author: Smith :

text:
    Medical Diagnostic Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96563.
    Promulgated August 27, 1940.

      J. Marion Wright, Esq., and Wm. G. Kottemann, O. P. A., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.

      G. Arden Gingery, Esq., as amicus curiae.

   OPINION.

Smith :

The petitioner claims to be exempt from income tax under section 101 of the Revenue Act of 1936. It is unable to point to any class of exempt corporations which expressly comprehends it. At the hearing of this proceeding counsel for the petitioner was ashed:

What provisions oí Section 101 of the Revenue Act of 1936 are you particularly relying upon in your claim that the Association here is exempt from filing any income tax returns?

He replied:

* * * the Medical Diagnostic Association does not come under the provisions of any specific class of organizations specifically exempt and yet, it savors of tests that are made for all of the associations. It has some of the characteristics of a scientific educational organization. It is similar to a business league in that it is an association of doctors. It is somewhat similar to what we might say, to a board of trade, although confined to professional men. It is — in a way, it has a scientific purpose and is sort of a civic league. * * *

Section 101 of the Revenue Act of 1936 provides in part as follows:

SEC. 101. EXEMPTIONS PROM TAX ON CORPORATIONS.
The following organizations shall be exempt from taxation under this title—
(6) Corporations, * * * 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 shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation.

It is not material that the petitioner is organized as a nonprofit corporation under the laws of the State of California; that it aims to perform its services for its members at cost; or that it can not and never has declared any dividends to its members. In this connection it may be noted that the Civil Code of the State of California provides for nonprofit corporations and states in section 593 thereof the formation and purposes for which a nonprofit corporation may be formed. It provides:

Formation and, purposes. — A nonprofit corporation may be formed by any number of persons, not less than three, for any lawful purposes, such as religious, charitable, social, educational, recreational, cemetery or for rendering services which do not contemplate the distribution of gains, profits or dividends to the members thereof, and for which individuals lawfully may associate themselves, subject to laws and regulations applicable to particular classes of nonprofit corporations or lines of activity. The carrying on of business at a profit incidental to the main purposes of the corporation and the distribution of assets to members on dissolution shall not be deemed forbidden to nonprofit corporations.

It can not be denied upon the evidence in this case that it was the thought and expectation of the three incorporators that laboratory services could be performed for members of the petitioner corporation at prices less than those charged by the commercial laboratories. This was undoubtedly one of the objects in the organization of the petitioner. It enabled the physicians and surgeons and dentists who were members of the association to obtain laboratory services at such a price as would enable them to serve patients of the lower income groups at prices less than they would have to charge if the laboratory services were paid for at higher prices. If the physicians and surgeons were disposed to reduce their charges to such low income groups, they could do so. By reason of this fact, counsel for the petitioner states that the organization of the petitioner was for a semialtruistic or semicharitable purpose. It is to be noted, however, that charitable .corporations are not exempt from income tax under section 101 (6) of the Kevenue Act of 1986 except where “organized and operated exclusively for * * * charitable” purposes. Even if it might be assumed that the petitioner is semicharitable, it is not within the class of exempt charitable organizations; it is not “exclusively” charitable.

The petitioner was also authorized to perform laboratory services for others than members, and the evidence shows that some such services were rendered. Charges for such services were made at commercial rates. Profits from such services inured to the benefit of all the members. It can not therefore be said that no part of the earnings inured to the benefit of the members.

The claim of the petitioner that it is exempt as a “business league” does not stand upon a better foundation than its claim for exemption as a charitable corporation. In article 518 of Regulations 62, 65, and 69 a business league is defined as “an association of persons having some common business interest, which limits its activities to work for such common interest and does not engage in a regular business of a kind ordinarily carried on for profit.”

In applying a provision of the Kevenue Act of 1928 to a corporation which claimed to be exempt from income tax as a chamber of commerce this Board, in Produce Exchange Stock Clearing Association, Inc., 27 B. T. A. 1214; affd. (C. C. A., 2d Cir.), 71 Fed. (2d) 142, held that under the doctrine noscitv/r a sociis a business league must have the general characteristics of a chamber of commerce, real estate board, or board of trade in order to be exempt from tax. In affirming the Board’s decision the United States Circuit Court of Appeals said:

Were the construction of the statutory provision in question a matter res integra, we should find little difficulty in holding that a corporation formed for the purpose of affording clearing house facilities to a limited group of traders in securities was not a “business league” entitled to exemption from taxation. The numerous subdivisions of section 103 of the Kevenue Act of 1928 (26 USCA § 2103) and the corresponding provisions in the earlier acts, specify organizations which, in the great majority of instances, are evidently granted exemption because of the benefit to be derived by the public from their activities. Cf. Trinidad v. Sagrada Orden, 263 U. S. 578, 581, 44 S. Ct. 204, 68 L. Ed. 458. There is reason why these should be favored, but none is apparent for exempting an association which merely serves each member as a convenience or economy in his business. This is the distinction which the Board of Tax Appeals and the courts have taken in applying the provision in question to somewhat analogous situations. Uniform Printing & Supply Co. v. Commissioner, 33 F. (2d) 445 (C. C. A. 7), affirming 9 B. T. A. 251; Crooks v. Kansas City Hay Dealers’ Ass’n, 37 F. (2d) 83 (C. C. A. 8) ; Northwestern Jobbers Credit Bureau v. Commissioner, 37 F. (2d) 880 (C. C. A. 8), affirming 14 B. T. A. 362; Louisville Credit Men’s Adjustment Bureau v. United States, 6 F. Supp. 196 (D. C. W. D. Ky.) ; A-1 Cleaners & Dyers Co. v. Commissioner, 14 B. T. A. 1314; Growers Cold Storage Co. v. Commissioner, 17 B. T. A. 1279.

A well founded claim for an exemption from income tax under any of the classes of corporations exempt under section 101 of the Revenue Act of 1936 must be predicated upon evidence which shows that the corporation falls fairly within .the exempt class. The evidence in this case does not show that fact.

The petitioner corporation was promoted by the Dieterles, only one of whom, Karl L. Dieterle, was apparently a physician. The father was not a physician and there was no requirement that the incorporators or directors should be physicians. Karl L. Dieterle testified that his father was the clerical or business executive officer of the corporation. So far as appears their salaries were fixed by themselves. The income tax returns show that father and son each received a salary from the petitioner for 1936 of $5,400, and for 1937 of $6,600. The question of the reasonableness of these salaries paid is not before us. But we think it clear that the corporation was organized in the manner in which it was organized for the purpose of obtaining business in volume for the laboratory by the Dieterles.

The determination of the respondent that the petitioner is not exempt from income tax is approved.

Much evidence was introduced with respect to the correct net addition to the bad debt reserve for each of the years 1936 and 1937. It appears that there were some old accounts on the books of the petitioner corporation that were properly known to be worthless prior to 1936. They had not been charged off, however, and no reserve had been set up against them. The addition to the reserve made by the petitioner for 1936 was $1,079.15, and for 1937 was $1,349.73: From a careful consideration of the evidence the Board is of the opinion that the net addition to the reserve should be one. percent of the volume of business for each year and that the correct net addition to the bad debt reserve for 1936 is $860.84 and for 1937 is $1,016.29.

Decision will be entered wider Buie 50.


source: Caselaw Access Project

author: ToRner :

license: Public Domain

text:
    J. C. Nichols, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89169.
    Promulgated August 27, 1940.

      Arthwr B. Foss, Esq., for the petitioner.

      David Altman, Esq., and Albert B. Peterson, Esq., for the respondent.
   OPINION.

ToRner :

In his determination of the deficiency the respondent concluded that the partnership during 1934 had forgiven the petitioner his indebtedness to the extent of $8,900, within the meaning of article 22 (a)-14 of Regulations 86 and that this forgiveness of indebtedness constituted income to the petitioner for that year. On brief it is pointed out that petitioner dominated the partnership and its business and was the principal producer of its income and that the release of petitioner from the said indebtedness was a further payment for services rendered, which payments under article 183-1 of Regulations 86 are “held to represent a division of partnership profits.” The respondent further contends that as the result of petitioner’s overdrafts his capital investment in the partnership had been completely exhausted prior to the taxable year; that the release of the indebtedness here in question amounted to a distribution to petitioner by the partnership, and, petitioner having previously recovered the full amount of his capital investment, the said distribution was in any event income to him. Helvering v. Smith, 90 Fed. (2d) 590.

In the amended petition it is alleged that petitioner was not relieved of liability for the $8,900 in question, “but he either remained fully liable to the said partnership or he became and remained indebted to his other partners individually.” It is now contended that he is indebted to each of the other partners for one-fourth of the $8,900 written off the partnership books. It is further contended that petitioner, having a one-fourth interest in the partnership, owned one-fourth of the debt and to that extent could not under any circumstances be said to have realized gain. The latter proposition suggests the question as to whether or not a partnership is to be regarded as an entity separate and apart from its members for the purpose of determining the separate income of a member in respect of transactions between it and such member. In the view we take of the case, however, it will not be necessary to consider that proposition. See, however, Helvering v. Walbridge, 70 Fed. (2d) 683, and Edward B. Archbald, 27 B. T. A. 837; affd., 70 Fed. (2d) 720.

