author: Aeundell: Leech,

text:
    F. Harold Johnston, Executor of the Estate of F. M. Johnston, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79029.
    Promulgated November 26, 1935.

      William P. Smith, Esq., for the petitioner.

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

Aeundell:

Section 44 (d) of the Revenue Act of 1928. provided for the recognition of gain or loss on the transmission of installment obligations upon the death of the holder, and that enactment has been consistently held valid. Alexander M. Crane et al., Executors, 30 B. T. A. 29; affd., 76 Fed. (2d) 99; Provident Trust Co. of Philadelphia, Executor, 29 B. T. A. 374; affd., 76 Fed. (2d) 810; Nuckolls v. United States, 76 Fed. (2d) 357. The same provisions were enacted in section 44 (d) of the Revenue Act of 1932, with an added sentence providing in substance that there need be no recognition of gain or .loss to the .decedent if a bond is filed to assure the return as income by the recipients of the installment obligations of the same amount as the decedent would have returned upon liquidation of the obligations. This provision was added to the Revenue Bill of 1932 by the Senate Committee on' Finance for the express purpose of alleviating hardships resulting to the estates of decedents under section 44 (d) of the Revenue Act of 1928. The report of the Finance Committee is set out in the margin. Being a relief provision, the construction should be liberal in favor of the taxpayer. Bonwit Teller & Co. v. United States, 283 U. S. 258. This enactment is but part of a, series of regulations and statutes designed to give relief to taxpayers who operate on the installment basis. Burnet v. S. & L. Building Corporation, 288 U. S. 406. And it has been held that following the enactment of the Revenue Act of 1926, which first gave statutory sanction to the installment basis of reporting income, it was an abuse of discretion on the part of the Commissioner to refuse to receive an amended return whereby the taxpayer sought to change from the installment basis to the deferred payment basis of reporting income, even though there was no statutory authority for amended returns. Morrow, Becker & Ewing, Inc. v. Commissioner, 57 Fed. (2d) 1. In that case the taxpayer’s original return showed a substantial net income, whereas the amended return showed a net loss. The court said:

In view of the radical changes in the law, of which the petitioner had scant notice, if any, in fairness and justice to the taxpayer the returns should have been received and considered. Taxes are assessed on income and not on honest mistakes of the taxpayer. It was the duty of the Commissioner to do nothing arbitrary or unreasonable that would deprive petitioner of rights created by the new law and the regulations thereunder. It was a breach of discretion on the part of the Commissioner not to receive the amended return from [.sic] 1925 under the circumstances disclosed.

The petitioner in this case is in a more favorable position than was the taxpayer in the Morrow, Becker & Ewing case. This petitioner is not seeking any diminution in the amount of income reported or taxes paid. True, by failing to comply literally with the statute and regulations the petitioner did not report all the income of his decedent, but he did thereafter attempt to comply by offering to file a bond, and prior to the hearing of these proceedings all the income was reported by the recipients of the installment obligations. The effect of sustaining respondent’s position would be to assert a deficiency against this petitioner and then require refunds to those who have heretofore paid the tax. Such complicated procedure may be justified where there is clear statutory warrant for it, but it is not present here.

If a rule of strict and literal compliance with the respondent’s regulations is to be applied, it should go all the way. The regulations, article 355 of Regulations 77, provide for the filing of a bond on form 1132 at the time of filing the final return of a decedent where the unrealized gain on installment obligations is to be reported by beneficiaries or distributees. Form 1132 did not become available until after the time for filing the decedent’s return, and so literal compliance was impossible. Respondent argues that petitioner could have applied for the privilege of filing a bond or for an extension of time. But article 355 does not provide for the filing of an application for the privilege of filing a bond and any such application would not have been a strict compliance with the regulations. We do not understand that there is any duty on the part of a taxpayer to delay filing a return or to ask for an extension of time to file because the respondent’s office is late in furnishing a form which is not a necessary part of the return. As matters stood at the time the return was filed on March 15, 1938, exact compliance with the regulations was impossible. The law does not require the impossible.

Summarizing, the petitioner could not comply with the regulations when filing the return; thereafter he did endeavor to comply, but his offer was refused by the Commissioner; all the income at the bottom of these proceedings has been reported; and nothing is to be gained by the procedure now proposed by the respondent. We hold that the respondent’s refusal to accept the offer of a bond was arbitrary and that the determination of the deficiency was unwarranted.

Reviewed by the Board.

Decision will 1)6 entered under Rule 50.

Leech,

dissenting: The decision of a hard case, upon apparent equitable grounds, frequently results in bad law. In my judgment, this is such a case, and the result reached in the majority opinion is wrong.

This Board has no equity powers. Northport Shores, Inc., 31 B. T. A. 1013.

Our concern here is the legal income tax liability, for 1932, of the present petitioner — nothing else.

The controlling statute, itself, here, not any regulation, makes the filing of a bond the condition precedent to the relief petitioner seeks. The enjoyment of that relief depends wholly upon compliance with that statutory condition precedent. Rock Island, A. & L. R. R. Co. v. United States, 254 U. S. 141.

As construed by the authorized regulation, obviously actual compliance was absent and literally impossible. But, it is said the present record discloses substantial compliance with the statute as construed by the pertinent regulation.

That regulation was clearly reasonable. It is not attacked in the majority opinion. It was promulgated by express statutory authority. So, I think, the rule adopted by the Board in reference to a somewhat comparable situation, in Alfred E. Hamill, 30 B. T. A. 955, and cited with approval many times since, is applicable here. This Board there said:

* * * Fortified with such a clear sanction in the statutory grant of power, the administrative determination in such a case must survive all but the strongest attack. Short of being arbitrary or capricious or based on a clear demonstration of error, the determination in any single instance ought not to be disturbed. This is not a matter of jurisdiction; for the Board clearly has the power of review’, Blair v. Oesterlein Machine Co., 275 U. S. 220, but is rather an attitude of the Board in the exercise of its jurisdiction not to interfere lightly with general administrative matters which the Congress has entrusted to the Commissioner’s discretion.

The inquiry here is not whether, if we were exercising our discretion on the acceptance or rejection of the proffered bond, we would have accepted it under the circumstances. We do not have that discretionary function. Nor is our inquiry whether the Commissioner’s acceptance of the tendered bond would have exceeded his discretion. Our function is much more narrow. That function is to decide only whether the discretion, clearly existing in the Commissioner, was here exercised by him in an arbitrary and capricious manner.

The record discloses the following relevant facts:

1. February 2, 1925 — Installment sale made.
2. February 5, 1982 — Decedent died.
3. June 6, 1932 — Revenue Act of 1932 approved (retroactive to January 1, 1932, as to the pertinent provision).
4. February 9, 1933 — Regulations 77 promulgated;
5. February 27, 1933 — Regulations 77 released to public.
6. March 15, 1933 — Return filed for decedent.
7. April 26, 1933 — Form of bond first became available.
8. About March 15, 1934 — Legatees reported income on first note.
9. May 1, 1934 — Executor first learned of provisions for bond requirement and applied for Form 1132, the prescribed bond.
10. June 4, 1934 — Executor’s application to file that bond denied.
11. March 13, 1935 — Deficiency letter mailed.
12. About March 15, 1935 — Legatees reported income on last two notes.

The majority opinion holds these facts constituted a compliance with the statute and regulation, so substantial, that the Commissioner was guilty of an abuse of his discretion in refusing to accept the bond here involved, which was tendered almost two years after the statute permitting its filing became law, and over one year after the regulations authorized by that law were promulgated and the form of the bond there prescribed became available to the public. And this conclusion is reached, though the taxpayer did nothing even in an attempted compliance with the statute or regulation until that late date, only because, until a few days before the bond was actually tendered, he did not know, of the law. See Export Leaf Tobacco Co. v. Commissioner, 78 Fed. (2d) 163, affirming 31 B. T. A. 28; certiorari denied, 296 U. S. 627; Radiant Class Co. v. Burnet, 54 Fed. (2d) 718, affirming 16 B. T. A. 610; Flambeau Public Service Co., 27 B. T. A. 299.

Under such circumstances, and in view of the cited rule the Board adopted in the Hamill case, and has since consistently followed, this record does not convince me that the refusal of the Commissioner to accept the petitioner’s bond was arbitrary.

Black, Smith, and Mellott agree with this dissent.

      This subsection shall not apply to the transmission at death of installment obligations if there is filed with the Commissioner, at such time as he may by regulation prescribe, a bond in such amount and with' such sureties as he may deem necessary, conditioned upon the return as income, by the person receiving any payment on such obligations, of the same proportion of such payment as would be returnable as income by the decedent if he had lived and had received such payment.

