author: Trammell :

text:
    Firemen’s Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mechanics Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 53679, 53680, 56379, 56380, 64419.
    Promulgated June 26, 1934.

      William Bistig, Esq., and Ernest G. Lum, Esq., for the petitioners.

      J. Arthur Adams, Esq., and Frank A. Surine, Esq., for the respondent.
   OPINION.

Trammell :

These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income tax as follows:

The only matters presented for determination are the correctness of the respondent’s action (1) in refusing, in each of the cases and in each of the years, to allow deductions for depreciation on furniture and fixtures which were acquired prior to the taxable years in controversy, the cost of such items having been charged to expense on the books of the taxpayers in the years in which paid, deductions therefor having been taken in the returns of the taxpayers for such years and such deductions having been allowed by the respondent; (2) in not allowing the Firemen’s Insurance Co. as a deduction for 1928 the amount of $5,949.97 representing an amount paid to a firm of accountants for services rendered in connection with the authoriza-fcion and. issuance of an increase in the company’s capital stock; and (3) in not allowing the Firemen’s Insurance Co. as a deduction for 1929 an amount of $1,000 representing the amount paid to á trust company for services rendered in connection with the acquisition by the Firemen’s Insurance Co. of more than 99 percent of the capital stock of another insurance company by the exchange of part of its own stock therefor. All other issues raised by the petitioners have been withdrawn. The proceedings were submitted upon stipulations of facts which are incorporated herein by reference and pertinent portions of which are set out herein.

Depreciation.

With respect to this issue the stipulation is in part as follows:

(1) The Firemen’s Insurance Company * * *, its affiliates * * * and the Mechanics Insurance Company * * * are insurance companies other than mutual or life insurance companies.
(2) The Firemen’s Insurance Company was affiliated with the following corporations during the years 1925 to 1929, inclusive, and the deficiencies here in controversy were determined on said basis:
Concordia Fire Insurance Company,
Girard Fire and Marine Insurance Company,
National Ben Franklin Fire Insurance Company,
Superior Fire Insurance Company.
The Metropolitan Casualty Insurance Company became affiliated with the Firemen’s Insurance Company on May 11, 1928. For the period May 11, 1928, to December 31, 1928, and for the calendar year 1929, said corporation was included in the consolidated returns filed for the calendar years 1928 and 1929 by the Firemen’s Insurance Company and the deficiencies here in controversy were computed on said basis. The said Metropolitan Casualty Insurance Company filed a separate return for the period January 1. 1928, to May 10, 1928, which period is not covered by the instant appeals.
The Milwaukee Mechanics Insurance Company became affiliated with the Firemen’s Insurance Company on February 7, 1929, and the Commercial Casualty Insurance Company became affiliated with the Firemen’s Insurance Company on April 30, 1929. From the respective dates of their affiliation with the Firemen’s Insurance Company, these two corporations were included in the consolidated income tax return of the Firemen’s Insurance Company filed on the basis of the calendar year 1929 and the deficiency for said year was computed accordingly. The Milwaukee Mechanics Insurance Company filed a separate return for the period January 1, 1929 to February 6, 1929 and the Commercial Casualty Insurance Company filed a separate return for the period January 1, 1929, to April 29, 1929, which periods are not covered by the instant appeals.
The Mechanics Insurance Company was included in the consolidated return filed by the Firemen’s Insurance Company for the years 1927, 1928 and 1929. The respondent held that said corporation was not affiliated with the Firemen’s Insurance Company or any other company during the years 1927, 1928 and 1929, and determined the deficiencies for the years 1927 and 1928 on said basis. Said corporation sustained a loss for the year 1929.
(3) Tlie following corporations made expenditures for additions and renewals of furniture and fixtures for tlie years 1016 to 1929, inclusive, * * *:
Fireman’s Insurance Company
Concordia Fire Insurance Company
Girard Fire and Marine Insurance Company
National Ben Franklin Fire Insurance Company
Superior Fire Insurance Company
*******
(4) Expenditures for additions and renewals of furniture and fixtures were made * * » by Metropolitan Casualty Insurance Company during the years 1919 to 1929, inclusive, and by Milwaukee Mechanics Insurance Company and Commercial Casualty Insurance Company during the years 1920 to 1929, inclusive,
*******
(5) The Mechanics Insurance Company made * * * expenditures for additions and renewals of furniture and fixtures during the years 191(5 to 1928, inclusive.
(6) The furniture and fixtures! acquired by the corporations shown in paragraphs (3), (4) and (5) hereof, had a life of ten years.
(7) The expenditures for furniture and fixtures made prior to 1916 in respect to those corporations set forth in paragraphs (3) and (5), and prior to 1919 and 1920 in respect to those corporations set forth in paragraph (4), are not shown since the life of said furniture and fixtures would have expired prior to the years here involved.
(8) The amounts expended for furniture and fixtures by the corporations (3), (4) and (5) hereof, were charged to expense in their books and records and deductions claimed for same by said corporations as operating expenses in their Federal income tax returns in the years in which said expenditures were made. In respect to the corporations whose names appear in paragraphs (3) and (5) hereof, tlie respondent allowed said deductions claimed for all years up to and including the year 1924 in his determination of the Federal income and profits tax of said corporations for said years. In respect to the expenditures made and deductions claimed for furniture and fixtures by the Metropolitan Casualty Insurance Company and Milwaukee Mechanics Insurance Company for all years prior to the year 1926, and by the Commercial Casualty Insurance Company for all years prior to 1927, the respondent allowed the deductions in his determination of the Federal income and profits tax of said corporations for said years. In respect to the corporations referred to above and in paragraphs (3), (4) and (5) hereof, the total expenditures for furniture and fixtures claimed as deductions as operating expenses in their Federal income tax returns for all years subsequent to those set forth above in this paragraph, were disallowed by the respondent as deductions from income for tax purposes on the ground that said expenditures represented the purchase of capital assets, the cost of which should be returned to the corporations in the form of annual depreciation deductions allocated over the life of such assets. For those years in which the respondent has disallowed the deductions claimed for furniture and fixtures by the corporations whose names appear in paragraphs (3), (4) and (5) hereof, the respondent has allowed as a deduction from income depreciation on such furniture and fixtures at the rate of 1.0% of the total cost of all furniture and fixtures purchased subsequent to the years for which the respondent allowed the cost of furniture and fixtures as deductions for income tax purposes.
(9) The corporations referred to in paragraphs (3), (4) (5) and (8) hereof, filed their income and profits tax returns on or before the due date for filing said returns for all years for which a deduction for furniture and fixtures was claimed in their returns and allowed by the respondent in his determination of the Federal income and profits taxes for said years, and no waivers or consents to any extension of the statutory periods of limitations for the assessment and/or collection of income or profits taxes for any of said years were subsequently executed by the said corporations.
In the determination of the proposed deficiencies for the years here in controversy, the respondent allowed depreciation on the furniture and fixtures acquired during the years here involved, but did not allow any deductions for depreciation on furniture and fixtures purchased during those years in which the cost of such furniture and fixtures was claimed as deductions by each of the corporations shown in paragraphs (3), (4), (5) and (8) hereof, in their Federal income tax returns filed for each of said years, and allowed by the respondent as deductions in the final determination of their taxable net incomes for said years, on the ground that said corporations claimed and were allowed deductions in their Federal income tax returns for the total cost of all such furniture and fixtures and are not entitled to again recover the cost of such furniture and fixtures, or any part thereof, by now being allowed deductions for depreciation in their Federal income tax returns for the years involved, and also on the ground that at the time of the audit of the books and records of said corporations upon the basis of which the proposed deficiencies were determined, the statute of limitations barred the assessment and/or collection of the additional tax, which results from increasing the taxable income of each of said corporations by the amount of the expenditures for furniture and fixtures (less depreciation thereon) in the years during which said expenditures were made.

The contention of the petitioners with respect to deductions for depreciation as set out in one of the stipulations is as follows:

It is the contention of the petitioner that under the several revenue statutes, expenditures for furniture and fixtures should be capitalized, and these amounts should be recovered by an annual depreciation deduction over the ten year life of such furniture and fixtures, and the mere fact that expenditures for this purpose during the years prior to those here involved were charged to expense and deducted in full in the income tax returns of petitioners and subsidiaries cannot operate to defeat the right of these companies to a depreciation deduction on furniture and fixtures where such furniture and fixtures are still used and retained by the petitioners and subsidiaries.

The respondent’s position is that the taxpayers, having claimed in their returns in prior years and having been allowed as deductions the full cost of the furniture and fixtures in controversy, are not entitled to the deduction of any further amount or amounts with respect to such property.

Pertinent provisions of the Eevenue Act of 1926 which are applicable to the taxable year 1927 are as follows:

Seo. 246. (a) In lieu of the tax imposed by section 230, there shall be levied, collected, and paid for each taxable year upon the net income of every insurance company (other than a life or mutual insurance company) a tax as follows:
(b) In the case of an insurance company subject to> the tax imposed by this section—
(1) The term “ gross income ” means the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subdivision, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners;
(2) The term “ net income ” means the gross income as defined in paragraph (1) of this subdivision less the deductions allowed by section 247;
Seo. 247. (a) In computing the net income of an insurance company subject to the tax imposed by section 246 there shall be allowed as deductions :
(8) A reasonable allowance for the exhaustion, wear and tear of property, . as provided in paragraph (7) of subdivision (a) of section 234;
* * * * * * *
(c) Nothing in this section or in section 246 shall be construed to permit the same item to be twice deducted.
Seo. 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
*******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescense;
*******

The pertinent provisions of the revenue Act of 1928 applicable to the years 1928 and 1929 are contained in sections 204 and 23 of that act and are practically identical with the foregoing.

