author: Mellott:

text:
    Lewis Spencer Morris, as Trustee under the Last Will and Testament of Louis Zborowski, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88524.
    Promulgated November 29, 1939.

      Bronson Winthrop, Esq., and Hamilton Hadley, Esq., for the petitioner.

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

Mellott:

The Commissioner determined a deficiency in the income tax of petitioner for the year 1933 in the amount of $2,205, all of which is in issue.

Petitioner, the duly appointed, qualified and acting trustee under the will of Louis Zborowski, in due time filed with the collector of internal revenue for the second district of New York a fiduciary return of income for the year 1933. Therein he reported total gross income of $38,407.42, consisting of interest in the amount of $38,007.42 and dividends on the stock of domestic corporations subject to tax in the amount of $400. . The following deductions were claimed:

Taxes paid — cheek tax — - $0. 78
George W. Griee-Hutchinson- 22, 500. 00
Other deductions authorized by law_ 1, 341. 62

The disallowance by the respondent of the deduction of the amount paid to Grice-Hutchinson gives rise to the present controversy. We find the facts to be as stipulated, but shall set out herein only those necessary for an understanding of the issue to be decided.

Prior to and during the year 1918 Louis Zborowski, a citizen of the United States, was living in England. He owned considerable property, most of which was situated in New York City, and was paying substantial income taxes to the United States and British Governments. He consulted George William Grice-Hutchinson (hereinafter referred to as Grice-Hutchinson), an English solicitor, who undertook to “devise, evolve and put into effect some scheme such as the creation of a trust for accumulation or the formation of some company or corporation to hold or accumulate a part of his income so that such income might legitimately avoid English taxation.” To that end the following steps were taken: On October 29, 1918, Zborowski gave Grice-Hutchinson a general power of attorney, authorizing him “to call in and to collect and to take possession of ¡my monies, funds, stocks, shares and securities” belonging to him and also “to enter into and take possession” of all his lands, tenements, hereditaments and real estate. Grice-Hutchinson then formed a Spanish corporation known as La Confianza Ibérica (hereinafter referred to as the Spanish company) with an authorized capital stock of 250 shares of the par value of 1,000 pesetas each, all of which were subscribed for at par, 146 shares being issued to Zborowski, 75 shares to a corporation with which Grice-Hutchinson was connected and in which he was personally interested, and the remainder to others.

Pursuant to the powers granted to liim by the power of attorney, Grice-Hutchinson entered into a contract with the Spanish company, dated March 3, 1919. This contract was later.modified by an agreement dated March 25, 1923. Pursuant to the.contract of March 3, 1919, Grice-Hutchinson, as attorney in fact for Zborowski, transferred to the Spanish company stock and bonds of various companies formed to hold real estate in the city of New York belonging to Zborowski, amounting in par value to approximately $5,000,000. In consideration for the transfer of these properties, the Spanish company paid Grice-Hutchinson the sum of $15,000 and gave its bond for $8,000,000, payable without interest on March 2, 1939 (or on the prior termination of the contract as therein provided), which bond amounted at the date of the death of Zborowski, i. e., on October 19, 1924, to $5,375,000, having been reduced to that amount under the agreement of March 25,1923.

The contract of March 3, 1919, provided for the creation of a “deposit, administration and trust” and for the appointment of Grice-Hutchinson as the depositary, administrator, and trustee. It was created in order that Grice-Hutchinson would have the possession of the properties sold to the Spanish company, and the income ¡herefrom, so (hat he might deliver these properties and income to the Spanish company at the termination of the trust. The “deposit, administration and trust” was to continue during the life of Grice-Hut'chinson, but not beyond the second day of March 1939. Of the securities transferred to the Spanish company, Grice-Hutchinson, as depositary and trustee, received securities amounting to approximately $4,000,000 in face value. Under the contract the legal title to the properties was vested in him as trustee and he was given wide and varied powers. He was authorized and empowered, and it became his duty, among other things, to administer the securities so held by him; to sell the same in his discretion; to invest and reinvest the proceeds; to receive all the income thereof; and to invest and reinvest the income and all accumulations thereof for the benefit of the corporation and as otherwise provided in the contract. The contract provided that Grice-Hutchinson “shall not deliver to the company either capital or income until the termination of the deposit or trust.” At the time of the death of Zborowski, Grice-Hutchinson held the stock and bonds of the various corporations which had been organized to hold Zborowski’s real estate in the city of New York and other securities amounting in par value to the aggregate of $3,185,477.12.

The contract of March 3, 1919, provided that upon its termination for any reason whatsoever the legal title to all the properties deposited should ipso facto vest in the company, and that the depositary, Grice-Hutchinson, or his representatives should deliver possession of all of said properties to the company at its office in Madrid. Under the terms of the contract Grice-Hutchinson was to be entitled to a reasonable compensation for the services to be rendered by him in connection with the custody and administration of the properties mentioned in the agreement, and in connection with the collection of the income arising therefrom, and for all other services rendered by him thereunder, together with such disbursements as he might make and liabilities which he might incur for certain purposes.

Grice-Hutchinson accepted such deposit, administration, and trust and entered upon the performance of his duties under the contract of March 3, 1919. He soon found that these duties made it imperative for him to retire from his practice as solicitor in London, England, and to take up his residence in Spain, and he accordingly abandoned his practice in England and his home and associations there to take up his residence in Spain. Thereafter he devoted his entire time and energy to the service of the Spanish corporation, to acting as depositary, administrator, and trustee, and to assisting Zborowski in the management of his property and business affairs. By a letter dated November 14, 1922, Zborowski agreed to pay Grice-Hutchinson for his services under the contract of March 3, 1919, and so long as he should live, an annual remuneration of $35,000 and also the following additional amounts: (a) 10 percent of any increased income over and above the income then produced by the real estate in which the said Zborowski was interested, and (b) the further sum of $10,000 per annum so long as it should be necessary or desirable for Grice-Hutchinson to reside out of England. Under this agreement Zborowski was not liable to Grice-Hutchinson in the first instance for the payment of any of these sums, but merely guaranteed that the payments to be received by him from the Spanish company would not fall short of the total compensation due him as above stated. It was further provided in the letter that in the event Zborowski should predecease Grice-Hutchinson and make provision for him under his will by way of an annuity, the amount of such annuity should be credited against the amount of compensation owing to him and should not be payable in addition thereto.

Grice-Hutchinson entered into a further agreement with the Spanish company dated March 25, 1923, under which he was appointed managing director of the Spanish company, with power to administer and conduct all the business of the company; to appoint and remove all the employees and servants of the company, with the sole exception of the secretary; to determine their duties and functions and their fees and remuneration; and to enter into contracts and execute all acts which he might consider necessary or suitable to the interests of the company.

During the years immediately following the execution of the contract of March 3, 1919, Grice-Hutchinson retained out of the funds of the Spanish company as his compensation the sum of $25,000 per annum until May 20, 1920, the sum of $35,000 per annum from the latter date to November 1922, and, thereafter, upon the retirement from his practice as a solicitor and taking up his residence in Spain, he retained the sum of $45,000 per annum. These amounts were retained with the approval of Zborowski. After the year 1922 and before Zborowski’s death the income of the real estate had so increased that Grice-Hutchinson was entitled to receive and was receiving additional compensation of approximately $2,000 per annum under the provision of the contract allowing him 10 percent of the increased income.

After the death of Zborowski on October 19, 1924, his will dated November 26, 1920, was duly admitted to probate in the Surrogate’s Court of the County of New York on December 4,1924, letters testamentary thereon were duly issued on December 5, 1924, to Lewis Spencer Morris (the petitioner herein) and Charles S. McVeigh and they duly entered upon the discharge of their duties as such executors.

By the sixth article of his will Zborowski appointed Alexander Fraser Nalder and Grice-Hutchinson as trustees under his will, and provided that, in the event either of them should predecease him, or should fail to qualify, or having qualified, should die, resign, or for any reason fail to complete the execution of his duties as such trustee, then Lewis Spencer Morris (petitioner herein) should be appointed. Haider and Grice-Hutchinson both renounced their appointments. Petitioner accepted, duly qualified, and is now the sole trustee under Zborowski’s will.

In the fifth article of his will Zborowski devised and bequeathed all of his residuary estate in trust to pay the net income as follows: an annuity of $30,000 per annum to Grice-Hutchinson during his life and the balance of the net income to his wife, Violet Ethel Zborowski (now Violet E. Singer) during her life or until her remarriage, with further provisions in the event of her remarriage or in the event of her predeceasing the testator not presently important. Grice-Hutchinson notified the executors of the decedent’s estate that he elected to waive the provision of the will giving him an annuity of $30,000 during his life and to claim the amounts due and to become due to him under the aforementioned agreements as creditor of the estate and of the Spanish company.

