author: Smith :

text:
    Albert Russel Erskine, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 36400, 41514.
    Promulgated May 24, 1932.

      Robert N. Miller, Esq., and J. Robert Sherrod, Esq., for the petitioner.

      W. F. Wattles, Esq., and B. D. Daniels, Esq., for the respondent.
   OPINION.

Smith :

The petitioner’s contentions in these proceedings, as stated in his brief, are as follows:

(1) That no income [other than the $100,000 salary reported] was realized by him, except upon the sale oí the stock:.
(2) Alternatively, if petitioner realized any income as compensation prior to the sale of the stock it was realized in the year 1922 when the contract was received to the extent of its then value (not less than $800,000.00) and that any subsequent appreciation in value would be a capital gain realizable upon sale.
(3) Alternatively, if income was realized upon the purchase of the stock, petitioner’s assignee, his wife, realized the income on the purchase of the preferred and common stock applicable to 1922 operations and the purchase of the preferred stock applicable to 1923 operations.
(4) The dividends in excess of 7 per cent declared on the shares of common stock held in escrow by the bankers, which inured to the benefit of your petitioner and his wife under said contract, should be taxable to your petitioner and/or Ms wife only at surtax rates as dividends and not also at the normal rates as determined by the respondent.

It seems to us that the controlling question in these issues is whether the agreement of June 27, 1922, is to be regarded essentially its a contract of employment or whether it is, at least in part, a contract of purchase and sale. In other words, did the value of the rights to buy the shares of stock of the Studebaker Corporation in excess of the price required to be paid for them each year upon the terms and conditions named in the agreement represent compensation for services actually rendered % If so, then such compensation to whatever extent it represents realized income is taxable to the petitioner in the years of its receipt, notwithstanding his assignments of all or a part of it to his wife in 1922 and 1923. Lucas v. Earl, 281 U. S. 111.

The agreement itself, which appears in full above, bears all of the essential characteristics of an ordinary employment contract. The petitioner was to serve as president of the corporation, or in some position of equal dignity, for a period of between four and five years, beginning January 1, 1922, and was to receive a fixed annual salary of $100,000 and further consideration in the form of rights to acquire certain shares of stock of the corporation at an advantageous price, contingent upon the corporation’s profits.

It is well established by the evidence, and the petitioner does not deny, that the rights to acquire the shares of stock at the prices named in the agreement were of great value. The contention is made, however, that the predominant motive of the corporation in entering into the agreement was to have the petitioner become a substantial stockholder in the corporation, and that the rights to acquire the shares of stock were offered for that purpose and not as compensation for the-petitioner’s services. This was the burden of the testimony of Frederick S. Fish, chairman of the board of directors and the controlling figure in the corporation at that time.

We have no reason to doubt that one of the purposes of the corporation in entering into the agreement was to have the petitioner become a large stockholder, nor do we question the wisdom of the plan adopted for carrying out that purpose. However, we do not understand that this answers our question. What we must determine is whether and to what extent what was received by the petitioner under the agreement is taxable to him as compensation. It is well to observe that the purpose of the corporation to have the petitioner become a substantial stockholder might have been carried out just as effectively by other plans which would have left no doubt as to the petitioner’s tax liability upon the receipt of the shares of stock. For instance, the agreement might have provided that the petitioner should receive for his services the fixed yearly salary of $100,000 and the right to a certain number of shares of stock of the corporation to be determined upon the basis of the earnings. Or, it might have provided that the petitioner should receive only the right to shares of stock for his services. In either case the rights would be taxable to the petitioner as compensation in the year when received by him, if reporting on a cash basis, to the extent of their fair market value at that time. Rodrigues v. Edwards, 40 Fed. (2d) 408; Lyle H. Olson, 24 B. T. A. 102; James R. Lister, 3 B. T. A. 475; Roscoe H. Aldrich, 3 B. T. A. 911; Anthony Schneider, 3 B. T. A. 920; Charles F. Pearce, Jr., 6 B. T. A. 450; Charles B. Johnson, 8 B. T. A. 992; C. A. Tilt, 14 B. T. A. 437; Fred J. Collins, 16 B. T. A. 1426; H. L. Carnahan, 21 B. T. A. 893. The final results were the same as if the petitioner had received only the rights to the shares of stock for each year’s services, since he was required to pay back to the corporation the exact amount of his cash salary already received in exchange for the shares of stock to which he was entitled in each year.

