author: Miller : Leech,

text:
    Transylvania Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79517.
    Promulgated July 16, 1937.

      J. M. McCready, Esq., for the petitioner.

      Byron M. Coon, Esq., for the respondent.
   OPINION.

Miller :

The petitioner in 1932 bought $19,000 par value of its outstanding bonds for $4,750. The respondent held that the difference of $14,250 was a taxable gain and determined a deficiency. This determination the petitioner assails on the theory, first, that it did not retire the bonds and, second, that the value of its entire assets in 1932 was less than the amount of outstanding bonds and that consequently no assets were freed by the purchase.

1. It is not necessary that reacquired bonds be retired in order that gain accrue from the purchase. This question has been decided by the Board, adversely to the petitioner, in Garland Coal & Mining Co., 28 B. T. A. 348; affd., Garland Coal & Mining Co. v. Helvering, 75 Fed. (2d) 663; Virginia Iron, Coal & Coke Co., 29 B. T. A. 1087; and Montana, Wyoming & Southern Railroad Co., 31 B. T. A. 62; affd., 77 Fed. (2d) 1007; certiorari denied, 296 U. S. 604; applying the decisions of the Supreme Court in United States v. Kirby Lumber Co., 284 U. S. 1, and Helvering v. American Chicle Co., 291 U. S. 426.

The petitioner says that it did not and would not retire these bonds because by keeping them alive it got the interest from the Southern Railway. This may be a good reason between the parties for recognizing the continuing obligation of the Southern to pay— whether as interest or rent would be unimportant between them. But it does not serve petitioner in the present controversy. When it acquired its own bonds it became in form both debtor and creditor and thus it wiped out its obligation qua obligation, irrespective of its continuing right to rent. To be sure, it could have revitalized its obligation by selling these bonds, cf. Garland Coal & Mining Co. v. Helvering, supra, or pledging them as collateral security, Washington Loan & Trust Co. v. Blair, 75 Fed. (2d) 671, but this would give a new interest against petitioner; which is properly to be recognized when it becomes actual. As we said in Garland Coal & Mining Co., supra: “The purchase of the bonds by the petitioner constituted such a closed transaction as gives rise to recognizable gain or loss under the revenue act. The fact that the petitioner had such bonds available for resale is not controlling. Such a resale would be an entirely new transaction.”

The petitioner relies upon the use of the word “retires” in article 68 (1) (c) of Treasury Regulations 77 and upon statements contained in Garland Coal & Mining Co. v. Helvering, supra, concerning the intention of the taxpayer to retire repurchased bonds. It is sufficient in this regard to quote from that case as follows:

To say, as the regulation does say, that when bonds are purchased and retired at less than the selling price, the excess is income, is by no means to say that when they are purchased, but not retired, it is not income; and if the regulation must be so construed, the question whether it violates the terms of the statute (Revenue Act 1928, § 22 (a), 26 U. S. O. A., § 2022) would at least be arguable, but we have no need to pass upon that question here.

2. It is true that a prima facie showing of gain, from the repurchase of bonds at a price less than issuing price, may be rebutted by evidence that the entire business in which the borrowing was a factor resulted finally in a loss, Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, and by evidence that the original bond issue brought nothing to the taxpayer’s treasury which was freed by the reacquisition of the bonds, Commissioner v. Rail Joint Co., 61 Fed. (2d) 751.

On the other hand, a showing of shrinkage in value, alone, is not sufficient to rebut a prima facie case. Consolidated Gas Co. of the City of Pittsburgh, 24 B. T. A. 901. In the case last cited it appeared that there was a shrinkage or loss in value of the company’s properties, used for manufacturing gas, resulting from the development of natural gas; which shrinkage was the primary cause for decrease in the value of the bonds repurchased. See also Commissioner v. Coastwise Transportation Corporation, 71 Fed. (2d) 104; certiorari denied, 298 U. S. 595.

In the instant case petitioner has failed to sustain its burden of proving either that the entire business in which the borrowing was a factor resulted finally in a loss or that the original bond issue brought nothing to the taxpayer’s treasury which was freed by the reacquisition of the bonds. Petitioner’s sole witness was obviously little acquainted with, the physical properties of the railroad. The books of the petitioner apparently contained no information concerning those properties since 1905. The witness' admitted on cross-examination that he had no information on the subject except what was in the books. He stated that he had made no attempt to compute the value of the properties for 1932. Presumably full information was available to the petitioner, upon the subject, because its lease agreement with the Southern Railway Co. required the lessee to keep a full record and account concerning the same. Obviously petitioner, has failed to show a failure of assets, or loss of the money originally borrowed. On the contrary, the evidence showed that the property of petitioner was still valued on its books at the'same price as when the bonds were issued; and that the Southern Railway has paid each year the amount specified in the lease, which includes both interest on the bonds and several thousand dollars in addition. There was no evidence of dissatisfaction upon the part of the lessee; nor upon the part of the bondholders, except those few who, in the depression year of 1932, offered to sell the bonds which were purchased by the petitioner. The lease still had 24 years to run, and there was not an iota of evidence that the lessee would fail to perform as it was required to do. Its present performance—up to the time of the hearing in 1936—was all that could have been expected or hoped for at the time of the execution of the lease, when, presumably, the petitioner’s prospects were brightest.

We conclude, therefore, that assets of the petitioner were released by the purchase of its own bonds at a price less than issuing price; that taxable gain was realized thereby; and that the Commissioner’s determination was correct.

Reviewed by the Board.

Judgment will be entered for the respondent.

Leech,

dissenting: The majority holds that petitioner, a corporation, realized taxable gain in the purchase of its own bonds at less than the issuing price, in spite of what I think is the conclusively established fact that it did not then intend nor has it since intended to cancel or retire these purchased bonds.

This conclusion is said to be supported by Garland Coal & Mining Co. v. Helvering, 28 B. T. A. 348; affd., 75 Fed. (2d) 663, which is the only court or Board case cited, touching the point. Instead of supporting that conclusion, in my judgment, the opinion of the court in that case definitely and convincingly opposes it.

The taxpayer there purchased its own bonds in 1928 for less than their issuing price, and retired them in the following year. The only question presented was in which of those years petitioner’s admitted gain was taxable. The answer to this inquiry was dependent on whether, in view of the respondent’s applicable regulation (Regulations 74, art. 68 (1) (c)), retirement of the purchased bonds was necessary to establish the transaction as “closed”, and thus give rise to gain.

Without doing more than doubting the validity of that regulation, the court recognized the existence of the superficially anomalous but nevertheless widely adopted rule that, whether the purchase of its bonds by a corporate obligor constitutes payment of the purchaser’s debt evidenced by the bonds, and thus is a “closed” transaction for tax purposes, depends upon the intention of the purchaser when it purchased the bonds. Thus, the court in that case, after stating this rule and citing a few of the many authorities therefor, says in the following paragraph of its opinion:

And so, in this case the question is, the intention of petitioner when it redeemed its bonds.

The court then decided that the mere purchase of the bonds in 1928 was a closed transaction, and that a taxable gain resulted then and not in 1929 when the bonds were actually retired, solely because the evidence established the fact that when petitioner purchased the bonds it then intended to retire them and so pay its debt thus evidenced. The actual retirement of the bonds was only corroborative of petitioner’s book entries during the year of purchase, which indicated its then intention to retire the bonds. And, of course, the fact that the bonds were not actually retired until the next year could not and did not change the decisive fact that the bonds were purchased with the intention of retiring them. It seems to me this interpretation of the meaning of the court in its opinion in the Garland case is confirmed rather than disputed from the excerpt of that opinion appearing here in the majority opinion.

If that intention of the purchaser of the bonds be controlling, it would be difficult to conceive a stronger case than this, proving that such intention was not to buy and retire the bonds, but was to keep them alive, as an investment. The Southern Railway Co., not the obligor, purchaser of the bonds, was obligated to pay the interest on them. That fact distinguishes the situation here from that in the Garland case and is convincing to me that the petitioner purchased its bonds here with the intention, not of retiring them, but of keeping the obligation they reflected, alive.

It seems to me that the rationale of the majority opinion faces the dilemma of either violating the elementary rule that a debt once paid is thereby extinguished and can not be revived thereafter, or recognizing the rule of intention for which I contend, in that the sale or pledge of such purchased bonds legally continues the obligation they evidence. I think the sale or pledge of such bonds, after their purchase, merely establishes the necessary fact to their continuing validity that the intention of the purchaser was not to retire the bonds but to keep them alive. Cf. Garland Coal & Mining Co. v. Helvering, supra; R. J. Reynolds Tobacco Co., 35 B. T. A. 949. Therefore, I do not think the petitioner realized taxable income by its purchase of its own bonds for less than the issuing price, and, accordingly, dissent.


source: Caselaw Access Project

author: Hill :

license: Public Domain

text:
    The American Packing & Provision Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77642.
    Promulgated July 16, 1937.

