text:
    S. G. Sample Co., Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9272.
    Promulgated January 10, 1927.
    On the evidence, an inventory taken at cost reduced by 25 per cent, representing the estimated decline in market values, does not establish the market price of the goods inventoried.

      O. M. Pasquier, G. P. A., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    This proceeding results from the determination by respondent of a deficiency in income and excess-profits taxes for the calendar year 1920, in the amount of $2,398.57. The question at issue arises over petitioner’s method, of arriving at its closing inventory for the calendar year 1920.
    BINDINGS OF FACT.
    Petitioner is a corporation organized under the laws of the State of Louisiana, having its domicile and principal office at Mansfield, and is engaged in the retail merchandise business, dealing in hardware, shoes, clothing, dry goods and groceries. Petitioner took its inventory as of December 31, 1920, at cost, and deducted 25 per cent of the cost figure to- represent decline in value of goods at an average date during 1920. The total cost of goods on hand on December 31, 1920, amounted to $48,314.08, which was reduced 25 per cent, or $12,078.52, leaving a figure of $36,235.56, which petitioner. used in submitting its income and profits-tax return for the year in question. Merchandise on hand at the close of the calendar year had been purchased in 1920, 1919, and some in still earlier years. Items represented in the inventory were not segregated nor was market determined, but in lieu thereof an estimate that the items had suffered a general decline in value of 25 per cent was held. The various classes of merchandise suffered divergent decline in value during the year 1920.
   OPINION.

Milliken:

Section 203 of the Revenue Act of 1918, as interpreted by the' respondent in article 1582 of Regulations 45, permits inventories to be valued at cost, or cost or market, whichever is lower. There can be no dispute that petitioner was entitled to value the items of its inventories at market, if the market was lower than cost. The difficulty arises by reason of the method adopted in order to arrive at market values. Petitioner did not take the items represented in its inventory and value same at cost or market, whichever was lower, but instead made an estimate that its several types of merchandise suffered a decline in value during the year of 25 per cent. The witness introduced by petitioner testified that some classes of merchandise declined in value less than 25 per cent and other items at more than 25 per cent, and that decline in value was widely divergent as to various types of goods on hand. We are unable to determine from the evidence that the inventory at cost, reduced by 25 per cent, which percentage was the estimated average decline in market price as of that time, represents the market price of the stock inventoried.

Judgment will be entered for the Gommissioner.


source: Caselaw Access Project

author: Trussell:

license: Public Domain

text:
    Appeal of Walter G. Morgan.
    Docket No. 3449.
    Promulgated January 10, 1927.
    1. Notice ojp deficiency.- — A letter prepared in the office of the Commissioner reciting the determination of a deficiency and addressed to a taxpayer residing at Jackson, Tenn., and mailed to the same taxpayer at Jacksonville, Tenn., by registered mail, and later returned by the postal service to the Commissioner’s office undelivered, did not notify the taxpayer of such deficiency as required by section 274 (a) of the Revenue Act of 1924 or section 274 (a) of the Revenue Act of 1926.
    2. The same letter remailed by the collector of internal revenue for the district of Tennessee to the same named taxpayer at his address in Jackson, Tenn., is the notice of deficiency required by the above-named sections and is effective as of the date when registered and placed in the mails at Nashville, Tenn.
    3. Statute oe limitations. — This taxpayer filed his income-tax return for the calendar year 1919 with the collector of internal revenue at Nashville, Tenn., on March 3, 1920. The deficiency letter mailed on April 1, 1925, was mailed after the expiration of the five-year period of limitation provided in section 277 of the Revenue Acts of 1924 and 1926, and on that date the Commissioner was barred from making any assessment or taking any proceeding for the collection of a deficiency in taxes for the year 1919.

      FranJc G. Olive, Esq., for the petitioner.

      L. G. Mitchell, Esq., for the Commissioner.
    The deficiency letter upon which this appeal is based asserted a deficiency in income taxes for the year 1919 in the amount of $18,261.34; overassessment for the year 1920, $2.80; overassessment for the year 1921, $7.67. The petitioner pleaded the bar of the statute of limitations as a complete defense to the alleged deficiency for the year 1919. He also pleaded, and at the trial was ready to prove, facts which he held would show that no deficiency existed.
    The trial proceeded with the hearing of evidence and argument upon the matter of the running of the statute of limitations, which was taken under advisement.
    BINDINGS OP FACT.
    The taxpayer is an individual residing in Jackson, Tenn.
    On February 20, 1925, the Commissioner mailed, in Washington, D. C., a registered letter showing the determination of a deficiency against the taxpayer in income and profits taxes for the year 1919 in the amount of $18,261.34. The records of the City Post Office at Washington and the receipt returned to the Commissioner show that the letter was addressed to “Mr. Walter G. Morgan, 553 East Main St., Jacksonville, Tennessee.” The letter reads as follows:
    IT: PA-4-60D IMG — 401 Treasury Department,

      Washington, Fel). 20, 1925.

    Mr. Walter G. Morgan,

      558 Fast Main Street, Jackson, Tennessee.

    Sir : An audit of your income tax returns for the years 1919, 1920 and 1921, in connection with an examination of your books of account and records, discloses a deficiency in tax amounting to $18,261.34 for 1919 and overassess-ments amounting to $10.47 for 1920 and 1921, as shown in the attached statement.
    In accordance with the provisions, of Section 274 of the Revenue Act of 1924, you are allowed 60 days from the date of mailing of this letter within which to file an appeal to the United States Board of Tax Appeals contesting in whole or in part the correctness of this determination.
    Where a taxpayer has been given an opportunity to appeal to the United States Board of Tax Appeals and has not done so within the 60 days prescribed and an assessment has been made, or where a taxpayer has appealed and an assessment in accordance with the final decision on such appeal has been made, no claim in abatement in respect to any part of the deficiency will be entertained.
    If you acquiesce in this determination and do not desire to file an appeal, you are requested to sign the inclosed agreement consenting to the assessment of the deficiency and forward it to the Commissioner of Internal Revenue, Washington, D. C., for the attention of IT: PA-4-60D, IMG-401. In the event that you acquiesce in a part of the determination, the agreement should be executed with respect to the items agreed to.
    Respectfully,
    D. H. Blair, Gonmvissioner.

    By (Signed) J. G. Bright

      Deputy Commissioner.

    Inclosures: Statements. Agreement-Form A.

      Upon the original manuscript of the above-quoted letter there are unmistakable evidences of erasures and rewriting in the line of the address where the words “Jackson, Tennessee,” now appear. Immediately following the letter “n” in the word “Jackson” there is plainly visible the outline of the letter “ v ” over which there appears to have been struck a comma, and the roughness of paper produced by the erasures continues over a large part, if not all, of the space now occupied by the word “ Tennessee.” Similar evidences of erasures and re-writing appear at the top of page 1 of the statement accompanying the letter.
    The letter quoted was returned to the Commissioner undelivered, and on March 20, 1925, it was enclosed with the following letter directed to the collector of internal revenue at Nashville, Tenn.:
    March 20, 1925.
    Collector oe Internal Revenue,

      Nashville, Tennessee.

    Dear Sir: A letter was addressed by this office to Mr. Walter G. Morgan, 553 Bast Main Street, Jackson, Tennessee, showing an additional tax liability of $18,261.34 for the year’ 1919. The letter was returned to the Bureau undelivered by the Post Office Department. The above address is the same as the one shown on the taxpayer’s 1921 return.
    It is requested that you ascertain the present address of the taxpayer, make delivery of the enclosed letter by registered mail, and advise this office as to the result of your investigation and the action taken by you.
    In the event that the enclosed letter can not be delivered to the taxpayer, it should be returned to this office, inasmuch as the statutory period for the year 1919 expires presently, and you are advised that the latest date on which the letter can be delivered is April 15, 1925.
    (Sgd.) J. G. Bright,

      Deputy Commissioner.

    By-,

      Bead of Division.

    A stamp appearing on the face of the deficiency letter shows that it was received in the office of, the collector at Nashville on March 23, 1925. On April 1, it was sent by registered mail to the taxpayer at Jackson, Tenn., and was received by him on April 2.
    The taxpayer’s income-tax return for 1919 was filed with the collector of internal revenue at Nashville on March 3, 1920.
   OPINION.

Trussell:

The petitioner has interposed a plea-of the statute of limitations. Section 277 (a) of the Revenue Act of 1924 reads in part as follows:

(2) The amount of income, excess-profits, and war-profits taxes imposed by the Act entitled “An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes,” approved August 5, 1909, the Act entitled “An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes,” approved October 3, 1913, the Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, and by any such Act as amended, shall be assessed within five years after the return was filed, and no proceeding in court for the collection of such taxes shall be begun after the expiration of such period.

