author: Hill:

text:
    Chauncey B. Borland, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93515.
    Promulgated January 15, 1941.

      Oscar D. Stern, Esq., Lincoln B. Olarh, Esq., and Myron D. Davis,. Esq., for the petitioner.

      E. G. Sievers, Esq., and Gerald W. BrooTcs, Esq., for the respondent.
   OPINION.

Hill:

Petitioner assigned as error respondent’s disallowance of :a claimed “credit of $70.54 for taxes paid to a foreign country”, but at the hearing petitioner abandoned such assignment and respondent's determination on this point is, therefore, approved.

The issue submitted for decision is whether or not petitioner is •entitled to deduct from gross income for each of the taxable years the amounts paid by him as his pro rata portion of the general taxes on real estate, the title to which was held by trustees, under the circumstances set out in our findings of fact hereinabove.

There is much discussion in the briefs of both parties on the question of whether or not the trust involved was an association taxable as a corporation. Respondent contends that the trust was such an association within the purview of sections 801 (a) (2) and 1001 (a) (2) of the Revenue Acts of 1934 and 1930 and, hence, since title to the property was in the trustees, that the deductions claimed by petitioner for taxes paid are allowable only to the trust. The petitioner urges the contrary contention. The conclusions reached do not follow the premise assumed in either case.

Under some circumstances, either an association taxable as a corporation or a member of such an association might pay taxes or interest, if a primary obligation, and the amount so paid would be an allowable deduction to the payor. Cf. Sterling Morton, 38 B. T. A. 1270, 1275; affd., 112 Fed. (2d) 320. In other circumstances, an amount so paid by a member of a taxable association might constitute an allowable deduction to the member as rental, if a business expense, and also be deductible by the association as taxes paid. Or taxes paid by a member as rental, if the amount constituted living expense, might be an allowable deduction to the association but deduction would be prohibited to the member under section 24 (a) (1) of the cited statutes. Cf. Charles B. Holden, 27 B. T. A. 530. In any event, respondent is not here seeking to tax the trust as an association, and the answer to that question alone would not be decisive of whether or not petitioner is entitled to the deductions claimed by him. Accordingly, we will undertake no further discussion of this point.

The issue presented for our decision must turn upon whether or not the amounts paid by petitioner represent payments of his own taxes, that is, taxes imposed upon him by the taxing authority by reason of his ownership of the property. It is not enough for him to show merely that he paid the taxes. Eugene W. Small, 27 B. T. A. 1219; Caroline T. Kissel, 15 B. T. A. 1270, 1274.

Petitioner argues in substance that he was in fact the beneficial owner of an undivided interest in the property proportionate to the amount of taxes paid; that the holders of the certificates of interest beneficially owned the property, since the trustees held only the legal title and there was no other person who could possibly have had any ownership interest therein; that the trustees as such did not maintain and operate the property, and performed practically none of the duties nor exercised any of the powers imposed upon or vested in them under the trust indenture, other than in connection with the oiiginal organization of the trust and the execution of certificates of interest; that petitioner, as part owner and not as trustee, looked after all matters of operation and maintenance either in person or through the firm of real estate agents; and that hence, because the amounts in controversy represent payments.made by him for taxes levied on Ms undivided interest in the property, they are deductible under section 23 (c) of the statutes, which provides that there shall be allowed as deductions “taxes paid or accrued witMn the taxable year”, with exceptions not material here.

Petitioner’s contentions, we think, are not supported by the facts. The trust instrument vested in the trustees both the legal and equitable title to the property, and conferred upon the trustees very wide powers in respect of the operation, maintenance, and final disposition of the trust properties. Article I of the trust indenture provided for forms of certificates of interest, and that such certificates should contain the express agreement that the holder should have no claim or interest, legal or equitable, in the premises or properties of the trust, but only an interest in the net income, avails, and proceeds thereof, and that the certificates should be personal property. Article II repeated substantially the same provisions, with the additional statement that the intention was to vest in the trustees the entire legal and equitable title. It was provided in article XII that the title to the trust properties should always be in the trustees in office for the time being, and in article XIX that upon termination of the trust, either by lapse of time or otherwise, the trust properties should be sold and the net proceeds thereof, less the debts and obligations of the trust, distributed pro rata to the then holders of the outstanding certificates of interest.

We also think that petitioner’s contention that the apartment building was not operated by the trustees, as such, can not be sustained. Plainly, petitioner in his individual and personal capacity had no authority to manage and operate the building. In contemplation of law, he acted impliedly in his fiduciary capacity and as agent of the other trustees. The trustees, with full knowledge of petitioner’s acts, long acquiesced therein, and such acquiescence is sufficient from which to imply authority as an agent. See Murphy v. Crane, 82 N. J. L. 557; 82 Atl. 854; Dickinson v. Salmon, 73 N. Y. S. 196; Russell v. Palentine Ins. Co., 106 Miss. 290; 63 So. 644. In Bliss v. Commissioner, 57 Fed. (2d) 984, the court points out that an owner of land who stands by and permits a trespasser to drill oil wells on his land, some of which resulted in dry holes, is liable to the trespasser for such expenditures on the ground of implied agency. Furthermore, in determining the status of the trust property involved here, the decisive factor is not the particular activities of the trustees in the taxable years, but rather the powers vested in the trustees. Cf. Marshall Heirs v. Commissioner, 111 Fed. (2d) 935, affirming on this point 39 B. T. A. 101, 110.

Of course, it can not be said that petitioner in the present proceeding had no interest of any kind in the trust property. He was entitled to receive his share of the net income and avails therefrom, and, upon termination of the trust, his share of the proceeds from the sale of the properties, after payment of the trust debts. However, in our opinion, such interest did not amount to beneficial ownership entitling petitioner to deduct, as taxes paid on his own property, amounts which constituted in fact a part of the annual rental which he was obligated under the trust indenture to pay to the trustees for his use of a residential apartment in the building, the entire title to which was vested in the trustees and on which the taxes were assessed in the name of one or another of the trustees.

The interest of petitioner was, in all material respects, the same as that of a stockholder in the property of a corporation. In Charles B. Holden, supra, we had before us the same question that it presented here, under similar facts, except that in that case the apartment building was operated by a corporation which held the title. There the taxpayer, as part of the consideration for the lease of a residential apartment, agreed to and did pay his proportionate part of the annual interest and taxes on the building on the basis of stock ownership in the corporation. We held that the amounts so paid were not deductible from gross income. That decision, we think, must rule the present case. See also Wood v. Rasquin, 21 Fed. Supp. 211; affirmed per curiam without opinion, 97 Fed. (2d) 1023.

Decision will he entered for respondent.


source: Caselaw Access Project

author: TURNER:

license: Public Domain

text:
    Alexander Davidson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85629.
    Promulgated January 15, 1941.

      >0. G. McDonaldÍ, Esq., for the petitioner.

      F. B. Schlosser, Esq., for the respondent.
   OPINION.

TURNER:

The first question for determination is whether petitioner’s income tax returns for the taxable years were false and fraudulent with intent to evade tax. If not, the statute of limitations bars the assessment and collection of the deficiencies determined, and the respondent so concedes. The petitioner contends that his returns for the years in question were not false and fraudulent, with intent to evade tax, and that the period within which any tax for such years may be assessed has expired; and in that connection he has alleged that by reason of his acquittal in the United States District Court for the Northern District of California on the charge that he willfully, knowingly, and feloniously attempted to defeat and evade income tax for the year 1924, the issue of fraud herein is res judicata. A similar contention was considered by the Supreme Court in Helvering v. Mitchell, 303 U. S. 391, and decided adversely to the contention made by the petitioner here. Accordingly the petitioner’s claim of res judicata is denied.

