author: Geeen:

text:
    Abraham Werbelovsky, Executor, Estate of J. H. Werbelovsky, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10106.
    Promulgated October 3, 1927.
    Statute op Limitations.- — On April 1, 1918, a return was filed for the above estate on Form 1041 (revised January, 1918) for the calendar year 1917. The return showed gross income of $71,030.19 and deductions of $77,177.21. It had written on its face “ No net income.” No return was filed for the estate on either Form 1040 or 1040-A as required by the Commissioner’s regulations in cases where the income of the estate was $1,000 or over. More than five years after April 1, 1918, the Commissioner determined the net income of the estate to be $192,570.71 and on November 6, 1925, mailed the executor a deficiency letter in which he notified him of a deficiency against the estate for the year 1917 of $46,619.74. Held,, the proposed deficiency is barred by section 277(a)(2) of the Revenue Act of 1924.

      Benjamin Mahler, Esq., for the petitioner.

      Henry Rawenel, Esq., for the respondent.

      In this proceeding the petitioner seeks a redetermination of its income-tax liability for the calendar year 1917, for which the Commissioner, as set forth in his deficiency letter dated November 6, 1925, has determined a deficiency in the amount of $46,619.74. The petition alleges seven errors, the last one being that “ The Commissioner erred in determining any deficiency of tax in view of the fact that the time within which such deficiency may be determined has expired.”
    FINDINGS OF FACT.
    In March, 1913, Jacob H. Werbelovsky died, testate. He was survived by his wife, a daughter and three sons. In his will his sons were named as residuary legatees, devisees and executors. The will was duly admitted to probate, the appointment of the executors confirmed, and according to the records of the probate court they were still acting in such capacity on December 30, 1924, not having filed any final account. The estate consisted of a glass business and certain pieces of real estate in Brooklyn.
    On April 1, 1918, Benjamin Werbelovsky as an executor of the estate of* Jacob H. Werbelovsky, filed with the collector of internal revenue for the first district of New York, a fiduciaries’ income-tax return on Form 1041 (revised January, 1918) for the calendar year 1917. Under the schedule captioned “ Disteibution of Net Income ” the executor wrote “ No net income.” Under schedule “ C ” captioned “ Income FROM Rents and Royalties ” the executor reported a gross income of $71,030.19, against which he claimed deductions itemized as follows:
    Repairs, wear and tear, and property losses_$26,120.38
    Interest_ 15, 688.68
    Taxes_ 10,612.72
    Other expenses_ 24, 755.43
    Total deductions- 77,177.21
    The “ other expenses ” in the amount of $24,755.43 were further itemized in detail on a separate schedule attached to the return on the business stationery of the estate of J. H. Werbelovsky. The item of “ Repairs, etc.” in the amount of $26,120.38, was further explained in a schedule at the bottom of page 3 of the return.
    At the bottom of page 2 of the return the executor made oath that he had sufficient knowledge of the affairs of the estate to enable him to make the return and that the return was to the best of his knowledge and belief true and correct.
    No return was filed for the estate on either Form 1040 or 1040-A as required by the Commissioner’s regulations in cases where the income of the estate was $1,000 or over.

      On November 6, 1925, tbe respondent determined that tbe net income of tbe estate was $192,570.71 and on that day mailed a deficiency letter to one of tbe executors of the estate proposing a deficiency against the estate for the calendar year 1917 of $46,619.74.
   OPINION.

Geeen:

There are seven issues involved in this proceeding. The last issue is whether the period has expired within which the Commissioner may assess a deficiency in income taxes against the estate for the calendar year 1917.

The various sections of the statutes material to the last issue are as follows :

Section 2(b), Revenue Act of 1916:

Income received by estates of deceased persons during tbe period of administration or settlement of tbe estate, shall be subject to the normal and additional tax and taxed to their estates, and also such income of estates or any kind of property held in trust, including such income accumulated in trust for the benefit of unborn or unascertained persons, or persons with contingent interests, and income held for future distribution under the terms of the will or trust shall be likewise taxed, the tax in each instance, except when the income is returned for the purpose of the tax by the beneficiary, to be assessed to the executor, administrator, or trustee, as the case may be: Provided, That where the income is to be distributed annually or regularly between existing heirs or legatees, or beneficiaries the rate of tax and method of computing the same shall be based in each ease upon tbe amount of tbe individual share to be distributed.

Section 8(c), Revenue Act of 1916:

Guardians, trustees, executors, administrators, receivers, conservators, and all persons, corporations, or associations acting in any fiduciary capacity, shall make and render a return of the income of the person, trust, or estate for whom or which they act, and be subject to all tlie provisions of this title which apply to individuals. Such fiduciary shall make oath that he has sufficient knowledge of the affairs of such person, trust, or estate to enable him to make such return and that the same is, to the best of his knowledge and belief, true and correct, and be subject to all the provisions of this title which apply to individuals : Provided, That a return made by one of two or more joint fiduciaries filed in the district where such fiduciary resides, under such regulations as the Secretary of the Treasury may prescribe, shall be a sufficient compliance with the requirements of this paragraph. (Italics supplied except for the word “ Provided.”)

Section 277(a) (2), Revenue Act of 1924:

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.

Section 278 (a), Revenue Act of 1924:

In the case of a false or fraudulent return with intent to evade tax or of a failure to file a, return the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. (Italics ours.)

Pursuant to the authority granted in the Revenue Acts of September 8,1916, and October 3,1917, the Commissioner, with the approval of the Secretary of the Treasury, promulgated on January 2, 1918, Regulations No. 33 (Revised). That part of those regulations which is material here is quoted as follows:

Article 27, Regulations No. 33 (Revised) :

Fiduciaries acting for minors or other incompetents will be required to make returns of income according to the marital status of the beneficiaries, and in all cases of return under section 2(b), act of September 8, 1916, as amended, when the income of the estate or trust, as an entity, is $1,000 or over. This return will be on Form 1040 or 1040A.
Fiduciaries are required to make returns of income on Income Tax Form 1041 whenever the interest of any beneficiary in the net income of an estate'or trust for which the fiduciary acts is $1,000 or over for an unmarried beneficiary, and in case they are married beneficiaries, then a return will be required whenever the interest of any such married beneficiary is $2,000 or over.

Article 29, Regulations No. 33 (Revised), in part:

Under the provisions of section 2(b) it is held that estates during the period of administration have but one beneficiary, and that beneficiary is the estate. Therefore a return on Form 1040 or 1040A, subject to all the deductions and exemption, shall be made by the executor or administrator for such beneficiary and the entire tax paid thereon.

The petitioner contends that the time within which the Commissioner could assess any income taxes against the estate expired on April 1, 1923, or five years after the return on Form 1041 was filed by Benjamin WerbelovsKy, one of the executors.

The respondent’s position is that in accordance with the Revenue Act of 1916 he was given authority, subject to the approval'of the Secretary of the Treasury, to prescribe the form or forms to be used by all taxpayers in reporting their income; that pursuant to such authority he, with the approval of the Secretary, promulgated certain regulations providing that in all cases of reporting under section 2 (b) of the Revenue Act of 1916, as amended, a return should be filed on Form 1040 or 1040A when the income of the estate, as an entity, was $1,000 or over; that no return had been filed on either Form 1040 or 1040A; and that, therefore, in accordance with section 278(a) of the Revenue Act of 1924 the tax here in question could be assessed, or a proceeding in court for its collection could be begun without assessment at any time.

We are of the opinion that both the assessment and collection of the tax here in question are barred by the statute of limitations. A careful reading of section 8(c) supra, indicates that Congress intended but one return to be filed for an estate; that such return could be filed by one of two or more joint executors who was to make oath that he had sufficient knowledge of the affairs of such estate to enable him to make such return, and that the same was, to the best of his knowledge and belief, true and correct; and that a return so filed under such regulations as the Secretary of the Treasury may prescribe, “ shall be a sufficient compliance with the requirements of this paragraph.”

In the instant case a return on Form 1041 was filed by one of the joint executors. This executor made oath to the fact that he had sufficient knowledge to enable him to make the return and that the same was to the best of his knowledge and belief, true and correct. The return filed was provided for in the regulations approved by the Secretary. Does the fact that the executor who filed the return for the estate did not include in such return certain income which the Commissioner has determined was income of the estate, but which the estate still denies was income, or the fact that the executor in filing “a return of the income” used Form 1041 instead of either Form 1040 or 1040A place the estate in the position of having failed to file a return within the meaning of the words or of a failure to file a return ” as used in section 278(a) of the Revenue Act of 1924? We think not. The estate did file “ a return.” The Commissioner has not alleged or contended that the return as filed was either a “ false or fraudulent return with intent to evade tax.” Under such facts and circumstances we fail to find any authority in section 278(a) for the proposition that the taxes here in question could be assessed or a proceeding in court for their collection could be begun without assessment at any time.

