author: Smith:

text:
    William B. Scaife & Sons Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94813.
    Promulgated February 6, 1940.

      Samuel Kaufman, Esq., for the petitioner.

      J. Harrison Miller, Esq., and Orris Bennett, Esq., for the respondent.
   OPINION.

Smith:

This proceeding involves an income tax deficiency for 1936 in the amount of $1,946.63 and an excess profits tax deficiency for that year in the amount of $942.15. Petitioner alleges that the respondent erred (1) in adding to its income an overstatement of Pennsylvania capital stock tax in the amount of $1,919.97, and (2) in refusing to allow a declared capital stock value of $1,000,000 as a basis for computing its excess profits tax.

The first issue has been settled by stipulation filed at the hearing, the parties having stipulated that petitioner is entitled to a deduction from gross income in the amount of $917.55, in addition to the amount of $2,294.25 previously allowed, and may be entitled to a further deduction in the amount of $229.42 depending upon the action taken on its petition to the Pennsylvania Board of Finance and Revenue.

As to the second issue the essential facts are as follows:

On July 29, 1936, there was filed on behalf of the petitioner a Federal capital stock tax return for the period ended June 30, 1936, in which the original declared value of its capital stock was stated at $600,000. This return was prepared by the petitioner’s treasurer and was signed by petitioner’s president, J. Y. Scaife. ■

Early in September 1936 it came to the attention of petitioner’s officers that in the preparation of the return the petitioner’s treasurer had declared a capital stock valuation of $600,000, whereas he had been instructed by petitioner’s vice president, A. M. Scaife, to report a declared capital stock value of $1,000,000. Petitioner’s president, who signed the return, did not examine it carefully and was not aware of the fact that the lower capital stock valuation of $600,000 had been declared. The petitioner’s president, J. Y. Scaife, and its vice-president, A. M. Scaife, were brothers.

On September 3, 1936, the petitioner lodged with the collector of internal revenue at Pittsburgh, Pennsylvania, its Federal capital stock tax return for the period ended June 30, 1936, in which the declared value of its capital stock was stated at $1,000,000 and tendered to the collector its remittance in the amount of $400 to cover the additional Federal capital stock tax computed on that basis. The collector returned to the petitioner the $400 so tendered and refused to accept for filing the amended capital stock tax return, but did retain the return and transmit it to the Commissioner of Internal Revenue as a part of the record in the case.

On November 24, 1936, the petitioner instituted in the District Court of the United States for the Western. District of Pennsylvania an action seeking to enjoin the collector of internal revenue at Pittsburgh from refusing to receive and accept the amended return and substitute it for the original return previously filed. The petition was denied by the District Court, 18 Fed. Supp. 748, and the lower court’s opinion was affirmed by the United States Circuit Court of Appeals for the Third Circuit, 94 Fed. (2d) 664.

Section 105 of the Revenue Act of 1935 provides in part as follows:

SEO. 105. CAPITAL STOCK TAX.
(a) For each year ending June SO, beginning with the year ending June 30, 1936, there is hereby imposed upon every domestic corporation with respect to carrying on or doing business for any part of such year an excise tax of $1.40 for each $1,000 of the adjusted declared value of its capital stock.
*******
(d) Every corporation liable for tax under this section shall make a return under oath within one month after the close of the year with respect to which such tax is imposed to the collector for the district in which is located its principal place of business or, if it has no principal place of business in the United States, then to the collector at Baltimore. Maryland. Such return shall contain such information and be made in such manner as the Commissioner with the approval of the Secretary may by regulations prescribe. The tax shall, without assessment by the Commissioner or notice from the collector, be due and payable to the collector before the expiration of the period for filing the return. * * *
(f) For the first year ending June 80 in respect of which a tax is imposed by this section upon any corporation, the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended), as of the close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section). * * *

In Haggar Co. v. Helvering, 308 U. S. 389, the Supreme Court held that the declaration of capital stock value as contained in the first capital stock tax return filed by a taxpayer pursuant to section 215 of the National Industrial Recovery Act of 1933, 48 Stat. 195, 207, which was carried forward into the subsequent revenue acts, may be amended within the time fixed for filing such return. The Board and some of the lower courts previously had taken the view that the statute permitted no amendment to the declaration of value contained in the first return properly filed by the taxpayer. See William A. Webster Co., 37 B. T. A. 800; Haggar Co., 38 B. T. A. 141; affd., 104 Fed. (2d) 24; A. J. Crowhurst & Sons, Inc., 38 B. T. A. 1072; Blake & Kendall Co. v. Commissioner, 104 Fed. (2d) 679; Chicago Telephone Supply Co. v. United States, 23 Fed. Supp. 471; certiorari denied, 305 U. S. 628. The Haggar Co. case sustains Glenn v. Oertel Co., 97 Fed. (2d) 495, and Philadelphia Brewing Co. v. United States, 27 Fed. Supp. 583, where the opposite view was taken.

There is a factual difference between the instant case and the Haggar Co. case which we believe to be vital. There, the amended capital stock tax return containing the new declaration of value was offered within the statutory time for filing such return, as extended by Treasury Decisions 4368 and 4386, whereas in the instant case the amended return was not submitted to the Commissioner until after the expiration of the due date.

Under section 105 (a) and (d), above, the time for filing the capital stock tax return for the petitioner’s taxable year ended June 30, 1936, expired on July 31, 1936. So far as the stipulated facts disclose, or as we are able to determine from an examination of the Treasury decisions and rulings, no extension of the time for filing such return was granted either by general extension, as in the Haggar Co. case, or by specific grant to this petitioner. Apparently no extension of time for filing was asked and no amendment of the return which it had already filed was suggested by the petitioner until September 3. 1936, more than a month after the expiration of the filing period.

Throughout its opinion in the Haggar Co. case the Court emphasized that the amended return there was offered within the time for filing of the return for that taxable year. We quote from the opinion:

In August, 1933, petitioner, a Texas corporation, mistakenly believing that it was required to state the par value of its issued capital stock in its tax return, filed a timely return for the year ending June 80, 1933, * * * The date for filing returns for that year having been extended to September 29, 1933, T. D. 4368, 4386, petitioner before that date filed an amended return. * * *
* * * The Circuit Court of Appeals for the Fifth Circuit affirmed, holding that § 215 (f) by its terms precluded any amendment of the tax return for the first year even though made witMn the time allowed for filing the return. 104 F. (2d) 24. * * *
The Commissioner founds his argument in support of the decision below upon a literal reading of the introductory sentence of § 215 (f) already quoted, which, he argues, precludes even a timely amendment of the tax return for the first year, and upon the administrative and Congressional interpretation of the statute. He insists that the phrase “first return” in the clause “declared value shall be the value as declared by the corporation in its first return under this section (which declaration of value cannot be amended)”, means the first paper filed by the taxpayer as a return, and that these words plainly forbid any amendment of the declared value of the capital stock, even though made witMn the time allowed for filing the return.
* * # * * * *
“First return” thus means a return for the first year in which the taxpayer exercises the privilege of fixing its capital stock value for tax purposes, and includes a timely amended return for that year. A timely amended return is as much a “first return” for the purpose of fixing the capital stock value in contradistinction to returns for subsequent years, as is a single return filed by the taxpayer for the first tax year. Glenn v. Oertel Co., supra; Philadelphia Brewing Company v. United States, supra; see also, similarly construing the phrase “first return” under § 114 (b) (4) of the Revenue Act of 1934, 48 Stat. 680, 710; C. H. Mead Coal Co. v. Commissioner, 106 F. (2d) 388, 390; cf. Pacific National Co. v. Welch, 304 U. S. 191, 194. Thus read the statute gives full effect to its obvious purposes and to the evident meaning of its words. To construe “first return” as meaning the first paper filed as a return, as distinguished from the paper containing a timely amendment, .which, when filed is commonly known as the return for the year for which it is filed, is to defeat the purposes of the statute by dissociating the phrase from its context and from the legislative purpose in violation of the most elementary principles of statutory construction. [Italics supplied].

As we read the Court’s opinion it goes no farther than to say that an amended capital stock tax first taxable year return containing a revised capital stock valuation may be filed within the time lawfully prescribed for filing such return. Without such a limitation on the time for filing an amended return the purpose of the statute to have a definite and fixed declaration of value “for the first taxable year,” as was recognized by the court, would be defeated, since the taxpayer might in any subsequent year submit an amended return declaring a different value.

