author: Teussell :

text:
    Autovent Fan & Blower Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 240.
    Decided October 30, 1926.
    1. Valuation of patent. — In 1918 the petitioner acquired a certain patent for which it issued shares of its capital stock. Upon the evidence, held, that at the time acquired this patent had a cash value of $12,500.
    2. Deduction fob exhaustion. — During the taxable years petitioner is entitled to deduction for this patent on the basis of $12,500 prorated over the life of the patent.

      F. E. Seidman, G. P. A., and M. Wexler, O. P. A., for the petitioner.

      John W. Fisher, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar years 1918, 1919, and 1920.
    The petitioner alleges that the Commissioner erred in disallowing, in each of the years involved, a deduction for depreciation on a patent acquired by the petitioner in 1918 at an alleged cost of $12,500.
    FINDINGS OP FACT.
    . The Autovent Fan & Blower Co. is an Illinois corporation, with its principal office at Chicago, and is the successor to the Batterman-Truitt Co.
    The Batterman-Truitt Co. was incorporated in January, 1916, by H. E. Batterman, Emil Ackerman, and Joseph E. Truitt, with an authorized capital stock of $5,000. Each of the three named incorporators held 166% shares of $10 par value. The corporation engaged in the- business of selling fans and ventilating equipment. In 1918, Ackerman and Truitt purchased Batterman’s 166% shares of stock for $4,000.
    In 1909, Truitt started working on the development of an automatic shutter, or damper, to be used as an attachment to fans and blowers to prevent a back-draft after turning off the fan or blower. This apparatus was known as a louvre. Truitt and Ackerman experimented together on this apparatus until about 1915. On January 1, 1918, patent No. 1,251,593 was issued to Truitt and Ackerman for this shutter apparatus or louvre. All expenses incurred in experimenting and in obtaining the patent were paid by Truitt and Ackerman. During the year 1917 and during a part of the year 1918 a few louvres were manufactured by the corporation and sold, with fans or separately, and the profits were included in the profits of the corporation, but the patent remained the property of Truitt and Ackerman. They received no royalties on the sale of this attachment by the corporation. At the time this louvre was invented there was one of a similar nature on the market, but it was rectangular in shape and operated by gravity, while the louvre patented by Truitt and Ackerman was circular in shape so as to fit the fan and was operated automatically, opening when the fan was turned on and closing when the fan was turned off.
    Truitt and Ackerman decided to have a third partner in the business and to sell their patent to the corporation. The following agreement was entered into:
    This Agreement made and entered into this 10th day of April, A. D. 1918, by and between Joseph E. Truitt and Emil Ackerman, parties of the first part, and Theodore E. LeJeune, party of the second part witnesseth :
    That in consideration of the purchase by the second party from the first parties of one hundred and sixty-six and two-thirds (166%rds) shares of the capital stock of Batterman Truitt Company, an Illinois corporation, for the sum of Four thousand dollars ($4,000) it is understood and agreed by and between the parties hereto, being the owners of all of the capital stock of said corporation, that said second party thereby acquires an equal one-third interest in said corporation, and in all of its business, assets and surplus of every kind and nature as the same stands of this date subject to the payment of all existing debts and obligations, it being a part of the inducement moving said second party to purchase said stock that he be permitted to enter said corporation on an equal basis with each of the parties of the first part.
    In further consideration of the premises and of the payment by the party of the second part to the parties of the first part of one-third of the cost and expense incurred by them in procuring a certain patent known as “Louvre” patent issued January 1, 1918, bearing patent number 1251593 and serial number 178094, said party of the second part shall be beneficially and equitably entitled to a one-third interest in said patent on an equal basis with each of said first parties. For convenience the legal title to said patent shall for the present remain in said first parties and no formal assignment thereof shall be made of said one-third interest to said second party, but said legal title is hereby understood to be held for the equal use and benefit of each of the three signers of this agreement and the proceeds of any disposition or use of said patent shall be equally divided among said Joseph E. Truitt, Emil Ackerman and Theodore F. LeJeune.
    In pursuance to above-quoted agreement, LeJeune acquired the 166% shares of stock which Truitt and Ackerman had acquired from Batterman, and the $4,000 represented the book value of the stock. At the time the taxpayer corporation made its offer to LeJeune he was earning from $6,000 to $8,000 a year. The corporation could not afford to pay him that amount for his services so, to offset the difference in salary, LeJeune acquired a one-third interest in the patent as well as a one-third interest in the corporation.
    During 1918, Arthur Donovan, attorney for the petitioner, and Benjamin M. Anderson, head of his own insurance business, offered in writing to purchase as much stock as the corporation would sell at the book value. Both of these men were ready, willing, and able to buy.
    In August, 1918, the capital stock of the Batterman-Truitt Co. was increased to $12,500 through the issue of a stock dividend of 750 shares of the total par value of $7,500. The stock was issued to Joseph E. Truitt, 250 shares; to M. O. Ackerman, 250 shares; and to Theodore E. LeJeune, 250 shares.
    September 19, 1918, the patent for the louvre was assigned to the Batterman-Truitt Co. The capital stock of the corporation was increased to $25,000, and the 1,250 shares of new stock, at a par value of $10 per share, were issued in payment for the patent. This new stock was issued to Truitt, 416% shares; to Ackerman, 416%; and to LeJeune, 416% shares. In 1919 the capital stock was increased to $30,000 by a stock dividend.
    The petitioner’s books show the following in reference to sales:

    The books do not show a separate record of the sales of louvres attached to fans or blowers, for they were sold as a unit. The greater percentage of fans sold had the louvre attachment, for the sale of the fan and lonvre as- a unit greatly increased the petitioner’s sales of fans.
    The petitioner in its original returns for the years 1919 and 1920 claimed a deduction for depreciation of the louvre patent, which the Commissioner disallowed.
   OPINION.

Teussell :

Prior to the assignment of the patent to the petitioner, Truitt secured three appraisals of the value thereof. In August, 1918, John Johnson Haines valued the patent at $25,000. Plaines is vice president and secretary of the Haines Company, which has been engaged in the business of ventilating contractor for twenty years. Haines has been connected with the company for twenty years, and in his business as a contractor he has come in contact with various patented articles used in ventilating. While he has never appraised patented articles, his experience in buying and selling such articles as are used in his business has familiarized him with the values of such patents. In placing the value of $25,000 on the patent in question, he took into consideration the business which the petitioner was doing; the demand and cost of the one other gravity-operated louvre which had been on the market for several years, and the demand which would be made for the petitioner’s automatic louvre; the fact that this attachment would materially increase the sales in fans, for he knew through experience that purchasers would rather buy the fan and attachment as a unit from one concern; and also the economic life of the patent, that is, about how long a time would elapse before a new and better shutter device would supersede it. After the petitioner began producing the louvre the Haines Company purchased articles from it for use in contracting work, and 90 per cent of the fans purchased were equipped with the patented louvre.

In August, 1918, Charles Edward Murray valued the patent at $15,000. Murray has been connected with the Mellish-IIayward Co. for thirty years, and is engaged in closing contracts, estimating, superintending and looking after finances for the company, which is a contractor for heating and ventilating. Murray is experienced in the matter of patented articles used in connection with ventilating and has assisted in valuing such articles as they effected increases in sales and profits. Murray was familiar with the gravity-operated louvre and the louvre covered by the patent here in question, and the value which he placed upon the latter was the amount his company would have paid for the patent had the company had the opportunity to purchase it. Murray estimated that the profits on the patented louvre would amount to $2,500 or $3,000 a year, and this was based on the fact that the article was satisfactory mechanically, that it was not a new proposition which would have to be introduced because there had been a similar article on the market for several years which was quite successful, that a louvre was necessary in proper ventilating, and, also, he foresaw a great demand for this patented louvre. Murray valued the patent at $15,000, independent and irrespective of the petitioner and its business.

In August, 1918, Fred B. Gillespie valued the louvre patent at $20,000. Gillespie is president of the Gillespie-Dwyer Co., contractor for heating and ventilating systems. Gillespie has been engaged in this line of business since 1914 and has been in constant contact with the various devices and equipment used in the business of ventilating and heating and also with improvements on such devices. He was familiar with the patented louvre and knew that it was mechanically superior to any louvre or shutter already on the market, being more substantially constructed and requiring less power to operate it. The valuation of $20,000 was based on Gillespie’s experience with ventilating devices and the values of the same; the fact that his concern had experienced difficulty in selling fans without shutters or louvres; that it had been at times embarrassing to purchase fans from one concern and louvres from another; that there was a great demand for shutters or louvres; that in 1918 his concern was interested in trying to produce a shutter or louvre of its own, and, further, that the sale of the fan and louvre as a unit by one concern would greatly increase sales. Gillespie had never valued patents before but based his appraisal on his own knowledge of the ventilating and heating business and the values of the various devices used.

