author: Hill:

text:
    W. W. Sutton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76946.
    Promulgated January 27, 1937.

      Walter G. Moyle, Esq., and Ralph P. Wanlass, Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent.
   OPINION.

Hill:

The principal and basic issue in this case is whether or not petitioner acquired, under the contracts of September 5, 1921, and. June 7, 1923, a presently vested economic interest in the proceeds of the oil and gas derived from the land owned by the Crews heirs. As petitioner succinctly states in his brief, the real issue is whether the sum of $150,000 paid to and received by petitioner in 1930 represented his share of the oil and gas proceeds arising out of such economic interest, or whether it represented attorney’s fees.

Petitioner reported the amount of $150,000 in his income tax return for 1930, and claimed a deduction for depletion of 27% percent thereof. In computing the deficiency respondent disallowed the deduction for depletion, and treated the entire amount as attorney’s fees or compensation for personal services, taxable as ordinary income at both normal and surtax rates.

Petitioner’s contention that by the contracts in question he obtained a then vested economic interest in the oil and gas production, and that the $150,000 paid to him in 1930 in the compromise settlement of the litigation represented his share of the proceeds arising out of such economic interest, wo think, can not be sustained. The contracts did not vest in petitioner a present economic interest in the proceeds of production, subject to defeasance by a condition subsequent, but the vesting of such an interest was by the express terms of the contracts dependent upon a condition precedent.

The contract of September 5, 1921, specifically provided that only in the event the lease or a part thereof should be canceled through the “effect” of the suit to be instituted and prosecuted by petitioner, the Crews heirs agreed to convey to petitioner an undivided interest in the oil and gas production for his services. The contract further stipulated that “In case no portion of said lease is canceled, set aside or released through the effects of said suit, it is then agreed between the parties hereto that the parties of the first part are not obligated to pay party of the second part anything for his services in said case.”

The contract of June 7, 1923, likewise gave petitioner a right to receive the additional compensation therein provided only upon the happening of a future event, namely, the recovery or collection of some amount from the defendants in the accounting sued for. If no amount vs^as so collected, petitioner was to receive no additional compensation.

Thus, the plainly stated provisions of the contracts, in our opinion, negative the idea that petitioner acquired a present vested economic interest of any kind either in the land, proceeds of production, or funds sought to be recovered through the suit for an accounting. The interests agreed to be conveyed to petitioner would have become vested economic interests only in the event of the termination of the litigation in favor of petitioner’s clients by final judgment of the court or a settlement by the parties out of court. Prior to the happening of such event, petitioner’s interest was contingent and amounted to no more than that of a lienholder, which, while recognizable in equity, is not a vested economic interest.

Section 4100, chapter 23, Compiled Oklahoma Statutes, Annotated, 1921, provides that an attorney who files a pleading for a client and endorses thereon his name, together with the words “lien claimed” shall have a lien upon such cause of action and same shall attach to any verdict, decision or judgment in his client’s favor and the proceeds thereof, and that no settlement between the parties without the approval of the attorney shall affect or destroy such lien. Petitioner so endorsed the petition and amended petition filed in the litigation involved in this proceeding, and contends that such endorsement, under Oklahoma law, gave him an enforceable economic interest in the production of the oil and gas from the Crews’ property. In support of this contention, petitioner cites decisions by the courts of Oklahoma, which, for reasons presently to be stated, we deem it unnecessary to discuss beyond pointing out that, whatever may be the correct interpretation of those decisions, they do not affect the conclusion we reach under the facts in tire instant case.

Whether or not the contracts of employment dated September 5, 1921, and June 7, 1923, under the views of the Oklahoma courts, operated as an equitable conveyance to petitioner of an interest in the land or the oil and gas production, subject to the condition subsequent of performance by petitioner of his obligations under the contracts, the evidence establishes, we think, that prior to such performance by petitioner or fulfillment of the condition subsequent, petitioner on October 11, 1930, agreed to the cancellation of the contracts and released all of his rights thereunder, accepting in place and in lieu thereof aiiother and different consideration as compensation for his services, to wit, $150,000 in cash to be paid to him, which was paid to him under the escrow contract of October 18, 1930.

Subject to performance of the provisions of the agreement of October 11, 1930, which provisions were subsequently carried out, petitioner agreed to and thereby did relinquish and cancel “all debts, claims or controversies in his favor and against the parties of the first part”, except the money payment of $150,000; and by the instrument entitled “Release of Contracts”, dated October 17, 1930, petitioner for a recited consideration of one dollar released, canceled, assigned, and quitclaimed all of his “right, title and interest in under and through” the contracts of September 5, 1921, and June 7, 1923.

Petitioner, therefore, surrendered his rights under the said contracts in consideration of the payment to him of a cash fee of $150,-000, which represented the final compensation paid to him for his services to the Crews heirs in the litigation, in lieu of the compensation originally agreed upon. The fact that the amount was paid directly to petitioner by the Sinclair Co. out of the settlement fund, we think, is immaterial, and does not change the character of the payment as a cash fee for personal services.

While it is true that in the contract of October 11, 1930, it was stated that petitioner was to have in cash $150,000 “as his share of the funds received in the contemplated settlement of the litigation out of court”, this recital, in the light of the other provisions of the contract and contemporaneous instruments, did not constitute the payment to petitioner a payment of royalties arising out of his original interest in the oil and gas production. It was a cash fee to be paid out of the funds received in the contemplated settlement. Indeed, the settlement fund itself had no connection whatever with the payment of royalties, but was merely an amount agreed upon by the parties in the compromise settlement of litigation prosecuted primarily to cancel the original lease. Nor did the compromise settlement provide for the cancellation of the lease. On the other hand, it continued the lease in effect and recognized Sinclair Oil & Gas Co. as the owner thereof. The cancellation of the lease was the condition precedent to the vesting in petitioner of a right to a share of the oil produced from the lands involved. Since the lease was not canceled either as a result of the litigation or of the compromise settlement, no economic interest in the lands ever vested in petitioner.

Having reached the conclusion that the sum of $150,000 received by petitioner in 1930 did not represent income derived from an economic interest in the production of oil and gas from the Crews’ property, it follows that petitioner is not entitled to a deduction for depletion at the statutory rate, as claimed by him.

There are two additional contentions urged by petitioner, which require but brief notice. Petitioner argues that if any portion of said sum of $150,000 should be held to represent a consideration for the release and quitclaim of his interest in the oil properties rather than his interest in the mineral production, then such portion of the income is taxable as capital net gain. This contention is sufficiently.answered by what we have said above. Petitioner canceled the contracts of September 5, 1921, and June 7, 1923, by the agreement of October 11,1930, under and pursuant to which latter contract he received a cash fee of $150,000 in lieu of the surrendered rights acquired under the old contracts. The cash fee so received is taxable as ordinary income. Cf. Escher v. Commissioner, 78 Fed. (2d) 815.

Petitioner further contends on brief that the oil and gas proceeds out of which the $150,000 was paid were received in part by the Farmers State Bank as a fiduciary, and, under section 161 of the Revenue Act of 1928, were taxable to the fiduciary as and when received by it. This contention can not be sustained under the facts. The $150,000 received by petitioner was paid directly to him by the Sinclair Oil & Gas Co. out of the $375,000 settlement fund. No part of the sum paid to petitioner came out of the fund held in escrow by the bank, nor was petitioner, under the final contract of October 11, 1930, entitled to receive any part of that fund.

The remaining issue raised by the pleadings is whether the sum of $150,000 received by petitioner in 1930 as compensation for personal services should be prorated over the years 1920 to 1930, inclusive, when it was earned. Petitioner did not argue this issue on brief, and in his reply brief indicates that it has been abandoned. In any event, the issue must be decided adversely to the petitioner. The entire amount was received by petitioner during the taxable year 1930. He kept his books and filed his income tax return on the basis of cash receipts and disbursements. In such circumstances, compensation for personal services, under section 41 of the Revenue Act of 1928, constitutes taxable income for the year in which actually received. Agnes B. C. Chormann et al., Executors, 10 B. T. A. 920; Adolph Schlett, 7 B. T. A. 150; E. F. Cremin, 5 B. T. A. 1164.

The deficiency determined by the respondent is approved.

Reviewed by the Board.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Black: Disney,

license: Public Domain

text:
    J. Russell Wait, Petitioner, v. Commissioner of Internal Revenue, Respondent. Katharyn Wait, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 75772, 75773.
    Promulgated January 27, 1937.

      D. A. Simmons, Esq., for the petitioners..

      Willis R. Lansford, Esq., and Edward M. Woolf, Esq., for the respondent.
   OPINION.

Black:

These proceedings, consolidated for hearing and report, involve the redetermination of deficiencies in income tax for 1932 of $91.23 in the case of J. Russell Wait and $116.40 in the case of Katharyn Wait.

There is only one issue and it is common to both proceedings, and that is whether the salary of J. Russell Wait paid to him by the Harris County Houston Ship Channel Navigation District for his services during the taxable year is subject to Federal income tax.

