author: Tyson:

text:
    R. D. Walker, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76762.
    Promulgated August 27, 1936.

      William H. Armbrecht, Esq., and Thomas E. Twitty, Esq., for the petitioner.

      L. W. Oreason, Esq., for the respondent.
   OPINION.

Tyson:

This proceeding seeks redetermination of an income tax deficiency in the amount of $3,673.73 for the calendar year 1930.

Petitioner assigns error in the respondent’s determination that the steps taken in a reorganization through recapitalization of the R. D. Walker Lumber Co. in 1930, by which petitioner in exchange for stock in that corporation received the equivalent of cash and stock in its recapitalization, constituted a single, nonseparable transaction and was taxable as such. Petitioner further assigns error in the respondent’s determination of the amount of gain derived from the transaction. Petitioner contends that he sold certain shares of stock of that company for the cancellation of his indebtedness to it without profit or loss and that, then, in a separate transaction his remaining shares of stock in that company were exchanged for new shares issued upon the reorganization, or, in the alternative, that the new shares were received as a nontaxable stock dividend.

Respondent denies the errors assigned and, in the alternative, by amended answer, to conform to proof, affirmatively alleges that the petitioner received in 1930 taxable dividends in the amount of $121,000, consisting of preferred stock of $41,300 and the cancellation of an indebtedness of $79,700, and requests that the deficiency be increased accordingly.

The stipulated facts are included herein by reference. A brief statement of the material facts as a part of our opinion will suffice.

Petitioner, an individual residing in Mobile, Alabama, had been engaged in the lumber business for many years. He had been the president of the R. D. Walker Lumber Co. since its organization on December 24, 1923, with a paid in capital of $200,000, represented by 2,000 shares of common stock of the par value of $100 each. There was no change in its capital structure until December 23, 1930, and no dividends were ever paid. The Lumber Co. engaged in the wholesale lumber business and petitioner not only managed and controlled the affairs of the corporation, but also personally handled practically all of its purchases and sales. The nature of the Lumber Co.’s business required a substantial line of bank credit. In or about 1930 the bank materially reduced the company’s line of credit.

On December 22, 1930, the stockholders of the Lumber Co. and their respective indebtedness to the company were as follows:

The cost of such shares of stock to each stockholder was $100 per share. The above stated indebtedness to the Lumber Co. was not created by loans or advances to those individuals in anticipation of or in lieu of dividends, but grew out of loans to pay off bank loans used to purchase stock in the Lumber Co. and also withdrawals on personal drawing accounts in excess of commissions or salaries earned over a period of years.

On December 23, 1930, the board of directors of the Lumber Co. adopted four resolutions providing, in part, as follows:

(1) * * * that the treasurer of the Company be authorized and instructed to accept in payment of notes and accounts an equal value in shares of stock of this company of the following stockholders:
R. D. Walker Harry Majerski H. L. Gaines, Jr. B. H. Buck
Further, that any excess in value per books of the company of the stock surrendered be credited to said stockholders and such value above the indebtedness be issued in new stock as hereinafter provided.
(2) * * * that it is desirable to amend its articles of corporation so as to authorize the issuance by it of 2,000 shares of preferred stock at the par value of $100.00 per share, and 20,000 shares of no-par common stock, both classes of stock having full voting rights; the said preferred stock to be issued on bas.is of 6% cumulative dividends, payable semi-annually irom the surplus or earnings of the Company on January 1st, and July 1st, and to be callable by vote of majority of directors, at a price of $105.00.
(3) Whereas the surrender of common stock by stockholders, R. D. Walker, Harry Majerski, H. L. Gaines, Jr., E. H. Buck, in payment of their accounts, will result in approximately $90,000.00 being outstanding in the old common stock of the Company, and whereas there will be approximately $105,000.00 in surplus and undivided earnings account, now therefore, be it resolved by the board of directors that a stock dividend be declared, issuing a total of $150,000.00, 1,500 shares of $100.00 par value, 6% cumulative preferred stock, and 20,000 shares, no par common stock in lieu of the outstanding old common stock and surplus and undivided earnings, ⅜ * *
(4) * * * that a special meeting of stockholders be held at once to act on the above mentioned matters.

On the same day, December 23, 1930, the stockholders of the Lumber Co. held a special meeting after a waiver by each of all notice thereof and all consenting thereto, at which meeting there was passed a resolution specifically setting forth and adopting the amendment to the Lumber Co.’s articles of incorporation for the increase in its authorized capital stock as set forth in the resolution adopted by the board of directors, and also there was adopted a resolution axiprov-ing the action of the board of directors “with reference to cancellation of debts of stockholders and issuance of stock dividend as shown in detail by resolutions adopted by the Board of Directors.”

At the close of and immediately after December 23,1930, the stockholders of the Lumber Co. and their respective stock holdings in and indebtedness to the company were as follows:

Petitioner concedes in his argument that the cancellation of his indebtedness of $79,700 in exchange for his surrender of 797 shares of $100 par value stock was the equivalent of the receipt of cash in that amount and with this we agree. Cf. Ida L. Dowling, 13 B. T. A. 787; Hugh H. Miller, 25 B. T. A. 418; B. F. Avery & Sons, Inc. 26 B. T. A. 1393; F. W. Fitch, 27 B. T. A. 615; aff'd., 70 Fed. (2d) 583; Moses Cohen, 28 B. T. A. 190; affd., 77 Fed. (2d) 184. Petitioner contends however that such exchange was really a sale, separate and distinct from his exchange of stock for stock. Upon the facts we conclude that the resolutions adopted on December 23, 1930, embraced a plan for the recapitalization of the Lumber Co. by the issuance of new preferred and common shares in lieu of the old outstanding common stock and, as an integral part thereof, the cancellation of the indebtedness of petitioner and three employees of the Lumber Co. Under the applicable statute, set forth in the margin, a recapitalization constitutes a “reorganization” as that term is therein defined and, in the instant case, since petitioner in exchange for his old common stock received not only new stock but also “other property or money” (i. e., the cancellation of his $79,700 debt to the corporation), the transaction falls within the provisions of section 112 (c) (1) and the gain “shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.” First Seattle Dexter Horton National Bank et al., Executors, 27 B. T. A. 1242; affd., 77 Fed. (2d) 45.

We do not regard the case of Bruce v. Helvering, 76 Fed. (2d) 442, as applicable to the facts of this case. In that case the taxpayer entered into a binding agreement to sell a part of her stock in E. E. Bruce & Co., a coloration, to the Churchill Drug Co., another corporation, for cash in a bona fide sale. Subsequently, on the same day, but after the agreement of sale was completed, she was informed that the Churchill Drug Co. was proposing to merge the two corporations and she was offered an exchange of stock of the Churchill Drug Co. for her remaining stock in E. E. Bruce & Co., which offer she accepted. It was held that these transactions were separate, as the taxpayer was neither informed of the proposed merger nor offered the exchange until after the sale had become a closed transaction. These facts are vastly different from those in the instant case, where the petitioner at the time of the cancellation of his indebtedness manifestly knew all about the plan of recapitalization, participated in carrying it out, and received under it new stock in the recapitalized corporation in addition to the cancellation of his indebtedness.

The two cases of A. W. Leonard, 21 B. T. A. 549, and C. George Armstrong, 31 B. T. A. 418, are distinguishable from the instant case on the facts, in that in both of those two cases the taxpayer prior to the reorganization owned two distinct classes of property, namely, common stock and preferred stock, and under the plan of reorganization specifically exchanged the old common stock for new common stock and specifically sold the preferred stock for cash, whereas, in the instant case, the taxpayer prior to the recapitalization owned only the one class of property, namely, the old common stock, which in one nonseparable transaction he exchanged for new common and preferred stock and cash, or its equivalent, in a recapitalization of the corporation.

In his determination of the deficiency here in controversy, the respondent, computed the petitioner’s gain as follows:

Received in reorganization:
Cash (through cancellation of indebtedness)_ $79,700.00
413.202 shares of preferred stock at $100.00 per share- 41,320. 20
9,320 shares of common stock at $2.77 per share- 25, 816. 40
Total Received_$146, 836.60
Cost of 932 shares of old stock- 93, 200.00
Profit_$53, 636. 60

We think such determination is erroneous as to value of the preferred and no par common stock received by petitioner in the transaction in question. The stipulation of facts sets forth the Lumber Co.’s gross sales in dollars and footage of lumber, its book net income and taxable net income or loss for each of the years 1924 to 1934, and its balance sheets for the years ended December 31, 1929, and 1930. In addition thereto we have the testimony of witnesses as to the nature and condition of the Lumber Co.’s business and affairs. The Lumber Co.’s book net worth on December 31, 1930, was $196,359.56, which included an amount of $50,000 Bladon Springs Lumber Co. stock which was worthless in 1930. Thus the capital and surplus of the Lumber Co. is reduced to $146,359.56, which is less than the $150,000 par value of the 1,500 shares of preferred stock issued and outstanding on December 31, 1930.