      Walter G. Moyle, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

Hill :

This case involves the correctness of respondent’s determination of a deficiency in income tax against the petitioner of $1,980.98 for the year 1930. The petitioner is the parent of a group of five affiliated corporations, of which one was the Union Stock Yards, which was wholly owned by the petitioner. The affiliated group filed consolidated income tax returns for the years 1928, 1929, and the taxable year 1930.

In 1924 the petitioner issued $600,000 of mortgage bonds in part payment for property purchased by it. Prior to 1929 the Union Stock Yards, wholly owned affiliate of the petitioner, purchased $34,450 par value of these bonds from outsiders for a consideration of $24,428.14, and at the same time purchased accrued interest coupons for $625.86. In 1930 the Union Stock Yards sold $34,450 par value of the bonds to the trustee under the mortgage at 80 cents on the dollar, or $27,560. The trustee also purchased from outside sources bonds of a par value of $3,050 at 80, or $2,440. Neither the petitioner nor the Union Stock Yards included any profit from the transaction in their consolidated return for the taxable year. The respondent determined a deficiency against the petitioner in the amount of $1,980.98, and fixed the profit at the difference between the amount paid by the Union Stock Yards when it purchased the bonds, and their par value, which petitioner alleges was erroneous because the transaction was an intercompany one from which no gain or loss is recognized.

The facts have been stipulated in writing and are adopted as our findings, as follows:

1. The petitioner is a corporation incorporated under the laws of the State of Utah on August 5, 1924, with its principal place of business at Ogden, Utah.
2. On August 5, 1924, petitioner issued at face value $600,000 of 6% mortgage bonds in part consideration for property purchased by it. Those bonds were issued as aforesaid under a first mortgage and collateral trust indenture.
3. In accordance with Article IV of the bond indenture, the petitioner was required to deposit $30,000 cash each year with the trustee for the purchase and redemption of said bonds.
4. The American Packing & Provision Company, the petitioner, is the parent corporation of an affiliated group of which the following named corporations are the subsidiary corporations:
American Packing & Provision gales Company
Union Stock Yards
Western Gateway Storage Company
Ogden Union Stock Yards Company
5. Consolidated income tax returns wore filed for the affiliated group for the years 1928, 1929 and 1930, the same being filed in the name of the parent corporation, the petitioner herein. All of the capital stock of the Union Stock Yards for said years was owned by The American Packing & Provision Company, petitioner.
(Note: No issue is raised in these proceedings as to the right of the affiliated group to file a consolidated return).
6. Pursuant to a resolution adopted by its board of directors, The American Packing & Provision Company, petitioner, on March 28, 1930, directed the trustee to solicit and secure offers from the holders of its bonds, and to purchase for retirement at lowest prices offered as many bonds as could be bought for $30,000. Pursuant to the action taken as aforesaid, petitioner deposited with the trustee the $30,000 in cash. Pursuant to the publication of a notice by the trustee, the Union Stock Yards, one of petitioner’s affiliates, by a telegram dated May 15, 1930, offered to sell to the trustee $37,500 face value of bonds at 80, or $30,000. The trustee accepted the aforesaid offer to the extent of $34,450 face value of bonds at SO, or $27,560. The transaction was consummated, the payment being made and the bonds retired as of September 1, 1930.
In addition to the aforesaid transaction, the trustee purchased from other sources bonds of the petitioner of a face value of $3,050 at 80, or $2,440.
Of the bonds of a face value of $37,500, purchased as aforesaid by the trustee, $34,450 were purchased from said subsidiary, the Union Stock Yards, for the sum of $27,560, or a discount of 20% of face value.
7. On the purchase and redemption of said $37,500 of bonds for $30,000, petitioner reduced its outstanding bond liability by $37,500, and credited its surplus account with the amount of $7,500, which amount was the difference between the purchase price of the bonds and their face value.
Of the aforesaid $7,500, $6,890 was the difference between the face value and the cost to the petitioner of the bonds purchased from petitioner’s affiliate, the Union Stock Yards. The balance of said $7,500 is the difference between the face value and the cost to the petitioner of the bonds purchased from the other interests as aforesaid.
8. The Union Stock Yards, an affiliate of petitioner, acquired by cash purchase prior to 1929, but during periods in which affiliated returns were filed, bonds of petitioner of a face value of $34,450 for a consideration of $24,428.74, and at the same time purchased interest accrued on said bonds at a cost of $625.86. The profit shown on the books of the Union Stock Yards as a result of the sale of said bonds to the trustee was $2,505.40, computed as follows:
Amount realized from sale-$27, 560.00
Cost, including said interest of $625.86_ 25,054.60
Profit_$ 2, 505.40
Respondent in his deficiency letter included in the taxable net income of the affiliated group for the year 1930 the profit, as set forth above, arising from the sale by the Union Stock Yards to the petitioner of bonds of the latter company, and also the profit derived by the petitioner through the acquisition of said $37,500, face value of its bonds, as set forth above, which included the purchase of petitioner’s bonds of $34,450 from the Union Stock Yards and $3,050 face value of petitioner’s bonds from interests outside of the affiliated group.
9. During the period for which consolidated returns were filed, as aforesaid, and during the period bonds of the petitioner corporation were acquired in open market by the Union Stock Yards at prices less than face value of said bonds, no income or profit was reported by either the said Union Stock Yards Company or the petitioner in respect of such purchases.

The petitioner does not contest the action of respondent in adding to petitioner’s gross income the sum of $610 as profit realized on the purchase of $3,050 par value of bonds from outside interests.

It is the contention of the respondent that the case of United States v. Kirby Lumber Co., 284 U. S. 1, applies here and that the purchase of these bonds was not an intercompany transaction.. Petitioner admits that if there were no affiliation and no filing of consolidated returns the profit would be taxable under the Kirby Lumber Co. case, supra, but contends that on account of affiliation and consolidated returns this was an intercompany transaction and under regulations of the respondent no gain is recognizable.

In United States v. Kirby Lumber Co., supra, it was held that where a corporation purchased bonds theretofore issued by it at a price less than the issuing price, making clear gain, and there was no shrinkage of assets, the difference was gain or income for the taxable year. This case applies here unless it was such an intercompany transaction as resulted in no recognizable gain under respondent’s Regulations 75.

Section 141 of the Revenue Act of 1928 granted the privilege to an affiliated group of corporations of making a consolidated return on condition that all joining in-such return consent to regulations prescribed by the Commissioner, who was given the power to prescribe such regulations with the approval of the Secretary.

Article 31 (a) of Regulations 75, mainly relied on by the petitioner, reads:

Except as otherwise provided in these regulations, the consolidated net income of an affiliated group, which makes or is required to make a consolidated return for any taxable year, shall be the aggregate of the gross income of each of the members of such group, less the aggregate of the allowable deduction of each of such members, except that gain or loss will not be recognized upon transactions between members of the group (referred to in these regulations as “intercompany transactions”).

Article 33 provides in substance that gain or loss from the sale or other disposition by a member of an affiliation of stocks or bonds issued by another affiliated member shall be determined as if no affiliation existed, except (1) “In the case of a disposition (by sale, dissolution, or otherwise) during a consolidated return period to another member of the affiliated group.”

Petitioner relies upon the above articles of Regulations 75 and Chicago, Rock Island & Pacific Railway Co., 13 B. T. A. 988; 47 Fed. (2d) 990; Old Mission Portland Cement Co. v. Helvering, 293 U. S. 289; Gulf, Mobile & Northern Railroad Co. v. Helvering, 293 U. S. 295; and Southern Railway Co. v. Commissioner, 74 Fed. (2d) 887.

The Chicago, Rock Island & Pacific Railway Co. case, supra, was decided prior to the Kirby Lumber Co. case, and the promulgation of Regulations 75. In that case the taxpayer had purchased from the public the outstanding bonds of a coal company of the face value of $2,336,000, for $2,022,011.85. Subsequently the taxpayer acquired all the capital stock of the coal company, they became affiliated and filed a consolidated return. During the affiliation and in the period for which the consolidated return was filed, the coal company retired the bonds, but it does not appear for what sum. The Commissioner determined a deficiency based on the difference between the par value of the bonds and the amount the taxpayer paid for them prior to the affiliation. The Board held in part:

It is clear petitioner made no gain at the time it purchased bonds at a discount; neither did the Coal Company lose anything by reason of the transaction. No funds of either company were used during the period of affiliation to purchase the outstanding obligations of the Coal Company. It appears that there was no affiliated group in existence at the dates of the purchases to which the purchases might be attributed. Petitioner, as a distinct taxable entity, purchased the bonds and subsequently brought them into the affiliation, at which time they became intercompany obligations, the payment or collection of which produced neither income nor loss.

