author: Smith : Mellott,

text:
    National Grocery Company, Petitioner, v. Commissioner of Internal Revenue, Respondent
    Docket No. 76600.
    Promulgated December 9, 1936.

      James D. Carpenter, Jr., Esq., and John M. Enright, Esq., for the petitioner.

      Ralph E. Smith, Esq., and Timothy C. Mooney, Esq., for the respondent.
   OPINION.

Smith :

The first question presented by this proceeding is whether the petitioner is liable to tax under section 104 of the Revenue Act of 1928 upon its profits for the fiscal year ended January 31, 1931. That section, so far as material to this proceeding, is as follows:

(a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
(b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.

In his deficiency notice the respondent stated:

After careful consideration of your protest dated July 19, 1932 and subsequent information furnished this office, the Bureau approves the revenue agent’s conclusion that in accordance with the provisions of section 104 of the Revenue Act of 1928 your company has permitted its gains and profits to accumulate beyond the reasonable needs of the business instead of being distributed, which is construed as prima facie evidence of a purpose to prevent imposition of surtax upon its stockholders.

Does the evidence overcome this prima facie presumption? And, if so, was the petitioner “availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed”, during the taxable year?

The petitioner was organized for the purpose of operating a chain of grocery stores. For a number of years after its organization the profits of the business were used in extending the chain. At some time prior to 1922 the petitioner began to invest a portion of its surplus profits in the purchase of bonds and stocks. Its balance sheet at January 31, 1922, shows its investment in bonds and stocks at $490,000 and $130,710, respectively. Its holdings of securities in subsequent years greatly increased. There was also, up to 1929, a very large increase in the market value of the securities acquired. Since 1929 the petitioner has not greatly expanded its grocery business. Its profits have been large but they have not been paid over to its sole stockholder in the form of dividends. Most of them have been invested in securities.

Petitioner’s balance sheet at the beginning of the taxable year shows cash on hand of $1,332,332.28; notes receivable (Henry Kohl), $470,000; accounts receivable, $26,816.37; bonds, mortgages, and stocks, $2,838,718.07; and other current assets against actual liabilities (exclusive of reserves) of $1,180,879.07. At the end of the taxable year petitioner’s balance sheet shows cash, $1,405,961.04; notes receivable (Henry Kohl), $610,000; bonds, mortgages, and stocks, $3,048,452.74; and other current assets against the actual liabilities (exclusive of reserves) of only $276,552.19. Its actual surplus at January 31, 1931, was $7,938,965.54.

Th,e petitioner contends that this large surplus was of benefit to it in obtaining credit at banks and in enabling it to purchase merchandise at a low price. It appears, however, that the petitioner’s credit had been excellent for many years prior to the taxable year and that it did not obtain loans from banks at a lower rate of interest simply because it had a large investment in bonds and stocks. Manifestly, the amounts invested in bonds and stocks were not used by the petitioner either in the taxable year or for several years prior or subsequent thereto in its grocery business. We find as a fact that the petitioner’s accumulation of earnings was far in excess of the “reasonable needs” of the corporate business.

We are also of the opinion that the evidence of record does not rebut the prima facie presumption created by the statute that the accumulation of earnings beyond the “reasonable needs of the business” was for the purpose of preventing the imposition of the surtax upon its sole stockholder. The evidence shows that Henry Kohl, personally, needed some of the profits of the business. Prior to the taxable year he had borrowed from the petitioner $470,000, and, during the taxable year, he borrowed an additional amount of $140,000. No interest was ever charged or paid upon these loans. If the amount borrowed during the taxable year had been distributed as a dividend the petitioner would have been subject to a large surtax upon it. By reason of the failure to pay the $140,000 as a dividend the petitioner escaped surtax upon that amount of income. See William C. De Mille Productions, Inc., 30 B. T. A. 826.

Upon the evidence before us we have made the finding that the petitioner was “availed of” during the fiscal year ended January 31, 1931, for the purpose of preventing the imposition of the surtax upon its sole stockholder “through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.” Cf. United Business Corporation of America, 33 B. T. A. 83; R. & L., Inc., 38 B. T. A. 857.

The petitioner contends that: “Section 104 of the Revenue Act of 1928, as construed and applied by the Commissioner of Internal Revenue, or his deputy, to the income of petitioner for the fiscal year ending January 31, 1931, violates rights secured to the petitioner under the Constitution of the United States.” It has not, however, advanced any argument in support of this proposition in its brief, and the constitutionality of the provision is sustained upon the authority of United Business Corporation of America v. Commissioner (C. C. A., 2d Cir.), 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635; United States v. Tway Coal Sales Co. (C. C. A., 6th Cir.), 75 Fed. (2d) 336; Williams Investment Co. v. United States, 3 Fed. Supp. 225; 77 Ct. Cls. 396.

Reviewed by the Board.

Judgment will be entered for the respondent.

Mellott,

dissenting: The majority holding, that the act is not unconstitutional, is, in my judgment, correct. I have considerable doubt, however, that the tax and penalty prescribed by it should be assessed and imposed under the facts before us.

The petitioner corporation was not formed for the purpose of preventing the imposition of the surtax upon its shareholders. It was formed many years prior to the enactment of the income tax law and for the purpose, as set out in the prevailing opinion, “of operating a chain of grocery stores.”

Was it “availed of” during the taxable year for the inhibited pur: pose? The respondent contends that it was. In his notice of deficiency it is stated that he “approves the revenue agent’s conclusion that * * * [it] * * * permitted its gains and profits to accumulate beyond the reasonable needs of the business.” Such determination apparently was made under section 104 (b) of the Revenue Act of 1928, which prescribes that such a finding is prima facie evidence of a purpose to evade the surtax.

It may, or may not, be significant that the respondent did not categorically find that petitioner was “availed of” for the interdicted purpose; but such finding must be made by this Board if it is to approve the deficiency. Before we make such finding, however, there should be at least a fair preponderance of the evidence to support it, and I am not satisfied that such requirement has been met.

The prevailing opinion makes reference to three or four facts relied upon as being particularly significant — that the profits, though large, were not paid over to the sole stockholder in the form of dividends but were invested partially in securities; that the surplus increased during the taxable year; and that the sole stockholder borrowed from the petitioner certain sums of money without interest. These are circumstances which should be considered, but I do not think, upon this record, that they are so indicative of the nefarious purpose as to compel the conclusion reached by the majority.

The respondent offered no evidence, except a statement of the cost and market value of the securities, prepared from the books of the company, and the income tax returns of the petitioner and its sole stockholder. The petitioner produced several witnesses. At the risk of unduly extending this discussion, I feel impelled to make reference to some of the facts established by the evidence.

The treasurer of the company, who had been associated with the sole stockholder for more than 30 years, stated that, in her opinion, the surplus was not in excess of the reasonable needs of the business. She testified that to carry on the business, to buy the large quantities of merchandise required, and to pay the other expenses of the business, required a large surplus and that even with the large surplus on hand, there were times when the company was short of cash and had to borrow temporarily from the banks in order to pay the invoices of incoming merchandise.

Kohl, the sole stockholder, when asked why he kept all of the earnings of the company in the business instead of drawing them out, stated, “I needed them in the business — always needed them in the business. I never had any too much money.” He also stated that he always.tried to hold the corporation ready at all times to buy, if necessary, a whole year’s supply of merchandise, if he thought that it could make money by doing so. When asked if, in his judgment, it was necessary for it to be continuously in the position of purchasing supplies in such quantity, he answered: “Well, the more money you have got, the cheaper you can buy and the more independent you are and the more you are recognized — and everything depends upon your statement, see?” It had been the policy of the business since its establishment “to keep in the statement and in the business every possible dollar and let them accumulate for the benefit of the business.” From the very beginning the sole stockholder had followed the policy of living simply, drawing only enough salary to live on and confining his expenditures outside of the business to his living expenses. In its first year the company operated three stores; in 1912, 57; in 1915, 171; in 1918, 268; in 1923, 388; and, as shown in the findings above, in 1928, 715, and in- 1931, 815. This growth corresponded in a general way with the ambition of the sole stockholder, one witness telling us that when he had 3 stores his ambition was to have 10; when he had 10, his ambition was to have 50; when he had 50, then to have 100, then 500, then 1,000, etc. With this idea in mind the warehouses, garages, bakery, and other facilities of the petitioner were expanded accordingly and such facilities now have sufficient capacity to take care of twice the number of stores which it owned during the taxable year.

Kohl further testified that before 1930 he had considered the purchase of a chain of stores in Paterson, New Jersey. During that year he also carried on negotiations with the owner of some 500 or 600 stores for their purchase. This was a business of from $5,000,000 to $6,000,000. While the stores were not actually purchased during the taxable year, the fact that such purchase was contemplated is a significant circumstance which should be considered by this Board in passing upon the question at issue.

Petitioner sold approximately $20,000,000 worth of merchandise during the taxable year, and, by taking advantage of its discounts, earned almost a half million dollars. Its pay roll and rents alone amounted to $4,000,000 a year. During the taxable year it paid Federal income taxes of $103,616.60. If it and its officers had wished to avoid paying Federal taxes, a method far more efficacious than accumulating “an unreasonable surplus” could have been adopted. For instance, it could have sold some of its securities, which had depreciated in value more than a million dollars, deducted its loss, and thus not only could have saved on its income tax for that year, but in addition could have adjusted its surplus and earnings so that its books would show an actual loss for the taxable year instead of a gain or profit.

