text:
    American Auto Trimming Co. and Subsidiaries, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3430.
    Promulgated April 25, 1927.
    1. The petitioners held not to be affiliated for 1918 and 1919.
    2. The claim of one of the petitioners against the Saxon Motor Oar Oo. was assigned to its principal stockholder in 1918 or 1919, and was reassigned to the principal stockholder in 1919. Held, that such corporation sustained no loss from the assignment of its claim in 1918 or 1919.

      George R. J acleson, Esg., and George E. H. Goodner, Esg., for the petitioners.

      J. Harry Byrne, Esg., for the respondent.

      This is a proceeding for the redetermination of deficiencies in income and profits tax as follows:
    American Auto Trimming Co., Detroit, Micb., 1918_$42,224.56
    American Auto Trimming Coi, Detroit, Mich., 1919_ 20, 770.90
    Kolb-Gotfredson Horse Co., 1919_ 1, 632. 85
    Kolb-Gotfredson Realty Co., 1919_._ 129. 54
    Petitioners contend that the Commissioner erred (1) in refusing to allow the American Auto Trimming Co., Detroit, Mich., and four associated companies to file consolidated returns for the years 1918 and 1919, and (2) in refusing to allow a deduction from the gross income of 1918 of an alleged loss on the sale of a note by one of the companies during that year. At the hearing of the appeal the petitioners moved to withdraw their appeal so far as it related to the years 1917 and 1920 and such withdrawal has been allowed by order of the Board.
    FINDINGS OF FACT.
    The five corporations involved in this appeal are the Kolb-Got-fredson Horse Co., Detroit, Mich., hereinafter referred to as the Horse Company; the American Auto Trimming Co., Detroit, hereinafter referred to as the Detroit Company; the Gotfredson Land Co<v hereinafter referred to as the Land Company; the Kolb-Gotfredson Realty Co., hereinafter referred to as the Realty Company; the American Auto Trimming Co., Cleveland, Ohio, hereinafter referred to as the Cleveland Company.
    The Horse Company was incorporated in Michigan in 1905 with a capital stock of $150,000. Its business during the taxable years was selling horses, vehicles, harness, etc., and holding and renting real estate. The Detroit Company was incorporated November 23, 1909. Its business is the manufacture and sale of automobile parts and bodies. The Land Company was incorporated in Michigan, in 1913, with a capital stock of $100,000 divided into 10,000 shares. Its business was dealing in real estate. It became inactive after operating for a few years but was revived and its stock reissued on July 1, 1918. The Realty Company was incorporated in Michigan, in 1914, with a capital stock of $25,000 divided into 2,500 shares. Its business was owning and dealing in real estate. The Cleveland Company was incorporated in Ohio, in 1916. Its business during the taxable years was the same as that of the Detroit Company.
    The stockholdings of the various companies for the years 1918 and 1919 and the changes in stockholdings during those years were as follows:

    About the year 1905, Benjamin Gotfredson and his father-in-law, one Kolb, owned and conducted a small livery business in Detroit under the name of Kolb-Gotfredson Horse Co. It sold horses, carriages, harness, etc. In the course of its business the Horse Company acquired various parcels of real estate which advanced rapidly in value. This demonstrated that real estate judiciously handled would show a very good return on capital invested. The Horse Company occupied an extensive building, part of which was rented to a concern which started an auto trimming business. The venture, fiow-Gver, was not a success. Gotfredson believed that auto trimming would prove a successful business venture and acquired the business of the concern occupying a part of the building of the Horse Company, and, in 1909, incorporated the Detroit Company. In 1913 and i 914, Gotfredson incorporated the Land Company and the Realty Company, and inasmuch, as the Detroit Company engaged in the auto trimming business proved to be a great success, he caused the Cleveland Company to be incorporated in 1916, to do a similar business in Ohio.
    A few years after the Horse Company was incorporated Gotfred-son bought out Kolb’s interest in the Horse Company and was always thereafter the principal stockholder in all o.f the companies involved herein.
    When Gotfredson organized the Detroit Company he permitted one Frank H. Joyce to become a stockholder therein. Joyce first invested $1,600 and later was permitted to acquire additional amounts of stock. He entered the employ of the Detroit Company in 1912, and remained with it until 1922. He had formerly been a salesman of leather goods and was employed by the Detroit Company because of his knowledge of the materials used in the automobile trimming business. During the taxable years Joyce owned 25 per cent of the stock of the Detroit Company and 12% per cent of the stock of the Cleveland Company. He had the absolute right to vote his stock and he never gave to Gotfredson any proxy with respect thereto. While Gotfredson made a trip to Europe in 1922, Joyce had much to do with the management of the Detroit Company. Upon his return Gotfredson was displeased with his management and discharged him. About one year later Gotfredson acquired his stock in the Detroit and Cleveland Companies.
    M. H. Coleman, another employee of the company, was permitted to acquire a small amount of stock of the Detroit Company. He invested no money of his own at the beginning. Coleman was bookkeeper for all five companies during the years 1918 and 1919 and owned a small amount of stock in each. All of his stock was held by Benjamin Gotfredson, whom he owed during the taxable years for a part of the purchase price.
    Robert Gotfredson was the son of Benjamin Gotfredson and all of his stock in the different companies was issued in his own name but was held by his father until his marriage in 1922. At that time both the stock and the accumulated dividends thereon were given to him. He took no part in the management of the business during the years 1918 and 1919.
    Mary Gotfredson was the wife of Bénjamin Gotfredson. Shares of stock were issued in her name but were held by Benjamin Gotfred-son and never delivered to her. She did not know when or in what manner stock was issued nor did she take any part in the manage-' ment of any of the companies.
    ■ Lawrence Gotfredson, brother of Benjamin, lived in Wisconsin during the years 1918 and 1919 and took no part in the management of any of the companies during those years.
    The other minority stockholders were employees of the several companies who took no part in the management of the business. Certificates for shares of stock owned by such employees were held in some instances by Benjamin Gotfredson.
    One office in Detroit served- all the companies and they all had the same officers. Benjamin Gotfredson was president and M. H. Coleman was secretary and treasurer of each. No regularly called stockholders’ meetings were ever held. The minutes were written up at the Detroit office at the direction of Benjamin Gotfredson and signed by the officers. None of the stock of any of the companies' was ever actually voted. Benjamin Gotfredson personally directed the business policies of all the companies. No officer or employee attempted to oppose his will and decision in the management of the companies.
    The Horse Company leased space to the Detroit Company at less than its rental value and at less than it could and did lease it to outsiders. The Detroit Company borrowed money and loaned it to the other companies and financed a new building for the Cleveland Company in 1919. The Land Company did not pay interest to the Detroit Company on loans to it. From time to time Benjamin Gotfredson made advances of substantial amounts of money to the various companies. At times the companies borrowed large amounts of money from banks, all of these loans being made by the banks upon the personal endorsement of Benjamin Gotfredson.
    The original returns filed for the petitioner corporations for the years 1918 and 1919 were consolidated returns. In the audit of these returns the respondent ruled that the Detroit Company and. the Cleveland Company were affiliated within the purview of the law and should file consolidated returns; that the Horse Company and the Realty Company were also affiliated within the purview of the law and should likewise file ■ consolidated returns; and that the Land Company, which was not affiliated with either of the two groups, should file separate returns. The deficiencies for the taxable years in question are based upon the amended returns made by the respondent.
    One of the principal customers of the Detroit Company was the Saxon Motor Car Co. The Detroit Company sold large quantities of goods to this company on open account. In 1917 the Saxon Motor Car Co. became financially involved and a creditors’ committee was appointed to take' over its business. Benjamin Gotfredson, as president of the Detroit Company,' one of the insolvent company’s largest creditors, was appointed a member of the committee and later made president of that company. Under direction of the committee, the Saxon Motor Car Co. gave a note to the Detroit Company in the amount of $72,429.76, due and payable November 1, 1917, in full settlement of its account. At the maturity of the note a payment of $7,242.98 was made on the principal and a new note was given for the balance. At the end of 1917, no further payments having been made on the note, the Detroit Company charged off as a loss $36,214.88, 50 per cent of the face value of the original note, and claimed 'that amount as a deduction from gross income on its income-tax return for 1917.
    In auditing the 1917 return the respondent disallowed the deduction of the above-mentioned amount of $36,214.88 and restored the amount thereof to an account receivable.
    ■ During 1918, the Saxon Motor Car Co. plant was leased to the United States Government for war purposes on very favorable terms to the company, which permitted it to make further payments on' its indebtedness. During this time the Detroit Company received $14,-485.97 on said note, which brought the unpaid balance down to $50,700.82 and the debit balance on the Detroit Company’s books to $14,485.94.
    Near the close of 1918, or early in 1919, the Detroit Company assigned the balance of its claim against the Saxon Motor Car Co. in the amount of $14,485.94 to Benjamin Gotfredson in consideration of his payment of $5,000 to the Detroit Company. Benjamin Gotfredson’s check for the said $5,000 was received by the Detroit Company on January 18, 1919. In closing its books for the year 1918 the Detroit Company charged oif the remaining $9,448.94 of the Saxon Motor Car Co. note as a loss and claimed the deduction of a like amount on its income-tax return for 1918. The respondent disallowed the deduction.
    During the year 1919 business conditions improved, and it became evident that the Saxon Motor Car Co. would be able to make further payments on its obligations. Thereupon, in August, 1919, Benjamin Gotfredson reassigned the claim against the Saxon Motor Car Co. to the Detroit Company. Under date of July 15, 1919, Benjamin Gotfredson was credited with $5,135 on the journal of the Detroit Company and notes receivable was debited with a like amount. The explanation of the entry carried by the journal is “For Saxon Motor Car Company notes purchased from Benjamin Gotfredson.” Up to July 15,1919, no further payments had been made on the notes by the Saxon Motor Car Co. In August, and again in September, 1919, the Saxon Motor Car Co. made further payments on the note to the Detroit Company in the respective' amounts of $10,140.16 áíid‘i$12,-168.20. The unpaid balance on the original claim of $72,429.76 at the end of the year 1919 was $28,392.46. On January 5, 1920, a further final payment of $8,033.77 in cash was made on the note and stock- of the par value of $32,300 was received by the Detroit Company. This stock was held until November, 1922, when it was sold through a broker for $2,894.08.
    During the years 1918 and 1919, the Detroit Company continued to sell goods in large quantities to the Saxon Motor. Car Co. on a cash basis. The sales for the year 1918 amounted to $506,976.06 and for the year 1919 to $234,642.68.