The burden of proving fraud is upon the respondent and that burden he assumed at the hearing. To establish fraud, he has introduced and relies upon the following: The deposition of Robert T. Colquhoun, together with 37 exhibits attached thereto, consisting largely of records, canceled checks, and correspondence taken from his files; deposition of W. E. Lyman, general auditor of the Wells Fargo Bank, together with certain ledger sheets showing petitioner’s accounts at that bank; deposition of R. F. Schacht, assistant cashier of the Bank of America, with certain exhibits attached thereto; deposition of J. E. Turner, assistant cashier of the First National Trust & Savings Bank of Santa Barbara, California, with several canceled cashier checks attached thereto; deposition of W. S. Davis, branch manager of the Seventh and Valencia Branch of the Security First National Bank of Los Angeles, with seven canceled checks attached thereto; deposition of Dan J. Chapin, internal revenue agent in charge at San Francisco in 1922; the oral testimony of E. H. Shine, assistant cashier of the Wells-Fargo Bank, together with several canceled checks identified by him; oral testimony of Raleigh M. Fremont, one of Colquhoun’s agents in the liquor business; and the oral testimony of several special agents of the Bureau of Internal Revenue who participated in the investigation, of petitioner’s tax liability.

Petitioner admits that he was engaged during the taxable years in an illegal liquor business along the general lines disclosed in the testimony of Colquhoun; he also admits that the results of his operations were not reported in his income tax returns, the reason offered for such failure being that his operations resulted in net losses for those years and that his attorney advised him that since the losses resulted from the operation of an illegal business they were not therefore deductible. He testified that he did keep records of all transactions in question but that such records were destroyed when he moved to Texas in or about 1930 or 1931. The evidence offered by the respondent clearly refutes the reasons given by the petitioner for his failure to disclose the results of his operations in his income tax returns. From this evidence it appears that the petitioner, instead of sustaining net losses in his liquor operations, realized substantial profits therefrom. From the record it appears that the only financial outlay made by petitioner-in each instance was the cost of the liquor sold. The expenses of operation were paid by Colquhoun out of the proceeds from sales and,, after taking out his share, the balance was paid by him to petitioner or to others for petitioner’s benefit. These payments, after making due allowance for the cost of the liquor sold, disclosed substantial profits to petitioner in each of the years before us. Obviously petitioner’s returns for the years 1922, 1923, and 1924 were false, and from the evidence of record we are convinced that the falsification of the returns was willful and with intent to evade tax. The reason given for the failure to report the income from his operations, namely, that he sustained net losses, was untrue, and certainly the petitioner was fully aware of that fact. It is accordingly our conclusion and we so hold that the petitioner’s returns for the years before us were false and fraudulent, with intent to evade tax, and as a result the period within which the income tax for those years may be assessed and collected has not expired. See M. Rea Gano, 19 B. T. A. 518; John Kehoe, 34 B. T. A. 59; affd., 309 U. S. 277; Frank A. Maddas, 40 B. T. A. 572; affd., 114 Fed. (2d) 548.

The respondent having sustained the burden of proving that the returns filed by the petitioner were false and fraudulent, with intent to evade tax, the burden of proving error in the deficiencies determined by the respondent is on the petitioner. John Kehoe, supra, and Frank A. Maddas, supra. He seemed content to rest his case principally on the fraud issue and has offered nothing substantial to refute the correctness of the deficiencies determined by the respondent. In fact there is little more to his testimony than a reiteration that the operation of the business resulted in a net loss for each of the years before us. There are some inferences that he considered Colquhoun as an extortioner and that, in the light of unfriendly relations between them at the time of the termination of their operations, Colquhoun’s testimony should be disregarded. He also denied that he ever used certain names under which Colquhoun claims petitioner received some of the payments. It appears, however, that in connection with his oral testimony Colquhoun supplied records and papers maintained currently during the operations with petitioner which reflected the moneys received and the payments made to petitioner or for his benefit. Furthermore, Colquhoun’s testimony as to numerous payments is corroborated by the testimony of Shine and various canceled checks and bank records. In making his determination as to the profits realized by petitioner, respondent has made allowance for the cost of the whiskey sold and in computing the items reflected or evidenced by amounts paid on petitioner’s loans in the Wells Fargo Bank, he has not included any sums tbat were paid from petitioner’s checking account or sums that were otherwise identified. The petitioner has failed to show that the items included by the respondent in his determination of the deficiencies did not represent income or were to any extent duplications of income items. The deficiencies determined by the respondent for the years 1922, 1923, and 1924 are accordingly sustained.

We also conclude from the evidence of record that a part or all of the deficiency for each year is due to fraud, with intent to evade tax, and the respondent’s determination of the fraud penalties is also sustained.

Decision will be entered for the respondent.


author: Turnee:

text:
    Park & Tilford, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 89181, 89182, 89184-89195, 94024-94069.
    Promulgated January 16, 1941.

      Hugh Satterlee, Esq., William R. Green, Jr., Esq., and Philip Zimet, Esq., for the petitioners.

      J. R. Johnston, Esq., for the respondent.

       Proceedings ot the following petitioners are consolidated herewith: 1931 Corporation; Magnus J. Witman; Estate of Thomas L. Chadbourne, deceased. Humphrey W. Chadbourne and Waldeman A. Chadbourne, Executors ; Louis S. Levy; William Wallace, Jr.; William M. Parke; Louis G. Bissell; Frederick Hoff; I-Ienry J. Wolff; Irma B. Levy ; Carrie E. Schulte; Estelle E. Frank; Nancy G. Handren; Arthur S. Meyer; J. Donovan Pheifer.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) Genekal Rule. — upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      *******
      (i) Definition of Reouganization. — As used in this section and sections 113 and 115— (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, are substantially all the properties of another corporation), * * *

       (b) Exchanges Solely in Kind.—
      ****** *
      (3) Stock foe stock on reorganization. — 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.

       (3) Definition of Control. — As used in this section the term “control” means the ownership 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 the corporation.

       (c) Gain from Exchanges Not Solely in Kind.—
      (1) If an exchange would be within the provisions of subsection (b) (X), (2), (3), or (S) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

       SBC. 27i>. 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.

   OPINION.

Turnee:

The petitioners in these proceedings are contesting the determination of the respondent that they are liable as transferees or as transferees of transferees of Large, Overholt, Distributing, or Geneva, or all of them. They question the liability of each of these corporations for both the income and excess profits tax with which the respondent seeks to charge them and contend, further, that if such liability ever existed there is now no liability against them, due to the running of the statute of limitations.

With respect to the liability of Large and Overholt, the question is whether the transfer of assets by Large to the L. D. Corporation for National stock and debentures and the transfer of assets by Overholt to the A. O. Corporation for National stock and debentures constituted reorganizations within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1932 and exchanges within the meaning of section 112 (b) (4). The liability of Geneva and a part of the liability with which Distributing is charged turns on the question whether the subsequent distributions in liquidation by Large and Overholt of the National Shares and debentures to Geneva and Distributing, respectively, were exchanges within the meaning of section 112 (b) (3) of the statute. With respect to the liability of Distributing, there is the further question whether the distribution to it by Overholt of 25,000 shares of Geneva stock was “in pursuance of a plan of reorganization” within the meaning of section 112 (g) of the statute.

As early as 1930 National had been interested in acquiring certain properties of Large and Overholt and, during the first several months of 1933, had been carrying on negotiations with respect thereto with Schulte, which, directly or indirectly, owned controlling interests in both Large and Overholt. National desired to acquire Large and Overholt as going concerns but was insistent that when acquired they should be free from existing liabilities. Furthermore, it was unwilling to take over the whiskey inventory of Large, which was subject to the optional contract of sale with Schenley. By May 26, 1933, it had been agreed that the consideration to be paid for the desired assets of Large and Overholt should be 102,000 shares of National common stock and $600,000 par value of its debentures.

Under date of June 9, 1933, the agreement between National and Schulte was reduced -to writing. The assets of Large and Overholt which were subject to the agreement were carefully designated. It was also provided that upon request of National the designated properties should be conveyed to any wholly owned subsidiary of National and that such subsidiary, upon nomination of National, might “assume the obligations (without, however, releasing National therefrom) and thereupon * * * become entitled to all and singular the rights and benefits of National” thereunder. National was a holding company and its activities had never been those of an operating company, and, in the light of the provisions just cited from the contract and the transaction as it was actually carried out, we think it is apparent that National never had any intention of acquiring as its own any of the properties of Large and Overholt.