In the circumstances here disclosed the refusal of the Commissioner to accept the amended return offered by the petitioner after expiration of the period for filing the return for the taxable year was not an abuse of his discretionary powers. Cf. Morrow, Becker & Ewing, Inc. v. Commissioner, 57 Fed. (2d) 1. The law under which, the original return was filed was not a “new law”, as in the cited case, and the petitioner had had ample notice of its rights and obligations under the statute.

Petitioner’s contention is that the -understatement of the value of its capital stock as disclosed in its original return was due to the error of its officers who prepared and signed the return. However that may be, the mistakes of its officers do not relieve the petitioner of the consequences of its failure to comply with the law. See Pioneer Automobile Service Co., 36 B. T. A. 213; George S. Groves, 38 B. T. A. 727.

The petitioner, having timely filed its capital stock tax return for the year ended June 30, 1936, and the period for filing such return for that year having expired on July 31, 1936, we are of the opinion that petitioner was not entitled to file an amended return changing the declaration of value contained in the original return.

Keviewed by the Board.

Decision will be entered wider Rule 50.


source: Caselaw Access Project

author: Opper:

license: Public Domain

text:
    Kehoe-Berge Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94246.
    Promulgated February 7, 1940.

      Robert S. Pasley, G. P. A., and Robert S. Pasley, Jr., Esq., for the petitioner.

      E. G. Sievers, Esq., E. 0. Hanson, Esq., and W. Frank Gibbs, Esq., for the respondent.
   OPINION.

Opper:

Petitioner is the lessee of a coal mine. For the tax year 1934 it filed a return disclosing that net income from the property was nonexistent. As of that year the cost of the lease to petitioner was zero. In its return it failed to indicate any election of the percentage depletion alternative provided by the Revenue Act of 1934, section 114 (b) (4).

Upon audit, the revenue agent made such adjustments that net income for the year in question resulted. Petitioner acquiesced therein and paid the tax as computed by the agent, the amount arrived at having made provision for an allowance to petitioner of depletion based upon the percentage method. In 1935 petitioner’s return showed a net income and percentage depletion was deducted. No amended return for the year 1934 has been filed and no return of any kind for that year on behalf of petitioner claims deduction on the percentage basis. Respondent having determined that petitioner’s failure to elect to take percentage depletion in the first return- filed after the enactment of the Revenue Act of 1934, requires the disallowance of depletion calculated by this method for both the years 1934 and 1935, has found the deficiencies which raise the only point of present controversy.

The section in question was the subject of two recent decisions of the Board, C. H. Mead Coal Co., 38 B. T. A. 1163, and Dorothy Glenn Coal Mining Co., 38 B. T. A. 1154. The former case was reversed by the Fourth Circuit Court of Appeals, Mead Coal Co. v. Commissioner, 106 Fed. (2d) 388. No appeal was taken in the latter case.

The salient distinction between these two cases, and one we consider significant in the proper treatment of the present proceeding, is that in the Mead case an amended 1984 return claimed depletion on the percentage basis, whereas in the Dorothy Glenn case no amended return was filed. The reversal of the Board’s decision in the Mead case was limited to the effect of the amended return and it was there decided that such a return conformed to the requirement of the statute that the election to take depletion on the percentage basis should be manifested in the “first return” filed for any year beginning with 1934. Cf. Haggar Co. v. Helvering, 308 U. S. 389. The Court was of the opinion that an amended return filed prior to the return for the following year was timely and should be accepted as a substitute for the return originally forwarded. But cf. Riley Investment Co. v. Commissioner, 108 Fed. (2d) 713. The Board had taken a contrary view, but the question of timeliness is not presented by the record here.

In the Board’s opinion in the Dorothy Glenn case this distinction was discussed (p. 1159):

* * * It is -unlike the Mead case in that the petitioner * * * has not at any time made a request in connection with any return, amended or otherwise, for percentage depletion. * * *

Petitioner had actually specified an election of unit depletion in its 1934 return but it argued that its situation was such that it could obtain no benefit from this, and, therefore, the case should be treated as though no election had been made. The Board’s opinion comments (p. 1161):

* * * If, on the other hand, it is not possible, as' the petitioner contends, for a taxpayer to elect to take depletion on the unit basis when on the unit basis no deduction will result, the petitioner is in the position of haying failed to make any election with or without regard to percentage depletion, and under such circumstances Congress has said “the depletion allowance * * * shall be computed without reference to percentage depletion.” C. H. Mead Coal Co., supra. The petitioner has lost no deduction to which it was at any time entitled, but through its failure to act as Congress prescribed has failed to obtain an added deduction.

The argument of petitioner, which is the same as that made here, that it was in fact deprived of the privilege of election since only by claiming percentage depletion could it obtain the benefit of any deduction, was disposed of as follows:

* * * The petitioner’s reasoning is that two remedies or rights must actually exist and if a party eleets to take a supposed right or benefit which is in fact nonexistent he is not precluded thereby from later claiming the other. We are not here concerned with the doctrine of election of remedies, however, but with a question of statutory allowance of a deduction from gross income, and, as we have pointed out in C. H. Mead Coal Co., supra, the allowance of a deduction is a matter of legislative grace and Congress may prescribe such prerequisites and conditions for the allowance thereof as it sees fit and a claim for deduction must come clearly within the conditions prescribed. New Colonial Ice Co. v. Helvering, 292 U. S. 435, and Independent Life Insurance Co. v. Helvering, 292 U. S. 371.

These considerations lead to the result that on the authority of Dorothy Glenn Coal Mining Co., supra, petitioner’s failure to elect at any time to take percentage depletion for the year 1984 deprives it of that privilege for that and subsequent years; and that nothing contained in the opinion reversing C. H. Mead Coal Co., supra, is opposed to that conclusion. See also, Commodore Mining Co., 40 B. T. A. 347; William B. Scaife & Sons Co., 41 B. T. A. 278. But apart from authority, it seems to us that the path of logic leads to the same destination.

Although it is true that in the years now in issue petitioner was precluded from deducting unit depletion by reason of the lack of any cost basis, it by no means follows that in the case of this petitioner on the present record, or of this type of taxpayers generally, such a condition must be regarded as permanent. Development costs are a commonplace in the mining industry and improvements, extensions, and other capital expenditures can, under appropriate circumstances, place a mining enterprise in a position where a cost basis would be created. Enterprise Coal Co. v. Phillips, 12 Fed. Supp. 49, affirmed per curiam, 84 Fed. (2d) 565; New Quincy Mining Co., 36 B. T. A. 376; Trace Fork Mining Co., 15 B. T. A. 872; see Blockton Cahaba Coal Co. v. United States, 24 Fed. (2d) 180; Sultana Oil Corporation, 40 B. T. A. 1196; cf. G. C. M. 13954. That being so, no one without the gift of unlimited prophecy can determine categorically that a choice between unit depletion on the one hand and percentage depletion on the other will never come into being and prove beneficial.

The method adopted by Congress for dealing with the question of depletion in the case of mines, as manifested by the legislative scheme disclosed by section 114 (b) (4), seems to us to make it apparent that a taxpayer is not to be allowed to change its mind with respect to the method of calculating depletion. Yet petitioner’s contention would present it with that opportunity. If its position is correct, it has never made the election described in section 114. It would, therefore, be free to argue that the opportunity to elect is still open. ,It might even contend in some later year that its election of unit depletion in 1934 — by the silence which the section makes as eloquent as any affirmance — would carry over to a later year and entitle it to that method without further action on its part. Cf. petitioner’s argument in C. H. Mead Coal Co., supra. On either hypothesis, unless the election was made in 1934 it would be impossible to say, under the language of the governing statute, when it had been made, or what it was. The precision obviously aimed at by the legislation would be wholly lacking. And if the election was made in 1934 it must have resulted, as the provision clearly requires in such circumstances, in a renunciation of the percentage method.

Upon first examination, it may seem a harsh and unnecessary emphasis which we thus place on the mechanical fact of petitioner’s declaration of its choice of method. It might be said that we are now deciding against petitioner for its' inconsequential failure to indulge in the futile gesture of electing percentage depletion in its oi’iginal return; or at least of filing an amended return after the revenue agent’s adjustments, see Mead Coal Co. v. Commissioner, supra; but cf. Riley Investment Co. v. Commissioner, supra. The answer must be that the gesture would not have been futile; the failure, was not inconsequential. Only by one or the other of those acts could petitioner’s election have been signified in a manner that would bind it for the future. And only a binding election not subject to alteration can conform to the general plan. If we remit that all-important prerequisite, we place petitioner in a favored position and one which is evidently forbidden by the legislative scheme. Under the express language of the. statute no return filed for 1935 or any subsequent year can be regarded as an election or commitment of any kind. As to this petitioner, that significance was reserved for the 1934 return. And under the equally explicit statutory language the election was made in 1934 as effectively by petitioner’s silence as it could have been by any form of words. We do not consider ourselves permitted so to modify the legislative expression as to bestow upon an act the opposite effect from that expressly imputed to it; or as to permit an election made in a return for a subsequent year to have the same effect as though made for the previous year for which it is expressly required.

