source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    Frank D. Darrow, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 929.
    Promulgated September 22, 1927.
    Tbe term “ dividends ” as defined in section 201 of tbe Revenue Act of 1921, includes distributions in liquidation of a corporation to tbe extent of tbe earnings or profits accumulated since February 28, 1913, contained therein, and to the extent of those earnings such distributions are taxable as dividends, subject to tbe surtax and exempt from tbe normal tax.

      Wilbur F. Denious, Esq., for the petitioner.

      A. H. Fast, Esq., for the respondent.
    In this proceeding a redetermination is sought of a deficiency in the income taxes of the petitioner for the calendar years 1921 and 1922. It is alleged that the Commissioner erred in including in petitioner’s taxable income the gain derived from the distribution in liquidation of all of the capital assets of a corporation, of which petitioner was the sole stockholder. In computing taxable income the Commissioner included the excess value of the assets distributed, over the cost to petitioner of his stock, and determined the deficiency from which this appeal is taken.
    FINDINGS OF FACT.
    The petitioner is, and during the taxable years was, a resident of and doing business in the city of Denver, Colo.
    The Darrow Music Co. was incorporated in 1914 under the laws of Colorado with a capital stock of $10,000 and a paid-in surplus of $30,600. The corporation was dissolved in the year 1919. The petitioner was at all times the owner of all the stock of the corpora • tion. At a meeting of the stockholders of the corporation held on December 20, 1919, the following resolution was adopted:
    Moved and seconded that the Board of Directors of said company be authorized and directed to sell and dispose of the assets of said company and to pay all of its debts after which the net assets of said company shall be distributed among the stockholders in proportion to their respective stockholdings.
    ' Said motion was put to a vote and carried by all of the stockholders of said company voting in the affirmative. /
    Upon dissolution of the corporation it had a capital stock of $10,000 and a surplus of $49,816.91. The increase of $19,216.91 in the surplus of the corporation over that paid in on incorporation, is the income upon which the respondent determined a deficiency in taxes for 1921 and 1922. After the dissolution of the corporation the petitioner continued the business of the corporation as before, under the name of the Darrow Music Co., but operated the business as an individual and not a corporation.
   OPINION.

Van Fossan:

The facts are stipulated. The issue raised by the pleadings is whether or not a gain derived from a distribution in liquidation is taxable income. In his brief, however, petitioner concedes that such a gain is taxable income, but he contends that the distribution is a dividend within the meaning of section 201 of the Eevenue Act of 1921 and as such is exempt from the normal tax under section 216(a) (1) of said Act.

Distributions in liquidation made by a corporation to its stockholders have been repeatedly held by this Board to result in taxable income to the stockholders, although the business is continued by them as individuals and no actual distribution in cash is made. Appeal of John K. Greenwood, 1 B. T. A. 291; Appeal of J. H. Morrow, Administrator, 1 B. T. A. 1148; Appeal of S. B. Quigley, 2 B. T. A. 159; Appeal of George Shapiro, 2 B. T. A. 620.

We have then to consider here only the question of whether the income derived from a distribution in liquidation is taxable as a dividend within the meaning of section 201 of the Revenue Act of 1921, or as a gain or profit from the sale or other disposition of personal property, the extent of which is to be determined upon the basis provided in section 202. If it be a dividend it is exempted from the normal tax by section 216(a)(1), otherwise it is taxable at both the normal and surtax rates. In view of the importance of the question, we deem a review of the income tax acts, passed since the adoption of the Sixteenth Amendment, so far as they relate to the definition and taxation of “ dividends,” essential to a correct understanding of the problem.

Section 213(a) of the 1921 Act provides:

That for the purposes of this title (except as otherwise provided in section 233) the term “ gross income ”—
(a)Includes gains, profits, and income derived from * * * dividends * * *. The amount of all such items * * * shall be included in the gross income for the taxable year in which received by the taxpayer * * *.

Section 216(a) provides:

That for the purpose of the normal tax only there shall be allowed the following credits:
(a) The amount received as dividends (1) from a domestic corporation other than a corporation entitled to the benefits of section 262 * * *.

Dividends are defined in section 201 of the Act as follows:

(a) That the term “dividend” when used in this title * * * means any distribution made by a corporation to its shareholders or members, whether in cash or in other property, out of its earnings or profits accumulated since February 28, 1913, * * *.
(b) For the purposes of this Act every distribution is made out of earnings or profits, and from the most recently accumulated earnings or profits, to the extent of such earnings or profits accumulated since February 28, 1913; * * *.
(c) Any distribution (whether in cash or other property) made by a corporation to its shareholders or members otherwise than out of (1) earnings or profits accumulated since February 28, 1913, or (2) earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, shall be applied against and reduce the basis provided in section 202 for the purpose of ascertaining the gain derived or the loss sustained from the sale or other disposition of the stock or shares by the distributee. (Italics ours.)

In the absence of a statutory definition of the term, “ dividend,” in its true meaning, does not include a distribution in liquidation (sometimes referred to as a liquidating dividend).

As generally understood and used, a dividend is a return upon the stock of its stockholders, paid to them by a going corporation without reducing their stockholdings, leaving them in a position to enjoy future returns upon the same stock. * * * It is earnings paid to him by the corporation upon his invested capital therein, without wiping out his capital. On • the other hand, when a solvent corporation dissolves and liquidates, it distributes to its stockholders, not only any earnings it may have on hand, but it also pays to them their stock, thus wiping out their interest in the company. * * * The corporation in effect buys up and retires all of its outstanding stock. Langstaff v. Lucas, 9 Fed. (2d) 691.

The Revenue Act of 1913 made “ dividends ” taxable as income, but failed to define the term and in two cases arising under that Act the Supreme Court applied the distinction between a dividend proper and a liquidating dividend. In Lynch v. Turrish, 247 U. S. 221, it was held that the distribution in liquidation by a corporation of all its assets, whose value at that time was the same as the value on March 1, 1913, the effective date of the Income Tax Amendment to the Constitution, was a return of capital and not taxable income, but in Lynch v. Hornby, 247 U. S. 339, the court held that the distribution by a going corporation to its stockholders after March 1, 1913, of profits accumulated prior thereto was a dividend and taxable income. In the latter case, the court, defining “ dividends,” said:

In short, the word “ dividends ” was employed in the Act as descriptive of one kind of gain to the individual stockholder; dividends being treated as the tangible and recurrent returns upon his stock, analogous to the interest and rent received upon other forms of invested capital.

Congress in all later revenue acts defined the term “ dividends ” so as to exclude distributions of profits accumulated prior to March 1, 1913.

The Revenue Acts of 1916 and 1917 made dividends taxable as income and provided in section 2 (a) of the 1916 Act:

* * * That the term “ dividends ” as used in this title shall be held to mean any distribution made or ordered to be made by a corporation * * * out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation * * * which stock dividend shall be considered income, to the amount of its cash value. (Italics ours.)

This definition was carried into the 1917 Act, by section 1211, as section 31(a) and supplemented by section 31(b), providing that—

Any distribution made to the shareholders or members of a corporation * * * in the year nineteen hundred and seventeen, or subsequent tax years, shall be deemed to have been made from the most recently accumulated undivided profits or surplus, and shall constitute a part of the annual income of the distributee for the year in which received * * *. (Italics ours.)

In construing these provisions of the 1917 Act the Supreme Court, in Edwards v. Douglas, 269 U. S. 204, held that distributions made by a corporation in 1917 were taxable to the distributee as dividends at the 1917 rates where it appeared that the 1917 earnings were sufficient to cover the distributions, even though the corporation had declared that they were made out of depletion reserves. In the district court the taxpayer contended that the distributions were of capital and not taxable, but the court rejected this contention, held that the distribution was clearly a taxable dividend within the meaning of the Act, and said:

It seems to me that the Congressional intent is clear. Distributions are to be regarded as made from current earnings and the most recently accumulated surplus. Congress, in my judgment, did not intend to lay doion a narrow rule, to be whittled away by technical definitions of the terms “ swplus, undivided profits, dividends and distributions ”. 298 Fed. 919, 924.

Though Congress exempted from taxation as dividends or otherwise, distributions of earnings accumulated prior to March 1, 1918, at the same time it so defined taxable dividends as to include every distribution of earnings accumulated since February 28, 1913, in whatever form the distribution might be made. The intention of Congress to tax as dividends, distributions, however made, of earnings since February 28, 1913, is evident from the broad and comprehensive language of the definition and the specific inclusion of stock-dividends to the extent of such earnings.1 So that under the 1916 and 1917 Acts distributions in liquidation to the extent of the earnings or profits accumulated since February 28, 1913, are taxable as dividends just as any other distribution of such earnings made by a going-corporation in the regular course of business. See Appeal of James Dobson, 1 B. T. A. 1082, and Appeal of A. B. Nickey & Sons, 3 B. T. A. 173. In the Dobson appeal we said, at page 1085:

And in “ any distribution ” must be included distributions made in liquidation as well as those made in ordinary course of business. The term distribution, in its commonly accepted meaning, certainly includes payments made to stockholders in liquidating a corporation.

