author: Kern :

text:
    Sophia P. O. Morton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89257.
    Promulgated August 30, 1938.

      Robert V. Jones, Esq., for tlie petitioner.

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

Kern :

This proceeding involves a deficiency in petitioner’s income tax liability for the year 1934, determined by respondent in the sum of $4,399.24 by reason of his inclusion in petitioner’s income of the income of two trusts created by petitioner for the purpose of paying premiums on certain life insurance policies covering the life of her husband, and the disallowance by respondent of $500.64 representing the payment by petitioner of certain legal expenses. With regard to this latter item, the parties have stipulated that petitioner is not entitled to deduct this sum from her gross income. Therefore, the only question for our consideration is whether respondent erred in including the income of the two trusts in computing the net income of petitioner.

The facts were stipulated by the parties, and may be summarized as follows: Sterling Morton, the husband of the petitioner, insured his life with the Equitable Life Assurance Society of the United States for $275,000, for which policies were issued to him at various times until he held eight life insurance policies. The petitioner, wife of Sterling Morton, was designated the beneficiary to whom the life benefits were to be paid at his death. These policies also provided that the petitioner had the right to the cash surrender and loan value of each policy and the right to change the beneficiary should she so desire. These rights were vested in her and her alone.

On February 3,1933, the petitioner created a trust and entered into a contract with the Bankers Trust Co. of New York City to act as trustee. The object of the trust was stated in the preamble thereof as follows: “The grantor desires to create a trust fund, the income of which shall be used to pay the premiums on the life insurance policies,” referring to the life insurance policies on the life of Sterling Morton. Thereupon, the petitioner transferred to the Bankers Trust Co., as trustee, 1,300 shares of the common capital stock of the American Telephone & Telegraph Co., Cleveland Union Terminal bonds of the face value of $4,000, New York Central Railroad Co. bonds of the face value of $3,000, Ontario & Western bonds of the face value of $4,000, and Remington Rand, Inc., bonds of a face value of $3,000.

The income of the trust for the year 1934 was as follows: Dividends, $11,553.75; interest, $618.09; capital gains, $21,886.68, of which $7,288.03 were subject to income tax. During the same year, the trustee paid $8,203.78 as premiums on the life insurance policies, a fee to the trustee of $250, and income tax amounting to $25.56. The balance of the income was held and accumulated by the trustee pursuant to the provisions of the trust agreement. The Bankers Trust Co., as trustee, filed a fiduciary income tax return for the year 1934, showing all of the income received from the trust estate, and paid the income tax due on the return.

The trust agreement provided that, subject to the provisions of article II thereof, the trust was to terminate upon the death of the last survivor of the petitioner’s husband, Sterling Morton, her daughter, Suzette Morton, and the petitioner. Article Y of the trust agreement provides:

1. If the said Steeling Mokton shall at any time cause to be delivered to the Trustee a memorandum in writing, stating that the said Steeling Mokton intends to terminate the trust herein created on or after the next succeeding first day of January following the date of delivery of such memorandum, and if, on or after the next succeeding first day of January following the delivery of such memorandum, the said Sterling Morton shall cause to be delivered to the Trustee a second memorandum, signed by the said Sterling Morton and stating that the said Sterling Morton, by the delivery of such second memorandum, thereby terminates the trust herein created, then and in such event the trust herein created shall terminate upon the delivery of such second memorandum to the Trustee as aforesaid; and on such termination in accordance with the provisions of this paragraph, the Trustee shall convey, assign, transfer and deliver all accumulated income of the Trust Estate then in the hands of the Trustee, accumulated by the Trustee as hereinabove provided, and any and all investments and reinvestments thereof, to the said Sterling Morton, and the Trustee shall convey, assign, transfer and deliver the remainder of the Trust Estate and all thereof to the Grantor, if she shall then be living, and if she shall not then be living, then to the said Sterling Morton.
2. In the event that the trust herein created shall not have been terminated prior to the death of the said Sterling Morton, as hereinabove provided, and in the event that the trust herein created shall continue in existence for three years following the death of the said Sterling Morton, then from and after the expiration of three years following the death of the said Sterling Morton, the following provisions shall be applicable: If the Grantor shall then be living, she shall have the right at any time thereafter and as long as she shall be living, to terminate the trust herein created by written notice to the Trustee, and from and after the death of the Grantor, the said Suzette Morton, if she shall survive the Grantor, and so long as she shall be living, shall have the right at any time to terminate the trust herein created by written notice delivered to the Trustee. In the event that the trust hereby created shall be terminated by written notice by the Grantor as aforesaid, then upon such termination the Trustee shall convey, assign, transfer and deliver all accumulated income then in the Trustee’s hands, accumulated as aforesaid, and any and all investments and reinvestments thereof to the said Suzette Morton, her heirs, executors, administrators and assigns, and the remainder of the Trust Estate and all thereof to the Grantor. In the event that the trust hereby created shall be terminated by written notice by the said Suzette Morton, as aforesaid, then upon such termination of Trustee shall convey, assign, transfer and deliver the Trust Estate and all thereof to the said Suzette Morton.

Tlie trust was not otherwise revocable.

On March 5, 1934, Sterling Morton created a trust and appointed the Bankers Trust Co., as trustee, to pay the premiums on certain life insurance policies covering the life of the petitioner. In these policies Sterling Morton was the designated beneficiary with the right to the cash surrender and loan value and the sole right to change the beneficiary. The terms of this trust agreement are, for all purposes, identical with the one under consideration in this case, with the exception that the grantor of the trust and the person in whom the power to revoke was vested were reversed.

Under date of August 6,1934, the petitioner and president and directors of the Manhattan Co., a New York corporation, entered into a trust agreement, and the petitioner delivered to the Manhattan Co., as trustee under said agreement, 20Q shares of common stock of American Telephone & Telegraph Co. and $10,000 in principal amount of the 6 percent bonds of the Morton Building Corporation, a corporation. On or about the same date the petitioner delivered to the Manhattan Co. the life insurance policy described in the schedule attached to the said trust agreement which insured the life of petitioner’s husband, Sterling Morton. The annual premium due on this policy was $2,228.50, while the probable annual fee of the trustee was $160.

During the year 1984 the Manhattan Co., as such trustee, received dividends in the amount of $450 and taxable interest in the amount of $299.01. The probable gross annual income of the trust from the securities held by it was $2,400, which was approximately equal to the probable annual expenditures of the trust.

Under the trust agreement with the Manhattan Co. the trust net income was payable by the trustee on the premiums on the life insurance policy described in the schedule attached to the trust agreement. The trust agreement further provided: “To insure the continued payment of premiums on the life insurance policies, the trustee is authorized to retain in its hands an undistributed balance of cash income.” After the payment of premiums and the retention of a balance of cash income in such amount as the trustee might consider suitable for the future payment of premiums, the trustee was authorized to distribute any balance to the grantor if she should be living. There was no probability that any such balance would ever be available for distribution.

The trust agreement provided that the trust should continue during the life of Sterling Morton and, if the grantor should survive Sterling Morton, then thereafter until the death of the grantor or until five years had elapsed, whichever should first occur, and thereupon the trust should terminate. Sterling Morton, the husband of the grantor, was given a right of termination at any time by serving notice on the trustee. In the event of such termination by Sterling Morton, all income of the trust in the hands of the trustee was payable to Sterling Morton, and the balance of the trust was payable to the petitioner, but if she were not at that time living, then to Sterling Morton. In the event that the trust terminated five years after the death of Sterling Morton, as above stated, then the trust estate was payable to the grantor if she were living, and if she were not living, to her daughter.

The insurance policy, the premiums on which were paid by the trustee was assigned to the trustee, and the proceeds were to be held in trust by the trustee for the petitioner and/or her daughter, depending upon who was living at that time.

The right to the cash surrender or loan value of the insurance policy and the right to change the beneficiary were reserved in petitioner and/or her husband.

The first contention of respondent is that the trust income should be included in computing the net income of petitioner because a power to revest in ber title to the corpus of the trusts is vested in petitioner’s husband, who was a “person not having a substantial adverse interest-in the disposition of such part of the corpus or income therefrom”, within the meaning of section 166 of the Revenue Act of 1934, set out in the margin.

The only right to terminate the trusts was in petitioner’s husband during his life. If he terminated them during the petitioner’s life, the original corpus of the trusts reverted to petitioner. The rather narrow question is, therefore, presented of whether petitioner’s husband had a substantial adverse interest in the corpus or income of the trusts.

