author: TtteneR: DisNet,

text:
    T. W. Lee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Helen Lee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95020, 95021.
    Promulgated November 15, 1940.

      Harry C. Weeks, Esq., and R. B. Common, Esq., for tbe petitioners.

      James H. Yeatman, Esq., for the respondent.
   OPINION.

TtteneR:

In his determination of the deficiencies the respondent included in gross income the full amount of collections under the ten oil payment contracts and allowed deductions for depletion with respect to each as shown in our findings of fact. The petitioners have alleged that the respondent erred in his inclusion in gross income of the full amounts collected, claiming that they are entitled to recoup the costs of their oil payment contracts before the amounts received are to be included in gross income. The respondent denies that he erred as petitioners allege, and further, by affirmative allegations, claims that he was in error with respect to the allowance of depletion deductions. By the second amended answer, which is the final answer herein, he admits that petitioners are entitled to depletion allowances with respect to oil payments Nos. 1, 6, 9, and 10, bat alleges that it was error to allow similar deductions with respect to the six remaining payments.

The stated purpose for the motion for leave to file the second amended answer was to request application of our decision in F. H. E. Oil Co., 41 B. T. A. 130, which had been promulgated subsequent to the hearing in these proceedings but prior to .the filing of the briefs. In his brief filed at the time of filing the second amended answer, the respondent took the position that, while oil payments 1, 6, 9, and 10 represented an economic interest in the oil in place, Thomas v. Perkins, 301 U. S. 655, and by reason thereof petitioners were entitled to depletion with respect to those payments, the six remaining payments did not represent any interest in the oil in place because of the lack of formal words of assignment of such an interest, F. H. E. Oil Co., supra, and with respect to the said remaining oil payments petitioners were not therefore entitled to any allowance for depletion.

The substance of petitioners’ argument seems to be that there is no sound basis for distinguishing between an oil payment contract where the agreement is to pay a specified amount out of oil, if, as, and when produced, and another oil payment contract where there are apt words of assignment or conveyance of oil to be produced until the amount specified has been paid; that the interest under each of the above types of oil payment contracts is a depletable interest; that the decisions dealing with the recoupment of cost and the allowance for depletion are contradictory and confusing, Commissioner v. Laird, 91 Fed. (2d) 498; F. H. E. Oil Co., supra; Cook Drilling Co., 38 B. T. A. 291; Edwards Drilling Co., 35 B. T. A. 341; Willis R. Dearing, 36 B. T. A. 843; affd., 102 Fed. (2d) 91; and Rocky Mountain Development Co., 38 B. T. A. 1303, and that the Board in these proceedings should reconsider the questions presented and “eliminate” the confusion by holding that under the oil payment contracts here involved the petitioners are entitled both to recoupment of cost out of collections and thereafter to depletion.

The respondent has now filed a supplemental brief stating that subsequent to the filing of his original brief the Supreme Court has decided the case of Anderson v. Helvering, 310 U. S. 404, which in his opinion negatives the distinction made in F. H. E. Oil Co., supra, between an oil payment contract containing a formal assignment of an interest in oil to be produced until a specified amount is paid and one containing no such formal assignment but requiring the payment of a specified amount out of oil if, as, and when produced, and necessitates the conclusion that all such contracts, whether containing formal words of assignment or not, represent an economic interest in the oil in place. Taking that view of the Court’s decision, the respondent concludes that oil payment contracts 2, 3, 4, 5, T, and 8, as well as contracts 1, 6, 9, and 10, represent economic interests in the oil to be produced and that petitioners are entitled to an allowance for depletion with respect to the production under each of the contracts, but they must look to depletion for the recovery of their cost or other basis for each such contract and may not recoup cost out of the proceeds of production and report in gross income only the excess of such proceeds over cost, as petitioners contend they are entitled to do.

Accordingly we have a situation where both parties argue that the distinction drawn by the Board in F. E. E. Oil Co., supra, is without merit and that the owner of an oil payment contract is the owner of an economic interest in the oil to be produced where the agreement is to pay a specified sum out of the proceeds of oil, if, as, and when produced, regardless of whether the contract contains a formal assignment of such, an interest. If the question of depletion were the only matter in issue, we might be justified in concluding our discussion at this point, since the respondent by the argument just stated concedes that the petitioners are entitled to a depletion allowance with respect to each of the ten oil payments, but, even so, we still have for determination the question as to the proper method of recovering the cost of the oil payment contracts, and as to that question we have no concession by either party. Furthermore as our decisions now stand, determination of the method by which the cost of oil payment contracts must be recovered turns on the distinction heretofore drawn between the two types of oil payments which the parties here argue is without merit. F. H. E. Oil Co., supra; Cook Drilling Co., supra; and Willis R. Dearing, supra. We must therefore either consider the question as to whether the oil payment contracts herein may properly be classified as evidencing ownership of economic interests in the oil in place, as the parties claim, or must ignore or overrule certain of our decisions merely because the parties here are in agreement that the distinction we have drawn between' the two types of contracts is without merit. The latter we may not do.

With respect to contracts 1, 6, 9, and 10, the petitioners had been the owners of oil and gas leases represented by a seven-eighths working interest and had assigned such interests to others for stipulated considerations and in' addition had retained the right to receive other specified amounts from a fractional part of the oil, if, as, and when produced. There was no personal obligation on the part of the assignees to make the further payments to petitioners, such further payments being wholly dependent upon the production of oil. We think it clear, under the doctrine of Thomas v. Perkins, supra, that the interests of petitioners in contracts 1, 6, 9, and 10 were interests in the oil in place and the parties are correct in so concluding.

With respect to contracts 2, 3, 4, 5, 7, and 8, the parties have proceeded on the assumption that, while they did represent obligations on the part of the assignors to pay specified amounts out of the proceeds of oil from certain wells, if, as, and when produced, there was no assignment or conveyance of the oil in place within the meaning of F. H. E. Oil Co., supra, and, if the distinction drawn in F. H. E. Oil Co., sufra, is sound, it would follow from the application of that case that the petitioners would be entitled to recover cost out of the proceeds of production before being required to report any of the amounts collected as gross income. Contracts 3, 7, and 8 were acquired by petitioners in consideration for the drilling of oil wells for other parties, while contracts 2, 4, and 5 were acquired by purchase. Examination of contracts 2, 3, 4, 7, and 8 convinces us that even under the test laid down in F. H. E. Oil Co., supra, they did represent the assignment of economic interests in the oil to be produced. Contracts 2, 3, and 8 made provision for the reversion of tbe interests ont of which the specified amounts were to be paid. In contract 7, E. M. Bramlette, receiver, was party of the first part and petitioner T. W. Lee was one of the parties of the second part. The contract provided that “after the payment of said consideration said interest ont of which said payment is made shall be the property of and run in the name of the Receiver.” In contract 4 it is recited that the parties from whom the petitioners acquired their interest were “the present owners and holders of all those said mineral rights, hereinafter described, to wit: the last seventeen thousand seven hundred dollars, ($17,700.00), out of twenty thousand dollars, ($20,-000.00), to be paid out of one fourth (½) of seven eighths (⅞) of the first oil produced, saved and sold from” the described property. The contract then recited the sale to petitioner T. W. Lee of one-half of “the hereinbefore described oil payment and property rights, to have and to hold the same unto the said assignees named, their heirs and assigns, forever.” There would have been no occasion for the insertion of the reversion clauses in contracts 2, 3, and 8 or the vesting-clause upon completion of the payment under contract 7 if there had been no assignment of interest in the oil to be produced, and as to contract 4 we think there can be no doubt from the language quoted that an assignment of an interest in oil in place was intended and made. We accordingly conclude that under contracts 2, 3, 4, 7, and 8 the interests of petitioners were economic interests in the oil in place and not merely contractual or personal rights against the obligor.

With respect to contract 5, however, we are unable to conclude on the record before us that there was an assignment of an interest in the oil in place within the meaning of F. H. E. Oil Co., supra, and it becomes necessary therefore to consider the present contention of the respondent that under the reasoning of the Supreme Court in Anderson v. Helvering, supra, an agreement to pay a specified amount out of oil, if, as, and when produced evidences an interest in oil in place and not a mere money obligation, regardless of the absence of formal words of assignment of such an interest.

