author: Murdoch:

text:
    The Edward Katzinger Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102421.
    Promulgated May 21, 1941.

      Harry Thom, Esq., and Ben jasmin A. Bagir, Esq., for the petitioner.

      E. G. Sievers, Esq., for the respondent.
   OPINION.

Murdoch:

The respondent does not deny that the petitioner actually sustained a loss in the taxable year of $29,950.06. He contends that this entire loss was a loss of the investment of the petitioner in the stock of Bruce-Hunt and was not divisible into an investment of $1,000 in the stock and a bad debt of $28,950.06. He reasons that no part of this loss is deductible because it comes within section 112 (b) (6) of the Revenue Act of 1936, which provides that “No gain or loss shall be recognized upon the receipt by a corporation of property distributed in complete liquidation of another corporation.” Property distributed “in complete liquidation” means “in complete cancellation or redemption” of the stock. Section 112 (b) (6) (C) and (D). There was a complete liquidation of Bruce-Hunt. But the contention of the respondent fails because the facts show, first, that the advances made by the petitioner to Bruce-Hunt were loans and not contributions of capital increasing the basis of the stock and, second, the petitioner received nothing in the liquidation of Bruce-Hunt in cancellation or redemption of the stock.

The respondent argues that all of the funds advanced by the petitioner must be regarded as additional capital contributions since Bruce-Hunt had to have more than $1,000 with which to conduct its operations. He cites no authority in support of this argument and we know of none. Funds advanced by shareholders to their corporation may or may not be contributions of capital, augmenting the cost of the shares, depending upon the circumstances under which the advancements are made. Advances are an additional contribution of capital if they are intended to enlarge the stock investment, but not if they are intended as a loan. Daniel Gimbel, 36 B. T. A. 539; Bernuth-Lembcke Co., 17 B. T. A. 599; William D. P. Jarvis, 43 B. T. A. 439. Here the parties intended the advances as loans. This is shown not only by the testimony of the officers, but by the entries on the books of the two companies and the consistent actions of the parties in regard to the advances, including their actions incident to the liquidation. The Commissioner’s argument is sound enough in regard to the investment of $1,000 and the petitioner, in its briefs, has made no argument in support of the deduction of $1,000, but the argument falls completely, in so far as it relates to the advances, by reason of the finding that those advances were loans. We hold that the petitioner sustained a loss of $28,950.06 from a debt which it ascertained to be worthless and charged off in 1936.

It does not follow, however, that this loss is deductible in its entirety. Bruce-Hunt joihed with the petitioner and other corporations in 1933 in filing a consolidated return, as a result of which a loss of Bruce-Hunt in the amount of $28,429.34 was deducted and actually offset income of the consolidated group which otherwise would have been subject to tax. The respondent contends that this circumstance prevents the allowance of any greater deduction for loss in 1936 than the excess of the 1936 loss over the deduction thus allowed in 1933, citing Regulations 78, articles 34, 35, 37, and 40 (c) ; Ilfeld v. Hernandez, 292 U. S. 62; Commissioner v. Emerson Carey Fibre Products Co., 70 Fed. (2d) 990; Greif Cooperage Corporations. Commissioner, 85 Fed. (2d) 365; and W. M. Ritter Lumber Co., 30 B. T. A. 231, 257, 282.

The parent in the Ilf eld case had invested in the stock of and had also made advances to the subsidiaries. Consolidated returns had been filed for the group in which losses of the subsidiaries had been deducted and had offset income in an amount in excess of the total amount which the parent had invested and advanced. The Court said that the affiliated corporations, by filing a consolidated return, had accepted the regulations prescribed by the Commissioner. It said further that the amounts paid for the stock and the advances later made to the subsidiaries stood upon the same footing. It held that the loss was not deductible, saying:

The allowance claimed would permit petitioner twice to use the subsidiaries’ losses for the reduction of its taxable income. By means of the consolidated returns in earlier years it was enabled to deduct them. And now it claims for 1929 deductions for diminution of assets resulting from the same losses. If allowed, this would be the practical equivalent of a double deduction. In the absence of a provision of the Act definitely requiring it, a purpose so opposed to precedent and equality of treatment of taxpayers will not be attributed to lawmakers. [Citation.] There is nothing in the Act that purports to authorize double deduction of losses or in the regulations to suggest that the Commissioner construed any of its provisions to empower him to prescribe a regulation that would permit consolidated returns to be made on the basis now claimed by petitioner.

The Emerson Carey Fibre Products Co. case also involved a deduction for a bad debt. The court said in the Qreif case that losses of affiliates are not allowable to the extent that they result directly or indirectly in a double deduction by the taxpayer of the same losses.

The petitioner seeks to avoid the effect of those cases. It points out that the loss of Bruce-Hunt, which was used as a deduction on the consolidated return, was for the year 1933; the amount advanced in 1933 was fully repaid after 1933; and, it concludes, the losses in question result from advances made after 1933 for which years no consolidated returns were filed. It argues that the first repayments must be considered as repaying the first advances so that the net amount owing at any time represents the most recent advances. The rule contended for by the petitioner may be invoked for certain purposes as, for example, to prevent the defense of the statute of limitations on an open account, and see Pembroke Realty & Securities Cor poration, 42 B. T. A. 341, and cases there cited, but it is of no significance here. Perhaps the petitioner might avoid the effect of the above cited cases if it could effectively separate the 1936 loss from the 1933 loss, as, for example, by showing that the 1933 balance was charged off and a new account started, or by showing that the debtor had completely recovered from the 1933 loss, had paid its debts, and thereafter the account became bad. The principle of applying the first repayments to the earliest advances does not serve this purpose, however, and the loss here comes within the Commissioner’s regulations which prevent double deduction of intercompany accounts receivable or other obligations resulting from an intercompany transaction during the consolidated return period. Regulations 78, art. 40 (c).-

The loss of Bruce-Hunt for 1933 was deducted on the consolidated return for that year, and any deduction for a bad debt at that time would have been limited, under the 'cited cases, to the excess over $28,429.34. However, the petitioner did not charge off any of the debt at that time but continued to make advances during the next two years through an open account, the entries on one side showing advances and the entries on the other showing repayments without any allocation of one to the other. The profits of Bruce-Hunt after 1933 just about equaled its losses for the same period. This shows that it never recovered from the 1933 loss and that most of the bad debt loss is traceable directly, through this uninterrupted series of transactions in the open account, to the 1933 operating loss.

The reason for denying a double deduction is the same whether the loss is claimed in 1933 or 1936. The allowance would result directly or indirectly in a double deduction for the taxpayer of the same losses. Where two affiliated corporations have been engaged in a series of continuous transactions resulting in a debtor-creditor relationship, and the debtor has sustained losses which have been deducted from income on a consolidated return, the creditor thereafter may not claim another deduction either by way of worthless stock or bad debt which is traceable directly or indirectly to the losses deducted on the consolidated return, except to the extent that the later losses exceed the earlier. Consequently, the petitioner’s loss is limited for the purpose of a deduction to $1,520.72, the amount shown by the Commissioner in his computation in the notice of deficiency.

Decision will be entered under Rule 50.


source: Caselaw Access Project

author: Kern :

license: Public Domain

text:
    Monte Glove Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104559.
    Promulgated May 21, 1941.

      Merle H. Miller, Esq., for the petitioner.
    /S'. U. Hihen, Esq., for tlie respondent.
   OPINION.

Kern :

The first issue for our decision here is whether petitioner is entitled to a dividends paid credit pursuant to section 27 (a) of the Revenue Act of 1936, or whether it is precluded from such credit by virtue of section 27 (g) of the same act and article 27 (g)-! of Regulations 94. Both of these sections of the act, together with this article of the regulations, are set out in the margin.

Without considering the question raised by the contract of Young and Soller to purchase the stock in petitioner owned by the so-called Montgomery interests, the factual background may be succinctly restated as follows: The stock in petitioner was owned prior to the taxable year in the following proportions: 35 percent by C. Stein-hauser, 35 percent by the Montgomery interests, 20 percent by Soller, and 10 percent by Young. Soller and Young were devoting all of their time to the business of petitioner, as its first vice president and secretary-treasurer, respectively. For several years prior to the taxable year the stockholders of petitioner, in consideration of the services of Young and Soller had adopted a petition addressed to petitioner’s directors authorizing and directing them to make a disposition of the net earnings of petitioner in the proportion of 25 percent to Soller, 25 percent to Young, 25 percent to Steinhauser and 25 percent to the Montgomery interests. In the taxable year, Young and Soller having entered into a contract to purchase the shares formerly held by the Montgomery interests, the stockholders’ petition was to the effect that the directors should distribute the net earnings in the proportion of 25 percent to Steinhauser, 25 percent to Young, 25 percent to Soller and 25 percent “to be proportionately divided according to the stock owned, to the owners of the stock formerly owned by H. G. Montgomery.” Thereupon, on April 19, 1937, the directors resolved

* * * that a dividend, for the fiscal year of 1936, ending April 30th, 1937, be declared in the sum of Ten Thousand Dollars ($10,000.00) and paid to common stockholders as follows:
O. Steinhauser, the sum of_$2,500.00
John S. Young, the sum of_ 3,928.57
Edwin Soller, the sum of_ 3,571.43

If the dividend had been distributed pro rata according to the stockholdings in petitioner, it is obvious that Steinhauser’s dividend would have been $3,500 instead of $2,500, the amount of his dividend as declared by the board of directors, and also obvious that the dividends to Young and Soller would have been less. Accordingly it is the contention of respondent that the distribution of dividends was preferential and not pro rata and, therefore, petitioner is not entitled to a dividends paid credit.

