author: Teammell : Steiinhagen, Murdock,

text:
    Columbian Carbon Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42743.
    Promulgated February 4, 1932.

      Harry J. G-errity, Esq., for the petitioner.

      Bruce A. Low, Esq., and F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Teammell :

Three issues were raised by the pleadings in this case, of which two were subsequently abandoned by the petitioner without objection by the respondent. The facts set out in our findings hereinabove were stipulated by parties under Buie 38, and the case was submitted on briefs without hearing.

The issue remaining for decision concerns the correct amount of the credit to which the petitioner is entitled on account of British income and war-loan taxes accrued in the taxable year 1920, and being the credit allowable under the Revenue Act of 1918, which provides:

Sec. 238. (a) That in the case of a domestic corporation the total taxes imposed for the taxable year by this title and by Title III shall be credited with the amount of any income, war-profits and excess-profits taxes paid during the taxable year to any foreign country, upon income derived from sources therein, or to any possessions of the United States.

And section 200 of the same act provides that:

The term “ paid ” for the purposes of the deductions and credits under this title, means “ paid or accrued ” or “ paid or incurred,” and the terms “ paid or incurred ” and “ paid or accrued ” shall be construed according to the method of accounting upon the basis of which the net income is computed under section 212.

The petitioner herein is a domestic corporation, organized under the laws of West Virginia, and its subsidiary, the L. Martin Company, is also a domestic corporation, organized under the laws of New Jersey.

At all times pertinent herein, the books of .the petitioner and of its subsidiary were regularly kept on the accrual basis, and for the taxable year a consolidated return was filed on the basis of an annual accounting period consisting of the calendar year. Pursuant to the above quoted statute, the petitioner is, therefore, entitled to a credit in the amount of any British income taxes incurred or accrued in the calendar year 1920.

The petitioner’s subsidiary owned and operated a branch factory in England, and under the laws of Great Britain was liable for and paid income and war-loan taxes, corporation profits taxes and excess-profits duty to the Government of Great Britain. Such taxes were accrued on the books of the subsidiary for the calendar year 1920 in the total amount of $46,616.20 and claimed by the petitioner as a credit under section 238 (a), supra. Of the amount of the credit claimed,' respondent allowed $40,867.61 and disallowed $5,748.59. The amount disallowed represents British taxes as follows :

(1) Income taxes_$5,152. 26
(2) War-loan taxes_ 592.17
(3) Excess-profits duty_ 4.16
Total_ 5, 748. 59

The three items comprising the total net amount of the credit-claimed by the petitioner and disallowed by the respondent will be considered separately in the order above set out.

(1) Credit for British income taxes. — The petitioner’s subsidiary accrued on its books for 1920 (as distinguished from accruals in or during 1920) on account of British income taxes, the amount of $6,779.99, and claimed this amount as a credit. The respondent disallowed the entire amount so claimed on the ground that liability to pay the particular taxes embraced therein was not incurred in or during the calendar year 1920. The respondent then computed the amount of the British income taxes which he determined accrued in 1920, and allowed credit on that account in the amount of $1,627.73. The net result of this action of the respondent was to allow as a credit on account of British income taxes an amount less than that claimed by the petitioner to the extent of $5,152.26.

There is no controversy between the parties respecting the nature of the tax in question, nor the amounts and dates of payment. The sole question on this point is, when did the British income tax accrue? — that is to say, when was liability to pay the tax incurred?

The petitioner contends that the tax accrued on or subsequent to April 6, 1920, and prior to December 31, 1920. While the tax in question was paid by a subsidiary of the petitioner, with which it filed a consolidated return, the tax on a consolidated basis is to be computed as a unit, and, in order to determine the tax liability of petitioner on a consolidated basis, we must determine the amount of credits for foreign taxes paid or accrued by its subsidiary. The credit claimed consists of amounts accrued on the books of petitioner’s subsidiary in the following manner:

That part of the tax for the British year of assessment beginning April 6, 1919, and ending April 5, 1920, which bears the same ratio to the total tax for said year as the number of days in said British year falling within the calendar year 1920 bears to the whole year, was apportioned to the calendar year 1920 and accrued as tax for said year. On the petitioner’s theory, this tax accrued in 1919 on or subsequent to April 6 and prior to December 31. Likewise, the petitioner in making its return accrued for the year 1920 on the same basis a proportionate part of the tax for the British year of assessment beginning April 6, 1920, and ending April 5, 1921, notwithstanding that the entire amount of this tax, under its contention, accrued in 1920. Obviously, the amounts thus accrued on the books of the petitioner’s subsidiary and claimed by it as a credit are inconsistent with its present contention that the correct amount of the credit to which it is entitled is the entire amount of tax for the British year of assessment beginning April 6, 1920, and which it contends accrued in 1920 on or after April 6 and prior to December 31.

On the other hand, the respondent reached the conclusion that, since the English tax was computed on the basis of the average income for the three-year period ending on that day of the year, immediately preceding the British year of assessment, upon which the accounts of the taxpayer had been usually made up, which in this case was December 31, the British tax accrued on that date! Thus, the first item of tax accrued on the books of the petitioner’s subsidiary for 1920, being a portion of the tax for the British year of assessment beginning April 6, 1919, was computed on the basis of the average income for 1916, 1917 and 1918. This tax the respondent concluded accrued on December 31, 1918. The second item accrued on the books of the subsidiary was for a portion of the tax for the British year of assessment beginning April 6, 1920, and was computed on the average income for 1917, 1918 and 1919. This tax respondent concluded accrued on December 31 of the last mentioned year. Hence, the respondent disallowed these amounts, but allowed a credit in the amount of the whole tax for the British year of assessment beginning April 6, 1921, which was computed on the average income for the years 1918, 1919 and 1920. The respondents determination in this respect, we think, is erroneous.

The question here presented is governed by the laws of England, a foreign country, and such laws do not prove themselves, but must be proved as facts. W. J. Burns et al., 12 B. T. A. 1209, 1224. Hence, the parties have attached to and made a part of their stipulation certain English statutes, the pertinent parts of which we have set out in our findings of fact. Our decision must, therefore, be based on the statutes so established.

The British tax in question, under the statutes mentioned, was imposed for a taxable year “ commencing on the sixth day of April and ending on the following fifth day of April,” designated as the “ year of assessment.” The statute further provided that, “ The tax * * * shall be computed on the full amount of the balance of profits or gains upon a fair and just average of three years ending on that day of the year immediately preceding the year of assessment on which the accounts of the said trade have been usually made up, or on the fifth day of April preceding the year of assessment.” In other words, the amount of the tax imposed for any “ year of assessment ” was computed upon the basis of the average profits of the three-year period ending on the day upon which the accounts had been usually made up immediately preceding the year of assessment, or on the average profits of the three-year period ending on the fifth day of April immediately preceding the year of assessment, regardless of the amount of profits, gains or income arising in the year of assessment.

The British Finance Act of 1926 (section 22) made this plain and was passed to clarify the situation after the decisions of the House of Lords in the cases of Brown v. National Provident Institution, 2 Appeal Cases 222; 8 Tax Cases 57, 100 (House of Lords, 1921); and Whelan v. Henning, Appeal Cases (House of Lords 1926), page 293, to which further reference will be made.

The above mentioned British Finance Act provided that “ The foregoing provisions of this section shall be deemed always to have had effect * * * ” in so far as the kind of income here involved is concerned.

Conceding, then, as both parties to this proceeding apparently agree, that the average profits of the three-year period immediately preceding the year of assessment is the amount on which the tax for the year of assessment is to be computed and assessed, the question is, When did the tax for such year of assessment accrue ? When did the tax liability for the year of assessment arise? Was there any liability incurred prior to the beginning of the year of assessment or after the end of such year? We do not think that the time when the assessment was to be made or the time when the tax was required to be paid is controlling. Our consideration concerns only the time when the liability was incurred or accrued.

Items of income accrue when the income has been definitely earned, or the right to receive it has definitely arisen, and, on the same principle, a liability accrues when the obligation is definitely incurred. This is true without regard to when the obligation is to be liquidated. In H. H. Brown Co., 8 B. T. A. 112, 117, we said:

The basic idea under the accrual system of accounting is that the books shall immediately reflect obligations and expenses definitely incurred and income definitely earned without regard to whether payment has been made or whether payment is due. Expenses incurred in the operations for a particular year are properly accrued in the accounts for that year, although payment may not be due until the following year. * * * the accrual system wholly disregards due dates. Neither is it necessary that the amount of an incurred liability be accurately ascertained in order to accrue it.

On the latter point, see Ernest M. Bull, Executor, 7 B. T. A. 993.