The revenue acts prior to that of 1921 did not contain any special provisions corresponding to those quoted above relative to the determination of the gross and net income of insurance companies of the class here involved. Article 548 of Regulations 45 (1920 edition), relating to the Revenue Act of 1918, provided with respect to insurance companies generally that gross income consisted of the total revenue from the operation of the business and of income from all other sources within the taxable year except as otherwise provided by statute. Article 568 of the same regulations provided that insurance companies are entitled to the same deductions from gross income as other corporations and also to the deduction of the net addition required by law to be made within the taxable year to reserve funds and of the sums other than dividends paid within the taxable year on policy and annuity contracts. Section 234 (a) (1) of the Revenue Act of 1918 provided that in computing the net income of other corporations there should be allowed as a deduction a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. Section 235 of the act provided that in computing the net income of a corporation no deduction should in any case be allowed in respect of any of the items specified in section 215, which in turn provided that in. computing net income no deduction should be allowed with respect to any amount paid for new buildings or for .permanent improvements or betterments made to increase the value of any property or any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made. In view of the foregoing provisions of the act and the regulations it seems clear that an insurance company of the class here involved was not authorized to deduct from its gross income in determining net income any amount expended for additions and renewals of furniture and fixtures, as was done by the taxpayers here involved, but was entitled to deduct only a reasonable allowance for the exhaustion, wear and tear of such property used in its business, including a reasonable allowance for obsolescence.

In April 1921 Internal Revenue Bulletin II, entitled “Income Tax Rulings Peculiar to Insurance Companies ”, was issued. The preface is as follows:

Tliis bulletin is issued for the use of employees of the Bureau engaged in the computation of the income and excess profits taxes of insurance companies and for the information of interested taxpayers. It is not intended as a set of regulations or as an amendment of the present Regulations 45 (1920 edition) but solely as a statement of the practice which has been established under those regulations. While not a complete manual of practice, it answers most of the questions which present themselves in everyday practice.

Bulletin H on page 10 contains the following:

24. General expenses and taxes. — The general expenses and taxes of a stock fire insurance company will consist of the amounts accrued during the taxable year for such purposes, except that the accrued taxes shown in item 18, page 5, of the annual statement must be so segregated as to show the amount of Federal income and excess profits taxes included therein. The deductibility of any item included in the foregoing classification will be governed by the regulations applicable to corporations in general, except that amounts expended for renewals and replacements of furniture and fixtures may he deducted as an expense. Amounts expended for furniture and fixtures in the equipment of new offices will be treated as capital expenditures and are not deductible from gross income. [Italics supplied.)

From the foregoing it appears that it was the practice of the Bureau to allow as a deduction for expense amounts expended for renewals and replacements of furniture and fixtures and from what was done in the cases of the taxpayers here involved it appears that expenditures for additions were also treated as falling within the same class as renewals and replacements.

Beginning with the Revenue Act of 1921 each act has contained more specific provisions relating to insurance companies than were contained in acts prior to that of 1921. In the Act of 1921 there appeared provisions practically identical with those heretofore quoted from the 1926 Act as being pertinent to the matter in controversy. These provisions were reenacted in practically the same form in all subsequent acts through that of 1928. While the provisions of these acts were more specific with respect to the method of determining the gross and net income of insurance companies of the class to which the taxpayers in these proceedings belong, the respondent’s regulations with respect to the matter in controversy do not appear to have been altered, and until 1931 the practice of the Bureau with respect to the allowance as an expense of renewals and replacements of furniture and fixtures as set out in Bulletin H appears to have continued to be the same as it was under the acts prior to that of 1921. Judging from the respondent’s treatment of additions to furniture and fixtures in these cases his practice with respect to additions appears to have been the same under the 1921 and later acts until 1931 as it was under the acts prior to that of 1921.

In the first part of 1931 G.C.M. 9333, C.B. X-l, p. 253, was promulgated. In this memorandum it was held that, in the case of insurance companies (other than life or mutual insurance companies) subject to the tax imposed by section 246 of the Revenue Act of 1926, the cost of furniture and fixtures, including the cost of furniture and fixtures previously charged off as an expense, should be capitalized as of the date of acquisition and depreciation allowed thereon on the basis of such cost and the period of the useful life of the asset from the date of acquisition, subject to the limitation that no depreciation is allowable upon any item, the cost of which has previously been deducted as an expense, when any additional taxes resulting from the subsequent capitalization of such cost are barred by the statute of limitations.

Notwithstanding what appears to have been the practice of the respondent with respect to the allowance as deductions for expense of amounts expended by insurance companies of the class here involved for renewals, replacements, and additions of furniture and fixtures down to 1931, the parties have not directed our attention to nor have we found anything in the various acts down through that of 1928, which covers the latest year here involved, that warrants the deduction as an expense of expenditures for renewals and additions of furniture and fixtures under the circumstances involved in these proceedings. We find nothing in the acts that warrants the deduction in determining taxable net income of amounts expended in the purchase of additional furniture and fixtures. So far as we can see they are properly to be considered as capital items. This being true, we know of no reason why amounts expended for renewals of furniture and fixtures which in the first instance, as the facts indicate, were charged to expense should likewise be charged to expense. In view of the foregoing it is our opinion that the action of the taxpayers in deducting in their returns as expense the amounts expended for renewals and additions of furniture and fixtures and of the respondent in allowing such deductions was erroneous.

Does the fact that the taxpayers have already been erroneously allowed in their returns for prior years the full benefit of the entire amounts expended for renewals and additions prevent their obtaining further benefits by way of depreciation allowances for the years in controversy with respect to such of the property as had not been completely exhausted in such years, especially where limitations have run against any adjustment with respect to prior years and the taxpayers make no offer by way of waivers to surrender any portion of the benefits obtained as a result of their own and respondent’s erroneous acts?

In Larrowe Milling Co., 3 B.T.A. 245, the taxpayer had, from 1909 to 1916, inclusive, charged to expense all expenditures made in the acquisition of office furniture and equipment. Notwithstanding that the cost of such property had been charged to expense, we held that the taxpayer was entitled to a deduction in 1918 for depreciation thereon. Other cases to the same effect are Clinton G. Edgar, 10 B.T.A. 110, and 20 B.T.A. 14; R. S. Newbold & Son Co., 7 B.T.A. 471; Milwaukee Brass Mfg. Co., 10 B.T.A. 936. These decisions were placed on the ground that the expenditures were made for property which was in fact of a capital nature and therefore depreciable over its useful life; that the expenditures therefor having erroneously been charged to expense, the taxpayer should not be precluded from correcting the error and obtaining a depreciation deduction in the current year with respect to depreciable property which was actually being used in the business during such year. Coincident with and subsequent to the foregoing line of decisions there has developed another line of decisions to the effect that where a taxpayer in prior years has had through depreciation deductions in such years the benefit of the full cost or other basis of the property he is not entitled to further depreciation deductions with respect thereto, notwithstanding the property is continued in use and is giving satisfactory service. Alpin J. Cameron, 8 B.T.A. 120; Alpin W. Cameron, 20 B.T.A. 305; aff'd., 56 Fed. (2d) 1021; Elliott-Granite Linen Corp., 26 B.T.A. 936; Graves, Cox & Co., 27 B.T.A. 546. The bases upon which these decisions are placed are as stated by the court in the Cameron case, supra:

Tlie evidence establishes that these eliminated items were not only in use in 1921, but were also giving satisfactory service in 1920. Rut “ the amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value; suffice to provide an amount equal to the original cost.” United States v. Ludey, 274 U.S. 295, 300, 47 S. Ct. 608, 610, 71 L. Ed. 1054. Obviously, the taxpayers are not entitled to a double deduction for the same capital assets, and, if the fact is, as the Board found, that the assets have been fully depreciated, the taxpayers can no longer rightfully claim an allowance for depreciation, even though such assets continue to give useful services,

and as stated in Graves, Cox & Co., supra:

Here we find that the petitioner has already recovered the cost of the assets by deductions allowed for years prior to 1929. Any further'allowance would result in a double deduction for the same capital assets, which the statute does not authorize. Cameron v. Commissioner, 56 Fed. (2d) 1021, affirming 20 B.T.A. 305; Lake Charles Naval Stores, supra.
In addition to the reason given for the conclusion announced, we are of the opinion that at a time when the respondent is precluded by the statute from making an additional assessment for 1919 the petitioner ought not to he heard to say that the allowance made for depreciation in that year, based upon its own claim, was excessive so as to enable it to get the benefit of a double deduction in a later year. See Alpin J. Cameron, supra.

The taxpayers here rely on the first line of decisions as supporting their position, while the respondent relies on the latter. While the petitioners here did not obtain the full benefit of the cost of the property in controversy through depreciation deductions as did the taxpayers involved in the second line of decisions above, but deducted it directly as operating’ expenses, they obtained the benefit just as fully and as effectively as if they had taken the cost through depreciation deductions. For a determination of the question here involved, we think it makes no difference which method was employed. The taxpayers have had returned to them tax-free the full amount of their cost.. Giving due consideration to both linas of decisions and having due regard for the rule that an overstatement of income for one year is not to be corrected by an offsetting deduction in a subsequent year, Gould, Paper Co., 26 B.T.A. 560, we think that where, as here, the period of limitations has run against any adjustment, a taxpayer may not receive a deduction for depreciation on any propei’ty the full cost of which was deducted from income as an operating expense in the return for the year in which paid or incurred and allowed as such. This we think is the sound rule to apply in such cases. Under it the taxpayer obtains a return of the entire cost of the property tax-free and at the same time he is not given a preferred status or advantage as a result of his own error over other taxpayers who correctly reported their income and who had not thus erred.