Petitioners, husband and wife, residing in the State of Texas, filed separate income tax returns on the community property basis. Neither reported any of the salary of $9,000 in question. Respondent has determined that such salary is taxable and has added one-half thereof to the reported income of each of the petitioners. The parties agree that if the salary is taxable the deficiencies are correct.

The facts were stipulated and no separate findings of fact are necessary. We will state such of the facts that have been stipulated as seem necessary to an understanding of the issue which we are to decide.

Prior to, during, and since the taxable year J. Russell Wait, hereinafter to be called the petitioner, husband of Katharyn Wait, served as general manager and secretary of the board of commissioners of the Harris County Houston Ship Channel Navigation District, hereinafter referred to as the district, at an annual salary of $9,000.

Tile statutes of Texas enacted under the provisions of article 3, section 52, of the state constitution, authorize the creation of navigation districts for improving “rivers, bays, creeks, streams and canals within or adjacent to such districts, and construct and maintain canals and waterways to permit of navigation or in aid thereof, and may issue bonds in payment therefor as hereinafter provided.” Art. 8198, Vernon’s Annotated Texas Statutes. A district wholly within one county is created, briefly stated, by the filing of a petition of resident property owners to the commissioners’ court, followed by a hearing before the court after due notice, and an election if the findings of the- court are in favor of the petitioners. Arts. 8200 to 8208, inclusive. ■ The District was created in 1910 pursuant to these statutes and its powers were continued and extended in 1922 by a vote of the people at an election.

The jurisdiction of the District is coextensive with the limits of Harris County, Texas, and extends to the Gulf of Mexico.

•The District is authorized to issue bonds not in excess of 10 percent of the assessed value of the real property in the navigation district. Art. 8236. In 1911 the District issued bonds in the amount of $1,250,-000, which, with an equal amount provided by Congress, it contributed to commence the dredging of a 25-foot channel from Houston to the Gulf of Mexico. In 1919 additional bonds in the amount of $1,500,000 were issued to match an equal amount appropriated by Congress to deepen the channel to a depth of 30 feet. In 1914 bonds in the amount of $250,000 were issued by the District and contributed with an equal amount appropriated by Congress to buy two dredges for use in maintaining the channel.

The District has the:

* * * right, power and authority to acquire, purchase, take over, construct, maintain, operate, develop and regulate wharves, docks, warehouses, grain elevators, bunkering facilities, belt railroads, floating plants, lighterage, lands, towing facilities, and all other facilities or aids incident to or necessary to the operation or development of ports or waterways, within the district and extending to the Gulf of Mexico, as provided in this subdivision. Article 8229.

Such powers are acquired by a petition of the navigation board to the commissioners’ court, a hearing thereon, and, if approved, an electioh to determine whether the District shall avail itself of the power.

The Harbors and Rivers Act of March 2, 1909, declared it to be the policy of Congress that water terminals are essential to all cities located on harbors or navigable waterways and that at least one public terminal shall be constructed, owned, and regulated by a municipality or other public agency of the state and open to all on equal terms. Pursuant to such declaration of policy, and in accordance with authority given by the voters in the District, in 1913' the District issued an additional $4,000,000 in bonds to purchase land and build wharves, a grain elevator, and a switch railroad, and make the facilities open to all on equal terms. In 1924 additional bonds in the amount of $400,000 were voted to extend the switch railroad and buy a fireboat as a public facility to operate on the channel for the protection of life and property. In 1927 bonds in the amount of $1,500,000 were voted to purchase land to add to the wharves, grain elevator, and other facilities. In 1930 additional bonds in the amount of $2,923,000 were voted for wharves, an elevator, buying land for Government uses, dumping grounds, etc.

The District is governed by a board of five commissioners appointed under the provisions of a state statute, two by the County Commissioners’ Court of Harris County, Texas, two by the City Council of Houston, and the fifth, the chairman, is appointed by the court and council, acting jointly. The commissioners receive no compensation for their services. The commissioners constitute the pilot board and supervise and appoint all pilots operating in the Houston Ship Channel, fix pilotage rates, and make and enforce rules and regulations governing the pilots in the port and District. They also have power to employ such persons as they deem necessary for the construction, maintenance, operation, and development of the District and its facilities, and prescribe their duties and fix their salaries. Arts. 8235, 8245, and 8248 to 8252, inclusive. The powers of the commissioners include the right to assess and collect charges for the use of all facilities in the District. Art. 8237.

Up to June 30, 1934, the agencies indicated invested the following sums in the Port of Houston:

The income from operations, and operation and maintenance expenses, exclusive of interest on bonds and depreciation, of the District for the years 1925 to 1932, inclusive, were as follows:

The taxes collected" were available to pay interest on and retire outstanding bonds and for maintenance, operating, and upkeep charges of the District. Art. 8222.

The cost of the assets of the District as of the close of 1934 was as follows:

The petitioner was employed by the board of commissioners of the District on a yearly basis, subject to termination by either party on notice of 90 days. His duties consisted of managing the affairs of the District under the title of director of the Port of Houston; acting as secretary of the board of commissioners of the District, as provided in the rules and regulations promulgated by the commissioners; supervising the maintenance and operation of the facilities of the District, including the wharves, docks, grain elevator, bunkering plant, and right of way of the switch railroad which connects the facilities of the port; supervising the purchase and acquisition of dumping grounds tendered to and used by the United States Government in connection with its operations in deepening and maintaining the Houston Ship Channel; supervising the appointment and activities of pilots, the policing of the channel and wharves by District policemen, and boats which clear the channel of debris; supervising the functioning of the public fireboat, the issuance of permits for the construction of private facilities within the harbor lines of the channel, the keeping of all records and minutes of the District, and the operations of all of its employees. He devoted all of his time to such duties, not being employed by any other person, firm, association, or corporation. He took no oath of office upon assuming his duties with the District.

The Revenue Act of 1932 taxes compensation for personal service “of whatever kind and in whatever form paid.” Sec. 22 (a). If the petitioners are to escape tax on the salary the husband received from the District, it must be under the principle that the instru-mentalities by which states exercise their essential or usual governmental functions are immune from taxation by the Federal Government. Collector v. Day, 11 Wall. 113. The petitioners contend that the District is a political subdivision of the State of Texas, engaged in the performance of essential and usual functions of sovereignty. The position of the respondent is that the activities of the petitioner’s employer are proprietary in character and therefore petitioner’s salary is not immune from taxation, even though the Board should hold that petitioner was an employee of a political subdivision of the State of Texas.

The District was organized under statutes enacted pursuant to article 3, section 52, of the Constitution of Texas, providing for:

(a) The improvement of rivers, creeks, and streams to prevent overflows, and to permit of navigation thereof or irrigation thereof, or in aid of such purposes.

Another provision of the state constitution makes districts created to perform any of such functions “governmental agencies and bodies politic and corporate with such powers of government and with the authority to exercise such rights, privileges and functions concerning the subject matter of this amendment as may be conferred by law.” Art. 16, sec. 59a.

That the District is a political subdivision of the State of Texas is clear. Smith v. Wilson, 13 Fed. (2d) 1007; appeal dismissed, 273 U. S. 388; D. G. Wood and Wife, 29 B. T. A. 919, involving the compensation of an employee of the Hidalgo County Water Control and Improvement District No. 6. It also seems clear that the petitioner, J. Russell Wait, was an employee of the District throughout the taxable year in question.

Although respondent in his answer to the petitions does not admit that petitioner was an employee of a political subdivision of the State of Texas, he does not contend otherwise in his brief. The chief contention upon which respondent relies is stated in his brief as" follows:

Compensation received by the petitioner as director of the Port of Houston, Texas, is not exempt but is subject to Federal income tax for the reason that the services for which the compensation was received were not rendered in connection with the exercise of an essential governmental function.

We think that the issue raised is controlled by Commissioner v. Ten Eyck, 76 Fed. (2d) 515, affirming 29 B. T. A. 1113, and Montgomery B. Case, 34 B. T. A. 1229. The Ten Eyck case involved the Albany Port District, Albany, New York, and Montgomery B. Case involved the Port of New York Authority. In each of these cases it was held that the respective port authority districts were political subdivisions of a state and were performing usual and essential governmental functions, and that the salaries of their officers and employees were not subject to Federal income tax.

We do not think that the facts of the instant case are sufficiently distinguishable from the facts in the two cases cited above to justify a holding here different from what was held in those cases. We therefore hold that during the taxable year in question the petitioner, J. Russell Wait was an employee of a political subdivision of the State of Texas, engaged in the performance of usual and essential governmental functions, and tliat the salary of $9,000 paid him was not subject to Federal income tax.

Inasmuch as the entire amounts of the deficiencies which respondent has determined are each due to the addition to the respective incomes of petitioners of one-half of the salary in question, Reviewed by the Board.

Decision will be entered for 'petitioners.

