author: Arundell:

text:
    Maco Stewart, Executor, Estate of Raymond A. Perry, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 63645.
    Promulgated April 18, 1935.

      Eugene Meaeham, Esq., Knox B. Phagan, O. P. A., and Raymond M. "White, Esq., for the petitioner.

      Mason B. Leming, Esq., for the respondent.
   opinion.

Arundell:

This proceeding contests -a deficiency in income tax for the year 1929 in the amount of $132,712.50. The only issue is the March 1, 1913, value of stock of the Standard Dredging Co.

In 1929 petitioner’s decedent, Raymond A. Perry, sold 67,248 shares of stock of the dredging company at $29.89 per share, receiving a total of $2,010,042.72. The company was incorporated in 1905 and Perry acquired this stock prior to March 1, 1913. In determining the gain on the sale the respondent fixed the March. 1, 1913, value at $4.21098 per share.

Perry was the sole owner of the stock of the dredging company, and prior to his sale of 67,248 shares in 1929, none of the stock had been sold on any exchange or otherwise. It was not listed on any stock exchange. In fixing the March 1, 1913, value of the stock the respondent determined the average capital, surplus, and earnings for the five-year period 1908 to 1912, inclusive.. Computing a 10 percent return on the average capital and surplus as attributable to tangibles, he capitalized the average excess earnings at 20 percent and thus reached a value for good will of $578,450.75. Adding to this good will figure a so-called “ balance sheet value ” of the dredging company of $673,449.41 and a “ balance sheet value ” of the North American Dredging Co. of Texas of $262,162, a total value of $1,514,-062.16 was reached. The North American Co.’s stock was wholly owned by the Standard Dredging Co. Dividing the $1,514,062.16 value by 359,550-50/89, the number of shares outstanding, gave respondent a per share value of $4.21098.

In the petition filed a March 1, 1913, value of at least $19.80 per share was claimed. Petitioner in his brief claims a value of $45.04369 per share.

Petitioner’s evidence was directed to showing the values of the Standard Dredging Co.’s assets at March 1, 1913. There was no evidence of any kind directly to the point of the value of the stock itself. The assets are separated by petitioner into four groups, namely, plant and equipment, Mexican contracts, sand deposits, and good will.

The plant and equipment concerning which there is evidence consisted of mobile facilities — dredges, tugs, barges, scows, and accessories therefor. The March 1, 1913, values of these facilities were given by men who in some instances were familiar with the equipment at the basic date and in others were qualified by their experience to express values upon being furnished descriptions and photographs. Based on the testimony of the witnesses we find the March 1, 1913, value of the items comprising “ plant and equipment ” to be $1,500,000.

The respondent’s calculation as set forth in the deficiency notice does not assign a value to plant and equipment separately from other assets. It does appear, however, that the figures used by the respondent are book values. According to information in the income tax returns placed in evidence by the respondent, plant and equipment were carried at cost. According to the returns, plant and equipment owned in 1912 cost $584,853 and that owned in 1913 cost $784,100. We do not know when the increase occurred, whether before' or after March 1,1913, and in the absence of any showing by the petitioner as to the time of acquisition or the amount allowed by the respondent for plant and equipment, we must assume that the respondent used the larger figure, $784,100. The petitioner has the burden of proving that the respondent used too low a figure, and where there is doubt as to which of two figures was used the doubt must be resolved against the petitioner. Consequently, we must assume that the respondent used the 1913 cost figure of $784,100 for plant and equipment in reaching the figure of $673,449.41 which he calls “ Standard Dredging Company balance sheet value ” in the computation set forth in the deficiency notice. We have found above the March 1, 1913, value of plant and equipment to be $1,500,000. It follows that the difference between $784,100 and $1,500,000, that is, $715,900, should be added to the $673,449.41 found by the respondent as “balance sheet value.” This will result in an increase of the same amount, $715,900, in the total of $1,514,062.16 used by the respondent as the dividend in his calculation of the per share value.

The Mexican contracts consisted of contracts with the Government of Mexico for harbor construction and dredging at Frontera, Tampico, and Salina Cruz. The Frontera contract was entered into on November 30, 1911, between an official of the Mexican Government and the North American Dredging Co. of Texas, and provided for the performance of certain work in the port of Frontera. A part of the work was to be completed within two years from the date of the contract. Payment was to be made as the work progressed on what may be termed a piece-work basis, that is, at certain stipulated prices per cubic meter or ton of materials dredged or construction work performed.

The Tampico contract was entered into on May 30, 1913, between the Secretary of State of Mexico and Edwin R. Davis, an employee of the Standard Dredging Co. By assignment of July 10, 1913, Davis transferred the contract to the United Dredging Co. which was a wholly owned subsidiary of the Standard Dredging Co. This contract called for the dredging of the Panuco River for a length of 13 kilometers. It was estimated that the material to be removed would amount to 10,000,000 cubic meters. The contractor was to receive an advance payment of 500,000 pesos at the time of delivery of machinery and equipment on location, and thereafter payment was to be made monthly on the basis of 56 cents per cubic meter of materials dredged, less a deduction of 12 percent until the advance payment was recovered.

The Salina Cruz contract was entered into on November 23, 1912, between an official of the Mexican Government and the North American Dredging Co. of Texas, called therein the contractor. Under it the contractor was to dredge the harbor and the entrance canal to the dike of the port of Salina Cruz. The minimum of material to be removed was 250,000 cubic meters .and the maximum was 300,000 cubic meters. The contractor was to be paid “ at the rate of one peso and sixty ($1.60) per cubic meter of material dredged and deposited ” at specified places. The contractor was to begin work within 60 days after the date of the promulgation of the contract and complete the work within 150 days from that date. Work was started on this project in March 1913.

The contractors on the Frontera and Salina Cruz projects were hampered in their work by reason of the unsettled political situation in Mexico in 1913. On both projects some of the contractors’ property was seized and its employees harassed. On the Salina Cruz project the contractor received payments in April and May aggregating $191,010.56. Other amounts owing for dredging completed were not paid and the North American Dredging Co. filed a claim therefor in the amount of $245,308.64 with the Claims Commission, United States and Mexico. In an affidavit in support of that claim Perry stated, “As a result of the losses of the claimant company at Frontera and Salina Cruz, it became and was, wholly insolvent for a number of years.” A claim was also filed with the Claims Commission on behalf of the North American Dredging Co., claiming $383,526.42 for damages and losses on the Frontera project alleged to have resulted from the acts of Mexican'Government troops and revolutionary forces. The Salina Cruz claim was dismissed by the Claims Commission for want of jurisdiction. The disposition of the other claim is not shown.

The above mentioned contracts were the first ever obtained by any American firm for dredging in Mexican waters. Prior thereto the dredging had been done by an English concern which withdrew from the Mexican field upon entry of the American companies. When dredging contracts were entered into it was contemplated by the Mexican officials and the contractors that extensions of the operations would subsequently be performed by the same contractors. The contemplated extensions were omitted from the original contracts in order to keep the price as low as possible and thus avoid the appearance of expenditures by the Government of unduly large sums. In the case of the Standard Dredging Co. and its subsidiaries, contracts were subsequently executed for extensions and the removal of silt from channels. These companies also performed considerable work for private concerns in Mexico, consisting of dredging channels from private docks to the Government channels.