It is admitted that the petitioner’s return for 1919, the year here involved, was filed on March 3, 1920, and that the five-year period expired on March 3, 1925.

The Commissioner takes the position that in this case February 20,1925, is the date of mailing the notice required by subdivision (a) of section 274 of the Revenue Act of 1924, which reads in part as follows:

If, in the case of any taxpayer, the Commissioner determines that there is a deficiency in respect of the tax imposed by this title, the taxpayer, except as provided in subdivision (d), shall be notified of such deficiency by registered mail, but such deficiency shall be assessed only as hereinafter provided. Within 60 days after such notice is mailed the taxpaj'er may file an appeal with the Board of Tax Appeals established by section 900.

From this subdivision it is apparent that the duty imposed on the Commissioner after a deficiency is determined is that of notifying the taxpayer, and the method of notification is prescribed to be by registered letter.

It is not denied that the Commissioner prepared a notice of his determination of a deficiency in taxes and that such notice was intended for the petitioner in the instant case; that said notice was dated February 20, 1925; and that it was delivered to the post office at Washington to be forwarded as a registered letter. The record establishes the fact that this letter was addressed to “ Mr. Walter G. Morgan, 553 East Main Street, Jacksonville, Tennessee.” The record further establishes the fact that the postal service, after having failed to find any person by that name at Jacksonville, Tenn., returned the letter to the office of the Commissioner undelivered; that thereafter the same letter, or the same letter with its address corrected, was forwarded to the collector of internal revenue at Nashville, Tenn., who mailed it to the petitioner at his residence in Jackson, Tenn., this last mailing having been done on April 1, 1925. April 1, 1925, was more than five years after the petitioner’s return for the year 1919 had been filed with the collector of his district. We are entirely satisfied from the record that the Commissioner’s letter dated February 20, 1925, was addressed to a person by the name of Walter G. Morgan- at Jacksonville, Tenn., and we are further satisfied that when that letter was returned to the Commissioner’s office the address “ Jacksonville, Tennessee,” was partially erased and rewritten to read “ Jackson, Tennessee.” There is no doubt that the Commissioner’s office made a mistake in the original writing of the address of the said letter of February 20, 1925. Such mistakes can not be construed to have the effect of arresting the running of the statute of limitations. This taxpayer was not notified of the proposed deficiency by the mailing of the erroneously addressed deficiency letter on February 20,1925. When this same letter had been corrected and remailed on April 1,1915, the five-year period of the statute of limitations had run, and we are, therefore, of the opinion that there is no deficiency against this petitioner for the calendar year 1919.

Judgment will be entered for the petitioner in due course.


author: Green:

text:
    Edgar P. Haney and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3486.
    Promulgated January 10, 1927.
    1. Payments of $3,065.30 and $1,066.96, received by the petitioner, Edgar P. Haney, in the years 1919 and 1920, respectively, were not salary.
    2. Held, that the amount of $10,000 was erroneously included in gross incpme.
    3. The determination of the Commissioner in all other respects is approved because of insufficient evidence to support the petitioners’ contentions.

      Don T. Haynes, Esq., and Clinton E. Smith, O. P. A., for the petitioners.

      Robert A. Littleton, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies ifi income tax for the calendar years 1919 to 1921, inclusive, in the total amount of $2,778.15. A deficiency of $1,400.03 was determined against the petitioner, Edgar P. Haney, and a deficiency of $1,378.12 against his wife, Maude Haney. The entire deficiency is in dispute. The controversy arises over:
    (1) The sum of $3,065.30, which the Commissioner included in the petitioners’ income for 1919 as salary received by Edgar P. Haney from the Burkburnett Home Oil Co., and the sum of $1,066.96 similarly included in income for 1920.
    (2) The sum of $7,000 which the Commissioner charged to the petitioners in 1919 as profit from the sale of a newspaper.
    (3) The sum of $11,816.92 and the sum of $9,018.55, which were charged to the petitioners in 1919 and 1920, respectively, as income. The amounts were unexplained bank deposits.

      (4) The refusal of the Commissioner to allow a loss of $4,000 in 1920, when the petitioners claim that the stock in the Burkb'urnett Home Oil Co. of this amount held by them became worthless.
    FINDINGS OF FACT.
    The petitioners, Edgar P. Haney and Maude Haney, are husband and wife residing at Wichita Falls, Tex. It is conceded that all of the income here involved was income to the marital community. All of the business of the community was carried on by the husband.
    Edgar P. Haney was a stockholder in and president of the Burk-burnett Home Oil Co. His stock was acquired by purchase at prices ranging from $100 to $150 per share. The total par value of the stock purchased by him was between $4,000 and $5,000. His wife and children were stockholders. The number of shares held by Haney, his wife, or his children, can not be ascertained from the record. In 1920 it was fully ascertained that the properties of the oil company were valueless and the stock of the company became worthless in that year.
    Haney, although president, devoted little, time to the company. He was paid no salary during the years 1919 and 1920. It was the practice of Haney and another officer of the company to advance money to the company when it lacked funds Sufficient to meet its current obligations or make purchases. The amounts so advanced were refunded from time to time as the company was able to pay. The amounts so repaid were treated as payments of salary by the revenue agent and the Commissioner and included in income.
    Prior to 1917 a partnership composed of Edgar P. Haney and others owned a newspaper.. In 1917'the News Tribune Publishing Co. acquired the newspaper in exchange for its stock of the par value of $20,000. Edgar P. Haney was the principal partner in the partnership and he, with his wife and children, owned practically all the stock of the publishing company. The assets exchanged were worth the par value of the stock issued therefor. At the time of the exchange, stock of the par value of $19,000 was issued to Haney.
    In 1919 the assets of the corporation were sold for a total .consideration of $40,000. The purchaser, in payment of a part of such consideration, assumed obligations in excess of $20,000 and paid the balance in several cash payments. The first cash payment was in the sum of $10,000 made soon after the contract of sale was made, and the others were made in small amounts over a period of time. After the payments were completed the corporation dissolved and liquidating dividends were paid to Haney and wife in the sum of $17,000. In his computation of gain resulting from the.sale, the Commissioner included the $10,000 cash payment as income to the petitioners as moneys paid directly to them.

      During the years in question Haney was engaged in the real estate, loan, collection, and stock brokerage business in and around Wichita Falls. In the regular course of his business he collected money belonging to his customers or patrons and deposited it in his own bank account. These amounts he subsequently disbursed. The Commissioner included in income for the years 1919 and 1920, $11,816.92 and $9,018.55, respectively, as unexplained bank balance.
   OPINION.

Green:

We are satisfied from the evidence that the petitioner was paid no salary by the Burkburnett Oil Co. in 1919 or in 1920 and that the amounts paid to him by that company were reimbursements for expenditures made by him for the company. Such amounts were improperly included in income.

The evidence introduced to establish the loss alleged to have been sustained on the Burkburnett Oil Co. stock is very unsatisfactory and confusing. Undoubtedly a loss was sustained. No records of the cost of this stock were produced at the hearing. Haney testified that he paid at least par for the stock. He likewise testified that he had invested from $4,000 to $5,000 in this acquisition. It also appears that he made gifts of a part of this stock to members of his family. We are thus in the situation of knowing that the petitioner acquired stock without knowing either the cost per. share or the total purchase price and that he gave a part of it to members of his family without knowing the number of shares thus disposed of. Under such circumstances we can not determine the loss, if any, to him or his wife, and, therefore, affirm the' Commissioner on this point.

The evidence with reference to the sale of the assets of the News Tribune Publishing Co. is equally confusing. The petitioner produced no records to confirm his testimony as to the cost of the assets transferred to the corporation. He testified that it was a partnership but did not state his proportionate interest therein and claims to have advanced some $6,000 to the corporation at some time not disclosed. It appears that his wife and children <?wn some of this stock but the amount of their holdings can not be determined. We can not determine the amount of cash over and above the indebtedness received by the corporation. The only thing established by the evidence is that the $10,000 cash payment which the revenue agent included in the income of the petitioners was not in fact paid to them, and we conclude that the petitioners’ income from this transaction should be reduced by the amount of $10,000, it being apparent that this amount was included in the amounts distributed by the corporation in liquidation. We must approve the Commissioner’s determination of income from this transaction in all other respects.

The Commissioner added to income substantial amounts which he found to have been deposited by the petitioner in his bank account. A large part of those amounts was money which was received by the petitioner in the course of handling business for others and was not income, but the evidence is wholly insufficient to enable us to determine what amounts should not have been included in income, and we therefore affirm the Commissioner as to this point.