We conclude that the Lumber Co.’s no par common stock had no fair market value and that its preferred stock had a fair market value of $97.57 per share on December 23, 1930, when received by petitioner in the transaction in question. Therefore, petitioner in exchange for his 932 shares of old common stock, which cost $93,200, received the cancellation of a $79,700 debt, the equivalent of cash in that amount, 413 shares of preferred stock having an aggregate value of $40,296.41, and 9,320 shares of no par common stock of no fair market value, or a total value of $119,996.41, and realized a taxable gain in the amount of $26,796.41.

Our holding as set out above necessarily leads to the further holding that under the facts disclosed in this record there was no dividend received by petitioner in 1930 either by way of the issuance to him of stock or otherwise.

Deóision will he entered under Bule 50.

       1928 Act—
      SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) General rule. — Upon tbe sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely in hind.—
      *******
      (3) Stock for stock on reorganization. — 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.
      *******
      (c) Gain from exchanges not solely in hind.—
      (1) If an exchange would be within the provisions of section (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
      (i) Definition of reorganization.—
      (1) The term “reorganization” means * * * (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.


source: Caselaw Access Project

author: Mellott :

license: Public Domain

text:
    Electrical Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74677.
    Promulgated September 3, 1936.

      Oourtland Kelsey, Esq., and Ernest N. Wood, Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Mellott :

Respondent determined that petitioner, during the year 1930 realized a taxable gain of $420,545.84 through an exchange of corporate stock and asserted a deficiency in income tax in the amount of $54,994.89. Petitioner appeals and seeks a redetermination. All of the facts have been stipulated. We set out herein only those necessary for an understanding of the issue to be decided.

Petitioner is a corporation organized under the laws of the State of New York. Its principal business is the holding of stocks and bonds of utility holding and operating companies. During the taxable year before us it had net assets of approximately $30,000,000.

The United Gas Improvement Co. is also a public utility holding-company. The stipulation does not disclose its capital stock structure or ownership, but petitioner owned 16,500 shares of its common stock, which had a cost basis to it (petitioner) of $357,016.66.

The United Corporation is a public utility holding company located at Wilmington, Delaware. Its capital stock issued and outstanding on May 12, 1930, consisted of 1,779,367 shares of preferred and 9,182,515 shares of common. At all times material hereto, it owned approximately 6,000,000 shares of the common stock of the United Gas Improvement Co. and a large amount of stock of Consolidated Gas Co. of New York, Public Service Co. of New Jersey, Niagara Hudson Power Corporation, and Commonwealth & Southern Corporation, in which corporations petitioner also had substantial holdings of stock.

On May 1, 1930, the United Corporation addressed a letter to the holders of the common stock of the United Gas Improvement Co., offering, until 3 o’clock p. m., May 12,1930, to exchange its stock on a share for share basis for stock of the United Gas Improvement Co. Sixteen thousand five hundred shares of the stock of the United Corporation had a fair market value at all times material herein, of $777,562.50.

On May 10, 1930, in order to take advantage of the offer of the United Corporation, petitioner and other holders of common stock of the United Gas Improvement Co., incorporated “The Diselin Corporation”, hereinafter referred to as “Diselin.” The incorporators, the number of shares of the United Gas Improvement Co. owned by each of them, and the shares of stock of Diselin issued to them, are as follows:

Diselin was formed for the sole purpose of consummating the transaction or transactions herein set out, after which it was promptly dissolved. It transacted no business at any time other than as herein set out. Briefly its activities were as follows.

On May 12, 1930, the incorporators of Diselin transferred to it the 93,320 shares of stock of the United Gas Improvement Co. in exchange for 933.2 of its shares of capital stock, which were the only shares ever issued. Before doing so, or contemporaneously therewith, the incorporators signed an agreement providing that the issuance and delivery of the shares of Diselin should be made to them at the office of Registrar & Transfer Co. at Jersey City, New Jersey, on the 12th day of May 1930, at 11 o’clock in the forenoon, at which time they would deliver the shares of the United Gas Improvement Co. owned by them. Thereafter, and apparently before 3 p. m., of the same day, they elected a board of directors, and signed an agreement consenting to the exchange of all of Diselin’s assets, viz., the 93,320 shares of common stock of the United Gas Improvement Co., for 93,320 shares of common stock of the United Corporation, “pursuant to the Plan of Reorganization adopted this day by the Board of Directors.” The stock of the United Corporation was issued direct to the stockholders of Diselin pro rata, and their stock in Diselin was surrendered to it for cancellation. Certificate of dissolution was filed on June 26, 1930. The “Plan of Reorganization” was contained in a letter from Diselin to the United Corporation, bearing date of May 12, 1930, and was accepted by the United Corporation on the same day. The letter and acceptance are as follows:

May 12, 1930.
The United Corporation.
Wilmington, Delaware.
The Board of Directors of this Corporation has adopted a Plan of Reorganization, which has also been approved by the stockholders, whereby this corporation offers to transfer all its properties, consisting solely of Ninets'-three Thousand three hundred and twenty (93,320) shares of Common Stock of The United Gas Improvement Company, to The United Corporation solely in exchange for stock of The United Corporation, on. a basis of (1) share of Common Stock of The United Gas Improvement. Company for one (1) share of Common Stock of The United Corporation. The Plan is as follows:
Plan of Reorganisation
Parties to the Plan:
1. — The Diselin Corporation.
2. — The United Corporation.
Description of Plan:
The Diselin Corporation shall transfer all its properties, consisting of Ninety-three thousand three hundred and ..twenty (93,320) shares of Common Stock of The United Gas Improvement Company, to The United Corporation solely in exchange for Common Stock of The United Corporation, on a basis of one (1) share of Common Stock of The United Gas Improvement Company for (1) share of Common Stock of The United Corporation. The said stock of The United Corporation is to be issued direct by The United Corporation to the stockholders of The Diselin Corporation pro rata, who shall receive the same in exchange for the surrender of the stock of The Diselin Corporation to that Corporation for cancellation. The Diselin Corporation being thereupon dissolved.
In pursuance of this Plan of Reorganization, we hereby make tender of-Ninety-three thousand three hundred and twenty (93,320) shares of Common Stock of The United Gas Improvement Company by enclosing certificates for said shares duly endorsed, with the signatures thereon appropriately guaranteed.
Thb Diselin Corporation,
By James W. Husted, Jr., President.
Mat 12th, 1930.
In pursuance of the above Plan of Reorganization, to which we are a party, we accept tender of the enclosed Common Stock of The United Gas Improvement Company.
The Uniteo Corporation,
By [Signed] L. A. Keyes, Vioe-Pres.

The respondent determined that petitioner exchanged its shares of stock of the United Gas Improvement Co. which had a cost basis to it of $357,016.66 for an equal number of shares of stock of the United Corporation which had a fair market value of $777,562.50, and that the difference between these two amounts represented taxable gain.

Petitioner contends that no gain should be recognized, either in connection with the transfer of the stock of the United Gas Improvement Co. to Diselin or in connection with the receipt of the United Corporation’s stock through Diselin. It argues that such transactions are expressly excepted by sections 112 (b) (5) and 112 (b) (3) of the Revenue Act of 1928 shown in the margin. It also avers that neither of such steps can be disregarded, since, it says “the purpose of the whole transaction was an ordinary business purpose and the petitioner had the undoubted right to adopt certain procedure to accomplish the purpose without incurring tax liability, even though liability would have been incurred had different procedure been adopted.”

If petitioner had sold the United Gas Improvement stock (whether it subsequently invested the proceeds in other stock or not) it would have realized a taxable gain measured by the difference between the cost (or other basis) of the stock which it sold and the amount realized upon the sale. (Secs. Ill and 113, Revenue Act of 1928.) If it had exchanged the stock owned by it for stock having a fair market value in excess of the cost (or other basis) of the stock given up in the exchange, it would have been taxable upon the difference. (Sec. 112, Revenue Act of 1928.) Has it escaped taxation by the method used? That is the question for our decision.

The briefs are devoted largely to discussion of the courts’ opinions in the Gregory case (Helvering v. Gregory, 69 Fed. (2d) 809; Gregory v. Helvering, 293 U. S. 465). Respondent contends that the case is determinative of the issue before us, while petitioner argues quite vigorously that it is not in point, especially, it says, since “later decisions of the Supreme Court (Helvering v. Minnesota Tea Co., 296 U. S. 378; Helvering v. Watts, 296 U. S. 387; Nelson Co. v. Helvering, 296 U. S. 374; Bus Transport Securities Corporation v. Helvering, 296 U. S. 391; G. & K. Mfg. Co. v. Helvering, 296 U. S. 389) substantially narrow” its scope.

