generators became its financial burden. But, when the provisions of the sixth paragraph were invoked and the generators were sold in accordance with those provisions, the respondent was no longer protected by the obligation of the assignee of the lease to return their value in full, and the loss determined by the sale became the respondent’s loss. It then was deductible. * * *

Finally, there is the question of respondent’s authority to collect from this petitioner a deficiency in tax for the affiliated group arising by reason of income of the parent and not of the subsidiary involved in this proceeding.

This question was decided adversely to petitioner’s contention in Pacific Coast Biscuit Co., 32 B. T. A. 39, 45, in the following language:

Finally, petitioners question the propriety of the respondent’s action in asserting a deficiency against each of them. The deficiency, it appears from the pleadings, arises from adjustments of income of the parent, Pacific Coast Biscuit Co. This action is in accordance with article 15 of Regulations 75, which provides that the parent and each subsidiary “shall be severally liable for the tax (including any deficiency in respect thereof) computed upon the consolidated net income of the group.” The subsidiaries each executed and filed a Form 1122 in which they unqualifiedly consented to the regulations. * * *

Here also this petitioner executed form 1122, one effect of which was that of “consenting to these regulations.”

Section 141, Revenue Act of 1932, provides, as did the comparable provision of the 1928 Act, for the assessment and collection of the tax due on a consolidated return in accordance with respondent’s regulations. These regulations require that “each subsidiary, a member of the affiliated group during any part of a consolidated return period, shall be severally liable for the tax (including any deficiency in respect thereof) computed upon the consolidated net income of the group.” “The making of the consolidated return constituted acceptance by petitioner and its subsidiaries of the regulations that had been prescribed.” Charles Ilfeld Co. v. Hernandez, 292 U. S. 62, 65.

Petitioner attacks the validity of the regulation. To this it may not only be answered that the filing of the consolidated return “was a voluntary act on their part and they will not be heard now to complain of the consequences”, Pacific Coast Biscuit Co., supra; but in addition, Regulations 18, issued under the 1932 Act, was in the respect here material identical with Regulations 75 governing the years 1929 through 1931 under the 1928 Act. The reenactment in the Revenue Act of 1932 of the provisions appearing in the 1928 Act, with the intervening establishment by means of the regulation of the liability here contested, is a persuasive evidence of Congressional approval. McFeely v. Commissioner, 296 U. S. 102, 108.

The action of the respondent is sustained as to the depreciation issue and overruled on the question of loss to petitioner upon the sale of the building.

Decision will he entered under Bule 50.

       The deficiency letter introduced by petitioner as proof of the facts therein contained includes among the “returns examined” the statement:

        Form Tear

      “Subsidiary Company: Mississippi River & Bonne Terre Rwy., 210 North 13th Street, St. Louis, Mo- 1122 1932”
      A similar statement appears for the year 1933.

       Regulations 78, art. 12 (b).

       Regulations 78, art. 15 (a).


author: Disney:

text:
    Eugene Higgins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 80052, 85961.
    Promulgated May 24, 1939.

      Orwill V. W. Hawkins, Esq., and Harry H. 'Wiggins, Esq., for the petitioner.

      O. P. Reilly, Esq., for the respondent.
   OPINION.

Disney:

Petitioner contends that the burden of proof is upon the respondent upon the ground that respondent, by calculating allowable deductions upon the proportion of tax-exempt income to gross income, and by reference to tax-exempt income as not giving rise to deductions, bad taken tbe position of allowing the entire deductions as being paid or incurred in trade or business, but of then disallowing them in part upon the theory, not now pressed, that tax-exempt income may not give rise to business deductions. In the deficiency letter for 1933 (though not in that for 1932), the Commissioner stated that petitioner was not engaged in trade or business within the meaning of section 23 (a) of the act (quoting the section); petitioner affirmatively alleged error of the respondent, “particularly by disallowing deductions * * * to the extent of * * * a part of the expenses paid by petitioner for legal and office expenses * * * in the conduct of his business.” Respondent does not seek increased deficiency, but, on the contrary, seeks to disallow as deductions less than the amount disallowed in deficiency notices, and did not ask affirmative relief. The stipulations of fact, contrary to petitioner’s argument on brief, state that respondent disallowed certain amounts of petitioner’s claim for deduction of ordinary and necessary expense. Under these circumstances, it may well be doubted whether the burden of proof shifted to respondent, but we find it unnecessary to decide that question. We assume, without deciding, that the burden of proof was upon respondent, and base our opinion upon the facts adduced and the law applicable.

