author: Marquette :

text:
    Randolph S. Warner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54109.
    Promulgated August 18, 1933.

      Harley E. Peters, Esq., and James I. Boulger, Esq., for the petitioner.

      M. B. Leming, Esq., and John R. Gaskins, Esq., for the respondent.
   OPINION.

Marquette :

The respondent has determined a deficiency in income tax for 1927 in the amount of $25,660.48. The principal issue is whether the proper basis for the computation of gain or loss arising from the sale of certain stocks acquired from the estate of a decedent is their fair market value at the date of the decedent’s death, or their fair market value at the time of distribution. A similar question is presented as to the stocks purchased by the executors. The petitioner insists that his interest in the decedent’s estate was contingent and therefore he did not acquire the stocks until the contingency was resolved. The solution of these issues involves the application of section 204 (a) (5) of the Revenue Act of 1926, The facts were stipulated,

From the stipulation it appears that Randolph S. Warner, a resident of Ohio, died testate on October 4, 1921. His will was admitted to probate by the probate court of Franklin County, Ohio. The testator left two sons, William D. Warner and Randolph S. Warner, Jr., the petitioner. At the date of execution of the will each of his sons was married and had heirs of his body, all of whom survived the distribution of the residuary estate. The material portions of the will are as follows: Item I directs the executors to pay all the testator’s debts and funeral expenses as soon after his death as shall by them be found convenient. The pertinent parts of items VII, VIII and IX are as follows:

• Item VIL I give and devise te my said two sons, William Deshler Warner and Randolph S. Warner, Jr., their heirs and assigns, the home wherein I now reside, being the real estate devised to me by my deceased wife, Mary Deshler Warner, situated at the north-west corner of East Broad Street and Lexington Avenue, and being Lots Nos. 9, 10, 11 and 27 feet offl the east side of Lot No. 8, of East Park Place Addition to the City of Columbus, Ohio, and known as No. 640 East Broad Street, Columbus, Ohio; Provided, however, that my said sons, or either of them, shall not sell, transfer or assign said real estate, or any part thereof, at any time within five years from my decease, and shall not, except as hereinafter provided, lease, or sub-let the same within said five year period, after which they can use their own discretion as to lease or sale of said premises.
Provided, further, that my said son, William Deshler Warner, shall have the right to use and occupy said premises, together with all its furnishings, of every kind and description belonging to me, as his residence for said period of five years from and after my decease, and to use all automobiles, tools and supplies belonging to me on, or in connection with said premises, paying as rental therefor at the rate of Twelve hundred Dollars ($1200.00) per year, and in addition thereto the taxes and assessments that may become due and payable thereon during said five year period. In the event of William Deshler Warner’s decease during said five year period, or should he choose not to exercise the right to so occupy said premises, or to continue to exercise said right during said entire period, then my said son, Randolph S. Warner, Jr., shall have the right to so occupy and use said premises as his residence during the remainder of said five year period, and to exercise and enjoy all the other rights hereinabove mentioned, and subject to the same terms and conditions as hereinabove provided. Should neither of my said sons choose to so occupy said premises at any time during said period, they shall have the right to lease or sub-let same for residence purposes only, for any period up to five years from date of my decease, sharing equally in the rentals therefrom. * * *
Item VIII. All the rest and residue of my estate, both real and personal, wheresoever the same may be situated, I give, devise and bequeath unto my Executors hereinafter named, who shall be Trustees for the purposes herein set forth, to have and to hold the same, and to receive the income therefrom, for and during the period of five years from and after my decease. Said income, after deducting the expenses incurred incident to my estate, shall each month be divided equally between my two sons, William Deshler Warner and Randolph S. Warner, Jr., share and share alike, or, in case of the death of either or both of my said sons, then to their heirs per stirpes.
Believing that the property disposed of in this Item is invested to the best interests ol' my Estate, it is my desire that my Executors shall not dispose of any part thereof during said five year period after my decease, or change the form of any of my said investments during said period; provided, however, if the best interests of my estate shall, in their sound judgment, require it, my said Executors are hereby empowered to dispose of any of said property and investments, and reinvest the proceeds therefrom at their sound discretion, said principal investment, to be held under the provisions of this Item.
At the expiration of said five year period from and after my decease, said Trust shall terminate and cease, and all said rest and residue of my Estate, by this Item disposed of, shall be by my Executors distributed and turned over in kind to my said two sons, William Deshler Warner and Randolph S. Warner, Jr., share and share alike, the same to become their property, absolutely and in fee simple. In case either or both of my said sons shall die during said five year period, then the share or shares of the one or ones so dying shall go to his or their respective heirs of the body.
My said Executors are hereby authorized and empowered to make, execute and deliver all necessary and proper deeds and other instruments of conveyance, and to do all things necessary or proper, without legal proceedings first had, for carrying out the powers and duties hereby in this Item conferred.
Item IX. I hereby nominate, constitute and appoint, William Deshler Warner, Randolph S. Warner, Jr., and William O. Willard, executors of this my last will and testament, and direct that said William O. Willard be paid the sum of Five Hundred Dollars ($500.00) per year, during the five year period following my decease, or for such part thereof as he may act as my Executor, and that said William Deshler Warner and Randolph S. Warner, Jr., shall act without compensation; hereby authorizing and empowering my said Executors to extend, compromise, collect, release and discharge, upon such terms and in such manner as they may deem for the best interests of my. estate, all debts and claims due to or from me; and I also confer upon them all such other additional powers and authority as may be necessary to do and perform any act or thing for the purpose of carrying out the provisions of this my will, although not herein expressly named, and to that end to sell at private or public sale, at such prices, and upon such terms of credit or otherwise, as they may deem best, and without first obtaining leave of Court the whole, or any part of my real estate or personal property, and to acknowledge, execute and deliver deeds and other proper instruments of conveyance thereof to the purchaser or purchasers; provided, however, the home property devised in Item VII shall not be sold by my Executors unless and until all the rest of my Estate has been disposed of and then only in the event that it is necessary to sell the same to carry out the provisions of Item I hereof.
♦ * * * # * *
I direct that no bond be required of my Executors, and request that no Inventory or Appraisal of my estate be made.

The nominated executors qualified. William C. Willard resigned and Daniel H. Sowers was appointed in his stead. The executors received as part of the estate of the testator certain stocks, the fair market value of which, both at the death of the testator and at the date of distribution, is stipulated. During the five-year period the executors bought other stocks, the cost and fair market value of which, at the time of distribution, is also stipulated. The executors distributed the residuary on October 4, 1926.

The respondent has determined that the basis for the determination of petitioner’s gain or loss arising from the sale of certain stocks is their fair market value at the death of the testator or their cost to the executors, depending on whether the executors acquired the stocks from the testator or by purchase. If the interests of the petitioner and his brother were vested as of the death of the testator, the respondent must be affirmed. Brewster v. Gage, 280 U.S. 327; Rod-man E. Griscom, 22 B.T.A. 979; Estate of Francis Abeles, 24 B.T.A. 435; William Huggett, 24 B.T.A. 669; affd., 64 Fed. (2d) 705; Isabelle Richardson Molter, 27 B.T.A. 442.

The petitioner insists that his father did not bequeath to him any of the stocks which he sold and that his only right to them was derived from the testator’s direction to his executors that at the end of the five-year period they distribute and turn over in kind the residuary estate to him and his brother and that their rights are further limited by the provision that if either be dead at the expiration of the period his share shall go to the heirs of his body. He also points to the fact that if either die during the period his share of the income shall go to his heirs. He seeks to apply the rule that where there are no words of gift, other than a direction to the executors or trustees to pay or divide at a future time, a gift is contingent and not vested.

Whether these interests were vested or contingent must be determined under the laws of Ohio, where the testator resided and where his will was probated. Isabelle Richarson Molter, supra; Pringle v. Commissioner, 64 Fed. (2d) 863. If instead of a direction to pay or divide the testator had bequeathed to his sons. the corpus of the estate after the termination of the five-year period, there is no doubt that under decisions of the Ohio courts each would have taken a vested remainder subject to be divested by death before the end of the period. Collins v. Collins, 40 Ohio St. 353; Millison v. Drake, 123 Ohio St. 249; 174 N.E. 776. Thus it is evident that if the rule of pay or divide is not applicable, the petitioner’s contention must fail.

It should be noted at the outset that the rule relied upon is not a rule of property but one of construction, which is to be applied, if at all, only as an aid to interpretation and not to override the intention of the testator. Barr v. Denney, 79 Ohio St. 358; 87 N.E. 267; Fulton Trust Co. v. Phillips, 218 N.Y. 573; 113 N.E. 558. The rule has many qualifications. Thus, the fact that all the income arising before the distribution is given to the one ultimately entitled to the corpus should be given great weight as indicating an intention to vest the interest. Vanderpoel v. Loew, 112 N.Y. 181; 92 N.E. 484; Fulton Trust Co. v. Phillips, supra; Armstrong v. Barber, 239 Ill. 389; 88 N.E. 246. See also on this point Irwin v. Gavit, 268 U.S. 161; Commissioner v. Field, 42 Fed. (2d) 820. Further, where the payment of the legacy is postponed not for reasons personal to the legatee, but for the convenience of the estate, the presumption is that the testator intended that the gift should vest. Carper v. Crowl, 149 Ill. 465; 36 N.E. 1040, and authorities cited. Armstrong v. Barber and Barr v. Denney, both supra. So also a distinction is to be drawn where the direction to pay over is to a named individual and not to a class to be thereafter determined. Armstrong v. Barber, supra. Lastly, the law favors that construction which will vest an interest. Linton v. Laycock, 33 Ohio St. 128.

