author: Black: Sternhagen, Murdock, and Adams Trammell,

text:
    C. B. Shaffer, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ray L. Erb, Earl G. Crain and Samuel W. Gregg, Executors of the Estate of E. E. Smathers, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 29259, 29260.
    Promulgated February 28, 1934.

      Charles D. Hamel, Esq., Lee I. Parle, Esq., Tracy B. Voorhees, Esq., and James G. Stanley, Esq., for the petitioners.

      Chester A. Gwinn, Esq., for the respondent.
   OPINION.

Black:

These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income taxes for the year 1919 of $577,171.41 and $546,600.02 determined by the respondent against C. B. Shaffer and E. E. Smathers, respectively. After filing the original petition in Docket No. 29260, Smathers died and the Board, upon suggestion of death and notice of the appointment of Nay L. Erb, Earl G. Crain and Samuel W. Gregg as executors, substituted them as petitioners in that proceeding.

The deficiencies arise principally from the redetermination by the respondent of the net income reported for 1919 by a partnership known as C. B. Shaffer No. 2, which was composed of Shaffer and Smathers, as equal partners, and the consequent redetermination of the distributive shares of profits reported by them from such partnership. The questions involved in the two proceedings are identical. Each of the amended petitions assigns 17 errors, lettered (a) to (q), inclusive, most of which relate to and grow out of a sale on May 31, 1919, of the partnership properties to a corporation, the Shaffer Oil & Befining Co. The proceedings were submitted upon several stipulations of fact, testimony of witnesses, and documentary evidence. Effect to the issues stipulated should be given in the recomputations under Bule 50. We will now dispose of the contested issues.

(a) Respondent erred in failing and refusing to find that the selling price of the property of the partnership known as G. B. Shaffer No. g was not in excess of $1,000,000.

This issue is automatically disposed of by our decision on the other issues relating to the determination of the sales price and the stipulated facts with respect thereto.

Issues (b), (c), and (d) are disposed of by stipulation, except a portion of issue (c) which petitioners state they will abandon in case issue (f), infra, is decided in their favor.

(e) Respondent en'ed in failing and refusing to find that certain oil leases transferred ty the partnership to Shaffer Oil & Refining Go. in 1919 had a fair market value as of March 1, 1913, in excess of $4,102,581.68, and ' in failing and refusing to find that said oil and gas leases had a fair market value as of said date of at least $15,000,000.

Some time prior to March 1,1913, C. B. Shaffer and E. E. Smathers became associated in certain oil ventures, in the development, production and sale of oil and its products. Prior to March 1, 1913, they entered into a partnership known as C. B. Shaffer No. 2 (hereinafter sometimes referred to as the partnership) and acquired through such partnership a number of properties (hereinafter sometimes referred to as the partnership properties) located in what later became known as the Cushing Oil Field, Oklahoma. The partnership properties thus acquired and owned prior to and on March 1,1913 (the valuation of which is here for determination) consisted of leases on an aggregate of 5,183.6 acres of land located in Creek County, Oklahoma, about ten miles east of the town of Cushing. Prior to March 1, 1913, production had been discovered on 1,435 acres of this acreage and on that date oil was being obtained therefrom. The remainder of the acreage, or 3,148.6 acres, was undeveloped on March 1, 1913.

On March 1, 1913, the partnership properties had been developed to a point where there were 31 producing wells which, from February 19 to February 28, 1913, both inclusive, had produced 35,936 barrels or an average of 3,593.6 barrels per day. On that date there was also on the properties one gas well which was producing about 35,000,000 cubic feet of gas per day. These producing wells were located upon the block of 1,435 acres heretofore described as being productive on March 1, 1913. However, on that date wells were being drilled on the partnership leases on undeveloped acreage at distances of from one to two miles from the producing block. While the remaining partnership acreage of 3,748.6 was undeveloped, it was considered by geologists and oil producers as favorably located on the Cushing anticline, a great proportion of which structure was outlined at that time.

On March 1, 1913, a large camp building and office had been erected on the partnership properties. There were 12 fully equipped machine shops. The properties were connected up with gas and water systems. A telephone system had been installed. A large amount of pipe, casing, and other drilling equipment had been assembled. Gathering lines were being placed over the field.

On March 1, 1913, a pipe line was under construction by the partnership from its properties in the field to its tank farm and to a refinery located about eight miles west of the properties near Cush-ing, and which was in the process of construction by the Consumers Refining Co., substantially all of whose stock was owned by Shaffer and Smathers. The capacity of the refinery was 5,000 barrels a day. At the time the construction of the refinery was started in November 1912 the partnership had entered into a verbal agreement with the Consumers Refining Co. by which that company was to purchase all of its oil requirements from the partnership at the highest market price per barrel and to pay the partnership 20 cents per barrel for piping the oil to it. Afterwards and on June 13,1913, the agreement was reduced to writing by the parties.

In the summer of 1912 there was erected on the properties a casing-head gas plant for the manufacture of gasoline. This plant belonged to the Consumers Refining Co., with which the partnership had an agreement respecting the manufacturing of the gasoline. In November 1912 the partnership had entered into a contract with one Rowland respecting the marketing of the dry gas from the partnership properties. L'ate in December 1912 Rowland organized the Creek County Gas Co. and transferred to it his interest in the contract.

With the foregoing equipment and the arrangements for the handling and marketing of the oil and gas produced therefrom the partnership properties were so organized into a unit that the full value thereof could be realized by the partnership.

On March 1, 1913, the production from the wells on the partnership properties, as well as from all other wells in the Cushing Field, was being taken from the Layton and Wheeler sands and there was no reason why an attempt should then be made to drill into the Bartlesville sand so long as commercial production could be had from these upper sands.

In the area where-the partnership properties were located a structural or anticlinal fold existed which was recognized as such prior to March 1, 1913, with definite dips east and west from a north and south alignment from an arch of considerable breadth and of great length. Under such a geological condition the Bartlesville sand in the oil fields and pools to the east and to the north of Cushing up to that time had been found productive. Geologists and practical oil men familiar with this condition prior to March 1, 1913, believed with practical certainty that the Bartlesville sand when drilled into in the Cushing field would be found productive. The fact that production was being had from the Layton and Wheeler sands in the Cushing field on March 1, 1913, led geologists and practical oil men to believe not only that the Bartlesville sand would be present, but that it would be more prolific than in any other of the fields brought in up to that time. This belief was based largely on the fact that in the Cushing field commercial production was being obtained from the Layton and Wheeler sands, while in the older fields, where Bart-lesville production existed, commercial production had not been obtained from sands corresponding to the Layton and Wheeler.

On March 1, 1913, Shaffer was fully aware of these geological conditions and believed with a certainty that the Bartlesville sand, considered to be the most prolific and most valuable producing sand in the Midcontinent Field, underlay the partnership properties. His opinion is supported by the opinion of recognized geologists.

On March 1,1913, it appeared that there was likely to be a shortage of crude oil. Oil men generally recognized the situation and as a consequence oil properties were in greater demand than they had been for years.

Subseqeunt to 1913 wells drilled in the Bartlesville sand on 12 of .the partnership leases produced a total of 1,889,991 barrels of oil during the period from 1914 to May 31,1919.

From 1913 to 1918, inclusive, the partnership received $12,193,-128.29 from the sale of oil to the Consumers Refining Co. and to outside interests. Receipts for the same period from lineage paid on account of pipe line according to the contract with the Consumers Refining Co. amounted to $2,113,129.53. Receipts from the sale of dry gas during this period amounted to $273,984.50.

On or about April 15, 1920, tbe partnership duly filed an income tax return for the calendar year 1919, and attached thereto a statement reading as follows:

The assets and good will of the partnership were sold during the taxable year ended December 31, 1919. The profit or loss resulting from such sale cannot be determined until the valuation of the assets and good will of the partnership as of March 1, 1913, is approved by the Bureau of Internal Revenue to whom there has been submitted data in respect to such valuation. When such approved valuations are received an amended return will be submitted.

On or about May 4, 1920, the partnership duly filed an amended income tax return for the calendar year 1919, and reported therein a profit from the sale of its assets of $5,896,822.89. In arriving at such a profit the partnership reported the March 1, 1913, value of its oil properties and leases in question as being $7,091,747.85, itemized as follows:

Nonproducing acreage owned March 1, 1913, producing December 31, 1918_ $878,459.00
Producing acreage owned March 1, 1913- 6,159, 288. 85
Nonproducing acreage owned March 1, 1913, and December 31, 1918_ 54, 000. 00
Total_ 7,091,747.85

The respondent determined that the acreage in question had a fair market value on March 1, 1913, of $4,102,581.63, and contends that his valuation should be sustained. The petitioners in their brief in effect concede that the value they alleged in their petitions, namely, $15,000,000, was too high, and now contend that the fair market value of the acreage on March 1, 1913, was at least the amount of $10,500,000.

Considerable evidence has been submitted on this issue. Part of the evidence relied upon by petitioners in support of the valuation contended for by them is the opinion testimony of six expert witnesses as to the fair market value of the leases on March 1,1913. We do not think there would be any profit in discussing the details of this evidence. Suffice it to say petitioners Shaffer and Smathers were oil men of long and varied experience and were thoroughly familiar and conversant with all the conditions with respect to their oil properties owned on March 1,1913, which we have detailed above. It is reasonable to suppose that they knew more about the value of their property as of March 1, 1913, when they filed their income tax returns for 1919 (in 1920) than these several expert witnesses knew in 1932 when they testified in the hearings held in these proceedings.

We do not think it is reasonable to believe that Shaffer and Smathers undervalued their oil properties as of March 1,1913, when they filed their income tax returns in 1920 for the year 1919 and reported the profit from the sale. Taxpayers do not usually undervalue their property when fixing a March 1,1918, value. Giving due weight to all of the evidence, opinion and otherwise, we find that the acreage in question had a fair market value on March 1, 1913, of $7,091,747.85. We make this finding from the evidence and not because we think petitioners would be estopped to claim a higher valuation than that used in the partnership return filed in 1920.

