author: Murdock:

text:
    Jacob Epstein, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70099.
    Promulgated June 15, 1937.

      Hugh Satterlee, Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $27,476.45 in income tax for the year 1929. The parties are in agreement that the Commissioner erroneously disallowed a deduction for contributions. They are prepared to make a proper adjustment of that item following this report. The Board is asked to determine the basis applicable to shares of stock of five corporations, which shares the petitioner sold in the taxable year and, if it is material, to determine also what portion of the gain is capital gain and what portion is ordinary income. The facts are not in dispute and have been stipulated. They need not be set forth in detail herein.

The petitioner in October 1929 sold 1,000 shares of the stock of the Chase National Bank for $198,452. He owned other shares of the same stock at that time. He had purchased at different dates and at different prices lots of stock of the Chase National Bank and of the National Park Bank prior to August 1929. The two banks were merged or consolidated in August 1929, under Federal law, to form a new corporation. Northwest B(incorporation, 33 B. T. A. 160, 171 and cases.there cited. The shares which the petitioner sold thereafter in 1929 were shares in the new bank which he received or was permitted to retain because of his stockholdings in the two combining banks. The Commissioner contends that the stock sold must be charged against the earliest purchases of stock of the combining banks; that is, he has applied article 58 of Regulations 74, his so-called “first in, first out” rule. The petitioner contends that the stock which he sold in 1929 was acquired by him in 1929 as a result of the combination of the two banks, and he is entitled to use, as his basis for gain or loss on his shares thus acquired, the average cost of all shares in the new bank acquired at that time. He obtains this average cost by adding up the cost of all shares of old Chase National Bank stock and of the National Park Bank stock which he owned at the time of the consolidation, and dividing by the number of new shares of Chase National Bank stock which he had immediately after the consolidation.

The parties agree that the Board has already decided this question in favor of the taxpayer and that decision has been approved by several of the Circuit Courts of Appeals. Christian W. Von Gunten, 28 B. T. A. 702; affd., 76 Fed. (2d) 670; Olive Hume Oliver, 30 B. T. A. 1381; affd., 79 Fed. (2d) 561; Helvering v. Stifel, 75 Fed. (2d) 583, affirming an unpublished decision of the Board. It follows that the Commissioner erred in applying the first in, first out rule, since the average cost is the correct basis.

The petitioner also sold in the latter part of 1929 a number of shares of stock of the following banks: National City Bank, Corn Exchange Bank & Trust Co., Irving Trust Co., and United States Fidelity & Guaranty Co. Most of these shares were received by the petitioner upon a recapitalization of each of the corporations earlier in 1929. In those recapitalizations there was no change of incorporation, but merely a change in the par value of the shares. The petitioner contends that the average rule should likewise be applied in computing his gain on those shares. The Commissioner again used his first in, first out rule. The petitioner concedes that the shares sold are not identifiable with any particular lot purchased and he also concedes the correctness of the Commissioner’s mathematics in applying the first in, first out rule. The parties concede that the Board has decided this question in favor of the Commissioner’s use of the first in, first out rule. Several courts have approved this decision of the Board. William P. Jenks, 22 B. T. A. 910; Robert E. Ford, 38 B. T. A. 1229; Solomon B. Krauss, 33 B. T. A. 1088; affd., 88 Fed. (2d) 616; Keeler v. Commissioner, 86 Fed. (2d) 265, affirming an unpublished decision of the Board; Skinner v. Eaton, 45 Fed. (2d) 568; certiorari denied, 283 U. S. 837.

The petitioner concedes that if it is proper to apply the first in, first out rule in determining the cost of the four blocks of stock discussed in the preceding paragraph, the Commissioner has made no mathematical error and furthermore has properly determined what part of the gain from the disposition of those blocks of stock •was capital gain and what part was ordinary income. It now appears that the Board has approved the average cost basis in the case of the Chase National Bank stock and has completely approved the Commissioner’s determination in regard to the taxation of the gain from the other four blocks of stock. The petitioner states in his brief that if such should be the conclusion of the Board, it will be unnecessary and immaterial to determine what paid of the gain from the disposition of the Chase stock should properly be classified as capital gain and what part should properly be classified as ordinary gain. He points out that no matter how the gain from the Chase stock be treated, the tax in this case will be computed on capital gain of $412,639.91. The reason for this is that there will be a loss shown in the ordinary income of this petitioner regardless of whether all, a part, or none of the gain from the disposition of the Chase stock be classified as ordinary income. That loss will be deducted from the capital gain and the tax computed on the remainder. The shifting of the gain from the Chase National Bank stock from capital gain to ordinary income, or vice versa, leaves unchanged the net amount subject to tax at 12 ½ percent.

Under the circumstances the Board is not required to decide what part, if any, of the gain on the disposition of the Chase stock was capital gain and what part, if any, was ordinary income. Any decision of that question by the Board would be obiter dictum. The. Commissioner has never acquiesced in the Von Gunten decision, has never recognized the propriety of using average cost in such a case, and has never promulgated regulations providing how the total gain is to be allocated between capital gain and ordinary income where the holding period on some of the shares is in excess of two years. The promulgation of some regulation on this subject by the Commissioner would appear to be highly desirable if the principle of the Von Gunten case is to stand. The Board is not called upon at this time to approve any method of allocation between capital gain and ordinary income and will not decide that question until it is required to do so.

Decision will be entered under Rule 50.

       Although the Board applied the averaging rule under somewhat similar circumstances in one phase of the case of Olive Hume Oliver, supra, and in the case of Alvan T. Fuller, 31 B. T. A. 154, it is satisfied that it erred in those cases. The Fuller case has been reversed and, although the Oliver case was affirmed by the Third Circuit, the court was apparently thinking and speaking of a situation where there was a change in the corporation as opposed to a mere change in the par value of stock.


source: Caselaw Access Project

license: Public Domain

text:
    George H. Stanton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62100.
    Promulgated June 15, 1937.

      George H. Stanton pro se.

      Philip A. Bayer, Esq., for the respondent.
   OPINION.

Murdock:

The petitioner, when he acquired controlling interests in the two banks, entered into the transactions for profit. The stock in the two banks became worthless prior to the taxable year 1929. The Commissioner does not dispute either of these points. He contends that the transfer by the petitioner of his property in trust in 1924 represented payment by him of legal obligations which he had as a stockholder and officer of the banks, increased the cost of his worthless bank stock, and represented a loss sustained by him at that time. If the petitioner had made an absolute and complete transfer of his property in 1924 the Commissioner’s theory of this case "would be correct. But the petitioner did not make an absolute and complete transfer of his property at that time. Instead he placed it in trust that he might be permitted to liquidate the assets of the two banks as best he could and that the depositors and creditors of the bank might be protected in case he should be unable to liquidate the assets of the banks for an amount sufficient to pay their claims. The trustees had no power to use the property to pay claims without his consent for the first five years. Had he been able to liquidate the assets of the banks for an amount sufficient to pay the claims in full, then his property would have been returned to him and he would have had no loss whatsoever. Likewise if some part of his property had not been needed to pay the claims it would have been returned to him. His loss was not sustained and could not have been computed prior to 1929.

The property in question was used by the trustees with his consent in 1929, prior to the end of the five-year period. Its use then was a continuation of the transactions originally entered into for profit when the petitioner acquired the stock of the two banks. Such use in 1929 was the equivalent of the payment by the petitioner of additional amounts as cost of his bank stock. The bank stock was already worthless. These additional payments were lost as soon as they were made. The Commissioner does not question that they were made because of the petitioner’s legal liability as a stockholder. Thus the petitioner had additional losses on his bank stock in 1929, when for the first time his property was absolutely committed to and actually used in the discharge of his legal obligation.

The only remaining question is, How should his loss be computed ? Since the property was sold in 1929 and the proceeds used in the same year, the answer to this question is simple. The amount which he is entitled to deduct in 1929 is his basis for gain or loss upon the properties disposed of. If any of the properties were sold for more than their bases to the petitioner, he would have to report that gain before he could claim a loss in excess of basis. Likewise, if any properties were sold for less than their bases to the petitioner he would be entitled, in one way or another, to deduct a loss in 1929 equal to the exact amount of the bases which the properties had in his hands. The return filed showed no tax due. Since his basis for gain or loss on these properties far exceeded the net income as determined by the Commissioner, it follows that there is no deficiency.

Decision will be entered for the petitioner.


author: Sternhagen:

text:
    Huntington-Redondo Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82366.
    Promulgated June 15, 1937.

      Bayley Kohlmeier, Esq., for the petitioner.