This conclusion is not only in harmony with decisions generally to the effect that unless specified by statute a taxpayer is not entitled to a deduction twice on account of the same expenditure, but is in harmony with the provision of section 247 (c) of the Revenue Act of 1926 and section 204 (e) of the Revenue Act of 1928 that nothing in the preceding provisions of such sections “shall be construed to permit the same item to he twice deducted.”

The petitioners contend that the foregoing provision of section 247 (c) and 204 (e) of the Acts of 1926 and 1928, respectively, was not intended to apply in a situation such as is involved here, but was inserted by Congress for the purpose of preventing the deduction in determining net income of certain items which under the special provisions of the acts respecting insurance companies constituted deductions in determining gross income. The provision in question first appeared in the Revenue Act of 1921 and was reenacted in practically identical language in all subsequent acts through that of 1928. Although we find nothing in its legislative history to indicate the purpose of Congress in its enactment, we are unable to give it the limited application contended for by the petitioners. The provision for the allowance of depreciation precedes this provision against double deductions and in view of the broad language of the latter we do not think it is susceptible of the interpretation urged by the petitioners.

In view of the foregoing the respondent’s action in not allowing deductions for depreciation on account of property which was acquired in prior years and the cost thereof deducted as an operating expense is sustained.

Expenditures on Account of Authorization and Issuance of Turerease in O'apital Stock.

With respect to this issue it is stipulated that:

During tlie calendar year 1928 the Firemen’s Insurance Company caused its authorized capital stock to be increased from $7,500,000.00 to $13,600,000.00. During said year 1928 the Firemen’s Insurance Company increased its outstanding capital stock by issuing capital stock of a par value of $6,000,000.00. In connection with the authorization and issuance of said capital stock in 1928 it employed the services of Joseph L. Froggatt and Company, a firm of accountants, at a cost of $6,949.97 and in the Federal income tax return for the year 1928 made claim for deduction of said amount. These services consisted of work performed in connection with an increase of issued stock of the Company, issuance of new certificates and posting of the stock transfer ledger and the proper recording of all transfers, and were performed solely in connection with an increase of shares of capital stock. The respondent in the determination of the deficiency appealed from, disallowed the deduction claimed.

The Firemen’s Insurance Co. contends that it is entitled to a deduction in 1928 as an ordinary and necessary business expense of the amount of $5,949.97 paid a firm of accountants for services rendered in connection with the authorization and issuance of an increase in its capital stock from $7,500,000 to $13,500,000. The respondent contends that the amount does not constitute an ordinary and necessary business expense and that his action in disallowing it as a deduction is correct.

Amounts paid accountants for services in connection with the organization and incorporation of a corporation are not deductible as ordinary and necessary business expenses. Morganite Brush Co., 24 B.T.A. 776. Fees paid to lawyers by a corporation for obtaining an authorization of an increase in its capital stock are not deductible as ordinary and necessary expenses of carrying on a business or trade. Emerson Electric Mfg. Co., 3 B.T.A. 932; Holeproof Hosiery Co., 11 B.T.A. 547. Expenditures made by a corporation in connection with the issuance of its authorized capital stock are not deductible as ordinary and necessary expenses. Borg & Beck Co., 24 B.T.A. 995; Baltimore & Ohio R.R. Co., 29 B.T.A. 368. Considering the fact that the services of the accountants were rendered solely in connection with the increase of the capital stock of the taxpayer, we think that, in the light of the foregoing decision, the action of the respondent was correct.

Expenditures on Exchange of Capital Stoolc.

As to this issue the stipulation is in part as follows:

Under date oí April 30', 1929 the Firemen’s Insurance Company, in accordance with an agreement entered into by it with the stockholder of the Commercial Casualty Insurance Company, acquired more than 99% of the total issued and outstanding capital stock of the Commercial Casualty Insurance Company in exchange for part of its own capital stock. Both the petitioner and respondent treated the said exchange of stock as a nontaxable transaction resulting in neither gain nor loss for income tax purposes. In connection with the exchange and the acquisition of the stock of the Commercial Casualty Insurance Company, the Firemen’s Insurance Company engaged the Fidelity Union Trust Company as depository to receive the stock of the Commercial Casualty Insurance Company from the owners thereof, to make examination and to determine the negotiability thereof, and to direct the issue of the stock of the Firemen’s Insurance Company therefor. The Firemen’s Insurance Company paid $1,000.00 to said Fidelity Union Trust Company for the services rendered by it and made claim in its Federal income tax return for 1929 for a deduction of said $1,000.00. The respondent disallowed the said claimed deduction of $1,000.00.
* * * * * * *
Each of the petitioners filed their Federal income tax returns for each of the years involved in the appeals with the Collector of Internal Revenue at Newark, New Jersey.

The Firemen’s Insurance Co. contends that it is entitled to a deduction as an ordinary and necessary business expense in 1929 of $1,000 paid to the Fidelity Union Trust Co. for services rendered by it in connection with the acquisition by the Firemen’s Insurance Co. of more than 99 percent of the outstanding capital stock of the Commercial Casualty Insurance Co. in exchange for a part of its own capital stock.

In Odorono Co., 26 B.T.A. 1355 we said:

Ordinarily, the costs incident to the acquisition or sale of property are considered capital expenditures, which, in the case of a purchase, are added to the cost of the property (see Marjorie Post Button, 12 B.T.A. 265; aff'd., 39 Fed. (2d) 459; I. N. Burman, 23 B.T.A. 639), and in the case of a sale are deducted from the sale price, thereby, in taxable transactions, either reducing the amount of the gain or increasing the amount of the loss. See W. A. Bahr, 10 B.T.A. 637. Cf. also Mrs. E. A. Giffin, 19 B.T.A. 1243.

We find nothing in the facts here presented to justify any other conclusion than that the amount in controversy represented a part of the cost to the Firemen’s Insurance Co. of the stock it acquired in the Commercial Casualty Insurance Co. The action of the respondent is accordingly sustained.

Reviewed by the Board.

Judgment will be entered under Rule SO.

MuRdock and McMahoN concur in the result only.


source: Caselaw Access Project

author: Murdock:

license: Public Domain

text:
    Manus-Muller & Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59778.
    Promulgated June 26, 1934.

      Wilbur H. Friedman, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $1,276.22 in the petitioner’s income tax for the calendar year 1929. The error assigned is the determination of the Commissioner that a consolidated return for the petitioner and the Fleck Cigar Co. was not proper for the calendar year 1929, and the consequent failure to offset against the petitioner’s income for that year the net loss of the Fleck Cigar Co. for the same year.

The facts have been stipulated and show that: The petitioner and Fleck Cigar Co. are domestic corporations, organized prior to the year 1929; throughout the calendar year 1929 B. H. Manus Tabakshandel, a foreign corporation, owned all of the stock of each of the two domestic corporations; the petitioner was engaged in the business of importing tobacco for sale and made the bulk of its purchases from B. H. Manus Tabakshandel; the Fleck Cigar Co. was engaged in the business of manufacturing cigars and a large amount of its purchases of tobacco were made from the petitioner and from B. H. Manus Tabakshandel; for the calendar year 1929 the petitioner had a net taxable income of $14,602.01 and the Fleck Cigar Co. had a net loss of $34,617.90; an original corporation income tax return for the calendar year 1929, purporting to be a consolidated return for the petitioner and the Fleck Cigar Co., was received in the office of the collector of internal revenue for the third district of New York on March 16, 1930, and on December 23, 1932, the same office received a corporate income tax return which purported to be an amended return of “ B. H. Manus Tabakshandel, Manus Muller Company, Inc. and Fleck Cigar Company comprising operations of Ma-nus Muller and Fleck Cigar Company.” The Commissioner held that the two domestic corporations were “ not affiliated ” for the calendar year 1929 for the reason that the one company did not own stock of the other. The explanation given in the statement attached to the notice of deficiency concluded with these words:

The fact that all of the stock in the two companies was owned, by the same individual is not a proper basis for filing a consolidated return for the year 1929.

The question presented in this case has never been decided by the Board or by the courts. Despite this fact, and despite the filing of a convincing brief by the petitioner, the respondent has filed no brief, but has merely called our attention to G.C.M. 11800, C.B. XII-2, p. 136. In that memorandum it is conceded that the provisions of section 141 of the Bevenue Act of 1928, standing alone, would lead to the conclusion that there could be an “ affiliated group ” with a foreign corporation as the common parent corporation. But the writer of the memorandum then goes on to say that because of section 238 a foreign corporation must be excluded from any consideration whatever under section 141, so that no effect can be given to its stockholdings in any other corporation for any purpose connected with section 141. The memorandum thus holds that section 238 eliminates a foreign corporation as a connecting link of the chain of stock ownership, there is no connection between any of the links interlocking with it, and consequently there is no affiliated group.

Section 141 provides for the filing of consolidated returns of corporations for 1929 and subsequent years. The privilege to file a consolidated return for 1929 and subsequent years in lieu of separate returns is given to “ an affiliated group of corporations ”, except that the “ return shall be made only for the domestic corporations within the affiliated group.” The term “ affiliated group ” is defined in the statute as “ one or more chains of corporations connected through stock ownership with a common parent corporation ” having a stated connection through stock ownership. The definition of “affiliated group ” uses no word to indicate that there is any distinction between foreign and domestic corporations having the necessary connection through stock ownership. The general terms of this definition indicate that Congress intended no such distinction, but intended that an “ affiliated group ” might contain both domestic and foreign corporations. Furthermore, there is no suggestion in the language of the definition that a foreign corporation might not be the parent corporation as well as any other link of the chain. The necessary inference from the language of subsection (e) is that a foreign corporation can be within an “ affiliated group.”