We are convinced from a study of the instrument itself and the circumstances disclosed by the evidence that the agreement must be considered primarily as a contract of employment. It superseded a prior employment agreement under which the petitioner had received a total compensation of $256,276.40 in 1920, $342,963.17 in 1921, and $382,636.85 in 1922, although his regular salary was not in excess of $100,000 in either year. These amounts represented the regular annual salary and bonuses computed on the prior year’s profits. With the prospect favorable for a continuation of the corporation’s large profits the petitioner might reasonably have expected to receive, under the prior employment agreement, compensation of at least $300,000 or $400,000 a. year. In the new agreement the corporation sought to reward the petitioner on account of u the very satisfactory and gratifying condition of the Corporation due in large measure to your able administration.” This purpose certainly would not have been served by reducing the petitioner’s compensation to one-third or one-fourth of that received under the prior agreement. Yet, that is the result if we eliminate from the petitioner’s compensation under the new agreement his rights with respect to the acquisition of the shares of stock. The contract does not expressly limit the petitioner’s total compensation to $100,000 a year. It merely provides for a fixed yearly salary of that amount. The rights to acquire the shares of stock, contingent upon profits, may reasonably be considered as taking the place of the cash bonus which was paid under the priod contract.

We see no basis- for construing that portion of the agreement relating to the petitioner’s rights to acquire the shares of stock separately as a contract of purchase and sale. In the first place, the petitioner was not obligated to purchase the stock, but might do so at his own option, contingent upon the corporation’s profits. The only true consideration for which the petitioner was obligated was his promise to serve the corporation for the period covered by the agreement. This consideration undoubtedly extended to all of the provisions of the contract. The petitioner’s promise to pay at his own option $10 and $25 per share, respectively, for the common and preferred shares that had a ready market value of many times those amounts would hardly constitute a fair or adequate consideration to support a contract of purchase and sale. The officers and directors of the corporation had no lawful right to make a gift to the petitioner of any part of the value of the shares of stock, or to “ sell ” them to the petitioner at a price known to be considerably less than their cost or market value. We must assume that the officers and directors did not act unlawfully. Noel v. Parrott, 15 Fed. (2d) 669.

We are aware that the agreement refers to the petitioner’s rights to acquire the shares of stock as the “ option to buy and receive,” but we must look to the things done rather than to the language employed, to the substance rather than the form. Weiss v. Steam, 265 U. S. 242. As said in Alger-Sullivan Lumber Co. v. Commissioner, 57 Fed. (2d) 3:

The use of the word “ sale ” in a contract does not necessarily conclusively determine its character. ■ Its meaning may be qualified and the word deprived of its ordinary force by other provisions of the agreement. * * *

In that case the court reversed the Board’s decision (20 B. T. A. 1109) in which the Board denied the taxpayer, the employer corporation, the right to deduct as a business expense the market value of certain shares of its stock allegedly paid to its employees as compensation. The court further said:

* * * It is evident that petitioner intended in good faith to give bonuses in stock to valued employees as additional compensation and there was no intention to make an outright sale of stock to them. The Board was wrong in holding the transactions to be sales.

In Martha Briggs Phelps, Executrix v. Commissioner, 54 Fed. (2d) 289, the court said:

If, under the facts stated, we are bound by the plain- meaning of the language employed in the resolution referred to in the statement of facts, then of course the transactions in controversy should be considered as sales, for that is what the resolution termed them, and pursuant thereto there was an exchange of stock for money. But in all relations of life it oftentimes happens that the thing done speaks so audibly that equity is prevented from hearing the language of the parties, and will classify the act by its real name rather than by the name which the interested parties have given it. In such instances the substance of the transaction will control the form, and the Board therefore was warranted in considering both form and substance in arriving at its conclusion. United States v. Phellis, 257 U. S. 156; United States v. Klausner, 25 F. (2d) 608.
That taxing statutes cannot be intentionally circumvented by anticipatory arrangements and contracts is settled by the principle laid down in Lucas v. Earl, 281 U. S. 111. * * * In liquidation of corporations it is quite proper and usual to take up the certificates of stock upon making the final distribution of assets. Such a transaction, however, is not to be regarded primarily as a sale of stock, although it has some such characteristics. It is more than a sale; it is primarily a liquidating distribution, and the sale, if it be such, is but an incident to the transaction. * * *

