text:
    Willard Foster, Sara Foster Wilson and Grace Foster Thomas, Executors of the Estate of N. C. Foster, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 32984.
    Promulgated January 29, 1932.

      John M. Campbell, Esq., and P. M. Beach, Esq., for the petitioners.

      A. E. Fast, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent has asserted a deficiency in estate tax in the amount of $13,663.92. The only issue is whether certain transfers to three separate trusts about three years prior to the death of N. C. Foster were made in contemplation of death.

N. C. Foster was a resident of Fairchild, Wisconsin. For about 60 years he was actively engaged in the lumber business, in railway construction and other money making enterprises in which he amassed a substantial fortune. He died March 16, 1923, and was survived by seven children. Many years before his death he organized the N. C. Foster Lumber Company, of which he was at all times the president and active manager. Upon the organization of that company he gave each of his seven children 120 shares of the capital stock thereof. For many years all the children received equal incomes from such stock. About 1918 this company paid its last dividend on its final liquidation.

In the year 1920 the petitioners’ decedent executed three trust agreements in which property of the value of approximately $300,000 was transferred to trustees. The trust instruments provided for the distribution of all trust income in equal amounts to the beneficiaries, the seven children of the trustor. In 1920 three of such children were widows dependent upon their father for support and a fourth daughter at that time was in a tuberculosis hospital. One son had suffered severe business reverses and was not self-supporting. The other two sons were self-supporting. The decedent always treated all his children exactly alike and throughout his life never made a gift to one without giving an equal amount to each of the others.

In 1920 the decedent was in his 86th year. He had always been a strong robust man and at that advanced age had no troubles, was in sound health, age considered, and was still actively engaged in business. Sometimes he would eat too heartily of pancakes and sausage and bring on attacks of indigestion, but this condition was temporary and not due to any organic disease of the digestive organs. Between 1920 and the date of his death he attended meetings of directors and stockholders of his corporations.

The executors of the estate of this decedent included no part of the corpus of either of the three trusts in the gross estate in the return which they made for Federal estate-tax purposes. Upon audit of such return the respondent held that the transfers in question had been made in contemplation of death and added the trus-teed property in the value of $295,076.50 to gross estate, made other minor adjustments and determined the deficiency here in controversy.

The lawyer who represented the decedent in much of his business for about 40 years and the physician who attended him for about 15 years have testified to the facts set out above. In the light of the evidence we are of the opinion that the .trusts in question were not established in contemplation of death. In each instance the decedent irrevocably parted with title and relinquished all control over the trusteed assets. Upon the record we are convinced that this was not done in contemplation of death, but was for the purpose of providing income in equal amounts for each of his children, several of whom were not then self-supporting. Accordingly, the determination of the respondent is reversed. United States v. Wells, 283 U. S. 102; 51 Sup. Ct. 446; Estate of John Wanamaker, 16 B. T. A. 15; Estate of Phillip Heipershausen, 18 B. T. A. 218; Rea v. Heiner, 6 Fed. (2d) 389; Meyer v. United States, 60 Ct. Cls. 474; Flannery v. Willcuts, 25 Fed. (2d) 951.

Decision will he entered for the petitioners.


source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    George P. Sacks, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39851.
    Promulgated January 29, 1932.

      J. B. Grice, Esq., for the petitioner.

      Hartford Allen, Esq., for the respondent.
   opinion.

Van Fossan:

The respondent determined a deficiency of $6,078.38 in income taxes for the year 1925. This action was based on the disallowance of an alleged net loss of $43,307.21 shown in petitioner’s 1924 return. The figure of $43,307.21 was based principally on two items, one of $15,261.59, an alleged loss incurred in the sale of stocks, and the second of $44,101.76, an alleged loss in connection with Golden and Company. Respondent disallowed both items as not falling within the provisions of section 206 of the Revenue Act of 1926, holding that the first was not incurred in a trade or business regularly carried on, and that the second arose from an investment.

Petitioner has been engaged in business in Washington, D. C., since 1892, much of that time in some phase of the manufacture and marketing of dairy products. Prior to 1904 the business was conducted as a partnership under the name of Chapin & Sacks. In 1904 the business of Chapin & Sacks was sold to Golden and Company, a concern engaged in the dairy and meat business. Thereupon petitioner became an officer of Golden and Company, being in charge of finances. As consideration for his interest in the partnership petitioner received $25,450 in stock of Golden and Company. Petitioner remained in an official position with Golden and Company until 1910, when he assumed the presidency of Columbia Cotton Oil Company, with which he was connected for two years. In 1912 he became the financial executive of Chapin and Sacks Manufacturing Company and about this time or later assumed similar positions in various other companies located in other cities but engaged in the same line of business — the production of ice cream and dairy products. Chapin and Sacks Manufacturing Company was succeeded by Chapin-Sacks Corporation in 1920 and petitioner became vice president and chairman of the board of the company in charge of its finances. Petitioner disposed of his entire holding in Chapin-Sacks Corporation November 13, 1923, and resigned his official positions effective December 31, 1923.

During all the years from 1904 to 1923, while engaged as above indicated, petitioner was also engaged in buying and selling stocks for his own account, in the earlier years his transactions running from forty to sixty per year and involving several hundred thousand dollars. During the later years of this period his trading in stocks increased. During 1923 he devoted approximately two hours each day to this activity.

Beginning in 1924, after retiring from other activities, petitioner devoted the major part of his time to the market, making studies and anatyses of stocks and market conditions. The volume of transactions increased and has continued substantially up to the year of the hearing. Petitioner estimated that the total value of all transactions from 1923 to the present, listed at the value of the stocks bought or sold, would approximate $40,000,000.

The loss on stock incurred during 1924 arose from some thirty-seven transactions of sale. During the year petitioner also bought stocks on numerous occasions, both on margin and outright.

After petitioner retired from official position with Golden and Company in 1910 he continued to own stock therein and acted as a director thereof. In April, 1923, the president of the company committed suicide and thereafter, sometime during 1923, a petition in bankruptcy was filed. The company was wound up in 1924, the creditors receiving approximately 35 per cent of claims and the stockholders receiving nothing. On November 26, 1923, a bill of complaint was filed by the trustee in bankruptcy against petitioner and other officers and directors of Golden and Company, alleging neglect and mismanagement in the conduct of the affairs of Golden and Company and praying an accounting and other relief. The litigation was terminated in 1924 by a compromise payment of $37,500. Of this sum petitioner paid $12,500, which is one item of the sum of $44,101.76 claimed by petitioner as a loss in 1924. The other items were $25,490, the cost or value of the petitioner’s investment in stock of Golden and Company; $3,901.76 paid to Continental Trust Company on account of a note of Golden and Company on which petitioner was an endorser; and $2,250 attorney fees paid in connection with the Golden and Company matter, the latter two items paid in 1924.