       Your committee has added to section 44 (d) a provision that the subsection shall not apply to the transmission at death of installment obligations if a bond is filed in the proper amount conditioned upon the return as income by any person receiving any payment on account of such obligations of the same proportion of such payment as would have been returnable by the decedent had he lived and received the same. It has come to the attention of your committee that considerable hardship sometimes occurs in the application of eixsting law to cases of decedents who die possessed of substantial amounts of installment obligations. In such cases the entire amount of the profit represented by the obligations must be reported as income in the return of the decedent for the year of his death. Your committee believes that if, for example, the estate of the decedent or his next of kin or legatees file a bond to return as income the proper proportion of the payments received by them on account of the installment obligations received from the decedent, the revenue will be properly protected. This section is accordingly amended to provide for such procedure. Rept. 665, 72d Cong., 1st sess., p. 21.


source: Caselaw Access Project

author: Murdock :

license: Public Domain

text:
    Frances Bartow Farr, Executrix, and Henry Bartow Farr, Executor of the Estate of John Farr, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76712.
    Promulgated November 26, 1935.

      N. N. Maper, Esq., for the petitioners.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $715.77 in the income tax of John Farr, deceased, for the year 1932. This proceeding was instituted by the executor. His assignments of error attack the action of the Commissioner in taxing the entire amount of gain from the disposition of 1,280 shares of Central Aguirre Associates stock as ordinary income subject to normal tax and surtax, instead of taxing all, or a part, of the gain as capital gain. The facts have been stipulated.

The decedent, on January 1, 1931, was the owner of 9,500 shares of stock of Central Aguirre Associates. He had- held those shares at that time for more than two years. He “ sold short ” 1,280 shares of Central Aguirre Associates at various times during the year 1931 for a total consideration or price of $25,613.80. He “ covered the short sales ” on March 22, 1932, by delivering 1,280 of the shares which he had held for more than two years on January 1, 1931. The shares used to cover had cost him $8,320. The Commissioner, in determining the deficiency for 1932, computed a profit of $13,-980.59 from the sale of the Central Aguirre Associates stock and taxed it as ordinary income subject to normal tax and surtax.

The parties agree that the gain is taxable in 1932. Cf. Charles H. Oshei, 31 B. T. A. 23. The treatment for tax purposes of stipulated amounts paid by the decedent in 1931 and 1932 representing dividends on the stock “ sold short ” does not seem to be in controversy. The cost of the stock delivered to cover and the price at which the stock was sold are not in dispute. The case presents only the legal question of how the gain is to be taxed, i. e., whether all of the gain is to be taxed as ordinary income or whether all or some part of it is to be taxed as capital gain.

Section. 101 of the Revenue Act of 1982 provides a special method of taxing capital net gains. It defines “ capital gain ” and “ capital loss ” as the gain or loss from “ the sale or exchange of capital assets.” “ ‘ Capital assets ’ means property held by the taxpayer for more than two years.” The gain in question would clearly be a capital gain under those provisions, if they stood alone, since the shares which the decedent disposed of had been held for more than two years even before he made the “ short sales.” The question arises because of the provisions of section 23 (s). Those provisions, as well as the provisions of section 23 (r) which may have some bearing upon the question, are as follows:

SEC. 23. DEDUCTIONS PROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
****** *
(r) Limitation on Stock Losses. — (1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not capital assets (as defined in section 101) shall be allowed only to the extent of the gains from such sales or exchanges (including gains which may be derived' by a taxpayer from the retirement of his own obligations).
****** *
(s) Same — Short Sales. — For the purposes of this title, gains or losses (A) from short sales of stocks and bonds, or (B) attributable to privileges or options to buy or sell such stocks and bonds, or (0) from sales or exchanges of such privileges or options, shall be considered as gains or losses from sales or exchanges of stocks or bonds which are not capital assets.

The Commissioner stated in the notice of deficiency that “the Bureau is adhering to the principle laid down in Income Tax Ruling 2683, wherein it is held that the gain or loss from short sales ‘is to be treated as resulting from sales of securities which were not capital assets, in accordance with section 23 (s) of the Revenue Act of 1932, regardless of the fact that the securities which were later delivered may have been held more than two years Counsel for the Commissioner stated at the hearing that the Bureau was considering whether or not it would reverse its ruling as set forth in I. T. 2683, C. B. XII-1, p. 43. He was to file a brief but failed to do so. The Commissioner has made no argument in support of his determination. The petitioner’s brief and a brief amicus cwñae have been filed opposing the view adopted by the Commissioner.

The question is whether the petitioner realized any gain from a short sale of stock within the meaning of the phrase “ short sales ” as used in section 23 (s). The first step is to determine what is meant by “ short sales.” Congress did not define the term and, therefore, must have intended it to have its usual and generally understood meaning. Avery v. Commissioner, 292 U. S. 210; De Ganay v. Lederer, 250 U. S. 376; Old Colony Railroad Co. v. Comm issioner, 284 U. S. 552; Woolford Realty Co. v. Rose, 286 U. S. 319. Short sales have been employed by business men for several centuries at least. Section 23 (s) applies only to short sales of stocks and bonds. Although the provision is not limited in its application to sales made through the New Yqrk Stock Exchange, nevertheless^ the practice there is of importance in deciding what is the generally understood meaning of “ short sales.” A “ short sale ”, as used on the New York Stock Exchange, is a device which has certain well established characteristics and incidents. These have been the subject of discussion by courts and financial authorities. A short sale made on the exchange is necessarily a margin transaction. The broker must agree to make the transaction as a short sale. Zimmerman v. Weber, 135 App. Div. 428; 120 N. Y. S. 483. When a broker has agreed to make a short sale for his customer, he next makes a sale in the regular way on the exchange. Certificates for the shares sold must be delivered to the purchaser on the following day under the rules of the exchange. The broker, by agreeing to handle the transaction as a short sale, has obligated himself to provide the certificates for delivery. His customer is not to provide them as he would in a regular sale. Unless .the broker has available certificates of his own, he must “ borrow ” certificates for delivery. In any event, certificates are actually delivered to the purchaser and the transaction, from his standpoint, is just like any other purchase. If the seller’s broker “ borrows ” the stock, he must keep on deposit with the “ lender ” the current market price of the stock “ borrowed.” The broker who makes the short sale for his customer receives the purchase price from the purchaser. He, therefore, has this money available with which to make the deposit with the “ lender.” He will also require his customer to keep on deposit with him a sufficient margin to protect him against market fluctuations in the stock. The “ borrowed ” stock must be returned eventually. The transaction which originated in the short sale may be closed by the return of stock purchased just for that purpose. This is called a “ covering purchase.” The transaction may also be closed by the short seller delivering, in return for those “ borrowed ”, certificates which he had purchased at an earlier date. When certificates are returned to the “lender” he releases the deposit made by the broker for the seller. Eegardless of the method of accounting used by the seller’s broker, whatever balance there is in the account is completely available to the short seller for the first time when the transaction is closed by the delivery of shares which are to be returned to the lender. For further discussion of the characteristics and incidents of a short sale see Provost v. United States, 269 U. S. 443; Boyle v. Henning, 121 Fed. 376, 380; Hess v. Raw, 95 N. Y. 359; Knowlton v. Fitch, 52 N. Y. 288; Appleman v. Fisher, 34 Md. 540; Lamprecht v. State, 84 Ohio, 32; 95 N. E. 656; Brown v. Carpenter, 168 N. Y. S. 921; Stock Brokers and Stock Exchanges, Dos Passos, 2d Ed. 1905, vol. 1, pp. 200, 323 to 326; Options and Futures (1921), McMath, p. xxxxi.

A short sale is defined by J. Edward Meeker, economist to the New York Stock Exchange, in his work on “ Short Selling ”, published in 1932, as a sale which creates a debt in terms of goods. He classifies in three groups the principal purposes for which the device is generally used in connection with securities. He places in one class the short sales made to obtain speculative profits. Persons who employ the device for this purpose make a short sale in the expectation that later they will be able to close the transaction by a covering purchase at a lesser price. Such persons in exchange parlance are called “bears.” The short sale device is employed as a temporary facility in another class of cases. An investor, owning securities and desiring to make an outright sale of some of the securities which he owns, may not have his certificates available for delivery in accordance with the rules of the exchange. For example, the certificates may be held at some point distant from New York, the owner may be away from home, or, due to mergers, consolidations, stock dividends, changes in par value, and the like, the certificates' may not be available for prompt delivery. Therefore, the short sale device is employed in order to effect a sale at market and yet permit a later delivery of certificates by the seller. In the third class are short sales made for the purpose of “ hedging.” These are called also “ sales against the box.” They occur when an owner of stock resorts to a short sale in order to avoid the risk of future price fluctuations. He owns sufficient securities to make delivery, but chooses to make a short sale involving the borrowing of shares for delivery, rather than to sell and make delivery of the shares which he owns. The owner of a large block of stock, which gives him a measure of control over the affairs of the corporation, may desire to take advantage of the current market price and yet retain his control in the corporation. He can accomplish his purpose by making a short sale. Later, if the stock declines, he can make a covering purchase and realize a profit, or, if the stock advances, he can make delivery of his own stock and lose control, or make a covering purchase and sustain a loss. Hedging is also resorted to by the odd lot dealers ” on the floor of the exchange in order to avoid the risk of owning a large block of stock. It is also adopted by professional speculators who seek to profit by buying in the cheaper and selling in the dearer market, where the same security is listed on two different exchanges. As authorities for the statements in this paragraph see Short Selling (1932), Meeker; The Work of the Stock Exchange (1922), Meeker; Short Selling (1933), Owen Taylor; Short Selling, For and Against (1932), Whitney and Perkins.

