author: Smith : Murdock,

text:
    Walter B. Lashar, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 37883.
    Promulgated July 10, 1936.

      J. Gilmer Kornev, Jr., Esq., and David E. Blair, Esq., for the petitioner.

      H. F. Morton, Esq., and Frcmlc M. Thompson, Esq., for the respondent.
   OPINION.

Smith :

It is the contention of the respondent relative to the principal issue that, even though several steps were taken in the recapitalization of the American Chain Co., each step was a part of a general plan of reorganization and that the petitioner really exchanged his 100,000 shares of old no par value common stock of that company which had a cost basis of $1,000,000 for 230,000 shares of new no par value common stock of a fair market value of $25 per share and $2,250,000 cash, and that he is taxable under section 202 (e) of the Revenue Act of 1921, as amended by the Act of March 4, 1923, to the extent of the cash received. The petitioner contends that he exchanged his 100,000 shares of old no par common stock for 125,000 shares class A stock and 250,000 shares of new no par common stock pursuant to a reorganization; that as a separate transaction he sold the class A stock and 20,000 shares of new no par common stock to the bankers for $2,250,000; that the cost of the shares sold was in excess of $2,250,000 and that he therefore sustained a deductible loss on the transaction.

The material provisions of section 202 of the Revenue Act of 1921, as amended by the Act of March 4, 1923, are as follows:

BASIS FOB DlimailNING GAIN OK LOSS
Seo. 202. (a) That the basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall he the cost of such property; except that—
⅜ ⅜ ⅜ ⅜ ⅜ ⅜:
(c) For the purpose of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized — i
⅜ ⅜ ¾: # ⅜ :⅜ ⅜
(2) When in the reorganization of one or more corporations a person receives in place of any stock or securities owned by him, stock or securities in a corporation a party to or resulting from such reorganization. The word “reorganization,” as used in this paragraph, includes a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form, or place of organization of a corporation (however effected) ; on
* * ⅜ * * * *
(d) (1) Where property is exchanged for other property and no gain or loss is recognized under the provisions of subdivision (c), the property received shall, for the purposes of this section, be treated as taking the place of the property exchanged therefor, except as provided in subdivision (e) ;
* * * * ⅜ * *
(e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2), and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the amount of the gain resulting from such exchange shall be computed in accordance with subdivisions (a) and (b) of this section, but in no such case shall the taxable gain exceed the amount of the money and the fair market value of such other property received in exchange.

Our first question is whether the sale by the petitioner of the 125,000 shares of class A stock and the 20,000 shares of common stock to the bankers for $2,250,000 occurred in the reorganization of the American Chain Co. so that the petitioner’s gain is to be computed under section 202 (e) above, or whether such sale was a separate transaction, independent of the reorganization, on which the petitioner’s gain or loss is to be computed on the basis of the cost of the shares sold.

The parties are in agreement that there was a statutory reorganization of the American Chain Co., as unquestionably there was under section 202 (c) (2) above, brought about by the recapitalization of that company. The exchange by the petitioner of his old shares for new shares pursuant to this reorganization was a nontaxable exchange.

We agree with the petitioner’s contention, however, that the sale by him to the bankers of the portion of the new shares of stock which he thus received was not an essential part of and was not within the reorganization. The reorganization was embodied in the “recapitalization” of the company. This was completed before the sale by the petitioner of any of the stock which he acquired in the reorganization. It is true that the provision for the sale was incorporated in the original agreement made by the petitioner and the bankers, as later amended, but the company itself was not a party to the agreement and the company’s reorganization was not conditioned upon it. In his offer to the bankers the petitioner, after setting out the details of the proposed reorganization, stated “I will then sell to you 100,000 shares of said Class A stock received by me and 20,000 shares of said common stock received by me for a total price of $2,250,000 * * *. All of said stock to be delivered to yon by me as aforesaid shall be delivered on April 2, 1923' at the office of Dillon, Reed & Company or as hereinafter provided.” (Italics ours.)

The petitioner and the bankers were entirely at liberty after completion of the reorganization to alter or revoke this part of the agreement, and in fact did alter it as to the number of shares which the petitioner should sell.

We have held in a number of cases that not every transaction which takes place as a consequence of a reorganization or which is provided for in an agreement embodying a plan of reorganization is to be treated for tax purposes as a part of a statutory reorganization. It is only those transactions which form an essential part of the reorganization that are to be so treated. See Daisy M. Ward, 29 B. T. A. 1251; aff'd., 79 Fed. (2d) 381; Ballwood Co., 30 B. T. A. 644 (reversed on a question of reorganization on the authority of Helvering v. Watts, 296 U. S. 387; Edison Securities Corp., 29 B. T. A. 483 (remanded to the Board, 78 Fed. (2d) 85) ; Liquidating Co., 33 B. T. A. 1173; Swiss Oil Corporation, 32 B. T. A. 777.

Under the provisions of section 202 (d) (1) above the 125,000 shares of class A stock and the 250,000 shares of common stock received by the petitioner in the reorganization in exchange for his 100,000 shares of old common stock are to “be treated as taking the place of the property exchanged therefor.”

Our question, then, is, What was the cost to the petitioner of the 100,000 shares of old common stock ?

In his income tax return for the year involved the petitioner used a cost basis for the 100,000 shares of $1,000,000. The same cost basis was used by the respondent in his determination of the deficiency. The petitioner now contends, however, that the cost basis was much greater than that amount.

The evidence shows that the 100,000 shares no par common stock in question were acquired by the petitioner on July 9, 1920, as the result of a nontaxable reorganization of the American Chain Co. on that date. These were acquired in exchange for all of the common stock of the American Chain Co. then outstanding, viz., 10,000 shares, par value $100 each, all of which was owned by the petitioner. The transaction which took place on July 9, 1920, was simply a split-up of the common shares, ten for one. Since the split-up was admittedly a nontaxable reorganization under the statute, the 100,000 shares of no par common stock bad the same cost basis as the 10,000 shares of $100 par common stock. Our problem, then, is to determine the cost basis to the petitioner of those shares.

This takes us back to December 31, 1915. On that date the petitioner purchased from the Weed Chain Tire Grip Co. 5,000 common shares of the American Chain Co. for $125,000. On the same date he purchased all of the other assets of the Weed Chain Tire Grip Co., at a net price of $1,713,221.98. On the next business day, January 3, 1916, but as of December 31, 1915, he turned over those assets, less $34,964.86, or of a book value of $1,678,257.12 plus $10,000 for the outstanding stock of the Weed Chain Tire Grip Co., plus $811,-742.88 shown on the journal of the Weed Chain Tire Grip Co. as “good will” for $2,500,000 par value of stock of the American Chain Co. divided into 5,000 common shares and 20,000 preferred shares, each of a par value of $100.

On brief, the petitioner admits that previous to the transaction here involved he recovered $2,000,000 of the cost basis through the sale of 20,000 shares of preferred stock of the American Chain Co.

The petitioner first contends that the cost to him of 5,000 shares of the American Chain Co. common stock purchased by him from the Weed Chain Tire Grip Co. on December 31, 1915, was not $125,000 as shown by the books of the Weed Chain Tire Grip Co. but was $777,901.38, representing the par value of the 5,000 shares plus $277,901.38 surplus shown by the books of the American Chain Co. He next contends that the cost to him of the 5,000 additional shares of common stock and the 20,000 shares of preferred stock received by him from the American Chain Co. for the assets paid in by him on January 3, 1916, was much greater than $2,500,000. He contends that the earnings of the Weed Chain Tire Grip Co. for the years 1913, 1914, and 1915 establish a very large value for the assets and that the value of the Weed patent paid in amounted to several million dollars. This claim is predicated in large part upon the testimony of Hiram Percy Maxim, who testified that in his opinion the value of the Weed patent at the beginning of 1916 plus the value of the license rights which inhered in the Parsons license was at least $5,000,000.

Although there are cases which hold that under the Revenue Acts of 1913,1916, and 1917 the cost of shares of stock is equal to the fair market value of assets paid in to a corporation in exchange for the shares, John J. Radel Co., 5 B. T. A. 250; Reliance Investment Co., 22 B. T. A. 1287; Volker v. United States (D. C.), 40 Fed. (2d) 697: Law v. McLaughlin (D. C.), 2 Fed. Supp. 601, we are of the opinion that those cases are not applicable to the facts here present.

