author: Trammell :

text:
    Thomas H. Redington, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50953.
    Promulgated February 29, 1932.

      George T. Evans, Esq., for the petitioner.

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

Trammell :

The petitioner contends that no taxable profit resulted from the exchange of his stock in the Windsor Company for stock in the Beatrice Company as set out in our findings of fact, since the acquisition by the Beatrice Company of all of the common stock of the Windsor Company was a reorganization within the meaning of the term as used in section 112 (i) (1) of the Revenue Act of 1928. The respondent denies the correctness of this contention of the petitioner.

Pertinent provisions of the Revenue Act of 1928 are as follows: Sec. 111. DETERMINATION OE AMOUNT OE GAIN OR DOSS.

(a) Computation of gain or loss. — Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in section 113, and the loss shall he the excess of such basis over the amount realized.
*******
(c) Amount realized.- — The amount realized from the sale or other disposition of property shall he the sum of any money received plus the fair market value of the property (other than money) received.
(d) Recognition of gain or loss. — In the ease of a sale or exchange, the extent to which the gain or loss determined under this section shall he recognized for the purposes of this title, shall he determined under the provisions of section 112.
*******
Sec. 112. RECOGNITION OF GAIN OR LOSS.
(a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) Exchanges solely in kind.—
(1) PBOPEBTY-HELD FOB PRODUCTIVE USE OB INVESTMENT.-No gain Or lOSS shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.
* * * * * , * *
(3) stock for stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
* * * * * * *
(i) Definition of reorganization. — As used in this section and sections 113 and 115—
(1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form or place of organization, however effected.
(2) The term “ a party to a reorganization ” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.
*******
Sac. 113. BASIS FOB DETERMINING GAIN OR LOSS.
(a) Property acquired after February 28, 1913. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; * * *
* * * * * * *
Sec. 701. DEFINITIONS.
(b) The terms “includes” and “including” when used in a definition contained in this Act shall not be deemed to exclude other things otherwise within the meaning of the term defined.

Subdivision (a) of section 111 provides tbe method for computing the amount of gain or loss from the sale or other disposition of property. Subdivision (d) provides that the extent to which the gain or loss determined under the section shall be recognized for the purposes of the tax, shall be determined under the provisions of section 112. Section 112 provides that the entire amount of the gain or loss upon the sale or exchange of property determined under section 111 shall be recognized except in certain* situations set out therein. Section 113 provides the basis for determining gain or loss.

Under the provisions of sections 111 and 113 the amount of gain realized by the petitioner is the diiference between the cost of the stock of the Windsor Company to him, $40,000, and the fair market value of the stock of the Beatrice Company at the time of its receipt in exchange therefor, $83,549. This gain, or $43,549, shall be recognized for the purpose of the tax unless it comes within the exceptions provided in section 112.

The stipulated facts show that the Beatrice Company acquired from the holders thereof for cash or in exchange for its own common capital stock all the common capital stock of the Windsor Company. It did not, however, acquire any of the preferred stock of the Windsor Company. The Windsor Company was not dissolved, but continued as a going concern, owning the same assets that it owned before the transaction took place. The capital structure of the Windsor Company was not changed in any way. Nor was the capital structure of the Beatrice Company changed as a result of the transaction. All the Beatrice Company did was to issue shares of its common stock in exchange for shares of stock in the Windsor Company. So far as the facts show there was no change in the identity, form or place of organization of the companies, nor did either of them acquire any of the assets of the other.

The exchange by which the petitioner acquired stock of the Beatrice Company does not come within the exception in paragraph 1, subdivision (b) of section 112, since that subdivision specifically provides that stocks are not included therein.

The exchange comes within the provisions of paragraph (3), subdivision (b) of section 112, provided there was a reorganization within the meaning of the term as defined in subdivision (i) of the same section. There, the term is defined as a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation) * * It is plain that the transaction does not come within the parenthetical clause above quoted. It is not even claimed that any preferred stock was acquired and, clearly, it was not. A majority of each class of stock was not acquired, as is necessary to bring a transaction within the parenthetical clause. Nor did either company acquire any of the assets of the other as provided in section 112 (i). There was no recapitalization of either of the corporations, nor any change in their identity, form or place of organization as set out in subsection (i) of section 112.

The petitioner urges that while the Beatrice Company did not acquire any of the preferred stock of the Windsor Company, it acquired all of the common stock of that company; that under the circumstances here involved such acquisition constituted a reorganization within the commonly accepted meaning of the term and accordingly meets the requirements of that portion of the parenthetical provision of subdivision (i) of section 112 relating to the acquisition by one corporation of stock in another. In support of this the petitioner relies on the provision of section 701 to the effect that the terms “ includes ” and “ including ” when used in a definition contained in the Act shall not be deemed to exclude other things otherwise within the meaning of the term defined.

The transaction, however, clearly was not a merger, as both corporations continued their separate existence with the same assets as before. Nor was it a consolidation. Neither corporation was dissolved ; no new corporation came into being; both corporations had their own assets as before, with separate management. They were organized and existed under laws of different States. In no sense were the corporations united. It does not meet the statutory definition. Section 709, which provides that “ .includes ” and “ including ” shall not be construed to exclude other things otherwise within the meaning of the term defined, does not enlarge the definition of reorganization, but merely means that the parenthetical clause following “ merger or consolidation ” in which “ including ” is used is not to be considered as an all-inclusive definition of “ merger or consolidation.”

To grant the petitioner’s contention would mean going a step further and including within the meaning of the term “ reorganization ” a transaction coming within neither the parenthetical nor other provisions of subdivision (i). In view of the foregoing, we hold that the transaction was one the entire amount of the gain from which is to be recognized. See Robert D. Green, 24 B. T. A. 719.

The petitioner further contends that he did not realize any income from the exchange, having only received stock in one corporation for stock in another. He further contends that, in so far as sections 111, 112 and 113 of the Act determine and recognize a taxable gain from the transaction, they lay a direct tax upon personal property without apportionment and contrary to Article I, section 2, clause 3, and Article I, section 9, clause 4, of the Constitution and are therefore to that extent invalid.

The contention that income was not realized from the exchange or that it could not be constitutionally taxed as income must be decided adversely to the petitioner. Marr v. United, States, 268 U. S. 536. Income having been realized, the tax thereon may, under the Sixteenth Amendment," be laid and collected without apportionment. The petitioner’s contentions as to the validity of sections 111, 112 and 113 of the Act must therefore be denied.

The parties have stipulated that, if the respondent’s determination is sustained, there is a deficiency for the calendar year 1928 of $5,443.63, and that an order of redetermination may be entered for '■hat amount.

Reviewed by the Board.

Judgment will be entered determining a deficiency of $5,J¡.fi2.63 for 1928.


source: Caselaw Access Project

author: Black :

license: Public Domain

text:
    Sallie Strickland Tricou, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 28093, 40258.
    Promulgated February 29, 1932.

      J. 8. Y. Ivins, Esq., and Eustis Meyers, Esq., for the petitioner.

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

Black :

The first issue which we have to decide is whether petitioner is entitled to deduct from her income of 1923 a “net” loss for tbe year 1922 amounting to $236,736.82. Section 204(a) of tbe Revenue Act of 1921 provides that tbe term “ net loss ” means only net losses resulting from tbe operation of any trade or business regularly carried on by the taxpayer.

If tbe petitioner’s husband, J. F. Strickland, had been living in 1922 when tbe loss in the Hidalgo Land Securities Syndicate occurred, it seems clear that under tbe doctrine announced in Glenn M. Averill, 20 B. T. A. 1196, he would have been entitled to take advantage of the “ net ” loss provisions provided in the 1921 Act. In Glenn M. Averill, supra, we pointed out that the promotion of the Berteschey Engineering Company was not an isolated venture, but typical of the manner in which petitioner carried out his business plans. So it was in the case of J. F. Strickland. The promotion and organization of the Hidalgo Land Securities Syndicate was not an isolated venture, but typical of the method which he used in promoting and organizing and financing many corporations and business ventures with which he was connected. Most of the corporations and business ventures which he promoted and organized were successful and made large profits, but the Hidalgo irrigation enterprise was an exception. Certainly as to him any loss in this Hidalgo Land Syndicate venture would have come under the net loss provisions of section 204,1921 Act, as interpreted in the Glenn M. Averill, supra, decision, and other decisions of the Board. That J. F. Strickland was engaged in the business of promoting and financing corporations, there seems to be no doubt. The doctrine announced by the Board in the Averill case was approved by- the Circuit Court of Appeals for the Eighth Circuit in Washburn v. Commissioner, 51 Fed. (2d) 949. Cf. Henry Turrish, 24 B. T. A. 913; Oscar E. Rehm, 21 B. T. A. 243; W. H. Ostenberg, 17 B. T. A. 738.

