author: Trammell:

text:
    Jamison Coal & Coke Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 31690, 34088.
    Promulgated November 2, 1931

      W. A. Seifert, Esq., and Frank G. Miller, G. P. A., for the petitioner.

      J. E. Marshall, Esq., and John A. McQamm, Esq., for the respondent.

      Walter S. Orr, Esq., as amicus curiae.

   OPINION.

Trammell:

The petitions as amended allege that the respondent has failed to compute correctly the invested capital of the petitioner for the taxable years 1917,1918 and 1920. The petitions contain the following statement as the facts relied on in support of this allegation of error:

Tbe petitioner in the year 1910 was a party to a reorganization and acquired substantially all of the property of the Georges Creek Coal & Iron Company, paying therefor in securities and cash. This reorganization took place on or about February 1, 1910. The petitioner acquired properties having a value of $16,920,659.89 as of this date, which results in a paid-in surplus of $7,945,966.66, thereby increasing invested capital of the petitioner in the sum of $7,945,966.66.

It is also stated that, in determining invested capital for the years. 1917, 1918 and 1920, “ The petitioner is entitled to have included therein the realized appreciation of the properties of the petitioner based upon the difference between the March 1, 1913, value and cost * *

In his answer the respondent denies the allegation of error complained of, as well as the statement of facts relied on by the petitioner.

With respect to the issue thus presented by the pleadings the parties have stipulated as follows:

If it is held that there was a reorganization of the petitioner in 1910, its invested capital, as a result of such reorganization, should be increased as follows:
Year Amount
1917_$3, 315, 929.57
191S_ 3,186,828.56
1919_ 3, 0S6,232.92
1920_ 2, 999, 877.15

The parties also stipulated that “ The only issues for determination by the Board are * * * and (2) reorganization.”

The petitioner’s brief, under the caption, “ Statement of Points Upon Which Petitioner Belies,” contains the following: “Point 1. Petitioner was reorganized in 1910, and is entitled to have its invested capital increased as a result thereof.”

Under the caption, “Argument,” the petitioner’s brief contains the following:

Point I.
Petitioner was reorganised in 1910 and is entitled to have its invested capital increased as a result thereof.
The petitioner company was reorganized as of January 10, 1910, through the purchase of substantially all of the Georges Creek Coal & Iron Company property ; the increase of its authorized and outstanding capital stock; the increase of its authorized and outstanding bond obligation, and the declaration of a stock dividend, all of which were essential to the plan of reorganization whereby the petitioner acquired the operating property of the Georges Creek Coal & Iron Company located in the State of West Virginia.
*******
The agreement [the stipulation setting forth the amounts by which petitioner’s invested capital is to be increased for the respective years if it is found that there was a reorganization in 1910] showing the adjustment of petitioner’s invested capital by recognizing the reorganization in 1910, is a clear expression of the intention of the parties to leave for decision to the Board solely the question as to whether or not a reorganization of the petitioner had taken place in January, 1910. There is no dispute and no issue before the Board for decision relative to a modification of petitioner’s invested capital on account of the reorganization of the petitioner in 1910.

In bis brief the respondent states the issue with respect to invested capital to be “(1) Whether a reorganization took place in the Jami-son Coal &• Coke Company as of January 1, 1910, which gave the petitioner the right to make a revaluation, it being stipulated that if there was such a reorganization petitioner’s invested capital should be increased in the amounts of $3,315,929.57, $3,186,828.56, $3,086,-232.96 and $2,999,877.15 for the years 1917, 1918, 1919 and 1920, respectively.” (Italics ours.)

In his opening statement counsel for the petitioner stated: “ There is a question as of January 10, 1910, whether a reorganization took place in the Jamison Coal & Coke Company, which gave us the right to make a revaluation, and it is stipulated that if it is held that there was a reorganization of the petitioner in 1910, its invested capital, as a result of such reorganization, should be increased as follows.” (Italics ours.) He then stated the amounts set out in the stipulation heretofore quoted.

The foregoing statements have been set forth at length to show just what the parties consider to be the effect of their stipulation and what they consider to be the issue submitted for determination. From the petitioner’s brief it appears that it considers the only question with respect to invested capital before us to be whether under the facts in the case there was a reorganization of the petitioner in 1910, while from the respondent’s brief it appears that he considers the question to be whether there was such a reorganization of the petitioner in 1910 as gave it the right to make a revaluation of the property acquired in that year from the Georges Creek Coal & Iron Company. Considering the entire record, including the opening statements of counsel, we think the question to be decided by us is whether the purchase by the petitioner of the property of the Georges Creek Coal & Iron Company in 1910, together with the attendant and incidental transactions as set out in our findings of fact, so affected the petitioner’s invested capital that in order for it to be correctly determined under the Bevenue Acts of 1917 and 1918 it must be increased for the years here involved by the amounts stipulated by the parties. If we regarded it otherwise, it would amount to permitting the parties to stipulate the law. Stipulations can relate only to facts. We can not recognize or give effect to stipulations of law. See Marguissee v. Commissioner, 11 B. T. A. 334; affirmed by the Circuit Court of Appeals February 16, 1931 (Prentice-Hall Federal Tax Service, 1931, p. 825); Ohio Clover Leaf Dairy Co., 8 B. T. A. 1249; affirmed by the Circuit Court of Appeals for the Sixth Circuit, 34 Fed. (2d) 1022.

In its brief the petitioner devotes its argument on this issue entirely to the question of whether there was a reorganization in 1910. It makes reference to the provisions of section 208 of the Revenue Act of 1917 and section 331 of the Revenue Act of 1918. These sections contain prohibitions on the inclusion of assets in invested capital at greater values than allowable to the preceding owners where süch assets were acquired in the reorganization, consolidation or change of ownership of a trade or business or the change..of ownership of property after March 3, 1917, and an interest or control in such trade or business or property of 50 per cent or more remained in the same persons or any of them. Even if the assets are acquired by another corporate entity, the invested capital is not increased over that of the predecessor under the conditions set out in section 208 of the 1917 Act and section 331 of the 1918 Act. But none of these sections even intimate that, where the samé corporation retained the' assets, a revaluation of assets would be made, notwithstanding that that corporation might have been reorganized. It may readily be conceded that, if there had been a reorganization which resulted in a new corporation in 1910 and shares of the new corporation had been issued for the assets of the old, the assets would be revalued. Section 326 of the 1918 Act would have provided for such increase by including the then value of assets paid in for stock. Although the word “ reorganization ” is used in the above mentioned sections of the Acts of 1917 and 1918, the petitioner admits that neither of the acts attempts to define it. The petitioner relies, however, on the definition of the term given in section 202 (c) (2) of the Revenue Act of 1921 and section 203 (h) (1) of the Revenue Act of 1924, especially the latter. The definitions contained in - these sections specifically relate to matters concerned with the determination of gains or losses and not to the determination of invested capital. There are no provisions in any of the reorganization sections which would supersede section 207 of the Act of 1917 or 326 of the 1918 Act, relating to invested capital. In determining invested capital, which is a creature of statute, we must follow those provisions.

As we perceive the issue, it is immaterial whether the petitioner’s purchase of the property of the Georges Creek Coal & Iron Company, together with the incidental transactions, constituted a reorganization in 1910.

The term “ invested capital,” as used in the Revenue Acts of 1917 and 1918, means (1) actual cash bona fide paid in for stock or shares (2) the actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment and (3) paid-in or earned surplus and undivided profits, not including surplus and undivided profits earned during the year, and (4) and (5) intangible property paid in for stock or shares, subject to certain limitations. The term does not include borrowed capital; that is, money or other property borrowed, whether represented by bonds, notes, open accounts, or otherwise.

The petitioner purchased the property from the Georges Creek Coal & Iron Company for a money consideration. It was not paid in for stock. It-is therefore not entitled to include such property in its invested capital at more than cost. H. T. Cushman Mfg. Co., 2 B. T. A. 39; Klamer-Goebel Furniture Co., 11 B. T. A. 1322; La-Belle Iron Works v. United States, 256 U. S. 377. See also A. C. F. Gasoline Co., 6 B. T. A. 1337; Pacific Coast Redwood Co., 5 B. T. A. 423. It may well be that in the LaBelle Iron Works case, supra, there was such a reorganization as is contemplated by the later revenue acts, but we think that case is authority for holding that-invested capital should not be increased under the facts.

. No stock having been issued by the petitioner for assets other than that sold by it to its stockholders for cash, and no part of the excess, if any, of the actual cash value of the property purchased from the Georges Creek Coal & Iron Company over the purchase price paid therefor being includable in the petitioner’s invested capital either as paid-in surplus or as earned surplus, we find nothing in the case to warrant the increases in petitioner’s invested capital by the amounts stipulated by the parties for the respective years, or for any other amounts than those indicated in the preceding paragraph. It not having been shown that the respondent did not include such amounts in making his determination, his action is sustained as to this issue.