The petitioner paid its sole stockholder more than $100,000 a year as a salary. This was reported by him in his income tax return and tax was paid accordingly. It was ample for his ordinary living expenses and there was apparently no good reason why he should pay out any more of the earnings of the corporation to himself. He paid a surtax of more than $8,000 on his salary and a total tax of more than $11,000 for each of the four years 1928 to 1931, inclusive.

William J. Field, president of a large bank, testified that in his opinion the capital and surplus of petitioner was not in excess of the reasonable needs of the business, pointing out that at that time “we were starting on a panic and panic conditions. No one could foretell the future at that time. The National Grocery Co. had a turn-over of over six to eight times its capital in the volume of business it did in those years * * *. They had experienced in previous years rather large losses on inventory and felt they should keep a considerable working capital and surplus to meet any additional losses they might encounter.” He also pointed out that the accumulation in surplus invested in securities enabled it to show a better credit statement and to borrow whenever it wished at low rates of interest. Frank C. Ferguson, another bank president, testified to substantially the same effect.

Another circumstance worthy of more than passing consideration is the fact that petitioner’s real estate holdings, as well as its stocks and bonds, had materially depreciated in value. This depreciation, though it had not been reflected in the balance sheet, was nevertheless a very real thing. The stocks and bonds had depreciated more than $900,000. The merchandise inyentory, due to the general decline, had decreased approximately a quarter of a million dollars, while the fair market value of the real estate had a shrinkage in value, over and above the depreciation charged off, amounting to approximately $125,000.

Being concerned, as we are, with actualities — a rule which certainly should be applied when we are passing upon the applicability of a penal statute such as we have before us, and regardless of the fact that the books of the company reflected an addition to surplus, the above evidence clearly shows that during the taxable period before us there was no unreasonable accumulation of gains and profits.

Congress was very careful to limit this highly penal statute to corporations which were formed or availed of for the purpose of avoiding the imposition of surtax upon the shareholders. In the first case which came before this Board under the section as originally enacted (United Business Corporation of America, 19 B. T. A. 809; affd., 62 Fed. (2d) 754; certiorari denied, 290 U. S. 685), both this Board and the Circuit Court upon appeal properly stressed the importance of establishing by the evidence the unlawful purpose. It was there pointed out that if such unlawful purpose was shown to exist, then it was immaterial whether the accumulation be large or small. The ultimate question before us, then, is, was there a purpose to enable the shareholder to escape surtaxes. The test, said the Second Circuit Court of Appeals in United Business Corporation, supra, is “the state of mind itself, and the presumption does no more than make the taxpayer show his hand.” This Board, in the recent case of A. D. Saenger, Ino., 33 B. T. A. 135; affd., 84 Fed. (2d) 721; certiorari denied, 299 U. S. 577, added that “the display of that ‘hand’ does not relieve the taxpayer if it discloses the state of mind the statute condemns.”

The inquiry as to whether there has been an accumulation of surplus beyond the reasonable needs of the business is not determinative of the ultimate question to be decided. Even if the evidence bei sufficient to show that there was an unreasonable accumulation— wdiich, however, I do not believe has been shown in this case — this' merely raises a rebuttable presumption of the existence of the .crucial purpose. Such presumption is overcome by the evidence in this case which shows an absence of such purpose. The corporation merely continued its long established practice of “ploughing its earnings back into the business.” Indubitably it had in the earlier years no “purpose of preventing the imposition of the surtax upon its shareholders”, for there was no surtax to escape. There had been no “sudden change of policy, coincident with large increases in the surtax rates, (which) might * * * betray a purpose to accumulate against a season more propitious for distribution.” (United Business Corporation, supra.) It had pursued the same policy throughout the years.

In Cecil B. DeMille, 31 B. T. A. 1161, 1174 (on appeal to the 9th Circuit), the facts made a much stronger case for the respondent than the facts before us here; but it was pointed out that the taxes and penalties prescribed by the section “are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed.” This language was recently quoted and reaffirmed by the Board in Sauk Investment Co., 34 B. T. A. 732, 738, and in the very last case which we decided under this section, Almours Securities, Inc., 35 B. T. A. No. 11, the Board said, “There must be such an intent on the part of those who were responsible for the organization of the corporation, or for the conduct of its operations.” In the DeMille case it was pointed out that the proof went well beyond mere denial of prohibited intent and showed affirmatively a plan necessitating the ac•cumulation of earnings and “the end to which they might ultimately be used.” The same, or stronger, language might be used here.

No case has come before the courts or this Board where a corporation engaged in a mercantile or industrial activity, organized prior to the enactment of the income tax law and which has consistently followed the policy of “ploughing its earnings back into the business”, has ever been required to pay the tax and penalty imposed by the section in question. In practically every case in which such penalty has been imposed, a large portion of the corporation’s assets had been conveyed to it at the time of its formation, or at a later time, by the principal stockholder or stockholders, or the corporation was “a mere holding company.” Typical cases are the following: United Business Corporation of America, supra; United Business Corporation of America, 33 B. T. A. 83 (reversed on stipulation of the parties) ; Keck Investment Co., 29 B. T. A. 143; affd., 77 Fed. (2d) 244; certiorari denied, 296 U. S. 633; William C. DeMille Productions, Inc., 30 B. T. A. 826; Cecil B. DeMille, supra; Fisher & Fisher, Inc., 32 B. T. A. 211; affd., 84 Fed. (2d) 996; Irvington Investments Co., 32 B. T. A. 1165; A. D. Saenger, Inc., supra; R. & L., Inc., 33 B. T. A. 857; affd., 84 Fed. (2d) 721; certiorari denied, 299 U. S. 588; Edward G. Swartz, Inc., 33 B. T. A. 355; Rands, Inc., 34 B. T. A. 1094; Almours Securities, Inc., supra. There is a substantial difference between the two classes of corporations, although I would not go so far as to say that the former could never be subjected to the penalty.

This being a “fact case”, it is with some reluctance that I reach a conclusion at variance with that of the Member who heard the testimony of the witnesses and had the advantage of observing their maimer and demeanor while testifying; but I feel that the evidence is not sufficient to justify the imposition of the penalty and accordingly I dissent.

SterNhageN, ArtjNdell, Mubdogk, Leech, Arhold, and DisNey agree with this dissent.


source: Caselaw Access Project

author: Hill:

license: Public Domain

text:
    Hawaiian-Philippine Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 69619.
    Promulgated December 17, 1936.

      George E. Cleary, Esq., and S. Milton Simpson, Esq., for the petitioner.

      E. A. Coes, Esq., and T. A. Dils, Esq., for the respondent.
   OPINION.

Hill:

Petitioner is a Philippine corporation which, during the fiscal year ended September 30,1930, sold in the United States certain sugar which it had received in the Philippine Islands as compensation for milling services. Admittedly it is subject .to the Federal income tax upon any net income derived from sources within the United States, and also it is conceded that if .petitioner realized any net profit from the sale of sugar in this country such profit was derived from these taxable sources. The issue presented for decision is whether or not petitioner in fact realized any net income from such sources during the taxable years, within the purview of the applicable provisions of the revenue act. The parties are in sharp disagreement as to the proper method of determining this question.

In the deficiency notice respondent determined a deficiency of $66,403.47, computed on the basis of a net income of $565,135.94 as shown in schedule 1 of the revenue agent’s report, which started with “Net income as disclosed by books”, subject to certain adjustments not material here. Thus, the adjusted net income, upon the basis of which respondent determined the deficiency, consisted of the total net income realized by petitioner from all sources, with the exception of certain items of Philippine income excluded by the revenue agent in the adjustments above referred to.

Respondent does not here contend that the deficiency so determined by him represents petitioner’s correct tax liability, nor that the proper method was used for computing petitioner’s net income from sources within the United States. On the contrary, respondent now argues on brief that the profits realized by petitioner from the manufacture of raw sugar in the Philippine Islands and its sale in the United States constituted “gains, profits and income from the sale of personal property” produced by petitioner without and sold within the United States, and that the statute requires that such profits should be apportioned between sources within the United States and sources without the United States. Obviously, such an apportionment, to the extent the profits were thereby attributed to Philippine sources, would reduce the amount of the deficiency originally determined by respondent.

Petitioner contends that the provisions of the statute relied on by respondent are hot applicable under the facts of this case, and asserts that it sustained a net operating loss of $16,792.45, instead of realizing net income, from sources within the United States during the taxable year.

The pertinent provisions of the statute are quoted in the margin.

That petitioner realized substantial net “gains, profits and income” from the operation of its business during the taxable year is not denied. The only controversy between the parties is whether or not any portion of such net income is properly attributable under the statute to United States sources. The statute lays down very comprehensive general rules for determination of the sources of income, and provides that items, either of gross income or deductions, not directly attributable to sources within or without the United States, shall be allocated or apportioned under rules and regulations prescribed by the Commissioner. It is settled that such rules and regulations, if reasonably designed to carry into effect the general provisions of the statute, have the force and effect of law. Maryland Casualty Co. v. United States, 251 U. S. 342, 349. However, detailed reference to the regulations promulgated under the quoted statute we think is unnecessary, since the issue goes to the matter of determining the particular source of the gross income rather than to an allocation of gross income from undeterminable sources. As to deductible items of expense not directly attributable to a definite source, there appears to be no controversy respecting the application of respondent’s regulations.