Our task is to discover if we can what was the intention of the testator; first, from the words of his will and, if doubt arises, then by applying the rules above set forth as an aid in arriving at the proper interpretation. The testator was survived by two sons, both married and both having children. These sons, and not a class to be subsequently ascertained, were named as beneficiaries. He nominated them, together with a third person, to be executors of his will and endowed them with extensive powers, thus evidencing his confidence in their integrity and business ability. Thus it appears that the provision for the five-year period was not caused by any reason personal to the sons. The reason for this particular provision must be looked for elsewhere. By item VII the testator disposed of his residence, which had been devised to him by his wife and concerning which he made most elaborate provisions. This property was not to be leased for five years after his death except for residence purposes. It was not to be sold during this same period except as provided in Item IX, where the executors are given power of sale and where it is directed that this property shall not be sold until all the rest of the testator’s estate shall have been disposed of, and then only for the purpose of paying his debts.

The insertion in item VII of the same five-year period which we find in item VIII, coupled with the directions in item IX, indicates that the testator was concerned but with the settlement and administration of his estate and especially the preservation of his home place. The testator conferred on his sons and the third person, as executors, the legal title to the whole of his residuary estate and, having done this, he provided that his sons should be paid monthly the net income from the property. They and another, in the capacity of executors, were vested with the legal title, and the sons alone with the equitable title, to the property during the whole five years.

We have here no elaborate trust. The executors were to act as trustees, and then only for five years. We think that the five-year period was provided by the testator for the protection of his estate, to give his executors breathing time and to relieve them from applying to a court for extensions of time within which to settle; and that the whole scheme was a method marked out by the testator for the administration of his estate and not for the purpose of setting up a continuing trust. So, far from distrusting his sons’ capacity to manage and dispose of their interests, he vests them with wide authority. Instead of postponing their right to enjoyment, he gives them all the income arising during the period. It .seems clear that the will shows an intention to vest each son with his share.

With minor differences the situation here is not unlike that involved in Brewster v. Gage and Estate of Francis Abeles, both supra. That the interest of the petitioner might have been divested by his death during the five years does not alter the fact that it was vested and, having survived the period, he acquired the stocks owned by the testator as of the date of the death of his father. In Tax Commission v. Commerce Guardian Trust & Savings Bank (Court of Appeals of Ohio), 157 N.E. 423, the facts were that the testator directed his testamentary trustee to divide his residuary estate into three equal parts, one to be held for his wife, one for his son, and one for his daughter. The son was to receive all the income of his trust and when he arrived at the ages of twenty-five, thirty, and thirty-five he was to receive parts of the corpus. When he arrived at the age of forty the trust was to terminate and the trustee was to pay over and deliver to him all the then corpus of the trust, the same to be his thereafter absolutely. The trust for the daughter was similar except that the payments to her were to be governed by the age of the son. If either child died without issue before the termination of the trusts, the remaining part of the corpus of his or her interest should pass to the survivor; if the one so dying left issue, then, under certain conditions, to his or her issue; and if both children died without issue before the termination of the trusts, then to the testator’s heirs and distributees. The court held that there vested in the children at the death of their father the absolute right to two thirds of the estate, subject to be divested on the happening of the contingencies. We conclude that the petitioner possessed at the date of his father’s death a vested interest in his share of the residuary estate; that, having survived the end of the period, he has not been divested thereof; and that on this point the respondent must be affirmed. What we have said relative to the stock owned by the testator applies to the stocks purchased by the executor.

In reaching this conclusion we have carefully considered the fol-lpwing cases on which the petitioner relies: Sinton v. Boyd, 19 Ohio. St. 30; Richey v. Johnson, 30 Ohio St. 288; Hamilton v. Rogers, 38 Ohio St. 242; Barr v. Denney, supra; Biles v. Webb, 118 Ohio St. 346; 161 N.E. 49. In each of these cases the court in reaching its conclusion looked to the intention- of the testator as its guiding star. In some of these cases the will involved had provisions similar to those in the will before us, but they also had other provisions which were different. None of them is controlling in the case before us.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: McMahon:

license: Public Domain

text:
    Fox River Paper Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 20878.
    Promulgated August 22, 1933.

      Edward J. Dempsey, Esg., and A. E. James, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

McMahon:

The determination of two of the questions involved in this proceeding — (1) whether the petitioner is entitled to a deduction on account of depreciation on the property here involved from June 8, 1920, to December 31, 1920, and (2) whether the petitioner is entitled to a deduction of a loss claimed to have been sustained on account of the abandonment in 1920 of certain machinery and equipment here involved — is dependent upon the construction of the contracts of June 8, 1920, and January 3, 1921, entered into by the petitioner and the Kimberly-Clark Co., hereinafter referred to as the seller.

The respondent contends that the contract of June 8, 1920, constituted an executory contract providing for the sale of the mill on January 1, 1921, or a memorandum or binder of the transaction ”; that the “land contract” of January 3, 1921, executed January 20, 1921, effected the transfer of title to such property; and that therefore the petitioner, not being the owner of such property until January 1921, is not entitled to deduct from gross income for the year 1920 any loss on account' of abandonment of machinery and equipment covered by the agreement of June 8, 1920, or depreciation on account of the buildings, machinery, and equipment. The petitioner contends that the sale was made on June 8, 1920, and that it was the owner of such property as of that date and is entitled to such deductions.

We will consider first tbe question as to whether the petitioner is entitled to deduct $103,524.92 from gross income of 1920 on account of abandonment of certain machinery, tools, and equipment covered by the agreement of June 8, 1920, under the provisions of section 234 (a) (4) of the Bevenue Act of 1918, which is as follows:

Sec. 234. (a) That in computing tlie net income oí a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * * * * * *
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise. * * *

In its petition filed with the Board on October 28, 1926, the petitioner alleges that it sustained a loss in 1920 through abandonment and scrapping of machinery and equipment purchased from the Kimberly-Clark Co., as follows:

Electrical machinery_$74, 513. 22
Pourdrinier part of paper machine_ 18,482.34
Miscellaneous machinery_ 45, 717. 94
Machinery lost or stolen_ 2, 024. 05
140,737. 55

In a stipulation filed'July 9, 1931, the parties stipulated, relative to the question of abandonment and scrapping of machinery and equipment, the following:

1. That on June 8, 1920, the Petitioner and the Kimberly-Clark Company entered into an agreement for the purchase and sale of certain property known as the Telulah Mill, situated at Appleton, Wisconsin, for a total consideration of $950,000.
3. That included in the said purchase was mill machinery and equipment which cost $492,688.23, included in the above named consideration.
5. * * * In the event that the Board shall determine that the Petitioner is entitled to a deduction of $103,524.92 for machinery and equipment scrapped during the year 1920, the basis for the computation of a reasonable annual allowance for exhaustion, wear and tear of mill machinery shall be reduced by the said $103,524.92. * * *
S. That Petitioner scrapped and discarded machinery and equipment which cost net $103,524.92, after the allowance for the scrap value thereof. The said $103,524.92 was included in the consideration of $950,000, as hereinabove stated.
9. * * * The Commissioner did not allow any deduction in 1920 for loss due to scrapping of machinery and equipment in the amount of $103,524.92, or any other amount.

Although the respondent in his answer denies the allegations contained in the petition relative to the abandonment and scrapping of machinery and equipment, it appears quite clearly from the stipulation that the petitioner satisfied the respondent that machinery and equipment costing net $103,524.92, after the allowance for scrap value, had actually been scrapped and discarded by the petitioner and that they were a part of the machinery and equipment purchased from the Kimberly-Clark Co. The machinery and equipment scrapped and discarded consisted of the wet end or Fourdrinier part of one of the paper machines, the electrical equipment, including generator, motors, rope drive, and other miscellaneous machinery, tools and equipment.

The respondent contends that no deductible loss can be claimed in 1920 on account of abandonment of this machinery and equipment, since the petitioner was not the owner of such property in that year, and that the petitioner did not in fact abandon such machinery and equipment in 1920, but in the following year or later.

The agreement of June 8,1920, provides that:

The Seller hereby agrees that it will sell and convey to the Buyer all its waterpower * * *, and all its land and mills * * * in said Appleton, * * * for the sum of Nine Hundred Fifty Thousand Dollars * * *.
*******
The Seller is to retain possession and use of said property until January 1, 1921, the Seller then to surrender possession * * *.
Notwithstanding the fact that the Seller retains general possession and use of said property until January 1, 1921, yet in the meantime Buyer shall have the right to mate such improvements to such property as may be desirable for its purposes, and as may not interfere with full operation of the paper mill plant by the Seller.
# sjs * * * * #
It is understood that all tools and machinery in use in the operation of the mill property conveyed shall pass to and he the property of the Bmyer. [Italics ours.]