Thus, a short sale may be made, not only by one who does not own any securities of the kind which he sells, but also by one who actually owns securities of the kind he sells. Short sales must frequently be made by brokers who are not informed whether or not their principal is the owner of shares which he could sell and deliver if he so desired. One of the chief differences between a regular sale and a “ short sale ” is that, in the former, the seller delivers his own shares to the purchaser and thus closes the transaction, while in the latter, he delivers “ borrowed ” shares and the transaction is not closed so far as the seller is concerned until he delivers shares to repay the “ loan.” If the shares sold are not furnished by the seller at the time of the sale but are supplied by the broker, the transaction is a short sale and sets in motion the short sale process. The fact that a transaction is a short sale must appear prior to the time when the broker must make delivery in accordance with the rules of the exchange. A transaction, which at that time, or earlier, is made as a short sale, forever remains a short sale, regardless of the manner in which it is closed, that is, regardless of whether it is closed by a covering purchase or by the delivery of shares which the seller has owned for some time.

The Supreme Court in the Provost case, supra, said:

As the phrase indicates, a short sale is a contract for the sale of shares which the seller does not own or the certificates for which are not within his control so as to be available for delivery at the time when, under the rules of the Exchange, delivery must he made.

A short sale has been similarly described by other courts and financial writers. See authorities above cited. The argument is advanced that the sale made by Farr was not a short sale within the above definition. The Court in the Provost case might not have had in mind a situation where the seller was long on the stock and may not have intended the definition as an all-inclusive one. However, the sale which Farr made was a short sale even under that definition. He did not sell in 1931 any shares which he owned at that time, but retained all of the shares which he then owned until March 22,1932. The shares which he sold in 1931, pursuant to his contracts of sale, were shares which he borrowed from or through his broker. The stipulation of facts makes this clear. Furthermore, if the shares sold and delivered in 1931 could be identified by the certificates which were delivered, such identification would disclose that they were not shares owned by Farr. Thus he made a short sale, since he sold shares which he did not own. Some cases contain dicta to the contrary which apparently arose from a partial misunderstanding of a short sale. We therefore conclude, after a rather exhaustive search of the authorities, that the sale which Farr made was a short sale within the usual and generally understood meaning of that term.

The gain or loss from a short sale is ascertained by matching the short sale price against the cost or other basis of the stock used to close the transaction. Robert W. Bingham, 27 B. T. A. 186. Here the decedent realized but one profit which the Commissioner seeks to tax. That profit is the difference between the cost of the 1,280 shares delivered in 1932 and the short sale price, with perhaps adjustments for the dividends. The profit was realized in 1932. Robert W. Bingham, supra; Charles H. Oshei, supra. The petitioner originally contended that there were two taxable transactions; the gain from the short sale was the difference between the short sale price and the market value of the stock at the date the short sale was covered; the gain from the disposition of the long stock was the difference between the cost of that stock and the market value of the stock on the date the long stock was used to: cover the short sale; and the first gain was taxable as ordinary income, while the latter gain was taxable as capital gain. The market value of the shares on March 22, 1932, has been stipulated. But the decedent did not buy or sell any shares at that price and, consequently, no such fictitious purchase and sale should be used to compute taxable gains in this case, since no impelling reason exists for adopting that unusual procedure. The petitioner in his brief made that contention as an alternative only and now contends that all of the gain was capital gain from the disposition of his shares held for more than two years.

There remains for consideration the question of whether Congress intended section 23 (s) to apply in all cases where gain or loss was realized from a short sale of stock or bonds or whether it intended the provision merely as a supplement to subsection (r). Counsel call attention to the caption of section 23, to the caption of subsection (s), and to the following language appearing in both Committee Beports :

Subsection (s) requires that gains or losses from short sales of stocks and bonds, or from privileges or options to buy such securities, shall be treated as gains or losses from the sale or exchange of stocks and bonds held for less than two years. Your committee is of the opinion that there should be no distinction between such transactions and other sales or exchanges of stocks and bonds. Accordingly, the limitation on stock losses is extended to this type of transactions.

See H. Rept. No. 708, p. 13, and S. Rept. No. 665, p. 19, 72nd Cong., 1st sess. They argue from the foregoing that Congress merely intended to make sure that short sales would be treated as sales, rather than as any other kind of transactions, for the purpose of limiting losses. This argument is not without force. The caption of subsection (s), if it had been printed in full, would have been as follows: “Limitation on stock losses — short sales.” The words of the caption “ Limitation on stock losses ” are obviously not well chosen, since the subsection deals with losses on both stocks and bonds. Yet this caption and the statement in the Committee Eeports certainly tend to indicate that Congress intended subsection (s) as a mere supplement to subsection (r) so that the limitation provided in (r) would also extend to losses from short sales. Furthermore, there is no very apparent reason for a provision that all gains and losses from short sales of stocks and bonds shall be eliminated from the capital gain provisions. Yet, in this respect, it is like subsection (r), which limits deductions for losses on stocks and bonds held for less than two years but does not limit deductions for losses on other kinds of assets.

Congress has said in subsection (s),“ For the purposes of this title ” gains or losses from short sales of stock shall be considered as gains or losses from the sales or exchanges of stocks which are not capital assets. The words quoted are not ambiguous and should be given the effect which their use so clearly implies. They must mean for all purposes of “ Title I — Income Tax.” They stand in sharp contrast to words used elsewhere in section 23, where Congress intended a greater restriction upon the application of other subsections. For example, in subsection (c) Congress said: For the purpose of this subsection.” If subsection (s) were to be interpreted in the way the petitioner contends, the words “For the purposes of this title”, which Congress actually used, would have to be read, “ For the purposes of determining the limitations provided in subsection (r) of this section.” Subsection (s) can not be limited in its application as the petitioner contends without doing violence to the text of the provision.

It is argued with some force that this produces a strange result. Perhaps it does. But results no less strange would result from the petitioner’s interpretation. As he would interpret the provision, where a taxpayer had gains from short sales which were closed by the delivery of stock held for more than two years at the time of the sale, the gains would be subject to tax under section 101, whereas, if a taxpayer had gains of that kind and also losses from short sales of any kind, the gains, to the extent of the losses, would be taxed as ordinary income and the remaining gains would be taxed either as ordinary income or as capital gain. Thus the question is not solved by considering the results of the different interpretations.

A choice between the plain words of the text of the provision, on the one hand, and the caption and legislative history of the provision, on the other, must be made. Where words in the caption and body of a statutory provision differ in meaning, the latter will prevail. Sugarland Industries v. Bass, 36 Fed. (2d) 375; Ware v. Hylton, 3 Dallas, 199. The heading of a section may be considered as an aid to the interpretation of the text, when the text is ambiguous, but may not be used to limit or set at naught the plain meaning of the text. Knowlton v. Moore, 178 U. S. 41; Patterson v. Bark Eudora, 190 U. S. 169; Strathearn S. S. Co. v. Dillon, 252 U. S. 348; Allen v. United States, 47 Fed. (2d) 735. If the language were ambiguous the rule, that doubts are to be resolved in favor, of the taxpayer, could not be applied since it can not be determined which interpretation would be most favorable to taxpayers generally. Burnet v. Guggenheim, 288 U. S. 280. The language of the text seems to be the safest guide in interpreting subsection (s). The provision, therefore, applies for all purposes of Title I. Gains or losses from short sales of stocks or bonds must be considered for all income tax purposes as gains or losses from sales or exchanges of stocks or bonds which are not capital assets. The gain in the present case was a gain from a short sale of stock and, therefore, is taxable as ordinary income and not as capital gain.

Reviewed by the Board.

Decision will he entered for the respondent.

      It is, however, possible to cover a short sale before the time for delivery.

       The Supreme Court, in Provost v. United States, 269 U. S. 443, has held ‘'that both the loan of stock and the return of borrowed stock involve * transfers of legal title to shares of stock ’ within the express terms of ” the War Revenue Act of 1917 imposing a tax upon such transfers.


author: Trammell :

text:
    Forest Glen Creamery Company, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51833, 64637-64639, 64653-64655.
    Promulgated November 26, 1935.

      George J. Dreiske, Esq., for the petitioner.

      Harold D. Thoonas, Esq., for the respondent.

       Proceedings of tlie following petitioners are consolidated herewith: Claus Jtmge; Thomas J. Riley; I. T. Czajke; IS. W. Iwieki; George L. Meyer; and Peter J. Wilson.

   OPINION.

