author: Smith :

text:
    William Phillips, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106062.
    Promulgated March 27, 1942.

      Harold L. Clark, Esq., for the petitioner.

      Martin M. Lore, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax for the year 1937 in the amount of $1,941.07. The single question presented for our consideration is whether the petitioner is entitled to a deduction for a bad debt ascertained to be partially worthless during the taxable year.

The petitioner is an individual residing in Boston, Massachusetts. The return for the taxable year was filed with the collector of internal revenue for the district of Massachusetts.

All of the evidence is contained in a written stipulation of facts filed by the parties and we adopt the stipulation as our findings of fact. The material facts are stated therein as follows:

6. The taxpayer on October 22, 1909, loaned $22,000 on a promissory note signed by one Lillior T. Nutting, said promissory note being for $22,000 payable five years from said date with interest payable semiannually at 3% per centum per annum, secured by a power of sale first mortgage of real estate located at 435 Beacon Street, Boston, Massachusetts. * * *
7. Thereafter interest payments on said note were made regularly by successive owners of said real estate to October 22, 1930; and three payments of $1,000 each in reduction of the principal of the obligation were so made on January 24, 1928, July 22,1929, and October 1,1929, respectively, thereby reducing the unpaid balance to $19,000.
8. Interest accrued after October 22,1930, was defaulted on April 22,1931.
9. On May 8,1931, the then owner of the said real estate, namely, A. F. Baker & Co. Inc., voluntarily and without payment of money or the receipt of other consideration therefor executed and delivered to one Gertrude L. Victory, a deed conveying title to said real estate subject to said first mortgage.
10. Said corporation was not a maker, endorser, surety or guarantor on either the note or mortgage, and had never obligated itself to the petitioner or any other person to pay the same.
11. Neither the petitioner nor said Victory paid consideration to said corporation for the deed and neither entered into any agreements with the corporation in respect of the property or said note and mortgage.
12. Said Victory acted at all times as nominee or agent for the petitioner, herself claiming no beneficial interest in the property.
13. The property was assessed for the year 1931 by the City of Boston for tax purposes at $29,500 and at the time of said conveyance in 1931 it was deemed by the petitioner to have a value at least equal to the balance of $19,000 then due on said note and mortgage.
14. From May 8,1931 to May 3, 1937, the petitioner paid the expenses of maintaining the property, including taxes assessed thereon, receiving, however, no income since the property was not rented. During this period, petitioner endeavored through his agents to effect a sale at successively reduced prices. In 1937, one Sioris, made an offer of $10,000 which was accepted by said Victory with approval of the petitioner or his attorney, said price to be paid solely by his assumption of said mortgage, reduced in amount to $10,000.
15. On May 3,1937, said Victory at request of the taxpayer’s attorney executed and delivered a deed conveying title to said real estate to said Sioris subject to said mortgage, and said deed contained the following paragraph, viz:
“Said premises are hereby also conveyed subject to a certain mortgage given by Lillior T. Nutting to William Phillips dated October 22, 1909, and recorded with said Deeds in Book 3401, Page 206, upon which mortgage there remains unpaid the sum of Ten Thousand (10,000) Dollars, and which mortgage the grantee hereby assumes and agrees to pay.” ***#*!}: *
16. No consideration was paid by said purchaser, Sioris, other than by his assumption of said mortgage, reduced to the said sum of ten thousand dollars, as aforesaid.
17. On May 3,1937, said mortgage was extended by an agreement between said petitioner and said Sioris. * * *
18. On May 1, 1937, in anticipation of said conveyance to Sioris, the taxpayer by his attorney endorsed upon said mortgage note the following, viz:
“May 1, 1937. It is hereby acknowledged that the amount of principal remaining unpaid on this note is $10,000, and that interest thereon to this date has been paid or satisfied.”
19. From and after October 1, 1929 to May 1, 1937, the petitioner carried said mortgage note on his books at a value of $19,000. On May 1, 1937, the petitioner by his attorney and agent charged off on his books of account kept by said attorney and agent in respect of said mortgage note the sum of $9,000, reducing the same on his books to $10,000. At no time here material did the petitioner show the property itself as an asset on his books. He elected not to merge the title and mortgage but sought to avoid that result by refraining from foreclosure or accepting legal title.
20. The then value of said mortgage note, secured as aforesaid, did not exceed $10,000 which represented the then full and fair market value of the mortgaged real estate and the price thereof paid in manner aforesaid by said Sioris.
21. The original mortgagor and maker of the mortgage note, Lillior T. Nutting, was a “professional straw” and acted as such in taking title and signing the note and mortgage. Nutting was without ability to pay the obligation otherwise than by application of the security therefor, and no other person prior to May 1, 1937, ever became obligated to pay said mortgage. An unsecured claim against Nutting was without value in 1937 and at all other times here material, and in 1937 the claim against him was barred by statute of limitations.

The petitioner contends that the mortgage debt was partially worthless to the extent of $9,000 in 1937 and that, having charged off that amount, he is entitled to a bad debt deduction in accordance with section 23 (k) of the Revenue Act of 1936, which provides as follows:

SEC. 23. DEDUCTIONS PROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
*******
(k) Bad Debts. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

In order to establish his right to a bad debt deduction the petitioner must prove that there was in fact a valid indebtedness outstanding during the taxable year. The respondent argues that the debt was extinguished when petitioner, through his nominee, reacquired the property in 1931 because at that time the legal and equitable interests in the property merged. The respondent has determined that the transaction in the taxable year constituted a sale or exchange of a capital asset and that the loss sustained by the petitioner is limited by the provisions of section 117 (d) of the Revenue Act of 1936. Petitioner contends that there was no merger of interests and that the debt remained outstanding after 1931 and during the taxable year.

It is not necessary for us to discuss the technical doctrine of merger of interests in this proceeding. We may assume that the legal title and the equity of redemption did not merge in the petitioner. Thus, the note remained outstanding as a valid legal obligation of the maker against whom the petitioner might then have had recourse for payment. Cf. Silverstein v. Saster, 285 Mass. 453; 189 N. E. 540. It is perfectly clear, however, that nothing could have been collected from the maker at any time. He was a professional judgment-proof straw man and this fact was known to petitioner. Except for the .security of the property the mortgage note was worthless at all times. This security was conveyed to the petitioner by the owner on May 8, 1931, by a deed made voluntarily and in lieu of foreclosure. The conveyance was made to petitioner’s agent, but the agent claimed no beneficial interest in the property and held it for the petitioner, who paid all taxes and was entitled to any income. The only possible conclusion is that the property belonged to the petitioner after May 8, 1931. The cost to him of the property was the unpaid principal of the mortgage note. If in 1937 the petitioner had sold the property at a profit, that profit would have been taxed as capital gain. He sold the property, however, at a loss. That loss was a capital loss as determined by the respondent in the determination of the deficiency.

The respondent’s disallowance of the claimed worthless debt in 1937 is approved.

Decision will be entered for the respondent.


source: Caselaw Access Project

author: HaRROn:

license: Public Domain

text:
    The Stollberg Hardware Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100791.
    Promulgated March 31, 1942.

      F. A. Harrington, Esq., and H&nry W. Seney, Esq., for the petitioner.

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

HaRROn:

In making its income and excess profits tax return for the fiscal year ended September 30, 1936, the taxable year, petitioner computed gain or loss on the disposition of the inventories and on the realization of the accounts and notes receivable, and depreciation on the depreciable assets, all of which it had acquired from the old company, by using the basis of those assets in the hands of that company. In the hands of the old company the basis of the inventories was $112,966.27 and of the accounts and notes receivable was $65,588.76; and the basis of the depreciable assets after adjustment for depreciation was $11,481.14.

Respondent determined that petitioner was not entitled to use the basis of the assets in question in the hands of the old company and that the correct basis of the assets in question was the cost thereof to petitioner. He determined that all of the assets acquired by petitioner had a total cost to it of $129,965.91 and that the cost to it of the assets in question was as follows: inventories, $74,006.36; accounts and notes receivable, $42,968.45; and depreciable assets, $7,521.53.

Petitioner bases its claim that the correct basis of the assets in question was the same as in the hands of the old company on section 113 (a) (7) of the Revenue Act of 1934, the pertinent provisions of which are set forth in the margin. The first requisite for the application of section 113 (a) (7) is that the assets in question be acquired by petitioner “in connection with a reorganization.” The definition of the term “reorganization” as used in section 113 (a) (7) is provided by section 112 (g) (1), the provisions of which are set forth in the margin. Petitioner argues that the transaction in which it acquired the assets of the old company was a reorganization within the meaning of both subdivisions (C) and (E), but especially within the meaning of subdivision (C), of section 112 (g) (1).

