author: Smith :

text:
    Claude R. Branch, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94248.
    Promulgated December 7, 1939.

      Charles Ryan, Esq., for the petitioner.

      Dmis Haskm, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency-in petitioner’s income tax for 1934 in the amount of $1,763.24. The questions presented for decision are (1) whether the petitioner is entitled to deduct from gross income as ordinary and necessary expenses in carrying on business the amount of $1,553, and (2) whether the petitioner is liable to income tax upon $9,295 income of a trust which was reported for income tax purposes by the petitioner’s wife, Hope S. Branch.

The first issue has been settled by stipulation of the parties. The petitioner is entitled to the deduction of $1,165.12 as ordinary and necessary expenses. The deduction of $387.88 was properly disallowed by the respondent in the determination of the deficiency.

In the audit of the petitioner’s income tax return for 1934 the respondent increased the dividends reported by the petitioner in the amount of $9,295, which represented the income of a certain trust created by the petitioner on August 18, 1928. The receipt of these dividends was accounted for by the petitioner’s wife in her own income tax return. In the deficiency notice the respondent -states:

It is the opinion of this office that since you as grantor may revest title to the corpus of the trust, in yourself if you survive your wife, it is a revocable trust under section 166, of the Revenue Act of 1934, and article 166-1, of Regulations 86, as amended by T. D. 4626, and the income of the trust is taxable to you.

Claude R. Branch is a resident of Providence, Rhode Island, and a practicing attorney, with offices in Providence and Boston.

The trust in question was created by the petitioner on August 18, 1928, soon after his marriage and was evidenced by an indenture executed by him as party of the first part, and by him, Walter A. Edwards, and William H. Edwards, as trustees, parties of the second part. By said indenture petitioner assigned and transferred to the trustees certain certificates representing the shares of stock mentioned therein. At the time some of the securities constituting the corpus of the trust were held by the Rhode Island Hospital Trust Co. as collateral on certain promissory notes of the petitioner in the amount of $400,000. Some of the securities constituting the corpus of the trust were upon the creation of the trust transferred from the name of the petitioner to the name of one of the other trustees under said trust and the rest were transferred from the name of the petitioner to the names of all three trustees as trustees under the trust. The principal of the trust estate has at all times consisted of shares of stock and occasionally cash received as proceeds from sales of securities. The income has consisted solely of income on stocks. All dividends received and all cash received as proceeds of sales of securities have been deposited in a checking account in the names of all three trustees, as trustees, and all of the certificates of stock have stood in the name of one of the trustees other than the petitioner, or in the name of all three trustees as trustees under the trust.

The trust instrument shows the assignment of the securities to the trustees and provides:

that notwithstanding the foregoing assignment, said Clatjdb R. Branch, or his executors or administrators, may, and he hereby reserves for himself and his executors and administrators, the right and power to, at any time or from time to time, pledge or mortgage to said Trust Company [Rhode Island Hospital Trust Co.], any or all of the trust estate as hereinafter defined, which shall at the time be pledged or mortgaged to secure any promissory note or notes made by him or them and held by said Trust Company, and also investments made with the proceeds of such pledged or mortgaged property, for the purpose of securing the payment, both principal and interest, of any promissory note or notes given in renewal in whole or in part of said note or notes so secured, and provided, further, that any such pledge or mortgage may be upon such terms and conditions as said Trust Company shall require, hut any and all property pledged or mortgaged under the foregoing power shall, subject to said pledge or mortgage, be and remain subject to the trusts hereinafter declared and set forth.

The trust further provided:

The trustees shall pay to Hope S. Bkan'ch during her lifetime, quarter-yearly or oftener in their discretion, the entire net income from the trust estate, as the same shall accrue due, and not by way of anticipation, for her separate use, to be enjoyed by her as an inalienable personal provision, free whenever she shall be covert from all control and engagements of her husband; and for such income her receipts alone shall be sufficient discharges to the trustees.

Upon the death of Hope S. Branch the entire trust property was to be paid to the grantor if living and, if not, held in such further trust as Hope S. Branch should appoint in her will, or, in default of such appointment, distributed to the grantor’s surviving children or their issue per stirpes.

Paragraph second (7) of the trust instrument provides:

It shall be lawful for the trustees to deliver securities to said Claude R. Branch for the purpose of enabling him to sell or pledge the same or to exercise rights of conversion, exchange or subscription in connection therewith under the powers hereinafter conferred upon him; and any other trustee or trustees shall not be accountable for any securities so delivered to said Claude R. Branch or for the proceeds of the sale thereof or any securities received in exchange therefor or subscribed for by him until placed by him in the control of such trustee or trustees, nor shall any trustee or trustees be accountable for any securities purchased by said Claude R. Branch under the power hereinafter conferred upon him until said securities have been delivered into his or their control.

Paragraph second (8) of the instrument provides in part:

And so long as said Claude R. Branch shall be a trustee hereunder, he may in his discretion himself alone exercise the powers of investment, of varying investments and of reinvestment hereby conferred upon the trustees and exercise rights of conversion, exchange or subscription in connection with any securities included in the trust estate, and his decision as to the advisability of any such action shall be sufficient without the concurrence of or without consultation with the other trustee or trustees for the time being, and for the purpose of the sale and transfer of any investments or the exchange of any investments or the exercise of any rights of conversion, exchange or subscription his endorsement or signature alone shall be sufficient. * * *

Paragraph, second (10) of the instrument provides:

It shall be lawful for the trustees to purchase investments from or sell investments to said Claude S. Branch, and such purchases or sales may be made as well by said Claude R. Branch alone under the powers herein conferred upon him as by the trustees under the powers herein conferred upon them.

Paragraph second (18) provides in part:

Provided, and it is hereby declared as a limitation upon all the foregoing provisions and powers, that it shall be lawful for said Hope S. Branch during the joint lives of herself and said Claude R. Branch, at any time or from time to time, by any proper instrument in writing under her hand and duly acknowledged by her before any magistrate or notary public, to revoke the foregoing uses and trusts as to all or any part or parts of the trust estate, and to appoint the same to new, further or other uses, in whole or in part, and to vest the same in the same trustees or in any new or other trustee or trustees, and upon and with new, further or other trusts, powers, discretions and limitations, or in herself, or in any other person or persons, freed and discharged of all trusts, as she may see fit.
The foregoing trusts are intended to be, and are hereby declared to be, irrevocable by said Claude R. Branch. And said Claude R. Branch hereby covenants, for himself and his executors and administrators, with the trustees from time to time under the foregoing trusts and with Hope S. Branch and any and all other beneficiaries under said trusts that he will, and his executors and administrators shall, indemnify and save harmless said Hope S. Branch, said trustees and said beneficiaries and the trust estate from and against any loss accruing to the trust estate or the income therefrom by reason of any resort to the trust estate, or any part thereof, for the payment of the principal and/or interest of any promissory note or notes of said Claude R. Branch secured at any time by a pledge of the trust estate, or any part thereof; but it shall he la%oful for the trustees to determine the amount of any liability of said Claude R. Branch, or his eweoutors or administrators, on account of the foregoing covenant and any determination made by them shall be binding ttpon the trust estate and the beneficiaries under the foregoing trusts. But nothing herein contained shall preclude the withdrawal by said Claude R. Branch, or his executors or administrators of any collateral not included in the trust estate pledged for the security of any such note or notes, the permission hereby accorded, however, not to operate or limit in any wise any liability under the foregoing covenant. [Italics supplied.]

At all times since the creation of the trust the three trustees named in the indenture as trustees have been acting as such. At no time has any property belonging to the trust estate been delivered to the petitioner except for the purpose of enabling him to deal with it in accordance with the trust indenture and the petitioner has never used any property of the trust estate except as part of the trust estate in the manner permitted by the trust indenture.

The petitioner has not used any of tbe trust property for bis individual purposes except to pledge the same as collateral for his individual notes representing indebtedness for which it was originally pledged or notes taking the place of such notes. The trust company to which the securities in the trust estate were pledged has never sold any of the securities in the trust estate or resorted to any part of the trust estate, and has never received any of the income from the trust estate.

Hope S. Branch is still alive and is the wife of the petitioner. During the year 1934 the trustees deposited all the income of the trust estate for that year (which consisted solely of $9,295 in dividends) in a personal checking account of Hope S. Branch in a bank except $100 thereof, which was paid as trustees’ fees to Walter A. Edwards and William H. Edwards. No payment of any kind was made to the petitioner by the trustees.

No person except Hope S. Branch has ever been authorized to draw checks on her checking account or to make withdrawals therefrom.

From August 18, 1928, to December 31, 1934, the petitioner paid for the maintenance and support of his wife or paid other sums sufficient for that purpose. Hope S. Branch during 1934 and all other years prior thereto used the income from the trust estate for whatever purposes she desired and applied no part of it to the payment of premiums on policies of insurance on the life of the petitioner. Petitioner at no time from August 18,1928, to December 31,1934, received any part of the income from the trust estate.

During the year 1934 the active handling of the receipt and disbursement of the income of the trust estate was done entirely by William H. Edwards, one of the trustees, or his personal secretary under his direction.

Section 166 of the Revenue Act of 1934 provides as follows:

SEO. 16 6. REVOCABLE TRUSTS.
Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
(1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
(2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
then the income of such part of the trust shall be included in computing the net income of the grantor.

Although in his deficiency notice the respondent asserts in effect that, because the grantor may obtain the corpus of the trust if he survives his wife, “it is a revocable trust under section 166, of the Revenue Act of 1934”, he makes no such contention in his brief. We think it is untenable. See S. Rodney Sharp, 38 B. T. A. 166; John Edward Rovensky, 37 B. T. A. 702; Phebe Warren McKean Downs, 36 B. T. A. 1129; Henry A. B. Dunning, 36 B. T. A. 1222; United States v. First National Bank of Birmingham (C. C. A., 5th Cir.), 74 Fed. (2d) 360; Shanley v. Bowers (C. C. A., 2d Cir.), 81 Fed. (2d) 13.

