author: Arnold :

text:
    Edward J. White, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82663.
    Promulgated June 24, 1938.

      A. L. Hodson, Esq., for the petitioner.

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

Arnold :

The present issue is controlled by section 23 (e) as limited by 23 (r) of the Revenue Act of 1932, the pertinent portions of which a.re set out in the margin. Section 23 (r) was enacted by Congress to protect the revenues from the growing practice of reducing tax liabilities by the sale of securities on which losses had accrued and to prevent speculative losses from wiping out ordinary income which represents real taxpaying ability. H. Denny Pierce, 37 B. T. A. 225. The Pierce case, in effect, holds that 23 (r) was enacted to prevent the class of speculative losses there mentioned (stocks and bonds) from wiping out income from other sources. The provisions of section 23 (r) first appear in the 1932 Act, and constitute a specific limitation upon losses otherwise allowable under subsection 23 (e). The peculiarity of 23 (r) is that the allowability of certain losses is dependent upon the existence of certain gains. H. Denny Pierce, supra.

The stipulated facts show that petitioner Avas a trader, as distinguished from a dealer; that all his transactions were solely for his own account for the profit to be deriyed from selling for a price in excess of cost; and that, for the purpose of enabling him to make purchases and sales, he maintained an office at 120 South LaSalle Street, Chicago, Illinois, and since 1921, including the year 1933, he has continuously kept and maintained at that office records and books of account in which were recorded all of said purchases and sales. It further appears that during the taxable year this petitioner, as a trader and not as a dealer, in several hundred separate. transactions bought and sold futures in wheat, corn, rye, and oats, bids and offers representing 7,835,000 bushels of wheat and corn, eggs, United States Treasury bonds, silver bullion, and Canadian dollars; that his total purchases for the year of such commodities, futures, eggs, and silver amounted to $6,975,699.50 and that he realized a profit from the sale of such commodities and futures in the taxable year of $49,299.60; that the total cost of the United States Treasury bonds was $376,369, from the sale of which in the taxable year he realized a profit of $341.31; and that, as a trader and not as a dealer, be bought in 227 separate transactions and sold in 210 separate transactions 187,050 shares of stocks and $50,-000 of bonds which were not capital assets. His total purchases for the year in securities amounted to $6,826,508.41 and he derived gains and sustained losses thereon, but his losses exceeded such gains by $80,792.82.

Upon the foregoing facts petitioner argues that as the total cost of all his purchases for the year 1983 amounted to more than his total receipts from all his sales he realized no income, but sustained a loss, and to apply section 23 (r) and limit his losses sustained in trading in stocks and bonds which are not capital assets to gains derived from that source denies him the use of cost as a basis for determining gain or loss and results in the creation of taxable income when no income in fact was realized. Petitioner contends, therefore, that 23 (r) as applied to his business is unconstitutional in that it taxes as income that which is not income, in violation of section 9, Article I, of the Constitution, and that section 23 (r) operates arbitrarily and capriciously and without foundation in fact to create taxable income, which results in a taking of his property without due process of iaw in violation of the Fifth Amendment to the Constitution.

In Davis v. United States, 87 Fed. (2d) 323; certiorari denied, 301 U. S. 704, the Second Circuit considered the same arguments with respect to the constitutionality of 23 (r) as the petitioner has raised in this proceeding. In sustaining the constitutionality of that section the court pointed out the distinction between true income and taxable income in the following language:

* * * While the computation of income is made with due and necessary regard to periods of time, which are established years either calendar or fiscal, it cuts altogether too fine to say that true, and therefore taxable, income can only be ascertained by putting together all the profit and loss transactions of the period and determining net income accordingly regardless of the fact that they may in whole or in part be quite unrelated except for the time element and the fact that they were those of the same taxpayer. If, for instance, a separate and distinct transaction during the year results in a net realized gain to the taxpayer in and of itself, income which is taxed has been received, but Congress may, or may not, have allowed deductions which as a matter of computation will relieve that income in whole or in part from the taxation to which otherwise it would be subject. As the allowance of deductions working such a result is discretionary with Congress, net income for any taxable period need not necessarily be the same as net taxable income for that period, and the variation may be to the extent that Congress has seen fit either to allow, to limit, or to deny deductions within its control as a matter of grace. See Brushaber v. Union Pacific R. Co., 240 U. S. 1, 36 S. Ct. 236, 60 L. Ed. 493, L. R. A. 1917D, 414 Ann. Cas. 1917B, 713; Denman v. Slayton, 282 U. S. 514, 51 S. Ct. 269, 75 L. Ed. 500; Helvering v. Independent Life Ins. Co., 292 U. S. 371, 54 S. Ct. 758, 78 L. Ed. 1311.
# * * * * * *

In considering whether section 23 (r) would adversely affect taxpayers in violation of the Fifth Amendment, the court pointed out that Congress had a perfect right to confine deductions for speculative losses to the gains from speculative transactions without in any way restricting the deduction of losses from other transactions. The court’s opinion states:

Permitting deductions for losses from transactions which may often be but one form of gambling only to the extent of like gains is not a limitation which will result in taxing as income that which is not, and we think it otherwise well within the bounds of reasonable action by Congress to curtail the effect of such losses upon the national revenue. It has much latitude in that respect. Compare Cohan v. Commissioner, 39 Fed. (2d) 540 (C. C. A. 2); Barclay & Co. v. Edwards, 267 U. S. 442, 45 S. Ct. 135, 69 L. Ed. 703; Denman v. Slayton, supra; Brushaher v. Union Pacific R. Co., supra; Reuss, Hesslein & Co., Inc. v. Edwards, 30 Fed. (2d) 620 (C. C. A. 2).

The Damis case, together with section 23 (r), establishes a classification which we may refer to as speculative losses in stocks and bonds. It should be noted that there is no corresponding limitation upon the deduction of other losses under section 23, and that there is no limitation upon speculative losses, other than those connected with transactions in stocks and bonds. Since it is clearly within the power of Congress to condition, limit, or deny the deduction of losses, New Colonial Ice Co. v. Helvering, 292 U. S. 435; Helvering v. Independent Life Ins. Co., 292 U. S. 371, there can be no question that it may segregate from speculative losses generally the speculative losses which result from stock and bond transactions, and may deny the taxpayer the right to deduct such losses in excess of the gains resulting from like speculative transactions. See also United States v. Hudson, 299 U. S. 498, where the Supreme Court sustained the right of Congress to segregate the income or profit from particular transactions (under the Silver Purchase Act of June 19, 1934) and tax such gains separately without regard to losses that might be sustained.

This petitioner, however, asserts that the deduction he seeks is not a statutory deduction, but falls within the first classification of deductions made by the court in the Davis case, wherein the court speaks of taking from all receipts “certain necessary items like cost of property sold”, and contends that the respondent’s action denies him the right to deduct from gross receipts the cost of all items purchased by him in the conduct of his business. In other words petitioner denies that he can have income in any amount until he has recovered his aggregate cost, and his entire argument is based upon the proposition that the denial of the right to reduce gross receipts by aggregate cost creates income where none in fact exists and, therefore, makes the application of 23 (r) unconstitutional as to his business.

That portion of petitioner’s argument relative to the denial of his right to use cost is answered in part by the court in the Davis case, supra, wherein it states that a net gain realized by a taxpayer from a separate and distinct transaction constitutes income that may, or may not, be subject to tax depending upon whether the Congress has allowed deductions which as a matter of computation will relieve that income in whole or in part from taxation, and by the further statement that anet income for any taxable period need not necessarily be the same as net taxable income for that period, and the variation may be to the extent that Congress has seen fit either to allow, to limit, or to deny deductions within its control as a matter of grace.” (Emphasis supplied.) The facts in this proceeding illustrate the truth of the court’s observations. This petitioner as a matter of fact lost money upon the basis of his operations over the entire year, and if all his losses were deductible he could have no statutory net income. However, in the absence of a statutory right to reduce other income by losses from stock speculations, and in view of the specific limitation of 23 (r), petitioner’s computation must show a statutory net income subject to tax.