Trammell :

These are consolidated proceedings for the redetermi-nation of a deficiency in income tax, in the case of the petitioner, Forest Glen Creamery Co., in the amount of $22,312.40, stated in the respondent’s deficiency notice to be “ for the taxable year 1926 and the period ended June 30,1927 ”, and for the redetermination of the liability of the other petitioners as transferees of the corporation’s assets, under the provisions of section 280 of the Revenue Act of 1926. The issues presented are (1) whether the notice of deficiency in the case of the petitioner corporation was a proper notice of deficiency for the calendar year 1927, and whether the notices in the cases of the individual petitioners were proper notices of transferee liability; (2) whether the corporation sold its assets and business in 1927 and realized a taxable profit therefrom, or whether the transaction constituted a sale by the stockholders of their stock; (3) whether the individual petitioners are liable as transferees of the corporation for a deficiency in tax for the calendar year 1927, under the provisions of section 280 of the Kevenue Act of 1926; and (4) whether the taxes in controversy are barred by limitations.

In the view we take of this case, it is necessary to discuss only issue (1) above stated. The facts as stipulated by the parties, show that on March 10, 1928, the corporation filed its income tax return “ for the calendar year 1927.” Under date of November 10, 1930, the respondent sent a letter to the corporation reading in part as follows:

In accordance with the provisions of section 279 (a) of the Revenue Act of 1926, there has been assessed against you an income tax amounting to $22,312.40, for the taxable year 1926 and the period ended June 30, 1927, the details of which are set forth in the statement attached.

Schedule 4 on page 2 of the statement referred to shows “net income as disclosed by return”, and sets forth six adjustments thereto made by respondent in computing the asserted deficiency.

On January 8, 1931, the corporation filed its petition with the Board “ for redetermination of the deficiency set forth by the Commissioner of Internal Revenue in his Notice of Deficiency dated November 10, 1930.”

On February 17, 1932, respondent sent a notice to each of the individual petitioners herein in which it was stated that the determination of the tax liability of the corporation “ for the taxable period ended June 30, 1927, disclosed a deficiency of $22,312.40 ”, which deficiency it was proposed to assess against each of the individual petitioners under the provisions of section 280 of the Revenue Act of 1926.

In the original petition filed by the corporation it was alleged that “ the taxes in controversy are income taxes for the year 1927 and are in the following amount, $22,312.40 ”, which averments were specifically admitted in respondent’s original answer. By an amendment to his answer filed on February 23, 1935, respondent admitted that the taxes in controversy are income taxes for the year 1927 and alleged “ that said year is the calendar year 1927.” The petitioner thereupon filed a reply to respondent’s amendment asserting that the taxes in controversy are those specified in the notice of deficiency, viz., “ for the taxable year 1926 and the period ended June 30,1927 ”, and denied that the taxes in controversy are “ for the calendar year 1927.” It was further pleaded in the reply that any claim by Bespondent for any alleged deficiency for any other part or period of the year 1927 than that specified in the said notice of deficiency aforesaid is wholly barred by the Statute of Limitations.”

The question presented here under issue (1) is essentially jurisdictional. The petitioner contends that the Board is without j urisdiction to redetermine the tax liability of the corporation other than “ for the taxable year 1926 and the period ended June 30, 1927 ”, in accordance with the notice of deficiency.

Bespondent says that he was without authority to determine a deficiency for the period ended June 30,1927, since the corporation was in existence throughout the year 1927 and reported its income on the basis of the calendar year; that he did in fact determine a deficiency for the calendar year 1927, because the statement showing his computation starts with the “ net income as disclosed by return ”, which was a return of income for the calendar year; hence that the notice of deficiency to which the computation was attached and made a part by reference was a notice of deficiency for the calendar year, and that therefore the erroneous statement in the deficiency letter that it was for the period ended June 30, 1927, is immaterial and does not restrict the Board’s jurisdiction to that period only.

The Bevenue Act of 1926, section 274 (a), authorizes the Commissioner to send a notice of deficiency to the taxpayer by registered mail in any case in which he determines a deficiency in income tax, and authorizes the taxpayer to file a petition with the Board within 60 days thereafter for a redetermination of the deficiency. The same section also provides that no assessment, distraint or proceeding in court for the collection of such tax shall be made, begun or prosecuted until such notice has been mailed to the taxpayer. These provisions, however, are limited by subdivision (g) of section 274, which reads as follows:

The Board in redetermining a deficiency in respect of any taxable year shall consider such facts with relation to the taxes for other taxable years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been overpaid or underpaid.

It is well settled that we have no jurisdiction to redetermine the tax liability of a petitioner in respect to any year for which the Commissioner has not determined a deficiency. See, among others, Gor- nelius Cotton Mills, 4 B. T. A. 255; Morrison Woolen Co., 10 B. T. A. 8, 9; Columbia State Savings Bank, 15 B. T. A. 219; affd., 41 Fed. (2d) 923; Oscar Daniels Co., 23 B. T. A. 260, 274; Teck Hobbs, 26 B. T. A. 241, 250. In Hans Pederson, 14 B. T. A. 1089, 1119, we said:

The jurisdiction conferred upon the Board by section 274 of the Revenue Act of 1926 to redetermine a deficiency is limited by subdivision (g) of the same section. * * *
It is clear that under the above provision the Board is without jurisdiction to redetermine-petitioner’s tax liability for the year 1918 for the reason, that no deficiency has been determined by respondent for that year. Such is not only the clear meaning of the subdivision, but has been the constant holding of the Board since its decisions in R. P. Hazard, Co., 4 B. T. A. 150, and Cornelius Cotton Mills, 4 B. T. A. 255.

But respondent argues in the instant case that he in fact determined a deficiency for the calendar year 1927 and sent a notice thereof by registered mail to the petitioner, and that hence the Board has jurisdiction to redetermine the tax liability for that year. We are unable to agree with this conclusion. The record, we think, fails to show that the deficiency determined by the respondent was for the calendar year. The deficiency notice plainly states that the tax assessed, which constitutes the deficiency asserted, was “ for the taxable year 1926 and the period ended June 30, 1927.” Also the statement showing the details of the computation attached to the deficiency letter is headed period ended June 30, 1927.” In any event, if it be true that the deficiency determined by respondent was for the calendars yecvr 1927, that fact not appearing on the face of nor being indicated by either the deficiency letter or the attached statement, the notice sent to the taxpayer does not, in our opinion, comply with the statute to give us jurisdiction in respect to the calendar year. See Mrs. Grant Smith, 26 B. T. A. 1178; Elgin Compress Co., 31 B. T. A. 273; Pittsburgh & West Virginia Railway Co., 32 B. T. A. 66, issue 3.

Two things are necessary to be done by the Commissioner to give us jurisdiction to review his actions. First, he must determine a deficiency for a particular taxable year or period, and, second, he must send a notice of such determination to the taxpayer. Obviously, for example, if the Commissioner determined a deficiency for each of the years 1926 and 1927 but sent the taxpayer a notice of the deficiency for 1926 only, we would have no jurisdiction on appeal to redetermine the tax liability for 1927, notwithstanding respondent had determined a deficiency for that year. Here, respondent has determined only one deficiency, which he stated in his notice was for the “ period ended June 30, 1927 ”. tie now claims that the deficiency is really for the calendar year 1927. That fact, however, is not established by proof; but if the proof were sufficient on that point, tibe notice sent to the taxpayer certainly would not constitute a notice of deficiency for the calendar year 19%7.

In these circumstances, it is our opinion that we have jurisdiction to redetermine the petitioner corporation’s tax liability only for the period ended June 30, 1927. Aside from the admitted fact that respondent was without authority to determine a deficiency for that period, the record shows that there is no deficiency for such period. The principal item in the adjustments to income of the corporation made by respondent in computing the alleged deficiency is “ profit on sale of capital assets on liquidation, $162,650.49.” It is clearly shown that if any profit was derived by the corporation from the sale of its assets in 1927, it was received subsequent to J une 30, 1927. Cf. Elgin Compress Co., supra.

There being no deficiency in tax due from the corporation for the period ended June 30, 1927, it follows that there is no liability on the part of the individual petitioners for the period ended June 30, 1927, as transferees of the corporation’s assets. Having reached the conclusion stated, and being without jurisdiction to determine the tax liability of the corporation for the calendar year 1927, it becomes unnecessary to consider the other issues raised by the pleadings.

Judgment limited to the period e/nded Jwne 30, 19%7, will be entered for the petitioners.


author: Beech:

text:
    Bertram J. Grigsby, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76436.
    Promulgated November 26, 1935.

      Edward H. McDermott, Esq., and Marvin P. Kahl, Esq., for the petitioner.

      Bruce A. Low, Esq., and L. H. Rushbrooh, Esq., for the respondent.
   OPINION.

Beech:

The ultimate question presented is whether petitioner’s acquisition of 18,730 shares of the common stock of Grigsby-Grunow Co. in 1929 was a transaction upon which loss was then realized and recognized for income tax purposes. If it was, petitioner’s asserted loss was sustained in that year. If that transaction was not closed by petitioner’s receipt of those shares of stock, but continued open until his admitted sale of them in a later year, then petitioner sustained no loss by reason of their mere receipt during 1929, the year here in dispute.