But J. F. Strickland, who promoted and organized the Hidalgo Land Securities Syndicate and many other Texas corporations and business ventures, died in 1921. Petitioner, who owned a one-half interest of the interest which stood in the name of J. F. Strickland in these various business enterprises, because of the community property laws of the State of Texas, succeeded to his interest at his death.

The petitioner, after the death of her huband, took charge of the property which had been accumulated by herself and husband during his lifetime and which he had managed prior to his death, and undertook the management of same. Since her husband’s death she has continued this management, selling her interest in some of the corporations in which she and her husband were investors at the time of his death and buying interests in other corporations. Petitioner has kept a regular set of books each year since her husband’s death, in which these transactions have been recorded.

The record shows that on several occasions prior to her husband’s death, petitioner visited the Hidalgo Syndicate property and after her husband’s death was in regular conference with her advisers in regard to its affairs. She caused her brother, Burr Martin, to be elected as one of the board of managers to fill the vacancy occasioned by the death of her husband. She met calls for further capital, not only on subscriptions made by her husband, but on guarantees of other subscribers. She advanced $90,000 to $100,000 to the Hidalgo Land Securities Syndicate in 1921 to 1922 in an effort to keep it going. She continued to advance money to the syndicate until it became apparent that it could not continue under the original contract, but would have to be refinanced. In this process of refinancing, petitioner’s loss occurred in 1922. Can it be said that this loss is such a loss as petitioner is entitled to use in determining a “net loss ” within the meaning of section 204 of the Revenue Act of 1921 and bring forward and use as a deduction in determining her net income for 192B? We do not think so.

It must be remembered that the business of the Hidalgo Syndicate was not petitioner’s business. It was an association taxable as a corporation and therefore the business it conducted was the same as other corporate enterprises. The business itself was the syndicate’s business. Petitioner had an investment in it and it was this investment which she lost in 1922. But mere investment losses do not constitute “ losses incurred in operating a trade or business regularly carried on ” by the taxpayer. Robert T. Cunningham, 20 B. T. A. 428; Fridolin Pabst, 6 B. T. A. 843; affd., 36 Fed. (2d) 614; Rogers v. United States, 41 Fed. (2d) 865. Such losses, to be used in determining a “ net loss ” within the meaning of the statute, must be of such character as to constitute a loss incurred in operating a trade or business regularly carried on by the taxpayer. Glenn M. Averill, supra; Washburn v. Commissioner, supra; Mente v. Eisner, 266 Fed. 161; Rogers v. United States, sufra.

It is clear petitioner was not engaged in any trade. Was she operating a business in 1922 within the meaning of the statute? There is nothing to show that after the death of J. F. Strickland petitioner became the organizer and promoter of corporations as he was in his lifetime. Up to his death she was engaged in no business at all, and after his death she looked after and cared for her investments, of which she became sole owner at his death. But merely safeguarding investments is not operating a business within the meaning of the statute.

As pointed out by the court in Washburn v. Commissioner, supra, “A party may have investments in corporate stock, have no particular occupation and live on the return of his investments. That would not constitute business under the statute in question. Cf. Bedell v. Commissioner, 30 Fed. (2d) 622.

The evidence shows that after the death of J. F. Strickland and in the intervening years between the date of his death and the hearing in this proceeding, petitioner bought and sold a considerable number of stocks and bonds of corporations and other securities— not much during the first two or three years after Strickland’s death, but more later as time went on. Even if it be conceded that these purchases and sales were sufficient in frequency and manner of dealing to constitute petitioner, in these later years, a dealer in securities, that fact would not help her any in this proceeding. The fact would still remain that the loss which she incurred in Hidalgo Land Securities Syndicate was an investment loss and not connected with any securities which she bought and sold in her business as a dealer in securities (if indeed she ever established any such business). George P. Sacks, 25 B. T. A. 415.

We sustain respondent in his disallowance of petitioner’s claimed “ net ” loss.

The next issue which we have to decide is what loss, if any, is petitioner entitled to deduct in determining her net income for 1925 because of her disposition in that year of her interest in the Liberty Investment Company and of 50 shares of stock in the Southwest National Bank, which she alleges became worthless in 1925. The circumstances by which petitioner acquired her interest in the Liberty Investment Company and her stock in Southwest Bank have all been stated in our findings of fact and will not be repeated here.

Petitioner’s exchange of 200 shares of stock in Security National Bank for 150 units of interest in the Liberty Investment Company and 50 shares of stock in Southwest Bank took place under the Revenue Act of 1921 and is governed thereby, but whatever loss, if any, she is entitled to deduct in the year 1925 is governed by the Revenue Act of 1926, and the basis for determining such loss, if any, we think is governed by section 204 (a) (6) of that act, printed in margin.

Becently we had before us in Securities Co., 25 B. T. A. 446, the question whether a taxpayer had the right to have the profit or loss from the sale of stock received in 1917 under a reorganization computed under the provisions of section 204(a)(6) of the Bevenue Act of 1924 (a section very similar to section 204(a) (6) of the Revenue Act of 1926). We held against petitioner’s contention and held that said section did not apply because the taxpayer in that case not only exchanged his common stock share for share for common stock of the new company, but, as a condition precedent to such exchange, he had to purchase $50 face value of bonds of the new company and pay cash therefor. We said, therefore, that section 204(a) (6) did not apply. In the instant case the facts show that the stockholders of the Security Bank exchanged their shares for shares in the Liberty Investment Company and the Southwest Bank and did not have to purchase anything as a condition precedent to such exchange of stock. True, each stockholder of the Security Bank was given the privilege to purchase other stock in the Southwest Bank in addition to that which he was to receive under the exchange plan, but many of the stockholders did not avail themselves of such option and petitioner was one who did not avail herself of such privilege and received only the shares which were allotted to her in the exchange. Such a situation it seems to us-comes squarely within section 204(a) (6) of the Revenue Act of 1926, and was very similar to the situation which we had before us in Glenn H. Curtiss, 21 B. T. A. 629, in which we held that section 204(a) (6) of the 1924 Act applied. In that case, one share of preferred stock in the Curtiss Aeroplane and Motor Corporation was exchanged for one-half share of preferred stock in the Curtiss Aeroplane and Motor Company, Inc., and one-half certificate of beneficial interest in the Curtiss Assets Company, and we held it was possible to apportion the cost of a share in the original corporation between the shares received in exchange in the two separate corporations, because we had evidence as to the fair market value of the respective shares of stock in the new corporations.

In the instant case the Commissioner refused to allow petitioner to take any loss on the Liberty Investment Company shares in 1921 because it was impossible to apportion the cost of the original shares in the Security Bank between the shares of the Liberty Investment Company and the shares in the Southwest Bank, and held that no gain or loss would be recognized on the disposition of either until all was disposed of. Bespondent’s counsel now argues that petitioner should have taken her loss on her shares of interest in the Liberty Investment Company in 1921, because it never had any value and became worthless in that year. We do not agree with this contention. The evidence shows that at the time stock in the Security Bank was exchanged for stock in the Southwest Bank and the Liberty Investment Company, the stock in the Southwest Bank had a book value of $125 per share and a fair market value in 1921 of $150 per share, but the shares in the Liberty Investment Company had no fair market value and what value, if any, such shares had was altogether uncertain. In this state of facts, it was impossible to apportion the cost of the original shares between the two classes of shares received in exchange. No gain or loss could be recognized to petitioner on the disposition of any of the stock until all was disposed of. Article 1567 of Regulations 62, reads in part as follows:

If property is exchanged for two lsinds of property and no gain or loss is recognized under Articles 1564 and 1566, the cost of the original property shall be apportioned, if possible, between the two kinds of property received in exchange for the purpose of determining gain or loss upon subsequent sale, or if no fair apportionment is practicable, no profit on any subsequent sale of any part of the property received in exchange is realized until, out of the proceeds of sale, shall have been recovered the entire cost of the original property.