The transaction in which petitioner acquired the assets of the old company was not a reorganization within the meaning of subdivision (C) of section 112 (g) (1). Subdivision (C) requires that “immediately after the transfer the transferor or its stockholders or both” be in “control” of the transferee. “Control” is defined in section 112 (h) as “the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.” In this case it is clear that immediately after the transfer “control” of petitioner was neither in the old company nor in its “stockholders.” Helvering v. Southwest Consolidated Corporation, 315 U. S. 194. Contrary to petitioner’s contention, the creditors of the old company could not be regarded as its “stockholders” within the meaning of subdivision (C). Helvering v. Southwest Consolidated Corporation, supra; cf. Commissioner v. Cement Investors, Inc., 122 Fed. (2d) 380. The stockholders of the old, transferor corporation did not own 80 percent of the voting stock or 80 percent of the shares of all other classes of stock of the new corporation, petitioner.

Nor was the transaction a reorganization within the meaning of subdivision (E) of section 112 (g) (1). In Helvering v. Southwest Consolidated Corporation, supra, the Supreme Court made the very pertinent observation that “a transaction which shifts the ownership of the proprietary interest in a corporation is hardly ‘a mere change in identity, form, or place of organization’ within the meaning of clause E.”

It follows that section 113 (a) (7) is not applicable.

The correct basis of the assets in question was thus the cost of such assets to petitioner. Sec. 113 (a). Petitioner acquired the assets of the old company by paying cash in the amount of $23,721.80, by assuming liabilities in the amount of $44,544.11, and by issuing 617 shares of preferred stock and 1,617 shares of common stock. Part of the cost was represented by a total of $68,265.91 in cash paid and in liabilities assumed. The balance of the cost was represented by the 617 shares of preferred stock and 1,617 shares of common stock issued. The measure of the part of the cost represented by the shares of stock was the fair market value thereof at the time of issue. Amerex Holding Corporation, 37 B. T. A. 1169; affd., 117 Fed. (2d) 1009; certiorari denied, 314 U. S. 620. Petitioner contends that the fair market value of the shares of stock at the time of issue should be measured in turn by the fair market value of the assets of the old company at that time less the total of $68,265.91 in cash paid and in liabilities assumed. See Amerex Holding Corporation, supra.

In our opinion the fair market value of the shares of stock at the time of issue should be measured by the fair market value of the assets of the old company less $68,265.91. In this case the fair market value of the assets (less $68,265.91) is the best evidence of the fair market value of the shares of stock issued therefor. See Amerex Holding Corporation, supra. The use of the 617 shares of preferred stock and 1,617 shares of common stock, issued for the assets of the old company, was fixed and determined by the amended plan of reorganization prior to their authorization, and was limited and restricted by that plan to the very use to which they were put. See Amerex Holding Corporation, supra. It is true that 185 units consisting of one share of preferred stock and one share of common stock were sold for $100 per unit in connection with the organization of petitioner. However, the number of shares of stock so sold was relatively small in comparison with the number of shares of stock issued for the assets of the old company; and about two-thirds of the number of shares so sold were sold to parties who already had an interest in the old company either as creditors or as stockholders. Under the circumstances the sale of the 185 units of stock at $100 per unit does not provide the best evidence of the fair market value of the shares of stock issued for the assets of the old company. Amerex Holding Corporation, supra; cf. West Point Investment Co., 1 B. T. A. 436, with Young & Vann Supply Corporation v. United States, 10 Fed. Supp. 697, and John J. Flynn, 35 B. T. A. 1064. In view of the limitations and restrictions on the use of the shares of stock issued for the assets of the old company, the best evidence of the fair market value of such shares is provided by the fair market value of the assets (less $68,265.91). Amerex Holding Corporation, supra.

The record satisfies us that the assets acquired by petitioner from the old company had a total fair market value at the time of acquisition of $195,910.63 ■; and that the fair market value of the inventories was $112,966.27; of the accounts and notes receivable, $65,588.76; and of the depreciable assets, $11,481.14. Thus the fair market value of the shares of stock issued for the assets was $195,-910.63 less $68,265.91, or $127,644.72; and the total cost of the assets to petitioner was $195,910.63. The total cost of $195,910.63 was allo-cable in part as follows: $112,966.27 to inventories, $65,588.76 to accounts and notes receivable, and $11,481.14 to depreciable assets. See Hazeltine Corporation, 32 B. T. A. 4; Regulations 94, art. 23 (l)-4.

Petitioner concedes that respondent correctly disallowed two deductions totaling $271.10. Respondent allowed three deductions totaling $16,733.20 which were not taken on petitioner’s original return. Therefore, there is no deficiency and there is an overpayment in income tax for the taxable year. The amount of the overpayment will be determined on computation under Eule 50. It has been found as a fact that petitioner paid $2,708.10 in income tax for the taxable year within three years before filing a claim for the refund of $2,129.93 in income tax for such year.

Eeviewed by the Board.

Decision will be entered umder Rule SO.

Murdock. concurs only in the result.

      The amount of $129,065.91 appears to be the total of the following amounts: $61,700, the total par value of the 617 shares of preferred stock issued by petitioner to the assenting creditors of the old company; $443.17, the net amount paid by petitioner to assenting creditors of the old company for fractional shares; $23,278.63, the total amount paid by petitioner to nonassenting creditors of the old company; and $44,544.11, the total amount of the liabilities of the old company or of the trustee assumed by petitioner.

       SEC. 113. adjusted BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (unadjusted) oí Property. — The basis of property shall be the cost of such property; except that—
      ***»*»•
      (7) Transfees to corporation where control of property remains in same persons. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. * * *

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      * * * * * * *
      (g) Definition of Reorganization.- — As used in this section and section 113.
      (1) The term “reorganization” means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock; of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E)i a mere change in identity, form, or place of organization, however effected.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.

        (h) Definition of Control. — As used in this section the term “control” means the ownership ot at least 80 per centum of the Toting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

       SEC. 113. adjusted BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (unadjusted) of Propertt. — The basis of property shall be the cost of such property; * * *

       It so happens that the basis of the assets in question to petitioner is approximately the same as the basis thereof to the old company at the time of the transfer of assets.


author: Arundell :

text:
    Prudential Financial Corporation of Quincy, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105634.
    Promulgated March 31, 1942.

      Sidney Oobacher, Esq., for the petitioner.

      Robert S. Garnett, Esq., for the respondent.
   OPINION.

Arundell :

The instant proceeding has been presented by the parties on the narrow question of whether the resolution of the board of directors of petitioner plus the entries on petitioner’s books in the taxable year constituted an irrevocable setting aside of an amount for the payment or discharge' of a debt. Although sections 26 (c) (2) and 351 (b) (2) (B), as amended, with which we are here concerned, contain different-requirements for the credit and deduction respectively granted, the parties seem agreed that the provisions of both sections are fulfilled if in fact petitioner irrevocably set aside the claimed amount in the taxable year. In order to obtain the benefit of the cited sections, petitioner must show that the amounts were set aside and that such setting aside was irrevocable. Accordingly, we shall consider the components of the phrase “irrevocably set aside” severally.

The resolution of the board of directors of petitioner directed that the amount in question be “irrevocably set aside in a special fund or reserve account * * * to be used exclusively for the retirement of the certificates of indebtedness' * * *.” In accordance with this direction an account entitled “Reserve for the retirement of Certificates of Indebtedness” was set up on petitioner’s books and the amount directed by the board of directors was credited thereto. Petitioner’s surplus account was charged with a corresponding amount. This treatment of the amount by petitioner without doubt constituted a setting aside. While it is true that the amounts were not delivered to a trustee, we do not think that material. If Congress had intended that the setting aside be accomplished by delivery to a trustee or other person outside the corporation, it would have made its intent known. Commissioner v. Strong Manufacturing Co., 124 Fed. (2d) 360.

We now turn to the question of whether the setting aside was irrevocable. The provisions of the contract between petitioner and the certificate holders required petitioner to “irrevocably set aside fifty per cent (50%) of its net earned income each calendar year for the retirement or payment of the principal amount of Certificates of Indebtedness outstanding * * This provision was a condition precedent to the purchase of certificates from petitioner. Thus it is clear that there was consideration for the resolution of the board of directors of petitioner. It is likewise clear that, because of the presence of such consideration, the book entries made pursuant to the resolution of the board of directors could not be reversed at the will of the directors. The rights of the certificate holders would intervene if petitioner attempted to treat the amount deposited in the special account as its own.

Nor does Securities Co. of New Jersey, 45 B. T. A. 1048, require a different result. In that case the resolution of the board of directors, coupled as it was with the appropriate book entries, was a purely voluntary act of the taxpayer. The contract with the creditors did not call for such setting aside and we found that there was no consideration for the action. In such circumstances the setting aside was not deemed “irrevocable.”

