text:
    Lock, Moore & Co., Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9295.
    Promulgated August 8, 1927.
    1. The deduction for loss of timber acquired prior to March 1, 1913, destroyed by storm in 1918, should be based on cost and not on the March 1, 1913, value where such value is in excess of cost.
    2. In 1917 the petitioner paid a premium on a life insurance policy assigned to it as security by a debtor, the deduction of which from gross income was disallowed by the respondent on the ground that it was a capital expenditure. The policy was allowed to lapse in 1918 and the premium paid in 1917 was claimed as a deduction from gross income of 1918 in its income-tax return for that year either as a bad debt or as a loss. Held,, that the deduction was properly disallowed.
    3. The invested capital of a corporation may not be reduced in determining the extent to which a dividend is paid from current earnings of a year by a “ tentative tax ” theoretically set aside from such earnings pro rata over such year.

      E. B. Burling, Esq., and Paul E. Short, Esq., for the petitioner.

      G. 8. Borden, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits tax for 1918 of $616.36. The issues raised are (1) whether the deductible loss from the destruction of timber acquired prior to March 1, 1913, should be the cost or the March 1, 1913, value, which was in excess of the cost; (2) the deductibility from income of 1918 of the amount of a premium paid in 1917 on a life insurance policy disallowed as a deduction from gross income of 1917 on the ground that it was a capital expenditure — the policy having been allowed to lapse and becoming worthless in 1918; and (3) the correct invested capital for 1918, the claimed invested capital being reduced by reason of dividends paid in 1918 in excess of earnings available therefor at date of payments after allowance for a “ tentative ” tax.
    FINDINGS OF FACT.
    The petitioner is a Louisiana corporation.
    During 1918, 5,750,000 feet of timber owned by the petitioner was destroyed by storm, which timber was acquired by the petitioner prior to March 1, 1913, at a cost of $4,447.05. The March 1, 1913, value was $34,789.23. The petitioner did not make a sale or other disposition of this timber; it was wiped out, destroyed, exhausted, and depleted by storm in 1918. In its income-tax return for 1918 petitioner deducted from gross income $34,789.23, representing the March 1, -1913, value of the destroyed timber, which amount was reduced by the respondent in the amendment of the return to $4,447.05, the cost thereof, and the difference was disallowed as a deduction.
    Prior to 1918 R. A. Armstrong of Wharton, Tex., was indebted to the petitioner. In 1912 Armstrong assigned to the petitioner in part payment of his debt a life insurance policy. In 1917 the petitioner paid a premium of $304.44 on this policy. This deduction was disallowed by the respondent as a business expense deduction for the year 1917 on the ground that it represented a capital charge. The policy was allowed to lapse and become worthless in 1918 and it has never been reinstated. Neither the amount of the indebtedness nor the amount of the premium has ever been recovered by the petitioner.
    During 1918 the petitioner paid the following dividends on the dates indicated:
    January 31_$10,000
    February 27_ 10, 000
    March 28_ 20, 000
    April 24_ 50,000
    May 27_ 20, 000
    June 28_ 20, 000
    July 30_ 20, 000
    In determining the amount of petitioner’s income available for dividends during the year 1918 the respondent reduced the petitioner’s income of $201,252.24 by $25,084.78, representing tentative Federal income and profits tax for the year 1918 and by $2,506.49, representing donations, or a total of $27,591.27. The result of this reduction in earnings was a reduction in petitioner’s invested capital for 1918.
   OPINION.

Smith:

The first point in issue is the basis for determining the amount of the deductible loss sustained in 1918 as a result of the destruction of 5,750,000 feet of timber by storm in that year. The petitioner claims that the deductible loss is the March 1, 1913, value thereof while the respondent claims that it is the cost, which was less than the March 1, 1918, value.

Section 202 of the Revenue Act of 1918 provides in part:

(a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be—
(1) In the ease of property acquired before March 1, 1913, the fair market price or value of such property as of that date. * * *

Section 234(a) of the same Act permits a corporation to deduct from gross income in its tax returns:

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence ;
* S* * >)< }j! * *
(9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not' otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date: • * * such reasonable allowance in all the above cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. * * *

The petitioner claims that the loss sustained is deductible under subdivision (9) of section 234(a), above quoted; that the timber was depleted by a storm in 1918; that since depletion may be taken upon the basis of the March 1, 1913, value, the deductible loss is the March 1, 1913, value.

Following the decisions of the Supreme Court in the case of Goodrich v. Edwards, 255 U. S. 527, and Walsh v. Brewster, 255 U. S. 536, respecting the basis for the determination of taxable gain or deductible loss in the case of property acquired prior to March 1, 1913, and sold or disposed of subsequent thereto, Treasury Decision 3206 and Treasury Decision 3209 were promulgated to bring the department regulations into harmony with the court rulings. Treasury Decision 3209 amended article 142 of Regulations 45 so as to read in part as follows:

* * * When loss is claimed through the destruction of property by fire, flood, or other casualty, the amount deductible will be the difference between the cost of the property and the salvage value thereof, after deduction from such cost the amount, if any, which has been or should have been set aside and deducted in the current year and previous years from gross income on account of depreciation and which has not been paid out in making good the depreciation sustained. In the case of property acquired before March 1, 1913, when the fair market value as of that date is lower than the cost, the deductible loss is the difference between such value and the salvage value thereof after deducting from the value as of March 1, 1913, the amount, if any, which has been or should have been set aside and deducted in the current year and previous years from gross income on account of depreciation and which has not.been paid out in making good the depreciation sustained * * *
The Bureau has consistently held that depletion signifies the process of using up a capital asset in the production of goods and that the provisions of law governing depletion allowances do not extend to the determination of deductible losses on account of storm, fire, or other casualty. The law itself would seem to make the distinction taken by the Bureau, for it specifically provides for losses on account of storm, fire, or other casualty. It is the normal shrinkage in the quantity of the timber due to its use that the depletion allowance of the statute is designed to take care of and not extraordinary losses due to casualty. It is believed that the position of the Bureau in making the distinction between depletion and losses should be adhered to and the tax liability of this company adjusted accordingly.

The Commissioner has consistently held that depletion signifies the process of using up capital assets in its business operations and that the provisions of law governing depletion allowances do not extend to the determination of deductible losses on account of storm, fire, or other casualty. The various income-tax laws from the Revenue Act of 1913, would seem to warrant the position taken.

We are of the opinion that the petitioner is not entitled to the deduction of the March 1, 1913, value of the timber destroyed by storm by virtue of subdivision (9) of section 234(a) of the Revenue Act of 1918. We are also of the opinion that the language of the stipulation which has been incorporated into the findings of fact— “ The petitioner did not make a sale or other disposition of this timber; it was wiped out, destroyed, exhausted and depleted by storm in 1918 ” does not serve to make the loss deductible under this subdivision. The fact is simply that the petitioner’s timber was destroyed by storm in 1918 and the stipulation that it was “ depleted by storm ” is not controlling.

The petitioner does not rest its claim entirely upon the language of subdivision (9). It calls attention to the fact that the taxing statute provides no basis for the determination of a reasonable allowance for depreciation; that depreciation has always been allowed by the Commissioner upon the basis of the March 1, 1913, value, and that this Board has sustained the position of the Commissioner in Appeal of J. J. Gray, Jr., 2 B. T. A. 672. The reasons for reaching that conclusion were clearly stated in the opinion. Congress has not provided in the Revenue Act of 1918 a basis for the determination of a deductible loss sustained through casualty. In the Revenue Act of 1921 it is provided that a corporation sustaining a loss arising from the destruction of or damage to property, where the property destroyed or damaged was acquired before March 1, 1913, may be computed upon the basis of its fair market price or value as of March 1, 1913. (Sec. 234(a) (4) of the Revenue Act of 1921.) In the Revenue Acts of 1924 and 1926, it is provided that the basis for the determination of a loss resulting from casualty shall be the same as that for the determination of a loss from the sale or other disposition of property. (Sec. 234(a) (4).)

The evidence indicates that the petitioner’s investment in the timber was only $4,447.05. This amount was unquestionably a loss sustained during the taxable year. The purpose of the statute is to allow the actual loss. United States v. Flannery, 268 U. S. 98; McCaughn v. Ludington, 268 U. S. 106. The excess amount claimed was merely a loss of unrealized appreciation in the value of timber which accrued prior to March 1,1913. We think that the deductible loss from casualty is the loss of an investment in property and not the loss of an unrealized appreciation therein. If Congress had intended to allow such deduction it would have done so in explicit terms.

Congress indicated that the basis for determination of loss in the case of a “ sale or other disposition of property ” should be the March 1,1913, value. (Sec. 202, Revenue Act of 1918.) McCaughn v. Ludington, supra. The petitioner contends that such basis is necessarily limited to a “ sale or other disposition ” of property; that its loss did not arise from a sale or other disposition of property and that therefore the basis is not applicable. Granting, but not conceding merit in this contention, we think that it is of no consequence. The actual loss in the case of property destroyed as a result of casualty is in no event any greater than the capital investment in the property.