On the other hand, petitioner contends that the petition of the stockholders authorizing the payment of the dividend in the amounts declared amounted to an assignment by stockholders other than Young and Soller of future dividends binding on the corporation, that the stockholders are individually taxable, on what would have been their pro rata distributions, but that if they chose to accept less than their pro rata distribution it should be considered that they had assigned any excess to those stockholders receiving more than a pro rata distribution. Accordingly, petitioner contends that Steinhauser should be taxable on a dividend distribution of $3,500 constructively received by him; of which amount he, in effect, assigned $500 to Young and $500 to Soller. The conclusion of petitioner’s argument seems to be that the dividend distribution must, therefore, be considered as, in reality, pro rata, and not preferential and that the fact that the actual payment by the corporation to its stockholders was in amounts not pro rata to the stockholdings was only because the corporation recognized, as it was bound to do, the prior assignments by some of its stockholders of part of these pro rata dividend distributions.

A sufficient answer to petitioner’s contention is that the right of the stockholders to the dividends actually declared and paid arose from the declaration of such dividends by petitioner’s board of directors and not by reason of any petition by stockholders. Richter & Co. v. Light (Conn.), 116 Atl. 600; Nutter v. Andrews (Mass.), 140 N. E. 744. In spite of petitioner’s ingenious argument, the fact stands out that no assignments of future dividends were executed by petitioner’s stockholders. In this vital respect the instant proceeding differs from the cases of Fred W. Warner, 5 B. T. A. 963, and Alfred Le Blanc, 7 B. T. A. 256, relied upon by petitioner, in each of which there was actually an assignment by a stockholder of a corporation to one not a stockholder of future pro rata dividends. Here all that was actually done was that all the shareholders of the corporation authorized a preference in the distribution of the dividend, something which is expressly stated in the quoted article of [Regulations 94, to in no way qualify the limitation imposed upon the granting of the dividends paid credit by section 27 (g). See also Report of Committee on Ways and Means on the 1938 Revenue Bill, H. Rept. No. 1860. The fact that stockholders of a corporation authorize or approve a preferential dividend distribution does not make it any less a preferential distribution. Lincoln National Bank v. Burnet, 63 Fed. (2d) 131. To hold, as petitioner would have us hold, that, where all the stockholders of a corporation assent to and authorize a preferential dividend distribution, such a distribution will not be considered as preferential within the meaning of section 27 (g), would necessitate our adding to that section the clause “or unless all of the stockholders assent to such distribution.” This, it goes without saying, is a matter proper only to the legislative branch of government. In view of the fact that a section similar to section 27 (g) was included in the Acts of 1938 and 1940 after the promulgation of article 27 (g)-1 of Regulations 94, we must conclude that Congress did not intend any such exception to be read into this section.

For the proposition that the petition of the stockholders was binding on the corporation and constituted an equitable assignment, petitioner relies heavily on Wabash Ry. Co. v. American Refrigerator Transit Co., 7 Fed. (2d) 335. The fact that in that case there was a formal and binding contract with regard to dividend payments, to which not only the stockholders but also the corporation were parties, and to which reference was made in the stock certificates themselves, is sufficient to distinguish that case from the instant proceeding, in which the stockholders’ petition, in so far as the corporation is concerned, is unilateral. It should also be pointed out that in that case the ultimate issue was a question of equity jurisdiction; there was no declaration of a dividend by the board of directors, and the case in no way involved a construction of the pertinent sections of the revenue act. The cases of New Jersey Car Spring & Rubber Co. v. Fields (N. J.), 88 Atl. 1031, and Farquar v. Canada-Atlantic & P. P. S. Co. (Mass.), 98 N. E. 1036, also cited by petitioner, are even less in point.

We conclude that, where a dividend is declared by a corporation and is paid by it to all of its stockholders, not in proportion to their stock-holdings, but in preferential amounts called for in the declaration of dividends, the stockholders take such dividend by virtue of the corporate resolution declaring it, even though they have by a petition assented to and authorized the declaration of dividends in such preferential amounts; that such a dividend distribution is preferential within the meaning of section 27 (g) of the Eevenue Act of 1936; and that by the terms of that section the corporation is not entitled to a dividends paid credit.

The other issue raised by the pleadings in this proceeding is as to the reasonableness of a salary paid to Myrtle V. Montgomery, deduction for which was claimed by petitioner in the amount of $2,255. Since this issue was first raised by respondent at the hearing, the burden of proof is upon respondent. Buie 32, Eules of Practice before the United States Board of Tax Appeals. On the strength of the testimony elicited by respondent at the hearing in relation to Myrtle Y. Montgomery’s activities and residence during the taxable year, we are of the opinion that the amount paid to her and deducted by petitioner in its return was unreasonable and excessive. Although petitioner asserts that she was acting in her capacity of second vice president when conferring on the cotton sales, it must be borne in mind that she was also one of petitioner’s principal stockholders. She did nothing, according to the evidence, except sit in, or have J. D. DePrez sit in for her, on the conferences pertaining to future purchases of cotton. As we pointed out in Home Industry Iron Works, 8 B. T. A. 1267, these services are not unusual nor unexpected from a principal stockholder, and do not merit the salary paid her by the petitioner. The deduction for salary is therefore disallowed.

Decision will be entered vmder Rule 50.

       SEC. 27. CORPORATION CREDIT POR DIVIDENDS PAID.
      (a) Dividends Paid Credit in General.—For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.
      *******
      (g) Preferential Dividends.—No dividends paid credit shall be allowed with respect to any distribution unless the distribution is pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class.
      Art. 27 (g)—1. Preferential distributions.—Section 27 (g) imposes a limitation upon the general rule that a corporation is entitled to a dividends paid credit with respect to aU dividends which it actually pays during the taxable year. Before a corporation may be entitled to any dividends paid credit with respect to a distribution, regardless of the medium in which the distribution is made, every shareholder of the class of stock with respect to which the distribution is made must be treated the same as every other shareholder of that class. The limitation imposed by the Act is unqualified and the existence of a preference is sufficient to prohibit allowance of the dividends paid credit regardless of the fact (1) that such preference is authorized by all the shareholders of the corporation, or (2) that the part of the distribution received by the shareholder benefited by the preference is taxable to him as a dividend. A corporation will not be entitled to a dividends paid credit with respect to any distribution upon a class of stock if there is distributed to any shareholder of such class (in proportion to the number of shares held by him) more or less than his pro rata part of the distribution as compared with the distribution made to any other shareholder of the same class. The disallowance of the dividends paid credit, where any preference or inequality in fact exists, extends to the entire amount of the distribution and not merely to a part of such distribution.


author: Mellott :

text:
    Estate of F. A. Gray, by the First National Bank of Kansas City, and William B. Dickinson, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101379.
    Promulgated May 21, 1941.

      M. B. Dickinson, Esq., for the petitioners.

      A. B. Shannon, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined a deficiency in estate tax in the amount of $17,914.41. In the petition it is alleged that there has been an overpayment of tax. At the hearing the parties filed a stipulation in which respondent concedes that certain deductions, aggregating several thousand dollars, which were not included in the original estate tax return should be allowed. On the basis of the stipulation respondent concedes that there has been an overpayment of tax in the amount of $3,956.02.

There is no substantial dispute between the parties as to the facts. All of them—except the fair market value of the real estate on April 20,1931, which we find from the evidence was $125,000—were admitted in the pleadings or at the hearing or are contained in exhibits, received in evidence without objection. We find the facts to be as admitted or shown in the exhibits, but set out herein only those necessary for an understanding of the questions to be decided.

Tbe decedent, F. A. Gray, was born January 1, 1887, and died November 19, 1935. He was a resident of Kansas City, Missouri, at the time of his death and his estate is being administered by the above named executors under the jurisdiction of the Probate Court of Jackson County, Missouri. An estate tax return was duly filed in the office of the collector of internal revenue for the sixth district of Missouri. Therein the real estate, which is the subject of controversy in this proceeding—lot 87, block 7, McGee’s Addition to Kansas City, Missouri, known as 1321-1323 Main Street—was reported and included in gross estate at a fair market value of $30,000. This value was accepted by the Commissioner, is supported by the testimony of a witness called by the petitioner, and is not in dispute.

In schedule J-l of the return, under the heading of “Mortgages”, a deduction from gross estate in the amount of $206,666.67 was claimed, with the following explanation:

In the petition it is claimed that deduction under schedule J-l should be allowed in the amount of $209,868.06. Inasmuch as the only witness who testified upon the subject placed the value of the real estate at $125,000 on April 20, 1931, petitioners upon brief concede that this is the maximum amount which may be allowed as a deduction.