The first item involved is the loss arising from sales of stock on the market. Petitioner contends, and respondent denies, that petitioner was during the year 1924 regularly engaged in the business of buying and selling stocks. On the evidence we are satisfied that petitioner should prevail. For a number of years petitioner had regularly traded in stocks, had devoted some part of each day thereto, and had made it a regular part of his business activity. In 1924 petitioner increased his activity in this field until it was his principal activity. The loss of $15,261.59 was incurred in a trade or business regularly carried on. Harry F. Harper, 20 B. T. A. 143; William A. Hodgson, 24 B. T. A. 256.

The second item arose from petitioner’s connection as a stockholder, officer and director in Golden and Company, which company went into bankruptcy in 1923, with no recovery to stockholders. The action of respondent in disallowing .this item was correct and is approved. Fridolin Pabst, 6 B. T. A. 843; affd., Court of Appeals, D. C., 36 Fed. (2d) 614; Harry J. Gutman, 7 B. T. A. 500.

Petitioner’s stock interest was an investment in the corporation. This was lost in 1923 or earlier. Moreover, this item, as well as the expenditure on account of the indorsement of the note of Golden and Company, the payment to compromise and settle the suit for mismanagement, and the payment to attorneys in connection with the law suit, were all related to the defunct Golden and Company and did not constitute losses incurred in a trade or business regularly carried on. There is no basis for petitioner’s claim for allowance of this item of $44,101.76.

Decision will be entered wider Rule 50.


author: SteRnhageN:

text:
    Hugh H. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 36075.
    Promulgated January 29, 1932.

      M. Manning Marcus, Esq., for the petitioner.

      James K. Polk, Esq., for the respondent.
   OPINION.

SteRnhageN:

In 1923 the petitioner was the record owner of 90 per cent and George B. Samuel owned 10 per cent of the shares of Holland Laundry. Petitioner was president and a director. By virtue of some contract or arrangement with two others who had formerly been interested in the business and who were in some way perhaps still interested, the petitioner was in some way accountable to these persons. From 1914 through 1922, petitioner had borrowed from the corporation sums which in 1923 aggregated $71,748.94. The corporation was in some sort of difficulty and, at the suggestion of one who was willing to invest in some of its shares, this account was written off the books. For it the petitioner turned in 250 of its preferred shares, having a par value of $12,500, which was accepted at that value, and $601.61 cash. The remaining $58,647.33 was canceled and written off in accordance with the following resolution of the directors adopted at a meeting of July 25, 1923, at which both shareholders were present:

Whereas Hugh H. Miller is indebted to the company to a large amount and Mr. Miller has turned over to the company in liquidation thereof all of his realizable assets, except common stock of this company and such indebtedness is deemed uncollectible, now therefore be it
Kesolved, that $58,647.33 of the account of Hugh H. Miller be charged off as an uncollectible debt, by crediting such account and debiting surplus as of June 30, 1923.

The petitioner omitted from the income shown on his tax return for 1923 any part of this $58,647.33. The respondent, citing Reg. 69, art. 52, held the amount to be a dividend and, by subjecting it to surtax only, he determined a deficiency of $6,876.39. Petitioner contends it was a gift, afitd was therefore excluded from gross income by virtue of section 213(b) (3), Revenue Act of 1921.

Both parties discuss the question whether the amount was collectible from petitioner. That question is beside the point, for in either event, the question remains whether the cancellation was a gift or income. But the petitioner was not shown to be insolvent and continued to receive a substantial salary of from $10,000 to $18,000 per year. He also retained his common shares, which appear to have continued to be worth at least par, and it could not, therefore, be found as a fact, as it was stated in the resolution, that the debt was uncollectible, or that it did not substantially improve petitioner’s financial position. Cf. United States v. Kirby Lumber Co., 284 U. S. 1. Whether the cancellation is income is determined not by what the charge-off was called (although no language by the corporation itself expressly denoted a gift), but by the evidence of the circumstances which disclose its character. We think the evidence shows a distribution of surplus by a corporation to its principal shareholder, and this is a dividend as defined in the statute, section 201. See Ida L. Dowling, 13 B. T. A. 787; Henry D. Muller, 16 B. T. A. 1015. That there was surplus to support such a dividend appears from the balance sheets attached to the corporation’s returns in evidence. At the end of 1922 its assets were $343,220.12 and its liabilities, $203,-514.05; preferred shares were $31,750 and common shares were $50,000, thus leaving surplus of $57,956.07. During 1923 the corporation had net taxable income of $6,618.95, and at the end of 1928, after charging off the petitioner’s balance, it had surplus of $4,415.88. The lack of a guid fro quo does not amount to want of consideration. The relation of corporation and shareholder, the existence of substantial surplus, and the acquiescence of all shares is enough, to support the dividend.

There is no support in the evidence for petitioner’s point that the debt was not in fact canceled. Nor is there sufficient evidence to support the suggestion of an accountant that the amount was compensation for past services, so as to justify an increase in the deficiency.

Judgment will be entered for the resfondent.


author: SteRnhagen: YaN Fossan,

text:
    L. Schepp Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42908.
    Promulgated January 29, 1932.

      J. S. 7. Ivins, Esq., Harry LeRoy Jones, Esq., and Lemuel Skid-more, Esq., for the petitioner.

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

SteRnhagen:

Of numerous assignments of error in the respondent’s determination of deficiency, there remain five principal issues to be decided by the Board, and these will be taken up in order.

1. Salary. — The petitioner paid Florence Schepp $20,000 in 1918 by crediting the amount to her personal account on its books, from which her personal bills were paid and debited. The petitioner deducted this amount among its business expenses, the Commissioner disallowed the deduction entirely, and the petitioner now assails this disallowance.

The Revenue Act of 1918, section 234 (a) (1), permits the deduction of

All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * *.

Florence Schepp was the daughter of the founder of the business and in 1918 she and her father owned all of its shares, the father being the president — “ the brains ” and directing head of the company, and personally engaged in all phases of its business — and the daughter being the vice president. She was also a director. The specific services she performed for the company were slight, consisting of suggestions as to an improved canvas cover for the storage bins, assisting in the preparation of the negligible amount of advertising (the total cost of which was about $500), suggesting improved toilet and other sanitary facilities at the factory, consulting with her father about improved retail containers, acting as her father’s amanuensis on a trip to Toronto, and discussing matters of a general nature with her father and with the secretary of the company. She had no desk at the corporation’s office, failed to attend the one directors’ meeting of the year, and sometimes made no appearance at the office for a week or more. The amount which was allotted to her varied between $3,000 and $25,000. The president’s salary varied between $25,000 and $100,000, being $50,000 in 1918. The secretary received $6,000, and the treasurer $2,100. The latter were regularly employed and occupied in the petitioner’s business.