Further answering the argument of petitioner, we can not agree that the Commissioner’s determination denies him the right to use cost as a basis for the determination of gain or loss. The cost of his purchases necessarily had to be and was deducted from the sale price in order to arrive at the $80,792.82 by which it was stipulated his losses exceeded his gains in his stock and bond transactions; likewise, as to the amount of $49,299.60, by which it was stipulated he realized gains from his other trading activities. To treat the aggregate cost of all purchases as a single cost basis and deduct that amount from his aggregate receipts, as contended for by him, would contravene section 113. In effect it would allocate a portion of the cost of stocks to the cost of futures, commodities, or other property, in disregard of the actual cost of that property, and in plain disregard of the provisions covering that class of transactions which Congress is dealing with in section 23 (r). One other fact in connection with petitioner’s computation of net income requires comment. In schedule A of his return petitioner has used inventories in computing his net loss. It should be noted that his entire net loss may have resulted from the use of inventories, since the difference between his inventory at the beginning of the year and his inventory at the end of the year amounts to $53,075. It is stipulated here that petitioner is a trader as distinguished from a dealer in securities. Article 105 of Kegula-tions 77 permits the use of inventories in reflecting the true net income of dealers in securities. But taxpayers who buy and sell or hold securities for speculation, irrespective of whether such buying or selling constitutes the carrying on of a trade or business, are not considered deciders in securities, and are not entitled to the use of inventories. It does not appear from the facts herein the extent to which, if any, inventories have distorted petitioner’s income, because the basis upon which the inventories were taken does not appear. This, however, is immaterial since the petitioner, being a trader or speculator, is required to use cost as the basis for computing gain or loss on each transaction. Sec. 113, Eevenue Act of 1932. See also Seeley v. Helvering, 77 Fed. (2d) 323; Schafer v. Helvering, 299 U. S. 171, affirming 32 B. T. A. 289.

Since petitioner’s speculative losses in stocks and bonds exceeded his speculative gains from like transactions by $80,792.82, and since his speculative gains from transactions other than stocks and bonds amounted to only $49,640.91, his speculative losses in securities would wipe out his speculative profits from all other sources if it were not for the limitation contained in section 23 (r). Being specifically prohibited from deducting his speculative losses in securities from his other income, derived from any source whatever, the petitioner has sought to circumvent the statute by treating his business as a unit and by showing that over a year’s operation he had no income because his gross receipts were exceeded by his aggregate cost. Thus he seeks to accomplish indirectly that which is specifically denied him by statute. In our opinion there has been no violation of petitioner’s constitutional rights, and there has been no denial to him of his right to use the cost basis provided by section 113 in determining his gain or loss upon the disposition of any of his speculative purchases. Cf. Asa R. Blish, 37 B. T. A. 260; Robert C. Winmill, 35 B. T. A. 804; affirmed on this point, 93 Fed. (2d) 494; Cohn v. United States (Ct. Cls.), 23 Fed. Supp. 534.

Decision will be entered for the respondent.

      SEC. 23. DEDUCTIONS PROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (e) Losses by Individuals. — Subject to the limitations provided in subsection (r) o£ this section, in the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—
      (1) incurred in trade or business ; * * *
      *******
      (r) Limitation on Stock Losses. — (1) Losses from sales or exchanges of stocks and bonds * * * which are not capital assets * * * shall be allowed only to the extent of the gains from such sales or exchanges. * * *


source: Caselaw Access Project

author: Murdock:

license: Public Domain

text:
    C. C. Partee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81214.
    Promulgated June 24, 1938.

      John D. Martin, Jr., Esq., and Oliver P. Cobb, O. P. A., for the petitioner.

      Harry R. Horrow, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency in income tax in the amount of $4,537.31 for the period January 1 to July 31, 1932. The only issue is whether the Commissioner erred in computing the deficiency pursuant to the provisions of sections 47 and 101 of the Revenue Act of 1932. All of the material facts have been stipulated by the parties and the stipulation is hereby adopted for all purposes of this proceeding.

The petitioner kept his records and made his Federal income tax return upon a calendar year basis for the years up to and including 1931. He made a timely application for permission to change his accounting period thereafter to a fiscal year ending July 31 and the Commissioner granted the permission. He then filed a return for the period of seven months from January 1 to July 31, 1932. That short period and that return were in accordance with the permission granted to change the accounting period. The correct items of income and deductions for the period of seven months are as follows:

1. Cotton business (loss)- ($6,625.16)
2. Fruit business_ 16,840.48
3. Interest_ 3,150.18
7. Rents_ 1,168.83
8. Ordinary gains on stock sales-$26,436. 05
10. Dividends- 3, 417.19
11. Profit Commodities- 2, 857.80
12. Total_ 47,245.37
19. Deduction of taxes_ 1,998.12
Loss from sale of shares of stock, which were capital assets, as defined by Section 101 (c) (8), and which loss was a deduction from gross income within the meaning of Section 23 (e) (2), of the Revenue Act of 1932_ 49,758.21
20. Net Loss_ (4,510.96)

The petitioner contends that the provisions of section 47 (c) and (d) of the Revenue Act of 1932 have no application, or, if they are applicable, at least they have no application to the capital net loss sustained by the. petitioner. The Commissioner applied those provisions in computing the deficiency.

Section 47 is entitled “Returns for a period of less than twelve months.” Subsection (a) provides, inter alia, that if a taxpayer, with the approval of the Commissioner, changes from a calendar year to a fiscal year, a separate return shall be made for the short period between the close of the last calendar year and the date designated as the close of the fiscal year. Subsection (b) provides that the income shall be computed on the basis of the period for which the separate return is made. Subsections (c) and (d) are as follows:

(c) Income Placed on Annual Basis. — If a separate return is made under subsection (a) on account of a change in the accounting period, the net income, computed on the basis of the period for which separate return is made, shall be placed on an annual basis by multiplying the amount thereof by twelve and dividing by the number of months included in the period for which the separate return is made. The tax shall he such part of the tax computed on such annual basis as the number of months in such period is of twelve months.
(d) Capitat, Net Gains and Losses. — Eabned Income. — The Commissioner with the approval of the Secretary shall by regulations prescribe the method of applying the provisions of subsections (b) and (e) (relating to computing income on the basis of a short period, and placing such income on an annual basis) to eases where the taxpayer makes a separate return under subsection (a) on account of a change in the accounting period, and it appears that for the period for which the return is so made he has derived a capital net gain, or sustained a capital net loss, or received earned income.

The Commissioner did not promulgate any regulations under subsection (d). He filed no brief in this case. Subsections (c) and (d) of section 47, when read with section 101 (b), clearly require the computation which the Commissioner has made. The provisions of section 47 (c) and (d) are made to apply in every case where a separate return must be made on account of a change in the accounting period. There is no justification for failing to apply them in cases involving capital net gains, capital net losses, or where earned income has been received.

The petitioner changed his accounting period. A return was filed for the short period. That is the period before the Board. Subsection (c) requires that the “net income” for that period shall be placed upon an annual basis by multiplying the amount thereof by twelve and dividing by the number of months included in the short-period. “Net income” is defined in section 21 as the gross income-computed under section 22, less the deductions allowed by section 23. The net income of this petitioner for the short period thus computed was a minus quantity, that is, a loss of $4,510.96. Obviously no tax would be due upon the petitioner’s “net income” and no consideration need be given to the question of whether “net income”, as used in (c), could include a minus quantity. Cf. Woolford Realty Co. v. Rose, 286 U. S. 319; Anna F. Ardenghi, 37 B. T. A. 345, 349. Here the loss of $4,510.96 is not used in any way in the computation of the deficiency.

The tax results from the computation required under section 101 (b). One of the deductions allowed by section 23 was an amount of $49,758.21, which was a capital net loss within the meaning of section 101. Section 101 (b) provides that, in the case of a taxpayer who sustains a capital net loss, the tax in lieu of all other taxes shall be determined as follows:

A partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner as if this section had not been enacted, and the total tax shall be this amount minus 12% per centum of the capital net loss; * * *

“Ordinary net income” is “net income” computed after excluding all items of capital gain, capital loss, and capital deductions. The ordinary net income of this petitioner for the short period amounted to $45,247.25. Since section 101 provides that a partial tax shall be computed upon the basis of the ordinary net income at the rates and in the manner as if section 101 had not been enacted, “ordinary net income” for the purpose of that computation becomes “net income.” That net income must be placed upon an annual basis under the provisions of section 47 (c) in order to find the tax on it “at the rates and in the manner as if” section 101 had not been enacted. Section 101 (b) provides that 12% percent of the capital net loss shall be deducted from the tax on the income thus computed. Here a question of detail might arise, in the absence of regulations, which, however, will not affect the result. If the partial tax on the ordinary net income is first reduced from that for the annual period to that for the shorter period by multiplying by %2, then 12% percent of the actual capital net loss should be deducted. But the same amount of tax would be determined by deducting from the partial tax on an annual basis, 12% percent of the capital net loss on an annual basis and reducing the result to the actual tax for the short period basis by multiplying by %2. It is apparent that Congress has been logical in this connection, for section 47 (d) clearly indicates that a capital net loss must be placed upon the same basis as the tax before the 12% percent is deducted. This is clear from a reading of section 47 (d), which section would have no meaning otherwise. The provisions of section 47 (c) and (d) and the provisions of section 101 (b) must be read together. They then leave no doubt that the partial tax on the ordinary net income and the capital net loss must be placed upon the same basis before 12% percent of the latter is deducted from the former.