In his brief the respondent relies upon two contentions — that “(a) The petitioner had the power to have the entire corpus exhausted in satisfaction of his personal note”, and “(b) The petitioner had complete direct control over the trust corpus.”

Upon the first point the respondent argues that when the trust was established the trust res was subject to a $400,000 encumbrance and in the event of default by the petitioner the bank had the right to exhaust the trust res to satisfy the petitioner’s obligation; that this action could be taken by the bank without any recourse against the bank by the trustees or beneficiary because the bank’s lien was superior to the title or interest of the trustees or beneficiary.

The respondent submits:

Under these circumstances how simple indeed for the grantor to effect a revocation of the trust! All the petitioner had to do was to default in the payment of his note to. the bank. The bank would thereupon foreclose upon the security, the trust corpus. To the extent of the value of the trust property the petitioner would have his obligation to the bank satisfied. The trust would be void of assets.

We think there is no warrant in the stipulated facts for this contention. In the first place, it was only a portion of the assets of the trust res which was pledged for the security of the notes. There is therefore no basis for the respondent’s contention that if the bank sold the collateral pledged to secure the notes the trust would be without assets. In the second place, the respondent gives no weight to the petitioner’s obligation to the trust to make good any loss which might be sustained by the trust as a result of the pledge of the securities to secure his promissory notes.

The respondent calls particular attention to the portion of paragraph second (18) of the trust instrument which has been italicised above and reads as follows:

but it shall be lawful for the trustees to determine the amount of any liability of said Clatjdb R. Branch, or his executors or adminstrators, on account of the foregoing covenant and any determination made by them shall be binding upon the trust estate and the beneficiaries under the foregoing trusts. * * *

The respondent argues that by virtue of this provision the petitioner alone may determine his liability to the trust in case of any loss which the trust might sustain by reason of a sale of pledged securities. It should be noted, however, that it is not the petitioner alone who is to determine the amount of the loss but the trustees, only one of whom was the petitioner. We are therefore of the opinion that there is no merit in the respondent’s contention that the petitioner had the power to have the entire corpus exhausted in satisfaction of his personal notes.

The respondent’s second contention is that “The petitioner had complete direct control over the trust corpus.” He argues that, since the interests of the trustees were not adverse to the grantor’s interests, Reinecke v. Smith, 289 U. S. 172, “his wish was their wish, his determination their determination.” This argument is inconclusive. The trustees are under a legal duty to protect and conserve the trust assets. In the administration of trust estates it is a well established rule of law that “A trustee must use the same care for the safety of the trust fund, and for the interests of the cestui que trust, that he uses for his own property and interests.” Perry on Trusts and Trustees, 7th Ed., vol. I, § 441. “The first care of the law is the safety of the trust fund. Upon this truism depends every rule which has been made for the conduct of the trustees.” In re Union Trust Co. of New York, 149 N. Y. S. 324.

It must be assumed that in all discretionary matters all trustees here, of whom there were two other than the petitioner, were to act in the best interests of the trust as they were legally bound to do. In so doing they would, of course, require the petitioner to make full restitution to the trust of any loss sustained by reason of the pledge of its assets on petitioner’s note.

The respondent further argues that by the express provisions of the trust agreement the petitioner retained such broad powers over the trust corpus that he must be regarded “as in substance the owner of the corpus.” In support of this contention respondent relies upon article 166-1 of Kegulations 86, as amended, following the decision in Douglas v. Willcuts, 296 U. S. 1, by Treasury Decision 4629, which reads in part as follows:

But the provisions of section 166 are not to be regarded as excluding from taxation to the grantor the income of other trusts, not specified therein, in which the grantor is, for the purposes of the Act, similarly regarded as remaining in substance the owner of the corpus. The grantor is regarded as in substance the owner of the corpus, if, in view of the essential nature and purpose of the trust, it is apparent that the grantor has failed to. part permanently and definitely with the substantial incidents of ownership in the corpus.
(d) If the grantor is regarded as remaining in substance the owner of the corpus the gross income of such corpus shall be included in the gross income of the grantor, and he shall be allowed those deductions with respect to. the corpus as he would have been entitled to had the trust not been created.

It is clear from the trust agreement that the petitioner’s reserved powers over the trust corpus to which the respondent refers, such as to invest, sell, or exchange the securities held by the trustees, were to be exercised by him as trustee and not as grantor of the trust. The fact that in the exercise of such powers the petitioner could act alone and without the concurrence of the other trustees was not detrimental to the trust. In no event could he have appropriated any of the trust funds to his own use without violating his trust. Again we must assume that the petitioner’s acts as trustee would have been for the best interests of the trust.

Even within the broad scope of the Commissioner’s amended regulations we do not think that the provisions of the trust agreement can be construed as leaving the petitioner in substance the owner of the securities which he conveyed to the trust. Neither do the subsequent acts of the parties lend support to that contention. It appears from the stipulated facts that there has never been any misuse of the trust funds or any departure from strict adherence to the provisions of the trust agreement. Cf Benjamin F. Wollman, 31 B. T. A. 37; William C. Rands, 34 B. T. A. 1107.

The respondent erred in including the dividends from the trust securities, which were paid to petitioner’s wife as beneficiary of the trust, in petitioner’s gross income.

Decision will be entered under Bule 50.


source: Caselaw Access Project

license: Public Domain

text:
    Realty Operators, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92387.
    Promulgated December 7, 1939.

      Charles M. Trammell, Esq., for tlie petitioner.

      C. H. Curl, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income and excess profits tax for the fiscal year ended February 29, 1936, of $35,934.83 and $809.16, respectively. The petition alleges that the respondent erred in the determination of the deficiency by failing to allow the deduction as an ordinary loss of $400,621.40 on the abandonment of the Maritime Building in New Orleans, Louisiana.

The facts have all been stipulated.

The petitioner is a Louisiana corporation, with offices in New Orleans. It was organized by the Canal Bank & Trust Co. of New Orleans on April 4, 1930. The next day the trust company transferred to the petitioner $3,000,000 cash in exchange for petitioner’s total authorized capital stock of 120,000 shares at $25 par value, which $3,000,000 was on the same date deposited by the petitioner with the trust company.

On April 5, 1930, the petitioner purchased from the trust company the Maritime Building in New Orleans, together with other property, at a total price of $6,986,833.89, of which $3,000,000 was paid in cash by checks and a note for $3,986,833.89 secured by vendor’s lien was given for the balance.

The cost of the Maritime Building and land to the petitioner was as follows:

Land_ $400,000. 00
Building_ 1, 507, 530. 35
Total_1, 607, 530. 35

There was a mortgage outstanding on the Maritime Building in the amount of $1,315,000, which mortgage was not assumed by the petitioxier. The cost'of petitioner’s equity in the property was therefore $532,530.35.

A reasonable rate for the allowance of depreciation upon the building is 3 percent per annum.

On November 17, 1933, the petitioner entered into a written agreement with the mortgagee, the New York Life Insurance Co., by which it gave to the insurance company physical possession of the property after that date and the right to receive all rents from the building subsequent to June 30, 1933. The agreement further provided :

If at any time before tbe institution of a foreclosure action as herein provided, tbe loan secured by tbe said bond, notes and mortgage is placed in good financial standing in every way, then tbe party of tbe second part [the insurance1 company] will immediately cancel this agreement.

The New York Life Insurance Go. has operated the Maritime Building continuously from November 17, 1983, to date, collecting all rents and paying all obligations thereon.

On February 14, 1936, the New York Life Insurance Co. instituted foreclosure proceedings against the Maritime Building in the United States District Court at New Orleans, and petitioner was duly made a party thereto.

On February 21, 1936, a meeting of the board of directors of the petitioner was held and a resolution was passed by which:

IS. N. Kearny, President of this Company be and he is hereby instructed to notify New York Life Insurance Company, Canal Bank and Trust Company in Liquidation and Reconstruction Finance Corporation, that this company forthwith gives them, as their interests may appear, peaceful possession of the property covered by the mortgage and that this company abandons any and all rights, title and interests which it has or might have in and to the said property.

The resolution further provided:

That E. N. Kearny, President of this company is authorized for, on behalf of and in the name of this company to sign, execute and record any and all acts, deeds and papers which, in his judgment, may be necessary and proper in order to carry out this resolution.

By letter dated February 21, 1936, the petitioner notified the New York Life Insurance Co. of the foregoing resolution and enclosed in said letter a certified copy of the resolution.

The foreclosure proceeding was brought to a successful conclusion and the property covered by the mortgage was sold March 11, 1937, pursuant to court order by the special master appointed by the said court and the sale was thereafter duly confirmed by the court.

On April 27, 1937, the court entered an order directing the petitioner to sign the master’s deed to the property “for the purpose of placing of record that it has no right, title and interest therein.” On the same day the petitioner signed the master’s deed for the purpose above indicated.

Under the laws of the State of Louisiana a mortgagor has no period of redemption after foreclosure.

The loss sustained by the petitioner upon its investment in the Maritime Building was not covered by insurance or otherwise.

On or before May 15, 1936, the petitioner filed its income and excess profits tax return with the collector of internal revenue at New Orleans, Louisiana, showing a net loss of $50,574.75 for the fiscal year ended February 29, 1936. In computing such net loss the petitioner took a deduction from gross income on account of loss of its equity in the Maritime Building in the amount of $400,621.40.