Schulte was desirous that the designated properties should be disposed of in such manner as to avoid liability for income taxes on such gains as might be realized by Large and Overholt. They consulted counsel and were advised that if the transactions were carried out in the maimer more fully set forth in our findings of fact the gain would not be recognizable for income tax purposes. Geneva was accordingly organized and, in order that it might literally appear that Large and Overholt were transferring all of their assets to the L. D. Corporation and A. O. Corporation, respectively, Large on June 23, 1933, and Overholt on June 24, 1933, transferred their assets not covered by the National-Schulte agreement to Geneva for its stock, the said stock in each instance being distributed on the day of its receipt to their stockholders. In the meantime National had organized the L. D. Corporation and A. O. Corporation and under date of June 20, 1933, had advised the L. D. Corporation that it had been designated as the nominee of National to receive the desired assets of .Large and the A. O. Corporation that it had been designated as the nominee of National to receive the desired assets of Overholt. It was stated in these communications that National would undertake the payment of the full consideration to Large and Overholt for the assets to be acquired and that the L. D. Corporation and A. O. Corporation should each issue and deliver to National 4,500 shares of its capital stock, being the remainder of the authorized but unissued stock of each corporation. On the same date, June 20, the L. D. Corporation and A. 0. Corporation adopted appropriate resolutions accepting the proposals of National and on June 26, 1933, National advised the Schulte interests that the designated assets of Large and Overholt were to be transferred directly to the L. D. Corporation and A. O. Corporation, respectively, and that these corporations had become entitled to all of the rights and benefits of National under the agreement of June 9. On June 30, 1933, Large and Overholt transferred and conveyed the assets covered by the Schulte-National agreement to the L. D. Corporation and A. O. Corporation, respectively, receiving therefor from National 102,000 shares of its common stock and $600,000 par value of its debentures.

It is the contention of the petitioners that the transactions whereby Large and Overholt transferred their designated assets to the L. D. Corporation and A. O. Corporation, both subsidiaries of National, and received therefor stock and debentures of National constituted reorganizations within the meaning of section 112 (i) (1) (A), supra, and that recognition of the gain realized by Large and Overholt is accordingly barred by the provisions of section 112 (b) (4). It is the contention of the respondent, however, that the L. D. Corporation and A. O. Corporation, prior to June 30, 1933, the date of the transfer of the assets of Large and Overholt, acquired all of the rights of National to those assets and, since the assets were transferred directly to and retained by the L. D. Corporation and A. O. Corporation, National may not be said to have been “a party to a reorganization” wherein Large and Overholt disposed of their assets, and the receipt of National’s stock and debentures by Large and Overholt was not without recognition of gain, as the petitioners claim. The respondent also contends that there was no reorganization of Large and Overholt within the meaning of section 112 (i) (1) (A), in that the assets transferred to the L. D. Corporation and A. O. Corporation did not constitute all or substantially all of the assets of Large and Overholt.

The facts here are substantially similar to those considered by us in Michigan Steel Corporation of New Jersey, 38 B. T. A.. 435, and the petitioners do not contend otherwise. It is their claim however that Groman v. Commissioner, 302 U. S. 82, and Helvering v. Bashford, 302 U. S. 454, do not justify the conclusion reached in that case and that we should overrule Michigan Steel and reach a contrary conclusion here. They concern themselves particularly with the fact that National was one of the contracting parties and that the consideration of 102,000 shares of National’s common stock and $600,000 par value of its debentures paid for the designated assets of Large and Overholt was issued and delivered directly to Large and Overholt by National. These facts, it is claimed, show acquisition by National of all of the assets of Large and Overholt in exchange for National stock and debentures within the meaning of subdivisions (i) (1) (A) and (b) (4) of section 112 of the statute, even though the said assets were transferred directly to and became the property of the L. D. Corporation and A. O. Corporation rather than National. We find nothing new in the contention of the petitioners and the arguments presented are no more convincing than when offered in Michigan Steel. There we expressed the view “that the Supreme Court was clearly disinterested in the question of whether the securities were transferred directly from the contracting parent corporation •or indirectly through a wholly owned subsidiary”, the important question being whether the securities issued for the assets were the securities of the corporation which became the owner of the assets and the business disposed of. In Helvering v. Bashford, supra, the Supreme Court said: “The participation of Atlas [in this case National] in the reorganization of its competitors [in this case Large and Overholt] into a new company [in this case L. D. Corporation and A. O. Corporation] which became a subsidiary did not make Atlas ‘a party to the reorganization.’ The continuity of interest required by the rule is lacking.” In Groman v. Commissioner, supra, we find the following:

It is argued, however that Ohio [in this case L. D. Corporation and A. O. Corporation] was the alter ego of Glidden [in this case National]; that in truth Glidden was the principal and Ohio its agent; that we should look at the realities of the situation, disregard the corporate entity of Ohio, and treat it as Glidden. But to do so would be to ignore the purpose of the reorganization sections of the statute, which, as we have said, is that where, pursuant to a plan, the interest of the stockholders of a corporation continues to be definitely represented in substantial measure in a new or different one, then to the extent, but only to the extent, of that continuity of interest, the exchange is to be treated as one not giving rise to present gain or loss. If cash or “other property,” that is, property other than stock or securities of the reorganized corporations, is received, present gain or loss must be recognized. Was not Glidden’s prior preference stock “other property” in the sense that its ownership represented a participation in assets in which Ohio, and its shareholders through it, had no proprietorship? Was it not “other property” in the sense that qua that stock the shareholders of Indiana assumed a relation toward the conveyed assets not measured by a continued substantial interest in those assets in the ownership of Ohio, but an interest in the assets of Glidden a part of which was the common stock of Ohio? These questions we think must be answered in the affirmative. To reject the plain meaning of the term “party,” and to attribute that relation to Glidden, would be not only to disregard the letter but also to violate the spirit of the Revenue Act.

We think it clear that the contentions of the petitioners must be rejected and that the stock and debentures of National may not be regarded as the securities of a corporation “a party to a reorganization” within the meaning of section 112 (b) (4). Groman v. Commissioner, supra; Melvering v. Bashford, supra; and Michigan Steel Corporation of New Jersey, supra. We are also of the opinion that the respondent is correct in his contention that the L. D. Corporation and A. O. Corporation did not acquire all or substantially all of the assets of Large and Overholt. At no time was it contemplated that National or any subsidiary should acquire the whiskey inventory of Large, which was subject to the Schenley contract, or the other assets transferred by Large and Overholt to Geneva. If therefore the assets transferred to the L. D. Corporation and A. O. Corporation actually had been acquired by and had become the property of National, there still would not have been an acquisition of substantially all the assets of Large and Overholt so as to make the transaction a reorganization within the meaning of section 112 (i) (1) (A). Helvering v. Elkhorn Coal Co., 95 Fed. (2d) 732; A. W. Mellon, 36 B. T. A. 977. Accordingly, the gain realized by Large upon the transfer of assets to the L. I). Corporation and by Overholt upon the transfer of assets to the A. O. Corporation for National stock and debentures was not without recognition. Furthermore, the said National stock and debentures not being the securities of a corporation a party to a reorganization, section 112 (b) (3) is not applicable to the distributions of the said National stock and debentures to Geneva and Distributing in liquidation of Large and Overholt, respectively, and the gain realized by Geneva and Distributing by reason of such distributions must be recognized.