The petitioner was confronted with the same dilemma as that which the taxpayer faced in the Gregory case. It wished to reduce its taxes as much as possible. To do so, it adopted substantially the same procedure as that used in the Gregory case. It, together with other owners of the same stock, “incorporated a new company, organized ad hoc * * * ” to which they transferred the stock which they wished to exchange, accepting in lieu thereof, stock in the new corporation. Being then in control of the new corporation, they forthwith, caused it to transfer all of its assets — consisting only of the stock which but a few minutes before, or at most a few hours before, had belonged to them — to another corporation in exchange for the stock which they individually wished to secure. The new corporation had now fulfilled its destiny, had performed its sole mission in life — in the language of the stipulation, “It was formed for the sole purpose of consummating the aforesaid transaction or transactions”— and was now ready to be put to death. This was done speedily and painlessly in the manner set out in the preconceived plan. The stockholders simply surrendered their stock in Diselin, accepting in lieu thereof the stock in the United Corporation, and Diselin was left as an empty shell — a corporation in name, perhaps, though it had no capital, stockholders, property, assets or liabilities.

Petitioner’s argument, by which it attempts to distinguish the Gregory case, is not persuasive. It italicizes the word “shareholder” in the following excerpt from the opinion of the Second Circuit: “To dodge the shareholder’s tax is not one of the transactions contemplated as corporate ‘reorganization’ ”, and contends that a different result should follow here. It argues that while the transaction in the Gregory case “could not well be considered in any way furthering the business of the corporation or as having any purpose beneficial to the corporation itself” a different result should be reached here because the beneficiary of the whole transaction is a corporation, as distinguished from a shareholder, and the result to be achieved is to “further the business of the corporation” in its disposal of stock. The contention is fallacious. It presupposes that Congress intended to give a corporate shareholder immunity from tax while denying such immunity to an individual shareholder; but no such intention can be gleaned from its legislative acts.

This case upon its facts is somewhat analagous to Thomas N. Perkins, 33 B. T. A. 606. In that case we pointed out that the intermediate companies — corresponding in a general way with Diselin here — were not operating companies and were never intended to be such. That they were merely organized to hold, for a short period of time, the shares of stock turned over to them, after which they were to be, and were, dissolved. We held that there was no corporate reorganization because there was not “a transfer of assets by one corporation to another * * * ‘in pursuance of a plan of reorganization’ of corporate business”, the transfer of assets not having been made in pursuance of a plan having relation to the business of the corporations, and concluded that the transaction was , one in which gain must be recognized.

In J. S. McInerney, 29 B. T. A. 1 (aff'd., 82 Fed. (2d) 665), this Board held that where a corporation was created for the sole purpose of passing title to the purchaser and passing payment to the vendor, the corporation being controlled by an attorney who acted for all the parties to the sale, payment made to the corporation by the purchaser must be regarded as constructively received by the vendor. The transaction before us is not unlike the above. Diselin was organized for the sole purpose of passing stock of the United Gas Improvement Co. to the United Corporation and passing stock of the United Corporation to petitioner and its associates. There was no merger, consolidation, or reorganization of a corporate business, but “simply an operation having no business or corporate purpose— a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner.” (Gregory v. Helvering, supra.)

We do not interpret the subsequent decisions of the Supreme Court, supra, as limiting or modifying its decision in the Gregory case. As a matter of fact, Mr. Justice McReynolds, the author of the opinion in Helvering v. Minnesota Tea Co., supra, specifically approves such decision in the following language: ’''Gregory v. Helvering, 293 U. S. 465, revealed a sham — a mere device intended to obscure the character of the transaction. We, of course, disregarded the mask and dealt with realities.”

We need not extend this opinion. Suffice it to say that we are convinced there was no reorganization of a corporate business and that the transaction or transactions before us resulted in taxable gain to- the petitioner. It follows that the respondent did not err in determining the above deficiency and his action in doing so is approved.

Judgment will be entered for the respondent.

       Sec. 112. (b) Ewohanges solety in Jcind.—
      *******
      (3) Stock for stock on reorganization. — 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.

        m ***** *
      (5) Transfer to corporation controlled by transferor. — No gain or loss shall be recognized If property is transferred, to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.


author: Muedogk :

text:
    Harry S. Blumenthal, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75143.
    Promulgated September 3, 1936.

      Solomon Eisner, Esq., for the petitioner.

      James H. Yeaimxm, Esq., for the respondent.
   OPINION.

Muedogk :

The Commissioner determined a deficiency of $811.79 in the petitioner’s income tax for 1931. The only- adjustment made by the Commissioner to the income as reported was the addition of $6,635.97 representing the income of two trusts created pursuant to a court order for the benefit of the petitioner’s divorced wife and their child. That action of the Commissioner is assigned as error. The facts were stipulated.

The petitioner is an individual, residing in West Hartford, Connecticut. He married Anna J. Maher in 1911. They had a child, Harriel A. Blumenthal, born in 1912. The wife instituted an action against the petitioner in 1923 in Connecticut for a divorce, for custody of the child, and for alimony. A committee, which heard the evidence, recommended to the court that the wife be granted a divorce, custody. of the child, and alimony of $132,500, of which $125,000 should be placed in trust for the benefit of the wife and child. The court issued its order in 1923 divorcing the couple, granting custody of the child to the mother, and decreeing alimony as follows:

The said defendant pay within ten (10) days from the date hereof, to the plaintiff the sum of Seventy-five Hundred (7500) Dollars, and for the benefit of the plaintiff and said minor child pay to the Hartford-Connecticut Trust Company of Hartford, Connecticut, the sum of One Hundred Thousand (100,000) Dollars, and the sum of Tyenty-five Thousand (25,000) Dollars, respectively, in trust, under the following terms and conditions and for the following uses and purposes: * ⅜ *

The net income of the $100,000 was to be paid to the plaintiff during her life, and thereafter the daughter was to receive all of the income until she became twenty-one years of age, when she was to receive one-half of the principal. The daughter was then to receive the income on the remaining one-half until she became twenty-five years of age, at which time she was to receive the rest of the principal. The daughter was to receive the income of the $25,000 trust until the principal was paid to her, one-half when she became twenty-one, and the remainder when she became twenty-five years of age. If the daughter predeceased her mother the $100,000 trust was to terminate at the death of the mother and the property was to be delivered to the defendant or his estate. If the daughter died before receiving all of the $25,000 trust, the remainder was to be delivered to her father or his estate. The trusts were created in accordance with the decree. The divorced wife remarried in 1926. The income of the trusts in 1931 amounted to $6,635.97 ($5,179.97 and $1,456). The trustee paid the income directly to the beneficiaries, both of whom are living. The petitioner has never had any voice in the management of the trusts and has never received any distribution from the trusts.

The Commissioner contends that the income of the two trusts is taxable to the petitioner under the general definition of gross income (sec. 22, Revenue Act of 1928) and the decisions in Douglas v. Willcuts, 296 U. S. 1; Helvering v. Stokes, 296 U. S. 551; Helvering v. Schweitzer, 296 U. S. 551; rehearing denied, 296 U. S. 665; Helvering v. Coxey, 297 U. S. 694; and Helvering v. Brooks, 82 Fed. (2d) 173. His theory is that the trust income was used to discharge a legal obligation of the petitioner, it directly benefited him, and, therefore, it is taxable to him. These cases are controlling so far as the income from the trust for the minor child is concerned. Cf. Helvering v. Schweitzer, 296 U. S. 551; rehearing denied, 296 U. S. 665. The obligation of the father to support her continued throughout the taxable year. Wright v. Leupp, 70 N. J. Eq. 130; 62 Atl. 464; Walder v. Walder, 359 La. 231; 105 So. 300; Fernandez v. Aburrea, 42 Cal. App. 131; 183 Pac. 366; Southern California Edison Co. v. Industrial Accident Commission, 92 Cal. App. 355; 268 Pac. 415; secs. 5187 and 1717, Gen. Statutes of Connecticut, 1930. But there was no obligation upon the part of the petitioner during the taxable year to support his former wife, who had remarried in 1926. Cary v. Cary, 112 Conn. 256; 152 Atl. 302. His entire obligation to support her had been discharged prior to 1931. He had only a contingent remainder interest in the trust established for her and was not taxable with the income of that trust. Cf. Reinecke v. Smith, 61 Fed. (2d) 324; Sidney R. Bliss, 26 B. T. A. 962; Nanaline H. Duke et al., Executors, 23 B. T. A. 1104; aff'd., 62 Fed. (2d) 1057; 290 U. S. 591.

Decision will be entered under Rule 50.


author: SteRnhagen :

text:
    Wadsworth R. Lewis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75957.
    Promulgated September 17, 1936.

      Ham/ W. Forbes, Esq., and John A. Wilson, Esq., for the petitioner.

      G-erald W. Brooks, Esq., for the respondent.

