source: Caselaw Access Project

author: Green:

license: Public Domain

text:
    Joliet-Norfolk Farm Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6795.
    Promulgated October 15, 1927.

      Robert J. Walker, O. P. A., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
    The petitioner herein seeks a redetermination of its income and profits taxes for the calendar year 1920, for which the Commissioner has determined a deficiency in the sum of $1,848.13. The question in the proceeding is whether a profit of $9,243.33 resulting from a sale of real estate in 1920, is to be treated as income for such year.
    FINDINGS OF FACT
    The petitioner is a Virginia corporation with its principal office at Norfolk. In 1920 it sold certain real estate for a total consideration of $44,100 with a resulting gain to it of $9,243.33. The purchaser assumed a first mortgage in the sum of $15,000, together with the interest thereon, and taxes in the sum of $1,980; paid cash in the amount of $5,500; and gave the petitioner notes in the amount of $21,419.34 secured by a second mortgage on the premises.
    The property sold consisted of approximately 700 acres of land situated in Norfolk County, Virginia, and some 15 miles from a railroad station and the City of Norfolk. At the time of the sale less than 50 acres of the land had been placed in cultivation and the remainder was covered with weeds and underbrush of various kinds. The only improvement upon the premises was a brick house which was in a very rundown condition having a value at the time of the sale of not to exceed $2,000. Prior to the sale in question the petitioner had endeavored to sell the property in acreage tracts but had been able in three years to dispose of only three small pieces, upon one of which it received no cash payment, upon another a cash payment of $100, and upon the third a cash payment of $300. The actual value of the property at the time of the sale was not in excess of its cost to the petitioner and it would have been willing to sell it for that amount. The notes secured by the second mortgage could not have been sold for an amount in excess of 25 per cent of their face value without the endorsement of persons who were financially responsible.
    One of the officers of the petitioner corporation took the notes and second mortgage to two different banks in Norfolk and was unable to obtain an offer therefor. He also asked these banks if they knew of anyone who would purchase the notes and both answered that they were unable to suggest a purchaser, and both banks advised that the mortgages could not be disposed' of. The market was flooded with second mortgage paper, some of it being offered at a discount of from 50 to 60 per cent. The maker of the notes resided in Illinois and was unknown to people in the vicinity of Norfolk. No payments were made on the notes during the year 1920. The second mortgage notes had no fair market value at the time received.
   OPINION.

Green:

The parties are in accord as to the amount of the profit ultimately resulting from the purchase and sale of the property. The petitioner contends that the second mortgage notes had no fair market value and that, therefore, in accordance with the provisions of section 202 (b) of the Revenue Act of 1918, it is entitled to recover its capital investment before any part of the payments received shall be treated as taxable income.

We have found as a fact that the second mortgage notes had no readily realizable market value. We have heretofore held in Appeal of Anton M. Meyer, 3 B. T. A. 1329, that under such circumstance^ the petitioner should be first permitted to recover his capital investment and after the recovery of this amount the remainder of the purchase price should be returned as income as the same was received by the seller. Inasmuch as the total profit from the transaction is less than the amount of the second mortgage notes, we hold that the petitioner derived no income in 1920 from the sale of the real estate in question.

Judgment will be entered after. 15 days’ notice, under Rule 50.

Considered by Arundell and Lansdon.


author: Lansdon:

text:
    Israel Oleet, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9622.
    Promulgated October 15, 1927.
    Certain promissory notes received in payment of goods sold were debts ascertained to be worthless and charged oft within the taxable year.

      Lawrence Koenigsberger, Esq., for the petitioner.

      B. A. Littleton, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency asserted by the respondent for the year 1921, of $1,276.83, resulting from the disallowance by the respondent of certain deductions from gross income taken by the petitioner in his income-tax return for that year, and claimed to be bad debts ascertained to be worthless and charged off within said year. The deductions so taken by the petitioner in his 1921 return amounted to $10,796.01. The petitioner conceded that $1,164.98 of this amount was properly disallowed, leaving as the amount of deductions in controversy in this proceeding, the sum of $9,631.03.
    FINDINGS OP PACT.
    The petitioner is a diamond merchant, having his place of business at 87 Nassau Street, New York City. His sole business for some 20 years has consisted in the purchase and sale of diamonds and other precious stones. His sales are made either by himself, personally, or through agents or brokers. The sales are made sometimes for cash, but usually on time, the petitioner receiving the purchaser’s promissory notes due from four to seven months after date. A separate promissory note is given for each payment. The agent or broker received one per cent commission on all goods sold by him, and was permitted to represent himself to the prospective purchasers as owner of the goods he was handling for the petitioner. When the agent, or broker, ascertained-, that he had a prospective customer, he secured possession of the stones from the petitioner for a short period in order to effectuate the sale. He then went to the customer, exhibited the goods, and, if a sale was effected, received from him cash or a promissory note or notes, or both, in the full amount of the sales price. Title to the property so sold passed to the purchaser on execution and delivery of his notes to the agent or broker. The broker was permitted by the petitioner to have, and did have, the notes executed in his own favor and an unwritten agreement existed between the petitioner and broker that the latter was not liable on said notes after having endorsed and delivered them to the petitioner. The broker’s commission of one per cent was paid by the petitioner coincidently with the delivery to him of the cash or with endorsement and delivery to him by the broker of the promissory notes involved in the sale. Upon delivery of the cash, or upon endorsement and delivery of the notes, by the broker to the petitioner, the broker’s financial responsibility in the transaction terminated as between himself and the petitioner. The majority of the notes taken in payment for the goods sold were discounted by the petitioner at banks in the city of New York. Others were placed in banks in said city for collection. On failure of the makers of the notes to pay at the maturity thereof, said notes were protested and returned to the petitioner, the latter making payment to the bank in those cases where the notes had already been discounted by him.
    Time payment sales made to purchasers residing in the City of New York, whether made through agents or otherwise, were not consummated until approved by the petitioner; but for such sales as were made by agents to purchasers beyond the city limits, the petitioner accepted the word of said agents that the purchasers were financially responsible.
    The petitioner had no bookkeeper, but kept a record of notes received by him in two notes receivable books. All deposits were entered by the petitioner in the deposit side of his check books. The total of the notes received by the petitioner in a given year, as recorded in the notes receivable books, plus the cash sales for the same year, as recorded in the check books, represented the petitioner’s gross sales for that year and was so reported by him in his return for said year. All of the sales giving rise to the items here involved were made in the years 1920 and 1921 and, in each instance, the entire sales price received by the petitioner in the form of cash and/or promissory notes was reported by him as gross income in the year of sale. At the close of and within the year 1921, the petitioner charged off as bad debts certain accounts due him on promissory notes received from vendees to whom he himself had made sales; and also certain amounts due him on promissory notes executed by other vendees in favor of petitioner’s agent or broker, and endorsed and delivered by said agent or broker to him under the arrangement above set forth. Of the notes here in controversy, the original amounts charged on, the payments received thereon, and the amounts charged off in 1921 as bad debts were as follows:

    George Crystal, the Davidson Diamond Jewelry Co., the Liberty Loan Shop, and the West Side Diamond Shop, each went into voluntary or involuntary bankruptcy during the year ' 1921. George Crystal paid 20 per cent and the Davidson Diamond Jewelry Co. 50 per cent to their creditors on composition agreements confirmed in 1921 by the court having jurisdiction of the bankruptcy proceedings. The Liberty Loan Shop and the West Side Diamond Shop paid nothing to their creditors, all of their known assets being used in defraying the expenses of the bankruptcy proceedings; the petitioner was apprised of their financial conditions prior to the charge-off in 1921. The remaining five debtors removed from their respective places of business within the year 1921, without notifying the petitioner thereof, and diligent search before the close of the year 1921, failed to disclose their whereabouts; none of them left any property from which recovery could be made, and no payment has since been received from any of them.
    The following debts were ascertained by the petitioner to be worthless and were charged off by him within the year 1921: George Crystal, $3,250; Davidson Diamond Jewelry Co., $1,778.67; Harry Elkin, $400; Frank Cohen, $230; and R. Steiner, $1,697.93; Liberty Loan Shop, $650; West Side Diamond Shop, $454; Louis A. Cohen, $534.71; and Joseph Weiss, $280; making a total of $9,275.31.
   OPINION.

Lansdon:

At the close of the year 1921, petitioner charged off $10,796.01 as bad debts ascertained to be worthless and deducted said amount from the gross income reported by him for that year. According to the deficiency notice, the respondent disallowed said deduction for lack of evidence as to whether certain items included therein had been reported as income during the current year or some prior year, and on account of insufficient evidence as to whether the remaining items were, in fact, ascertained to be worthless and charged off during the taxable year 1921.

The petitioner conceded that $1,164.98 of the deductions so taken was erroneous, leaving the sum of $9,631.03 as the amount involved in this proceeding. As indicated by our findings of fact, the petitioner deducted $2,134.39 as representing a worthless account resulting from the bankruptcy of the Davidson Diamond Jewelry Co. The court order confirming the composition offered by the bankrupt to its creditors discloses that the petitioner received in 1921, 50 per cent of the debt. We are therefore of the opinion that in 1921 the petitioner actually ascertained that only the remaining 50 per cent (or $1,778.67) of the Davidson Diamond Jewelry Co. account was worthless. The petitioner’s bad debt claim with respect to the Davidson Diamond Jewelry Co. account is therefore allowed to the extent of $1,778.67 and disallowed as to the remainder, or $355.72.