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

Sternhagen:

The Commissioner determined a deficiency of $1,267,95 in petitioner’s income tax for 1932. He determined that $64,715.97 received by petitioner in 1932 should be regarded as interest $7,704.18 and sale price of land $57,011.79, of which $46,554.69 was profit. The petitioner urges that it correctly treated the amount on its return as $63,314.92 received in repayment of loans and $1,401.05 -as interest thereon. The facts are all presented in a written stipulation.

The petitioner in 1927 sold a tract of land in Los Angeles County, California, to Clifford It. Reid, Inc., for $1,209,000, to be paid $234,400 down in 1927 and the rest, with interest, during succeeding years out of the proceeds of sales or leases of lots and improvements. Petitioner’s cost basis of the tract was $221,785.31, or 18.342 percent of the sale price, and that percentage of each installment payment was therefore treated as cost and the rest gain. The land was conveyed in trust to the Los Angeles First National Trust & Savings Bank, which was to hold the title in trust and receive the payments from Reid, Inc., and pay them to petitioner to be applied to the sale price and interest.

At various times in 1931 petitioner had loaned money to Reid, Inc., aggregating $63,314.92, which it was understood should be repaid from the proceeds of the tract.

In 1932 the trustee paid petitioner $64,7.15.97, pursuant to the trust, and petitioner in its accounts allocated this, $57,011.79 principal of purchase price of tract, $5,337.84 interest on an earlier note of 1930, and $2,366.34 interest on the 1931 loans. Thereafter, on December 22, 1932, petitioner and Reid, Inc., agreed in writing upon a system •of allocating payments received from the trustee, including the $64,715.97, according to a prescribed schedule. In conformity with this agreed schedule, petitioner, before the end of 1932, made the proper accounting entries to change the above allocation of the $64,715.97 and to allocate it according to the agreement, $63,314.82 to principal of the 1931 loans and $1,401.05 to interest on such loans.

Petitioner’s accounts were kept on the cash receipts and disbursements basis.

On its income tax return it omitted from income the $63,314.92, treating it as repayment of money loaned, and included in income the $1,401.05 as received interest.

The only question is whether the petitioner is bound by its first accounting allocation to include in its 1932 income $46,554.69 as the properly computed gain on the sale of land, and $7,704.18 as interest on notes, as the Commissioner has determined, or is free for tax purposes to change the allocation before the end of the year to accord with its agreement. No one challenges the binding force of the supplementary agreement prescribing the allocation. Deering’s Civil Code California § 1479; Cardinell v. O'Dowd, 43 Cal. 586. Under it, Reid, Inc., could not thereafter contend that it had paid any part of the $64,715.97 as purchase price of the tract, and petitioner could not insist that the 1931 loans had not been paid. The parties to these transactions had a right to earmark the payments and to regard, with binding force, the petitioner’s first accounting allocation as a mistake. Whenever the revenue act has deprived taxpayers of the right to earmark, it has done so in clear language, as in respect of the source of corporate dividends, Revenue Act of 1928, sec. 115 (b).

So long as the correct and final allocation was made by the taxpayer within the year of' the receipt, there is no reason why the return should not be made in accordance with the correct entry. The reasoning is similar to that used heretofore to relieve a taxpayer from tax on that part of a salary which within the year was restored to the employer. Albert W. Russel, 35 B. T. A. 602; see O. B. Barker, 3 B. T. A. 1180; Carey Van Fleet, 2 B. T. A. 825.

Judgment will be entered for the petitioner.


author: Disney:

text:
    Mark A. Mayer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78980.
    Promulgated June 15, 1937.

      Herbert L. Swett, Esq., for the petitioner.

      Clay G. Holmes, Esq., for the respondent.
   OPINION.

Disney:

The respondent has determined a deficiency of $311.05 against the petitioner for 1932. The question is whether the net loss of Fleischner, Mayer & Co., a partnership of which the petitioner was a member, should include income and deductions of the Northwest Real Estate & Investment Co., a corporation. The facts were stipulated.

The partnership, formed many years prior to 1897 and having its principal business in Portland, Oregon, owned the premises upon which its office and warehouse were located, and other real estate which it acquired in settlement of accounts and notes receivable. In 1897 the partnership organized the Northwest Real Estate & Investment Co. under the laws of Oregon, and transferred to the corporation all of the real property then owned by it. Thereafter the partnership acquired no real estate in its own name, and whenever it settled accounts with customers in exchange for real estate or acquired real property for the needs of its business, title was taken in the name of the corporation. Any money necessary to acquire the property was supplied by the partnership. The partnership has at all times owned all of the stock of the corporation except qualifying shares outstanding in the names of the managing partners, which were beneficially owned by the partnership.

The corporation transacted no business of any kind and was at all times a holding company. It never owned any real estate other than parcels acquired in the manner set forth above. The corporation did not keep books of account, and has not at any time had an office, employees, agents, or a bank account. Items of income from its real estate were entered in the books and deposited in the bank account of the partnership and treated the same as other income of the partnership. Expenses relating to the property were paid by, and proceeds of sales were paid to, the partnership. Separate accounts were kept in the books of the partnership for each item of real estate held by the corporation. The partnership dealt with the property the same as it did with assets to which it had legal title.

The purpose of forming and continuing the existence of the corporation was for the convenience of the partnership in handling the property, including conveying title, and avoidance of title complications in the event of death of a partner.

The information returns of the partnership included the income and expenses of the corporation the same as if the real estate were owned by it. This fact was explained in each income tax return filed by the corporation, commencing in 1920, by notations attached thereto reading substantially as follows:

The Northwest Real Estate & Investment Company is a corporation whose stock is owned exclusively by the partnership of Fleischner, Mayer & Co. and it acts only as a holding company for the real estate belonging to that firm. It does not deal in real estate. The corporation does not keep books of its own. All of its transactions are recorded in the books of Fleischner, Mayer & Co. and are treated as part of the operations of that partnership.

The distributions made to the petitioner and other partners of partnership income did not distinguish between partnership income and income or proceeds derived from real estate held by the corporation.

The partnership discontinued its business in 1930 and ever since has been engaged in liquidating its affairs, including the real estate held in the name of the corporation. It did not alter the method of keeping its books or the manner of handling the real estate of the corporation.

Ordinarily corporations are held to have a legal existence for income tax purposes separate from their stockholders. See Eisner v. Macomber, 252 U. S. 189; Dalton v. Bowers, 287 U. S. 404; Burnet v. Commonwealth Improvement Co., 287 U. S. 415. The courts and this Board have looked through form and regarded substance where the facts were peculiar. See North Jersey Title Insurance Co. v. Commissioner, 84 Fed. (2d) 898; 112 West 59th St. Corporation v. Helvering, 68 Fed. (2d) 397; Stewart Forshay, 20 B. T. A. 537; Moro Realty Holding Corporation, 25 B. T. A. 1135; affirmed per curiam, 65 Fed. (2d) 1013; Greenleaf Textile Corporation, 26 B. T. A. 737; affirmed per curiam, 65 Fed. (2d) 1017; Southern Pacific Co. v. Lowe, 247 U. S. 300; Gulf Oil Corporation v. Lewellyn, 248 U. S. 71; United States v. Jelenko, 23 Fed. (2d) 511; Thrift Realty Co., 29 B. T. A. 545. The question here must turn upon whether the facts warrant ignoring the form of the two separate entities.

In North Jersey Title Insurance Co. v. Commissioner, supra, the petitioner, to avoid jeopardizing its business by a disclosure of the fraudulent circumstances of some of its investments, formed a corporation, known as the Belhall Co., to acquire and deal with the properties for it. All of the stock of the Belhall Co., except one share to qualify the holder as a resident officer, was held by the petitioner. The corporation had no paid officers; only two paid employees, and obtained needed funds from the petitioner without interest. The petitioner kept separate books for the Belhall Co. and did all of the work of the corporation without charge. In holding that while in form two separate entities existed, in substance it was but one enterprise, the court said:

The principle that substance and not form should control in the application of income tax law is fundamental. Fictional corporate camouflage cannot be made the device to escape taxation. On the other hand equal equity demands that the creation of a subsidiary corporate structure with no purpose of evading tax but solely for the purpose of meeting the exigencies of a serious and possible fatal financial situation should not be regarded as the birth of a new entity completely unidentified with the former for taxing purposes, particularly under the peculiar circumstances surrounding the instant case.

In 112 West 59th St. Corporation v. Helvering, supra, counsel for a Massachusetts trust, to facilitate a contemplated resale of property, formed the petitioner corporation to hold and convey title to a parcel of real estate during absences abroad of the principal trustee of the trust. The petitioner never had funds; it kept no books, and held no stockholders’ meetings. The purchase money for the property acquired in 1919 was paid directly to the seller by the trust, and on the sale thereof in 1921 the selling price was paid directly to the trust. The trust paid the carrying charges for the property while the petitioner held title. The corporation’s officers and directors were employees of the law firm in which the transaction was carried out. The court taxed the trust on the gain realized from the sale on the theory that the trust had the beneficial interest therein, and used the corporation merely as a “conduit.”