That the Studebaker Corporation regarded the entire agreement as an employment contract is indicated by the fact that in its income-tax returns for the years 1923, 1924, 1925, and 1926 it deducted as compensation paid to the petitioner not only the yearly salary of $100,000, but also amounts representing approximately the value of the shares of stock acquired by the petitioner under the agreement in each year less $100,000, the amount paid for them by the petitioner or his assignee. The petitioner himself, as president of the corporation, signed the returns. He testified that he knew at that time that the corporation had deducted the cost of the shares of stock, but did not know that the deductions were classified as compensation paid to him. The fact that the corporation in its returns treated the transfers of the shares of stock to the petitioner as payments for compensation is, of course, not determinative of the petitioner’s tax liability, but unquestionably it does show that the corporation put a different construction upon the agreement from that contended for by the petitioner. In Noel v. Parrott, supra, the court said:

* * * It needs neither argument nor citation of authority to establish the proposition that the directors were without authority to give away the corporate assets, and that for them to mate to several of their members and other persons a gift of a large sum of money from the corporate assets would be neither “ wise ” nor “ proper,” and would amount to an illegal misapplication of corporate funds. We must assume that the directors did not intend such a flagrant violation of their trust. Delaware, L. & W. R. Co. v. Kutter, (C. C. A. 2nd) 147 F. 51, 77 C. C. A. 815; Hobbs v. McLean, 117 U. S. 567, 6 S. Ct. 870, 29 L. Ed. 940; U. S. v. Cent. Pac. R. Co., 118 U. S. 285, 6 S. Ct. 1038, 30 L. Ed. 173. It is no answer to this position to say that the stockholders ratified the gift by accepting the offer of $75 per share after notice that the distribution was to be made, for we are dealing with the interpretation of the resolutions, not with the validity of the action taken under them. And that this interpretation was the one intended is shown by the subsequent action of the corporation in claiming the disbursements made under the resolution as salary deductions from gross income.

The agreement here placed no restriction whatever upon the sale of the stock by the petitioner. On the day of its receipt in each year the petitioner might have sold all of the shares of stock in the open market at prices commensurate with the amounts which the respondent has included in the petitioner’s income. It was entirely optional with the petitioner whether he should keep the shares of stock or should immediately convert them into cash. Since there was admittedly a readily realizable market value for the stock this was tantamount to an option to receive either the shares of stock, or the equivalent, that is, the differential in value, in cash.

It has been recognized that under some conditions rights to purchase shares of stock may constitute taxable income. In B. F. Saul, 4 B. T. A. 639, the petitioner and other stockholders of a District of Columbia bank sold their shares of stock in the bank, receiving for each share $400 cash and the right to subscribe for four shares of other stock in a newly organized trust company at $100 a share. The new stock had a value of $220 a share. We said:

* * * The right of each Bank stockholder to purchase four shares of the Trust Company’s stock at $100 a share was a part of the consideration which the Trust Company agreed to pay for the Bank’s stock, and the value of that right should be considered in measuring the profit realized by the Bank stockholders to the same extent as if it had been cash. The amount received by the Bank stockholders for their stock was, therefore, $400 a share, plus the value of the right to subscribe for four shares of the Trust Company’s stock at par.
Under the provisions of the contract and under all of the evidence submitted, the Board is of the opinion that the fair market price or value of the right received by each Bank stockholder to subscribe to the Trust Company’s stock at par was $120 a share. The result therefore is that the price received by each Bank stockholder for each share of Bank stock sold was $400, plus $480, the value of the right to subscribe for four shares of the Trust Company’s stock, or $880 a share. This amount, less the cost or March 1, 1913, value of the Bank stock, which is not in dispute, is the proper measure of the profit per share of the Bank stock to each of these taxpayers.