The Commissioner has proceeded in accordance with the principles above discussed. He has placed all factors upon an annual basis by multiplying each by the fraction %2. Thus actual ordinary net income for the short period became $77,566.72 upon an annual basis and the capital net loss of $49,758.21 became $85,299.79 upon an annual basis. He then made the computation of tax upon the item of $77,566.72. It was necessary in that connection for him to place dividends upon an annual basis and also to use the full personal exemption of $2,500. See section 47 (e). He deducted 12% percent of $85,299.79 from the tax thus computed, leaving $7,778.24 as the total tax upon an annual basis. He took %2 of that tax as the tax for the short period of seven months and thus determined the deficiency of $4,537.31. That method complies with the provisions of section 47 (c) and (d) and with the provisions of section 101 (b). Consequently, there is no reason to disturb the Commissioner’s determination.

The conclusion thus reached is in accordance with, rather than contrary to, the purpose which Congress had in mind in enacting provisions like those contained in section 47 (c) and (d). A provision similar to that contained in (c) first appeared as section 226 (c) of the [Revenue Act of 1921. The provision corresponding to (d) first appeared as section 226 (d) of the Revenue Act of 1924. Similar provisions were retained in all subsequent acts until the Revenue Act of 1984. Congress then changed the entire scheme of capital gains and losses and the provisions of (d) were dropped because in that new scheme they were no longer necessary or appropriate. House Rept. 704, 73d Cong., 2d sess., pp. 9, 10, 24. Senate Report 558, 73d Cong., 2d sess., pp. 12, 29. The purpose of the provisions was to prevent taxpayers from avoiding tax through the use of a short period. Ways and Means Committee, House Report 350, 67th Cong., 1st sess., p. 13; Senate Finance Committee, Senate Rept. 275, 67th Cong., 1st sess., p. 17; Conference Report 486, 67th Cong., 1st sess., p. 31; Ways and Means Committee, House Report 179, 68th Cong., 1st sess., p. 23; Senate Finance Committee, Senate Report 398, 68th Cong., 1st sess., p. 27. The tax rates were calculated to produce the desired revenue if applied to the income of taxpayers for a full period of 12 months. They would produce much less revenue if the full period could be divided in any way into shorter periods, or if a short period could be inserted between two full periods. The reduction in tax would result from the fact that the taxes were graduated and increased in percentage as the income of a taxpayer increased. The method adopted by Congress to prevent avoidance was to require (through the provisions above discussed) that the tax be computed on an annual basis (by placing the income for the short period upon an annual basis) and then taking the proportion of the tax for the full period which would be properly allocable to the short period. The taxpayer would thus be required to pay for the short period a proportionate part of the tax which he otherwise would have been required to pay for the full period of twelve months, assuming that his income for the full period had been in proportion to his income for the short period. The computation of the Commissioner in this case has carried out exactly the intent of Congress, whereas the contentions made by the petitioner would result in the very avoidance which Congress intended to prohibit. The petitioner, by completely ignoring the provisions of section 47 (c) and (d), contends that the correct tax for the period of seven months is $799.42. Yet the computation made by the Commissioner in accord-anee with the statute, shows that, had the petitioner’s earnings and losses proceeded for a full year in exact proportion to the way they did occur during the first seven months of the year, his income tax for the year would have been $7,778.24. Seven-twelfths of the latter amount, or $4,537.31, is the portion applicable to the short period. The interpretation sought by the petitioner would thus enable him to avoid tax to the extent of the difference between the improper figure of $799.42 and the correct tax liability of $4,537.31, as determined by the Commissioner.

Reviewed by the Board.

Decision will be entered for the respondent.

Hum concurs only in the result.

         The notice of deficiency shows that he also placed the loss of $4,510.96 upon an annual basis, but the resulting figure of $7,733.07 was not used in any way in computing the tax upon the annual basis or the deficiency.

       The taxpayer seeks to pay for %2 of a year only a little more than %0 of the tax for a year.


author: Sterni-iagbn : Smith,

text:
    George S. Jephson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 79303, 83835, 88161.
    Promulgated June 24, 1938.

      A. Harding Paul, Esq., for the petitioner.

      Lloyd W. Oreason, Esq., for the respondent.
   OPINION.

Sterni-iagbn :

The Commissioner disallowed the deductions of expenses of $846.41 and depreciation of $1,135.06 taken by petitioner for 1932, expenses of $962.41 and depreciation of $1,135.06 taken for 1933, and expenses of $3,083.26 taken for 1934. Three notices of deficiency were sent to the petitioner, one for each year. The notice for 1932 disallows the amount of $1,981.47 as if it were all “expenses of maintaining real estate.” It was held that petitioner was “not in the real estate business but that the purchase of this property was in the nature of an isolated business transaction. * * * Inasmuch as no income has ever been received from this property, there is no provision in the law for the allowance of the deductions claimed.” In the notice for 1933 the two amounts were specifically described as depreciation and expenses, and the explanation given for the disallowance was “Deductions claimed for depreciation and other expenses on property that has never been rented have been disallowed.” The notice for 1934 seems to readjust depreciation to a 3 percent rate on improvements and disallows $3,083.26 “inasmuch as this property is adjacent to your residence.”

The issue upon which the proceeding was tried and is now argued is whether the expenses of maintaining the property may properly be regarded as ordinary and necessary expenses of carrying on a trade or business. Revenue Act of 1932, sec. 23 (a). It has been found as a fact from the evidence that the petitioner’s only purpose in buying the property at No. 331 was to rent it and that he tried to do so by listing it with a broker and showing it to prospective tenants, and that later he bought No. 332 as a step in assembling property on which to build an apartment house. He had no purpose to occupy the property as his own residence and never in fact did occupy it. Thus it can fairly be said that he was carrying on a business, albeit without actual profit during the years in question. Obviously the inability to rent or sell the property at a profit during the taxable years does not take from the venture its business character, nor does the fact that the petitioner was not devoting his full time to a real estate business.

The argument is made by the respondent that because the statute, section 23, provides expressly, subdivision (e) (2), for the deduction of losses in single transactions entered into for profit, after providing, subdivision (e) (1), for losses incurred in trade or business, and makes no provision in similar language for the deduction of expenses of transactions entered into for profit, the latter class of deductions must be regarded as deliberately omitted from recognition. This argument) has no application to the present case since there was here no isolated! transaction entered into for profit though not connected with a trade or business analogous to that covered by the loss provision, but a continuing devotion of the property to a business use and purpose, not at once successfully, to be sure, but no less ardently and hopefully. The pay of a caretaker and the cost of repairs of a property acquired and held solely for rent or sale are ordinary and necessary expenses of carrying on a business, and the statute provides for their deduction. Salo Auerbach, 2 B. T. A. 67. Cases where the property was originally1 acquired or at some time used for private residence which in various circumstances have held that the deductions are not allowable are obviously distinguishable. Rumsey v. Commissioner, 82 Fed. (2d) 158; Morgan v. Commissioner, 16 Fed. (2d) 390; Joseph F. Cullmam, Jr., 16 B. T. A. 991; cf. Heiner v. Tindle, 276 U. S. 582.

The decision as to expenses of all three years under section 23 (a) compels a similar conclusion as to the depreciation under section 23 (k). Kittredge v. Commissioner, 88 Fed. (2d) 632; cf. Buckwalter v. Commissioner, 61 Fed. (2d) 571. This seems to have been recognized and allowed by the Commissioner in the determination for 1934, but there is no explanation for the apparent inconsistency in either the notices of deficiency or the briefs.

The petitioner, using the accounting basis of cash receipts and disbursements, deducted in each year the insurance premiums paid, irrespective of the period covered by the policy. In 1934 he paid premiums on policies for one-year periods extending into the following calendar year and for three years. The Commissioner disallowed such deduction to the extent of “$1,139.86 applicable to future periods.”

The one-year premiums are deductible in the year of payment. Kauai Terminal, Ltd., 36 B. T. A. 893. The three-year payments are affected by conflicting decisions. Since 1927, Higginbotham-Bailey-Logan Co., 8 B. T. A. 566, prepaid insurance for a term exceeding one year has been treated similarly to the cost of an exhaust-able asset with a determinable life and not as an ordinary and necessary business expense deductible entirely in the year of payment. See G. C. M. 13148, XIII-1 C. B. 87 (May 7, 1934). The petitioner relies upon the recent decision in Welch v. De Blois, 94 Fed. (2d) 842, which supports him squarely. The view expressed in that decision is at variance with the long established conception applied not alone to insurance, but to expenditures of various character, such as prepaid rent, J. Alland & Brother, Inc. v. United States, 28 Fed. (2d) 792, and fees and commissions, Julia Stowe Lovejoy, 18 B. T. A. 1179, which may not be lightly overthrown. Despite the respect which we have for the court which decided Welch v. Be Blois, supra, we are unable to follow that decision in this proceeding reviewable by another court. The disallowance of so much of the three-year premiums as extends beyond the first year is sustained.