On April 20,1931, the decedent executed a trust agreement naming Mairtin B. Dickinson trustee, and by deed dated the same day conveyed to the trustee “an interest to the extent and amount of Two Hundred Thousand Dollars” in the real estate above described, to be held “subject to the reservations by the party of the first part [decedent] and with the limitations contained in the trust agreement * * The deed recited that the trustee was authorized and agreed “to reconvey the above described property to the party of the first part upon the payment to him of Two Hundred Thousand ($200,000) Dollars by the party of the first part, or upon the deposit with the party of the second part of securities acceptable to him of the value of Two Hundred Thousand ($200,000) Dollars * * *.” The deed also provided that party of the first part should pay to party of the second part “as rent on said property Ten Thousand ($10,000) Dollars per year * * * and party of the first part shall manage, rent and lease said property and receive all rents and income therefrom as long as said payments shall be promptly made * * In the event of partial payment by the decedent on account of the $200,000 provided for in the deed the annual rent was to be reduced fro tanto.

The trust agreement contained a provision obligating the settlor “on or before the date of his death to repurchase from the Trustee for the sum of Two Hundred Thousand ($200,000) Dollars * * * the above described interest in said real estate * * It also contained a provision requiring the settlor to pay $25,000 to be applied upon the agreed repurchase price within one year after the death of certain of the named beneficiaries in the event they, or any of them, should predecease the settlor. The trust, according to its terms, was to be regarded as consisting of eight equal parts of $25,000 each. Since none of the beneficiaries died prior to the death of decedent, none of the $25,000 payments could be required and none had been made. The decedent had made no payments upon the “repurchase” of the real estate and after his death, on December 26, 1935, the Probate Court of Jackson County, Missouri, directed the executors to pay over to the trustees the sum of $200,000 in cash, “plus rent at the rate of Ten Thousand ($10,000) Dollars per year for the period from November 1, 1935, to the date such payment is actually made, in full payment of all obligations of the estate under said trust agreement and deed * * Pursuant to this order the executors paid to the trustees $100,000 on December 31, 1935, $50,000 on May 27, 1936, $50,000 on June 29, 1938, $4,166.67 on May 4, 1936, and $5,701.39 on June 29, 1938, a total of $209,868.06.

While petitioners originally contended that they were entitled to deduct from gross estate $209,868.06 on the theory that it was an “unpaid mortgage upon, or an indebtedness in respect to property” within the purview of section 303 (a) (1) of the Revenue Act of 1926 and represented a claim, mortgage, or indebtedness “incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth”, they now urge only that they be allowed $125,000, which, they admit, is the maximum amount that can be said to represent a liability contracted for an adequate and full consideration in money or money’s worth.

Petitioners contend that the decedent divested himself of a portion of his interest in the real estate and on the same date, for a valid consideration, agreed to repurchase the same interest. Recognizing that the transaction fits into no well established category, they say that, “in general, it is similar to a mortgage.” This seems to have been the theory under which the deduction was claimed in the return. Petitioners do not seriously urge upon brief that there was any conveyance of property to secure the performance of an obligation, the conveyance to be void on the due performance thereof, or that there was any real pledge of property as security for a debt. It is obvious that there was no mortgage. But was there an obligation which may be classified as a claim or indebtedness incurred or contracted bona ■ fide and for an adequate and full consideration in money or money’s worth ?

The phrase “adequate and full consideration in money or money’s worth” is not ambiguous. In Latty v. Oom/missioner, 62 Fed. (2d) 952, the court construed it “to evidence an intent upon the part of Congress to permit the deduction of claims only to the extent that such claims were contracted for a consideration which at the time either augmented the estate of the decedent, granted to him some right or privilege he did not possess before, or operated to discharge a then existing claim, as for breach of contract or personal injury.” This language was quoted with approval in Glaser v. Commissioner, 69 Fed. (2d) 254, and has recently been followed by this Board. See e. g., Estate of Louis D. Markwell, 40 B. T. A. 65, 10; affd., 112 Fed. (2d) 253; Bennet B. Bristol, 42 B. T. A. 263 (on appeal C. C. A., 1st Cir.). In Taft v. Commissioner, 304 U. S. 351, the Supreme Court discussed the requirement of consideration for deductible claims, holding that not all valid and enforceable claims against an estate are deductible. It pointed out that the change in the act from “fair consideration” to “adequate and full consideration” indicated that there was an evident intent to narrow the class of deductible claims. The effect of this decision was to overturn the view which several Circuit Courts and the Board had taken that an agreement to make a contribution to a charitable corporation in consideration of the subscriptions of others was a claim “incurred * * * for an adequate and full consideration.” It will be noted that the Court refused to give the words any strained construction in the cited case, even though it was dealing with a charitable contribution. We should be equally careful in applying the statute in the instant proceeding; for “Deductions are a matter of legislative grace, and one seeking a deduction must show that he comes clearly within the statute allowing it.” Empire Trust Co. v. Commissioner, 94 Fed. (2d) 807.

It seems to be clear that if the rule enunciated in Latty v. Commissioner, supra, be correct—and we do not intimate that it is not— the claim which this decedent’s trustee had against his estate had not been contracted for a consideration which, at the time, either augmented his estate or granted to him any right or privilege which he did not possess before. On the contrary such effect as it had— indeed the effect which petitioners insist it had—was to diminish the estate of the decedent or to take away from him a right which he possessed before. Nor can it be said to have operated to discharge a then existing claim against his estate. If the reality of the transaction is kept in mind, the agreement, at most, was that there should be taken out of decedent’s estate $200,000 to be the corpus of a trust which he had created for relatives of his wife and himself. As petitioners state upon brief “he obviously desired all the beneficiaries to have a fixed and regular income of 5% per annum” upon $200,000. No doubt this was a laudable ambition and, as petitioners point out, had he seen fit to give the beneficiaries, or a trust created for their benefit, the sum of $200,000 during his lifetime, his estate would have been diminished to that extent and no such controversy as that now before us would have arisen. But he did not choose to do so. What he actually did was to make a voluntary promise, without consideration, to create a trust estate in the future to the extent of $200,000 and in the meantime to pay over to the trustee 5 percent upon that amount or $10,000 per annum. If any interest in the real estate passed from him by the deed, which is doubtful, it amounted to no more than a pledge that his promise to give the trust a corpus of $200,000 would be fulfilled. At no time did any actual consideration in money or money’s worth pass from the trustee to the decedent. When his executors made the payments to the trustee they were carrying out his promise; but in our opinion they were not paying a claim or indebtedness contracted “for an adequate and full consideration in money or money’s worth.”

Upon brief petitioners cite Charles Steele, 38 B. T. A. 589, which, though it involved a question of gift tax liability, they contend is somewhat analogous. In the cited case the petitioner, possessed of a fortune in excess of $10,000,000, made a valid, complete and absolute gift to his wife, in 1917, of $1,000,000. Thereafter she made a loan to him of the same amount, accepting his note, secured by high grade securities. The note was paid off subsequent to the enactment of the statute taxing gifts and the issue was whether the amount paid to the wife was a gift or payment of petitioner’s obligation. The question was primarily one of fact and the issue was resolved in favor of the taxpayer. The cited case furnishes but slight aid in determining the issue before us.

One of the purposes of section 303 (a) (1), <supra, if not its main purpose, was “to prevent deductions, under the guise of claims, of what were in reality gifts or testamentary distributions.” Carney v. Benz, 90 Fed. (2d) 747. Cf. Phillips v. Gnichtel, 27 Fed. (2d) 662. The deduction in issue in the instant proceeding falls within this category. It is unimportant that the decedent may have had no intention to diminish his estate by making the anticipatory arrangement disclosed by the exhibits. Inasmuch as the claim, in our opinion, was not incurred or contracted “for an adequate and full consideration in money or money’s worth”, it must be and is, held that the Commissioner committed no error in disallowing the claimed deduction.

Petitioners’ alternative contention is that there should be excluded from decedent’s gross estate the fair market value—$30,000—of the real estate at the time of his death. Admitting that the decedent held the legal title to the property at the time of his death, they contend that he “had no substantial beneficial interest therein, being obligated to pay therefor $200,000 when the value thereof at that time was only $30,000.” This contention can not be sustained.

It is clear that decedent had an interest in real property which must be included in his gross estate under section 302 (a) of the Revenue Act of 1926 as amended by section 404 of the Revenue Act of 1934. Apparently petitioners admit as much, but contend that the value of such interest should not be included in gross estate because decedent or his estate would be required to pay another and larger obligation before the full use of the property could be enjoyed.

In Henry Adams Ashforth et al., Executors, 30 B. T. A. 1306 (affd. July 19, 1937, C. C. A., 2d Cir., without opinion) a somewhat similar state of facts was before this Board. The decedent had executed and delivered to her husband, without monetary consideration, a mortgage for $700,000 on real estate which, at the date of her death, had a fair market value of $766,000. It was found that the mortgage did not meet the statutory condition of having been contracted “for an adequate and full consideration in money or money’s worth” and therefore was not deductible. The inclusion of the full value of the property in the gross estate was nevertheless sustained. On the authority of the cited case and for the reasons therein set out, we hold that the Commissioner correctly included the fair market value of the property in decedent’s gross estate. Cf. City Bank Farmer’s Trust Co. v. Bowers, 68 Fed. (2d) 909; certiorari denied, 292 U. S. 644.

