author: Aenold:

text:
    Rebsamen Motors, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99532.
    Promulgated April 3, 1941.

      G. Russell Brown, O. P. A., for the petitioner.

      8. B. Anderson, Esq., for the respondent.
   OPINION.

Aenold:

The Commissioner determined a deficiency in excess profits tax in the amount of $102.69 and a deficiency in personal holding company surtax under section 351 of the Revenue Act of 1934 in the amount of $725.76, for the taxable period May 1 to December 31, 1935, the latter only being in controversy herein. The petitioner alleges that the respondent erred in determining that it was a personal holding company. It also claims that it overpaid personal holding company surtax for the taxable period involved in the amount of $4,157.83 plus interest in the amount of $352.45. The proceeding was submitted upon the pleadings and a written stipulation of facts.

The petitioner is an Arkansas corporation with its principal office in Little Eock, Arkansas. On February 18, 1938, the then corporate name of petitioner, “The Finance Corporation of Arkansas”, was changed to its present name, “Bebsamen Motors, Incorporated.”

The petitioner’s gross income for the taxable period involved, May 1 to December 31, 1935, and the percentage of each item thereof to the total income was as follows:

At and for some time prior to October 16, 1935, the petitioner was the owner of all of the issued and outstanding capital stock of the Union Savings Building & Loan Association, an Arkansas corporation. After the payment of all its debts the association completely liquidated during the taxable period. On October 16, 1935, the entire assets of the association, consisting of cash, real estate, real estate mortgages, and accounts receivable, were distributed as a final liquidating dividend to petitioner. The fair market value on that date of such assets so received was not in excess of the amounts as follows:

Gash- $1,784. 27
Real estate- 46, 900. 54
Real estate mortgages_ 79,452. 62
Accounts receivable_ 17, 923. 68
Total- $146,061.11

The cost basis of the entire stock of the association to petitioner was $128,111.62. Petitioner realized a gain upon the receipt of the final liquidating dividend of $17,949.49 ($146,061.11—$128,111.62).

On September 15, 1937, the petitioner paid to the collector of internal revenue $4,510.28 for the taxable period involved, of which amount $4,157.83 was on account of the surtax on personal holding companies imposed by section 351 of the Eevenue Act of 1934, with interest thereon of $352.45. A claim for refund of the amount of $4,510.28 was filed with the collector of internal revenue for the district of Arkansas on December 3,1938.

Section 351 (b) (1) of the Revenue Act of 1934 provides, in so far as applicable herein, that the term “personal holding company” means any corporation where:

* * * (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals.

The petitioner concedes that more than 50 percent of its outstanding stock during the latter half of the taxable period involved was owned directly or indirectly by or for not more than five individuals. The petitioner admits that its income derived from interest on loans, notes, etc., rent, recoveries, and capital gain, comprising 32.17 percent of its total income, should be included in determining the necessary 80 percent under provision (A). It contends, however, that the liquidating dividend of $17,949.49, comprising 67.83 percent of its total income, does not fall within any class of income mentioned in provision (A).

The respondent contends that the profit of $17,949.49 was derived from the exchange of stock for property and that the term “sale” in provision (A) should be construed to include an exchange as provided in article 351-2 (5) of Regulations 86, which provides in part as follows:

(5) Gains from the sale of stock or securities.—The term “gains from the sale of stock or securities” applies to all gains (including gains from liquidating dividends and other distributions from capital) from the sale or exchange of stock or securities includible in gross income under Title I.

The respondent refers to section 115 (c) of the Revenue Act of 1934 as warranting the construction given the term “sale” in article 351-2 (5). This section is in part as follows:

■(c) Distkibutions in Liquidation.—Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock.

While section 115 (c) may justify the designating of a distribution of a liquidating dividend an “exchange”, it does not in our opinion warrant the extension of the meaning of the term “sale” in section 351 (b) (1) (A) to include exchanges.

The respondent made a similar contention in Montague, Miles & Co., 38 B. T. A. 144, with respect to a payment on a note in excess of the unrecovered cost to taxpayer. In that case it was held that “the term ‘sale’ in section 351 (b) (1) [1934 Act] means a sale in the ordinary sense of the WQrd” and that:

* * * article 351-2 (5) of Regulations 86 goes beyond the statutory definition set forth in section 351 (b) (1) of the Revenue Act of 1934 in so far as it makes gains from exchanges of stock or securities a factor in classifying companies as personal holding companies. To this extent that part of the regulation .in question becomes legislative in character, rather than an administrative construction of legislation, and must, therefore, be invalid.

That case is controlling here. We therefore hold that the petitioner was not a personal holding company as defined in section 351 (b) (1) of the Revenue Act of 1934 during the taxable period involved and was not, therefore, subject to the surtax on personal holding companies imposed by section 351.

Decision will be entered, under Bule. 50.


source: Caselaw Access Project

author: Opper :

license: Public Domain

text:
    Gertrude B. Chase, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97902.
    Promulgated April 3, 1941.

      Trumam, Henson, Esq., and Boy G. Peterson, Esq., for the petitioner.

      James O. Maddox, Esq., for the respondent.
   OPINION.

Opper :

We are asked to determine whether a nontasable reorganization occurred when the stockholders of Truscon transferred virtually the entire stock of that company in exchange for stock of Republic by turning over their shares to Republic’s wholly owned subsidiary, a corporation organized for the purpose of taking the stock, which, after about a year, transferred the Truscon stock to Republic and was dissolved.

There should be little doubt that a transfer to a subsidiary is not the equivalent of a transfer to the parent, Groman v. Commissioner, 302 U. S. 82; that in such circumstances the subsidiary and not the parent is the party to the reorganization; and that if the parent’s stock is involved, its receipt is not freed from tax by the reorganization sections. Anheuser-Busch, Inc., 40 B. T. A. 1100; affd. (C. C. A., 8th Cir.), 115 Fed. (2d) 662; certiorari denied, 312 U. S. 699. It is equally clear that a plan must be viewed as a whole and that if the transferred property, although designed to pass temporarily through one corporation, is intended to rest permanently in another, the holding by the first may be of such a transitory nature as to be without real substance. Helvering v. Bashford, 302 U. S. 454. Hence, if the Truscon stock passing through, the Truscon Holding Co., Republic’s subsidiary, was intended to come to rest in Republic, it could safely be concluded that a plan of reorganization involving an exchange of stock of Republic for stock of Truscon had been completed, and that, both corporations being parties to the reorganization and Republic having acquired at least 80 percent of the voting stock and at least 80 percent of the total number of shares of all other classes of stock of Truscon, the nonrecognition provisions, specifically section 112 (b) (3), would have become operative.

The issue then appears to narrow itself to the question whether dissolution of the Truscon Holding Co. and transfer by it to Republic of the Truscon stock may be considered to have been a part of the plan of reorganization. In Anheuser-Busch, Inc., supra, assets were transferred from the petitioner in that case to> Borden and immediately retransferred by Borden to its subsidiary, pursuant to an option specified in the plan of reorganization. The petitioner had received Borden stock in exchange and the question was whether the transaction was covered by the nonrecognition provisions of section 112. We held that it was not and said, at page 1107:

We need not decide whether the result would be different if the transfer to Borden’s subsidiary had occurred after a significant interval. The question might then arise as an issue of fact whether the subsequent transfer was part of the effectuation of the plan of reorganization or independent of it.

Here, although the situation is reversed as to the order of the transfers, the question we disregarded in Anheuser-Busch must be answered. For if the “continuity of interest” required for the application of the nonrecognition provisions may be gathered from the transfer of Truscon stock to Republic as a part of the plan of reorganization, even though that transfer took place after an appreciable period, we should be justified in holding that the two principal corporations were parties to the reorganization and that the intervention of the subsidiary was temporary and inconsequential.

In considering the comparable question in the Anheuser-Busch case, the Circuit Court of Appeals for the Eighth Circiltt, affirming the Board, emphasized the indications appearing from the plan of reorganization that (p. 666):

* * * It was not intended * * * to merge or consolidate the business * * *• The sole object and accomplishment of the plan was to transfer the business of New Yorlr, a subsidiary of the taxpayer, to Delaware, a subsidiary of Borden. It was clearly not contemplated that the taxpayer should continue to have a substantial interest in the business which was transferred. The contract itself negatived any purpose to retain that continued interest required in a merger.

Applying a similar test to the negotiations and transactions which accompanied the present exchange, we are led to the conclusion that a merger of the two businesses and a continuity of interest in the merged enterprise was intended. Among other things, the prospectus filed by Republic announced:

* * * the [Republic Steel] Corporation will obtain control of a diversified steel fabricating enterprise which has been for some time a large buyer of the Corporation’s steel products and should increase its use of such products, Truscon Steel Company has numerous well-located warehouses which should also facilitate the distribution of the other products of the combined enterprise.

A similar thought finds expression on the part of the other party to the transaction, Truscon, in its letter recommending the exchange to its stockholders, in which it says:

* * * Truscon would become directly affiliated with a rolling mill and would therefore be in an advantageous position in the purchase of its materials. The combined enterprise could control its materials from the ore to the finished product * * *. Our stockholders will acquire in this exchange the securities of the third largest steel corporation of this country.