The contract of June 8, 1920, deals with two kinds of property, viz., (1) water power and land, including buildings, and (2) tools and machinery. Neither the land contract nor the deed dated February 5, 1926, mention the “ tools and machinery ” referred to in the contract of June 8,1920.

Under the provisions of the contract above quoted the seller reserved to itself the right to use and operate the “ paper mill plant ” and the petitioner acquired the right to enter upon the property and make such improvements thereon as might be desirable for its purposes, without interfering with the full operation of the paper mill plant by the seller. The paper mill plant did not constitute the entire property conveyed. While the seller was operating the paper mill plant, the petitioner built a new large ironclad warehouse. It entered into a contract for remodeling the “ old Pulp Mill and Rotary Building ” into a new rag room and for the building of a filter plant, both of which were to be completed in 1920. It laid cement floors and made other improvements, all while the seller was operating the paper mill plant. The seller therefore used so much of the Telulah Mill property as was necessary for the “ full operation of the paper mill plant ” while the petitioner was active upon the remaining property making it suitable for its purposes.

Although the contract did not expressly provide what machinery and equipment the seller was to use in the operation of the paper mill plant, obviously it implies, and it appears, that the parties contemplated that the seller was to use all the machinery and equipment necessary to operate the paper mill plant; and the seller did use such machinery and equipment in the operation of the mill.

While it clearly appears therefore that the seller was to use the machinery and equipment and that there was to be no interference on the part of the petitioner in its use thereof for the operation of the paper mill plant, yet the contract provides that “ all tools and machinery in use in the operation of the mill property conveyed shall pass to and he the property of the Buyer” It seems to us that the clear import of the above quoted provisions of the contract, viewed in the light of all the facts and circumstances, is that, notwithstanding the reservation of the possession and use of the paper mill plant, together with the tools and machinery, nevertheless, title to the tools and machinery was to pass to the petitioner upon execution of the agreement of June 8, 1920. This is substantiated by the fact that the petitioner, after the seller vacated the plant, within a few days after December 17, 1920, took possession and exercised all the rights of ownership thereof without objection from or interference by the seller. As early as September 1920, the seller had knowledge of the fact that petitioner was trying to dispose of the electric motors and other electrical equipment, as it was offered for sale to the seller by the petitioner (the buyer) and negotiations were had between them for the repurchase thereof by the seller, while the seller was still operating the paper mill plant. Obviously, the petitioner acquired possession of the machinery, equipment, and tools in 1920, and, as shown later, exercised complete dominion and control thereof.

Furthermore, the petitioner in 1920 paid $450,000 of the purchase price of $950,000, $400,000 of which was not payable under the terms of the contract of June 8, 1920, until January 1, 1921. The seller permitted the petitioner to paint all the buildings, including the paper mill plant, in a distinctive color scheme according to custom established by the petitioner, thus permitting the property to bear publicly the petitioner’s indicia of ownership. The contract provided that the petitioner “shall have the right” to make improvements upon the property and the petitioner, without any objection on the part of the seller, placed valuable and substantial improvements on the property in 1920. A few days after December 17, 1920, the petitioner had, as stated before, possession of the entire property and exercised all the rights of ownership relative thereto without objection on the part of the seller.

The principle that, in applying the provisions of the Sixteenth Amendment and the income tax laws enacted thereunder, matters of substance or the actualities of the situation or what, was actually done should be regarded rather than mere form has been repeatedly enunciated by the courts and this Board. Weiss v. Stearn, 265 U.S. 242; United States v. Phellis, 257 U.S. 156; Robert C. Roebling, 28 B.T.A. 644; W. E. Guild, 19 B.T.A. 1186; William H. Mullins, 14 B.T.A. 426; B. F. Saul, 4 B.T.A. 639; Anna M. Harkness, 1 B.T.A. 127.

Taking into consideration only what was done by the parties in 1920 in carrying out the terms of the contract, no other conclusion than that the petitiner became the owner of such machinery, tools, and equipment in 1920 can reasonably be reached.

The Board has held, in Reuben H. Donnelley Corp., 26 B.T.A. 107; I. G. Zumwalt, 25 B.T.A. 566; Belridge Oil Co., 11 B.T.A. 127, that whether or not there has been an abandonment depends on the intention of the owner, coupled with the act of abandonment, both to be ascertained and determined from all the facts and surrounding circumstances.

All of the property was purchased by the petitioner with the intention of using it in the operation of its business, with certain changes to make it suitable for the manufacture of paper from rags. After the execution of the agreement in 1920, the petitioner discovered that certain of the machinery and equipment was not in condition for its use and not suited for its purpose. Thereafter and in the same year the petitioner incurred substantial obligations in the purchase of machinery and equipment to replace that which it found unsuitable for its purpose. In two letters of the seller, dated December 17, 1920, addressed to the petitioner, the seller stated:

As soon as shut down, [within a few days thereafter] and, a's a matter of accommodation to you, * * * we have no objection to your beginning repairs and remodeling over the entire mill * * *.
Under the circumstances we will be very glad to permit you to go ahead with your plans in the repairs and remodelling * * *.

A few days after the date of the above letters the seller turned over the paper mill plant to the petitioner. As soon as it was able to do so and immediately upon the vacating of the paper mill plant by the seller, the petitioner commenced and practically completed in 1920, the work of dismantling and removing from the plant the machinery and equipment which it did not intend to use. It disposed of such of it as it could at scrap value and the rest was thrown out or stored.

It is our conclusion that the petitioner did sustain a loss in the amount of $103,524.92 in 1920 and that such loss is deductible under section 234 (a) (4) of the Revenue Act of 1918. Parma Co., 18 B.T.A. 429; Winter Garden, Inc., 10 B.T.A. 71; Peoples Ice & Cold Storage Co., 10 B.T.A. 16; Union Bed & Spring Co. v. Commissioner, 39 Fed. (2d) 383; Wheeling Tile Co. v. Commissioner, 25 Fed. (2d) 455.

The fact that the petitioner in 1923 or 1924 sent the rotor of the electrical equipment to the manufacturer does not refute, under the circumstances, the intention to abandon it in 1920. The rotor was returned to the petitioner without charge, and placed in its warehouse, where it has remained ever since. This confirms the petitioner’s claims that it was unsuitable and could not be utilized for its purposes or otherwise. Wheeling Tile Co. v. Commissioner, supra. See also Independent Brick Co., 11 B.T.A. 862, 867.

In view of the stipulation entered into between the parties, it seems to us that the argument of the respondent that “ The burden of proof was also upon the taxpayer to allocate the $103,524.92 representing the cost of scrapped and discarded machinery and equipment to the three items ” is without merit. The machinery and equipment scrapped and discarded consisted of more than three items, but was referred to as part of a paper machine, electrical equipment consisting of various motors and other parts, and miscellaneous machinery and equipment. We fail to see how the respondent could have entered into a stipulation fixing the total cost of machinery and equipment abandoned without considering the kind, nature and character of the various machinery and equipment involved. It is impossible to determine cost without knowing what the article is, the cost of which is to be determined. These stipulations are entered into for the convenience of the parties and to eliminate long and detailed proof of facts which can more readily, and with a saving of time, effort and expense, be determined by the parties themselves. In view of the agreements reached in the stipulation we are of the opinion that the petitioner has not failed in his proof in not allocating the total cost stipulated to the various items of machinery and equipment abandoned and scrapped. In our opinion, under all the facts and circumstances, the petitioner was justified in relying upon the stipulation to the extent to which it did rely upon it.

Since we have held that the petitioner is entitled to a deduction of $103,524.92 in 1920, on account of the loss by abandonment of machinery, tools and equipment, under paragraph 5 of the stipulation, we are not here concerned with the question of a deduction on account of depreciation in that year of such property; and in what follows herein upon the subject of depreciation, our discussion is limited to the remainder of the property covered by the agreement of June 8, 1920, exclusive of the land and water power.

The next question we will consider is whether the petitioner is entitled to a deduction of a reasonable amount for depreciation of the buildings, machinery, tools and equipment exclusive of the machinery, tools and equipment abandoned in 1920, under section 234 (a) (7) of the Revenue Act of 1918, which is as follows: ■

Sec. 284. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: *******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence;

The contract of June 8, 1920, provides in part that:

The Seller is to retain possession and use of said property until January 1, 1921, the Seller then to surrender possession * * *.
The Seller shall maintain the property in good operating condition and in as good condition as the same now is, until the first day of January, 1921, excepting ordinary wear and tear and decay. [Italics ours.]

It is to be noted that the property involved is not property which was not subject to depreciation between June 8, 1920, and the date of delivery under the contract. On the contrary, the contract covered property which had been in use prior to June 8, 1920, and, under the terms of the first contract, such property was to be used thereafter for about seven months by the seller in the operation of the mill. Furthermore, the transaction was a business transaction, the parties dealing with each other at arm’s length and in the ordinary course of business. The president of the seller, who acted throughout the negotiations in behalf of the seller, testified that:

* * * We were reluctant to consider the sale of it, because we had contracts carrying us through the year, which put all of our equipment to its utmost capacity to fill; so that to discharge our obligations under the contracts we could not possibly consider the sale of the mill for delivery earlier than the 1st of January.

