author: Mellott:

text:
    Jane B. Shiverick, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84442.
    Promulgated March 9, 1938.

      H. A. Mihills, G. P. A., for tlie petitioner.

      S. B. Pierson, Esq., for the respondent.
   OPINION.

Mellott:

The commissioner added $3,612.95 to the net income reported by the petitioner for the year 1933 and determined a deficiency in her income tax for said year in the amount of $190.54. The proceeding was submitted upon a stipulation of facts. We find the facts to be as stipulated but set out herein only those necessary for an understanding of the issue to be decided.

The petitioner, a resident of Cleveland, Ohio, on March 19, 1930, conveyed bonds and other securities, aggregating approximately a half million dollars, to the Cleveland Trust Co. as trustee. The trust instrument provided, in general, that the trustee should collect the income and pay it over to petitioner during her life. After her death and the death of her husband, the income was to be paid to her children until they attained certain ages, when the principal was to be paid over to them. The trustee was authorized and empowered to pay the settlor such amounts from the principal of the trust estate as her husband, as cotrustee, should deem to be proper for her maintenance, support, and comfort. After her decease, in the event her husband was then living, the income was to be paid to him during his life, and, while he was the recipient of income, the trustee was authorized to pay him, from the principal of the trust, such amounts as it should deem necessary or proper for his maintenance, support, and comfort.

The trust was subsequently modified to include policies of insurance on the life of the husband of the settlor and residence property owned by them. After the modifications the trust instrument, in so far as pertinent to the issue to be decided, provided as follows:

For the purposes of this instrument, I hereby constitute and appoint my husband. Asa Shiverick, as co-Trustee to serve with The Cleveland Trust Company, Trustee. Upon the death, or in case of his resignation, failure or inability to act as co-Trustee hereunder, I hereby constitute myself as such co-Trustee. Upon my death or in case of my unwillingness to serve, or in event of my resignation, failure or inability to act as such co-Trustee, my son, Asa Shiygrick, Jr., provided he has attained the age of twenty-five (25) years, or upon his attaining said age, shall become such co-Trustee. * * *
Before the Trustee sells, leases, exchanges or purchases any securities or property, it shall first secure the written approval thereto of the co-Trustee as hereinabove provided. * * *
* * * In addition to such payments of income the Trustee is authorized and empowered to pay me from time to time from the principal of the trust estate, such sum or sums as the acting co-Trustee (if such co-Trustee be not myself), or if there be no acting co-Trustee, other than myself, as the trustee hereunder may deem necessary or proper to provide for my suitable support, maintenance and comfort, in event my income hereunder and from other sources be, in the judgment of such co-Trustee or the Trustee, as the case may be, insufficient therefor.
Subject to the provisions hereinbefore made and after my decease, the Trustee shall pay my husband Asa Shiverich from time to time, from the net income derived from the trust estate, such sum or sums as he may demand by written instrument signed by him and delivered to the Trustee. In addition to the payments hereinabove provided to be made to my said husband, the Trustee is authorized and empowered to pay him from time to time, from the principal of the trust estate, such sum or sums as it may deem necessary or proper to provide for his suitable support, maintenance and comfort, regard being had by the Trustee, however, to his income from this and other sources. If during any calendar year my said husband does not withdraw the entire net income derived from the trust estate during such year, the Trustee shall have power and authority to pay to or expend for the benefit of each of my children hereinafter named, so much of such excess income as it may deem necessary or proper to provide for his or her suitable support, maintenance, education and advancement in life; provided, however, that no more than one-third (%) of such excess shall be paid to or expended for the benefit of any such child. If less than one-third thereof is paid to or expended for the benefit of any such child, the balance of such one-third ( V,í ) shall be added to the principal of the share of the trust estate hereinafter created for such child’s benefit.
*******
I reserve the right at any time during the lifetime of my husband, Asa Shive-etok, to revoke the settlement hereby evidenced, either in whole or in part, as well as the right to modify in any respect the terms of this settlement, provided the consent and approval of my husband be had and obtained, any such revocation or modification to be evidenced by written instrument signed by me, bearing the written approval of my husband, and delivered to the Trustee. To whatever extent this settlement shall be so revoked, the Trustee shall thereupon transfer and deliver to me such part or all of the property comprising the trust estate as may have been withdrawn under such revocation; conditioned, however, upon my repaying any advances made by the Trustee, and satisfactorily indemnifying it against any liabilities incurred by it in the execution of this trust.

In accordance with the last paragraph, set out above, the petitioner withdrew certain securities from the trust during the taxable year, with the consent of her husband, and sold them at a loss of $16,324.05. The loss was deducted by her in her return of income for said year and is not in controversy. She reported as income $17,828.46, paid over to her by the trustee, said amount being all of the income of the trust except a net profit of $3,612.95 arising from the sale by the trustee of some of the securities. The trustee reported the sum of $3,612.95 as income and paid the tax thereon, amounting to $104.52.

The respondent determined that the net profit arising from the sale of securities by the trustee should be added to petitioner’s income, saying in his notice of deficiency:

An examination of the trust agreement discloses that it provides that you, as grantor, may at any time during the lifetime of your' husband revoke the settlement evidenced by the agreement, either in whole or in part, as well as the right to modify in any respect the terms of settlement, provided the consent and approval of your husband is obtained. It is apparent that the changing of the revenue acts relative to revocable trusts by the inclusion of “substantial adverse interest,” would eliminate your husband in the case, as the trust agreement provides that he has only a life interest in the income of the trust after your death, providing he survives yon. The trust agreement also provides that under certain condition portions of the corpus may be paid to the grantor without the consent of the beneficiary but as approved by your husband as co-trustee.

The words quoted in tifie notice of deficiency, “substantial adverse interest”, appear in section 166 of the Eevenue Act of 1932, and this is 'the section which respondent relies upon in taxing the profit to the petitioner rather than to the trustee. The parties apparently agree that petitioner and the trustee correctly reported the items of income (see sections 161, 162, et sequa, Eevenue Act of 1932) unless the trust is a revocable one within the meaning of section 166. This question will be determined by deciding whether petitioner’s husband, during the taxable year, had “a substantial adverse interest in the disposition of” any part of the corpus of the trust or the income therefrom, inasmuch as it is apparent that the settlor had “the power to revest in [herself as] the grantor title” to a part of the corpus in conjunction with him.

The purpose of the enactment of section 166 of the Eevenue Act of 1928 and corresponding sections of earlier acts (sec. 219 (g), Eevenue Acts of 1924 and 1926) was “to prevent the evasion of tax by means of trusts.” Joseph H. Bromley, Jr., 26 B. T. A. 878, 880; affd., Bromley v. Commissioner, 66 Fed. (2d) 552. As pointed out by the Supreme Court in Burnet v. Wells, 289 U. S. 670, the section was enacted, “To neutralize the effect of the device [of creating trusts with power of revocation] in its application to incomes.” It has been upheld by the Supreme Court in Corliss v. Bowers, 281 U. S. 876, and other cases, and similar provisions of the revenue act requiring the inclusion in gross estate of property held in a revocable trust have also been approved. Cf. Reinecke v. Smith, 289 U. S. 172, Helvering v. City Bank Farmers Trust Co., 296 U. S. 85. The earlier acts provided that the income of the trust should be included in computing the net income of the settlor when he “either alone or in conjunction with any person not a beneficiary in the trust” had, at any time during the taxable year the power to revest in himself title to any part of the corpus. (Sec. 166, Bevenue Act of 1928.)

The substance of the amendment in 1932 was to substitute for the words “any person not a beneficiary of the trust” the words “any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom.” The purpose, as disclosed by its legislative history, was to make the evasion of taxes through the use of trusts increasingly difficult. In other words, borrowing the language used by the Supreme Court in Burnet v. Wells, supra, “to keep pace with the fertility of invention whereby taxpayers had contrived to keep the larger benefits of ownership and be relieved of the attendant burdens.” The report of the Finance Committee (No. 665, 72d Cong., 1st sess., p. 34) clearly shows such intent.