       Kolb-Gotfredson Horse Co., Detroit, Mich.; American Auto Trimming Co., Detroit, Mich.; Gotfredson Land Co.; Kolb-Gotfredson Realty Co.; American Auto Trimming Co., Cleveland, Ohio.

   OPINION.

Smith:

1. The first question presented by this proceeding is whether the petitioner corporations are affiliated within the purview of section 240 (b) of the Revenue Act of 1918,. for the years 1918 and 1919. This provides:

For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all of the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

The Commissioner held that the Detroit Company and the Cleveland Company were affiliated for the years 1918 and 1919 and that the Horse Company and the Realty Company were also affiliated in a separate group for the same years; but that the Land Company was not affiliated with either of the two groups. In the light of the evidence we are of the opinion that the Horse Company, the Realty Company and the Land Company were affiliated during the taxable years.

From January 18, 1918, the Detroit Company owned 50 per cent of the stock of the Cleveland Company but no part of the stock of the other companies. There is no evidence that the Detroit Corn-pan^ had any actual control over the shares of stock which it did not own. To be sure a majority of the stock in each company was owned by Benjamin Gotfredson, president of the Detroit Company, and Benjamin Gotfredson may well be held to be an affiliated interest. We have held, however, in Appeal of Block Street Wharf & Warehouse Co., 2 B. T. A. 183, that where one corporation owned.50 per cent of the stock of another corporation and the president of the first corporation owned the balance of the stock of the second com: pany, that fact alone did not constitute the two corporations affiliated. Similarly we must hold here that the Detroit Company did not own directly or control through closely affiliated interests substantially all the stock of the other companies so as to constitute an affiliated group.

It remains to be considered whether substantially all the stock of the five companies was owned or controlled by the same interests.” Although there is evidence that the shares of stock held by other stockholders than Joyce were controlled by Benjamin Gotfredson and M. H. Coleman there is no evidence that these individuals had any actual control over the shares of stock standing in the name of Joyce. We are of the opinion that based on percentages alone the ownership or control by Gotfredson and Coleman of substantially all of the stock of the Horse Company, the Realty Company, and the Land Company, but of only 75 per cent of the stock of the Detroit Company, and of between 82y2 and 87y2 per cent of the Cleveland Company, can not be regarded as substantially all the stock of those companies. Industrial Co. of Binghamton, 2 B. T. A. 360; United Metal Spinning Co., 2 B. T. A. 520; Wadhams & Co., 2 B. T. A. 569; Ullman Manufacturing Co., 2 B. T. A. 1294. The test of the statute is ownership or control of substantially all the stock of all of the corporations of the affiliated group by the same “ interests.” We do not have that situation here. The Detroit and Cleveland Companies were engaged in a business essentially different from those carried on by the other three companies. The fact that Gotfredson had absolute control of the business methods, policies, and relations of all of the corporations is not decisive of the issue. Appeals of Rishell Phonograph Co., 2 B. T. A. 229; Watsontown Brick Co., 3 B. T. A. 85; Adaskin-Tilley Furniture Co. v. Commissioner, 6 B. T. A. 316. We are of the opinion that the Detroit and Cleveland Companies were affiliated in one group for the years 1918 and 1919, as found by the respondent, and that the Horse Company and the Realty Company were affiliated in another group, and that the Land Company from the date of its organization in 1918, was also affiliated in the same group. _ Deficiencies should be computed accordingly.

Upon the second point it is contended on behalf of the petitioners that the Detroit Company made a sale of its claim against the Saxon Motor Car Co. in 1918 for $5,000 and sustained a loss of $45,700.82 on the transaction; that from the date of the sale of this claim to Gotfredson there was an appreciation in the value of the claim and that the appreciation in the value from $5,000 to its worth at the time that it was reassigned to the Detroit Company constitutes a paid-in surplus of the Detroit Company and that the Detroit Company realized no income from collections upon the note in the year 1919. -

The evidence with regard to this transaction is decidedly unsatisfactory. Gotfredson, who should have a lively recollection with regard to the transaction if it was bona fide, deposed as follows with respect thereto:

Q. It appears from these pleadings here that the claim of the American Auto Trimming Co. at Detroit against the Saxon Motor Car Co. was purchased by you personally for $.5,000. Do you recall that?
A. I remember something about it.'
Q. Who fixed the price of $5,000 for that claim?
A. I couldn’t remember.
Q. Can you state whether the amount of the claim, was approximately $50,000?
A. No, I couldn’t.
Q. Do you recall your assigning the claim back to the American Auto Trimming Co., and getting your $5,000?
A. No, I don’t remember. You see Mr. Coleman is the secretary and treasurer, and it was just kind of an every day occurrence what I would sign and what I would do. I don’t remember.
Q. That is what I am asking you, Mr. Gotfredson. Wouldn’t the amount of $5,000 be fixed by you, and not by some subordinates?
A. It would naturally be agreed to by me, if I gave a check for it or paid for it.
Q. Wouldn’t you be the one who would set the price?
A. I would not say that. It might be, and it might not.
Q. Did you take over that claim just for convenience, because you were in close connection with the Saxon Motor Car Co., and could handle it for your own eompany to advantage?
A. I could not remember the details.

It is further to be noted that there is no satisfactory evidence as to whether the note was assigned to Gotfredson in 1918 or in 1919. The deposition of M. H. Coleman, secretary and treasurer of the Detroit Company, upon this point was in part as follows:

Q. (By Mr. Doyle) What was the date of the sale of the Saxon Motor .Car Co. claim to Mr. Gotfredson?
A. Sometime in December of 1918, I don’t remember the exact date. I think I testified to it this morning.
Q. Was the money paid at that time? *
A. He paid the money in January of 1919, he paid the company the money. Do you mean that?
Q. Yes, that is what I mean, the time that he bought the claim.
A. He paid the company Jasnuary 1st, 1919, or in January of 1919, I do not just remember the date.
Q. Why do you say that the sale was made in 1918?
A. Because that is when it was made.
Q. Was there a contract drawn up in connection with it?
A. No, I do not think there was a contract drawn up. It was for closing the books that that sale was made.
Q. When would you close the books?
A. The books were closed at the end of the year, that is, as of the end of the year.

The petitioners have not shown that any loss on account of the sale of the note was actually sustained during either of the years 1918 or 1919.

Judgment will be. entered on 16 days’ notice, under Rule 60.


source: Caselaw Access Project

author: TRAmmell :

license: Public Domain

text:
    The Gazette Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9031.
    Promulgated April 25, 1927.
    1. An amount of $15,000, representing salaries and traveling expenses of subscription solicitors during the years 18S4 to 1891, disallowed in invested capital for 1919, 1920, and 1921 for lack of evidence.
    2. Certain amounts expended for library and archives and originally charged to expense disallowed in invested capital for lack of proof.
    3. The deductions for 1919, 1920, and 1921, for amortization of certain amounts expended for' library and archives, originally charged to expense and not determined to be chargeable to capital are disallowed.
    4. Section 1207 of the Revenue Act of 1926, relating to the adjustment of invested capital on account of Income and profits taxes for prior years, held applicable where books of account are kept on the cash .receipts and disbursements basis.