3. Petitioner attempts to make an argument of his right to deduct $935 charitable contributions and the effect of the statutory limitation of 15 percent, citing Pleasants v. United States, 22 Fed. Supp. 964. But the facts are not sufficiently in evidence to substantiate a finding or raise the legal question. The Commissioner’s determination is sustained.

Reviewed by the Board.

Judgment will he entered under Rule 50.

Smith,

dissenting: I dissent from so much of the opinion in this case as holds that a taxpayer making his return on a cash receipts and disbursements basis may not deduct from gross income the full amount of the fire insurance premiums paid within the taxable year. The petitioner’s tax return was admittedly made on the cash basis. TTis right to do so is not questioned. The respondent simply contends that the portion of the premiums paid within the calendar year 1934 “applicable to future periods” may not be deducted from gross income.

I think it plain that in a return on a cash basis a taxpayer is entitled to deduct from gross income cash payments of expenses. The real question here is whether fire insurance premiums are an expense. I think they are. Manifestly, if the fire insurance company’s agent had extended credit to the petitioner and the premiums had not been paid until 1937 the petitioner would not be entitled to deduct them from the gross income of 1934, because not paid within the year. When paid in 1937 they would be allowed as a deduction from gross income of 1937, because paid within that year.

The significance of the cash basis is that the flow of cash into and out of. the taxpayer’s treasury determines the amount of the gross receipts and deductions therefrom to be reported in the return. Speaking of the cash basis, the Supreme Court, in Avery v. Commissioner, 292 U. S. 210, said:

* * * unless Congress has definitely indicated an intention that the words should be construed otherwise, we must apply them according to their usual acceptation.

In the opinion of the Board reliance is placed upon Higginbotham-Bailey-Logan Co., 8 B. T. A. 566. The taxpayer involved in that case was on the accrual basis. It paid fire insurance premiums on policies running for more than one year. It sought to deduct in its return the full amount of the premiums paid although in its balance sheet it carried as an asset the portion of the premiums allocable to the unexpired insurance at the end of the year. The Board held that, since a return made on the accrual basis aims to allocate to the taxable year the expenses properly belonging to that year, the taxpayer was not entitled to deduct from gross income of the taxable year the portion of the premiums allocable to future periods. The Board did not hold in that case- that the fire insurance premiums were a capital expenditure; that the taxpayer acquired a capital asset which was to be depreciated over the fife of the policies. It simply held that fire insurance premiums should be expensed over the life of the policies so as to allocate to the taxable year the portion of the premiums that properly belonged to the taxable year. I do not think that the taxing statute warrants the deduction from gross income of fire insurance premiums under the heading of an allowance for depreciation.

Reference is also made to J. Alland & Brother, Inc. v. United States, 28 Fed. (2d) 792. In my opinion the principle involved in that case is not applicable to this one. The facts were that the taxpayer in 1921 agreed to pay $18,000 bonus in the acquisition of a leasehold, the period to start January 1, 1922. The taxpayer paid $10,500 of the amount in 1921 and claimed the amount as a deduction from gross income upon the ground that it made its return on a cash basis and that it was an expense of that year. The court held that it was capital expenditure. Manifestly, the principle has no application to the proceeding at bar.

The reasoning of the court in Welch v. Be Blois, 94 Fed. (2d) 842, seéms to me to be correct. In the course of its opinion the court said:

* * * Insurance which is purchased and paid for this year obviously will not furnish a deductible expense for next year. If the cost of insurance is apportioned between different years, the cost of many other kinds of materials and supplies and equally ordinary requirements, must also be apportioned, and great difficulties in accounting will be introduced which are foreign to the principle which the statute contemplates and will serve no useful purpose. Expenditures for such things are in no true sense capital expenditures. * * *

The effect of the Board’s opinion in this case is needlessly to complicate the administration of the law. It denies to the taxpayer the right to make a return on a cash basis — at least so far as fire insurance premiums are concerned. It does not put the petitioner strictly on an accrual basis so far as these are concerned. It puts it on a hybrid basis for. it allows the petitioner to deduct a portion .of the premiums allocable to the period extending beyond December 31, 1934. It seems to me that it should be the policy of the Board to simplify rather than to complicate the administration of the taxing law, especially where, as here, the deferment of the deduction of a part of the premiums will, as stated by the court in Welch v. Be Blois, supra, “serve no useful purpose.”

AeNold and Hilt, agree with this dissent.


author: Mellott :

text:
    D. W. Douglas, Petitioner, v. Commissioner of Internal Revenue, Respondent. William E. Douglas, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 87419, 87420.
    Promulgated June 29, 1938.

      G. 0. Carlson, Esq., and Frank Mergenthaler, Esq., for the petitioners.

      L. Tl. Bushbrook, Esq., for tbe respondent.
   OPINION.

Mellott :

In these consolidated proceedings the Commissioner determined that the distribution of certain stock to each of the petitioners in 1933 constituted liquidating dividends, rather than nontaxable distributions made in pursuance of a plan of reorganization, as contended by them. This resulted in the determination of deficiencies in income tax for the year 1933 in the amounts of $11,951.19 and $4,052.22, respectively.

Inasmuch as there is no substantial controversy between the parties as to the facts, most of which were either stipulated or contained in exhibits received in evidence without objection, we may dispense with the making of findings of fact and address ourselves to the questions of law after a brief statement of the essential facts.

The Douglas Co. was a corporation, duly organized under the laws of California during the month of July 1921, with a capital stock of 1,000 shares of the par value of $100 per share. It was engaged in the general business of developing and manufacturing airplanes at Santa Monica, California, the United States Government being practically its only customer. Seventy-five percent of its capital stock was owned by D. W. Douglas, who was also its president, his father, William E. Douglas owning the remaining 25 percent.

The Douglas Aircraft Co. (hereinafter referred to as the new company) was organized in November 1928 under the laws of Delaware, with an authorized capital of 1,000,000 shares of common stock with no par value, for the purpose of acquiring all of the assets of the Douglas Co. D. W. Douglas, by a letter dated November 22, 1928, addressed to some bankers, offered to cause, by proper corporate action of the Douglas Co., a sale or exchange to be made of all of its assets to a new corporation, to be designated “The Douglas Aircraft Co. Inc.”, for 200,000 shares of the no par stock of the new company. The 200,000 shares were to be issued to the Douglas Co. or its nominees and the bankers were to purchase an additional 100,000 shares at $10 per share for cash, this, i. e., 300,000 shares, being all of the shares then to be issued. In addition the bankers were to purchase, or cause to be purchased, from petitioners 100;000 shares of the 200,000 shares which were to be delivered to the Douglas Co., for which they were to pay $10 a share.

In the letter of D. W. Douglas to the bankers it was stated:

After the purchases and transfers herein provided for, I agree without further compensation to cause a prompt distribution of the proceeds thereof received by the present company [old company] to myself and my father as the sole stockholders thereof and thereafter to deliver or cause to be delivered all of the stock of the present company to the new corporation or its nominee.

The new company was organized and the 300,000 shares of stock were issued. Under date of December 5, 1928, in a letter addressed to the new company, the Douglas Co. offered to sell, assign, transfer, and deliver all of its assets of:

* * * every nature and description which can be assigned by law and will perform for your account the Government contracts now held by this company or which may be hereafter secured in the name of this company, conditional upon your furnishing all machinery, equipment, tools, materials and labor necessary in the performance of said contracts, and paying all liabilities which may arise out of the performance of said contracts, and any and all of them. Without limitation of the generality of the foregoing', we include all machinery, tools, implements, dies, jigs, molds, furniture and fixtures belonging to the undersigned and contained in its factory and building at Glover Field, California, or elsewhere, also the stock and materials of every kind, whether in raw, in manufactured or partially manufactured state, and all trade marks, trade names, patent applications, patents, secret processes, formulae, specifications and drawings of the undersigned and its business as a going concern, in consideration of
(1) The issuance and delivery to the undersigned of 200,000 shares of your no par value common capital stock, full-paid and non-accessable, and
(2) Tour assumption of all of the liabilities of the undersigned as shown by the said balance sheet of Ernst & Ernst of December 31st, 1927, and its attached schedules, and all of the liabilities of the undersigned as shown on the balance sheet of The Douglas Company as of November 30th, 1928, attached hereto, and current liabilities incurred in the ordinary course of the undersigned company’s business to the date of the transfer, and all of the liabilities which may arise in carrying out the contracts now on hand or which may hereafter be secured for the manufacture and delivery of airplanes by this company to any governmental agency of the United States Government.
The closing of this transaction shall take place in the office of Blair & Company, Inc., New York City, at o’clock on December 12th, 1928, at which time the undersigned will deliver to you, or upon your direction, proper instruments of assignment, transfer, and conveyance of its assets as specified above against receipt of 200,000 shares of your no par value common capital stock.