James F. Shea, 11 B. T. A. 557, involving the identical facts, the taxpayers being other parties to the same transaction, was decided upon authority of the Saul case- The latter case was appealed and was affirmed by the Court of Appeals of the District of Columbia in Moran v. Lucas, 30 Fed. (2d) 546. The court in its opinion said:

It appears by competent and convincing evidence that at the time of this transaction the stock of the American Security & Trust Company possessed a fair market value of $220 a share. In practical effect therefore the owner of a share of stock in the Home Savings Bank received $400 in cash for each share of stock transferred by him, and became entitled to convert the $400 thus received into four shares of the stock of the American Security & Trust Company, having at the time an aggregate fair market value of $880. The modus operandi thus pursued was induced by certain restrictions prescribed by the -laws relating to corporations in the District of Columbia. However, it was manifestly contemplated by the contract that the vendor of each share of stock would avail himself of the right to secure, in payment thereof, the stipulated shares of stock in the other corporation having a value of $880, instead of resting satisfied with $400 in cash.
**4*4*4
Appellants contend that the subscription right was not transferable, and therefore had no market value. We do not agree with this view, for it does not appear that the right, when matured, was not transferable, and in any event it was a property right which permitted the holder of each share of stock to buy for $100 a security having a present market value of $220. It may be noted that the appellants in fact availed themselves of this right, and that it was a substantial part of the consideration which induced them to part with their original holdings.
The uppollants contend that the subscription right cannot represent any taxable income until a sale is made of the stock purchased under its terms. It is argued that, until a sale is made, the value of the stock thus secured cannot be definitely ascertained, nor determination made of the loss or profit resulting therefrom. We think, however, that the question is one of present value, and the price realized on actual sales made in the usual and customary manner is admissible to fix such value. See Appeals of B. F. Saul, et al., 4 B. T. A. 639, involving the same transaction as this, but with other stockholders as parties.

We can see no difference in principle between those cases and the instant case. There, the rights to subscribe for the shares of stock at less than value were received in consideration for the sale of other stock. Here, the rights to subscribe for the stock at less than value were received in consideration for services performed. The question of the taxability of the rights to receive the shares of stock is substantially the same.

The instant case is distinguishable from those in which it has been held that no taxable gain results from the bona fide purchase of shares of stock at a bargain price, Rose v. Trust Co. of Georgia, 28 Fed. (2d) 767; George W. Van Vorst, Executor, 22 B. T. A. 632; Taplin v. Commissioner, 41 Fed. (2d) 454; Miles v. Safe Deposit & Trust Co., 259 U. S. 247, or from the purchase by an officer or employees, under a general corporate plan, of shares of stock of a corporation at par or for less than market value, Durkee v. Welch, 49 Fed. (2d) 339. In Durkee v. Welch, supra, one of the cases relied upon by the petitioner, the court said:

The plan involved in this case does not present any question of bonus or profit sharing as such terms are used in income tax matters. The corporation offered an opportunity to its employees, in order to arouse their interest in the welfare of the company and to increase their efficiency as workers therein, to become participants in its prosperity by purchasing its common capital stock and by paying the full par value thereof out of their own money. There was no gift of the stock and there was no distribution of it as a bonus. The right or privilege conferred upon such employees was substantially the same as corporate transactions whereby stockholders are permitted to subscribe at par for stock which is worth more than par in the market. Such transactions result in no taxable income to the purchasing stockholders until they shall liave sold their stock and actually realized a profit thereon. Miles v. Safe Deposit Co., 259 U. S. 247, 42 S. Ct. 483, 66 L. Ed. 923. I see no reason for discriminating between stockholders of a corporation who are thus permitted to purchase stock at par and employees of a corporation who are permitted to do the same tiling.
* * * It is incorrect to state that the plaintiff received his stock as piart of a profit-sharing plan in the nature of compensation for service rendered as an employee of long standing, because under the terms of the arrangement plaintiff could have paid the full amount of the purchase price the day after he made his subscription and could have taken his stock at that time and could have left the employ of the company. Under such circumstances, it cannot be said that the stock is in reality compensation for future services, or that any value of the stock in excess of the amount paid for it was additional compensation.