There is no suggestion that the corporation was organized and continued in existence for anything other than the mere purpose of holding bare legal title to real estate acquired with consideration furnished by the partnership. The partnership at all times treated the corporation as existing in name only and regarded the activities -of both entities as a single enterprise. The corporation did not function as such, except in taking and conveying title to real property as a convenience for the partnership. The partnership having supplied the consideration paid for the property of the corporation, it was the beneficial owner of the corporate assets. Neppach v. Norval, 116 Or. 593; 240 Pac. 883; Rhodes v. Peery, 142 Or. 165; 19 Pac. (2d) 418; Blacklaw v. Blachlaw, 150 Or. 244; 44 Pac. (2d) 728.

Recognition by the partnership of no material distinction between its activities and those of the corporation has been continuous since the creation of the corporation, and since 1920 with the knowledge of the Commissioner. In the absence of anything of record or in the briefs to the contrary, we may assume that the partnership’s treatment of the operations of the corporation as its own from 1920 to the taxable year has never been questioned by the Commissioner. The peculiar circumstances present in the case do not, in our opinion, warrant a holding that for the taxable year the corporation should be treated as a. taxable entity separate from the partnership. Accordingly, and pursuant to the stipulation, we .find that, the partnership sustained a net loss of $16,995.25 in 1932.

Decision will be entered under Rule 50.


author: Sternhagen : Leech,

text:
    George Hyatt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82594.
    Promulgated June 15, 1937.

      A. John Pfeiffer, G. P. A., for the petitioner.

      Hugh Brewster Esq., for the respondent.
   OPINION.

Sternhagen :

The petitioner contends that, because of his contract with the Bruce Co., 10 percent of each customer’s contract price must be regarded when received by him as being in trust and therefore not within his income. He relies upon Commissioner v. Cleveland Trinidad Paving Co., 62 Fed. (2d) 85; Benjamin Franklin Patterson, 21 B. T. A. 8; petition for review dismissed, 59 Fed. (2d) 1055. In those cases, however, the customer retained an amount to assure the performance of the contract, and it was held that while so rightfully retained by the customer the amount could not be properly regarded as the contractor’s income. Here, however, the contractor, the petitioner, collected the contract price from the customer and accounted for it on his books immediately as his own. An amount of $1,760.12 was sent to the Bruce Co. “on account of the escrow fund”, but it does not appear how this amount was computed.

As between the petitioner and his customer, it would appear that the petitioner rightfully received the full amount in consideration for the contract. The obligation to the Bruce Co. in respect of part of the contract price was only an obligation to make a deposit in escrow to be held by the Bruce Co. during the term of the guarantee of the contract. Certainly such amounts as the petitioner omitted to transmit to the Bruce Co. could not be omitted from his income. Consolidated Asphalt Co., 1 B. T. A. 79; Uvalde Co., 1 B. T. A. 932. Cf. Preston R. Bassett, 33 B. T. A. 182, 191 (on review C. C. A., 2d Cir.); Gibbs & Hudson, Inc., 35 B. T. A. 205. As for the $1,760.12 actually transmitted, it likewise was no less owned by the petitioner, even though subject to temporary possession in the escrow fund of the Bruce Co. Whether this fund, while in the possession of the Bruce Co., was diminished by expenditures made in discharge of the guarantee, thus giving rise to statutory deductions in subsequent income tax returns, needs not to be considered now.

It cannot be said, therefore, that the Commissioner erred in failing to readjust petitioner’s income by excluding or deducting any part of the $4,340.91.

The Commissioner seems to have treated the amount paid by the petitioner in the taxable year as his share of the premiums upon the surety bonds as an advance premium amortizable over the five-year period of the bonds, and has allowed the deduction of only the proper amount of annual amortization. Upon this point the facts do not appear clearly enough from the evidence to justify a finding, and for that reason alone the petitioner must fail. On principle, however, it cannot be said that, to a taxpayer whose accounts are kept on an accrual basis, the premium on a five-year surety bond may be deducted in its entirety in the year when paid. Cf. G. C. M. 13148, XIII-1 C. B. 67.

Reviewed by the Board.

Judgment will be entered for the respondent.

Leech,

dissenting: It seems to me that petitioner, during the tax year, never received, as his own, the $1,760.12 he paid to E. L. Bruce Co. That money was not then subject to his “unfettered command * * * to enjoy at his option”, as the Supreme Court said in Corliss v. Bowers, 281 U. S. 376. He received it merely as agent for his customers to pay to the Bruce Co. for the account of those customers under the contract of purchase. As to that item, I think the case is controlled by Commissioner v. Cleveland Trinidad Paving Co., 62 Fed. (2d) 85, and Benjamin Franklin Patterson, 21 B. T. A. 8; petition for review dismissed, 59 Fed. (2d) 1055. Cf. Stoner v. Commissioner, 79 Fed. (2d) 75; reversing 29 B. T. A. 953.

Black and Arundell agree with this dissent.


author: Arundell: Murdock,

text:
    International Cigar Machinery Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 71331, 76285.
    Promulgated June 16, 1937.

      Robert H. Montgomery, Esq., Thomas G. Haight, Esq., J. Marvin Haynes, Esq., and James 0. Wynn, Esq., for the petitioner.

      P. M. Clark, Esq., and S. B. Pierson, Esq., for the respondent.
   OPINION. ■

Arundell:

The net income determined by the respondent in the deficiency notice for 1929 will be adjusted for depreciation on tools, jigs, dies, and patterns and for additional New York State franchise taxes, in accordance with paragraphs 11 and 13 of the agreed statement of facts set forth in the findings, in the recomputations to be made under Rule 50.

The principal issue arises out of the respondent’s treatment of the lump sum payments received by the petitioner from cigar manufacturers. The Commissioner in determining the deficiency treated them as advance rentals or bonuses for the use of patents. The petitioner has never treated them on its books or in its returns as income.

The petitioner contends that its method of accounting and reporting clearly reflects its income and is in accordance with good accounting practice, whereas the respondent’s proposed treatment is not. The petitioner’s books have reflected as income from royalties the periodic sums paid to it by the cigar makers based on the number of cigars manufactured and these amounts have been returned as income. Petitioner’s books and returns have also carried as income the fair value of the machines repossessed in the few cases of bankruptcy of cigar manufacturers. The immediate question for decision is whether the carrying of these items on petitioner’s books correctly reflects the income from the patents or whether there should also be included the lump sum payments in order to clearly reflect income.

Section 41 of the Revenue Act of 1928 provides in part as follows:

The net income shall be computed * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the Income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income * ⅜ *.

Article 823 of Regulations 74 reads in part as follows:

Act. 323. Methods of accounting.—It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems of accounting- as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so.

Under similar provisions of other statutes, it has been said that “the method employed by the taxpayer is never conclusive.” Brown v. Helvering, 291 U. S. 193. On the other hand, it has been said that the requirement that the method of accounting clearly reflect income means only “that the books shall be kept fairly and honestly. * * * In other words, the books are controlling, unless there has been an attempt of some sort to evade the tax.” Osterloh v. Lucas, 37 Fed. (2d) 277.

There is no question as to what the petitioner has done in this case. It has computed its net income in accordance with the method of accounting regularly employed in keeping its books. Consequently, we have the narrow question of whether that method clearly reflects income.

At the outset, we are clearly of the opinion that the lump sum payments are not in the nature of rentals or royalties. Rentals or royalties are paid for the use of property. The lump sum payments here were made for the construction of a capital asset for the use of which royalties were paid. The situation here is somewhat like that in Duffy v. Central Railroad Co., 268 U. S. 55, where the lessee of a railroad under the terms of the lease spent a substantial sum for additions and betterments and construction of a pier. The lessee sought a deduction for such expenditures under the provisions of the 1916 Act which included “rentals” among ordinary and necessary business expenses. The deduction was disallowed, the- Court saying: “The term ‘rentals’, since there is nothing to indicate the contrary, must be taken in its usual and ordinary sense, that is, as implying a fixed sum or property amounting to a fixed sum, to be paid at stated times for the use of property.” From the viewpoint of the lessor it is now held that improvements to leased premises made by the lessee currently give rise to income to the lessor only to the extent of either (a) value of the improvements subject to the lease, or (b) an aliquot part of the depreciated value at the expiration of the lease. Emma C. Morphy, 35 B. T. A. 289. Applying either of these methods, there is nothing for this petitioner to report, as the useful life of the machines was shorter than the term of the lease. In this case the lessee, that is, the cigar maker, pays for the cost of construction, of a machine that he desires to lease on a royalty basis just as the lessee in the realty lease case pays the cost of erecting a building which, with the land, it rents for periodic cash rentals. If in this case the construction costs had been paid by the cigar makers directly to the American Machine & Foundry Co., then clearly, under the principle of the realty lease cases, they would not be income to the petitioner. The substance of the transaction is not changed by having the construction costs pass through petitioner’s hands under a system whereby it did not profit from the funds.