The evidence before us supports the conclusion that the personal services actually rendered by Florence Schepp were not worthless, as determined by respondent. A reasonable allowance therefor, however, would not, in our opinion, exceed $4,000, and this has been found as a fact.

The petitioner argues that the judgment of the directors is presumptively reasonable and that the evidence supports the presumption ; that the test of the statute must be applied to the single aggregate amount of all officers’ salaries; and that tbe aggregate sum of all salaries paid to its officers is reasonable in the light of petitioner’s history and in proportion to corporate earnings. But, in our opinion, the argument must fail.

While the judgment of the corporate directors is not to be disregarded, there is no rule that it is conclusive or that it comports with the statutory qualifications of the tax deduction. Directors have a fairly free hand in fixing corporate salaries, and if the Government were seeking to prevent or set aside their payment, a heavy burden would be upon it. But, however honest may be the directors’ judgment and however great their power to effectuate it, these do not determine the deductibility of such amounts under the tax law. For the purpose of determining taxable net income, the deduction is limited to amounts which are reasonably commensurate with the personal services actually rendered and thus are no more than ordinary and necessary expenses of carrying on the business. Hence the directors’ duty to the corporation is no criterion of the Commissioner’s duty to limit the tax deduction within the statutory bounds, and the two are not in conflict. When the Commissioner has made a determination, the taxpayer who attacks it must prove by evidence of the services rendered and their value that a correct determination would exceed that of the Commissioner. Where the payments are to kinsfolk or to shareholders, the proof must also show that they were not influenced by family considerations and were not disguised distributions of profits. See Botany Worsted Mills v. United States, 278 U. S. 282; Becker Bros. v. United States, 7 Fed. (2d) 3; United States v. Philadelphia Knitting Mills, 273 Fed. 657; Benz Bros. Co., 20 B. T. A. 1214; C. S. Ferry & Son, Inc., 18 B. T. A. 1261; Home Industry Iron Works, 8 B. T. A. 1267; Meyer Hecht, 2 B. T. A. 319; Gustafson Mfg. Co., 1 B. T. A. 508.

The suggestion has not heretofore been considered in the decided cases that the deduction must be tested as an aggregate amount and that no single salary may be held nondeductible unless the sum of all salaries is too large. We think the statute requires no such construction. Each of the deductions of section 234 is described as a class, and several are described by the term “ a reasonable allowance.” To test the salary deduction by ascertaining the ratio of the aggregate salaries to net earnings or gross sales would result in the recognition of a mathematical gross maximum and either the disregard within that figure of any relation between individual service and the compensation therefor, however plainly disproportionate, or else the consideration of the sum of all services and the relation of the whole to the gross salaries paid. This would practically nullify the clear statutory language and be at variance with the judicial tests laid down in the decisions above set forth. While it might superficially appear that the total paid to all four of petitioner’s officers is small in comparison to its gross sales and net earnings, it does not appear that the amount credited to Florence Schepp is reasonable in comparison to her service. There is no evidence whatever of services and salaries actually performed and paid by and to other individuals in the same or comparable businesses, and no evidence of how much the company would have to pay to get someone else to do what Florence Schepp did. Becker Bros. v. United States, 7 Fed. (2d) 3; Becker Bros., 9 B. T. A. 1260, affd., 37 Fed. (2d) 1010. But the evidence shows that there were services performed and as best we can we are required to fix the statutory deduction indicated by the evidence.

2. Royalty. — The petitioner claims the right to a deduction for 1918 of $34,745 as royalty “ paid or credited ” to Florence Schepp. It argues that Leopold and Florence Schepp had a valuable property right in the idea and design of the cake and bread boxes, and that a royalty computed at 40 a pound on all package cocoanut sold in such boxes in 1918 was deductible as an ordinary and necessary expense.

There are, in our opinion, several different reasons why the petitioner’s claim can not succeed. Neither Leopold Schepp nor his daughter had such a property as would support a claim for royalty from this petitioner. Cf. Thornburgh Mfg. Co., 17 B. T. A. 29, 34. There was neither a patent nor a copyright, nor yet a trademark, and, so far as this record shows, the subject matter of the alleged royalty was not susceptible of patent, copyright or trademark. There is nothing which can be called an invention. The subject is not the physical box, and it is not the design, style or decoration of the box. It is solely the idea of selling cocoanut to the retail trade in these containers in order to attract consumers — a mere method of distribution. No authority is cited which supports the view that such an idea is patentable or in any way property which the petitioner might not freely use or for the use of which it would be required to pay a royalty or other consideration.

But, passing that, it appears that the basic idea — namely, that of using cake and bread boxes — was disclosed by Schepp before incorporation and was adopted by the corporation with his full knowledge and consent as part of the business which it acquired in 1901 in exchange for its shares. The subsequent modifications of the box may be regarded as incidental improvements of the predominant idea, and made while Schepp was employed by the corporation. The 1918 model dates back to 1908 or earlier. During all this time Schepp knowingly consented to and promoted the extensive use of the idea and permitted the corporation to incur obligations for the manufacture of such boxes and the distribution of its product in them. He would have been completely estopped either to prevent such use or to demand payment therefor. Cf. Gayler v. Wilder, 51 U. S. 477; Marsh v. Nichols, Shepard & Co., 128 U. S. 605; Baldwin Co. v. R. S. Howard Co., 238 Fed. 154; certiorari denied, 243 U. S. 636.

Since he was in no position to impose upon the corporation any obligation, it can not be said that any amount which he, the principal shareholder, might cause the corporation to pay was a royalty or otherwise an ordinary and necessary expense of the business. There is no occasion to consider whether the amount was reasonable. It seems plain that whatever amount was paid or credited was a mere distribution of profits to the sole shareholders under a misnomer. The resolution of 1917 adds no legal sanction to the royalty claim, — and this is especially so as to the 4 cents claimed for 1918, as the resolution is by its terms confined to 1917, and provides for a 6%-cent payment.

In 1915 the “ royalty account ” was first established, and credits thereto were made without the name in the ledger of any obligee thereof. Had there actually been an obligation to either Leopold or Florence Schepp for royalties there might have been some ground for treating the credits to the royalty account or the royalties payable account as book accruals of liability. But since, as has been seen, there was in substance no such liability, the mere crediting of the amounts in these royalty accounts can have no force to prove the deductibility of the items.