Respondent raises a further barrier to the coveted credits. The resolution of the board of directors stated that the amounts paid into the special account might be paid to the certificate holders, retained in the form of bank deposits, or “used to make loans if they are considered to be choice risks.” Inasmuch as petitioner is engaged in the business of making loans, respondent urges that the resolution, allowing as it does the investment of the funds in choice risks, in effect permits the use of the money in petitioner’s business. It is possible that the phrase read by itself may be so interpreted. The resolution provided, however:

That such sums so set aside from time to time in the special fund or reserve account shall be irrevocably set apart and shall not be used for any other purpose; and the Treasurer is hereby authorized and instructed to turn said funds over to the Certificate holders at any time if they request it in writing.

Thus read in its entirety, the resolution clearly prohibits the use of the funds of the special account in petitioner’s business. It seems clear that the investment of the funds in choice risk loans if made would enure to the benefit of the certificate holders rather than to the petitioner. It is not unusual that funds set aside for particular purposes be put to work -with proper safeguards rather than to lay idle and there have been times when the safety of such a fund was better guarded by this method than when left in the form of cash in the bank. However, if this be an objection it should be observed that the funds actually were retained in petitioner’s bank account at all times and were neither used in the business of petitioner nor in the making of choice risk loans.

The surtax on undistributed profits and the personal holding company surtax were designed to force a distribution of corporate earnings to the stockholders. But Congress recognized that there were many legitimate reasons which prevent corporations from distributing their entire earnings and the credit and deduction provisions were designed to care for these cases. There is no occasion to construe the sections before us so as to deny the very relief Congress sought to grant. The revenue may be safeguarded without so harsh a construction.

Our conclusion is that there was an irrevocable setting aside of the sum of $1,200 in the taxable year. It follows that petitioner is entitled to the claimed credit under section 26 (c) (2) for purposes of the surtax on undistributed profits and to the deduction from adjusted net income granted by section 351 (b) (2) (B), as amended, for purposes of the personal holding company surtax.

Decision will be entered for the petitioner,


author: Leech :

text:
    Oswego Falls Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102164.
    Promulgated March 31, 1942.

      Gerald H. Henley, Esq., and H. A. Mihills, O. P. A., for the petitioner.

      Loren P. Oakes, Esq., for the respondent.
   OPINION.

Leech :

The first issue is whether petitioner is entitled to a credit under section 26 (c) (1) of the Revenue Act of 1936 by reason of a provision of a written contract executed prior to May 1, 1936, expressly dealing with and restricting the payment of dividends. Petitioner relies on the mortgage indenture executed July 1, 1926, as a contract which operates as a restriction on the payment of dividends within the meaning of the statutory provision. It contends that section 38 of the mortgage, providing that “no dividend shall be paid or declared upon or set apart for the Preferred Stock ($750,000 issue) or for the Common Stock of the Company if such action will result in the reduction of its net current assets below One Million Dollars ($1,000,000)”, constituted an effective contractual restriction on the payment of dividends, thereby entitling it to the statutory credit. Respondent argues that the petitioner’s “net current assets”, as defined in the indenture, were not, at all times, below $1,000,000 during the taxable year. Moreover, he says that even if they were below this minimum amount, the petitioner was not prohibited by the indenture from paying dividends in some form such as bonds with maturities in excess of one year or taxable stock dividends.

It is clear that section 38 of the indenture is intended as a prohibition on petitioner’s payment of dividends on its preferred ($750,000 issue) or its common stock only if such action would result in a reduction of its net current assets below $1,000,000. The term “net current assets” is defined in section 39 as “the excess of the value, of the current assets over the amount of current liabilities.” Thus, to determine whether the “net current assets” were below $1,000,000, it is necessary to ascertain what items are included in “current assets” and “current liabilities” within the definitions in section 39 of the indenture.

We have found the items which fall within the definition of “current assets” and “current liabilities” as those terms are used in the indenture. Respondent argues, however, that the asset, “account receivable — Sendel Corporation” should be included in current assets since the petitioner has not sustained its burden of showing that it is not a “good and collectible” account within the definition of “current assets.” We think the evidence is sufficient to support the exclusion of this item from current assets, as we have found. Respondent also maintains that the item “Federal tax on income (1936) estimated” is not a current liability and should be excluded therefrom on the ground that a taxpayer’s liability for income tax is determined on an annual basis and does not accrue until the end of the year. However, we are not concerned here with whether this item may be accrued during the year for tax purposes, but whether the accrual of the item is properly included in “current liabilities” as defined by section 39 of the indenture. We think it is and have so found. See W. A. Patón, Accountants’ Handbook, 2d Ed., p. 874.

During the taxable year, petitioner paid dividends on its first preferred stock in full and, in addition, paid dividends on its common stock in the amount of $125,251.20 for which a dividends paid credit has been allowed. Since the payment of those dividends reduced “net current assets” below $1,000,000, petitioner could not have paid additional dividends without violating section 38 of the mortgage indenture.

In support of his contention that petitioner was not restricted in paying dividends in bonds maturing in more than a year, respondent argues that dividends so paid would not fall within the definition of current liabilities in section 38 of the indenture. This section defines current liabilities as “all current liabilities of the Company, whether absolute or contingent, including (a) notes, bills, acceptances, accounts payable and other obligations, which mature within one year after their date.” It might be true that dividends paid in bonds maturing in more than a year would not fall within the definition of current liabilities and, as a consequence, would not affect the net current assets. But we think such action would be a violation of the indenture provisions. The indenture “must be read in its entirety and with due regard for the purpose which it was intended to achieve.” Meridian & Thirteenth Realty Co., 44 B. T. A. 865. It is clear that the primary intent and purpose of the indenture was to preserve all of the petitioner’s assets, other than its current assets, for the benefit of the bondholders under the mortgage and to permit current assets to be used for the payment of dividends only to the extent that the net current assets exceeded $1,000,000. Under section 30 of the indenture petitioner is under an obligation that it will not, except as allowed, “do or suffer any act or thing whereby the trust estate might or could be impaired * * A distribution of dividends in the form of bonds with maturities occurring in less than a year would obviously be reflected in the current liabilities and thereby affect the net current assets in violation of section 38 of the indenture. We think that such a distribution with maturities in excess of a year would be similarly violative of the indenture provisions.

Respondent’s last argument is that the petitioner was not prohibited from paying dividends in stock. The answer to this is simple. Such dividends could only be paid, if at all, on the common stock, since dividends on the preferred stock were required to be paid in cash. Petitioner had no authorized first preferred stock subject to issue for any purpose, and its treasury second preferred stock could not be issued as a stock dividend until it first paid the cash dividends which had accrued since 1930 on its issued second preferred, which, of course, would have resulted in a violation of the indenture. Thus, it is clear that it could only have paid a common stock dividend on its common stock and then only after the extinguishment of the second preferred issue resulting from the recapitalization on September 10,1936. Such a dividend, however, would be nontaxable in the hands of the recipient. We have consistently held that the ability or authority to pay a dividend does not preclude the allowance of the credit under section 26 (c) (1), supra. Paraport Theatre Leasing Corporation, 44 B. T. A. 108; E. C. Atkins & Co., 44 B. T. A. 441; Columbia River Paper Mills, 43 B. T. A. 263; cf. Helms Bakeries, 46 B. T. A. 308.

We are not unmindful of the recent decision of the Eighth Circuit Court in United States v. Dakota Tractor & Equipment Co., 125 Fed. (2d) 20, in which that court announced a contrary view. However, with all due respect for that court, we adhere to our declared position.

The several violations of section 38 of the mortgage indenture, during the taxable year, may be some indication of a waiver of its restrictions. See Coca Cola Bottling Co., of Blytheville, Arkansas, 44 B. T. A. 1110. However, there is no evidence here, as there was there, that the other party to the restricting contract waived such restrictions. In any event, respondent has not raised the point and we therefore pass it.

We hold, therefore, that the credit under section 26 (c) (1) should be allowed.

The second issue is whether petitioner is entitled to deduct a contribution of $3,500 to a fund to be used for making improvements to the Fulton Club as an ordinary and necessary expense paid in the taxable year in carrying on its business within section 23 (a) of the Revenue Act of 1936. While we think that petitioner derived a direct business benefit as a result of this contribution, we are unable to agree that the enjoyment of such a benefit was limited to the year for which the deduction is made. Petitioner was on the accrual basis. The contested contribution was made for improvements, the benefits of which would be enjoyed over a period of years. In fact, they were made to preclude the necessity of petitioner making such improvements at its own plant. It is settled that such an expenditure should have been capitalized when made and then exhausted over the period for which the benefits would be enjoyed.

Petitioner, it is true, has not shown what part of such expenditure was exhausted during the taxable year. However, some part of it undoubtedly was. Following the rule announced in Cohan v. Commissioner, 39 Fed. (2d) 540, we hold that 2 percent of the contested expenditure, or $70, was exhausted during the taxable year. Petitioner’s reduction will be limited to that amount.

Decision will be entered u/nder Rule 50.