Considering the relationship of the parties, the source of the capital of the business, the actual withdrawals by the four individuals, the treatment of petitioner’s overdrafts, the conduct of the business, and the disposition and terms of disposition of the interests of J. Toussaint and G. A. Nichols, it might be forcefully argued that no actual partnership ever existed or was intended. Be that as it may, the respondent in making his determination of deficiency and the parties in trying this proceeding have assumed the existence of a partnership, and in reaching our conclusion we shall do the same. By so doing, however, we are not required to close our eyes to the facts and to determine the income of the individual partners according to the ratios or terms originally prescribed in the partnership agreement if the subsequent acts and conduct of the partners themselves show that actual participation in the fruits of the business has been placed on a different basis. Our task here is to determine the income of J. C. Nichols, one of the partners, and if, by reason of his dominant position in the business and because of personal or business relations between him and the other partners, he was able to obtain and did obtain a greater portion of the partnership profits than was originally indicated in the partnership agreement, actual events must control and any additional amount so acquired should be included in his income, regardless of whether it be described as an increased share of profits, compensation for servicés rendered, or indebtedness forgiven.

According to the partnership agreement a partnership under the firm name J. C. Nichols was organized under date of April 12, 1925, with J. C. Nichols, J. Toussaint, P. G. Nichols, and G. A. Nichols each having a 25 percent interest therein. J. C. Nichols was to be manager in charge of sales and J. Toussaint office manager in charge of accounts, while G. A. Nichols and P. G. Nichols were to act in a promotional and advisory capacity. J. C. Nichols was to receive a salary of $16,000 per annum and J". Toussaint a salary of $3,900, while G. A. Nichols and P. G. Nichols were to be entitled to receive advances against future profits. It was provided that salaries might be changed by mutual consent of all parties. A capital account was opened on the books of the company in the name of each of the four individuals. These accounts purport to show that on April 14, 1925, each of the individuals named paid into the business in cash or property the total amount of $29,344.93. That a substantial portion of these payments was in the nature of good will is indicated by a debit appearing in each of the accounts some two years later, described as a charge-off of good will, in the amount of $14,506.55.

While the above agreement tends to show that a partnership in the profits of which the four individuals were to share equally was organized in 1925 and the capital accounts on their face indicate capital contributions by the four in equal amounts, the record shows that the capital was in fact advanced by petitioner and that amounts substantially in excess of 25 percent of the profits were appropriated to petitioner’s personal needs and uses. In 1925 petitioner, according to his testimony, invited his father, his brother, and his brother-in-law to become partners in an established business for the selling of veneer or rotary cut lumber. None of these individuals actually put anything in the business, and with respect to Toussaint the record certainly indicates that he had no means from which such a capital investment might have been made. The business had been built up by the petitioner through his own efforts and no other person, unless it was his father, G. A. Nichols, owned any part or share therein, and any interest that his father might have had was obviously not substantial. J. Toussaint, P. G. Nichols, and G. A. Nichols each gave petitioner his noninterest-bearing demand note for $47,000, but we would hesitate to conclude in the light of subsequent events that it was ever intended that anything should be paid thereon, and we do know that after approximately 14 years nothing had been paid. The business was successful from its inception and the profits were credited in equal shares to the capital accounts of the partners, and by the close of 1934, the taxable year, the total profits shown in each such account amounted to $81,279.21. During that same period the petitioner had withdrawn substantially more than the 25 percent of the profits credited to his account. In 1930 transfers were made from the accounts of the other three partners of a total amount of $47,626.06 to bolster petitioner’s capital account, which in turn was used to absorb overdrafts in his personal drawing account. By December 31, 1930, such overdrafts totaled $107,679.56, all of which as of that date had been debited to his capital account. By the end of 1932 he was again overdrawn, in the amount of $31,554.96, for which he executed his promissory note, but during the following year the note was written off the partnership books to the extent of $22,500 through a corresponding write-up of certain stock owned by the partnership, while on December 12, 1934, the balance of the note was similarly written off to the extent of $8,900, and the remaining $154.96 was charged back to petitioner’s personal drawing account. At the same time his drawing account had again become substantially overdrawn and at December 31, 1934, the overdrafts amounted to $30,419.03.

On the record here it is impossible to tell with certainty the exact amounts appropriated by the other three partners for their own use and benefit, but the facts are sufficient to show that they were not in any way comparable to those appropriated by petitioner, and, in the case of J. Toussaint and P. G. Nichols, were quite small. The total charges against the capital accounts of J. Toussaint, P. G. Nichols, and G. A. Nichols from the beginning of the partnership to December 31,1934, were $60,893.53, $50,719.76, and $60,463, respectively, but of those charges $14,506.55 in each account covered the charge-off of good will and $21,899.97, $22,073.11, and $3,652.98 covered respective transfers to petitioner’s capital account.

Exclusive of the charges explained in the preceding paragraph and which obviously did not represent appropriations to his personal use, the debits to J. Toussaint’s account for the period from April 14,1925, to December 31,1934, amounted to $24,487.01 and might possibly have been appropriated for his personal use, but even if that should be true such withdrawals were offset to the extent of $12,887.67 by bank loans and proceeds from the sale of stock deposited in the account. Also, common to the capital accounts of each of the partners except petitioner, there is a debit of $4,000 in favor of O. It. Nichols whose relationship has not been explained but who it may reasonably be presumed was another member of the f amily circle. If the O. R. Nichols debit be eliminated, Toussaint’s net personal withdrawals up to the close of the taxable year did not exceed $7,600.34 as compared to similar withdrawals by petitioner approximating $150,000, and yet according to the record Toussaint was, during that period, experiencing financial difficulties.

Exclusive of the good will charge-off and the transfer to the capital account of the petitioner, the total debits to the capital account of P. G. Nichols at December 31, 1934, amounted to only $14,140.10, and if the debit of $4,000 in favor of O. it. Nichols, previously discussed, should also be eliminated and it be concluded that the remaining withdrawals were for the personal use and benefit of P. G. Nichols, those withdrawals for the period from April 14,1925, to December 31,1934, amounted to only $10,140.10. From December 31,1934, through 1938, his withdrawals amounted to only $963.38 and apparently covered the payment of income tax. For the same period the credits amounted to $18,718.12, and, except for four items totaling only $408.55, represented one-fourth of the profits of the business during the period described.

The debits in the account of G. A. Nichols which may be said to have been appropriated to his personal use and benefit are more substantial. Exclusive of the good will charge-off and the transfer to petitioner’s capital account under date of April 19, 1930, the total debits amounted to $42,303.57, and if we further eliminate the $4,000 debit in favor of O. K. Nichols, previously discussed, there is still a balance of $38,303.57, which possibly may have been appropriated by G. A. Nichols to his personal use. It is to be noted, however, that the total profits from the business credited to his account during the same period were more than twice that amount, and, further, that G. A. Nichols, on December 31, 1937, transferred his entire interest in the partnership, including further accumulated earnings, to petitioner’s son and his grandson without consideration other than the possible assumption of his $47,000 noninterest-bearing demand note which the petitioner had held since 1925, and in view of the further fact shown by the record that G. A. Nichols continued to make monthly withdrawals from the business after the transfer of his interest to his grandson, such withdrawals being charged against the interest so transferred, it might be reasonably argued that the withdrawals for his personal use during the entire period from the beginning of the partnership were in the nature of gratuities from petitioner.

We also think the disposition and terms of disposition of Toussaint’s interest in the partnership is of significance. On December 31, 1935, his capital account was closed by transferring the credit balance of $66,008.62 to petitioner’s capital account, in return for which, according to the testimony, Toussaint received his previously described non-interest-bearing demand note for $47,000 and a further note or notes for $6,500 covering loans made to him by petitioner. A prior transfer of $21,899.97 under date of April 19, 1930, described as a loan, had already been made from Toussaint’s capital account to the capital account of petitioner. The record is silent as to the effect of the transaction of December 31,1935, on that item, and there is no showing whether or not Toussaint thereafter retained any claim for that amount. In his reply brief, however, petitioner classifies any consideration of the $21,899.97 in connection with the closing of Toussaint’s capital account as obvious error and suggests that the interest in the, partnership transferred by Toussaint to the petitioner at the time of his withdrawal was worth approximately the amount of his indebtedness to the petitioner, namely, $53,500. As we understand it, it is the petitioner’s claim that the interest transferred by Toussaint to petitioner was a full one-fourth interest in the business and the profits therefrom. If that is correct, Toussaint transferred to petitioner a one-fourth interest in a business which had been successful from the beginning, a business which during the period from April 14,1925, to December 31,1935, had produced profits in the amount of $338,340.52, a one-fourth share therein being $84,585.13, and further Toussaint was not only giving up an interest which had such an earning record but was also handing over to petitioner as a part of the same transaction and without additional consideration his right to past earnings amounting at least to $38,282.57. This amount is arrived at by excluding from consideration the $21,89.9.97 transferred in April 1930, with respect to which the record is silent, and by eliminating from the credit balance transferred on December 81, 1935, $14,838.38 representing the balance of the original capital entry after the charge-off of good will in 1927, also $12,887.67, being the amount of bank loans and proceeds from the sale of stock which had been deposited presumably by Toussaint in the said account.