Not until 1921 is there an attempt to reflect on the ledger an obligation to Florence Schepp, and even that attempt is surrounded by ambiguity. At that time the royalty account contained credits accumulated since 1915 of $306,378.66. Against this was now made a debit entry of $283,635.06, a check was drawn to the order of Florence Schepp and deposited apparently to the credit of the corporation and so entered in its cash book. Thereafter the amount was credited to the Florence Schepp loan account. Why this roundabout course was taken is not explained. If the royalty credit had already represented an incurred liability to Florence Schepp, there was no occasion for any further accounting until the liability was discharged. The drawing of the check in 1921 was only a simulation of payment, because simultaneously it was deposited to the corporation’s account. The credit then entered in the Florence Schepp loan account would indicate that she, having been paid her royalty, was now lending the amount to the corporation. All this was clearly fictitious accounting, regardless of the fact that it was carried on until 1926 and 1927. And the fact that Florence Schepp projected the fiction into her personal-tax return, made on the cash basis, by including as gross income actually received in 1918 the $34,745 which, as has been seen, she did not actually receive in that year, does not give substance to the corporation’s deduction. Its only significance is to indicate the care and thoroughness with which the plan for the deduction was attempted to be fulfilled.

We are of opinion, therefore, that there was no basis for a royalty and that no liability for an ordinary and necessary business expense was paid or incurred in the taxable year in question. The respondent correctly determined that the item claimed was not a deduction.

3. Invested Capital. — On its return the petitioner included in its invested capital of January 1, 1918, the amount of $197,189.92 which had been entered in its books in 1917 as a credit to surplus taken from Leopold Schepp’s personal account. The respondent, in determining the deficiency, held that this amount was not within petitioner’s statutory invested capital. Petitioner now claims not only that this amount falls within invested capital, but also that the entire amount of $523,537.22 should be restored to its statutory surplus. It argues that, notwithstanding the resolution and accounting of 1912 and the more substantive facts of that period, the amount did not actually leave the corporation’s surplus; and, furthermore, that if it did go out of surplus, then $197,189.92 of it came back by the reversing entry of 1917.

We are of opinion that the evidence supports the respondent’s determination and establishes that no part of the $523,537.22 is within invested capital of 1918. The question is limited to section 326 (a) (3), Revenue Act of 1918, which includes in invested capital “ paid-in or earned surplus and undivided profits,” there being no contention and no evidence that the amount represents cash or property, tangible or intangible, paid in for stock or shares.

On February 20, 1912, the directors, upon motion of two of their number who were minority shareholders and employees, voted to distribute the accumulated surplus; and on March 1, 1912, with express reference to this vote, the amount of $523,537.22 was credited to L. Schepp and debited to the various reserve accounts which had been set up on petitioner’s books as a method of appropriating surplus. No objection was made to'this at that time or afterwards by any shareholder. A year later Leopold Schepp acquired all the shares of others except those of his daughter.

That the distribution of 1912 was more than an empty bookkeeping entry is clear. It completely wiped out Schepp’s debit balance of $379,940.87, giving him a credit of $143,596.35 (which was less than the figure of $197,189.92). To the extent of $379,-940.87, there was an immediate disposition and appropriation of the surplus. Of the remaining $143,596.35, withdrawals were made by Schepp, so that by June 25, 1912, his balance was reduced to $92,903.44, there having been no intervening credits. At the end of the year 1912 it was still only $186,171.41, or less than the $197,-189.92; a year later it was $95,262.49, and a year later, on December 31, 1914, after having the day before dropped below $60,000, it was still only $146,730.50. Not until December 31, 1915, more than three years after the original distribution, was Schepp’s credit ($202,502.05) sufficiently high to be free from the need of the $197,189.92.

In view of this treatment of the surplus in a way consistent only with its complete appropriation by Schepp, there is no merit to the argument that the resolution and book entry were ineffective. Petitioner urges that after so carefully setting up these various reserves, it is not to be believed that there was an intention to wipe them out by distribution, and this to a single shareholder. But the directors had the right to do so, and the direct evidence that they did so without complaint from shareholders leaves no room for debate as to the wisdom or reasonableness of their action. We see nothing either in the resolution itself or the surrounding circumstances to support the petitioner’s contention that only an ordinary dividend of 2 per cent or 4 per cent was intended by the resolution. Nor is the effectiveness of the distribution lessened by the fact that it all went to Schepp. A distribution may be valid although not apportioned to shareholdings, and when the shareholders make no objection the corporation itself has no ground for attack. Joseph Goodnow & Co., 5 B. T. A. 1154; Henry F. Michell Co., 16 B. T. A. 1297; cf. Leo G. Hadley, 6 B. T. A. 1031; 36 Fed. (2d) 543.

The decision in Eaton v. English & Mersick Co., 7 Fed. (2d) 54, although somewhat similar, is not sufficiently so to be controlling. The court found that the resolution was itself not a declaration of dividend, that in fact it was not so intended, that in fact it was not so treated, and that under Connecticut law it could not be so held. All of these circumstances led the court to hold that surplus had not in fact been reduced. In the present case there was a deliberate recognition of the distribution in the conduct of everyone concerned. Flynn v. Haas Bros., 20 Fed. (2d) 510, was likewise predicated upon the lack of substantial recognition of a distribution by the corporation or the shareholders, holding that the resolution and book entry alone did not give substance to the alleged distribution as against conduct showing intent to be otherwise. Here the resolution is clear and has never been revoked or changed, the corporation acted upon it by crediting the amount to Schepp, wiping out his indebtedness and permitting him to draw upon the balance, as he did, and there is no evidence that the corporation ever intended otherwise and no inconsistent acts or conduct. Cf. Elgin Butter Tub Co., 12 B. T. A, 1313. In our opinion, therefore, the amount was not paid-in or earned surplus in 1918 and is not to be included in petitioner’s invested capital.

But, argues the petitioner, at least the $197,189.92 must be included in invested capital because before 1918 it was effectively restored to surplus by the journal entry of 1917. This, we think, is not so. In contrast with the substantial effect of the entry of 1912, we find no substance whatever in the entry of 1917. It purported only to reverse pro tanto the entry of 1912 (1911 was obviously an error) upon the supposition that it was erroneous as to the profit and loss surplus as no authority for it could be found. As we have seen, there was full authority for the entry in the resolution of distribution and it was not erroneous. Surely there is no reason to say it was at the same time erroneous as to $197,189.92 and effective as to the rest. The entry was made by an accountant who knew nothing about the facts and who acted without instructions from the secretary or, so far as the record shows, from anyone else. It was not made as a record of any fact or transaction which substantively took place.

Furthermore, as has been seen, the 1912 credit of $523,537.22 immediately wiped out Schepp’s debit of $379,940.87 and within four months thereafter was further withdrawn, bringing the remaining credit balance down to $92,903.44 at the end of June, 1912, and was not for three years above the $197,189.92 figure. If it be suggested that these figures are not reflective of the true condition because of the omission ratably to accrue salaries monthly, it may be said that, so far as the evidence discloses, the entry upon the books of accrued salaries would still leave Schepp’s credit balance for the same period at a figure below $197,189.92. Thus it appears that, not only was the amount authorized and credited, but it was actually appropriated by Schepp in part immediately and in greater part soon after. The credit went on for over five years at Schepp’s individual disposal. In view of this record and the conduct of the persons acting under it, there is no support for a contention that as to this lesser amount the surplus was never reduced. And having been reduced in fact, so that Schepp had and exercised a right in respect of it, it would require more than an entry on the corporation’s books to bring it back into the corporation’s rightful surplus. So far as the evidence shows, Schepp neither gave back the amount nor acted so as to estop himself to deny it; and, as has been seen, the entry itself appears merely as an accountant’s mistake. Under these circumstances, L. H. Manning & Co., 10 B. T. A. 633, is not controlling.