This view is further strengthened when section 142 is considered. That section contains provisions similar to those of earlier acts relating to consolidated returns. But it is limited in its application to the year 1928. It defines “ affiliation ” by saying that “ two or more domestic corporations shall be deemed to be affiliated ” under certain circumstances. (Italics supplied.) The House had decided to discontinue the use of consolidated returns after 1928 and when the bill, which subsequently became the Revenue Act of 1928, came to the Senate, it contained no provision for making consolidated returns for 1929 and subsequent years. The present section 142 was then numbered 141. The Senate decided, however, that consolidated returns should be continued for 1929 and subsequent years on a somewhat different basis. It therefore wrote in entirely new provisions, the House agreed, and section 141 was the result. The change of language was, of course, deliberate. Instead of using the words “ affiliation ” and “ affiliated ” the phrase “ affiliated group ” was adopted. Cf. section 113 (a) (12). The qualifying word “domestic ” was not used in that definition. These changes are significant and indicate that for 1929 and subsequent years Congress intended to include foreign corporations in an “ affiliated group.” Cf. Brewster v. Gage, 280 U.S. 327, 337.

The next inquiry is whether or not a different interpretation of section 141 results from a consideration of the provisions of section 238. The form and arrangement of the Revenue Act of 1928 is quite different from that of earlier acts. The change was designed to secure greater clarity and more logical sequence in the related provisions of the act. It is divided into “ Introductory Provisions ”, “ General Provisions ”, and “ Supplemental Provisions.” Section 141 is in “ Supplement D — -Returns and Payment of Tax.” Section 4 provides that “ the applicAation of the General Provisions and of Supplements A to D, inclusive, to each of the following special classes of taxpayers, shall be subject to the exceptions and additional provisions found in the Supplement applicable to such class.” One of the classes is foreign corporations, and the applicable supplement is I. Thus the provisions of Supplement I were intended to apply only to the special class mentioned, foreign corporations, and to make certain exceptions from and additions to the application of the general and supplemental (A to D) provisions when applied to foreign corporations. However, unless the particular taxpayer comes within one of the special classes, no reference need be made to Supplements E to K, inclusive, in order to determine how the income of that taxpayer is to be returned and its tax computed. Neither the petitioner nor the Fleck Cigar Co. belongs to any special class of taxpayers to which Supplements E to K, inclusive, apply.. These two corporations are domestic corporations. There is an affiliated group within the meaning of section 141, consisting of B. H. Manus Tabakshandel, the Fleck Cigar Co., and the petitioner. B. H. Manus Tabakshandel, being a foreign corporation, may not join in the consolidated return. The record does not show that the foreign corporation had any tax liability and it may not be a “ taxpayer ” of the special class covered by Supplement I. Nevertheless the two domestic corporations are allowed by section 141 to file a consolidated return. Section 238 is a part of Supplement I which applies only to foreign corporations. Since we are not concerned with the tax liability of a foreign corporation, but only with the question of the propriety of two domestic corporations filing a consolidated return, section 238 does not apply.

Although section 238 applies only to foreign corporations and its precise meaning may be immaterial in the determination of the tax liability of a domestic corporation, nevertheless we have considered the probable meaning of that section in interpreting section 141. This was to avoid adopting an interpretation of section 141 which would deprive the other section of purpose and effect. An examination of the provisions of Supplements E to K, inclusive, and various parts of the General Provisions and of Supplements A to D, inclusive, shows that some of the provisions of Supplements E to K, inclusive, serve no greater purpose than to repeat or restate some part of the General Provisions and of Supplements A to D, inclusive, relating to one of the special classes. One of these provisions of Supplements E to K, inclusive, is an exact duplication of provisions contained in the General Provisions and Supplements A to D, inclusive. Compare section 263 with sections 141 (f) and 142 (d). In other instances an earlier provision may be restated in somewhat different language or the obvious effect of an earlier provision may be stated. Compare, for example, those provisions of Supplements E to K, inclusive, relating to net losses and credits for foreign taxes, with the more general provisions of sections 117 and 131. Also compare section 251 (h) with sections 141 (g) and 142 (e), and section 238 with section 142 (c). It is obvious that many of the provisions of Supplements E to K, inclusive, were not intended to change or add to the more general provisions of the other sections of the act, but merely to repeat those provisions in the supplement applicable to some special class, for convenience in discovering and applying the law applicable to that class. This obvious and limited purpose and effect of these provisions of Supplements E to K, inclusive, can be considered in determining the purpose and effect which Congress intended section 238 to have. If other sections of Supplements E to K, inclusive, do not change or enlarge the provisions of the act to which they relate, but merely restate or repeat for convenience what has already been provided in those sections, then it is reasonable to believe that section 238 may have been intended to serve a similar purpose.

The legislative history of section 238 indicates that it was not intended to change in any way the more general provisions of either 141 or 142. Originally it related only to the provisions of section 142. When the Senate inserted the provisions of section 141, it was necessary to make a number of changes in other related provisions of the act. Section 238 was then amended to relate to 141 or 142.” The words “ deemed to be affiliated ” used in section 238 were chosen when they related only to section 142. These words are ill-chosen to modify or change section 141 in any way, for their meaning is not at all clear in so far as they relate to the provisions of section 141. Apparently the legislative draftsmen, in making this amendment to section 238, lost sight of the fact that section 141 was quite different from section 142. See also sections 45 and 141 (f).

Two interpretations of section 238 have been suggested. One is that in so far as the section relates to the provisions of section 141, it simply means that a foreign corporation may not join in a consolidated return thus repeating, for convenience, the provision of section 141 (e). This would make its effect on 141 and 142 the same for it would then provide that foreign corporations could not join in filing the consolidated returns allowed by those sections. The other, the meaning contended for by the respondent, is that a foreign corporation is not a part of an affiliated group and no effect can be given to its stockholdings in any other corporation for any purpose connected with section 141. Thus the definition of an “ affiliated group ”, contained in section 141, even as it relates to domestic cor porations, would be changed materially by a provision of a supplement intended to relate only to foreign corporations. An intention to limit an affiliated group to domestic corporations could have been shown quite simply and clearly by using the qualifying word “domestic” in section 141 (d), as was done in section 142 (c). If section 238 was intended to have the broad effect of excluding foreign corporations from an affiliated group, then there was no need to enact the first sentence in section 141 (e) providing that “ a consolidated return shall be made only for the domestic corporations within the affiliated group.” This is demonstrated by the absence of any such provision in section 142. Of the two suggested interpretations, the first seems far more reasonable.

The question of the effect of the Commissioner’s regulations remains. These regulations should be given careful and respectful consideration in interpreting a revenue act. Fawcus Machine Co. v. United States, 282 U.S. 375.. But if convinced of a proper interpretation of an act, we should not fail to make that interpretation because it is in conflict with the Commissioner’s regulations. B. B. Todd, Inc., 1 B.T.A. 762, 764. The Commissioner was authorized in section 141 (b) to make rules and regulations for certain purposes therein mentioned, and a taxpayer filing a consolidated return was deemed to consent to all of these regulations. See subsection (a). Pursuant to the authority contained in section 141 (b), the Commissioner prescribed Regulations 75. In paragraph (5) of article 2 of those regulations, he gives a definition of the term “ affiliated group ” and states that it “ does not include any corporation which under section 141 can not be included in a consolidated return (for example, a foreign corporation * * *).” Thus, there is a conflict between this regulation and what we regard as a correct interpretation of the act. The phrase “ affiliated group ” is expressly and adequately defined in the statute. Sec. 141 (d). The definition in article 2 (5) of the regulations is not the same as the statutory definition. The Commissioner was not authorized to define the term “ affiliated group." Cf. In re Temtor Corn & Fruit Products Co., 299 Fed. 326, 331; aff'd., Schlafly v. United States, 4 Fed. (2d) 195; Utah Power & Light Co. v. United States, 243 U.S. 389. There was no need for his definition. He can not in this way alter, modify, or change the statutory definition of this phrase. Morrill v. Jones, 106 U.S. 466; Merritt v. Cameron, 137 U.S. 542; Ramsey v. Commissioner, 66 Fed. (2d) 316; Wilson v. Anderson, 60 Fed. (2d) 52; Sawyer v. United States, 10 Fed. (2d) 416; South Carolina Produce Assn., 19 B.T.A. 1028; Waynesboro Manufacturers Assn., 1 B.T.A. 911, 915; Cape Henry Syndicate, 30 B.T.A. 794. The petitioner, by filing a consolidated return, may not be deemed to have consented to a regulation which the Commissioner had no authority to make and under which the petitioner would have no right to file the consolidated return. Under such circumstances the definition of “ affiliated group ” contained in Regulations 75, article 2 (b) must be disregarded. Cf. Burnet v. Moore Cotton Mills Co., 49 Fed. (2d) 59.