The petitioner contends that for the years 1918 and 1920 it is entitled to deductions of $133,004.40 and $105,280.70, respectively, representing minimum rents or royalties in excess of rents or royalties based on actual production during those years under the Thaw and Fuller leases. Of the amount contended for for 1918, $83,004.40 is applicable to the Thaw lease and $50,000 to the Fuller lease, while of the amount contended for for 1920, $15,446.20 is applicable to the Thaw lease and $89,834.50 is applicable to the Fuller lease.

The Thaw lease was for a period of 40 years from January 1, 1918. It provided for certain stipulated rents or royalties per ton of coal mined. It also provided that from January 1, 1918, to December 31, 1954, the rents or royalties in any one year should in no event be less than a sum based on a minimum production of not less than 250,000 tons of coal per year, whether the actual production of coal during said year should amount to 250,000 tons or not. For the remaining years of the lease rents or royalties on lesser amounts of minimum production were provided. The lease provided that if for any year the rent or royalty paid based on the minimum production specified for that year exceeded the rent or royalty due -on the actual production for such year, the excess or difference could be applied in the subsequent year or years of the lease to the rent or royalty for such year or years when the actual production exceeded the minimum specified for such years. In order that the mining of the coal contained in the leased property should be gradual and that its. exhaustion should' not occur until at or near the end of the term of the lease, it was provided that not more than 500,000 tons of coal should be mined in any one year. This amount, however, was exceeded in 1924 and 1925.

The Fuller lease was for the term beginning June 15, 1918, and ending September 1, 1928, when the lands and the coal remaining unmined were to be conveyed to the petitioner herein. The-lease provided for a stipulated rent or royalty of 35 cents per ton for the coal mined. It also provided that the rent or royalty for the period ending August 31, 1919, should be based on a minimum removal of 250,000 tons of coal, whether the actual production of coal during that period should amount to 250,000 tons or not. The minimum rent or royalty for the yearly periods thereafter was to be based on a minimum removal of 450,000 tons of coal whether the actual coal removed reached 450,000 tons " or not. The lease further provided that if during the period ending August 31, 1919, or if in any year or years of the term of the lease, the petitioner should pay for more coal than it had actually mined, it would be entitled to a credit for the same on account of coal mined in any later year or years in excess of the minimum royalty for such year or years. Any and all payments made during the term of the léase which should exceed the value of the coal actually removed prior to September 1, 1928, computing the value of the same at 35 cents per ton, being the rent or royalty under the lease, were to be credited on the' purchase price' of the premises. The lease also contained provisions as to' ho\v the quantity of coal remaining unmined at September 1, 1928, should -be ascertained and how the amount to be paid the lessors therefor should be determined, as well as the manner in which payment of such amount should be made. Under this lease the petitioner was not only entitled to have the excess of the minimum rents or royalties over the rents or royalties on the coal actually mined for any year.or years of the term of the lease applied against the rents -or royalties on the coal actually mined above the minimum rents or royalties for a subsequent year or years, but was entitled to have applied against the purchase price of the property in 1928 any and all amounts paid during the term of the lease in excess of the value of the coal actually removed.

Since the petitioner was to have as a credit against the purchase price of the property the excess of the amounts paid during the term of the lease over the value of the coal removed during the term of the lease, it is clear that such excess would represent payment for the property. The provisions of paragraph 18 of this lease indicate that while the instrument is designated a lease, it is in fact a contract of sale, intended by the parties as such, and as such comes within the decision in Jefferson Gas Coal Co. v. Commissioner, 52 Fed. (2d) 120. In that case it was held that where as a result of payments made by the taxpayer under a contract of sale it acquired an equity in property, the payments constituted capital expenditures and were not allowable deductions in determining taxable income. Whether the so-called lease be considered as a lease or a sale, it was manifestly the intention of the parties that any amount paid as so-called royalties in excess of royalties on coal actually mined was to be applied as a part of the purchase price. The lessee was to have the benefit in the form of payment for property to which title was being taken or an equity acquired. On the reasoning of this case in so far as the Fuller lease is concerned, we think that the minimum royalties in excess of royalties on coal actually mined are to be treated as capital expenditures and are not deductible as expense.

With respect to the Thaw lease, since we are not bound by the State court decisions as to whether this is a lease or a sale of coal in place (see Rodenberger v. McCaughn, 25 Fed. (2d) 699, certiorari denied), we must determine from its terms whether the payments were rentals or royalties, or purchase price. We think that, clearly, for Federal income-tax purposes the payments are to be treated as royalties.

In W. B. Bogle & Co. et al., 5 B. T. A. 541, 552, where the Board considered the question of whether minimum royalties paid are deductible as expenses or should be carried in the capital account we said:

With reference to the minimum royalties, we are of the opinion that they constitute rent and are allowable deductions. It is well settled that royalties paid under the provisions of mining leases constitute rents. Appeal of Estate of Mary E. McCahill, 2 B. T. A. 875; Lynch v. Alworth-Stephens Co., 267 U. S. 364; Von Baumbach v. Sargent Land Co., 242 U. S. 503; and United States v. Biwabik Mining Co., 247 U. S. 116. The mere fact that the basis of computing such rents is at a rate of so much per ton, provided a certain quantity of ore or coal is removed, or is fixed at a certain specified amount if the required quantity is not mined, does not in any way affect the nature of the payment.

In the Bogle case the record discloses that the minimum royalties involved in excess of royalties on coal actually mined might be applied against the royalties due on coal mined in the later years of the lease, as is true in this case, although no reference thereto was made by the Board.

In Marsh Fork Coal Co., 11 B. T. A. 685, 693, reversed on another point, 42 Fed. (2d) 88, the Board said with respect to the inclusion of minimum royalties in invested capital:

The claim of the petitioner that certain royalties and taxes paid on inactive and undeveloped land be restored to capital is denied, first, because nothing in the lease indicates that a separate royalty was to apply to each tract or that such royalties accrued to the credit of the petitioner and could be satisfied by unlimited future shipments, and, second, because items such as annual rental and annual taxes are deductible as expense each year and are paid for benefits received during the year. The mere fact that the petitioner did not take the fullest advantage of the benefits for which it paid rentals and taxes does not change the character of the expenditures.

We think that those decisions are applicable here.

Minimum royalties are not necessarily advance royalties. They are at most only contingently advance royalties. When a minimum royalty is paid, the taxpayer does not have an absolute equity in unmined coal, as in the case where the excess payments apply on the purchase price or where an advance royalty is paid for the future. He may never have the opportunity to receivé any benefits in the future. It all depends upon uncertainties and contingencies which may never happen. When the payments are made it is not known whether the excess over actual royalties can ever be recovered. The recovery clause may or may not be of any benefit, it being dependent upon unknown future conditions. If the taxpayer over the lease period was never able to acquire the benefit of excess minimum royalties over actual royalties, serious problems would arise when too late to make proper adjustment to properly reflect income. We do not think a taxpayer should be required to wait for years in the future to know how he stands with the Government on taxes. . We are therefore of the opinion that the minimum royalties in the Thaw lease are deductible as expense. We must keep in mind that the tax laws are on an annual basis, and this is annual royalty or rental required to be made.

The minimum royalties are required to be paid each year for the continued use or possession of the property to which the taxpayer has not taken and is not taking title and in which it acquires no absolute equity. This brings the case within the scope of deductions allowed by section 234 (a) (1) of the Revenue Act of 1918.

Judgment will be entered wader Rule 50.


source: Caselaw Access Project

author: Teussell:

license: Public Domain

text:
    Hallie D. Elkins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39255.
    Promulgated November 3, 1931.

      J. B. Grice, Esq., for the petitioner.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Teussell:

This proceeding presents for our determination two questions of law. The first issue is whether petitioner may elect to treat the loss of $127,259.41 sustained in 1924 as an ordinary loss deduction from gross income instead of having the normal and surtax on her “ ordinary net income ” reduced by only 12½ per cent of such loss, which is admitted to be a capital net loss.

The law applicable to this issue is found in section 208 of the Revenue Act of 1924, as follows:

Sec. 208. (a) For the purposes of this title—
(1) The term “ capital gain ” means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921;
(2) The term “ capital loss ” means deductible loss resulting from the sale or exchange of capital assets;
(3) The term “ capital deductions ” means such deductions as are allowed by section 214 for the purpose of computing net income, and are properly allocable to or chargeable against capital assets sold or exchanged during the taxable year ;
(4) The term “ ordinary deductions ” means the deductions allowed by section 214 other than capital losses and capital deductions;
(5) The term “capital net gain” means the excess of the total amount of capital gain over the sum of (A) the capital deductions and capital losses, plus (B) the amount, if any, by which the ordinary deductions exceed the gross income computed without including capital gain;
(6) The term “ capital net loss ” means the .excess of the sum of the capital losses plus the capital deductions over the total amount of capital gain;
(7) The term “ ordinary net income ” means the net income, computed in accordance with the provisions of this title, after excluding all items of capital gain, capital loss, and capital deductions; and
(8) The term “capital assets” means property held by the taxpayer for more than two years (whether .or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a hind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business.
(b) In the case of any taxpayer (other than a corporation) who for any taxable year derives a capital net gain, there shall (at the election of the taxpayer) be levied, collected and paid, in lieu of the taxes imposed by sections 210 and 211 of this title, a tax determined as follows:
A partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner provided in sections 210 and 211, and the total tax shall be this amount plus 12½ per centum of the capital net gain.
(e) In the case of any taxpayer (other than a corporation) who for any taxable year sustains a capital net loss, there shall be levied, collected, and paid, in lieu of the taxes imposed by sections 210 and 211 of this title, a tax determined as follows:
A partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner provided in sections 210 and 211, and the total tax shall be this amount minus 12½ per centum of the capital net loss; but in no case shall the tax under this subdivision be less than the taxes imposed by sections 210 and 211 computed without _ regard to the provisions of this section.