Respondent admits that the real estate activities of petitioner from his New York office constituted trade or business. The question before us, whether activity in investments constitutes trade or business within section 23 (a) of the Revenue Act of 1932, has been variously answered under various circumstances, and of course is to be viewed in the light of the facts involved in each proceeding. Both petitioner and respondent cite cases which tend to support their respective contentions. We shall not attempt to review in detail all of the various situations involved in those cases. Petitioner most particularly, perhaps, points out our decision in Caroline T. Kissel, 15 B. T. A. 1270; Cornelia W. Roebling, 37 B. T. A. 82; and Kales v. Commissioner, 101 Fed. (2d) 35, reversing Alice G. Kales, 34 B. T. A. 1046. Reliance is placed also upon Austin D. Barney et al., Executors, 36 B. T. A. 446. Respondent, on the other hand, relies heavily upon Kane v. Commissioner, 100 Fed. (2d) 382, affirming Helen W. Heilbroner, 34 B. T. A. 1200; Foss v. Commissioner, 75 Fed. (2d) 326, and other cases.

In Washburn v. Commissioner, 51 Fed. (2d) 949, it was said:

* * * A party may have investments in corporate stock, have no particular occupation, and live on the return of his investments. That would not constitute business under the statute in question. He may, however, take such an active part in the management of the enterprise in which he has investments as to amount to the carrying on of a business. * * *

In Foss v. Commissioner, supra, a rule is laid down as follows:

* * * A person of property, who devotes his time to the active management of it and also to active participation in the management of the companies in which his property is invested, and who maintains an office for that purpose where he spends a substantial part of his time, is carrying on business within the meaning of this statute. * * * The line comes between those who take the position of passive investors, doing only what is necessary from an investment point of view, and those who associate themselves actively in the enterprises in which they are financially interested and devote a substantial part of their time to that work as a matter of business. The maintenance of an office for this purpose, though not conclusive, is significant. * * *

The mere fact that investments produce income is not decisive. Monell v. Helvering, 70 Fed. (2d) 631, states:

* * * If we were to agree with the argument of the petitioner’s counsel that the real test of deductibility is whether the expense was an ordinary and necessary one in obtaining income, we would take what might be supported as a fair one. If Congress had intended to allow deductions on that basis, however, it would have been too simple and easy to have said so to make it reasonable to believe that such was intended by the language which plainly limited expenses deductible to those incurred ordinarily and necessarily in carrying on a trade or business. * * *

We must therefore decide petitioner’s position as to whether he was “doing only what is necessary from an investment point of view”, or whether, on the contrary, he was among “those who associate themselves actively in the enterprises in which they are financially interested and devote a substantial part of their time to that work as a matter of business.” Weighing the petitioner in these balances, we find that the petitioner has not been in the United States since 1921, and a fair interpretation of the following testimony seems to remove petitioner from the company of those who participate actively in the management or control of investments. We quote:

Q. Does Mr. Higgins devote any time to tibe business -of tfie corporations in wbicb he owns stocks or is he merely an investor in those stocks?
A. In the early days he was on the Board of Managers of the Delaware, Lackawanna and Western Railroad Company.
Q. I am speaking now of the years 1932 and 1933.
A. He was not in the country in 1931, 1932 or 1933. The last time he was here was 1921.
Q. Then would your answer be that he did not devote any time to the business of the corporations in which he owned stock?
A. May I ask a question? Do you mean to imply he didn’t watch any financial statements of the company?
Q. No, in the affairs of the corporation itself—
A. That he was right present?
Q. Taking an active part in the affairs or was he merely an investor in the stock?
A. Oh, he was an investor in the stock then.
Q. In other words, would you say that the extent of Mr. Higgins’ activities in the corporate enterprises in which his money is invested is to receive reports and keep track of the dividends and interest he receives?
A. Yes.

In Bedell v. Commissioner, 30 Fed. (2d) 622, it is said: “Most men who have capital change their investments, and may speculate all the time; we should hardly call this a business, though the line is undoubtedly hard to draw.” Therein, as herein, the fact of real estate business was relied upon as proof that there was a single business, including real estate, negotiable securities, etc., and that therefore the party was in business as to the securities. That interpretation of the statute was rejected. It is true that the statute there considered was section 204 (a) of the Revenue Act of 1918 as to “business regularly carried on”, yet the emphasis is placed by the court not upon the lack of regularity, but upon the lack of essential business nature of the transactions.

In Kane v. Commissioner, supra, we were affirmed in holding that a taxpayer deriving income from investments and securities is not entitled to deductions as business expenses, office rent, services of a bookkeeper, and fees as custodian and for collection of income, charged by a trust company. The same elements, in effect, enter into this proceeding, for the petitioner here desires to deduct rent and salaries of bookkeeper and other employees, and purchased his securities through a trust company. The court was of the opinion that in order to secure business deductions it would not be enough “to secure or attempt to secure income or capital stability by conversions of bonds into stock or vice versa, or by otherwise safeguarding the taxpayer’s investments”, and, after referring to Foss v. Commissioner, supra, to the effect that to do only what is necessary from an investment point of view is insufficient to amount to engaging in business, states:

* * * The activities of the taxpayer’s brother as to her investments and the employment for personal convenience of a bookkeeper to record financial transactions, or of a bank to cut and collect coupons, did not, in our opinion, amount to the carrying on of a business. If so, every owner of property can obtain an income tax deduction of whatever sums he may expend to save the trouble of personal attention to his affairs. Lloyd v. Commissioner, 55 F. (2d) 842. (C. C. A. 7). There is no reason to suppose that the employment of a bookkeeper to keep accounts, or of a bank to make income collections, is more than a personal, as opposed to a business, expense.