With respect to Distributing, there remains the question whether the gain realized upon the distribution to it by Overholt of 25,000 shares of Geneva stock under date of June 28, is to be recognized. Of the said 25,000 Geneva shares Overholt had received 5,2126%53 shares on June 23 in partial liquidation of Large and 19,787%53 shares direct from Geneva on June 24 in exchange for the Overholt assets not covered by the Schulte-National agreement of June 9. It is the claim of the petitioners that the transfer of assets by Over-holt to Geneva on June 24, for Geneva stock was a reorganization within the meaning of section 112 (i) (1) (B) of the act and that the distribution of the 25,000 shares of Geneva stock to Distributing on June 28 was a distribution without recognition of gain within the meaning of section 112 (g), supra. The respondent has made no determination that the gain realized by Overholt upon the transfer of assets to Geneva for Geneva stock is to be recognized. He does contend, however, that the transaction was not a reorganization under section 112 (i) (1) (B), but an exchange within the provisions of section 112 (b) (5). and, not being a reorganization, the gain realized by Distributing upon the receipt of the Geneva stock in liquidation or partial liquidation of Overholt does not escape tax under section 112 (g), but is to be recognized in full. The argument of the respondent in support of the proposition that there was no reorganization between Overholt and Geneva is not very clear. The inference seems to be that, since the declared purpose for the organization of Geneva and for its continued existence was the liquidation of the assets of Large and Overholt omitted under the Schulte-National agreement, there was no business purpose for its organization under the doctrine of the “Gregory case”, presumably Gregory v. Helvering, 293 U. S. 465, and, therefore, no reorganization within the meaning of the statute. It may be that the respondent does not desire to press this argument, in as much as he has determined that Geneva is liable for excess profits tax, which liability is dependent upon the doing of business. Furthermore, Geneva did succeed to the business of Large, namely, that of selling an inventory of whiskey. At any rate, the respondent counters in his reply brief with the proposition that, even though the transfer by Overholt of part of its assets to Geneva for Geneva stock did constitute a reorganization within the meaning of section 112 (i) (1) (B) and by reason thereof the gain attributable to the 19,78'7%53 shares acquired directly from Geneva escapes recognition, it may not be held that the gain attributable to the 5,2126% 53 shares similarly escapes recognition, since those shares had been received by Overholt in partial liquidation of Large and not as a part of the reorganization between Overholt and Geneva.

According to section 112 (i) (1) (B), the term “Reorganization” means “a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the tranferor or its stockholder's or both are in control of the corporation to which the assets are transferred.” In the instant case, Overholt transferred assets to Geneva for shares of Geneva stock and immediately .after the transfer was in control of Geneva. Sec. 112 (|).'° The shares acquired directly from Geneva and the shares which had been received the previous day in partial liquidation of Large constituted more than 80 percent of all of the stock of Geneva and the claim that a reorganization under section 112 (i) (1) (B) took place between Overholt and Geneva is not defeated by the fact that the ownership of the 5,212%53 shares of Geneva stock previously received was necessary to constitute ownership by Overholt of 80 percent or more of Geneva’s stock outstanding. Rawco, Inc., Ltd., 37 B. T. A. 128. As we have noted, however, the respondent contends that the gain realized by Distributing upon the receipt •of the Geneva shares previously received by Overholt in partial liquidation of Large is not to escape recognition of gain, since those ■shares were not acquired in the reorganization between Overholt and Geneva. He cites no authority for this pRoposition, however, and makes little or no argument. In our opinion the argument is not well founded. The shares, even though not acquired directly from Geneva, were essential to the reorganization between Overholt ■and Geneva, since without them Overholt was not in control of Geneva, as the statute requiRes. Furthermore, if a reorganization under section 112 (i) (1) (B) did occur between Overholt and Geneva, and we have held that it did, the 5,2126%23 Geneva shares, even though received in partial liquidation of Large, were the shares of a corporation a party to the reorganization and the facts show that the plan of reorganization contemplated theiR distribution by Overholt to Distributing, its sole stockholder. Accordingly the gain realized by Distributing upon the receipt of the entire 25,000 shares of Geneva stock is not to be recognized and, since the Overholt stock had no basis in the hands of Distributing and there is therefore no necessity to consideR any proration of such basis between the Geneva shares received on June 28 and the National shares and debentures received on June 30 (in that connection see A. W. Mellon, supra; Rudolph Boehringer, 29 B. T. A. 8; North American Utility Securities Corporation, 36 B. T. A. 320), it matters not in computing the amount of gain to be recognized whether it be said that the Geneva stock was distributed in partial liquidation of Overholt without the surrender by Distributing of its Overholt stock, as contemplated by section 112 (g), or was distributed with other property, namely, National shares and debentures, in complete liquidation of Overholt within the meaning of section 112 (c) (l).

The next issue involves the liability of Large, Overholt, Geneva, and Distributing for excess profits tax. In their original and reply briefs the argument of the petitioners is that the excess profits tax “should and may still be held unconstitutional,” and the claim that the said corporations could easily have relieved themselves of any claim for excess profits tax by declaring a greater capital stock tax value if they had thought the transactions with National might be held not to have been statutory reorganizations. A supplemental brief has been filed, however, in which it is argued that Distributing was not carrying on or doing business within the meaning of the statute.

According to the record, Distributing was organized in 1925. Its assets consisted of the stock of Overholt and stock of the West Overton Distilling Co. During the period here under consideration the latter corporation was not engaged in business and had no assets of value. Distributing’s articles of incorporation were not introduced in evidence, and we are not advised as to the declared purposes for its organization. It does appear that shortly after its organization it acquired the stock of Overholt and continued to hold that stock throughout its existence. It was a business corporation and we have no doubt that as originally organized it was intended to manage or participate in the management of Overholt and there is some indication that on one or more occasions it received distributions from Overholt, which amounts in turn were distributed to its stockholders. While the receipt of dividends by a holding company and the distribution of the amounts so received to its stockholders may not alone be sufficient to constitute the carrying on or doing of business for the purpose of sustaining the excess profits tax, it is well established that the participation by a parent corporation in the management and direction of the affairs of its subsidiary are sufficient to bring it under the statute. Edwards v. Chile Copper Co., 270 U. S. 452. Whatever may have been the activities of Distributing prior to June 9, 1938, and whether it may have been engaged in operations sufficient to bring it within the rule laid down in Edwards v. Chile Copper Co., supra, we are convinced from the record before us that it was not engaged in such activities from and after June 9, 1933, the date of the Schulte-National agreement. During that period its activities did not extend beyond the holding of the Overholt stock and the receipt and distribution in liquidation of the Geneva stock and the National stock and debentures. Undoubtedly it also performed such formal acts as might be required of a sole stockholder with respect to the disposition by Overholt of its business and assets and its succeeding liquidation. Such activities, in our opinion, did not constitute the carrying on or doing of business within the meaning of sections 215 and 216 of the National Industrial Recovery Act. Cf. Eaton v. Phoenix Securities Co., 22 Fed. (2d) 497; Rose v. Nunnally Investment Co., 22 Fed. (2d) 102; United Mercury Mines Co. v. Viley, 20 Fed. Supp. 734. The petitioners are accordingly sustained in their claim that the respondent erred in determining that Distributing was liable for excess profits tax.

The petitioners do not claim that Large, Overholt, or Geneva were not carrying on or doing business within the meaning of the statute and the record would not support such a claim if it had been made. Overholt had been actively engaged in manufacturing and selling whiskey and there is nothing to indicate that it did not continue such activities up to June 30, 1933. Large was engaged principally in the selling of whiskey and that activity certainly continued until June 23, 1933, when it transferred its whiskey inventory to Geneva, while Geneva from and after June 23 succeeded to the business previously conducted by Large, namely, that of selling a substantial inventory of whiskey. In the light of these facts and the further fact that the question as to the constitutionality of the excess profits tax has been previously decided adversely to the petitioners, Briggs-Darby Construction Co., 41 B. T. A. 136; Chicago Telephone Supply Co. v. United States (Ct. Cls.), 35 Fed. Supp. 471, the respondent is sustained in his determination that Large, Overholt, and Geneva are liable to excess profits tax for the year before us.

The petitioners next claim that the respondent has committed certain errors in computing and determining the gain realized by Geneva and Distributing. The gain of Geneva resulted from the distribution to it by Large of 15,099 shares and $89,000 principal amount of debentures of National. In computing the gain realized by Large on receipt of the National shares and debentures, the respondent recognized the effect of the option held by Lehman Brothers and valued the shares so received by Large in proper proportions at $56, $61, and $97.75 per share. In computing the gain of Geneva, be ignored tbe effect of tbe option and valued tbe entire 15,099 shares received by it in liquidation of Large at $97% per share and used tbe gain so computed in determining the deficiency against Geneva. On the same date that Large received tbe National shares and debentures for that portion of its assets transferred to the L. D. Corporation, it distributed the said shares and debentures to its stockholders in liquidation. The shares so distributed were subject to the option of Lehman Brothers in the hands of the stockholders of Large just as much as they were subject to the option in the hands of Large, and there is no justification for the respondent’s determination that the entire 15,099 shares received by Geneva had a value of $97% per share. The values used for the said stock in computing the gain of Large are, in our opinion, correct, and those values should be applied according to the same ratios in computing the gam of Geneva. Similarly, there is an inconsistency in the values used by the respondent in determining the gain realized by Overholt upon receipt of the National shares and debentures in. exchange for that portion of its assets transferred to the A. O. Corporation and in determining the gain realized by Distributing upon the receipt of the said National shares and debentures in liquidation of Overholt. The value used by the respondent in computing the gain realized by Distributing is, in our opinion, erroneous in as much as he failed to take into consideration the option held by Lehman Brothers. The gain of Distributing should accordingly be computed by using in proper ratios the values used for the National stock in computing the gain of Overholt.