Negotiations for the purchase and sale of the property were commenced early in 1920 and such negotiations finally resulted in the agreement of June 8, 1920. The petitioner had orders substantially in excess of the capacity of its facilities and it was desirous of increasing its facilities -as soon as possible to meet its contract obligations. The position of both parties in this respect is reflected in the provisions of the contract, the seller reserving the right to use and operate the mill and the petitioner having the right to enter upon the property and “ to make such improvements to such property as may be desirable for its purposes and as may not interfere with full operation of the paper mill plant by the Seller.” [Italics ours.] The president of petitioner viewed the property at the time of the negotiations and execution of the first contract, and knew that as to that part of the property referred to in the contract of June 8, 1920, as the “paper mill plant”, it would not, under the circumstances, be delivered to it in the same condition as it was in on June 8,1920. The condition, at the time of delivery, of the property which was subject to the use of the seller over a considerable period of time would be a matter of grave concern to the petitioner. That this matter did not escape the attention of the petitioner is evidenced by the above quoted paragraph which describes the condition in which the property was required to be in at the time of delivery, i. e., the same good operating condition as of June 8, 1920, “ excepting ordinary wear and tear and decay? [Italics ours.] The president of the seller further testified that between June 8, 1920, and the end of the operation of the mill by it, it had made a profit in “ round figures, $200,000 ” from the operation of the mill. To retain the use and possession of the property was of substantial value to the seller, and, since the petitioner was desirous of obtaining the use and possession thereof as soon as possible, the delay therein would be a disadvantage to it in that it was unable to prepare and use the property for its own purposes as rapidly and as soon as it would have been able to do had it secured the immediate delivery of the property. Certainly all of these factors entered into the determination by the parties of the consideration to be paid for the property by the petitioner. It would be unreasonable to say that the seller, in view of the condition of its business at the time and its need for the utmost capacity of all its facilities, would have fixed the same price for the property as stated in the contract of June 8, 1920, had it been required to deliver the property on June 8, 1920, or shortly thereafter. It would not be reasonable to say that the petitioner would have agreed to pay the same purchase price for the property irrespective of the time of delivery and use thereof by some one other than itself. The officers of both the seller and the petitioner, who negotiated this deal and who acted on behalf of their respective corporations, were men of wide business experience. They certainly would know and realize that the value of the property was greater on June 8,1920, than on January 1, 1921, to the extent of the depreciation caused by the use thereof by the seller and lapse of time. It seems to us that the conclusion is inescapable that the property actually purchased by the petitioner was the property in its condition at the time of delivery, i. e., the property in good operating condition and in as good condition as the same now is [June 8,1920], “ * * * excepting ordinary wear and tear and decay.” [Italics ours.] Hence, since the petitioner contracted to buy the property in its condition as of January 1, 1921, or in as good operating condition as of June 8, 1920, minus or excepting wear, tear, and decay, it cannot be said that the property purchased was subject to any depreciation which would have to be borne by the petitioner during the period between June 8, 1920, and January 1, 1921, or that its investment was being reduced, since its investment represented the property as of January 1, 1921. As to the condition of the property now under consideration, the petitioner bought it in its depreciated condition as of January 1, 1921. Therefore, it did not experience, suffer or sustain any depreciation of the property before that date. As a matter of pure fact it had no depreciation on the property in 1920 and hence it cannot deduct any depreciation of the property for that year.

In view of the foregoing, it is not necessary to determine, for purposes of depreciation, whether the petitioner was the owner of the property as of June 8, 1920; nor is it necessary to determine whether or not such property was “ used in the trade or business ” within section 234 (a) (7).

All the cases cited by the petitioner and respondent have been carefully considered, but the facts in those cases are so different from the facts in this proceeding that it would serve no useful purpose to enter into a discussion of them. We base our decision on the peculiar facts of this proceeding.

It is our conclusion, therefore, that the petitioner is not entitled to a deduction in 1920 for depreciation of the buildings, machinery, tools, and equipment not covered by our disposition of the issue of abandonment.

As the respondent confessed error as to the disallowance of a deduction for income taxes due the State of Wisconsin for the year 1920 in the sum of $20,599.97, such sum, as well as the item of $13,543.37 which parties stipulated should be allowed as ordinary necessary expenses for the year 1920, should be deducted upon recomputation under Rule 50.

Redetermination of petitioner’s income and profits taxes for 1920 was made by respondent under the provisions of sections 327 and 328 of the Revenue Act of 1918. On motion of respondent, the hearing was limited to the issues defined in paragraph (a) of Rule 62. Therefore, no evidence with respect to assignments of error numbered 4, 5 and 6 was adduced at the hearing. Unless motion for hearing under Rule 62 (a), to be filed within 30 days, is granted by the Board.

Reviewed by the Board.

Judgment will be entered under Bule 50.

Smith, Black, and Matthews concur in the result.

Marquette dissents.

Trammell dissents on the question of depreciation.

Van Fossan dissents on the question of the ownership of machinery.


author: Matthews:

text:
    Ray Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 34332, 43123, 45219, 48015, 61554.
    Promulgated August 22, 1933.

      A. E. Hill, Esq., and J. G. Beavers, O. P. A., for the petitioner.
    IF. B. Lansford, Esq., for the respondent.
   OPINION.

Matthews:

1. The first proceeding, Docket No. 34332, arises on a deficiency of $1,105.94 in income tax for the calendar year 1923 and involves the sole question, whether the petitioner was taxable in that year as a trust or as an association under section 2 (2) of the Revenue Act of 1921. The petitioner invoked the aid of section 704 (a) of the Bevenue Act of 1928, set out in the margin. The rulings of the Commissioner referred to in this section are those cited in E. A. Landreth, 15 B.T.A. 655; Wilkins & Lange, 15 B.T.A. 1183; Woodrow Lee Trust, 17 B.T.A. 109; and Van Cleave Trust, 18 B.T.A. 486; and are predicated upon the control test laid down by the Supreme Court in Crocker v. Malley, 249 U.S. 223. In the Landreth case at 667, we said:

* * * It is sufficient to say that beginning in the year 1919 and up to and including the period July-Deeember, 1922, the Bureau of Internal Bevenue was consistently ruling that irrespective of whether the taxpayer was engaged in business under the corporate forms, it was taxable as a trust in all cases where the shareholders could not control the actions of the trustees.

In the Van Cleave case we held that the same test applied as late as July 1, 1924.

Here the three trustees held the legal title to the trust property, their liability and that of the beneficiaries being limited to this property. The trust Instrument was duly recorded and notice was held out to the public that petitioner was operating as a trust. The trustees were given “ absolute control, management and disposition without giving bond.” They held an annual meeting and designated certain of their number as officers. The trustees might alter the amount of shares within a certain fixed minimum. Two of the three trustees at any meeting could take valid action. They alone might appoint their successors. The shareholders held no meeting and exercised no powers. They had no legal title in the trust property nor any right to its partition or to dissolution of the trust. The shareholders’ beneficial interest was to be represented by transferable certificates.

The purpose of petitioner was to prospect for oil and gas lands and to sell them. It sunk two wells and then sold the leases and collected on the royalties. Nothing whatever appears in the evidence to indicate any interference by the shareholders with the conduct of the enterprise by the trustees. The trustees collected the royalties and distributed them to the shareholders. They were given full power to invest, reinvest, or otherwise dispose of trust funds.

In such circumstances it does not require argument to show that the trustees in this proceeding, as we said of trustees in a similar situation in Twin Bell Oil Syndicate, 26 B.T.A. 165, “ were here the real masters of the situation, unchecked by the veto of the holders of the beneficial interest.”

As the petitioner filed a return as a trust on March 16, 1924, we are of the opinion that for the year 1923 it comes within the operation of the remedial provision and is entitled to its benefit.

2. Dockets 43123, 45219, 48015, and 61554, for the respective years of 1926, 1927, 1928, and 1929, raise the same issue as the proceeding for 1923, the only difference being that with respect to the latter years, the petitioner may not avail itself of section 704 (a) of the Revenue Act of 1928; and we must determine the question under the principles laid down by the Supreme Court in Hecht v. Malley, 265 U.S. 144, and subsequently decided cases. Twin Bell Oil Syndicate, 26 B.T.A. 172, 175; Morriss Realty Trust, 23 B.T.A. 1076, 1083.

The petitioner relies strongly on our decision in Extension Oil Co., 16 B.T.A 1028; affd., 47 Fed. (2d) 65, contending that the present case is almost on all fours with that case. We agree with this contention. There are enough resemblances in essentials in the present case to bring it within the Extension Oil Co. decision. We have already pointed out that the trustees were empowered to act and did act independently of any control by the shareholders. Control by the trustees is not, however, enough.