This case went to the Circuit Court of Appeals, Seventh Circuit, and was reversed on another point.

We do not think the above case is decisive of the instant case. The controlling reason for the decision seems to be that the purchase of the bonds by the taxpayer was made before there was any affiliation and that no funds of the affiliated group were used in the purchase of the bonds. In the instant case, the bonds were purchased during the affiliation and were paid for with funds of the affiliated group and the affiliated group undoubtedly made a profit under the Kirby Lumber Co. case.

The other cases cited and relied upon by petitioner involve the question of annual amortization of discount on sale of bonds and it was held that such amortization was not allowable as a deduction in a consolidated income tax return, where the bonds were held by an affiliated company. This was because they were intercompany transactions. It is not believed that these cases are applicable or controlling, as the transactions there did not result in a profit to the affiliated group and the transactions seem to have been purely inter-company. In the instant case the affiliated group derived a profit by its dealing with persons outside of the affiliated group.

The permission to file consolidated returns “was to provide a method of computing the tax upon the true net income of what is in practical effect a single business enterprise, with substantially common ownership, as though it were that of a single taxpayer.” Old Mission Portland Cement Co. v. Helvering, 293 U. S. 289. The regulations relative to consolidated returns and intercompany transactions were designed to prevent the shifting of gains or losses from one member to another so as to prevent distortion of correct income. There was no purpose to relieve an affiliated group of profits derived from transactions with strangers. Burnet v. Aluminum Goods Manufacturing Co., 281 U. S. 544.

In the last cited case the taxpayer was the owner of the entire capital stock of its subsidiary. The stock of the latter became worthless and in addition the taxpayer made numerous advances to the subsidiary, which were not repaid. The taxpayer claimed these losses as deductions on a consolidated return, but it was held by the Commissioner that they were not allowable because they were inter-company transactions. In holding that the losses were allowable the Supreme Court said in part:

These provisions plainly do not lay down any rigid rule of accounting to be applied to consolidated returns which would exclude from the computation of taxable income the results of every intercompany transaction, regardless of its effect upon the capital or the net gains or losses of the business of the affiliated corporations. Instead, they merely disclose the purpose underlying regulations and statute to prevent, through the exercise of a common power of control, any intercompany manipulation which would distort invested capital or the true income of the unitary business carried on by the affiliated corporations. Hence no method of accounting, in calculating taxable income upon the consolidated return, can be upheld, which would withhold from the taxpayer all benefit of deduction for losses actually sustained and deductible under the sections governing the computation of taxable income, and which at the same time would not further, in some way, the very purpose for which consolidated returns are required.
The loss was a real one, suffered by respondent as a separate corporate entity, and it was equally a loss suffered by the single business carried on by the two corporations during the period of their affiliation, ultimately reflected in the 1917 loss of capital invested in that business. While equitable principles of accounting applied to the calculation of the net income of the business unit do not permit the deduction of the loss twice, they do require its deduction once. Hence the loss was deductible in 1917 under the statute and regulations controlling computation of taxable income, and its deduction is not forbidden by the regulations applicable to the consolidated return. Articles 77 and 78 of Treasury Regulations 41 would, indeed, require the elimination of any losses resulting from intercompany transactions, the inclusion of which would defeat the purpose of consolidated returns to tax the true income of the single business of affiliated corporations, calculated by correct accounting methods. The deductions claimed here had no such effect.

In Corco Oil Refining Co. v. Helvering, 72 Fed. (2d) 177, where the taxpayer had all of its dealings with an affiliated member and derived a large profit, it was held that the profit was taxable, although an intercompany transaction. The court there said in part:

It is conceded that all of the transactions of the Coreo Corporation were had with the Crystal Corporation and that the Coreo Corporation had no dealings with any other party than the parent company. Accordingly, all of its transactions were intercompany transactions. But this fact alone does not necessarily exclude the gains or losses resulting from such intercompany transactions from the consolidated returns of the affiliated companies. The statute contains no limitation in regard to intercompany transactions, and the regulations provide for the elimination only of those intercompany transactions which do not result in any actual gain or loss. As is said in G. C. M. 8618, IX-2 Cumulative Bulletin 180: “From a practical standpoint, in determining consolidated net income it is only necessary to eliminate from the combined net incomes of the several corporations, determined separately, the unrealized profits and losses in intercompany transactions. * * * To eliminate all intercompany transactions, whether or not they affect the consolidated taxable net income in determining the net income properly assignable to each member of the affiliated group, would give rather absurd results, showing large losses for some members of the group and excessive income for others.” Such inter-company transactions as result in actual gains to any of the affiliated corporations must be recognized and considered in computing the net consolidated income.
The record in the present case clearly discloses that the Coreo Corporation actually realized gains for the year 1928 in the amount determined by the Commissioner, and these are none the less assessable for income-tax purposes because of the fact that the company was affiliated with the Crystal Corporation during that year. See Burnet v. Aluminum Goods Co., 287 U. S. 544, 53 S. Ct., 227, 77 L. Ed. 484.

See also Autocar Go. v. Commissioner, 84 Fed. (2d) 772; Briarcliff Investment Co. v. Commissioner, 90 Fed. (2d) 330; Helvering v. American Chicle Co., 291 U. S. 426; Century Circuit, Inc., of Delaware, 31 B. T. A. 764.

The bonds in controversy were held by and bought from outsiders by the affiliated group with funds of the affiliated group and a profit resulted to the subsidiary when it sold them to the petitioner and to the petitioner when it acquired them for redemption and cancellation at less than par.

It is clear to us that this was not such an intercompany transaction as escapes recognition of gain or loss. It was a purchase of outstanding bonds from outside holders by the affiliated group at less than par and is governed by the Kirby Lumber Co. case. If the transfer from the subsidiary to the petitioner was an intercompany transaction it resulted in real gain and, under the Aluminum Manufacturing Co. and Corco Oil Refining Co. cases, supra, should be included in taxable income. To hold otherwise, would render it easy for affiliated groups to evade the ruling in the Kirby Lumber Co. case.

Responding to the suggestion of petitioner that the gain was made prior to 1930, when the subsidiary acquired the bonds, it is sufficient to say that the subsidiary was not the obligor. No profit was made by the subsidiary until it sold the bonds in 1930, and none was made by the petitioner until it acquired them in the same year. Garland Coal & Mining Co. v. Helvering, 75 Fed. (2d) 663, is not in point, for there the obligor acquired them in the earlier year.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Sternhagen :

text:
    E. E. Black, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86961.
    Promulgated July 20, 1937.

      Livingston Jenks, Esq., for the petitioner.

      Arthur E. Fast, Esq., and Henry L. Young, Esq., for the respondent.
   OPINION.

Sternhagen :

The Commissioner determined a deficiency of $2,559.56 in petitioner’s individual income tax for 1934. Aside from minor adjustments which are not assailed, the Commissioner included in petitioner’s income $8,000 dividends on corporate shares held by four trusts created by petitioner in 1933, of each of which petitioner’s wife and three minor children were the respective beneficiaries. This inclusion the petitioner assails.

We are of opinion that the Commissioner’s determination is in error. The trusts were complete and irrevocable. Petitioner had no right to the income either presently or prospectively, and none of it actually came to him. He did not benefit by its use for the support and maintenance of his wife and children or in discharge of any other of his own obligations (cf. Commissioner v. Grosvenor, 85 Fed. (2d) 2), and the trusts were at all times administered with a strict regard for their separate jural personalities (cf. William C. Rands, 34 B. T. A. 1107). There is no occasion, therefore, to regard the income as constructively received by petitioner.

The uncontested adjustments will result in increasing the net income, and therefore require redetermination of the deficiency.

Judgment will be entered under Rule 50.


author: Leech:

text:
    Summerill Tubing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74070.
    Promulgated July 20, 1937.

      W. A. Seifert, Esq., W. W. Booth, Esq., Robert L. Kirkpatrick, Esq., and A. G. Wallerstedt, C. P. A., for the petitioner.

      John F. Greaney, Esq., and L. C. Mitchell, Esq., for the respondent.
   OPINION.

Leech:

The controlling Revenue Act of 1928, section 275, obviously, bars the assessment of the present deficiency and, a fortiori, the contended fraud penalty (Samuel L. Huntington, 35 B. T. A. 835), unless, under section 276 of that act, the return for 1929 was “false or fraudulent with intent to evade tax.” This issue is separate from that involved in section 293 (b), under which the amount, only, of the fraud penalty is fixed, and must be answered before we reach the question of the existence of any deficiency. See Charles J. Delone, 34 B. T. A. 1139. Respondent has the burden of proving by the preponderance of clear and convincing evidence that such intent existed. Charles J. Delone, supra.