It is true the transfers in April 1930 to petitioner’s capital account were described as loans from the other three partners, and, while the partnership accounts show no continuing obligation of petitioner with respect to the note of December 31, 1932, which was written off in 1933 and 1934 by a write-up of certain partnership assets, there is testimony to the effect that when $22,500 thereof was written off in 1933 petitioner gave notes to each of the other three partners for one-fourth of the amount written off and when the $8,900 item involved in this proceeding was written off in 1934 there was an intent to give similar notes. The fact is, however, that no notes were given with respect to the $8,900, there is no showing that it was entered on the accounts of any of the parties as a continuing liability of petitioner, and nothing has ever been paid thereon. It is equally true that all of the partners consistently refrained from making any payments on any of the apparent obligations arising out of or in connection with the partnership arrangement, and not only were no payments made, but, even though there were numerous cases of the overlapping of paper obligations, no balance was ever struck between the petitioner and any of the partners, not even when Toussaint withdrew from the business in 1935 and G. A. Nichols withdrew in 1937. During all that time the petitioner continued his practice of overdrawing his purported one-fourth share of the profits, while the other partners were taking only a small part of their purported shares.

Our particular problem has to do with the $8,900, being that portion of the note of December 31, 1932, written off in 1934. With respect to the origin of the note and the reasons for writing it off there is considerable confusion. The petitioner stated that the write-off and the form it took was suggested by an official at a bank with which the partnership did business, the reason for the banker’s suggestion being that the presence of petitioner’s obligation on the partnership books made the partnership’s financial statement look bad. Toussaint testified that the suggestion for the write-up of the partnership assets as a means of eliminating the note came from the partnership auditor. Petitioner and Toussaint seemed to be in agreement, however, that, regardless of where the idea to write up partnership assets came from, the elimination of petitioner’s obligation under the note both in 1933 and in 1934 came from the bank official, the purpose being to improve the partnership’s financial statement. During 1934, however, when petitioner was so seeking to satisfy the bank and improve the partnership’s financial statement by the elimination of a $8,900 liability under a note, he was accumulating a much larger overdraft in his personal drawing account, which at December 31, 1934, amounted to $30,419.03. Accordingly we are not greatly impressed with the explanation given for the write-off. Taking into consideration the manner in which the partnership was formed, the source of its capital, the continued practice of the petitioner to withdraw amounts far in excess of one-fourth of the partnership profits, the method of eliminating his overdrafts, the comparatively small withdrawals by the other partners, the consistency with which petitioner has refrained from making any repayment to the partnership or any of the partners with respect to his overdrafts written off the partnership books, the equal consistency with which the other partners refrained from making any payments on their notes of $47,000 each given to petitioner when the partnership was formed in 1925, and the care with which Toussaint and petitioner have indicated that no offsets were made or intended by reason of the overlapping liabilities, it is our conclusion that, while the partnership profits were regularly entered in the four capital accounts, the shares of Toussaint, P. G. Nichols, and G. A. Nichols were intended to be and at all times were subject to the needs and demands of petitioner. Our earn here involves only the $8,900 eliminated from the books in 1934, which petitioner maintains he still owes pro rata to the partners, and we are not called upon to determine the tax effect of other adjustments. It is our opinion that any thought on the part of petitioner to ever make payment, to the partnership or any of the partners, of the $8,900 written off the partnership books on December 12, 1934, was too remote to justify any conclusion that there was any continuing obligation therefor, and we accordingly conclude that the cancellation of the note did result in a realization by petitioner in 1934 of additional income in the amount of the $8,900 written off, regardless of whether it be said that such realization was effected through the forgiveness of indebtedness, the payment of increased compensation by mutual consent of the partners, or by apportionment of the 1934 profits.

The second question presented is whether respondent erred in including in petitioner’s taxable income $2,400 which was received by him in the form of monthly credits of $200 each to his personal drawing account, allegedly for traveling and automobile expenses. The record shows that $1,200 of this amount was in fact paid to a chauffeur employed by the partnership to operate a partnership automobile, $964.95 of which was paid by partnership checks charged to petitioner’s personal account and the remainder of which was paid in cash out of petitioner’s pocket. While the chauffeur was not carried as an employee on the books of the partnership, we think the evidence establishes that he was in fact an employee of the partnership, and we do not think the petitioner’s income should include the $1,200 paid to him as salary. With respect to the remaining $1,200, which was supposed to represent the amount of small payments made by petitioner to the chauffeur from time to time to cover traveling expenses, the evidence is not convincing. The partnership maintained a separate account on its books to cover automobile expenses and also a separate account to cover petitioner’s traveling expenses. Most of the entries in this latter account fail to disclose the manner in which petitioner traveled, but at least one entry, in the amount of $300, is described as an “auto trip to all mills.” In view of the fact that petitioner kept no record of Ms expenditures while traveling and in further view of the manner in which his traveling expenses were kept in a separate account on the partnership books, we are not convinced that the remaining $1,200 was in fact used in the partnership business and that the respondent erred in determining that this $1,200 should be included in petitioner’s income. To that extent his determination is sustained.

Decision will be entered wider Rule 50.

       Akt. 22 (a) — 14. Cancellation of indebtedness. — The cancellation -of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. * * *


author: Smith:

text:
    Lillie S. Wegeforth, Petitioner, v. Commissioner of Internal Revenue, Respondent. Harriet Holbrook Belcher, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94708, 94879.
    Promulgated August 28, 1940.

      Herbert W. OlaHe, Esq., and Leon de Fremery, Esq., for the petitioners.

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

Smith:

1. The first question for consideration is whether the petitioners are entitled to deduct from their gross incomes of 1935 any amount by reason of losses sustained through the operation of the Belbrook Stables, claimed to be a partnership business operated by the petitioners for profit. In his deficiency notice in the case of petitioner Wegeforth the respondent stated:

The Belbrook Stables were operated by you with your daughter, Mrs. H. H. Beleher, for breeding, raising and training horses for exhibition purposes to be entered in various horse shows on the Pacific Coast and elsewhere. Although such stables were maintained by you for several years previous to the taxable year, the operations always resulted in losses which were not claimed as deductions on your income tax returns.
Information at hand indicates such stables were operated in the taxable year for personal pleasure and as hobbies by yourself and your daughter, in the same manner that they were operated in prior years. * * *

Although the net operating losses of the Belbrook Stables for the year 1935 were $32,604.87, the petitioners each claimed the deduction from gross income of only $9,876.08. This is the only amount of the loss for 1935 in issue in these proceedings.

The petitioners admit that the Belbrook Stables were not operated for profit prior to 1935. They claim that in 1935 the stables were operated as a business and with the expectation of deriving a profit therefrom; that beginning with 1935 show horses with the best blood strains werte converted into brood mares and that the stables began to be extensively advertised.

From a consideration of all of the evidence we can not doubt that it was the intention of the petitioners to operate the Belbrook Stables in 1935 for the purpose of deriving a profit therefrom. Each of the petitioners is entitled to deduct from her gross income of 1935 one-half of the loss here in issue, or $9,876.08. This determination is upon the authority of Thomas F. Sheridan, 4 B. T. A. 1299; George D. Widener, 8 B. T. A. 651; affd. (C. C. A., 3d Cir.), 33 Fed. (2d) 833; Margaret E. Amory, 22 B. T. A. 1398; Commissioner v. Field (C. C. A., 2d Cir.), 67 Fed. (2d) 876; Dupont v. United States (Dist. Ct., Dist. of Del.), 28 Fed. Supp. 122; Farish v. Commissioner (C. C. A., 5th Cir.), 103 Fed. (2d) 63.

2. The second question for our consideration is whether the income of petitioner Wegeforth for each of the years 1934 and 1935 should be increased in the amount of $1,195 and the income of petitioner Belcher for 1935 by a like amount by reason of the payments by the trustee of the irrevocable trust to investment counsel and attorneys designated by the grantor of the trust. There is no question here as to the right of the trustee to deduct from the gross income of the trust the expenses paid out by the trustee other than the payments to investment counsel which were made at the direction of petitioner Wegeforth. The respondent increased the net income of the petitioners by the amounts indicated, saying: “These payments were made for legal and investment advice rendered by your attorneys and investment counsel.”

The respondent considered that the amounts of $2,390 paid by the irrevocable trust in 1934 and 1935 were income of the petitioners paid out by the trustee in accordance with their direction; that the petitioners^were not engaged in a trade or business with reference to the operation of the trust property; and that therefore they are not entitled to exclude those amounts from their gross incomes.

The evidence does not show that either of the petitioners, or, for that matter, the trust, was engaged in a trade or business which would warrant the deduction of the amounts here in question. They were not ordinary and necessary expenses paid in connection with the carrying on of a trade or business. The action of the respondent in increasing the net incomes of the petitioners by the above amounts is approved. See City Bank Farmers Trust Co., Trustee, 39 B. T. A. 29; affd. (C. C. A., 2d Cir.), 112 Fed. (2d) 457.

3. Petitioner Wegeforth claims the deduction from gross income of 1934 of $95 representing an amount paid by her for investment counsel. The respondent has disallowed the deduction upon the ground that she was not engaged in any trade or business which warranted the deduction. We approve his determination.

4. Petitioner Wegeforth created two revocable trusts in 1934. She is admittedly taxable upon the income of them under section 166 of the Revenue Act of 1934. She returned as net income the gross income of the trusts less payments made by the trust to attorneys and investment counsel, etc., of $6,416.05 for 1934, and $12,476.17 for 1935. In the determination of the deficiencies the respondent increased the petitioner’s income from the trusts by the amounts above stated, alleging that the petitioner is not entitled to those deductions since they were not ordinary and necessary expenses paid or incurred in the carrying on of any trade or business.