The respondent contends that if we should alter the value of the properties on March 1, 1913, as determined by him, the oil reserves should be redetermined so as to make them commensurate with the redetermined value. In their brief the petitioners agree to this contention of the respondent. The respondent’s contention on this point is therefore sustained.

(f) Respondent erred in reducing the March 1, 1918, value and subsequent costs of the properties of the partnership so transferred in 1919 by depletion and, depreciation sustained prior to December 81, 191-5, in excess of 5% of the gross value of the oil produced from, said properties during the period from March 1, 1918, to December 81, 1915.

In determining the profit from the sale of the partnership assets the respondent reduced the March 1,1913, value and subsequent costs by depletion for the period March 1, 1913, to December 31, 1915, in the amount of $1,270,209.37 and by depreciation alleged to have been sustained on lease equipment for the period in the amount of $349,827.07. The respondent admits that the depletion allowable for the period is limited to $211,630.98, or 5 percent of $4,232,619.74, the gross value at the well of all oil produced by the partnership for the period. He also admits that the remainder of the reduction of $1,270,209.37 made by him on account of depletion, or $1,058,578.39, should be restored to the base in computing the profit on the sale in 1919. However, he denies that any depreciation allowed prior to the date of sale may be restored.

The petitioners contend that the aggregate of the deductions for depletion and for depreciation of lease equipment for the period March 1, 1913, to December 31, 1915, should not exceed 5 percent of the gross value at the well of all the oil produced during the period, relying on the provisions of paragraph B, section II, of the Act of October 3, 1913; United States v. Ludey, 274 U.S. 295; and our decision in J. M. Loffland, 10 B.T.A. 14.

In J. M. Loffland, supra, we had before us the identical question here presented. We there held, under the decision in the Ludey case, that in computing the gain or loss upon the sale of oil properties in 1920 depreciation and depletion for the years 1913, 1914, and 1915 should be computed under the provisions of paragraph B, section II, of the Act of October 3, 1913, and that the aggregate amount for both depreciation and depletion for those three years was limited to 5 percent of the value of the annual production or output of the oil at the well for such years. In accordance with onr decision in the Loffland case, the contention of the petitioners on this point is sustained.

Since this issue is decided in favor of the petitioners, it is not necessary to discuss that portion of issue (c), supra, which petitioners state they would abandon if the present issue were' decided in their favor.

Issues (g) and (h) will be considered together.

(g) In computing the partnership’s profit on the sale of said assets, respondent en'ed in failing and refusing to find that the depreciation sustained on physical equipment-prior to the date of sale was not in excess of $1,016,011.68.
(li) In computing the partnership profit on the sale of said assets, respondent erred in redwomg the March 1, IBIS, value and subsequent costs of physical equipment by the amount of $1,567,01/8.50, or any other amount in excess of $672,1/01.8%, on account of depreciation allowable prior to the date of sale.

In determining the profit from the sale of the partnership assets, the respondent reduced the basis of the property sold by “ Depreciation sustained to January 1, 1919,” in the amount of $1,567,048.50. Petitioners contend that the depreciation actually sustained to May 31, 1919, was no more than $1,076,077.68.

The amount of $672,407.32 referred to in assignment of error (h), supra, as depreciation allowable “ prior to the date of sale ” is the total of the alleged depreciation sustained for the years 1916, 1917, and 1918 of $186,911.85, $227,205.07, and $258,290.40, respectively, and contains no part of the alleged depreciation sustained prior to the year 1916 or for the period January 1 to May 31, 1919. As will later appear, however, this is not important. We mention it merely to account for the above amount of $672,407.32.

The depreciation originally claimed by the partnership, the depreciation allowed by the respondent, and the amount now claimed by petitioners to have been sustained from 1912 to and including May 31, 1919, by years, is summarized as follows:

Of the above amount of $1,567,048.50 allowed by the respondent, $1,392,824.63 was on lease equipment 'and the balance, or $174,223.87, was on other assets, consisting of horses, wagons, automobiles, furniture, fixtures, telephone lines, pipe lines, pump stations, and a ferryboat. In their brief the petitioners accept the amounts allowed by the respondent on all of the physical equipment except the lease equipment. They contend in their brief that depreciation sustained on lease equipment prior to the date of sale did not exceed $894,439.19.

The parties have stipulated the depreciation claimed, allowed, and now claimed by petitioners to have been sustained on “ lease equipment ” down to the date of sale, May 31, 1919. Said stipulation is incorporated herein by reference.

The difference of $1,071.26 between the total of $895,510.45 shown in the stipulation and the amount of $894,439.19 contended for in the brief of the petitioners as depreciation actually sustained on lease equipment, represents an adjustment made in accrued depreciation on assets sold in 1914.

From the table in the stipulation filed, it is apparent 'that the partnership consistently from 1912 to December 31, 1918, charged off depreciation on its books on lease equipment at the rate of 20 percent annually and claimed deductions therefor in its returns at that rate. For three of the years the respondent allowed depreciation at the rate claimed by the partnership; for two years he allowed only half the rate claimed; and for two other years he allowed approximately three fourths of the rate claimed. Although the partnership uniformly wrote off and claimed depreciation at the rate of 20 percent from 1912 through 1918, the petitioners now contend that depreciation at the rate of only 10 percent was sustained and that that rate should be used in determining the profit from the sale. The respondent, while conceding that depreciation for the period from January 1 to May 31, 1919, is allowable (the amount of which is to be considered hereafter), contends that no adjustment should be made in the amount allowed by him down to December 31, 1918, and used by him in determining the profit from the sale.

In support of their contention the petitioners introduced testimony and certain stipulated facts for the purpose of showing that the depreciation deductions allowed by the respondent in determining income for years prior to the sale are excessive. The respondent in certain of those years allowed the deductions claimed by the partnership and in other years allowed lesser amounts than those claimed.

Whatever the useful life of the lease equipment was, whether 5 years as used by the partnership in its returns, or 10 years as indicated by testimony, or some other period as might be indicated by the stipulation, we think a determination of the question is not to be based upon this consideration alone. The taxpayers have had the benefit of the deductions allowed by the respondent in determining taxable income for prior years. If such amount is now to be reduced, they will have the benefit of a double deduction to the extent of the reduction. In the prior years the partnership claimed greater deductions for some years than were allowed and claimed at least as much as was allowed in each year. We think that this question is governed in principle by our decision in the case of Alpin J. Cameron, 8 B.T.A. 120; affd., 56 Fed. (2d) 1021. In affirming our decision, the Circuit Court of Appeals said:

The evidence establishes that these eliminated items were not only in use in 1921, but were also giving satisfactory service in 1926. But “ the amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost.” United States v. Ludey, 274 U.S. 295, 300, 47 S.Ct. 608, 610, 71 L.Ed. 1054. Obviously, the taxpayers are not entitled to a double deduction for the same capital assets, and, if the fact is, as the Board found, that the assets have been fully depreciated, the taxpayers can no longer rightfully claim an allowance for depreciation even though such assets continue to give useful services.

While in this case there is uo question as to the assets having been fully depreciated, the fundamental principle is the same. In that case the claim was made that depreciation deductions in prior years were in error and that too much had been allowed as shown by the continued use of the assets. In our opinion a double deduction is no more warranted in this case than in the Gamer on case. This contention is therefore denied, except to the extent that it is affected by our ruling under issue (b).

No depreciation was claimed by or allowed to the partnership for the period January 1 to May 31, 1919. The respondent admits that the partnership' is entitled to depreciation for the period. In his brief, which was in reply to the brief of the petitioners, the respondent takes no exception to allowance of depreciation at the rates which the petitioners state in their brief they are willing to accept. Accordingly, we hold that for the period from January 1 to May 31, 1919, the partnership is entitled to depreciation deductions at the rate of 10 percent on lease equipment; at the rate of 18 percent on horses and wagons; at the rate of 12 percent on furniture and fixtures; at the rate of 7 percent on pipe lines; at the rate of 10 percent on pump stations; and at the rate of 10 percent on telephone lines. The amount of depreciation thus determined for the period January 1 to May 31, 1919, should also be deducted from the basis in determining the profit from the sale in the recomputations to be made under Rule 50.

(i) In computing the profit on said sale, respondent erred in eliminating from costs subsequent to March 1,1918, the sum of $716,987.03, representing capital expenditures incurred for drillingl subsequent to December 81, 1915.

In determining the cost of the partnership properties the respondent included therein a total of $704,959.26, representing expenditures made by the partnership from March 1, 1913, to December 31, 1915, for labor, fuel, repairs, etc., in connection with the exploration of the properties, drilling wells, etc., which had been capitalized by the partnership on its books. The respondent, however, did not include in the cost of the properties an amount of $669,910.48, representing expenditures made by the partnership from January 1, 1916, to December 31, 1918, for labor, fuel, repairs, etc., in connection with the exploration of the properties, drilling wells, etc., which were not capitalized by the partnership, but were deducted by it as operating expenses under the option contained in T.D. 2447 and art. 223 of Regulations 45. These expenditures were allowed by the respondent as deductions to the partnership in the determination of the tax liability of Shaffer and Smathers for the years 1916, 1917, and 1918.

Although the expenditures made between January 1, 1916, and December 31, 1918, were deducted by the partnership and allowed by the respondent as operating expenses, the petitioners now claim that they should be treated as capital expenditures and used to reduce the profit from the sale of the properties in 1919. The respondent contends that, the partnership having elected under the option given it under art. 223 of Regulations 45 to deduct such expenditures as operating expenses, the petitioners may not now have the expenditures treated as capital expenditures. The petitioners contend that the partnership originally elected to treat such expenditures as capital expenditures, as is shown by its capitalizing those made from March 1, 1913, to December 31, 1915, and that, having made that election for 1913, 1914, 1915, it was bound by it for all subsequent years under article 223 of Regulations 45.

T.D. 2447, promulgated February 8, 1917, under the Act of September 8, 1916, provided in part as follows:

Tlae incidental expenses of drilling wells, that is, such expenses as are paid for wages, fuel, repairs, etc., which do not necessarily enter into and form a part of the capital invested or property account, may, at the option of the individual or corporation owning and operating the property, be charged to property account subject to depreciation or be deducted from gross income as an operating expense.