The evidence is clear that the only amount paid by the petitioner to the Weed Chain Tire Grip Co. for 5,000 shares of common stock of the American Chain Co. on December 81, 1915, was $125,000. *The evidence is equally clear that the petitioner paid only $1,713,-221.98 for the remaining net assets of the Weed Chain Tire Grip Co., on December 31, 1915, which included all of the other assets of the Weed Chain Tire Grip Co. except $10,000 cash retained for the purpose of meeting contingent income tax liabilities. These same assets of the net amount of $1,678,257.12 plus $10,000 for the stock of the Weed Chain Tire Grip Co. and $811,742.88 for good will plus the Weed patent individually owned by the petitioner from 1910 or 1911 were transferred by the petitioner to the American Chain Co. for the remaining 5,000 shares of common stock and 20,000 shares of preferred stock of that company. The record contains no evidence as to the cost to the petitioner of the Weed patent acquired in 1910 or 1911 or as to its value on March 1, 1913. Apparently the Weed Chain Tire Grip Co. had an exclusive license to manufacture under this patent during its life. The license rights under the Weed patent and under the Parsons patent were obtained by the petitioner from the Weed Chain Tire Grip Co. on December 31, 1915, along with other assets for which the petitioner paid, as above stated, a net amount not exceeding $1,713,221.98.

The petitioner’s income tax return for the taxable year involved and the respondent’s determination of the deficiency are both based upon the premise that the cost of the petitioner’s shareholdings in the American Chain Co. during 1916 and thereafter was $3,000,000; that the petitioner recovered $2,000,000 of that cost upon his sale of the preferred shares prior to 1920; and that the cost basis of the remaining 10,000 shares, exchanged in 1920 for the 100,000 shares of no par'common stock and in 1923 exchanged for 125,000 shares of Class A stock and 250,000 shares of no par value common stock, was $1,000,000. We are of the opinion that the evidence does not warrant a greater cost basis.

In point of fact it may be noted that $811,742.88 shown as good will on the American Chain Co.’s voucher record under date of January 4, 1916, is shown in the ledger of the American Chain Co. as the cost to that company of patents which included the Weed patent. So far as the record shows, the only value which the Weed patent had to the petitioner during the years 1913, 1914, and 1915 was the right to receive royalties from the Weed Chain Tire Grip Co. The evidence does not show that the fair market value of this right on January 3, 1916, was in excess of $811,742.88.

The next problem is to determine the portion of the cost basis of $1,000,000 allocable to the 325,000 class A shares and 20,000 no par value common shares sold by the petitioner to the bankers in 1923 for $2,250,000 cash. The petitioner suggests that a proper allocation of the cost basis to those shares can be made upon the basis of their fair market value when received by the petitioner.We accept that suggestion. Cf. Clifford Hemphill, 25 B. T. A. 1351; Theodore W. Case et al., Trustees, 26 B. T. A. 1044; Frances Elliott Clark, 28 B. T. A. 1225. In Clifford Hemphill, supra, we ascertained the fair market value of the shares of each class of stock to be $25.50 per share for the class A stock and $5 per share for the common stock. Upon the evidence of record in this case we make the same determination.

Upon the basis of such allocation the gain or loss realized by the petitioner upon the sale of the 125,000 shares of class A and 20,000 shares of no par common stock for $2,250,000 is computed as follows:

Cost per share oí common stock, $281,700 divided by 250,000_ $1.1268
Realized on sale of 125,000 class A and 20,000 shares common of American Chain Co-$2, 250,000.00
Cost:
125,000 shares class A (as above)_$718,300.00
20,000 shares common at $1.1268_ 22,536.00
Transfer stamps, attorney’s fees and accounting
fees_ 8, 989.42 749, 825...42
Capital gain_ 1,500,174.58

The only other question which is before us in this proceeding is whether a loss of $441,251.98 sustained by the petitioner as a result of the liquidation of E. F. von Wettberg, Inc., was a capital net loss¡ as the petitioner contends, or an ordinary loss as determined by the respondent.

The evidence is to the effect that the petitioner advanced variousi sums of moneys on open account to von Wettberg beginning in 1913. These advances continued into the year 1923 and amounted to a net aggregate of $441,339.48. It is the petitioner’s contention that all of the amounts represented capital investments in E. F. von Wettberg, Inc.

We are of the opinion that the evidence does not support the petitioner’s contentions. The money was first advanced to von Wett-berg and upon the organization of the corporation the shares of stock were issued to von Wettberg. The petitioner testified that these were endorsed in blank by von Wettberg and qualifying stockholders and turned over to the petitioner as “collateral.” Granted that the petitioner had an investment in the shares of stock of the corporation, it is clear from the evidence that the shares of stock were utterly worthless long prior to 1928. Amounts advanced to the von Wettberg enterprise subsequent to the issuance of the shares of stock were advanced on open account. It certainly was clear to the petitioner long prior to 1923 that only a small portion, if any, of these advances would be repaid. The petitioner made the advances for the purpose of meeting operating deficits and for paying all claims against E. F. von Wettberg, Inc. The advances did not represent capital assets within the contemplation of the taxing statute. The disallowance of the claimed loss of $441,251.98 as a capital loss is approved.

Eeviewed by the Board.

Judgment will be entered wnder Rule SO.

Murdock,

dissenting: I think the reasoning of the prevailing opinion upon the first point is unsound in that it fails to consider the correct method of determining the basis to which the petitioner is entitled. The petitioner acquired 5,000 shares of $100 par common of the American Chain Co. for $125,000 by purchase on December 31, 1915. He acquired another 5,000 shares of the same stock, together with 20,000 shares of preferred, on January 3, 1916, by transferring certain property to the American Chain Co. in exchange for the shares. The cost and basis for these shares was the fair market value of the property exchanged for them. That cost should be allocated between the common and preferred in proportion to the total fair market value of each received. The part allocated to the preferred is not used further in the present computation. The part allocated to the common, together with $125,000, the cost of the first 5,000 shares, forms the total basis of the 100,000 no par shares which the petitioner exchanged in 1923. It may be that the record does not show all of the values necessary to this computation. In that event the result reached in the prevailing opinion may be proper, because the Commissioner seems to concede that the basis of the 100,000 shares should be at least $1,000,000.

Mellott agrees with this dissent.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    Havana Electric Railway, Light & Power Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 40304, 42570, 47339.
    Promulgated July 14, 1936.

      Laurence A. Crosby, Esq., WilUam F. Kennedy, Esq., R. R. Loen-ing, Esq., and J. Marvin Haynes, Esq., for the petitioner.

      Philip M. Clark, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Smith :

Section 238 (a) of the Revenue Act of 1918 provides:

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

Section 238 (a) of each of the Revenue Acts of 1921, 1924, and 1926 is the same in substance.

The purposes of section 238 (a) of the taxing statutes referred to above have been fully explored and expounded by this Board in Chicago Portrait Co., 16 B. T. A. 1129, and by the courts in the opinions in affirmance thereof in Commissioner v. Chicago Portrait Co., 50 Fed. (2d) 683, and Burnet v. Chicago Portrait Co., 285 U. S. 1. The specific question involved in that case was whether the words “foreign country” in the credit provision included the various political subdivisions making up the foreign country.

In affirming the Board’s decision, the Circuit Court of Appeals for the Seventh Circuit said:

The evident purpose of section 238 is to prevent duplication of income and war-profits taxation upon the same income, and there is no logical reason why the deduction which the section undertakes to authorize should be that of one form of government or of another, so long as the country by which the tax is levied, and to which it is paid, is foreign to the United States.
We see no reason why the proper administration of section 238 would authorize deduction of such taxes when paid to the commonwealth of Australia or to New Zealand, or both, and be denied when paid to the self-governing colony of New South Wales.

The United States' Supreme Court held that the meaning of the words “must be determined by reference to the purpose of the particular legislation” (285 U. S., p. 6), and that “it is necessary to consider the object of the enactment and to construe the expression * ⅛ * so as to achieve, and not defeat, its aim.” The Supreme Court further stated:

* * * The fact that the provision is for a credit to the domestic corporation, against income taxes payable here, of income taxes “paid during the same taxable year to any foreign country,” itself demonstrates that the primary design of the provision was to mitigate the evil of double taxation. Cognate provisions in the case of individuals disclose .a similar intent. * * *
In the case of domestic corporations, the purpose is also disclosed to facilitate their foreign enterprises. * * *

From the foregoing it is plain that it was the purpose of Congress in enacting section 238 (a) of the applicable statutes to relieve domestic corporations from tax upon their income to the extent that in foreign countries in which they do business they are likewise subject to an income tax in the foreign country. Clearly the statute must be interpreted broadly to carry out the legislative intent. In general it must be said that the respondent and this Board have so construed the provision.