Petitioner argues the transaction was a mere loan of credit, or a contract of insurance or indemnity — completely executed and closed, as to petitioner, by his acquisition of the stock. He contends the stock so acquired was analogous to salvage received by an insurer from an insured upon performance of an insurance contract — the gain or loss on the disposition of which salvage must await its disposition — but that the insurance transaction, separate from that involving the disposition of the salvage, is completely closed by payment under the insurance contract and the acquisition of the salvage, and, that, upon his acquisition of the 18,730 shares of Grigsby-Grunow stock, petitioner here sustained a loss — -in the amount of the difference between tbe amount be paid the Grigsby-Grunow Co. upon acquisition of that stock and its fair market value when thus received in the tax year.

Respondent’s position is that the disputed transaction was merely a purchase of the stock by petitioner, and that petitioner’s loss is not deductible until the later years when, and not before, for income tax purposes, the transaction was closed by the admitted sale of the stock.

The intent of the parties to the present “ underwriting agreement ” is decisive of its legal effect. The best evidence of that intent, of course, is the agreement itself, construed as a whole Heryford v. Davis, 102 U. S. 235; William S. Gordon, Trustee, 33 B. T. A. 460; and by what the contracting parties did thereunder, First National Bank in Wichita v. Commissioner, 57 Fed. (2d) 7, affirming 19 B. T. A. 744; certiorari denied, 287 U. S. 636.

Though not in itself determinative (A. B. Watson, 24 B. T. A. 466), it is important to note that the written records of the Grigsby-Grunow Co., covering the transaction, as well as the underwriting contract to which petitioner became a party, and the notice of John Burnham & Co., syndicate managers and participants, calling for petitioner’s performance under the contract, clearly denominated it under an underwriting agreement of purchase or sale. International Products Co. v. Vail’s Estate, 123 Atl. 194 (Vt.). In one instance only, which appears in the resolution of the Grigsby-Grunow directors authorizing the contract, was it referred to as anything else, and then as “ for the purpose of insuring the sale.”

Clearly the contract was not a mere loan of credit. Busch v. Stromberg-Carlson Telephone Mfg. Co., 217 Fed. 328; certiorari denied, 239 U. S. 644; In re Danville Hotel Co., 38 Fed. (2d) 10.

The primary purpose of the present underwriting contract was the sale of the new Grigsby-Grunow common stock. Such a contract is fundamentally different from underwriting as used in insurance, and is so treated by the courts. Fraser v. Home Telephone & Telegraph Co., 157 Pac. 692 (Wash.); International Products Co. v. Vail’s Estate, supra. It is true, the definitions there given of underwriting agreements, substantially similar to that here, include the terms “ guaranty ” and “ sale.” Fraser v. Home Telephone & Telegraph Co., supra; International Products Co. v. Vail’s Estate, supra. But, that “ guaranty ” means, apparently, only the assurance or guarantee of performance a seller and buyer receive upon the execution of an absolute contract of purchase and sale. If the agreement between the syndicate and Grigsby-Grunow Co. had been unconditional, its character as a simple purchase and sale contract would be undoubted. The interposition of the right to bring about a sale of the stock to others does not change that identity. Nor did the provision which entitled the syndicate members to $4 per share on the stock underwritten. Busch v. Stromberg-Carlson Telephone Mfg. Co., supra. True, it was, in its inception, contingent upon failure in the sale of the stock to others during the contract period. But it became absolute, as obviously contemplated by the parties, when that contingency occurred. And, upon that occurrence, in accordance with the expressed and unambiguous provisions of the underwriting contract, the disputed stock was, in fact, purchased by petitioner. That the purchase price was. in excess of the then market does not change that fact. Hugh M. Matheson, 31 B. T. A. 493. As intended and executed, we conclude the transaction in 1929 was simply a purchase and sale. In re Hackett, Hoff & Thierman, Inc., 70 Fed. (2d) 815; Minot v. Burroughs, 112 N. E. 620 (Mass.); International Products Co. v. Vail's Estate, supra; Fraser v. Home Telephone & Telegraph Co., supra; Busch v. Stromberg-Carlson Telephone Mfg. Co., supra. As the Circuit Court of Appeals for the Seventh Circuit in In re Danville Hotel Co., supra, stated:

All the parties hereto agree that this agreement is an underwriting contract, and that by its terms Caldwell & Co. agreed, for a valuable and sufficient consideration, to sell the bond issue of the hotel company or to purchase it in case it failed to sell the issue. It has been decided, without exception, we think, that such an instrument is not an agreement to loan money, but it is a guaranty either to sell or to buy the bonds, and the underwriter is in fact considered the ultimate purchaser of the bonds. [Emphasis supplied.]

Another inquiry, possibly implicit here, is whether this sale constituted a distribution of rights to purchase the stock, to petitioner, from an underwriting syndicate, upon which no loss was sustained until the later years when the stock, acquired in the exercise of these rights, was sold. Cf. Bradley W. Palmer, 32 B. T. A. 550.

The disposition of this question depends upon “ whether participants and managers are one, and this determination in turn [depends] upon the measure of control which the former have relinquished to the latter. * * * Where the managers are no more than mere agents, the participants stand in the relation of partners or joint venturers, at all times able to deal as they please with their own property. A distribution by managers to subscribers in such circumstances passes nothing to the latter, therefore, which they did not have before. J. Henry Dick Estate, 20 B. T. A. 637. But where the measure of control given the managers is unfettered, so that their investment, sale, reinvestment and general disposal of the subscribers’ stock or cash temporarily entrusted to them is beyond the power of the subscribers to forbid or to regulate, the managers in the person of the syndicate assume a corporate will and entity independent of the contributors.” Wm. S. Gordon, supra. Cf. Oliver W. Birckhead, 33 B. T. A. 466.

The pending agreement is rather brief. It provides:

As Managers, we shall have full control and discretion in all syndicate affairs, and to do all things which in our unrestricted judgment are for the best interest of the syndicate, including the right to trade in shares of the Company or subscription warrants to be issued in connection with the proposed issue, provided, however, that the total commitment in such trading, either for long or short account, shall at no time exceed 15% of the maximum syndicate obligations.

But it then stipulates:

This agreement is made for the benefit of Grigsby-Grunow Company as well as for the benefit of yourselves and ourselves, and shall be enfordble by Grigsby-Grunow Company. [Emphasis supplied.]

This underscored provision seems to indicate clearly that petitioner held himself out to and here contracted with the Grigsby-Grunow Co. as a principal for whom John Burnham & Co., syndicate managers, as well as a participant, was acting only as an agent. Cf. J. Henry Dick Estate, supra.

In any event, it was petitioner’s burden to establish the fact that the underwriting syndicate was intended and treated as a separate entity. Glenmore Securities Corporation v. Commissioner, 62 Fed. (2d) 780; certiorari denied, 289 U. S. 754.

Petitioner does not sustain that burden on this record.

Thus, petitioner received nothing from the syndicate that he did not have before, as a principal. J. Henry Dick Estate, supra. The stock was, in fact, purchased from the Grigsby-Grunow Co. by petitioner.

Thus, since the disputed transaction was a mere sale of the stock to petitioner, no deductible loss was sustained on its acquisition — that must be deferred until its later admitted sale.

Reviewed by the Board.

Decision will be entered for resfondent.


author: Mellott : McMahoN, Leech,

text:
    S. E. Thomason, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 58987.
    Promulgated November 27, 1935.

      Willis D. Nance, Esq., for tbe petitioner.

      Paul D. Page, Jr., Esq., for tbe respondent.
   OPINION.

Mellott :

We shall discuss separately the two questions involved. The first is whether a deductible loss occurred in connection with the sale of the stock. Petitioner contends that the above facts show that he sustained a loss in 1928 of $73,333.33 and that such loss is deductible under section 23 (e) of tbe Revenue Act of 1928. The section relied upon allows as a deduction from gross income “ losses sustained during the taxable year * * * (1) if incurred in trade or business; or (2) if incurred in any transaction entered into for profit, though not connected with the trade or business.”

Petitioner partially states his position by adopting the language of this Board in David Stewart, 17 B. T. A. 604:

Ordinarily, where an individual sells securities to a corporation at less than the cost of the securities, the sale establishes the amount of the individual’s loss for income-tax purposes. It has been shown in this case that the petitioner sold his securities to a corporation for less than those securities cost him. Why, then, should he not have a deduction for a loss?

Respondent does not question the correctness of the above decision, but contends that the transfer of the 5,000 shares of the Journal Co. stock by the petitioner to the International Paper Co. was not a sale for a consideration of $10,000, but was merely a part of, and an incident to complete performance of an “ entire contract ” between petitioner and his associate on the one hand, and the International Paper Co. on the other.