In Glenn H. Curtiss, supra, we held that while Regulations 65 (Revenue Act of 1924) and Regulations 69 (Revenue Act of 1926) do not contain any provisions corresponding to article 1567 of Regulations 62 (Revenue Act of 1921), nevertheless, the provisions of said article lay down a principle which is equally applicable to reorganization provisions of subsequent acts.

In 1925 petitioner sold her 150 shares in the Liberty Investment Company for $3, and her stock in the Southwest National Bank became worthless in the same year. In view of these facts, we hold that petitioner’s claim for loss on account of disposition of shares in the Liberty Investment Company and on account of worthlessness of stock in the Southwest National Bank should be allowed. The deficiency for 1925 will be computed accordingly.

In Cullen F. Thomas, 14 B. T. A. 1341, we had before us the question of a loss arising through the sale of some Liberty Investment stock in 1921 (same sort of stock as involved herein). We there held that the taxpayer was entitled to take his loss on such shares in 1921 because he had disposed of the shares in that year.

The rules for determining loss in that case came under the Revenue Act of 1921, whereas the basis for determining gain or loss in the instant case is determined by section 204 (a) (6) of the Revenue Act of 1926, as we have already explained. The Revenue Act of 1921 had no provisions similar to section 204 (a) (6).

Reviewed by the Board.

Decision will he entered vmder Rule 50.

       Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property ; except that—
      *******
      (6) If the property was acquired upon an exchange described in subdivisión (b), (d), (e), or (f) of section 203, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the property so acquired consisted in part of the type of property permitted by paragraph (1), (2), (3), or (4) of subdivision (d) of section 203 to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it.


author: Van Fossan:

text:
    Fred T. Murphy, John H. Emmert, Joseph J. Wrangovich and Sidney T. Miller, Trustees of Murphy Personal Property Trust, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43795.
    Promulgated February 29, 1932.

      Edward S. Reid, Jr., Esq., for the petitioners.

      Chester Gwinn, Esq., and J. R. Gashins, Esq., for tbe respondent.
   OPINION.

Van Fossan:

An association is an unincorporated body of persons organized in the general form of a corporation and employing usual corporate methods in carrying on a business for profit. See Lucas v. Extension Oil Co., 47 Fed. (2d) 65. Testing the petitioning organization by this formula, it will be noted that, though it bore some resemblance to a corporation in form, there are certain important departures. In a corporation the ultimate power of control is Tested in the stockholders, who act through their duly elected directors. In the' declaration before us all power of management is vested in self-perpetuating trustees, while the unitholders had no power of control. They had no power to appoint trustees nor could they remove a trustee if objectionable.

The power to initiate proceedings to terminate the trust is vested in the trustees subject only to approval by the unitholders. The trustees in the instant case were responsible for losses incurred in loans, and all transactions of whatever nature must have the unanimous approval of all the trustees. No meeting of unitholders is provided for or was ever held and the power to dispose of unithold-ings was limited. The unitholders had no power to compel dividends, the decision of the trustees being expressly made final. Thus it can scarcely be said that the declaration of trust created an organization similar in its fundamental respects to a corporation. The powers conferred on the trustees and the trust structure, as well as the rights of the beneficiaries thereof, much more closely resemble the usual trust than a corporation. Jackson-Wermich Trust, 24 B. T. A. 150,

Passing from the form of the organization to its operation, we find that the purposes of the same, as shown by its dealings, were the conservation of the income of the several estates represented and the financial accommodation of its unitholders. The making of money as evidenced by the payment of dividends and the accumulation of surplus was an incidental concomitant. Investment in the trust was actually limited to members of the Murphy family. Loans were likewise limited to members of that family or to family-controlled corporations. The operating expenses were all paid by the Murphy Family Trusts. That organization was limited to lineal decendants of Simon J. Murphy. True, the trustees invested the funds of the trust with a view to gaining an appropriate return, but such is the duty of every trustee. There is a basic distinction between such a return of interest on capital funds in the trustees’ hands and the income of a business carried on for profit. The trustees in the instant case never traded on the market or bought and sold securities for profit. They bought securities solely for investment. Their investment of funds no more resembled a business for profit than does the normal investment by testamentary trustees. See Gardiner v. United States, 49 Fed. (2d) 992.

Similarly, the making of secured loans to members of the Murphy family was a corollary of the investment policy. This policy was pursued not primarily to make money for the trust, but to accommodate the cestuis. All loans were conservatively made on collateral and usually at an interest rate of 5 per cent.

Considering all of the evidence before us, both as to form and actual operation, we are of the opinion that Murphy Personal Property Trust was a trust and not an association. It should be taxed accordingly.

Reviewed by the Board.

Decision will he entered under Bule 50.


author: Lansdon:

text:
    Interstate Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46272, 50981.
    Promulgated February 29, 1932.

      John E. McClure, Esq., for the petitioner.

      Nathan Gammon, Esq., for the respondent.
   OPINION.

Lansdon:

In the proceeding at Docket No. 50981 relating to petitioner’s tax liability for the fiscal year 1927, the deficiency is based upon determination of the respondent as follows: The addition to income of $22,152.45, $5,625.55 and $2,199.95 representing, respectively, realization of profit from the collection of deferred payment notes, interest on the notes, and a collection on the principal thereof. The additional tax liability asserted for such year is $4,047.02. At Docket No. 46272, the deficiency for 1928 in the amount of $4,396.82 is based upon respondent’s additions to income of $22,152.45, $5,625.55, $1,194.30, $347, $2,199.95 and $1,500, representing realization of profit from deferred payments notes, accrued interest on such notes, profit on an exchange of property, rent, collection on notes and loss from the operation of an insurance agency. The first three items in each of the above categories are identical and decision thereon for either year automatically removes it from consideration as an element of tax liability for the other.

The major controversy here relates to the taxability of certain distributions of notes and accrued interest thereon. The respondent has determined that such distribution took place on October 3, 1927, which is within the petitioner’s taxable year ended at July 31, 1928, and that it falls within the provisions of section 44(d) of the Revenue Act of 1928. The petitioner contends that the transaction was completed within its taxable year ended at July 31,1927; that it was a distribution in kind and so not taxable, and relies upon our decision in Virginia Beach Golf Course Annex Corporation, 23 B. T. A. 1169. It also argues that even if we should find that ,the distribution was made in the petitioner’s taxable year ended July 31, 1928, the realized profits therein are not taxable under the provisions of section 44(d) of the Revenue Act of 1928, since that section applies expressly and only to profits resulting from the realization of installment notes and the sales in question were on the deferred payment plan, under which capital must be recovered before any profit becomes taxable. A further question of law, not argued by either party, is whether the 1928 Act is applicable in any event, since the taxable transaction, if any, occurred in 1927 and the law relied on by the respondent was not enacted until late in May, 1928, and, except as to certain matters not pertinent to the issues of these proceedings, was not retroactive.

The historical sequence of the events involved in this controversy is clearly disclosed by the record. Fariss, a stockholder, director and the president of this petitioner, desired, on account of failing-health, to dispose of his stock and withdraw from all participation in the affairs of the corporation. After many oral conferences the stockholders’ agreement, which we have incorporated in our findings of fact, was entered into by all the parties in interest. On May 16, 1927, under that agreement, Fariss endorsed his stock certificates in blank and turned them over to Koplin, Fant, and Richardson, who, at the same time, delivered to him the deferred purchase money notes of the face value of $25,358.45, upon which interest had then accrued in the amount of $5,625.55. Apparently the petitioner contends that these acts and the nature of the stockholders’ agreement effected a closed transaction at May 16, 1927, in which stock was transferred and a dividend was declared and discharged.