The purposes of the trust as set out in the instrument of trust were various and comprehensive, generalty to lease and purchase gas and oil rights; to carry on all necessary operations in the development of oil wells and the sale of oil; to acquire and operate under franchises for the sale of gas, electricity and water, and to deal in stocks and bonds. That these purposes had no real relation, however, to the intentions of the seven men who organized the petitioner, appears from the testimony of the secretary and the treasurer of petitioner (also an original trustee) who said, in answer to the question why those provisions were put in:

The witness: We had an attorney draw up that trust agreement for us, We did not state just what we wanted, other than that we did not want to he bound to some individual obligation of somebody who might be a certificate holder in the company. That perhaps was just some form the attorney fixed up. I don’t know just why all that was put in there. It never was intended to do all those things.
Q. And you state that you did not do them?
A. No, we did not.
Q. Your operations were confined to what?
A. Well, we controlled two wells there and since have just been holding our royalty interest, and collecting and distributing the money that accumulates.

The actual operations of the petitioner were confined, as stated in the testimony above, to sinking two oil wells which the trustees sold in the same year to the Magnolia Petroleum Co.; and after the sale, to collecting the royalty. As to petitioner’s other activities it appears that one royalty was bought by the petitioner with trust money requiring reinvestment, but apparently the trustees carried on no further operations of any kind and merely collected royalties and distributed them to the beneficiaries. The sinking of the two original wells is explained apparently on the ground that the territory owned by the petitioner was “ wildcat ”, that is to say, unproven, and until oil was struck the probability of disposing of it on a royalty basis was not large.

We may safely conclude, therefore, notwithstanding the purposes of general business operation set forth in the trust declaration, that the business purpose was strictly limited, and that the actual operations after 1923 amounted to scarcely more than the passive receipt of income from the trust’s investments.

The facts of the Extension Oil Co. case, as stated by the circuit court, were as follows:

Five men, owning an oil and gas lease wbicb was about to lapse unless drilled, in order to realize on the property trusteed the land in the name of the Extension Oil Company, and in the declaration of trust they named four of the five as trustees, declared “ the trust estate hereby created shall be divided into 400 units,” provided for the sale of the units, the drilling on the property by the Extension Oil Company, gave the trustees full power to handle the property, collect the rents, sell and dispose of it, and particularly provided that the trustees should collect all revenue from the trust estate, as well as the proceeds from the sale of any of the trust property and distribute it to the unitholders.
The trust instrument authorized the trustees to fill all vacancies in the office of trustees and amend the terms of the trust. It provided that the unitholders should have no vote, nor any control over the trust or the trustees, and that absolute control and discretion was vested in the trustees to manage and control the trust according to their own best judgment.
It also provided that the unitholders should have no interest by virtue of their certificates in the corpus of the estate, but merely the right to participate in the earnings and profits of the trust estate when realized in money.
Of the four hundred units less than fifty were sold to others than the creators of the trust.
After its creation, in May, 1922, the trust drilled a well, produced oil from which some returns were derived, and in January, 1923, it sold its properties to the Magnolia Oil Company for the sum of $200,000, and thereafter the trustees ceased the active management of the trust, and its affairs were wound up by the bookkeeper, Holmesly.

The circuit court, as said, affirmed the decision of this Board, holding that the taxpayer was a trust and not an association, whether looked at from the standpoint of what it might potentially do or from what it did in fact. In the Extension Oil Co. case, the trust was created to sink a test well and, after it had proved productive, the property was sold to the operating company and the trust within the year went out of business. Here, likewise, the petitioner sank two wells in unproven territory, found them productive, and sold the lease. We do not think it a significant difference that the petitioner here continued in existence to receive royalties on its property after the operation of the wells had been disposed of by sale. In both cases the trust instrument gave full and complete powers to the trustees, and excluded the “ unitholders ” or shareholders from any management or control. In both, certificates of interest were created, but in the Extension Oil Co. case some 50 out of 400 units went to outsiders, while here all the beneficiaries had held their interests from the beginning and themselves created the trust. As was suggested by the circuit court in the Extension Oil Co. case, and we hold the same opinion now, too close a scrutiny of the purposes of the petitioner as set out in the trust instrument — especially in the light of the testimony of petitioner’s secretary and treasurer that the seven set-tlors of the trust really entertained no such intentions — would be a surrender to formalism; and that a regard to the realities of the case must take fully into account what was done in fact. Viewing petitioner thus, we are satisfied that it should not be classified as a business trust.

Respondent contends, however, that the present case falls within the rule of Little Four Oil Co. v. Llewellyn, 35 Fed. (2d) 149, and Willis v. Commissioner, 58 Fed. (2d) 121. It is significant that the circuit court in the Little Four Oil Co. case took as its test “ whether the trust is a business concern and the trustees are operating it in active business for profit.” It then recited the essential facts with respect to the creation of the trust by four men, the issuance of beneficial shares and the general control exercised by the trustees — facts similar to those presented here. The court concluded that the character of the trust was not to be determined by the powers of trustees or stockholders, “ but by what the trust was acually doing through its trustees.” Here, in the fact of the taxpayer’s actual operations, lies the important difference between that case and this, for the court had previously in its opinion quoted the taxpayer’s admission as to its activities:

The trust (in this case) was created for the purpose of buying and selling real estate and mining and drilling for oil and gas thereon. * * * The trust engaged in business pursuant to the purpose as set forth in the declaration of trust, during the years in question.

“ Buying and selling real estate ” and “ mining and drilling for oil ” cannot properly be said to be the character of the petitioner’s activities. The sinking of a test well, as was held in the Extension Oil Co. case, is very different from the continued operation of wells. Cf. Twin Bell Oil Syndicate, 26 B.T.A. 172, 176.

The respondent also relies on Willis v. Commissioner, supra, affirming 22 B.T.A. 564. In that case devisees of certain improved real property organized a trust for the administration of the property, since it could not then be equitably divided. But the trustees were much more than passive recipients of rent to be distributed to the beneficiaries. They sold some property, exchanged other property, tore down some houses, and erected an office building, in addition to collecting rents from the office building. The court said, “ the question is to be determined from the facts showing what the trustees did in their handling of the property,” and it therefore concluded as follows:

* * * The exchange of property as noted, and the erection of a new building at a considerable cost, was considered without question as a profitable investment. Judged by their course of action as shown, it would be reasonable to assume that the trustees would continue to deal with the property in lite manner as long as the trust remained alive. Such acts, as enumerated, gave to the trust operations the character of an active business enterprise. * * *

Numerous decisions of the Board, including those cited by the petitioner, such as C. W. Cowell Co., 21 B.T.A. 1274, and G. F. Sloan, 24 B.T.A. 61, have followed the same rule, whei’e active operations were required of the trustees holding real estate. We do not see, however, that these cases have any application here.

In Emery Co. v. United States, 237 U.S. 28, arising under the Corporation Tax Law of August 5, 1909, the Supreme Court, in holding the respondent in error not subject to the tax, through Mr. Justice Holmes, said:

The question is rather what the corporation is doing than what it could do. * * * The claimants’ characteristic charter function, and the only one that it was carrying on, was the bare receipt and distribution to its stockholders of rent from a specified parcel of land. Unless its bare existence as an intermediary was doing business, it is hard to imagine how it could be less engaged.

The cases of Commissioner v. Atherton, 50 Fed. (2d) 740; Lansdowne Realty Co. v. Commissioner, 50 Fed. (2d) 56; Gardiner v. United States, 49 Fed. (2d) 992; and Dunbar v. Commissioner, 65 Fed. (2d) 447, all support the same conclusion. Cf. Tyson v. Commissioner, 54 Fed. (2d) 29. The circuit court in the Dunbar case expressly rejected the argument that the later Treasury regulations, interpreting the Hecht case, properly include as associations those trusts with large powers but not actually engaged in carrying on business. These cases all hold that the essential element is not what the trust may potentially do, but what it actually does in practice; and that the passive receipt of income by the trustees does not constitute doing business. We see no reason on the decided cases, therefore, why the petitioner does not fall within the rule of the Extension Oil Co. case, which it so closely resembles on its facts. The fact that the trust might run for twenty-one years is immaterial in view of the other facts, as the decided cases show. Nor is it important that in a single instance trust money, instead of being distributed, was reinvested in another lease. Such a single instance was disregarded in the Gardiner case, supra. The petitioner was in strict form a trust, carried on its only operations for test purposes, and thereafter lapsed into a mere agency for the collection of its royalties. In these circumstances we must conclude that after 1923 it did not carry on business, and, therefore, is not an association taxable as a corporation.

Reviewed by the Board.

Judgment will he entered under Rule 50.

         SEC. 704. TAXABILITY OF TRUSTS AS CORPORATIONS — RETROACTIVE.
      (a) If a taxpayer filed a return as a trust for any taxable year prior to the taxable year 1925 sucb taxpayer stall be taxable as a trust for such year and not as a corporation, if such taxpayer was considered to be taxable as a trust and not as a corporation either (1) under the regulations in force at the time the return was made or at the time of the termination of its existence, or (2) under any ruling of the Commissioner or any duly authorized officer of the Bureau of Internal Revenue applicable to any of such years, and interpretative of any provision of the Revenue Act of 1918, 1921, or 1924, which had not been reversed or revoked prior to the time the return was made, or under any such ruling made after the return was filed which had not been reversed or revoked prior to the time of the termination of the taxpayer’s existence.


author: Sternhagen:

text:
    Edmund R. Halsey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51246, 56310, 61217, 67231.
    Promulgated August 22, 1933.