Pursuant to the terms of the trusts, the income thereof was to be used by the trustee in paying the premiums due upon several policies of life insurance covering the life of petitioner’s husband, all written in years prior to the establishment of the trust. In the policies held by one trust petitioner, as wife of the insured, was irrevocably named as beneficiary and as the one entitled to the cash and loan values thereof, while in the policy held by'the other trust the trustee was made beneficiary thereof, and was obligated under the terms of the trust to pay over the proceeds of the policy to petitioner, if she should survive her husband, the right to any cash surrender value of the policy and to change the beneficiary thereof being reserved to petitioner and/or her husband. If the trusts were in existence at the time of petitioner’s death, then upon their termination by her husband he would become entitled to all of the assets of the trusts, including both accumulated income and corpus. So long as the trusts continued during his life, the income was devoted to paying premiums on policies insuring his life for the benefit directly, or indirectly, of his wife, for whose care after death he would, naturally, feel concern and responsibility. Any excess income of the trusts which might be accumulated was payable to him if the trusts were terminated during his life. Under these circumstances, we are of the opinion that his interests were adverse to those of the petitioner as settlor of the trusts and substantially so, even though contingent in nature. Jane B. Shiverick, 37 B. T. A. 454. Cf. Burnet v. Wells, 289 U. S. 670. The fact that the corpus and accumulated income of the trusts might, under certain contingencies, revert to the petitioner as settlor, would not, of itself, make the income of the trusts taxable to petitioner. John Edward Rovensky, 37 B. T. A. 702.

Respondent’s second contention is that, since the petitioner directly, or indirectly, was the beneficiary under the insurance policies covering the life of her husband and was also entitled to the cash value of the policies upon their surrender, the income of the trusts which was expended in the payment of premiums on the policies was income “held or accumulated for future distribution to the grantor” and should be included in computing the net income of petitioner pursuant to the provisions of section 167 of the Revenue Act of 1934, set out in the margin. Respondent cites the case of Kaplan v. Commissioner, 66 Fed. (2d) 401, and calls our attention to general statements of principle made by the Circuit Court of Appeals in its opinion. The argument of the respondent is not without merit. However, in two cases involving facts closely similar to those of the instant case and calling for a construction of the same section of the act, we have held that the income of a trust used for the payment of premiums of life insurance policies covering the life of one other than the settlor of the trust is not to be included in computing the net income of the settlor, even though the settlor is directly, or indirectly, the beneficiary under such policies. Lucy A. Blumenthal, 30 B. T. A. 591; Gail H. Baldwin, 36 B. T. A. 364. In the absence of any direct authority to the contrary, we are not inclined to alter the views which we expressed in those two cases.

Decision will be entered wider Rule 50.

       SEC. 166. REVOCABLE TRÜSTS.
      Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a sub-tantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, then the income of such part of the trust shall be included in computing the net income of the grantor.

       SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (o), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.
      (b) As used in this section, the term “in the discretion of the grantor” means “in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.”


source: Caselaw Access Project

author: Mellott :

license: Public Domain

text:
    Security First National Bank of Los Angeles, as Executor of the Estate of Mary S. Mason, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84133.
    Promulgated August 30, 1938.

      Joseph D. Brady, Esq., W. W. Phelps, Esq., and Frederick E. Hines, Esq., for the petitioner.

      L. H. Rushbrooh, Esq., for tbe respondent.
   OPINION.

Mellott :

The first question to be determined is whether the decedent had more than a life interest in the estate of her mother.

Petitioner contends that the “Amended Order Fixing Inheritance Tax,” dated May 7, 1928, in the mother’s estate is a decree of a state court of competent jurisdiction, determining property rights, and, as such, is final and conclusive when the existence and nature of those property rights are in issue before any other tribunal. It is well settled that statutes and decisions of state courts as to property rights or interests are controlling and conclusive upon Federal courts and the Board. Uterhart v. United States, 240 U. S. 598; Burnet v. Harmel, 287 U. S. 103; Freuler v. Helvering, 291 U. S. 35; Blair v. Commissioner, 300 U. S. 5; Letts v. Commissioner, 84 Fed. (2d) 760. The respondent concedes that this is a general rule; but he contends that the order involved is not a final and conclusive decree as to the nature and extent of the property rights or interests of petitioner’s decedent in the estate of her mother and hence that the rule is not applicable.

In In re Lloyd’s Estate 106 Cal. App. 507; 289 Pac. 892, involving the construction of that part of a will which disposed of any residue remaining after the payment of all debts, expenses of administration, and legacies, the question was raised whether the distribution under it should have been made to the named legatees equally, or in proportion to the amounts of the specific legacies given to each of thefii under the will. The trial court determined the latter method was the one intended by the testator. On appeal the appellants contended that the court could not adopt such a construction because it had previously made an order determining the inheritance tax on the basis of an equal distribution of the residuum to the residuary legatees. The court, in its opinion, said:

A reference to the “Inheritance Tax Act” (Deering’s Gen. Laws 1923, p. 3501, Act 8443) demonstrates that it is purely a taxation statute, and, while the inheritance tax appraiser, for the purpose of making his report as therein provided for, must of necessity determine the several interests in the estate of the decedent for the purpose of computing the tax upon “any property passing” therein, it can hardly be said that the proceeding should be conclusive upon any question other than that of taxation. Certainly the Legislature never had such a thought in mind, and it is to be doubted if any of our courts ever entertained such an opinion. While the question has not, to our knowledge, been raised heretofore in California, it has been discussed by the New York courts, where there exists a statute very similar to our own. [Citing and discussing New York decisions.]

In In re Rath's Estate, 75 Pac. (2d) 509, 512, the California Supreme Court stated:

* * * The or(jer fixing inheritance taxes, which may incidentally determine questions in regard to succession and beneficial ownership, is not binding except for tax purposes as between those who claim the estate, whether as heirs, legatees, or beneficiaries of a trust extrinsic to the will. In re Lloyd’s Estate, 106 Cal. App. 507, 289 Pac. 892.

See also sections 1020 and 1021, Deering’s Probate Code of California, 1933.

We are of the opinion that the order fixing the inheritance tax, based upon the appraiser’s determination and report that the petitioner’s decedent had a “life interest” in the estate of her mother, is not final and conclusive upon any question other than the amount of tax due to the state, and -is not binding, except for such purpose, upon the heirs or legatees.

Section '1020 of the Probate Code of California provides in part that immediately upon the final settlement of the accounts of the executor or administrator, or at any subsequent time, upon the application of tlie executor or administrator, or of any heir, devisee, or legatee, or his assignee, grantee, or successor in interest, the court must proceed to distribute the residue of the estate among the persons entitled thereto. Section 1021 of the Probate Code of California provides, in so far as applicable herein, that in its decree of distribution the court must name the persons and the proportions ox-parts to which each is entitled and that such order or decree, when it becomes final, is conclusive as to the rights of the heirs, devisees, and legatees. Luscombe v. Fintzelberg, 162 Cal. 433; 123 Pac. 247. No such final accounting or decree of distribution has been made hi the mother’s estate.

Since the order fixing the inheritance tax is not a final and conclusive determination of the interest of decedent in the estate of her mother, and since no decree of distribution has been made, it is necessary to look to the mother’s will to ascertain the extent of the interest of petitioner’s decedent in the estate.

On brief the respondent states that he does not contend that the so-called charitable trust set up in the mother’s will is invalid because of indefiniteness, but he now contends, first, that the will itself is so ambiguous, vague, indefinite, uncertain, and contradictory that it is void and that decedent therefore shares in her mother’s estate as though her mother had died intestate; and, second, that if the will is not so ambiguous and indefinite as to be void, the only charitable devise made in it is the devise of the 76 acres (lot A of Eanchito del Fuerte) for the establishment of a horticultural college and technical school for girls of California.

Sections 380 and 384 of the Probate Code of California, 1933 (formerly sections 1327 and 1333 Code Civil Procedure), provide that if no person contests the validity of a will, or the probate thereof, within six months after it is probated, “the probate of the will is conclusive” except as to infants and persons of unsound mind who were not made parties to the proceeding.

The will of the mother consists of four separate writings. Section 101 of the Probate Code of California, 1933 (formerly sections 1317 and 1320 of the Civil Code of California), provides as follows:

Several testamentary instruments executed by the same testator are to be taken and construed together as one instrument. A will is to be construed according to the intention of the testator. Where his intention cannot have effect to its full extent, it must have effect as far as possible.

Section 103 of the Probate Code of California, 1933 (formerly sections 1321 and 1323 of the Civil Code), provides as follows:

Where the meaning of any part of a will is ambiguous or doubtful, it may be explained by any reference thereto, or recital thereof, in another part of the will. All the parts of a will are to be construed in relation to each other, and so as, if possible, to form one consistent whole; but where several parts are absolutely irreconcilable, the latter must prevail.

Section 102 of the Probate Code of California, 1933 (formerly section 1326 of the Civil Code), provides in part that “of two modes of interpreting a will, that is to be preferred which will prevent a total intestacy.” Furthermore, courts are reluctant to hold wills void for uncertainty and will not do so if a construction effectuating the testator’s intent is possible. 68 C. J. 937.

