author: Disney:

text:
    Norman Cooledge, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92289.
    Promulgated June 20, 1939.

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

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

       Vacated; order dated July 11, 1939. See p. 1325.

   OPINION.

Disney:

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

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

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

We think respondent’s position must be sustained on this point, although Falk Corporation v. Commissioner, 60 Fed. (2d) 204, cited by him as authority, does not, we think, sustain him, because of an obvious typographical error pointed out by petitioner. Nevertheless, we do not agree that it follows, as petitioner argues, that, because in that case the court also stated that “he [the vendee] cannot be considered a taxpayer,” and that “we are convinced that Falk Company [the vendor] in fact paid the taxes in controversy, for it furnished to petitioner the money and property with which to make the payment”, that the vendor herein is entitled to deduction. Petitioner did not, in fact, pay the taxes or interest, and he was on a cash basis of accounting. He might have made a contract of sale providing that he pay the taxes, or providing that the vendee pay taxes as his agent and with his money, out of the purchase price; but he did not do so. Actually, he sold property for a purchase price, a part of which was payment of accrued interest and taxes by the vendee. That contract did not constitute the vendee the vendor’s agent or attorney in fact to pay such taxes and interest, but served rather merely to deduct the amount thereof from the purchase price. In the absence of the element of actual agency to pay taxes, we think the interest and taxes were investment in the property by the vendee, and it can add them to its base upon resale. California Sanitary Co., Ltd., 32 B. T. A. 122; Falls Corporation v. Commissioner, supra.

In Falls Corporation v. Commissioner, supra, the court did not have before it the vendor nor the question of its income taxes or deductions, and anything said as to the position of the vendor is necessarily dictum. The court indicates plainly, we think, that it is holding merely that in effect the vendor paid the taxes, or rather that “petitioner has not brought itself within the statutes because in reality it has paid no tax in the true sense of that word.” Moreover, it appears that in that case the vendor transferred its corporate assets to vendee for its entire capital stock and that vendee “also assumed and agreed to pay the liabilities of Falk Company [vendor], including the state income tax”, whereas herein only the ad valorem taxes and tax liens against the property (and interest on mortgage thereon) are involved, the amounts of which were a part of the purchase price of the property sold. We think that the cited case is not determinative here. Mere furnishing of funds is not payment of taxes. Edward Hagelin, 37 B. T. A. 8.

A vendor, though denied deduction for the amounts as interest and taxes, is nevertheless in the position of getting the benefit thereof, for by the amounts paid his sale price is lessened, to his benefit either in computation of gain or loss, for if he has gain, it will be less than if he had received a purchase price including the amount paid for interest and taxes, and if he has a loss, it will be the greater for the same reason. The accident that in the instant situation petitioner is denied loss (as he admits) because of owning more than 50 percent of the stock in the corporate vendee, under section 24 (a) (6), Revenue Act of 1934, is obviously immaterial. Nor do we find in Carl K. Lifson, Administrator, 36 B. T. A. 593, or the rulings of the respondent, any support for petitioner’s theory, for all depend upon payment — and taxpayer did not pay the interest or taxes here. We conclude and hold that petitioner is not entitled to deduction of the amounts paid by his vendee for interest and taxes.

II. — During 1934 petitioner received $59,064.82, or $22.39 per share, in complete liquidation of 2,638 shares of stock owned by him in the Finance Co. of the South, a corporation. The cost or other basis of the stock and date of acquisition thereof were as follows:

In the deficiency notice, respondent charged petitioner with a gain of $2,492.46, but by amended answer seeks to charge petitioner instead with a net profit of $4,137.28, a figure reached by deducting, from gain on the stock acquired prior to 1926, recognizable losses on the blocks acquired thereafter, as shown above, resulting in a proposed increase of deficiency from $721.06 to $934.89. The change in respondent’s theory is to a view that gain or loss, instead of being computed on the stock as a whole as originally treated, should be determined separately on each block of stock, according to the length of time the stock was held by petitioner, that gams should be taxed in their entirety under section 115' (c), Revenue Act of 1934, and that the amount of deductible losses should be limited to the percentages set forth in section 117 (a) of that act. Petitioner contends that his taxable gain is the difference between the total basis of his three blocks of stock and aggregate amount distributed to him in 1934 in complete liquidation, as originally determined by the respondent.

We think respondent’s construction of the applicable statutory provisions is correct. The statute, section 115 (c), provides first that amounts received in complete liquidation shall be treated as in full payment in exchange for the stock; next that gain or loss from the exchange shall be determined under section 111 and recognized to the extent provided under section 112; and then that 100 percent of “the gain so recognized” shall be taken into account in computing net income, despite section 117 (a), which provides that of the loss or gain recognized, only certain percentages thereof shall be taken into account in computing net income (depending upon length of time the capital asset has been held). It is apparent from these provisions of the statute that gain or loss on liquidation distributions is to be computed in the same manner as sales. White v. United States, 305 U. S. 281; Helvering v. Weaver Co., 305 U. S. 293. On the basis that “a distribution in liquidation of a corporation is treated in the same manner as a sale of stock” — quoted by the Court from the report of the Senate Committee on Finance — in the Weaver case the Court held the limitation on losses provided by section 23 (r) (1), Revenue Act of 19S2: to be applicable to losses on liquidating dividends; and in the White case held that section 101, Revenue Act of 1928, as to treatment of capital net losses, was applicable to losses on liquidating dividends. Section 115 (c), Revenue Act of 1934, requires that in case there is gain as thus determined, 100 percent thereof shall be taken into account in computing net income, but of losses, all, or only a certain percentage, depending upon the length of time the stock had been held, is recognized as deductible, under section 117 (a). The provision relating to gain was inserted in section 115 (c) to prevent avoidance of surtaxes in the liquidation of corporations with large surpluses. Helvering v. Weaver Co., supra.

Here the stock was acquired by petitioner during three periods, the first group of shares for $17,622.36, and the last two blocks at $25 per share, which was $2.61 per share in excess of the liquidating dividend of $22.39 per share. We assume from the stipulation and the absence of any controversy on the point that all of the stock purchased prior to 1926 had a cost basis of less than $22.39 per share.

If all of the stock had a basis of less than $22.39 per share, obviously gain would have resulted on each block surrendered in liquidating proceedings and the amount thereof would be the same whether computed as a unit or as three separate items of assets. But in view of the limitation provided in section 117 (a) on losses sustained on stock held in excess of one year and graduated for longer periods, it is imperative that a separate computation be made of gain or loss on each group of stock according to its classification in the statute; otherwise, its clear intent could not be applied to facts such as those before us here. This method is the natural result of the rule that liquidating dividends must be applied ratably to the entire number of shares held by each stockholder and not to a particular block, even though surrendered at the time of distribution. Florence M. Quinn, 35 B. T. A. 412; Alvina Ludorff el al., Executrices, 40 B. T. A. 32. If this taxpayer had sold the shares acquired in 1930, for example, his gain or loss would be the difference between cost and the amount realized upon sale at $22.39 per share and the tax result could not be deferred pending the disposition of the other blocks of stock. The situation is no different here because the three classifications of stock were disposed of at one time; each continued to have its own basis for tax computing purposes.

The case of First National Bank et al., Executors, 34 B. T. A. 631, involved the question of whether the stock was disposed of as a unit in one transaction or in two separate blocks and does not govern the question here. The Quiwn case, supra, involved a taxpayer with one block of stock and the theory upon which it was decided is opposed, rather than favorable, to the petitioner’s contention.

The respondent’s method of computing the net profit is sustained.

Decision will be entered for the respondent.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

      (e) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income. In the case of, amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) Generad Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
      100 per centum if the capital asset has been' held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years;
      40 per centum if the capital asset has been held for more than 5 years but not for more than 10 years;
      30 per centum if the capital asset has been held for more than 10 years.


source: Caselaw Access Project

author: Leech :

license: Public Domain

text:
    Midtown Tower, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87479.
    Promulgated June 21, 1939.

      Jacques Brawistein, Esq., Jacob Babkin, Esq., and Mark H. Johnson, Esq., for the petitioner.

      Walt Mandry, Esq., for the respondent.
   OPINION.

Leech :

This is a proceeding to redetermino a deficiency in income tax of $1,472.98 and a deficiency in excess profits tax of $529.38 for the fiscal year ended February 28,1934. The issues arc, first, whether petitioner is entitled to include in the cost of a leasehold, for purposes of exhaustion, a consolidated mortgage on the leasehold and the value of certain shares of stock issued in connection with the assignment of the lease to petitioner, and, second, whether the cost of the lease should be exhausted and recovered over the remaining term of the lease or over the life of the consolidated mortgage.

The facts were stipulated and are so found. Petitioner, a New York corporation, became the lessee of premises located at 50 Seventh Avenue, New York City, in the following manner. On November 11, 1930, the Metropolitan Temple, a New York religious corporation, leased the premises to the Ambrose Realty Co. for a term of 21 years, with provisions for three optional renewals of 21 years each, in consideration of certain specified rentals and the performance of certain covenants and conditions contained in the lease.