Decision will be entered wider Rule 50.

       SEC. 114. BASIS FOR’ DEPRECIATION AND DEPLETION.
      (b) Basis toe Depletion.—
      *******
      (4) Percentage depletion foe coal and metal mines and sulphur. — Tbe allowance for depletion under section 23 (m) shall be, in tbe case of coal mines, 5 per centum, in tbe case of metal mines, 15 per centum, and, in tbe case of sulphur mines or deposits, 23 per centum, of the gross income from tbe property during tbe taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by tbe taxpayer in respect of tbe property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property. A taxpayer making his first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election, thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section.


author: Disney:

text:
    George Brothers & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93248.
    Promulgated February 7, 1940.

      I. M. Pechham, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Disney:

This proceeding involves income and excess profits taxes as follows:

The questions presented are, whether the Board has jurisdiction, whether petitioner is an association taxable as a corporation, whether it is entitled to deduction for compensation for services rendered by its members, and whether it is subject to excess profits tax.

The petitioner, an organization of Chinese people, engaged for profit in the business of manufacturing overalls and work clothing, in San Francisco, California. The Chinese name of the organization is Dor Lee. It was first organized some time between 1880 and 1900. In January 1914 a “Partnership Agreement”, as it was captioned, was prepared and signed by the then members of the organization. The instrument begins with the words, “This AGREEMENT oe COPARTNERSHIP”, and recites, that the parties agree to associate together “as co-partners” for the purpose of manufacturing working clothing, etc.; that profits and losses shall be taken by each in proportion to his interest; that the parties have delivered as capital $26,100 to be used in common in the business; that the style and title “of said copart-nership shall be Dor Lee” ; that 10 percent of the profits shall each year be awarded as bonus to the “partners” actively managing the business; that there shall be distributed to the “copartners each year” 6 percent interest on the paid-in capital, with provision for limitation or deferment thereof in case of shortage of cash; that the partners actively engaged in the management of the business shall receive monthly salaries, with no advance thereon of more than $20; that in case of embezzlement or misappropriation by the manager, his share or interest shall be forefeited to cover the loss, and he shall make further restitution until the loss is returned; that “the appointment in the personnel for the operation of said business shall be entrusted to the manager, the cashier and the sales manager; the silent partners shall have no voice in the matter”; that the manager shall make an annual report and account on the business for the inspection of the partners; that no manager, cashier, or sales manager shall leave the service of the copartnership suddenly and without giving notice, and shall remain for six months to give assistance to his successor; that a partner wishing to withdraw shall give six months notice, shall be entitled to no account or inventory of the business, but shall wait until the end of the year, when the value of his interest in the co-partnership shall be determined; that if the copartnership takes over his interest, he shall be paid 90 percent of the value as determined by inventory and accounting at the end of the year, and may transfer his interest to an outsider only when neither the copartnership nor any of the copartners desires to acquire it, and then only upon the consent of the other parties; that the manager shall be appointed by the copartners, and may for dereliction in duties be removed by the action of the copartners in meeting assembled; that during the last month of each calendar year the manager shall give formal notice to those active partners whose services he desires to retain for the ensuing year, and any active partner failing to receive such notice may not draw further compensation for services. Attached to the agreement is a list of the copartners and the interest, in dollars, of each, with notations showing three transfers, apparently all in 1926, with amounts transferred. Between 1914 and 1935 there were 21 withdrawals, partial withdrawals, changes and partial changes, of interest. There were changes of managers. There was no change in membership in 1934 or 1935. Throughout those years there were 15 members, of whom 9 lived in China and 6 in San Francisco. Five, including a manager, worked actively in the business. The manager took care of the finances, wrote checks, and supervised the keeping of the books, and was consulted by the others; another took care of accounts, bought goods, and supervised the office employees, his duties being roughly that of office manager; another was an inside salesman; another was a general salesman; another was foreman of the factory where the women worked. Federal income tax returns for 1934 and 1935 were filed on the partnership form, in which no salaries or compensation of partners was included. The reasonable compensation of the manager, Bong Hin, was $350 per month and of the office manager, Lai Shun, the general salesman, Chan Sing, and the foreman, Chan Son, each $200 per month, and of Chan Tim, the inside salesman, $125 per month. All policies of the organization were decided by calling together all the partners resident in San Francisco. The members in China were not consulted about management; they trusted the active partners to handle the business properly. The organization, in purchasing on credit, always represented itself to be a partnership.

Petitioner carried a loan account with Wells Fargo Bank, which from time to time took signature cards and statements as to the nature of the organization, and it was invariably described as a partnership. The bank had a corporation form, but petitioner filled the statement on the partnership form. The bank had no form for a voluntary association or joint stock company. Credit was extended by tbe bank to petitioner as a partnership. They represented to the bank that they were partners. J. L. Bailey & Co. and the Universal Button Co. have sold cotton goods to petitioner since 1919 on credit, on the representation of petitioner that it was a partnership. It had for the past ten years been rated by Dun & Bradstreet, Inc., and other credit agencies as a partnership. Partners and general partners are mentioned in a report of Dun & Bradstreet, Inc., of May 8, 1934; a report of the same agency November 1, 1933, refers to three active partners and about twenty general partners, one-half of them living in China. Petitioner was described as a partnership in its application for casualty and compensation insurance and in the policies. It has from time to time received from the Commissioner extensions of túne for filing partnership returns.

In 1928 the petitioner published duly acknowledged notice of a “Certificate of Copartnership Doing Business Under a Fictitious Name”, and on November 15, 1928, filed same in the office of the clerk of the Superior Court of the City and County of San Francisco. The certificate was signed by Lai Shun, Dong Hin, Chan Chew, Chan Son, Chan Loy, and Lai Ting, who were resident in San Francisco, and recites that they are “all of the members of said copartnership.” Two others, resident in San Francisco, Loo Yee Toe and Loo Yee Koung did not sign. All the signers were employed in the organization. The Federal income tax returns for 1934 and 1935 each recites the nature of the organization as partnership and recites distribution of profits to 13 partners (also “Estate of Lai Chow, China,” and “Chan Loy Estate”, address San Francisco), of whom 9 are shown as in China. The returns were filed on the accrual basis and on a calendar year basis. The net worth of petitioner was, on December 31, 1933, $128,890.86, and on January 1, 1935, $137,107.04 — not including good will. The members in 1934 and 1935 were the same who signed the agreement in 1914, except that a father in 1928 transferred a $500 interest to each of two sons; and another father transferred to his son two-fifths of his interest; and the son was admitted by consent of the other members. There had been withdrawals. One member, Loo Sing Won, died and his interest, under the Chinese law and custom, passed to his widow, and when she died, it passed to her two sons. Four members withdrew. One had an interest under two different names and withdrew the interest held under one name, retaining the other. The rest of the 21 changes were withdrawals.

The individual members repeatedly rendered their income tax returns disclosing their receipts from the petitioner, and no complaints were made by the collector’s office. There were no units in the organization, and no documents evidencing ownership except what was called the “partnership book” containing entries. The members resident in China receive 6 percent on their investment-. All profit is divided.

The petitioner first challenges the jurisdiction of the Board. The question was raised in the petition and by motion to strike that portion of the petition. In opposition to the motion petitioner filed a brief extensively arguing the jurisdictional question. The motion to strike was sustained. We therefore consider the question as already passed upon. However, we believe and hold that we have jurisdiction, under Continental Products Co. v. Commissioner, 66 Fed. (2d) 434, and Thalhimer et al. v. Commissioner, 62 Fed. (2d) 703.

Is petitioner a partnership or an association taxable as a corporation, within the intendment of the Revenue Act of 1934? Petitioner contends that it is a general partnership. Respondent raises no contention that it is a special limited partnership and there was no compliance with the prerequisites necessary to such partnership. We have, therefore, to decide between general partnership and association taxable as a corporation. The question is not one controlled by local law. Wholesalers Adjustment Co. v. Commissioner, 88 Fed. (2d) 156.

As stated in Regulations 86, article 801-4: “The Act provides its own concept of a partnership.” The definition is:

SEC. 801. DEFINITIONS.
(a) When used in this Act [1934]—
*******
(3) The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this Act, a trust or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or 'organization.