While the terms of the documents themselves may not be entirely unambiguous as to what the plan of reorganization designed for the eventual disposition of the Truscon stock, we think the explicit purpose of the parties typified by the quoted passages, together with what actually came to pass, is sufficient to resolve any such ambiguity. We think they justify our conclusion that the plan contemplated a merger of the two enterprises rather than the conduct of the acquired business by the vanishing subsidiary, and that it envisaged a continuity of interest in the merged enterprise on the part of those in receipt of its securities. We accordingly take the view that the nonrecognition provisions are applicable and that respondent erred in his determination on this issue.

The remaining question involves gain resulting from the redemption of joint stock land bank bonds. Petitioner’s contention that such gain is exempt has been ruled upon adversely. United States v. Stewart, 311 U. S. 60. Since respondent now recedes from his earlier position and concedes that such gain is capital gain under the provisions of section 117 (f), this issue need not be further considered. Cf. William H. Noll, 43 B. T. A. 496.

Reviewed by the Board.

Decision will be entered voider Bwle 50.

       SEC. 112. RECOGNITION OE GAIN OR LOSS. [Revenue Act of 1936.]
      * * * * * * *
      (b) Exchanges Souelt in Kind.—
      *******
      (3) Stock toe stock on eeobganization.—No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      *******
      (g) Definition of Reoeganization.—As used in this section and section 113—
      (1) The term “reorganization” means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock: of at least. 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E) a mere change in identity, form, or place of organization, however, effected.
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.


author: Black:

text:
    Holly Development Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99618.
    Promulgated April 3, 1941.

      Bayley Kohbnder, Esq., for the petitioner.

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

Black:

The Commissioner has determined a deficiency of $2,103.76 in petitioner’s income tax liability for the year 1935. The deficiency is due to certain adjustments made by the Commissioner in petitioner’s income tax return for 1935 as follows:

Unallowable deductions:
(a) Depletion-$13, 745. 49
(b) Depreciation_ 1, 554.55
Total_ 15,300.04

The petitioner does not contest adjustment (b). By an appropriate assignment of error petitioner does contest adjustment (a).

Thus there is presented for our decision only one issue, namely, whether the respondent erred in deducting $23,667.03 interest paid by petitioner during the year 1935 on Federal income tax deficiencies for seven prior years as a part of petitioner’s overhead expense in determining the net income from petitioner’s oil properties for the purpose of computing the deduction allowable for depletion for the year 1935 under the provisions of section 114 (b) (3) of the Kevenue Act of 1934. This section is as follows:

(3) Pekcentage depletion FOR oil and gas wells.—In tbe case of oil and gas wells tbe allowance for depletion under section 23 (m) shall be 27½ per centum of tbe gross income from tbe property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by tbe taxpayer in respect of the property. Such allowance shall not exceed SO per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall tbe depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph. [Italics supplied.)

In computing the “net income of the taxpayer * * * from the property” the respondent deducted from the gross income from the property the $23,667.03 interest paid on income tax deficiencies for prior years. Petitioner contends that no part of the interest should have been so deducted.

The facts were stipulated. We adopt the stipulation as our findings of fact and set forth herein only those facts which are necessary to an understanding of the issue involved.

Petitioner is a corporation, with its principal office at Huntington Beach, California. It is engaged principally in the business of producing and selling oil and other petroleum products. Its income tax return for the taxable year 1935 was filed with the collector of internal revenue for the sixth district of California.

During the year 1935 petitioner paid additional income taxes for the years 1925, 1926, 1927, 1930, 1931, 1932, and 1933. At the time these additional taxes were paid, petitioner paid interest tliereon in the total amount of $28,667.03.

During the year 1935 petitioner operated five oil properties, known as .the Turley lease, Harvey lease, De Francis lease, Barnett lease, and Miller .lease, and derived a total gross income of $101,404.23 from the production and sale of oil and gas from these properties. It also received income from other sources as follows:

Interest___$1, 529.07 Dividends_ $125.00
Rents__ 600.00 Tax exempt interest_ 3, 002. 44
Sales of securities_ 6,240. 00 Sale of miscellaneous items- 2,205.24

On December 31,1927, petitioner carried on its books of account an account designated reserve for Federal income taxes. Certain amounts were added to this .account from 1928 to 1934, inclusive. The additional taxes for prior years and the $23,667.03 interest thereon paid by petitioner during the year 1935 were charged against this reserve account.

In its income tax return for the year 1935 petitioner took a deduction for depletion of its oil properties in the total amount of $26,813.29. The respondent in determining the deficiency disallowed $13,745.49 of the amount deducted and in explanation thereof said:

(a) Depletion of $26,813.29 deducted in ae return has been reduced to $13,067.80, in accordance with the provisions of Section 114 (b) (3), Revenue Act of 1934.

Petitioner now contends that the correct deduction for depletion of its oil properties for the year 1935 is the toal amount of $24,372.45 instead of $26,813.29 as originally claimed and instead of $13,067.80 as allowed by the respondent. If the above mentioned interest in the amount' of $23,667.03 should be deducted from the gross income from the properties in determining the “net income of the taxpayer * *' * from the property”, then the respondent’s determination must be sustained; and if the interest should not be so deducted, then the correct allowance for depletion is the amount of $24,372.45, as contended for by petitioner.

Section 114 (b) (3) of the Revenue Act of 1934, as far as the above italicized portion is concerned, is identically the same as section 114 (b) (3) of the Revenue Act of 1928, which was involved in Helvering v. Wilshire Oil Co., 308 U. S. 90. The question in that case was whether the Wilshire Oil Co. in computing its -net income for 1929 and 1930 for the purpose of applying the 50 percent limitation on depletion allowable under section 114 (b) (3) of the Revenue Act of 1928, was required to deduct certain ’ development expenditures where it had deducted those expenditures in computing its taxable net income. The Supreme Court, in holding that the development expenditures there involved must bé deducted in computing the “net income of the taxpayer * * * from the property”, laid special emphasis on the power of the Commissioner to promulgate regulations relative to the computation of the depletion allowance. It held valid the regulations promulgated under the 1928 Act, which regulations in so far as the present question is concerned, are substantially the same as the regulations promulgated under the 1934 Act. Article 23 (m)-l of the latter regulations provides:

(⅛) “Net ineome of the taxpayer (computed without allowance for depletion) from the property,” as used in section 114 (b) (2), (3), and (4) and articles 23 (m)-l to 23 (m)-28, 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. Deductions not directly attributable to particular properties or processes shall be fairly allocated. To illustrate: In cases where the taxpayer engages in activities in addition to mineral extraction and to the processes listed in paragraph (g), deductions for depreciation, taxes, general expenses, and overhead, which can not be directly attributed to any specific activity, shall be fairly apportioned between (1) the mineral extraction and the processes listed in paragraph (g) and (2) the additional activities, taking into account the ratio which the operating expenses directly attributable to the mineral extraction and the processes listed in paragraph (g) bear to the operating expenses directly attributable to the additional activities. If more than one mineral property is involved, the deductions apportioned to the mineral extraction and the processes listed in paragraph (g) shall, in turn, be fairly apportioned to the several properties, taking into account their relative production.

Petitioner and respondent are in agreement upon the “gross income from the property” as that phrase is used in the above quoted regulations. They differ on whether the $23,667.03 interest item is a deduction attributable to the mineral properties. Petitioner contends that the interest in question was in no way related to or attributable to the production of oil or the operation or development of any of its oil properties. The respondent contends that the interest was attributable to the mineral properties as a part of petitioner’s overhead expenditures.

In Mirabel Quicksilver Co., 41 B. T. A. 401, we held that interest on money borrowed for development and equipment expenses and amounts paid for capital stock taxes were clearly overhead expenditures which bore a direct relation to the taxpayer’s mineral operations and the production therefrom, and must therefore be deducted in computing the “net income of the taxpayer * * * from the property.” In St. Marys Oil & Gas Co., 42 B. T. A. 270, we held that interest paid on money borrowed to purchase part of the property from which oil and gas was produced must likewise be deducted. In Montreal Mining Co., 41 B. T. A. 399, we held that the payment of silicosis claims must be placed in the same category as the development expenses involved in Helvering v. Wilshire Oil Co., supra. And in Grison Oil Corporation, 42 B. T. A. 1117, we held that income taxes paid to the State of Oklahoma were no less attributable to the oil property upon which depletion was claimed than development expense. See also Guanacevi Mining Co., 43 B. T. A. 517.

In the instant proceedings it was stipulated that petitioner also received income from other sources, such as interest, rents, dividends, and profit from sales of securities and miscellaneous items. Notwithstanding this stipulation, petitioner makes no contention that it was engaged in “activities in addition to mineral extraction” as that phrase is used in the above quoted regulations so as to bring into operation that portion of the regulations providing that “Deductions not directly attributable to particular properties or processes shall be fairly allocated.” Cf. Rocky Mountain Oil Co., 36 B. T. A. 365, 869; Grison Oil Co., supra, p. 1120. Petitioner merely contends that the interest was in no way related to or attributable to the production of oil or the operation or development of any of its oil properties.