A careful study of the agreement indicates that it is an executory contract in which all the parties recognized that Fariss was receiving assets of the corporation from the stockholders as individuals who were discharging their private obligations by using the property of the petitioner. This agreement, therefore, includes a provision in which Koplin, Fant, and Richardson “ jointly and severally covenant and agree that they shall and will, in due legal form and manner, and by unimpeachable corporate action, procure from said Interstate Realty Company, a good, legal and sufficient title to all and every one of said promissory notes.” It is perfectly clear that the “ good legal and sufficient title ” to the notes could lodge in Fariss in only one way, that is, by the corporate distribution of such notes to Koplin, Fant, and Richardson, as a dividend payable from “ the assets of the corporation ” and the delivery thereof to Fariss by such distributees. Petitioner argues that the terms of the agreement explicitly declare the intention of the first parties and as they had the power as the sole stockholders and directors of the petitioner to accomplish any lawful corporate act at any time it must be presumed that every obligation imposed by the agreement was discharged at the date of the exchange of the stock for the notes and that any subsequent formal act of the corporation was no more than a bookkeeping record of something already done.

The theory of the petitioner is plausible, but not convincing, and is not supported by the evidence. The record shows that on May 16 the stockholders of the petitioner delivered corporate assets equal in value to accumulated earned surplus to Fariss, with a guaranty that by appropriate corporate action they would later lodge title thereto in him. There is considerable testimony by the petitioner’s attorney that the action contemplated was taken in June and counsel offered in evidence an undated and unsigned carbon copy of what purported to be a resolution which it was alleged was adopted by the corporation some time before June 15, 1927. No officer or director of the petitioner has testified that such a meeting was held or that the resolution was adopted. No satisfactory evidence that the original, if any, had been lost was offered. The respondent’s objection to the carbon copy as evidence was sustained by the sitting member of the Board. The only other evidence of corporate action to effect the guarantee in the stockholders’ agreement is the minutes of a directors meeting held on October 3, 1927. These minutes, set out in full in our findings of fact, were produced from the records of the petitioner and are duly and properly signed by the president and secretary thereof. The corporate acts there recorded are (1) a recital that at July 31,1927, the books of the petitioner, after audit, showed earned surplus in the amount of $33,053.04; (2) the declaration of a dividend on the outstanding common stock of the petitioner in the amount of $31,000; and (3) that the dividend so declared should be discharged by the transfer and delivery of a series of notes held and secured by the company. Obviously this was the “ unimpeachable corporate action ” pledged in the agreement.

Petitioner must destroy the probative value of the minutes of October 3, 1927, in order to prevail on its contention that the distribution was effected in either May or June of that year. The preponderance of authority favors the view that the records of a private corporation are conclusive evidence of its acts and may not be varied or contradicted by parol testimony. Corpus Juris 22, at page 1088, citing Indiana Refining Co. v. Burhman, 220 Fed. 426, in which the court said that “ the written minutes may be explained but not changed, barred or modified by oral testimony.” In Dennis v. Joslyn, 19 R. I. 666; 36 Atlantic 129, the Supreme Court of Ehode Island said:

The declaration, of a dividend is one of the most important acts of a corporation. It is an assignment pro tanto of its property. It clearly implies corporate action to that effect. It is action of such a character that it should appear on the boohs of the corporation.

In our opinion the record does not sustain the petitioner’s contention. The stockholders’ agreement and the delivery of the notes to Fariss on May 16 are not enough to establish a dividend in kind at that date. The probative value of the minutes of October 3 has not been impeached by the oral evidence. On that date the dividend of $31,000 was voted and discharged by surrender of title to the notes which had been delivered to Fariss on May 16, 1927.

The petitioner further contends that even if the dividend was voted and discharged by the notes on October 3,1927, the transaction does not fall within the provisions of section 44(a) of the Eevenue Act of 1928, which explicitly applies to the realization of profits from the disposition of installment notes. The notes in question represented deferred payments and the petitioner was required to report no profit as income until its capital investment had been recovered. In our opinion this is not a transaction to which section 44(a) of the Eevenue Act of 1928 is applicable.

The controversy here is not disposed of, however, by our conclusions above. The parties agree that at May 16, 1927, the petitioner had recovered all its investment in the LaBelle subdivision except the amount of $1,022.05. From that date all realization from the notes in question in excess of the unrecovered capital was taxable income. Had there been no disposition or realization other than by collection it is clear that income so derived was reportable only as and when it resulted from such collections. The facts, however, destroy the petitioner’s right to report its income from the notes as and when collected. On October 3, 1927, the corporation declared a dividend of $31,000 payable to its stockholders of record. The legal effect of that act was to separate such amount from surplus and create a corporate liability equal thereto. United States v. Ginzburg, 278 Fed. 363; Staats v. Biograph Co., 236 Fed. 454; William H. Davidow Sons Co., 1 B. T. A. 1215; W. J. Hunt, 5 B. T. A. 356; A. H. Stange, 1 B. T. A. 810; Eugene E. Paul, 2 B. T. A. 150. The liability so created was discharged by the distribution of the notes. In our opinion the petitioner then realized taxable income to the extent that profit was included in the distribution. The record indicates that the distribution included profits and interest in the respective amounts of $24,335.95 and $5,625.55, or a total of $29,961.50. This amount was income to the petitioner in the fiscal year ended July 31, 1928, and is taxable to it at the corporation tax rates imposed by the Revenue Act of 1928.

The instant proceeding is clearly distinguishable on its facts from Virginia Beach Golf Course Annex Corporation, supra. The distribution there was in kind and apparently was one of the steps in the liquidation of the taxpayer. There it was impossible to determine to what extent the notes distributed represented the return of capital or the realization of profit. Here the conditions are quite different. The distribution was in kind, but was not made in the course of liquidation. It was in discharge of a liability incurred by the declaration of dividend out of surplus. In the circumstances it is clear that the petitioner realized the profits that it had theretofore derived from the sale of its property. There is no reason that it should escape taxation on realized income. Its distributees are subject only to the surtax on dividends received from a domestic corporation. The petitioner must pay the normal tax unless the revenues are to be deprived of an impost authorized by law.

The respondent has determined that the exchange of property in 1928 set out in our findings of fact, resulted in a profit of $1,194.30. This determination is based on a finding that the property received by the petitioner had a fair market value of $12,206.08 at date of the exchange. A witness for the petitioner, Richardson, who is a director thereof, testified that in his opinion the property was not worth more than $10,000 when received. In cross-examination he admitted that he had priced it in proposed trades for other property at $12,500 and at $15,000. This testimony is not sufficient to overcome the presumption that the determination of the respondent was correct. On this issue the contention of the petitioner is denied.

On February 18, 1928, Koplin, Fant, and Richardson, who were the owners of all the capital stock of the petitioner outstanding at that time, entered into a contract with one Homer A. Parrish for the purpose of conducting an insurance agency with Parrish as manager. The petitioner contends that such agency was its property at all times and that the losses sustained were its losses and deductible from its income in the year in which they were sustained. The insurance agency was conducted under a different name because of petitioner’s charter limitations under the laws of Tennessee. Witnesses testified that the petitioner was at all times the beneficial owner of the insurance agency. This evidence was not overcome by any rebuttal testimony. We conclude, therefore, that on this issue the respondent must be reversed. Cf. D. Bruce Forrester et al., 12 B. T. A. 104; Carnie-Goudie Manufacturing Co., 24 B. T. A. 679.

The respondent has determined that petitioner realized income in its fiscal year ended July 31, 1927, in the amount of $2,199.95 resulting from the collection of notes from the sale of lots in the LaBelle subdivision upon which the original capital investment had been recovered. This amount was included in the notes delivered to Fariss on May 16, 1927, and was collected by the petitioner for his account and paid to him. It is included in the notes which discharged the dividend of $31,000 declared on October 3, 1927, and in conformity with our conclusions above is already included in the computation of the petitioner’s tax liability for the year 1928.

In almost every particular the matters involved in. Dockets 50981 and 46272 are identical and the- two proceedings are practically duplicates. Our conclusion is that there is no deficiency involved in the proceeding at Docket No. 50981 and that the deficiency asserted at Docket No. 46272 must be redetermined under Bule 50.