The Revenue Act of 1918 also made dividends taxable as income and in section 201(a) defined the term “dividend,” substantially as defined in the preceding Acts, as—

* * * Any distribution made by a corporation * * * to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913 * * *. (Italics ours.)

Again we find clearly expressed the intention of Congress to tax as a dividend every distribution of earnings accumulated since February 28, 1913, in whatever form or manner made, and in the absence of a contrary intent appearing from the Act, a liquidating distribution of such earnings would be taxable as other dividends. But m this Act Congress added subdivision (c) to section 201, providing that—

* * * Amounts distributed in the liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits.

This Board has held that it was the intention of Congress under this Act to exclude from its broad definition of “ dividends ” a so-called “ liquidating dividend ” even though the latter consists in part of earnings accumulated since February 28, 1913, and to subject to both normal and surtaxes any gain derived from liquidating distributions in the same manner as other gains derived from the sale or other disposition of property. Appeal of John K. Greenwood, supra; Appeal of E. C. Huffman, 1 B. T. A. 52; Appeal of J. H. Morrow, supra; Appeal of S. B. Quigley, supra; Appeal of George Shapiro, et al., supra. See also Langstaff v. Lucas, 9 Fed. (2d) 691; 13 Fed. (2d) 1022; 71 L. Ed. 276; 47 Sup. Ct. 111; 273 U. S. 721.

The Circuit Court of Appeals for the Eighth Circuit in a recent case, however, has taken a different view and held that even under the 1918 Act distributions in liquidation, to the extent of earnings accumulated since February 28, 1913, are dividends within the meaning of section 201 (a) and are taxable as other dividends. The court there holds “ that subdivision (c) is not an exception to or qualification of section 201(a) but is supplemental thereto”. Hellmich v. Hellman, 18 Fed. (2d) 239.

When we come to the Revenue Act, of 1921 we find “dividends” included in taxable income and defined in section 201(a) substantially as in prior Acts, as—

* * * Any distribution made by a corporation to its shareholders or members, whether in cash or in other property, out of its earnings or profits accumulated since February 28, 1913 * * *.

But subdivision (c) as carried in the 1918 Act is omitted and no specific provision for liquidating dividends is made, except the negative one contained in the new subdivision (c), set forth above. Congress dropped the distinction between liquidating dividends and dividends as defined in section 201(a) which it has recognized in the 1918 Act, and declared anew its intent to tax as dividends all distributions of earnings accumulated since February 28, 1913, whether the same be made in liquidation or otherwise, as was the case under the 1916 and 1917 Acts. This clearly appears from the provision of the new subdivision (c) that “any distribution * * * made * * * otherwise than out of (1) earnings or profits accumulated since February 28, 1913, * * * shall be applied against and reduce the basis provided in section 202 ” for determining gain or loss on the sale or other disposition of property. Earnings or profits accumulated since February 28, 1913, distributed in liquidation are to be excluded from the computation of gain derived or loss sustained from such distribution, and are to be taxed as other dividends, regardless of whether there is a gain derived or loss sustained from such distribution. The intent of Congress to remove the distinction between liquidating dividends and other dividends, and to make its definition of the term in section 201(a) comprehensive and all-inclusive, so far as earnings or profits accumulated since February 28, 1913, are concerned, appears even more clearly from the history of the 1921 Act in process of enactment. The House Bill provided, in section 201(c), for the treatment of liquidating dividends in the identical language of the 1918 Act. The Senate amendment eliminated the provision entirely and substituted as subdivision (c) the provision as to stock dividends appearing as subdivision (d) in the Act as passed. The House accepted the amendment with an amendment which appears as subdivision (c) in the Act as finally passed. The statement of the House Managers from the Committee on Conference relative to this provision, is :

The House bill provided that amounts distributed in liquidation of a corporation shall be treated as in part or in full payment in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the dis-tributee as other gains or profits. The Senate amendment strikes out this provision. The House recedes with an amendment, * * *. [Referred to above.]

There would seem to be no doubt that Congress intended its definition of “ dividends ” to include liquidating dividends to the extent of earnings accumulated since February 28, 1913.

It is our conclusion that the term “ dividends ” as defined in section 201 of the Bevenue Act of 1921 includes distributions in liquidation to the extent of the earnings or profits accumulated since February 28, 1913, contained therein, and that to the extent of those earnings such distributions are taxable as dividends, subject to the surtax and exempt from the normal tax. To the extent that the deficiency represents a normal tax upon earnings or profits accumulated since February 28, 1913, and distributed to petitioner upon liquidation of the corporation, the respondent is in error.

Eeviewed by the Board.

Judgment wül be entered on 15 days’ notice, under rule 50,

       The Supreme Court subsequently held stock dividends nontaxable and this provision of the Act unconstitutional. Eisner v. Macomber, 252 U. S. 189. The intention of Congress, however, to make all manner of distributions of earnings accumulated since February 28, 1913, taxable as dividends is not otherwise affected by that decision.


author: Smith :

text:
    Shafpa Realty Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10105.
    Promulgated September 22, 1927.
    1. A corporation receiving during the taxable year a part payment on a mortgage note acquired at a 20 per cent discount from its face value received income to the extent of 20 per cent of the amount of the payment.
    2. The evidence is insufficient to show that the Commissioner was in error in failing to credit any part of an overpayment of tax for the fiscal year ending within the calendar year 1922 against a tax due upon the calendar year return for 1921.

      Benjamin Mahler, Esq,, for the petitioner.

      J. W. Fisher, Esq., for the respondent.
    The petitioner complains against a deficiency of $009.26 for the calendar year 1921. There are two questions in issue: (1) Whether a payment received on account of amortization of a mortgage note acquired at a discount of 20 per cent of the face value includes part income or is wholly a return of principal, and (2) the proper credit for taxes paid.
    FINDINGS OP PACT.
    1. The petitioner is a New York corporation.
    2. During the years 1920, 1921, and 1922 it filed its returns on a fiscal year basis ended September 30. The basis of its return was changed by the Commissioner to a calendar year, which change was acceptable to the petitioner.
    3. During the year 1920 the petitioner sold a building and received in part payment a second mortgage with a face value of $300,000. For the purpose of arriving at the profit or loss sustained from the transaction in 1920 the petitioner and the respondent agreed upon the market value of the second mortgage of $240,000. The mortgage was to be paid off at the rate of $20,000 a year.
    4. During 1921 the mortgagor made a payment of $10,000, which was considered by the petitioner as a return of principal. The respondent held that since the mortgage was acquired for $240,000, or at a discount of 20 per cent from its face value, the petitioner realized income to the extent of 20 per cent of each installment payment made. He held that $2,000 of the $10,000 received in 1921 represented income and increased the petitioner’s reported income accordingly.
    5. For the fiscal year ended September 30,1921, the petitioner paid on its income-tax return for such year a tax of $1,396.08. One-fourth of the income of such fiscal year was thrown into a prior period for the purpose of arriving at the income for the calendar year 1920. Accordingly, one-fourth of the tax paid on such return, or $349.02, was applied against the tax due and payable for the calendar year 1920, leaving $1,047.06 as being unapplied tax paid for the fiscal year ended September 30, 1921.
    6. For the fiscal year ended September 30, 1922, the petitioner paid upon its income-tax return for such fiscal year a tax of $1,563.52. One-fourth of the income shown for that fiscal year was placed by the respondent in the income of the calendar year 1921 and forms a part of the income of which the deficiency in tax is computed. The respondent this time did not take one-fourth of the tax paid for the fiscal year, ended September 30, 1922, although he had taken one-fourth of the income and had taken one-fourth of the tax paid for the fiscal year ended September 30, 1921, and applied it against the prior year’s income. The result is that the deficiency for the calendar year 1921 has not been reduced by any part of the tax paid by the petitioner for the fiscal year ended June 30, 1922.
   OPINION.

Smith :

On the basis of the decision of the Board in Corn Exchange Bank v. Commissioner, 6 B. T. A. 158, and of the decision of the Supreme Court in New York Life Insurance Co. v. Edwards, 271 U. S. 109, the petitioner contends that no part of the installment payment of $10,000 on the mortgage received during the calendar year 1921 constituted income of 1921, but that the entire amount was a return of principal. It is the petitioner’s contention that it could receive no income from the mortgage until it had received $240,000 representing its investment in the mortgage.