Judgment will be entered after 16 days’ notice, under Rule 50.


author: Morris:

text:
    Appeal of Shope Brick Co.
    Docket No. 6531.
    Promulgated January 10, 1927.
    1. The value of United States and Canadian patents paid in to a corporation for a' consideration of $1 and $2, respectively, may not be included in invested capital under the Revenue Acts of 1918 and 1921 as a paid-in surplus.
    2. March 1, 1913, value of patents determined.

      Frederich L. Pearce, G. P. A. and George M. Morris, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    This is an appeal from the Commissioner’s determination of a deficiency of $9,550.02 income and profits taxes for 1919, 1920 and 1921. The petitioner alleges that the Commissioner erred in refusing to allow a paid-in surplus for intangibles and in disallowing a deduction taken for exhaustion of patents, and that it is entitled to special assessment.
    FINDINGS OF FACT.
    The petitioner is an Oregon corporation, having incorporated on April 13, 1911, under the name of Shope National Concrete Machinery Co. The name was changed to Shope Brick Co. on March 9, 1917, without other amendment to the original charter.
    Prior to 1909, David F. Shope, residing in St. Paul, Minn., had been experimenting with a process for waterproofing brick and cement blocks. Having perfected his process and a machine to manufacture the new type of brick, he applied for letters patent. On July 19, 1910, he was issued United States Patent No. 965,027 for his machine, and on February 28, 1911, United States Patent No. 985,709 for his process. The cement brick machine puts into operation the method of waterproofing cement blocks covered by the basic process, and the former patent is controlled by the latter. Shope also applied for and was issued Canadian letters patent on December 29, 1911, for the machine and on November 19, 1912, -for the process. The life of a Canadian patent is 6 years, with the privilege of renewal for a further term of 12 years, or a total life of 18 years.
    At incorporation, stock in the amount, of $4,961 — 4,961 shares of $1 par value — was issued for the tangible assets of Shope’s brick business in Portland, Oreg. Shope received 10 shares, his wife 4,950 shares, and Robert H, Downes one share.
    At the date of incorporation Shope assigned his two United States patents to the corporation for a cash consideration of $1, no stock being issued therefor. The assignments were recorded in the United States Patent Office on May 15, '1911. Thereafter Shope assigned his Canadian patent applications to the corporation for a cash consideration of $2. The assignment dates of the two applications for patent were July 21, 1911, for the machine, and February 1, 1912, for the process.
    Sales of territorial rights made in the years 1909 to 1918, inclusive, by either Shope or the petitioner under the Shope patents, are as follows:

    Sales of territorial rights under the Shope patents during 1919, 1920 and 1921 were as follows:
    1919-$33,404.45
    1920-:_ 41, 701. 83
    1921--- 48, 862. 77
    The sales of territory were made by Shope, and, after incorporation, by the petitioner, upon a certain well defined basis. Shope could produce brick at a saving of $10 per thousand and it was sold at practically the same prices as brick of similar quality. He figured that a new Shope brick plant should do.a minimum of 10 per cent of the normal business in the territory during its first year of operation. By multiplying 10 per cent of the-face brick consumed within the territory for the preceding year by $10 a thousand, the saving by his process to the manufacturer, he arrived at the price at which he sold the territory. This method of arriving at a sales price has been consistently followed. The experience of the company has been that the actual sales of the licensees reach 10 per cent of the territory. The expenses and overhead in selling the territorial rights amounted to approximately 30 per cent of the sale price.
    The Shope machine was made by contract at a cost of $75. A certain number of machines were sold with each territory. Additional machines could be secured at prices of $175, $200 or $250 each, according to the contracts of sale of the various territories. The Shope machine had an annual capacity of 375,000 bricks, computed upon a basis of 1,500 bricks per day and 250 working days per year. The machine was simple to operate and the work could be done by common labor. The product was a high class face brick that would resist moisture and not absorb it. The bricks were made in 115 sizes and in various colors and shades.
    The value of the United States patents on April 13, 1911, was $5,250; on March 1, 1913, it was this value less depreciation for the period from April 13, 1911, to March 1, 1913. The value of the Canadian patents on March 1, 1913, was $6,105.08.
    The amount allowed by the Commissioner for paid-in surplus resulting from the donation to the petitioner of the two United States patents at the date of incorporation is $1,240. He allowed no amount for paid-in surplus for the two Canadian patents. A March 1, 1913, value was allowed for the United States patents and no value as of that date for the Canadian patents. No allowance for exhaustion of the United States patents was made in determining taxable net income for 1919, but a deduction of $83 was allowed in each of the years 1920 and 1921 for such exhaustion. No allowance for exhaustion of the Canadian patents was made for any of the years in question.
   opinion.

Morris:

At the hearing petitioner withdrew its claim for special assessment, leaving two questions for our consideration, first, whether, under section 326 of the Revenue Acts of 1918 and 1921, petitioner is entitled to a paid-in surplus on the United States and Canadian patents in computing invested capital, and, if so, the amount thereof; and, second, the value, if any, on March 1, 1913, of those patents for exhaustion purposes. In connection with the first point, the Commissioner raised the question at the hearing whether it was proper for him to have included a paid-in surplus of $1,240, resulting from the turning in of tlie two United States patents to the petitioner at the date of incorporation.

Under section 325 of the Revenue Acts of 1918 and 1921, patents are intangible property. We have previously considered the question whether, under the Revenue Acts of 1917 and 1918, intangibles acquired by way of gift may be included in invested capital as paid-in surplus in the Appeal of Herald-Despatch, Co., 4 B. T. A. 1096. In that case we held:

It seems clear to us, however, that in providing for the inclusion in invested capital of intangibles paid in for stock or shares, subject to very specific and arbitrary limitations, Congress intended to exclude intangibles paid in as a gift. It would be absurd construction indeed which would permit the inclusion in invested capital, under very arbitrary limitations, of intangibles paid in for a consideration, and at the same time,permit the inclusion of intangibles paid in as a gift to the full extent of their actual cash value.

As there is no difference between the Revenue Acts of 1921 and 1918 so far as the question under consideration is concerned, that decision is controlling here. The petitioner may not therefore include in invested capital as a paid-in surplus the value of the patents in question, and the Commissioner was in error in including the amount of $1,240 in invested capital as a paid-in surplus for the United States patents.

The petitioner Iras submitted two methods of computation of the values of the patents at the date turned in and at March 1; 1913, which, being based .on anticipated profits and other assumptions, are of little use. The mere stating of them seems to us to be sufficient to show how inherently fallacious the computations and resulting values are. In the first method, the petitioner took the population' of the • territories sold at the time the patents were paid in and found that it represented .6 of 1 per cent of the total population of continental United States. These territorial rights were sold for $7,500. By multiplying this amount by the petitioner found that the sale of rights in the balance of continental United States would bring $1,250,000, which was reduced by 30 per cent, represent-' ing selling cost and overhead, to $875,000. Discounting the latter amount for the life of the patents by Hoskold’s formula, using 8 and 4 per cent, a net value on April 13, 1911, of $421,225 was arrived at. The March 1, 1913, value was computed by the same method and a net value of $265,734 was reached. The Canadian patents were computed for each of the dates as having a net value of $35,919.

The second method consisted of taking the face brick production in the United States in 1911, assuming that the petitioner would produce one-tenth of the face brick produced therein, and multiplying that one-tenth by $7, the difference between the saving of $10 per thousand in the manufacture of its brick, and $3, which represented selling cost and overhead. Petitioner computed this to be $510,937 and, by using Hoskold’s formula, as above, arrived at a net value on April 13, 1911, of $245,965. A like computation for value on March 1, 1913, of the United States patents gave a total of $279,214. In the computations, population and production estimates were secured from publications of the Census Bureau, United States Department of Commerce.

What we said in Appeal of Gamon Meter Co., 1 B. T. A. 1124, 1131, is particularly applicable:

It appears from the evidence that the valuation * * * for the patents at the time paid in was predicated to a considerable extent upon future hopes and nbt altogether upon what the patents were actually worth in cash at that time. The experience of the men interested in the patents perhaps justified their belief that they would ultimately prove successful and result in large earnings, but the Revenue Act contemplates a cash value at the time the patents are paid in.

If the patents are to be valued as of March 1, 1913, the Revenue Act contemplates a cash, value at that time.

Undoubtedly the patents were valuable. Any higher value, however, than that set forth in our findings of fact would be merely speculative and prospective. We have used the actual sales of territorial rights in arriving at our determination, which seems to us to be the only conclusion warranted by the record. Prior to April 13,1911, the only sales made were the three in 1909, amounting to $7,500, which reduced by 30 per cent, representing selling expenses and overhead, gives an amount of $5,250 which we consider the only evidence of value attributable to the patents as of that date. As there were no sales from 1909 until the latter part of 1913, the value of the patents on April 13, 1911, depreciated to March 1, 1913, is taken as the value on the latter date. The March 1, 1913, value of the Canadian patents, which we find to be $6,105.08, represents the sales of Canadian territory less 30 per cent for selling expenses and overhead. In our opinion, the Canadian sales set forth in the findings of fact are close enough to March 1, 1913, to be indicative of value as of that date. The petitioner is entitled to exhaustion, there-’ fore, for the taxable years in question on the March 1, 1913, value of the patents above set forth. The life of the patents should be computed from the date of the process patents for the reason that, although the machine patents would expire some months prior to the process patents, the machine by itself is of little value without the process.