In defining what is an “income” tax under the foreign tax credit provisions, the respondent has consistently held that “by the use of the term ‘income taxes’ in section 238 (a) is meant a tax on income” (G. C. M. 6042, C. B. VIII-1, p. 186) ; “a tax on net profits is a tax on income” (G. C. M. 7629, C. B. IX-1, p. 147; “it is the tax on im come in its fundamental sense as meaning gain or profit that is subject to be credited” (I. T. 2620, C. B. XI-1, p. 46); a “tax on profits derived from the mining industry is an income tax” (I. T. 2070, G. B. III-2, p. 251).

The respondent has also said that determination of whether a given foreign tax is thus “a tax on income” is to be made from an examination of the foreign tax law itself, without regard to any title or classification given to it by the foreign government: I. T. 2620, supra; G. C. M. 7629, supra; G. C. M. 800, C. B. V-2, p. 75; S, M. 1614A, C. B. I V-2, p. 203; I. T. 2070, supra.

In I. T. 2070, supra, it is stated: “The Bolivian Government levies a tax on mining properties in proportion to the ratio of profits to capital invested.”

A translation of the Bolivian law is then set forth, which provides that :

The companies and mining enterprises, whatever the form in which they may be established, shall be subject to the payment of tax on the net profits shown on their annual balance sheets effected in the territory of the Republic as of the 31st of December, in accordance with the following bases of taxation:
(a) The application of the rate of taxation shall be effected on the percentage resulting from the profit derived in relation with capital paid up, * * *

including any capital reserves already invested in the exploitation and development of the mining business. Yearly reserves are limited to 5 percent of the total net profit. The ruling states:

In view of the foregoing provisions of the Bolivian tax law, it is held that the tax on profits derived from the mining industry is an income tax, although it is limited to income from one source. Accordingly, a domestic corporation which pays tax to the Bolivian Government on the profits derived from the mining industry carried on in Bolivia is entitled to take such tax as a credit against the tax due to the United States under the provisions of section 238 (a) of the Revenue Acts of 1921 and 1924, * * *

In G. C. M. 800, supra, was involved a Brazilian tax computed by an optional method. The memorandum states:

An examination of the pertinent provisions of the Brazilian income tax law discloses that the tax imposed on income computed by the optional method is not imposed on gross income. The gross receipts or the volume of sales of the corporation are used as a basis for determining the net income, such net income being calculated by means of coefficients established by a technical committee authorized to be appointed, or, pending the organization of the table of coefficients, by certain percentages already established. Actual net income is defined by the Brazilian law as gross profits less actual expenses. Net income computed by the optional method is a certain percentage of the gross profits.
Held, that the tax imposed by the Brazilian income tax law upon the income of a corporation computed by the. optional method as provided by that law is an income tax and is, therefore, allowable as a credit under section 238 of the Kevenue Act of 1926.

In Manati Sugar Co., 26 B. T. A. 206, the issue was whether in the circumstances of the particular case the taxpayer had a right to a credit with respect to the Cuban 8 percent income tax on sugar companies under the law of July 31, 1917, which amended Military Order No. 463 of 1900. The Board stated?

As the parties have raised no question as to whether the Cuban income tax here involved is of the character referred to in the statute quoted [section 238 (a) of the Kevenue Act of 1921], we will assume that it is such a tax. * * *

In G. C. M. 7629, supra, and in I. T. 1522, C. B. 1-2, p. 199, the respondent has held that the income tax paid to the Cuban National Government was an income tax within the purview of section 238 (a) of the Kevenue Acts here in question.

In Herbert Ide Keen, 15 B. T. A. 1243, the Board held that a French tax on the “income” of alien residents, which income was presumed to be equal to seven times the rental value of the apartment occupied, was a valid credit under section 238 (a). The Board said:

* * * Whatever may be the nature of the tax, it is imposed upon what the French Government determines to be income. * ⅜ ⅜ The fact that under the law the taxable income is determined in a manner different from the taxable income under the Kevenue Act of 1921 does not change the nature of the tax. The fact that the net income of the petitioner as computed under the Revenue Act of 1921 was much in excess of the income of the petitioner determined for the purposes of the French tax does not change the character of the tax paid. The petitioner clearly paid to the Republic of France a tax upon his income in 1923. The amount of the tax paid is a credit against the income tax leviable under the provisions of the Revenue Act of 1921.

The taxes paid by the petitioner to the Municipality and Province of Havana for the tax years 1919 and 1922 to 1926, inclusive, were imposed under the provisions of the Organic Municipal Law of Cuba, May 29, 1908. The law was promulgated on May 19, 1908. Chapter IV of Title V, under “Municipal Kevenues”, provides in part as follows:

Art. 216. — The municipal councils may establish the revenues necessary to meet the expenditures provided for in the budgets, aside from the income of the municipality derived from its communal property and from any other legitimate sources, conforming, for this purpose, to the following bases and maximum rates of taxation, which, for said purpose, are declared compatible with the system of taxation of the state:
* ⅜ ⅜ * ⅜ * *
(3) Tax on the exercise of industries, commerce, professions, arts and trades, which shall not exceed the rates fixed by classes and headings in the first three tariffs attached to the law of municipal taxation, and which may be freely regulated by the municipal council as to the remaining tariffs.
# ⅜ ⅜ * ⅜ * if.
(7) A tax not exceeding eight per cent, of the net profits of companies or copartnerships doing business with funds contributed by the members thereof at one time, or at periodical or irregular intervals. When their by-laws or regulations contain penal clauses for non-payment, or other clauses of a similar character, they shall pay not more than eight per cent, on their gross receipts.
This tax shall be paid to the municipality in which the company has its legal domicile.

The following are excepted:

(a) Savings banks, pawnshops and mining companies; insurance companies and banks of issue and discount, which pay taxes to the state by virtue of another law.
(b) Those companies or copartnerships which are comprised in any manner in the tariffs attached to the law of municipal taxation, or in the tariffs freely regulated by the municipal councils, and which, as industrial enterprises, pay taxes to the municipality.

After the Organic Municipal Law was promulgated companies operating gas and electric light plants protested that a tax of 8 percent upon their revenues as provided for by article 216, clause (7), of chapter IV of Title V was overburdensome. As a result of their protest the Provisional Governor, Charles E. Magoon, who had authority to change the original draft of the Organic Municipal Law promulgated on May 19, 1908, amended article 216, clause (7), by Decree No. 917, of September 21, 1908, by adding after its first paragraph the following paragraph:

Companies or persons furnishing gas, electricity or any other public service, not included in any other express provision of this law, shall pay a tax not to exceed six per cent of the net proceeds.

As amended by Decree No. 917, the Organic Municipal Law was put into effect by the same decree on September 21, 1908. The Organic Municipal Law required as its complement the Municipal Tax Law and Collection Procedure of Cuba of September 22, 1908. The specific quota taxes contemplated by article 216, clause (3), of chapter IV of Title V of the Organic Municipal Law, were made specific by certain tariffs made a part of the Municipal Tax Law and Collection Procedure. The third tariff of the latter set forth the license taxes payable by persons or corporations on the exercise of industries, commerce, professions, arts, and trades. These specific quota taxes are comprehended in 130 paragraphs. The final paragraph of the third tariff provides:

131. — Gas and Electric Light works belonging to stock companies or private persons, shall pay six per cent, of their net earnings. For the purposes of the tax, the net earnings shall be considered to be the amount resulting from their balances, deducting from their receipts the expenses, properly vouchered, for all items of operation and maintenance of the business to which they are dedicated.

In support of his position that the tax here in question is a privilege or concession tax imposed under the quoted paragraph 131 of the third tariff, the respondent relies upon the testimony of de Cardenas and other Government witnesses and the opinion of the Court of Appeals of Havana, Sentencia 685 of 1931, cited by de Cardenas in his testimony.

The decision of the Court of Appeals, which is a nisi prim court, referred to above, supports the contention of the respondent. The petitioner has, however, now presented to the Board numerous decisions of the same court which hold directly contrary to Sentencia 685, many of which were rendered prior to Sentencia 685 and one thereafter. The petitioner has also called the Board’s attention to decisions of the Supreme Court of Cuba involving the precise point, some of which are directly opposed to Sentencia 685. Among these is Supreme Court Decision No. 31, November 30, 1911; No. 37, May 30, 1927, which affirmed Audiencia (Court of Appeals) of Havana Decision No. 865, November 25, 1926; No. 24, November 22, 1913; No. 2, January 23,1913; and No. 27, February 18,1930.