At the time of his death Zborowski still owned the obligation of the Spanish company created by the agreement dated March 3, 1919, in the original principal amount of $8,000,000 without interest, as amended by the agreement of March 25, 1923, which reduced the principal of the bond to $5,375,000 without interest, and also the 146 shares of stock of the Spanish company, together with other miscellaneous securities and property. After his death his executors acquired the outstanding 104 shares of the Spanish company stock and thereby acquired the ownership of all the outstanding stock of the company.

During the early part of 1925 the executors of the decedent’s estate, the Spanish company, the widow of the decedent, and three other persons entitled to a remainder interest in the trust estate requested Grice-Hutchinson to retire from the deposit, administration, and trust created under the contract of March 3, 1919, as amended, and to deliver the securities and other property held by him to new depositaries. Grice-Hutchinson expressed his willingness to retire and to relinquish all claim to further compensation from the corporation upon receiving proper compensation by reason of his enforced retirement from the practice of his profession and the enforced removal of his residence from Great Britain to Spain.

Under date of June 25, 1925, a contract was entered into between Grice-Hutchinson, the Spanish company, Lewis Spencer Morris, and George G. Plant. The objects of the contract were stated to be the resignation and retirement of Grice-Hutchinson as depositary, administrator, and. trustee for the Spanish company under the contract of March 3, 1919, and the settlement of his accounts with that corporation; the determination and settlement of the liability of the Spanish company to Grice-Hutchinson under the terms of that contract ; and the appointment of new depositaries, administrators, and trustees for the Spanish company, who were to succeed Grice-Hutch-inson and receive from him the property which he held as depositary, administrator, and trustee. In this contract Grice-Hutchinson agreed to resign and retire and to settle his accounts with the Spanish company, and to release the Spanish company and the new depositaries from all further claim or liability for compensation for his services under the contract of March 3, 1919. The Spanish com-pam/ agreed to pay him the following consideration: the sum of $300,000 in cash or securities (this sum being the approximate equivalent of an annuity of $22,500 per annum during his life) and also to pay him $12,500 per annum during his life in quarterly installments. The contract further provided for the appointment of Lewis Spencer Morris and George G. Plant as the new depositaries, administrators, and trustees to hold the properties in the same manner and subject to the same trusts and conditions as those set out in the agreement of March 3, 1919, in respect of the property to be held by Grice-Hutchinson.

On the same day that the above contract was made, i. e., June 25, 1925, another contract was entered into between the executors of the decedent’s estate and Grice-Hutchinson, in which the executors agreed to pay Grice-Hutchinson $10,000 per annum during his life, and in which they, as executors, guaranteed that the Spanish company would duly and promptly pay him the annual sum of $12,500 during his life as specified in the other contract bearing the same date. In this contract Grice-Hutchinson agreed to accept (1) the sum of $300,000 paid to him by the Spanish company; (2) the obligation of the Spanish company to pay him $12,500 annually during his life, guaranteed by the executors; and (3) the obligation of the executors to pay him the sum of $10,000 annually during his life in full satisfaction of all claims against the estate of the decedent under the agreement of November 16, 1922.

On October 10, 1930, the executors ox the decedent’s estate delivered to the petitioner, as the sole acting and qualified trustee under the will of the decedent, all the assets of the estate of the decedent remaining in their hands and the petitioner agreed to assume the covenants, claims, and guarantees previously entered into between the executors and Grice-Hutchinson in the agreement of June 25, 1925. Thereafter, and prior to the year 1933, the Spanish company was dissolved and such proceedings were had and taken that all of the assets of that company and of its depositaries were turned over to the petitioner as trustee under the will of the decedent, subject to the obligations of the Spanish company and its depositaries, and thenceforth the petitioner paid Grice-Hutchinson the annual sum of $10,000 which the executors had theretofore been obligated to pay and the annual sum of $12,500 which the Spanish company had theretofore paid. The aggregate of these sums, paid in 1933, is the amount now in issue.

Upon brief petitioner contends (1) that the payments to Grice-Hutchinson were not made in settlement of an amount owing by Zborowski at the time of his death and are not therefore payments in discharge of a capital obligation; (2) that they were made in compromise and settlement of an obligation which had devolved upon the executors and trustee by operation of law to continue Grice-Hutchinson in the employ of the estate and to pay him compensation for services which he should render into the future; (3) that the payments to him under the compromise retained their original character of compensation for services; (4) that they “were a necessary business expense of the trust for the benefit of income”; (5) that they have twice been held by the state court to be properly chargeable to the income of the trust and those determinations are controlling; and (6) that, since the compromise with Grice-Hutchinson was not a device to evade or minimize income tax, “the petitioner is entitled to the favorable consideration of the Board.”

The last contention need not be discussed at any length. The question for our determination is solely one of law and in resolving it consideration must be given to all the facts of record. The effect, if any, of the judgments of the state courts — which have not been referred to in our recapitulation of the facts — will be discussed later.

Petitioner’s first four contentions may be considered together. We interpret them generally to be that the payments to Grice-Hutchinson were “ordinary and necessary expenses paid or incurred during the taxable year in carrying on * * * (a) trade or business.” If so, then they were deductible from gross income under section 23 (a) of the Revenue Act of 1932; for the net income of a trust, under section 162 of the Revenue Act of 1932, is to be “computed in the same manner and on the same basis as in the case of an individual.” Respondent determined the deficiency upon the theory and now contends that the payments “do not represent ordinary or necessary business expenses incurred in carrying on the business of the trust”; that they were made in settlement of claims and cancellation of contracts and are not deductible from income; that they were either capital expenditures or expenditures of the “nondescript” type for which no deduction from gross income may be allowed; and that, even if it be assumed for the purpose of argument that they constituted expenses of carrying on a business, still they can not be classified as “ordinary.”

In George Vanderbilt Trust, 36 B. T. A. 967, this Board considered the question of whether or not trustees invested with powers similar to those given to petitioner under the will of Zborowski were carrying on a trade or business. The petitioners in that proceeding contended that an attorney’s fee paid by the trust as an incident to litigation involving the trust’s claim to accumulated income and corpus of another trust was deductible as an ordinary and necessary business expense. It was held that the trust there involved was not engaged in carrying on a trade or business and the deduction was denied. Some of the language used in that opinion seems to be apposite here:

* * * Conceivably, testamentary trusts such as these petitioners may be engaged in business of one bind or another, and no less conceivably they may refrain from engaging in business. The statute applies its provisions similarly to trusts and to individuals, and it can not be dogmatically said as to a trust, even though it he one of long standing, that an attorney’s fee reasonably and necessarily paid by it is deductible as an expense of carrying on business any more than it can be said as to an individual. Dorr v. United States, 18 Fed. Supp. 92; Morse v. Helvering, 85 Fed. (2d) 262; Monell v. Helvering, 70 Fed. (2d) 631; Ames v. Commissioner, 49 Fed. (2d) 853.

Petitioner, as trustee under the will of Louis Zborowski, was empowered to hold, invest, and reinvest the principal of the trust estate, to collect and receive the rents, income, issues, and profits, to pay taxes and other necessary and proper charges, and to pay the net income to the widow of the decedent. He was authorized to sell or exchange the whole or any part of the real or personal property contained in the trust estate, to borrow money for the purpose of paying any loans or debts, and, generally speaking, to act toward the trust estate as an individual would act in handling property and funds owned by him. During the taxable year, however, his activities were confined to the receipt of interest and dividends amounting to $38,407.42, the payment of $22,500 to Grice-Hutchinson, $1,341.62 for legal fees and trustees’ commissions, 78 cents for check tax, and the distribution of $14,565.02 to the widow of the decedent. He reported nothing under schedules A to D, inclusive, of the return, these schedules being entitled “Income (or loss) from trade or business”, “Income from rents and royalties”, “Profit or loss from sale of stocks, bonds, real estate, etc.”, and “Capital net gain or loss from sale of capital assets.” These limited activities indicate that petitioner was a mere passive conservator of a well invested trust estate. Apparently neither he nor the trust did anything which could properly be classified as carrying on a trade or business. George Vander bilt Trust, supra; cf. Kane v. Commissioner, 100 Fed. (2d) 382; Sir William, Plenda, 2 B. T. A. 940; F. Tinker & Sons Co., 1 B. T. A. 799; Scobb v. Commissioner, 29 Fed. (2d) 472; Brawner v. Burnet, 63 Fed. (2d) 129.