Judgment will Toe entered on 16 days’ notice, wider Rule 60.


author: Trammell:

text:
    Appeal of Robert G. Gordon.
    Docket No. 5806.
    Promulgated January 10, 1927.
    An amount received by an attorney for professional services rendered to the Commonwealth of Kentucky under a contract is not exempt from income tax.

      iS. Lyman Barber, Esq., Robert N. Miller, Esq., and Harry Friedman, Esq., for the petitioner.

      Ellis W. Manning, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency of $1,398.34 for the year 1921, resulting from the Commissioner including in the petitioner’s taxable income an amount of $8,816.79 received during the year from the Commonwealth of Kentucky, for professional services rendered under a contract and in connection with the ascertainment and collection of inheritance taxes due from an estate.
    FINDINGS OF FACT.
    Petitioner is a resident of Louisville, Ky., where during the past twenty-five years he has been engaged in the practice of law.
    Some time prior to October 10,1917, Mrs. Mary Lily Bingham died in Jefferson County, Kentucky, where she had been residing for a number of months. It was known that she had left a large estate. However, it appeared that no substantial portion of it was located in Kentucky. Her will was probated in Florida, and shortly thereafter two trust companies in Louisville engaged in litigation as to which of them was the duly and properly appointed and qualified administrator with the will annexed. Subsequently the will was also probated in Kentucky, and that precipitated a controversy between the two trust companies over their appointment as administrators.
    At this time the Attorney General of Kentucky was in ill health. The condition of the work in his office was such that the three assistants and the clerk regularly provided him by statute had all the work they could properly do.
    In this situation the Attorney General, believing that the matter of the collection of the inheritance tax due from the estate of Mrs. Bingham required special attention, notified the Governor that an emergency existed and requested that additional counsel be appointed.
    The pertinent provision of the Kentucky law relative to the appointment of additional counsel to the Attorney General appears at subsection 5 of section 112 of Carroll’s Kentucky Statutes, and reads as follows:
    The attorney-general and his assistants shall attend to all litigation and business in or out of the state, required of him or them under this act, or other existing law or laws hereinafter enacted, and also any litigation or business that any state officer may have in connection with or growing out of his official duty; and no state officer, board of trustees or the head of any department or institution of the state shall have authority to employ or to be represented by any other counsel or attorney-at-law, unless an emergency arises, which, in the opinion of the attorney-general, requires the employment of other counsel, in order to properly protect the interest of the commonwealth, in which event the attorney-general shall, in writing, setting forth the reasons for such employment, request the governor to employ' such additional counsel.. Before such employment, said written requests shall be filed in the office of the secretary of state, and shall be a public record, and a copy thereof shall be retained and kept on file in the office of the attorney-general.
    Before such counsel is employed, his fee and compensation shall be agreed upon and fixed by written contract by the governor and said counsel, subject to the approval of the attorney-general, and copies thereof shall be kept on file in the office of the attorney-general and the secretary of state.
    Subsequent to notification by the Attorney General that an emergency existed, the Governor of Kentucky, on October 10, 1917, entered into the following contract with the petitioner and two others:
    This contract made and entered into this the 10th day of October, 1917, between A. O. Stanley, as Governor of the Commonwealth of Kentucky, of the first part, and Robert G. Gordon, Iíite Hufiaker and James Garnett, parties of the second part.
    Witnesseth : That whereas the Commonwealth of Kentucky is vitally interested in the collection of the entire amount of the inheritance taxes which may be due it from the estate, heirs, devisees, distributees, legatees and personal representatives of Mrs. Mary Lily Bingham, deceased, late of Jefferson County, Kentucky, and
    Whereas, the Attorney General has delivered to first party his opinion in writing to the effect that such an emergency exists as requires the employment of additional counsel in order to properly protect the interests of the Commonwealth in the premises, and setting forth his reasons therefor and requesting the employment of such additional counsel, which said opinion and request have been filed in the office of the Secretary of State, and a copy thereof retained in the office of the Attorney General, and
    Whereas, the first party concurs in the reasons and conclusions set forth in said request and opinion, and
    Whereas, second parties are regularly licensed and practicing attorneys of the Commonwealth of Kentucky,
    Now, thebefobe, in consideration of the premises and the mutual covenants and agreements hereinafter set out, the parties hereto agree as follows:—
    (1) First party hereby employs second parties as special counsel to represent the Commonwealth of Kentucky in the ascertainment of the amount and collection of inheritance taxes due or which may be due the Commonwealth of Kentucky from the estate or beneficiaries of said Mrs. Mary Lily Bingham, deceased, or the legal representatives of said estate.,
    (2) Second parties agree and bind themselves to
    (a) make a prompt and thorough investigation of the nature and extent of said estate subject to inheritance tax and report the result thereof to said first party and to the Attorney General.
    (b) To render to first party and to the Attorney General, as promptly as pan reasonably be done, an opinion as to the legal rights of the Commonwealth with respect to the collection of said tax, and as to what steps should be taken by the Commonwealth to enforce said collection.
    (c) To institute and conduct in any and all courts within and outside of the Commonwealth any and all litigations which in their judgment or the judgment of the Attorney Genefal may be necessary and proper for the collection of said taxes and for the protection and interest of the Commonwealth.
    (3) All reasonable traveling and other necessary expenses incurred by second parties, both in and out of the State, on business covered by this contract of employment, shall be treated as a part of the consideration for this contract, and a part of the compensation for services rendered, and shall be paid on vouchers approved by first party, when accompanied by receipts as are now required by law for payment of expenses to officers and employees of the Commonwealth. ■ -
    (4) The compensation to be paid by the Commonwealth to the second parties for the services rendered and to be rendered by them under the provisions of this contract shall be as follows:
    (a) Second parties are to receive, jointly, a certain fee o’f Ten Thousand ($10,000.00) Dollars, of which sum Dive Thousand ($5,000.00) Dollars shall be paid upon the execution of this contract, and the balance of Five Thousand ($5,000.00) Dollars on January 1st, 1918, out of the State Treasury, upon vouchers duly approved by first party; and in the event the taxes herein referred to be collected without litigation, or with litigation or other proceedings in the County Court of Jefferson County, Kentucky, only, then said second parties shall receive a sum equal to two and one-half (2⅛) per cent of the amount of taxes collected, less the sum of Ten Thousand ($10,000.00) Dollars, heretofore fixed as a fee certain, said fee to be paid as and when said taxes are collected or their payment secured by bond, as prescribed by the inheritance tax law — that is to say, if said taxes should be collected or secured in parts or installments, second parties shall be paid on account of fee a sum equal to said two and one-half (2½) per cent of such part so paid or secured at the time when same shall be collected or so secured.
    (b) In the event the collection of said taxes should involve litigation in any court or courts other than the County .Court of Jefferson County, Kentucky, then said second parties shall jointly receive, in lieu of the fee equal to the two and one-half (2½) per cent of the amount collected or secured as here-inbefore provided, a sum equal to Five (5) per cent of the aggregate amount of all inheritance taxes collected or secured as above set out, under this contract, less the Ten Thousand ($10,000.00) Dollars above fixed as a fee certain, said fee to be paid at the time and upon the terms and conditions as set out in paragraph (a) immediately preceding.
    (5) Second parties hereby accept the foregoing employment and agree to faithfully discharge the duties thereunder upon the terms and conditions here-inabove set out.
    This contract is executed in four counterparts, one for each of the parties hereto.
    (Signed) A. O. Stanley,
    Governor of the Commonwealth of Kentucky.

    Robt. G. Gordon.
    Hite Htotaker,
    James Garnett.
    Approved October 10, 1917.
    Gharles H. Morris,

      Attorney General.

