author: Lansdon:

text:
    Bankers Commercial Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7145.
    Promulgated October 4, 1927.
    The petitioner and Commercial Security Company, Inc., were not affiliated during the taxable period.

      Robert G. Cooley, Esq., for the petitioner.

      P. J. Rose, Esq., for the respondent.
    The respondent has asserted a deficiency in income tax and excess and war-profits tax against the petitioner for the period January 1, 1918, to April 30, 1918, inclusive, in an amount in excess of $10,000. In March, 1924, the respondent imposed an assessment against the petitioner in the sum of $50,274.44, and the deficiency notice giving rise to this proceeding determines a further tax liability, in addition to the aforementioned assessment, in the amount of $3,338.66. According to the petitioner’s brief, the actual amount in dispute is a sum, exclusive of interest, amounting to more than $38,000. This deficiency results from the denial by the respondent of the petitioner’s claim that it was affiliated with the Commercial Security Co., Inc., during the period above specified.
    FINDINGS OP PACT.
    The Bankers Commercial Corporation was organized under the laws of the State of New York. It was engaged in the business of handling automobile and installment paper. Its office during the period in question was at 14 Wall Street, New York City. It was one of two predecessor banking corporations, later merged under the laws of the State of New York under the name of Bankers Commercial Security Co., Inc., which merged organization is located at 270 Madison Avenue, New York City. It is agreed by the parties litigant that the legal merger of these two constituent companies occurred, for the purposes of this proceeding, ón May 1, 1918. The deficiency notice herein involved was issued on that basis. The legal and accounting work in connection with effectuating this merger began in the fall of 1917 and continued constantly until May, 1918.
    The Commercial Security Co., the other predecessor corporation above mentioned, was originally incorporated under the laws of the State of Illinois in 1907. Its capital in the beginning consisted of $80,000 of so-called piano paper and was supplied by one' George G. Foster. This paper was deposited with the Central Trust Co., for which gold bonds were issued to the Commercial Security Co., and the latter in turn offered them to various banks. R. A. Crandall was the operating head of the Commercial Security Co. He developed a market for these securities, principally in the banks throughout the middle west. He had very strong New York financial connections. The Commercial Security Co. moved to New York in the latter half of 1917 and at that time there were approximately 500 banks throughout the country buying securities of the company. The Commercial Security Co. was reincorporated under the New York laws. At the time of its removal it enjoyed credit facilities largely in excess of its needs. The volume of business the company was handling per year at that time and about January 1, 1918, was running between three and one-half and four million dollars a year.
    The officers of the Commercial Security Co. during the period in question were: R. A. Crandall, president; George G. Foster, vice president; Wm. L. White and R. A. Crandall, each treasurer during a part of the period; Wm. L. White, secretary during all the period except the first few weeks in January, 1918.
    The officers of the Bankers Commercial Corporation during this period were: George G. Foster, president; Don C. McCord, vice president; J. A. Bower, secretary; and R. A. Crandall, treasurer.
    Wm. L. White was counsel of both companies during, prior to, and subsequent to the period in question.
    The directors of the Commercial Security Co. during this period were: George G. Foster, R. A. Crandall, Frederick W. Zoller, George L. Eaton, and J. H. Shale.
    The directors of the Bankers Commercial Corporation during this period were: George G. Foster, R. A. Crandall, George L. Eaton, Joseph A. Bower, E. C. Converse, A. L. Scheuer and Wm. T. Graham.
    About January 1, 1918, George G. Foster had endorsed over a million dollars worth of the. obligations of the Bankers Commercial Corporation. This fact was known to the principal stockholders of the company. The Bankers Commercial Corporation had already reached its limit of credit with the banks and it was necessary to give a bank additional security before the latter would increase its loan to the company. It would make its own promissory note in favor of the bank involved in each such transaction and Foster would endorse the note personally. This was necessary in order that the company might get and handle business that was being offered it at that time.
    Beginning several months prior to January 1,1918, and continuing throughout the period January 1 to May 1, 1918, the Bankers Commercial Corporation received automobile and installment paper with collateral in the regular course of business, in excess of the amount that it was able to finance. On account of the better financial arrangements and the better credit enjoyed by the Commercial Security Co., such excess paper was sent to the office of the Commercial Security Co. and purchased by it as though it was business that had come to it in the regular way. There was no credit or profit to the Bankers Commercial Corporation on this account.
    During the taxable period involved, the Commercial Security Co. advanced money to the Bankers Commercial Corporation to enable the latter to bay paper that otherwise it would have been unable to purchase. On January 1, 1918, the business of the Bankers Commercial Corporation was running about one million dollars a month. It maintained throughout January to April, 1918, inclusive, the same volume of its own business. It was not possible for the Bankers Commercial Corporation, with its own resources and credit, to handle that volume of business. It was compelled to turn over to the Commercial Security Co. several hundred thousand dollars worth of business per month.
    J. II. Shale was a vice president of both companies during this period and while he spent most of his time at the office of the Bankers Commercial Corporation, he was at the office of the Commercial Security Co. assisting in its affairs several times a week. William L. White in his capacity as counsel for the two companies, and after his election as secretary of the Commercial Security Co. in January, 1918, spent a quarter of his time at the office of the Bankers Commercial Corporation, assisting it in operating problems. Throughout the period in question it was the practice of.the two companies to supply printed notes and installment contracts to dealers and manufacturers in blank, to be filled out by the latter upon the sale of motor vehicles or pianos, according to the terms of the sale, and said form notes and contracts were printed with the names of both com-panics upon them so that upon their receipt one name could be crossed off and one company or the other would purchase the paper as might be most convenient at that time.
    The office of George G. Foster during the period in question was located at 14 Wall Street in the office of the Bankers Corporation. He gave constant attention to the affairs of the two companies. The offices of the two companies were in daily communication either personally or by telephone. The office of the Commercial Security Co. was located at Fifth Avenue and 42nd Street.
    During the period in question each company held regular meetings. The meetings of the Commercial Security Co. were merely routine affairs, and the minutes do not show discussion of any matters outside of the routine required by law. The commercial affairs of the two companies during this period were practically directed by George G. Foster and R. A. Crandall, jointly. Wm. L. White became secretary of the merged companies in May, 1918. Each company kept its own books throughout the period. A dividend was paid to the stockholders of the Commercial Security Co. at the end of the first quarter according to the stockholders of record. A dividend was paid to the stockholders of the Bankers Commercial Corporation at the end of the first quarter, according to the stockholders of record. The true stock ownership of each company during this period was:

    Wm. L. White was intimately acquainted with the affairs of both companies. White did not know of any right or power by which anyone other than stockholders of record in either corporation could exercise any dominion over any other person’s stock in either corporation. All of the stockholders of the Bankers Commercial Corporation, with negligible exceptions, were close business associates or personal friends of George G. Foster or of R. A. Crandall.
   OPINION.

Lansdon:

After a careful study of the evidence and comparison with similar cases previously decided, we are of the opinion that the petitioner and the Commercial Security Co. Inc., were not affiliated during the taxable period.

Reviewed by the Board.

Judgment will be entered on 10 days’ notice, voider Rule 50.


source: Caselaw Access Project

author: Lansdon :

license: Public Domain

text:
    Joseph O’Brien Leather Finish Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9630.
    Promulgated October 4, 1927.

      Held- that the petitioner incurred a certain salary for the services of its president during the taxable period.

      John J. Barry, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
    The respondent has asserted a deficiency in income and profits tax for the year 1921, in the amount of $1,312.94, all of which is in controversy. Respondent is alleged to have erred in disallowing a certain amount as a deduction from gross income as ordinary and necessary expenses for salary incurred in the taxable year for the services of its president and secretary. No question as to the reasonableness of the salary deduction claimed is involved.
    FINDINGS OF FACT.
    The petitioner is a New York corporation, with its principal office in Little Falls. It was incorporated on May 20,1921, with an authorized capital stock in the amount of $10,000, divided into 100 shares of the par value of $100 each. During the taxable period, the stockholders and their stockholdings were as follows: Joseph O’Brien, 85 shares; George O’Brien, 5 shares; Jack O’Brien, 5 shares; and Margaret O’Brien, 5 shares. The three O’Brien men are brothers. The record does not disclose the relationship of Mrs. Margaret O’Brien to the brothers or to any one of them. George O’Brien, Margaret O’Brien, and Joseph O’Brien, were the directors of the petitioner during the taxable period.
    At the date of organization, Joseph O’Brien was elected president and treasurer of the petitioner. At that time the stockholders and directors entered into an oral agreement, of which there is no written record, that Joseph O’Brien should receive for his services, as presir dent and treasurer, a salary at the rate of $8,500 per annum. No part of such agreed salary was paid until August 13, 1921, and, from that date until December 31, 1921, payments on such account were made at the rate of $50 per week in the total amount of $805.
    On January 19, 1922, the directors of the petitioner ordered that the income and profits-tax return for the taxable period should be made in conformity with the salary agreement of May 20, 1921. The incurred, accrued, and unpaid salary due Joseph O’Brien was credited to his account on the books of the petitioner about January 20, 1922, as of December 31, 1921. In its income and profits-tax return for 1921, the petitioner deducted from gross income the amount of $6,715 as officers’ salaries, and, of such deduction, the amounts of $5,255 and $1,460 were for salaries of the president and secretary, respectively. This return was made on the accrual basis. Upon audit of such return the Commissioner disallowed $4,400 of the deduction from gross income on account of salaries, made some minor adjustments, and determined the deficiency here in controversy.
   OPINION.

Lansdon :

Since the respondent does not question the reasonableness of the salaries in question and proves, by the submission of the petitioner’s income and profits-tax return for the period involved, that such return was made on the accrual basis, the only question for our consideration is whether the petitioner, in 1921, incurred liability for such salaries.