       SEC. 26. CREDITS OP CORPORATIONS.
      ♦ * * * * * *
      (c) Contracts Restrictino Payment of Dividends.—
      (1) Prohibition on payment of dividends. — An amount equal to the .excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * *

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      (a) Expenses. — 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; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.


author: Van Fossan :

text:
    Estate of Edward Doerken; Stephanie Doerken, Henry Hennig and Ferdinand A. Schumacher, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103695.
    Promulgated March 31, 1942.

      Robert H. Cunning ham. Esq., for tbe petitioners.

      Albert H. Monaeelli, Esq., for the respondent.
   OPINION.

Van Fossan :

The issue before us is whether or not the proceeds of two policies of insurance taken out upon the life of the decedent, Edward Doerken, are includible in his estate.

The statute controlling the situation is section 302 (g) of the Revenue Act of 1926, as amended by section 404 of the Revenue Act of 1934, and the decision turns upon the correct construction of the words “taken out by the decedent upon his own life.”

The petitioners contend that the policies in question were not literally taken out by the decedent on his own life; that they were not acquired through expenditure by him; that there was no shifting of interest in the policies as a result of the decedent’s death; and that the regulations in effect at the time of the decedent’s death were ineffectual to throw the proceeds of the policies into his estate.

The respondent argues that the premiums were paid indirectly by the decedent; that he retained all the legal incidents of ownership in the policies; and that, in any event, the proceeds are includible in the decedent’s estate under the provisions of section 302 (a) (footnote 1) because the payment of the premiums by the corporation amounted to gifts, additional compensation, or distributions of corporate earnings, made to him or for his benefit.

We shall first discuss the points raised by the respondent. The first and third are interdependent and will be considered together. The respondent draws inferences from the record which find no support therein. He states repeatedly that the decedent was owner of half the stock of the corporation. The decedent owned only 251 shares out of the 1,000 shares of the corporation, which was conducted strictly as a manufacturing company, with a definite and recognized corporate entity. Though decedent’s wife owned an almost equal share, there is no fact justifying the disregard of the corporate entity. The respondent assumes that because of such relationship to the corporation the decedent caused the corporation to pay the premiums as gifts, additional compensation, or the distribution of earnings.

There is no intimation in the record that the payment of premiums by the corporation through its directors reflected an intent to make a gift to a stockholder — an illegal act in itself. The corporation neither sought nor obtained a deduction from its gross income by reason of any additional compensation, paid or credited to either the decedent or to Meyer. There is no suggestion that either of those officers or the corporation ever treated or thought of the premium payments as such or that the decedent included them in his own income tax return. The corporation had four stockholders and there is no evidence leading us to disregard this fact.

The respondent’s argument that the insurance proceeds are taxable under section 802 (a) as well as under section 302 (g) is answered in Proutt v. Commissioner, 125 Fed. (2d) 57, as follows:

It would seem that Section 802 (a) of botii the 1924 and 1926 Acts refers to real estate and personal property exclusive of life insurance, for the reason that Section 302 (g) deals separately and specifically with such insurance. Therefore, the amendment of Section 302 (a) is not reasonably to be construed as intended to change or affect the meaning of the separate provisions of Section 302 (g). The long life of the section strengthens this inference. “Section 302 (g) first appeared in identical language in the Revenue Act of 1918 as Section 402 (f), 40 Stat. 1057, 1098. It has never been changed.” Helvering v. LeGierse, 312 U. S. 531, 538. Had Congress intended to effectuate a change in the meaning of the section, it could easily have done so by express amendment. Amendment by implication should not be assumed, unless clearly indicated from the context.

We think that section 302 (g) “deals separately and specifically” with taxation of insurance policies and excludes the consideration of the present question under the provisions of section 302 (a). The respondent’s inclusion of the proceeds of the insurance policies in the decedent’s estate was justified on neither the first nor the third grounds advanced by him.

The respondent asserts that the decedent “possessed”, “had”, and “reserved” the incidents of ownership in the insurance policies. With this statement we do not agree. The reservation clause relating to the powers to change the beneficiary, to surrender or cancel the policy, to pledge the policy for a loan, or to obtain a loan against the surrender value did remain in the policy in the name of the decedent, but be was only the nominal owner thereof. A careful study of the facts shows conclusively that the policies were wholly the property of the corporation. It obtained the insurance and paid the premiums. It kept the policies in its custody, thus preventing the decedent from exercising any of the rights reserved to him as the insured, even if he had wished or attempted to do so. The corporation charged the premium payments on its books to expense and meticulously credited itself with the cash surrender value of the policies as it increased yearly.

Thus the corporation’s control of the policies and its treatment of them shows that it considered them its sole and exclusive property. For more than 13 years, during which the policies were in force, the decedent exercised none of the “legal incidents of ownership” thereof. The counsel for petitioner states in his brief that the reservation of such rights must have been an error on the insurance agent’s part and that the possession of the rights was not brought to the attention of the corporation until after the decedent’s death. Whether this was true we do not know and, since the insured is dead, can not ascertain. However, there is ample evidence of record to demonstrate that the policies in reality belonged to the corporation.

If the decedent had attempted to exercise for himself any of the rights nominally held by him, the corporation could have restrained him by proper equity procedure. In fact, it would have been difficult, if not impossible, for him to do so while the policies were held in the corporation’s custody.,

The fundamental test now recognized to be controlling is the expenditure for the premium. The insurance is not considered to have been “taken out” if no part of the premium or other consideration was paid either directly or indirectly by the- insured. Therefore, in the case at bar the payment of the premium by the corporation meets that test, with the resulting effect of excluding the proceeds of the insurance policies from the decedent’s estate.

Since the policies were not “taken out by the decedent upon his own life”, the provisions of article 27 of Regulations 80, as amended, do not govern and we need not consider the question of its validity. As stipulated, the value of the stock of Audiger & Meyer Silk Co., owned by the decedent at the time of his death, was $182.69 per share, or a total of $43,855.19. This value will be taken into consideration upon recomputation of the estate tax.

Decision will he entered wider Rule 50.

         Sec. 302. [as amended by section 404 of the Revenue Act of 1934], The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside the United States.
      (a) To the extent of the interest therein of the decedent at the time of his death; * * *
      * * * * * * *
      (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance uiider policies taken out by the decedent upon his own life. * * *

       Aet. 27. Insurance receivable by other beneficiaries. — The amount in excess of $40 000 of the aggregate proceeds of all insurance on the decedent’s life not receivable by or for the benefit of his estate must be included in his gross estate as follows:
      (1) To the extent to which such insurance was taken out by the decedent upon his own life (see article 25) after January 10, 1941, the date of Treasury Decision 5032, and
      (2) To the extent to which such insurance was taken out by the decedent upon Ms own life (see article 25) on or before January 10, 1941, and with respect to which the decedent possessed any of the legal incidents of ownership at any time after such date or, in the case of a decedent dying on or before such! date, at the time of his death.
      Legal incidents of ownership in the policy include, for example, the right of the insured or his estate to its economic benefits, the power to change the beneficiary, to surrender or cancel the policy, to assign it, to revoke an assignment, to pledge it for a loan or to obtain from the insurer a loan against the surrender value of the policy, etc. The insured possesses a legal incident of ownership if his death is necessary to terminate his interest in the insurance, as for example if the proceeds would become payable to his estate, or payable as he might direct, should the beneficiary predecease him. [T. D. 5032- c' B 1941-1, p. 429.]


author: Van Foss an :

text:
    Alfred D. Edwards, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102191.
    Promulgated March 31, 1942.

      John E. Letsinger, Esq., and Metellus Thomson, Jr., Esq., for the petitioner.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Van Foss an :

The first and major issue is the correct valuation of the eight annuity contracts which the petitioner transferred by gift to the trustee of the annuity trust on June 11,1936.

We find no precise or recognized precedent to serve as a guide in determining this issue, but the Commissioner’s regulations suggest a rule which in principle is applicable to the facts before us. Article 19 (9) of Regulations 79 provides a method of determining the approximate value of an annuity contract which the purchaser pays for in installments, i. e., adding to the interpolated terminal reserve a proportionate part of the premium paid since the last contract anniversary, the date on which terminal reserve was calculated.

The first sentence of article 19 (9) seems to contemplate the simultaneous acquisition and gift of the contract. In the present case, however, since considerable time elapsed after the contracts in question were acquired, the sale price of the contracts affords no proper test of their value on June 11, 1936. The record clearly shows that the contracts were not comparable to those being sold currently on July 1, 1936, or on June 11, 1936, and that comparable contracts could not have been obtained. The changes in interest rate and loading charge, the enlargement of the contractual rights of the purchaser and the beneficiary, the lapse of time (as contemplated by article 19 (9)) and the numerical increase of guaranteed refund payments were factors of procurable contracts which differentiated them unmistakably from the contracts under consideration.