Petitioner claims a March 1, 1913, value for the Mexican contracts of $8,000,000. This is based in the testimony of Perry and the other officers of the companies as to the amount of profits they expected to realize from the original contracts plus the expected extensions. We cannot agree with the conclusion of the witnesses. The Tampico contract was not in existence on March 1, 1913. There is testimony that an oral agreement for the performance of the work had been made prior to that date and all that remained to be done at March 1 was its reduction to writing. It is hard to see wherein the company whose stock we are valuing had any property or property right at March 1 which is susceptible of valuation. It had no contract, and it is scarcely possible that the oral agreement could be assigned. All that the company had at the basic date was the possibility of securing a contract which has not been shown to be susceptible of valuation. The Frontera contract called for performance of a part of the work within two years of its date, which was November 30, 1911. In the absence of a contrary showing, we must assume a compliance with the terms. There is no showing how much the contractor was to receive for the work remaining to be done at March 1, 1913. Undoubtedly a willing buyer of the contracts, if such could be found, would have heavily discounted the prospective receipts from the Frontera and Salina Cruz contracts. It is a matter of history that as early as 1912 Mexico was beset with serious political disturbances and that condition continued throughout 1913. In February 1913 Francisco I. Madero was forced from the presidency and- executed. The United States did not recognize the government organized by his successor, Victoriano Huerta, who held office until July 1914. No doubt a prospective purchaser would have taken the political situation into consideration in making any bid for the contracts. According to the claims filed with the Claims Commission, the companies here involved were adversely affected by the unsettled political conditions. The estimates of profits given by petitioner’s witnesses are based on the original contracts plus the extensions. At March 1, 1913, there were no agreements for extensions sufficiently definite to be susceptible of valuation. Perry’s statements to the Claims Commission indicate that the original contracts themselves resulted in losses rather than profits. Considering all the evidence, it does not convince us that the Mexican contracts had any value at March 1, 1913, substantial enough to affect the fair market value of the Standard Dredging Co. stock at that date.

At March 1, 1913, the operation of raising the grade of the city of Galveston, Texas, was under way. The city had been flooded in 1900 and thereafter sea walls had been built and the plan was to fill in sand back of the walls and raise the grade of the city. There were two deposits of sand available for this purpose. One was in Offatt’s Bayou. About 1906 Perry acquired approximately 250 acres in the bayou, which acreage was so located as to prevent the dredging of sand from any other part of the deposit for use in grade raising at Galveston. This 250-acre tract was turned over to the North American Dredging Co. of Texas upon its organization and, with other land, the total being about 407 acres, was listed as having a value of $100,000 in the certificate of incorporation. The other sand deposit was on Galveston Island, east of the city of Galveston. This land, comprising some 1,500 acres, was owned by Maco Stewart, who was Perry’s friend and business associate. Stewart, prior to March 1, 1913, had orally given Perry the exclusive right to remove sand from his acreage. Others attempted to secure from Stewart the privilege of dredging sand from his acreage, but he refused, saying that that had been promised to Perry. Pilling operations were started by a foreign company, but it was forced to discontinue prior to March 1, 1913, because of the lack of available sand. The contract for filling was taken over by the North American Dredging Co. of Texas in 1910, under an agreement whereby the North American Co. was to receive 18y2 cents per cubic yard of filling material. By reason of these deposits being privately owned they were exempt from the state tax imposed on the removal of material from public waters.

Petitioner claims a value of $5,300,000 for the sand deposits. This is based upon the dredging company’s claimed ownership or control of over 1,500 acres of sand deposits containing an estimated 53,000,-000 cubic yards of sand worth 10 cents per yard.

Perry’s testimony, by deposition, was that he or his companies owned 1,570 acres of sand deposit in Offatt’s Bayou. This was disproved, Stewart’s testimony being that there was not that much land in the bayou, and it was developed that the total amount owned by Perry or his companies in the bayou was 250 acres. The claim now is that by reason of Perry’s exclusive right to dredge from Stewart’s property the value of the sand deposit on the property should be treated as an asset of the Standard Dredging Co. There are several manifest weaknesses in petitioner’s claim to a value of $5,300,000. The testimony of two other witnesses on this subject, like that of Perry’s, was based on ownership of some 1,500 acres of sand deposit in Offatt’s Bayou. Perry’s conclusion of value was based in part on the notion that the dredging company received “ from 30 to 31 cents per cubic yard, sometimes more” for the fill at Galveston. The parties subsequently stipulated that under the contract of 1910 the company received 1814 cents per yard. Perry also testified that the net profits from filling operations in the vicinity of Galveston down to 1928 were $1,895,952.61. There is no segregation of this into amounts realized before and after March 1,1913, so we have no way of knowing whether the anticipated profits at March 1, 1913, have been realized. There is evidence that the dredging of sand from Offatt’s Bayou was started in 1906, and it is entirely possible that a substantial part of the profits were made between then and 1913.

It is obvious that the 1,500 or more acres of land owned by Stewarc can not be treated as dredging company land merely because of oral permission given to Perry to remove sand. This was a privilege that, as far as the record shows, Stewart could have terminated at any time. But even assuming an indefeasible right in the dredging company to remove sand, there is no showing of how much sand would be needed to complete the Galveston filling operations, nor is there any showing that the sand was of any value for any other purpose. For all we know, it is quite possible that only a fraction of the sand deposits would be necessary after March 1, 1913, in the filling operations then in view.

Considering all the evidence, we are not convinced that the dredging company’s sand deposits and its right to dredge from Stewart’s land had a value at March 1, 1913, in excess of $100,000. According to counsel for the respondent, in stating the issues, and not questioned by counsel for petitioner, the amount of $100,000 has been included by the respondent in tangible assets for the purpose of figuring the value of the stock.

Good will is claimed to have had a value of $1,500,000. The testimony of the witnesses ranged all the way from $1,000,000 to $5,000,-000 for the value of good will. Upon analysis, the testimony does not support the conclusions expressed. The only witness who explained his method of computation appears to have had in mind the value of all properties, tangible and intangible. The respondent in determining the value of the stock included good will as an element in the amount of $578,430.75. The evidence is not convincing that good will had any greater value.

The items which we have so far considered, being those to which the evidence was directed, are only some of the elements which, in the absence of sales of stock, usually go into a determination of stock value. The other elements are entirely missing except as some few are shown in the computation upon which the Commissioner based his determination. Net income is not shown except as it appears in returns placed in evidence by the respondent. These returns for the five calendar years 1909 to 1913, inclusive, show an average annual net income of a little over $49,000. The Commissioner used $142,-454.40 as “ average total earnings ” for the five years 1908 to 1912 in figuring good will. There is no evidence of either total assets or liabilities, consequently we do not know the amount of surplus except as shown by the respondent’s computation. This computation shows a deficit for each of the years 1908 and 1909, a surplus of $15,206.94 for 1910, $513,447.61 for 1911, and $576,135.99 for 1912; an average of $217,642 for the five-year period. We have indicated above that the evidence does not establish the value of the sand deposits as being greater than allowed by the respondent. We have also set forth our conclusion as to the value of the plant and equipment. Ordinarily proof of value of a particular asset, or even proof of value of all assets, without more, is insufficient to establish the market value of stock. But in this case it is shown that the respondent has based his computation of stock value on asset values, and neither party now questions that method. The petitioner’s evidence is directed entirely toward showing a higher value for the corporate assets, and the respondent’s is directed toward sustaining the valuation he has used. In this situation, where the taxpayer establishes an asset value higher than that used by the respondent, we feel warranted in holding that the increase shown should be added to the amount used by the respondent. In this case the increase, as set out above, is $715,900 applicable to plant and equipment. The evidence as to the other items being insufficient to convince us of error in the respondent’s determination, the other items will remain unchanged. Adding the increase of $715,900 to the value of $1,514,-062.16 used by respondent as net asset value, and dividing the sum by the number of shares of stock outstanding, gives a per share value of $6.20207. This figure should be used as the basis to determine gain on the sale of stock instead of the figure of $4.21098 used by the respondent.

Decision will be entered under Rule 50.


source: Caselaw Access Project

author: ARundell :

license: Public Domain

text:
    The Pennsylvania Company for Insurances on Lives and Granting Annuities, Executor and Trustee under the Will of Joseph G. Hendrickson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73029.
    Promulgated April 18, 1935.

      Frederick E. Spotts, Esq., for the petitioner.

      RoifN. McMillan, Esq., and W. H. Payne, Esq., for the respondent.
   opinion.