The debts owing to the petitioner from R. Steiner, Liberty Loan Shop, West Side Diamond Shop, Louis A. Cohen, and Joseph Weiss, resulted from sales negotiated by an agent or broker (Toepfer). Inasmuch as the promissory notes of these debtors held by the petitioner had been made payable to the agent or broker and endorsed by him, on delivery thereof, to the petitioner, it seems advisable to determine whether the petitioner held a legal claim against said agent as endorser. There was an unwritten agreement between the petitioner and said agent that the latter would not be liable on these notes after having endorsed and delivered them to the former. The true intention of endorsers to a negotiable instrument, as between themselves, can always be shown by oral evidence. Kohn v. Consolidated Butter & Egg Co. (1900) 63 N. Y. S. 265, 266; Witherow v. Slayback (1899) 158 N. Y. 649; 53 N. E. 681.

On the facts disclosed by this proceeding it is clear that the petitioner held no legal claim against his agent on presentation of the promissory notes to their makers for payment and default in payment.

We are of the opinion that the petitioner has established that debts in the amount of $9,275.31 were ascertained by him to be worthless and charged off at the end of the taxable year 1921 and, as such, are allowable deductions from gross income for that year.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Green and Artjndell.


author: TRAmmell:

text:
    Theodore H. Beckman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9541.
    Promulgated October 17, 1927.
    The evidence is insufficient to show that the Commissioner was in error in determining the tax upon the basis of cash receipts and disbursements.

      H. H. Tooley, Esq., for the petitioner.

      P. M. Glarle, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income tax for the years 1919 and 1920 in the amounts of $396.83 and $2.42 respectively. The error assigned is the action of the Commissioner in computing the income for income-tax purposes on the basis of cash receipts and disbursements instead of on the accrual basis.
    findings of fact.
    The petitioner is a farmer, raising grapes, horses, cattle and hogs. He disposed of a portion of his dairy business in 1919 and the balance in 1920. In his income-tax return for the calendar year 1918, the petitioner showed an inventory of cattle, hogs, and horses on hand at the beginning of the year and at the close of the year. Returns were filed for 1919 and 1920 upon the same basis as for 1918. The petitioner did not make any application to the Commissioner to change the basis of filing his income-tax return.
    The petitioner kept books of account for 1918, 1919, and 1920, but certain of the books or work sheets from which entries were made in the books were lost. The petitioner’s books of account consisted of a cash book, a bank book in which he kept a record of every item that was deposited in the bank, and another book in which he kept account of his labor and the money that was paid out for machinery and expenses of the ranch. All the money paid out was by check and on the stub he wrote what the amount was for. When he received cash, he put it in the bank and an entry was made in his bank book. Opposite the deposit on the other page he put down what it was and from what source. When the petitioner sold horses and cattle he was paid for them in cash. He did not sell any of his stock except for cash. When they were paid for the purchasers drove them off the place and when he bought cattle he paid cash for them. He did not have any accounts payable or receivable on his books. The petitioner took inventory at the beginning and close of each year of all of his stock.
    The Commissioner upon the audit of the petitioner’s income-tax returns for 1919 and 1920 determined the tax upon the basis of cash receipts and disbursements. In the returns filed for those years in answer to question 12, which is as follows: “ Write E if you kept no books or books on the cash basis, or write A if you kept books upon the accrual basis,” there was written the letter E in response to this direction.
   OPINION.

TRAmmell:

The Commissioner determined that the cash receipts and disbursements method was the proper basis for reporting income for the years in question. The burden was upon the petitioner to show otherwise. The income-tax returns upon their face indicate that they were filed upon the cash receipts and disbursements basis. The fact that inventories were taken at the beginning and close of each year is not sufficient in itself to show that the cash receipts and disbursements method did not clearly reflect income. It also appears from the meagre testimony to have been the basis used by the petitioner in keeping his books of account. The testimony does not convince us that the Commissioner was in error in determining the tax upon the basis of cash receipts and disbursements.

Judgment will be entered for the respondent.

Considered by Morris and Littleton.


text:
    Popular Priced Tailoring Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9222.
    Promulgated October 17, 1927.

      John 0. Bigelow, Esg., and Edward B. Bv/rt, G. P. A., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
   Lansdon:

This appeal is from the refusal of the respondent to allow the claim of the petitioner for affiliation with another company engaged in the same business under the same management and occupying the same office and business rooms. The period involved is January 1 to June 30, 1920, and the amount in controversy is $9,960.18.

FINDINGS oe fact.

The petitioner was a corporation engaged in the wholesale tailoring business in Chicago, Ill. It was organized in 1915 under the laws of the State of Illinois. The corporation with which affiliation is claimed is H. A. Elman & Co., which was organized in 1910 under the laws of the State of Illinois and at all times since its organization has been engaged in the wholesale tailoring business. The two companies were organized by H. A. Elman and were completely under his control and management at all times, and especially during the period here involved. They occupied the same rooms, had the same -'mployees and were engaged in exactly the same kind of business from the date of the organization of the petitioner until June 30, 1920, at which time H. A. Elman & Co. purchased all the stock of the Popular Priced Tailoring Co.

The companies’ books indicate that the capital stock of the two companies was held as follows during the period here involved:

Ella D. Elman held the stock of Elman & Co. in her name for the benefit and to the use of H. A. Elman and for no other purpose or use. Elman was the owner of the stock held by her, exercised complete control over it, voted it and transferred it at pleasure. When Elman requested her to transfer shares to other parties, she simply signed her name as and where requested. The company’s books show that all cash dividends on account of this stock were allocated and paid to H. A. Elman.

Separate books were kept for the two companies and each also had a separate bank account. The disbursements were allocated to the companies according to the amounts they respectively had available when payments were due.

The respondent found the deficiency of $9,960.18 against the petitioner and overpayments of about $4,000 by H. A. Elman & Co.

Two years prior to the organization of H. A. Elman & Co., Elman endorsed a note for a friend on which suit was afterward brought and judgment secured against him. He arranged to pay off the judgment at the rate of $2 per week. In 1910, just after he organized the corporation, he transferred 239 of his 240 shares to his sister because he feared that otherwise his creditors might' make trouble for him and cause him considerable loss. Although he satisfied the judgment before the close of 1912, he continued for business reasons to keep a large part of his interest in the stock of the petitioner in the name of his sister. He always treated this property as his own and she received no financial return whatever from it. She testified that she did not at any time during the half year involved, have any financial interest whatever in H. A. Elman & Co. nor receive any cash dividends whatever from the stock and that so far as she knew, he exercised complete control over it.

The petitioner and H. A. Elman & Co. were affiliated during the taxable year.

Judgment will be entered for the petitioner on 15 days’ notice, under Bule 50.

Considered by Steünhagen and Arundell.


text:
    Irving Bank-Columbia Trust Co., Beulah H. Emmet, and Cordelia H. Cushman, Executors of the Last Will and Testament of Alonzo Barton Hepburn, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9651.
    Promulgated October 17, 1927.
    That part of the income received by the executors during the administration and settlement of the estate, which, pursuant to the terms of the will, had been permanently set aside during the taxable period as belonging to charitable and educational corporations, held to be a proper deduction from the gross income of the estate, under section 219 (b) of the Revenue Act of 1921.

      John D. Fearhake, Esq., and R. M. 'White, Esq., for the petitioners.