The lease provided that the lessee would erect an apartment house, maintain it in good repair until the end of the term, and surrender it in good order at that time. The “Sixth” paragraph of the lease provided, inter alia:

As a further consideration of this lease, the lessee shall, as additional rent, pay and discharge within thirty (80) days after the same shall become due and payable, all taxes and assessments which may during the term hereby demised or any renewal thereof, be imposed and charged upon the demised promises and all buildings and improvements thereon; and shall pay the interest and installments of principal upon any and all mortgages now or hereafter a lien upon the demised premises not exceeding in the aggregate the principal sum of $900,000 or such lesser amount as shall remain due and unpaid from time to time on the mortgage and mortgages and/or consolidated mortgage referred to in paragraph fifteenth hereof * * *.

In paragraph “Fifteenth”, in order to assist the lessee in financing the building operation, the lessor authorized the lessee to contract a loan, secured by a mortgage on the leased premises and the buildings and improvements thereon, not in¡ excess of $767,500, in the execution of which mortgage the lessor was to join. Though the lessor was to assume no personal liability on such loan, it agreed to execute the mortgage jointly with the lessee. The lessee there agreed to consolidate with the Building & Loan mortgage, an existing mortgage already a lien on the premises, in the sum of $132,500, and cause the existing mortgagee to release the lessor from all liability thereon.

This paragraph also provided as follows:

The principal sum secured by the said consolidated mortgage on the demised premises shall be amortized by the Lessee at the rate of not less than Eighteen Thousand Dollars ($38,000) per annum, payable in two semi-annual installments, said amortization to commence not later than twelve (12) months from the date fixed by the terms of this lease for the completion of said building and to continue at that rate until either the said mortgage shall have been fully paid or until the date originally fixed for the termination of the term of this lease, or if such lease is renewed until the date on which said renewal term expires, or if said renewal lease is renewed for the second time then until the time when the full principal sum of said consolidated mortgage has been paid, and all renewal, replacement and extension agreements relating to the original and/or consolidated mortgage hereunder authorized shall so provide.

Paragraph “FoRTY-pikst” of the lease provided that all payments required to be made by the lessee under the leasing either to the lessor or otherwise should be regarded as additional rent.

On November 12, 1930, the Ambrose Realty Corporation assigned the lease to the Fifty Seventh Avenue Corporation, the assignee covenanting with both the assignor and Metropolitan Temple to perform all the obligations of the lessee contained in the lease. Notwithstanding the assignment, it was provided that the Ambrose Realty Corporation would continue to remain liable under the lease. Thereafter, Fifty Seventh Avenue, joined by the Metropolitan Temple, executed the consolidated mortgage of $900,000, due March 13, 1937, entered upon the property, and erected the required building, in accordance with the terms of the lease.

Because of arrears in taxes, interest, and mortgage amortization, the lease was modified on February 27, 1933. The changes made, so far as here material, were as follows: The requirement to amortize the principal of the mortgage prior to January 1, 1937, was omitted, except in so far as the holder of the mortgage might require it. On January 1, 1937, amortization payments by the lessee were to be resumed at a rate not less than $9,000 semiannually and continued until the termination of the original lease term or until the expiration of the first renewal term, and if there should be a second renewal, until the full principal sum of the mortgage should have been paid. The provision that all payments required to be made by the lessee under the lease to persons other than the lessor should be regarded as rent, was reiterated. Finally, the modification agreement provided that on condition the lessee should remain liable on all the terms, covenants, and conditions of the lease as modified, the lessor consented to the assignment of the lease, as modified, to petitioner.

On the same day, the Fifty Seventh Avenue Corporation and Metropolitan Temple entered into an agreement with the New York Title & Mortgage Co., the holder of the mortgage bond, which deferred payment of all installments of principal due or to become due until March 13, 1937. The modified lease was thereupon assigned by the Fifty Seventh Avenue Corporation to petitioner, subject to the mortgage on the fee on which there was then unpaid the sum of $900,000.

The final transaction of February 27, 1933, was the execution of an agreement between the Metropolitan Temple and petitioner which recited that in consideration of the consent by the Metropolitan Temple to the assignment of the lease to petitioner, petitioner assumed and agreed to be bound by all of the terms, covenants, provisions, and conditions to be performed on the part of the lessee, as modified by the agreement between the Fifty Seventh Avenue Corporation and the Metropolitan Temple. In addition, this agreement stated that the Metropolitan Temple consented to the assignment, provided the Fifty Seventh Avenue Corporation continued to be bound under the lease.

In connection with the assignment of the lease, petitioner expended $43,167.61, representing payments of arrears of interest, taxes, etc., due at the time of the execution of the assignment.

On February 27, 1933, the Fifty Seventh Avenue Corporation wrote the following letter to petitioner:

Referring to the sale of the lease and leasehold estate of premises 48-60 Seventh Avenue, New York City, by the undersigned to you, consummated this day as of March 1, 1933, kindly draw or endorse the checks for the consideration to the extent of Forty Thousand Thirty-Two and 15/100 Dollars ($40,032.15) to the order of New York Title and Mortgage Company, check for One Thousand Dollars ($1,000) in accordance with approval of payment thereon, and kindly issue the two and one-half (2%) shares of stock of your corporation in the name of Edward Levy.

Simultaneously with these instructions, petitioner’s chief stockholder entered into an agreement with Edward Levy whereby the stockholder received an option to purchase this stock. The stockholder actually purchased the stock from Levy on December 18, 1933, for the sum of $5,000.

In its return, on the accrual basis, petitioner deducted $18,863.35, representing a 2 percent amortization of the cost of the leasehold apparently spread over the expected period of the mortgage. In this cost, petitioner included the $900,000, principal of the mortgage, and the $43,167.61 expended in connection with the assignment. In its petition it contends that $5,000, representing the value of the stock issued to Edward Levy in connection with the assignment, should also be included.

In its return for the fiscal year ended February 28, 1934, petitioner claimed a deduction of $18,863.35 for amortization of its leasehold costs. This sum constituted two percent of $943,167.61, which is the aggregate of $900,000, the principal amount of the consolidated mortgage, and $43,167.61, which it paid on account of past due taxes and other expenses in connection with the assignment of the lease to it. The respondent disallowed the deduction except as to the item of $43,167.61, which he determined was properly amortizable over the term of the original lease. This determination, as to the proper period over which this conceded item of cost of the lease is to be amortized, is correct. Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381; 1620 Broadway Corporation, 36 B. T. A. 149.

The issue remaining is whether the cost of this leasehold to petitioner includes also any part of the consolidated mortgage and $5,000, as tlie value of two and one-half shares of petitioner’s stock issued to a nominee of the assignor in connection with the assignment of the lease to petitioner. The position of petitioner is that (1) it assumed the entire mortgage obligation of $900,000 at the time it acquired the lease and is therefore entitled to include this entire item in its cost; and (2) even if the fact of that assumption be ignored, the mortgage existing on the leasehold represents a cost thereof to petitioner.

It would seem clear that only such part of this mortgage as may be considered invested by the petitioner in the leasehold can be considered as includable in its cost for amortization purposes. Duffy v. Central Railroad of New Jersey, 268 U. S. 55. It may well be that the personal assumption of the mortgage by petitioner, even though payments thereon were postponed until a year after the tax year, would suffice for that purpose. See Brons Hotels, Inc., 31 B. T. A. 376; John D. Fackler, 39 B. T. A. 395. But, without petitioner’s assumption of that personal liability, at least, payments, neither due nor made during the tax year, do not constitute an investment in or cost of the lease to petitioner. That is the converse of our decisions holding that one who owns real estate subject to a mortgage, the payment of which the owner did not personally assume, receives nothing upon a foreclosure sale of such real estate. Commonwealth, Inc., 36 B. T. A. 850; Sol Greisler, 37 B. T. A. 542; affd., sub nom Commissioner v. Freihofer, 102 Fed. (2d) 787. This disposes of petitioner’s second contention on this issue.

Assuming, but not deciding that such part of the consolidated mortgage here, the payment of which was personally assumed by the petitioner, was includable in its amortizable cost of the leasehold — was any part of this mortgage so assumed?

Petitioner acquired the lease from the lessor, through its assignor, the Fifty Seventh Avenue Corporation. Thus, as to the provisions of the lease, petitioner is in exactly the position of the prior lessee. Cogar v. Commissioner, 44 Fed. (2d) 554. But petitioner was neither a party to nor has assumed the payment of the mortgage as such. It is personally liable only so far as the lease provides. Its only obligation in that connection under the lease was to “pay the interest and installments of principal upon any and all mortgages now or hereafter a lien upon the demised premises not exceeding in the aggregate the principal sum of $900,000, or such lesser amount as shall remain due and unpaid from time to time on the mortgage and mortgages and/or consolidated mortgage referred to in paragraph fifteenth hereof.”