      Arnold L. Guesmer, Esq., and Clifford Yewdall, G. P. A., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes of $2,519.61, $6,478.04, and $5,499.81 for the years 1919, 1920, and, 1921, respectively. The deficiencies result in part from the respondent having (1) refused to permit the peti- * tioner to include in invested capital for each of the years an amount of $15,000 claimed by the petitioner to have been expended during the years 1884 to 1891, inclusive, for building up its circulation structure; (2) refused to permit the petitioner to include in invested capital the amounts of $12,664.71, $11,847.41 and $11,176.80 for 1919, 1920, and 1921, respectively,, claimed by the petitioner to have been expended for building up a library and archives, which in newspaper parlance are called the “morgue (3) excluded from petitioner’s invested capital for each year the prorated income and profits taxes for the preceding year; (4) disallowed deductions of $1,404.50, $1,389.57, and $1,341.63, claimed by the petitioner as amortization of library and archives, and (5) reduced invested capital for each of the years 1919, 1920, and 1921 because of additional taxes found due for prior years as a result of disalloiving as deductions for such years amounts claimed as amortization of library and archives, and excluding from invested capital for prior years the -amounts claimed as expenditures made for building up a library and archives and a circulation structure.
    FINDINGS OF FACT.
    The petitioner is an Iowa corporation organized in March, 1884; and since that time has been engaged continuously in publishing at Cedar Rapids, Iowa, The Evening Gazette, a daily newspaper. . In the fall of 1885 the circulation was about 700 and as the result of a gradual growth was about 3,000 at the end of 1891.' The subscription price was $5 per year both in the city and in the country.
    From 1885 to 1891, the petitioner had in its employ, two men, and sometimes more, who were engaged in soliciting subscriptions in the surrounding country and near-by towns. Where payments were made in'advance these solicitors collected the money. They were paid a salary of $12 per week and their traveling expenses, which included meals, lodging, and livery stable bills. Part of the time one of the men, while soliciting subscriptions, used a .horse belonging to the petitioner. To the solicitor who did not use petitioner’s horse, petitioner paid $125 per month, which in addition to being his salary of $12 per week was also intended to cover his expenses for meals, lodging, and traveling. Petitioner has no record prior to 1892 relating to expenditures for building its circulation structure or relating to the circulation of the paper.
    Petitioner in due course filed its return for the years 1919, 1920, and 1921. In November, 1924, it executed and filed with the respondent “ amended ” returns wherein the petitioner claimed the allowances which the respondent rejected.
    Mats, cuts, and sources of statistical and general information, after being used once were either discarded or filed-away. Those which it was thought would be of no further use were discarded. Those which it was believed would be needed in the future were filed or stored away in the archives and library, called the “ morgue.” Included in the “ morgue ” were cuts and mats of people prominent in politics, athletics, the moving-picture business and other walks of life. The “morgue” is made use of by the editorial and news departments of the paper. From time to time petitioner eliminated certain material from the “morgue.” In 1906 and again in 1925 there was a general cleaning out of the “ morgue ” by which material of no further use was eliminated. The amount of material from the “morgue” thrown away from 1885 to 1895 was not as great as that thrown away during the last twenty years. During the latter period, the “morgue” was gone over and cleaned out more thor-oughiy.
    During the hearing the parties to this proceeding submitted a stipulation, a portion of which is as follows:
    It is stipulated between the parties in the above-entitled cause that during the years 1893 to 1922, inclusive, the taxpayer corporation maintained no capital accounts on its books showing the cost or costs of so-called “ morgue ” investments; that all disbursements made on account of the so-called “ morgue ” investment were charged to operating expense during all of said years and also during the year 1923; that during 1923 the taxpayer corporation had its records analyzed and now seeks to restore to capital as so-called “morgue” investment certain disbursements below mentioned made during said years; that this analysis was made from available records for the years 1893 to 1914, inclusive, by taking from such records certain items of disbursements appearing therein as operating expenses which it, the taxpayer, considered as a capital charge and restored the same to the so-called “ morgue ” investment ; that from 1915 to 1922, inclusive, the taxpayer in its analysis took from its records, particularly the “income and operating account” (a summary for each year) the amount shown in said “ operating account ” under the heading “ Illustrating and Engraving,” and restored these amounts to so-called “morgue” investment; that the amounts so selected and restored are set forth on pages 1 and 2 of the taxpayer’s Exhibit 6-1, attached to its petition filed with the Board, and represents such amounts so taken from the records of the taxpayer corporation and considered by it as representing so-called “ morgue ” investment, and further considered by it proper capital charges.
    The respondent in auditing petitioner’s return refused to include in invested capital the amounts claimed by the petitioner to represent the “ morgue ” investment. The amounts excluded from invested capital for the years 1919,1920, and 1921, were $12,664.'?!, $11,847.41, and $11,176.80, respectively.
    For the years 1919, 1920, and 1921, the petitioner deducted $1,404.50, $1,389.57, and $1,341.63, respectively, for amortization at the rate of 5 per cent on the balance of the “ morgue ” investment at the beginning of each year.
    Taxes assessed against petitioner, with dates of payment and the amounts of current earnings available for the payment of taxes for the years 1918, 1919, and 1920, were as follows:

    The respondent reduced petitioner’s invested capital for 1919, 1920, and 1921, by $7,741.19, $4,283.66, and $8,409.62, respectively, representing petitioner’s prorated income and profits taxes for the respective year preceding. During the years from 1916 to 1921, inclusive, petitioner’s books of account were kept on the cash receipts and disbursements basis and the returns filed by it for 1917 to 1921, inclusive, were also on that basis. Income and profits taxes for 1917, 1918, 1919,1920, and 1921, were not accrued on the books.
   OMNION.

TRAmmell :

The petitioner contends that it is entitled to include m its invested capital for each of the years for which deficiencies have been proposed, an amount of $15,000 which it claims to have spent during the years 1884 to 1891, inclusive, in building up its circulation structure. Prior to 1892, the petitioner has no records relating to expenditures for building the circulation structure, or relating to circulation. The evidence offered was the testimony of an employee who came to the company in 1885 and from that year until 1901, was in charge of the composing room. This employee was not an officer of the company during that time, nor did he keep its accounts. The knowledge he had as to expenditures and circulation was gained from discussion with the officers and other employees of the company and from his observations around the plant.

In support of its contention the petitioner submitted evidence showing that it regularly employed two subscription solicitors, and sometimes more, during the years 1885 to 1891; that their salaries were $12 per week and that they were granted additional allowances for meals, lodging, livery stable bills, and other traveling expenses, sufficient to make the total amount $125 per month per man when not using the horse and vehicle belonging to the company. There is no evidence as to how many more, if any, than two solicitors were employed, the time for which they were employed or the salaries and expenses paid them. We do not know whether the number of additional solicitors were few or many, whether they were employed only for a few days or for several months, or whether they were allowed more salary and expense money or less than was allowed the two regular solicitors. The evidence relates to the two solicitors regularly employed and we are asked to find from the evidence that petitioner spent $15,000 from 1885 to 1891, inclusive, in building up its circulation structure. In order to make such a finding we would have to hold that only a small part (approximately one-sixth) of the total salaries and expenses of the two subscription solicitors was to be considered as an ordinary and necessary expense and that the remainder should be treated as capital expenditures. In our opinion the facts in this case do not warrant'such a holding. We can not make such a finding in the absence of evidence as to what part of the expenditures represented expenses and what part capital expenditures. The action of the respondent in refusing to allow $15,000 to'be included in -invested capital on account of such expenditures is, therefore, approved. Appeal of Carter Medicine Co., 3 B. T. A. 212.

The petitioner contends that there should be included in its invested capital certain amounts which represent expenditures made in building up its library and archives or “ morgue.”

During the years 1898 to 1923, we find that the petitioner kept no capital accounts on its books showing the cost of the “ morgue ” investment but that all disbursements made on account of the “ morgue ” investment were charged to operating expense. In 1923, petitioner had its records analyzed and thereafter sought to include in its invested capital as the “ morgue ” investment certain disbursements made during the years 1893 to 1923 which its accountant considered to be capital expenditures. The accountant was not an employee of the petitioner during that period and had no personal knowledge as to what the expenditures were for or what portion thereof represented assets having a life in excess of a year, or what was for current expenses.

Since no competent testimony was offered in support of the petitioner’s contention, we have no way of knowing whether the amounts were capital expenditures or whether they were properly chargeable to expense, as was originally done by the petitioner. The respondent’s action, therefore, is approved.

It was also contended by the petitioner that it should be allowed a deduction each year representing amortization on its “ morgue ” investment. Since it has failed to establish that it is entitled to capitalize the amounts claimed as “ morgue ” investment, it therefore is not entitled to a deduction for amortization thereof.

The two remaining issues relate to the respondent’s action in reducing petitioner’s invested capital for the years 1919, 1920, and 1921, by the prorated amount of income and profits taxes for the years 1918, 1919, and 1920, respectively, and also by the amounts of additional taxes found due for certain years prior to 1918. The petitioner contends that article 845, Regulations 45 and 62, and section 1207 of the Revenue Act of 1926, which have to do with the adjustment of invested capital on account of prior-year taxes, do not apply to it inasmuch as it keeps its books and files its returns on the cash receipts and disbursements basis. The petitioner also contends that since it was on the cash basis and had, on the date it made payment of its tax for the preceding year, current earnings in excess of such payments, the reduction of its invested capital on account of taxes for prior years is unwarranted. The petitioner makes no complaint, however, that the adjustment of its invested capital as made by the respondent is not in accordance with article 845 of Regulations 45 and 62.