In Anderson v. Helvering, supra, the owners of certain royalty in terests, fee interests, and deferred oil payments in certain properties conveyed the said properties and interests to a second party for the agreed consideration of $160,000, payable $50,000 in cash and $110,-000 from one-half of the proceeds from the sales of oil and gas from such properties and from the sale of the land so conveyed until the said $110,000 had been paid with interest. It was further provided that the sellers, as security for the payment of the said amount of $110,000, should have a first lien against one-half of all oil and gas produced and against the fee interest. The question for decision was whether the income from the subsequent production of oil to the extent of one-half was the income of the purchaser or that of the sellers. The issue as stated by the Court was as to who had- a capital investment in the oil and gas in place and the extent of that interest. Pointing out that the reservation of the lien on the fee was in the nature of a guarantee that the payments should in all events equal the specified sum, regardless of the production of oil, the Court held that the sellers had not reserved an interest in the oil in place, as was true in Thomas v. Perkins, supra, and that the income from the production of oil was the income of the purchaser and not the income of the sellers. Distinguishing the two cases, the Court said:

Thomas v. Perkins, 301 U. S. 655 [supra], relied upon by petitioners, presented the issue whether the right to oil payments — -that is, the right to a specified sum of money, payable out a specified percentage of the oil, or the proceeds received from the sale of such oil, if, as and when produced — should be treated for tax purposes like the right to oil royalties or like the right to cash payments upon a sale. In that ease, the assignment of lease provided for payments in oil only without the reservation of a royalty interest. The question was whether the assignees’ gross income should include moneys paid to the assignors by purchasers of the oil. We stated (p. 659) : “The granting clause in the assignment would be sufficient, if standing alone, to transfer all the oil to the assignees. It does not specifically except or exclude any part of the oil. But it is qualified by other parts of the instrument. The provisions for payment to assignors in oil only, the absence of any obligation of the assignee to pay in oil or in money, and the failure of assignors to take any security by way of lien or otherwise unmistakably show that they intended to withhold from the operation of the grant one-fourth of the oil to be produced and saved up to an amount sufficient when sold to yield $395,000.” Under these circumstances, the moneys received by the assignors from the sale of the oil were deemed not to be income to the assignees. See also Palmer v. Bender, 287 U. S. 551.
The holder of an oil payment right, as an original proposition, might be regarded as having no capital investment in the oil and gas in place. The value of the right, even though dependent upon the extent of the oil reserves, is fixed at the moment of creation and does not vary directly with the severance of the mineral from the soil. In this sense it resembles the right to cash payments more closely than the right to royalty payments. Yet it does depend upon the production of oil, ordinarily can be realized upon only over a period of years, and permits of a simple and convenient allocation between lessor and lessee of both the gross income derived from production and the allowance for depletion. Compare Burnet v. Harmel, 287 U. S. 103, 106-107. Accordingly, this Court in Thomas v. Perkins decided that the provision in the lease for payments solely out of oil production should be regarded as a reservation from the granting clause of an amount of oil sufficient to make the agreed payments and should be given the same tax consequences as a provision for oil royalties. The decision did not turn upon the particular instrument involved, or upon the formalities of the conveyancer’s art, but rested upon the practical consequences of the provision for payments of that type. See Palmer v. Bender, 287 U. S. 551, 555-557; Burnet v. Harmel, 287 U. S. 103, 111.
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'* * * The economic consequences of the transaction are not materially affected by the circumstance that the provision for oil payments is not phrased in terms of a reservation from the conveyance to Oklahoma Company of an interest in the oil and gas in place. And the fact that the payments to Oklahoma Company are in cash rather than directly in oil is of no moment in determining the issues presented for decision. * * *

It seems clear from this language that the Supreme Court regards any oil payment right (a right to a specified sum of money payable only out of a specified percentage of oil or the proceeds received from the sale of such oil, if, and when produced) as an economic interest in oil in place, the holder thereof being the owner of the share of gross income from production represented by the payments to him and being entitled to the attending depletion allowance. Under the Court’s explanation of the Perkins decision, it would seem that the proceeds received on an oil payment contract should be treated the same as proceeds received on oil royalties, provided, of course, the contract did not by reason of additional security guaranteeing payment of the sum specified represent merely a money obligation. The Court said that the decision in Thomas v. Perkins, supra, “did not turn upon the particular instrument involved, or upon the formalities of the conveyancer’s art, but rested upon the practical consequences of the provision for payments of that type.” It then referred to the “economic consequences” of the transaction and said that they were not materially affected by the circumstance that the provision for oil payments was not “phrased in terms of a reservation from the conveyance” of an interest in the oil and gas in place. Furthermore, there is nothing whatever in the language of the Court to indicate that any importance should be attached to the manner of acquisition. The Court was obviously more interested in the “practical consequences” of the contract or the “economic consequences” of the transaction, and we do not think it would make any difference whether the holder of the oil payment right reserved it when assigning a lease, acquired it by purchase, or- received it as payment for drilling and equipping a well. As a practical matter the “economic consequences” of the transaction, or the holder’s rights as provided for in the contract, should be the determining factors. In that connection, see also the pronouncements by the Supreme Court in Palmer v. Bender, 287 U. S. 551.

In the instant case the receipt of the amounts prescribed, or any part thereof, was wholly dependent upon the existence of oil reserves and production therefrom. The specified amounts were payable solely out of oil production and any personal or contractual obligation to make such payments was wholly contingent and no different from that of parties required to make payments in respect of reserved oil royalties. The “practical consequences” of the provisions for oil payments were exactly the same in each and every one of the ten oil payment contracts here under consideration, and in the light of what the Supreme Court has said in Anderson v. Helvering, it is our conclusion that the interests of the petitioners therein were economic interests in the oil in place and the respondent, having correctly assumed that the petitioners’ interests were interests in the oil in place, has properly conceded that they are entitled to an allowance for depletion with respect to the production therefrom. Palmer v. Bender, supra. To the extent that Cook Drilling Co., supra, F. H. E. Oil Co., supra, and other cases applying the rule pronounced in those cases are contrary to the conclusion just reached they will no longer be followed. For cases in which the interests involved were not interests in the oil in place, see Helvering v. Bankline Oil Co., 303 U. S. 362; Helvering v. O'Donnell, 303 U. S. 370; and Helvering v. Elbe Oil Land Development Co., 303 U. S. 372.

Having concluded that the interest of the petitioners under each of the oil payment contracts was an interest in the oil in place, we also conclude that they must look to depletion for the recovery of their cost and may not recoup cost out of production before being required to report any of the proceeds as gross income. Palmer v. Bender, supra; Willis R. Dearing, supra; F. H. E. Oil Co., supra; and Vinton Petroleum Co. v. Commissioner, 71 Fed. (2d) 420. See also Columbia Oil & Gas Co., 41 B. T. A. 38; Charles Pettit, 41 B. T. A. 264; and Heep Oil Corporation v. United States (Court of Claims), 32 Fed. Supp. 762. The petitioners have referred us to no provision in the statute which in the absence of sale or failure of production supports any right to recoup the cost of an interest in oil in place other than through depletion, and we do not have here any question involving the application of the regulation which on election permits the deduction of intangible drilling costs as expenses. The most we are able to make of petitioners’ argument is that the denial of such recoupment of cost out of the proceeds of production is contrary to the holding in Commissioner v. Laird, supra, and an unpublished opinion of the Board. Even if we assume that the decisions mentioned stand for the proposition for which petitioners contend, we can not overlook the fact that the question has since been considered in numerous cases and a conclusion contrary to that which the petitioners seek has been reached. One such case, Willis R. Dearing, supra, was affirmed by the same court that previously had decided Commissioner v. Laird, and it took no notice of the Laird, decision. Furthermore, the logic of the situation offers no basis for the allowance of petitioners’ claim. The allowance of depletion, as the court in the Dearing case pointed out, is to- permit the recovery of cost or capital investment where the interest in the oil in place is not sold or exchanged but is exhausted or depleted through production, and to allow the recoupment of cost out of the proceeds of oil produced as well as depletion would to the extent allowed be comparable to the allowance of a double deduction, which, in the absence of plain and clear language to that effect by Congress, may not be done.

The petitioners also claim that certain of the oil payment contracts dealt with in Rocky Mountain Development Co., supra, and Edwards Drilling Co., supra, represented interests in the oil in place even under the test of F. H. E. Oil Co., supra, and that recoupment of cost without respect to depletion was permitted in both cases. Even if petitioners are correct in their interpretation of the facts in those cases, namely, that certain of the contracts did contain formal assignments of interests in oil in place, that fact can be of little comfort to them here. It would merely indicate that the Board incorrectly concluded that the petitioners did not have an interest or capital investment in the oil in place and not that, having such an interest, they are entitled to recoup cost out of production before being required to report any of the proceeds in gross income.

From the above, we hold that the interests under the contracts herein are interests in the oil in place, and that, being so, the petitioners are properly required to look to depletion for the recovery of their cost of such interests, and may not recoup cost out of production before being required to report any part of the proceeds in gross income.

One other issue, relating to the treatment of intangible drilling and development costs for the purpose of applying the limitation on percentage depletion, was abandoned at the hearing.

Eeviewed by the Board.

Decision will he entered under Rule 50.