The expression “association” is likewise a broad one, as used in the Regulations. No single characteristic of the organization examined or element has been presented as determinative, though stress, in various cases, has been laid upon different aspects of the situation. In Wholesalers Adjustment Co. v. Commissioner, supra, and in Helvering v. Coleman-Gilbert Associates, 296 U. S. 369, weight has been given to the purpose, as found in the agreement of the parties. Here we have a written agreement. Examination is, of course, to be made of all other facts, and each case rests primarily upon the facts presented. The question herein presented is not an easy one. The organization presents some aspects tending under some of the decisions to indicate partnership, others to indicate an association. Upon review of all of the evidence, however, we think it indines strongly towards establishment of partnership. There were articles of copartnership, not essentially different from those usual with partnerships; and the term “partner” is repeatedly used. Of course the designation is not conclusive ; yet we think it is not without bearing.

As in Helvering v. Coleman-Gilbert Associates, supra, the parties were not considered free to say that their purpose was other or narrower than that which they formally set forth in the instrument under which their activities were conducted, so here their formal articles of agreement, executed in 1914, must be given consideration. The same appears logically true of the fact that credit for a number of years had been extended to the corporation as a partnership, and upon representations by the members that it was such, and that the same representation had been made in obtaining casualty and industrial insurance.

A formal certificate of doing business as a partnership under a fictitious name, and the publication of notice thereof, in 1928, six or seven years prior to the taxable years, is strong indication, we think, of the true character of the group. It is true that only six members signed, and that they represented themselves in the certificate to be all of the partners, and this, unexplained, indicates deception in that regard. Yet it does not, we think, indicate that others were not members; but only that from inconvenience or otherwise, the others did not sign. The certificate does show that the intent was to carry on as partners, and the names of other members are furnished by the articles and records of the organization.

The agreement by its terms negatives the idea of free assignability of interests, often cited as an indication of an association, for it provides for transfer to one outside the organization only when neither the organization nor the other members desire to acquire, and then only by consent of the other members. There were no certificates of interest as in case of a corporate organization, the only record of a member’s interest appearing in a book in a Chinese dialect. From 1914 to 1935, inclusive, there had been only one transfer of an interest to an outsider, and that with the consent of the other members. There had been withdrawals, and transfers between members, and in two cases there was distribution of profits to the estates of deceased members in 1934. Withdrawals, of course, are not unusual in partnerships, nor is it unusual for the heirs or estates of deceased persons to be permitted to share. The terms of the agreement aire plain that this can be only by agreement, and by such agreement, of course, any sort of change as to members or other matters can be made in a partnership; since that relationship depends upon agreement. It is apparent from the articles that without agreement for the admission of the heirs or estate of a deceased person, none such could enter the group. This is, of course, the negation of continuity regardless of death of members.

[Respondent urges that there was centralized management and quotes Morrissey v. Commissioner, 296 U. S. 344. There was centralized management in a sense, yet we think it bears more resemblance to that of a partnership with a manager and assistants than that of a corporation. A partnership not infrequently has a manager. Petitioner had no president, secretary, or board of directors, or board of control at all similar to that of a corporation. The authority of the manager, moreover, was limited. He is given power with the cashier and sales manager to appoint the personnel necessary for the operation of the business; and the silent members had no voice in the matter. Apparently the silent members had a voice in everything else. All had agreed to “associate themselves as copartners for the purpose of manufacturing * * * to the faithful performance of which they mutually bind and engage themselves.” There was from profits a 10 percent “bonus to the partners actively managing said business”, and compensation was paid monthly “to the partners actively engaged in the management of said business”; so that it is apparent that they were actually engaged as partners, rather than in a position similar to that of corporate officers. The manager himself was “appointed by the copartners” and was removable by them, “in meeting assembled”, for dereliction in duties. He made an annual account and report on the business “for the inspection of the partners.” The residuum of power was obviously with the members. We think that the organization in this respect is that of active and silent partners, a usual arrangement, rather than of a corporate character.

Nothing appears to limit the liability of the members, except that each took profits and losses in proportion to his interest. Though this does not definitely state that the provision is as between the members only, it is an agreement among themselves, without other effect. There is no provision, as in the case of an ordinary corporation, limiting liability to the amount of investment. The provision is rather that of whatever liability or gain there may be, each will, as to the others, contribute in proportion, without regard to the amount he has invested. We think there is not here the similarity to the corporate set up which would indicate an association taxable as a corporation.

It is also urged that the members each received only 6 percent, similar to a corporate dividend; and that the corporate capital was the original contribution of $26,100. But the evidence indicates otherwise. Though there is provision for distribution of .6 percent each year, and it is referred to as “interest”, yet “in the event of shortage of cash the distribution of said interest may be limited or deferred”, and that the share is not limited to 6 percent is shown by the provision that the “profits * * * of said business shall be taken by each partner proportionately as his interest bears to the total capital.” Moreover, in 1934 and 1935, the amounts reported as distributed to partners do not represent 6 percent. Thus Lai Quon or Quong, one of the original signers, contributed $2,500 out of the $26,100. His distribution in 1934 was $816.64, in 1935, $2,167.76; while Dong Hin, originally contributing $1,000, received distribution in 1934 of $612.48 and in 1935 of $1,625.74.. Whatever profit was made was either divided or credited to the “partners” on the books. We think there is little similarity to shares of stock held. There was no unit, such as $100. In two instances a $250 interest was transferred.

After a study of this interesting Chinese organization in the light of the leading cases on this subject, which it is unnecessary to enumerate further, we are convinced that it is not essentially different from an ordinary partnership having inactive or silent partners. The definition of “partnership” by section 801 (a) (3) of the Revenue Act of 1934 is obviously so broad as to cover it. It is not a trust, an estate, or a corporation. We, therefore, conclude and hold that it was not an association taxable as a corporation.

In the light of such conclusion it is unnecessary to decide the remaining questions as to excess profits tax and deductions for compensation to members.

Decision will be entered, for the petitioner.

       Art. 801-2. Association. — The term “association” is not used in the Act in any narrow or technical sense. It includes any organization, created for the transaction of designated affairs, or the attainment of some object, which, like a corporation, continues notwithstanding that its members or participants change, and the affairs of which, like corporate affairs, are conducted by a single individual, a committee, a board, or some other group, acting in a representative capacity. It is immaterial whether such organization is created by an agreement, a declaration of trust, a statute, or otherwise. It includes a voluntary association, a joint-stock association or company, a “business” trust, a “Massachusetts” trust, a “common law” trust, an “investment” trust (whether of the fixed or the management type), an interinsurance exchange operating through an attorney in fact, a partnership association, and any other type of organization (by whatever name known) which is not, within the meaning of the Act, a trust or an estate, or a partnership. If the conduct of the affairs of a corporation continues after the expiration of its charter, or the termination of its existence, it becomes an association.


text:
    Paul Legallet, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92520.
    Promulgated February 7, 1940.

      Lloyd Dinkelspiel, Esq., for tbe petitioner.

      Marry B. Morrow, Esq., for the respondent.
   OPINION.

Disney:

This proceeding involves income tax for the calendar year 1935 in the amount of $4,680.04. The question presented is as to the proper cost basis to petitioner of an interest in a partnership, purchased by him upon decease of his partner, pursuant to an agreement between the partners.

The greater portion of the facts was stipulated, including documents referred to and received in evidence pursuant to the stipulation. The facts so stipulated are found by us, and will be referred to only so far as necessary to consideration. They may be summarized as follows:

Petitioner, resident of San Francisco, California, filed his income tax return for the year 1935 with the collector for the first district of California, upon the basis of cash receipts and disbursements. He has since 1920 been in the business of leather tanning, and from 1923 had as a partner, without written agreement of partnership, one Neil O’Neill, who died September 15, 1935. From 1923, except for a short period in 1929-1930, the interests of the two partners were equal. After O’Neill’s death petitioner acquired his interest in the partnership pursuant to an agreement hereinafter referred to, and in 1935 sold a portion of the assets so acquired, to wit, accounts receivable and merchandise, giving rise to the present question as to the proper base to be applied to the partnership interest so acquired.