No case has come to our attention which is closely analogous to the present case. However, the Board recently decided a case (Corner Broadway-Maiden Lane, Inc., 29 B.T.A. 762, now on appeal to the Circuit Court of Appeals for the. Second Circuit), in which the parent company was an insurance company subject to tax imposed by section 204. Section 141 (e) provides that such a company “ shall not be included in the same consolidated return with a corporation subject to the tax imposed by section 13.” The Board held in that case that a purported consolidated return, filed by or for the corporations subject to the tax imposed by section 13, was ineffectual and the tax should be computed as if separate returns had been filed because the Commissioner’s regulations required that the return be filed by the parent corporation, and the corporation which filed the return was not the parent corporation. The Commissioner was sustained in that case simply because the return was not filed by the proper party. That case does not hold that a proper consolidated return cannot be filed for a group of corporations subject to the tax imposed by section 13 having an insurance company subject to the tax imposed by section 204 as the common parent. In the present case the question raised is whether or not a consolidated return can be filed for two domestic corporations where their common parent is a foreign corporation. The only reason stated by the Commissioner for his determination in the present case is that the two domestic companies did not belong to an affiliated group and, therefore, no consolidated return could be filed by or for them. He has not argued that even though a consolidated return could be filed, the returns in question were improper in form or inadequate in any way. Furthermore, the facts and the law are not the same in the two cases. We do not think that the decision in the Corner Broadway-Maiden Lane, Inc., case impinges in any way upon the question which we are deciding in the present case.

Reviewed by the Board.

Decision will be entered under Rule 50.

Black, Marquette, Smith, Morris, and Arundell dissent.

       SEC. 141. CONSOLIDATED RETÜRNS OF CORPORATIONS — 1929 AND SUBSEQUENT TAXABLE HEARS.
      (a) Privilege to file consolidated returns. — An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of mating a consolidated return for the taxable year 1929 or any subsequent taxable year, in lieu of separate returns. The mating of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) prescribed prior to the mating of such return; and the mating of a consolidated return shall be considered as such consent. * * *
      *******
      (d) Definition of “affiliated, group”. — As used in this section an “affiliated group” means one or more chains of corporations connected through stoct ownership with a common parent corporation if—
      (1) At least 95 per centum of the stoct of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations ; and
      (2) The common parent corporation owns directly at least 95 per centum of the stoct of at least one of the other corporations.
      As used in this subsection the term “ stoct ” does not include nonvoting stoct which is limited and preferred as to dividends.
      (e) A consolidated return shall be made only for the domestic corporations within the affiliated group. An insurance company subject to the tax imposed by section 201 or 204 shall riot be included in the same consolidated return with a corporation subject to the tax imposed by section 13.

       SBC. 142. CONSOLIDATED RETÜENS OP CORPORATIONS — TAXABLE YEAR 1928.
      (a) Consolidated returns permitted. — Corporations which are affiliated within the meaning of this section may, for the taxable year 1928, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return for the taxable year 1927 was made upon either iof such bases, return for the taxable year 1928 shall be upon the same basis unless permission to change the basis is granted by the Commissioner.
      (b) Computation and 'payment of taa. — In any case in which a tax is assessed upon the basis of a consolidated return, the total tax shall be computed in the first instance as a unit and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income properly assignable to each. There shall be allowed in computing the income tax only one specific credit computed as provided in section 26 (b).
      (e) Definition of affiliation. — Nor the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subsection the term “ stock ” does not include nonvoting stock which is limited preferred as to dividends.
      (d) China Trade Act corporations. — A corporation organized under the China Trade Act, 1922, shall not be deemed to be affiliated with any other corporation within the meaning of this section.
      *******

      SEC. 238. AFFILIATION.
      A foreign corporation shall not be deemed bo be affiliated vith any other corporation within the meaning of section 141 or 142.

       Sections 141 and 238 have been continued without substantial change in the Revenue Acts of 1932 and 1934. The fact that the meaning of section 238 has been questioned for the first time in the present ease may explain the failure of Congress to realize that a change in its wording would be desirable.

       Sec. 141 (b) Regulations. — The Commissioner, -with the approval of the Secretary, shall prescribe such regulations as he may deem necessary in order that the tax liability of an affiliated group of corporations making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be determined, computed, assessed, collected, and adjusted in such a manner as clearly to reflect the income and to prevent avoidance -of tax liability.


author: Seawell:

text:
    Arthur F. Thurnauer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54283.
    Promulgated June 26, 1934.

      Harry J. Lejfert, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Seawell:

Petitioner in his brief says: “The payments made by petitioner were solely in satisfaction of his obligations to his partners as created by the partnership agreements and not in the acquisition of any asset, and therefore, constituted a deduction against bis partnership earnings.” We were not told by what section of the taxing act such a deduction from gross income is directed to be allowed, or how the payment of money not in acquisition of any asset ” is necessarily deductible. Section 214 of the Revenue Act of 1926, applicable here, contains no such direction and affords no explanation of petitioner’s claim. Petitioner further says in his brief that “ payments when made by any of the partners to the others based upon the artificially established criterion (the difference between the sum of $80,000 on the one hand, and the last official sales price of a Stock Exchange membership on the other hand) were in adjustment of the individual profit and loss accounts of the various partners in that specific transaction.” We do not understand the transaction referred to between the several partners to have been in any sense artificial or unrelated to the business in hand. The partnership was built up around the membership in the exchange, and without such membership there was to be no partnership. Petitioner, as the individual holding the membership in the exchange, was the key man and indispensable to the brokerage business to be set up. He was not to pay into the establishment of the business as much money as Wertheim, and possibly was not to contribute as much to its capital as Kay, when the contribution of the good will of Kay’s former business is considered. Petitioner, however, was to have as large a share in the profits as any other. The contributions to the capital account by Kay and Wertheim were in a measure static — cash, the amount of which could be returned in kind — while that of petitioner was more subject to fluctuations of value. The hazard of his contribution ought not to be borne by petitioner alone while that of his partners was comparatively secure; and so it was provided in the contract of partnership that losses on the investment in the exchange seat should be borne proportionately by the partners, and also that the rise in the price of such membership should be profit to the three. To ascertain this loss or gain upon the cost of the exchange membership, it was provided that the cost to petitioner should be the base and the last officially announced purchase price of a membership in the New York Stock Exchange should measure the profit or loss. These data are all furnished in the stipulation of facts and show plainly that the rise in value of the exchange membership, measured as required by the contract, resulted in a profit of $221,000. Thirty-five percent of this gain amounts to $77,350, the exact amount paid in 1927 by petitioner to Kay, as he says in the brief above quoted, “ in adjustment of the individual profit ” of Kay in the “ specific transaction.” Likewise, in the succeeding year petitioner paid the other partner $51,300 in “ adjustment ” of his share in the profit of the same transaction.

What petitioner paid was not to buy his peace or settle any controversy as to his title to his exchange membership. There was no peace threatened or title disputed. The cases of A. King Aitkin, 12 B.T.A. 692, and Kornhauser v. United States, 276 U.S. 145, and other cases cited by petitioner are, therefore, not in point. It matters not that the seat on the exchange was held in petitioner’s name and so evidenced in the records of the exchange. The other partners in the brokerage firm had an equitable and legal claim to share in the rise of its value, just as, for instance, if it had been a patent right or other property of the petitioner brought into the contract of partnership.

The rise in value of the exchange membership was not gain taxable to petitioner at that time, because it had not been sold or otherwise disposed of by him. We do not understand that it was so dealt with in petitioner’s returns. The stipulation of facts, as we read it, negatives the suggestion. The issue is the claimed deduction’, not the amount of gross income. To entitle the petitioner to any deduction, he must bring himself within the provisions of the statute allowing deductions. Sec. 214, Revenue Act of 1926; sec. 23, Revenue Act of 1928.

The parties had the right to contract among themselves as to how their respective interests in the partnership assets should be ascertained. What the petitioner paid to his partners was never his own' under the contract, but belonged to them as their part in the partnership assets as the value of the seat on the exchange increased. These payments are not deductible items. Cf. Arthur C. Hilmer, 27 B.T.A. 1165.

Petitioner cannot hold to the fruits of the partnership contract and refuse to pay his partners their part of the profits ascertained in the way agreed upon between them; or claim such payment when made to be a deductible loss suffered and not compensated for by insurance, or a bad debt ascertained to be worthless and charged off, or an ordinary and necessary expense of his business. It was none of these things.

Under the stipulated facts we must sustain the respondent and hold that there rvas no overassessment against petitioner in the year 1927 as claimed by him and that the respondent was not in error in refusing the deductions claimed.

Judgment will ~be entered for the respondent, except that as to the year 1927 the deficiency is $6744■ instead of as stated in the deficiency notice.


author: McMahon :

text:
    Harry Johnston Grant, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 51794.
    Promulgated June 26, 1934.

      Edwin 8. Mack, Esq., James B. Blake, Esq., and Leon F. Foley, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

McMahon :

The petitioner contends that he is entitled to a deduction for loss sustained during the year 1921 and not compensated for by insurance or otherwise, under section 214 (a) (6) of the Revenue Act of 1926.

The principal question to be determined is whether the sinking of petitioner’s property described in our findings is within the meaning of the phrase “ or other casualty.” (Emphasis supplied.)

As appears from the statement attached to the notice of deficiency, the respondent in determining the asserted deficiency “conceded” that the petitioner was “entitled to a deduction * * * for loss sustained from casualty ” for the year before us, “ to the extent of ” $14,684.26. (Emphasis supplied.)

In proceedings of this character a decision turns upon the facts and circumstances of each proceeding; and, under the peculiar and unusual facts and circumstances detailed in our findings of fact, the Commissioner was correct in thus treating the phenomenon there described as a casualty. In our opinion the loss was the result of a casualty within the meaning of the statute.

As appears from the statement attached to the notice of deficiency, the respondent attributes the damage done to petitioner’s property to “ a certain underground disturbance, which resulted in the sudden subsidence of the surface of a portion of ” the land.

In the instant proceeding there was the unexpected, unusual, un-looked for extensive physical alteration of the earth’s surface, in the nature of a catastrophe, which resulted disastrously to the petitioner.