DisNet,

dissenting: I agree with the majority opinion that the assignments as to wells Nos. 1, 6, 9, and 10 convey such economic interest as to cause application of depletion principles. Those instances are obviously covered by Thomas v. Perkins, 301 U. S. 655, because in that case the owner of a depletable interest retained, in his assignment, a portion thereof. I am impelled, however, to dissent, in so far as concerns the remainder of the “oil payments” involved. They are not all of precisely the same character. Contracts Nos. 3, 7, and 8 were received in consideration of drilling done, while contracts Nos. 2,4, and 5 were purchased. The majority opinion is in error, it seems to me, in concluding that there was any conveyance of more than a right to receive money in contracts Nos. 2, 3, 4, 5, 7, and 8. Contract No. 2 plainly assigns “the sum of Twenty Seven Hundred ($2700.00) Dollars”; contract No. 3 assigns “the sum of Thirty Five Thousand ($35000.00) Dollars”; contract No. 4, after reciting that the transferor is the owner of “the last seventeen thousand seven hundred dollars, ($17,700.00), out of twenty thousand dollars, ($20,000.00)”, assigns “all of the herein above described property”; contract No. 7 provides that the transferee shall receive for drilling, etc., “the sum of Thirty Two Thousand Five Hundred ($32,500.00) Dollars”; and contract No. 8 provides that the transferee shall receive for drilling, etc., “the sum of ThiRtt Five TiiousaNd ($35000.00) Dollars.” Each of the above contracts, of course, provides in addition that the money shall be paid out of oil produced “until” the sum named is received, with the exceptions of Nos. 4 and 7, which merely convey the right to receive the money out of a specified interest in the first oil produced. In the case of contract No. 5, the majority opinion is unable to find an assignment of an interest in the oil in place. There the assignment is merely of an undivided one-third interest in an oil payment to be paid out of a certain interest in the first oil produced.

I am unable to find in any of these instances a conveyance of the oil in place or connected with a transfer of any interest in the lease or fee. I therefore do not believe that a depletable interest was conveyed. Reliance is placed by the majority opinion upon Palmer v. Bender, 287 U. S. 551; Thomas v. Perkins, supra, which cites Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312; and Anderson v. Helvering, 310 U. S. 404. In each of those cases there was considered the question of an assignment, or reservation, of mineral rights by one who owned an undoubtedly depletable interest. In Palmer v. Bender, the transferor owned oil and gas leases. In Thomas v. Perkins, the same is true. In Helvering v. Twin Bell Oil Syndicate, the taxpayer was the assignee of a lease and obligated to pay royalties of one-fourth of the oil. The Court held that its depletable interest did not include the royalties. In Anderson v. Helvering, the transferor owned royalty interests, fee interests, and deferred oil payments, all of which it conveyed “without reservation” and under a contract “to sell all of its right, title and interest of whatsoever nature”, the transferee to pay partly in cash and partly from proceeds from oil and gas produced from the properties and from the sale of fee title to land conveyed. It was there held that no depletable interest was retained by the transferor. The decision is placed upon the ground that in addition to a reservation of rights against oil or gas to be produced, there was a reservation of an interest in or a lien upon the fee.

It thus appears that none of the above authorities involved a situation analogous to that involved herein in contracts Nos. 2, 3,4, 5,7, and 8. Except for the Anderson case, the above authorities are, in fact, a pronouncement of the same idea — that the transferor, owner of the de-pletable interest, did not intend to convey, and was therefore held not to convey, such depletable interest, to a certain degree. The matter turns on the original ownership of the depletable interest and intent of the parties as to conveying same, the contract in each case being ex-a mined for such, intent. Where one owns a depletable interest in oil and gas in connection with ownership of a fee or lease, it is easy logic to deduce that in a conveyance providing that be should be paid out of such oil and gas, he to that extent did not intend to convey and did not convey such oil and gas. But it seems to me that such cases offer no analogy or authority in situations such as here presented, where the assignee receives a right which is plainly and primarily that of collecting money. In terms, in most of the instances here involved and applied, his connection with the oil and gas under the land is to last only until he is paid. His right would clearly, I think, in case of a contest between the holders of different interests, such as lien holders, secured creditors, etc., in a bankruptcy proceeding, be held to be only by way of security for the payment of his money and not to possess the dignity of any greater interest. A lien or mortgage does not, I take it, confer a depletable economic interest upon the holder thereof. In such cases and in the cases here involved the extraction of oil does not, in fact, affect the right of the holder of the “oil payment” proportionately with the extraction. The holder of a $10,000 “oil payment”, for example, has a right to recover the entire amount thereof and that right remains even though, for example, a million barrels of oil has been taken from the ground. The owner of the fee or lease has had his rights depleted by such million barrels of oil, yet the owner of the $10,000 oil payment, if for any reason he has failed to secure payment, still has the right to receive the entire $10,000 — so long as the well produces. In other words, his rights are cut off, not by extraction or “depletion”, but by the end of production from the well or tract of land. Obviously, the actual decrease in production does not affect him in the same manner or to the same extent that it does the owner of the fee or lease. I think, therefore, that he should not be placed in the same position as the owner of such fee or lease, and that as to him a fair and simple workable rule is to allow the collection of the money, which is his right, without taxation, until he has recovered his base.

The majority opinion stresses the language in the Anderson case, and in Palmer v. Bender, to the effect that too much weight should not be attached to the words of conveyance. I do not think it follows from this language in interpreting a reservation in an assignment made by the holder of a depletable interest that an assignee, such as those herein involved, should be held to have received a depletable interest without some actual conveyance of an interest in the oil itself which will actually be diminished or depleted by extraction of oil, in the same manner as that of the holder of the fee or lease. Depletion is intended to prevent taxation of capital. Indeed the Anderson case is ample authority that the form of conveyance must have attention and may serve to affirm or deny tbe passage of a depletable interest, for tbe Court assigns, as its particular reason for holding that a depletable interest passed, tbe fact that in addition to language which might not have passed a depletable interest under Thomas v. Perkins, supra, the instruments also provided for a lien upon and right to payment from proceeds of the fee estate. It thus appears that, in the consideration of this question of the passage of a depletable interest, the intent of the parties is to be gathered from the language used, and all of it. When this is done, I find no facts in the above citations from the Supreme Court of the United States parallel to the situation here presented sufficient to indicate that the holder of a right to receive, not oil subject to uncertainty of production, but a certain amount of money, but with payment limited from oil or gas produced, suffers the same actual depletion as does the holder of a fee or lease, or to indicate that in such cases depletion offers a simpler or more workable rule than the application of the money payments received against the base.


source: Caselaw Access Project

author: Hill : MuRdocK,

license: Public Domain

text:
    E. F. Blaise, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98294.
    Promulgated November 15, 1940.

      Claris G. Clinton, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) Gbnekal Rule. — In the ease of a taxpayer, other than a corporation, only the following percentages of gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
      *******
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      *******
      30 per centum if the capital asset has been held for more than 10 years.

   OPINION.

Hill :

The question in this case is whether petitioner is entitled to deduct from gross income for the taxable year 1935 only 30 percent of the loss sustained by him upon liquidation of 50 shares of the capital stock of H. T. Lockwood, Inc., a California corporation, as contended by respondent, or whether 80 percent of such loss is an allowable deduction under section 117 (a) of the Revenue Act of 1934, as contended by petitioner.

There is no controversy as to the amount of the loss sustained by petitioner, nor that the shares of stock constituted a capital asset within the meaning of the statute. The sole issue relates to the period or length of time the stock was “held” by petitioner prior to its liquidation in 1935. If it was held by petitioner for more than 1 year but not more than 2 years, he is admittedly entitled to deduct 80 percent of his loss. If the stock was held by petitioner for more than 10 years, he is concededly entitled to deduct only 30 percent of his loss.

The word “held” as used in the statute is synonymous with “owned.” In McFeely v. Commissioner, 296 U. S. 102, the Court said:

In common understanding to liold property is to own it. In order to own or hold one must acquire. The date of acquisition, then, is that from which to compute the duration of ownership or the length of holding.

See also Alvin Mercer Parker et al., Executors, 35 B. T. A. 609, 613; Arthur E. Otto, 37 B. T. A. 479, 482; Harvey S. Strassburger, 37 B. T. A. 881, 889.

In order, therefore, to determine how long the stock in controversy here was held by petitioner prior to 1935, we must ascertain the date of acquisition, or that on which he became the legal owner and holder of the stock. Clearly this question involves a state rule of property, and by such rule, as established under the statutes and decisions of the courts of California, we are bound. Warburton v. White, 176 U. S. 484, 496; Tyler v. United States, 281 U. S. 497; Christine Smith Kendrick et al., Executrices, 34 B. T. A. 1040, 1044. “State law determines the ownership of property subject to its jurisdiction.” Cannon v. Nichols, 80 Fed. (2d) 934, citing Poe v. Seaborn, 282 U. S. 101, and Hoeper v. Tax Commission of Wisconsin, 284 U. S. 206.

Petitioner subscribed and paid for at par 50 shares of the California corporation in 1925, shortly prior to which date the corporation had obtained a permit from the State Cpmmissioner of Corporations authorizing it to sell 500 shares of capital stock to its incorporators. Petitioner was not an incorporator. Section 12 of the Corporate Securities Act of California, in effect, during the year 1925 (Deer-ing’s General Laws of California, 1923, part I, p. 1414) provided as follows:

Securities Void. — Every security issued by any company, without a permit of the commissioner, authorizing the same then in effect, shall be void, and every security issued by any company, with the authorization of the commissioner but not conforming in its provisions to the provisions, if any, which it is required by the permit of the commissioner to contain, shall be void.