In all the years of petitioner’s operation it has never in fact made, a profit from the receipt and disbursement of the lump sum payments. Where there is in fact no profit, the income would be distorted rather than clearly reflected by including in income accounts! the non-profit items. Of course, methods of accounting may differ but they may still arrive at the same net income. This is contemplated by both the statute and regulations quoted above. There is testimony in this case by well qualified accounting experts that it might have been proper to treat the lump sum payments as deferred income spread over the life of the contracts and to deduct an equivalent amount annually for depreciation of the machines. The result reflected on the books under that system would be precisely the same as under the petitioner’s method. There would be no income reflected for any year or any cycle of years. The advantages of petitioner’s method over that of charging on and charging off over a period of years are its simplicity and exactness. Under the other method the accounts would need be carried over a period'of years and if the useful life of the machines was not exactly coextensive with the contract period adjustments would need to be made to reflect the difference. The life of the contracts in this case would be difficult to determine in view of the provision that they were to continue in effect during the life of the patents in existence covering the particular machine and further for the life of any additional patents that might be granted on any new parts, attachments, or improvements that might be made or added to the machine. The lives of the contracts have been repeatedly extended by reason of the issuance of new patents. Approximately 50 such patents have been issued to the petitioner. A typical example is that of the “Cross Feed.” The patent on the cross feed was issued in 1929 and that improvement was attached to 99 percent of the machines in the hands of cigar makers, thus prolonging the lives of the 99 percent of the contracts beyond the useful life of the machines.

Section 41 of the Revenue Act of 1928 quoted above does not require any particular method of accounting. The Commissioner’s regulations recognize that no uniform method of accounting can be prescribed for all taxpayers and that the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. We have had occasion to refer with approval to similar provisions of earlier regulations. The one qualification to the broad rule of the regulations is that the method adopted meets the statutory requirement of clearly reflecting income. Ribbon Cliff Fruit Co., 12 B. T. A. 13; H. Stanley Bent, 19 B. T. A. 181; affd., 56 Fed. (2d) 99; Alfred E. Badgley, 21 B. T. A. 1055; affd., 59 Fed. (2d) 203. Any departure from a method long and consistently followed can be justified only on the ground that it does not clearly reflect income. Bradstreet Co. of Maine, 23 B. T. A. 1093; affd., on this point, 65 Fed. (2d) 943.

It is our opinion that petitioner’s method of accounting for the income from its patents, i. e., by including royalty payments and value of repossessed machines in its income accounts, and excluding from such accounts the lump sum payments made by the cigar makers, does clearly reflect income. We are confirmed in our conclusion on this point by the testimony of the accounting experts who gave it as their opinion that petitioner’s method of accounting for the lump sum payments was in accordance with good accounting practice.

We do not intend to hold that the method of accounting used by the petitioner is the only correct one, but that the method employed does clearly reflect its income, it has been long and consistently adhered to, and should not therefore be disturbed. It follows from our holding on the above issue that the petitioner is not entitled to depreciation deductions on the cigar machines.

The second issue for consideration is the date of the beginning of the 17-year period over which the development cost of the fresh work cigar machine patent is to be amortized and pro rata deductions therefore made in income tax returns. The respondent has held that this period begins on March 1, 1913, since application for the patent was made prior to and was pending on that date, and,, accordingly, he has allowed only a proportional deduction of two months for 1930 and none for 1931. However, on the brief, the respondent concedes that the issue is controlled by our decision in Stephens-Adamson Manufacturing Co., 16 B. T. A. 41; affd., 51 Fed. (2d) 681. See, also, Hartford-Fairmont Co., 12 B. T. A. 98; A. E. Starbuck, Administrator, 13 B. T. A. 796; and John Douglas Co., 23 B. T. A. 1308. Under those decisions, the 17-year amortization period begins to run from the date the patent was issued, which, in this case, is April 6, 1915. The petitioner, therefore, is entitled to a deduction for each of the years 1930 and 1931 equal to one-seventeenth of the patent development cost.

The third issue is pressed by the petitioner only as an alternative to, and in the event of a decision unfavorable to it on, the first issue. We have sustained the petitioner’s contention, in our decision on the first issue, that the respondent erred in including the construction costs received from the cigar manufacturers in income. Too, under that holding, the entire costs of the cigar machines are recovered in the years when acquired and delivered to the cigar manufacturers, and there are no remaining costs to be recovered by way of depreciation allowances. Any loss deductions for machines returned and scrapped must be limited to those machines which the petitioner has repossessed and which it has, under its method of accounting, included in income at their fair market value as of the time of repossession. These losses the parties have stipulated may be computed in the recomputations to be made under Rule 50.

Reviewed by the Board.

Decision will be entered under Rule 50.

Murdock,

concurring: The bookkeeping method which the taxpayer had long and consistently followed clearly reflected its net income. It made its income tax reports in accordance with that method. Thus, there is no occasion to require it to change to some other method which might also clearly reflect its net income. The decision of the case does not require the holdings made in the prevailing opinion that the lump sum payments are not in the nature of rentals or royalties and the inclusion of the lump sum payments in gross income would distort net income.

Disney concurs in the above.


author: Arundell :

text:
    Ellen S. Booth, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81961.
    Promulgated June 16, 1937.

      Thomas G. Long, Esq., for the petitioner.

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

Arundell :

It is agreed by the parties that the sole issue to be determined is the correctness of the respondent’s determination that the sums of $324,000 and $232,000 constituted taxable income to the petitioner for the years 1931 and 1932 respectively.

The respondent contends that the petitioner did not convey by her assignment to the Cranbrook Foundation any present property or right of property; that at most she undertook to assign future or anticipated income to which she might be entitled under the trust; that the income was distributable to her by the trustees to the same extent as if the assignment had not been executed; and that hence it was all taxable to her.

Under the express provisions of the trust agreement, .one-fourth of the distributable income of the trust was payable to the petitioner, her heirs and assigns upon the death of her father and until the termination of the trust on May 4, 1936, and the right to receive such income vested in her, her heirs and assigns during such period. Although the trust agreement provided that the equitable as well as the legal title in the trust- property should be vested in the trustees, the right to receive the income vested in her and she had at least the right to enforce the performance of the trust by the trustees. Sec. 12982, Comp. Laws of Mich., 1929; Roberts v. Michigan Trust Co., 213 Mich. 91; 262 N. W. 744. Such right or beneficial interest is “present property alienable like any other, in the absence of a valid restraint upon alienation.” Blair v. Commissioner,. 300 U. S. 5, and cases cited therein. The trust agreement contained no restriction upon alienation and the income of the trust was payable to the beneficiaries, “their heirs and assigns.”

The validity of the assignment has not been questioned by the respondent. The trustees recognized the validity of the assignment and paid the income directly to the Cranbrook Foundation during 1931 and 1932, the period during which the assignment was in force and effect. Furthermore, the validity of an assignment of a right to receive income of a trust under the laws of Michigan was considered by the Board in Grace Scripps Clark, 16 B. T. A. 453. That case involved an assignment executed in California by one of the four children of the grantor of the same trust involved herein of one-half interest in all the income of the trust, which may from time to time be payable to her or to which she may be thereafter entitled, to her husband. The Board therein stated that “It is well established in California, as also in Michigan, that a beneficiary of a trust of the nature of that under consideration may assign his interest therein”, and held that the legal effect of the assigning instrument was to vest in the husband all right, title, and interest in and to one-half of her interest in the trust fund, including the income therefrom, and that one-half of the income distributed to her was taxable to her husband and not to her.