In accordance with the stipulation of the parties,

Decision will be entered, that there is am, overpayment of tax in the amount of $3,9-56.02.

       Sec. 303. For the purpose of the tax the value of the net estate shall be determined-» (a) In the case of a resident, by deducting from the value of the gross estate—
      (1) Such amounts for funeral expenses, administration expenses, claims against the estate, unpaid mortgages upon, or any indebtedness in respect to property, * * * to the extent that such claims, mortgages, or indebtedness were incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth. * * *

         Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside the United States—
      (a) To the extent of the interest therein of the decedent at the time of his death; * * *


author: Tyson :

text:
    J. W. Wells Lumber Company Trust A, A. C. Wells, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. W. Wells Lumber Company Trust B, A. C. Wells, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 97134, 97135.
    Promulgated May 21, 1941.

      Meredith P. Sawyer, Esq., for the petitioner.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Tyson :

The petitioners assail the determination of the respondent that the trusts were associations and taxable as corporations, on the grounds (1) that the trusts were created and operated for the sole purpose of liquidating the assets conveyed to them by the corporation, and (2) that their organization in form bears no resemblance to that of a corporation.

Whether a trust is taxable as a corporation depends upon whether it is an “association” within the provision of the applicable revenue act which defines the term “corporation” as including “associations.” The meaning of that provision was considered by the Supreme Court in 1935 in Morrissey v. Commissioner, 296 U. S. 344; and in the companion cases of Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; and Helvering v. Coleman-Gilbert Associates, 296 U. S. 369. In the leading Morrissey case the Court said that, in order to be taxable as an association, the trust must have been created as a joint enterprise for the carrying on of a business and sharing the profits; and that in form of organization it must resemble a corporation. Attributes of a trust having such resemblance to corporate form were enumerated in effect as (1) trustees, as a continuing body with provision for succession, and holding title to property; (2) centralized management.; (3) continuity unaffected by the death of beneficiaries; (4) transferability of interests without affecting the continuity of the enterprise; and (5) limitation of personal liability of the participants. See Commissioner v. Rector & Davidson, 111 Fed. (2d) 332; Del Mar Addition v. Commissioner, 113 Fed. (2d) 410, affirming on this point, Del Mar Addition, 40 B. T. A. 833.

Creation for a business purpose is necessary to classification as an association. If the trust is created for purposes other than the conduct of a business for profit, such as for instance for the complete liquidation of its assets, and its business activity is merely incidental to the preservation of the property held, it is not taxable as an association even though in form its organization is similar to that of a corporation. United States v. Davidson, 115 Fed. (2d) 799; Cleveland Trust Co. v. Commissioner, 115 Fed. (2d) 481; Helvering v. Washburn, 99 Fed. (2d) 478; Sears v. Hassett, 111 Fed. (2d) 961. Also, while similarity or dissimilarity to corporate form is often considered in granting or denying classification of a trust as an association, such similarity or dissimilarity has been given minor consideration in some cases. Commissioner v. Vandergrift R. & Inv. Co., 82 Fed. (2d) 387; Helvering v. Washburn, supra; Porter Proferty Trustees, Ltd., 42 B. T. A. 681. In other cases, the Mor-rissey opinion has been interpreted as not requiring the presence in an association of all the attributes of corporate form mentioned in that opinion, but only as requiring that the form of the alleged association be compared with all of such attributes for the purpose of determining whether its form more nearly resembles that of a corporation than that of a partnership or a pure trust. Commissioner v. Brouillard, 70 Fed. (2d) 154,; Bert v. Helvering, 92 Fed. (2d) 491; Commissioner v. Rector & Davidson, supra; Commissioner v. Horseshoe Lease Syndicate, 110 Fed. (2d) 748; Del Mar Addition, supra; Porter Property Trustees, Ltd., supra.

The petitioners, in order to support their contention that the two trusts were created and operated for the sole purpose of liquidating their respective assets, have shown certain circumstances. surrounding the creation of the trusts and their activities throughout their existence, and they rely further upon oral testimony of the trustee that the parties merely intended to liquidate the assets formerly belonging to the corporation.

The purpose for which the trusts were created, as was pointed out by the Supreme Court in Helvering v. Coleman-Gilbert Associates, supra, is found in the agreement of the parties, and the parties are not at liberty to say that such purpose was other than that which is formally set forth in those written instruments. To the same effect, see Commissioner v. Vandergrift R. & Inv. Co., supra; Title Insurance & Trust Co. v. Commissioner, 100 Fed. (2d) 482; and Sears v. Hassett, supra. In Commissioner v. Gibbs-Preyer Trusts Nos. 1 & 2, 117 Fed. (2d) 619, the Circuit Court of the Sixth Circuit rejected the contention that the purpose of the creation of the trust must be determined solely from the language appearing in the trust instrument, and said that the crucial test must be found in what the trustee actually does rather than in the existence of powers long unused by him. In the present cases, the actual activities of the trustee were not any narrower than the powers conferred upon him by the trust instruments; Whether we look to the terms of the written instruments alone or whether we consider the question from the standpoint alone of the actual activities of the trustee in carrying out the trusts, the same result is reached, for under either test the facts fully support the conclusion that the trusts were created for the purpose of carrying on business for profit.

While each of the trust deeds conveys assets pertaining to a separate branch of the business of the corporation whose life was about to expire, neither manifests any intention to liquidate. The paragraph in the deeds fixing the life of each trust gives the trustee absolute discretion to continue or dissolve the trust at any time during his life, or to liquidate it in part, with like discretion in his successors. In other words, it authorized continuation of the business or distribution of the corpus in kind, or continuation of the business after a partial distribution; and, when considered in connection with the enumerated powers of the trustee, the conclusion is inescapable that the deeds intend continuance of the business and a liquidation thereof only if and when the trustee should elect to do so. Under those enumerated powers the trustee had the right to sell, assign, mortgage, or convey the assets—powers which, standing alone, might be classed as incidental business powers—but he had the additional powers to exchange property, to expand or reduce the operations at will, to engage necessary employees, and to borrow money; and, by yirtue of his specific right to lend the assets and income of one trust to the other without security, the trustee could have loaned the funds of trust B to trust A and used same to acquire additional timberland or other assets for trust A, or loaned the funds of trust A to trust B, as he did, to carry on the manufacturing activities of trust B. Moreover, the fact that the deeds conveyed the right to use the name and the goodwill and “going business value” of the trans-feror corporation is consistent only with an intention on the part of the trusts to remain in business. Goodwill can not be disposed of as an asset independently of the business to which it relates. Metropolitan Bank v. St. Louis Dispatch Co., 149 U. S. 436, 446.

Trust A was engaged continuously over the period from 1933 to 1940 in selling its timber and timberlands. It was making loans during several of these years, without security, from the proceeds of these sales to trust B, the beneficiaries of which were the same as the beneficiaries of trust A, and of interests in identical proportions. All its other funds were retained, with the exception of small distributions to the beneficiaries and some small investments. We think these facts are not only inconsistent with an intention to liquidate, but that they establish that the activities of the trust constituted a business carried on for profit; and it is immaterial even if it was so contemplated that all the timber and timberlands would be sold and no additional lands were acquired. Morrissey v. Commissioner, supra; United States v. Rayburn, 91 Fed. (2d) 163.

The petitioners suggest in the case of trust A, that two-thirds of the timber and timberland had been sold before December 31, 1932, the date of the creation of the trust, and assert that the only function of the trust was to collect the outstanding proceeds and dispose of the unsold residue. There is no support for any such assertion in the record. The trustee was unable to state how much timber or land was sold in any one year and no other witness gave such information. Forty to fifty million feet of timber were on hand in 1931 and the returns in evidence disclose that as much as sixteen million feet were sold in 1934 and 1936.

In the case of trust B, the activities on its behalf unquestionably constituted the carrying on of a business for profit. The only differ-erence between its activities and those of the precedent corporation was that they were carried on in a reduced volume, and,'in lieu,of securing logs from timberlands owned, it purchased them in the market. Its business was buying raw materials, manufacturing them, and selling the finished product. The assertion of petitioners that this. was done not for profit but solely to secure better prices for the timber on the timberlands belonging to trust A is inconsistent with the fact that the plant acquired by the trust in 1932 was enlarged in 1936, that the operations after the acquisition of the plant by the trust were expanded rather than contracted, and that in 1940 the plant was still in operation and no effort had been made to liquidate. The petitioners concede that there was some profit. They have produced no evidence of sales or expenses of this trust, and the returns show only combined income and expenses of the two trusts which increased over the period 1934 and 1936. The net result of operations of both trusts as shown on the returns was affected by large deductions for depletion on sales of timber in two of those years. However, the annual labor costs of the two trusts increased from $26,000 in 1934 to $44,000 in 1936, and, since little labor was hired by trust A, this further indicates that there was expansion by trust B. The trustee has never made any distribution either from income or proceeds of sales of this trust.

We are of the opinion that trusts A and B were created and operated for the purpose of carrying on business for profit.