The petitioner, in onr opinion, had no right to include the $197,-189.92 in its invested capital and respondent correctly disallowed it; nor has petitioner any right to have its invested capital increased by including any part of the $523,537.22. The respondent is sustained. Adjustment will be made as stipulated in respect of petitioner’s inadmissible assets.

4. Stoele Trading Losses. — The petitioner deducted $268,692.50 as a loss sustained by it in 1918 in dealing in securities. The respondent disallowed $267,875 because it was not sustained by the petitioner, and extensive proof of the circumstances has been made by the petitioner in an effort to establish the loss as its own. This circumstantial proof has been substantially all set forth in the findings and need not be repeated. In our opinion, it not only falls short of proving a loss by the petitioner, but rather strengthens the respondent’s determination that the loss was not that of the petitioner.

The difficulty and such doubt as there is on this point are attributable to Schepp and the corporation. Instead of conducting their businesses clearly and distinctly separately, they voluntarily mingled them with resulting uncertainty and confusion. To Schepp the corporation was a mere convenience and, since he was accountable to no one else, he treated it as such without strict regard to the integrity of its separate function. As between him and the corporation, it was of no importance how their financial affairs were accounted for. If, therefore, the evidence upon the present issue prevents an affirmative conclusion favorable to petitioner, the failure is chargeable to petitioner and its officers and need arouse no feeling of hardship.

The corporation in prior years made no pretense of marginal trading in securities. Such trading was not its ordinary function. Schepp, on the other hand, had carried on speculative trading for a number of years, and had consistently claimed the right to deduct the resulting losses. It was only because the Government denied this right (whether rightly or wrongly) that the attempt was made to attribute the losses to the corporation. The first definite and unequivocal act of recognition by the corporation to this end was the book entry of December 31, 1918, after the transactions of the year had taken place. This was the first such entry on the corporation’s general books. The blotter which had been currently used to note the stock transactions was a memorandum book and entirely independent of the corporation’s accounts in so far as marginal trades were concerned. No current postings were made from it to the corporation’s general books and, so far as appears, the marginal trading shown by tbe blotter was not reflected in any trial balance or other periodic financial summary. Indeed, in the first instance, the losses were reflected in Schepp’s personal account, and only at the end of the year credited to him and debited to the corporation’s profit and loss. On the other hand, there were contacts between the blotter and the cash book as to a few investment transactions, admittedly of the corporation, in Liberty bonds and stocks. The testimony of the witnesses added no certainty to the record in lieu of this indefiniteness of the bookkeeping. Even if any of the margin transactions could be attributed to the corporation, it would be necessary to exclude those prior to September, when, as shown by the evidence, Schepp is said to have first determined to have the corporation trade in stocks. But, in view of our decision as to the transactions of the entire year, it is unnecessary to discuss the force of the evidence in this respect.

We hold that the petitioner did not sustain the losses claimed as the result of stock margin transactions. Adjustment should be made to allow the loss of $5,788.62 sustained in the sale of Liberty bonds-.

The petitioner argues that, since the respondent has imposed a fraud penalty predicated upon this deduction, it is the respondent’s burden to prove not only the elements of fraud, but also the error of the deduction. This, in our opinion, is an unsound view. It confuses the substantive issue, whether the losses were sustained by petitioner, with the issue whether, in taking such a deduction petitioner wilfully understated its income for the purpose of evading its lawful taxes. These issues are clearly separate, for, although the determination of fraud necessarily implies falsity in the claim of loss, yet the respondent can and may determine the deduction to be based on a false or incorrect claim and still find no justification for imposing the fraud penalty. In either event his determination disallowing the loss deduction is by law presumed to be correct, while his determination of fraud carries no such presumption because section 601, Revenue Act of 1928, amending section 907 (a), Revenue Act of 1926, provides:

* * * In any proceeding [before tbe Board] involving tbe issue whether tbe petitioner has been guilty of fraud with intent to evade tax * * * tbe burden of proof in respect of such issue shall be upon the Commissioner. * * *

It is not difficult to separate and distinguish these issues in a case such as this. Deductions are frequently taken through error of law or fact which involve no suggestion of fraud. They require no consideration of intent, motive or conduct in making the return. Bona fides is not questioned, in either the moral or unmoral sense of that term. The question is only whether the deduction was unfounded in fact or law. When, however, the Commissioner adds a fraud penalty, he in effect asserts that fraud has been practiced in the return; not merely that the transactions in which the deduction is grounded lacked bona fides, but that, whether or not the transactions were themselves bona fide, their treatment in the return embodied a fraudulent understatement. As to the issue raised by his determination of fraud, the burden is upon him; and he may fail to sustain such burden, notwithstanding the determined and presumed error in the return. In other words, both parties may fail through inadequate proof on their several issues, and thus the deficiency would be sustained and the penalty set aside.

The petitioner cites two decisions, Taplin v. Commissioner, 41 Fed. (2d) 454, and Budd v. Commissioner, 43 Fed. (2d) 509, decided by the Circuit Courts of Appeals of the. Sixth and Third Circuits, respectively. These cases, however, do not, in our opinion, support petitioner’s view. In respect of sales ultimately held to have been made, the Commissioner had challenged their bona fides and determined that they were sham and hence that no losses were sustained. He had not determined fraud or imposed penalties. The courts, however, held that his determination of lack of bona fides was essentially a determination of fraud, and, since fraud is never presumed, that the burden was upon the Commissioner who had in effect asserted it. In the Budd case, the court regarded the above quoted provision of section 601 of the 1928 Act as applicable to not only a direct issue of fraud, but also the issue as translated from the challenge of bona fides when no penalty was imposed.

This we have difficulty in understanding. But there is no difficulty in seeing the difference between those cases and this. Here there is no doubt as to whether the transactions were genuine or sham. That such sales occurred is admitted by all, and the Commissioner does not intimate that they lacked vitality. The entire question is whether these recognized transactions were by petitioner. The respondent’s determination that they were not by petitioner is not ipso facto the equivalent of a charge of fraud. It may represent either a difference of view as to the legal significance of facts or a difference in inferences of fact to be drawn from a confused mass of evidence. To say that, standing by itself, it was the same as a fraud charge, and upon that translated premise, to apply section 601 and throw the burden of proof upon respondent, would be merely a confusion of issues which generally and by statute are readily distinguishable.