The respondent contends that the Clark case, supra, is not applicable here on the ground that the assignment in that case was irrevocable whereas the assignment herein by its terms was revocable by the petitioner. A beneficiary may transfer a part of his interest as well as the whole, Blair v. Commissioner, supra. Although the assignment was revocable by the petitioner, it was in effect an assignment for a term of years, since it could be revoked only to terminate at the end of the calendar year in which notice of revocation was given. Had the petitioner revoked the assignment in 1931, it would not have been effective until the end of the year 1931, and the same is true as to the year 1932, as disclosed by the facts. She revoked the assignment in October 1932, effective as of January 2, 1933. The assignee under the provisions of the assignment was entitled to receive one-half of the income for a year certain and thereafter from year to year until revoked, and in the event of revocation, until the end of the year in which revoked. It had the right to enforce the payment to it by the trustees under the assignment of one-half of the income for 1931 and 1932. It became by virtue of the assignment a beneficiary of the trust to the extent of the interest assigned. “The one who is to receive the income as the owner of the beneficial interest is to pay the tax.” Blair v. Commissioner, supra. In our opinion the Cranbrook Foundation received the income during 1931 and 1932 as the owner thereof. Cf. United States v. First National Bank of Birmingham, 74 Fed. (2d) 360.

In Mabel A. Ashforth et al., Executors, 26 B. T. A. 1188, involving the question whether income from a trust revocable by notice to be given within the “first fifteen days in December in the calendar year next preceding such contemplated revocation” was taxable to the grantor thereof, the Board held that, the grantor having failed to notify the trustees of an intention to revoke the trust prior to the taxable year as provided therein, “the income was not subject to his ‘unfettered command’ as he was not free to enjoy it during the taxable year”, and that therefore the income of the trust during the taxable years involved was not taxable to the grantor. To the same effect are Langley v. Commissioner, 61 Fed. (2d) 796; Lewis v. White, 56 Fed. (2d) 390; Faber v. United States, 1 Fed. Supp. 859; Frances Marshall Canfield et al., Executors, 31 B. T. A. 724. In Lewis v. White, supra, the court stated:

* * * nor does the fact that such possibility of evasion exists operate to extend the taxing powers of Congress to the point where they can tax one person on the income of another when that income is wholly and completely acquired and beyond any power or right in the taxpayer to reach or control its disposition in any manner whatsoever.

The respondent on brief has not called to our attention any statute authorizing the inclusion of the income paid to the Cranbrook Foundation in 1931 and 1932 in the taxable income of the petitioner except sections 161 (a) (2) and (4) and 162 (b) and (c) of the Revenue Acts of 1928 and 1932, which provide in effect that income to be distributed currently by a trustee to a beneficiary, or income which in the discretion of the trustee is distributed to a beneficiary, is taxable to the beneficiary, and deductions are to be allowed to the trustee for the amounts distributed. However, herein in 1931 and 1932 the trustees distributed only one-half of the income to the petitioner and the other half directly to the Cranbrook Foundation, as beneficiary by virtue of the assignment.

Hazel T. Power, 23 B. T. A. 428; affd., 61 Fed. (2d) 625; certiorari denied, 288 U. S. 612, cited and relied upon by the respondent, is not controlling here. The assignment therein to her husband of one-third of the income of a trust estate to which the assignor was entitled contained a restriction upon alienation and limited the payment and use of such income to his personal enjoyment. It was an assignment in the nature of a spendthrift trust. Furthermore, in affirming the decision of the Board, the court stated:

* * * As to actualities, the assignment might have been a blank page. * * * The facts are that this entire matter starts with a trust estate in which petitioner has a right to one-half the annual income, and ends with that income paid by the trustees, at her direction, to a joint bank account of herself and her husband. Whatever her intentions and whatever she did concerning .the disposition of her income or interest in the trust estate, the net result was that her entire income under the trust was deposited directly to an account over which she had entire control.

Herein the petitioner had no such control of the interest assigned. The petitioner had no right to stop at any time within the year the payment of the income to the assignee before it took place, Cf. Corliss v. Bowers, 281 U. S. 876, in which the Court stated: “But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed—the actual benefit for which the tax is paid.”

The fact that the petitioner expressly reserved all interest in the corpus to which she would be entitled under the trust agreement in the event she survived the termination of the trust does not invalidate the assignment or make it ineffective as an assignment of a present interest. She had no right in any event to transfer or assign as such the corpus of the trust estate. Her right to transfer and assign was coextensive with her interest therein. Whether or not she survived the termination of the trust, she had a vested right to receive the income of the trust until the termination of the trust or until her death, whichever occurred first. It is well established that an assignment by a beneficiary of a trust of income payable thereunder vests in the assignee a present interest in the trust. Blair v. Commissioner, supra; Lowery v. Helvering, 70 Fed. (2d) 713; Commissioner v. Field, 42 Fed. (2d) 820; Robert G. Dodge, 29 B. T. A. 632; Grace Scripps Clark, supra; Edith E. Blarney, 13 B. T. A. 1315.

In our opinion the amounts paid by the trustees in 1931 and 1932 to the Cranbrook Foundation under the assignment herein are not taxable to the petitioner.

Decision will be entered for the petitioner.


author: Murdock :

text:
    Irving Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78489.
    Promulgated June 16, 1937.

      Frank Weinstein, Esq., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner notified the petitioner that he had determined a deficiency of $303.81 in the income tax of Stecher & Spelrein Co. for the year 1927, “which deficiency, plus interest as provided by law, it is proposed to assess against you as transferee of said corporation, in accordance with the provisions of section 280 of the Revenue Act of 1926.” The petitioner denies that it is liable for the tax due from Stecher & Spelrein Co. (hereinafter called the taxpayer or the bankrupt). The facts are not in dispute.

The taxpayer was adjudicated a bankrupt on December 1, 1931, following the filing of a voluntary petition in bankruptcy on November 9, 1931. The petitioner became receiver on November 9 and trustee in December. Proper, notices of the bankruptcy proceeding were given to known creditors and were published. A composition was approved, the assets were sold, and the petitioner distributed all moneys in its hands pursuant to a court order. The petitioner’s final report was approved and the petitioner was discharged as trustee in April 1932. In the course of its duties it examined all of the books and records of the bankrupt which it could find, and it orally examined the officers of the bankrupt in regard to the assets and liabilities. The Commissioner never filed any claim in the bankruptcy proceedings, and the petitioner first learned that there was a deficiency in tax for 1927 when it received the transferee notice in 1934. Although the petitioner had had in its possession assets of the bankrupt of a value in excess of $2,000, it distributed those assets in 1931 and never thereafter had possession of any property of the bankrupt.

The Commissioner claims that the petitioner is liable for the deficiency under the provisions of section 280 (a) (2) of the Revenue Act of 1926 and section 3467 of the revised statutes. Section 280 is entitled “Claims Against Transferred Assets”, and section 280 (a) (2) relates to “The liability of a fiduciary under section 3467 of the Revised Statutes in respect of the payment of any such tax from the estate of the taxpayer.” Section 3467 of the revised statutes is as follows:

Every executor, administrator, or assignee, or other person, who pays any debt due by the person or estate from whom or for which he acts, before he satisfies and pays the debts due to the United States from such person or estate, shall become answerable in his own person and estate for the debts so due to the United States, or for so much thereof as may remain due and unpaid.

The Commissioner also argues that he has no burden of proof in this case since section 912 of the Revenue Act of 1924, as amended by section 602 of the Revenue Act of 1928, provides only that the burden of proof shall be upon the Commissioner to show that a petitioner is liable as a transferee of property of a taxpayer, whereas in this case the liability is not that of a transferee, but of a fiduciary. However, that question need not be decided since the facts are fully disclosed in the record and there is no failure of proof. The real question in the case is whether the petitioner ever became liable under section 3467 of the revised statutes.

Section 3466 of the revised statutes gives priority to debts due to the United States over debts due to other creditors in the estate of an insolvent debtor. Section 3467 imposes personal liability upon a trustee who distributes the debtor’s property to other creditors before satisfying the debts due the United States. The trustee may become personally liable even though the United States has not proved its claim in the bankruptcy proceedings. But the courts have held, in interpreting section 3467, that in order to render a trustee personally liable, it must appear that the trustee is chargeable with knowledge of the debt due to the United States. “It is only when the assignee has notice of the claim of the government that lie incurs personal liability for making distribution of the estate without providing for the claim.” United States v. Barns, 31 Fed. 705. The claim may be listed in the schedules of the bankrupt, notice may be given to the trustee, or the trustee may learn of the debt in some other way. If the trustee has knowledge of the debt, it matters not how that knowledge was obtained. The trustee can not disregard or ignore the debt, and if he does, his breach of duty renders him liable personally. United States v. Kaplan, 74 Fed. (2d) 664. “It is enough if the trustee be in possession of such facts as that a faithful and fair discharge of his duty would put him on inquiry.” United States v. Clark, 25 Fed. Cases 447, 451. But he is not personally liable for a tax without notice which should put a reasonably prudent man upon inquiry. Livingston v. Becker, 40 Fed. (2d) 673; United States v. Eyges, 286 Fed. 683. No case is cited which holds a fiduciary personally liable where he was not chargeable with knowledge of the debt due the United States.