The petitioners’ next contention is that the organizations in form bear no resemblance to that of a corporation. The title to the property of each trust was held by the trustee as a continuing body, with provision for successors, during the life of the trust, and the exclusive management was delegated to him for the duration of the trust. The fact that there were no formal directors’ meetings or that the beneficiaries had no voice in the management or did not exercise control is not determinative. The trustee conducted the affairs of the trusts and the parties in interest secured centralized management when, in the trust agreement executed by the corporation in which they were stockholders, the trustee was designated as their representative. Helvering v. Coleman-Gilbert Associates, supra; Helvering v. Combs, supra. The continuity of the enterprise was not affected by the death of any beneficiary. The deeds do not so expressly provide, but, on the contrary, provide for termination only at the death or pleasure of the trustee or his successor and that the trustee may expand or reduce the operations at his will. There is no specific restriction in the deeds upon the transferability of the beneficial interests nor any express limitation of personal liability of the beneficiaries; but the silence of the agreements in these particulars is not enough to prevent classification as an association. Del Mar Addition v. Commissioner, supra; Bert v. Helvering, supra. The failure to include in the trust deeds a limitation on the personal liability of the beneficiaries was apparently due to the fact that it was considered that the property held by the trusts was sufficient to meet their liabilities and that the beneficiaries would never be called on to pay any of such liabilities. Del Mar Addition v. Commissioner, supra. As to matters of form the real test is resemblance, not identity; and, when the facts are considered in this light, we think the trusts sufficiently resemble a corporation to bring them within the statute.

We hold that the trusts are associations and taxable as corporations.

With respect to the loans by trust A to trust B, it is contended that if the trusts are taxable as corporations, trust B should be allowed deductions for interest thereon. Interest was computed on the monthly balances by an accountant, at the legal rate of interest under the law of Michigan, and deductions are claimed in the amounts of $2,116.59 for 1934, $3,400.13 for 1935, and $5,146.43 for 1936. No portion of these latter amounts was charged on the books of the trust. But this computation of the accountant was based on the assumption that trust B was obligated to pay interest on the loans. It does not however appear that trust B was so obligated, and the issue was not raised by the pleadings. The accountant, the only witness testifying as to this interest, did not know whether any agreement existed for payment of interest on such loans, and the evidence does not otherwise establish one or that the loans from trust A to trust B, for any other reason, bore interest. Since the claimed deductions of interest are not in issue and it also does not appear that any interest was paid, or agreed to be paid, or that the loans, for any other reason, bore interest, the claimed deductions for such interest are denied. Hundahl v. Commissioner, 118 Fed. (2d) 349.

The petitioner in Docket No. 97134 assigns error in the disallowance-of a deduction of $11,437.71 for depletion. No evidence has been produced to establish that this was error.

Decision will he entered for the respondent.


author: Disney;

text:
    Citizens Hotel Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100000.
    Promulgated May 21, 1941.

      H. A. Mihills, O. P. A., for the petitioner.

      D. D. Smith, Esq., for the respondent.
   OPINION.

Disney;

Income tax for the taxable period February 1, 1937, through December 31, 1937, is involved in this proceeding. The respondent determined a deficiency of $5,031.94. All facts were stipulated, and we find the facts to be as so stipulated. Omitting formal parts, the stipulation reads:

I. That the petitioner is a corporation organized under the laws of the State of Texas with its principal office at 106 West Eighth Street, Fort Worth, Texas, and thé return for the period here involved was filed with the Collector for the 2nd District of Texas.
2. That prior to, during, and subsequent to the period here involved, the petitioner’s books were kept and its income tax returns were filed on the accrual basis of accounting.
3. That in January 1937 the Commissioner granted the petitioner permission to change the basis for filing its income tax return from that of the fiscal year ending March 31 to that of the fiscal year ending January 31, and in September 1937 the Commissioner granted the petitioner permission to change the basis for filing its income tax return from that of the fiscal year ending January 31 to that of the calendar year. The petitioner, pursuant to and in accordance with the requirements of the permission granted, filed an income tax return for the period April 1,1936, to January 31, 1937, and another income tax return for the period February 1,1937, to December 31,1937.
4. That at all times material hereto the petitioner was the owner of certain real and personal property located in Texas and used in connection with its business, and said property was subject to the following ad valorem taxes, which were assessed and levied for the year 1937 under, by virtue of, and in accordance with the Constitution and Articles 1165, 7204-7222, and 7232 of the Texas Revised Civil Statutes (1925 Rev.):
CITY TABBANT
FORT WORTH. COUNTY TEXAS TOTAL
Real Property_$25,647.44 $13,125.00 $38,772. 44
Personal Property_ 2,013.96 350.00 2,363. 96
$27,661.40 $13,475.00 $41,136.40
5. That on August 16, 1937, the Commissioners of Tarrant County, Texas, passed a resolution, a copy of which is hereto attached, marked “Exhibit A,” and made a part hereof.
6. That Fort Worth is a municipal corporation and on December 11, 1924, was chartered under Section 5 of the Constitution of Texas and Chapter Thirteen of the Revised Civil Statutes of Texas (1925 Rev.). On September 29, 1937, the City Council of Fort Worth passed Ordinance No. 1964, a copy of whi<*ji is hereto attached, marked “Exhibit B,” and made a part hereof.
7. The city and county taxes involved herein were paid on-
8. That the petitioner claimed a deduction of $37,911.34 of the aforesaid $41,136.40 of ad valorem taxes in its income tax return for the period herein involved, but the respondent disallowed the entire amount of $37,911.34 so deducted on the ground that ad valorem taxes in Texas accrue on January 1 of each year. The ad valorem taxes in controversy were allowed as deduction to the taxpayer for the period ended January 31,1937.
9. That the petitioner accrued ad valorem taxes for prior taxable years and for prior taxable periods upon the property giving rise to the taxes in question upon its books on the basis of a monthly proration of the taxes levied and for the period herein involved, January 31, 1937, to December 31, 1937, so reckoned the $37,911.34 in controversy.

The ordinance passed by the City Council of Fort Worth, a municipal corporation, on September 29, 1937, exhibit B attached to the stipulation, in so far as material, provided for the levy and collection of an annual direct ad valorem tax on real and personal property in the city of Fort Worth, on January 1, 1937, for certain purposes named; and provided that the taxes should be due and payable one-half on October 1, 1937, delinquent December 1, 1937, and one-half due on April 1, 1938, delinquent June 1,1938; and provided penalties for nonpayment.

The resolution passed on August 16,1937, by the Commissioners of Tarrant County, Texas, exhibit B, attached as a part of the stipulation, recites in pertinent part that the county taxes, occupation taxes, poll taxes and school taxes for the year 1937 be levied, assessed, and collected at specified rates.

The stipulation recites that the city and county taxes involved herein “were paid on-”, the date being left blank. Therefore, though in his brief the petitioner supplies dates of payments, we can make no findings in that regard.

The question for determination here is whether the petitioner, on the accrual basis, is required to accrue real estate and personal property taxes imposed by the county and city of its situs, for the year 1937, during its fiscal year ending January 31, 1937, or whether it may accrue one-twelfth thereof, from January 1, 1937, in that fiscal year, and accrue eleven-twelfths thereof, or $37,911.34, monthly throughout the remainder of the year 1937. By permission given in January 1937 by the Commissioner, the petitioner changed its fiscal year, for reporting Federal income tax returns, from a year ending March 31, 1937, to one ending January 31; and again, in September 1937 was permitted to change to the calendar year basis; and filed a return for the period February 1, 1937, to December 31, 1937. The Commissioner denied deduction of $37,911.34 taxes accrued for such period, but allowed the deduction of the ad valorem taxes in dispute for the period ending January 31, 1937. The petitioner had accrued its taxes for prior periods and years on' a basis of monthly proration, and did so for the period January 31, 1937, to December 31, 1937, in the total amount of $37,911.34, here in controversy.

The ordinance above referred to provides a levy of annual taxes for the year 1937 on property owned on January 1, 1937. In American Liberty Oil Co., 43 B. T. A. 76, 81, we held that the Commissioner properly disallowed deduction of accrued state, county and' independent school district taxes in Texas for 1932 by a corporation which acquired property on May 28, 1932. We followed Texas Coca-Cola Bottling Co., 30 B. T. A. 736, wherein we held that taxes in Texas accrued and became a lien on January 1 of each year. In both cases we said that such Texas taxes became a lien on January 1, and that the owner on that date is personally liable for the amount of the taxes. Decisions involving different tax statutes of other states are not of controlling weight. State of Texas v. Farmer, 94 Tex. 232; 59 S. W. 541, strongly relied on by the petitioner, involved an assessment invalid for indefiniteness, and does not, in our opinion, determine that January 1 is not the date of tax incidence in Texas, as held by us in the above cited cases and by others such as Cadena v. State, 185 S. W. 367 (Tex. Civ. App.). We hold that January 1, 1937, was the date of incidence of the 1937 taxes herein involved. We considered in American Liberty Oil Co., supra, the question whether taxes accrued monthly and concluded that they could not be so accrued. We see no reason in New Orleans Cold Storage & Warehouse Co., Ltd., 40 B. T. A. 121, involving Louisiana tax statutes, to depart from our conclusion in the American Liberty Oil Co. case, for although in the New Orleans Cold Storage (Sc Warehouse Co., Ltd., case, as here, there was no change in ownership of the property, but a change in taxable years by one on the accrual basis, nevertheless in Louisiana there was no personal liability for the taxes and no lien, in the previous taxable year, while in Texas there is both. Though the petitioner suggests that only cases from the Texas Court of Civil Appeals support the idea that the owner of property on January 1 is personally liable, we note that the Supreme Court of that state followed the rule in Childress County v. State, 92 S. W. (2d) 1011. We think, therefore, that herein the taxes were properly to be accrued in the previous taxable year, and that such accrual would properly reflect income. In our opinion the respondent is not shown to have erred in disallowing the deduction of the $37,911.34 taxes accrued for eleven months of 1937, in petitioner’s taxable year beginning February 1 of that year.