There can be no such thing as the accrual of a conditional or contingent liability. Liability is either incurred or it is not incurred. So long as the question of liability is contingent, no liability has been definitely incurred, and until definitely incurred it can not be said to have accrued. Edwards v. Keith, 231 Fed. 110 (certiorari denied, 243 U. S. 638); S. Naitove & Co. v. Commissioner, 32 Fed. (2d) 949 (affirming 8 B. T. A. 589); Highland Milk Condensing Co. v. Philips, 34 Fed. (2d) 777 (certiorari denied, 280 U. S. 608); Vang v. Lewellyn, 35 Fed. (2d) 283. See also United States v. Anderson, 269 U. S. 422; American National Co. v. United States, 274 U. S. 99.

Edwards v. Keith, supra, was an action brought to recover a part of the income tax for 1913 paid by the plaintiff, Edwards, who was an insurance agent employed to procure applications for assurance on the lives of individuals. As compensation for his services, the insurance company was obligated to pay him a certain commission on the first premium paid by the assured when the policy was issued. It was further obligated, as the assured paid subsequent renewal premiums, to pay him stated commissions on each. The issue involved concerned the question of accrual of the commissions on the renewal premiums, the plaintiff contending that the entire amount of the commissions accrued at the time the policy was issued. The court rejected this contention, and held that there could be no accrual of a liability which depended upon the happening of subsequent events, saying:

It may be noted that, although fully earned by work already done, there is no certainty that the sum conditionally promised for an ensuing year will ever be paid or will accrue or come due; John Doe (the assured) may die within the first year, or at its expiration may refuse to renew his policy, in which event the company is not obligated to pay its agent anything beyond the amount already paid him; the obligation to pay does not arise until John Doe actually pays his renewal premium in cash.

In S. Naitove & Co. v. Commissioner, supra, the taxpayer corporation, keeping its books by the accrual method, entered into an agreement with certain employees whereby it agreed to pay each employee as contingent compensation a percentage of the net profits for the year 1919, subject, however, to the condition that no employee should be entitled to withdraw any amount credited to him pursuant to the agreement except upon consent of the president of the corporation, unless he should remain in the employ of the corporation for a period of five years, and subject to the further condition that during the period of five years the amounts credited to each employee should refiiain in and at the risk of the business. The cóurt held that the amounts so credited did nut constitute income to the employee nor liabilities to the corporation until they became finally payable. The court said:

Construing the provisions of tbe income tax law here involved, we are of the opinion that under the accrual system of accounting income may be said to be accrued when it is definitely received, and that likewise liabilities or expenses will be considered to have accrued only when the events have occurred from which liability or expense can be determined and fixed, even though payment is not yet due. [Citing United States v. Anderson, supra, and American National Co. v. United States, supra.]

After discussing the case of Edwards v. Keith, supra, the court, in its opinion in the Naitove case, said:

The decision of the court in the above case is conclusive, we think, to the effect that in a unilateral or conditional contract, as the one here involved, the liability incurred is not to be deducted as expense until it has become fixed and determined, and it is then deductible as of the year when the event occurs — in the instant case, at the expiration of the five-year period.

In Highland Milk Condensing Co. v. Philips, supra, the taxpayer sold goods in 1917, for which it received invoice prices with the understanding that the purchasers would be insured against loss by subsequent decline in market price. In 1918 declines occurred, and in that year the taxpayer corporation made payments to prior purchasers on that account. The court held that the payments made in the subsequent year did not constitute allowable deductions from income for 1917, because prior to 1918 the liability was contingent; in that year the events occurred which fixed and determined the liability, which thereupon accrued.

In Vang v. Lewellyn, supra, the court applied the same principle in holding that certain reserves for contingent liabilities were not deductible in the year when set up for the reason that the liability was not definitely incurred in such. year. The plaintiff in that case was a road construction company, which, under its contracts, was required at its own expense to maintain the roads constructed by it free of defects arising from materials or construction for a period of five years after completion. The company estimated the probable maintenance costs and set aside a reserve to cover them, which it sought to deduct in computing the profit made on each contract. In its opinion, the court said:

Tile company’s engagement to maintain the work in good condition for five years after completion as a pledge of its workmanship was clearly a contingent liability which might or might not cost money — it occurred in only 3 out of every 12.5 jobs — and, accordingly, might or might not reduce the net income from a contract closed by final payment long before. * * *
Nor does the fact that the company kept its books on the accrual basis help it, for, however looked at, the liability for maintenance was contingent upon the need of maintenance. When books are kept on an accrual basis, a liability must be fixed either in terms or by the occurrence of events from which it is determined before it can be deducted.

The foregoing principle was sanctioned and applied by the Supreme Court in Lucas v. American Code Co., 280 U. S. 445, where it was held that a loss by reason of breach of contract by a corporation keeping its books on the accrual basis, as determined by final judgment several years subsequent to the year in which the breach occurred, was not deductible as of the year of the breach. The court said:

It may be assumed that, since the company kept its books on the accrual basis, the mere fact that the exact amount of the liability had not been definitely fixed in 1918 would not prevent the deduction, as a loss of that year, of the amount later paid. But here there are other obstacles. Obviously, the mere refusal to perform a contract does not justify the deduction, as a loss, of the anticipated damages. For, even an unquestionable breach does not result in loss, if the injured party forgives or refrains from prosecuting his claim. And, when liability is contested, the institution of a suit does not, of itself, create certainty of loss. * * *
The prudent business man often sets up reserves to cover contingent liabilities. But they are not allowable as deductions.

Cf. also Lucas v. Ox Fibre Brush Co., 281 U. S. 115; Aluminum Castings Co. v. Routzahn, 282 U. S. 92.

The case of Stuart W. Webb, 5 B. T. A. 866, involved the question as to when the Massachusetts income tax was accrued. That law of Massachusetts provided, “ The return shall be made on or before the 1st day of March in each year and shall relate to the income received during the calendar year ending on the preceding 81st day of December. * * * Every person who is an inhabitant of the Commonwealth at any time between the 1st day of January and the 30th day of June, both inclusive, in any year, shall be subject to the taxes imposed by this Act.” We said:

Under the foregoing provisions of the statute, an individual taxpayer is not liable for the tax until he has been an inhabitant of the Commonwealth during some portion of the first six months of the year following the year in which the income was earned. This condition must occur before any liability for the tax comes into existence. At the close of December 31 in any year, there is no liability for the tax. In the opinion of the Board, the Massachusetts income is a tax for the year in which it is assessed and becomes payable, in this case, for the year 1920, and is measured by the income for the preceding year.

Of course in that case all events had occurred at December 31 which fixed the amount of the tax, except the liability to pay any tax at all. This is the same in principle as the case at bar. All the events had occurred on December 31, 1919, which fixed the amount of the tax, but the year of assessment had not arrived, and if it had never arrived on account of the taxpayer having ceased to possess the source of income, there would have been no tax for the 1920 year of assessment.

United States v. Anderson, supra, involved a tax on the profits derived from the sale of munitions manufactured and sold in 1916, but the tax was not assessed nor paid until 1917. In that case the court laid down the principle that where all the events occur in the taxable year which -fix the amoimt of the tax and determine the liability of the taxpayer to pay it, the liability accrues in that year, although the tax may not be assessed or become payable until the following year. In its opinion the court said:

The appellee’s true income for the year 1916 could not have been determined without deducting from its gross income for the year the total cost and expenses attributable to the production of that income during the year. The reserve for munitions taxes set up on its boohs for 1916 must have been deducted from receivables for munitions sold in that year before the net results of the operations for the year could be ascertained. * * * In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it.

Bearing in mind the application of the principles of accrual as illustrated by the cases hereinabove referred to, the instant case on the facts is readily distinguishable from the Anderson case, but the principles of law as to accrual set forth in that case are the principles on which we base our decision in this case. The Anderson case involved a munitions tax levied for the year 1916. Being a tax levied for the calendar year 1916, certainly no liability to tax could arise prior to the beginning of that taxable year. But liability was not incurred on the first day of the taxable year for the reason that the amount of the tax, like our income tax, was measured by the profits and gains of the year for which it was imposed. Thus, all the events which fixed the amount of the tax had not occurred until the last day of the taxable year. However, on that date not only had all the events occurred which fixed the amount of the tax, but, the tax being imposed for that year, the liability of the taxpayer to pay the tax was determined. The liability to pay the tax was then incurred, regardless of when it was due and payable. The liability had accrued. It is immaterial that the tax was not assessed or paid until the following year.

A wholly different situation appears in respect of the English income tax. This tax was levied for a definite “ year of assessment ” just as our munitions tax and income tax were levied for a definite taxable year. No liability on account of the tax could, therefore, be incurred prior to the beginning of the “ year of assessment.” The British tax was computed and assessed on the basis of the average gains and profits of the three-year period preceding the year of assessment. On the last day of such preceding three-year period all the' events had occurred which fixed the amount of the tax, but this alone was not sufficient to constitute an accrual of liability. In addition to the occurrence of the events which fixed the amount of the tax, there must also have occurred all the events which determined the liability of the taxpayer to pay it. At the end of the prior three-year period, the year of assessment for which the tax was imposed had not yet arrived, hence, prior to the first day of the year of assessment the event had not occurred which determined the liability of the taxpayer to pay the tax. On the first day of the British year of assessment all the events had then occurred which fixed the amount of the tax and determined the liability of the taxpayer to pay the tax. On that date the liability was incurred or accrued.