Paragraph “Fifteenth” provided that the consolidated mortgage “shall be amortized by the Lessee at the rate of not less than Eighteen Thousand Dollars ($18,000) per annum payable in two semi-annual installments.” And the modification of the lease, effected before the assignment to petitioner, postponed any payments on the mortgage until March 13, 1937. Under such circumstances, we think that petitioner’s only personal liability was that of a lessee and not as a borrower. See 379 Madison Ave., Inc., 23 B. T. A. 29; reversed on other grounds, 60 Fed. (2d) 68. And as such, during the taxable year, it had no personal liability to make any payment on account of the mortgage. It follows, we think, that no part of the consolidated mortgage on the leasehold forms a part of the cost of the leasehold to petitioner. Respondent was right in denying petitioner any amortization deduction on account of it, for the taxable year.

Petitioner raises, for the first time in its petition, the question as to whether or not the value of two and one-half shares of its stock, issued to a nominee of the assignor of the lease, should be included in petitioner’s cost of the leasehold. Aside from any other frailties in this position, the agreement under which this stock was issued is not in evidence nor is anything disclosed as to why it was issued. We hold that this item is not a part of petitioner’s cost of the leasehold for amortization purposes.

Decision will be entered for the respondent.


author: Smith: Black,

text:
    New Orleans Cold Storage and Warehouse Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94518.
    Promulgated June 22, 1939.

      Percy S. Benedict, Esq., for the petitioner.

      Oliarles PL. Owl, Esq., for the respondent.
   OPINION.

Smith:

This is a proceeding for the redetermination of deficiencies of $1,848.46 and $881.15 in income tax and excess profits tax, respectively, for the period March 1 to December 31, 1936.

The only error alleged in the petition is:

* * * the failure of the respondent to allow as a deduction against petitioner’s income ten-twelfths of the real estate and personal property taxes paid to the City of New Orleans, and the State of Louisiana, on August 4, 1936, and December 30, 1936, amounting to Sixty-three Hundred Fifty-two & 40/100 ($6352.40) Dollars.

The petitioner is a Louisiana corporation with its principal place of business at New Orleans. The pertinent facts are stipulated as follows:

1. The petitioner was incorporated on July 3, 1901 under the laws of the State of Louisiana. It keeps its books and filed its income tax returns on the accrual basis.
2. For several years prior to and including the fiscal year ended February 28, 1936 petitioner filed its income tax returns on a fiscal year basis ending on the last day of February.
3. During the year 1936 petitioner made application to change from the fiscal year basis to a calendar year basis and under date of November 12, 1936 the Commissioner of Internal Revenue granted the petitioner permission to change its accounting period to a calendar year basis.
4. The petitioner filed an original and an amended return for the period March 1, 1936 to December 31, 1936. On both returns a deduction for property taxes in the amount of $6,352.40 was made. This was the amount of the property taxes for the year 1936 that had not been claimed on the return filed for the fiscal year ended February 29, 1936.
5. For the fiscal year ended February 29, 1936, the property tax deduction was arrived at by taking the portion of the property tax for the year 1935 that had not been claimed as a deduction on the return filed for the fiscal year ended February 28, 1935 and adding thereto an estimated two-twelfths of the property tax for the year 1936. The same method of computation of deduction for property taxes was employed for years prior to 1935. The books and records were kept on the same basis.
6. Property taxes in the State of Louisiana accrue as a liability against the property on January 1 of each year. In 1936 the real estate assessment rolls for the Parish of Orleans, Louisiana were first opened for fifteen days from February 1 to February 15.
7. Following the instructions of the Internal Revenue Department, petitioners, when they changed their fiscal year so as to make it end December 31, closed their books in accordance with this change.

The sole question, presented by this proceeding is whether the petitioner is entitled to deduct from its gross income for the fiscal period March 1 to December 31, 1936, the amount of property taxes accrued upon its books and paid during that period. In its return petitioner deducted from gross income $6,352.40 for such taxes, which was the amount of property taxes for the calendar year 1936 that had not been) claimed on the return filed for the fiscal year ended February 29, 1936. Respondent has disallowed this deduction for the following reason, stated in his notice of deficiency:

(b) Inasmuch as the state and city property taxes became a liability as at January 1, 1936, it is held that the entire amount due instead of two-twelfths is properly deductible in the taxable year ended February 29, 1936 and therefore unallowable in the taxable year March 1, 1936 to December 31, 1936, in accordance with the provisions of Income Tax Unit Ruling 2643, Cumulative Bulletin XI-2, page 81 (1932).

The above referred to I. T. 2643 bears the following headnote:

Ownership of property in Louisiana on January 1 is the event which determines the liability for both real estate and personal property taxes and fixes the amount, though not ascertainable on that date. Real and personal property taxes in Louisiana accrue, therefore, for Federal income tax purposes, on January 1 of each year.

Citing numerous court decisions of the State of Louisiana, the Commissioner concludes:

* * * that the levying of taxes is for the “calendar years,” and the “assessment” of property for the “purpose of levying” the “annual taxes” is likewise for the calendar year. So, when the law provides that assessment must begin on the 2d of January and be completed on the 1st day of March, it contemplates an assessment on the basis of the condition of things existing on the 1st day of January.

There appears to be no question but that under the laws of the State of Louisiana real and personal property taxes become a liability of the person who owns the property on January 1. Personal property acquired after January 1 may likewise be taxable. In City of New Iberia v. Police Jury of Iberia Parish, 135 La. 769; 66 So. 193, it is stated: “For the purpose of assessment, the status of the property is to he taken as of date the 1st of January of the year in which the assessment is to be made. See Bunkis Brieh Works v. Police Jury, 113 La. 1062; 37 South. 970; Insurance Co. v. Board of Assessors, 49 La. Ann. 401, 21 South. 913.”

Personal and property taxes in Louisiana are “annual taxes.” In New Orleans the commission council at its first meeting in the month of December in each and every year levies the taxes for the following calendar year. The assessors are required to meet not later than November 1 of each year and are required to complete assessments on or before January 31 of the following year. The assessment rolls are open to the inspection of the public for correction for a period beginning February 1. After the rolls are completed they are delivered to the collector, the recorder of mortgages, etc. Beginning with the year 1935 the first installment of taxes in New Orleans became payable in the month of June, the second installment during the month, of September, and the third and final installment during the month of December.

By an amendment to the law in 1936 (Act No. 227 of 1936), the owner of property] on August 1 of each year is made liable for the tax which may later be levied and assessed for the following calendar year. This amendment became effective for real and personal property taxes for 1937 and succeeding years.

So far as the briefs of the litigants in this case show and so far as the Board has been able to determine, no case involving similar facts has ever been presented to the Board for decision. The Board has had occasion, however, to determine whether taxpayers on an accrual basis were entitled to deduct from gross income taxes which had become a fixed liability within the taxable year and charged as an accrual upon its books of account even though the date for payment thereof had not arrived. We have sustained the taxpayers’ contentions upon this point in the following cases: H. H. Brown Co., 8 B. T. A. 112; John Hancock Mutual Life Insurance Co., 10 B. T. A. 736; Crown Willamette Paper Co., 14 B. T. A. 133; Arcade Department Store, Inc., 18 B. T. A. 1172. In Patrick Cudahy Family Co., 36 B. T. A. 1147, the facts and decision of the Board were as follows:

Under the laws of the State of Wisconsin both real and personal property-taxes are assessed as of May 1 in each year. The rate of tax is not determined and the assessment of the tax is not made until after November 1. The petitioner keeps its books of account and makes its income tax returns upon the accrual basis and for a fiscal year ended June 30. In its income tax returns for 1933 and 1934 it deducted from gross income personal property and real property taxes which became due and were paid by it within each fiscal year. The respondent has amended such returns and allowed as a deduction from gross income the taxes which were assessed as of May 1 falling in each fiscal year. Held, that the petitioner is entitled to deduct from the gross incomes of the fiscal years ended June 80, 1933, and June 30, 1934, the real property and personal property taxes which it claimed as deductions in its returns.

In the last cited case it ivas the contention of the respondent that, inasmuch as! the assessment of the tax was made as of May 1, that date was the accrual date for the taxes. The Board held otherwise, however, upon the theory that all of the facts for the determination of the tax liability were not known by the taxpayer on May 1. Our decision in that case was affirmed by the United States Circuit Court of Appeals for the Seventh Circuit, 102 Fed. (2d) 930. In its opinion the court said: “We think it cannot be said that liability for the taxes accrues until the events by which that liability is fixed have occurred.”

Applying the same principle to the proceeding at bar, we think it must be held that the liability for the taxes here in question did not accrue within the meaning of the taxing statute on January 1, 1936. The assessment roll was not completed on that date. The assessors apparently had until some time in May for the determination of the exact tax liability. The petitioner was not required to file its income tax return for the fiscal year ended February 29, 1936, until May 15, 1936. It “estimated” what two-twelfths of the 1936 levy would be in making up its return. This fact shows that the petitioner did not know its actual personal and property tax liability for 1936 at the date the return was filed.