Examining the several writings in the light of these statutory rules of construction, we find that none contains any express or specific devise of real estate or other property to the daughters. In providing for the daughters and granddaughter, the testatrix refers to the “income” of the estate. In the writing of September 19,1925, in discussing her plans regarding the disposition of her estate, she states, in substance, that she had devoted time and energy to using and employing her land and other resources so as to provide for her daughters “beyond peradventure.” She expresses the desire that the property be used to that end, and directs that the details “be worked out by others so that the income and properties shall be secured” to her daughters. The will provides that all the ranch property, lot A, the 76-acre tract, and lot B, a 132-acre tract, both in the Eanchito del Fuerte tract, be held in trust, and also a 115-acre tract in Eancho Paso de Bartolo. It further provides for the sale of the above realty, except the 76-acre tract, which is to be held in perpetuity, and directs that the “houses — home — and about eleven acres of ground” be used as a home for her daughters and granddaughter “during their respective lives”, and that the funds received from the sale of the property be invested in “income business property of first grade.” In the writing of September 19, 1925, it is restated that the 76-acre tract, lot A, of Eanchito del Fuerte, shall be held as a home so long as her daughters require it, after which it is to be held for the benefit of the girls of California for a horticultural college and technical school. In the last writing of July 26, 1926, she sums up her plans as follows: “My efforts have been and are for my dear children when they are through with the income they will arrange for the college and technical school.”

While there is some ambiguity in the several writings, a careful reading of all of them discloses that the testatrix had two purposes in mind: (1) To provide for her daughters (in particular her two unmarried daughters) and granddaughter during their respective lives, and (2) upon the death of the survivor, the establishment and maintenance of a horticultural college and technical school for girls. If she had set aside the 76-acre tract only for the use of the school, as contended by the respondent, it is apparent that her second purpose would fail. Since the testatrix provided specifically that the 76-acre tract should be held in perpetuity,' it is obvious that without provision for other and additional property or funds no college could have been established or maintained. However, if the provisions of the will are construed so as to give the daughters and granddaughter a life interest in the income only, the residue to be held and used for the establishment and maintenance of the college, both purposes of the testatrix are made possible. It is our opinion that the testatrix intended to give to her daughter, petitioner’s decedent, only a share in the income of the estate above that required for the comfort and happiness of the unmarried daughters. Since the interest of decedent in her mother’s estate ceased at her death, the respondent erred in including the amount of $30,125.42 in her gross estate as the value of her interest, at the date of her death, in her mother’s estate.

As to the second issue the evidence shows, and we have found, that item 1 of the real estate schedule had a value of $25,000 at the date of the death of the petitioner’s decedent.

At the close of the hearing counsel for the respondent moved, upon the proof, for an increased deficiency, in the event that the Board should hold the order of the Superior Court of California to be controlling as to the property interest of the decedent. His theory seems to be that, since the inheritance tax appraisers determined the value of the real estate belonging to the estate to be $157,000, which value was approved by the court, this amount should be used in determining the value of the gross estate for the purpose of the Federal estate tax rather than the value determined by him of $124,338. He accordingly seeks to include in decedent’s gross estate an additional $32,662.

We have not held the order of the court to be controlling, though we have held that the respondent erred in including- in the estate the $30,125.42 discussed in the earlier portion of this opinion. No amended answer was filed asking for an increased deficiency, and the claim for such is not referred to, nor discussed, upon brief. Apparently it has been abandoned; but if not, it must be denied.

No evidence was adduced, nor was any issue raised, as to the value of the real estate. The executor included it in the return at a value of $124,338. The respondent apparently accepted this value as correct when he determined the deficiency on February 10, 1936, notwithstanding the fact that the second amended report of the inheritance tax appraisers finding the value to be $157,000 had been filed in the court months previously, i. e., on August 1,1935. A presumption of correctness attached to respondent’s determination of value and he can not lightly set it aside or ignore it. The burden rested upon him to prove that he erred in his original determination. Schilling Grain Co., 8 B. T. A. 1048; Estate of Irving Lee Stone, 26 B. T. A. 1; affd., 61 Fed. (2d) 1022; Alexander D. Falck, 26 B. T. A. 1359; affd., Houghton v. Commissioner, 71 Fed. (2d) 656; certiorari denied, 293 U. S. 608; Rainbow Gasoline Corporation, 31 B. T. A. 1050. He has failed to make such proof.

Decision will be entered wider Rule 50.


author: TURNER:

text:
    Michigan Steel Corporation of New Jersey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82404.
    Promulgated August 30, 1938.

      Montgomery B. Angelí, Esq., and Weston Vernon, Jr., Esq., for the petitioner.

      Hartford Allen, Esq., for the respondent.
   OPINION.

TURNER:

The petitioner contends that the transaction whereby it transferred all its assets to the Michigan Steel Corporation of Delaware, a subsidiary of the National Steel Corporation, in exchange for stock, debentures, and cash of the latter constituted a reorganization within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1928 and that the gain is not recognizable under the statute. Respondent contends that the transaction was an outright sale, that the debentures of National were not securities within the meaning of the reorganization provisions of the act, and that the gain must be recognized in its entirety.

The petitioner receives support for its claim that the debentures were “securities” from Lucien H. Tyng, 36 B. T. A. 21, and Karl B. Segall, 38 B. T. A. 43, but in the view we take of the issue here presented it is not necessary to consider or rule on that question.

In support of its claim that the transaction whereby it disposed of its assets for stock and debentures of National and for cash was a statutory reorganization and that National was a “party to the reorganization”, petitioner seeks to distinguish this case from Groman v. Commissioner, 302 U. S. 82; Helvering v. Bashford, 302 U. S. 454, and A. W. Mellon, 36 B. T. A. 977. As to the Gromam, case petitioner states on brief that “Glidden received nothing from Indiana stockholders and transferred nothing to them”, whereas in the instant case National “constructively” received the petitioner’s assets and issued and delivered its own stock, debentures and cash directly to petitioner. With respect to whether National received anything from the petitioner in the present case, and whether Glidden received anything from the Indiana stockholders in the Gromcmi case, the facts are indistinguishable. National and Glidden were the contracting parties in each case and directed that the assets acquired be transferred to their wholly owned subsidiaries, Michigan of Delaware and Ohio, respectively. In Helvering v. Bashford, supra, the taxpayer tried to distinguish the Groman case by pointing out that Atlas, the parent corporation, “was a party to all the exchanges”, but the Supreme Court said:

Any direct ownership by Atlas of Peerless, Blade Diamond, and Union was transitory and without real substance; it was pivrt of a plan which contemplated the immediate transfer of the stock or the assets or both of the three reorgan-ised companies to the new Atlas subsidiary. Hence, under the rule stated, the above distinctions are not of legal significance. Tlie difference in the degree of stock control by the parent company of its subsidiary and the difference in the method or means by which that control was secured was not material. The participation of Atlas in the reorganization of its competitors into a new company which became a subsidiary did not make Atlas “a party to the reorganization.” The continuity of interest required by the rule is lacking. [Italics ours.)

The alleged distinction betweten the Gromcm case and the present case, to the effect that Glidden transferred nothing to the Indiana stockholders, whereas National transferred its own stock, debentures, and cash directly to petitioner, is of no significance inasmuch as the Supreme Court on December 6,1981, deleted from the Gromcm opinion the sentence “Glidden transferred nothing to them [Indiana stock,holders]”, and at the same time denied a motion for a rehearing. (302 U. S. 654.) We think that fact shows that the Supreme Court was wholly disinterested in the question of whether the securities were transferred directly from the contracting parent corporation or indirectly through a wholly owned subsidiary. This point was also presented to the Court in the Bashford case and was disposed of as already shown.

We are unable to satisfactorily distinguish the present case from the Groman and Bashford cases and we think those cases hold that a parent corporation may not be regarded as a “party to a reorganization”, where as part of the plan it was contemplated that the purchased assets would be and in fact were transferred to a subsidiary. That was the situation in the present case. It was never contemplated that National would hold and operate the properties purchased from the petitioner. We therefore hold that the transaction comes within the general rule of section 112 (a) of the Revenue Act of 1928 and the entire amount of petitioner’s gain is recognized. A. W. Mellon, supra, and Gilbert B. Hedden, 37 B. T. A. 1082.

Petitioner contends that if the transaction in question is held to be a sale, it was a closed transaction in 1930 and the gain, if any, accrued and was taxable in that year. The respondent contends that the transaction was not consummated until January 19,1931, at which time the petitioner’s directors and trustees in dissolution approved the contract of sale previously entered into.

As to the effective date of the contract between petitioner and National, the parties agreed specifically as follows:

Fifth. It is understood and agreed that Michigan Steel Corporation shall not he obligated to consummate the sale herein agreed to until the Secretary of State of New Jersey has issued his certificate of its dissolution pursuant to the consent and authority of its stockholders, and said Michigan Steel Corporation agrees to promptly submit this contract to its stockholders for their approval and to take proper action looking to its dissolution.