Edward T. Blaker, sales engineer for the Bishop & Babcock Sales Co., is a bachelor of mechanical engineering and for seven years has been engaged as sales engineer, his duties being to investigate new devices and patented articles to determine their mechanical utility and sales value. Blaker first became acquainted with the louvre covered by the patent here in question in the latter part of 1918 in a competitive manner. He was selling a louvre manufactured by another concern. It was a part of Blaker’s duties to make a special examination for his company of the mechanical and sales features of this patented louvre. This patented louvre is the same article today as it was in 1918, when it was first put on the market. In the latter part of 1925, or early in 1926, Blaker suggested to his company that they negotiate with the petitioner corporation in regard to their handling the fan and louvre because of its mechanical differences and advantages over the type thej? used and its benefit to the sales organization. This suggestion was based upon Blaker’s investigation of the patented louvre’s mechanical operations and without reference to sales made by the petitioner corporation. Blaker’s appraisal of the patent here in question was $20,000, which amount he would have paid for the patent in 1918 as well as in 1925.

At the time the louvre patent was assigned to the petitioner, its owners and the petitioner placed a value upon it in the amount of $12,500. Four competent witnesses have testified that in their opinion this patent, at the time acquired by the petitioner, had a value ranging from $15,000 to $25,000.

It may also be observed from the figures of annual sales made by the petitioner that the sales of fans increased from an average of $75,055 for the two years 1918 and 1919 to an average of $138,000 per year for the four years 1920 to 1923, inclusive; and that the total sales made by the petitioner increased from an average of $64,747 for the three years 1916 to 1918, inclusive, to an average of $189,059 for the five years 1919 to 1923, inclusive. It thus seems that there can be no doubt that when the petitioner acquired this patent it acquired a valuable asset which contributed in a considerable degree to the volume of the petitioner’s business, and we are therefore of the opinion, and find, that at the time acquired this patent had a cash value of $12,500, and that for the years here in question the petitioner is entitled to a deduction based upon the pro rata exhaustion of $12,500 over the period of the life of the patent.

Judgment will be entered on 15 days' notice, xmder Rule 50.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Laurens Hardware Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11252.
    Decided October 30, 1926.
    A debt ascertained to be worthless after the close of the taxable year is not deductible from the gross income of the petitioner for such taxable year.

      Thomas W. Hardwick, Esq., for the petitioner.
    IF. Frank Gibbs, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits tax for the fiscal year ended June 30, 1920, in the amount of $1,378.29, only a portion of which is in controversy. The point in issue is the right of the petitioner to deduct from gross income debts ascertained to be worthless after the close of the fiscal year and charged oil the petitioner’s books of account in 1925 as of June 30, 1920.
    FINDINGS OF FACT.
    The petitioner is a Georgia corporation with its place of business at Dublin. It is a retail dealer in farming implements and other hardware. In its income-tax return for the fiscal year ended June 30, 1920, it deducted from gross income $972.56 for bad debts ascertained to be worthless and charged off within the taxable year. In 1924 or 1925, the Commissioner audited the petitioner’s tax return and determined a deficiency in tax for the taxable year under review of $1,378.29. In the determination of such deficiency the Commissioner did not disallow the deduction of any amount for bad debts taken in the return. The petitioner then had an audit made of its books of account by an accountant and determined that of its accounts receivable at June 30, 1920, (after the $972.56 had been charged off), $2,863.44 thereof constituted bad debts. The petitioner thereupon, on April 30, 1925, charged off its books of account as of June 30, 1920, the $2,863.44 in question.
    The amount of $2,863.44 charged off in 1925 was the sales price of merchandise sold during the fiscal year ended June 30, 1920. Subsequent to June 30, 1920, the petitioner brought suit and obtained judgment against a number of its debtors whose accounts were charged off as worthless in 1925. A number of individuals whose debts were charged off in 1925 went through bankruptcy subsequent to June 30, 1920, and the petitioner never collected anything from them.
   OPINION.

Smith:

The petitioner claims the right to deduct from its gross income for the fiscal year ended June 30, 1920, $2,863.44, for bad debts, in addition to an amount of $972.56 charged off its books of account and allowed as a deduction from gross income by the Commissioner as debts ascertained to be worthless and charged off within the taxable year. The claim of the petitioner is that the merchandise was sold during the fiscal year ended June 30, 1920, and that in truth the loss was sustained during that year.

Section 234(a) of the Revenue Act of 1918 permits a corporate taxpayer to deduct from gross income, inter alia:

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
(5) Debts ascertained to be worthless and charged off within the taxable year.

We think that the petitioner is entitled to claim a deduction for bad debts under subdivision (5) only of the statute above quoted. Deductions from gross income may be made only in accordance with 'the provisions of the statute. Claims for deductions as losses sustained may not be made in respect of bad debts. Electric Reduction Co. v. Lewellyn, 8 Fed. (2d) 91; 11 Fed. (2d) 493.

It may further be noted that the petitioner sold merchandise during the fiscal year ended June 30, 1920, on credit. In exchange for merchandise, it had an account receivable against the debtor. Until that account receivable has been ascertained to be worthless, the petitioner has sustained no loss. The evidence in the instant case shows that the accounts receivable in the amount of $2,863.44 in question were not ascertained to be worthless during the fiscal year ended June 30, 1920. There was therefore no loss sustained during that year in respect of the sales of merchandise, nor was there any bad debt ascertained to be worthless or charged off within the fax-able year. The amount was not a legal deduction from gross income in the tax return for the year ended June 30,1920.

Judgment will be entered for the Commissioner.

Steenhagen concurs in the result only.


author: Littleton:

text:
    Appeal of Box Board & Lining Co.
    Docket No. 5438.
    Decided October 30, 1926.
    1. The evidence is insufficient to show that taxpayer acquired good will of any determinable cash value, when it purchased the assets and business of another corporation in 1903.
    2. Upon organization in 1903 taxpayer entered upon its books good will in the amount of $115,753.56, which amount it thereafter reduced from time to time in subsequent years, including the fiscal year ending April 30, 1919, by charges against surplus in the total amount of $48,091.59. Held, that the amount of $48,091.59 should be restored to surplus and included in invested capital for the fiscal year ending April 30, 1920.

      Herbert B. Hawkins, G. P. A., for the petitioner.

      Arthur H. Murray, Esq., for the Commissioner.
    The Commissioner determined a deficiency of $3,876.88 for the fiscal year ending April 30, 1920. The taxpayer computed its invested capital for the taxable year by including therein alleged good will claimed to have been acquired in 1903 for stock at $67,622.27. It assigns the exclusion of this item from invested capital by the Commissioner as error.
    FINDINGS OF FACT.
    The taxpayer is a New York corporation organized April 9, 1903, to take over the assets, other than cash on hand and open accounts, of G. S. Cook & Co., a New Jersey corporation. In May, 1903, it purchased the assets of the business of D. J. O’Connell & Co., a Maine corporation.
    G. S. Cook & Co. was organized about 1897, and until 1903 had been engaged in the box and straw-board business. The profits of the company from its first year’s operations amounted to $6,000. There was a gradual increase thereafter until .1903, in which year the profits were $20,000.
    In the early part of 1903, Joseph J. Kline, who owned all of the stock of Cook & Company, desired to retire. He approached Daniel J. O’Connell, who was engaged in the same business, with the view of selling him the assets of Cook & Company. O’Connell was interested and proposed that Kline give him an option to purchase the assets and business of Cook & Company at the inventory value of the tangible assets at that time. This was done. O’Connell paid $5,000 in cash for this option. The cash and accounts receivable retained by the corporation amounted to approximately $40,000.
    On May 2,1903, O’Connell submitted to the taxpayer the following propositions:
    I learn that your Company has been established with an authorized capital stock of One Hundred and fifty thousand Dollars ($150,000) divided into Five hundred (500) shares of preferred capital stock of the par value of One hundred Dollars ($100) each, and One thousand (1,000) shares of common stock of the par value of One hundred Dollars ($100) each, * * *; that your Company wishes to acquire properties sufficient for the prosecution of its lawful corporate purposes, and in connection therewith I submit the following proposition:
    I have made arrangements whereby I am entitled to acquire and to transfer or cause to be transferred the merchandise, machinery, good will and entire properties of the G. S. Cook Company, a corporation organized under the laws of the State of New York, having its principal place of business in the Borough of Manhattan, City of New York, at 152 Wooster Street.
    I offer to transfer or cause to be transferred said merchandise, machinery, good will and properties of the G. S. Cook Company, to the Box Board & Lining Company, upon payment by your Company to the G. S. Cook Company of the sum of Seven thousand Dollars ($7,000) in cash, and an additional sum in cash, equal to the inventory value of the merchandise of the G. S. Cook Company, such merchandise to be valued and inventoried at the market price to authorized dealers of such stock.
    I also offer to pay or cause to be paid to your Company the sum of Sixteen thousand Dollars ($16,000) in cash, such amount to be credited on the amount of cash payable to the G. S. Cook Company as above stated, in the event that said properties and business of said Cook Company are transferred or are caused to be transferred by me.
    I also offer to work for your Company for a period of one year, at a salary of Dour thousand Dollars ($4,000) per annum and expenses and during the said period to use my best endeavors to put your Company upon a sound basis and in good working condition.
    The consideration of the transfer of the properties and business aforesaid, of the payment of said Sixteen thousand Dollars ($16,000) in cash and of my agreement to enter your employ for the period of one year, upon the terms stated, is to be the issue to me of the full paid non-assessable stock of your Company as follows:
    All of the preferred stock, to-wit, Dive hundred (500) shares, and all of the common stock (less such shares as have heretofore been subscribed for by the Incorporators and Subscribers) to-wit, Nine hundred and ninety-five (995) shares, all of such shares of stock being of the par value of One hundred Dollars ($100) each, aggregating a total amount of One Hundred and forty-nine thousand five hundred Dollars ($149,500), all of said stock to be issued and delivered to me simultaneously with the perfection of arrangements for the transfer to your Company of the properties and business and the payment of the cash aforesaid.