The decisions cited are clearly not authority for the contention made. In Corn Exchange Bank, sufra, we held that the amounts by which bonds purchased at a discount were written up in each year did not represent accrued income within the year and that the bank was not required to return any income in respect of such a bookkeeping transaction. The New York Life Insurance case was of similar import. The amortization of discounts and premiums representing nothing more than bookkeeping transactions are not accrued income or deductible losses within the meaning of the taxing statutes. The situation in the case at bar is entirely different. The petitioner received a part payment on the mortgage note held by it. It is no more correct to say that the part payment was all a return of principal than it is to say that it was all a return of income. Since the Commissioner in computing the gain discounted the mortgage 20 per cent, only 80 per cent of the face value represented the basis for computing the gain upon the payments made on the mortgage. Each payment made was a payment on the face of the mortgage, 80 per cent of which represented a return on the principal and 20 per cent a realization of discount or of income. Cf. Ruth Iron Co., 4 B. T. A. 1151.

The petitioner complains that the respondent in determining the deficiency for the calendar year 1921 has not applied against that deficiency any part of the payment of the income tax for the fiscal year ended September 30, 1922. In argument the respondent contended that one-fourth of the tax paid upon the return for the fiscal year ended September 30, 1921, had been applied against the tax due upon the calendar year return for 1920 and three-fourths of the tax upon the return for the calendar year 1921, that due to a change in the practice of the respondent no part of the tax paid for the fiscal year ended September 30, 1922, was applied against the tax due for the calendar year 1921 but against taxes due for other periods. The evidence does not show whether this was done or not. Under section 284 (a) of the Bevenue Act of 1926 the Commissioner has authority to credit an overpayment of any income, war-profits or excess-profits tax against any like tax due from the taxpayer. We are of the opinion that the evidence does not show that the Commissioner was in error in refusing to credit against the tax due for the calendar year 1921 any part of the tax paid for the fiscal year ended September 30, 1922.

Beviewed by the Board.

Judgment will be entered for the respondent.


author: Lansdon :

text:
    Liebman-Swaney Realty Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8805.
    Promulgated Sept. 22, 1927.
    1. HeW, that the petitioner is entitled to deduct from gross income an amount incurred and paid as salary during the taxable year.
    2. The petitioner is not entitled to. have its tax liability computed under section 328 of the Revenue Act of 1918.

      Arthur L. Jones, G. P. A., for the petitioner.

      J. L. Deveney, Esg., for the respondent.
    The respondent has determined a deficiency in income and profits tax for the year 1919 in the amount of $2,417.88, of which approximately $1,700 is in controversy. The issues are whether the petitioner may deduct from gross income certain amounts which it is alleged were incurred and paid in the taxable year as salaries of officers, and whether it is entitled to have its tax liability computed under the provisions of section 328 of the Bevenue Act of 1918.

      FINDINGS OF FACT.
    The petitioner is an Ohio corporation, with its principal office at Youngstown, where it is engaged in the real estate business. Its income is derived from commissions on sales and from profits resulting from trading on its own account. Its total authorized stock is $1,000, divided into 10 shares of the par value of $100, each, all of which were subscribed for, issued, and outstanding, in the taxable year.
    The original income-tax return of the petitioner for the year 1919 was that of a personal service corporation, and, in such return, all the net profits were divided in equal shares between two officers who were the only stockholders actually employed in the‘business, and no deduction was made from gross income on account of salaries for officers. Personal service classification was denied by the Commissioner. For the years 1916, 1917, and 1918, the petitioner made corporation income-tax returns and took deductions from gross income on account of salaries to officers.
    The by-laws of the petitioner provide that salaries of officers shall be fixed by the directors. During the taxable year such directors were Alfred Liebman and Selma B. Liebman, his wife; Hugh Swaney and Caroline Swaney, his wife; and David F. Griffith, the attorney of the corporation. The laws of Ohio require a minimum of five directors for each corporation organized and operating thereunder. The stock in the names of Selma B. Liebman, Caroline Swaney, and Griffith, was issued to them as qualifying shares. There were no formal meetings of directors during the taxable year, or at any other time. Griffith, the attorney' for the corporation, and the petitioner had offices in the same building. Informal meetings of the directors were held almost daily.
    For the taxable year Swaney and Liebman were the executive officers of the petitioner, and each of them devoted his entire time to the business. There was a verbal understanding agreed to by all the directors that such officers should each have a drawing account limited by the financial condition and business necessities of the petitioner. Pursuant to this understanding and agreement, Swaney and Liebman, whose personal services produced the greater part of the income of the petitioner, drew various amounts during the taxable year and such payments to them, in the total amount of $4,400, were charged, as drawn, to their respective personal accounts as compensation or salaries for services rendered.
    During the taxable year the gross income of the petitioner from all sources was $24,684.44, which was reduced by statutory deductions to the amount of $18,763.70, without deduction of salaries for Swaney and Liebman. Such income was made up of commissions, $17,170.82; profits from sale of properties, $7,513.62.
   OPINION.

Lansdon :

During the taxable year the petitioner was a close corporation operating under the laws of Ohio. In the circumstances established by the evidence, we are of the opinion that the drawing accounts informally authorized by an oral agreement, to which all stockholders and directors were parties, established the liability of the petitioner for an amount of $4,400 drawn in accordance therewith as compensation or salaries of officers incurred and paid in the year 1919.

There is nothing in the record to indicate that the petitioner is entitled to have its tax liability computed under the provisions of section 328 of the Revenue Act of 1918.

Judgment wiU be entered on 10 days’ notice, under Bule 50.

Considered by Sternhagen and Arundell.


author: Lansdon:

text:
    Capitol Theatre Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6224.
    Promulgated September 22, 1927.
    1. Theatre leases determined to have no bonus value on date of acquisition by petitioner.
    2. Petitioner’s gross income determined for tbe eight-month period, January 1 to August 31, 1920.

      John D. WatT&ms, Esq., and J. Roberts Sherrod, Esq., for the petitioner.

      A. George Bouchard, Esq., for the respondent.
    The respondent has determined a deficiency in income and profits taxej of the Capitol Theatre Co. for the year 1920 in the amount of $10,023.01. Two issues are involved: (1) The refusal by the respondent to allow as a deduction from gross income for the first eight months of 1920, an item of $4,285.68, claimed by the petitioner as exhaustion of leasehold interests; (2) the inclusion by the respondent in the petitioner’s gross income for the first eight months of 1920, of an amount of $37,266.66, whereas the petitioner alleges that only $12,000 was actually received by or accrued to it, and that its income for said period is accordingly erroneously increased by the sum of $25,266.66. The parties litigant stipulated that the correct deduction for exhaustion, wear, and tear of improvements on leased property for the first eight months of 1920 was $5,869.18. The remainder of the deduction originally claimed by the petitioner under this heading was necessarily waived, in view of the stipulation of the parties.
    FINDINGS OF FACT.
    The petitioner is a Georgia corporation with its principal office at 485 Fifth Avenue, New York, N. Y. It was incorporated by an order of the Bibb County Superior Court, Macon, Ga., on October 21, 1916, with a capital stock of $50,000, all of which was issued to its incorporators, G. T. Howard and Brown Wimberly, in the proportion of two-thirds to the former and one-third to the latter. Howard and Wimberly were during and subsequent to 1916 engaged in the cotton export business in Macon, under the name of the Taylor Cotton Co., and had been for many years.
    On April 29, 1916, the premises known at Nos. 366, 368, and 370, Second Street, Macon, Ga., consisted of land and of two-story brick buildings which were constructed about the year 1902 or 1903 at a cost of $30,000. The ground floors of these buildings were, at that time, occupied by a jewelry store and a shoe store; the upper floors by doctors and an insurance company. Such buildings were in good condition and were located in the heart of the business district of Macon.
    The properties here involved were leased to Howard and Wimberly by two lease contracts in writing dated, respectively, April 29, 1916, and July 24,1916. The lease dated April 29, 1916, covered the entire premises above described, except the ground floor of the building known as 366 Second Street, which was covered by the lease dated July 24,1916. The specified duration of each of said leases was from July 1, 1916, to September 30, 1921, inclusive, with option in the lessees to renew for an additional term of five years, expiring September 30, 1926, upon giving the lessor six months’ notice in writing.
    The lease dated April 29, 1916, provided for a graduated scale of rental payments as follows: From July 1 to September 30, ?916, $250 per month; from October 1, 1916, to September 30, 1919, $350 per month; from October 1, 1919, to September 30, 1921, $400 per month; and, in case the lessees’ option to renew were exercised, $450 per month throughout the renewal term of five years.
    The lease dated July 24, 1916, also provided for a graduated scale of rental payments as follows: From July 1, 1916, to September 30, 1920, $125 per month; from October 1, 1920, to September 30, 1921, $150 per month; and, in case the lessees’ option to renew were exercised, $150 per month throughout the renewal term of five years.
    The lease dated April 29, 1916, contains, among others, the following additional provisions:

      The lessees shall have the right at their option to renew this lease at its expiration for an additional term of five years expiring on the 30th day of September, 1926, upon the same terms and conditions, at a monthly rental of Pour Hundred and Pifty Dollars ($450.00) per month. The lessees shall give the lessor written notice six months in advance of the expiration of the lease if they desire to exercise this right of renewal, and shall give rent notes in evidence of renewal as aforesaid.
    The lessor binds herself to remove her tenants from the upper floors of the buildings now on said property, and to deliver to the lessees peaceable and quiet possession of said property on said first day of July, 1916, save and except that the said lessees undertake to arrange with the tenants of the storehouses on the ground floor of said building for their removal from the same, the said lessees to pay any expenses necessary to secure the removal of said tenants upon the ground floor of said property.
    The lessees agree and undertake that at the expiration of this lease, or any renewal thereof, they will, if the lessor so desires, restore the property to the same condition it was in at the time of the making of this lease, and deliver the property to the lessor in substantially the same condition it was at the time the said lessees received the same. If the lessor shall desire the property to remain as a picture show, then the lessees shall not be liable to pay any sum on account of this clause in this agreement, but if the lessor shall desire to change the property into a mercantile building, then the amount necessary to put the property back in the same condition it is now shall be ascertained and paid to the lessor in cash. The lessees agree to deposit with the Macon Savings Bank as Trustee security satisfactory to the lessor for the performance of this clause. The liability of the lessees to pay any sum under this clause shall not exceed Ten Thousand Dollars. If the lessees shall desire to sell said securities so deposited or to use them, the lessees shall have this privilege by substituting other securities in lieu thereof, satisfactory to the lessor. If at any time the value of the securities so deposited shall depreciate so that the market value of the same shall not be Ten Thousand Dollars, then the lessees agree to deposit additional securities or to substitute other securities in the place thereof so as to make the value of the securities so deposited Ten Thousand Dollars.
    The lessor shall pay all taxes and assessments upon the property described in this lease, but the lessee shall refund to the lessor an amount equal to the taxes paid by the lessor on account of the permanent improvements placed upon the property by the lessees, the taxable value of said permanent improvements to be determined by taking three-fourths of the amounts actually expended by the lessees for permanent improvements.
    In case the leased premises are totally destroyed or rendered untenantable by fire, flood, earthquake, or windstorm, then and in that event they shall be replaced in the same condition they were in at the time of the fire, each party contributing to the replacing thereof in proportion to his interest therein. In case the premises are so destroyed or rendered untenantable, then and in that event the monthly rental agreed to be paid shall abate, and the lessees shall pay to the lesser one-half the agreed rental during the time the premises are not tenantable.
    It is hereby agreed that the property shall be fully insured from loss or damage by fire in good and responsible fire insurance companies, the loss to be made payable by proper stipulations in said policies to said Macon Savings Bank as trustee. The lessor shall pay the premium on Sixty-Five Hundred Dollars ($6,500.00) of said insurance. The lessees shall pay the premiums on the balance. In the event of fire, all amounts collected on said policies shall be held in trust by the trustee, and a sufficient sum shall be applied by the lessees to replace the buildings or buildings destroyed or injured in the condition they were in at the time of the fire. The Trustee shall be in no way liable or responsible for the insuring of the property or keeping it insured. The Trustee shall allow the insurance money received on the policies to be applied by the lessees to replacing the property destroyed or injured, and the trustee shall, upon request, pay over the same to the lessees for that purpose, in installments of not more than twenty-five per cent at a time, on receipt of a certificate by the lessees and some reputable contractor or builder showing that a sum at least equal to the amount of money so requested to be paid over has been expended, or an indebtedness therefor incurred by the lessees in replacing the property lost or damaged; and such certificate shall be sufficient evidence to the trustee that such sum has been paid, or such indebtedness incurred, as therein stated.
    The lease dated July 24, 1916, contains similar provisions in practically identical language, except that it does not provide for a deposit with a trustee to insure the performance of the clause respecting restoration of the property at expiration of the lease.
    Immediately following the acquisition of the lease of April 29, 1916, Howard and Wimberly began the remodeling of the premises and the construction of the Capitol Theatre. For these purposes, the sum of $45,158.51 was expended in 1916, and the sum of $5,139.96 January, 1911, making a total of $50,298.47. Of this amount, $10,606.68 was paid to prior lessees then on the premises, to induce them to vacate their leases; a total of $900 was paid to the lessor as rent prior to November, 1916; and a total of $625 was paid prior to November 11, 1916 to lawyers and as salary to B. H. DeBruler, who was manager and superintendent of the Capitol Theatre during the period of construction and thereafter. The Capitol Theatre opened its doors and commenced operations as a motion picture theatre on November 11, 1916.
    On December 6, 1916, the theatre and motion picture business were conveyed by Howard and Wimberly to the petitioner by an indenture, the material clauses of which read as follows:
    Witnesseth, That for and in consideration of the sum of Sixty-Nine Thousand Nine Hundred and Ninety Dollars the parties of the first part have this day bargained, sold, aliened and conveyed, and by these presents do bargain, sell, .alien, convey and confirm unto the party of the second part, its successors and assigns, the following described property, to wit:
    A certain moving picture business situate at Nos. 366, 368, and 370 Second Street in the city of Macon, Georgia, together with all the appurtenances, improvements, apparatus, furniture, decorations, fixtures, notes, choses in action, accounts, and any and all other things connected with said moving picture business, together with the good will. Also, two certain leases dated the 29th day of April, 1916, and the_day of July, 1916, from Mrs. Josephine Jones Miller to the parties of the first part, with all its rights, privileges and liabilities, and for the term stated in said leases, together with any renewals thereof.
    It is the intention of this instrument to convey to the party of the second part said moving picture show now being operated as a going concern, together with any and all property rights appurtenant to and connected therewith.
    To Have and To Hold said bargained property in fee simple forever.

      The true consideration, for this conveyance is not recited in the indenture of December 6,1916. The consideration received by Howard and Wimberly for this conveyance was the entire authorized capital stock of the petitioner of a par value of $50,000.
    The physical assets of the petitioner at the close of the year 1916 were: building, $34,362.94; fixtures and equipment, $9,288.83; total, $43,651.77. The physical assets of the petitioner at the close of the year. 1917 were: building, $36,088.04; fixtures and equipment, $12,903.24; total, $48,991.28.
    The net income of the Capitol Theatre for the period from November 11, 1916, to December 31, 1916, was $2,474.64.
    The petitioner operated the Capitol Theatre for about nine months. The operation of the Capitol Theatre was turned over to the Macon Photo Play Theatre Co. from the latter part of August, 1917. G. T. Howard, Brown Wimberly, E. W. Gould, and L. A. Mitchell petitioned the Superior Court of Bibb County, Georgia, on November 15, 1917, to incorporate them under the name of the Macon Photo Play Theatres Co. with a capital stock of $1,000, all of which had been paid in, and their petition was granted, and they were incorporated by order of said court dated Decéinber 15, 1917. Howard had a four-tenths interest in the company, and, the other three incorpo-rators had a two-tenth interest each. The petitioner sublet the Capitol theatre to this corporation, under oral lease, which provided for the payment of a monthly rental of $1,500, in addition to the rent stipulated in the original leases, above mentioned. Howard, Wim-berly, Gould, and Mitchell each received salaries from the Macon Photo Play Theatres Co. during the period it operated the Capitol Theatre. B. H. DeBruler was elected manager. The Macon Photo Play Theatres Co. never had minute books, or formal meetings. There were no formal declarations of dividends. Its four incorpo-rators and shareholders, however, met together and conferred on policies regularly. The profits of said company were distributed regularly. The Macon Photo Play Theatres Co. reported its income as a personal service corporation.
    The Macon Company operated the Capitol Theatre until August 30, 1920, when the oral lease between it and the petitioner was terminated. During the three years the Macon Company operated the Capitol Theatre, checks for rent were made out in the name of the petitioner, but checks for profits were made out in the individual names of its shareholders. The returns of the Macon Company show that its profits were distributed to G. T. Ploward, Brown Wim-berly, E. W. Gould, and L. A. Mitchell, in the ratios above given.
    Howard and Wimberly sold one-half of their holdings in the petitioner about September 1, 1920, for $75,000, and shortly thereafter the remainder of their holdings in the petitioner to Southern Enterprises of Atlanta, Ga., which was controlled by New York interests with offices in New York City. The operation of the petitioner and its theatre were thereupon turned oyer to the purchasers, and they filed a return covering the last four months of 1920. The net income reported in this return was accepted by the Commissioner, and amounts to $1,549.76.
    When Howard and Wimberly began the construction of the Capitol Theatre in 193 6, and prior to the incorporation of the petitioner, a record of the expenditures was kept in a joint account on the books of the Taylor Cotton Co., headed “ Howard and Wimberly.” This was done because they owned the Taylor Cotton Co., had their offices there, the Taylor Cotton Co. advanced the money for the improvements, and it was the most convenient place to keep the account. After the petitioner began to operate the theatre, its manager kept a record of the receipts and expenditures at the petitioner’s office, but Howard and Wimberly continued to keep a joint ledger account on the books of the Taylor Cotton Co. of everything they received and expended in connection with the petitioner.
    After the operation of the Capitol Theatre was turned over to the Macon Company, the petitioner had no office except the office of Howard and Wimberly with the Taylor Cotton Co. The petitioner then stopped keeping a detailed record of receipts and expenditures. Howard and Wimberly continued to keep the joint account on the ledger of the Taylor Cotton Co. In the 1918 ledger of the Taylor Cotton Co. the name “ Howard and Wimberly ” for this joint account was scratched out and the name “ Capitol Theatre Company, Macon, Ga.,” substituted therefor at the suggestion of the revenue agent.
    The return for the first eight months of 1920 was made under the following circumstances: Wimberly moved to Savannah, Ga., after selling his interest in the Capitol Theatre Co. in 1920. He had no interest of any kind in the company after the sale. In 1924 he was approached several times by revenue agents attached to the Savannah, Ga., office, in reference to making a return for the Capitol Theatre Co. to cover the first eight months of 1920. Finally he directed one of his clerks to give the agent a copy of an account on the ledger of the Taylor Cotton Co. headed “ Capitol Theatre Company, Macon, Georgia.” The clerk copied the debit and credit sides of this account from January 1, 1920, to August 31, 1920, the debit side totaling $8,170.54 and the credit side $37,295.41, prepared a letter of transmittal to the collector at Savannah, which Wimberly signed without examining the attached copies. This letter was sent to the collector, who then sent Wimberly a blank return with request to sign it, which Wimberly did, and the copy of the credit side of the account was attached to the return as the gross income of the Capitol Theatre Co. for the first eight months of 1920 and the copy of the debit side of the account was attached to the return as the expenses or deductions of the company for the same period.
    A net income of $29,897.40 was determined by the Commissioner for the first eight months of 1920, and was arrived at by deducting the debit side of the account just referred to from the credit side, with the exception of $772.53, representing Federal income-tax payments. Of the amount so allowed as a deduction from gross income by the Commissioner, the parties litigant have stipulated that $5,867.49 represented capital expenditures, and should not be allowed as a deduction from gross income. The debit side of the account contained no item representing depreciation on the improvements made to the leased premises and no depreciation was allowed on said improvements in determining the petitioner’s taxable net income for the first eight months of 1920. A deduction for depreciation of said improvements had been allowed the petitioner in prior years. The parties have stipulated that the petitioner is entitled to a deduction from gross income of $5,869.18 for exhaustion, wear and tear of improvements during this eight-month period.
    The two leases dated April 29, 1916, and July 24, 1916, together with the motion picture business of the Capitol Theatre, conveyed to the petitioner by the indenture dated December 6, 1916, had a fair market value on that date of $50,298.47. The gross income of the petitioner for the period January 1 to August 81, 1920, Avas $1,500 per month, or $12,000. The net income of the petitioner for the period September 1 to December 31,1920, was $1,549.76.
   OPINION.