Disney,

dissenting: I dissent. I can not believe that the idea as to the management of ports involving the principle of essential governmental agency, under the various facts discussed in Montgomery B. Case, 34 B. T. A. 1229, following Commissioner v. Ten Eyck, 76 Fed. (2d) 515, requires that principle to be extended over proprietary functions such as appear in the instant case. It has been said that taxation is a practical matter, and I believe that tenuous theories have been followed far enough in a matter of such practical import and of reciprocal relations between state and nation, without impinging further upon situations involving functions indubitably proprietary in their essential nature, and as a matter of fact involving competition with ordinary business. Assuming, in a situation of national or near-national importance, where state sovereignty has been exercised and state aid rendered because necessary to the project, that comparatively unimportant incidental proprietary functions might be included, there is violation of logic in allowing the covering of competitive and proprietary business enterprise within the mantle of essentially governmental functions. They are, in fact, and under common custom and practice, not such, and can logically be included only upon the ground of necessity and as indispensable incidents in a project of such breadth as to render them inconsequential. In the instant case I fail to see such a situation.

Hill agrees with this dissent.


author: Black :

text:
    Edward Hines Lumber Co., Petitioner, v. Commissioner of Internal Revenue, Respondent. Trustees of Lumber Investment Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 52270, 52274.
    Promulgated January 29, 1937.

      William 8. Bennet, Esq., for the petitioners.

      J. Arthur'Adams, Esq., and Frank A. Surme, Esq., for the respondent.
   OPINION.

Black :

The legal principles involved in the one assignment of error in Docket No. 52270 seem to be well settled. It is petitioner’s contention, however, that, under section 204 (a) and (b) of the'Eevenue Act of 1921, it is entitled to deduct from the $2,112,774.29 consolidated net income of the affiliated organizations for 1923 the total consolidated net losses of the group as an entity for 1921 and 1922 of $1,450,212.18 and $246,953.47, respectively, after such net losses are-reduced to a combined total of $1,564,154.48 by deducting therefrom the nontaxable income of the Trustees of Lumber Investment Association for 1921 and 1922 of $79,253.15 and $53,758.02, respectively,, thus leaving a taxable consolidated net income for 1923 of $548,-619.81. In support of this contention petitioner argues that, because it and the organizations affiliated with it had agreed in writing among themselves, under section 240 (b) of the Eevenue Act of 1921, that respondent was authorized and directed to assess the tax accruing from the affiliated group for 1922 and 1923 against petitioner, this fact made petitioner the “taxpayer” as to all the tax due and owing from all the affiliated organizations as the term “taxpayer” is used in section 204 (a) and (b) ; that in any event the several affiliated organizations were in substance and reality but one corporation; and that, therefore, respondent should have looked through the form to the-substance, assessed them as one corporation, and carried forward the net losses of 1921 and 1922 as if they were the net losses of only one corporate taxpayer and deducted them from the 1923 consolidated net income. Petitioner in support .of its contention cites and relies principally upon United States v. Lehigh Valley Railroad Co., 220 U. S. 257; Southern Pacific Railroad Co. v. Lowe, 247 U. S. 380; and Gulf Oil Corporation v. Lewellyn, 248 U. S. 71. It should be noted at this point that none of these cases deal with the question we have here and that the right of a corporation to carry forward a net loss from one taxable year and use it as a deduction from net income in the following year is strictly a statutory concept. Its application must be made in the manner intended by Congress as expressed in the language of the statute. Therefore, we do not regard the cases cited by petitioner as authority on the issue which we have here to decide.

Respondent contends that the affiliated group is merely a tax computing unit; that, although the several affiliates may agree among themselves who is to pay the tax, each affiliate remains nevertheless a taxpayer; that section 204, supra, contains no provision for permitting a net loss sustained by one taxpayer to be availed of by another and different taxpayer; and that, therefore, we must determine the statutory net loss of each affiliate separately and allow it as a deduction in either of the two succeeding taxable years only to the extent that the affiliate sustaining the net loss has income from which the net loss may be taken. The respondent’s position on this issue is sustained. Woolford Realty Co. v. Rose, 286 U. S. 319; Swift & Co. v. United States, 38 Fed. (2d) 365; Kaiwiki Sugar Co. v. Burnet, 63 Fed. (2d) 822; Delaware & Hudson Co., 26 B. T. A. 520; affd., 65 Fed. (2d) 292; certiorari denied, 290 U. S. 670; Beneficial Loan Society, 26 B. T. A. 858; affd., 65 Fed. (2d) 759; certiorari denied, 290 U. S. 677; Seiberling Rubber Co. v. Commissioner, 70 Fed. (2d) 651, affirming a Board memorandum opinion of June 29, 1932; certiorari denied, 293 U. S. 611; Corco Oil Refining Corporation v. Helvering, 72 Fed. (2d) 177; California Wharf & Warehouse Co., 28 B. T. A. 509.

Affiliation of Park Falls Lumber Co. and Edward Hines Farm Land Co. with Trustees of L. I. A.

Consideration will now be given to assignment of error (a) raised in the amended petition in Docket No. 52274. This assignment of •error raises the question of whether the Park Falls Lumber Co. and Edward Hines Farm Land Co. were affiliated with the Trustees of L. I. A. for the period January 1, 1924, to July 31, 1926. Under section. 240 (c) of the Revenue Acts of 1924 and 1926, “* * * two or moi'e domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the voting stock of the other or others, or (2) if at least 95 per centum of the voting stock of two or more corporations is owned by the same interests.” See also section 240 (d), Revenue Act of 1926. The instant case turns upon the ownership of the outstanding capital stock of the Park Falls Lumber Co. and Edward Hines Farm Land Co. The respondent determined that the stock of these two corporations was owned as follows:

On the other hand, petitioner (in Docket No. 52274) contends that the stock of said two corporations was owned as follows:

It is clear that, if petitioner’s contention that the Trustees of L. I. A. were the owners of the 2,000 shares of the Park Falls Lumber •Co. which stood in the name of Clubine is true, then the Trustees of L. I. A. were the owners of more than 95 percent of the stock of the Park Falls Lumber Co., and the twro organizations were affiliated •during the period in question under section 240. (c) (1). And it is likewise true that the Edward Hines Farm Land Co. would be a member of the affiliated group, because in such case more than 95 percent of its stock would be owned by the same interests. Sec. 240 (c) (2). See G. C. M. 8982, Cumulative Bulletin X-1, p. 250; Olds & Whipple v. Commissioner, 75 Fed. (2d) 272.

In addition to the facts heretofore set out regarding the ownership ■of the 2,000 shares determined by respondent to have been owned bj Clubine, the parties have stipulated substantially as many facts regarding the ownership of the 250 shares determined by respondent to have been owned by Gertrude W. Bennet. Petitioner contends that the 2,250 shares were owned by it, or, in other words, that it owned 100 percent of the stock of the Park Falls Lumber Co. In our narrative of some of the stipulated facts we have omitted to state any facts relative to said 250 shares, for it is at once apparent that even if petitioner owned those shares, but did not own the said 2,000 shares, it owned only 94.20 percent of the stock of the Park Falls Lumber Co., which is less than the 95 percent required by the statute. Oil the other hand, if petitioner owned the 2,000 shares, but not the 250 shares, it owned 99.28 percent of the stock, or 4.28 percent more than than is necessary under the statute. Both petitioner and respondent concede in their briefs that a determination of who owned the 250 shares which stood in the name of Gertrude W. Bennet is unimportant to a decision of the question of affiliation. Since it is therefore immaterial, as far as the present affiliation question is concerned, who owned the 250 shares, we will make no further reference to them in this report. The question is thus narrowed to whether the remaining 2,000 shares of the Park Falls Lumber Co. were owned by Clubine, as respondent determined and contends, or by petitioner (Trustees of L. I. A.), as it contends.

In determining this question we of course must look to all the facts in the record. Some of these facts unquestionably support respondent’s contention. Other facts however seem to establish that it was never intended that Clubine should be the owner of this stock until it was paid for in the manner agreed upon. The stock, it is true, was placed in his name, but he immediately endorsed the certificate in blank and turned it over to the Trustees of L. I. A., to be kept by them with the agreement entered into and the note for $200,000 which he had executed. If this note for $200,000 had been intended to be unconditionally payable to the Trustees of L. I. A., then clearly it would be proper to hold that the contract was a contract of sale and that title to the 2,000 shares of stock in question passed immediately to Clubine and was merely being held by the Trustees of L. I. A. as collateral security for the payment of Clubine’s note. Handy & Harmon v. Burnet, 284 U. S. 136. But the contract and note, and the circumstances surrounding their execution, do not seem to indicate that. Clubine was unconditionally liable to pay the $200,000 note.

An analysis of the agreements of January 1, 1920, and July 17,. 1924, shows that neither party expected the note to be paid except from dividends. The provisions relating to the note are:

[Paragraph 3.] * * * in consideration whereof said party of the second part agrees to and does give to said Trustees of Lumber Investment Association his promissory note of even date for the sum of two hundred thousand dollars ($200,000.00) payable on or before five years from date with interest at the rate of five per cent per annum.
Said certificate or certificates shall be endorsed in blank by the party of the second part and shall remain in the custody of the Trustees of Lumber Investment Association as collateral security for the note hereinbefore described.
[Paragraph 4.] All dividends declared on said stock shall be applied so far as necessary, to payment of interest on said note, and the remainder, if any, shall be applied on the principal of the note.