      Under the above contract the petitioner, in conjunction with the two associate counsel, made investigations which carried him into other States, assisted in filing suits, preparing and trying such suits and in the preparation of briefs in connection therewith. He also signed stipulations and objections as such became necessary during the progress of the suits. The Attorney General supervised in a general way the work of the petitioner. There was no matter of policy in any important feature of the case which was determined upon without the acquiescence of the Attorney General, to whom oral and written reports of the progress -of the case were made. The Attorney General’s name appeared at the top of the list of counsel on all briefs as the chief law officer of the Commonwealth.
    The reasonable traveling and other necessary expenses of the petitioner were paid by the Commonwealth upon submission of vouchers accompanied by receipts, as was required by law for payment of expenses of officers and employees. The same form of receipt book was issued to petitioner as to officers and employees of the Commonwealth. The Attorney General furnished petitioner with a card or certificate showing that he was an employee of the Commonwealth and instructed petitioner, when traveling on business connected with the case, to make affidavit that he was on business for the Commonwealth so that the Federal transportation tax would not attach to his railroad and Pullman tickets.
    The petitioner did not take an oath of office, nor was any commission issued to him. In Kentucky no assistant in the Attorney General’s office is issued a commission or required to take an oath of office.
    Petitioner’s services under the contract continued until February or March, 1920. During this time he maintained his office and continued his law practice. While petitioner always gave precedence to the work arising under the contract, yet he lost no other business on account of the contract. From the time the contract was entered into until his services thereunder were completed, he devoted from 25 to 30 per cent of his time to work arising in connection with it.
    The only services performed by the petitioner for the Commonwealth of Kentucky were those under the contract quoted above.
    During the year 1921 the petitioner received $8,816.79 from the Commonwealth of Kentucky as compensation for services rendered under the contract. In filing his income-tax return for 1921 he did not include this amount as taxable income. The Commissioner included the amount as taxable income on the basis that it did not represent compensation received by an officer or an employee of a State or political subdivision thereof, and determined a deficiency of $1,398.34.
   OPINION.

Trammell:

The question presented in this appeal is whether the income received by the petitioner from the Commonwealth of Kentucky, as compensation for services rendered in the handling of litigation and other legal work for the Commonwealth under the contract set out in the findings of fact, is exempt from Federal income tax. It is not contended that the petitioner was an officer of the Commonwealth of Kentucky, and clearly he was not. This leaves for consideration the question as to whether he was an employee of the Commonwealth of Kentucky, and if not an employee, whether he was such an agency or instrumentality of the Commonwealth through which it exercised an essential governmental function as to bring the case within the scope of those decisions of the United States Supreme Court holding that the very nature of our constitutional system of dual sovereign governments is such as impliedly prohibits the Federal Government from taxing the instrumentalities of a State government.

The petitioner’s services were of a temporary character and not for any specific or definite period of time, and were in connection with one matter only, viz, the collection of the estate tax due the Commonwealth from the Bingham estate. With respect to one employed for a special or single transaction, the United States Sup-preme Court, in the case of the Louisville, Evansville & St. Louis R. R. Co. v. Wilson, 138 U. S. 501, said:

The terms “ officers ” and “ employés ” both, alike, refer to those in regular and continual service. Within the ordinary acceptation of the terms, one who is engaged to render service in a particular transaction is neither an officer nor an employé. They imply continuity of service, and exclude those employed for a special and single transaction. An attorney of an individual, retained for a single suit, is not his employé. It is true, he has engaged to render services ; but his engagement is rather that of a contractor than that of an employé.

The Commonwealth of Kentucky was interested in the discovery of the nature and extent of the estate subject to tax and in the recovery of the taxes due. The means of ascertaining the information and the collection of the taxes were left to the petitioner and his associates, subject only to the judgment of the Attorney General with respect to the necessity or propriety of litigation, but even in that respect the judgment of the Attorney General was not by the terms of the contract made controlling on the petitioner. When proceedings were instituted, under the terms of the contract, the petitioner and his associates were solely responsible for the conduct of the case and for the results obtained. The services rendered were no different than those which a lawyer would ordinarily render to a private client. The taxpayer could use his own discretion as to the hours of his work, over which the Commonwealth had no control. He was free to use his own efforts according to his own judgment and pleasure as to the manner of performing his work, subject, as above stated, to the advice and judgment of the Attorney General as to the propriety of litigation which, however, was not made binding upon him under the terms of the contract. The relationship of master and servant did not exist. He was free to determine what was to be done and how it should be done. The petitioner, in our opinion, was, therefore, not an employee of the Commonwealth bf Kentucky, but his position was that of an independent contractor with the Commonwealth. Metcalf & Eddy v. Mitchell, 269 U. S. 514.

Inasmuch as the petitioner was neither an officer nor an employee of the Commonwealth of Kentucky, his case does not come within the scope of the decisions of the United States Supreme Court in the cases of Collector v. Day, 11 Wall. 113, and Dobbins v. Commissioners, 16 Pet. 435. Those cases held that the officers and employees of a State or the Federal Government who administer its laws and carry on essential governmental functions are immune from taxation by the other government.

Officers and employees are the usual means by which a State carries into execution its sovereign powers, and, with respect to taxes upon individuals or their income, the Supreme Court has not gone beyond those decisions, in which there was no question but what the individuals were officers or employees. The petitioner was one who, as a private practitioner, was retained by the Commonwealth of Kentucky to represent it as a client in a particular matter. He rendered services in that case without in any way divesting himself of the character of a private practitioner of law and only by virtue .of a special contract for the particular matter. It is contended, however, that even if he was not an officer or employee of the Commonwealth, he was nevertheless, by virtue of his' employment, an instrumentality or agency by or through which the Commonwealth functioned in the exercise of an essential sovereign power, viz, the collection of a tax. It is contended that the compensation received by him was for services rendered as such instrumentality or agency and is, therefore, exempt from Federal taxation.

In the case of the compensation of an officer or employee of a State, the imposition of the Federal tax operates to diminish his compensation, is a direct burden upon the State, and impairs it in the exercise of its sovereign powers. Dobbins v. Commissioners and Collector v. Day, supra. It is, therefore, sufficient, in order to establish the exemption from Federal taxation of compensation received for services of such a person, to show that he is an officer or employee of the State.

In the case of a person employed by a State as a contractor engaged in rendering services in a particular matter or transaction, the same considerations do not of necessity obtain. It is true that compensation is a necessary incident of such services as well as in other employment, but the important question to be considered is whether a Federal tax imposed upon the compensation of such a contractor will have the effect of impairing the efficiency of the agencies or instrumentalities of the State government in any substantial way or amount to an interference with the exercise of a sovereign power. There is no evidence 'of such fact here. It does not appear that the Commonwealth was interfered with to any extent on account of the tax in securing the petitioner’s services or that it did not receive as efficient service without any additional financial or other burden on that account.

In the case of Metcalf & Eddy v. Mitchell, supra, the United States Supreme Court said:

* * * The tax is imposed on the income of one who is neither an officer nor an employee of government and whose only relation to it is that of contract, under which there is an obligation to furnish service, for practical purposes not unlike a contract to sell and deliver a commodity.

The court in that case also said:

The tax is imposed without discrimination upon income whether derived from services rendered to the state or services rendered to private individuals. In such a situation it cannot be said that the tax is imposed upon an agency of government in any technical sense, and the tax itself cannot be deemed to be an interference with government, or an impairment of the efficiency of its agencies in any substantial way.

In conclusion, the court in the case of Metcalf & Eddy v. Mitchell, supra, said:

But we do decide that one who is not an officer or employee of a state, does not establish exemption from federal income tax merely by showing that his income was received as compensation for service rendered under a contract with a state; and when we take the next step necessary to a complete disposition of the question, and inquire into the effect of a particular tax, on the functioning of the state government, we do not find that it impairs in any substantial manner the ability of plaintiffs in error to discharge their obligations to the state or the ability of a state or its subdivisions to procure the services of private individuals to aid them in their undertakings. Cf. Central Pacific Railroad v. California, 162 U. S. 91, 126. We therefore conclude that the tax * * * was properly asssesed.

The Revenue Act of 1921, which was in effect during the taxable year involved, did not by its terms exempt the salaries of officers and employees of a State from the income tax, but section 1211 of the Revenue Act of 1926, which is retroactive and effective as to all prior revenue acts, provides as follows;

Any taxes imposed by the Revenue Act of 1924 or prior revenue Acts upon any individual in respect of amounts received by him as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded.

The above section is the only provision of the statute with respect to the compensation received by State officers and employees. That section does not expressly exempt the compensation of officers or employees of the State from the Federal income tax. It, however, clearly indicates that it was not the intention of Congress to tax compensation for personal services rendered by an officer or employee of a State. In effect, it merely incorporates into the statute the principle that had been long established by judicial construction and may fairly be considered as an interpretation of the different revenue acts. The United States Supreme Court had long prior to the enactment of the Revenue Act of 1926 held that the Federal Government had no power to levy or collect a tax upon the compensation of officers or employees of States. The above section of the statute, however, has no relation to the question as to whether the compensation of individuals who were neither officers nor employees of a State government should or should not be subjected to the Federal tax.