      D. D. Shepard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the period January 26, 1922, to December 31, 1922, inclusive, in the amount of $121,712.85. The facts have been stipulated by the parties, and the single issue of law presented is whether the amount of $231,506.81, representing that portion of the income received by the executors during the period of administration and settlement of the estate, which had been permanently set aside during the taxable period, pursuant to the terms of the will, as belonging to charitable and educational corporations was a proper deduction from gross income under the provisions of section 219 (b) of the Revenue Act of 1921.
    FINDINGS OF FACT.
    The petitioners, Irving Bank-Columbia Trust Co., Beulah H. Emmet, and Cordelia H. Cushman, are the duly appointed, qualified and acting executors and trustees of the last will and testament of .Alonzo Barton Hepburn, deceased, who died on January 25, 1922, a resident of the City, County and State of New York. The deceased left a last will executed February 19, 1918, and two codicils thereto dated February 19, 1920, and January 19, 1921, respectively, which were duly admitted to probate on February 7,1922, by the surrogates’ court of said county and the appointment therein of the said executors was confirmed.
    Upon their appointment, the executors caused an appraisal of the estate to be made, and took into their possession property valued in said appraisal at $7,484,890.69, of which securities represented a value of $6,632,981.33. Practically all of said securities were listed on the New York Stock Exchange and were readily salable. During the taxable period involved, interest, dividends and other accruing income and monies were collected; notice to creditors to present their claims was published for the time and in the manner prescribed by law; all claims and current and other expenses incidental to and connected with the administration of the estate were paid; a large amount of the property was sold; all specific devises and bequests were delivered; all general or money legacies were paid in full; and generally, the affairs of said estate were managed and conducted in compliance with the will and codicils and in accordance with the rules and practice of said surrogates’ court, and resulted in the filing by the executors of an intermediate accounting verified August 23, 1923. This intermediate accounting was thereafter judicially allowed and settled by a decree of said court entered December 14, 1923.
    During the taxable period, the executors collected in interest and dividends on the property of the estate $233,313.02, no part of which represented profits on . sales. The executors paid funeral expenses, claims, Federal and sundry State inheritance taxes, Federal and State income taxes accrued against decedent in his lifetime, and current and incidental expenses of administration (exclusive of legacies) in the total amount of $1,011,304.47. During the same period, the executors delivered all specific devises and bequests of property, of the total value, as appraised by the executors, of $219,320.37, and paid in cash all money legacies in the amount of $2,929,000.
    The seventh paragraph of the first codicil to the last will and testament of decedent provided as follows:
    Seventh: I hereby revoke and cancel the Ninth Paragraph of my said Last Will and Testament, and the whole thereof, and in lieu and instead thereof, I hereby direct my said Executors and Trustees named in my said Last Will and Testament, after paying any and all gifts, devises and bequests, or making proper provision therefor, as in my said Last Will and Testament and in this my Eirst Codicil, hereinbefore provided, to pay over and distribute all the rest, residue and remainder of my estate among my wife, Emily L. Hepburn, my daughters, Beulah H. Emmet and Cordelia S. Hepburn, my son, Charles Fisher Hepburn, and to add to the trust fund provided by Paragraph Sixth of my said Last Will and Testament and as modified, changed and increased by paragraph Third of this Codicil, and among the various Educational Institutions named in said Eighth Paragraph of my said Last Will and Testament as modified by Article Fifth of (his Codicil, namely, — St. Lawrence University, Middlebury College, Wellesley College, Williams College and Columbia University, and A. Barton Hepburn Hospital located at Ogdensburg, New York, in the ratio or proportion which the several gifts, devises and bequests made to any of said persons or corporations in my said last Will and Testament, as modified by this Codicil, shall bear to the entire residue of my estate, as the same shall be ascertained and determined in due course of administration, and that the said several sums or amounts be paid to said devisees or legatees as soon as possible in due course of administration after my decease, absolutely and for their own use.
    The second codicil revoked and canceled so much of the eighth paragraph of the will as gave the sums therein mentioned to Welles-ley College and Williams College, and also revoked and canceled so much of the seventh paragraph of the first codicil as included said colleges as participants in the distribution of the residue and remainder of the estate.
    The total amount of all gifts, devises and bequests to the persons and corporations sharing in the residue, other than their interests in the residue itself, was $3,007,804.87. The total amount of the gifts, devises and bequests to the hospital and educational institutions, other than their interest in the residue itself, was $700,000. Pursuant to the formula prescribed in the seventh paragraph of the first codicil for determining the interests of the persons and corporations sharing in the residue of the estate, the executors divided the total amount of the gifts, devises and bequests to such beneficiaries into the specific or several amounts given to each. The combined interest of the hospital and educational institutions was determined by dividing the total of the gifts, devises and bequests to them, in the amount of $700,000, by the aggregate of all gifts, devises and bequests to the residuary legatees in the amount of $3,067,804.87, which resulted in the fraction 0.22817618.
    During the taxable period involved herein, and after determining in the manner above mentioned the fractional interests of the several beneficiaries sharing in the residue of the estate, the executors opened an account in a book auxiliary to the main ledger in which the estate accounts were kept, in which auxiliary account were recorded, amongst other things, the respective fractional shares of the residuary legatees. The aggregate of the several fractional shares of the hospital and educational corporations, so determined and recorded, was the said fraction 0.22817618, and the said fraction determined and fixed the exact aggregate interest of said corporations in the whole or any part of the residuary estate.
    During the period involved, the executors kept the accounts of the estate upon the cash receipts and disbursements basis, and so reported its income.

      On March 15, 1923, the executors filed an individual income-tax return on behalf of the estate for the taxable period involved herein, in which was listed the amount of $943,612.21 as representing the net profit on sales of securities of the estate, based upon the executors’ appraisal. Due to the fact that respondent made certain changes in the executors’ appraisal of the values of the securities, the executors thereafter filed an amended income-tax return in which the amount of the profits on sales was shown as $894,481.82. In the amended return the executors claimed a deduction from gross income in the amount of $231,506.81 as representing the portion of the said profits on sales distributable to the hospital and educational corporations, as determined by said fraction.
    Under the second paragraph of the will, the executors were authorized and directed at their discretion to pay and satisfy any legacies either in money or specific property at the valuation placed thereon by the executors’ appraisal, to be by them selected, or partly in money and partly in such articles. In the exercise of the discretion so conferred, and because it would have been impracticable to have sold the securities in their entirety for the reason that such sales would have depressed the market and the estate would thereby have suffered serious losses, the executors sold the securities in small lots from time to time during the taxable period involved.
    After the close of said period, the executors continued to sell securities of the estate, and the proceeds of such sales, added to those of the prior sales, were paid over to the hospital and educational corporations between the dates of February 5, 1923, and July 25, 1923, to the extent of the amount of $815,000, which included the amount claimed by the executors as a deduction in the amended return.
    Pursuant to the terms of the decree allowing the intermediate accounting, the executors set aside in their hands property of the estate of the value of more than $500,000 to secure the payment of any sums that might be found due on account of additional Federal or State income or inheritance taxes, or claims against the estate that might arise. The property so retained was part of the estate taken over by the executors at the testator’s death, and no part thereof was profits on the sales of securities.
   OPINION.

TRAmmell:

The material facts of this proceeding, as set out in our findings hereinabove, have been stipulated by the parties, who differ only as to the construction or application of the provisions of section 219 (b) of the Revenue Act of 1921. Subdivision (a) of that section provides that the tax imposed by sections 210 and 211 shall apply to the income of estates, including income received by estates of deceased persons during the period of administration and settlement of the estate; and subdivision (b) provides that:

* * * The net income of the estate or trust shall he computed in the same manner and on the same basis as provided in section 212, except that (in lien of the deduction authorized by paragraph (11) of subdivision (a) of section 214) there shall also be allowed as a deduction, without limitation, any part of the gross income which, pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in paragraph (11) of subdivision (a) of section 2i4. * * *

The section last mentioned provides:

Sec. 214. (a) That in computing net income there shall be allowed as deductions:
»»*»***
(11) Contributions or gifts made within the taxable year to or for the use of: * * * (B) any corporation * * * organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, * * * no part of the net earnings of which inures to the benefit of any private stockholder or individual * * *.

There is no dispute that the gifts, the income or profits from the sale of which forms the subject matter of this proceeding, were made to corporations coming within the above classification. Accordingly, the only issue presented for our decision is whether that part of the income or profits received by the executors during the period of administration and settlement of the estate from the sales of securities during the taxable period involved, which was allocable to and ultimately destined to be paid over to the charitable and educational corporations, constituted a lawful deduction from the gross income of the estate. The executors deducted in the amended return the amount of $231,506.81 from the gross income as representing that part of the net profits received from the sale of securities allocable to the charitable and educational corporations. Respondent disallowed said deduction and computed the deficiency involved herein.

The statute provides that any part of the gross income shall be so deductible, if, pursuant to the terms of the will, it is during the taxable year paid or permanently set aside for such purpose. The facts show that the income in question was not paid to the corporations during the taxable period, nor was any specific amount credited to them on the books of the estate during that period. Only the fractional interest of each residuary legatee was determined and recorded. Can it be said then that the amount claimed as a deduction was permanently set aside for charitable and educational purposes during the taxable period %

Precisely the same question was before us in Appeal of Herbert Jermain Slocum et al., Executors, 6 B. T. A. 36, and our decision there is controlling here. In that connection, we said:

* * * We think that under the provisions of subdivision (b) of section 219 it was not necessary for the entry to be made upon the books crediting the income to these residuary legatees in order for it to be allowable as a deduction by the estate in computing its net income, if it can be said that such income was permanently set aside for the residuary legatees pursuant to the terms of the will.
* % * * * * *
We think that Congress intended by subdivision (b) of section 219 that all or any portion of the gross income of an estate should be deductible when, conformable to and in pursuance of the provisions of the will, it was appropriated and dedicated finally and for all time to charitable and religious uses as specified in section 214 (a) (11), so that, thereafter, there would be no changes which would destroy the character of such action. * * * Subdivision (b) of section 219 does not make the deduction depend upon the crediting or payment but upon the permanent setting aside of the income for charitable, religious, or educational purposes. The will directed that the residuary estate * * * be distributed to the exempt institutions. When the executors received the income it became a part of the residuary estate and was permanently set aside for and belonged to the exempt institutions. It was, therefore, a proper deduction by the estate.

See also Slocum v. Bowers, 15 Fed. (2d) 400, affirmed by the Circuit Court of Appeals, Second Circuit, 20 Fed. (2d) 350.

In the Slocum case, supra, the entire residuum of the estate, and hence the entire income thereon, was given to the exempt institutions. In the instant case, only a specified portion of the residuary estate, and hence only a proportionate part of the income thereon, was given to such corporations. However, the principle involved is exactly the same, particularly in view of the express provision of the statute that any part of the gross income under the conditions stated, shall constitute an allowable deduction, without limitation. The facts in the Slocum case, supra, are very similar to those in this proceeding, with the exception just mentioned.

