author: Tetissell:

text:
    Appeal of Arrowhead Mills, Inc.
    Docket No. 3214.
    Decided November 9, 1926.
    Paid-in subpi.us.' — The taxpayer claimed a paid-in surplus under the provisions of section 326(a) (2) of the Revenue Act of 1918. Held, that the evidence respecting the character and value of the property paid in, as well as the opinion testimony concerning such value, is too general and indefinite to warrant the Board in finding a definite value in excess of the amount for which stock was issued, and that the claim for paid-in surplus is not sustained.

      Lawrence A. Baker, Esq., and J. Edward Murphy, Esq., for the petitioner.

      A. H. Fast, Esq., for the Commissioner.
    The petitioner complains of a deficiency letter, dated February 25, 1925, asserting deficiencies in tax for the fiscal year ended April 30, 1919, in the amount of $604.41, and for the fiscal year ended April 30, 1920, in the amount of $16,104.74, and showing an over-assessment for the fiscal year ended April 30, 1921, in the amount of $4,211.76, and prays for a redetermination of the deficiencies in tax there set forth. The issue in controversy is the actual cash value of a sulphite mill on May 10, 1916, when paid in to the taxpayer corporation for stock, and whether the taxpayer may include in its invested capital a paid-in surplus under the provisions of section 326(a) (2) of the Revenue Act of 1918.
    FINDINGS OF FACT.
    The taxpayer is a New York corporation with its principal office at Fulton. It was incorporated in April, 1916, with an authorized capital stock of $250,000, consisting of 2,500 shares with a par value of $100 each.
    The Battle Island Paper Co., a New York corporation, was organized in 1901. Soon after the company was organized it constructed a sulphite mill on an island in the Oswego River about two miles north of the Town of Fulton. The power for operation of the mill was derived from what was known as the Battle Island Dam, located about one and one-quarter miles below the mill. In 1912 the property in and around the dam ivas appropriated by the State of New York for barge canal purposes, and a dam known as the Minetto Dam was built by the State two and one-half miles below the Battle Island Dam. This dam was raised to such a height that the Battle Island Dam was submerged and the water power destroyed.
    In July, 1914, the Battle Island Paper Co. went into bankruptcy. The actual cost of the mill “ at the time of the bankruptcy ” was $392,294.13. The land on which the mill was located cost $5,500. On November 27, 1915, the mill, including land, was sold by the trustees in bankruptcy to S. Gay Daley for $35,000. Subsequently, F. A. Emerick, through his agent, Nelson T. Whitaker, entered into negotiations with Daley for the purchase of the property. The purchase was concluded on December 24,1915, when Daley and his wife conveyed the property to Whitaker for a consideration of $50,000. At that time the mill had been idle for approximately two years because it had no power on which to operate.
    On the 16th day of February, 1916, Whitaker, again acting as agent for F. A. Emerick, negotiated a lease with the Granby Pulp & Paper Co., for water power sufficient to generate 1,200 horse-power of electricity, for which the lessee was to pay $25 per horse-power per year. The lease was for a period of one year from the date on which the lessee should begin to use the power and was renewable from year to year for nineteen successive years on the same terms. The majority of the stock of the Granby Pulp & Paper Co. was owned by F. A. Emerick, for whom Whitaker acted as agent. The dam of the Granby Pulp & Paper Co. was located two and one-half miles above the Battle Island Mill.
    On March 20, 1916, a permit was issued, on certain conditions, to Nelson L. Whitaker, by the Superintendent of Public Works of the State of New York, whereby Whitaker was permitted to construct and maintain transmission lines along the river north of the City of Fulton to the mill property. The conditions were accepted by Whitaker on March 21, 1916. On March 13, 1916, a resolution was passed.by the Board of Public Works of the City of Fulton granting permission to Nelson T. Whitaker to construct and maintain a conduit for the purpose of conducting electrical current through the City of Fulton.
    On May 10, 1916, the sulphite mill at Battle Island was conveyed to the taxpayer and $50,000 of the capital stock of the taxpayer was issued to F. A. Emerick therefor. On May 12, 1916, the permit, issued to Whitaker by the State of New York authorizing construction and maintenance of the transmission lines was transferred to the taxpayer. On May 15, 1916, Whitaker assigned to the taxpayer the permit issued to him by the City of Fulton, and on the same day he assigned to the taxpayer the lease of water power from the Granby Pulp & Paper Co. These assignments recited as consideration one dollar and other valuable consideration.
    The only other power available for the operation of the sulphite mill was owned by the Niagara Company and could be obtained only by the payment of a power charge, a service charge, and a peak load charge. Inasmuch as the operation of the sulphite mill would be very irregular, the cost of power from the Niagara Company would be prohibitive, since it would be approximately $100 per horse-power per year.
    Following the organization of the taxpayer corporation, and between May 19 and October 23, 1916, F. A. Emerick purchased and paid cash for $108,000 par of the taxpayer corporation’s stock, and other persons purchased and paid cash for $92,000 of such stock.
   OPINION.

Tetissell:

The taxpayer claims that the sulphite mill at Battle Island had on May 10, 1916, a true value of at least $300,000, and that it is therefore entitled to have the benefit of a paid-in surplus of $250,000 under the provisions of section 326(a) (2) of the Revenue Act of 1918, which provides for the inclusion in invested capital, among other things, of

Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus * * *.

It appears from the record of this case that, the Battle Island Mill property, constructed in the year 1901, together with additions and improvements made up to July, 1914, had cost, together with the land upon which it was located, $397,794.13; that in July, 1914, its owner had become bankrupt, that on November 27,1915, the trustees in bankruptcy sold the property for $35,000, and that thereafter, on December 24, 1915, the purchaser at the trustees’ sale sold the property for $50,000. We have held in the Appeals of Markenheim Co., 1 B. T. A. 1240, and Pittsburgh Grinding Wheel Co., 2 B. T. A. 712, that prices received for property sold by receivers or trustees in bankruptcy or under mortgage foreclosure are not necessarily a measure of the true or fair value of such properties, and that for establishing the invested capital of a taxpayer the true values of such properties may be determined upon the basis of other evidence.

It is also shown in this record that the Battle Island Mill had been deprived of its source of power by having the same appropriated by the State of New York for public uses; that the mill had thus been forced into a state of disuse and that at the time of the bankruptcy sale it had remained idle for approximately two years, and that, deprived of its source of power, it was incapable of being used for the purposes for which it was constructed and intended. The record also shows that the last named purchasers had been able to arrange for the restoration of power and thus again to restore the property to a condition capable of its profitable uses and the taxpayer’s claim for the value of $300,000 rests chiefly upon the situation created by the restoration of power privileges. We are not unconscious of the merit of this contention and we find much support for it in such authorities as Pittsburgh, &c. Ry. Co. v. Backus, 154 U. S. 421; Boom Co. v. Patterson, 98 U. S. 403; and San Diego Land & Town Co. v. Neale, 78 Cal. 63; 20 Pac. 372.

We are thus brought to a consideration of the testimony respecting the value and the uses of the property here under consideration. We know what the property had cost, that it had been in use for about 13 years, and that it had remained idle for 2 years, but concerning its condition in May, 1916, the record is silent. Whether all of the construction and machinery and equipment which had entered into the figures of its cost were present in May, 1916, we are uninformed, and the record furnishes us no information respecting the exhaustion, wear and tear which the property had suffered during the years of its use and the years of its idleness.

The taxpayer produced two witnesses who gave opinion testimony concerning the value of the property with power restored. One of these witnesses was the purchaser at the $50,000 sale and the organizer of the taxpayer corporation. The other was a member of an engineering organization engaged in designing and constructing properties of a similar character. We have no doubt that both of these witnesses are qualified, both by education and experience, to testify concerning the values of such property, but their testimony does not convince us of the value claimed. In other cases, notably Appeal of American Express Co., 2 B. T. A. 498, where the Board has accepted opinion testimony of value, the witnesses have given much detailed information and data in support of their opinions, the like of which is wholly lacking in the record of this case.

While we might have little doubt that this sulphite mill property, in May, 1916, had a value in excess of $50,000, we are unable from the testimony to determine what the amount of that excess might be, and we are, therefore, unable to find with any approximate certainty that the property had an actual cash value substantially in excess of the par value of the stock issued in exchange for it. Judgment must, therefore, be found for the Commissioner.

Order of redetermination finding deficiencies for the fiscal years ended April SO, 1919, and 1920, in the amounts of $60⅛.⅛1 and $16,10^.7^., will he entered.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    W. S. Peebles and Lutie Patton Pryor, Administrators, Estate of Luke Pryor, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9380.
    Decided November 9, 1926.
    Value of gross estate determined.