The meaning of the language quoted is in our opinion too obvious to require extended discussion. The parties, in so many words, agreed that the petitioner should “not be obligated to consummate the sale” until the happening of a certain event, namely, the delivery of the certificate of dissolution, and the facts show that that event occurred in January 1981. The respondent is accordingly sustained on this issue.

Decision will l>e entered wider Rule SO.


text:
    Valley Waste Disposal Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86371.
    Promulgated August 30, 1938.

      Robert N. Miller, Esq., and Melvin D. Wilson, Esq., for the petitioner.

      L. H. Rushbrooh, Esq., for the respondent.
   OPINION.

Mellott :

Kespondent, quoting the all inclusive definition of gross income contained in section 22 of the Kevenue Act of 1932/ contends that petitioner received payments for services performed in excess of the amount expended and that it therefore had an income of $7,180.67. The amount expended in the purchase of the real estate will be considered later. Petitioner contends that the corporation had no income; that the amounts which it received fall into one of two categories, neither of which is taxable; that as to the payments received from nonmembers, they were merely gifts and not taxable income under section 22 (b) (3) of the Kevenue Act of 1932, and that the payments received from members were in the nature of capital contributions made by the stockholders, represented an additional price paid for the stock, and are not taxable income but are to be treated, as respondent in his regulations had always treated such contributions, “as an addition to and as part of the operating capital of the company.” (Art. 67, Eegulations 77.)

We are inclined to agree, in the main, with petitioner. The money received from nonmembers was paid voluntarily by them and not as the result of any valid contract. It is quite doubtful if any of the payments could have been compelled. The waste oil flowed into the sumps constructed by petitioner for the purpose of collecting the waste from the wells of members. They were so located that they also collected the waste from the wells of nonmembers — a mere fortuitous circumstance so far as the nonmembers were concerned — and when the accumulated oil was burned or otherwise disposed of they were benefited, notwithstanding the fact that petitioner had not been employed to dispose of it. We are not concerned with the question whether or not the payments made by the nonmembers were deductible as expenses. Our question is simply, Were the amounts received by petitioner mere gifts, and, if so, should they have been included in gross income? If they were gifts they formed no part of petitioner’s gross income under section 22 (b) (3), supra.

A gift has been defined as a voluntary transfer of property by one to another without consideration or compensation therefor. Cf. David R. Daly, Estate, 3 B. T. A. 1042. Kespondent contends that petitioner rendered bills to the nonmembers for services performed and that the nonmembers simply paid the bills. This, he says, indicates that there was a consideration. But our findings show that the nonmembers were simply advised as to the amount which they would have been required to pay if they had been members. No enforceable obligation rested upon them to make payment. The rendering of the services may have created a “moral obligation”; but a payment made to discharge such an obligation is nevertheless a gift. Cf. Jessie Chase, 19 B. T. A. 1040; John H. Rosseter, 12 B. T. A. 254; affd., 33 Fed. (2d) 286. Being of the opinion that the amounts received by petitioner from nonmembers were contributions or gifts, we hold that they should not have been included in petitioner’s gross income. Cf. Edwards v. Cuba Railroad Co., 268 U. S. 628; Liberty Light & Power Co., 4 B. T. A. 155; Decatur Water Supply Co. v. Commissioner, 88 Fed. (2d) 341. Inasmuch as we can not determine from the evidence the exact amount received from such source during the taxable year, it is necessary that the other questions also be determined.

Did the amounts received from members constitute income to petitioner ? We think not. It is clear that petitioner was not organized for profit. The articles of incorporation so state. Its purpose was to dispose of the waste and thus obviate the necessity of each member undertaking to collect, identify and dispose of that coming from its wells. It did not attempt to “sell” its services nor did it charge the member in proportion to the oil coming from its wells. It estimated the total amount necessary to dispose of the waste, assessed its members accordingly, and any funds collected during the taxable year which were not expended during that year were to be used for the same purpose during the succeeding year, thereby reducing pro tanto the amount to be collected during the succeeding year. Even though it might, for bookkeeping purposes, be labeled “surplus”, it really represented an indebtedness to its members, or pay in advance, for services to be rendered during a later year. It was, in no sense, gains, profits, and income as such terms have been defined in Eisner v. Macomber, 252 U. S. 189, and kindred cases. At best it was a mere accumulation, paid in by the members, to be used for the purpose of disposing of the waste or to be returned to them upon dissolution. As was said by this Board in a case somewhat analogous—Growers Gold Storage Co., 17 B. T. A. 1279—the surplus overassessment “was really an indebtedness or refund due the members and was a liability, and not taxable. Anamosa Farmers Creamery Co., 13 B. T. A. 907; Home Builders Shipping Association, 8 B. T. A. 903.” Cf. Board of Fire Underwriters of Duluth, 26 B. T. A. 860; Uniform Printing & Supply Co. v. Commissioner, 88 Fed. (2d) 75, reversing Uniform Printing & Supply Co., 33 B. T. A. 1073.

In view of our decision upon the above issues it is unnecessary to discuss or decide whether the $2,607.25 invested in real estate by the petitioner during the taxable year is, as contended by the petitioner, deductible as an expense or, as contended by the respondent, represents a capital expenditure.

The respondent erred in determining the deficiency.

Judgment will be entered for the petitioner.

       SEC. 22. GROSS INCOME.
      (a) General Definition. — “Gross income” includes gains, profits and income derived from salaries, wages, or compensation for personal service, of whatever hind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. In the case of Presidents of the united States and judges of courts of the united States taking office after the date of the enactment of this Act, the compensation received as such shall be included in gross Income; and all Acts fixing the compensation of such Presidents and judges are hereby amended accordingly.

       SEC. 22. GROSS INCOME.
      (b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title;
      * * * *)*l * *
      (3) Gifts, bequests, and devises. — The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).


author: Tyson :

text:
    Hunt Production Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81341.
    Promulgated September 2, 1938.

      George H. \Abbott, G. P. A. and J. B. McEntire, Esq., for the petitioner.

      John H. Pigg, Esq., for tlie respondent.
   OPINION.

Tyson :

This is a proceeding for the redetermination of a deficiency in income tax for the year 1932 in the amount of $22,810.96.

The petitioner alleges that the respondent erred (1) in including in petitioner’s gross income the amount of $5,000 as profit derived from the sale of the Joe Lee “D” Lease; (2) in including in that income the amount of $1,317.05 as profit derived from certain contingent interest contracts not completed in the taxable year; (3) in failing to allow $5,781.29 as a deduction from petitioner’s gross income for depletion based upon oil bonus received by 'petitioner; (4) in failing to allow a deduction from petitioner’s gross income of $3,462.50 for taxes paid; (5) in including in petitioner’s gross income the amount of $118,584.52, received by the transferor of certain oil and gas leases from the production of oil from such leases subsequent to the transfer of the leases to petitioner; and (6) in deducting from the gross income of petitioner’s oil and gas producing properties intangible drilling and development costs in the amount of $223,035.11 to ascertain the net income from such properties for the purpose of applying the 50 percent limitation provided by section 114 (b) (3) of the Kevenue Act of 1932. By amended answer, filed at the hearing, respondent claims an increased deficiency on the ground that he erroneously allowed $223,035.11 as a deduction from the current gross income of petitioner if that amount may not be included in the deductions from gross income from the oil properties in determining the net income from such properties for the purpose of applying the 50 percent limitation in respect of the allowable deduction for depletion within the meaning of section 114 (b) (3), supra.

All the facts have been stipulated and the stipulation and exhibits attached thereto are included herein by reference. Only such of those facts as are deemed necessary to decision will be' set out herein.

During the year 1932 the petitioner assigned the Joe Lee “D” Lease, which cost it nothing, for a stated consideration of $10,000 to be paid out of the oil and gas when, as, and if produced from the leased lands. During 1932 petitioner collected nothing from the lease and reported no income therefrom in its income tax return for that year, but respondent valued the oil payment contract at $5,000 and included that amount in the income of petitioner.

Eespondent, in his deficiency notice, increased the profit of petitioner from certain contingent interest contracts not completed in the taxable year by the amount of $1,317.05.

During the year 1932 petitioner received $21,022.88 as oil bonuses, or advance royalties, from leases assigned by it to others. Eespond-ent did not allow any depletion in respect of that amount.

Incident to incorporation in 1932, petitioner paid in that year to the State of Texas the amount of $962.50 as a franchise tax, which had accrued in that year, and the amount of $2,500 for its charter. The books and records of petitioner were kept and its income tax returns made on the accrual basis.