      This proposition was accepted by the taxpayer and it exercised the option to purchase the assets of Cook & Company and paid that company the inventory value of such assets, totaling $27,425.75, which included the $5,000 paid by O’Connell for the option. Joseph J. Kline subsequently caused Cook & Company to be dissolved and, having no further use for the books and records of the corporation, destroyed them in 1908 or 1909. The taxpayer’s total authorized capital stock was $150,000 par value, consisting of $50,000 preferred and $100,000 common, and has since remained in that amount. All of this stock, with the exception of five qualifying shares of common stock, was issued to Daniel J. O’Connell for his option to purchase the assets of Cook & Company, for $16,000 in cash paid in by him, and for his agreement to manage the affairs of the taxpayer for one year at a salary of $4,000. Prior to 1903, O’Connell had been in the box and straw-board business for about twenty-seven years in various capacities with other concerns. At the time of taxpayer’s organization and his election as its president, he was treasurer of D. J. O’Connell & Co., a Maine corporation, which had been engaged in the straw-board business for about two years.
    About May, 1903, O’Connell turned back to the taxpayer certain of the preferred and common stock theretofore issued to him, and during the same year the corporation sold 355 shares of preferred stock at par, one share of common stock being given as a bonus with each of the 240 of the preferred shares sold.
    At a meeting of the directors of the taxpayer on May 27, 1903. the following proceedings were had:
    The president then referred to a proposition for the purchase of the properties and business of the D. J. O’Connell Company, a corporation of the State of Maine, engaged in a similar business to that of the Box Board , & Lining Company, in the City of New York. He stated that he thought he could purchase the properties of the Company or acquire the same through the purchase of the stock of the Company, for the sum of $15,000 — $6,000 in cash, $6,000 in time notes of this Company and $3,000 in preferred stock, the outstanding liabilities of the D. J. O’Connell Company to be assumed by the Box Board & Lining Company in the event of the purchase of its properties rather than the acquisition of its stock. He stated that he had surrendered to the Company 150 shares of its preferred stock, which had been duly issued to him and which was now available as treasury stock for the purpose aforesaid. He stated that he thought it was essential to the interests of the Company that the purchase should be made, but as to the means to be adopted he was not yet able to decide. Discussion thereupon ensued at length, and after due deliberation, on MOTION duly seconded and unanimously carried, the following resolutions were duly adopted:

      Resolved that this Company purchase or otherwise acquire the properties, business and good will of the D. J. O’Connell Company, a corporation of the State of Maine, having a capital stock of $10,300 par value outstanding, for the consideration as follows: $6,000 in cash, $6,000 in time notes of this Company, and $3,000 in preferred stock; further

      Resolved that the President and Secretary of this Company be and they hereby are authorized, empowered and directed to enter into negotiations with the D. J. O’Connell Company and with the stockholders thereof, to purchase the properties and good will of said Company or acquire the same by the purchase of the stock of said Company, the manner and method of acquisition, whether by purchase of properties or by the purchase of stock, the terms and conditions thereof and the entire management of and procedure in such purchase or acquisition to be absolutely in the discretion of such President and Secretary; the consideration for such purchase not to exceed the sum of $15,000 payable as and in the manner aforesaid; and in event of the purchase of the properties of such Company as distinguished from the purchase of the stock thereof, the additional consideration on the part of this Company to assume all outstanding liabilities of said D. J. O’Connell Company; further

      Resolved that such President and Secretary be and they hereby are authorized, empowered and directed to do any and all things, and to make, execute and deliver any and all instruments by them deemed necessary or proper for the XDurchase of said properties or the purchase of said stock, including the power in event of the purchase of properties, to assume the outstanding liabilities of said D. J. O'Connell Company and to effectuate the intentions of these resolutions.
    On the same date the stockholders authorized the purchase of the stock or the assets of the O’Connell Company at a price not to exceed $15,000. A few days subsequent the assets of the O’Connell Company were purchased for $15,000.
    Upon the acquisition of the aforementioned properties, taxpayer entered upon its books good will at $115,753.56.
    The taxpayer’s operations have been profitable from the start, its earnings from the date of incorporation to September 7, 1903, amounting to $12,502.12. Since its organization it has, with the exception of a few years, paid annual dividends upon its preferred and common stock.
    After the payment of dividends the remaining surplus or a portion thereof was credited to the good will originally entered upon the books in the amount of $115,753.56, with the result that from April, 1903, to the close of the fiscal year ending April 30, 1919, $48,091.59 had been so credited and the good will account thereby reduced to $67,662.27.
   OPINION.

Littleton:

The taxpayer claims that when it acquired the assets and business of G. S. Cook & Co. through the exercise of an option to purchase theretofore given to D. J. O’Connell, and by reason of the contract with O’Connell to work for the company for one year at a salary of $4,000, it acquired for stock good will of an actual cash value of $67,622.27. The evidence submitted does not convince the Board that taxpayer acquired good will of any determinable cash value. It has been shown however that upon organization the taxpayer entered upon its books good will in the amount of $115,-753.56, and that in the years following, including the fiscal year ending April 30,1919, this amount was reduced from time to time by charges against surplus in the total amount of $48,091.59; $21,225.43 being so charged in the fiscal year ending April 30, 1918.

In view of the fact that the Commissioner has held that taxpayer acquired no good will having an actual cash value and has refused to include any amount in invested capital of this account, and we have approved this action on his part, it is apparent that surplus in the amount of $48,091.59 credited to alleged good will arbitrarily entered upon the books at $115,753.56 should be restored to the surplus account and included in invested capital for the taxable year. The Commissioner included in the invested capital for the taxable year surplus of $51,000. If this figure included the above sum of $48,091.59 credited to good will, the Commissioner’s determination was correct; otherwise it was erroneous.

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


author: Sternhagen:

text:
    Appeal of Pennant Cafeteria Co.
    Docket No. 6469.
    Decided October 30, 1926.

      William T. S. Gurtis, Esq., and Walter E. Barton, Esq., for the petitioner.

      Henry Ravenel, Esq., for the Commissioner.'
   Sternhagen:

The petitioner contests the determination of an aggregate deficiency of $2,558.28 for the years 1921, 1922, and 1923. It alleges in its petition and proves that its books for the years prior to 1922 were all destroyed in a fire which occurred in August 1922. A revenue agent made an investigation of the petitioner’s returns and upon his recommendation the Commissioner made certain adjustments upon which the deficiency is founded. The petitioner took the depositions orally of two witnesses, one its secretary, treasurer and manager in whose charge the books of account were kept, and the other a person who prepared the returns for the years in question. From these depositions the petitioner asks the Board to find that the returns were correctly made and in accordance with the books. Upon such a finding the petitioner contends that it is entitled to judgment setting aside the deficiency.

The record contains no evidence upon which we can hold that the Commissioner’s determination is in error. Any presumption that the petitioner’s returns were correct disappears when the Commissioner after an examination officially and in the manner prescribed by statute determines that they were incorrect and so notifies the taxpayer. Otherwise the proceeding before the Board in which the taxpayer undertakes to prove the Commissioner’s error and Rule 20 of the Board’s Rules of Practice would amount to nothing. The very root of every case before the Board is the taxpayer’s statutory return under oath. Manifestly he does not prove his case by proving his statutory return.