Upon an audit of the petitioner’s income tax return for the fiscal year ended February 29,1936, the respondent disallowed the deduction of the claimed loss in the amount of $400,621.40 and in lieu thereof allowed the deduction from gross income of $45,225.91 depreciation upon the Maritime Building. The depreciation was 3 percent of the admitted cost to the petitioner, viz, $1,507,530.35. The respondent determined that the correct net income of the petitioner for the fiscal year was $261,344.21 and that there was an excess profits tax due from the petitioner in the amount of $809.16.

The parties have further stipulated:

27. A deduction of $133,034.81 was claimed by tbe petitioner as an ordinary loss for loss of equity in the Maritime Building on its Federal income tax return, Form 1120, filed for the fiscal year ended February 28, 1938, at the suggestion of the Revenue Agent and on advice of Counsel that it was necessary to do so to protect its rights in the event the loss should be finally disallowed for the year ending 2/29/36. Petitioner contends and has at all times contended the loss is allowable in year ending 2/29/36 as an ordinary loss. In the final notice of deficiency dated December 15, 1938, the loss was allowed but the deduction was limited to $2000, it being held to be a capital loss subject to the limitation contained in Section 117 (d) of the Revenue Act of 1936, since the Maritime Building was sold in foreclosure proceedings pursuant to court order during the fiscal year ended February 28, 1938.

Three questions are presented for the determination of the Board in this proceeding as follows:

(a) Is the petitioner entitled to a deduction on account of its loss of equity in the Maritime Building in the fiscal year ended February 29,1936?

(b) Is the loss, if any, a loss on the sale or exchange of a capital asset subject to the limitation on losses under section 117 of the Revenue Act of 1936, or an ordinary loss deductible in full under section 23 of the same act?

(c) What is the period over which petitioner is to compute depreciation on the Maritime Building?

1. In his deficiency notice the respondent gives as the reason for disallowing the claimed loss upon the petitioner’s investment in the Maritime Building the following:

It is held that no loss could be sustained until title had definitely passed in accordance with article 23 (e)-3, Regulations 86. See cases of A. J. Schwarzler, United States Board of Tax Appeals, volume 3, page 535 and Frederick Krauss, United States Board of Tax Appeals, volume 30, page 62.

In Greenleaf Textile Corporation, 26 B. T. A. 737, the Board stated that it had early adopted the rule that a taxpayer could not sustain a deductible loss as to the value of real estate while retaining title thereto upon the theory that, as stated in A. J. Schwarzler Co., 3 B. T. A. 535, losses “growing out of the ownership thereof, are deductible only when ascertained and determined upon an actual, completed, and closed transaction during the taxable year, and are not sustained through the mental processes by which a taxpayer determines that the property is worthless and charges it off on its boohs, while it still retains the title to the property itself.”

We think it clear that the petitioner’s case falls outside of this rule. Here, the loss is not made to depend upon the “mental processes” of the taxpayer in determining that the property is worthless. The taxpayer actually renounced its title and notified the mortgagee of the renunciation.

The execution of a deed to property is not necessary to sustain the loss arising out of the sale or abandonment of property. In Rhodes v. Commissioner (C. C. A., 6th Cir.), 100 Fed. (2d) 966, the facts were that the taxpayer had purchased Florida real estate for speculation purposes. Due to the collapse of the Florida land boom and to successive hurricanes, the value of the land suffered complete collapse. The taxpayer claimed a loss during the year 1921, which was disallowed by the Commissioner and affirmed by the Board because there was no identifiable event to sustain the loss. As to one property the petitioner had sought its sale unsuccessfully in 1927 and in 1928 disposed of it for one-twentieth of its cost. The second property was sold by the state in 1927 for unpaid delinquent taxes. There being no bidders, the state acquired the property. Under the statute the owner or others interested therein had two years within which to redeem the property and unless redeemed the title to the property vested in the state. Although the taxpayer charged the loss off on its books and deducted the sum from gross income for 1927, the respondent disallowed it on the ground that the petitioner still retained title to the property. In its opinion the court stated:

The Board rested its decision largely on its rule that a loss on real estate is not deductible so long as the taxpayer retains title in fee.
The unsoundness of this principle is readily apparent when subjected to the searchlight of reason. The ownership of real estate may become a burden with recurring taxes and the impossibility of finding a purchaser at any price. * * *
Standing alone, a tax sale of property is not an identifiable event showing its worthlessness to the owner the year of the sale, but if the taxpayer is financially able to pay the¡ taxes and refuses to do so, the tax sale is of weight along with other evidence as to the time the loss became fixed. The loss statute makes no distinction between real and personal property and there may be an abandonment of real estate in a very practical sense without the taxpayer divesting himself of legal title. Denman v. Brumback, 58 F. (2d) 128 (6 C. C. A.).

In Denman v. Brumback, 58 Fed. (2d) 128, the court said:

The loss claimed was deducted by Brumback under section 214 (a) of the Revenue Act of 1921 (42 Stat. 239). It was disallowed by the Commissioner in reliance upon the case of Appeal of A. J. Schwarzler, 3 B. T. A. 535, and upon article 141, of Regulations 62, of the Bureau of Internal Revenue, which provides inter alia that losses incurred in any transaction entered into for profit must usually be evidenced by a closed and completed transaction. The Schwarz- ler Case seems to hold, and it is contended by tbe appellant that it does bold, that losses suffered in tbe purchase of real estate cannot be determined until tbe property is sold, and that there can be no closed transaction with respect to real estate short of its sale, voluntary or enforced. We tbinls no such inflexible rule is to be found either in tbe statute or the regulation. The general requirement that losses be deducted in the year in which they are sustained calls for a practical, not a legal, test. Lucas v. American Code Company, 280 U. S. 445, 50 S. Ct. 202, 74 L. Ed. 538. Having in mind the practical test, we think the case falls within United) States v. White Dental Company, 274 U. S. 398, 47 S. Ct. 598, 600, 71 L. Ed. 1120. * * *

In W. W. Hoffman, 40 B. T. A. 459, the Board held that where th6 interest of the taxpayers in improved real estate owned by them, subject to a mortgage, became worthless in 1934 the taxpayers were entitled to deduct their loss in that year under section 23 (e) (2) of the Revenue Act of 1934, although title remained in them until foreclosure was completed in the following year, despite their efforts to abandon their interest in the property during 1934.

We can not doubt from the resolution of the board of directors of the petitioner corporation on February 21, 1936, that it intended to and did equitably transfer to the mortgagee all of its right, title, and interest in and to the Maritime Building. Thereafter, it had no equity in the building. The naked legal title gave it no equitable interest. We conclude that the petitioner’s loss was sustained within the taxable year ended February 29, 1936.

2. The respondent contends that in any event the allowable loss is limited to $2,000 by section 117 (d) of the Revenue Act of 1936, which provides in material part that “Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges.” We think it manifest from the stipulated facts in this case that there was no “sale or exchange” by the petitioner of the Maritime Building. It was not the obligor upon the mortgage held by the New York Life Insurance Co. It simply had an equity in that property. That value was obliterated when it abandoned all of its claims to the property. See Commonwealth,, Inc., 36 B. T. A. 850; Sol Greisler, 37 B. T. A. 542; Commissioner v. Freihofer, 102 Fed. (2d) 787. In the Freihofer case the Circuit Court of Appeals for the Third Circuit said:

We think it compels the conclusion that the sales of capital assets referred to in Section 117 are those sales only which are voluntarily made by a taxpayer and that judicial sales made by the sheriff in execution of a judgment in a proceeding for the foreclosure of a mortgage given by a prior owner are not included.

But, in the present case there was clearly no sale by the petitioner; neither was there any exchange. The facts in the case clearly take the proceeding out of the ambit of section 117 (d) of the Revenue Act of 1936. The loss is allowable to the full extent of the amount sustained.

3. The petitioner acquired title to the Maritime Building on April 5, 1930. Its investment in the building was $1,507,530.35. The parties have stipulated that the depreciation rate is 3 percent per annum. The depreciation period extended to the time when the petitioner surrendered all right, title, and interest in and to the property, viz., February 21, 1936.

Decision will be entered wider Bule 50.


author: Disney:

text:
    Mascot Stove Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91265.
    Promulgated December 7, 1939.

      Robert A. Littleton, Esq., for the petitioner.

      L. W. Greason, Esq., and A. H. Monacelli, Esq., for the respondent.
   OPINION.

Disney:

This proceeding involves income tax liability for the fiscal year ended June 30, 1934. The deficiency determined by the Commissioner is $3,197.22.

The Mascot Stove Manufacturing Co. (hereinafter called the old company) was adjudicated a bankrupt on June 20, 1933. Its real estate, situated in Hamilton County, Temiessee, and its machinery, tools, and other equipment located on its premises and fully described in an inventory filed with the trustee in bankruptcy, together with the good will of the old company, were encumbered by a mortgage to Adolph S. Ochs, which mortgage, with interest and taxes, amounted to in excess of $30,000; and the property covered by the mortgage was appraised in the bankruptcy proceedings for less than the amount of the mortgage.

On July 3, 1933, the trustee in bankruptcy received an offer from one Luke O. Morin, as trustee for himself and a corporation to be organized, to pay $50 for a conveyance of the property mortgaged to Ochs, subject to the mortgage and existing liens. As the trustee, under the circumstances, had been preparing to disclaim interest in the property, the offer was accepted, and deed of conveyance was by the court ordered made upon payment of the $50.

On July 7,1933, Alvin Ziegler, trustee, made an offer1 to pay $7,500 for the old company’s assets, not covered by the mortgage, consisting in the main of an inventory of castings, stove parts, stoves, materials, and an equity in accounts receivable, which were subject to a lien of $11,297.26 to a finance company and which equity was appraised at $2,351.75. The remainder of the assets purchased by Ziegler was appraised at $9,280.50.