While the purpose of the amendment is readily discernible from its legislative history, it furnishes little assistance in determining the question before us. Whether the interest of the one in conjunction with whom revestiture may be made is, or is not, “a substantial adverse” one is largely a question of fact, though in determining it we should consider the legal principles applicable to the' interests created by the trust instrument. Cases decided under other sections of the revenue act, though not determinative, may furnish some light. Thus, in Bessie R. Jones, 27 B. T. A. 171, where the facts were somewhat similar to those before us, it was held, following Smith v. Commissioner, 59 Fed. (2d) 56, that under sections 166 and 167 of the Revenue Act of 1928 the profit from the sale of trust assets was not taxable to the settlor-taxpayer, the trust instrument providing that she could amend, alter or revoke the trust only with the consent of trustees who were also contingent beneficiaries. The holding was premised partially upon the theory that Congress had not intended, by the use of the term “beneficiary”, to include only those having vested interests but that the term also included those having contingent interests.

In Savage v. Commissioner, 82 Fed. (2d) 92, the foster mother of two children had created a trust for their benefit, naming her husband, the foster father, as trustee and providing that the trust could be revoked or amended only with his consent. The Board held (Lillian T. Savage, 31 B. T. A. 633) that the husband was not a beneficiary and that the income of the trust was taxable to the settlor under section 166 of the Revenue Act of 1928. The court reversed, holding that the husband had more than “a nominal interest in the income or principal” as such term was used in a Treasury regulation defining the term “beneficiary”, its view being that the husband was “very substantially benefited” because the trust made possible the maintenance of a home for him and the children, for whose support he was responsible.

In Margaret A. Holmes, 27 B. T. A. 660, the Board reviewed the legislative history of section 219 (g) of the Revenue Act of 1924 and section 166 of the Revenue Act of 1928 and concluded that, where a husband and wife had created separate trusts, each naming the other as beneficiary and reserving the power to revoke with the consent of the beneficiary, the income was not taxable to the grantor. For the reasons therein pointed out, the fact that the marital relationship existed, was not deemed to be material. Cf. Hooper v. Tax Commissioner of Wisconsin, 284 U. S. 206.

It can not be gainsaid that petitioner’s husband had an interest in the corpus of the trust adverse to that of the settlor, not because he was a trustee (Reinecke v. Smith, 289 U. S. 172), but because he had the right, in the event the settlor predeceased him, to have the income of the trust for the remainder of his life and such part of the corpus as the trustee should deem to be necessary for his suitable support, maintenance, and comfort. Cf. Reinecke v. Northern Trust Co., 278 U. S. 389; Mackay v. Commissioner, 94 Fed. (2d) 558. While his interest was contingent upon the death of his wife occurring before his decease, he might reasonably be expected to object to any change in the assets of the estate which would be inimical to his rights under the trust instrument in the event he outlived her. To that extent, at least, his interest was adverse.

Having concluded that the husband’s interest is adverse to that of the settlor, there yet remains for decision the question whether such adverse interest is “substantial.” The dictionary definition of the term is at best only suggestive rather than expressive of the exact sense in which the term is used in the section under consideration. One of the definitions given in Webster’s New International Dictionary of a substantial right is, “a right materially affecting those interests which a man is entitled to have preserved and protected by law; a material right.” Other definitions of substantial are “material; not seeming or imaginary; not illusive; real; true; having good substance.” We can not say that the husband’s rights were not substantial within the above definitions or as such term is generally understood. The property placed in trust by the settlor was very “substantial” in amount — more than a half million dollars in bonds alone, half of which were Government bonds. The interest on the bonds was more than $20,000 a year. His right to receive this amount, contingent though it was, is sufficient, we think to justify us in holding that he had a substantial adverse interest.

We hold, therefore, that the respondent erred in including in petitioner’s income the amount in dispute.

Reviewed by the Board.

Judgment will be entered for the fetitioner.

       SBC. 166. REVOCABLE TRUSTS.
      Where at any time during the taxable year the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
      then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

       Under tie present law the income of a trust is taxable to the grantor -where, at any time during the taxable year, the grantor has power to revest in himself title to any part of the corpus of the trust, either alone or in conjunction with any person not a beneficiary of the trust. In an attempt to avoid this section, the practice has been adopted by some grantors of reserving power to revest title to the trust corpus in conjunction with a beneficiary having a very minor interest or of conferring the power to revest upon a person other than a beneficiary; in such cases the grantor has substantially the same control as if he alone had power to revoke the trust. While it is, of course, yet to be established that such device accomplishes its purpose, it is considered expedient to make it clear that in any of these cases the income shall be taxed to the grantor. The house bill made the grantor of a trust taxable upon the income of any part of the corpus of the trust, where the power to revest in the grantor title to such part of the corpus was in the grantor alone or was in the grantor in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus. Your committee has extended the scope of this provision so as to include, as well, the cases where the power to revest title to any part of the corpus is held, either alone or in conjunction with the grantor, by a person not having a substantial adverse interest in such part of the corpus or in the income therefrom.


source: Caselaw Access Project

author: Leech::

license: Public Domain

text:
    Charles J. Hepburn, Executor of the Estate of Mary Morton, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82242.
    Promulgated March 15, 1938.

      Wm. Barclay Lex, Esq., for the petitioner.

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

Leech::

The Revenue Act of 1926, section 302 (f), provides, for purposes herein material, as follows:

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—
*******
(f) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will * * *.

Our sole inquiry is to decide whether the property, the value of which was thus included in the gross estate of petitioner’s decedent for estate tax purposes was “property passing under a general power of appointment exercised by the decedent (1) by will * *

The Supreme Court, in Helvering v. Grinnell, 294 U. S. 153, in passing on this section, said:

* * * Analysis of this clause discloses three distinct requisites: (1) The existence of a general power of appointment; (2) an exercise of that power by the decedent by will and (3) the passing of the property in virtue of such exercise. * * *

Since, whatever power the decedent possessed was exercised by her will and the disputed property passed by virtue of the exercise of such power, our only question is to determine whether or not petitioner’s decedent possessed under the will of her father, Levi P. Morton, a general power of appointment, by will, of the contested property.

A power of appointment is general when it is exercisable in favor of any person the donee may select and special or limited when it is exercisable only in favor of a person or class of persons designated in the instrument granting the power. Johnstone v. Commissioner, 76 Fed. (2d) 55, affirming 29 B. T. A. 957. The respondent contends that the petitioner’s decedent had a general power of appointment under the will of her father, Levi P. Morton, arising from the following provision of the will:

* * * I authorize each of my children who may survive me by her last will and testament to give, dispose of and distribute one-half of her share of said residue, of which half the amount, if any, so disposed of for the benefit of her husband shall be deemed a part, to and among such person or persons, including such husband, and in such proportions as she shall by her said last will' and testament designate and appoint, but the power hereby given and created shall extend only to such child’s original share in my residuary estate and not to any addition to or accretion thereof from the distribution of any other share in my residuary estate. Such appointees may be natural persons or corporations, and such appointment of any part of said two-thirds to take effect only after my wife’s death * * *.