The petitioner contends that inasmuch as the statute (section 208(b)) provides for an election by the taxpayer as to the treatment of capital net gains in computing tax liability, there is also an election as to the treatment of capital net losses. However, it will be noted that section 208 (b), supra, specifically states that where capita] net gains have been derived the tax may be computed at the rates and in the manner therein provided in lieu of the tax imposed by sections 210 and 211 of the same act, at the election of the taxpayer. Section 208 (c), supra, makes no specific provision for an election as to the treatment of capital net losses, and we are of the opinion that had Congress intended to grant such an election it would have so provided in language as clear as that incorporated in section 208 (b). We are of the opinion that section 208 (c) provides for a limitation upon deductions which may be allowed on account of capital net losses and that the taxes must be computed at the rates and in the manner provided therein, with one exception, namely, “but in no case shall the tax under this subdivision be less than the taxes imposed by sections 210 and 211 computed without regard to the provisions of this section.” In the instant case, if the taxes were computed at the rates and in the manner provided in sections 210 and 211, upon the net income of this taxpayer determined pursuant to sections 213 and 214, with the allowance of a deduction of $127,259.41 as an ordinary loss deduction under section 214 (a) (5), there would be no tax liability, for such computation would produce a loss for Í924, as shown on petitioner’s tax return. Therefore, this petitioner’s taxes must be computed at the rates and in the manner provided by section 208 (c), supra, and the'respondent’s determination as to this first issue must be approved.

After excluding the said capital net loss, the respondent determined that petitioner’s “ ordinary net income ” for 1924 amounted to $113,151.98, upon which he has computed normal and surtaxes amounting to $23,766.77, which latter amount he reduced by 12½ per cent of the capital net loss and certain credits. There is no controversy over the correctness of the amount of $113,151.98 as petitioner’s “ ordinary net income,” except as to the amount of $8,632.65 charitable contributions for which the respondent has made no allowance. The second issue is whether petitioner may deduct such contributions in determining her “ ordinary net income,” as contended by her, or whether the respondent is correct in determining that the capital net loss may not be excluded in computing net income for the purpose of determining the amount deductible as contributions under section 214 (a) (10). The respondent’s contention is that the petitioner has a net income for 1924 upon which she must pay a tax computed under section 208 (c), supra, and that at the same time she has no net income to be used as the basis for determining the amount of the contribution deduction allowed by section 214 (a) (10) and limited to 15 per cent of her net income computed without such deduction. The respondent relies upon his own office decision, I. T. 2104, Cumulative Bulletin III-2, p. 152, as authority for disallowing the deduction of $8,632.65 in determining petitioner’s “ ordinary net income ” subject to normal and surtax. That ruling is as follows:

Aetici® 251: Charitable contributions. III-45-1863
I. T. 2104
REVENUE ACTS OF 1918, 1921, AND 1924
Capital losses can not be excluded in computing net income for tbe purpose of determining the amount of charitable contribution deductions.
Advice is requested as to whether capital losses may be excluded in determining net income for the purpose of computing the amount of charitable contributions allowable as deductions under the Revenue Acts of 1918, 1921. and 1924.
Under the provisions of section 214 (a) 11 of the Revenue Acts of 1918 and 1921 and section 214 (a) 10 of the Revenue Act of 1924, contributions or gifts made by an individual to organizations organized and operated exclusively for charitable or other specified purposes are deductible to an amount not in excess of 15 per cent of the taxpayer’s net income, including such payments.
Sections 212 of the Revenue Acts of 1918 and 1921 define the term “ net income” as follows:
(a) That in the case of an individual the term “net income” means the gross income as defined in section 213, less the deductions allowed by section 214.
Net income is defined by section 212 of the Revenue Act of 1924 as follows:
(a) In the case of an individual the term “net income” means the gross income as defined in section 213. less the deductions allowed by sections 214 and 206.
Section 206 of the Revenue Act of 1921 and section 208 of the Revenue Act of 1924, pertaining to capital gains and losses, do not allow as a deduction any loss resulting from the sale or exchange of capital assets that is not deductible under section 214 or that does not enter into the computation of a net loss deductible under section 206 of the Revenue Act of 1924. Such sections merely give the taxpayer the option of being taxed at the rate and in the manner therein provided instead of at the rates and in the manner provided by sections 210 and 211.
Inasmuch as losses resulting from the sale or exchange of capital assets are deductible under section 214 of the Revenue Acts of 1918, 1921, and 1924, and enter into the computation of the net loss that is deductible under section 206 of the Revenue Act of 1924, it follows that such losses can not be excluded in computing the net income for the purpose of determining the amount of charitable contributions that are deductible under section 214 (a) 11 of the Revenue Acts of 1918 and 1921 and section 214 (a) 10 of the Revenue Act of 1924.

The Revenue Acts of 1918 and 1921 contain no provision similar to section 208 (c) of the 1924 Act, and capital losses, if deductible, are deductible under section 214 of those two prior acts, and we may say, without deciding, that the ruling seems to be a correct interpretation of the 1918 and 1921 Acts. However, we are of the opinion that said ruling is not sound with respect to its attempted interpretation of the 1924 Act. In the instant case the capital net loss is not allowed as a deduction under section 214 of the 1924 Act, and such loss does not enter into the computation of a net loss under section 206 of that act because of section 208 (c) of the same act, which is an entirely new provision and effects a limitation upon a deduction attributable to the capital net loss. The reasonable and, in our opinion, the proper interpretation of the applicable sections of the 1924 Act is that when section 208 (c) is applied, as it must be in this case, the ordinary net income ” is the basis for determining the amount deductible on account of charitable contributions. We can not see how any other conclusion may be properly reached, for the “ ordinary net income ” is determined pursuant to sections 213 and 214 (after excluding all items of capital gain, capital loss and capital deductions) and becomes the taxpayer’s net income for the specific purpose of computing the tax liability'at the rates and in the manner provided in sections 210 and 211, and the total tax is the amount so computed minus 12½ per cent of the capital net loss. That 12½ per cent is in the nature of a credit against the normal and surtaxes computed finder 210 and 211. It is untenable to say that for the purpose of computing a tax liability this petitioner has a net income of $113,151.98 and that at the same time she has no net income for the purpose of computing the amount allowable as a deduction for contributions.

During 1924 the petitioner made deductible contributions totaling $8,632.65, which is less than 15 per cent of her ordinary net income computed without the benefit of section 214 (a) (10), and in accordance with our foregoing opinion she is entitled to a deduction of that amount from her ordinary net income as determined by respondent.

The petitioner did not sustain a statutory net loss in 1924 which could be deducted from income for 1925, and, inasmuch as no other error has been assigned with respect to the year 1925, the respondent’s determination as to that year is sustained.

Reviewed by the Board.

Judgment will be entered -pursuant to Rule St).

       This decision was prepared during Mr. Trussell’s term of office.


author: Teammell :

text:
    Manchester Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 33392.
    Promulgated November 3, 1931.

      W. IS. Pritchard, Esq., for the petitioner.

      Arthur Oarnduff, Esq., for the respondent.
   OPINION.

Teammell :

In 1923 the petitioner expended $829.65 for steel rails and fittings to be used in building extensions of its plant railroad to the site of its mining operations. The railroad so extended did not increase production nor decrease the cost of production, but the extensions were made for the purpose of maintaining the normal output of the mine. The petitioner charged the' above amount to expense and deducted it from income for the taxable year. The respondent disallowed the deduction claimed, treated the expenditure as capital, and allowed a deduction for depreciation. On the authority of our decision in the case of West Virginia-Pittsburgh Coal Co., 24 B. T. A. 234, the petitioner is entitled to the deduction.

During the taxable years, the petitioner was engaged in the business of strip-mining coal. The method pursued in extracting th.e coal is described in detail in our findings of fact above, and will be referred to here only briefly. The petitioner acquired the mineral rights by lease from the Tennessee Coal, Iron & Railroad Company, on condition that it would acquire also the surface rights prior to removal of the coal. This condition was imposed by the lessor for the reason that the coal lay near the surface of the earth and could be mined profitably only by the strip method; that is, by stripping off the over-burden of earth and rock with a steam shovel, thus exposing the seam of coal, and this operation necessarily resulted in destroying the value of the surface. Pursuant to its agreement with the Tennessee Company, the petitioner acquired title to . the surface of the lands in question by purchase for cash - from the various-fee owners. By these transactions the petitioner became the owner of two separate and distinct propérty rights, namely, (1) the right to extract and market the coal, acquired by lease, and (2) the surface of the land acquired by purchase. DTo question is raised in this proceeding with respect to an allowance for depletion of the coal. The sole issue is whether the petitioner is entitled to a deduction from income for the taxable years on account of destruction of the surface of the land resulting from its mining operations in those years.