Ziegler’s offer was accepted. The order of the court confirming the sale to him directed the purchaser to pay to the trustee in bankruptcy the sum of $2,500 and execute for the balance three notes, each for the sum of $1,000, and one note for $2,000, all payable to the trustee, respectively, in 30, 60, 90, and 120 days after date. The order further provided: “The title to the assets herein sold shall remain vested in the trustee in bankruptcy until the balance of the purchase price is paid. * * * Upon the payment of said notes evidencing the payment of the purchase price, the trustee will execute a bill of sale transferring and conveying the property herein described to the purchaser.”

Alvin Ziegler, trustee, in purchasing the inventories, accounts receivable, etc., assets of the old company, acted for himself and for most, but not all, of the stockholders of the old company and a corporation to be formed. In the transaction, Ziegler represented the following named persons, who held stock in the old company in the amounts set opposite their names:

Shares Shares held
John O. Fowler, 208 shares of the preferred stock, being all of the
preferred and 369 shares of the common_577 Mary E. Fowler- 75 Lena S. Fowler- 89 Ben W. Fowler, deceased, Frank E. Fowler, administrator_ 75 John O. Fowler, Jr_ 9 Frank E. Fowler-150 Richard C. Fowler_ 9 James Sterchi Fowler_ 3 987
W. R. Samuels, 200 shares issued in the name of Alvin Ziegler, trustee, and 272 issued in the name of Agnes O’Connell, maiden name of wife of Samuels, but all considered and treated as Samuels’ stock. 472
Shares held
O. T. Tindell, Jr., 340 shares issued in name of O. T. Tindell, Sr.; 60 shares issued in the name of Nell Hall (maiden name of O. T. Tindell, Jr.’s wife) ; 30 shares issued in the name of Nell Hall Tindell (wife of O. T. Tindell, Jr.) and 827 shares in the name of O. T. Tindell, Jr., all treated as the stock of O. T. Tindell, Jr. Alvin Ziegler-W. J. Lammers_ George L. Dover-A. R. Hudson_ 1,257 67 20 15 258
Total_3, 076

The entire stock, preferred and common, of the old company, was approximately 3,800 shares. The exact number of shares is not shown by the record.

On July 7,1933, application for a charter was made to the State of Tennessee, and on July 8, 1933, it was issued to the petitioner herein, the Mascot Stove Co. (hereinafter called the new company). The incorporators were E. B. Cooke (Ochs’ attorney), Alvin Ziegler (a lawyer), and L. D. Hill, a stenographer in Ziegler’s office. The maximum number of shares of stock the company was authorized to have outstanding at any time was 5,500, of which 500 shares were to be preferred stock, having a par value of $100 per share, or an aggregate authorized preferred stock of $50,000, and 5,000 shares were to be common stock without any par value.

The first meeting of the incorporators of the new company was held on July 14, 1933, at the office of E. B. Cooke, the following persons, incorporators, being present: E. B. Cooke, Alvin Ziegler, and L. D. Hill — Cooke serving as chairman and Ziegler as secretary. The charter of the new company was presented and accepted, and the following action was taken, as shown by the minutes:

On motion duly made, seconded and carried it was ordered that the books of the company be opened for subscription to preferred stock, and the following subscribers for such preferred stock were announced:
Name No. Shakes Pab Value Total
Alvin Ziegler_ 10 $100.00 $1,000.00
Alvin Ziegler, Trustee_ 25 ” 2, 500. 00
Alvin Ziegler ” _ 25 ” 2,500.00
Alvin Ziegler reported that in bis own name as trustee be bad purchased the finished goods, accounts receivable, both pledged and unpledged of the old Mascot Stove Manufacturing Company by an order which had been entered in the Bankruptcy Court for the sum of $7,500, $2,500.00 cash and the remainder represented by four notes, the first three for $1,000.00 each and the 4th note for $2,000.00, maturing 1, 2, 3 and 4 months after date respectively.
Mr. Ziegler also reported to the meeting that the plant of the Mascot Stove Manufacturing Company, consisting of land, buildings, machinery, equipment and patterns, was covered by a mortgage owned and beld by Hr. Adolpb S. Ocbs; that an associate, Luke O. Morin, beld a conveyance of tbis property from tbe trustee in bankruptcy; that Adolpb S. Ocbs bad foreclosed on the mortgage, but on account of tbe identity of the individuals whom be (Ziegler) represented and who are organizing tbe Mascot Stove Co., he is willing for tbe new company to take over tbe plant upon execution of a new mortgage to him and payment of the accrued taxes and other expenses. Mr. Ziegler then offered to transfer to the new company tbe assets acquired from tbe trustee in bankruptcy and tbe privilege of acquiring tbe plant, upon tbe following terms:
Payment of_$7,500.00
To be paid $2,500.00 in cash and notes to himself to correspond to the notes which be bad executed to tbe trustee in bankruptcy.
Taking the Accounts Receivable subject to the claim of tbe Manufacturers Finance Corporation for_ 11,297.26
Assuming and paying expenses of_ 532.00
Assuming and paying accrued taxes of- 2,090.13
Executing to Adolph S. Ochs a mortgage, secured by tbe plant, for_ 33, 000.00
Issuance to bis order of 5,000 shares of no par common stock, having a stated value on the books of tbe Mascot Stove Company of_ 70,124. 00
On motion duly made, seconded and carried, it was ordered that tbe above offer be accepted and that tbe officers of tbe company be authorized and instructed to do the things necessary to complete tbe transaction and acquire tbe property.
Tbe incorporators then tendered their resignations as members of the board of directors to become effective when a meeting of stockholders was beld, and a new board was elected. Upon motion duly made, seconded and carried, it was ordered that said meeting be adjourned.

Twenty-five shares of preferred stock subscribed for by Alvin Zielger, trustee, as above indicated were for W. E. Samuels and tbe other 25 preferred shares similarly subscribed were for John O. Fowler. Tbe preferred stock was paid for in cash, $6,000. Immediately after tbe meeting of tbe incorporators, on July 14, 1933, the first meeting of stockholders was beld. There were present Alvin Ziegler, individually and as trustee, and O. T. Tindell, Jr., and O. T. Tindell, Sr., by proxy. Tbe only business transacted was adoption of bylaws an,d election of L. O. Morin, A. E. Hudson, O. T. Tin-dell, Jr., George Dover, and Alvin Ziegler as directors.

Tbe board of directors of tbe new 'company, on July 14, 1933, elected the following officers: L. O. Morin (who had been president of the old company) was elected president of tbe new company; A. E. Hudson was elected vice president, O. T. Tindell, Jr., treasurer and general manager, and Alvin Ziegler, secretary.

The interest of each person in tbe property acquired- by Alvin Ziegler, trustee, at tbe bankruptcy sale was in tbe same ratio that the nuimber of shares beld by each in the old company bore to the total number of. shares in the old company represented by the group, and the amount of stock in the new corporation which each was entitled to receive and did receive, was in substantially the same proportion as his ownership of the assets exchanged for stock, although the stock certificates issued at a later date were not in the same proportion. The transferors were in control of the new corporation immediately after the exchange.

The new company, by transfer through Alvin Ziegler, trustee, acquired the inventoried assets and accounts receivable of the old company, and the assets that were covered by the mortgage to Ochs were deeded by Ochs to the new company and it executed back to Ochs a mortgage for $33,000, paid the expenses incident to the transaction, amounting to $532, and paid the accrued taxes, amounting to $2,019.13. The real estate, machinery, tools, and equipment and the patterns that had been used in manufacturing the inventoried parts and finished goo,ds and included in the sale under the mortgage to Ochs, and the conveyance to Luke O. Morin by the trustee in bankruptcy were included in the transfer by Alvin Ziegler, trustee, to the new company, Ziegler having acquired the right to deal therewith, though the record does not otherwise show a conveyance to Ziegler of the rights of Luke O. Morin.

The new company paid Alvin Ziegler, trustee, for the assets that he transferred to it, $2,500 in cash and executed to him $5,000 in four notes and issued to him and stockholders whom he represented 5,000 shares of no par common stock. The four notes were in the same amounts and, due on the same dates as the notes which Ziegler himself had originally executed to the trustee in bankruptcy for said assets. All four notes were paid by the new company. The $2,500 paid by Ziegler, trustee, on the purchase of the assets, was supplied by W. R. Samuels and 25 shares of the preferred stock of the new company of the par value of $100 a share was issued to Alvin Ziegler, trustee, for W. R. Samuels, as hereinabove set forth.

From the time the old company was adjudicated a bankrupt down to and including the acquisition by the new company of the real estate, equipment, inventories, and accounts receivable of the old company, Ziegler, trustee, Morin, an,d their associates contemplated the organization of another corporation and acquiring for it the assets of the old company and carrying on the same character of business.

On September 18, 1933, the entire common stock of the new company was issued to or for the hereinafter named individuals whom Alvin Ziegler, trustee, represented in the purchase from the trustee in bankruptcy of the old company’s assets, which were to be and ' were turned over to the new company. In the division of the stock of the new company no distinction was made as between the preferred and common stock held by John O. Fowler in the old company. The common stock of the new company was divided and issued as follows:

Skares
O. T. Tindall, Jr-1,000
Alvin Ziegler-1, 000
John O. Fowler-1,200
Mrs. Mary E. Fowler- 75
Ben W. Fowler (Frank E. Fowler, administrator)- 75
Frank E. Fowler- 150
A. It. Hudson_ 150
W. J. Lammers- 70
T. B. Hannah-.- 15
Irma K. Dover- 65
W. R. Samuels_1,200
Total_5, 000

The face amount of good accounts receivable acquired by the new company is shown to have been $11,311.66 (book figures $22,608.92 less $11,297.26 sold to finance company to discharge mortgage thereon). Of the $7,500 paid the trustee in bankruptcy, the respondent determined $2,148 thereof was for the accounts receivable. The respondent determined that during the fiscal year ended June 30, 1934, there remained a realizable profit in the amount of $9,163.66 of accounts receivable when collected, that at the end of the fiscal year ended June 30, 1934, there remained uncollected $1,747.48, making the profit realized during the taxable year ended June 30,1934, $7,416.18.