As hereinabove pointed out, the British income tax under the 1918 Act was imposed upon the basis of an annual period, designated as the “year of assessment,” commencing on the sixth day of April and ending on the following fifth day of April, but measured by income of preceding years. Throughout the British Income Tax Act the tax is referred to as a charge “ for ” the year of assessment. In section 1 of Part I, it is stated that “ where any Act enacts that income tax shall be charged for any year at any rate, the tax at that rate shall be charged for that year * * *,” and, in section 2, that “ Every assessment and charge to tax shall be made for the year commencing on the sixth day of April and ending on the following fifth day of April * * *.” (Italics supplied.)

Whatever income the tax may have been laid upon, as distinguished from measured by, it was a tax imposed for the respective years of assessment, and this being true, it would seem to be self-evident that if a taxpayer discontinue business prior to the beginning of the year of assessment no tax liability for that year would or could have been incurred. This conclusion is supported by the decision in Whelan v. Henning, supra, where it was stated:

The Acts themselves say nothing about the existence or nonexistence of sources. But the returns and assessments are made in advance. The measure of the amount is to be found in the result of previous years and their average. How then is it to be decided whether or not a return and assessment are to be made for the current year? The question in nine cases out of ten arises under Case I. or Case II. in respect of trades and professions, and it became a commonplace among those dealing with income tax that if the trade or profession had been discontinued (a matter determinable at the beginning of the year) the liability to make a return and be assessed ceased.

This interpretation of the English law was also given by the Board of Inland Revenue in a letter dated September 25,1929, reading as follows:

With reference to your letter of the 11th instant, I am directed by the Board of Inland Revenue to inform you that in the ease of a trading concern or company dissolving and discontinuing its business on 31st December, 1918, there would not be any liability to income tax for the year 1919-20, commencing 6th April, 1919. Liability for assessment to income tax for any year in respect of business profits arises normally only where a concern is in existence during that income tax year.

In addition to the point that where a taxpayer discontinued business prior to the beginning of the tax year or year of assessment no tax liability for such year was incurred, it was decided by the House of Lords in Brown v. National Provident Institution, supra, and in Whelan v. Henning, supra, that the tax was intended to be on the profits and gains forming income in the year of assessment although not measured by the income of that year, and that if in the year of assessment no income was derived, no tax could be levied or collected in respect of a nonexistent income. These decisions gave rise to the enactment of those provisions of the British Finance Act of 1926, to the effect that notwithstanding no profits or gains arose for or within the year of assessment, income tax computed by reference to the amount of profits or gains of the period preceding the year of assessment should nevertheless be charged for that year. However, the 1926 Finance Act did not change the rule that where the taxpayer discontinued business prior to the beginning of the year of assessment no liability to tax for such year was incurred.

Applying the principles of accrual hereinabove discussed, in the light of the English statutes and decisions mentioned, leads us to the conclusion that liability under the British Income Tax Act of 1918 was incurred on the first day of each year of assessment, and not prior or subsequent thereto. Prior to such date it could not be known that the taxpayer would be in operation of the business on the first day of the year of assessment, and if the business had been discontinued prior thereto, no liability would have been incurred.

Prior to the first day of the year of assessment, the liability to tax was not even conditional or contingent. No liability had been imposed. The liability was wholly in futuro, merely a prospective or anticipated liability. Whether any liability would in fact ever be incurred depended upon a future event which might or might not occur, namely, the continuance of the business until the first day of the year of assessment. If the business was continued until the first day of the year of assessment, the taxpayer then and there became liable to tax for such year, the amount to be computed in the specified manner on the basis of the profits of a prior period. While the tax so computed was subject in certain contingencies to subsequent readjustment and possible reduction of the amount, the liability was definitely incurred on the first day of each year of assessment on the basis of a statutory income, and, as we have hereinbefore pointed out, under such circumstances, became accrued.

It may be contended that since the amount of the British tax in this case, which was to be assessed for the year of assessment 1920-1921, was definitely known on December 31,1919, the end of the three-year period immediately preceding that year of assessment, it should at that time be accrued. But the fact is that while the amount could then be ascertained, if there would be any liability at all to pay a tax for that year of assessment, no liability actually arose until the year of assessment arrived. Even if the taxpayer had definitely known that it would be in business in the year of assessment, it would not change a future ascertained liability into a present liability. Only a liability actually incurred can be accrued, not one which, it may be known, will be incurred in the future.

From the foregoing it follows that the British income tax assessed against the petitioner’s subsidiary for the year of assessment beginning April 6,1920, is the only tax shown by the facts before us which accrued in the .calendar year 1920. The amount of that tax, as stipulated by the parties and found by us, was $7,517.06. This amount was subsequently paid by the petitioner’s subsidiary and no part thereof has been refunded by the British Government. Under section 238 (a) of the Revenue Act of 1918, supra, the petitioner is therefore entitled to have said amount applied as a credit against the deficiency asserted by the respondent. It may be contended that at the beginning of the j^ear of assessment it could not be definitely known that the corporation would be in business during the entire year of assessment, and that, therefore, until the year had elapsed, no definite amount of liability had been incurred. The fact is, however, that on the first day of the year of assessment the liability for the tax arose measured by factors then known. If the taxpayer during the taxable year had ceased to possess the source of income, that is, had gone out of business, a refund or adjustment of the fixed tax liability might be allowed, but this does not mean that no liability had been incurred to pay the tax determined by the average of the income of the three preceding years. The taxpayer had three months after the end of the year of assessment to make claim for adjustment or refund if it ceased to do business during the year, but this does not alter the fact that the liability had actually been incurred on the first day of the year of assessment. When a liability has been incurred during a taxable year, a taxpayer is entitled to a deduction thereof if on an accrual basis. An incurred liability may in some future years be adjusted, increased or decreased as to amount, but such a possibility does not deprive a taxpayer of the right to accrue and deduct a liability in the year when incurred. Such a possibility was contemplated by section 238 (a) of the 1918 Act quoted above. This section provides that if accrued taxes paid differ from the amounts claimed as credits, or if any tax paid is refunded in whole or in part, the Commissioner shall redetermine the amount of taxes due on account thereof.

(2) Credit for British war-loan taxes. British war-loan taxes were paid on behalf of the petitioner’s subsidiary for the year 1920 in an amount equivalent to $592.17. These taxes were all paid during the calendar year 1920, being withheld or deducted at the source, and were levied on interest on 5 per cent national war bonds of the British Government. The subsidiary was actually charged with and paid the amount of tax, and the total amount of the interest on which such tax was paid was included in its gross income for the year 1920. Respondent allowed the amount of the tax as a deduction from income for 1920, but not as a credit, as claimed by the petitioner. In the stipulation of the parties, the respondent concedes that if this tax is an income tax, within the meaning of section 238, supra, the amount is allowable as a credit for foreign taxes for 1920.

The basis of the respondent’s action is not disclosed by the record. In the deficiency letter it is merely stated: “ The British war loan taxes do not constitute a credit against the taxes due and payable but they are allowed as a deduction from income.” The respondent makes no reference to this point in his brief, and apparently is not pressing his position. However that may be, it is our opinion that the tax in question is in the nature of an income tax and constitutes a credit under the provisions of section 238 of the Revenue Act of 1918. Interest, whether derived from a loan to the government evidenced by war-loan bonds, or from any other kind of public or private loan, constitutes income as that term is ordinarily understood, and a tax levied thereon is essentially an income tax. The respondent’s action on this point is reversed.

(3) Excess-profits duty. In the stipulation signed by the parties, the respondent confesses error in not allowing the amount of $4.16 as a credit for British excess-profits duty paid on March 14, 1921, for the assessment period July 1, 1919, to June 30, 1920. No facts were stipulated in this connection. We have only the statement that the respondent confesses error. In the absence of any showing that the confession of error is not well founded, effect will be given thereto in recomputing the deficiency.

Reviewed by the Board.

Judgment will be entered under Rule SO.

Matthews did not participate in the consideration of or decision in this report.

Steiinhagen,

dissenting: In my opinion, the British tax accrued at the close of the preceding calendar year, the income of which year measured the amount of this taxpayer’s British assessment. The essentials as to this question are the same as those in United States v. Anderson, 269 U. S. 422. See Ernest M. Bull, Executor, 7 B. T. A. 993.

MoRRis agrees with the above dissent.

Murdock,

dissenting: I think the deduction for British income tax should be allowed in the amounts actually accrued in each calendar year by the L. Martin Company. In this way a proper portion of the tax for each British tax year is offset against the income of the company’s income-computing year and the tax is not accrued before the liability is fixed.