Paragraph 5 gave Clubine, or his estate, two elections in case Clubine left his employment “prior to the termination of this contract, or the payment of said note by the application of dividends thereto”, the two elections being “ (1) To purchase the said stock, or, (2) To sell it to the Trustees of Lumber Investment Association.” Then followed provisions for ascertaining value:

From the total so found shall be deducted the amount due on said note, if any, with interest at five per cent (6%) per annum from the date the amount of the note was last fixed. If the party of the second part, or his estate, as the case may be, elects to purchase the said stock, it or they shall pay to the party of the first part, the sum so found to be still due upon the said note, and shall receive the said stock and the cancelled note. If, however, the party of the second part or his estate, elects to have the1 Trustees of Lumber Investment Association purchase said stock, the said Trustees will pay to the said party of the second part, or to his said estate, the book value of the stock, less the amount due on the note as so fixed, and become the owners of the said stock; and shall cancel and return to the party of the second part, or to his estate, the said note. In case the book value of the said stock is less than the amount due on said note, the said party of the second part, or his estate, shall not be held to pay any deficiency but in that case said note shall be cancelled, as well as all claims of either party upon the other concerning the said stock.
[Paragraph 6.] If the said second party at the end of said five year period has not then fully paid for said stock according to the .method prescribed in Paragraph J¡ [i. e., dividends], the said Trustees of the said Lumber Investment Association agree that if the second party continues in the employ of the first party for a further term of five years, said Trustees will continue the said agreement in all respects for the further period of five years. [Italics ours.]

It will be noted that paragraph 6 contemplates no payments except from dividends.

[Paragraph 7:] All payments of interest and principal on said note to be made to the Trustees of Lumber Investment Association.

The agreement of July 17, 1924, does not mention the note at all, but gives Clubine, in case of his becoming incapacitated by accident or sickness, or of his death:

The additional options of, first, having the Trustees of Lumber Investment Association, their successors or assigns, hold the said stock until such a time as the dividends have paid the purchase price thereof, including both principal and interest; or, second, the option to sell the said stock to outside parties, in which case the Trustees agree to transfer the stock upon the payment of the sum due thereon at the time of said transfer.

The note itself was dated January 1, 1920, payable on or before five years, with interest at the rate of 5 percent per annum after date, and contains a clause:

This note is subject to that certain contract executed under even date between the Trustees of Lumber Investment Association and myself.

Not a dollar of Clubine’s salary from the Park Falls Lumber Co. could be retained to pay on the note. No property which he may have had could have been subjected to the payment of the note. It is true that the facts show that from 1920 to 1926, inclusive, the Trustees of L. I. A. accrued on their books interest on the note at the rate of 5 percent per annum, but no interest was ever in fact collected from Clubine and all of this accrued interest was canceled in 1926, when the contract and note were canceled and turned back to Clubine. No interest on this note was properly accruable on the books of the Trustees of L. I. A., for none was payable except out of dividends of the Park Falls Lumber Co. and no dividends were ever declared and paid. t

The facts with reference to this employment contract with Clubine, carrying with it certain rights to become the owner of 2,000 shares of stock in the Park Falls Lumber Co., are very similar to those which were present in Moore v. McGrawl, 63 Fed. (2d) 593. In that case the agreement with an employee recited the sale of stock at par and the giving of a note therefor payable on demand. The court pointed out however that, while the note expressed an unconditional obligation to pay, nevertheless the real agreement was that the note should be paid out of dividends accruing upon the stock. The contract further provided that it was at the option of the employee whether he would pay for the stock, the option to last so long as he should continue to remain an employee, and the certificate of stock placed in the name of the employee was endorsed and redelivered to the company. On these facts the court held that there was no obligation on the part of the employee to pay for the stock, the agreement was lacking in mutuality, and, consequently, there was no sale or transfer of title to the stock. The court further held that a consolidated return of the parent corporation and its two subsidiary companies was proper.

To the same effect is our decision in Hennepin Holding Co., 23 B. T. A. 119. That was a case involving a claim of affiliation under the 1924 Act as here. One of the corporations claiming to be a member of the affiliated group was t-he Plymouth Clothing Co. One hundred and thirty-four shares of its stock stood in the name of H. L. Tucker, an old -employee who did not own any stock in the other corporations involved. Of the stock owned by him, we said:

* * * It is true that this stock stood on the books in the name of Tucker, but it remained in the possession of the corporation, and its issue appears to have been an incident in the carrying out of an arrangement whereby this old employee was to be permitted to acquire a stock interest from future earnings of the corporation which it was anticipated would result from his employment by it and his efforts in its behalf. This anticipation as to earnings did not bear fruit, the corporation producing -no profit for distribution, and consequently no equity was acquired by Tucker on this stock and after some years the agreement was canceled and the stock turned back into the treasury of the corporation. * * *

On these facts we held that the affiliation should be allowed. Cf. W. N. Ritter Lumber Co., issue No. 8, 30 B. T. A. 231.

The facts in the instant case are distinguishable from those in Handy & Harmon v. Burnet, supra. In that case the parent corporation caused a subsidiary corporation to be organized to take over the work of one of its departments. The stock of the new corporation was issued to the extent of 20 percent to one Hamilton, who became its president. Hamilton owned no stock in the parent corporation. He w'as without funds to purchase the stock in the new corporation,, and one of the shareholders in the parent corporation arranged for him to borrow the necessary money from a bank upon his notes endorsed by the shareholder mentioned. This stockholder then received the stock under an “irrevocable stock power”, executed by Hamilton-as collateral for the payment of the notes. On these facts the' Supreme Court held that, notwithstanding the execution of this irrevocable stock power and the placing of the stock as collateral security for the .payment of the notes, Hamilton was still the beneficial owner of the stock, and disallowed affiliation.

As we have already pointed out, Clubine did not borrow the money with which to purchase the 2,000 shares in question. If he had done so and had executed his note for the borrowed money and had used the money for paying for the stock, he undoubtedly would have become the owner of the stock in question, even though he immediately placed it as collateral security for the payment of his-note, and the Commissioner’s determination of no affiliation would stand. What he did do was to enter into a contract whereby he would become the owner of the stock, if and when sufficient dividends of the Park Falls Lumber Co. were declared and paid, to pay for it. This never happened and he never became the owner of the stock. Cf. Goodhue v. United States, 17 Fed. Supp. 86.

In the Goodhue case, Goodhue was an employee of the Chicago Pneumatic Tool Co. In 1924 he entered into a contract with his employer to purchase 1,000 shares of its capital stock at $82.50 per share. Payments for the stock were to be made by crediting Goodhue’s account with one-half of any bonuses in excess of his regular salary and by the dividends actually paid by the corporation on a like amount of its outstanding stock. Interest was to be both charged and credited. The stock was not to be delivered until payments therefor “shall be sufficient to pay for the same in full, after making the adjustments above provided for.” At the trial the parties agreed that only 900 shares were involved, on which Goodhue had paid $40,240 by November 19, 1928. About that time the corporation had decided to recapitalize and there was offered and accepted by Good-hue a proposition to cancel his contract of 1924 and receive for his rights to purchase the 900 shares $45,327.22 in cash and 2,935 shares of new class B stock of a value of $35 per share, or $102,725. On December 31, 1928, the certificate of incorporation was amended and in 1929 Goodhue received the $45,327.22 in cash and the 2,935 shares of new stock. Goodhue contended that he was not taxable on the 2,935 shares for the reason that he had exchanged stock in a corporation a party to a reorganization for stock in such corporation. The Court of*Claims denied this contention upon the ground that Goodhue was never a stockholder in the old corporation.

On this issue we sustain petitioner, and, as we have already pointed out in holding that the Park Falls Lumber Co. was affiliated during the period in question with the Trustees óf L. I. A., it necessarily follows that during the same period the Edward Hines Farm Land Co. was also a member of the affiliated group and is entitled to join in the consolidated return.

In arriving at the conclusion which we have reached on this issue, we have not overlooked Gardner-Denver Co., 27 B. T. A. 1171; affd., 75 Fed. (2d) 38, and A. Levy and J. Zentner Co., 31 B. T. A. 386, cited and urged by respondent in support of his contention. We think these cases are distinguishable on their facts. Each of these cases involved stock subscription plans which we held under the facts involved contracts of purchase and sale of the stock and not contracts of employment. The situation in the instant case is different in the respect which we have endeavored to point out.

The parties have stipulated as follows:

Should the Board find and determine that the Edward Hines Hardwood and Hemlock Company (name changed in 1924 from Park Falls Lumber Co.), and the Edward Hines Farm Land Company, were affiliated with the Trustees of Lumber Investment Association for the years 1924 and 1925 and the period January 1, 1926 to July 31, 1926, then, and in that event, the Board may and should find that the income of Trustees of Lumber Investment Association for the year 1926 should be increased by $48,000 and the income of said organizations for the years 1921, 1922, 1923 and 1925 should be reduced by $10,000 for 1921, $10,000 for 1922, $10,000 for 1923 and $8,000'for 1925 and the deficiencies stipulated herein, subject to- the decisions of the Board on the issues involved in the appeals, redetermined accordingly.