The respondent in effect is asking us to read into section 278(a) the word “ required ” as if the statute read “ or of a failure to file a required return.” This we can not do. The word “ required ” was in a similar provision of the Revenue Act immediately prior to the Revenue Act of 1924. See the second proviso of section 250(d) of the Revenue Act of 1921, which reads:

Provided further, That in the case of a false or fraudulent return with intent to evade tax, or of a failure to file a required return, the amount of tax due may be determined, assessed, and collected, and a suit or proceeding for the collection of such amount may be begun, at any time after it becomes due.

It must be assumed that Congress intended to omit the word “ required ” in the latter Act.

But even if we were to hold that when Congress spoke of “ a return ” in section 278(a), it meant “ a required return,” since in section 277 (a) (2) of the same Act it provides for the assessment of the tax “ within five years after the return was filed,” yet we are of the opinion that the return filed for the estate satisfies this requirement. Section 8(c) of the 1916 Act requires the executor to “make and render a return of the income ” of the estate. The regulations provide that a return shall be filed only if the net income of the estate is $1,000 or over. See article 27, supra. This article has reference to Forms 1040, 1040-A, and 1041. According to the best knowledge and belief the executor had at the time he filed Form 1041, the estate had “ no net income.” He would not then, in accordance with the regulations, be required to file any return for the estate. But according also to his best knowledge and belief the estate had a gross income of $71,030.19, and in accordance with section 8(c) of the act he was required “ to make and render a return of the income.” The executor who filed the return believed that no tax was due. If the regulations themselves did not provide for a return in such a case, it does not appear to us material what form the executor used in making and rendering a return of the income as long as he filed “ a return.” The Commissioner was put on notice that a return had been filed and was given five years to examine the return and determine whether any taxes were due. This he did not do until after more than two and one-half years after the five-year period had expired. We are, therefore, of the opinion that the assessment and collection of the taxes now proposed by the respondent are barred by the statute of limitations. Compare Appeal of Mabel Elevator Co., 2 B. T. A. 517, and Bastrop Mercantile Co., Ltd., v. Commissioner, 7 B. T. A. 529.

In view of our conclusions in the foregoing opinion it does not become necessary to consider the remaining six issues raised in the pleadings.

Judgment of no deficiency will be entered for the petitioner.

Considered by SterNhageN, LaNsdoN, and AruNdell.


source: Caselaw Access Project

author: Green:

license: Public Domain

text:
    Parker Wire Goods Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3999, 5452.
    Promulgated October 3, 1927.
    Losses Rather Than Bad Debts. — Upon tbe evidence, held, that certain transfers of moneys and properties by the president and minority stockholder of the petitioner to another corporation in which the said president and minority stockholder was the principal stockholder, the latter corporation being at all times insolvent, amounted to a fraudulent appropriation of the petitioner’s goods and that the losses suffered by the petitioner on account thereof were deductible as “ losses sustained ” during the taxable years ' 1918 and 1919 instead of as “ debts ascertained to be worthless and charged off ” within the year such losses were discovered.

      J. Robert Sherrod, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar years 1918 and 1919, for which the Commissioner has determined deficiencies in the sums of $21,356.58 and $5,241.34, respectively. The issue involved is whether the petitioner sustained losses during 1918 and 1919 due to an alleged embezzlement of moneys and properties on the part of one of its minority stockholders who was also its president. A motion for the consolidation of the appeals was granted.
    FINDINGS OF FACT.
    The petitioner is a Massachusetts corporation, having its place of business in Worcester. It was incorporated in 1901 with an authorized capital stock of $10,000, divided into 100 shares having a par value of $100 each. Its shares at that time were subscribed for and
    issued as follows: ShaK
    Arthur H. Parker_ 31
    Edward D. Priest- 30
    Mabel Caldwell Willard_ 25
    Jeanette S. Priest_ 2
    James M. Jackson_ 2
    Frank C. Turner_ 10
    Total_100
    Prior to 1918 its stock was increased to 250 shares, par value $100 each, the additional shares being fully paid up. During the taxable years 1918 and 1919 its outstanding stock was owned as follows:
    Shares.
    Edward D. Priest_140
    Arthur H. Parker_ 60

      Shares.
    Mabel C. Willard- 49
    George S. Davis- 1
    Total_250
    Edward D. Priest, Arthur H. Parker and Mabel C. Willard were cousins and had been born and reared together in Northfield, Mass. The stockholders had from 1901 to 1921 allowed Parker to manage the business of the corporation and it was commonly understood by the public and the employees that he was the principal owner. Parker had always been furnished proxies and Priest had never attended a stockholders’ or directors’ meeting after the petitioner was incorporated until December, 1921.
    The petitioner was organized to manufacture, buy and sell hardware and wire goods. Parker was the president, general manager and clerk. From time to time, he furnished the stockholders with a written report of the results of his management, including a balance sheet. The balance sheets so furnished to Priest represented the accounts receivable and notes receivable due the petitioner to be as follows on the dates indicated:

    Priest, the principal stockholder, questioned Parker about the increasing accounts receivable and was assured by Parker that none of the accounts receivable shown on the balance sheets exceeded three or four thousand dollars. It was true, however, that one corporation, The Stenman Wire Specialty Co., owed the taxpayer the following amounts as of the dates indicated below:
    December 31, 1916_$5,631.88
    December 31, 1917_ 11,526.27
    December 31, 1918- 29,462.35
    December 31, 1919_ 50, 337. 58
    December 31, 1920_ 63,164. 91
    The petitioner manufactured wire specialty goods such as screw eyes, gate hooks, coat hooks, etc., in rented space on the sixth floor of the Bradley Building, Worcester, Mass. At some time prior to 1910 Parker had organized or secured control of the Stenman Wire Specialty Co., a corporation (hereinafter referred to as Stenman Company). He was the principal stockholder therein. His housekeeper owned some of the stock of the Stenman Company. This corporation was also located in the same Bradley Building on the second floor, and was engaged in the manufacture of similar products. Parker also acted as manager for the Stenman Company, a Mr. Sanders acting as manager in Parker’s absence. The Stenman Company obtained the greater part of its raw material (wire) from the petitioner in lots of 100 pounds, upon the basis of prices per carload lots. Such raw material costs 15 or 16 per cent more if purchased in lots of around 100 pounds. Nothing was added by the petitioner for insurance or storage. The Stenman Company had also borrowed part of its machinery from the petitioner. Parker assigned one of the petitioner’s employees, Wellsley H. Lawrence, to duty with the Stenman Company, but Lawrence was paid only by the petitioner corporation. The financial condition of the Stenman Company, as shown by statements filed by said company with the secretary of the Commonwealth of Massachusetts, was as follows on the dates indicated:
    Stenman Wire Specialty Oo.

      Balance Sheet.

    As shown by the above balance sheets of the Stenman Company, its liabilities exceed its assets as follows:
    December 31, 1917-$10,996.98
    December 31, 1918_ 20,167.65
    December 31, 1919_ 26,736.99
    December 31, 1920- 41, 689. 94
    For some time prior to 1918 and during the taxable years, Parker caused the petitioner corporation to advance to the Stenman Company moneys to meet its pay rolls. The Stenman Company rarely failed to meet its pay roll in this manner. The petitioner’s bookkeeper strenuously objected to this practice because in her opinion there was no chance of the petitioner recovering these sums in view of the financial condition of the Stenman Company, and further because the petitioner needed cash for its own purposes.

      During the year 1918 the transactions between the petitioner and the Stenman Company as reflected by the petitioner’s books are summarized as follows:

    Parker warned several employees whom Priest was likely to meet if he visited the plant that the existence of and the transactions with the Stenman Company should not be mentioned to Priest, stating that Priest knew nothing of and was to know nothing of these matters.
    The manufacture of goods ordered from the petitioner was delayed because it was short of raw material, which shortage was caused by the transfers of raw material to the Stenman Company. On one occasion a salesman, after trying for a considerable time, was successful in securing an order from Landers, Frary & Clark, a large hardware company, for 10,000 knife handles, provided delivery was made within a certain time. The salesman in checking up on this order found that said order and the materials necessary to fill it had been transferred to the Stenman Company.
    In his reports to the stockholders of the petitioner corporation, Parker stated that while business had been good, it would have been better if the petitioner had not been handicapped by inability to get raw material.