Smith agrees with the above dissent.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Louis D. Beaumont, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 31931, 46569, 49422.
    Promulgated February 9, 1932.

      James Oraig Peacoclc, Esq., John W. Townsend, Esq., and G, E. Ross, Esq., for the petitioner.

      O. J. Tall, Esq., for the respondent.
   OPINION.

Smith:

The principal issue in these proceedings is whether the salaries received by the petitioner from the Beaumont Investment Company, the Dayton Securities Company, the Beaumont Investment Trust, and the Commercial Investment Trust, Inc., in 1926,1927, and 1928, are exempt from taxation under the following provisions of the Revenue Acts of 1926 and 1928:

Section 213 of the Revenue Act of 1926:

For the purposes of this title, except as otherwise provided in section 233—
* * * * * * *
(b) The term “ gross income ” does not include the following items, which shall be exempt from taxation under this title:
*******
(14) In the case of an individual citizen of the United States, a bona fide nonresident of the United States for more than six months during the taxable year, amounts received from sources without the United States if such amounts constitute earned income as defined in section 209; but such individual' shall not be allowed as a deduction from his gross income any deductions properly allocable to or chargeable against amounts excluded from gross income under this paragraph.

Section 209 of the Revenue Act of 1926:

(a) For ttie purposes of this section—
(1) The term “earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. * * *

Section 22 of the Revenue Act of 1928:

* * $ ‡ * $ $
(b) Exclusions from gross income. — The following items shall not be included in gross income and shall be exempt from taxation under this title:
# # * * * *
(9) Miscellaneous Items. — The following items, to the extent provided in section 116:
Earned income from sources without the United States;
* * * * $ * *

Section 119 of the Revenue Act of 1928:

# * * * * * «
(e) Gross income from sources without the United States. — The following items of gross income shall be treated as income from sources without the United States:
* # * * # * %
(3) Compensation for labor or personal services performed without the United States;
* # * * * # #

It is agreed that the petitioner was a citizen of the United States and the facts show that he was a tona fide nonresident for more than six months of each of the years 1926, 1927, and 1928. Did the amounts of the disputed salaries constitute “ earned income ” received “ from sources without the United States.”

The statutory definition of earned income includes salaries and other amounts received as compensation for personal services actually rendered. In his deficiency notices covering the years 1926, 1927, and 1928, the respondent has treated the amounts in question as earned income for the purpose of computing the petitioner’s earned net income credit for each of the years, but in his brief filed in these proceedings the respondent makes the contention that the evidence adduced fails to show that the petitioner actually performed any services in foreign countries for which the salaries were paid and that the amounts in question were in fact distributions of earnings or profits which the statute specifically excludes from “ earned income.”

In Ingram v. Bowers, 47 Fed. (2d) 925, it was said that in cases where the income is from the exercise of a profession or vocation the place where the services are performed determines the source of the income. In that case the court held that the income received by Enrico Caruso, a nonresident alien, from royalties on the sales in foreign countries of phonograph records of his voice made in the United States constituted income from sources within the United States. See also Louis Roessel & Co., Ltd., 2 B. T. A. 1141.

The petitioner in his deposition testified that the salaries in question were paid to him for personal services performed in France and Monte Carlo as an officer or representative of the companies. Nowhere in the evidence, however, are we able to find proof of any specific services performed on behalf of any of the companies from which the salaries were received. The Beaumont Investment Company, the Dayton Securities Company, and the Beaumont Investment Trust are admittedly holding companies for the petitioner’s securities. The first two companies had their home offices at Wilmington, Delaware, and the Beaumont Investment Trust was a Massachusetts common law trust, which apparently had no activities. The Commercial Investment Trust, Inc., was a financing company, with its office in New York City. The petitioner was one of the vice presidents of that company. He deposed that it had a business in France of the same character as its business in the United States. Ho was asked to, “ State in some detail the nature of the services which you rendered to the corporation.” He replied, “ I am acting in the capacity of their representative in France.”

From the record, we can not determine that the petitioner performed any services outside of the United States for the companies from which he received his salaries.

We see no foundation for a construction of the exempting provisions of the statute which would permit a citizen, merely by absenting himself from the United States for the statutory period, to avoid the tax upon income not in any way attributable to his activities abroad and upon which as a resident he would clearly be taxable.

The legislative history of the section of the statutes in question, as shown by the hearings before the Ways and Means Committee and the Committee Reports, is enlightening. The provision first appears in the 1926 Act. It was proposed at the instance of the National Foreign Trade Council for the purpose of promoting foreign trade. We quote from the Ways and Means Committee Report on the 1926 Act:

Section 213 (b) (14) :
In an endeavor to take one further step toward increasing our foreign trade it is recommended in this paragraph that there shall be excluded from gross income in the case of our citizens employed abroad in selling our merchandise amounts received as salary or commission for the sale for export of tangible personal property produced in the United States in respect of such sales made while they are actually employed outside the United States, if they are so employed for more than six months during a taxable year.

In its final form, as enacted in the 1926 Act (see sections quoted above), the statute exempts all of the earned income from sources without the United States of a bona fide nonresident citizen for more than six months of a taxable year.

Aside from any question of statutory construction or legislative intent, we are of the opinion that the issue must be decided against ' the .petitioner, for the reason, as indicated above, that the evidence fails to show that the salaries in question represented earned income from sources without the United States. It is not at all improbable that the business carried on by the companies required the personal attention of the petitioner only on his infrequent visits to the United States. This appears to be the situation. The inclusion of the salaries in the taxable income of the petitioner is sustained.

In his income-tax return for 1924 the petitioner claimed a bad debt deduction of $4,250, representing a loan of that amount made to one L. Paumjier in 1921. The petitioner undertook to collect the indebtedness in 1924, but learned that the debtor was unable to pay; that he had many debts and no means of paying them. The debt was not secured in any way. The petitioner was informed that the debtor had gone to South America. Petitioner consulted with his attorney and was advised that it would be useless to bring suit to collect the debt. We are of the opinion that the debt was ascertained to be worthless in 1924 and that it is deductible in that year.

In his return for 1926 the petitioner claimed the deduction of $2,000 representing a bad debt owed by one Hallandar on a personal loan of that amount made to him by the petitioner in 1914. This deduction is denied. The petitioner testified that Hallandar had promised “ year after year ” to pay the indebtedness, but had failed to do so. In his letter to the petitioner written in 1926 Hallandar stated that he had been ill or out of work since 1914 and that the petitioner’s lawj^er had called upon him several times in regard to the debt. These facts indicate that the debt was worthless prior to 1926 and that the petitioner knew of its worthlessness in prior years. The statute does not permit a taxpayer to await a favorable opportunity to deduct a known bad debt. Avery v. Commissioner, 22 Fed. (2d) 6; Ralph H. Cross, 20 B. T. A. 929; affd., 54 Fed. (2d) 728.

In his returns for 1926, 1927, and 1928 the petitioner claimed the deduction of gambling losses at Monte Carlo in the respective amounts of $11,300, $9,100, and $9,804. The amounts stated represent his net gambling losses for those years as computed from mem-oranda kept by him of his winnings and losses for each year.

The statute permits the deduction of “ losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business.” See section 214 (a) (5) of the 1926 Act, and section 23 (e) (2) of the 1928 Act. In his deficiency notices the respondent has disallowed the deductions claimed for lack of proof of the amounts of the losses. This objection to the deductions has been met by the uncontradicted testimony of the petitioner that he kept an accurate memorandum account of his winnings and losses each year and that the losses claimed represent the net result of each year’s gambling transactions.

In the Commissioner’s published rulings upon the question of the deductibility of gambling losses, a distinction is made between losses incurred in legal transactions and illegal transactions. In S. M. 2680, Cumulative Bulletin III-2, p. 110, it was held that losses incurred in betting on horse racing in the State of Arkansas, where such betting is illegal, arc not deductible and that losses incurred in certain forms of betting on horse racing in the States of Kentucky and Louisiana, not illegal in those States, are deductible. See also article 141, Cumulative Bulletin II-2, p. 125.

In Mitchell M. Frey, Jr., et al., Executors, 1 B. T. A. 338, the Board denied the deduction of the gambling losses of a resident of Pennsylvania upon the grounds that the losses, having resulted from participation in illegal pursuits, were not “ incurred ” within the meaning of the statute, since there was no legal enforceable liability in respect thereof, and that the gambling operations were not “ transactions ” within the meaning of the statute, because illegal. Cf. James P. McKenna, 1 B. T. A. 326. The gambling transactions under consideration here all took place within the Principality of Monaco. Even though the gambling was legal, as contended by the petitioner, we are of the opinion that the petitioner’s case is not aided thereby. The deduction allowed by the statute is of losses incurred in any transactions entered into for profit. The question whether the gambling transactions under consideration were entered into for profit is a question of fact, upon which the evidence before us in these proceedings is entirely silent. We can not proceed upon a presumption that all gambling transactions are entered into for profit within the meaning of the statute. The petitioner was a wealthy man living abroad at fashionable resorts, apparently as a matter of choice. He was not a professional gambler and was not dependent upon the success of his gambling ventures for a livelihood. It may well be that he indulged in games of chance for sport and recreation and without serious concern as to the financial results. Upon the evidence the respondent is sustained in disallowing the deductions.