Joseph O’Brien testified at the hearing that on May 20, 1921, all the stockholders and directors orally agreed that the president should receive a salary at the rate of $8,500 per annum. Cunningham, an accountant, testified that he was present at the meeting of May 20, 1921, and that the matter of salaries was discussed by the directors. The minutes of the meetings in January, 1922, at which it is alleged that the salary agreements of May 20, 1921, were ratified, were not offered in evidence nor did any of the witnesses, who were present at such meetings and participated therein, testify that such action was taken. Proof of confirmation of the informal agreement rests solely on the testimony of Cunningham, who made out the tax return for the petitioner,' and testified that on January 19 or 20, 1922, he was instructed to deduct the salaries agreed to in May, 1921.

In our opinion the evidence is conclusive that the salary of Joseph O’Brien for the taxable period was fixed by informal action of the directors of the petitioner on May 20, 1921, at the rate alleged. As the petitioner is a closely held corporation, chartered under the laws of New York, such informal action was sufficient to incur liability for the salary so determined. Appeal of Reub Isaacs & Co., 1 B. T. A. 45. The petitioner made its income-tax return on the accrual basis and it follows, therefore, that the accrued salary clue Joseph O’Brien was a liability at December 31, 1921, and was properly deductible from gross income for that year at the rate of $8,500 per annum from May 20, 1921, to December 31, 1921. No evidence supporting the claim for deduction of salary incurred for the services of the secretary, George O’Brien, was offered at the hearing. We, therefore, approve the action of the respondent in adding such alleged salary to the petitioner’s gross income for the taxable period.

Reviewed by the Board.

Judgment will be entered on 10 days’ ■notice, wider Ride 50.


text:
    Frank G. Robins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9649.
    Promulgated October 4, 1927.
    1. Payment of attorney’s fees made by a husband for services on beliulf of bis wife in her suit for separation and alimony and to his own attorney for services in securing a settlement of the proceedings held not deductible in the ascertainment of the husband’s taxable income.
    2. An alleged loss on account of a guaranteed payment of the indebtedness of a corporation in which petitioner is the principal stockholder held not to have been proven.

      Chas. /S. Tavjger, Esq., for the petitioner.

      A. /S'. Lisenby, Esq., for the respondent.
    This appeal is from a deficiency of $477.45 determined by the respondent for the year 1920 and a claim in abatement of $3,185.43 filed by the petitioner for the same year, making a total of $3,662.88. Both claims have their basis in the refusal of the respondent to allow petitioner’s claim of an expense allowance of $6,750 for attorney’s fees paid by him to hjs own and his wife’s attorneys in settlement of her suit against him for separation and for securing such settlement, and the disallowance of petitioner’s claim of a loss of $15,516.04 on account of his guarantee and the assumption of payment of indebtedness of the Armstrong-Eobins Corporation which became insolvent during the year.
    FINDINGS OF FACT.
    The petitioner is an individual residing in the State of New York. In December, 1919, his wife sued for separation. She alleged desertion, and failure to provide. In a separate instrument supporting her claim for alimony, she alleged adultery on his part, naming parties and places. Some newspapers published these allegations. Eobins directed his attorney to compromise the case, giving as his reason that while the statements were untrue, their publicity was injuring him with Cannon Mills, which company was the sole source of his shade-cloth business from which he received a large percentage of his personal income. The attorney secured a settlement. Eobins paid his wife’s attorney $5,000. He also paid his own attorney $1,750. Claiming that these two payments were necessary business expenses, he deducted the total amount from his personal income for the year in order to ascertain his taxable income. Ee-spondent disallowed the deduction.
    The Armstrong-Eobins Corporation, hereinafter sometimes designated as the corporation, organized in 1916, conducted a commission business in the purchase and sale of cotton goods and also bought and sold cotton goods on its own account. Petitioner owned all of the preferred stock of the company and two-thirds of the common stock. In the early months of 1920 the corporation bought largely from Vieter-Achelis Co., L. W. Lawrence, and Cannon Mills. These purchases were made on credit, and in order to make them and to secure himself a commission of 2 per cent thereon, Robins gave these and other companies written guarantees of payment. Following is the form and purport of these guarantees.
    Gentlemen : In consideration of the special commission of two (2) per cent to be allowed to me, I hereby guarantee to you tlie payment of your invoices which may issue in fulfillment of orders placed with you by Armstrong, Robins Corporation, of New York, or Frank G. Robins Company of Havana, Cuba, and New York, provided, of course, that such invoices are true and Just and represent shipments made in accordance with specifications and terms as stated on said orders. This guarantee applies to all such invoices, whether they be made to Armstrong, Robins Corporation, Frank G. Robins Company, or customers of either of these.
    This letter is intended to guarantee the financial responsibility only of the parties to whom your invoices are made in fulfillment of orders from the above mentioned sources, and in no way guarantees you against claims that may arise through your failure to properly comply with instructions, etc., although we stand ready at all times to act in your behalf in the avoidance or adjustment of all difficulties.
    Yours very truly,
    Fbank G. Robins.
    . In May and June, 1920, a violent depression occurred in the cotton and cotton goods market. It continued throughout the country to such an extent that on June 30th, the Armstrong-Robins Corporation was insolvent, and from then on until the close of the year was in process of liquidation. Before the close of the year, petitioner was advised by Vieter-Achelis Co. that it would look to him for payment of its credit to Armstrong-Robins Corporation. That corporation’s tax return for the year 1920 shows its assets and liabilities to have been as follows at December 31, 1920.
    Assets
    Cash_ $224. 53
    Bills receivable-2, 000. 00
    Accounts receivable-71,907. 67
    Merchandise stock-$14, 742.71
    “ “ Special_ 8,861.59
    “ “ Samples_ 436.11
    24, 040.41
    Furniture and fixtures. 310.31
    Good will_ 10,000.00
    108,482.92

      Liabilities
    $7, 500. 00 Bills payable_ Accounts payable:
    Trade_$77,882.45
    103,859.04 Others_ 25,976. 59
    Capital stock:
    Common_ 10, 000.00
    Preferred_ 5, 000. 00
    16, 000.00
    $17,876.12
    126, 359. 04 126, 359. 04
    The good will of the corporation had no actual value at this time. The “ special ” merchandise stock shown in its return at $8,861.59 was actually worth only 40 per cent of that amount. This increased the balance against the company $5,316.95, making the actual book balance $23,193.07. Adding to this the value at which good will was carried on the books, gives an actual balance of $33,193.07 against the corporation.
    By far the heaviest creditor of the corporation at this time was the Yieter-Achelis Co., to which it owed on account $67,194.14, on December 31, 1920. On that date it owed L. W. Lawrence, $2,686.99 and Cannon Mills, $1,143.12, making a total of $71,024.25 to these three parties. The payment of these accounts was guaranteed by petitioner in writing.
   OPINION.

Lansdon:

There is no question of fact as to the payments made the attorneys, but respondent does not admit that such payments were “ ordinary and necessary expense of the business ” in which petitioner was engaged. We concur with this view. Sarah Backer, et al, 1 B. T. A. 214; John Stephens, 2 B. T. A. 724; David G. Joyce, 3 B. T. A. 393.

As to whether petitioner’s deduction of the loss of $15,516.04 ascertained by him to have been incurred on account of his having guaranteed the payment of indebtedness of Armstrong-Robins Corporation should be allowed is not so clear. Petitioner has proven a loss of more than double this amount by the corporation during the year 1920, but he has not proven that under his guarantee he was required to pay or did pay any of this loss out of his own personal funds. He has shown that he had guaranteed the payment of $71,024.25 of the indebtedness of the corporation, but he has also shown that at the close of the year the corporation had available for meeting its obligations, cash $224.53, bills receivable $2,000, accounts receivable $71,907.67, merchandise $18,723.44, and furniture $310.31, a total of $93,165.95. He has not shown how much of these tangible assets he could and did use in payment of the secured debts, nor how much in payment of the unsecured debts, nor for how much or what part, if any, of the unsecured debts he was responsible as a stockholder of the corporation over and above his actual investment in its capital stock, nor the amount of such investment. These essential matters are too much in doubt to justify us in saying that the respondent erred in disallowing the deduction claimed.

Reviewed by the Board.

Judgment will he entered for the respondent.


text:
    J. W. Bowman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7467.
    Promulgated October 6, 1927.
    The amount of petitioner’s income for the calendar year 1919, from a partnership having a fiscal year ended January 31, 1919, which is subject to tax at 1918 rates determined.

      John B. Geyer, Esq., and Paul G. Smith, Esq., for the petitioner.

      Brice Toole, Esq., for the respondent.
    The Commissioner has asserted a deficiency in income tax against the above named petitioner, for the year 1919, by the rejection of a claim in abatement of $1,269.97, which forms part of a larger amount assessed by the Commissioner in March, 1925. The circumstances and basis of the asserted deficiency will sufficiently appear hereinafter.
    FINDINGS OF FACT.
    The petitioner was, during the years 1918 and 1919 and prior thereto, a member of the firm of J. K. Bowman, J. W. Bowman, and H. H. Bowman, trading as Bowman & Co., and engaged in conducting a department store as a copartnership with store and principal office located at 314-316-318 Market St., Harrisburg, Pa.
    The partnership keeps its books and makes its report of income upon the basis of a fiscal year ending January 31. J. W. Bowman, the petitioner, reported his income for the year 1919 on a calendar year basis. Pie reported as income received in 1919, his distributive share of the profits of such partnership for the fiscal year ending January 31, 1919.