Undoubtedly, if that provision were read alone, the position of the respondent would be sound. It may be said further that unless the intention of the testator to limit the power there defined to a special power is established, the power must be construed as general. Thompson v. Garwood, 3 Wharton, 287. However, the intention of the testator, Levi P. Morton, which is controlling, is to be ascertained, not from any part of his testament but from the whole instrument considered as an entity. Travers v. Reinhardt, 205 U. S. 423; Mississippi Valley Trust Co. et al., Executors, 28 B. T. A. 387; affd., 72 Fed. (2d) 197; certiorari denied, 293 U. S. 604. And, when so considered, other provisions of the will become pertinent. Thus, it is later provided that:

* * * I also direct that the power of appointment herein given to my said daughters over one-half of her original share of my residuary estate, including as part thereof, if she shall so by will direct the continuance of the trust during the life or until tha re-marriage of a husband over not exceeding one-third of her original share, shall be subject to the approval in writing of my said individual trustees or such of them as shall accept the trust, or the survivors or survivor of them, such approval to be indicated by endorsement on any such will, signed by such individual trustees or the survivors or survivor of them, or by separate paper approving a particular testamentary disposition or dispositions made or to be made by either of my said daughters. * * *

Bespondent argues that, in no event does this paragraph indicate a purpose to limit the general power of appointment granted in the earlier paragraph because petitioner’s decedent was never married and the provision for approval of the individual trustees was meant to apply only “if she shall so by will direct the continuance of the trust during the life or until the re-marriage of a husband over not exceeding one-third of her original share.” We disagree. The quoted clause, upon which respondent bases his argument, affects not the necessity of the approval of the individual trustees in any exercise of the power given by the testator but only describes certain property over which the power to appoint shall conditionally exist.

But respondent then says, in effect, that the approval of the individual trustees in the exercise of the power was intended by the testator, Levi P. Morton, to be a mere perfunctory, administrative act. Cf. Proctor Patterson et al., Executors, 34 B. T. A. 689; appeals dismissed, 90 Fed. (2d) 1009, 1016. The record unquestionably contradicts that statement. See Farmers’ Loan & Trust Co. v. Bowers, 29 Fed. (2d) 14; Security First National Bank of Los Angeles et al., Executors, 28 B. T. A. 289.

The will of Levi P. Morton is replete with provisions clearly indicating his desire that his property, after his death, should, so far as it was within his power, remain within his own family. The investment and reinvestment of the share of petitioner’s decedent and her sisters in their father’s estate could be made only with the approval of the individual trustees. The sale and leasing of property included as part of those shares was subject to the same approval. The use to which funds applicable to the petitioner’s decedent and her sisters under her father’s will, could be put, was determinable only with the approval of those trustees. The testamentary expression is not only mandatory that the exercise of the power “shall be subject to the approval * * * of my said individual trustees * * *” but it provides that such approval shall be evidenced in the formal and specific manner of a writing signed by such trustees. That the approval of the individual trustees, who occupied the position of personal representatives of the testator, Levi P. Morton, was recognized as a substantial and actually necessary requisite in the exercise of the power by petitioner’s decedent and those trustees' alike, significantly and repeatedly appears. See Lowrey v. Hawaii, 206 U. S. 206; Case Manufacturing Co. v. Soxman, 138 U. S. 431. In fact, so far as the record discloses, no attempt was made to exercise the power without that approval. And, if any doubt existed, as to the all-important testamentary intention as to the contested power, we think it is removed by the codicil of Levi P. Morton, dated June 14, 1911, wherein he said:

My purpose in mating this change is to carry out more effectually than I could do as a citizen of New York, my general purpose to keep my estate in my own family so far as I may do so lawfully and consistently with the power which I have given my daughters to dispose by will subject to the approval of the co-trustees named in or appointed conformably to my will, of one-half of their original shares in my residuary estate.

The Federal estate tax is an excise tax imposed not upon the property of the decedent but upon the transmission of that property by decedent. Ithaca Trust Co. v. United States, 279 U. S. 151; Y. M. C. A. of Columbus, Ohio v. Davis, 264 U. S. 47. Thus, as stated by the Circuit Court of Appeals in the case of Fidelity-Philadelfhia Trust Co. v. McCaughn, 34 Fed. (2d) 600:

* * * A logical explanation of the inclusion of property passing under general powers of appointment and the exclusion of property passing under special powers is that where the original testator has limited the right to appoint to certain named beneficiaries or to a limited class of beneficiaries, it is he and not the donee of the power who in the broadest sense transmits the property to the beneficiaries. The donee’s exercise of such narrow and limited powers may be taken rather as a mere stage in the original scheme of inheritance than as an independent source of descent. In such case, it is really the death of the original testator which may reasonably be taken as the transmission of the property for the purpose of taxation. Where, however, the donee has full power to direct the property to any beneficiary that he pleases, there is in a real sense a transmission of it from him rather than from the original testator. The important thing is the latitude of the donee’s power of disposition rather than the quantum of the interest which he may dispose of or the time of its vesting. * * *

Thus, an absolute and unconditional power to revoke a trust is equivalent to a general power to appoint. Bullen v. Wisconsin, 240 U. S. 625. But a power to revoke is not absolute where it requires the joinder or consent of the trustees or a majority of them. Reinecke v. Northern Trust Co., 278 U. S. 339; Farmers' Loan & Trust Co. v. Bowers, supra.

Since the period at which the limitation of the power must be construed is the time of its exercise (Johnstone v. Commissioner, supra; 1 Sugden on Powers, 495), the exercise of the presently contested power, by which the disputed property actually did pass, was possible when thus exercised, only, in favor of those and in the amounts as then formally approved in accordance with the provisions of the Levi P. Morton will. Obviously that was not the exercise of a general power of appointment by decedent. Whatever else it may have done, the condition making the disputed power of appointment “subject to the approval in writing of my said individual trustees * * *” limited the petitioner’s decedent, in the exercise of that power, at any time, to those, corporate or otherwise, then having the formal approval of the trustees. That limitation of those in favor of whom the power can be exercised effectively distinguishes the cases of Johnstone v. Commissioner, supra, and J. Gilmore Fletcher, Executor, 29 B. T. A. 503, upon which the respondent relies.

The conclusion follows that the property, the value of which supports the pending deficiency, was not “property passing under a general power of appointment exercised by the decedent * * * by will * * Bevenue Act of 1926, sec. 302 (f).

Decision will be entered under Rule 50.


author: Hareon:

text:
    Harriet W. Rosenau, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86407.
    Promulgated March 15, 1938.

      Fred W. Weitzel, Esq., and Morris H. Goldman, Esq., for the petitioner.

      Frtmh T. Homer, Esq., and Harold F. Noneman, Esq., for the respondent.
   OPINION.

Hareon:

The question presented in this proceeding is whether a transfer in trust wherein the donor reserves to herself a life estate in the net income and the power to name or change the beneficiaries of the corpus of the trust and direct the manner of distributing the corpus and undistributed accumulated income of the trust upon her death, is a gift to the extent of the remainder interests after the donor’s death, and taxable under section 501 (a) and (b) of the Revenue Act of 1932. The trust instrument expressly provides that “this document and the trust hereby created” shall be irrevocable by the settlor.

The respondent determined that the present value of the remainder interest is $23,838.81. There is no dispute as to this computation. He contends that petitioner has made a completed gift of the remainder interest which is subject to the gift tax.

The petitioner contends that there was no gift because the settlor had retained the benefit of the property conveyed to a trust during her lifetime and the right to designate the beneficiaries, of the property upon her death. We agree with the petitioner.

The respondent relies upon Thomas E. Wells, 34 B. T. A. 315; affd., Commissioner v. Wells, 88 Fed. (2d) 339. This case may be distinguished upon its facts and is not controlling here. In the Wells case the taxpayer transferred property by irrevocable trust providing for accumulation of income until the named beneficiary attained the age of 21 years, and payment of income to the beneficiary thereafter until the age of 30, or the death of his mother, whichever occurred first, when he was to receive the corpus. The question there was whether the donor was entitled to the exemption of $5,000, allowed in case of gifts other than of future interests under section 504 (b) of the Revenue Act of 1932. The donor reserved no interest whatever in the corpus and retained no power to name or change the beneficiary to receive the corpus. The beneficiaries of the trust were living and were designated in the instrument.

Here, the settlor reserved a life estate in the trust property and the power to name or change the persons to receive the corpus ultimately. The remaindermen were undetermined. The trust provided for a life estate after the death of the settlor and the remainder to settlor’s surviving children or issue of deceased children when they attained 30 years of age when the trust would cease and determine. The question here was not in the Wells case and arises under a different section of the statute.