In the instant case, it was the duty of the executors, under the directions contained in the seventh paragraph of the first codicil to the will, after paying any and all gifts, devises and bequests, to pay over and distribute the residue of the estate among the legatees specifically mentioned therein, including the charitable and educational institutions, in the ratio which the several gifts bore to the entire residue of the estate as the same should be determined in the due course of administration; and it was further directed that the several amounts be so paid to the said legatees as soon as possible in due course of administration, absolutely and for their own use.

Prior to the end of the taxable period involved, the executors had delivered all specific bequests and paid all general or money legacies in full, together with all claims against the estate and expenses of administration. Subsequently, they set aside a part of the corpus of the residue to cover any additional tax liability or claims against the estate which might arise; and during the taxable period determined and recorded the exact fractional interest of each residuary legatee in the whole or any part of the residue of the estate. The net profits on the sales of securities received during the taxable period became a part of the residuary estate. Those profits, together with the balance of the proceeds of the sales, were permanently set aside for and belonged to the residuary legatees according to their respective fractional interests, determined pursuant to the terms of the will, and actual distribution thereof was commenced early in the succeeding year. Accordingly, we must hold that that part of the profits or income which was thus permanently set aside for and which belonged to the charitable and educational corporations constituted a proper deduction from the gross income of the estate.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Smith and Littleton.


author: Teammell :

text:
    Feeders Supply Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7606.
    Promulgated October 17, 1927.
    1. Under the facts of this proceeding, held that during the year 1917, petitioner was engaged in a trade or business haying an invested capital which was more than a nominal capital, and is therefore not entitled to have its profits tax for that year computed under the provisions of section 209 of the Revenue Act of 1917.
    2. Certain notes held not to have been bona fide paid in for stock or shares, under section 320 (a) of the Revenue Act of 1918.

      Theodore B. Benson, Esq., and P. W. Shraeder, Esq., for the petitioner.

      J. Arthur Adams, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes for the fiscal years ended June 30,1917,1918, 1919, and 1920, in the amounts of $9,548.31, $460.85, $1,563.83 and $497.01, respectively. The issues are: (1) Whether petitioner is entitled, for the parts of the fiscal years ended June 30, 1917 and 1918 falling within the year 1917, to have its profits tax computed under the provisions of section 209 of the Revenue Act of 1917, on the ground that it was engaged in a trade or business having no invested capital or not more than a nominal capital; and (2) whether petitioner is entitled to have included in its invested capital, for the fiscal years ended in 1919, and 1920, the actual cash value of certain notes given by stockholders for shares of stock issued to them.
    FINDINGS OF FACT.
    Petitioner is a Missouri corporation, with its principal office at Kansas City. It was organized June 5, 1913, with an authorized capital stock of $5,000, and succeeded to the business theretofore conducted by a partnership under the same name.
    During the year 1910, R. D. Nathan and A. R. Hollcroft began the business of buying and selling cottonseed meal and cake and other feed for livestock, principally in carload lots. A. L. Parnham and J. L. Whittington were admitted to the partnership in 1911 and 1912, respectively. Upon organization of the corporation in 1913, the partnership transferred to it assets in the amount of $18,829.34 and liabilities in the amount of $11,366.36. The difference between the assets and liabilities in the amount of $7,462.98 appeared on the opening books of the corporation as $5,000 capital stock and $2,462.98 paid-in surplus.
    The incorporators were Nathan, Hollcroft, Parnham and Whit-tington, and stock was issued to each in proportion to his interest in the partnership. The four incorporators were elected directors, and the directors thereupon elected Nathan president and general manager, Parnham vice president and sales manager, Hollcroft secretary, and Whittington treasurer and traffic manager. These four men held the same offices, performed the same duties and devoted their entire time to the business from the date of incorporation up to and including the fiscal years involved herein.
    During 1914, two shares of stock were sold to W. R. White, who was then employed by petitioner as assistant traffic manager. The stock was issued to White by the four incorporators, whose respective shares were reduced in approximately the same proportion. In 1916, one share was issued to O. S. Nathan, who was employed as cashier, and the holdings of the other five stockholders were reduced proportionately.
    . The petitioner was authorized under its charter to buy, sell and deal in cottonseed products, grain and other similar commodities, cattle, hogs and other live stock; also to borrow money and to acquire and hold land. During the fiscal years ended in 1917 and 1918, petitioner was actually engaged in the business of buying and selling and dealing in cottonseed products, and other feed for live stock. Sales were made either in carload lots shipped directly from the manufacturer to the consumer on petitioner’s order, or in less than carload lots shipped from petitioner’s warehouse.

      In the case of sales in carload lots, petitioner would order the goods shipped by the manufacturer consigned to the petitioner at the customer’s railroad station. The manufacturer would draw a sight draft on petitioner, to which was attached the bill of lading covering the shipment. The draft with the bill of lading attached would be sent by the manufacturer through its bank for collection, and would be presented to petitioner in the usual course of business and paid by its check drawn on the Interstate National Bank of Kansas City. Petitioner would thereupon immediately draw a sight draft on its customer, attach thereto the bill of lading and deposit same to its credit in the bank. The draft on the customer would then be sent through the usual channels by the bank for collection, to which the proceeds would be remitted when paid by the customer.
    Petitioner’s bank accepted such drafts on customers for immediate deposit, without requiring petitioner to give a note, contract or other evidence of indebtedness, but made a charge of $1 per thousand, required petitioner to pay exchange charged by its correspondent banks, and also charged the petitioner interest at the rate of 8 per cent per annum for the number of days elapsing between the dates when the respective drafts were deposited as cash in the checking account of the petitioner and the dates when the proceeds of the collection were received by the bank.
    During the taxable years in question, petitioner maintained a warehouse in Kansas City, from which it made shipments of feed-stuff to its customers in less than carload lots. It also maintained a sales office at Omaha, Nebr., in charge of Ilollcroft. For a time it also maintained a branch office at Forth Worth, Tex.
    Advertising expenses for the fiscal year ended in 1917 amounted to $2,972.62, and such expenses for the fiscal year ended in 1918 amounted to $4,932.90.
    At July 1, 1916, the beginning of the fiscal year ended June 30, 1917, the assets of the petitioner amounted to $30,191.89, and liabilities to $15,939.34. The net worth in the amount of $14,252.55 represented $5,000 capital stock and $9,252.55 surplus. Of the liabilities, petitioner owed $644.85 to trade creditors, and $13,601.09 to other creditors, of which latter amount $12,865.51 was owed to three of its stockholders, R. D. Nathan, Hollcroft, and White. The invested capital of the petitioner for the fiscal year ended June 30, 1917, was $14,252.55.
    During the fiscal year ended June 30,1917, gross sales made by the petitioner amounted to $2,089,353.25, of which amount $1,811,065.54 was from goods sold in carload lots on sight drafts, and the balance in the amount of $278,287.71 was from sales of goods carried in the petitioner’s warehouse, and as to which its books showed opening and closing inventories. The gross profits from sales amounted to $141,765.41, of which $93,395.17 was realized from sales in carload lots, and $48,370.24 was realized from sales of goods shipped from petitioner’s warehouse. Total deductions amounted to $53,673.22, which included $19,171.83 paid in salaries and wages to officers, stockholders and other employees. Net income amounted to $88,692.28.
    At July 1, 1917, the beginning of the fiscal year ended June 30, 1918, the assets of the petitioner amounted to $92,807.36, and liabilities to $48,415.38. The net worth in the amount of $44,391.98 represented $5,000 capital stock and $39,391.98 surplus. Of the liabilities, $2,775.85 was owing to trade creditors and $41,556.06 to other creditors. Of the latter amount, $40,076.14 was owing to the six stockholders. Petitioner’s invested capital for the fiscal year ended in 1918 was $44,391.98.
    During the fiscal year ended June 30, 1918, the gross sales made by petitioner amounted to $2,694,065.79, of which amount $2,164,-232.91 was from goods sold in carload lots on sight drafts, and the balance in the amount of $529,832.88 was from sales of goods shipped from petitioner’s warehouse, as to which its books showed opening and closing inventories. The gross profits from sales amounted to $144,349.66, of which $65,941.86 was from sales in carload lots, and $78,407.80 was from sales of goods shipped from the warehouse. Total deductions amounted to $99,464.73, which included $58,311.97 paid as salaries and wages to officers, stockholders, and other employees, and the net income amounted to $46,502.33.
    At July 1, 1918, the beginning of the fiscal year ended June 30, 1919, petitioner’s assets amounted to $130,468.95, and its liabilities to $46,759.04. The net worth of $83,709.04 represented $5,000 capital stock and $78,709.04 surplus.
    During the fiscal year 1919, the petitioner decided to and did commence' the manufacture of feed products. To that end, it purchased the necessary real estate, constructed a manufacturing plant and installed machinery therein. The plant began operations during the fiscal year ended June 30, 1920.
    On August 31, 1918, petitioner made an application for and was granted authority to increase its common stock from $5,000 to $125,000, and to issue preferred stock in the amount of $50,000. The full amount of the authorized additional common stock was issued in the amount of $120,000. Of the authorized issue of preferred stock, in the amount of $50,000, only the amount of $35,000 was actually issued. The preferred stock was issued to holders of common stock to discharge loans, E. D. Nathan receiving 200 shares, A. E. Hollcroft 140 shares and O. S. Nathan 10 shares, and was paid for by charges against amounts owed to them by the petitioner. Of the $120,000 additional authorized common stock, $75,000 was paid for by the stockholders through a stock dividend, no actual cash being paid in. The additional common stock was issued to the stockholders in proportion to their previous stockholdings. Under date of September 5, 1918, the balance of the additional common stock in the amount of $45,000 was issued for the subscriber’s notes, as follows:

    The notes given for the stock were in the usual form of promissory notes, dated September 5, 1918, payable to petitioner 12 months after-date, with interest from date at the rate of 6 per cent per annum, and were secured by the stock certificates attached thereto. The note for $7,620.48 given for the certificate of stock issued to Lora M. Parn-ham, wife of A. L. Parnham, was paid in full at the approximate rate of $350 per month by charges to the account of A. L. Parnham carried on petitioner’s boobs. When this note became due on September 5, 1919, the total sum of $3,500 had been paid and credited thereon. Payments were made on the other notes to the extent of cash dividends in the amount of $13,686.29 declared by petitioner on July 19, 1920. Of the total amount of the notes, $21,306.77 was paid by charges to the personal accounts of the makers. The unpaid balance of the notes, in the amount of $23,693.23, was canceled December 30, 1921, and a proportionate amount of the stock issued therefor was canceled by petitioner, pursuant to the following resolution :
    Resolution Adopted at Meeting oe Board of Directors, Dec. 13, 1921, Relative to Cancellation of Part of Stock Issued for Notes
    Be it Resolved by tlie Feeders’ Supply Company, that — ■
    Whereas, on or about September 5, 1918, the Feeders’ Supply Company did sell and cause to be issued under certificate 23, 76.2048 shares of the common stock of this Company and did accept in full payment thereof promissory note for $7,620.48 of R. D. Nathan dated on or about September 5, 1918, due one year after date witli interest at six (C) per cent after September 5, 1918, said stock being held as collateral to said note; and

      Whereas, there has been paid upon said note, after making allowance for all interest to date, approximately thirty (30) per cent of the principal of said note; and
    Whereas, it is to the interest of this Company to dispose of said note and cause to be returned to this Company as much of said stock as is reasonably possible;
    Now, Therefore, this offer be and is hereby made to the said R. D. Nathan, or to whomsoever may own the said stock collateral to said note at the time of the acceptance of this offer, said offer to be good for acceptance up to and including January 20, 1922: That this Company will issue to the said R. D. Nathan, or his assigns, twenty (20) per cent of the par value of said collateral stock as fully paid and non-assessable and cancel said note, the Company to retain all the payments made upon said note, and there to be returned to the Company as its property eighty (80) per cent of said collateral stock. Acceptance of and compliance with this offer to be full settlement and discharge between' the Company and said R. D. Nathan, or his assigns, as to this transaction.
    It was moved and seconded that said resolution be adopted, and after thorough discussion the same was adopted by the unanimous vote of A. L. Parnham, J. L. Wittington and A. R. Holleroft, R. D. Nathan not voting.
    (Resolutions of the same tenor and purport were adopted in respect of notes signed by W. R. White, C. S. Nathan, J. L. Wittington, A. L. Parnham and A. R. I-Iollcroft.)
    Interest was paid on the notes from their date to the date of cancellation, during which time the stockholders had personal accounts on petitioner’s books, to which were credited salaries, dividends, cash advances and other items, together with interest thereon, for which petitioner was indebted to them, and against which accounts were charged payments of cash to or on behalf of such stockholders and other items, together with interest thereon, for which the stockholders were indebted to the petitioner. The makers of the notes were financially responsible and able at all times to pay them.
    During each of the fiscal years ended June 30, 1919 and 1920, interest was paid on borrowed money used in the business of petitioner.
   OPINION.

Teammell :

The facts of this proceeding, as set out in our findings hereinabove, are not in dispute. The parties differ only in the application of the law thereto, and under the pleadings, two issues of such nature are presented for decision here.

First issue. Is petitioner entitled, for those parts of the fiscal years ended in 1917 and 1918 falling within the calendar year 1917, to have its profits tax computed under the provisions of section 209 of the Revenue Act of 1917?

Petitione# made its tax returns on the basis of fiscal years ended June 30, and contends that for the parts of the fiscal years 1917 and 1918 falling within the year 1917, it is entitled to have its excess-profits tax computed at the rate of 8 per cent as provided in section 209 of the 1917 act, on the ground that it was engaged in a trade or business having no invested capital or not more than a nominal capital. Upon audit of petitioner’s returns for the years in question, respondent computed the profits tax under section 210 of said act, and denies that the petitioner is entitled to assessment under section 209. That part of the statute, applicable here, reads as follows:

Sec. 209. That in the case of a trade or business having no invested capital or not more than a nominal capital there shall be levied, assessed, collected and paid, in addition to the taxes under existing law and under this Act, in lieu of the tax imposed by section two hundred and one, a tax equivalent to eight per centum of the net income of such trade or business * * *.

The respondent contends that the word “ invested ” was purposely omitted in connection with the phrase ‘‘not more than a nominal capital ” and should not be construed to mean “ not more than a nominal invested capital.” In harmony with this construction, respondent urges that in determining whether petitioner had not more than a nominal capital, all kinds of capital used by it must be considered, including borrowed money, credits, and inadmissible and other assets. Section 207 of the 1917 Act defines “ invested capital ” and specifically excludes therefrom “ money and other property borrowed,” but does not define “ nominal capital.”

It will be unnecessary to answer this question and pass on the construction of the statute urged by the respondent in order to decide the issue raised if, under the facts of the instant case, it can fairly be said that the petitioner’s invested capital in and of itself was more than “a nominal capital.” If the petitioner’s invested capital was more than nominal, it is obvious that to add thereto the amount of capital borrowed would not tend to bring the petitioner within the classification sought.

Do the facts, then, justify the conclusion that the petitioner’s invested capital constituted not more than a nominal capital ” ? Petitioner urges that the answer to this question should be in the affirmative, for the reason, as stated in its brief, that its invested capital was out of all proportion to the exigencies of the business and ridiculously small in comparison with the gross sales.

The ratio which invested capital bears to gross sales we do not conceive to be a proper criterion for determining whether such capital is nominal or otherwise. The word “ nominal ” is defined in Black’s Law Dictionary, 2d ed., p. 821, as meaning “titular; existing in name only; not real or substantial; connected with the transaction or proceeding in name only, not in interest.”

It is readily apparent that a trade or business might have a substantial invested capital, which because of rapid turnover, might bear a small ratio to gross sales. The true measure for determining the relative importance of invested capital it seems to us lies in whether or not it is used directly and to a substantial extent in producing the profits or income of the business. This view has been adopted by the courts in numerous cases.

In Park Amusement Co. v. McCaughn, 14 Fed. (2d) 553; 5 Am. Fed. Tax Rep. 6155, the court, in considering this question, said:

The real criterion is in the fact finding- of whether money as an income producer played any real and substantial part in producing the income to be taxed. Each tub must thus stand on its own bottom, and the sole question becomes how the facts stand here.

In Hubbard-Ragsdale Co. v. Dean, 15 Fed. (2d) 410, affd. 15 Fed. (2d) 1013, the trial court said:

Under section 209 of the Revenue Act of 1917 * * * a different, though somewhat analogous, question was repeatedly presented in determining whether a trade or business had “not more than a nominal capital.” Under that law the invested capital was considered as merely nominal, if it was used solely as a fund from which to advance salaries, wages, etc., and to provide office furniture, accommodations, and equipment. Under such circumstances it played no integral part in the actual production of income. It was incidental to the earning power of the corporation, which functioned independently of it. De Laski, etc., v. Iredell, Collector, (D. C.) 268 F. 377; affirmed 290 F. 955 (C. C. A. 3). But where the use of capital served a direct and necessary function in carrying on a business as it was in fact carried on, it was not to be classified as merely nominal.

Cf. R. H. Martin, Inc. v. Edwards, 293 Fed. 258; 4 Am. Fed. Tax Rep. 3634; Cartier v. Doyle, 277 Fed. 150; 2 Am. Fed. Tax Rep. 1580.

In De Laski, etc., Tire Co. v. Iredell, 268 Fed. 377; 2 Am. Fed. Tax Rep. 1266; affd. 290 Fed. 955; 2 Am. Fed. Tax Rep. 1993, it was held that a corporation whose sole business was the granting of licenses under its patents and collecting the income therefrom, having a capital of $10,000, which it used to provide its ofiice and furniture and equipment and to maintain its organization between the royalty payments, had not more than a nominal capital within the meaning of section 209 of the Revenue Act of 1917. The facts of the case disclose that the capital of the corporation was not used directly in the production of the taxable income.