      On July 1, 1924, the Commissioner mailed a deficiency notice to the petitioner asserting a deficiency in income tax of $3,411.76. Thereafter an appeal was taken to the United States Board of Tax Appeals, within the time required by law, which appeal was entered as Docket No. 39. On November 14, 1924, the Board rendered a decision in said appeal (which decision is reported in volume 1 of United States Board of Tax Appeals Reports, at page 60), in which it was determined that the deficiency in income tax of J. W. Bowman for the calendar year 1919, was $1,479.93. Said deficiency of $1,479.93 was determined by the Board on the basis of a stipulation by the parties litigant.
    Under date of January 22, 1925, the following letter was mailed to the petitioner’s counsel.
    Mr. Paul G. Smith,

      Attorney at Law, Kunhel Building, Harrishurg, Pa.

    In re: Appeal of J. W. Bowman, 314 Market Street, Harrisburg, Pa. Docket
    No. 39.
    Sib: Reference is made to the tax liability of the above-named appellant for the year 1919, and to deficiency letter dated July 1, 1924.
    In the letter of July 1, 1924, the taxpayer was notified that his deficiency tax liability for the year 1919 amounted to $3,411.76. Prom this deficiency letter the taxpayer filed his petition for an appeal to the United States Board of Tax Appeals, and by the decision of the Board to appellant’s tax liability for the year 1919 was reduced to the amount of $1,479.93. In the recompu-tation of the appellant’s tax liability for the year 1919 in accordance with the decision of the Board, it is found that an error in the original audit of the appellant’s return was not corrected in the letter of July 1, 1924, and since this error in the original audit has been discovered and correction made, the result is that the deficiency proposed to be assessed in the letter of July 1, 1924, was understated by the amount of $1,269.97, and that by adding this amount to the amount of deficieijcy tax found to be due from this taxpayer by the United States Board of Tax Appeals in the amount of $1,479.93, as shown by a recomputation which is enclosed herewith, the deficiency tax which should be assessed against the taxpayer for the year 1919 amounts to $2,749.90.
    Will you please take this matter up with your client, Mr. J. W. Bowman, and ascertain from him whether or not he will concede the error that was made in the original audit of his return, and whether or not he will be willing to pay the deficiency tax arising out of this error, along with the deficiency found to be due by the Board at the hearing of his appeal. If you desire to have a hearing before the Unit with reference to this additional deficiency arising out of the error in the original audit of the taxpayer’s return, will you suggest a date that will suit your convenience for this purpose.
    Respectfully,
    (Signed) Nelson T. Habtson,

      Solicitor of Internal Revenue.

    Enel.
    RAL: BJ.

      The claimed error referred to in the above quoted letter was based upon the following calculation:
    1919 Income
    Block J, original Revenue Agent’s report-Loss Additional contributions allowed, (Supplemental Revenue Agent’s Report)_ $1, 527. 53 , 445. 65
    Bad Debts allowed partnership by United States Board of Tax Appeals_$16, 935. 27
    Your 2/5 share_ 6,774.11
    1/12 for 1919_ 564.51 2, 092. 04
    Block J. corrected_Loss $10, 537. 69
    Plus 1919 dividends- 6, 974. 00
    1919 income subject to Normal tax_ none $3,563. 69
    Partnership 1918 income original Revenue Agent’s Report_$42, 244. 97
    Bad Debts allowed partnership by United Board of Tax Appeals-$16, 935. 27
    Your 2/5 share_ 6, 774.11
    11/12 for 1918_ 6,209.60
    Subject to Normal tax at 1918 rates-$36, 035.37
    Block K (c) corrected_$36,035.37
    Block L, corrected_$32, 471.68
    Tax at 1918 Rates
    1918 partnership income-$36, 035.37
    Personal exemption- 2,400. 00
    $33, 635.37
    Normal tax at 6%- 4,000.00 240.00
    Normal tax at 12%_■_$29, 635. 37 3, 556. 24
    Surtax on Block L ($32,471.68)- 2,160.75
    Total corrected tax liability_ $5, 956. 99
    No 1919 tax, therefore no tax paid at source allowed or involved.
    Original assessment No. 325708_ 3,207. 09
    Increase of tax_ $2, 749. 90
    On March 13, 1925, the petitioner was advised by the respondent that owing to the impending expiration of the statutory period of limitations within which assessments of additional taxes for 1919 must be made, it had become necessary to make an assessment of the full amount of $2,749.90. The same letter further advised the petitioner that under the provisions of section 279(a) of the Revenue Act of 1924, he had the right to file with the collector of internal revenue, within 10 days after notice and demand for payment, a claim for abatement on this tax or any part thereof. On April 2, 1925, a claim for abatement in the amount of $1,269.97 was filed with the collector of internal revenue of the first district of Pennsylvania under the provisions of section 279(a) of said Act. On August 4, 1925, the petitioner was notified of the rejection in full of said claim for abatement.
    The basic facts for the computation of the 1919 income-tax liability of the petitioner are not in dispute and are as follows:
    Loss from outside sources exclusive of partnership profits_$13, S13.63
    Reduced by 1/12 of partnership income (attributable to 1919)_ 3,275.95
    Loss as reduced by 1/12 of partnership income_ 10, 537.68
    Reduced by dividends received directly in 1919_ 6, 974.00
    Loss as reduced by 1/12 of partnership income and dividends_ 3, 563.68
    Eleven-twelfths of partnership income (attributable to 1918)_ 36,035.37
    Taxable net income for 1919_ 32, 471. 69
   OPINION.

Lansdon:

This proceeding presents an unusual situation. Two deficiency notices were mailed the petitioner, each involving the same year (1919). The first deficiency notice, mailed July 1, 1924, gave rise to the appeal reported in volume 1 of the United States Board of Tax Appeals Reports, at page 60. According to the report of said case—

The only issue presented at the bearing related to a disallowance by the Commissioner of the income-tax return of the partnership of certain claimed deductions on account of bad debts. The parties thereafter stipulated that of $21,613.17 bad debts deducted by the partnership and disallowed by the Commissioner, the sum of $16,935.27 represented debts ascertained to be worthless and charged off within the taxable year and the sum of $4,077.90 represented accounts not determined to be worthless and not charged off as such.
The parties have further stipulated, with respect to the tax liability of each individual partner, that the correct deficiency in the case of J. W. Bowman is $1,479.93 on account of income tax for the year 1919; that the correct deficiency for the same year in the case of H. H. Bowman is $964.62, and of J. K. Bowman, $834.93.

The Board thereupon determined that the asserted deficiency against J. W. Bowman for the year 1919 was allowed in part and disallowed in part and that the deficiency was $1,479.93. This decision was made November 14, 1924.

Thereafter the Bureau of Internal Revenue ascertained that what it regarded as an error in the original audit of the petitioner’s liability for the year 1919, had not been corrected in the deficiency notice of July 1, 1924, and it so advised the petitioner by the letter of the then Solicitor of Internal Revenue dated January 22, 1925, quoted above in full. The attempted correction of this alleged error gave rise ultimately to an assessment of the amount in dispute under section 274 (d) of the Revenue Act of 1924, the filing of a claim in abatement under section 279 (a) of said Act, followed by the rejection by the Commissioner of the abatement claim under date of August 4, 1925, upon which action the instant proceeding is based.

The facts involved raise a preliminary question as to the right of the Commissioner to issue a second deficiency notice covering the same taxable year under the Revenue Act of 1924. In connection with the preparation of the Revenue Bill of 1926, this matter received consideration. A new provision incorporated in the Revenue Act of 1926 (subdivision (f) of section 274) provides that the Commissioner shall have no right to determine any additional deficiency in respect to the same taxable year, with certain exceptions not here material, if after the enactment of this Act the Commissioner has mailed to the taxpayer notice of a deficiency. The explanation of this new provision made by the Committee on Ways and Means in its report to the House of Representatives, is as follows:

Subdivision (f) provides that after tire enactment of tbis act and after the Commissioner has notified the taxpayer of the deficiency he shall have no right to determine an additional deficiency in respect of the same taxable year, except in the case of fraud and except as may be provided by the Board of Tax Appeals under the provisions of subdivision (e) of this section. Under this section, if the Commissioner has sent a 60-day letter after the enactment of this Act, he may not thereafter send another 00-day letter, but must raise before the Board in accordance with subdivision (e) of this section his claim for a deficiency greater than that set out in the 60-day letter. It should he noted that this section prohibits the sending of a second G0-day letter only in cases where there has already been, after the enactment of this Act, one 60-day letter sent to the taxpayer. (Italics ours.)

The Congressional intent thus expressed would seem to leave no doubt but that the Commissioner had the right under the Revenue Act of 1924 to issue a second deficiency notice covering the same taxable year. Cf. Dallas Brass & Copper Co., 3 B. T. A. 856.

The only issue presented in the prior proceeding as stated by the Board “ related to a disallowance by the Commissioner * * * of certain claimed deductions on account of bad debts.” The deficiency notice of August 4, 1925, presents an issue not raised in the prior proceeding either by the pleadings or otherwise, namely, the .correct interpretation of sections 205(c), 206 and 218(b) of the Revenue Act of 1918. The construction of said provisions contended for by the Commissioner and embodied in his deficiency notice of August 4, 1925, has the practical effect of increasing the petitioner’s taxable net income for 1918 for purposes of normal tax, from $32,471.69 to $36,035.37.

We believe that the Commissioner was entirely within his rights in issuing the second deficiency notice in this case; that the matter is properly before this Board under section 279(b) of the Revenue Act of 1924; and that a new issue is raised thereby which was not before this Board in the prior proceeding above mentioned.

The proposed deficiency involves the statutory method of computing the income-tax liability of an individual member (reporting income on the calendar year basis) of a partnership, which partnership has a fiscal year beginning in 1918 and ending in 1919. The respondent has applied the rates prescribed for the year 1918 to the sum of $36,035.37 (being eleven-twelfths of the petitioner’s distributive share of the partnership profits for its fiscal year ended January 31, 1919), without reducing said sum by losses sustained in 1919 and without allowing as a credit for the purpose of the normal tax, the corporate dividends received directly by the petitioner during 1919.