The Supreme Court of California, in Regan v. Albin, 26 Pac. (2d) 475, 476, referring to the above statute, said:

The rule that a security issued without a permit or in violation of the terms of a permit, is void under former section 12 of the Corporate Securities Act. has been frequently declared, and must now be taken as well settled in this state. * * * In 1931 (St. 1931, p. 949) a provision making such a security voidable was substituted for the old section * * * but this has no application in the instant case.

The corporation involved in the present case not only was without authority under the corporation commissioner’s permit to issue stock to petitioner in 1925, but the stock was issued in direct violation of the terms of the permit, and was therefore void. The fact that both the corporation and petitioner treated the stock as valid, as evidenced by the payment to petitioner of a 75 percent cash dividend in 1929, did not validate the void stock. In Tatterson v. Kehrlein (Cal.), 263 Pac. 285, it was said:

The doctrines of estoppel by contract and ratification have no application to a contract which is void because it violates an express mandate of the law or the dictates of public policy. Such a contract has no legal existence for any purpose and neither action nor inaction of a party to it can validate it and no conduct of a party to it can be invoked as an estoppel against its invalidity.

See also Regan v. Albin, supra, where the Supreme Court of California held that stockholders were not estopped from claiming invalidity of stock issued in violation of the terms of the permit because they received dividends.

Petitioner did not become a legal owner and holder of the stock of the corporation in 1925 because the stock issued to him in that year was void, and the corporation at all times held the money paid in therefor for the use and benefit of petitioner. Grossman v. Ballman (Cal.) 298 Pac. 829; Regan v. Albin, supra. In the latter case the court held that the defendants, to whom stock had been issued in violation of the terms of the permit, were not liable as stockholders for debts of the corporation. In Cecil B. de Mille Productions, Inc. v. Woolery (C. C. A., 9th Cir.), 61 Fed. (2d) 45, the court declared that an act or contract prior to 1931 violating the California Corporate Securities Act was void, not voidable, and a party not in pari delicto, if entitled to any relief, might have restitution only.

It is respondent’s contention that the period of petitioner’s holding of the stock here in controversy should be computed from the date of issuance in 1925, and that, since petitioner had held the stock for more than ten years prior to the close of the taxable year, he is entitled to deduct only BO percent of the stipulated loss. In support of his argument, respondent cites Angelus Building & Investment Co. v. Commissioner, 57 Fed. (2d) 130, affirming 20 B. T. A. 667; certiorari denied, 286 U. S. 562.

The cited decision, we think, does not rule the present proceeding. There, the controversy was whether or not amounts paid to the holders of “preferred” stock issued in violation of the California statute constituted interest deductible by the corporation which had illegally issued such stock without a permit. The question of legal ownership of the stock was not directly involved, and, since it appeared from the facts that payments were made by the corporation out of profits to all of the stockholders in proportion to shares, it was held, for the purposes of that case, that the amounts claimed as deductions did not constitute interest, but dividends.

What was said in the cited case must be viewed in the light of the facts under consideration. The taxpayer there could not be said to be £⅛ party not in pari delicto”, an essential condition to the application of the rules and doctrines hereinabove referred to. On the contrary, the Angelus Building & Investment Co., in connection with the determination of its tax liability, was seeking to benefit by its own wrongdoing. This point was stressed in the opinions of both the Board and court, the latter saying:

The government in the collection of its revenues tafees no notice of any situation of accountability to a state that the taxpayer may have caused to exist through his own wrongdoing.

The principle stated is not applicable in the instant case. Petitioner was not a party in pari, delicto in causing the stock to be illegally issued in 1925, and hence is not here seeking to benefit from his own wrongdoing. Petitioner was a member of the investing public for whose protection the Corporate Securities Act of California was primarily enacted.

We hold, therefore, that petitioner became the legal owner and holder of the stock here involved on September 15, 1934, and, in accordance with the provisions of section 117 (a), supra, is entitled to deduct from gross income for the taxable year 80 percent of the loss sustained by him.

Beviewed by the Board.

Decision will he entered under Bule 50.

MuRdocK,

dissenting: The petitioner is claiming a deduction for loss which occurred when a corporation in which he had invested was liquidated. Section 115 (c) provides that amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. The Commissioner has determined that the loss was a capital loss under section 117 and limited to 30 per centum, since the asset had been held for more than ten years. A capital asset is defined as property held by the taxpayer. The petitioner made an investment of $5,000 in the.corporation on or before July 20, 1925. He retained that investment until the latter part of 1935, a period of more than ten years. He received during that time a 75 percent cash dividend on the investment, which was taxable to him as a dividend. Angelus Building & Investment Co. v. Commissioner, 57 Fed. (2d) 130, affirming 20 B. T. A. 667; certiorari denied, 286 U. S. 562. Although the original certificates evidencing his investment were illegally issued, nevertheless the group of investors recognized that all were upon the same basis and permission was obtained whereby valid certificates were issued. I think it was the intent of Congress to limit the deduction under such circumstances to 30 percent of the loss. Cf. Lyeth v. Hoey, 305 U. S. 188. The view taken by the majority seems too narrow. It permits no satisfactory answer to the questions of how the dividend of $3,750 was taxable and of how the petitioner would have been taxed had he sold his investment prior to 1934.

AkUndell, SteRNhageN, Mellott, and DisNet agree with this dissent.


author: Mukdock:

text:
    Mortgage Trust Certificate Pool, Berks County Trust Company Alleged Successor Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98207.
    Promulgated November 15, 1940.

      Albert S. Lisenby, Esq., and Stef hen T. Dean, Esq., for the petitioner.

      Brooks Fullerton, Esq., and Charles L. Orpin, Esq., for the respondent.
   OPINION.

Mukdock:

The Commissioner has determined deficiencies for the calendar years 1934 and 1935 and has mailed notice thereof to “Mortgage Trust Certificate Pool, Berks County Trust Company, Successor Trustee, Reading, Pennsylvania.” He has done this upon the theory that there was a “Mortgage Trust Certificate Pool” of Reading which was an association taxable as a corporation separate from Reading during those years. Decision of the question depends upon the facts in this particular case. Although it has not seemed advisable to set forth the various stipulations filed by the parties and the exhibits attached thereto, and although not all of the facts will be mentioned in discussion, nevertheless, all of the facts in the record have been carefully considered.

Reading was one of those national banks which was found to be insolvent and not permitted to open its doors for business after having been closed by the proclamation of the President on March 4, 1933. A conservator was appointed for it on March 18, 1933, and he has been succeeded by receivers. It is still in receivership and will be unable to pay the claims of its depositors in full. Neither the name “Mortgage Trust Certificate Pool” nor any similar name appeared upon the accounts of Reading. The conservator found, however, that 2,043 mortgage trust certificates in the face amount of $1,928,069.73 were outstanding on March 4, 1933, and a number of mortgages and some bonds were listed upon the books of Reading as “Investments securing Mortgage Trust Certificates.” The securities at that time and at all times thereafter were insufficient to pay off in full the face amount of the certificates. The conservator, and later the receiver, decided that those investments should be held and liquidated for the special benefit of the certificate holders. No new certificates were ever issued after the closing of the bank and the only changes made in the investments after that event were those incident to and necessary in the economical liquidation of the securities. A liquidating distribution was made on December 18, 1933, and other distributions of principal and income were made from time to time thereafter by the receiver as funds became available. The administration and liquidation of the assets proceeded during the two taxable years under the conservator and the receiver upon orders or instructions from the Court of Common Pleas of Berks County, Pennsylvania. The certificate holders had no voice in the appointment of the conservator or of the receiver. They had no organization and no books or records. Their interests were not identical. They took no part whatsoever in the management of the securities which the conservator and the receiver had taken over for their benefit. The Commissioner, in determining the deficiencies, included in income the entire amount of income received from the securities during the taxable years. He allowed deductions for expenditures shown upon the books of the conservator and the receiver, including interest, taxes, and some other items. He allowed no deduction for losses in connection with about thirteen foreclosures which took place in 1934.

The alleged association which the Commissioner has taxed as a corporation began in March 1933, when the conservator decided to bold and liquidate certain assets for the benefit of the certificate holders. The receiver of insolvent Reading followed the same policy. Their actions were in some instances directed by the court and in all instances approved by the court. They were acting in a fiduciary capacity for the benefit of the certificate holders. The situation was apparently a receivership, but, whatever it was, it may be regarded as practically the equivalent of a trust for the present purpose of determining whether it was an association taxable as a corporation. The situation bore little, if any, analogy to a corporate organization in form, purpose, or activities. The conservator and the receiver did not intend “to provide a medium for the conduct of a business and sharing its gains.” Cf. Morrissey v. Commissioner, 296 U. S. 344. They never used the assets to carry on any business, but at all times administered them solely for the purpose of liquidation. A liquidating trust is not an association taxable as a corporation. Fidelity National Bank & Trust Co., 37 B. T. A. 473; Frederick Pitzman et al., Trustees, 36 B. T. A. 81; Broadway-Brompton Buildings Liquidation Trust, 34 B. T. A. 1089; Girard Trust Co., Trustee, 34 B. T. A. 1066; Dolese & Shepherd Co., Syndicate No. 3, 30 B. T. A. 1171; Dauphin Deposit & Trust Co., Trustee, 21 B. T. A. 1214; Wilson Syndicate Trust, 14 B. T. A. 508; affd., 39 Fed. (2d) 43. The so-called “Mortgage Trust Certificate Pool” was not an association taxable as a corporation during the years 1934 and 1935.