Art. 223 of Regulations 45, issued under the Revenue Act of 1918, contains substantially the same provision as the foregoing, except that in addition thereto there is the provision that “An election once made under this option will control the taxpayer’s returns for all subsequent years.”

The validity of the above quoted provision of T.D. 2447 and the corresponding provision of art. 223 of Regulations 45, with the added provision quoted above, is no longer open to question. C. E. Wentz, Trustee, 26 B.T.A. 868; W. R. Ramsey, 26 B.T.A. 277; affd., Ramsey v. Commissioner, 66 Fed. (2d) 316; certiorari denied, 290 U.S. 673.

A careful reading of T.D. 2447 fails to disclose that, where prior to 1916 a taxpayer had capitalized the expenditures described therein, he was required to continue to do so under that decision. That decision clearly indicates the contrary by expressly providing that at the option of the taxpayer such expenditures might be charged to property account or be deducted from gross income as an operating expense. Furthermore, there is nothing in the decision which expressly limits him with respect to the method of handling-similar expenditures in future years. Under T.D. 2447 and article 223 of Regulations 45, the partnership was free, in its returns under the Act of 1916, and as amended by the Act of 1917, and under the Act of 1918, respectively, to have continued its method of capitalizing the class of expenditures here in controversy, but it saw fit to do otherwise. Having been permitted to do so and having done so, no change may now be made with respect to the option thus exercised by it. C. E. Wentz, Trustee, supra; Ramsey v. Commissioner, supra.

The stipulated facts show that from January 1 to'May 31, 1919, the partnership expended $47,076.55 for the same purposes as that for which the expenditures we have just been considering were made. It is not clear from the record to what extent, if any, this amount was allowed as a deduction in computing the earnings from the operations of the partnership. Since we have held the partnership bound for the years 1916 through 1918 by the option exercised by it, and in view of the restriction as to a change contained in art. 223 of Regulations 45, the amount of $47,076.55 may not now be treated as a capital item. To the extent that the amount has not been considered by the parties as an operating expense in computing the income from operations for the period, it should be treated as such in a recomputation of the tax liability of the petitioners.

Issue (j) is the same as issue (i), supra, except that it is restated in a different manner.

Issues (k), (1), and (m) will be considered together, as they all involve the question whether the respondent erred in including in the selling price of the assets and in the income of the partnership the amount of $1,910,442.02 representing Federal income taxes for 1919 of Shaffer and Smathers, arising from such, sale and paid by the Shaffer Oil & Refining Co. in 1920, pursuant to the purchase agreement.

In 1919 Shaffer and Smathers not only owned the assets of C. B. Shaffer No. 2, but also substantially all of the stock of the Theta Oil Co. and the Consumers Refining Co. On May 20,1919, C. B. Shaffer and H. M. Byllesby & Co. entered into a contract of sale of the assets of the partnership, C. B. Shaffer No. 2, together with the assets of the Theta Oil Co. and the Consumers Refining Co. to a company to be formed.

Under the terms of the contract, Shaffer was to cause a corporation to be formed having 500,000 authorized shares of common stock without par value and 500,000 authorized shares of preferred stock of the par value of $100 each. Under the contract there were to be conveyed to the company to be formed the oil and gas leases here in controversy, together with certain physical property used and held in the business of the partnership in the development and production of oil and gas. In consideration for the transfer of the foregoing assets, the partnership was to be paid therefor as follows: Cash, $7,000,000; notes, $1,000,000; and 44,000 shares of the preferred stock and 80,000 shares of the common stock in the company to be formed. In addition to the foregoing consideration for the transfer, the contract contained the following provision respecting the payment of taxes of the partners arising from the transaction:

The Company to be formed shall pay to the owners in C. B. Shaffer No. 2, all United States Internal Revenue Tax whatsoever that may he assessed by the Government for the calendar year 1919 arising from the profits of the sale of the G. B. Shaffer No. 2 property to the Company to be formed, and in addition, such increase of the surtax as provided in Article 13 of Regulations 45 promulgated by the Internal Revenue Department, which said owners on C. B. Shaffer No. 2 property may be assessed on an amount not to exceed Two Hundred Thousand Dollars ($200,000) for each of said owners for other income than that derived from the profits of the sale of C. B. Shaffer No. 2 property because of such sale and profits derived therefrom. It- being the intention that there shall be paid by the Company in addition to the tax upon the profits derived from such sale, only the difference between the sur-tax that would be payable by the owners on an amount of income not to exceed Two Hundred Thousand Dollars ($200,000) each, if no sale had been made or profits derived, and the increased sur-tax on said Two Hundred Thousand Dollars ($200,000) for each of said owners -resulting because of profits derived by such owners from such sale. To provide for payment of such taxes, there shall be reserved and set aside by the Company to be formed and held within its Treasury, the sum of Three Million Dollars ($3,000,000), the same and no part of which shall be used for any other purpose until such taxes have been fully paid.

Pursuant to the provisions of the contract the Shaffer Oil & Refining Co. was organized as a corporation on May 31, 1919, and on the same day the sale was consummated substantially in accordance with the terms of the contract.

As stated under issue (e), supra, the partnership in its amended return for the year 1919 reported a profit of $5,896,322.89. It arrived at that amount as follows:

Cash and notes_$8,000, 000. 00
44,000 shares preferred stock_ 4,400, 000. 00
80,000 shares of common stock_ 80,000.00
Tax of partners to be paid by vendee- 1, 910,442. 02
14,390,442.02
Less: March 1, 1913, value and subsequent cost
of property_$10, 382, 971. 34
Deduct depreciation and depletion_ 1,888, 852.21
5,896, 322.89

On May 5,1920, Shaffer filed an amended return for 1919 in which he reported $3,153,988.63 as income received from the partnership. On June 15, 1920, Smathers filed an amended return for 1919 in which he reported $3,153,988.62 as income received from the partnership. In determining the deficiencies against petitioners the respondent determined a profit of $7,917,268.14 from the sale of the' assets of the partnership to the Shaffer Oil & Refining Co., computed as follows:

Selling price:
Cash_$7, 000,000.00
Notes_ 1,000,000.00
44,000 shares of preferred stock_■ 2, 051,280. 00 — $46.62 per share
80,000 shares of common stock- None
Tax ón sale C. B. Shaffer No. 2 (paid)_ 1, 910,442. 02
Depletion sustained to Jan. 1, 1919_ 2, 312,652. 86
Depreciation sustained to Jan. 1, 1919_ 1, 567, 048. 50
Total selling price- $15, 841,423. 38
Cost:
March 1, 1913, value (Depletable)_$4,102,581.63
March 1,1913, value of equipment-,— 397,418.27
Capital additions and subsequent costs- 952, 586. 76
Equipment added subsequent to March,
1, 1913_ 2,477,888.58
- $7,924,155.24
7, 917, 268.14

In May 1920 the Shaffer Oil & Refining Co. paid to Shaffer and Smathers pursuant to the provisions of the contract of sale the amount of $1,910,442.02, which represented the aggregate amount of tax paid by them for which they were in 1920 reimbursed under the terms of the sales agreement. The respondent was advised by the individual partners prior to the issuance of the deficiency letters for 1919, and also prior ■ to the issuance of certain deficiency letters covering the years 1920 and 1921, that they had erred in reporting the $1,910,442.02 as income to the partnership and to themselves as partners in the year 1919 and they insisted that such amount be held to be income to them as individuals in 1920 and not in 1919. Neither Shaffer nor Smathers included in his original return for 1920 any part of the amount of $1,910,442.02 as income in such year, nor did either file an amended return for 1920 showing any part of such amount as income for such year.

Shaffer and Smathers each had extensive investments other than the investments in the property sold to the Shaffer Refining Co. They had large investments in other oil leases and in June 1919 a suit was pending against Shaffer in respect to a certain Fred Tucker lease, upon which a judgment was later rendered against him for $750,000. Smathers was an extensive trader on the New York Stock Exchange and during 1919 sustained a loss of $204,084 as a result of such operations. During that year his purchases and sales of stocks amounted to $10,961,847.50 and $10,747,627.08, respectively.

Shaffer and Smathers kept their books of account and filed their income tax returns on a cash receipts and disbursements basis.

Petitioners contend that the partnership also kept its books and filed its returns on the cash receipts and disbursements basis; and that the obligation of the purchasing company to pay petitioners’ taxes on the sale had no fair market value on or about May 31, 1919, the date of the sale, and was not income to petitioners until 1920. The respondent contends that the position petitioners took in their amended returns for 1919 was proper, and that they are now estopped to change their position to the detriment and loss of the Government.

We do not believe, as will immediately appear, that it is material in deciding the present issue whether the partnership’s books were kept on the cash receipts and disbursements basis or on the accrual basis. The result would be the same in either case. The test for determining profit to be applied is found in section 202 (b) of the Revenue Act of 1918, which reads in part as follows:

When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any; * * *

The sale in the instant case occurred on May 31, 1919. Of course it is plain that all the cash received was to be accounted for in 1919 as well as the notes for $1,000,000, admittedly worth their face value, and also the 44,000 shares of preferred stock to the extent of their admitted fair market value. Another part of the consideration received was the vendee’s promise to “ pay to the owners in O. B. Shaffer No. 2, all United States Internal Revenue' Tax whatsoever that may he assessed by the Government for the calendar year 1919 arising from the profits of the sale of the C. B. Shaffer No. 2 property to the Company to be formed, and in addition such increase of the surtax * * In applying section 202 (b), supra, two questions present themselves: (1) As of what date is the obligation of the purchaser to pay the taxes of the partnership owners to be valued? (2) having decided upon the date, did the obligation have a fair market value as of that date ?