As a matter of fact, the petitioner did not suffer a net loss, operating or otherwise, during the taxable year 1919. His net income for that year was $32,471.69. The Revenue Act of 1918, however, prescribes that under the instant facts the petitioner’s distributive share of the partnership profits for its fiscal year ended January 31, 1919, shall be split up for the purpose of ascertaining the rates to be used in computing the tax, into the proportion of eleven-twelfths attributable to 1918 and one-twelfth attributable to 1919. It is from the standpoint of that portion of his income for 1919, subject to tax at 1919 rates that the petitioner discloses no income subject to tax. The statute does not provide that the income shall be regarded as of two years or that the tax is a tax to any extent for the earlier year. The income is all income of the later year (1919), the tax upon which is, in recognition of the source of the income, measured pro tanto by the schedule of both years. See Appeal of Charles Colip, 5 B. T. A. 123, 125.

The specific provisions of the Revenue Act of 1918 covering the instant situation are as follows:

Sec. 205. (c) If a fiscal year of a partnership begins in 1917 and ends in 1918 or begins in 1918 and ends in 1919, then notwithstanding the provisions of subdivision (b) of section 218 (1), the rates for the calendar year during which such fiscal year begins shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable to such year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rates for the calendar year during which such fiscal year ends shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable to such calendar year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year: Provided, That in the case of a personal service corporation with respect to a fiscal year beginning in 1917 and ending in 1918, the amount specified in clause (1) shall not be subject to normal tax.
Sec. 206. That whenever parts of a taxpayer’s income are subject to rates for different calendar years, the part subject to the rates for the most recent calendar year shall be placed in the lower brackets of the rate schedule provided in this title, the part subject to the rates for the next preceding calendar year shall be placed in the next higher brackets of the rate schedule applicable to that year, and so on until the entire net income has been accounted for. In determining the income, any deductions, exemptions or credits of a kind not plainly and pi-operly chargeable against the income taxable at rates for a preceding year shall first be applied against the income subject to rates for the most recent calendar year; but any balance thereof shall be applied against the income subject to the rates of the next preceding year or years until fully allowed. (Italics ours.)
Sec. 218. (b) If a fiscal year of a partnership ends during a calendar year for which the rates of tax differ from those for the preceding calendar year, then (1) the rates for such preceding calendar year shall apply to an amount of each partner’s share of such partnership net income equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rates for the calendar year during which such fiscal year ends shall apply to the remainder.

The partnership’s fiscal year began in 1918 and ended on January 31, 1919. Pursuant to the specific exception contained in section 205 (c), supra, we may ignore the provisions of section 218 (b) in determining the issue herein presented. The respondent, however, seems to rely upon the literal interpretation of that part, either of section 205 (c) or of section 218 (b), which provides in effect, as adapted to the facts in this case, that the rates for the calendar year 1918 (the calendar year during which the partnership’s fiscal year begins), “ shall apply to an amount of each partner’s share of such partnership net income ” equal to the proportion which the part of such fiscal year falling within the petitioner’s calendar year bears to the full fiscal year. The proportion just mentioned will in this case be eleven-twelfths, and amount to $36,035.37. The sections of the statute under consideration also provide that the rates for the calendar year 1919 (the calendar year during which the partnership’s fiscal year ends) “ shall apply to an ’amount of each partner’s share of such partnership net income,” equal to the proportion which the part of such fiscal year falling within the petitioner’s calendar year bears to the full fiscal year. This proportion is one-twelfth on the present facts and amounts to $3,275.95. It is noted that in the respondent’s revised computation forming the basis of this proceeding, no 1919 income was found subject to normal tax at the 1919 rates. This seems inconsistent with his position respecting the amount of 1919 income subject to tax at 1918 rates, for one-twelfth of the petitioner’s income from the partnership and to which the 1919 rates would apply consistently with the respondent’s action, amounts to $3,275.95.

The solution of this question is not difficult to find in a reading of the provisions of the statute as a whole. By sections 210 and 211 of the Revenue Act of 1918, a normal tax and a surtax are imposed upon the “ net income ” of every individual, at specified rates. In section 212 of said Act, the term “net income” is stated to mean gross income as defined in section 213 less the deductions allowed by section 214. These are the vital sections of the statute. See Theodore Schilling, 3 B. T. A. 936, 939. Section 216 of said Act allows certain credits for the purpose of the normal tax only, one of which is the amount received as dividends from a corporation which is taxable under this title upon its net income. The 1918 Act also contains provisions respecting the computation of the tax where parts of a taxpayer’s income for an accounting period are made subject to rates for different years. Section 205 (c), section 206, and section 218 (b) are of that nature and give rise to the question of statutory construction raised herein. The respondent seeks to lift certain language out of section 205 (c) or 218 (b), disassociate it from the statute as a whole, and compute the tax on that portion of the petitioner’s distributive share attributable to 1918 without allowing any deductions or credits whatsoever. The respondent does allow authorized deductions and credits in ascertaining that portion of the petitioner’s income subject to tax at the 1919 rates. The reason for his following the literal language of section 205 (c) or section 218 (b), above referred to, in computing the tax on that portion of the petitioner’s income subject to 1918 tax, and adopting a contrary construction in computing the tax on that portion of the distributive share subject to 1919 rates, has not been explained. We are unable to find the basis for such a distinction in the statute.

Net income, as defined therein, is the object of the tax imposed by Title II of the Revenue Act of 1918. We are of the opinion that when a taxpayer reports income for the calendar year 1919 and said income includes the taxpayer’s distributive share of partnership profits determined on a fiscal year basis, all deductions, exemptions or credits provided by the applicable revenue act must be granted in ascertaining the amount or amounts to which the prescribed rates shall be applied. If any possible doubts could exist on this point, they would seem to be dispelled by the provisions of the last sentence of section 206, above quoted. This section provides in terms that in determining a taxpayer’s income any deductions, exemptions, or credits of a kind not plainly and properly chargeable against the income taxable at rates for the preceding year (1918), shall first be applied against the income subject to rates for the most recent calendar year (1919); but any balance thereof shall be applied against the income subject to the rates of the next preceding year or years until fully allowed. In construing section 205(c) of the Revenue Act of 1921, which except for the years named therein, is substantially identical with section 205(c) of the Revenue Act of 1918, the Board said: “ Section 205 (c) is subordinate to section 211, and the expressed intent of the latter is controlling in the construction of section 205(c).” Theodore Schilling, supra, p. 939.

This extract indicates quite clearly that the view taken by the Board is that a method prescribed for computing the tax is subordinate to, and must be construed in harmony with, those provisions of the statute dealing with the ascertainment of taxable net income, credits, and exemptions.

Reviewed by the Board.

Judgment of no deficiency will be entered for the petitioner.

Sternhagen, Murdock and Sieekin dissent on the first point.


text:
    Thomas J. Locke, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10616.
    Promulgated October 6, 1927.
    1. Cost of a warehouse roof as ordinary and necessary expense paid or incurred in the taxable year disallowed.
    2. Petitioner sold merchandise to the management of a dormitory owned by the State of Mississippi, and operated by employees of a State institution for the service of students. The State made no appropriations for such dormitory, which was maintained by collecting funds from students. Prior to or during the taxable year, dormitory funds were embezzled, and, at the end of such year, there were unpaid claims against the dormitory management in large amounts. The State was under no legal liability for the debts of the dormitory management. Held, that the amount due the petitioner from the dormitory management was a worthless debt at December 81, 1920, and that, for Federal tax purposes, it was a proper deduction from gross income for that year.

      Henry M. Jay, O. P. A., for the petitioner.

      W. Franlc Gibbs, Esq., for the respondent.
    The respondent has determined deficiencies in income tax for the years 1919 and 1920, in the respective amounts of $2,199.43 and $4,954.28. In his brief, counsel for the petitioner avers that there is an error in the computation of the deficiency for 1920, and that, even if the- respondent properly disallowed the deductions claimed, the true deficiency is only $4,906.57. The petitioner concedes that the deficiency for 1919 is correct. The issues for 1920 relate to the respondent’s disallowance as a deduction from the petitioner’s gross income for that year of certain amounts alleged to represent ordinary and necessary business expenses and a debt ascertained to be worthless and charged off in the taxable year.

      FINDINGS OF FACT.
    The petitioner is an individual residing at Columbus, Miss., where he is in business as a wholesale grocer.
    In his income-tax return for 1920, the petitioner deducted the amount of $4,620.91 from his gross income,«^claiming the same as ordinary and necessary expense paid or incurred in the construction of a new roof on 6 warehouse owned by him and used in his business. The respondent disallowed such deduction. *

    Prior to, and during the year 1920, the petitioner furnished certain supplies to the dormitory management of the Mississippi Agricultural and Mechanical College at Starkville. This dormitory was owned by the State and was conducted by employees of the said college, which is a state institution, maintained by legislative appropriations, made from session to session. The legislature makes no appropriation for food or other dormitory expenses, which are met by assessments or collections from the students who use such facilities. The petitioner has sold commodities to the dormitory department continuously since 1913, receiving payment therefor direct from the college up to 1919; then the account began to grow in arrears notwithstanding all efforts possible to collect. At December 31, 1920, the dormitory management was indebted to the petitioner in the amount of $16,595.14.
    At the request of the petitioner and creditors similarly situated, an audit of the affairs of the dormitory management was begun about July 15, 1920, and completed in the fall of 1920. This audit disclosed that there had been waste or misappropriation of funds paid by students for dormitory privileges in the amount of approximately $80,000 and that there were no funds available for the payment of any of the overdue dormitory accounts. The petitioner then and in 1920, presented his claim for reimbursement to the Governor of the State (who was ex-officio a member and chairman of the board of trustees of the college), and to state senators.
    In 1922 the legislature of the State of Mississippi enacted a law making appropriations for the claims against the dormitory management of the college. This act was passed by a very close vote after one of the hardest fights the then governor had before the legislature. From such appropriation in the total amount of $18,251.68, the petitioner received a payment of $15,155.57, leaving unpaid on the account in question the sum of $1,438.17.
    Prior to the close of the year 1920, the petitioner ascertained that the account in question was worthless and charged it off his books. The petitioner had been advised in person by the Governor of the State of Mississippi of the latter’s efforts in his behalf and of the failure to secure the legislators’ permission to negotiate a loan to pay the account, before said account was charged off.
   OPINION.