. Article 845 of Regulations 45 and 62 is as follows:

Ror the purpose of computing invested capital federal income and war profits and excess profits taxes are deemed to have been paid out of the net income of the taxable year for which they are levied. It is immaterial, therefore, whether reserves for the payment of such taxes for the preceding year have been set up or not, or if set up whether such taxes when paid have actually been charged against such reserves. Amounts payable on account of such taxes for the preceding year may be included in the computation of invested capital only until such taxes become due and payable. A deduction from the invested capital as of the beginning of the taxable year must therefore be made for such taxes or any installments thereof, averaged for the proportionate part of the taxable year after the date when the tax or the installment is due and payable. Where as a result of an audit by the Commissioner, or the acceptance of an amended return, or for any other reason, the amount of any such tax for the preceding year is subsequently changed, a corresponding adjustment will be made in the invested capital for the taxable year upon the same basis as if the corrected amount of the tax for the preceding year had been used in the original computation of the invested capital for the taxable year.

Section 1207 of the Revenue Act of 1926 provides as follows:

The computation of invested capital for any taxable year under the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, shall be considered as having been correctly made, so .far as relating to the inclusion in invested capital for such year of income, war-profits, or excess-profits taxes for the preceding year, if made in accordance with tho regulations in force in respect of such taxable year applicable to the relationship between invested capital of one year and taxes for the preceding year.

The above section of the statute validated the regulations of the Treasury Department above quoted and gave that article the force and effect of law.

From a careful consideration of the article in connection with the section of the Act quoted, we see nothing that would justify petitioner’s contention that it does not apply to cases where the boobs are kept and the returns filed on a cash receipts and disbursements basis but is applicable only where the accrual method of accounting is employed. The language of article 845 does not differentiate in any way between the two methods of accounting. In fact to our minds it is sufficiently comprehensive and specific to include those cases where the cash receipts and disbursements method of accounting is employed as well as those employing the accrual method.

If any doubt remained in our minds that Congress intended section 1201 of the Revenue Act of 1926 and article 845 of the Regulations 45 and 62 to apply only to those cases where the accrual method of accounting is employed, it would be removed by the legislative history of section 1207. This section was added by the Senate as an amendment to the bill as originally reported from the House. The amendment as added by the Senate reads as follows:

The computation of invested capital for any taxable year under the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, in the case of a ta-aipaycr whose books of account were kept on the accrual basis, shall be considered as having been correctly made, so far as relating to the inclusion in invested capital for such year of income, war-profits, or excess-profits taxes for the preceding year, if made in accordance with the regulations in force in respect of such taxable year applicable to the relationship between invested capital of one year and taxes for the preceding year.

The following was eliminated from the section in conference:

In the case of a taxpayer whose books of account were kept on the accrual basis.

The bill, as finally passed by both the House and the Senate, contained section 1207 as reported from conference. Since Congress eliminated from the section that portion of it which might warrant the application contended for by the petitioner, we find no error in the action taken by the respondent. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168; Appeal of B. F. Boyer Co., 4 B. T. A. 180; Appeal of Randall Brothers, Inc., 4 B. T. A. 291; Appeal of Hutchins Lumber & Storage Co., 4 B. T. A. 705; Appeal of Manville Jenckes Co., 4 B. T. A. 765.

Judgment will be entered on 10 days’ notice, v/nder Rule 50.


author: Sternhagen :

text:
    C. A. Hawkins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 418.
    Promulgated April 25, 1927.
    1. General or compensatory damages received by way of settlement for injury to personal reputation and health caused by defamatory statements constituting libel or slander are not income.
    2. Query as to special or exemplary damages.

      A. E. Graupner, Esq., for the petitioner.

      A. B. Marrs, Esq., for the respondent.
    Deficiency of $19,718.39 income tax for 1919, part of which is contested on the ground that the Commissioner erroneously included in petitioner’s income an amount received in settlement of a claim for libel and slander. There is no brief or argument for respondent.
    findings of fact.
    Petitioner, an individual residing in San Francisco, Calif., was an industrial engineer engaged in corporate management. Prior to March 23, 1918, he had for some time been president of the C. L. Best Gas Traction Co. On that date he was removed from office by the directors, and thereafter certain of the officers of the corporation made and published defamatory statements about him. He instructed his attorney to file against the corporation and the individual officers a suit in libel and slander demanding $1,000,000 damages for injury to his reputation, business and health. Two of the officers of the corporation had already filed suits against the petitioner, one for libel and one for money owed by reason of an alleged misuse of corporate funds during petitioner’s term of office. Before petitioner’s attorney began the suit in his behalf a settlement of petitioner’s claims was orally negotiated and made. By this settlement the petitioner received, on or about January 15, 1919, $100,000 in cash and the corporation’s note for $12,500. He also received $306.41 as interest. In further consideration under the settlement agreement the two suits which had been begun against him were dismissed.
   OPINION.

Sternhagen :

The consideration of the question whether the damages received for libel and slander are taxable as income must proceed not so much according to the refinements of economists, Lynch v. Turrish, 247 U. S. 221; Merchants’ Loan & Trust Co. v. Smietanka, 255 U. S. 509, as according to such decisions of the Supreme Court as mark the course. That stock dividends, Eisner v. Macomber, 252 U. S. 189; stock rights, Miles v. Safe Deposit & Trust Co., 259 U. S. 247; subsidies, Edwards v. Cuba R. R. Co., 268 U. S. 628; or savings, under certain circumstances, on the liquidation of indebtedness through a drop in foreign exchange, Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, have been held not to be income; while the gain from capital sales, Merchants' Loan & Trust Co. v. Smietanka, 255 U. S. 509; Goodrich v. Edwards, 255 U. S. 527; dividends in specie, Peabody v. Eisner, 247 U. S. 347; United States v. Phellis, 257 U. S. 156; and periodic payments under a will from a trust fund in which the payee has no direct interest, Irwin v. Gavit, 268 U. S. 161, have been held to be income, narrows the course but little, because the nature of the situations which gave rise to those decisions is inherently different from the question here.

The petitioner cites some of these decisions for the statement therein contained that income is the gain derived from capital or labor or both, including profit from the conversion of capital assets, and that nothing else answers the description. Whether this description of income is to be regarded as exclusive of everything not clearly within its terms, so that both the Sixteenth Amendment and the statute (which is said to be the fullest exercise of the constitutional power, Eisner v. Macomber, 252 U. S. 189; Irwin v. Gavit, 268 U. S. 161) are forever to be limited by a judicial definition, may still be doubtful, for the Supreme Court is not in the habit of defining words abstractly, but only for the purpose of determining whether the matter then under consideration comes within their fair intendment. The court has itself said that the word is not a crystal, Towne v. Eisner, 245 U. S. 418, and it is conceivable that since the income tax is primarily an application of the idea of measuring taxes by financial ability to pay, as indicated by the net accretions to one’s economic wealth during the year, there may be cases in which taxable income will be judicially found although outside the precise scope of the description already given.

This we think is not such a case, but is on the other hand one which in no event involves income. So far as the evidence shows, the amount which petitioner received was wholly by way of general damages for the personal injury suffered by reason of the defamatory statements made. It was compensation for injury to his personal reputation for integrity and fair dealing, including, as the record indicates, the injury'to his health. This is the ordinary basis for compensatory damages, Childers v. San Jose Mercury Printing & Publishing Co., 105 Cal. 284; 38 Pac. 903. No suggestion is made that there was special damage paid or that any was asserted or that punitive or exemplary damages were claimed or paid,- and we need not consider the law as to them. Plere there is only the compensation which the law sanctions as the only remedy which has thus far been devised for an injury which in its nature is wholly personal and nonpecuniary. Even to the economist, character or reputation or other strictly personal attributes are not capital or otherwise measurable in terms of wealth, notwithstanding that all will recognize them as important factors of economic success. They are not property or goods. Such compensation as general damages adds nothing to the individual, for the very concept which sanctions it prohibits that it shall include a profit. It is an attempt to make the plaintiff whole as before the injury.

There is some support for this reasoning in the dictum of the Chief Justice in United States v. Supplee-Biddle Hardware Co., 265 U. S. 189, as to the insurance received by a corporation upon the life of its officer:

* * * Life insurance in such a ease is like that of fire and marine insurance, a contract of indemnity. Central Bank of Washington v. Hume, 128 U. S. 195. The benefit to be gained by death has no periodicity. It is a substitution of money value for something permanently lost, either in a house, a ship, or a life. Assuming without deciding that Congress could call the proceeds of such indemnity, income, and validly tax it as such, we think that in view of the popular conception of the life insurance as resulting in a single addition of a total sum to the resources of the beneficiary, and not in a periodical return, such a purpose on its part should be express, as it certainly is not here.

If compensation for the loss of a life is not taxable as income unless expressly provided, compensation for the injury to personal reputation should similarly require an exjiress provision.

Alimony has been held not to be taxable income, Gould v. Gould, 245 U. S. 151.

The amount of $306.41, so far as the evidence shows, was interest, and so is expressly within statutory gross income. The amount of $112,500 was properly omitted by petitioner, and as to it the Commissioner is reversed.

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


author: Phillips :

text:
    Old Colony Railroad Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7820.
    Promulgated April 25, 1927.
    Bonds were issued at a premium prior to the taxable year and were outstanding at its close. The Commissioner included a pro rata portion of such premium based upon the life of the bonds, in income of the taxable year. Sold, that no part of such premium is income for the taxable year.