      At the close of 1918, Parker gave the petitioner’s bookkeeper orders to record in its journal the following entries:
    Dr: Suspended entries, December 31, Sales Account_$13, 294. 56
    Or: Raw Material_$13, 294. 56
    Dr: Notes Rec_ 13,294.56
    Or: Stenman Wire Specialty Oo_ 13, 294. 56
    To correct error in entry above.
    The effect of these entries was (1) to reduce the sales and purchases for the year, (2) to increase the ratio of profits on sales, and (3) to reduce the amount of accounts receivable shown at the end of 1918.
    The bookkeeper never saw the note for $13,294.56 and Parker, when questioned about it in 1921 stated that he knew nothing about it. An accountant investigating in 1921 found an unsigned note for the same amount among the effects of the Stenman Company. This note was never paid.
    Among the transactions between the petitioner and the Stenman Company, as reflected by the petitioner’s books of account, there appear entries showing that on July 16, 1919, Parker personally withdrew by means of four checks on four different banks a total sum of $7,050, and directed the bookkeeper to charge it to an account labeled “A. H. Parker account #2.” At the end of 1919, Parker directed the bookkeeper to charge the $7,050 to the Stenman Company which was done. These checks were cashed personally by Parker on July 16, 1919.
    In December, 1921, Priest, who lived in Schenectady, New York, received a letter from one of the employees of the petitioner corporation suggesting a conference. Priest met this employee in Albany, N. Y., and, in this manner learned for the first time of the existence of the Stenman Company, its ownership and something of the nature of the transactions between it and the petitioner, all under the management of his cousin, Parker. Priest came to Worcester, engaged a public accountant, and called on Parker. When again questioned about the petitioner’s business, Parker again assured Priest that the business was in good shape, and that none of the accounts receivable were large. Priest demanded a list of the accounts and Parker suggested “going to lunch.” When told it was too early for lunch, Parker admitted that when Priest saw the accounts he would want to discharge him.
    Parker was not prosecuted due to the family relationship between him and Priest. The Stenman Company returned to the taxpayer the machinery it had borrowed and the machinery owned by the Stenman Company was also taken by the petitioner. Its value was fixed at $3,500 by a neutral person and this amount was credited against the debits for cash and raw materials transferred to the Stenman Company and applied against the earliest withdrawals which were prior to 1918.
   OPINION.

Green:

The question here is whether the moneys and properties transferred by Parker from the petitioner to the Stenman Company during 1918 and 1919 amounted to embezzlement, thereby entitling the petitioner to a deduction from gross income on account of “ losses sustained ” during 1918 and 1919, respectively, or whether such transfers were in fact tona -fide advances and sales to the Stenman Company, in which case the petitioner would only be entitled to a deduction for “bad debts” in the year in which such debts were ascertained to be worthless and charged olf. The petitioner claims that Parker’s actions amounted to embezzlement, whereas the Commissioner contends they were tona -fide advances and sales. The petitioner relies on section 234(a) (4) of the Revenue Act of 1918, whereas the Commissioner relies on section 234(a) (5) thereof. Sub-paragraphs (4) and (5) of section 234(a), supra, provide as follows:

Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * . * * * * *
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
(5) Debts ascertained to be worthless and charged off within the taxable year.

Embezzlement losses not compensated for by insurance or otherwise are deductible in the year in which they are “ sustained ” rather than in the year in which they are first discovered. They are deductible as “ losses sustained ” rather than as “ debts ascertained to be worthless.” Appeals of Emil Stern, et al., 5 B. T. A. 89. See also Appeal of Webb & Bocorselski, Inc., 1 B. T. A. 871. Appeals of J. A. Bentley, et al., 5 B. T. A. 314. National Sash & Door Co. v. Commissioner, 5 B. T. A. 931.

Did the petitioner sustain embezzlement losses as a result of Parker’s actions or were such losses as it suffered essentially in the nature of bad debts? We do not believe that the moneys and properties transferred by Parker from the petitioner to the Stenman Company during 1918 and 1919 were in fact tona fide advances and sales to the latter company. In our opinion the facts as set out in the findings clearly show that the transactions between the petitioner and the Stenman Company were inherently fraudulent on the part of Parker. He as an officer of the petitioner “ ostensibly loaned ” cash and machinery to an insolvent corporation principally owned by himself and his housekeeper. He also “ disposed ” of certain raw materials to the same insolvent corporation. He was in control of both corporations and can not be said not to have had knowledge of the financial condition of the Stenman Company. He personally took $7,050 in cash during 1919 and later had it charged to the Stenman Company. In order to set at rest Priest’s suspicions, Parker ordered ' the bookkeeper to make an entry as of December 31, 1918, which had the effect of reducing the “ accounts receivable ” (the only item Priest had ever inquired about) in the amount of $13,294.56. Although Parker told the bookkeeper he had received a note for $13,294.56 from the Stenman Company, it appears that he never signed or delivered such note, as it was found unsigned among the Stenman Company effects, by the public accountant, in 1921. He then denied all knowledge of the note. Parker ordered several employees whom Priest was likely to meet if he visited the plant not to mention the Stenman Company or the transactions had with such company. Cash was advanced to the Stenman Company at times when the petitioner needed it. Raw materials were transferred to the Stenman Company when they were needed by the petitioner, resulting in delay in filling orders and dissatisfaction among the petitioner’s customers. The Stenman Company was a competitor making practically the same line of goods. Valuable orders obtained after long effort by salesmen for the petitioner were transferred to the Stenman Company, together with the materials necessary to make the articles so ordered. An employee was assigned to duty with the Stenman Company by Parker but paid by the petitioner. Parker made false statements to Priest and the other stockholders in rendering annual reports when he represented that business would have been larger except for the inability to get raw materials, when at the same time he was disposing of badly needed raw materials to the Stenman Company. Materials were transferred to the Stenman Company at carload lot prices, which were 15 or 16 per cent under cost prices on the hundredweight basis. Parker’s conversation with Priest in December 1921, when detailed statements were demanded, shows a guilty mind.

In our opinion all of the foregoing circumstances clearly show Parker’s intent to fraudulently manage the petitioner’s affairs to its detriment and to the benefit of himself and his housekeeper, through his artificial creature, the Stenman Company. We think that under such circumstances the losses suffered by the petitioner are not essentially in the nature of bad debts but come within the embezzlement decisions cited above.

None of the losses sustained by the petitioner during 1918 and 1919 on account of Parker’s actions between it and the Stenman Company were compensated for by insurance or otherwise. We are, therefore, of the opinion that the petitioner is entitled to deduct under section 234(a) (4) of the Revenue Act of 1918 the amounts of $17,936.08 and $20,875.23 as losses sustained during 1918 and 1919, respectively. The deficiencies should be recomputed accordingly.

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

Considered by Steenhagen, Lansdon, and Artjndell.


text:
    Badger Talking Machine Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10239.
    Promulgated October 3, 1927.
    Tbe petitioner was affiliated with the Interstate Music Corporation from January 1, to November 30, 1920.

      Chester A. Cwimn, Esq., for the petitioner.

      A. TEL. Fast, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar year 1920 for which the Commissioner determined a deficiency in the sum of $7,389.31.
    The petitioner has alleged three errors on the part of the Commissioner, two of which have been eliminated by stipulation, leaving at issue the refusal of the Commissioner to compute the tax liability of the petitioner and the Interstate Music Corporation as affiliated corporations pursuant to the provisions of section 240 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    The petitioner is a corporation organized under the laws of the State of Wisconsin in the year 1914, with its principal office in Milwaukee. The petitioner is engaged in the distribution of Victor talking machines. Its authorized capital stock upon organization was $50,000, divided into 1,000 shares of common stock of $50 par value each. From the date of incorporation to the present time George F. Ruez, H. A. Goldsmith, and S. Goldsmith have been its principal stockholders and have at all times been its managing officers and directors. In the sale of Victor talking machines the petitioner gave exclusive territorial rights. Seeing the possibility of the further development of the trade in talking machine accessories in these territories, the Record Needle & Manufacturing Co. was incorporated under the laws of the State of Wisconsin in November, 1917. The purpose of this corporation was the manufacturing and development of trade in accessories, with persons other than those who handled the Victor products. Upon organization 950 shares, par value $50 each, of the authorized 1,500 were issued. Ruez received 500, H. A. Goldsmith 250, and S. Goldsmith 200. In November, 1919, at a special meeting, it was voted to amend the articles of incorporation so as to increase the authorized capital stock to $100,000 par value, divided into 4,000 shares, each having a par value of $25, and to change the name to “ Interstate Music Corporation.”
    On January 1, 1920, the outstanding capital stock of the petitioner amounted to $100,000 represented by 2,000 shares, which were held as follows:
    Stares.
    George F. Ruez and Esther N. Ruez (his wife)- 999
    Chet GofE_ 1
    H. A. and S. Goldsmith_ 972
    J. Slottow- 28
    Total_2,000
    On the same date there was outstanding capital stock of the Interstate Music Corporation $60,000 par value represented by 2,400 shares of $25 each, of which the stockholders of the petitioner owned the following shares:

    Ruez and the two Goldsmiths were the officers and directors of the petitioner from the date of its incorporation. When the Record Needle & Manufacturing Co. was organized they became its officers and directors. They have served as officers and directed the policy of both corporations since the date of their organization. Ruez, who was the president of the Record Needle & Manufacturing Co. at the time of its organization, later resigned from this position and became treasurer, and was succeeded as president by an employee of the petitioner named Zinke.
    The two concerns occupied different floors of the same building; had common storage space and kept separate books of account, but the corporate records of the Record Needle & Manufacturing Co. and its successor, the Interstate Music Corporation, were kept in the safe of the petitioner. Each had separate salesman, who sold, as a matter of courtesy, without charge, the goods of the other. During the period from January 1 to November 30, 1920, the stock of the Interstate Music Corporation was held as follows :
    Per cent.
    Stockholders of the petitioner_ 66. 8
    Relative of stockholders of petitioner- 15. 0
    Business associates of stockholders_ 11. 9
    Friends of stockholders of petitioner_'- 5.3
    Quiescent stockholders, living at a distance- 1.0
    Total_100.0
    None of the stock of the Record Needle Co. or the Interstate Music Corporation was ever offered at general sale. The minority stockholders consisted of a group that had been associated with Ruez and the two Goldsmiths in several other ventures and allowed them to conduct the business without interference. There is no record of any stockholders’ meetings except the special meeting which was held to increase the capital and change the name of the corporation.
    In 1919, the business of the Record Needle & Manufacturing Co. had so declined that it had sustained a loss amounting to approximately one half of its capital. In November of 1919 the special meeting above referred to was called for the purpose of increasing the capital stock and changing the corporate name. At the date of the meeting there were 950 shares of stock outstanding, of which 572 ivere owned by the stockholders of the petitioner. The Wisconsin Statute, section 180.07, requires the acquiescence of two thirds of the outstanding stock to make such changes. At the meeting 667 shares were represented by the owners, 202 by proxy and 81 were not represented. The name of the corporation was changed to Interstate Music Corporation and the capital stock was increased to $100,000. One share of $25 par value stock ivas to be exchanged for the outstanding stock of $50 par value and the right to subscribe for an additional share of $25. Ruez and the two Goldsmiths agreed to and did subscribe for all the stock not taken by the former stockholders under these rights. In order to aid the corporation the petitioner turned over to it without pay a valuable contract for the sale of Rythmodic Player Rolls. Subsequently this contract was canceled, depriving the Interstate Music Corporation of its principal business. The petitioner then proposed to exchange its 6 per cent preferred stock for the stock of the Interstate Music Corporation par for par. This proposal was accepted and on December 1, 1920, the petitioner acquired all the stock of the Interstate Music Corporation.
    It has been stipulated that the net loss of the Interstate Music Corporation for the calendar year 1920 was $10,874.80.
   OPINION.

Green:

The petitioner here is seeking an affiliation for the first eleven months of the year 1920 under the provisions of section 240(b) of the Revenue Act of 1918, which reads as follows:

(b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

The facts here show that the petitioner and the Interstate Music Corporation had, (1) common interest, and purpose of joint success, (2) the same officers and interlocking directors, (3) minority stock held by either persons related by blood or marriage or by employees, business associates and friends, (4) business harmony evidenced by friendly minority stockholders, (5) control exercised by proxies, (6) and that the owners of the stock of the petitioner owned 66.8 per cent of the stock of the Interstate Music Corporation.

We believe from the above state of facts that all the elements of affiliation are present and that any other conclusion would be contrary to the meaning of the statute.

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

Considered by Sternhagen, Lansdon, and Arundell.


author: Green :

text:
    Adams-Roth Baking Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10073.
    Promulgated October 4, 1927.
    An anticipated loss on a contract to purchase flour to be delivered in 1921 was properly disallowed by the Commissioner as a loss in the year 1920.

      Frederick P. Schaefer, G. P. A., and Hardy 8. Walters, G. P. A., for the petitioner.

      A. H. Murray, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of its income tax for the year 1920, for which year the Commissioner has made a determination of a deficiency in the amount of $1,764.48.
    The case was submitted on the pleadings and the only matter at issue is the alleged loss of $7,139 claimed as a deduction in 1920, which arose by reason of the petitioner setting up on its books the difference between the price of flour purchased under contract and its market value at the close of the year.
    FINDINGS OF FACT.
    The petitioner is a Connecticut corporation with its principal place of business at Bridgeport, where it conducts a wholesale bakery. In 1920, its gross sales were $358,523.62. Its books of account are kept, and tax returns rendered, on the accrual basis of accounting for calendar year periods. The flour used by the petitioner is practically all purchased from mills in the western part of the United States and Canada through contracts for future delivery. During the latter part of the year 1920 the petitioner entered into contracts for the purchase of a quantity of flour, deliveries of which were to extend to June 1, 1921. The admitted allegation of the petition states the conditions under which this flour was purchased as follows:
    The purchase contracts referred to above provide for the purchase of a stated quantity of flour, of a definite grade described usually by a brand, at a fixed price, with deliveries to be made at a determined or determinable time, usually thirty or more days after the contract date, and payment for the goods to be made on “ arrival of draft with bill of lading attached ” meaning that on payment of draft for the purchase price, which draft is presented upon arrival of the goods at destination, the purchaser secures the bill of lading and thru it the legal title and possession of the goods.
    At December 31, 1920, the market price of flour was less than at the dates the contracts were entered into, and in determining its net income for 1920, the petitioner deducted the amount of $7,139, which represents the difference between the purchase price of flour under contract for future delivery, $70,876.75, and its market value at the close of the year, $63,737.75. It credited the item of $7,139 on its books to an account called “ Contracts Payable.” The Commissioner disallowed the deduction of this amount and determined a deficiency in tax in the amount of $1,764.48.
   OPINION.

Green :

The amount of $7,139 was not a true loss on December 31, 1920. It was nothing more than an anticipated loss. The petitioner did not have in its possession on December 31, 1920, any of the flour for which it had contracted. It had paid nothing on the contracts nor had it acquired title to any of the flour. The only liability of the petitioner would occur after January 1, 1921, when the flour would be delivered. It was then bound under the terms of the contract to accept the flour on certain specified dates and to pay for the same on the date of delivery, all of which was to occur subsequent to December 31, 1920.

A similar question was before the Board in the Appeal of Haas Bros., 3 B. T. A. 113, in which case, at the close of the year, the taxpayer had outstanding contracts to purchase merchandise, which was undelivered. The taxpayer set up on its books as a loss the difference between the contract price and the market price and deducted such alleged loss upon its income-tax returns. It was there held that as title to such goods had not passed at the close of the year, such goods could not be included in inventory and no deduction could be taken.

The Board has held in the Appeal of Ewing-Thomas Converting Co., 1 B. T. A. 121; Appeal of Morrison-Ricker Manufacturing Co., 2 B. T. A. 1008, and Appeal of Haas Bros., supra, that there is no provision in the law which permits the deduction of anticipated or prospective losses.

Judgment will l>e entered for the respondent.

Considered by Sterniiagen, LaNsdox, and AetjNdell.


author: Smith:

text:
    Herman Adaskin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9591.
    Promulgated October 4, 1927.
    Taxpayer acquired assets at a cost of $105,000 which on the same day he transferred to a newly organized corporation in exchange for shares of preferred and common stock; later, on the same day, the corporation acquired other assets in exchange for shares of its common stock. Held, that the two transactions were separate. Held, further, that the evidence does not warrant a finding that the shares of stock received by the taxpayer had a fair market value in excess of the value of the assets transferred to it by the taxpayer, or that the taxpayer derived taxable income from the transaction.