The petitioner was organized on May 28, 1932, and began business on June 1, 1932, by the acquisition, in exchange for all its capital stock, of the net assets and business of H. L. Hunt, trustee, a co-partnership. Included in those assets were numerous oil and gas leases on lands situated in Eush and Smith Counties, Texas, which the partnership had previously acquired on November 26, 1930, from the lessees C. M. Joiner, Trustee, and C. M. Joiner, individually, the lessees hereinafter being referred to as Joiner.

Two of the assignments by Joiner in the partnership provided for the payment to Joiner of certain amounts in cash and the other assignment provided also for the payment of an amount in cash and a further amount as evidenced by four promissory notes. All assignments provided for the payment to Joiner of further amounts out of the proceeds of the sales in certain specified percentages of oil if and when produced, saved, and marketed from the lands embraced in the leases. The assignments further provided that the as-signee should “deliver to the credit” of Joiner “in the pipe line to which” the lease would be connected “the undivided portion of said oil produced and saved belonging to the party of the first part under the terms hereof and the party of the first part shall apply the proceeds of the sales thereof as a credit on the deferred payments as herein set out”. Joiner was the party of the first part. Thera was no assumption by the - assignee of personal liability for the amount, or any portion thereof, which was to be paid out of the proceeds of the oil produced, saved, and marketed. Under these assignments the purchasers of the oil produced, saved, and marketed from the properties covered by the leases paid, in 1932, to the parties from whom the petitioner had acquired the leases, Joiner, or their predecessors in title, the sum of $118,584.52, which was the share of those parties in the proceeds from the sale of oil produced, saved and marketed from the lands embraced in the leases. In its income tax return for 1932 the petitioner did not include the $118,584.52 in its income, but respondent included it therein in his determination of the deficiency herein and allowed a deduction for depletion thereon.

The petitioner expended $223,035.11 on its oil-producing properties during 1932 in intangible drilling and development costs. Pursuant to the policy adopted by it in the taxable year these costs were charged off petitioner’s books and deducted as expenses from its gross income in its return for 1932. In determining petitioner’s income for 1932 respondent allowed such deduction. Nothing embraced in such costs had any salvage value.

In determining the net income of petitioner from its oil properties for the purpose of applying 50 percent thereof as a limitation upon allowable depletion, under section 114 (b) (3), sufra, respondent deducted the $223,035.11 intangible drilling and development costs from the gross income from such properties.

The decision as to whether or not respondent erred in including in petitioner’s income the amount of $5,000 as profit derived from the sale of the Joe Lee “D” Lease is controlled by the cases of Edwards Drilling Co., 35 B. T. A. 341; affd., 95 Fed. (2d) 719; Willis R. Dearing, 36 B. T. A. 843; Cook Drilling Co., 38 B. T. A. 291, and authorities cited therein. Following these authorities, we hold that the respondent erred in including in petitioner’s gross income the $5,000 as profit from the sale of the Joe Lee “D” Lease.

As to its second assignment of error it is conceded by stipulation and on brief by petitioner that its gross income should include the amount of $1,317.05 as profit derived from certain contingent interest contracts not completed in the taxable year, as determined by respondent, and in addition the further amount of $668.07. Consequently, we so hold.

The failure of respondent to allow any deduction for depletion based upon oil bonuses, or additional royalties, received by petitioner in the amount of $21,022.88 from leases assigned by it to others was in error. We so hold, under authority of Palmer v. Bender, 287 U. S. 551, and cases therein cited. Kespondent, on brief, apparently abandons contest on this issue, since he states therein that “In view of the decision * * in the case of Commissioner v. Fleming, 82 Fed. (2d) 324, the respondent see's no useful purpose will be served by briefing this issue.”

Included in the deduction from petitioner’s gross income of $3,462.50 for taxes paid, which was disallowed by respondent, was the item of $2,500 paid the State of Texas for its charter and the item of $962.50 paid that state as franchise tax. Petitioner, on brief, waived its claim for the deduction of the $2,500 charter cost, but adhered to its claim for deduction of the $962.50 franchise tax. The statute laws of Texas impose on every corporation authorized to do business in that state, with certain exceptions immaterial here, an annual franchise tax payable in advance on or before May 1 of each year, or if the corporation is organized after May 1 of any year a certain proportion of the amount of the annual tax to cover the period intervening between the time of its organization and the following May 1; the amount of the annual tax being based upon a certain proportion of the corporation’s outstanding capital stock, surplus, and undivided profits, plus the amount of its outstanding bonds, notes and debentures, etc. We are of the opinion, and so hold, that the $962.50 paid as a franchise tax by petitioner was allowable as a deduction from its gross income. This amount accrued and was paid during the taxable year to the State of Texas as a tax and comes within the general provision of section 23 (c) of the Revenue Act of 1932 and is not embraced in any of the exceptions to that general provision. Kossar & Co., 16 B. T. A. 952. Cf. Jamestown Worsted Mills, 1 B. T. A. 659; Petaluma & Santa Rosa Railroad Co., 11 B. T. A. 541; Holeproof Hosiery Co., 11 B. T. A. 547; United States Trust Co. of New York, 13 B. T. A. 1074; and United Carbon Co., 32 B. T. A. 1000, reversed on another point.

The inclusion by respondent in petitioner’s income of the amount of $118,584.52 received by petitioner’s transferors from the production and sale of oil from the leased premises was in error and is disapproved. The question is clearly controlled by the case of Thomas v. Perkins, 301 U. S. 655, and is so conceded to be by respondent on brief. See also Rocky Mountain Oil Co., 36 B. T. A. 365; I. Rudman, 36 B. T. A. 803.

As shown above, the respondent, in Ms determination of the net income from the oil properties, for the purpose of applying a 50 percent limitation thereon as the allowable depletion, deducted from the gross income from those properties the amount of $223,035.11 expended on them by petitioner as intangible drilling and development costs. The point presented by these facts needs no extended discussion since decision thereon is clearly controlled by the holdings in the following cases: Ambassador Petroleum Co. v. Commissioner, 81 Fed. (2d) 474, reversing on this point Ambassador Petroleum Co., 28 B. T. A. 868; Commissioner v. Wilshire Oil Co., 95 Fed. (2d) 971, affirming Wilshire Oil Co., 35 B. T. A. 450; Rocky Mountain Oil Co., supra; I. Rudman, supra; and Ralph W. Crews, 37 B. T. A. 387. Upon the authority of these cases we hold that the respondent erred in deducting from the gross income of the oil properties the intangible drilling and development costs of $223,035.11 for the purpose of applying the limitation of 50 percent of the net income from such properties to allowable depletion.

In support of the affirmative allegations of his amended answer, respondent contends that if the Board, as it has, should hold herein that the intangible drilling and development costs of $223,035.11 are not deductible from the gross income from the oil properties in determining the net income from those properties for the purpose of applying the 50 percent of such income as a limitation on allowable depletion as provided in section 114 (b) (3), supra, that then such amount should not be allowed as a deduction from the gross income of petitioner in determining its taxable net income. This contention invokes violation of respondent’s own regulation, article 236, Regulations 77, in force during the taxable year. Regulations on the same subject, substantially the same in substance so far as the question here involved is concerned, have been in effect under the Revenue Acts of 1926 and 1928 and have received legislative sanction by repeated reenactments of substantially the same provisions in the various acts to which the regulations apply. These regulations expressly give the taxpayer the option to deduct such intangible drilling and development costs from his gross income as an expense or to charge same to capital account. The petitioner exercised this option in the taxable year in which it began business by electing to deduct such costs from its gross income rather than to charge same to its capital account. Such election remained binding on petitioner for all subsequent years. That the amount of $223,035.11 expended for intangible drilling and development costs on its oil properties is an allowable deduction from the gross income of petitioner under respondent’s current regulation is clear; and this is true notwithstanding that the amount of such expenditure is not to be deducted from the gross income from these properties in determining the net income therefrom for the purpose of applying the 50 percent limitation on allowable depletion. Cf. I. Rudman, supra.

This would not be improper as resulting in a double deduction, since the matter of depletion allowance under section 114 (b) (3), supra, is separate and distinct from the matter of deduction from tbe gross income to determine taxable net income under section 23 (1), Revenue Act of 1932; one being the determination of the allowance for depletion and the other being the determination of taxable net income, which “are approached by the taxing statutes from entirely different angles”. Cf. Ambassador Petroleum Co. v. Commissioner, supra, concurring opinion; Mountain Producers Corporation v. Commissioner, 92 Fed. (2d) 78-80; Commissioner v. Wilshire, supra.

When Congress enacted section 23 (1), supra, under which, in accordance with the respondent’s regulations of long standing, the taxpayer had the right to, by election, deduct intangible drilling and development costs from gross income in determining taxable net income, it knew the taxpayer also had the right, under section 114 (b) (3), supra, simultaneously enacted, to have such costs included in the net income from the oil properties for depletion purposes, and it is clear that in enacting the two sections Congress intended to and did confer both rights upon the taxpayer. Cf. Commissioner v. Wilshire, supra.