Lansdon:

The petitioner claims that the tAVO leases dated April 29, 1916, and July 24, 1916, involved in this proceeding, had a fair market or bonus value at date of acquisition by it (December 6,1916) of $80,623.06, or about $30,000 in excess of the actual expense of Messrs. HoAvard and Wimberly in getting the leased premises vacated and remodeling the same into a motion picture theatre. An inspection of the rigid terms of the leases and a consideration of the incomplete evidence adduced by the petitioner on the question of their fair market value on December 6, 1916, convince this Board that the petitioner has not established that said leases had any value on the date of their acquisition in excess of $50,298.47, the cost of the improvements upon which the parties have stipulated that the petitioner is entitled to deduction for exhaustion in the amount of $5,869.18. The action of the respondent is, therefore, approved as to this phase of the petitioner’s appeal.

The respondent Avas in error in including in the petitioner’s gross income the profits of the Macon Photo Play Theatres Co. distributed by it to its own incorporators and shareholders. The Macon Company leased the Capitol Theatre from the petitioner by an oral lease, paying to the latter a net rental of $1,500 per month. These rental payments represented the only gross income of the petitioner for the eight-month period January 1 to August 31, 1920. The petitioner’s taxable net income for the four-month period September 1 to December 31, 1920, as set forth in the deficiency notice forming the basis of this proceeding, was $1,549.70. Other deductions which are allowed the petitioner in the deficiency notice, and are not the subject of dispute, total $1,530.52. The taxable net income of the petitioner should be recomputed in conformity with the findings of fact and the opinion herein above expressed.

Judgment will be entered on 10 days’ notice, under Rule SO.

Considered by Sterniiagen, Green, AND Arundell.


author: SterNhagen :

text:
    Bruno O. A. de Paoli, Executor, Estate of Louis de Paoli, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7978.
    Promulgated September 24, 1927.

      George E. D. Foster, Esq., for the petitioner.

      Arthur H. Fast, Esq., for the respondent.
    Deficiency in income tax of $19.26 for 1920, $2,469.01 for 1921, and an overassessment of $506.41 for 1922. The petitioner claims the right in determining the net income of the partnership of which the decedent was a member, to deduct a percentage of the partnership earnings by virtue of a contract obligation to pay said percentage to employees as compensation for services.
    FINDINGS OF FACT.
    1. The taxpayer and one Kelly as partners did business during the year 1920 and during the year 1921 until June, when said Kelly died.
    2. In December, 1919, the partnership made a legal and binding contract with two of its employees to pay each of them wages of $40 per week, and an additional sum equal to 25 per cent of the net profits of the business after deducting 10 per cent interest for the capital invested by the partners.

      3. The two employees duly performed the contract on their part.
    4. Five hundred dollars of the amounts due each of the employees was paid in December, 1920, on account, and further payments were not made at that time, because the amount of the profits had not been determined.
    5. Thereafter the taxpayer, as surviving partner, refused to pay the balance of said compensation although admitting it to be due, solely on the advice of counsel.
    6. The reason for such advice of counsel was that Kelly had died and his legal representative questioned the fact of the said partnership agreement with its employees.
    7. Each of said employees began actions at law in the Supreme Court of the State of New York in December, 1921, to recover the balance of said compensation.
    8. All parties in interest, including,the legal representative of said Kelly, were parties to said actions.
    9. Said actions were duly tried and judgment therein duly rendered on June 20,1922, in favor of each of the plaintiffs, for the sum of $13,071.11.
    10. Each of said judgments was duly and promptly paid.
    11. The taxpayer’s 1920 income-tax return was rendered on a cash basis.
    12. The taxpayer’s 1921 income-tax return was rendered on a cash basis.
   OPINION.

SterNhagen :

The foregoing findings of fact, with the exception of findings 11 and 12, are those proposed by the petitioner, and are amply supported by the evidence. There is no doubt from the evidence that the partnership of de Paoli & Kelly incurred the contract obligation to pay to each of the two employees 25 per cent of the partnership profits after subtracting an amount equal to 10 per cent upon the partnership investment. From the official proceedings contained in the judgment roll of the Supreme Court of New York in each of the lawsuits brought by the employees to enforce this obligation, it appears that partnership capital account was $30,845.27, and that the profits for 1920 after deducting said 10 per cent amounted to $32,511.80, and for 1921 to $31,875.70. The judgment of the court in those proceedings establishes that the liability existed in respect of the profits of those years.

Although petitioner’s counsel was clearly and definitely put upon notice at the trial before the Board that the right to the deduction was materially affected by the question whether, under section 212 (b), the accounts were kept on the cash basis or on some other basis, he nevertheless failed to make the proof. On the other hand, the respondent introduced in evidence the original individual returns of the decedent, and it appears that the 1920 return is expressly stated to be upon a cash basis, and the 1921 return, while making no express statement in this respect, appears to be upon the same basis. There is not a scintilla of evidence as to the accounting method of the partnership or the basis of its returns.

That a taxpayer who consistently makes his returns upon the basis of income actually paid, may not at the same time so far depart from the adopted method as to deduct some items not actually paid and thus distort his income for a single year and reduce his tax, should be plain, and has been frequently decided. United States v. Mitchell, 271 U. S. 9; 5 Am. Fed. Tax Rep. 6008; Henry Reubel, 1 B. T. A. 676; Atlantic Coast Line R. R. Co., 2 B. T. A. 892. Here the amount was not paid until 1922, and in the absence of any evidence as to the partnership basis and the apparent cash basis of the decedent, it may not be deducted in 1920 or 1921.

As to 1922, no deficiency has been determined by the respondent, and the Board is without jurisdiction of that year. Cornelius Cotton Mills, 4 B. T. A. 255. The determination of the respondent must therefore be sustained.

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

Considered by LaNsdoN and Artjndell.


author: Steenhagen :

text:
    Estate of Charles J. Kelly, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7976.
    Promulgated September 24, 1927.