The facts in the case at bar seem to bring it clearly within the principle underlying the final method outlined in the cited regulation. Here no future payments of premium were to be made, the entire premium or purchase price having been made in one lump sum. Therefore, no correction in amount need be made for installment premiums. The interpolated terminal reserve is based on the company’s experience in dealing with similar annuity contracts and certainly is more nearly an index of the true value of the contract than any data which could be submitted from the annuitant’s viewpoint.

We are of the opinion that the regulation affords a fair measure of evaluating the contracts and comprehends, in its effect, the various elements of value requisite to the proper determination thereof. The interpolated terminal reserves were found to aggregate $182,653.56, and this sum, therefore, represents the correct valuation of the contracts at the time of gift.

The recent cases of Guggenheim v. Rasquin, 312 U. S. 254, and Ryerson v. United States, 312 U. S. 405, cited by both the petitioner and the respondent, do not control the issue before us. In those cases, both involving single premium life insurance policies and not annuities, the Court held that the cash surrender value at the time of the gift did not determine their correct value. In the Guggenheim case (in which the gift was made at substantially the same time as the purchase) the value was fixed by the cost of the policies to the donor and in the Ryerson case by the cost of similar policies at the time of gift. The Court further stated that “all of the economic benefits of a policy must be taken into consideration in determining its value for gift-tax purposes.” Here, as we have seen, the gifts were made a considerable time after the purchase and no comparable contracts were obtainable at the time of gift.

The remaining issue relates to the number of exclusions of $5,000 to which the petitioner was entitled. The petitioner contends that he may claim an exclusion of $5,000 for each of the donees. This question has been settled by the United States Supreme Court in Helvering v. Hutchings, 312 U. S. 393, in which it was held that the donor was entitled to an exclusion of $5,000 for each beneficiary, provided the gift is not of a “future interest.” It is the contention of the respondent that the gifts here in question were of future interests, particular attention being directed to the fact that the beneficiaries were not entitled to the receipt of income from the trust unless in being on the date appointed for its distribution.

The trust agreement provided that income payments should be made “upon the dates determined by Trustee to be convenient and practicable but at least annually” (if any net income were distributable). There was no provision for accumulations of any sort except as income may be collected, allocated, and distributed during the current year. As a practical matter it would be impossible to distribute each dollar of income as it is received. Taxes and other charges must be paid before net income can be determined. The important provision is that income must be paid within the year. See Elizabeth H. Fisher, 45 B. T. A. 958. The trustee was not directed to accumulate income as in United States v. Pelzer, 312 U. S. 399, but was compelled to distribute it annually. In the Pelzer case the beneficiaries had no right to the present enjoyment of either the corpus or the income and would never receive any part of either unless they should survive a ten-year period. See Commissioner v. Taylor, 122 Fed. (2d) 714; certiorari denied,-U. S.-; Welch v. Paine, 120 Fed. (2d) 141; Annie B. Smith, 45 B. T. A. 948. See also Arthur C. Stifel, 46 B. T. A. 568, and cases there cited and discussed.

In Helvering v. Blair, 121 Fed. (2d) 945, the trustee had the absolute discretion to change the amounts to be paid to each beneficiary and thus cause their interests to be so variable that they had no certain, determinable value on the date of gift. Here, the shares of each beneficiary were precisely fixed. There was no possibility of a change in their amount.

We see no merit in the respondent’s argument that because the trust instrument prohibited distribution to a beneficiary “unless in being” future interests were created. Obviously, a recipient of income to be earned in the future must exist or he does not receive.

The words “unless in being” do not convert the interests here created into “future interests” and the exclusion of $5,000 for each beneficiary is accordingly allowed.

Decision will be entered under Rule 50.

       Art. 19. Valuation of property. — * * *
      * * * if * * *
      (9) Life insurance and annuity contracts. — The value of a life Insurance contract or of a contract for the payment of an annuity issued by a company regularly engaged In the selling of contracts of that character is established through the sale of the particular contract by the company; or through the sale by the company of comparable contracts. As valuation through sale of comparable contracts is not readily ascertainable when the gift is of a contract which has been in force for some time and on which further premium payments are to be made, the value may be approximated, unless because of tlie unusual nature of the contract such approximation is not reasonably close to the full value, by adding to the interpolated terminal reserve at the date of the gift the proportionate part of the gross premium last paid before the date of the gift which covers the period extending beyond that date.


author: Turner :

text:
    Valentine-Clark Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101352.
    Promulgated March 31, 1942.

      Hayner N. Larson, Esq., for the petitioner.

      Jonas Smith, Esq., for the respondent.
   OPINION.

Turner :

The question here is whether in determining undistributed net income for the purpose of computing the surtax on undistributed profits the petitioner is entitled to a credit under section 26 (c) (1) of the Revenue Act of 1936. In that section it is provided that a credit shall be allowed in “An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends.” With the consent of the bank and under the provisions of the contract of November 18, 1935, the petitioner made certain distributions to its stockholders and to Sperry, its manager, and has claimed credit under section 26 (c) (1) in respect of profits not distributed, on the ground that it could not have distributed any further sums as dividends during the taxable years here involved without violating the provisions of the said contract. Holding that the contract did not prohibit the payment of further dividends, the respondent has disallowed the credits so claimed by petitioner.

The contract was in writing, it was executed by the petitioner prior to May 1, 1936, and it did expressly deal with the payment of dividends, but, says the respondent, it does not meet the test of the statute. He claims (1), citing Metal Specialty Co., 43 B. T. A. 891; Thibaut & Walker Co., 42 B. T. A. 29; Henry Mill & Timber Co., 43 B. T. A. 1073; and Lehigh Structural Steel Co., 44 B. T. A. 422, that this contract is between petitioner, its officers, and stockholders, whereas the statute contemplates a contract between the corporation and its creditors; (2) that the contract did not bar the payment of dividends to Sperry, who under the agreement with the bank was to become a stockholder and did so become a stockholder prior to January 1, 1936; and (3) that even though the contract did bar the payment of cash dividends, it still does not meet the test of the statute in that it did not bar the payment of dividends in forms other than cash.

The first two claims of the respondent are not, in our opinion, well taken and the cases cited are not controlling. The contract here was not merely an agreement between members of the corporate family, which could have been changed by them at any time, as the respondent contends; its purpose was to establish a needed line of credit with the bank and it was designed to benefit and protect the bank by restricting the distribution of profits so long as the line of credit should be available to the petitioner and so long as the petitioner should be indebted to the bank under the line of credit. The facts show that the line of credit contemplated by the contract was extended by the bank to the petitioner throughout the taxable periods here in question and during those periods the petitioner was indebted to the bank for substantial sums. The written contract was not executed by the bank, it is true, but it was executed by the petitioner as required by the statute and upon advancement of money to petitioner the bank had definite and substantial enforceable rights under the contract. Except to the extent specified in the contract or consented to by the bank, the petitioner could not, without violating the provisions of said contract, have made disbursements in cash or other property to its stockholders or to Sperry as its manager, so as to deplete or diminish the funds or property otherwise available for use in the business.

This leaves for consideration the final contention of the respondent, that the contract did not bar the payment of dividends in forms other than cash. Under section 27 (e) of the Revenue Act of 1936, a dividends paid credit is provided in the case of taxable stock dividends to the extent of the fair market value of the stock distributed. We think it apparent therefore that a contract which bars the payment of dividends in cash or other property but permits the payment of dividends in the form of taxable stock dividends is not such a contract as was contemplated by section 26 (c) (1), supra. Helms Bakeries, 46 B. T. A. 308. The contract in the instant case specifically restricts withdrawals from corporate funds. The facts surrounding the making of the contract and the entering into of supplemental agreements convince us that the only thought was that except to the extent allowed by the agreement the corporate funds and properties should remain in the corporation and be available for corporate operations and that there was no thought of restricting the payment of dividends in stock, taxable or otherwise. In fact, it was contemplated that stock should be issued under some plan so as to give Sperry a proprietary interest. This was finally worked out by a rearrangement of the stock structure. Prior to the agreement the authorized stock of the corporation was in the form of common stock and was limited to 1;000 shares, all of which was issued and owned by Lillian S. Clark and Grace C. Pyle. As worked out to meet the desires of the bank, the stock became 1,500 shares of preferred and 200 shares of common. The preferred stock was issued 1,3124/2 shares to Mrs. Clark and 187% shares to Mrs. Pyle, while the 200 shares of common stock were issued 85 shares to Mrs. Clark, 15 shares to Mrs. Pyle, and 100 shares to Sperry, and, except for some shifting of the common shares as between Mrs. Clark and Mrs. Pyle on August 20, 1936, the above described distribution of stock continued throughout the year 1936 and the taxable period January 1 to June 30, 1937. We find nothing in the contract of November 18, 1935, nor in the intention of the parties thereto, including the bank, which would have prohibited the payment of stock dividends, taxable or otherwise, during the taxable periods before us, and under such circumstances it can not be said that the petitioner could not have distributed taxable stock dividends during those periods without violating a provision of the said contract. Helms Bakeries, supra. Compare United States v. Dakota Tractor & Equipment Co., 125 Fed. (2d) 20; Paraport Theatre Leasing Corporation, 44 B. T. A. 108; and E. C. Atkins & Co., 44 B. T. A. 441. The action of the respondent in disallowing the credits claimed by petitioner is accordingly sustained.