Section 213 (a) of the Revenue Act of 1921 reads in part as follows:

See. 213. That for tbe purposes of this title (except as otherwise provided In section 233) the term “ gross income ”—
(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including in the case of the President of the United States, the judges of the Supreme and inferior courts of the United States, and all other officers and employees, whether elected or appointed, of the United States, Alaska, Hawaii, or any political subdivision thereof, or the District of Columbia, the compensation received as such), of whatever kind and in whatever form paid, or from professions, vocations, trades * * *.

The above section is clearly broad enough to cover and to impose a tax upon the compensation received by this petitioner for services rendered in his professional capacity to the Commonwealth of Kentucky as an attorney. There is no other provision contained in the statute which would exempt such compensation, and his relationship to the Commonwealth was not such as to bring him within the scope of the decisions of the Supreme Court holding that the Federal Government is without authority to levy a tax upon the agencies or instrumentalities of the States.

Judgment will "be entered on 15 dags’ notice, under Bule 50.


author: Lansdon: Sternhagen,

text:
    Reginald C. Vanderbilt, Petitioner, v. Commissioner of Internal Revenue, Respondent. James R. Deering, Executor, Estate of Reginald C. Vanderbilt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 2299, 16651.
    Promulgated January 11, 1927.
    The decedent owned and operated a stock-breeding and produce farm. He kept numerous mares and stallions for breeding purposes, and produced some vegetables, poultry, and eggs for market. He realized no income from tbe sale of young animals bred on the farm, but, during the taxable years, received small amounts for service fees for stallions kept at stud and from the sale of produce. Held, that, in the circumstances disclosed by the evidence adduced in this appeal, the farm of the decedent was not a business conducted for profit.

      J. Harry Covington, Esq., and Spencer Gordon, Esq., for the petitioner.

      Shelby S. Faulkner, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income taxes for the years 1919, 1920, and 1921, in the respective amounts of $8,741.73, $17,692.85, and $8,865.48, or a total of $35,-300.06, of which nearly all is in controversy. The deficiencies arise from the action of the Commissioner in adding to the gross income of Reginald C. Vanderbilt for each of the years an amount representing the loss sustained in operating a stock-breeding and produce^ farm for such respective years. Subsequent to the filing of the first petition, now under consideration, Vanderbilt died, and the proceeding is prosecuted by the executor of his estate. By agreement of the parties the cases were consolidated for hearing and decision.
    FINDINGS OF FACT.
    The decedent was a resident of New York and maintained an office at No. 3708, Grand Central Terminal, as an agent of the estate of Cornelius Vanderbilt.
    Prior to the taxable years the decedent acquired a stock-breeding farm of about 235 acres, located at Portsmouth, in the State of Rhode Island. This property, designated as Sandy Point Farm, was equipped with some thirteen buildings, which included barns, cottages for the superintendent, employees, and servants, and a structure about 250 feet long, which enclosed and covered a training and show ring. The buildings, devoted to the purposes of the farm, represented an investment of .approximately $75,000. In addition to the farm buildings there was a large family mansion which was not used for any purpose during the taxable years.

      Sandy Point Farm was maintained primarily for breeding English Hackney horses. During the years involved in this controversy the decedent kept eighteen or twenty mares and three stallions of this breed. Two of his stallions were prize winners in their class at various horse shows throughout the country. All three of these horses were kept at stud on the farm, and breeding fees in the usual amounts for such animals were charged and collected for their services. Much of the farm was in cultivation for the production of forage and grain for feeding the animals kept thereon, and there was also a considerable area cultivated as a truck and vegetable garden. Including the superintendent and his wife, there was an average of fourteen employees who devoted all their time all the year round to actual farm work.
    The decedent was at the farm very frequently, spending several months of each year there. During the taxable years while at the farm he did not live in the large house or mansion, but with his personal servant, and any friends who accompanied him, he lodged in a small cottage. At such times meals for himself and guests were cooked and served by the wife of the farm superintendent, and the entire cost thereof was credited to farm income.
    Beginning prior to 1913, and continuing through the taxable years, the decedent advertised Sandy Point Farm and the Hackney stallions kept thereon in all the leading journals devoted to fine horse-breeding news, and also printed and had circulated many cards and folders describing the stallions kept at stud and setting forth the pedigrees of such animals and the charges for their services for breeding purposes. During the same period the decedent also exhibited some of his animals at fairs and horse shows throughout the country, and won many cash prizes and trophies offered for the best horses of the Hackney breed. He organized and was president of the Association of American Horse Shows until the date of his death, and was also president of the American Hackney Horse Society.
    The gross income of Sandy Point Farm for 1919 was $2,285.53, of which $1,579.26 resulted from the sale of vegetables and eggs, and $706.27 from breeding fees; for 1921, $2,506.06, of which $1,934.74 resulted from the sale of vegetables, etc., and $571.32 from breeding fees. The operating deficits of the farm for the taxable years were $24,975.28 for 1919, $30,449.95 for 1920, and $26,989.33 for 1921. In his income-tax returns for such years, the decedent deducted such respective deficits from his gross income for each of the several years as losses sustained in trade or business. Upon audit the Commissioner disallowed the deductions so made, on the ground that the losses were not incurred in the trade-or business of the decedent.
   OPINION.

Lansdon:

In his original petition in Docket No. 2299, the petitioner, in setting forth the alleged errors of the Commissioner, stated that “said loss was sustained in a business carried on for profit.” At the hearing, however, the efforts of counsel for his executor were directed to presentation of proof that the costs of operating Sandy Point Farm for each of the taxable years were ordinary and necessary business expenses. In his answer to the original petition the Commissioner states as a* propositon of law upon which he relies that “ the expenses incurred by the petitioner in operating his farm are not ordinary and necessary expenses paid or incurred in carrying on any trade or business and are, therefore, not properly deductible [from gross income] in computing net income under the provisions of sec. 214(a) (1) of the Revenue Act of 1918.” In Docket No. 16651, the petitioner asserts and the Commissioner denies that the decedent operated the farm in question as-his trade or business during the year 1921. It appears, therefore, that the petitioner may be asking for a deduction from gross income under one provision of the law, and that the Commissioner is disallowing it under a different provision of the same Act. Although the issues raised by the pleadings and argued at the hearing are somewhat confused, we shall consider that the controversy to be adjudicated arises from the Commissioner’s disallowance of losses which it is contended the decedent sustained in conducting his trade or business during each of the taxable years.

The Revenue Act of 1918, under which relief is sought, provides:

Sec. 214. (a) That in computing net income there shall be allowed as deductions:
* * * * * * *
(4) Losses sustained during the taxable year and not compensated for bj insurance or otherwise, if incurred in trade or business.

The parties agree as to the amount of the losses in question, that such losses were sustained during the respective taxable years, and that, if the decedent was engaged in a trade or business, they are proper deductions from his gross income in his income-tax returns for such years. It remains for us, therefore, to determine (1) whether in all circumstances the operation of a stud, stock, and truck farm is a trade or business within the meaning of the taxing statute, and (2) if it is a trade or business, whether the decedent was engaged therein during the years 1919, 1920, and 1921.

That farming is a business and, as such, is entitled to all deductions from gross income allowed in other branches of industry is well established both by the courts and the decisions of this Board. Plant v. Walsh, 280 Fed. 722; Wilson v. Eisner, 282 Fed. 38; Appeal of J. H. Sanford, 2 B. T. A. 181; Appeal of Kansas City Savings & Trust Co., 2 B. T. A. 1253; Thomas F. Sheridan v. Commissioner, 4 B. T. A. 1299.

The remaining question for our consideration is whether the decedent was engaged in the business of farming for profit during the taxable years. It is in evidence that he acquired Sandy Point Farm about the year 1906. The farm was equipped with all the necessary buildings suitable for the purposes for which it was operated. Such buildings, though substantial, represented no excessive capital investment. The mansion which .was located on the farm was not used during the taxable years. The decedent was deeply interested in the breeding and exhibition of Hackney horses. He kept on the farm about twenty brood mares and three stallions of this breed. All these animals were used for breeding' purposes, and, in addition, some of them were exhibited at fairs and horse shows, where they won many large cash prizes and other valuable trophies and ribbons. The arable land on the farm was all in cultivation for the production of forage crops and vegetables. The farming operations were under the direction of a superintendent, and not less than twelve persons were employed in farm labor for the entire year. Substantial amounts of money were spent during many years prior to and during the taxable years here involved, for the purpose of advising the public through advertising of the merits, pedigrees, and records of the stallions kept at stud by the decedent and the fees charged the public for the services of such animals for breeding purposes. The decedent did not use the farm as his residence, but was there often; and the cost of his meals was credited to farm income.