The two partners had from time to time discussed and considered means by which in the event of the death of either the other should acquire the interest of the deceased, and deceased’s wife should receive/, the value thereof, and to that end considered insurance. In 1923, when one Hermann was also a partner, O’Neill and Legallet each took out! | $2,000 life insurance, payable to Hermann and to the other partner^, with right in the insured to change the beneficiaries. Later in 1923 Hermann was eliminated as beneficiary in each policy. In 1926 these! policies expired, and in the same year O’Neill and Legallet each took| out a $10,000 life insurance policy upon ¿is life, with the other asj beneficiary, O’Neill’s policy being in the Missouri State Life Insurance \ Co. In 1929 O’Neill’s wife was.named beneficiary instead of Legallet in the Missouri State Life Insurance Co. policy and O’Neill’s wife collected on the policy after his death. The policy taken out by Legallet with O’Neill as beneficiary continued until its expiration in 1930. On July 1,1929, during a short period when one Metten was a third member of the firm, Legallet and O’Neill agreed in writing that the life insurance should remain as before, “Namely, that on the death of either \ party the other is to get the entire sum of the policy, to be used in pur- \ chasing the deceased’s share of the business.” In March 1932 Legallet and O’Neill each took out $20,000 life insurance on his life with the pother partner as beneficiary, with right to change beneficiary reserved. In May 1932 the beneficiaries on O’Neill’s policy were changed to his wife or daughter, and on Legallet’s policy the beneficiary was changed to his wife or children, and both policies were divided into four policies of $5,000 each. These changes of beneficiaries were made after an insurance agent named Deutsch, in an effort to promote his business, had discussed with Legallet and O’Neill the purpose and method of payment of proceeds of the insurance to the beneficiaries. A few days later, on May 25,1932, Legallet and O’Neill and their respective wives entered into an agreement practically identical with the final agreement of February 8, 1935, described below, except that in the latter there was included reference to an additional $5,000 insurance policy taken out by each partner in July 1933, with his wife as beneficiary.

The agreement under which petitioner acquired the interest of his deceased partner was as above stated executed on February 8,1935. In effect it provided, so far as herein material, that in case of the death of either, the survivor should purchase the decedent’s partnership interest, that to effect that end each has procured five policies of insurance of $5,000 each on his life; that the parties agree to pay all premiums promptly, and that the firm, Legallet & O’Neill, is authorized and directed to pay same and deduct the sums paid from amounts payable to the partners; that the proceeds of the policies shall be disposed of as follows: the wife of each partner agrees to accept $25,000 paid by the life insurance companies as first payment on the deceased partner’s interest, the full purchase price, until December 31, 1935, to /He one-half of $111,871.63, the agreed full value, until that date, of the partnership; that if the sum received by the wife of the deceased partner from insurance should exceed the value of the interest transferred, she should nevertheless retain the full amount as purchase price for the '^partnership interest, but if the sum received by her is not sufficient f to purchase the interest, the surviving partner agrees to pay to the wife of the deceased the difference between amount received and the value of the partnership interest, giving fifty 6 percent nonnegotiable notes each of 2 percent of the amount due, payable every thirty days.

The life insurance premiums were paid by the partnership (except that as to the one policy in Missouri State Life Insurance Co. after change of beneficiary to O’Neill’s wife), and were charged on the partnership books to an insurance expense account, which account also included other insurance such as fire insurance. The premiums were charged against profit and loss and, therefore, were divided equally between the partners, as had been the custom for many years. Premium notices were addressed by one insurance company to each insured “c/o Legallet & O’Neill, 1099 Quesada Street, San Francisco, California,” while the other company sent notices addressed to each insured at “1099 Quesada Avenue, San Francisco, Cal.” The policies were kept at the partnership office until O’Neill’s death.

After the death of O’Neill there was paid or credited to his wife, by the insurance companies, $25,113.59, and pursuant to the agreement she accepted $25,000 out of the insurance proceeds as the first payment on the partnership interest, and received from petitioner 50 promissory notes of $618.72 (2 percent of the amount due), totaling $30,936. All of the notes which have matured have been paid with interest. Petitioner did not include in his individual income tax return for 1935 the $25,000 received under the insurance policies, or any part thereof.

In addition to the stipulated facts above epitomized, we find from testimony adduced the following additional facts: When Deutsch, the life insurance agent, in May 1932 called on the firm of Legallet & O’Neill he did so in the course of soliciting business and had not been before acquainted with either partner. In conference the question arose as to how the insurance on the policies then held would be paid to the wife of O’Neill. O’Neill wanted her to be certain to have fixed installments during her entire life. As then written, the policies provided a lump sum payment to the surviving partner and the agent suggested that a change was necessary if O’Neill wanted the insurance payable covering her entire life. The policies were changed as suggested by the agent.

The amount of insurance was raised in July 1933 from $20,000 to $25,000, as to each partner, with no change of other terms. The agent drew the rough draft of the agreement entered into by the partners and their wives upon February 8,1935.

The respondent determined, in arriving at the deficiency herein, that the $30,936 represented by the promissory notes given by peti-. tioner was petitioner’s cost basis for the partnership interest acquired by him; petitioner contends for a cost basis of $55,936 by adding the $25,000 proceeds of insurance. Is petitioner entitled to the addition thereof as a part of his cost basis? The $25,000 was not in fact r«T\ ceived by him, but by O’Neill’s wife, and was not in fact paid by_, petitioner to her. Is the effect, for the present purpose, as if he had so received and paid the $25,000 as purchase price of the partnership interest acquired ? The question is not easy of solution. Counsel for both parties state that no adjudication is squarely in point, but cite cases which they offer as helpful analogy. In fact, to a large extent they both offer the same cases, drawing opposite conclusions therefrom.- Petitioner, in effect, contends that looking through form to substance, the insurance proceeds should be considered as received by petitioner as provided by earlier agreements between the partners, though not by the last agreement, that they were constructively received by him, and that the insurance proceeds when received by O’Neill’s wife were impressed with a trust and subject to use as part payment of the purchase price of the partnership interest acquired by petitioner, in accord with the use in the contract of the expression “part payment.” Respondent contends that the last contract as actually made controls, that it, as distinguished from earlier insurance and the contract of July 1,1929, does not provide that petitioner was beneficiary of the life insurance proceeds, that he did not receive them, did not pay them to O’Neill’s wife, and, therefore, can not use them as a part of cost basis.

Of the cases allegedly analogous pointed out by the parties, we think Boston Safe Deposit & Trust Co. et al., Executors, 30 B. T. A. 679; M. W. Dobrzensky, Executor, 34 B. T. A. 305; and Estate of John T. H. Mitchell, 37 B. T. A. 1, come nearest to being of assistance. In the Boston Safe Deposit case a partnership owned a life insurance policy of $100,000 on the life of each member, with an agreement in effect that in case of a partner’s death the amount should be credited upon the value as purchase price of the deceased partner’s interest. We held that $129,247.19, the full value of the partnership interest, was includable in decedent’s gross estate, but that no insurance was so includable. From this, petitioner concludes in substance that for estate tax purposes O’Neill’s estate would be required to include the full $55,936, the agreed value of the partnership interest, and that it follows that petitioner must be allowed the same amount as cost basis. But in the Dobrzensky case, supra, we held that the reasoning, though not the result, in the Boston Safe Deposit case was wrong, that the insurance proceeds should have been included in the estate, and the value of the partnership interest only above the amount of insurance proceeds; and we so held on the facts in the Dobrzenshy case, wherein the insurance was applied for by and upon the life of the partner who later died. The premiums were paid by the partnership but upon the agreement that the insurance proceeds be accepted by his wife in lieu of certain interests of decedent in the firm, including the right to use his name. We took the view that though the premiums were paid by the firm, it was for a consideration including the right to use his name and his interest in the good will, and that, therefore, the decedent bought the policies and they should be regarded as “taken out by the decedent upon his own life” under the statute and so includable in his gross estate. Estate of John T. H. Mitchell, supra, involved a situation much like that herein. Though there was no partnership, two men were each holders of the same amount of stock in a corporation and made an agreement protecting the survivor in his right to purchase the shares of the deceased, entailing life insurance taken out by each on his own life, the proceeds of which in case of death were to be applied upon the purchase price of the stock to be purchased by the survivor. Though originally each was to pay the premiums upon the life of the other and one (as herein) on account of difference in age, had a heavier premium to pay, this was modified by-agreement that the expense should be borne equally, and both premiums were paid by the corporation and charged, in equal amounts, against the personal accounts of the stockholders and offset by avails for salaries and dividends due to each. The beneficiary in each case was the estate of the insured, the right to change beneficiary was reserved, and the policy on the life of each was delivered into the possession of the other. We held that the amount of insurance proceeds received by the estate of the decedent must be included in his gross estate under section 302 (g) of the Revenue Act of 1926, and that only the remainder of the purchase price need be included.