But oyen though, the trust were carrying on a trade or business, it still must be held that the payments made to Grice-Hutchinson were not ordinary or necessary expenses paid or incurred in carrying on such trade or business. When the decedent died the executors of his estate were faced with a rather unusual situation, which is aptly described in petitioner’s brief in the following language:

* * * substantially all of tbe income producing properties were beld by Grice-Hutehinson under the Deposit Agreement of March 3, 1910, and under this agreement all of the income from these properties was to be impounded by Grice-Hutchinson as Depositary until the year 1939 at which time the properties plus the accumulated income were to be applied to the payment of the obligation of the Spanish Company to pay Zborowski or his estate the sum of $5,375,000 as reduced from the original figure of $8,000,000.
The fact that the Executors received from Zborowski a controlling interest in the stock of the Spanish Company was of no help in this situation. The assets actually held by the Spanish Company amounted to only approximately $20,000 and the income of this was applicable to Spanish taxes and other current expenses of that company. All of its other property was held and controlled by Grice-Hutchinson under the Deposit Agreement and there was no way in which that agreement could be terminated prior to the year 1938 without his cooperation. * * * A sale of the Spanish Company’s obligation and its stock was obviously out of the question except at enormous sacrifice — first, because there would have been no income for the purchaser until the year 1939, and second, because the purchaser would not have control of the income producing assets until that year. Nevertheless, some arrangement had to be made so that tbe potential income of Zborowski’s properties could be realized for tbe benefit of his widow. These were the motivating considerations underlying the June 25, 1925 contracts with Grice-Hutchinson.

It is obvious from tbe stipulated facts that the executors of the estate, the Spanish company, the widow of the decedent, and all those entitled to an interest in the remainder of the estate were desirous ox eliminating Grice-Hutchinson to the end that the property of Zborowski and the income from it should be available to them immediately. Grice-Hutchinson agreed to retire upon receiving proper compensation for the loss sustained by reason of his enforced retirement from the practice of his profession and the removal of his residence from Great Britain to Spain. This was the background for the contract of June 25, 1925. It provided that in consideration of Ms resignation and retirement as depositary and trastee, and his release of the Spanish company from all further claim or liability to compensate him for his services under the contract of March 3, 1919, the Spanish company should pay him $300,000 in cash or securities and an annuity of $12,500 during his life, and that the executors of the estate should pay him an annuity of $10,000 during his life and guarantee that the Spanish company would perform its agreement. Grice-Hutchinson agreed to accept these payments in full satisfaction of all claims against the estate and they were so accepted.

Whether the payments so made should, or should not, be characterized as capital expenditures need not be decided. “The idea that everything which is not strictly a capital investment must be a deductible expense is unsound.” Connolly Realty Co., 31 B. T. A. 349, 350. The obligation to make the annual payments to Grice-Hutch-inson had its genesis in the desire of the executors and beneficiaries of the trust to get immediate control of the assets which, prior to the execution of Grice-Hutchinson’s tax avoidance scheme, had belonged to Zborowski and otherwise would not have been available to them until 1939. In order to do this they had obligated themselves to make the payments in question. Petitioner, as their transferee, had assumed the same obligation. As stated by petitioner upon brief: “* * * Zborowski’s arrangements with Grice-Hutch-inson were an impediment to the collection of the potential income of the estate. The annual payments of $22,500 to Grice-Hutchinson were a part of the consideration necessarily paid to him for the removal of that impediment.” The payments may not, in a strict sense, be capital expenditures; but that is not the important question. Were they expenses “paid or incurred in carrying on a trade or business?” We think not. They were incurred when petitioner, as trustee, acquired the assets. They were not paid for services rendered or to be rendered. Grice-Hutchinson had paid himself, as he had a right to do under the contract with Zborowski, for all services rendered prior to June 25, 1925; and under the contract of that date he not only had no duties to perform but, having shorn himself of all offices, he could not have served the Spanish company, executors, or this trustee if he had desired to do so. The payments were made in consideration of Grice-Hutchinson resigning and retiring as depositary, administrator, and trustee and there is no justification for treating them as compensation for services or as expenses paid by this trustee in carrying on any trade or business of the trust. Cf. Commissioner v. Field, 42 Fed. (2d) 820; Callie E. Robertson, 28 B. T. A. 635; National Cottonseed Products Corporation, 28 B. T. A. 67; affd., 76 Fed. (2d) 839.

Petitioner’s contention that certain “determinations” by the Supreme Court of blew York are controlling remains to be considered. Incorporated in the stipulation filed herein is a “final Judgment” of the Supreme Court in and for New York County, entered on September 19, 1930. It indicates that an action had been instituted by the executors for the purpose of settling their accounts; that a referee had examined the accounts and vouchers and filed his findings of facts and conclusions; and that on the strength thereof the court had entered its order finding that the executors had “well and properly accounted for all and singular the moneys and securities belonging to” the estate of Zborowski. The court ratified and confirmed the settlement made with Grice-Hutchinson, found that the $300,000 “was properly made out of principal, and that the annuities of $10,000 and $12,500 per annum which the plaintiffs as such executors have made or caused to be made to said George William Grice-*Hutchinson pursuant to said compromise and settlement out of the income of the estate and out of the income of the [Spanish company] * * * respectively, be and the same hereby are ratified and confirmed and that the same were properly made out of income * * *.” Also incorporated in the stipulation are: (1) Complaint filed by petitioner in the Supreme Court, (2) final order approving agreement of compromise, etc., entered October 11, 1936, and (3) agreement of compromise signed by the widow, beneficiaries under Zborowski’s will, and other interested parties, dated March 18,1936.

The last mentioned documents disclose that under date of April 10, 1929, an agreement of compromise had been made between the executors and the heirs with reference to the “Allocation and/or apportionment of receipts and/or disbursements of cash and/or property as between principal account and income account”, made by the executors. While the agreement is not in evidence, the references to it in the documents which are in evidence indicate that the parties had agreed that the annuities to Grice-Hutchinson should be charged to income and the lump sum of $300,000 paid to him should be charged to principal, even though both were paid for the same purpose. The judgments relied upon apparently merely approved— ratified and confirmed — the earlier agreements of the parties. In our opinion they are not controlling upon the issue before us. United States v. Mitchell, 74 Fed. (2d) 571; Edgar M. Carnrick, 21 B. T. A. 12; First Mechanics National Bank of Trenton, Executor, 40 B. T. A. 876, and cases therein cited.

Respondent’s alternative contention, that the payments in question were not “ordinary” business expenses even though it should be held that they were “necessary”, has been considered. While- we believe that this contention is not without merit, we choose to bottom our decision upon the grounds set forth above. The respondent did not err in denying the claimed deduction.

Judgment will he entered for the respondent.


source: Caselaw Access Project

author: Van Fossan :

license: Public Domain

text:
    Hercules Motors Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92225.
    Promulgated November 30, 1939.

      H. A. Mihills, <7. P. A., and F. E. Gleach, Esq., for the petitioner.

      T. F. Gallaban, Esq., for the respondent.
   OPINION.

Van Fossan :

The issue is whether or not, under the circumstances here presented, trade acceptances constituted capital assets within the meaning of section 117 (b) of the Revenue Act of 1934. In each instance the determination of the question must rest on the facts of the case. The character of the taxpayer’s business, the methods of its operation, the measures required to carry it on, and all acts and transactions incidental to such business must be considered.

Here the petitioner’s primary business was the manufacture and sale of motors and motor parts and accessories. In order to sell to Amtorg it became necessary to receive its payment in Amtorg’s trade acceptances. Because of the uncertain credit status of both Amtorg and the Russian Government, the price of the articles sold was increased to equalize the difference between the possible proceeds from the sale of the acceptances and their face value. This increased price was reflected in petitioner’s income account.

The trade acceptances came into the petitioner’s possession as a necessary incident to the sale of its merchandise and were not received, or were intended to be held, as a capital asset. The respondent does not suggest that the petitioner acquired the trade acceptances as an investment. In support of his position that they were capital assets, respondent contends they do not come within the precise language of the statute.

Here the trade acceptances related directly to the sale of the petitioner’s products to Amtorg. They had become a usual and regular factor in the petitioner’s transactions with that customer and the sales were accomplished largely through the means of such obligations. Their receipt was thus necessary to the normal conduct of the petitioner’s business. Their disposition likewise became essential. Petitioner offered them to several potential buyers, finding a customer in J. H. Leader, Inc. Petitioner had sold acceptances to other buyers in other years. Such activities, in our opinion, come within the purview of the statutory phrase “held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.”

The respondent has recently published the opinion of the Chief Counsel, Bureau of Internal Revenue (G. C. M. 21497, C. B. 1939-35-9981) in which he holds:

‘A bank, mortgage finance company, or a building and loan association which is offering for sale parcels of real estate on which it has been compelled to foreclose is holding property “primarily for sale to customers in the ordinary course of * * * trade or business” within the provisions of section 117 (b) of the Revenue Acts of 1934 and 1936, and the gains or losses incurred in such sales are to be treated as ordinary gains or losses and not as capital gains or losses.

Respondent’s position in the present case is entirely inconsistent with the above opinion, which we believe to be sound in law. In our judgment, the sale of negotiable evidences of indebtedness by the petitioner, which had been forced to accept them in order to make its sales of motors, is no more foreign to its business than the sale by a bank of real estate on which it has been obliged to foreclose.

The respondent argues that the foregoing conclusion does violence to the petitioner’s accrual basis of accounting. We are unable to follow respondent’s line of reasoning. The petitioner included in its income account the full face amount of the invoices and seeks to deduct therefrom appropriate amounts representing losses from the sales of trade acceptances taken as part or full payment for the goods invoiced.