      A. Chauncey Newlin, Esq., filed a brief amicus curiae.

   OPINION.

SteRnhagen :

The Commissioner determined a deficiency of $5,825.99 in petitioner’s income tax for 1931. The essential facts were stipulated at the hearing and the rest of petitioner’s evidence is undisputed. The facts may be summarily stated.

Petitioner, on December 21, 1931, sold in open market on the New York Stock Exchange through one firm of brokers certain stocks which he had held for more than two years, and the next day he purchased through another brokerage firm the same number of shares of the saíne stock, which he thereafter instructed his brokers to sell. These later acquired stocks were accordingly sold from December 28 to 30, 1931. The loss realized on these last sales was $132,280.35.

The petitioner assails the Commissioner’s determination that this amount is to be treated as a capital rather than as an ordinary loss. The issue thus presented is the same as the first question raised in Howard Heinz, 34 B. T. A. 885, whether stock purchased within the thirty-day period so as to render nondeductible under the wash sale provision the loss sustained on the first sale, is a capital asset, and the loss sustained on a later sale a capital loss. In accordance with the decision in the Heinz case, the Commissioner’s determination upon this point of law is reversed.

The Commissioner in an amended answer pleads affirmatively that in no event is the loss deductible, because the second transaction, in which alone it may be recognized, was not a “transaction entered into for profit.” This negative allegation is denied in petitioner’s reply, and the respondent must therefore prove it. He offers no evidence of his own, and the only testimony for petitioner which might give it color is a statement that the purpose of the sales was in part to realize losses as tax deductions. All purchases and sales were at market. This is plainly not enough to require or justify a finding that the losses were not sustained in transactions entered into for profit.

As a matter of law, it can not be said that a “transaction entered into for profit” must result in a profit or that it may not exist because it has but scant hope for profit. Such a construction would stultify the term completely or else limit it to sudden or unforeseeable losses. The statute applies rather to a type or character of transaction, and serves to enlarge the group of deductible losses beyond those incurred in trade and those incurred by casualty, etc. The Commissioner’s proposed construction would not only prevent the wash sale deduction, but would prevent the loss deduction entirely, no matter when the sharps were sold, unless the taxpayer when he made his second purchase reasonably believed that the market would carry their value up to a sale price higher than the cost of the shares originally purchased, and intended to hold them for a profitable sale. This construction is too narrow for adoption. The loss is deductible.

Judgment will ~be entered under Bule 50.


author: Hill :

text:
    Edward Klauber, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79241.
    Promulgated September 22, 1936.

      N. Normrni Mayer, Esq., for the petitioner.

      Irving M. TnMwr, Esq., for the respondent.
   OPINION.

Hill :

This is a proceeding for the redetermination of a deficiency in income tax for the year 1932 in the amount of $3,001.12. The sole issue is whether or not petitioner is entitled, under the provisions of section 23 (r) of the Revenue Act of 1932, to apply his individual loss resulting from sales during the taxable year of stocks and securities, not capital assets, against his distributive share of partnership gain in the same year from sales of stocks and securities, not capital assets.

The facts were stipulated by the parties as follows:

During the year 1932, petitioner traded in stocks and other securities in his individual capacity.
During said calendar year, petitioner incurred a net loss of $21,398.13 through sales of stocks and other securities which had been held by him for a period of two years or less.
During the calendar year 1932, petitioner was a member of the partnership of Spero & Company, of 50 Broad Street, New York, New York, which likewise in said year traded (not as a dealer) in stocks and other securities.
During the said calendar year, said partnership derived a profit of $69,311.43 through the sale of stocks and other securities which had been held by it for a period of two years or less, of which petitioner’s distributive share amounted to $34,186.75.
Said partnership also had income from other sources during the calendar year 1932.
Both petitioner and the partnership, Spero & Company, filed their income tax returns for the calendar year ended December 31, 1932.
In his income tax return for the calendar year 1932, petitioner in arriving at net taxable income applied the loss of $21,398.13, sustained by him in his individual sales of securities as an, offset against his distributive share of the aforementioned partnership profit, such profits amounting to $33,311.75 as computed by petitioner and as reflected in the original return filed by the partnership, but actually amounting to $34,186.75 as finally and correctly determined by Commissioner.
In computing the deficiency as set forth in his deficiency notice, the Commissioner failed to allow petitioner’s individual loss as a deduction or as an offset against petitioner’s distributive share of the partnership profits.

The precise question presented in this case was considered and decided by us adversely to petitioner in Percy H. Johnston, 34 B. T. A. 276. On authority of that decision, which is controlling here, respondent’s determination is approved.

Judgment will be entered for respondent.


author: Hill:

text:
    James R. Duncan and the City National Bank of Binghampton, as Surviving Executors of and Trustees under the Will of George Fowler, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79419.
    Promulgated September 22, 1936.

      Israel T. Deyo, Esq., and B. 0. Wolcott, O. P. A., for the petitioners.

      E. G. Smith, Esq., for the respondent.
   OPINION.

Hill:

This proceeding is for the redetermination of a deficiency in income tax for the year 1932 in the amount of $598.48. Petitioners assign as error the action of respondent in disallowing a deduction of $10,243.72 in computing the net. income of the trust estate-taxable to the fiduciaries or trustees, which amount is alleged to represent income distributed currently by the trustees to the widow of decedent as a beneficiary of the estate and not as a legatee. The alleged error is denied by respondent. The parties filed an agreed statement of facts, which we adopt in full as our findings of fact,, but only so much thereof will be set forth as we deem necessary to' a discussion of the issue.

George Fowler, hereinafter called decedent, died testate on November 4, 1924. By his will, duly probated, decedent gave and bequeathed to his wife, Eda Fowler, all the household furniture and' fixtures, certain automobiles, and the use of his residence and farm,, including adjacent realty, for life with remainders over.

After providing for several general legacies and a specific devise,, decedent, in the nineteenth paragraph of his will, gave all the residue of his estate to his executors and trustees in trust for certain specified uses and purposes, including the following:

* * * to collect the rents, issues, income and profits therefrom, and, after-deducting all necessary costs, charges and disbursements, to pay over therefrom to my wife, Eda Fowler, and to my son, George W. Fowler, during tbe term of tlieir joint lives, each the sum of Twelve Thousand Dollars ($12,000) per annum, from and after the date of my decease, * * * and upon the death of either, then to pay over to the survivor the sum of Twelve Thousand Dollars ($12,000) during the remaining term of her or his natural life; and in case such rents, income and profits should be insufficient to pay the same, then to pay out of the principal of the funds in their hands such an amount as will make up the deficiency each year, provided, however, that any such payment made out of principal shall be replaced out of any income subsequently received by my trustees in excess of the amount requisite to make the annual payments above provided for. ⅜ * *

By the twenty-third and twenty-fourth paragraphs of his will, decedent directed that certain real property owned by him on the northwest corner of Court and Water Streets in the city of Bing-hampton, New York, as well as the farm and residence the use of which was given to his wife for life, should not be sold during the lifetime of his wife or son, but the executors and trustees were authorized “to mortgage, sell and convey any and all other real estate” of which decedent might die seized.

The twenty-sixth paragraph of decedent’s will recited that “the provisions herein contained made for my wife, Eda Fowler, shall be in lieu of dower and all other common law or statutory rights or interests in both my real and in my personal estate.”

The trustees under decedent’s will duly filed with respondent on behalf of the estate a return of income for the calendar year 1932 on form 1041, showing net taxable income of $42,329.45, which amount was distributed and paid over to the beneficiaries, including the payment of $10,243.72 to decedent’s widow, Eda Fowler. The fiduciaries paid no tax on the income of the estate so received and paid over.

Upon examination of the return, respondent held that the amount paid to Eda Fowler was taxable to the fiduciaries and not to the beneficiary, and fixed the amount of the tax at $598.48.

The parties further stipulated that if the contention of the petitioners is sustained there is no deficiency due from them, and that if the contention of the respondent is approved, the deficiency as determined by him is correct. Thus, a single issue of law is presented.

The statutes applicable here are sections 22 (b) (3) and 162 (b) of the Revenue Act of 1932, quoted in the margin.

Respondent filed no brief in this proceeding, but in the deficiency notice it is stated that deduction of the amount paid to Mrs. Fowler in the taxable year by the trustees is not allowable for the reasons (1) that it was an annuity payable at all events, did not depend upon income from the trust estate, and therefore did not represent taxable income to her; (2) that the widow was an ordinary legatee and the amount so paid to her is not deductible by the trustees; and (3) that the payments were not distributions of income, but were paid in discharge of a gift or legacy. In support of his action, respondent relies upon Helvering v. Pardee, 290 U. S. 365; Boston Safe Deposit & Trust Co. v. Commissioner, 66 Fed. (2d) 179, affirming 26 B. T. A. 486; Burnet v. Whitehouse, 283 U. S. 148; George D. Harter Bank, Executor, 29 B. T. A. 926.