In Appeal of Jackson County State Bank, 2 B. T. A. 1100, the Board had under consideration the loss sustained by the taxpayer as a result of the demolition of a building to make way for a new building. The question was whether the loss should be computed on the March 1, 1918, value, or on cost. In the course of the opinion the Board said:

The statute provides for a deduction on account of losses sustained during the taxable year. The expression “ losses sustained ” means actual losses and not paper losses. Where the March 1, 1913, value of property was greater than the cost, the actual loss sustained when the property is destroyed or demolished must be based on the cost of the property. Any other interpretation would be inconsistent with the principle announced in United States v. Flannery, 268 U. S. 98; and McCaughn v. Ludington, 268 U. S. 106. While in those cases losses on the sale of assets and not losses on account of destruction of property were involved, the basic principle is the same. In the case of a loss on the sale of property the statute expressly provides that, for the purpose of ascertaining the gain derived or loss sustained in the case of property acquired before March 1, 1913, the basis for determining the deductible loss is the March 1, 1913, value. Yet the court held that the March 1, 1913, value was merely a guidepost to determine whether a loss had been sustained since March 1, 1913, and that the loss was not to be based on March 1, 1913, value unless that value was less than cost. The principle applies with equal force in the case of a loss on account of destruction of property. The basic principle of the decisions in the Flannery and Ludmgton cases was that the March 1, 1913, value of the property subsequently disposed of was not the fixed basis for computing the loss.

The decision upon this point must be in favor of the Commissioner.

The second question in issue is whether the petitioner is entitled to deduct from the gross income of 1918, $304.44, representing a life insurance premium paid by it on a policy assigned to it as security by a debtor, which policy the petitioner permitted to lapse in 1918 and which became worthless in that year. It appears that the Commissioner disallowed the deduction of the premium paid in 1917 on the ground that it was a capital expenditure. The petitioner, therefore, claims the deduction as a loss in 1918.

The record fails to show the character of this policy whether it was a term insurance policy or whether there was any surrender value on the policy. We can not determine whether the action of the Commissioner was correct in disallowing the deduction from the gross income of 1917 of the premium paid in that year. It was apparently paid for the protection of the petitioner during that year. If this is so, there is no element of capital expenditure in the payment and there is no evidence that the petitioner acquired a capital asset as a result of the payment. Life insurance premiums are paid for protection and there is always an element of expense in the premium. As was stated in Appeal of E. A. Armstrong, 1 B. T. A. 296:

* * * The cost of earned life insurance is not a capital investment any more than tlie cost of earned fire or marine insurance. It is a current expense, and should not he treated as anything else.

Upon the evidence we can not find that the petitioner sustained a deductible loss in 1918 as a result of the lapsing of the policy.

The third point in issue is whether the earnings available for the payment of dividends during 1918 shall be computed after the deduction therefrom of an amount or amounts representing tentative taxes payable for 1918 upon the income of that year. This is the same question which was decided adversely to the contentions of the petitioner herein in Appeal of L. S. Ayers & Co., 1 B. T. A. 1135. In accordance with that decision it is held that the reduction of invested capital by a “ tentative ” tax theoretically set aside out of earnings prorated over the year 1918 was in error.

Reviewed by the Board.

Judgment will be entered on 15 days’ notice, under Rule 50.


source: Caselaw Access Project

author: Littleton:

license: Public Domain

text:
    Mechanics-American National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8795.
    Promulgated August 8, 1927.
    A debt charged off may not be allowed as a deduction from gross income in tbe absence of sufficient evidence of determination of worthlessness within the taxable year.

      R. E. Gave, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    The Commissioner refused to allow petitioner a deduction of $98,746.14 for alleged worthless debts taken by it in its income-tax return for the year 1919, and determined a deficiency of $6,547.31,

      BINDINGS OF FACT.
    The petitioner is a national banking association with its principal office in St. Louis, Mo.
    The Memphis, Dallas & Gulf R. R. Co. was a corporation operating a small railroad in Arkansas. During the year 1914, petitioner made loans of $50,000, $12,500, and $14,750 to said railroad company, taking notes therefor, which notes were indorsed by W. W. Brown, C. C. Henderson, C. W. Dodson and A. C. Ramsey. Bonds of the railroad company of the par value of $125,000 were delivered to petitioner as security for the amount of its first two loans. The notes were not paid at maturity, and in 1915 renewal notes, payable on demand, were given petitioner. In 1916, petitioner loaned the railroad company an additional amount of $4,274.50, for which a demand note indorsed by the same four individuals, with same collateral, was taken by petitioner. On December 31, 1917, petitioner charged off the notes for $14,750 and $4,274.50, amounting then with accrued interest to $19,772.77. At the beginning of the year 1919, petitioner held as collateral security for the notes given it bonds of the railroad company in the amount of $188,000 par value. Other banks in St. Louis made similar loans to the railroad company.
    During and subsequent to 1915 the railroad was operated at a deficit. It was delinquent in the payment of certain taxes and of various judgments and claims of laborers and material men.
    In order to prevent a sale of property of the railroad to satisfy such taxes, judgments and liens, several St. Louis banks formed a syndicate to advance funds to pay off such judgments and liens. One, Edward Whitaker, an officer of one of the St. Louis banks, acted as trustee of the syndicate and to him the syndicate banks advanced money, with which he purchased assignments of the various judgments and liens mentioned. These judgments and claims constituted valid liens against the railroad property.
    In September, 1915, the petitioner made its first advance to the trustee, Whitaker, in the amount of $15,128. By April 14, 1919, the total of advances by petitioner to the trustee for the purposes mentioned was $41,274.47. Of such amount, the sum of $18,161 was used to pay off or purchase liens for taxes against the property of the railroad. The railroad by court proceedings to which petitioner was a party, as hereinafter mentioned, was placed in the hands of a receiver in 1920. No part of the advances made to the trustee by petitioner had been repaid prior to the receivership. No payments of principal or interest on the bonds held by petitioner as collateral were ever made. The $188,000 par value of bonds held by petitioner were part of an issue of first and refunding mortgage bonds, of which approximately $1,600,000 was outstanding in 1919. These bonds were subordinate to an issue of underlying bonds, of which $420,000 were still outstanding in 1919.
    Under the date of December 31, 1917, the petitioner charged off its books $19,772.77 of the loans to the railroad company for which notes had been taken. The balance of such loans, amounting to $61,751.73, was charged off the books of petitioner under date of July 7, 1919. The total advances to Whitaker, Trustee, amounting to $41,274.47 were also, on the same date, charged off.
    In 1920 and prior thereto efforts were made to sell the railroad, but no satisfactory offers were received.
    The petitioner, together with other St. Louis banks, in 1920 instituted receivership proceedings in the United States District Court in Arkansas and a receiver was appointed to liquidate the railroad corporation. In 1922, the property of the railroad was sold for $115,000, which sum was less than the amount of the indebtedness incurred by the receiver during his operation of the road.
    W. W. Brown and C. C. Henderson, two of the indorsers on the notes held by petitioner, paid $50,000 in compromise settlement of their liability as indorsers on notes held by petitioner and the other St. Louis banks. Said amount was accepted in full satisfaction of their liability, the petitioner receiving its pro rata share of same, $10,748.86.
    In 1922, one Conway, who held liens on a portion of the railroad’s property, purchased from Whitaker, Trustee, all of the claims he held as such, for the participating banks, for $70,000. The participating banks, including petitioner, received as their share of the $70,000, $49,347.07. The total of the advances by the St. Louis banks to Whitaker, Trustee, for purposes heretofore indicated, aggregated approximately $170,000. Lesser Goldman & Co., who had made similar advances to Whitaker, Trustee, and who held approximately $420,000 of outstanding first mortgage bonds on the railroad, received the remainder of the $70,000. The petitioner received as its share $13,303.97.
   OPINION.

Littleton:

The indebtedness to the petitioner of the Memphis, Dallas & Gulf Railroad Co. consisted of advances aggregating $41,274.47, made through Whitaker, Trustee, and of notes of the railroad, in the aggregate amount of $81,524.50, indorsed by four individuals and secured by second mortgage bonds of the railroad of the par value of $188,000. The sum of $41,274.47 was advanced for the purchase of various claims which were liens against the railroad property. These claims and judgments were purchased by Whitaker, Trustee, for the benefit of petitioner and others. The tax claims or liens paid or purchased were such as were imposed upon the property of the railroad by the laws of the State of Arkansas. See section 10023, Digest of Statutes of Arkansas, Crawford and Moses, 1921 (Act of March 24, 1911). The advances made to Whitaker, Trustee, which were not used to satisfy claims for taxes, were’ used for the purchase of various claims of laborers and material men for work done or material furnished in connection with the construction or operation of the railroad, and such under section 8555 of the Digest of the Statutes of Arkansas, Crawford and Moses, 1921, Act of March 31, 1899, are made liens upon the entire property of the railroad, superior, whether prior in point of time or not, to the lien of any mortgage.

The petitioner having purchased such lien claims against the property of the railroad, became entitled, by the principle of subrogation, to the same security and preference which attached to the claims in the first instance. As to such claims, petitioner was preferred to general creditors, and to the holders of the first mortgage bonds. That such were petitioner’s rights was recognized and evidenced by the disposition made of the $70,000 realized from the sale made to Conway.

The evidence indicates that some inquiry and investigation was made by petitioner, looking to the collection of its indebtedness against the railroad company, but the evidence fails to show that petitioner’s claims against the railroad were ascertained to be worthless in 1919. Such action was not taken prior to 1919 nor in that year, when such indebtedness was charged off petitioner’s books. The evidence does not show that conditions in 1919, were such that petitioner could reasonably have anticipated by the end of that year that the sale of the railroad’s property, upon which it had superior and preferred liens, would produce nothing to be applied towards payment of the indebtedness due it. After the road went into the hands of a receiver and was sold in 1922, petitioner received about 30 per cent of this portion of its indebtedness. The Board is of the opinion that in 1919 the petitioner was not warranted in charging off such indebtedness as having been properly ascertained and determined to be worthless.