Consideration of the general provisions of the statute fails to indicate any intention on the part of Congress arbitrarily to fix the “sources” of income or to give to the term “income” any other than its ordinarily accepted meaning, as defined in Eisner v. Macomber, 252 U. S. 189. The allocation or apportionment provisions apply, and plainly are intended to apply, only to items of income and deductions which can not properly be ascribed in their entirety to sources within or without the United States. Here we are not dealing with income of that classification, and hence respondent’s position, we think, can not be sustained.

Petitioner, under the milling contracts, ground the cane of the planters and manufactured the sucrose content into raw centrifugal sugar, receiving as compensation for its milling services a portion of the sugar, which it sold in the United States. The cane belonged to the planters, and the title to the share of the sugar retained by petitioner passed to petitioner only upon the manufacture thereof. The milling contracts were in the nature of a bailment, not a sale, and petitioner’s portion of the sugar constituted income to it at the place and time of receipt to the extent of its fair market value. San Carlos Milling Co., Ltd., 24 B. T. A. 1132; affd., 63 Fed. (2d) 153.

The facts in the cited case, in all material respects, are the same as in the case at bar. There the petitioner operated a sugar mill in the Philippine Islands under contracts with planters of sugar cane whereby it milled the cane produced by the planters and accepted as compensation for its milling services a percentage of the manufactured sugar. In our opinion, we said, beginning at page 1140.:

The record supports the intent of the parties, as expressed in the contract, to compensate the petitioner for milling the cane into sugar by allowing the petitioner to retain 40 per cent of the sugar produced. * * * The plain language of the contracts and the action of the parties show that these were milling contracts for the manufacture of sugar by the petitioner from the planter’s cane and that petitioner was to have a toll or share of the sugar manufactured as compensation for its services. Such provisions would have been wholly unnecessary had the parties to those contracts contemplated a sale of the cane to the petitioner. * * * the transaction contained elements of bailment and lacked elements of sale. * * * The petitioner realized income at the time and place the sugar was received to the extent of its fair market value. * * *
The amount of sugar received by petitioner being stipulated, there remains the question of its fair market value on the several dates when received. There was an established market for 96-degree centrifugal sugar in the Philippine Islands and the record shows that petitioner sold some of its sugar there. We have before us quotations of prices on actual sales of sugar on or about the dates that petitioner received the sugar for its milling services. In the circumstances we hold that the average quoted price on a given date is the fair market value of the sugar received by the petitioner on or about that date. Cf. Ralph Andrew Applegate, Executor, 10 B. T. A. 705; Western Bank & Trust Co., 19 B. T. A. 401.
Upon the sale of sugar in the United States the petitioner received income from sources within the United States, even though the sugar was manufactured in the Philippine Islands. See Porto Rico Consolidated Fruit Co., 16 B. T. A. 778, and eases there cited. The amount of that income is the gain derived from the sale, and not the total amount of the sale price received for the sugar. The cost basis of the sugar received as compensation for services rendered in the Philippine Islands and sold within the United States is the fair market value of that sugar at the time received (cf. W. R. Jacques, 5 B. T. A. 56; J. Heninger, 9 B. T. A. 1318; William T. Bivin, 21 B. T. A. 1051), to which should be added the expense incurred by the petitioner in forwarding the sugar to the United States, since the sales were made upon the basis of the price in the United States.

The principles applied in the Sam, Garlos case are equally applicable here, and all of the factors mentioned have been established either by stipulations of the parties or by undisputed evidence contained in the record. Based upon such factors and in harmony with the principles referred to, petitioner has appended to its brief a detailed computation which discloses that it sustained an operating net loss during the taxable year from sources within the United States.

Respondent has raised no objection to the deductions from gross income claimed by petitioner, nor otherwise pointed out any error in petitioner’s computation, except only in respect of certain specific items as follows:

(1) Respondent takes the position that petitioner has not correctly computed the fair market value of the sugar at its mill, which is used as the cost basis. It is the generally accepted rule that the value of goods for which there is no local market may be fixed by the value at the nearest market, less the cost of transportation thereto. See 17 C. • J. 909, 22 C. J. 189, and authorities cited. The evidence in the record before us shows that there was an established market for raw centrifugal sugar at Iloilo, about 25 miles from petitioner’s mill,, with daily government quotations. But respondent asserts that petitioner has taken the Iloilo price and instead of deducting therefrom the cost of transporting the sugar to Iloilo to determine the fair' market value at the mill, has added 8 centavos to the Iloilo price for lighterage charges. This contention appears to be based upon a misapprehension of the facts.

Petitioner’s computation starts with the Iloilo price and makes, certain compensating adjustments necessary to reflect the value at the mill. A small portion of the sugar was transported from petitioner’s dock to Iloilo at a cost of 12 centavos per picul, and was later transported by lighter from the warehouse in Iloilo to steamers in Iloilo harbor at an additional cost for lighterage of 8 centavos per picul. The balance of the sugar was lightered directly from petitioner’s dock to steamers in Iloilo harbor at a cost of 15 centavos per picul.

For convenience of computation petitioner first valued all the sugar at the Iloilo price, and then with respect to the sugar actually transported to Iloilo, excluded from United States deductions the cost of such transportation, but added to the Iloilo price the 8 centavos per picul for lighterage to the steamers. This latter item was properly treated as a part of the cost of getting the sugar from Iloilo to the United States, and the result is precisely the same whether the amount be deducted from the gross proceeds of sale as expense or added to the cost basis and deducted, as it was treated by petitioner. The sugar could not be shipped directly from petitioner’s mill to the United States but had to be lightered to steamers in Iloilo harbor.

As to the ^alance of sugar, which was taken by lighter directly from petitioner’s dock to steamers in Iloilo harbor, petitioner valued at the Iloilo price, plus the 8 centavos cost for lighterage to the steamers. The transportation cost from the mill to Iloilo is excluded from United States deductions. As above pointed out the lighterage cost at Iloilo is a proper United States deduction, and petitioner has merely added that amount to the Iloilo price instead of deducting from the proceeds of sale as expense.

Thus, as to both classes of sugar, petitioner’s computation reflects exactly the same result as would be obtained by taking as the fair market value of the sugar at the mill the Iloilo price, less the cost of transportation to Iloilo, and then treating all subsequent costs of transporting and selling as deductions from gross proceeds of sale in the United States. We find no merit in respondent’s contention on this point.

(2) The second item to which respondent objects is the deduction of commission paid by petitioner to its general agent for selling the sugar in the United States. Eespondent argues that the amount should be apportioned between sources within and without the United States. There is no contention that if the amount in controversy was in fact paid as commission for selling the sugar in the United States, it would not properly be deductible, but respondent asserts that it was compensation to the agent for its general services and not exclusive selling commission. The record, we think, does not sustain respondent’s contention. The evidence clearly establishes that the petitioner paid to Welch-Fairchild, Ltd., 75,214.77 pesos under the terms of the agency contract as “a commission of 2%% on the total sales of sugar in the United States.” It was not compensation for any other services, but constituted in its entirety commission on United States sales. We hold that the deduction claimed is allowable.

(3) Petitioner paid to the Philippine Government a sales tax in the amount of 25,067.46 pesos on the. sugar sold in the United States, which amount is claimed as a deduction from United States income. Eespondent assails this deduction on the ground that the amount represents an expenditure which petitioner in any event would have been compelled to make in order to receive the Iloilo price, and argues that the result of petitioner’s computation is to charge the tax against United States income twice, first when it is included in the Iloilo price, and again when deducted from United States income as a selling expense. Eespondent presents a novel contention on this point, and one which we think can not be sustained.

We can find no justification for concluding that the Iloilo price “included” the Philippine sales tax any more so than commissions, handling charges, transportation costs, or other expenses necessarily incurred in obtaining such price. We have reached the conclusion above that petitioner realized income in the Philippine Islands to the extent of the fair market value of the sugar at the mill when received. The word “income” as so used refers to gross income. It is immaterial whether petitioner derived any net income from the receipt of the sugar as compensation for milling services. The fair market value of the sugar at the time and place of receipt constitutes the cost basis of the sugar sold in the United States, and we are not advised of any judicial decision which holds that such value is to be determined by deducting from current market quotations the expense of selling the property. Ordinarily, expenses of selling are treated as deductions from gross income in computing net income, and do not enter into the determination of the fair market value. Market value, within the generally accepted meaning of that term, is defined as “the price at which a seller willing to sell at a fair price and buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will trade.” Mount v. Commissioner (C. C. A., 2d Cir.), 48 Fed. (2d) 550, 552. See also article 1568 of respondent’s Regulations 45.

The Revenue Act of 1928, in section 23 (c), provides that “Taxes paid or accrued within the taxable year” (with exceptions not applicable in this case) shall be allowed as deductions in computing net income. Since the taxes in controversy were paid during the taxable year solely on sugar exported to the United States, the amount in its entirety is properly deductible from gross income from sources within the United States, and there is no occasion to apply the apportionment provision of section 119 (e), supra.

(4) The remaining deduction to which respondent takes exception involves a portion of the income tax paid by petitioner to the Philippine Government, measured by its income from all sources. The total amount of this tax was 29,578.60 pesos, of which petitioner deducted from United States income 5,579.77 pesos. Respondent argues that this deduction should be disallowed for the reason that petitioner’s computation shows that it received a net income of more than half a. million dollars from Philippine sources and sustained a net loss from sources within the United States. Petitioner replies that it allocated the tax on the basis of the gross income derived from sources within and without the United States, in accordance with respondent’s own regulations.