      Frederick W. Tillinghast, Esq., and Roger T. Glapp, Esq., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for 1919 of $18,114.01, arising in large part from the addition to the net income returned by the taxpayer of $53,880.99, alleged to be profit from the sale or disposition of assets acquired by the petitioner from the Anthony Furniture Co. to the Flint-Adaskin Furniture Co.
    FINDINGS OF FACT.
    Prior to December 5, 1919, Herman Adaskin, a retail furniture merchant of Springfield, Mass., pursuant to a plan of expanding his business by establishing branches, proposed to establish a branch in Providence, E. I., by consolidating the businesses of two furniture companies located there, namely, Anthony Furniture Co. and Flint & Co., Inc., neither of which concerns had been doing a prosperous business. The Anthony Furniture Co. had been operating at a loss, and Flint & Co., Inc., had been operating at only a small profit.
    With this end in view, Adaskin negotiated with the stockholders of the Anthony Furniture Co. and with those of Flint & Co., Inc., and arranged a meeting of all parties to be held on the evening of December 5, 1919, for the purpose of completing and consummating the deal.
    Upon the basis of negotiations previously had with the stockholders of these two companies, the petitioner caused to be incorporated on December 5, 1919, a new corporation under the laws of Ehode Island, which was called the Flint-Adaskin Furniture Co., with an authorized capital stock of $425,000, $175,000 of which was preferred stock and $250,000 common stock. Until the evening of December 5, 1919, none of this stock was issued except three shares of common stock as qualifying shares. On the evening of December 5, Adaskin brought together in one room the owners of all the outstanding stock of the Anthony Furniture Co. and the owners or proxies for the owners of all the stock of Flint & Co., Inc. He then purchased all of the stock of the Anthony Furniture Co. for $105,000 cash. At 6 p. m. a meeting of the stockholders of the Anthony Furniture Co. was held and the stockholders voted to liquidate its affairs by transferring to Adaskin all of its assets in exchange for its entire capital stock. The assets were thus placed in his hands as an individual and transfers, bills of sale, assignments, assignment of lease, etc., were recorded and delivered. Immediately thereafter Adaskin caused a meeting of the stockholders of the Flint-Adaskin Furniture Co. to be held and submitted to them the following offer:
    I have purchased all the property and assets of every kind and nature, wherever situated, real, personal and mixed, of Anthony Furniture Company, a corporation under the laws of the State of Rhode Island and located in Providence, as of the close of business on December 6, 1919. I will convey, assign and transfer to your company or cause to he conveyed, assigned or transferred to it by a good and sufficinet instrument or instruments of conveyance, assignment or transfer all of said property and assets of every kind and nature, wherever situated, real, personal and mixed of said Anthony Furniture Company as of the close of business on said December 6, 1919 upon the following terms and conditions:
    1. You are to issue to me at once one hundred five thousand dollars ($105,000) in the first preferred stock of your company at par.
    2. The total assets and properties of said Anthony Furniture Company and of Flint and Company, Incorporated, shall be appraised by a method acceptable to Richard E. Smith, J. Palmer Barstow and myself, Avhieh method shall be the same in the manner of appraisal of both of the said companies’ total assets and properties, and in case the total net assets and properties of said Anthony Furniture Company shall exceed the total net assets and properties of said Flint and Company, Incorporated, as shown by said appraisal, you are to issue to me, in addition to the foregoing, an amount of the first preferred stock of your company at par equal to one-half of the said difference in total net assets.
    3. You are also to issue to me at once one hundred forty-two thousand five hundred dollars ($142,600) in the common capital stock of your company at par.
    4. I will further agree in the event of your accepting this offer to return to your company for its use as treasury stock, common stock in your company of the par value of fourteen thousand dollars ($14,000).
    5. At the time of the transfer your company is to deliver to me a proper and sufficient agreement assuming the payment of all the debts, obligations and liabilities of every name and nature and the performance of all the contracts and agreements of every kind of said Anthony Furniture Company, or assumed by me in connection with the purchase of their assets.
    6. Your company is to assume all expenses in connection with its organization and the consummation of this offer.
    Very truly yours,
    (Signed) Herman Adaskin.
    The offer was accepted by the stockholders and thereupon transfers were executed by Adaskin to the new corporation and the stockholders of the new corporation thereupon voted to issue to Adaskin $105,000 of its preferred stock and the number of shares of common stock agreed upon, which after allowing for a bonus of stock to remain in the treasury for the purposes stated in the offer amounted to $128,500. The vote was consummated by the actual delivery of the bill of sale transferring the assignment of the lease, etc., by Adaskin to the new corporation and the issuance to him of the stock so voted.
    Adaskin, who had previously been made the president of Flint-Adaskin Furniture Co., thereupon stated that as a result of negotiations “ between this company and Flint & Company, Incorporated, an opportunity was presented of purchasing all the property and assets of Flint & Company, Incorporated, of every kind and nature, wherever situated, real, personal and mixed, upon the assumption by this company of all contracts, indebtedness and other obligations of Flint and Company, Incorporated, in exchange for one thousand and seventy-five (1075) shares of the full paid and non-assessable common stock of Flint-Adaskin Furniture Company to said Flint and Company, Incorporated, or its nominees.”
    Upon motion duly made and seconded the following preambles and resolutions were thereupon unanimously adopted:
    Whereas, Flint and Company, Incorporated, is prepared to transfer, sell and assign to tbis corporation all of its property and assets of every kind and nature, wherever situ^ed, real, personal and mixed, upon the assumption by this corporation of all of its contracts, indebtedness and other obligations as of the elose of business on December 5, 1919 for tbe sum of one hundred seven thousand five hundred dollars ($107,500) to he paid in the full paid and non-assessable common capital stock of this corporation at par, to be issued to said Mint and Company, Incorporated, or to such person or persons as it may name; and
    Whereas, in the judgment of this meeting said purchase upon the terms and conditions set forth is necessary for the purposes of this corporation and is of the full and clear value of one hundred seven thousand five hundred dollars ($107,500), and is a good and sufficient consideration for the shares of stock demanded therefor:
    Now Therefore Be It Resolved: That the treasurer be and he hereby is authorized to offer to consummate said purchase upon said terms and conditions by a letter in the following form:
    Providence, R. I.

      December 5, 1919.

    Flint and Company, Incorporated,

      Providence, B. I.

    Gentlemen : This Company hereby offers to purchase from you all of your property and assets of every kind and nature, wherever situated, real, personal and mixed, and to assume all of your contracts, indebtedness and other obligations, as of the close of business on December 5, 1919, for the sum of one hundred seven thousand five hundred dollars ($107,500) payable to you or to such person or persons as you may name in the full paid and non-assessable common capital stock of this corporation.
    We further agree in case this offer is accepted to make all proper and satisfactory arrangements to the end that an agreement for the voting control of said Flint-Adaskin Furniture Company shall be executed upon mutually satisfactory terms.
    This offer will remain open for ten days from date, and if not then accepted shall cease and determine.
    Awaiting your reply, we are Very truly yours,
    Flint-Adaskin Furniture Company
    (Signed) By J. P. Barstow, Treasurer.

    The books of account of the Anthony Furniture Co. at the close of business on December 5, 1919, showed the net worth of that company to be $111,732.45. The books of account of Flint & Co., Inc., at the same date had—
    Total assets_$187, 532.20
    Total liabilities- 96, 779.10
    Net worth_ 90, 753.10
    The offer of Flint-Adaskin Furniture Co. to purchase the assets of Flint & Co., Inc., was acco, .ed by the stockholders of the last named company at a stockholders’ meeting, held immediately after the stockholders’ meeting of Flint-Adaskin Furniture Co., and in due course the stockholders of Flint & Co., Inc., received 1,075 shares of common stock of Flint-Adaskin Furniture Co. in payment therefor.

      Pursuant to the agreements reached on the evening of December 5, 1919, Adaskin turned over to the Flint-Adaskin Furniture Co. 140 shares of common stock to be held in the treasury of the corporation for use as bonus stock. Adaskin then turned over to the newly organized corporation $25,000 of preferred stock at par, receiving in payment therefor notes of the company. The corporation then issued 100 shares of preferred stock at par, with a bonus of 20 shares of common stock of Barstow Stove Co., in part payment of an account due it from Flint & Company, Inc. The first actual sales of stock of the new corporation were not made until April 1, 1920, at which time 60 shares of the preferred stock were sold at par, with a bonus of common stock at the rate of one share of common stock for each five shares of preferred stock.
    The petitioner returned no income for the year 1919 resulting from these transactions. The Commissioner added to the net income reported $53,880.99, as profit upon the sale by Adaskin to the Flint-Adaskin Furniture Co., of assets acquired from the Anthony Furniture Co. at a cost of $105,000 in exchange for the stock received from the Flint-Adaskin Furniture Co. The computation by which he arrived at this profit was as follows:
    Value of stock received_$158, 943. 06
    Cost of assets transferred_$105,000.00
    Cash payment to- adjust_ 62. 07
    - 105,062.07
    Total profit_ 53, 880.99
    The value of the stock received by petitioner was determined by the Commissioner upon the basis of the combined net worth of the Anthony Furniture Co. and of Flint & Co., Inc., on December 5, 1919, plus certain adjustments. The fair market value of such stock at the date of receipt was $105,000.
   OPINION.