The petitioner claimed in its returns deductions for “ depletion ” of the surface, which deductions were disallowed by the respondent^ who now contends that his action should be approved substantially for the reason that the mining operations’ carried oh' by the petitioner resulted merely in damage' to the surface or a reduction in its useful value, which could not be computed until the land is sold. The respondent’s position is disclosed in his brief', as follows:

Petitioner’s claim to depletion, thereby resolves itself into a claim’ to deduct damage to the surface caused by its mining operations. ⅜ *i * However, such a deduction whether it be called depletion or damage, or loss, is clearly not allowable, when it is borne in mind that petitioner still owns the surface. * * * Until there has been a sale or other disposition of the property, it is impossible to say whether a gain or loss occurred.

In support of his contention, the respondent cites our decision in Mrs. J. C. Pugh,, Sr., Executrix, et al., 17 B. T. A. 429; affd., 49 Fed. (2d) 76, where it was held that shrinkage in value of the surface was not an allowable deduction.

We are unable to accept the premise upon which the respondent’s argument is based, and for the same reason we think the decision cited is clearly distinguishable on the facts from the present proceeding.

In the Pugh case, it appears that the fair market value of the surface rights in land owned by the petitioners was reduced due to the fact that the land became impregnated with oil and salt water from oil wells drilled thereon and was ' thereby rendered permanently less fitted for cultivation. And we held that the shrinkage in value was not an allowable deduction from gross income, saying in that connection:

There was a shrinkage in fair market value, but such shrinkage in value does not give rise to a deductible loss, any more than' án increase in such value gives rise to income. Until there has been a sale or. other-disposition of the property it is impossible to say whether a gain or .loss- win be sustained.

Here a different situation is presented. We have found that the mining operations of the petitioner resulted in the destruction of the entire value of the surface, not merely in an impairment or shrinkage of such value. The petitioner purchased the fee to the surface for cash, and its aggregate expenditures for this purchase constituted a capital investment which was wholly and completely exhausted or lost as the land was strip mined, acre by acre. It is true that after the mining operations were completed the petitioner still owned the surface, but the value for all practical purposes had been completely destroyed. Thereafter the surface had no market value. It had no salable value whatever. It is within the realm of bare possibility that some unforeseen event might occur at some undeterminable time in the future to give some value to the petitioner’s remaining surface rights, but such a possibility is too remote, uncertain and speculative to entitle it to consideration in determining tax liability. The land now has no market or salable value, and there is no reasonable prospect of its ever having such a value.

Under the facts here presented, where the land itself is destroyed or the coal is mined, we think that the cost of the land should be added to the cost of the coal in determining the depletion allowable. As each ton is mined a proportionate part of the cost of the land should be attributed to it. We know the number of acres and their cost and the estimated number of tons. The total cost of the land divided by the number of tons of coal would give a fair and reasonable basis for depletion for each ton mined.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Lansdon and Sternhagen dissent.*


author: Van Fossan: Seawell,

text:
    A-C Investment Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43192, 49682.
    Promulgated November 4, 1931.

      John 0. White, Esq., for the petitioner.

      M. M. Mahany, Esq., and E. L. Updilce, Esq., for the respondent.
   OPINION.

Van Fossan:

The fundamental issue in these proceedings is whether or not the petitioner was an association taxable as a corporation.

The word “ association ” as used in the revenue acts is a term “used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise. * * * An organized but unchartered body analagous to but distinguished from a corporation.” Hecht v. Malley, 265 U. S. 144.

The petitioner was an unincorporated body of persons. The petitioner’s plan, scope and method of operation are definitely and specifically set out in its constitution and the by-laws which were adopted by its members. As stated in its constitution, it was organized for the purpose of providing “ an investment fund for the benefit of the contributing employees of Anderson, Clayton & Company of Houston, Tex., and the organizations affiliated with that firm. Membership in the petitioner was voluntary. Such membership consisted of “units or shares of a par value of $10 each.” Under the provisions of the by-laws as amended any of the employees of Anderson, Clayton & Company or of its affiliated companies might purchase 120 such units each year and might also purchase units for members of their families. No certificates of stock were issued nor did the association have any stated capital stock. Under the by-laws of the association adopted pursuant to the provisions of the constitution, the interest of each member of the association was evidenced by a deposit book in which were entered the amount of deposits made by the member for the purpose of purchasing the units or shares of the par value of $10 each provided for by the constitution. Among other things, the by-laws defined the duties of the officers. The association was governed by an executive committee chosen by the members from the membership pursuant to the provisions of the constitution, each member having one vote for each unit or share owned by him as evidenced by the entries of deposits made in his deposit book. Kegular meetings both of the association and of its executive committee were held. The executive committee performed the same kind of duties as are performed by the directors of business corporations and the duties of the officers were similar to the usual duties of officers of such corporations. Both the investment fund of the petitioner, which was contributed by the members, and the produce thereof increased largely in amount during the taxafole years. The operations effecting this result were carried on by the executive committee and the officers. It is true that the association had no capital stock as such but, as was said in similar circumstances in Sears, Roebuck & Company’s Employees’ Savings, etc. v. Commissioner, 45 Fed. (2d) 506, reversing 17 B. T. A. 22, there are many kinds of corporations and not all of them have capital stock. The essential facts of the above cited case were quite similar to those of the proceedings now under discussion. The court held that the organization was an association operating as a corporation and taxable as such.

In the case of the petitioner the constitution adopted by its members was its fundameiital law, its charter, so to speak. Its by-laws were duly adopted and were in all essentials like the by-laws of any business corporation. Its executive committee was its governing board and its officers conducted its business in a manner similar to that in which the business of a business corporation is conducted. Accounts were kept with its members by the petitioner. Petitioner’s members had a large voice in the management of their organization, since, under the constitution adopted by them, they could elect the executive committee. The deposit books referred to in the findings of fact were evidence of the members’ interest in the petitioner. The petitioner was engaged in investing the pooled funds of its members for the purpose of securing a profitable return. It invested these pooled funds in real estate mortgage notes, purchased through trust companies and trust departments of banks, industrial bonds, United States Treasury certificates, United States Liberty bonds, stock in building and loan associations, first mortgage loans made directly to the borrower, and in a few small loans made to members on their pass books. Its operations constituted doing business within the definition of that phrase set forth in Flint v. Stone Tracy Co., 220 U. S. 107. It is our opinion that during the taxable years petitioner was an association taxable as a corporation.

But petitioner contends that even if it were an association carrying on business according to the practices of corporations, it was either a mutual savings bank not having a capital stock represented by shares, or a cooperative bank without capital stock, organized and operated for mutual purposes and without profit and is therefore exempt from taxation under the provisions of section 231 (2) and (4) of the Revenue Acts of 1921, 1924 and 1926 and section 103 (2) and (4) of the Revenue Act of 1928. We are not impressed with this contention. The evidence and petitioner’s constitution disclose that the purpose for which the petitioner was organized was to pool the funds of the members for investment. It was not organized for any other purpose. The petitioner’s name itself indicates this purpose. The following statement was made by the petitioner’s sole witness at the hearing herein:

There were plenty of first mortgage notes on real estate, as Houston was a growing city, that paid 8 per cent interest on which you could get security worth double the amount of the notes. The difference between 4 per cent and 8 per cent was the inducement for organizing a mutual organization, by which the various employees could pool their little savings together and get all that the law could afford in the way of interest.

There is nothing to show that at the time of its organization it intended doing a banking business or doing anything other than pooling its members’ funds for investment and profit. It made no effort to organize itself as a savings bank or other form of bank under any statute in force in the State of Texas, the State of its location. Although the proof discloses that at the time of its organization its members were advised by counsel learned in the banking law of the State of Texas, the petitioner, nevertheless, failed until 1928 to attempt to comply with the statute controlling individuals, partnerships, associations and common law trusts -engaged in the banking business. That statute provided that any such entity should add the word “ unincorporated ” in brackets to its name. Acts 1905, S. S., p. 11; Acts 1923, p. 422. Vernon’s Annotated Texas Statutes, Revision of 1925, Vol. I, art. 541, p. 418.

It is significant that no statutory provision of Texas has been cited authorizing the organization of a savings bank not having capital stock represented by shares, or a cooperative bank without capital stock, organized and operated for mutual purposes and without profit. The Texas statutes provide for the incorporation, operation, regulation and supervision of ordinary commercial banks and trust companies having a capital stock, savings banks having capital stock, savings departments in State banks and trust companies and so-called “ Morris Plan ” banks. Vernon’s Annotated Texas Statutes, Vol. I, Title 16, chs. 1 to 9, inclusive. Nor has any decision of the courts of Texas supporting petitioner’s contention that it was either a savings bank having no capital stock, or a cooperative bank without capital stock, organized and operated fon mutual purposes and without profit, been referred to. • We are of the opinion that in using the words “ mutual savings bank having no capital stock ” and “ cooperative banks without capital stock organized and operated for mutual purposes without profit,” as found in the sections of the revenue act hereinbefore referred to, Congress used those terms in relation to such banks as are commonly so known. See United States v. Cambridge Loan & Building Co., 278 U. S. 255.