      J. S. F. Ivins, Esq., and O. R. Folsom-Jones, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.

      The taxes in controversy in this proceeding are income taxes for the calendar year 1920. The petition alleges that the following errors were committed in computing the deficiency:
    (1) The amount of $6,960.64 has been erroneously added to the taxable Income for the year 1920, representing an apportionment of premiums on bonds sold prior to the year 1909.
    (2) The amount of $696.06 has been erroneously added to the taxable income for the year 1020, representing an amount equal to the Federal income tax computed on the addition to its taxable income for such year made by the Commissioner, as set forth above, on account of the apportionment of premiums on bonds.
    PINDmGS OP PACT.
    The petitioner is, and was in 1920, a Massachusetts corporation with its principal office at Boston.
    The New York, New Haven & Hartford Railroad Co. was, during 1920, a corporation existing under and by virtue of the laws of Massachusetts, Rhode Island, and Connecticut.
    By a lease dated March 1, 1893, which was in force throughout 1920, the petitioner leased its property to the New York, New Haven & Hartford Railroad Co., and by virtue of such lease the lessee undertook to pay the Federal income and profits taxes of the petitioner upon its taxable income for each taxable year.
    During the years 1895 to 1904, inclusive, petitioner issued and sold its bonds for divers amounts, receiving therefor, in addition to the face amount of such bonds, premiums aggregating $199,528.08. Such premiums were credited to a “ Premium on Bond ” account and remained there undisturbed until 1914, when the Interstate Commerce Commission required the petitioner, for the purposes of its reports to the Interstate Commerce Commission, to amortize such premiums over the periods of the respective lives of the bonds. For the purpose of meeting the requirements of the Interstate Commerce Commission and over its protests to the Commission, the petitioner made such adjustments, and for each year subsequent to 1914 reported a ratable proportion of such premiums to the Interstate Commerce Commission as income. On its books in each such year petitioner credited such proportion of the premiums to profit and loss account (a surplus account) and not to its income account. The amount so credited to profit and loss account for 1920 is $6,960.64. The Commissioner increased petitioner’s taxable income for 1920 by such amount of $6,960.64. The Commissioner further increased petitioner’s taxable income for 1920 by $696.06, on the theory that the income tax of 10 per cent should be computed upon the amount of $6,960.64, mentioned above, and that this tax, being payable by the petitioner’s lessee under the terms of the lease, constituted additional income to the petitioner.

      The accounts oí the petitioner were kept on the accrual basis.
   OPINION.

Phillips :

From 1895 to 1904 petitioner sold its bonds at a premium. Those bonds are not yet due. It is the contention of the Commissioner that the premium received must be allocated over the life of the bonds and an aliquot part included in income each year during their life. The converse of the instant case, where bonds were sold at a discount and it was sought to amortize such discount over their life, has been passed upon by the courts in several cases, in each of which it was held that no such amortization was allowable as a deduction from income. Baldwin Locomotive Works v. McCoach, 221 Fed. 59; 1 Am. Fed. Tax Rep. 450; Chicago & Alton Railroad Co. v. United States, 53 Ct. Cls. 41; 3 Am. Fed. Tax Rep. 3385. A similar conclusion was reached by the Supreme Court in New York Life Insurance Co. v. Edwards, 271 U. S. 109, where it refused to allow a purchaser of bonds to amortize a premium paid on their purchase. See also Corn Exchange Bank v. Commissioner, 6 B. T. A. 158.

The same principles which governed those cases would appear to govern the decision here. The amortization of the premium on the bonds may be desirable and may be material in keeping accounts for rate-making purposes, but at most it is a matter of accounting and can not give rise to income where no transaction has occurred during the taxable year with reference to the sale, purchase, or payment of the bonds. We therefore reach the conclusion that the Commissioner erred in treating the amount of the amortization as income.

Without objection on the part of counsel for the respondent, counsel for the petitioner introduced evidence with respect to certain matters not within the issues framed by the pleadings, the decision of which issues would be controlled by the decisions of the Board in the Appeals of New York, Ontario & Western Railway Co., 1 B. T. A. 1172, and Providence & Worcester Railroad Co., 5 B. T. A. 1186. While presenting such proof counsel carefully refrained from amending the pleadings to raise any issue with respect to such facts and in their brief counsel for the petitioners state that they reserve their rights under such facts until after the courts have passed upon the decision of the Board in the latter case. We have confined our decision to the issues presented by the pleadings. There is no deficiency.

Decision will he entered accordingly.


author: Trammell :

text:
    Donnelly Brick Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7314.
    Promulgated April 25, 1927.
    A tunnel brick kiln constructed for the burning of common brick, although it had never before been used for that purpose, field to be a capital asset, and no part of its cost is deductible as expense.

      D. P. O’Connor, Esq., and A. F. Hall, C. P. A., for the petitioner.

      Jos. K. Moyer, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes for 1920 in the amount of $11,974.30. The deficiency arises from the action of the Commissioner in disallowing as a deduction claimed by the petitioner as an ordinary and necessary expense, a portion of the cost of a tunnel kiln which it installed in 1920.
    FINDINGS OF FACT.
    The petitioner is a Connecticut corporation, with its principal place of business at New Britain. It is engaged in the manufacture and sale of common brick.
    After some investigation the petitioner decided to install at its plant a tunnel kiln for the burning of common brick. While tunnel kilns were being successfully used, the petitioner was the pioneer in using this method of burning common brick. It was not known whether the tunnel kiln could be successfully used for this purpose and some experimenting was necessary to be done (1) as to the proper way to load the cars so that the brick would burn uniformly; (2) as to a fuel to place with the brick on the car; (3) as to car tops that would stand up for a reasonable length of time; (4) as to combustion chambers that would stand up; (5) as to a dependable fuel to use for heating the kiln, and a proper heat range; (6) as to the proper kind of pyrometers to be used.
    The construction of the kiln was begun in August, 1920, and completed in May, 1921. Coincident with the beginning of the construction of the kiln the petitioner suspended operations which were resumed after the completion thereof in May, 1921.
    It was necessary that the petitioner turn out 48,000 bricks daily in order to operate profitably and it was understood that the kiln which was being installed had that capacity, although the contract entered into with the American Dressier Tunnel Kiln Co. contained no provision as to the capacity of the kiln.
    After the kiln was completed in 1921, it was found that it would not turn out 48,000 bricks daily, although this could not be determined until after the kiln was lighted and put in use in May, 1921, As a result of this condition certain parts of the kiln were replaced and the kiln enlarged. The major part of the replacement took place in 1923 when twelve additional burners were installed. The petitioner kept an account on its books headed “Tunnel Kiln Account,” which showed charges of $47,036.23 at the end of 1920, and the total cost of constructing the kiln contracted for with the American Dressier Tunnel Kiln Co. was $55,385.19. After the changes had been made and the kiln had been enlarged in 1923, the total cost was approximately $135,000, at which time it was in condition to produce 48,000 burned bricks per day.
    In 1923 it was decided to install oil-burning apparatus m place of apparatus for burning gas. A portion of the kiln was torn away- and additions made in order to get the correct soaking zone or heat curve and to increase the capacity. The following parts were taken out and discarded:
    Expansion boxes, gas ducts and labor_$14, 594.03
    Stack discarded_ 735.34
    Gas producers- 3, 500.00
    Gas ducts- 637. 50
    Gas ducts- 365. 75
    Gas ducts, labor- 500. 00
    Expansion boxes, one-bali_ 657. 50
    Eire brick- 216. 09
    Eire brick_ 949. 60
    One-half the cost of blueprints_ 3, 500. 00
    Total_ 25, 655. 81
    A total of $1,590.40 was expended in 1920 for fire brick, silicate, carborundum, cilocel and combustion chambers.
    The petitioner in 1920 did not charge any jmrt of the expenditures in connection with the kiln to capital account, but subsequently charged approximately $24,000 to capital account and charged off the balance of the expenditures made in 1920 to expenses.
    The kiln was not used in 1920 and none of the parts or any of the material were taken out and scrapped in that year and it ivas not known until the kiln was first used in 1921 that any of the parts or material would have to be removed and replaced. Most of the parts ay ere removed in 1923, when the kiln ivas materially altered and the heating system changed to use oil instead of gas.
    The petitioner claimed a deduction from gross income in the amount of $24,929.76 in 1920, Avith respect to the expenditures made during that year in building and installing the kiln. The respondent has disallowed any deduction with respect to such expenditures.
   OPINION.

Trammell :

The petitioner contends that it is entitled to a deduction in 1920 with respect to approximately one-half of the expenditures made in that year in building and installing the tunnel kiln, upon the ground that such expenditures were in the nature of experimental expenses.

While it is true that the tunnel brick kiln had never before been used in burning common brick and the petitioner was the first to use it for that purpose, this fact does not establish the right to the deduction claimed. The petitioner acquired a capital asset. During 1920 the kiln was only partly completed and it was not known during that year that any of the parts or material used would ever have to be abandoned prior to the exhaustion of their normal useful life. This fact was not ascertained in 1920, and most of the parts •and material were not scrapped until 1923 or subsequent thereto. The parts when acquired had an expected life of at least more than a year.

We see no reason, under the facts in this case, to depart from the ordinary rule relating to the acquisition of capital assets. When capital assets become useless for the purpose for which acquired and are scrapped or abandoned, deductions may be allowed with respect thereto, or if it can be foreseen in advance that assets will have to be scrapped and abandoned because they can not be used in the business, a reasonable deduction may be allowed. The petitioner, however, in 1920 had no knowledge that the parts or material entering into the kiln would have to be scrapped or abandoned or replaced on account of not being suitable for the purposes for which acquired or installed.