But it is said that the petitioner here made its return in due course from its books which, it is said, reflected its income, and that when these books were destroyed it was deprived of its evidence and left helpless. This is not necessarily true. However, in the present case we are not convinced of the hardship upon the petitioner. The depositions of the two witnesses leave it far from clear as to whether the books were in fact a true reflection of income, and the categorical statement that they were is not convincing. The petitioner argues that the revenue agent’s adjustments were arbitrary and should therefore not be sanctioned by the Board. It calls the Commissioner to task for not calling the examining revenue agent to the stand to explain his adjustments. The revenue agent was present at the taking of the depositions and so far as we are aware he was entirely available to the petitioner to be called as a witness. If through him the petitioner could have proven that the adjustments were arbitrary or otherwise not in accordance with the facts, it might have established the preponderance in its favor. But until it did so in one way or another there was no occasion for the respondent to prove the correctness of his action.

Judgment will be entered for the Commissioner.


text:
    Everett L. Millard, Donald S. Boynton, and Continental and Commercial Trust and Savings Bank of Chicago, as Co-trustees under the Last Will and Testament of Charles T. Boynton, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 840.
    Decided October 30, 1926.

      Everett L. Millard, Esq., for the petitioners.

      L. C. Mitchell, Esq., for the respondent.
   Sternhagen:

The petitioners contest the determination of a deficiency in income tax for the calendar year 1920 in the amount of $9,110.76. The deficiency results from the disallowance of part of an alleged loss on the sale of stock. The Commissioner allowed a loss 'of $4,160. The petitioners claim an additional loss on the same transaction in the amount of $14,768. The Commissioner found the value of the stock to be $100 per share at the date of acquisition, while the petitioners claim the fair market value at that time was $171 per share.

BINDINGS OB PACT.

The decedent, W. L. Brown, and Charles P. Wheeler were the principal stockholders of Pickands, Brown & Co. The company had 15,000 shares of capital stock outstanding during 1916 and for the years prior thereto. Brown owned 4,818 shares, Wheeler 4,232, Boynton 3,715, and the remaining 2,175 shares were owned by employees of the company. The three principal stockholders, under an agreement with the corporation, made advances to the corporation in proportion to their stock ownership. On January 4, 1909, they advanced $220,000; on January 25, 1909, $57,000; on January 25, 1910, $50,000; on January 23, 1911, $200,000; making a total of $527,000. No advances were made by any of the other stockholders of the company. By the terms of the agreement the corporation was to pay interest at 5 per cent per annum, payable quarterly. As these advances ceased to be needed for working capital the money was invested in securities. On December 19, 1916, by resolution of the board of directors, these securities were authorized to be distributed among all the stockholders. Boynton received in this distribution, among other securities, 208 shares of By-Products Coke Corporation stock. The company distributed this stock on the basis of the book value or cost, which was $100 per share. The fair market value of this stock on December 19, 1916, was $171 per share. On December 30, 1920, Boynton sold 396 shares of By-Products Coke Corporation at $80 per share, sustaining a loss in the aggregate of $18,928, of which the Commissioner has allowed $4,160.

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


author: GReen :

text:
    Lobsitz Hardware Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3620.
    Decided October 30, 1926.
    The amount of earnings credited to stockholders’ accounts held to have been properly excluded from invested capital.

      Herman Muhlherr, G. P. A., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency for the year 1921 in the amount of $23.62.
    FINDINGS OF FACT.
    The taxpayer, a small Oklahoma corporation the stock of which is closely held, is engaged in the mercantile business at Perry, Okla. No meetings of the stockholders or directors have been held at any time. At the close of each year it has been the custom of the corporation to credit its earnings for the year to the stockholders’ accounts according to the stock held. In determining the deficiency here involved, the Commissioner has excluded from invested capital $5,285.48, representing earnings for 1920 which were credited to the stockholders’ accounts as of December 31, 1920.
   OPINION.

GReen :

On the evidence we are of the opinion that the Commissioner must be sustained. The pertinent parts of section 328 of the Revenue Act of 1921, which define the term “ invested capital,” read as follows:

(a) Tliat as used in this title the term “ invested capital ” for any year means (except as provided in subdivision (b) and (c) of this section) :
(1) Actual cash bona fide paid in for stock or shares;
(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of sncli tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: * * *
(3) Paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year.”

From this definition, the amount in question, if it is to be included in invested capital, must be included as earned surplus and undivided profits. The question then is whether the crediting of the amounts to the stockholders’ accounts in proportion to the stockholdings represents a distribution. That no distribution was made as a result of a formal act of the directors or stockholders is disclosed by the facts, but that does not necessarily mean that the earnings were not effectively distributed. Smith v. Moore, 199 Fed. 689; Hartley v. Pioneer Ironworks, 181 N. Y. 73; 73 N. E. 576; Central of Georgia Ry. Co. v. Central Trust Co., 135 Ga. 472; 69 S. E. 708; and Redhead v. Iowa National Bank, 127 Iowa, 572; 103 N. W. 796.

We have had the same question before us in the Appeal of Kelly-Buckley Co., 1 B. T. A. 1154, and Appeal of Electrical Supply Co., 1 B. T. A. 658. In those appeals formal dividends were not declared but earnings were credited to stockholders in the same maimer as in the instant case. In those cases the facts also show that the accounts were subject to withdrawal by the stockholders and that withdrawals were actually made. See also Appeal of H. H. Hornfeck & Son, Inc., 3 B. T. A. 1165. We held that the Commissioner properly excluded the amounts so credited from invested capital on the ground that the crediting of the profits amounted to a division and distribution and that such amounts as were still used in the business represented borrowed capital.

In the instant case, the record fails to show the attitude of the stockholders toward these accounts and whether or not they were subject to withdrawal at the will of the stockholders, or whether they were in fact drawn on by them.

The taxpayer has advanced in support of its case the decisions in English & Mersick Co. v. Eaton, 299 Fed. 646, affirmed by the Circuit Court of Appeals, 7 Fed. (2d) 54, and Davidson & Case Lumber Co. v. Motter, 14 Fed. (2d) 137. In the case first cited the court found that the crediting of profits did not constitute a distribution, that it was not so considered by the stockholders, and that the surplus remaining in the business had at all times been invested in machinery and equipment and no fund had been placed at the disposal of the stockholders. In the Davidson case it also appears that the court had sufficient facts before it to convince it that the amount in question had never been placed at the disposal of the stockholders but at all times belonged to the corporation and was so considered. In that respect the court was in an entirely different position from that in which we find ourselves. In this case the taxpayer has failed to submit evidence to show that the amounts so credited were not subject to withdrawal at will, or that amounts were not customarily so drawn. The Commissioner has found that a distribution was made, and, since the burden is on the taxpayer to show error on the part of the Commissioner (which has not been done in this case), we must approve his findings.

Judgment will be entered for the Commissioner.

Smith dissents.


author: Thussell:

text:
    Philip R. Brand, Hedwig B. Gottfried, and Alfred Brand, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8432, 8553, 8572.
    Decided October 30, 1926.
    Valuation of property acquired by devise. — Evidence respecting the value of properties acquired by the petitioners by devise as of March 24, 1916, held to be too indefinite and uncertain to warrant us in overthrowing the values determined by the Commissioner.

      R. A. Gallagher, Esq., for the petitioners.

      J. W. Fisher, Esq., for the respondent.
    Each of the three above-named petitioners complained of deficiency letters dated September 4,1925, asserting deficiencies in income taxes against each of the respective petitioners, as follows:
    1920. 1921.
    $279. 90 $654.41 Philip R. Brand_
    87. 01 299.64 Hedwig B. Gottfried.
    529.92 1, 296.28 Alfred Brand-

      The issue presented for our consideration is, What was the true value of certain properties acquired by the petitioners by bequest from their father on March 24, 1916, which must be used as a basis for ascertaining the question of gain or loss on the sale of such properties in the years 1919 and 1920?
    By agreement of all parties the three actions were consolidated for hearing and decision.
    FINDINGS OF FACT.
    The three petitioners are individuals residing at Chicago, Ill.
    Each taxpayer acquired a one-third interest in certain property by bequest and devise from their father, Rudolph Brand, who died on March 24,1916. To facilitate and equalize the distribution of this property to the heirs, a partnership, known as the Brand Heirs Trust, was formed on July 6, 1917, consisting of the three petitioners named herein. The sales of the assets of the partnership were to be effected at prices agreeable to the members thereof and distribution of the amount realized made in cash. Each partner was to share equally with the others in the profits and losses. Approximately 60 per cent of the assets of the partnership consisted of real estate, improved and unimproved, and the balance consisted of personal property.
    During the years 1920 and 1921 sales of real estate were made as follows:

    In the foregoing tabulation, the figures of special assessments, selling expenses and selling price were established either by evidence or by agreement of the parties to these proceedings. The Commissioner’s valuations as of March 24, 1916, as to all the properties except the Palos Farm, Group C, are the values stated in an appraisal made for the purposes of the Illinois state inheritance tax. The Commissioner’s valuation as of March 24, 1916, for the Palos Farm was $60,000, which amount is in excess of the valuation for state inheritance tax purposes. The valuations as of March 24, 1916, claimed by the petitioners are the result of an appraisal made in the year 1922 as of March 24, 1916, by an experienced real estate agent and dealer of Chicago.
   OPINION.