In the case of National Bank of Redemption v. Boston, 125 U. S. 60, the court said:

Savings banks are institutions under public management, in pursuance of a great and public policy, organized for the purpose of investing the savings of small depositors.

The petitioner is not shown to have been known .as a savings bank or to have held itself out to the public as-such, nor does its constitution, which states its purpose, indicate that it was organized to act as a savings bank. It was not under any form of public control or supervision, its permissible investments were not controlled by statute, and it was not engaged in any service to the public in general.

We are of the opinion that the petitioner was not within the provisions of the statute exempting from tax mutual savings banks not having a capital stock represented by shares.

Likewise, we are not persuaded by the contention that the petitioner was a cooperative bank without capital stock, organized and operated for mutual purposes and without profit, within the contemplation of the phraseology contained in the several revenue acts. It does not appear that such an organization was known to the law of Texas. The petitioner was not known as such a bank. It was organized solely to pool the funds of its members for investment and it was, as we have held, operated for profit, this last fact alone being sufficient basis for denying it the classification asked.

The petitioner contends also that the respondent erred in not holding it either a joint venture or a series of revocable trusts, the income from which was duly reported by the several members. A joint venture is “ a special combination of two or more persons, where in some specific venture a profit is jointly sought without any actual partnership or corporate designation.” Alger Melton, 7 B. T. A. 717. The business conducted by the petitioner was not a single enterprise. It was a continuing series of investments of the funds of the association in securities which changed from time to time, and, as disclosed by the provisions of the constitution and by-laws and the facts, its membership was subject to change and did change by reason of additions and withdrawals. Furthermore, we have held that the petitioner was an association, doing business for profit, upon the methods, forms and practices of a corporation. Petitioner’s enterprise was not a joint venture.

Nor do we consider that there is merit in the contention that the petitioner constituted a group of revocable trusts, the income of which is taxable to the grantor of the trust. In our opinion there is nothing .in the. facts which brings these proceedings within the provisions of section 219 (g) of the Revenue Acts of 1924 and 1926 or within the same provision of section 166 of the Revenue Act of 1928. These sections provide that:

Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of a trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

There was no trust agreement of declaration of trust connected in any way with the organization of the petitioner. It is evident too that the contributions of the petitioner’s members were pooled and constituted a common fund for investment. They were not held or invested in separate amounts representing the respective contributions of the members. The facts disclose that the members could withdraw from the association at will, but whatever the liability on the part of the petitioner’s executive committee and officers to the individual members created by this fact, there is nothing in the facts or the constitution and by-laws of the petitioner to show that the relationship between any parties to the association was that of trustee and beneficiary. In the Sears, Roebuck & Company's Employees' Savings, etc., case, supra, the court had under consideration whether the employees’ saving fund was a trust, and held that it was not, but, as already stated, that on the contrary, the savings fund was an association conducted according to the methods and practices of a corporation.

None of the several alternatives suggested by petitioner commend themselves to our judgment or entitle it to the exemption asked.

The second issue is whether or not the 25 per centum added by respondent to the deficiencies for the years 1921 to 1926, inclusive, was properly so added.

Section 3176 of the Revised Statutes, as amended, provides in part as follows:

In case of any failure to make or file a return or list within the timé prescribed by law, or prescribed by the Commissioner of Internal Revenue or the collector in pursuance of law, the Commissioner shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax.

Under the above quoted provision no such addition to the tax shall be made “ when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect.” The sentence is in the conjunctive. Both conditions must exist. There must have been a filing (though late) of a return and there must have been reasonable cause for the failure to file on time. Here the stipulation is that no returns were filed for the years 1920 to 1927, inclusive. The stipulated facts do not make clear whether the form filed in 1927 related to one year only or to all previous years, but even if such claim for exemption were filed for the entire period, in our opinion such filing would not be equivalent to filing a return required by the statute. The statute is clear and definite that a return must be filed to entitle taxpayer to relief from penalties. Petitioner, therefore, fails to meet one of the two conditions prescribed as prerequisite for relief. The action of respondent in adding 25 per centum of the amount of the tax to the deficiencies determined by him is approved.

Reviewed by the Board.

Judgment will be entered for the respondent.

Seawell,

dissenting: I do not agree with so much of this opinion as approves the addition of a penalty to the tax for any year, especially for the year 1927.


author: McMahon:

text:
    Household Products, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44809.
    Promulgated November 4, 1931.

      O. H. OhmiUon, Esq., J. Robert Sherrod, Esq., and Evoing Everett, Esq., for the petitioner.

      Eugene Meacham, Esq., and O. E. Lowery, Esq., for the respondent.
   OPINION.

McMahon:

During 1926 the petitioner received certain refunds from the Government by virtue of overpayments of its taxes for 1920 and 1921. Interest on said overpayments, computed under section 1116 of tlie Revenue Act of 1926, amounts to $18,226.56 for 1920 and $24,773.49 for 1921, which said amounts have been included in petitioner’s gross income for 1926.

Petitioner contends that, since it keeps its books on the accrual basis, the interest on the 1920 overpayment should be accrued ratably from the date of overpayment until November 2,1925, when respondent allowed the refund, and that all of said interest, $18,226.56, accrued prior to 1926, and, therefore, no part thereof constitutes taxable net income for said year. In the alternative, petitioner contends that the interest accrued in its entirety on November 2, 1925, when respondent approved and scheduled the overassessment. As to interest on the 1921 overpayment, petitioner contends that $22,734.24 thereof accrued prior to January 1, 1926, and does not, therefore, constitute taxable net income for 1926.

Section 1116 of the Revenue Act of 1926, hereinabove referred to, provides that:

(a) Upon the allowance of a * * * refund of any internal-revenue tax * * * interest shall be allowed and paid on the amount of such * * * refund at the rate of 6 per centum per annum from the date such tax, penalty, or sum was paid to the date of the allowance of the refund * * *.

The date of the allowance of the refund is defined in subdivision (b) of said section as the “ first date on which the Commissioner signed the schedule of overassessments in respect thereof.”

The language used by the Congress in providing for interest in the above quoted portions of section 1116, in our opinion, indicates that prior to the allowance of the refund there was no liability for interest running from the Government to a taxpayer. It is only upon the allowance of the refund that interest in any sum is to be allowed. Therefore, prior to November 2, 1925, there was no interest due from the Government which the taxpayer could have accrued as income on its books of account.

This interpretation of section 1116 is supported by language contained in the decision of the Court of Claims in Hind v. United States, 41 Fed. (2d) 892, wherein taxpayer was suing for additional interest on refunds of 1918 and 1919 income taxes, basing his contention on the Supreme Court’s decision in Girard Tnost Co. v. United States, 270 U. S. 163; whereas the Commissioner, relying on section 1116 of the Revenue Act of 1926, had reduced the amount of interest which taxpayer would have received under the Supreme Court’s decision in the Girard Trust Co. case. In the Hind case the court, after stating that the plain purpose of section 1116 of the 1926 Act was to shorten the interest period, said (p. 895) :

Except as given by Congress, plaintiff liad no right to interest; nor did be bave a right to maintain a suit for the recovery of interest that could not be taken away, even though such suit had been authorized by existing law at the time it was commenced. The allowance of interest hy the soverign is a matter of grace, depending -upon its consent, which it can withdraio or modify at any time. [Italics supplied.]

In Brooklyn Union Gas Co., 22 B. T. A. 507, we considered both the accrual of income and the accrual of deductions, and with respect to each class of accruals we held that the taxpayer was required to follow a consistent practice in order to clearly reflect its income. Speaking with respect to the accrual of income, we said (p. 524) :

We think that a taxpayer on an accrual basis who renders service in a taxable year and asserts in that year a right to payment in a given amount is then chargeable with income in that amount if, at the close of that year, all of those conditions have been met, all those things done, which give rise to the right asserted, irrespective of the fact that the right may be contested and ultimate collection may be postponed until some future year. In such case the right to receive the income is a right then perfected and the litigation later concluded merely determines the right as having existed in the former year.

Likewise, in that case we discussed our decisions “ in the so-called Federal Control Cases, in which properties of railroad companies were taken for public use under act of Congress (40 Stat. 451) providing that just compensation be paid for such use,” and pointed out that there was no material difference in the questions presented, because the right of the railroads to just compensation was guaranteed by the act providing for their control and by the Federal Constitution. In the Federal Control Cases (one of which, the Texas Pacific Railway Co. case, is hereinafter more fully considered), we held that the rentals represented income to the companies accruable for the jmars in which the Government’s obligation to make and the taxpayer’s right to receive payment arose.