The petitioner contends -that the tunnel kiln was like a machine and not a building, but this to our mind is not material. It was, in any event, a capital asset, the cost of which the taxpayer was entitled to have returned to it over the life thereof. While the evidence shows that the installation of this kiln was in the nature of an experiment by the petitioner and it was not known whether it would work successfully or not, this is not sufficient, in our opinion, to entitle the petitioner to the deduction claimed as ordinary and necessary expense. The expenditure was for the acquisition of capital assets. The fact that the capital asset had never been tried before for the particular purpose for which it was acquired by the petitioner does not change its character to an expense item. The acquisition of such property was not an ordinary, current, annual occurrence. It was acquired for use over a period of years.

Judgment will be entered for the respondent.


author: Steenhagen :

text:
    Leo G. Hadley, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5383.
    Promulgated April 25, 1927.
    Amounts credited by a close corporation to its principal stock-bolder as a distribution of earnings in the same account with other substantial credits consistently over a period of years, from which account the stockholder withdrew varying amounts at his pleasure, while another stockholder was regularly paid his distributive share of earnings in cash, and there being no evidence as to whether the return and accounts of the stockholder were on the receipts or. the accrual basis, held the amounts so credited are income to him.

      LutJier F. Speer, Esq., and Fred A. Woodia, Esq., for the petitioner.

      A. H. Murray, Esq., for the respondent.
    This proceeding involves an aggregate deficiency of $9,464.18 for the calendar years 1917, 1918, and 1919. The controversy arises by reason of the fact that the Commissioner included in the petitioner’s income as dividends certain amounts credited to the petitioner on the books of a corporation of which he was one of the principal stockholders. Most of the facts are stipulated by the parties, and are hereafter set forth in the form stipulated.
    FINDINGS OF FACT.
    The petitioner is an individual residing in St. Louis, Mo.
    The Hadley-Lean Glass Co. is a corporation organized under the laws of the State of Missouri in 1897. Its business is the manufacture and sale of plate and window glass. The following is a list of the stockholders and a statement of their holdings from the date of organization through the taxable years involved in this proceeding:
    Owen M. Dean-105 shares
    Leo G. Hadley- 91 shares
    George G. Heffernan- 1 share
    From 1898 to 1910, the directors of the corporation held annual meetings in December and declared dividends to the stockholders. The last express declaration of dividends was on December 31, 1909, from the earnings of that year, and the dividend was credited to the stockholders on the books of the company on January 1, 1910. The corporation did not own a building in which to do business, and these dividends were declared for the purpose of enabling the two principal stockholders, Dean and Hadley, to accumulate sufficient funds with which to build a building.
    From 1897 up to and including 1910 there were also credits to the account of the petitioner for salary, interest, and cash contributed to the business by him.

      From 1910 to 1918, inclusive, there were no express declarations of dividends by the board .of directors. líeífernan was paid one two-hundredth of the net earnings, and the balance of the earnings was allowed to remain in the business, one-half being credited to Dean and one-half to petitioner, notwithstanding the fact that Dean owned 105 shares and petitioner 94 shares of the stock of the corporation. The accounts of both these individuals were also credited with salaries, rentals, and an equal amount of interest, computed sometimes upon the basis of the capital stock of the corporation and sometimes with additional amounts which appear to have been computed in various ways, sometimes upon monthly balances, sometimes upon individual loans, and sometimes in an amount which Dean supposed was a legal interest deduction for income tax purposes under the then existing tax laws. An accurate determination of the basis in each case is not possible from an examination of the books. The rate of interest used in computing interest credits varied for the different years. The amounts credited were arbitrary and generally at much less than the legal rate.
    The books were kept in an unscientific manner. Dean acted as bookkeeper, and Hadley, who is not an accountant or bookkeeper, occasionally made an inspection to determine whether or not they were, in his judgment, correct.
    The earnings of the corporation for the calendar year 1918 amounted to $122,342.22. After the payment to Heffernan of his share of the earnings, $611.76, the balance was credited in equal amounts of $60,865.23 to the petitioner and Dean. The earnings of the corporation for the calendar year 1917 amounted to $125,763.80. After the payment to Heffernan of his share, $628.82, the balance was credited in equal amounts of $62,567.49 to the accounts of the petitioner and Dean. The earnings of each year were credited to the accounts on January 2 of the following year.
    The Commissioner made several adjustments in the amounts credited to the stockholders’ accounts for taxes accruing against the income of the corporation and certain other minor matters. An adjustment of the earnings was also made upon the basis of the percentage of stock ownership of the two principal stockholders. Of the $60,865.23 of the earnings for the year 1916 credited to the petitioner’s account on January 2, 1917, the respondent determined that $56,350.83 was a dividend to the petitioner in the year 1917. Of the $62,567.49 of the earnings for 1917 credited to the petitioner’s account on January 2, 1918, the respondent determined that $27,603.71 was a dividend to the petitioner in 1918.
    The following salaries were credited to the petitioner’s account during the years stated:

    During the years from 1910 to. 1917, inclusive, the corporation credited to the accounts of the petitioner and Dean the following equal amounts for the rent of the building occupied by the corporation and owned and built by them from the dividends declared prior to 1910:

    As to 1916, additional credits were made to the accounts of the two stockholders of $8,775.97 each, which was one-half of a discrepancy between the bank balance of the corporation and the balance sheets of the corporation, the discrepancy having been discovered by a revenue agent. A similar credit of $7,308.08 to the petitioner’s account was made as to 1917, covering an accumulation in the bank balance of the corporation.
    The balance on the petitioner’s account as of January 1, 1910, the credits to the account subsequent to that date of earnings, other credits excluding earnings, total credits, withdrawals, the balance excluding earnings, and the balance including earnings, are as follows:

    During the year 1918 the books of the Hadley-Dean Glass Co. were audited by public accountant's and a modern accounting system installed. In connection with this audit the amounts to the credit of Hadley and Dean on the books of the corporation were credited to the surplus account set up by the accountants making the audit and were subsequently considered as surplus by the respondent.
    All purchases máde by the Hadley-Dean Glass Go. were paid for in cash within 10 days from the dates of the invoices, and advantage taken of cash discounts obtained thereby. The merchandise purchases from December, 1916, to June, 1918, which were paid for in cash, are as follows:

    The balance sheets of the corporation as of December 31, 1916, and December 31, 191T, are as follows :

    The inventories 'of the corporation on hand at December 31, 1916, and December 31, 1917, consisted of polished plate glass and window glass, and the stock of such glass contained in the inventory was necessary in the operation of the business of the Hadley-Dean Glass Co. The accounts receivable as of the same dates represented amounts due the corporation for the work of installing glass in buildings.
   OPINION.

Steenhagen :

The respondent, after an examination of the books of the Hadley-Dean Glass Co., and as the basis for his determination of the deficiency in question, has included within the petitioner’s income certain amounts found to have been credited to him on the books of the corporation as his distributive share of the annual corporate earnings. The petitioner contests this because it attributes to him income which he alleges was never in fact received and was not in truth available for his use and enjoyment. Thus the issue offered by petitioner is primarily one of fact provable by evidence. It is well established, as urged by petitioner’s counsel, that in a close corporation such as this the formality of corporate action as between the corporation and its stockholders is not of primary importance. Corporate earnings may be distributed with the effect of dividends, although formal declaration by the usual resolution has not been made. The consideration in such cases is necessarily concerned largely with whether the evidence indicates a dividend or otherwise.

That there was in fact a consistent accounting by the corporation reflecting an annual distribution of its earnings to the stockholders, is plain. The petitioner, however, insists that such accounting does not truly reflect the fact.

The corporation credited to the stockholders not. only salaries, rent, and an amount ambiguously called interest, but also a distribution of the earnings, not exactly in accordance with stockholdings but upon a basis satisfactory to the stockholders themselves. From these personal accounts the stockholders actually drew whatever cash they desired. Sometimes, as shown by the stipulated tabulation, these cash withdrawals were less than the annual credits, and sometimes more. So far as appears, there was no consistent relation between the annual credits and the annual withdrawals. As to the minority stockholder, however, there was a consistent cash payment to him of his pro rata share of the earnings. It is said that this payment to him was not made as a distribution but rather as additional compensation for attendance at directors’ meetings, but we can not accept this as correct. Thus it appears that one stockholder actually received his distributable share of the earnings each year, and the remaining two stockholders, both of whom were actively in control of the business and its funds, caused their shares of the earnings to be credited to their personal accounts and withdrew them or not, at their pleasure.

A question of first importance is left entirely unanswered by the evidence, and that is whether the petitioner accounted for his income on the basis of actual receipts or on the basis of accruals. The stipulation ignores the question and Hadley as a witness did not know. Clearly on the accrual basis the credits were income. On the receipts basis, the evidence leaves it too uncertain to sustain the petitioner. Having it entirely within his power to withdraw the earnings, having caused the corporation to credit the amount, together with other substantial amounts, to his personal account, and having in fact withdrawn amounts indiscriminately from this personal credit, there is substantial warrant for the Commissioner’s determination, and in our opinion the petitioner has not proven his cause.