Petitioner contends that in the above cases there was no difference in the total result whether the full partnership interest and not the insurance, or the insurance and only the balance of the partnership interest, were to be included in gross estate; but this is not correct, for if the insurance had been found payable to the other party, to be classed as “receivable by all other beneficiaries as insurance under policies taken out by decedent upon his own life”, under the latter part of section 302 (g), only the amount thereof above $40,000 would hafe been included in gross estate. Regardless of that, however, we think our conclusions in the above cases indicate the proper conclusion her'e. In those cases, particularly'nf'the Mitchell case, the fact that the insurance proceeds were to be applied upon purchase price to the survivor did not prevent a conclusion that such proceeds were insurance. In the Mitchell case the policies were actually delivered to the other party. The premiums were paid almost exactly as herein, out of common funds, in that the corporation paid them, as did the partnership here, and charged them to the individual accounts, offsetting, as here, amounts owing to the individuals. In all three of the above cases, and in this, the purpose was to provide a part of the purchase price of the partnership interest. If the insurance proceeds were insurance, to be included in gross estate in the cited cases, they would be such to the estate of O’Neill, and only the balance of the purchase price would be included in gross estate as from Legallet on the contract. Therefore we think petitioner can take as cost base only the latter amount. The conclusion that such proceeds must be considered insurance receivable by the wife of O’Neill, and not by petitioner, is further justified by the fact that the small amount of $113.59 above the $25,000 was received by O’Neill’s widow as insurance, and it is not argued otherwise. If that was insurance so received, we think the whole $25,113.59 is such. Moreover, if the insurance proceeds had exceeded the value of the purchase price, the wile would nevertheless have retained same — likewise indicating that they were insurance. Petitioner’s argument that we should look to substance through form and find that the parties intended that petitioner be the beneficiary, as in previous transactions, is nullified by the mere fact that the parties, for reasons duly considered, deserted the older form of agreement and method of insuring with the other as beneficiary and adopted a different one. They wished a change of substance as well as form, for they wished a certain kind of distribution, and in order to obtain it, found it necessary to deviate from the old payment in a lump sum to the survivor. We can not reasonably now say that the change was unintentional or ineffectual. Likewise the idea that the insurance proceeds was a trust fund for payment to the petitioner is, we think, not accurate. It was, as in the three cases above discussed, subject to a contract, but not by way of such trust as to dictate constructive receipt of the amount by petitioner. A mere contract entailing the elements here involved does not constitute constructive receipt.

Upon the authority of the Dobrzensky and Mitchell cases, supra, above discussed, we conclude and hold that petitioner’s cost basis does not include the $25,000 insurance proceeds received by the wife of his deceased partner.

Decision will be entered wider Rule 50.


author: ARnold :

text:
    Black Motor Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97232.
    Promulgated February 13, 1940.

      George E. H. Goochner, Esq., for the petitioner.

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

ARnold :

The first issue is to be determined under section 23 (k) of the Revenue Act of 1936, which authorizes the petitioner to deduct “Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; * * *”

In this proceeding the respondent, in the exercise of his sound discretion, determined that $79,332.24 represented a reasonable addition to petitioner’s reserve for bad debts for the taxable year. The petitioner offers no proof to support its contention that $94,680.87 is the proper addition to its reserve for bad debts, other than a mathematical computation, whereby it fixes the percent of losses from bad debts, to be applied against its total accounts and notes receivable and deferred certificates of $174,020.71, at 40.95 percent in lieu of the 32.13 percent used by the respondent.

The test, however, is whether the amount ultimately determined, regardless of formula, constitutes a reasonable addition to petitioner’s reserve. What constitutes a reasonable addition will depend upon the facts and circumstances of the business engaged in with relation to general business conditions., A method or formula that produces a reasonable addition to a bad debt reserve in one year, or a series of years, may be entirely out of tune with the circumstances of the year involved. Such, in our opinion, is the situation here, and, in the absence of a showing that the allowance contended for by petitioner is more reasonable than the addition determined by the respondent, the latter amount is approved as a reasonable addition to petitioner’s reserve for bad debts.

Our approval of respondent’s determination could be fortified, if necessary, by the computation appearing in the deficiency notice relating to petitioner’s tax liability for 1937. It appears therefrom that respondent permitted the deduction of $6,654.00 more than petitioner’s bad debts actually totaled in the subsequent taxable year, which fact corroborates the reasonableness of respondent’s determination.

The second issue involves the petitioner’s right to deduct an additional $1,500 as salary owed its manager. No accrual was made on petitioner’s books of this amount and no claim therefor was made in its tax return. The resolution under which this liability was created was adopted long prior to the taxable year, and said resolution had not been rescinded. The failure to accrue the $1,500 due the manager was reasonably explained, and, since the liability was fixed, the petitioner’s taxable income should reflect the existence thereof. American Snuff Co. v. Commissioner, 93 Fed. (2d) 201; certiorari denied, 303 U. S. 662. In our opinion petitioner is entitled to the additional deduction.

The next issue involves petitioner’s dividends paid credit. The applicable statutory provisions respecting this credit provide:

SEC. 27. CORPORATION; CREDIT FOR DIVIDEND,S PAID.
(a) Dividends Paid Credit in General. — Por the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.
* sfc sfc t}: >}{ »Je 4c
(g) Preebeenttai, Dividends. — No dividends paid credit shall be allowed with respect to any distribution unless the distribution is pro rata, equal in amount, and with no preference to any share of stock as compared with other shares of the same class.

Section 27 grants corporations a credit against the surtax on undistributed profits imposed by section 14 of the 1936 Act. Standing alone, subsection (a) of section 27 would provide for a dividends paid credit in the amount of the dividends paid by the corporation during the taxable year. The broad provisions of subsection (a) are, however, expressly limited by the succeeding subsections, and particularly (g) and (h). Subsection (g) specifically limits the credit to dividends that are distributed pro rata, equal in amounts, and without preference. Distribution means division among those entitled to share.

It appears from the deficiency notice that respondent disallowed the entire amount of the dividends paid credit claimed by petitioner upon the ground that the distributions made were not pro rata and without preference. Our findings show that the distributions were irregular in amount and were not without preference, since the two majority stockholders secured the full amount of their dividends and the other stockholders received only 50 or 25 percent of their dividends. Had the dividends been distributed pro rata in the mamier provided for by the petitioner’s directors, that is, 2% percent on the 15th of each month for four months, starting October 15, petitioner would have been entitled to a dividends paid credit of $5,625. Not only did petitioner fail to follow the minutes of its own directors’ meeting, but it definitely preferred its principal to its minority stockholders in the distributions made. Such preference and inequality of distribution among stockholders in the same class destroys the fight to the credit given in subsection (a), and respondent’s determination is therefore approved. See article 27 (a)-l and article 27 (g)-l, Regulations 94.

In arriving at this construction of section 27 (a) and (g) we have considered petitioner’s argument that the declaration created a liability to its stockholders and that such an obligation constituted a property right to each stockholder. But we can not carry this theory to the extent that petitioner contends, namely, that its stockholders were “paid” within the meaning of section 27 by the obligations created when the dividend was declared. Section 27 requires more than the creation of a liability to pay; it grants a credit only with respect to “dividends paid during the taxable year.”

Petitioner contends in the alternative that it is entitled to a “dividends paid credit” of three-fourths of the dividend, or $5,625, the amount to be paid in cash in 1936; or three-fourths, plus the additional one-fourth of $972.50 which was paid to two of the stockholders in cash, total $6,597.50; or the total amount paid in cash in 1936 of $5,487.50; or the total amount of cash paid on the three installments payable in 1936 of $4,515; and that in no case should the Board allow less than $1,875, the amount of the first installment which was paid in 1936.

Petitioner’s last alternative contention that it is entitled to a credit of $1,875, as each stockholder received at least 25 percent of his portion of the dividend in the taxable year, can not be sustained. The record does not show that the dividend payable October 15 was distributed pro rata among the stockholders. Petitioner’s two principal stockholders, from the facts shown, may have received more than their pro rata share of that distribution, in fact, may have received the entire distribution, in wbicb event the distribution could not have been made to all the stockholders pro rata. This view likewise disposes of petitioner’s other alternative contentions.

Petitioner’s argument with respect to the excess profits tax issue is that if the Board sustains it on the other issues there will be no deficiency with respect thereto. The alleged unconstitutionality of the tax is not argued, possibly because of the weight of authority against this contention, Del Mar Addition, 40 B. T. A. 833, and cases cited. We have sustained petitioner on one of the issues presented and in view thereof the excess profits tax deficiency should be recomputed in accordance therewith.

Reviewed by the Board.

Decision will be entered wnder Rule 50.


author: Leech :

text:
    Trico Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85176.
    Promulgated February 13, 1940.

      John Lord O'Brian, Esq., and Ralph Dish, Esq., for the petitioner.