From the stipulated facts it is impossible, to determine just when all the events had occurred that fixed the petitioner’s 1936 liability for personal and property taxes. That date was after January 1 and prior to the date the first installment was due in June. We do not think, however, that) it is necessary in this proceeding to determine the exact date when all the events had occurred which fixed the petitioner’s liability for 1936 taxes. The Revenue Act of 1936, consonant with similar provisions of the income tax acts from 1916, provides:

SEC. 41. GENERAL RULE.
The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the ease may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *

According to the stipulated facts it had long been the practice of the petitioner to deduct, from gross income in its fiscal year returns ending on the last day of February, ten-twelfths of the property taxes levied for the prior calendar year and two-twelfths of such taxes levied for the calendar year in which its fiscal year ends. The respondent has accepted such returns and has never raised any question as to the correctness of such accounting. Pursuant to authority granted by the respondent, the petitioner changed its accounting period from a fiscal year to a calendar year basis in 1936 and filed a tax return for the fiscal period March 1 to December 31,1936, deducting from gross income the portion of the taxes levied for 1936 which it had not deducted in the prior fiscal year return. The taxpayer’s books of account show such accrual of taxes. The deduction of these taxes has been disallowed by the respondent in the determination of the deficiency.

By section 47 of the Revenue Act of 1936, returns for a period of less than 12 months are provided for where there is a change in the accounting period from a fiscal year to a calendar year or vice versa. Under article 47-1 of Regulations 94, the return for a short period must be made upon the same basis as the return for a full year. The petitioner has followed this regulation and made its return for the period March 1 to December 31 in accordance with its books. The respondent has not. By his determination the petitioner will never get the benefit of the deduction from gross income of the portion of the taxes paid for 1936 which were not claimed in the return filed for the fiscal year ended February 29, 1936. We do not think that this result was contemplated by Congress.

The pertinent question here is whether the method of bookkeeping employed by the petitioner correctly reflected the income of the petitioner for 1936 and prior years. We think that it did.

In Thurman v. Studebaker Corporation (C. C. A., 7th Cir.), 88 Fed. (2d) 984, the court stated:

Where a taxpayer’s books are kept on an accrual basis, the expenses paid or incurred, properly charged upon the books of the taxpayer and properly attributable to the process of earning income during the period covered by the return, must be deducted in that period, in order to reflect the true income of the taxpayer. United States v. Anderson (United States v. Tale & Towne Mfg. Co.), 269 U. S. 422, * * * American National Co. v. United States, 274 U. S. 99, * * * In the first mentioned case, certain taxes accrued in the year 1916 but could not be determined until the following year, at which time the exact amount became evident. The taxpayer, though it entered a reserve for the taxes in 1916, made the deduction in 1917 when the taxes were fixed and paid. The books having been kept on an accrual basis, the Supreme Court ruled that the deduction should be made in the year 1916, as the expense was properly allocable to the income realized that year. The court said the accrual system was approved “to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period; and indeed, to require the tax return to be made on that basis, if the taxpayer failed! or was unable to make the return on a strict receipts and disbursements basis. The appellee’s true income for the year 1916 could not have been determined without deducting from its gross income for the year the total cost and expenses attributable to the production of that income during the year. The reserve for munitions taxes set up on its books for 1916 must have been deducted from receivables for munitions sold in that year before the net results of the operations for the year could be ascertained.”

Ill the early case of United States v. Woodward, 256 U. S. 232, it it was said that the word “accrued” means “became due.”

In United States v. Anderson, 269 U. S. 422, the same Court held that when it thus defined the term “accrued” it did not have in mind the provision of an earlier income tax act corresponding to section 41 of the Bevenue Act of 1936. In the last named case the Court said that the accrual system was incorporated into the law:

* * * to enable taxpayers to keep their books and make their returns according to the scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period * * *. [Italics supplied.]

The principle thus announced was further extended in Fawcus Machine Co. v. United, States, 282 U. S. 375, in which it was held that taxes upon the profits for the year 1918 accrued in that year even though the Revenue Act of 1918 was not passed until February 24, 1919, and made changes in the rates. The Court observed that:

* * * The Act [Revenue Act of 1918] was passed in ample time to allow the taxpayer to readjust its accounts for that year by including these taxes; and, since its books were kept on an accrual basis, it was necessary that this should be done in order clearly to reflect the income for 1918.

From the above cited opinions we think it is clear that the .petitioner is entitled to deduct from the gross income for the period March 1 to December 31, 1936, the portion of the taxes levied for 1936 which were not claimed as a deduction in the return filed for the fiscal; year ended February 29, 1936. At least ten-twelfths of the property taxes levied for the calendar year 1936 appertained to the period March 1 to December 31,1936. In our opinion it is illogical for the respondent to contend as he does in this proceeding that the petitioner’s ownership of property during this period was without any burden for property taxes, although the return for such period was made in accordance with its books of account. The petitioner in order clearly to reflect its income for the ten-month period has allocated to that period ten-twelfths of the tax for the calendar year 1936. The amount allocated was “properly attributable” to the process of earning income during the ten-month period.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Black,

dissenting: I respectfully dissent from the majority opinion because, as I view the facts, no taxes accrued against petitioner during the period from March 1 to December 31,1936. That is the period that we have before us.

Petitioner kept its books on the accrual basis. Therefore, since no taxes accrued against petitioner during the period' in question, it would have no right to take a deduction for taxes accrued during such period. I think the Commissioner should be sustained.

Leech agrees with this dissent.


author: Kern :

text:
    The Pacific National Bank of Seattle, as Executor of the Last Will of Frank V. Morgan, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91048.
    Promulgated June 22, 1939.

      W. H. Thompson, Esq., and Harold L. Scott, O. P. A., for the petitioner.

      B. II. Neblett, Esq., for the respondent.
   OPINION.

Kern :

1. Respondent’s inclusion in the decedent’s gross estate, under section 302, Revenue Act of 1926, with such additional tax as may be required under section 401, Eevenue Act of 1932, and section 405, Eevenue Act of 1934, of the community interest of decedent’s surviving widow rests wholly on the waiver which she executed on March 18,1931, simultaneously with the execution by the decedent of his will and of the testamentary trust transfer; the respondent contending that this act transferred the wife’s community property to the decedent during his lifetime and that consequently the entire estate held by the marital community passed at the decedent’s death. Since the petitioner admits that the decedent’s own one-half of the community property passed at his death and is taxable, no question arises on that. More elaborately stated, respondent’s argument is that to treat the wife’s community interest otherwise will enable her to transfer her estate at death free of estate taxes; that this object to avoid taxes is implicit in the whole scheme; that the scheme itself is one which has generally been recommended by trust companies in community property states, as is evidenced by the general printed form of the trust instrument employed by the trust company here, and therefore contemplates tax avoidance on a large scale; and he draws the conclusion, it would seem, that the intention to avoid taxes vitiates the transfer.

We believe that we fully appreciate the force of this argument, but it is one which should properly be addressed to Congress. This Board, in so far as it performs a judicial function, may construe the statute so as to accomplish the ends which the statute itself makes plain; cf. Lucas v. Earl, 281 U. S. 111, and the other cases cited by Cardozo, J., in Burnet v. Wells, 289 U. S. 670, at 677; but there are necessary limits to judicial discretion, and when those limits are reached, administrative officers must find the stopgap in legislative action. Disregarding the motives, therefore, with which the transfer may have been made, we look to what was actually done and the legal effect of those acts.

All the property in question here was acquired after the marital community had been established and, no part of it having been acquired by the husband by gift, bequest, devise, or descent (§6890, Eemington’s Compiled Statutes of Washington) nor any part so acquired by the wife (§6891, ibid.); it was all community property (§ 6892, ibid.). The husband is given the management and control of community real property but he may not sell, convey, or encumber it “unless the wife join with him in executing the deed”, which he and she must both acknowledge. § 6893, ibid. The provision on descent of community property is as follows (Eemington’s Compiled Statutes of Washington § 1342) :

§ 1342. Descent of Community Property. Upon the death of either husband or wife, one-half of the community property shall go to the survivor, subject to the community debts, and the other half shall be subject to the testamentary disposition of tlie deceased husband or wife, subject also to the community-debts. In c'ase no testamentary disposition shall have been made by the deceased husband or wife of his or her half of the community property, it shall descend equally to the legitimate issue of his, her, or their bodies. If there be no issue of said deceased living-, or none of their representatives living, then the said community property shall all pass to the survivors to the exclusion of collateral heirs, subject to the community debts, the family allowance, and the charges and expenses of administration. [Cf. L. ’75, p. 55, § 2; Cd. ’81, §§ 3303., 2411, 2412; 1 H.C., §1481.1

Dower and curtesy are abolished, § 1348, ibid.; and likewise survivor-ship between joint tenants, §1344.

The community interest in realty may be transferred by either spouse to the other, as § 10572, ibid., provides:

§ 10572. [87661 Conveyances Between Husband and Wife. A husband may give, grant, sell, or convey directly to his wife, and a wife may give, grant, sell, or convey directly to her husband his or her community right, title, interest, or estate in (all or any portion of their community real property. And every deed made from husband to wife, or from wife to husband, shall operate to divest the real estate therein recited from any or every claim or demand as community property, and shall vest the same in the grantee as separate property. The grantor in all such deeds, or the party releasing such community interest or estate, shall sign, seal, execute and acknowledge the deed as a single person, without the joinder therein of the married party therein named as grantee: Provided, however, that the conveyances or transfers hereby authorized shall not affect any existing equity in favor of creditors of the grantor at the time of such transfer, gift, or conveyance: And provided further, that any deeds of gift conveyances or releases of community estate by or between husband and wife heretofore made, but in which the husband and wife have not joined as grantors, shid deeds, where made in good faith and without intent to hinder, delay, or defraud creditors, shall be and the same are hereby fully legalized as valid and binding. [L. ’88, p. 52, § 1; 1 H.C., § 1443.]