      E. W. G-odbey, Esq., for the petitioners.

      Ward Loveless, Esq., for the respondent.
    This is a proceeding for the rédetermination of a deficiency in estate tax in the amount of $277.60. Questions at issue are: (1) Did the Commissioner in determining the deficiency include in the value of the gross estate a homestead exemption of $2,000? (2) Was the amount of $7,458.89, representing rents, correctly included in the value of the gross estate?
    FINDINGS OF FACT.
    The decedent, Luke Pryor, died intestate on September 30, 1923, leaving real and personal property in excess of $50,000. Part of the property consisted of a large plantation in Limestone County, Ala., the value of which, as reported in the Federal estate-tax return, was $97,500.
    The value of the gross estate, as first determined by the Commissioner in a letter addressed to the petitioners under date of April 22, 1925, was $259,616.67. This letter stated a deficiency in tax of $374.44. As a result of protests that the Commissioner had included in the value of the gross estate $2,000, representing a homestead exemption allowed by the statutes of Alabama, the Commissioner reduced the value of the gross estate to $257,616.67, as shown by the deficiency letter of September 26, 1925, from which this appeal is taken. This letter shows a deficiency in estate tax of only $277.60.
    The decedent’s plantation was farmed in three Avays: (1) By hired hands, (2) by share croppers, and (3) by tenants paying one-fourth of the cotton produced and one-third of the other crops raised.
    At the date of decedent’s death, September 30, 1923, the crops were largely ungathered and unmatured. Only a part of the cotton was ready for picking and no corn had been harvested or was fit for harvest. Prior to decedent’s death, 27 bales of cotton of the average weight of 500 pounds each, and of the average value of 28 cents per pound, had been picked and ginned and, after having been ginned, had been hauled and deposited on the landlord’s “ grass-lot ” near the mansion house. An additional bale raised by one tenant had been purchased and acquired by the decedent. The landlord’s portion of the 1923 crops gathered up to the date of his decease is shown by the following:

    Included in the gross estate shown by the Federal estate-tax return Avas $7,458.89 for rents. The summary of rents is as follows:
    Louis Poll, rent Oakland Place-$2, 989.79
    Tenant’s rent, cotton, ⅛- 8,132.44
    Tenant’s rent, corn, ⅛- 323. 25
    Tenant’s rent, bay- 30. 00
    Tenant’s rent, beans and peas_ _
    Tenant’s rent, cotton seed, ⅛- 348.46
    Tenant’s rent, seed cotton_ 59. 04
    Share croppers’ cotton rents, ½ of ⅛- 750. 21
    Share croppers’ corn rents, ½ of ½- 29.25
    Share croppers’ cotton seed, ⅜ of ½- 37.53
    Share croppers’ hay, ½ of ½- -
    Share croppers’ seed cotton, ½ of ½- -
    7, 699. 97
    Less for poison, fertilizers, etc., furnished by owner- 241. 08
    7, 458.89
    After the decedent’s death the administrators completed the gathering and marketing of the crops. The tenant (Poff) of the Oakland Place, the most important single unit, proved contentious. As soon as possible after the rents matured (November first), the administrators sued out a sweeping attachment against his crops. The total yield of the entire section of land was less than $3,800 and was, according to the sheriif⅛ inventory, as follows:
    Cotton, 10,944 lbs_$3, 502. 08
    Corn, 9,800 lbs_ 122. IT
    Hay, 6,585 lbs_ 46.79
    Cotton seed, 1,513 lbs_ 31.77
    3, 702. 81
    The customary rental of one-fourth of the cotton and one-third of the other crops called for a rental of less than $1,000. The litigation was settled for $2,989.79, which is the amount listed above as rent for the Oakland Place.
   OPINION.

Smith:

The petitioner alleges error on the part of the Commissioner with respect to the $2,000 homestead exemption. It is very evident, however, from the findings of fact, that the Commissioner has not included in the value of the gross estate shown in the deficiency letter the $2,000 homestead exemption.

The only other point in issue is whether there should be included in the value of the gross estate $97,500 as the value of the real estate, and in addition $7,458.89 for the landlord’s portion of the 1923 crops, most of which were unmatured and ungathered at the date of his decease. The petitioners listed the rents received by the administrators in the estate-tax return, but it is their contention that they were listed only for the purpose of showing the income from the real estate; that they were fully taxed when the decedent’s lands were assessed for estate-tax purposes as part and parcel of the land itself, and that it was error on the part of the Commissioner to add to the $97,500, reported as the value of the real estate, any amount representing the decedent’s interest in the growing crops.

At the hearing of this appeal it was admitted by the petitioners that the value of the decedent’s interest in the crops which had been severed, amounting to $1,401.95, was properly included by the Commissioner as a part of the gross estate.

Section 402 of the Revenue Act of 1921, under the provisions of which the estate-tax return was made, provides in part:

That the value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
(a) To the extent of the interest therein of the decedent at the time of his death which after his death is subject to the payment of the charges against his estate and the expenses of its administration and is subject to distribution as part of his estate.

Section 5841 of the Civil Code of Alabama, 1923, provides that:

Any crop commenced by a decedent may be completed and gathered by the executor or administrator, and, the expenses of the plantation being deducted therefrom, is assets in his hands, and may be sold by him at private sale, either in or out of the state.

The general rule of the common law is that growing crops, which are the product of annual sowing or planting, form a part of the real estate to which they are attached. Chancellor v. Teel, 141 Ala. 634; 37 So. 665. Growing and unharvested crops on the land of a decedent at the time of his death, such as are raised annually or periodically by labor and planting, go to the personal representatives as assets rather than to the heirs-at-law where the land is not specifically devised. Marx v. Nelms, 95 Ala. 304; 10 So. 551; Mitcham v. Moore, 73 Ala. 542.

In the instant case we are not concerned primarily with the question whether the growing crops at the date of the death of the decedent were realty or personalty. In either case the value of the decedent’s interest in them must be included in the value of the gross estate.

With respect to the amount of rent reported as having been received from Louis Poff, with the explanation that it represented the amount of rent from the Oakland Place, i. e., $2,989.79, the findings of fact show that this amount was received as a compromise of litigation started by the administrators. It further appears that the total yield of the crops raised on the Oakland Place for 1923 was only $3,702.81. The decedent’s rent, collectible as rent from Poff, was $947.72. How then can it be contended that the balance of the amount recovered from Poff, $2,042.07, represented the value of the interest of the decedent in the rents at the date of his death?

It is further to be noted that, under the statutes of Alabama, rents due from croppers for the year 1923 did not become due until November first. Civil Code, 1923, section 8800. The amount of the rents actually collected is no clear indication of the value of the interest of the decedent in the growing crops at the date of death.

From a consideration of the entire record, we are of the opinion that the value of the decedent’s interest in the growing crops should have been and was included in the value of the real estate. That value should not be duplicated by adding to the $97,500 for the realty any amount for growing crops. We are of the opinion that only $1,401.95 of the $7,458.89 in question should be included in the value of the gross estate.

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


author: Smith :

text:
    Appeal of Red Wing Linseed Co.
    Docket No. 2862.
    Decided November 9, 1926.
    Evidence held, insufficient to show that the Commissioner’s determination of the fair market price or value of buildings, machinery and equipment on March 1, 1913, was erroneous.

      Eugene B. Van Veen, Esq., and Oswald D. Luby, Esq., for the petitioner.