Regarding the first' question, we think it is axiomatic that the date to use is the date of the sale itself. The only reason for entertaining the question at all is that it is at once apparent that on May 81, 1919, the date of the sale, it was-absolutely impossible to determine whether the partnership owners would be liable for any taxes whatever for the calendar year 1919, whereas, on December 81, 1919, the close of the taxable year, it was possible to ascertain that fact, and also the amount of the tax, if any. But for the purpose of determining gain or loss under section 202 (b), supra, we believe Congress intended that the property received in exchange should be treated as the equivalent of cash to the amount of its fair market value on the date received and not at some other date during the current taxable year. For instance, suppose a taxpayer, reporting on the calendar year basis, exchanged during February property which had cost $1,000 for other property having a fair market value on the date of exchange of $1,200. We say the taxpayer realized a gain of $200. But suppose on the following December 31 the property received in exchange only had a fair market value of $900. Would we say that in reporting for the full taxable year the taxpayer would report a loss of $100 instead of a gain of $200? We think not.

Regarding the second question, we are of the opinion that the obligation to pay petitioners’ taxes by the purchaser falls within the ambit of the language used by the Supreme Court in Burnet v. Logan, 283 U.S. 404, wherein the Court said:

The liability for income tax ultimately can ■ be fairly determined without resort to mere estimates, assumptions, and speculation. When the profit, if any, is actually realized, the taxpayer will be required to respond. The consideration for the sale was $2,200,000 in cash and the promise of future money payments wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty. The promise was in no proper sense equivalent to cash. It had no ascertainable fair market value. The transaction was not a closed one.

At the time of the receipt of the promise to pay the taxes in May 1919 it could not be determined whether any amount would ever be paid. The taxes to be paid were those on the income of the partners, including certain surtaxes for the calendar year 1919. They were extensively engaged in many enterprises, certain transactions giving rise to gains and others to losses. On the one hand, the net result of such operations might be losses, resulting therefore in no tax liability for the year, while again such operations might have resulted in such large profits as to produce a much greater tax than the amount finally paid by the vendee. In view of the highly speculative and contingent nature of the right acquired from the vendee, we do not think it can be said to have had a fair market value at the time of its receipt. Burnet v. Logan, supra. The contention of the petitioners is accordingly sustained. The taxes paid in 1920 would under the circumstances above related be an income item to petitioners in 1920. Cf. Charles Bispham Levey, 26 B.T.A. 889, affd., 68 Fed. (2d) 401; Old Colony Trust Co. v. Commissioner, 279 U.S. 716.

We fail to see any grounds for estoppel. The respondent was notified, prior to the time that the statute of limitation had run as to the year 1920, that petitioners were contending that they erred when they reported the $1,910,442.02 in question as income for 1919 and that they should have reported it as income for 1920. The respondent’s contentions on this point are denied.

. Issue (n) was waived by petitioners.

(o) Respondent made a, mathematical error in Ms computation of profit to the pwtnersMp, G. B. Shaffer No. g, on said sale of the assets in 1919.

Any mere mathematical errors in the computation of the tax may be corrected in the settlement under Eule 50.

Issue (p) was waived in a separate stipulation. Issue (q), which was the last assignment of error, was also disposed of by stipulation.

Eeviewed by the Board.

Decision will be entered under Bule SO.

Goodeich dissents.

Sternhagen, Murdock, and Adams

: As to the vendee’s obligation to pay the resulting taxes (issues k, 1, and m), while we agree with the result because petitioners’ partnership was on the cash basis, we disagree with the reasons given for the decision.

Trammell,

dissenting: I cannot agree on the question of valuation of the property as of March 1, 1913. In my opinion, the evidence clearly shows that the value shown on the return was erroneous and that the true value was at least $9,000,000. My opinion is based on having heard the testimony.


source: Caselaw Access Project

author: Abtjndell :

license: Public Domain

text:
    OREGON Terminals Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68893.
    Promulgated February 28, 1934.

      Charles E. McCulloch, Esq., and Ivan F. Phipps, Esq., for the petitioner.

      Willis R. Lansford, Esq., for the respondent.
   OPINION.

Abtjndell :

The facts developed in this case bring it within the principle of Great Northern Ry. Co., 8 B.T.A. 225, wherein we held that the taxpayer was not required to include uncollectible interest in income even though its books were kept on the accrual basis. The evidence in this case establishes to our entire satisfaction not only that the rentals were uncollectible in full within the year when due, but also that collection in the future was highly improbable and that petitioner’s officers were fully aw'are of this situation before the close of the fiscal year 1930. Following the Great Northern case, swpra, we hold that it was error to include in income any more than the amount of $39,000 actually received as rentals. See to the same effect, Turners Falls Power & Electric Co., 15 B.T.A. 983; Sowers Mfg. Co., 16 B.T.A. 268.

Decision will be entered under Rule 50.


author: Ap.undell: GoodRTch,

text:
    George H. Chisholm, Petitioner, v. Commissioner of Internal Revenue, Respondent. Harry L. Chisholm, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61664, 61665.
    Promulgated February 28, 1934.

      Joseph H. Morey, Esq., and W. W. Spalding, Esq., for the petitioners.

      Mason B. Leming, Esq., for the respondent.
   OPINION.

Ap.undell:

It is alleged in each case that the respondent erred in determining that the sale of Houde Engineering Corporation stock was made by the petitioner, when in truth and in fact the sale was made by the partnership of H. L. & Gr. H. Chisholm, and the purchase price was received by the partnership.

There is no question but that the sale of the stock was, in form, a sale by the partnership. On the date that the stock was transferred to the purchaser the certificate for the 600 shares was in the name of the partnership, the certificate was endorsed over to the purchaser by the partnership, and the check for the sale price was made payable to and was received by the partnership. If we went no further into the matter than this and gave consideration only to the form of the transaction, we would be obliged to say that there was a sale by the partnership and the gain or loss thereon was that of the partnership. The Commissioner, upon consideration of the facts, concluded that the sale was made by the petitioners, individually, and not by the partnership, and determined that the difference between cost to the individual petitioners and the sale price was income to them. The difference between cost to the individuals and the selling price is much greater than the difference between value of the stock when the partnership was formed and the selling price; hence, the income on the basis of a sale by the individuals is a higher amount than on a sale by the partnership. See Edward B. Archbald, 27 B.T.A. 837. Our task is to decide whether the Commissioner erred in his determination. In so doing it is obvious that we are not required to stop short with the surface indications of the case, but it is our right and duty to examine all the surrounding circumstances to find the substance of the matter, for, as has often been said, it is substance and not form that controls in the application of tax laws. United States v. Phellis, 257 U.S. 156. We should especially not be blinded by form and lose sight of the substance where, as here, the cloak of formality is donned for the express purpose of tax avoidance. The avoidance or reduction of taxes effected through legal means is not prohibited, United States v. Isham, 17 Wall. 496, and if the method used, whether a partnership or some other device, is a bona fide transaction occurring in the ordinary course of business and reflects the real rights of the parties, the tax must be levied accordingly.

The question that arises here is not whether legal means were used to avoid tax; it is whether, at bottom, the intent of the petitioners was to make a bona fide transfer to a new entity so that it in truth and in fact was the owner of the property and entitled to enjoy the income from the sale as its own, or whether this entity of their creation was merely a conduit used for the purpose of passing title and receiving the proceeds of the sale for the petitioners as beneficial owners.

The events with which we are concerned, all occurring in 1928, were as follows in chronological order:

September 26 — Execution and delivery of tbirty-day option.
October 11 — Notice from optionee of election to exercise option.
October 20 — Stock endorsed over to partnership; formal assignment of stock and interest in “ option contract ” to partnership; partnership agreement signed.
October 22 — Execution of partnership agreement acknowledged before notary public; notice to optionee and prospective purchaser of assignment to partnership; certificate for 600 shares of stock issued to partnership; certificate for 600 shares assigned, by endorsement by partnership, to purchaser and delivered to bank in escrow.
October 23 — Receipt of earnings statement of Houde Corporation for period September 1-October 11.
October 24 — Check for $1,004,849.04 issued to partnership by purchaser of the stock; receipt for that sum executed by partnership.
October 25 — New stock certificate issued to purchaser.

It is claimed by petitioners that the letter of October 11 from the optionee was not an effective exercise of the option, because the option called for “ payment of cash ” and the' cash was not produced and tendered with the letter. There are numerous cases to the effect that an option must be exercised in strict accordance with its terms. See Crancer v. Lareau, 1 Fed. (2d) 117, and cases there cited. However, we do not understand this to be decisive of the questions here mentioned. Most of the cases cited to us deal with questions of specific performance and there is no such issue here. It is not claimed that the option given by petitioners and others was allowed to lapse and no performance had under it. In Lucas v. North Texas Lumber Co., 281 U.S. 11 (affirming 7 B.T.A. 1193), the option specified a cash consideration for timber lands and timber rights and within the period of the option the optionee gave notice that it would exercise the option and would pay over the money “ as soon as the papers were prepared.” The Supreme Court said that “An executory contract of sale was created by the option and notice * * And so, even though there was no sale of the stock at October 11, when the stock was still in the name of petitioners, the acceptance of that date together with the option did constitute an “ executory contract of sale.” This com tract, through the subsequent acts of the interested parties, include ing petitioner’s assignee, which they completely controlled at all times, within a few days was converted into an executed contract o.f sale. The assignee partnership, which it must be remembered consisted only of the two petitioners and so was dominated by them, entered into no new contract for the sale of the stock, but merely at the direction of the petitioners carried out their prior engagement. There is testimony that petitioners had for several months considered the advisability of forming a partnership, but it is admitted that the imminence of the sale of the Houde stock was the immediate occasion for its formation, and that it probably would not have been formed when it was except for the prospective tax liability. Their obvious purpose was to escape the tax on the profit from the sale. In these circumstances a proper regard for the substance of the transaction impels the conclusion that the partnership was acting on behalf of the individuals in taking title to and selling the stock. Under somewhat similar facts, but where the control over the recipient of proceeds was more remote than that of partners over partnership income, it has been held that recipient was nothing more than an agent, or conduit for passing title and receiving the money, for the real party in interest. In J. L. McInerney, 29 B.T.A. 1, the petitioner had made an oral agreement to sell certain properties, both real and personal. Shortly thereafter his attorney caused to be organized a corporation which was controlled by the attorney. Petitioner then executed a bill of sale for one half the personalty to his wife and through an intermediary had the realty deeded to himself and his wife. He and his wife then offered to sell the entire property to the newly organized corporation, controlled by petitioner’s attorney, which offer was accepted and the new corporation then sold the property to the purchaser with whom petitioner had made the oral agreement to sell. The new corporation received the proceeds of the sale and paid a portion thereof to petitioner. We held that all of the profit on the sale was taxable to the petitioner. As to the corporation organized and controlled by petitioner’s attorney, we said that it “ was created for the sole purpose of passing title in the properties * * * and passing payment therefor to petitioner. * * * As a conduit, it received * * * the purchase money due petitioner.” Respecting the bill of sale and deed to petitioner’s wife just prior to the sale, we pointed out that when these were given all arrangements .for the sale had been made; it remained only to pass title and receive the consideration, and the sale was carried out as arranged. We concluded that:

The transfers were a subterfuge, effected upon the eve of the consummation of the sale in the hope that it would serve to avoid a part of the tax to be imposed upon the profit derived therefrom. We conclude that the real owner and vendor of the properties was petitioner, and that the entire profit is taxable to him.