Solution of the issue presented here depends upon whether the annual amount provided by decedent in his will to be paid to his widow was payable at all events as a charge against the corpus of the trust, not necessarily dependent upon current income of the trust estate, or whether it was payable only out of income.

We think it is clear that under the terms of the will the amount in question was payable at all events and constituted a charge against the whole estate, with the possible exception of certain realty. Payment was not dependent upon the amount of income received by the trustees. The nineteenth paragraph of decedent’s will provided for the payment of the specified amount out of rents, income, and profits, after deducting all necessary costs, charges and disbursements, but it was further provided that if such net income was insufficient then the deficiency each year was to be paid out of principal. Our conclusion on this point is not affected by the further provisions of the will that any such payment made out of principal should be replaced out of any income subsequently received by the trustees in excess of the amount requisite to make the annual payments provided for. These provisions merely directed how and in what manner the income of the trust estate, if any, should be disposed of. Obviously, income in excess of the payments directed to be made to decedent’s widow and son might not be received, but such payments were nevertheless to be made and they were therefore in no way dependent upon the receipt of excess income to replace the portion paid out of principal, nor was payment dependent upon the receipt of any particular .amount of income by the trustees. The sum was payable annually ■at all events, out of net income if available in sufficient amount; ■otherwise it was to be paid out of principal.

In these circumstances, we are of the opinion that the amount in controversy is not deductible by the trustees in determining the net income of the trust estate under section 162 (b) of the statute above ■quoted.

Helvering v. Pardee, supra, along with other cases, was consolidated for decision by the Supreme Court with Helvering v. Butterworth. In the Butterworth case the decedent gave the residue of his estate to trustees, with directions to pay the net income to his widow. :She elected to take under the will in lieu of her statutory rights. The Court held that she was a beneficiary of the trust, and that the trustees were entitled to deduct the income so distributed to her. In the Pardee case the decedent gave to his wife an annuity of $50,000, which, as in the present case, was payable at all events and not restricted to income of the trust estate. The Court held the payments were not deductible by the trustees under a prior statute substantially the same as section 162 (b), supra, saying:

Payments to Mrs. Pardee by the fiduciary were not necessarily made from the income. The charge was upon the estate as a whole; her claim was payable without regard to income received by the fiduciary. Payments to her were not distribution of income, but in discharge of a gift or legacy. The principle applied in Burnet v. Whitehouse, 283 U. S. 148 * * * is applicable.

In Burnet v. Whitehouse, it was held that an annuity chargeable against the corpus of a trust estate was not taxable to the annuitant as income. Such payments not being taxable to the annuitant would be taxable to the fiduciary, and so could not be deducted in computing the net income of the trust estate under the doctrine of the Butterworth case, supra. On this point the Court there remarked:

The evident general purpose of the statute was to tax in some way the whole income of all trust estates. If nothing was payable to beneficiaries, the income without deduction was assessable to the fiduciary. * * * Certainly, Congress did not intend any income from a trust to escape taxation unless definitely exempted.

We think the case at bar is clearly distinguishable on the facts from the Butterworth decision, and is ruled by the principles applied in Helvering v. Pardee, supra.

Petitioners argue, however, that the payment to Mrs. Fowler here in controversy was in fact made wholly out of income, and is therefore an allowable deduction to the trustees as a current distribution of income of the trust estate. We can not agree with this contention. It is not the source from which the payment of a particular year may be made which fixes the nature of the bequest. A widow who accepts the provisions of her husband’s will and receives part or all of the income from a trust established thereunder, occupies the position of a beneficiary. The amount distributed to her is taxable to her, and therefore constitutes an allowable deduction to the fiduciary. Helvering v. Butterworth, supra. If a definite, fixed amount is given to the widow, payable at all events (out of income, if available; if not, out of corpus) she is an ordinary legatee. The amount so paid then is not a distribution of income to her, but a gift or legacy exempt from income tax under section 22 (b) (3), supra. Hence, the amount is not deductible in computing the taxable income of the trust estate. Helvering v. Pardee, supra.

It is immaterial whether the annuity be in fact paid out of income or principal in a given year. This point was specifically considered in the Whitehouse case above referred to. There the annuity was satisfied from the corpus of the estate prior to November 14, 1920; after-wards out of income derived therefrom. The Court said:

It would be an anomoly to tax tlie receipts for one year and exempt them for another simply because the executors paid the first from income received and the second out of the corpus.

On authority of the decisions hereinabove cited the deficiency determined by respondent is approved.

Judgment will be entered for the respondent.

       SEC. 22. GROSS INCOME.

        *******

      (b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title:
      * * * * * * *

      (3) Gifts, bequests, and devises. — The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income.)

        SEC. 162. NET INCOME [of estates and trusts].
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the ease of an individual, except that—
      *******
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *


author: Muedock:

text:
    Big Lake Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52803.
    Promulgated September 23, 1936.

      S. Leo Ruslander, Esq., for the petitioner.

      Gonway N. Kitchen, Esq., for the respondent.
   opinion.

Muedock:

The Commissioner determined a deficiency of $97,-009.85 in the petitioner’s income tax for the calendar year 1927. He also determined a deficiency for 1926, but the issue relating to that year has been waived. The only issue is whether the petitioner is taxable in 1927 with $598,571.01, representing the agreed fair market value in January 1927 of 2,450 shares of stock.of the Reagan County Purchasing Co., which the Commissioner determined were received by the petitioner in January 1927. Most of the facts in the record have been stipulated. The stipulated facts will not be set forth herein in full.

The petitioner and other producers in a certain oil field had no access to a pipe line in 1924. They entered into an agreement with the Marland Oil Co. on October 22, 1924, whereby the Reagan County Purchasing Co. was organized to build a pipe line to the field. The Marland Oil Co. put up the necessary cash as needed, through subscriptions for the preferred stock of the new company. The preferred stock was to be retired rapidly out of the first earnings of the new company. The Marland Oil Co. also paid in $500 and received 51 percent of the common stock. The petitioner and the other producers entered into contracts with the new company agreeing to sell their oil to it up to certain amounts not exceeding 20,000 barrels per day. The parties agreed that 49 percent of the common stock should be divided among these producers as part consideration for their agreements to sell their oil to the new company. A certificate for one-half of the 49 percent was issued in the name of the petitioner and a certificate for the remainder of the 49 percent was issued in the names of the other producers, jointly. These two certificates were endorsed, delivered to an “escrow agent”, and held by the latter for the benefit of the producers in such proportion as should be agreed upon between the producers, to be evidenced by a written agreement filed with the escrow agent. The 49 percent was not to be sold except to the Marland Oil Co. or to another of the producers after their respective interests had been agreed upon. Each certificate was stamped to show that it was subject to the restrictions contained in the agreements. The escrow was to continue until all of the preferred stock had been retired. New certificates were to be issued whenever the producers agreed upon the amount of the 49 percent each was to own. If the escrow was still in effect, these new certificates were to be placed with the escrow agent, as the others had been, pending the retirement of all of the preferred stock.

The producers had agreed among themselves in 1924 that “The said forty-nine per cent (49%) of the stock shall be divided between us as soon after December 1, 1926, as can conveniently be done, based proportionately upon the amount of oil that we each deliver to the purchasing company between December 1, 1925 and December 1, 1926, in fulfilling or attempting to fulfill deliveries of twenty thousand (20,000) barrels per day.” Deliveries in excess of 20,000 barrels were not to count. The petitioner had nine producing wells and was producing about 4,000 barrels per day at the time of entering into the agreements. The other group of producers had one well and was producing about 1,400 barrels per day. The proven acreage belonging to the petitioner was much larger than that belonging to the other group. The officers of the petitioner, at the time in 1924 when the agreements were executed, confidently believed that the petitioner would be able to deliver at least 10,000 barrels per day during the period from December 1, 1925, to December 1, 1926, and that it would thereby become entitled to one-half of the 49 percent, or 2,450 shares.

The contracts were carried out in accordance with their terms. Both groups delivered more than 10,000 barrels per day during the period specified. The last remaining preferred stock was retired on January 1, 1927. The petitioner and the other producers executed a letter of instructions to the escrow agent in January 1927 (but dated December 15, 1926, and authorized in December 1926) terminating the escrow and advising:

Second. Further, that the true and ultimate ownership of said forty-nine per cent (49%) of the common stock of Reagan County Purchasing Company, Inc. (being all and the same shares evidenced by the aforesaid certificates No. C-2 and No. C-3 for 2450 shares each), has been determined by and between Big Lake Oil Company, on the one hand, and Texon Oil and Land Company, Group No. 1 Oil Corporation, and Group No. 2 Oil Corporation, aforesaid, on the other hand, and this agreement as to the said last named four corporations is intended, and shall be taken to evidence the agreement between said named companies as to such true and ultimate ownership of said 49% of the common stock, and for that purpose, among other things, this agreement is executed and the duplicate original copies are filed with your bank as Escrow Agent, and with Reagan County Purchasing Company. The true and ultimate ownership of said 49% of the common stock of said Reagan County Purchasing Company as last herein referred to, is now agreed and determined to be as follows:
To Big Lake Oil Company, twenty-four Hundred and Fifty (2450) shares (To Texon Oil and Land Company; Group No. 1 Oil Corporation; Group (No. 2 Oil Corporation (by one joint certificate), Twenty-four (Hundred and Fifty-(2450) shares

The petitioner received a certificate for 2,450 shares in March 1927, free of any restriction. It never reported any income from the receipt of the shares.