This offer was accepted by the new company.

Although it was intended originally, and the contract between the investment bankers and D. W. Douglas contemplated, that a prompt distribution to the stockholders of the Douglas Co., would be made of the 200,000 shares of the new company’s stock upon the surrender of their stock in the Douglas Co., two factors were thereafter found which necessitated, according to opinion and advice of counsel, the continuation of the existence of the old company, and the postponement of the completion of the plan until such time as the old company could be legally dissolved. These factors were as follows:

(1) There were disputed claims pending against the Douglas Co. which the new .company had not agreed to assume. Subsequently lawsuits were commenced, which had not been settled, tried, or disposed of prior to the date of its dissolution as hereinafter set out. Section 1228 of the Code of Civil Procedure of California, relating to the dissolution of California corporations, at that time provided in part as follows:

Application for dissolution of corporation, what to contain. The application must be in writing, and must set forth:
*******
(2) That all claims and demands against the corporation have been satisfied and discharged.

The pendency of the disputed claims prevented the making of the statement required under the above law and made it necessary that the Douglas Co. remain in existence until the claims were settled, unless the law should be, as it subsequently was, amended.

(2) The contracts between the Douglas Co. and the United States specifically provided that “the contract shall not, nor shall any right to receive payment or any other interest therein, be transferred or assigned by the contractor to any person, firm or corporation.” Because of this provision and E. S. 8737 the attorneys advised that the contracts could not be assigned.

Faced with the situation that the Douglas Co. could not be dissolved, as contemplated, and not wishing to abandon the contemplated reorganization, petitioners caused the board of directors of the Douglas Co. to adopt, on December 11, 1928, a resolution, reading in part as follows:

Resolved, that a partial distribution of the stock of the Douglas Aircraft Company, Inc., to the extent of 190,000 shares, be distributed to the present stockholders of the Douglas Company when, as and if such shares of the Douglas Aircraft Company, Inc., are issued and received, in proportion to the number of shares that each of the present stockholders of The Douglas Company now own, and that the remainder of said stock, to wit, ten thousand shares, of said Douglas Aircraft Company, Inc., be held in the treasury of this company for further distribution to the stockholders of this company in completion of the plan of reorganization.
Be It Ftjbther Resolved, that a proportionate part of 190,000 shares of the stock of the Douglas Aircraft Company, Inc., be issued directly to each stockholder of this company, or his nominee, upon request.

The foregoing plan was carried out. All tbe assets of the Douglas Co., except the United States Government contracts, were assigned, transferred and turned over to the new company. The new company issued 190,000 of its shares to the petitioners and 10,000 of its shares; to the Douglas Co.

The Government contracts were carried out and completed in 1930 by the new company for the account of the Douglas Co. The vouchers were made in the name of the Douglas Co. and checks in payment thereof were made payable to it. All of the checks were endorsed by tbe officers of the Douglas Co. and turned over to the new company for deposit in its bank account. The Douglas Co. bad no other income after November 30, 1928, except dividends upon the 10,000 shares of stock of the new company as follows:

1930_$12, 500
1931_ 12, 500
1932_ 8, 750
1933 _ 7, 500-
Total_ 41, 250

These dividends were paid by check of the new company to the Douglas Co. and were immediately endorsed by D. W. Douglas as its president, the proceeds being proportionately distributed to himself and his father. None of the above checks was deposited by the Douglas Co. It had no bank account from December 1, 1928, to December 28, 1933, and kept no books of account during such period.

By 1933 the contracts between the Douglas Co. and the United States Government had been completed and the law of California had been amended to permit the assumption of the liabilities of a dissolving corporation by responsible parties, so nothing then stood in the way of a dissolution of the Douglas Co. Accordingly, in December of 1933, D. W. Douglas having assumed all of the liabilities of the Douglas Co., it was dissolved and its remaining assets, consisting of the 10,000 shares of the new company stock, were distributed proportionately to its stockholders, D. W. Douglas receiving 7,500 and William E. Douglas 2,500.

In the deficiency notices the respondent treats the distribution of the 190,000 shares to the petitioners in 1928 as nontaxable because made pursuant to a plan of reorganization. He says, however, that “* * * the distribution of the 10,000 shares made in 1933, approximately five years later, constituted a liquidating dividend.” Accordingly he increased the capital net gain reported by D. W. Douglas $99,310.50 and that reported by William E. Douglas $33,-137.50, these amounts representing the “cash value” — as to which there is no dispute — of the stock which they received. In other words, respondent determined the deficiencies upon the theory and now contends that the reorganization was completely effectuated on December 28,1928; that everything necessary to complete it was then done; that under the rule enunciated and applied by the Supreme Court in Helvering v. Minnesota Tea Co., 296 U. S. 378, and G. & K. Manufacturing Co. v. Helvering, 296 U. S. 389, it was unnecessary and immaterial that the transferor had not then, and as part of the reorganization, been dissolved; and that when the transferor corporation was dissolved and its assets distributed in a later year— after, as he contends, carrying on business for five years — a distribution in liquidation under section 115 (c) of the Revenue Act of 1932 occurred.

Petitioners contend that the dissolution, of the Douglas Co. and the distribution to them of the 10,000 shares of stock in the new company, although not made until 1933, were nevertheless integral parts in, and took place in pursuance of, the plan of reorganization formulated and partially carried out in 1928; that therefore no gain is to be recognized because of the provisions of section 112 of the Revenue Acts of 1928 and 1932, which, as applicable here, are identical.

While it is true, as pointed out by the respondent, that the courts and this Board have beld that the mere fact the transferor corporation was not dissolved after transferring all, or a major portion of, its assets, does not preclude a finding that a reorganization had occurred inasmuch as dissolution is not prescribed by the act, we are of the opinion that the mere application of that rule is not sufficient to solve the present problem. In this connection, however, it should be found as a fact, and we make such a finding, that the transferor did not actually carry on a business during the interim between 1928 and 1933. It was, we think, merely kept alive to comply with the laws of the state under which it was organized and to obviate any possible complications which might arise in connection with its contracts with the United States Government. We have set out above all of the facts upon which this conclusion is based and we are of the opinion that it is fully justified. It is also obvious that the liquidation of the transferor was not completed until 1933, so technically there was a distribution in liquidation during that year. But all of the sections of the revenue act must be construed together. Indeed, the section relied upon by the respondent (115 (c), supra) specifically requires that we give consideration to the applicability of section 112; for it provides that the gain “shall be recognized only to the extent provided in” it. This limitation has been recognized in such cases as Gross v. Commissioner, 88 Fed. (2d) 567, and North American Utility Securities Corporation, 36 B. T. A. 320.

We think the conclusion is inescapable that the distribution which was made in 1933 was the “further distribution to the stockholders * * * in completion of the plan of reorganization” which was contemplated when the directors, on December 11,1928, adopted the resolution referred to above. Nor is there any evidence justifying the conclusion that the petitioners waived their rights to the 10,000 shares or that they accepted the 190,000 shares in lieu of the 200,000 shares which they were to receive in the reorganization. The fact that they ultimately received the number of shares contemplated by their agreement, is, in our opinion, a strong circumstance indicating that they never intended to accept less than that number. The original plan was not changed. The execution of a part of it was merely postponed until it could be carried out in full. In the meantime the petitioners retained their stock in the Douglas Co. Under the circumstances we are of the opinion that the lapse of time is not decisive; and in this connection it may be noted that the act contains no limitation as to time and specifies no time within which an exchange must be made. Stock in a corporation, a party to a reorganization, was exchanged solely for stock in another corporation, also a party to the reorganization, in pursuance of the plan of reorganization, after which, and as a part of the same plan, the stock was distributed to petitioners. This, we think, was sufficient to make it a transaction in which, under section 112, no gain should be recognized.

The action of the respondent is disapproved.

Judgment will he entered under Mule 50.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      (e) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. * * *

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) Generad Rude.. — * * *
      (b) Exchanges Sodedy in Kind. — * * *
      (3) Stock for Stock on Reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * # * * * * *
      (i) Definition of Reorganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), * * *
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the ease of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.


author: Black : OpeeR,

text:
    Mercer McCall Tharpe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78243.
    Promulgated June 30, 1938.

      M. E. Kilpatrick, Esq., for the petitioner.

      O. A. Bay, Esq., for the respondent.
   OPINION.

Black :

It is the contention of the petitioner that his employment by the Georgia Tech Athletic Association as assistant coach in charge of the freshman football team, constituted him an employee of a department of the Government of the State of Georgia, and that in the performance of his duties he was exercising an essential governmental function, thereby exempting his salary from payment of income tax thereon. There is no contention that he was an “officer” within the meaning of that word as defined in similar cases.