Thussell:

At the trial of these actions the petitioners produced as a witness the same real estate dealer who made the appraisals upon which the petitioners rely and which they claim to be the true lvalues as of March 24, 1916. This witness’ testimony respecting the properties described in groups A, B, D, E and F does not convince us of the value claimed, and we must, therefore, conclude that the Commissioner’s valuations are representative of the true values on the date when the. properties were acquired by the petitioners.

As to the properties included in groups C and G, the witness’ testimony shows that these properties are farms in the environs of the City of Chicago, and the witness testified that during the years 1915, 1916 and 1917, various farms somewhere in the near neighborhood had been acquired for the Chicago Forest Preserve and that such farms had been purchased at various prices ranging from $250 to $500 per acre. None of the farms so purchased for the forest preserve were identified, either as to location, character of land, or improvements, nor did the witness state how far any of such forest preserve property was from the properties here under consideration. The witness’ valuation of the Palos Farm was, land $59,760, improvements $25,010, which is the equivalent to about $452 per acre, exclusive of the improvements, and his description of the farm indicated that he regarded it in the light of a gentleman’s farm and that much of the cost of improvements was in landscaping and shrubberies, which might be of special value to the owner causing them to be made, but of little value to a buyer, and would add little to the general market value of the property.

This witness’ valuation of Group G, the Murphy Farm, was, land $34,931.25, improvements $6,840. This value placed upon the land is the equivalent of approximately $225 per acre, exclusive of the improvements, and he described the farm as being poor farm land, very little tillable, and the buildings as being hardly worth talking about.

There were also introduced in evidence certificates of appraisal made by the valuation committee of the Chicago Beal Estate Board in 1924, as of March 24, 1916, of which valuation committee the witness hereinabove described was a member. The aggregate of values shown by these certificates is slightly in excess of the values claimed by the petitioners.

In view of all the testimony which we have here briefly summarized, we have arrived at the conclusion that it is not of such a character as will warrant us in overthrowing the values determined by the Commissioner, and wé are of the opinion that the gain or loss upon the sale of each of the several groups of property herein under consideration must be computed on the valuations determined by the Commissioner as of March 24, 1916, plus the special assessments paid by the petitioners between that date and the date when the properties were sold, and the selling price less selling expenses, as hereinabove shown.

A redetermination of deficiencies in each case will he made upon 15 days' notice, fur-suant to Rule 50, and judgment entered thereon in due course.


author: Trammell :

text:
    Appeals of Julia Andrews Bruce and Edith Andrews Logan, Executrix, Estate of Louisa Andrews.
    Docket Nos. 4447, 5461.
    Decided October 30, 1926.
    Taxpayer sold stock on March 11, 1916, for more than cost and less than the March 1, 1913 value. A part of the consideration received was a contract providing for future payments as ore was mined. The contents and life of the mine and the annual production were capable of determination. Held, that the transaction in 1916 was a completed sale resulting in no taxable gain or loss, and the payments made under the contract in the taxable year were in part a return of capital, that is, the present worth of the future payments as of the time of the receipt of the contract, and a portion was gain.

      John W. Ford, Esq., Walter M. Anderson, Esq., and George Oliver May, O. P. A., for the petitioners.

      L. 0. Mitchell, Esq., for the Commissioner.
    These are appeals from the determination of deficiencies in income tax, in the amount of $6,138.95 for 1920 in the case of Julia Andrews Bruce, and in the amount of $9,210.88 for 1918 in the case of the estate of Louisa Andrews. The deficiencies arose out of the sale of certain stock on March 11, 1916, where part of the consideration was paid in cash and part in deferred payments.
    FINDINGS OF FACT.
    Julia Andrews Bruce, is a resident of Greenwich, Conn. Edith Andrews Logan is the duly appointed, qualified and sole surviving executrix of the estate of Louisa Andrews, and is a resident of Youngstown, Ohio.
    Prior to March 1, 1913, and continuously to March 11, 1916, the Andrews & Hitchcock Iron Co., an Ohio corporation, had outstanding 4,000 shares of capital stock, of which the petitioner Julia Andrews Bruce owned 350 shares, and the decedent Louisa Andrews, mother of Julia Andrews Bruce, owned 1,180 shares. That corporation owned 12 per cent of the capital stock of the Mahoning Ore & Steel Co., a Pennsylvania corporation, and, by virtue of a contract (referred to as exhibit A in the contract, excerpts from which are herewith quoted), was entitled to 12 per cent of the ores mined by that company. On March 11, 1916, all of the stockholders of the Andrews & Hitchcock Iron Co., including Julia Andrews Bruce and Louisa Andrews, entered into a written contract with the Youngstown Sheet & Tube Co., a corporation of Ohio, providing for the sale of their stock in the Andrews & Hitchcock Iron Co. to the Youngstown Sheet & Tube Co., according to the terms of such contract, the pertinent parts of which are as follows:
    First. The stockholders, for themselves and their respective heirs, representatives and assigns, agree with The Youngstown Company, for itself, its successors and assigns, that they will sell, assign, transfer and set over to The Youngstown Company, and the others hereinafter designated, all of said capital stock of said The Andrews & Hitchcock Iron Company, and The Youngstown Company agrees that it will purchase said stock, for itself and said others, hereinafter designated, and pay therefor to the dollar savings & trust company of Youngstown, Ohio, for the benefit of said stockholders, the sum of one thousand dollars ($1,000.00) cash in hand upon the execution and delivery of this agreement, receipt whereof is hereby acknowledged; the further sum of TWO MILLION ONE HUNDRED NINETY-NINE THOUSAND DOLLARS ($2,199,-000.00) on the 11th day of April, A. D. 1916, and the further sum in amount and manner to be determined as provided in paragraph 4 hereof.
    Second. Said stockholders further agree that forthwith upon the execution and delivery of this contract, they will deliver, or cause to be delivered to said The Dollar Savings & Trust Company all of said capital stock properly assigned, and that they will cause said The Dollar Savings & Trust Company to deliver the same to said The Youngstown Company and others upon the payment of said sum' of two million one hundred ninety-nine thousand dollars ($2,199,000.00) to said The Dollar Savings & Trust Company on said 11th. day of April, as above provided, it being the intention of the parties that the title to said stock shall pass to and rest in The Youngstown Company, and said others, upon the making of said payment on April 11th, 1916, and that delivery of said stock and the making of said payment shall be simultaneous.
    * * * * * * *
    Fourth. It is understood that said The Andrew & Hitchcock Iron Company is the owner of twelve percent of three hundred sixty (360) shares of-the capital stock of the Mahoning Ore & Steel Company, a corporation of the State of Pennsylvania, having a capital stock of three hundred thousand dollars ($300,000.00)) divided into Three Thousand (3,000) shares of the par value of One Hundred Dollars ($100.00) each, which said Ore & Steel Company is the. owner of certain valuable mines for the production of iron ore, and that the said The Andrews & Hitchcock Ikon Company, by an agreement in writing in quintuplícate being date of December 10, 1914, is entitled to take each year, a full quota of each grade of ore to be produced by said Ore & Steel Company in proportion to the amount of stock owned by or represented for it, as provided for in said agreement, a copy of which is hereto attached, and marked “ Exhibit A ” for the purpose of making the same a part hereof; and for the purpose of fixing the balance of the purchase price to be paid by The Youngstown Company. * * *