The record discloses convincingly that the return for the tax year was filed by its president, who had the authority so to do; that such return was false in its statement of taxable income because that statement reflected its deduction of fictitious purchases in the comparatively substantial amount of $76,939.63. See National Bank of Commerce v. Allen, 223 Fed. 472; United States v. Ninety-Nine Diamonds, 139 Fed. 961. The authorities are clear that such facts constitute convincing evidence of the intent of the corporation to evade income taxes in the filing of the return. Lorraine Corporation, 33 B. T. A. 1158; L. Schepp Co., 25 B. T. A. 419. But petitioner, apparently, argues this effect of that evidence is contradicted here by the logical conclusion from the record that, in filing the false return, petitioner’s president, Gabel, intended, only, to hide his corporate defalcations from the corporation for what were, obviously, selfish reasons. Ingenuous as this position seems, we do not think it avails petitioner here. Gabel’s selfish interest in saving himself by filing the false return is entirely consistent with and does not contradict the concurrent existence of his intent to evade corporate income tax by that return, which the record otherwise clearly reveals.

The request of Parker, who succeeded Gabel as president, to the respondent to audit the corporate records after Gabel’s depredations were discovered, discloses, at most, only a change of corporate intent. But the intent with which we are alone concerned was the corporate intent in filing the return, which is reflected here by that of its then president, Gabel, who was authorized to make the return in question.

Consequently, we have found that the return was filed “with intent to evade tax.” From this fact, under section 276, supra, it follows that the disputed deficiency is not barred by section 275, supra.

We, therefore, pass to the question of the deficiency. Petitioner has the burden of proof in establishing error in the determination of the deficiency. Charles J. Delone, supra.

The substantial part of the deficiency results from petitioner’s overstatement of purchases. Respondent concedes that there were fictitious purchases but contends that they were less than the amount claimed by petitioner and that the corporate payments or credits, therefore, were not made or effected until 1930.

It is true the cash book of the corporation contains entries indicating the payment for several items of the fictitious purchases in January 1930. But those entries are not controlling here. Doyle v. Mitchell Brothers Co., 247 U. S. 179. The reconciliation from the books; the evidence that the actual date of cancellation of the only available check given in payment for a fictitious purchase was October 1929, while the cash book showed its entry as of January 4, 1930; the established practice of the corporation of reflecting on its books for the first week of a calendar year transactions that occurred during the prior year; respondent’s explicit admission in his first amended formal answer to petitioner’s petition “that during the year 1929 one Samuel Landis Gabel, took from the petitioner corporation the sum of $76,939.63 in cash which was used in his own personal affairs * * *”; and other evidence establishes to our satisfaction that Gabel, the president of petitioner, during the calendar year 1929, by means of fictitious purchases wrongfully took from petitioner the sum of $76,939.63 and converted the same to his own use. Likewise, it is clear petitioner never received any consideration from those fictitious purchases, nor has it been compensated in any manner, by note, promise, or otherwise, for that amount thus wrongfully taken from it. The conclusion follows that petitioner is entitled to a deductible loss of $76,939.63 for the tax year. Revenue Act of 1928, sec. 23 (f). Commissioner v. Highway Trailer Co., 72 Fed. (2d) 913; Earle v. Commissioner, 72 Fed. (2d) 366; First National Bank of Sharon v. Heiner, 66 Fed. (2d) 925; Grenada Bank, 32 B. T. A. 1290; Gottlieb Realty Co., 28 B. T. A. 418; Parker Wire Goods Co., 8 B. T. A. 448.

The allowance of the deduction of the amount of fictitious purchases, $76,939.63, on this record, leaves for our determination, only, the propriety of respondent’s disallowance of petitioner’s deduction of $500 paid the Commonwealth of Pennsylvania during the tax year as a bonus on its increased issue of capital stock in the computation of the disputed deficiency. The disallowance of this deduction was right. United Gas Improvement Co., 25 B. T. A. 1382; affd., 64 Fed. (2d) 957. But it is not contended nor does the evidence indicate that the deduction of this item was “due to fraud with intent to evade tax.”

Thus, since that part of the deficiency resulting from the petitioner’s overstatement of purchases is eliminated from the deficiency by reason of the allowed deduction of a loss in the amount of that overstatement, no part of the deficiency, as redetermined here, was “due to fraud with intent to evade tax.” It follows that no basis exists for the imposition of any fraud penalty. Revenue Act of 1928, sec. 293 (b), supra. See Samuel L. Huntington, supra.

Decision will be entered under Rule 50.

       SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
      Except as provided in section 276—
      (a) General rule.—The amount of income taxes imposed by this title shall be assessed within two years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.
      (b) Request for prompt assessment.—In the case of income received during the lifetime of a decedent, or by his estate during the period of administration, or by a corporation, the tax shall be assessed, and any proceeding in court without assessment for the collection of such tax shall be begun, within one year after written request therefor (filed after the return is made) by the executor, administrator, or other fiduciary representing the estate of such decedent, or by the corporation, but not after the expiration of two years after the return was filed. This subsection shall not apply in the case of a corporation unless—
      (1) Such written request notifies the Commissioner that the corporation contemplates dissolution at or before the expiration of such year; and
      (2) The dissolution is in good faith begun before the expiration of such year; and
      (3) The dissolution is completed.
      (c) Corporation and shareholder.—If a corporation makes no return of the tax imposed by this title, but each of the shareholders includes in his return his distributive share of the net income of the corporation, then the tax of the corporation shall be assessed within four years after the last date on which any such shareholder’s return was filed.

       SEC. 276. SAME—EXCEPTIONS.
      (a) False return or no return.—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.
      (b) Waivers.—Where before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.
      (c) Collection after assessment.—Where the assessment of any income tax imposed by this title has been made within the period of limitation properly applicable thereto, such tax may be collected by distraint or by a proceeding in court, but only if begun (I) within six years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by the Commissioner and the taxpayer before the expiration of such six-year period. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

       SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.
      *******
      (b) Fraud.—If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended.

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (f) Losses by corporations.—In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.


text:
    Beverly Wall Paper Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82698.
    Promulgated July 20, 1937.

      John K. Hulse, O. P. A., for the petitioner.

      L. W. Creason, Esq., for the respondent.
   OPINION.

Leech:

Respondent has determined deficiencies in income and excess profits taxes in the respective amounts of $3,253.36 and $1,183.04 against petitioner for the calendar year 1933. The deficiencies arise through the increase by respondent of the net income of petitioner realized from the sale of its assets in the taxable year, due to his decrease of the cost basis to petitioner of the assets sold.

The parties have stipulated the facts and we include by reference the formal stipulation filed as our findings of fact.

The primary contention of the petitioner, that the assessment and collection of any deficiency is barred under the provisions of section 275 (b) of the Revenue Act of 1932 will be disposed of first. It is stipulated that petitioner, on the face of its return filed for the calendar year 1933, placed a notation reading: “Final return—examination desired so that Company may dissolve.” Following this, on April 23,1934, the collector to whom the return was transmitted forwarded the same to the Commissioner, with a letter reading:

There is enclosed, herewith Form 1120 filed by Beverly Wall Paper Co., 1st National Bank Building, Beverly, New Jersey for the year 1033, serial number 850036, which is being forwarded to the Bureau promptly as the taxpayer desires a final examination in order that the company may dissolve.

On June 8,1934, the petitioner wrote the collector calling attention to the fact that on its return it had asked an audit in order that it might wind up the affairs of the company, and asking that the matter be given attention. This letter was acknowledged by the collector on June 11, advising that the request for final audit had been forwarded to the Bureau of Internal ¡Revenue for appropriate action. On October 24,1934, the petitioner, for the first time, wrote the Commissioner of Internal ¡Revenue. Its letter stated:

Upon several previous occasions we have written the Camden office and your office, asking if we might have an audit of the income tax report of the Beverly Wall Paper Company, Beverly, New Jersey, filed at Camden last February, as we-are axious to wind up the affairs of this Company.
Upon inquiry at Camden, we were advised that this matter is in the hands of your office.

This letter was acknowledged on October 26,1934, by the Commissioner, advising that the return of petitioner had been forwarded to the revenue agent at Newark, New Jersey, and the matter would be given attention upon receipt of his report.

Following this, the Commissioner, on April 8, 1935, proposed a deficiency of $1,165.24, and extended an opportunity for a hearing, and after a conference on June 14, 1935, denied by letter of October 5, 1935, petitioner’s contentions with respect to the proposed deficiency and enclosed a consent for execution. In this letter the Commissioner stated:

On October 24, 1934 you requested that an early audit of your income tax return be made since you were “anxious to wind up the affairs of this company.” Although section 275 of the Revenue Act of 1932 was not mentioned, it is believed that that was your intention; therefore, under that section of the law the statutory period of limitation for assessment of additional tax on your return would expire on October 24, 1935.