The petitioner relies on Hesslein v. Hoey, 18 Fed. Supp. 169; affd., Hesslein v. Hoey, 91 Fed. (2d) 954. In the Hesslein case the settlor conveyed property to trustees to pay the income to named beneficiaries during the trust and on its termination upon his death, or his wife’s death if she survived him, to distribute the principal among named beneficiaries, or to those whom he might appoint by will if he should survive his wife, and reserved to himself the power to change the beneficiaries and to alter the trust in any manner not beneficial to himself or his estate.

In holding that section 501 of the Revenue Act of 1932 was not intended to impose a gift tax with respect to the corpus of such a trust, the Court of Appeals of the Second Circuit points out that the gift tax and the estate tax are closely related in purpose and structure; the two statutes being in pari materia, Burnet v. Guggenheim, 288 U. S. 280, and must be construed in conjunction. In the opinion, the Circuit Court says:

* * * Indeed, it would seem that the purpose of the gift tax was to supplement the estate tax and prevent avoidance of it by inter vivos gifts. See Cong. Ree. 72d Cong., 1st Sess., pp. 5691, 5788. * * * Since the primary purpose of the gift tax statute is to supplement the estate tax statute, it is reasonable to construe the former as excluding gifts so incomplete by reason of powers reserved to the donor, as to be expressly made subject by the latter to the estate tax. Section 302 (d), Revenue Act 1926 (44 Stat. 70, 71). * * *

In the Hesslein case the court calls attention to the fact that section 510 of the Revenue Act of 1932 makes the donee of a gift personally liable for the gift tax to the extent of the value of the gift if the tax is not paid by the donor and observes that it “seems unlikely that Congress would intend to impose personal liability upon a donee who might thereafter be deprived of all interest in the property at the will of the so-called donor.”

Where the settlor of a trust estate reserves the power to change the beneficiaries and designate the persons who shall possess or enjoy the property after his death, the corpus of the trust must be included in his gross estate, section 302 (c) of the Revenue Act of 1926 as amended by Joint Resolution of March 3,1931. We think this is true where the instrument provides that the trust is irrevocable. Cf. Porter v. Commissioner, 288 U. S. 436; Commissioner v. Chase National Bank of New York, 82 Fed. (2d) 157. It seems reasonable therefore to assume that, if the reservation of the power to change the beneficiaries results in a retention of ownership and control sufficient, when cut off by death, to subject the property to the estate tax, the transfer of the property to the trustee subject to the power is not such a complete transfer of ownership as to subject the property to the gift tax. The statute imposes a tax upon “the transfer” of property by gift, cf. Thomas E. Wells, supra, but there must be a gift if the tax is to attach. Where there is a transfer of the present legal title but the reservation of a power in the donor to exercise further dominion and control over the income and corpus the requirements of a gift have not been met. See Adolph Weil, 31 B. T. A. 899, and compare Burnet v. Guggenheim, supra.

The respondent’s argument gives chief consideration to the situation created by the terms of the trust whereby the petitioner conveyed property to the trust irrevocably, and appears to ignore the additional provision in the trust that petitioner reserved the power to designate in her will the person or persons who should receive the remainder interest. We believe that the reserved power to designate the ultimate remaindermen may not be ignored because the very interest which the respondent seeks to tax may be transferred to beneficiaries not known at the time the trust was created and not ascertainable under the terms of the trust at the time it was created. Further, the petitioner could name an ultimate beneficiary of the remainder interest and receive consideration from such person in return for having exercised the reserved power for benefit of the person giving a consideration. There is nothing to prevent petitioner here, after the time of making the alleged gift, from not only disposing of her life interest in the trust .for a consideration, but for exercising the reserved power to designate the beneficiaries of the remainder interest for a consideration.

Viewed from our concept of what constitutes a gift in the light of the relation of the gift tax to the estate tax and our interpretation of the decisions of the courts, we think the respondent erred as contended by the petitioner.

Beviewed by the Board.

Decision will be entered for the petitioner.

Murdock and Turner dissent.


author: Steenhagen :

text:
    Herbert H. Franklin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78673.
    Promulgated March 15, 1938.

      Benjamin E. Shone, Esg., for the petitioner.

      Eugene G. Smith, Esg., for the respondent.
   OPINION.

Steenhagen :

The Commissioner held that the shares sold were not susceptible of identification with any bought at a particular price, and that the first in, first out rule must therefore be used so as to use up first the earliest cost of $5,875, then the next cost of $2,403.83, thus leaving only the remainder to be applied against the last purchase of $43,250. The petitioner says that the shares sold could be identified with those last bought and that he did enough to establish such identity. Short of matching up certificates, which under the circumstances would have been an unreasonably cumbersome process, the petitioner did as much as might be expected to express an intent to sell the shares most recently bought, to communicate such intent to the person by whom the sale was to be executed, and immediately on his accounts to treat the shares sold as so identified. This satisfies the requirement of identity sufficiently to overcome the first in, first out rule, Helvering v. Rankin, 295 U. S. 123; Fuller v. Commissioner, 81 Fed. (2d) 176; Miller v. Commissioner, 80 Fed. (2d) 219. Cf. Kraus v. Commissioner, 88 Fed. (2d) 616.

The respondent’s determination is reversed.

Judgment will be entered wider Rule 50.


author: Smith :

text:
    Fidelity National Bank and Trust Company, Alleged To Be an Association Taxable as a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Fidelity National Bank and Trust Company of Kansas City, a National Banking Association, Petitioner, v. Commissioner of Internal Revenue, Respondent. Henry C. Flower, Lester W. Hall and W. D. Johnson, Trustees for Stockholders of Fidelity National Bank and Trust Company of Kansas City of Record, December 31, 1928, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 85644, 85648, 85649.
    Promulgated March 15, 1938.

      Justin D. Bowersook, Esq., for the petitioners.

      John H. Pigq, Esq., and Arthur Clark, Esq., for the respondent.
   OPINION.

Smith :

The above facts are all of those essential to the general or preliminary issue raised. In view of our ruling on this issue, as discussed below, that none of the petitioners in these proceedings is liable for any of the tax deficiencies herein asserted, it is not necessary to state the facts pertaining to the issues on the merits.

Questions relating to the income tax liabilities of the various participants in transactions of the same general character as those here involved have been considered by the Board and by the courts in a number of cases. In William E. Fulton, 15 B. T. A. 1018, the facts were almost identical with those in the instant proceedings except that no certificates of interest were issued to the stockholders of the old banks representing their interests in the excess assets transferred to the trustees. The Board held that the transfer of the excess assets to the trustees constituted the declaration of a dividend which was taxable to the distributees when the distributions were made to them by the trustees. On appeal the Board was affirmed, Fulton’s Executors v. Commissioner, 47 Fed. (2d) 436.