    It was further agreed, between the parties as follows:
    That the Youngstown Company shall, and will each year hereafter, take or cause to be taken the full quota of ore to which the said The Andrews & Hitchcock Ikon Company, its successors or assigns, may be entitled, under and by virtue of the terms of said written agreement of December 16, 1914, and shall give the notice provided for in said agreement, and will pay or cause to be paid to said The Dollar Savings & Trust Company for the benefit of said stockholders, and as the balance of said purchase price, each year, on or before thirty days after the close of navigation of the transportation of ore on the Great Lakes, the sum of Sixty Cents (60c) per ton for each and every ton of twenty-two hundred forty (2240) pounds of iron ore so entitled to be taken for such year, and actually delivered by said Ore & Steel Company, it being understood that if any part of the quota for any year be left at the mine by election of The Youngstown Company, The Youngstoivn Company shall pay on account thereof to the stockholders in the same manner as though the same had been shipped from the mine, but shall not thereafter be required to pay any additional sum on account thereof.
    Fifth: In order to secure the making of said deferred payment of said purchase price, as provided for in Paragraph Fourth, it is further agreed between the parties that said three hundred sixty (360) shares of said Ore & Steel Company stock shall be properly assigned and deposited in the hands of said The Dollar Savings & Trust Company as collateral security therefor, and shall be so held until all of the balance of said purchase price is fully determined and paid. If at any time The Youngstown Company fails to pay punctually any installment of said purchase price as it falls due, and such default continues for the period of thirty days after written notice and demand therefor made by the stockholders, or any of them, then any of said stockholders, in addition to any other lawful remedy, may elect to take and keep as and for his own, his proportionate share of said Ore <& Steel Company stock to which his pro rata holdings of stock of said The Andrews & Hitchcock Iron Company, as herein set forth, may entitle him. and shall have the further additional right to recover any and all costs, expenses, damages and attorney fees suffered or incurred by him in the premises. * * *
    The pertinent part of “Exhibit A,” above referred to, is as follows :
    The tonnage of each grade to be produced annually shall be fixed by the Board of Directors on or before April 1st, in each year, and notice of the fixing of said tonnage shall be mailed i>romptly to each stockholder.
    Each of the interests, as hereinbefore set forth, shall be entitled to take a full quota of each grade to be produced, in proportion to the amount of stock owned by or represented for them, and within fifteen days after receipt of notice referred to in preceding paragraph, shall notify in writing the President of said Mahoning Ore & Steel Company, whether or not it elects to take the full quota to which it is entitled. Undesired tonnage, if any, shall be offered pro rata to the other stockholders, and such portion thereof not desired by them can he disposed of by the Board of Directors by reducing the originally fixed production to the extent of the unaccepted tonnage or in any other manner the Board of Directors may agree upon.
    The price of ores shall be fixed each year by the Board of Directors and shall be at or about the cost of production, including all costs, transportation, delivery, handling, etc., to the lower lake ports. * * *
    Louisa Andrews died on the 22nd day of March, 1917, and Julia Andrews Bruce received by will a one-half interest in the residuary estate of Louisa Andrews. Prior to her death, but subsequent to March 11, 1916, Louisa Andrews gave to John Shaw an 80/4000 interest in the sale price under said contract of March 11, 1916, unpaid at the time of said gift and there was contained in the residuary estate of Louisa Andrews an 1100/4000 interest in said sale price under said contract of March 11, 1916, unpaid at the time of her death.
    The value as of March 1, 1913, of 350 shares of capital stock of the Andrews & Hitchcock Iron Co., then owned by Julia Andrews Bruce, can not be determined by the evidence, but it was stipulated that such value was in excess of $274,093.33. Julia Andrews Bruce, with respect to her ownership of 350 shares of said stock, received as her share of the cash consideration of $2,200,000 paid under said contract of March 11,1916, the sum of $192,500. In addition thereto, she received in respect of the sale price of said 350 shares, and further in respect of the 550/4000 interest in the unpaid sale price under said contract of March 11, 1916, which she received from her mother’s estate, the following sums of money in the aggregate: in the year 1917, $13,860; 1918, $15,750; 1919, $32,383; 1920, $19,599.53. Of the sums so received by her, the part thereof attributable to the 550/4000 interest in said unpaid sale price inherited from her mother, Louisa Andrews, was less than the value fixed by the Commissioner upon said interest, for the purposes of Federal estate tax imposed upon the estate of Louisa Andrews, namely, $277,164.50.
    The value as of March 1, 1913, of 1,100 shares of the capital stock of the Andrews & Hitchcock Iron Co., then owned by Louisa Andrews, can not be determined from the evidence, but it was stipulated that it was in excess of the $698,060, and that Louisa Andrews, with respect to her ownership of the said 1,100 shares of stock, received as her share of the cash consideration of $2,200,000 paid under said contract of March 11, 1916, the sum of $605,000; in addition thereto, Louisa Andrews and her estate received, in respect of the sale price of said 1,100 shares, the following sums in the aggregate : in 1917, $43,560; in 1918, $49,500. The amount so received by the estate of Louisa Andrews for the taxable year, namely, $49,500, was less than the value fixed by the Commissioner for the purpose of Federal estate tax upon the 1100/4000 interest of Louisa Andrews in the unpaid sale price under said contract of March 11, 1916, namely, $554,329.
    Louisa Andrews and her estate, between March 1, 1913, and December 31, 1918, and Julia Andrews Bruce, between March 1, 1913, and December 31, 1920, kept no books, and their returns for Federal income taxation purposes for the years 1916 to 1918, inclusive, in the Louisa Andrews estate, and for the years 1916 to 1920, inclusive, in the Julia Andrews Bruce case, were made upon the basis of cash receipts and disbursements.
    At the date of the contract, March 11, 1916, the estimated ore reserves of the Mahoning Ore & Steel Go. were 82,858,535 tons. The .Commissioner, in fixing the deficiencies in these appeals, has determined that the estimated annual production at that time was 1,841,300 tons. The determination of the Commissioner as to annual production and life of the mine was based upon opinions of engineers qualified by education and training in the mining industry to give such opinions. The actual production for three years prior to March 11, 1916, was in accordance with the Commissioner’s finding, as to the estimated future production. At the rate of 60 cents per ton, the amount to be received in the future, under the provisions of the contract of March 11, 1916, was upon the basis of ore reserves of 82,858,535 tons — at that date $5,965,814.52. The present worth of this amount, at March 11, 1916, discounted at 6 per cent with provision for a sinking fund of 4 per cent, covering a period of 45 years, was $1,942,111.46.
    The petitioners’ returns were made upon the theory that there was no taxable income received by virtue of the payments made under the contract of March 11, 1916, until the March 1, 1913, value, or the value at the time of the death of the decedent, of the stock sold had been returned. The Commissioner did not accept this theory of the transaction and determined that income was received each year as payments were made for ore mined during the respective years, after attributing a portion of the payments to a return of capital.
   OPINION.

Trammell :

These appeals grow out of the sale on March 11, 1916, by the stockholders of the entire capital stock of the Andrews & Hitchcock Iron Co. to the Youngstown Sheet & Tube Co. The issues involved are as follows:

(1) What amount, if any, is taxable to the estate of Louisa Andrews in 1918 and to Julia Andrews Bruce in 1920, on account of the deferred payments of the Youngstown Sheet & Tube Co. received by them as vendors of the shares of the Andrews & Hitchcock Iron Co. stock under the contract for the sale of that stock made by them along with the other stockholders on March 11,1916?

(2) What amount, if any, is taxable to Julia Andrews Bruce on account of her interest of 550/4000 in the deferred payments acquired by her by inheritance from her mother, Louisa Andrews, who died on March 22, 1917?

The Commissioner has determined that- the total consideration received from the sale on March 11, 1916, consisting of the cash payment and the present worth of the future payments exceeded the cost of the stock prior to March 1, 1913, but was less than the value as of March 1, 1913; that the contract right received by the stockholders had a determinable market value, and that the sale on March 11,1916, constituted a completed transaction from which no-taxable gain or deductible loss resulted; that as a consequence a new basis; for determining gain or loss was created; that the amounts received from the contract in excess of the present worth thereof when the right was received in 1916 were taxable gain; and that the amount reserved by Julia Andrews Bruce with respect to the 550 shares of stock inherited by her was taxable to the extent of the excess of the payments received over the value of the right to receive them, or their present worth, when received. It has been stipulated that the estimated ore reserves of the Mahoning Ore & Steel Co. on March 11,' 1916, were 82,858,535 tons. It was also stipulated that engineers qualified by training and education to give opinions as to the annual production and life of the mine estimated the future production at 1,841,300 tons annually, and that the life of the mine was 45 years as of. March 11, 1916. The total ore payments to be made to the stockholders of the Andrews & Hitchcock Iron Co., under the contract of March 11,1916, would then be $5,965,814.52. It was further stipulated that the present worth of this amount at the time of the sale, assuming that it would be received in equal annual installments for 45 yearé, discounted at 6 per cent, with provisions for a sinking fund at 4 percent was $1,942,111.46. In accordance with these estimates and calculations, the Commissioner determined that the 4,000 shares of Andrews & Hitchcock Iron Co. stock were sold on March 11, 1916, for $2,200,000, cash, and for future payments having a- present worth of $1,942,111.46. ' • -

Louisa Andrews died on March 22, 1917. She possessed at the time of her death the right to receive ore payments at the Tate of 60 cents per ton incident to her former ownership of 1,100 shares of the Andrews & Hitchcock Iron Co. The Commissioner valued this contract right for estate-tax purposes at $554,329 at the time -of her death. There is no other evidence as to its value and we therefore accept that valuation. In the year 1918 the estate received- as ore payments the total sum of $49,500. Of this total sum the Commissioner determined that $16,383.68 represented a return of capital, that is, the present worth of future payments, and that the pro rata portion of the remainder represented taxable income.