Decision will be entered for the respondent.


author: ARNOLD:

text:
    C. T. McDaniel, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99189, 99190, 99191, 99192, 99273, 99302, 99358, 99377.
    Promulgated May 22, 1941.

      Allan A. Smith, Esq., for the petitioners.

      John H. Pigg, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Estate of Addison-L. Tulley by Jesse B. Tulley, Trustee; C. A. Hunter; J. F. Ravenseroft; Bari J. Pfeffer; Emma P. Hackett; Eugene J. Mimnaugh; and L. Mimnaugh Johnston.

   OPINION.

ARNOLD:

The petitioners contend that the assessment of the deficiency in tax liability of Nibley-Mimnaugh for the year 1923 against them as transferees is barred by the statute of limitations. The respondent contends that the assessment is not barred because neither the tentative return filed March 15, 1924', nor the return filed on June 12, 1924, constituted a return required to be filed under section 239 (a) of the Eevenue Act of 1921 in order to start the running of the four-year statutory period. Section 239 (a), in so far as applicable, provides that every corporation subject to taxation “shall make a return stating specifically the items of its gross income and the deductions and credits allowed.”

No claim is made by petitioners that the tentative return was such a return as would start the running of the statutory period. In Florsheim Brothers Drygoods Co. v. United States, 280 U. S. 453, wherein the Court held that a tentative return did not start the running of the statutory period of limitations, the Court stated:

* * * The burden of supplying by the return the information on which assessments were to be based was thus imposed upon the taxpayer. And, in providing that the period of limitation should begin on the date when the return was filed rather than when it was due, the statute plainly manifested a purpose that the period was to commence only when the taxpayer had supplied this information in the prescribed manner.

The respondent contends that the return filed on June 12, 1924, is not such a return as required to be filed because it did not purport to be the calendar year return of Nibley-Mimnaugh for 1923. The return was made on the form required and reflected all the transactions of the company both prior to and subsequent to August 3, 1923, except the sale of the company’s assets to the Bowman-Hicks Lumber Co. It was filled out in detail and numerous schedules were attached thereto. The return disclosed the transfer of the assets on August 3, 1923, and also that the company was in the process of liquidation thereafter. The respondent ,was not misled. Except for the addition of the gain realized on the sale of the company’s assets the respondent’s determination of the taxable net income of the company for the calendar year 1923 involved herein is the same as the taxable net income of the company for the calendar year 1923 as determined by him in 1926 as shown by the notice of deficiency dated April 7, 1926. This deficiency notice also covered the calendar year 1923 as well as the years 1922 and 1924. At that time he claimed that the gain, now included in taxable income for 1923, was properly includible in 1924 income. The amount of taxable income determined by him for the calendar year 1923, as shown by the notice of deficiency dated April 7, 1926, was the same as that reported in the return filed June 12, 1924, except that the respondent increased the reported income by disallowing depreciation from August 3 to December 31, 1923, claimed in the return. Certainly as to that item the respondent must have known that the amount of depreciation claimed in the return covered the entire calendar year 1923. It is reasonable to assume that if that item covered the entire calendar year 1923, other items in the return did so also. The statements contained in the return filed June 12, 1924, that the company’s assets had been transferred on August 3, 1923, and that the inventory was taken on that date was not a misrepresentation. It apparently did not mislead the respondent. On its face the return filed June 12, 1924, purported to be a return “For Calendar Year 1923.” The reference to the transfer of the company’s assets merely called attention' to such transfer and the position of the company in regard to it. No doubt this caused the examination of the company’s records and resulted in the redetermination of its tax liability as shown in the 30-day letter dated October 15, 1925, and the notice of deficiency dated April 7, 1926, at which time no question was raised as to the period covered by the return filed on June 12, 1924. At that time, it was apparently treated as covering the calendar year 1923.

In Zellerbach Paper Co. v. Helvering, 293 U. S. 172, the Court stated:

* * * perfect accuracy or completeness is not necessary to rescue a return from nullity, if it purports to be a return, is sworn to as such (Lucas v. Pilliod Lumber Co., 281 U. S. 245 * ⅜ . *). and evinces an honest and genuine endeavor to satisfy the law. This is so though at the time of filing the omissions or inaccuracies are such as to make amendment necessary.

The books of the company were kept on a calendar year basis, the return was prepared accordingly, and the taxable net income reported therein reflected all transactions made during the calendar year except the gain realized on the sale of its assets to the Bowman-Hicks Lumber Co. No allegation has been made that the return filed June 12, 1924, was false or fraudulent and made with intent to evade tax. Under the facts and circumstances we hold that the return of Nibley-Mimnaugh filed June 12, 1924, was a return as required by the Eevenue Act of 1921 which would start the running of the statute of limitations.

The deficiency in tax herein involved has never been assessed against the taxpayer or against the petitioners herein as transferees. The statutory period for assessment of taxes imposed by the Eevenue Act of 1921 is “four years after the return was filed.” Sec. 250 (d), Eevenue Act of 1921; sec. 277 (a) (1), 1924 Act; and sec. 277 (a) (2), 1926 Act. The period for assessment of the liability of a transferee is “one year after the expiration of the period of limitation for assessment against the taxpayer.” Sec. 280 (b) (1), 1926 Act. The deficiency notice for 1922,1923, and 1924 mailed to Nibley-Mimnaugh on April 7, 1926, was within the four-year period commencing June 12, 1924, and therefore timely. By the provisions of section 274 (a) and 277 (b) of the Eevenue Act of 1926, the running of the statute against assessment was suspended 60 days after the mailing of a notice of deficiency for an appeal to the Board and for 60 days thereafter. This extended the statutory period of limitations from June 12, 1928, to October 10, 1928. The deficiency notice for the year 1923 mailed May 6,, 1936, to Nibley-Mimnaugh, was not within the statutory period as suspended and was therefore not timely and was ineffective, to revive or to suspend the running of the statutory period. When once the statutory period has completely run, as it did herein on October 10, 1928, against Nibley-Mimnaugh, the Commissioner can not revive it by the mailing of another notice of deficiency. William M. Greve, 42 B. T. A. 142. The notices of deficiency addressed to the petitioners herein dated April 4,1939, were not mailed within the one year additional time allowed for assessment against transferees, or on or before October 10, 1929, and therefore were not timely. The assessment of the taxes involved herein has long since been barred.

In view of this holding, it is not necessary to decide whether the petitioners, Eugene J. Mimnaugh and L. Mimnaugh Johnston, are transferees of the property of Nibley-Mimnaugh within the meaning of section 280 of the Revenue Act of 1926.

Decision will be entered for the petitioners.


author: HaRRon: Muedock, Disney,

text:
    Reed Drug Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101325.
    Promulgated May 22, 1941.

      L. F. Loux, Esq., for the petitioner.

      T. F. Callahan, Esq., for the respondent.
   OPINION.

HaRRon:

The sole question is whether in the computation of the surtax imposed by section 14 of the Revenue Act of 1936 petitioner is entitled under section 27 (f) to a dividends paid credit of $54,130.38, the amount of its earned surplus at the time of the transfer of all its assets to the new corporation. Under section 14 undistributed net income, on which the surtax is based, is computed by subtracting from adjusted net income the “dividends paid credit provided in section 27.” The provisions of section 27, in so far as pertinent to the present question, are set forth in the margin. In the computation of the surtax imposed by section 14 on its corporation income and excess profits tax return for the taxable year petitioner took a dividends paid credit of $54,130.38, under the assumption that the distribution of the stock of the new corporation in exchange for its own stock, and in liquidation, was a distribution which was properly chargeable to accumulated earnings within subsection '(f) of section 27. In the statement attached to the deficiency notice respondent disallowed the full amount of the dividends' paid credit taken by petitioner.

Respondent contends that petitioner is not entitled to any dividends paid credit under subsection (f). He argues that no gain to petitioner’s stockholders from the receipt of the shares of stock of the new corporation was recognized by law; that thus under section 115 (h) of the Revenue Act of 1936 the distribution by petitioner of such stock did not constitute “a distribution! of earnings or profits of any corporation”; and that thus no part of such stock distributed by petitioner was “properly chargeable to the earnings or profits accumulated after February 28, 1913” within the meaning of subsection (f). The provisions of section 115 (h), in so far as pertinent to the present question, are set forth in the margin.