The petitioner argues that by reason of the size of the trusts and the many purchases and sales of securities this issue falls within the principle of Kales v. Commissioner (C. C. A., 6th Cir.), 101 Fed. (2d) 35. The facts in that case showed that Mrs. Kales carried on a large business in the purchase and sale of securities, and the court held that she was engaged in a business for profit which permitted her to deduct from gross income, as from a business carried on for profit, expenses incurred in the carrying on of such business.

Although the evidence in the instant case shows that petitioner Wegeforth devoted some time and attention to purchases and sales of securities, we do not think that the evidence shows that she was engaged in a trade or business involving her investments.

The facts in the proceedings at bar are somewhat similar to those involved in the case of Helen W. Heilbroner, 34 B. T. A. 1200; affirmed, sub nom. Kane v. Commissioner (C. C. A., 2d Cir.), 100 Fed. (2d) 382, where the petitioner employed a trust company to look after her investments. The Board and the court held that the amounts paid as expenses to trustees were not a legal deduction from gross income.

Section 23 (a) of the Revenue Act of 1934, as above indicated, provides for deductions of all “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” In a concurring opinion in the recent decision of the United States Supreme Court in the case of Deputy v. duPont, 308 U. S. 488, Mr. Justice Frankfurter stated in part:

* * * To avail of the deductions allowed by §23 (a), it is not enough to incur expenses in the active concern over one’s own financial interest. “* * * carrying on any trade or business”, within the contemplation of §23 (a), involves holding one’s self out to others as engaged in the selling of goods or services. * * *

In Miller v. Commissioner (C. C. A., 9th Cir.), 102 Fed. (2d) 476, as in the instant proceedings, the property of the decedent taxpayer had been placed in a revocable trust, with the taxpayer as sole beneficiary and the right reserved in him to direct all investments and reinvestments of the corpus. The taxpayer there maintained an office in an office building in which he spent a few hours almost every day and he employed two men to do clerical work, keep his personal books, and read trade journals, financial services, and corporate statements. The Board decided that such activity did not constitute a trade or business and the Board’s decision was affirmed by the Ninth Circuit. See also City Bank Farmers Trust Co., Trustee, supra.

The action of the respondent on this issue is approved.

Decision will be entered v/nder Rule 50.


text:
    George R. Myers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94764.
    Promulgated August 28, 1940.

      Albert Grossman, Esq., and Charles Goldring, C. P. A., for tbe petitioner.

      Byron M. Coon, Esq., for the respondent.
   OPINION.

Smith:

In his petition to the Board the petitioner alleges, first, that the liquidation of the Automotive Sales Co. and Automotive Sales, Inc., in 1935 was a tax-free reorganization, and, second, that in any event the gain, if any, from the liquidation of the 145% shares of Automotive Sales Co. stock and 15% shares of Automotive Sales, Inc., stock which he transferred to his wife under the settlement agreement of May 29,1933, is not taxable to him.

The first of these contentions was waived by the petitioner at the hearing before the Board, leaving for our determination only the question whether the gain on the liquidation of the 145% shares of Automotive Sales Co. stock and the 15% shares of Automotive Sales, Inc., stock is taxable to the petitioner. The amount of the gain from the liquidating distribution on said shares has not been put in dispute in this proceeding. Petitioner’s protest against the additional assessment is based entirely upon his contention that he was not the owner of the shares of stock in question at the time the liquidating distribution was made.

The respondent has taxed the gain on the distribution to the petitioner on the ground that the legal title to the stock in escrow was his at the time of the liquidation. This conclusion rests in turn on the fact that certain important incidents of equitable ownership in the stock were then in the petitioner and on the respondent’s interpretation of the written agreement of the parties. We do not think the respondent can be sustained in his position.

The decision of the issue before us has been made by the courts to depend on ownership of the income-producing property at the time of the gain. In each instance primary emphasis has been placed on the varying circumstances of separate cases as they illumine questions of title to the property involved. See Commissioner v. Swift, 54 Fed. (2d) 746; Robert L. Stearns, 24 B. T. A. 1013; Theodore R. Gerlach, 27 B. T. A. 565. See also Max Viault, 36 B. T. A. 430. For dominion over, or possession of, that property see Brunton v. Commissioner, 42 Fed. (2d) 81; Anna L. Dirksen, Executrix, 24 B. T. A. 1152. Cf. Ruml v. Commissioner, 88 Fed. (2d) 257; Robert L. Stearns, supra; and as to the method of sale as it may affect the realization of the gain sought to be taxed, see Theodore R. Gerlach, supra; Dakota Creek Lumber & Shingle Co., 26 B. T. A. 940.

In the instant case it appears to us, contrary to respondent’s position, that the title to the stock in escrow was in Rhoda A. Myers. The determination of this question must be made largely to depend on the intention of the parties as evidenced by their method of dealing and on the surrounding circumstances. It is plain from the agreement of May 29, 1933, that the intent of the parties was that the petitioner should buy out Ehoda A. Myers’ interest in the community at an agreed price. It seems clear, moreover, that they were not satisfied with the more direct method which might have been followed of the relinquishment by the wife of her interest in consideration of the agreed price, that interest to be pledged as security for the performance of the agreement. Eather, the method adopted was first to place title to the stock in Rhoda A. Myers individually, to reflect this transfer on the corporate books, and to execute an agreement for their sale through a trustee. The significant difference between these methods is that under the one utilized Ehoda A. Myers was enabled to reserve the power to repossess the securities in kind on petitioner’s default, whereas under the alternative method she would hold only a power to levy on the stock and to derive therefrom sufficient funds to supply the balance owing. Cf. Theodore R. Gerlach, supra; Walter M. Hort, 39 B. T. A. 922.

The incorporation in one instrument of these two transactions requires that they be construed together and from a careful study of the instrument we think it clear that it was the intention of the parties that title to the stock was to remain in Ehoda A. Myers until the completion of the contract. Corroborative evidence is found in the fact that the stock remained on the books of the corporation in the name of Ehoda A. Myers and that in the liquidation of the corporation she was treated as the owner.

The reservation in the agreement, even though it be by inference, of the power to “sell, assign, transfer or hypothecate” the stock on petitioner’s default shackles the passage of title with a contingency and makes it evident that performance of the agreement was a condition precedent to assumption of title by the purchaser. See Solomon Silberblatt, 28 B. T. A. 73.

Respondent argues, nevertheless, that the petitioner was invested with the significant powers to vote the stock while in escrow and to receive the dividends paid thereon. These privileges, it is said, are the substance of possession and ownership and for our purposes must override drier considerations. We think, however, that the execution of proxies to the petitioner is explained by the fact that the corporations were small concerns, of which the petitioner was the president, and the purpose of this provision was largely to facilitate the operation of the corporations. The assignment of the dividends, in view of the fact that the petitioner was to pay interest upon the debt, loses significance.

The intention of the parties must control or even override the terms of the contract if properly evidenced. See East Coast Oil Co., S. A., 31 B. T. A. 558; affd., 85 Fed. (2d) 322; certiorari denied, 299 U. S. 608. In the instant case some importance attaches to the fact that the terms of the instrument appear to bear out our conclusion that the parties contemplated no instant sale. The contract provides that Rhoda A. Myers “agrees to sell” and petitioner “agrees to purchase” the stock, marking this agreement as a contract “to sell” and not a contract “of sale.” Cf. Jacob Carp, 31 B. T. A. 541, where actual assignment to the buyer of the stock in escrow was considered more significant of the parties’ intention than the terms of the instrument.

We think, in addition, that paragraph five of the agreement, by which it is provided that “all property heretofore or hereunder vested in Rhoda A. Myers * * * shall be vested in her as her sole and separate estate, free and clear of any community property or other interests or claim therein, upon the part of George R. Myers excepting only as to the rights and privileges herein granted to him by this Agreement and to the voting power of the certain stocks hereinbefore mentioned and set forth”, has some significance. (Italics supplied.) The instrument is described as granting to petitioner only “rights and privileges” and does not attempt to convey to him an “interest” which must characterize an actual passage of title or true equitable ownership. It should be noted, moreover, that no course was followed which could be interpreted as entailing payment for the stock at the time of making the agreement. No notes were executed as evidence of the payments to be made. Cf. Jacob Carp, supra.

The situation here present differs from those wherein dealings under which a loss has been definitely incurred have not been carried through to a conclusion. See Hoffman v. Commissioner (C. C. A., 2d Cir.), 71 Fed. (2d) 929; Ruml v. Commissioner, supra. Cf. Stiver v. Commissioner, 90 Fed. (2d) 505.

The present case likewise appears to us to differ from Long v. United States, 66 Ct. Cls. 475, where the payment of dividends during the taxable year reduced then the obligation of the taxpayer to pay principal and interest on the stock-purchase debt. The taxpayer there realized a gain during the year in question.

From these varied considerations we have reached our conclusion that title to the stock in escrow was not in the petitioner during the taxable year, that the reservation of the right to dispose of the stock on petitioner’s default placed a substantial contingency blocking the passage of that title, and that by the terms of the instrument itself it is apparent that the petitioner was not the owner of the stock. In the light of these facts we hold that respondent’s determination that the petitioner realized gain on the liquidating distribution was error.

Decision will be entered for the petitioner.


author: AruNdeil:

text:
    May Hosiery Mills, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99006.
    Promulgated August 29, 1940.

      Theodore B. Benson, Esq., for the petitioner.