The case of Benjamin L. Allen, 19 B. T. A. 1005, involved substantially the same facts as those in William E. Fulton, supra, except that there the trustees to whom the excess assets were transferred did issue certificates of beneficial interest to their old stockholders, as was done in the instant proceedings. The Board held, following the Ful ton case, that the transfer of the assets to the trustees constituted a dividend by the old corporation and that the distributions made by the trustees were taxable to the distributees not as dividends under section 201, but as exchanges under section 202 of the Eevenue Act of 1921 to the extent that the distributions exceeded the base of the certificates in the hands of the distributees. The Board also held that the trust was not such a trust as was contemplated under section 219 of the Eevenue Act of 1921. The Board was affirmed by the Circuit Court of Appeals for the Second Circuit, Allen v. Commissioner, 49 Fed. (2d) 716. The court held, however, that the trust involved was a trust within the meaning of section 219 and was not an association taxable as a corporation, as the Commissioner contended. In its opinion the court stated:

We agree with the appellant that the trust did not create an “association” under section 2 (2) of the Revenue Act of 1921 (42 Stat. 227), and that section 201 (c) did not in terms apply. This was not a trust like those before the court in Hecht v. Malley, 265 U. S. 144, 44 S. Ct. 462, 68 L. Ed. 949, where the trustee was conducting a business. The only purpose was to hold the assets as security for a season, and then to distribute them. Little of the assets proved necessary to make whole the trustee, and the delay arose only because of difficulties in liquidation. We therefore assimilate the trust to those considered in procker v. Malley, 249 U. S. 223, 39 S. Ct. 270, 63 L. Ed. 573, 2 A. L. R. 1601, and White v. Hornblower, 27 E. (2d) 777 (C. C. A. 1), and we accept section 219 as the controlling section. If so, section 219 (c) imposed the tax primarily upon the trustee, and this covered profits arising from the sale of the trust property. Merchants’ etc., Co. v. Smietanka, 253 U. S. 509, 41 S. Ct. 386, 65 L. Ed. 751, 15 A. L. R. 1305. However, in the case at bar the trustee paid over the principal together with any profit as the liquidation proceeded, as well as any interest that was available. Hence the trust was for the “periodic,” though irregular, payment of any income that arose, and fell within section 219 (a) (4). If so, the certificate holders were subject to the tax under section 219 (d), and so we understand every one agrees in the case of property sold by the trustee and distributed in cash.

In both of the above cases the taxpayers were the old stockholders or beneficiaries of the trusts against whom the Commissioner had determined a tax on the distributions made to them by the trustees out of the liquidated assets. In the instant proceedings, however, the respondent has asserted deficiencies against the trustees in the operation of the trust, as trustees for the Fidelity Bank in the one instance, Docket No. 85649, and in the other, Docket No. 85644, as an association taxable as a corporation.

It is our opinion, as stated above, that no liability for the taxes involved in these proceedings rests upon any of the petitioners before us on either of the theories advanced by the respondent, or on any other theory. It is clear beyond reasonable doubt that the trustees engaged in the liquidation of the excess assets in accordance with the terms of the trust agreement were not an association taxable as a corporation under the provisions of section 701 of the Eevenue Act of 1928.

In the first place, the trust here was purely a liquidating trust as distinguished from a business trust. The trustees were not authorized or expected to engage in carrying on any business enterprise and, so far as the facts show, they did not do so. This distinction has always been recognized to be of paramount importance. It was relied upon in our ruling in Dolese & Shepherd Co., Syndicate No. 3, 30 B. T. A. 1171, and in other of the Board and court cases therein cited, which were decided previous to the decision of the Supreme Court in Morrissey v. Commissioner, 296 U. S. 344, and in Girard Trust Co., Trustee, 34 B. T. A. 1066, and Broadway-Brompton Buildings Liquidation Trust, 34 B. T. A. 1089, thereafter decided. In the last named case we said:

* * * Here, the activities of the trust were all reasonably incident to and consistent with orderly liquidation. The declared purpose was neither obscured nor abandoned and its accomplishment was the primary consideration at all times.
We have carefully considered the recent decisions of the Supreme Court arid do not believe they dictate a contrary conclusion. In the Morrissey case the Chief Justice was at pains to point out that the trust in question “was not a liquidating trust.”
Consequent on the above, it is held that petitioner is taxable as a trust and not as a corporation. See Dolese & Shepherd Co., 30 B. T. A. 1171, and cases there cited.

See also Frederick Pitzman et al., Trustees, 36 B. T. A. 81.

We conclude that the trust here was a liquidating trust and not an association taxable as a corporation.

It follows that, if the trust is to be regarded as a taxable entity, it must be under section 161 (a) (2) of the Eevenue Act of 1928, which provides in material part that:

(a) Application of taso. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
*******
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries, * * *

It is further provided in section 162 of the Eevenue Act of 1928, however, that:

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
* * * $ 4s * *
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *

The trust agreement here implicitly directs that “All income from the trust estate not needed for expenses or for the purposes authorized herein shall be distributed to the beneficiaries annually”, or more frequently, if desired. Distributions of capital also were to be made from time to time. Whatever income the trust may have realized in the liquidation of the trust assets was therefore deductible by it and taxable to the beneficiaries.

Since the beneficiaries are not before us individually, we are not called upon to determine the amount of the distributable income of the trust for either of the years 1930 or 1931. For this reason we have omitted from our findings of fact the facts relating to the issues on the merits.

As to the petitioners before us, we find that there is no deficiency in tax for either of the years 1930 or 1931. It follows, of course, that since there is no tax liability there is no liability for the penalties asserted.

Judgment of no deficiency will he entered.


author: Kern : Murdock,

text:
    Arthur E. Otto, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81874.
    Promulgated March 17, 1938.

      Charles D. Hayes, Esq., for the petitioner.

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

Kern :

The question here is whether the shares of Chase National Bank stock sold by petitioner! on December 31, 1932, at a loss of $8,059.68 were capital assets within the meaning of section 101 (c) (8) of the Kevenue Act of 1932. If they were not capital assets, then the loss sustained by petitioner as a result of the sale would not be deductible in the taxable year of 1932 under the limitation imposed by section 23 (r) of the revenue act, since the petitioner had no gains from sales of noncapital assets during the year. The pertinent sections of the revenue act are set out in the margin.

The parties hereto agree that the sale of the stock by petitioner was made on December 31, 1932. The petitioner must have held the stock for more than two years in order that the stock might be considered a capital asset. See Harriet M. Hooper, 26 B. T. A. 758. The period of holding within the meaning of section 101 (c) (8) of the revenue act begins at the time petitioner acquired title. See McFeely v. Commissioner, 296 U. S. 102; Helvering v. San Joaquin Fruit & Investment Co., 297 U. S. 496. The narrow question, therefore, for our decision is whether petitioner acquired title to the Chase National Bank stock on December 30,1930, or, as respondent contends and has determined, on a later date. Because of this determination by respondent, the burden is on petitioner to show that title to the stock was acquired by him on the earlier date.

Petitioner contends that this question should be decided under the law of the District of Columbia, where the common law rule prevails, while the respondent contends that the law of New York should govern, in which jurisdiction the Uniform Sales Act and the Uniform Stock Transfer Act are in force. Since there is no question but that Murphy & Co. was acting as a dealer and not as a broker in making the sale of the Chase stock to petitioner, and since the contract to sell was made and the delivery took place in the District of Columbia, it is our opinion that the law of that jurisdiction governs. However, this point is not particularly important, since, even assuming in petitioner’s favor that the contract was for the sale of goods and not of choses in action, it is clear that the contract was for the purchase of unascertained goods and, under the common law, as well as under the Uniform Sales Act, some act on the part of the vendor in appropriating the goods to the contract of sale was necessary before title passed to the vendee. Williston on Sales, 2d ed., vol. 1, pp. 556-557. Meyer’s Law of Stock Brokers and Stock Exchanges, supplement page 35, succinctly states the law governing a case of this kind as follows:

The legal rights and duties of a stock dealer are, in the main, no different from those of a dealer or jobber in merchandise. No fiduciary or trust relationship arises out of the sale to or purchase from his customer. The contract which he makes with his customer is regarded as a contract for the sale of “unascertained goods”, entitling the seller to deliver any shares of the kind sold. Title does not pass to the purchaser until there has been an appropriation by the seller of specific stock to the contract, and mere notice of purchase or sale given hy the dealer does not constitute a sufficient appropriation to effect transfer of title even if the customer has made payment. If a dealer who has received payment in full fails to deliver or to allocate securities to the customer, the customer’s remedy is merely one for breach of contract. He has no cause of action in conversion, as he would have against a broker. * * * [Italics supplied.]