It is our opinion that the interest here involved must be regarded as an overhead expenditure. To what was it attributable? If petitioner’s only business activity was that of producing and selling oil, and it seems clear that it was, then we think it would necessarily be attributable to those operations. We can not find from the evidence, nor do we understand petitioner to contend, that there were any substantial activities other than its business of producing and selling oil and other petroleum products. We, therefore, hold that the interest in question was overhead expense and attributable to the mineral properties upon which depletion is claimed, and that under the regulations above quoted it should be deducted from the “gross income from the property” in computing the “net income of the taxpayer * * * from the property” as those phrases are used in section 114 (b) (3), sufra.

In its brief petitioner says it should be noted that the interest was not paid out of current earnings, but was paid with funds accumulated for that purpose during prior years and charged to the reserve for Federal income taxes account. We think this is not controlling. The expenditure was an allowable deduction during the taxable year, and it makes no difference out of what funds it was paid. Cf. Helvering v. Wilshire Oil Co., supra.

The respondent’s determination is approved.

Decision will he entered for the respondent.


author: Black :

text:
    The Stanton Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89796.
    Promulgated April 4, 1941.

      Hugh Satterlee, Esq., and I. Herman Sher, Esq,, for the petitioner.

      Allen T. Alan, Esq., and E. O. Hcmson, Esq., for the respondent.
   OPINION.

Black :

The sole issue for us to decide in this proceeding is whether petitioner is subject to taxation under section 104 of the Bevenue Acts of 1928 and 1932. The material provisions of both acts are identical and are printed in the margin.

The applicable regulations are articles 541, 542, and 543 of Begu-lations 74 and 77, respectively, as they were promulgated on February 15, 1929, and February 10, 1933, respectively. These articles in both regulations are identical, with the exception of two instances which are not material here. Articles 541, 542, and 543 of Begulations 74, in so far as is material, are printed in the margin.

The question whether petitioner was formed or availed of for the purpose mentioned in section 104 is one of ultimate fact rather than law. Our function is to draw inferences, to weigh the evidence, and to declare the result. The respondent’s determination that section 104 applies is presumed to be correct until the contrary appears from the evidence. Section 104 (b) mentions certain facts, which, if any one is present, shall be prima facie evidence of the condemned purpose. The presumption thus arising under subsection (b) is in addition to tbe presumption of correctness attaching to the respondent’s determination. Any of these presumptions that may exist are.rebuttable, however, and the respondent can not prevail,if there is satisfactory proof that petitioner was neither .formed nor availed of for the purpose mentioned in the statute. Olin Security Co., 42 B. T. A. 1203, and cases therein cited.

Although the respondent did not indicate in his deficiency notice the ground upon which his determination was based other than that petitioner was “subject to taxation under the provisions of section 104”, he now contends that the evidence shows (1) that during the taxable years in question petitioner was a mere holding or investment , company, (2) that during those, years petitioner permitted its gains' or profits to accumulate beyond the reasonable needs of the business, (3) that petitioner was formed for the disapproved purpose, and (4) that during the taxable years petitioner was availed of for the same purpose. We shall consider these contentions in the order named.

1. The words “mere holding or investment company” are not defined in the statute. Petitioner relies upon the interpretation afforded by article 542, supra, and contends that petitioner’s business, in addition to “holding stocks, securities, or other property and collecting the income therefrom or investing therein”, must also be regarded as including the businesses being conducted by New York and Louisiana, and when so-viewed it can not be found to be a mere holding or investment company, citing in support thereof Mellbank Corporation, 38 B. T. A. 1108, and Industrial Bankers Securities Corporation v. Higgins, 104 Fed. (2d) 177. We do not think, however, that the businesses being conducted by New York and Louisiana may be considered in substance the business of petitioner. Article 542 in this connection provides: “To establish that the business of one corporation can be regarded as including the business of another it is ordinarily essential that the -first corporation own substantially all of the stock of the second.” Petitioner did not own substantially all of the stock of either New York or Louisiana. The term “substantially all” as construed by the courts has been generally held 'to include percentages in excess of 90 percent, and there is almost complete uniformity in the decisions to the effect that- 85 percent is not substantially all. • See sec. 38.94, vol. 4, Paul and Mertens; Burnet v. Bank of Italy, 46 Fed. (2d) 629; certiorari denied, 283 U. S. 846. During the taxable years in question section 141 of the- Revenue Acts of 1928 and 1932 required ah ownership of at least 95 percent 'as a prerequisite' to file consolidated returns. During these years petitioner owned only 83½ percent -of the stock of New York and 50.7 percent of the common stock and 83 percent of the preferred stock of Louisiana. It filed its returns for 1931 and 1932 on a separate basis, and we think that whether it was a mere holding or investment company must be determined upon the basis of its separate business, exclusive of the businesses of New York and Louisiana. In this manner petitioner was quite different from the taxpayer in Industrial Bankers Securities Corporation v. Higgins, supra. In that case the taxpayer owned 100 percent of the stock of the subsidiaries there involved.

In' so holding we have not overlooked the phrase “ordinarily essential” in the quoted sentence from article 542. No doubt the effect that phrase was intended to have was that in some cases the business of one corporation might be regarded as including the business of another, even though the first corporation might own a little less than “substantially all” of the stock of the second. We think, however, that these exceptional cases were intended to be limited to those where, as stated in a previous sentence of article 542, the first corporation “in effect operates the other corporation.” In this connection petitioner argues that it was “a management, a financing and, in a broad but very real sense, an insurance company.” The record does not show that petitioner exercised any managerial control over either the New York or the Louisiana company, or in effect operated them. These companies had their own officers and boards of directors, who developed their policies and carried on their activities. True, Aron, who was a member of all the boards, was instrumental in developing the policies of all the companies, but this fact does not place petitioner in the business of managing, supervising, and operating those companies, as was the situation in Mellbank Corporation, supra.

In Chicago Stock Yards Co., 41 B. T. A. 590, the Board, in referring to the phrase “mere holding or investment company”, said:

* * * It was apparently the intention of Congress in using the phrase to differentiate a holding or investment company actively engaged in a trade or business from one which has income only from interest and dividends and profits from the sale of securities, and limits its activities to those incident to an ordinary holding or investment company.

During the taxable years 1931 and 1932, petitioner’s income consisted exclusively of interest, dividends, and gains from the sales of securities for its own account. Its expenses consisted of interest, taxes, and a few miscellaneous amounts. The itemized items of income and expenses are in our findings, which show that during these years petitioner’s net available gains and profits amounted to $907,-062.49 and $116,086.05, respectively. Of these amounts petitioner distributed as dividends $185,425 in 1931 and $29,668 in 1932, and accumulated the balance, which amounted to $808,055.54 for both years.

, An examination of the evidénce in our opinion shows that petitioner’s principal activity in the taxable years and years prior thereto, aside from collecting interest and dividends and making a few sales of securities for its own account, was borrowing money from the Aron family to purchase additional securities and to make loans to Hampt-worth, which corporation owned the country estate occupied by the Arons. In our opinion these activities are no more than those incident to an ordinary holding or investment company and, when considered in the light of the fact that all of petitioner’s stock as well as the stock of Hamptworthwas owned by petitioner, his wife, and by petitioner in trust for his son, and also in the light of the fact that petitioner was organized mainly for the purpose of taking over the securities already held by J & H, undoubtedly a mere holding or investment company, we have no hesitation in finding as a fact that petitioner was a mere holding or investment company. Chicago Stock Yards, Co., supra.

2. Did petitioner during the taxable years permit its gains or profits to accumulate beyond the reasonable needs of the business instead of dividing or distributing them? We have found as a fact that it did. Petitioner contends that our finding should be in the negative. It divides its argument on this phase of the case into two parts—first, that petitioner did not permit its gains and profits for the taxable years to accumulate at all, and, second, that the gains and profits were not at any time or in any event permitted to accumulate beyond the reasonable needs of the business.

There is no merit in petitioner’s contention that it did not permit its gains and profits for the taxable years to accumulate at all. The evidence clearly shows that during 1931 and 1932 petitioner had gains and profits of $907,062.49 and $116,086.05, respectively, and that during these years it distributed $185,425 and $29,668, respectively. By simple subtraction it thus permitted its gains and profits for these years to accumulate in the respective amounts of $721,637.49 and $86,418.05, instead of being divided or distributed.