The Commissioner determined that the petitioner received the 2,450 shares. in 1927, and their fair market value at that time was taxable income of the petitioner for 1927. The figures are not in dispute. The only question is whether there was any realization of income in 1927.

The petitioner states in its brief that it relies upon two points, one that “the date of acquisition, for income tax purposes, of said Reagan County Purchasing Company stock was December 8, 1924”, and the other that the stock was acquired in 1924 in a nontaxable exchange. The original certificate issued in the name of the petitioner was dated December 8, 1924. The petitioner contends that, since the stock was issued “fully paid and nonassessable” in 1924 for a consideration which passed at that time and there was no uncertainty about the- production of the petitioner, the petitioner acquired title to 2,450 shares at that time. It says the only uncertainty was whether the other group of producers would qualify to take the other one-half of the 4,900 shares making up the 49 percent.

However, the parties agreed to withhold the vesting of title and they could not sell the shares until the test period was over and their agreement was filed with the escrow agent. Furthermore, the evidence fails to show that there was no uncertainty in 1924 about the ability of the petitioner to deliver its full quota of 10,000 barrels per day during the period December 1,1925, to December 1,1926. It was producing only about 4,000 barrels daily at that time. The evidence is merely that its officers firmly believed it would produce its full share and that its territory and production were then better than those of the other group. But, what is more important, actual receipt, not the certainty of receiving income, is the basis of reporting. Sec. 213 (a), Revenue Act of 1926. The petitioner did not actually receive the stock until 1927. Why and upon what theory should its value have been taken into income prior to that time? Constructive receipt is the only theory upon which to base the petitioner’s argument.

The petitioner .argues that if there were conditions precedent to the vesting in it of title to 2,450 shares, then the events (the delivery of oil during the test period) occurred and title passed at the close of the period on December 1, 1926. But after that the parties were allowed a reasonable time to agree as to the ownership of the stock and file their agreement with the escrow agent .and the issuing company. These were also conditions precedent to the vesting of title to any definite number of shares in the petitioner. Until that writing was filed the escrow agent was to hold the stock as originally placed with it. Then, and only then, were the producers entitled to new certificates in definite .amounts. The escrow for the benefit of the preferred stockholders was an independent arrangement restricting the sale of the 4,900 shares.) It happened to be terminated at the same time that the producers filed their agreement. Still, the escrow agent held the shares in an indefinite .amount for the benefit of the producers until they agreed upon definite amounts and filed their agreement with the escrow agent. The petitioner’s right to any specific shares was contingent until the oil was delivered and the agreement filed. Even if title vested prior to 1927, the income was not taxable until 1927. Cf. K. E. Merren, 18 B. T. A. 156 (affirmed on another point, 51 Fed. (2d) 44); Otto Braunwarth., 22 B. T. A. 1008.

Constructive receipt is a fiction and is sparingly applied. It ought not to be invoked to permit a taxpayer to escape tax except, perhaps, in a very clear c,ase and for some unusual reason which does not presently occur to us. If property is credited or set aside for a taxpayer, subject to his unqualified demand without any substantial limitation or restriction, it may, under some circumstances, be regarded as constructively received for income t,ax purposes prior to its actual receipt. The petitioner has not shown that the 2,450 shares were unqualifiedly subject to his demand prior to 1927. The evidence indicates that there were substantial limitations and restrictions on the petitioner’s rights to any shares prior to 1927 when the producers filed their agreement of division as required by the agreement of October 22, 1924. The petitioner would have had a valid defense had the Commissioner tried to tax this income as constructively received in any year prior to 1927. Cf. Stoner v. Commissioner, 79 Fed. (2d) 75; North American Oil Consolidated v. Burnet, 286 U. S. 417, 423; Preston R. Bassett, 33 B. T. A. 182. The petitioner does not w,ant it shifted to 1926 but contends only that it was income in 1924. In that, the petitioner is clearly wrong.

The petitioner next makes a brief argument that the shares were acquired in 1924 in a nontaxable exchange. It cites section 203 (b) (4) of the Revenue Act of 1924, which is as follows:

(4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the casé of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

The Marland Oil Co. subscribed ,and paid in cash for preferred stock, not at once but as the cash was needed, and it also subscribed and paid in cash for 51 percent of the common stock of the Reagan County Purchasing Co. The producers transferred nothing to the new corporation, but merely entered into contracts with it. Neither the petitioner nor any other producer received any certain amount of the stock or securities of the new corporation in 1924 and it could not have been said in 1924 that “The amount of stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.”' The respective interests in “the property” prior to the “exchange” could not have been determined either. We do not think the section applies or was intended to apply to such a transaction as took place in 1924.

Decision will be entered for the respondent.


text:
    Manchester Savings Bank and Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79658.
    Promulgated September 29, 1936.

      Walter W. MeVay, Esq., for the petitioner.

      Owfen W. Swecker, Esq., for the respondent.
   OPINION.

Hill :

This is a proceeding for the redetermination of a deficiency in income tax for the year 1932 in the amount of $1,552.44. The issues raised by the pleadings are (1) whether respondent erred in failing to treat the return filed for the year 1932 as a consolidated return of petitioner and its affiliate, the Manchester Realty Co., or, on the other hand, to permit the filing of a consolidated return for said companies; and (2) whether respondent erred in determining that petitioner realized a profit in the taxable year upon the liquidation of its affiliate, computed on the basis of reducing the cost to petitioner of the stock of the affiliate in the aggregate amount of losses sustained by the affiliate during the period of affiliation as reflected in the consolidated returns filed during such period.

The facts were stipulated by the parties as follows :

The Manchester Savings Bank and Trust Company owned all of tbe capital stock of the Manchester Realty Company from 1917 to the date of its liquidation in 1932.
From 1917 to 1931, inclusive, the Manchester Savings Bank and Trust Company filed consolidated returns in which it reported the net income and net losses of the Manchester Realty Company for each of the respective years.
For the year 1932 the Manchester Savings Bank and Trust Company filed a separate income tax return, no return whatsoever being filed by the Manchester Realty Company.
The net income and net losses of the Manchester Realty Company for the years 1917 to 1931, inclusive, as reflected in the consolidated returns, were as follows:
The respondent computed the gain on liquidation as follows:
Value of assets received from Manchester Realty Company, $13,169.45; cost of stock, $9,500.00, less losses sustained by the Manchester Realty Company and deducted on consolidated returns filed by Manchester Savings Bank and Trust Company, $5,745.12; net cost, $8,754.88; gain on liquidation, $9,414.57.
The value of the assets received by the Manchester Savings Bank and Trust Company from Manchester Realty Company upon liquidation, in the amount of $13,169.45, and the cost of stock'of the Manchester Realty Company to the Manchester Savings Bank and Trust Company, in the amount of $9,500.00 are agreed upon.

The first point on which petitioner complains is that respondent erred in failing to treat its separate return filed for the' taxable year as a consolidated return, or, on the other hand, to permit the filing of a consolidated return, for itself and subsidiary. The purpose of this contention is to bring petitioner within article 37 (a) of Regulations 78, promulgated under the Revenue Act of 1932, which provides that gain or loss shall not be recognized upon a distribution during a consolidated return period, by a member of an affiliated group, in cancellation or redemption of all. or any portion of its stock; and that any such distribution shall be considered an inter-company transaction.

Under the provisions of section 141 of the 1932 Act, petitioner had the privilege of filing a consolidated return for the taxable year by consenting to and complying with the regulations issued thereunder. It did not elect to exercise such privilege, but filed a separate return, which was accepted by respondent and its tax liability determined thereon. It was prohibited thereafter from changing its method of reporting for such year by article 10 of Regulations 78, which provides that the privilege of making a consolidated return for any taxable year of an affiliated group must be exercised at the time of making the return of the common parent corporation for such year, and under no circumstances can such privilege be exercised at any time thereafter. These regulations, being in conformity with the statute and issued pursuant to its expressed authority, have the same force or effect as statutory provisions. We-think respondent did not err in the particulars alleged, and the provisions of article 37 (a), supra, that neither gain nor loss shall be recognized from a liquidation occurring during a consolidated return period has no application here, since the liquidation of petitioner’s subsidiary did not take place during such period.