Section 6894 provides specifically for the mode of transfer of any community property by one spouse to the other, as follows:

§ 6894. [5919] Agreements as to Status of. Nothing contained in any of the provisions of this chapter, or in any law of this state, shall prevent the husband and wife from jointly entering into any agreement concerning the status of disposition of the whole or any portion of the community property, then owned by them or afterward to be acquired, to take effect upon the death of either. But such agreement may be made at any time by the husband and wife by the execution of an instrument in writing under their hands and seals, and to be witnessed, acknowledged, and certified in the same manner as deeds to real estate are required to be, under the laws of the state, and the same may at any time thereafter be altered or amended in the same manner: Provided, however, that such agreement shall not derogate from the rights of creditors, nor be construed to curtail the powers of the superior court to set aside or cancel such agreement for fraud, or under some other recognized head of equity jurisdiction, at the suit of either party. [Cd. ’81, §2416; 1 H.C., §1401.]

The decedent in his will declared (art. 5th) that he was disposing of “not only any separate estate I may have at the time of my death but also all the community property and estate of myself and my said wife, including the community interest and share of my wife therein, to all of which my said wife has consented and has elected to take under this will by written instrument executed by her and bearing date the 18th day of March, 1931.” The decedent’s wife in her waiver executed on the same day declared this likewise to be her intention, electing to take under the will, and waiving all claims to her share of the community property. This waiver she on the same day duly acknowledged before a notary public.

Petitioner urges that section 6894 has provided an exclusive method of transfer of community property between spouses and that its requirements have not been complied with, citing Bloor v. Bloor, 105 Wash. 110; 177 Pac. 722. Respondent relies on Sponogle v. Sponogle, 86 Wash. 649; 151 Pac. 43; Shea v. Commissioner, 81 Fed. (2d) 937, and other cases to support an opposite conclusion. We do not think it necessary, however, to discuss or decide the question whether an effective transfer under local law could have been made by decedent’s wife to him during his lifetime by the means she employed. The wife’s transfer to the trustee has been treated as effective, it may be noted, by all parties concerned, and we may assume in respondent’s favor that a transfer to the husband by the same means would have been effective. We can not on that account, however, conclude the case for the respondent, for we must look to what the waiver sought to accomplish and, on our assumption that the proper statutory forms were employed, did accomplish.

The wife’s transfer of her interest in the marital community to her husband was not a present outright transfer to him, such as respondent attempts to spell out, but a transfer in trust to named trustees, under the fourth article of the will by which decedent disposed of the residue of his estate by a transfer in trust, the wife’s transfer in trust being limited by the condition precedent that her husband predecease her. The husband created a testamentary trust, the wife made a gift in trust inter vivos on the condition named. A recent writer on the subject, cited by petitioner’s counsel, has concisely stated the conclusion to be drawn in respect of the analogous state inheritance law when he says:

* * * Por it is manifest that at the time of the death of the husband, under a will such as we are here discussing, the state is in no position to levy any tax whatever upon the wife’s half of the community property.
Before the state can plausibly make such an attempt, a further, voluntary and affirmative action on the part of the wife is required. In other words, she must agree and consent, either by a formal written acceptance of the will and relinquishment of her interest in the community property, or by virtue of an estoppel, that her half of the community property shall, along with the husband’s half, be turned into the trust. But this amounts to nothing more than a conveyance by the wife to the trustee, after the death of the husband, of her interest in the community property. The fact that the entire community property finds its way into the trust does not mean tliat the trustee of the beneficiaries under tfie trust receive tRe property by will or inheritance; it simply means that one-half of the community property goes to the trustee for the benefit of the named beneficiaries by virtue of the will of the husband, and the other half of the community property goes into the trust because of the voluntary and, what clearly seems to be, the legally affirmative act of the wife. [Judson F. Falknor, 5 Wash. Law Review 65, at 63 (1930).]

Our decision in Coffman-Dobson Bank & Trust Co., Executors, 20 B. T. A. 890, supports the same conclusion and involves facts very similar to those here. There;

The last will of the decedent disposed of his own estate, which, under the laws of the State of Washington, is % of the aggregate property, and further provided that if the widow would permit her property to be placed in trust and be disposed of ultimately, as directed by the decedent, she would receive the income from the whole estate. The widow elected to take under the will.
As thus submitted we have for determination a single issue of law, viz., Does the act of a widow in placing her part of community property in a trust created by the will of her deceased husband, in consideration of a condition in said will giving her the income from the trust, which also included the interest of the decedent, vest, ad interim, her part of such property in the decedent’s estate, so as to subject it to the Federal estate tax?

After briefly reviewing the necessary procedure under Washington law to effect a transfer from wife to husband of community property, we concluded at page 891:

There is no claim here that the decedent required, or that the widow attempted to accomplish, a transfer of her interest in the community property to the former’s estate if, by such informal procedure as indicated, it could have been done. The only condition specified by the will was that the widow permit her property to he placed m trust, and it was this condition to so permit it to be placed that she accepted in the election made. Without passing upon any hypothesis not before us as to what might have been done had the parties so intended, it is clear, under the facts here shown, that the interests of the widow in the property put in trust passed direct from her to said trust, and that it at no time was a part of the taxable estate of the decedent.

The respondent seeks to distinguish this case, but we find nothing different in substance from the instant case. We are unable to accept his suggestion that the arrangement there was “an ordinary election” by the widow between her right to take by descent or under the will. Such an election is ordinarily made after the testator’s death and while the will is in probate, not by an agreement inter vivos between the testator and his wife. There is nothing in the Coffman-Dobson case to indicate that the wife’s consent or waiver was not absolute, as respondent contends, but even if it were ,so in that case and not so here, we still think that in the instant case the wife’s waiver created no present property interest in her husband and did no more than create a trust effective only on the condition precedent that her husband predecease her.

On the first point, therefore, we hold for petitioner.

2. The respondent contends that the proceeds of decedent’s life insurance to the amount of $2,085.50, which was the sum of the expenses of the decedent’s last illness and burial, should be included in the gross estate. There is no dispute over the amount. Respondent insists that since those proceeds were subject, under article 9(a) of the trust agreement, to “the expenses of the last illness and burial of the Trustor”, an equivalent amount should be added to the gross estate. It is contended that the policy proceeds, although not expressly includable as such under section 302(g), Revenue Act of 1926, since they are payable to beneficiaries other than the executors and are not in excess of $40,000, are includable as part of the estate as being subject to charges against the estate, expenses of administration, or to distribution; includable, that is, to the extent used for these purposes. The insurance proceeds, it .is said, were used to the extent mentioned for the benefit of the estate, and as such are subject to the estate tax. Marmaduke B. Morton, Administrator, 23 B. T. A. 236, is relied on. Petitioner contends that the decedent’s funeral expenses and expenses of his last illness had in that order priority under Washington law (§ 1541, Remington’s Statutes) over all other expenses; and that they were in fact paid out of the general and not the trust estate. Petitioner also relies on the direction in decedent’s will that “I direct that all my just debts and funeral expenses be paid as soon after my decease as conveniently may be.” It ,is obvious that this direction is insufficient to alter the prior express direction in the trust deed, and, since the insurance proceeds were in law subjected to the charge in question, it is immaterial that they were in fact paid otherwise.

We think it is clear on the authority of that case that, notwithstanding the fact that the proceeds here were not payable to the bank as executor but as trustee, they were subjected by the trust agreement to the charges in question and to that extent and on that account are properly includable in the gross estate.

It does not appear from the record of this case when the insurance policies were issued nor whether the premiums were paid from community funds. Therefore no question is presented similar to those involved in Lang v. Commissioner, 304 U. S. 264, and Elizabeth C. McCoy, Administratrix, 39 B. T. A. 822.

3. A further question is raised by the respondent in respect of the deduction properly allowable for the decedent’s last illness and burial. It is said that if we hold that only the decedent’s half of the marital estate passed at his death, only one-half of the sum claimed for such expenses, $2,085.50, is allowable as a deduction. The additional deficiency thus claimed has been properly pleaded in the respondent’s amended answer; and since its correctness is admitted by tlie petitioner in its reply brief, we sustain the respondent on this point. Cf. Lang's Estate v. Commissioner, 97 Fed. (2d) 867.

Decision will be entered- under Rule 50.


author: Smith:

text:
    The Estate of Dr. Charles Jefferson Miller, The Hibernia National Bank in New Orleans, Testamentary Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94006.
    Promulgated June 23, 1939.

      Percy S. Benedict, Esq., and Burt W. Henry, Esq., for the petitioners.

      Joe D. Hughes, Esq., and William P. Blake, Esq., for the respondent.
   OPINION.