Nor can we say that the burden as to the loss deduction is on respondent because of the statements and conduct of the several examining revenue agents. There was, according to the present record, sufficient ground to disallow the claimed deduction; and upon this the respondent made the definitive determination which petitioner assails. We are far from the opinion that this determination is so wholly arbitrary or wanting in probable foundation or merit as to require evidence in the first instance to support it. See Pennant Cafeteria Co., 5 B. T. A. 293; Jacob F. Brown, 18 B. T. A. 859, 867; Edgar M. Carnrick, 21 B. T. A. 12, 21; Benedict Crowell, 21 B. T. A. 849, 851; James P. Gossett, 22 B. T. A. 1279, 1284.

5. Fraud Penalty. — Having held as we have that the petitioner did not sustain the loss which it deducted, it becomes necessary to decide whether the respondent has correctly determined that a fraudulent return was wilfully made by the petitioner corporation with intent to evade tax, and added to the tax 50 per cent of the amount of the deficiency. Section 250 (b), Revenue Acts of 1918 and of 1921; section 275 (b), Revenue Acts of 1924 and of 1926; section 293 (b), Revenue Act of 1928. Upon this issue the burden is, by section 601, placed upon the respondent. The issue is restricted by respondent’s specification that the fraud is in the deduction taken for losses sustained in marginal trading in stocks. Since respondent makes no specification of fraud in respect of any of the other items in the return which have been determined by him and held by us to be incorrect, our consideration of fraud leaves out those items entirely.

We can not, however, escape the definite view that in taking the deduction for stock-trading losses on its return, the petitioner and its officers wilfully acted contrary to the truth within their knowledge and that it deliberately made false statements on its return for the purpose of evading its lawful tax. No one reading this record could reasonably escape the belief that the petitioner’s president and its secretary were astute and intelligent business men who were fully aware of the facts and implications of their business and reasonably cognizant of the general effect upon the corporation’s tax liability of its acts and transactions. There is no room for an extenuating plea of ignorance or inadvertence. What was done was done deliberately and knowingly. That it was done incorrectly appears not only from our foregoing discussion in the light of the burden of proof which rested on petitioner, but also from a consideration of the evidence irrespective of the petitioner’s burden. In other words, giving full consideration to all the evidence, we are clearly of opinion that the petitioner did not engage in the marginal transactions and hence that it sustained no loss on account thereof. As to the years earlier than 1918, this is practically beyond dispute. When the trading accounts were opened they were intended and understood to be the transactions of Schepp individually. For several years this was the accepted fact. These accounts were never closed, and, in 1918, Schepp had no intention of closing them. (The #11 account was expressly closed in a later year.) No new accounts were opened in 1918 at any time before the end of the year. Only two things happened to give any color to the notion that the account became that of the corporation — one, that Schepp sometime in 1918, probably as late as September, told Belgard that the accounts with Miller & Company would be those of the corporation, and, two, that the corporation, on December 31,1918, at Schepp’s direction, transferred the net loss which appeared in Schepp’s personal account on its general books from such personal account to its own profit and loss account. The testimony of the broker’s representative indicates no change in the handling of the accounts or the responsibility of Schepp. The accounts continued to be carried by the same anonymous designations with Schepp’s individual guaranty.

But even these two facts, if they proved that the corporation were engaged in trading with Miller & Company, would affect only such transactions as took place subsequent to the president’s determination and announcement. Thus the many transactions of the first two-thirds of the year would still remain those of the individual, and such of the deducted losses as resulted therefrom were entirely beyond the reach of the corporation. Belgard testified orally that Schepp’s statement to him was made “ sometime in 1918 ” and “ I think the early part,” while the petitioner’s written statement to the Bureau which Belgard verified in writing was that “ after September 16, 1918, and prior to the closing of the books for 1918 ” the determination of Schepp and his daughter was made. This deliberate written statement verified by Belgard is more reliable than his vague recollection at the hearing. So, in any event, the petitioner knowingly and deliberately founded its deduction upon a great many transactions with which it had no connection and from the result of which it had not suffered. Of course its voluntary book entry at the end of 1918, even if it were an assumption of the misfortunes of the year, would be gratuitous and not a loss.

The rationale seems to have been that Schepp had suffered trading losses which, despite his protests, the Bureau had persistently disallowed as deductions; thereupon the corporation began to deduct them, regardless of whether it had suffered them or not, and the books were by a single closing entry adjusted to that end. This we think was without warrant in law, deliberately contrary to fact, and hence within the statute prescribing the penalty.

Schepp died in 1926, and consequently his presence and testimony were not available at the trial in 1931. This has caused us to ponder long upon this determination of a fraudulent return. The petitioner criticises the respondent for making this determination after Schepp’s death. Our function, however, is to consider the evidence as it appears and decide whether it establishes the fraud which respondent has determined. If, as has been found, the corporation was guilty of fraud, it may not escape the prescribed penalty either on ethical grounds relating to the respondent’s method of investigation or out of too high a regard for its deceased president. Its responsibility for his official acts did not -lapse with his death, and when a penalty is determined and presented to this Board for review under the rules of evidence, the decision may not be deflected by a charge that the investigation was not timely. The statute clearly intends a fraud charge to be without limitation of time, and it places the burden of proof on respondent. We have no authority to add a standard of conduct as a further condition. Ernest M. Bull, Executor, 7 B. T. A. 993, 1000; James Couzens, 11 B. T. A. 1040, 1148, 1158. It should be said, however, that we have given full consideration to the possibility that Schepp’s testimony might have served to strengthen petitioner’s defense, and have in the light of that possibility weighed the evidence with the utmost care. It is only because the evidence of fraud is compelling that we have reached this conclusion, however regrettable it may be that the record may not contain Schepp’s testimony on the subject.

It is also urged by petitioner that respondent’s affirmative evidence upon the fraud issue utterly fails to support the determination. If the respondent’s statutory burden of proof could be discharged only by means of the testimony of the Government witnesses brought forward in his behalf, we should at once say that such testimony was inadequate to sustain the charge of fraud. But we do not understand that this is what the respondent’s burden of proof means. The question is whether upon the entire record properly before the Board the conclusion is fairly to be drawn that fraud was committed. Doubts and omissions are to be held against respondent. His is the risk of failure — not of failure to bring forward enough witnesses or enough testimony through his own witnesses, but of failure to submit a record of persuasive evidence of fraud. His risk is only that the truth may be contrary to his determination, not that he or his organization may not have been aware of it. If the weight of all the valid evidence properly in the case is such as to establish fraud, his burden is discharged; and it matters not by which of the opposing parties the evidence was introduced or in what order it was received. Adjective considerations of convenience as to the order of proof may- arise at the trial, but they do not affect the ultimate question whether the evidence adequately supports the respondent’s determination.