The above quotation is amply supported by the authorities therein cited. A leading case on the question here is Wills v. Investors’ Bankstocks Corporation, 257 N. Y. 451; 178 N. E. 755, which holds that the property in unascertained goods will pass to the buyer only when such goods in a deliverable state are unconditionally appropriated to the contract with the assent of the buyer. The goods in that case, as here, consisted of over the counter securities for which the plaintiff had given an order to a dealer to buy.

Applying the above rules to the facts in the present case, we are of the opinion that the petitioner has not shown that there was any appropriation of Chase stock to his contract on December 30, 1930. Clearly the petitioner has not established that Murphy & Co. had on hand any Chase stock on that date. The evidence on this is that Murphy & Co. had no position in the stock on December 30. This fact does not lead to the necessary inference that Murphy & Co. had acquired the stock and had appropriated it to the contract. The petitioner has not shown that such an appropriation had been made, and on this state of the record we can not make the assumption in his favor. The stock then must be treated as unascertained goods, and, so treating it, we are unable to find in the record any evidence of appropriation to the contract on December 30.

The petitioner relies largely on the case of Dee Furey Mott, 35 B. T. A. 195. That case is not in point here. The stock in that case was in the possession of the vendor and constituted specific ascertained goods in a deliverable state, and in the opinion emphasis was placed on that fact. In this case, as above pointed out, from the state of the record the Chase stock must be treated as having the status of unas-certained goods on December 30,1930. •

Summarizing, the petitioner has not shown that there was any appropriation of shares of stock to his contract on December 30, 1930, and, therefore, he has not established that he acquired the shares on that date.

Beviewed by the Board.

Judgment will he entered for the respondent.

Murdock,

concurring: The reasoning of the prevailing opinion leads irresistibly to the conclusion that the period of “more than two years” during which property is “held by the taxpayer” begins only at the time title to the property passes to the taxpayer. Yet, I think it is unfortunate that the Board was required to render such a decision because I believe that a different method of computing the period of ownership has been generally used up to this time. Many purchases of securities are made by taxpayers through brokers. The broker notifies his customer that a purchase has been made upon a certain day. The customer in making up his income tax return generally uses the date of purchase in computing his period of ownership. The Commissioner has accepted and has himself applied that method of computing the period of ownership in innumerable cases. The present opinion holds that that method is not in accordance with the law. Claims for deficiencies and refunds may be expected in a great many cases as a result of this decision.

The difficulty of correctly reporting gains and losses will be increased tremendously if this opinion is followed, as will the work of the Commissioner in auditing returns. Taxpayers who have made a purchase of securities through a broker seldom know the exact day upon which title to the securities purchased passes to them. They are notified by the broker of the day upon which the purchase was made and perhaps of the settlement date. It now appears that ithe date of purchase is unimportant and the taxpayer-customer must learn from the broker, if he can, the facts pertaining to the passing of title. Those facts may not be readily available. The taxpayer, after he learns the facts, will have to decide the legal question of exactly when title passed. Many taxpayers are not qualified to decide that question, even with full knowledge of the facts.

Although in the present case the decision is in the Commissioner’s favor, the principle established will apply equally to the advantage of taxpayers in the case of losses. If, as I have some reason to believe, this is an unfortunate decision, it may, at least, demonstrate that not all rights should be pressed through litigation. The Board, of course, has no alternative but to decide the case, and the law seems to be as stated in this opinion.

Mellott agrees with the above.

       SEC. 101. CAPITAL NET GAINS AND LOSSES.
      *******
      (e) Definitions. — For the purposes of this title—
      *******
      (8) “Capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business. For the purposes of this definition * 4 *.
      SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions :
      *******
      (r) Limitation on Stock Losses.—
      (1) Losses from sales or exchanges of stocks and bonds (as defined in subsection (t) of this section) which are not .capital assets (as defined in section 101) shall be allowed only to the extent of the gains from such sales or exchanges (including gains whiph may be derived by a taxpayer from the retirement of his own obligations).
      (2) Losses disallowed as a deduction by paragraph (1), computed without regard to any losses sustained during the preceding taxable year, shall, to an amount not in excess of the taxpayer’s net income for the taxable year, be considered for the purposes of this title as losses sustained in the succeeding taxable year from sales or exchanges of stocks or bonds which are not capital assets.
      (3) This subsection shall not apply to a dealer in securities (as to stocks and .bonds acquired for resale to customers) in respect of transactions in the ordinary course of his business, nor to a bank or trust company incorporated under the laws of the United States or of any State or Territory, nor. to persons carrying on the banking business (where the receipt of deposits constitutes a major part of such business) in respeqt Qf transactions in the ordinary course of such banking business.


author: .Arnold :

text:
    Frances M. Averill, Petitioner, v. Commissioner of Internal Revenue, Respondent. George G. Averill, Petitioner, v. Commissioner of Internal Revenue, Respondent. George G. Averill and Frances M. Averill, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 80076, 82913, 82914, 82915.
    Promulgated March 17, 1938.

      Leonard A. Pierce, Esq., and Oarroll N. Perkins, Esq., for the petitioners.

      Dean P. Kimball, Esq., and A. T. Akin, Esq., for the respondent.
   OPINION.

.Arnold :

These proceedings, consolidated for hearing, involve deficiencies, individual and joint, for the years and in the amounts following:

The issue presented is whether the gain realized upon payment at maturity of bonds owned by the petitioners is taxable as capital gain or as ordinary income. Petitioners have abandoned the other allegations set forth in their petitions.

The parties have submitted the proceedings upon a written stipulation of facts with attached exhibits. We adopt the stipulation as our findings of fact, summarizing herein the facts deemed necessary to understand the issue presented.

Petitioners are husband and wife, residing in Waterville, Maine. The circumstances under which they acquired the bonds maturing during the taxable years were as follows:

For more than two years prior to January 1,1927, petitioners were stockholders of the Keyes Fibre Co., a Maine corporation, whose only outstanding stock consisted of 6,000 shares of common. George G. Averill owned 1,888 shares thereof and Frances M. Averill owned 1,500 shares thereof; their stock had a statutory basis for determining gain or loss of $223,295 and $187,500, respectively.

By a contract dated July 27, 1927, the owners of 5,912 shares of stock of the Keyes Fibre Co., hereinafter called the old company, agreed with the Rex Pulp Products Co., a Maine corporation, hereinafter referred to as Rex, that they would “sell, assign and convey all of the shares owned by them to a new corporation to be organized * * * at the agreed purchase price of seven hundred fifty dollars ($750) per share.” Rex agreed that it would cause the newly organized corporation to pay the purchase price of $750 per share on or before August 11, 1927, and that payment “of the purchase price for said shares” would be four-ninths in cash and five-ninths in first mortgage bonds of the new corporation. The agreement provided that the first mortgage securing the bonds should “constitute a first lien 'on all the real estate, machinery, patents, patent rights, application for patents, contracts and all other property now owned or hereafter acquired” by either the old company, Rex, or the corporation to be organized.

Pursuant to the contract of July 27, 1927, the Keyes Fibre Co., a Maine corporation, hereinafter referred to as the new company, was formed. On August 11,1927, the necessary corporate resolutions were voted by the directors and stockholders of the old company, Rex, and the new company, whereby the business and the assets of the old company and Rex were combined in the new company. The new company acquired all the assets of Rex in exchange for 134,993 shares of its common stock and the assumption of all liabilities of Rex. The new company acquired all but 88 shares of the stock of the old company, which it assigned and delivered to a trustee for the shareholders of the old company, the assignment being collateral security for the new company’s obligations under the contract of July 27,1927. Tbe old company then, duly voted to sell and convey all its real and personal property to the new company for the agreed purchase price of $4,500,000, payable four-ninths in cash and five-ninths in bonds, plus interest on $2,500,000 from August 11 to September 1, 1927, at which date the bonds began to draw interest. Payment of the purchase price for the assets was made to the old company, which distributed the proceeds by a liquidating dividend of $750 per share, payable four-ninths in cash, $2,000,000, and five-ninths in bonds of the new company, $2,500,000, plus $3.38 per bond for interest adjustment from August 11 to September 1, 1927. The new company, as a stockholder of the old company, upon receipt of the liquidating dividend, immediately transferred it to the former stockholders in exchange for their stock, in accordance with the terms of the contract of July 27, 1927. Following payment in full of the liquidating dividend the ofiicers of the old company were directed to dissolve it.