Among the witnesses presented by the petitioner were Otto Schoen-rich, member of the Bar of New York, and several other states, as well as of Cuba and Puerto Rico, formerly a judge in Puerto Rico, Secretary and Chief of Office of the Provisional Government of Cuba during the second American intervention, 1906 to 1909, and a member of the Advisory Commission which in 1907-1908 drafted the Cuban Municipal and Provincial legislation involved in this case; Oscar Garcia Montes, a prominent member of the Cuban Bar and an authority on Cuban taxation, who for 13 years was successively assistant professor and full professor of political economy and public finance at the University of Havana; Jose Victor Tapia y Puente, a member of the Cuban Bar, and a member of the Cuban Supreme Court for 29 years. He participated in all the Cuban Supreme Court decisions bearing on the issue in this case, including No. 31 of 1911, No. 24 of 1913, No. 37 of 1927, and No. 11 of 1928. All of these witnesses testified that in their opinion the taxes paid by the petitioner to the Municipality and Province of Havana were taxes upon the net income of the petitioner from the operation of gas and electric light plants; that they were in no sense taxes imposed upon the doing of business by the companies; that they represented simply a portion of the income taxes payable by those companies made available to the municipalities. Montes testified that the tax under clause (7) of article 216 of the Organic Municipal Law was of the same nature as the national income tax on share companies under Order No. 463 of 1900. It furthermore appears that Carrera Justiz, the draftsman of the law, said at the meeting of the Advisory Commission which discussed clause (7) of article 216: “It is Order No. 463 [the national income tax], brought in part to the Municipalities.”

By the great weight of legal authority in Cuba it must be held that the taxes paid by the petitioner to the Municipality and Province of Havana were imposed by article 216, clause (7) of chapter IV of Title V of the Organic Municipal Law and not under clause (3) which relates to fixed quota or privilege taxes. If article 216 had not been amended by Decree No. 917 of September 21, 1908, by adding to clause (7) the following paragraph:

Companies or persons furnishing gas, electricity or any other public service, not included in .any other express provision of this law, shall pay a tax not to exceed six per cent of the net proceeds.

we think there would be grounds for the contention made by the respondent that the inclusion of the tax in paragraph 131 of the third tariff of the Municipal Tax Law and Collection Procedure of Cuba of September 22, 1908, was determinative of the nature of the tax; for in Flint v. Stone Tracy Co., 220 U. S. 107, it was said:

While the mere declaration contained in a statute that it shall be regarded as a tax of a particular character does not make it such if it is apparent that it cannot be so designated consistently with the meaning and effect of the act, nevertheless the declaration of the lawmaking power is entitled to much weight, and in this statute the intention is expressly declared to impose a special excise tax with respect to the carrying on or doing business by such corporation, joint stock company or association, or insurance company. * * *

To the same effect is the case of Spreckels Sugar Refining Co. v. McClain, 192 U. S. 397, in which a special tax measured by the gross receipts of the business of refining oil and sugar was sustained as an excise in respect to the carrying on or doing of such business. Also, in Security Savings & Commercial Bank v. District of Columbia, 279 Fed. 185, a tax on gross earnings was held a franchise” tax, and in Potomac Electric Power Co. v. Rudolph, 29 Fed. (2d) 634, a tax on gross receipts was held a franchise tax as distinguished from a property tax. Since, however, there are many decisions of the Supreme Court of Cuba and also of the Court of Appeals of Havana and other provinces which hold that the tax was not a privilege tax, and since the evidence in this case shows that the petitioner had no franchise or concession from the municipalities of Cuba or from other governmental authorities for the carrying on of business and that the tax was not payable as a condition of doing business, it must be held that the tax is not a franchise or privilege tax.

In the circumstances of this case we do not find it necessary to pass upon the question whether a franchise or privilege tax payable on net income is an income tax within the purview of section 238 (a) of the Revenue Acts here in question.

The taxes were paid upon the petitioner’s “net proceeds” from the operation of gas works and electric light plants. If the only income of the petitioner had been from the operation of these facilities we think there could be no question but that they were income taxes. The fact that they were paid to the Municipality and Province of Havana rather than to the Cuban National Government is of no importance. Burnet v. Chicago Portrait Co., supra. Likewise, it is unimportant that they were not paid upon the petitioner’s entire net income. The tax paid upon net income of one branch of a taxpayer’s business is as much an income tax as one paid upon net income from all sources.

From a consideration of all of the evidence in this record we conclude that the taxes paid to the Municipality and Province of Plavana are income taxes which may be credited against the income tax payable to the United States under section 238 (a) of the Revenue Acts of 1918, 1921, 1924, and 1926. The action of the respondent in disallowing the claimed credits is reversed.

Reviewed by the Board.

Judgments will loe entered wider Rule 50.

Leech dissents.


author: Black:

text:
    Ralph Hochstetter, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76160.
    Promulgated July 14, 1936.

      John L. Kenefich, Esq., Ralph M. Andrews, Esq., and John W. Sanborn, Esq., for the petitioner.

      R. H. Transue, Esq., and Harold Allen, Esq., for the respondent.
   OPINION.

Black:

Petitioner complains of an income tax deficiency of $66,203.09 for the calendar year 1931. Instead of the deficiency, he claims an overpayment of $7,980. Three errors are assigned as follows:

(a) In determining the taxable net income of the petitioner for the year 1931 the Commissioner erroneously disallowed a deduction of $145,562.50 representing loss from sale of securities.
(b) The Commissioner has erroneously disallowed a deduction of capital net loss in the amount of $54,975.
(c) The Commissioner has erroneously increased the petitioner’s net income in the amount of $150,909.75 representing dividends claimed by the Commissioner to have been received by the petitioner.

All the facts have been stipulated, which makes separate findings of fact unnecessary. A brief statement of such facts relative to the first two assignments of error follows.

Petitioner is an individual and a resident of Buffalo, New York. During 1918 he and others caused the Cliff Petroleum Co. to be incorporated under the laws of Delaware. The purpose of this corporation was mainly to engage in the oil business. It immediately acquired extensive oil properties. By 1926 its authorized capital stock had been duly increased to 50,000 no par shares, of which petitioner owned 49,900. During June 1926 the Cliff Petroleum Co. duly sold all of its oil properties to the Texas Co. for $1,642,915.05 in cash and invested the proceeds in corporate securities.

During 1929, but prior to December 17, petitioner purchased certain shares of common stock of three corporations, as follows:

250 shares General Capital Corporation-$18, 750.00
500 shares Air Reduction Co- 47,975. 00
500 shares American Can Co_ 51,187. 50

During 1980 and 1931, but prior to December 17, 1931, petitioner purchased certain shares of common stock of two corporations, as follows:

10, 400 shares McLellan Stores Co_— $119, 512. 50
1, 000 shares National Biscuit Co_ 86,450. 00

On December 17, 1931, petitioner duly assigned, transferred, and delivered to the Cliff Petroleum Co. certain shares of common stock of five corporations in consideration of the transferee crediting petitioner’s indebtedness to it, which was then in excess of $123,337.50, in amounts as follows:

In determining the prices for which the above securities were transferred to the Cliff Petroleum Co., the above per share quotations on current market sales were obtained from a Buffalo broker by an employee of the Cliff Petroleum Co.

Immediately upon delivery of the above securities to it, the Cliff Petroleum Co. debited its “Stocks and Bonds” investment account with a total of $123,337.50 and credited “Ralph Hochstetter” with a like amount and explained the entry as follows: “Purchased above stocks this day.” At the same time petitioner entered upon his journal an entry summarized as follows:

Debits Credits
Cliff Petroleum Company_$123, 337. 50
Stocks and Bonds Profit and Loss_ 200, 537. 50 Stocks and Bonds Investment Acct_$323, 875. 00
To record Sale of following Stocks:
[Here is set out a list of the stocks sold corresponding to the list given above.]

In connection with the transfer of the said securities petitioner executed and delivered to the Cliff Petroleum Co. a bill of sale to which were attached canceled stamps showing that petitioner had paid $455 in Federal and state stock transfer taxes.

Petitioner did not at any time reacquire any of the securities transferred by him on December 17, 1931, to the Cliff Petroleum Co., nor did he acquire any substantially identical stock or securities on that date or within 30 days before or after that date, nor did petitioner have on that date a contract or option to acquire any substantially identical stock or securities.