In his return for 1925 the petitioner claimed a deduction of $6,350 representing an alleged loss resulting from the sale of French francs in that year. The facts of record are that the petitioner on different occasions in 1925 purchased 545,000 francs at an aggregate cost of $26,350 and that he sold these francs in October, 1925, for $20,000. The evidence does not show whether the petitioner purchased or sold other francs in 1925. The petitioner kept no inventories or records of francs on hand at the beginning and at the close of the year. The respondent contends that in the absence of such inventories or records the loss on the single transaction in question is not an allowable deduction. However, there is nothing in the record to indicate, and we will not assume, that the petitioner was a regular trader in francs year in and year out, or that he had other francs on hand at the beginning and at the close of the taxable year which properly should have been inventoried. The respondent contends in his brief that the evidence does not show whether the francs sold by the petitioner in October, 1925, were purchased in that year, or the cost thereof. The petitioner’s testimony upon this point is as follows:

Q. 54. Calling your attention to paragraph numbered ten of the Stipulation as to Facts, heretofore mentioned, state whether or not the loss on foreign exchange of $6,350 claimed in your 1925 income tax return involved the purchase and sale by you in that year of French francs as shown by Exhibits “ C,” “ D ” and “ E ” attached to said stipulation.
A. It does.
Q. 55. State on what dates, at what prices, in what amounts and from whom you purchased the francs on which you claimed such loss.
A. October 1st, 1925, bought 211,000 Francs costing $10,000. October 5th, 1925, bought 200,000 Francs costing $9,275. Different times in 1925, bought 134,000 Francs costing $7,075.
Q. 56. State on what dates, at what prices, in what amounts and to whom you sold the francs on which you claimed such loss.
A. On December 24th, 1925, I sold to the Equitable Trust Company, five hundred and forty-five thousand (545,000) Francs, receiving therefor twenty thousand (20,000) dollars. [Italics supplied.]

It seems to us that the petitioner has met the burden of proof in showing that in 1925 he purchased certain francs which in that same year he sold at a certain amount less than their cost. In our opinion the amount claimed by the petitioner in his return is a deductible loss.

The remaining issue relating to the deduction of taxes paid to the French Government by the petitioner in 1928 is settled by stipulation as stated above.

Reviewed by the Board.

Judgment will he entered under Rule B0.

Maequgtte and Tkammell dissent.


author: Murdock':

text:
    Charles O. Middleton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 38069.
    Promulgated February 9, 1932.

      Melvin D. Wilson, Esq., for the petitioner.

      J. A. Lyon, Esq., and E. L. Updike, Esq., for the respondent.
   OPINION.

Murdock':

The Commissioner determined a deficiency of $12,744.47 in the petitioner’s tax liability for the year 1923. He now concedes that he erred in failing to allow a deduction of $7,205.38. The only remaining issue relates to an alleged loss of $20,000. The Commissioner, in determining the deficiency, added $20,000 to the petitioner’s reported income as “ Loss in White Star Plaster Company.” He explained this adjustment as follows:

Loss on the investment in the White Star Plaster Company has been disallowed inasmuch as the company was not adjudicated bankrupt until 1925 and the loss was not definitely determined until that time.

We have heretofore pointed out that such explanations in the deficiency notice do not frame the issues. Edgar M. Carnrick, 21 B. T. A. 12. Cf. Charles F. Ayer, 7 B. T. A. 324; affd., 26 Fed. (2d) 547. The assignment of error is that the Commissioner “ erred in failing to allow as a loss in 1923, the amount of $20,000 on the White Star Plaster Company stock.” The Commissioner denied that he had so erred. The issue is plain — Did the Commissioner err in that he has denied the petitioner a loss to which the latter is entitled? The responsibility for having the record contain proof of facts showing the petitioner’s right to the deduction rests upon the petitioner. This proof should disclose the basis for loss in respect to the stock in question and also the circumstances indicating that a loss not compensated for was actually sustained in 1923, as opposed to any other year, in a transaction entered into for profit. Section 214 (a) (4), Revenue Act of 1921. The petitioner’s counsel does not seem to have been misled as to this burden, for he offered proof intended to show the necessary facts.

The petitioner is an individual who resides in Los Angeles, California. He was the owner in 1923 of 200 shares of the stock of the White Star Plaster Company.

The parties stipulated the following:

The White Star Plaster Company was a Nevada corporation organized October 80, 1816, with an authorized capital stock oí $250,000, all of which was issued on December 1, 1916, for mining property, building and machinery formerly owned by the Arrowhead Plaster Company, a bankrupt corporation. Operations were not commenced until October 1, 1919, and losses were sustained each year as follows:
December 31, 1919, Loss_$23,315.77
“ “ 1920 “ 15,173.81
“ “ 1921 “ _ 106,608.67
“ “ 1922 “ 57,189.66
“ “ 1923 “ 104,372.80
The books of the White Star Plaster Company show assets and liabilities during the period as follows:
The gross sales of the White Star Plaster Company amounted to $118,671.50 for 1920, and to $220,662.09 for 1923.
A petition in bankruptcy against the White Star Plaster Company was filed in the United States District Court at Los Angeles on October 12, 1925. This petition stated that the liabilities amounted to $747,801.00, and assets to $1,085,000.00.
The petition in bankruptcy states that the assets amounted to $1,085,000 but the petitioner does not admit that the assets had such value.
Bonds aggregating $95,000.00 were due and payable December 1, 1923, by the White Star Plaster Company. They were not paid, up to and including December 31, 1923.

Three certificates were received in evidence, number 22 for 100, number 23 for 40, and number 24 for 60 shares. Each is dated December 1,1916, and bears a seal stating “ White Star Plaster Company, Nevada, incorporated October 30, 1916.” Each “ certifies that First National Bank, as pledgee of Chas. O. Middleton is the owner.” On the back of each is an assignment dated May 5, 1921, from First National Bank of Los Angeles, pledgee Chas. O. Middleton to Chas. O. Middleton.

The petitioner was his own principal witness. We are unable to reconcile his testimony on many important points with the stipulation and the stock certificates, and as a consequence, we are unable to find facts which show his right to the claimed loss. The certificates were received in evidence without objection when the petitioner first took the stand. The stipulation was read into the record after the testimony was in. If there was any possible reconciliation of the apparent discrepancies, the petitioner’s counsel should have brought it out and, having failed to do so, the petitioner must stand the consequences. There was here no 'prima facie showing which cast any burden upon the respondent. The petitioner testified that he first purchased fifty shares for $5,000 late in 1912 or early in 1913; shortly after that ten shares were sent to him and his bank account debited $1,000; later he bought forty shares for $4,000; finally, “ when the mill was ready to start — I don’t remember whether that was 1913 or 1914 — they had no money to start the mill,” so he was pursuaded to take 100 shares until two other subscribers could take these shares. He said he pledged his 200 shares at the First National Bank to secure a loan of the $10,000 needed and the two subscribers never relieved him of the 100 shares.

If the discrepancy were only as to the dates, we might think that the petitioner was merely confused as to the time when he acquired the 200 shares of White Star Plaster Company stock, but there are other discrepancies. The stipulation states that all of the authorized capital stock of the White Star Plaster Company was issued on December 1, 1916, for mining property, building and machinery formerly owned by the Arrowhead Plaster Company, a bankrupt corporation. The petitioner’s certificates are dated December 1,1916. The White Star Plaster Company did not start its operations until the latter part of 1919, yet, the petitioner testified that in 1913 or 1914 he provided $10,000 to “ start the mill.” At another time he testified that the property was being operated at the time he bought his original stock. He speaks of meeting the representative from whom the machinery was bought and of the building of a spur track by the Union Pacific Railroad Company, as if these things were being done at or about the time he made his original investment. There are other statements in his testimony which rather indicate that he made bis original investment of $20,000 in connection with this particular gypsum deposit at some time prior to the date upon which the White Star Plaster Company came into existence. If this is so, his original investment is not the basis for loss on the White Star Plaster Company stock. After considering all of the evidence, we are unable to find from the record that the petitioner paid $20,000 or any other particular amount for the 200 shares of White Star Plaster Company stock which he held in 1923. This circumstance alone is fatal to the petitioner’s contention.

There is at least one other reason, however, why he must fail. He cites a part of article 144 of Regulations 62. This article provides, first, that the owner of stock may not deduct a loss representing shrinkage in value, but is allowed only the loss actually suffered when the stock is disposed of. It continues as follows:

However, if stock of a corporation becomes worthless, its cost or other basis determined under section 202 may be deducted by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing of its worthlessness be made, as in the case of bad debts.