In the light of our conclusions previously stated with respect to the distribution to Distributing by Overhoit of the 25,000 shares of Geneva stock, it becomes unnecessary to consider the differences between the parties with respect to the value of the Geneva shares when so distributed.

The petitioners make the further claim that the respondent in determining the gain realized by Geneva and Distributing from the liquidation of Large' and Overholt, respectively, has not made allowance for the liability of those corporations for any income and excess profits taxes for which they were liable. The respondent admits that no such allowance has been made, making some reference to the fact that what ever the liabilities of Large and Overholt may have been, those liabilities were not satisfied or paid by Geneva and Distributing, and are not therefore to be taken into consideration in determining the gain realized by them upon the liquidation of Large and Overholt. The contention of the respondent is not exactly clear, but his counsel seems to have confused the contention of the petitioners with a claim of deduction for taxes paid. To the contrary, the substance of the contention is that Geneva and Distributing received the assets of Large and Over-bolt in liquidation, subject to any unpaid liabilities of Large and Over-holt for income and excess profits taxes and that such unpaid liabilities must be taken into consideration in determining the amount of gain realized by them as stockholders of Large and Overholt, just as would have been the case with any other unpaid liabilities of those corporations. The claim is not a claim for the deduction of taxes paid and the petitioners are sustained in their contention. Cf. T. H. Symington & Son, Inc., 35 B. T. A. 711. In this connection, however, the petitioners contend that Distributing, in determining its gain upon the liquidation of Overholt, is also entitled to offset an amount equal to 83.33 percent of any deficiency in income and excess profits taxes for which Geneva is liable. There is no merit in that contention. None of the assets received by Distributing were subject to any liability of Geneva. Distributing at one time and for a period of approximately four days held 25,000 shares of Geneva stock, but on June 28 those shares were distributed by it to its stockholders as a step in liquidation. At no time did Distributing receive any distribution of assets in liquidation of Geneva.

The petitioners contend that the right of assessment against them of any transferee liability for the income and excess profits taxes of Large, Overholt, Distributing, and Geneva expired prior to the mailing of the notices of determination herein. The following is a tabular statement of the dates on which the returns of the indicated corporations were filed, the date of expiration of the period for making assessment against each such corporation, and the dates on which respondent sent notices to petitioners of transferee liability in respect of the ta.x of such corporations:

No part of the deficiencies against Large, Overholt, Distributing, and Geneva has been assessed or paid. The distributions made in June 1933 by Large, Overholt, and Distributing rendered them without assets and the distributions made then and in December 1934 and January 1935 have left Geneva with approximately $55,000, an amount insufficient to discharge the deficiency in its tax.

It is the contention of the petitioners that in as much as the period for assessment of the tax against the transferors, namely, Large, Overholt, Geneva, and Distributing, expired without the assessment of the deficiencies claimed herein, sections 275 (a) and 276 (c) of the Revenue Act of 1932, the liability of those corporations for tax was extinguished, section 607 of the Revenue Act of 1928, and accordingly no transferee liability exists which may be assessed against these petitioners.

Claims against transferees are controlled by the provisions appearing under sections 311- and 312, supplementing the Revenue Act of 1932, and in subsection (b) of section 311 it is provided that the period for limitation of assessment shall be “In the case of the liability of an initial transferee of the property of the taxpayer, — within one year after the expiration of the period of limitation for assessment against the taxpayer”, and “In the case of the liability of a transferee of a transferee of the property of the taxpayer, — within one year after the expiration of the period of limitation for assessment against the preceding transferee, but only if within three years after the expiration of the period of limitation for assessment against the taxpayer.” In Gideon-Anderson Co., 20 B. T. A. 106, involving facts substantially similar to those presented here, the same question was presented with respect to the corresponding provisions of the Revenue Act of 1926, and we held adversely to the claim of the petitioners. Later the question was presented in City National Bank v. Commissioner, 55 Fed. (2d) 1073, affirming 19 B. T. A. 1080; certiorari denied, 286 U. S. 561. In also holding adversely to the petitioners, the court said:

It is also contended that the transferee cannot be held, because under section 1106 (a) 26 U. S. C. A. § 1249 note, the statute of limitations not only operates to bar the remedy but extinguishes the liability. A complete answer to that contention is that limitation had not run against the transferee, because the assessment of its liability was made within the year allowed by section 280 (b) (1) after the expiration of the period of limitation for assessment against the taxpayer.

To concede the contention of the petitioners would require us to hold that before the Commissioner could proceed against transferees after the expiration of the period of limitations applicable to the transferor he is required to assess the tax against the transferor prior to the expiration of the period of limitations applicable to the transferor. In practically all cases, as here, such action would mean assessing tax against transferors entirely or substantially devoid of assets, which would be a futile and useless act. This question was considered and disposed of adversely to the petitioners in Flynn v. Commissioner, 77 Fed. (2d) 180, affirming 28 B. T. A. 578, wherein the facts were comparable to those presented here and the transferee provisions were those of the Revenue Act of 1928.

Finding nothing in the instant proceedings and the above quoted statutory provisions or in the argument of the petitioners in connection therewith which would justify our reaching a conclusion here different from that reached in the Gideon-Anderson Co., City National Bank, aiid Flynn cases, we deny the contention of the petitioners. See also A. R. McLennan, 25 B. T. A. 1052; England Walton & Co., 25 B. T. A. 1091; Newport Co., 24 B. T. A. 1246; Federal Oil Corporation, 24 B. T. A. 622; J. A. Kemp, 20 B. T. A. 875. Cf. Catharine D. Sharpe, 38 B. T. A. 502; affd., 107 Fed. (2d) 13; certiorari denied, 309 U. S. 665.

On brief the respondent concedes that the period of limitations had run at the time of sending transferee notices to the following named petitioners with respect to the indicated amounts of National stock and debentures distributed to them by Large on June 30, 1933, and that they were not transferees of transferees with respect to such distributions:

We have set out in our findings of fact the distributions made by Large, Overholt, Distributing, and Geneva on June 80, 1933 (and subsequently in the case of Geneva), the persons to whom they were made, and what each received. The recipients received such distributions without payment of value therefor and as a result thereof the corporations were rendered insolvent and unable to discharge their corporate liability for taxes, and in the case of Distributing and Geneva their liabilities as transferees of Overholt and Large, respectively. Except to the extent conceded otherwise by the respondent, as stated above, we conclude that the petitioners are transferees, direct or indirect, of the assets respectively received by them to the extent of the value of such assets at the time of their receipt as indicated in our findings of fact, in respect of the taxes-of the corporation of which they were respectively transferees, direct or indirect.

In the recomputations of the liabilities of the petitioners to be submitted under Rule 50, effect will be given to the stipulation of the parties which has been set out in our findings of fact.

Eeviewed by the Board.

Decisions will he entered under Rule 50.

       (b) Exchanges solely in kind..—
      *******
      (4) Same — Gain of Cokpoeation. — No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.

         (g) Distribution of Stock on Reorganization. — If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.

       (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. 276. EXCEPTIONS.
      * * * * * * *
      (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 (1) within six years after the assessment of the tax, or (21 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 bo extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.

       SEC. 607. EFFECT OF EXPIRATION OF PERIOD OF LIMITATION AGAINST united STATES.
      Any tax (or any interest, penalty, additional amount, or addition to such tax) assessed or paid (whether before or after the enactment of this Act) after the expiration of the period of limitation properly applicable thereto shall be considered an overpayment and shall be credited or refunded to the taxpayer if claim therefor is filed within the period of limitation for filing such claim.


author: TurneR :

text:
    Estate of Mrs. Cornelia Adair, Deceased, Montgomery H. W. Ritchie, Administrator, de Bonis Non, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95451.
    Promulgated January 22, 1941.