      'William Huch, Jr., Esq., for the petitioner.

      A. W. Gregg, Esq., for the respondent.
    Deficiencies in income tax of decedent before death for the period January 1 to June 24, 1921, $520.74, and the period June 24 to December 31, 1921, $586.32, and overassessment for 1920 of $7.74. The proceeding was submitted by the parties upon a stipulation that the evidence and record in Bruno O. A. de Paoli, Executor, Estate of Louis de Paoli, Docket No. 7978, should be taken as the basis for decision.
    FINDINGS OF FACT.
    1. Louis de Paoli and Charles J. Kelly were engaged, as partners, in the terrazzo and tile flooring business in New York City in 1920 and for a great many years prior thereto, under the firm name of de Paoli & Kelly.

      2. Each partner had an equal interest in the firm.
    3. Kelly’s only income, during the years 1920 and 1921, was what he received out of the firm of de Paoli & Kelly.
    4. During the year 1919, Louis de Paoli entered into agreements with his son, Bruno de Paoli, and his son-in-law, Frank Bacchetti, both of whom were employees of de Paoli & Kelly, to pay them for the year 1920 and subsequent years, in addition to fixed salaries of $40 per week, a sum equal to 25 per cent each of the net profits of the firm after deducting 10 per cent on the invested capital of the firm.
    5. During 1920 and 1921, the firm paid each of the aforesaid employees the sum of $500 on account of these profits.
    6. During much of 1920 and 1921 Kelly was ill and took no part in the business or affairs of the firm, and he died on June 24, 1921.
    7. During 1920 and 1921 de Paoli declined to pay the balance of the profits to the two employees until he was protected by judgments obtained by his son and his son-in-law.
    8. Suits were brought by these two men against de Paoli, as sole surviving partner of the firm, in the Supreme Court of New York, New York County, in March, 1922.
    9. De Paoli, in his answers to these suits, admitted the making of the agreements as above stated, and testified as a witness on the trial and in his testimony likewise admitted the making of the agreements as stated.
    10. On June 20, 1922, each of the plaintiffs in said suits obtained a judgment against Louis de Paoli, as sole surviving partner of the firm of de Paoli & Kelly, for $12,266.61, which, with interest and costs, amounted to $13,487.66, which was the sum paid on each judgment in 1922. Of this sum of $13,487.66, the sum of $5,350.45 represented 1920 profits, the sum of $4,398.45 represented profits from January 1 to June 24, 1921, and the sum of $3,738.76 represented profits from June 24 to December 31, 1921.
   OPINION.

Steenhagen :

The foregoing findings of fact are as submitted by petitioner, but, as in the companion case of Bruno O. A. de Paoli, Executor, 8 B. T. A. 294, the petitioner fails for the reason that on the cash basis he or the partnership may not deduct an unpaid liability. Petitioner here has not proved the basis of his or the partnership’s return or the method of his or its accounts, although in his petition he alleges that he kept no books. See John A. Brander, 3 B. T. A. 231. This failure of proof, as in the companion case, is not a mere oversight, because the question was squarely suggested at the trial.

It should be added, in view of the petitioner’s brief, that counsel for the petitioners have expressly maintained throughout these proceedings that the two employees were not partners and were therefore not participating in the profits as such. The question, therefore, is not whether the two partners can be charged with having received the income of the partnership, but whether the partnership is entitled to the deduction in 1920 and 1921 for compensation to employees not paid until 1922. The determination is sustained.

Judgment will be entered on 16 days’ notice, u/nder Rule 60.

Considered by LaNsdok and AeuNdell.


author: Van Fossan :

text:
    Hyman Levine, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7435.
    Promulgated September 26, 1927.

      Dan J. Ghapin, Esq., for the petitioner.

      Brice Toole, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income tax of $574.44 and $626.90 for the calendar years 1920 and 1921, respectively. The alleged deficiencies arise from the inclusion in petitioner’s income of salary earned by his wife.
    FINDINGS OF FACT.
    Petitioner and his wife were during the two years here involved domiciled and living together in Los Angeles, Calif., where petitioner was engaged in the cooperage business. Beginning in 1909 or 1910 and at the beginning of each year thereafter including the taxable years, petitioner and his wife agreed orally that petitioner would pay his wife a stipulated sum each week as salary for her services in connection with his business, and that such salary should be her separate property to do with as she chose. During 1920 and 1921 petitioner paid his wife regularly at the rate of $60 per week, which sum she placed in her own bank account. Petitioner had no control over the funds so paid and never questioned his wife’s right to use or spend the same. Petitioner had charge of the outside work of the business while his wife did the buying and selling and all office work.
   OPINION.

Van Fossan :

This case is controlled by our decision in Appeal of Estate of George W. Randall, 4 B. T. A. 679. See also Louis Gassner v. Commissioner, 4 B. T. A. 1071.

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

Considered by MaRQtjette, Milliken, and Phillips.


text:
    James Neill, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9290.
    Promulgated September 26, 1927.

      D. 'Webster Egan, Esq., for the petitioner.

      Brice Toole, Esq., for the respondent.
    This proceeding was brought for the redetermination of an alleged deficiency in income taxes for the calendar year 1922, amounting to $444.01. It is alleged that respondent erred in adding to petitioner’s income the sum of $5,822.98 earned by petitioner’s wife.
    FINDINGS OF FACT.
    Petitioner and his wife were domiciled and living together during the taxable year in Glendale, Calif. Both were professional actors employed duriiig 1922 as moving picture actors. As a result of her employment petitioner’s wife earned a salary which was returned by her in her separate income-tax return.
    About February 10, 1922, petitioner and his wife entered into an oral agreement that all household expenses should be paid out of petitioner’s income and that whatever his wife earned should be hers absolutely to do with as she chose. They kept separate bank accounts and never drew on each other’s accounts nor did petitioner in any way handle or control the funds received by his wife. They never pooled their funds for investment or any other purpose. Petitioner’s wife also owned outright the residence in which they lived.
   OPINION.

Van Fossan :

This case is controlled by our decision in Appeal of Estate of George W. Randall, 4 B. T. A. 679. See also Louis Gassner v. Commissioner, 4 B. T. A. 1071.

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

Considered by MaRQuette, Milliken, and Phillips.


text:
    Davis Yarn Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6885.
    Promulgated September 27, 1927.
    Where a corporation, organized on March 1, 1921, filed its returns on a calendar year basis and the return included the income from organization to December 31,1921, held that such return is a return for a full taxable year of 12 months and it is entitled as an excess-profits credit to the entire specific exemption of $3,000, plus an amount equal to 8 per cent of its invested capital, averaged over the full taxable year of 12 months.

      Milton M. Wecht, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    In this proceeding the petitioner appeals from the determination of a deficiency of income and profits taxes for 1921 in the amount of $1,001.88. The alleged deficiency arises from the action of the respondent in treating the return of the petitioner as a return for a fractional part of a year instead of a return for a full taxable year, and in prorating the specific exemption and excess-profit credit of 8 per cent of invested capital on the basis of such fractional part.
    BINDINGS OB BAOT.
    The petitioner is a New York corporation, organized on March 1, 1921. Its business is trading in silk and woolen yarn and its principal office is located at Brooklyn, N. Y.
    The petitioner began business on March 1, 1921. It kept and closed its books on a calendar year basis, the books being closed for the first time on December 31, 1921. The outstanding capital stock at both March 1, 1921, and December 31, 1921, amounted to $100,000, and the invested capital covering this 10-month period likewise amounted to $100,000. On or before March 15, 1922, the petitioner filed a return which is styled “Corporation income and profits tax return for the calendar year 1921, or for the period begun March 1, 1921, and ended December 31, 1921.”
    In determining its excess-profits credit under Schedule C in the return so filed, the petitioner claimed the specific exemption of $3,000, plus 8 per cent of its invested capital of $100,000, ($8,000) or a total excess-profits credit .of $11,000.
    The respondent in determining the excess-profits credit, prorated both the specific exemption of $3,000 and the invested capital of $100,000 on the basis of a return for ten-twelfths of a year, thereby arriving at a total excess-profits credit of $9,166.67.
   OBINION.

Van Fossan :

The question in this case is the amount of the excess-profits credit to which the petitioner, a corporation organized March 1, 1921, and filing a return covering its operations to and including December 31, 1921, is entitled under section 312 of the 1921 Act. This section provides:

That the excess-profits credit shall consist of a specific exemption of $3,000 plus an amount equal to 8 per centum of the invested capital for the taxable year.