The remaining portion of indebtedness due petitioner consisted of notes of the railroad company, indorsed by four individuals. The petitioner did not take necessary action in 1919 to force payment by any of the indorsers. Its ascertainment and determination of the worthlessness of the debts was limited to reports received from an Arkansas banker and a credit agency which had been employed to investigate the financial condition of two of the indorsers. The information received was to the effect that two of the indorsers, Brown and Henderson, had within two years made transfers of their property to their wives, yet there is no evidence that any efforts were made by petitioner to ascertain the value of the property so transferred, the conditions under which same were made, nor whether such transfers might not be set aside and recovery had upon the indebtedness due petitioner. That a resort to a creditor’s bill in favor of petitioner might have, in 1919, resulted in petitioner making a substantial recovery appears probable, from the fact that in 1920 petitioner realized out of the settlement made by the same indorsers about 12 per cent of the entire indebtedness due upon its notes. The amount so realized also appears to have been raised from property standing in the names of the wives of said indorsers.

The situation existing in 1919 and the facts then known by petitioner, apparently gave no good grounds for the assumption in that year that its notes were worthless — wholly uncollectible, even though they might not be collected in full from the railroad company.

The institution of receivership proceedings subsequently, indicated that petitioner and other banks holding similar claims, expected thereby to realize something on their claims, otherwise such action would not have been taken.

The Revenue Act of 1918, which permits a deduction for debts ascertained to be worthless in their entirety and charged off in the taxable year, does not include debts ascertained to be worthless only in part. Appeal of Steele Cotton Mill Co., 1 B. T. A. 299; Murchison National Bank, 1 B. T. A. 617.

The Board finds no error in the action of respondent in disallowing the deduction claimed by petitioner.

Reviewed by the Board.

Judgment will he entered for the respondent.


author: Aeundell :

text:
    Rouse, Hempstone & Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7673, 10987.
    Promulgated August 8, 1927.
    1. Petitioner took over the assets of a partnership, issuing to the partners stock for a part of the value thereof and agreeing to pay cash to the partners for their interests in excess of the value purchased for stock. Thereafter one of the partners elected to take additional stock in the amount of $98,000 in lieu of a part of the cash due him and subsequently the balance due the partners was ascertained and paid to them. Held, the amount of $98,000 paid one of the partners in stock may not be included in invested capital prior to the date of issuance of the stock. Further held that the amount due the partners was borrowed capital until the cash was paid and may not be included in invested capital prior to the date of payment.
    2. Petitioner took over the merchandise of the partnership at cost to the partnership, issuing stock therefor. Held, the petitioner may write up its opening inventory to actual value in determining cost of goods sold.
    3. Evidence does not establish that accounts written off as bad debts were ascertained to be worthless in the taxable years.
    4. Commissioner’s reduction of invested capital on accotint of taxes for prior years approved with such changes as are necessary to reflect the correct amounts of taxes for the prior years.
    5. Invested capital may not be reduced in determining the extent to which a dividend is paid from current earnings of the year by an estimated tax theoretically set aside out of such earnings pro rata over such year.

      Chester A. Owirm, Esq., for the petitioner.

      F. O. Gra/ues, Esq., for the respondent.
    These appeals are from determinations of deficiencies in income and profits taxes for the fiscal years ended November 30, 1918, 1919, and 1920, in the respective amounts of $14,430.33, $1,634.61, and $8,598.30. At the hearing petitioner abandoned its claim for special assessment for the fiscal year 1918. Of the remaining issues one relates to claimed bad debts for the years 1919 and 1920, one to the inventory value to be used in determining cost of goods sold, and the rest relate to invested capital.
    FINDINGS OF FACT.
    The petitioner is a Maryland corporation with its principal office at Baltimore. It was organized December 1, 1917, with an authorized capital stock of $1,000,000, divided into 5,000 shares of common and 5,000 shares of preferred stock of the par value of $100 per share.

      The petitioner was incorporated for the purpose of succeeding to the firm of Rouse, Hempstone & Co., which theretofore had been engaged under a series of partnership agreements in business as importers, jobbers, and vendors of hosiery, gloves, white goods, ladies’ and men’s furnishings, notions and fancy goods.
    The balance sheet of the partnership at November 30, 1917, as revised by a revenue agent was as follows:
    Assets Liabilities
    Cash_$63,788.66 Reserve for depreciation- $11,971. 66
    Accounts receivable_ 504, 861.98 Capital- 1, 050,461. 98
    Bills receivable_ 192,456. 80
    Merchandise inventory_ 232, 430.72
    Stocks_ 31, 349.43
    Furniture and fixtures_ 14,602. 54
    Trucks- 4, 094.51
    Horses and wagons_ 2,203. 21
    Automobiles_ 572.18
    Real estate_ 37. 98
    Liberty bonds_ 15, 000. 00
    Accrued interest_ 1, 035.60
    1,062, 433.61 1, 062, 433. 61
    By letter dated December 1, 1917, addressed to the board of directors of the petitioner, the members of the partnership offered to subscribe for 3,980 shares of preferred stock and 4,470 shares of common stock of the petitioner, a total of 8,450 shares of the par value of $845,000, and agreed to pay for such stock on the terms set forth in the letter as follows:
    By assigning, transferring and delivering to your corporation all the assets of the said partnership of Rouse, Hempstone and Company, of every kind, nature and description, including
    (a) all office and store furniture and fixtures, trucks, wagons, signs, and other similar property and apparatus of the business contained in building at the corner of Hopkins Place and German Street, or wherever else situated;
    (b) all merchandise of every kind belonging to said partnership, whether contained in said building, in transit, or wherever situated, said merchandise consisting chiefly of hosiery, gloves, white goods, ladies’ and gentlemen’s furnishing goods, notions and fancy goods;
    (c) all stocks, bonds, or promissory notes, or other choses in action, and all cash and moneys on deposit in banks, belonging to said partnership;
    (d) all bills and accounts receivable from any and all persons, firms or corporations, belonging to said partnership;
    (e) all the good-will, trade-marks, patents, patent rights and licenses belonging to said partnership.
    Your corporation is to assume and agrees to pay any and all liabilities of said partnership, including United States War Excess Profits Tax due from said partnership, and any other Federal or State taxes payable by it; and you are also to assume and agree to execute in due course of business, all current contracts, orders and obligations of said partnership, including assumption of leases on real estate and obligations for rent payable thereunder.
    The present net worth of the partnership assets over and above liabilities exceeds the sum of one million dollars ($1,000,000) and the present net capital interests of all the partners in said assets exceeds the following sums for said partners -respectively:
    Wm. O. Rouse_ $540,000
    John G. Rouse_ 20,000
    Edward M. Buracker- 260,000
    George W. Corner, Jr_ 80, 000
    Benjamin C. Eley, Jr_ 80,000
    Thomas J. Kelly_ 25,000
    1,005, 000
    The exact amounts by which the net capital interests of the said partners respectively exceeds the sums above mentioned cannot be exactly ascertained until the outstanding accounts are hereafter in due course collected and the Federal Excess Profits Tax determined. Your corporation is to assume and agree to pay to said partners respectively, as and when the net amounts above mentioned have been ascertained, such sums of money as, when paid to them respectively, will reduce the net shares of said several parties to the exact sums above mentioned, except that to the said Edward M. Buracker there shall be paid such sum as will reduce his net share of the capital to one hundred thousand dollars (-$100,000) ; said payments to be made to said Edward M. Buracker, and other partners, from time to time pro rata as the amounts are ascertained; so that upon final payments to all said partners, the net value of all the partnership assets (over and above all liabilities) so passing to your corporation as of December 1st, 1917, will be eight hundred and forty-five thousand dollars ($845,000).
    At a meeting of the board of directors of the petitioner the offer made by the members of the partnership was considered and the following resolution, among others, was adopted:
    And Whereas, said property mentioned and referred to in said offer is suitable for the purpose of the corporation:
    Now, Therefore, Be It Resolved, that in the judgment of the Board of Directors of Rouse, Hempstone and Company, Incorporated, it is advisable to issue three thousand nine hundred and eighty (3,980) shares of the Preferred Stock of this corporation, and four thousand four hundred and seventy (4,470) shares of the Common Stock of this corporation in payment for property suitable for the purposes of this Company, and specified in writing by Messrs. William C. Rouse, John G. Rouse, George W. Corner, Jr., Thomas J. Kelly, Benjamin C. Eley, Jr., and Edward M. Buracker, dated December 1st, 1917, said property being valued by its Board of Directors at the sum of eight hundred and forty-five thousand dollars ($845,000), and the issuance of three thousand nine hundred and eighty (3,980) shares of the Preferred Stock and four thousand four hundred and seventy (4,470) shares of the Common Stock of this Company for said property, be and it is hereby expressly authorized; and that said offer of Messrs. William C. Rouse, John G. Rouse, George W. Corner, Jr., Thomas J. Kelly, Benjamin G. Eley, Jr., and Edward M. Buracker, to subscribe for said three thousand nine hundred and eighty (3,980) shares of Preferred Stock and four thousand four hundred and seventy (4,470) shares of Common Stock of this Company, be and it is hereby accepted * * *