ARundell :

The respondent disallowed a claimed deduction for inheritance tax paid to the Commonwealth of Pennsylvania, and as the result of such disallowance he determined a deficiency in income tax for the year 1930 in the amount of $708.94. The parties have stipulated that the sole question for decision is whether or not the respondent erred in disallowing the claimed deduction.

The facts were stipulated at length; we summarize them briefly here. Joseph G. Hendrickson, a resident of Pennsylvania, died testate November 14, 1915. The petitioner became substituted executor and trustee under the will upon the death of the individual nominated in the will. By the terms of the will the decedent gave four fifteenths of his residuary estate to his executors in trust for the benefit of Addie C. Carpenter for and during the term of her natural life, with remainder over at her death. Addie C. Carpenter died May 9,1930. Under the provisions of the Pennsylvania Inheritance Act of June 20, 1919, P. L. 521, upon the death of Addie C. Carpenter there became due to the Commonwealth of Pennsylvania collateral inheritance tax at the rate of 5 percent upon the reappraised value of the estate passing to the remaindermen as of the date of death of the life tenant. On November 8, 1930, the petitioner, as trustee, paid such collateral inheritance tax in the sum of $20,-480.61, which was the tax due upon the transfer of the estate of the decedent passing to the remaindermen upon the death of Addie C. Carpenter. Such tax was not due and payable by the trustee until the death of the life tenant on May 9, 1930. In returning the net income of the estate for the calendar year 1930 the petitioner claimed as a deduction the $20,481.61 tax paid by it. The respondent disallowed the deduction so claimed.

The respondent’s disallowance of the claimed deduction is predicated on that part of section 23 (c) of the Eevenue Act of 1928 which provides that “ For the purpose of this subsection, estate, inheritance, legacy, and succession' taxes * * * shall be allowed as a deduction only to the estate.” His argument is that the phrase “the estate ” in the statute means “ the decedent’s estate properly speaking.” That includes, as we understand the argument, only estates administered by executors or administrators, and not those in the hands of testamentary trustees.

The same question was presented and decided in Junius Beebe, Trustee, 26 B. T. A. 190; affd., 67 Fed. (2d) 662. It is not claimed that any different decision is required by reason of the Beebe case originating in Massachusetts and this one in Pennsylvania. Nor is it claimed that there is any difference in facts between the two cases which would warrant a different conclusion. In the Beebe case we allowed the deduction claimed by the trustee, saying in part:

The word “ estate ” was used in a sense sufficiently broad to include any and all fiduciaries required by the laws of the state to respond in the payment of estate, legacy, inheritance or succession taxes, whether it be a trust estate or an estate presided over by executors and administrators, usually and commonly referred to as legal representatives.

In the absence of a showing for any reason for holding otherwise, we follow the decision in the Beebe case, and hold that the respondent erred in disallowing the deduction claimed.

Decision will be entered for the 'petitioner.


author: Turner:

text:
    Ida I. McKinney, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 45823.
    Promulgated April 18, 1935.

      Walter J. Garrie o, Esq., and James B. Bansley, O. P. A., for the petitioner.

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

Turner:

The first issue is disposed of by the last paragraph in our findings of fact, and a recomputation of tax, in so far as this issue is concerned, can be made under Rule 50.

The second issue presents a more difficult question. In 1927 the J ohneda Oil Co. made a distribution to the petitioner, its sole stockholder, in the sum of $165,519.20. She included $78,400 of this amount in her return. Whether it was returned as dividends subject to surtax only, or as ordinary gain subject to both surtax and normal tax, is not shown. The respondent, in his determination, treated $140,449.35 as dividends and the remaining $25,069.85 as having been paid from capital. The error assigned is that, the respondent failed to determine that of the total distribution the sum of $145,968.55 represented a distribution out of capital and is not taxable as dividends in the hands of the petitioner. That the remaining $19,550.65 should be taxed as dividends is not disputed.

The parties have agreed that the transfer by the petitioner of the oil and gas leases to the Johneda Oil Co. for all of its capital stock was a nontaxable transaction under section 203 (b) (4) of the Eevenue Act of 1924, and that the stock in her hands had a basis of $63,766.35. It is also agreed that under section 204 (a) (8) of the Revenue Act of 1926, the basis of the oil and gas leases, for the purpose of determining gain or loss to the corporation from the sale or other disposition of said leases, is $57,570.99, of which amount $28,776.38 is attributable to the lease on sections 22 and 23, Osage County.

The petitioner rests her case on the contention that, since the lease on sections 22 and 23, Osage County, had a fair market value of $247,500 on the date paid in for stock, such value represented the cost of the lease to the corporation and thereby constituted a part of the capital of the corporation, and, further, that allowances for the depletion and depreciation of such value, or capital, must be made in determining earnings and profits distributable as dividends, even though a different basis is required in computing the depreciation and depletion deductions to be used in determining the taxable net income of the corporation.

It is argued on behalf of the respondent that since $57,570.99 is to be used by the corporation as the basis for determining gain or loss from the sale or other disposition of the oil leases paid in for its stock, it is the basis for all purposes, including the computation of earnings and profits subject to distribution as dividends. Accordingly he has given no recognition, in his computation of the amount distributable by the Johneda Oil Co. as dividends, to the fact that the lease on sections 22 and 23, Osage County, had a fair market value of $247,500 on the date paid in for stock.

The pertinent provisions of the statute are to be found in section 201 of the Revenue Act of 1926, under the heading “ Distributions by Corporations.” The obvious purpose of this section is to provide for the taxation to corporate stockholders of all gains derived by them as distributions based on their stockholdings and to provide a complete plan whereby such gains, if not taxable as dividends, may be subjected to tax as ordinary gains. It is to be noted that subsection (a) defines the term “ dividend ” as “ any distribution made by a corporation to its shareholders * * * out of its earnings or profits ”, while subsection (b) provides that “ every distribution is made out of earnings or profits to the extent thereof.” Provision is then made in subsection (c) for the treatment of distributions in partial or complete liquidation, and, following that, subsection (d) prescribes the manner and extent to which distributions not in partial or complete liquidation, nor out of earnings or profits, are to be reported as income. A distribution falling within subdivision (d) must first be applied against the basis of the stock in the hands of the stockholders and the excess, if any, is taxable not as dividends but in the same manner as gain from the sale or exchange of property. It is on this provision of the statute and on the regulations thereunder that the petitioner relies.

While the statute, by section 201, swpra, limits the use of the term “ dividend ” to distributions made out of earnings or profits ”, it does not define or amplify the meaning of the term “ earnings or profits.” It is apparent, however, that since section 201 does make full and complete provision for the taxation to stockholders, either as dividends or- as ordinary income, of all gains received by them as the result of corporate distributions, there is no occasion to place a strained and unnatural construction on the meaning of the term “ earnings or profits ” of a corporation as used in that section. The petitioner claims that the logical and natural construction to be placed on that term in applying it to the distributions here involved is already contained in article 1546 of Regulations 69. If this article does cover the distributions in question and places a reasonable interpretation on the statute, the regulation is controlling and disposes of the case.

The article in question reads as follows:

Abt. 1546. Distributions from depletion or depreciation reserves. — A reserve set up out of gross income by a corporation and maintained for the purpose of making good any loss of capital assets on account of depletion or depreciation is not a part of surplus out of which ordinary dividends may be paid. A distribution made from a depletion or a depreciation reserve based upon the cost of the property will not be considered as having been paid out of earnings or profits, but the amount thereof shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent sale of the stock. If such a distribution is in excess of the basis, the excess shall be taxed as a gain from the sale or other disposition of the property. A distribution made from a depletion reserve based on the discovery value of a mine shall be similarly treated (by virtue of section 201 (d)), but a distribution from any other depletion reserve based upon discovery value, to the extent that such reserve represents the excess of the discovery value over cost or March 1, 1913, value, is, when received by the shareholders, taxable as an ordinary dividend. In the case of oil and gas wells the amount by which a corporation’s depletion allowance for any taxable year based upon the income from the property (see section 204 (c) (2) and article 221) exceeds a depletion allowance based on cost or value, constitutes a part of the corporation’s “earnings or profits accumulated after February 28, 1913,” within the meaning of section 201, and, upon distribution to shareholders, is taxable to them as a dividend. A distribution made from that portion of a depletion reserve based upon a valuation as of March 1, 1913, which is in excess of the depletion reserve based upon cost, will not be considered as having been paid out of earnings or profits, but the amount of the distribution shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent sale of the stock. No distribution, however, can be made from such a reserve until all the earnings or profits of the corporation have first been distributed.