      Fred Van Dolsen, Esq., for the petitioner.

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

Sternhagen:

The petitioner invokes the Constitution for immunity from the proposed tax liability on the ground that the income derived by him, representing 5 percent of the cost of engineering projects of the townships, was the compensation of a public officer or employee of a state or municipal government which the Federal Government is prohibited from taxing, since such a tax would have the effect of interference with the performance of the functions of the state. We may assume without discussion, and without deciding, that the petitioner was an officer or employee of a municipal subdivision of the state,- and assume further that the percentage form of his compensation makes his case no weaker than if he received a fixed statutory salary. Cf. Metcalf & Eddy v. Mitchell, 269 U.S. 514. There is still, however, a lack of sufficient evidence to establish, as the petitioner must, in order to overcome the presumption that respondent’s determination is factually correct, that the services and functions petitioner performed were entirely governmental in character and were to no extent proprietary. Flint v. Stone Tracy Co., 280 U.S. 107; South Carolina v. United States, 199 U.S. 437; Blair v. Byers, 35 Fed. (2d) 326; T. P. Wittschen, 25 B.T.A. 46; Leland Powers, Executor, 26 B.T.A. 1381; C. S. Denman, 27 B.T.A. 256. The facts were stipulated, and give no opportunity for inquiry. It appears not only that petitioner’s compensation was derived from projects which were more or less or perhaps entirely connected with the furnishing of water and light, but by the use in the stipulation of an undefined “ etc.” it is made impossible to say what the nature and extent of his other services be.

The factors which indicate and those which delimit the Constitutional immunity have never been easy to apply. The exemption of the individual is only derivative and incidental to the state’s right to freedom from Federal interference with its sovereign activities. Manifestly the individual is not to be given the exemption upon a record which leaves it doubtful what services he performed, whether they pertained to the state’s sovereign functions, and whether the tax would amount to an interference with their exercise. Willcuts v. Bunn, 282 U.S. 216; O'Gorman & Young v. Hartford Inswrance Co., 282 U.S. 251.

Judgment will he entered for the resfondent.


text:
    James Bliss Coombs, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47782, 49297.
    Promulgated August 22, 1933.

      Harvey L. RcébUt, Esq., for the petitioner.

      R. W. Wilson, Esq., for the respondent.
   OPINION.

Sternhagen:

Deficiencies in the petitioner’s individual income taxes for 1926 of $19,912.53, and 1927 of $13,371.48, are assailed by the petitioner in these two proceedings. The petitioner made his returns on the basis of cash receipts and disbursements. In 1926 he deducted as a loss an amount of $157,024.01, which was the unpaid balance of a syndicate subscription which he had made several years earlier and for the recovery of which suit was instituted against him in 1926, which he defended on the ground of no liability and which remained pending and undecided throughout the year 1927. The Commissioner disallowed the deduction on the ground that no loss was sustained by him in 1926 and that there was consequently no deduction for that year and no net loss which could to any extent be carried over into 1927.

The facts were orally stated at the trial and agreed upon, and no evidence was introduced. No briefs or oral argument were submitted.

The respondent’s disallowance was obviously correct, and an examination of the entire record, beginning with the original petitions with the appended notices of deficiency, to and including the expiration of the time requested by petitioner in which to file a brief, leaves no reasonable doubt that the petitions were frivolous and that the proceedings have been instituted by the taxpayer merely for delay. Under such circumstances it is provided by section 911, Revenue Act of 1924, as amended by section 1000, Revenue Act of 1926, that damages in an amount not in excess of $500 for each case shall be awarded to the United States by the Board in its decision. This provision was, as appears from the House Ways and Means Committee Report and the Senate Finance Committee Report upon the Revenue Act of 1926, patterned after R.S. sec. 1010 (28 U.S.C.A. sec. 878). The maximum damages of $500 in each case amount to approximately 3 percent of the deficiencies, and such amount is hereby awarded.

Judgment in favor of the respondent foi° the full amount of the deficiency plus $500 in each case will be entered.

       PKIVOLOUS APPEALS TO BOARD
      Sec. 911. Whenever it appears to the Board that proceedings before it have been instituted by the taxpayer merely for delay, damages in an amount not in excess of $500 shall be awarded to the united States by the Board in its decision. Damages so awarded shall he assessed at the same time as the deficiency and shall be paid upon notice and demand from the collector, and shall be collected a,s a part of the tax.


author: Sternhagen :

text:
    John Reid, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46761, 53208.
    Promulgated August 22, 1933.

      Fred E. Youngmam,, Esq., for the petitioner.

      G. A. Bay, Esq., for the respondent.
   OPINION.

Sternhagen :

The respondent added to petitioner’s income the compensation received for his architectural services to the city of San Francisco during the years 1924 to 1928, inclusive. Article 88 of Regulations 62, 65, and 69, and article 643 of Regulations 74, all provide in part that:

Compensation paid to its officers and employees by a State or political subdivision thereof * * * is not taxable.

Kegulations 69 and 74 restrict the article’s application to compensation paid for services rendered in connection with the exercise of an essential governmental function. The 1926 Act, section 1211, provides:

Sec. 1211. Any taxes imposed by tlie Revenue Act of 1924 or prior revenue acts upon any individual in respect of amounts received by bim as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded.

The cited regulations are not based upon any section of the acts, but upon the constitutional ground that those agencies through which the state or the Federal Government immediately and directly exercises its sovereignty are immune from the taxing powers of the other. McCulloch, v. Maryland, 4 Wheat. 316; Metcalf & Eddy v. Mitchell, 269 U.S. 514. The exemption, however, is limited to an exercise of those powers which are governmental in character and does not extend to a state’s activities in the operation of water or lighting plants, which have the characteristics of an ordinary private business, or to other proprietary functions. Flint v. Stone Tracy Co., 220 U.S. 107; South Carolina v. United States, 199 U.S. 437; Blair v. Byers, 35 Fed. (2d) 326.

Petitioner has introduced a mass of evidence establishing that he was designated city architect of San Francisco by a resolution of the board of public works; that the board’s appointment of him as such was authorized by an ordinance of the board of supervisors, a legislative branch of the city government, and that his compensation as architect was fixed at 6 percent of the cost of the specific projects assigned him for planning and supervising or 4% percent in the case of those which he was to plan but not supervise. The resolution specifies no duties other than those required in the proper performance of specific assignments, but in practice petitioner rendered very substantial additional services in advising, supervising, reporting, recording, and making recommendations on all the architectural and construction work in which the board of public works and other city agencies were interested. He was provided with an office and staff in the city hall, and maintained at his own expense another office and another staff elsewhere. In his dealings with the public he acted generally as if he were a public official. He argues that his additional routine duties, his advice on all matters in which the board was interested, and the official recognition accorded him show that his own position and general supervision differentiate him from the other architects to whom the board also assigned specific Avork, and constitute him an officer or employee of a state agency.

The case is so similar to Underwood v. Commissioner, 56 Fed. (2d) 67 (H. A. Underwood, 20 B.T.A. 1117), that the decision must likewise sustain the respondent’s determination. In that case a joint building committee, authorized by a North Carolina statute and consisting of commissioners appointed by the Governor, engaged Underwood by contract to devote his entire time and services as an architect to specified state projects at a monthly salary of $500, plus expenses, which included those of his office and staff of assistants. In 1928 this contract was abrogated; petitioner continued as architect and supervisor of public construction work, but in lieu of salary and expenses he received as compensation from iy2 to 6 percent of the moneys expended on the several projects, the percentage being measured by the services which he performed. He continued to devote his entire time to the public buildings, remained under the direction of the joint building committee, and attended meetings of the Am-rious boards interested in the projects. But he personally maintained his office, employed his own staff, and paid all expenses incident to his business out of the fees received from the state. In deciding that he was a private contractor and not a state employee, it was held that the services which he performed were those ordinarily performed by an architect and engineer, that he complied with the instructions and directions of his employers, but brought about the desired results through his own methods and instrumentalities; that the joint building committee was without technical skill and that their control of petitioner was confined to a determination of the kind and character of building construction and repairs to be undertaken, which petitioner proceeded to execute free from interference by the committee. These circumstances, together with the fact that his compensation was regulated by the value or amount of work done, the necessity for the use of judgment by petitioner, the maintenance of an office and staff of his own, and his personal liability for expenses, were held to establish that petitioner was an independent contractor although he had no other employment and was always at the command of the commission for a continuous and indefinite period.

There is no material difference in the facts here. Petitioner seeks to distinguish the Underwood case on the ground that Underwood’s relation with the state was contractual, obliging him to devote his entire time and attention to state services. He contends that the resolution appointing him has no resemblance to a contract “ other than that inherent in the acceptance by every officer or employee of the position tendered him.” This distinction is not valid. In the first place the original contract of Underwood was abrogated in 1923, and while he continued to perform the same duties required by it, his compensation and liabilities were altogether changed. The “ contract ” referred to in the opinion is the new contract arising from the later arrangement. In any event, petitioner’s acceptance of the conditions of employment listed in the resolution here resulted in an implied contract equally as effective as a written one.