      On the same date, December 1, 1917, capital stock of the petitioner was issued to members of the partnership as follows:
    William O. Rouse_$460, 000
    John G. Rouse_ 100,000
    Edward M. Buracker_'_ 100,000
    George W. Corner, Jr_ 80, 000
    Benjamin C. Eley, Jr_'_ 80, 000
    Thomas J. Kelly_ 25, 000
    845, 000
    On January 11,1918, the directors of the petitioner confirmed sales of 570 shares of stock to employees and salesmen for. $57,000 cash.
    At the time of the meeting on December 1, 1917, Edward M. Buracker, one of the partners, was too ill to decide fully to what extent he desired to participate in the new corporation. Subsequently, he decided to take additional stock and at the directors meeting on January 11, 1918, the remaining unsold stock, being 735 shares of preferred and 245 shares of common, a total of 980 shares, were issued to him. For this stock of the par value of $98,000 the petitioner accepted in payment a part of Buracker’s interest in the partnership in ekcess of the amount of $100,000 in stock originally issued to him.
    On January 24,1918, the excess of the net worth of the partnership over the par value of the capital stock of the petitioner was ascertained and such excess was paid by the petitioner to the former partners as follows:
    William C. Rouse, January 24, 1918_$15, 078. 66
    George W. Corner, Jr., January 25, 1918_ 4, 948.98
    Tilomas J. Kelly, January 25, 1918_ 4, 745. 26
    Benjamin C. Eley, Jr., January 25, 1918_ 3,967.28
    Edward M. Buracker:
    March 20, 1918_$3, 029.47
    April 4, 1918_ 10, 000. 00
    April 9, 1918_57,112.11
    - 70,151.58
    Total_ 98,891.76
    The amount of $232,430.72, set forth above in the partnership balance sheet, represents the cost to the partnership of the merchandise carried in its inventory on November 30, 1917, and was entered on the books of the petitioner as its opening inventory at December 1, 1917. That value was arrived at by taking a detailed inventory of all stock on hand, and represents the value of the merchandise at the time it was invoiced to the partnership. In many cases there was an advance in price between the time the goods were invoiced and the time of their receipt by the partnership. During the year preceding petitioner’s organization, there occurred a marked increa.se in the market value of the kind of goods dealt in by the petitioner. In order to give effect to such increase in market value, the petitioner in the latter part of 1925 undertook a revision of its opening inventory of December 1, 1911, which had been taken in detail. The petitioner’s merchandise was grouped into five numbered departments and a sample department. In Department I were what was known as small wares, that is odds and ends or notions. The inventory of that department amounting to $23,752.98 and of the sample department which was $515.73 were not priced in the revision made in 1925 although the value of the goods in those departments was higher than the figure at which they were entered in the petitioner’s opening inventory. In the other four departments the merchandise was repriced in accordance with its market value at December 1, 1917. Adding the repriced inventory of the four departments and the original inventory figures for the notions and sample departments, gives an opening inventory of the market value of $286,349.72.
    In computing the cost of goods sold for the fiscal year ended November 30, 1918, the Commissioner took as the petitioner’s opening inventory the amount of $232,430.72, which, as stated above, was the cost thereof to the predecessor partnership.
    Most of the petitioner’s sales are to country merchants and small stores in cities in the southern and eastern States. In 1917 goods were sold mainly on six months’ credit and thereafter on four months’ credit. Before extending credit the petitioner secured information as to the credit standing of the customer through such agencies as Dun and Bradstreet, through local attorneys and banks or through a system of interchange of credit information with other wholesale houses. When an account had run two or three months beyond the credit period and the debtor failed to answer letters of the petitioner, or when the petitioner received advice that a receiver had been appointed or bankruptcy proceedings instituted against the debtor, the treasurer of the petitioner, who was also its credit manager, directed that such account be taken off the active books and put on a “ suspended ledger.” In many cases collections were subsequently made on the accounts written off and in such cases the amounts collected were reported as income for the year in which received.
    During the year ended November 30, 1919, the petitioner charged off as bad debts and claimed as a deduction from gross income for that year the amount of $9,309.10, of which the Commissioner allowed $4,272.29 and disallowed $5,036.81. During the fiscal year ended November 30, 1920, the petitioner charged off as bad debts and claimed as a deduction the amount .of $57,359.69, of which the Commissioner allowed $29,621.12 and disallowed $27,738.57. The amounts allowed by the Commissioner as deductions for bad debts for the years 1919 and 1920 (except for one account of $3,251.51 charged off by petitioner in 1920) were the amounts claimed by the petitioner, less collections made thereon during the period beginning December 1, 1920, and ending September 1, 1925, which collections have been reported by the petitioner as income for the years in which collected. The amount of $3,251.51 disallowed by the Commissioner as a deduction for 1920 represents an account charged off on November 30, 1920. The petitioner obtained a judgment against the debtor, but was advised by attorneys in 1925 and again in 1926 that they were unable to collect on the judgment.
    The amounts charged off by petitioner as bad debts in prior years and collected and restored to income in 1919 and 1920 were $6,356.74 and $7,622.13, respectively.
    The Commissioner reduced petitioner’s invested capital for the fiscal year ended November 30, 1919, by the amount of $92,341.91, representing the prorated portion of tax determined for the preceding year. For the fiscal year ended November 30, 1920, the Commissioner reduced petitioner’s invested capital by the entire amount of tax determined for the year 1918 and by a prorated portion of tax determined for the year 1919.
    In the computation of invested capital for the fiscal year ended November 30, 1920, the Commissioner reduced the amount of current earnings available for the payment of dividends on February 2, 1920, by a tentative tax for that year in the amount of $36,594.83, thereby finding the amount of $46,942.63 paid from surplus, which, prorated for the balance of the year, resulted in the reduction of invested capital by the amount of $38,862.34.
   OPINION.

Aeundell :

The errors alleged with respect to invested capital for the fiscal year ended November 30, 1918, are that the Commissioner failed to allow the inclusion as paid-in surplus of $98,000 for the period December 1, 1917, to January 10, 1918, and $98,891.76 for the period December 1,1917, to January 24, 1918.

The amount of $98,000 in dispute represents the par value of stock issued on January 11, 1918, to Buracker, a former partner, for a portion of his interest in the predecessor in excess of that part of the partnership assets turned in for stock. The amount of $98,891.76 here involved is the amount ascertained on January 24, 1918, as owing to the partners (in addition to Buracker’s $98,000 paid for in stock) as the value of the partnership assets in excess of the amount thereof paid in to the petitioner corporation for stock on December 1, 1917.

The gist of the entire transaction was that the petitioner agreed to pay to the partners stock of the par value of $845,000 for a portion of the assets of the partnership, and, upon ascertaining the amount by which the assets exceeded that value, to pay such excess in cash to the partners. Thereafter Buracker decided to take' $98,000 in stock for a part of the excess due him. Subsequently the balance due in cash to the partners was ascertained and paid to them. Buracker’s $98,000 was properly an item of invested capital from the time stock was issued on January 11, 1918, and was so allowed by the Commissioner. As to that item for the period prior to the date of issuance of stock and as to the item of $98,891.76 for any period, we can not see that they belong in invested capital. They were sums borrowed from the stockholders for the time being under a definite obligation to repay them and as such they constituted borrowed capital, which, under both the Revenue Acts of 1917 and 1918 is specifically excluded from invested capital.

The second question for the fiscal year ended November 30, 1918, is whether the petitioner in determining the cost of goods sold is entitled to write up its opening inventory from its cost to the predecessor to market value at December 1,1917. The petitioner’s opening inventory was the same as the partnership’s closing inventory, which was taken at cost of the goods to the partnership. The actual value at December 1, 1917, was considerably higher than cost. The petitioner seeks approval of the use of the higher amount which it determined in 1925 by ascertaining the actual December 1, 1917, value of a great number of items in each of four departments, applying the percentage of increase thus determined to the entire department, and adding to the sum thus obtained the cost to the partnership of the items in the two departments which were not repriced. The value of the merchandise in the two departments not repriced was less than 10 per cent of the total merchandise value and the value of those two departments had likewise increased to a figure above that at which carried on the partnership books. In many cases it was possible to ascertain the actual December 1, 1917, value by correspondence with the manufacturers of the merchandise, and in other instances the value of merchandise at that date was shown by the books of petitioner’s buyers, to which reference was made in the repricing process.

We are convinced from the evidence that the petitioner’s merchandise inventory at December 1, 1917, had a market value of at least $286,349.72. As the inventory, among other assets, was purchased for stock, that amount then becomes the cost of the merchandise to the petitioner, for, where goods are purchased for stock, in the absence of evidence of the market value of the stock, it is deemed equivalent in value to the property for which it was issued. Appeal of William Ziegler, Jr., 1 B. T. A. 186. The claim of the petitioner in respect of its inventory is the same as that made in Appeal of Munising Motor Co., 1 B. T. A. 286. We disallowed the claim of the taxpayer in that case for lack of evidence to prove that the actual value was the amount contended for, but on the question of law we held as follows:

The Board is of the opinion that the taxpayer had the legal right to use the actual proved cash value of the merchandise purchased by it from its predecessor as a proper inventory entry in its accounting and in computing the cost of merchandise sold by it in the business operations of its first taxable year.

We need not go so far in the present case, for there can be no question that the petitioner may value its opening inventory at cost and the cost we have found to be $286,349.72, which should be used in determining cost of goods sold for the first fiscal year.