We hold that the Commissioner did not err, as claimed by his amended answer, in his allowance of the deduction of $223,035.11 from the current gross income of petitioner.

Decision will be entered imder Buie 50.

       SBC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall he allowed as deductions :
      *******
      (c) Taxes Gbnbkally. — Taxes paid or accrued within the taxable year, except—

       Art. 236. Charges to capital and to expense in the case of oil and gas wells. — (a) Items chargeable to capital or to expense at taxpayer’s option.
      (1) Option with respect to intangible drilling and development costs in general: All expenditures for wages, fuel, repairs, hauling, supplies, etc., incident to and necessary for the drilling of wells and the preparation of wells for the production of oil or gas, may, at the option of the taxpayer, be deducted from gross income as an expense or charged to capital account. Such expenditures have for convenience been termed intangible drilling and development costs. * * *
      * * * * 5⅛ * *
      (d) * * * Any election so made is binding for all subsequent years, * * *

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      * * ⅜ * * * *
      (1) Depletion. — In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. * * *


author: Kern:

text:
    Joseph B. Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Alice Fynes Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 86618, 86619.
    Promulgated September 6, 1938.

      William L. Latimer, Esq., for the petitioners.

      Carroll Walker, Esq., and Chester C. Guy, Esq., for the respondent.
   OPINION.

Kern:

The first issue is a very narrow one, whether petitioners are to be denied the deduction as a capital loss on the ground that they made a short sale, although they did not intend to make a short sale and were then long on the stock sold and could have made delivery immediately, but, in fact, did not make delivery until several days later.

The record is silent on what stock certificates were actually delivered by the broker on the sales, but the Federal stamp tax imposed under section 723 of the Revenue Act of 1932 and charged by the broker to petitioners on the transactions, and the well known rule of the New York Stock Exchange requiring delivery within twenty-four hours, raises a strong presumption that deliveries of the stock sold were made immediately and that the certificates actually delivered to the purchaser, therefore, were not those held by petitioners and received by the broker from them some four to eleven days afterward, but were certificates either held by the broker himself in “street names” or borrowed by him for just such an emergency. Upon this presumption respondent strongly relies to support his contention that the “sale” by the broker was necessarily a short sale made on petitioner’s behalf. He disregards, however, the question of whether the intent of the petitioners was to make a short sale.

We shall assume in respondent’s favor that the broker did not deliver to the market purchaser petitioners’ certificates.

A “short sale”, as defined by the Supreme Court in Provost v. United States, 269 U. S. 443, 450, “is a contract for the sale of shares which the seller does not own or the certificates for which are not within his control so as to be available for delivery at the time when, under the rules of the Exchange, delivery must be made.” In that case the Supreme Court held that both the “loan” of stock certificates by one broker to another and their “return” after the seller has fulfilled his obligation to the borrowing broker constituted transfers of title to the certificates physically passing, and as such were taxable transfers under the Federal stamp tax then applicable. The above definition of a short sale would not apply to the circumstances here presented, but, as we intimated in Frances Bartow Farr, Executrix, 33 B. T. A. 557, 561, the Supreme Court may not have intended the definition as an “all-inclusive one.” We thereafter held in Arthur S. Kleeman, 35 B. T. A. 17, that where the taxpayer clearly intended to sell certain shares short and made deliveries from certificates later obtained, the sale was a short sale, notwithstanding the fact that the taxpayer was, during the transaction, “long” on the same stock in another account. We allowed the taxpayer’s intent, in other words, to govern the nature of the transaction.

In Provost's case, supra, the Supreme Court set out with great particularity the various sales which successively took place in completion of the transaction of a so-called short sale, “in each of which”, the Court pointed out, “there is either a sale or a complete transfer of all the legal elements of ownership.” They are:

(1) the sale of the stock by the person effecting the short sale, followed by the transfer and delivery of the certificates for the borrowed stock to the purchaser’s broker; (2) the transfer of the shares from the lender to the borrower, who uses them for delivery on the customer’s short sale; (3) the purchase by the borrowing broker of the stock required to repay the loan; and (4) the transfer and delivery by the borrower to the lender of the certificates for the purchased shares to replace the shares borrowed. * * *

Physical transfer of the certificates may accompany all four transfers but usually accompanies only (1) and (4). We touch upon these particulars merely to emphasize the fact that, as the Supreme Court’s definition of a short sale quoted above may not have been intended to be definitive, so, likewise, its analysis of the several steps of legal import involved in a short sale may not have been intended to comprehend the situation of a sale by a person then “long” on the stock, much less that of a person, as here, both long on the stock and not intending to make a short sale but to make later delivery of certificates held at the time of the sale. Situation (1) above in such circumstances would require further analysis. The Court speaks of the sale “by the person effecting the short sale” assuming, apparently, that the broker acts for his principal, the short-seller, and effects the sale for him by delivery of the borrowed certificates. In doing so, obviously, the broker, as agent, merely carries out the will of his principal and acts within the scope of his authority in procuring by “loan”, or more accurately, as the Court has held, by purchase, the necessary certificates for prompt delivery. But what if the seller does not intend to sell short? The broker then would have no implied authority to obtain other certificates and deliver them for the seller. On the contrary, the broker then becomes a principal acting for himself if he chooses to sell immediately and to deliver other certificates. Two sales are effected — the sale by the broker to the purchaser on the market and the sale by the “seller” to the broker.

While our prior decisions have not carried the analysis so far in words, it is obvious that this principle has been controlling. In Francis S. Appleby, 31 B. T. A. 533, appeal dismissed April 8,1935, petitioner owned shares of certain stocks and held them in his safe deposit box. He ordered his broker to sell them on December 30, 1930, which was done, but no delivery was made until January 5, 1931. We held that it was not a short sale, that “failure to make delivery was a mere inadvertence, for he was at all times in position to make a complete transfer”, and that the loss was sustained in the earlier year. In C. B. Ferree, 32 B. T. A. 125; affd., 84 Fed. (2d) 124, the situation was similar but, if anything, went further. There the petitioner had the certificates in his safe deposit box. On December 19,1929, he sold part of the certificates through his broker and made delivery on the next day. The remainder he instructed the broker to sell on December 21, identifying them as those in the box. The broker sold on December 31, but no delivery was made. Finally, a month later, on January 31,1930, and on February 3,1930, petitioner bought certain certificates of the same stock through the broker, the broker delivering only the balance after deducting a number equal to those sold on December 31. We held the sale not a short sale and that the loss was sustained in 1929 when the sale became effective, saying (at p. 726):

* * * Indeed, if we are to treat the broker as a mere agent, it must be assumed that in behalf of his principal, the petitioner, he made a delivery as required by the rules of the Stock Exchange, and thus completed the sale. It was to his own broker that the petitioner was then obligated to deliver the certificates, and we can not regard his delay as postponing the realization of loss. * * *

In Dee Furey Mott, 35 B. T. A. 195, the same question of the year of loss was involved. The taxpayer directed sale on December 30, 1930, of certain stock which she held in a safe deposit box, and sale was then made by her broker, but there was no delivery by the taxpayer until January 2, 1931. The Commissioner contended that it was a short sale, and that in any event no title passed until delivery of the certificates. We answered these two objections, respectively, as follows (at p. 197, 201):

* * * Here the petitioner owned the shares and they were within her control and available for delivery. She intended to sell the shares that she owned, and it is stipulated that they were sold. Mere failure to deliver certificates is not alone enough to establish a short sale. * ⅜ *
* * * The petitioner intended to sell in 1930 specific shares then available for delivery and the broker intended to sell those shares. And, as said in the Ferree case, the Sales Act allows delay in delivery.

The respondent admits the force of these decisions, but relies on our decision in Frances Bartow Farr, supra, which involved precisely the same question as is here presented, whether section 23 (s) of the Eevenue Act of 1932 was applicable in the circumstances, so as to render the resulting loss or gain not one on capital assets. There the taxpayer had certain stock on January 1,1931, which he had held for more than two years. He “sold short” a certain number of shares of the same issue of stock in 1931 and “covered the short sales” in March 1932 by delivery of the aforesaid certificates. No further facts appear on tbe intention of the parties, and since the language quoted above is apparently that of the stipulation, we must assume that the taxpayer intended to sell short. On that assumption, the narrow question decided by the case is whether such an intended short sale could be a “short sale” within the meaning of section 23 (s) if the seller at the same time held available, at the time of the order to sell, certificates which he might have delivered. Without discussing the question of intent, which appearsi to have been assumed, we held that in the circumstances presented the transaction was a short sale. Ibid, p. 561. We have already pointed out that the same rule, where intent was evident, was followed in Kleeman’s case, suprd. In the course of our opinion in Farr’s case, however, we defined a short sale as follows (at p. 561):

* * * If the shares sold are not furnished by the seller at the time of the sale but are supplied by the broker, the transaction is a short sale and sets in motion the short sale process. The fact that a transaction is a short sale must appear prior to the time when the broker must make delivery in accordance with the rules of the exchange. A transaction, which at that time, or earlier, is made as a short sale, forever remains a short sale, regardless of the manner in which it is closed, that is, regardless of whether it is closed by a covering purchase or by the delivery of shares which the seller has owned for some time.