      L. W. Greason, 'Esq., for the respondent.
   OPINION.

AruNdeil:

The petitioner seeks redetermination of the deficiency here in question on three different bases, each involving a different aspect of the same transaction. The first two stem from the requirement that 15 percent of the petitioner’s net income annually be set aside in a sinking fund and applied to the purchase or redemption of its preference stock. Petitioner argues that this provision of the agreement of August 19,1927, brings within section 26 (c) (2) of the Eevenue Act of 1986 (1) the amount of $51,189.68 which was required during the taxable year to be set aside in the sinking fund, or (2) the amount of $49,165.51 which petitioner spent in the purchase of its stock, thus entitling petitioner to a credit in one of those sums. We think petitioner may not claim a credit in either of these amounts. The statute provides a credit only when the amounts so set aside or ex - pended are for the “discharge of a debt” and neither the sinking fund nor the expenditures in the instant case may be so characterized. The shares of stock retired plainly represented capital interest and not indebtedness. They had no fixed date of maturity, see United States v. South Georgia Railway Co., 107 Fed. (2d) 3. Cf. Commissioner v. Holding Corporation, 76 Fed. (2d) 11; Palmer, Stacy-Merrill, Inc., 39 B. T. A. 636; affd., 111 Fed. (2d) 809. The principal amounts and dividends were made payable only out of net profits, see Haffenreffer Brewing Co., 41 B. T. A. 443. The obligation imposed by contract on the petitioner to set aside and apply a percentage of its profits to the retirement of its stock does not alter the nature of the transaction. The significant characteristic of a debt certain — that its payment may be forced in case of default, see United States v. South Georgia Railway Co., supra—is here lacking. At least the two elements of the contingency of the profits from which payment was to be made and the absence of a maturity date for the shares retired brand the stock here a capital interest for the redemption or retirement of which no credit may be claimed under section 26 (c) (2) of the Revenue Act of 1936.

Moreover, for an additional reason in the present case the petitioner may not claim a credit for the $51,189.68 which was required to be set aside during the taxable year in the sinking fund for the redemption of preference stock. It is not enough that this amount was required to be irrevocably set aside; the credit is allowed only to the extent that the required amount is actually set aside. In the present case no evidence has been presented that the required $51,189.68 was so set aside and in face of this lack of evidence we are unable to hold that petitioner is entitled to a credit in that amount.

The third position taken by the petitioner is that the payment of $49,165.51 made to its stockholders was in fact a distribution in liquidation, $37,468.44 of which represents profits accumulated since February 28, 1913, for which petitioner is entitled to a dividends-paid credit under section 27 (f) of the Revenue Act of 1936. Against this contention of the petitioner, the respondent argues that the sum paid out may not by its nature be considered a distribution in liquidation and entitles petitioner to no credit under section 27, supra, even if labeled a liquidating distribution, since it was not made pro rata or without preference among shares of the same class, as required by section 27 (g). Petitioner contends, however, that subsection (g) may not be applied to distributions in liquidation in the absence of specific provision to that effect, since such distributions are granted the credit in question by singular language in subsection (f). We do not think petitioner can succeed in this argument. By its very terms section 27 (g) applies to "any distribution” and, following as it does subsection (f), must, we think, be applied to liquidating distributions. This interpretation is in keeping with the ruling of the Commissioner in I. T. 3244 (C. B. 1939-1), which by its terms covers the exact situation presented here. The facts are accurately reflected by the headnote:

The M Company is not entitled to a dividends-paid credit with respect to liquidating distributions made in acquiring a part of its outstanding preference shares at different prices by direct purchases from stockholders and by purchases on the It stock exchange.

The reason for this holding is assigned to the “fact that the purchase of preference shares for cancellation and retirement was not on a pro rata basis and that every shareholder of the class did not receive (in proportion to the number of shares held by him) his pro rata part of the distribution” and, therefore, “it is held that the M Company is not entitled to a dividends-paid credit for any portion of the distribution in partial liquidation by reason of the limitation imposed by section 27 (g) of the Act.”

With this interpretation of the statute we are in agreement. It plainly - appears in the instant case that the purchase of the shares was made unequally among the holders of preference stock. We are not shown the prices at which individual shares were purchased. It is sufficient that they were bought from only a portion of the holders of preference stock. /

There is no merit in petitioner’s argument that the stockholders to whom the distribution was made constituted a separate class by virtue of the fact that their stock was purchased for retirement and that section 27 (g) is thus satisfied. It seems plain that all of the preference shares issued were of the same character, with identical provisions. The purchase of preference stock by the issuing corporation does not alter this character, however much retirement and cancellation may by destroying it take the stock out of the class. See Black Motor Co., 41 B. T. A. 300.

In view of our conclusion it is unnecessary to pass on the additional contention of the respondent that the $49,165.51 was not paid out as a liquidating distribution.

Decision will be entered for respondent.

       SEC. 26. CREDITS OF CORPORATION'S.
      In the ease of a corporation the following credits shall be allowed to the extent provided in the varions sections imposing tax—
      » * * * * * *
      (c) Contracts Restricting Payment of Dividends.—
      * * ⅝ # * * * *
      (2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings and profits of a taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.

       SEC. 27. CORPORATIO,N CREDIT FOR DIVIDENDS PAID.
      * * * * * ft *
      (f) Distbibutions in Liquidation. — In the case of amounts distributed in liquidation the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913, shall, for the purposes of computing the dividends-paid credit under this section, be treated as a taxable dividend paid.
      (g) Peefebbntiai, Dividends. — No dividends-paid credit shall be allowed with respect to any distribution unless the distribution is pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class.


author: Murdock :

text:
    Peck & Peck (New York), Petitioner, v. Commissioner of Internal Revenue, Respondent. The Peck-Peck Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99288, 99314.
    Promulgated August 29, 1940.

      Andrew B. Trudgian, Esq., and Milton P. Kupfer, Esq., for the petitioner.

      Leonard A. Spalding, Jr., Esq., for the respondent.
   OPINION.

Murdock :

Peck & Peck, the parent, owned all of the 1,000 outstanding shares of its subsidiary, the Peck-Peck Corporation. The estate of George F. Peck was indebted to the subsidiary in the amount of $111,458.09 and owned stock of the parent. The stock was the only asset from which it could pay the debt. The attorney for the corporations put in effect a plan whereby the amount of the debt would be eliminated from the working capital of the corporations. The estate transferred 326 shares of parent stock to the subsidiary in cancellation of the debt and received $206.69 in cash, being the excess of the fair market value of the shares over the amount of the debt. The subsidiary then transferred the 326 shares of parent stock and $2,106.90 in cash to the parent in exchange for 176 shares of subsidiary stock. The cash was equal to the difference in the fair market values of the two blocks of stock. The parent then decreased its capital by the 326 shares and the subsidiary decreased its capital by the 176 shares. All of the foregoing steps were part of a single plan to eliminate the amount of the debt from the working capital of the two corporations. The parent still owned all of the outstanding stock of the subsidiary, now 824 shares. The debt due the subsidiary was canceled. The outstanding capital stock of the parent consisted of 1,674 shares after the retirement of the 326 shares.

The Commissioner in determining the deficiencies against the parent held that it realized a profit of $17,656.32 from the exchange of the subsidiary stock for its own stock. The profit was the difference between its basis for gain on the subsidiary stock and the fair market value of its own stock plus the cash received.

The Commissioner contends that the 176 shares were disposed of by the parent in a partial liquidation of the subsidiary and the gain of the parent is taxable under section 115 (i) and (c) of the Eevenue Act of 1934. The petitioners do not dispute the amount of the gain or the fact that a gain was realized from the exchange. They also concede that there was a partial liquidation of both corporations but they point out, inter alia, that the gain to a distributee from a partial liquidation is recognized only to the extent provided in section 112. They argue that the transactions between them constituted a reorganization within section 112 (g) (1) (C), (D), and (E), since there was a transfer by the parent of a part of its assets (176 shares of subsidiary stock) to another corporation, the subsidiary, and immediately afterwards the transferor was in control of the transferee, since there was a recapitalization of the subsidiary, and since there was a mere change in form. They then conclude that the provisions of section 112 (b) (3) and (c) (1) apply and the gain is recognized only to the extent of the cash received.

The respondent maintains that there was no reorganization within section 112 (g) (1) (C), and (b) (3) and (c) (1) of section 112 do not apply. He says that section 112 (g) (1) (C) does not cover a transaction where the transferor was in control of the transferee both before and after the transfer, but includes only transactions in which control was acquired by the transfer. He cites no authority for this proposition and we know of none. The definition contains no such restriction and none need be implied to carry out the intent of Congress. If corporation A transferred 26 percent of its assets to corporation B in exchange for all of B’s stock, clearly there would be a reorganization within section 112 (g) (1) (C). If, thereafter, A transferred 33½ percent of its remaining assets to B and continued in control of B, there would be no material difference between the two transfers so far as the words or purpose of section 112 (g) (1) (C) are concerned. The transactions involved herein were carried out for a real business purpose as opposed to any exogenous or tax avoidance purpose, so that cases like Gregory v. Helvering, 293 U. S. 465, do not apply. We conclude that there was a statutory reorganization, to which both the parent and subsidiary were parties.