The facts are found by us as above stipulated by the parties and effect will be given thereto in a redotermination under Rule 50.

This leaves us now to consider petitioner’s assignment of error (b) in Docket No. 52274. This assignment of error raises the same issue except as to different taxable years as the one assignment of error in Docket No. 52270. We have decided that issue against petitioner and, for the reasons already stated, we hold against petitioner on issue (b), Docket No. 52274.

Reviewed by the Board.

Decision will he entered wnder Bule 60.


author: Aeundell :

text:
    S. H. Berch, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Rose Berch, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 64746, 64747.
    Promulgated January 29, 1937.

      Robert P. Smith, Esq., and Arthur U. Deibert, Esq., for petitioners.

      Elden McFarland, Esq., and John F. Greaney, Esq., for the respondent.
   OPINION.

Aeundell :

The question for decision is whether the profit realized on the sale of Western Dairy stock in July 1927 was capital gain or ordinary income. Berch actually held the Western Dairy stock less than two years. Whether any period can be added to the period of actual holding of that stock depends upon whether or not it was acquired under circumstances prescribed by section 208 (a) (8) of the Revenue Act of 1926, set out in the margin. Stated broadly, that section provides that the period during which a taxpayer has held stock or securities received on a nontaxable exchange or upon a nontaxable distribution may include the period in which he held the property exchanged therefor or the stock in the distributing corporation. In more detail, it provides that in computing time for capital gain purposes a taxpayer may add to the period that he actually held particular property (a) the period of holding property exchanged therefor if the exchange was such that the property takes the same basis as that exchanged therefor, (b) the period of holding the particular property by some other person if it has the same basis in the taxpayer’s hands as in the hands of the other person, and (c) the period of holding the particular property by a corporate owner if the taxpayer received it as a nontaxable dividend under section 203 (c). The provisions that we have referred to under (b) may be read out of the case at the outset, inasmuch as there was no prior holding of Berch’s Western Dairy stock by another person.

First, then, is the question of whether Berch acquired the Western Dairy stock in such an exchange that it took the same basis as the property exchanged therefor. The petitioners say that Berch acquired the Western Dairy stock in a nontaxable exchange under the reorganization provisions (section 203 (b) (2)), hence, it took the same basis as his stock in the Berch Ice Cream Co. under section 204 (a) (6), and that consequently the time that he held the stock of the Berch Ice Cream Co. (1922 to 1925) should be added to the time of holding the Western Dairy stock. They contend that the Berch Ice Cream Co., the Velvet and Seattle companies, Spencer Trask & Co., and Western Dairy were all parties to the reorganization.

The respondent assumes, and we agree, that the exchange by Berch and Spencer Trask & Co. of all the stock of the Velvet and Seattle companies for stock of Western Dairy was a nontaxable exchange that came within section 203 (b) (2) as an exchange of stock in a corporate party to a reorganization for stock in another corporate party. It came within the definition section as the acquisition by one corporation of at least a majority of all classes of stock of another corporation. Sec. 203 (h) (1). That exchange took place on October 8, 1925, less than two years from the time of sale of Western Dairy stock. By reason of the transaction being nontaxable and the Western Dairy stock having the same basis in Berch’s hands as the stock of the Velvet and Seattle companies, it is proper to go back to the time of Berch’s acquisition of the stocks of the Velvet and Seattle companies in computing the time of holding. That acquisition occurred on August 5, 1925, when the Crystal Investment Co. and the Berch Ice Cream Co. were ordered dissolved, and their assets distributed to tlieir stockholders.

The next step is to determine whether any period prior to August 5, 1925, should be added on. This depends, under the first part of section 208 (a) (8), on whether there was a nontaxable reorganization to which the Berch Ice Cream Co. was a party, and under the last part of that section on whether the distribution whereby Berch acquired the Velvet and Seattle stocks was a nontaxable distribution.

We are of the opinion that the Berch Ice Cream Co. was not a party to a reorganization under the statutory provisions here involved. The original plan conceived by Spencer Trask & Co. was to obtain control of the Velvet and Seattle companies by purchase. Berch and his associates orally agreed to sell their interests for cash. The written option of August 3, to which the Berch Ice Cream Co. was a party, xvas an option to sell for cash. Berch, individually, agreed to take stock of the new company. Even under his individual agreement the transaction was in substance a purchase for cash and the use of part of the cash to buy stock of the new company. The parties have stipulated that Spencer Trask & Co. deposited the full $1,250,000 which is referred to in the basic document — the option— as the “purchase price.” It was not contemplated that the Berch Ice Cream Co. would acquire any of the stock of the new corporation. It or its stockholders were, under the agreement, to receive cash. Nor was it intended that the new corporation would acquire the stock or assets of the Berch Ice Cream Co. It is stipulated that the only asset of the Berch Ice Cream Co. was its stock in the Crystal Investment Co. That stock did not enter into the transaction in any way. Thus the Berch Ice Cream Co. was not in any way a party to the reorganization effected between the Velvet and Seattle companies and the Western Dairy Products Co. Consequently, the period that Berch held the stock of the Berch Ice Cream Co. can not be added in under the part of section 208 (a) (8) which refers to exchanges coming within section 204.

We are further of the opinion that the case does not come within the last provision of section 208 (a) (8), which allows the tacking of periods where the property exchanged is “securities received upon a distribution where no gain is recognized to the distributee under the provisions of subdivision (c) of section 203.” We quote section 203 (c):

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

We have pointed out above that there was no plan of reorganization in this case to which the Berch Ice Cream Co. was a party. The plan to which it was a party was strictly a plan to sell as distinguished from one to reorganize. The general rule of the statute is to treat as taxable income gains realized by stockholders on corporate liquidations, and only those transactions coming squarely within the exception may escape tax. Swiss Oil Corporation, 32 B. T. A. 777, 783. The petitioners seem to think that the dissolution and liquidation of the Berch Ice Cream Co. were by inference necessary steps in the plan for the absorption of the Velvet and Seattle companies by Western Dairy because of an agreement by Berch and his associates not to engage in the manufacturing or wholesaling of ice cream or to be officers or stockholders in or otherwise associated with a corporation engaged primarily in such manufacturing or wholesaling. They do not, however, give any reasons why this covenant could not be observed in other ways than by dissolution and liquidation.

For the foregoing reasons we hold that the petitioners have not brought themselves within provisions of section 208 (a) (8) and they may not add to the period beginning August 5, 1925, any of the prior period in which Berch held the stock of the Berch Ice Cream Co. The period from August 5, 1925, to July 1927, being less than two years, the gain realized was ordinary income and properly so treated by the respondent.

There is no issue as to the division of the income on a community property basis.

Reviewed by the Board.

Decision will be entered for the respondent.

       Sec. 208. (a) For the purposes of this title—
      (1) The term “capital gain” means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921;
      ****** *
      (8) The term “capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business) * * *. In determining the period for which the taxpayer has held property received on an exchange there shall be included the period for which he held the property exchanged, if under the provisions of section 204 the property received has, for the purpose of determining gain or loss from !¡*a sale or exchange, the same basis in whole or in part in his hands as the property ex-liihanged. In determining the period for which the taxpayer has held property however acquired there shall he included the period for which such property was held by any other person, if under the provisions of section 204 such property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of such other person. In determining the period for which the taxpayer has held stock or securities received upon a distribution where no gain is recognized to the distributee under the provisions of subdivision (c) of section 203 of this Act or of the Revenue Act of 1924, there shall be included the period for which he held the stock or securities in the distributing corporation prior to the receipt of the stock or securities upon such distribution.


author: HaRRON :

text:
    Julius E. Lilienfeld, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 79298.
    Promulgated January 29, 1937.

      G. K. Richardson, Esq., for the petitioner.

      R. N. McMillan, Esq., for the respondent.
   OPINION.

HaRRON :

The question in this proceeding is whether royalty payments made to petitioner’s wife during the year 1932 by the Amrad Corporation, and its successors, pursuant to a license agreement, are taxable to the petitioner. Petitioner contends that he assigned to his wife property rights which produced the income here in question, whereas respondent contends that no property rights have been assigned so as to relieve the petitioner from taxation in this proceeding.