During 1934 the Cliff Petroleum Co. sold to purchasers unknown the 10,400 shares of McLellan Stores Co. for $99,326.85 and also the 1,000 shares of Rational Biscuit Co. for $28,427.92, and deposited the proceeds in its bank account. It still owns the 250 shares of General Capital Corporation, the 500 shares of Air Reduction Co., and the 500 shares of American Can Co.

All dividends paid after December 17, 1931, on the stocks in question while owned by the Cliff Petroleum Co. were received by and reported by that company in its income tax returns.

In filing his income tax return for the year 1931 petitioned deducted $145,562.50 from his gross income as ordinary losses from the sale of stocks, and 12½ percent of $54,975 from the tax on his net income, the $54,975 representing capital net losses from the sale of stocks, that is, from stocks which petitioner had held for more than two years. There is no controversy between the parties as to the amounts and character of the losses if the Board sustains petitioner’s contention that the stipulated facts show a real bona fide sale.

In disallowing both the ordinary and capital net losses the respondent, in a statement attached to the deficiency notice, said in part:

Losses from sales of securities held for less than two years and for more than two years have been disallowed, in the amounts of $145,562.50 and $54,975.00, respectively. The losses have been disallowed for the reason that the sales of the securities were made to Cliff Petroleum Corporation of which you owned 98% of the stock. It is held that the sales were not bona fide for income tax purposes, * * * It is obvious that you did not part with control of the securities in question upon their sale. Por all practical purposes you were just as effectively in control of them after they were purchased by the Cliff Petroleum Corporation as when you owned them individually.

The facts relative to the third assignment of error were stipulated as follows:

27. The petitioner in his return for the year 1931 (Exhibit “E”) reported dividends from domestic corporations of $291,190.18. The respondent in his final determination (Petition, Exhibit “A”) which is incorporated in this stipulation by reference, has increased the amount of dividends from domestic corporations to $442,099.93.
28. Of the amount of $442,099.93 stated in the deficiency notice as being the amount of dividends received by petitioner, $441,349.93 constitutes the amount of dividends reported on Forms 1099 by various payer corporations as having been paid to petitioner as record holder of their stocks.
29. Petitioner at no time prior to the filing of this appeal reported his ownership of said stocks as nominee for Cliff Petroleum Company by filing Forms 1087. Said Forms 1087, however, were filed by petitioner on January, 1935, with the Commissioner of Internal Revenue, Sorting Section, Washington, D. C.
30. It is now stipulated and agreed by the parties hereto that petitioner, individually and for his own account, received dividends from domestic corporations of $251,290.18 instead of $291,190.18, as reported by petitioner in his return, and instead of $442,099.93, as determined by respondent. It is further stipulated that the balance of dividends, aggregating $190,809.75 reported to respondent on Forms 1099 as having been received by petitioner, were received by petitioner as nominee for Cliff Petroleum Company and others. Cliff Petroleum and said others reported said dividends received by petitioner as their nominee, in their returns for the calendar year 1931.

Petitioner argues that a loss resulting from a sale otherwise bona fide is not nondeductible merely because the sale is to a closely held or even a solely owned corporation, and in support thereof relies principally upon A. S. Eldridge, 30 B. T. A. 1322; affd. (C. C. A., 9th Cir.), 79 Fed. (2d) 629. The respondent contends that the determination of the deductibility of the losses in question is governed by Sydney M. Shoenberg, 30 B. T. A. 659; affd. (C. C. A., 8th Cir.), 77 Fed. (2d) 446; certiorari denied, 296 U. S. 586.

In the Eldridge case, Eldridge owned all the stock except qualifying shares of the Eldridge Buick Co., a corporation engaged in distributing and retailing automobiles. During October 1929 he purchased 2,000 shares of stock in two corporations for $68,104. The market immediately declined and two months later he transferred the 2,000 shares to the Eldridge Buick Co. in consideration for a credit to his account with that corporation of $35,000, which amount was the then market price of the securities so transferred. Eldridge and his wife filed returns on a community property basis, each claiming a loss of $16,552, which was one-half of the difference between the cost of $68,104 and the credit of $35,000. The Commissioner disallowed the losses; the Board allowed them; and in affirming the Board the Circuit Court said in part:

Having found the facts as above set forth, the Board held that the corporation was an entity separate and distinct from respondents, and that the transfers by respondents to the corporation resulted in a deductible loss, one-half of which ($16,552) was properly allowed to each respondent. The correctness of this holding is challenged by the Commissioner, his contention being that the separate entity of the corporation should be disregarded, and the corporation and its stockholders treated as one.
This is sometimes done in tax cases [Citations], but only when warranted by exceptional circumstances. Generally, in tax cases, as in other cases, a corporation and its stockholders are to be treated as separate entities. [Citations.]
The facts found by the Board of Tax Appeals in this case do not, in our opinion, warrant us in disregarding the separate entity of the corporation. The fact that respondents owned all its stock and were in complete control of it is no reason for disregarding its separate entity. [Citations.]
It is argued by the Commissioner that the transfers by respondents to the corporation were made for the purpose of establishing a deductible loss for income tax purposes. This, if true, is unimportant. A taxpayer may resort to any legal method available to him to diminish the amount of his tax liability. [Citations.]

In the Shoenberg case, Shoenberg owned 70 percent of the stock of the Globe Investment Co., the remaining 30 percent being owned by his widowed mother, an aged woman in poor health. In December 1030 Shoenberg, desiring to establish a loss on certain stocks owned by him for the purpose of reducing his income taxes, instructed his broker to sell the stocks at market (which was about $310,000) and at the same time to buy the same amount of the same stocks at the market for the account of the Globe Investment Co. At the same time he transferred to the Globe Investment Co. approximately $120,000. The sales and purchases were made as ordered. About 31 days thereafter Shoenberg, acting under a blanket grant of authority from the Globe Investment Co., caused that corporation to transfer to himself, as an individual, all of the shares in controversy at the then market price, for which Shoenberg issued his checks for a total of $304,593.87. New certificates were issued to the Globe Investment Co. for the shares it purchased, but in the transaction about 31 days later no new certificates were issued. Shoenberg claimed a loss of $191,886.30, which the Commissioner and this Board disallowed. In affirming the Board the Circuit Court said that the matter should be viewed in its entirety; that for all practical purposes Shoenberg had used the Globe Investment Co. merely as an agency for purchasing, holding, and reselling to him stocks identical with those he had sold to establish the claimed loss.

It is our opinion that the facts in the instant proceeding closely resemble those in the Eld-ridge case and are clearly distinguishable from those in the Shoenberg case in that a plan for the reacquisition by petitioner of identical stocks is wholly lacking in the instant proceedings. The Cliff Petroleum Co. was a going corporation of long standing and not a corporation organized solely to reduce the income taxes of its incorporators. It was an entity separate and apart from petitioner. There are no exceptional circumstances present that would, in our opinion, warrant a disregard of the two taxable entities. The, transaction between petitioner and the Cliff Petroleum Co. on December 17, 1931, was legal in every respect. Prom the stipulated facts there is no reason to question its bona fides. The sale by petitioner to the corporation was at the current market price. None of the stocks thus sold were ever reacquired by petitioner. From the facts which have been stipulated, we find as a fact that the sale by petitioner to the Cliff Petroleum Co. on December 17, 1931, was a bona fide sale. We therefore sustain the petitioner in his first two assignments of error. Cf. Edward Securities Corporation, 30 B. T. A. 918; affirmed by the Circuit Court of Appeals for the Seventh Circuit without opinion, 83 Fed. (2d) 1007; Marston v. Commissioner, 75 Fed. (2d) 936; Chisholm v. Commissioner, 79 Fed. (2d) 14; Ewing Hill v. United States, 12 Fed. Supp. 798; Commissioner v. Neaves, 81 Fed. (2d) 947; United States v. Huntington Laboratories, Inc., 82 Fed. (2d) 356; Commissioner v. McCreery, 83 Fed. (2d) 817.