The Commissioner argues that, in any event, the petitioner’s gain does not escape recognition because of the provisions of section 112 (b) (3) and (c) (l), since the subsection was intended to cover a situation where a reorganization involves more than two corporations and does not cover a transfer of assets by a corporation in exchange for its own stock. He would apply section 115 (c). This same argument was made by the Commissioner and was rejected in Winston Brothers Co., 29 B. T. A. 905; affd., 76 Fed. (2d) 381. There only two corporations were parties to the reorganization. The parent exchanged stock which it owned in the subsidiary for its own stock and the Board and the court held that the gain was not recognized because of section 112 (b) (3). See also General Motors Corporation, 35 B. T. A. 523; Isidor Kahn, 36 B. T. A. 954. We follow those decisions and reach the conclusion here that the gam is taxable only to the extent of the cash.

The petitioners make a further argument that, since the parent exchanged subsidiary shares for its own stock, which stock was to be and was retired, the parent was merely liquidating partially and realized no gain from the distribution of its assets in kind. Regulations 86, art. 22 (a)-21. Our holdings above makes unnecessary the consideration of this argument except as it may apply to the cash received by the parent. Clearly, the receipt of cash by the parent was not a distribution of its assets in kind. The question of gain or loss to a corporation from the acquisition and disposition of its own shares is a difficult one (Niagara Share Corporation, 30 B. T. A. 668; National Home Owners Service Corporation, 39 B. T. A. 753), but the cash was received by the parent not for its own shares but for shares of its subsidiary. It has not shown by facts or argument that the cash was not taxable gain.

The Commissioner has shown that he erred in allowing the Peck-Peck Corporation a deduction of $2,000 upon the transactions discussed herein. The petitioners make no argument to the contrary.

Decision will be entered under Bule 50.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      *******
      (g) DEFINITION of ííeorqanization. — As used in this section and section 113—
      (1) The term “reorganization” means * * * (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the trans-feror or its stockholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E) a mere change in identity, form, or place of organization, however effected.

       SEC. 112. RECOGNITION OP GAIN OR LOSS.
      « * * * * ⅜ .
      (b) Exchanges Solely in Kind.—
      (3) Stock foe stock on '.reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      (c) Gain from Exchanges Not Solely in Kind.—
      (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or
      (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, If any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.


text:
    Spencer Thorpe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97266.
    Promulgated August 29, 1940.

      A. Codder Machay, Esq., for petitioner.

      Byron M. Coon, Esq., and R. T. Miller, Esq., for the respondent.
   OPINION.

Smith :

In this proceeding the petitioner admits that he realized a gain on the above transaction in the amount of $35,000, less the amount of $7,395 which he paid as a commission in securing the sublease, but he contends that the transaction giving rise to this gain was in substance and effect a sale or exchange of a capital asset, or capital assets, comprising his property rights in the leasehold agreement of October 1, 1924, and the surety bond given in connection therewith, and that the amount of his gain on the transaction is taxable at the capital gain rates as provided for in section 117 of the Revenue Act of 1934.

Section 117 of the Revenue Act of 1934 reads in part as follows:

SEO. 117. CAPITAL GAINS AND LOSSES.
(a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
*******
(b) Dehhmon op Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock In trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

Granting that- the petitioner’s interest in the leasehold agreement and in the surety bond given in connection therewith constituted property rights which might be classified as capital assets, we do not think that there was in any sense “a sale or exchange” of those property rights. In substance the petitioner merely agreed to relieve his lessee and the lessee’s surety of the obligation to erect a new building on the leased premises in consideration of the lessee’s payment of $35,000 in cash. The lease itself was not sold or exchanged or canceled, but was merely amended so as to eliminate the provisions pertaining to the erection of the new building.

We held in Walter M. Hort, 39 B. T. A. 922, that the complete cancellation of a lease for a consideration paid to the lessor was not a sale or exchange of the lease and that the amount received by the lessor for such cancellation was ordinary income and not a capital gain.

In Fairbanks v. United States, 306 U. S. 436, the Supreme Court held that the redemption by a corporation of its outstanding bonds before their maturity date was neither a sale nor an exchange within the commonly accepted meaning of the words.

In Hale v. Helvering, 85 Fed. (2d) 819, it was held that a compromise settlement of promissory notes for an amount less than their face value was not a sale or exchange of capital assets giving rise to a capital loss deduction. In its opinion the court said:

* * * There was no acquisition of property by the debtor, no transfer of property to him. Neither business men nor lawyers call the compromise of a note a sale to the maker. In point of law and in legal parlance property in the notes as capital assets was extinguished, not sold. In business parlance the transaction was a settlement and the notes were turned over to the maker, not sold to him. In John H. Watson, Jr. v. Commissioner of Internal Revenue, 27 B. T. A. 463, overruling Henry P. Werner v. Commissioner of Internal Revenue, 15 B. T. A. 482, it was held that the payment at maturity, of the face amount of bonds purchased at a premium, was not a sale or exchange resulting in a capital loss. If the full satisfaction of an obligation does not constitute a sale or exchange, neither does partial satisfaction. * * *

We do not think that the petitioner’s agreement to accept a compromise payment of $35,000 in settlement of his claim against his lessee, and the lessee’s surety, for breach of a covenant of the lease was in any sense a sale or exchange of a capital asset.

Petitioner submits that the amount of $7,395 which he paid as a commission in subleasing the property to Barker Bros., Inc., constituted a part of the cost of the sublease, or the surety bond, or both, and should be applied against the $35,000 which he received in the transaction. This would be true if the payment of the $35,000 had been received in a sale or exchange or other disposition of the sublease but, as we have found, that is not what took place. The sublease was not disposed of by the petitions!’, but is still held by him. Moreover, there is no basis for an allocation of any portion of the $7,395 commission to that feature of the leasehold agreement pertaining to the erection of the building of the sublessee.

We find no error in the respondent’s determination that the entire amount of $35,000 represented taxable gain in 1935.

A further contention is made by the petitioner, that in any event the amount of $85,000 constituted community income under the laws of the State of California and is taxable to him and his wife in equal shares. Although the petitioner and his wife filed separate income tax returns for 1935, it does not appear that any portion of the amount of $35,000 was reported by the wife in her return.

It is plain from the facts above set forth, we think, that the leasehold interest which gave rise to the income in dispute was community property. It does not follow, however, that such income is not taxable to the petitioner in its entirety. For the law is well settled that the income from community property in the State of California acquired prior to July 29,1927, the effective date of the amendment to the code of California conferring a vested interest in community property upon each spouse (sec. 172 (a) of the California Civil Code), is taxable in its entirety to the husband. Hirsch v. United States, 62 Fed. (2d) 128; certiorari denied, 289 U. S. 735; Helen N. Winchester, Administratrix, 27 B. T. A. 798; Gouverneur Morris, 31 B. T. A. 178; Clara B. Parker, Executrix, 31 B. T. A. 644; Estate of J. Harold Dollar, 41 B. T. A. 869. Since the petitioner acquired the original leasehold interest as well as the sublease to Barker Bros., Inc., prior to July 29, 1927, all of the income therefrom is taxable to him individually.

It cannot be questioned, we think, that the $35,000 payment which the petitioner received from Barker Bros., Inc., was income arising from this leasehold interest. This amount was paid to the petitioner by his sublessee in settlement of its obligations under the leasehold agreement. In this respect it was no different from the rents or other revenue received under the leasehold agreement. In Sara R. Preston, 35 B. T. A. 312, 322, we said: .

The Board has consistently hold that the test of when property is acquired for the purpose of determining whether or not it is community or separate property is not the time of the vesting of the property in the husband or receipt of the income therefrom, but the time of the inception of the rights whereby income is earned. See John M. King, 26 B. T. A. 1158; affd., 69 Fed. (2d) 639; Helen N. Winchester, Administratrix, 27 B. T. A. 798; Gouverneur Morris, 31 B. T. A. 178; Albert J. Houston, 31 B. T. A. 188. The controlling principle is that as between husband and wife:
* * * when a right, legal or equitable, is acquired whether before or during marriage, all things of value into which the initial right develops by the performance of conditions, the running of time or the like, or into which it is converted by an assignment, or. if the initial right rests in obligation, all that which is obtained through the performance, discharge, satisfaction, enforcement or assignment of the obligation, are deemed in law to have been acquired as of the date of the acquisition of the initial right, and take the character, as separate or common, of that right. [Community Property — McKay, § 517.]

We sustain the respondent in his determination that the entire amount of $35,000 is taxable to the petitioner in 1935 as ordinary income.

Decision will be entered for the respondent.


text:
    Majestic Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96380.
    Promulgated September 3, 1940

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

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

Smith :

1. Depletion deduction. — In its income tax return for 1935 petitioner reported a net income of $10,531.83. This was after the deduction from gross income of a deplet..ion deduction of $13,213.10. The respondent disallowed the deduction of the claimed depletion allowance in the determination of the deficiency and determined a net income of $29,886.41. In his deficiency notice he stated:

(g) You deducted in your return depletion in an amount of $13,218.10, whereas no depletion is allowable as shown by the following computation:
Regular oil sales_$50,859.19
Less payments in oil (item i herein)_ 24,832.38
Corrected oil sales_$26, 026.81
Expenses_ 37,376.33
Net income_ None
Article 28 (m) — 4, Regulations 86.
* * * * ‡ * *
(i) Royalties paid in oil, pursuant to lease agreement with Shell Oil Company, constitute allowable deductions from your gross income in the amount of $24,882.38.
Section 23 of the Kevenue Act of 1934 provides in part:
In computing net income there shall be allowed as deductions:
* * * * * * *
(m) Depletion-. — In the case of * * ⅜ oil and gas wells, * * * a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. ⅜ * *
Section 114 (b) of the same revenue act provides in part :
(b) Basis roa Depletion.—
****** *
(3) Pebcentage depletion fob ore. and gas wells. — In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27½ per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 60 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.