The second and principal contention of petitioner is that respondent erred in computing the profit realized upon the liquidation of its subsidiary by reducing the cost basis of the subsidiary’s stock in the aggregate amount of losses sustained by the subsidiary in prior years and reflected in consolidated returns filed by the affiliated group for such years.

Article 37 (b) of Regulations 78 provides that any distribution in liquidation by a member of an affiliated group after a consolidated return period shall be treated as a sale of the stock, and article 34 provides that from the base there shall be deducted the sum of the losses of the issuing corporation sustained during each of the consolidated return periods.

These regulations are in harmony with G. G. M. 11676, C. B. XII-1, p. 75, in which appears an extended discussion of consolidated returns of affiliated corporations for 1932 and subsequent taxable years, including an analysis of court and Board decisions on the general subject. It is now well settled by the decisions (1) that upon the surrender and cancellation of stock in complete liquidation of a subsidiary the liquidation occurs after the termination of affiliation, and any gain derived or loss sustained should be reported in the separate return of the parent company for the taxable year immediately following the termination of affiliation; and (2) that in computing gain or loss from such liquidation the parent’s investment in the subsidiary’s stock should be reduced by the aggregate amount of the subsidiary’s operating losses used in preceding consolidated returns to offset the income of the parent company, such operating losses not to be diminished by prior operating profits of the subsidiary for any year reported in the consolidated returns. This rule is applicable to all years, including 1932, where the liquidation occurs after a consolidated return period. See Riggs National Bank, 17 B. T. A. 615; aff'd., 57 Fed. (2d) 980; Burnet v. Aluminum Goods Manufacturing Co., 287 U. S. 544; Commissioner v. National Casket Co., 78 Fed. (2d) 940, modifying 29 B. T. A. 139.

However, petitioner says that the above cited decisions rest fipon the theory that by filing the consolidated returns and using the operating losses of the subsidiary to offset its own taxable income, the parent corporation for tax purposes thereby in effect reduces pw tanto its investment in the subsidiary’s stock, but where such result is not effected by the filing of consolidated returns this principle should not be applied. Petitioner further asserts that if the affiliated corporations involved here had filed separate iristead of consolidated returns for the years prior to 1932, each would have been entitled, under section 236 (b) of the Revenue Acts of 1924 and 1926, to a specific credit of $2,000, and that if separate returns had been so filed there would have been a greater saving in tax than was effected by the filing of consolidated returns in which the subsidiary’s operating losses were deducted. Petitioner contends, therefore, that the rule established by the cited decisions should not be applied in the present'case.

We are not impressed by this argument. Tax liability must be determined upon the basis of what was actually done, not upon events which might but did not happen. Petitioner filed consolidated returns for itself and affiliate for th,e years prior to 1932, and for the latter year it filed a separate return. Petitioner must now abide by its election and suffer the disadvantages, if any, as well as enjoy the benefits, resulting therefrom.

In any event, the fact remains that by filing consolidated returns for the prior years petitioner received the benefit of the subsidiary’s operating losses by way of deductions from its own taxable incom,e, and it may not again deduct the same amounts in computing the taxable profit derived upon liquidation of its subsidiary. Whether or not it might have effected a further saving of tax by reporting on a different basis is immaterial.

Respondent’s determination is approved.

Judgment will be entered for the respondent.


text:
    Elton Hoyt, 2nd, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62905, 64691, 64710-64712, 70951-70954.
    Promulgated September 29, 1936.

      John B. Putnam,, Esq., for the petitioners.

      P. A. Bayer, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: H. 6. Dalton; H. G. Dalton, W. G. Mather and S. L. Mather, Executors, Estate of Samuel Mather; S. E. Bool; William McLauchlan, II, S. E. Bool, J. B. Putnam, Executors, Estate of William McLauchlan.

   OPINION.

Mellott :

In these proceedings which were consolidated for hearing and determination, petitioners contest the following deficiencies in income taxes determined by the respondent:

The sole issue presented for our determination is what part, if any, of the distributions received by the petitioners from the Hemlock River Mining Co. during the years 1929 and 1930, is taxable as dividends received. The facts, all of which were stipulated, may be briefly summarized.

The Hemlock River Mining Co. had outstanding on March 1, 1913, 20,000 shares of common stock of a par value of $25 per share on which $9.50 per share, or a total of $193,000, had been paid in by its stockholders. The balance of the subscription price, to wit, $15.50 per share, had not been called at that time. The company called the balance of the subscription to its capital stock, $15.50 per share, in the year 1925, and during the latter months of that year and the early months of 1926, the full amount aggregating $310,000 was paid in by the stockholders, making a total of $500,000 of paid-in capital.

On March 1, 1913, the corporation had $122,379.39 accumulated earned surplus in excess of its then paid-in capital of $190,000. Its net income for the last ten months of 1913, and its net income or loss for each of the calendar years thereafter, to and including 1930, computed by including nontaxable income and deducting Federal taxes and other unallowable expenditures, and without reference to any deduction for depletion of discovery or other valuation of mines, and its surplus or capital deficit at the beginning of each year are as shown in the following table:

In 1933 the respondent found that the Hemlock River Mining Co. had discovered its Warner mine in 1921, and determined that the fair market value (in excess of cost, if any) of the company’s interest in this mine as of the date of discovery, or within 30 days thereafter, and for the purposes of determining discovery depletion allowance as provided in section 114 (b) (2) of the Revenue Act of 1928, and similar provisions of prior revenue acts was $501,512. The estimated tonnage on which this valuation was based was 1,253,930 tons, resulting in a per ton value of 40 cents.

The tonnage of ore shipped from the Warner mine in each year from 1921 to 1930, inclusive, and the result of multiplying such tonnage for each year by 40 cents, are shown in columns I and II of the schedule set out below. In column III of the schedule are shown the amounts allowable as deductions for depletion based upon the discovery value of the Warner mine, computed in accordance with the provisions of the revenue acts in effect for said years:

The Hemlock River Mining Co. made no distributions to its stockholders, as dividends or otherwise, after March 1, 1913, until December 31, 1929. On that date it distributed $200,000, or $10 per share on each outstanding share of capital stock. On December 24, 1930, it distributed $120,000, or $6 per share on each outstanding share of its capital stock. The issue before us is the treatment to be accorded the amounts received by these petitioners, as stockholders, through such distributions. In their income tax returns for the years 1929 and 1930 they reported no part of such distributions as taxable dividends.

The number of shares owned by the petitioners, and the amounts received, are as follows:

During the years 1929 and 1930 the basis of all stock of the Hemlock River Mining Co. owned by petitioners was in excess of $16 per share.

The respondent computed the results of the operation of the Hemlock River Mining Co. from 1913 to 1929, inclusive, as follows :

Earned Surplus Marcli 1, 1913-$122,679.39
Earned Surplus from Discovery in 1921_ 501, 572. 00
Total_$624,251.39
Net Losses 1913-1927, inclusive, (before Depletion)_$269,724.13
Depletion sustained_ 251, 091. 60 - 520,815.73
Balance earned surplus as at December 31, 1927_ 103,435. 66
1928 Net Income (Before Depletion)_ 77,735. 50
1928 Depletion sustained_ 62,176. 40
1928 Earnings available for dividends_ 15, 559.10
1929 Net Income (Before Depletion)_ 147,880.44
1929 Depletion sustained- 68, 662. 40
1929 Earnings available for dividends- 79,218. 04
Total 1928 and 1929 Earnings available for dividends_ 94, 777.14

Based upon the above computation the respondent determined that $94,777.14, or 47.3885 percent of the distribution of $200,000 paid by the company on December 31, 1929, represented taxable dividends in the hands of the stockholders. He also determined that the company had net earnings or profits before depletion of $160,581.75 for the year 1930, and in that year sustained depletion based on discovery value of $67,322.80, which left available earnings of $93,258.95 for the entire year; that $91,214.91 of the $93,258.95 was available on December 24, 1930, when the distribution of $120,000 was made; and that 76.0125 per cent of the distribution represented taxable dividends when received by the stockholders.

The petitioners compute the results of the operations of 'the Hemlock River Mining Co. from 1913 to 1930, inclusive, as follows:

The petitioners contend that neither at the time of the distribution in 1929, nor at the time of the distribution in 1930, did the Hemlock River Mining Co. have any accumulated earnings or surplus from which dividends could be declared; that the distributions miade must have been and were from accumulated discovery depletion reserve funds and from capital; and that inasmtuch as the stipulated tax basis of the stock of each taxpayer at the time of the receipt of such distributions exceeded the total of all distributions, no taxable income is chargeable to the taxpayers on account of such distributions.

The pertinent provisions of the Revenue Act of 1928 are shown in the margin.