The Underwood case is in conformity with the holdings of other courts. In Metcalf & Eddy v. Mitchell, 269 U.S. 514, followed in Lucas v. Howard, 280 U.S. 526, the Supreme Court said:

An office is a public station conferred by tbe appointment of government. The term embraces the idea of tenure, duration, emolument and duties fixed by law. Where an office is created, the law usually fixes its incidents, including its term, its duties and its compensation, United States v. Hartwell, 6 Wall. 385; Hall v. Wisconsin, 103 U.S. 5. The term “ officer ” is one inseparably connected with an office; * * *

In refusing to exempt from taxation compensation paid to construction engineers, the Court said:

They took no oath of office; they were free to accept any other concurrent employment; none of their engagements was for work of a permanent or continuous character. * * * Their duties were prescribed by their contracts and it does not appear to what extent, if at all, they were defined or prescribed by statute. * * * the performance of their contract involved the use of judgment and discretion on their part, and they were required to use their best professional skill to bring about the desired result. This permitted to them liberty of action which excludes the idea of that control or right of control by the employer which characterizes the relation of employer and employee and differentiates the employee or servant from the independent contractor. * * * we do not find that it (i.e., taxation of compensation) impairs in any substantial manner the ability of plaintiffs in error to discharge their obligations to the state or the ability of a state or its sub-divisions to procure the services of private individuals to aid them in their undertakings.

Reid v. Boyle, 28 Cal. App. 34; 184 Pac. 423, cited by respondent, is not directly in point. It merely construed a local statute and held that petitioner was not such an employee or officer of the city “ in the ordinary sense ” as to prevent his being paid other than monthly.

In Mesce v. United States, 64 Ct. Cls. 481; certiorari denied, 278 U.S. 612, Mesce was employed by virtue of a Chicago ordinance authorizing the board of local improvements to retain the services of a building expert for testimony in court proceedings growing out of public improvements. The ordinance prescribed compensation of $50 a day and a percentage of the value of buildings for which plans, diagrams, etc., had to be prepared. In denying Mesce exemption as a city officer, the Court said:

He selected his own office, paid the rent and for its equipment, and employed at his own expense his assistants. * * * He used his own methods and in-strumentalities and did the work of appraising values in his own way and as his judgment dictated, and in so doing he was free, and for such work he received his pay.

Again in Kreipke v. Commissioner, 32 Fed. (2d) 594; affirming 7 B.T.A. 777, the Eighth Circuit Court of Appeals denied exemption to a construction engineer, employed by contract to repair state buildings, and said:

tie was not compelled to devote all his time to the work. There were no working hours. He was not on any payroll. He did not receive a salary or wages; he could accept concurrent employment * * *; was liable for damages caused by delay; employed and paid his own men * * *.

Similar considerations have supported similar conclusions in numerous other cases. See David A. Reed, 281 U.S. 699; reversing 34 Fed. (2d) 263; and affirming 13 B.T.A. 513; Walter G. Winne, 27 B.T.A. 369; Packard Thurber, 20 B.T.A. 1208; Edwin J. Raber, 20 B.T.A. 975; Charles M. Haft, 20 B.T.A. 431; William Maxwell Conley, 18 B.T.A. 736; dismissed on respondent’s motion, 53 Fed. (2d) 1080; Jolm B. Spelmam, 18 B.T.A. 313.

On the other hand, if an architect, lawyer, physician or other professional man is employed by a state to perform whatever tasks may be assigned him (although not precluded from accepting other employment), if his service is continuous and regular, if his work is of a routine and recurring character, or if no definite object is to be accomplished, he has been held an officer or employee and not an independent contractor. United States v. Butler, 49 Fed. (2d) 52; Burnet v. Livezey, 48 Fed. (2d) 159; affirming 15 B.T.A. 806; Blair v. Matthews, 29 Fed. (2d) 892; David K. Cochrane, 26 B.T.A. 1167; Rosalie C. Rand, Executrix, 27 B.T.A. 182; G. Ridgely Sappington, 25 B.T.A. 1385; Frederick A. Brown, 22 B.T.A. 581; Charles J. Tobin, 17 B.T.A. 1261. Although petitioner’s service was in fact regular and continuous, this was because of the city’s building activity; had it ceased, he would have been without work or remuneration. While he did much routine, attended meetings, and made recurring reports, and in fact gave recommendations whenever asked, these services were beyond the express contemplation of the resolution and had no effect upon his compensation. Each task which the resolution authorized had to be specially assigned, and any compensation which he might draw had to rest entirely on such special assignment, which, moreover, the board of public works was not legally bound to give in any instance. Had it become dissatisfied with his services, no discharge would have been necessary to dismiss him; a mere failure to assign him new pirojects would instantly have left him without responsiiblity of any kind and without compensation. If his services were continuous, the continuity resulted from no term employment, but from a series of fresh employments which kept him steadily engaged. This is characteristic of an independent contractor, not an employee.

In his brief petitioner refers to sworn statements made before the Internal Revenue Bureau, wherein he said that the numerous services performed by him in addition to those required by the projects assigned for his preparation and supervision were done in a spirit of public service and not for compensation. He now seeks to deny that this is true, and argues that such statements are not admissions against interest. It seems unnecessary to pass upon the question of admission because the record is sufficiently complete to indicate that no part of the compensation paid was expressly intended to cover these additional services. The resolution of appointment limits the duties of the city architect to the preparation of plans for and supervision of construction of those works which “ the Board shall direct him to plan and supervise,” and his compensation is limited to the cost of these specific projects. Petitioner stated that he was unwilling to accept a salary as city architect because it would infringe a rule of the local Institute of Architects regarding fees. He and other architects were all paid on the same basis and that basis was prescribed by the institute. If a part of petitioner’s compensation is expressly allocated to his additional services, he would not be receiving the 6 percent for his specific services, and would hence infringe the rule which his scruples require him to observe strictly.

This uniform 6 percent‘rule has a further significance, for if all available architects in the city were committed to charge alike and all others paid income tax, there is in fact no burden upon the municipality in taxing the petitioner likewise. Cf. Willcuts v. Bunn, 282 U.S. 216. Thus the petitioner’s principal ground for his derivative Constitutional claim is absent.

Judgment will be entered for the respondent.


author: Leech:

text:
    Frances Elliott Clark, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54735.
    Promulgated August 22, 1933.

      A. E. James, Esq., for tbe petitioner.

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

Leech:

The petitioner, an individual residing at Camden, New Jersey, filed an income tax return for the calendar year 1928, in which she reported, inter alia, the receipt of $24,120 from the sale of Victor Talking Machine Co. stock, that the cost thereof was $5,580.50 and that the gain realized amounted to $18,539.50. The Commissioner determined that she received $46,917 for such stock, that the stock cost her $10,408.71 and that she realized a taxable gain of $36,508.29. The Commissioner increased petitioner’s income by the amount of $17,968.79 and determined the deficiency in controversy in the amount of $2,620.81. Our inquiry is the correct amount of taxable gain realized in 1928 from petitioner’s sale of 470 shares of common stock of the Victor Talking Machine Co. (hereinafter referred to as the Victor Co.).

On March 8, 1918, petitioner purchased 10 shares of the common capital stock of the Victor Co. for $4,003 and, on February 21, 1922, she purchased 10 additional shares for $5,090. Those 20 shares were purchased pursuant to the terms of an employees’ agreement which provided, briefly, that certain trustees, named by the Victor Co., agreed to sell and petitioner agreed to buy the stock at 70 percent of the then book value thereof, to be paid for within five years and the unpaid balance to bear interest at 3 percent per annum. The agreement further provided that petitioner should hold title to such stock only while employed by the Victor Co.; that she should not sell or dispose of her interest in the stock without first giving the trustees 60 days notice in writing, during which time the trustees could repurchase the stock at 70 percent of its then book value; and that if the trustees elected not to repurchase the stock they should endorse it as being free from all conditions and restrictions. When the stock was fully paid for the certificates issued to the employee bore an endorsement setting forth such conditions and restrictions as to the sale thereof.

In November 1922, the Victor Co. declared a stock dividend of six shares of common stock for each share of the same class of stock then outstanding. Petitioner received thereby 120 additional shares of common stock subject to this restriction as to sale. The original certificates remained outstanding and as a result petitioner then owned 140 shares of common stock which had cost her $9,093.

On January 29, 1927, the Victor Co., in exchange for such 140 shares of common stock, issued to petitioner, subject to the same restrictions as to sale, 231 shares of common stock, 84 shares of 7 percent preferred stock and 49 shares of 6 percent convertible preferred stock.

In 1926 some of the employees of tbe Victor Co. petitioned the trustees to either repurchase their stock or remove the restrictions thereon. At various times up to September 1927, the trustees repurchased a total of 1,755 shares on the basis of 70 percent of the then book value, which was $154.04 per share for the common stock prior to January 29, 1927, and subsequent to that date, $38.40 per share of common, $98.40 per share for prior preferred and $90.40 per share for convertible preferred.