In Lincoln Chemical Co. v. Edwards, 289 Fed. 458, the facts were that the only asset of the taxpayer corporation was a secret process, which was intangible and of no value in April, 1909, but that thereafter money was expended in developing the process, so that in 1917 the corporation had a surplus above its capital stock. The corporation had an authorized capital stock of $10,000 and an earned surplus of at least $2,000. The invested capital, represented by the improved secret process, was used directly in producing the taxable income. The court held that the corporation had more than a nominal “invested capital.”

We also have heretofore followed this same rule in J. J. O'Connor & Co. 1 B. T. A. 1021, and Rice & Fielding, Inc., 3 B. T. A. 1080.

The business conducted by the petitioner herein during Üie fiscal years 1917 and 1918 was sharply divided into two classes: First, that part which consisted of the sales of goods shipped by the manufacturer directly to the consumer on bills of lading attached to sight drafts. This class of business petitioner handled on borrowed capital, under the circumstances set out in our findings of fact. The second class consisted of the sales of goods shipped from the petitioner’s warehouse, with respect to which petitioner’s books showed opening and closing inventories. During the years in question, a substantial portion of petitioner’s gross income was realized from each class of business.

During the fiscal year 1917, petitioner’s gross profits from sales amounted to $141,765.41, of which $93,395.17 was realized from sales in carload lots, and $48,370.24 was realized from sales of goods shipped from the warehouse.

During the fiscal year ended in 1918, petitioner’s gross profits from sales amounted to $144,349.66, of which $65,941.86 was from sales in carload lots, and $78,407.80 was from sales of goods shipped from the warehouse.

Thus, for the fiscal year 1917, more than 34 per cent of petitioner’s gross income was realized from the sale of goods shipped from its warehouse, and for the fiscal year 1918, more than 54 per cent of its gross income was realized from the same source.

Petitioner’s invested capital for the fiscal year ended in 1917 was $14,252.55, and for the fiscal year ended in 1918, its invested capital was $44,391.98.

While it is clearly shown by the evidence that petitioner handled its sales in carload lots on borrowed capital, we are not informed as to how it financed that portion of its business represented by sales in less than carload lots, shipped from its warehouse. The facts would seem to justify the inference that its invested capital was used in carrying its warehouse stock, and counsel for petitioner in connection with argument in its brief in effect directly assumed such fact. However, if this assumption is not correct, then we do not know how its invested capital was employed, as otherwise on this point the record before us is silent. If the petitioner’s invested capital was used directly in handling that portion of its business consisting of sales of goods shipped directly from its warehouse, which produced an average of more than 44 per cent of its total gross income for the years under consideration, we must conclude that its invested capital was more than nominal. If this assumption is incorrect, then we must hold that the petitioner has tailed to establish its case on the first issue, for the reason that it has not shown that its invested capital was not used directly and to a substantial extent in the production of its taxable income.

The Revenue Act of 1917, in section 201, imposed a war-excess-profits tax upon corporations and others according to a graduated scale, beginning with 20 per centum of the amount of the net income in excess of the deductions and not in excess of 15 per centum of the .invested capital for the taxable year. In the event that the invested capital could not be satisfactorily determined, it was provided in section 210 that the profits tax should be computed on a comparative basis; and in section 209, it was provided that in the case of a trade or business having no invested capital or not more than a nominal capital, the profits tax should be computed at 8 per centum of the net income in excess of the deductions. Thus, section 209 excepts those coming within its terms from the higher rates imposed by section 201 or section 210. Petitioner herein is seeking to bring itself within the scope of the exception and the burden is therefore upon it to establish that fact by a preponderance of the evidence.

In Hubbard-Ragsdale Co. v. Dean, supra, the court, in considering a similar situation, said:

The plaintiff claims the benefit of an exception to the general method and extent of taxing corporations. The burden is upon the plaintiff to show that it clearly comes within the terms of such exception. In such cases, a reasonable doubt is fatal to the claim. Prima facie every presumption is against it. It is only when the terms of the concession are too explicit to admit fairly of any other construction that the proposition can be supported.

We are not satisfied, from a consideration of all the facts and circumstances of this case, that the petitioner has brought itself within the purview of section 209, and the decision of the first issue must, therefore, go against it. Accordingly, the action of the respondent in computing petitioner’s excess-profits tax for the portions of the fiscal years ended in 1917 and 1918 falling within the calendar year 1917, under the provisions of section 210 of the Revenue Act of 1917, is approved.

Second issue. Is the petitioner entitled to have reflected in the computation of its invested capital, for the fiscal years ended in 1919 and 1920, the actual cash value of certain promissory notes given by the stockholders for shares of stock issued to them?

On September 5, 1918, the petitioner increased its authorized common stock from $5,000 to $125,000. Of the $120,000 additional common stock, it issued $75,000 as a stock dividend, each stockholder receiving his proportionate part on the basis of his former holdings. The balance of the additional common stock, of the par value of $45,000, was issued to the stockholders for their promissory notes, payable one year after date, with interest at the rate of 6 per cent-per annum. Petitioner contends that it is entitled to have the face value of the notes in the amount of $45,000, included in its invested capital for the purpose of computing its profits tax for the fiscal years ended in 1919 and 1920. The respondent refused to include the notes in petitioner’s invested capital, but allowed the full amount of all payments made on the notes from the dates of such payments. Respondent urges that the petitioner is not entitled to have the notes included in its invested capital for the years in question, either at their face value or in any amount, for two principal reasons: First, because the statutes of the State of Missouri provide that no note given by any stockholder of a corporation shall be considered as payment of any part of the capital stock; and second, because the notes were not otherwise bona -fide paid in for stock.

The Revenue Act of 1918 provides, in section 326 (a), that invested capital for any year means, among other things, (1) actual cash bona fide paid in for stock or shares, and (2) actual cash value of tangible property other than cash, bona fide paid in for stock or shares, at the time of such payment. Section 325 (a) of the same Act provides that the term “ tangible property ” means, among other things, notes and other evidences of indebtedness.

Under the provisions of the sections of the Act referred to, petitioner is clearly entitled to have included in its invested capital the actual cash value of the notes in question, at the time they were paid in, if they were in fact bona fide paid in for stock or shares. As affecting the question of whether the notes were so bona fide paid in, we will consider first the provisions of the Missouri statutes (Revised Statutes of Missouri, 1919), which in pertinent parts read as follows:

Sec. 9740. * * * The stock or bonds of a corporation shall be issued only for money paid, labor done or property actually received. * * *
Seo. 10155. * * * No note or obligation given by any stockholder, whether secured by deed of trust, mortgage or otherwise, shall be considered as payment of any part of the capital stock, and no loan of money shall be made by the corporation to any stockholder therein * * *

Our attention has not been called to, nor have we been able to find, any reported case in which the Missouri courts have passed on the validity of a note given for stock of a Missouri corporation, contrary to the above-quoted statutory provisions. However, the New York Stock Corporation Law contains a similar provision, in that it prohibits any stock corporation or officer thereof from receiving any note or other evidence of debt in payment of any installment or any part thereof due or to become due on any stock in such corporation; and in considering the effect of the New York State law, we said, in the Appeal of Hewitt Rubber Co., 1 B. T. A. 424, at page 430:

We reach the conclusion that Congress intended by the language used in section 326 (a) [Revenue Act of 1918] that for the purpose of computing the profits tax, notes in reality and without fraud or collusion paid in for stock should be included in invested capital unless such sale of stock is rendered absolutely void by positive statute.
We do not believe that the New York State statutes relating to the issuance and sale of stock in any way conflict with the conclusion reached because:
(1) Congress has laid down a rule in clear and unambiguous terms for determining invested capital of corporations and where all requirements of that rule are met, a State statute imposing certain restrictions upon corporations for the purpose of enforcing full payment for its stock, designed and intended to serve an entirely different purpose, can not operate to nullify the plain provisions of the Federal statute.
(2) The statutes of the State of New York do not make void a bona fide sale of an original issue of stock by a corporation paid for by a promissory note of a responsible and solvent maker. They were intended merely to circumscribe the transaction with certain restrictions to prevent fictitious sales, to enforce full payment of subscriptions and to make the directors and officers personally liable for the protection of stockholders and creditors of the corporation.

This same question was considered at length in Max Kaufman & Co. v. Bowers, 11 Fed. (2d) 662; 5 Am. Fed. Tax Rep. 5909, and the court reached the conclusion “ that, while the directors may have violated the provisions of the New York State law, and thereby subjected themselves to possible penalties, that fact would not make the notes void. * * * The notes were enforceable in the hands of the corporation.”

The statutes of Pennsylvania provide (P. L. 30, sec. 4) that “ no such corporation shall issue either bonds or stock except for money, labor done, or money or property actually received, and all fictitious increase of stock or indebtedness in any form shall be void;” and (P. L. 56, sec. 1) that “ No note or obligation given by a stockholder, whether secured by pledge or otherwise, shall be considered as a payment of any part of the capital stock.”

In considering the effect of the Pennsylvania statutes above quoted, we held in American Steel Co., 1 B. T. A. 839, that they did not make void a bona fide sale of stock for a note, and that such a note was enforceable by the corporation against the maker thereof, citing-authorities.