The questions arising in the instant proceeding are substantially the same as those involved in the Louis Hymel Planting & Manufacturing Co., 5 B. T. A. 910. That case arose under the Revenue Act of 1918, but we find no material difference in the pertinent sections of Acts involved in the two proceedings. In that case, the question of what is a return for a fractional part of a year and what is a return for a year was discussed at length and decided in accordance with principles laid down in the case of Bankers’ Trust Co. v. Bowers, 295 Fed. 89. The Board has further had occasion in other instances wherein similar questions were involved, to apply the principles laid down in the Bankers’’ Trust Co. case; Carroll Chain Co., 1 B. T. A. 38; Lynch Construction Co., 3 B. T. A. 313. See also Arthur Walker & Co., 4 B. T. A. 151, and Durabilt Steel Locker Co., 5 B. T. A. 239.

Following the reasoning used in the above cited cases, we are of the opinion that the petitioner’s return in which was included the income for the period from March 1, 1921, the date of organization to December 31, 1921, was not a return for a “ fractional part of a year ” but was a return for a full taxable year of 12 months and that it is entitled to the full specific exemption of $3,000.

The remaining question is the proper basis to be applied in arriving at the invested capital for computing the additional deduction of 8 per cent allowed as an excess-profits credit under section 312. On this point also the decision is governed by the principles announced by the Board in Louis Hymel Planting & Manufacturing Co., supra.

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

Considered by MaRquette, Milliken, and Phillips.


text:
    Estate of C. W. Crews, Kate Downing Crews, Administratrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 981.
    Promulgated September 27, 1927.
    1. Where a contract for the sale of a farm, executed by both the owners of the fee and the owner of a life estate therein, provided that the life owner should receive all interest and benefit from the principal purchase price during his life, and the fee owners were entitled to none of the proceeds nor the use thereof during his life, the initial payment under the contract made to the common agent of both grantors was a payment to, and a receipt thereof by, the owner of the life estate.

      2. And where such contract further provided that the owner of the life estate should be reimbursed, out of the first payments of the principal purchase price, for improvements to the farm made by him, the initial payment, which was less than the cost of such improvements, was a partial return of capital and not taxable income.

      Turner 8. Underwood, G. P. A., for the petitioner.

      W. H. Lcmder, Esq., for the respondent.
    In this, case a redetermination is asked of a deficiency in income tax for the year 1920 found by the Commissioner to amount to $640.14. It is alleged that the Commissioner erred by including in taxable income the sums of $3,000, as rent, and $30, as dividends, and by disallowing an alleged loss on the sale of two tracts of land, all of which is denied by the Commissioner. It is further alleged that the Commissioner asserted a deficiency in tax for 1919, whereas in fact there is an overassessment for that year. The Commissioner denied that a deficiency had been determined or asserted for 1919 and no evidence was submitted in support of this assignment of error. At the hearing petitioner abandoned the assignment of error as to the $30 item, and introduced no evidence in support of the alleged loss on the sale of two tracts of land.
    FINDINGS OF FACT.
    The petitioner is an individual, residing at Pueblo, Colo., and is administratrix of the estate of C. W. Crews, deceased.
    C. W. Crews, for many years prior to the taxable year, was a merchant in Pueblo, Colo., and prior to 1904 owned a farm, near Pueblo, with certain water rights appurtenant thereto. In or about 1904 Crews conveyed the farm and water rights to his two daughters, Lucille Crews Marsh and Clara Crews Wells, both of whom resided in California, reserving to himself a life estate therein. Ia the year 1918 Crews installed upon the farm a tile drainage system at a cost of $4,919.80. Thereafter, but prior to 1920, to facilitate a sale of the farm, Crews informally agreed with his daughters that he would release his life estate, with the understanding that out of the first payments received from the sale he would be reimbursed for the cost of said drainage system.
    Early in the year 1918 Crews suffered a stroke of paralysis and from that time until his death in 1923 his wife, Kate Downing Crews, conducted all his business affairs. In the fall of 1919 negotiations for the sale of the farm were entered into between C. W. Mills and Mrs. Crews, representing Crews and the two daughters. On September 12, 1919, a contract for the sale of the farm was entered into between Lucille Crews Marsh and Clara Crews Wells, parties of the first part, C. W. Mills, party of the second part, and C. W. Crews, party of the third part. By the terms of the agreement the farm, together with the water rights, was sold, free of incumbrances, to Mills for $24,000, of which $3,000 was payable on or before January 1, 1920, and the balance payable in annual installments of varying amounts, the last installment being due January 1, 1932. Among other things, the agreement provided:
    Whereas, the first parties are the owners of—
    The North Half of the South-west Quarter of Section Twenty-three, Township Twenty-two South of Range Fifty-nine West of the Sixth P. M. Otero County, Colorado, containing eighty acres,
    subject to a life estate of the third party, and likewise own twenty-six (26) shares of the capital stock of the Oxford Farmers’ Ditch Company, represented by Certificate No. 290, duly issued February 9th, 1900, to the said C. W. Crews, and said first parties desire to sell and dispose of the real estate above described, and sixteen (16) shares of water stock above referred to, to the second party for the sum of Twenty-four Thousand Dollars ($24,000) free and clear from all liens and incumbrances, and
    Whereas, the second party is desirous of purchasing the land above described together with sixteen (16) shares of said water stock, and offers to pay therefor the sum of Twenty-four Thousand Dollars ($24,000) on the terms and conditions hereinafter set forth,
    Now, it is mutually agreed between the parties hereto that the first parties will and they do hereby sell to the second party the land above described, together with sixteen (16) shares of the capital stock of The Oxford Farmers’ Ditch Company, above referred to, for the aggregate sum of Twenty-four Thousand Dollars ($24,000), to be paid as follows:
    Two Hundred and Fifty Dollars ($250.00) Cash when this contract is signed, receipt whereof is hereby acknowledged, and Twenty-seven Hundred and Fifty Dollars ($2,750) in cash on January 1st, 1920, the balance of Twenty-one Thousand Dollars ($21,000) to be paid in annual installments as follows:
    ******* all of said deferred payments to be represented by promissory notes, payable to said first parties, of even date with this contract, all drawing interest at six per cent (6%) per annum, on and after January 1st, 1920, payable annually on the first day of January each and every year thereafter until the principal and interest on all of said notes have been fully satisfied and paid, all of said promissory notes to be payable on or before maturity.
    *******
    It is Further Mutually Agreed between the parties hereto that the first parties will join in a good and sufficient Warranty Deed of Conveyance along with the third party, as grantors to said second party, when this contract is signed, which said deed shall be duly signed and acknowledged by said grantors, and said Warranty Deed along with this Contract, said promissory notes, Abstract of Title, Fire Insurance policies, together with a Certificate of Stock in The Oxford Farmers’ Ditch Company for sixteen (16) shares of the capital stock of said Company, duly issued in the name of C. W. Crews, and properly endorsed, shall be placed in escrow in the First National Bank of Pueblo, Colorado, to be there held by said Bank, pursuant to the terms, covenants and conditions of this contract.

      It is ITurtheR Mutually Agreed between tbe parties hereto that out of the first moneys paid on said purchase price of Twenty-four Thousand Dollars ($24,000), the said third party, in consideration of the releasing of his life estate in said land and water as hereinafter provided, shall receive all interest accruing on said purchase price during his life time, whether’’ the same shall arise from deferred payments or from a reinvestment of payments after they have been made, and in addition thereto will be entitled to receive in consideration of the improvements heretofore made by the said third party on the land above described, the first Ten Thousand Dollars ($10,000) of the principal sum of said purchase price as the same is paid, to be his absolutely.
    It is Mutually Agreed between the parties hereto that after the said third party has received Ten Thousand Dollars ($10,000) as above provided, the remainder of the principal of said purchase price shall be invested in interest-bearing securities subject to the approval of the first and third parties, and said third party shall receive all interest arising therefrom during his life time.
    * X H= * * X #
    It is Further Mutually Agreed between the parties hereto that in the event of the death of said third party, said bank shall pay all of the proceeds thereafter arising from the sale of said land and water above described, including principal and interest to said first parties, except the payment of $6,000.00 of the $10,000.00 to be paid to the third party, or his estate, as hereinbefore provided, said $10,000.00 payment being reduced to $6,000.00 by the terms of another contract between the first and third parties hereto and John Garner, which obligates the South Half of the South-west Quarter of said Section Twenty-three for $4,000.00 of said payment of $10,000.00.
    It is Further Mutually Agreed between the parties hereto that at any time during the life of this agreement, said second party pays off and fully satisfies all of said promissory notes, representing the unpaid balance of said purchase price of the land and water hereinabove described and set forth, then and in that event said Bank is hereby authorized and fully empowered to deliver all of said escrow papers above enumerated and held by said Bank to said second party, for his sole use and benefit, and shall receive said purchase price for the use and benefit of the parties entitled thereto, pursuant to the terms of this agreement.
    ***** * *
    It is Further Mutually Agreed that in the event the second party defaults in the performance of any of the terms, covenants and conditions of this contract, he shall immediately surrender and deliver up possession of said premises to said first and third parties, peaceably, and if on being notified thirty days in writing by said first and third parties, he shall fail and refuse to surrender and deliver up possession of said premises, together with all of the improvements thereon, then and in that event, said first and third parties or either of them shall have full right and power to eject, dispossess and put off the said second party from said premises, and the said Bank shall within ten days after the expiration of said thirty days surrender and deliver up to said first and third parties any and all papers, securities, conveyances or evidences of indebtedness held by it in escrow as aforesaid, and any payments made pursuant to the terms hereof prior thereto, shall be considered as rent for the use of said premises for the lapsed period, and shall become the property of the first and third parties, respectively, as herein provided, to be theirs absolutely, as a penalty for the failure of said second party to comply with the terms of this agreement; * * *.