Decision will be entered wader Rule 50.


author: SteRNHagen :

text:
    Western Acceptance Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105282.
    Promulgated April 1, 1942.

      George F. Kachlein, Jr., Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent.

       SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
      *******
      (b) Definitions. — As used in this title—
      (1) The term “personal holding company” means any corporation ** * * if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) * * *

   OPINION.

SteRNHagen :

The petitioner contends that it is not a personal holding company, as defined by section 351 (b), Revenue Act of 1936. The respondent narrows the issue by a statement that the petitioner’s gross income is, to the specified 80 percent, derived from interest, and that this is the ground upon which he has classified the petitioner as a personal holding company.

As shown in greater detail in the findings, the petitioner’s income consists principally of the gains derived from its purchase and disposition of the conditional sales contracts of automobile dealers with customers. The petitioner pays the dealer the cash price of the car and' takes the dealer’s contract with the customer, who is to pay a greater amount in periodic payments. The petitioner is in a position substantially similar to that of the acceptance corporation in General Motors Acceptance Corporation v. Mid-West Chevrolet Co., 66 Fed. (2d) 1. The petitioner then assigns the contract to the National Discount Corporation at a discount, receiving an amount greater than that paid by it to the dealer. These transactions are all covered by express writings the forms of which are in evidence. Nothing in any of them suggests, either in express language or by implication, that any of the parties was thinking of a loan and its repayment or of interest. They were buying and selling conditional sales contracts and were not lending and borrowing money and using the contracts as collateral security for the loans. There is no more ground for construing interest in the arrangement in the field of taxation than in the field of usury. General Motors Acceptance Corporation v. Mid-West Chevrolet Co., supra; Coast Finance Corporation v. Powers, 209 Pac. 614 (Oreg.); Martin v. McAvoy, 228 Pac. 694 (Wash.). This has frequently been held as to the installment buyer’s claim for an interest deduction in computing net income. Daniel Brothers Co. v. Commissioner, 28 Fed. (2d) 761, affirming 7 B. T. A. 1086; Marsh & Marsh, Inc., 5 B. T. A. 902; cf. Baltimore & Ohio R. R. Co., 29 B. T. A. 368, 372; affd., 78 Fed. (2d) 456; Corbett Investment Co. v. Helvering, 75 Fed. (2d) 525; Hudson-Duncan Co., 36 B. T. A. 554. An automobile dealer has been held not entitled to treat the amount received from the finance company as a loan but required to treat it as sale price of the conditional sale contract, a conception which, prevented the dealer from using the installment method. Elmer v. Commissioner, 65 Fed. (2d) 568, affirming 22 B. T. A. 224; Packard Cleveland Motor Co., 14 B. T. A. 118; cf. MacDonald v. Commissioner, 76 Fed. (2d) 513. On the general subject of interest, see also Old Colony R. R. Co. v. Commissioner, 284 U. S. 552; Deputy v. duPont, 308 U. S. 488.

The income derived by the petitioner from the conditional sales contracts was not interest, and the Commissioner was in error in so regarding it as the ground for classifying the petitioner as a personal holding company under section 351 (b). Cf. Elverson Corporation, 40 B. T. A. 615, 643; affd., 122 Fed. (2d) 295.

Although respondent does not urge that petitioner’s income is gain from the sale of securities, petitioner argues, in the alternative, that “if the Board should find that the gain designated as ‘discount earned’ derived by the petitioner from the purchase and sale of conditional sales contracts is ‘a gain from the sale of securities,’ such gain is received by petitioner as a dealer in securities and therefore not personal holding company income.” The Board does not find it necessary to hold whether the “discount earned” is a gain from the sale of securities, since the respondent has not determined that it is, and in his brief he expressly concedes that the conditional sales contracts are not “securities” within the meaning of section 351. The question whether petitioner is a dealer in such contracts is therefore irrelevant.

Since petitioner was not in the taxable year a personal holding company, it was under no duty to file a personal holding company return, and since there is no deficiency upon which to base a percentage penalty, no such penalty may be assessed.

Decision will be entered for the petitioner.


author: Disney:

text:
    Estate of Charles H. Greenwood, Deceased, Kenneth R. Greenwood, Administrator, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104987.
    Promulgated April 3, 1942.

      John M. Schwartz, Esq., for the petitioner.

      Frank T. Horner, Esq., for the respondent.
   OPINION.

Disney:

The question which we are required to answer here is whether under the law of Arizona decedent’s wrife had a community property interest to be excluded from the computation of his estate. We are, of course, controlled herein by state law. Black v. Commissioner, 114 Fed. (2d) 355. See also Talcott v. United States, 23 Fed. (2d) 897.

The property involved is personalty, consisting of stocks and bonds, largely corporate stock of the Carborundum Co.; also cash. A portion of the property, the amount not shown except that it was “sizeable”, was inherited by the husband, and inherited property is by the Arizona statute specifically excepted from community estate, so that with such a record we could not determine that any of the property was originally community. The evidence clearly indicates that the husband separately acquired the property prior to removal to Arizona. The petitioner pointedly disclaims any contention that the property was originally acquired as community property. We therefore hold that the property was originally the separate property of the decedent. The petitioner states the question as follows: “The primary question presented is that of transmutation by understanding and intention.” We therefore examine the record to ascertain whether under all of the evidence it is shown that property originally separately owned by the decedent became that of a marital community in Arizona. The petitioner relies in substance upon the idea that there was a general understanding between the husband and wife that their property was held as community estate, and upon statements which the husband made to the effect that half belonged to her and that the property was community. There was no written communication, understanding or document on the subject. The husband made such statements on two occasions to a friend and upon one occasion, in the presence of such friend and in the course of a family argument, the wife said to her husband, “You know, Charles, that one-half of all we own belongs to me”, to.which the husband stated, “That is correct, and I know it as well as you do.” This is the only occasion shown by the evidence where any agreement between husband and wife expressly appears. It is obvious, of course, that the oral statements above recited do not amount to a conveyance. The petitioner, however, urges that under the law of California such statements suffice to transmute separate property into community estate and urges us to follow such decisions. Under the law of California an executed oral agreement is sufficient transmutation of separate property into community. Schipper v. Penkalski, 115 Pac. (2d) 231; Yoakam v. Kingery, 126 Cal. 30; 58 Pac. 324; Estate of J. Harold Dollar, 41 B. T. A. 869; United States v. Goodyear, 99 Fed. (2d) 523. Title Insurance & Trust Co. v. Ingersoll, 94 Pac. 94; and Kaltschmidt v. Weber, 79 Pac. 272, indicate that in California express agreement need not be shown if it is proven by the nature of the transaction or surrounding circumstances. Estate of Joe Crail, 46 B. T. A. 658.

We have for consideration here, however, not only the oral expressions above noted, but also documents in writing, signed by both husband and wife. In 1928, the year following that in which the decedent moved to Arizona, and several years before the family argument and statement above referred to, petitioner and his wife signed a contract of rental of safety deposit box from the Southern Arizona Bank & Trust Co. Therein, over their signatures, it is stated that they declare and represent that they own as joint tenants with the right of survivorship all of the property within or which may be deposited in the box, and that it shall be and is owned by them as such joint tenants. They jointly and severally authorized the bank to grant access to either of them, and jointly and severally obligated themselves to save the bank harmless. Further reference is made to the survivor. It is recited that the signers have read, received a copy of, and approved the bank’s rules covering safe deposit boxes as printed on the reverse side. On the reverse side reference is made to the survivor.

On or about January 5, 1928, a checking account was opened in the same bank in the name of “Greenwood, C. H., or Albertine, Either, or Survivor of Either”, that expression appearing on the signature cards which bear the signatures of C. H. Greenwood and Albertine Greenwood. In 1934 a savings account was opened in the same bank by “Greenwood, O. H. or Albertine”, that expression appearing upon the signature card bearing the signatures of C. H. Greenwood and Albertine Greenwood.