The petitioner has failed to establish that the amounts charged in 1919 and 1920 as bad debts and disallowed by the respondent were ascertained to be worthless in those years. It was the practice of the petitioner to write off accounts which had run two or three months beyond the period for which credit had been extended or when word was received that the debtor was involved in bankruptcy or receivership proceedings. As set forth in the findings of fact, the Commissioner has allowed as deductions the amounts claimed by the petitioner, less amounts subsequently collected, except for one item of $3,251.51 charged off in 1920. The petitioner has not shown upon what facts it bases its claim that the accounts disallowed by the Commissioner were ascertained to be worthless in the years in which it charged them off. A good portion of the total allowed by the Commissioner is made up of the accounts in which the debtors were in bankruptcy or involved in receivership proceedings. In the cases of accounts disallowed, in which detailed evidence was given, it appears that the accounts were charged off at the close of the fiscal year in which the goods were sold and thereafter collections were made, in some cases within a few days after the close of the year, and in others within a month or two. In the case of the one item of $3,251.51 charged off in 1920, the only evidence offered was the advice received from attorneys in 1925 and 1926 that they were unable to collect on the judgment which had been obtained against the debtor- Such methods of charging off accounts may be commendable from the standpoint of valuing receivables conservatively in the balance sheet, but they do not establish the worthlessness of the debts.

Error is alleged against the Commissioner in reducing petitioner’s invested capital for the fiscal year ended November 30, 1919, by a prorated portion of the tax determined for the previous year. The method used by the Commissioner was correct, section 1207, Revenue Act of 1926; Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168; but adjustment should be made in the tax for 1918 by allowing the inventory value claimed by the petitioner in determining cost of goods sold. A like error is alleged with respect to the fiscal year ended November 30, 1920. This issue is governed by the same ruling as that applied to the fiscal year 1919; that is, the respondent is correct in principle, and only the amount of tax prorated requires revision.

The petitioner complains further against the Commissioner’s reduction of invested capital for the year ended November 30, 1920, on account of taxes for the year ended November 30, 1918. One of the arguments of the petitioner is that the alleged “ taxes ” for 1918 are not taxes at all because they have never been determined to be such. The amount determined by the Commissioner to be due for any year is the tax for such year, unless contrary to the statute. The other ground advanced by the petitioner is that section 1207 of the Revenue Act of 1926 relates in terms only to taxes “ for the preceding year,” and hence does not allow the exclusion from invested capital for any year of tax for other than the immediately preceding year. The regulations of the Commissioner which were validated by section 1207 use the same language and refer only to taxes “ for the preceding year.” Article 845, Regulations 45. However, the reasoning applies to the due and unpaid taxes for all prior years, and the Commissioner’s action is, in our opinion, correct.

A reduction of the income therefor will necessarily result in a reduction of surplus which will be reflected in invested capital. The invested capital as thus reduced remains throughout subsequent years and can be increased only by adding thereto such items as are allowed by statute. We have had several cases before us in which the Commissioner has reduced invested capital for the taxable year on account of unpaid taxes for more than one preceding year, and, though we did not rule in specific words on the question as raised here, we held that such reduction of invested capital was proper. E. B. Crabtree Co. v. Commissioner, 5 B. T. A. 732, and cases there cited.

The final issue is whether the Commissioner erred in the computation of invested capital for the fiscal year ended November 30, 1920, by reducing current earnings available for the payment of a dividend on February 2, 1920, by a tentative tax for that year. On this issue we must sustain the petitioner. Appeal of L. S. Ayers & Co., 1 B. T. A. 1135.

Reviewed by the Board. .

Judgment will be entered on 15 days’ notice, v/nder Rule 50.


author: Marquette :

text:
    Concord Electric Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4355.
    Promulgated August 8, 1927.
    1. Under the circumstances herein, certain payments made by petitioner held, to constitute ordinary and necessary business expenses.
    2. Where interest upon payments is payable upon a certain date, contingent upon a contract not being terminated before that date, it is not a proper deduction from gross income over the years when payments were made upon the contract, .but becomes a liability when the obligation to pay interest is fixed.

      W. P. Wormhoudt, Esq., for the petitioner.

      Joseph K. Moyer, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income and profits taxes for the years 1918, 1919,1920, and 1921, in the amounts of $178.37, $423.22, $152.57, and $271.43, respectively. The deficiency letter states that there are overassessments for the fiscal year ended June 30, 1917, and the six-month period ended December 31, 1917, and the petition alleges that the taxes for that year and part of year are also in controversy.
    FINDINGS of fact.
    The petitioner is a New Hampshire corporation with its principal office at Concord, N. H. It is and was during the years 1916 -to 1921, inclusive, engaged as a public utility, supplying electricity to the City of Concord. Its electric current is and was generated at its hydroelectric plant and auxiliary steam station at Sewall’s Falls, and transmitted to a substation at Concord, a distance of about five miles. The Manchester Traction Light & Power Co., hereinafter called the Manchester Company, is and was during the years mentioned, also a public utility operating in Manchester, N. H. It owns and owned in the years 1916 to 1921, inclusive, several hydroelectric plants, including a plant known as Garvin’s Falls Station, in Bow, 1ST. H., adjoining Concord on the south.
    Prior to July 27,1916, the petitioner and the Manchester Company had at various times surplus electric current which they furnished to each other. The ability of each company to furnish electric current to the other was subject to the increasing requirements of the regular business of both companies and this fact made it necessary that each company should have the right to terminate any contract entered into with the other company whenever the demands of its business should render such action necessary or advisable. Under these circumstances the petitioner and the Manchester Company on July 27,1916, entered into the following written contract:
    This Agreement, by and between tbe Manchester Traction, Light and Power Company, a corporation duly established by law and having its principal place of business in the City of Manchester, County of Hillsborough, State of New Hampshire, party of the first part, hereinafter referred to as the Manchester Company, and the Concord Company, a corporation duly established by law and having its principal place of business in the City of Concord, County of Merrimack, State of New Hampshire, party of the second part, hereinafter referred to as the Concord Company,
    "Witnesseth : that whereas both parties hereto are engaged in the generation and distribution of electric energy and whereas each party has at time surplus power which it desires to sell to the other party,
    Now, Therefore, said parties hereto, each for itself, its successors and assigns, covenant and agree together as follows:—
    The term of this contract shall be for three (3) years from January 1, 1917, and thereafter until the same shall be terminated by one year’s written notice by either party to the other% Such notice may be given by either party at the expiration of the second year so that the entire term shall be three years from the date of execution.
    Bach party hereto agrees, at such times as it has surplus water generated electric energy which it desires to sell to the other party upon the terms set forth in this contract, and said party desires to purchase said energy on said terms, to sell such surplus water generated electric energy to said other party at the rate of one-half cent ($0,005) per kilowatt hour.
    Whenever the Manchester Company has not sufficient surplus water generated electric energy to supply the needs of the Concord Company, it agrees to sell steam generated electric energy to the Concord Company, if the Concord Company so requests, at the rate of one and three-eighths cents (1%0) per kilowatt hour, if and when the Manchesíer Company shall be producing at any or all of its steam plants steam generated electric energy for its own customers. However, if said Concord Company shall request steam generated electric energy when the Manchester Company shall not be producing at its steam plants steam generated electric energy for its own customers, then the price to be paid by the Concord Company shall be the cost of producing such electric energy, plus ten (10) per cent, but not in any case to be less than one and three eighths cents per kilowatt hour.
    The Concord Company agrees to purchase of the Manchester Company all the steam generated electric energy which it may require so long as the Manchester Company is able to furnish the same, provided, however, that the Concord' Company may at its option, use its own steam equipment if the Manchester Company is not at the time operating its steam plants for its own customers. The Manchester Company agrees, that, during the term of this contract it will furnish all the steam generated electric energy required by the Concord Company not exceeding 2000 K. W. in capacity measured at its Gar-vin’s Balls power station.
    Each party hereto agrees to pay to the other party on or before the 6th day of each month in arrears for the preceding month for such electric energy as it may have purchased under this agreement from the other party during the said preceding month.
    The frequency voltage and character of the electric energy furnished under this agreement by either party shall be three (3) phase and approximately thirty-five thousand (35,000) volts, sixty (60) cycle, at the Garvin Falls Power House.
    The Concord Company agrees, at its own expense, to modify the present transmission line switching and protective devices, etc., at its station in Concord and also at the Manchester Company’s station at Garvins Falls, so that they shall be suitable for the voltage at the Garvins Falls bus bars, and so that the plants of the two companies shall at all times operate properly in parallel and that it will so maintain the same during the term of this agreement. The switching, protective devices and other apparatus installed at the Manchester Company’s Garvin’s Falls Station by the Concord Company, shall be of General Electric Company’s make, uniform in material and arrangement with that now being installed, and shall be subject to the approval of the Manchester Company. The Manchester Company shall operate and care for said apparatus in the same manner as its own similar apparatus in said sub-station, without expense to the Concord Company. The Manchester Company shall supply all labor, superintendence and materials required for repairing, replacing or renewing said apparatus or any part thereof, and the Concord Company shall pay the bills therefor promptly upon presentation. The Concord Company shall have access to said sub-station by its representatives at all reasonable times for the purpose of inspecting its apparatus therein, but shall not interfere with the operation thereof.
    The Manchester Company agrees to extend the present substation building at its southerly and a distance of about fourteen (14) feet to accommodate the current and potential transformers and switching devices to be installed by the Concord Company, the cost of said extension to be paid by the Concord Company in four (4) equal annual payments as follows:

      % on January 1, 1917.
    % on January 1, 1918.
    % on January 1, 1919.