Beviewed by the Board.


author: McMahon :

text:
    B. Hayman Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 16552.
    Promulgated February 29, 1932.

      George E. Roster, Esq., for the petitioner.

      G. H. Curl, Esq., for the respondent.
   OPINION.

McMahon :

The Commissioner disallowed as an expense deduction an item of $2,200 set up at the end of the fiscal period on the books of account of petitioner and representing the balance due on account of a catalogue published during the fiscal period, on the ground that this amount was not a proper deduction for the taxable year in question, but an expense prepaid.

Thomas F. Osborn, petitioner’s secretary and treasurer, testified that, because of the loss of the Oliver Chilled Plows Company contract in June, 1920, which was petitioner’s major line, the catalogue just published became obsolete. Even though the intention of the petitioner at the time the catalogues were published was to use the catalogues for several years, supplemented by price lists, as indicated by the custom followed in prior years, when the catalogues for some unforeseen occurrence became obsolete in the year publishd, as in this proceeding, the petitioner sustained an operating loss which it is entitled to deduct in such year. As the catalogues became obsolete in the year published and as petitioner’s liability for the cost of the catalogues was fixed at the time of the delivery and acceptance thereof, and fully accrued on petitioner’s books and credited in full on the printer’s account, which was an open account, the balance of the cost of the catalogues, in the amount of $2,200, is deductible as a business loss sustained during the taxable year. Cf. Tom Moore, 19 B. T. A. 140; H. K. Gardiner, 7 B. T. A. 1089; A. W. D. Weis, 13 B. T. A. 1284; Fraser Brick Co., 10 B. T. A. 1252; and Deerland Turpentine Co., 4 B. T. A. 1236.

The petitioner contends that its excess-profits taxes should be computed under the provisions of sections 327 and 328 of the Revenue Act of 1918 because (1) its invested capital can not be properly determined because of the impossibility of determining the value of the good will and agency contracts acquired through purchase by it of the business theretofore conducted by B. Hayman, and (2) its taxable income is abnormal in that salaries paid by the petitioner to its officers and rent paid by the petitioner for its place of business are abnormally low.

The petitioner’s claim that it is impossible to determine its invested capital is based upon the fact that at the time of its organization it acquired for all but three shares of its capital stock the entire business of B. Hayman, including the good will of the going business, and certain agency contracts of B. Hayman not included in invested capital by the Commissioner, which petitioner claims were of considerable value in excess of the par value of the stock paid therefor. There is no evidence whatever from which we can determine the value of the good will of the business of B. Hayman except that he had been in-that business for a considerable length of time and had had for years a number of these contracts which were turned over to the petitioner. The fact that these contracts were on a yearly basis is not sufficient to show that the value thereof, if any, can not be determined. No evidence was presented from which we'can determine that it is impossible to ascertain the value, if any, of the good will and contracts. Their exclusion, therefore, from invested capital is not a ground for granting special assessment. Keystone Wood Products Co., 19 B. T. A. 1116; Electric Appliance Co., 19 B. T. A. 707; and Coca-Cola Bottling Works of Pittsburgh, 19 B. T. A. 267.

The petitioner claims that the salaries paid its officers were wholly inadequate to compensate for the services rendered by them. It argues that the conservatism of its officers, who also owned all the capital stock of the petitioner, as shown in paying themselves salaries just sufficient to cover their living expenses, resulted in an increase to its surplus available for dividends and that it was of no concern to these officers whether they'were compensated in the form of salaries or in the form of dividends. This conservatism, however, in increasing surplus effected an increase .in invested capital. However, mere inadequacy of salary does not, of itself, create an abnormality. Primrose Tapestry Co., 20 B. T. A. 702. In our opinion the evidence is not sufficient to enable us to determine that the low salaries paid the officers created an abnormality within section 327 of the Bevenue Act of 1918. California Vegetable Union, 23 B. T. A. 935. Abnormality is a fact that must be determined in each case and the burden of proof in this respect is upon the petitioner. Primrose Tapestry Co., supra; Clark Brown Grain Co., 18 B. T. A. 937; Wright Lumber Co., 17 B. T. A. 814.

What has been stated in reference to the low salaries paid to officers may be applied also to the contention that the payment of low rental by the petitioner created an abnormality. Kimball Tyler Co. of Maryland, 18 B. T. A. 729, and Wright Lumber Co., supra. There was no evidence of a reasonable rental for the property or sufficient evidence from which the reasonable rental can be determined. We are, therefore, unable to say that the rent paid created such an abnormality as to justify special assessment. Henry F. Michell Co., 16 B. T. A. 1297.

,The fact that the income of the petitioner was very high or about 95 per cent of invested capital is not a ground in itself for computing its tax under section 327 of the Revenue Act of 1918. Wright Lumber Co., supra; Moses-Rosenthal Co., 17 B. T. A. 622; and Enameled Metals Co., 14 B. T. A. 1392.

At the hearing the petitioner also contended that it was required to borrow large sums of money in the conduct of its business, which created a hardship and abnormality. This contention was not referred to in its brief and apparently has been abandoned by the petitioner. There is evidence showing that the petitioner borrowed money during the taxable year in question, but there is no evidence whatever showing that the use of it created an abnormal condition or that the borrowing of such money was unusual in a business of its kind. Therefore there is no evidence on which we can base an opinion of either normality or abnormality. Little Rock Tent & Awning Co., 22 B. T. A. 1204; Primrose Tapestry Co., supra; and Clark Brown Grain Co., supra.

Nor does an aggregate of a number of conditions, each inadequate in itself, necessarily constitute a basis for special assessment. Primrose Tapestry Co., supra; and Semon Bache & Co., 20 B. T. A. 275.

No abnormality within section 327 of the Revenue Act of 1918 having been shown to exist, in our opinion, the petitioner is not entitled to the benefit of the special assessment provision.

The petitioner contends that the collection of the unpaid balance of $9,589.04 of the original tax is barred by the statute of limitations. To refute this contention the respondent presented five waivers as set forth in our findings of fact, which he contended extended the statutory period of limitation.

Section 506 of the Revenue Act of 1928, amending section 278 of the Revenue Act of 1926, is as follows :

Sec. 606. WAIVERS AFTER EXPIRATION OF PERIOD OF LIMITATION.
(a) Section 278 (c) and (d) of the Revenue Act of 1926 are amended to read as follows:
*******
“(d) Where the assessment of any income, excess-profits, or war-profits taxes imposed by this title or by prior Act of Congress has been made (whether before or after the enactment of this Act) within the period of limitation properly applicable thereto, such tax may be collected by distraint or by a proceeding in court (begun before or after the enactment of this Act), but only if begun (1) within six years after the assessment of the tax, or (2) prior to the expiration of any period for collection agreed upon in writing by the Commissioner and the taxpayer before the expiration of such six-year period. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.”
(b) Section 278 of the Revenue Act of 1926 is further amended by adding at the end thereof a new subdivision to read as follows:
“ (f) Any agreement which would be within the provisions of subdivision (c)or (d) of this section but for the fact that it was executed after the expiration of the period of limitation extended by such agreement, shall be valid and effective according to its terms if entered into after the enactment of the Revenue Act of 1928 and before January 1, 1929.”
(c) The amendments made by this section to the Revenue Act of 1926 shall not be construed as in any manner affecting the validity of waivers made prior to the enactment of this act, which shall be determined according to the law in existence at the time such waiver was filed.

In examining these five waivers we find that the fourth waiver entered into on October 15,1928, extending the time within which to collect the taxes herein involved to December 31, 1929, comes squarely within subdivision (f) of the above quoted section, as it was entered into after the enactment of the 1928 Act, May 28, 1928, and before January 1, 1929. It is therefore valid and effective according to its terms. Knight-Campbell Music Co. et al., 23 B. T. A. 1233; F. A. Gillespie, 20 B. T. A. 1068.

The fifth waiver was executed October 16,1929, before the expiration of the time fixed in the fourth waiver, and provides that the unpaid portion of the income tax assessed for the year ended August 31, 1920, may be collected by distraint or by a proceeding in court begun at any time prior to December 31, 1930. Since the fourth waiver was validated by subsection (b) of section 506 of the Bevenue Act of 1928 and since section 506 (a), supra, provides that the period agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon, the fifth waiver in our opinion is also ■ valid and effective according to its terms.