The evidence is clear and undisputed that the sinking was unexpected. It did not proceed from a definitely known cause. It was not an ordinary sliding of the bank, often occuring on lake shore property, but was the result of a subterranean disturbance, the exact cause of which is not known or ascertainable. It was an unusual effect of several causes and conditions. We hold, therefore, that the phenomenon, as heretofore described, was a casualty within section 214 (a) (6).

The instant proceeding is distinguishable, upon the facts, from the situation presented in I.T. 1561, C.B. II-l, p. 90, referred to by respondent in his statement attached to the notice of deficiency but not cited in argument or on brief. It involves ordinary action of the sea, during storms, upon residence property adjacent thereto, requiring no expenditures for repairs or removal.

As appears from this same statement, respondent allowed petitioner to deduct his loss to the extent of $14,684.26. This apparently was done upon the theory, which we deem to be correct, that a loss resulting from a casualty, under section 214 (a)(6), is deductible notwithstanding that the property has not completely disappeared or has not been completely iestroyed. While no question in this respect has been raised in the pleadings, at the hearing, or on brief, it may not be amiss to point out that it has been repeatedly held by the courts and the Board, under this and similar sections in other acts, that losses resulting from partial destruction of or damage to property attributable to causes specified in these sections are deductible ; and no authorities to the contrary have been cited or have come to our notice. In Shearer v. Anderson, 16 Fed. (2d) 995, the court said: “ Shipwreck does not mem, comflete loss; drnnage to the ship suffices. * * * Furthermore the ship may be a pleasure yacht in no way connected with a trade or business.”

The next question to be determined is the amount of the loss arising from the casualty sustained by the petitioner.

The respondent on brief suggests two “ yardsticks ” or methods for determining the amount of the loss: (1) The amounts expended by the petitioner during 1927, 1928,1929, and 1930 to arrest the sinking of' the land and to restore the property to its original condition, citing Shearer v. Anderson, supra; and (2) the amount obtained by multiplying the cost by the difference between the value immediately before the casualty and the value immediately after the casualty divided by the value immediately before the casualty, as follows :

Value prior to casualty — value after casualty., , , „ -, -£ — ==^=-=—¿7--¿X cost=amount of loss, Value prior to casualty
or, arithmetically expressed in the figures presented in this proceeding :
$113,750 — $50,000 $113,750 X $128,903.41=$72,242.57, the amount of loss.

In our opinion the aggregate amount expended by the petitioner for repairs does not adequately or fairly measure the loss sustained by him. as a result of the casualty. The evidence discloses that the repairs made did not restore the property to its original condition before the casualty and that such amount does not represent the loss sustained based on cost. Furthermore, there is no basis in the statutes for holding that cost of repairs measures the amount of the loss in a situation such as we have here. Moreover, section 214 (a) (6) of the Revenue Act of 1926 expressly provides that the basis to be used in determining the loss shall be the same as provided in section 204 of the same act. Under the latter section “ cost ” is the basis applicable where, as in the instant proceeding, the property was acquired after February 28, 1913.

Theré is, however, nothing in the applicable provisions of the statutes contrary to the second of the “ yardsticks ” suggested by respondent and illustrated by the formula. We have not overlooked section 202 (a), Revenue Act of 1926, which, among other things, is expressly limited to situations where something may be realized.

The loss allowed by the act is a loss arising from casualty. The difference between the value of the property prior to the casualty and its value after the casualty constitutes the loss due to the casualty. However, under the applicable provisions of the act, in determining the amount of the deductible loss, c@st must be used as the basis, the amount of the deductible loss in the event of total loss being limited to the cost of the property and in the event of partial loss being limited to a proportion of the cost dependent on the difference in values before and after the casualty (the same being wholly due to the casualty) as compared with the value before the casualty. This is most clearly illustrated by the formula set forth above, and is a fair and reasonable way of determining the amount of the loss caused by the casualty. Hence, the amount of deductible loss is $72,242.57, which in our opinion is the amount of the loss sustained by the petitioner, due to the casualty, under the applicable statutes.

While the respondent on brief contends that the petitioner has failed to show that the damage to his property was the result of a casualty, it appears from the statement attached to his notice of deficiency that he conceded that the petitioner was entitled to a deduction for loss sustained from a casualty to the extent of $14,684.26. Therefore, this amount, if it has been allowed as a deduction by the respondent in his computation of petitioner’s tax liability for the year 1927, is to be deducted from the amount of $72,242.57, upon recompu-tation of petitioner’s tax liability under Rule 50 in accordance with this opinion.

Shearer v. Anderson, supra, thus relied upon by the respondent, is not controlling. It is governed by the 1918 Act which contained no provisions, such as are applicable in the instant proceeding, to the effect that the basis shall be cost. These provisions first appeared in the 1924 Act.

In Tracy V. Buckwalter, 20 B.T.A. 1005, which arose under the 1924 Act and involved a loss caused by fire, value prior to the fire was used as the basis. However, in E. C. O'Rear, 28 B.T.A. 698, which arose under the 1921 Act and involved the destruction of a residence by fire, the Board stated:

The deduction for fire loss must be computed upon the cost of the property acquired subsequent to February 2'8, 1913, and upon the fair market value on March 1, 1913, of the property acquired before that date. See. 214 (a) (6), Revenue Act of 1921. In Tracy V. Buckwalter, 20 B.T.A. 1005 (affirmed on other points 61 Fed. (2d) 571), the Board erred in using value at the time of destruction. The cost and value should not be reduced by depreciation or obsolescence. Deposit Trust & Savings Bank, Executor, 11 B.T.A. 706; W. B. Brooks, 12 B.T.A. 31; affirmed on other points 35 Fed. (2d) 178. Cf. J. A. Talbot, 23 B.T.A. 792.

Respondent also contends that the burden of proof is upon the petitioner to show that the damage was due to one of the causes set forth in the statute and that upon the evidence the doctrine of ejvs-dem generis can not be applied, for it is not shown what specifically caused the damage. As heretofore indicated, we can not agree with the reason given for this contention. We agree, however, that the doctrine is not applicable here.

The respondent contends further that the loss claimed represents a mere diminution in value of the property and has not been finally determined by a closed and completed transaction.

On brief, however, respondent tabes the position that “ a casualty to property constitutes a disposition of the property ”, citing Pioneer Cooperage Co., 17 B. T. A. 119; aff'd., 53 Fed. (2d) 43; certiorari denied, 284 U.S. 686. Furthermore, it has been held that when a casualty occurs resulting in a loss the transaction is closed, and the amount of the loss is deductible, under provisions essentially similar to the corresponding provisions applicable in this proceeding.

The respondent contends further that, granting a casualty was the cause of the damage to petitioner’s property, the amount of the loss should be limited to the land, as the house was in no way physically damaged. We do not agree with this contention.

It is common knowledge that the location of a residence, as well as its surroundings and the character of the neighboring property, greatly affects the value not only of the land, but, perhaps to a greater extent, that of the buildings thereon. Location, adaptability, and usefulness for either commercial, agricultural, or residential purposes give land value for purchase, sale, and ownership. This applies to buildings or other improvements on the land. They become an integral part of it and to divorce them in the situation here present would be contrary to the common, ordinary understanding and conception of such values.

In 1927 an event occurred which clearly and beyond doubt established the instability of the land, at least for a period extending over a number of years. The loss sustained by the petitioner arose from an identifiable event which established instability. That fact becoming public knowledge, because of the unusual and extraordinary character of the event and its peculiar result and effect, completed and fixed the loss so that it was capable of being ascertained in terms of dollars and cents. The continuing manifestation of such instability and the effect of the remedies applied are in the nature of cumulative evidence of the instability of the land.

No mere paper loss or fluctuation in price or value is here involved. Though the petitioner retained the property and the loss must be measured as heretofore indicated, the loss is an actual loss, for it resulted from damage to and destruction of petitioner’s property. In testifying on cross-examination with respect to the method pursued by the committee which appraised the property for the Milwaukee Beal Estate Brokers Board, a member of the committee, as witness for the petitioner, in a few sentences rather graphically described the damage:

We did not have to inspect the depression very carefully because, as we got into the second floor and looked out over the bedroom; we looked down a very precipitous bank; in fact, perpendicular, 40 to 50 feet, with a raw clay bank there, and we did not dally any longer than we had to iu that building— I am frank to say that — for fear that there might be a further depression. This was very extensive in width, and at that time no one could tell whether that would go any further.

He testified further on cross-examination as follows:

Q. And, it is your opinion that this simply affected the value of the land, and not the physical value of the house?
A. Oh, no, it affects the value of the building just as much as if the new courthouse was placed in the middle of the Sahara Desert. It would be valueless. This is the overdevelopment of an inferior lot, which immediately reflects upon the value of the improvement.
Q. When did you visit this property prior to the appraisal by the Committee?
A. When the publicity first occurred relative to this phenomenon, which was possibly a period of three to six months prior to the time of the appraisal— six months more likely than three months.
*******
Q. And the day after this thing occurred, you could not have gotten a purchaser for any more than $48,000?
A. Yes; and I do not believe I could have gotten that for it, unless the purchaser might not have gotten full information of what had occurred there, after restoration.
*******

The damage to the house was none the less actual and real. The land upon which the house was located was injured. There was a subterranean disturbance, not visible to the eye. There was a level space about thirty feet in width between the house and the edge of the slope prior to the casualty, which was reduced to a width of about eight feet. Land, 22 feet in width, level with the base of the house, dropped 40 to 50 feet, and the contour of the slope was drastically changed, destroying that part of the property which gave it the greatest beauty and value.