Respondent adjusted inventories and reduced the opening inventory at the beginning of the taxable year from $28,184.34 (as per taxpayer’s books) to $5,352' (portion of the $7,500 purchase price allocated to inventories). The closing inventory at the end of the taxable year (June 30, 1934) was, by respondent, reduced from $30,426.24 to $21,-393.30, predicated upon the fact shown by the record that about 40 percent of the opening inventory was on hand at the close of the taxable year, 60 percent thereof having been disposed of. Realizable profit on all inventories was determined by the respondent to be $22,832.34, being the amount of the opening inventory, $28,184.34, less $5,352 purchase price, 60 percent thereof, or $13,699.40, being the profit realized from said inventories during the taxable year.

The first question herein presented for determination is as to what is the proper base to be used in calculating profit or loss to petitioner during the taxable year from certain of the assets acquired as above set forth by petitioner. Profit was determined by respondent (a) by adjustment in petitioner’s inventory of assets because of sales during the taxable year, and (b) because of profit in collection of certain accounts receivable during the taxable year. Respondent contends that the base to be applied in computing profit or loss is the price paid for the assets at the bankruptcy sale, on the theory that Ziegler, trustee, the buyer, was agent or trustee for the petitioner corporation, or, if not, that lie and those represented by him were in control of the petitioner corporation immediately after the exchange of property for stock of the corporation, and received stock substantially in proportion to their interests in the assets exchanged, under the provision of section 112 (b) (5), Revenue Act of 1932’, and that therefore under section 113 (a) (8) (A) the base is the same as that of the transferors, and therefore the price paid at the bankruptcy sale by Ziegler, trustee; whereas petitioner contends that the base is the fair market value at time of acquisition on July 14, 1934, contending in effect that Ziegler and those for whom he was trustee acted individually, not as agents or trustees for the new corporation, and, though admitting that the trans-ferors of the assets to the petitioner in exchange for stock were in control of the company immediately after the exchange, affirming that the statutes relied upon by respondent do not apply because the amount of petitioner’s stock received by the transferors was not substantially in proportion to the interest of each transferor in the assets exchanged for stock.

We hold that there was no reorganization. There was no continuity of interest between the old company and the new, no exchange of stock or securities for stock or securities, under section 112 (b) (3) of the Revenue Act of 1932, the only section relied upon to prevent recognition of gain or loss on the exchange, and the old company did not pursue a plan of reorganization, the only plan being that of about three-fourths of the stockholders, acting not as such but as individuals, there being no corporate action. There was no representation of the old company by creditors or bondholders as in Commissioner v. Kitselman, 89 Fed. (2d) 458. A mere purchase of assets at bankruptcy sale does not demonstrate reorganization. Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; Petree v. United States, 34 Fed. (2d) 563; affd., 41 Fed. (2d) 517; Beverly Wall Paper Co., 36 B. T. A. 353.

Upon brief petitioner asserts that respondent, in contending that petitioner was the purchaser at the bankruptcy sale, has varied from the deficiency notice, without affirmative pleading. We think the respondent’s present position is within the purview of the determination of deficiency. JSTo increase of amount of deficiency is sought.

Examination of the record herein indicates, we think, that the petitioner corporation was, as contended by respondent, the purchaser at bankruptcy sale and takes as basis the price then paid for the assets in question. That a new corporation was contemplated at all times after the adjudication can not successfully be denied in the face of the fact that Luke O. Morin, in purchasing the equity of the bankrupt estate in the other assets of the old company, that is, the real estate, machinery, equipment, stove patterns, etc., covered by the Ochs mortgage, purchased “as trustee for a new corporation to be organized.” This expression occurs three times in the record of that sale. In fact, title to the same property acquired by Morin later passed directly to the new corporation, when Ochs conveyed same. Morin was an associate of Alvin Ziegler, who purchased the assets here involved, that is the inventory (of stoves, parts, etc.) and accounts receivable. That they were cooperating can not be overlooked. Though Ziegler as trustee purchased the last named assets, the title could not pass, under the order of the bankruptcy proceeding, until the last note, due in 120 days, was paid. By that time, of course, the new corporation had long been formed. Though the record is silent as to whether title then passed directly from the trustee in bankruptcy to the new corporation, title could not have passed to it from Ziegler at the date of the exchange on July 14, because at that time, prior to payment of the notes, Ziegler had no title to convey. Though in a sense Ziegler did represent in the purchase at bankruptcy sale a part of the former stockholders, we think he represented them as trustee in an agreement to form the new corporation, in the same position in that respect as was Morin for the other assets. Tindel was “working up the corporation * * * working the deal through * * * trying to continue the business.” Ziegler was his attorney. The new corporation stepped into the shoes of the trustee, Ziegler, made notes in the same amounts and payable at the same times as had Ziegler to .the trustee in bankruptcy. Though there was testimony that propositions other than incorporation were mentioned, the fact is that on the day of Ziegler’s purchase, July 7, application for the corporate charter for petitioner was applied for, and charter was issued the next day and the first meeting held less than a week later. It is obvious that the parties intended to, and did, proceed at once with a new corporation. We believe that the old stockholders who entered into the block represented by Ziegler as trustee had a right to the formation of the new corporation to hold the property, that Ziegler as trustee was under that duty, and that when the whole sequence of events is considered he must be considered as purchasing as trustee for the new corporation; and that therefore the basis to the petitioner is the price paid at the bankruptcy sale. This conclusion is sustained by the petition, which recites that a part of the old stockholders “entered into a plan or arrangement between themselves, the trustee in bankruptcy and the secured creditors * * * to perfect a reorganization, by organizing a new corporation * * * in the name of the Mascot Stove Company to acquire the assets of the Mascot Stove Manufacturing Company by the payment of $7,500 in cash * * etc. Though this did not result in reorganization, it does outline the plan which was consummated. This conclusion is supported too by O. T. Tindell’s testimony that the new corporation was “formed to take over that property,” and, referring to the plant of the old company (sold under mortgage to Ochs, “Mr. Ziegler acquired the right to transfer this, •property into a new company for the purpose of going ahead with the stove business.” (Emphasis supplied.) We hold that the purchase at the bankruptcy sale by Ziegler, trustee, was for and by the petitioner through trustee. That the price at such sale was a low or bargain price, because the inventory of stoves and parts had small value, unless acquired by one owning the patterns, is immaterial; that price represented cost to the petitioner.

However, even if we were incorrect in the above conclusion, the same basis was properly applied by the respondent for there was, in our opinion, the substantial equivalence between ownership of assets prior to exchange and stock in petition after the exchange as required by section 112 (b) (5) of the Revenue Act of 1934.

The petitioner relies upon the fact that the stock certificates in petitioner corporation, when issued to the transferors of assets, were not in substantially the same proportion as they had owned the assets. The stock certificates were issued September 18, 1933, as to the entire 5,000 shares, whereas the exchange was, under petitioner’s own theory, effected on July 14, 1933. Issuance of certificates in certain amounts on September 18 does not, of itself, determine ownership of the stock on July 14. It has been held that the control which affects the question of computation of gain or loss on base, must be “immediately after the exchange.” Schmieg, Hungate & Kotziam, Inc., 27 B. T. A. 337, 342; Federal Grain Corporation, 18 B. T. A. 242; Evans Products Co., 29 B. T. A. 992, 997; sec. 112 (b) (5), Revenue Act of 1932. Obviously, the same thought applies to the ownership of stock in proportion to previous ownership of stock transferred, for the base involved in the exchange is determined by the situation at the time of exchange. Later acts, such as transfer of stock owned at time of exchange, can not affect the base. But ownership of stock is not dependent upon possession of certificates therefor. Federal Grain Corporation, supra; Elvira Scatena, 32 B. T. A. 675; Anita Owens Hoffer, 24 B. T. A. 22, citing Richardson v. Shaw, 209 U. S. 365, and Jellnick v. Huron Copper Mining Co., 177 U. S. 1. Petitioner, therefore, has not met its burden of proof merely by showing that the certificates issued September 18, 1933, were out of proportion with the ownership of assets prior to July 14, 1933. The record contains no evidence that the actual ownership of stock immediately after the exchange was the same as represented by the stock certificates at a later date. Indeed, the stock book, showing the 5,000 shares issued September 18, had to be explained and was explained, for in a number of instances the stock was issued in one name when the stock was owned by another. Regardless, however, of the burden, we think it plain, that the evidence of the petitioner shows that, at the time of the exchange, title to the stock was received in proportion to previous ownership of assets; O. T. Tindell, Jr., prominent officer in both corporations, in explaining the stock certificates received by him, testified :

A After we undertook to divide the new stock based on our holdings, Mr. Ziegler wanted more stock on account of Ms activities in the business and Mr. Samuels wanted more stock on account of having advanced the money and Mr. Powler insisted that the stock be divided according to the original agreement, and that I get as much stock anyway as I had in the old one, and that is the reason that the 200 shares were issued in my name and endorsed by me to Mr. Ziegler, because I was interested in getting the business going, primarily, but, as a matter of fact, I would have taken less stock than I did, as I was not putting any money into it.
Q You were not putting any money into it?
A No, sir, outside of — I put my equity in the accounts receivable and the merchandise purchased out of the Bankrupt Court.