However, decision of this question is not required since in any event, whether the disputed deduction is or is not properly allowable, the facts establish, and we so find, that petitioner derived no net income during the taxable year from sources within the United States. It is not important that we determine the amount of the operating loss sustained by petitioner from sources within the United States. It follows there is no tax due, and there is no question of overpayment. In these circumstances, no necessity appears for a recomputation under Rule 50.

Reviewed by the Board.

Judgment will be entered for the petitioner.

       Revenue Act of 1928—
      SBC. 119. INCOME FROM SOURCBS WITHIN UNITED STATES.
      *******
      (e) Income from sources partly within and partly without United States.• — Items of gross income, expenses, losses and deductions, other than those specified in subsections (a) and (c) of this section, shall be allocated or apportioned to sources within or without the united States, under rules and regulations prescribed by the Commissioner with the approval of the Secretary. Where items of gross income are separately allocated to sources within the united States, there shall be deducted (for the purpose of computing the net income therefrom) the expenses, losses and other deductions properly apportioned or allocated thereto and a ratable part of other expenses, losses or other deductions which can not definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the united States. In the case of gross income derived from sources partly within and partly without the united States, the net income may first be computed by deducting the expenses, losses or other deductions apportioned or allocated thereto and a ratable part of any expenses, losses or other deductions which can not definitely be allocated to some item or class of gross income ; and the portion of such net income attributable to sources within the United States may be determined by processes or formulas of general apportionment prescribed by the Commissioner with the approval of the Secretary. Gains, profits and income from * * * (2) the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the United States, or produced (in whole or in part) by the taxpayer without and sold within the United States; shall be treated as derived partly from sources within and partly from sources Without the United States. Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property without and its sale within the United States, shall be treated as derived entirely from sources within the country in which sold, except that gains, profits and income derived from the purchase of personal property within the United States and its sale within a possession of the United States or from the purchase of personal property within a possession of the United States and its sale within the United States shall be treated as derived partly from sources within and partly from sources without the United States.


author: MoRRis:

text:
    Jacob Schneider and Ben W. Hollander, as Executors of the Estate of Adolph Hollander, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79862.
    Promulgated December 17, 1936.

      J. Marvin Hmjnes, Esq., O. J. McGuire, Esq., and W. G. Magathan, Esq., for tlie petitioners.

      Frank T. Homer, Esq., and Ralph F. Staubly, Esq., for the respondent.
   OPINION.

MoRRis:

The respondent “recognizes that the decedent, at the time the transfers were made, was in excellent physical condition, active, and robust, and that the transfers were not made causa mortis, that is, that the transfers were not motivated or prompted by any apprehension arising from a physical condition that led the decedent to believe death was imminent, impending, or near at hand”; and he does “not contend that the transfers are taxable by reason of such an apprehension, or because such transfers were made cama mortis.”

Whether a gift is made in contemplation of death or not depends upon the primary or dominating motive which prompted the making of the gift and this motive is to be ascertained from all of the surrounding circumstances when the gift was made. If death — be it impending or distant — prompted the gift, it falls within the ambit •of the statute. The respondent admits the good health of the decedent during all of the period when the transfers under consideration were made.

There is an abundance of testimony substantiating the fact that these various transfers — excepting the Atlantic City property purchased by the decedent in his wife’s name — were not only not made in contemplation of death but that other motives associated entirely with life were the generating source. They were prompted by the state.of affairs which grew out of the decedent’s early remarriage. Two trusts were established to provide an income for the decedent’s wife, one at the time of separation, and because of separation, and the other in order to effect reconciliation. Those were the irrevocable trusts of January 24, 1923, and April 12, 1923, from which she received the income and finally the corpus.

The February 3, 1923, transfer of the High Street property added little to what had been accomplished by the transfer of that property on October 3, 1922, except that, out of precaution, the decedent’s wife had been joined in the conveyance in order that there be no question about the property being free from dower claims. This transfer, at the outset, was to carry out the expressed wish of the decendent’s first wife by a devise found to be erroneously conceived when her will was admitted to probate. The other transfers were a part of the plan devised by the decedent’s children in combination with his personal attorney to protect the decedent’s estate from dissipation and to provide him with a life income. There is not a scintilla of evidence in the record — except what amounts to pure inference drawn from the advanced age of the decedent in 1923 when these various transfers took place — from which any logical conclusion could be drawn that the decedent contemplated or even gave thought to the question of death.

We believe, from all of the testimony and documentary evidence, that there is no justification whatsoever for the determination that he made these various transfers in contemplation of death within the meaning of that term as defined in United States v. Wells, 283 U. S. 102.

The purchase of the Atlantic City property by the decedent in his wife’s name occurred after he was stricken with paralysis. Practically all we know is that the property was purchased and that it was placed in the name of Mrs. Hollander. The record is silent of any motive for the gift. In this particular the respondent’s determination must be approved, for lack of evidence.

It is the contention of the respondent that certain of these transfers are nevertheless taxable to the estate of the decedent under section 302 of the Revenue Act of 1926, as amended by section 803 of the Act of 1932, as transfers intended to take effect in possession or enjoyment at or after death. We are of the opinion that, except as to the trust involving the Málveme Street property, they can not be so classified. In order for the estate tax to apply to these transactions, they must have been testamentary in effect, and in order for them to have been testamentary in effect, the thing to which the tax applies must have passed at the death of the decedent from his “possession, enjoyment, or control.” Helvering v. St. Louis Union Trust Co., 296 U. S. 39. Where the decedent has unqualifiedly vested a property right in another, in a transaction begun and completed during his lifetime, the tax does not attach, notwithstanding, the decedent reserved to himself a life interest. May v. Heiner, 281 U. S. 238. Nothing whatsoever passed to the living upon the death of this decedent which was not passed in 1923. This case is a much stronger one for the petitioner’s cause than where it is provided that upon failure of the property to vest in possession due to death of the grantee, it shall revert to the grantor, but the Supreme Court, in Helvering v. St. Louis Union Trust Co., supra, and Becker v. St. Louis Union Trust Co., 296 U. S. 48, has held that even under those circumstances and notwithstanding there is a possibility of a reversion to the grantor, nevertheless, such a grant is not one to take effect in possession or enjoyment at or after death. In respect to this contention, except as to the trust involving the Málveme Street property, the respondent is in error.

With respect to the Málveme Street property trust, the settlor reserved the right during his lifetime to manage and control the corpus without interference by the trustee and the power to lease the property the same as if no trust had been executed, at the same time reserving to himself all the income therefrom. By the retention of such powders, the “possession, enjoyment, or control” of the corpus passed at his death, and the transfer was testamentary in effect. The value of the corpus of this trust, which the respondent placed at $82,200, should be included, therefore, in the decedent’s gross estate.

Section 803 (a) of the Revenue Act of 1932 is not retroactive and has no bearing on the question here. Elizabeth B. Wallace, Executrix, 27 B. T. A. 902; affd., 71 Fed. (2d) 1002; certiorari denied, 293 U. S. 600.

Reviewed by the Board.

Judgment will be entered under Bule 50.


author: Tyson :

text:
    Easton Tractor and Equipment Company, Inc., and Ruth M. Easton, Liquidator of Easton Tractor and Equipment Company, Inc., Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 79891, 79892.
    Promulgated December 18, 1936.

      Ed. J. de Verges, Esq., and Sol Weil, G. P. A., for the petitioner. Lloyd W. Greason, Esq., for the respondent.
   opinion.

Tyson :

These consolidated proceedings seek redetermination of income tax deficiencies in the amounts of $624 for 1930, $390.75 for 1931, and $692.54 for 1932. That part of the deficiency asserted for the year 1931 growing out of the disallowances of $231.25 for donations and $625 for campaign contributions is not in controversy.

Petitioners assign error in the respondent’s disallowance of a claimed deduction in each of the years 1930 and 1931 for the amount of commissions paid to H. R. Brothers on sales of tractors to the Louisiana State Highway Commission based upon respondent’s determination that such commissions did not constitute ordinary and necessary business expense. Petitioners also assign error in the respondent’s disallowance of a claimed bad debt deduction in the amount of $10,073.32 for the year 1932.

The petitioner, Easton Tractor & Equipment Co., hereinafter called Easton, was during the taxable years a Louisiana corporation, with its principal office at Alexandria, Louisiana, and was at the time of the hearing herein in process of liquidation, with Eutli M. Easton, petitioner, as liquidator.

During the years here in controversy the petitioner, Easton, was engaged in the business of selling tractors and road machines. It was the exclusive agent of the Caterpillar Tractor Co. for making sales of that company’s tractors in a territory embracing 40 parishes in the northern part of the State of Louisiana and as such was allowed a 20 percent discount from the list price on all tractors sold by it. Other agents of the Caterpillar Co. making sales of its tractors in Easton’s territory were required to pay the latter certain commissions thereon. The petitioner, Easton, regularly employed four salesmen, other than E. H. Brothers, each of whom was paid a fixed salary and expenses, the total of which sometimes amounted to more and sometimes to less than 10 percent of the list price of tractors sold. Petitioner’s entire exclusive territory was divided between those four salesmen.