Nothing further appears in the instant proceeding. The petitioner, as in Kane v. Commissioner, supra, employed others, largely to carry on his real estate business, as to which deductions are admitted by the respondent as allowable, and in a lesser degree simply to “keep accounts”, to receive for deposit, beep records of, and report to him upon investments which he made from a foreign country through the United States Trust Co. of New York, in securities obviously selected for their attributes as investments and not primarily from the angle of profit and loss in dealing actively therein. There was no contention that he was a dealer in securities. To allow the deductions claimed in the present proceeding and to disallow them as was done in Kane v. Commissioner, supra, would be to make a distinction between the small investor and one investing like the petitioner upon a very large scale, for the nature of the expenses disallowed by the Commissioner obviously is the same in both cases. We can not make distinction merely because of the extent of investments or of expenses commensurate therewith.

Considering this proceeding upon the facts involved, different as it is in many respects from cases cited by both petitioner and respondent, we conclude that the activities of the petitioner did not constitute the carrying on of a trade or business within the purview of section 23 (a) of the Revenue Act of 1932. We hold therefore that the petitioner is not entitled to deduct expense incurred on account of investments in securities, stocks, and bonds. We do not think that those cases wherein expenses have been allowed are on their facts determinative of the situation herein involved.

Petitioner contends that to disallow deduction of expenses incurred as to tax-exempt securities would be unconstitutional. We merely point out that he also relies upon John H. Watson, Jr., et al., Trustees, 35 B. T. A. 706, to demonstrate that there is no distinction between tax-exempt and other securities as to deduction of business expenses. We think there is none, and therefore no violation of constitutional principles in disallowance of deduction of expenses on a common basis as to both tax-exempt and nonexempt securities.

Respondent argues particularly that, as to the expenses of petitioner’s office in Paris, the maintenance of an office there was unnecessary and personal to the petitioner, and therefore the expense connected therewith was not deductible. We are not willing to say that one conducting a business may not set up additional office facilities, and incur additional expense, when residing elsewhere than at the place of his principal business. We think it is within taxpayer’s discretion as to what offices he maintains. The Paris office was a mere adjunct to that maintained in New York, and the division of effort and expense between investments and real estate business is logically upon the same basis. We therefore, considering the expense thereof ordinary and necessary business expense, allow deduction thereof upon the same basis as that of the New York office.

It seems necessary, in order definitely to dispose of this matter, to itemize the various deductions claimed, as treated by us in accordance with our conclusions above expressed: Of salary claims, since the evidence indicates that two-thirds of the office time and effort was devoted to real estate, wb allow as deductions two-thirds of all salaries of the New York office, except that of Martin J. Dietz, all of whose time was devoted to real estate, and deduction of whose full salary is therefore approved. The Paris office being merely ancillary to that in New York, and logically upon the same basis, two-thirds of the salary of D. P. Cousteau is allowed as deduction. The strictly office expense in New York, denominated rent, stationery, radiograms, postage, petty cash, newspapers, and miscellaneous, are allowed as deductions to the extent of two-thirds thereof. As to legal expenses: For the year 1932, the item of $3,000, and disbursements of $189.02 in connection therewith arose from investment matters, and deduction is therefore disallowed. The items of $12,000 and disbursements of $100.69 connected therewith (and off $13,000 and $692.30 connected disbursements for 1933) are for business matters, as admitted by respondent, and deductions are therefore allowed. The item of $1,000 and $11.50 disbursements in connection therewith, arose from Federal and state income tax returns, and, in accord with our conclusion as to division between investment matters and real estate business, two-thirds thereof is allowed as deduction. The $1,500 item is agreed to be for advice as to investment in stocks and is disallowed under our conclusions above. The item of $2,500 for Services with $113.03 disbursements, for the year 1932, and of $1,000 with $127.75 disbursements for the year 1933, are stipulated to be personal matters, and deduction thereof is therefore disallowed. The item of $2,500 with $10 disbursements connected therewith, for 1933, is shown to have arisen from real estate matters, condemnation of New York real estate, as to $2,000 thereof, and $2,000 is therefore allowed in full as a deduction; the remaining $500 being allowed as a deduction as to two-thirds thereof, the same appearing to be for income tax matters in general. Deduction of the item of $1,000 for advice as to investments is disallowed. As to the Paris office expense, two-thirds thereof is allowed as deduction, and the item of $600 for depreciation is allowed in full for each year, under section 23 (k) of the Revenue Act as property used in trade or business. It was so used. There seems no contention as to these Paris office items, except as to whether they are ordinary and necessary expense of trade or business. An erroneous overstatement of deduction in the amount of $969.21 is stipulated, as is a refund of $26.14, and respondent does not oppose an item of $90.71 for depreciation on the New York office furniture. These items will therefore be reflected accordingly in the deficiency.