Petitioner contends, however, that only a part of the $907,062.49 and $116,086.05 represents gains and profits of the taxable years. It argues that, since $800,320 of the $907,062.49 represents dividends from New York and Louisiana, and, since $19,920 of the $116,086.05 represents dividends from. Louisiana, these dividends can only be considered as gains and profits of the taxable years to the extent that they represent profits of New York and Louisiana for the taxable years. Petitioner then makes an analysis of the net income and distributions of New York and Louisiana for several years and comes to the conclusion that of the $750,000 dividend received by petitioner during 1931 from New York only $104,754.90 represented 1931 profits of New York and $645,245.10 represented profits accumulated by New York prior to 1929; that of the $50,320 dividend received by petitioner during 1931 from Louisiana only $7,275 represented 1931 profits of Louisiana and $43,045 represented profits accumulated by Louisiana in 1927; and that all of the $19,920 dividend received by petitioner during 1932 from Louisiana represented profits accumulated by Louisiana from 1925 to 1927. On this basis petitioner contends that its total gains and profits for 1931 and 1932 amounted to $314,938.44, computed as follows:

Miscellaneous income for 1931
($907,062.49 minus $800,320)_!_$106,742.49
1931 Profits of New York_ 104, 754. 90
1931 Profits of Louisiana-_ 7,275. 00
Petitioner’s 1931 gains and profits___ 218,772. 39
Miscellaneous income for 1932
($116,086.05 minus $19,920)__ 96,166.05
Total- 314,938. 44

Petitioner then contends that there should be added to the distributions of $185,425 in 1931 and $29,668 in 1932, $118,736.03 of the distribution by petitioner on May 26, 1933, in the amount of $207,676, on the ground that $88,939.97 of the 1933 distribution was from 1933 gains and profits and $118,736.03 from 1932 gains and profits. On this basis petitioner says it distributed during 1931 and 1932 a total amount of $333,829.03, which is in excess of the above amount of $314,938.44, thus proving, so petitioner contends, that it did not permit its gains and profits for the taxable years to accumulate at all.

The general rule in tax cases, as in other cases, is that a corporation and its stockholders are to be treated as separate entities. Burnet v. Clark, 287 U. S. 410, 415; Burnet v. Commonwealth, Improvement Co., 287 U. S. 415, 420; Dalton v. Bowers, 287 U. S. 404, 410. Cf. Mead Corporation v. Commissioner, 116 Fed. (2d) 187. Prior to the declaration of the dividends in 1931 and 1932 by New York and Louisiana, petitioner had no proprietary interest in the accumulated gains and profits of those companies. United States v. Phellis, 257 U. S. 156. But, when those dividends were declared by New York and Louisiana in 1931 and 1932, they became gains and profits of the petitioner to the extent of petitioner’s stock ownership in the declaring companies. Lynch v. Hornby, 247 U. S. 339. Cf. Helvering v. Canfield, 291 U. S. 163, wherein the Court said:

* * * yrnen a corporation continued in business after March 1, 1913, the dividends it later declared and paid to its stockholders, whether out of current earnings or from profits accumulated prior to that date, constituted income to the stockholders, and not capital, and were taxable as income if the Congress saw fit to impose the tax. Lynch v. Hornby, 247 U. S. 339, 38 S. Ct. 543, 62 L. Ed. 1149. ¶

It follows that petitioner is in error in its contention that its share of the dividends of New York and Louisiana declared in 1931 and 1932 can only be considered as gains and profits in those years to the extent that they represent profits of New York and Louisiana for the taxable years. We think petitioner is also wrong in adding $118,736.03 distributed by petitioner to its stockholders May 26, 1933, to the distributions made in 1932, when as a matter of fact only $29,668 was actually distributed during that. year. There is no basis for adding: this $118,736.03 to the amount distributed in 1932.

In an attempt to show that it did not permit its gains and profits for the taxable years to accumulate at all, petitioner has also set out in its brief complicated schedules of income, deductions, and distributions on a so-called consolidated basis, in which petitioner’s activities have been combined with the activities of New York, Louisiana, 95 Wall, Lafayette, and California. Suffice it to say that such schedules are not material in this proceeding, if for no other reason than that petitioner did not own substantially all the stock of any of the corporations named. The businesses of these corporations can not be regarded as the businesses of petitioner.

Neither is there any merit in petitioner’s contention that its gains and profits were not at any time or in any event permitted to accumulate beyond the reasonable needs of the business. We have found as a fact that petitioner was a mere holding or investment company. Such a company has very little need, if any, for the accumulation of gains or profits. Cf. Williams Investment Co. v. United States, 3 Fed. Supp. 225; Keck Investment Co., 29 B. T. A. 143; affd., 77 Fed. (2d) 244; certiorari denied, 296 U. S. 633; R.& L. Inc., 33 B. T. A. 857; affd., 84 Fed. (2d) 721; certiorari denied, 299 U. S. 588; Nipoch Corporation, 36 B. T. A. 662; Chicago Stock Yards Co., supra. In the latter case we said:

As a holding company, the petitioner had no need for the accumulation of gains and profits. ' In the ordinary holding or investment company the excess of income over expenses is either paid out in dividends or invested in additional income-producing assets. That is the use which the petitioner made of its excess income. That use can not be regarded within the reasonable needs of the business.

Up to December 31, 1930, the beginning of the taxable years in question, petitioner had accumulated gains and profits of $2,132,316.37, including $560,886.70 which it took over from J & H at the time petitioner was organized. Cf. Commissioner v. Sansome, 60 Fed. (2d) 931. During the taxable years it further accumulated its gains and profits in the total amount of $808,055.54, thus bringing its total accumulation of gains and profits' on December 31, 1932, up to $2,940,371.91 on which date it declared a stock dividend of $2,225,100. Since the interests of petitioner’s stockholders in petitioner were not changed by the stock dividend, the declaration of the latter has no bearing on the question now before us. Cf. Koshland v. Helvering, 298 U. S. 441.

Petitioner devotes practically all of its argument under this part to the contention that, in considering the needs of the business, we must consider the needs of the businesses of New York and Louisiana. The businesses of these concerns were not petitioner’s businesses. It did not operate them. Cf. Olin Security Co., supra. Prior to 1933 petitioner had never loaned these companies any money or securities, but on the contrary had borrowed from New York. Beginning in 1933, petitioner did make substantial loans to New York and Louisiana. But, since Aron and his wife and son owned all of petitioner’s stock, these loans could have been made by petitioner’s stockholders if petitioner had distributed its gains and profits instead of permitting them to accumulate. Helvering v. National Grocery Co., 304 U. S. 282.

In addition to the cases heretofore cited petitioner, in support of its argument on this phase of the case, relies strongly on Delaware Terminal Corporation, 40 B. T. A. 1180, and also cites Charleston Lumber Co. v. United States, 20 Fed. Supp. 83; appeal'dismissed by Fourth Circuit at 93 Fed. (2d) 1018. The Delaware Terminal case is distinguishable from this proceeding for the same reasons we gave for distinguishing Industrial Bankers Secwrities Corporation v. Higgins, supra. The Delaware Terminal Corporation owned 100 percent of the stock of the Terminal Barber Shops, Inc., which corporation in turn owned 100 percent of the stock of approximately 14 subsidiaries. Petitioner did not own substantially all the stock of any of the Aron companies. Furthermore, the stock of the Delaware Terminal Corporation was not owned by a closely related family group, but by a group of business associates, the largest stockholder being Schusser, who owned a little less than 50 percent. Here all of the stock of petitioner was owned by a closely related family group—father, mother, and son. The Charleston Lumber Co. case involved an operating corporation and not a mere holding or investment company, such as we have found petitioner to be in the instant proceeding. In In R. & L. Inc. v. Commissioner, supra, the court in affirming the Board, among other things, said:

* * * The only active business that the corporation engaged in was that in.which it earned the commissions. That required no capital except the salary of the employee Bryan. There was no need of more capital to carry on business which prevented paying out its net profits in dividends.. In 1927 and 1928 no reason is suggested for not declaring dividends except that the cash money received as income was put into additional stocks and real estate. This is just the accumulation which the tax is intended to discourage.

3., Was petitioner formed for the disapproved purpose? Petitioner contends that it was not, and relies among other things upon the oral testimony of Aron, in which he categorically denied that he had any such purpose in mind when he formed either J & H or the petitioner. We can not, however, accept this testimony as conclusive in the light of other evidence which in our opinion is inconsistent with those statements. Helvering v. National Grocery Co., supra; Reynard Corporation, 37 B. T. A. 552, 561. At the time petitioner was formed Aron had decided to divide the properties of J & H between two new holding companies. As set out in our findings, Hamptworth was incorporated on October 13, 1925, and petitioner on the following day. Hamptworth issued .one-half of its authorized capital stock to members of the Aron family for $50,000 in cash, which it used to acquire the real estate held by J & H. Petitioner issued one-half of its authorized capital stock to members of the Aron family for all the outstanding capital stock of J & H on the basis of one- share for two shares, so that each stockholder of J & H maintained the same proportion of holdings in petitioner which he or she had held in J & H.