The question involved in the last assignment of error is whether petitioner is taxable on dividends of $251,290.18 or $442,099.93. In his return petitioner reported $291,190.18 as taxable dividends. He later filed a claim for refund on the ground that he should have reported as taxable dividends only the amount of $251,290.18. The parties have stipulated that petitioner received for his own account only dividends from domestic corporations in the amount of $251,-290.18 instead of $291,190.18 as reported by petitioner in his return and instead of $442,099.93 as determined by the respondent in his deficiency notice. The parties have also stipulated that in addition to the $251,290.18, petitioner also received dividends from domestic corporations of $190,809.75 as nominee for the Cliff Petroleum Co. and others. The respondent determined and still contends that petitioner is also taxable on this $190,809.75. on the ground that petitioner did not upon receipt of such dividends immediately execute form 1087 and disclose to the Commissioner the name and address of the actual owners thereof, as required by article 818 of Regulations 74, the material part of which is as follows:

Akt. 818. Information as to actual otoner. — When the person receiving a payment falling within the provisions of the Act for information at the source is not the actual owner of the income received, the name and address of the actual owner shall be furnished upon demand of the individual, corporation, or partnership paying the income, and in default of a compliance with such demand the payee becomes liable to the penalties provided. (See section 146.) Dividends on stock are prima facie the income of the record owner of the stock. Upon receipt of dividends by a record owner, he should immediately execute Form 1087 to disclose the name and address of the actual owner. Form 1087 should be filed with the Commissioner of Internal Revenue, Sorting Section, Washington, D. C. Unless such a disclosure is made, the record owner will be held liable for any tax based upon such dividends.

Petitioner did, however, execute form 1087 during January 1935, and it is stipulated that the “Cliff Petroleum and said others reported said dividends received by petitioner as their nominee, in their returns for the calendar year 1931.”

Paul and Mertens, in their “Law of Federal Income Taxation”, vol. 1, par. 8.117, discuss the above quoted regulation under the title of “Taxability of Unidentified Dividends Received by Stock Brokers.” While the quoted regulation undoubtedly has a broader application than merely to stock brokers, we think the comment of Paul and Mertens on the regulation in question is pertinent here. Among other things they say:

The regulations provide that dividends on stocks are prima facie the income of the record owner of the stock. However despite the failure to have the transfer recorded on the corporate records, the transferee is the true owner of the stock and dividends declared thereon. It has been ruled that such dividends (prior to the running of the state statute of limitations in favor of the broker) are not properly taxable as income of the broker. Since the broker has actual possession of the dividends, he is required to make a full disclosure of the names of the actual owners in the next information return if and when the identity of such owners is discovered. Prior to the discovery of identity the broker is required to execute form 1087 setting forth the fact that he holds such dividends fox parties of identity unknown as the result of reasonable search and inquiry. He should furnish the reason for his inability to establish the identity and state the efforts he has made to do so. When the actual ownership is not disclosed prior to the running of the State statute of limitations upon the right of the actual owner to demand payment of dividends, the broker will be in receipt of taxable income to the extent of the dividends held.

The purpose of the cited regulation is to provide a means by which the Commissioner will be advised of the true owner of income in ample time prior to the running of the statute of limitations to permit him to determine and assess the correct amount of tax against the true owner of the income. This purpose is accomplished when, as in the instant proceeding, the true owner has himself duly reported the income received by the nominee for the taxable year during which it was so received. The instant proceeding is not a case where the nominee has entirely failed to file the required form 1087. Nor is this a case where although having filed the required form it was so delinquent that the Commissioner’s rights were jeopardized thereby. What our decision would be in the event of either of such situations we need not now decide. Suffice it to say that in the instant proceeding the Commissioner has not been prejudiced in any way by the failure of petitioner to file form 1087 prior to January 1935. That being true we think the Commissioner is without statutory or constitutional authority to include in petitioner’s taxable income dividends properly taxable to and reported by another. We hold, therefore, that petitioner is taxable on dividends of $251,290.18 instead of $442,099.93 as determined by the respondent.

Reviewed by the Board.

Decision will be entered under Rule 50.


author: Van Fossan:

text:
    Maude L. Porter, Alexander L. Porter and Edwin R. Bartlett, Executors under the Last Will and Testament of Alexander J. Porter, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79822.
    Promulgated July 14, 1936.

      Ansley Wilcox, 2nd, Esq., for the petitioners.

      Eugene G. Wilcox, Esq., for the respondent.
   OPINION.

Van Fossan:

This proceeding involves estate taxes in the sum of $10,373.71. Three issues are presented, viz:

(1) Whether a claim of the decedent against Porter-Bartlett, Inc., in the face amount of $5,000, had a fair market value equal to $5,000;
(2) Whether petitioners are entitled to deduct $75,000 from the gross estate, being an amount paid by them as executors on account of a guarantee given by decedent for the obligations of W. Keith Schneidau;
(3) Whether petitioners are entitled to deduct $1,300 from the gross estate on account of the payment of pledges of the decedent to charitable, religious, scientific, or educational institutions.

The parties submitted the proceeding upon a written stipulation of facts, together with exhibits attached thereto. For the purpose of determining the issues presented, we set forth only such portions thereof as are deemed pertinent.

The decedent, Alexander J. Porter, was, prior to his decease on November 29, 1932, a resident of Niagara Falls, New York. By his last will and testament he named the parties petitioners as the executors of his estate, and said parties were duly appointed, and are now acting as the executors of decedent’s estate.

On or about November 3, 1932, Porter-Bartlett, Inc., a corporation engaged in the real estate and insurance business in Niagara Falls, New York, issued a note to the Power City Trust Co. in the sum of $5,000, which note was endorsed by decedent and was payable on December 5, 1932. The corporation could not have secured the loan covered by said note without the endorsement of the decedent, who was president of the corporation. Porter-Bartlett, Inc., was operated by decedent’s son and other relatives. At maturity of the note on December 5, 1932, it was not paid by the corporation and claim was made by the bank against the executors of the estate. The executors were required to, and did, pay to the Power City Trust Co. $5,000 in satisfaction of decedent’s endorsement. Payment was made by the executors on or about March 31, 1933.

The executors petitioned the Surrogate’s Court for a review and approval of this $5,000 payment, and upon a satisfactory showing to the court, a decree approving said payment was granted on October 19, 1934.

A statement of the assets and liabilities of Porter-Bartlett, Inc., at November 30, 1932, shows that this corporation had total assets of $10,390.33, liabilities totaling $14,674.14, and a profit and loss deficit of $4,283.81. The corporation operated at a loss during each of the fiscal years 1930, 1931, and 1932.

The executors of decedent’s estate have not received or realized directly or indirectly any payment with respect to the satisfaction of said payment on account of said endorsement.

In the estate tax return the petitioners listed their claim against Porter-Bartlett, Inc., as a claim of no value, but they deducted their $5,000 payment to Power City Trust Co. on account of the Porter-Bartlett, Inc., note, as a debt of decedent existing at the time of his death.

The respondent allowed the deduction but increased decedent’s gross estate by $5,000 as the value of the estate’s claim against Porter-Bartlett, Inc., the maker of the note, which respondent held was a solvent corporation.

On June 28, 1926, W. Keith Schneidau was indebted to the Bank of Niagara, a predecessor bank of Power City Trust Co., on account of loans in the amount of $20,250. Schneidau had pledged as security 500 shares of the capital stock of Shredded Wheat Co., the collateral value of which was approximately $24,500. On that date Schneidau borrowed an additional $950 from said bank, which sum was payable on July 28, 1926. As a condition to the additional loan by the Bank of Niagara, the decedent was required to guarantee the payment of the $950. Between June 28, 1926, and November 21, 1926, Schneidau reduced his indebtedness from $21,200 to $850, but no release of the guarantee of decedent was given by the bank.

Between the date of decedent’s $950 guarantee and October 31, 1929, various additional loans were secured by Schneidau from the bank and various payments were made by him on his indebtedness. On the latter date Schneidau was indebted to the bank, another predecessor of Power City Trust Co., in an amount of $56,975.37. On October 31, 1929, the officers of the bank estimated that Schneidau’s collateral had a fair market value aggregating $70,400, and on that date decedent executed an additional guarantee to the bank with respect to Schneidau’s loans in the amount of $15,000.

On July 10,1930, upon demand of the bank, the decedent increased his guarantee on the note of Schneidau by executing to the bank an additional guarantee of $15,000, thereby raising decedent’s total guarantee to $30,950. At that time Schneidau’s loan amounted to $124,400, against which he had pledged as collateral certain specified securities, not here material, having an aggregate market value of $139,807.

On July 16, 1930, decedent replaced his three guarantees with one guarantee for $30,000. On October 11, 1930, decedent increased the amount of his guarantee to $45,000. On September 30,1931, decedent executed an additional guarantee of $30,000, and on October 3, 1931, a new guarantee of $75,000 was executed by decedent to the bank and the old guarantees were surrendered.