The petitioner sustained a loss of $15,205.22 on property held by it primarily for sale to customers in the ordinary course of its trade or business. Such loss is deductible as an ordinary loss.

Decision will be entered under Bule 50.

       SEC. 117. CAPITAL GAINS AND LOSSES.

      (b) Definition of Capital Assets. — Por tbe purposes of this title, “capital assets" means property held by the taxpayer (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 tbe taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.


author: Tyson :

text:
    Carleton H. Palmer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89854.
    Promulgated December 5, 1939.

      M. T. Moore, Esq., and George G. Tyler, Esq., for the petitioner.

      George R. iSherriff, Esq., for the respondent.
   OPINION.

Tyson :

The issue presented is whether the petitioner is taxable upon the $25,503 dividends declared and paid during the period May 26 to December 31, 1932, upon the shares of E. R. Squibb & Sons stock which were the subject matter of the trust agreement of May 26,1932, as set forth in our findings of fact.

The respondent determined, and now contends, that the execution of the trust agreement of May 26, 1932, was ineffectual; that there was no complete, irrevocable conveyance of the stock to the trust in praesenti/ that the petitioner retained and continued to exercise throughout 1932 the unfettered dominion and control over the stock; that the petitioner was the owner of the stock during the taxable year; and that, therefore, the dividends in question, which were paid direct to petitioner by E. E. Squibb & Sons and immediately thereafter by petitioner to his wife, are taxable to him under the provisions of section 22 (a) of the Eevenue Act of 1932.

In our opinion the trust agreement of May 26, 1932, clearly evidences the petitioner’s intention to irrevocably convey, in praesenti, to the trust his legal title to the stock in question, and, also, to irrevocably convey, in praesenti, the beneficial interest in such stock including the income arising therefrom to his wife during her lifetime, with remainder interests to his children and their issue. Further, in our opinion, the trust agreement effectuated such irrevocable conveyance.

The fact that the stock referred to in the trust agreement of May 26, 1932, was at that time pledged by petitioner as collateral security for certain loans did not prevent the petitioner’s conveyance of such stock to a valid trust, subject to the existing lien, for the petitioner, as the pledgor, retained the title to and the proprietary interest in that stock, while the pledgee had only a lien on the stock for the amount of the loan, the right to possession of the stock until the loan was repaid, and the right to sell same in case of default in payment of the loan. Gillet v. Bank of America, 160 N. Y. 549; 55 N. E. 292; In re Hollenbeck's Estate, 231 N. Y. 409; 132 N. E. 131; Walter F. Henningsen, 30 B. T. A. 301. “Every kind of vested right which the law recognizes as valuable may be transferred in trust.” United States Trust Co. of New York v. Commissioner, 296 U. S. 481, 487; Furthermore, the petitioner expressly covenanted with the trustees “to indemnify and hold harmless the Trust Estate against the collection of any of said loans, or any part thereof, out of said shares of stock, or any part thereof”, and he was in a financial position to carry out that covenant.

The fact that the petitioner was unable to make a manual delivery of the stock in question to the trustees because it was pledged as security, and the further fact that during the taxable year the stock remained registered in the petitioner’s name, did not preclude a sufficient delivery and a completed transfer of said stock in trust on May 26, 1932, as contended by respondent, for the execution of the trust agreement, of itself, effectively passed title to the stock in question from the petitioner individually to himself and his wife as trustees, and the beneficial interest in the stock became vested in the cestuis que trust, who could enforce their rights thereto. Estate of James F. Foster, 13 B. T. A. 496; Walter F. Henmngsen, supra; cf. Robb v. Washington and Jefferison College, 185 N. Y. 485; 78 N. E. 359; In re Brown's Will, 252 17. Y. 366; 169 N. E. 612; In re Sweeney's Estate, 155 Misc. 461; 279 N. Y. 927; Daniel P. Woolley, 39 B. T. A. 802.

The broad powers and control which the petitioner could exercise over the stock in question after the execution of the trust agreement are not indicia of individual ownership of the stock by petitioner, as contended by respondent. Under the trust agreement the petitioner, alone, but acting solely in his capacity as one of the trustees, was given authority to exercise such powers and by that instrument the legal title to and control over the stock passed from the petitioner individually, as grantor, to himself and his wife as trustees, just as effectively as if some other persons had received the conveyance as trustees. Those powers which petitioner as grantor reserved to himself as one of the trustees relate to the management of the trust corpus and do not vest in the grantor any control as an individual over the economic benefits or enjoyment of the trust property. Reinecke v. Northern Trust Co., 278 U. S. 339, and Henry A. B. Dunning, 36 B. T. A. 1222; petition for review dismissed, 97 Fed. (2d) 999; cf. Commissioner v. Waterbury, 97 Fed. (2d) 383; certiorari denied, 305 U. S. 638 (affirming 33 B. T. A. 208). The petitioner’s reservation of an option to reacquire the common stock from the trust by purchase at a fair price to be fixed by a specified formula prescribed in the trust instrument and over which he had no control after the execution of that instrument did not affect the validity of the trust and did not constitute a reservation by him of a power of revocation in whole or in part. Cf. Shanley v. Bowers, 81 Fed. (2d) 13. It is obvious that under such restrictions a sale by the trust of its Squibb common shares to petitioner would have no effect upon the continued existence of the trust, but would result merely in a change in character of the trust corpus by substitution of a fair purchase price paid for the stock in place of the stock itself.

While the respondent makes no contention for the application of either section 166 or section 16T of the Revenue Act of 1932 in the instant case, we deem it proper, because of the nature of the issue involved, to hold that neither section is applicable. Here the trust, by its terms, was “irrevocable” and could be amended, modified, or changed only by the written consent of all of the adult beneficiaries and the trustee or trustees in office at the time and, further, no part of the trust income was or could be distributed to or held for future distribution to the grantor under any circumstances. See Phebe Warren McKean Downs, 36 B. T. A. 1129; Meredith Wood. 37 B. T. A. 1065; affirmed, per curiam, 104 Fed. (2d) 1013.

Under the express terms of the trust agreement the entire net income of the trust was distributable quarterly to Winthrop B. Palmer during her lifetime for her unrestricted use and during the taxable year in question such income was so distributed. We hold that the respondent erred in including in the petitioner’s gross income for the year 1932 the dividends in the amount of $25,503 here in question.

Decision will be entered wider Bule 50.

       SEC. 22. GROSS INCOME.
      (a) Genebal Definition. — “Gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever hind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or Interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

       SEC. 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.
      SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.
      (b) As used in this section, the term “in the discretion of the grantor” means “in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.”


author: Oppek :

text:
    United States Fidelity and Guaranty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91398.
    Promulgated December 5, 1939.

      Cla/rence M. Gbarest, Esq., and John W. Fisher, Esq., for petitioner.

      Arthwr W. Oamdu/f, Esq., Ellyne E. Strichlamd, Esq., and Chester A. Gwirm, Esq., for respondent.

       Revenue Act of 1934—
      SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:

      (b) Interest. — All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title.

      SEC. 121. [Added August 27, 1935] DEDUCTION OF DIVIDENDS PAID ON CERTAIN PREFERRED STOCK OF CERTAIN CORPORATIONS.
      In computing the net income, for any taxable year beginning after December 31, 1934, of any national banking association, or of any bank or trust company organized under the laws of any State, Territory, possession of the United States, or the Canal Zone, or of any other banking corporation engaged in the business of industrial banking and under the supervision of a State banking department or of the Comptroller of the Currency, or of any incorporated domestic insurance company, there shall be allowed as a deduction from gross income, in addition to deductions otherwise provided for in this title, any dividend (not including any distribution in liquidation) paid, within such taxable year, to the United States or to any instrumentality thereof exempt from Federal income taxes, on the preferred stock of the corporation owned by the United States or such instrumentality.

   OPINION.

Oppek :

This proceeding presents the single question of the deduc-tibility of certain payments made in the year 1935 to the Reconstruction Finance Corporation. Briefly stated, the facts giving rise to the controversy are that the petitioner in a prior year and at the request of R. F. C. had paid off a loan owing to the latter from the proceeds of a transaction whereby a note of petitioner’s wholly owned subsidiary, the Del Mar.Co., and preferred stock of petitioner issued for the purpose, were used to obtain funds from the R. F. C. These funds in turn were repaid to the latter in discharge of the previous obligation. On its face the transaction took the form of an interest-bearing note secured by the preferred stock as collateral. The payments in question were those made to the R. F. C. by Del Mar as “interest”, the amounts having been received by the latter from its parent for that purpose but in the form of “dividends” on the preferred stock.