      John D. Foley, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes for the year 1918 in the amount of $16,033.74, and is based upon the following allegations:
    (1) That the Commissioner erroneously computed a taxable gain derived from the sale of capital assets, a large part of which were acquired prior to March 1, 1913.
    (2) That in computing the tax liability for the year 1917 the Commissioner used an incorrect basis for computing the deduction for exhaustion, wear and tear and failed to credit ■ against the deficiency for the year 1918 overassessments for prior years.
    At the hearing no testimony or argument was offered respecting the latter issue.
    FINDINGS OP PACT.
    In the year 1901 there was organized a corporation known as the Red Wing Linseed Mills Co., which then acquired a site and constructed and equipped a linseed oil mill at Red Wing in the State of Minnesota. The original construction, which was completed in the year 1902, consisted of a three-story brick and stone building, 61½ by 80⅛ feet, a three-story brick and stone warehouse, 26% by 44½ feet, and a one-story brick boiler house, 15 by 23 feet; and in all of these buildings there was installed all the machinery, equipment and facilities necessary for the operation of a thoroughly equipped linseed mill. The company experienced financial difficulties, was declared bankrupt on or about October 1, 1907, and on December 14, 1907, all its property was purchased at a receiver’s sale by local bankers for the sum of $41,158, the same being the amount of the accrued indebtedness to the bankers. Thereupon, said bankers caused to be organized the present petitioner corporation, known as the Red Wing Linseed Co. During the years 1908 and 1909, the petitioner constructed additions to the warehouse and built a new 80,000-bushel elevator and a 135,000-gallon tank, installed new plumbing, a new electric lighting system, a 100-ton track scale, and many other items of machinery and equipment.
    The land owned by the petitioner on which its mill and other properties are located consists of lots 6, 7, and 8, and part of lot 11, in Block 41 of the City of Red Wing. The Commissioner and the petitioner have agreed that the March 1, 1913, value of this land, exclusive of improvements, was $7,157.
    The crushing of flax seed and the manufacturing operations of the mill produced a vaporized oily substance which settles upon all the machinery and equipment and throughout the buildings used, and forms an oily coating for everything within its reach. This oily coating is a natural protection against oxidation, erosion, and all the elements of decay in respect to both buildings and machinery, and results in a marked slowing down of the processes of exhaustion, wear and tear.
    In making his adjustments of taxable income for the period from March 1, 1913, to November 1, 1918, the Commissioner computed annual deductions for exhaustion, wear and tear.
    The petitioner’s property is situated in the City of Red Wing, Minn., on the banks of the Mississippi River, and is built into a solid sandstone hill, so that its wagon-road approach on the westerly side is on a level with the third floor of the buildings, while on the easterly side its buildings abut upon the right-of-way of the Chicago, Milwaukee & St. Paul Railway Co., and the first floor of its buildings is on a level with such right-of-way, and the railway side trackage extends to and supplies transportation facilities for the shipping uses of the mill and elevator. Red Wing is on the main line of the Chicago, Milwaukee <& St. Paul Railway and is a terminal point of a branch of another railway system operating through the farming country to the westward. Agricultural production, of which flax growing was a considerable factor, had been fully developed throughout this territory for many years prior to 1913.
    On November 4, 1918, the petitioner sold its entire plant to the Pittsburgh Plate Glass Co. for a net selling price of $100,116.77. It returned no profit from such sale. The Commissioner, in making his computation of income-tax liability for the year 1918, added $12,050.21 as a gain derived from the sale of the property, which amount was arrived at in the following manner:
    March 1, 1913, value:
    Buildings- $57,144.17
    Additions_ 2, 428. 06
    Machinery, furniture and fixtures, etc- 40,198. 83
    Additions_ 2, 067. 05
    Total_$101,838.11
    Deduct:
    Depreciation — building- 5, 938. 70
    Machinery, furniture and fixtures, etc- 14, 989. 85
    - 20, 928. 55
    80.909.56

      Add
    Cost o£ land. $7,157. 00
    Total value as at November 1, 1918. 88, 000. 56
    Amount received from sale-100,116.77
    Correct gain on sale. 12, 050.21
   OPINION.

Smith :

In its income-tax return for 1918, the petitioner returned no profit from the sale of its plant to the Pittsburgh Plate Glass Co. at a net price of $100,116.71. The Commissioner has added to the net income reported $12,050.21, as a profit upon the sale of this property. The petitioner alleges error on the part of the Commissioner in so doing.

It appears from the deficiency letter from which this appeal is taken that the Commissioner determined that the March 1, 1913, value of the property sold to the Pittsburgh Plate Glass Co. in 1918 was $104,500. In order to show that the March 1, 1913, value of the property was in excess of that amount, the petitioner caused two appraisals to be made, one in May, 1924, which showed a value for the property at March 1, 1913, of $140,325.87, and another made in May, 1925, by an appraiser who spent two days at the plant. His estimate of the value of the property on the basic date, exclusive of small tools, implements, and office furniture and fixtures, was $119,846.29, and inclusive of such assets, $121,504.76. These appraisals showed the reproduction cost new on March 1, 1913, less an estimated amount for depreciation sustained to that date. Neither appraisal company pretended to have any knowledge as to what the plant would have brought if placed on the market for sale. Officials of the companies stated, however, that if a person had wished to build a plant in 1913, the cost of building the plant at that time, less reasonable depreciation from the time that the petitioner’s plant had been built to March 1, 1913, would be the amounts above stated.

The basis for determining the profit upon the sale of the property is the cost or fair market price or value of the property on March 1, 1913, whichever is higher. The fair market price or value of property must be determined in the instant case from all of the evidence which has a bearing upon that value. In the absence of a sale of the property at or near the basic date, other relevant factors must be taken into consideration in determining such value. In the instant case, it appears that the plant had not been operating at a profit prior to the time when it was acquired by the petitioner in 1907 at a foreclosure sale for less than $50,000 cash; that it had been operated for only about 40 per cent of the time from 1907 to 1917, and that during the ten-year period operations of the plant did not

The only evidence before us as to the March 1, 1913, value of the property in question is the retrospective appraisals made by two appraisal companies in the manner indicated above. We have held in numerous instances that retrospective appraisals upon the cost of reproduction, less an estimate for depreciation, are not of themselves competent evidence to determine the fair market price or value of property. Appeals of Kinsman Transit Co., 1 B. T. A. 552; Rockford Malleable Iron Works, 2 B. T. A. 817; Tibby-Brawner Glass Co., 2 B. T. A. 918; Stokes Milling Co., 2 B. T. A. 1284; Strong, Hewat & Co., 3 B. T. A. 1035.

We are of the opinion that the evidence of record does not warrant a finding of fact that the fair market price or value of the property sold in 1918 to the Pittsburgh Plate Glass Co. had a fair market price or value on March 1, 1913, in excess of $104,500, the amount found by the Commissioner.

Judgment will be entered for the Commissioner.

Tettsselii dissents.


author: Stehnhagen :

text:
    Appeal of Mrs. D. W. Fish.
    Docket No. 6564.
    Decided November 9, 1926.

      Louis B. Montfort, Esg., for the petitioner.

      John W. Fisher, Esg., for the Commissioner.
    Deficiency in income tax of $1,484.91 for 1919, resulting from the Commissioner’s inclusion in petitioner’s gross income of an amount of $16,000 received by her upon the sale of oil, gas and mineral rights. The facts are stipulated.
    FINDINGS OF FACT.
    Petitioner’s mother, Modena Jennings, died in 1916, and by her will left all her personal property to her husband, E. Y. Jennings, petitioner’s father, who survived her. As to real property the will provided:
    Thi*d, I give to my beloved husband El. T. Jennings during his natural life, and so long as he may live, all of my real estate and he is hereby given power to sell and dispose of the same, as he may see proper and after his death, the said real estate shall pass to our beloved children, or their descendants, share and share alike, as they would inherit, under the law of descent, and distribution as provided for under the laws of the State of Texas, and in the event the said real estate should be sold, by my beloved husband, during his life, then the proceeds arising therefrom shall descend and pass as the said real estate, as above mentioned.

      The will was refused probate by the County Court, and an appeal was taken to the District Court, which sustained the decision of the County Court and refused the probate of said will. The probate of said will was being opposed by certain children of Mr. and Mrs. E. Y. Jennings, on the ground that E. Y. Jennings had exercised undue influence upon his wife prior to her death with reference to the making of said will.
    After the decision of the District Court, and on or about May 27, 1919, petitioner and other heirs sold to one Anson Hazlewood, by warranty deed in fee simple, the oil, gas, coal, and other minerals in certain land which had been owned by petitioner’s mother prior to her death, for which petitioner received from said Anson Hazle-wood $16,000.
    After this sale the case involving the will contest was appealed by others than petitioner to the Court of Civil Appeals, which reversed the decisions of the District Court and the County Court and remanded the case to the court of original jurisdiction for retrial. On May 16, 1922, said will was admitted to probate without retrial, the contestants having withdrawn their action. Said case is reported under the title of Jennings v. Jennings, 212 S. W. 772.
    Demand was made by Anson Hazlewood upon petitioner for the return of the purchase money paid by him to petitioner. Anson Hazlewood claimed that under said decision petitioner did not have clear title to the oil, gas and mineral rights she had transferred.
    Petitioner’s father, E. Y. Jennings, by quitclaim deed dated June 7, 1919, deeded the oil, gas and mineral propei'ty rights in question to Anson Hazlewood. Said quitclaim deed recited that the prior deed had been given and that “title to said land is not vested wholly and in fee simple to the grantors” in such deed. It contained further the following:
    Now therefore, for and in consideration of the sum of Ten ($10.00) Dollars to me in hand paid by Anson Hazlewood, the receipt of which is hereby acknowledged, and for the further purpose of perfecting the title in the said Hazlewood in and to the mineral rights and interest conveyed to him by the parties ajjove mentioned, in the respective deeds hereinbefore referred to, I, E. Y. Jennings, of the County of Stephens, and State of Texas, do hereby sell, assign, release and convey unto the said Anson Hazlewood, of the County of Palo Pinto and State aforesaid, all the rights, title, and interest owned, claimed or held by me in and to the mineral rights and interests conveyed by the parties above mentioned, to the said Hazlewood, in and to each and all of the tracts of land described in the several deeds aforesaid, which deeds and the mineral interest therein conveyed are here referred to and made a part hereof, but it is not my intention to convey to the said Hazlewood, any interest in the minerals, in, on or under the said tracts of land above described, other than the interests conveyed therein by the said J. Y. Jennings, Eddie Jennings, D. W. Fish and wife Eloiza Eish, W. O. Barnes and wife Luta Barnes, to the said Anson Hazlewood, in and by virtue of each and all of the deeds hereinbefore referred to, reserving to myself, the balance of the mineral rights in said lands other than such as was conveyed by said deeds.
    Petitioner retained all of the $16,000 originally paid by Anson Hazlewood.
    E. Y. Jennings on September 19, 1924, made an affidavit that he regarded his relation to the real estate in question as that of trustee and that he did not regard his quitclaim deed as a gift.
   OPINION.