Lansdon :

The petitioner admits that his tax liability for the year 1919 has been correctly determined by the respondent and we, therefore, approve the asserted deficiency for that year in the amount of $2,199.43.

The petitioner introduced no evidence respecting the amount or the deductibility of $4,621.91 claimed as a deduction from gross income of 1920 as an ordinary and necessary expense paid or incurred in the construction of a new roof on a warehouse owned by him and used in his business. As to this issue the petitioner submitted his case on the pleadings, relying upon an admission in the respondent’s answer which reads as follows:

Admits that the Commissioner of Internal Revenue has disallowed a deduction of $4,620.91 claimed by the taxpayer to have been expended during the year 1920 for placing a new roof on taxpayer’s warehouse, but denies he committed error in so doing.

The answer of the respondent also denies that said expenditure represents an ordinary and necessary expense to the taxpayer in 1920 and further contains a general denial which in terms denies generally and specifically each and every allegation contained in the petition not previously admitted, qualified, or denied by the answer. Obviously, there is no admission by the respondent upon which we can base findings of fact sufficient to enable us to determine that the deduction claimed was an ordinary and necessary expense actually paid or incurred in the taxable year involved. On this point the determination of the respondent is approved for lack of evidence.

Prior to, and during the year, the dormitory of the Mississippi Agricultural and Mechanical College was managed by employees of that institution. The money to pay for the service so provided was collected from the students. The State made no appropriation for operating or revolving funds for this purpose. During the. year 1920, an audit disclosed that dormitory funds, collected from students, in the amount of approximately $80,000, had been lost or misappropriated. The dormitory management was without resources to meet its obligations to the petitioner and other creditors. The State of Mississippi was under no legal obligation to replace the misappropriated funds, but it was within the power of the legislature to appropriate public funds for the payment of such claims. Consulted by the Governor, the individual members of the legislature declined, for the most part, to commit themselves as to an appropriation or to approve the suggestion of borrowing money for the payment of the claim of the petitioner and others. There was no regular session of the legislature until 1922.

In all the circumstances, we are of the opinion that the petitioner’s claim against the dormitory management of the Mississippi Agricultural and Mechanical College was worthless at December 31, 1920. It was charged off during the taxable year and should be allowed as a deduction from gross income for such year. See United States v. S. S. White Dental Manufacturing Co. of Pennsylvania, 274 U. S. 398.

The petitioner’s brief filed in this proceeding, calls attention to an alleged mathematical error in the computation of the proposed deficiency in tax for the year 1920, and asserts that on the basis of the respondent’s action, the correct deficiency would be $4,906.57, instead of $4,954.28. We do not have sufficient data in the record to pass upon this question. Inasmuch, however, as the alleged error, if it exists, is purely mathematical, the matter can no doubt be checked and adi usted in the recomputation of the deficiency under Rule 50.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Pule 50.


text:
    Appeal of Blackstone Manufacturing Co.

      Docket No. 4899.

    Promulgated October 6, 1927.
    Evidence does not establish a value of water rights paid in for' stock at March 5, 1841, in excess of that allowed by the Commis-missioner as a factor of invested capital.

      Harry P. Gross, Esq., and J. Robert Sherrod, Esq., for the petitioner.

      J. Arthwr Adams, Esq., for the Commissioner.
    The Commissioner has asserted a deficiency of $11,708.28 in income and profits taxes for the year 1918, arising from the disallowance of the petitioner’s claim for paid-in surplus on account of certain water rights acquired by it in 1841.
    FINDINGS OF FACT.
    1. The petitioner is a corporation organized and chartered in 1841 under the laws of Rhode Island. Its incorporators were the members of the Blackstone Manufacturing Co., a partnership, formed in 1808. It purchased all the property belonging to the partnership, paying therefor to the shareholders of the firm a total of 200 shares of stock having a par value of $1,500 each. Its principal office is located at Providence, R. I. At all times after its organization until a date subsequent to December 31, 1918, it was engaged in the manufacture and sale of cotton cloth.

      2. Its manufacturing plant was at all times on the Blackstone River some 20 miles above Providence. The river is nonnavigable. The raw material was carried from the seaboard to the factory via the Blackstone Canal, and the manufactured goods were shipped by the same route until railway communication was established some years subsequent to 1841.
    8. Until 1870 water was the sole motive power used in the factories. From 1870 until 1917, water and steam power were both used. In 1917 steam was discarded and electrical power has since been used to supplement the water power.
    4. The business was established in 1808-1809 by the Blackstone Manufacturing Co. The dam was constructed near the state line in Massachusetts, where it remained until a comparatively recent date, when a new dam was built a short distance down the river in Rhode Island, and the old one discarded. The mills are on both sides of the state line.
    5. In 1841 the actual fall used by the partnership at the dam was 2814 feet, and the fall controlled by and belonging to the company was about 32 feet.
    6. The number of spindles in use prior to 1841 was 16,000, and the number of looms 325. . In 1841 a second mill was constructed containing 10,000 spindles and 187 looms, and, in 1845, a third mill containing 10,000 spindles and 206 looms. No change is shown to have been made in the dam or race during these four years.
    7. The yearly production of cloth, insofar as is material, was as follows:

      Yards per weejs.

    1840_ 3.184, 622
    1841_ 3,381,581
    1842-•— 3, 840, 540
    1847- 150, 000
    8. About one-fourth mile below the Blackstone Manufacturing Co.’s dam there was, in 1841, the Farnum dam. The owners of the latter had secured their water-power rights from the Blackstone Canal Co., the relation of which to the petitioner is not disclosed and is not material to the issues involved in this proceeding. It was found that this dam was not high enough to give the owners of the Farnum dam the power they needed. They could not increase its height without the permission of the Blackstone Manufacturing Co. They bought from such company for $5,000, the right to increase the height of their dam 7% inches, and to maintain it at that height so long as the Farnums and their assigns could, under their agreement with the Canal Company, legally keep the dam at the height it then was.
    9. According to its charter the stock of the Blackstone Manufacturing Co. could “not exceed $500,000; to be divided into 200 shares.” The company at a meeting of its incorporators held at its counting room Friday, March 5, 1841, passed the following resolutions :

      Voted, that the 200 shares of the stock in this corporation be divided amongst the owners in the firm of the Blackstone Manufacturing Company in proportion to the interest owned by each in the property of said firm-.

      Voted, that an assessment of 1500 Dollars on each share of the stock of this Company be called and made payable this day-.

      Voted, that this corporation purchase from the partners in the firm of the Blackstone Manufacturing Company, the whole of the property of the said firm of every kind and description subject to the debts due by said Company for the sum of 300,000 Dollars and that payment of the same be made to the owners in the said firm by issuing to them certificates of shares in the Capital Stock of this Company on which the receipt of payment of 1500 Dollars per share is acknowledged-.
    10. The property of the partnership was held in common. It was divided into 200 shares, each partner owning a stated number. When a partner sold any of his property in the company, he described it in his deed as so many shares. There are in evidence five such deeds of sale as follows:

    The sales of June 19, 1813, May 24, 1814, and March 2, 1829, were to outsiders. The sales of March 11, 1826, and July 13, 1840, were between partners.
    11. Petitioner’s Exhibit No. 8 contains inventories of the property of the Blackstone Manufacturing Co. from January 1, 1828, to January 1, 1842. Preceding the inventory for January 1, 1828, the properties are enumerated in detail and the value of each stated. The value of the “Water Privilege” as given is $3,000, and the total value of all other property, except cash and amounts due on account and notes, $283,922.92.
    The balance for subsequent years is in part as follows:
    January 1, 1830-$335, 549.94
    1, 1832-420,178. 62
    1, 1834_ 372,478. 95
    1, 1836— 305,454. 94
    1, 1938-415,264.14
    1, 1840-395,421.47
    1, 1841-367,499.84

      The balance as of January 1, 1841, represents the net assets of the petitioner after deducting the amount of $60,000 distributed to the ■ partners on February 1, 1841.
    12. In its income and profits-tax return for 1918, the petitioner claimed invested capital as follows: Capital Stock, $900,000; surplus, $732,279.30; reserve for taxes $50,000, or a total of $1,682,279.30. Upon audit of such return the Commissioner disalloived the claim of the petitioner for water rights, thereby reducing surplus in the amount of $145,279.30.
   OPINION.

Lansdon:

This appeal presents two issues for our consideration: (1) Whether the Commissioner erroneously reduced the petitioner’s invested capital by the amount of Federal taxes accrued for the prior year, prorated for that part of the taxable year remaining after such taxes became due and payable, and (2) whether the petitioner may include in its statutory invested capital, as paid-in surplus, the alleged cash value of certain assets for which it exchanged its capital stock in the amount of $300,000, par value at date of its incorporation in 1841.

Our decision on the first issue is against the petitioner. Section 1207, Revenue Act of 1926; Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

The second issue is largely one of fact. The petitioner asserts that the property which it received in 1841 in exchange for its stock of the par value of $300,000 had a cash value at that date in excess of the par value of such stock and asks that such excess cash value shall be included in the computation of its statutory invested capital for the taxable year. Section 326(a) provides, “That as used in this title ‘ invested capital ’ means * * * (2) Actual cash value of tangible property, other than cash, tona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus.”