In Nace Realty Co., 28 B.T.A. 467, the petitioner corporation owned a leasehold which it contracted to sell, the purchase price to be paid upon delivery of a proper deed. The petitioner then assigned the leasehold to its two stockholders, who a few days later assigned it to the purchaser and received the purchase price. We held the entire profit to be taxable to the corporation, saying that “A reasonable view of the substance of the transaction demands that we regard the individuals as acting on behalf of the corporation in taking title to and disposing of the lease.”

In S. A. MacQueen Co., 26 B.T.A. 1337; affd., 67 Fed. (2d) 857, a corporation, on February 1, 1927, agreed to sell its property to its principal stockholder, MacQueen, for $85,000. The next day MacQueen agreed to sell the property to one Hatfield for $150,000. The transfers from the corporation to MacQueen and from him to Hatfield tóok place on March 1, 1927. On February 11, 1927, MacQueen executed an instrument wherein he declared that the profit on the transaction was to be received by him in trust for the stockholders of the MacQueen corporation. The Commissioner added the $65,000 profit to the income of the corporation, and we sustained his action on the theory that the transfer to MacQueen was merely one in trust. Our decision was affirmed on appeal, the Circuit Court saying:

Although, in form there were two sales of the corporation real estate, first the purported sale by the petitioner to MacQueen, aud, second, the sale by MacQueen to Hatfield, in substance the transaction was a sale by the petitioner to Hatfield through the agency of MacQueen. So also, although in form MacQueen was a trustee for the distribution of the profits earned by the sale of his own real estate to Hatfield, in substance he was the agent of the petitioner for the distribution of the profits from the sale of the corporation’s real estate among its stockholders.
The corporate tax rate imposed by the applicable taxing statutes is higher than the individual rate. The obvious purpose of the procedure followed by the petitioner, its directors, and stockholders, was to take advantage of the lower tax rate permitted individuals and thereby avoid the corporate tax rate on the profits of the ultimate sale of the real estate. Such anticipatory arrangements and contract, intended to circumvent the taxing statutes, are not looked upon with favor. Lucas v. Earl, 281 U. S. 111. Phelps v. Commissioner, 54 Fed. (2d) 289, certiorari denied, 285 U. S. 558.

The principle of the above cases we think should control those before us here. The evidence is that petitioners had offered to sell their property, that they were in receipt of a written acceptance, and that -they caused their part of the bargain to be carried out through a partnership of which they were the only members. The intervention of the partnership was nothing more than an anticipatory arrangement “ intended to circumvent the tax statutes.” The partnership was not a bona fide owner of property acquired in the ordinary course of business. The petitioners were the real owners and vendors of the stock, using the partnership as an instrumentality for passing title and receiving the proceeds for them.

Our conclusion is in harmony with decisions of the Supreme Court, which have refused to give effect to transfers not in the ordinary course of business but resorted to solely for the purpose of escaping tax. Some devices for reduction or avoidance of taxes are, in the language of Mr. Justice Holmes in Bullen v. Wisconsin, 240 U.S. 625, on the “ safe side ”, while others fall on the “ wrong side of the line indicated by the policy if not by the mere letter of the law.” In judging upon which side of the line a given act falls, a distinction may well be taken according to whether it is within the scope of the normal operating methods of the taxpayer with no more than a change in form so as to minimize future taxes, or whether the procedure adopted represents a radical departure from normal methods for the sole purpose of escaping taxes on transactions already carried so close to consummation that the shadow of taxation hovers over them. Such is the trend of the court decisions as we read them. Typical of the one class of cases is United States v. Isham, supra, where a corporation in the normal course of its business operations issued drafts drawn in such form as to fall outside the scope of the language of the statute designating certain kinds of drafts as subject to a stamp tax. That course of conduct, the Court said, was open to no legal censure. The decision there was put upon two grounds. First, that the drafts so drawn did not come within the several classes of instruments described in the statute as subject to tax. This follows the rule that the taxing statutes are construed most strongly against the Government. Second, that a holding which would bring such instruments within the scope of the statute, when on their face they were outside the list of taxed papers, would require an investigation into every paper presented in the form of nontaxable drafts or checks to see whether it was subject to tax, and that this “ would produce difficulties and inconveniences vastly more injurious than that complained of. Such a rule would destroy the circulating capacity of bills, or drafts or orders. * * ⅝ That the rule contended for is impracticable in a commercial country is too obvious to require further illustration.” Considering the decision of the Court in the light of the facts in that case, we think it cannot with any show of reason be said to give unqualified approval to all cases of tax avoidance through means of legal forms. On the contrary, the reports contain numerous instances of transactions on the “ wrong side of the line ”, which have been condemned as evasions although carried out through legal forms. Notable cases are those where persons normally carrying substantial bank balances converted their deposits into United States notes shortly prior to the date for assessment of personal property under state taxing statutes, solely for the purpose of escaping taxation. In one such case, Mitchell v. Commissioner, 91 U.S. 206, the taxpayer filed a bill in equity to restrain collection of the tax asserted against the amount of his bank balance so converted. The Supreme Court, sustaining a dismissal of the bill by the state court, said that “ 4 court of equity will not knowingly use its extraordinary powers to permit any such scheme as this plaintiff devised to escape his proportionate share of the burden of taxation. His remedy, if he has any, is in a court of law.” Later another such case, Shotwell v. Moore, 129 U.S. 590, reached the Supreme Court through the law courts, and the conduct of the taxpayer was there condemned as severely as in the equity case. While the decision of the Court, in holding the device ineffectual, was based on the ground that the state statute was valid, it is significant that a large part of the opinion is devoted to numerous authorities to the effect that, since the transaction of conversion of the bank deposit into greenbacks was transitory and not in the ordinary course of business, it was an indefensible evasion of the revenue laws of the state. In the course of the opinion the Court concedes the proposition advanced that the state tax laws could not reach the United States “ greenbacks ” owned by the taxpayer on the day of assessment, but adds this important qualification: “if'- the thing done had been done in the ordinary course of business, and the conversion of his general deposit in the bank into a private package of greenbacks, exempt from taxation, were free from illegal purpose or fraudulent motive.” (Italics ours.) To the claim that a property owner in such cases might have relief in a court of law as distinguished from a court of equity, the Supreme Court, after citing several cases, including the Mitchell case, supra, answered:

All these decisions show that the courts look upon this transaction as indefensible, and consider it an improper evasion of the duty of the citizen to pay his share of the taxes necessary to support the government which is justly due on his property.

From the above cases we think it may be taken as the announced policy of the courts, both in cases at law and in equity, that they will not countenance a scheme to escape taxes which involves an abrupt departure from normal procedure, devised and adopted with reference to a transaction upon which the imposition of tax is imminent, and solely for the purpose of avoiding liability.

Such is the case here. The petitioners owned property which had cost them $16,000 and which they were about to sell for more than $1,000,000. They had been notified that the deal would be consummated and they were dealing with men who they believed were financially responsible. The tax on this transaction, if consummated, would be high. So in order to escape their just share of tax to which their profit would be subject, upon advice of their attorney, they transferred the property to an entity created and controlled by themselves from which at any time they could take the entire proceeds of the sale.

The transitory holding of title by the partnership under these circumstances may' not be regarded as a matter of substance which changed the substantive rights or tax liability of the real owners and vendors of the property, and the plan resorted to should not be , permitted to alter the tax liability of petitioners upon income from the sale of their property.

Our holding herein is not contrary to cases cited by petitioners. See Charles W. Walworth, 6 B.T.A. 788; J. V. Leydig, 15 B.T.A. 124; affd., 43 Fed. (2d) 494; Leonard Marshall Wright, 26 B.T.A. 21. The evidence in those cases satisfied us of bona fide transfers pursuant to prior agreements, and it did not appear that the income from the property transferred was subject to the control of the trans-feror to the extent that it was here by reason of petitioners comprising the entire partnership.

-We accordingly affirm the action of the respondent in treating as income to petitioners the difference between cost to them of their stock and the price paid by Cooley, the purchaser.

Reviewed by the Board.

Decision in each case will be entered for the respondent.

GoodRTch,

dissenting: I disagree with the majority opinion in lajdng as a test for successful tax avoidance the adherence by the taxpayer to the so-called normal procedure in the conduct of his affairs. In the first place, from the number of controversies involving avoidance attempts, it might well be argued that the normal procedure of most taxpayers in the conduct of their affairs includes any acts necessary to carry out a determination to pay taxes in such amounts as the law demands, and no more — a fact of which the majority opinion takes no cognizance.

Next, I do not understand that a taxpayer must sit by idly twirling his thumbs until a tax liability alights upon him. If he is warned of its approach, if he sees it coming, he may seek such shelter as the law offers in an effort to escape it or diminish its blow. Of course, by examination, it must be determined whether the shelter he reaches is really constructed of statutory material, and by close scrutiny of the facts it must be determined whether the taxpayer really got himself and- his transactions within it. But he should not be counted out merely because the shelter lies off his beaten path and he scurries for it.