Stehnhagen :

We are of opinion from the evidence that the Commissioner correctly held the $16,000 received by petitioner as income to her. It was the proceeds of a sale of whatever she had. There is no evidence of cost or other basis to measure the gain upon which we can find it to be less than the full amount.

There is not the slightest evidence to support petitioner’s argument that Jennings intended to or did make a gift to petitioner either of the property or the proceeds. His quitclaim deed to Hazle-wood was a confirmation in Hazlewood of his title. It affected petitioner only by relieving her from a possible lawsuit. She already had the income.

Judgment will be entered for the Commissioner.


author: Teussell :

text:
    Geo. J. Grant Construction Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2584.
    Decided November 9, 1926.
    Severable contracts. — -Written instruments evidencing contractual relations between the petitioner and the Board of Water Commissioners of the City of St. Paul, Minnesota, held, to evidence two separate contracts upon which the contractor’s losses may be taken in the accounting period within which work upon each separate contract was completed.

      G. 8. Macartney, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    The petitioner complains of a certain deficiency letter dated February 15, 1925, asserting a deficiency in income and profits taxes for its fiscal year ended March 31, 1919, in the amount of $1,214.84, and an overassessment for its fiscal year ended March 31, 1920, in the amount of $310.18.
    The deficiency for the fiscal year ended March 31, 1919, results from the Commissioner’s holding that losses sustained by the petitioner must be accounted for as of the fiscal year ended March 31, 1920.

      FINDINGS OP PACT.
    The Geo. J. Grant Construction Co. is a Minnesota corporation, having its principal office at St. Paul, and, during the period under consideration, was engaged in a general contracting and construction-work business.
    In December, 1916, the Board of Water Commissioners of the City of St. Paul advertised for bids for the construction of a high service reservoir and earth embankments surrounding such reservoir. The specifications accompanying such call for bids were as follows:

    Thereafter the petitioner, having been found to be the lowest bidder, received an award for the construction work called for in words and figures as follows:
    March 6, 1917
    AWARD OP CONTRACT
    P. B. 1119
    The Contract Committee hereby awards the contract for furnishing all labor and material (excepting cement, reinforcing steel, gate valves, sluice gates and cast iron pipe and special castings) and constructing the High Service Kein-forced Concrete Covered Reservoir at the end of Dale Street for the Board of Water Commissioners of the City of St. Paul, Minnesota, excepting Item Six of the bidding sheet, being earth embankments and fill over structure, to the George J. Grant Construction Company for the lump sum of $194,158.01 and the contract for earth embankments and fill over structure, known as Item Six is hereby awarded to the said George J. Grant Construction Company on the basis of cost plus fifteen per cent, in accordance with their modified bid of March 2, 1917, and at a total cost of not exceeding $51,896.00 and at a total aggregate cost for the complete contract not exceeding $246,054.01.
    Approved: The Contract Committee
    (Signed) O. H. Keller
    Jesse Boot
    H. W. Austin
    MATERIAL AND SUPPLIES CONTRACT
    This agreement, Made and entered into this 12th day of March A. D. 1917, by and between The George J. Grant Construction Company, a corporation, party of the first part, hereinafter designated as the Contractor, and the Board of Water Commissioners of the City of St. Paul, a municipal corporation, of the State of Minnesota, party of the second part, hereinafter designated as the City, Witnesseth:
    That in and for the consideration hereinafter mentioned, the Contractor hereby sells and agrees to furnish and deliver to the City all labor and material (excepting cement, reinforcing steel, gate valves, sluice gates and cast iron pipe and special castings) and construct the High Service Reinforced Concrete Covered Reservoir at the end of Dale Street, excepting Item Six of bidding sheet, being earth embankments and fill over structure, at lump sum of ($194,158.01), and agrees to construct and furnish earth embankments and fill over structure on the basis of cost plus fifteen per cent, at a price of not to exceed $51,896.00, in strict accordance with the plans and specifications thereof, and in accordance with the bid or proposal of the Contractor bearing No. 1119, submitted pursuant to advertisements, dated December 16th & 23rd, 1916, which specifications, bid or proposal, and advertisements are hereto attached and each and all made a part of this agreement.
    The Board of Water Commissioners of the City agrees to pay to the Contractor as the consideration for the full and faithful performance of this contract, the sum of Two Hundred Forty Six Thousand Fifty Four and 1/100 (246,054.01) Dollars, which sum shall be payable solely out of the Water Fund, and at the times and in the manner provided for in the said specifications.
    ' It is hereby agreed that the provisions of all ordinances of the City of St. Paul relating to contractors is hereby made a part of this agreement.
    In Witness Whereof the City and the Contractor have signed this contract the day and year first above written.
    The reservoir was completed in the late fall of 1918, when the city turned water into it, and it has been used ever since. By March 31, 1919, all work on the reservoir had been entirely completed. The work on the earth embankments, including the sodding and seeding, was completed during the petitioner’s fiscal year ended March 31,1920.
    Upon the construction of the reservoir the petitioner sustained a loss of $43,240.96. Upon the construction of the embankments, etc., the petitioner sustained a loss of $53,759.04. These losses were largely due to an increase in laborers’ wages from $2.50 to $6 per day. The petitioner received payments from the Board of Water Commissioners as the construction work progressed on the basis of 85 per cent of the amount of each item completed.
    The petitioner kept its accounts and rendered its income-tax returns on the basis of completed contracts; it claimed its loss upon the construction of the reservoir for its fiscal year ended March 31, 1919, and claimed its loss upon the embankment construction for its fiscal year ended in 1920.
   OPINION.

Teussell :

A study of the language of the award of contract discloses that the petitioner was to receive for the construction of the reservoir a fixed and definite amount as compensation, and (hat amount was $194,158.01. It further discloses that the work of building the embankments was to be done on the basis of the cost plus 15 per cent but not to exceed a total amount of $51,896. It thus appears that the contractual relations entered into between the petitioner and the Board of Water Commissioners contemplated the performance of one piece of work for a fixed and determined amount, and the performance of another piece of work upon an entirely different basis— cost plus 15 per cent, but limited to the maximum figure stated.

The record establishes that the advances made by the Board of Water Commissioners from time to time were computed upon 85 peí-cent of the proportion of the work of the two separate classes as reported completed.

Ruling Case Law, vol. 6, Contracts, sec. 246, relating to entire and severable contracts, among other things, sa,js:

Where an agreement embraces a number of distinct subjects, which admit of being separately executed and closed, the general rule is that it shall be taken distributively, and each subject be considered as forming the matter of a separate agreement after it is so closed. If the part to be performed by one party consists of several and distinct items, and the price to be paid by the other is apportioned to each item to be performed, or is left to be implied under the law, such a contract will generally be held to be severable.

This doctrine of entire and severable contracts has frequently had the attention of the Supreme Court of Minnesota, in which State the petitioner has its domicile. In the case of McGrath v. Cannon, 55 Minn. 457; 57 N. W. 150, the court, among other things, said:

Whether a contract is entire or severable, like most questions of construction, depends on the intention of the parties, and must be determined in each case by considering the language employed and the subject-matter of the contract, and how the parties themselves treated it. One of the best statements of the law on the subject, and one often cited by the courts with approval, as that in 2 Pars. Oont. 648, which is: “ If the part to be performed by one party consists of several distinct items, and the price to be paid by the other is apportioned to each item to be performed, or is left to be implied by law, such contract will generally be held to be severable.” As complete and legally accurate a statement of the rule as anywhere to be found is that of Mr. Justice Field in Norris v. Harris, 15 Cal. 226, viz: “ A contract made at the same time, for different articles, at different prices, is not an entire contract, unless the taking of the whole is essential from the character of the property, or is made so by the agreement of the parties, or unless it is of such a nature that a failure to obtain a part of the articles would materially affect the object of the contract, and thus have influenced the sale had such a failure been anticipated.”