Both parties have discussed in considerable detail the complete history of the mortgage trust certificates and some discussion herein of that history may not be amiss, although, as has been said above, we are concerned with the situation as it existed during the years 1934 and 1935, after Reading had been closed and when the entire matter was in the hands of the conservator or the receiver of Reading. Reading issued mortgage trust certificates for the first time after its board of directors had adopted a resolution on January 27,1920, authorizing the issuance of such certificates not to exceed $500,000 in amount, bearing interest at 4 percent. The resolution provided, inter alia, that the principal of the certificates would be payable in two years without deduction for expenses or losses incurred in the management of the trust fund. It directed the opening of an account in which should be recorded all receipts of income (including interest, commissions, and profits of every nature from the investments held in trust for the certificate holders), all expenses (including losses), and all changes in the capital account. However, no such account was ever set up on the books of Reading. Reading issued mortgage trust certificates following the adoption of that resolution. They certified that Reading had received a stated amount in trust for the registered owner, which, together with other moneys received by Reading under similar certificates, it field as a trust fund separate and apart from the assets of the bank in trust for the certificate holders and it would keep the same invested in certain securities. Each certificate stated that it was transferable only on the books of the bank and was payable on a certain day, usually about one year from the date of issuance, with interest at the rate of 4½ percent, “without deduction for the State Tax of four (4) mills or any expenses or losses incurred in the management of the Trust Fund.” One hundred and seventy-nine of those certificates in the face amount of $155,270 were still outstanding on March 4, 1933.

The directors of Reading likewise resolved on January 27, 1920, to take over, from the Commercial Trust Co., securities constituting a trust fund for the payment of mortgage trust certificates issued by that company “and Administer the same for the purpose of liquidation.” Those certificates were substantially similar to the ones issued by Reading, except that they provided for interest at 4 percent and contained the further statement that the company guaranteed payment of the principal and interest in full. One hundred and twenty-one of those certificates in the face amount of $32,000 were outstanding on March 4, 1933.

Reading authorized the issuance of an increased amount of certificates in 1923 and in 1924 it began issuing a new form of certificate. Those certificates did not contain the provision in regard to the losses which was contained in the earlier form. The change was apparently made to satisfy the Comptroller of the Currency, who had complained that the old form represented a direct obligation of the bank rather than a mere interest in a collection of investments. The new form stated that Reading had received a specified amount in trust, which, together with other moneys received under similar certificates, it held as a trust fund, as defined or referred to by section 11 (k) of the Federal Reserve Act, separate and apart from the assets of the bank, in trust for the holders of the certificates. It also contained the following statement. “The holder further directs that as compensation, for such services rendered, the trustee hereof shall retain all income in excess of 4½ percent.” The certificate was payable on a day certain usually about one year after the date of issuance. Three hundred and twenty-five of those certificates, having a face value of $253,140, were outstanding on March 4,1933.

Reading purchased the assets and assumed the liabilities of the Reading Liberty Bank on March 17,1925. Some mortgages and other assets securing mortgage participation certificates which had been issued by Liberty were among the properties taken over by Reading. Two of those in the face amount of $3,000 were still outstanding on March 4, 1933. Their form was somewhat different, but since they are relatively unimportant, their differences will not be discussed.

Reading again changed the form of its certificate in January 1927. One change was that the trustee was directed to retain all income in excess of 5 percent. It also provided: “The term of this trust shall expire on the first day of_, 19-and this certificate will be liquidated pro rata from the proceeds of the trust fund as and when collected.” Inserted in the space for a date on each certificate was a date approximately one year after the date upon which the certificate had been issued. One thousand, four hundred and sixteen of those certificates in the face amount of $1,484,659.73 were outstanding on March 4, 1933.

The certificates, 2,043 in number, above described as outstanding on March 4, 1933, were the certificates with which the conservator was concerned and which were outstanding during the two taxable years before the Board. Reading, in handling the five different kinds of certificates, made no distinction between them except for the rate of interest. It did not separately invest and separately account for the outstanding amount of each of the five different types of certificates. Neither did it separately invest or separately account for the outstanding amount of any combination or of all of the different types of certificates. It never purchased any securities as a fiduciary representing any of the certificate holders as beneficial owners. It never maintained any pool of mortgages or investments, the profit or loss and the income of which was accounted for separately as pertaining to any group of certificate holders. It maintained no income or profit and loss records in the name of or on behalf of any pool of securities or group of certificate holders. It filed no income tax returns for any such pool. It did not administer as a separate trust fund the amounts paid in by certificate purchasers.

Reading commingled with its other trust funds the amounts received by it for mortgage trust certificates. It made investments from those commingled funds, some of which it allocated to various trusts of which it was trustee, some of which it sold to customers, some of which it allocated to other so-called mortgage trust pools, and some of which it allocated to “Investments securing Mortgage Trust Certificates.” The latter allocation was merely to guarantee that it would pay to the certificate'holders the principal amount of their certificates and interest at the specified rate up to the date of redemption. The securities were allocated to that account without any distinction whatsoever between the five different types of certificates which were outstanding. Reading purchased all of those securities with its general trust funds and held them in its own name. It took into the income of its trust department, as its own income, all income from those securities, whether by way of interest, commissions, or profit. All interest paid to certificate holders was charged to expense of the trust department as were other expenditures of that department. It regularly paid the interest on the certificates and redeemed them as they were presented for payment by paying out funds from its trust department. The resulting profit or loss of the trust department, along with other profit or loss of that department, was entered in Reading’s general profit and loss account and was included in its income tax returns as its income. Thus, although it allocated certain investments as security for the mortgage trust certificates, it treated those securities as its own property and not as the separate property of any group of certificate holders. It administered those securities and dealt with them as it chose. It made changes in the list as it saw fit. It took all profits from those securities and simply paid the certificate holders principal and interest. When the income from the securities was insufficient to pay the interest on the certificates, Reading made up the difference from its own funds. It never recognized that the certificate holders were entitled to any income or profit from any particular securities and the certificate holders never received any amount in excess of their principal with interest at the specified rate.

Each certificate holder entered into a separate agreement with Reading, paid his money to Reading, and received the agreement of Reading shown on his certificate. The certificate holders did not join with each other in any single or general contract. They had no organization, no officers, no seal, no name, no books or records, no meetings, and no voice in the management of any securities. In fact, there was no property or income from property which could be identified as the property or income of any group of certificate holders. The certificate holders were never consulted or advised by Reading in regard to the management of any securities, the amount of any securities held by Reading, the income from any securities, the amount of certificates issued or to be issued, or in regard to any other matter pertaining to the management or administration of any securities held by Reading. One form of certificate was different from another form. The maturity dates depended upon the date of purchase of the certificate and, therefore, were different on the various certificates.

There is considerable variance between the resolution of January 27, 1920, and the original form of certificate, between one form of certificate and another, and between the provisions of the resolution and those of the certificates, on the one hand, and the actual practice of Reading in administering and accounting for transactions relating to the investments, on the other. Furthermore, there may be some inconsistency in the provisions of the resolution and also in the provisions of the certificates. Reading might have adopted a practice which would have conformed more nearly to its agreements as evidenced by certificates. But such possibilities have no particular significance here. We need not decide whether there would have been an association taxable as a corporation had Reading actually created a separate trust fund for each, or some, group of certificate holders. Likewise, we need not decide whether there was an association taxable as a corporation under the practice which Reading actually followed for over thirteen years. A decision is required only for the circumstances as they actually existed during the taxable years.

The Commissioner argues that the certificate holders pooled their resources in a trust, which was to carry on a business for profit, in order to obtain a wider spread for their investments, centralized management, a continuing body, and limitation of risk. He says the certificates, freely transferable, were like stock certificates and that there was a trust which owned and held assets separate from those of Reading. No good purpose would be served by applying this argument to the situation as it might have been or as it was prior to the time that Reading was closed. The situation after Reading was closed has been discussed already. The Commissioner cites as the case nearest on the facts, and as his only authority in support of his contention that there was an association taxable as a corporation, the case of Fidelity Bankers Trust Co. v. Helvering, 113 Fed. (2d) 14. The opinion in that case is helpful, since it contains an able discussion of the general subject, but it is not controlling here, since the facts in the two cases are so different. The trust in that case was created by a single instrument, a tri-party contract. The subscribers acted jointly in all matters pertaining to the trust. The trust owned its own property and had its own income, within certain limitations. There was an organization with a business name. The trustee had broad powers acting with the approval of the subscribers. It could purchase, sell, lease, rent, and otherwise act in regard to property. The certificates were transferable. It carried on a business. The trust had a definite term. The trust borrowed money. Other differences could be pointed out, but enough has been said to show that the two cases are not much alike. The holding of the court on another point in that case was that money paid by the bank to the certificate holders in accordance with its guarantee of a fixed rate was not income to any intervening organization. However, we need not consider the possible applicability of that part of the opinion io the present controversy.