Decision will ~be entered under Rule 50.


author: Tyson:

text:
    Paul W. Litchfield, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91769.
    Promulgated May 24, 1939.

      David A. Gashill, Esq., and Howard L. Hyde, Esq., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Tyson:

In the deficiency notice the respondent determined deficiencies in income taxes in the amounts of $15,639.47 and $11,883.84 for the calendar years 1934 and 1935, respectively. By amended answer the respondent prays that the deficiencies be increased to the amounts of $21,226,16 for 1934 and $17,091.05 for 1935 and affirmatively alleges certain errors on his part and the facts relied on in support thereof. A stipulation of the parties, included herein by reference, completely disposes of the issues raised by the amended answer and the reply thereto. Effect to such stipulation will be given in the recomputation under Rule 50.

The sole remaining issue involves the question of whether the respondent erred in including in petitioner’s taxable income for the years 1934 and 1935 all or any part of the income of a trust distributed to petitioner’s wife and two daughters for each of those years, respectively. Although there was oral testimony, most of the facts pertaining to this issue are embraced in a stipulation, which, together with the exhibits attached thereto, is adopted as part of our findings and included herein by reference. Only the salient facts will be set out herein.

On June 29, 1931, the petitioner, a resident of Akron, Ohio, as grantor, entered into a written trust agreement with the Guardian Trust Co. of Cleveland, Ohio, as trustee, and such agreement remained in full force and effect during 1934 and 1935. That agreement provided, inter alia, as follows:

II. Irrevocability or Trust
Tliis trust shall he irrevocable except that by and with the consent of his wife, Florence B. Litchfield, during her lifetime, the Donor may, from time to time, withdraw from the operation of this Agreement all or any part of the subject matter. In like manner, in the event of the decease of the Donor’s said wife, the Donor may withdraw all or portions of the principal trust estate upon securing the consent of either of his children, Katherine Litchfield Hyde, and Edith Litchfield Denny.
III. Distribution of Income and Principal
The net income from the trust estate shall be distributed one third (%) to the Donor’s wife, Florence B. Litchfield, one third (Vs) to the Donor’s daughter, Katherine Litchfield Hyde, and one third (%) to the Donor’s daughter, Edith Litchfield Denny.
Upon the decease of the Donor’s said wife, Florence B. Litchfield, one half (%) of the principal trust estate shall be distributed to the Donor if he be living. The residue of the trust estate, or the entire trust estate in the event that the Donor shall be deceased, shall, upon the decease of the Donor’s said wife, be divided into two equal parts; one portion to be held for each of the Donor’s said daughters, Katherine Litchfield Hyde and Edith Litchfield Denny.
The Trustee shall distribute to each of the Donor’s said daughters, in regular instalments, the net income arising from that portion of the trust estate held for her benefit. Subject to the prior decease of the Donor, as each daughter attains the age of thirty (30) years, the Trustee shall pay over to each daughter so attaining said age, one-fourth (%) of her portion of the principal held for her benefit, and thereafter said trust shall continue as to the balance thereof, and the entire net income thereafter shall be paid over to such daughter until she attains the age of thirty-five (35) years, at which time an additional one-fourth (%) of such daughter’s portion of the principal held for her benefit shall be paid over to her by the Trustee, to be hers absolutely, and said trust shall continue as to the remaining one-half (%) of such daughter’s portion of said trust fund, during her lifetime, and the net income derived therefrom shall be paid to her so long as she may live.
From and after the decease of the Donor, the Trustee may distribute portions of the principal trust estate to or for the use and benefit of the Donor’s said wife, if living, and/or each of the Donor’s said daughters, respectively, if in its judgment the net income at the time distributable to such beneficiary hereunder, together with all other means of support, which she may have shall be insufficient for her comfortable maintenance and support. All such distribution from the principal trust estate to or for the use and benefit of the Donor’s daughters, Katherine Litchfield Hyde and Edith Litchfield Denny, or issue thereof, shall be charged as an advancement from the share of the trust estate held for such beneficiary.
*******
VI. Addition of Property to Trust Estate
Additional property may be brought within the terms of this Agreement by transferring, assigning, and conveying the same to the Trustee, and by annexing hereto additional exhibits setting forth a concise description of the same.