      % on January 1, 1920.
    The interest on the above payments at the rate of seven per cent, (7%) per annum on January 1, 1921.
    Provided, however, that if the contract is terminated by the Manchester Company before the above payments have been made, then no further payments shall be required of the Concord Company on account of the cost of said extension beyond the date of the expiration of said contract.
    It is mutually agreed that the Concord Company shall acquire no ownership in the extension of said building on account of the above payments. If the contract is terminated by the Concord Company at the expiration of three (3) years, or any time thereafter, before the full payment covering the cost of the extension of the building and interest thereon at seven (7) per cent has been made, then the balance due with interest shall become due and payable to the Manchester Company.
    All electric energy bought or sold under this contract shall be measured as it enters or leaves the bus bars of the Manchester Company in said Garvin’s Falls power house and such instruments as may be required for this purpose shall be furnished by the Manchester Company, except that all high tension current and potential transformers shall be furnished by the Concord Company. All meters and indicating instruments located at the Garvin’s Falls Station and belonging to the Concord Company may be used in the new installation so far as possible. The indication of these instruments shall be used as a basis in computing monthly payments.

      Either party furnishing water generated electric energy to the other under this agreement shall have the right to interrupt the supply without notice, but shall endeavor to give notice to the other party whenever possible.
    Neither party shall be liable to the other party for any loss or damage occasioned such other party by or in connection with the interchange of electric energy under this contract, or caused by or to the apparatus installed therefor or occasioned in any way by the use of the same. The Manchester Company shall not be liable in damages for failure to furnish steam generated electric energy to the Concord Company under the terms of this contract, if it shall diligently employ all the available steam capacity, owned or controlled by it, for such purpose, after supplying by steam power the demands of its other customers which it is unable to supply from its available water power plants.
    Each party hereto to indemnify and save harmless the other party from any loss or damage arising from any liability of the latter for injury to the person or property of third parties by reason of the maintenance or use of the wires, circuits, fixtures, or other apparatus owned by the former, or by or on account of the electric current flowing therein; meaning that each party shall be ultimately responsible for the liability to third parties for the damages occasioned by the maintenance and use of its own property, whether its own electric current is being used thereon or not; provided, however, that for the purposes of this paragraph the wires, fixtures, and other apparatus owned by the Concord Company inside of the Garvins Falls substation of the Manchester Company shall be regarded as owned by the Manchester Company so long as the same are operated and cared for by it, so that the Manchester Company shall be responsible for any liability to third parties occasioned by the maintenance and use thereof.
    The Manchester Company hereby grants to the Concord Company during the life of this agreement permission to erect and maintain in such locations on the land of the Manchester Company as are mutually agreed upon, the poles and fixtures of the Concord Company, constituting a. part of the transmission line required by said agreement, and to remove any growth and trim any trees which may interfere with said line or the operation thereof, upon the following conditions:
    The said poles and fixtures, together with the manner of their erection and maintenance, shall at all times be satisfactory to the Manchester Company, and shall not in any way interfere with its lines, machinery or other apparatus.
    In case the Manchester Company shall desire that the location of any part of said transmission line over its land be moved to some other suitable location on its land on account of the sale of land, the development or improvement of the property or other reasonable cause, the Concord Company agrees, at its own expense, to move the said line as the Manchester Company may require.
    On the expiration or other termination of this contract the Concord Company shall have the right to remove its poles, fixtures, and other apparatus used in connection with said line, including the apparatus owned by it in the Garvins Falls substation, but in so doing shall cause no unnecessary inconvenience to the operation of the plant, or damage to the land, buildings, or other property of the Manchester Company.
    Agreement dated May 13, 1911, between the parties hereto for the purchase and sale of surplus power is hereby abrogated.

      The Manchester Company expended the amount of $7,526.18 for the extension of its substation at Garvin’s Falls in order to accommodate the current and potential transformers and switching devices to be installed by the petitioner as provided in the contract of July 27, 1916, and pursuant to that contract one-fourth of the amount so expended, namely, $1,881.54 was billed to and paid by the petitioner each year. The petitioner also paid $188.16 for the services of engineers employed for the purpose of facilitating the construction work. These payments were made by the petitioner as follows:
    During the six-month period ending December 31, 1917_$2,069. 70

    During the year 1918_ 1, 881. 54
    During the year 1919_ 1, 881. 54
    During the year 1920_ 1, 881. 54
    Total payments_ 7, 714.34
    During the year 1921 the petitioner also made the final payment provided by the contract of July 27, 1916, as “the interest on the above payments at the rate of 7 per cent per annum on January 1, 1921,” amounting to $1,317.08. The amounts above set forth were, when paid by it, charged to expense on its books of account and were deducted from gross income on its income and profits-tax return as business expenses for the years in which they were paid. The petitioner’s books were kept on the accrual basis.
    Upon audit of the petitioner’s return for the years mentioned the respondent disallowed as deductions from gross income the amounts paid by it to the Manchester Company on account of the extension of the substation at Garvins Falls, on the ground that they were capital expenditures and should be capitalized, and he also disallowed as a deduction from gross income for the year 1921, the interest payment of $1,317.08 on the ground that the interest accrued during the years in which the indebtedness existed, and that it should be allocated ana taken as deductions in those years.

       Including $188.16 paid to outside engineers.

   OPINION.

Marquette :

The petitioner alleges that its tax liability for the fiscal year ended June 30, 1917, and its tax liability for the six-month period ended December 31,1917, are in controversy, as well as its tax liability for the years 1918, 1919, 1920, and 1921. However, the deficiency letter shows that the respondent has determined over-assessments for the fiscal year ended June 30,1917, and the six-month period ended December 31, 1917, which do not arise from the disal-lowance or partial disallowance of a claim for abatement. We therefore have no jurisdiction to hear and determine this proceeding in so far as it relates to the fiscal year and the six-month period. Appeal of R. P. Hazzard Co., 4 B. T. A. 150; Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

The next question presented is whether the payments made by the petitioner to the Manchester Company in the years 1918, 1919, and 1920, under the circumstances set forth in the findings of fact, were capital expenditures or ordinary and necessary business expenses. We have carefully considered the contract which gave rise to these payments and we are unable to see any reason for considering that they constituted capital expenditures. Capital expenditures result in the acquisition of capital assets, but in this case the contracts specifically provide that the petitioner “shall acquire no ownership in the extension of said buildings on account of the above payments.” We are of the opinion that the payments in question constituted ordinary and necessary business expenses of the petitioner which are deductible in computing its net income for the years in which the obligations accrued.

The last question is whether the amount of $1,311.08, paid by the petitioner to the Manchester Company on January 1,1921, as interest on the payments heretofore mentioned, is deductible in the year 1921 or should be allocated to the years in which the payments were made. The contract between the petitioner and the Manchester Company provided that the several payments should be made on January 1, 1917, January 1, 1918, January 1, 1919, and January 1, 1920, and that interest thereon at the rate of 7 per cent should be paid on January 1, 1921. The contract also provided that if it was terminated by the Manchester Company before the payments, including interest payment, had been made, no further payments would be required from the petitioner. The contract was to run at least three years from January 1,1917, but either party could terminate the contract on January 1, 1920, by giving one year’s notice of its intention so to do. The petitioner was not obligated to pay any interest until four years from the date of the contract, and if the contract was terminated by the Manchester Company before that date, no interest was due from the petitioner. The interest was payable on January 1, 1921, contingent upon the contract not being terminated before that date, and we are of the opinion that under the circumstances it constituted a proper accrual for the year 1921, and that the amount thereof is deductible from the petitioner’s income for that year.

Reviewed by the Board.

Judgment mil T>e entered on 15 days’ notice, wnder Rule 50.


author: Smith :

text:
    James D. Williamson and Frank B. Carpenter, Executors and Trustees, Estate of Emma D. Freeman, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8003.
    Promulgated August 8, 1927.
    The claim of the petitioners that, under the provisions of the decedent’s will, all of the income of an estate was payable to two income-tax-exempt charitable corporations as residuary legatees held not proven by the evidence submitted.