A study of the entire history of the trust certificates and consideration of the argument and authority cited by the Commissioner casts no doubt upon the reasoning which we used in the beginning of this opinion to reach the conclusion that there was no association taxable as a corporation, at least during the taxable years 1934 and 1935.

Decision will be entered for the petitioner.


author: T /uranTT:

text:
    Blenheim Company, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95026.
    Promulgated November 15, 1940.

      Thomas F. Boyle, Esq., for the petitioner.

      B. M. Brodsky, Esq., for the respondent.
   OPINION.

T /uranTT:

The correctness of both contested deficiencies depends upon whether petitioner has perfected its right to certain asserted deductions. New Colonial Ice Co. v. Helvering, 292 U. S. 435.

The petitioner was a foreign corporation. Section 233 of Title I of the Revenue Act of 1934, controlling here, provides:

A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this title only by filing or causing to be filed with the collector a true and accurate return of its total income received from all sources in the United States, in the manner prescribed in this title; including therein all the information which the Commissioner may deem necessary for the calculation of such deductions and credits.

Was the so-called normal tax return filed by petitioner on Form 1120 a sufficient compliance with section 233 to entitle petitioner to the deductions therein claimed? We think not.

Undoubtedly a taxpayer may litigate a determination of respondent on the basis of a return made by the latter under section 3176 of the Revised Statutes. But, a “return” filed by a taxpayer after such a return has been prepared and filed for him by¡ respondent, under the circumstances existing here, is a nullity and does not comply with section 233, supra. The taxpayer can not thus take advantage from an alleged return submitted by the taxpayer not only after the respondent’s filing of its return under section 3176, but also after the issuance of a notice of deficiency. Taylor Securities, Inc., 40 B. T. A. 696; Sarah Briarly, 29 B. T. A. 256; Joe Goldberg, 14 B. T. A. 465; Theodore R. Plunkett, 41 B. T. A. 700. Cf. Del Mar Addition v. Commissioner, 113 Fed. (2d) 410. The case of Anglo-American Direct Tea Trading Co., Ltd., 38 B. T. A. 711, does not aid petitioner, since it held only that a return filed before the determination of a deficiency was sufficient compliance with section 233. Moreover, in that case, the return filed by the revenue agent was never accepted by the Commissioner, and the taxpayer’s delinquent return was made the subject of an audit by respondent. In the Taylor case, supra, the Board held that these facts distinguished the Anglo-American case.

Was petitioner’s timely personal holding company surtax return on Form 1120 H a compliance with section 233, supra, sufficient to entitle it to the deduction of dividends received from domestic corporations subject to tax, in the computation of its normal tax? We think not.

Respondent did not prepare and file the normal tax return for the petitioner until after a failure of compliance with his repeated requests to the petitioner to file such a return.

Clearly, the normal and surtax here in dispute are separate and distinct taxes. Revenue Act of 1934, Title I, Title I-A; Taylor Securities, Inc., supra. The revenue act undoubtedly contemplates the filing of separate returns for these taxes. Secs, 52, 53, 54, and 351 of the Revenue Act of 1934. Collateral Mortgage & Investment Co., 37 B.T.A. 630; Rotorite Corporation, 40 B. T. A. 1304; Noteman v.Welch, 108 Fed. (2d) 206; Taylor Securities, Inc., supra. That being so, it would seem obvious that our decision on the first question would conclude the petitioner here. Moreover, it seems to us to be the plain in-tendment of section 233 that a normal tax return on Form 1120 is required to be filed in order to secure deductions from income subject to normal tax, especially because the section specifies a “true and accurate return” filed “in the manner prescribed in this title.” .That can relate only to the normal tax return, Form 1120, required by section 53. The personal holding company return, Form 1120 H, does not contain all the information which the Commissioner “deems necessary” for the calculation of deductions and credits in respect of normal tax liability. For instance, there is no requirement in a Form 1120 H return of the schedule “Reconciliation of Net Income and Analysis of Changes in Surplus,” nor is there provision for the schedule “Balance Sheets.” Form 1120 H requires only 14 basic items, while Form 1120 requires approximately 25. Thus, the one return filed by petitioner is insufficient for normal tax purposes, and the sanction provided by section 233 must be applied. Gladstone Co., Ltd., 35 B. T. A. 764.

Did the timely personal holding company surtax return entitle the petitioner to deduct from its income subject to surtax the amount of its capital losses disallowed by section 117 (d) and included, as such, in that return ? We think it did.

It is stipulated that the income set out on the personal holding company surtax return on Form 1120 H was correct and that the correct amount of the “losses from sale or exchange of capital assets (disallowed by section 117 (d) of the Revenue Act of 1934) ” and thus deductible in the computation of the surtax was in an amount exceeding that claimed on the personal holding company surtax return on Form 1120 H. However, despite those facts, respondent contests the deductibility of any amount for such losses. He argues that section 233 applies to the surtax provisions which are contained in the separate Title I-A, by reason of section 351 (c), which reads:

All provisions of law (including penalties) applicable in respect of the taxes imposed by Title I of this Act, shall insofar as not inconsistent with this section, be applicable in respect of the tax imposed by this section, * * *.

His position then is that petitioner has not complied with the provisions ,of section 233, supra, in that the personal holding company .surtax return, on Form 1120 H, was not “a true and accurate return of * * * [petitioner’s] total ineome received from all sources in the United States, in the manner prescribed in this title; including therein all the information which the Commissioner may deem p.e<?ess,ary for &e calculation of such deductions and credits” ,as are here disputed. He argues that the schedules contained in the personal holding company surtax return do not provide for information sufficient to calculate the deduction now contested, and that the scheme of returns formulated by the respondent contemplates the filing of both forms so that information contained in the normal tax return may be used to supplement and emphasize the items required in the personal holding company surtax return, the first return on Form 1120 and the second on Form 1120 H.

Respondent complains specifically that the personal holding company tax return discloses no data which would enable him to determine whether petitioner falls within the characterization of a personal holding company and that there is no breakdown of the item “Net income (as defined in Title I of the Revenue Act of 1934)” and no breakdown of the item “Losses from sale or exchange of capital assets”, so that audit of such figures is impossible.

Respondent can hardly complain of any difficulty in determining whether petitioner is a personal holding company within the act when petitioner has filed a return which admits that it is such a company and upon that basis respondent has determined a liability against it for surtax, and, so far as the impossibility of making an audit is concerned, respondent had it in his power to require petitioner to produce books and records in support of the facts appearing on the return. Sec. 54, Revenue Act of 1934. We refuse to hold that, in order to obtain any deductions in the computation of its surtax, petitioner must have filed a timely normal tax return on Form 1120, as well as a personal holding company surtax return on Form 1120 H, both of which must satisfy section 233, supra. We know of no authority requiring such a conclusion. Petitioner filed a timely personal holding company surtax return, on the form approved, and issued for that purpose by the respondent. That return was complete and substantially correct. We conclude that this return contained, for the purposes of section 233, supra, “all the information which the Commissioner may deem necessary for the calculation of such deductions and credits” as are material to the computation of the surtax. See section 233, supra.

Respondent is sustained in his determination of a deficiency in normal tax, but reversed in his determination that petitioner is liable for surtax as a personal holding company. The deficiency in normal tax will be increased in recomputation under Rule 50, since the parties have stipulated that petitioner’s income from sources within the United States shall be increased by the sum of $677.65, representing the profit from the sale of Pacific Gas & Electric Co. stock which respondent failed to include in petitioner’s taxable income.

Respondent is sustained in bis imposition of a 25 percent delinquency penalty, since petitioner did not file a timely normal tax return. Taylor Securities, Inc., supra.

Decision will be entered under Rule 50.


author: Kern:

text:
    Morris K. Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98024.
    Promulgated November 15, 1940.

      Irvin H. Fathchild, Esq., for tbe petitioner.

      Dawid Altman, Esq., for tbe respondent.
   OPINION.

Kern:

Tbis proceeding involves the fiduciary liability of the petitioner for an assessed deficiency of $633.25, plus interest as provided by law, in tbe income tax liability of John C. Spry, deceased, for tbe taxable years 1923 and 1924.

As stipulated, tbe sole question presented is whether petitioner’s liability under section 3467 of tbe Revised Statutes, later amended in section 518 (a) of tbe Revenue Act of 1934, for tbe assessed deficiencies for 1923 and 1924, or either of them, is barred by any statute of limitations.