Petitioner was advised that the waiver should be executed within five days, otherwise a notice of the final deficiency would be issued. The waiver was not executed by petitioner and the notice of deficiency here involved was mailed October 24, 1935.

It is petitioner’s contention that the notation, made upon its return filed for the calendar year 1933, constituted a request for prompt assessment under section 275 (b) of the Revenue Act of 1932, but that if this is not so, the letters following this, sent to the collector and calling attention to the request made on the return, constituted a sufficient request and that the notice of deficiency, having been mailed more than twelve months subsequent thereto, assessment and collection are barred.

Section 275 (b) is specific. A taxpayer corporation is entitled to the benefit of the limited time for assessment and collection, only, where it has notified the Commissioner, in writing, that it contemplates dissolution at or before the expiration of the year. Notice to this effect is not shown by the record to have been given by petitioner in any letter sent by it, either to the collector or to the Commissioner nor by the notation made by petitioner upon its return.

The facts here are clearly distinguishable from those involved in Maffitt v. Becker, 65 Fed. (2d) 880, in which the court held that a formal request for prompt assessment of a decedent’s income tax, made by the executor and attached to the return filed by the latter, was a sufficient notice to set in motion the one-year limitation provided by section 275. That case involved the estate of a decedent and the cited section required merely a request for prompt assessment. The specific information required by the statute to be included in such request filed by a corporation, and lacking in the so-called request here, was not there required. It was not questioned in that case that the request was in proper form since it asked for prompt assessment and stated that it was made under section 275. The only question raised was whether its presentation to the collector simultaneously with the return, constituted a filing “after the return”, in compliance with the statute. The court held that, on such facts, the showing that the attention of the collector was called, specifically, to the fact that the request was being made, and that the request was accepted without question by the latter, it would be presumed that the acts of filing the return and presenting the request were done in the order required, there being no indication that it was presented before the return was filed.

In the present case the first letter addressed by petitioner to the Commissioner, on October 24, 1934, merely states that the company is anxious to wind up its affairs and fails to give the specific information required by section 275 (b), but it was construed by the Commissioner to be an attempt to comply with that section and was accepted as a sufficient notice. ,The record shows that the final notice of deficiency was mailed within one year from the date of this letter and we hold that assessment and collection of the deficiency are not barred.

Briefly stated, the facts with respect to the second issue are that petitioner is a corporation organized in 1932. All of its capital stock was issued in exchange for property jointly owned by three corporations, II. G. Craig & Co., Macrae & Rose Print Cutting Co., and the First National Bank & Trust Co. of Beverly, New Jersey. Petitioner’s capital stock was issued to these three corporations in proportion to their interest in the property acquired. The three named corporations acquired the property conveyed to petitioner by purchase from a receiver in bankruptcy appointed for Robert F. Hobbs, Inc. The consideration paid by these three corporations for the assets was $14,955 in cash and the assumption of a mortgage on the property of $38,000.

The circumstances under which this acquisition of property occurred were that the three named corporations were the largest creditors of Robert F. Hobbs, Inc., when that company was adjudged bankrupt. Their allowed claims aggregated the sum of $79,355.51 out of a total indebtedness of the bankrupt of $107,000. The three named corporate creditors, upon the sale of the bankrupt property, conceived the plan of jointly buying this property with the purpose of selling it at a profit and recouping, to that extent, the loss which they would sustain on the debts due them. They accordingly bid in the property for the amount above set out, which was contributed by the corporate creditors in proportion to the individual claims of each. The amount paid for the assets was distributed by the receiver in bankrutcy to the creditors and these three purchasers of the assets received as creditors of Robert F. Hobbs, Inc., their proportionate distribution of the amount realized by the receiver on the sale.

On acquiring this property, the three corporations conveyed it to the petitioner, which they had caused to be organized, receiving in exchange all the capital stock of petitioner issued to them individually in the proportion of their interests in the property.

In the following year the petitioner sold this property for a total of $80,765.98, or $27,810.98 more than the total consideration paid for those assets upon their purchase from the receiver in bankruptcy.

In computing its income for the calendar year 1933, petitioner used as a cost basis of the assets sold, the amount of the indebtedness of the three corporate creditors of Robert F. Hobbs, Inc., plus the consideration paid the receiver in bankruptcy for the assets, less the amount of $9,649.63 distributed to these three creditors as a dividend upon their allowed claims. In determining the deficiency respondent has used as the cost basis of the assets the figure at which they were acquired from the receiver in bankruptcy, or $14,955 cash, plus a mortgage assumed of $38,000, or a total of $52,955.

It is urged by petitioner that the purchase of these assets by its three organizers was merely an incident in their refinancing and adjustment of the indebtedness due them from Robert F. Hobbs, Inc.; that the entire transaction must be considered as a whole; that the unrecouped balance of the indebtedness due from Hobbs to the three represents a cost to them of the assets acquired; and that this is the cost basis to be used by petitioner in computing gain or loss on the resale of those assets.

Petitioner’s contention can not be sustained. The transaction does not fall within the reorganization provisions of the statute. The three named corporations, creditors of Robert F. Hobbs, Inc., were merely general creditors of that company and had no investment therein. The rule is well established that continuity of investment interest is essential to all tax deferment under the reorganization provisions. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; and Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U. S. 599. It may be said in addition, however, that even had these three corporations been stockholders in the bankrupt corporation, a purchase by them for cash at the receiver’s sale of the bankrupt assets at a sale for less than the amount of the corporate indebtedness would not establish continuity of the original investment in a corporation to which the acquired assets were transferred by them for stock. Petree v. United States, 34 Fed. (2d) 563; affd., 41 Fed. (2d) 517.

In the present case these three corporations were merely the purchasers of the assets sold by the receiver. The fact that they were creditors of the bankrupt corporation had no bearing on that purchase because their claims against the bankrupt constituted no part of the consideration paid. The basis to them for gain or loss upon the sale of these assets was the cost in their purchase from the receiver in bankruptcy, and these assets having .been transferred to the petitioner in exchange for all of the capital stock issued to the owners of the assets in proportion to their ownership therein, the basis for gain or loss to petitioner upon the sale of those assets is their cost to these three stockholders, under sections 112 (b) (5) and 113 (a) (8) of the Revenue Act of 1932. Farmers Cotton Oil Co., 27 B. T. A. 106.

One of the deficiencies determined by the respondent is for excess profits tax hi the sum of $1,183.04. Upon the hearing it'was admitted by counsel that subsequent to the determination of this deficiency the petitioner had filed an amended capital stock return upon which it had declared a value and paid a tax, and that this would require a recomputation of excess profits taxes. The necessary correction in the excess profits tax determination should be made in the recomputation of the deficiency.

Judgment will be entered under Rule 50.

       SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION. Except as provided in section 276—

      (b) Request for Prompt Assessment.—In the case of income received during the lifetime of a decedent, or by bis estate during the period of administration, or by a corporation, the tax shall be assessed, and any proceeding in court without assessment for the collection of such tax shall be begun, within one year after written request therefor (filed after the return is made) by the executor, administrator, or other fiduciary representing the estate of such decedent, or by the corporation, but not after the expiration of two years after the return was filed. This subsection shall not apply in the case of a corporation unless—
      (1) Such written request notifies the Commissioner that the corporation contemplates dissolution at or before the expiration of such year; and
      (2) The dissolution is in good faith begun before the expiration of such year; and
      (3) The dissolution is completed.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.

      (b) Exchanges Solely in Kind.—

      (5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.-No gain Or loss Shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
      SEC. 113. adjusted BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (Unadjusted) of Property.—The basis of property shall be the cost of such property; except that—

      (8) Property acquired by issuance of stock or as paid-in surplus.—If the property was acquired after December 31, 1920, by a corporation—
      (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or
      (B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.


author: Smith:

text:
    Thalia W. Malcom, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 81192, 82651.
    Promulgated July 20, 1937.

      A. Harding Paul, Esq., for the petitioner.

      Frank M. Thompson, Esq., and Loren P. Oakes, Esq., for the respondent.
   OPINION.

Smith:

These proceedings, consolidated for hearing, involve income tax deficiencies for 1932 and 1933 of $1,604.27 and $1,401.74, respectively. Petitioner alleges that the respondent erred in the determination of the deficiencies by including $10,443.25 and $2,346.91, respectively, in gross incomes for 1932 and 1933, representing amounts of income received by a trust of which she was the sole_ life income beneficiary, even though not paid over to her during the taxable years.

The parties have stipulated that the petitioner is entitled to deductions from gross income in addition to those reported on the returns of $205.11 for 1932 and $534.89 for 1933, representing taxes paid to Great Britain.

The petitioner is a citizen of the United States and the daughter of Robert E. Westcott, who died a resident of the City, County, and State of New York, on April 23, 1907, leaving as his survivors his widow and the petitioner. The decedent left a last will and testament which was duly admitted to probate and recorded.