      The first payment of $3,000 was made to Mrs. Crews, representing Crews and the daughters, in January, 1920, and no further payment upon the principal purchase price or interest thereon was made at any time. Mills was in possession of the property during the years 1920, 1921, and 1922. Thereafter, Mills, being unable to make the agreed payments because of farming conditions, surrendered the property and the contract was canceled. The initial payment of $3,000 was forfeited in 1923 and retained pursuant to the terms of the contract.
    The $3,000 initial payment was made to Mrs. Crews and by her paid over to the two daughters. Neither Crews nor his estate was otherwise reimbursed for the cost of the drainage system installed.
   OPINION.

Van Fossan:

The only matter requiring our consideration is whether or not the $3,000 initial payment made under the Mills contract was taxable income received by the decedent, Crews, in the year 1920. All other issues raised by the pleadings were abandoned by the petitioner.

The contract of sale is a tripartite agreement under which Crews and his daughters engaged to convey their independent interests in the farm to Mills for the consideration therein specified. Crews was. the owner of a life estate in the farm and the daughters were the owners of the fee, and in the agreement of sale the parties evidenced their intention to preserve their respective interests in the proceeds to be derived from the sale. Crews, after receiving a stipulated sum of $10,000 as reimbursement for improvements made to the property, was to receive all interest and profits from the balance of the proceeds during his lifetime. It is clear from a' consideration of this agreement as a whole that the daughters would receive no benefit from or any part of the proceeds of the sale until after the death of Crews. When, therefore, Mills paid the $3,000 to Mrs. Crews she received money belonging to Crews, and that sum was in law received by him at the time it was paid to her. (See Appeal of Julia A. Strauss, 2 B. T. A. 598.) It is immaterial that Mrs. Crews also acted as the agent of the daughters. Since they had no interest in or title to the $3,000 payment and were to receive no benefit from any of the proceeds of sale so long as Crews lived and the agreement remained unmodified, it can not be said that Mrs. Crews received the $3,000 as agent for the daughters. The fact that Mrs. Crews subsequently paid the money to the daughters instead of to Crews does not alter the fact that it had been received by Crews. The circumstances surrounding the transfer of this sum to the daughters showed it to be nothing more than an advancement or loan from Crews. It was not paid to them in recognition of any right or title thereto.

Although Crews received the $3,000 it does not follow that it was taxable income to him. Respondent calls attention to the forfeiture clause of the contract under which this sum was designated as rent upon default by the purchaser, and urges that as rent it was income to Crews under the contract. That clause, however, is not determinative of the question before us, nor do we conceive it to be material. Whatever may have been the intention or purpose of the parties in stipulating that payments forfeited upon default should be considered rent, whether or not the payment was in fact income at the time made must be determined from all the facts and circumstances existing at that time. Default and forfeiture under the contract were not availed of until 1923 and can not alfect the nature of a payment made in 1920. We must determine whether' or not the $3,000 was in fact taxable income in 1920. The name by which the parties may provide that such payment shall be called upon the happening of a future event, which may or may not happen, is immaterial.

The contract clearly expresses the intention that Crews should be reimbursed to the extent of $10,000, out of the first payments made upon the principal purchase price, for improvements to the property made by him. The only payment of any nature made under the contract was the $3,000 initial payment upon principal, which was considerably less than the amount specified in the contract as reimbursement to Crews for improvements and was even insufficient to reimburse him for' the drainage system, the installation and cost of which is not disputed.

Upon the whole record we think it evident that the $3,000 received by Crews in 1920 was not taxable income, but was a partial reimbursement of his capital investment. It was, therefore, not taxable. Appeal of Mandel Brothers, 4 B. T. A. 341, 351.

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

Considered by Marquette, MillikeN, and Phillips.


author: VaN FossaN:

text:
    Hughes Coal Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7142.
    Promulgated September 27, 1927.
    1. Reduction oí officer’s salary approved.
    2. Rates of depreciation, with respect to mine cars, mining machines, and miners’ houses determined.

      Ira L. Smith, Esq., for the petitioner.

      M. E. McDowell, Esq., for the respondent.

      In this proceeding the petitioner seeks a redetermination of a deficiency in income tax for the year 1920 in the amount of $5,585.75. It is alleged that the Commissioner committed error in reducing the amount paid as salaries to officers from $40,000 to $32,500, and in reducing the depreciation claimed on mine cars, mining machines, and houses by an amount of $4,642.92.
    FINDINGS OK FACT.
    The petitioner is a West Virginia corporation, organized and incorporated on February 8, 1917. Its business is coal mining and its principal office is located at Fairmont, W. Va.
    In 1920, the year under question, about 2,080 shares of the corporation’s capital stock, par value $100 per share, were outstanding. The president, Clarence D. Robinson, owned or controlled about 50 per cent.
    During 1917 and 1918 the corporation’s property was in the development stage, no coal being mined in 1917 and but 7,050 tons being mined and shipped in 1918. During 1919 the corporation, under adverse market conditions, mined and shipped 31,534 tons of coal. In 1920, with favorable market conditions prevailing, 67,552 tons of coal were mined and shipped, or a total shipment covering the four-year period of 106,136 tons.
    The corporation had but little income, if any, during its first three years of existence, but in its fourth year, 1920, it made some money.
    Since organization in 1917 and during the year involved the principal burden of developing, financing, and managing the corporation was left to the president, Clarence D. Robinson. In addition to his duties of managing the affairs of the corporation herein involved, Clarence D. Robinson was employed in 1920 as general manager of another coal company from which he drew a salary. He was also interested in various other business enterprises. Of his total working time in 1920 about three-fourths was devoted to managing the affairs of the corporation herein involved and about one-fourth devoted to managing the affairs of the other coal company.
    No salaries were paid the officers of the corporation until 1920. Pursuant to an action taken by the corporation’s directors at a meeting on December 9,1920, the officers were paid the following amounts as salaries in 1920 :
    Clarence D. Robinson, president-$30,000
    H. P. Kobinson, vice president- 5,000
    Hugh IT. Smith, secretary- 5,000
    it —--
    Total_ 40,000
    The total amount of salaries ($40,000) paid the officers in 1920, was claimed as deductions from the petitioner’s gross income that year. The respondent, allowed these salary deductions in 1920 with the exception of $7,500 of the amount paid to Clarence D. Robinson.
    Mine cars of an inferior grade were purchased by the corporation in 1917 as it was unable to purchase cars of a standard grade. These cars had a capacity of two tons each, with plain-bearing wheels, and were constructed of oak and iron. These inferior-grade cars, purchased in 1917, were worn out and discarded by 1922 and in some instances prior to that time.
    Mining machines, two in number, and electrically operated, were purchased in 1917 or 1918 at a cost of about $2,800 each. Both machines were unsatisfactory, becoming worn out and obsolete in 1922 and were discarded with no scrap value. New machines of an improved type were purchased to take the place of the discarded machines.
    The miners’ houses were built by the corporation in 1917 and 1918. These houses were of frame construction, pine and hemlock, one story, and beaver-boarded inside. The houses had no cellars and no founda - tions other than wood posts. The roofing was of rubberoid material. The wear on the houses due to use was considerable as the tenants were moving in and out at approximately from one to two-month intervals.
    The rates of depreciation in 1920 claimed by the petitioner with respect to the three foregoing classes of assets and the corresponding rates for the same period allowed by the respondent were as follows:

   OPINION.

VaN FossaN:

Petitioner was a small coal company with a production of only 67,552 tons for the taxable year. Its president had served during 1917, 1918, and 1919 without salary. In 1920 it paid him $30,000. The Commissioner reduced this amount to $22,500. Petitioner’s president was also general manager of another and larger coal company and was paid a salary by it. He had various other business interests to which he gave some time and from which he received -compensation. The evidence is insufficient to prove that the action of the Commissioner was in error.

The second issue presented relates to the proper rates to be applied to certain of the corporation’s depreciable assets. In view of the evidence presented, we are of the opinion that the following rates oí depreciation should be applied, as constituting a reasonable allowance for the exhaustion, wear and tear of the assets in question for the year 1920:

The deficiency should be recomputed in accordance with this decision.

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

Considered by MaRquette, Milliicen, and Phillips.