Examination of the assignments dated July 30, 1927, and June 5, 1930, shows that petitioner did not assign to his wife any property rights in the inventions themselves which are covered by the license agreement with the Amrad Corporation. The assignment of July 30, 1927, was only an executory agreement to assign inventions and did not convey any property rights at the time. “An agreement to assign inventions, patents for which have not yet been secured, may be enforced only where the assignment is sufficiently definite as to subject matter.” 48 C. J. 244, 245, ¶375. In 1927 the petitioner had not yet developed his ideas into tangible form and so was unable to convey to his wife property rights in praesenti in the inventions here in question. The assignment of June 5, 1930, attempts to confirm any prior assignments of patents and inventions to petitioner’s wife, but does not cure the .defects of the first effort, for there is still a failure to make the purported assignment sufficiently clear as to subject matter. Furthermore, the license agreement made by petitioner with the Amrad Corporation, on June 5, 1930, constitutes an assignment to the Amrad Corporation of all the inventions covered by the license agreement, for petitioner granted to the Amrad Corporation an exclusive, nontransferable license to manufacture, use and/or sell throughout the United States products embodying the improvements on a condenser covered by patents described in the license agreement. See Waterman v. Mackenzie, 138 U. S. 252, 255; 48 C. J. 240, 241, pars. 368, 369. Petitioner’s wife did not execute this license and we have found as a fact that she did not join in the license agreement. Petitioner testified that his wife gave her oral assent, but we can not see that this has any legal effect upon the issues involved.

There is another question which requires consideration. The assignment of June 5, 1930, transferred to petitioner’s wife all the benefit of the license agreement and any and all moneys to which petitioner was or should become entitled by reason of the license agreement. Did this assignment constitute conveyance to the petitioner’s wife of a property right which produced the income here in question? It is well settled that an assignment of income does not relieve the assignor of the tax thereon, but if property rights are assigned the income subsequently arising therefrom is not taxable to the assignor. See William, Ernest Seatree, 25 B. T. A. 396; affd., in Helvering v. Seatree, 72 Fed. (2d) 67.

In the instant ease the testimony and evidence show that petitioner intended to give to his wife property rights in his inventions and patents for a limited period, although his purported assignment of the inventions themselves failed to meet the legal requirements of an assignment of inventions and patents. However, on June 5,1930, petitioner assigned to his wife all benefits in general of the license agreement with the Amrad Corporation. The right to receive royalty payments was the chief benefit of the agreement. The assignment of all money to be received made the meaning of “all benefits” more specific. The right to receive money under the license agreement was fixed and certain. Petitioner had completed all work on the inventions involved; the Amrad Corporation was under obligation to manufacture and sell products embracing the inventions and to pay royalties at stated rates. In our opinion petitioner did more than assign the future income to be received from the license agreement. He divested himself of the right to receive the income. The license agreement was productive of the income and the assignment of all benefits of the agreement for a stated consideration, under circumstances which show a consistent intent to assign the inventions covered by the agreement, leads to the conclusion that petitioner’s assignment constituted an assignment of the license agreement. It is therefore held that the royalty payments here in question should not be included in the gross income of petitioner for taxation. Cf. Hall v. Burnet, 54 Fed. (2d) 443; certiorari denied, 285 U. S. 552; Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 286 U. S. 565; Thomas A. O’Donnell, 32 B. T. A. 1277.

Reviewed by the Board.

Decision will be entered for the petitioner.

Sternhagen, Morris, Murdock, Leech, Turner, and Hill dissent.


author: Disney :

text:
    Harry and Dorothy Makransky, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78237.
    Promulgated February 5, 1937.

      D. Hays Solis-Gohen, Esq., D. Benjamin Kresch, Esq., and A. E. James, Esq., for the petitioners.

      George D. Brabson, Esq., for the respondent.
   OPINION.

Disney :

Cases are cited by the parties as authority for a holding in accordance with their respective contentions. There is similarity in this proceeding both as to cases where the dividend has been held to be stpck and as to those in which it has been held to be cash. Our decision, in the final analysis, must turn upon the facts in the record, and in reaching it, we may not ignore what was actually done in favor of substance alone.

The resolutions have all of the earmarks of a cash dividend on preferred stock and a purchase by all of the stockholders, except Metz, of unissued preferred and common stock. There is nothing in the dividend resolution expressing intention to pay the dividend in stock at par or any other value. The stock subscription resolution was passed in reliance upon a statement of the corporation’s treasurer that the Makranskys had “offered to purchase”, as therein set forth, stock, and it authorizes the officers to issue the stock subscribed for only “as and when paid for in cash.” The resolution discloses intent to pay accumulated dividends on the preferred stock in cash and to issue additional shares of common and preferred stock of a par value in excess of the dividend, as subscribed for, for cash. Only for cash could the new stock be issued within the authority of the resolution. All of the stockholders had a clear right to demand their dividends in cash and there is nothing in the resolutions requiring the Makranskys to apply their dividends against their stock subscriptions or to pay for their stock concurrently with the distribution of the dividend.

One of the stockholders, Metz, received his dividend in cash in a regular way and was not consulted about the dividend payment or extended the privilege of subscribing for additional shares of stock at par or any other value. The dividend check in favor of all of the stockholders was signed by Harry Makransky, president of the corporation and one of the petitioners in this proceeding. As a director he voted for the resolution and approved the minutes of the meeting. This corporate act under the resolution, the regularity of which is not being questioned here, discloses that promptly after the adoption of the resolution Harry Makransky construed it to contain authority for the payment of the dividend in cash. The effect of the argument now being made is that the corporation had the option to pay the dividend in cash or stock, for if there was power to pay Metz in cash, authority also existed for like payments to the other stockholders. If the resolution authorized only a stock dividend, as we are asked to construe it with reference to the issue here, no authority existed to make the payment to Metz.

Clearly, to the extent that the par value of the stock exceeded the dividend, there was an ordinary sale of stock for cash. We find nothing in the resolutions and other evidence to warrant a finding that the remaining stock was received as a stock dividend. To do so would be equivalent to saying that the resolution required the payment of a cash dividend to one stockholder and a stock dividend to all others. Its plain terms do not warrant such a finding.

The declaration of the dividend created a debtor and creditor relationship between the corporation and its stockholders, as held in Eugene E. Paul, 2 B. T. A. 150, a case in which the language of the resolution is similar to the dividend resolution involved here. The resolution accepting offers to purchase stock as and when paid for in cash created a definite contractual relationship between the corporation and its stockholders which can not be made subservient to the understanding between the stockholders, to which the corporation as such was no party. Such an understanding between stockholders is not sufficient to overcome the relation which the resolutions of the directors’ meetings created in this case. There was obligation by the stockholder to buy and pay cash for both common and preferred stock; there was obligation by the corporation to pay a dividend upon outstanding preferred stock. It had cash on hand sufficient to pay same and the fact that these funds were needed to meet operating expenses is not controlling.

The provision of the preferred stock certificate quoted above suggests prohibition against the holder of preferred stock receiving a stock dividend out of increase of the capital stock. Petitioner argues that this language means increase of the authorized capital stock, but language immediately following states an exception in that the holder of preferred stock shall have preemptive right to the purchase of additional preferred stock authorized or issued by the corporation, and it therefore seems to us that the prohibition goes against any stock issued, whether out of the stock presently authorized or authorized in the future. We conclude that the preferred stock certificate indicates that the holder shall not share in additional stock issued, by way of stock dividends, even within the capital stock authorized at the time of issuance of the certificate. It may be that such a prohibition, however positive, would not prevent a waiver of its provisions by the unanimous consent of the stockholders, but the record herein negatives any idea of unanimous consent in the transaction here considered. In any event, such a provision as quoted above raises a presumption that it was not violated, which it would be if the stock dividend contended for by the petitioner were sustained. The evidence before us does not, in our opinion, overcome such presumption, and therefore for this additional reason we conclude and hold that the dividend was one in cash.

In United States v. Mellon, 281 Fed. 645, the corporation’s board of directors was fully aware of the plan among the holders of substantially all of the stock to accept a 100 percent dividend in stock and to take, at par, such shares of stock as minority stockholders did not accept as a dividend payment, and passed the resolution upon the faith of the agreement. As the court pointed out, the whole plan was in “reality a refinancing of the corporation, in which this defendant and other large stockholders bound themselves to pay, and in fact did pay, into the company’s treasury the additional capital which it required. Their position was not that of having an option to take stock or to take money, but it was an obligation to take stock for which they agreed to pay.” In Jackson v. Commissioner, 51 Fed. (2d) 650, the board of directors relied upon an agreement of the corporation’s principal stockholders that they would turn their dividend checks in for stock as they had done for several years prior thereto and the corporation had insufficient cash to pay the dividend. In each case the proportionate interests of the taxpayers in the respective corporations were not changed by the transaction, a circumstance not present here.

The dividend declared was payable and paid in cash. The fact that the Makranskys applied the amounts received against the purchase of additional stock did not have the effect of changing it to a stock dividend. See Eugene E. Paul, supra; W. J. Hunt, 5 B. T. A. 356; J. E. Brading, 17 B. T. A. 436; Margaret B. Payne, 19 B. T. A. 1305.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Haeeon:

text:
    Martin P. O’Connor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74383.
    Promulgated February 5, 1937.

      Martin P. O’Connor, Esq., pro se.