      G-e,org& Thompson, Esq., and ATbeH G. Moss, G. P. A., for the petitioner.

      James H. Yeatman, Esq., for the respondent.
   OPINION.

TurneR :

There is no controversy between the parties as to whether the use of inventories of live stock is necessary to the correct determination of the petitioner’s income, but they are in disagreement as to the method to be used in valuing such inventories. The respondent contends that the farm price method is the proper method and that his action in using it should be sustained. The petitioner concedes that it is not entitled to use the constant price method which it employed in filing its return. However it contends now, as prior to the determination of the deficiency, that it is entitled to use cost and that the true cost of its live stock can be ascertained through the use of a method or formula proposed by it and explained as follows:

(1) The cost of a breeding animal, bom on the ranch and raised to maturity, is its cost when bom plus the cost to raise it during a two year period of growth into maturity as a breeder.
(2) The cost of all calves born during the year is the sum of (1) the cost of maintaining the breeding cattle during the year and (2) the cost value of such number of said cattle as die during the year. The cost of a single calf is the said sum divided by the number of calves born during said year.
(3) The cost of all colts born during the year is the sum of (1) the cost of maintaining the breeding horses during the year and (2) the cost value of such number of said horses as die during the year. The cost of a single colt is said sum divided by the number of colts born during said year.
(4) The cost of raising calves and colts (sometimes referred to as growing .•animals) after they are born, and during the two year period before they mature into breeders, constitutes an additional cost of these animals. The •cost to be added to said animals each year is the sum of (1) the ranch ex-| penses applicable to said animals and (2) the cost value of such number of said animals as die during the year. The cost to be added to each such growing animal each year is said sum divided by the number of growing animals which survive.
(5) The cost of raising steers after they are born, and during the period they remain unsold, constitutes an additional cost of these animals. The cost to be added to said animals each year is the sum of (1) the ranch expenses applicable to said animals and (2) the cost value of such number of said animals as die during the year. The cost to be added to each such steer each year is said sum divided by the number of steers which survive.
(6) The cost of a growing animal purchased is the actual purchase price plus raising cost. The cost of a grown animal purchased is the actual purchase price.
(7) All ranch expenses, other than selling, general and administrative expenses, are apportionable on a per head basis each year to the breeding and growing animals. In addition, the cost value of such number of main herd horses (saddle and work horses and mules) as die during the year is so apportionable also.
(8) Ranch expenses constitute two general classes, viz: (1) Breeding and raising expenses and (2) Selling, general and administrative expenses. Class (1) expenses are chargeable to the cost of animals produced and raised in determining gross income from live stock sales. Class (2) expenses are deductible from gross income in determining net income. Certain ranch expenses are direct expenses of breeding a^d raising animals. Under this class falls forage and grain, repairs to properties, depreciation and taxes. Other ranch expenses are applicable to both said general classes (1) and (2). * * * The table following shows such expenses as are incurred annually and the bases of apportionment:

The method or formula of the petitioner provides for the application of the “first in, first out” rule authorized in article 22 (c)-2 of Regulations 86 for identifying goods in an inventory where they have become so intermingled as to lose their identity.

The parties have stipulated that if it should be determined that the petitioner is entitled to value its inventories of live stock upon the basis of cost and that the petitioner’s method or formula for determining cost is correct, the amounts of $493,173.50 and $525,728.24 shall be accepted as correctly reflecting the values of the petitioner’s inventories of live stock at the beginning and end of 1935, respectively.

Section 22 (c) of the Revenue Act of 1934 provides as follows:

(c) Inventoeies. — Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

Regulations 86, relating to the Revenue Act of 1934, provides in part as follows:

Art. 22 (e)-2. Valuation of inventories. — Section 22 (c) provides two tests to which each inventory must conform:
(1) It must conform as nearly as may be to the best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.
The bases of valuation most commonly used by business concerns and which meet the requirements of section 22 (c) are (a) cost and (b) cost or market, whichever is lower. * * *
In respect of normal goods, whichever basis is adopted must be applied with reasonable consistency to the entire inventory. * * * Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be the goods most recently purchased or produced, and the cost thereof will bo the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired. * * *
The following methods, among others, are sometimes used in taking or valuing inventories, but are not in accord with these regulations, viz: * * *
(4) Using a constant price or nominal value for so-called normal quantity of materials or goods in stock.
****!***
Art. 22 (c)-3. Inventories at cost. — Cost means:
(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods.
(2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.
(3) In the ease of merchandise produced by the taxpayer since the beginning of the taxable year, (a) the cost of raw materials and supplies entering into or consumed in connection with the product, (b) expenditures for direct labor, (c) indirect expenses incident to and necessary for the production of the particular article, including in such indirect expenses a reasonable proportion of management expenses, but not including any cost of selling or return on capital, whether by way of interest or profit.
(4) In any industry in which the usual rules for computation of cost of production are inapplicable, costs may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry. Among such cases are (a) farmers and raisers of live stock (see article 22 (c)-6), (b) miners and manufacturers who by a single process or uniform series of processes derive a product of two or more kinds, sizes, or grades, the unit cost of which is substantially alike (see article 22 (c)-7), and (c) retail merchants who use what is known as the “retail method” in ascertaining approximate cost (see article 22 (c)-8).
* * * * * # *
Abt. 22 (e)-6. Inventories of livestock raisers and other farmers. — * * *
Because of the difficulty of ascertaining actual cost of live stock and other farm products, farmers who render their returns upon an inventory basis may value their inventories according to the “farm-price method,” which provides for the valuation of inventories at market price less direct cost of disposition. If the use of the “farm-price method” of valuing inventories for any taxable year involves a change in method of valuing inventories from that employed in prior years, permission for such change shall first be secured from the Commissioner as provided in article 41-2. In such case the opening inventory for the taxable year in which the change is made should be brought in at the same value as the closing inventory for the preceding taxable year. If such valuation of the opening inventory for the taxable year in which the change is made results in an abnormally large income for that year, there may be submitted with the return for such taxable year an adjustment statement for the preceding year. This statement shall be based on the “farm-price method” of valuing inventories, upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate of tax in effect for such preceding year. If an adjustment for the preceding year is not, in the opinion of the Commissioner, sufficient clearly to reflect income, adjustment sheets for prior years may be accepted or required. [Emphasis supplied.]

In filing its return petitioner valued its inventories by the constant price method, which concededly is condemned by the respondent in his regulations and by decided cases, Lucas v. Kansas City Structural Steel Co., 281 U. S. 264; Reynolds Cattle Co., 31 B. T. A. 206. Rejecting the constant price method with respect to the main cattle herd and rejecting the contention of the petitioner that it should be permitted to value its entire inventory on the basis of cost, computed according to its formula, the respondent valued the live stock in the main cattle herd by the farm price method but accepted the petitioner’s constant price method for valuing the live stock in the three other herds as used in filing its return. While not conceding error, the respondent offers no explanation of his action in employing such a hybrid method for making his valuation and points to nothing in the record in support of its propriety. It is therefore apparent that consistency was not observed in making the respondent’s valuations and that the use of such valuations does not tend to properly reflect income.

In the light of the foregoing situation the first question for decision is what basis or method should be used in valuing petitioner’s live stock inventories at the beginning and end of 1935. Obviously the constant price method may not be used. Under the provisions of article 22 (c)-6 the use of the farm price method by a taxpayer is not compulsory but is only optional in case he desires to employ it. Here the petitioner does not desire to employ such method and we find nothing in the statute or the regulations which requires that the petitioner should accept its use because of the fact that in prior years, with the respondent’s apparent approval, the petitioner had used a proscribed basis.