The trust instrument further provided: That the trustee should have the power, with certain restrictions, to invest or sell the corpus, or any portion thereof, and to reinvest the proceeds of such sales; that each of petitioner’s daughters should have a power of appointment to dispose of that portion of the corpus of the trust which was to be held for her benefit after the death of petitioner’s wife; that upon failure to exercise that power such portion of the corpus should vest in and be distributed to her surviving issue after such issue should have attained the age of 21 years; that if there should be no such issue and either daughter failed to exercise her power of appointment, the portion of the corpus held for her benefit should be added to and form a part of the trust created for the other daughter; that the foregoing provisions with respect to distribution to the surviving issue of either of the two daughters were to become effective only upon the death of both the petitioner and his wife. The trust instrument also provided that, should both daughters die without surviving issue and without exercising their power of appointment, the entire residue of the trust fund should be distributed to the grantor, if living, and if deceased, to his wife, if living, and in the event that neither the grantor nor his wife was then living, such residue should be administered and ultimately distributed as prescribed in petitioner’s will.

On or about July 16,1931, the petitioner transferred to the Guardian Trust Co., as trustee, numerous shares of stock, as listed in the stipulation, which were his separate property and had a total market value of $276,263.25. On the same date, Florence B. Litchfield, the petitioner’s wife, transferred to the same trustee numerous shares of stock, as listed in the stipulation, which were her separate property and had a total market value of $415,828. The stipulation sets forth all of the subsequent transfers of securities and cash to, and withdrawals of securities from, the trust by the petitioner; all the purchases and exchanges of securities by the trustee; and, also, the income received by the trustee during 1934 and 1935 from the list of securities held by it during those years.

During 1934 and 1935 the net income of the trustee amounted to $29,920.65 and $22,862.77, respectively, all of which was distributed by the trustee in equal shares to petitioner’s wife and two daughters, who reported the same on their respective individual income tax returns and paid the tax thereon.

The present ages of the petitioner, of his wife, Florence B. Litch-field, of his daughter, Katherine L. Hyde, and of his daughter, Edith L. Denny, are 63 years, 58 years, 33 years, and 28 years, respectively. Katherine has two children and Edith has three children, all of whom are living at the present time.

The respondent has included in the petitioner’s taxable income the amounts of $29,920.65 for 1984 and $22,862.77 for 1985, representing the total net income received by the trust for each of those years, respectively, based upon his determination (1) that one-half of such income is taxable to petitioner because one-half of the corpus of the trust will revest in him should his wife predecease him, and (2) that the other half of such income is taxable to petitioner because there is vested in the grantor (petitioner) the power, in conjunction with a person (petitioner’s wife) not having a substantial adverse interest therein, to revest in himself that part of the trust corpus from which the income of the two daughters was derived.

On brief, respondent now contends that the two-thirds of the trust income which was distributed to the two children is taxable to petitioner under sections 166 and 167 of the Revenue Act of 1934 and the regulations pertaining thereto. The petitioner contends that neither of those sections is applicable because the trust is not revocable by the petitioner, as grantor, within the meaning of section 166, and the income from the trust may not be distributed to or accumulated for future distribution to the petitioner, as grantor, within the meaning of section 167. In the alternative, petitioner contends that in any event he is not the “grantor” within the meaning of those sections, or either of them, as to that portion of the trust corpus contributed by his wife.

Clearly the respondent erred in including in the petitioner’s taxable income for 1934 and 1935 any portion of the trust income on the ground that one-half of the corpus of the trust will revest in petitioner should his wife predecease him. Such contingency constituted merely tbe possibility of a reverter to petitioner of a portion of the trust corpus, because, by the terms of the trust instrument, such re-verter may occur only upon the happening of an event over which petitioner, the grantor, has no control and may not occur through petitioner’s exercise of any vested “power to revest” within the ambit of section 166, supra. Phebe Warren McKean Downs, 36 B. T. A. 1129; William E. Boeing, 37 B. T. A. 178; and John Edward Rovensky, 37 B. T. A. 702.

The next question presented for our consideration is whether petitioner, as grantor of the trust, is taxable on two-thirds of the trust income distributed to his two daughters, in the taxable years, on either of two grounds, namely (a) that the petitioner, as grantor, is vested with the power, in conjunction with his wife as a person not homing a substantial adverse interest in the disposition of two-thirds of the trust corpus, or the income therefrom, to revest such corpus in himself, under section 166, supra, or (b) that two-thirds of the trust income distributable to the two daughters under the terms of the trust instrument may, in the discretion of petitioner, as grantor, in conjunction with a person, his wife, not having a substantial adverse interest therein, be distributed to or accumulated for future distribution to him, within the meaning of section 167, supra.

The trust instrument provides that the trust is irrevocable, except that the grantor may withdraw all or any part of the trust corpus by and with the consent of his wife during her lifetime, or, if she predeceases him, then by and with the consent of either of his daughters.