Petitioner contends that we may in this situation disregard the corporate existence of Del Mar and treat all of its actions and transactions as though they were in fact those of petitioner. It suggests that this is one of the exceptional cases to which the courts refer when they look through the corporate fiction. The practice, however, of disregarding corporations which the corporate parties themselves have meticulously preserved is one capable of serious abuse. This is particularly true when we are asked to do so for the benefit of the very interests which have themselves chosen to take advantage of the corporate relationship. Cf. Mississippi River & Bonne Terre Railway, 39 B. T. A. 995. The present circumstances suggest an illustration of the inconsistency which we are asked to approve. Del Mar was organized, according to the testimony, for the purpose of holding stock which, under the law of some jurisdictions, may not be owned by insurance companies. If Del Mar is to be regarded as nonexistent, the very purpose of its formation will be destroyed, because then the ownership of Del Mar will have to be treated as in reality that of its parent, the insurance company. Cf. Munson S. S. Line v. Commissioner, 77 Fed. (2d) 849, reversing 30 B. T. A. 946. And if that is so, petitioner was in legal contemplation the true owner of the stock in violation of the prohibition of the jurisdictions in question. We are unwilling to accept that formula for dealing with these facts.

Nevertheless the transaction which gave rise to the present controversy may profitably be analyzed to determine whether, even if we accept the separate existence of Del Mar, the terms of the statutes permitting deductions have been rendered inapplicable. As the arrangement was actually carried out only petitioner and R. F. G. were the real participants. Only they obtained any benefit whatever. When the stock was delivered it was issued directly to R. F. C. and in its name. The proceeds were paid to petitioner, which instructed the Federal Reserve Bank of Richmond to apply it on its loan from R. F. C. Upon redemption the stock was received back from the R. F. C. without endorsement, and canceled; and the redemption payment was directed by petitioner’s board of directors to be made directly to R. F. C. By the original transaction petitioner accomplished the discharge of its four million dollar liability in exchange for the issuance of a comparable amount of its own preferred stock. R. F. 0. obtained every right which could possibly inhere in that stock to the exclusion in every conceivable- respect of Del Mar. Even the dividends which were payable by the terms of the issue were relinquished by Del Mar, except to the extent that they had to be transferred through it to discharge the interest obligation to R. F. C. Passing the question of whether under those circumstances Del Mar’s note was given for any valid consideration, and assuming that it was infra vires, it seems clear that at most Del Mar’s position was that of an accommodation maker. Norfolk National Bank of Commerce & Trusts v. Commissioner, 66 Fed. (2d) 48, 51 (C. C. A., 4th Cir.). It did not and could not conceivably obtain any benefit from the transaction. It did not receive the funds borrowed nor the stock issued, nor the notes canceled. It was not possible that it ever would receive any benefit. Cf. Abrams Sons’ Realty Corporation, 40 B. T. A. 653. If that is so the obligation, whatever it is determined to be, was the equitable liability of the accommodated party, in this case the petitioner. Building & Engineering Co. v. Northern Bank of New York, 206 N. Y. 400; 99 N. E. 1044; In re Wingert, 89 Fed. (2d) 305 (C. C. A., 4th Cir.); certiorari denied, 302 U. S. 697; see Shannon v. Sutherland, 74 Fed. (2d) 530 (C. C. A., 4th Cir.); Elswick v. Combs (Va.), 198 S. E. 501; Browning v. Fuller (Va.), 149 S. E. 462, 463. The same tiling would be true if Del Mar had been an individual, for example, a stockholder, whose name had been signed to an accommodation note because of the lender’s insistence. We need not resort to a disregard of Del Mar’s corporate existence for that conclusion.

If we are correct in this, the payments made to the E. F. C., originating as they all did with the petitioner, and terminating as they all did with E. F. C., were payments on account of petitioner’s obligation to the latter. The tax consequence is identical, whether we say that they are payments of dividends on the preferred stock which E. F. C. held, or interest on an obligation which was actually that of the petitioner. That being so, we need not determine which legal phrase more nearly describes them. It is sufficient to hold, as we do, that either as interest paid or as dividends on a domestic insurance company’s preferred stock held by an instrumentality of the United States they were deductible under section 23 (b) of the Eev-enue Act of 1934, or section 121 of that Act, as added by the Act of August 27, 1935.1

Decision will be entered u/nder Bule 50.

         See footnote 1, supra.


author: SteRnhagen :

text:
    Edith Pulitzer Moore, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89702.
    Promulgated December 5, 1939.

      John G. Jackson, Jr., Esq., for the petitioner.

      J. Richard Biggies, Jr., Esq., for the respondent.
   OPINION.

SteRnhagen :

The Commissioner determined a deficiency of $1,-823.42 in gift tax for 1935, by disallowing three of the four $5,000 exclusions claimed by the petitioner in respect of securities transferred in trust. He held:

Under the trust agreement the only present payments directed or authorized to be made are to your husband. No payments can be made to the children until the death of your husband. The Bureau holds, therefore, that the gifts to the children are gifts of future interests against which no exclusions are allowable. Therefore, only one exclusion is allowable in this case. * * *

The facts were stipulated and the only issue is whether the trust instrument makes one gift or whether, if it makes separate gifts to the petitioner’s three sons, such gifts are gifts of future interests, the exclusion being in either event limited to $5,000 under section 504 (b) of the Eevenue Act of 1932.

(b) G-nrTS Less Than $5,000. — In the case of gifts (other than of future interests in property) made to any person by the donor during the calendar year, the first $5,000 of such gifts to such person shall not, for the purposes of subsection (a), be included in the total amount of gifts made during such year.

On December 31, 1935, the petitioner, as donor, executed a trust indenture under which she irrevocably conveyed to the Central Hanover Bank & Trust Co., as trustee, securities having a market value of $204,031.45 at that date:

subject to the trusts herein created, together with the proceeds thereof, all of which are hereinafter collectively called the “Trust Estate”, * * * [to] be held by the Trustee * * * upon the trusts and for the uses and purposes * * * herein set forth * * *.

The petitioner agreed to execute any further instruments necessary:

to vest title to the Trust Estate or any part thereof in the Trustee or to enable the Trustee to perform the trusts as hereinafter directed.

The trustee was authorized to collect rents and to deduct expenses in connection with the administration of “the trusts”:

To pay the net income in convenient installments to the Donor’s husband, William S. Moore, during his life.
Upon the death of said William S. Moore to continue to hold and to divide, pay over and distribute the principal of this trust then in the hands of the Trustee in the following order of preference, to wit:
1. If the Donor’s son, David Moore, or any of his issue shall survive the Donor’s said husband, there shall first be set aside and retained by the Trustee * * * $145,000 * * * and the Trustee shall continue to hold the same In Trust and to pay over the net income therefrom in convenient installments to the Donor’s son, David Moore, during his life and upon his death to pay over and distribute the principal per stirpes to and among his issue, him surviving; but if the Donor’s son, David Moore, shall predecease his father, William S. Moore, leaving issue surviving his said father, then to pay over and distribute said sum per stirpes to and among the issue of the Donor’s son surviving his father, William S. Moore; provided, however, that if the Donor’s son, David Moore, shall leave no issue surviving both him and his said father then to pay over said sum, or the principal of this trust, as the case may be, in equal shares, to such of the brothers of the Donor’s son, David Moore, as shall survive him and his father, William S. Moore, and to the issue, per stirpes, then surviving of any brother who may predecease them, such issue of a deceased brother taking per stirpes the equal share his, her or their parent would have taken if living.

A similar provision was made for another of petitioner’s sons, reading, in part, as follows:

2. If the Donor’s son, Richard Moore, or any of his issue shall survive the Donor’s said husband, there shall next be set aside and retained by the Trustee * * * $40,000 * * *.

Another provision as to the balance was made to give equal shares to the petitioner’s three sons, David, Richard, and William.

The trust indenture also provided that in the event all three of the sons, David, Richard, and William, should predecease petitioner’s husband:

then the whole of this Trust shall be paid in equal shares to such of the Donor’s sons Adrian Moore and Clement C. Moore as shall survive the Donor’s said husband * * *.

The donor expressly reserved the right of increasing the principal of “this trust.”

On her gift tax return for 1935 petitioner returned the gift at a value of $198,771.30 and deducted therefrom $20,000 for four exclusions of $5,000 each, as well as the specific exemption of $50,000, leaving a net gift of $128,771.30, upon which a tax of $6,789.41 was assessed and paid on March 16, 1936. In his deficiency notice the Commissioner computed the value of the gift as $204,031.45, which petitioner does not now controvert, and allowed one exclusion of $5,000, which, after deducting the $50,000 specific exemption, resulted in a net gift of $149,031.45. The petitioner’s husband and her three sons, David, Richard, and William, were still living at the time of filing the stipulation in 1939.

The stipulation, interestingly enough, indicates that the petitioner in her return and the parties in their stipulation conceive of a single gift in trust; which helps only to show that this is the natural way to regard it.