It is the respondent’s position that the $63,500 received by the petitioner from Koyalty during 1935 was not “income from the property” within the meaning of section 114 (b) of the Kevenue Act of 1934; that the petitioner sold an economic interest in its lease’ with Shell to Koyalty, and that under the decision of the Supreme Court in Thomas v. Perkins, 301 U. S. 655, the petitioner is not entitled to depletion in respect of the $63,500 received from the sale of such economic interest.

The facts in this case are analogous to those in Ortiz Oil Co., 37 B. T. A. 656; affd. (C. C. A., 5th Cir.), 102 Fed. (2d) 508. In 1932 the Ortiz Oil Co. entered into contracts with three individuals whereby they furnished certain sums of money to the Ortiz Oil Co. for the purchase and development of oil and gas mining leases, on condition that it “pay and account” to them for specified proportions of the mineral production “if, as and when produced, saved and sold.” We held that the rights of the respective parties each constituted an economic interest in the oil production, and that the Ortiz Oil Co.’s gross income for the taxable year included only the portion of the proceeds from oil sales for which it was not required to account to the other parties; that the $154,000 which the company received from Westbrook and Thompson in payment of $350,000 oil payment thereafter to be made to Westbrook and Thompson was income of the Ortiz Oil Co. for the year 1932 as sale of a part of its properties, and that if the Ortiz Oil Co. were to reduce this $154,000 it would not be by way of depletion but by way of an allocated part of the cost of the original leasehold. We said:

* * * Proceeds from sales of production, therefore, constituted income to Westbrook and Thompson to the extent of the proportion received by them, and the balance only constituted gross income to petitioner. Thomas v. Perkins, 301 U. S. 655; Commissioner v. Elliott Petroleum Co., 82 Fed. (2d) 193; Commissioner v. Fleming, 82 Fed. (2d) 324; Commissioner v. Williams, 82 Fed. (2d) 328. Petitioner is entitled to a deduction for depletion computed on the basis only of the income received by it as its portion of the production in the taxable year. Palmer v. Bender, 287 U. S. 551. It is not entitled to allowance for depletion on the proceeds of the sale to Westbrook and Thompson. Cf. Commissioner v. Fleming, supra, which affirmed 31 B. T. A. 623; Darby-Lynde Co. v. Alexander, 51 Fed. (2d) 56; and Lester W. Fritz, 28 B. T. A. 408.

The petitioner attempts to distinguish the Ortiz Oil Co. case from the instant proceeding and says:

* * ⅜ The case [Ortiz Oil Co.] involved two contracts which the Board stated were indistinguishable as to facts and were governed by the same conclusions of law. Only parts of the contracts are quoted in the Board’s opinion. In the Staley contract (quoted on page 661), it appears that Staley was given “an undivided one half of all oil and/or gas produced, saved and sold from the following described tract of land * * * together with an undivided one half interest in and to the said oil and gas leases and leasehold estates thereupon.” The quoted portions of the Westbrook and Thompson contract do not disclose that the lease was assigned to them, but since the Board stated that there was no material difference between the two contracts, it may be assumed that the unquoted part of the contract provided that the lease in this instance was also assigned to Westbrook and Thompson. But the quoted portions of the contract do provide (page 659) that the agreement to pay and account to Westbrook and Thompson “for said proportions of the production from said leases and leaseholds shall constitute covenants rumrnng with the land." Furthermore, Ortiz Oil Company bound itself to warrant and defend forever the interests “herein obligated to the amount of said oil payment” unto the said Westbrook and Thompson. Such provisions establish the intent to convey an interest in the land. Such covenants and warranties do not appear in petitioner’s contract.

The Board is of the opinion that the distinction sought to be made between the Ortiz Oil Co. case and the proceeding at bar is without substance. Cf. Anderson v. Helvering, 310 U. S. 404.

There is no question in this proceeding but that the $63,500 received by the petitioner in 1935 from Boyalty is taxable income of the petitioner. It was not, however, from a sale of oil. The petitioner is not entitled to depletion in respect of the economic interest in the lease sold by it. We think that the respondent did not err in excluding from “income from the property” the $63,500 here in question. With the exclusion of such amount of $63,500 the petitioner had no net income for 1935 “from the property” and hence was not entitled to any depletion deduction for that year.

2. Depreciation allowance in respect of well drilling equipment.— At December 31, 1930, petitioner had on hand well drilling equipment which had an undepreciated cost of $15,087.79. This equipment was not used during the years 1931,1932, and 1933, but was in storage. The petitioner contends that this well drilling equipment suffered no depreciation during those years. The testimony is to the effect, however, that there was an obsolescence of this equipment of from 5 to 10 percent per year. The parties have stipulated relative to this point as follows:

* * * is is agreed that the undepreciated balance or unreeovered cost of said drilling equipment as per the books as of December 31, 1930 was $15,081.79, and that a reasonable depreciation rate on that equipment was 25 percent per year.

Upon the basis of this stipulation the respondent contends that the drilling equipment that was on hand at December 31, 1930, was fully depreciated prior to 1935 and that, even though the 25 percent annual rate was intended to apply only while the drilling equipment was in use, the facts show that the obsolescence deduction based upon original cost would show that the drilling equipment was fully depreciated at the end of 1934.

We sustain the respondent’s contention upon this point.

There is no question between the parties but that the petitioner is entitled' to some depreciation allowance in 1935 in respect of purchases of drilling equipment during the years 1934 and 1935. The respondent computed the depreciation allowance at $1,008.85. We are of the opinion, however, from the evidence, that a rate of 25 percent per year is reasonable and that the equipment purchased in 1935 should be considered as having been in use for a period of only six months. Upon this basis the correct depreciation allowance on drilling equipment for 1935 is $1,257.94.

3. Depreciation allowance in respect of San Joaquin lease equipment. — In the determination of the deficiency the respondent determined a depreciation allowance of $4,745.97 in respect of this equipment for 1935. On brief he admits that the depreciation allowance is in a greater amount. Both parties are agreed that the depreciation allowance for 1935 should be computed upon units of production. During 1935 it was determined that the total amount of recoverable oil from the San Joaquin lease was 750,000 barrels, 94,959 of which were produced in 1934 and 331,654 barrels in 1935. The total cost of lease equipment at December 31,1934, was $52,637.01. The salvage value of the lease equipment was stipulated to be 10 percent of the original cost. As we understand the respondent’s argu-meat, it is that a reasonable allowance for depreciation for 1935 is 331,654 „ , , , , . , , , ⅜50 000 °* cost °* ^8ase equipment to be recovered through depreciation allowances. The petitioner contends, however, that the 331654 allowance should be ggg ⅛8 denominator representing the oil reserves on January 1, 1935, and that the depreciation of $747 taken on the lease equipment in 1934 is not to be affected by the fact that in 1935, pursuant to an agreement of the parties, the depreciation allowance for 1935 and subsequent years is to be taken on units of production.

We are of the opinion that the correct depreciation allowance for lease equipment for 1935 should be computed as follows:

Total cost of equipment_$52,637.03
Less equipment in well No. 2 abandoned in 1935_ 8,437.86
44,199.15
Less salvage value of 10%- 4,419.92
Net depreciable cost_ 39,779.23
Less 1934 depreciation_ 747.00
39,032,23
Depreciation allowance on 1935 productionof $39,032.23_ 19, 762.43

We therefore hold that a reasonable allowance for the depreciation deduction on lease equipment for 1935 is $19,762.43.

4. The final question for consideration is whether the petitioner is entitled to deduct from gross income of 1935 the cost of casing, etc., which was lost in well No. 2, which became valueless to the petitioner in 1935. The respondent contends that the petitioner is not entitled to the deduction of this loss for the reason that it did not in 1935 notify the California authorities that it had abandoned well No. 2 and did not comply with the California statutes, which require that in the case of the abandonment of a well it must be cemented so as to prevent the penetration of water into oil sands. In reply to this argument the petitioner points out that the loss was actually sustained by the petitioner in 1935 and that the cementing of the well as required by the California authorities would simply mean an additional investment or loss to it in the completion of the abandonment.

The evidence conclusively shows that the petitioner had a loss of $8,437.86 on its equipment in well No. 2 in 1935. The well had turned to water and was valueless. We think that the loss was sustained by the petitioner in 1935 and that it is a legal deduction from the gross income of that year. In our determination of the depletion allowance in respect of the lease equipment above we have eliminated from the total cost of lease equipment ($52,631.01) the $8,437.86 loss sustained in 1935.

Decision will be entered under Bule 50.


author: Opper:

text:
    Irving Berlin, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 95236.
    Promulgated September 4, 1940.

      T. Newman Lawler, Esq., Arthur F. Driscoll, Esq., and Milton Bindler, G. P. A.., for the petitioner.

      Gomaay N. Kitchen, Esq., for the respondent.
   OPINION.