There is an express provision in the trust that one-third of the net income of the trust estate shall be distributed to the petitioner’s wife during her lifetime and, also, that after the petitioner’s death the trustee may distribute portions of the trust corpus to or for the use and benefit of petitioner’s wife if, in the trustee’s judgment, her income is insufficient for her comfortable maintenance and support. The petitioner’s withdrawal of any part or all of the trust corpus would necessarily effect a diminution or possibly the destruction of his wife’s present interest in one-third of the income of the trust estate as a whole and, also, of her contingent interest in future possible distributions to her from the trust corpus for her maintenance and support. This being true, the petitioner’s wife, in our opinion, had a “substantial adverse interest” in the entire trust corpus, within the meaning of section 166, supra. Jane B. Shimerick, 37 B. T. A. 454 and Sophia P. O. Morton, 38 B. T. A. 419. Accordingly, as to ground (a) above, we conclude that two-thirds of the trust income may not be included in the petitioner’s taxable income for either 1934 or 1935, under section 166, supra, because petitioner did not have a vested power, in conjunction with a person (his wife) having no substantial adverse interest in two-thirds of the trust corpus, to revest that two-thirds of the trust corpus in himself.

The trust instrument does not expressly give the petitioner any power to modify, amend, or alter, the terms of the trust. The respondent, however, contends that petitioner reserved a general power of revocation, to be exercised in conjunction with his wife, and that such power included, by implication, the power to alter, amend, or modify, the terms of the trust instrument; that under such power to alter, amend, or modify, petitioner could, in conjunction with his wife, who had no substantial interest in the two-thirds part of the trust income distributable to the two children, amend the trust instrument with regard to such part of the income so as to have same distributed to or accumulated for future distribution to himself, within the meaning of section 167, supra.

The fallácy in this contention is that the trust instrument did not reserve to petitioner a general power of revocation. By its express terms the trust was declared to be irrevocable, with one stated exception, viz., that the petitioner, with the consent of his wife, could only withdraw from the operation of the trust all, or any part, of the subject matter, i. e., the corpus thereof. Although it is true that under such conditional power the petitioner could, by withdrawing a part or all of the trust corpus, cause the trust to terminate as to the withdrawn portion, such mode of termination of the trust, in whole or in part, is a particular mode which must be strictly pursued in order to make the termination or revocation effective. That specific exception to the irrevocability of the trust does not embrace the power to alter, amend, or modify, the terms thereof relating to the income therefrom, or any portion thereof. We therefore conclude that as to ground (b) above, the two-thirds part of the trust income distributable to the two daughters may not be distributed to or accumulated for future distribution to petitioner, as grantor, within the meaning of section 167, supra, and, accordingly, is not taxable to him as determined by respondent.

The conclusions hereinbefore set forth sustain the petitioner’s contention that no part of the trust income here in controversy is taxable to petitioner for the years 1934 and 1935, under sections 166 and 167, supra, or either of them, and obviate the necessity of any discussion of petitioner’s alternative contention.

Decision will be entered wnder Bule 60.

       SEC. 166. REVOCABLE TRUSTS.
      Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition ol such part of the corpus or the income therefrom, or
      *******
      then the income of such part of the trust shall be included in computing the net income of the grantor.
      SEC. 167. INCOME EOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      ***-****
      then such part of the income of the trust shall be included in computing the net income of the grantor.
      (b) As used in this section, the term “in the discretion of the grantor” means “in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.”

       See National Newark & Essex Banking Co. v. Rosahl (N. J.), 128 Atl. 586; Richardson v. Stephenson (Wisc.), 52 A. L. R. 681-684; 4 Bogert on Trusts and Trustees 2908 (par. 120); 65 C. J. 347 (par. 120); 26 R. C. L. 1206 (par. 48).


author: Leech:

text:
    The Dill Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89583.
    Promulgated May 24, 1939.

      F. E. Gleaeh, Esq., and H. A. Mihills, G. P. A., for the petitioner.

      Elmer L. Corbin, Esq., H. D. Thomas, Esq., and A. D. King, Esq., for the respondent.
   OPINION.

Leech:

In the first issue, respondent bases Ms disallowance of a deduction for loss on the United States bonds on that part of Begula-tions 77, article 71, which reads as follows: “® * * No gain or loss is realized by a corporation from the mere distribution of its assets in kind in'partial or complete liquidation, however they may be appreciated or depreciated in value since their acquisition * *

Similar regulations, with slight differences in wording immaterial here, have been in force since the Bevenue Act of 1918. Because such regulations had long been in force without change in the law, Begu-lations 69, article 548, the prototype of and substantially similar for present purposes to the quoted regulations, was held to be valid in Hellebush v. Commissioner, 65 Fed. (2d) 902, although there it was found no distribution in kind on dissolution occurred. See also Central National Bank of Lincoln, Nebraska, 29 B. T. A. 719. A like conclusion of validity was reached in Stock Yards Bank of Cincinnati, 25 B. T. A. 964. In that case, a bank, in competition with the petitioner bank, acquired all of petitioner’s outstanding stock through a nominee, and turned it over to the latter. Petitioner thereupon conveyed all of its assets to the competing bank, then the sole stockholder, and dissolved. The stock was surrendered for cancellation. It was held on the basis of the same regulation that the petitioner had realized no gain or loss when it distributed its assets to its sole stockholder in complete liquidation.