The suggestion of the majority that every taxpayer must needs plod along the path laid by the past requirements of his business, meeting and paying any and all tax liabilities encountered, is highly Utopian — at least from the governmental viewpoint — and offers an ethical canon, interesting but quite beyond the necessities of decision in the instant controversy. Apparently it does not recognize that high taxes, like high water, may make an old path unusable, nor that on occasion a new path may be charted during the survey preliminary to entering upon a transaction in order to reckon with the tax demands certain to come. To say that the old path must be blindly followed, that bypaths or new paths may not be laid out by proper strides within legal bounds, goes too far.


author: James:

text:
    Appeal of MATHER PAPER CO.
    Docket No. 1378.
    Submitted April 30, 1925.
    Decided November 12, 1925.
    The taxpayer was one of a group of corporations which filed a consolidated return for the year 1920. Theretofore, Commissioner Williams had held the taxpayer to be affiliated with other corporations for the year 1919, and the conditions respecting affiliation were identical as to the year 1920. The taxpayer advanced the funds with which to pay its share of the tax, which amount was more than its pro rata share of the consolidated tax. The parent corporation thereafter became insolvent. Commissioner Blair, thereafter, determined correctly that the taxpayer was not affiliated with the parent corporation in the year 1920. Held, that the determination by Commissioner Blair was not an overruling of Commissioner Williams with respect to the year 1920. Held, further, that in the computation of the deficiency against the taxpayer, credit should be given for the pro rata portion of the tax paid by the parent corporation theretofore advanced by the taxpayer.

      Joseph M. Dohan, Esq., for the taxpayer.

      Percy 8. Or ewe, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1920 in the amount of $20,-231.05.
    FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation organized in 1917 under the name of Shuttleworth, Hogg & Mather, Inc., and, after its incorporation, including the year in question, was engaged in business in Philadelphia as a wholesale and retail dealer in paper and paper bags.
    Shuttleworth, Keiller & Co., hereinafter referred to as the Shuttle-worth Co., was, during the taxable year in question, a New York corporation engaged in business in New York City as a wholesale and retail dealer in paper and paper bags and as a jobber distributing paper products to other dealers in the same business. That company, through its stockholders, controlled a majority of the stock of a number of other corporations, including the taxpayer, engaged in the same line of business in various cities, operated the' group of corporations substantially as one unit and, through the medium of said corporations, effected a large sale or distribution of' its merchandise.
    On the organization of the taxpayer, its stock, consisting of 1,400' shares, was subscribed to in the amount of 50.14 per cent by the Shuttleworth Co., and distributed among its stockholders. The-remaining 49.86 per cent was acquired by H. J. Hogg, Charles W. Mather, James J. Gallen,, and William S. Graham, in the amounts,, respectively, of 279 shares each by Hogg and Mather, 100 shares by Gallen, and 40 shares by Graham. During the year 1920, Hogg-sold 128 shares of his stock to the stockholders of the Shuttleworth. Co., increasing its percentage of control, some time during that year, to 59.28 per cent.
    Under an agreement dated January 17, 1919, in order to assure-uniformity of control by the Shuttleworth Co. and to prevent the sale of the stock of the associated companies, except with the-knowledge and consent of the Shuttleworth Co., the stockholders off that company transferred to it, as trustee for the respective depositors, all of the shares in the associated companies, including Shuttle-worth, Hogg & Mather, Inc., except 28 shares in the last-named company. This agreement, after reciting that, by virtue of the stock controlled by the Shuttleworth Co., all of the associated companies were managed and directed as to their policies and methods-of operation to the advantage of the depositing stockholders and that the depositors desired to prevent division of their holdings, and to assure a permanent policy in the management, provided that-the Shuttleworth Co. should have the exclusive right to vote all the deposited shares and to control, in so far as that was possible-through the control of the majority of the stock, all of the business-activities of the said associated companies. This agreement remained in effect throughout the taxable year here in question. To. the 674 shares of the taxpayer originally deposited under this agreement were added 80 shares of the 128 shares disposed of by Hogg-in that year. The remaining 48 shares were held by stockholders: of the Shuttleworth Co. without deposit. The 28 shares not originally deposited were owned and held by one Tompkins at the time-of the execution of the agreement and, upon his death, were acquired by other stockholders, who deposited them imder the terms-of the agreement.
    During the year 1920, four of the seven directors of the taxpayer were selected by the Shuttleworth Co., Mather, Hogg, and Gallen, comprising the other three directors. During that year Shuttle-worth was president, Mather vice president, and Gallen and Graham, secretary and treasurer, respectively.

      From and after its organization the taxpayer made total purchases on account of its business and purchases from the Shuttle-worth Co. as set forth below:

    In general, the method of doing business between the taxpayer and the Shuttleworth Co. was as follows: The Shuttleworth Co. acted as agent of the Union Paper Bag Co., purchased from them and sold to the taxpayer. In so far as requirements could be supplied by the Shuttleworth Co., the taxpayer made all purchases from that source, and fully advised the Shuttleworth Co. of any purchases made elsewhere.
    Prior to the taxable year in question the taxpayer made separate ■and independent income and profits-tax returns to the collector of internal revenue at Philadelphia. On November 1, 1920, and after the Shuttleworth Co. had furnished to the Commissioner certain information in respect of its activities, the Commissioner sent to the Shuttleworth Co. a communication reading in full as follows:
    Treasury Deparment, Washington, November 1, 1920.

    ■Office of Commissioner of Internal Revenue,
    IT: SA: CR: Af.
    AILS.
    Shuttleworth Keiller & Co.,

      JfUf West Broadxmy, New York, N. Y.

    Sirs : Reference is made to the Affiliated Corporations Questionnaire filed by you tor each oí the taxable years 1917, 1918 and 1919.
    From the facts presented, you are informed that, for the taxable years 1917 and 1918, the companies listed below were affiliated within the purview of Article's 77 and 78 of Regulations 41, Treasury Decision 2662, and Section 240 of the Revenue Act of 1918. For the purpose of consolidation the companies should be divided into.two groups. A consolidated excess profits tax return for 1917 and a consolidated income and profits tax return for 1918 should be filed for each group:
    Group I.
    Shuttleworth, Keiller and Co. (Parent.) W. E. Shuttleworth and Co.
    •Congress Warehouse and Forwarding Co.
    Group II.
    ■Gallen Paper Company.
    ■Shuttleworth Hogg and Mather, Inc,

      For the taxable year 1919 the companies listed below were affiliated within, the provisions of Section 240 of the Revenue Act of 1918. Therefore, a consolidated income and profits tax return should be filed for these companies-if such action has not been taken:
    Shuttleworth, Keiller and Co. (Parent.)
    W. ID. Shuttleworth and Co.
    Congress Warehouse and Forwarding Co.
    Gallen Paper Co.
    Shuttleworth Holly Co.
    Shuttleworth, Hogg and Mather, Inc.
    Shuttleworth Dumouchel Co.
    Shuttleworth Wollny Co., Inc.
    George A. Fink Co.
    The companies listed below were not affiliated within the purview of the-law and regulations hereinbefore referred to and each company should, therefore, file a separate return for each of the taxable years indicated, where such action has not already been taken, and provided they were not affiliated with any other companies not herein considered:
    Doscher-Tetamore Co., Inc., 1917, 1918 and 1919.
    Shuttleworth Holly Co., 1917 and 1918.
    Shuttleworth Dumouchel Co., 1917 and 1918.
    Shuttleworth Wollny Co., Inc., 1918. «
    Kolb Carton Co., 1919.
    Berlin Veneer Works, Inc., 1917, 1918 and 1919.
    Wm. Spreen and Co., Inc., 1917, 1918 and 1919.
    The consolidated excess profits tax returns for the taxable year 1917 should be forwarded direct to this office within thirty days from the date of this letter.
    A copy of this letter should be attached to each return when filed.
    In your reply, refer to IT: SA: CR: Af-MLS.
    Respectfully, (Signed) G. V. Newton,

      Deputy Commissioner.

    During the year 1920 the stockholders and the respective percentages of stock held by them in the Shuttleworth Co. and the taxpayer were as follows:

      For the taxable year 1920 tlie taxpayer filed a return on Form 1122, notifying the collector at Philadelphia of the filing of a consolidated return with the Shuttleworth Co. with the collector at New York, and the Shuttleworth Co. duly filed the consolidated return above mentioned. Form 1120, as issued by the Commissioner for the use of corporation taxpayers for the year 1920, instructed corporations required to file consolidated returns as follows:
    That the parent company should file the consolidated return in the office of the collector at the place where its principal office was located and that the subsidiaries should file Form 1122 in the offices of the collectors of their respective districts.
    That if the stock ownership was between 95 per cent and 50 per cent, the parent company must furnish the information called for in the return by questions 11 to 14, page 3.
    That the department preferred that the total tax assessed against the affiliated companies be allocated to and paid by the parent company to the collector of its district.
    The information return of subsidiary or affiliated corporation, Form 1122, contained the following instruction:
    The department prefers that the entire tax shown on a consolidated return be paid by the parent or principal reporting corporation instead of being apportioned among the corporations composing the affiliated group.
    The official Form No. 1120, filed for the year 1920 by the Shuttle-worth Co. as its consolidated return (including taxpayer), directed the corporation to state whether it owned or controlled over 50 per cent of the stock of another corporation, and, if so, to state whether the corporation had filed an affiliated corporations questionnaire for 1917 or subsequent taxable years, and stated that, if such a questionnaire had been filed, a further questionnaire need not be filed; it further required the parent company to state whether substantially the same conditions as set forth in such prior questionnaire obtained during the taxable year 1920.
    The Shuttleworth Co. answered all questions in the affirmative and filed no further questionnaires for the year 1920.
    The Shuttleworth Co., prior to the filing of the consolidated return as above set forth, notified each of the companies proposed to be included therein that a consolidated return was required and requested each of them to send statements to it, together with their checks for the amount of tax shown to be due upon a separate computation of their tax liability. The Congress Warehouse & Forwarding Co.; George A. Finir Co.; Shuttleworth, Holly Co.; W. E. Shuttleworth & Co.; Shuttleworth, Dumouchel Co.; Shuttleworth Wollny Co.; Gallen Paper Co.; and Shuttleworth, Hogg & Mather, Inc., forwarded such statements, together with remittances of the amounts of tax computed upon their several statements as set forth in the following table:
    Amount
    Congress Warehouse & Forwarding Co_$20,229.20
    George A. Fink Co_ 1, 466.01
    Shuttleworth, Holly Co_ 3, 048. 93
    W. E. Shuttleworth & Co_ 274. 50
    Shuttleworth, Dumouchel Co-
    Shuttleworth, Wollny Co- 2,115.11
    Gallen Paper Co_ 565.00
    Shuttleworth, Hogg & Mather, Inc^_ 20,272. 96
    By reason of losses incurred by the Shuttleworth Co. in the calendar year 1920, the amount of income and profits tax due by it a the companies consolidated with it on the above-mentioned return was $27,135.52, which said company duly paid to the collector for the second district of New York.
    Thereafter, and on July 24, 1922, the Shuttleworth Co. was adjudicated a bankrupt, and on August 11, 1922, subject to the approval of the court, which was given on or about October 18, 1922, all of the remaining assets of the said bankrupt were sold to W. E. Shuttleworth, the president of the Shuttleworth Co., and the said sale included “ Claims against the United States of America and the State of New York for refund of taxes improperly paid.”
    Thereafter, and on May 23, 1923, the Commissioner addressed a communication to the Shuttleworth Co. reading as follows:
    IT : SA: OR: E.
    CEL-Af.
    Mat 23, 1923.
    Shuttleworth, Ketller and Company,