The quoted part of this regulation means that before the Commissioner will allow a loss based on the alleged worthlessness of stock, the worthlessness of the stock must be demonstrated to him satisfactorily, as in the case of bad debts. But it does not mean that a loss on stock is to be allowed for the year in which the owner ascertains its worthlessness and charges it off his books. Losses are deductible only in the year in which sustained. In the case of a loss of an investment in stock, this usually necessitates the proof of the occurrence in the taxable year of some identifiable event from which the worthlessness of the stock dates. United States v. White Dental Manufacturing Co., 274 U. S. 398.

We have searched the present record in vain for proof of the occurrence of such an event in the year 1923. The petitioner never received any dividends on his White Star Plaster Company stock. The company operated at a loss in 1923,. but that was nothing new for it had always operated at a loss and its loss for 1921 was even larger than its loss for 1923. It is true that the steady accumulation of losses might discourage a reasonable person at some time, but we see no reason to say that this event occurred in 1923 as opposed to some other year. We do not know what happened in 1924, but in 1925 the company went into bankruptcy. The petition in bankruptcy stated that the assets were largely in excess of the liabilities. The petitioner does not admit the truth of this statement, but we do not know whether or not it was true. One of the petitioner’s customers started building its own plaster mill in 1922. This mill was finished at some time in 1923. The purchases of this company from the White Star Plaster Company were much less in 1923 ($44,636.05) than they were in 1922 ($170,814.90). We do not know what the gross sales of the White Star Plaster Company were in 1922, but it has been stipulated that in 1923 they amounted to $220,662.09. This customer was apparently a rather important one, but the falling off in its purchases does not show that the stock of the White Star Plaster Company became worthless in 1923. The only other thing which occurred in 1923 was that $9,500 par value of bonds came due on December 1, 1923. We know that these were not paid at the end of the year, but we can not conclude from this fact that the stock became worthless within the year. The petitioner stated that he never knew anything about the plaster business himself, but went into it on the strength of the representations of a banking associate. He testified that he had been away from Los Angeles for about three years, during which time he did not know much about the affairs of the White Star Plaster Company, but when he returned, probably at some time in 1922, he read in the paper that this customer was going to build its own mill. He then had a lawyer make an investigation of the White Star Plaster Company. This lawyer was never called as a witness, although the petitioner’s counsel stated during the cross-examination of the petitioner that he was going to call this witness. It appears from a letter introduced by the respondent that this attorney wrote the petitioner on March 5, 1923, but this does not constitute proof of the facts or conclusions stated in the letter of March o, 1923. At some undisclosed date the president of the customer above mentioned refused to buy the petitioner’s stock at any price. In claiming the worthlessness of the stock as a loss deduction from his income for 1923, the petitioner undoubtedly relied upon the investigation and statements of persons who have not testified in this case. We do not know that any person informed of the true facts and with ability to judge ever came to the conclusion that this stock became worthless in 1923. Even if we were convinced that the petitioner suffered a loss of some certain amount on this stock, we would be unable to conclude, contrary to the determination of the Commissioner, that the loss was sustained in 1923.

Reviewed by the Board.

Judgment will be entered under Buie 50.

Lansdon, Marquette, and TRAmmell dissent.

       Prom other evidence it appears that only $9,500 par value of bonds were due and payable on December 1, 1923. The stipulation contains incorrect addition.


author: Smith :

text:
    The Modern Tailoring Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40041.
    Promulgated February 9, 1932.

      W. E. Lewis, G. P. A., for the petitioner.

      O. W. Sweeher, Esq., for the respondent.
   OPINION.

Smith :

The petitioner’s sole contention m this proceeding is that it is entitled to have its income tax for the calendar year 1926 computed upon the basis of a consolidated return filed by it and Farr’s Clothes, Inc., for that period. The respondent has ruled that petitioner and Farr’s Clothes, Inc., were not affiliated in 1926 within the meaning of section 240 (d) of the Revenue Act of 1926. The wording of this section of the statute referred to is as follows:

For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subdivision the term “ stock ” does not include nonvoting stock which is limited and preferred as to dividends. This subdivision shall bo applicable to the determination of affiliation for the taxable year 1926 and each taxable year therafter.

Since the petitioner did not own any of the stock of Farr’s Clothes, Inc., the question to be determined is whether at least 95 per cent of the voting stock of both companies was owned by the “ same interests.” The stipulated facts as to stock ownership in the companies are that the three individuals, William Schnurmacher, Howard Lieb-enthal, and Rose Liebenthal, who owned 99.6 per cent, all but four qualifying shares, of the voting stock of Farr’s Clothes, Inc., owned only 91.6 per cent of the petitioner’s voting stock, and a fourth individual, Frank Cerney, owned 8 per cent of petitioner’s voting stock and no stock in Farr’s Clothes, Inc.

The petitioner urges, however, that in the circumstances of this case, its minority stockholder, Cerney, comprised the “ same interests ” with the majority stockholders. Unquestionably, there was a very close business relationship between them. Cerney was a salaried employee, as well as a stockolder of the petitioner." He had been employed by the petitioner and its predecessor for many years. He was also a director of the petitioner and was in complete harmony with the majority stockholders. He held his stock in the petitioner under an agreement which prohibited him from disposing of it without first offering it to the other stockholders at its book value. Notwithstanding these considerations, however, we can not agree that Cerney and the petitioner’s other stockholders, who owned 99.6 per cent of the stock of Farr’s Clothes, Inc., constituted the same interests within the meaning of the statute. The courts have construed the words “ same interests ” as meaning the same “ beneficial interests.” Commissioner v. Hirsch & Co., 30 Fed. (2d) 645; Handy & Harmon v. Commissioner, 284 U. S. 136. In the latter case the Supreme Court said:

The purpose of Sec. 240 was, by means of consolidated returns, to require taxes to be levied according to the true net income and invested capital resulting from and employed in a single business enterprise even though it was conducted by means of more than one corporation. Subsection (b) clearly reflects the intention, by means of such returns, to secure substantial equality as between shareholders who ultimately bear the burden. That intention is shown by the legislative history and was given effect by the regulations contemporaneously promulgated. It requires no discussion to show that such returns will not make against inequality or evasion unless the same interests are the beneficial owners in like proportions of substantially all of the stock of each of such corporations. Alameda Investment Co. v. McLaughlin, 28 F. (2d) 81. Montana Mercantile Co. v. Rasmusson, 28 F. (2d) 916. Commissioner v. Adolph Hirsch & Co., 30 F. (2d) 645, 646. Commissioner of Internal Revenue v. City Button Works, 49 F. (2d) 705. * * *

Cf. also Commissioner v. Gong Bell Mfg. Co., 48 Fed. (2d) 205; certiorari denied, 284 U. S. 670.

Obviously, the conditions existing with respect to the ownership of the voting stock of the petitioner and Farr’s Clothes, Inc., in 1926 do not meet the test laid down by the Supreme Court for affiliation. Cemey, not being a stockholder in Farr’s Clothes, Inc., would neither have benefited by a gain nor shared a loss of that company. See also East Jersey Lumber & Timber Co., 24 B. T. A. 1047; J. P. Burton Coal Co., 24 B. T. A. 1052.

Judgment will be entered for Che respondent.


author: Lansdon :

text:
    Wesley G. Rogers, Petitioner, v. Commissioner of Internal Revenue, Respondent. Bascom H. Rogers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 41894, 41895.
    Promulgated February 9, 1932.

      Charles PL. Garnett, Esq., for the petitioners.

      Maxwell M. Mahany, Esq., for the respondent.
   OPINION.

Lansdon :

The petitioners herein are members in equal interest of a partnership. At Docket Nos. 41894 and 41895 the respondent has asserted deficiencies in income tax for the year 1926 against Wesley G. Rogers and Bascom II. Rogers in the respective amounts of $2,-062.70 and $2,044.19. Several assignments of error are made in each petition, but at the hearing all were abandoned except the allegation that the Commissioner erred in the inclusion of certain amounts received by the partnership as bonuses on oil and gas subleases. The two proceedings were consolidated for hearing and decision. The facts are stipulated as follows:

The petitioners, members having equal interests in the partnership of Rogers & Rogers of Holdenville, Oklahoma, during the year 1926, were engaged in the business of purchasing undeveloped and unleased oil and gas properties, for which there was a demand for oil and gas leases thereon, pursuant to which they acquired, by purchase, either the fee title to lands believed to contain oil and gas, or the so-called royalty or mineral rights therein, all of which lands and mineral rights were located within the State of Oklahoma.
During the year 1926 they executed as lessors, with respect to such lands, oil and gas leases in the form set forth in the Oil & Gas Mining Lease designated as Mid-Continent No. 88, Revised, a copy of which is submitted herewith and made a part of this stipulation. The leases so executed were upon tracts in which the petitioners owned either the fee simple title or the entire so-called royalty or mineral interest, title to which had been acquired by them through purchase during the years 1925 and 1926. Upon none of these tracts were there as of the date of purchase or of the execution of these leases, any valid prior or existing oil and gas leases.
Pursuant to the execution of said leases the petitioners received a cash consideration, commonly referred to as a bonus. The legal description of such tracts, the character of the interest owned, the cost of such interest, and the amount received pursuant to the execution of said leases, which are for convenience referred to as Group (a) and Group (b), were as follows:
In determining the deficiencies herein, the respondent included as income the entire amount of the sums received, namely $2,359.87 and $4,777.08, and has not allowed as either a deduction or as cost any part of the sums theretofore paid by the petitioners for the fee simple title or mineral interests in the tracts involved.