The bankruptcy proceeding appears to have been regular in every respect. There is no suggestion that it was too hastily completed. Known creditors were notified by mail. Notice was given to all creditors by publication. The petitioner appears to have used reasonable diligence in discharging its duties as receiver and trustee. It never had actual knowledge of the debt due the United States nor did it ever discover anything in the record before it which might have put a reasonably prudent trustee upon inquiry as to whether or not there was any debt due the United States. The debt was not shown in the schedules furnished by the bankrupt and sworn to by its officers. It was not shown in the books and records. It- was not disclosed in the oral examination of witnesses. The petitioner distributed all moneys in its hands, made its report, and was discharged. Why, then, should it be held personally liable for this debt? The Commissioner says that the petitioner should have inquired of the collector whether or not any taxes were due. But the petitioner was under no duty to seek out unknown creditors of the bankrupt under the circumstances. The Commissioner also says that the petitioner should have notified him that it was acting as trustee, citing section 281 (a) of the Revenue Act of 1926. That section did not require the petitioner to give notice to the Commissioner in order to escape personal liability under section 3467 of the revised statutes. Its purpose was wholly different. The Commissioner ignored the bankruptcy proceeding at the risk of the loss of his debt in case the trustee distributed the assets without knowledge of the debt. The petitioner did not learn of the debt until after its responsibility had ceased.

Decision will be entered for the petitioner.


author: Harron :

text:
    1620 Broadway Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78836.
    Promulgated June 16, 1937.

      T. Newman Lawler, Esq., for the petitioner.

      B. M. Goon, Esq., for the respondent.
   OPINION.

Harron :

Petitioner claims its deduction from gross income under the provisions of section 23 (a) and (k) of the Revenue Act of 1932, which provides as follows:

In computing net income there shall be allowed as deductions:
(a) Expenses.—All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, ⅜ ⅜ ⅜
* * * * * * * *
(k) Depreciation.—A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

The determination of the respondent is based on article 130 of Regulations 11, promulgated under the Revenue Act of 1932, which is quoted in the margin.

The only question here is the amount of the deduction to be allowed .the petitioner for depreciation of the building erected and installations at its own expense on leased premises. The petitioner maintains the right to exhaust its cost of the building and improvements over the term of the lease of 20 years without regard to the life of the building and improvements or the privilege o.f renewal. The respondent contends that the depreciation deductions should be spread over the useful life of the property, which he estimates as 24⅜ years from the beginning of 1932. The petitioner does not contest this estimate.

We have before us the year 1932. At that time the lease in question had not been renewed by the petitioner and there is no evidence in the record to show that there was any certainty then that it would be renewed. There is evidence in the record to show that the petitioner elected to renew the lease in 1936 but we feel constrained to decide the issue on the facts existing at the end of the taxable period,. i. e., the fact that then neither the petitioner nor its sublessee, the operating company, had determined to exercise their respective options of renewal and there are no facts as of that time showing any reasonably certain probabilities that there would be renewals. There is the added fact that at the end of the 20-year term, November 1,193T, title to the building and improvements vests in the lessor. The petitioner relies on Varick Charlton Corporation v. Bowers, 78 Fed. (2d) 1020, a per curiam decision affirming judgment for the plaintiff given by a lower court on the authority of Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381. The facts in the Variek Charlton Corporation case are very similar to the facts here. The respondent relies upon Commissioner v. Pittsburgh Union Stock Yards Co., 46 Fed. (2d) 646. In that case the taxable years were 1919 to 1925, inclusive. The facts showed that prior to March 1, 1913, the lessee had been given assurance that the lease would be renewed and that less than a year from March 1, 1913, the lease was renewed and occupation was continuous. Upon the facts existing in 1932 in this case, it is distinguishable from the case of Pittsburgh Union Stock Yards Co., for the petitioner had not renewed his lease in 1932.

This issue has been before this Board and the courts previously and the petitioner relies upon the court decisions in Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381; certiorari denied, 284 U. S. 690, followed by three decisions, Millinery Center Building Corporation v. Commissioner, 73 Fed. (2d) 1007; Poly Holding Corporation v. Commissioner, decided by the Circuit Court of Appeals for the Second Circuit, February 27, 1935, no opinion, reversing 30 B. T. A. 911; and Varick Holding Corporation v. Bowers, supra, no opinion.

The facts in this proceeding are substantially the same as those in Poly Holding Corporation, 30 B. T. A. 911, reversed by the Circuit Court of Appeals for the Second Circuit, supra. There is the additional fact in this proceeding that the title to the building and improvements vests in the lessor on November 1, 1937. This fact was present in the facts in the case of Variek Charlton Corporation, supra. The decisions of the Circuit Court of Appeals for the Second Circuit relied on by the petitioner are in point. The only fact in the instant case which would seem to justify distinguishing it from the cases relied upon by the petitioner is that we are on notice that just prior to the hearing of this proceeding, in October 1936, the petitioner exercised its option to renew the lease. However, as stated above, we feel constrained to arrive at a decision on the situation existing at the end of 1932, with respect to possible renewal of the lease in question. Further, Regulations 77, article 130, quoted above, recognizes that improvements made by a lessee at his own expense on leased property represent investment of capital and that annual deductions are in lieu of a deduction for depreciation and are allowed over the term of a lease in such way as to return to the taxpayer his investment of capital. It appears to be consistent with the Commissioner’s regulation that where title to improvements vests in the lessor at the expiration of a lease, the taxpayer should be allowed annual deductions over the term of that lease rather than over the estimated useful life of the property. Upon the authority of Bonwit Teller & Co. v. Commissioner, supra, and the subsequent court decisions, the petitioner is sustained in its assignment of error and the Commissioner’s disallowance of the claimed deduction is reversed.

Since the entire deficiency is due to disallowance of the claimed deduction,

Decision will be entered for the petitioner.

       The cost borne by a lessee in erecting buildings or mailing permanent improvements on ground of which he is a lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the total cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.
      [The above provision has been contained in the Treasury regulations from 1921 to date: Regulations 62, art. 109; Regulations 65 and 69, art. 110; Regulations 74 and 75, art. 130; Regulations 86 and 94, art. 23 (a)—10.]


text:
    Roy J. Kinnear, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80103.
    Promulgated June 16, 1937.

      H. B. Jones, Esq., for the petitioner.

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

Disney:

The deficiency of $338.21 in income tax for 1932 involved in this proceeding resulted, in part, from the inclusion in petitioner’s income of amounts aggregating $13,210.48 as dividends received from G. Kinnear Co. The petitioner claims that the amounts received constituted loans from the corporation, and that if they were dividends, the corporation lacked earnings available for their payment.

The petitioner is and was in 1932 secretary of the G. Kinnear Co., a corporation organized prior to March 1, 1913, and engaged in the real estate business. In 1930 he and Charles A. Kinnear each owned one-half of the corporation’s outstanding stock. The evidence does not show any change in the stockholdings in subsequent years.

Prior to and in 1932 the stockholders withdrew large sums of money from the corporation. The amounts withdrawn were not in. proportion to stockholdings. The aggregate amount withdrawn by the petitioner at various times in 1932 was $6,353.04, and not $13,-210.48 as determined by the respondent. Other than that the amounts-were large, the record does not disclose the extent of the withdrawals in years prior to 1932. All of the withdrawals were recorded in the books of the corporation as accounts receivable and treated as assets of the corporation. No evidence of indebtedness-was given for, and no interest was paid on, the amounts withdrawn.

The respondent’s determination that the amounts were received as dividends, not loans, must be accepted as correct unless overcome by evidence to the contrary. The book entries are only evidentiary. The decision must rest upon the actual facts. Doyle v. Mitchell Brothers Co., 247 U. S. 179. The corporation did not formally declare a dividend, but dividends may be paid without a formal declaration. Helen Sperry Lea, 35 B. T. A. 243, and cases cited therein. Neither is it important that each of the equal stockholders did not receive a like amount. Lincoln National Bank v. Burnet, 63 Fed. (2d) 131.

The petitioner and Charles A. Kinnear, as sole stockholders of the corporation, were in a position to conduct the affairs of the corporation in accordance with their own ideas. None other had any interest in the corporation’s net assets. It does not appear that any of the alleged loans were ever repaid in whole or in part. The only evidence of record on the point is testimony of the petitioner that if any repayments were made the amounts repaid were small. The books of the corporation were available at the hearing, but they were not offered to prove the amount of the repayments, if any. Neither was any proof offered to show whether the corporation ever endeavored to collect the withdrawals or to establish financial inability of the petitioner to pay his obligation. Neither does it appear that the corporation was in the business of loaning money to its stockholders, at or without interest. Corporations do not ordinarily loan, money to their stockholders, particularly without receiving-some evidence of indebtedness, and interest. This is especially true where the corporation, as here, had a large net operating deficit over a period of about twenty years. We hold that of the amount in-question, $6,353.04 was received by the petitioner as a distribution,, and not as a loan. See Chattanooga Savings Bank v. Brewer, 9 Fed. (2d) 982; affd., 17 Fed. (2d) 79; certiorari denied, 274 U. S. 761; W. A. Graeper, 27 B. T. A. 632; George P. Marshall, 32 B. T. A. 956; M. Jaehson Crispin, 32 B. T. A. 151.