The respondent, on the other hand, presents several arguments in opposition — (1) that because of the skill required of the petitioner in the duties performed and because of the part time nature of his duties, his relationship was more in the nature of an independent contractor as distinguished from master and servant; (2) that coaching a football team to engage in intercollegiate athletics is not an essential governmental function; and (3) that the tax upon the petitioner’s salary imposed no burden upon the State of Georgia.

We sustain points (2) and (3) made by respondent, and find it unnecessary to discuss point (1).

We shall assume that petitioner, as an employee of the Georgia Tech Athletic Association, was thereby an employee of the Georgia School of Technology, and that the Georgia School of Technology is an agency of the State of Georgia. Cf. G. Ridgely Sappington, 25 B. T. A. 1385. However, the mere holding that petitioner is employed by an agency of the State of Georgia does not mean that the compensation which he receives from such employment is immune from Federal taxation. Cf. Commissioner v. Gerhardt, 304 U. S. 405. The duties performed by petitioner for the athletic association were to coach the freshman football team of Georgia Tech. In performing these duties, we do not think he was engaged in the performance of essential governmental functions. Cf. Allen v. Regents of University System of Georgia, 304 U. S. 439.

One of the cases cited by petitioner in support of his contention was Regents of the University System of Georgia v. Page, 81 Fed. (2d) 577. That decision reversed the United States District Court for the Northern District of Georgia, which had held on motion, without a hearing on the merits, that intercollegiate athletics, including football, carried out as a part of the program of physical education at Georgia Tech, was not carrying on a governmental function. On reversal by the Fifth Circuit, the United States District Court heard the case on its merits and found in favor of the regents of the University System of Georgia. The Government then appealed to the Fifth Circuit and that court affirmed the decision of the District Court. See Page v. Regents of the University of Georgia, 93 Fed. (2d) 887. Writ of certiorari was granted by the Supreme Court. In the meanwhile, Collector Page had died and Collector Marion H. Allen was substituted as petitioner. The Supreme Court decided the case in favor of the Government on May 23, 1938. See Allen v. Regents of the University System of Georgia, supra. We recognize of course that the question involved in that case was not the same as the question here involved.' In Allen v. Regents of the University System of Georgia the question involved was the right of the Government to collect admission taxes on football tickets, where the tickets were sold by the Georgia Tech Athletic Association, for admission to football games held under the auspices of the athletic association, while here the question is whether the compensation of petitioner, as an employee of the athletic association engaged in coaching the freshman football team, is immune from taxation. While the questions involved in the two cases are not the same, it seems clear to us that the implications of the Supreme Court’s decision in Allen v. Regents of the University System of Georgia, supra, are against the contentions of petitioner.

Aside from the fact that we hold that petitioner, as an employee of the athletic department of Georgia Tech engaged in coaching the freshman football team, was not engaged in the performance of essential governmental functions, and therefore his compensation is not immune from the Federal income tax, we also hold that a tax on petitioner’s salary would impose no burden upon the State of Georgia.

The evidence affirmatively shows that the Legislature of the State of Georgia made no appropriation in either of the taxable years to defray the expenses of the athletic department of Georgia Tech. The evidence shows that this department was sustained entirely by a fund raised from two sources — (1) athletic fees of $7.50 a year paid in by each student of Georgia Tech, and (2) receipts from intercollegiate contests, mostly football games. The latter made up much the larger part of the funds of the athletic association. The receipts from (1) were paid over to the athletic association and receipts from (2) were received directly by it. From this common fund all expenses of the athletic department of Georgia Tech were paid, including the salary of petitioner.

In view of these facts, we would hold that petitioner’s compensation is not immune from the Federal income tax even if all other factors were in his favor. If there would be any burden imposed on the State of Georgia by taxing petitioner’s salary under such circumstances, it would be entirely too contingent and remote to justify any constitutional immunity. Cf. Commissioner v. Gerhardt, supra; Commissioner v. Therrell, 303 U. S. 218; Ned R. Harman, 34 B. T. A. 654; affd., 90 Fed. (2d) 622.

The petitioner, in support of his contention that the athletic department of Georgia Tech is a part of the educational system of the State of Georgia and therefore it is immaterial that it derives its chief support from admission fees to football games, cites the Supreme Court decision in Commissioner v. Coronado Oil & Gas Co., 285 U. S. 393. He quotes the language of the Supreme Court in that case, as follows: “Here the lease to the respondent was an instrumentality of the state for the purpose of carrying out her duty in respect of public schools. To tax the income of the lessee arising therefrom would amount to an imposition upon the lease itself.’’ From this language petitioner argues that the fact that an incidental admission charge is made to athletic contests and the proceeds therefrom furnish the chief support of the athletic department does not affect the tax immunity of the salaries of the employees of that department. Since the filing of petitioner’s brief and the citation of the Coronado Oil & Gas Co. case, that case has been expressly overruled by the Supreme Court in Commissioner v. Mountain Producers Corporation, 303 U. S. 376. Therefore, if it may be assumed that the Coronado Oil ds Gas Co. case did support petitioner’s contention, it is now no longer authority.

Reviewed by the Board.

Decision will be entered for the respondent.

OpeeR,

concurring: While in accord with the conclusion reached in the majority opinion, we feel compelled to record our inability to agree with its discussion of the second point; that is, whether petitioner’s duties involve the performance of an essential governmental function on behalf of the State of Georgia. By this we do not wish to be understood as suggesting that a football team is an essential element of a program of higher education or that the coaching of such a team is an inherent part of the process of collegiate instruction. But we do feel that any reference to the character of petitioner’s occupation, and especially any discussion of whether or not an instrumentality of the State of Georgia was thereby engaged in the performance of an essential governmental function, is unnecessary for the determination in this case. It is even more evident here than it was in Commissioner v. Gerhardt, 304 U. S. 405, that a tax upon the salary of petitioner would constitute at most a burden “so indirect or conjectural as to be but an incident of the co-existence of the two governments and therefore not within the constitutional immunity.” That ground is the only one we consider necessary for the decision of this proceeding.

ARuwdell, Turner, and Disney agree with the above.


author: Mellott:

text:
    R. E. Baker, Petitioner, v. Commissioner of Internal Revenue, Respondent. Arthur G. McKee, Petitioner, v. Commissioner of Internal Revenue, Respondent. T. W. Rutledge, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 58152, 61120, 61121.
    Promulgated June 30, 1938.

      Arthur O. Denison, Esq., and Oscar I. Kofee, O. P. A., for the petitioners.

      B. B. Pierson, Esq., for the respondent.
   OPINION.

Mellott:

The issues raised in the proceedings of McKee (No. 61121) and Baker (No. 61120) will be discussed first. The principal one may be stated generally in the form of a question as follows: “May the petitioners, in computing their gains from the sales in 1928 of their stock in the reorganized Delaware Co., use other than a ‘zero basis’ for the stock sold?” In other words, what basis should be used for the purpose of computing petitioners’ gain or loss upon the sales of such stock and are they now estopped to claim a larger basis than zero?

The determination of the Commissioner that zero is the proper basis for the stock is predicated primarily upon section 113 (a) (6) of the Revenue Act of 1928. Under that section, which provides by its terms that the basis shall be the same as the property exchanged, “increased in the amount of gain * * * that was recognized upon such exchange under the law applicable to the year in which the exchange was made * * it is necessary to examine the law as it existed at that time (April 1, 1920). This is reflected in section 202 (b) of the Revenue Act of 1918.

The stock which was sold by these petitioners in 1928 was stock which had been received by them in a nontaxable exchange in April 1928. Accordingly, it had the same basis for the computation of gain or loss that the stock exchanged had in their hands on April 1, 1920, except in so far as such basis had been affected by the sales and purchases made subsequent to April 1, 1920, and prior to the date of the reorganization in 1928. Whatever effect such sales or purchases had upon the basis, and respondent’s contention that the petitioners are estopped to use a basis other than zero, will be discussed later; but first the basis of the stock as of April 1, 1920, will be determined.

Columns 1 and 3 of the following schedule reflect the method, as we interpret the respondent’s notice of deficiency and his argument, upon brief, by which the basis of the common stock of the Delaware Co. stock was determined to be zero. Columns 2 and 4 reflect the present contentions of the petitioners.

Petitioners, stating that they have consistently followed the “recovery of cost” theory in respect to proceeds realized from sales, now insist that they have overpaid their tax. McKee contends that he should have reported a gain of $111,349.07 instead of the $217,289.67 which he reported. Baker contends that he should have reported a gain of $25,419.04 instead of the $86,234.62 which he reported. The details of their present contentions are reflected in the following schedule:

The first difference between the parties is in connection with the cost of the Pennsylvania Co. stock. The respondent used the amounts shown by the books of the corporation as contributed by the partners, viz., $15,000, $6,000, and $6,000, or a total of $27,000. This did not include any value for what the petitioners refer to as “intangibles”, i. e., good will, uncompleted contracts, patterns, patent licenses and rights, designs, drawings, formulae, etc., turned over by the partnership to the corporation but not shown on the books. Petitioners place a value upon all of the assets of $234,000 on January 1, 1915, determined as hereinafter shown. We have determined that the assets had a value of $115,000 rather than that ascribed to them by either of the parties. In making such determination we have considered all of the evidence and the contentions made by the respective parties. It will not be amiss, however, to point out some of the reasons why we have not accepted the value fixed by either.

