author:
Murdock :
      Disney,

text:
    John O. Fowler and Lena S. Fowler, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91162.
    Promulgated December 27, 1939.

      Albert W. Taber, Esq., and Robert N. Chambliss, Esq., for the petitioners.

      Stanley B. Anderson, Esq., for the respondent.
   OPINION.

Murdock :

The determination and contention of the respondent that the loss in this case is a capital loss and the deduction therefor limited to $2,000, is rejected on authority of Commissioner v. Freihofer, 102 Fed. (2d) 787; Lloyd Jones, 39 B. T. A. 531; Sherwin A. Hill, Administrator, 40 B. T. A. 376. Thus the petitioners have sustained the burden of proof and are entitled to a favorable decision on the only issue submitted for decision up to and including the moment when all of the evidence in the case had been submitted and the petitioners rested.

Counsel for the respondent asked leave of the Board, after all of the evidence was in, “to file an amended answer to conform to the proof”, stating “It is now the respondent’s position that the petitioner has failed by the evidence to prove any cost basis whatsoever, and * * * the claimed loss should be eliminated entirely.” Permission to file the amended answer was granted with the understanding that the petitioners denied any allegations to be made in the amended answer. An amended answer was filed in which it was alleged that the petitioners had deducted a loss of $17,996.06 of which the respondent had allowed $2,000 and “the said sum of $2,000 was erroneously allowed as a deduction in computing net income for the year 1935 for the reason that petitioner has failed to prove the cost basis of the real estate in question.” The respondent made claim for the increased deficiency which would result. The Board’s rules require that the answer shall contain a statement of any facts upon which the Commissioner relies for affirmative relief. The Commissioner also has the burden of proof to establish facts to support any claim for affirmative relief. He has not in this case made any allegations to show what the cost of the property to these petitioners was or that it was less than $80,800, as shown in the return. Obviously, the Commissioner can not profit by a motion to amend his answer to conform to the proof, which proof he contends is a failure of proof on the part of his adversary to prove a fact which was not in issue up to that time.

A further answer to this contention of the respondent is that the evidence shows with reasonable certainty under the circumstances that the fair market value of the stock given by these petitioners in exchange for the property was at least $80,800. The petitioners do not claim a loss based upon any greater basis. The opening price for the stock on the New York Curb Exchange in the spring of 1929 was $28.50 a share. Both John O. Fowler and J. G. Sterchi, the person from whom the real estate was purchased, were familiar with the corporation Sterchi Brothers Stores, Inc. They agreed in their negotiations leading up to the exchange that the stock had a value of $20 a share and would pass in the exchange at that value. It is also clear that the value of the real estate at that time was at least $80,800. The fact that an exchange took place under these circumstances is some evidence that the value of the stock and the value of the real estate were about the same. The petitioner had additional shares of the stock which is also some indication that the parties, after bargaining at arm’s length, must have thought that 4,400 shares were about equal in value to the value of the real estate. The cost of the building is shown by the deductions claimed and allowed for depreciation. The petitioner, later in the fall of 1930, sold his remaining shares at what he described as a sacrifice at $10 a share. We conclude from all of the evidence that the value of the shares given for the property was not less than $80,800 when exchanged. Thus if that figure is important it is proven.

The petitioners contend that their basis for gain or loss on the real estate was the fair market value of the real estate at the time it was received in exchange for the stock because their gain or loss on the stock would be computed by taking the fair market value of the real estate as the amount realized and, consequently, that same figure would have to be used thereafter in computing gain or loss on the real estate. Here, however, there is no reason to believe that the value of the stock was substantially different from the value of the real estate at that time and we need express no opinion about this argument of the petitioners.

Reviewed by the Board.

Decision will be entered wider Rule 50.

Disney,

dissenting: Petitioners’ application for order to take depositions recited that deponent John O. Fowler would testify as to the cost basis to petitioners of the property involved, and that other witnesses named would testify as to the fair market value of the real estate. Upon deposition petitioner John O. Fowler, in answer to the question, “What was the consideration paid for the property?” answered “Four thousand shares of Sterchi stock. * * * I believe it was forty-four hundred”, and that it was his intent to compute the cost of the property as forty-four hundred times $20, which would give $88,000, that that was the agreed exchange price, that he considered the value of the property acquired to be worth more than $88,000. On his opening statement, counsel for petitioners, although stating that the case involves the question whether loss sustained constitutes an ordinary loss or a capital loss, stated: “I believe the only matter in controversy as to the facts will be the cost basis to petitioners of the property * * *. Petitioners’ contention is that their cost basis of the property which was lost in the foreclosure is the fair market value of the real estate at the time it was acquired in 1930 ' * * *. The fair market value of the property at the time of acquisition will be shown by the deposition of John O. Fowler, [etc.] * * *. This, in brief, is our case.” After the evidence was introduced, respondent moved to file amended answer to conform to proof, on the ground that petitioners had proved no cost basis whatever, and for increased deficiency accordingly; and petitioners’ counsel in response to a question from the Member stated: “I would say that the Board has jurisdiction to increase the deficiency if we have not proven the cost, we have got no loss.” Amended answer was accordingly filed alleging petitioners to have failed to prove cost basis of the real estate and for increase of deficiency.

Under all of these circumstances, I think it plain that the question of cost basis was squarely before the Board and that the burden was upon the petitioners. The major part of the testimony was directed to that issue, and had the issue been merely one of ordinary loss or capital loss, most of the testimony adduced by petitioners would have been unnecessary. Plainly petitioners assumed the burden of proving cost basis of property acquired. Respondent nowhere admitted any allegation of loss in any amount, but pointedly admitted only certain formal matters. I do not agree with the majority opinion that the Commissioner has the burden of proof to establish facts to support any claim for affirmative relief. Under the rules of the Board he has the burden only in so far as petitioner is relieved of it by statute and with respect to new matter pleaded in his answer. I do not consider a contention, akin to a demurrer to the evidence under many jurisdictions, as new matter. Contrary to the majority opinion, I think it obvious that from the filing of the original answer with its specific denial of the allegations of cost of $80,800 and specific denial of error and of the claim of full amount of loss, the issue of cost basis was before the Board. Certainly if treatment by the parties as an issue is of any efficacy, as is commonly so held, then that was the real issue in the hearing. That issue being pleaded and tried, a contention by respondent that the necessary proof had not been made is not introduction of new matter and under our rule he has not the burden. It seems anomalous to require him to prove a fact as to which he merely points to the record — the fact that the petitioners have not proved their case. I therefore consider that the issue here was that of cost basis, inherently the burden of the petitioner, and the subject of much attempt at proof. The petitioners nowhere contend that the bwrden was on respondent. That suggestion is first made in the majority opinion.

The majority opinion is further in error, I think, in stating that “the evidence shows with at least reasonable certainty under the circumstances that the fair market value of the stock given by these petitioners in exchange for the property was at least $80,800.” No evidence so shows such value. The testimony of John O. Fowler that $28.50 per share was the opening market price of the stock on the New York Curb as of the date the stock was issued in the spring of 1929 is obviously of no probative effect to show value on March 18, 1930, the date of the exchange, and was for that reason not given weight; and the same witness testified that he did not know the market quotation of the stock on March 18, 1930. He had filed with the Bureau of Internal Bevenue a protest, stating in part: “The market value of this stock two years after April 1, 1929, was practically nothing.” There was no attempt to show value of stock on March 18,1930. The only other evidence as to value of the stock is that of a sale of the remaining shares of John O. Fowler sometime in the fall of 1930 for $10 per share at a sacrifice. I know of no logical reasonable or legal criterion by which the evidence above can be made the basis for a conclusion that the stock on March 18, 1930, was of a value of approximately $20 per share, or $80,800. We have repeatedly rejected evidence of this nature.

The fact is that, as shown throughout the record, petitioners’ contention was that the real estate received was of a value of $80,800 and that such was their basis. They do not put it upon the ground of impossibility of proving fair market value of the stock exchanged, but vigorously contend that such is not the proper base. On brief they state: “* * * petitioners’ cost basis was the fair market value, at the time of the exchange, of the property received in exchange.” The question in the case, upon which it was pleaded and tried, is then the choice between a basis of fair market value of property received, or of fair market value of the stock exchanged. I think it should be decided. I do not agree that the fact of exchange under the circumstances is evidence that the value of the stock and of the real estate received were about the same. The cases so holding are carefully confined to exchanges by corporations of their stock, at incorporation, for property, and are specifically put upon the ground of impossibility of proof of the value of such new stock. I know of no case applying the principle to a simple exchange by individuals of property as here. Holmby Corporation, 28 B. T. A. 1092; Pierce Oil Corporation, 82 B. T. A. 403 (429).

The statute, section 113 (a) of the Revenue Act of 1934, in unequivocal terms provides that the base of property shall be the cost thereof, with certain exceptions. The instant case obviously falls within none of such exceptions and no such contention was made. We have here a simple exchange between individuals of property. The fact that the petitioners gave corporate stock for real estate, is of course immaterial and the case is the same as if they had exchanged real estate for real estate. The maj ority opinion upholds petitioners, who contend that the base of the real estate received is its value at the time of acquisition. That such value is not its cost seems entirely patent. Cost is the value of that which is surrendered in exchange, whether it be cash or property. Tex-Penn Oil Co. v. Commissioner, 83 Fed. (2d) 518 (524), and authorities cited.

To adopt a rule that property received in a taxable exchange has a basis for future purposes of its fair market value is merely to say that the original cost has merely been increased by the amount of recognized gain. But this is the rule provided for transactions involving “tax-free exchanges generally” under section 113 (a)(6). That statute has been reenacted for many years, with no suggestion that the same rule applies to taxable exchanges. If it was the intent to apply the same rule to taxable exchanges and to nontaxable exchanges in general as provided by section 113 (a) (6), it seems to me remarkable that Congress has never so stated, simple as that would have been; and I conclude that under the doctrine of inolusio unius exclusio alterius, it was not the intent of Congress in any of the several acts which might have provided the rule adopted by the majority, to say that simple taxable exchanges were to be an exception to the general basis of cost provided in section 113 (a), and to provide á base of cost plus recognized gain or minus recognized loss, or as the majority opinion puts it, the basis of value at tire time of acquisition. That such was not the intent seems demonstrated by the fact that in the same section, in subsection 113 (a) (4), a basis of fair market value at time of acquisition is provided in case of gift or transfer in trust before Jaunary 1, 1921, and in section 113 (a) (5) in case of acquisition by bequest, devise, or inheritance or by decedent’s estate from the decedent. It thus appears that when value , at date of acquisition was intended as base, Congress specifically said so. They did not say so in case of the simple taxable exchange. Petitioners on brief argue that the “exchange was a closed tramaction in 1930, for income tax purposes.” That idea is relied on in Law v. McLaughlin, 2 Fed. Supp. 601, as reason for holding base to be market value of property given in exchange. Moreover, it seems to me there is some refutation of the majority idea in the fact that section 113 (b) as to adjusted basis does not provide any such adjustment as the rule of the majority opinion entails. The basis of cost is not by the statute adjusted for the tax consequences of a taxable transaction.

Exhaustion, wear and tear, obsolescence, and depreciation are to be allowed upon the same basis as the basis for determining the gain upon the sale or other disposition of the property, in general and of course after adjustment, which means in the absence of exceptions, cost adjusted as required by the situation. We have held that such base upon property received in exchange is the fair market value of the property given in exchange for that which is received. In Pelham Hall Co., 33 B. T. A. 329, a new corporation issued its shares for bonds of an old corporation. It exchanged such bonds for real estate by purchasing such real estate with the bonds at foreclosure sale. The new corporation contended that its base for depreciation was the value of the property when acquired. We held the base was cost, saying, “that the depreciation base is actual cost to the taxpayer of the depreciable property and not the value of the property when acquired, for it is the taxpayer’s investment which is being preserved by depreciation.” We pointed out that the bonds which were given in exchange were property in the hands of the taxpayer corporation, and said: “Thus the cost of the depreciable property acquired is the value of the property (bonds) and cash given up for it.” We had already pointed out that when the old bondholders transferred their bonds to the taxpayer corporation for stock they “must be regarded as liquidating their old bonds and realizing gain or loss in the exchange measured by the cost to them of their old bonds and the value of the shares received. Cor-relatively, the cost to the new corporation of the old bonds received and the value of the new shares issued are likewise measured by the value of the old bonds.” Thus it appears that as in the case of John O. Fowler, something having a base for computation of profit or loss was exchanged for property. Yet we held that the basis for depreciation is cost, and not value of property when received.

Likewise, in La Arcada Bondholders Committee, 35 B. T. A. 80, a bondholders’ committee exchanged bonds for property. Obviously, the bonds had a basis in the hands of the bondholders represented by the committee, such basis of course being cost or the amount of money paid by them for the bonds. For such bonds the committee received property and the question was as to the basis for depreciation thereof. Again we held that the basis was cost, that is, value of the bonds, plus some cash paid for or exchanged for the property acquired. We went to considerable trouble to ascertain the value of the bonds. That trouble would have been unnecessary, on the theory of the majority herein, that the base should be the value of the property acquired in an exchange, for the property in the cited case was acquired in exchange by those who had a base for the old property for purposes of computation of profit and loss — as suggested in Pelham Hall Co., supra. The petitioners’ contention that the actual value of the property to be taken as depreciation base was denied.

If in the face of the statute any distinction could be made between a basis for depreciation and a basis for computation of profit and loss upon property received in exchange, we are not confined to such cases. In Peter Doelger Brewing Co., 22 B. T. A. 1176, we considered an exchange in 1915 of stock in an old corporation for shares in a new. The situation arose prior to the effective' date of the Revenue Act of 1918, and at a time when the exchange of securities upon corporate reorganization under circumstances present in the case resulted in realized profit and loss. It would appear, therefore, that there is no difference in the cited case and the present case of an exchange between individuals. We held that the exchange resulted in realized gain or loss, measured by the difference between the cost of the old securities and the market value of the new securities received in the exchange, and that the cost of the new securities was the market value of the old securities at the time of the exchange and that that was the base to be used when loss was claimed in 1928 upon the stock received becoming worthless.

In Jules Omar Cole, Executor, 13 B. T. A. 1310, trustees for petitioner’s deceased exchanged real estate for Liberty bonds in 1919, and distributed same to decedent. In 1921 decedent sold some of the bonds. The trust was taxed upon the basis of having received the bonds at par value and the decedent was required to pay and did pay taxes on his part of the distributable income on the basis of par. Petitioner therefore claimed a loss upon the basis of par value for the bonds when acquired in exchange, invoking, estoppel. We pointed out that, “The basis laid down by the statute for determining the profit upon the sale of the bonds in 1921 is the ‘cost’ thereof”, that the evidence did not show cost of the bonds, that they were acquired for real estate, that the fair- market value of the real estate at time of exchange is not shown, that the Commissioner had used as basis the fair market value of the bonds when received, to wit, 93 cents on the dollar, that “If the consideration paid for the bonds had a greater fair market value than 93 cents on the dollar the record does not disclose it”, that the statutory base is cost, that “If the determination of the Commissioner with respect to the cost of the bonds to the decedent is in error, the evidence does not prove it”, that “A showing that he used an erroneous basis for determining the profit on the sale of the land in 1919 is not a showing of the ‘cost’ to the decedent”, and that “For lack of proof of error in the determination of the basis used by the respondent such determination must be approved.” The syllabus states that “For lack of evidence that the cost of the bonds to the decedent was greater than their market value at the date of receipt, the determination of the Commissioner is sustained.” It is apparent that if petitioner had shown cost the market value would not have been considered, that we applied a test of value of the property exchanged as cost of that received, and that we denied application of value of the property received as cost merel/y because such value had been used in computing pro-fit upon the former transaction; and it is to be particularly noted that the exchange was a taxable transaction and was tasted. The case was reviewed by the Board.

In Blair v. Commissioner, 91 Fed. (2d) 992, the Circuit Court of Appeals for the Second Circuit considered a case wherein four sisters in 1926 turned in notes of a face value of $134,400 to a corporation, apparently for all of its capital stock. The corporation in 1930 sold the notes for $66 and claimed a deduction of $134,334. It is held that it was not established that the sisters’ interests in the corporation were substantially identical in value to the property contributed by them so as to render cost to the sisters available as cost basis for the corporation for income tax purposes, and that therefore the transaction did not come within the provisions of the statute as to nonrecognition of gain or loss. The court said:

The cost of the notes to the petitioner, measured by the market value of the stock given in exchange, Rice v. Com’r, 47 F. (2d) 99 (C. C. A. 1), was not proved. No basis, therefore, was established for computing the loss and on this record no loss is deductible. Burnet v. Houston, 283 U. S. 223, 51 S. Ct. 413, 76 L. Ed. 991.

In Rice v. Commissioner, 47 Fed. (2d) 99, relied upon in Blair v. Commissioner, supra, a trust in 1920 exchanged 400 of its shares for a hotel and sold the hotel. The question was the profit, depending upon the base. Laying down the rule that “fair market value of property exchanged for that acquired determines cost as basis for determining gain or loss on sale thereof”, the court reverses the Board, which had approved the Commissioner’s idea that the cost of the hotel should be determined by the par value of the trust shares, and remands for the Board to find the fair market value of the 400 shares of the capital stock of the trust, which value the court thinks could be determined.

In Vother v. United States, 40 Fed. (2d) 697 (U. S. Dist. Ct., W. Dist. of Mo.), taxpayer exchanged assets for certificates of interest in a trust, which in 1920 were sold in part. Quoting section 202 (a) of the Eevenue Act of 1921 (in effect the same as section 113 (a) of the Kevenue Act of 1934, controlling herein), designating cost in general as the basis of property, the court says:

Now, as I view the ease, it must be said that the cost to the plaintiff of the 24,000 shares or certificates which he received in August, 1917, was the value of the assets, including the good will of William Volker & Co., which he transferred in exchange for them. * * * But the plaintiff has failed to prove the value of the assets which he transferred to the trusts in exchange for the shares or certificates he received. He has proved that the value of the good will, one of the assets, was $500,000. Where he has fallen short is in failing to prove the value of other assets than good will at the time of the transfer of all of the assets to the trust. He has proved only the cost of those other assets. But cost is not value, and may be far different from value.

The court therefore found against plaintiff for the very reason I think we should find herein against petitioner.

If there is any distinction to be made between cases involving exchanges after March 1, 1913, and exchanges prior to that time, same is not suggested in the general language used in George W. Baumhoff, 3 B. T. A. 392, St. Louis Union Trust Co., Executor, 14 B. T. A. 323, or Otto H. Kahn et al., Trustees, 27 B. T. A. 244, where we held the bases of property received in exchange to be the fair market value of that given in exchange. The inquiry was as to cost (or March 1,1913, value). The same inquiry applies as to cost since March 1,1913, and in the instant proceeding.

Since Congress has never in any of the revenue acts over a period of more than 25 years provided that property received in an ordinary nontaxable exchange shall take the base adopted by the majority opinion, but on the contrary has throughout provided that cost shall be the basis, with exceptions not pertinent here, and since as pointed out in Otto H. Kahn et al., Trustees, supra, the base of property received in exchange is fair market value at that daté of the property given in exchange, I think that we should not indulge in judicial legislation. If there is reason for the rule favored by the majority, I think Congress should state the rule. It can not be implied from anything that Congress has said, but is contradicted thereby. If, however, we are to do what I think is legislating judicially, we can hardly Avoid, I think, overruling the Board cases above mentioned, involving exchanges since March 1, 1913, and prescribing- a basis of fair market value of tbe property given in exchange.

I have hesitated to impose upon the Board consideration of so lengthy an expression, and have done so only because I believe decision of the question presented requires examination of the above thought. I dissent.


source: Caselaw Access Project

author: Turner : MtjRdook,

license: Public Domain

text:
    Rotorite Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88606.
    Promulgated December 27, 1939.

      Raymond H. Schultz, Esq., and Victor J. Voorheis, Esq., for the petitioner.

      D. A. Taylor, Esq., for the respondent.
   OPINION.

Turner :

The respondent now concedes that the payments made after June 13,1935, amounting to $14,759.74, should not be treated as royalties. His position is that the letter of June 13, 1935, constituted notice by the Sunbeam Co. of the exercise of its right under the contract between the parties to become the purchaser of the patents, that the payments made prior to that date were royalties and the payments thereafter made constituted the selling price of the patents. The petitioner, on the other hand, still contends that all of the payments received in 1935, amounting to $80,556.81, must be treated for income tax purposes as the selling price of the patents and no part of such payments may be treated as royalties.

Both parties agree that under the contract the selling price of the patents was not a fixed amount but was the maximum amount agreed to, reduced by such amounts paid under the contract as properly may be regarded as the payment of royalties. The petitioner agrees that the payments made in 1933 and 1934 were royalty payments and that they are not affected by the subsequent exercise by the Sunbeam Co. of its right to purchase the patents. With respect to 1935, however, it is claimed that inasmuch as Sunbeam did exercise its right to purchase the patents in that year, all payments made in 1935, including the payments made prior to the exercise of the right to purchase, became a part of the purchase price. In, support of this proposition, petitioner relies on Indian Creek Coal & Coke Co., 23 B. T. A. 950, and in further support thereof cites, among others, Albert W. Bussell, 35 B. T. A. 602; Guy Fulton, 11 B. T. A. 641; H. B. Hill, 3 B. T. A. 761; Burnet v. Sanford & Brooks Co., 282 U. S. 359; and Huntington-Redondo Co., 36 B. T. A. 116.

In Indian Creek Coal & Coke Co., supra, the taxpayer had reported all payments made during the year in which the option was exercised as the selling price of the property. The respondent increased the selling price by the amount of royalty payments made in preceding years but made no change with respect to the treatment of the payments made in the year in which the option was exercised. Accordingly there was no issue before us as to the character of the payments made in the year the option was exercised, and that case does not support the claim of the petitioner in the instant case. To the extent that the payments were in issue, however, we decided that they were royalty payments and not a part of the selling price of the property. It is thus apparent that Indian Creek Coal & Coke Co. gives support to the claim of the respondent rather than the petitioner.

In Albert W. Russell, supra, Guy Fulton, supra, and H. B. Hill, supra, there was an adjustment of salaries of the taxpayers prior to the close of the taxable year, the taxpayers refunding to their employers a portion of the amounts previously received by them during the taxable year as salaries. It was held that the salary income of the taxpayers was the net amount received during the year. As the respondent points out in his brief, those cases make no determination as to the nature of income; they merely have to do with the amount of income received. Here the amount of the payments received is not in dispute. Those cases are not in point.

Under the contract between the Sunbeam Co. and the petitioner, the Sunbeam Co. had the right to use the patents belonging to the petitioner upon the payment of a specified royalty. It had a further right to become a purchaser through the exercise of an option, the price to be paid to be determined by subtracting the amount of the royalties previously paid from a maximum purchase price specified in the contract. The nature of the payments in the instant case was fixed by the parties themselves and so long as the patents belonged to the petitioner and there was no exercise on the part of the Sunbeam Co. of its right under the contract to purchase and acquire them as its own, the payments were royalties. Huntington-Redondo Co., supra, is clearly not in point. There the parties, prior to the close of the taxable year in which the payments in question were made, contracted specifically as to the allocation of the said payments between principal and interest, while in this case there was no subsequent contract and the nature of the payments remains as fixed and determined by the terms of the contract existing when they were made. Neither is the situation here affected by the rule laid down by the Supreme Court in Burnet v. Sanford & Brooks Co., supra. In that case the Court decided only that certain items of gross income were to be reported as such for the taxable year in which received. The character of the items as gross income was not in dispute. Here the situation is exactly the reverse. The question is not as to the period for reporting income but rather the character or nature of payments received.

On first impression this case seems to have some resemblance to Virginia Iron Coal & Coke Co., 37 B. T. A. 195; affd., 99 Fed. (2d) 919. In that case the taxpayer, in years prior to the taxable year, had received certain amounts of money under an option to purchase certain of its property, which payments were to be applied upon the purchase price in case the option should be exercised. In the taxable year the option was surrendered without purchase, and it was held that the payments in question were income in the year, of surrender. In reaching our conclusion, however, we specifically distinguished cases involving the question presented in the instant case, as follows:

* * * Cases involving royalties are distinguishable. Royalties have been held to be income at the time received where they represent a payment for the right to remove or use some of the property even though they are to be applied against the purchase price. The owner, of course, offsets this income by depreciation and depletion deductions which permit him to recover his basis tax-free despite the fact that the entire amount of the royalties is included in income. Here the payments were not of that character. * * *

In connection with the above quotation, see Edward E. Haverstick, 13 B. T. A. 837, and Indian Creek Coal & Coke Co., supra.

The petitioner seeks to avoid the conclusion that by reason of the letter from the Sunbeam Co. on June 13, 1935, the contract between the parties became a contract of sale and purchase by pointing to the language contained in the letter. It stresses particularly the first paragraph, reading as follows:

This is to advise you that we wish to exercise our option to purchase the Rotorite Patents upon completion of the stipulated royalty payment. We expect that this will pay out in the June shipments, although orders have been slumping off a bit and it is possible that we might not be able to pay out before July.

While the message thereby conveyed was not couched in words as definite as it might have been, there is no doubt in our minds that it was intended as'the notice provided for in the contract between the petitioner and Sunbeam; nor is there any doubt in our minds that the petitioner accepted it as such. Furthermore, the fact that the Sunbeam Co., in keeping with its consistent practice of writing down patents to the amount of $1, entered on its books all of the payments with the exception of $1 as the payment of royalties is no more controlling than the entries made on the petitioner’s books designating payments received prior to April 30, 1935, as royalties and those received after that date as the selling price of the patents. The contract between the parties, and not such book entries, is controlling. It is accordingly held that the payments received up to June 13,1935, represented royalties and the payments received thereafter constituted the selling price of the patents.

It is obvious, and there appears to be no contention to the contrary, that the patents were capital assets and the respondent is sustained in his claim that the deduction in respect of the loss sustained is limited to $2,000 by the provisions of section 111 (d), supra. The petitioner is entitled, however, to depreciation on the patents up to the date of sale.

Our next question is whether the petitioner is subject to surtax as a personal holding company imposed by section 351, supra, and further, whether it is liable to a 25 percent penalty for failure to file a personal holding company tax return. A personal holding company is defined in section 351 (b) (1) as any corporation if “at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and * * * gains from the sale of stock or securities * * The facts show that from and after June 30, 1934, the only activities of petitioner were the receiving of the payments from the Sunbeam Co. under the contract and the distributing of the amounts so received to its preferred stockholders. We have just held that the payments received by the petitioner from the Sunbeam Co. from January 1 to June 13, 1935, were royalties. It is thus apparent that substantially all, if not all, of the income of the petitioner during the taxable year was royalties and the petitioner falls within the definition of a personal holding company within the meaning of section 351 (b) (1), supra.

The petitioner contends, however, that even though the payments received in 1935 were in the nature of royalties, it had no undistributed adjusted net income within the meaning of section 351, supra, and is not therefore liable to the tax imposed by that section. In support of this contention it points to the distributions made during the year to its preferred stockholders, claiming that the said distributions were “dividends paid during the taxable year” within the meaning of section 351 (b) (2) (C). According to the facts the petitioner was in process of liquidation. In December preceding it had taken steps to reduce the call price for its preferred stock from $110 to $85 per share. This act became effective on January 8, 1935, when the Secretary of State of Illinois issued a certificate so amending its articles of incorporation. During 1935, the taxable year, the petitioner made distributions to the holders of preferred stock amounting to $85 per share and the preferred stock certificates were delivered to petitioner and canceled. After such distributions petitioner had on hand cash in the amount of $8,172.48; it had no other assets. This amount was withheld from its stockholders to enable it to meet taxes and expenses of final liquidation. There is no showing that it was retained to retire indebtedness incurred prior to January 1, 1934. The petitioner, pointing to the language of section 351 of the Revenue Act of 1936 and section 27 (f) of that act dealing with the corporation credit for dividends paid, contends that such part of the distribution made to the preferred stockholders as is properly chargeable to earnings or profits is to be treated as dividends paid within the meaning of section 351 (b) (2) (C), supra. This interpretation of the term “dividends paid during the taxable year” rests not upon the provisions of the Revenue Act of 1934, but upon the provisions of the Revenue Act of 1936; the Revenue Act of 1934 contained no such provision. We have previously considered the question as to whether or not the term “dividends paid during the taxable year” as that term is used in the Revenue Act of 1934 included distributions in liquidation and reached a conclusion contrary to the contention of the petitioner here. Gaston da Co., 39 B. T. A. 640. We find nothing in the arguments advanced by the petitioner to indicate that the term was misconstrued. Cf. Foley Securities Corporation, 38 B. T. A. 1036; affd., 106 Fed. (2d) 731.

With respect to the penalty for failure to file a personal holding company return, the petitioner argues that all requirements in that respect were met when the petitioner filed its corporate income tax return. The question here presented was considered by the Board and decided contrary to the views of the petitioner in Collateral Mortgage & Investment Co., 37 B. T. A. 630, and we find nothing in the arguments advanced which has not been considered and decided. It is accordingly held that, inasmuch as no personal holding company return was filed, the imposition of the penalty in respect thereto is mandatory.

With respect to the liability of petitioner for excess pi’ofits taxes under section 702 of the Revenue Act of 1934, the record shows that after June 30, 1934, its activities consisted of receiving the payments from the Sunbeam Co. and distributing them to its stockholders. It engaged in no other activities. Such activities do not constitute carrying on or doing business within the meaning of the act so as to make it subject to the capital stock tax, Ambergris Consolidated Mining Co. v. United States, 27 Fed. Supp. 968; Kingkade Hotel Co. v. Jones, —- Fed. Supp. — (U. S. Dist. Ct., W. Dist. of Okla., June 26, 1939); and Lyon Lumber Co. v. Harrison, - Fed. Supp.(U. S. Dist. Ct., N. Dist. of Ill., June 15, 1939), and since it is not subject to the capital stock tax, it is not subject to the excess profits tax. Colson Co., 37 B. T. A. 1031.

Reviewed by the Board.

Decision will be entered u/nder Rule 50.

MtjRdook,

dissenting: The agreement between the petitioner and Sunbeam gave to Sunbeam an option to purchase the patents for the sum of $135,000, and further provided that if Sunbeam exercised its option to purchase, all royalties therefore paid should be credited upon the purchase price. Those provisions gave to the payments a dual character. They might be royalty payments for the use of the patents or payments of the purchase price for the patents, depending upon whether or not Sunbeam exercised its option to purchase. It may have been necessary to treat them as royalties in prior years in order to permit the orderly collection of income taxes upon an annual basis. The petitioner did not know in those years whether or not the option would be exercised. But the inherent uncertainty of character which attached to the payments was removed in the taxable year when Sunbeam exercised its option to purchase the patents. Cf. Virginia Iron Coal & Coke Co., cited in the majority opinion. It then became clear for the first time that the payments were payments of purchase price. The character of the payments made in 1935 did not have to be determined for income tax purposes prior to the date the option was exercised, and there is no reason why all of the payments made during that year should not be recognized for income tax purposes as payments of the purchase price, which, in fact, they finally turned out to be. Thus, the petitioner is not subject to any tax or penalty as a holding company.

Although the Commissioner here refuses to recognize these payments as a part of the purchase price of the assets, he has insisted, in the case of Sunbeam,, that they were a part of the purchase price and not deductible by Sunbeam as royalties. He thus recognizes the dual character of the payments for his own double and inconsistent advantage.

I can not believe that Congress ever intended a personal holding company tax and penalty for failure to file a return to apply in a situation like that presented here and, therefore, the result reached by the majority seems particularly unfortunate.

Arundell, Van Fossan, Mellott, Kern, and Opper agree with this dissent.


author: Sternhagen :

text:
    Trinity Buildings Corporation of New York, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rockwood Alabama Stone Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92551, 92552.
    Promulgated December 28, 1939.

      Paul L. Peyton, Esq., for the petitioner.

      Conway Kitchen, Esq., for the respondent.
   OPINION.

Sternhagen :

The Commissioner held that the consolidated return filed by the Realty Co., as parent would not be recognized because the Savoy-Plaza Corporation had omitted to file form 1122. He determined deficiencies as on separate returns. The petitioners, members of the affiliated group, demand the recognition of the consolidated return, arguing primarily that the Savoy-Plaza Corporation was in bankruptcy during the taxable year, its shares worthless, its corporate organization a “mere shell”, and that hence it was not properly to be regarded as affiliated.

A similar question as to the year 1932 was presented by the same affiliated group of taxpayers in Lawyers Building Corporation, 35 B. T. A. 540; affirmed sub nom Fuller Co. v. Commissioner, 92 Fed. (2d) 12. It was held that, since the adjudication in bankruptcy was not made until December 1, 1932, the corporation was properly regarded as a member of the affiliated group under section 141 (d), and that its failure to file its consent on form 1122 prevented the filing of a consolidated return. In the present case the bankruptcy existed throughout the entire year 1933 and the petitioners urge that this distinction in fact makes the decision inapplicable and requires a different result. This is not so.

Bankrupt corporations are dealt with in section 52 of the Revenue Act of 1932, providing that returns for the corporations shall be made by the trustee, and any tax due collected from the trustees in the same manner as from the corporations. By a reference to section 141, affiliated corporations were brought within the section. Eegulations 77, article 392, implements the statute. Section 52 is not discussed in argument by either party here, although it was clearly suggested in Lawyers Building Corporation, supra, as support for the Commissioner’s refusal to recognize the consolidated return. On appeal, the court apparently found it unnecessary to consider section 52 because to support the decision it was enough that the Savoy-Plaza Corporation had not been in bankruptcy during the entire year and had withheld the consent which the regulations required and the corporation was free to give. While, therefore, the court’s opinion affords no authority for the decision of the present case, the Board’s opinion clearly pointed the way.

Looking alone, therefore, at section 52 and section 141, it seems clear that the bankrupt corporation was, by reason of the Realty Co.’s ownership of its shares, a member of the affiliated group for which a consolidated return could not as of right be filed unless all members of the group consented on form 1122 to the applicable regulations; and that this is none the less so because the shares of the bankrupt corporation may have been worthless or because its business and properties were being operated by a trustee in bankruptcy.

Reviewed by the Board.

Decision will be entered for the respondent.

       SEC. 52. CORPORATION RETURNS.
      (a) Requirement. — Every corporation subject to taxation under this title shall make a return, stating specifically the items ot its gross income and the deductions and ereditB allowed by this title. The return shall be sworn to by the president, vice president, or other principal officer and by the treasurer or assistant treasurer. In cases where receivers, trustees in bankruptcy, or assignees are operating the property or business of corporations, such receivers, trustees, or assignees shall make returns for such corporations in the same manner and form as corporations are required to make returns. Any tax due on the basis of such returns made by receivers, trustees, or assignees shall be collected in the same manner as if collected from the corporations of whose business or property they have custody and control.
      (b) Consolidated Returns. — Eor provision as to consolidated returns of affiliated corporations, see section 141.

       It may not be amiss to say that despite the alleged worthlessness of the Savoy-Plaza Corporation shares they were not charged off the Realty Co.’s books until February 1933.


author: Harron :

text:
    Estate of Waldo Rohnert, Bank of America National Trust & Savings Association, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87304.
    Promulgated December 28, 1939.

      Em/met W. Gottenberg, Esq., for the petitioner.
    ■ Harry R. Horrow, Esq., for the respondent.
   OPINION.

Harron :

The Commissioner included in decedent’s gross estate the sum of $32,870.68 representing the proceeds held by an insurance company which had been subject to payment direct to decedent. This sum is the balance of proceeds of insurance policies which decedent, during his lifetime, surrendered for their cash value. This sum was included properly in the gross estate. It appears that this determination is not contested by petitioner. These proceeds were payable to decedent during his lifetime. Upon his death, they were payable to the estate.

Section 302 (g) of the Revenue Act of 1926 provides that the amount of insurance receivable by the executor of an estate shall be included in gross estate for estate tax, and that insurance receivable by all other beneficiaries shall be included in gross estate to the extent of the excess thereof over $lfifi00. The insurance on the life of the decedent was made payable, on the policies, to beneficiaries other than the executor of the estate. However, since estate taxes were to be paid from the inter vivos trust which included all the insurance, respondent has treated all the insurance, in the total amount of $166,-205.79, as subject to the payment of a claim against the estate, and, therefore, as receivable by the executor rather than by other beneficiaries. As a result of the respondent’s treatment of the insurance, he has determined that the total amount of the insurance is includable in the gross estate under the terms of the first clause in section 302 (g). The sole question is whether that determination is correct, or whether the insurance is of the class described in the second clause of section 302 (g) so as to make the $40,000 exemption, allowed by the statute, applicable thereto, and only the excess over $40,000 includable in gross estate.

The property in the inter vivos trust is of two classes; 20,527 shares of various stocks, and the proceeds of six policies of insurance upon the life of the decedent. Each of the policies was payable to the trustee of the inter vivos trust, who was to hold the net corpus of the trust for the benefit of decedent’s widow and children.

Since the insurance on the face of each policy was payable to the trustee, it is only by construction of the terms of the 1926 trust agreement that it can be held that any of the insurance was receivable by the executor of decedent’s general estate, under section 302 (g). The trustee was obligated to pay all estate taxes from the inter vivos trust. The executor of the estate was a limited beneficiary of the trust. There is no direction to the trustee to pay estate taxes from property other than the insurance proceeds. The taxes could be paid from any funds or property in the trust. However, in the absence of readily available funds from other property in the trust, some of the insurance was clearly subject to payment of a particular charge against the estate, namely, estate taxes. It is, therefore, concluded that, under the terms of the 1926 trust, at least some of the insurance was subject to payment of a charge against the estate, namely, estate taxes.

The total amount of estate taxes for which the trustee of the inter vivos trust was liable, is known. That amount is approximately $54,306. That amount represents all of the charges against the estate of which it can be said that the insurance was subject to meet charges against the estate. That amount is all of the insurance which can be said to be “receivable by the executor” under the first clause of section 302 (g). The balance of the insurance, approximately $111,900, is clearly such insurance as is described in the second clause of section 302 (g). It is receivable by a beneficiary other than the executor. None of the remainder of the insurance is for the benefit of the estate, nor is it distributable by the executor of the estate. The executor of the general estate exercises no control over the remainder of the insurance proceeds. It is concluded that the balance of the insurance, about $111,900, is includable in gross estate to the extent of the excess over $40,000, under the provisions of the second clause of section 302 (g).

It is pointed out, further, that the insurance in question was taken out by the decedent to provide decedent’s wife and children with an estate to be administered by a bank as trustee. It would be unreasonable to conclude that all the insurance was taken out by the decedent to provide funds to meet the estate taxes, as respondent contends, in view of the fact that the face amount of all the insurance was $165,000, and all the estate taxes amount to only $54,306.47.

Congress has seen fit to include in the gross estate of a decedent only the excess over $40,000 of the amount of insurance receivable by other beneficiaries than the executor. Congress intended to allow the exemption of $40,000 of insurance passing directly to a beneficiary over which the executor exercises no control. See Report No. 767 (p. 22) of the Committee on Ways and Means, submitted to Congress when the Revenue Bill of 1918 was under consideration, quoted in Marmaduke B. Morton, Administrator, 23 B. T. A. 236, 243. Respondent’s contention in this case disregards the express intention of Congress in enacting the second clause of section 302 (g), and disregards the language of that statutory provision. It is noted that, under somewhat similar facts, in Pacific National Bank of Beattie, Executor, 40 B. T. A. 128, 137, the Commissioner contended that insurance receivable by beneficiaries other than an executor was includable in gross estate only to the extent used for the payment of claims against the estate. We sustained that contention. We stated:

* * * notwithstanding the fact that the proceeds here were not payable to the bank as executor but as trustee, they were subjected by the trust agreement to the charges in question, and, to that extent and on that account are properly in-cludable in the gross estate. [Italics supplied.]

Respondent relies upon the Morton case, supra, as authority for his contention that the total proceeds of insurance should be held to be receivable by the executor of decedent’s estate and, therefore, in-cludable in the gross estate for estate tax. In the Morton case, the decedent appointed the Bartlett Trust Co. as executor under his will. Under the will, the decedent bequeathed the residue of his estate in trust to the Bartlett Trust Co., as trustee. Insurance on the life of the decedent was payable to the Bartlett Trust Co., as trustee under the will. In the will, the decedent directed the trustee under the will to pay all charges against the estate from the residuary estate, and the insurance proceeds were part of and commingled with the residuary estate. Under the particular facts, it was held that all of the proceeds of insurance was subject to the payment of claims against the estate and, therefore, was insurance “receivable by the executor”, so as to be includable in gross estate under the first clause of section 302 (g). In Estate of Willard T. Carleton, 37 B. T. A. 66, 70, the rationale of the opinion in the Morton case is stated to be as follows:

* * * The effect of our opinion in that case was to bold that no express trust was created by decedent’s making the policies of insurance payable to Bartlett Trust Co., trustee, under the will and that, because no express trust was thereby created, there was a resulting trust in favor of the estate and the estate was therefore the beneficiary of the policies and the $40,000 exemption did not apply.

It further appears in the opinion in the Morton case that, under the facts, we concluded that all the insurance in question was subject to distribution as part of the estate. The trustee under the will and the executor of the estate being the same institution, the situation was the same as though the insurance was receivable by the executor of the estate.

In this case, the insurance is receivable by a trustee of an inter vivos trust for named beneficiaries. The inter vivos trust is separate from the general estate, and from a testamentary trust created under a will. Cf. Boston Safe Deposit & Trust Co. v. Commissioner, 100 Fed. (2d) 266. In Pacific National Bank of Seattle, Executor, supra, we held that insurance receivable by beneficiaries other than an executor of a general estate was includable in gross estate only to the extent used for the payment of claims against the estate. In so holding, we modified the rule of the Morton case, at least in so far as the respondent argues that it supports his contentions in this case. We reach the same result'here as was reached in the Pacific National Bank of Seattle case. See, also, Commissioner v. Jones, 62 Fed. (2d) 496, 497.

Upon the conclusions reached above, there should be included in the gross estate for estate tax, $82,870.68, the proceeds of the cash value of policies surrendered by decedent during his life; $54,306.47, the amount advanced by the trustee of the inter vivos ti’ust for estate taxes; $71,899.32, the extent of insurance receivable by a beneficiary other than the executor above $40,000.

Reviewed by the Board.

Decision will he entered under Rule 50.

       Sec. 302. (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.


author: Disney: Smith,

text:
    Norman Cooledge, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92289.
    Promulgated December 29, 1939.

      Edward B. Kane, Esq., and Hilary H. Gardner, O. P. A., for the petitioner.

      Stanley B. Anderson, Esq., and Elizabeth, B. Fegan, Esq., for the respondent.

       For prior opinion see p. 110.

   OPINION.

Disney:

Tbis proceeding involves income tax for the year 1934. Petitioner filed income tax return with the collector of internal revenue for the district of Georgia. Deficiency was determined in the amount of $721.06, and respondent by amended answer asks increase thereof to the amount of $934.89. Two questions are presented: (a) As to disallowance of deduction claimed for accrued taxes and interest, and (b) as to application of sections 115 (c) and 117 (a), Revenue Act of 1934, in computation of net income received upon liquidation of shares of stock. The facts were stipulated (and the stipulation adopted as our findings of fact) and will be referred to only in so far as necessary to determination of the issues presented.

I. — Petitioner filed income tax return for 1934 on the cash receipts basis with the collector of internal revenue for the district of Georgia. On July 21, 1934, he sold to the Sterling Discount Corporation certain real estate in Atlanta, Georgia, and as a part of the purchase price the vendee agreed to pay all taxes and mortgage interest then or thereafter due upon the property, and during 1934 in pursuance of said agreement did pay $4,017.68 ad valorem taxes and tax items, and $2,798.24 in discharge of interest on a mortgage upon the property, all of which had accrued against the property and against petitioner prior to date of sale. Petitioner alleged error by respondent in disallowance of deduction of such amounts, and disallowance of deduction of loss which was taken by petitioner upon sale of the property, the disallowance of the loss being by reason of section 24 (a) (6), Revenue Act of 1934, the petitioner having owned more than 50 percent of the stock of the vendee corporation. The vendee has not been allowed deduction of the above amounts.

Petitioner contends, in effect, that he, on a cash basis, paid the taxes and interest by virtue of the fact that the vendee, under numerous cases, is not entitled to deduction of the amounts paid by it; that therefore to deny deduction by petitioner-vendor is contrary to the intent of section 23, Revenue Act of 1934, providing for allowance of taxes paid; that though the petitioner did not in person pay the taxes and interest, such payment in person is not necessary, the amounts being paid by the Tendee as a part of the purchase price of the property sold; that the purchase price belonged to petitioner and therefore the taxes were paid with petitioner’s funds; that the effect is the same as if full purchase price had been paid to petitioner and he had handed back to the vendee the amount of taxes and interest with directions to use same in making the payments. The respondent answers in effect that the payment of the taxes and interest by the vendee was on its part a capital expenditure and additional cost of the property; that petitioner did not in fact pay; that what was done, and not what might have been done, must control; that the fact that section 24 (a) (6) of the Revenue Act of 1984 prevents petitioner from being entitled to a loss on the sale is immaterial — the vendee being a corporation with entity separate from that of petitioner — and that therefore the disallowance was proper.

Opinion in this proceeding was promulgated on June 20, 1939, 40 B. T. A. 110. On July 3, 1939, petitioner filed his motion for reconsideration and review by the entire Board of the opinion. The motion was confined to the first issue decided relating to the deduction sought for taxes and interest paid. On July 11, 1939, order was entered vacating the decision and directing review by the Board, and the decision entered June 21,1939, was vacated and set aside, pending such review. On September 15, 1939, upon review proceeding was rereferred to Division No. 4 for further consideration.

We have in various cases, including Leamington Hotel Go., 26 B. T. A. 1004, considered the question of the position of the vendee who pays vendor’s taxes as a part of the purchase price, and have held that the payment was capital expenditure and not deductible as taxes paid. Here we must consider the question of the position of the vendor in such a case. Is he entitled to deduction for taxes (and, herein, interest) paid?

On December 6,1939, the parties to this proceeding filed their stipulation, thereby stipulating “that the loss to the Petitioner on the sale of the property in question was based upon a sales price to Petitioner, which sales price included the amount of interest and taxes paid by the purchaser.”

In our former opinion herein we denied petitioner the deduction claimed. Though showing himself to be the person upon whom the taxes and interest were imposed, Eugene W. Small, 27 B. T. A. 1219, and that he was on a cash basis, he had at that time not shown that he was in the position, for income tax purposes, of having paid the taxes.

In the light of the above stipulation, however, we think the petitioner’s position must be sustained on this point. It now becomes apparent for the first time that the effect of what was done was the same as if full purchase price had been paid to petitioner in cash, he had then paid back to the Sterling Discount Corporation the amount of the taxes and interest, and the Sterling Discount Corporation had used the money to pay such interest and taxes in effect as the agent of the petitioner. S. M. 4122, V-l C. B. 55, upon this subject uses the following language:

Inasmuch as A was the record owner of the property in question as of April 1-, 1925, and as under the statutes and court decisions of Massachusetts the record owner as of that date is personally liable for the taxes so assessed, she is entitled to deduct the total amount of taxes paid with respect to the real property in question for the year 1925 under section 214 (a) (3) of the Revenue Act of 1924. However, the taxes assumed and actually paid by her vendee should be included in the selling price of the property for the purpose of determining gain or loss from such sale. The amount so paid should be included as part of the purchase price paid by A’s vendee for the purpose of determining gain or loss in the event of subsequent sale by such vendee.

It seems obvious that petitioner, having in effect added the amount to his income as cash received, should then be allowed to deduct it as cash paid for' the interest and taxes which the income tax law, section 23 (b) and (c), Revenue Act of 1934, allows as deduction. This is consonant with those cases holding that the vendee is entitled, as to vendor’s taxes or interest paid by him, not to deduction as taxes, but to increased base as investment made. John Hancock Mutual Life Insurance Co., 10 B. T. A. 136; Lifson v. Commissioner, 98 Fed. (2d) 508. The vendee on his part actually expends in payment for the property a fixed amount, including amount of interest and taxes, and is logically entitled to that amount as cost basis; the vendor on his part accounting for the same amount as income, has in effect placed himself in the position of receiving the entire amount, including amount of interest and taxes, and not merely the net amount less those items which he actually received. Thus, in effect, as between vendor and vendee, the amount of interest and taxes is not such, but is merely purchase price, to be used by each in calculation of tax consequences; and vendor, putting himself in a position of liability for income tax upon the whole amount received, has in substance paid the taxes and is entitled to deduction therefor. There is thus no duplication of the deduction, as feared by respondent, as would be the effect if vendor were allowed the deduction without accounting in income for full purchase price, including the amount of interest and taxes, for then vendee would have the benefit of the amount as basis and the vendor as deduction from that which was not considered received; whereas when, as here, vendor accounts for the full purchase price, the deduction to which he becomes, as we believe, entitled, does not duplicate the benefit vendee receives by way of basis, but merely cancels the ampqnt which vendor is considered as receiving, above what he actually receives. In sum and substance, the vendee, having paid the full amount, takes same as his basis; the vendor, though not actually having received the full amount, accounts for all as purchase price, and authorizes the vendee as his agent to pay his, vendor’s, interest and taxes, and takes deduction accordingly. California, Sanitary Co., Ltd,., 32 B. T. A. 122. Thus we arrive at consistent treatment, without duplication, as to both parties. To the circumstances now established herein, we think Falls Corporation v. Commissioner, 60 Fed. (2d) 204, applicable, for therein the court said:

* * * The object of the statute is to arrive fairly at taxpayer’s net income by permitting him to deduct from his gross income what Congress regards as proper items of expense in producing his income.

The stipulation that petitioner’s loss from the sale of the property was based upon a sale price including the interest and taxes in question demonstrates the inclusion thereof in his gross income, within the thought just quoted. Petitioner’s property gave rise to the deduction. Merchants Bank Building Co. v. Helvering, 84 Fed. (2d) 478. He now appears in a consistent position in asking the deduction involved. We conclude and hold that the petitioner is entitled to deduction of the amounts included by him in the sale price of the real estate sold, in calculation of loss on the transaction, and paid by his vendee.

II. — The motion for consideration and review by the Board of the previous opinion herein was specifically confined to the above issue as to deduction of interest and taxes. The order directing review by the Board, and, upon review, the order rereferring the proceeding to this division for further consideration were general in terms. We therefore, by reference to the opinion herein promulgated on June 20, 1939, 40 B. T. A. 110, adopt and include herein what we therein set forth as findings of fact and opinion upon the second issue, as to treatment of stock in Finance Co. of the South. We therefore sustain the respondent’s method of computing net profit on such stock.

Beviewed by the Board.

Decision will be entered wider Bule 50.

Smith,

dissenting: I dissent from so much of the opinion of the Board in this proceeding as holds that the petitioner is entitled to deduct from gross income $2,798.24 claimed as interest paid on his behalf by the Sterling Discount Corporation and $4,017.68 representing taxes paid on his behalf by the same corporation.

In his return the petitioner claimed no loss deduction in respect of the transaction whereby he sold the Houston Street property to the Sterling Discount Corporation, nor did he claim the deduction for the interest and taxes which the vendee assumed as a part of the purchase price. In his petition to the Board he claims the deduction of the interest and taxes, alleging that:

(a) On or about July 21, 1934, I sold improved real estate in the City of Atlanta to the Sterling Discount Corporation, in which I owned more than 50% of the outstanding capital stock. I sustained a loss on this sale which is not allowable under Section 24 (a) 6 of the Revenue Act of 1934. A profit on this sale would have been subject to income tax. Ad valorem taxes were paid on this property during 1934 in the amount of $4,017.68. Interest was paid in 1934 on mortgage secured by this property in the amount of $2,798.24. These payments were made by checks of the Sterling Discount Corporation which I signed as President. Under the decisions, these payments were a part of the purchase price paid by Sterling Discount Corporation for the property sold to them by me. By the same token, these payments of interest and taxes were made with my money and in my behalf and as such are deductible by me when paid as my income tax returns are made on a cash basis.

The parties have stipulated:

* * * that the loss to the Petitioner on the sale of the property in question was based upon a sales price to Petitioner, which sales price included the amount of interest and taxes paid by the purchaser.

The taxpayer’s return was made upon the cash receipts and disbursements basis. The interest and taxes claimed as deductions may not be allowed unless those payments were made by the petitioner during the taxable year.

The stipulated facts are that the payments in question were made by the Sterling Discount Corporation. They were made as a part of the purchase price of the property. They constitute an investment of capital by the corporation. They constitute a part of the cost of the property to the corporation. In the case of Lifson v. Commissioner (C. C. A., 8th Cir.), 98 Fed. (2d) 508; certiorari denied, 305 U. S. 662; rehearing denied, 306 U. S. 618, the court said:

When one purchases land which is subject to a lien for taxes, the subsequent payment of those taxes by the purchaser does not constitute an allowable deduction from gross income, for the reason that the taxes accrued while the land was in other ownership and the payment of them is merely a payment of a part of the cost of acquiring the property. Merchants Bank Bldg. Co. v. Helvering, 8 Cir., 84 F. 2d 478, 481; Helvering v. Missouri State Life Ins. Co., 8 Cir., 78 F. 2d 778, 781; * * *

When the corporation sells the property the gain will be the excess of the sale price over the cost basis, which includes the payments of the interest and taxes in question; and the loss will be the excess of that basis over the amount received by the corporation.

The opinion of the Board holds that the corporation paid the taxes as agent for the petitioner. This is an assumption contrary to fact as shown by the stipulated facts and by the claim made relative thereto by the petitioner.

It seems clear that if the petitioner may deduct the interest and taxes in question there will be a double deduction; for clearly the corporation will be entitled to the deduction in the computation of its gain or loss upon the sale or other disposition of the property. This is the contention made by the respondent. In my opinion it is correct.

The net result of the Board’s decision is to give the petitioner the deduction of a loss in respect of the transaction where such loss is contrary to the provisions of section 24 (a) (6) of the statute.


author: Hill :

text:
    City Bank Farmers Trust Company, as Executor of the Estate of Julian Peabody (Also Known as Julian Livingston Peabody), Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90468.
    Promulgated January 5, 1940.

      James Lloyd Derby, Esq., for the petitioner.

      Benjamin M. Brodslcy, Esq., for the respondent.
   OPINION.

Hill :

Respondent determined a deficiency in the Federal estate tax liability of petitioner in the amount of $4,918.94, only a portion of which is in controversy. The sole issue raised by the pleadings is whether or not respondent “erred in including in the decedent’s gross estate, as property jointly owned, the sum of $44,450 representing the entire value of improvements upon land situated in Westbury, Nassau County, New York, instead of the sum of $22,225, or one-half the value of said improvements.”

The decedent, Julian Peabody, and his wife, Celestino H. Peabody, acquired by gift from the wife’s mother approximately twenty acres of land situated at Westbury, Nassau County, New York. The land was acquired in 1913, and decedent and his wife took title as joint tenants. Subsequent to 1913, certain improvements were constructed upon the property, and decedent and his wife made the property their home.

On or about January 24,1935, decedent and his wife perished at sea in a common disaster, namely, the shipwreck of the S. S. Mohamh.

In the Federal estate tax returns filed for Celestine H. Peabody, deceased, and for Julian Peabody, deceased, 50 percent of the value of the improvements before mentioned was included in each. Upon audit of the return filed for Celestine H. Peabody, deceased, respondent withdrew from her estate 50 percent of the value of such improvements and included same in the value of the gross estate of decedent. Thereupon a refund was made to the estate of Celestine H. Peabody of the amount resulting from that adjustment.

The value of the improvements iii question was $44,450. Respondent determined the deficiency in controversy on the basis of his holding that the decedent paid the entire cost of the improvements.

Petitioner contends (1) that the question at issue must be resolved by the laws of the domicile, the State of New York; (2) that by the deaths of the joint tenants in a common disaster, the joint tenancy was converted by operation of state law into a tenancy in common; (3) that in the case of a tenancy in common, the presumption in New York is that the tenants owned .the property in equal shares; and (4) that since respondent has failed to prove that at the time of his death decedent owned a greater interest in the' property than one-half, his determination is arbitrary and there is no presumption that it is correct.

In support of point (3), petitioner cites In re Blumenthal's Estate, 236 N. Y. 448; 141 N. E. 911; Jackson v. Moore, 94 App. Div. 504; 87 N. Y. S. 1101; Wetherow v. Lord, 41 App. Div. 413; 58 N. Y. S. 778. These cases do not appear to hold, as argued by petitioner, that in New York the presumption is that tenants in common own the property in equal shares, but that such presumption is indulged only “in the absence of any evidence on the subject.”

In support of its second contention, petitioner cites, among others, In re Fowles’ Will, 222 N. Y. 222; 118 N. E. 611; Bierbrauer v. Moran, 244 App. Div. 87; 279 N. Y. S. 176; and Stelz v. Schreck, 128 N. Y. 263; 28 N. E. 510. These decisions hold to the effect that, where two or more persons who own property jointly perish in a common disaster, there is no presumption of survivorship in New York, that survivorship is a matter of proof, and where there is no proof, such circumstances result in the devolution of the property as if it had been held by the decedents as tenants in common. Petitioner further argues under its second contention that, in order to bring this case within the purview of section 302 (e) of the Revenue Act of 1926 as-amended, respondent must show that decedent’s wife survived him.

Petitioner’s position, we think, is untenable. The burden of proof is on the taxpayer to show that the Commissioner’s determination is invalid, Lucas v. Structural Steel Co., 281 U. S. 264, 271; Wickwire v. Reinecke, 275 U. S. 101, 105; Welch v. Helvering, 290 U. S. 111, 115, and in the absence of such proof, the Commissioner’s determination must be approved. This rule is subject only to the modification that if the taxpayer shows that the Commissioner’s determination is arbitrary and excessive “without rational foundation”, it will' not be enforced even though the correct amount of tax lawfully due is not established. Helvering v. Taylor, 293 U. S. 507. Obviously the principle applied in the Taylor case is not applicable here. Petitioner has not shown that respondent’s determination is arbitrary or excessive but seeks to shift to respondent the burden of proving the material facts upon which his determination rests. To sustain petitioner’s contention on this point would be to destroy wholly the primary presumption of correctness which attaches in all cases to respondent’s determination of a tax deficiency.

Respondent’s determination of deficiency in the present case is based squarely upon his holding that the decedent paid the cost of the improvements involved, and hence the value of such improvements, the amount of which the parties have stipulated, is includable in decedent’s gross estate. Petitioner seeks to shift to respondent the burden of proving the shares owned by decedent and his wife in the property as tenants in common on the theory that in the absence of such proof the presumption in New York is that each owned a one-half interest. A similar contention was considered in Robinson v. Commissioner, 63 Fed. (2d) 652, where the taxpayer sought the benefit of a presumption arising under the law of Michigan to the effect that a joint bank account would be treated as owned in equal shares in the absence of evidence to the contrary. The court said:

But the Revenue Act provides that all of the amount of such deposit shall be included in the decedent’s estate, except such part as may be shown to have originally belonged to tbe survivor. This provision can not, we think, be vitiated by a state court decision construing a state statute as giving rise to a presumption. * * * As said in New Orleans & N. E. R. Co. v. Harris, 247 U. S. 367, * * * “the question of burden of proof is a matter of substance and not subject to control by laws of the several states.”

In Colonial Trust Co., Executor, 38 B. T. A. 1398, we held that where securities and cash were added to a trust and it was not disclosed by whom the contributions were made, the decedent’s interest in the trust as determined by respondent would not be disturbed.

In Foster v. Commissioner, 90 Fed. (2d) 486, affd., 303 U. S. 618, it was held that where the executor of an estate contended that only one-half of the total value of the property held by decedent and his wife as joint tenants should be included in the decedent’s gross estate, the burden of proof was on the executor to show the part that originally belonged to the wife, or the proportionate part of the consideration furnished by the wife, and in the absence of such proof, the Commissioner’s action in including the entire value of the property in the decedent’s gross estate was approved.

The rule is none the less applicable, if, as suggested in the petition filed in the present case, there is no evidence available to establish the essential facts. The impossibility of producing such proof does not aid petitioner here. Such a situation “simply leaves the claimant upon whom the burden rests with an unenforceable claim, a misfortune to be borne by him as it must be borne in other cases, as the result of a failure of proof.” Burnet v. Houston, 283 U. S. 223.

The issue presented here is not, in our opinion, controlled by the laws or decisions of the courts of the State of New York, as argued by petitioner. While the quantum or quality of ownership of property is a question of state law, the power of Congress to tax is not subject to state control. “State law may control only when the operation of the federal taxing Act, by express language or necessary implication, makes its own operation dependent upon the state law.” Burnet v. Harmel, 287 U. S. 103. To the same effect is Bankers’ Pocahontas Coal Co. v. Burnet, 287 U. S. 308. And compare Allen v. Henggeler. 32 Fed. (2d) 69.

Since petitioner has failed to show that the entire cost of the improvements on the property owned by decedent and his wife at the time of their deaths was not paid by decedent, it is immaterial whether they held such property as joint tenants or tenants in common, or whether the one survived the other. In either event, the amount properly includable in decedent’s gross estate would not be less than the amount so included by respondent.

Decision will he entered for the respondent.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside the United States—
      * * * * * . * ' . ’ ■*
      (e) To the extent of the interest therein held as joint tenants by the decedent and any other person, or as tenants by the entirety by the decedent and spouse, or deposited, with any person carrying on the banking business, in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money’s worth; Provides,, That where such property or any part thereof, or part of the consideration with which such- property was acquired, is shown to have been at any time acquired by such other person from the decedent for less than an adequate and full consideration in money or money’s worth, there shall be excepted only such part of the value of such property as is proportionate to the consideration furnished by sucb other person: * * *


author: Leech:

text:
    Monroe Abstract Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95286.
    Promulgated January 5, 1940.

      Thomas E. Remington, Esq., for the petitioner.

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

Leech:

Petitioner contends, first, that the sum of $3,411.93 which it deposited in 1936 pursuant to the terms of its contract with the Insurance Co., is not subject to the normal tax on corporate incomes and, second, that it is entitled to a credit of $3,411.93 under section 26 (c) (1) of the Revenue Act of 1936, on the ground that it had entered into a contract restricting the payment of dividends within the meaning of that section.

The essence of petitioner’s position on the first point is that the amount it had to deposit in certain banks pursuant to the agreement with the Insurance Co. does not constitute income because it was not realized gain since petitioner did not then have unlimited control of the fund.

The agreement required petitioner to deposit an amount equal to 5 percent of its monthly income derived from its business of making abstracts of title. The fund comprising the aggregate of these deposits was to be held only for the payment of losses arising out of the liability of petitioner on searches and abstracts issued under the agreement. The countersignature of the Insurance Co. was required for any withdrawals. The fund was to remain on deposit until the termination of the agreement, but at any time thereafter petitioner might withdraw the reserve, provided it first deposited with the Insurance Co. a surety bond equal in amount to the then existing reserve.

It should be noted that petitioner is not required to deposit 5 percent of its monthly gross income in this reserve account, but an amount equal to- that percentage. In other words, petitioner may satisfy the contract by a use of existing surplus or capital or by borrowing the necessary amount. It should further be noted that we are not concerned here with moneys actually used to pay losses, but only with moneys deposited, pursuant to agreement, against the payment of losses sustained in the future.

The general proposition that amounts deposited in a reserve to cover contingent liabilities may not be deducted until such liabilities become fixed, is well settled. Lucas v. American Code Co., 280 U. S. 445; Brown v. Helvering, 291 U. S. 193; Lane Construction Corporation, 17 B. T. A. 826.

But petitioner argues that the tax effect is different where the deposits are made pursuant to a restrictive agreement like the present one, citing Commissioner v. Cleveland Trinidad Paving Co., 62 Fed. (2d) 85; Benjamin Franklin Patterson, 21 B. T. A. 8; petition to review dismissed, 59 Fed. (2d) 1055; Portland Cremation Association v. Commissioner, 31 Fed. (2d) 843; American Cemetery Co. v. United States, 28 Fed. (2d) 918; Troost Ave. Cemetery Co. v. United States, 21 Fed. (2d) 194; and Stoner v. Commissioner, 79 Fed. (2d) 75.

These cases are not in point. In all of them the use of the contested amounts by the recipient was limited by a trust imposed by agreement of the payor with the payee. Here no such trust existed. The restriction imposed by the contract went not to the income itself but only to its equivalent, and existed by virtue of petitioner’s contract with the Insurance Co. and not with the payor of the income. The use to which income is put after its receipt does not affect its tax-ability when received. Clemmons v. Commissioner, 54 Fed. (2d) 209; Lonsdale v. Commissioner, 32 Fed. (2d) 537; certiorari denied, 280 U. S. 575; William B. Grise, 6 B. T. A. 743.

The petitioner is foreclosed in its first position. George Hyatt, 36 B. T. A. 121.

Accordingly, we conclude that petitioner has not overpaid its tax in so far as that income was imposed on earnings in the amounts deposited pursuant to the agreement with the Insurance Co., for the reason that such amounts were properly includable in taxable income.

The second issue requires the consideration of the contract. Does it expressly prohibit the payment of dividends under the conditions obtaining during the taxable year? Such a prohibition is a stated condition precedent to the application of section 26 (c) (1), supra.

It may be conceded at the outset that petitioner may not use the amounts it deposits under the agreement for any purpose except to pay losses, and that, by the agreement, dividends are forbidden if capital funds and reserve fall below $38,000 or if, out of those capital funds, there is not, at least, $15,000 in cash on hand, or its equivalent. However, we are unable to follow petitioner in its contention that this contract prohibited the payment of dividends by the petitioner during the taxable year. Throughout that period the capital funds, reserves, and cash on hand were well over the amounts specified.

The agreement provided for the deposit of a reserve against losses, and such incidental restrictions as there are on the use of the deposit and the maintenance of sufficient capital and liquid assets are only for the purpose of assuring the maintenance of that reserve and the proper conduct of petitioner’s business. There is nothing in the agreement to prevent petitioner from paying dividends out of its existing surplus if the guarantee deposit, the capital, and the cash on hand were in the required amounts.

Petitioner, as shown by its balance sheet, in the taxable year had an actual surplus in excess of $16,000. Its claim that only $1,640.73 of this was “free surplus” available for payment of dividends, is based upon the fact that it has, voluntarily and not by reason of a contract restriction, charged the required guarantee deposits on its books to its earnings. It merely adopted this business policy instead of recording a use of a portion of its comparatively large cash capital for this purpose. The reserve did not represent an actual liability but a mere guarantee. If capital were used to make the deposit it would represent the employment of that capital in a specific business use and no depletion would result. Only in case of payments actually made from the reserve would surplus be called upon to restore the deficit. Petitioner’s voluntary method of keeping its accounts can not affect the facts here upon which the prohibition against dividend payments rested. Cf. Doyle v. Mitchell Brothers Co., 247 U. S. 179. None of them existed.

Section 26 (c) (1) is a credit provision and petitioner must bring itself strictly within the terms of the statute to have the benefit of the credit therein provided. Crane Johnson Co. v. Commissioner, 105 Fed. (2d) 740. We do not think it has done so or that it is entitled to the credit provided in that section.

Petitioner makes a final contention which is so vague that it does not form an issue in the case. It argues that the free surplus existing from prior years may not be used to cut down the amount of credit to which petitioner is entitled under section 26 (c) (1), and that this section should be so construed as to avoid questions of constitutionality. With the latter proposition we agree, but we are unable to find that respondent has anywhere taken the position with which petitioner charges him. He has merely disallowed the credit in toto, and we have concluded that he did so properly.

Decision will be entered for the respondent.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      (c) Contracts Restricting Payment op Dividends.—
      (1) Prohibition on payment op dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.