      220 West Broadway, New YorJe, N. Y.

    Sirs : Reference is made to an executed Affiliated Corporations Questionnaire for tlie taxable year 1919 filed by your corporation, and to other data appearing in the case.
    After a reconsideration of all tbe facts in the case, you are advised that during the taxable year 1919 the companies as grouped below were affiliated within the purview of Section 240 of the Revenue Act of 1918.
    Group I.
    Shuttleworth, Keiller and Company.
    W. B. Shuttleworth and Company.
    Congress Warehouse and Forwarding Corporation.
    Group II.
    Gallen Paper Company.
    Shuttleworth, Hogg and Mather, Incorporated.
    A consolidated income and profits tax return should have been filed by each group of companies indicated for that year. In the event that such consolidated returns should be needed in auditing the case, you will be notified by this office.

      You are further advised that during the taxable year 1919, the companies listed below were not affiliated with each other or with any other company named herein, within the purview of the authority cited.
    Shuttleworth, Holly Company.
    Shuttleworth, Dumouchel Company.
    Shuttleworth, Wollny Company, Incorporated.
    George A. Pink Company.
    Kolb Carton Company.
    Berlin Veneer Works, Incorporated.
    Wm. Spreen and Company, Incorporated.
    Each company, therefore, should file a separate income and profits tax return for that year, provided that such action has not been taken.
    The ruling outlined herein supersedes that contained in office letter dated November 1, 1920, relative to the affiliation of the companies named herein during the taxable year 1919.
    If not in agreement with this ruling, you are granted thirty days from the date of this letter within which to submit an answer setting forth your exceptions.
    In the event of further correspondence, reference should be made to IT: SA: OR: E — CEL: Af.
    Respectfully, E. W- Chatterton,

      Deputy Commissioner.

    (Signed) By Wm. P.Bisd,

      Chief of Subdivision.

    Thereafter, and on November 21, 1923, the Commissioner addressed a communication to the taxpayer asserting a tax against it and the Gallen Paper Co. for the year 1920 as affiliated companies in the amounts, respectively, of $20,231.05 and $1,894.62, of which the deficiency here in question is a part, and in the computation of that deficiency gave no credit whatever for the payments, or any part thereof, theretofore made by the taxpayer and the Gallen Paper Co. to the Shuttleworth Co. and by it paid in part to the collector of the second district of New York as tax due upon the consolidated return.
    The Commissioner in office on the date of the affiliation ruling of November 1, 1920, was William M. Williams.
    The Commissioner in office on the date of the ruling of May 23,. 1923, rescinding the affiliation ruling of November 1, 1920, was David H. Blair.
    All of the facts above set forth in respect of affiliation were before Commissioner William M. Williams at the time of* the ruling of November 1, 1920, as fully as they were in possession of Commissioner David H. Blair at the time of the rescinding ruling of May 23, 1923.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days’ notice, under Bule 50.
   OPINION.

James:

The first question to be determined in this appeal is whether the taxpayer was properly affiliated with the Shuttleworth 'Co. for the year 1920. If this point should be decided in favor of the taxpayer, it becomes unnecessary to consider whether the Commissioner in 1923, David H. Blair, could ride differently with respect to affiliation for the year 1920 from the ruling of his predecessor for the year 1919.

It appears from the evidence that the taxpayer was in many respects operating under the direction of the Shuttleworth Co. during 1920; that its officers were in the main selected from that company, and that a majority of its stock was controlled through a voting trust agreement by that company. But it-is apparent that independent stockholders of the taxpayer owned and controlled at the beginning of the year 49.9 per cent of its stock and at the end of the year 39.9 per cent, and neither they nor their stock were in any respect under the control of the Shuttleworth Co. We can not hold that 60.1 per cent of the stock of a corporation constitutes substantially all of that stock for purposes of control in the absence of evidence of- other factors indicating a control over at least a very considerable portion of the balance of the stock. On the merits, therefore, we are of the •opinion that Commissioner Blair was correct in determining that the taxpayer and the Shuttleworth Co. were not affiliated during the .year 1920.

We are next to inquire whether Commissioner Blair could lawfully rule in respect of affiliation for the year 1920 in a manner different from the ruling of Commissioner Williams for the year 1919.

This question also divides itself into two parts: (1) Whether the letter of November 1, 1920, which Commissioner Williams sent to ■the Shuttleworth Co., was, in the light of that letter and the regulations and instructions of the Commissioner, a ruling of affiliation as to the year 1920; and (2) if it was such a ruling, whether Commissioner Blair had authority to reverse it ?

Upon the first of the foregoing points we are of the opinion that the ruling contained in the letter of November 1, 1920, was not a ruling in respect of affiliation for that year, but related solely to the years 1917, 19Í8, and 1919. It so states, and nowhere in its contents can be found any statement with respect to the year 1920. But the taxpayer contends that the instructions of the Commissioner in respect of the filing of affiliated corporations questionnaires and the instructions contained upon the forms provided for income-tax returns indicated that a ruling once made on a question of affiliation continued until reversed, and was, in fact, a ruling for all years until •official notice of the reversal was sent by the Commissioner. With this position we are unable to agree. It is true that the Commissioner, upon the forms provided for returns, asked questions relating to prior filings of consolidated returns, and, if the conditions were unchanged in respect of stockholdings and in other particulars, excused the filing of further information, which, in the nature of things, would consist merely of the filing of cumulative evidence, hut this falls far short of holding out the promise or representation that a taxpayer once held affiliated for one year would be held affiliated for all succeeding years, and there is nothing in the instructions or directions upon the returns or elsewhere which contains any such implication. At the most, taxpayers were instructed that, if previous returns had been made in a certain manner, successive returns would continue to be so made until or unless a change was directed. No doubt this resulted, in the taxpayer’s case, in contributing to placing it in the unfortunate position in which it finds itself under the present circumstances, but that unfortunate position is no excuse for the misinterpretation of the instructions of the Commissioner or for placing upon those instructions any unwarranted construction.

It being our view that Commissioner Williams made no ruling as to the year 1920, it is unnecessary for us to consider whether, had he done so, Commissioner Blair could have reversed such a ruling.

This brings us to the consideration of the effect of the payments made by the taxpayer to the Shuttleworth Co. and by it to the collector.

It appears from the letter of May 23, 1923, that the Commissioner determined as to the year 1920 two groups of affiliation. In Group I is included the Shuttleworth Co., W- E. Shuttleworth & Co., and Congress Warehouse & Forwarding Co. The Shuttleworth Co. contributed nothing toward the payment of the tax upon its consolidated return for the year 1920. The entire tax was paid by the several associated companies. Of the companies in Group I, W. E. Shuttleworth & Co. contributed $274.50, and the Congress Warehouse & Forwarding Co. $20,229.20, a total of $20,503.70. Of the companies in Group II, Gallen Paper Co. and Shuttleworth, Hogg & Mather, Inc., contributed $565 and $20,272.96, respectively, a total in that group of $20,837.96; and the other companies, George A. Fink Co., Shuttleworth, Holly Co., and Shuttleworth, Wollny Co., contributed $1,466.01, $3,048.93, and $2,115.11, a total of .$6,650.05. The total contributed by all companies was $47,971.71. From these contributions the Shuttleworth Co., for and on behalf of all the corporations of the affiliated group, paid thé tax of $27,135.52 shown on the consolidated return.

The Commissioner apparently proposes to credit this amount of $27,135.52 to Group I alone, leaving the companies in Group II, and those not affiliated at all, to pay their taxes anew. By implication it would appear that the companies in Group I, since the loss of the Shuttleworth Co. will be offset against a smaller balance of profits, must show taxes upon their consolidated return of much less than $27,135.52, and that the Commissioner will credit or refund the entire amount of such overplus either to Group I, to the Shuttle-worth Co. itself, or to W. E. Shuttleworth & Co. For such a procedure we find no warrant in the Revenue Act of 1924, and for such an allocation of credit for taxes paid none in the Revenue Act of 1918.

■ Section 240 (a) of the Revenue Act of 1918 provides, in part, as. follows :

In any case in which a tax is assessed upon the basis of a consolidated' return, the total tax shall be computed in the first instance as a unit and shall then he assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of any such agreement, then on the basis of the net income properly assignable to each.