We do not agree with respondent’s contention that no value can be attributed to the so-called intangible assets because none was set up on the books of the company. This is a mere evidentiary fact and1 not controlling. Doyle v. Mitchell Brothers Co., 247 U. S. 179; Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216; D. N. & E. Walter & Co., 4 B. T. A. 142. Nor do we agree that it is improper to ascribe any value to the good will and similar factors merely because of the fact that the corporation afterwards claimed and was allowed the classification of a “personal service” corporation. If the partnership, through the character, skill, industry, integrity, and ability of the partners had built up good will, which was transferred to and utilized by the successor corporation, it was an asset of value and could have been set up on the books of the corporation. Though this was not done, it is nevertheless our duty to determine its value. No uniform rule can be stated for the determination of such value. It is a question of fact to be determined in the light of all the facts and circumstances. Cf. Watab Paper Co., 27 B. T. A. 488; House & Herrmann, 13 B. T. A. 621; affd., 36 Fed. (2d) 51; Mossman, Yarnelle & Co., 9 B. T. A. 45; Schulz Baking Co., 3 B. T. A. 470.

Some of the facts and circumstances which have been considered are the following: The partners had carried on their highly specialized and technical trade or business for several years. They were experts in their line and had attained enviable reputations, both individually and as members of the firm of Arthur G. McKee & Co. The firm name was well known, especially to the iron and steel companies in the United States and Canada, many of whom had employed it to supervise the construction and installation of new blast furnaces and ovens. Considerable sums of money had been expended by the partnership and its members in the development of patents, new processes, formu-lae, drawings, designs, blueprints, and methods of construction, all of which -were available to the corporation. In addition the corporation had the exclusive right to the use of some eighty patents owned by the Appliance Co. many of which were basic. The record of the earnings of the partnership for the four years immediately preceding the organization of the corporation shows a progressive increase in earnings each year after the deduction of substantial salaries paid to the partners. These factors, we think, show a substantial value for the good will of the partnership, though we do not deem it necessary to set out such value in dollars and cents. Cf. Henry F. McCreery, 4 B. T. A. 967; Theo Planz, Inc., 10 B. T. A. 1158.

Another factor which has been considered in fixing the cost or value of the total assets turned over by the partnership to the corporation is the Appliance Co. stock. Fifty-one shares of the 100 shares issued were carried on the books at $510. During 1914 this company paid dividends of $13,000 and had undistributed profits of $3,366.38. This, we think, indicates that the stock had a value greatly in excess of that set up on the books of the corporation. Whether such value should be classified as part of the good will or added to the value of the tangible assets need not be decided. It is, however, a factor to be, and which has been, considered in determining the value of all the assets to be $115,000, when turned over by the partnership to the corporation.

The value urged by the petitioners of $234,000 is not justified by the evidence. It was determined, as shown in the margin, through the use of a formula. Apparently an effort was made to apply the formula suggested by the Commissioner in A. E. M. 34, 2 C. B. 31; but instead of using the average earnings over a period of years prior to the basic date, petitioners have used an average of the earnings for two years prior and two years subsequent to that date. In addition, the stipulated earnings for three of the years were less than those used by the petitioners. If, therefore, a formula should be used for the purpose of determining the value of the assets, the one set out in the margin as “Formula under A. E. M. 34” would probably give a fairer and more nearly accurate approximation than the one used by petitioners.

The fair market value of the stock of the Delaware Co. received by petitioners in exchange for their stock in the Pennsylvania Co. must next be determined. It will be noted that the respondent treated the par value of 10 shares of the preferred stock of the Delaware Co. ($1,000) as the combined fair market value of 10 shares of the preferred and 5 shares of the common, received by petitioners for each share of the common stock of the Pennsylvania Co. He then attributed all of such value to the preferred stock of the Delaware Co., leaving a “zero basis” for the common, “for the reason [as stated in his notice of deficiency] that the preferred stock was issued in an amount equal to the book value or net worth of the old corporation and since no intangible value is recognized, no value is assigned to the common stock.”

Petitioners, as shown in their contentions, supra, assign an aggregate fair market value to the 1,943.% shares of common and 3,886% shares of preferred of $1,000,000. Deducting the par value of the preferred, which they owned, from their aliquot portions of the $1,000,000, they determine their basis for the common stock to be as shown in the tabulation, i. e., for McKee’s 750 shares, $235,940, and for Baker’s 550 shares, $173,020.

The evidence shows that the income of the Pennsylvania Co. from 3915 to 1920, after deducting the salaries paid to McKee, Baker, and Herr, increased from $24,801.44 to $174,327.82; that the net worth, as shown by its books, increased from $27,000 to at least $388,666.66 during the same period; that the secretary determined a value of $172.55 for the common stock of the Delaware Co. as of April 1, 1920, for the purpose of establishing a selling price and that both he (Baker) and McKee made sales during that year at that price; that during the years 1920 and 1921 McKee and Baker purchased such stock at $259.49, $379.08, and $399.50 per share. Baker, testifying at the hearing before us, stated that in his opinion the stock of the Delaware Co. on April 1, 1920, was worth 8 times the earnings for the preceding 12 months. One investment banker expressed the opinion it was worth 6% times the average earnings during the period from January 1, 1918, to April 1, 1920, while another (both called by petitioners) stated that he would value it on the basis of from 5 to 7 times its net earnings available for the payment of dividends. We have carefully considered all of the evidence and have concluded, as shown in our findings, that the fair market value of the 3,886% shares of the preferred stock of the Delaware Co. on April 1, 1920, was $388,666.66 and the fair market value of the 1,943% shares of common was $443,978.54, a total of $832,645.20.

Respondent’s affirmative plea of estoppel will be considered next. He contends that even if it be held that the common stock had a fair market value on April 1, 1920, petitioners should not be allowed to use it because they elected to treat the transaction in 1920 as nontaxable, elected to report no profit on subsequent sales, escaped taxa tion on the profit derived from the sales made prior to 1928, and, since the statute of limitations has now run against the collection of taxes for those years, that they are estopped to claim a stepped-up cost basis.

In United States v. Scott & Sons, Inc., 69 Fed. (2d) 728, the court stated:

* * * To constitute estoppel (1) there must be false representation or wrongful misleading silence. (2) The error must originate in a statement of fact and not in an opinion or a statement of law. (3) The person claiming the benefits of estoppel must be ignorant of the true facts, and (4) be adversely-affected by the acts or statements of the person against whom an estoppel is claimed. * * *

The evidence shows that no gain was reported by the petitioners in 1920 because they believed, and were so advised, that the transaction constituted a distribution óf a nontaxable stock dividend, since merely the surplus, consisting entirely of earnings upon which the stockholders had paid income taxes, had been capitalized. Baker testified — and notwithstanding the fact that he was an interested party we are of the opinion that he was an entirely credible witness— that no profits were reported on the sales between 1920 and 1928 because petitioners believed they were “merely recovering cost.” Inasmuch as investigations were made by revenue agents and no questions were raised, he was of the opinion that they had acted properly. The report made by the revenue agent indicates that he was justified in this belief; for therein it is stated that the capital of $38,866.66 outstanding at the date of reorganization in 1920 was “increased to $388,666.66 by a stock dividend.” We do not understand that the respondent is making any claim that the petitioners acted fraudulently or that they were guilty of willful misrepresentation or wrongful misleading silence.

There is no showing that the respondent was ignorant of the true facts or that he was misled by any act of commission or omission on the part of these petitioners. As stated in Brooklyn City Railroad Co., 27 B. T. A. 77, 83; affd., 72 Fed. (2d) 274, “certainly misconstruction of the law, and action based upon a legal theory rather than upon a factual theory, would not constitute a false representation concerning a material fact.” Nor can estoppel “originate in a mere statement of law or in silence due to an error of law.” Commissioner v. Union Pacific R. R. Co., 86 Fed. (2d) 637, affirming 32 B. T. A. 383. Estoppel can not be “predicated on a mistake of law in the absence of some misrepresentation of fact,” Estate of William Steelz, 34 B. T. A. 173, 175; nor does an innocent mistake made in a tax return afford a basis for its invocation. Wother Brothers, 35 B. T. A. 890, 892. Estoppel must be proven by the one asserting it, and the proof “should be clear and not depend upon inference or argument.” Tide Water Oil Co., 29 B. T. A. 1208, 1221; Helvering v. Brooklyn City Railroad Co., 72 Fed (2d) 274, affirming 27 B. T. A. 77. Cf. Lansing McVickar, 37 B. T. A. 758.