Since we have concluded that the fourth and fifth waivers are valid and effective according to the terms thereof, it is unnecessary in our opinion, to consider and determine the validity of the first three waivers.

The guarantee by the First National Bank of Los Angeles to secure payment of the outstanding assessment in the event the claim in abatement filed by the petitioner was disallowed does not constitute a waiver of the statute of limitations. Gulf States Steel Co., 12 B. T. A. 1244; C. B. Shaffer, 12 B. T. A. 298.

Reviewed by the Board.

Judgment will be entered under Rule 50.

YaN Foss AN dissents.


author: Matthews:

text:
    Barnett Anchor Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 30994.
    Promulgated February 29, 1932.

      Melvin D. Wilson, Esg., and Joseph D. Peeler, Esq., for the petitioner.

      Arthur Garnduff~ Esq., for the respondent.
   OPINION.

Matthews:

The petitioner concedes that the respondent’s allowance for depletion on the oil lease in the amount of $209,243.73 for 1923, computed on the basis of its fair market value at the time acquired, as far as income for that year is concerned, is correct. In view of the fact that such computation is in accordance with the statute, we affirm the respondent’s determination of the deficiency for that year. We then have to decide the correct amount of depletion deductible from income for 1924 and 1925 and the amount of profit sustained on the sale of the petitioner’s 70 per cent interest in the lease in 1925. The resolution of both these questions hinges on the ultimate question of the basis to be employed in each instance.

As to the amount of depletion deductible from income for the year 1924, the Revenue Act of 1924 provides as follows:

Sec. 234. (a) In computing tlie net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
% s-s ijt *5* >5* #
(8) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.
Seo. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale, or other disposition of such property, * * *
Seo. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
• ***•••
(7) If the property (other than stock or securities in a corporation a party to the reorganization) was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss, recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made;
(8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.
# * * * * * *
Seo. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

In view of these provisions of the Act, we must determine whether the property in question was acquired under the provisions of section 204 (a) (7) or (8).

It should be noted in this proceeding that the individuals who had acquired the lease exchanged their interests in the lease for stock of the petitioner; that they at all times held title to these interests ; that they received stock in proportion to their interests, and til at after the exchange they controlled more than 80 per cent of the stock of the petitioner.

The petitioner immediately took over the interests in the lease and, according to the stipulation, “ dissolved ” the association. As wc view it the net result of these transfers was that petitioner corporation exchanged its stock for the interests in the lease and that (he same individuals who at all times owned these interests, and who also owned all the interests in the association, owned, after the transfer, over 80 per cent of the stock of the petitioner corporation. The transfer was not one of stock for stock, but a transfer by individuals of property for stock. In other words, the property was “ acquired by a corporation by the issuance of stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203,” and is, therefore, governed by the provisions of section 204 (a) (8) of the Revenue Act of 1924.

The petitioner contends, however, that it did not acquire property for stock, but that it acquired stock of the association or interests in the association for its stock; that it later caused the association to be dissolved, at which time it realized a profit or sustained a loss; and that the fair market value of the assets received from the association upon its dissolution is the basis to be used in determining later profit or loss. The petitioner lays a great deal of stress on its contention that the dissolution of the association is not a step in a reorganization.

It may indeed be questioned whether in any event an association could be a party to a reorganization within the meaning of the statute. However, we do not believe it is necessary to pass on this question. Counsel for the petitioner in his brief states that the petitioner exchanged stock for stock in the association, but there is no evidence of this. Neither is there any evidence submitted as to the nature of the association or that it even issued stock or certificates of interest therein. The lease was operated as an association by a committee acting for the owners from September 31, 1922, to January 8, 1923, but the individual owners retained title at all times to their interests in the lease. The stipulation, states that the petitioner caused the association to be “dissolved.” We have no knowledge that any formal steps were taken to effect this dissolution. The petitioner had already acquired the interests in the lease from individuals under the provisions of section 204 (a) (8).

We are, therefore, of the opinion that the basis for determining the depletion deduction allowable for 1924 is the same as it would be in the hands of the transferors, the individuals who transferred their interests in the lease for stock of the petitioner, and that this basis should be “ increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.”

The transfer of these assets to the petitioner took place in 1923, at which time the Revenue Act of 1921 was in effect, section 202 (c) (3) of which provides as follows:

Seo. 202. (c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized?—
* * * * * * *
(3) When (A) a person transfers any property, real, personal or mixed, to a corporation, and immediately after the transfer is in control of such corporation, or (B) two or more persons transfer any such property to a corporation, and immediately after the transfer are in control of such corporation, and the amounts of stock, securities, or both, received by such persons are in substantially the same proportion as their interests in the property before such transfer. For the purposes of this paragraph, a person is, or two or more persons are, “ in control ” of a corporation when owning at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

Since it is clear that under section 202 (c) (3) of the Revenue Act of 1921 no gain was recognized by the transferors upon the transfer in 1923, the basis for determining depletion for 1924 is the cost to such transferors. The parties have stipulated that the amount of depletion for 1924 computed upon such basis is $53,093.28.

With regard to the amount of depletion deductible from income for 1925, the Revenue Act of 1926 provides:

Sec. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that—
*******
(2) In the case of oil and gas wells the allowance for depletion shall be» 27% per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

The parties have agreed that the amount computed in accordance with this section is $35,952.33. This amount is greater than the depletion allowance would be if computed witbo.ut reference to this paragraph and such is the amount which the petitioner is entitled to deduct from its gross income for that year.

With regard to the basis for determining the profit from the sale in 1925, section 202 (a) (b) (2) of the Revenue Act of 1926 provides:

Sec. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized.
(b) In computing the amount of gain or loss under subdivision (a) —
*******
(2) The basis shall be diminished by the amount of the deductions for exhaustion, wear and tear, obsolescence, amortization, and depletion which have since the acquisition of the property been allowable in respect of such property under this Act or prior income tax laws; but in no case shall the amount of the diminution in respect of depletion exceed a depletion deduction computed without reference * * * to paragraph (2) of subdivision (e) of section 204. * * *

Section 204 (a) (7) and (8) of the Revenue Act of 1926 is identical with the same section of the Revenue Act of 1924, above quoted. Since we have already determined that the property was acquired by the petitioner for stock from individuals within the meaning of section 204 (a) (8), it is clear that in computing the profit from the sale the cost to the individual transferors (plus subsequent capital expenditures made by petitioner) should be used as the basis.

We are of the opinion that the provisions of section 202 (b) (2) mean that in determining profit or loss from a sale the basis shall be reduced by the aggregate deductions for depletion which the taxpayer was entitled to deduct from its gross income for each year in which the property had been owned by the taxpayer, computed under the law governing the determination of income for that specific year, except that the diminution for depletion for the years in which the 1926 Act was in force shall not exceed a depletion deduction computed without reference to paragraph (2) of subdivision (c) of section 204. Section 202 (b) (2) of the 1924 Act provides that in computing gain or loss on a sale, adjustment shall be made for any item of depletion “ previously allowed with respect to such property.”