Julia Andrews Bruce inherited a part of the contract right possessed by her mother. During the year 1920 she received a total of $19,599.53 from ore payments. These payments accrued to her by reason of the sale of her stock in 1916 and through her succession to contract rights owned by her mother. The Commissioner determined that of the total amount received $6,41-5.65 represented return of capital and that the remainder represented taxable income.

The petitioners contend that the Commissioner erred in adding to the taxable income any part of the ore payments received; that the consideration received in 1916, in addition to the cash, possessed no market value'; that it was undeterminable by reason of the fact that the tonnage to be produced annually was to be fixed by the board of directors of the Mahoning Ore & Steel Co. on or before April 1 of each year, and that there were no means of determining the annual or total production; that, as a consequence, the sale in 1916 did not result in taxable gain and that the amounts received should not be subjected to tax until the March 1, 1913, value has been returned to the petitioners, and with respect to the 550 shares inherited by Julia Andrews Bruce, until the value thereof at the time of the death of Louisa Andrews has been recovered.

Considering, first, the contention of the petitioners that the consideration for the stock received on March 11, 1916, was not determinable, we find in the stipulation of facts that on that date the estimated ore reserves of the Mahoning Ore & Steel Co. were 82,858,535 tons; that the stockholders of the Andrews & Hitchcock Iron Co. were entitled to receive 60 cents per ton, or 12 per cent of the total tonnage, or 9,943,024 tons. From these facts it follows that the stockholders were to receive total ore payments of $5,965,814.52 during the life of the mine. The controversy, however, arises over the possible annual production and life of the mine. But it was stipulated that the Commissioner’s determination of an anticipated annual production of 1,841,300 tons and an anticipated life of 45 years were based upon the opinions of engineers qualified by education and training in the iron mining industry to give such opinions. It is also agreed that for three years prior to March 11, 1916, the actual production was substantially 1,841,300 tons annually.

The Massabe Range, where this mine is located, is one of the outstanding iron producing regions of the world. The annual production of this mine for several years prior to 1912 had been around 1,250,000 tons. During the earlier years of the World War period, and up to 1916, it was approximately 1,870,000 tons. The company, as of March 11, 1916, in the midst of the World War, and with the greatest demand for steel in its history, was contemplating a production of 3,000,000 tons annually. In 1918, when this country was in the war and the demand for steel was great, the production was 2,500,000 tons, as shown by the payment of $49,500 to the estate of Louisa Andrews, attributable to 1,100 shares. In 1920, when the war was over, the production had dropped to approximately 1,361,000 tons, as shown by the payment of $19,599.50 to Julia Andrews Bruce, attributable to 900 shares. These results indicate that the annual production of 1,841,300 tons was a fair and reasonable estimate and that the life of the mine from 1916 would be approximately 45 years.

While testimony was introduced to the effect that the contents of the mine and the annual production could not be determined in 1916, from a consideration of all the evidence we are disposed to accept the figures of the engineers who, it was stipulated, were qualified to express an opinion with respect thereto.

The petitioners have also raised the point that there was no market value for the contract right received by Julia Andrews Bruce and Louisa Andrews in 1916. The only testimony offered in support of these contentions was by Hitchcock, former president of the Andrews & Hitchcock Iron Co. This witness testified that in the negotiations for the sale of the stock there was no discussion concerning a full cash payment, because the buyer, the Youngstown Sheet & Tube Co., could not afford to pay cash in full. This is all the testimony offered in support of the allegation that the contract to receive future payments had no market value.

The contract of December 16, 1914, between the Mahoning Ore & Steel Co. and its stockholders was unequivocal and applied to the total contents of the steel company’s mine, as and when mined. The contract of March 11, 1916, between the Youngstown Sheet & Tube Co. and the former stockholders of the Andrews & Hitchcock Iron Co., assured to the latter deferred payments equivalent to 60 cents per ton on 12 per cent of the total ore reserves of the steel company’s mines. The deferred payments were secured by shares of the capital stock of the steel company owned by the Andrews & Hitchcock Iron Co., which had been placed in the hands of a trustee for that purpose, and, under the terms of the contract by virtue of which these shares were deposited with the trustee, the stockholders were assured that, in the event of default in any of the deferred installments by the purchaser of the stock, they would receive their pro rata share of the ore produced by the steel company by exercising their option to take over the collateral securities. It must follow that the contract right was of such nature and the payments therein provided for were so determinable and assured that it had a market- value when received. The amounts received in the taxable years were in excess of the value which, the contract had when received. The property, consisting of the contract for future payments received, had a market value.

The transaction of March 11, 1916, was complete within itself. It amounted to what is commonly known and referred to as a “ closed transaction.”. It was of such a nature that it created a new basis for determining gain or loss with respect to the subsequent payments made under the terms of the contract. In view of this fact the March 1, 1918, value of the assets sold becomes immaterial to the consideration or decision of the case. The Commissioner in his determination of the deficiency has determined the fair market value of the right to receive future payments, and from the evidence presented we can not say that his determination is not correct. A portion of each payment under the contract was a return of capital and a portion represented gain. The Commissioner has determined what portion is gain by dividing the 1916 value of the contract by the total tonnage to be obtained, reaching the conclusion that the payment for each ton represents 19.53 cents return of principal and 40.47 cents income, or, in other words, that each payment, whether made one year after the agreement was made or 45 years thereafter, is made up 85.554 per cent return of principal and 67.446 per cent income.

The payments to all the stockholders were estimated by the Commissioner to be $132,573.60 annually for 45 years. These payments were reduced to present worth, using a discount of 6 per cent on future payments with a 4 per cent return on sinking fund. It is evident that the present worth of the payment to be received at the end of the first year differs substantially from the present worth of the payment to be, received 45 years in the future. It is further evident that the present worth of all bf the payments is the sum of the present worth of each annual payment, proper adjustment for the sinking fund being made. In determining what portion Of the payment represented a. return of the 1916 value, the Commissioner has made the allocation between principal and gain as if the present value in 1916 of each of the annual payments to be received was exactly the same. The proper manner in which to determine what portioii of the payment is principal is to split up the total 1916 present worth into its component parts and to treat the present value of the first year’s payment as a return of principal upon the first 1,841,300 tons (the estimated annual production) mined, the present value of the second year’s payment as a return of principal upon the second 1,841,300 tons mined, and similarly each year until the mine becomes exhausted, or the principal is ,all returned.

With respect to the stock received by Julia Andrews Bruce on the death of Louisa Andrews there is no reason or authority for going back of the date of death for a basis for computing gain or loss. The rights of the taxpayer under the contract had a market value in 1917, when her right thereunder was received, and upon a subsequent sonversion of such contract right, or upon receipt of any gain by virtue thereof, the value thereof at the date of acquisition is to be taken as the basis for computing taxable gain or deductible loss.

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


author: Tkammell :

text:
    Elm City Cotton Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7636.
    Decided October 30, 1926.
    A payment made by a corporation to another corporation organized and operated exclusively for the promotion of social welfare work among the employees and families of the employees of the incorporators, for the advancement of the physical, mental and moral interests of such employees and théir families, and to assist them in sickness, disability, old age and death, is an ordinary and necessary expense of the business of the petitioner.

      Hatton Lovejoy, Esq., for the petitioner.

      Henry Ravenel, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes of $6,900 for the year 1919. ' The deficiency results from the action of the Commissioner in disallowing a deduction of $15,000 representing the payment made to the Textile Benefit Association.
    FINDINGS OF FACT.
    The petitioner is a Georgia corporation with its principal office at La Grange. During 1919 it operated a cotton manufacturing plant employing approximately 450 persons. The employees, with their families, lived in houses owned by the petitioner, which surrounded the plant. From the.time it began operation in May, 1907, the petitioner has taken an active interest in promoting welfare work among its employees. Such interest had manifested itself' in the construction of school houses, churches, and a Y. M. C. A. building. It contributed to the payment of salaries of teachers and ministers, provided ground for children’s gardens, furnished supervision therefor, promoted the activities of the Boy Scouts, the Salvation Army and the Y. M. C. A., which serves men and women, boys and girls, and furnished play grounds and other facilities for various athletic and recreational activities. It also provided nurses and hospital facilities for its employees in case of illness. These facilities were provided by the taxpayer for the exclusive use of its employees and their families. Not over 5 per cent of the attendance at the churches and schools was by outsiders.