      L. W. Creason, Esq., for the respondent.
   opinion.

Haeeon:

The question presented is whether the compensation of the petitioner as counsel for the board of education of Elizabeth, Hew Jersey, is exempt from tax under the implied constitutional prohibition against the taxation by the Federal Government of the instrumentalities of a state. This depends upon whether the petitioner was an officer or employee of the board of education or was merely an independent contractor. Metcalf & Eddy v. Mitchell, 269 U. S. 514. Ho question is raised as to whether the duties performed by petitioner on behalf of such board were performed in connection with the exercise of an essential or usual governmental function, but it has been held that the operation of public schools is an essential governmental function. Burnet v. Coronado Oil & Gas Co., 285 U. S. 393, and G. Ridgely Sappington, 25 B. T. A. 1385.

We find it unnecessary to determine whether the petitioner was an officer of the board in the taxable year, since we are satisfied and hold that he was an employee thereof.

In Louisville, etc., R. R. Co. v. Wilson, 138 U. S. 501, the Supreme Court defined “officers” and “employees” as follows:

The terms “officers” and “employees”, both, alike, refer to those in regular and continued service. Within the ordinary acceptation of the terms, one who is engaged to render service in a particular transaction is neither an officer nor an employee. They imply continuity of service, and exclude those employed for a special and single transaction. An attorney of an individual retained for a single suit, is not his employee. It is true, he has engaged to render services; but his engagement is rather that of a contractor than that of an employee.

In the instant proceeding the petitioner was appointed by the board of education, pursuant to statutory authority, and his duties were prescribed in regulations of the board promulgated pursuant to statutory authority. He was not employed for a special or single transaction. He was in regular and continual service of the board of education. The board of education controlled or had the right to control his actions, thus characterizing his relation to the board as that of an employee rather than that of independent contractor.

The case of R. Lawrence Coughlin, 32 B. T. A. 1048, is quite similar to the instant proceeding and is governing in principle. We there held that compensation received by the taxpayer from a poor district and from a school district in the State of Pennsylvania is exempt from taxation, the taxpayer being held to be an employee of such districts. In that proceeding we found as a fact that the taxpayer was under the direction and control of the board of directors, except as to legal procedure necessary to accomplish desired results. The same situation exists in the instant proceeding. We there stated in part:

Tbe duties of the petitioner were continuous and embraced all the ordinary legal services required by the districts. The respective boards of directors had the right to demand all of the petitioner’s time for the rendition of services within the scope of his employment. The fact that they did not utilize all of his time and that the petitioner conducted a private law practice during his spare time is not controlling. Neither is it fatal to the petitioner’s claim, that he relied on his own ability as a lawyer to carry out duties assigned him. Burnet v. Livezey, 48 Fed. (2d) 159; Robert Carey, 31 B. T. A. 839; Robert P. Bay, 28 B. T. A. 1169. There was present at all times the right to control the petitioner’s activities, which distinguishes an employee from an independent contractor. Metcalf & Eddy v. Mitchell, 269 U. S. 514.

See also the following cases, which are governing in principle: Hector McGowan Curren, 34 B. T. A. 946; Joseph J. Sullivan, 33 B. T. A. 629; Jeremiah Wood, 31 B. T. A. 1141; Robert Carey, 31 B. T. A. 839; petition to review dismissed, March 27, 1936, by the United States Circuit Court of Appeals for the Third Circuit; Burnet v. Livezey, 48 Fed. (2d) 159; Blair v. Matthews, 29 Fed. (2d) 892; and United States v. Butler, 49 Fed. (2d) 52. In each of those cases, except Joseph J. Sullivan, the taxpayer carried on a private-law practice and in some instances the income therefrom far exceeded the income from employment by a governmental instrumentality.

Here, as in the Coughlin, case, we are of the opinion that petitioner’s claim is not invalidated by the fact that petitioner conducted a private law practice in his spare time, or that he exercised his-specialized skill as a lawyer in carrying out his duties.

The instant proceeding is clearly distinguishable from such cases as Lucas v. Reed, 281 U. S. 699, reversing Reed v. Commissioner, 34 Fed. (2d) 263; Lucas v. Howard, 280 U. S. 526, reversing Howard v. Commissioner, 29 Fed. (2d) 895; and Metcalf & Eddy v. Mitchell, supra, in each of which cases the taxpayer was an independent contractor engaged to accomplish some specified object or objects, and where there were not continuing general duties and supervision or right of supervision thereof which obtain in the instant proceeding.

We hold that the compensation in question is not subject to the Federal income tax.

Decision will be entered wider Rule 50.


author: Leech :

text:
    Mellie Esperson Stewart, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68781.
    Promulgated February 5, 1937.

      Llewellyn A. Luce, Esq., for the petitioner.

      Thomas F. Callahan, Esq., for the respondent.
   OPINION.

Leech :

There appears to be no dispute with respect to the income received or the amounts of the several deductions. The only questions raised are as to what portions of the income and deductions constitute separate income and separate deductions of the petitioner, and what portions, if any, are community income and deductions.

Petitioner contends that by reason of the execution by her husband of a conveyance of all of his interest in the community property and the community income thereafter to be received, all of the income from her separate property was her separate income. With this we do not agree. We think that, under the decisions of the Texas courts, a husband may convey to his wife, by gift or otherwise, as her separate property, community property, but such property must then be in existence. Frame v. Frame, 36 S. W. (2d) 152; Kahn v. Kahn, 58 S. W. 825; Heaton v. State, 87 S. W. (2d) 256; Sorenson v. City National Bank, 49 S. W. (2d) 718; Owen v. Willis, 20 S. W. (2d) 338; Polk v. Mead, 3 S. W. (2d) 112; Cauble v. Beaver-Electra Refining Co., 274 S. W. 120; Armstrong v. Turbeville, 216 S. W. 1101. The income here in dispute was received in 1930. Thus, in determining petitioner’s gross income for the purpose of Federal income tax computation, that income must be treated as community income under the rule that an assignment of future income does not relieve the assignor from the burden of the income tax thereon. Lucas v. Earl, 281 U. S. 111; Turbeville v. Commissioner, 84 Fed. (2d) 307; Rose v. Commissioner, 65 Fed. (2d) 616.

Since, under the general rule in Texas, income from the separate property of a spouse is the income of the community (Anna Davis Terry, 26 B. T. A. 1418; affd., 69 Fed. (2d) 969), the interest, rents, and dividends received by petitioner constitute community income taxable to petitioner and her husband in equal amounts. The record is not clear as to the source of the “other income” reported by petitioner in the sum of $23,881.06. This has been treated in part as community and the balance as separate income. In view of the record, we sustain the respondent upon his allocation.

However, oil and gas royalties are an exception to the general rule just stated. Under the laws of Texas, an oil and gas lease constitutes a sale of those minerals in place. True, for Federal income tax purposes, those royalties are ordinary income from the property leased. Burnet v. Harmel, 287 U. S. 103. But, in Texas, such royalties are not income from the property, per se, but are the separate property, in another form, of the spouse owning the lands from which the royalties arise, and thus are not community income. Commissioner v. Wilson, 76 Fed. (2d) 766; David Hannah, 31 B. T. A. 971; Rosalie Hampton, 31 B. T. A. 853; J. T. Sneed, Jr., 30 B. T. A. 1121. It follows that the oil and gas royalties received by petitioner from her separate property, less the depletion of $19,529.13, are taxable in their entirety to petitioner.

This brings us to the question of the deductions which respondent has treated as allowable in equal parts to petitioner and her husband, with the exception of one item of $2,000 which he now alleges is a capital expense. Petitioner urges that even though it be held that certain of the income received by her from her separate estate constitutes community income, taxable one-half to her, she is entitled to the deduction of the total amount of her deductible expenses actually paid by her from her funds, and that the expenditures included in the deductions taken were so paid. It is argued that her husband, not having paid any portion of this expense, is not entitled to the benefit of the deduction of any part thereof from that portion of the community income taxed to him. This argument overlooks the fact that the portion of community income taxable to the husband is not gross but net taxable income, after the deduction of the expenses incidental to its production. Before the execution by petitioner’s husband of his conveyance of all his interest in petitioner’s separate estate, his tax liability with respect to the income from petitioner’s separate estate was a sum not in excess of one-half of the net income. Obviously, the execution of that instrument did not increase his tax liability on that income. We must bear in mind that the community is entitled not to the gross income from the separate property of husband and wife, but to the net income remaining after payment of expenses incidental to its production. The inclusion of gross income from separate property in the community, without deducting the expenses of producing it, would deplete the separate property or, in other words, would result in an inclusion in the community of a portion of the separate property, since the gross income therefrom would necessarily constitute, in part, a liquidation of capital. As Corpus Juris states the principle, citing Sharp v. Zeller, 110 La. 61; 34 So. 129:

Where separate property is encumbered, the revenue therefrom may be applied to the discharge of the encumbrance, leaving only the excess to fall into the community [31 C. J. 32, Sec. 1116.]