Petitioner argues that the contract is a severable contract and that the consideration for the sale of the stock “ is entirely separate from the consideration for the making of the $1,000,000 loan by the International Paper Company.” He contends that the express language of the contract shows an intention of the parties to make a division and apportionment of the “ consideration ”, and that the price to be paid is to be “ apportioned to each item according to the value thereof and not as one unit.”

Both parties cite the rules laid down in Corpus Juris for determining whether the contract is entire or severable. (13 Corpus Juris, p. 561, et seq.) They agree that ordinarily if the consideration is single the contract is entire; but if the consideration is either expressly or by necessary implication apportioned, the contract will be regarded as severable. Where, however, the portion of the contract to be performed by one party consists of several and distinct items, and the price to be paid is apportioned to each item according to the value thereof and not as one unit in a whole or a part of a round sum, the contract will ordinarily be regarded as severable. This rule applies even though the contract may in a sense be entire, if what is to be paid is clearly and distinctly apportioned to the different items as such, and not to them as part of one whole. (13 Corpus Juris, p. 563, sec. 528.)

The courts have found it very difficult to lay down a rule which will apply in all cases, frequently stating that each case must depend very largely on the terms of the contract involved. This case must be so determined, though the testimony may aid us in giving it the proper construction.

Petitioner testified that he was motivated in transferring the shares of stock to the paper company by his agreement to do so. He also stated that he would not have sold them on the open market for $10,000 on the date they were transferred.

Petitioner was a man of means, with a background of legal training and experience of several years as a practicing attorney, and vice president and general manager of a large metropolitan newspaper. This circumstance makes it quite improbable that he would have expended the sum of $83,333.33 in the “ purchase ” of stock and within one week thereafter would have “ sold ” it at a loss of $73,-333.33. We do not mean to infer that such a thing could not happen; but we are concerned with ascertaining whether it did happen in this case.

While petitioner testified that in his opinion the loan would have been made without the sale of the stock to the International Paper Co., such testimony can not vary the ternas of the written contract. The contract is before us and must be construed independently of the petitioner’s conclusion as to what was in the minds of the contracting parties.

The law furnishes certain rules for the construction of written contracts. These rules should so far as possible be applied with consistency and uniformity. The primary rule is that we must, if possible, ascertain and give effect to the mutual intention of the parties so far as that may be done without contravention of legal principles. The intention of the parties is to be deduced from the language employed by them. The contract must be construed as a whole and the intention of the parties must be ascertained from the entire instrument and not from detached portions. (13 Corpus Juris, p. 525, sec. 486; Uinta Tunnel Min. & Tramp. Co. v. Ajax Gold Mining Co., 141 Fed. 563, 566; Cleveland-Cliffs Iron Co. v. East Itasca Mining Co., 146 Fed. 232, 235; United States v. Ansonia Brass & Copper Co., 218 U. S. 452, 467; Green County, Kentucky v. Quinlan, 211 U. S. 582, 594.)

Construing it as a whole, is it entire or severable and divisible? It provided that upon the delivery and payment for the debentures 10,000 shares of stock would be delivered. Manifestly, if the debentures had not been taken by the paper company no correlative obligation would have rested upon petitioner and his associate to deliver the shares of stock and such delivery could not have been compelled by suit or otherwise. This much can be gathered from the face of the contract.

If, in tbe construction of the contract, we give consideration to the testimony of the petitioner, the fallacy of his present contention simply becomes more apparent. Under cross-examination, he testified:

Q. The purpose of the entire contract was to secure this financing?
A. That is correct.
Q. And one of the precisions of the contract was that you were to transfer this stock to the International Paper Company, was it not?
A. That is correct.

Another circumstance which points very clearly to the inevitable conclusion that the contract was intended to be entire is the second portion of paragraph No. 8, set out in full in the findings. In that paragraph it is stated that “ as fwther consideration ” the International Paper Co. is to pay the sum of $20,000. The use of the word “ further ”, we believe, clearly indicates that there were other considerations. One of them, obviously, was the purchase of the debentures and the financing of the entire transaction. Clearly, petitioner received for the transfer of the shares in question more than his aliquot part of the $20,000 paid. No testimony was introduced from which we can ascertain the value of such other consideration. We are satisfied it had some value. Gain or loss can not be ascertained unless all factors entering into its computation are proven. The burden of making such proof was upon petitioner.

But the petitioner argues that the consideration for the making of the million dollar loan did not flow from him and his associate, but from the various corporations involved. He contends that they did not pay any price for the loan, that it was not made to them personally, but to the holding company, and that they individually received no part of it. Let us analyze that contention.

The Bryan-Thomason Newspapers, Inc., was not a party to the contract. On the date the contract was executed it was nonexistent. Petitioner and Bryan agreed to form such company and to cause it and other corporations also to be formed by them to do certain acts. They were the owners of all of the stock of the holding company. Their contract made it incumbent upon them — petitioner and Bryan — to deliver to the International Paper Co. the stock here in question, “ upon the delivery of and payment for said debentures.” The purchase of the debentures was contingent upon the delivery of the stock. That such was a fact is plainly shown by the contract; but if there were any doubt about it, petitioner in his testimony has dispelled it.

We therefore hold that the cash received by petitioner was not the sole consideration for the transfer of the stock, and that his loss is not the difference between the cost of the stock and the amount of cash so received. It follows that judgment upon this issue should be entered in favor of the respondent.

The next question is whether the petitioner is entitled, under section 23 (b) of the Revenue Act of 1928, to a deduction of the sum of $8,243 as interest paid. This section authorizes the deduction from gross income of “ all interest paid or accrued within the taxable year on indebtedness except ” (exceptions not here important).

Petitioner contends that by giving a new note he paid the old note and the interest thereon. He argues that, if he had gone to a bank or a third party, borrowed the sum of $190,61/1! ($119,400 plus $8,¶&!(3) and had paid his creditor, no question could be raised as to its deduct-ibility. We need not determine the correctness of that contention. We are not concerned with what might have happened, nor need we decide whether, under a different set of circumstances, some other conclusion would be reached. We are concerned with the sole question of whether this taxpayer, on a cash basis, being indebted for principal and accrued interest on a promissory note, having negotiated another loan from his creditor for an amount sufficient to cover the principal and accrued interest on the first loan, is entitled to deduct the amount of interest so adjusted, as interest paid.

Petitioner apparently is not confused by the use of the word “ accrued ” in the revenue act. He recognizes that under the construction which has consistently been followed, interest “ accrued ” can only be deducted when the taxpayer is making his return on an accrual basis, as distinguished from a cash receipts and disbursements basis. Nothing more need be said on this feature.

It is well settled that deductions are only allowed as provided by statute and in order to secure them the taxpayer must bring himself clearly within the terms of the statute. New Colonial Ice Co. v. Commissioner, 292 U. S. 435; Burnet v. Thompson Oil & Gas Co., 283 U. S. 301; Woolford Realty Co. v. Rose, 286 U. S. 319, 326; Ilfeld Co. v. Hernandez, 292 U. S. 62, 66. Petitioner has not done so. We have held, under similar situations, that taxpayers on the cash receipts and disbursements basis may only deduct from their gross income in the taxable year, interest actually paid in that year. Utah Orpheum Co., 3 B. T. A. 1041; Francis R. Hart, 21 B. T. A. 1001.

In Hart v. Commissioner, 54 Fed. (2d) 848, affirming our decision, the Circuit Court of Appeals for the First Circuit, after referring to United States v. Mitchell, 271 U. S. 9, said:

Prom this decision of the Supreme Court, we reach the conclusion that the word “ paid,” as used in the statute refers to cash payments during the taxing year if the taxpayer’s hooks are kept upon the cash receipts and disbursements basis, and that the word “ accrued ” has reference to books or accounts from which returns are made upon the accrual basis.
It is inconsistent with the cash receipts ancl disbursements method of accounting that the petitioner be permitted to claim a deduction where there has been, no actual payment of cash. This basis of accounting requires that he report only actual receipts and deduct only actual disbursements.
The fact that the American Trust Company stamped the bill for interest “ paid ” and entered the amount of the petitioner’s note as a credit to interest on its books of account does not establish a cash payment entitling the taxpayer to a deduction for interest paid where his return is on a cash basis. If the note is never paid, the taxpayer has parted with nothing more than his promise to pay. A promise to pay is not cash, and a deduction from [for] interest is permissible only in the taxable year in which the taxpayer pays cash. [Citing cases.]

The question at issue here is closely akin to that involved in Blair v. First Trust & Savings Bank, 39 Fed. (2d) 462, and Helvering v. Martin-Stubblefield, Inc., 71 Fed. (2d) 944, in which the courts held that notes representing commissions received by the taxpayers need not be reported as income. In the latter case the court quoted with approval the language used in Blair v. First Trust & Savings Bank, supra, as follows:

It is plain that until the loan is paid or rediscounted the respondent has earned no profit, but has simply parted with its funds on the faith of the security. The commission is not actually received until respondent gets back what it has previously paid out plus the commission. The deduction of the commission from the face, of the loan .brings nothing into the coffers of the bank.