Judgment will be entered on W days' notice, wider Rule 50,


author: Teammell :

text:
    Farmers National Bank of Rome, N. Y., Executor under the Last Will and Testament of Nelson Adams, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8038.
    Promulgated April 25, 1927.
    The amount of damages for breach of contract awarded by judgment of a lower court is not deductible in determining net income when the judgment is appealed from until the decision of the appellate court. Until affirmed the liability is contingent.

      Neal Brewster, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1920, in the amount of $1,276.51, only the amount of $1,215.65 being in controversy.
    The deficiency arises from the action of the Commissioner in denying a deduction claimed in the income-tax return of Nelson Adams in the amount of $9,515.31, which was one-half of a judgment with interest against the partnership of Adams & Jewell, which judgment was entered in the lower court in 1920, and was affirmed on appeal in 1921.
    FINDINGS OF FACT.
    Nelson Adams and Frank J. Jewell, at all times during the calendar years 1920 and 1921, were copartners carrying on business under the firm name and style of Adams & Jewell. The petitioner, Nelson Adams, died on May 14, 1925. At the time of his death he was residing in Rome, N. Y. Under date of June 16, 1925, letters testamentary were issued by the Surrogate’s Court of Oneida County, N. Y., to the Farmers National Bank of Rome, New York, as executor under the last will and testament of the said Adams.
    One Frank L. Page, as plaintiff, brought action in the Supreme Court of Oneida County, New York, against Nelson Adams, Frank J. Jewell, and the Betson Plastic Fire Brick Co., Inc., as defendants, on September 24,1919. The plaintiff in that action claimed that the defendants had breached a contract theretofore entered into with the said plaintiff and damages were claimed by the plaintiff against the defendants in “the sum of $50,000 and such other damages as he may have sustained at the time of the trial of this action.” It was claimed by the plaintiff that the defendants had violated a contract which was entered into between the plaintiff and the defendants on March 24, 1916. The case was brought on to trial on February 4 and 5, 1920, and was tried before the court without a jury. The trial resulted in a decision and judgment in the plaintiff’s favor, declaring valid the contract and supplemental contract entered into by and between the plaintiff and defendants, decreeing that the defendants specifically perform their contract and awarding damages to the plaintiff in the sum of $18,000 with costs, including an extra allowance of $600. The judgment for money damages in the sum of $18,000 and costs and an extra allowance of $600 was entered against Nelson Adams and Frank J. Jewell only and not against the corporation which was formed by them. Judgment was accordingly entered in favor of Page against Adams and Jewell in the sum of $18,718.65 on September 20, 1920, and the judgment was duly docketed by the county clerk of Oneida County.
    Interest upon the judgment of $18,718.65 from the date of entry thereof to December 31, 1920, amounted to $312, making the total amount of the judgment and interest as of December 31, 1920, '$19,-030.65. One-half of this amount Adams deducted in his income-tax return for 1920 as a liability on that date.
    The Commissioner disallowed the deduction claimed in the return and increased the income as the result of such disallowance $9,515.32 to each of the partners.
    The judgment, in addition to money damages against Adams and Jewell for violation of the contract, enjoined Adams and Jewell and the Betson Plastic Fire Brick Co., Inc., from selling their product in certain territory. The money damages against Adams and Jewell were for the amount determined by the court to be due on account of past sales, the court stating as follows: “ That the profit of the plaintiff through his contract with, and by the purchase of their products from, the defendants, Nelson Adams and Frank J. Jewell, and the sale of those products by him for the year ending June 30, 1918, was the sum of $21,506.94, and for the year ending June 30,1919, the sum of $39,401.42; that for the six months succeeding June 30, 1919, the profit of the plaintiff from his business was only the sum of $4,395.19; that the plaintiff has sustained damages by the breach of their contract by the defendants, Nelson Adams and Frank J. Jewell, in the sum of $18,000.00.”
    On October 14, 1920, the defendants appealed from the judgment to the Appellate Division of the Supreme Court, Fourth Department, of the State of New York, and on May 4, 1921, the Appellate Division affirmed the judgment. Notice of further appeal from the decision of the Appellate Division was served and other steps were being taken to perfect this appeal when, in November, 1921, the co-partnership of Adams & Jewell paid to Frank L. Page the sum of $27,500 in full satisfaction of the judgment against Adams and Jewell and for cancellation of the contract outstanding between Page and Adams and Jewell, individually, and the Betson Plastic Fire Brick Co., Inc., and for a release of an injunction then outstanding.

      In its original return for the calendar year 1920 which was filed on March 10, 1921, the partnership of Adams & Jewell did not claim as a deduction the amount of the judgment entered in the lower court in that year with interest, and the books of the partnership did not show that the said amount was set up by the partnership as a liability in 1920. The partnership filed an amended return on December 21, 1921, for the calendar year 1920, claiming the amount of said judgment as a deductible loss in 1920.
    The partnership kept its books of account and filed its return for the years 1920 and 1921 upon the accrual basis.
   OPINION.

Teammell :

The question is whether the amount of the judgment with interest which was paid by the partnership of Adams & Jewell in 1921 is a deductible loss in that year or in 1920 when the judgment was entered in the lower court. The suit was instituted in 1919 for the alleged breach of contract. Judgment was entered in 1920 in the lower court and an appeal taken during the same year. In 1921 the judgment was affirmed on appeal. A further appeal was being perfected in 1921 when the amount in controversy was settled by compromise and payment.

The question- thus is whether the amount of the liability should be accrued as of the date of the breach of the contract, as of the date judgment was entered adjudicating the fact of the breach and awarding damages, at the time when the judgment was affirmed on appeal, or at the time the further appeal was withdrawn and the compromise made.

At the time of the alleged breach in 1919 when suit was instituted, there was no known liability, liability for breach of contract being denied. ' When judgment was entered in the lower court, the liability still was not definitely determined. It was contingent upon the affirmance of the judgment on appeal. While it was affirmed in the Appellate Division of the Supreme Court, that was not the final determination and final affirmation. The Appellate Division of the Supreme Court was not the court of final resort. The liability still remained contingent and was so until it had been finally affirmed on appeal or until liability was acknowledged. A different situation would have resulted if further appeal had not been taken. When further appeal was taken the question of the liability depended upon the action of the appellate court and it was not known until the disposition of the appeal whether there would be a liability or not.

We held, in the Appeal of Bump Confectionery Co., 4 B. T. A. 50, that “A liability to respond in damages for breach of contract occurring in 1920, which the taxpayer does not admit to the injured party and does not accrue on its books, is not a proper deduction for the taxable year in which the breach occurred.” There is the same fundamental principle involved here.

While it is true that the adjudication of the lower court was that there was a liability for the breach of contract, that adjudication was not final, was not considered by the partnership of which the petitioner was a member as being a final determination of the question, nor was it known that a liability would ever be finally determined and adjudicated against the partnership.

In the case of the Malleable Iron Range Co. v. United States, 82 Ct. Cls. 425, a similar question was presented. In that case it appears that in January, 1918, a judgment was entered against the taxpayer. In March, 1920, that judgment was, upon appeal, affirmed in principle as to liability but increased as to amount. The taxpayer in that case deducted in its return for 1918 the amount of the judgment and the interest thereon and in its return for 1919 deducted an additional amount to provide for a possible increase in the final judgment together with the interest which had accrued during 1919. In that case the court said:

It would seem plain from the foregoing that when there is a question of whether or not there is any liability, no amount can accrue until it is determined that a liability exists. When the amount in question is in litigation, it can not be determined until the litigation is ended. If any other rule were adopted, it would inevitably result in confusion and there would be no certainty at any given time as to when the liability should be allowed for. * * *
When the plaintiff appealed the case it denied in effect the liability, and certainly that liability did not accrue to it on the date of the judgment in the lower court. The plaintiff by its action in talcing the appeal distinctly denied the liability.
The liability which is being claimed by the plaintiff in this case is not a fixed liability. * * * For the liability was contingent upon the action of the higher court, and until that action was taken there was no fixed liability which could be deducted under the internal revenue act of 1918.

An actual liability incurred during a taxable year may be deducted, but the deduction is not allowable so long as the liability remains contingent. The judgment entered in this case in 1920 was not final so long as an appeal was pending or in process of preparation. During that time it was not known that there ever would be any liability to respond in damages for the amount claimed, or any other amount. See Appeal of H. Northwood & Co., 4 B. T. A. 697; Appeal of Lane Construction Corporation, 4 B. T. A. 1133.

For the foregoing reasons, it is our opinion that the petitioner is not entitled to the deduction claimed for 1920.

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


author: Trammell:

text:
    Frank J. Jewell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8041.
    Promulgated April 25, 1927.
    An action for breacli of contract was brought against petitioner and others in 1919. An adverse judgment was entered by the trial court on September 20, 1920. An appeal from this judgment was seasonably prosecuted, and on May 4, 1921, the judgment was affirmed by the appellate court. Steps were taken to perfect a further appeal, when, in November, 1921, the controversy between the parties was settled and the judgment paid. Petitioner deducted in his income-tax return for 1920, his share of the judgment as a liability in that year, his books being kept upon the accrual basis. Held, petitioner is not entitled to the deduction claimed for 1920.