The applicable statute defines the term “dividend” as meaning “any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.” Sec. 115 (a), Revenue Act of 1932. Subdivision (d) provides, to the extent material here, that “If any distribution * * * is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from, the sale or exchange of property.”

The rule is that a corporation does not have earnings or profits available for distribution as dividends until impairments of capital or paid-in surplus resulting from operating losses have been restored. Willcuts v. Milton Dairy Co., 275 U. S. 215; Crystal Ice Co., 14 B. T. A. 682; Arthur C. Stifel, 29 B. T. A. 1145; Louise Glassell Shorb, 22 B. T. A. 644; Loren D. Sale, 35 B. T. A. 938. The rule is recognized by the Commissioner. G. C. M. 1552, C. B. VI-1, p. 10.

The G. Kinnear Co. had a paid-in surplus of $2,485,955.35 on March 1, 1913. It sustained losses each year thereafter through 1929. The corporation’s operating losses for the period from March 1, 1913, to the close of 1931 were $1,742,642.77 in excess of gains. Its losses from March 1, 1913, to the close of 1932 were materially in excess of gains during the same period.

In his audit of the petitioner’s return the revenue agent found that the operating losses of the G. Kinnear Co. from March 1, 1913, to the close of 1931 were $1,742,642.77 in excess of its gains during that period. Without objection the report of the revenue agent was admitted in evidence as proof of the fact. Counsel for the respondent did not make an opening statement at the hearing or file a brief. Nothing appears in the deficiency notice or pleadings disclosing that he ever concluded that the corporation’s total loss from March 1, 3913, to the end of 1931, less gains, was not a true operating loss, or deficit based upon cost. We have accepted the evidence as establishing an impairment of the March 1,1913', paid-in surplus to the extent of $1,742,642.77 at the close of 1931.

The revenue agent found that the corporation had net income of $33,967.29 in 1932, but his report was not introduced into the record for the purpose of establishing corporate earnings or profits in 1932, the taxable year. Proof was made, however, that at the close of the taxable year the gains of the corporation were still materially less than losses previously sustained, which establishes that whatever gains were realized in 1932 were insufficient to restore the impairment of paid-in capital existing at the beginning of the year. It follows that in 1932 the Gr. Kinnear Co. did not have earnings or profits available for the distribution of a taxable dividend and that the respondent erred in including the sum of $13,210.48 in petitioner’s gross income for 1932 as a taxable dividend. The amount of $6,353.04 actually received by the petitioner in the taxable year should be applied against and reduce the basis of petitioner’s stock, and if it exceeds such basis, the excess constitutes income taxable as gain. Sec. 115 (d), supra.

Decision will be entered under Rule 50.


author: Hill :

text:
    Standard Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79847.
    Promulgated June 17, 1937.

      W. E. Baird, G. P. At., for the petitioner.

      Clay O. Holmes, Esq., for the respondent.
   OPINION.

Hill :

This is a proceeding for the redetermination of a deficiency in petitioner’s income tax liability for the year 1932 in the amount of $1,103.32. The sole issue is whether interest received by petitioner on special tax bills issued by the municipalities of Kansas City and St. Louis, Missouri, in payment for public improvements, is subject to Federal income tax. The facts were stipulated by the parties.

Petitioner is a Missouri corporation, and for the calendar year 1932 duly filed its income tax return with the collector of internal revenue at Kansas City.

In connection with its authorized activities, petitioner has from time to time purchased various kinds of securities, including special tax bills issued by the cities of Kansas City and St. Louis, Missouri. During the calendar year 1932 petitioner received interest on special tax bills as follows:

In preparing its Federal income tax return for the year 1932, petitioner did not include the above amount of $18,957.78 in its gross income, but reported it as nontaxable interest received on obligations of a state, or political subdivision thereof. Respondent included the amount of the special tax bills interest in petitioner’s taxable income in the amount of $18,957.78, and allowed as a deduction interest paid in the amount of $10,933.65, which latter amount had previously been disallowed as interest paid to carry tax-free securities.

Kansas City is an incorporated city operating under a charter adopted February 24, 1925, effective during the taxable year, pursuant to provisions of the Constitution of Missouri. St. Louis is an incorporated city, operating under a special charter adopted August 29,1914, and in effect during the taxable year.

The Kansas City and St. Louis special tax bills held by petitioner, from which the interest in controversy arose, were for paving and sewer improvements issued by those cities in conformance with the provisions of their respective charters.

Petitioner contends that the interest in controversy is exempt from Federal income tax (1) under section 22 (b) (4), Revenue Act of 1932, and (2) under “the Constitutional limitation which prevents the federal government from imposing a tax which might burden or handicap the instrumentalities of such cities.”

Section 22 (b), Revenue Act of 1932, provides:

(b) Exclusions From Gross Income.—The following items shall not be included in gross income and shall be exempt from taxation under this title:
*******
(4) Tax-free interest.—Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia. * * *

Under the quoted statute, exemption of the interest received on special tax bills here involved depends upon whether they constituted “obligations” of political subdivisions of the State of Missouri. That Kansas City and St. Louis are such political subdivisions is not, of course, questioned, but, on the facts presented, we think the special tax bills were not “obligations” of those cities within the meaning of that term as used in the statute.

Pursuant to charter authorization, tax bills were issued in part payment for paving and sewer improvements, under contracts to which the respective cities were parties, but the charter of each city provided that it should not be liable thereon. These tax bills had no security back of them other than liens against the specific tracts of land benefited by the improvements, and payment could not be enforced except by foreclosure of the liens. They were payable to the contractors named therein, and, after issuance by the cities to the contractors in payment of the contractual liability of the cities, the latter had no further liability to the contractors or subsequent holders.

These facts establish, in our opinion, that the special tax bills did not constitute “obligations” of the cities issuing them, either within the statutory or the commonly understood meaning of that term. They were not in form or substance obligations of the cities; in fact, after issuance the cities had no further interest in or obligation in connection with such tax bills, other than the keeping of routine records.

The Kansas City charter provided for the issuance of special tax bills to the contractor, who, if he was to be paid in cash, endorsed the tax bills to the city, or the tax bills might be issued directly to the city. And the city was authorized to sell tax bills owned or held by it without recourse at any time, for an amount not less than face value. The general procedure for financing public improvements constructed by the city of St. Louis was substantially the same as for Kansas City. It seems evident, therefore, that where the city paid its contractual obligations by issuing the special tax bills directly to the contractor, it in effect sold its tax liens on the benefited properties, and thereafter had no further interest in the matter. The tax-ability of interest subsequently paid by the property owners to the contractor or purchaser of the tax bills in no wise involves an “obligation” of the city.

Neither property owned by a political subdivision of a state, nor income therefrom while so owned, is subject to tax by the Federal Government, but when the property is sold to a third person the income thereafter derived is none the less subject to the Federal income tax even though the property which produced it was formerly owned by such political subdivision and was sold by it to, raise revenue for governmental purposes. This principle is well stated in the •opinion of the Supreme Court in Group No. 1 Oil Corporation v. Bass, 283 U. S. 279, from which the following extract is quoted:

Property sold or otherwise disposed of by the government, either state or national, in order to raise revenue for government purposes, is in a broad sense a government instrumentality, with respect to which neither the property itself before sale, nor its sale by one government, may be taxed by the other. But it does not follow that the same property in the hands of the buyer, or Ms use or enjoyment of it, or the income he receives from it, is also tax immune. City of New Brunswick v. United States, 276 U. S. 547, * * * Forbes v. Gracey, 94 U. S. 762, * * * Tucker v. Ferguson, 22 Wall. 527. * * *

In the case at bar Kansas City and St. Louis “sold or otherwise disposed of” the tax liens represented by the special tax bills. They were property, worth in money their face value. After issuance or assignment, the cities had no further interest therein, and in no respect had any liability thereunder. The St. Louis charter, in section 1 of Article XXIII provided that “the City shall not be liable in any manner for any work or improvement to be paid for in special tax bills.” The Kansas City charter, in section 273, contained substantially similar provisions. The tax bills were issued to the respective contractors in payment of the contractual obligations of the cities, and they were in turn sold by the contractors to the petitioner, who is here claiming exemption from Federal income tax on the interest received by it from the land owners. Since the tax bills clearly were not “obligations” of the cities, the interest is not exempt under the provisions of section 22 (b) (4) of the Revenue Act of 1932, supra,.