After carrying out the provisions of the contract of July 27, 1927, and the corporate resolutions of August 11, 1927, the new company had acquired all the assets of the old company and of Rex, and the petitioners had accepted in exchange for their shares of stock a lesser amount of cash and a larger amount of bonds than provided for in said contract, namely, $346,000 cash and $1,070,000 bonds, as to George G. Averill, and $275,000 cash and $850,000 bonds, as to Frances M. Averill. The bonds were serial bonds, maturing 10 percent each year on and after September 1, 1931, until September 1, 1937, when the remaining 40 percent matured. The bonds were worth par at the time of their receipt in 1927, and no other cash or property was received by petitioners in 1927 on account of these transactions.

Petitioners filed separate income tax returns for 1927 and reported the gains from the disposition of their stock upon the installment basis, the cash received being 24% percent of the total consideration for their stock. Respondent made no adjustment as to Frances M. Averill’s return for 1927, but he disallowed the use of the installment basis as to George G. Averill and computed the gain under the reorganization exchange provisions. Since the gain involved was greater than the cash received, the respondent taxed as gain the entire cash received, giving credit, however, for the gain already reported. As a result of this adjustment George G. Averill paid under protest an additional tax for 1927. No claim for refund was filed by George G. Averill for 1927.

During the taxable years certain of the bonds received by the petitioners in the 1927 transaction matured and petitioners received payment therefor from the new company. In 1932 George G. Averill received $107,000 for 107 bonds. In his income tax return for 1932 he reported a capital gain therefrom of $84,074.81, which amount respondent has treated as ordinary income in determining the deficiency herein.

In 1931 Frances M. Averill received $85,000 for 85 bonds and reported a capital gain therefrom of $70,831.05 on her 1931 income tax return. Respondent treated this gain as ordinary income in determining the deficiency herein.

In 1932 Frances M. Averill received $85,000 from 85 bonds and reported a capital gain therefrom of $70,730.95 in her 1932 income tax return. Respondent treated this gain as ordinary income in determining the deficiency herein.

In 1933 George G. Averill and Frances M. Averill, together, received $167,000 from 167 bonds. They reported in their joint income tax return for 1933 a capital gain of $135,719.29, which the respondent has treated as ordinary income in determining the deficiency herein.

At all material times up to August 11, 1927, George G. Averill was a director, treasurer, and clerk of the company. Frances M. Averill held no office in the old company. Neither of the petitioners held office in nor was employed by the old company, Rex, or the new company after August 11,1927.

The real issue in these proceedings, whether the gain realized in the taxable years is capital gain or ordinary income, necessarily relates back to the transaction which occurred during July and August 1927. In order to understand the present contentions of the parties, their opposing positions with respect to that transaction must be understood. The petitioners considered the 1927 transaction a sale and reported the profits realized therefrom upon the installment basis. The respondent, however, considered the transaction a statutory reorganization, and recognized gain, at least as to George G. Averill, to the extent of the cash received under section 203 (b) (2) and (d) (1) of the Revenue Act of 1926. The amount of gain realized, the statutory basis for computing gain, the amounts of cash received, and the value of the bonds at the time of the sale or exchange, have been stipulated by the parties.

Our first inquiry, therefore, is whether there was a statutory reorganization. The petitioners seek to apply the general rule, section 203 (a), that the entire amount of the gain or loss shall be recognized upon the sale or exchange of property. They would eliminate the 1927 transaction from the reorganization provisions found in the exceptions to the general rule. If, however, there was a reorganization, the 1927 transaction necessarily falls under the exception appearing in subdivision 203 (b) (2) and 203 (d) (1), which limits the gain recognized to the amount of the cash received, recognition of the remainder being postponed until disposition of the stock or securities received in the exchange. The principal argument advanced by petitioners against the, application of these subdivisions is that the bonds were not to be treated as “securities” within the meaning of section 203 (b) (2). It is contended that the bonds were worth their face value, were the equivalent of cash, and that the entire transaction is governed by the Supreme Court’s decision in Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U. S. 462, and the decisions of the Second Circuit in Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; 288 U. S. 599, and Worcester Salt Co. v. Commissioner, 75 Fed. (2d) 251. It is further pointed out that petitioners’ contention here is in accordance with the respondent’s ruling appearing in Mimeograph 4555, C. B. 1937-1, p. 244.

Petitioners’ argument that the bonds are not “securities” within the meaning of the reorganization provisions of the statute has been decided adversely to them by the Supreme Court in Helvering v. Watts, 296 U. S. 387, wherein the Court specifically stated: “The bonds, we think, were securities within the definition, and can not be regarded as cash, as were the short-term notes referred to in Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U. S. 462.” In Burnham v. Commissioner (C. C. A., 7th Cir.), 86 Fed. (2d) 776; certiorari denied, 300 U. S. 683, the Circuit Court held that ten-year promissory notes were of sufficient dignity and formality to fall within the term “securities” as used in section 203 (b) (2). In Commissioner v. Kitselman (C. C. A., 7th Cir.), 89 Fed. (2d) 458; Helvering v. Leary (C. C. A., 4th Cir.), 93 Fed. (2d) 826; Commissioner v. Newberry Lumber & Chemical Co. (C. C. A., 6th Cir.), 94 Fed. (2d) 447; and Frederick L. Leckie, 37 B. T. A. 252, the courts and the Board recognized that bonds are securities.

There remain, however, certain additional statutory requirements which must be met before it can be said that this 1927 transaction was in fact a reorganization. Section 203 (b) (2) provides that the securities received must be in a corporation a party to the reorga.ni-zation; that the stock exchanged must be stock in a corporation a party to the reorganization; and that the exchange must have been made in pursuance of a plan of reorganization.

The plan of reorganization is contained in the contract of July 27, 1927. The primary purposes of that contract was to bring about a merger or consolidation of the old company and Rex in the new company. The intermediate steps, as revealed by the minutes of stockholders’ and directors’ meetings of the different corporations, were si in ply a part of the entire scheme to effect the consolidation or merger. The exchange of petitioners’ stock for cash and bonds was made pursuant to the plan of reorganization. The old company was a party to the reorganization because the majority of its voting stock was acquired by the new company, which clearly conforms to the definition of the term “a party to a reorganization” found in section 203 (h) (2) of the Revenue Act of 1926. Likewise, the new company is a party to the reorganization because it acquired the old company’s stock, thereby fitting the facts herein to the statutory pattern, which is, that stock of the old company a party to a reorganization was, in pursuance of a plan of reorganization, exchanged for cash and securities in another corporation a party to the reorganization.

In Helvering v. Minnesota Tea Co., 296 U. S. 378, the Supreme Court, in considering what constitutes a reorganization, reaffirmed the language used in its opinion in Pinellas Ice & Gold Storage Co., supra, that a merger or consolidation includes some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words, and added that the interest which the seller acquires in the affairs of the purchasing company “must be definite and material; it must represent a, substantial part of the value of the thing transferred. This much is necessary in order that the result accomplished may genuinely partake of the nature of merger or consolidation.” Whatever definite and material interest these petitioners acquired in the transferee corporation is represented by their bonds. It has been held by the Board and by the courts that bonds received in exchanges, similar in many respects to the exchanges here in question, gave the bondholders a sufficient continuity of interest to meet the requirements of a statutory reorganization. Kaspare Cohn Co., Ltd., 35 B. T. A. 646; Lucien H. Tyng, 36 B. T. A. 21; Lilienthal v. Commissioner (C. C. A., 9th Cir.), 80 Fed. (2d) 411; Helvering v. Watts, supra; Helvering v. Leary, supra.