We think it is beyond question from this language that an attempt was made to divide the new stock “based on our holdings”, which can reasonably only mean on the basis of holdings in the assets conveyed, that there then arose a desire on the part of some for a disproportionate amount of stock, particularly a desire by Ziegler for more stock because of his activities and by Samuels because of his advancement of money, whereas Fowler “insisted that the stock be divided according to the' original agreement.” This, too, plainly indicates that the original agreement for division of stock was for division in accordance with the holdings, or if not that, means that there was some agreement for division of the stock different from the manner or proportion in which the stock was finally divided. Witness Tindell merely “put my equity in the accounts receivable and the merchandise purchased” into the matter. We think this strong indication that such was the basis upon which the other owners of the assets were entitled to stock. Tindell testified further, discussing the question as to whom Ziegler represented: “I told all smaller stockholders that they would come in on the same basis as the larger ones, their equity in the property.” Again he stated, as to stock, “I took less than what I was supposed to get.” He testified also, “I was the man who was working up the corporation; I waa handling it for myself and the rest of the former stockholders and working the deal through, and I was trying to protect myself and the stockholders’ interest and continue the business.” It is plain that the 5,000 shares of stock were the consideration for the exchange of assets and the owners of the assets were obviously entitled to stock in proportion thereto. The test is the comparative value of holdings, before and after exchange, rather than number of shares. United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. FTo change in proportion as to value of holdings after exchange of assets for corporate stock was shown herein. In onr opinion, the stock was owned upon the acquisition of the assets by the corporation, and in consideration thereof, by the owners of the assets substantially in proportion to their holdings of the assets, and, therefore, under sections 112 (b) (5) and 113 (a) (8) of the Revenue Act of 1932, the basis of the property acquired and sold in the taxable year, to wit, the inventory and the accounts receivable, is the same as it was in the hands of the transferors, that is to say, the price paid for it by Ziegler as trustee at the bankruptcy sale, or $7,500.

The only question remaining is as to proper allocation of the base between the inventory and the accounts receivable. Of the $7,500 base above approved by us, the respondent allocated $2,148 to accounts receivable and $5,352 to inventory. Since at the hearing petitioner accepted as correct respondent’s valuation of $11,311.66 for the equity in the accounts receivable ($22,608.92 book value, less $11,297.26 for discharge of encumbrance to finance company), and since petitioner’s books set up the inventory as of a value of $28,184.34, mere mathematical calculation discloses that the allocation made by the respondent is substantially in accord with petitioner’s book values, after discharge of existent lien on accounts receivable. Petitioner’s argument for comparative values of $21,000 and $28,000 for accounts receivable and inventory neglects the necessity of deducting the encumbrance upon the accounts. We therefore find no error in respondent’s allocation of the base of $7,500. Petitioner has shown no error in respondent’s computation of the profit realized upon the accounts realized, or in adjustment of inventory, upon the basis of $7,500 and allocated as above approved.

The above opinion modifies the memorandum opinion originally entered herein.

Reviewed by the Board.

Decision will he entered for the respondent.


author: Steenhagen:

text:
    Maryland Land and Transportation Corporation, Name Changed from Maryland Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93477.
    Promulgated December 7, 1939.

      Frederick A. Schutte, Esq., for the petitioner.

      Harold D. Thomas, Esq., for the respondent.
   OPINION.

Steenhagen:

The Commissioner determined a deficiency of $7,-876.81 in petitioner’s surtax for 1934. In the computation of undistributed adjusted net income under section 351 of the Revenue Act of 1934, dividends declared December 29, 1934, to stockholders of record December 31, 1934, payable January 2, 1935, were denied subtraction under subdivision (b) (2) (C). The books were kept on an accrual basis. In fact the dividend was not paid until 1935, and the principal shareholders included the amounts in their individual gross incomes for 1935.

The taxpayer contends that since the dividend accrued in 1934 it is to. be regarded as a “dividend paid during the taxable year.” It urges that subdivision (b) (4) of section 351 gives the term “dividends paid” the meaning of “dividends accrued.” This, it says, is by virtue of section 48 (c) :

Paid, Incuebed, Accrued. — The terms “paid or incurred” and “paid or accrued” shall be construed according to the method of accounting upon the basis of which the net income is computed under this Part.

Thus the single term “paid” would be given the meaning not of the same term used in Title I but of the composite term “paid or accrued” found in section 48 (c). Literally Title I does not contain a prescribed meaning for the word “paid” and unless there is a substantial necessity for treating it as identical with the term “paid or accrued” they should not be confused.

The taxpayer’s view is so palpably in contravention of the clear intendment of section 351 that it can not be adopted. As shown by the structure of Title I A of the Revenue Act of 1934 and by the purpose disclosed in the legislative reports preceding its enactment, the intendment of the surtax on “personal holding companies” was to stop the prevailing practice by corporations of withholding from shareholders the distribution of corporate earnings and thus preventing the assessment of shareholder tax which would enlarge the Government revenue. The existing instrument of section 104 for taxing undistributed earnings was found inadequate principally because it was conditioned upon a tax prevention purpose. Report Ro. 704, Committee on Ways and Means, 73d Congress, 2d sess., p. 11. It was to strengthen the means of taxing the earnings, if they were not distributed, at rates above the normal corporation rates that the surtax on personal holding companies was enacted. See the opinion of Judge Clark in Sanford Corporation v. Commissioner, 106 Fed. (2d) 882.

Plainly, the petitioner’s interpretation would frustrate the very purpose Which the statute was intended to accomplish. It is true that to one on an accrual basis the existence of a legal obligation and its entry on the accounts as accrued may operate to reduce his annual net income; but this general accounting concept may not defeat the plain purpose of the statute in a new scheme of taxation. In common parlance the word “paid” does not necessarily import an unpaid accrual. That under some circumstances it has been held to do so, as in United States v. Anderson, 269 U. S. 422, is explained by a necessity to promote the harmonious construction and administration of the general income tax law. That case dealt with the Revenue Act of 1916, and held that the Treasury regulation which permitted a taxpayer using an accrual system to deduct taxes in the year of accrual was effective to prevent the taxpayer from postponing such deductions from the year of accrual to the following year of payment. In the realm of the general income tax, items of gross income and of deductions are factors in the computation of corporate net income, and the doctrine of that decision has continued to be applied in the administration of succeeding income tax acts.

The present controversy, however, relates not to the general income tax but to a new special surtax upon a specially defined “undistributed adjusted net income.” The definition is designed to serve the purpose of the new tax. Subdivision (b) (2) (B) uses the word “incurred”; subdivision (b) (2) (C) uses the word “paid”; and subdivision (b) (3) (A) uses the term “paid or accrued.” Apparently petitioner would treat all three of these terms as indifferently used to mean the same thing, although manifestly this was not intended. Subdivision (b) (2) (B) relates not to amounts actually paid to retire indebtedness but only to amounts retained by the corporation to retire accrued indebtedness. Subdivision (b) (2) (C), on the other hand, reduces the adjusted net income by amounts which during the taxable year have been actually distributed to the shareholders and thus serve to enlarge their taxable income. Subdivision (b) (3) (A) uses the term “paid or accrued”, which is literally a term borrowed from section 48 (c), and requires the same construction which it would have in that section under similar circumstances. This use of different terms in the several nearby subdivisions of this section indicates legislative care to prevent like construction; and more particularly the use of the composite term “paid or accrued”, which is the very term of section 48 (c), would indicate that it was deliberately omitted from subdivision (b) (2) (C).

It should be borne in mind that in no place in the computation of ordinary net income for the purposes of the corporation income tax has the taxpayer been given a deduction for dividends. No question lias arisen as to whether, from the standpoint of the corporation, a declared dividend may be regarded as paid. It is reasonable, therefore, when the question arises now in the setting of a new and specially conceived subject of tax, that the term “dividends paid” shall be construed to promote the purpose of the statutory scheme of which it is a part.

The petitioner’s proposed construction would apply equally to the same term used in section 102 (c); and, with equal effectiveness, it would operate there to defeat the purpose of the statute. If the penalty tax upon accumulated surplus could be avoided by a simple declaration of a dividend, payment of which was to be deferred until a future year, a facile means would be available for avoiding the imposition of tax upon the shareholders and at the same time relieving the corporation of any charge of failure to distribute.

The respondent’s determination is sustained.

Decision will be entered for the respondent.

       (4) Tlie terms used in this section shall have the same meaning as when used in Title I.


author: Van Fossan :

text:
    Estate of Louis M. Faber, Helen J. Faber, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92981.
    Promulgated December 7, 1939.

      W. D. Hopkins, Esq., for the petitioner.

      W. W. Kerr, Esq., for the respondent.
   OPINION.

Van Fossan :

The issue for our determination is whether or not the sum of $2,500 paid by the estate to the widow pursuant to the provisions of section 10509-54 of the General Code of Ohio is includible in the gross estate.

The applicable provisions of the Federal law are sections 302 (a) and 303 (a) (1) of the Revenue Act of 1926, as amended by subsequent acts.