In accordance with this principle, the respondent has consistently computed the income of the spouses by including in the net income of each, one-half of the net community income, thus giving each, equally, the benefit of the deductions properly attributable to such income. As far as we have been able to find, no question has been raised heretofore as to this treatment. The usual method pursued was to have each spouse report all of the community income, and the deductions therefrom, and then include in his or her individual income, one-half of the net amount so computed. The rule consistently applied is stated by O. D. 909, 4 C. B. 254, as follows:

In returns in wbicb community income is divided between husband and wife domiciled in States where such income is divisible for income tax purposes, both husband and wife should report in detail the gross income from such community property. The deductions properly chargeable against such income should be equally divided between husband and wife.

We approve that rule and hold that the deductions, constituting expenses, depreciation, interest and taxes pertaining to petitioner’s separate property, the income from which falls into the community and is taxable in equal parts to petitioner and her husband, are to be ■equally divided between the two. The gross income of the community shall be taxed equally, between the two spouses and each granted the benefit of one-half of the deductions.

It is conceded that the contested contributions made by petitioner in 1930 were of charitable character as defined by the applicable revenue act. Eespondent contends, however, that they constitute a community deduction because made from a bank account in which community income was deposited. But, the funds in such bank account belonged to the petitioner and not to the community. The contributions were made by the petitioner out of her funds, and she is, therefore, entitled to deduct them in full. ' No part of the charitable contributions made by petitioner’s husband is deductible by her.

Included in the deductions is one of $4,139.44, expenses incurred in connection with receipt of oil and gas royalties. Eespondent does not question the accuracy or reasonableness of this expense but treats it as a community deduction. This is error, as decided above, since these royalties were separate income of and taxable, in their entirety, to petitioner. We conclude this item is a deduction, to the-whole of which petitioner is entitled.

We also hold respondent to be in error in treating as a community -deduction a loss of $33,401.28 from sale of stock in 1930. This stock was purchased by the wife and paid for with her separate property. It became her separate property. Trammell v. Trammell, 269 Fed. 114; Armstrong v. Turbeville, supra; O'Farrell v. O'Farrell, 119 S. W. 899; Gale Mfg. Co. v. Dupree, 146 S. W. 1048. Any loss resulting from a sale of petitioner’s separate property constitutes a reduction of or decrease in her separate estate. Certainly, a decrease in her estate as a result of a sale, constitutes a loss substained by her. In our judgment, the amount of this loss, which is not contested, is allowable in full to petitioner. Similarly, the loss of $302 sustained by petitioner’s husband on the sale of stock plays no part in computation of petitioner’s net income.

The same reasoning applies to the bad debt deduction of $2,954.60, since this debt constituted an investment by petitioner of her separate property. The loss occasioned by its becoming worthless is allowable in full to petitioner. The items of deduction consisting of interest, taxes, depreciation, salaries, and miscellaneous office expenses are not questioned as to their amounts, except for certain small adjustments not in controversy. As to these we sustain the respondent in treating them as community deductions to which petitioner and her husband are entitled in equal amounts.

As stated in our findings of fact, the respondent treated salaries paid and miscellaneous office expenses, as community deductions to which petitioner was entitled to the benefit of one-half. Petitioner claims these amounts, in their entirety, as separate deductions. But the record discloses nothing indicating the portion of any that was incidental to petitioner’s separate business. Thus, respondent’s determination is sustained on that issue.

With respect to the deduction of $2,556 as “Esperson Industrial District Expenses” we sustain the respondent in his contention that $2,000 of this amount, constituting payments for subdividing and plotting the Esperson Industrial District tract for sale, is a capital, expenditure and not deductible. Frishkorn Real Estate Co., 15 B. T. A. 463. Respondent, apparently, does not question the balance of this total deduction as one to which petitioner is separately entitled.

In addition to the deductions discussed, petitioner has claimed as community deductions, losses due to the financial collapse of certain corporations. The bases for these losses are investments in stock and advances made to the corporations. This issue has been closed by a formal stipulation that during 1930 petitioner sustained a deductible capital loss in the amount of $10,000, which constituted her share of a community loss from the investments in question. Effect will be given to this stipulation.

Reviewed by the Board.

Decision will Toe entered- under Rule 50.


author: Steenhagen :

text:
    Florence M. Quinn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80005.
    Promulgated February 8, 1937.

      Thomas R. Dempsey, Esq., for the petitioner.

      Hartford Allen, Esq., for -the respondent.
   OPINION.

Steenhagen :

The Commissioner determined a deficiency of $29,-427.55 in the petitioner’s income tax for 1932. Three adjustments were made, only one of which remains in issue. The Commissioner added to petitioner’s income $231,294, with the following explanation :

(c) Dividends from the Holmby Corporation have been determined to be liquidating dividends and taxable as capital gain. The amount of $231,294 representing distributions made by the corporation is therefore included as capital gain for the reason that all distributions in 1932 are in excess of the cost basis of the stock which has been recovered.

The petitioner contends that although this $231,294 is a liquidating distribution as described in the Revenue Act of 1932, section 115, she has not realized taxable gain in 1932, since the total amount received by her in liquidation, including this $231,294, is still less than her basis. The facts have all been presented in a written stipulation and it is only necessary to state such as aid the determination of the controversy.

Petitioner, a resident of California, was the wife of Arthur Letts, Sr., who died testate on May 18, 1923. By his will petitioner acquired 69,168 shares of the Holmby Corporation, which were distributed to her on August 20, 1925. On that date the fair market value of such shares was, in the aggregate, $9,139,167.84. Petitioner, on September 1, 1925, transferred 100 such shares to her husband, Charles H. Quinn.

Letts had been the owner of 138,336 shares of the total of 138,442 outstanding. Soon after his death the corporation determined upon complete liquidation, and distributions in pursuance thereof were made from time to time, including that in 1932 now under consideration. Prior to August 20, 1925, $2,367,358.20 ($17.10 for each share) had been distributed. Thereafter, before 1932, distributions were made, including distributions to the petitioner, as follows:

It is stipulated that “each of the distributions referred to * * * constituted steps in the Holmby Corporation’s process of complete liquidation.” The distributions of May 17 and October 11, 1927, were made pursuant to corporate resolutions, and in accordance therewith the corporation received from each of the shareholders one share of stock for each $100 distributed, i. e., the petitioner, on May 17, 1927, surrendered 19,179 shares and received $1,917,900, and on October 11, 1927, surrendered 38,875 shares to receive $3,887,500. The amounts of these distributions were charged on the corporation’s books to its capital stock account. In 1932 the corporation distributed, as jmrt of its complete liquidation, $463,743, of which petitioner received $231,294, the amount here in controversy.

The essence of the respondent’s theory is that the two distributions of May 17 and October 11, 1927, for which the shareholders surrendered shares, are to be regarded as “partial liquidations” as defined in section 115 (h), and treated separately as sales of shares at that time for $100 each, upon which loss is now to be recognized as deductible then. In this view, it would logically follow that such loss-of 1927 would reduce the basis of the petitioner’s shares remaining .after such surrender, to the end that such reduced basis would be less than the total amounts received by the petitioner. Gain in the 1932: distribution would thus be found. Respondent, while stipulating that the corporation was, after Letts’ death, always in process of complete liquidation, and that every amount received by the petitioner between 1923 and 1932 was an incident of complete liquidation,, advances the theory that the distributions of May 17 and October 11T 1927, were each a “partial liquidation” within a larger project of complete liquidation. This is said in justification for treating the shares given up on those dates as separate and independent from the rest of petitioner’s holdings. There is, however, no authority cited: to support the idea that in a continued process of complete liquidation a single distribution, which may if isolated answer the statutory description of a “partial liquidation”, may be separately treated. Indeed, the precedents are the other way. Recently the 1927 distributions of the Holmby Corporation to other shareholders were specifically considered in Arthur Letts, Jr. v. Commissioner, 84 Fed. (2d) 760, and the court recognized the continuing nature of the liquidation and treated all distributions as properly to be applied against the aggregate base of the taxpayer shareholder, with resulting gain only after the entire base had been recovered. While the present contention appears not to have been there considered, there is nothing in the opinion of the court to indicate that it would have treated the distributions for shares differently from the other distributions. In. James P. Gossett, 22 B. T. A. 1279 (affd., Gossett v. Commissioner 59 Fed. (2d) 365), it was said, in holding that a distribution was one in liquidation, “it is immaterial whether at the time of the distribution all or any part of the shares were surrendered or retired.” See also Holmby Corporation v. Commissioner, 83 Fed. (2d) 548. From John B. Willimns, 28 B. T. A. 1279, it would appear that a different-rule would be applied to the distributions of May 17 and October 11, 1927, if, instead of being incidents of a complete liquidation, either of them had been a separate and complete “partial liquidation”,, although it is not easy to reconcile that decision with the accepted view that shares are but the indicia of proportionate interests in the-corporate enterprise, the concept underlying Eisner v. Macomber, 252 U. S. 189 (stock dividends) ; and Kistler v. Burnet, 58 Fed. (2d) 687; Bed Rock Petroleum Co., 29 B. T. A. 118; Edith Scoville, 18 B. T. A. 261 (stock surrender).

The petitioner correctly excluded the $231,294 from her income of 1932, and the respondent’s determination is reversed.

Judgment will he entered u/nder Rule SO.