Petitioner then took over all the assets of J & H, consisting mainly of stock of Louisiana and other securities, and assumed all of its liabilities, whereupon J & H was dissolved. During its existence J & H had accumulated net gains and profits of $560,886.70, chiefly from dividends, interest, gain from the sale of securities, and rent paid by Aron for use of the real estate as a residence and for use of the yacht. J & H never paid a dividend. The $560,886.70 of accumulated gains and profits were taken over by petitioner and thus became available for distribution by petitioner. Commissioner v. Sansome, supra. Petitioner then proceeded to accumulate more gains and profits exclusively from interest, dividends, the sale of securities, except for $3,600 of miscellaneous income in 1929, until at the beginning of the taxable years in question it had accumulated gains and profits (including those taken over from J & H) of $2,132,316.37 after paying dividends during this period of $745,850, or 25.9 percent of its gains and profits of $2,878,166.37 available for distribution. Aron testified that petitioner was formed:

Principally to coordinate or unify into one company all the companies, first the Louisiana, with the intention of later also acquiring these in New York; putting all the outside securities of all the family in one company as a reservoir and being able to have them all together so that on short notice you could use them for the benefit of the operating companies, and also to buy and sell securities and to use the securities for margin, both in stock as well as moneys. It would be a reservoir to have them all together because I was given assurance against the guarantee that I was giving for the operating companies, and by having the— Stanton became a Delaware Corporation which were very liberal in their charter, and in that, way you could save State taxes in New York.

Petitioner’s books show, however, that as soon as petitioner was formed it commenced to loan money without interest to Hamptworth and continued to loan money to Hamptworth every year until at the beginning of the taxable years it had loaned Hamptworth a total of $988,956.29, which Hamptworth used to improve the real estate occupied by the Aron family as a country estate and to purchase a yacht and considerable household furnishings. In 1929, at a time when petitioner did not own any of the stock of New York, it loaned without interest $482,841.76 to 95 Wall, a 100 percent owned subsidiary of New York, which loan, without any repayments, was still outstanding on December 31,1937. In discussing the previous points we have already stated the amounts of gains and profits and dividends paid during the taxable years, during which years petitioner added $808,055.54 more to its accumulation, thus making a total accumulation of gains and profits on December 31,1932, of $2,940,371.91.

Petitioner continued to make loans to Hamptworth until on December 31, 1934, it had loaned Hamptworth a total of $1,222,575.48. In 1935 a part of this loan was liquidated through the organization by the Arons of the Bristol Associates, Inc., as set out in our findings, and the balance was apparently charged off by petitioner as a bad debt in its 1935 income tax return.

As a result of the accumulation of $2,940,371.91 over a period of years, surtaxes were avoided by the shareholders of J & H and petitioner in the total amount of approximately $590,000.

Considering all the evidence in the case, particularly the circumstances surrounding the formation of petitioner, the sources of its income, the manner in which that income was used, and the surtaxes that were avoided, we are of the opinion that petitioner was formed for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its'gains and profits to accumulate instead of being divided or distributed, and we have so found as a fact in our findings.

4. Was petitioner availed of in 1931 or 1932 for the disapproved purpose? In Helvering v. National Grocery Co., supra, the Supreme Court said that the function of the Board in a case of this kind was “To draw inferences, to weigh the evidence and to declare the result * * We have already found that petitioner was a mere holding or investment company and that it permitted its gains and profits to accumulate beyond the reasonable needs of the business. The statute makes such facts “prima facie evidence of a purpose to escape the surtax.” We have also found that petitioner was formed for that purpose and, even without the benefit of the presumptions, we think the evidence shows that petitioner was availed of in 1931 and 1932 for the purpose of enabling its shareholders to escape the surtax.

Beginning in 1916, Louisiana declared a dividend every year up to and including 1937, which is as far as the evidence goes. Prior to the formation of J & H those of the stockholders of Louisiana who became stockholders of J & H were required to pay surtaxes on such dividends. The same- was true respecting the stocks of other domestic corporations which Aron purchased with the dividends received from Louisiana. New York bad adopted the policy of paying no dividends until the two dividends of $900,000 each in 1930 and 1931, although on December 31, 1929, it had accumulated gains and profits of $5,151,-246.32. When J & H was formed in 1922, the Arons transferred to that company 99.7 percent of all the stock held by them in Louisiana, but did not transfer' to that company any of the stock of New York. Aron also transferred to J & H at the same time 8,020 shares of stock in ten different domestic corporations. This relieved the Arons of paying any surtax on the dividends being paid on such transferred stock, except to the extent that J & H might in turn declare dividends, which it never did. When petitioner was organized in 1925 it merely took over all the securities then held by J & H.

In 1918 Aron and Feingold entered into a written agreement the details of which are set out in our findings. Feingold had made several demands that New York declare a dividend, but until the latter part of 1930 Aron had been successful in persuading Feingold to silence his demands. In 1930, however, the matter came to a head, and New York in December of that year declared a dividend of $900,0001 At the beginning of the year Aron held 25,746 of the 30,000 outstanding shares of New' York. Had he held these shares until the dividend was declared he would have had to pay a substantial surtax thereon. But he did not so hold them. In January 1930 Aron transferred to petitioner 25,000 of his 25,746 shares of New York. Thus during the taxable years petitioner held practically all of the New York and Louisiana shares that had at some prior.date been owned by the Aron family.

We think it is reasonable to infer and that it is apparent from the foregoing that the principal reason for Aron’s transfer of the 25,000 shares to petitioner in 1930 was because he knew then, as a result of Feingold’s demands, that eventually a dividend would have to be declared by New York. By having the dividend paid to petitioner instead of himself, Aron availed himself of petitioner for the purpose of escaping surtaxes. We do not think it makes any difference that the dividend-paying stocks were transferred to J & H and to petitioner in years prior to the taxable years before us. Cf. United Business Corporation of America, 19 B. T. A. 809; affd., 62 Fed. (2d). 754; certiorari denied, 290 U. S. 635; A. & J., Inc., 38 B. T. A. 1248; Williams Investment Co. v. United States, supra. The thing that matters is whether during the taxable years petitioner was availed of for the forbidden purpose.

As a holding or investment company petitioner had very little reason for accumulating any gains or profits. Yet on December 31, 1930, the beginning of the taxable years in question, petitioner had accumulated $2,132,316.37 or 287.49 percent of its outstanding capital stock. During the taxable years it accumulated additional gains and profits of $808,055.54. If this latter amount had been distributed instead of accumulated, petitioner’s-stockholders would have had to pay for these two years alone additional surtaxes of $162,566.28. These facts are not without significance. Furthermore, the stockholders of petitioner could have completely avoided the application of section 104 if in accordance with subsection (d) of this section they had included (at the time of filing their returns) in their gross income their entire distributive shares of petitioner’s net income for the taxable years. This they did not do. They chose rather to avail themselves of petitioner for the purpose of escaping the surtax.

Upon the whole we think the evidence amply sustains the ultimate findings we have made.

In its brief petitioner makes the statement that the taxes asserted by the respondent were incorrectly computed through the inclusion in net income of interest wholly exempt from tax. This was not assigned as an error, and, even if it had been, the evidence does not support the contention.

The respondent’s determination is approved.

Reviewed by the Board.

Decision will ~be entered for the respondent.

       SEC. 104. ACCUMÜLATION OE PROEITS OE SURPLUS TO EVADE SURTAXES.
      (a) If any corporation, however created or organised, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 60 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation is a' mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
      (c) As used in this section the term “net income” means the net income as defined in section 21, increased by the sum of the amount of the dividend deduction allowed under section 23 (p) and the amount of the interest on obligations of the United States issued after September 1, 1917, which would be subject to tax in whole or in part in the hands of an individual owner.
      (d) The tax imposed by this section shall not apply if all the shareholders of the
      corporation include (at the time of filing their returns) in their gross income their entire distributive shares, whether distributed or not, of the net income of the corporation for such year. * * *