In the instant proceeding the Government’s obligation to pay interest on refunds, and the taxpayer’s right to receive such interest, arose at the moment the respondent signed the schedule of overas-sessment, section 1116, supra. Prior to that time there was no liability on the part of the Government to pay interest, because the allowance of interest is based specifically upon the final determination of the respondent that a refund should be granted. If the taxpayer were entitled to interest on all refunds as a matter of right, the petitioner’s position would be stronger, but, as quoted above, “ the allowance of interest by the sovereign is a matter of grace,” and until the statutory requirements are fulfilled, that is, until there is a final decision by respondent, the taxpayer has no right to interest and the Government has no liability with respect thereto. In this connection it should be noted that prior to the enactment of section 1324 of the Revenue Act of 1921, which is the prototype of section 1116, there were no provisions in the revenue acts authorizing the payment of interest on refunds.

We have examined the cases replied upon by the petitioner, Texas & Pacific Railway Co., 9 B. T. A. 365, 373; Southeastern Express Co., 19 B. T. A. 490, and United States v. Anderson, 269 U. S. 422, but we are of the opinion that those cases are not helpful in determining the present issue. In the Southeastern Express Co. case the taxpayer accrued certain claims which it had against the American Express Company and reported them as income in 1921. The claims were resisted, and three years later the Supreme Court decided that the amounts were properly claimed and should be paid. We held that the amount of said claims represented income in the year accrued, and not in the year 1924, when the matter was finally determined. In the Texas Pacific Railway case the taxpayer claimed as a part of its compensation interest on betterments and improvements which was determined and allowed by the Director General of Railroads in 1923 for the years 1918 and 1919. We held that the said interest, which had been accrued, constituted taxable income for the years 1918 and 1919. In both of these cases it should be noted that income was accrued by the taxpayers on their books of account as a result of services rendered, or as the result of a contractual liability, despite the fact that the exact amount of said income was undetermined until subsequent years, whereas in the instant case there was no accrual of interest as income by the petitioner. Cf. United States v. Anderson, supra.

In view of the foregoing we are of the opinion that while petitioner can not accrue the interest ratably over the several years, it is entitled to accrue the $18,226.56 item as income on November 2,1925, which is the relief sought in petitioner’s alternative contention as to interest on the 1920 refund. With respect to the interest on the 1921 refund, the respondent properly included it in petitioner’s taxable income for 1926, since the schedule of overassessment was approved by the Commissioner on or about April 14, 1926.

Reviewed by the Board.

Decision will be entered under Rule 50,


author: MaRquette :

text:
    Alexander Sprunt & Son, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 38408.
    Promulgated November 4, 1931.

      J. Marvm Haynes, Esq., and O. J. McGuire, Esq., for the petitioner.

      B. M. Goon, Esq., and O. R. Marshall, Esq., for the respondent.
   OPINION.

MaRquette :

1. The first issue has been somewhat beclouded by the different positions taken by the petitioner in the pleadings and in its brief. In the preliminary statement of this report, we have quoted verbatim under (1) the assignment of error as set forth in the petition. In the statement of facts contained in the petition, the petitioner alleged as follows:

These commissions were taken as a deduction from gross income in the 1923 tax return filed ky the petitioner. The respondent has in its 00-day letter disallowed these commissions as a deduction from gross income and has stated, in its 60-day letter the following reason for the disallowance:
“ This item represents commissions earned through your Bremen agency and represents taxable net .income to you.”

In his answrer the respondent, though denying any error in his determination, admitted the above allegation of fact; and upon the basis of these pleadings the case came on for hearing. In its brief the petitioner entirely ignores the question of whether the amount credited on its books to the Bremen firm in 1923 and subsequently paid as commissions constitutes a proper deduction from the gross income of that year, and, contending that the respondent is bound by the explanation of his determination in the deficiency notice and that he must win or lose accordingly as the Board finds that such explanation does or does not legally support his determination, it sets forth that the sole question , for decision is whether the commissions received by the Bremen firm are properly chargeable to the petitioner as its income. Devoting its entire brief to an argm ment on the latter question, the petitioner asserts that the evidence conclusively proves that the Bremen firm and the petitioner are separate and distinct taxable entities; consequently, that the income of the Bremen firm can not be charged to this petitioner; and that the respondent’s deficiency determination, so far as based on the addition of $286,071.30 to the reported net income, must fail. In other words, the petitioner argues that, since the respondent explained the addition of $286,071.30 to the reported net income as income of its “ Bremen agency ” properly includable in its tax return, and since he did not specifically say that the addition was based upon the dis-allowance of a portion of the deduction which the petitioner claimed for commissions paid or credited to the Bremen firm, the Board must assume that the respondent’s determination is that the petitioner is entitled to a deduction for the entire amount of such commissions and it must set aside so much of the deficiency as is based upon this item, if it finds that the petitioner is not properly chargeable with the income of the Bremen firm.

There are fundamental weaknesses in this line of argument that are not easily disposed of. In the first place, the pleadings contain allegations by the petitioner, readily admitted by the respondent, to the effect that the petitioner claimed “ a deduction from gross income in- the 1923 tax return ” for the commissions paid to the Bremen firm, in the amount of $286,071.30, and that “ the respondent has in its 60-day letter disallowed these commissions as a deduction from gross income,” though the respondent admits further that the explanation of his action in the deficiency notice was entirely different. Further, as was stated by the Board in Edgar M. Carnrick, 21 B. T. A. 12:

The phrasing of the notice of deficiency relating to the item in controversy, even if clear, is not the cause of action and does not frame the issues. The petitioner may not, without an expressly pleaded admission or a stipulation, treat the notice as an official acquiescence by the Commissioner in all petitioner’s propositions as to this item except those expressly determined adversely to him. If the Commissioner finds one fact or reason which he believes supports his adverse determination, he is not required to express his views on any or all other matters relating to the item, and his failure to deal with them carries no implication as to their treatment. It is not the Commissioner’s method of determination or computation which is the substance of the proceeding, for the deficiency may be correct despite a weakness in arriving at it or explaining it. Woodside Cotton Mills Co., 13 B. T. A. 206; Jacob F. Brown et al., 18
B. T. A. 859. “ It is immaterial whether the Commissioner proceeded upon the wrong theory in determining the deficiencies. In any event the burden was on the petitioner to show that the assessment was wrong.” Altschul Tobacco Co. v. Commissioner, 42 Fed. (2d) 609.

On the record before us, it is clear that the petitioner claimed a deduction, in computing taxable net income for 1923, of $336,554.48 for “ commissions ” paid or accrued in that year; and that the respondent allowed a deduction of only $50,483.13 and disallowed $286,071.30. The question, therefore, to be decided is whether the petitioner is entitled to the whole amount of the deduction claimed.

It is obvious that if this item is a proper deduction in computing net income, authority therefor must be found in section 214 (a) (1) of the Revenue Act of 1921, since no other section of the statute is broad enough to include an item of this character. That section provides for the deduction of “All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on'any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * *

It seems clear enough from the findings of fact that the new Bremen firm and the petitioner corporation are separate and distinct entities, though composed of the same persons, with like interests in both. These two entities were entirely free to deal with each other and fix their relations, by formal or informal agreements, as though they were composed of different persons, and business transactions between them are entitled to the same respect and consideration, in fixing their income-tax liabilities, as are accorded to dealings between less closely related business organizations, so long as their relations are not availed of as a mere vehicle for evasion of the tax. Cf. Louis C. Rollo et al., 20 B. T. A. 799. If, therefore, the payments made by the petitioner to the new Bremen firm were ordinary and necessary in the conduct of its business and in the earning of its income, and were reasonable in amount, considering the services rendered, there is no bar to their deduction in the computation of net income. For what then were these payments, totaling $336,554.48, made by petitioner to the new Bremen firm ?

It may be conceded, upon the evidence, that the old Bremen firm had enjoyed a very lucrative business in the cotton markets of Central Europe, and, at the outbreak of hostilities between the United States and the German Government, was possessed of an established good will of considerable value. With the outbreak of hostilities, however, it was forced to cease its business activities at Bremen, the seat of its operations, and apparently elected to iemain inactive during that emergency. After the close of the war, it definitely abandoned the thought of resuming the business and reopened the Bremen office solely for the purpose of liquidation. In the interim, the petitioner had opened a branch office at Rotterdam and through that office had established connections with the former customers of the old Bremen firm and was carrying on business with those customers with apparently much success and not at all handicapped by reason of the former connections of those customers with the old Bremen firm. Such were the conditions existing at the time of the alleged demands of the members of the old Bremen firm for some sort of compensation, because the petitioner was capitalizing upon the business which they had built up, and when the petitioner was actually in possession of and enjoying the benefits of that business and its good will. What then was the necessity for the payment of these so-called “ commissions ” to the members of the old Bremen firm ? The only explanation therefor is to be found in the testimony of the petitioner’s president, who was a member of the old and new Bremen firms and a stockholder in the petitioner, that it was very much to the petitioner’s interest “ to ke.ep the former partners of the Bremen partnership in a friendly frame of mind.” We are left to draw upon our own imagination as to the probable consequences of petitioner’s failure to meet those alleged demands.