The petitioners purchased oil and gas rights on divers tracts of lands in Oklahoma at costs above stipulated, and later executed oil and gas leases covering the sazne lands, and in each instance reserved one-eighth of the production and received a bonus. Their contention is that the amounts paid for the mineral rights were capital investment and that no profit or income inures to them until the amount of such investments has been recovered. In Group (a) the bonus received for each lease exceeded the cost of the mineral rights and they contend that their income therefrom was the difference between the cost of such rights and the bonus received upon the execution of the lease. In Group (b) in each instance the bonus received was less than the cost of the rights leased and their contention is that a loss was sustained in each transaction measured by the difference between cost and bonus. The respondent has determined the deficiency on the theory that all the bonus received in the execution of an oil and gas lease is income to the lessor.

It is now well settled the owners of mineral rights in Oklahoma lands merely own the right to go upon the land and reduce all oil and gas or other minerals to possession by exploration, development and production. They do not own the oil and gas in situs. In the same State it is held that the execution of an oil and gas lease does not convey minerals in place. Such a lease is not real property, but a chattel real. Duff v. Keaton, 33 Okla.; 92, 124 Pac. 291; Papoose Oil Co. v. Swindler, 95 Okla. 264; 221 Pac. 506. It is also established that such a lease does not involve a sale of either real or personal property, and is no more than a contract for development. It is not necessary, therefore, to consider or follow the statute covering sales of real and personal property. Adams v. Tidal Oil Co., 237 Pac. 443. It is, of course, true that the cost of mineral rights acquired by the petitioners was a capital investment and if the execution of the lease constituted a sale, the petitioners’ contention would be sound. Upon the authority of the case cited above we hold, however, that the leases were not sales, but mefÜy licenses to the lessees for certain purposes.

That the bonus received on the execution of a gas and oil lease is income is no longer an open question. In Work v. United States, 261 U. S. 352, Chief Justice Taft said:

The bonus which was the result of bidding for desirable and profitable oil and gas leases secured for the members of the Osage Tribe the just value of the use of their property which the fixing of royalties in advance by the President was not adapted to give them. It was in effect a supplement to the royalties already determined. It was really part of the royalty or rental in a lump sum or down payment. We do not see how it can be classified as anything else. It was income from the use of the mineral resources of the land. Of course, it involved a consumption and reduction of the mineral value of the land, but so does a royalty. This is an inevitable characteristic of income from the product of the mine.

The Oklahoma courts adhere to this general principle. Kimbley v. Luckey, 72 Okla. 217; 179 Pac. 928; Pierce Oil Corporation v. Schact, 75 Okla. 101; 181 Pac. 731; Gypsy Oil Co. v. Schonwald, 107 Okla. 253; 231 Pac. 864. This Board has also consistently held that a bonus received upon the execution of an oil and gas lease is all income and that no part thereof can be regarded as a return of capital. Nelson Land & Oil Co., 3 B. T. A. 315; R. H. Hazlett, 10 B. T. A. 332; Murphy Oil Co., 15 B. T. A. 1195; F. O. Burket et al., 18 B. T. A. 1062. The determination of the respondent is approved. Petitioners, through their counsel, having abandoned all other allegations of error, the determination of the respondent in respect thereof is approved.

Decision will be entered for the respondent.


text:
    J. Kammerdiner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 41643, 46555.
    Promulgated February 10, 1932.

      Olaude I. Parker, Esq., John B. Milliken, Esq., George H. Proctor, Esq., and L. A. Luce, Esq., for the petitioner.

      P. M. Clark, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has asserted deficiencies in income taxes for the years 1925, 1926, and 1927, in the respective amounts of $4,220.70, $5,969.56, and $9,619.95. The only issue is whether the petitioner and his wife were equal partners in a certain business throughout the taxable years. The two proceedings have been consolidated for hearing.

The petitioner is an individual. He has been a resident of Los Angeles, California, for about thirty years and during the entire time has been engaged in some phase of the oil business. Prior to 1922 he worked for many large oil companies as a well driller. In drilling an oil well it often happens that tools part from the operating equipment and become jammed in the uncompleted hole. The recovery of such lost or dropped equipment is usually a tedious and costly job, but in almost all cases it must be effected before actual deepening of the well can be resumed. Within the petitioner’s knowledge and experience it has happened that as many as nine out of eighteen drilling crews on a certain development were engaged in “ fishing ” operations at the same time.

Prior to 1922 the petitioner invented a device for the recovery of lost tools from oil well holes, which was patented and became known to the oil business as the “ rotary jar.” After the usefulness of such device had been proved by successful tests he formed a partnership with his wife, Myrtle B. Kammerdiner, for the purpose of manufacturing, renting and/or selling rotary jars to oil well drillers. Petitioner’s wife insisted that the device should be patented and personally secured the services of a patent attorney for that purpose. About April, 1923, petitioner began to produce and rent or sell rotary jars and for several years thereafter a large income was derived therefrom.

Petitioner married Myrtle Brown, then an office worker in a brokerage firm, in 1908, and has lived with her continuously since that date. While he was employed for a number of years by the Associated Oil Company as a driller, his wife conducted a boarding house for the labor engaged on the job and accumulated profits to the amount of several thousands of dollars. Such profits, together with the savings from the petitioner’s own income, were deposited in a joint bank account upon which both husband and wife could check without restriction. The capital required for beginning the rotary jar business was drawn from this account and the receipts therefrom were deposited in such' account.

When petitioner determined to engage in the manufacture and distribution of rotary jars he and his wife entered into an oral agreement to share equally in the profits or losses therefrom. Under this agreement the husband was to attend to the installation and operation of the device and the wife was to have charge of the office. She bought materials, made arrangements with the machine shop for the manufacture of rotary jars, each of which cost about $500, billed all customers for amounts due, collected all accounts, deposited all receipts in the joint bank account, passed on the credit of prospective customers, and, in general, had charge and supervision of the business operations of the partnership. The customers who used the fishing tools, the salesmen and solicitors who placed the device with well drillers, and the oil trade generally knew that the petitioner and his wife were operating the business as a partnership. The patents in this country, England and the Irish Free State were in the name of the petitioner and the business was conducted under the trade name of James Kammerdiner. In each of the taxable years the business made a partnership return in which the net distributable income was shown to belong in equal parts to the petitioner and his wile. In each of such years the petitioner and his wife made separate individual income-tax returns and each included one-half the partnership profits in gross income reported. Upon audit of such returns the respondent held that no partnership existed, that all the income resulting from the rotary jar business should be taxed to the petitioner, and asserted the deficiencies here in controversy.

Section 158 of the Civil Code of California provides that, “ a husband and wife may enter into a partnership in California, and if there is any agreement which shows that the intention of the parties is to create a vested interest in the partnership in the wife as her separate property, such intention will change the character of their property from community to separate property.” In this proceeding it is perfectly clear that the petitioner and his wife joined together in April of 1923 to carry on a business enterprise for their mutual benefit. This is sufficient to establish a partnership. Cf. Meehan v. Valentine, 145 U. S. 611; E. C. Wilson et al., 11 B. T. A. 963.

A common law contract of partnership may be oral. E. C. Wilson, supra; Bates v. Hancock, 95 Cal. 479; 30 Pac. 605; Koyer v. Willmon, 150 Cal. 785; 90 Pac. 135; Musick Consolidated Oil Co. v. Chandler, 158 Cal. 7; 109 Pac. 613. The fact that for business reasons the operations were conducted in the name of the husband does not defeat the partnership. Cf. John T. Newell, 17 B. T. A. 93; Leonard M. Gunderson, 23 B. T. A. 45. Nor is it material that no capital account was maintained on the books kept by the partnership. B. A. Bartley, 4 B. T. A. 874; John T. Newell, supra; E. L. Kier, 15 B. T. A. 1114. In the light of the evidence and of the many decided cases and proceedings involving this issue, we are of the opinion that the determination of the respondent that there was no partnership in the taxable year between petitioner and his wife must be reversed. L. S. Cobb, 9 B. T. A. 547; E. L. Kier, supra.

Decision will be entered for the petitioner.


author: Lansdon:

text:
    Edward J. and Josephine McCormack, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39369.
    Promulgated February 10, 1932.