       Art. 541. Taxation of corporation utilised for evasion of surtax.—Section 104 is designed to discourage the formation or use of a corporation for the purpose of preventing the imposition of surtaxes upon its shareholders, through the device of permitting its gains and profits to accumulate instead of being distributed. If a domestic or foreign corporation is so formed or availed of, it Is subject to a tax at the rate of 50 per cent upon its net income in addition to the tax imposed by section 13. * * *
      Am, 542. Purpose to escape surtax.—Prima facie evidence of a purpose to escape the surtax exists where a. corporation is. a mere investment company, where, a corporation has practically no business except holding stocks, securities, or other property and collecting the income therefrom or investing therein, or where a corporation other than a mere holding or investment company permits its gains and profits to accumulate beyond the reasonable needs of the business. The statutory presumption that a mere holding or investment company is subject to the additional tax imposed by section 104 may be overcome if the corporation can show, either by reason of the fact that it distributed a large portion of its earnings for the year in question,, or that its stock was held not by the members of a family or of a small group but by a large number of persons and in comparatively small blocks, or by other evidence, that it was not availed of for the purpose of preventing the imposition of the surtax upon its shareholders.
      The business of a corporation is not merely that which it has previously carried on, but includes in general any line, of business which it may legitimately undertake. However, a radical change of business when a considerable surplus has been accumulated may afford evidence of a purpose to escape the surtax. When one corporation owns the stock of another corporation in the same or a related line of business and in effect operates the other corporation, the business of the latter may be considered in substance the business of the first corporation. Gains and profits of the first corporation put into the second through the purchase of' stock or otherwise may therefore, if a subsidiary relationship is established, constitute employment of the income in its own business. To establish that the business of one corporation can be regarded as including the business of another it is ordinarily essential that the first corporation own substantially all of the stock of the second. Investment by a corporation of its income in stock and securities of another corporation is not without anything further to be regarded as employment of the income in its business.
      Aut. 543. Unreasonable accumulation of, profits.—An accumulation of gains and profits is unreasonable if it is not required for the purposes pf the business, considering all the circumstances of the case. It is not intended, however, to prevent reasonable accumulations of surplus £<p the needs of the business. No, attempt can be made to enumerate all the ways in which gains and profits of a .corporation may be accumulated for the reasonable needs of the business. Distributions made by a corporation shortly, after the close of its taxable year sfiall be taken into consideration in determining the reasonableness of the amount of earnings and profits of the corporation retained by it for such year, undistributed income is properly accumulated if invested in increased inventories or additions to plant reasonably needed by the business. It is properly accumulated if retained for working capital required by the business or in accordance with contract obligations placed to the credit of a sinking fund for the purpose of .retiring bonds issued by the corporation. In the case of a banking institution the business of which is to receive and loan money, using capital, surplus, and deposits for that purpose., undistributed income actually represented by loans or reasonably retained for future loans is not accumulated beyond the reasonable .needs of the ;busiiiess. The nature of the investment pf gains and profits is immaterial if they are not in fact needed in the business. It is an unreasonable accumulation of gains and profits by corporations with the purpose of enabling their shareholders to escape surtaxes on such gains and-profits which subjects, such corporations to the additional tax imposed by section 104. , Among other things, the financial condition of the corporation at the close of the taxable year and the manner in,which its funds are invested at tliat date, determine the reasonableness of tlje .accumulation^.


author: Smith:

text:
    Morton L. Kahn and Beulah Kahn, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99877.
    Promulgated April 8, 1941.

      Max G. Baylinson, Esq., for tbe petitioners.

      Paul E. Warmg, Esq., for the respondent.
   OPINION.

Smith:

Section 24 (a) (6) of the Revenue Act of 1936 provides in part as follows:

SEC. 21. ITEMS NOT DEDUCTIBLE.
(а) General Rule.—In computing net income no deduction shall in any case be allowed in respect of—
****** *
(б) Loss from sales or exchanges of property, directly or indirectly, (A) between members of a family, * * * and (D) the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.

The petitioner contends that the above quoted provisions of the Revenue Act of 1936 do not apply in this case for the reason that there was no sale or exchange of property by him as the result of his relinquishment of his interest in the properties at 3537 and 3539 Ger-mantown Avenue. He submits that he received no consideration for the execution of the deed of relinquishment. He' further submits that the evidence shows that he made, an investment of $5,000 in the properties and that the proof is clear that he had no interest in the, properties after the deed of relinquishment, and that the deed of relinquishment was the identifiable event which established the loss as having occurred in 1986.

We think it plain from the evidence in this case that the petitioner’s investment in the so-called joint adventure in 1927 or 1928 was lost long prior to 1936. This is indicated by the fact that in the estate tax return filed for the estate by the petitioner and his mother the properties were then returned as having a fair market value less than the amount of the mortgages thereon, and further by the fact that the estate tax return does not show any liability of the estate to the petitioner or to Kleeblatt in respect of the investment by each of $5,000.

In W. W. Hoffman, 40 B. T. A. 459, we held that, where the interest of the taxpayers in improved real estate owned by them subject to a mortgage became worthless in 1934, they were entitled to deduct the loss in that year under section 23 (e) (2) of the Revenue Act of 1934, although title remained in them until foreclosure was completed in the following year, despite their efforts to abandon their interest in the property during 1934. Our decision in that case was affirmed, per curiam (C. C. A., 2d Cir.), 117 Fed. (2d) 987. In its per curiam opinion the court stated:

The commissioner seeks reversal of a decision of the Board holding that under section 23 (e) (2) of the Revenue Act of 1934 the taxpayers were entitled to deduct from gross income a loss sustained in 1934, when the interest in improved real estate owned by them subject to a mortgage upon which they had not assumed liability, became worthless and they abandoned their interest and so advised the mortgagee, although title remained in them until completion of foreclosure proceedings in the following year. 40 B. T. A. 459. Upon amply sufficient evidence the Board found specifically that the taxpayers’ interest in the property became worthless in 1934. We see no valid ground to differentiate between a loss suffered on real estate and one on personalty, if worthlessness is definitely established. Compare Wieboldt v. Commissioner, 113 F. 2d 384, 386 (C. C. A. 7). On the authority of Denman v. Brumback, 58 F. 2d 128, 129 (C. C. A. 6) and Rhodes v. Commissioner, 100 F. 2d 966 (C. C. A. 6) the Board’s decision is affirmed.

The action of the respondent in disallowing the claimed deduction is approved.

Decision will be entered for the respondent.


author: ARNOLD:

text:
    Woods Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97474.
    Promulgated April 8, 1941.

      W. G. Boone, Esq., for the petitioner.

      John R. Stivers, Esq., for the respondent.
   OPINION.

ARNOLD:

The Commissioner disallowed the Clarendon mill operating loss of $14,077.10 upon the ground that the Arkansas operations were conducted by a separate and distinct entity for income tax purposes. This determination was predicated on the assumption that the petitioner was the stockholder of the Arkansas company.

For income tax purposes corporations are generally treated as entities separate and distinct from their stockholders. Burnet v. Clark, 287 U. S. 410; Dalton v. Bowers, 287 U. S. 404; and Burnet v. Commonwealth Improvement Co., 287 U. S. 415. However, where exceptional or peculiar factual situations prevail, form has been disregarded in favor of substance and equity. See New Colonial Ice Co. v. Helvering, 292 U. S. 435; Southern Pacific Co. v. Lowe, 247 U. S. 330; Gulf Oil Corporation v. Lewellyn, 248 U. S. 71; North Jersey Title Insurance Co. v. Commissioner, 84 Fed. (2d) 898; Munson Steamship Line v. Commissioner, 77 Fed. (2d) 849; 112 West 59th Street Corporation v. Helvering, 68 Fed. (2d) 397; Mark A. Mayer, 36 B. T. A. 117; Kaspare Cohn Co., Ltd., 35 B. T. A. 646.

The purpose for taking steps to organize an Arkansas corporation is not disclosed. However, it was treated as existing in name only. It had no property or funds except such as were furnished by petitioner in the ordinary course of operations. It was never formally organized. It never functioned as a corporation. None of its shares of stock was ever issued to petitioner and neither Woods and his two sons nor the petitioner ever paid any money or property to the corporation for its stock. . The petitioner conducted the business, consisting of the operation of the sawmill at Memphis, the sawmill at Clarendon, and the river logging equipment as its own prior to the issuance of the Arkansas charter and continued to do so without change thereafter and throughout the year 1935, except that a bookkeeping entry was made, indicating that the petitioner acquired the capital stock of the Arkansas company. Book entries are evidentiary merely and not conclusive. Helvering v. Midland, Mutual Life Insurance Co., 300 U. S. 216; Mitchell Brothers Co. v. Doyle, 225 Fed. 437; affd., 235 Fed. 686; 247 U. S. 179. The petitioner was the actual owner of all the assets listed in both sections of its ledger and the beneficial owner of the small piece of timber taken in the name of the Arkansas company. In our opinion the Arkansas corporation neither functioned as a de jure or de facto corporation nor operated the Clarendon sawmill and river logging equipment. However, even if it had been fully organized and had acquired title to the business involved, nevertheless the peculiar circumstances disclosed by the evidence bring this case within the exception to the general rule. See New Colonial Ice Co. v. Helvering, supra, and other cases cited. We therefore conclude that for income tax purposes the operations of the business in Arkansas and Tennessee should not be treated as operations of two separate entities. See Mark A. Mayer, supra; and United States v. Jelenko, 23 Fed. (2d) 511.

The respondent contends that, in the event the Board determines to disregard the separate entity of the Arkansas corporation, the loss alleged to have been sustained from the operations of the Clarendon mill and river logging equipment should be reduced by one-half of the claimed depreciation of $11,214.93. Woods, Sr., testified that in his opinion, based upon his experience, the river logging equipment had a probable useful life of 10 years and that a 10 percent depreciation rate was proper. This is the only evidence in that regard except that petitioner adduced in evidence an agreement as to final determination of tax liability for the year 1928 (Form 866) entered into between petitioner and the Commissioner, with a statement attached showing the Commissioner’s computation of petitioner’s tax liability for that year. It apears therefrom that a 7½ percent depreciation rate was allowed on a “Saw Mill Plant and Equipment No. 1” and a 10 percent rate on a “Saw Mill Plant and Equipment No. 2” and that a 10 percent rate was allowed on “River Equipment.” The petitioner did not acquire the Clarendon min until 1932. There is not sufficient evidence from which a proper rate of depreciation applicable to the property here involved could be determined. The respondent concedes that a rate of 5 percent is a reasonable allowance for depreciation. In view of the record made we hold that the operating loss of the Clarendon mill and river logging equipment must be reduced by one-half of the depreciation claimed or $5,607.47, the deductible operating loss therefor being $8,469.63.