Under paragraph sixth of his will the decedent bequeathed the residue of his estate in trust to be held during the lives of his widow and the petitioner, the income to be paid in accordance with the terms thereof. The decedent’s widow, the mother of the petitioner, died in 1919, after which time the petitioner was entitled to receive the entire net income of the trust estate.

On August 19,1931, the trustees of the trust were the petitioner, the Chase National Bank of the City of New York, and Stephen C. Millett, Jr., and on that date as such trustees they executed a lease agreement covering premises located at the corner of 181st Street and Broadway, New York City, with the Masol Realty Corporation, a New York corporation. The lease agreement was made on the basis of the petition filed by the trustees with the Supreme Court for the County of New York in New York City on April 21, 1931, and was entered into subsequent to orders of that court under dates of June 27 and August 12, 1931.

On March 3, 1920, the then acting trustees had by an agreement in writing leased the above mentioned premises to D. A. Schulte, Inc., a New York corporation, for a term of 21 years beginning May 1, 1920, and ending May 1,1941.

On or about April 8, 1924, D. A. Schulte, Inc., sublet for the term of the lease the above mentioned premises to the Masol Realty Corporation, which on that date became and ever since has been the sublessee.

In 1931 the Masol Realty Corporation, desiring to insure its continued possession of the premises for a term beyond May 1, 1941, opened negotiations with the trustees for a 21-year lease covering a term from May 1,1941, to May 1,1962. The trustees were unwilling to make this proposed new lease without receiving a cash payment from the Masol Realty Corporation and it was agreed, therefore, subject to certain qualifications, that the Masol Realty Corporation should make 10 annual payments to the trustees of substantially $10,000 each, known as “annual consideration payments” between the years 1931 and 1941, when the new lease went into effect.

Under date of May 11, 1933, an agreement was entered into by and between the trustees and the Masol Realty Corporation whereby the “annual consideration payments” provided for in the agreement of October 19, 1931, were reduced. On May Y, 1934, the trustees entered into an additional agreement with the Masol Realty Corporation by which the trustees waived for a period payment of the “annual consideration payments” as reduced by the aforesaid agreement of May 11, 1933.

The petitioner did not in 1932 or 1933 receive, and has not since received, the above mentioned “annual consideration payments” or any part thereof from the trustees. The trustees received from the Masol Realty Corporation on account of the aforesaid “annual consideration payments” $10,443.25 in 1932 and $2,346.91 in 1933, and ever since their receipt have held and retained such payments and continue to hold them in a special account as and for distribution to unascertained beneficiaries, and the trustees reported these sums in fiduciary income tax returns for the years 1932 and 1933 as “undistributed income.”

Under the lease agreement entered into on August 19, 1931, to begin May 1, 1941, rentals were to be paid by the Masol Realty Corporation upon the basis of a 6 percent return upon the appraised value of the land as of May 1, 1941, plus $6,400 per annum, less 2 percent per annum for depreciation on the agreed value of the buildings, and for the period May 1, 1952, to May 1, 1962, at the annual rate of 6 percent upon the appraised value of the land at May 1, 1952, plus $4,640, less depreciation at the rate of 2 percent per annum on the buildings. The lease provided:

It is expressly understood and agreed that as part consideration for the making of this lease by the Landlords to the Tenant and as a condition precedent to the taking by the Tenant of possession of the premises under this lease and as a condition precedent to the commencement of the term hereof, there shall be paid by the Tenant to the Landlords in addition to any and all other payments required to be made hereunder, sums of money hereinafter also called “annual consideration payments” in equal monthly payments in advance as follows: At the rate of seven thousand five hundred ($7,500.) per annum from the date hereof until October 1, 1931, or until the commencement of the term hereof if the same should commence on a day earlier than October 1, 1931; and at the rate of Ten thousand dollars ($10,000.) per annum from October 1, 1931 to May 1, 1941, or until the commencement of the term hereof if the same should commence on a date after October 1, 1931 and before May 1, 1941. Such payments shall be made with adjustment for any period less than one month.

Petitioner has kept her books of account and filed her income tax returns on the cash receipts and disbursements basis. The trustees likewise kept their books of account and filed their returns upon the same basis.

On September 10, 1935, an additional income tax for the year 1932 in the amount of $1,604.27 was paid by the petitioner and thereafter interest on such sum was also paid by her. On about April 11, 1936, an additional income tax for the year 1933 of $1,401.74 was likewise paid by the petitioner and thereafter interest on such sum was also paid by her.

The question presented by this proceeding for the determination of the Board is whether the petitioner is liable to income tax for the years 1932 and 1933 upon the amounts of $10,443.25 and $2,346.91, received by the trust in 1932 and 1933, but not actually paid over to her during those years. The respondent contends that these amounts constitute taxable income of the petitioner for those years upon the ground that the petitioner was the sole life income beneficiary of the trust and that the amounts represented income received by the trust currently distributable to her. The contention of the petitioner is that they were not currently distributable to her and that she therefore is not taxable upon them.

Section 161 (a) (1) and (b) and section 162 (b) of the Revenue Act of 1932 determined persons subject to taxation upon “annual consideration payments” involved in these proceedings. They read as follows:

SEC. 161. IMPOSITION OP TAX.
(a) Application op Tax.—The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
(1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust.
SEC. 162. NET INCOME.
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
* * * * ⅜ * ⅜
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (e) of this section in the same or any succeeding taxable year.

The petitioner does not deny that the payments in question constituted taxable income to either the trust or to her in both tax years. She contends that they were taxable income of the trust and not of herself; that they represented amounts to be accumulated in trust for the benefit of unascertained persons; that it would not be known until 1941, or upon the prior termination of the trust in case of her death, who would receive the income.

The petitioner admits that no court passed upon the question as to whether the payments received in 1932 and 1938 were distributable to her. John J. Graeber, Jr., vice president of the Chase National Bank of the City of New York, one of the trustees, when asked why he did not secure a court order with reference to the distribution of the “annual consideration payments” testified:

I was advised by counsel that the initial rent represented income to the persons who may be entitled to the income from time to time after 1941 when the lease went into effect, and the parties in interest agreed with counsel to treat it in that manner.

In Mary Clark De Brabant, 34 B. T. A. 951 we held that where the person to whom income of a trust was distributable was ascertained, but the distributability of that income, withheld during the tax year by the trustee on the ground that part or all of the amount withheld was corpus and not income, was contested, conclusively adjudicated in a later year as distributable income of the trust, and then paid to the beneficiary, such income was not taxable to the trust under section 161 (a) (1), but was taxable to the beneficiary thereof for the year when distributable, whether or not it was then distributed, under sections 161 (a) (2) and 162 (b). In the course of our opinion we said:

It is that right of petitioner, beneficiary, to receive the contested income then, not her actual or constructive receipt of such income during that year, which fixes her liability for the tax thereon, as income “currently distributable” during that year, under sections 101 (a) (2) and 162 (b), supra.. The possession of that right to receive income, not its actual or constructive receipt, is the test of petitioner’s liability here. That is the applicable test announced in Freuler v. Helvering, 291 U. S. 35. * * *

Our decision in that case was affirmed by the Circuit Court of Appeals for the Second Circuit on June 7, 1937, 90 Fed. 433. In the course of its opinion the court said:

In McCrory v. Commissioner, 69 F. (2d) 688 (CCA. 5), a trustee to liquidate holdings of real estate had failed to set aside during the year 1924 amounts of income sufficient to discharge taxes and expenses of the trust and to distribute the remainder to the beneficiaries at the end of the year. He stated that he did not do these things though they were prescribed by the terms of the trust deed because gift and other taxes that were burdens upon the trust had not been adjusted with the federal government during the year. The question before the court was whether the remainder of the income for 1924 after setting aside sums estimated as sufficient to discharge the trust burdens was taxable against the beneficiaries. The court held that the trustee ought to have set aside the required sums and that the remainder was income “to be distributed currently” to the beneficiaries and taxable to them. Sibley, J., said:
The test here is not what this trustee thought or did, but what his trust empowered or. required him to do. What instructions would a court of equity, if appealed to on December 31, 1924, have given him?

The petitioner in these proceedings is one of three trustees of the trust. At the date the lease was entered into in 1931 the petitioner had three children, all of whom were of age. They joined with their mother in 1931 in the petition to the Supreme Court of the County of New York for permission to enter into the lease agreement executed in that year. Although it may not be inferred from the evidence of record that tax liabilities were given consideration in the failure on the part of the trust to distribute to the petitioner the “annual consideration payments” received by the trust in 1932 and 1933, it apparently was immaterial to her whether the amounts were distributed or not. She had a large taxable income without the receipt of these moneys.