      Henry Borsje, Esq., for the petitioners.

      Nathan Gammon, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent asserts a deficiency in income tax for the year 1926 in the amount of $9,190.65. The only issue is whether the basis for determining the profit realized from the sale of certain securities given to the petitioner, Josephine McCormack, by her father is the cost to the donor or the fair market value thereof at the date of the gift.

The petitioners are individuals residing in Memphis, Tennessee. On December 30, 1924, the father of petitioner, Josephine McCor-mack, gave his daughter 100 shares of stock of the Northern Royalty Trust which had cost him $5,000 in 1923. The fair market value thereof at the date of the gift was $70,000. In February, 1926, the donee sold such stock for $79,111.50 and reported income in the amount of $9,111.50 from such sale in the income-tax return jointly filed by herself and her husband for that year. Upon audit of such return the Commissioner increased the income from such sale to $74,111.50 and asserted the deficiency here in controversy.

The father of Josephine McCormack, J. A. Crisler, Sr., is, and for many years prior to 1923, was a physician in Memphis, actively engaged in the practice of his profession as an operating surgeon. Prior to the date of the gift here in controversy he had been advised by his personal physician that he might die at any time. At that time he was told that he had myocarditis. He had previously suf-ferred from goiter, a ruptured gall bladder and the passing of a stone from his kidney. He had also survived an attack of typhoid fever. His physicians advised him to discontinue drinking, smoking and other things likely to shorten his life. He disregarded such advice, continued to live in his usual way and regularly practiced his profession up to the date of the hearing on September 28, 1931, when he testified as a witness in behalf of the petitioners herein.

After having been advised of the state of his health, Crisler conferred with his family, consisting of a wife, son, and daughter, and told them that he desired to live free from the care of hi.s property, which he proposed to divide equally among them. Accordingly he gave his daughter the stock here involved, deeded an office building of about equal value to his son, and made a will in which all the remainder of his estate was left to his wife.

The petitioners here contend that the gifts to his wife and children were made by Crisler in contemplation of death and constituted, in effect, a testamentary disposition of property which they received by devise, bequest or inheritance. If this position is sound the issue here is governed by section 204 (a) (o) of the Revenue Act of 1926, which provides that the basis for determining gain or loss resulting from the sale of assets so acquired shall be the fair market value thereof at the time of acquisition. The respondent has based his determination on the theory that the transfer of the stock by Crisler to his daughter was a gift inter vivos and that the tax liability resulting from the sale thereof must be computed under (a) (2) of the same section, an act which provides that the basis fdr ascertaining gain or loss shall be co.st to the donor.

The evidence that the gift here in controversy was made in contemplation of death is not convincing. At the date of the transfer and for at least seven years thereafter the donor was actively engaged in the practice of his profession. In September, 1931, he was still living and quite able to testify at the hearing of this proceeding. In our opinion there is no occasion for any extended discussion of the authorities cited by counsel for the petitioner. It is well established that property is received by devise only on the death of the devisor. That event had not occurred when the sale here involved was made. In these circumstances we think that, even if the transfer were made in contemplation of death, that fact could have no bearing on the issue here. It is our opinion that the transfer of the stock in question was a gift inter vimos and that the determination of the respondent is correct. Taft v. Bowers, 278 U. S. 470.

Decision will be entered for the respondent.


author: Black:

text:
    Central Market Street Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 24837.
    Promulgated February 10, 1932.

      Lawrence A. Baker, Esq., for the petitioner.

      James L. Backstrom, Esq., and P. A. Sebastian, Esq., for the respondent.
   OPINION.

Black:

The principal issue in this proceeding is the correctness of the action of the Commissioner in allocating to petitioner all of the deficiencies determined for 1918 and 1919 upon the basis of consolidated income of petitioner and certain other corporations with which it was affiliated during the respective taxable years.

Petitioner contends that no agreement was ever filed with the Commissioner consenting to the assessment of the entire deficiency against petitioner and that none was ever entered into. Respondent, at the hearing, while admitting that no such agreement was ever filed with the bureau of internal revenue, contended that petitioner and its affiliated corporations by their course of conduct had entered into such an implied agreement and are now estopped to deny that such an agreement existed. Respondent filed no brief.

Section 240 (a) of the Revenue Act of 1918 provides: “In any case in which the tax is assessed upon the basis of a consolidated return, the total tax shall be computed in the first instance as a unit and shall then be assessed upon the respective affiliated corporations in such proportions as may be agreed upon among them, or, in the absence of such agreement, then on the basis of the net income properly assignable to each.”

The record is uncontroverted to the effect that there was no agreement that all the tax shown by the consolidated returns should be assessed against petitioner, the Central Market Street Company. In fact, the Central Market Street Company did not file the consolidated return for 1919; it was filed for that year by the Stanley Company of America as the reporting company and the Central Market Street Company (petitioner) was included in the return as one of the subsidiaries, and the information return which petitioner filed on Form 1122 specifically instructed that none of the tax should be apportioned to petitioner because it had a loss instead of income in 1919.

When the consolidated returns were filed for 1918 and 1919, in each instance they were accompanied by information returns on Form 1122, wherein it was requested that the tax be apportioned against the afliliated corporations in the amounts set out in these respective information returns. Notwithstanding these instructions, the assessment for the year 1918 was made against the petitioner, which paid the first two installments of the tax. For the year 1919 the tax shown on the consolidated return was assessed against the Stanley Company of America, which paid the tax assessed for that year as well as the last two installments of the previous year. On this state of facts we see no warrant for holding that the entire amount of the deficiencies should be assessed against petitioner.

In Morganite Brush Co., 24 B. T. A. 176, we held that the burden of proving the existence or nonexistence of an agreement between affiliated corporations respecting allocation of consolidated tax liability was upon the taxpayer. In the instant case the petitioner has met the burden of proof by showing that there was no agreement to the effect that all the tax should be assessed against the petitioner, but that, on the contrary, in each of the taxable years the subsidiaries filed information returns on Form 1122 in which they each directed how much of the total tax shown on the original return should be apportioned to each corporation included in the consolidated return.

In the instant case we have no such state of facts as we had before us in American Textile Woolen Co. et al., 23 B. T. A. 670, where we held there was an implied agreement to the effect that all the tax should be assessed against the parent corporation. In that case there were four corporations affiliated with the parent corporation, and only one of them filed an information return on Form 1122 directing how the tax shown on the consolidated return should be apportioned.

In the instant case, information returns on Form 1122 were filed by all the subsidiaries, directing how the tax should be apportioned. Such directions are controlling as to the part of the deficiencies properly allocable to them and we are without authority to disregard them. Flannery Bolt Co. v. Commissioner, 54 Fed. (2d) 365.

As to the year 1918, it has been pointed out in the findings of fact that the consolidated net income as shown on the return was $98,-289.73, and this has been increased by the respondent to $113,265.16. Petitioner does not contest the correctness of this increase. Most of the increase is due to increasing petitioner’s net income from $99,-611.90, as shown on the original return, to $110,653.80, as reauditecl by the Commissioner.

Petitioner is liable for that part of the deficiency asserted by the respondent for the year 1918 which is due to its own increase in income, as shown above. Petitioner had no net income for 1919 and is not liable for any of the deficiency asserted by the respondent for that year.

Where respondent, as in the instant case, was fully advised that directions for apportioning the tax were on file for both taxable years, he can not plead estoppel against petitioner merely because petitioner, in its several protests to the bureau against .the deficiencies, did not raise the question of respondent’s right to allocate all the deficiencies to petitioner. The Commissioner can not create an estoppel by his own failure to perform the act directed by the plain provisions of the law. Every fact necessary to be known for the performance of his duty was within his knowledge when the return was filed. Cf. Newport Co., 22 B. T. A. 833.

Although respondent has filed no brief in this proceeding, at the hearing his counsel contended that we had before us on the appeal not only the petitioner, Central Market Street Company, but its subsidiaries as well. In support of such contention he cited American Auto Trimming Co. et al., 6 B. T. A. 1007; affirmed in part and reversed in part, 37 Fed. (2d) 801. In that case the facts show that deficiencies were determined not only against the parent corporation, but also against the corporations claimed to be affiliated, and that all appealed. In such a situation we held that we had jurisdiction of the subsidiaries.

In Furniture Exhibition Building Co., 24 B. T. A. 1279, we again followed that ruling, but we also held that we had no jurisdiction of years in which no deficiencies were determined against the subsidiary.

In the instant case, no deficiencies have been determined against the subsidiaries. They are not before us in any way as petitioners and respondent’s contention that we have jurisdiction to determine deficiencies against them is denied. Furniture Exhibition Building Co., supra; Caughey-Jossman Co., 8 B. T. A. 201; New York Talking Machine Co., 13 B. T. A. 154; Phoenix National Bank, 14 B. T. A. 115; American, Creosoting Co., 12 B. T. A. 247.

Reviewed by the Board.

Decision will be entered under Rule 50.