We are of the opinion that Farr’s case for the reasons stated is clearly distinguishable from the instant case, and that the definition of a “short sale” there set out must be qualified by the condition that it is intended to be a short sale by the seller. Since our decision in that case, the Third Circuit Court has affirmed our earlier decision in Ferree's case, supra, and the Second Circuit Court in Ruml v. Commissioner, 83 Fed. (2d) 257, has reversed our decision in that case, 31 B. T. A. 534. The facts of that case go beyond the situation here, and the Circuit Court’s opinion states articulately the theory foreshadowed in our own decisions before Farr’s case, cf. C. B. Ferree, supra, at p. 725.

In Ruml's case the taxpayer owned certain stock in December 1928 which was deposited with a bank as collateral for a loan. As the Circuit Court said:

* * * He desired to sell that stock at the then market, and instructed his broker to do so, advising him how the shares were held as collateral and telling him that there might be some delay in making delivery. His broker informed him that the stock would be sold, and that petitioner might make delivery to the broker at his convenience when he paid off the loan or substituted other collateral to release the shares.

Tbe broker sold tbe same number of shares of the same stock as petitioner held in December, and the taxpayer delivered part of his certificates in the same month, but the majority not until February 1929.

On January 1, 1929, the petitioner received a statement from the broker indicating that he was being carried short 2,500 shares of the stock, and upon inquiring what that meant, was told, “That is simply the way we carry it until you deliver it.” The petitioner neither intended to make what is known as a short sale nor instructed his broker to do so, though he did direct his broker to sell the shares, leaving the broker free to make the sale as he might.

The question was whether a short sale had been made, and, if so, whether the loss was realized in 1928 or 1929. The court continues:

It is clear that the petitioner intended to sell the specific shares he owned and only those. If the broker made a short sale to his customer, it was for his own account, not for the petitioner who had authorized no short sale for his account. It seems to us clear that the transaction between the petitioner and the broker was a sale by the petitioner to the broker of the specific shares pledged to the bank, under an understanding with the broker that certificates therefor were to be later delivered. The result was that the petitioner became bound in December, 1928, to deliver to the broker the shares sold to him. Actual delivery was not made that month, and so the transaction in that respect was not completed, but we are primarily concerned with whether or not the loss evidenced by the sale was realized within the meaning of that term as applied to income taxation * * * But when the evidence of realization is a sale of personal property, it is not always necessary to deliver the property before there may be a deduction of a loss. It is enough that the obligation to deliver is so fixed that the loss is reasonably certain in fact and ascertainable in amount. * * *

Here we are not concerned with the precise time when title passed from petitioner, as was so in Ruml's case, supra, and others discussed, but only with the point whether title to the shares held by petitioner passed so as to create a loss on capital assets. Under both the common law and the Uniform Sales Act the seller’s intent will govern in cases of sales of stock such as the instant case, cf. Arthur E. Otto, 37 B. T. A. 479; so that delivery was not necessary to effect the sale, but delivery was, in fact, made by the petitioner here as soon as he could conveniently do so. Petitioner here had at all times complete dominion over the certificates in question, and his arrangement with his broker was very similar to that involved in RwnVs case.

We think the instant case is ruled by that case; that there was here a sale by petitioner of certificates which he had held for more than two years; that this sale was not a short sale, and was not, therefore, within the terms of section 23 (s); and that a capital loss thereby resulted which should have been allowed.

We pass now to the second question, of the rate of depreciation petitioner Alice Wilson claims, that 4 percent and not 2½ percent should have been allowed in respect of a frame, stuccoed dwelling house. Since the evidence is insufficient to establish the probable life of the house, we must hold on this point for the respondent.

Decision will be entered umder Rule 50.


author: Hill:

text:
    Dixie Margarine Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79372.
    Promulgated September 8, 1938.

      George N. Murdoch, Esq.., for tbe petitioner.

      Ralph E. Smith, Esq., and Freeman R. Paulson, Esq., for the respondent.
   OPINION.

Hill:

Respondent determined a deficiency in petitioner’s income tax liability for the year 19B2 in the amount of $16,775.60. Petitioner showed on its return for the taxable year a net loss of $112,508.47, which respondent adjusted by adding to income “Refund of stamp taxes $284,512.86”, with the explanation that during 1932 petitioner received refunds of stamp taxes in the amount of $241,819.64, representing the aggregate of stamps deducted as cost of sales in prior years, of which total amount of refunds $7,306.78 was used to reduce a net loss claimed for 1931 on the 1932 return. Petitioner assigned as error the action of respondent in adding to income the amount of the refunds stated, and contends that such amount does not constitute income taxable to it in 1932.

The issue was submitted on evidence consisting of a stipulation of facts, oral testimony, and certain documentary exhibits. The facts were fully covered by the stipulation of facts. The oral testimony and documentary exhibits presented only corroborative evidence of the facts stipulated. We adopt the stipulated facts as our findings of fact, which, in so far as deemed necessary to a discussion of the issue, will be set out hereinbelow. In the stipulation it is stated that in 1932 respondent refunded to petitioner the amounts paid as stamp taxes during the periods specifically mentioned in two certain claims for refund, “being $241,819.64 and $56,772.03, respectively.” Respondent’s notices of adjustment, introduced in evidence by petitioner as Exhibits 12 and 14, show the amounts of refunds allowed were $184,953.18 and $56,772.03, respectively, while the deficiency, as above stated, was computed on the basis of total refunds of $241,819.64. However, these discrepancies appear to be of no materiality in deciding the issue presented.

Petitioner is a corporation, organized under the laws of Tennessee, with its principal office at Memphis. Its business was the manufacture and sale of food products, the principal one being mixtures of vegetable oils, salt, and skimmed milk, with or without coloring matter, which respondent called and treated as oleomargarine.

During the period from March 15, 1923, to June 10, 1931, petitioner was engaged in the manufacture and sale of the above described product. The Bureau of Internal Revenue construed the Oleomargarine Act (being section 2 of the Act of August 2, 1886, and section 8 of that act as amended by section 3 of the Act of May 9, 1902) as applicable to petitioner’s product, and accordingly during the aforementioned period petitioner paid various amounts as a stamp tax on its product, selling only to wholesalers and retailers who held annual licenses as prescribed by said act, and petitioner received and paid for annual licenses as a manufacturer of oleomargarine.

In 1927 petitioner concluded that its product was not oleomargarine, and was not taxable as such, under the law. Thereafter, on November 30, 1929, petitioner filed a claim for refund of amounts paid from December 1, 1925, to October 30, 1929, which claim was rejected by the Commissioner on December 26, 1929. On December 17,1931, petitioner filed suit in a district court for the amount sought to be recovered in the claim for refund.

On September 14, 1931, petitioner filed a claim for refund of the amounts paid from November 1, 1929, to July 1931, and that claim was rejected by the Commissioner on December 14, 1931.

On February 15, 1932, the Supreme Court decided the case of Miller v. Standard Nut Margarine Co., 284 U. S. 498, in which it was held that a product of the character of that of petitioner did not come within the taxing statutes. The Commissioner accordingly, on or about April 7, 1932, reopened the two claims referred to above and refunded to petitioner the amounts paid during the periods specifically mentioned in those claims. The amounts refunded, however, did not include $87,412 which had been paid by petitioner between March 15, 1923, and December 1, 1925, for the reason that the claim for refund was not presented within four years after the purchase of the stamps and refund was barred by the statute of limitations.

On June 15, 1935, suit for recovery of the $87,412, above mentioned, with interest, was brought in the Court of Claims. Respondent filed a demurrer, which was sustained in November of that year, and the petition dismissed (12 Fed. Supp. 548) on the ground that the amount was not refundable because of statutory prohibition. Petitioner then filed a petition for writ of certiorari in the United States Supreme Court and on March 2, 1936, its petition was denied (297 U. S. 713).

The aggregate amount paid by petitioner to the collector for stamp taxes from March 1923, when it began business, to November 28,1925, was $87,412, and the aggregate amount paid from December 1925, to and including 1931, was $241,819.64, or a total for both periods of $329,231.64.

These sums were paid to the collector in advance in cash, and the licenses and stamps procured therefor were under the law as construed by respondent a requisite for the conduct of the business or sale of the goods. Corporation income tax returns were filed annually by petitioner, in which these sums were included in gross income and taken as deductions under the head of revenue stamps used, which were in turn included as cost of goods sold.