In the above article it is stated that a “ distribution made from a depletion or a depreciation reserve based upon the dost of the property will not be considered as having been paid out of earnings or profits, but the amount thereof shall be applied against and reduce the cost or other basis of the stock on which declared.'1'’ Obviously the cost ” of property referred to is the cost to the corporation, and it is to be noted that the regulation specifies depletion reserves based on “ cost ” and not on “ cost or other basis.” This is particularly noticeable since in the same sentence it is provided that such distributions in the hands of the stockholders are to be applied against and reduce the “ cost or other basis of the stock ” upon which declared. If it had been intended by this regulation to treat all distributions made out of depletion reserve as being made out of earnings and profits, except those made out of depletion reserves used in determining taxable net income, it would have been a very simple matter to have inserted the words “ or other basis ” after the word “ cost ” as has been done later in the same sentence. As the article reads, however, it conveys to us a deliberate intention to construe the statute as meaning that “ earnings or profits ” distributable as dividends under the circumstances before us are to be computed on the basis of cost to the corporation of the property being depleted, and, in our opinion, such a construction of the statute is not only reasonable and proper, but is a logical as well as correct construction.

It is well settled that the cost to a corporation of the property acquired through the issuance of its capital stock is the fair market value of such capital stock on the date issued, and where all of the capital stock of a corporation is issued for property and there is no other method of measuring the fair market value of the stock so issued, such fair market value on that date may properly be determined to be the equivalent of the fair market value of the property received. Reliance Investment Co., 22 B. T. A. 1287; Mead Realty Co., 21 B. T. A. 1062; L. H. Philo Corporation, 16 B. T. A. 130; John Glackner Realty Corporation, 11 B. T. A. 151; Realty Sales Co., 10 B. T. A. 1217.

It has been stipulated that the fair market value of the lease on sections 22 and 23, Osage County, the property forming the basis for the controversy herein, was $247,500 on the date acquired by the Johneda Oil Co. for its stock, and, under the decisions cited, this value was the cost of the property to the corporation. Accordingly, a distribution made out of a depletion reserve based on such cost is not a dividend, but, under article 1546, supra, must first be applied against the basis of petitioner’s stock and, under subsection (d), supra, any excess is taxable as ordinary gain.

The respondent, in his brief, argues that article 1546 is not susceptible of the above construction, but that if it should be so held, it is contrary to the “ clear, explicit, and unambiguous provisions of the Revenue Act as enacted by Congress.” The brief is in itself vague and ambiguous as to the manner in which the regulation is declared to be contrary to the statute. The substance of the argument seems to be that the statute requires that “ earnings or profits ” of a corporation, as the term is used in section 201, supra, must be determined in the same manner and on the same basis as its taxable income. That the statute does not so provide is, in our opinion, well settled. See our discussion in Charles F. Ayer, 12 B. T. A. 284. Furthermore the respondent himself in computing the tax in this case has necessarily recognized a distinction between taxable net income and “ earnings or profits.” Under section 204 (c) (2) of the Revenue Act of 1926 the depletion deduction allowable to the Johneda Oil Co., in computing its taxable net income for the years 1925,1926, and 1927, is a percentage of the gross income from the property depleted, while the respondent has stipulated that he computed “ earnings or profits ” on an entirely different basis, namely, the basis which would have been applicable in determining gain or loss from a sale or other disposition of the leases. Section 201 (d) on its face distinguishes between “ earnings or profits ”, as used in subsection (a), and taxable net income by providing in its last sentence that distributions from depletion reserves based on the discovery value of mines should not be treated as having been paid out of “ earnings or profits ”, while in section 204 (c) (1) it is provided that the depletion deduction for determining net income shall be based on such discovery value.

That the application of article 1546 contended for by the petitioner does not do violence to the intent and meaning of the statute so as to make it invalid seems to be definitely conceded by a conclusion contained in the respondent’s brief, wherein it is stated that the construction asked for “would avail the petitioner nothing in view of the explicit requirement that any distribution in excess of the basis of the transferor is taxable to the distributee.” That statement and a further conclusion contained in the brief would seem to indicate that under the respondent’s theory of the case the result would be the same whether the distribution is out oí “ earnings or profits ” or is an admitted distribution out of capital. After reviewing various provisions of the Eevenue Acts of 1924 and 1926, the brief states:

It seems clear that the “gain or loss” spoken'of in Section 204 (a), supra, which must be determined on the same basis as it would be in the hands of the transferor (Section 204 (a) (8), supra) is a generic term and the word “gain” includes “earnings or profits” provided for in Section 201 (a), supra, which are taxable to the distributee if in excess of the basis of the trans-feror (Section 201 (d), supra).

We do not, of course, subscribe to the suggestion contained in the statement quoted, that the statute provides that dividends as defined in section 201 (a), supra, are taxable to the stockholder only if in excess of the basis for the stock, and even the petitioner has not gone that far. We merely recite the discussion contained in the respondent’s brief to show that nothing of substance has been offered to maintain the assertion that the provisions of article 1546 covering the question here involved give an unreasonable construction to the statute so as to justify a repudiation of the regulation, and we have already pointed out that, in our opinion, the regulation is reasonable and is a proper construction of the statute.

It is suggested that Commissioner v. Sansome, 60 Fed. (2d) 931, is most nearly in point and supports the respondent’s position here. The facts am so dissimilar that a detailed distinction of that case from the instant case seems unnecessary. In view of the fact, however, that the rule there laid down has been followed by us in a number of cases, Helen V. Crocker, 29 B. T. A. 773; George F. Baker, Jr., Executor, 28 B. T. A. 704; and W. Gibson Carey, Jr., 30 B. T. A. 572, it seems advisable to point out a few of the distinctions. The case here does not involve the reorganization of a corporation, as did the Sansome case, but deals with the organization of a corporation where no corporation existed before. In the San-some case the only change effected was a mechanical change. The successor corporation did not carry on a business of any kind and the rights of stockholders and creditors were in reality the same as before. While in this case we have a business actually conducted and carried on. The oil and gas leases were exploited and the oil reserves converted into the money which was distributed by the corporation to its stockholder. In the Sansome case the court said in substance that since by statute the corporate reorganization should not result in the realization of gain or loss, it was extremely unlikely that the transaction should be recognized as breaking “the continuity of the corporate life ” so as to change accumulated profits into capital. If, by reason of the fact that the transfer of the oil leases in this case for the stock of the Johneda Oil Co. was a nontaxable exchange under the statute, we should ignore the corporate entity and determine the petitioner’s profits as if the corporation did not exist, we would find a situation far different from that in the San-some case. The petitioner would still be required to report her gains as ordinary gains and not as dividends. She would further be permitted to deduct- from gross income a depletion allowance based upon a percentage of the income from the property and would very likely have a much smaller taxable net income than under our holding that the distributions here in question fall within the provisions of section 201 (d), supra. We see no justification in the law or the facts for applying here the rule laid down in the Sansome case.

It is not apparent from the record whether we have before us sufficient facts for computing the correct amount of the deficiency under Bule 50. Neither party has given us any statement of the financial condition of the Johneda Oil Co. at the time the distributions were made, and, so far as the record is concerned, the leases other than that on sections 22 and 23, Osage County, might have yielded sufficient earnings or profits to pay a dividend in the full amount of the distribution made by the corporation during the taxable year. Neither do we know whether the petitioner’s stock basis has previously been reduced by similar distributions made in prior years. The respondent has not suggested or argued these points, however, and we have considered and decided that question as it was presented.

Beviewed by the Board.

Decision will be entered wnder Bule 50.

       Sec. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such cor-poratlon, and immediately after the exchange such person or persons are in control of the corporation; hut in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

       Seo. 204. (a) (8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be In the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.

       Sec. 201. (a) The term “ dividend ” when used in this title (except in paragraph (9) of subdivision (a) of section 234 and paragraph (4) of subdivision (a) of section 245) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.
      (b) For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. * * *
      *******
      (d) If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1. 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 204, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale rr exchange of property. The provisions of this paragraph shall also apply to distributions from depletion reserves based on the discovery value of mines.


author: Smith:

text:
    William R. Scharton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 66939.
    Promulgated April 18, 1935.

      Maurice Palais, Esq., for the petitioner.

      F. B. Schearer, Esq., for the respondent.
   OPINION.

Smith:

At the hearing of this proceeding the petitioner made three contentions which are not specifically made in the petition, viz:

(a) That the assessment and collection oí deficiencies in income tax for 1926 and 1927 was barred by the statute of limitations;
(b) That the Board is precluded from redetermining the liabilities therein by reason of the fact that the petitioner was indicted for having filed false and fraudulent income tax returns for 1926 and 1927, which indictment was quashed by the District Court of Massachusetts, whose judgment was affirmed in United States v. Scharton, 285 U. S. 518; and
(e) That liabilities for deficiencies and penalties for 1926 and 1927 have been discharged by reason of the fact that he and the respondent “ had an accord and satisfaction by the acceptance” by the respondent of the sum of $8,692.10 in September, 1931, in full settlement of all claims against the petitioner relating to income taxes and penalties due for those years.

1. To meet the claim of the petitioner that the deficiencies for 1926 and 1927 are not barred by the statute of limitations, the respondent has submitted in evidence a series of waivers, all executed by the petitioner, extending the statute of limitations to December 31, 1932. Prior to that date and on July 11, 1932, the petition in this proceeding was filed. It should be noted, however, that the bar of the statute of limitations does not run against false and fraudulent returns. Section 278 of the Revenue Act of 1926.

2. The present proceeding relates to deficiencies in income tax for 1926 and 1927 and to penalties imposed by section 275 (b) of the Revenue Act of 1926, which provides:

If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended

It is the petitioner’s contention that the quashing of the indictment in the criminal proceeding, United States v. Scharton, supra, is a bar to the imposition of the penalties provided for in section 275 (b) of the statute.

The penalties provided by section 275 (b) are civil and not criminal penalties. They are aids in collecting revenue. Ely & Walker Dry Goods Co. v. United States, 34 Fed. (2d) 429; Thomas J. McLaughlin, 29 B. T. A. 247; Henry S. Kerbaugh, 29 B. T. A. 1014; McDowell v. Heiner, 9 Fed. (2d) 120; affd., 15 Fed. (2d) 1015; certiorari denied, 273 U. S. 759. See also United States v. Stowell, 133 U. S. 1; Louis Ginsburg, 13 B. T. A. 417; Taylor v. United States, 3 How. 197; Murphy v. United States, 272 U. S. 630. The question for decision herein not being the same as that involved in the criminal case, no estoppel by judgment arises. Tait v. Western Maryland Rwy. Co., 289 U. S. 620; Cromwell v. County of Sac, 94 U. S. 351; Hanby v. Commissioner, 67 Fed. (2d) 125.

Even if the quashing of the indictment in the criminal proceeding might be said to be a judgment of acquittal, it is not res judicata in this proceeding. It is not even admissible as evidence of the truth or falsity of the fapts decided in the prior proceeding. See Coffey v. United States, 116 U. S. 436; Stone v. United States, 167 U. S. 178; 34 Corpus Juris 971; 15 Ruling Case Law 1000-1003, and cases cited.

The contention upon this point is not sustained.

3. The contention of the petitioner that liabilities for deficiencies and penalties for 1926 and 1927 have been discharged because he and the respondent “ had an accord and satisfaction by the acceptance ” by the respondent of an amount offered in compromise is without merit. The proof shows that the offers in compromise were rejected by the respondent. There was no acceptance of those offers. Hence, there was no “ accord and satisfaction ” of the tax deficiencies and penalties. The contention of the petitioner upon this point is not sustained.

4. From his gross income for 1926, the petitioner omitted $50,000 debenture stock of E. I. duPont de Nemours & Co. received in part payment of a fee from Annie Eogers duPont, and also $16,000 of the $36,000 cash fees received from the same individual.

The proof shows that the petitioner called to the attention of David Lasker, the attorney employed by him to make out his income tax return for 1926, the receipt of the duPont stock. Lasker thought the amount should be included in the petitioner’s gross income. He desired, however, to secure the advice of his associate, Julius Nelson, a more experienced attorney in income tax law. The petitioner and Lasker both went to Nelson’s office and discussed with him whether the value of such stock should be included in the petitioner’s gross income for 1926. With regard to this conference Nelson testified as follows:

Q Well, tell us what the facts are. Will you state them, as you recall it?
A I remember the original settlement and the amount of the settlement and the amount of money that you got, and subsequently the turning over to you of certain bonds, and the request of Mrs. duPont that you hold those bonds and try to obtain the fee from Mr. duPont, which you agreed to try to do.
Q Was there anything said in relation to whether or not those $50,000 worth of bonds received by the petitioner were to be included in the return as income for that year?
A As I knew the facts, and as you asked me the question, my advice to you was that it wasn’t obliged to be returned for that year.
Q And what reasons did you assign for your advice, if any?
A My reasons for that were that it wasn’t received by you in payment. You were to hold those bonds in escrow and attempt to get from Mr. William duPont your fee; and as good faith on her part, to show that she wasn’t reneging, those bonds were given to you with the express purpose, to you, to hold them until such time as you had exhausted your ability to get the money from Mr. duPont, she having assured you, and you assuring me, there wouldn’t be much question but that you could obtain that fee from him.
By the way, my opinion has not changed, either, in 1934; I don’t think it was returnable income.

The evidence shows that the facts with respect to the receipt of this stock were misrepresented to Nelson by the petitioner. In December 1925 or January 1926 the petitioner sent a bill to Annie Eogers duPont for his fee of $180,000. She had hoped that she would be able to persuade her husband to pay at least a part of this bill. Not later than January 1926 Mrs. duPont wrote the petitioner in part as follows:

I received your letter and bill today. Unfortunately Mr. duPont will not, at present at any rate, help me pay it. Would it be satisfactory if I sent you at once $50,000 duPont bonds, 6 per cent, and pay the remainder out of my allowance by degrees, $4,000 a quarter until the remaining $130,000 are paid?

Subsequent thereto and in January 1926, Mrs. duPont sent the peti- ■ tioner her personal check for $20,000 and certificate Nos. H 9160-4 for 500 shares of E. I. duPont deNemours & Co. debenture stock. The petitioner immediately had the stock registered in his name and thereafter received the dividends thereon.

The petitioner then sent a contract regarding his fee to Mrs. duPont, then in London, for her signature, which reads as follows:

Whereas, William R. Seharton, my attorney, was successful in procuring for me a settlement in re duPont v. du Pont, t>y a trust agreement dated January 2, 1926, whereby I have received two hundred thousand ($200,000) dollars in cash and a trust fund of eight thousand ($8,000) dollars annually in quarterly payments. I, Annie Rogers duPont, do hereby agree to pay to the said William R. Seharton, my attorney, for legal services rendered for me in the above matter, the sum of one hundred and eighty thousand ($180,000) dollars, payable in the following manner-, twenty thousand ($20,000) dollars by check dated January 13, 1926, and five hundred (500) shares of Debenture Stock, Certificates Nos. H 9160-4, in the amount of fifty thousand ($50,000) dollars, and the balance of one hundred and ten thousand ($110,000) dollars to be paid at the rate of four thousand ($4,000) dollars quarterly until the full sum of one hundred and ten thousand ($110,000) dollars and interest is paid, the first payment of four thousand ($4,000) dollars to be made on or before March 25, 1926, and a like payment of four thousand ($4,000) dollars on the fifteenth day of every quarter thereafter.

It is further agreed between the said William R. Seharton and myself that I have the right to pay the balance in a lump sum at any time which I wish or am able to do so.

On February 14, 1926, Mrs. duPont wrote the petitioner from London in part that “I enclose the papers you sent me signed.” Mrs. duPont died in January 1927. On June 28, 1927, the petitioner sent a bill to the estate of Annie Rogers duPont for his fee of $180,000 in which he gave credit for having received on account cash, $36,000, and debenture stock, $50,000. The balance shown to be due was $94,000, plus interest from December 24, 1925.

At the time the petitioner had his conference with Nelson in the spring of 1927, Mrs. duPont was dead. He knew at that time that there was no ground for any claim that Mrs. duPont would ever redeem the stock. Furthermore, the correspondence had with Mrs. duPont by the petitioner shows that the debenture stock was received by the petitioner in part payment of the $180,000 fee owed by Mrs. duPont.

Clearly the value of the duPont stock received by the petitioner constituted a part of the petitioner’s gross income for either 1926 or 1927. Crowell v. Commissioner, 62 Fed. (2d) 51; Olsen v. Commissioner, 67 Fed. (2d) 726. It was not returned as a part of petitioner’s income for 1927 and the petitioner filed no amended return for 1926 including the stock as income for that year. When asked why the value of the stock was not included in gross income for 1927, the petitioner replied that he thought he was not required to include it in income until he sold it. This testimony is not believed.

In view of the fact that the petitioner never reported the receipt of the stock as income and in view of the proof that the stock was received by the petitioner in part payment of his fee in 1926, we are of the opinion that the petitioner’s income tax return for 1926 was false and fraudulent and filed with intent to evade tax within the meaning of section 275 (b) of the Eevenue Act of 1926.

In part payment of his $180,000 fee charged Mrs. duPont, the petitioner in 1926 received cash in the amount of $36,000. Of this amount he included in gross income in his income tax return only $20,000. His reason for not including the balance was that he had an understanding with George Zinn, Mrs. duPont’s son, that he would pay him a percentage of his fee in consideration of services rendered by Zinn in securing petitioner’s employment by his mother. The testimony upon this point is confusing. The petitioner was much in the company of Zinn. He stated that his oral agreement with Zinn was to pay him 50 percent of the fee received from his mother, and pursuant to this agreement he did pay him $10,000 out of the first $20,000 cash received. Petitioner then testified that he made an arrangement with Zinn that Zinn should receive only 25 percent of each additional cash payment, and that pursuant to that agreement he paid him $1,500 out of each $4,000 installment received. This made $16,000 the total payments to Zinn during 1926.

The petitioner also testified that it was his expectation originally that he could secure for Annie Eogers duPont a trust fund of $5,000,-000, in which event Zinn would be well provided for by his mother; that when he found he could obtain for his client a trust fund of only $1,800,000, he felt under some obligation to Zinn and it was for that reason that he agreed to pay Zinn a portion of the cash fees received from Mrs. duPont.

From a consideration of all the evidence upon this point it is somewhat doubtful whether the $16,000 paid to Zinn represented anything more than gratuities. Zinn was not an attorney and the evidence does not show what the nature of the services, if any, rendered by Zinn to the petitioner were. At any rate we are satisfied that they were not ordinary and necessary expenses incurred in the carrying on of the petitioner’s trade or business, and hence are not deductible from gross income. Cf. Welch v. Helvering, 290 U. S. 111.

The petitioner claims the right to deduct from gross income of 1926 numerous small items which he claims were not deducted on the original return or allowed as deductions by the respondent in the determination of the tax deficiency. Among these are amounts paid to Julius Nelson. The petitioner was of the opinion that such payments to Nelson were for services rendered. But Nelson testified that the petitioner was in error in making such a claim; that they represented repayments of loans made by Nelson to the petitioner or else represented moneys paid to Nelson to be paid over to other persons in settlement of claims made by such other persons against the petitioner, the nature of which is not in evidence.

Among them also was a payment of $1,000 to James Saulsbury, an attorney of Wilmington, Delaware. This amount was not claimed as a deduction on the original return or allowed by the respondent in the determination of the deficiency. The contention of the petitioner is sustained. The proof shows that this amount was paid for services and was a proper charge against fees received in 1926.

The petitioner’s claims for further deductions from gross income are not sustained.

From a consideration of all of the evidence relating to the petitioner’s income tax return for 1926, we sustain the respondent’s determination that the return was false and fraudulent and filed with an intent to evade tax.

5. The petitioner’s income tax return for 1927 was prepared by Joseph S. Luther, a certified public accountant. The work sheets used by Luther, which were introduced in evidence, show the manner in which he, under the direction of the petitioner, prepared the return. The petitioner told Luther that he had received two fees in 1927 as follows:

Cash from estate of Annie Rogers duPont-$90,000
Pees from Zinn case_ 20, 000
Total_110,000

A preliminary work sheet indicates that the petitioner also declared the receipt of fees from various sources totaling $5,400. But Luther determined gross income of $72,500 by deducting from $110,000, $37,500. The petitioner testified that he did not know why this deduction was made; Luther testified that he was informed by the petitioner that that represented a portion of his fees received by others. The petitioner did not advise Luther of the receipt in 1927 of a fee of $28,000 from the settlement of the Whipple-Searles case.

The petitioner claims that his reason for not including in his gross income for 1927 the amount of $28,000 received upon the settlement of the Whipple-Searles case is that his brother, Victor, claimed that he was entitled to a part of it. The petitioner’s brother was not an attorney, but was employed by the petitioner in his office at a salary of $50 per week. The basis of the claim of Victor to a share of the $28,000 fee is not disclosed by the evidence. After the correctness of earlier returns had been called in question by the respondent, the petitioner returned, for 1929, $23,000 of the $28,000 received in 1927 from the settlement of the Whipple-Searles case. The petitioner testified that his brother’s claim to a part of the fee was settled in 1929 by the petitioner paying $5,000 to Victor.

The evidence shows the receipt of gross fees by the petitioner in 1927 of $156,175. There is no color of excuse for the petitioner not having returned that amount. Not only is there no excuse for not having returned the fee of $28,000 received on the settlement of the Whipple-Searles case, but there is no excuse for having reported to Luther that $37,500 of the $110,000 declared was received by others.

Out of the $30,750 fee received in the Zinn case, $10,000 was paid to George W. Lilly for services performed in connection with the settlement of petitioner’s claim against the estate of Annie Rogers duPont. In reality the $10,000 fee to Lilly was a charge against the $90,000 received from the duPont estate and not a charge against the petitioner’s fee from the Zinn case.

In addition to the deductions allowed by the respondent in the determination of the deficiency, the Board has found from the evidence that the petitioner is entitled to the deduction of $14,500 representing amounts paid to attorneys in Wilmington, Delaware, in connection with the settlement of cases there from which he received his fees in the duPont estate and in the Zinn case.

In addition to the deductions from the gross income of 1927 herein allowed the petitioner in the amount of $54,371.34, the petitioner claims the deduction of certain other items, one of $10,400 representing a loan to Galbo & Co. in 1920 or 1921. The deduction of this item was not claimed on the petitioner’s income tax return. The evidence shows that the account was proved to be worthless long prior to 1927. The petitioner contends, however, that, in view of the fact that the statute of limitations had not run against the notes which he held until 1927, he is entitled to deduct the amount from gross income. The pertinent provision of the statute, however, permits the deduction from gross income of “ debts ascertained to be worthless and charged off within the taxable year.” Sec. 214 (a) (7), Revenue Act of 1926. Since the $10,400 item in question was not claimed as a deduction from gross income in the income tax return filed for 1927, and since there is no evidence that it was charged off by the petitioner in 1927, the petitioner’s claim in respect thereof is not sustained.

The petitioner also claims the deduction of numerous small items which he paid out in 1927. We cannot, however, determine from the record that such amounts were not claimed as deductions in the petitioner’s income tax return for 1927 for which he was given credit in the computation of the deficiency. Such claims are, therefore, not sustained.

From the foregoing it is apparent that the petitioner’s income tax return for 1927 grossly understated the amount of both his gross income and his net income. The petitioner did not file an amended return to show the true amount of his net income. The $28,000 fee received in 1927 from the Whipple-Searles case was not accounted for except in the 1929 income tax return. But this was not until after the correctness of his returns for prior years had been questioned by the respondent’s agents.

The petitioner kept no books of account or records from which his returns could be readily verified. It was only after painstaking and costly investigations that the respondent discovered the undisclosed income.

It is inconceivable that the petitioner did not know that his returns for both 1926 and 1927 were false when he filed them. They grossly understated both gross and net incomes and the taxes paid thereon were only small fractions of the amounts legally due. The only conclusion that can reasonably be drawn from the facts proved is that the false returns were filed with an intent to evade tax. The determination of the respondent that the 50 percent addition to the deficiencies provided for by section 275 (b) of the Revenue Act of 1926 is due from the petitioner in respect of deficiencies for 1926 and 1927 is sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: McMahon: Murdock, Leech:

text:
    Theodore C. Jackson and W. R. Gallagher, Administrators of the Estate of Charles B. Maxwell, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57026.
    Promulgated April 23, 1935.

      R. P. Smith, Esq., and Harold Boulton, Esq., for the petitioners.

      Bean P. Kimball, Esq., and E. O. Adams, Esq., for the respondent.
   OPINION.

McMahon:

We are asked by petitioners to hold that Maxwell made a valid and completed gift of certain stock to his nieces prior to the sale thereof, with the result that the profit realized on the sale was income of the donees and not income of the donor, Maxwell. The amount of profit realized from the sale is not in dispute, only the question of ownership of the profits. If the stock belonged to Maxwell at the date of sale, respondent’s determination is correct, but if Maxwell made a valid and completed gift of the stock prior to the sale thereof, so as to entirely divest himself of ownership, control, and dominion over the stock, then the profits constituted income to Maxwell’s nieces, Dollie and Josephine Stine.

In Adolph Weil, 31 B. T. A. 899, the Board set forth the essential elements of a bona fide gift inter vivos, as follows:

* * .* (1) a donor competent to make the gift; (2) a donee capable of taking the gift; (3) a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti; (4) the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that the donor can exercise no further act of dominion or control over it; (5) a delivery by the donor to the donee of the subject of the gift or of the most effectual means of commanding the dominion of it; (6) acceptance of the gift by the donee; Edson v. Lucas, 40 Fed. (2d) 398, and authorities there eited. Cf. Allen-West Commission Co. v. Grumbles (C. C. A., 8th Cir.), 129 Fed. 287; Edwin J. Marshall, 19 B. T. A. 1260; affd. (C. C. A., 6th Cir.), 67 Fed. (2d) 663, certiorari denied, 282 U. S. 61.

We find the same essential elements required for a valid gift inter vivos under decisions of the Pennsylvania courts. Packer v. Clemson, 112 Atl. 107; In re Kaufman's Estate, 127 Atl. 133; In re Scanlon’s Estate, 169 Atl. 106; Sullivan v. Hess, 241 Pa. 407; 88 Atl. 544. See also Cook v. Lum, 55 N. J. L. 373; 26 Atl. 803; Bauernschmidt v. Bauernschmidt, 97 Md. 35; 54 Atl. 637, which quotes from Walsh’s Appeal, 122 Pa. 177; 15 Atl. 470.

In the last analysis the determination of the issue herein depends upon whether petitioner has established elements (3) and (4) set forth in the above quotation from the Weil case. These essentials are a clear and unmistakable intention on the part of Maxwell to absolutely and irrevocably divest himself of the title, dominion, and control of the stock, in praesenti, and the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the Stine sisters, so that Maxwell could exercise no further act of dominion or control over it.

We must first determine whether there was an intent to give. The evidence in this record fails to show a clear and umnistakable intention on the part of Maxwell to absolutely and irrevocably divest himself of the title, dominion, and control of this stock. The formal transfers of the stock on the books of the corporation, under all the facts and circumstances, were insufficient to establish a donative intent. In re Raub’s Estate, 286 Pa. 575; 134 Atl. 451; Southern Industrial Institute v. Marsh, 15 Fed. (2d) 347; certiorari denied, 273 U. S. 747; In re Crawford, 21 N. E. 692. The burden of proving an intention to make a gift is upon the petitioners, McConville v. Ingham, 268 Pa. 507; 112 Atl. 85, and it must be coupled with, delivery, which is the manual act that executes the purpose originally formed. However, since the quantum of evidence necessary to establish a gift is less where a relationship such as that of parent and child exists, Northern Trust Co. v. Huber, 274 Pa. 329; 118 Atl. 217; Yeager's Estate, 273 Pa. 359; 117 Atl. 67, we must determine whether the evidence here is sufficient to establish such intent.

Transfer and delivery of property, including corporate stock, are not conclusive upon the question of intent where change of title is involved from the standpoint of taxation; and surrounding circumstances, including subsequent acts of the taxpayer, often establish intent more clearly than parol evidence. Wishon-Watson Co. v. Commissioner, 66 Fed. (2d) 52, and Commissioner v. Dyer, 74 Fed. (2d) 685. See In re Raub's Estate, supra.

The record contains no expressions by Maxwell to friends or his nieces showing an intent at the time of the transfer to make an outright gift to his nieces of this stock. Josephine Stine testified that her uncle told her several times that she<“ would be well taken care of ”, but we can not interpret this testimony to mean a specific intent on the part of Maxwell to give each of his nieces 1,000 shares of stock outright on or about March 30, 1928.

In our view the proof establishes the absence of any such intent. It indicates that Maxwell was motivated otherwise in formally transferring the stock. Based on respondent’s determination, Maxwell’s net taxable income for 1928 would be increased over $62,000 by the sale of these 2,000 shares of stock, but if transferred to his nieces, and the sale was consummated with them as stockholders of record, the taxable profits from his total holdings of the company’s stock might be split three ways. Maxwell was a banker, presumably conversant with the income tax laws and aware of the surtax provisions thereof. It was to his interest to eliminate profits from this sale for tax purposes. An apparent sale by his nieces would still give him control over the proceeds, because he controlled and dominated them.

Furthermore, the proof is open to the inference that these purported gifts, although formally transferred on the corporate books, were merely devices to reduce the amount of Maxwell’s tax liability. See Liberty Service Corporation, 28 B. T. A. 1067; affirmed in Liberty Service Corporation v. Commissioner, 77 Fed. (2d) 94, which deals with the sale of similar stock owned by the Liberty Service Corporation; and also Gregory v. Helvering, 293 U. S. 465.

Our attention has not been called to a case which holds that a formal transfer on the books of a corporation is sufficient, in and of itself, to establish an intent to make a gift inter vivos, under facts and circumstances such as are present in the instant proceeding; and we are unwilling to so hold. Yet, that is the principal basis upon which petitioners rest their case.

Secondly, while it is clear that Maxwell formally transferred legal title to the stock, nevertheless, he continued to exercise control and dominion over the stock after the transfer, and over the proceeds after the sale. His actions at the time of the alleged gift are entirely inconsistent with the usual actions of a benefactor toward the recipients of his bounty. Maxwell failed to tell his nieces at any time that he had made a gift of stock to them. There is no evidence that he told his business associates of the gift. He did not let his nieces see the certificates of stock which stood in their names on the books of the corporation, nor did he turn the certificates over to them. When he requested Dollie Stine to sign a paper for him, he offered no explanation and made no other comment; all she knew about what she signed was that it was a little piece of white paper. That was the first intimation to Dollie Stine of the transfer. Josephine Stine denied all knowledge of ever signing the power of attorney. Again, when Maxwell came to Dollie Stine to withdraw the proceeds of the sale, he had an opportunity to tell her of his gift, but he made no disclosure. He requested her to sign two checks for large amounts in favor of payees he named without explaining his reasons therefor. That she did this without question, although her bank account had rarely been above $100, only serves to emphasize how completely she was controlled and dominated by her uncle and how willing she was to obey him. Throughout this whole transaction we find the Stine sisters obeying the requests of their uncle and acting as he directed. It would be unsound to hold, under these circumstances, that Maxwell ever irrevocably relinquished control and dominion over these 2,000 shares' of stock. J. L. McInerney, 29 B. T. A. 1.

The record shows that Maxwell executed two trust deeds, one for each of his nieces, transferring to the trustee therein named, the Moshannon National Bank, certain securities that he had purchased. It appears from the separate verified bills of complaint in equity, in which are incorporated copies of the trust agreements, filed against Moshannon National Bank and others by the Stine sisters, that such trusts were created and that the ultimate proceeds from the sales of the stock were used to purchase the securities which Maxwell placed in trust. These bills of complaint, hereinafter referred to, were offered in evidence by the petitioners and without objection. In our opinion, Maxwell could not create trusts in favor of his nieces out of funds that already belonged to them. By the very terms of the trust instruments Maxwell declared that, “I * * * do hereby give, assign and transfer * * This declaration is entirely inconsistent with the theory of a prior complete and irrevocable relinquishment of dominion and control over the stock or the proceeds thereof.

Furthermore, it may be pointed out that when Maxwell died in September 1928, he had in his possession, so far as the evidence shows, more than $16,000 of the $51,380 check signed by Josephine Stine, and $1,330 of the proceeds of the checks signed by Dollie Stine.

The foregoing discussion discloses that Maxwell had no clear and unmistakable intention to make a gift, and it establishes further that there was no irrevocable transfer of the dominion and control over the stock to the donees, so that the donor could exercise no further act of dominion or control over it. Since these two essential elements of a valid gift inter vivos are missing, we can not make a finding of fact or hold that decedent made a valid and completed gift to his nieces of the stock in question.

In this view, we deem it unnecessary to consider the other essential elements of a valid gift.

We have not overlooked Fidelity-Philadelphia Trust Co., Executor, 16 B. T. A. 1214; J. M. Walsh, 18 B. T. A. 571; D. B. Malernee, 31 B. T. A. 662; and J. M. Kessler, 31 B. T. A. 849. Kessler announced to a third party that he was going to make a gift to his wife and advised her of the gift by letter. She acknowledged the gift. It was agreed between them that he was to look after her interests for her. He endorsed the certificate of interest and delivered it to a fourth party with instructions that it be held for the benefit of his wife, directed that the note derived from the sale of the subject of the gift be made payable to her, and deposited in a bank to her account the proceeds derived from the payment of the note. There was no countervailing evidence upon the subject of delivery of possession and surrender of dominion. The only question presented was whether he made a gift of his interest before the sale or a gift of the proceeds after the sale; and we merely held that a gift of his interest was made before the sale. As appears from our findings, the facts and circumstances in the instant proceeding are quite different. The other three cases are even more readily distinguishable.

Petitioners cite the Uniform Stock Transfer Act adopted by Pennsylvania as of January 1, 1912, Pa. Stat. 1920, secs. 5700-5723, and In re Connell's Estate, 282 Pa. 561; 128 Atl. 503, which interprets the same. The court there held that the provisions of this act, which prescribe that title shall pass by endorsement as of the time of registration of the transfer, cannot affect the rights of the parties, as between themselves, because such provisions were evidently inserted for the protection of the corporation itself, so it could safely deal with the registered owner of stock in dividend and other matters. This case and the act are of no assistance in determining whether, as between the parties, there was a gift of the stock. See In re Raubs' Estate, supra. Cf. Packer v. Clemson, supra.

Petitioners lay stress upon the allegations contained in separate bills of complaint in equity brought by Dollie Stine and Josephine Stine against the Moshannan National Bank wherein it is alleged by each complainant, verified under oath, that she became the owner, by gift, on or about April 2, 1928, of 1,000 shares of the common capital stock of the company. The bills of complaint were brought to reform the trusts created by Maxwell in favor of the Stine sisters and by a consent decree in compromise of their claims both trusts were reformed. The question of whether 1,000 shares of the company’s stock was given by Maxwell to each of his nieces was not in issue. The allegation of ownership by gift was a conclusion of law; the facts upon which this allegation was based were not pleaded or tried. It is elementary that allegations contained in pleadings are not, in a situation like this, proof of the conclusions alleged. Petitioners assert that such statements are admissions against interest; but the Stine sisters are not parties litigant herein. They were called as witnesses and such allegations could only be used for purposes of impeaching their testimony because of prior contradictory statements. Furthermore, the Stine sisters explained their prior allegations by stating that they alleged ownership of the stock because it stood in their names on the books of the corporation. It appears that the pleadings were prepared by counsel and signed by each of the Stine sisters upon his advice and in reliance thereon. In view of these explanations, the nature of the pleadings, and the settlement of the suits by consent, we are unwilling to attach as much weight to this evidence as petitioners contend for, or hold that they have been thereby impeached as witnesses.

At the hearing petitioners introduced a copy of a petition filed by Josephine Stine’s guardian in the Orphans’ Court of Clearfield County, wherein her guardian made certain allegations relative to her banking relations, her rights under an insurance trust, and her rights under the $85,000 trust created by Maxwell for her. The guardian asked the court to authorize the acceptance of an offer in compromise of her claims from the administrators of Maxwell’s estate, payment of which would relieve the Moshannon National Bank and the estate from any further liability to Josephine Stine. The court approved acceptance of the offer by the guardian, so that the allegations contained in the petition were never settled by court decision, but were disposed of by the compromise settlement. Josephine Stine never signed or verified the petition, or other papers, in that proceeding, and she has not been impeached, as a witness, by them in the instant proceeding.

It may not be amiss to point out that in Edgar M. Carnrick, 21 B. T. A. 12, we stated:

* * * Irrespective of what may be the force and effect in proceedings before the Board of Judgments of State courts upon matters of fact after a contest, cf. Charles L. Suhr, 4 B. T. A. 1198; Guaranty State Bank, 12 B. T. A. 543, there is no doubt that a formal settlement of an executor’s uncontested account is not, as against the respondent here, res adjudicata of the inventory or its valuation, nor does it alone establish a prima facie case of their correctness. [Emphasis supplied.]

To similar effect, in principle, is Fidelity & Columbia Trust Co. v. Lucas, 52 Fed. (2d) 298; reversed on other grounds at 66 Fed. (2d) 116. Cf. Edward T. Blair, 31 B. T. A. 1192.

Reviewed by the Board.

Decision will Toe entered under Rule 50.

Murdock,

concurring: I concur in the results reached in this case and in the closely related cases of Dollie M. Stine and M. Josephine Stine, 32 B. T. A. 482. If the cases were considered together, as I think they should be, instead of separately, the correctness of the results would be even more apparent.

Leech:

I agree with the foregoing comment. However, in my judgment, the result reached in the majority opinion is correct — not for the reason which, among others, that opinion indicates, Maxwell could not have accomplished a completed gift of the stock to the Stine sisters since they were under his personal domination — but is correct only because he did not here intend a gift. This record apparently establishes, at least by implication, that the Stine sisters were merely agents for Maxwell in the sale of the stock upon which the disputed deficiency arises. Thus, the estate of Maxwell, the principal, was the taxable recipient of the proceeds of that sale.

Smith and Sea well agree with the above.