The petitioner corporation is the successor of a partnership of closely related individuals which was formed in 1808. Participation in the partnership was measured by the ownership of units or shares of the nominal value of $1,500 each. Upon incorporation each partner received one share of stock for each unit of his interest in the partnership. During the period from 1808 to 1841, there were several sales of partnership units at prices ranging from $968.75 to $1,700. The transactions involving the highest and the lowest prices were in 1814, and in each case was between partners and outsiders. In 1829,16% units were sold to outsiders at $1,591.84. In 1840 there was an intra-partnership sale of 16% units at $1,500 per unit.

The balance sheet of the partnership at January 1, 1841, discloses net tangible assets in the amount of $367,492.84 after the deduction of $60,000 to be distributed to the partners at February 1 of that year. The balance sheets as of January' 1, 1836, 1838, and 1840, disclose net tangible asset balances in the respective amounts of $385,454.94, $415,264.14, and $395,421.47. The ancient documents in evidence disclose net operating profits of the partnership and the petitioner for the years 1839, 1840, 1841, and 1842, in the respective amounts of $30,553.35, $46,026.78, $52,487.15, and $53,487.05. The petitioner offers these figures to support its claim that the tangible assets paid in to the petitioner in 1841 had a value substantially in excess of the par value of the stock issued therefor. To our minds they merely indicate the apparent prosperity of the partnership and the petitioner about the date involved and have very slight probative value as to the question at issue. The evidence is taken from ancient documents that were properly identified as business records of the partnership and corporation, but was not confirmed or supported by proof of many essential facts. We know nothing of the methods of accounting that resulted in such figures. There may have been no deductions from income or asset values on account of depreciation. Deductions for expenses are unknown either as to nature or amount. We have no knowledge of the capital contributions of the various partners. Since the partnership had been very successful for about 30 years prior to the date of these statements, a considerable part of the net earnings may have resulted from good will used in the business.

In 1841 one Welcome Farnum owned a power site, a power plant, and a dam with a head of about 4% feet on the Blackstone Fiver one-fourth of a mile below the property of the petitioner. On August 16, 1841, the petitioner sold to Farnum, for $5,000, the right to raise his dam 7% inches. It is contended that if 7% inches of head in the Blackstone Fiver at that time and place was worth $5,000, the head of 28.25 feet owned and used by the petitioner had a value directly in proportion to that amount, or approximately $226,000. That a head of 28.25 feet of water has potential energy proportional to one of 7% inches is a physical fact that can not be controverted without disregarding the law of gravitation. That it has value in the same proportion depends on so many conditions that the physical fact, unsupported by other evidence, has little eviden-tiary weight. The Commissioner points out that there is no evidence that the petitioner parted with any water power in this transaction, and that, inasmuch as it owned the riparian lands between the two power plants, the payment may have been for overflow dam ages resulting from raising the lower dam. He insists that in any event the price that Farnum was willing to pay for inches of additional head at his power site for undisclosed purposes in connection with the operation of his property can not be regarded as a true measure for determining the value of the petitioner’s head of 28.25 feet some distance up stream. This is sound reasoning. We are of the opinion that the Farnum sale does not prove the value of the petitioner’s water privileges and rights in the amount for which it contends.

In further support of its contention the petitioner introduced and qualified a witness expert in the valuation of water privileges and rights. This witness, reasoning from the terms and conditions set forth in the deed to Farnum, was of the opinion that the power privileges in question had a value of $150,000 in 1841. He arrived at this conclusion by a mathematical computation resulting in a maximum value of $226,000, based on the $5,000 paid by Farnum for N/2 inches of head, and then decreased such result by making allowances for the possible relatively greater value of a small part than of the whole, and for such part of the payment as may have been consideration for flooding the riparian lands of the petitioner. This witness also testified that he had worked out the cost of installing and operating a theoretical steam plant in 1841 with horse power equal to that of the petitioner’s water-power plant, and that, by comparison of the theoretical steam plant with the petitioner’s water-power rights and privileges, he was of the opinion that the latter had a value of $145,858.80 at the date it was paid in to the corporation. Obviously such a computation involves many unknown factors and the result obtained can be no more than an approximation. We are without the facts required to confirm and verify this approximation. We do not know the unit of power cost in 1841 of either a steam or water-power plant on the Blaekstone River, at the time of the reorganization here involved. We do not know the relative cost of maintaining and operating such plants. If the alleged capital value is allowed, we do not know whether the power plant in question was operated at a saving as compared with a steam plant of equal capacity.

It appears from the testimony, and from the laws and decisions which wo have consulted that the petitioner’s water privileges and rights emerged from its ownership of land on both sides of the Blaekstone River, and of the riparian rights appertaining thereto. The Commissioner has accepted the petitioner’s valuation of its riparian lands as a factor of its invested capital. The petitioner has not proved that it received water power of tbe value alleged separable from other riparian rights in exchange for stock in 1841. Reviewed by the Board.

Judgment will be entered for the Commissioner.


author: GREEN:

text:
    Ralph L. Evans, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7107.
    Promulgated October 6, 1927.
    Petitioner, in 1923, invented at no cost a certain secret process or formula applicable to bair dyes. He desired to obtain tbe business of Inecto, Incorporated, a New York corporation, all of tbe stock of wbicb was owned by P. W. Ducker. Ducker caused Inecto, Incorporated, a Delaware corporation, to be organized. The New York corporation transferred all its assets to tbe Delaware corporation in exchange for all of tbe latter’s stock. Tbe Delaware corporation then borrowed $75,000 from a finance company evidenced by a certified check. Tbe Delaware corporation then endorsed and delivered said check to the petitioner in 1923 in consideration for tbe secret process. Tbe petitioner then endorsed and delivered said check to tbe New York corporation in consideration for all of the capital stock of tbe Delaware corporation. Held, that under section 202(e) (3) of tbe Revenue Act of 1921 the petitioner received no income in 1923 as be bad no proprietary right in tbe check and was in control of tbe Delaware corporation immediately after tbe transfer to it of bis secret formula.

      Gordon Gordon, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of his income-tax liability for the calendar year 1923 for which the Commissioner has determined a deficiency in the amount of $16,159.47. The error assigned is that the Commissioner erred in including in the petitioner’s income the amount of $75,000 which passed through his hands while consummating a prearranged plan whereby the petitioner was to transfer a certain secret process or formula to a corporation and was to be in control of such corporation immediately after the transfer. The petitioner contends that under section 202(c)(3) of the Revenue Act of 1921 no gain or loss should be recognized.
    FINDINGS OF FACT.
    The petitioner, a citizen of the State of New York, in or about the month of May, 1923, without cost or expense, invented a certain secret formula or process applicable to hair dyes. He then sought to acquire the hair-dye business then being conducted by Inecto, Incorporated, a New York corporation, all tbe shares of the capital stock of which were then owned or controlled by one Phillip W. Ducker.
    Thereafter and as the result of negotiations between the petitioner and Ducker, or between their respective attorneys, looking to the purchase by the petitioner and sale by Ducker of the hair-dye business, Ducker caused a corporation to be organized under the laws of the State of Delaware bearing the name Inecto, Incorporated.
    On or about July 28, 1928, and in furtherance of the purchase and sale arrangement above mentioned, Inecto, Incorporated, of New York, transferred and conveyed all its assets to Inecto, Incorporated, of Delaware, and in consideration thereof the entire authorized capital stock of Inecto, Incorporated, of Delaware, to wit, 1,000 shares, was issued and delivered to Inecto, Incorporated, of New York.
    In about four hours’ time on the afternoon of August 28, 1928, at the office of Stephen M. Bell, attorney for Inecto, Incorporated, corporations, and Ducker, and in the presence of the petitioner, Gordon Gordon, his attorney, Seymour Phillips, an assistant in Gordon’s office, Bell, Neal B,. Andrews and one Pledger, officers and directors of Inecto, Incorporated, corporations, and Milton J. Kupfer, attorney for the Manufacturers Finance Co. of Baltimore, Md., the following acts and things were done and performed:
    The petitioner, his attorney, Gordon, and one Phillips, who was Gordon’s assistant, were first elected officers of the Inecto, Incorporated, of Delaware. The petitioner then offered to transfer and deliver to Inecto, Incorporated, of Delaware, his secret process or formula applicable to hair dyes. Inecto, Incorporated, of Delaware, by resolution of its board of directors, Evans not voting, accepted said offer and authorized the pledging of its accounts receivable in the amount of $100,000 odd, to secure a loan from the Manufacturers Finance Co. of Baltimore, Md., in the amount of $75,000. The Manufacturers Finance Co., acting by and through Kupfer as its attorney, delivered to Inecto, Incorporated, of Delaware, as a loan, its certified check for $75,000, and took as security the pledging of the accounts receivable of the Delaware corporation in the amount of $100,000 odd and in addition the personal guarantee of the petitioner as an individual. The check was then endorsed as follows:
    Pay to tlie order of Ralph L. Evans
    Inecto Inc. a
    Delaware Corp.
    by Neal R. Andrews, Mgr.
    Gordon Gordon, V. Pres.
    Pay to tbe order of Inecto Inc. a
    N. Y. Corporation
    Ralph L. Evans

      All of the above quoted endorsement was in the handwriting of Gordon, except the signatures of Neal E. Andrews and Ealph L. Evans, the petitioner. At the time the check was handed to Evans, Gordon had already prepared the endorsement to the New York corporation with the exception of Evans’ signature. It was then handed to the petitioner in consideration of the transfer by him of the secret process to the Delaware corporation. It was not intended that Evans was to have any control over the check. He immediately affixed his signature to Gordon’s endorsement, handed the check back to Gordon, who then delivered it to Bell, the attorney for Inecto, Incorporated, of New York, and simultaneously as attorney for the petitioner, received from Bell, acting for Inecto, Incorporated, of New York, a certificate duly endorsed in blank for the entire capital stock, to wit, 1,000 shares of Inecto, Incorporated, of Delaware.
    Subsequently, the check for $75,000 was deposited to the credit of Inecto, Incorporated, of New York, and in due course such sum was paid out and distributed by the corporation in liquidation to Phillip W. Ducker, its sole stockholder.
    Ducker was unwilling to part with control of the corporation unless simultaneously he received $75,000 by means of this indirect method. It had been suggested that the check be endorsed directly to Inecto, Incorporated, of New York, but Ducker’s attorney said the only way he would part with the stock was to part with it for a check made payable to Evans personally and endorsed by him to the New York corporation.
   OPINION.