During each of the years 1930 and 1931 the petitioner, Easton, employed E. H. Brothers as its agent at Baton Eouge, the state capital, and agreed to pay him a commission of 10 percent on all tractors sold by him on behalf of Easton to the Louisiana State Highway Commission. Baton Eouge was not in Easton’s territory, but was in the territory of the New Orleans Tractor & Equipment Co., which employed Brothers in the same capacity as did petitioner.

The secretary and treasurer of the petitioner, Easton, testified in part as follows:

Q. Do you know of any reason why Mr. Brothers could make sales any better than or quicker or any more of them than any of the other ones of your salesmen?
A. Yes, I do.
Q. What were those reasons?
A. It was understood that Mr. Brothers was close to the administration — that any tractors sold would be — In other words that he could sell the tractors better than we could.
Q. When you say that “he was closer to the administration” you mean close to the State of Louisiana Administration, or government of that state?
A. That is what I understood.
Q. And because of the fact that he could facilitate these sales better than the others, is that right?
A. That is what I understood Mr. Easton to mean.
Q. Meaning by that, that he had some sort of inside connection or “pull” with the administration, which others did not have?
A. Well I do not know that.
Q. But that is your understanding?
A. That is my understanding from Mr. Easton, yes.
Q. And for that reason you employed him instead of leaving it to some of your regular employees?
A. That is what Mr. Easton advised.

The Mr. Easton referred to in the quoted testimony was the president of the petitioner, Easton, during the taxable years and at the time Brothers wa.s employed, but was deceased at the time of the hearing herein.

Upon the whole record we conclude that Brothers was employed by the petitioner, Easton, for the reason that his personal influence with the administration or government of the State of Louisiana placed him in an advantageous position to make sales to the Louisiana State Highway Commission.

During 1930 and 1931 Brothers made a number of sales of tractors on behalf of the petitioner, Easton, to the Louisiana State Highway Commission. The tractors were billed to the highway commission at the regular list price plus freight, just as was done in the case of each other customer. At various times during those two years Brothers drew drafts on the petitioner, Easton, which were honored by that petitioner’s checks, payable to the banks through which the drafts were presented. Brothers’ drafts on Easton were frequently made in advance and in excess of the 10 percent commission on sales completed by him, but at other times Easton was indebted to him for commissions due. During 1930 and 1931 Easton paid to Brothers commissions in the amounts of $2,200 and $2,400, respectively, on sales made by him to the Louisiana State Highway Commission. In its income tax returns for those years the petitioner, Easton, claimed deductions for such amounts, respectively, as ordinary and necessary business expenses. Despondent has disallowed the deductions upon his determination that the amounts so paid to Brothers were not ordinary and necessary business expenses within the meaning of the revenue acts. The agreement under which Brothers made the sales to the highway commission for which he was paid the commissions above mentioned was entered into for the purpose of utilizing, in the making of said sales, the personal influence Brothers had by reason of being “close” to the state administration or government.

We are immediately led to a consideration of whether the agreement was void and unenforceable as contrary to public policy, as is urged by the respondent. The question of the validity of agreements made with agents for the procurement by the agents of contracts from governmental departments, or to influence legislation, has been presented to the courts in many cases and it is held by the overwhelming weight of authority that when such agreements are made for the purpose of enlisting the exercise of the personal influence of the agent employed in securing such contracts with the Government or such legislation, the contract with the agent is void as against public policy.

A leading case on this subject is Tool Co. v. Norris, 2 Wall. 45. In that case, Norris was employed by the Tool Co. to obtain a contract for the sale to the United States Government through the Secretary of War of 25,000 muskets and was to be paid “in case he obtained a contract * * * for his services proportionate to its extent.” Norris “then set himself to work * * * to getting letters from people who might be supposed to have influence with Mr. Cameron, at that time Secretary of War, recommending him and his objects” and “By one means and another”, received influential introduction to the Secretary of War and “got the contract” for the Tool Co. Subsequently, the parties disagreed as to the amount of compensation to be paid Norris and he instituted suit for an amount claimed and obtained judgment therein. In reversing the judgment and holding the employment agreement to be against public policy, the Court said:

The question, then, is this: Can an agreement for compensation to procure a contract from the Government to furnish its supplies be enforced by the courts? We have no hesitation in answering the question in the negative. All contracts for supplies should be made with those, and with those only, who will execute them most faithfully, and at the least expense to the Government. Considerations as to- the most efficient and economical mode of meeting the public wants should alone control, in this respect, the action of every department of the Government. No other consideration can lawfully enter into the transaction, so far as the Government is concerned. Such is the rule of public policy; and whatever tends to introduce any other elements into the transaction, is against public policy. That agreements, like the one under consideration, have this tendency, is manifest. They tend to introduce personal solicitation, and personal influence, as elements in the procurement of contracts; and thus directly lead to inefficiency in the public service, and to unnecessary expenditures of the public funds. [Italics ours.]
* * * all agreements for pecuniary considerations to control the business operations of the Government, or the regular administration of Justice, or the appointments to public offices, or the ordinary course of legislation are void as against public policy, without reference to the question, whether improper means are contemplated or used in their execution.

In Oscanyan v. Arms Co., 103 U. S. 261, Oscanyan sued the Arms Co. for $136,000 alleged to be due him as commissions on an agreement with the Winchester Repeating Arms Co. for the sales of fire arms to the Ottoman Government, effected through his influence. From a judgment for the defendant in the United States Circuit Court, Oscanyan appealed to the Supreme Court, which affirmed the judgment of the lower court. The pertinent facts in this case showed that the Ottoman Government had sent to the United States a special representative of high rank to examine and report in regard to the purchase by that government of arms and machinery for its use. Oscanyan was Ottoman Consul in New. York and was a friend of the special representative, who made his headquarters in Oscanyan’s office while in this country. Manufacturers soon became aware qf the relation between the two men and one of them, a manufacturer of fire arms, the said Arms Co., agreed with Oscanyan to pay him commissions for the use of his influence in making sales to the Ottoman Government through the recommendations of his friend, its special representative. Such sales were made by Oscanyan and upon disagreement as to Oscanyan’s compensation the suit followed. The Court quoted with approval the excerpt above set out from the Tool case, supra, and, in holding the contract of employment of Oscanyan to be void as against public policy, and, after consideration of that feature of the case showing that both Oscanyan and the special representative were officers of the Ottoman Government and that the contract was consequently a corrupt one, further said:

But, independently of the official relation of the plaintiff (Oscanyan) to his government, the personal influence which he stipulated to exert upon another officer of that government was not the subject of bargain and sale. Personal influence to be exercised over an officer of government in the procurement of contracts, as justly observed by counsel, is not a vendible article in our system of laws and morals, and the courts of the United States will not lend their aid to the vendor to collect the price of the article. Numerous adjudications to this effect are found in the State and Federal courts. This is true when the vendor holds no official relations with the government, though the turpitude of the transaction becomes more glaring when he is also its officer.

The agreement of the petitioner, Easton, with Brothers under which Brothers sold the Louisiana State Highway Commission tractors and received the commissions here involved was, under the authority of the above cited cases, void as against public policy, the agreement having been made with the obvious purpose of securing the exercise by Brothers of his personal influence with the state administration or government in making said sales. Cf. Meguire v. Corwine, 101 U. S. 108; Hazelton v. Sheckells, 202 U. S. 71; Hayward v. Nordberg Manufacturing Co., 85 Fed. 4; Gil v. Williams & Davis, 12 La. Ann. 219; Burney's Heirs v. Ludeling, 47 La. Ann. 73; 16 So. 507; and Schneider v. Local Union No. 60, 116 La. 270; 40 So. 700.

We conclude that such commissions, having been paid on an agreement void and unenforceable because of its being in direct contravention of positive law, did not constitute such an ordinary and necessary expense as was contemplated by the applicable statute and the determination of the respondent in disallowing the deduction of such commissions is therefore approved. Cf. Great Northern Railway Co. v. Commissioner, 40 Fed. (2d) 872; certiorari denied, 282 U. S. 855; Burroughs Building Material Co. v. Commissioner, 47 Fed. (2d) 178; Chicago, R. I. & P. Ry. Co. v. Commissioner, 47 Fed. (2d) 990; certiorari denied, 284 U. S. 618; Mitchell M. Frey, Jr., et al., Executors, 1 B. T. A. 838; M. L. Heide, 2 B. T. A. 451; Bonnie Brothers, Inc., 15 B. T. A. 1231; M. Rea Gano, 19 B. T. A. 518; Lawrence A. Wagner, 30 B. T. A. 1099, and authorities cited therein; Kelley-Dempsey & Co., 31 B. T. A. 351.