      E. A. Mihills, O. P. A., for the petitioners.

      D. D. Shepard, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income tax for the year 1921 in the amount of $885.02. The error alleged on the part of the Commissioner is that he refused to exempt the income of the estate from income taxation.
    BINDINGS OB BAOT.
    Emma D. Freeman, a resident of the State of Ohio, died at Cleveland, Ohio, on December 28, 1919. Her will was probated January 5, 1920, and letters testamentary were issued to James D. Williamson and Frank B. Carpenter as executors upon the same date, and letters of trusteeship were issued to them on January 16, 1920. A certified copy of the will of Emma D. Freeman reads in part as follows:
    Item Twenty-Five. I give and bequeath to the Welfare Federation of Cleveland, Ohio, or to Its Successors in like or similar work, the sum of Fifty Thousand Dollars. It is my will that the income of said sum shall be paid annually as said Welfare Federation shall deem most helpful to the institutions or Organizations hereinafter named in this item of my Will or as hereinafter in this Item provided and in such proportions to each of said Institutions as said Federation shall in the exercise of its best judgment deem wise. In determining such annual distributions the officers, Trustees or Board of Directors of said Federation shall give careful consideration thereto and shall pass upon such distribution. The Institutions to be aided under this provision of my Will are hereinafter enumerated, to-wit: and are all institutions of the City of Cleveland, Ohio.
    * % * * * * *
    If in the best judgment of the officers and trustees of said Welfare Federation some of the income of said bequest should be used for the help of charitable organizations other than those enumerated above; it is hereby given full power and authority to make such other or further distribution of the income as it concludes to be wise and most helpful. In determining such questions however, I ask the officers of said Federation to consider that I am especially interested in the care and help of poor children.
    The fact that any organization may not be incorporated shall not be a bar to its receiving help under this item of my Will.
    Item Twenty-Six. It is my Will that my Executors and Trustees hereinafter named shall pay the annuities provided in this item of my Will, in the amounts, to the persons, and upon the conditions herein stated, and only upon such conditions.
    Such annuities shall be paid annually during the natural life of each annuitant and beginning one year after the date of the probate of my Will. The persons who are to receive said annuities are as follows, and to amounts to be paid are those set after their respective names:
    To Edward E. Gilbert, the sum of two hundred dollars per annum.
    To Mrs. It. M. Lowry, the sum of two hundred dollars per annum.
    The present addresses of the two annuitants last above named are either Lancaster, New York or Lyons, New York.
    To Mrs. Lou Gilbert Shepherd of Lyons, New York, the sum of two hundred dollars per annum.
    ijc # >>i # * * *
    Item Twenty-nine. It is my will that five years after the probate of this my Will, there shall be paid by my Executors to each of the individual persons who are legatees hereinbefore named in any of the foregoing items of my Will who are related by blood to me, if then living, and if not, to their respective heirs, an amount equal in each case to the legacy first hereinbefore provided to be paid to each of them. The further distribution provided in this item of my Will is not intended, however, to increase or repeat any of the annuities herein-before provided, and has no connection with them.
    Item Thirty. It is my Will that ten years after the probate of this, my Will, there shall further be paid by my Executors to each of the individual persons who are legatees hereinbefore named in any of the foregoing items of my Will who are related by blood to me, if then living, and if not, to their respective heirs, an amount equal in each case to the legacy first hereinbefore provided to be paid to each of them. The further distribution provided in this item of my Will is not intended however, to increase or repeat any of the annuities hereinbefore provided and has no connection with them.
    The distribution and payments provided to be made under this item of my Will and also under the preceding Item number twenty-nine hereof, are not intended to repeat or increase in any way the bequests to Institutions, as provided in this my Will. The additional distributions of such items are only to be made to individual persons related by blood to me.
    $ # ^ * $ # $
    Item Thirty-two. All the rest, residue and remainder of my estate, both real and personal, wherever situated, I give, devise and bequeath to my Executors and Trustees hereinafter named, in trust, however, for the following uses and purposes, and as hereinafter stated. And in case of the trusts herein confided to my Executors and Trustees cease from any cause whatever, then I give, devise and bequeath the same to their successors in this trust, to be used, controlled, invested and disposed of as hereinafter provided: hereby giving my Executors and Trustees herein named, and to their successors in the trust hereby created, full, ample, and complete power and authority to sell, convey, manage, direct, control, rent or improve the same, and every part thereof, as well as the proceeds from the income therefrom according to their own judgment and discretion * * *.
    I also hereby authorize and empower my Executors and Trustees herein named, and their successors in this trust to dispose of, whenever they deem it for the best interest of my estate so to do, any and all my personal property * * * and to invest * * * in such manner and in such property as they deem best, the proceeds arising therefrom * * *. It being my purpose and intention to empower and invest my Executors and Trustees herein named, and their successors with full power to manage and control as herein expressed my entire estate, according to their best judgment and discretion, th'e same as I could do, if living.
    # # * ❖ * * #
    Item Thirty-three. Ten years after the probate of my Will, my Executors and Trustees shall make further and partial distribution of my estate in thft following manner, to-wit:
    They shall retain the sum of Eifty Thousand Dollars, and as Trustees of “The George Freeman Charity Fund” to which Trusteeship they are hereby appointed, they shall expend annually the net income from said sum of Fifty Thousand Dollars, for the benefit of the poor children of the City of Cleveland, Ohio, in such manner, as in the exercise of their best judgment, or the best judgment of the survivor, seems most useful and desirable. Said trust shall be known as “ The George Freeman Charity Fund ”, and same is created in loving memory of my late husband. Said trust shall be administered as aforesaid by the said James D. Williamson and Frank B. Carpenter, or the survivor of them, as long as they or either of them shall live, and be able to serve as such Trustees. They or either of thejn, upon the death or inability of the other to serve shall have the same full and complete power and authority over said trust fund * * *.
    Upon the death or inability to serve of both said Trustees, said trust fund, and any accumulations thereof shall be paid over to and transferred to The Cleveland Trust Company of Cleveland, Ohio, which shall thereafter administer said trust.
    I direct that the entire net income derived from said fund or trust estate with its accumulations, if any, shall be annually expended or appropriated perpetually, until the principal may have been disbursed for charitable uses and purposes set forth in a resolution adopted by the Board of Directors of The Cleveland Trust Company on the second day of January, 1914, providing for a community charitable trust designated in said resolution as the “ Cleveland Foundation.” I further direct that said trust estate or fund, after the death of James D. Williamson and Frank B. Carpenter, both principal and income shall thereafter vest in The Cleveland Trust Company and be managed, controlled, administered and disbursed in all respects as provided in said resolution.
    Item Thirty-four. All the rest, residue and remainder of my estate, both real and personal wherever situated, except the sum of One Hundred Thousand Dollars, I give, devise and bequeath as follows:
    One-half thereof to The Cleveland Chapter of the Bed Cross, for its appropriate uses and purposes, preferably for hospital work, and the remaining one-half thereof to the Welfare Federation of Cleveland, Ohio, for its appropriate uses and purposes. But said bequests shall not be paid by my Executors to said The Cleveland Chapter of the Bed Cross and the said Welfare Federation of Cleveland until ten years after the date of the probate of my Will, at which time such payment shall be made.
    Item Thirty-five. If for any reason the foregoing bequests to institutions or any of them shall fail or become void, then the amount thereof shall be distributed at the times, and in the manner provided by the statutes of descent and distribution of the State of Ohio, without any restrictions thereon, express or implied by virtue of this my Will.
    Item Thirty-six. The sum of One hundred thousand dollars hereinbefore reserved, after making distribution as provided in Item Thirty-four shall be held in trust, by my Executors and Trustees for the following uses and purposes, for the term of twenty-one years after my decease.

      My said Executors and Trustees shall pay one-half of the net income thereof to my nephew, George E. Eellows, or his heirs during said period of twenty-one years, and the remaining one-half of said net income to my nephew, Frank L. Fellows, or his heirs during said period of twenty-one years. Such payments to my said nephews of such net income shall be in quarterly instal-ments or otherwise, as my Executors may think best. It is my wish that said income so distrtibuted shall be used for the education of the families of my said nephews or other .useful purposes.
    My Executors are further authorized and empowered to pay from the principal sum of which my nephews or their heirs are to derive the income, such other sums as from time to time they may deem necessary or desirable to meet any emergencies which may arise causing a real need for extra money by my said nephews, or, after their death, by their heirs. Any such payments shall, if made at all from the principal, be at such times and under such conditions as my Executors and Trustees deem wise. All matters relating to such payments, I leave to the good judgment and discretion of my Executors and Trustees, and their successors to do or not to do as they deem best under all the circumstances. Any receipts of said nephews or either of them„ or their heirs, after their death for any payments made to them, shall be good and valid vouchers to my Executors and Trustees or their successors for the amount so paid to them in the final settlement of my estate.
    Item Thirty-seven. Twenty-one years after my decease, I give, devise and bequeath one-half of the amount of said Trust Fund of One Hundred Thousand Dollars, then remaining in the hands of my Executors and Trustees to my nephew, George F. Fellows and his heirs, and one-half thereof to my nephew, Frank L. Fellows, and his heirs.
    A committee of three was appointed by the Probate Court of Cuyahoga County, Ohio, to appraise the assets of the Estate of Emma D. Freeman for probate court purposes as at December 28, 1919, the date of her death. This committee consisted of the private secretary to Frank B. Carpenter and two bankers of the City of Cleveland. They inventoried the assets of the estate and valued them as follows:
    Stocks and bonds-$741, 846.85
    Personal effects_ 2, 022. 50
    Gash in bank- 9, 893.12
    Total value of estate_ 753, 762.47
    The value of stocks and bonds was taken from published sales of securities listed on the New York Stock Exchange, New York Curb, Cleveland Stock Exchange and Chicago Stock Exchange, and those securities which were not listed on any of these exchanges were appraised by the two bankers, who were members of the appraisal committee. This valuation was used for both probate court and Federal estate-tax purposes.
    The will provides for the payment of specific legacies amounting to $212,719, payable as follows: $149,719 immediately; $31,500 five years after probate, and $31,500 ten years after probate. It also provides for the payment of certain annuities, the prospective total amount payable from January 1, 1921, to .the annuitants, based on expectancy tables, being $118,237, as shown below:

    With respect to “ The George Freeman Charity Fund ” and the residuary estate, there was no segregation of either corpus or income of the estate, nor were any accounts set up on the books of the estate relative thereto. The $100,000 bequest to the “Fellows Trust Fund ” was set up separately on the books of account of the estate some time during the year 1921. An account was opened in the name of each of the legatees who were to receive immediate legacies and in the name of each of the annuitants, but only the amounts paid to the annuitants were entered in their accounts.
    The total amount of specific legacies, including the two trust funds and the prospective amount payable as annuities, provided for in the will is $480,956. After the settlement of estate debts and expenses, losses on realization of securities and other minor adjustments of the accounts of the estate, there remained at December 31, 1926, $386,327.08 of the corpus of $753,762.47 which existed at December 28,1919.
    The book value of the assets of the estate as at December 31, 1920, and December 31, 1921, was $749,375.01 and $533,694.18, respectively. The book value of the assets of the estate as at December 31, 1926, was $593,141.33 and the market value thereof as at January 20, 1927, as determined from quotations of the New York Stock Exchange, New York Curb, Cleveland Stock Exchange and local investment houses, was $693,990.76. The following statements taken from the books of the estate show the condition of the estate as at December 31, for the years 1920, 1921, and 1926:

      December 31, 1920.