Distributions in complete or partial liquidation result in no gain or loss to the distributing corporation. Helvering v. General Utilities & Operating Co., 296 U. S. 200, affirming 29 B. T. A. 934; Columbia Pacific Shipping Co., 29 B. T. A. 964; affd., 77 Fed. (2d) 759; W. P. Fox & Sons, Inc., 15 B. T. A. 115; Chicago Binder & File Co., 4 B. T. A. 1002.

Was the transfer of cash, preferred stock, and United States bonds to the syndicate, in exchange for 25,000 shares of common stock in petitioner, a distribution in partial liquidation of petitioner ?

The original intention of the parties may have been that the petitioner should acquire the syndicate’s common stock with its preferred stock and cash. However, that intention was abandoned. It was not carried out. Petitioner did not, in fact, do that, and the fact controls the tax incidence here. Weiss v. Wiener, 279 U. S. 333; Gregory v. Helvering, 293 U. S. 465; C. M. Menzies, Inc., 34 B. T. A. 163; W. F. Kennemer, 35 B. T. A. 415; affd., 96 Fed. (2d) 177. The plan, finally adopted and executed, obligated the petitioner to deliver to the syndicate, preferred stock, cash, and United States bonds. The obligation to deliver United States bonds was not a debt payable in money. It could not have been satisfied except by the transfer of those bonds, assets of the petitioner. See Helvering v. General Utilities & Operating Co., supra.

The position of petitioner is that since it had no intention to liquidate any portion of its business in the acquisition of this stock interest, no liquidation occurred. However, absence of intent does not contradict the statutory status of liquidation if, in fact, a liquidation occurred, by the cancellation or redemption of capital stock. Palmetto Quarries Co., 30 B. T. A. 544; Salt Lake Hardware Co., 27 B. T. A. 482.

Here a partial liquidation actually occurred. The capitalization of petitioner was reduced from $700,000 to $100,000. The 25,000 shares of common stock, so reacquired, were not held in petitioner’s treasury for resale but were canceled and retired. The authorized capital stock of petitioner was reduced from 50,000 to 25,000 shares. Cf. William A. Smith, 38 B. T. A. 317.

It follows that petitioner suffered no allowable loss by the distribution of the United States bonds as a part consideration for 25,000 shares of its outstanding common stock. 1

The second issue is raised by the affirmative allegation in respondent’s amended answer that petitioner vis subject to the 50 percent penalty of net income for the taxable year, under section 104 of the Revenue Act of 1932, and the consequent request for an increase in the deficiency of $4,992.92, as determined, to the sum of $110,079.94.

Respondent supports this allegation on the ground that petitioner was “availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.” Respondent has the burden of proof. Rule 32 of the, Board’s Rules of Practice; Security-First National Bank of Los Angeles, Executor, 38 B. T. A. 425.

It may be conceded that the shareholders of petitioner would have been obliged to pay surtaxes in a larger amount if more of petitioner’s gains and profits had been distributed during the taxable year. “Bub the taxes under these statutory provisions are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct, which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed.” Cecil B. de Mille Productions, Inc., 31 B. T. A. 1161; affd., 90 Fed. (2d) 12; certiorari denied, 302 U. S. 713.

True, the proscribed purpose may be evidenced in many ways. See United Business Corporation of America v. Commissioner, 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635; William C. de Mille Productions, Inc., 30 B. T. A. 826. But the contested tax is “highly penal” and thus “While the plain intent of such a statute must be given full effect, it should be strictly construed and should not be extended to cover cases which do not fall within its letter.” United Business Corporation of America v. Commissioner, supra.

Since the respondent has the burden of proof and petitioner is not a holding company, no presumption of the existence of the proscribed purpose may be indulged here until it be established by the weight of the evidence that there was an unnecessary accumulation of gains and profits. Moreover, respondent is limited to the contention, as he admits, that petitioner “was availed of” during the taxable year, for the prohibited purpose. The respondent argues that the record sustains his burden of establishing that in the taxable year petitioner permitted its gains and profits to accumulate beyond the reasonable needs of its business and that the consequent presumption of the existence of the penalized purpose has not been overcome. See C. H. Spitzner & Sons, Inc., 37 B. T. A. 511.

The question of what are reasonable or unreasonable needs of business is always one of fact. The answer is rarely easy to find. However, the law does not require that “a business should remain static; it must be assumed that any business shall have the right to grow.” William C. de Mille Productions, Inc., supra. A fortiori, a corporation certainly must have the untrammeled right, within reasonable limits, to financially protect itself and its shareholders.

Justice Holmes once said “A page of history is worth a volume of logic.” New York Trust Co. v. Eisner, 256 U. S. 345. Thus, the economic history of the country and this company is both pertinent and illuminating. So, particularly where, as here, the petitioner is not a holding company but is engaged in a manufacturing business, which is so obviously hazardous from a business viewpoint, we will hesitate before substituting our judgment upon the reasonableness .of the corporate accumulations, for that of the directors. See Klug & Smith Co., 18 B. T. A. 966.