The penalty is sustained at 50 per cent of the amount of the deficiency. .

6. Other issues have either been withdrawn by petitioner or conceded by respondent, and the parties can readily, in accordance with their statements made at the trial and appearing in the record, readjust the deficiency in respect thereof.

Eeviewed by the Board.

Judgment will be entered under Rule 50.

LaNsdoN dissents.

Smith and Black dissent as to the imposition of the fraud penalty.

YaN Fossan,

dissenting in part: It is elemental that fraud must be proved by clear and convincing evidence; a mere preponderance is not sufficient. When the evidence in this case is subjected to this test, I find myself unable-to concur in the imposition of the'penalty for fraud.


author: Sternhagen:

text:
    Mary G. Mulqueen, Executrix of the Last Will and Testament of Michael J. Mulqueen, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 41444.
    Promulgated January 30, 1932.

      Thomas B. Gilehrist, Esg., for the petitioner.

      William E. Davis, Esg., for the respondent.
   OPINION.

Sternhagen:

The petitioning executrix, having admittedly received the amounts in question from Lamb, omitted them from the estate’s income-tax return, and now urges that such omission was proper because the amounts were gifts from Lamb and hence were not within statutory gross income as described in section 213 (a), Revenue Acts of 1924 and 1926, but were expressly excluded therefrom by section 213 (b) (3). The argument is that the estate had no legal right to any part of the fees; and that therefore what Lamb gave up he gave gratuitously, with knowledge that he was not legally obligated, and that this is not income to the estate, but a gift.

The evidence does not support the argument. While it may be true under New Tork law that the deceased attorney’s representative could not, in respect of some of the condemnation proceedings, have recovered from the decedent’s clients any compensation under the contingent retainers, Badger v. Celler, 41 App. Div. 599; 58 N. Y. S. 653; Sargent v. McLeod, 209 N. Y. 360; 103 N. E. 164, it is also true that where some substantial services were performed by the deceased, reasonable compensation could be had, Sargent v. McLeod, supra; see note 52 L. R. A. N. S. 380. The evidence does not show, except through the provisions of the contract of July 6, 1925, whether in this respect there was any foundation for compensation to decedent or his representatives or any fair legal basis for a claim. The contract rather indicates that services had been performed by the decedent sufficient to support a claim, although the extent of such services and the amount of any such claim could not be determined from the evidence.

The amounts here in question, however, were received not from the decedent’s clients by virtue of his retainers, but from Lamb under an arrangement of some sort which later was embodied in a written contract. As between Lamb and petitioner there was a recognition of such a balance of claims as to require an “ arrangement ” which culminated in a formal contract. On its face it indicates a valid consideration and dispels any suggestion of gift. Even if, as petitioner’s counsel suggests, Lamb made new contingent contracts with the clients (which we can not necessarily infer from the bare testimony that Lamb was “ substituted ”), and then contracted to share with petitioner, who was not a lawyer, such a sharing contract might be enforceable against him if not by him, since he would not be heard to raise the defense that his contract was in violation of law or the canons of professional conduct. Irwin v. Curie, 171 N. Y. 409; 64 N. E. 161. Since, however, he has performed under it and the petitioner has received under it, its validity is not justiciable here. See Reese v. Resburgh, 54 App. Div. 378; 66 N. Y. S. 633. Even if it were plainly invalid, this would not demonstrate that the amounts already received under it were gifts. James P. McKenna, 1 B. T. A. 326. Rather to the contrary, the existence of the contract would tend to show a lack of any intention to make a gift. Cf. Herschel V. Jones, 1. B. T. A. 1226. Income acquired through illegal transactions is nevertheless taxable, United States v. Sullivan, 274 U. S. 259; L. Weiner, 10 B. T. A. 905; and so is an amount in excess of that legally due, Chicago, Rock Island & Pacific Ry. Co., 13 B. T. A. 988, 1022; affd., 47 Fed. (2d) 990, 992.

The evidence to establish a gift was all given by the petitioner, who seems to have no definite idea of what was done or why. Lamb, who is alleged to have made the gift, did not give evidence, and there is in the record nothing outside the contract to indicate Ms actual intent or his own construction of the arrangement. If this had been a gift from him of money which had rightfully been his own, it would have been within his taxable income, with no deduction, since gifts are not deductions to the donor, section 215. Whether he took such a deduction or omitted the amount from his gross income, thus in either case indicating that he did not regard the transaction as a gift, does not appear in evidence, and we can not assume favorably to petitioner that he did not, or that her view that he made a gift reflects his intention.

The petitioner constructs her argument as if the gift exemption were an omnibus provision embodying any receipt which can not be fitted into the several categories set forth in the statutory description of gross income. This is contrary to good reasoning. Claiming such exemption, the petitioner must prove affirmatively that what she received was a gift; and failing to prove it to be a gift, it may properly be held within the broad definition of gross income, and that the respondent’s determination to that effect has not been overcome.

Judgment will be entered for the respondent.


author: Tkammell :

text:
    The Securities Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Clinchfield Securities Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 40553, 40554.
    Promulgated February 2, 1932.

      Winthrop H. Kellogg, Esq., for the petitioners.

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

Tkammell :

This proceeding has been submitted upon a stipulation of facts including a copy of the “ Plan and Agreement of Reorganization.” We have set forth as paragraph 20 of the findings of fact pertinent provisions of said plan. Paragraph 19 of the stipulation as set forth in our findings consists of a computation made and submitted by the petitioners to the respondent as a proposed basis for a settlement of these proceedings.

In the consolidated return the petitioners took a deduction of $40,882.50 as a loss on the sale of the 3,000 shares of the common stock of the Missouri Pacific Railroad Company in 1924. In the proposed basis for settlement submitted to the respondent they computed the amount of the loss at $34,458.47. In their brief they contend that they are entitled to deduct a loss of $42,106.57 or an additional amount of $1,224.07 in excess of the deduction taken in the return. The respondent contends .that the petitioners not only did not sustain any deductible loss on the sale of the stock in 1924, but realized a profit of $10,117.50.

Pertinent provisions of the Revenue Act of 1924 are as follows:

Seo. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (&) of section $0J/, and the loss shall be the excess of such basis over the amount realized. [Italics supplied.]
*******
Sec. 203. (a) Upon the sale or exchange of property the entire amount of gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section, (b) * * * (2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
* * * * ‡ * *
Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
*******
(6) If the property was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the laws applicable to the year in which the exchange was made.. * * *

It is thus seen that section 202 provides the method for computing gains or losses while section 203 provides what gains or losses shall be recognized for purposes of taxation under the Act. Section 204 provides the basis upon which gains or losses shall be computed under section 202.