The bonds which these petitioners received were secured by a “First Mortgage and Deed of Trust” on practically all of the property of the new company. An examination of that indenture reveals that the bondholders, under certain circumstances and in some respects, had superior equities to the equities of the stockholders. This was particularly true in cases of default in the payment of interest or principal, as the trustee therein named was thereupon authorized to take possession of the mortgaged property, exclude the company and its agents and servants wholly therefrom, and manage, operate, and conduct the mortgagor’s business, and exercise all the rights and powers of the company in its name or otherwise as the trustee might deem best, with full power and authority to sell and dispose of the property for the benefit of the bondholders. Likewise, in case of foreclosure proceedings the rights of the stockholders were subordinated to the rights of the bondholders. If, therefore, the mortgagor became financially involved the bondholders’ interest in the corporate assets and business became paramount to the interest of the ordinary stockholder. This relationship is explained by the court in the Kitselman case, sufra, as follows:

The bondholders are ordinarily viewed merely as creditors but when the assets of the corporation are less than its obligations, the bondholders are actually, and for all practical purposes pretty much the corporation. All that remains for the stockholders is the corporate charter — the corpse of the defunct corporation.

Considering all the facts herein and the foregoing authorities, it is our opinion that the contract of July 27, 1927, constituted a plan of statutory reorganization and that, pursuant to that plan, a statutory reorganization was effected wherein petitioners exchanged their stock for cash and securities in the new corporation. Our decision that there was a statutory reorganization distinguishes this case from Worcester Salt Co., supra, relied upon by the'petitioners. The petitioners’ argument respecting the effect of the respondent’s ruling in Mimeograph 4555, supra, is inapplicable, as the Board has already rejected this principle in its decisions in the Kaspare Cohn and Tyng cases, supra.

Petitioners’ second contention is that, even if the 1927 transaction was a statutory reorganization, nevertheless, they are entitled to report the gain from the transaction upon the installment sales basis under section 212 (d) of the Revenue Act of 1926. The contention is based upon an unusual 'construction and application of subdivisions (d) and (e) of section 202 with relation to section 203. It is argued that (d) and (e) incorporate section 203 in section 202, the effect of which is to preserve to the taxpayer the privilege granted by section 212, regardless of the provisions of section 203 (b) (2) and (d) (1).

In our opinion any such construction of sections 202 and 203 is unwarranted. Section 202 deals with the determination of gain or loss from the sale or other disposition of property, while section 203 deals with the recognition of gain or loss from sales or exchanges of property, and lays down the general rule that “the entire amount of gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.” Considering the specific subdivisions of section 202, we find that (a) is correlated with subdivisions (a) and (b) of section 204, so that the statutory basis, provided in section 204, will be used in determining the amount of gain or loss realized from the sale or other disposition of property. Subdivision (b) provides for computing the amount of gain or loss. Subdivision (c) defines “the amount realized from the sale or other disposition of property.” Subdivision (d) specifically provides that the gain or loss determined under section 202 shall be recognized, in the case of a sale or exchange, to the extent provided for by section 203. This subdivision, therefore, expressly recognizes the applicability of section 203 to questions of when gain is to be recognized. Subdivision (e) obviously makes no provision for the determination of the amount of gain or loss. The provisions thereof are “merely a statutory authorization for reporting income on the installment basis.” Wobbers, Inc., 26 B. T. A. 322, 328. It simply preserves to taxpayers tlie privilege of making their returns on the installment basis in accordance with section 212 (d), notwithstanding any other provisions of section 202.

In considering the petitioners’ first contention we have held that the 1927 transaction was a statutory reorganization, and that it comes within the exception contained in section 203 (b) (2). Standing alone, section 203 (b) (2) would postpone the recognition of any gain until a sale or other disposition of the bonds. But when the provisions of section 203 (d) (1) are considered with relation to section 203 (b) (2), gain is to be recognized to the extent of the cash received. Recognition of the remaining gain is postponed until the sale or other disposition of the bonds, and, as some of these bonds matured during the taxable years herein, gain will be recognized accordingly.

Petitioners’ last contention is that the payment of bonds maturing during the taxable years here in question constitutes a “sale or exchange” within the meaning of the capital gain provisions of section 101 of the Revenue Acts of 1928 and 1932. This question has already been determined against the taxpayers’ contention in a number of Board cases. In Ernest Brown, 36 B. T. A. 178, it was specifically discussed, and the arguments which petitioners are now advancing were rejected, as they had been before in our decisions in John H. Watson, Jr., 27 B. T. A. 463, and Arthur E. Brawn, Trustee, 29 B. T. A. 1161. Prior to the Watson decision the Board had held the opposite view, Henry P. Werner, 15 B. T. A. 482, but the latter case was overruled by the former, and since then the rule has been that the payment of bonds at maturity is not a sale or exchange of capital assets, but the fulfillment of a contractual obligation to repay money in accordance with fixed terms.

In view of our decisions that the gain resulting from the redemption of bonds shall be taxed as ordinary income, we deem it unnecessary to again review the authorities, but there are two cases cited by the petitioners that we shall discuss briefly. We can not attribute to our decision in John D. McKee et al., Trustees, 35 B. T. A. 239, the persuasive quality which petitioners seek to give it. The facts in the McKee case are essentially different, because there the trustees sold their bonds prior to the date of maturity. With the sale there was a realization of profit, and the mere fact that the bonds matured on the following day can not detract from the fact that profit was realized by a sale of the capital assets, and not by the maturity of the bonds. Likewise, our opinion in Mary S. Childs, 35 B. T. A. 1125, does not control the question here presented, because the Childs case involved the redemption of preferred stock, while here we are concerned with the payment of bonds upon their maturity. Payment of a bond in accordance with its terms “is nothing more than the discharge of a contractual obligation to repay a sum loaned”; whereas the redemption of preferred stock, issued subject to retirement, is “in every real sense a sale.” Mary S. Childs, supra, p. 1127.

The foregoing analyses of the petitioners’ contentions, and the authorities examined with respect thereto, indicate that these contentions are not well founded. Therefore, we approve the respondent’s determination and hold that the gain realized upon maturity of the petitioners’ bonds during the taxable years was properly subjected to tax as ordinary income.

Reviewed by the Board.

Decision will be entered for the respondent.

       Sec. 203. (a) upon the gale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
      ****** *
      (b) (2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      *******
      (d) (1) If an exchange would be within the provisions of paragraph (2), * * * of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted .by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

       Sec. 203. (h) As used in this section and sections 201 and 204—
      ****■(;>!?*
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.

       Sec. 212. (d) Under regulations prescribed by tbe Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the .basis and in the manner above prescribed in this subdivision. As used in this subdivision the term “initial payments” means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.

      Sec. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized.
      (b) In computing the amount of gain or loss under subdivision (a) — •
      (1) Proper adjustment shall be made for any expenditure or item of loss properly chargeable to capital account, and
      (2) The basis shall be diminished by the amount of the deductions for exhaustion, wear and tear, obsolescence, amortization, and depletion which have since the acquisition of the property been allowable in respect of such property under this Act or prior income tax laws; but in no case shall the amount of the diminution in respect of depletion exceed a depletion deduction computed without reference1 to discovery value or to paragraph (2) of subdivision (c) of section 204. In addition, if the property was acquired before March 1, 1913, the basis (if other than the fair market value as of March 1, 1913) shall be diminished in the amount of exhaustion, wear and tear, obsolescence, and depletion actually sustained before such date.
      (c) The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
      (d) In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this title, shall be determined under the provisions of section 203.
      (e) Nothing in this section shall be construed to prevent (in the case of property sold under contract providing for payment in installments) the taxation of that portion of any installment payment representing gain or profit in the year in which such payment is received.