Smith:

The question presented by this proceeding is whether the respondent erred in including in the gross estate of the decedent, Charles Jefferson Miller, $69,464.07 representing the corpus of the trust created by the decedent on June 30, 1921. The respondent contends that he did not err and that the entire value of the corpus of the trust constituted a part of the gross estate of the decedent .and not one-lialf of the value thereof, which would be the case if the fund was includable in the gross estate.

In his deficiency notice the respondent states:

It is contended that the transfer by the decedent formed no part of his gross estate on the date of death. Clause five of the trust instrument reads as follows:
“That in the event of the death of the Donee, or the expiration of this agreement before the death of the Donor, said bonds and the income accumulated therefrom shall revert to the Donor.”
The trust agreement clearly indicates the length of time it will remain in force is limited to ten years from the date of the agreement. As no new agreement was created or provision made by the donor as to the disposition of the property, upon expiration of the trust agreement the Bureau considers that the property in question reverted to the donor. The language of the trust agreement does not appear to be ambiguous, but clearly shows the intention of the donor at the time it was created.

On brief the petitioner contends:

* * * that the Donation Inter Vivos was complete and irrevocable when made by Dr. Miller, and accepted by him for his daughter, and that Article 5 has reference only to the administration of the securities by the Trustee, and that the provision,
that in the event of the expiration of the agreement before the death of the donor, the bonds and the income accumulated therefrom should revert to the donor,
is so contrary to and violative of the provisions of the law of Louisiana relating to gratuitous donations, Inter Vivos, that when construed in the light of the conduct of the parties at the time of and following the making of the donation, must be reputed as not written; or in any event, as referable to the trust only.

Under the laws of Louisiana donations inter vivos are of three kinds:

(a) The donation purely gratuitous, or that which is made without condition and merely from liberality;
'(b) The onerous donation, or that which is burdened with charges imposed on the donee;
(c) The remunerative donation, or that the object of which is to recompense for services rendered.

We think there is no question but that the donation, if it was a donation under the laws of the State of Louisiana, was a gratuitous donation and was without any charges or conditions. It was made merely because of the love and affection of the donor for his daughter. No burden was imposed upon the donee by the instrument of donation and, as no services were required to be rendered or performed by the donee, the donation can not be classed as either an onerous or a remunerative donation.

Under the Kevised Civil Code, article 1527, by which the interpretation of the act of donation must be governed, the donor may impose upon the donee any charges or conditions that he pleases provided they contain nothing contrary to law or good morals.

Under the jurisprudence of Louisiana the word “charges” can only mean that a burden is placed upon the donee to do something that is required to be done by the donor, such as to pay taxes, etc.

The Supreme Court of Louisiana, in interpreting articles 1527 and 1559 of the Revised Code in the case of Voinche v. Town of Marksville, 124 La. 712; 50 So. 662, held as follows:

The donor may impose on the donee any charges or conditions ho pleases, provided they contain nothing contrary to law or good morals. Civ. Code, Art. 1527. Donations inter vivos are liable to be revoked or dissolved on account of nonperformance of the conditions imposed on the donee. Id. Art. 1559. The word “conditions” as used in this article, is synonymous with the word “charges”; and when a donation contains charges it is considered as made under the condition that it may be dissolved or revoked if they are not executed. Mourion, Examen Du Code Napoleon, vol. 2, p. 366. “Conditions” moan charges or obligations of the donee. Delloz, Repertoire de Legislation, Supplement 5, No. 404, p. 149.

It will be noted that the instrument of donation provides “That this agreement is made under the provisions of Act 107 of 1920.” The creation of trusts is not contemplated by the Civil Code of Louisiana. There was no provision of a Louisiana Statute for the creation of trusts prior to Act 107 of 1920. Section 1 of that act provided:

It shall be lawful for anyone to make a donation inter vivos or mortis causa of any kind of property, and of any amount, whereby an individual or individuals or, a bank or banks now or hereafter organized under the laws of this state for the purpose of conducting savings, safe deposit and trust banking business, or which have accepted the provisions of law relative thereto, and banks organized under the acts of congress of the United States, are designated as trustee or trustees; provided, however, that nothing in this act shall be construed to affect the law in regard to the disposable portion, save that it shall be permissible to provide that the legitime or any portion thereof of any forced heir or heirs shall be administered in trust for his or their benefit by said trustee or trustees, the income to be paid annually or oftener to said forced heir or heirs, or his or their legal representatives.

Section 2 of tbe same act provides:

* * * the period of duration of said trust, which shall not exceed ten years after the death of the donor, except when the beneficiary is a minor at the time of the death of the donor, in which case it shall not exceed ten years after the minor has attained majority. * * *

Section 16 of article 4 of the Statutes of Louisiana, adopted June 18, 1921, provides:

* * * No law shall be passed abolishing forced heirship or authorizing the creation of substitutions, fidei commissa or trust estates; except that the legislature may authorize the creation of trust estates for a period not exceeding ten years after the death of the donor; provided, that where a natural person is the direct beneficiary said period may be made to extend ulntil ten years after Ms majority; * * *

The respondent submits that the instrument of donation is unambiguous ; that it created a trust which was to continue for a period of 10 years, at the end of which time the donated bonds and the accumulated income therefrom should revert to the donor. This argument overlooks, however, the fact that the instrument also provides:

That in the event of the death of the Donor, while the Donee is still a minor, the income from said bonds shall be paid over to the tutor or guardian of said minor for her support, or if she shall have reached her majority, the annual income will be paid to her during the life of tMs trust agreement.

Of course, if it was the understanding of the donor that the period of the trust instrument was to espire on June 30, 1931, the beneficiary would not have reached her majority during the life thereof. Why then should the instrument make any reference to the beneficiary reaching her majority during the life of the instrument?

In the circumstances of this case the Board is of the opinion that it is unnecessary to determine whether the donation made by the decedent on June 30,1921, was an irrevocable donation.

The petitioner contends that if the donated bonds and the accumulated income therefrom reverted to the decedent ten years after the date of the instrument of donation, there was, nevertheless, a manual delivery of the fund to Elizabeth Miller after that date and prior to the close of 1933. We sustain this contention.

There can be no question that the decedent considered the corpus and income of the trust fund as Elizabeth Miller’s on and after May 20, 1933, at which date she attained her majority. The decedent was in close touch with the Hibernia National Bank. That was where he had his bank account. He always referred to the trust fund as constituting the property of his daughter, Elizabeth. He never made any claim to any part of the fund or the income therefrom. The bank’s officers considered the property as belonging to Elizabeth Miller and not to the decedent. With the knowledge of the decedent the bank carried on correspondence with Elizabeth Miller and obtained her permission for the transfer of the securities from the Hibernia Bank & Trust Co. in Liquidation to the Hibernia National Bank.

It is also to be noted that under the instrument of donation the bank was entitled to receive a fee of 5 percent per annum on the natural income from the bonds and from any other bonds in which the accumulated income might be invested. Elizabeth Miller, however, made an agreement with the Hibernia National Bank that its compensation for services rendered should be 3 percent on all coupons collected and 2 percent on all dividends collected. This was not an arrangement by the decedent with the bank but an arrangement between the bank and Elizabeth Miller.

The respondent insists that there was no manual delivery of a gift by the decedent to Elizabeth and the officers of the bank were unable to testify that the decedent ever stated to them after June BO, 1981, that he was making a gift of the fund to Elizabeth. The evidence plainly shows, however, that the decedent at all times considered the fund and accumulations thereof as belonging to Elizabeth and that she with the knowledge of her father dealt with the fund as her own and in 1933 received money from the fund to complete her education and thereafter received the income from the fund.

In Lunsford Richardson, 39 B. T. A. 927, we said:

It is well settled that before there can he a completed gift the donor must surrender dominion and control of the subject matter of it. Edson v. Lucas, 40 Fed. (2d) 398; Allen-West Commission Co. v. Crumbles, 129 Fed. 287; Delight Ward Merner, 32 B. T. A. 658; 79 Fed. (2d) 985; Adolph Weil, 31 B. T. A. 899; 82 Fed. (2d) 561; certiorari denied, 299 U. S. 552; Jackson v. Commissioner, 64 Fed. (2d) 359; Dulim v. Commissioner, 70 Fed. (2d) 828. The “delivery” must be as perfect as the nature of the property and the circumstances and surroundings of the parties will reasonably permit. City Bank Farmers Trust Co. v. Hoey, 23 Fed. Supp. 831; In re Van Alstyne, 207 N. Y. 298; 100 N. E. 802. Manual delivery of the thing given is not necessary, Owen v. Commissioner, 53 Fed. (2d) 329; and delivery need not be made directly to the donee. The gift may be executed by delivery to a third person for the benefit of the donee where there is an intention that present title and ownership shall pass and appropriate language is employed to effect such intention. Grissom v. Sternberger, 10 Fed. (2d) 764. In such instances “constructive delivery is recognized, not on principles of agency, but because the third person becomes a trustee for the donee.” Dulin v. Commissioner, supra. The fact that such third person also acted as agent of the donor does not affect the validity of the gift nor prevent title to the subject matter from passing to the donee. Bingham v. White, 31 Fed. (2d) 574; Copland v. Commissioner, 41 Fed. (2d) 501; but “If the donor deliver the property to the third person simply for the purpose of his delivering it to the donee as the agent of the donor, the gift is not complete until the property has actually been delivered to the donee.” Bickford v. Mattocks, 95 Me. 547, 550; 50 Atl. 894, 895. Cf. Vincent v. Putnam, 248 N. Y. 76; 161 N. E. 425.