This case has been cited and its reasoning followed by the same court in Stauff v. Bingenheimer, 94 Minn. 309; 102 N. W. 694; Mulcahy v. Dieudonne, 103 Minn. 352; 115 N. W. 636; Duluth Log Co. v. Hill Lumber Co., 110 Minn., 124; 124 N. W. 967; Blake v. Neils Lumber Co., 111 Minn. 513; 127 N. W. 450.

The record of this case conclusively establishes that the petitioner considered and treated its contractual relations with the Board of Water Commissioners of St. Paul as two separate and distinct contracts, and from the language used in the form of award of contract approved by the Board of Water Commissioners and also the language used in the supplemental material and supplies contract it seems to be plain that the Board of Water Commissioners regarded and treated the same contractual relations as being two separate and distinct agreements. The construction of the reservoir itself was to be performed and paid for at a fixed and stipulated amount of $194,158.01, while the construction and work of filling the earth embankments is separated from the construction of the reservoir and is to be paid for on an entirely different basis of cost plus 15 per cent, although limited to a figure of maximum cost to the Board of Water Commissioners.

We are, therefore, of the opinion that, when the petitioner entered into the contractual relations respecting the construction of the reservoir and the filling of the earth embankments, it undertook the performance of two severable and separate agreements, and that it properly kept its accounts on the basis of two separate contracts and is entitled to deduct the loss on the reservoir contract from its gross income in the year ended March 31, 1919, and to deduct its loss on the earth-embankments contract in the year ended March 31, 1920.

A redetermination of the deficiency in accordance with the foregoing findings of fact and opinion will be made upon 15 days’ notice, pursuant to Rule 50, and judgment will be entered accordingly.


author: TRUssell :

text:
    Mereen-Johnson Machine Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3531.
    Decided November 9, 1926.
    Valuation of patents fob exhaustion deduction. — Evidence respecting tbe value of petitioner’s patents considered and valuation determined.

      Harman G, J. Peisch, G. P. A., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    The petitioner complains of a deficiency letter dated March IB, 1925, asserting deficiencies in income and profits taxes for the year 1919 in the amount of $755.38, and for the year 1920 in the amount of $1,062.43.
    The only issue presented for consideration is the March 1, 1913, value of certain patents owned by the petitioner and upon which value the deduction for exhaustion is claimed.
    FINDINGS OP PACT.
    The petitioner, Mereen-Johnson Machine Co., is a Minnesota corporation with its principal ollice at Minneapolis, and it is hereinafter referred to as the corporation.
    The corporation was incorporated February 10, 1905. The capital stock was issued to A. M. Mereen, 125 shares, and to Charles A. Smith, Chester T. Johnson, Charles Jones, 41% shares each, and in consideration therefor and as full payment for the par value thereof ($100 per share), each of such stockholders assigned to the corporation all his patents or applications for patents and contracts of property relating to the affairs of the corporation, and further, as part consideration for the said shares of stock, agreed that any new devices or machines, relating to the affairs of the corporation, invented and patented by any of the four named stockholders and incorporators, should become the property of the corporation. This was the only consideration paid in for the $25,000 capital stock issue. The patents acquired at the time of the incorporation have not been described but were set up on the books at a value of $25,000. However, from the record it is inferred that the patents or applications for patents so acquired were for the three types of .machines named — the “ Squeezer,” the “ Box Resaw,” and the “ Ferris Wheel Trimmer.”
    The corporation has been since its organization, and was during the years here in question, engaged in the business of the operation of a machine shop and the manufacture and sale of machines used principally in the manufacture of box boards, under certain patents owned by it for a number of years prior to 1913 and during the years in question. The two principal machines manufactured and sold under patents were the “ Bos Resaw ” and the “ Squeezer.” The corporation also manufactured and sold under patent the “ Ferris Wheel Trimmer,” but only a few of these machines were sold as compared with the number of sales of the “ Box Resaw ” and “ Squeezer ” machines. The record does not give a description of the “ Ferris Wheel Trimmer,” nor does it disclose the date of issuance of patent therefor. Patent number 737,434, issued under date of August 25, 1903, covers the “ Bos Resaw.” Patent number 869,923, issued under date of November 5, 1907, covers the “ Squeezer,” which is a machine for assembling matched stock and which saves the time and labor of from two to six men, the old method being to pound out matched stock by hand with wooden mallets. The petitioner corporation also sold matchers, cut-off and rip saws, and various other machines which were developed from time to time.
    Gross sales for the years 1908 to 1912, inclusive, of patented machines and other articles separately stated, and the total sales are as follows:

    Sales of patented machines were 48.1 per cent of the total sales.
    During the same years, 1908 to 1912, inclusive, the average tangible assets employed by the corporation and the net profits of each year were as follows:

    The two patents numbered 737,334 and 869,923, respectively, had ah average life after March 1, 1913, of ten years, five months and four days.
   OPINION.

TRUssell :

Although the petitioner did not in its orignial income-tax returns for the years here under consideration claim a deduction for exhaustion of patent values, it is not precluded from now asserting a claim to such deductions. Appeal of Union Metal Mfg. Co., 1 B. T. A. 395.

Respecting the March 1, 1913, value of petitioner’s patents, the record is not as clear as might bo desired, but the fact that during the five years prior to 1913 the sales of machines made under these patents were maintained at a comparatively steady figure and that the net income of the company during the same years showed a similar steady production of profits convinces us that these patents had a value which must be reflected in the profits realized, and we are of the opinion, and therefore find, that the March 1, 1913, value of the two patents described in the findings of fact is $7,500, and that for the years here under consideration the petitioner is entitled to the deduction from gross income on account of the exhaustion of such values computed on the basis of the average life of the said two patents after March 1, 1913.

A redetei-mination of the deficiencies in accordance with the foregoing findings of fact and opinion will he made on 15 days’ notice, under Rule 50, and judgment will be entered accordingly.

Sternhagen dissents.


author: Sterniiagein :

text:
    Richard L. Birkin, Petitioner, v. Commissioner of Internal Revenue, Respondent. Thomas I. Birkin, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles W. Birkin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 2097-2099.
    Decided November 9, 1926.
    1. Under the Sixteenth Amendment and section 213 of the Revenue Act of 191S, defining gross income, income includes the entire gain realized upon the sale of goods in the ordinary course of business in this country, irrespective of where an increment in value has its situs.
    2. The capital or labor from which income is derived in this country need not be within the territorial jurisdiction of the United States in order that the income may be taxed.
    3. Where goods are manufactured abroad by nonresident alien individuals and sold in this country, the entire profit constitutes “gross income from sources within the United States,” within the meaning of section 2K5 (c) of the Revenue Act of 1918.
    4. The statute does not provide for the apportionment or exclusion of any part of the profit in determining the source of the income from such sales.
    5. The fact of manufacture of goods abroad does not reduce the profits from their sale in this country.
    0. An opinion of the Attorney General is not determinative before the Board, although it will be given regard to the extent that it may aid toward a sound conclusion.

      George 0. May, O. P. A., and Edward B. Burling, Esq., for the petitioners.

      George K. Bowden, Esq., and S. Duffield Mitchell, Esq., for the respondent.
    Deficiencies in income tax for 1919 against nonresident aliens who manufacture abroad and sell in the United States. The parties agree upon the facts.
    FINDINGS OF FACT.
    The petitioners are nonresident aliens residing in England and doing business in a partnership called Birkin & Co. with an office in New York. The partnership manufactures laces in Great Britain and ships them to and sells them in the United States. They carry on no manufacturing in the United States.
    In 1919 they sold in the United States certain laces which they had manufactured in Great Britain and imported into the United States. The jirice realized on account of such sales ivas $457,494.21. Selling and other expenses incurred in the United States in 1919 in connection therewith were $53,096.09. The actual market value or wholesale or factory price of the said laces in Great Britain at the time of exportation, plus the duty paid to the United States under the United States customs laws, plus shipping and landing charges, aggregated $347,813.63. The cost of manufacturing the said laces in Great Britain, plus the duties paid to the United States, plus shipping and landing charges, was $312,899.28.
    The Commissioner determined that the net income of the partnership was $91,498.84, the difference between the sale price of $457,-494.21 and the sum of manufacturing cost of $312,899.28 and selling and other expenses of $53,096.09.
    Richard L. Birkin included in his income of 1919 from sources within the United States $14,616.66, which was his distributive share of the net income of $56,582.49 reported by the partnership for the fiscal year ended October 31, 1919. Thomas I. Birkin so reported $14,616.67, and Charles W. Birkin, $27,349.16.
   OPINION.