      December SI, 1921.

      December 31, 1926.

    The Cleveland chapter of the American Ked Cross and the Welfare Federation of Cleveland were specific legatees under the will, as well as residuary legatees, and payments on account of the specific legacies were made to each of them during the year 1921.
   OPINION.

Smith :

The issue in this appeal is whether or not the estate of Emma D. Freeman is liable to income taxation on its net income for the year 1921.

The position of the petitioners with respect to the question before us is that the total amount of legacies, both immediate and future, as provided in the will of Emma D. Freeman, was less than the amount of corpus at the date of her death, and that, under the provisions of her will, all of the residue of her estate, both corpus and income, was payable in equal portions to the Cleveland chapter of the American Red Cross and the Welfare Federation of Cleveland, a trust having been created under which payment was to be made to the residuary legatees ten years from date of probate of the will, which was on January 5, 1920.

The petitioners contend (1) that since the amounts payable out of the corpus of the estate necessary to pay the specific legacies and the annuities (based upon recognized expectancy tables), and to establish the two trust funds of $50,000 and $100,000 are, in the aggregate, less than the amount of corpus at the date of death, all the income of the estate becomes part of the residuum payable ten years from the date of probating the will to two charitable organizations as residuary legatees; (2) that each of the residuary legatees is an organization exempt from income taxation; and (3) that, therefore, the income of the estate for the year 1921 was not subject to income tax.

The respondent admits that the American Red Cross is an organization exempt from income taxation and that the Welfare Federation of Cleveland is a corporation apparently engaged in social welfare work, but denies in his answer that the latter organization is exempt from income taxation. He contends that the income of the estate was not “ paid or permanently set aside ” within the meaning of section 219 (b) of the Revenue Act of 1921, and that such income is taxable to the estate as to a single individual.

The trust created under item 32 of the will is not a corporation or a community chest, fund or foundation. Neither is it an association. It is an ordinary trust and as such trust does not fall within the following provisions of section 231 of the Revenue Act of 1921:

Seo. 231. That the following organizations shall be exempt from taxation nncler this title—
*******
(6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual.

Consequently, if the income of the estate is exempt from taxation such exemption will be pursuant to the provisions of section 219 of the Revenue Act of 1921, which are, in part, as follows:

Seo. 219. (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including—
(1) Income received by estates of deceased persons during the period of administration or settlement of the estate;
(2) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests;
(3) Income held for future distribution under the terms of the will or trust; and
(4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals, and the income collected by a guardian of an infant to be held or distributed as the court may direct.
(b) The fiduciary shall be responsible for making the return of income for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, except that (in lieu of the deduction authorized by paragraph (11) of subdivision (a) of section 214) there shall also be allowed as a deduction, without limitation, any part of the gross income which, pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in paragraph (11) of subdivision (a) of section 214. * * *

The pertinent provisions of section 214 of the Revenue Act of 1921 are;

Sec. 214. (a) That in computing net income there shall be allowed as deductions :
*******
(11) Contributions or gifts made within' the taxable year to or for the use of: * * * any corporation, or community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, * * * no part of the net earnings of which inures to the benefit of any private stockholder or individual; * * *

The Welfare Federation of Cleveland was incorporated, not for profit, under the laws of Ohio on January 13, 1917. It is a central planning body composed of over 100 charitable and social welfare agencies of the City of Cleveland, the majority of which receive support through it from the Cleveland Community Fund. It has no stockholders, the corporate body being the general board, which is composed of two representatives from each member agency. The powers, business and property of the Federation are exercised, conducted and controlled by the board of trustees, the members of which are elected by the general board. Its activities comprise the planning and correlating of the work done by the various member agencies and the budgeting of the income of the agencies and the annual appropriations made to them by the Cleveland Community Fund. Certain services which are common to all agencies such as publicity, accounting and bookkeeping, mimeographing, housing, etc., are centralized in the Welfare Federation.

It is authorized by its charter to receive and hold funds or real property, in trust or otherwise, whether given by will, gift, or otherwise, and to distribute the same among such organizations as may be deemed best, or to make such other use thereof or engage in such other activities as may be deemed in the general interest of charity and education in Cleveland and its vicinity. The regulations of the Welfare Federation provide that only such organizations shall be considered eligible to financially participating membership as are justified in making an appeal for funds to the general public and not merely to a restricted constituency of support limited to religious, denominational or other special affiliations. No organization is admitted to membership unless it can demonstrate that it fills a need not already well filled or capable of being thus filled by an existing agency. Propaganda organizations in the field of controversial questions and organizations which recommend in favor of or against the election of individual candidates to political office are not admitted to membership.

In our opinion the Welfare Federation of Cleveland is exempt from taxation under the above quoted provisions of section 231 of the Revenue Act of 1921.

The only remaining question involved is whether the income received by the estate was paid or permanently set aside for charitable purposes within the meaning of the Act. Counsel for the respond-, ent argued that no part of the income of the estate was paid or credited to the residuary legateesthat the date of payment of the residuum is uncertain and in the future; that the corpus and accumulations may be depleted to such an extent that there is nothing left to distribute or to pay over to the exempt corporations; and that the income could not be appropriated and dedicated finally and for all time to charitable uses, as specified in section 214 (a) (11), so that thereafter there will be no change which would destroy the character of such action because such action could not be taken for a number of years and because contingencies resulting from other items of the will might divert the accumulated income and the corpus from the residuary legatees.

Counsel for the petitioners argued that since the corpus of the estate at the time of the death of the testatrix was greatly in excess of the aggregate amount of legacies provided for in the will, the entire income of the estate passed to the residuum and as such became payable to the two designated charities ten years after th'e will was probated. In support of his argument he shows that the will provided for the payment of specific legacies, annuities, and the establishment of two trust funds aggregating $480,956, leaving a residuum of $272,806.41, based on a valuation of the corpus of the estate as of date of death of $753,762.47, said valuation having been used both for probate court and Federal estate-tax purposes. Corroborative evidence was presented showing that the earnings of the estate for each year subsequent to the date of death were more than sufficient to pay expenses of administration and that on Decembei 31, 1926, the book value of the corpus was $386,327.08, subject to the payment of legacies, annuities and the establishment of the $50,000 trust fund aggregating $174,337, leaving a book value of the remaining corpus alone amounting to $211,990.08. The book value of the residuum, including corpus and income, as at December 31, 1926, was $408,804.33 and the market value thereof as at January 20, 1927, was $519,653.76.

We are not convinced, however, that all of the income of the estate became part of the residuum in view of the provisions of items 34 and 36 of the will. Under those items, a trust with a principal of $100,000 was created immediately which was to exist for twenty-one years after the death of the testatrix. The income of said trust was to be divided equally between two nephews of the decedent and was to be distributed to them in quarterly installments, or at the discretion of the executors and trustees, who were also empowered to distribute from the principal of the trust such other sums as they might deem necessary or desirable. At the expiration of the twenty-one-year period, the then remaining principal was to be divided equally between the two nephews. Although it appears that this trust fund was set up separately on the books of account during or at the close of the year 1921, no evidence was presented to show that no part of the income claimed by the respondent to have been received by the estate in 1921 was received upon such trust fund. So far as appears the whole estate was considered an entity prior to the creation of the Fellows Trust Fund and the income of the estate, after the payment of expenses, was invested and added to the remaining corpus. ‘

It results, therefore, that the contention of the petitioners that all the income of the estate became part of the residuary estate and as such was ultimately payable to the Cleveland chapter of the American Eed Cross and the Welfare Federation of Cleveland can not be sustained. Even if it be conceded that that portion which did pass to the residuary estate would be deductible as having been paid or permanently set aside for the use of two exempt charitable corporations, we could not, from the evidence submitted, decide what portion, if any, could be deducted.

The facts in this case are essentially different from those which obtained in Appeal of Herbert Jermain Slocum, 6 B. T. A. 36; Bowers v. Slocum, 20 Fed. (2d) 350. There it appeared that it was the duty of the executors, pursuant to the terms of the will, to pay to the residuary legatees or permanently set aside for them the income upon the residuary fund. In the case at bar there is no evidence that any part of the income of the estate during 1921 was paid to or permanently set aside for the residuary legatees.

Judgment will be entered for the respondent.

Considered by LittletoN.


author: Smith:

text:
    American Leather Products Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10619.
    Promulgated August 8, 1927.

      A. 8. Lisenby, Esq., for the respondent.
   Smith:

This is a proceeding for the redetermination of a deficiency in income and profits tax for the calendar year 1920 in an amount less than $10,000. All issues have been withdrawn except that with respect to the correctness of the Commissioner’s action in reducing petitioner’s invested capital for 1920 by reason of accruing a tentative tax for the year 1920 pro rata throughout the year. This reduced the amount available for dividends on March 15,1920, by an amount alleged to be $1,873.43. The answer of the Commissioner admits that the Commissioner did not adjust the petitioner’s invested capital in accordance with the decision of the Board in Appeal of L. S. Ayers & Co., 1 B. T. A. 1135. The deficiency should be redetermined in accordance with the rule laid down in that appeal.

Judgment will be entered on 15 days' notice, under Bule 50.

Considered by Littleton.