      Since the organization of the petitioner corporation, only on one occasion has it had any serious labor trouble and that was in 1909. Approximately 10 per cent of its present employees have been with petitioner since it began operations in 1907, and about one-half of the employees have been with it for a period of 10 years. Petitioner’s labor turnover has been small and the employees generally are contented. This has been due largely to the promotion of welfare work among the employees. Ho labor disputes were pending between the petitioner and its employees on December 31, 1919.
    On December 30, 1919, the petitioner and four other mills organized the Textile Benefit Association, which was incorporated for a period of 20 years, with the privilege of renewal. As provided in the charter, the corporation was “ not to be operated for pecuniary profit but to be operated exclusively for religious, charitable and educational purposes, and for the promotion of social welfare; to promote the welfare of employees and families of employees of the incorporators, their associates and other employers who may become connected herewith; to advance the physical, mental, moral and religious interests of such employees and families of the employees; and to assist them in sickness, disability, old age and death; such corporation to have no capital stock.”
    The articles of incorporation provide that officers of each mill connected with the association shall select a trustee for each mill or plant and each trustee shall hold office at the pleasure of the officers of the company selecting him. The trustees thus selected, together with a trustee selected by them jointly, compose the board of trustees.
    The board of trustees manages, controls and directs the business and property of the association. The association has “ the right and authority to receive gifts, bequests and devises, to invest the funds of the corporation in stocks, bonds, choses in action and every character of property real and personal; and to handle and manage such property in such manner as will best insure safety of investment and return upon the same; to act as trustee in any trust created for the promotion of the object of its incorporation; and to apply any money or property in its hands to the promotion of the objects of its incorporation.” A majority vote of the board of trustees is sufficient to authorize or accept an amendment to the association’s charter or to authorize its surrender.
    On December 31, 1919, the petitioner and the Textile Benefit Association entered into a contract containing the following provisions :
    That whereas the said Company desires to enter into a contract with the said Association and to pay certain money to said Association for the benefit of the employees and families of employees of the said Company: now, therefore, in consideration of the sum of Fifteen thousand dollars paid by the said Comi>any to the Association and of such money as may hereafter be paid, the said Association agrees on its part:
    First. That upon the death of each employee of the said Company, who has been in such employment for three months immediately prior to such death, the Association will pay the sum of $100.00 toward the burial expenses of the said employee. Said sum shall be paid to the undertaker or to the family of the employee to be used for the said purpose, or to any person who has paid the burial expenses, as may be determined by the Association.
    Second. The Association agrees to employ and furnish a competent physician to give a thorough medical examination to each employee of the said company and also to each member of the family of each employee when the'said Company so desires, and also to examine each person becoming an employee or desiring to become an employee of the said company at any time hereafter, when so requested.
    Third. The Association agrees that the remainder of the above amount paid by the Company to the Association as well also as any amount hereafter paid by the said Company to the said Association under this contract shall be used and applied by the said Association for the benefit of the employees and families of the employees of the said Company for such other purposes as shall be agreed upon by the said Association and the officers of the said Company. Such money is not to be held and accounted for separately; but is to become a part of the common assets of the Association and subject to its liabilities and contracts.
    Fourth. It is the intention and desire of the parties thereto that the amount received shall be invested and the income therefrom primarily to be used for the purpose stated, and that the corpus may be increased as a basis for and income to be used in increasing proportions and for other and wider purposes; for the benefit of the employees and families of the employees in whose interest this contract is made, but if it should become necessary to carry out the terms of this contract or when otherwise so agreed by the said Association and the said Company, the corpus may be used for such purpose.
    Fifth. In the event that in the future the administration of these funds and the execution of this contract shall prove unsatisfactory, or should become impossible for any reason, this contract may be rescinded by either party and thereupon the Association shall repay to the said Company the remainder in its hands from the money paid into the said Association by the said Company, or the said Association shall pay to the said Company the proportion of the net assets of the said Association, which the amount paid in by the said Company bears to all the money paid to the Association, by the said Company and by other companies under similar contracts.
    The petitioner, on the 30th day of December, 1919,, made a contribution of $15,000 to the association. -This was about 4 per cent of the petitioner’s payroll.
    By the end. of 1919, the amount of $105,000 had been paid in to the association by the incorporators. Part of the amount paid in has been expended under the prolusions of the contract. However, the greater part has been invested. Of that invested, a portion was used to purchase stock of the incorporators, the remainder being invested in securities of other corporations. The petitioner paid in to the association an additional $15,000 in 1920. The books and records of the association are kept separately from those of the petitioner or of the other incorporators. The property of the association is held in its own name and separate and distinct from that of the incorporators. The amounts paid in by each of the incorporators are paid into a common fund.
    The activities of the association down to date have consisted largely of paying $100 toward burial expenses of employees of the different mills which organized it, as provided in the contract; providing nurse and hospital care for employees, and giving physical examinations to employees and their families. Prior to entering into the contract with the association, the petitioner’s hospital budget ran about $12,000 a year. Since that time petitioner does not furnish nurses or hospital facilities, except to furnish a janitor in times of epidemics.
    While the trustees have exercised great care in the management of the association’s funds, they have been unable to keep the expenditures below the amounts received from the investments. It was the purpose to accumulate the association’s assets to the point where the funds would be sufficient to begin the payment of pensions to old and disabled employees of the different members of the association.
   OPIXION.

Tkammell :

The benefits rendered by the association were the physical examination of all of the petitioner’s employees and their families, the payment of $100 for burial expenses of deceased employees,. and the furnishing of nurses to employees in the case of illness. Of these the physical examinations and burial payments were benefits not previously offered to its employees by the petitioner. The nursing service previously furnished by the petitioner to its employees was, under the contract, taken over and rendered by the association.

The expenditures made in connection with furnishing nurses and hospital facilities to sick employees and other benefits derived from the association produce a direct benefit to the petitioner. The method by which such services are furnished — directly by the employer itself or through another as in this case — does not change the result. In this case there was a material saving in expenses, since the petitioner’s hospital budget of about $12,000 was almost eliminated, in addition to the other direct benefits.

It is our opinion that an expenditure made under the conditions presented by this case is one which can be considered as ordinary and necessary expense of the business of this petitioner. Appeal of Poinsett Mills, 1 B. T. A. 6.

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


author: Trammell:

text:
    Appeal of C. A. Weaver.
    Docket No. 8920.
    Decided October 30, 1926.
    An individual who kept Ms books and filed his returns on the calendar year basis was a member of a partnership which kept its books on the basis of a fiscal year ended in the calendar year 192-1. Held, that he is not entitled to the benefit of the 25 per cent reduction in tax provided in the 1924 Act for the year 1923 with respect to his share of the partnership profits for the fiscal year ended in 1924.

      Willis Grane, Esq., for the petitioner.

      T. M. Wilkins, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income tax for the calendar year 1924 in the amount of $11,027.01.
    The question presented is whether the taxpayer is entitled to the 25 per cent reduction of his income tax by virtue of sections 1200 and 1201 of the Revenue Act of 1924.
    The facts are not disputed. The Commissioner moved to dismiss the petition upon the ground that it did not state a cause of action.
    FINDINGS OF FACT.
    The taxpayer is a partner in the partnership of C. H. Weaver & Co. The partnership operated and filed its income-tax return upon the fiscal year basis. Its fiscal year ended March 31, 1924. The taxpayer’s share of the profits of the partnership for the fiscal year ended March 31, 1924, attributable to the year 1923, was $79,555.24. This amount was reported in the taxpayer’s return for the calendar year 1924 as taxable at the 1923 rates. The income was shown on the regular printed return Form 1040-FY, -which provided “For calendar year 1924 if income is derived from a partnership or fiduciary computed on the fiscal year basis.”
    This return form provided for separate computation of taxes on income taxable at 1923 rates and provided for a deduction of 25 per cent of such taxes computed at 1923 rates. The total tax on income taxable at 1923 rates, without the deduction of 25 per cent, would be $44,108.08. Twenty-five per cent of this amount is $11,027.01. The tax on income taxable at 1923 rates, less the 25 per cent, would be $33,081.04. The Commissioner disallowed the 25 per cent deduction referred to.
   OPINION.

Trammell:

The decision of the question involved in this appeal is governed by Appeal of Charles Colip, 5 B. T. A. 123.

Judgment will he entered for the Commissioner.