Section 23 (k) of the Revenue Act of 1934 allows the deduction of “Debts ascertained to 'be worthless and charged off within the taxable year.” The respondent disallowed the bad debt deduction claimed by petitioner to the extent of $1,219.08, for the reason that such amounts were worthless prior to 1935.

The employee in charge of credits' and the collection of retail accounts was of the opinion, based upon his investigations and familiarity with the financial situation of each debtor, that the accounts, excepting the Midwest Hardware Co. account, were not worthless prior to 1935. He knew nothing about the Midwest Hardware Co. account, which apparently was a wholesale account. From the evidence it appears that the petitioner exercised diligence and care in the checking and following up of accounts. It has been held that some latitude and discretion is allowed to the taxpayer in the ascertainment of worthlessness of accounts or debts, provided that he exercises good faith, and that “there is no absolute duty on the taxpayer to ascertain worthlessness at his peril, during the same year when the debt in fact became uncollectible.” Commissioner v. MacDonald Engineering Co., 102 Fed. (2d) 942, affirming 35 B. T. A. 3. It appears that petitioner received $100 in 1937 on the Davis account and $50 on the Lipscombe account in a year subsequent to 1935. The right to a bad debt deduction is not affected by the fact that recoveries are made in a later year if the debt was ascertained to be worthless and charged off in the taxable year. Fort Worth Warehouse & Storage Co., 6 B. T. A. 536; Ed. S. Hughes Co., 6 B. T. A. 949; Continental Trust Co., 7 B. T. A. 539; and Iberville Wholesale Grocery Co., Ltd., 17 B. T. A. 235. Here the debts, with one exception as to which there is no evidence, were ascertained to be worthless and were charged off in the taxable year. We therefore conclude that, with the exception of the Midwest Hardware Co. account, the accounts involved herein, totaling $1,120.93, are deductible as bad debts in the taxable year.

Decision will be entered under Rule 50.


author: Van Fossan:

text:
    G & C Frost Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100444.
    Promulgated April 8, 1941.

      Boy Raymond Colby, Esq., for the petitioner.

      Arthur L. Murray, Esq., for the respondent.
   OPINION.

Van Fossan:

The petitioner contends that it realized no taxable gain from the cancellation of its lease with the bank but, on the contrary, sustained a loss in the transaction. ,The respondent seeks to tax the petitioner on the full amount of the cash received ($45,000 less fees and commissions of $1,200, or a net of $43,800) and also on the $9,000 representing the fair market value at the time of cancellation of the bank building erected on the leased land.

The petitioner contends that the correct criterion is a comparison of the petitioner’s situation immediately before the cancellation of the lease with that thereafter; that the value of the land itself was $90,000 before and $36,000 after the transaction; that the petitioner received a net sum of $43,800 and thus had assets worth $10,200 less after the cancellation than before it. Further, it is urged that the value of the building on the land in 1912 was $10,000 and the value of the bank building in 1937 was $9,000; wherefore, petitioner suffered an additional diminution of $1,000 in assets.

The case of Warren Service Corporation v. Commissioner, 110 Fed. (2d) 723 (affirming on this point 39 B. T. A. 856), presented a situation in some respects similar to that found here. There, by agreement, a deposit of $125,000 was retained by the lessor upon the cancellation of the lease. Such absolute possession of the deposit by the lessor is essentially the same as the receipt of $43,800, net, in cash by the petitioner. In that case the court held that the present worth of $125,000 was taxable income to the lessor and allowed no offsetting deductible loss by reason of the lessor’s inability to re-lease the property. So here, the diminution in capital value of the petitioner’s property is reflected in the decrease of prospective rentals therefrom. The failure to receive expected profits or profits equivalent to those theretofore received does not support a loss deduction. Estate of Wilton J. Lambert, 40 B. T. A. 802, and cases there cited.

The petitioner cites and relies on Blatt Co. v. United States, 305 U. S. 267; and Helvering v. Bruun, 309 U. S. 461. But we are unable to find in those cases any support for petitioner’s position on this phase of the case. The petitioner also cites Commissioner v. Langwell Realty Corporation, 47 Fed. (2d) 841. In Warren Service Corporation, supra, the Board declined'to follow the Langwell Realty Corporation' case, while the Circuit Court of Appeals, in the same case, stated:

If the ease of Commissioner v. Langwell Realty Corp., 47 Fed. (2d) 841 (C. C. A. 7) is to be read supporting the taxpayer’s contention, we must respectfully decline to follow it as did the Board.

The petitioner argues that the liability to pay $15,128 in bond obligations, payable by the lessee under the requirements of the lease but assumed by the petitioner upon its cancellation, should be deducted from the cash payment, thus producing additional loss from the transaction. The record does not show that the improvements for which the bonds were executed were not beneficial to the petitioner’s property. In this situation we need not further consider the argument that the amount payable on the bond obligations is an allowable deduction. See Mary E. Evans, 42 B. T. A. 246, and cases there cited.

It is obvious from the facts' that the acquisition in 1937 of the bank building, stipulated to be then worth $9,000 apart from the land, in place of a building worth at the time of demolition $10,000, resulted in no taxable gain. See Helvering v. Bruun, supra, in which the unamortized cost of an old building was deducted from the fair market value of a new building in order to arrive at the net fair market value which was adopted by the court as the proper measure of the net gain. Moreover, on the same authority, we are of the opinion .that the difference of $1,000 between the value of the old building and the stipulated value of the bank building should be deducted in determining the net gain realized by the petitioner.

Decision will Toe entered umder Rule 50.


author: TTtt.t. :

text:
    Jacob Abelson and Celia K. Abelson, Petitioners, v. Commissioner of Internal Revenue, Respondent. Lester Abelson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Oscar Getz and Emma Getz, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95102, 95103, 95114.
    Promulgated April 8, 1941.

      Harry N. Wyatt, Esq., and Richard H. Levin, Esq., for the petitioners.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

TTtt.t. :

The partnership of Abelson & Getz, of which all the present petitioners were members, purchased in 1928 certain real property in Chicago known as the Southfield Apartment Building, subject to a first mortgage in the amount of $130,000. Neither the partnership nor petitioners assumed personal liability for the payment of the mortgage. The mortgage was foreclosed and on February 11, 1935, the property was sold pursuant to decree of the court, but under Illinois law the partnership had the right to redeem within a period of 12 months from the date of sale. The cost of redemp-I; tion would have been approximately $80,000, while the actual value I of the property in 1935 was not in excess of $60,000. The property was not redeemed, and as a result of the foreclosure sale the part- ' nership sustained a loss of $44,413.69, representing the amount of its depreciated investment in the property. Petitioners deducted their proportionate shares of such loss in their individual returns for the taxable year.

Petitioners contend that the loss was sustained, for tax purposes, in 1935 at the time of the sale, and that the entire amount is deductible as an ordinary loss, relying upon Commissioner v. Hammel (C. C. A., 6th Cir.), 108 Fed. (2d) 753, and other decisions of like effect.

In determining the deficiencies, respondent disallowed in their entirety the loss deductions claimed by petitioners from gross income of the taxable year, holding that any loss suffered by the partnership on account of the foreclosure sale of the Southfield Apartment Building was sustained in 1936, upon termination of the period of redemption, and was a capital loss subject to the limiting provisions of section 117 of the Revenue Act of 1936. On brief, respondent urges the same contention, and also, in the alternative, that if the loss be held to have been sustained in 1935 it was a capital loss, subject to the limiting provisions of section 117 of the Revenue Act of 1934. Sections 117 (d) of both acts are identical and, so far as material here, provide that losses from “sales or exchanges” of capital assets shall be allowed only to the extent of $2,000, plus the gains from such sales or exchanges.

' The contention of petitioners that the loss sustained by the partnership is deductible as an ordinary loss is predicated upon the holding of the Circuit Court of Appeals in the Hammel case, supra, that a foreclosure sale is not a “sale or exchange” within the meaning of the statute. This decision, however, was reversed by the Supreme Court in Helvering v. Hammel, 311 U. S. 504, where it was held that the term “sales” applied to forced sales as well as voluntary sales, within the purview of section 117 of the Revenue Act of 1934, limiting the deduction of capital losses. The Supreme Court further held that the definitive event fixing the loss was the foreclosure sale and not the decree of foreclosure which ordered and preceded the sale. It is to be noted that in the Hammel case there was no statutory period of redemption extending beyond the date of the foreclosure sale. The decision last cited governs the instant case, and the contention of petitioners that the loss in question is deductible in full can not be sustained, j It is immaterial that neither the partnership nor any of these petitioners assumed personal liability for payment of the mortgage. Edward F. C. McLaughlin, 43 B. T. A. 528; Welch v. Street, 116 Fed. (2d) 953.