In a recent case, Estate of Nellie Grant Burbank Dodge, 40 B. T. A. 209, we had for decision the question of the right of the estate to deduct as a claim against the estate an amount paid to decedent’s surviving husband in satisfaction of his statutory right to a “marital portion” of the estate under the laws of Louisiana. The right to deduct the amount claimed was denied. In that case we observed:

It follows, of course, that if the marital portion here was taken from the succession or the heirs it must first have passed from the decedent and must have been a part of her estate at the time of her death. It is not material to our question whether it passed by inheritance or by operation of the state statutes. The Federal estate tax is levied upon the property passing at or by reason of death. It is a tax not on the interest in property to which another succeeds, but on the interest of the decedent which ceases by reason of death. Knowlton v. Moore, 178 U. S. 41; Edwards v. Slocum, 264 U. S. 61; Tyler v. United States, 281 U. S. 497. In Grooks v. Loose, 36 Fed. (2d) 531, it was said:
* * * the Federal Estate Tax Law is not concerned primarily with the character of the interest or estate acquired by the beneficiary, or its subsequent status; but the law is primarily concerned with the ceasing of the interest of the decedent in the property, with the “shifting of economic benefits” of property from the decedent. If there is such a ceasing of the interest of the decedent, such a “shifting of economic benefits”, the federal estate tax comes into play.
In Empire Trust Co. et al., Executors, 35 B. T. A. 866; affd., 94 Fed. (2d) 307, we said:
* * * We think it is clear that the purpose of the Revenue Act of 1926 was to include in the gross estate of the decedent the value of all property at the time of death which passed from the dead to the living to the extent of any interest which the decedent had therein. * * *

In tlie Dodge case the petitioner contended that the surviving husband’s “marital portion” was a claim against, or an indebtedness of, the estate which is deductible under section 803. Holding this contention to be unsound, the Board went on to say:

In his regulations the Commissioner construes the statutory provisions for the deduction of claims against the estate as pertaining only to claims representing “personal obligations of the decedent existing at the time of his death.” . The right of the decedent’s surviving husband to his marital portion was in no sense a personal obligation of tbe decedent and did not come into existence until ber death, and the fulfillment of the conditions enumerated in article 2382 above of the Louisiana Civil Code.
Petitioner points out in its brief that under the Louisiana law the marital portion is not an inheritable interest in the separate estate left by the deceased spouse and is therefore not taxable under the inheritance tax statutes of that state, citing Succession of Justus, supra; Succession of Marsal, 118 La. 212; 42 So. 778; In re Stelly’s instate, 185 So. 637. Granting that this is true, however, the rules governing the administration of the Louisiana inheritance tax law have no controlling effect on questions involving the Federal estate tax law.

It was ruled that the right so to take was “by virtue of a statute creating an estate in lieu of dower or curtesy” within the meaning of section 302 (b) and is taxable to the same extent as a testamentary bequest. It was also held that it represented no debt of the decedent in her lifetime and only such debts are claims against the estate cognizable under section 303 (a) (1) (C).

We believe the principles underlying the Dodge case to be applicable and controlling here. Section 302 provides that all property of the decedent except real property situated outside the United States shall be included in the gross estate. It can not be argued successfully that the item of cash in question was not property of decedent at the time of his death. It was, by Ohio law, included in the inventory of the estate. The fact that it was, by local statute, not deemed an asset of the estate nor administered as such in Ohio does not alter its precedent character. Nor is it controlling or persuasive here that the item is deducted from the estate in computing the Ohio inheritance tax. We are construing and applying the Federal estate tax law. The legal concepts and principles underlying the two laws are very different.

The estate tax law, like other Federal tax laws, establishes its own criteria. By specific provision and interpretation it pronounces its own definitions and specifications of property to be included or excluded from the taxable estate. The relatively few instances where the state law controls are indicated in Lyeth v. Hoey, 305 U. S. 188. The present situation is not such. We conclude that the item must be included in the taxable estate.

We must likewise reject petitioner’s contention that, even if the item be includible in the gross estate, a deduction should thereupon be allowed as a claim against the estate. Estate of Nellie Grant Burbank Dodge, supra.

Decision will be entered for the respondent.

       When a person dies leaving a surviving spouse, or minor child or children, the following property if selected as hereinafter provided, shall not be deemed assets or administered as such, but must be included and stated in the inventory of the estate; household goods, live stock, tools, implements, utensils, wearing apparel of the deceased and relics and heirlooms of the family and of the deceased, ornaments, pictures and books, to be selected by such surviving spouse, or if there be no surviving spouse, then by the guardian or next friend of such minor child or children, not exceeding in value twenty per centum of the appraised value of the property, real and personal, comprised in the inventory, but in no event is the value of the property not deemed assets to be more than twenty-five hundred dollars, if there be a surviving spouse, nor more than one thousand dollars if there be no surviving spouse, but surviving minor child or children, nor less than five hundred dollars in either case if there be so much comprised in the inventory and selected as herein provided ; or, if the personal property so selected be of less value than the total amount which may be selected as herein provided, then such surviving spouse, guardian or next friend shall receive such sum of money as shall equal the difference between the value of the personal property so selected and such amount, and such sum of money shall be a charge on all property, real and personal, belonging to the estate, prior to the claims of all unsecured creditors of the deceased or of the estate.

       Sec. 302. [As amended by section 404 of the Revenue Act of 1934]. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real of personal, tangible or intangible, wherever situated, except real property situated outside the United States—
      (a) To the extent of the interest therein of the decedent at the time of his death.

        Sec. 303. [As amended by section 805 of the Revenue Act of 1932 and section 403 (a) of the Revenue Act of 1934.] For the purpose of the tax the value of the net estate shall be determined—
      (a) In the case of a citizen or resident of the United States, by deducting from the value of the gross estate — •
      (1) Such amounts—
      (A) for funeral expenses,
      (B) for administration expenses,
      (C) for claims against the estate,
      (D) for unpaid mortgages upon, or any indebtedness in respect to, property where the value of decedent’s interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate, and
      (E) reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent * * *.


author: Murdock:

text:
    Estate of Mildred Sheppard Legg, Safe Deposit and Trust Company of Baltimore, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89942.
    Promulgated December 7, 1939.

      Edgar Allen Poe, Esq., for tlie petitioner.

      Arthur Camdujf, Esq., for the respondent.
   OPINION.

Murdock:

The petitioner makes two arguments in support of its contention that the value of the remainder interests should not be included in the gross estate of the decedent as property passing under a general power of appointment. Sec. 302 (f), Eevenue Act of 1926. The first argument is that the attempted exercise of the power was partially void since it was in violation of the rule against perpetuities and, as a consequence, only the life estates actually passed under the attempted exercise of the power. The second argument is that the power granted to the decedent was a special and not a general power of appointment. The parties recognize that both of these questions must be decided under the laws of Pennsylvania. A. Maxwell Sheppard and William Sheppard resided in that state and all of the property in question was located there. The petitioner, in support of the first argument, points to the provision of the will of the decedent whereby the residue of her estate, including the funds in question, was to be held in trust during the life of her children and for twenty-one years thereafter. The argument is that she might have had children who were not living at the date of the death of her father and, therefore, the future estates which she created might not vest within a life or lives in being at the time of the death of her father and twenty-one years thereafter, not counting periods of gestation. She had only one child at the date of her death and that child was alive when A. Maxwell Sheppard died.

The rule against perpetuities in Pennsylvania has been stated as follows: “the limit * * * for the creation of executory interests to commence is ‘within the period of a life or lives in being and twenty-one years, allowing for the period of gestation.’ ” In re Warren's Estate, 320 Pa. 112; 182 Atl. 396. See also, McArthur v. Scott, 113 U. S. 340. The period during which the vesting of the future estate is postponed is measured from the date of the death of the donor who created the power by will and not from the time of the exercise of the power at the death of the donee. The Supreme Court of Pennsylvania held in 1936 that, in testing a given case under the rule, the actual facts, as they have happened, govern, rather than mere possibilities under the words of the will of the donee. In re Warren’s Estate, sufra. Thus, in the present case there would be no violation of tbe rule against perpetuities, since the decedent postponed the vesting of the future estate only during the life of her daughter and twenty-one years thereafter, and the daughter was a life in being at the time of the death of A. Maxwell Sheppard, the donor of the power.

The petitioner points out that the Warren case was decided in 1936, whereas the decedent died in 1934, and contends that her exercise of the power would have been held to violate the rule against perpetuities under the law of Pennsylvania in 1934, citing Smith's Appeal, 88 Pa. 492, and Cox v. Dickson, 256 Pa. 510; 100 Atl. 947. This argument is sufficiently answered by the following quotation from the Warren decision:

The learned justice [who wrote the opinion in the Smith ease] then makes the test of remoteness as of the date of the death of the donor. He treats the appointment as if made by the donor himself and subjects it to the test * * * of “possible and not by actual events.” This of course is not the generally accepted rule. All authorities are now in accord that the true test is to ascertain what in fact the donee of the power actually did, and if that does not transgress the rule the appointment is valid.
Judge Penrose of this court regarded Smith’s Estate as overruled when he wrote the opinion, affirmed per curiam in Boyd’s Estate, 199 Pa. 487, 49 A. 297. Certainly the affirmation by the Supreme Court of Judge Penrose’s opinion in that case had the effect of overruling Smith’s Estate, which unquestionably was an erroneous statement of the law, subsequently criticized not only by its author and by such an eminent textwriter as Gray, and not followed by either Judge Penrose or by the Supreme Court. In our opinion the decision in Boyd’s Estate, taken in consideration with the facts, squarely settled any doubt as to the state of the law now prevailing.

The court then pointed out that the Cox case was one in which the exercise in fact violated the rule because the donee appointed a person who was not living at the time the donor died. The Boyd case was decided in 1901. Thus the petitioner is in error when it argues that the law of Pennsylvania in 1934 on this subject was different from what it was in 1936. The exercise of the power was not in violation of the rule against perpetuities under the law of Pennsylvania.

A power is general only in case it is exercisable in favor of any person whom the donee may select, including his creditors or his estate. In re Miller’s Trust, 313 Pa. 18; 169 Atl. 362; Fidelity-Philadelphia Trust Co. v. McCaughn, 34 Fed. (2d) 600. The petitioner concedes that the language in the will of A. Maxwell Sheppard conferring the power of appointment upon his daughter, the decedent, is sufficient to create a general power of appointment under the law of Pennsylvania if it stood alone. The petitioner points, however, to that provision of the will in which Sheppard directed that the payments to be made to his wife and daughters were not to be anticipated, assigned, or encumbered in any way for debts which they might contract. It then argues that the donee could not have appointed to her creditors or to her estate, since no part of the property could be applied to the payment of her debts, and, therefore, the power was a special rather than a general power.