Whether or not any part of the distributions received by petitioners represented taxable dividends depends upon whether the Hemlock River Mining Co. had, at the time such distributions were made, any earnings and profits accumulated after February 28,1913. This can be ascertained only by determining two questions, namely (1) the treatment which must be accorded the discovery value allowed to the corporation for the purpose of depletion; and (2) the treatment which must be accorded the earnings, which the petitioners contend were in a depletion reserve based upon the discovery value of the Warner mine, at the time the distributions were made.

The respondent has treated the discovery value as earned surplus, and argues that it represents the basis upon which the allowances for depletion are based; that it is a recognized asset of the corporation which should be set up on its books; and that without this asset-there is nothing against which to allow depletion.

As a general rule the basis used for depletion is the same as the Basis used for computing gain or loss upon the sale of property. Depletion based upon discovery value is, however, an exception to this general rule. The discovery depletion provision first appeared in the Revenue Act of 1918. It was enacted to stimulate prospecting and exploration. Congress deliberately gave to taxpayers discovering mineral properties, if such discoveries increased the value of their holdings to an extent materially disproportionate to cost, the right to receive a portion of the increased value free of tax. Melville G. Thompson, 10 B. T. A. 25. The taxpayer making the discovery was permitted to value “his capital investment for purposes of depletion at the date of discovery rather than at its original cost.” Palmer v. Bender, 287 U. S. 551.

In computing the earnings and profits of a corporation available for distribution as dividends, its assets are generally included at cost, less depletion or depreciation. Appreciation in the value of such assets at the time of the computation is not taken into consideration. In LaBelle Iron Works v. United States, 256 U. S. 377, the Supreme Court said:

* * * There is a logical incongruity in entering upon the books of a corporation as the capital value of property acquired for permanent employment in its business and still retained for that purpose, a sum corresponding not to its cost but to what probably might be realized by sale in the market. It is not merely that the market value has not been realized or tested by sale made, but that sale cannot be made without abandoning the very purpose for which the property is held, involving a withdrawal from business so far as that particular property is concerned. * * ⅜

It has been stipulated that the discovery value of $501,572 was in excess of cost, if any. As no cost has been shown, we interpret this to mean that the entire discovery value exceeded cost and represented unrealized appreciation in the value of the property resulting from the discovery of the Warner mine. To include this unrealized appreciation in the value of the property in the computation of earnings and profits, as the respondent has done, and at the same time disregard the unrealized appreciation in the value of other assets, would be inconsistent and would result in an erroneous computation of the corporation’s earnings and profits to the extent that the discovery value exceeded cost.

The sole purpose of the legislation authorizing the determination of a discovery value in the case of mines was to grant taxpayers an extraordinary basis for computing the depletion deduction; but its significance ends in the deduction section of the statute, S. T. Hunt, 4 B. T. A. 1077, and the respondent erred in including it as part of the earned surplus of the corporation as he has done here. Cf. Chapman v. Anderson, 11 Fed. Supp. 913; Margaret P. Daly, 32 B. T. A. 965.

The second question is the treatment to be accorded that portion of the earnings which both parties have treated as being in a depletion reserve based upon, the discovery value of the Warner mine when distributed to these petitioners. In Charles F. Ayer, 12 B. T. A. 284, this Board, in discussing the difference between a depletion allowance based upon cost or March 1, 1913, value and a depletion allowance based upon discovery value, said:

* ⅜ * A depletion allowance based npon tbe cost or March Í, 1913, value oí a natural resource which is being removed and used up represents a return to the owner thereof of parts of the actual cost or March 1, 1913, value of the property. But inasmuch as the total of these allowances can never exceed the cost or March 1, 1913, value of the property, the return of these amounts can never represent a profit to the owner. A depletion allowance based upon so-called discovery value ⅜ * ⅜ permits the corporate owner of the natural resource to have returned to it untaxed a portion of its gross income greater in amount than the basis for gain on the sale or other disposition of the property, and the Commissioner has held that this excess is earnings or profits accumulated since February 28, 1913, subject to tax as dividends when distributed to the stockholders. It represents earnings or profits of the corporation accumulated after February 28, 1913,' which were realized from an increase in value accrued since March 1, 1913.
* * * * ⅜ * ⅜
* ⅜ ⅜ The fact that the statute .permits a corporation to deduct from its gross income an amount in excess of the basis for gain on the sale or other disposition of its property, which excess represents a profit to the corporation, does not change the fact that such profit has been realized, ⅜ ⅜ ⅜

The Ayer ease was decided under the Revenue Act of 1921. In the decision it was pointed out that, while under the provisions there under consideration taxable dividend distributions might be made from depletion reserves based upon discovery value, a change was made in the 1924 Act, (sec. 201 (d)) which rendered distributions from such reserves not taxable to the stockholders as ordinary dividends. The 1924, 1926, and 1928 Acts provided, in effect, that any distribution made from a depletion reserve based upon the discovery value of a mine should be applied against and reduce the basis of the stock, and if in excess of such basis, that such excess should be taxable in the same manner as a gain from the sale or exchange of property. (See section 201 (d), Revenue Acts of 1924 and 1926, section 115 (d), Revenue Act of 1928.)

The 1928 Act is applicable to the distributions made in 1929 and 1930. In 1929 the Hemlock River Mining Co. had earnings of $147,880.44. Of these earnings $68,662.40 were proper additions to a depletion reserve account based on the discovery value of the Warner mine. The remaining earnings of $79,218.04 could have been distributed to the stockholders as dividends were it not for the fact that on December 31, 1928, the Hemlock River Mining Co. had an operating deficit which, computed in accordance with the decision of the Supreme Court in Helvering v. Canfield, 291 U. S. 163, amounted to $69,309.24. It is now well settled that an operating deficit must be made good out of accumulated earnings before taxable dividends can be declared. Hadden v. Commissioner, 49 Fed. (2d) 709; Louise Glassell Shorb, 22 B. T. A. 644; Arthur C. Stifel, 29 B. T. A. 1145.

After restoring the deficit existing on December 31, 1928, the accumulated earnings available for distribution as dividends on December 31, 1929, amounted to $9,908.80. It is our conclusion, therefore, that $9,908.80 of the $200,000 distribution made by the Hemlock River Mining Co., on December 31,1929, represented accumulated earnings taxable as dividends when received by its stockholders. The balance of the distribution had to come either from the gross receipts from the Warner mine which had been set aside in its depletion reserve based upon discovery value, or from capital. In either case the proportionate part thereof, received by these petitioners, is exempt from tax, as it did not exceed the basis of their stock. (Sec. 115 (d), supra.)

Before considering the distribution made by the Hemlock River Mining Co. in 1930, we desire to refer briefly to the treatment given to depletion sustained or allowable in the computations made, both by petitioners and by respondent. They treat such depletion as decreasing the amount of the accumulated earnings and profits available for distribution as taxable dividends. This could only be done on the theory that it was set aside by the corporation in a depletion reserve, as otherwise it would not decrease the amount of surplus available for dividends. But petitioners are in error in treating the depletion added to the reserve in each year as increasing the amount of any deficit which the corporation might have had at that time. Any gross receipts of the Warner mine set aside in the depletion reserve were in excess of cost and were profits of the corporation. They represented realized appreciation in the value of property. Placing them in a depletion reserve account did not change their character as profits nor affect the corporation’s deficit. Margaret P. Daly, supra. How, then, should the distribution of $120,000 in 1930, be treated?

We have determined that the Hemlock River Mining Co. had no operating deficit at the end of 1929. Its earnings during the year 1930 amounted to $160,581.75. It sustained and was allowed $67,322.80 as depletion. We hold that this amount could be, and properly was, placed in its depletion reserve account. It therefore had earnings available for distribution during the year 1930 amounting to $93,258.95. Ninety-one thousand two hundred fourteen dollars and ninety-one cents of such earnings was available for distribution on December 24, 1930, and was included in the distribution made on that date. It is, as found by respondent, 76.0125 percent of the total distribution; and. the pro-rata portion thereof received; by these petitioners'is-taxable to them as a dividend under section .115 (a) of the Revenue Act of 1928, supra. .The balance of :such .distribution came from the depletion reserve based upon discovery value or from capital-, and as it did not exceed The- basis of petitioners’ stock, is -not- taxable (sec. 115 (d)). - ,

An issue relating to the deduction of contributions was settled by stipulation of the parties filed at the hearing. It will be given effect upon settlement under Rule 50. ;

Eeviewed by the Board.

Judgment will be entered under Rule 50.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      (a) Definition of dividend- — The term “dividend” when used in this title (except in section 203 (a) (4) and section 208 (e) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
      (b) Source of distributions. — For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 113.
      * # * * * ★ *
      (d) Other distributions from capital. — If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. The provisions of this subsection shall also apply to distributions from depletion reserves based on the discovery value of mines.