It is true that various situations may arise where the injury to land may not affect the buildings and improvements thereon or only in a slight degree. However, such is not the case here, and the house and lot should be treated as a unit in measuring the loss sustained. Here the injury to the land caused greater damage to the house than to the land itself when viewed in the light of cost and values. The cost of the house was $102,092.93, and the cost of the lot was $26,810.48. However, the fair market value of the house and lot after the sinking of the land was $36,500 and $13,500, respectively. This results in a decrease from cost to fair market value of $65,592.93 and $13,310.48 on the house and lot, respectively, or a decrease of approximately 64 percent on the house and approximately 49 percent on the lot. This decrease does not represent a mere diminution in value resulting in the usual and ordinary course of events, in which case no deduction would be allowable, but a loss caused by an event which was unforeseen, unusual, unexpected, not brought about by economic conditions, a change in its use, or by acts of the petitioner or others. The cause of the loss was entirely beyond his control and due to a subterranean disturbance.

While we are not here concerned with the recovery of damages or indemnity for loss resulting from unlawful or wrongful act, it may not be inappropriate to point out the rule evolved in that regard in reference to the measurement of damages where the injury to land is of a similar character. As a general rule the diminution in value of the whole property is the measure of damage where the injury to realty is of a permanent nature. In Nelson v. Village of West Duluth, cited in this footnote, the court further held that the trial court did not erf in excluding evidence of the separate value of the building on the lot, since the evidence that was admitted showed the value of the whole property, land and building, before the injury and after the injury.

Apparently the above rule was followed in cases which arose under corresponding provisions of the Revenue Act of 1921, previously cited herein for other purposes. In all of these cases, although only certain parts of the property involved were physically damaged or injured, the amount of loss was based on the damage to the proferty as a whole.

Reviewed by the Board.

Decision will he entered umder Rule 50.

Marquette, SternhageN, and Aeundell dissent.

       Sec. 214. (a) In computing net income there shall be allowed as deductions:
      (6) Losses sustained during the taxable year of property not connected with the trade or business (but in the case of a nonresident alien individual only property within the united' States) if arising from fires, storms, shipwreck, or other casualty, or from theft, and if not compensated for by insurance ior otherwise. The basis for determining the amount of the deduction under this paragraph, ,or paragraph (4) or (5), shall be the same as is provided in section 204 for determining the gain or loss from the sale or other disposition of property.

        Chicago, etc. R.R. Co. v. Pullman Car Co., 139 U.S. 79, 86; Benjamin or Metropolitan St. Ry. Co. 151 S.W. (Wis.) 91; William J. Mattheson, 18 B.T.A. 674; aff'd., Mattheson v. Commissioner 54 Fed. (2d) 1537; Shearer v. Anderson, 16 Fed. (2d) 995; Webster’s New International Dictionary; Black’s Law Dictionary; Ballentine Law Dictionary; Bouvier’s Law Dictionary; vol. 1, Words & Phrases, 1st, 2d and 3d series; 11 C.J. 29-30, cases cited therein; United States v. New York O. & W. Ry. Co., 216 Fed. 702, 705; O.D. 1076, 5 C.B. 138 (1921); and I.T. 2231, C.B. IV-2, p. 53. See also Eaton v. Glinderman, 195 Pac. (Ida.) 90; Webb v. Baldwin, 147 S.W. (Mo.) 849, 851; Brisco v. Metropolitan St. Ry. Co., 120 S.W. (Mo.) 1162; Century Dictionary; 1 C.J. 390-392, 394-395, 1173-1180, and cases cited therein.

         Ferguson v. Commissioner (C.C.A., 10th Cir.), 59 Fed. (2d) 893; Pioneer Cooperage Co. v. Commissioner (C.C.A., 8th Cir.), 53 Fed. (2d) 43; certiorari denied, 284 U.S. 686; affirming Pioneer Cooperage Co., 17 B.T.A. 119; Whipple v. United States (U.S. Dist. Ct., Dist of Mass.), 25 Fed. (2d) 519; Shearer v. Anderson (C.C.A., 2d Cir.), 16 Fed. (2d) 995; Francis M. Bass, 30 B.T.A. 4; Frederick H. Nash, 22 B.T.A. 482; John S. Hall, 16 B.T.A. 71; Mary Cheney Davis, 16 B.T.A. 65; W. B. Brooks, 12 B.T.A. 31; W. B. Bronson, 9 B.T.A. 1008; and F. M. Reed, 6 B.T.A. 1140.

       Sec. 20á. (a) Tlie basis lor determining tbe gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; * * *

        Mason v. United States, 260 U.S. 545; Corona Coal Co. v. United States, 21 Fed. (2d) 489; cases cited in 36 Cyc. 1121-1122; Prussian v. United States, 282 U.S. 675, 679; United States v. Mescall, 215 U.S. 26; and Matty Eitingon, 27 B.T.A. 1341. See also Shearer v. Anderson, 16 Fed. (2d) 995.

      To this effect are the cases cited in footnote No. 3.

        Barnett v. St. Anthony Falls Water Power Co., 33 Minn. 265; 22 N.W. 535, Nelson v. Village of West Duluth, 55 Minn. 497; 57 N.W. 149; Fessum v. Chicago St. P. Ry. Co., 80 Minn. 9; 82 N.W. 979; Cooper v. New York S. & W. Ry. Co., 122 App. Div. 128; 106 N.Y.S. 611; Harvey v. Sanitary Dist. of Chicago, 260 Ill. 54; 102 N.E. 1070.

         Whipple v. United States (U.S. Dist. Ct., Dist of Mass.), 25 Fed. (2d) 519; Frederick Nash, 22 B.T.A. 482; John S. Hall et al., Executors, 16 B.T.A. 71; and Mary Cheney Davis, 16 B.T.A. 65.


author: Adams: Seawell,

text:
    Charles Stewart Mott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51585, 57506.
    Promulgated June 26, 1934.

      David S'her, Esq., and J ohn Thomas Smith, Esq., for the petitioner.

      J ohn H. Pigg, Esq., for the respondent.
   OPINION.

Adams:

Practically all of the questions in controversy here depend upon the validity of section 219 (h), Revenue Act of 1926, and section 167, Revenue Act of 1928, and their application to the facts in these cases.

These sections are substantially the same, section 167 being as follows :

Where any part of the income of a trust may, in the discretion of the grantor of the trust, either alone or in conjunction with any person not a beneficiary of the trust, be distributed to the grantor or be held or accumulated for future distribution to him, or where any part of the income of a trust is or may be applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution” deduction), such part of the income of the trust shall be included in computing the net income of the grantor.

It is tbe contention of the petitioner that, as applied to the facts of these cases, to tax against petitioner the income of the trusts not actually used for the payment of premiums on policies of insurance on the life of the petitioner would be unconstitutional, in violation of the Fifth Amendment to the Constitution.

The United States Supreme Court, in the cases of Burnet v. Wells, 289 U.S. 670, and Du Pont v. Commissioner, 289 U.S. 685, has declared section 219 (h) of the Act of 1926 to be constitutional. As stated above, this section is substantially the same as the corresponding section (167) of the Eevenue Act of 1928. While it is true, as suggested by the petitioner, that in those cases a part of the income of the trusts was actually used in payment of premiums on life insurance of the taxpayers, we do not understand the opinions to hold that this is absolutely necessary. It seems to us that, where as here the fund was available for such use and was under the control of the petitioner, who had the right to use it for that purpose, it comes within the language of section 219 (h), Eevenue Act of 1926, and section 167 (a), Eevenue Act of 1928, and that the inclusion in petitioner’s income of the amounts necessary to pay the life insurance premiums is constitutional, and we so hold.

We are not impressed by petitioner’s argument that the expression in the trust deeds that “ He is also empowered to pay from income of this trust, the premiums on such insurance as may be taken out for the benefit of the beneficiary of this trust” refers only to such ¡molicies as may be taken out in the future and should be payable to the single beneficiary of each trust. This is entirely too narrow a view and such a construction would provide an easy way to evade taxes, which the statute was framed to prevent. The beneficiaries of the three trusts were undoubtedly beneficiaries of the insurance policies and we consider it immaterial whether the insurance policies were obtained before or after the creation of the trusts. It is the right to use the income of the trusts to pay the premiums during the taxable years that is being taxed and the time of issuance of the policies is of no consequence. The action of the respondent in including within the income of petitioner the respective amounts of $36,350.08 and $56,542.70 for the years 1927 and 1928 is approved.

Eelative to the petitioner’s right to compensation to the extent of 3 percent of the gross income of the three trusts, it is admitted that he made no charge for his services and did not receive anything in consideration therefor. Petitioner and the trusts kept their accounts and made their returns on a cash receipts and disbursements basis. The respondent added to petitioner’s income $14,303.03 for 1927 and $42,448.56 for 1928, on the ground that the taxpayer had constructively received said sums as he had possession and control of the trust properties. To say that petitioner received these amounts as compensation is to indulge in a deliberate legal fiction. Petitioner had the right to render his services free if he wished, and we know of no rule of law which requires a person to accept compensation or income. The fiction of constructive receipt of income is resorted to usually to fix the time of receipt, where it is ultimately actually received and accepted.

This case is similar to and governed by our decision in S. A. Wood, 22 B.T.A. 535. In that case the taxpayer was the executor of an estate, and in view of the extra amount of work entailed in the settlement he was allowed by order of court a salary of $500. per month. After the first year the taxpayer decided he was not entitled to the monthly salary and declined to take it, but the court order was not set aside or modified and remained in effect. The Commissioner attempted to include this salary for three years in taxpayer’s income, but in holding that this was improper the Board said in part:

After the first year of service by petitioner to the estate, he did not perform those extra duties for which the extra compensation was granted him by the court, and hence for the succeeding years he was not entitled to such additional compensation. He did not deem himself entitled to it, and decided in advance not to take it, and did not take it, and hence it was never income to him.