The record does not show that the new Bremen firm was directly responsible for a single dollar’s worth of petitioner’s sales in 1923, that is, that the members of the firm consummated a single dollar’s worth of sales for the petitioner’s benefit. If any portion of the petitioner’s 1923 cotton sales in Central Europe can be attributed to the activities of any of the fourteen members of the firm, they may likewise be attributed to their activities as officers, directors and stockholders of the petitioner corporation. So far as we have been able to discover, the only services rendered by the new Bremen firm in 1923, for the petitioner’s benefit, were represented by the activities of only three of its fourteen members, Walker, Lippitt and W. H. Sprunt. Walker was also manager of petitioner’s branch office at Rotterdam, and Lippitt and Sprunt were executive officers of the petitioner, located at Wilmington, IST. C. Walker divided his time about equally between Rotterdam and Bremen, at the latter place attending to the affairs of the old and new Bremen firms. Lippitt and Sprunt made several trips to Europe for the purposes of assisting in the liquidation of the affairs of the old Bremen firm and of further developing and retaining the business of that firm for the petitioner’s benefit. It is wholly impossible from the evidence to draw any line of demarcation between their activities, as members of the Bremen firm, in the interests of the petitioner and their activities as officers, directors and stockholders of the petitioner. In any event the evidence does not justify the conclusion that they, as partners, rendered any services to the petitioner which would not ordinarily have been required or expected of them as officers of the petitioner. The fact that the payments made to the Bremen firm were not in excess of the commissions usually paid to selling agents does not of itself prove the reasonableness of these payments. The question is, was the total amount paid reasonable for the services rendered by the Bremen firm to the petitioner; and the answer must be in the negative, since the evidence is far from convincing that the firm rendered any services of substantial benefit to the petitioner. If the respondent had no more before him upon which to reach a determination in the matter than the evidence presented to us, we think he was more than reasonable in the allowance which he made.

We think the true character of these payments to the Bremen firm is best indicated by the fact of the admission to the partnership, apparently -without any contribution of capital or services, of the seven individuals who were not members of the old Bremen, firm but who, at the time of the organization of the new firm, were holders of common stock in the petitioner corporation, and the allotment to each of the fourteen members of the firm of an interest proportionate to his holdings of common stock in the petitioner. Asked if he could explain the admission to the firm of the seven new members under such circumstances, the petitioner’s president testified that they were admitted “ merely by agreement to satisfy their claim.” What claim had these seven new members which could be satisfied only in this fashion ? They had no interest in the old Bremen firm and no claim upon its business and good will. They contributed- nothing in the way of capital or services to the new firm. All of the circumstances of which we have been apprised tend to indicate that their sole claim was the right to share with the majority of petitioner’s common stock holders in any distribution of profits. We find no error in the respondent’s determination in this matter.

2. The second issue raises the question as to whether the entire .amount of commissions accrued on the petitioner’s books, to the credit of the Societe Cotonniere Franco-Americaine, may be deducted in computing net income. The respondent contends that the French corporation is “merely an incorporated branch office of the petitioner,” and that the accruals in its favor, on the petitioner’s books, represent nothing more than distributions of profits. We think that the respondent’s determination in this matter is erroneous. The evidence leaves no room to doubt the separateness of the two corporations, and there is no indication of fraud, attempt at tax evasion, or other circumstance which might justify or require a disregard of the separate corporate entities. The allowance of commissions to the French corporation could hardly be termed distributions of profits, since the corporation owned none of the petitioner’s capital stock. The only question which might arise in connection with these commission allowances would be the matter of the bona fides of the allowances, and as to that, the evidence shows clearly that the allowances were made for services actually rendered in the consummation of sales for petitioner’s benefit, and were computed at rates customarily allowed to petitioner’s other selling agents. They represent a proper charge against the petitioner’s gross sales as a part of their cost, and are a proper deduction in computing net income. The net income shown in the deficiency notice should be reduced by $33,736.28.

3. The third issue relates to respondent’s action in adding to the reported net income an item of $601.05 on the ground that the net income of the Houston branch office-had been understated bj^ that amount. The evidence shows that the respondent’s determination in this matter is erroneous. The alleged understatement is due to the petitioner’s payment of bonuses of $601.05 to employees of the Houston branch office. For reasons of its own, the petitioner made payments direct from its Wilmington office and without making any record thereof in the books of account of the branch office. In accounting for the profits of the branch office on the books of the home office, a charge was made against those profits for the amount of the bonus payments; consequently, the profits of the branch office as shown by the home office books were less, by the stated amount, than the profits shown by the branch office books. The net income shown by the deficiency notice should be reduced by $601.05.

4. In this issue the petitioner, questions the propriety of the respondent’s action in disallowing as deductions eight items, totaling $19,120.32, which the petitioner had claimed- in its return as a part of its general expenses. The respondent, in' his brief, confesses error as to the disallowance of two of these items, to wit: bonuses to employees, in the amount of $13,682.82, and cost of purchases of cotton samples, in the amount of $50; and the petitioner, in its brief, withdraws the assignment of error as it relates to three other items, to wit: payment to the Hew York Cotton Exchange in the amount of $20, a further payment to the Hew York Cotton Exchange in the amount of $20, and Wilmington Light Infantry dues in the amount of $100. There are left for our consideration three items, to wit: a contribution of $5,000 to a fund to be used in eradicating the boll weevil; a payment of $25 to the Order of Railway Yardmen for advertising inserted in a magazine published by that order; and payments amounting to $262.50 for advertising inserted in magazines published by the American Legion and various labor and trade organizations. .

The respondent contends that the contribution of $5,000 to the fund raised by various cotton exchanges, to be used in the eradication of the boll weevil, should not be allowed, for the reason that the petitioner has failed to show definitely' that it was in any way benefited by this contribution. We are of a different opinion. The petitioner was engaged in the business of exporting raw cotton and of operating a warehouse for the storage of the same commodity. Its business was dependent upon a normal production and a crop of good quality, both of which were, in turn, dependent upon the successful control of the boll weevil. We may take judicial notice of a situation generally known to exist, the prevalence of the boll weevil and its destructive effects upon the cotton crops of our southern States, to remedy which much is being done by the States and national and private enterprise. In máking the contribution there was no thought of charity or philanthropy; the motives of the petitioner were purely mercenary, its expectation being that its business would be benefited proportionately to the degree of success attendant upon the campaign of eradication or control of the pest. It is entirely unreasonable to ask the petitioner to measure the benefits of this contribution in terms of dollars and cents. The question always is whether balancing the outlay against the benefits to be reasonably expected, the business interests of the taxpayer will be advanced. American Rolling Mills Co. v. Commissioner, 41 Fed. (2d) 314. All circumstances considered, we think the benefits “ to be reasonably expected ” to flow from this contribution were, at least, fairly proportionate to the expenditure.

As to the amounts expended for advertising inserted in magazines published by the Order of Railway Yardmen, American Legion and various trade and labor organizations, totaling $287.50, the respondent contends that the names of the magazines in which the advertisements were inserted indicates that the expenditures were merely “good will donations.” While such an inference might be drawn, it does not necessarily follow and it is negatived by the evidence.

Accordingly, the net income shown in the deficiency notice should be reduced by $13,682.82 for bonuses to employees; by $50 for cost of purchases of cotton samples; by $5,000 for contribution to the fund for eradication of the boll weevil; and by $287.50 for advertising in various magazines, a total of $19,020.32.

5. For some reason not disclosed by the deficiency notice, any admitted pleadings, or evidence, the respondent increased the 1923 inventory of petitioner’s Charlotte branch office by $11,185.96. The petitioner asks us to set aside the respondent’s determination in this matter, on two grounds: (1) Because his action, in holding that adjustments with sellers of en route cotton should be treated as additional cost of that cotton and reflected in its inventory value and not accounted for as an expense of the- later year in which such adjustments are made, is contrary to the petitioner’s consistent accounting practice and the best accounting practice in the industry; and (2) because the respondent failed to make a similar revision of the 1922 inventory, which is the opening inventory for 1923, in respect of the 96 bales of en route cotton included in that inventory, thus placing the opening and closing inventories for 1923 on different bases, with a resulting distortion in net income. - '

Both reasons are premised on the assumed fact that the increase made by the respondent in the Charlotte inventory reflects the adjustments made in 1924 with the sellers of the 1,396 bales of en route cotton included in the 1923 inventory of the Charlotte branch. But we do not know whether the assumption is correct or not. Certainly, nowhere in the record is there an admission of the fact by the respondent — his brief is entirely silent on this issue; and there is no proof of a single fact which would indicate that the respondent’s inventory adjustment is related to the 1,396 bales of en route cotton included in that inventory. For all we know, the respondent may have determined, in respect of the Charlotte inventory, that there was an erroneous count in the number of bales of cotton, or that inventory weights were incorrect, or any other of a number of possible errors which might be suggested. In short, we do not know why the respondent increased the Charlotte inventory by $11,185.96; consequently, the decision on this issue can not be limited to the consideration of any one particular element of the inventory valuation, but must embrace the whole matter of that valuation. Since the petitioner has failed to show that the Charlotte inventory was of a value less than that determined by the respondent, we are not in any position to disturb the respondent’s determination. Furthermore, even if we could assume that the premise of petitioner’s contentions is correct, there is no evidence that there were adjustments with sellers in 1923 in respect of the 96 bales of en route cotton included in the 1922 inventory; consequently, the petitioner has failed to prove that the respondent has been inconsistent in his treatment of adjustments with sellers in respect of the en route cotton in the opening and closing inventories for 1923 and thereby has placed the two inventories on different bases.