Respondent also makes the somewhat related argument that on the exchange by petitioner of all its assets for the shares of stock of the new corporation the earned surplus of petitioner was not convertible into capital of the new corporation, but still remained earned surplus in the hands of the new corporation, and that thus no part of the stock of the new corporation subsequently distributed by petitioner to its stockholders in complete liquidation was properly chargeable to earnings or profits. In support of this argument he cites Commissioner v. Sansome, 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667; United States v. Kauffman, 62 Fed. (2d) 1045; Murchison v. Commissioner, 76 Fed. (2d) 641.

In our opinion respondent’s determination is correct.

Under section 27 (f) not all distributions in liquidation are to be treated as a taxable dividend paid for the purposes of computing the dividends paid credit. Only amounts distributed or the part of such distribution which is “properly chargeable to the earnings or profits accumulated after February 28, 1913”, shall be treated as a taxable dividend paid. Petitioner has not presented any argument whatever to support a contention that the distribution of the stock of the new corporation was such distribution as is specified in section 27 (f) to be the kind of distribution which shall be treated as a taxable dividend paid. Petitioner makes a “philosophic” argument, for want of a better term, that it ought to be entitled to a dividends paid credit because it distributed all that it retained in a complete liquidation; namely,, stock of a new corporation received in an exchange of property for stock pursuant to a plan of reorganization. Petitioner makes a wholly untenable argument that the holding in Credit Alliance Corporation, 42 B. T. A. 1020, supports a determination in its favor in this case, completely ignoring the great difference in facts in that case where the distributing corporation distributed its cash and property in a complete liquidation, and no distribution of stock of another corporation, a party to a reorganization, was involved. In reality petitioner has made no analysis whatsoever of its case and it comes to this Board with no more than a plea that the respondent’s determination be set aside. The foregoing is pointed out to make it clear that petitioner has presented little or no authority for its general contention. It is hardly necessary to point out that the Credit Alliance Corporation case is distinguishable on the facts and that the holding there made is in no way controlling here.

Furthermore, petitioner has stipulated that all of the parties concerned in the exchanges made pursuant to a plan of reorganization treated the exchanges as not involving gain or loss. Petitioner did not report gain or loss from the exchange of its assets for stock of the new corporation and petitioner’s stockholders did not report gain or loss from receipt of stock of the new corporation in exchange for petitioner’s stock.

The first step taken by petitioner pursuant to a plan of reorganization was to exchange all of its assets solely for the stock of the new corporation. Under section 112 (b) (4) no gain or loss was recognized by law. The second step, taken a few months later, was the exchange of the stock of the new corporation for petitioner’s own stock, in pursuance of the plan of reorganization. No gain or loss was recognizable at law upon this exchange under section 112 (b) (3). Section 115 (h) deals specifically with the kind of distribution with which we are concerned here. It refers to a distribution by one corporation of stock in another corporation and it provides that such distribution “shall not be considered a distribution of earnings or profits of any corporation—(1) if no gain to such distributee from the receipt of such stock * * * was recognized by law, * * (Italics supplied.) Clearly, the distribution by petitioner of the stock of the new corporation to its stockholders falls squarely within the terms of section 115 (h). It follows that no part of the distribution in question is “properly chargeable to the earnings and profits accumulated after February 28,1913,” and no part of the distribution can be treated as a taxable dividend paid under section 27 (f). In short, in our opinion, section 27 (f) is not applicable to the distribution of stock involved in this case.

It is hardly a possibility that section 27 (f) was drafted without cognizance of the provisions of section 115 (h), which is entitled “Effect on Earnings and Promts of Distributions of Stock.” It is clear from the report of the Senate Committee on Finance to accompany the Revenue Bill of 1936 that section 115 (h) of the 1936 Act was drafted to make clear the rule at law of the effect on earnings and profits of a distribution of stock in connection with a reorganization on which distribution gain is not recognized. The Committee stated in its report that “earnings- or profits are not diminished by such distribution (of stock).” Furthermore, if the petitioner’s contention could be sustained, such result would do violence to the real purpose of section 27, because a corporation could obtain a dividends paid credit each year by the device of a reorganization and a distribution of stock of the new corporation to its stockholders without reducing its accumulated earnings and profits.

To apply the express provisions of section 115 (h) in determining whether or not the distribution (in liquidation of the old corporation) of stock of the new corporation in exchange for stock of the old corporation can be treated as a taxable dividend paid,' does not in our opinion result in any modification of section 27 (f). Rather, section 115 (h) aids in the application of section 27 (f), for it limits the dividends paid credit to a distribution which is properly chargeable to accumulated earnings and profits, and section 115 (h) states what kind of distribution can not be said to be a distribution of earnings and profits. But, even so, it does not appear to be necessary to rely on the bare terminology of section 115 (h) except to save time and space which, discussion of principles requires otherwise. The situation here involves a statutory merger of petitioner into a new corporation having the same name, and a “reorganization” of petitioner resulted within the definition in section 112 (g). The provisions of section 27 (f) certainly can not be applied in total disregard of the status, generally, under the statute of a tax-free reorganization. What is it that happens when corporation A is merged with corporation X, a new corporation, upon a transfer of all its assets, including accumulated earnings and profits, to X in exchange for the stock of X, and when corporation A dissolves and gives the stock of X to its stockholders? It has been said that in such reorganization the stockholders of the transferor corporation A, to whom the stock of X was distributed, retain a continuing interest in the business proceeding in modified corporate form in X. Reorganization presupposes continuance of business under modified corporate forms. Helvering v. Winston Brothers Co., 76 Fed. (2d) 381. Here the petitioner admits that there was a reorganization upon which no gain or loss was recognized to it or to its stockholders, and, since no issue is raised as to whether or not that admission holds water on all legal counts, we must proceed upon the assumption that the admission means all that it ordinarily must mean. We must assume that there was a continuity of interest of petitioner’s stockholders in the new corporation X, and, if that is true, that petitioner’s stockholders still retain an interest in petitioner’s assets and accumulated earnings and profits which were transferred to the new corporation.

^Another question is, what happened to the accumulated earnings of the old corporation ? Has there been any distribution of them to petitioner’s stockholders? If a merger contemplates that the interests of the stockholders of the old corporation shall be retained in the newly created corporation it is difficult to visualize that there has been any distribution of the accumulated earnings of the old corporation, upon its liquidation, which were transferred to the new corporation, with other assets, in exchange for its stock, particularly since it appears to be an established rule that in such reorganization as we have here the accumulated profits of the old corporation do not become capital of the new corporation, but remain earnings and profits in its hands even though earned by the trans-feror or old corporation. Murchison v. Commissioner, supra.

It was pointed out in the Murchison case that, “Unless the undistributed gains of the old business are taken over by the new as wndwided profits distributable as dividends, they escape proper taxation.” (Italics supplied.) Giving attention to that factor here, what light does it cast upon our problem arising under section 27 (f) ? The following appears to be evident: If no gain could be taxed to petitioner’s stockholders upon their receipt in liquidation of petitioner of stock of the new corporation in exchange for petitioner’s stock, petitioner’s stockholders could not be taxed for any dividend or distribution out of accumulated earnings and profits. It would appear to be inconsistent to allow petitioner a dividends paid credit under section 27 (f) as though the stockholders had received a taxable dividend when under the reorganization provisions of the statute they have not received a taxable dividend. And, also, to allow petitioner a dividends paid credit for the distribution of the stock of the new corporation upon its liquidation would be tantamount to a holding that petitioner’s accumulated earnings and profits had been reduced, and yet for purposes of any distributions by the new corporation the accumulated earnings and profits of petitioner are regarded as held intact by the new corporation and subject to being reduced by distributions by the new corporation under the rule of the Murchison cas&) It would appear to be a very undesirable result if in construing the provisions of section 27 (f) the situation were created whereby for tax purposes the same accumulated 'pro-fits were made available for two dividends paid credits to two corporate entities.

Such dilemma and contradictions as we have endeavored to indicate by the foregoing are avoided by applying the terms of section 115 (h) in construing the facts of this case under section 27 (f) and, indeed, we believe section 115 (h) can not be ignored. We believe it must be held that the distribution in question which petitioner made in liquidation, being a distribution of stock of a new corporation to which all of petitioner’s assets had been transferred, was not such distribution as is “properly chargeable to the earnings or profits accumulated after February 28,1913.”

It is held that the distribution in liquidation of the stock of the new corporation by petitioner was not a distribution chargeable to earnings or profits accumulated after February 28, 1913, and petitioner is not entitled to a credit for dividends paid under section 27 (f). Respondent is sustained.

Other contentions of respondent need not be considered.

There is no merit in petitioner’s claim that it is entitled to a dividends paid credit under article 27 (f)-l (c) of Regulations 94, because there is no evidence to show that any part of the dividends paid by the new corporation during the portion of the taxable year subsequent to the nontaxable exchange of petitioner’s assets for the new corporation’s stock was apportioned and allocated to petitioner as a distribution out of its earnings or profits. Cf. Credit Alliance Corporation, 42 B. T. A. 1020, 1029.

Reviewed by the Board.

Decision will he entered for the respondent.