The taxpayers in the above cited cases did not receive the commissions when the notes were delivered to them. By a parity of reasoning, the petitioner in the instant case did not pay the item of interest in question when he gave his note therefor.

The case of Robert B. Keenan, 20 B. T. A. 498, is cited by petitioner, but we are unable to see that it has any applicability. In that case we held that the payment of expenses with borrowed money did not postpone the deduction of such amount from gross income until the year in which the borrowed money was repaid. The conclusion therein reached is not decisive of the question here under consideration.

In the instant proceeding petitioner substituted one promise to pay for another. In so doing, even though he extinguished his liability under the first note for principal and interest, he “ paid ” nothing in the sense in which this word is used in section 23 (b), supra. After giving the new note, he still owed his creditor the principal and interest due on the old one, and the only change was that his obligation to pay was represented by a new and different piece of paper, the effect of which was to postpone the date of payment. A promise to pay does not satisfy the provisions of the statute allowing a deduction for interest paid.” Eckert v. Burnet, 283 U. S. 140.

The case of John C. Hermann, 27 B. T. A. 409, in so far as it is contrary to the views herein expressed, is hereby overruled.

It follows, therefore, that petitioner was not entitled to deduct as interest paid, the sum in question.

Eeviewed by the Board.

Judgment upon both issues will be entered in favor of the respondent.

McMahoN,

dissenting on the second point: Bearing in mind that taxation is eminently practical, and looking through form to substance, which is vital and controlling, as we must do, in the final analysis we have presented in this proceeding a simple situation substantially and essentially as follows: Petitioner gave to a bank his promise in writing to later pay it money with interest thereon— a chose in action, property, an asset in the possession of the bank— and also collateral — property, an asset — securing the fulfillment of his promise, for all of which he received from the bank money or its equivalent. Such money so received thereupon became his money. Thus having the money, he used a portion of it, $8,243, to pay in cash or its equivalent interest which he owed the bank on a previous uncollateralized similar written promise to pay to the same bank a smaller amount with interest.

For all practical purposes, and in effect, the result is the same as if he had thus gotten the $8,243 in cash from a second bank and immediately carried it over and delivered it to the first bank in payment of such interest, or, immediately thus used it to pay interest which he owed to a third bank.

Obviously, if he had pursued either of the latter two courses the deduction of the interest would be allowable; and the same principle requires that the deduction for the interest in issue in this proceeding be allowed.

It may be added that in the instant proceeding the interest in question was, and in each of the other two assumed analagous situations would be, simultaneously and correspondingly income to the bank.

If there is anything in any of the precedents contrary to or in conflict with these conclusions, they, to that extent, should not be adhered to.

Leech,

dissenting on the second point: The administration of the income taxing statutes is necessarily highly practical (Tyler v. United States, 281 U. S. 497) and, so far as reasonably possible, therefore, effect should be given to the customs and usages of business. To one on a cash basis, these taxing acts unqualifiedly permit the deduction of certain specific items, including taxes, interest, and ordinary and necessary expenses of doing business, “ paid ” during the tax year. It would seem unquestioned that a taxpayer on such a basis, who owed taxes to A municipality, accrued interest at B bank, and ordinary and necessary expenses of his business to C, and who then borrowed funds at X bank on his promissory note, and paid these items, would be entitled to their deduction from his gross income in the determination of taxable income for the year in which they were paid. Robert B. Keenan, 20 B. T. A. 498. If the taxpayer has a loan at X bank, and, before an interest maturity date thereon, he borrows additional funds from that bank which are deposited in his account and then later, upon the maturity of the interest on the original loan, he pays that interest by a check on his own account, at that bank, certainly that amount is deductible as interest paid. I disagree with the majority conclusion that the taxpayer is denied this statutory deduction for accrued interest merely because the loan is made from the creditor to whom the interest is due. Contrary to the premise of the majority opinion, the payor and payee of interest met by the giving of a note in such instance are not in pari passu, where the obligation of such interest is satisfied by a mere promise to pay, in the form of a promissory note, and the deductions summarily denied as in the case of Hart v. Commissioner, 54 Fed. (2d) 848, affirming 21 B. T. A. 1001. (Cited in the majority opinion.) The recipient of that note admittedly receives taxable income upon the sale or other disposition of that note. But that sale or other disposition by the payee does not entitle the promissor on the note to deduct any part of it as interest paid, since he has not yet paid it.

It seems that a logical and practical test here which will not only reconcile the so-called commission cases (Blair v. First Trust & Savings Bank, 39 Fed. (2d) 462, and Helvering v. Martin-Stubblefield, Inc., 71 Fed. (2d) 944), but which will give the taxpayer the right which Congress specifically granted, without an absurd pyramiding of interest payments or unjustifiable postponement of absolute statutory deductions, and avoid a result which may well lead to the necessity of impracticable inquiry into the source of funds with which such unconditionally deductible items were paid, is that — such deductions for interest paid are allowable when made from funds arising from loans made in independent transactions from those upon which the interest paid has accrued, whether such loans be made from the same creditor to whom the interest is owed ,or another. I think the transaction disclosed in the case of John C. Hermann, 21 B. T. A. 409, was such an independent transaction. The facts in the pending record, presenting the second issue, are even stronger to that effect since, not only was the second loan approximately double the amount of the first, but the second loan was collaterally secured while the first was not. In my judgment, the decision of the Board in the Hermann case upon the facts there presented was right, and controls the disposition of the second issue here.

TRamMeul, AruNdell, VaN FossaN, aNd McMahon agree with this dissent.


author: Van Fossan : Black,

text:
    Central United National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 69-212, 71063.
    Promulgated November 27, 1935.
    ' Oarmi A. Thompson, Esq., and Orville Smith, Esq., for the petitioner.

      Olay 0. Holmes, Esq., for the respondent.
   OPINION.

Van Fossan :

These proceedings were brought to redetermine deficiencies in the income taxes of the petitioner for the years 1929 and 1930 in the sums of $10,131.52 and $8,620.76, respectively.

The facts were stipulated and are substantially as follows:

The petitioner is a national banking association duly organized under the laws of the United States, located at Cleveland, Ohio, with its principal office at 308 Euclid Avenue, Cleveland, Ohio.

For the calendar years 1928, 1929, and 1930 the petitioner accrued on its books and claimed as deductions on its income tax returns for said respective years, the amounts of personal taxes charged against it on the county treasurer’s duplicate of Cuyahoga County, Ohio, for the said respective years, in the following amounts, to wit:

Tear Original assessment
1928_ $110,083.23
1929_ 153, 507.89
1930_ 165, 520.15

These taxes were not paid as assessed and billed by the proper taxing authorities of Cuyahoga County, Ohio, before the close of each said respective calendar year. As hereinafter appears, the petitioner subsequently instituted certain equitable suits for injunctive relief in the District Court of the United States for the Northern District of Ohio, Eastern Division, and in the Court of Common Pleas of Cuyahoga County, Ohio, questioning whether or not the said taxes were illegally discriminatory.

For the years in controversy, as well as prior and subsequent thereto, the petitioner kept its books of accounts and filed its returns on the accrual basis of accounting.

On August 5, 1929, the petitioner filed a bill of complaint against Alex Bernstein, treasurer of Cuyahoga County, in the said Federal court for the purpose of enjoining him from collecting personal taxes charged against the petitioner for the year 1928. On August 19,1929, the motion for an injunction was denied and on November 21, 1929, a stipulation between counsel was filed, agreeing to defer state action pending a decision on a similar case in the District Court of the United States for the Southern District of Ohio, Northern Division, brought by the Huntington National Bank and involving the same question. On February 26, 1981, the suit was dismissed without prejudice.

On May 1,1931, the petitioner filed a suit in the Court of Common Pleas for Cuyahoga County restraining the then county treasurer from collecting personal taxes charged against it for the years 1928, 1929, and 1930. During the pendency of this suit an injunction was granted in the Huntington National Bank case and the Federal court held, in effect, that personal taxes assessed against national banks in Ohio were illegally assessed because of discrimination between national banks and other moneyed capital coming into competition with the national banks (45 Fed. (2d) 213). The Huntington National Bank case was appealed to the Circuit Court of Appeals for the Sixth Circuit, where it was reversed, the case being decided, on June 29, 1932, in favor of the county treasurer. (59 Fed. (2d) 479.)

For some time prior to the decision of the district judge in the Huntington National Bank case, negotiations had been carried on between the petitioner and the taxing officials of Cuyahoga County, Ohio, looking to an adjustment of the petitioner’s personal taxes for the years 1928, 1929 and 1930, and, after the decision of the district judge and prior to the reversal of the decision by the Circuit Court of Appeals, the petitioner had reached a basis of compromise with the taxing officials of Cuyahoga County, under which an adjustment was to be made on the following basis:

Carrying into effect the compromise so reached, the Court of Common Pleas in the injunction suit against the county treasurer entered its order finding that the petitioner owed the county treasurer the respective amounts indicated in the above schedule as 1932 settlement. The court order required the county treasurer to accept the amounts in full for the taxes to be paid for the several years, and payment thereof was made on February 1, 1932.