We adopt the stipulated facts as our findings and herein set forth that portion thereof deemed necessary to determine tbe issue presented.

Tbe taxpayer, John C. Spry, now deceased, duly filed bis Federal income tax returns for tbe year 1923 on March 14, 1924, and for the year 1924 on March 15, 1925. Spry died November 25, 1926, and tbe petitioner in tbis proceeding and two others were duly qualified in December of that year as the executors of Spry’s estate.

On November 11, 1927, the Commissioner of Internal Kevenue, under section 274 (a) of the Revenue Act of 1926, duly issued to Morris K. Wilson and the other two executors, in their capacity as executors of the estate of John C. Spry, a notice of deficiency for the years 1923 and 1924, determining the amount thereof to be $95.54 for 1923 and $4,860.57 for 1924.

On January 9, 1928, the petitioner and the other two executors, as such, filed a petition (Docket No. 33727) with this Board for a rede-termination of the deficiencies mentioned in the foregoing paragraph. On June 20, 1934, the Board entered its memorandum opinion directing entry of decision under Rule 50. On July 30, 1934, we entered the following decision: “That there are deficiencies in Federal income tax in the respective amounts of $95.54 and $537.71 for the years 1923 and 1924.”

On October 24, 1934, the Commissioner filed a petition for review in the United States Circuit Court of Appeals for the Seventh Circuit in which eight assignments of error were set forth. The eighth assignment was :

The Board erred in failing to sustain the determination of the Commissioner of Internal Revenue that there is a deficiency in income taxes for the year 1924 due from the estate of John C. Spry in the amount of $4,860.57.

No assignments of error were made as to the year 1923.

The respondents on review, being the executors, filed no cross appeals as to any part of our decision, nor did they file an independent appeal. On June 21,1937, the United States Circuit Court of Appeals promulgated its opinion and entered its decision affirming our decision. The court’s decision is reported under the name of “Commissioner of Internal Revenue v. Wilson et al.,” 90 Fed. (2d) 788 (C. C. A., 7th Cir., 1937).

On November 15, 1935, the Commissioner duly made ordinary non-jeopardy assessments against the estate of John C. Spry, Morris K. Wilson, Gladys Spry Augur, and George C. Wilce, executors, in the amounts of $95.54 for 1923 and $537.71 for 1924. The theory of the Commissioner in making such assessments was that the assessments were authorized under section 1001 of the Revenue Act of 1926, as amended by section 603 of the Revenue Act of 1928, and section 1101 of the Revenue Act of 1932. These assessments, together with interest as provided by law, are still unpaid and outstanding.

The estate of John C. Spry was insolvent. However, the final account of the executors in 1932 showed that considerable assets had been held — cash receipts of $110,290.39 and cash disbursements of $119,154.82. The final report and account of said executors were duly filed and approved, and the executors were discharged from their offices on October 19,1932.

The petitioner, as one of tbe executors of tbe estate of John C. Spry, had notice of the additional taxes claimed by tbe United States for the years 1923 and 1924.

On January 23,1939, tbe Commissioner issued a notice of deficiency to the petitioner herein based upon section 280 (a) (2) of the Revenue Act of 1926.

The petitioner in this proceeding contends that the Commissioner is barred by the statute of limitations from asserting against him as fiduciary any part of the deficiency in income tax found to have been owing from John C. Spry, deceased. Petitioner calls attention to section 280 of the Revenue Act of 1926, relied upon by the Commissioner, and particularly paragraph (b) thereof, which reads as follows:

(b) Tbe period of limitation for assessment of any such liability of a transferee or fiduciary shall be * * *
(1) Within one year after the expiration of the period of limitation for assessment against the taxpayer; * * *

For reasons which will become apparent, we shall consider petitioner’s liability for the 1923 deficiency before going on to a consideration of the 1924 deficiency.

Section 277 of the Revenue Act of 1926 provided in paragraph (a) (2) that the period of limitation for assessment against the taxpayer was “four years after the return was filed.” This section provided further, however, in paragraph (b), that such limitation period was to be suspended “after the mailing of a notice” of deficiency “for the period during which the Commissioner is prohibited from making the assessment * * * and for 60 days thereafter.”

The Commissioner, by section 274 of the Revenue Act of 1926, was prohibited from making an assessment until after the issuance of a deficiency notice, and, if the taxpayer filed a petition with the Board, “until the decision of the Board had become final.” In the instant case the taxpayer did file such a petition with the Board. From the decision of the Board the Commissioner petitioned for review as to the deficiency involving the year 1924.

Section 1001 provided for court review of Board decisions and provided further, in paragraph (c), that despite the restriction on assessment contained in section 274, supra, such court review was not to operate as a stay of assessment or collection of the amount of the deficiency determined by the Board unless a petition for review in respect of such portion is filed by the taxpayer, and then only if the taxpayer (1) on or before his petition for review is filed has filed with the Board a bond in a sum fixed by the Board not exceeding double the amount of the portion of the deficiency in respect of which the petition for review is filed.

The taxpayer filed his 1923 return March 14, 1924. Accordingly, except for suspension periods, the time for assessment of any deficiency therein expired March 14, 1928. The deficiency notice was' issued November 11, 1927. From that date, by reason of a petition filed with this Board, the Commissioner was prohibited from assessing the asserted deficiency throughout the balance of the four-year assessment period, a suspension of 124 days. Those extra days, by section 277, were carried forward from and after the date that the decision of this Board became final with respect to the 1923 deficiency. As stated above, the judgment of this Board confirming the Commissioner’s asserted deficiency for 1923 in the amount of $95.54 was entered July 30, 1934. Neither the taxpayer nor the Commissioner took exception thereto, and, when the Commissioner appealed as to the Board’s decision as to 1924, the decision in regard to the 1923 deficiency was not mentioned in the Commissioner’s petition for review. The time within which to bring such an appeal expired three months thereafter, on October "30, 1934. Accordingly, it is the petitioner’s contention that, under section 1005, the decision of the Board became final as to the 1923 deficiency on October 30, 1934. Adding thereto the 124 days, plus the 60 days allowed by section 277, the last day for assessment of the 1923 deficiency against the taxpayer became May 2, 1935. And petitioner contends that, the period for assessment against the taxpayer having expired on that date, the period for assessment against himself, as fiduciary, expired, in accordance with section 280 (b) above, one year thereafter, on May 2, 1936. Accordingly, he asserts, the deficiency notice for the 1923 deficiency which was issued to him January 23, 1939, was plainly beyond the period of limitation for assessment of the 1923 deficiency against this petitioner, and is therefore illegal and should be vacated.

While there are no authorities directly in point on this question, we agree with the petitioner’s contentions. The problem is, of course, whether, when the Board finds a deficiency for two years in one decision, the decision as to one year can become final while an appeal as to the other year is being heard. This question we answer in the affirmative. The case of Jacob Brothers Co. v. Commissioner, 64 Fed. (2d) 107, cited by the petitioner does not squarely meet the question. The United States Circuit Court of Appeals for the Second Circuit specifically said that they were not deciding the point. In that case this Board entered a decision as to three years in one document, which set forth deficiencies for 1919, 1920, and 1921. The petitioner filed a petition for review, specifically presenting for the court’s consideration the questions of the correct computation of its invested capital for the years 1919 and 1920. In the redetermination of the deficiency for 1921 no excess profits taxes were involved and no assignments of error were filed to raise any question of error as to that year. The Circuit Court reversed this Board as to 1919 and 1920 and said nothing about 1921. Since they found in favor of the taxpayer on another ground, there ‘was no necessity for a decision on our question, although the court said:

Although the parties by no means agree as to whether the former petition for review was broad enough to cover the redetermination of the deficiency for 1921 or as to whether our previous mandate affected that at all, we think that the action of the Board after our mandate went down and the subsequent inaction of the Commissioner until February 25, 1932, requires the reversal of the order then made, even on the assumption that the former petition for review did include the redetermination of the deficiency for 1921. Accordingly, we shall assume, arguendo, that it did, though we do not decide the point. If it did not, it is obvious that the statute of limitations on the assessment and collection of the 1921 tax ran before our mandate went down.

Ill the instant case the petition for review did not cover the year 1923, nor do we feel that an appeal from this Board such as the one in this proceeding is broad enough to cover by mere cohesion an undisputed and unrelated deficiency for a separate year. The implication, though not the holding, of the Jacob Brothers Co. case, supra, supports this conclusion. Consequently, we find in favor of this petitioner as to the amount of the $95.54 deficiency for the year 1923. The respondent is barred by the statute of limitations from assessing this deficiency against the petitioner.

We come now to a consideration of the deficiency for the year 1924, and are confronted with an entirely different problem. The petitioner claims that the decision of this Board in relation to the 1924 deficiency contained two items, viz.:

[1] Ordered and Decided: That there is a deficiency in Federal income tax for the year 1924 in the amount of $537.71.
[2] Ordered and Decided: That the balance of the asserted deficiency for the year 1924 is disallowed.