On October 1,1931, the loan ledger of Power City Trust Co. showed the indebtedness of Schneidau to be $120,391.58. Against said loan Schneidau had collateral pledged that was valued at $70,792. At the date of decedent’s death Schneidau’s loan with Power City Trust Co. was $123,970.96, against which the Trust Co. held the same collateral as it had on October 1, 1931, together with decedent’s $75,000 guarantee.

The written guarantee was, in part, in the following form:

Niagara Falls, N. Y., October 1, 1931
To Power City Trust Company,
Niagara Falls, N. Y.
The undersigned request(s) that you forbear from demanding payment tbis day of tbe sum(s) for which W. Keith Schneidau (hereinafter called “the Obligor”) is obligated to you upon his demand note dated June 30, 1930, for .$123,970.96 and in consideration of such forbearance, and of other valuable considerations, receipt of which is hereby acknowledged by the undersigned, the undersigned hereby guarantee(s) and agree(s) to be responsible for the payment of such sums and any and all other indebtedness and/or liability of the ■Obligor of every name or nature whatever now due or owing or which may hereafter become due or owing to you, in whatever form such indebtedness and/or liability may be, and whether heretofore or hereafter contracted or incurred, together with any and all interest due, accrued or which may heeafter accrue thereon, and any and all costs, charges, fees and! expenses which you may incur or which you may be or become entitled to recover from the Obligor in •connection therewith, provided, however, that the extent of the liability of the undersigned hereunder shall not at any one time exceed $75,000.
#*$***$*
[Signed] Alexander J. Porter

Subsequent to decedent’s death Power City Trust Co. demanded payment of the indebtedness of Schneidau. Upon failure to make .any payment, the Trust Co. sold the collateral, applied the proceeds against his indebtedness, and after determining that the proceeds left an unpaid balance in excess of decedent’s guarantee, the Trust Co. demanded payment in the amount of $75,000. Thereafter, and on or about March 31, 1933, the petitioners paid Power City Trust Co. $75,000 in satisfaction of decedent’s guarantee.

The executors petitioned the Surrogate’s Court for review and approval of said $75,000 payment, and upon a satisfactory showing to the court a decree dated October 19, 1934, was granted approving said payment.

The petitioners have not received or realized, directly or indirectly, any payment with respect to the satisfaction of the said guarantee. At no time since decedent’s death has Schneidau been in possession •of property or assets against which the executors could secure satisfaction for all or any part of the $75,000 payment.

On the estate tax return the executors deducted the $75,000 as a debt of decedent existing at the time of his death. The respondent disallowed the deduction upon the ground that the “obligation was not incurred for a full and adequate consideration in money or money’s worth.”

Prior to his death decedent had made pledges to certain charitable, religious, educational, and scientific organizations, on which pledges the following amounts were unpaid at November 29,1982:

Mt. St. Mary’s Hospital_$500
Niagara Palls Community Chest_ 500
Young Men’s Christian Association_ 100
Old Port Niagara Association_ 200

Each of the decedent’s subscriptions contained the words “in consideration of the gifts of others”, or similar phrases. After his death the executors paid the above amounts due on decedent’s pledges. These payments were reviewed by the Surrogate’s Court and approved by its decree of October 19, 1984.

On the estate tax return the executors claimed the amounts paid in satisfaction of decedent’s pledges as deductions for debts of decedent existing at the time of his death. The respondent disallowed the deductions upon the ground that “the same are not allowable deductions, the obligations not having been incurred for an adequate and full consideration in money or money’s worth.”

The consideration for the endorsement of the note of $5,000 and guarantee of $75,000, and the pledges made by the decedent aggregating $1,300 did not augment the estate of the decedent, nor did it grant him any right or privilege he did not have before, except the right of subrogation which at the date of decedent’s death and at all times since has had no value, and it did not operate to discharge him from an existing claim, as for a breach of contract or personal injury.

The first issue is whether the claim which petitioners had against Porter-Bartlett, Inc., should be included in the gross estate at its face value of $5,000 as determined by the respondent. The determination of the respondent is prima fade correct and, therefore, petitioners carry the burden of proving that his determination is erroneous. Botany Worsted Mills v. United States, 278 U. S. 282. In our opinion the petitioners have failed to establish that their claim is worthless. The evidence consists of the stipulated fact that the loan could not have been secured without decedent’s endorsement of the note, the failure of Porter-Bartlett to pay at maturity, and the balance sheets of Porter-Bartlett, Inc., showing liabilities in excess of assets and an operating deficit. While this evidence establishes the financial instability of the corporation and indicates that it may have been insolvent, standing alone and without more, it is insufficient to establish the complete lack of value of the entire claim. It would appear that the claim had some value, but in what amount the evidence will not permit us to say. This situation leaves us no alternative but to approve respondent’s determination.

The second issue is whether petitioners are entitled to deduct $75,000 paid to Power City Trust Co. under the guarantee given by decedent during his lifetime. The respondent contends that the deduction is not allowable because the obligation was not incurred or contracted by decedent for an adequate and full consideration in money or money’s worth within the meaning of section 303 (a) (1) of the Revenue Act of 1926; that while the statute does not expressly provide that the adequate and full consideration in money or money’s worth shall have been received by decedent personally, yet this is the obvious purpose and intent of the provisions, Latty v. Commissioner, 62 Fed. (2d) 952, (C. C. A., 6th Cir.); and that in substance decedent agreed to make a gift to Schneidau not in excess of $75,000.

Petitioners rely on United States v. Mitchell, 74 Fed. (2d) 571, (C. C. A., 7th Cir.) in which the basic facts were very similar to the present case. There the decedent, to induce a trust company to lend money to corporations in which deceased’s kin were interested, agreed orally to indemnify the trust company against loss on the loans. In that case as here, the Government contended that the “adequate and full consideration in money or money’s worth” must have passed to the decedent before a claim may be deducted and relied on the Latty case. After quoting at some length from the opinion in the Latty case, the court rejected the Government’s contention and held- that the claim based on the indemnity agreement was based on “an adequate consideration in money or money’s worth” so as to be deductible for estate tax purposes, though consideration did not pass to the decedent. Directing itself to this matter the court observed:

We are unable to accept the Government’s contention. While deductions are a matter of statutory allowance and are not determined on the basis of equity, yet it is legitimate to assume that Congress intended to provide for a tax on net estates and that, in determining net estates, deductions for debts might be made. It was to avoid the successful presentation of swollen or fictitious claims that the amendments were adopted. Fictitious claims and deductions crept in under the words “claims against the estate”. Impositions were still possible under the language of the 1924 act; hence the amendment in 1926. However, in none of the amendments was it specifically required that the said full and adequate consideration should pass to the decedent.

Moreover, the facts in the Tatty case are so dissimilar as to make that decision inapplicable here. In that case (23 B. T. A. 1250) the claim arose out of the failure of the decedent to create a trust for the benefit of his daughter, in consideration of her promise to accept such provision in full satisfaction of all her rights against decedent or his estate. She also agreed not to contest decedent’s will. The Board held that the consideration was in essence a promise to refrain from claiming more, and was not in money’s worth within the requirements of section 303 (a) (1) of the Revenue Act of 1924. The Board’s decision was affirmed by the Circuit Court of Appeals for the Sixth Circuit. In Jeptha H. Wade, Jr., et al., 21 B. T. A. 339, we had under consideration the same statute and we there held:

From a careful consideration of the provisions of section 303 (a) (1) of the Revenue Act of 1926, and of the legislative history of the section, we are of the opinion that it is not necessary that the consideration for the claim against the estate or mortgage upon or indebtedness in respect of property referred to in the section should have been received by the decedent. The law does not require that the consideration should be received by the decedent. The statute requires (1) that the indebtedness should be incurred or contracted bona fide; (2) that there shall be an adequate and full consideration; and (3) that the consideration shall be in money or money’s worth.

We believe that the petitioners’ case meets each of these tests fully. The guarantee was given to secure an extension of credit to Schnei-dau and recites the forbearance to demand payment and other valuable considerations. The credit was extended in reliance on the guarantee. The obligation to protect the bank was valid, legal, and enforceable. It resulted in a liability which was paid by the estate and formed the basis of the deduction claimed. There is no question as to the bona fides of the transaction.

Under the facts here present and in reliance on these authorities, we reverse the respondent’s action.

The final issue is whether the unpaid portions of certain pledges constitute allowable deductions from decedent’s gross estate. It is controlled by prior decisions of this Board. Jeptha H. Wade, Jr., et al., supra; Robert A. Taft, Executor, 33 B. T. A. 671; and Margaret Day et al., Executors, 34 B. T. A. 11, wherein we held that the monetary pledges of others constituted an adequate and full consideration within the meaning of section 303. It is stipulated that the unpaid pledges herein were “in consideration of the gifts of others”, or in phrases of similar purport, and, therefore, the rule announced in the above cited cases is applicable.