Smith:

The sole question involved in this proceeding is whether the petitioner realized taxable gain under the provisions of section 202(b) of the Revenue Act of 1918 in connection with certain transactions which took place on December 5, 1919. Section 202 of the Revenue Act of 1918 provides a basis for determining gain or loss in connection with certain transactions and reads in part as follows:

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

Petitioner contends that he derived no taxable gain from the transactions outlined in the findings of fact; that the events which took place on December 5, 1919, were separate and distinct transactions and that when the petitioner transferred to the Flint-Adaskin Furniture Co. certain assets for shares of stock of that company the Flint-Adaskin Furniture Co. had no assets whatever and that, therefore, the shares of stock received must be considered as having the same value as the assets turned in to the corporation for such shares of stock; that, even if the proof as to the separateness of the transactions was insufficient, nevertheless there is no proof that the fair market value of the shares of stock received by Adaskin on December 5, 1919, in exchange for the assets turned in for such shares of stock had a fair market value in excess of $105,000. The respondent on the other hand contends that at the time Adaskin transferred the assets to the Flint-Adaskin Furniture Co. for shares of stock there was an enforceable understanding between the parties concerned that the Flint-Adaskin Furniture Co. was to acquire the assets of Flint & Co., Inc., and was to issue in payment therefor only shares of its common stock and that the substance of the transaction is that the fair market value of the assets to be acquired by the Flint-Adaskin Furniture Co. was equal to the book value of the assets of the two concerns acquired, and that upon any reasonable basis of apportionment as between preferred stock and common stock the petitioner received shares of stock which had a market value in excess of $105,000.

The evidence plainly shows the successive steps to this transaction. The negotiations between Adaskin and the stockholders of Flint & Co., Inc., which took place prior to 6 p. m., December 5, 1919, in no wise operated to bind the Flint-Adaskin Furniture Co. The first meeting of the stockholders of the Flint-Adaskin Furniture Co. was at 6.30 p. m., on December 5, 1919.

Although the deponents all testified that , there had been preliminary discussion and negotiations between all parties concerned with reference to Adaskin’s known purpose in initiating the proceedings in question, namely to consolidate the Anthony Furniture Co. with Flint & Co., Inc., and to refinance them, and that to this end the Flint-Adaskin Furniture Co. had been incorporated and the meeting of the principal parties interested had been arranged for the evening of December 5, 1919, yet it is the uncontradicted testimony of all deponents that there was no actual agreement reached and no final action taken until after thorough discussion on the evening of December 5,1919, and that not until after Adaskin had consummated his purchase of the Anthony Furniture Co.’s assets and transferred them to the Flint-Adaskin Furniture Co. was the stockholders’ meeting of Flint & Co., Inc., held and the offer of the Flint-Adaskin Furniture Co. accepted. The transactions took place in Rhode Island, and involved the transfer of the assets of two Rhode Island corporations to a third Rhode Island corporation, and are necessarily governed by and are to be interpreted in accordance with the law and decisions of the court of Rhode Island. On the point thus raised the Supreme Court of that State has twice had occasion to decide that an agreement purported to be made in behalf of a corporation before its organization is not binding upon nor enforceable by such corporation, at least until it has been adopted. In Ireland v. Globe Milling & Reduction Co. (1897) 20 R. I., 190; 38 Atl. 116, it definitely appeared that certain of the incorporators and proposed stockholders of a corporation to be organized agreed that no stockholder should sell his stock to any person without first giving the corporation an opportunity to purchase the same. The corporation was subsequently organized and stock subscribed for and issued. Some time later the plaintiff, a stockholder, sold some of his stock without first offering it for sale to the corporation itself. The corporation, basing its action on the above agreement between its incorpo-rators, refused to transfer the stock upon its books and the plaintiff brough suit for damages for such refusal. The court held that admitting the agreement above described to have existed, it constituted no defense to the action in question since the corporation was not bound by and could not enforce the provisions of such contract.

In Anderson v. Johnson (1923) 45 R. I. 17; 119 Atl. 642, the Supreme Court of Rhode Island affirmed the decision in the Globe Milling Co. case and held that stock issued pursuant to an agreement between the promoters before the organization of the corporation, the issue of which was otherwise entirely unauthorized by vote of the stockholders or directora, was invalid, the court stating, citing the Globe Milling Co. case:

As the corporation was not in existence when the contract was made it was incapable of making the contract and the promoters had no authority to bind the corporation by any contract made by or between them.
That this is the law in substantially all jurisdictions is shown by the following:—
14 O. J. Corporation, Sec. 289, p. 255 and cases cited; Fletcher Cyc. Corporations, Sec. 150, p. 306 and cases cited.
In the case of Plaquemines, etc. Co. v. Buck, 52 N. J. Eq. 219, 27 Atl. 1094 (1893) the court said:
“No rights, legal or equitable, arise in favor of a corporation in respect to transactions, whether complete or inchoate, merely because entered into in contemplation of the creation of such corporation.”

See also Winters v. Hub Mining Co. (1893) 57 Fed. 287; Penn Match Co. v. Hapgood (1886) 141 Mass. 145; 7 N. E. 22.

It would follow in the case at bar that even if there had been an agreement between either Flint & Co., Inc., or its stockholders with Adaskin, made prior to the evening of December 5, 1919, such contract could not be imputed to the Flint-Adaskin Furniture Co. when made before its organization and so could not upon such organization be enforced by it.

Turning to the principal contention on behalf of the petitioner that the transactions in question, having taken the form of a series of distinct legal steps, must be so treated in connection with the determination of taxable gain or loss resulting therefrom, it appears that this position is fully supported by decisions of this Board. Appeals of Edward A. Langenbach, 2 B. T. A. 777; West Point Investment Co., 1 B. T. A. 436; Herbert E. Clayburgh, 1 B. T. A. 573; H. F. Kerr, 5 B. T. A. 1073. Clearly, under the statute petitioner derived no gain from the sale of his assets to Flint-Adaskin Furniture Co. for shares of stock of that company unless the fair market value of the shares of stock received was in excess of the cost of the assets transferred, namely, $105,000. It is the contention of the respondent that the assets turned in by Adaskin were to be appraised and that the assets acquired from Flint & Co., Inc., were to be likewise appraised; that for any excess in the appraisal of the assets turned in by Adaskin over those acquired from Flint & Co., Inc., same was to be paid for by the issuance to Adaskin of additional shares of preferred stock. This we think proves no fair market value of the shares of stock received by Adaskin in excess of the $105,000 paid by him for the assets of the Anthony Furniture Co. Even if this were so, the appreciation in the value of Adaskin’s shares is not taxable as income. The increment in value, if any, occurred after Adaskin had acquired his shares of stock, the valúe of which is here involved. Deponents, who were in position to know of the value of the preferred and common stock, testified that the value of the stock on December 5, 1919, was at most problematical. The earnings of the predecessor companies afford no basis for a contention that the value of the stock received by Adaskin was in excess of $105,000. It was, of course, believed by Adaskin and the others interested, that the Flint-Adaskin Furniture Co. could be operated at a profit. But only the future could tell.

From a consideration of the entire evidence we are of the opinion that the fair market value of the shares of stock received by Adaskin for the assets paid in was not in excess of $105,000 and that the petitioner derived no taxable income from the transaction.

Beviewed by the Board.

Judgment will be entered on 15 daps' notice. imder Rule 50.


author: VAN FossaN:

text:
    Cocks-Clark Engraving Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6604.
    Promulgated October 4, 1927.
    1. A corporation the business of which is acquired through the reputation of its principal stockholders as photo-engravers of exceptional skill and ability, who devote their entire time to the affairs of the corporation, and the capital of which is invested in tools and equipment and materials used by the stockholders in the rendition of services, is entitled to personal service classification, even though a staff of assistants is employed.
    2. Capital invested in tools and equipment used by the principal owners in performing personal services is not a material income-producing factor.
    3. A corporation engaged in producing and selling an»article whose value arises from the performance thereon of personal services requiring a high degree of artistic skill and ability, which article is valuable to him for whom it is especially prepared but of no value to others, is not producing and selling merchandise or commodities, but is selling personal services. Where the principal stockholders perform or supervise all the work entering into the services offered for sale, the corporation is not “ trading ” in the services of others although a part of the physical detail work be performed by assistants to the principal stockholders. Such a corporation is not “ trading as a principal ” within the meaning of the statute.