The second issue in these proceedings, involves petitioners’ claim of a bad debt deduction in the amount of $10,073.32 for the year 1932, which was disallowed by respondent. In 1932 the petitioner, Easton, held approximately $50,000 of certificates of indebtedness issued to it by the Louisiana State Highway Commission, which in that year was indebted to many other creditors in addition to Easton, in amounts aggregating a very large sum, for which amounts similar certificates of indebtedness had been issued. During 1932 the State of Louisiana Highway bonds were selling below par and in order to satisfy the pressing claims of these creditors an arrangement was made whereby State of Louisiana Highway bonds of the par value of $15,000,000 were issued to the Pyramid Securities Co., to which company the creditors surrendered their certificates of indebtedness, which, in turn, wTere transferred to the Louisiana State Highway Commission. The Pyramid Securities Co. then pledged to several state banks the $15,000,000 par value of bonds as collateral for loans totaling $12,-000,000, the proceeds of which it used'to pay in cash to the creditors, including Easton, 80 percent of their claims. For the remaining un-j>aid 20 percent of such claims each creditor received a “Certificate of Participation in Proceeds Of State of Louisiana Highway Bonds, Series F” issued by the Hibernia Bank & Trust Co. as trustee under an agreement dated April 23, 1932, between that bank and the Pyramid Securities Co. Such certificates entitled the bearer, upon certain conditions, to participate proportionately in the net proceeds from the sale of the $15,000,000 par value State of Louisiana Highway bonds after payment therefrom of the $12,000,000 loan with interest. The certificate of participation provided for interest at the rate of 5 percent per annum, payable September 15, 1932, and semiannually thereafter, until the bonds should be sold. For the 20 percent unpaid portion of its original claim against the Louisiana State Highway Commission, Easton received one of the certificates of participation, dated April 25, 1932, for the principal amount of $10,073.32, and in the fall of 1932 the semiannual interest thereon was paid to and received by Easton. The State of Louisiana Highway bonds pledged as collateral were not sold during 1932. The petitioner, Easton, m 1932 charged off the amount of $10,073.32 as a worthless debt.

The record contains no evidence as to the actual worthlessness of the certificate of participation or the ascertainment that it was worthless during the year 1932. On the contrary, the fact that Easton was paid interest on its certificate in the fall of the year 1932 in which it was issued would indicate that the certificate was not worthless. Section 23 (j) of the Revenue Act of 1982, in providing for a deduction for bad debts, which corresponds to the similar provisions of the earlier acts, requires both an ascertainment of actual worthlessness and a charge-off within the taxable year for which the deduction is sought. Cf. Paul Pryibil, 31 B. T. A. 164. Because of petitioners’ failure to establish that the debt in controversy was in fact worthless and that petitioners ascertained such fact during the taxable year 1932, the respondent’s disallowance of the claimed bad debt deduction must be approved. Cf. Higginbotham-Bailey-Logan Co., 8 B. T. A. 566, 578; Domhoff & Joyce Co., 17 B. T. A. 1015; affd., 50 Fed. (2d) 893.

Reviewed by the Board.

Decision will be entered for respondent in both proceedings.


author: Arundell:

text:
    Dee Furey Mott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71903.
    Promulgated December 18, 1936.

      Prewitt Senvnies, Esg., for the petitioner.

      E. L. Gorbin, Esg., for the respondent.
   OPINION.

Arundell:

The loss claimed on the sale of Fourth National Investors stock was disallowed solely because of petitioner’s inability to substantiate cost and sales price figures at the time her return was audited. These figures were supplied at the hearing, and we have found them as facts with the amount of resulting loss which is deductible in 1930.

There is no issue as to the amount of the losses sustained on the Westinghouse and United States Steel stocks; the controversy is as to the year in which the losses are deductible. They are claimed as deductions for 1930. The respondent disallowed them as 1930 deductions, taking the position, as we understand it, first, that the sales were short sales and not covered until 1931, and, second, that if not short sales they were nevertheless not completed in 1930 because of petitioner’s failure to deliver stock certificates in that jrear.

The first proposition is unsound. “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 be made.” Provost v. United States, 269 U. S. 443. Here the petitioner owned the shares and they were within her control and available for delivery. She intended to sell the shares that she owned, and it is stipulated that they were sold. Mere failure to deliver certificates is not alone enough to establish a short sale. C. B. Ferree, 32 B. T. A. 725; affd., 84 Fed. (2d) 124. Accordingly, it is held that the sales of Westinghouse and United States Steel shares were not short sales.

Bespondent’s second proposition brings us into a field in which there is some confusion among the cases. His claim is that section 9520 of the Michigan Compiled Statutes of 1929 requires delivery of the certificates to complete the sale. That section, and those immediately following it enact into the Michigan statutes the provisions of the Uniform Stock Transfer Act, which has been adopted in twenty some states. That section, so far as material here, provides:

9520 Section 1.. (How title to certificates and shares may he transferred.) Title to a certificate and to the shares represented thereby can be transferred only,
(a) By delivery of the certificate indorsed either in blank or to a specific person * * *, or
(b) By delivery of the certificate and a separate 'document containing a written assignment of the certificate or a power of attorney to sell, assign, or transfer the same or the shares' represented thereby * * *.

The Michigan statutes also contain, like those of many other states, the provisions of the Uniform Sales Act, among which are the following, as numbered in Michigan Compiled Statutes of 1929:

9457 Section 18. Property in specific gcods passes when parties so intend. Where there is a contract to sell specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties' to the contract intend it to be transferred:
(2) For the purpose of ascertaining the intention of the parties, regard shall be had to the terms of the contract, the conduct of the parties, usages of trade and the circumstances of the case.
9458 Section 19. Rules for ascertaining intention. Unless a different intention appears, the following are the rules for ascertaining tlie intention of the parties as to the time at which the property in the goods is to pass to the buyer:
Rule 1. Where there is an unconditional contract to sell specific goods, in a deliverable state, the property in the goods passes to the buyer when the contract is made, and it is immaterial whether the time of payment, or the time of delivery, or both, be postponed.

The presence of the above provisions in the same statute books has given rise to the question of whether corporate stocks are subject to the provisions of the Uniform Sales Act (Sales of Goods Act it is called in some states), or whether they are in all respects governed by the Uniform Stock Transfer Act. No uniform rule has been laid down by the courts in the various jurisdictions. In Agar v. Orda, 144 Misc. 149; 258 N. Y. S. 274, it is said:

* * * The question whether shares of stock are “goods” within the meaning of the Sales Act has long been the subject of controversy. 44 Harv. Law. Rev. 998; 32 Col. Law Rev. 547, 896. The passage of the Uniform Stock Transfer Act (Personal Property Law, art. 6, as added by Laws 1913, c. 600) has further complicated the problem.
Williston and Benjamin both hold that shares of corporate stock do not fall within the definition of “goods” laid down in the Sales Act. Williston, Sales, Section 619; Benjamin, Sales (5th Ed.) p. 173.
In some jurisdictions it has been expressly held that shares of stock are not subject to the Sales Act. Millard v. Green, 94 Conn. 597, 110 A. 177, 9 A. L. R. 1610; Goodhue v. State Street Trust Co., 267 Mass. 28, 165 N. E. 701; Guppy v. Moltrup, 281 Pa. 343, 126 A. 766; Smith v. Lingelbach, 177 Wis. 170, 187 N. W. 1007. In other jurisdictions a contrary view prevails. Postal v. Hagist, 251 Ill. App. 454; Davis Laundry & Cleaing Co. v. Whitmore, 92 Ohio St. 44, 110 N. E. 518, Ann. Cas. 1917C, 988; Corwin v. Grays Harbor Washingtonian, 151 Wash. 585, 276 P. 902. In numerous eases the question was not squarely decided, the courts resorting to various sections of the Sales Act, as declaratory of the rules at common law. Walker v. Northern & Western Finance & Trading Corp'n., 199 App. Div. 471, 191 N. Y. S. 722; State ex rel. Spillman v. Central Purchasing Co., 118 Neb. 383, 389, 225 N. W. 46.

In concluding the opinion the court refers to an earlier New York case, Friedman, v. Bachmann, 234 App. Div. 267; 254 N. Y. S. 689, in which it was held without discussion that corporate shares were subject to the Sales of Goods Act, and holds:

* * * The decision in Friedman v. Bachmann purports to lay down a definite rule on a subject of widespread commercial interest. Although the historical correctness of this rule may be challenged, it reflects a practical rather than a legalistic conception of the status of shares of corporate stock, and tends to conform to the needs of modern business practice.

In affirming Agar v. Orda, the Court of Appeals said (264 N. Y. 248; 190 N. E. 479) :

* * * a strong argument may be made that the Legislature did not intend -to include certificates of stock in its definition of “goods.” Assuming that to be true, yet the fact remains that certificates of stock, like other “goods”, are freely bought hand to hand, and analogy so complete may dictate that the rules governing sales be applied alike to “goods” and other personal property freely bought and sold and passing from hand to hand.

In Louisiana the Uniform Stock Transfer Act was enacted in 1910. The limited purpose of section 1, prescribing how title may be transferred, is described by the Supreme Court of that state in State v. Schofield, 136 L. 720; 67 So. 557, as follows;

The statute does not undertake to prescribe an exclusive mode of evidencing as between the parties a sale of stocks; its object is merely to regulate the mode of transfer upon the books of the corporation and to furnish a rule for deciding between claimants contesting over the ownership of the stock.