In Succession of Zacharie, 119 La. 150; 43 So. 988, the Supreme Court of the State of Louisiana said:

The manual gift — that is, the giving of corporeal movable effects, accompanied by a real delivery — is not subject to any formality, Civ. Code, art. 1539. If the donation has been executed by delivery, it has full effect though not accepted in express terms. Civ. Code 1541.
*******
Where the decedent, an old bachelor of means, caused a certain sum of money to be deposited in a savings bant to the credit of his two dependent sisters, living with him, the delivery to the bank was a delivery to the sisters, and the donation had full effect eo instante.

The above cited case was referred to with approval in Gibson v. Hearn, 164 La. 65; 113 So. 766, in which the Supreme Court of Louisana said:

Money may be donated by manual gift, Succession of Sale, 26 La. 195. And in the Succession of Zacharie, supra, it was held to be an unconditional donation of money where the decedent, a bachelor of means, caused a certain sum of money to be deposited in a savings bank to the credit of his two dependent sisters living with him, the delivery to the bank being a delivery to the donees, the donation becoming effective eo instante.

In Succession of Moore, 40 La. 531; 4 So. 460, it was held:

Bonds payable to bearer, and title to which is transmissible without endorsement or assignment, but, by simple delivery, may be the objects of a manual gift, and are not required to be donated by authentic act. This sort of donation is subject to no formality.

Upon the authority of the cases above cited, the Board concludes that the entire trust fund in the possession of the Hibernia National Bank to the credit of Elizabeth Miller at the date of decedent’s death formed no part of the decedent’s gross estate.

Reviewed by the Board.

Judgment will be entered u/nder Bule 50.


author: Black :

text:
    Pearl Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86415.
    Promulgated June 23, 1939.

      L. A. Luce, Esq., for the petitioner.

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

Black :

The petitioner assails the action of the Commissioner in disallowing percentage depletion for each of the taxable years. The respondent denies that he erred in the matters complained of.

Paragraph 12 of the stipulation which has been filed says that “The respondent has allowed cost depletion for the years 1932 and 1933. The petitioner is claiming in this proceeding deductions for only the excess of statutory percentage depletion over and above the amount of cost depletion heretofore allowed by the respondent.”

We have carefully examined the statement which is attached to the deficiency notice and is a part thereof, and it does not show that the Commissioner has allowed any depletion based on cost as to the $10,860.42 collected on the judgment in 1932 and the $51,252.97 collected on the judgment in 1933. On the contrary, this statement shows that the Commissioner in his determination expressly disallowed any depletion on these judgment payments. In his determination of the deficiency, the Commissioner has allowed depletion of $1,049.69 for 1932 and $289.98 for 1933. In each case it was stated by him that the depletion allowed was on an “overriding royalty.” But be this as it may, the Commissioner does not here contend that any depletion he has allowed should be disallowed and that the deficiency should be increased. Therefore, the depletion which the Commissioner has already allowed to petitioner in his determination of the deficiency, whatever the basis of it was, will remain undisturbed.

The case has been submitted to us as if it involves the issue as to whether petitioner had such an “economic interest” in the oil production as to entitle it to percentage depletion on the payments received in pursuance of the judgment of the court. We shall so treat the issue.

When petitioner sold and assigned to Paul Vitek, trustee, the lease on 133.3 acres of the Eaton land, it was an outright sale for $250,000, payable in promissory notes secured by valid liens upon the property. No interest in the oil to be produced was reserved by petitioner, such as in those cases where the seller is to be paid a certain sum out of oil, if and when produced, and if the oil is not produced, then the payment is never to be made. In this latter kind of cases, the Board and the courts have held that depletion is allowable on the contingent oil payments when received. Chester Addison Jones, 31 B. T. A. 55; Commissioner v. Williams, 82 Fed. (2d) 328; Commissioner v. Elliott Petroleum Co., 82 Fed. (2d) 193; Fleming v. Commissioner, 82 Fed. (2d) 324.

But where the obligation for payment is unconditional and is a personal liability of the purchaser, no depletion is allowable even though the obligation is discharged out of proceeds from oil produced on the premises. Such is merely a payment on account of the agreed consideration for the sale of a capital asset. Cf. Macon Oil & Gas Co., 23 B. T. A. 54; Lester W. Fritz, 28 B. T. A. 408; Darby- Lynde Co. v. Alexander, 51 Fed. (2d) 56; certiorari denied, 284 U. S. 666; Rocky Mountain Development Co., 38 B. T. A. 1303.

Therefore, it is perfectly clear that if petitioner had been paid any of the notes executed by Paul Vitek, trustee, petitioner would have been entitled to no depletion on such payments, even though they had been made out of oil produced on the premises. Petitioner would have been merely collecting the unpaid purchase price due it from the sale of a capital asset.

But Paul Vitek, trustee, died without the payment of any of the notes in question and petitioner had to sue on its notes in court and ask for a foreclosure of its liens on the property in question. The suit was compromised between petitioner and the several corporations which were then the owners of the property, subject to petitioner’s liens. By this compromise, petitioner secured a judgment against the several corporations named therein for $150,000 and a foreclosure of its liens, to be satisfied out of a part of the gross oil production from the premises. We do not think that this compromise agreement and judgment of foreclosure means that petitioner became the owner of any depletable interest in the oil to be produced. It was merely protected in its rights as a lien holder by the judgment of the court.

The judgment of the court, as we view it, gave petitioner no greater interest in the property than it had before, but merely described the method and manner of the discharge of petitioner’s liens on the property in question, including the oil to be produced from the premises. The facts show petitioner to, be a lien holder against the oil properties in question rather than one who has withheld from the operation of the grant which it has made a percentage of the oil to be produced. Cf. Thomas v. Perkins, 301 U. S. 655.

Petitioner in its brief relies largely upon the broad and sweeping language of the Supreme Court in Palmer v. Bender, 287 U. S. 551, in which the Court, in discussing the statute which allows depletion on oil and gas, among other things said:

Tlie allowance to tlie taxpayer is not restricted by the words of the statute to cases of any particular class or to any special form of legal interest in the oil well. * * * The language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil to which he must look for a return of his capital.

Certainly the above language of the Supreme Court is very broad and sweeping and if it stood without limitation perhaps it might be plausibly argued in the instant case that petitioner had such an “economic interest” in the oil to be produced as to entitle it to depletion. But the Supreme Court in subsequent decisions has, in our judgment, very considerably narrowed the broad and sweeping language quoted above from Palmer v. Bender. See Helvering v. Elbe Oil Land Development Co., 303 U. S. 372; Helvering v. O'Donnell, 303 U. S. 370; Helvering v. Bankline Oil Co., 303 U. S. 362.

The Supreme Court, in the Elbe Oil Land Development Co. case, among other things said:

The words “gross income from the property” as used in the statute governing the allowance for depletion means gross income received from the operation of the oil and gas wells by one who has a capital investment therein — not income from the sale of the oil and gas properties themselves. See Darby-Lynde Company v. Alexander, 51 Fed. (2d) 56. We conclude that, as respondent disposed of the properties, retaining no investment therein, it was not entitled to make the deduction claimed for depletion. [Citing cases.] [Italics ours.]

As we have already pointed out, when petitioner sold the leases in question to Paul Vitek, trustee, it retained no investment interest therein. And, for reasons which we have endeavored to point out, we do not think that petitioner acquired any capital investment in the oil in place by reason of the compromise agreement which was entered into and was approved by the court and made the basis for its judgment. We therefore hold that petitioner is not entitled to the additional deductions for which it contends in its assignments of error.

Respondent states in his deficiency notice that the petitioner’s full cost of the property sold was deducted in 1931. Nothing to the contrary has been shown in the instant case. Therefore since we have held that petitioner is not entitled to percentage depletion, there is nothing further to deduct in the way of capital costs of the lease in question.

In addition to Palmer v. Bender, supra, the petitioner cites in support of its contentions, Wilbert Mineral Corporation, 38 B. T. A. 355, and Transcalifornia Oil Co., Ltd., 37 B. T. A. 119. We have examined both of these cases carefully and we think they are distinguishable on their facts. We find nothing in them contrary to the conclusions which we have here reached. The effect of our decision in disallowing the additional depletion deductions claimed by petitioner is to affirm the deficiencies as determined by the Commissioner.

Decision will be entered for the respondent.


author: Tyson:

text:
    The Tennessee Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91137.
    Promulgated June 27, 1939.

      Paul Patterson, Esq., and John G. Horley, Esq., for the petitioner.