The parties have stipulated that in 1909 the Securities Company purchased 4,000 shares of the capital stock of the Missouri Pacific Railway Company at an average cost of $70.36875 per share, or at a total cost of $281,475. On June 11, 1913, the Securities Company purchased an additional 1,000 shares of the capital stock of the Missouri Pacific Railway Company at $26% per share, or at a total cost of $26,125.

Sometime in 1913 and subsequent to June 11, the Securities Company sold 1,000 shares of the stock of the Railway Company for $30,467.50. Since the 1,000 shares thus sold were not identified, it becomes necessary to apply the rule of “ first in, first out ” and to hold that the shares were part of the purchase made in 1909. George W. Megeath, 5 B. T. A. 1274; David Stewart, 17 B. T. A. 604.

As a result of the foregoing transaction the Securities Company owned, at the time of the reorganization of the Missouri Pacific Railway Company, 3,000 shares of the stock of that company which were purchased in 1909 at a cost of $70.36875 per share, or a total cost of $211,106.25, and had a market value of $37.75 per share, or a total market value of $113,250 on March 1,1913. The Securities Company also owned the 1,000 shares of stock purchased on June 11, 1913, at a cost of $26,125.

Pursuant to the plan of reorganization the Securities Company paid to the “ Readjustment Managers ” an amount equal to $50 per share of stock held in the old Railway Company. In the stipulation submitted by the parties it is stated that such payment was an assessment. The other evidence in the record however is inconsistent with this stipulation and shows that it was not an assessment. The “ Plan and Agreement of Reorganization ” shows that the deposit of stock with the depositaries or subdepositaries, and the payment of the amount of $50 per share of stock so deposited as provided therein was purely voluntary on the part of the stockholders of the Missouri Pacific Railway Company. The stockholders were free to elect whether they would participate in the reorganization. But in order to participate in the reorganization under the plan and agreement it was necessary for the stockholders to deposit their stock and to make the payment required by such plan and agreement. Instead of there being a mere exchange of stock in the old company for common stock in the new company and cash for bonds, the two were inseparable. The stockholders had to turn in their stock in the old company plus $50 per share and received in return therefor an equal number of shares of common stock in the new company and bonds of the new company of a par value equal in amount to the cash paid.

The petitioners contend that the profit or loss from the sale of the stock in 1924 is to be computed under the provisions of section 204 (a) (6) of the Revenue Act of 1924, since the transaction in 1917 whereby the common stock and bonds in the new company were acquired for stock in the old company plus the cash payment comes within the provisions of section 203 (b) (2) of that act. The respondent contends that the provisions of section 204 (a) (6) are not applicable, for the reason that the transaction in 1917 does not come within any of the subdivisions (b), (d), (e), or (f) of section 203, because the Securities Company gave stock and cash for stock and bonds.

In our opinion the respondent’s contention is correct. The provisions of section 204 (a) (6) are applicable only if the property sold was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203. The petitioners do not contend that the transaction in 1917 comes within the provisions of the subdivisions (d), (e), or (f) of section 203. They contend that the transaction was one whereby 4,000 shares of common stock in the new company and $200,000 principal amount of its bonds were received in exchange for 4,000 shares of stock in the old company, thereby bringing the transaction within subdivision (b) of section 203. This subdivision deals with an exchange, pursuant to a plan of reorganization, of stock or securities in a corporation a party to the reorganization solely for stock or securities in the same corporation or in another corporation a party to the reorganization. From what has been said heretofore, we think it is clear that the transaction in 1917 in which stock in the old company and cash were exchanged for common stock and bonds in the new company was not an exchange of stock or securities solely for stock or securities within the intendment of subdivision (b) of section 203. A cash payment being involved, the transaction was one outside the provisions of the subdivision. The transaction in 1917 not coming within the provisions of subdivision (b) of section 203 or subdivisions (d), (e) or (f), the profit or loss from the sale in 1924 may not be computed under the provisions of section 204 (a) (6), as contended for by the petitioners.

The Revenue Act of 1916, as aménded by the Revenue Act of 1917, provides as follows:

Sec. 10. (a) That there shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding calendar year from all sources by every corporation * * * a tax of two per centum upon such income; * * *
*******
For the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition by a corporation * * * of property, real, personal, or mixed, acquired before March first, nineteen hundred and thirteen, the fair market price or value of such property as of March first, nineteen hundred and thirteen, shall be the basis for determining the amount of such gain derived or loss sustained.
Seo. 12. (a) In the case of a corporation * * * such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources—
*******
Second. All losses actually sustained and charged off within the year and not compensated by insurance or otherwise * * *.

The respondent contends that the exchange in 1917 of stock in the old company and money for common stock and bonds of the new company was a closed transaction in that year in so far as taxable gain or deductible loss resulted from the disposition of the stock is concerned.

With this view we agree. There is no provision in the Revenue Act of 1916 for the postponement of the determination of gain or loss on the sale or other disposition of securities. Under that act the transaction in 1917 gave rise to gain or loss. In the case of Marr v. United States, 268 U. S. 536, the court held that where a new corporation was organized to take over the assets and assume the liabilities of an old corporation and acquired the stock of the old corporation in exchange for its own stock, the difference between the cost of the old stock and the value of the new constituted a taxable transaction under the Revenue Act of 1916. Following this principle, when the stockholders gave up their old stock and cash for new stock and bonds, they realized a taxable profit or sustained a deductible loss on the disposition of their old stock. This profit or loss was the difference between the fair market value of what they received, to wit, the fair market value of the bonds and new stock on the day they were entitled to receive them, and the cost or March 1, 1913, value of the old stock, plus $50 per share. Since in this transaction the fair market value of the bonds and the fair market value of the new stock on the date the old stockholder was entitled to receive them were the amounts to be used to determine the amount of gain or loss from the disposition of the old stock, it is necessary in any subsequent disposition of the bonds or the new stock to use this same fair market value as the basis for gain or loss upon the disposition of these securities, so that there will not be a duplication of gain or loss. Alden Anderson, 19 B. T. A. 371; Paul A. Staley, 15 B. T. A. 625; Regulations 45, art. 1564. We must, therefore, determine the date upon which the exchange of the old stock was consummated so that the petitioner was entitled to receive the bonds and new stock. The petitioner did not make its final payment under the plan of reorganization until August 22, 1917, and it was not entitled to receive the new securities until that date. But on that date it made the final payment and it actually received the new securities. In our opinion the exchange of the old stock was consummated on this date, and the fair market value of the new securities on this date is the basis to be used in computing the gain or loss on the later sale of 3,000 shares of the new common stock received by the petitioner on this date. It has been stipulated that on this date the new common stock sold for 27%-29%. The average of these figures is $28.50, which we accept as being the fair market value. The Commissioner erred in using a basis of $28 per share.

Reviewed by the Board.

Judgment will be entered v/nder Rule 50.