Prior to the filing of the petition herein, the period of limitation for the assessment of a deficiency in Federal income tax for any of the years 1923 to 1930, inclusive, had expired, and no deficiency in such tax may now be assessed against petitioner for any of such years.

Eespondent affirmatively pleaded estoppel, and contends that, since petitioner deducted the so-called oleomargarine stamp taxes in computing its income tax liability for years in respect of which the period of limitation has run, petitioner should not now be permitted to change its position to the prejudice of the Government and deny that the amounts refunded constituted taxable income for the year 1932. Much is said in the briefs of both parties respecting this matter, but we think it unnecessary in the present case to discuss application of the principles of estoppel or similar doctrines. The controlling question presented here is whether the amounts of the stamp taxes refunded to petitioner in 1932 constituted income taxable for that year in the circumstances disclosed.

As we said in South Dakota Concrete Products Co., 26 B. T. A. 1429, 1432, and have repeated in many subsequent decisions:

* * * income-tax liability under the Federal revenue acts is to be determined on annual periods on the basis of facts as they existed in each period, and when an adjustment occurs which is inconsistent with what has been done in the past in the determination of tax liability, the adjustment should be reflected in reporting income for the year in which it occurs.

In the cited case it was held that where amounts embezzled and offset against income in prior years were subsequently recovered, they must be reported as income for the year of recovery.

In conformity with the legal principle above stated, it has also been held that where a debt, deducted from gross income of a prior year as worthless, is subsequently collected in part, the amount recovered must be returned as taxable income for the year of recovery; that expenses paid and deducted in one year but later recovered must be included in the taxpayer’s gross income for the year of recovery; that, where losses resulting from fire were deducted from gross income, insurance subsequently received constituted taxable income; and that additional compensation received in 1920 for transporting United States mails during the years 1916 and 1917, but not returned as income for those years, constituted taxable income for 1920.

Broadly stated, the reason for the rule is that where unforeseen events later disclose that deductions were improperly taken from gross income in prior years, or amounts were improperly omitted from gross income, and adjustment of the tax liability for such prior years can not be made because barred by limitations or is impractical for other reasons, the amounts subsequently received, recovered, or canceled must then be included in gross income to offset such deduction or omission.

Applying the principle to facts substantially similar to those of the instant case, we held in Houbigant, Inc., 31 B. T. A. 954, that where the taxpayer received a refund of customs duties during the fiscal year ended June 30, 1931, which it had paid and deducted from gross income in its tax returns for prior years, the amounts recovered constituted gross income for the taxable year. Our decision was affirmed at 80 Fed. (2d) 1012.

In Victoria Paper Mills Co., 32 B. T. A. 666, the petitioner obtained judgments against the city of Fulton, New York, in 1931 for the recovery of property taxes paid in excess for prior years, which it had deducted from gross income in its Federal income tax returns. Petitioner assigned the judgments to a bank and received credit for the value thereof. We held the amount was taxable income of the petitioner for the year 1931.

In Chevy Chase Land Co., 34 B. T. A. 150, the petitioner paid special improvement taxes on its real estate and included the amounts in the cost of the real estate, which it sold in later years but prior to 1932. In 1932 tlie law under which, the taxes had been assessed was declared unconstitutional and the amounts were refunded. Since petitioner had added the refunded taxes to the cost of its real estate in computing taxable gain on sales, we held the amounts recovered were taxable as income for the year recovered.

In Charles W. Nash, 34 B. T. A. 675, the petitioner paid income taxes to the State of Wisconsin for the years 1926 to 1931, inclusive, which amounts he deducted on his Federal income tax returns. The Wisconsin statute was declared unconstitutional and the income taxes paid by petitioner thereunder were refunded to him in 1932. We held the amounts so refunded constituted income to the petitioner for 1932.

Petitioner argues that the cited cases are not controlling here, for the reason that the refunded amounts in controversy were claimed and allowed as deductions in the prior years due to a mutual mistake of law; that in fact they did not represent taxes paid and were not properly allowable deductions; hence should not be treated as taxable income of the year in which refunded. We are unable to agree.

In E. L. Bruce Co., 19 B. T. A. 777, and Charles F. Fawsett, 30 B. T. A. 908, we held that amounts paid as taxes under unconstitutional and void state statutes, where such amounts had not been later refunded and refunds were barred by limitations or otherwise, were allowable deductions in computing Federal income tax liability for the years in which paid. In the present case petitioner is not seeking deductions of the amounts in controversy from income of prior years; such deductions have already been allowed, and adjustment of the tax liability for those years is barred by limitations. But we think the amounts were none the less properly allowable deductions in the years of payment because they were paid pursuant to void regulations of the Commissioner instead of a void statute. Such amounts have been held not to constitute allowable deductions from gross income for the year in which paid only in those cases where refund was received prior to the final determination of the tax liability for the year in which the refunded payment was made. Inland Products Co., 10 B. T. A. 235; affd., 31 Fed. (2d) 867; Mary W. Leach, 16 B. T. A. 781; affd., 50 Fed. (2d) 371; and compare Joseph V. Horn, 23 B. T. A. 1131. Obviously, these latter decisions have no application here, for the reason that the refunds were received subsequent to final determination of the petitioner’s tax liability for the prior years.

It should be borne in mind that the disbursements made by petitioner for stamp taxes in the years prior to the taxable year were not' deducted as “taxes paid or accrued” in computing net income of the respective years, but petitioner received the benefit of the deductions as a part of cost of its product manufactured and sold in such years. Petitioner, therefore, actually and in fact derived additional income at the time of the receipt of the refunds equal to the amount thereof. The net result is precisely the same as if petitioner had received the refunded amounts as additional proceeds of sale instead of a reduction of the cost basis of goods sold. In such event, it seems obvious that the entire amount would represent taxable income of the year of receipt. Compare on this point Chevy Chase Land Co., supra, and Houbigant, Inc., supra. In the latter case, at page 956, we said:

The facts in this ease show that in the income tax returns filed by the petitioner for the years 1924 to 1930, inclusive, the petitioner claimed and was allowed the deduction of the full amounts of the customs duties paid. They were not allowed under the name of customs duties, but in increased cost of goods purchased by the petitioner. Having been deducted in prior year returns, if they are not taken up in the gross income when recovered, the petitioner clearly, over a series of years, escapes tax upon gains and profits equaling the amount of the customs duties recovered. It can not be presumed that such a result was contemplated by Congress. Furthermore, from any standpoint, the petitioner was enriched by the recoveries of the import duties in the fiscal year ended June 30, 1931. The argument that the income received from this source is exempt from tax has no support in the law.

Petitioner here further asserts that it was not enriched by the receipt of the refunds in controversy, since the Government retained $87,412, paid for stamp taxes during the period March 15, 1923, to December 1, 1925, refund of which is barred by limitations, and insists it would be inequitable to tax it upon the amounts refunded for the reason that the amount of such tax is much less than the amount of the retained stamp taxes.

On this state of facts petitioner urges a right to recoup the money so retained by respondent to the extent of the deficiency, if any, in income tax determined on the basis of refunds in 1932 of the money paid by it in the years subsequent to 1925 for oleomargarine stamp taxes and license fees. The claim of recoupment must be denied. The money so paid in the years 1923-1925 is no part of, and has no connection with, the money refunded to it in 1932. This proceeding involves in no way the transaction of such payment in the years 1923-1925. Recoupment is “confined to matters arising out of, and connected with, the transaction or contract upon which the suit is brought.” Waterman on Set-off and Recoupment (2d ed.), p. 480; Crossett Lumber Co. v. United States (C. C. A., 8th Cir.), 87 Fed. (2d) 930; Bull v. United States, 295 U. S. 247. Under this view the question of whether the claim of recoupment in the instant case is barred by the statute of limitations loses importance.

On authority of the decisions hereinabove cited, the deficiency determined by respondent is approved.

Judgment will be entered for the respondent.

         Iberville Wholesale Grocery Co., Ltd., 17 B. T. A. 235; Putnam National Bank, 20 B. T. A. 45; affd., 50 Fed. (2d) 158; Askin & Marine Co., 26 B. T. A. 409; Davidson Grocery Co. v. Lucas, 37 Fed. (2d) 806; Commissioner v. Liberty Panic & Trust Co., 59 Fed. (2d) 320.

        Burnet v. Sanford & Brooks Co., 282 U. S. 359; Charleston & Western Carolina Railway Co., 17 B. T. A. 569; affd., 50 Fed. (2d) 342; Atlantic Coast Line Railroad Co., 23 B. T. A. 888. Cf. B. F. Avery & Sons, Inc., 26 B. T. A. 1393.

        Cooper v. United States, 9 Fed. (2d) 216.

        International-Great Northern Railroad Co., 24 B. T. A. 726.