It appears that Sandy Point Farm was operated with all the outward appearance of a business conducted for profit or, at any rate, with hope of profit from operations. There is, however, a reverse side to the picture. A witness, who was the financial secretary of the decedent, testified that the accounts of the farm were kept by himself in the same books with the other personal accounts of the decedent, and that all items of income and expenditure pertaining to the operation of the farm were in separate columns and readily distinguishable from purely personal accounts. This may be true but, if so, there must have been many items of expense and income omitted from such accounts. It is established that the decedent exhibited his animals at horse shows throughout the country and won many cash prizes, but the record fails to disclose that the amounts of such prizes were included in the income of the farm or that the expense of attending shows and fairs was not included in farm operation cost. It was also proved at the hearing that about twenty mares were kept for breeding purposes, but there is no record of any sales of young stock. Three horses, one a top liner at many American shows, were kept at stud, but the largest income from this source for any one year was only a little more than $700, although stud fees were $100, $50, and $35, for the respective stallions. Considering the number of breeding animals kept, the evidence discloses that there should have been at least fifteen young horses for sale annually, of which several should have been high class show horses and the remainder good, salable, commercial Hackneys. The receipts reasonably to be expected from this source should have been a substantial amount per year. The income from stud fees for three horses of the type owned by the decedent should also have been substantial in amount. Over and against the income that might reasonably have been expected, had the farm been operated for profit, are the facts that it is not in evidence that any horses, young or old, were ever sold, and that the maximum receipts from stud fees for any one of the taxable years was slightly in excess of $700. The number of animals kept was small for profitable operation of a property of the value and extent of Sandy Point Farm. The income received from sales of produce and fees was practically negligible.

Counsel for the executor argued that the fact that losses were sustained raises no presumption that the farm was not operated as a business, and seeks to support his position by citing the cases of Plant v. Walsh and Wilson v. Eisner, supra. Each of these cases is clearly distinguishable from the instant proceeding. In the Plant case the losses were sustained during the earlier years of the operation of a very extensive agricultural project. The court holds that in such circumstances losses may not be regarded as evidence that the enterprise was not conducted as a business. • In the instant proceeding the enterprise was established at least twelve years before the first taxable year, and, on the. admission of the executor’s principal witness and also of counsel, sustained losses in each year in which it was operated. In such conditions the operating losses must have extinguished the original invested capital before 1918, and, had the farm been operated for business purposes by anyone relying on the receipts therefrom for livelihood or income, it would probably have been sold by the sheriff long before the beginning of the taxable years here in question. In the case of Wilson v. Eisner, sufra, the taxpayer made a business of operating a breeding and racing farm. During many of the taxable years there involved, the farm was operated at a profit, and, for the whole period, it was carried on as a business and for the purpose of earning income for its owner.

Although it is asserted that farming was-the only business in which decedent was actively engagéd during the taxable years, the record discloses that.he maintained an office in New York, where he acted as' an agent for the estate of Cornelius Vanderbilt, and that he received for such services as he may have rendered an annual salary of $5,000. It is also in evidence that during the taxable years he bought and sold considerable volumes of securities, and that, when he sustained losses from such transactions, he deducted such losses from his gross income in his income-tax returns.

We are of the opinion that the decedent was not engaged in farming as a trade or business during the taxable years. The loss claimed from farm operations for each of the years in question was not a proper deduction from gross income.

Judgment will he entered for the Commissioner.

Sternhagen,

dissenting: I can not agree that the operation of the farm was not a business. The facts indicate to me that the decedent conducted it as best he could to make a profit. That in fact it was not profitable is obviously not evidence against its being a business, Thomas F. Sheridan, 4 B. T. A. 1299, nor is the fact that he had other activities to occupy some of his time. It seems to me that this Board should be slow to judge that the conduct of an enterprise is so unbusinesslike as to deprive it of business deductions. Only in a clear case should it be done, and in my opinion this is not such a case.

Milliken and Murdock concur in this dissent.


author: Smith:

text:
    Milling Moore Mercantile Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7560.
    Promulgated January 11, 1927.

      B. O. Wallace, O. P. A., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
   Smith:

This is a proceeding for the redetermination of a deficiency in income tax for the year 1919 in the amount of $945.57. The petitioner protests only $624.70 of this amount, arising from the dis-allowance of a deduction from gross income of $1,570.64 for bad debts.

FINDINGS OF FACT.

The petitioner is a South Carolina corporation with its place of business at Greenwood, and was engaged in the retail grocery business. During the year 1919 it sold groceries to many different individuals on credit. The corporation was dissolved on December 31, 1919,.and the business was thereafter conducted by the former stockholders as partners. In opening the partnership books as of January 1,1920, the partnership did not take up as assets the amounts owed to the corporation by twelve or thirteen individuals, in the aggregate amount of $1,514.60, for the reason that they were then uncollectible. The corporation never formally closed its books in any year but in the treatment of uncollected accounts eliminated them from its assets on its balance sheets and thereafter dealt with them as uncollectible. During 1920 and subsequent years the partnership extended further credit to some of the corporation’s debtors whose accounts were treated as worthless on December 31,1919, in the manner above indicated. Certain of the debtors whose accounts had been treated by the corporation as worthless had property and at least one of the debtors had delivered to the corporation a pair of mules in settlement of his account. The partnership collected from certain debtors in 1919 and subsequent years a portion of the amounts owed by them. The following accounts were ascertained to be worthless and charged off within the taxable year, within the purview of section 234(a) (5) of the Revenue Act of 1918:

W. H. Rush-$411.'02
Jacob Johnson_ 13.15
Ned Sanders_■_ 9.51
J. P. Summers_ 19.20
Joseph Johnson_ 38.39
O. P. McLean_ 12.99
T. M. Dennard___ 46.13
Total_‘ 550.39

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


author: Murdock:

text:
    L. J. Bardwell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 18801.
    Promulgated January 11, 1927.
    Before a debt can be deducted under section 214(a)(7) of the Revenue Act of 1921, it must be proven that the ascertainment of worthlessness took place in the taxable year.

      L. J. Bardwell pro se.

      Jos. K. Moyer, Esq., for the respondent.
    The Commissioner determined a deficiency of $238.43 in the petitioner’s individual income tax for the calendar year 1923, by;disallowing a deduction of $1,407.50, claimed as a worthless debt under section 214(a) (7) of the Revenue Act of 1921.
    The facts were stipulated.

      FINDINGS OF FACT.
    The petitioner, who is an individual residing in Minneapolis, Minn., was the owner oí a Detroit Electric Brougham automobile which was used by himself and family for purposes other than in his business.
    On December 10, 1920, the Kansas Casualty & Surety Co. of Wichita, Kansas, issued to the petitioner its combination automobile policy of insurance, No. CA 38194, covering a twelve-month period beginning December 23, 1920, at noon and ending December 23, 1921, at noon.
    During the month of September, 1921, while the aforementioned Detroit Electric Brougham automobile was being operated by petitioner’s daughter, who at that time was of legal age, it injured Mary M. Williams, a resident of Minneapolis, Minn., who brought suit-in the District Court, Fourth Judicial District, State of Minnesota, against the petitioner for damages in the amount of $25,100. This suit was compromised for the sum of $3,207.50 on April 25, 1923.
    On March 2, 1922, in the case of Vernon H. Branch et al v. Kansas Casualty da Surety Co. et al., in the District Court of Sedg-wick County, Kansas, a receiver was appointed for said Surety Company. He later admitted liability on behalf of the company under the policy of insurance issued to the petitioner.
    On account of the financial condition of the Kansas Casualty & Surety Co., petitioner’s attorneys advised him to accept the sum of $1,900 from said company in preference to obtaining judgment for the amount of $3,207.50 against the company.
    On April 25, 1923, the petitioner paid to Mary M. Williams the sum of $1,307.50 from his personal funds, at the same time endorsing to her the draft in the amount of $1,900 issued to him on that day by the receiver for the Kansas Casualty & Surety Co., which the petitioner accepted in full payment of his claim against the company.
    Petitioner claimed a deduction in his return in the amount of $1,407.50. However, he concedes now that $100 of this amount, representing attorneys’ fees, is not an allowable deduction, and alleges error only to the extent of $1,307.50 which was disallowed as a deduction by the Commissioner for the calendar year 1923.
   opinion;

Murdock:

It is the contention of the petitioner that on and after the day of the accident in September, 1921, the insurer owed him a debt in an unascertained amount, that the amount of this debt was, on the day a compromise was agreed upon, ascertained to be $3,207.50, and that, having ascertained that a portion of this debt w.as worthless, he charged off $1,307.50 of it on April 25,1923, when he accepted $1,900 from the insurer in full payment of the debt. We note that the petitioner alleged that the policy of insurance was to indemnify him against loss, but the stipulation is silent as to the terms of the policy. Before we could decide this case in favor of the petitioner on the reasoning advanced by him, it might be necessary to inquire more fully into this question of loss in relation to the facts in the case. In addition we are unable to find from the evidence that the amount here sought to be deducted was ever “ charged on ” by the petitioner in his accounts, and therefore we must decide against him under the authority of our decision in the Appeal of Charles A. Collin, 1 B. T. A. 305.