The intention of the donor is controlling and that intention must be ascertained from his will considered as a whole and not from any part thereof standing alone. That will indicates an intention that the life tenants, the wife and daughters, were to have the entire income of the trust estate during their lives, free from any debt or power of anticipation or assignment, so that each daughter at the end of the life estate would have a power of appointment over one-third of the estate free and clear of encumbrances of all kinds. But the will gives no indication of an intention by Sheppard to protect the remainder interests further or to limit the powers of appointment given to his daughters, so that they could not, if they chose to do so by an effective exercise of their powers, provide for the payment of their debts after their death. Cf. In re Miller’s Trust, supra; In re Hall's Estate, 248 Pa. 218; 98 Atl. 944. Creditors of a donee of a power of appointment exercisable by will alone can not at any time under the laws of Pennsylvania reach property subject to the power. Thus, the remainder interests were going to be free and clear of encumbrances arising out of debts of the life tenants at the time the powers were to be exercised, and Sheppard did not have to devise any restriction to accomplish that result. The petitioner’s argument that Sheppard intended to have his grandchildren benefit from unencumbered trust estates is unimpressive in view of the fact that the daughters could have appointed in favor of others and could have left their children out entirely. It is our conclusion from a consideration of the entire will that the spendthrift provisions were intended to apply only to the payment of the income to the life tenants and were not intended to apply to the remainder interests over which the daughters were given powers of appointment. The very words of the restriction indicate the correctness of this conclusion. The testator said that “the payments to be made to my wife and children” shall not be subject to any charge for their debts. The payments to which he was referring were the payments of the income to them for life. The powers of appointment which he gave to the daughters are certainly not fittingly described as payments. It follows that the power of appointment of this decedent was a general power.

The other issue in the case is whether interest accrued on certain property of the estates at the date of the death of the decedent should be included as a part of the value of the estates in computing the value of the remainder interests subject to the power of appointment. The items in question consisted of bond interest which was not due at the time the decedent died. The Commissioner has attempted to determine the value of the entire Sheppard estate as of the date of death of the decedent, and from this total has eliminated the value of the life estates of the two widows to arrive at the value of the remainder interest passing under the power. The Commissioner argues that his determination must stand, since the petitioner has not proven that the accrued interest was actually paid thereafter to the widows. Such proof was unimportant in view of the rule in Pennsylvania that interest accrues and vests from day to day so that the life tenant is entitled to all interest accrued during her life. In re Davidson’s Estate, 287 Pa. 354; 135 Atl. 130. Thus, the accrued interest in question belonged to the widows and was no part of the Sheppard estates at the date of the death of the decedent. It could not serve in any way to give value to the remainder interest passing under the power of appointment and the Commissioner erred in using it in his computation.

Decision will Toe entered under Ride 50.

       Counsel for the petitioner states that the opinion in the Warren ease was the opinion of a judge of the Orphans’ Court and was not an opinion of the Supreme Court of Pennsylvania. The opinion quoted in the report is indeed the opinion of Judge Stearne of the Orphans’ Court of Philadelphia County, Pennsylvania. But the Supreme Court of Pennsylvania considered the ease on appeal, affirmed it per curiam, and stated: “This case was correctly determined by the orphans’ court sitting in bane, as will appear by that part of the opinion of Judge Stearne set forth in the reporter’s notes.” It thus seems clear that the Supreme Court adopted verbatim the opinion of Judge Stearne set forth in the reporter’s notes from which the quotations appearing herein are taken.


text:
    Helen G. Bonfils, Thomas L. Bonfils, Charles A. Bonfils, F. W. Bonfils, J. B. Grant, and the Denver National Bank, Executors of the Estate of F. G. Bonfils, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91501.
    Promulgated December 8, 1939.

      J ames B. Grant, Esq., and Stephen EL. Hart, Esq., for the petitioners.

      R. P. Hertzog, Esq., and L. O. Mitchell, Esq., for the respondent.
   OPINION.

Van Fossan :

The sole question at issue is whether or not capital gains, which, by the terms of the decedent’s will, automatically became part of the corpus of a trust, which corpus ultimately was to be paid to a charitable corporation but might be invaded if necessary for the purpose of paying testamentary annuities, are subject to income tax.

The respondent’s position is that, so long as invasion of corpus is theoretically possible, the capital gains from sales of corpus securities are not permanently set aside for, or to be used exclusively for, charitable purposes, as provided in section 162 (a) of the Revenue Act of 1934.

The petitioners contend that even though there is a theoretical possibility of invasion, yet there is no reasonable probability thereof and accordingly the capital gains are “permanently set aside” and hence not taxable to the petitioners, as executors of the decedent’s estate.

The respondent cites a number of cases to support his position, none of which is precisely parallel in fact and law. In our opinion the basic principle underlying the decision in Ithaca Trust Co. v. United, States, 219 U. S. 151, suggests the proper approach to the interpretation of the phrase “permanently set aside.” Hartford-Connecticut Trust Co. v. Eaton, 36 Fed. (2d) 710. In the Ithaca Trust Co. case, Mr. Justice Holmes said:

TRe case presents two questions, the first of wliicb is whether the provision for the maintenance of the wife made the gifts to charity so uncertain that the deduction of the amount of those gifts from the gross estate under See. 403 (a) (3), supra, in order to ascertain the estate tax, cannot be allowed. Humes v. United States, 276 U. S. 487, 494, 72 L. Ed. 667, 670, 48 Sup. Ct. Rep. 347. This we are of opinion must be answered in the negative. The principal that could be used was only so much as might be necessary to continue the comfort then enjoyed. The standard was fixed in fact and capable of being stated in definite terms of money. It was not left to the widow’s discretion. The income of the estate at the death of the testator and even after debts and specific legacies had been paid was more than sufficient to maintain the widow as required. There was no uncertainty appreciably greater than the general uncertainty that attends human affairs.

See also United States v. Provident Trust Co., 291 U. S. 272; City Bank Fanners Trust Co. v. United States, 74 Fed. (2d) 692.

Though a deduction is a matter of legislative grace and the proof must bring it clearly within the statutory provisions, it is a matter not only of judicial inclination but also of legislative policy to encourage gifts and transfers to charitable institutions. Old Colony Trust Co. v. Commissioner, 301 U. S. 379, and many other decisions of the courts and the Board.

Thus, whether or not the income of the estate was “permanently set aside” calls for the application of the test of reason, not the blind adherence to a dictionary definition of words. The question of the reasonable probability that any part of the capital gains would be required to pay annuities is a factual one. In many cases we have held that deductions for charitable purposes are allowable when the income from the corpus is sufficient to provide for precedent bequests or annuities. Benjamin B. Sanderson, Executor, 18 B. T. A. 221; Marion M. Jackson, Executor, 18 B. T. A. 875; Boston Safe Deposit & Trust Co. et al., Executors, 21 B. T. A. 394; Michigan Trust Co. et al., Executors, 27 B. T. A. 556. The cases upholding this view relate to estate taxes and involve other statutes, but we believe there is a parallelism in principle when income tax is involved. Hartford- Connecticut Trust Co. v. Eaton, supra. Moreover, income taxes are annual payments based on successive foundations of fact which may vary with the years. Opportunity is thus afforded for adjustment for errors of judgment. The question here relates solely to capital gains which automatically became part of corpus. They were not subject to the ordinary uses as income.

Turning to the facts of record, we find that the present fair market value of the corpus is approximately $8,000,000. Over $3,600,000 of that amount is in Government and municipal bonds and about $164,-000 in cash. In 1934 the petitioners received over $165,000 in ordinary income and about $320,000 in capital gains. In 1935 the corresponding receipts were about $162,000 and over $15,000, respectively. Deductions of slightly over $400 in 1934 and over $15,000 in 1935 were allowed. The trustees’ average net income from 1934 to 1938, inclusive, was well over $500,000.

In 1934 the annuities paid amounted to $62,035.48 and in 1935 to $90,150. In 1936 they were $110,600, while in 1931 and 1938 they were $110,200. It is obvious from the terms of the will that the annuity charge which the trustees must pay will constantly decrease, and in view of the advanced age of many of the annuitants and the minimum age of 48 years, such a diminution will be relatively rapid.

The income received in 1938 from Government, municipal, and, to a small extent, from corporate bonds, was within $1,655.63 of meeting the annuity charge. The small deficiency was met out of dividends on stocks, which amounted to $412,131.44.

Faced with these facts and figures, we can conclude only that the probability that the capital gains realized in 1934 and 1935 would ever be required to pay any part of the annuities was so remote that it should be held that such gains were permanently set aside in the taxable years for charitable purposes as contemplated by section 162 (a) of the Kevenue Act of 1934. Lederer v. Stockton, 260 U. S. 3. Hence, they are allowable deductions from the petitioners’ gross income.

Boston Safe Deposit & Trust Co. v. Commissioner, 66 Fed. (2d) 179, affirming 26 B. T. A. 486, relied on by respondent, is not authority contrary to the above conclusion when the facts in that case are considered. That the factual situation here is more favorable to petitioners is conceded by respondent on brief. In the cited case the margin separating the actual payments from possible invasion of corpus was so narrow as to make it impossible to say that possibility of invasion was remote. Moreover, the margin was growing less. In that case it might fairly have been said that the possibility of invasion appeared to be dangerously imminent.

Decision will be entered wider Bule 50.

       SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
      (a) There shall be allowed as a deduction (in lieu of the deduction for charitable, etc., contributions authorized by section 23 (o)) any part of the gross income, without limitation, which pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in section 23 (o) or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit.