author: ARNOLD: TuRner,

text:
    Del Mar Addition, B. G. Barnes, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94804.
    Promulgated October 31, 1939.

      George S. Atkinson, Esq., and M. S. Garneiro, O. P. A., for the petitioner.

      Elmer L. Corbin, Esq., for the respondent.
   OPINION.

ARNOLD:

This petitioner was created to subdivide, improve, and sell a tract of land, and its creators adopted the trust mechanism as a medium for carrying on their enterprise and dividing their gains. Our question is whether the organization so created should be considered an association taxable as a corporation. The fundamental principles involved have been fully discussed in Morrissey v. Commissioner, 296 U. S. 344, and its companion cases; Swanson v. Commissioner, 296 U. S. 362; Helvering v. Coleman-Gilbert Associates, 296 U. S. 369; Helvering v. Combs, 296 U. S. 365. In each of these cases the agreement involved purported to create an ordinary trust, but in each instance the Court held that an organization having so many of the features of a corporation should be treated for tax purposes as an association taxable as a corporation.

The salient features of a trust, created and maintained as a medium for the carrying on of a business and sharing its gains, were fully set forth in the Morrissey opinion, supra, and may be briefly restated as follows: (1) Trustees, as a continuing body with provision for succession and holding title to property; (2) centralized management; (3) security from termination or interruption by death of owners of beneficial interest; (4) transfer of beneficial interest without affecting continuity of enterprise; and (5) limitation of personal liability to property embarked in the undertaking. If, as petitioner contends, its tax status turns upon how closely it resembles a corporation, its salient features should be compared with those above set forth to determine wherein petitioner’s features are analogous to a corporation, and wherein there is a marked dissimilarity. If the comparison shows that corporate features preponderate it should be held to be an association and taxed as though it were a corporation. N. B. Whitcomb Coca-Cola Syndicate, 35 B. T. A. 1031; affd., 95 Fed. (2d) 596; Bert v. Helvering, 92 Fed. (2d) 491, affirming 34 B. T. A. 805.

An analysis of the trust instrument herein reveals that provision was definitely made for three of these features, namely; title was taken in the trustees as a continuing body with provision for succession; management and control were centralized in the trustees; and the enterprise was secured against termination or interruption through the death of owners of beneficial interests. While the instrument contains no provisions relative to the transfer of beneficial interests, the right existed and such interests were actually transferred by the participants by bill of sale, the usual method by which the transfer of title to personal property is declared and established, without affecting the continuity of the enterprise.

The failure to include a specific provision limiting the personal liability of the participants will not prevent the classification of this enterprise as an association, since it is resemblance, and not identity, with which we are concerned. The absence of such a limitation did not prevent the court in Bert v. Helvering, supra, from holding a syndicate to be an association, and its absence will not prevent a like classification here. The failure to include the provision in the present trust instrument may be partially explained by the belief of the participants that the enterprise would create no liabilities in excess of their original investments. B. G. Barnes testified that the matter of personal liability was discussed and “It was considered there might have been a personal liability, but they did not consider they were going into a business where any liability would be created.” This indicates that the parties thought it unnecessary to limit tlieir liability to the property embarked in the undertaking.

While the witness Barnes testified that no use was ever made of the instrument executed by the interested parties on August 4, 1980, it aids in interpreting the trust agreement of May 9, 1925, by more specifically declaring the intention of the interested parties under the generalities of that instrument. It clearly shows the parties intended by the May 9,1925, agreement, a continuing business organization under representative management until the purposes of the (rust were fully accomplished.

This petitioner has attempted to fortify its theory that it is preponderantly akin to a trust or partnership by stressing the absence of corporate forms and procedure, but we think this argument is answered by the Supreme Court’s language in Helvering v. Coleman-Gilbert Associates, supra, wherein it stated:

The significant resemblance to the action of directors does not lie in the formalities of meetings or records hut in the fact that, by virtue of the agreement for the conduct of the business of a joint enterprise, the parties have secured the centralized management of their undertaking through designated representatives.

Eecent decisions of the Board have pointed out that the purpose for which a trust is created is probably the most important single factor to be determined where the question raised is that of a trust or an association, Cleveland Trust Co., Trustee, 39 B. T. A. 429, 435; and that it is the powers conferred by the trust instrument which determine the character of the trust, Lee H. Marshall Heirs, 39 B. T. A. 101, 110. See also Williams Trust, 39 B. T. A. 612, and the Morrissey and companion cases, supra. The purpose of the present trust was stated in the trust instrument to be a “desire to subdivide and sell” the property acquired. The trustee, B. G. Barnes, testified that this was the purpose, and in furtherance of that purpose the property was improved, houses were built and sold, an office force was maintained, and all the land acquired was sold to the public in the ordinary course of business. Both the provisions of the trust agreement and the activities conducted thereunder convince üs that this was a so-called “business trust”, Bogert, Trusts and Trustees, vol. 2, p. 971 et seq., which was created as a convenient method for dealing in real estate, developing the acreage, improving it, and selling the property to the public. It was definitely an organization for profit, the profits were still coming in during the taxable year, and the trust should, in our opinion, be classified as an association taxable as a corporation.

We find no conflict in our decision here with the Supreme Court’s decision in Lewis S Co. v. Commissioner, 301 U. S. 385, or with our decision in Gibbs-Preyer Trust #1, 39 B. T. A. 492. Upon an examination of Commissioner v. Gerstle, 95 Fed. (2d) 587, affirming 33 B. T. A. 830, we think that case is distinguishable on its facts. While each proceeding must stand upon its own particular facts we find support for our conclusion in the decisions of the courts in Thrash Lease Trust v. Commissioner, 99 Fed. (2d) 925, affirming 36 B. T. A. 444; certiorari denied, 306 U. S. 654; Wellston Hills Syndicate Fund v. Commissioner, 101 Fed. (2d) 924, affirming 36 B. T. A. 575; and Kilgallon v. Commissioner (C. C. A., 7th Cir.), 96 Fed. (2d) 337; certiorari denied, 305 U. S. 622.

Petitioner’s first alternative contention is that sections 105 and 106 of the Revenue Act of 1935, as amended by sections 401 and 402 of the Revenue Act of 1936, are unconstitutional because they are arbitrary and capricious and are violative of the due process clause of the Fifth Amendment to the Constitution. The respondent asserts that it is unnecessary for the Board to pass upon the constitutionality of section 105, since the deficiency relates to excess profits taxes and no deficiency has been asserted with respect to the capital stock tax.

Section 105, as amended, provides for an excise tax of one dollar per $1,000 upon the “adjusted declared value” of petitioner’s capital stock. Section 106, as amended, imposes an excess profits tax upon each income tax taxable year ending after the close of the first year in respect of which petitioner is taxable under section 105. The rates of tax prescribed are 6 percent on that portion of the net income in excess of 10 percent and not in excess of 15 percent of the “adjusted declared value” of petitioner’s capital stock as fixed and determined under section 105, and 12 percent on the net income in excess of 15 percent of the adjusted declared value.

The constitutionality of section 105 of the Revenue Act of 1935 has been considered .and decided adversely to petitioner’s contention in Allied Agents, Inc. v. United States, 26 Fed. Supp. 98. In considering the question the court found it necessary to examine the relationship that existed between the capital stock and the excess profits taxes provided for in sections 105 and 106, respectively, of the 1985 Act and like provisions appearing in the National Industrial Eecovery Act and the Eevenue Act of 1984, sections 215 and 216 of the National Industrial Eecovery Act, and sections 701 and 702 of the Eevenue Act of 1934. In its discussion of the constitutional question the court held that “the two taxes are inseparable and must be considered together”, and this petitioner has recognized the inseparability of the two taxes by alleging the unconstitutionality of both taxes in order to reach the one in which' it is interested.

In our opinion the reasoning of the court in Allied Agents, Inc., supra, is dispositive of petitioner’s contention. Furthermore, in A. J. Crowhurst & Sons, Inc., 38 B.T.A. 1072, and W. & K. Holding Corporation, 38 B.T.A. 830, 844, the Board has upheld the constitutionality of sections 215 and 216 of the National Industrial Eecovery Act, the provisions of which are substantially identical to the sections here involved. See also Chicago Telephone Supply Co. v. United States (Ct. Cls.), 23 Fed. Supp. 471; certiorari denied, 305 U.S. 628, which discusses the constitutionality of sections 701 and 702 of the Eevenue Act of 1934.

Petitioner cites and relies upon Oertel Co. v. Glenn, 13 Fed. Supp. 651; affd., Glenn v. Oertel Co. (C. C. A., 6th Cir.), 97 Fed. (2d) 495. That case related to the right of the taxpayer to file an amended capital stock tax return and correct the alleged mistake of fact under sections 215 and 216 of the National Industrial Eecovery Act, 48 Stat. 195, 207, and 208. The District Court discussed the constitutional question, but turned its decision upon the fact that there had been no proper determination of value. The Circuit Court ignored the constitutional question but affirmed the taxpayer’s right to file an amended return where the return was -filed within the period as extended. We can see no reason for holding that these decisions invalidate the sections in question, or that they are authority for a determination that sections 105 and 106, as amended, are unconstitutional.

The second alternative issue is whether petitioner’s delinquent filing of its 1936 capital stock tax return will satisfy the statutory requirements. The capital stock tax return filed by petitioner on January 12, 1939, wasi due during the month of July 1936. The return was filed in 1939 after the case was at issue and five days before the hearing, for the sole and only purpose of obtaining the benefit of an exemption for excess profits tax purposes should it be held that petitioner was liable to tax as an association. In this return petitioner fixed the. adjusted declared value of its capital stock at $250,000, which would prevent the imposition of an excess profits tax, since 10 percent of the declared value of its capital stock is in excess of petitioner’s taxable net income.

In determining the excess profits tax deficiency respondent reduced the petitioner’s net income by the amount of its income tax liability and taxed the remainder at the rate of 12 percent upon the theory that, no declaration of value of the capital stock having been made, the applicable rate was 12 percent. Sec. 106, as amended. The respondent contends that, since petitioner did not file a capital stock tax return as required by the statute, it is not entitled to a “credit” of 10 percent of the value declared on January 12,1939, in computing its excess profits tax liability.

The statutory requirements for filing the capital stock tax return are specific. Section 105 (d) of the Eevenue Act of 1935 provides that “Every corporation liable for tax under this section shall make a return under oath within one month after the close of the year with respect to which such tax is imposed. * * The section further provides that “The tax shall, without assessment by the Commissioner or notice from the collector, be due and payable to the collector before the expiration of the period for filing the return.”

Under the foregoing provisions, petitioner’s filing of the capital stock tax return on January 12, 1939, for the year 1936 was not a timely return, as it should have been filed on or before July 31, 1936. The only exception to the statutory rule is where the time for filing has been extended and there is no evidence here that any such extension was granted.

The petitioner, however, relies upon that portion of section 105 (f) which provides that “For the first year ending June 30 in respect of which” a capital stock tax is imposed “the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended),” and contends that the capital stock tax return filed on January 12,1939, was its “first return” under section 105, as amended.

The first return under the 1936 Act, as amended, is important because of the inseparability of the capital stock tax and the excess profits tax. In Allied Agents, Inc., supra, the court explained the reason for and nature of the two taxes as follows:

* * * The main purpose of the new plan for levying these two taxes was to do away with the difficult and innumerable controversies in determining the actual value of invested capital or capital stock; let the taxpayer make a declaration of the value of the capital stock; and then apply an excess-profits tax framed in such a way that there would be an inducement to the taxpayer to place a fair and reasonable value on the stock and if it did not, would so increase the excess-profits tax that little or nothing would be gained by putting an unreasonably low value thereon. This plan made the taxes self-adjusting and, as before stated, Congress had the right to prescribe the basis for the two taxes. It prescribed the declared value as this basis. * * * Moreover, except in very unusual situations such as no statute can guard against, the taxpayer cannot control the taxes that it will pay under the two statutes under consideration by its statement as to the declared value. These statutes are so framed that the higher the declared value of the capital stock the lower will be the excess-profits tax, and the lower the declared value the higher will be the excess-profits tax. In this way when the two taxes are considered together, as they should be, they are as stated above self-adjusting both as to the taxpayer itself and in comparison with what is paid by others under them.

If this petitioner should be permitted to file a return more than two years after it was due and, with full knowledge of its taxable net income, declare a value for its capital stock which would wipe out its excess profits tax liability, the primary purpose of the Congress in enacting the two taxes would be defeated. Petitioner urges that to impose the excess profits tax now would result in an undue hardship, but it must be remembered that from 1925 to the taxable year this petitioner has had benefits to which it was not entitled under the law, as it should have been treated as a corporation for those years.

The Oertel case, supra, and Philadelphia Brewing Co. v. United States (Ct. Cls.), 27 Fed. Supp. 583, held that an amended capital stock tax return could be filed within the period for filing such returns as extended. These decisions do not hold that a taxpayer may file a return more than two years after it is due. The weight of authority, however, is opposed to any filing of an amended return, whether timely or otherwise, as shown by the decisions in Haggar Co. v. Commissioner (C. C. A., 5th Cir.), 104 Fed. (2d) 24, affirming 38 B. T. A. 141; Blake & Kendall Co. v. Commissioner (C. C. A., 1st Cir.), 104 Fed. (2d) 679; and Jacob Froehlich Cabinet Works v. United States (U. S. Dist. Ct.), 28 Fed. Supp. 882.

The Board’s recent decision in Flomot Gin Co., 40 B. T. A. 689, is distinguishable. In that case the taxpayer was permitted to file a return out of time because a return filed timely was deemed to be incomplete and not in “substantial compliance” with the statute. No such facts obtain here. In its brief the taxpayer states that “This return was filed for the sole and only purpose of, in the alternative, getting the benefit of the credit for excess profits tax purposes, if it should be held that petitioners are liable as an association.” The deliberate filing of such a return for the purposes stated is not the return required by section 105 (f) and its filing and acceptance by the Commissioner is ineffective to secure the credit granted by sections 105 and 106, as amended, and will not relieve this taxpayer from its excess profits tax liability. Cf. Taylor Securities, Inc., 40 B. T. A. 696; Gladstone Co., Ltd., 35 B. T. A. 764.

In view of the foregoing discussion we hold that petitioner is an association taxable as a corporation, that sections 105 and 106 of the Bevenue Act of 1935, as amended, are not unconstitutional, and that petitioner is subject to excess profits tax liability.

Beviewed by the Board.

Decision will be entered for the respondent.

TuRner,

dissenting: Under the common plan of the various revenue acts, each particular tax or group of taxes, such as excise taxes, is imposed under a separate title. The statutory provisions, substantive or administrative, peculiar to a particular tax are regularly included in the title imposing the tax. Beginning with the Bevenue Act of 1918, each of the revenue acts has concluded with a title or titles under some such heading as “General Administrative Provisions” or “General Provisions,” which provisions have been made applicable to all taxes imposed by the act in so far as they were not inconsistent with or contrary to the specific or peculiar provisions of the various tax-imposing titles. The period to be covered by the return and the time within which a return may be filed is regularly fixed by the provisions of the title wherein the tax is imposed and no instance comes to mind where any such title has ever contained words or provisions to indicate that the filing of delinquent returns was contemplated. Begardless of that fact, however, section 3176 of the Bevised Statutes, as amended, has been extended and applied to all of the revenue acts as part of the “General Administrative Provisions” or “General Provisions” either by specific reenactment or by- reference. The last revenue act to specifically amend or reenact section 8176 was the Bevenue Act of 1926, and so much of that section as is pertinent to the discussion here reads as follows:

Seo. 3176. If any person, corporation, company, or association fails to make and file a return or list at the time prescribed by law or by regulation made under authority of law, or makes, willfully or otherwise, a false or fraudulent return or list, the collector or deputy collector shall make the return or list from his own knowledge and from such information as he can obtain through testimony or otherwise. In any such ease the Commissioner of Internal Revenue may, from his own knowledge and from such information as he can obtain through testimony or otherwise, make a return or amend any return made by a collector or deputy collector. Any return or list so made and subscribed by the Commissioner, or by a collector or deputy collector and approved by the Commissioner, shall be prima facie good and sufficient for all legal purposes.
The Commissioner of Internal Revenue shall determine and assess all taxes, other than stamp taxes, as to which returns or lists are so made under the provisions of this section. In case of any failure to make and file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the collector in pursuance of law, the Commissioner shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax. * * *

In the instant case the question is whether or not the petitioner had the right or could under, the statute file an effective capital stock tax return after the time prescribed by statute. Section 105 (d) of the Eevenue Act of 1985 provides that “every corporation liable for tax under this section shall make a return under oath within one month after the close of the year with respect to which such tax is imposed” but contains no provision for the filing of delinquent returns. It continues as follows: “All provisions of law (including penalties) applicable in respect of the taxes imposed by section 600 of the Eevenue Act of 1926 shall, insofar as not inconsistent with this section, be applicable in respect of the taxes imposed by this section.” Section 600 of the Eevenue Act of 1926 levies an excise tax upon the sale or lease by the manufacturer of certain specified articles. Monthly returns are required and, consistent with the general plan of the revenue acts, section 600 contains no provision for the filing of delinquent returns. Section 1100 of the Eevenue Act of 1926, the first section of Title XI — General Administrative Provisions — provides, however, that “All administrative, special, or stamp provisions of law, including the law relating to the assessment of taxes, so far as applicable, are hereby extended to and made a part of this Act.” Section 1103 of that title reenacts the provisions of section 3176 of the Eevised Statutes, part of which has been quoted above, and from the provision quoted it appears that the filing of delinquent returns not only is anticipated but is required, even though it may be necessary for a collector, a deputy collector, or the Commissioner of Internal Eevenue himself to make such returns. I am unable to find anything in the statute to indicate that any exception was made or intended with respect to capital stock tax returns.

The reasoning advanced in the majority opinion is that the purpose of Congress in imposing the excess profits tax would be defeated if delinquent capital stock tax returns were permitted, since a taxpayer filing a delinquent capital stock tax return could declare a value for its capital stock which would wipe out any liability for excess profits tax. While such a case may be possible, the Commissioner at all times has the power to prevent it. Where a taxpayer fails to make and file a return or list at the time prescribed by law, the collector or a deputy collector is directed by the statute to make a return for such taxpayer, or the Commissioner himself may make the return, and the statute further provides that any return so made “shall be prima facie good and sulficient for all legal purposes.” A return so made would, in my opinion, constitute the taxpayer’s first return within the meaning of section 105 (f) and the taxpayer would be hound by the value therein declared for his capital stock, and his return subsequently filed would be ineffective to change the value so established. If, however, the collector, his deputy, or the Commissioner fails to act, it is my view that the statute not only permits but anticipates the filing of a delinquent return by the taxpayer, subject to the penalty prescribed.

For the reasons stated above, I respectfully note my dissent.

ARUNdell, Smith, and Leech agree with this dissent.


source: Caselaw Access Project

author: Haibron:

license: Public Domain

text:
    Edwin B. De Golia and Eva R. De Golia, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91130.
    Promulgated October 31, 1939.

      B. A. Bronson, Esq., and Walter Hood, O. P. A., for the petitioners.

      Alva 0. Baird, Esq., and Arthur L. Murray, Esq., for the respondent.
   OPINION.

Haibron:

Petitioners did not include the sum of $20,000 in gross income for the year 1935. The Commissioner added that amount to taxable income as prepaid rent, taxable in the year of receipt. Whether or not the determination of the Commissioner is correct depends upon the construction to be placed upon the terms of the lease and upon the special considerations which must be given to the receipt of income, under the pertinent revenue act, by taxpayers reporting income on a cash basis.

The considerations here necessarily differ from considerations which would be pertinent in another type of proceeding where, for example, under local law, a lessee seeks to recover a sum paid in advance under a lease upon termination of or breach of a lease. Petitioners’ argument that the question is to be considered with regard for what is contended to be the law of the State of California relating to deposits under leases, suffers from failure to give more consideration to the rule that, for purposes of taxation, earnings of property are gross income in the year received by a taxpayer on a cash basis, where there is no present restriction on the use of the money received, and where the possibility of having to return any of such income in future years is only a remote contingency.

Petitioners contend that they did not receive title to the $20,000 paid ; to them by the lessee under the particular lease and that, consequently,: they are not taxable thereon. The contention is that the payment was a mere deposit as security for performance by the lessee and that title to the money remained in the lessee. Numerous decisions of courts of the State of California are cited to support the contention. However, our examination of the cases cited shows that there is no clear-cut rule and in each case the question may be whether an advance lump-sum payment, under a lease, is an absolute payment in consideration for the execution of a lease, or an advance payment of rent, or a deposit given to secure performance by the lessee. The terms of each particular lease are controlling and it is not the form of the particular terms, but the substance thereof, which is determinative. Sullivan v. Johnson, 116 Cal. Supp. 591; 3 Pac. (2d) 72. • The question here must be considered by reference to the terms of the lease, as determinative of the nature of the payment in question for purposes of taxation.

Careful reading of the terms of the lease shows that no provision is made anywhere for the return of any part of the advance payment of $20,000 to the lessee. The payment was required under the rent provisions of the lease. The payment was both a down payment and a payment of rent in advance. It apparently constituted part of the consideration for the execution of the lease. When the sum was received, the right of the lessors to the money in question was absolute. That the term “deposit” is used in the lease to describe the payment, is not determinative. Even though the advance payment served to bind the lessee to strict compliance with the terms of the lease, it is a presumption that contracts will be observed and not broken, Wells v. Savannah, 181 U. S. 581; Central Trust Co. v. Chicago Auditorium Association, 240 U. S. 581, and such effect of the advance payment does not prevent it from being held to be income in the year received. United States v. Boston & Providence Railroad Corporation, 87 Fed. (2d) 670. Since the lease does not provide, in any way, for return of the payment to the lessee, it can not be concluded that there was even a contingent liability at the time of the payment to return any part, in the future, to the lessee. The lease leaves unstated any provisions for the use of the $20,000 payment in the event of any breach of covenant by the lessee, and it clearly provides that the payment is to be applied to rent. Nothing in the lease indicates that the advance payment was a loan to the lessors. In our opinion, under the terms of the lease the payment, in substance, was an advance payment of rent. Petitioners received the payment without any obligation to return it to the lessee and, being on the cash basis, they are taxable upon the $20,000 in the taxable year. It is so held, upon authority of the following cases: Renwick v. United States, 87 Fed. (2d) 123; Brown v. Helvering, 291 U. S. 193; Commissioner v. Lyon, 97 Fed. (2d) 70; North American Oil Consolidated v. Burnet, 286 U. S. 417,424; Grand Central Public Market v. United States, 22 Fed. Supp. 119.

Decision will be entered for the respondent.


author: Mukdock :

text:
    Nathan Stein, Petitioner, v. Commissioner of Internal Revenue, Respondent. Moritz Straus, Petitioner, v. Commissioner of Internal Revenue, Respondent. Meier A. Straus, Petitioner, v. Commissioner of Internal Revenue, Respondent. Friedrich A. Straus, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 83178, 83179, 83180, 83181.
    Promulgated October 31, 1939.

      Fred R. Angevine, Esq., and Harry W. Forbes, Esq., for the petitioners.

      John R. Wheeler, Esq., for the respondent.
   OPlNtON.

Mukdock :

The first question for decision is whether Straus & Co. had any gross income from sources within the United States within the meaning of section 119 (e) of the Revenue Act of 1928. The only contention made by the Commissioner is that the transactions which the partnership had in drafts drawn on banks in the United States represented “gains, profits and income * * * from the purchase of personal property without and its sale within the United States.” Section 119 (e) of the Revenue Act of 1928, upon which he relies, provides that such gains, profits, and income shall be treated as derived entirely from sources within the United States. The argument of the respondent is that Straus & Co. purchased drafts from its clients in Germany and sold those drafts in the United States for more than it had paid for them. The soundness of this argument obviously depends upon two things — first, whether Straus & Co. purchased personal property in Germany, and, second, whether it sold that personal property in the United States. The respondent has neglected to make any argument or cite any authorities to show that Straus & Co. purchased personal property in Germany.

Decisions of courts in the United States uniformly hold that the original negotiation of paper is a loan and not a sale. Schermerhorn v. Taiman, 14 N. Y. 93; Stirling v. Gogebic Lumber Co., 165 Mich. 498; 131 N. W. 109; Bank of Ashland v. Jones, 16 Ohio St. 145; MacLean v. Lafayette Bank, 16 Fed. Cases, 264. The rationale of those decisions is that a promise or agreement to pay is not property in the hands of the person who makes the promise or agreement, and since) there must be a transfer of some property to another for a price in order to constitute a sale, the original negotiation whereby one gives his promise or agreement to pay to another is not a sale but is merely the borrowing of money. The paper is property in the hands of the payee after the completion of the original negotiation, and all subsequent transfers, with the possible exception of the final payment of the paper, may be sales. First National Bank of Blanchester v. Stengel, 169 N. Y. S. 217; affd., 171 N. Y. S. 1085; Heinrich v. First National Bank of Middletown, 219 N. Y. 1, 5; 113 N. E. 531; Ogdin v. Goodwin, 76 Fed. (2d) 196; Douglas v. Federal Reserve Bank of Dallas, 271 U. S. 489; In re Ruskay, 5 Fed. (2d) 143; Union Electric Steel Co. v. Imperial Bank, 286 Fed. 857. Straus & Co. acquired all of the drafts in question from the original drawers in Germany. Those transactions were not purchases of personal property without the United States, and, consequently, the contention made by the Commissioner must fall.

The respondent cites cases to show that the deposit of a draft in the ordinary course of business, without any special understanding which might color the transaction, is a sale. There is a general rule that the deposit of a draft by one other than the drawer, is a sale. The court said in First National Bank of Blanchester v. Stengel, supra:

It is a well-understood rule of law that a deposit of a draft or cheek in the ordinary course of business, the depositor receiving a credit against which he can draw, has the effect of transferring title. The rule is based upon the reason that the check or draft is deposited and received by the bank as so much cash, which immediately becomes the property of the bank. The transaction is a sale. The banker has become absolutely responsible to the depositor. With such a relation existing, the bank, in case of the dishonor of a deposited check or draft, possesses no right to charge back the depositor’s account with the amount of the dishonored cheek or draft. Its sole recourse is to hold the depositor to his liability upon his contract of indorsement. In order for the rule to apply, the deposit must be a naked deposit, and the credit given must be unconditional and unrestricted, and without any special understanding or general usage of business obtaining in the locality which might color the transaction.

The rule applies in New York. See In re Ruskay, supra, where the court said:

In New York it is not open to question that if a deposit is made by a customer in a bank in the ordinary course of business either of money, or drafts or checks received and credited as money, the title to the money, or to the drafts or checks, is immediately vested in and becomes the property of the bank * * *.

The paper involved in the case of Union Electric Steel Co., supra, was a draft payable 60 days after date which was discounted by a bank before maturity. The bank credited the proceeds to the account of the payee. The court said:

When the bill in question was deposited in the bank, discounted, and the proceeds were placed to the credit of the [payee], title to it, in the absence of any agreement to the contrary, was thereafter in the bank. These transactions were the ordinary method of the transfer or sale of the instrument by the holder and the purchase of it by the bank. * * *

The respondent relies upon the rule as stated in the above cases to show that Straus & Co. sold the drafts in the United States when it had them discounted. Those drafts were foreign bills of exchange. Sec. 213, New York Negotiable Instruments Law. They were in form orders from various parties in Germany to banks in the United States for the payment of money to Straus & Co., or its order, on account of the drawer. They were payable so many days after sight. Drafts payable after sight must be presented for acceptance in order to charge the drawee and the drawer and to fix the time for payment. Richard v. Connecticut Electric Manufacturing Co., 194 N. Y. S. 497. Acceptance makes the acceptor the principal debtor to the extent of the acceptance and the paper thereby becomes similar to a promissory note, with the acceptor standing in the position of promisor and the drawer standing in the position of a first endorser. Cox v. National Bank, 100 U. S. 704; Haddock, Blanchard & Co. v. Haddock, 192 N. Y. 499; 85 N. E. 683; U. S. Rail Co. v. Wiener, 169 App. Div. 561; 155 N. Y. S. 425.

However, the drafts in this case were somewhat different from ordinary drafts. They were not accepted by the New York banks upon the credit of the drawer, but were accepted upon the credit of Straus & Co. in accordance with the agreement of the latter to pay the accepting bank the full amount of each draft two days prior to its maturity. Thus, when Straus & Co. had the drafts discounted, it was not simply depositing those drafts in the ordinary course of business and receiving credit for the proceeds without any further obligation, except as an endorser, and it may be that the cases cited by the respondent are not in point. Since Straus & Co. had agreed to pay the amount of the draft to the accepting bank just prior to maturity, it was somewhat in the position of obtaining a loan upon its own promise to pay when it had the drafts discounted. Perhaps that transaction was a loan and not a sale under the cases first cited above, and perhaps an excessive discount rate would have been usury under those cases. No case involving a similar set of facts has come to our attention. However, in view of the holding that Straus & Co. did not purchase personal property without the United States, this point need not be decided. Another point which would have to be decided before the determination of the Commissioner could be approved, would be whether or not there was a fatal difference between the drafts acquired by Straus & Co. in Germany and the bank acceptances which it had discounted in this country. The liabilities of the parties were very different after acceptance from their liabilities before acceptance. The words of the statute relied upon by the Commissioner may refer only to a purchase of personal property and a sale of the same property.

This decision, however, is placed upon the ground that Straus & Co. did not purchase personal property without the United States. The substance of the transactions was, apparently, that Straus & Co. loaned money in Germany at a higher rate than the rate at which it was able to borrow the money in the United States. Its transactions in Germany were loans and its transactions in the United States were in effect borrowings. It derived no profit from the transactions in the United States. Its profit, if any, was earned in. Germany from the lending of the money on the credit and risk of its clients. It does not appear that Congress intended to tax that kind of a profit. Cf. sec. 119 (c) (1). Certainly the profit is not taxable under the statutory language relied upon by the Commissioner, and we know of no other provision of the statute under which it would be taxable. We, therefore, hold that the partnership had no taxable income from these transactions.

The petitioners raised the second issue only as an alternative in case of a holding that the partnership had income from sources within the United States from the transactions in foreign bills of exchange. Since that first issue has been decided favorably to the petitioners, the second issue does not arise and need not be decided.

The only question remaining for decision is whether the petitioners are liable for penalties of 25 percent under section 291 for failure to file required returns. These petitioners, nonresident aliens, were required by section 217 to file their returns on or before the fifteenth day of June following the close of each calendar year. The Commissioner has provided in article 1081 of Eegulations 74 that a full and accurate return shall be made for a nonresident on form 1040B of income received from sources within the United States, regardless of amount, unless the tax on such income has been fully paid at the source. Section 51 requires a return to be filed by every individual whose net income is $1,500 or over in the case of a single person, whose net income is $8,500 or over in the case of a married person, or whose gross income is $5,000 or over regardless of the amount of net income. The stipulation shows that the net income of the petitioners from sources within the United States was sufficient to require them to file returns even though the income of the partnership from foreign bills of exchange discounted in this country was not income from sources within the United States. They did not file timely returns and section 291 applies. If no returns were filed, there is no escape from the penalty, whei’eas if returns were filed late, the penalty may be escaped only by a showing that the failure to file on time was due to reasonable cause and not to willful neglect.

The petitioners filed returns for the calendar years 1929 and 1980 in July 1932. The Commissioner contends that those are not returns because they did not report all income from sources within the United States and did not contain the information required in section 215 (a). However, the provisions of section 291 are entirely different from the provisions of section 215 (a), and it does not appear that a return could not be satisfactory for the purpose of the former without being satisfactory for the purpose of the latter. The petitioners argue that the record contains evidence to show that the failure to file returns on time was due to reasonable cause and not to willful neglect. They point to the letters accompanying the partnership returns stating that the partners were not filing returñs because the partnership income was a minus quantity and offering to file returns if requested to do so. They also point to the fact that they filed returns voluntarily before any request was made and despite their belief that no tax was due. The stipulation shows that each petitioner in each year had net income in excess of $3,500 from sources within the United States. It is not clear whether this income was all partnership income, all nonpartnership income, or a combination of partnership and nonpartnership income. The record contains no explanation whatsoever why the petitioners did not file timely returns reporting their nonpartnership income from sources within the United States. The excuse given for failing to report any partnership income from sources within the United States would seem to be that the partners believed that the partnership had deductions in excess of income and that a loss would be deductible by the partners under the revenue act. However, the facts in the record do not disclose how any reasonable person could conclude that the partnership was entitled to the large deductions claimed, that it sustained losses from its transactions in foreign bills discounted in this country, or that it had losses of any kind which would be deductible by the partners under the revenue act. The Board can not make a finding that their failure to file returns on time was due to reasonable cause and not to willful neglect in the absence of an adequate explanation of their failure to make a substantially correct and timely report of all of their income from sources within the United States. The parties have stipulated the amount of tax due under this decision and we hold that an additional 25 percent of the tax is due under section 291.

Decisions will be entered wader Rule 50.

       The redemption of bonds is not a sale. Fairbanks v. United States, 306 U. S. 436; Arthur U. Braun, Trustee, 29 B. T. A. 1161; John H. Watson, Jr., 27 B. T. A. 463.


author: Murdock:

text:
    Dayton & Michigan Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94831.
    Promulgated November 2, 1939.

      R. Kemp Slaughter, Esq., for the petitioner.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $15,155.76 in the income tax of the petitioner for the calendar year 1935. The issue for decision is whether the petitioner is entitled to deduct, as interest, $96,900 paid on its preferred stock. The petitioner contends that the preferred stock was in fact an indebtedness and the payments were not dividends but interest. The parties agree that a subordinate issue will depend entirely upon decision of this main issue. The facts have been stipulated and are found in accordance with the stipulation.

The petitioner was incorporated in Ohio in 1851. A law of the State of Ohio was enacted on April 16, 1870, which authorized any railroad company incorporated under the laws of the state to issue [ preferred stock and to guarantee dividends of not more than 8 \percent on the stock, for the purpose of providing means for the redemption of its bonds. The petitioner at that time had 7 percent mortgage bonds outstanding and it also had common stock outstanding. The petitioner issued 8 percent preferred stock pursuant to that act. The stock had no voting rights. Dividends ■jin the amount of 8 percent were guaranteed by the petitioner. IA mortgage of the petitioner’s property was executed as security for 1 the payment of the dividends on the preferred stock. The mortgage provided that the properties should not thereafter be encumbered to the prejudice of the preferred stockholders, and that in case of default in the payment of dividends on the preferred stock the trustee under the mortgage could enter into possession and take over management of the railroad upon demand of a preferred stockholder. It } also provided that the proceeds of any sale of the property, after I the payment of all lawful prior charges, should be applied to the redemption of the preferred stock at its par value. The petitioner had leased its properties in 1863 to the Cincinnati, Hamilton & Dayton Railroad Co. The lessee, which' had been paying the interest on the mortgages of the petitioner, assented to the issue of the preferred stock and to the mortgage, guaranteed punctual payment of the dividends on the preferred stock according to the terms of the stock, and thereafter paid the dividends on the preferred stock. The Toledo & Cincinnati Railroad Co., a wholly owned subsidiary of the Baltimore & Ohio Railroad Co., acquired the lease of the Cincinnati, Hamilton & Dayton Railroad Co., upon the properties of the petitioner. Thereafter, the Baltimore & Ohio Railroad Co. in 1917 assumed the guarantee of the dividends on the preferred stock of the petitioner. It paid $96,900 in 1935 to the holders of the preferred stock of the petitioner as the dividends of 8 percent on the stock.

The above recital of facts is not intended as a full statement of the stipulated facts. Its purpose is merely to indicate the way in which the the issue has arisen. All of the stipulated facts have been carefully considered in reaching the conclusion hereinafter indicated. The parties agree that the payment of $96,900 is a part of the gross income of the petitioner. The petitioner recognizes that if the payment of that amount to its stockholders was the payment of a dividend, it is not entitled to any deduction, whereas the respondent concedes that if the payment was of interest, then the petitioner is entitled to a deduction, regardless of the fact that the payment was made by the Baltimore & Ohio Railroad Co. directly to the holders of the preferred stock. The petitioner contends that the certificates of so-called preferred stock were in fact not preferred stock but certificates of indebtedness, so that the payment of 8 percent thereon was a payment of interest deductible under section 23 (b) of the Revenue Act of 1934.

Many cases involving similar questions have been considered by the Board and the courts. Each case has turned, of necessity, upon the facts of that particular case. However, certain basic principles for deciding whether or not a certain issue is a stock or an indebtedness, are now well established. These principles are sufficiently stated for present purposes in Helvering v. Richmond, Fredericksburg & Potomac Railroad Co., 90 Fed. (2d) 971, as follows:

The essential difference between a “stockholder” and a “creditor” is that the stockholder intends to embark upon the corporate adventure, taking the risks of loss attendant upon it that he may enjoy the chances of profit. The creditor on the other hand, does not intend to take such risks so far as they may be avoided but merely to lend his capital to others who do intend to take them. Warren v. King, 108 U. S. 389, 399, 2 8. Ct. 789, 27 L. Ed. 769. While no comprehensive rule may be laid down for distinguishing in' all cases between an investment in a corporation and a loan to it, one of the most important considerations is whether the right to share in the assets of the corporation in case of dissolution is subject to the rights of the creditors. If subject to such right, there is a strong presumption that the interest in question is that of a stockholder. * * * If it is not subject to such right, or if, as here, it is preferred over the right, the status of a creditor rather than a stockholder is indicated.

The Supreme Court of Ohio in 1890 decided the case of Miller v. Ratterman, 47 Ohio St. 141; 24 N. E. 496. The plaintiff held some of the preferred stock of the Dayton & Michigan Railroad Co., the same stock that is involved in the present proceeding. He brought suit against the treasurer of Hamilton County, Ohio, to enjoin the collection of a tax. He contended that the preferred stock was stock of an Ohio corporation and, as such, was not subject to the tax. The county treasurer claimed that the certificates were in reality evidence of indebtedness of the company and subject to tax. The court considered the matter fully and carefully. The question was whether the certificates were certificates of stock or certificates of indebtedness because, if they were the latter, they were taxable. The court first considered the purpose and effect of the Act of April 16, 1870, and stated that it authorized the issuance of preferred stock to enable railroad companies to pay their bonded debts, but did not authorize the exchange of one form of indebtedness for another, and the payment of dividends as authorized by the act was limited to payment from earnings. The court held that the stock actually issued by the Dayton & Michigan Railroad Co. under the act gave to the stockholders the right to receive the dividends only out of earnings and the mortgage did not give to the preferred stockholders rights prior to those of creditors, including general creditors. It held further that, taking all of the facts and circumstances into consideration, the rights of the preferred stockholders were subordinate to those of all creditors, and concluded that the certificates were preferred stock and not evidences of debt. It said that any other interpretation of the provisions of the various instruments would mean that the entire transaction was illegal. It held finally that the shares were not subject to the tax.

The Board may not be bound to follow the conclusion of the Ohio court that the certificates were stock and not evidences of indebtedness, but a decision of the highest court in a state as to property rights within the state is, if not binding, at least competent authority for the Board to follow. The Supreme Court of the State of Ohio held in that case that the dividends on this stock were payable only out of earnings of the corporation, the mortgage did not give the preferred stockholders rights prior to those of creditors, and the rights of the preferred stockholders under all of the circumstances were subordinate to those of creditors. The rights of the preferred stockholders having thus been determined by the highest court in Ohio, and there being no conflict of authority on the subject in the state, we conclude from those rights that the stock was in fact stock and not evidence of indebtedness.

The petitioner relies upon the case of Helvering v. Richmond, Fredericksburg & Potomac Railroad Co., supra, wherein the court held that certain preferred stock, with guaranteed dividends, was an indebtedness. The guaranteed stock in that case was issued pursuant to a statute of Virginia and was secured by a mortgage prior to liens of general and secured creditors which could be foreclosed on default in payment of the guaranteed dividends. One very obvious difference between this case and the Richmond, Fredericksburg & Potomac Railroad Co. case is that the issuance of certificates of indebtedness under this statute of Ohio would have been illegal, whereas the issuance of the certificates of indebtedness under the law of Virginia was legal. Other important differences are that there the dividends were payable without regard to earnings, while here they were payable only out of earnings, and the certificates in this case did not give the holders' thereof rights equal or prior to those of general creditors, whereas the certificates in the Virginia case did.

Decision will be entered for the respondent.


author: HaReon :

text:
    Edwin C. F. Knowles, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91495.
    Promulgated November 2, 1939.

      B. J. Feigenbaum,, Esq., and N. L. McLaren, G. P. A., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

HaReon :

It is conceded by respondent that the stocks of the four corporations in question were community property. It follows that the income from dividends on the stocks was community income. The question is, whether all of the income from dividends paid on the stock of the California and Arizona corporations in 1934 and 1935 is taxable to petitioner, a husband, or is taxable one-half to petitioner and one-half to his wife, under the community property law of the State of California.

The particular question arises because of a change made in the community property law of California by enactment of section 161a of the Civil Code of California, effective July 29, 1927. Prior to enactment of section 161a, it was the law in the State of California, perhaps peculiar to that state, that a husband was the sole owner of community property and the wife had no title or vested, one-half interest, but only a mere expectancy, as heir, if she survived him. Stewart v. Stewart, 269 Pac. 439. Giving recognition to the peculiarities of California community property law, the Supreme Court held, in 1926, that income of community property may be taxed wholly against the husband. United States v. Robbins, 269 U. S. 315.

The enactment of section 161a is regarded as expressing a legislative intent to change the theory of ownership in community property acquired after enactment of the statutory provision, and to afford the wife a one-half interest therein. See 22 California Law Review, 417; 7 So. California Law Review, 13; Bank of America National Trust & Savings Association v. Mantz, 49 Pac. (2d) 279, although the appellate courts of California have not yet passed on the effect of the enactment of section 161a on this point. At least, no decisions have been brought to our notice. However, the attitude of the Supreme Court of the United States, expressed in United States v. Malcolm (1931), 282 U. S. 792, and in cases cited therein, is highly significant. The Supreme Court in the Malcolm case recognized a proprietary vested interest in the wife (in California) in community income, by virtue of the provisions of section 161a, in community income earned by a husband after enactment in 1927 of the provision in the Civil Code, and held that under section 161a a wife had such an interest in the community income that she should separately report and pay tax on one-half of such income.

It has been stated by California courts, however, that whatever the effect of section 161a may be on the rights of the respective spouses in community property acquired subsequent to its effective date, July 29, 1927, the new section of the code can not relate back to or govern the ownership of property acquired prior to the effective date. Stewart v. Stewart, supra, p. 442; McKay v. Lauriston, 269 Pac. 519, 528; Levell v. Metropolitan Life Insurance Co., 5 Pac. (2d) 480. See, also, Hirsh v. United States, 62 Fed. (2d) 128; certiorari denied, 289 U. S. 735; Devlin v. Commissioner, 82 Fed. (2d) 731.

It would appear to be the legislative intent that the effect of section 161a is limited to community property acquired after July 29, 1927, and is to give a wife a present, one-half interest in such property. It seems to be consistent with the view of the Supreme Court, expressed in the Maloolm case, that a wife should report and pay tax on one-half of income produced by community property acquired after July 29, 1927, the income acquired after July 29, 1927, being governed by the same rule applicable to other types of community income. See Clara B. Parker, Executrix, 31 B. T. A. 644, 656.

The question in this proceeding turns upon when the shares of stock in the Marsh & McLennan corporations were acquired. The respective rights of husband and wife in community property are determined by the law in force at the date of its acquisition. Trimble v. Trimble, 26 Pac. (2d) 477. Determination of the narrow question depends entirely upon construction of the agreements by and between petitioner and the Delaware corporation. Petitioner contends that on the crucial date, July 29, 1927, he had no enforceable right of any sort, under the agreement of December 31,1926, other than a right to receive salary earned; that no interest in the stocks in question was acquired prior to July 29, 1927; that the interest in the stocks arose out of the 1928 agreement, rather than the 1926 agreement, because the second agreement was intended to expressly cancel the first agreement. [Respondent contends that petitioner acquired inchoate and vested rights in the stock, on December 31, 1926, upon execution of the 1926 agreement. The argument is that the “date of acquisition” is! when an equitable interest arises and not when legal title is transferred. Respondent contends, also, that the 1926 agreement was not canceled, as between petitioner and the Delaware corporation, by the 1928 agreement, but that the 1928 agreement supplemented and modified the 1926 agreement.

First, putting aside the argument that the 1926 agreement was canceled by the 1928 agreement, the question to he considered is when petitioner acquired the mitial right to the stocks in question, particularly in the stocks in the California corporation and in the Arizona corporation.

The time when property is deemed by law to be acquired, as between husband and wife, is as of the time of the acquisition of the initial right. See McKay, Community Property, 2d ed., par. 517, p. 852, where it is also stated that:

* * * it is assumed the initial right of the series is of such character that it is recognized as valid in law or equity and is available against someone. It must be more than a mere unenforceable claim. [Italics ours.]

Also, in a broad sense, contractual obligations are property, and such property, as between husband and wife, is acquired as of the date when the obligation becomes binding. McKay, Community Property, 2d ed., pars. 531, 533, pp. 358, 359.

Under the 1926 agreement, the obligation to sell petitioner stock in the California corporation, only, moved from the Delaware corporation to petitioner, and was subject to two conditions precedent — (a) acquisition of ten shares of stock of the California corporation by the Delaware corporation, from Kinney; (b) petitioner, at such time, had to be in the employ of the California corporation. Unless and until both of these conditions precedent were met, there was no binding obligation on the Delaware corporation to sell ten shares of California corporation stock to petitioner and, certainly, no binding obligation on petitioner to buy such stock.

Turning then to the facts, it is clear that the obligation in the Delaware corporation to sell the California corporation stock to petitioner did not become binding upon it until December 31, 1927, on which date both the conditions precedent were met. On that date, petitioner was in the employ of the California corporation, and Kinney resigned and transferred the particular stock to the Delaware corporation.

It must be concluded, upon reference to the terms of the 1926 agreement alone., that prior to December 31, 1927, petitioner did not have an enforceable claim against the Delaware corporation for acquisition of the California corporation stock; that petitioner did acquire his initial right to the ten shares of California corporation stock on December 31, 1927, and not before, which was after the crucial date, July 29, 1927. It is so held.

It must also be concluded that, without any doubt whatever, petitioner did not, at any time, under the terms of the 1926 agreement, acquire any interest in shares of stock in the other Marsh & McLen-nan corporations in Arizona, Oregon, and Washington. Under the 1926 agreement, there were no obligations in the Delaware corporation to sell stock in any of these corporations to petitioner, and he was not obligated to buy any stock in these corporations. Without any question, and whether or not the 1928 agreement was supplemental to the 1926 agreement, or an entirely new agreement, petitioner acquired the initial interest in the stock of the Arizona, Oregon, and Washington corporations under the 1928 agreement and on January 1, 1928, and not before. It is so held.

Upon our conclusions and holdings made above, it is unnecessary to consider whether the 1926 agreement, as between petitioner and the Delaware corporation, was canceled by the 1928 agreement. However, we are of the opinion that the parties intended to rescind the 1926 agreement by the execution of the 1928 agreement. We are of the further opinion that the 1928 agreement was not an amendment of or supplement to the 1926 agreement, but was a new agreement, complete in itself, creating new rights and obligations as of January 1, 1928. See sections 1688 and 1699 of the Civil Code of California; Boomer v. Muir, 24 Pac. (2d) 570; Early v. Forbes, 43 Pac. (2d) 368.

Since, under our holdings above, the stock in the California and Arizona corporations was acquired subsequent to July 29, 1927, the effective date of section 161a of the Civil Code of California, petitioner’s wife acquired a present one-half interest in the stocks. Consequently, the dividends paid on the stocks in 1934 and 1935 are taxable, one-half to petitioner and one-half to the wife of petitioner. United, States v. Malcolm, supra. It is so held. Respondent erred in including the full amount of the dividends in petitioner’s taxable income.

There is no deficiency for the year 1934. There will be a small deficiency for the year 1935 because of an uncontested addition to income in that year. Recomputation under Rule 50 is necessary.

Decision will be entered irnder Bule 50.

       Section 161a. Interests in Community Peopeety.
      TRe respective interests of the husband and wife in community property during continuance of the marriage relation are present, existing and equal interests under the management and control of the husband as is provided in sections 172 and 172a of the Civil Code. This section shall be construed as defining the respective interests and rights of husband and wife in community property.


text:
    The Andrew Jergens Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96562.
    Promulgated November 7, 1939.

      Carl M. Jacobs, Esq., and William R. Seaman, Esq., for the petitioner.

      P. M. Clark, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Murdock:

The parties have stipulated that more than 50 percent in value of the petitioner’s outstanding stock was owned, directly or indirectly, by or for not more than five individuals during the taxable year. The respondent concedes that the gross income of the pe-tioner was $1,789,954.15, an amount somewhat larger than that reported on the original return. The stipulated amount of income derived from royalties, dividends, interest, annuities, and gains from the sale of stock and securities was about 84 percent of the gross income conceded by the respondent. The respondent contends, upon these facts, that the petitioner was liable for tax as a personal holding company under section 351. The first contention made by the petitioner is that its correct gross income for 1935 was $2,033,198.51, or $243,244.36 greater than the amount conceded by the respondent, and since its personal holding company income was less than 74 percent of that amount, it was not subject to tax under section 351. If the amount of $243,244.36 was properly a part of the gross income of the petitioner, then the other contentions of the petitioner to the effect that section 351 was never intended to apply to an operating company like the petitioner, and, if applied, would be unconstitutional, need not be considered.

The petitioner, at the end of each year, computed the portions of its overhead and general expenses which were applicable to the conduct of the business of Woodbury and Sales. It then allocated those portions of its expenses to Woodbury and Sales and charged them to those two corporations on its books in accounts receivable. The respondent does not attack the method of allocation and he does not contend that an incorrect amount has been allocated to either Wood-bury or Sales. He first suggests that the record is not clear that the two subsidiaries actually paid to the petitioner the amounts charged to them. However, since the petitioner was using an accrual method of accounting, actual payment was not necessary and there is no reason to believe that the accounts receivable were not genuine and adequate. He also suggests that the contracts were not entered into for profit. It is clear, however, that the contracts were entered into for business purposes and for profit in a broad sense, even though the petitioner may have expected no direct profit from the contracts themselves. But in any event, this suggestion seems to lead nowhere. He next suggests that the amounts in controversy were advances, citing Boston Elevated, Railway Co., 37 B. T. A. 494, the petitioner and its subsidiaries were engaged in a joint venture, and the items in controversy were a mere adjustment of expenses. The real question is whether the items in controversy were properly a part of the gross income of the petitioner or whether they merely served to reduce the expenses of the petitioner without becoming a part of its gross income.

It is immaterial for the purpose of computing the income tax due under section 13 whether the petitioner reported the amounts charged to Woodbury and Sales as income and deducted the full amount of its expenses, or whether it applied the amounts charged to Woodbury and Sales directly to reduce the amount of its deductible expenses. It chose the latter method until it realized that under that method it might be liable for a tax under section 351. It then attempted to change retroactively its accounting method for 1935. The original method of accounting for these items may have some evidentiary value, but it is not determinative of the case. If the items in controversy were a part of the gross income of the petitioner, as that term is defined in section 22 of the Revenue Act of 1934, then section 351 does not apply.

Gross income is defined in section 22 of the Revenue Act of 1934 as including gains, profits, and income derived from businesses, commerce, or dealings in property growing out of the ownership or use of or interest in such property, from rent or the transaction of any business carried on for gain or profit, and gains, profits, and income derived from any source whatever. The petitioner under its contract with Woodbury agreed to use its property and supply its services in manufacturing the Woodbury products. It was to receive compensation from Woodbury for those things. The compensation which it was to receive was measured by and was to be equal to that portion of its total overhead expenses allocable to Woodbury. The amount of the compensation was computed and was actually charged to Wood-bury as an account receivable. The petitioner used an accrual method of accounting, and the amount charged to Woodbury was income to the petitioner under the broad definition of section 22. The same is true of similar items charged to Sales. The petitioner, as owner of the property, was entitled to deduct the full amount of the taxes which it actually paid on its property, and the full amount of depreciation which it sustained on that property, as well as the full amount expended for labor and materials in repairing its property. The respondent does not contend to the contrary. Neither does he suggest any reason why the petitioner was not entitled to deduct on its returns the full amount which it paid for light, heat, power, and the full amount of its other expenses incurred in the operation of its properties during 1935. Woodbury and Sales did not pay any taxes, suffer any depreciation, or expend any amounts for repairs. They were not owners of the property. The amounts charged to them by the petitioner were deductible by them on some other basis. Those amounts represented expenses of their business. They were either wholly, or partly, rent, and if not entirely rent, they were expenses paid out as compensation for services rendered by the petitioner. Similar expenditures were held to be deductible as rent in the case of Denholm & McKay Co., 39 B. T. A. 767. See also Charles R. Holden, 27 B. T. A. 530, where somewhat similar items were held to be rent even though the contract stated that they were not rent. The petitioner in the latter case leased a part of a building for a long period as a residence, and agreed to pay his proportionate part of the operating expenses of the building, including annual interest charges and taxes. The Board held that all of the payments constituted rent, a nondeductible item in the case of a residence, and that no part of them were deductible as interest and taxes. See also Frank Holton & Co., 10 B. T. A. 1317. Thus, whether the expenditures are viewed from the standpoint of the petitioner or from the standpoint of Woodbury and Sales, they represent income of the petitioner. Cf. Hamilton v. Kentucky & Indiana Terminal Railroad Co., 289 Fed. 20; Terminal Realty Corporation, 32 B. T. A. 623; Rowland Realty Co. v. Commissioner, 47 Fed. (2d) 1018; United States v. Boston & Maine Railroad, 279 U. S. 732. See also articles 22 (a)-20 and 23 (a)-10 of Regulations 86. Whether the amounts charged to Woodbury and Sales are designated as rents or as some other kind of income is not now important. The petitioner could not clearly reflect its correct gross income unless it reported the full amount which it charged to Woodbury and Sales to compensate it for the use of its property and the services which it rendered to those two companies.

It might be pointed out in conclusion that if the petitioner and its subsidiaries were engaged in a joint venture, or if the case of Southern Pacific Co. v. Lowe, 247 U. S. 330, applied, the petitioner would not be liable for tax under section 351. The Southern Pacific case is cited for the proposition that the mere receipt of money or other property does not necessarily imply the receipt of gross income. The proposition is, of course, sound. For example, the cost of goods sold is never regarded as a proper part of gross income and has been eliminated in the present case. But the Supreme Court in the Southern Paoific case completely disregarded the corporate entity of a subsidiary and held that dividends paid by the subsidiary were not income to the parent under the “very peculiar facts.” Woodbury had no bank account, no manufacturing plant or equipment, and no employees of its own. All of its business and affairs were conducted for it by the petitioner. If the separate entity of Woodbury were to be disregarded, then all of the earnings of the group would be the earnings of the petitioner and there would be no dividends from Wood-bury to the petitioner. Likewise, if the transaction were regarded as a joint venture, then the entire amount which the petitioner took out of the venture would be regarded as its share. In neither case would the personal holding company income of the petitioner amount to 80 percent of its gross income. The penalty falls with the tax.

Decision will be entered wider Rvile SO.


author: Tyson :

text:
    The First-Mechanics National Bank of Trenton, and Ella T. Forst, Executors, Estate of Arthur D. Forst, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91248.
    Promulgated November 8, 1939.

      John A. Gordin, O. P. A., for the petitioners.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Tyson :

The only question presented for decision is whether under the facts in the record petitioners are entitled to deduct for estate tax purposes the claim of Daniel P. Forst in the amount of $26,957.06. There is no question but that the claim was allowed and paid by the executors of the estate and that such action of the executors was approved and authorized by the Orphans Court of Mercer County, New Jersey.

The petitioners rely upon the claim submitted to the Mercer County Orphans Court and the decree of that court approving its allowance as establishing their right to the deduction here claimed from the gross estate of the decedent. The respondent contends that the decree of the Orphans Court was in effect a consent decree; that the court did not pass on the merits of the claim, there being no objection to its allowance by any of the beneficiaries of the estate or any one else; and that in any event the decree is not controlling as to whether or not the deduction claimed here should be allowed. We agree with this contention. The facts show not only that there was no contest as to the allowance of the claim, but, on the contrary, that such allowance was consented to by all of the beneficiaries' of the estate. In our opinion, the decree of the- Orphans Court is not controlling in determining the deductibility of the claim for tax purposes under the applicable statute. United States v. Mitchell, 74 Fed. (2d) 571; Edgar M. Carnrick, 21 B. T. A. 12; Estate of Hugo Goldsmith, 36 B. T. A. 1201; Estate of Julius C. Lang, 34 B. T. A. 337; affirmed in part, 97 Fed. (2d) 867; Estate of Herbert A. Schoenfeld, 37 B. T. A. 36, and authorities cited therein; cf. Glaser v. Commissioner, 69 Fed. (2d) 254; and Allie E. Nicholson, Executrix, 21 B. T. A. 795.

Our inquiry, therefore, is whether the deduction claimed by the petitioners is an allowable one from the gross estate under the applicable statute, set out in the margin.

Under the terms of the agreement between decedent and his son, Daniel P. Forst, the note given by the latter in payment for the 1,500 shares of common stock was to be paid “solely” from dividends on the stock, which payments were to be first credited to the payment of interest and the balance, if any, credited on the principal- of the note. But notwithstanding this agreement Daniel P. Forst paid to the decedent during the period of July 1, 1929, and January 2, 1934, interest in the amount of $26,957.06, none of which payments, so he claims, were made from receipts by him during that period of dividends on the 1,500 shares of common stock. These payments of interest were received and accepted as such by the decedent. Under the agreement, the decedent could not have required the payment of interest on the note except from dividends received by Daniel P. Forst from the 1,500 shares of stock, but there was nothing in the agreement to prevent Daniel P. Forst from waiving the provision as to the source from which payment should be made. In our opinion, the payments of interest by Daniel P. Forst from funds not derived from dividends on the stock constituted a waiver by him of his privilege under the agreement to make such payments only from such dividends and this, together with the acceptance of such payments by the deceased, effectuated a modification of the original contract with reference to such payments, under which modification payments of the interest here involved were validly made. Both parties were mutually benefited by these payments, the deceased by receiving them at an earlier date than he would have received them had he waited for payment of dividends on the stock as prescribed in the original agreement, and Daniel P. Forst, by keeping up his interest payments, could have dividends, when paid, applied to the payment of the principal and when the amoimts so applied equaled the purchase price of 100 shares these shares would be released to him by decedent, who held them as collateral security for the payment of the purchase price thereof.

A waiver may be defined as an intentional relinquishment of a known right or such conduct as warrants an inference of such intention. Words & Phrases, Fourth Series, Yol. 3, p. 825; Champion Spark Plug Co. v. Automobile Sundries Co., 213 Fed. 14; Jones v. Savin, 91 Atl. 591. It may be created by the act or conduct of the parties, Words & Phrases, Fourth Series, Yol. 3, p. 828; Jones v. Savin, supra; Murmann v. Wissler, 92 S. W. 355; Marine Iron Works v. Wiess, 148 Fed. 145, 153; Mitchell v. Kemp & Burpee Manufacturing Co., 218 Fed. 843; and where a right has been waived it can not be regained. Libby v. Haley, 39 Atl. 1004; Sanitary District of Chicago v. Chicago Title & Trust Co., 116 N. E. 161, 168.

We do not think it can be seriously contended that Daniel P. Forst made these payments under a mistake of fact and could recover them for that reason, because the terms of the agreement and the note are clear and unambiguous and not susceptible of misunderstanding.

We conclude that Daniel P. Forst had no valid and enforceable claim growing out of the interest payments here in question against the decedent or his estate within the meaning of the applicable statute. The claimed deduction, therefore, in the amount of $26,957.06, must be denied.

Decision will be entered under Bule SO.

       [Revenue Act 1926.]
      Sue. 303. Eor the purpose of the tax the value of the net estate shall be determined—
      (a) In the case of a resident, by deducting from the value of the gross estate— [Amendment by Revenue Act 1932, Sec. 805.]
      (1) Such amounts—

      (O) for claims against the estate,

      * * * to the extent that they were contracted bona fide and for an adequate and full consideration in money or money’s worth. * * *


author: KeRN :

text:
    Marlborough House, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent. Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 90452, 90486, 90487.
    Promulgated November 9, 1939.

      Wm. Z. Kerr, Esq., and Harold L. Scott, O. P. A., for tbe petitioners.

      Edward O. Adams, Esq., for the respondent.
   OPINION.

KeRN :

The first issue to be determined in these proceedings has to do with the basis for depreciation of the property held by petitioners. The answer depends upon whether the acquisition by the bondholders of a corporation of the latter’s property as a result of a foreclosure action, and the subsequent acquisition of the same property by another corporation organized for that purpose by the bondholders, constitute a reorganization within the meaning of the statute, so that the basis for depreciation of the property in the hands of the bondholders and later in the hands of the second corporation would be the same as the basis for depreciation in the hands of the first corporation against which the foreclosure action was brought. It is the contention of petitioners that there was such a reorganization. Respondent contends that there was no reorganization and that the basis for depreciation in the hands of the petitioners must be the amount bid for the property at the foreclosure sale.

The rule applied by us until recently in similar cases was that the basis for depreciation in the hands of foreclosing bondholders and corporations organized by them for the purpose of acquiring the property foreclosed was either the fair market value of the property at the time it was sold on foreclosure, or the fair market value of the bonds used by the bondholders in payment of the price bid at the foreclosure sale. Suncrest Lumber Co., 25 B. T. A. 375; Newberry Lumber & Chemical Co., 33 B. T. A. 150.

But in the case of Commissioner v. Kitselman, 89 Fed. (2d) 458 (certiorari denied, 302 U. S. 709), the Circuit Court of Appeals for the Seventh Circuit, in reversing our decision reported in 33 B. T. A. 494, held under similar circumstances that there was a reorganization as defined in section 112 (i) of the 1928 Act. To the same effect is Commissioner v. Newberry Lumber & Chemical Co., 94 Fed. (2d) 447 (reversing 33 B. T. A. 150), decided by the Circuit Court of Appeals for the Sixth Circuit. In that case the precise question presented by the instant proceedings was considered and it was held that the basis for depreciation in the hands of the corporation organized by the bondholders to take over the assets upon foreclosure would be the same as that of the mortgagor corporation. In the cases of Luden H. Tyng, 36 B. T. A. 21 (affirmed on this issue, 106 Fed. (2d) 55), and Frederick L. Leckie, 37 B. T. A. 252, we indicated our intention to now apply the rule laid down in Commissioner v. Kitselman, supra, and Commissioner v. Newberry Lumber & Chemical Co., supra.

In one respect the instant proceedings differ from the Kitselman case and the Newberry Lumber & Chemical Co. case. The record here does not contain any evidence specifically relating to a plan of reorganization. There is testimony as to the different steps taken by which the second corporation acquired title after the foreclosure proceedings and the bondholders of the first corporation became the stockholders of the second. There is also testimony to the effect that, since no market existed for the sale of the property, no attempt at liquidation was made by the bondholders upon foreclosure. The deposit agreement, which was put in evidence and under which the committee was created, grants broad powers to the committee such as are usual in corporate reorganizations, and makes several references to a “plan” to be adopted by the committee for the purpose of protecting the interests of the depositors. In other words, the record discloses a reason for a reorganization rather than a liquidation, and also discloses the taking of steps usual in the most common type of reorganization. Cf. I. T. 2071, III-2, C. B. 34. As we said in William H. Redfield, 34 B. T. A. 967, 973: “It is not necessary, however, that such a plan of reorganization be evidenced by a formal written document, such as a contract or corporate minutes. It is sufficient if the circumstances indicate that the various steps taken were pursuant to a definite plan of reorganization.” We can not doubt that under the circumstances present in these proceedings there was a plan of reorganization formulated by the committee and pursuant to which the steps were taken as disclosed by the record.

Holding as we do that there was here a reorganization within the meaning of sections 112 (a) (3Vand 112 (i), Act of 1932, it follows that the basis for depreciation~m the hands of petitioners will be the same as that in the hands of the predecessor corporation, the Marlborough Investment Co., less the depreciation already taken by such predecessor. Sec. 113 (a) (6), Act of 1932.

The next issue has to do with the income received by the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds, petitioner in Docket No. 90486, while it was in possession of the property from July 1 to November 20, 1933. The double question is raised of who should have returned this income and the rate at which it should have been taxed. This income was reported in the return of the new corporate petitioner, but the committee made no return of any kind. It is plain that this procedure was erroneous (see Chicago, Rock Island & Pacific Railway Co. v. Commissioner, 47 Fed. (2d) 990) and petitioners do not now contend otherwise. The petitioner Bondholders’ Committee now contends, however, that it is taxable as a liquidating trust and not as a corporation, and that its failure to file a return was due to reasonable cause. Respondent, on the other hand, contends that the committee was an association doing business in an organized capacity, the net income of which was distributable to its members in proportion to the capital each had invested, and was, therefore, taxable as a corporation (see arts. 1312 and 1314, Regulations 77); and he further contends that an additional tax of 25 per centum is to be properly assessed against the committee because of its failure to file a return pursuant to section 291 of the Revenue Act of 1932. The pertinent cases relied on by petitioner are Broadway-Brompton Buildings Liquidation Trust, 34 B. T. A. 1089, and Dolese & Shepherd Co., 30 B. T. A. 1171. The pertinent case relied upon by respondent is Bondholders Protective Committee v. United States (U. S. Dist. Ct., So. Dist. Calif., Nov. 16,1938).

Having held as we have that the acts of petitioners constituted a reorganization and that there was a plan of reorganization, we can not consistently adopt the view urged on us by petitioners that the primary object of the committee was the liquidation of the property and not its transfer to a newly organized corporation. A careful reading of the deposit agreement convinces us that the primary object of the committee was to hold, manage, and operate the property after foreclosure and pending the organization of the corporation which would take over the property in consummation of the plan of reorganization worked out by the committee. There is nothing in the record to indicate that liquidation by selling the property on the market was ever contemplated or desired. The mere fact that the committee had an incidental power to sell which could have been exercised in the event the contemplated reorganization was unsuccessful does not persuade us that the activities of the committee constituted a liquidation. Since it was not a liquidating trust but an association meeting the tests laid down in Morrissey v. Commissioner, 296 U. S. 344, we hold that the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds was properly taxable as a corporation on the income received by it.

Since the committee filed no return, it is liable for the additional tax of 25 per centum computed upon its taxable income, regardless of the reason for its failure to file such a return. Moulton Green, Trustee, 24 B. T. A. 1121; Marry D. Kremer, 31 B. T. A. 566.

The next issue involves the proper rate to be applied in ascertaining the amount of depreciation to be deducted by petitioners for the taxable years. It is the contention of petitioners that the apartment building had an economically useful life of only 30 years after July 1,1933, instead of 45 years as determined by the respondent, and that respondent, in applying a rate of depreciation determined by estimating a remaining life of 45 years, did not include a reasonable allowance for obsolescence as required by section 23 (k) of the Act of 1932 and section 23 (1) of the Act of 1934. Two witnesses testified as experts on behalf of petitioners. They were familiar with the history of apartment house values in the city of Seattle and were familiar with the general location and general construction of the apartment house building owned by petitioners. Their testimony was that such an apartment building had a useful life of from 30 to 35 years, and they justified their conclusion by relating case histories of other apartment buildings of similar type and location which had lost their value within such a period by reason of the construction of newer apartment buildings better and more suitably arranged with more modem plumbing and equipment, and also by reason of the shifting of regions thought desirable for apartment buildings. They further testified to the effect that the economic and useful life of an apartment building was not as long as that of an office building because of the former’s continuous use throughout the full day. While this evidence was, as respondent points out, rather general in its scope, it nevertheless embraced and definitely referred to the property in question, and since it is uncontradicted and we have no special knowledge on our own part which would justify its rejection, we can not disregard it. Pittsburgh Hotels Co. v. Commissioner, 43 Fed. (2d) 345, and cases there cited. Therefore, we must conclude that the apartment building owned by the petitioners had an economic and useful life of 35 years after it was constructed in 1927. Since under the pleadings the petitioners claim depreciation calculated on a basis of a useful life of the property of 30 years from July 1, 1933, we have made our finding to that effect. The rate of depreciation will be determined accordingly.

Petitioners have, apparently, abandoned the issues having to do with accrued interest on bonded indebtedness and accrued taxes. No evidence was adduced to substantiate the assignments of error in regard thereto which were set out in the petitions. The determination of the respondent as to these issues is affirmed.

Petitioners concede that the allocation of the basis for depreciation as between real and personal property is correctly made by respondent. They also concede that the rate used as to the personal property is correct.

Eeviewed by the Board.

Decision will be entered under Pule 50.


author: Tyson:

text:
    Gertrude Thompson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92349.
    Promulgated November 9, 1939.

      Courtland Kelsey, Esq., for the petitioner.

      James R. Johnston, Esq., for the respondent.
   OPINION.

Tyson:

The respondent determined a deficiency of $2,943.80 in income tax for the calendar year 1934.

Of her two assignments of error the petitioner has abandoned that one set forth in paragraph 4 (b) of the petition. The only remaining issue presented to the Board involves the question of whether the respondent erred in disallowing a claimed deduction of $5,527.69 in computing tbe petitioner’s income from two trusts of which she was the beneficiary.

The proceeding has been submitted upon a stipulation of facts which is adopted as our findings of fact and incorporated herein by reference. Only such facts as are deemed necessary for the purposes of this opinion will be set forth herein.

The petitioner, an individual whose address is “% Price, Water-house & Co., 56 Pine Street, New York, New York”, duly filed an income tax return (form 1040) for the year 1934, with the collector of internal revenue for the second district of New York.

The petitioner is the widow of William Boyce Thompson, who died a resident of the State of New York on June 27, 1930, leaving a will dated January 24, 1930, and a codicil thereto dated March 1, 1930, which will and codicil were duly admitted to probate in the Surrogate’s Court of Westchester County on July 15, 1930. During 1934 Thomas W. Lamont, Fred Searls, Jr., Thomas D. Thacher, and Percy Bullard were the duly qualified and acting trustees under that will.

By his will the decedent made various specific bequests and devises and created several trusts for the benefit of various persons. The tenth clause of the will devised certain real property in Yonkers, New York, and bequeathed the personal property thereon, with certain exceptions, to the testator’s wife if she survived him, and if she did not, to his daughter if the latter survived him, and further provided, inter alia:

* * * If either my said wife or daughter shall survive me I give to my trustees, hereinafter named, Two Million Dollars ($2,000,000), In Trust, to hold the same so long during the lives of my said wife and daughter as either shall continue to reside on said real property and to invest and reinvest the same and to pay the net income therefrom to my said wife so long during her life as she shall continue to reside on said real property; but if she shall cease to reside on said real property then from and after the time that she shall cease to reside there, to pay the net income therefrom to my said daughter so long as she shall live and continue to reside there; and if at any time while either my said wife or said daughter be living neither shall reside on said real property to pay the net income thereof to my said wife so long as she shall live and at her death to pay the net income thereof to my said daughter during her life; * * *

The codicil to the will, relating to the disposition of the testator’s residuary estate, provided, inter alia:

I give, devise and bequeath one-half of all the rest, residue and remainder of my estate, of whatsoever kind and wheresoever situate, to the trustees named in said Will, In Trust, to invest and reinvest the same and receive the income therefrom, and to pay over the net income thereof to my said wife during her life, and at her death to pay the net income thereof to my said daughter during her life, and at her death to transfer the same absolutely in equal shares per stirpes to the issne of my said daughter then living, * * *

The taxable and nontaxable income realized for tbe year 1934 by the trustees of the two above mentioned trusts, which income was distributable to the petitioner, was as follows:

The trustees’ commissions and miscellaneous expenses listed in the above tabulation were not paid directly by the petitioner, but were paid by the trustees out of the income collected by them before determining the amount distributable to the petitioner. The trustees rendered to petitioner an annual account of their receipts and disbursements for the year 1934 in accordance with the provisions of section 285 of the Surrogate’s Court Act of the State of New York and the petitioner approved and accepted such account as rendered.

On her return for 1934 the petitioner reported as item 6, “Income from Fiduciaries”, the amount of $17,812.64 as taxable income, itemized on an attached schedule as follows:

In determining tbe deficiency involved herein the respondent, inter alia, added the item of $5,527.69 to the item of $17,812.64 reported on petitioner’s return, both of which items are disclosed in the tabulation set forth in the next preceding paragraph. As the basis for his action, the respondent set forth in his deficiency notice that while the trustees’ expenses embraced in the item of $5,527.69 constituted an allowable deduction from the taxable income of the trust, a separate entity, they were not allowable as a deduction from the petitioner’s taxable income as a beneficiary of the trust.

The respondent contends that the trust created by the tenth clause of the will and the trust created by the codicil to the will are two separate trusts; that each of those two trusts and the petitioner was a separate taxable entity; that the taxable income and the deductions of the two trusts, respectively, may not be consolidated in determining the petitioner’s taxable income as the beneficiary of those trusts; and that the net taxable income distributable to petitioner by each of those trusts, respectively, must be determined separately before the petitioner’s taxable income from each of those two sources can be determined.

Petitioner contends that her taxable net income as distributee of those two trusts should be determined by throwing into “hodgepodge” the items of taxable income and deductions of the two trusts, resulting in a consolidated net taxable income of $17,812.64 from fiduciaries as reported in item 6 on her return.

The petitioner does not dispute the respondent’s contention that two separate trusts were created. In our opinion the testator’s will clearly evidences his intent and purpose to create under the tenth clause one trust embracing certain subject matter for specified uses and purposes and to create under the codicil a second trust embracing certain other distinct subject matter for other specified and separate uses and purposes, and, we are of the further opinion that the will and codicil accomplish that purpose. Cf. United States Trust Co. of New York v. Commissioner, 296 U. S. 481. Each of those two trusts and the petitioner constituted a separate taxpayer and each is entitled only to its or her own separate appropriate deductions. Cf. Anderson v. Wilson, 289 U. S. 20. The petitioner as beneficiary of the two separate trusts may not claim the expenses of $5,527.69 of the trust under the tenth clause of the will as a deduction from her taxable income of $28,340.88: received by distribution from the trust under the codicil to the will.,' Cf. Bush v. Commissioner, 50 Fed. (2d) 800, affirming 17 B. T. A. 592; Ardenghi v. Helvering, 100 Fed. (2d) 406, affirming 37 B. T. A. 345; certiorari denied, 307 U. S. 622.

Here we are concerned only with the tax liability of the petitioner as the beneficiary and distributee of the net income of each of the two separate trusts. The above set out expenditures of each separate trust, respectively, reduced her distributable share of the income of each trust, irrespective of whether such expenditures would be deductible in determining the separate tax liability of each trust. Augusta Bliss Reese, 29 B. T. A. 565. Furthermore, the expenditures by each trust must be deducted, wholly, from the taxable income of such trust, respectively. John H. Watson, Jr., et al., Trustees, 35 B. T. A. 706.

Accordingly, in regard to the trust created by the tenth clause of the will we hold that, the expenditures of the trust having been in excess of its taxable income, there remained only nontaxable interest distributable to the petitioner as the beneficiary thereof and that she derived from that trust no income taxable to her for the year 1934. We hold further that the trust created by the codicil to the will received taxable income of $30,448.29, incurred expenditures of $7,107.96, and had a net taxable income of $23,340.33 (including dividends) distributable to petitioner, which latter amount is includable in the petitioner’s gross income as taxable income received by her from that trust for the year 1934. In her return the petitioner reported the amount of $17,812.64 as taxable income received from fiduciaries, arrived at by deducting the item of $5,527.69 from the item of $23,340.33 as hereinbefore set forth. The respondent has increased such amount to $23,340.33 in determining the deficiency in question. Accordingly, the respondent’s determination is sustained.

Decision will he entered for the respondent.