Both parties agree that under Mary M. Hutchings, 40 B. T. A. 27 (on review, C. C. A., 5th Cir.), the “trust entity” and not the beneficiary is the donee. That case dealt with a trust whereby the beneficiaries were given immediate enjoyment as was the husband here, and it would seem a fortiori that the same rule would apply to the present trust, which gave to each child an expectancy of future enjoyment in a prescribed order of preference. There is no more reason here to find several trust entities than there was in the Hutchings case.

But the Hutchings case is on appeal, and two higher courts have recently held that the number of exclusions is fixed not by the number of trusts but by the number of beneficiaries, Rheinstrom v. Commissioner, 105 Fed. (2d) 642; Welch v. Davidson, 102 Fed. (2d) 100; so we dare not rely too heavily upon our own decision. But no case holds that there is more than one exclusion when the gift is in trust for A for life and remainder to B if he survives A. That question is open. The statute expressly withholds the exclusion from gifts of future interests, and we think it clear that each gift to a child here is of a future interest. It is only to begin after the life of the husband has ended. The husband has an intervening estate which may survive the life of the child and thus the gift to the child may never vest in him. There is no present distribution to the child and no present accumulation for his benefit. It matters not that the entire estate was transferred from the donor, for that reasoning only serves to support the $5,000 exclusion which the respondent has already recognized because of the present gift for the benefit of the father. Cf. Commissioner v. Wells, 88 Fed. (2d) 339; Commissioner v. Krebs, 90 Fed. (2d) 880. The fact that after the child’s death, if before the death of the husband, the child’s issue shall take the amount which would have gone to the petitioner’s child is not because of the succession, but because of the provision of the trust bestowing the interest directly upon the issue if the petitioner’s child should die. The interests created by the trust succeeding the death of the husband were future interests. Hence we think the Commissioner was right in confining the exclusion to $5,000.

Reviewed by the Board.

Decision will be entered for the respondent.

Smith, Disney, and Hakkon concur only in the result.


author: Black :

text:
    Dallas Title & Guaranty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90466.
    Promulgated December 6, 1939.

      James P. Swift, Esq., for the petitioner.

      Hugh Brewster, Esq., for the respondent.
   OPINION.

Black :

We shall consider the issues, stated elsewhere, in the inverse order.

Was petitioner exempt from the excess profits tax imposed by section 702 of the Revenue Act of 1934? This section provides in part that:

(a) There is hereby imposed upon the net income of every corporation, for each income-tax taxable year ending after the close of the first year m respect of which it is tamable under section 101, an excess-profits tax * * *. [Italics supplied.]

Section 701 imposes a capital stock tax upon certain corporations and under subdivision (c) (2) thereof, it provides that the taxes thus imposed shall not apply “to any insurance company subject to the tax imposed by section 201, 204, or 207.” Petitioner contends that it is an “insurance company” subject to the tax imposed by section 204. The material provisions of section 204 are set out in the margin.

The parties have stipulated that “during the taxable year involved, petitioner was engaged in the title insurance business.” On cross-examination of petitioner’s witness, F. D. Price, it was brought out that petitioner also engaged in business other than the title insurance business. A corporation may be organized under the insurance laws of a state, be subject to supervision by the insurance officers of the state, and actually do a certain amount of insurance business, and yet fail to classify as an “insurance company” as that term is used in the Federal tax statutes. Bowers v. Lawyers’ Mortgage Co., 285 U. S. 182; Lincoln Mortgage & Title Guaranty Co. v. Commissioner, 79 Fed. (2d) 585; Empire Title & Guarantee Co. v. United States, 101 Fed. (2d) 69. It is the character of the business actually done in the tax year that determines whether the corporation is taxable as an insurance company. Bowers v. Lawyers' Mortgage Co., supra. If insurance is its principal business, it is taxable as an insurance company. United, States v. Home Title Insurance Co., 285 U. S. 191. If, therefore, petitioner’s title insurance business is its principal business, it is an insurance company taxable under section 204.

The character of petitioner’s business actually done during- the taxable year was testified to by F. D. Price, the auditor having supervision and control of petitioner’s records, as follows:

Q Will you state what the records show as to the gross income for the Dallas Title and Guaranty Company in the year 1934?
A The gross income, according to the records, of the Dallas Title and Guaranty, was $92,558.37.
Q Mr. Price, have you figured what percentage of that income is derived from premiums on title policies and investments on title company holdings?
A Approximately 60% is underwriting income, and approximately 20% is insurance investment income, thereby making a grand total of approximately 80% of the gross income derived from the insurance business.

Petitioner also introduced in evidence its income tax return, in which it had reported taxable gross income of $89,302.50 and nontaxable gross income of $3,255.87, or a total of $92,558.37. The break-down of these figures into separate items is shown in our findings of fact. We think these facts, together with the stipulation that “during the taxable year involved petitioner was engaged in the title insurance business”, establishes that petitioner was engaged in the insurance business, other than “life or mutual.” We, therefore, hold that petitioner is an insurance company subject to the tax imposed by section 204, and that it is not subject to the excess profits tax imposed by section 702.

Is petitioner taxable on the $40,000, or any part thereof, transferred from the premium reserve account to the undivided profits account during the taxable year 1934?

Petitioner contends (1) that the $40,000 had been on hand as an asset since prior to 1930 and as such was not taxable gain in 1934; (2) that the transaction does, not fall within the defined items of income contained in section 204 of the Revenue Act of 1934; (3) that all of the reserve fund of $149,829.88 on hand at the close of 1929 was legally taxable in the years in which it was earned prior to 1930, and consequently was not taxable in 1934; and (4) that the fact that no income tax was paid on the $149,829.88 in the years in which it was earned furnishes no authority for subjecting any part of the fund to income tax in 1934, prior to which year the entire fund was a part of petitioner’s capital assets.

The respondent’s position is that since petitioner has had the benefit of the net increase in the premium reserve account for the years 1913 to 1929, inclusive, as deductions from gross income in years prior to 1930, it should be required to include in its gross income for the taxable year 1934 that part of the reserve which was released during the taxable year, namely, $40,000. In support of this position, the respondent cites, among other cases, Maryland, Casualty Co. v. United States, 251 U. S. 342, and Estate, of William H. Block, 39 B. T. A. 338, and cases therein cited. The respondent has also affirmatively pleaded that petitioner is estopped to deny that the amount of $40,000 is taxable income to it for the year 1934.

In approaching the contentions thus made by both parties, it will be pertinent, we think, to determine the validity of the deductions taken by petitioner in years prior to 1930 of the net additions to the premium reserve account. Petitioner now says these were all illegal and should have been restored to income in the years when they were taken as deductions. The revenue acts prior to the Revenue Act of 1921, together with the Act of August 5, 1909, all allowed insurance companies to deduct from their gross income “the net addition, if any, required by law to be made within the year to reserve funds * * * .” Section 38 second of the Act of August 5, 1909 (36 Stat. 113); section II G. (b) of the Tariff Act of October 3, 1913 (38 Stat. 173) ; section 12 of the Act of September 8, 1916 (39 Stat. 768); section 234 (a) (10), Revenue Act of 1918 (40 Stat. 1079). Section 234 (a) (10) of the Revenue Act of 1921 (42 Stat. 256) allowed for the year 1921 a deduction “In the case of insurance companies (other than life insurance companies), in addition to the above (unless otherwise allowed): (A) The net addition required by law to be made within the taxable year to reserve funds * * See Hoosier Casualty Co., 6 B. T. A. 1343, 1357; affd., 32 Fed. (2d) 940; certiorari denied, 280 U. S. 581; and art. 691, Regulations 62. This deduction was not allowable for 1922 and subsequent years.

The Texas law (art. 4971, note 1, supra) under which the reserve of $149,829.88 was built up required petitioner to have “a fully paid up and safely unimpaired capital of at least” $100,000, and also “good available assets exceeding its liabilities, which liabilities for the purpose of this subdivision shall be taken to be its capital stock, its outstanding debts and a premium reserve at, the rate of fifty per cent of the current annual premiums * * (Italics supplied.) It is our opinion that, in the absence of any evidence to the contrary, the deductions taken by petitioner in yearsl prior to 1922 of the net additions to the premium reserve account in the total amount of $45,-504.57 were all legal and proper deductions from gross income.

At this point, we think it is appropriate to remark that, while it is stipulated that at the close of 1912 petitioner carried on its books an account designated thereon as “Premium Reserve Account”, with a then credit balance of $15,500.75, it was not stipulated that this amount had been deducted in determining the amount of petitioner’s excise tax under the 1909 Act. The stipulation as to deductions is as follows:

In the various income tax returns made by petitioner for the years 1913 to and inclusive of 1929, petitioner claimed and was allowed a deduction from its gross income of the amount of the net increase in such “Premium Reserve Account” for each such year.

Hence we have computed these deductions so taken from 1913 to 1921, both years inclusive, and arrived at the figure of $45,504.57 legal deductions, as stated above.