The proceeding before us is clearly distinguishable from Michael Pontarelli, 35 B. T. A. 872, and Carey-Reed Co., 36 B. T. A. 36. The latter cases involved interest on bonds issued by cities for street and sewer improvements and while the interest was payable solely out of collections of improvement taxes assessed against the benefited property, it was none the less interest on obligations of political subdivisions of the respective states, and so specifically exempt from tax under section 22 (b) (4) of the Revenue Acts of 1928 and 1932.

Petitioner here further urges in the alternative that the interest received by it on the tax bills is exempt under the constitutional limitation prohibiting the Federal Government from imposing a tax “which will be a burden or work a hardship on the instrumentality of the state or political subdivision.” This contention, we think, can not be sustained.

The tax resisted here by petitioner obviously is not laid directly upon an obligation or instrumentality of the cities in question, but it is argued that to sustain the tax would be to impose indirectly a burden upon the power of those cities to finance the construction of public improvements. All taxes levied either by the Federal Government or the states, may affect remotely and to some extent the instrumentalities of the other. But, to come within the implied constitutional restriction, the burden must be one that is “necessary, immediate and direct”, and not inconsequential and remote. Trinity Farm Construction Co. v. Grosjean, 291 U. S. 466. Id Willcuts v. Bunn, 282 U. S. 216, the Court said:

It must be remembered that we are dealing, not with any express constitutional restriction, but only with an asserted implication. The constitutional provisions authorizing the Congress to lay taxes * * * are certainly broad enough to cover the tax in question, and before we can restrict their application upon the ground of a burden cast upon the State’s borrowing power, where the tax is not laid upon the contracts made by the State in the exercise of that power, or upon the amounts payable thereunder, but is laid upon distinct transactions by private owners, it must clearly appear that a substantial burden up on the borrowing power of the State would actually be imposed.

The Bunn case involved the question whether, under the constitutional restriction of the taxing power of the Federal Government, profits derived by the taxpayer from the sale of Minnesota municipal bonds were subject to the Federal income tax. In connection with the quoted extract from the Court’s opinion, it was held that they were. In the present case, as in the cited decision, the tax was not “laid upon the contracts made by the State” in the exercise of its borrowing power “or upon the amounts payable thereunder.” No amount, either principal or interest, due on the special tax bills was payable by Kansas City or St. Louis. The payment and receipt of interest constituted a transaction between third persons, after the cities issuing the tax bills had ceased to be concerned therewith.

It may be within the realm of possibility that the proposed tax would cast some burden upon the cities referred to. If it had been definitely known that the interest on the tax bills would not be subject to the Federal income tax, it is conceivable that such tax bills might have been sold to better advantage. However, we think such burden is too remote and speculative to justify exemption of the interest from Federal taxation. In Group No. 1 Oil Corporation v. Bass, supra, the Court pointed out that:

Theoretically, any tax imposed on the buyer with respect to the purchased property may have some effect on the price, and thus remotely and indirectly affect the selling government. We may assume that, if the property is subject to tax after sale, the governmental seller will generally receive a less favorable price than if it were known in advance that the property in the hands of later owners, or even of the buyer alone, could not be taxed.
But the remote and indirect effects upon the one government of such a nondiscriminatory tax by the other have never been considered adequate grounds for thus aiding the one at the expense of the taxing power of the other.

Respondent’s determination of the deficiency herein is approved.

Judgment will be entered for the respondent.


text:
    Living Funded Trust of Harry E. Lyman, by Harry E. Lyman, One of Its Trustees, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78200.
    Promulgated June 17, 1937.

      A. Marry Crane, Esq., and Delos C. Johns, Esq., for the petitioner.

      Carroll Walker, Esq., for the respondent.
   OPINION.

Hill :

Respondent has determined that petitioner is an association taxable as a corporation, and has computed the deficiency on that, basis. Petitioner assigns such action as error.

The Revenue Act of 1932, in section 13, levies a tax upon the net income of corporations, and in section 1111 (a) (2), provides that “the term ‘corporation’ includes associations, joint-stock companies, and insurance companies.”

Neither the facts nor the parties suggest that petitioner is a joint-stock company or an insurance company, and obviously it is not. The sole question is whether it is an “association” within the meaning of the quoted statute.

The Supreme Court of the United States, in Hecht v. Malley, 265 U. S. 144, defined the word “association” as used in the revenue acts in the following language:

The word “association” appears to be used in the Act in its ordinary meaning. It has been defined as a term “used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise.”

In the cited case, the Court held that the Hecht Real Estate Trust was an association taxable as a corporation, saying:

The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder.

That the trust involved in the case at bar is distinguishable from the Hecht trust in many vital respects is at once apparent. In the case under consideration the beneficiaries did not establish a trust for the management of properties owned by them as tenants in common. They did not associate themselves together for the prosecution of a common enterprise; they did not create an “association” upon the methods and forms used by corporations; they had no part in establishing the trust, and were without power to modify the trust agreement or to terminate the trust. The trust, irrevocable by its terms, was established by Harry E. Lyman, who was himself in no event a beneficiary. The primary purpose of the grantor was to provide “for the maintenance, welfare, comfort and happiness” of his wife, son, and daughter, and grandchildren, if any. It was the method selected by him for the making of gifts for the benefit of those who were the natural objects of his bounty.

The trust is not operated in essential respects according to corporate forms of management. The beneficiaries as such, have no control over the affairs of the trust. The trustees were all designated by the grantor, except only that after his death the son and daughter might select an additional trustee to serve at their pleasure.

No stock certificates or certificates of beneficial interest, transferable or nontransferable, are provided by the trust instrument. Title to all trust properties is vested in the trustees, subject to the execution of the trusts, and the net income is not distributable upon the basis of capital contributions of the respective beneficiaries. While the periodical distribution of the net income is mandatory under the terms of the trust agreement, the manner and proportion of distribution during the grantor’s lifetime are matters within the discretion of the trustees. After the grantor’s death, the manner and proportion of distribution are fixed by the trust instrument.

Neither the principal nor income of the trust estate is liable for the debts of the beneficiaries, and no beneficiary has any power to sell, assign, encumber or otherwise anticipate or dispose of his or her interest in the corpus or income, prior to its actual receipt.

A trust established by the owners of property who voluntarily associate themselves together for the purpose of holding and operating the property for business purposes and according to corporate form is materially different from a trust such as we are dealing with here. The fundamental distinction is clearly indicated in the following extract from the opinion of the court in Blair v. Wilson Syndicate Trust, 39 Fed. (2d) 43:

* * * A distinction is to be made between an agreement between individuals in the form of a trust and an express trust created by an ancestor, although they may have some features in common. The controlling distinction is that one is a voluntary association of individuals for convenience and profit, the other a method of equitably distributing a legacy or donation. Congress has recognized this distinction, classing the former as associations, to be taxed as corporations, and at the same time providing for a separate and distinct method of taxing the income of estates and trusts created by will or deed, classing them together for that purpose.

In Morrissey v. Commissioner, 296 U. S. 344, it is pointed out that the term “association” implies associates, who enter into a joint enterprise for the transaction of business and the sharing of its gains. The principal additional characteristics of such an association are stated to be, (1) vesting in the trustees title to the property embarked in the undertaking; (2) designation of the trustees as a continuing body; (3) centralized management; (4) security of the enterprise from termination or interruption by the death of the owners of the beneficial interests; (5) transfer of beneficial interests without affecting continuity of the enterprise, and the introduction of large numbers of participants; and (6) limitation of the personal liability of the participants to the property embarked in the undertaking. To, the same general effect, see also Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; Helvering v. Coleman-Gilbert Associates, 296 U. S. 369; Lewis & Co. v. Commissioner, 301 U. S. 385; Vernon J. Bert, Trustee, 34 B. T. A. 805.

When viewed in the light of the essential attributes above enumerated, we think it is plain that the trust in the present case does not fall into the classification of associations taxable as corporations.

The facts of the instant case, in all material aspects, are similar to Guitar Trust Estate, 25 B. T. A. 1213; affirmed on this point at 72 Fed. (2d) 544. On authority of the decisions cited, we hold that petitioner is not an association taxable as a corporation. Respondent’s determination is reversed.

Apparently all tax due at the rates applicable to a fiduciary has been paid either by the trustees or beneficiaries. In any event, respondent has not determined, nor is he here claiming, any deficiency in tax due from petitioner as a fiduciary.

Judgment will be entered for the petitioner.