      W. F. Demons, Esq., and Montgomery B. Smith, Esq., for the petitioner.

      A. H. Fast, Esq., for the respondent.
    This an appeal from the determination by the Commissioner of a deficiency in income and profits taxes for the calendar years 1919, 1920, and 1921, amounting to $4,751.19, $5,745.53, and $2,892.50, respectively. Petitioner alleges that the Commissioner erred in denying it classification as a personal service corporation; in refusing special assessment under sections 327 and 328 of the 1918 and 1921 Revenue Acts; and in disallowing the deduction of certain items of depreciation. At the hearing the respondent confessed error as to the third allegation and petitioner abandoned its claim for special assessment.
    FINDINGS OF FACT.
    Petitioner is a Colorado corporation with its principal office in Denver, Colo., and is and during the taxable year was engaged exclusively in the‘business of photo-engraving.
    The process of photo-engraving employed by petitioner was as follows : The s'ubject to be reproduced is photographed and conformed to the size desired. By the “old wet-plate process” a negative is made upon glass and transferred to a plate of either zinc or copper by the use of a solution of either enamel or ink. If the plate is enameled the print is then baked in, and if inked it is “ topped,” so that the plate may be etched. The plate is then etched (with nitric acid or perchloride of iron, dependent upon whether zinc or copper is used) to the printing depth, so that it may be clearly reproduced on a letter press. If it is to be used for type-high printing the plate is mounted. The surplus metal is “ routed ” or cut away, and the plate, if mounted, is packed upon a base of metal or wood type-high, and carried through a finishing or proving process. After the correction of any imperfections that may have appeared the plate is proved on a hand press and a proof of the engraving is submitted to the customer for approval.
    The amount of capital stock of petitioner was the same during the taxable years as it was 'upon organization. It consisted of 5,000 shares, par value $1 each, and in 1919 was distributed as follows:
    Shares.
    William M. Cocks-2, 448
    Charles A. Clark_2,448
    Mrs. William M. Cocks- 1
    Mrs. Charles A. Clark- 1
    William B. McNulty_ 2
    McNulty was an employee of petitioner and the other two stockholders, holding one share each, were the wives of Cocks and Clark, respectively. McNulty left the employ of petitioner at the close of 1919 and his two shares of stock were transferred one share each, to Cocks and Clark, so that in 1920 and 1921 all the stock was held by them, with the exception of the two shares held by their wives. At all times during the taxable years Cocks and Clark were the real owners of all the stock. Clark was president and Cocks vice president of the corporation, and both devoted all their time exclusively to the business. Petitioner derived no income from any source other than its business of photo-engraving.
    Cocks and Clark have been engaged in the photo-engraving business for 33 and 35 years, respectively, and were thoroughly familiar with every phase of the work. Each enjoys a reputation for exceptional skill and ability in this class of work. Cocks was in personal charge of transferring the negatives to the metal — the etching, the routing, and the blocking, and Clark had personal charge of the photographing, finishing, and proofing, and also attended to the oifice and consulted with customers. During the taxable years petitioner had from 12 to 14 employees, none of whom were skilled photo-engravers, with salaries ranging from $6 to $40 per week. In addition to a janitor, errand boy, bookkeeper, and stenographer, there were employed two photographers, who served as assistants to Clark and whose duties were to make copies of the subject to be reproduced, which required familiarity with the work but no especial skill in photo-engraving; two etchers whose duties were to assist Cocks in the copper and zinc etching; one apprentice; one assistant to Clark in the finishing and proofing of plates; and four artists who made up designs and drawings to be later photographed and reproduced. All the work pertaining to the photo-engraving was either performed or supervised by Cocks or Clark in person, and none of the employees was capable of doing the work without their assistance. The employees were desirable, but not essential to the business, which could have been conducted on a small scale by Cocks and Clark alone. No salesman or solicitors were employed. All customers transacted their business with Cocks or Clark, whose advice was frequently sought, and they often suggested and developed ideas in cuts, drawings and designs for customers. The skill and ability of Cocks and Clark, their advice, counsel and personal service to customers, and their reputation as the highest class of engravers in that part of the country, were responsible for and produced all the business received by petitioner.
    Petitioner carried no stock of engravings for sale, all work being done on special orders. During each of the taxable years it carried a small stock of supplies merely as a matter of convenience. Sales were made at a lump-sum price for the finished product and charges were not made for material independently of service and advice. The machinery and equipment were increased in amount in the years 1920 and 1921, by reason of the purchase of some etching machines to replace old ones that had been leased. The new machines were purchased to satisfy a sense of pride and not because there was any advantage in owning rather than leasing them. All business was done on a 30-day payment basis, which was considered cash in the locality and trade. The cash balance carried was not necessary to the conduct of the business, but existed chiefly because Cocks and Clark withdrew only such amounts as they required. This item was always largest at the close of the year, withdrawals in large amounts being made at the first of each year. In 1919 Cocks and Clark each drew a salary of $3,900, and in each of the years 1920 and 1921 they each drew a salary of $5,200. During all the years each could have obtained $10,000 per year in the employ of other photoengravers. The small amount of borrowed money shown on the books as bills payable, and paid off in 1920 was not necessary to the conduct of the business in the taxable year. The assets and liabilities at the beginning and close of each of the taxable years were:

   OPINION.

VAN FossaN:

Respondent having confessed error in denying the depreciation deduction, and petitioner having abandoned its claim for special assessment, we have to consider only the question of whether or not petitioner was a personal service corporation within the meaning of the Revenue Acts of 1918 and 1921.

Section 200 of the Revenue Acts of 1918 and 1921, so far as material, provides:

The term “ personal service corporation ” means a corporation whose income is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves regularly engaged in the active conduct of the affairs of the corporation and in which capital (whether invested or borrowed) is not a material income-producing factor; but does not include * * * any corporation 50 per centum or more of whose gross income consists * * * of gains, profits, or income derived from trading as a principal * * *.

In considering those elements which are essential and must be coexistent to bring any corporation within the personal service classification defined by the statute, we have heretofore observed that the elasticity of the terms of the definition precludes the formulation of any rigid rule and requires the “ application of a flexible judgment” to the peculiar facts and circumstances of each case as it arises. (See Appeal of Bryant & Stratton Commercial School, Inc., 1 B. T. A. 32, and Appeal of Cliver-Wright-Rainey Co., 2 B. T. A. 561.) We have also pointed out that “ the concept underlying the whole theory of personal service corporations was to give relief to those corporations, the income of which was primarily attributable to the personal and individual activities of the principal stockholders” (Appeal of Hanley-Ried Co., 2 B. T. A. 315, 318), and that “the purpose of the statute was to grant a privilege to certain corporations whose activities consisted of the rendition of personal services, by its stockholders, for money.” (Appeal of William Morris Enterprises, Inc., 1 B. T. A. 946, 950.)

A photo-engraving is not a commodity or article of merchandise in any true sense of the term, nor was petitioner a manufacturer or producer or dealer in merchandise. In dealing with the petitioner, customers were not purchasing a commodity or an article of merchandise, as those terms are ordinarily understood, but were engaging the services which the petitioner offered for sale. Photo-engraving requires the exercise of a high degree of artistic skill, chemical knowledge, optical judgment and individual discretion of the draftsman. It is for this service that the customer contracts. -The physical material upon which the service is performed has little or no independent value, but is merely the means through which the desired service is rendered to the customer. The engraving is of value only to him for whom it has been especially prepared and has no value as a commodity or article of merchandise for general trade. In dismissing an indictment under the anti-trust laws of New York, charging a combination to affect the price of articles and commodities in common use, the court said:

Under no definition that I have seen can a photo-engraving be called a commodity. It is simply a substitute for wood engraving or steel engraving, or engraving on stone, which formerly performed the service now rendered by the photo-engraving.
No one has alleged that a photo-engraving is ever seen on sale in any shop in any place.
The only cases which refer or even remotely relate to photo-engravings are those in which it was held that lithographs — which resemble photo-engravings— are not commodities.
Photo-engraving is rather to be regarded as an art or a process. The defendants are not prohibited by the statute from dictating the terms on which they shall render their services, since their labors cannot in any proper sense be said to result in the production or sale of an article or commodity in common use. People v. Epstean, 170 N. Y. Supp. 68.

In a case involving a contract for lithographing, which, as the New York Court observes, is similar to photo-engraving, it was said:

The contract to manufacture and furnish articles for the especial, exclusive and peculiar use of another, with special features which he requires, and which render them of value to him but useless and unsalable to others, articles whose chief cost and value are derived from the labor and skill bestowed upon them and not from the materials on which they are made, is a contract for work and labor and not a contract of sale. Beck Lithographing Co. v. Colorado Milling, etc., 52 Fed. 700.

It seems clear, therefore, that petitioner’s business is an art requiring artistic skill and discretion and that Cocks and Clark were selling and offering for sale their personal services. They were not manufacturing or merchandising. Its customers do not seek merchandise or a commodity of exchangeable value, but desire a special service in satisfaction of their own peculiar requirements, for which they are willing to pay the stipulated price.

The evidence here discloses that the two owners of the corporation were highly skilled engravers, considered as the best in that part of the country, and personally performed or supervised all work of the corporation. They transacted all business with customers and it was solely upon them that customers relied for advice and suggestions and satisfactory rendition of the services desired. No salesmen or solicitors were employed and all business received was wholly attributable to the reputation of the two owners as skilled engravers of the highest class. No capital was employed in the business except that represented by the tools, machinery and equipment and the supply of materials used. The employees were a janitor, errand boy, bookkeeper, stenographer, assistant shopmen, and artists. The assistant workmen were not skilled engravers, could not complete any piece of work without the supervision, direction and assistance of the two owners, and none of the employees came in contact with customers or directly produced or attracted business to the petitioner.