Decision will be entered wider Rule 50.

       Sec. 303. For tlie purpose of the tax the value of the net estate shall he determined—
      (a) In the case of a resident, by deducting from the value of the gross estate—
      (1) Such amounts for funeral expenses, administration expenses, claims against the estate, unpaid mortgages upon, or any indebtedness in respect to, property (except, in the case of a resident decedent, where such property is not situated in the United States), to the extent that such claims, mortgages, or indebtedness were incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth * * *.


text:
    Vernon J. Bert, Trustee, for D. M. Nelson, et al., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56594.
    Promulgated July 15, 1936.

      George M. Wolcott, Esq., and John E. McCbj/re, Esq., for the petitioner.

      G. R. Marshall, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax for 1928 in the amount of $19,388.01. The deficiency has been asserted against the petitioner as trustee for a syndicate which the respondent has held to be an association taxable as a corporation.

By a memorandum opinion entered October 7,1935, the Board held that petitioner was not an association taxable as a corporation for the year 1928 and entered its decision therein on November 5, 1935, in which it was:

Okdeke» and Decided that there is no deficiency due from the petitioner for the year 1928 but that there has been an overpayment of tax in the amount of $19,383.01, which is refundable in accordance with section 504 of the Revenue Act of 1934.

On January 4, 1936, the respondent filed a motion to vacate the decision entered November 5, 1935, and to reconsider the memorandum opinion entered October 7, 1935. The bases for this motion are decisions of the Supreme Court of December 16,1935, in Morrissey v. Commissioner, 296 U. S. 344; Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; and Helvering v. Coleman-Gilbert Associates, 296 U. S. 369.

The decision entered November 5, 1935, was vacated by an order entered January 18,1936. The memorandum opinion is hereby overruled and this opinion substituted therefor.

On January 11, 1928, D. M. Nelson, V. J. Bert, Carl Kresl, J. H. Rubel, D. L. Atkinson, A. S. Barrows, C. V. Williams, E. S. Parrish, and E. H. Powell, all department managers of Sears, Roebuck & Co., formed what they called a “syndicate” to buy and sell the stock of Sears, Roebuck & Co. A formal written agreement was executed by and between the parties named and Samuel H. Shevelson, trustee, setting forth the manner in which the syndicate was to be organized and operated. The essential provisions of the agreement were that each of the members would lend to the syndicate 100 shares of his individually owned Sears, Roebuck & Co. stock to be used as collateral for loans on which the syndicate would operate; that the syndicate members would share the beneficial interest in the syndicate in proportion to the number of shares of Sears, Roebuck & Co. stock lent to the syndicate; that certificates of beneficial interest would be issued to the members, transferable on endorsement and surrender to the trustee; that the syndicate would operate by and through the trustee, who was authorized to borrow money on behalf of the syndicate, pledging the shares of Sears, Roebuck & Co. stock lent by the members, purchase and sell Sears, Roebuck & Co. stock at his discretion, receive dividends on the shares held by him, mate additional assessments on the syndicate members in proportion to their interests for necessary expenses of the syndicate, and, upon termination of the syndicate’s operations, to distribute the cash holdings to the members in proportion to their beneficial interests. The syndicate was to be terminated on or before December 31,1931, unless extended by written consent of all the members. The trustee was given full power, as authorized in the agreement, to act for the syndicate in dealing with the public, but was subject to the majority control of the syndicate members. Meetings of the syndicate members might be called at any time by the trustee on a majority vote of the members and syndicate matters decided upon by a majority vote, proxies being permitted. The trustee might resign at any time by giving notice of 10 days, or be removed by a majority vote and a successor elected. The trustee was not to be personally liable for any act on behalf of the syndicate except for “willful wrongdoing or gross and willful abuse of his powers and discretion.”

The syndicate was put into operation upon the execution of, and under the provisions of, the above described agreement.

The original trustee, Samuel H. Shevelson, died on February 25, 1928, and on February 27,1928, one of the syndicate members, Yernon J. Bert, was elected to take his place.

The actual operation of the syndicate was very informal. ISTo certificates of beneficial interest were ever issued and no formal meetings were ever held except for the purpose of electing the successor trustee after the original trustee’s death. The nine men who comprised the syndicate membership were friends and fellow employees of long standing who had been in the habit of eating lunch together daily in the Sears, Roebuck & Co. lunch room. The idea of forming the syndicate originated from their conversations at the lunch table. It was explained by Yernon J. Bert in his testimony as follows:

We were busy men there in our regular business, and we thought that we would like to take advantage of opportunities to make a little extra money through speculation, and it was felt that we could better do it if we had one of our number sort of handle the detail, somebody having to be the spokesman acting for the other 8.
I would say that written agreement was gotten up for two reasons. There was always the possibility there might be a death among our membership during the time of the pool, and then also I think that the trustee, Mr. Scherverson [Shevel-son], felt there would [should] be some document which would hold him free from any financial contingency that might'arise, any claim. * ⅜ ⅜

The original trustee, Samuel H. Shevelson, was not a member of the syndicate, but was an employee in the office of one of the members. He had no reputation as a stock market expert. Neither of the trustees of the syndicate received any compensation for his services.

The operations of the syndicate during its existence consisted of 11 purchases and 3 sales of Sears, Roebuck & Co. stock, the gross amount of the purchases being $571,622.50, and the gross amount of the sales being $742,643.53, and the net profits $165,735.54.

The decisions to buy and sell stock were arrived at in the informal discussions of the members at the lunch table. When a decision had been reached to buy or sell stock the trustee telephoned the order to an officer of the bank where the syndicate trading account was kept.

During the syndicate’s operations the interest charged on loans by the banks was greater than the dividends on the shares of Sears, Roebuck & Co. stock held by the trustee, so that additional assessments of from $50 to $75 per month, amounting in the aggregate to $610 per member, were made against each member of the syndicate.

The syndicate was dissolved on September 14, 1928, and its assets were then distributed to the syndicate members. Each syndicate member received $19,025.06, representing a profit of $18,415.06 and the return of his assessment of $610. The original 100 shares of Sears, Roebuck & Co. stock which the syndicate members lent to the syndicate were also returned to them.

The individual members of the syndicate reported the amount .of their profit from the operation of the syndicate in their income tax returns for 1928. The deficiency herein results from the respondent’s determination that the syndicate was an association taxable as a corporation. Whether the respondent erred in so determining is the only question raised in this proceeding.

In our opinion this issue is controlled by the decisions of the Supreme Court in Morrissey v. Commissioner, 296 U. S. 344; Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; and Helvering v. Coleman-Gilbert Associates, 296 U. S. 369.

In the cases cited the Supreme Court has made it plain that the statutory definition of an association, as used in the Revenue Act of 1928 and prior revenue acts, includes such organizations as the one here under consideration where a group of persons unite and carry on a business enterprise in the manner above described.

In view of the broad scope of the rule laid down in those cases, it is unnecessary, we think, to point out the applicability of the Court’s reasoning therein to the facts presented in the instant case. The following language from Helvering v. Combs, supra, however, appears to be directly in point and conclusive:

In considering whether an association was created, the fact that the beneficiaries did not exercise control is not determinative. Hecht v. Malley, 265 U. S. 144; Morrissey v. Commissioner, supra. The parties joined in a common enterprise for the transaction of business, and the beneficiaries who contributed money for that purpose became associated in the enterprise according to the terms of the arrangement. The essential features of the enterprise were not affected by the fact that the parties confined their operations to one oil well. See Swanson v. Commissioner, decided this day. Parties may form an association for a small business as well as for a large one. Here, through the medium of a trust the parties secured centralized management of their enterprise, and its continuity during the trust term without termination or interruption by death or changes in the ownership of interests, and with limited liability and transferable beneficial interests evidenced by certificates. Entering into a joint undertaking they avoided the characteristic responsibilities of partners and secured advantages analogous to those which pertain to corporate organization. The fact that meetings were not held or that particular forms of corporate ¡procedure were absent is not controlling. Morrissey v. Commissioner, supra.
We think that the taxpayer was taxable as an association. * * *

Upon authority of the cases cited we hold that the petitioner during and for the year 1928 was an association taxable as a corporation.

Reviewed by the Board.

Judgment will be entered for the respondent.