Although prior revenue acts contained no provisions corresponding to section 202 (b) (2) of the 1924 and 1926 Acts, the Supreme Court, in United States v. Ludey, 274 U. S. 295, held that in computing the gain or loss under the 1917 Act the basis should be adjusted by the aggregate of the amounts of depletion which a taxpayer had been entitled to deduct from gross income. The court said:

We are of opinion that the revenue acts should be construed as requiring deductions for both depreciation and depletion when determining the original cost of oil properties sold. Congress, in providing that the basis for determining gain or loss should be the cost or the 1913 value, was not attempting to provide an exclusive formula for the computation. The depreciation charge permitted as a deduction from the gross income in determining the taxable income of a business for any year represents the reduction, during the year, of the capital assets through wear and tear of the plant used. The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost. The theory underlying this allowance for depreciation is that by using up the plant, a gradual sale is made of it. The depreciation charged is the measure of the cost of the part which has been sold. When the plant is disposed of after years of use, the thing then sold is not the whole thing originally acquired. The amount of the depreciation must be deducted from the original cost of the whole in order to determine the cost of that disposed of in the final sale of properties. Any other construction would permit a double deduction for the loss of the same capital assets.
»*»***•
The Court of Claims erred in holding that no deduction should be made from the original cost on account of depreciation and depletion; but it does not follow that the amount deducted by the Commissioner was the correct one. The aggregate for depreciation and depletion claimed by Ludey in the income tax returns for the years 1913, 1914, 1915 and 1916, and allowed, was only $5,156. He insists that more cannot be deducted from the original cost in making the return for 1917. The contention is unsound. The amount of the gain on the sale is not dependent on the amount claimed in earlier years. If in any year he has failed to claim, or has been denied, the amount to which he was entitled, rectification of the error must be sought through a review of the action of the Bureau for that year. He cannot choose the year in which he will take a reduction. On the other hand, we cannot accept the Government’s contention that the full amount of depreciation and depletion sustained, whether allowable by law as a deduction from gross income in past years or not, must be deducted from cost in ascertaining gain or loss. Congress doubtless intended that the deduction to be made from the original cost should be the aggregate amount which the taxpayer was entitled to deduct in the several years.
The findings do not enable us to determine what that aggregate is. The sale included several properties purchased at different times. The deduction allowable in the several years for each of the properties is not found. Under the Act of 1913 the full amount of the depletion was not necessarily deductible. In order that the amount of the gain in 1917 may be determined in the light of such facts, the case is remanded for further proceedings in accordance with this opinion.

In the case of J. M. Loffland, 10 B. T. A. 14, we held that for the purpose of determining gain or loss upon a sale in 1920 the amount of depreciation for the years 1913, 1914 and 1915 should be determined under the provisions of the Revenue Act of 1913, which were to the effect that individuals in computing net income were limited in their deductions for exhaustion, etc., in the case of mines, to 5 per cent of the gross value at the mines of the output for the taxable year.

We have already determined that the petitioner is entitled to deduct from gross income as depletion the following amounts: For 1923, $209,243.73; for 1924, $53,093.28; for 1925, $35,952.23. Obviously the provision in section 202 (b) (2), that the amount of diminution in respect of depletion shall not exceed a depletion deduction computed without reference to paragraph (2) of subdivision (c) of section 204, applies only to the years governed by the 1926 Act, since section 204 (c) (2) is only applicable to the determination of the depletion deduction for such years. The parties have stipulated that for 1925 the amount of depletion computed without reference to section 204 (c) (2) is $25,658.79, which is less than the depletion deduction computed under that section. It follows, therefore, that in determining the profit from the sale the cost basis should be reduced by the sum of the depletion allowable from gross income for 1923 and 1924, as set forth above, and $25,658.79.

One question remains, petitioner’s contention that the applicable provisions of the Revenue Acts of 1924 and 1926, which fix cost in the transferor’s hands, and not realizable market value at date of exchange, as the basis for depletion and for gain or loss on subsequent sale, are unconstitutional in that they deprive it of property without due process of law. This argument has already been answered. T. W. Phillips, Jr., Inc., 23 B. T. A. 1271; Osburn California Corporation v. Welch, 39 Fed. (2d) 41; certiorari denied, 282 U. S. 850; Newman, Sanders & Co. v. United States, 36 Fed. (2d) 1009; certiorari denied, 281 U. S. 760; Cf. Haas Building Co., 22 B. T. A. 528. Section 204 (a) (8) of the Revenue Act of 1924 and its corresponding section in the 1926 Act are not unconstitutional.

Judgment will be entered under Rule 50.


author: Matthews :

text:
    Central Union Trust Company of New York, as Executor of the Estate of Daniel T. Carrie, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 31736.
    Promulgated February 29, 1932.

      Frank W. Chambers, Esq., for the petitioner.

      Maxwell E. McDowell, Esq., for the respondent.
   OPINION.

Matthews :

In the notice dated August 12, 1927, there is asserted against the estate of Daniel T. Garrie a deficiency in tax for 1919 in the total sum of $124,167.75, of which amount the sum of $98,-524.53 represents a timely assessment made in March, 1925. The fraud penalty amounting to $49,262.27, which was also assessed in March, 1925, was withdrawn by the respondent at the hearing. It was admitted by the respondent that the balance of the deficiency in the sum of $25,643.22 was barred from assessment by the statute of limitations unless fraud could be shown and the respondent assumed the burden of proof in respect of fraud, in accordance with the provisions of section 601 of the Revenue Act of 1928. The total deficiency asserted was claimed by the respondent to have arisen out of the fraudulent understatement of income from the sale of cigarettes. Although the notice of deficiency does not clearly set out the method used in arriving at the proposed additional tax, it is stated in the brief filed for the respondent that the additional assessment in the sum of $98,524.53 was based on the disallowance by the respondent of a deduction for commissions which was claimed by Garrie in the sum of $361,737.30, and that the unassessed portion of the deficiency in the sum of $25,643.22 resulted from the action of the respondent in adding to the income reported by Garrie one-half of the profits from the business carried on under the name of A. H. Hillman Company.

We shall not discuss in detail the evidence which was introduced at the hearing, but a brief resume of the essential facts will prove helpful in outlining the issues presented for determination.

At the beginning of the taxable year Garrie was the holder of valuable orders for the sale of cigarettes to the Knights of Columbus and he had enlisted the aid of A. H. Hillman, who had been closely connected with the tobacco business for many years, in securing manufacturing sources to be utilized in filling these orders. Hillman testified that it was easy to get orders for cigarettes at this time, but that it was not so easy to supply the cigarettes. Hillman procured a factory in 1918 to manufacture cigarettes and the total output was applied toward filling the orders which had been obtained by Garrie from the Knights of Columbus. For several months during 1918 the sales were handled through the A. H. Hillman Company under contracts with the Turko-American Tobacco Company trading under the name of Oriental-American Tobacco Company. After December 23, 1918, the orders were filled by Garrie trading as the Oriental-American Tobacco Company. Garrie’s books were kept on the accrual basis, in the name of Oriental-American Tobacco Company. On December 30, 1918, Garrie entered into contracts with Hillman, with Konwiser (who was Hillman’s associate in publishing a trade paper) and with Hillman’s three sons, by the terms of which he agreed to pay to these parties commissions totaling 15 per cent of the gross sales of the Oriental-American Tobacco Company. These contracts determined the division between Garrie, on the one hand, and the Hillmans and Konwiser, on the other, of all profits derived in 1919 from the sale of cigarettes to the Knights of Columbus. The gross sales of cigarettes in 1919 amounted to $2,411,581.96, and 15 per cent of this amount is $361,737.30.

We do not know the underlying reasons for the execution of these contracts of employment. The petitioner claims that A. H. Hillman was in a position to dictate terms to Garrie and that Hill-man contrived to spread his share of the profits by having Garrie pay over such profits to himself, his three sons and Konwiser under the guise of commissions, it being contended by the petitioner that the three sons and Konwiser were dummies for Hillman and that he ultimately received the entire amount of the commissions which Garrie agreed to pay under the several contracts of employment. The respondent questions the tona fides of the contracts of employment, claiming that they were only a blind intended to obscure the real nature of the transactions. The respondent admits that the gross sales of cigarettes were correctly reported by Garrie, but has wholly disallowed the deduction for commissions in the sum of $361,737.30, on the ground that the sums making up this item were not in fact paid out by Garrie. It is further claimed by the respondent that certain payments which were apparently made in 1919 under the contracts of employment were repaid to Garrie in the same year.

Respondent contends that although the terms of the contract between Garrie and Hillman dated May 1, 1918, are not known, it may be inferred from other evidence that it provided for an equal division of the profits between them and that this original contract was revived by the cancellation on December 30, 1918, of the contract of December 23, 1918, so that the terms of the contract of May 1, 1918, remained in force throughout the taxable year. In addition to disallowing the deduction for commissions the respondent has included in Garrie’s income one-half of the profits from the business carried on under the name of A. H. Hillman Company.