All of the personalty and assets involved in this case, consisting of stocks, bonds, certificates, and documents of title, was, at the date of the death of the decedent, in the safe deposit box above described. Of the cash, $3,553.52 was in the joint checking account in the Tucson bank, $4,320.01 in the savings account therein, and $18,834.74 represents savings accounts in decedent’s name in other banks. It is apparent that, if the decedent and his wife were at the date of his death the owners in joint tenancy of the property deposited in the safe deposit box and in the joint checking account, such property must be included in the gross estate of the decedent, under the provisions of section 302 (e), Revenue Act of 1926. Moreover, the language of the act seems specifically to cover the deposits both in safe deposit box and checking account. The petitioner argues that the doctrine of survivorship is not favored by the law in Arizona, and that it is a matter of intention on the part of the parties, In re Baldwin's Es tate, 7 1 Pac. (2d) 791, and suggests that the right of survivorship in that state may have been abolished. However, upon examination of the Arizona statute and construction thereof by the Supreme Court of Arizona, we find that if the instrument expressly vests estate in the survivor, the right of survivorship exists, although proof of a contrary intention on the part of the parties would suffice to destroy the joint ownership. In re Baldwin’s Estate, supra; Blackman v. Blackman, 43 Pac. (2d) 1011. Examination of the contract signed and entered into by the decedent and his wife in renting the safe deposit box containing the larger portion of his estate indicates clearly to us that the instrument does “expressly vest the estate in the survivor” under the Arizona statute, section 986, Revised Code Arizona 1928, and negatives any idea of a contrary intent on the part of the signers. The provisions of such written agreement were never revoked nor modified throughout more than ten years prior to the death of the decedent.

Agreements as to safe deposit boxes essentially the same as that above described have been held to preclude claims of community property by the California courts. In re Harris’ Estate, 147 Pac. 967, involved a claim of community property. The husband and wife had orally agreed that property should be owned as joint tenants and their moneys were deposited in a bank in a joint account with a written agreement in the pass book reciting joint tenancy and sur-vivorship. It was held that there was joint tenancy. The same court in In re Gurnsey’s Estate, 170 Pac. 402, considered a bank deposit in form to be paid to either husband or wife or the survivor, additions to become the property of the persons making the deposit as joint tenants, and concluded that community property deposited in such account passed out of the community at the time of the deposit and became the joint property of the husband and wife. In In re McCoin’s Estate, 50 Pac. (2d) 114, it was held that a husband and wife having community ownership of money converted same into joint ownership by the terms of a signed signature card similar to that hereinabove described. The card bore the recitation that the undersigned gave each other a joint ownership in moneys deposited or thereafter to be deposited, payable to either or the survivor. Young v. Young, 14 Pac. (2d) 580, involved a question of community property or joint estate in connection with the renting of a safe deposit box by a husband and wife, as herein, and which safety deposit box contained the personal property in question — stocks and bonds. An agreement in writing between husband and wife in renting the safety deposit box recited a declaration that the contents then or thereafter should be joint property with ownership in the survivor. In addition, somewhat similar to the situation herein, the husband and wife opened a “deposit account” in another bank with an agreement signed to the effect that moneys deposited should he paid by the bank to either or the survivor. The court held that the property was joint and not community estate, although the personal property involved was placed in the safe deposit box by the husband, whose executor contended that it was community as against the wife’s claim by right of survivorship.

The above decisions clearly indicate, we think, not only the weight which should be given to the agreement of joint ownership as to the safe deposit box and the joint bank account, but refute the petitioner’s contention that joint tenancy can not be created by one person conveying to himself and another as joint tenants. In that respect see also Colson v. Baker, 87 N. Y. S. 238; In re Gaines' Estate, 100 Pac. (2d) 1055; In re Nelson's Estate, 286 Pac. 439. In the light .of such decisions we conclude that the evidence of oral understanding or agreement between the husband and wife here involved is not sufficient to indicate a change from the joint estate set up in writing in the safe deposit agreement and in the agreement as to the checking account. Indeed, it seems to us that in the light of such written agreement the oral statements later are explained and that they refer to the joint tenancy set up in writing. The oral references to community property and to ownership as half in each of the spouses may well have referred, in the minds of the decedent and wife, as iaymen, to the joint estate in the property in bank. At least we think such references do not negative the written agreements or show an executed oral agreement sufficient under primary rules of law to overcome a previous written contract. We therefore hold that all property in the safe deposit box and in the checking account payable to either or the survivor was not community property, but joint estate, to be included in the estate of decedent. The record indicates plainly that the property did not originally belong to the survivor within the exception recited in section 302 (e) of the Revenue Act of 1926.

As to the remainder of the decedent’s estate not appearing to have been covered by the written agreements as to joint ownership: We conclude that the evidence is not sufficient to indicate community property. Assuming that an oral understanding is sufficient to transmute separate estate into community property, under the law of the state in question, we note that the evidence as to oral agreement placed all property in the same category — the contention being that all was community and that everything was owned in like manner by the husband and wife. Having concluded that almost the entire estate was held in joint tenancy, we believe this indicates that the remainder was so held; or, if not, that the effect of the written evidence as to joint tenancy is such as to indicate that the separate estate of the husband in the other bank accounts is not shown to have been transmuted into community estate. The evidence is that all of his assets, including documents of title and certificates, were in the safe deposit box — which we above concluded contained property held by joint tenancy. The box, therefore, apparently contained the certificates of deposit by the husband in the other separate bank deposits in Massachusetts; Phoenix, Arizona; and Los Angeles, California, for they obviously are covered by the expression “assets, securities and other documents of title” and “certificates” used to describe the contents of the safe deposit box. Certainly that they were not in such box is not shown by the record. The oral understanding relied upon by the petitioner can not, we think, overcome the presumption of correctness of the Commissioner’s determination as to any property, in the light of our conclusion as to the written agreements covering the joint bank accounts and deposits, for no distinction is made in the evidence as to oral agreement sufficient to separate one bank account from the other. Moreover, we find that section 265, Revised Code Arizona 1928, particularly provides that:

Whenever a husband and wife open a joint account with any bank, and either one dies, such bank shall pay to the survivor the amount standing to their joint credit and upon making such payment such bank shall be released from all further liability for such amount.

This section places the savings account in the Tucson bank in the same category as the other accounts where “survivor” is used. Since all bank accounts shown to enter into the computation of the estate, except those which we have above concluded represent joint estate, are in the name of the decedent, and certificates therefor were apparently in the joint safe deposit box, we conclude and hold that no sufficient showing of community estate therein has been made, and that error on the part of the respondent is not shown.

Decision will ~be entered wider Rule SO.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      * * * * * * *
      (e) To the extent of the interest therein held as joint tenants by the decedent and any other person, or as tenants by the entirety by the decedent and spouse, or deposited, with any person carrying on the banking business, in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money’s worth: Provided, That where such property or any part thereof, or part of the consideration with which such property was acquired, is shown to have been ati any time acquired by such other person from the decedent for less than an adequate and full consideration in money or money’s worth, there shall be excepted only such part of the value of such property as is proportionate to the consideration furnished by such other person: Provided further, That where any property has been acquired by gift, bequest, devise, or inheritance, as a tenancy by the entirety by the decedent and spouse, then to the extent of one-half of the value thereof, or, where so acquired by the decedent and any other person as joint tenants and their interests are not otherwise specified or fixed by law, then to the extent of the-value of a fractional part to be determined by dividing the value of the property by the: number of joint tenants.


author: Abnold:

text:
    The Journal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106877.
    Promulgated April 3, 1942.

      Edmimd B. Shea, Esq., and G. F. MiMcelson, Esq., for the petitioner.

      Jonas M. Smith, Esq., for the respondent.
   OPINION.

Abnold:

This proceeding involves a deficiency in income tax for 1938 in the sum of $10,537.77. The principal issue is whether the petitioner is entitled to a dividends paid credit in 1938 by reason of its payment on July 1, 1938, of certain promissory notes, amounting to $440,625, issued and distributed as dividends in 1937, for which a dividends paid credit was claimed and allowed for 1937. Respondent affirmatively alleged that a part of the deficiency herein is “due to negligence, or intentional disregard of rules and regulations” within the meaning of section 293 (a), Revenue Act of 1938, and asks the Board to find and determine that he is entitled to the 5 percent addition to the deficiency provided for by said section, claim for which is asserted pursuant to section 272 (e), Revenue Act of 1938.

The facts as stipulated are adopted as our findings of fact, the pertinent portions thereof being hereinafter summarized.

Petitioner, a Wisconsin corporation, is located at Milwaukee, and is engaged in publishing a newspaper known as the Milwaukee Journal. It filed its income and excess profits tax return for 1938 in the Milwaukee collection district.

On December 1, 1937, petitioner distributed to its stockholders a dividend upon its common stock consisting of promissory notes exe- ' cuted by the petitioner as maker in the aggregate principal amount of $440,625. These dividend notes became due January 1, 1939, with interest at 3% percent per annum until maturity, or until redeemed. The notes were transferable and were subject to redemption in whole or in part at any time prior to maturity at the option of the; petitioner. The fair market value of the notes on December 1, 1937, was not less than $440,625. Rone of the notes was paid during 1937.

In its Federal income and excess profits tax return for 1937 petitioner claimed a dividends paid credit which included the amount of said promissory notes, and credit accordingly was allowed by respondent in auditing the return. If no part of the $440,625 had been included in computing the dividends paid credit for 1937, petitioner’s income tax liability would have been $73,457.38 in excess of the tax liability of $212,099.70 determined for that year.