Inasmuch as the Commissioner was the party who filed the petition for review by the court, the petitioner here contends that only the second of the two items was before the Circuit Court, and as a consequence the decision as to the first item became final when the time for appeal had run. Respondent, on the other hand, contends that separate amounts for the same year can not be treated individually and thus create more than one decision for that year. According to the viewpoint of the respondent, the entire deficiency for the year 1924 was contained in one compact decision, and as long as any error is assigned in connection with that decision, no component part of the decision can become final before any other; and this is so even though the Commissioner is claiming that at least the amount found by the Board is correct and is now appealing only for a further amount.

The legal effect of the November 11,1927, notice of deficiency was to suspend the running of the statute of limitations on the making of assessments for the year 1924 until the decision of this Board became final and for sixty days thereafter. Under section 1005 (a) (2), where a petition for review of the Board’s decision is filed, the Board’s decision does not become final until the expiration of the time allowed for filing a petition for certiorari if, as was the case herein, the decision of the Board has been affirmed. The decision of this Board was affirmed by the Circuit Court on June 21,1937. The time allowed for filing a petition for certiorari expired three months later. Therefore, on September 21, 1937, by operation of law the Board’s decision which had been appealed from in the case of Estate of John C. Spry became final. And if, as the respondent asserts, the entire deficiency for 1924 was contained in one and only one indivisible decision, then this action of the Commissioner’s is timely, since the statute was suspended for approximately one year and four months, and in addition to this another year is allowed by section 280 in which to assert liability against the fiduciary. Consequently, respondent could have asserted the deficiency even as late as January 1940.

This necessitates an answer to the question of whether, as petitioner contends, there were two separate parts of the Board’s decision as to 1924, one of which became final before the other. It must be borne in mind that the Commissioner brought the appeal from the Board’s ruling and that this petitioner filed no cross petition to the Circuit Court. While we have found no cases in point on this question, it is our determination that the petitioner’s argument fails.

The eighth assignment of error set forth in the Commissioner’s petition for review was that the Board had erred in failing to sustain the determination of the Commissioner of a deficiency of $4,860.57 for the year 1924. Thus the Commissioner brought the entire deficiency for that year before the scrutiny of the Circuit Court. The $4,860.57 included the $537.71. Consequently, no part of the decision as to the deficiency for the year 1924 could become final until the time had expired in which to apply for certiorari. To hold otherwise would open the way for many impractical situations wherein the fiduciary might claim the Commissioner is barred by the statute from assessing certain other deficiencies for the same year,

On this issue we find for the respondent. Having already held for the petitioner as to the 1923 deficiency, we conclude that there is a deficiency due and owing from this petitioner in the amount of $537.71, plus interest.

Reviewed by the Board.

Decision will be entered wider Rule 50.

       Sec. 280. (a) The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by this title * * *
      *******

        (2) The liability of a fiduciary under section 3467 of the Revised Statutes in respect of the payment of any such tax from the estate of the taxpayer. Any such liability may be either aa to the amount of tax shown on the return or as to any deficiency in tax.


author: Hun:

text:
    John P. Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93140.
    Promulgated November 22, 1940.

      G. F. Sel fridge, Esq., for the petitioner.

      D. A. Taylor, Esq., and Drnid Altman, Esq., for the respondent.
   OPINION.

Hun:

Since this proceeding was submitted to the Board, the Supreme Court has rendered two decisions construing section 166 of the Revenue Act of 1934, upon which respondent rests, in part, his argument in this case—Helvering v. Clifford, 309 U. S. 331, and Helvering v. Wood, 309 U. S. 344. The distinction between a reversion, with which we are faced in the instant case, and a power to revest or revoke is clearly set forth in the Wood case, supra:

* * * generally speaking, the power to revest or to revoke an existing estate is discretionary with the donor; a reversion is the residue left in the grantor on determination of a particular estate. ⅜ * * Congress seems to have drawn Sec. 166 with that distinction in mind, for mere reversions are not specifically mentioned. * * * And where Congress has drawn a distinction, however nice, it is not proper for us to obliterate it. * * ⅜

The interest of this petitioner in the 1933 trust was clearly a reversion. He reserved no power to revoke the trust set up for his son, and the trust was certain to terminate in two years. In the case of the trust for his daughter and her husband the facts are different; but the ultimate vesting of the trust estate, either in the petitioner or in his estate is no less certain to occur than in the case of the 1933 trust, nor did petitioner have the power either to change the conditions set forth in the instrument or to revoke the trust.

Both of the trusts clearly fall within that class of trusts which the Supreme Court in the Wood case, supra, specifically excluded from the scope of section 166. They are not revocable trusts.

In the brief of counsel for respondent the income of the two trusts is sought to be attributed to petitioner on the theory that the direction of investments and sales and the accumulation of capital income is tantamount to control over the income. Clearly this view is erroneous. Cf. Christopher L. Ward, 40 B. T. A. 225, where, as here, the corpus was actually conveyed to the trustees who collected and distributed the income to the beneficiaries in accordance with the trust agreements. The advice given by petitioner for sales and investments could not nullify a trust otherwise valid.

Respondent, however, has a further alternative contention, i. e., that the capital gains of the two trusts for the year 1935 are taxable to the petitioner as grantor under section 167 of the Revenue Act of 1934. That section, unlike section 166, does not apply solely to trusts where the grantor retains a power of revocation. Several cases tend to shed light upon the application of section 167. Everett D. Graff, 40 B. T. A. 920, and Commissioner v. Morris, 90 Fed. (2d) 962. In the Morris case the court said, at page 964, in upholding a decision of this Board :

As to its decision regarding the capital gains which has to be added to the principal, regardless of any exercise of discretion by the trustees, for disposal when the trusts terminated, we think the Board was right. It held that as to such income from capital gains absolutely distributable as principal at the termination of the trust section 167 of the 1928 Act did not apply. * ⅜ ⅜ There is, indeed, no plausible reason apparent why, when income which may be accumulated for eventual distribution to the grantor is taxed to him, he should not also be taxed on income which must be accumulated for that purpose. In the Revenue Act of 1932 (Section 167 (26 U. S. C. A. Sec. 167 and note)), the tax was so extended * * * Nor does the fact that In the Revenue Act of 1932 Congress changed the law to cover such instances as this indicate more than that the amendment was for the purpose of filling a gap in the previous law. * * * [Italics ours.]

And at page 924 of the Graff case, supra, the Board said:

⅜ * * But section 167, in its present form, operates as effectively upon accumulated trust income where it “is ⅞ * * held * * * for future distribution to the grantor” as it does where that future distribution may be contingent upon the exercise of a nonadverse discretion. * * *

In the instant case the income from capital gains of the 1933 trust was paid to petitioner in 1935 as a part of the reverted trust corpus. Furthermore, there is no dispute as to the amount of that income. Clearly, therefore, the petitioner is taxable thereon pursuant to section 167.

As to the 1935 trust for the daughter, the situation is materially different. The corpus, including any and all capital gains which the trustees must accumulate, must at some future date vest either in the petitioner or his estate. It will vest in the petitioner himself only if (1) Cynthia Wilson Compton dies without issue during the lifetime of the petitioner, or, (2) her youngest surviving child attains the age of 20 or dies prior thereto during the lifetime of petitioner. And it will vest in petitioner’s estate upon (3) the death of petitioner at any time.

There is not only no reasonable certainty that the corpus will ever vest in the petitioner, but, on the contrary, it would seem that such vesting is not reasonably probable. The future life expectancy of the daughter is now greater than that of the petitioner. And, even should she predecease him, he would not become entitled to the corpus until her youngest surviving child reached the age of 20 or died prior thereto. In view of these contingencies, it can not be said that the petitioner has any more than a mere possibility of reverter in the corpus. This Board and the courts have now definitely established that the grantor of a trust is not subject to tax upon accumulated income if his only interest is a mere possibility of reverter. William E. Boeing, 37 B. T. A. 178; J. S. Pyeatt, 39 B. T. A. 774; Genevieve F. Moore, 39 B. T. A. 808; Christopher L. Ward, supra. It is our conclusion that such interest as petitioner retained in the property of the 1935 trust was not of sufficient substance to justify a reasonable expectation that he will ever benefit by the accumulations of the income thereof.

As already pointed out, however, the corpus must vest in petitioner’s estate, if not in petitioner himself. Because of this fact, counsel for respondent concludes that the situation falls within the scope of section 167, a conclusion with which we do not agree. The wording of that section is “for future distribution to the grantor.” Nowhere is there any mention of “or his estate”, the additional scope which counsel for respondent would impute to the section.

Accordingly, we hold in favor of the respondent as to the taxability to petitioner of the accumulated capital gains of the 1933 trust, and in favor of the petitioner on all issues concerning the 1935 trust for the daughter.

Decision will he entered under Bule 50.

       SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income oí a trust—
      (1) is, * * * held or accumulated for future distribution to the grantor, or
      * * * * v * *
      then such part of the income of the trust shall be included in computing the net income of the grantor.