The same rule applies in the instant case, and we, therefore, hold that the Missouri statutes do not operate to prevent the inclusion of the actual cash value of the notes in question in petitioner’s invested capital for the fiscal years 1919 and 1920, under section 326 (a) of the Revenue Act of 1918, if they were in fact bona fide paid in for stock.

There remains for consideration, then, only the question of whether the notes were bona fide paid in for stock, and if so, the actual cash value thereof at the time of such payment.

The evidence shows that the notes were dated September 5, 1918, and were due and payable one year after date, with interest at the rate of 6 per cent per annum. The makers of the notes were at all times fully able financially to pay them. When the notes matured and became payable on September 5, 1919, the sum of $3,500 had been paid and- credited on the note given Parnham for. the stock issued in his wife’s name. This was less than one-half of the principal amount of the note, and the payments were made by charges against the credit balance of Parnham’s account on the petitioner’s books. No payments whatever had been made at that time on the other notes, except interest. The record before us does not disclose that the petitioner treated the notes in a practical way as capital assets, or used them in its business as a basis for credit, or in any other manner; nor does the record show that any demand for payment of the notes was made. On July 19,1920, more than 10 months after the notes became due, petitioner declared a cash dividend in the amount of $13,686.29, which the stockholders applied as payments on their notes. Parnham continued to make payments on his note, by charging the sum of $350 per month against the credit balance of his account, until the full amount of $7,620.48 had been paid, together with the interest. This sum, plus the dividend of $13,686.29 made a total of $21,306.77 paid on the notes, and the unpaid balance of $23,693.23 was finally canceled by the corporation and a proportionate amount of the stock retired on December 30, 1921, more than two years and three months after the notes had become past due. During all of this time the petitioner continued to borrow money from the bank on which to operate its business, paying the bank interest at the rate of 8 per cent per annum, while the notes of the stockholders bore interest at the rate of 6 per cent per annum, and no demand for payment of the notes was made, although the makers were solvent and able to pay them.

In the case of Max Kaufman & Co. v. Bowers, supra, it was held that interest-bearing demand notes, given to a New York corporation in good faith for stock, were properly included in invested capital. However, the court in its opinion laid stress on the fact that the notes were actual assets of the corporation, and were subsequently fully paid in cash,” and that “they were actually used as money capital, being made the basis of buying credits.”

In the Appeal of Hewitt Rubber Co., supra, we held that an interest-bearing demand promissory note of a responsible and solvent maker actually and in good faith paid in for stock constituted invested capital. In that connection, we said:

The evidence introduced by taxpayer clearly shows that the sale of the 10,000 shares of 8 per cent cumulative preferred stock by the taxpayer and the purchase thereof at par by H. H. Hewitt and paid for by his demand note for $1,000,000 was a real transaction, entered into in good faith, without fraud, deceit, or collusion; that the stock was actually and in good faith issued by the corporation to Mr. Hewitt; that the $1,000,000 demand note was carried on the books of taxpayer as an asset; that the regular quarterly dividends were •paid on the stock, and that the entire note with interest was paid within the year. There is not a scintilla of evidence in the record to indicate that the purchase and sale of the stock was mala fide; not a real transaction, or that it was not entered into in good faith, and for the best interests of the taxpayer.

Cf. Appeal of American, Steel Co., 1 B. T. A. 839; Cross Mountain Coal Co. 2 B. T. A. 587.

In the Appeal of Stamey-Mackey Construction Co., 4 B. T. A. 383, we held that interest-bearing demand promissory notes of solvent and responsible makers, actually and bona fide paid in for preferred stock of a Kansas corporation constituted invested capital. In considering the bona fides of the transaction in that case, we said :

The case for the petitioner in the present appeal is stronger than in the Cross Mountain Co. appeal, for here we have the petitioner making use of the notes to increase its working capital. There is nothing in the record to show that this transaction was not entirely in good faith between the petitioner and the holders of its preferred stock; that it was not a real transaction, or that it was not entered into for the best interests of the petitioner.

In the Appeal of Citizens Underwriters Agency, 2 B. T. A. 1116, we found, inter alia, the following facts:

The taxpayer carried on its books, as bills receivable, $5,350, representing demand notes from stockholders given in 1907 for stock. These notes were never paid, although the makers were financially responsible, nor was demand ever made for payment, the taxpayer having borrowed money for its own use during the period.

We held that the notes in that case were not bona fide paid in for stock.

In the case under consideration, the makers of the notes were the stockholders, directors and officers of the corporation, and had the full and unrestricted control of its affairs. No cash payments were ever made at any time on the notes, other than the cash dividend declared by petitioner, which appears to have been passed to the credit of the stockholders and then charged against their accounts as payments on the notes. With the exception of the Parnham note, on which $3,500 was paid by charges against his account, no payment of any kind was made on the notes until long after they were past due. The makers of the notes, in their capacity as officers of the corporation, did not permit petitioner to use the notes to increase its working capital, notwithstanding the fact that during the entire period intervening between the date of the notes and the date of their cancellation more than three years later petitioner was in such urgent need of additional capital that it was compelled to borrow money from the bank at a higher rate of interest than that received by it on the notes.

In the light of these facts, we are impelled to the conclusion that the notes in question were, not bona fide paid in for stock or shares.

It follows that the action of the respondent in regard to the seoond issue is affirmed.

Judgment will be entered for the respondent.

Considered by Smith and Littleton.


text:
    Zouri Drawn Metals Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4908.
    Promulgated October 17, 1927.
    Depreciation and obsolescence of certain assets determined. Evidence not sufficient to establish value of good will and patents.

      Lawrence H. Cake, Esq., for the petitioner.

      L. L. Eight, Esq., for the respondent.
    The respondent asserts a deficiency in income and profits tax for the year 1920 in the amount of $4,824.38. Two issues are involved:
    (1) The deduction from gross income of an amount alleged to represent obsolescence of assets discarded in the taxable year, and
    (2) the value for invested capital purposes of certain patents acquired at date of incorporation in exchange for stock.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation with its principal office at Chicago, where it is engaged in the manufacture and sale of metal products, and in construction and building operations. It was incorporated in January, 1913, with a capital of $100,000. divided into 1,000 shares of the par value of $100, each, as the successor of two corporations theretofore engaged in similar activities.
    At the date of its incorporation the petitioner purchased the assets of the Drawn Metals Co., a corporation, consisting of machinery, patterns, tools, equipment, office furniture, fixtures, supplies, and good will, and issued in payment therefor, 248 shares of its capital stock, of which 20 shares were issued for good will and the remaining 228 shares for tangible property. At the same time it purchased from the Zouri Manufacturing Co. certain equipment, patterns, office furniture and fixtures, machinery and tools, and 13 patents covering processes in the production of drawn metal work and issued, in payment therefor, 324 shares of its capital stock, of which 250 were issued for patents, 54 for tangible assets, and 20 for good will. At the same date it sold 428 shares to one of the incorporators at par for cash.
    From the date of its incorporation until December 31, 1920, the petitioner acquired certain dies for use in its operations at a total cost of $21,630.14. Such dies were worthless for its purposes at December 31, 1920, and, at that date, had salvage value as junk in the amount of $746.53. These dies had an average, useful life of 10 years. The original cost, dates of acquisition, depreciation for each year, accumulated depreciation, and depreciated cost at December 31, 1920, are set forth below:

    In its income and profits-tax return for 1920, the petitioner included $27,000 in its invested capital, representing the value of good will and patents acquired for stock at date of incorporation, and deducted the amount of $27,849.74 from its gross income as a reasonable allowance for exhaustion, wear and tear, including a reasonable amount for obsolescence of assets used in its trade or business. Upon audit of such return, the Commissioner excluded $27,000 from his computation of invested capital, and disallowed $15,855.87 of the amount claimed as a deduction for obsolescence, added such amount to gross income and determined the deficiency here in controversy.
   OPINION.

Lansdon:

We are convinced that at December 31, 1920, certain dies, acquired by the petitioner at a cost of $21,630.74, were discarded and that at that date such assets were worthless and had only a salvage value, which w® have found was $746.53. It appears from the evidence that the petitioner carried these dies on its books at cost and that it had never taken depreciation thereon. From the evidence we conclude that the average useful life of the discarded assets was ten years and by computation we have determined that depreciation thereon at December 31,1920, had accrued in the amount of $9,276.93. It follows, then, that the unextinguished useful value of such property at the close of the taxable year was $12,353.21. Changes in the art in which they were employed had rendered these dies obsolete. Under the provisions of section 234(a) (7) of the Revenue Act of 1918, the petitioner is entitled to deduct their depreciated unextin-guished cost, less salvage, from the gross income for the taxable year.

In support of its estimate of the alleged value of certain patents and good will acquired for stock at date of incorporation, the petitioner introduced the evidence of two patent attorneys. Each testified that in his opinion the patents in question had a cash value of at least $25,000 at the date of acquisition. It is apparent from the testimony that these witnesses were more expert in the determination of the validity of patents than of the cash value of such property. This evidence has very little evidentiary weight. The only additional proof offered was that at the date of organization one of the incor-porators bought 428 shares of the capital stock of the petitioner at par for cash. As no shares were offered or sold to the public, we can not regard this transaction as evidence of the value of the intangibles that were included among the assets of the corporation. As the statute provides that assets purchased for stock at the incorporation of a company can be taken into invested capital only at their actual cash value, it is the petitioner’s burden to prove such value. We are not convinced that this has been done.