Sterniiagein :

The petitioners are British subjects who in 1919 sold in the United States goods which they manufactured in Great Britain. They were subject to tax under the Revenue Act of 1918.

Section 213, after setting forth in (a) the items included in the term gross income and in (b) the items excluded, treats of nonresident alien individuals in (c), as follows:

In the case of nonresident alien individuals, gross income includes only the gross income from sources within the United States, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, dividends from resident corporations, and including all amounts received (although paid under a contract for the sale of goods or otherwise) representing profits on the manufacture and disposition of goods within the United States.

The controversy calls for a determination of the “gross income from sources xvithin the United States.” The petitioners say that, since manufacture abroad is a factor from which the price acquired on sale in the United States results, a part of the profit contained in such price is to be attributed to manufacture and hence to be regarded as from a source not within the United States. The part of the profit so to be treated is taken by petitioners to be the difference between cost of manufacture abroad and market value abroad at the time of exportation. Thus, to arrive at what they regard as the statutory gross income, petitioners subtract from the gross sales price in the United States the market value abroad plus United States customs duty and freight and incidental import costs. The Commissioner has held that all the profit is derived from sale in this country and that gross income is the difference, as it is for residents, between gross sale price on the one hand and actual cost of goods sold, including duty and incidental charges, on the other. Thus the Commissioner eliminates from the subtraction the increment contained in market value abroad and taxes as income its realization by sale in this country.

The issue is said to be not as to the power of Congress, but as to the meaning and proper application of the statute; specifically as to the word “ source.” We lay aside at once the dictionary definition, since the word is of such general application and may be so variously used that discussion of it would go too far afield to be helpful. The true question is as to how far the language of the statute indicates that Congress intended to go in taxing the income of these nonresident alien individuals.

Both parties in brief and argument discuss at some length the merits of an opinion of the Acting Attorney General officially given to the Secretary of the Treasury on November 3, 1920, (32 Ops. Atty. Gen. 336) touching upon the same subject and upon which the Secretary has relied in his administration of the statute. 22 T. D. 566, Dec. No. 3111. Notwithstanding the great respect to which that high officer’s opinion is entitled, it is not determinative before this Board. The Board is required by the statute to decide in accordance with the law as it understands it and as authoritatively adjudicated by the courts. To this end it must examine for itself the merits of the question at issue, and it will give regard to the Attorney General’s opinion only to the extent that such opinion may aid toward a sound conclusion.

That the acquisition of profit by these petitioners when their goods are sold in the United States is in some way related to the manufacture of the goods as well as to their sale is irrefutably true. Whether this be an economic fact or a legal fact is beyond the scope of our determination; its recognition as a fact is sufficient. This does not carry with it any answer to the present problem, for the question still is whether the fact of manufacture abroad reduces the profit from sale here — whether it necessitates the conclusion that such profits are to any extent from sources abroad.

As a matter of law we can not conclude that they are. The profits are all brought about by sale here. In the terminology of the tax return, they represent “ gross sales,” from which should be subtracted “ cost of goods sold ” to arrive at gross income. And cost of goods sold is what the term indicates, namely, cost — which has nothing to do with value whether here or abroad. The fact, if in any case it be true, that the sale price reflects an appreciation of value in the goods before their importation into this country does not increase cost or reduce the actual gain at the time of sale. Nor would a diminution of value abroad below cost increase the gain. Neither cost nor sale price is changed because the intervening transportation has crossed the boundary, except for the transportation expense.

The law of the United States recognizes no income in the unrealized appreciation of value of goods or property, Lynch v. Hornby, 247 U. S. 339; Eisner v. Macomber, 252 U. S. 189; but treats such appreciation as taxable income only when it comes to hand as the profit from sale. Merchants Loan & Trust Co. v. Smietanka, 255 U. S. 509. As to property owned on March 1, 1913, the time of the effective date of the first Income Tax Act after the adoption of the Sixteenth Amendment, unrealized increment may be added to actual cost, but only in certain cases, Lynch v. Hornby, supra, and, to a certain extent, McCaughn v. Ludington, 268 U. S. 106. It must be, therefore, that under the Constitution and the Act, “ income from whatever source derived ” includes the entire gain realized upon sale of goods in the ordinary course of business in this country, irrespective of where the increment has its situs.

Looking at the statement in Eisner v. Macomber, 252 U. S. 189, and other cases, that income is the “ gain derived from capital, from labor, or from both combined,” including “ profit gained through a sale or conversion of capital assets,” the petitioners argue that so much of the profit as represents market value abroad is not derived from capital or labor in this country, and hence is not United States income, — which is a constitutional question. Even assuming that the foregoing statement of the attributes of income was intended to be definitive so as to exclude all accretions to wealth not within the scope of its terms — a proposition not simply to be adopted, cf. Irwin v. Gavit, 286 U. S. 161 — it still does not necessarily mean that the capital or labor must be itself within the territorial jurisdiction of the United States — cf. Cook v. Tait, 265 U. S. 47. Since under our law the conversion of capital appreciation into profit by sale is income and not capital, and since in this case such profit was entirely acquired in the United States, the effect of taxing it is simply to tax income derived in this country.

But it is argued that as to nonresident aliens Congress has not taxed all such income but only such as is derived from sources within the United States; and further, that as manufacturing is part of the source of all the income, it may be said that it is the entire source of an allocated part of the income, which part is therefore not taxed. This we think is reasoning beyond the statute in question. It may be quite reasonable from the standpoint of cost accounting or other statistical study to say that because manufacturing is part of the cause of the whole income a reasonable part thereof should be so attributed and allocated to manufacture. But this does not establish as a fact that the source of such aliquot part is not sale. Sale was necessary to its existence and was the most recent if not the entire source. If not the entire supporting arch, it was the indispensable keystone. As Congress within its power did not either exclude or apportion it, we can not say it intended to do so. It will be noted that apportionment on one basis or another is expressly provided in section 214 as to certain deductions, and has since been expressly provided in the Revenue Act of 1921 and later acts. Whether Congress took into consideration the fact that the United States was at the same time receiving import duty ad valorem and thus to some extent in effect taxing the same value which it later taxed as income derived from sale, we are not at liberty to consider, this being a legislative question. Nor may we assume that Congress ignored the comparison between the British method of taxation and our own.

The decisions such as Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113; Bass v. Tax Commission, 266 U. S. 271; and also Erickson v. Last, 4 Brit. Tax Cas. 422, all involve statutes and law so different from that before us that they are not in point. Congress made no apportionment and none may be imported into the statute.

Judgment will be entered for the Commissioner.

Trammell did not participate.


author: Phillips:

text:
    Appeal of Continental Life Insurance Co.
    Docket No. 2672.
    Decided November 10, 1926.
    1. In the absence of any evidence of the method of accounting regularly employed in keeping the books of a taxpayer, the action of the Commissioner in computing income upon a cash receipts and disbursements basis must be approved.
    2. Where the evidence dicloses that the taxpayer, an insurance company, is required to file report with the insurance departments of the jurisdictions in which it operates, showing income and disbursements upon a cash basis and its balance sheets upon an accrual basis, it can not be assumed that the books of account are kept upon an accrual basis.
    3. Prior to 1919, returns had been made upon the basis of cash received and disbursed. In 1919 gross income was reported on the basis of cash received and deductions upon the basis of cash disbursed plus liabilities accrued and unpaid. Held, that, the return upon such basis distorts taxable income.
    4. In the case of corporations issuing policies covering life, health, and accident insurance combined in one policy, issued on the weekly premium payment plan, continuing for life and not subject to cancellation, the net addition to be made to reserve funds is to some degree in the discretion of the proper officials of the company. Where the evidence is insufficient clearly to establish that the addition to the reserve made during the taxable year was insufficient, no greater amount will be allowed as a deduction than that set up on the books.
    5. Quaere: Whether any amount can be allowed as an addition to reserve funds where such amount has not been set up as a part of such reserve?

      Chester A. Gwinn, Esq., for the petitioner.

      Ellis W. Manning, Esq., for the Commissioner.
    Petitioner appeals from the determination of deficiencies in income and profits taxes of $6,028.96 for 1919 and $1,301.77 for 1920.