There remains for consideration the question of the year in which the loss was sustained; that is, whether the loss was complete in the taxable year 1935 when the property was sold under foreclosure, or in 1936 upon expiration of the period of redemption. It has been held that a taxpayer is entitled to deduct the loss sustained on account of foreclosure of a mortgage on real property only in the year when the period of redemption expires. But this rule is not applicable in a case where it is shown that the right of redemption was wholly without value in the year of sale and was abandoned by the taxpayer, whether or not he retained legal title to and possession of the property until expiration of the redemption period. The loss is allowable in the year in which it reasonably appears that the taxpayer’s investment in the property became wholly worthless.

The facts in the present case show (1) that the actual value of the property at the time of the foreclosure sale was very materially less than the amount it would have cost the partnership to redeem; (2) that immediately after the sale the partners met for a discussion of the advisability of redeeming, and, although financially able to redeem, they definitely and unanimously decided that their investment was not worth the cost of redemption and abandoned such right; and (3) that neither the partnership nor the partners individually ever took any further action in the matter. Subsequently there was in fact no redemption. The partners were the persons most directly interested, and there is nothing disclosed by the record which calls in question the bona fides of their action or even indicates other than the exercise of good business judgment. The facts, we think, constitute persuasive proof that the value of the partnership investment in the property and of its right of redemption was completely extinguished during the taxable year.

■ For the reasons indicated, we hold that the loss of the partnership was sustained in the taxable year 1935, and that pursuant to section 117 (d), supra, the amount thereof is deductible only to the extent of $2,000, plus the gains from capital sales or exchanges, if any.

Decisions will be entered under Rule 50.

         J. C. Hawkins, 34 B. T. A. 918; affd., 91 Fed. (2d) 354; Derby Realty Corporation, 35 B. T. A. 335; Nickoll v. Commissioner, 103 Fed. (2d) 619, 621; Ferdinand Hotz, 42 B. T. A 432. Cf. also Frederick Krauss, 39 B. T. A. 62

        Denman v. Brumback, 58 Fed. (2d) 128; Rhodes v. Commissioner, 100 Fed. (2d) 966; W. W. Hoffman, 40 B. T. A. 459; affd., 117 Fed. (2d) 987.


author: Smith :

text:
    W. Hinckle Smith, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93663, 102884.
    Promulgated April 8, 1941.

      William R. Bpoford, Esq., and Charles B. Jacobs, Esq., for the petitioner.

      Brooks Fullerton, Esq., for the respondent.
   OPINION.

Smith :

These proceedings, consolidated for hearing, involve income tax deficiencies for the years 1934 to 1937, inclusive, as follows:

The only question in issue, which is common to all of the years involved, is whether the petitioner is entitled to deduct the dividends paid on shares of stock which he had sold short and which were carried in his short accounts with brokers during those years. The proceedings were submitted on a written stipulation of facts, which reads in part as follows:

1. Petitioner is an individual residing at Roberts and Ithan Avenues, Bryn Mawr, Pennsylvania, and maintaining an office at 2314 Girard Trust Building, Philadelphia, Pennsylvania. The returns for the periods here involved were filed with the Collector of Internal Revenue for the First District of Pennsylvania.,.
2. During the years 1934, 1935, 1936 and 1937 petitioner was engaged in the business of buying and selling securities for his own account and all shares of Kennecott Copper Company sold -“short”, as hereinafter set forth, were sold in the normal course of such business.
3. During the years 1934, 1935, 1936 and 1937, petitioner maintained a brokerage account with Hayden, Stone & Co., known as No. 3 Account, and a brokerage account with Wurts, Dulles & Co., known as No. 11 Account.
4. Prior to January 1, 1934, petitioner sold certain shares of Kennecott Copper Company “short”, and during the years 1934, 1935, 1936 and 1937, petitioner was “short” 9,000 shares of Kennecott Copper Company stock in his No. 3 Account. During the years 1934, 1935, 1936 and 1937, petitioner was “short” shares of Kennecott Copper Company stock in his No. 11 Account, varying from 14,450 shares on January 1,1934, to 7,768 shares on December 31, 1937. * * *

It is further stipulated that during the years 1934 to 1937, inclusive, petitioner was credited with interest on an amount equal to the current value of the 9,000 short shares in his No. 3 account, and likewise was credited with interest on the proceeds from the shares sold short in his No. 11 account. The aggregate amounts of these credits for interest in the years involved were as follows:

1934___$38,767. 67
1935-,- 37,402. 68
1936- 33,905.93
1937- 31,579.11

Petitioner treated the above amounts of interest as taxable income for the years in which they were credited to his accounts and in his income tax returns for those years claimed the amounts thus credited as an offset against the deduction which he claimed for interest paid to his brokers.

In order for the petitioner to receive the credit interest referred to above it was necessary for him to pay, and he did pay, to his brokers the following amounts, in lieu of dividends on the shares sold short:

1934_$10, 552. 50
1935___ 14,742. 50
19.36_ 31,460. 30
1937___ 58,688.00

The amounts so paid as “short” dividends were claimed as deductions by the petitioner in his returns for those years.

During the years 1934 to 1937, inclusive, the petitioner was “long” a greater number of shares of Kennecott Copper Co. stock than he was “short” of such shares. The dividends received from the long shares, which were at the same rate as the dividends charged on his short shares, were included in taxable income.

The respondent in his deficiency notices disallowed the deduction of the short dividends on the ground that such dividends represented additional cost of covering the short sales.

In his brief the respondent abandons the position taken in his deficiency notice, that the short dividends represented an additional cost of covering the sales, and contends that the petitioner is not entitled to the deduction of the short dividends because he was:

* * * merely an investor of his personal funds and was not carrying on any trade or business within the statutory concept of these terms permitting deductions of ordinary and necessary expenses paid or incurred in carrying on a trade or business. * * *

In support of this contention the respondent relies upon Deputy v. du Pont, 308 U. S. 488; Higgins v. Commissioner (C. C. A., 2d Cir.), 111 Fed. (2d) 795; affd., 312 U. S. 212; and Henry F. du Pont, 38 B. T. A. 1317; affd. (C. C. A., 3d Cir.), 110 Fed. (2d) 641.

In Deputy v. du Pont, supra, the Court held that the dividends paid on shares of stock which the taxpayer had sold short were not deductible as an ordinary and necessary business expense because the taxpayer was not engaged in the business of trading in securities. However, the Court cited with approval Dart v. Commissioner (C. C. A., 4th Cir.), 74 Fed. (2d) 845, where the deduction of such short dividends was allowed taxpayers who were engaged in the business of buying and selling securities, saying in its opinion:

* * * Thus, it has been held that one who was an active trader in securities might take as deductions carrying charges on short sales since selling short was common in that business.0 But the carrying charges on respondent’s short sale in this case cannot be accorded the same privilege under § 23 (a). The record does not show that respondent was in the business of trading in securities. * * *

The footnote reads as follows:

9 Dart v. Commissioner, 4 Cir., 74 F. 2d 845. Cf. Terbell v. Commissioner, 29 B. T. A. 44, affirmed, 2 Cir., 71 F. 2d 1017, where such carrying charges were disallowed as deductions. The Board of Tax Appeals said, 29 B. T. A. at page 45, “We have only the stipulated facts and there is no suggestion in those facts that the decedent was engaged in the business of making short sales or in dealing in securities generally.”

In paragraph 2 of the “Agreed Statement of Facts” on which these proceedings were submitted, it is stipulated that:

2. During the years 1934, 1935, 1936 and 1937 petitioner was engaged in the business of buying and selling securities for his own account and all shares of Kennecott Copper Company sold “short”, as hereinafter set forth, were sold in the normal course of such business.

This stipulation of facts is conclusive against the respondent in his contention that the petitioner was not engaged in a business of buying and selling securities (albeit for his “own account”). Moreover, the stipulation gives to the petitioner precisely the status which the Court said in Deputy v. du Pont, supra, would entitle him to the deduction of the short dividends, that is, the status of a trader in securities.

Higgins v. Commissioner, supra, lends no support to the respondent’s position in these proceedings. The court there found, as a basis for its disallowance of the deduction of expenses incurred in the management of a portion of the taxpayer’s estate consisting of “stocks and bonds”, that with respect to that portion of his estate the taxpayer was not engaged in carrying on a business.

Again, in Henry F. du Pont, supra, where the deduction of short dividends was disallowed, we said: “The evidence shows that the petitioner was not a broker nor engaged in a business of buying and selling securities.”

The question of whether the petitioner here was engaged in a business of trading in securities is a question of fact. Since it is stipulated that the petitioner was so engaged and since there is no evidence of record to the contrary (see William Ernest Seatree, 25 B. T. A. 396; affd., 72 Fed. (2d) 67), we are bound by the stipulation.

We hold accordingly that the petitioner, being engaged in the business of buying and selling securities during all of the taxable years involved, is entitled to deduct as ordinary and necessary business expenses the short dividends which he paid to his brokers in those years.

Decisions will be entered u/nder Buie 60.