There is nothing in the evidence before us which indicates that the taxpayer corporations participating in the consolidated return for the year 1920 ever agreed to the assumption of the tax by the Shut-tleworth Co. On the contrary, it is clearly in evidence that that tax was paid through the Shuttleworth Co. and that the subsidiaries furnished the funds from which payment was made. The Commissioner was never advised of any agreement among the companies that he should look to the Shuttleworth Co. solely for the amount of tax and, in the absence of any such agreement, it was his duty to assess the tax among the companies in the proportion shown on the consolidated return of their respective net incomes to the total net income thereon, ignoring, for that purpose, minus quantities. This, apparently, he did not do, but instead he assessed the entire-tax to the Shuttleworth Co., a mere ministerial error on the part of the collector, subject to correction at any time. In our opinion the assessment against the several companies should be corrected to conform to the above-quoted provision of section 240 (a).

Under the provisions of section 273 of the Revenue Act of 1924 it is the duty of the Commissioner to determine the deficiency upon the basis of the correct amount of tax, less the amount of tax shown by the taxpayer upon his return, with other adjustments not here in issue. Upon its return, this taxpayer, through the medium of the-. Shuttleworth Co., indicated an amount of tax shown to be due in the proportion of the net income returned by this taxpayer in the-consolidated return to the total net income, exclusive of minus-quantities. This amount the Commissioner has not credited in connection with the computation of the deficiency here in question It should be credited in the determination of this deficiency. The return of the taxpayer filed as a part of the above consolidate.! return is in evidence and the proper computation can. be made therefrom. The deficiency determined by the Commissioner will be •corrected in the manner above set forth, and, as so corrected, will be settled as set forth in the decision.


author: Smith:

text:
    Appeal of W. A. BELLINGRATH.
    Docket No. 2018.
    Submitted April 20, 1925.
    Decided November 12, 1925.
    The taxpayer and wife entered into a partnership agreement on or about December 31, 1919, by wbicb enterprises theretofore conducted by the taxpayer alone would thereafter be conducted as a partnership. Held, that a valid partnership existed between the taxpayer and wife for the calendar year 1920.

      William M. Williams, Esq., for the taxpayer.

      B. G. Simpich, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1920 in the amount of $11,584.70. The ■question in issue is whether a valid partnership existed between the taxpayer and wife, as claimed.
    FINDINGS OF FACT,
    1. The taxpayer is an individual residing at Cloverdale, Montgomery, Ala., and has been engaged in the business of bottling Coca Cola since 1903.
    2. Prior to December 31, 1919, he was the sole owner of the business conducted by him as an individual under the name of Coca Cola Bottling Co. of Montgomery, Ala., and under the name of Coca Cola Bottling Co. of Tuscaloosa, Ala., and was the sole owner of the assets employed in the conduct of said businesses. Prior to this time he also was a member of three partnerships, namely, Coca Cola Bottling Co. of Dothan, Ala., in which he owned a three-fourths interest; Coca Cola Bottling Co. of Selma, Ala.; and Coca Cola Bottling Co. of Andalusia, Ala., in each of the latter two of which he owned a one-half interest. The partnership agreements were not in writing.
    3. W. M. Brown, of Selma, Ala., a brother-in-law of the taxpayer, was the owner of a one-half interest in the business of the Coca Cola Bottling Co. of Selma, Ala.; G. M. Lewis, of Dothan, Ala., was the owner of a one-fourth interest in the business of the Coca Cola Bottling Co. of Dothan, Ala., and John L. Barnett, a brother-in-law of the taxpayer, was the owner of a one-half interest in the business of the Coca Cola Bottling Co. of Andalusia, Ala.
    4. The taxpayer was the executive head and S. E. Elmore was general manager and auditor of these companies, but the general manager and auditor had no interest in the business. He audited the books and distributed the income each year according to the interest each partner had in the business.
    5. In the year 1914 the taxpayer suffered a stroke of paralysis and was taken to Hot Springs, Ark., to New York, and to Philadelphia for treatment by skilled physicians, returning home about January 1, 1915. Taxpayer has not yet fully recovered from the stroke of paralysis that he suffered in 1914. During the years 1915- and 1916 he was too ill to take actual charge o.f the business and relied largely upon his wife, who was a business woman, for information regarding it. In 1917 and 1918 the taxpayer was more active in the business but relied largely on others, including his wife, who was-his assistant in all his affairs, for information about his business.
    6. About the middle of the year 1919 the taxpayer discussed with his attorney and his banker at Montgomery, Ala., the matter of making his wife a partner in the business. They both advised him it was the proper thing to do, and the banker thought she ought to-have an active hold on the business. During the fall of 1919 the taxpayer visited each one of- the places of business and discussed with each one of the partners the proposition of transferring one-half of his interest in the holdings of each company to his wife and to make her a partner in the business. Each one of the partners said that was satisfactory and made no objections.
    7. The taxpayer then caused his attorney to prepare the following-document, which was signed by the taxpayer and his wife, Mary E. Bellingrath, on or about December 31, 1919 :
    This agreement this day made and entered into by and between the undersigned, W. A. Bellingrath, party of the first part, and Mary E. Bellingrath, party of the second part,
    Witnesseth:
    That for and in consideration of the sum of One Dollar, and other ,sufficient and valuable consideration in hand paid, the receipt whereof is hereby acknowledged, the party of the first part does hereby sell, transfer and assign to the-party of the second part, an undivided one-half interest in the property, business, assets and good will owned by party of the first part, in the following businesses or enterprises, namely:
    The Coca Cola Bottling Company of Montgomery, Alabama; the Coca Cola Bottling Company of Tuscaloosa, Alabama; the Coca Cola Bottling Company of Dothan, Alabama, and the Coca Cola Bottling Company of Selma, Alabama,, and the Coca Cola Bottling Company of Andalusia, Alabama.
    It is understood that each of these enterprises are going concerns, and party of the second part hereby assumes one-half of the liability or liabilities that may accrue in the conduct of said enterprises against the party of the first part, and shall be entitled to one-half of the net earnings which shall accrue to favor of the interest of party of the first part in said enterprises.
    It being further understood and agreed that party of the first part shall, so. far as concerns the interest of party of the second part in said enterprises,, have the exclusive management and control of said enterprises.
    8. Each of these enterprises was a going concern and Mary E. Bellingrath, according to the terms of the agreement, was to assume one-half of the liability or liabilities that might accrue in the conduct of said enterprises or businesses and was also entitled to one-half of the net earnings which would have accrued to the taxpayer had this agreement not been executed.
    9. On December 31,1919, the assets owned by and used in the business of the various companies were approximately as follows:
    Ceca Cola Bottling Co. of Montgomery_$245,000 or $250,00ft
    Coca Cola Bottling Co. of Tuscaloosa_ 50,000
    Coca 'Cola Bottling Co. of S'elma_ 95,000
    Coca Cola Bottling Co. of Dothan_ 62, 00ft
    Coca Cola Bottling Co. of Andalusia_i 36, 00ft
    Among the said assets was some real estate which was held and recorded in the partnership name.
    10. The taxpayer in the early part of the year 1920 delivered the agreement, above referred to, to S. E. Elmore, general manager and auditor of these companies, to be used by him in making his audits. The books of the several companies for the year 1920 were closed shortly after January 1, 1921, and there was at that time set up on the books of each company the distributive share of the 1920 profits of each partner, including Mary E. Bellingrath, on the basis of the agreement dated December 31, 1919, and Mary E. Bellingrath actually received from each company her share, so set apart for her, in the aggregate amount of $41,127.83.
    11. The Commissioner, in auditing the individual income-tax return of the taxpayer for the year 1920, added the $41,127.83 to the income returned by him and proposed to assess against him an additional tax in the sum of $17,584.70.
    12. During the year 1919 and prior years Mary E. Bellingrath had a separate income of approximately $8,000 or $10,000.
    DECISION.
    The deficiency determined by the Commissioner is disallowed*
   OPINION.

Smith:

The deficiency determined in this appeal arose from the action of the Commissioner in adding to the income reported by the taxpayer $41,127.83, which is claimed to have been income of the taxpayer’s wife as her share of the profits of an alleged partnership existing between herself and her husband, the taxpayer herein. The issue is whether the wife was in reality a partner in the Coca Cola companies enumerated in the findings of fact.

From the uncontroverted evidence in this appeal and from the record as it now stands, we must sustain the contention of the taxpayer that a bona -fide partnership existed between himself and his wife and that the wife is taxable upon her distributive shares of the profits of the partnership enterprises for the year 1920. We have the written partnership contract, executed prior to the taxable year, the agreement between the members of the partnership to divide the profits and losses, and the actual distribution of the actual partnership profits to the taxpayer’s wife. This is true with respect not only to the business conducted by the taxpayer as a sole proprietorship prior to December 31,1919, but it is also true with respect to the partnerships of which the taxpayer was a member prior to that date; under the partnership agreement executed under date of December 31, 1919, the taxpayer’s wife was made a member of the partnerships in which the taxpayer was interested and the other members of those partnerships agreed to take in the taxpayer’s wife as a member of the partnerships in which they were interested.

Under the laws of the State of Alabama, husband and wife are authorized to be partners in any kind of lawful business. Belser v. Tuscumbia Banking Co., 105 Ala. 514; 17 So. 40; Schlapback v. Long, 90 Ala. 525; 8 So. 113. In the last-named case the court said:

As modified by the statutes, there is nothing- in. the relation of husband and wife which prevents them from contracting to enter into partnership and constituting a firm.

At the hearing of this appeal some question was raised as to the effectiveness of the partnership agreement upon the real property owned by the partnership, as the instrument was not witnessed as required for the transfer of real estate. It appears, however, from the evidence that the real property was acquired and stood in the partnership name. The courts of Alabama hold that such lands are to be treated as personalty until the purposes of the partnership are accomplished. Walton v. Atkinson, 165 Ala. 644; 51 So. 826; Brewer v. Browne, 68 Ala. 210; Espy v. Comer, 76 Ala. 501. In view of the uncontradicted testimony on the part of the taxpayer, we are of the opinion that a legal partnership did in fact exist between the taxpayer and his wife and between these parties and the other members of the partnerships in which the taxpayer was interested prior to December 31, 1919, which entitled the wife to her distributive share of the profits.