Muedock,

dissenting: The purpose of Congress, in imposing the surtax upon undistributed profits, as indicated by the legislative history, was to force corporations to distribute their profits or suffer the high rates imposed in section 14. Here the section is being applied in the case of a corporation which dissolved during the taxable year and, in dissolving, distributed everything which it had, including both capital and accumulated profits. This seems like an unwarranted application of the act beyond its purpose.

The prevailing opinion, in order to reach this result, holds that the special provision of section 27 (f) is modified by section 115 (h), a general provision of the act. The Board, in the case of Credit Alliance Corporation, 42 B. T. A. 1020, held that section 27 (f) was not modified by section 27 (h), even though the latter related specifically to surtax on undistributed profits and seemed on its face to apply. Here, we go much farther than we were asked and refused to go in the Credit Alliance case. • ■

■ Section 115 (h) appeared for the first time in the Revenue'Act of 1934. It was there entitled “Disteibtttion of Stock on Reoeganization—Effect on Futuee Disteibutions.” It provided that a distribution of stock or securities by a corporation, pursuant to a plan of reorganization, where no gain or loss to the distributee was recognized, should not be considered a distribution of earnings or profits within the meaning of section 115 “for the purpose of determining the taxa-bility of subsequent distributions by the corporation.” Thus, the whole purpose was to make sure that future distributions by the corporation would be from earnings or profits accumulated after February 28,1918, in so far as the corporation had any such earnings. Clearly, the section was not intended to apply in the case of the complete liquidation of a corporation where there could be no subsequent distributions by the corporation. Congress could not have had in mind the provisions of the undistributed profits tax because those provisions were not enacted until a later revenue act. The changes made in section 115 (h) of the Revenue Act of 1936 were merely for the purpose of clarification. Furthermore, it seems to me that Congress did not have section 115 (h) in mind when it enacted section 27 (f) of the Revenue Act of 1936, and it did not intend that reference should be made to section 115 (h) (which has no purpose in the case of a complete liquidation), in order to determine what part of the amount distributed in complete liquidation of a corporation might properly be chargeable to the earnings or profits accumulated after February 28,1913.

The meaning of the phrase “properly chargeable to the earnings or profits accumulated after February 28,1913”, as used in section 27 (f), was determined in the Credit Alliance case. We pointed out that cases like Commissioner v. Sansome, 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667, had no application. We said that the quoted words merely make a distinction between a charge to capital and a charge to earnings, so that no credit may be allowed for any distribution which should be charged to earnings or profits accumulated prior to March 1, 1913, or as a return of capital, and a'dividends paid credit is allowed only for that portion of a distribution which is properly allocable to earnings or profits accumulated after February 28,1913. “The intent, in our opinion, went no farther.” The regulation of the Commissioner and the legislative history of the provision were cited in support of the above conclusions. Obviously, the accounting for a complete liquidation requires that charges be made wiping out both capital and all accumulated profits, and under such circumstances, the amount properly chargeable to the earnings or profits accumulated after February 28, 1913, is the entire amount of those earnings or profits.

Disney agrees with this dissent.

Disney,

dissenting: I find myself unable to agree with the majority report in its conclusion that section 115 (h) of the Revenue Act of 1936 requires the holding that the expression “properly chargeable to the earnings or profits accumulated after February 28, 1913” in section 27 (f) of the Revenue Act of 1936 does not apply to the distribution by the petitioner of stock in another corporation which in a nontaxable reorganization it secured in exchange for its earned surplus. In my opinion, the language of section 115 (h) of the Revenue Act of 1936 should not be given a meaning and application essentially different from section 115 (h) of the Revenue Act of 1934. As stated in a footnote to the majority opinion, the report of the Senate Committee on Finance, as to section 115 (h) of the 1936 Act, points out that “The rule, under existing law” (as to effect on corporate earnings or profits of a nontaxable stock dividend or a nontaxable distribution of stock in a reorganization), is that “such earnings or profits are not diminished by such distribution” and that they remain intact, available for distribution as dividends by the distributing corporation, or another which receives them in reorganization. After stating that this rule is stated only in part in section 115 (h) of the Revenue Act of 1934, the report says that the rule is applied in the Samóme, case and others. The report concludes: “While making no change in the rule as applied under existing law, the recommended amendment is desirable in the interest of greater clarity.” This seems to indicate the view that no substantive change was made in section 115 (h) of the 1934 Act, but that it was only clarified. That section in the 1934 Act, however, was in part entitled “Effect on Future Distributions”, and provided that the distribution there involved “shall not be considered a distribution of earnings or profits within the meaning of this section for the purpose of determining the tax-ability of subsequent distributions by the corporation.11 (Italics supplied.) If section 115 (h) in the 1936 Act makes no essential change and merely clarifies the above language in the 1934 Act, obviously effect upon section 21 (f) and the new undistributed profits tax provisions was not within Congressional intent. It seems to me that the intent, as in 1934, was merely to provide that a nontaxable distribution of stock should not diminish earnings and profits “for the purpose of determining the taxability of subsequent distributions by the corporation”, that section 115 (h) does not determine what is “properly chargeable to the earnings or profits” under section 27 (f), and that, as stated in Regulations 94, article 27 (f)-l (b), “To determine the amount properly chargeable to the earnings or profits accumulated since February 28, 1913, there must be deducted from the amount of the distribution that part allocable to capital account”; in other words, that if the distribution represented earnings or profits and not capital, and was a part of the liquidation distribution particularly covered in section 27 (f), the dividends paid credit should result. In this matter the petitioner originally had earned surplus of approximately $54,000. This was exchanged for stock of another corporation, and was then distributed to stockholders in liquidation.

I think the fact that the exchange was in a reorganization furnishes no alchemy to change the $54,000 earned surplus into capital, that the stock, the substitute for the $54,000, remained earned surplus the same as it would have been if the $54,000 earned surplus had been invested in stock of any other corporation, and that when such stock was distributed in liquidation, it was “properly chargeable to the earnings or profits.” I can not discern that it became capital of the distributing corporation, and think that the ordinary bookkeeping transaction would have charged it to “earnings or profits.”

Further, in my opinion, the line of cases beginning with Commissioner v. Sansome, 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667, is not decisive that in this matter there was no distribution of earnings or profits to a distributee in liquidation, as covered by section 27 (f). The true test which should be followed in applying such cases is, in my opinion, not whether there was merely a tax-free reorganization, but whether there was substantial identity of the two corporations. Paul and Mertens, vol. 1, ¶ 8.45. Here the facts show that there was no substantial identity of the two corporations." I therefore think that Commissioner v. Sansome, and the cases following it, interpreting other statutes than those here involved, should not be given effect under the facts here found in the interpretation of the undistributed profits tax provisions of the Revenue Act of 1986, as they are, in the reliance placed by the majority opinion upon the committee report which cites them. As I view the matter, the committee report itself indicates that section 115 (h) of the 1936 Act should be given effect only in the matter of future distribution of earnings or profits following a stock dividend, or distribution of stock or securities in a nontaxable reorganization to dictate that there has been thereby no diminution of earnings or profits; but'that it does not follow that a definition is furnished for “properly chargeable to the earnings or profits” in section 27 (f), a more particular section involving liquidations, and the new matter of undistributed profits tax under section 14, Revenue Act of 1936. I must therefore respectfully dissent.

       SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
      (a) Dividends Paid Credit in General.—Eor the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.
      *******
      (f) Distributions in Liquidation..—In the case of amounts distributed in liquidation the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913, shall, for the purposes of computing the dividends paid credit under this section be treated as a taxable dividend paid.
      *******
      (h) Nontaxable Distributions.—If any part of a distribution (including stock dividends and stock righis) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      *******
      (h) Effect on Eaknings and Pkofits of Distkibdtions of Stock.—Tlie distribution (whether before January 1, 1936, or on or after such date) to a distributee by or od behalf of a corporation of its stock or securities or stock or securities in another corporation shall not be considered a distribution of earnings or profits of any corporation—
      (1) if no gain to such distributee from the receipt of such stock or securities was recognized by law, * * *

       Rept. No. 2156 of the Senate Committee on Finance to accompany the Revenue Bill of 1936, H. R. 12395, p. 19 :
      “SECTION 115 (h). EFFECT OF DISTRIBUTIONS ON EARNINGS AND PROFITS.
      “The rule, under existing law, with respect to the effect on corporate earnings or profits of a distribution which, under the applicable tax law, is a nontaxable stock dividend or a distribution of stock or securities in connection with a reorganization or other exchange, on which gain is not recognized in full, is that such earnings or profits are not diminished by such distribution. In such cases, earnings or profits remain intact and hence available for distribution as dividends by the corporation making such distribution, or by another corporation to which the earnings or profits are transferred upon such reorganization or other exchange. This rule is stated only in part in section 115 (h) of the Revenue Act of 1934, and corresponding provisions of prior acts, but is the rule which is applied by the Treasury and supported by the courts in Commissioner v. Sansome, 60 Fed. (2) 931; V. S. V. Kauffman, 62 Fed. (2) 1045; MurcMson v. Comm,, 76 Fed. (2) 641.' While making no change in the rule as applied under existing law, the recommended amendment is desirable in the interest of greater clarity.”