GREEN:

The deficiency here in controversy arises as the result of the determination of the Commissioner that the petitioner realized taxable income in the amount of $75,000 on the basis that he received $75,000 from Inecto, Incorporated, of Delaware in exchange for his secret process or formula which had cost him nothing. On the other hand, it is the petitioner’s contention that under section 202(c) (3) of the Eevenue Act of 1921 he realized no taxable income for the reason that looking at the transaction as a whole, he had merely transferred property to a corporation and immediately after the transfer was in control of such corporation.

The section relied upon by the petitioner provides in part as follows:

(c) for tlie purposes of tliis title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in. exchange has a readily realizable market value, no gain or loss shall be recognized—
(3) When (A) a person transfers any property, real, personal or mixed, to a corporation, and immediately after the transfer is in control of such corporation, or (B) two or more persons transfer any snch property to a corporation, and immediately after the transfer are in control of such corporation, and the amounts of stock, securities, or both, received by such persons are in substantially the same proportion as their interests in the property before such transfer. Bor the purposes of this paragraph, a person is, or two or more persons are, “ in control ” of a corporation when owning at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

It is clear that had Inecto, Incorporated, of Delaware, endorsed the check of $75,000 over to the New York corporation in exchange for all its own stock and then exchanged its own stock for the petitioner’s secret process, this question could not have arisen. Does the fact that all the parties to the transaction agreed between themselves upon this indirect method of first having the Delaware corporation endorse the check over to the petitioner in exchange for his secret process or formula and then having the petitioner endorse the check over to the New York corporation in exchange for the Delaware corporation’s stock, take the transaction out of section 202(c) (3) supra. We think not. The petitioner at no time had any proprietary right in the check for $75,000. He had no right to use it and employ it as his own. It had been suggested that the check be endorsed directly to Inecto, Incorporated, of New York, but Ducker’s attorney had refused to part with the stock unless the check first went through the petitioner’s hands. It was not intended that Evans was to have any control over the check. He was to transfer his formula to the Delaware corporation and although the check was first endorsed to him, it was not intended that he was to receive anything except all the capital stock of the Delaware corporation.

The respondent contends that the solution to the question here is controlled by the decisions of this Board in the appeals of Edward A. Langenbach, 2 B. T. A. 777; B. F. Saul, et al., 4 B. T. A. 639; and W. J. Hunt, 5 B. T. A. 356. In our opinion those cases are not in point for the reason that the questions, facts, and statutes involved therein were entirely different. The peculiar wording of the 1921 Act is a complete departure from the prior acts under which the three cited cases were decided. The Senate Finance Committee at page 11 of its Beport No. 275, refers to this complete change in the law in the following language:

Section 202 (subdivision c) provides new rules for those exchanges or trades in which, although a technical “ gain ” may be realized under the present law, the taxpayer actually realizes no cash profit.
Under existing law “ when property is exchanged for other property, the property received in exchange shall, for the purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair market value, if any * * * Probably no part of tbe present income tax law bas been productive of so much uncertainty or bas more seriously interfered with necessary business readjustments. The existing law makes a presumption in favor of taxation. The proposed act modifies that presumption by providing that in the case of an exchange of property for property no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value, and specifies in addition certain classes of exchanges on which no gain or loss is recognized even if the property received in exchange has a readily realizable market value. These classes comprise the cases * * * where an individual or individuals transfer property to a corporation and after such transfer are in control of such corporation.
The preceding amendments, if adopted, will, by removing a source of grave uncertainty and by eliminating many technical constructions which are economically unsound, not only permit business to go forward with the readjustments required by existing conditions but also will considerably increase the revenue by preventing taxpayers from taking colorable losses in wash sales and other fictitious exchanges.

In order to come within the statute under which the petitioner claims exemption, it is only necessary for him to show (1) that he transferred property to a corporation, and (2) that immediately after such transfer he was in control of such corporation. It is admitted that he transferred the secret process to the Delaware corporation. The only question remaining is whether it can be said that he was in control of the corporation immediately after the transfer. The evidence shows that prior to the transfer it was agreed that Evans was not to have any rights in the check, but that immediately he was to endorse it over to the New York corporation and receive simultaneously all the stock of the Delaware corporation. Ducker would not part with control of the stock except it be done in that manner. Under such circumstances, it is our opinion that Evans acted as a mere conduit to pass the check from the Déla-' ware to the New York corporation and that he realized no taxable gain or loss on the transaction.

Keviewed by the Board.

Judgment will he entered on IB days’ notice, under Rule 50.


author: Trammell :

text:
    Simon Kohn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 13169.
    Promulgated October 6, 1927.
    Where no facts were ascertained in 1921 relating to the worthlessness of a debt, they being known in prior years, the petitioner is not entitled to a deduction in that year on account of a debt ascertained to be worthless although it was charged off in that year.

      Simon Kohn pro se.

      A. H. Murray, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1921 in the amount of $333.04. The deficiency arises on account of the action of the Commissioner in disallowing as a deduction the amount of a debt claimed by the petitioner to have been ascertained to be worthless and charged off during the taxable year.
    FINDINGS OF FACT.
    The petitioner, on December 2, 1913, loaned his brother, Adolf Kohn, $2,370. He agreed that the interest on this money should be paid to the debtor’s wife. Adolf Kohn lived in Germany and during 1914 and 1915 was in serious financial circumstances. His financial circumstances remained in that condition until 1921 when the petitioner made an entry on his books of account charging the amount to profit and loss on December 30 of that year. The petitioner ascertained no facts relating to the indebtedness or the ability of the debtor to pay or the probability of payment in 1921, which had not been ascertained prior thereto.
   OPINION.

Trammell :

In order for the petitioner to be entitled to the deduction claimed it is incumbent upon him to introduce evidence to show that the indebtedness was ascertained to be worthless and charged off within the taxable year. There is no evidence that the debtor was in worse financial condition in 1921 than he was in years prior thereto. Nothing occurred during that year which would indicate that it was any more uncollectible at that time than in 1920 or at any period since 1914. The only evidence relating to the indebtedness, insofar as the year 1921 was concerned, was the charge-off. If the debtor had no assets and could not pay the debt in 1914 or 1915, or in any other year prior to 1921, and that fact was ascertained by the petitioner, he was not permitted to wait until 1921 in order to make the charge-off of the account where no additional facts were ascertained in 1921.

In view of the evidence, we are not convinced that the petitioner ascertained the debt to be worthless in 1921. He is accordingly not entitled to the deduction claimed.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: Trammell:

text:
    Sterling Coal Co., Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8048, 13358.
    Promulgated October 7, 1927.
    A taxpayer is not permitted to revise its depletion deduction for previous years as the result of factors determined in subsequent years. If subsequent developments show that a material error has been made in the original estimates of ore reserves a new estimate may be made and the capital remaining to be recovered distributed accordingly.

      Sterling Newell, Esq., for the petitioner.

      A. G. Bouchard, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes for the fiscal years ended March 31, 1917, Docket No. 13358, and for the fiscal years ended March 31, 1918, and 1919, Docket No. 8048, in the amounts of $2,532.25, $5,546.58, and $13,752.56, respectively. The two appeals were consolidated for the purpose of hearing and decision. The only assignment of error in each of the proceedings is that the Commissioner erred in determining the petitioner’s depletion allowed on its Cecil Mine. No testimony was introduced, all of the facts being either stipulated or admitted in the pleadings.
    FINDINGS OF FACT.
    The petitioner is a corporation organized and existing under the laws of the Dominion of Canada, with its principal office in Toronto. Its principal office in the United States is at Cleveland, Ohio. The petitioner acquired the Cecil property in 1910, consisting of a mine opening and 1,179 acres of coal land in the Freeport seam in Taylor County, West Virginia.
    The fair market value on March 1, 1913, of the coal deposit and development located in the Cecil Mine and owned by the Sterling Coal Co., Ltd., on March 1, 1913, was $117,737.24. The depletion allowed by the Commissioner on the Cecil Mine was, for the fiscah year ended March 31, 1918, $1,767.09, and for the fiscal year ended March 31,1919, $1,092.56, which was computed at a rate of 3.46 cents per ton. The said depletion rate was arrived at by the Commissioner by estimating the coal content of the said Cecil Mine to be 4,965,576 tons on March 1, 1913, and the fair market value of the depletable property on March 1,1913, of the Cecil Mine to be $171,808.96.
    The Commissioner admits the petitioner is entitled to deductions from income on account of depletion of coal deposit and development of the Cecil Mine for the fiscal year ended March 31, 1918, of $1,873.51 and for the fiscal year ended March 31, 1919, $1,158.36, which is computed at a rate of 3.66837 cents per ton. The said depletion rate is arrived at by the Commissioner by estimating the coal content of the Cecil Mine to be 4,681,577 tons on March 1, 1913, and the fair market value as of March 1, 1913, of said coal deposit and development located in the Cecil Mine to be $171,737.24.
    The petitioner’s net taxable income, before depletion deductions on the Cecil Mine and after all of the other charges, was for the fiscal year ended March 31, 1918, $51,836.59, and for the fiscal year ended March 31, 1919, $51,234.36.
    The tons of coal mined by the petitioner during the fiscal year ended March 31, 1918, from the Cecil Mine was 51,072 tons and during the fiscal year ended March 31,1919, 31,577 tons.
    A reasonable estimate of the tons of coal in place in the Cecil Mine on March 1,1913, was 4,681,577 tons.
    A reasonable estimate of the tons of coal in place in the Cecil Mine from March 1, 1913, to the latter part of the year 1922 was 4,681,577 tons, less the number of tons of coal mined from time to time.
    By reason of conditions developed in said Cecil Mine in the latter part of the year 1922, the petitioner made tests which established that there was no additional minable coal in the 1,179 acres constituting the said Cecil Mine and the mine was totally abandoned on January 15, 1923, after only 372,206 tons of coal had been mined therefrom, and that 337,783 tons of said 372,206 tons were mined subsequent to March 1, 1913.
   OPINION.