As stated in article 22 (c)-2, supra, the bases of valuation most commonly used by business concerns which meet the requirements of section 22 (c) of the act, supra, respecting conformity to the best accounting practice in the business or trade and the clear reflection of income are (a) cost and (b) cost or market, whichever is lower. From the evidence it appears that there is some diversity of method by which taxpayers engaged in the livestock business in the Southwest walue their inventories. While it appears that a substantial number of operators use the farm price method, doubtless due to the fact that it is permitted by the regulations and relieves them of the keeping of cost records, and it further appears that the use of the cost basis is exceptional, probably due to the fact that in the case of the small operators the keeping of the necessary cost records would be unduly burdensome, we do not find anything in the law or regulations which makes that a bar to the use of that basis by those who desire to use it and who are in a position to keep the records necessary for the determination of cost. No contention is made by the respondent that the bookkeeping system of the petitioner does not contain adequate data from which to determine cost. Since the use of the constant price method of valuing inventories will not correctly reflect income and since the method of valuing inventories at cost is approved by the regulations as being one which will clearly reflect income, we find nothing in the statute or regulations wThich would prevent a taxpayer who has been using the constant price method from changing to the cost basis if he so desires. Cf. Chicago Frog & Switch Co. v. United States, 68 Ct. Cls. 186.

Being of the opinion that the petitioner is entitled to value its inventories on the basis of cost, the next question for determination is whether the use of the petitioner’s formula will correctly reflect cost.

The respondent contends that the use of the petitioner’s formula in computing cost of its livestock is objectionable for two reasons: (1) Because it apportions to animals born during the year the cost of maintaining the breeding animals, and (2) because it apportions death losses to surviving animals, that is it apportions the cost value, (a) of breeding animals dying during the year to the animals born during the year, (b) of growing animals dying during the year to the growing animals which survive the year, and (c) of saddle and work horses and mules dying during the year to breeding and growing animals.

Eespecting the first objection of the Commissioner, it is to be observed .that the petitioner’s ranch is operated primarily for the production of calves. The breeding animals therefore are the instruments of production and the animals they produce are the products. The principle contended for by the respondent in his objection would require the maintenance expenses each year of an animal, after reaching the productive state, to be treated as part of its cost so long as it remained in the herd, which would mean until it was worn out or no longer useful as a breeding animal. Proper consideration- of the purpose for which the ranch is operated leads, we think, to the conclusion that after a breeding animal reaches the productive state the cost of its maintenance should not be treated as part of and added to its cost, but should fall on the animal which it produces and be treated as a part of the cost of the animal so produced. In our opinion, after an animal reaches the productive state, expenditures for itsi maintenance bear a similar relationship to the animals it produces as the expenditures set forth in paragraph (3) of article 22 (c)-3, supra, bear to the merchandise there referred to as being produced. The expenditures there mentioned are regarded as constituting part of the cost of the merchandise so produced and we think that here expenditures for the maintenance of the breeding animals are likewise to be treated as a part of the cost of the animals produced.

The respondent’s other objection to the use of the formula, because of the manner in which it apportions to surviving animals death losses occurring during the year, is sound. While the evidence shows that death losses are losses recurring year after year in substantial amounts, we fail to see why that fact makes them appor-tionable to surviving animals as a part of the cost of such animals. While it is true that the breeding animals are maintained as instruments of production and that the animals they produce are the products thereof, yet when a breeding animal dies its usefulness is terminated. The petitioner sustains its loss thereon at that time and under the statute such loss is deductible in the year in which sustained. Relative to the manner in which such losses are to be deducted, Regulations 86 provides as follows:

Abt. 23 (e)-5. Losses of farmers. — Losses incurred in the operation of farms as business enterprises are deductible from gross income. * * * A farmer engaged in raising and selling stock, suck as cattle, sheep, horses, etc., is not entitled to claim as a loss the value of animals that perish from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. * * * If gross income is ascertained by inventories, no deduction can be made for live stock or products lost during the year, whether purchased for resale or produced on the farm, as such losses will be reflected in the inventory by reducing the amount of live stock or products on hand at the close of the year. * * *

The petitioner has not directed our attention to any authority and we know of none which warrants a holding that death losses from breeding animals in a given year are to be regarded as a part of the cost of the animals born in that year and as such are to be carried forward and used as an offset against income for a later year or years in which such animals are sold. The petitioner’s apportionment of death losses on growing animals, saddle and work horses and mules is objectionable for the same reason.

In a recomputation of the petitioner’s tax liability under Rule 50 the inventories will be valued at cost, computed by the petitioner’s formula, but so modified as to- eliminate from such cost all death losses.

While conceding that he has allowed as a deduction against ranch income the amount paid Ritchie as salary for his services, the respondent contends that Ritchie’s bond was given to guarantee his good faith, honesty, and integrity in administering the estate and that the premium paid by the petitioner on such bond is as much an administration expense' as are court costs, attorneys’ fees, or executors’ commissions which are not allowable deductions in determining income and that his action in disallowing a deduction from income of the amount of such premium therefore should be sustained. The petitioner concedes that the bond was a fidelity bond but contends that the premium thereon is just as much a business expense as insurance premiums against fire, storm, theft, accident, or other similar losses, which are expressly classed as business expenses in the respondent’s regulations.

Since the will directed that all properties of the decedent be disposed of as soon as possible after her death but only at prices deemed satisfactory to the executors, and since the ranch was still held and operated in 1935 under the terms of the will, no sale thereof having been made, and since Ritchie was appointed administrator in that year, it appears that administration of the estate had not been fully completed even after the lapse of 14 years. So far as the record shows, nothing was being done during 1935 to prepare the estate for settlement and distribution. Such activities as are disclosed for that year, with the possible exception of the appointment of Eitchie as administrator, indicate that nothing was done except carry on the business. This being the situation, we think the following statements made in George W. Oldham et al., Executors, 88 B. T. A. 523, 529, are applicable:

* * * Where, however, such fees or commissions [of executors, administrators, attorneys, and other representatives of estates] are paid for services rendered exclusively in carrying on the affairs of the estate as a business, rather than in preparing it for settlement and distribution, such payments constitute ordinary and necessary expenses and may be deducted for income tax purposes. Grace M. Knox et al., Executors, 3 B. T. A. 143; William W. Mead, et al., Executors, supra; George W. Seligman, Executor, 10 B. T. A. 840; Henrietta Bendheim, 8 B. T. A. 158; Charles Lesley Ames, Executor, 14 B. T. A. 1067; Margaret B. Sparrow, 18 B. T. A. 1; Florence Grandin, 16 B. T. A. 515; Estate of William, G. Peckham, 19 B. T. A. 1020, 1023; Chicago Title & Trust Co. et al., Trustees, 18 B. T. A. 395; H. Alfred Hansen, Executor, 6 B. T. A. 860. * * *
* * * On the other hand, in eases where, according to the provisions of the will or testamentary trust, it is necessary to continue the estate intact over a period of years, and to carry on its affairs as a business in the interim,, the fees and commissions paid to representatives of the estate for such services constitute expenses, deductible for income tax purposes. William W. Mead et al., Executors, supra; H. Alfred Hansen, Executor, supra; Florence Grandin supra; * * *

The respondent having allowed as a deduction from income the salary paid Eitchie in 1935 as administrator, we fail to see why the premium paid for his bond, the furnishing of which was a prerequisite to his acting as administrator, is not also allowable. Both the salary and the bond premium were incurred primarily in connection with the conduct of the petitioner’s business. We accordingly hold that the bond premium constitutes an allowable deduction for income tax purposes.

Decision will be entered under Rule 50.


author: Hill :

text:
    Maud Gillespie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98770.
    Promulgated January 22, 1941.

      Harold E. BorsohaoA, Esq., for the petitioner.

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

Hill :

The substantial question which we are called on to decide here is the nature of the contract entered into between petitioner and F. A. Gillespie and the company on May 15, 1929. The petitioner argues initially (1) that it constituted a sale of the properties transferred, with payment to be made in annual installments, and the annual payments, therefore, constituting a return of capital, may not be taxed as income. (2) It is contended in the alternative that if the amounts agreed under the contract to be paid to petitioner are considered annuities, their taxation under section 22 (b) (2) of the Revenue Act of 1934, is unconstitutional, since the statute, in making an arbitrary division between return of capital and income, taxes the former as income. This result, it is contended, is beyond the limits of the power conferred by the Sixteenth Amendment. (3) Petitioner argues further that, if the amounts in question are held taxable as annuities, the cost basis to be used in applying section 22 (b) (2), supra, must be only the cost from a reputable insurance company of the annuity payable to the petitioner. It is agreed by both parties that the petitioner was the owner of one-half the properties transferred, the value of which was in excess of the fair cost of annuity agreed to be paid to petitioner. This excess, it is contended, did not constitute consideration for the annuity but was a gift to the petitioner’s children through the agency of the company and thus may not be included in the base on which the 3 percent taxable return is to be computed. (4) Finally, it is argued that $2,666.25 of the amount in question may not be taxed as income in any event, for the wholly separate reason that it represented the proceeds of a loan.