      DeWitt M. Evans, Esq., Wilford E. Payne, Esq., and Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Tyson:

In this proceeding there is no dispute as to the amount of the petitioner’s “adjusted net income” within the meaning of section 351 (b) (3) of the Revenue Act of 1934. The primary question presented here is whether, in determining the amount of petitioner’s “undistributed adjusted net income”, the petitioner is entitled to a deduction of the amounts, totaling $97,700, paid to the Hawkins Co. and the Howard Co. during 1934, as amounts used to retire indebtedness incurred prior to January 1, 1934, within the meaning of section 351 (b) (2) (B) of the Revenue Act of 1934.

The petitioner contends that its tiro “promissory notes” given in December 1933 evidenced indebtedness incurred prior to January 1, 1934, and that the payments of $97,700 in question were made to retire a portion of such indebtedness, within the meaning of section 351 (b) (2) (B), supra. The respondent contends (1) that the instruments designated “promissory notes” were not evidences of indebtedness, but in reality constituted certificates of preferred stock issued by petitioner for contributions of capital subject to the risks of the enterprise and returnable only out of net earnings and that the payments in question were merely a return of capital and, if not certificates of preferred stock, respondent further contends (2) that petitioner’s “promissory notes” constituted contingent obligations payable only out of earnings and at the petitioner’s convenience and were not evidences of absolute obligations incurred prior to January 1, 1934, to pay fixed amounts on demand or within a given time and that the payments in question were not made to retire an indebtedness within the meaning of section 351 (b) (2) (B), supra.

The contention that the two instruments designated “promissory notes” constituted certificates of preferred stock of petitioner can not be sustained, for, in our opinion, such a holding would be contrary to the facts herein and the principles of law heretofore announced by this Board.

The petitioner’s entire authorized capital stock of 3,000 no par value shares had been issued and were outstanding prior to December 13, 1933, and remained outstanding subsequent thereto and at all times material here. On December 13,1933, the petitioner entered into an agreement with the Hawkins Co. and the Howard Co. whereby it acknowledged an “existing indebtedness” in the principal sum of $5,000 to the Hawkins Co. and the latter agreed to “loan” to petitioner an additional sum in excess of $150,000 and, also, the Howard Co. agreed to “lend” to petitioner the sum of $149,000. In the same agreement the petitioner agreed to issue its interest bearing “income note” to each of those companies in the principal amount of their respective loans payable out of net earnings prior to the declaration or payment of any dividends on petitioner’s capital stock. The terms of that agreement were carried out. The agreed loans were made to petitioner during December 1933 and at the same time the petitioner issued instruments denominated “promissory notes” as evidences of its indebtedness so incurred. Clearly, the parties to those transactions intended to create a debtor-creditor relationship in December 1933, and all of their acts have been upon the basis of and have given full effect to such a relationship.

By the terms of each note, the petitioner promised to pay a definite principal sum of money and a specified rate of interest thereon to the Hawkins Co. and the Howard Co., respectively. The interest was cumulative and, while the payment thereof might be deferred by the obligor only if it lacked sufficient earnings in any one year, the petitioner was not thereby relieved of its obligation for such interest to the obligees, since the unpaid interest of one year would be payable out of the earnings of later years. Both principal and interest were payable out of petitioner’s net earnings, as defined in the “promissory notes”, or, at petitioner’s option, out of other funds. The incurring by petitioner of additional liabilities, other than for current expenses, was specifically circumscribed so that the holders of the notes were, to a certain degree, preferred creditors. The petitioner was obligated to apply its available net earnings first to the payment of interest due and then to the reduction of the principal of the notes, and such obligation has, in fact, been met. The holders of the notes were not required to await final liquidation of petitioner for the return of the principal of their loans. They had no voting rights, no right to participate in the general management of petitioner, and no right similar to a stockholder’s pro rata participation in the final distribution of any net assets on hand upon dissolution or liquidation of petitioner. The fact that both principal and interest of the notes were payable primarily out of net earnings and that the notes had no fixed due date does not, in the light of their other attributes, destroy the character of the “promissory notes” as evidences of indebtednesses. Upon authority of the principles of law announced in Schmoll Fils Associated, Inc., 39 B. T. A. 411, and the cases cited therein, as applied to the facts of the instant case, we hold that the petitioner’s two instruments denominated “promissory notes” dated December 13 and December 22, 1933, to the Hawkins Co. and the Howard Co., respectively, did not constitute shares of preferred stock, but constituted evidences of petitioner’s indebtedness to each of those two creditor companies. Cf. Commissioner v. LaFayette Life Insurance Co., 67 Fed. (2d) 209, reversing 26 B. T. A. 946. While the Schmoll case, supra, involved a claimed deduction for interest paid on indebtedness for the purpose of determining income tax on ordinary net income and the instant case involves a claimed deduction for payments in partial retirement of an indebtedness for the purpose of determining surtax on the undistributed adjusted net income of a personal holding company, the fundamental question in the Schmoll case was whether an indebtedness had been incurred, just as in the instant case. Here, the facts disclose a stronger case for the taxpayer, for petitioner was obligated to apply its available net earnings to the repayment of the principal of the loans to it, while in the Schmoll case the principal of the loans became due only at the option of the taxpayer, except in case of bankruptcy, dissolution, or liquidation.

In our opinion the petitioner incurred, prior to January 1, 1934, an “indebtedness” of $158,600 to the Hawkins Co. and of $149,000 to the Howard Co., as evidenced by the above mentioned two instruments, within the meaning of section 351 (b) (2) (B), supra. During the taxable year 1934 petitioner paid a total of $97,700 to partially retire such indebtedness and since it was obligated to do so by the terms of its indebtedness there is no question but that such amount was reasonable. The respondent erred in disallowing the claimed deduction of $97,700 from petitioner’s adjusted net income for the purpose of determining its undistributed adjusted net income.

In view of this conclusion, petitioner’s alternative assignment of error need not be considered.

Reviewed by the Board.

Decision will be entered for the petitioner.

Mellott and KerN dissent.

       SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
      (a) Imposition op Tax. — There shall be levied, collected, and paid, for each taxable year, upon the undistributed adjusted net income of every personal holding company a surtax equal to the sum of the following:
      *******
      (b) Definitions. — As used in this title—
      * * * * * % *
      (2) The term “undistributed adjusted net income’’ means the adjusted net income minus the sum of:
      (A) 20 per centum of the excess of the adjusted net income over the amount of dividends received from personal holding companies which are allowable as a deduction for the purposes of the tax imposed by section 13 or 204;
      (B) Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable, with reference to the size and terms of such indebtedness; and
      (C) Dividends paid during the taxable year.


author: ICeRN :

text:
    Auto Interurban Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94461.
    Promulgated June 27, 1939.

      B. E. Lowe, Esq., and A. W. Morris, G. P. A., for tbe petitioner.

      B. H. Neblett, Esq., for the respondent.
   OPINION.

ICeRN :

The ultimate question involved in this proceeding is whether petitioner is entitled to a credit provided in section 26 (c) (1) of the Eevenue Act of 1936, set out in the margin hereof, relating to contracts restricting dividends, in an amount equal to or in excess of $37,878.05 representing the undistributed net income of petitioner determined by respondent to be taxable under section 14 of that act.

The contract described in our findings of fact, to which petitioner was a party, is a written contract executed by petitioner corporation prior to May 1, 1936, which expressly dealt with the payment of dividends and operated as a legal restriction upon petitioner as to amounts which it could distribute as dividends on its common stock so long as any of its preferred stock remained unretired pursuant to the contract. (See art. 26-2 (b), Eegulations 94.) Eespondent insists, however, that, since petitioner had an excess of $25,000 cash on hand at the end of 1936 and could, therefore, have retired the remaining outstanding $20,000 par value of preferred stock and thus have removed any contract restrictions on the payment of dividends on its common stock, petitioner is not entitled to such a credit.

The short answer to respondent’s contention is that petitioner did not retire its remaining outstanding preferred stock during the taxable year and was under no legal obligation so to do. Therefore, it

could not distribute any amount as dividends without violating the express provision of the contract and was entitled to a credit in the amount of its adjusted net income pursuant to the provisions of section 26 (c) (1) of the Act of 1936.

In this proceeding we are not called upon to decide nor do we decide a question which might be presented if a corporation, with cash and liquid assets greatly in excess of both its current obligations and its secured obligations which were by written contract to be retired before the payment of dividends, delayed the retirement of such securities for an unreasonable length of time for the purpose of obtaining the credit provided for by section 26 (c) (1) of the Act of 1936. Such was not the case here. In this case petitioner’s balance sheet attached to its 1936 income tax return showed as of the end of the taxable year current assets as follows:

Cash _$25,213. 01
Notes receivable_ 40.00
Amounts receivable- 11, 561. 61

It showed current liabilities (exclusive of taxes) as follows:

Notes payable_$7,239. 35
Accounts payable- 10. 542. 67

It is obvious that petitioner’s liquid assets were insufficient to pay its current liabilities and at the same time retire all of its preferred stock outstanding. It had retired all-of its preferred stock except this amount even before it was called upon to make such retirements by the terms of the contract. It retired preferred stock of a par value of $25,000 in 1934, of $10,000 in 1935, and of $20,000 in 1936, and in 1937 it retired the balance outstanding of a par value of $20,000.

On these facts we hold for petitioner.

Decision will be entered wider Rule 50.

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