Trammell:

The respondent contends that the petitioner is entitled to deductions on account of depletion sustained on the Cecil Mine for the fiscal year ended March 31, 1918, of an amount not in excess of $1,783.51 and for the fiscal year ended March 31, 1919, $1,158.36, based upon depletion rate of 3.66837 cents per ton and computed on the valuation of $171,737.24, value as of March 1, 1913, and estimated coal reserve of 4,681,577 tons as of March 1, 1913, and a deduction for the fiscal year ended March 31, 1918, of 51,072 tons and for the fiscal year ended March 31, 1919, of 31,577 tons.

The petitioner contends that it is entitled to depletion allowances on account of depletion sustained on the Cecil Mine for the fiscal year ended March 31, 1918, of $25,965.36, and for the fiscal year ended March 31, 1919, of $16,053.75, being an allowance of 50.84 cents per ton on a production of 51,072 tons mined during the fiscal year ended March 31, 1918, and 31,577 tons mined during the fiscal year ended March 31, 1919, and based upon a fair market value as of March 1, 1913, of its depletable property of $171,737.24 and the coal content of 337,783 tons as of March 1,1913.

The question is thus presented as to whether the depletion deductions allowed by the statute are to be determined on the basis of estimates of ore reserves determined and accepted as fair and reasonable during the taxable years for which returns were filed or whether such deductions are to be based on facts developed and ascertained and estimates made in subsequent years.

The provisions of the statute applicable are section 12 (b) of the Revenue Act of 1916 as amended by the Revenue Act of 1917, the pertinent portion of which is as follows:

In the ease of mines a reasonable allowance for depletion thereof not to exceed the fair market value in the mine of the product thereof which has been mined and sold during the year for which the rate and computation are made, such reasonable allowance to be made * * * under rules and regulations to be prescribed by the Secretary of the Treasury.

Section 214 (a) (10) of the Revenue Act of 1918 provides under that Act as follows:

In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date: Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter; such reasonable allowance in all .the above cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.

These provisions of the statute allow taxpayers reasonable deductions from gross income on account of depletion of mines, oil and gas wells, and other natural resources. If the property was acquired before March 1, 1913, the value on that date was permitted to be returned by way of depletion allowances. There are many variable factors entering into the determination of a reasonable allowance for depletion of mines and Congress merely provided that this reasonable allowance for capital depletion should be made under rules and regulations to be prescribed by the Secretary of the Treasury under the 1916 Act, and by the Commissioner with the approval of the Secretary under the 1918 Act. Neither statute prescribes any method by which the reasonable allowance should be determined.

Under both the Revenue Acts of 1916 and 1918, regulations were promulgated pursuant to the statute. Articles 171 and 172 of Regulations 33 and article 210 of Regulations 45 provide that the allowance for depletion for any year shall be determined by dividing the cost or the March 1, 1913, value by the number of tons or other unit of mineral estimated to be in the ground at the basic date and multiplying this quotient by the number of tons or other unit of ore mined and sold during the year. In the case of New Creek Co. v. Lederer, 295 Fed. 433, the Circuit Court of Appeals, Third Circuit, had before it for consideration whether articles 171 and 172 of Regulations-33 were in accordance with the statute. The taxpayer in that case contended that the method of determining the allowance for depletion provided for in those articles of the regulations was not the reasonable allowance for mine depletion which the statute gave it. The court held, however, that the articles of the regulations referred to were not unreasonable and did not deprive the taxpayer of the reasonable deduction allowed by the statute.

The Revenue Act of 1918 is more specific in prescribing the basis upon which the depletion allowance should be made. It provides that in the case of such property acquired prior to March 1, 1913, the fair market value of the property on that date should be taken in lieu of cost.

This statute did not prescribe any method by which a reasonable allowance during the taxable year should be determined, but left that matter to be provided for in regulations to be prescribed by the Commissioner with the approval of the Secretary. The same method for determining this allowance that had been prescribed in articles 171 and 172 of Regulations 33 were provided by Regulations of the Commissioner approved by the Secretary.

The March 1,1913, value when ascertained is to be divided by the number of tons estimated to be in the mine. This quotient is to be multiplied by the number of tons sold during the year. This, in our opinion is a fair and reasonable method of arriving at the reasonable allowance for depletion provided by the statute. The contents of a mine can only be determined by estimates. The number of tons of minable coal can not be actually measured until the coal is mined. There may be many factors shown by development and discovery work carried on in subsequent years which would demonstrate that the estimates made as of the basic date, as well as during the taxable year, were erroneous, but in our opinion it was not the purpose of the statute to postpone the definite determination of taxable liability for an indefinite number of years. Taxes should be computed on an annual basis and on the basis of facts known or ascertainable during the taxable years. The rate of depletion should be determined in this case by dividing the March 1, 1913, value by the estimated number of tons in place. It does not seem to us that Congress contemplated that the reasonable allowance for depletion provided for by statute should not be determined or be capable of determination until the contents of the mine had actually been mined and measured, or until development work of subsequent years demonstrated what the actual content of the mine was.

If the estimated ore reserves were to be definitely and finally determined only after actual demonstration or development work, it would be just as reasonable to revise the March 1,1913, valuation for the same reason and upon the same basis. One of the factors entering into the valuation of ore deposits as of March 1,1913, is the estimated tonnage in place.

But the petitioner does not seek to revise and lower the March 1, 1913, value as the result of the knowledge acquired by subsequent development work. It seeks to recover the established March 1, 1913, value of $171,737.24, which was arrived at when it was estimated that the ore reserves were 4,681,577 tons by revising its estimates of ore reserves upon the basis of knowledge acquired subsequent to the filing of its returns. The subsequent knowledge gained by development work indicates that the actual content of the mine was only 372,206 tons. With the actual tonnage of the smaller amount the petitioner contends that the valuation as of March 1, 1913, determined on estimates of the reserves of 4,681,577 tons should be returned by depletion allowances by revising the estimates of coal reserves, but not the March 1, 1913, value. We see no more reason for altering or revising the estimate of ore reserves as established on the factors known and conditions existing on the basic date and during the taxable years than for changing the March 1, 1913, valuation as the result of subsequent events.

It was stipulated in this case that a fair estimate of the coal reserves of the Cecil Mine on March 1, 1913, was 4,681,577 tons. It was not until the latter part of 1922, which was after the returns for 1918 and 1919 had been filed that the petitioner discovered that this estimate was inaccurate and that the number of tons of minable coal in the mine was materially less than the number estimated as of the basic date.

In Stouts Mountain Coal Co. v. Commissioner, 4 B. T. A. 1292, we had a similar state of facts before us. There we said:

* * * At the time the petitioner started operations, and during the year 1920, it believed that the recoverable tons of coal in its property were 400,000. It developed, however, prior to the close of its fiscal year ended October 31, 1921, that the recoverable tons were in all not in excess of 75,000. The depletion deduction for such year is the undepleted cost of the coal in place at the beginning of such year; in other words, the undepleted cost on November 1, 1920, should be spread over the number of tons of coal removed during the fiscal year ended October 31, 1921. Only in this way will the petitioner be allowed to recover from gross income, as a depletion deduction during the life of the mine, the undepleted cost of the coal in place at the beginning of the taxable year.

We think that this method is sound and by the application of it the petitioner would be entitled to the reasonable allowance for depiction as provided by the statute.

The rule contended for by the petitioner is that in the case of mines the rate of depletion applicable for any year is contingent upon the determination of the reserves in the ground as ascertained by the development prosecuted and carried on in subsequent years. Under this rule there would be no time until the end of the life of a mine or at least there would be an indefinite length of time before a final estimate of the recoverable coal in place could be made. The petitioner contends that unless it is given the right in this case to revise its depletion allowances for 1917, 1918, and 1919 upon an estimate of reserves made in 1922, it will not have returned to it its capital tax-free. In our opinion, this contention is not sound. In the first place, a taxpayer is entitled only to a reasonable allowance for depletion, and that reasonable allowance must of necessity be computed upon the basis of factors known to exist during the year for which the return was filed. It is not in our opinion the purpose of the statute to permit taxpayers to determine their net incomes for a given year on the basis of facts developed in the future.

Under our decision in Stouts Mountain Coal Co. v. Commissioner, supra, if subsequent developments show that a material error has been made in the original estimates of the ore reserves, a new estimate may be made, and the capital remaining to be recovered distributed accordingly. This is in accordance with article 209 of Regulations 45, and in our opinion is a fair and reasonable interpretation of the statute. To the extent that our opinion in Appeal of Kehota Mining Co., 3 B. T. A. 885, is inconsistent with the views herein expressed, it will not be followed in the future.

Reviewed by the Board.

Judgment will ie entered on 15 days’ notice, under Bule 50.