From a consideration of the above cases it seems to us sound to conclude that the Uniform Stock Transfer Act is not intended to prescribe an exclusive method for transferring property in shares of stock and that the question of when the property passes may be determined under the provisions of the Uniform Sales Act (Sale of Goods Act). The courts of Michigan do not appear to have passed on this question, although it has been held in that State that corporate stock is “goods” within the statute of frauds. Sprague v. Hosie, 155 Mich. 30; 118 N. W. 497. Under the provisions of the Uniform Sales Act quoted above it is not necessary that the goods be actually delivered in order to have a completed sale. The time of passing of title, and completion of sale, of specific or ascertained goods depends on the intent of the parties to the contract. In this case the petitioner through her broker contracted to sell specific goods — her shares of stock — which were in a deliverable state, and her intent was to sell them in the year 1930. In fa'ct, the parties to the proceeding have stipulated that the shares “were sold by petitioner through E. A. Pierce and Company, a member of the New York Stock Exchange, on the 30th day of December, 1930.” We have not regarded this as conclusive of the question presented, as the question is one of law and, further, it must be read in connection with the other matters stipulated, including that of the date of delivery. Cf. Compania General, etc. v. Collector, 279 U. S. 306. The stipulation, however, is in accord with our conclusion that the petitioner did sell her shares on December 30, 1930.

The Circuit Courts of Appeal have reached the same conclusion in cases very close on their facts to this one arising in jurisdictions where both of the Uniform Acts above quoted are in effect. In Ruml v. Commissioner, 83 Fed. (24) 257, a New York case, the taxpayer in 1928 directed a broker to sell 4,000 shares of corporate stock owned by the taxpayer but then held by a bank as collateral for a loan. By reason of the loan, the taxpayer was unable to make delivery of certificates for 2,500 shares until 1929 and the loss on those shares was held by the Commissioner not deductible in 1928. The Board affirmed the Commissioner and the Circuit Court reversed. ‘The court found that it was the intention of the taxpayer to sell “the specific shares he owned and only those”, and upon this, coupled with the further intent of the parties “that the particular shares then owned by the petitioner should be delivered to the broker, it follows that title to them passed to the broker in December [1928].” The opinion reads in part:

* * * Losses must be realized before they are deductible. Weiss v. Wiener, 279 U. S. 333 [49 S. Ct. 337, 73 L. Ed. 720, 7Am. Fed. Tax. Rep. 8865], But when the evidence of realization is a sale of personal property it is not always necessary to deliver tile property before there may be a deduction of a loss. It is enough that the obligation to deliver is so fixed that the loss is reasonably certain in fact and ascertainable in amount. Lucas v. American Code Company, 280 U. S. 445.

In C. B. Ferree, 32 B. T. A. 125; affd., 84 Fed. (2d) 124, the taxpayer on December 27, 1929, had in his safety deposit box certificates for 800 shares of corporate stock. On that date he directed the sale of those 800 shares and the broker sold them on December 80 and 31 below cost to the taxpayer. There was no delivery of the certificates. In January and February 1930, the taxpayer through the same broker, bought 1,500 shares of the same stock and the broker delivered to him certificates for 700 shares. The Commissioner disallowed the loss on the 800 shares as a 1929 deduction, and the Board reversed, saying in part:

* * * In the present case, the failure to deliver appears to have been without substantial significance. In all substantial respects the transaction was complete and petitioner had realized the results of his purchase and sale as completely as he ever would.

The Circuit Court, in affirming the Board, referred to the provisions of the Sales Act of Pennsylvania and the Uniform Sales Act that “the intention of the parties governs” and quoted the provisions of rule 1 for ascertaining intention under the Sales Act, set out above in our quotation from the Michigan statutes. The opinion of the court concludes:

This petitioner intended to sell these shares in order to take a loss. This is justifiable under the statutes. The broker intended to execute the petitioner’s order. The Sales _ Act allows delay of delivery. The Revenue Act does not prevent the petitioner from keéping 800 shares of stock which he owes to the broker when the broker owes him 800 shares of the' same stock.

In Francis S. Appleby, 31 B. T. A. 533, a New York case (dismissed, C. C, A., 2d Cir., Oct. 1935), the taxpayer on December 30, 1930, directed a broker to sell for him shares in three corporations. The taxpayer owned the shares and had the certificates in his safety deposit box. The shares were sold on December 30, without delivery of the certificates by the taxpayer, who left town about that time and did not return until January 5, 1931. He made delivery the next day. In that case, as in this, the loss on the sale was claimed as a 1930 deduction and was disallowed by the Commissioner. It was contended there, as here, that as delivery was not made in 1930 title was not transferred under section 162 of. the Personal Property Law (which is the New York enactment of the Uniform Stock Transfer Act), and there was no completed sale in that year. Without analysis of the cited statute, we held that “in all substantial respects the transfer was, as to all concerned, effective in the earlier year [1930]”, and allowed the loss in that year.

The above cases in the state courts, the Federal courts, and the Board give what seems to us a sound interpretation to the Uniform Acts. They recognize the practical situation that exists in the daily purchase and sale of the shares of the many corporations whose stocks are on the market and apply to such transactions the general rules governing sales of personal property. Under the cited cases harmonizing the two Uniform Acts it must be held in this case the sales involved were completed in 1930. The petitioner intended to sell in 1930 specific shares then available for delivery and the broker intended to sell those shares. And, as said in the Ferree case, the Sales Act allows delay in delivery.

Our conclusion here need not rest on our interpretation of the Uniform Acts. These acts can not control the matter of deductions under a Federal revenue act. Deductions for losses, like those for depletion, Palmer v. Bender, 287 U. S. 551, and depreciation, Weiss v. Wiener, 279 U. S. 333, are determinable by the Federal statute. “State law may control only when the operation of the Federal taxing act by express language or necessary implication, makes its own operation dependent on state law.” Burnet v. Harmel, 287 U. S. 103. Here the statute allows deductions for “losses sustained during the taxable year.” In the cases cited above — the Ruml, Ferree, and Appleby cases — this statute has been interpreted to mean that the loss has been sustained in the year in which the shares are sold by the broker, even though delivery of the certificates is delayed until the next year. This construction of the loss provision of the statute is in line with the tendency of the courts “to give a uniform application to a nationwide scheme of taxation.” Burnet v. Harmel, supra. In this view it must be held here, following the Ruml and Ferree cases, that the loss was sustained in 1930 when the broker executed her order. In that year, regardless of refinements of title law, her obligation to deliver was fixed; her loss was certain in fact and ascertainable in amount. Ruml v. Commissioner, supra. Whether a different rule applies where certificates are not available for delivery need not be determined in this case.

Reviewed by the Board.

Decision will be entered imder Rule 50.


author: Smith:

text:
    Mrs. William P. Kyne, Petitioner, v. Commissioner of Internal Revenue, Respondent. William P. Kyne, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 83302, 83303.
    Promulgated December 23, 1936.

      William B. Hornblower, Esq., and Robert L. Schwerin^ O. P. A., for the petitioners.

      Owen W. Swecker, Esq., for the respondent.
   OPINION.

Smith:

These proceedings are for the redetermination of deficiencies in petitioners’ income tax for 1932 as follows:

The proceedings were consolidated for hearing. The only question in issue, which is common to both proceedings, is the right of the petitioners to deduct from gross income certain amounts expended during the taxable year to secure legislation which would legalize horse racing in the State of California.

The petitioners are husband and wife. They resided together in the State of California in 1932 and for that year filed separate income tax returns on the community property basis.

Petitioner William P. Kyne, hereinafter referred to as the petitioner, is general manager of the California Jockey Club and the Riverside Jockey Club of Kansas City, Missouri. He became interested in horse racing in the State of California in 1928. In 1932 he owned a one-third interest in the Tanforan Race Track located near San Francisco, California, -which had been in operation for about three years.

From 1928 until 1933 horse racing or betting on horse racing was illegal in the State of California, but was practiced at the Tanforan track under a so-called “option” system. The petitioner was manager of the option department.

In May or June 1932 the petitioner began a campaign to have horse racing legalized in the State of California. Threats of arrest against officers of the Tanforan Race Track were being made at that time. The petitioner’s associates in the Tanforan Race Track refused to cooperate with him in this undertaking and as a result the petitioner, on July 8, 1932, sold his one-third interest in the business for $90,000. He received $40,000 cash and notes for the balance. The petitioner continued his efforts to have horse racing legalized in the state and during the taxable year 1932 expended for that purpose $56,284.85. Of that amount $44,113.71 was his own money and $12,171.14 represented contributions made by others. The bulk of the expenditures was for office rent, printing and stationery, postage, attorneys’ fees, radio time, and advertising. A petition to have the question submitted to the people for a vote was circulated and the signatures of about 200,000 registered voters were secured.

As a result of the petitioner’s efforts a proposed act to legalize horse racing in the state was submitted to the voters in 1932 and failed by only one-half of one percent of the total vote cast. In the following year, however, a bill to make horse racing legal in the state was passed and became law.

In December 1933 the petitioner secured a permit from the Racing Commission of the State of California and acquired an interest in the California Jockey Club, which operates a race track at Bay Meadows, San Mateo, California.

In their separate income tax returns for 1932 each of the petitioners claimed the deduction of $22,056.86, representing one-half of the said amount of $44,113.71, as an ordinary and necessary business expense of that year. The respondent has disallowed the deduction of these amounts in determining the deficiencies herein.

Section 23 (a) of the Revenue Act of 1932 authorizes the deduction from gross income of “All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

In Welch v. Helvering, 290 U. S. 111, it was said that allowable deductions from gross income under this provision of the statute must be both “ordinary” and “necessary.” The Court there held that the payment of another’s debt without legal or other obligation was, in a high degree, “extraordinary” and not within the deductions contemplated by the statute. No less so, we think, are expenditures for the purpose of bringing about the enactment of laws favorable to horse racing.