On July 1,1938, petitioner paid and discharged its indebtedness of $440,625 evidenced by said promissory notes. In its Federal income and excess profits tax return for 1938 petitioner treated this disbursement of $440,625 as a dividends paid credit under section 27 (a) (4), Eevenue Act of 1938, and applied 2y2 percent thereof, amounting to $11,015.62, against the tax.

Petitioner claimed the dividends paid credit under section 27 (a) (4), supra, upon the advice of counsel that it was entitled thereto under the Eevenue Act of 1938 and that the provisions of article 27 (a)-3 of Eegulatioris 101, approved by the Secretary of the Treasury on February 7, 1939, were contrary to the statute and therefore unenforcible. This opinion of its counsel was received by petitioner on or about March 13,1939, and was relied on and followed in completing and filing its income tax return for 1938.

The dividends paid credit claimed on petitioner’s return for 1938, for the purpose of deducting 2% percent thereof under section 13 (c) (2) (B), Eevenue Act of 1938, was computed as follows:

Dividends paid:
Cash___$360,000.00
Obligations distributed in 1938_ 360,000.00
720,000. 00
Amounts paid July 1, 1938, on 1937 notes_ 440,625.00
Dividends paid credit claimed on return_1_ 1,160, 625.00
Amount deducted by petitioner pursuant to section 13 (c)
(2) (B)_¿_ 29, 015. 62

In determining the deficiency for 1938 the respondent disallowed that part of the dividends paid credit pertaining to the item of $440,625, and determined petitioner’s dividends paid credit as follows:

Dividends paid:
Cash-$360,000
Obligations distributed in 1938- 360,000
Amount of dividends paid credit allowed_ 720,000
Amount deducted by respondent pursuant to section 13 (e) (2) (B)_ 18,000

The deficiency of $10,537.77 is attributable to the foregoing adjustment.

We shall consider first the question as to petitioner’s right to a dividends paid credit, using the term credit herein as relating solely to the $440,625 item. Petitioner contends that it is entitled to the credit under the provisions of section 27 (a) (4) of the Revenue Act of 1938, independently of section 27 (e), the pertinent portions of which are set forth in the margin. Respondent denied the credit because a credit in an identical amount was claimed and allowed in 1937 when the promissory notes were issued and distributed to petitioner’s stockholders. Respondent points out that the allowance of a credit in 1938 would give petitioner a double credit on the same transaction, a situation not intended by the statute, and which is expressly provided against in article 27 (a)-3 of Regulations 101, supra. Respondent cites and relies upon our decision in Spokane Dry Goods Co., 43 B. T. A. 793.

Petitioner concedes that this issue is “precisely similar to that which was decided in Spokane Dry Goods Co. v. Commissioner, 43 B. T. A. 793”, wherein the Board held that sections 27 (a) (4) and 27 (e) dealt with the same subject matter and that in accordance with the recognized principles of statutory construction the general provisions of 27 (a) (4) must yield to the specific limitations appearing in 27 (e). Petitioner denies, however, that the majority opinion of the Board is correct and asserts that the reasoning of the dissenting minority of the Board is sound and should be applied here. If the Board’s decision in Spokane Dry Goods Co., supra, be judicially confirmed, petitioner concedes that respondent’s regulation must be accepted as a proper interpretation of the law.

Such judicial confirmation occurred on February 18, 1942, when the Circuit Court of Appeals for the Ninth Circuit affirmed the Board’s opinion in Spokane Dry Goods Co. v. Commissioner, 125 Fed. (2d) 865. The court held that sections 27 (a) (4) and 27 (e) were related and must be considered together in order to prevent the double credit which would result if said sections were considered to be entirely independent of each other. The court specifically considered article 27 (a)-3, supra, and pointed out that Congress must be deemed to have áccepted the interpretation therein set forth as it did not change the 'wording of “indebtedness of any kind” in amending section 27 (a) (4) in 1939. Respondent’s determination on this issue is therefore approved.

The second issue, affirmatively raised in the answer, is whether any part of the deficiency is due to petitioner’s negligence, or intentional disregard of respondent’s rules and regulations as provided in section 293 (a), of the Revenue Act of 1938. Respondent rests his argument, not on any alleged negligence of the petitioner, but upon an alleged intentional disregard of rules and regulations. Respondent asserts that petitioner’s reply admits that its officers, employees, and agents knew of the provisions of article 27 (a)-3, and, since the validity of the regulation is established by the Board’s decision in the Spokane case, supra, that the 5 percent addition is mandatory. Respondent contends that reliance on the advice of counsel does not exonerate petitioner’s intentional disregard of the rules and regulations.

The issue turns upon the construction of the statutory phrase “intentional disregard of rules and regulations.” The stipulated facts show that petitioner was fully cognizant of the statutory provisions, section 27 (a) (4) and (e), and of respondent’s interpretation thereof. Petitioner sought the advice of counsel as to what it should do under the circumstances then existing. Counsel advised that petitioner was entitled to the credit provided by section 27 (a) (4) and that respondent’s regulation was an invalid interpretation of the statute. Petitioner then had to decide which of two opposite constructions it would follow in making and filing its return. The stipulated facts indicate that petitioner gave careful consideration to the problem before electing to follow the advice of counsel. Its choice was made deliberately, with full knowledge that the administrative interpretation was contrariwise. Obviously, therefore, petitioner intentionally disregarded respondent’s regulation.

The defense advanced is in the nature of confession and avoidance. Petitioner stipulates that it acted with knowledge but upon advice of counsel and directs attention to the division of opinion on this Board in Spokane Dry Goods Co., supra, as proof of the soundness of its action and as justification for its belief that the respondent’s regulation was invalid. Be that as it may, the statute speaks in mandatory language when it states that if “any part of any deficiency is due to * * * intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency * * As hereinbefore demonstrated, petitioner did intentionally disregard the regulations, and, since this conclusion is inescapable under the stipulated facts, it is mandatory that the 5 percent addition be assessed, collected, and paid in the same manner as if it were a deficiency under section 293 (a).

We have examined the authorities cited without finding one dis-positive of this issue. In Frank T. Heffelfinger, 32 B. T. A. 1232; affirmed on another point, 87 Fed. (2d) 991, we found as a fact that there was no intentional disregard of rules and regulations. Clearly the stipulated facts are susceptible of no such ultimate finding in this proceeding. Most of the cases cited dealt with the 5 percent addition for negligence. In the few cases where “intentional disregard of rules and regulations” was considered, the opinions coupled negligence with intentional disregard, see Lucian T. Wilcox, 44 B. T. A. 373; Gibbs & Hudson, Inc., 35 B. T. A. 205; and Oscar G. Joseph, 32 B. T. A. 1192. Negligence has neither been urged nor established in this proceeding, so none of the latter cases involved comparable situations.

Harsh though the conclusion may seem, the stipulated facts herein leave, no recourse but to grant respondent’s request for a 5 percent addition to the deficiency.

Decision will be entered umder Rule 50.

       The pertinent provisions of said article read as follows :
      “Double credits are not permitted, either for the same .year or for separate years. Thus, amounts which have been or may be properly taken as a credit pursuant to section 27 (e) of the Act or section 27 (d) of the Revenue Act of 1936 (both sections relating to dividends in obligations of the corporation) may not again be included in the dividends paid credit under section 27 (a) (4) when the obligations are paid. * * *”

         SEC. 27. CORPORATION DIVIDENDS PAID CREDIT.
      (a) Definition in General. — As used in this title with respect to any taxable year the term “dividends paid credit” means the sum of:
      * * * * * *
      (4) Amounts used * * * to pay or to retire indebtedness of any kind, if such amounts are reasonable with respect to the size and terms of such indebtedness. As used in this paragraph the term “indebtedness” means only an indebtedness of the corporation existing at the close of business on December 31, 1937, and evidenced by a bond, note, debenture, * * * issued by the corporation and in existence at the close of business on December 31, 1937, or * * *
      * * * * * # *
      (e) Dividends in Obligations of the Corporation. — If a dividend is paid in obligations of the corporation, the amount with respect thereto which shall be used in computing the basic surtax credit shall be the face value of the obligations, or their fair market value at the time of the payment, whichever is the lower. If the fair market value of any such dividend paid in any taxable year of the corporation beginning after December 31, 1935, is lower than the face value, then when the obligation is redeemed by the corporation in a taxable year of the corporation beginning after December 31, 1937, the excess of the amount for which redeemed over the fair market value at the time of the dividend payment (to the extent not allowable as a deduction in computing net income for any taxable year) shall be treated as a dividend paid in the taxable year in which the redemption occurs.

       SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.
      (a) Negligence. — If any part of any deficiency is due to negligence, or intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency, except that * * *.
      46 B. T. A.