In the journal entry recording the decision of the court in the last mentioned case, reference is made to a certain action brought by the petitioner in the United States District Court for the Northern District of Ohio, Eastern Division, against Walter E. Cook, in which the petitioner sought to recover personal taxes paid by the petitioner for the year 1921, and in which court order it was stated that the petitioner would dismiss its action in that court.

In its income tax return for the year 1932, the petitioner reported as income to it in the said year, the amount of savings on the settlement of its personal taxes for the years 1928, 1929, and 1930, as set forth in the above settlement schedule, such savings being in the sum of $244,514.75. Petitioner’s income tax return for the year T932 did not show any net taxable income.

In determining the petitioner’s taxable income for the years 1929 and 1930, the respondent allowed as deductions $61,403.16 for the year 1929 and $82,760.07 for the year 1930. These amounts represented payments made by the petitioner for personal property taxes as determined by the compromise agreement effected in 1932.

The petitioner contends that for the years in question it accrued properly on its books the full amount of personal taxes assessed against and billed to it, that it so reported to the Comptroller of the Currency, as required by section 5211, U. S. ^Revised Statutes, and that on December 31 of the respective years it had not challenged the correct amount of such taxes. It contends further that after the decision of the Circuit Court of Appeals holding the tax valid it correctly reported as income in 1932 the saving effected by the compromise.

The respondent’s theory is that simultaneously with making the accruals on its books the petitioner protested the correctness of the taxes; that the various actions brought by it were for the purpose of correcting a mistake and that, therefore, the amount of taxes as paid through compromise should relate back to the years for which they were due.

The facts do not support the respondent’s position. As to each year, the petitioner entered on its books correct accruals of the personal taxes which the taxing authorities of Cuyahoga County had determined it was compelled to pdy. All of the events necessary to fix the amount of the tax and the liability of the taxpayer to pay it had occurred within the respective taxable years. United States v. Anderson, 269 U. S. 422. Subsequent to December 31 of each year, it attacked the assessment of such taxes as being illegally discriminatory. It did not question the correctness of the amount assessed or the valuation employed. Cf. Inland Products Co. v. Blair, 31 Fed. (2d) 867; Brooklyn Union Gas Co., 22 B. T. A. 507. Thus, it was not a matter of correcting an error, but a denial of the petitioner’s liability for any tax such as was imposed.

In Ohio, under state law as it stood in the taxable years, the day preceding the second Monday in April was the date of tax incidence. John H. Hord, 33 B. T. A. 342. The Revenue Act of 1928, section 23 (c), allowed a deduction of the amount of taxes paid or accrued.” Petitioner accrued the taxes due from it on its books in the respective years and deducted them in its returns. This action was in accord with its legal rights. Later, in 1932, by compromise petitioner effected a saving in the amount of taxes to be paid. The Circuit Court of Appeals subsequently in the same year held the tax valid. Accordingly, petitioner, by reason of the compromise, paid less tax than was due. The amount of this saving was income to petitioner and was reported as such in 1932, the year in which it arose. North American Oil Consolidated v. Burnet, 286 U. S. 417. This action conformed to law and gave effect to the action of the Circuit Court of Appeals.

Under the facts in the case at bar we believe that the method employed correctly reflects the petitioner’s income as computed under the accrual basis of accounting. See Continental Baking Co., 30 B. T. A. 354; affd., 77 Fed. (2d) 119; Russell-Miller Milling Co. v. Helvering, 69 Fed. (2d) 392; affd., 27 B. T. A. 405.

Reviewed by the Board.

Decision will be entered u/nder Bule 50.

Moeeis dissents.

Black,

dissenting: In my judgment the Commissioner should be sustained in his contentions in this proceeding.

Undoubtedly one on the accrual basis must accrue on his books taxes in the year when such taxes accrue and the petitioner was entirely justified in accruing tbe amounts which, it did in the respective taxable years, but now that we have the tax years before us on appeal, it seems to me that we should adjust the accruals in accordance with the true tax liabilities for the respective taxable years as finally determined.

To treat the matter as petitioner contends would ordinarily work a clear distortion of income. In the instant case petitioner is willing to add to income for 1932, $244,514.15, but to do so works no hardship on petitioner because it evidently had heavy losses in that year which absorb this $244,514.75. That fact is shown by the finding in the majority opinion, which says:

In its income tax return for the year 1932, the petitioner reported as income to it in the said' year, the amount of savings on the settlement of its personal taxes for the years 1928, 1929, and 1930, as set forth in the above settlement schedule, such savings being in the sum of $244,514.75. Petitioner’s income tax return for the year 1932 did not show any net taxable income.

But suppose 1932 had been a normal year with' a good healthy income to petitioner. Doubtless under such circumstances petitioner would contend strongly against adding $244,514.75 to income and would assert that to do so would be a clear distortion of its income.

Petitioner would doubtless contend that 1928, 1929, and 1930 should be adjusted in accordance with the taxes finally agreed upon and in so contending I think petitioner would find support-in Board cases. See Joseph V. Horn, 23 B. T. A. 1131; also Philip C. Brown, 10 B. T. A. 1122. In the latter case the Board quoted with approval from Producers Fuel Co., 1 B. T. A. 202, as follows:

While it appears that at the end of the year 1920 this taxpayer estimated its liability under the breached contracts with appropriate accuracy and set the sum up on its books of account and then made its income and profits-tax return in accordance with such books, we have now before us a review of that income and profits-tax return and in making such review it is our duty to consider not only the facts known and recorded at the close of December, 1920, but also those same facts as modified by subsequent events. These subsequent events have developed the fact that the damages and losses sustained by the taxpayer on account of the breach of the Monongahela contract were settled for the sum of $5,500, and that the damages and losses sustained by the taxpayer on account of the breach of the Campbell contract were finally determined and settled for the sum of $29,742.40. With these facts before us, and for the purpose of determining the final net taxable income of the taxpayer for the year 1920, the amounts of damages and losses as finally determined must now be substituted for the estimate originally made, and in place of the deductions claimed by the taxpayer in his return and disallowed by the Commissioner the losses and damages as finally settled must be allowed as the deduction contemplated by the law.

It may be argued that in both the Horn and Brown cases, the taxpayer was on the cash basis, but I think that makes no difference. Both cases stand for substantially this proposition: That, if in 1934, for example, a taxpayer paid $10,000 taxes, but contends that he did not owe that much and in 1935 gets a refund of $2,500, he must adjust his deduction for taxes in 1934 and make it only $7,500 instead of $10,000, as originally deducted.

I think one on the accrual basis would make no difference. If under such circumstances he accrued $10,000 in 1934 but arrived at a compromise settlement in 1935 of $7,500 for his 1934 taxes, he would have to go back and adjust his accruals for 1934 to a deduction of only $7,500.

I do not think that the authorities cited in the majority opinion in support of the conclusion therein reached are in point. For example, Continental Baking Co., 30 B. T. A. 354, is cited. In that case, the corporation, keeping its accounts on the accrual basis, in July 1925 filed a capital stock tax return in which it claimed exemption from the tax as not being engaged in business. In 1929 the Commissioner denied the claimed exemption and in that year the tax was paid. In its income tax return for 1929 the corporation took a deduction for the amount of tax which was paid. The Board held that the tax accrued in 1925 and was not a proper deduction from income in 1929, to one on the accrual basis.

That is exactly the principle for which I contend in the instant case. Whatever taxes the petitioner owed the State of Ohio for the taxable years 1929 and 1930, the two taxable years which we have before us, were accruals for those two respective years. Petitioner accrued on its books, and took a deduction therefor on its income tax returns, $153,507.89 taxes for 1929 and $165,520.15 for 1930. Petitioner did not pay these amounts, but, on the contrary, in 1932 settled for $61,403.16 for 1929 and $82,760.07 for 1930. Therefore it is my opinion that the proper accrual for taxes in 1929 is $61,403.16 and for 1930 is $82,760.07, and, now that we have the years before us on appeal, that is the amount which we should allow petitioner as accruals for those years.

It is a fact well known to all that the Commissioner makes refunds to taxpayers of estate taxes which have been overpaid in prior years and taken as a deduction by the estate. It has never been held by the Board or the courts, so far as I know, that the principal amount of these refunds is taxable income to the estate. If any interest is paid on the refunds, that is taxable income but not the principal of the refund itself. Yet under the doctrine of the majority opinion as I understand it, if in these refund cases the Commissioner could show that the tax-paying estate had taken deductions from its income tax returns of the estate taxes paid in the prior years, he should hold the refunds to be income to the taxpayer in the year in which such refunds are made. That it seems to me would be wholly unsound and that is why I think the majority opinion is unsound, and I respectfully dissent from such view.

Seawell and Arnold agree with this dissent.