However, admitting for the moment the soundness of the petitioner’s contention, he has failed’ to prove that in the taxable year he ascertained this alleged debt to be worthless. The receiver for the insurer was appointed in March, 1922. We do not know when the compromise was first agreed upon, nor when the petitioner’s attorney advised the acceptance of $1,900. This failure of proof is fatal to the petitioner’s claim. Appeal of Murchison National Bank, 1 B. T. A. 617; Appeal of Joseph E. Reid Estate, 2 B. T. A. 1198; Appeal of Anderson & Lind Mfg. Co., 2 B. T. A. 1297; Appeal of Masajiro Furuya, 4 B. T. A. 357; R. C. Middleton v. Commissioner, 5 B. T. A. 205. See also the Appeal of Alemite Die Casting & Manufacturing Co., 1 B. T. A. 548, in connection with charging off a debt upon the advice of an attorney.

It is agreed by all parties to this appeal that this loss is not deductible under section 214(a) (6) of the Revenue Act of 1921. Charles N. Burch v. Commissioner, 4 B. T. A. 604.

Judgment will'be entered for the Commissioner.

Phillips and Tettssell dissent.


text:
    Appeal of Mortimer C. Adler.
    Docket No. 5770.
    Promulgated January 11, 1927.
    The petitioner procured a policy of insurance on his own life, naming therein as beneficiaries certain religious and charitable corporations. Held, that the payment of the premium was not a gift or contribution within the meaning of section 214(a) (11) of the Revenue Act of 1921.

      W. W. Spalding, Esq., for the petitioner.

      Henry Ravenel, Esq., for the Commissioner.
    The Commissioner determined a deficiency in income taxes for the year 1921 in the sum of $361.05. The petitioner prays a redetermination of his tax liability and alleges that the Commissioner erred in that he disallowed a certain deduction in the sum of $1,159 claimed by the petitioner by reason of having paid said amount within the taxable year as premiums due upon a certain life insurance policy the beneficiaries of which were religious and educational institutions.
    FINDINGS OP PACT.
    Prior to the taxable year here involved, the petitioner procured a policy of insurance upon his own life. The beneficiaries named therein were religious and educational institutions. The policy contained a clause or provision under which the insured was permitted to change the beneficiaries named therein. During the year 1921 the petitioner paid the premium on said policy amounting to $1,159. During the year 1924 the clause or provision under which the insured was permitted to change beneficiaries was revoked or canceled by an agreement between the insured and the insurer. On his income-tax return for the year in question, the petitioner claimed as a deduction the amount of the premium so paid.
   OPINION.

Green:

The parties are in accord as to the facts and the only question we are called upon to determine is whether the petitioner, as a matter of law, is entitled to deduct the premium so paid as a contribution within the provisions of section 214(a) (11) of the Revenue Act of 1921, it being conceded by the Commissioner that the “ organizations ” are religious or educational corporations within the purview of the statute.

In cases where the insured had not reserved the right to change the beneficiaries named in the policies, the Commissioner has heretofore allowed an insured to take as a deduction the amount of premiums paid where the beneficiaries of the policies were corporations of the sort mentioned in the statute.

In support of his contention that the deduction should be allowed even though the right to change the beneficiary be reserved to the insured, the petitioner calls our attention to the ruling of the Commissioner published as Law Opinion 1102, C. B. 1-2, page 50. In that opinion the conclusion was reached that the creator of a trust, the income of which was to be distributed annually, need not include in his gross income the income of the trust, even though he retain the right to change beneficiaries or make himself the sole beneficiary thereunder so long as such action was not taken by him. In the opinion it is pointed out that the creation of the trust vests in the beneficiaries an interest m praesenti; that the beneficiaries could, not have maintained an action to compel the trustee to make the annual payments; and that no new rights were vested in the beneficiaries by reason of the death of the creator of the trust, the only effect being to extinguish the possibility of revocation or change of beneficiary.

It is contended that the rights of the beneficiaries of the policy of insurance taken out by the petitioner are analogous to the rights of the beneficiaries of a revocable trust, to the extent that they also have a definite vested interest in the policy or its proceeds. The' rights of a beneficiary named in a life insurance policy wherein there has been reserved to the insured the right to change the beneficiary, have frequently been the subject of consideration by the courts.

In the case of Mutual Benefit Life Insurance Co. v. Swett, 222 Fed. 200, the court said:

The rule is well settled that, under an ordinary policy oí life insurance in which there is no reservation of a right to cut off- or modify the interest of the beneficiary, the policy and the money to become due under it belong, from the time it issued, to the person named in it as the beneficiary, and that the insured is without power, whether by deed, assignment or will, or by surrender of the policy for a new one, or by any other act of his, to transfer to any other person the interest of the person so named as beneficiary. In such a policy the beneficiary acquires, the moment it is issued, a vested right which cannot be affected by any act of the insured subsequent to the execution of the policy, except it be a breach of condition. Washington Central Bank v. Hume, 128 U. S. 195 * * *. If, however, by the terms of the policy itself there is reserved to the insured the right, without the consent of the beneficiary, to change the appointee with the assent of the insurer, the beneficiary acquires only an expectancy and not a vested interest during the life of the insured. * *' * Hopkins v. Northwestern Life Assur. Co., 99 Fed. 199, 40 C. C. A. 1 (C. C. A. 3); Hogan v. Fauerbach Brewing Co., 194 Fed. 846, 848, 114 C. C. A. 634 (C. C. A. 7) * * *.
The right so reserved rests upon the terms of the contract, and is the same as that conferred on the insured by the certificate, charter, or by-laws of a mutual or benefit association, when insurance is effected in such an organization. As the policy to Swett stipulated that he might, on his written request-of the company for its appropriate indorsement on the policy, change the beneficiary, his wife did not acquire a permanent or vested interest in it. The existence of such an interest during her husband’s lifetime was made impossible by the control over the contract of insurance. given to him, independent of her will. Her right was inchoate,- a mere expectancy during his lifetime, dependent on the will and pleasure of her husband as holder of the policy, and could not vest until his death happened with the policy unchanged. His control over the policy was, subject to its terms, as complete as if he himself had been the beneficiary. Denver Life Ins. Co. v. Crane, 19 Colo. App. 191, 200, 73 Pac. 875.

See also In re Hogan, 194 Fed. 846; Slocum v. Metropolitan Life Insurance Co., 245 Mass. 565; 139 N. E. 816; Eltonhead v. Travelers’ Insurance Co., 163 N. Y. S. 838; and Wagner v. Thierot, 194 N. Y. S. 610.

The petitioner herein, by taking out the policy of life insurance, did not in so doing create or vest in the beneficiaries a vested interest in the policy or its proceeds. Their interest, if such it may be called, was a mere expectancy. The payment of premiums due upon the policy did not enlarge this interest. The effect of such payment was only to perpetuate the expectancy.

Section 214(a) (11) of the Revenue Act of 1921 provides that there shall be allowed as deductions in computing net income:

Contributions or gifts made within the taxable year to or for the use of: * * * (B) any corporation, or community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including posts of the American Legion or the women’s auxiliary units thereof, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual * * *.

Contributions or gifts are deductible if they are to, or for the use of, organizations of the type described in the statute. Obviously the payment of premiums to the insurance company is not a contribution or gift to the beneficiaries named in the policy. If such premium payment is deductible it must be because it is a contribution or gift “ for the use of ” the beneficiaries. Two questions are thus presented: First, is such payment a gift or contribution; and, second, is it for the use of the beneficiary? In every contribution or gift there are at least two essential elements; first, that the maker or donor part with something, and, second, that the donee receive something. Under the facts in this appeal it can not be said that the petitioner, by paying the premium, parted with anything by way of contribution or gift, for he still retained the right to name the recipient of the thing purchased with the payment. It is equally clear that the beneficiaries received nothing. For the same reason it can not be said that the payment was for the use of the beneficiaries. We therefore hold that the premium payment was not a gift or contribution within the contemplation of the statute.

We are not called upon to decide whether the petitioner may deduct premiums paid after he had waived or revoked his right to change beneficiaries. That action was taken in 1924 and could have no effect upon the relationship existing between himself and the beneficiaries in 1921. The legal rights of the parties were fixed by the conditions then existing and the right to the deduction may not be determined in the light of changes in the relationship effected in subsequent years.

Judgment will be entered for the Commissioner.