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

Considered by Green and Arundeel.


author: ARundbll :

text:
    Fuller Brush Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10487.
    Promulgated October 17, 1927.

      Warren M. Brown, G.P. A., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
    The Commissioner had determined a deficiency in income and profits taxes for the year 1921 in the amount of $27,871.66. The only question in dispute is the deductibility of $40,000, representing an estimate of the bonus to be paid in the year 1922 to certain employees of the petitioner provided certain conditions were fulfilled.
    FINDINGS OF FACT.
    Petitioner was organized under the laws of the State of Connecticut and had its principal offices at Hartford.
    Beginning with January 1, 1921, petitioner instituted a system of annual bonuses to sales representatives based on sales made, payable at the close of each employee’s fiscal year, if such employee was in petitioner’s employ an entire year. At the close of the year 1921, bonuses in the amount of $56,449.17 were paid to sales representatives who had been with the petitioner during the entire year of 1921 and who had sold the required amounts of merchandise to place them in the bonus class. For the salesmen who entered the employ of petitioner during the year 1921, and whose year of employment did not end until some time during the year 1922, an estimated reserve of $40,000 was set up on the books of petitioner to provide for the amount of bonus which, based on the amount of sales made, would have been attributable by apportionment to 1921 and a charge in this amount was made against profit and loss.
    The Commissioner disallowed as a deduction the reserve of $40,000.
   OPINION.

ARundbll :

We have held that contingent reserves may not be deducted from income under the several revenue acts. Consolidated Asphalt Co., 1 B. T. A. 79; Uvalde Co., 1 B. T. A. 932; Pan-American Hide Co., 1 B. T. A. 1249; M. I. Stewart & Co., 2 B. T. A. 737; Crescent Cotton Co., 5 B. T. A. 850.

Before an employee became entitled to a bonus he must have remained in petitioner’s employ for at least one year and must moreover have sold a certain amount of merchandise. On December 31, 1921, none of the employees for whom the reserve of $40,000 was established had been in petitioner’s employ for one year and no evidence was introduced as to the volume of their sales, or indeed what amount of merchandise they must sell to entitle them to a bonus. Petitioner’s liability being purely contingent, the deduction was properly disallowed.

Judgment will be entered for the respondent.

Considered by Lansdon and Green.


author: Akundell :

text:
    Moses Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 12122.
    Promulgated October 17, 1927.

      Moses Miller pro se.

      W. F. Gibbs, Esq., for the respondent.
   Akundell :

The respondent has determined a deficiency in income tax for the year 1921 in the amount of $250.69. The case was submitted on the pleadings.

FINDINGS OF FACT.

Petitioner was the owner of a one-half interest in certain real estate which was sold in 1921. Petitioner reported a profit from the sale of this property in the amount of $1,080.90. The respondent computed a profit to petitioner on this transaction in the amount of $3,836.87. The increase in the profit determined by the respondent over that reported by petitioner resulted from the respondent taking into consideration the allowance for depreciation on the property during the period petitioner was the owner of an undivided one-half interest in the same.

Judgment will be entered for the respondent.

Considered by Lansdon and Gkeen.


author: Akundell:

text:
    J. L. Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10748.
    Promulgated October 17, 1927.
    March 1, 1913, value of land determined.

      Franklin T. Duprew, Esq., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
   Akundell:

The Commissioner has determined a deficiency in income taxes for the year 1919 in the amount of $2,066.95.

The only question in dispute is the March 1, 1913, value of a tract of land which petitioner sold in 1919.

FINDINGS OF FACT.

Petitioner acquired prior to March 1, 1913, approximately 600 acres of land. Subsequent thereto he placed improvements on the land to the value of $10,400. In 1919 he sold the property for an agreed price of $60,000 and received in part payment certain notes, which notes were, within the taxable year sold at a discount of $5,000, making the net amount realized from the sale $55,000.

The land lies on a divide between the Black River and the Cape Fear River in Arnett County, 1ST. C. It is comparatively level and all but 50 acres is adaptable for the raising of crops. Tire soil is a sandy loam particularly suitable for the cultivation of tobacco, cotton and corn.

The land is located about twro miles from the town of Angier, which was incorporated in 1901 and in 1913 contained between 400 and 500 people. In 1907 there was erected in Angier a High School which was attended by the children of the farmers in the neighborhood. A railroad runs through the property and a railroad siding is located on it. These facilities were constructed prior to March 1, 1913. In 1910 a number of people interested in the raising of tobacco moved into the neighborhood of the petitioner’s land and in the same year a tobacco market was established some 7 or 8 miles away. This movement served to create an interest in the land for the growing of tobacco and caused land values to materially increase.

In determining petitioner’s tax liability respondent placed a value on the land as of March 1,1913, of $24,000. The fair market value as of March 1, 1913, of the 600 odd acres of petitioner’s land which he sold in 1919 was $40,000 and this figure should be used in determining his taxable profit on the sale. The cost of the land was less than its value on March 1,1913.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Lansdon and Gkeen.


author: Trammell:

text:
    Jefferson Planting & Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9600.
    Promulgated October 17, 1927.
    Actual cash values placed by respondent on land, plantation improvements and* sugar factory at the time of acquisition in 1903 by petitioner in exchange for its capital stock approved.

      George O. H. Kernion, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes of $10,269.02, $17,086.65, and $1,661.01 for the years 1917, 1918, and 1919, respectively. The deficiencies result from the respondent excluding from petitioner’s invested capital for each year an amount of $257,230.17, which the petitioner contends represented paid-in surplus, at the time of its organization in January, 1903.
    FINDINGS OF FACT.
    In December, 1902, E. Godfrey Robichaux purchased for $120,000 from the Willswood Planting & Refining Co. a sugar plantation, known as the Willswood Plantation, consisting of 3,700 acres of land with certain plantation improvements and a sugar factory of an estimated capacity of 800 tons, located about 10 miles from New Orleans, La. Thereafter, before the end of the year, he sold a one-fifth interest in the plantation to each of four other parties for $24,000 cash or a total of $96,000, retaining a one-fifth interest.
    In January, 1903, Robichaux and his associates formed the petitioner corporation, which was incorporated under the laws of Louisiana with a capital stock of $120,000. The incorporators then on January 21, 1903, transferred their interests in the Willswood Plantation to the petitioner for its stock amounting to $120,000 par value. In November, 1904, Robichaux and two of the stockholders bought the stock of the two other stockholders on the basis of $325 for each $100 originally invested.
   OPINION.

Trammell:

The petitioner contends that in January, 1903, when it exchanged its capital stock of the par value of $120,000 for the assets set out in the findings of fact those assets had an actual cash value of $377,230.17, or a value of $257,230.17 in excess of the par value of the stock issued therefor, which amount it contends represents a paid-in surplus and that it is entitled to have the amount included in its invested capital, for the years 1917, 1918, and 1919. In an audit of the petitioner’s returns for these years, the respondent excluded the amount in excess of the par value of the stock from invested capital on the ground that the petitioner had failed to establish that the assets acquired at the time of their acquisition by the corporation had any value in excess of the par value of stock issued therefor, and allocated to the assets values in the following amounts:

Depreciable assets-.-$79, 600
Mules_ 12,500
Seeds_ 1, 000
Land_- 26, 900
120,000

The keystone upon which petitioner rests its contention for the paid-in surplus of $257,230.17 is a retrospective appraisal made in 1924 of its assets as of January 21, 1908, concerning which appraisal there was considerable testimony, but which appraisal was not introduced in evidence. The person in charge of making the appraisal testified with respect to the manner of making it and to reproduction cost of the various assets less an estimated amount for depreciation as shown thereon, but did not express an opinion as to the correctness of the figures, or as to the value of the assets at the time acquired.

In our opinion the evidence relating to the value on January 21, 1903, of the sugar factory and plantation improvements is not sufficient to sustain petitioner’s contentions. We know nothing as to what the plantation improvements consisted of, when they were made, how long they had been in use, the amount of depreciation actually sustained, the purpose for which used, or their condition as of January 21, 1903.

While the person who had charge of making the appraisal expressed no opinion as to the values of the assets, he did testify as to the sales of land similarly situated and comparable with the land acquired by the petitioner. This testimony would tend to show that the land in controversy might have been worth at least $35 an acre, but actual transactions involving the land in controversy is stronger evidence and carries more weight than transactions relating to other lands. The particular land in controversy was purchased only a few weeks prior to the time it was turned in to the corporation for stock. The four other individuals bought their interests on the same basis that Robichaux bought the assets.

The person who sold the assets to Robichaux testified that he secured the best price obtainable; that if he could have gotten a better price he Avould have done so. That transaction was between persons dealing at arms’ length who were familiar with the property and was at approximately the time when the corporation acquired the property.

From the evidence in the record it would appear that the sale of the stock in November 1904 at $325 per share represented increased or appreciated values which did not exist in December 1902 or in January, 1903.

We are unable to find from the evidence submitted that the properties received by the petitioner in exchange for its stock had at the time of their acquisition any greater value than that placed on them by the respondent.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by MoRRis and Littleton.