      FINDINGS OF FACT.
    1. The petitioner is a corporation organized under the laws of the Commonwealth of Virginia, with its principal office in Washington, D. C., and is engaged in the life insurance business.
    2. On February 20, 1920, said company filed its corporation income and profits-tax return for the calendar year 1919, reporting total net income amounting to $24,163.15, and claiming deduction of taxes accrued during the year 1919 amounting to $11,483.21, and unpaid death claims accrued during the year 1919 amounting to $2,310.18.
    3. On or about March 15, 1921, petitioner filed its corporation income and profits-tax return for the calendar year 1920, showing total net income of $24,566.44 and claiming as a deduction the sum of $14,565.55 on account of taxes accrued during the year 1920.
    4. Upon the audit of the above-mentioned returns the Commissioner changed the basis of the petitioner’s accounting from the methods used in said returns to a so-called “ cash and disbursements ” method, and in making such change disallowed the deduction of $11,483.21 claimed by the petitioner as and for taxes accrued during the year 1919, and $2,310.18 claimed as a deduction by the petitioner for death claims accrued during the year 1919.
    5. The Commissioner having disallowed the above-mentioned deductions for the year 1919, added those amounts to the net income of the petitioner, and determined an additional tax thereon in the amount of $6,028.96 for the year 1919.
    6. On the audit of the petitioner’s return for the year 1920 the Commissioner disallowed the deduction taken therein of taxes accrued during the year 1920 in the amount of $14,565.55, restored the amount of taxes disallowed for the year 1919 and allowed same for 1920, added the difference of $3,082.34 to petitioner’s net income for the year 1920, and determined a deficiency tax in the sum of $1,301.71 for the year 1920.
    7. The following statement explains the disallowances made by the Commissioner and the additions to income resulting therefrom:
    1919.
    Net income, Bureau letter, Feb. 18, 1925_$38, 248. 44
    Net income per return_ 24,763.15
    Net increase- 13, 4S5.29
    Increases:
    Taxes accrued Dec. 21, 1919_$11, 483. 21
    Unpaid death claims Dec. 31, 1919_ 2,310. 78
    Interest on money to carry United States obli-gations_ 267.97
    Error in computation by Bureau- . 10 14, 062.06

      Decreases:
    Interest received a/c United States obligations_ $267.97
    Increase of nontaxable income_ 308.80 $576. 77
    13,485.29
    1920.
    Net income, Bureau letter Feb. 18, 1925_ 26, 865. 08
    Net income per return_ 24, 566.44
    Net increase_ 2,298.64
    Increases:
    Taxes accrued Dec. 31, 1920_$14, 565. 55
    Taxes accrued Dec. 81, 19¾9_ 11,483.21
    - 3,082.34
    Decreases:
    Federal income tax — return_$7,216.82
    Federal income tax — Bureau letter_ 7,209. 59
    - 7.33 [sic]
    Nontaxable interest_ 655. 54
    Unpaid death claims Dee. 31, 1919_ 2,310. 78
    Unpaid death claims Dec. 31, 1920_ 2,189.95
    - 120. 83
    - 783.70
    2,298.64
    8. The sum of $11,483.21 deducted by the petitioner in its income-tax return for the year 1919, as and for taxes accrued during said year, was a liability for excise taxes payable to the Collector of Taxes of the District of Columbia on or before March 1, 1920, and to the Treasurer of the Commonwealth of Virginia on or before April 1, 1920, on premiums collected by the petitioner during the year 1919, and was carried and reported in its annual statements made and submitted by it to the Commissioner of Insurance of Virginia and to the Superintendent of Insurance for the District of Columbia.
    9. The sum of $14,565.55 deducted by the petitioner on its income-tax return for the year 1920, as and for taxes accrued during said year, was a liability for excise taxes levied on premiums collected by the petitioner and was payable to the Collector of Taxes of the District of Columbia on or before March 1, 1921, and to the Treasurer of the Commonwealth of Virginia on or before April 1, 1921.
    10. The petitioner issues combined life, health, and accideift policies, and, with the approval of the Superintendent of Insurance of the District of Columbia, as well as of the Commissioner of Insurance of Virginia, sets up a reserve using the premiums collected on such policies to provide a fund for claims thereon, said reserve being based on the company’s experience for preceding years. The experience of the petitioner under its combined life, health and accident policies for the years 1914 to 1924, is and was as follows:

    11. When the petitioner was notified by the Commissioner of the proposed deficiency, it protested the same and submitted to the Commissioner that, if the amount claimed for accrued taxes in the year 1919 was disallowed, the amount disallowed should not be restored to net income but should be restored to the reserve necessary to protect the holders of combined life, health, and accident policies for which the amount of reserve set up during the year 1919 was insufficient, as shown by the experience of the petitioner during preceding years. The Commissioner disallowed the petitioner’s contention.
    12. For 1919 the petitioner increased its reserves by $100,000.71, which was allowed as a deduction by the Commissioner in computing net income. Of the amount of addition to reserves so set up and allowed $28,972.71 was upon account of the combined life, health, and accident policies.
    13. The petitioner was required by the laws of the Commonwealth of Virginia and of the District of Columbia, and the regulations established thereunder, to render annual statements showing income and disbursements upon a cash basis and balance sheets upon an accrual basis.
    14. Prior to 1919 petitioner made its income-tax returns upon the basis of cash receipts and disbursements.
   OPINION.

Phillips:

The findings as set out in the first eleven paragraphs above were stipulated. Oral and documentary evidence submitted is the basis for the remaining findings of fact.

One of the principal errors alleged in the petition is that the Commissioner changed the basis of petitioner’s returns from an accrual to a cash basis. Upon the hearing and in its brief the petitioner contended that the returns filed were made in accordance with the method of accounting employed in keeping its books and should therefore not be disturbed.

It appears from the stipulated facts that, except for adjustments of nontaxable income, the Commissioner did not disturb the gross income reported in its return by the petitioner, nor did he disturb the deductions claimed, except that taxes accrued and death claims accrued but unpaid at the close of each taxable year are disallowed as deductions for such year and are allowed as deductions in the year in which paid. These adjustments are alleged by the petitioner to be erroneous.

There is nothing in the record from which we may determine the method of accounting regularly employed by the petitioner in keeping its books. Not only this, but we lack any evidence of the basis upon which the returns were made (except that the items in controversy were deducted as accruals) and any evidence that would prove that the returns filed were made upon the same basis upon which the petitioner kept its accounts. Such assumptions as we are able to make are based upon a comparison of the computations in the return with those in the deficiency letter and the stipulated fact that, by disallowing these two accruals, the income was placed by the Commissioner upon a “ cash and disbursements basis.”

It is reasonably clear that the gross income, at least, was reported by the petitioner in its return on the basis of cash received, and apparently the petitioner claimed as deductions in 1919 all expenses paid during 'that year and, in addition, death claims accrued but unpaid and taxes incurred on business transacted in that year which were not payable until the following year. If we understand the situation correctly, the result has been that in 1919 the petitioner has claimed as deductions taxes paid in 1919 on its 1918 business and taxes incurred in 1919 on its 1919 business; also unpaid death claims outstanding on January 1, 1919, and paid in 1919, as well as those unpaid on December 81, 1919. There has thus been a duplication of deductible items caused by the fact that prior to 1919 income-tax returns were made by the petitioner on a cash receipts and disbursements basis, with adjustments for reserves. Clearly the basis used by the petitioner in 1919 distorts its income to the extent that there is a deduction in that year of taxes incurred on the business of two years and of death claims unpaid at both the beginning and end of the taxable year.

There is in the record considerable evidence of the basis on which reports are required to be made to the insurance departments of the Commonwealth of Virginia and of the District of Columbia, in which the petitioner operated, b’ut, as stated before, no evidence of the method of accounting employed by the petitioner in keeping its books. The evidence concerning the reports to the insurance departments is to the effect that payments and disbursements must be shown upon a cash basis, and assets and liabilities upon an accrual basis. No profit and loss statement upon an accrual basis is required. The form of these reports is not such as to lead us to assume that the books of the petitioner are kept upon an accrual basis. Such assumptions as we can draw from the record would indicate that the petitioner seeks to report its income upon the basis of cash receipts and disbursements, with adjustment in the deductions for taxes accrued and unpaid death claims. The contention is that these accruals must be set up in the balance sheets filed with the insurance departments for the purpose of showing the true financial condition of the petitioner.

We have no doubt that this is so, but it also appears that in such balance sheets the petitioner would be required to set up accrued but uncollected income, such as premiums and interest, and also accrued but unpaid liabilities for commissions, salary, interest and any other such accrued liabilities. The petitioner seeks to report its income upon a cash receipts and disbursements basis with adjustments for only two items of such accruals. This hybrid method of reporting income is not reflective either of correct income or of the progress of the company as shown in its reports to the insurance departments. While it may well be that the cash receipts and disbursements basis adopted by the Commissioner does not reflect the income as accurately as would an accrual system, it appears that it more nearly reflects income than the system for which the petitioner contends. Without any proof of the basis on which the books were kept, or of the adjustments which would be necessary to more nearly reflect the correct income, we must approve the Commissioner’s determination. See United States v. Mitchell, 271 U. S. 9; Appeal of Consolidated Asphalt Co., 1 B. T. A. 79; Appeal of Henry Reubel, 1 B. T. A. 676; Appeal of Estate of E. T. Earl, 4 B. T. A. 322.