On the basis of all the evidence adduced at the hearing we believe that petitioner has sustained the burden of proving that the respondent’s determination is incorrect and that the respondent has failed to establish that Garrie was guilty of fraud with intent to evade tax. Although the method of dividing profits from the sale of cigarettes may seem to be unusual, we find nothing in the record to impeach the bona fides of the contracts of employment. We have found that in compliance with the terms of these contracts Garrie paid by check in 1919 sums totaling one-half of the commissions due thereunder, proper entries being made on his books under the names of the several payees, and that the remaining one-half of the total commissions due was entered on his books as “ accrued commissions.” Inasmuch as his books were kept on the accrual basis, such an entry was authorized and he was entitled to claim as a deduction the full amount of the commissions, whether paid or accrued. Petitioner introduced in evidence Garrie’s books and records, together with a number of canceled checks, vouchers, receipts and other papers and this documentary evidence is relied upon to support the petitioner’s position. The book entries were not always made on the dates the respective transactions occurred, but were entered by Garrie’s accountant from time to time from vouchers, check stubs, invoices, receipts and other memoranda. The cash book entries show the numbers of the checks and the checks themselves were offered in evidence to show that the-money was received by the payees or by A. H. Hillman. The commissions which were accrued were shown to have been paid in cash and bonds in January, 1921, and an entry of payment of the balance due on the accrued commissions was made on Garrie’s books as of December 31,1920.

The respondent is claiming that even if these sums were paid to the persons “ employed ” by Garrie, the money was repaid to Garrie in the same year. An examination of the checks drawn by Garrie to Konwiser and the three Hillman sons shows that some of these checks were endorsed to A. H. Hillman and it was testified that no consideration moved from A. H. Hillman to his sons or to Konwiser for the amounts so received. Hillman testified that he turned back to Garrie in 1919 cash amounting to approximately $120,000. His testimony with respect to repayments to Garrie was greatly weakened by his imperfect recollection of the transactions and nothing in the record indicates that they exceeded $120,000.

We think the respondent has failed to establish that any of the amounts returned by Hillman to Garrie represented income to Garrie or was kept by him for his Own use. On the contrary, we have found that Garrie paid to Konwiser and the three Hillman sons in 1919, in addition to the payments covering one-half of the commissions due under the contracts of employment, an aggregate amount of $112,000, or $28,000 each, which payments were made by checks drawn by Garrie and were not charged on his books to the accounts of the several payees, but were charged in each instance to the Liberty bond account. No deduction is claimed on Garrie’s income-tax return for 1919 on account of the payment of these amounts totaling $112,-000. We do not know why Garrie should have paid out these sums only to take them back and invest them in Liberty bonds, which were subsequently turned over to the Hillmans in payment of accrued commissions, but we find the petitioner’s explanation, supported by Garrie’s books and the contracts, to be more plausible than the theory advanced by the respondent.

It must be borne in mind that Garrie is dead and can not come before us to explain the full nature of the transactions or to defend against the charge of fraud. The evidence leaves many loopholes and it is difficult to ascertain the true facts. Where no convincing explanation is given, we must draw whatever conclusion appears to be most reasonable, but fraud will not be imputed to a taxpayer in the absence of persuasive evidence.

The presumption that the respondent’s determination is prima facie correct does not extend to that portion of the deficiency in the sum of $25,643.22 which has not been assessed and which, in the absence of fraud, is barred by the statute of limitations. The respondent’s determination in respect of this amount admittedly rests upon the conclusions drawn by him from the books of the A". H. Hillman Company, but he has not produced those books. No evidence has been introduced to show that Garrie failed to report any income received by him in 1919 from the business of the A. H. Hillman Company, or that he was entitled to any share of the profits from such business.

It not appearing in the instant case that Garrie understated his income for 1919, and his return being supported in all particulars by his books and records, we are of the opinion that the respondent erred in rejecting the claim for abatement which was filed by the executors of his estate.

Judgment will be entered for the petitioner.


author: Arundell:

text:
    Francis Ward Paine, Robert H. Gross, Morris F. LaCroix, Stephen Paine and Isaiah R. Clark, Executors of the Estate of William A. Paine, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 34113.
    Promulgated March 2, 1932.

      Sidney P. Simpson, Esq., A. O. Reámele, Esq., John K. Watson, Esq., and Henry B. Fernald, O. P. A., for the petitioners.

      Arthur Garnduff, Esq., and Samuel L. Young, Esq., for the respondent.
   OPINION.

Arundell:

Petitioners contend that the interest item of $104,721.43 became taxable income in 1920, when the notes of the Chippewa Power Company were received, rather than in 1922, when the notes were liquidated. They urge that under the laws of both Wisconsin and Massachusetts the presumption is that a negotiable promissory note of a third person is given in satisfaction of a preexisting debt, rather than as mere evidence of the debt. See Quimby v. Durgin, 148 Mass. 104; 19 N. E. 14; The Kimball, 3 Wall. 37; Grubbe v. Lahay, 156 Wis. 29; 145 N. W. 207. Whatever the rule may be as between the maker and holder of the notes, it is not necessarily controlling in deciding the question of when income is realized. Hart v. Commissioner, 54 Fed. (2d) 848. But .granting that the rule urged is correct, the notes would be income in the year of their receipt only to the extent of their value. Aaron W. Wolfson, 1 B. T. A. 538; Percy K. Hexter, 8 B. T. A. 888. The evidence in this case is to the effect that the accounting practice of the partnership was to enter interest notes as income in the year of receipt, but in this instance they were not so entered because of the doubt as to their collectibility. The maker of the notes was without funds to pay them, and the value of the group of notes, covering both principal and interest, was not more than the amount of the principal. Under these circumstances we think it was proper not to record or report the interest notes as income in 1920 and that it was proper to include in income for 1922 the amount received in payment of them.

Whether the item of $153,000 was taxable income in 1922 depends upon whether the cost of the Chippewa Power Company bonds to the partnership was $900 per $1000 bond, as contended by petitioners, or $815 as contended by respondent. Petitioners contend, (1) that the oral agreement of May, 1922, fixed the price at $900 and that that agreement was not superseded by the written agreement, and (2) that, if the written agreement controls the transaction, it fixed a lump-sum consideration for both bonds and stock and an equitable apportionment should be made, based on the relative values of the two classes of securities. Kespondent argues that the written contract provides for a cost price of $815 for each bond, and as a matter of fact that was all that the partnership paid for the bonds.

Our view of the matter is that the written contract should be construed as providing for a lump sum to be paid for the bonds and stock and that the agreement to pay specified sums upon the delivery of each bond and each certificate of stock was merely a method of payment. The evidence is clear that such was the intent of the parties to the agreement, and, in so far as the bonds were concerned, it was carried out in that manner and so recorded -on the partnership books. Due to unforeseen circumstances the preferred stock could not be issued, but in lieu thereof the Chippewa Company issued its notes, which, the evidence shows, were of the same value in relation to the bonds as the stock originally contemplated. It is clearly established that the bonds were worth at least 90 and the stock not more than 85. In the face of this evidence it seems obvious that to hold that the cost of the bonds to the partnership was at the rate of 81%, as contended by respondent, would be to do violence to the intent and the agreement of the parties. Petitioners do not contend that the $153,000 was never income. On the contrary, they admit that it was, but they say that it was realized in 1926, when the transaction between the partnership and the Chippewa Company was brought to a conclusion. We are not called upon to determine whether it was income in 1926, but we are satisfied that it was not income in 1922. Even if it be conceded that the figures of $815 and $100 set out in the written agreement were designed to represent “ cost ” of the bonds and stock, respectively, we could not say, in the light of the evidence, that they were bona fide figures. Tax liability may not be fixed or evaded by means of inserting fictitious prices in contracts. Had the agreement provided, for example, that the partnership was to pay a sum considerably in excess of the face amount of the bonds, we clearly could not say, in view of the relation of the partnership and corporation and the evidence as to values, that a bona fide loss had been sustained upon the sale within a day or two at less than the face amount of the bonds.

We accordingly hold that the interest item of $104,721.43 was properly included in income in 1922, and that the amount of $153,000 income from the sale of bonds was not realized by the partnership in 1922.

Decision will be entered under Rule 50.