      Neal Brewster, Esq., for the petitioner.

      1). I). Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for 1920 in the amount of $1,234.09. Only the amount of $1,215.16, however, is in controversy.
    It was stipulated that the facts in Farmers National BcmJc of Rome, Executor, v. Commissioner, 6 B. T. A. 1036, are identical with the facts in this proceeding.
    FINDINGS OF FACT.
    Nelson Adams and Frank J. Jewell, at all times during the calendar years 1920 and 1921, were copartners carrying on business under the firm name and style of Adams & Jewell. Nelson Adams died on May 14, 1925. At the time of his death he was residing in Rome, N. Y. Under date of June 16, 1925, letters testamentary were issued by the Surrogate’s Court of Oneida County, N. Y., to the Farmers National Bank of Rome, N. Y., as executor under the last will and testament of the said Adams.
    One Frank L. Page, as plaintiff, brought action in the Supreme Court of Oneida County, New York, against Nelson Adams, Frank J. Jewell, and the Betson Plastic Fire Brick Co., Inc., as defendants, on September 24, 1919. The plaintiff in that action claimed that the defendants had breached a contract theretofore entered into with the said plaintiff and damages were claimed by the plaintiff against the defendants in “ the sum of $50,000 and such other damages as he may have sustained at the time of the trial of this action.” It was claimed by the plaintiff that the defendants had violated a contract which was entered into between the plaintiff and the defendants on March 24, 1916. The case was brought on to trial on February 4 and 5, 1920, and was tried before the court without a jury. The trial resulted in a decision and judgment in the plaintiff’s favor, declaring valid the contract and supplemental contract entered into by and between the plaintiff and defendants, decreeing that the defendants specifically perform their contract, and awarding damages to the plaintiff in the sum of $18,000 with costs, including an extra allowance of $600. The judgment for money damages in the sum of $18,000 and costs and an extra allowance of $600 was entered against Nelson Adams and Frank J. Jewell only and not against the corporation which was formed by them. Judgment was accordingly entered in favor of Page against Adams and Jewell in the sum of . $18,718.65 on September 20, 1920, and the judgment was duly docketed by the county clerk of Oneida County.
    Interest upon the judgment of $18,718.65 from the date of entry thereof to December 31, 1920, amounted to $312, making the total amount of the judgment and interest as of December 30, 1920, $19,030.65. One half of this amount the petitioner deducted in his income-tax return for 1920 as a liability on that date.
    The Commissioner disallowed the deduction claimed in the return and increased the income as the result of such disallowance $9,515.32 to each of the partners.
    The judgment, in addition to money damages against Adams and Jewell for violation of the contract, enjoined Adams and Jewell and the Betson Plastic Fire Brick Co., Inc., from selling their product in certain territory. The money damages against Adams and Jewell were for the amount determined by the court to be due on account of past sales, the court stating as follows: “ That the profit of the plaintiff through his contract with, and by the purchase of their products from, the defendants, Nelson Adams and Frank J. Jewell, and the sale of those products by him for the year ending June 30, 1918, was the sum of $21,506.94, and for the year ending June 30, 1919, the sum of $39,401.42; that for the six months succeeding June 30, 1919, the profit of the plaintiff from his business was only the sum of $4,395.19; that the plaintiff has sustained damages by the breach of their contract by the defendants, Nelson Adams and Frank J. Jewell, in the sum of $18,000.00.”
    On October 14, 1920, the defendants appealed from the judgment to the Appellate Division of the Supreme Court, Fourth Department, of the State of New York, and on May 4, 1921, the Appellate Division affirmed the judgment. Notice of further appeal from the decision of the Appellate Division was served and other steps were being taken to perfect this appeal when, in November, 1921, the copartnership of Adams & Jewell paid to Frank L. Page the sum of $27,500 in full satisfaction of the judgment against Adams and Jewell and for cancellation of the contract outstanding between Page and Adams and Jewell, individually, and the Betson Plastic Fire Brick Co., Inc., and for a release of an injunction then outstanding.
    In its original return for the calendar year 1920 which was filed on March 10, 1921, the partnership of Adams and Jewell did not claim as a deduction the amount of the judgment entered in the lower court in that year with interest, and the boobs of the partnership did not show that the said amount was set up by the partnership as a liability in 1920. The partnership filed an amended return on December 21, 1921, for the calendar year 1920, claiming the amount of said judgment as a deductible loss in 1920.
    The partnership kept its books of account and filed its returns for the years 1920 and 1921 upon the accrual basis.
   OPINION.

Trammell:

This case is governed by Farmers National Bank of Rome v. Commissioner, 6 B. T. A. 1036.

The deduction claimed for 1920 is accordingly disallowed.

Judgment will Toe entered on 15 days’ notice, wider Rule 50.


author: Stebniiagen :

text:
    Harry P. True, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lona True Hodgdon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5326, 5327.
    Promulgated April 26, 1927.
    An inventory on basis of the lower of cost or market is not sufficiently proved by evidence that, in the judgment of certain witnesses in the business based on their experience the valuation represents market value.

      Robert C. Cooley, Esq., for the petitioners.

      F. O. Graves, Esq., for the respondent.

      Morris L. Ernst, Esq., and John J. Wildberg, Esq., as amici curiae.

    Deficiencies of $340.92, $1,353.21, and $3,162.23 in the case of Harry 'P. True, and $285.87, $645.15, and $2,703.16 in the case of Lona True Hodgdon, for the years 1919, 1920, and 1921, respectively, in both cases. The Commissioner restored the cost basis of inventories of a partnership of which petitioners are members.
    FINDINGS OF FACT.
    The petitioners during each of the taxable years involved were partners in the firm trading as True Brothers, conducting a retail jewelry business in Springfield, Mass. In the years 1919 and 1920 each owned a 50 per cent interest in the partnership. In 1921 each owned a 45 per cent interest, and one Granville Stevens was also a partner, owning a 10 per cent interest.
    The partnership had about sixteen departments in its business. In taking the inventory each individual item was set down at its actual cost. The partners then determined from their experience in the business, from comparison with similar articles purchased, and from the sales demand, what they considered represented the market value of the articles. The amount so determined was recorded as the inventory value.
    The years 1918, 1919, and 1920 were years of rapidly fluctuating costs.
    The inventories so determined as of January 31, for each of the following years, and the inventory on the cost basis used by respondent in determining the deficiencies involved are:

    The partnership was formed in 1898, and the inventories were taken in the same way each year from that time through the years involved in this proceeding.
   OPINION.

Stebniiagen :

The petitioners, being members of a partnership in the retail jewelry business, included in their returns for each of the years in question an inventory purporting to be taken upon the basis of “ cost or market whichever is lower.” As will be seen from the findings of fact, the alleged value of the inventory was in each year lower than cost by the amounts of $10,000, $13,000, $25,000 (less 11 cents), and $41,236.45. The Commissioner, acting under section 203 of the Revenue Act of 1918 and the Revenue Act of 1921, determined that the alleged market values were not correct, and that the inventories as shown by the return did not most clearly reflect the income, and therefore he determined the inventory by the use of the actual cost figures as agreed by both parties.

Petitioners have undertaken to prove that the figures used by them correctly represent market value. To do this they introduced the testimony of three witnesses. Two of these witnesses were members of the partnership, and the third was a retail jeweler in Washington, D. C. The substance of the testimony of the two partners was that their valuation represented what in their judgment was market value; and the Washington jewelry dealer said that this was the method used generally in this business. How nearly their judgment approximated the fact of value or whether their judgment has been well founded, does not appear. Thus, the Board, instead of being able to use its own judgment upon evidence to determine whether the figures truly represent market value, is asked to place its stamp of approval upon the judgment of the petitioners themselves. How utterly vacuous such a proceeding would be must be apparent. It is equivalent to having the petitioner merely assert that his method is correct and having this serve as proof. Surely the judgment of the Board is expected to be more substantial than this.

Lest there be any doubt that we have adequately summarized the evidence, the following is.quoted from petitioners’ brief:

That the inventories in question had been taken for said years by Messrs. Stevens and True in the following manner: The various articles were divided into some 16 departments, each article or each group of the same articles was personally examined by Messrs. True and Stevens and in every instance the cost of each article was before them and the value of each article as set out in the inventory was calculated by taking the cost or the present market value whichever was lower, determined from the experience of Messrs. True and Stevens in the jewelry business and the factors known to them entering into its salable character at the time of the inventory. Such readily realizable value was referred to by them in their testimony as “ market value.”

In behalf of the American National Ketail Jewelers Association a brief has been filed by amici cv/rice urging that the Board refrain from any general approval of the cost method of taking inventories in the retail jewelry business. It need only be said that the evidence of true market value is in the present case so inadequate that it is unnecessary to consider whether in any case market value is susceptible of proof. Conceivably, market value can be established in this business as in many others; and if in a given case the evidence supports the value claimed, the question will arise as to whether such value may properly be used instead of cost. The door is still open for him who shows his right to enter. But such right is not proven by its mere assertion. In the present case we are asked to accept the judgment of the petitioners as our own, with nothing to show that such judgment is well founded, and under these circumstances the determination of the respondent must be sustained.

Judgment will be entered on %0 days’ notice, v/nder Rule 50.