Beginning with the Revenue Act of 1921, effective January 1, 1922, Congress changed its method of taxing “Insurance Companies Other Than Life Or Mutual.” See sections 246 and 247 of the Revenue Acts of 1921, 1924, and 1926 and section 204 of the Revenue Acts of 1928, 1932, and 1934. After the year 1921, Congress no longer allowed as deductions from gross income the net addition required by law to he made within the taxable year to reserve funds. Congress did provide, however, in section 246 (b) (1) of the Revenue Acts of 1921, 1924, and 1926 and section 204 (b) (1) of the Revenue Act of 1928, that in computing the gross income:

The term “gross income” means the combined gross amount, earned during the taxable year, from investment income and from underwriting income as provided in this subdivision, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners.

la section 246 (b) (4) of the Revenue Acts of 1921, 1924, and 1926 and section 204 (b) (4) of the Revenue Act of 1928, Congress provided that the term underwriting income “means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred”, and in the following paragraph it provided as follows:

(5) The term “premiums earned on insurance contracts during the taxable year” means an amount computed as follows :
Prom the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.

Apparently petitioner deducted the net additions to the premium reserve account during the years 1922 to 1929, inclusive, in the total amount of $88,824.56 on the ground that this amount of the premiums collected was “unearned premiums”, for in its balance sheets as of December 31, 1933 and 1934, attached to its 1934 return, it reported this reserve as “Reserve Unearned Premium Dec. 31, 1933, $140,000 and Dec. 81,1934, $100,000.”

It is now settled, however, that premiums paid a title insurance company are earned when paid and constitute gross income when received, and that reserves set up to meet future liabilities under title insurance policies are not deductible from gross income. American Title Co., 29 B. T. A. 479; affd., 76 Fed. (2d) 332. Cf. Pacific Employers Insurance Co. v. Commissioner, 89 Fed. (2d) 186; Massachusetts Protective Association, Inc. v. United, States, 22 Fed. Supp. 755. It, therefore, was improper for petitioner to deduct on its returns for the years 1922 to 1929, inclusive, the net additions to its premium reserve account during those years in the amount of $88,824.56. If this were the only part of the reserve with which we were dealing, we would sustain petitioner’s contention that none of the $40,000 in question could be taxed to petitioner in 1934.

The situation is different, however, as to the additions to the premium reserve account during the years 1913 to 1921, inclusive. As we have already stated, the aggregate of the net additions to reserve in those years was $45,504.57, all of which petitioner deducted on its income tax returns for those years. The Commissioner properly allowed these deductions under the law and regulations which were in force during those years. In 1931 petitioner transferred by book entry from said account designated “Premium Reserve Account” to “Undivided Profits Account” the sum of $9,829.88. Presumably the Commissioner taxed that amount as income of petitioner for that year. He makes no contention to the contrary. This $9,829.88 subtracted from the $45,504.57 which the Commissioner had legally allowed as deductions in years from 1913 to 1921, inclusive, leaves $35,674.69. If, in a later year, any part of this legal reserve for which deductions have been properly allowed in prior years is released to the general uses of the petitioner and thus increases petitioner’s free assets, to that extent the reserve should be treated as income in the year in which it became so available. Maryland Casualty Co. v. United States, supra; art. 240, Regulations 33 (Revised); art. 548, Regulations 45 (1920 Edition).

We think such a release as is referred to above took place during the taxable year 1934. On July 5 of that year, petitioner called a special meeting of its board of directors to consider the recommendation of its executive officers that $40,000 be transferred from the premium reserve account to the undivided profits account. After considerable discussion of the matter, a resolution was adopted whereby petitioner’s officers were directed to make the transfer. We think this transfer of $40,000 amounted to a release of petitioner’s legal reserve to that extent and was income to petitioner in 1934 to the extent of $35,674.69, upon authority of Maryland Casualty Co. v. United States, supra, and Commercial National Insurance Co., 12 B. T. A. 655. Cf. Massachusetts Fire & Marine Insurance Co., 16 B. T. A. 625; Central National Fire Insurance Co., 22 B. T. A. 1051; Utah Home Fire Insurance Co., 24 B. T. A. 225; affd., 64 Fed. (2d) 763; certiorari denied, 290 U. S. 679. We do not think the change in the Texas law (art. 1302a, note 2, supra) which became effective on August 12, 1929, com-' pels, a different holding from that we have just made, in view of the fact that petitioner took no steps to release the amount in question until the taxable year 1934. Cf. Estate of William H. Block, supra, and cases therein cited, and Creamette Co., 37 B. T. A. 216.

Our holding above disposes of all of petitioner’s contentions except the second, namely, that the transaction does not fall within the defined items of income contained in section 204 of the Revenue Act of 1934. In support of this contention, petitioner relies principally upon Commissioner v. Van Schaick, 83 Fed. (2d) 940. That case involved section 204 (b) (1) of the Revenue Act of 1928, which contained a restricted definition of gross income of insurance companies other than life or mutual. This definition of gross income was enlarged by section 204 (b) (1) of the Revenue Acts of 1932 and 1934 to include “and (C) all other items constituting gross income under section 22.” See note 4, supra. For the reasons already given, we hold that $35,-674.69 of the $40,000 in question should be included in petitioner’s gross income under section 204 (b) (1) (C) of the Revenue Act of 1934.

For the reasons we have already stated, the remainder of the $40,-000 in question would not be taxable income to petitioner in 1934, unless it is so by some principle of estoppel. The Commissioner has specially pleaded estoppel, but we do not think he has proved any facts which establish it. It is true that the facts show that from 1922 to 1929, inclusive, the petitioner claimed and was impi’operly allowed deductions for additions to reserves in those taxable years amounting to $88,824.56. There were no misrepresentations of fact connected with these deductions. Petitioner did actually set up these reserves on its books, as required by the laws of the State of Texas, but it was not legally entitled to take deductions therefor and the Commissioner should not have allowed these deductions. American Title Go., supra. However, a misunderstanding of the law by both parties does not establish estoppel. Cf. United States v. Scott & Sons, Inc., 69 Fed. (2d) 728. Estate of William Steele, 34 B. T. A. 173, and cases there cited. On the issue of estoppel we hold in favor of the petitioner.

Reviewed by the Board.

Decision will be entered under Bule SO.

       SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL.

      (b) Definition- of income, etc. — In the case of an insurance company subject to the tax imposed by this section—
      (1) Guoss income. — “Gross income” means the sum of (A) the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners, and (B) gain during the taxable year from the sale or other disposition of property, and (C) all other items constituting gross income under section 22;

      (3) Investment income. — “Investment income” means the gross amount of income earned during the taxable year, from investment income and from underwriting income as

      (4) Underwriting income. — “Underwriting income” means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred;


author: Arnold :

text:
    Marian Neal, J. Robert Neal, Jr., and Nina Margaret Neal Trust, Second National Bank of Houston, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92948, 92949, 95462.
    Promulgated December 7, 1939.

      'Wright Matthews, Esq., for the petitioner.

      James EL. Yeatman, Esq., for the respondent.
   OPINION.

Arnold :

Whether the instrument of July 8, 1929, created one trust or three separate trusts depends upon the intention of the settlor and that intention must be ascertained from the instrument itself. Langford Investment Co. v. Commissioner, 77 Fed. (2d) 468; McGinley v. Commissioner, 80 Fed. (2d) 692; State Savings Loan & Trust Co. v. Commissioner, 63 Fed. (2d) 482; Huntington National Bank v. Commissioner, 90 Fed. (2d) 876.

An examination of the trust instrument of July 8, 1929, and the amendments thereto, as to terminology used, indicates an intention to create a single trust, the corpus to be divided into three shares by the trustee. The settlor transferred to a trustee personal property consisting of stocks and bonds, as stated in the habendum clause, to have and to hold to the trustee in trust for the benefit of settlor’s three grandchildren and to divide the trust fund into three equal shares, one share for each of the settlor’s named grandchildren, and within the limits of the trust term to dispose of the income and principal as directed.

Article first, paragraph A, refers to the expiration of the trust term. In paragraph B, in the event of afterborn grandchildren, the trustee shall unite the principal of all shares then held and shall redivide the trust fund. In article second, paragraph C, no assignment by a beneficiary of any part of the income of the trust herein created shall be valid, nor can the principal or income of said trust be attached. In paragraph E, all stock and extraordinary dividends shall be treated as principal and added to the trust fund. In paragraph F, the trustee shall not be required to make physical division of the funds, but in his discretion may keep the trust corpus in one or more funds. In paragraph G, the trustee shall not be required to register stocks or bonds belonging to the trust in bis own name as trustee. In article third, paragraph B, the settlor reserves the right to designate the investments of the trust fimd. Article fourth authorizes the trustee to receive other property for the purposes of the trust hereby created. It is stated in article fifth that the trust hereby created shall be deemed a Texas trust. In article eighth, as compensation for services in the administration of this trust, and in article ninth the trustee accepts the said trust.