In Kornhauser v. United States, 276 U. S. 145, the Supreme Court held that an expenditure directly connected with or which proximately resulted from the taxpayer’s business was a deductible business expense under the statute. It is to be noted that at the time the expenditures here were made the petitioner was not engaged in horse racing or, so far as the evidence shows, in any related business within the State of California. He had sold his interest in the Tanforan Nace Track before the expenditures were made and did not acquire an interest in the California Jockey Club race track until some time during the following year. In the light of these facts it can in no wise be said that the expenditures in question were directly connected with or proximately resulted from any business carried on by the petitioner.

The case of Sunset Scavenger Co. v. Helvering, 84 Fed. (2d) 453, is in point. The court there held, reversing the Board on this issue (31 B. T. A. 758), that expenditures made by the Sunset Scavenger Co. during 1927 and 1929 in printing circulars, newspaper advertising, and employment of speakers to address civic organizations and public gatherings to prevent enactment of certain proposed ordinances which were calculated to damage its business, were not ordinary and necessary business expenses and were not deductible from gross income. In its decision the court relied upon the Commissioner’s regulations — article 562 of Regulations 69, promulgated under the Revenue Act of 1926, and article 262 of Regulations 74, promulgated under the Revenue Act of 1928. These regulations provide in part that:

* * * Sums of money expended for lobbying purposes, tbe promotion or defeat of legislation, tbe exploitation of propaganda, including advertising other than trade advertising, and contributions for campaign expenses, are not deductible from gross income.

The same provision is found in article 262 of Regulations 77, promulgated under the Revenue Act of 1932. The quoted provision of the regulations relates to deductions allowable to corporations, but we see no reason why the same rule should not apply to deductions of individuals. In both instances the statute provides for the deduction of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

In Adler Co., 10 B. T. A. 849, we disallowed the deduction of an expenditure for the purpose of influencing laws favorable to the taxpayer’s liquor business. See also Old Mission Portland Cement Co. v. Commissioner, 69 Fed. (2d) 676; affd., 293 U. S. 289.

The respondent’s determination that the expenditures made by the petitioner to bring about the enactment of laws favorable to horse racing in the State of California are not deductible from gross income is sustained.

Judgments will he entered for the respondent.


author: SterNHAgen :

text:
    Gibbs & Hudson, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74683.
    Promulgated December 23, 1936.

      H. B. Jones, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   OPINION.

SterNHAgen :

1. The Commissioner, in the notice of deficiency, said, as to 1930:

1. Gain from sale of apartment understated-$142,031.55

and explained this item thus:

Profit realized in 1030 is $155i639.21, whereas the profit reported on the 1930 return was $13,607.76; the difference, or $142,031.55, is included in the adjusted income.

This adjustment by the Commissioner is not broken down in the deficiency notice, but it seems to embrace several adjustments which must be separately considered.

(a) In computing the gain from the sale of the Lowell apartment building, the petitioner includes, and the Commissioner refuses to include, in cost the $41,593 paid to Gibbs and Hudson, pursuant to the corporate resolution of June 15, 1928, for services performed. The services were entirely related to the construction of the building, being the architectural plans and specifications, the engineering and supervision of construction, the purchasing of materials, and the securing of loans and signing of the mortgage. The general duties of Gibbs and Hudson as officers of the corporation were not covered by this payment or the resolution authorizing it. The fact that these individuals were officers and equal shareholders, and their compensation for architectural and construction services were also equal, is a circumstance to be considered but not sufficient to establish the character of the payment of $41,593 as other than part of the cost of the building. The Commissioner’s exclusion of this amount from cost w7as error, Federal Plate Glass Co., 6 B. T. A. 351, 357; Grelck Condensed Buttermilk Co., 7 B. T. A. 79, 83; cf. New Jersey Bergen Square Realty Corporation, 22 B. T. A. 1324; Tom (Fayette T.) Moore, 19 B. T. A. 140.

(b) The petitioner now claims that the cost of The Lowell should include the $2,250 paid to Logan in 1932 in settlement of his claim to a “bonus” or share of the profit. The contention is not supported by the evidence. Neither the evidence as to the alleged promise to Logan in 1928 nor that as to the'settlement in 1932 is sufficient to establish a liability in 1930 or that the settlement made in 1932 was properly part of the cost of the building. And there is no more support for a deduction in 1930 as an accrued or sustained expense. The petitioner’s contention is not sustained. Cf. Lucas v. American Code Co., 280 U. S. 445; J. N. Pharr & Sons, Ltd. v. Commissioner, 56 Fed. (2d) 832; Clark Dredging Co. v. Commissioner, 63 Fed. (2d) 527; Pierce Oil Corporation, 32 B. T. A. 403, 418; Leichner & Jordan Co., 4 B. T. A. 133.

(c) Both parties are now agreed that the sale of the Lowell building was properly treated by the Commissioner as an installment sale under Revenue Act of 1928, section 44 (b), since in no event were the initial payments more than 40 percent of the selling price, the amount of the mortgage ($390,000) being treated as part of the selling price but not included in the initial payments, Burnet v. S. & L. Building Corporation, 288 U. S. 406. The controversy turns upon the proper treatment of the assigned right to certain future installments of the General Fruit Corporation’s note, the petitioner insisting that they may not be regarded as part of the initial payment, first, because they were in escrow and contingent upon the payment by the purchaser of his $50,000 note, and, if not for that reason, then because they were wholly without fair market value.

It has been held that when an escrow stands in the way of receipt by a vendor of his sale price, he may not be taxed as if he received the price directly. Preston R. Bassett, 33 B. T. A. 182, 190 (on review, C. C. A., 2d Cir.) ; Rebecca J. Murray, 28 B. T. A. 624. The petitioner, therefore, did not receive the escrow in 1930, and it may not be treated as part of the initial payment in that year.

But, although the assigned installments of the Fruit Co.’s note are no part of the initial payment, they are properly part of the sale price, and serve to measure the total profit to be realized from the entire.installment sale of the building and in turn the proportionate part of the initial payment which is to be taxed in 1930 as gain. It is necessary for this purpose to determine their fair market value on April 15, 1930. The sale was on that date in all substantial respects complete, even though the deed was not delivered to the purchaser in 1930, Union Pacific Railroad Co., 32 B. T. A. 383, 390; affd., 86 Fed. (2d) 637. It can not be held, as petitioner urges, that Youell had only an option, or that petitioner’s right to the assigned installments of the Fruit Co.’s note was so contingent as not to be a present part of the price.

The question is their value on April 15,1930, when they became part of the total price. Upon this there is substantial evidence of various qualities and weight. As shown in the findings, the installments were of a face value, when payable in the future, aggregating $191,129.87, and were, on April 15, 1930, of a fair market value of $48,079.13. This finding is the result of a full consideration of all the evidence, and is the amount which should be included as the part of the total sale price represented by the Fruit Co.’s note. The other factors of computation of the total sale price and initial payment are not in dispute. This sale- price should be applied against a cost which includes the $41,593 paid to Gibbs and Hudson and excludes the $2,250 paid to Logan.

2. The Commissioner reduced the deduction for salaries of Gibbs and Hudson from $30,000, the amount actually authorized in 1930, to $12,000, the amount which the Commissioner regarded as the maximum reasonable allowance for the services performed. The evidence shows what the services were and a reasonable measure of their value. Considering all the evidence results in the finding that has been made that the salaries of $30,000 were authorized and accrued in 1930 and were no more than a reasonable allowance for the services performed. The amount is, therefore, properly a part of ordinary and necessary expenses and properly deductible. The respondent’s determination as to this is reversed.

3. The petitioner included no interest on Youell’s note for $50,000 in its gross income for 1930. The Commissioner computed the interest at 7 percent from April 15 to December 31, 1930, and added the amount, $2,429.17, to gross income in determining the deficiency. This was correct. The petitioner’s tax was computed on the accrual basis and the interest had clearly accrued. There is no force in the possibility that Youell might in fact have defaulted or that the maturity of the note was postponed until 1931. In either event the interest was a contractual obligation which accrued in 1930. This item of the respondent’s determination is sustained.

4. The Commissioner disallowed the deduction of $300 out of $900 legal fees paid in 1930, because he thought the amount was a retainer for 1931. The evidence shows that the Commissioner was mistaken and that the attorney’s employment was discontinued in 1930. The character or amount of the payment is not otherwise questioned. The Commissioner’s disallowance is reversed.'

5. The Commissioner imposed a penalty of 5 percent under the Revenue Act of 1928, section 293 (a), and this is proper “if any part of the deficiency is due to negligence or intentional disregard of rules and regulations.” Unlike a fraud penalty, the burden is upon the taxpayer to prove the 5 percent penalty to have been imposed in error. Regulations 74, article 353, clearly requires -that the total selling price be used in the computation of the total profit and as a means of computing the amount of profit in the initial payment of the taxable year. There was no good reason for the petitioner to omit entirely the Fruit Co.’s notes or the Youell $50,000 note from the total selling price. Nothing in the evidence justifies the omission, and it was in plain disregard of the clear rule of the regulation. That it was intentional is inescapable. If, however, there were any doubt about the intent, it would still be necessary to attribute the omission to negligence. The penalty of 5 percent was properly applied, although of course the amount will be modified in accordance with the modified deficiency.

Judgment will be entered under Rule SO.

       Paul and Mertens, Law of Federal Income Tax, §12.17.