Opper:

The question is whether income’which petitioner received from the use of his songs in two motion pictures is taxable as capital gain or ordinary income. Petitioner took the former view and in his tax return the income, while conceded to be taxable in full, was treated as partly offset by capital losses. Respondent has determined a deficiency based on the assumption that petitioner’s compensation was ordinary income and that capital losses could not be deducted from it. The correctness of this action petitioner contests here.

The parties differ as to the character and proper interpretation of the contracts between petitioner and RKO pursuant to which he was engaged to supply the musical material for the two motion pictures in question. It is respondent’s contention that the contracts called for the rendition of personal services and hence that the compensation thereunder was clearly ordinary income, and that, if the contracts resulted in the acquisition by RKO of rights in petitioner’s property, the transaction was not a sale but merely a license, with the result that its proceeds are not to be treated as gains from the sale or exchange of capital assets. Petitioner on the other hand takes the position that all or, in the alternative, at least a considerable portion, estimated by him at 50% in one instance and 40% in another, of the materials supplied were capital assets and that the effect of the contracts was a sale thereof resulting in the receipt of capital gain.

Whether or not the contracts called solely for the rendition of personal services, it seems clear from their language and from the practical effect given to them in their performance by petitioner that some personal services on his part were involved. In order to comply with the provision that the material supplied by him be “necessary and suitable”, petitioner spent a large part of his time in attending conferences and rehearsals. Even if we assume that the original work of composition is not to be regarded as the rendition of personal services, the most that can be said of the contract is that it was a hybrid arrangement, dealing in part with capital assets and in part with the performance of some personal services. Whether the compensation received is susceptible of apportionment, and, if so, how this could be done, presents serious difficulties. And it seems equally difficult to regard the work involved in such composition as other than the rendition of services of an intensely personal nature. It is true that to some extent, and presumably as the result of chance circumstance, the petitioner had on hand, material resulting from his creative work in earlier years which was available for and was adapted to use in the performance of the contract. But this was not called for thereby, and there can be no question that if petitioner had furnished suitable musical material which was the result of his current efforts' his performance under the contract would have been complete. It seems questionable in the extreme whether the purely fortuitous contribution by petitioner of the result of labors performed by him in previous years is sufficient to transmute the present contract, even in part, into one resulting in the disposition of capital assets, assuming that unpublished or uncopyrighted musical and literary works can be considered as such.

These, however, seem to us questions which it is unnecessary to decide in this proceeding. For it is not sufficient to grant that the contracts dealt with capital assets. In order for income to be available for offset by capital losses there must be capital gain from “sales or exchanges” of such assets. See 2 Paul & Mertens “Law of Federal Income Taxation”, 532; Henry Harmel, 19 B. T. A. 376; affd., 287 U. S. 103. We think the respondent is correct in suggesting that this was no sale, but at most a mere license to US9 the material in connection with specific motion picture productions. While there is no magic in words, and to call the contracts “licenses” rather than “sales” advances us little; yet the term is but a shorthand expression of the nature of the ultimate transaction, which, in its essence, appears not to be the final disposition of anything, but a mere permission to use, in a restricted field and for a specific purpose, for a stipulated sum. The rights granted by petitioner under the contracts were limited to the use of the material in question in the motion pictures under production, and in the advertising and exploitation thereof. Such rights in the words and' music of the songs as were not expressly granted or limited by the contract were retained by petitioner, even including the right to license their use in other motion pictures. The copyrights were to be his and assignment of rights thereunder to the motion picture company was confined to those expressly granted in order to fulfill the purpose of tbe contract. In these circumstances “the author remained the owner of his works and merely licensed their use for a particular object for a period. There was no transfer of title necessary to a complete sale.” Sabatini v. Commissioner, 98 Fed. (2d) 753 (C. C. A., 2d Cir.). Accordingly, we conclude that the income in question is not to be regarded as capital gain but is subject to treatment as ordinary income.

Decision will be entered for the respondent.

       Petitioner characterized it as “very difficult to answer” and his own estimate as “only a guess.”

       Revenue Act of 1934, sec. 117 (d).

       So much is almost conceded by petitioner, for in seeking to demonstrate that these were not personal service contracts his brief states: “the sole right obtained by RKO was the right to use the songs in motion pictures,” and distinguishes the case of an employee where “the author had parted with his entire property in the work and had no interest l^ft * * *.” Shapiro, Bernstein & Co. v. Bryan, 27 Fed. Supp. 11.


text:
    American Society of Cinematographers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96411.
    Promulgated September 4, 1940.

      Edward L. Conroy, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Smith :

The petition filed in this proceeding alleges error upon the part of the respondent as follows:

(a) Determination that petitioner is not exempt under § 101, Revenue Act of 1934.
(b) Including as taxable income amounts contributed to a segregated fund used only as a disability and death benefit fund for the petitioner.

Section 101 of the Revenue Act of 1934 provides in part as follows:

The following organizations shall be exempt from taxation under this title—
(1) Labor, agricultural or horticultural organizations;
*******
(6) Corporations, * * * organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, ⅜ * * no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation;
(7) Business leagues, chambers of commerce, real-estate boards, or boards of trade, not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

On brief the petitioner argues that it falls under one or more of the classifications above referred to. It is organized as a nonprofit organization under the laws of California and one of its objects is to bring together cinematographic artists “in order that by the free and untrainmeled interchange of ideas and experiences the Art of Cinematography shall be advanced.”

Although the activities of the organization partake somewhat of the nature of a labor organization and of a business league, we think that the organization properly falls in the class of corporations organized and operated exclusively for scientific purposes. If it properly falls in that class, it is not to be denied exemption from tax because its activities to some extent show it to be a labor organization or a business league.

In his deficiency notice the respondent does not state the grounds for denying exemption from income tax. On brief he contends that the petitioner is not entitled to exemption as a corporation organized and operated exclusively for scientific purposes because of the fact that it publishes a monthly magazine called “The American Cinematographer”, from which it derived a small amount of income during the taxable year ended March 31, 1936.

The evidence shows that this magazine was at its inception an organ for the dissemination of scientific information to its members. This membership was not limited to persons living in Los Angeles or the immediate vicinity. The problems which were met by the directors of photography or first cameramen were not problems restricted to the directors of photography in the studios which centered in the Los Angeles area. The magazine is concerned exclusively with the publication of articles which are of assistance to its members and to news cameramen throughout the world. It was never expected that the magazine would be operated at a profit to the membership and the evidence shows that over a period of 14 years it operated at a loss of $2,333.92.

The courts have uniformly held that the destination of the income rather than the source is the ultimate test of exemption. See Trinidad v. Sagrada Orden De Predicadores, 263 U. S. 578. In that case the collector claimed that a religious corporation had lost its exempt status because it owned and operated large properties in the Philippines, consisting of real estate and stocks in private corporations, and loaned money at interest. The Supreme Court held, however, that the corporation was operated exclusively for religious purposes and that it did not lose its exempt status because it realized profits from certain enterprises which were devoted to the objects of the order. The destination of the income was held to be the factor of prime importance.

In Unity School of Christianity, 4 B. T. A. 61, the respondent contended that the corporation was not exempt from tax because it had been formed under the business corporation law of Missouri and that because it published various magazines and operated a cafeteria, farm, reading room and library, it was not exempt from tax. We reversed the respondent’s determination.

Roche’s Beach, Inc. v. Commissioner, 96 Fed. (2d) 776, involved the question of whether a corporation organized for the purpose of being the medium through which a charitable foundation could operate property and collect the income therefrom was exempt from taxation. The function of the corporation consisted of operating a bathing beach business of 3,000 bath houses, which were rented to transient bathers and accommodated as many as 6,000 bathers a day. The income of the corporation for 1931 was more than $85,000. In determining that the corporation was exempt, the court held that, while to gain exemption the corporation must be operated as a charitable corporation and no part of its earnings could inure to the benefit of any private shareholder, yet the exemption statute should not be narrowly construed. To the same effect see Sand Springs Home, 6 B. T. A. 198.

We do not think that the petitioner is to be denied exemption from tax because of the publication of a magazine, the American Cinematographer. The publication of the magazine was necessary for the advancement of the art of cinematography. It was not published for profit.

The respondent also points to the fact that the petitioner made assessments upon its members for the purpose of establishing a fund for the payment of a benefit to totally disabled members and, in the case of the death of a member, to such member’s family or beneficiary. He contends that such an activity is incompatible with the petitioner’s claim that it ,is operated exclusively for scientific purposes.

In Harrison v. Barker Annuity Fund (C. C. A., 7th Cir.), 90 Fed. (2d) 286, the question before the court was whether a corporation organized for nonpecuniary purposes under the statutes of Illinois was exempt from tax. The United States District Court held it to be exempt from tax. The United States Circuit Court of Appeals affirmed. A part of the income from the corporation was used to pay pensions to employees of the Haskell & Barker Car Co., in which Katherine Barker Spaulding, the principal donor of the funds, had had a very substantial interest. The donor no longer had any interest in the formerly existing Haskell & Barker Co. She was related in no way to the beneficiaries and knew none or few of them, but was inspired to reward the faithful employees of the company which had ceased to exist. The court held that the corporation was operated exclusively for charitable purposes within the meaning of the statute.

We think that the petitioner did not forfeit its claim to exemption because of the operation of the emergency fund. It was merely incidental to the general purposes of the organization. Moreover, it is to be noted that the petitioner acted merely as a trustee of the emergency fund.

Since the petitioner contends that not only is it not liable for any deficiency but is entitled to a refund of the tax paid,

Decision will be entered under Rule SO.