      Allen T. AJcin, Esq., for the respondent.
   OPINION.

Leech :

The first question is whether petitioner was formed for the purpose of avoiding the surtax on its shareholders through the medium of permitting its gains and profits to be accumulated instead of being divided or distributed.

It has been found, as a fact, that petitioner was organized as a mere holding or investment company. From this fact the presumption arises that the condemned purpose existed at its organization. Revenue Act of 1932, sec. 104 (b). However, this presumption is rebut-table and, in our judgment, has been conclusively overcome here.

The witnesses of petitioner testified that avoidance of surtax was neither discussed nor entertained as a motive by anyone concerned at the time of its organization. This testimony was neither shaken nor contradicted on cross-examination. While this testimony is certainly not conclusive as to the nonexistence of the interdicted purpose (Reynard Corporation, 37 B. T. A. 552, and Rands, Inc., 34 B. T. A. 1094), nevertheless it is entitled to weight if there is corroborating evidence. Cecil B. deMille Productions, Inc., 31 B. T. A. 1161; affd., 90 Fed. (2d) 12; certiorari denied, 302 U. S. 713; Mellbank Corporation, 38 B. T. A. 1108.

In our opinion, such evidence exists here. Fifty percent of the total outstanding stock of Trico, in November 1929, had been released from the restrictions of both the voting trust and the waiver of dividends. The voting trustee retained only the barest practical control of Trico and, consequently, its policies and management. But, the proscribed intent may not be inferred from an intent to concentrate and maintain control of the corporation, without more. W. S. Farish & Co., 38 B. T. A. 150; affd., 104 Fed. (2d) 833. Moreover, when a block of stock was released from its restrictions, there was a danger that it would be dumped on the market, thus driving the price down or at least preventing a rise. That petitioner may have been organized for the additional purpose of avoiding any such adverse effect on the market value of Trico stock, under the present circumstances, is wholly reasonable and just as proper. Cf. Dill Manufacturing Co., 39 B. T. A. 1023.

The only asset that was intended to be acquired and that was acquired by petitioner upon its organization, was this stock of Trico, which was then producing no income. Under the circumstances, in all probability, no income would arise from holding such stock and comparatively little could have been reasonably expected in the foreseeable future from such of that stock as would be released from restrictions. The intent thus evidenced, though consistent with the purposé of retaining control and protecting the market, value of Trico stock, is inconsistent with'any intent to accumulate gains and profits in order to avoid surtax.

Respondent suggests that, since 1930 surtax was avoided in fact, because petitioner’s dividend income in that year was used for corporate purposes, instead of being distributed, those in control of petitioner must have intended, “as keen American business men”, this particular consequence. This contention is sufficiently answered by Dill Manufacturing Co., supra, C. H. Spitzner & Son, Inc., 37 B. T. A. 511, and Cecil B. deMille Productions, Inc., supra, wherein the Board held that the prohibited purpose, upon which, alone, the imposition of' the tax can depend, is not established by avoidance of surtax per se. Moreover, the amount of surtax avoided in 1930 by stockholders of petitioner was trivial in amount when compared with the magnitude of petitioner, the capital employed, and the risk to such capital in the operations being carried .on to stabilize the market. In that year, a total amount of $7,647.44 in surtax was avoided by three of petitioner’s 23 stockholders through petitioner’s earnings for that year not being distributed. As to the other 20 stockholders, there is no. evidence of a saving. Such a condition does not support a theory of a purpose to avoid surtax in the organization of petitioner. Common sense teaches us that it is unreasonable to assume that 21 “keen American business men” would borrow and risk some $600,000 in operations on the market to effect a saving of a tax liability of less than $8,000 to three of their number.

Accordingly, we have found that petitioner was not formed for the interdicted purpose.

Was petitioner availed of, in 1933, the taxable year, for the purpose penalized under section 104?

The reason for the creation of petitioner was to hold, in one unit, 50 percent of the stock of Trico. Admittedly, petitioner made an investment in 6,710 shares of Trico in March of 1930.' But this was done in order to free such of Trico’s moneys as were tied up in that treasury stock and make those funds available for production of earnings. And, the evidence is clear and overwhelming that from 1930 onward, petitioner’s function was to create and support a market for Trico stock. More fully set out in our findings, it shows that, from 1930 to 1934, substantial percentages of the total volume of trading in Trico on the New York Stock, Exchange were due to petitioner’s market activities. In 1933, petitioner accounted for 20.1 percent of the total volume, buying 12,200 shares and selling 21,000 in 100-share lots. Expressed in dollars, the 1933 purchases totaled $357,652.50, and the 1933 sales aggregated $655,778.46. In prior years, petitioner’s supporting activities were even greater, rising' in 1932 to 67 percent of all market transactions in Trico. These operations undoubtedly stabilized the price of Trico stock and aided in lessening its decline through the course of the depression. There is no indication of trading for profit per se. No more than reasonable stabilization was effected. When that was accomplished, the operations ceased, the corporate debts were paid, and, thereafter, the dividends received on its remaining Trico stock were distributed.

The business reason motivating this extraordinary activity of petitioner was to prevent, as far as possible, depreciation in the market value of Trico stock. Many of the stockholders of Trico had pledged this stock as collateral on loans and margin accounts; should that collateral decline too far, their financial ruin was inevitable. Moreover, all of petitioner’s capital consisted of Trico stock.

Although it must have been hoped that a profit on these protective trading transactions would be made, it is strongly indicated that their only purpose was to create and support a market for Trico stock. See Brooklyn Trust Co., Trustee, 31 B. T. A. 1070; affd., 80 Fed. (2d) 865; certiorari denied, 298 U. S. 659; Investment Trust of Mutual Investment Co., 27 B. T. A. 1322; affd., 71 Fed. (2d) 1009. That, among those facing catastrophe were the persons responsible for petitioner’s organization and market activity, or that the motives of that activity were ultimately selfish in the sense that they were for the protection of the market value of Trico stock in which many of petitioner’s stockholders were not only vitally interested but upon the maintenance of which value their economic lives and that of petitioner depended, does not affect the validity of or the need for the market operations carried on by petitioner. Cf. Dill Manufacturing Co., supra. Such a motive is not that which the statute condemns.

However, we have made no finding as to whether petitioner was a mere holding or investment company in the taxable year 1933, because, even if it were so designated, the statutory presumption thus raised (Revenue Act of 1932, sec. 104 (b)), is, we think, conclusively overcome by the evidence.

The business need, not only for the use of all of petitioner’s gains and profits but also its large borrowings in its market activities, is amply demonstrated, and contradicts the existence of the proscribed purpose. W. S. Farish & Co., supra; Mellbank Corporation, supra. In the years prior to 1933, petitioner had losses in its trading activities in two years and a small profit in one. In 1932 its market operations resulted in a loss. In 1933, purchases totaled $357,652.50 and sales were in the amount of $655,778.46. The income from Trico dividends in 1933 was $156,265.44. The book surplus, as of the close of 1932, was $339,735.51. This surplus was composed mainly of Trico stock acquired in the course of trading. At the beginning of 1933, petitioner owed $869,364.49 on loans which it had contracted in order to finance its market operations. It had agreed with two banks that it would not pay dividends until it had fully repaid loans which they had made to it. Such loans were still outstanding in substantial amounts in 1933.

Faced with the necessity for reducing outstanding obligations and with a need for operating capital, the requisite amount of which could not be estimated in advance, petitioner could not reasonably have paid out anything in dividends in 1933. To have done so would not only have violated two agreements with the banks and have required a new loan, but, obviously, would have been an act of financial folly, under the circumstances. A corporation certainly need not increase its indebtedness, merely to avoid the application of section 104, when the reasonably possible consequence of such increase would be its economic injury or death. See Dill Manufacturing Co., supra, and Mellbank Corporation, supra.

Respondent bases his argument that petitioner was availed of in 1933 for the purpose of preventing imposition of surtax on its shareholders, by his analysis of petitioner’s balance sheet for that and preceding years and on certain isolated acts in prior years in which some of its then accumulated surplus was used to extend relief to some of its large stockholders in carrying Trico stock owned by them, and by purchasing and holding, for a short period, securities which they wished to sell to realize individual losses for tax purposes.

Respondent thus relies upon his analysis and reconciliation of surplus as establishing that petitioner received substantial income in each year, from 1930 to and including 1933, and that an increasing surplus existed at the close of each successive year, which amounted to $540,134.79 at the close of 1933.