The petitioners computed and reported the gain on the sales made in 1928 according to their theories. The respondent finally determined that the transaction in 1920 was taxable and that to compute the gain in 1920 in order to ascertain the basis under section 113 (a) (6), 1928 Act, “it is necessary to determine the original cost to the shareholders of the corporation stock received in 1915 and the fair market value of the new stock received in 1920” and that for this purpose “the fact that such gain was not reported by or taxed to the respective individuals is immaterial.” Whether his present plea of estoppel is inconsistent with these statements need not be determined. If the determination of the respondent of the factors required by law for the ascertainment of the basis to be used for the computation of gain or loss in 1928 is erroneous, estoppel can not be availed of to justify or perpetuate such, errors. Furthermore, the Board stated in Sugar Creek Coal Mining Co., 31 B. T. A. 344, 348, as follows:

* * * As a general proposition, estoppel does not support a belated assessment merely because the taxpayer bas omitted the income from his earlier returns and the statute of limitations has barred the correct assessment.

We are of the opinion, and hold, that no estoppel has been shown and that petitioners are entitled to use the bases which we have determined in computing gain or loss upon the sale or disposition of their common stock.

The basis of the 750 shares of common stock owned by McKee, computed in accordance with the statute and the views herein expressed, is $127,150.67, while the basis of the 550 shares owned by Baker is $115,693.29. We show the computation of such bases in the margin. It is necessary, however, to pass upon one more question before actual computation of the gain or loss sustained by the petitioners upon the disposition of the stock can be made.

It lias been found that after the organization of the Delaware Co. in 1920 and before the reorganization in 1928 McKee sold 443% shares and purchased 408 shares of the common stock while Baker sold 348% shares and purchased 367% shares. There is no evidence to enable us to identify the shares sold; hence the “first in, first out” rule must be applied. Cf. Jacob Epstein, 36 B. T. A. 109; Miller v. Commissioner, 80 Fed. (2d) 219. Applying the rule to the sales made by McKee (subject to the right of either party to call our attention to any mathematical errors) we conclude that the gain which should have been reported by him was $257,073.42 instead of the $217,289.67 reported. A similar computation with reference to the sales made by Baker discloses that he should have reported a gain of $157,827.15 instead of the $86,234.62 which he reported.

The petitioners in the three proceedings — and this is the sole issue in Docket No. 58152 — contend that, because of the restriction of ownership in officers and employees of the company and in particular because of the trust agreement, the class B stock was not marketable; that therefore the apportionment of the basis of the old stock between the two classes of new stock is impracticable; and that they are entitled to recover the entire cost. While the trust agreement was entered into to limit the ownership of the class B stock to officers and employees of the company, the sale of such stock was not made impossible. . Under the trust agreement the trustees were authorized to purchase class B stock and to sell such stock to any officer or employee making application therefor. The trust agreement has 41 signatures, presumably all holders of class B stock. We do not know how many employees the company had at this time, but the number may have been considerably more than 41. Class B stock was sold during 1928, McKee having sold 4,981 shares and Rutledge 470 shares. Additional purchases and sales may have been made by others. The sale price was fixed at $12.66 a share. The situation herein is not comparable to the situation existing in Helvering v. Tex-Penn Oil Co., 300 U. S. 481; Propper v. Commissioner, 89 Fed. (2d) 617; and Morris D. Kopple, 35 B. T. A. 1056.

' In those cases the sale of stock was absolutely restricted for a certain period of time, sale during the period of restriction being impossible. In H. A. Green, 33 B. T. A. 824, 830; dismissed, 84 Fed. (2d) 1003, 1004, the Board stated:

* * * the principle of allocation is based on market value. Where there is no market value, no allocation can he made, and the taxpayer is entitled to recover his entire original basis before gain or loss will be recognized on the disposition of the new securities. Edwin D. Axton, supra. [32 B. T. A. 613.]

The fact that the class B stock was not available for sale to the public does not prove that it had no market value. The situation is somewhat analogous to that pertaining to closely held stock. As to the latter the courts and this Board have held that the absence of actual trading or sales in closely held stock or the fact that no sale was made in the open market does not prove that such stock had no market value. Insurance & Title Guarantee Co., 12 B. T. A. 452; affd., 86 Fed. (2d) 842; and George M. Wright, 19 B. T. A. 541; affd., 50 Fed. (2d) 727. There was a market here, though limited to officers and employees as evidenced by the sales. Such sales show a demand on the part of the officers and employees for the stock and a supply to meet the demand. In fact the trustees were authorized to meet any demand by a purchase pro rata of the deposited stock. The petitioners do not claim that the class B stock had no fair market value, but merely that it was impracticable to apportion the aggregate value between the two classes of stock.

In H. A. Green, supra, it was held that the following provision of article 1567 of Regulations 62 under the Revenue Act of 1921:

* * * the proportion of the original cost, or other basis, to be allocated to each class of new securities is that proportion which the market value of the particular class bears to the market value of all securities received on the date of the exchange.

lays down a principle equally applicable in determining gain or loss under subsequent acts. This principle of allocation was applied by the respondent in determining the gain realized by Rutledge and, in our opinion, it should have been applied. It is equally applicable in apportioning the basis of the common stock held by McKee and Baker in April 1928, between the class A and B stock owned by them.

Decision will be entered for the respondent in Docket No. 58152. Decision will b& entered under Rule 50 in Docket Nos. 61120 and 61121.

       SEC. 113. BASIS FOR DETERMINING GAIN OR LOSS.
      (а) Property acquired after February 28, 1913. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property ; except that—
      *******
      (б) Tax-free exchanges generally. — If the property was acquired upon an exchange described in section 112 (b) to (e), inclusive, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the property so acquired consisted in part of the type of property permitted by section 112 (b) to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it.

       Sec. 202. (b) When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; but when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged.
      When in the ease of any such reorganization, merger or consolidation the aggregate par or face value of the new stock or securities received is in excess of the aggregate par or face value of the stock or securities exchanged, a like amount in par or face value of the new stock or securities received shall be treated as taking the place of the stock or securities exchanged, and the amount of the excess in par or face value shall be treated as a gain to the extent that the fair market value of the new stock or securities is greater than the cost (or if acquired prior to March 1, 1913, the fair market value as of that date) of the stock or securities exchanged


author: Steiínhagen :

text:
    Suffolk Company Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81817.
    Promulgated June 30, 1938.

      Thomas F. Boyle, Esq., for the petitioner.

      Philip M. Clark, Esq., for the respondent.
   OPINION.

Steiínhagen :

The Commissioner’s determination of deficiency includes several items of adjustment. The only one contested by petitioner is described in the notice of deficiency, without further explanation, as follows:

(i) Refund of New York City Money Capital Tax received fey you during the taxable year is held to be taxable income.
Amount received_$426, 773.12 Less:
Legal expenses in connection therewith_ 45, 009.40
Balance added to income-$381, 763. 72

The petitioner contends that this determination is incorrect, first, because as a foreign corporation its gross income from sources within the United States may include only those items enumerated in Revenue Act of 1932, section 119, subdivision (a) , of which this is not one; and second, because in any event the amount received from the city of New York as a refund of taxes originally overpaid by Blair & Co. is not income to petitioner, even if its gross income is to be tested by an omnibus description such as that of section 22, applicable to domestic corporations. For the respondent here there has been no argument in defense of his determination and no brief. The facts were stipulated.

In N. V. Koninklijke Hollandische Lloyd, 34 B. T. A. 830, it was held that as to foreign corporations the income taxable was confined to that expressly described in section 119. While there is room in subdivision (e) of that section for an expansion of the gross income found in the items of subdivision (a), such for example as the gain from the sale of personal property (see Hubert De Stuers, 26 B. T. A. 201), there is nothing in the entire section which would support the inclusion in a foreign corporation’s gross income of a refund of overpaid city taxes. This alone requires the reversal of the Commissioner’s determination and leaves unnecessary any decision upon the more general question whether the petitioner’s receipt of the tax refund due to its predecessor would have been taxable to petitioner under section 22 because of the intervening reorganization.

Judgment will be entered vmder Rule SO.

       SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES.
      (a) Gross Income from Sources in United States. — The following items of gross income shall be treated as income from sources within the United States :
      (1) Interest. — Interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, not including—
      *******
      (2) Dividends. — The amount received as dividends— ****** +
      (3) Personal services. — Compensation for labor or personal services performed in the United States;
      (4) Rentals and royalties. — Rentals or royalties from property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States, patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property; and
      (5) Sale of real property. — Gains, profits, and inepme from the sale of real property located in the United States.