(1) We may dispose of the first argument of the petitioner without extended consideration. The contract of May 15, 1929, may not, in our view, be interpreted as an ordinary sale or exchange of capital assets with payment to petitioner extended over several years. The distinguishing peculiarity of an annuity — that its continuance is dependent entirely on the life of the recipient of the payments — is here present. By statute, amounts received under contracts of this nature are made taxable to a limited degree and the direction of the statute may not be ignored. It can make no difference, in our opinion, that the consideration for the annuity was the transfer of property rather than money, and in this view we are sustained by Florence L. Klein, 6 B. T. A. 617, and Guaranty Trust Co. of New York, Executor, 15 B. T. A. 20.

(2) Adverting to petitioner’s argument that the application of section 22 (b) (2) to the facts presented is unconstitutional, we deem this contention without substantial basis. The scheme devised by Congress for taxing amounts received as annuities may not, in the light of its legislative history, be considered arbitrary, see Title Guarantee & Trust Co., Executor, 40 B. T. A. 475, 480-482, or a tax on capital, see F. A. Gillespie, 38 B. T. A. 673. It is rather a method reasonably arrived at, which in the great majority of cases will result fairly for both the taxpayer and the tax gatherer. In a situation where the division between income and a return of capital is difficult, if not impossible, some latitude must be allowed to the lawmaker and the possibilities for an arbitrary result in isolated cases must be appraised against the necessity for taxing the transaction in question both as a means to revenue and as a means to discourage or prevent tax avoidance. In the light of the circumstances requiring the enactment of the statute in question, which are set out more at length in the cases cited above and in Anna L. Raymond, 40 B. T. A. 244, we can not say that it is unconstitutional as sought to be applied here by the Commissioner. Accordingly, petitioner must fail in this contention.

(3) The alternative argument of the petitioner presents essentially a question of fact: Whether the consideration for the annuity agreed to be paid to her under the contract of May 15, 1929, was the entire property transferred by her under that agreement, or only that portion of the property required to purchase those annuities from a reputable insurance company.

This identical question as it related to the tax liability of F. A. Gillespie, cotransferor with petitioner under the agreement of May 15, 1929, was before us in F. A. Gillespie, supra, and we held there that the entire properties transferred were consideration for the annuities, in view of the provisions of the contract and in the absence of other evidence explaining the purpose of the transferors in conveying properties in excess of the fair cost of such annuities. In the present case that excess has been explained and the deficiency in evidence supplied. In her deposition petitioner has testified that her purpose in making transfer of the excess properties was to benefit her children or grandchildren and to safeguard their future income. This she thought best to accomplish by transferring all but a small portion of her properties to the company, instigating thereby a similar transfer by her husband. Since the children were then the beneficial owners of the larger part of the company and were, by virtue of the 1921 trust agreement, to become the sole owners of the company, along with the grandchildren, this transfer secured to them the properties then owned by their parents. The last possibility of the diversion of any of it away from them was precluded by the provision of the contract of May 15, 1929, that F. A. Gillespie might not sell any of the stock of the company held by him as trustee without the consent of the directors of the company. Petitioner testified in this proceeding, in effect, that she gave her properties to the company to safeguard her children and grandchildren, subject to the provision that certain sums be paid to her annually during her lifetime, and that she considered the remainder of the value of the property over the cost of such annuity to be a gift or contribution for the benefit of her children and grandchildren. This evidence, fitted with the circumstances of the instant case, compels the finding that the properties transferred to the company by petitioner in excess of the fair cost of the annuity secured to her thereby did not constitute consideration for that annuity. In the present circumstances it becomes unnecessary to go further and decide whether the excess amount was paid to the company as a gift, as in Anna L. Raymond, supra, or as a contribution to capital, see Robert E. Scanlon, 42 B. T. A. 997. In neither event may this excess amount be included in the cost basis of the annuity required for computation of the tax due under section 22 (b) (2).

Respondent objects to the consideration of the evidence noted on two grounds: It is argued, first, that the “issue that a part of the property transferred to the corporation was a gift” was not properly raised in the pleadings or at the hearing. This “issue” we regard .as properly presented under petitioner’s contention that only the fair ■cost of the annuities acquired may be used in computing the 3 percent limitation placed on the tax by section 22 (b) (2). It forms .an integral part of that argument and need not be pleaded as a separate issue. In the second place, respondent has moved to strike petitioner’s entire testimony on this point on the ground that it is immaterial and that it conflicts with the parol evidence and best evidence rules. At the hearing ruling on this motion was reserved for disposition in this opinion. The materiality of the testimony to the issues presented we deem apparent. The parol evidence rule applies only as between the parties to the agreement and can not, therefore, apply in the instant case. See Bertelson & Peterson Engineering Co. v. United States, 60 Fed. (2d) 745; Indianapolis Glove Co. v. United States, 96 Fed. (2d) 816. Moreover neither rule may apply where there is ambiguity in the written language; here the terms of the two agreements entered into on May 15, 1929, conflict. In one the payment of annuities is described as “consideration” and in the other as “part consideration” for the transfer of the properties. The resultant confusion of meaning may properly be dispelled in this instance by the testimony of petitioner. See Bertelson & Peterson Engineering Co. v. United States, supra, at page 747. Cf. A. L. Wilson Co., 24 B. T. A. 1056. This conflict of terms was noted in F. A. Gellespies, supra, at page 677, but in the absence of any explanatory evidence the presumption favoring the Commissioner compelled the result reached there. Respondent’s objections and motion are accordingly overruled.

(4) The final point of controversy on which we must rule here is the petitioner’s claim that $2,666.25 of the amount received from the company was intended as a loan to be used to discharge a portion of the mortgage on petitioner’s property, together with accrued interest. The evidence shows, however, that no note was executed as evidence of that loan, that no interest was agreed on or paid, and that no repayment of principal has been made. Neither was the loan reflected in the balance sheet of the company as an asset. In these circumstances, we think the petitioner has failed to make adequate proof that such an amount constituted a loan. The impression that it was paid as a part of the amount due under the agreement of 1929 is gained and strengthened by the fact that the company was a closely held corporation and that petitioner had shortly before the taxable year relinquished the right to receive a portion of her annuity in return for the payment of an installment on the mortgage in question from another source. Accordingly, we hold that no part of the $17,666.25 received by petitioner during the taxable year was a loan and that the entire amount was paid as an annuity under the contract of May 15, 1929.

There remains the determination of the amount of income taxable to petitioner. This is to be computed on the basis of 3 percent of the cost of an annuity of $25,000 purchased by petitioner on May 15, 1929, from a reputable insurance company. The $25,000 figure must be taken in preference to the $15,000 sum contended for by petitioner, since the former amount was that for which the properties were transferred. Subsequent relinquishment of a portion of the annuity can not alter the determination of the amount which was transferred under the 1929 contract as consideration for the annuities receivable by petitioner. No argument is made, it should be noted, that the $10,000 guarantee of the dividends to be received annually by petitioner did not in itself constitute an annuity. Both parties seem to concede that it falls in a class with the $15,000 annuity and we have so treated it.

Since the parties have stipulated that the cost of such an annuity is $327,562.50, petitioner’s taxable income in 1935 is held to be 3 percent of that amount, or $9,826.88.

Decision will be entered v/nder Bule 50.

       SEC. 22. GROSS INCOME.
      **•*#«*
      (b) Exclusions feom Gross Income. — Tlie following items shall not be included in gross income and shall be exempt from taxation under this title:
      * * * ¡it * * *
      (2) Annuities, etc. — Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than" amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be included in gross income. Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation under paragraph (1) or this paragraph.