From a consideration of the entire record, we are of the opinion that the “annual consideration payments” made by the Masol Realty Corporation in 1932 and 1933 were not intended to be any part of the rental for the use of the premises after 1941. The Masol Realty Corporation for reasons of its own desired to have a lease upon the property which would not terminate prior to 1962. In order to obtain an assurance of a continued tenure of the demised premises it was willing to make the “annual consideration payments.” The trustees for the benefit not only of the remainderman but of the person entitled to the life income insisted that there should be a cash consideration currently payable. The “annual consideration payments” were admittedly taxable income of the trust. Under the terms of the will of the petitioner’s father the entire net income was payable to the petitioner after the death of his widow. We see no reason why the “annual consideration payments” did not constitute distributable income of the trust during the taxable years which are before us.

A case on its face closely resembling the proceedings at bar is In re Archambault's Estate, 232 Pa. 347; 81 Atl. 314. The facts in that case were that in 1909 a trust was the lessor of property. The term of the lease expired January 1, 1913. The United Gas Improvement Co. arranged with the then lessee to rent the property. The new lease was to begin upon the expiration of the old lease. The United Gas Improvement Co. agreed to pay a $10,000 bonus for the execution of the new lease and also a monthly rental of $1,041.67 to January 1913. The trust received the bonus payment in 1909, together with additional monthly payments. The life tenant claimed that she was entitled to receive as income in 1909 the $10,000 bonus paid. A niece contended that this sum should be ratably distributed over the whole term of the new lease for the benefit of those entitled to it during the term. The court held, however, that as the life tenant was entitled to all of the income of the trust for 1909, the $10,000 received by the trust in 1909 was a part of the income which was distributable to her. The determination of the court clearly supports the contentions of the Government herein.

From a consideration of all of the evidence we are of the opinion that the respondent did not err in his determination that the petitioner is liable to income tax for the years 1932 and 1933 upon the' “annual consideration payments” received by the trust in those years.

Judgment will he entered under Rule 50.


text:
    Gail H. Baldwin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83665.
    Promulgated July 22, 1937.

      Urban E. Wild, Esq., and Ernest R. Cameron, C. P. A., for Ihe petitioner.

      Arthur H. Fast. Esq., and Henry L. Young, Esq., for the respondent.
   OPINION.

Sternhagen :

The Commissioner determined a deficiency of $46.29 in petitioner’s individual income tax for 1933, all of which is the result of including in petitioner’s income $8,930.99 which was received by the Gail H. Baldwin Trust as dividends on corporate shares which were held by the trust. The explanation for the adjustment is stated in the deficiency notice as follows:

Dividends received by the Gail H. Baldwin Trust have been consistently held to be taxable to the grantor of the trust. Therefore, the dividend amounting to $8,930.99 has been eliminated from the taxable income of the trust.

The facts have all been stipulated and need not, therefore, be specially found. The petitioner on May 7,1930, took out a $200,000 life insurance policy on the life of her husband, she being the original beneficiary. On May 27, 1980, she created an irrevocable trust, to which she transferred 400 shares of H. P. Baldwin, Ltd., and to which she assigned the insurance policy, with the duty of the trustee to use the income of the trust to pay the premiums on the policy and give her the excess. There has been no excess. There is nothing more than this, and the case falls squarely within Lucy A. Blumenthal, 30 B. T. A. 591. On this point, no appeal was taken in the Blumenthal case, and its holding has not been narrowed in any later decision.

The determination is reversed.

Judgment will be entered for the petitioner.


text:
    Rocky Mountain Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent
    Docket No. 79421.
    Promulgated July 23, 1937.

      Harry C. Weeks, Esq., for the petitioner.

      Byron M. Coon, Esq., and W. G. Cullen, Esq., for the respondent.
   OPINION.

Leech:

This proceeding seeks redetermination of a deficiency in income tax in the sum of $593.28, determined against petitioner for the calendar year 1932. The petitioner assigns as error that respondent in determining the deficiency (a) increased its reported income by an amount constituting the proceeds of oil production to which the original lessors of the property were entitled under the terms of the leases and which was paid over to these lessors, and (b) determined the limitation upon depletion allowable to petitioner in the amount of 50 percent of net income from the property by deducting from gross income intangible drilling costs and overhead expenses.

Petitioner is a Texas corporation which owns and operates two oil and gas leases known as the “S. S. Cook 10 acre lease” and the “S. S. Cook 3⅓ acre lease.” These leases were treated as a unit by respondent for the purpose of computing depletion. Petitioner acquired both of the leases in question by assignments which in each instance reserved to the assignor the right to certain amounts payable from the proceeds of oil, if and when produced. In the case of the 10-acre lease, the assignment provided for payment of $30,000 to the assignors, payable out of ¼ of ⅞ of the first oil, as, if, and when produced, this payment to be made direct to these parties by the purchaser of such oil. As to the 3⅓-acre lease, the assignment provided for a payment of $10,000 to the assignors out of ½ of ⅞ of the first oil produced and saved, the assignor expressly reserving to himself ¼ of ⅞ of all oil from said premises until the $10,000 provided for should be paid. The properties as held and operated in the taxable year by petitioner were subject to the terms and conditions, above set out, and contained in the original assignments.

In accordance with the general practice existing in such cases in the oil business, so-called division orders were presented to the pipe line company purchasing the oil produced from petitioner’s wells during the taxable year. These division orders set out the proportion of the proceeds of the oil purchased to which the assignors of the leases were entitled and payments were duly made by the pipe line company direct to such assignors in that year in the total sum of $9,191.92.

Petitioner in making its return for the calendar year 1932 did not include in its income any p^art of the $9,191.92 paid direct to the original assignors by the pipe'line company, but in determining the deficiency respondent included this amount in petitioner’s income and also included it in determining net income of petitioner from the wells for the purpose of computing the limitation upon depletion allowable under section 114 (b) (8) of the Revenue Act of 1932.

Petitioner drilled a well upon the property in 1932 and expended in this operation $14,479.54 for intangible drilling and development costs. This amount it deducted as expense under the Commissioner’s regulations in determining its net income for that year. It also in that year expended $825 in the way of salary to its president, $792.24 for interest, and $59.52 for office expense.

No question is raised by the respondent as to the allowability of these deductions in computing taxable income but in computing the aforesaid 50 percent limitation upon allowable depletion he also reduced gross income from production by the amounts of these expenditures.

With respect to the first issue, the taxability of petitioner upon the $9,191.92 received from oil production by the assignors of the two leases, it appears that respondent relies on Comar Oil Co. v. Burnet, 64 Fed. (2d) 965. However, since the decision of that case this question has been presented directly, or the principle controlling it has been passed upon, in a number of decisions by the courts in which a different conclusion is reached, and the question appears to have been definitely settled by the recent decision of the Supreme Court in Thomas v. Perkins, 301 U. S. 655. See also Commissioner v. Fleming, 82 Fed. (2d) 324; Commissioner v. Elliott Petroleum Co., 82 Fed. (2d) 193; Alexander v. Continental Petroleum Co., 63 Fed. (2d) 927; Commissioners. Williams, 82 Fed. (2d) 328; Commissioner v. O’Donnell, 90 Fed. (2d) 907; Elbe Oil Land Development Co. v. Commissioner, 91 Fed. (2d) 127; Chester Addison Jones, 31 B. T. A. 55; affd., 82 Fed. (2d) 329. In these cases there was presented the question of whether or not taxpayers who occupied the position of the assignors in the present cases were entitled to depletion upon the proceeds of oil production paid over to them under assignments similar to the ones here involved. In these cases the courts held these recipients of oil payments to be entitled to the deduction of depletion since, under the rule laid down in Palmer v. Bender, 287 U. S. 551, they had a retained economic interest in the leased properties. In other words, the courts in these cases hold that the recipients of oil payments, under the conditions here existing, received income from the property. This conclusion resolves the question in the present case, because, if these payments constituted income from the property to the assignors they can not also constitute income from the property to petitioner. If these payments were income from the property to these petitioners there could be no question but that they would be entitled to depletion. We would have a condition, then, of 27½ percent depletion deduction allowed to two parties upon the same income, a result not permitted under the act. Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312. On authority of the cited cases we conclude that the $9,191.92, in question, did not constitute gross income to petitioner.

The second issue is the correctness of respondent’s action in deducting intangible drilling costs and overhead expenses in computing net income from production for the purpose of applying the 50 percent limitation upon allowable depletion. The deduction of intangible drilling costs by respondent in computing net operating income was disapproved in the decision of the court in Ambassador Petroleum Co. v. Commissioner, 81 Fed. (2d) 474; reversing 28 B. T. A. 868. The Board has accepted the view taken by the court in that case. Mountain Producers Corporation, 34 B. T. A. 409. It is true that both of the above cases arose under the 1926 Revenue Act, whereas, the question here arises under the Revenue Act of 1932. But the Commissioner has, under the 1932 Act, provided by his Regulations, that the net income from property for the purpose of the 50 percent limitation on depletion must be computed by the deduction of the amount of development expense if such expense had been taken as a deduction in the determination of taxable net income.