See also Samuel Keller Jacobs, 22 B.T.A. 1166.

The action of the respondent in including the amounts of $14,303.03 for 1927 and $42,448.56 for 1928 in petitioner’s income as compensation received by him for services to the trust estate was erroneous and is disapproved.

Petitioner’s claim for an overpayment of $14,737.59 for 1928 appears to have occurred in the following manner. He received a salary of $75,000 annually from the General Motors Corporation and was also a large stockholder of the company. In making up his return for taxation the salary item was erroneously included with the dividends from General Motors stock, and was also specifically returned as salary. It was thus returned twice. Claim for refund was made, which was rejected by the respondent for the reason that in computing the deficiency the amount of $75,000 was deducted from income. This clearly corrected the error and was substantial compliance with section 271, Revenue Act of 1928, regulating the method of computing deficiencies.

By amended answer in each case the respondent seeks to include within the income of petitioner the entire income of the three trusts, including capital gains, and asks that the deficiencies be increased accordingly. This is upon the theory that the petitioner, who was both grantor and trustee under the trust instruments, had the entire management and control of the trust properties, and controlled the distribution of the trust income, which made it taxable as his income under section 219 (h). We think not. While it is true petitioner had the control of the trust properties and the disposition of the trust income, he had no beneficial interest therein, could not revoke the gifts, and could not hold or accumulate the income for his benefit or future distribution to him. The section of the act in question is aimed at beneficial control and interest. Here the petitioner was acting purely as trustee for others and he had no interest whatever in the trust properties, nor any interest in the income except as above indicated in reference to the payment of insurance premiums and compensation for services. The claims for increased deficiencies by respondent in the amended answers are rejected.

Reviewed by the Board.

Decision will he entered under Bule 50.

SteRNHageN dissents.

MoRRis, Murdock, and Goodrich dissent on that portion of the opinion which holds that the 3 percent of the gross income of the trust is not taxable to the grantor.

Seawell,

dissenting: I disagree with the conclusion reached by the majority of the Board that the right to use the income of the trusts to pay the premiums is taxable to petitioner, where, as here, that right has not been exercised, but refused, and the premiums have been paid by others from a wholly different source.

It is conceded that no part of the trust income in this case was used in either of the taxable years to pay any life insurance premiums. The petitioner neither individually nor as trustee ever agreed to receive or to use any part of the trust income for that purpose. The premiums- in question were, in fact, paid by others from funds which were never received by and never belonged to the petitioner. To say that this was taxable income to petitioner seems as much a legal fiction as to tax him for compensation which he never received. The Supreme Court, in Burnet v. Wells, 289 U.S. 670, and in Du Pont v. Commissioner, 289 U.S. 685, wholly relied on for support of the main opinion, never held that section 219 (h) of the Revenue Acts of 1924 and 1926 was in accord with the Constitution when applied to a situation comparable to that presented in the instant case. Mr. Justice Cardozo, in the prevailing opinion in the Burnet v. Wells case, said:

Income of a trust lias been reckoned by the taxing officers of the Government as income to be attributed to the creator of the trust in so far as it has teen applied, to the maintenance of insurance on his life. Section 219 (h) of the Revenue Acts of 1924 and 1928 permits this to be done. The question is whether as applied to this case the acts are constitutional.
* # sfc $ ♦ *
* * * Upon an audit of the returns the Commissioner of Internal Revenue assessed a deficiency to the extent that the income of the trusts had been applied to the payment of premiums on the policies of insurance. There was .no attempt to charge against the taxpayer the whole income of the trusts, to charge him with the excess applied to other uses than the preservation of the policies. The deft&ietnoir assessment was limited to that part of the income which had kept the policies alive. [Italics supplied.]

In the Du Pont v. Commissioner case, the same Justice, speaking for the Court, said:

The Commissioner of Internal Revenue, following the command of section 219 (h) of the applicable statutes * * * made a deficiency assessment by adding to the taxpayer’s income the amount expended by the trustee in the preservation of the policies.

It appears, therefore, that in each case relied on as authority for the main opinion only such part of the trust income as was expended in payment of premiums on the life policies of the settlors of the trusts was taxed to the settlors. In the instant case respondent has assessed a deficiency against petitioner on trust income not applied to the maintenance of insurance on petitioner’s life, and has not limited the deficiency assessed to that part of the trust income which has “ kept the policies alive,” contrary to what was done in the Wells and Du Pont cases. The assessment here is not based upon any constructive receipt of income by petitioner, but upon the power and opportunity, which he had declined to exercise, to receive it. As was said in Georgia Trust Co. v. Rose, 25 Fed. (2d) 997, “ To be income, it must ‘come in’; to be derived [the word used in the Sixteenth Amendment], it must be separated, taken ‘from the stream ’, as the two compounded Latin words signify.”

There is here no contention made but that where income derived from a trust may be — i.e., under the trust instrument — and is used for the benefit or advantage of the settlor in payment of premiums on his life insurance, as was done in the Wells and Du Pont cases, he should be taxed thereupon as for income to him under section 219 (h) of the act.

A statute may be valid as applied to one state of facts and invalid as applied to another. Milling Co. v. Bondurant, 257 U.S. 282, 289.

I am persuaded that when the permissive may be of the statute is interpreted, fictionally, to mean is, and some status under which income tax may be assessed is on that account declared to exist although it does not, in fact, exist, then either the interpretation of the meaning of the statute is wrong or the statute is in conflict with the fundamental law, and void. Cf. Hoeper v. Tax Commission. 284 U.S. 206; Heiner v. Donnam, 285 U.S. 312; Schlesinger v. Wisconsin, 270 U.S. 230; Bowers v. Kerbaugh-Empire Co., 271 U.S. 170,


author: Sternhagen:

text:
    Farmville Oil and Fertilizer Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67600.
    Promulgated June 26, 1934.

      W. F. Evans, Esq., for the petitioner.

      Samuel L. 'Youmg, Esq., for the respondent.
   OPINION.

Sternhagen:

The petitioner, having for the fiscal year ended July 31,1930, charged to “ fertilizer discount account ” and credited ■ to “ reserve for inactive contingencies ” $21,545.42, which it deducted on its tax return, used this amount as a reduction of gross sales in arriving at the gross income shown upon its return. The Commissioner in effect disallowed $20,859.70 of this amount and restored so much to gross income. Strictly speaking, therefore, the disallowance of the Commissioner is not of a statutory deduction. The petitioner, however, in assailing the Commissioner’s determination argues that the amount in controversy is properly a statutory deduction of either an addition to its reserve for bad debts or to its reserve for inactive contingencies, or partly both.

That a reserve for inactive contingencies such as possible repayments, price discounts, or price rebates, the amounts of which have not been fixed or were not fairly susceptible of ascertainment prior to the end .of the taxable year in question, is not the basis of a statutory deduction has now become a settled doctrine. Brown v. Helvering, 291 U.S. 193. This general doctrine includes the disallowance of unascertained price discounts, for the Supreme Court expressly disapproved Virginia, Lincoln Furniture Corp. v. Commissioner, 56 Fed. (2d) 1028, which held to the contrary. Thus, by its title alone the reserve for inactive contingencies, reflecting as it did “ fertilizer discounts ” would be no basis for the deduction claimed.

The petitioner argues that, of the amount originally deducted, some part (said without supporting evidence to be $16,292.72) was an additional reserve for bad debts. Since the evidence fails to support this as a proper accounting classification and since also the amount of the allocation of such part is without supporting evidence, the petitioner must fail. The method of accounting, for bad debts through a reserve does not found an absolute right in the taxpayer, for the statute expressly sanctions the Commissioner’s discretion. Cf. C. P. Ford & Co., 28 B.T.A. 156. Here the Commissioner’s determination has clearly not been arbitrary or capricious. The taxpayer has been permitted during the preceding years to make substantial increases in the ratio of its bad debt reserve to its receivables. First, it had established this ratio at an amount varying between 6 and 8 percent. Later this was increased to 12 percent. In the taxable year 1930, that now in question, the taxpayer was permitted to add a further $64,405.44, arrived at by its own estimate at the end of the taxable year of the collectibility of specific accounts. Apparently when this permissive increase was allowed by the Commissioner it was not suggested that the reserve for inactive contingencies might include any further reserve for bad debts. But the petitioner, after the end of the taxable year and after its return was filed, discovered that its collections would be even less than the amount contemplated - when the return was filed. In this proceeding it sought by the evidence of actual subsequent collections to establish the propriety of treating its reserve for inactive contingencies as an additional reserve for bad debts. This we think is contrary to the intendment of the statute and the regulations. While a bad debt reserve may and properly should be permitted to fluctuate from time to time in accordance with actual experience and well founded prophecy, cf. Rhode Island Hospital Trust v. Commissioner, 29 Fed. (2d) 339, the amount of the addition must be fixed at the approximate end of the taxable year. There is no support for the view that such a reserve may later be retroactively enlarged because the subsequent realization upon the debts has proved to be less than the estimate made at the close of the year. Such an unexpected development should be taken care of by the taxpayer, either by an enlargement of the subsequent annual additions to the reserve or by doing as this taxpayer did in 1932, giving up the reserve method entirely and deducting the debts as they are ascertained to be worthless and charged off.

Judgment will Toe entered for the respondent.