Upon this basis it is urged that petitioner was well able to distribute the earnings of $213,998.89 realized in that year, the retention and use of which earnings, it is said, were not necessary in the operation of its business. As establishing the fact that a large part of such surplus was not necessary, respondent points to an item on the balance sheet for 1933, showing $100,000 represented in securities carried “for others” and $65,548.46 outstanding on loans made to two of its large stockholders. In addition to this'it is .contended that the balance of the existing surplus and a large part of its borrowings were merely invested in stocks and that these funds were thus accumulated in that form. It is then argued that if petitioner had surplus to invest or to loan to others it was available for dividend distribution instead.

If petitioner had no. business purpose during 1933, beyond the mere purchase and holding of securities for investment, respondent’s argument would undoubtedly be sound. Rands, Inc., supra. But petitioner’s purpose was not so- limited in 1938, nor had it been since 1980. In our opinion, the evidence is compelling that this purpose was to create and support a market for Trico stock. Having in mind that purpose and the activity of the petitioner during those years in effectuating such purpose, the conclusion is inescapable that these acts which respondent contends are consistent, only, with the intent prohibited in section 104, are, in fact, either inconsequential in the total picture or are, not only 'consistent with but reasonably necessary in carrying out the established purpose of creating and supporting a market in Trico stock.

Thus, the use of $100,000 in carrying Trico stock in brokerage accounts for others was as reasonable as the expenditure by petitioner of a larger sum in the purchase of such stock which would probably have been necessary had the stock been thrown on the market. The loans to two stockholders engaged in buying Trico stock and assisting in the support petitioner was giving the market, were in definite furtherance of that purpose. And, in view of the proof, we can not agree with respondent’s contention that any of the Trico stock acquired and held by petitioner was a mere investment rather than a purchase made with the view of stabilizing the market and with the purpose to resell it as the market strengthened and could absorb it.

The three purchases of securities by petitioner in prior years to permit a stockholder to take a loss for income tax purposes, we think, are of no consequence here. In each instance the stock was resold at purchase price in slightly over 30 days. Both the number of such transactions and funds involved; when compared to the total trading and amounts so used, contradict any possible pertinent significance in them in this proceeding.

Petitioner entered the year 1933,-engaged actively in effectuating its plan of supporting the market for Trico stock. It then had an indebtedness of $869,364.49, incurred in furnishing that support: During that year, it realized a net. income of $213,998.89 and closed the year with a book surplus of $540,134.19. But, during that period, it paid $430,756.18 on account of its indebtedness. This payment was more than twice the amount of its net income for the year and, at the close of the year, its cash on hand amounted to only $19,949.11. The book surplus was represented by Trico stock bought to stabilize a weak market. Had petitioner paid a dividend at the close of 1933, it would have been forced to borrow the money to do so or, as respondent contends, sell Trico stock. The use of either such alternative was, in our judgment, impractical here. In view of then market conditions, it seems apparent that the potential needs of petitioner’s business in the taxable year might reasonably require the use of all of its credit and thus bar any use of that credit for dividend purposes. And such suggested sale of Trico stock by petitioner would have defeated the very purpose of petitioner’s then existence and precipitated a condition, the result of which might well have been the elimination of profits and accumulated surplus as well. See Delaware Terminal Corporation, 40 B. T. A. 1180.

In addition, it may be noted that the payment of a dividend would have violated the agreements not to pay dividends, made by the petitioner with the two banks as conditions for the advancement of credits. These conditions were reasonable and were imposed on petitioner by the banks. The credits were not merely two specific loans of $300,000 each, but were two “lines of credit” in that amount. Thus, though one of the loans had been substantially curtailed by 1933, and the balance was therefore more readily payable, a violation of the agreements might well have entailed a loss of the entire lines of credit. The activities of petitioner in supporting the market were not yet ended. Such further support might reasonably have necessitated further loans.

We have therefore found as a fact that petitioner was not availed of in 1933 for the purpose of preventing imposition of the surtax on its shareholders through the medium of permitting its gains and profits to accumulate. In view of this conclusion, it is unnecessary to pass on petitioner’s argument that the statute can not constitutionally apply because only some and not all of its stockholders actually avoided surtax.

Reviewed by the Board.

Decision will be entered for the petitioner.


author: Smith :

text:
    Paul Autenreith, Petitioner, v. Commissioner of Internal Revenue, Respondent. F. Julian Autenreith, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. Harold Autenreith, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94070, 94071, 94072.
    Promulgated February 13, 1940.

      John A. McCawn., Esq., for tbe petitioners.

      Orris Bennett, Esq., for the respondent.
   OPINION.

Smith :

The petitioners’ first contention is that the annual payments which were made to their mother out of partnership income are deductible from their gross income as interest paid under section 23 (b) of the Revenue Act of 1934. The provision of the statute is that in computing net income there shall be allowed as a deduction from gross income “all interest paid or accrued within the taxable year on indebtedness.” (Emphasis supplied.) It is quite plain that the payments which the petitioners made to their mother were not interest “on indebtedness.”

It was clearly the intention of the partners that the principal amounts of the notes which the petitioners executed in favor of their mother should never be paid. They were to become payable only upon default of the payment of interest and in the absence of such default they were to be canceled upon the mother’s death. Since their ultimate payment depended entirely upon the wishes and acts of the obligors themselves, they did not represent indebtedness of the petitioners. It is axiomatic that, if the notes did not evidence an indebtedness, the so-called interest paid on them was not interest “on indebtedness” within the meaning of the statute.

The payments in question were, we think, more in the nature of annuities. Looking at the decedent’s will and at the preexisting partnership agreement, the terms of which in this respect are substantially the same, and at the contracts between the petitioners and their mother, each of the petitioners was obligated to pay to his mother annually an amount computed at 6 percent of the value of his one-third interest in his deceased father’s interest in the partnership. Unquestionably the petitioners were legally bound to make these annual payments to their mother and it may be assumed, as the petitioners argue in their brief, that under the laws of the Commonwealth of Pennsylvania the payments were a charge upon the partnership assets, at least to the extent of the interest of the deceased father.

The facts here are similar to those in Commissioner v. Smiley, 86 Fed. (2d) 658, where the court held, reversing 33 B. T. A. 198, that the devisees who took a hotel property subject to certain annuities and operated the property under a partnership agreement were taxable on the entire partnership income without deduction of the annuity payments. The devisees were said to be personally liable for the annuities, regardless of the amount of income derived from the property, and the annuities were held to be a charge against the devised property, on which the annuitants had a lien as security for the payments due them.

Although the point is not raised by the parties to these proceedings, there is a question whether the petitioners here acquired their father’s interest in the partnership by devise under his will or by purchase under the preexisting partnership agreement. See discussion in 68 Corpus Juris 619, where it is stated:

* * * it lias been held by some antborities that an agreement as to tbe disposition of partnership assets in case of tbe death of a partner is of a testámentary character, and by other authorities that it is contractual only.

See also McKinnon v. McKinnon, 56 Fed. 409; In re Eisenlohr's Estate, 258 Pa. 438; 102 Atl. 117; In re McGinley’s Estate, 257 Pa. 478; 101 Atl. 807; Ferrara v. Russo, 40 R. I. 533; 102 Atl. 86. The above cited Pennsylvania cases support the general principle that a valid contract based on adequate consideration to dispose of property after death is enforceable by the surviving contracting party.

If then, as appears to .be the case, the petitioners acquired their interests in their father’s share of the partnership assets by purchase under the partnership agreement of January 10, 1929, it must follow that the payments which the petitioners made to their mother pursuant to the partnership agreement were capital expenditures, constituting a part of the consideration paid for such assets. See Scott v. Commissioner, 29 Fed. (2d) 472; Hill v. Commissioner, 38 Fed. (2d) 165; Corbett Investment Co. v. Helvering, 75 Fed. (2d) 525; Edwards v. Commissioner, 102 Fed. (2d) 757.

In Scott v. Commissioner, supra, a father transferred his interest in a partnership business to his three sons in consideration of their payment to him of an annuity for life and after his death a farther annuity to his widow for life. The court held that the sons were taxable on their entire shares of partnership income without deduction of the annuity payments. To the same effect is Edwards v. Commissioner, supra. There a father and son operated a business jointly under an agreement that upon the death of either the survivor should become the owner of the business and should pay a certain amount monthly to the widow of the deceased joint owner. The court held, affirming the Board, that the payments which the son made to his mother after his father’s death, pursuant to the agreement, were not deductible in computing his net income from the business.

We are of the opinion that the petitioners here are taxable on the entire amount of the income received from the partnership without either the deduction of the annuities paid to their mother as interest on indebtedness or the exclusion of the amounts from their distributable shares of partnership income.

Reviewed by the Board.

Decisions will be entered for the respondent.