In Wilshire Oil Co., 35 B. T. A. 450, the question was presented whether the rule adopted in Ambassador Petroleum Co. v. Commissioner, supra, and Mountain Producers Corporation, supra, applied under the Revenue Act of 1928, in view of the fact that under the latter- act respondent (by article 221 (i) of Regulations 74) had specifically provided, as here, that development costs charged to expense by the taxpayer and reflected in computing net taxable income should be deducted in computing net income for the purpose of applying the 50 percent limitation upon depletion. In that case the Board held that since the statutory construction of the provisions of the 1926 and 1928 Revenue Acts with respect to depletion were the same, respondent, by regulations, could not change the rule for the computation of net income under the later act for the purpose of computing the limitation upon depletion. That conclusion disposes of the issue here because the controlling act and regulations are similar to the one there involved.

This brings us to the propriety of respondent’s deduction of overhead expenses in computing net income for the purposes of the limitation on depletion. This question is not answered by the decision of the court in Ambassador Petroleum Co. v. Commissioner, supra, on the deductibility here, of intangible drilling costs. The conclusion there is upon the basis that no part of the latter costs constituted operating expenses. This is not necessarily true of overhead costs such as those present. Administrative salaries, interest, and office expenses are segregated from general operating expenses merely because of the fact that they are compensation for services performed or expenditures made with respect to all of the activities of the corporation. However, such portion of this overhead expense as is properly allocable to the activities of the corporation which have to do with the production of oil, are just as much an expense of that production as pay rolls of the laborers engaged in the work.

Respondent, by his deduction here, has allocated some, at least, of this expense to production. Petitioner does not attack the allocation as improper but merely raises the broad question that no part of the expense can constitute an operating cost. With his contention we do not agree. The record does not disclose that the allocation to expenses of operation, as made by respondent, is in error. In fact, it is indicated that petitioner’s activities in this year were limited to the operation of these two wells except for the drilling of one well. Whether any of the services or expenses included in the overhead cost apply to such drilling and development, we do not know. Petitioner in proving merely the amount and general character of the expenditures has not shown the action of respondent to be in error. Upon this point the respondent is sustained.

Judgment will be entered umder Rule 50.

       SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
      * * * * * * *
      (b) Basis for Depletion.—

        * * * * * * *
      (3) Percentage depletion for oil and gas wells.—In the case of oil and gas wells the allowance for depletion shall be 27½ per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

       [Regulations 77.] Art. 221. Depletion of mimes, oil and gas wells, other natural deposits, and timber; depreciation of improvements.— * * *
      *******
      (h) “Net income of the taxpayer (computed without allowance for depletion) from the property,” as used in section 114 (b) (2), (3), and (4) and articles 221 to 248, inclusive, means the “gross income from the property” as defined in paragraph (g) less the allowable deductions attributable to the mineral property upon which the depletion is claimed and the allowable deductions attributable to the processes listed in paragraph (g) in so far as they relate to the product of such property, including overhead and operating expenses, development costs properly charged to expense, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion. * * *


author: Miller:

text:
    Julia Willms Sloan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84886.
    Promulgated July 27, 1937.

      George M. Brady, Esq., for the petitioner.

      A. E. Arent, Esq., for the respondent.
   OPINION.

Miller:

Two questions are raised by this case: (1) Whether petitioner realized any gain from the alteration, by the lessee, of the building which she owned at 306-310 North Howard Street, Baltimore, Maryland, because of improvements thereto and a resulting enhancement of value of the building, and, if so, (2) whether such gain would be realized only after the sale of the property by the lessor, or whether it was realized when the improvements were completed and it then became proper for the Commissioner to spread, over the period of the lease, an aliquot portion of such gain as income for each year thereof.

(1) The value of the building was greatly increased by the improvements made by the lessee. The alterations which were made produced a substantially new building, with an entirely new and handsome front and a new roof. Old portions of the building were incorporated so skillfully into the reconstructed one as to give them permanence equal to that of the new additions.

The lease provided that upon its termination the lessee might remove all lighting and trade fixtures installed by it, provided that it surrendered the premises in a tenantable state and condition in all respects. The petitioner failed to show what part of the cost of improvements was attributable to the installation of such fixtures; and thus failed to sustain her burden of proof. The Commissioner conceded approximately $8,000 for this purpose. His determination under the circumstances is entitled to a presumption of correctness.

Petitioner’s contention is based not so much on the theory that the lessee may remove lighting and trade fixtures pursuant to the terms of the lease as on the theory that improvements permanent in character, such as the stairway, ironwork, and flooring must be removed by the lessor “unless you find somebody who is willing to buy or rent that particular class of building”; and that when such improvements have been removed, the losses resulting from the destruction of the property would be greater than the value of the improvements. We have considered and rejected the same argument, in Shelby D. Scott, 9 B. T. A. 1219, as applied to a motion picture theatre. In the instant case petitioner’s argument is even less pertinent. Her own witness testified that the trend of small retail business is away from the area in which her building is located, because of the growth of such shops in outlying centers of the city. On the other hand, because of the presence of motion picture theatres and large department stores in this area, the Oriole Cafeteria seems to be ideally located and the prospect of successful renting of the building for such purposes seems even more favorable than for a small retail shop.

It is true the evidence indicated that the building, after the alterations, was not so well adapted for the purpose of a retail shop and that to reconvert it for that purpose would require tearing out the present front, reinstalling show windows, removing the arched ceiling and the front stairs, reinstalling an elevator, and various other changes. In short, the new building would not be suitable for a retail shop without complete reconversion. Moreover, the petitioner contends that the improvements, while admittedly increasing the building’s value as a cafeteria for so long as it should be occupied by the present lessee, were of such a peculiar and eccentric character that they really decreased its value. However, these facts and contentions are fully met by abundant evidence of the highly successful business conducted by the lessee, Oriole Cafeterias, Inc. Petitioner’s witnesses were all skeptical in the beginning as to the wisdom of the changes proposed and as to the possibility of such success, but they enthusiastically admitted their error in the light of subsequent events. The property admittedly was bringing a higher rent than in previous years and the lease provided for an increase in rent every five years. The marked success of the tenant’s business, however unexpected it may have been to the petitioner, showed every indication of continuing. In these circumstances, we think the fact that the building might not be used as a retail shop without substantial changes is immaterial, and the possible necessity of the building’s reconversion may be disregarded. Shelby D. Scott, supra. We hold, therefore, that the petitioner realized income from the alterations made by the lessee, because of the enhanced value of the property which resulted therefrom.

(2) The second question is, When did the improvements made by the lessee become income to the petitioner? It was expressly provided by paragraph 8 of the lease that “any alterations, additions and improvements made by the Lessee shall immediately be and become the property of the Lessors, without payment of compensation therefor to the Lessee”, with a right reserved to the lessee to remove on expiration of the lease all lighting and trade fixtures. It was further provided by paragraph 9 that no improvements were to be made by the lessee without the approval of the lessors in writing. This approval was given.

By article 63 of Regulations 74, the Commissooner established the following practice:

Art. 63. Improvements l)y lessees.-—When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases:
(а) The Lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.
(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

The Commissioner has since construed this article to include improvements permitted to be made by the lessee, although not required under the lease, G. C. M. 10969, C. B. XI-2, p. 64.

In the instant case it is apparent that the Commissioner has used the alternative method of apportioning, over the period of the lease, the income realized in the year of the completion of the improvements. This method has been approved in our earlier decisions. Shelby D. Scott, supra; Joseph L. B. Alexander, 13 B. T. A. 1169; Cataract Ice Co., 23 B. T. A. 654; W. H. Martin, 24 B. T. A. 813; Louise C. Slack et al., Executors, 35 B. T. A. 271; Emma C. Morphy, 35 B. T. A. 289.

The petitioner relies on Hewitt Realty Co. v. Commissioner, 76 Fed. (2d) 880, in which the Circuit Court of Appeals for the Second Circuit, reversing this Board, 29 B. T. A. 1205, rejected the Commissioner’s method of determining realization of income, as constitutionally unsound.

In the recent case of Emma C. Morphy, supra, we gave careful consideration to the decision in Hewitt Realty Co. v. Commissioner, supra, and, relying upon the cases of Miller v. Gearin, 258 Fed. 225, and Cryan v. Wardell, 263 Fed. 248, came to the conclusion that, since no other court had adopted the theory of the Hewitt Realty Co. case, we should adhere to our former opinion and again sustain the validity of the contested regulations. See also United States v. Boston & Providence Railroad Corporation, 37 Fed. (2d) 670. Pursuant to that conclusion we sustain the Commissioner here.

Decision will be entered under Rule 50.