At the beginning of 1919 the reserves of the petitioner, as shown upon the balance sheet attached to its return, were $65,920.50. During 1919 this was increased by $100,000.71, which was allowed as a deduction by the Commissioner in addition to claims paid of $304,-367.46. Of the amount of the addition to the reserves so set up and allowed, $28,972.71 was upon account of combined life, health, and accident policies. It is now contended that this was inadequate and that a larger amount would have been added except that the financial condition of the company would not permit it without showing a deficit, and that we should now increase the amount. Section 234(a) (11) of the Revenue Act of 1918 provides that in the case of companies issuing such policies there shall be allowed as a deduction “such portion of the net addition (not required by law) made within the taxable year to reserve funds as the Commissioner finds to be required for the protection of the holders of such policies only.” The petitioner computes the deduction which it now seeks as follows:

Gross premiums received_$538, 018.33
Ratio of premiums to reserve as indicated by previous experience (per cent)- 39.26
Necessary reserve ($538,018.33 by 39.26)- 228,834.89
Payments during year_ 185, 223.64
Net addition_ 43, 611.25

The law permits the deduction only of an addition made to a reserve and it may be doubted whether any deduction could be allowed where, as here, the addition which it is sought to deduct has not been made. However that may be, the computation discloses that the losses paid and the addition to the reserve totaled 36.74 per cent of the premiums received. This is slightly in excess of the ratio established by the losses of the preceding twd years. Whether the petitioner should use a ratio of 36.74 per cent, based- on two years’ experience, or 39.26, based on five years’ experience, was a matter which rested, to some extent at least, in the discretion of the officers of the petitioner. Furthermore, the amount to be added to the reserve may well have been affected to some degree by an examination of the balance sheets to determine whether the reserves set aside in previous years had been adequate or inadequate. Nor are we impressed with the argument that a greater reserve would have been set up had the financial condition warranted it, for it appears that in March, 1920, the petitioner paid dividends of $20,000 to its stockholders, only a small portion of which were paid from 1920 earnings. The determination of the Commissioner must be approved.

The deficiencies for 1919 and 19W are redetermined to be $6,088.96 and $1,301.77, respectively. Order will be entered accordingly.


author: Sternhagen: Phillips:

text:
    Appeal of Samuel V. Woods.
    Docket No. 7365.
    Decided November 10, 1926.
    Where an owner leases property, and in the lease agreement directs that the lessee shall pay to third persons portions of the rents and royalties as they become due, this action constitutes an exercise of control over income when it actually arises, is an incident of the enjoyment of the fruits of ownership, and the amounts so paid are properly treated as income of the lessor.

      E. V. Campbell, Esq., and Arthur 8. Dayton, Esq., for the petitioner.

      P. J. Rose, Esq., for the Commissioner.

      Deficiency of something less than $732.20 income tax for 1920, arising from the addition by the Commissioner to petitioner’s income of amounts of royalties paid directly to his wife and daughter under the terms of the royalty instruments. The facts are all stipulated.
    FINDINGS OF FACT.
    Petitioner was in 1920 the owner in fee of property leased by him and his wife on August 1, 1916, to George I. Stafford and others and later assigned by the lessee to the Big Run Coal Co. This lease contains the following provision:
    For the year following January 30th, 1918 to January 30th 1919, the lessees shall mine and remove from the leased premises not less than thirty-six thousand tons of coal, and pay for the same as aforesaid at ten cents per ton, whether mined and removed or not, as follows: To Mollie S. Woods $150.00 per quarter, to Samuel V. Woods the residue thereof. For the year following from January 30th, 1919 to January 30th, 1920, the lessees shall mine and remove and pay for as aforesaid at least sixty-five thousand tons, Mine Run, and therefrom pay Mollie S. Woods quarterly $400.00 and to Samuel V. Woods the residue, and for the year following from January 30th, 1920, to January 30th, 1921, and every year thereafter, the lessees shall mine and remove and pay for, whether mined and removed or not, not less than seventy-five thousand tons, Mine Run, from the leased premises, to be paid as aforesaid, in the proportion aforesaid, and they shall in addition thereto mine, remove and market the said coal with all reasonable dispatch, and within the period of this lease mine, remove and pay for the whole thereof.
    Petitioner was in 1920 the owner in fee of an undivided one-half interest in the property leased by him and his wife and Cora M. Peck and her husband on June 7, 1917, to George I. Stafford and Samuel Hale and later assigned by the lessee to the Meadowville Coal Co. This lease contains the following provision:
    On the 7th day of September, December, March and June, in every year, and to the extent of one-half thereof, .shall, until otherwise ordered by him, be payable to Samuel V. Woods, at the Citizens National Bank of Philippi, except that out of the one-half so payable to him there shall be paid quarterly, at the times and place aforesaid, to Mollie Strickler Woods, One Hundred Dollars, and as to the remaining one-half thereof, the royalty shall be payable as aforesaid in equal proportions to Edmund H. Crim and Cora M. Peck.
    Payments under these two leases were made during 1920 in the total amount of $2,000 to Mollie S. Woods.
    Petitioner was in 1920 the owner in fee of an undivided one-half interest in the property leased by him and his wife and Cora M. Peck and her husband on December 17, 1917, to the Lee Collieries Co. This lease contains the following provisions:
    Beginning with the operations-under this lease in the year 1918, and monthly thereafter, the royalties herein to be paid by lessee, shall be payable as follows, that is to say:

      To Samuel V. Woods, at the Citizens National Bank of Philippi, until otherwise ordered by him, one-half of all royalties accruing, except that out of his one-half thereof lessee shall pay, after the year 1918 until otherwise ordered by him, $50.00 thereof monthly, to his daughter, Ruth Woods Dayton, and the residue pay to Woods as aforesaid.
    And the remaining one-half of such royalty shall be payable to Cora M. Peck and E. H. Crim equally, and until otherwise ordered by them, at the Bank aforesaid.
    Payments under this lease were made during 1920 in the total amount of $591.46 to Ruth Woods Dayton.
    Mollie S. Woods and Ruth Woods Dayton are the wife and daughter, respectively, of petitioner. They included said amounts as income on their returns and paid income taxes thereon.
    The Commissioner has included the said amounts in the income of petitioner.
   OPINION.

Sternhagen:

Is the mere order by a property owner to his lessee to pay part of the rent or royalties to his wife or daughter, upon which the lessee acts, enough to take the income thus diverted out of the taxable income of the owner? So far as appears from the facts stipulated, there was no legal obligation to the wife and daughter at the base of the arrangement, and in the Meadowville and Lee Collieries leases the payment was “ until otherwise ordered by ” petitioner. Even if, under the local law of any litigation which might be founded on these leases, these designated payees might as third parties beneficiary enforce payment from the lessee directly to them, this would not prove that the owner had no interest in the amount or that it was not his income. Rensselaer & Saratoga R. R. Co. v. Irwin, 249 Fed. 726. This decision, which the Supreme Court refused to review, 246 U. S. 671, held that where the lessor had contracted away its right to receive rent and gave its stockholders a direct claim against the lessee, the rent was nevertheless taxable as income of the lessor. It is clearly authority for taxing the owner in this case where, so far as the record shows, he merely designates another to receive during his pleasure. Conceded that he did not have actual possession of the amount so paid, possession is not the determining fact of income even on the cash receipts basis. If it were, there would be many questions arising from a system of credit and banking which all now recognize as settled.

The petitioner, the parties agree, was the owner of the property from which the income was derived. As such owner he had the right to the income or the right to dispose of it. In the enjoyment of this right, he ordered it paid directly to another until otherwise ordered. He might have taken it, or he might have ordered it sent to liis bank, paid directly to a creditor, or held by the lessee. Whichever of these courses he took was an exercise of his enjoyment of the fruits of his ownership inherent in such ownership. It measured his ability to contribute to the cost of government. Such a voluntary act in anticipation of actual receipt and before the income exists can only affect the income when it actually arises, and in our opinion it may properly be treated as coming to him and immediately disposed of. See Ormsby McKnight Mitchel, 1 B. T. A. 143.

Judgment will be entered in accordance with the foregoing findings of fact and opinion on 15 days’ notice, under Bule 50.

Phillips:

I dissent in so far as the decision affects payments to the wife under the Big Bun and Meadowville leases.