On June 20, 1933, John W. Neal, the settlor, executed an instrument amending the trust agreement to permit an accounting between him as settlor and a successor trustee, wherein it is recited he created a trust of the property by the agreement of July 8, 1929, and in the amendment proper he refers in two instances to the income and principal of the trust created, and in two other instances to the trust.

On February 4, 1935, the settlor, designating the Second National Bank of Houston as trustee, stated he created a trust by the agreement of July 8, 1929, and in the acceptance by the Second National Bank of Houston of its appointment as trustee, John W. Neal is referred to as the donor of a trust created under trust agreement made by him dated July 8, 1929.

Neither the original trust agreement nor the amendments thereto specify three separate trusts, nor does it appear from the language used that more than one trust was intended to be created by the settlor. While terminology alone is not conclusive, the frequent references to a single trust require that indications of a contrary intention should be clear. Huntington National Bank v. Commissioner, supra; Langford Investment Co. v. Commissioner, supra; State Savings Loan & Trust Co. v. Commissioner, supra.

We can find no clear indications in this agreement that the settlor intended to create three trusts. He designated no specific lot of securities in which any grandchild had a beneficial interest. He made no direction for specific segregation, and none of the successive trustees made any segregation. The direction of the habendmn clause that the trustee divide the trust fund into three equal shares and dispose of the income and property of said shares, as qualified by the settlor’s direction of distribution: of income and principal which follows, convinces us that he intended to create one trust with three equal beneficiaries. The provision that afterborn grandchildren should share equally with the three provided for in the agreement is a further indication that one general trust fund was set up with three or more equal beneficiaries.

In McGinley v. Commissioner, supra, the Board was affirmed in holding but one trust was created where the trust instrument provided: “My said Trustees shall divide said trust estate hereby created into five (5) equal shares, one (1) share to be held in trust for each of my five (5) children * * The Board in its opinion said:

It will be observed that there is nothing said about separate trusts, but the direction is to divide the trust estate into five equal shares and that the income from each child’s share shall be paid to it and its share of the principal of “said trust estate” upon the happening of certain events.

The cases cited and relied on by petitioner all involve facts and circumstances differing from those here present to an extent sufficient to make them distinguishable from the case before us on facts. The trust here was administered as one entity, both the corpus and the income were kept in a single fund, no segregation or division of the trust property, as between the beneficiaries, was ever made, and a single account was kept by the various trustees. The instrument before us, considered as a whole, and in connection with all other relevant facts and circumstances, does not in our opinion show an intention on the settlor’s part to create three separate trusts, and we hold the trust created thereby is taxable as a single entity.

Judgment will he entered for the respondent.


author: Opper :

text:
    Henry C. and Lillie M. Wright Smith, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96475.
    Promulgated December 7, 1939.

      Henry G. Smith, Esq., for the petitioners.

      E. O. Hanson, Esq., and William G. Ruymamn, Esq., for the respondent.
   OPINION.

Opper :

Respondent determined a deficiency of $23.62 in petitioner’s 1937 income tax. This was due to the disallowance of a deduction claimed by petitioners, who are husband and wife, for sums spent by the wife in employing nursemaids to care for petitioners’ young child, the wife, as well as the husband, being employed. The facts have all been stipulated and are hereby found accordingly.

Petitioners would have us apply the “but for” test. They propose that but for the nurses the wife could not leave her child; but for the freedom so secured she could not pursue her gainful labors; and but for them there would be no income and no tax. This thought evokes an array of interesting possibilities. The fee to the doctor, but for whose healing service the earner of the family income could not leave his sickbed; the cost of the laborer’s raiment, for how can the world proceed about its business unclothed; the very home which gives us shelter and rest and the food which provides energy, might all by an extension of the same proposition be construed as necessary to the operation of business and to the creation of income. Yet these are the very essence of those “personal” expenses the deductibility of which is expressly denied. Kevenue Act of 1936, section 24 (a).

We are told that the working wife is a new phenomenon. This is relied on to account for the apparent inconsistency that the expenses in issue are now a commonplace, yet have not been the subject of legislation, ruling, or adjudicated controversy. But if that is true it becomes all the more necessary to apply accepted principles to the novel facts. We are not prepared to say that the care of children, like similar aspects of family and household life, is other than a personal concern. The wife’s services as custodian of the home and protector of its children are ordinarily rendered without monetary compensation. There results no taxable income from the performance of this service and the correlative expenditure is personal and not susceptible of deduction. Rosa E. Burkhart, 11 B. T. A. 275. Here the wife has chosen to employ others to discharge her domestic function and the services she performs are rendered outside the home. They are a source of actual income and taxable as such. But that does not deprive the same work performed by others of its personal character nor furnish a reason why its cost should be treated as an offset in the guise of a deductible item.

We are not unmindful that, as petitioners suggest, certain disbursements normally personal may become deductible by reason of their intimate connection with an occupation carried on for profit. In this category fall entertainment, Blackmer v. Commissioner, 70 Fed. (2d) 255 (C. C. A., 2d Cir.), and traveling expenses, Joseph, W. Powell, 34 B. T. A. 655; affd., 94 Fed. (2d) 483 (C. C. A., 1st Cir.), and the cost of an actor’s wardrobe, Charles Hutchison, 13 B. T. A. 1187. The line is not always an easy one to draw nor the test simple to apply. But we think its principle is clear. It may for practical purposes be said to constitute a distinction between those activities which, as a matter of common acceptance and universal experience, are “ordinary” or usual as the direct accompaniment of business pursuits, on the one hand; and those which, though they may in some indirect and tenuous degree relate to the circumstances of a profitable occupation, are nevertheless personal in their nature, of a character applicable to human beings generally, and which exist on that plane regardless of the occupation, though not necessarily of the station in life, of the individuals concerned. See Welch v. Helvering, 290 U. S. 111.

In the latter category, we think, fall payments made to servants or others occupied in looking to the personal wants of their employers. David Sonenblick, 4 B. T. A. 986. And we include in this group nursemaids retained to care for infant children.

Decision will be entered for the respondent.

         Bourne v. Commissioner, 62 Fed. (2d) 648 (C. C. A., 4th Cir.), affirming 23 B. T. A. 1288; certiorari denied, 290 U. S. 650.


author: Sternhagen :

text:
    John Nicholas and Chemical Bank & Trust Company, as Executors of the Last Will and Testament of Willard A. Lalor, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92113.
    Promulgated December 7, 1939.

      Dallas S. Townsend, Esq., for the petitioner.

      John B. Wheeler, Esq., for the respondent.
   OPINION.

Sternhagen :

1. The taxpayer estate claims the deduction from gross estate of the $400,000 paid by the executors to the Lalor Foundation, Inc., because the corporation was a charitable or educational corporation, bequests to which are deductible, Revenue Act of 1926, sec. 303 (a) (3). The Commissioner has denied the deduction for several reasons.

It is necessary to consider the force of only one ground for the Commissioner’s disallowance. The will provided clearly that if the selection of charitable or educational recipients of the $400,000 bequest was not made by the designated persons within one year after probate of the will, the possibility of such charitable legacy should lapse and the amount should become part of the residuary estate. The residuary estate was left to a trust for the benefit of private individuals. This provision, it must be held, defeats the deduction claimed. Mississippi Valley Trust Co. v. Commissioner, 72 Fed. (2d) 197; Davison v. Commissioner, 81 Fed. (2d) 16; Knoernschild v. Commissioner, 97 Fed. (2d) 213.

Although the evidence shows that the decedent had little doubt that his sister and his nephew would carry out his desire to make a charitable contribution, nevertheless he left it entirely within their discretion to effectuate such a philanthropy or to permit it to lapse and thus have the $400,000 go into the residuary estate. The last word was theirs. The bequest, therefore, can not be designated as a bequest by the decedent to a charitable organization. It was only to become such if the sister and her son by their own volition designated such a legatee. The effect of the testamentary provision was to create a simple alternative — on the one hand, a charitable bequest if certain living individuals were willing to have it so; and, on the other hand, a residuary bequest to private legatees if the individuals so elected. The belief arising from the circumstances in which the testamentary provision was made, that the sister and her son were not likely to permit the decedent’s charitable purpose to lapse, does not soften the operation of the fact that the charitable bequest was in terms not absolute but conditional upon the voluntary conduct of the sister and nephew.

The Commissioner’s determination must be sustained.

2. The petitioner also claims the deduction of the amounts paid to the nieces because, in reliance upon the decedent’s promise, they had refrained from marriage until after they were twenty-five. It is sufficient to defeat the deduction that the consideration for the claims was not in money or money’s worth, as the statute requires, section 303 (a) (1) (e) , Revenue Act of 1926, as amended by section 805, Revenue Act of 1932. Central Union Trust Co. of New York et al., Executors, 24 B. T. A. 296. The Commissioner’s disallowance of these deductions is sustained.

Several items of the deficiency determination were disposed of by the parties and the disposition may serve to modify the deficiency.

Decision will be entered under Bule 60.