The attitude of petitioner toward its earlier gains and profits may have a bearing upon the reasonableness of the accumulation existing in the tax year. See United Business Corporation of America v. Commissioner, supra; and C. H. Spitzner & Sons, Inc., supra. But respondent points to the large corporate surplus account of petitioner in the tax year as constituting “accumulated gains and profits” under the act. However, the greater part of this surplus is the result of accumulations over many years and represents physical plant and improved manufacturing facilities by which the petitioner has been enabled to sustain and increase its income upon which it has already paid income tax.

Little benefit can be obtained by repeating the evidence here. That the plant and production facilities represented by such a large part of petitioner’s accumulations were actually used in its business can scarcely be doubted. Nor, in view of the evidence, does it seem any less certain that they were reasonably needed in the business.

The Board has said in United Business Corporation of America, 19 B. T. A. 809, that:

* * * No corporation which is actively engaged in business is to be subjected to the penalty of the statute unless and until it permits its course of conduct to be diverted from its normal business interests by a purpose to save its stockholders from surtax.

Respondent argues that the liquidation of the syndicate common stock was planned when the syndicate bought that stock in 1925; that this was a diversion from its ordinary business interests for the purpose of Saving surtax to its stockholders and that this procedure can be repeated and thus deprive the Government of its taxes unless the penalty is imposed here. The answer is that the existence of no such plan is disclosed. In fact, we are convinced the plan to liquidate was bom when the liquidation occurred as the result of the petitioner’s then pressing and reasonable business need.

At the close of the fiscal year ended in 1931, petitioner had cash on hand in the amount of $149,554.23, and Government bonds which cost it $320,071.41. During the fiscal year ended in 1932, here involved, it realized net earnings of $210,174.03. At the close of the latter year, it had cash on hand in the amount of $343,959.08 and United States bonds which cost it $93,774.42. During this year it had expended about $200,000 in liquidating the common stock interest of the syndicate, and, in addition thereto, it had paid dividends for that year in the amount of $48,152.98.

Investments in securities of outside companies may be evidence that the funds thus used were not reasonably necessary in a corporate business. See National Grocery Co., 35 B. T. A. 163. But such an investment is a far cry from the purchase of Government bonds here. Such investment, per se, is not evidence in the present circumstances of the absence of reasonable necessity for the retention of the funds thus used. Nor is that conclusion affected by the facts that the preferred stock was being acquired by petitioner at a price under par and retired, that its earnings for the taxable year, in the amount of $47,727, were used in that acquisition and that the entire preferred issue was retired before maturity. The amount of these investments in Government bonds, just as the cash on hand, is their only value as evidence in the present situation.

More might be said. But, in the face of this record, the conclusion seems inescapable that petitioner has not “[permitted] its course of conduct to be diverted from its normal business interest by a purpose tc save its stockholders from surtax.” United Business Corporation of America v. Commissioner, supra.

The consistently conservative policy of petitioner’s management was merely continued through, the tax year. It is not disclosed that the petitioner loaned money to its shareholders either with or without interest. See R. & L., Inc., 33 B. T. A. 857; affd., 84 Fed. (2d) 721; certiorari denied, 299 U. S. 588; William C. de Mille Productions, Inc., supra; and National Grocery Co., supra. Not only that, but the salaries of its officers were actually reduced for the taxable year. The petitioner constituted the life work of its operating officers. They had built it and were proud of it. The protection of the economic and financial independence of that work was scarcely less warranted as a business purpose than if petitioner had been an individual.

The issue of preferred stock with the obligation to retire it within five years evidenced a debt. Palmer, Stacy-Merrill, Inc., 39 B. T. A. 636; Schmoll Fils Associated, Inc., 39 B. T. A. 411; Richmond, Fredericksburg & Potomac Railroad Co., 33 B. T. A. 895; affd., 90 Fed. (2d) 971. And this record, at most, does not establish that the liquidation of the syndicate stock by the partial use of that preferred stock, under the circumstances here, was not required by a reasonable business necessity. Cf. Sauk Investment Co., 34 B. T. A. 732; Mellbank Corporation, 38 B. T. A. 1108.

The dividend policy of petitioner may have been conservative. The company was successful. However, on the whole record, it certainly has not been established that petitioner, during the taxable year, permitted its gains and profits to accumulate beyond the reasonable needs of its business. And, even if it had been so established, we believe the same record conclusively overcomes any presumption that such accumulations and the failure to distribute them as dividends were permitted “for the purpose of preventing the imposition of the surtax upon ^petitioner’s] * * * shareholders.” It follows that the contested penalty proposed under section 104 of the Revenue Act of 1932, falls.

Decision will be entered wnder Rule 50.