The testimony of the revenue agent, who, after examination of petitioner’s returns, allowed personal service classification, was that—

Cocks and Clark were the sole life and body of this business. * * * Without these men the business would not have existed very long, * * * the bulk of their business was due to their personal ability and efforts.

The statute requires only that petitioner’s income shall be “ ascribed primarily to the activities of the principal owners of stockholders.” Strictly speaking, every employee of a corporation contributes something to producing its income and unless full force be given to the word “primarily” no corporation could be given personal service classification if it employed any assistants, however minor their duties. We do not believe the statute contemplated such a narrow construction. The word “ primarily ” was used advisedly and should be construed reasonably. In the face of the above testimony and the testimony of other witnesses who were attracted to petitioner because of the superior skill and ability of Cocks and Clark and in order to receive their advice and counsel in the work, we believe it clear that the income of this corporation was to be ascribed primarily to the activities of Cocks and Clark and that they were engaged in the active conduct of its affairs.

It would seem no less clear that capital was not a material factor in the production of its income. All the capital employed consisted of the materials and equipment with which petitioner worked in rendering the services purchased by its customers. This equipment was not a material income-producing factor in the sense contemplated by the Act. It was no more than the tools employed in performing personal services. Nor were the materials an income-producing factor for as such they were' of little or no value and certainly were not the things for which customers paid. These materials were nothing more than the medium through which the petitioner transferred to its customers the skilled services of Cocks and Clark, which was the real thing contracted and paid for. Our reasoning in Appeal of Rhoades, Brownson & Kampman, Inc., 2 B. T. A. 194, 198, is equally applicable here:

These tools and equipment, which constitute practically all the capital of the company, are not unlike the kit of tools carried by every mechanic in the conduct of his business; they differ little in general from the equipment of the physician or surgeon in carrying on his profession, or the office furniture and library of the lawyer; and we a.re of the opinion that such funds as any mechanic, physician, surgeon or lawyer has invested in the tools and equipment necessary for his business are not such a form of capital as to be considered under the Revenue Act * * * as a material factor in producing earnings and profits.

Nor can it be said that the petitioner was “ trading as a principal ” within the intendment of the Act. It was not the services of the employees that the petitioner sold or traded in, for none of them were skilled engravers capable of completely performing the work from which its income was derived. These employees were engaged in separate phases of .the detail work entering into the finished object and were merely assistants to Cocks and Clark in the performance of physical details incident to completing for delivery the service desired. These employees were not known to petitioner’s customers and none of its business was acquired by reason' of their independent services or reputations as engravers. That they were of material assistance in the rendition of the services performed by Cocks and Clark and that because of such assistance a greater volume of business could be done are undoubtedly true, but that does not necessarily demonstrate trading as a principal. Congress certainly did not intend such a narrow limitation as would exclude from personal service classification every corporation, otherwise satisfying the requirements of the Act, in which the owners did not themselves physically perform every detail of the work. We can not assume that Congress intended to grant a privilege, and, in the act of granting1, imposed a limitation which would for all practicable purposes revoke the very privilege granted. As we said in Appeal of Moser & Wacker, Inc., 4 B. T. A. 1021, 1025:

Every lawyer, physician or engineer who uses the services of an employee or who has a brief typed by a public stenographer, a test made by a* chemist, or a plan traced by a draughtsman, is in this sense “ trading ” in the services of other people. Would it be seriously contended that such “ trading ” was contemplated by section 200? We think not.

In Appeal of William Morris Enterprises, Inc., supra, we said:

When a client goes to a lawyer, a doctor or an engineer, he retains his services. It may be that a large part of the work done under the retainer will be performed by a clerk, a nurse or a draftsman^ in the employ of the professional man, but it is ¡Ms ability, skill, or judgment that is desired, whether exercised directly or by way of supervision. It is Ms reputation that attracts patrons. It is he who will be held responsible for the quality of the services rendered.

And so it is in the instant appeal. Customers sought the services of 'Cocks and Clark and it was their ability, skill and judgment that was desired, whether exercised directly or by supervision. It was their reputation that attracted patrons and they were responsible for the quality of the services rendered. In the case of Westermann & Pagano, Inc., 2 B. T. A. 1308, personal service classification was granted though it appeared that at times the corporation employed as many as 25 copy artists, whose aggregate salaries in the taxable year amounted to $80,593.88. In that case, as in the present, customers were attracted solely by the skill and reputation of the stockholders.

We say here, as we did in Appeal of Rhoades, Brownson & Kampman, Inc., supra:

The record in this case is clear and contains convincing evidence that the taxpayer as a corporate organization * * * was engaged only in selling the services of its members in the performance of a business requiring special qualifications as to skill, experience, and knowledge of a .technical character, and that the corporate form of organization must have been adopted by the members of the taxpayer company simply as a matter of convenience in organizing and selling the personal services of its members.

We have carefully examined the cases cited by respondent and find that each of them is clearly distinguishable upon its facts from the instant appeal.

Petitioner complies with all the requirements of a personal service corporation imposed by the Revenue Acts of 1918 and 1921 and respondent erred in denying it classification as such. See Bryant & Stratton Commercial School, Inc., supra; Westermann & Pagano, Inc., supra; Moser & Wacker, Inc., supra; and Innes-Behney Optical Co., 7 B. T. A. 982.

Reviewed by the Board.

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


text:
    David Kimball, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11968.
    Promulgated October 4, 1927.
    The beneficiary of an estate is not liable to income tax in respect of income of the estate not received by him but held by the estate pursuant to the provisions of the will of the decedent until such time as the principal of certain advancements has been wiped out.

      Henry II. Kimball, Esq., for the petitioner.

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

      This is a proceeding for the redetermination of a deficiency in income tax for the year 1923 in the amount of $242.55, arising from the addition to net income reported of $3,500 representing one-half of the income of property held by the executor of the estate until such time as advancements made to the petitioner should have been paid in full.
    FINDINGS OF FACT.
    The petitioner is a resident of Boston, Mass., and was during the year 1923 a beneficiary under the will of his father, David P. Kim-ball, late of Boston, Mass., while the estate of the said David P. Kimball was in process of settlement.
    Petitioner filed an income-tax return for the calendar year 1923 with the collector at Boston, in which return he included all income received from the estate, which was $3,500. In the audit of the return the Commissioner has increased this item by adding thereto $3,500 withheld by the executor in accordance with the provisions of the will.
    The fourteenth clause of the will of David P. Kimball provided that the net annual income of the trust should be paid in equal shares to the testator’s three children during their lives. The petitioner’s share of the income of the estate for 1923 under the fourteenth clause of the will was $7,000.
    The fifteenth clause of the petitioner’s father’s will provided as follows:
    If at the time of my death my son shall be found indebted to my estate by way of advancements, I authorize and direct my executor and trustee to deduct from the net income, otherwise due and payable to him, one-lialf part thereof and to apply the amount so deducted from time to time to the reduction of such indebtedness until the same is paid in full. All advancements are, not to bear interest either during my life time or after my decease and the deductions are to be made whenever and as often as any income is paid.
    The amount withheld under the fifteenth clause of the will by the executor from the petitioner in 1923 was $3,500.
   OPINION.

Smith:

It was stipulated by the parties to this proceeding that the only issue to be decided by the Board is whether under the facts above found the amount of $3,500 withheld by the executor in accordance with the fifteenth clause of the will of David P- Kimball constituted income to the petitioner for the year 1923.

An advancement in its legal acceptation does not involve the idea of obligation of future liability to answer. Yundt's Appeal, 13 Pa. 575, 580; 53 Am. D. 496; Kinney v. Newbold, 115 Iowa 145; 88 N. W. 328.

In its legal sense, and as employed in the law of descent and distribution, an advancement is an irrevocable gift in praesenti of money or property, real or personal, to a child by a parent to enable the donee to anticipate his inheritance to the extent of the gift. 18 C. J. 911. See also Osgood v. Breed, 17 Mass. 356.

The law is well settled that an advancement creates no debt to the person making it and in all its features and in its very nature is distinguishable from a debt. Dawson v. Macknet, 42 N. J. E. 633, 635; 8 Atl. 312.

The petitioner is clearly liable to income tax in respect of the amounts of income paid over to him by the executor or trustee during the year 1923. That amount was $3,500. There is no question as to his liability in respect of that amount. We think, however, that he is not liable to income tax in respect of any portion of the income of the trust which he did not receive and had no right under the will to receive in 1923 or in any year thereafter.

Reviewed by the Board.

Judgment of no deficiency will he entered.

Marquette, Sternhagen, Morris, Milliken, and Murdock dissent.