6. The record does not show whether the sum of $1,500 paid to Goldman and Unger in 1923, for services in connection with legal proceedings to recover war risk insurance premiums, was in payment of services rendered entirely to the petitioner or in payment of services rendered partly to the predecessor partnership and partly to the petitioner. If any part thereof was in payment for services rendered to the partnership, the payment was in satisfaction of a liability of the partnership which the petitioner assumed in part payment for the partnership’s assets, and that part of the whole amount paid would represent a capital expenditure — additional cost to the petitioner of the partnership’s assets, which would not be a proper deduction in computing net income.

Even if we assume that the payment was for services rendered entirely to the petitioner, the whole amount thereof still would not be deductible, because a portion thereof was expended in establishing petitioner’s right, as assignee of the partnership by purchase, to recover amounts paid out by the partnership for war risk insurance premiums; and that portion of the payment represents an additional cost to the petitioner of the partnership assets, a capital expenditure which may not be deducted in computing net income.

The evidence does not contain any facts upon which we could base a reasonable apportionment of the payment to the claims of the two entities, and we are unable, therefore, to determine what portion of the whole payment is a proper deduction in computing net income. Under the circumstances, the respondent’s determination in the matter must stand.

7. This issue raises the question of the propriety of respondent’s action in holding that certain expenditures made in 1923, and claimed as deductions by the petitioner in computing net income, were made for additions and betterments which materially prolonged the lives of the buildings, and, therefore, were of a capital nature and may not be deducted in computing net income.

As to the payment of $4,200 for the construction of a concrete wall around the petitioner’s warehouse at Charlotte, the findings of fact clearly show the nature of this expenditure. Unquestionably, the concrete wall which replaced a wooden one no longer useful for the purposes for which constructed was a substantial and permanent betterment and rendered the building better suited to the purposes for which it was used. The expenditure for the construction of the concrete wall is of a capital nature and, therefore, is not a proper deduction in computing net income. Cf. Georgia Car & Locomotive Co., 2 B. T. A. 986; Black Hardware Co., 16 B. T. A. 551; affd., 39 Fed. (2d) 460; certiorari denied, 282 U. S. 841.

It is also clear that much that was done in renovating Building A at Wilmington, for the purpose of renting the building, was in the nature of permanent betterments. The entire plumbing system was overhauled, the building was rewired for electricity, new window sashes were installed, and window screens and screen doors replaced. While these betterments may not have materially prolonged the life of the building, they unquestionably rendered it better suited to the petitioner’s purposes. Some part of the work done might well be considered as ordinary repairs which may be deducted in computing net income; however, the record affords no basis for a segregation of these items from those of a capital nature and, consequently, we can not determine what part of the entire cost of renovating the building is a proper deduction. I. M. Cowell, 18 B. T. A. 997. However, the respondent restored to income the sum of $3,050.07, which was the superintendent’s estimate of the cost of renovating the building, whereas the actual cost was only $1,630.44, and only the latter amount was deducted by the petitioner in computing net income.

Our conclusions on this issue require a reduction in the net income as shown by the deficiency notice, in the amount of $1,319.63.

8. The petitioner contends that the inventory of the Wilmington branch, as of December 31, 1923, was overstated by $33,412.60, due to using incorrect and excessive weights in valuing the cotton of six grades, resulting in a like overstatement of net income. In the deficiency notice, the respondent reduced the net income reported in the return by $3,403.29; but the petitioner contends that there should be a further reduction of $30,009.31.

The petitioner placed in evidence the original inventory sheet showing the grades of cotton on hand, number of bales of cotton in each grade, weight of cotton in each grade, and value of the cotton in each grade. This sheet showed a total value for the' inventory, of $4,122,-404.33. It also put in evidence a revised inventory sheet showing corrected weights for six grades of cotton; and the total value of the inventory, as shown by this revised sheet, is $4,088,991.13, which is $33,412.60 less than the value shown by the original inventory sheet. Not all of the difference of $33,412.60 is due to a correction in weights. An examinatipn of the revised inventory sheet shows that of the total difference, $2,526.73 is due to a change in the unit price per pound of cotton en route to destination — the original inventory showing a unit price of $0,345 per pound, while the revised inventory shows a unit price of $0.3325 per pound. No evidence was presented by the petitioner to support this change in price; hence, the change may not be allowed.

While we have found that incorrect weights were used as to six grades of cotton in valuing the inventory, there is not sufficient proof to show error in the respondent’s determination as to the value of the inventory. After investigating the inventory, the respondent determined, as indicated by the deficiency notice, that the inventory reported in the return had been overstated by $3,403.29. The deficiency notice, pleadings and evidence do not show the basis of that determination. The fact that the respondent did not make as great a reduction in the inventory as might be required by a revision of weights in six grades of cotton indicates that in all probability he found offsetting errors elsewhere in the makeup of the inventory. He was under no obligation to set forth fully in the deficiency notice the basis of his determination. The obligation rested on the petitioner, therefore, to prove the value of the inventory and the inventory value used by the respondent in his deficiency determination. The first required proof of quantities, according to grades, basis used in valuing the inventory, whether cost of cost or market, whichever is lower, and the unit price of each grade, cost or market, according to the basis of valuation, but the petitioner failed to prove either the basis or the unit prices used. As to the inventory value used by the respondent in the deficiency determination, we can only assume that-it was the value shown by the original inventory sheet reduced by $3,403.29; the deficiency notice indicates only that the respondent reduced the inventory value reported in the return by $3,403.29, but the value reported in the return may have been entirely different from the value shown by the original inventory sheet. The evidence is insufficient to show error in the respondent’s determination as to the value of the inventory of the Wilmington branch.

9. The petitioner increased the book value of its compress equipment in 1923 by $15,622.53, and credited profit and loss account with a like amount. The amount so credited to profit and loss was included in gross income in the return, but $4,173.16 was eliminated from income by the respondent in the deficiency notice. The revaluation of the compress equipment and the arbitrary write-up on the books of the value of that equipment on the books did not give rise to any taxable income, and the whole amount of the write-up should have been excluded by the respondent from income. The net income shown in the deficiency notice should be reduced by $11,449.37.

10. The expense of removing a cotton compress from Wilmington to Houston, was an ordinary and necessary expense of carrying on the petitioner’s business, MacAdam & Foster, Inc., 8 B. T. A. 967; Eastern Shoe Manufacturing Co., 8 B. T. A. 1169; and since the cost thereof has not been allowed as a deduction by the respondent, the net income shown by the deficiency notice should be reduced by $8,355.19.

11. The petitioner complains of respondent’s failure, in computing net income for 1923, to allow as a deduction the sum of $350,000 representing alleged interest paid to the holders of petitioner’s certificates of paid-in surplus in that year.

In James Sprunt Benevolent Trust et al., 20 B. T. A. 19, it was held that the payments received from this petitioner on the certificates of paid-in surplus under consideration in this case were interest income and not dividend'income to the trust, and were subject to both the normal and surtaxes. In the instant case, however, the evidence as to the nature of these payments is much more full and complete than that presented to the Board in the cited case, and clearly reveals the true nature of these payments to be dividends and not interest. Clearly the holders of these certificates of paid-in surplus are shareholders in the petitioner and not creditors. The resolution adopted at the stockholders’ meeting of June 9, 1919, and the instrument itself disclose that the funds represented by these certificates have been invested in the business without any guarantee of return and subject to all the risks and hazards of the business. The semiannual payments to the certificate holders of 7 per cent upon the face value of the outstanding certificates are denominated “ dividends ” in .the certificate, and are required to be paid, by the provisions of the certificate, out of earned surplus or net profits of the corporation. The rights of the certificate holders to repayment of the principal sums or face values of their certificates and the accrued dividends thereon are subordinate to those of the general creditors of the business. They have only preferred rights over the holders of common stock. In the last analysis, these certificates are nothing more nor less than certificates of preferred stock, and the amounts paid to the holders thereof in 1923, in accordance with the provisions as to dividends, are dividends and not interest payments. The decision in James Sprunt Benevolent Trust et al., supra, is not controlling here. There is no error in respondent’s determination by reason of his failure to allow as deductions, in computing net income, the amounts so paid to holders of certificates of paid-in surplus.

12. We have already held in our decision of the first issue that the Bremen firm and the petitioner are separate and distinct taxable entities; and there is no provision of law under which the net loss of the Bremen firm for 1923 may be allowed as a deduction in computing the petitioner’s net income for that year.

Reviewed by the Board.

Judgment will be entered under Rule 50.