On December 23, 1927, the Victor Co. removed the restrictions on the stock acquired and then owned by its employees under the aforementioned agreement by retiring and canceling the old certificates and issuing therefor new certificates for the same number and kind of shares free of all restrictions. On that date petitioner received new certificates, free of all restrictions, for 231 shares of common, 84 shares of 7 percent prior preferred and 49 shares of 6 percent convertible preferred. On March 30, 1928, petitioner converted the said 49 shares of convertible preferred stock to 98 shares of common stock.

Due to the above mentioned stock dividend, exchange and conversion, the petitioner’s original 20 shares of common stock, purchased at a cost of $9,093 under an employees’ agreement, resulted in her ownership of 329 shares of common stock and 84 shares of 7 percent prior preferred stock free of all restrictions as to sales.

During the years 1923, 1924, and 1926, petitioner purchased on the open market 60 shares of Victor Co. common stock, free of all restrictions, at a total cost of $7,812.50.

On January 29,1927, the Victor Co., in exchange for such 60 shares of common stock, issued to petitioner 99 shares of common, 36 shares of 7 percent prior preferred and 21 shares of 6 percent convertible preferred. On March 30, 1928, petitioner converted the 21 shares of convertible preferred stock into 42 shares of common stock. As a result of petitioner’s purchase of 60 shares of common stock in the open market and the exchange and conversion, she owned 141 shares of common and 36 shares of 7 percent prior preferred, at a cost of $7,812.50.

The fair market values per share of the three classes of the Victor Co. stock were the following amounts on the following dates:

Petitioner made the following sales of Victor Co. common stock and received therefor the following amounts:

Petitioner did not sell or otherwise dispose of her 120 shares of 7 percent prior preferred stock during 1928.

On January 29, 1927, petitioner owned 200 shares of Victor Co. common stock which she had acquired at a total cost of $16,905.50, such 200 shares including the 60 shares purchased on the open market, the 20 shares purchased under the employees’ agreement, and the 120 shares acquired by the stock dividend of November 1922. On January 29, 1927, when the Victor Co., in exchange for such 200 shares of common stock, issued to petitioner 330 shares of common, 120 shares of 7 percent prior preferred and 70 shares of 6 percent convertible preferred, did she realize taxable gain which must be added to the original cost in determining the basis for computing gain on the sale in 1928? Our first consideration is the status under the pertinent taxing act of the transaction of January 29, 1927, by ivhich petitioner received certain shares of two classes of preferred and new common stock for old common stock in the Victor Talking Machine Co.

Petitioner directs our attention to Tillotson Mfg. Co., 27 B.T.A. 913. There, a corporation, having both preferred and common capital stock, used unissued common stock in payment of a then declared accumulated dividend on preferred stock — some of the preferred stockholders receiving cash in lieu of such common stock. We held this distribution not a stock dividend because it “ was not a proportional redistribution of existing or inchoate rights. There was a substantial change in the stockholders’ interests not only of this petitioner but of all other stockholders.” But in Pearl B. Brown, Executrix, 26 B.T.A. 901, where, in increasing corporate capitalization, then consisting of common stock alone, preferred and an increased amount of common stock was issued and distributed to the old stockholders in exchange for and in the same proportion as the old stock was held, we decided, in construing section 201 (f) of the Revenue Act of 1926, which is the applicable statutory provision here, that such distribution was a stock dividend since it was “ a proportionate distribution among existing shareholders of new certificates reflecting their unchanged interests in the corporation— a mere proliferation of existing interests.”

Consistent with the rule there announced, within which the present facts fall, so far as the record discloses, the respondent here determined the pending deficiency upon the basis that the disputed distribution resulted in no recognized income and therefore no increase in the basis for determination of gain or loss in the later disposition of the stock so received. Petitioner has failed to show any facts contradicting the existence of the basis of fact upon which this determination was made. She has not shown affirmatively that this stock distribution was not “ a proportionate distribution among existing shareholders of new certificates reflecting their unchanged interest in the corporation, a mere proliferation of existing interests.” Accordingly, upon the authority of the Brown case, supra, we sustain the respondent on this issue and hold that petitioner received thereby a stock dividend, which neither constitutionally, Eisner v. Macomber, 252 U.S. 189, nor by statute, section 201 (f) of the Revenue Act of 1926, supra, is subject to income tax.

Petitioner’s further contention on this point that such an exchange of stock for stock is not within section 203 (b) (2) of the same act is aptly and properly answered by our decision in the Brown case just cited. We there said:

It is not necessary to analyze the statute to determine whether the 1922 issue involved an exchange of property in reorganization, for this could not he definitely determined in this proceeding. Since reorganization is defined to include recapitalization, it is possible that the statutory provisions literally overlap; but this construction would probably be avoided in resolution of the apparent confusion thus created. For a stock dividend is constitutionally free from tax, and there would be much to consider before applying the exchange provisions to its substantial equivalent, either to tax it thereby or to find it doubly free.

In determining the gain or loss upon subsequent disposition of the stock, the original cost of the common stock owned immediately prior to January 29, 1927, must be allocated between the three classes of stock received on that date upon the basis of that proportion which the fair market value of each class bears to the total fair market value of all three classes on that date, Glenn H. Curtiss, 21 B.T.A. 629; affd., 57 Fed. (2d) 847; Edward Stephen Harkness, 21 B.T.A. 1068; Clifford Hemphill, 25 B.T.A. 1351; Theodore W. Case et al., Trustees, 26 B.T.A. 1044, as follows:

8,778 21,420 of ¡¡!0,093=cost apportioned to 231 shares of common.
8,232 21, 420 of $9,093=cost apportioned to 84 shares of 7% prior preferred.
4,410 21, 420 of $9,093=cost apportioned to 49 shares of 6% convertible preferred later converted to 98 shares of common.
of $7,S12.50=cost apportioned to 99 shares of common.
I’ jjjj of $7,812.50=eost apportioned to 36 shares of 7% prior preferred.
q of $7,812.50=cost apportioned to 21 shares of 6% convertible pro- “ ferret! later converted to 42 shares of common.

The remaining issue in the inquiry is whether on December 23, 1927, the petitioner realized taxable gain as a result of the Victor Co.’s removal of the restriction as to sale of the stock acquired under the employees’ agreement and the stock dividends thereon. Petitioner urges that the removal of the restriction resulted in taxable gain to the extent of the difference between 70 percent-of the book value of such stock and its fair market value on that date and, further, that such gain must be added to the prior cost basis of each class of stock in determining the gain realized upon the sales consummated in 1928.

Petitioner argues that since the employee of a corporation may realize taxable gain by receipt of a distribution of stock in its entirety, Rodrigues v. Edwards, 40 Fed. (2d) 408, or by the exercise of a valuable option similarly received, Albert Russel Erskine, 26 B.T.A. 147, it is not only logical but necessary to prevent a ready means of tax avoidance that the doctrine be extended to the receipt of a cancellation of a contractual right, as is present here.

There are several compelling reasons why this contention can not prevail. The premise upon which it rests is the presence of consideration, in the form of compensation for the rendition of past or future services, in the contract by the execution of which the stock, valuable exercised rights or the cancellation were received. Cf. Rodrigues v. Edwards, supra; Albert Russel Erskine, supra. The present record discloses no such factual basis.

There may be no doubt that the removal of the restrictions, effected by the exchange, was beneficial to the holders of the restricted stock. Similarly, it may be assumed the company received benefit therefrom. In any event there is nothing in the record before us establishing the existence of consideration in the form of compensation for past or future services or otherwise except the respective stocks involved, for the disputed exchange. Mutual benefit resulting therefrom is not alone sufficient upon which, to find a consideration. Gardner-Governor Co., 27 B.T.A. 1171.

The contractual right which was voluntarily canceled by this exchange of stock was no more than a mere option or right to repurchase at a specified price, reserved by the company through its trustees. Neither a sale by the employees nor a purchase by the company was compulsory.

There is nothing apparent in the record before us upon which a market value of this unexecuted option or right can be fixed. Reg. 69, art 39, approved in Kirkland v. Burnet, 57 Fed. (2d) 608; Philip D. C. Ball, 27 B.T.A. 388, and cases cited therein. But even if there were, since the unexecuted option would not be taxable income in the hands of the Victor Talking Machine Co., conversely, no taxable income and therefore no gain or consequent increase in basis for determination of gain upon a later disposition of the stock received in such exchange could result to petitioner by the receipt of its cancellation. Cf. Miles v. Safe Deposit & Trust Co. of Baltimore, 259 U.S. 247; T. I. Hare Powel, 27 B.T.A. 55. We conclude that the exchange of December 23, 1927, by which the petitioner received common and two classes of preferred stock without restriction thereon as to its disposition for an equal number of the respective classes of such stock so restricted, is within the provisions of section 203 (b) (1) of the Eevenue Act of 1926.

It follows that the basis for determining the gain realized upon the sale of 470 shares of Victor Co. stock in 1928, is that appearing at the conclusion of our discussion of the first issue.

Judgment will l>e entered wider Bule 50.

         Sec. 201 (f). A stock dividend shall not be subject to fax.

       Sec. 203 (b) (2). No gain or loss shall be recognized if stock or securitiies in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

       Sue. 203 (b) (1). No gain or loss shall be recognized * * * if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.