The facts in the instant case are materially different. The agreement under which the petitioner received his rights was no part of a general corporate plan. It included no other officer or employee. There is ample evidence, too, that the petitioner’s rights to acquire the stock were “ in the nature of compensation for services rendered ” or a “ bonus.” The petitioner here could not have bought his shares of stock until he had performed the services required of him. He assumed no risk in the possible event of a subsequent decline in the market value of the shares below the price named in the agreement because he was under no obligation to purchase them.

The petitioner also relies upon Rose v. Trust Co. of Georgia, supra. In that case, the Circuit Court of Appeals for the Fifth Circuit, affirming the lower court, held that a transaction through which certain shares of stock were purchased at a price considerably less than their market value resulted in no taxable gain to the purchasers, since the transaction was apurchase in good faith.” The court said:

Conceding that compensation for personal services may be paid in property, instead of in money, and that income taxes may be assessed on the value of the property, we agree with the District Court that the transaction here in question was a purchase in good faith. In such case no taxable income would be derived until the disposal of the stock, except, of course, that arising from dividends. Eisner v. Macomber, 252 U. S. 189, 40 S. Ct. 189, 64 L. Ed. 521, 9 A. L. R. 1570; McCaughn v. Ludington, 268 U. S. 106, 45 S. Ct. 423, 69 L. Ed. 868.

The facts permitting, we would unhesitatingly apply that principle in the instant case but, as we have said, we can not regard the substance of the transactions here merely as a purchase and sale. This does not imply, as the petitioner argues it must, that the transaction was a fraudulent and unlawful attempt to evade taxes or even that it was an attempt lawfully to avoid the taxes. We are not confronted with these alternatives in the matters before us. Our question is whether the transaction was in substance and effect a plan to compensate the petitioner for his services, or a bona fide purchase and sale. Cf. L. Schepp Co., 25 B. T. A. 419, 436; Taplin v. Commissioner, 41 Fed. (2d) 454; Budd v. Commissioner, 43 Fed. (2d) 509. There is not the slightest evidence of the latter except as found in the bare words of the agreement.

We doubt that a further discussion of the numerous cases cited by the parties in support of their contentions with respect to this issue would prove helpful. It suffices to say that we do not regard any of them as controlling here. Our determination that the entire value derived by the petitioner under the agreement of June 27, 1922, represented compensation for services rendered to the Studebaker Corporation is necessarily based upon the facts disclosed by the evidence in this case. See Joseph W. Robinson, 21 B. T. A. 907; E. Louis Jacobs, 20 B. T. A. 529.

The petitioner’s alternative contention that the income, if any, received by him as compensation under the agreement was realized in 1922 when the agreement was entered into, or when the contract was received by him, to the extent of its then value of not less than $800,000, must also be denied. While the contract may have had the assignable value claimed for it by the petitioner at the time of its receipt, this value does not in any sense represent realized income to the petitioner in that year. It could not be determined definitely until the end of each year and until the profits had been computed just what amount of stock the petitioner would be entitled to buy under the agreement. With exceptions not here material, the petitioner was not entitled to buy any of the stock until he had performed the services required of him. The construction of the agreement as a contract for services to be performed by the petitioner seems in itself a complete denial of the contention that the income resulting therefrom was realized in the year of the execution of the contract rather than in the years of its performance. The statute clearly provides that the “ gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid * * * shall be included in the gross income for the taxable year in which received by the taxpayer.” See section 213 (a), Eevenue Acts of 1921, 1924, and 1926.

A similar question was considered by the Board in John A. McPherson, 22 B. T. A. 390. The petitioners in that case were contending that the amounts received by them in subsequent years in performance of certain contracts entered into prior to 1913 were taxable to them only to the extent of the excess of such amounts over the March 1, 1913, value of the contracts. The Board, in denying the contention, said:

* * * Petitioners, on March 1, 1913, not only liad no right to demand any specific sum, but had no right to make any demand under the contracts. What, if anything, they were to receive depended entirely on what the future might hold. Payment, when and if made, was to be not only for services rendered by the partnership prior to March 1, 1913, but covered as well services to be rendered by the petitioners after that date. They were to continue to perform certain duties until such time as the timber would be sold and it was impossible at March 1, 1913, to tell when that would be.
.Regardless of whether the contracts had an ascertainable value at the basic date, the question of law presented has been decided adversely to petitioner’s claim in a number of cases. * * * [Citing Edwards v. Keith, 231 Fed. 110, certiorari denied, 243 U. S. 638; Woods v. Lewellyn, 252 Fed. 106; Workman v. Commissioner, 41 Fed. (2d) 139, affirming W. F. Workman, 14 B. T. A. 1414; E. S. Jones, 6 B. T. A. 1048; and J. Noble Hayes, 7 B. T. A. 936].

See also Benedict Crowell, 21 B. T. A. 849; Old Colony Trust Co. et al., Administrators, 22 B. T. A. 1062; Kaufmann Department Stores, Inc., 11 B. T. A. 949; affd., 34 Fed. (2d) 257.

We are also of the opinion that the respondent was correct in allocating to the years 1923, 1924, 1925, and 1926 the additional compensation or bonus received in those years based upon the profits of the business in the preceding years 1922 to 1925, respectively. The contract of June 27, 1922, provided that the petitioner should “ have the right and option to buy and receive, at any time after the completion of the annual audit for any and each such year and prior to January 1, 1927,” the additional shares which were acquired. The audit for 1922 was not completed until sometime in 1923, shortly after which the compensation shares were acquired by the petitioner or his assignee. The same is true for the subsequent years. The amount of the bonus or additional compensation received each year was the value of the rights to acquire the additional shares with accrued dividends. The respondent has computed this value as the difference between the market value of the shares with accrued dividends over the price which the petitioner was required to pay therefor. No evidence was offered that the value of the rights was otherwise.

As we have already indicated, we are of the opinion that the issue relative to the petitioner’s assignments to his wife in 1922 and 1923 of his rights to acquire certain of the shares of stock, such rights representing compensation for services to be performed, is controlled by the decision of the Supreme Court in Lucas v. Earl, supra. The petitioner seeks to distinguish the instant case largely upon the grounds that the assignments here were of the option to purchase the shares of stock and not, as in the Earl case, of future earnings from services to be performed. This distinction is, of course, predicated upon the petitioner’s earlier contention, which we have decided adversely.

At the time of the assignments here the petitioner had no clear option to purchase any of the shares of stock. His rights to acquire the stock depended entirely upon the contingency of the corporation’s earnings and the continuation of his services. The option itself at its maturity represented compensation for services.

As we understand the Earl case, it holds that future income from personal services can not be assigned to another so that it will not be taxable first to the assignor who earns it. Citing the sections of the Revenue Act of 1918 corresponding to those of the later acts applicable to the years here involved, the court said:

* * * There is no doubt that the statute could tas salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew.

In his supplemental brief the petitioner cites Ferguson v. Nelson, 51 Fed. (2d) 121. In that case the taxpayer in 1917 assigned to his wife his interest in a certain contract under which he was to receive from a corporation one-third of the profits from a patented article invented by him. The court, in holding that the income from such contract in the years 1917 to 1921, inclusive, was taxable to the assignee, pointed out that the assignment was of a property right presently existing ” and not “ of future earnings of the assignor arising out of his future services, as in the Earl and Luce cases.” There is nothing in the court’s opinion in the Earl case to indicate that any different conclusion would have been reached if the assignment there had been of the assignor’s interest in an employment contract under which he was to receive compensation for personal services. Elizabeth D. Smith et al., Executors, 25 B. T. A. 291, and William Ernest Seatree, 25 B. T. A. 396, also cited by the petitioner, are distinguishable upon the same grounds as Ferguson v. Nelson, supra.

If we are correct in our conclusion that the value of the rights measured by the excess value of the shares of stock acquired by the petitioner or his assignee in each year under the agreement represented compensation for services, then, under the rule in the Earl case, we think that such compensation must be taxed to the petitioner as his own income, regardless of the assignments to his wife. See also Burnet v. Leininger, 285 U. S.; 136; Edward J. Luce v. Burnet, 55 Fed. (2d) 751; Parker v. Routzahn, 56 Fed. (2d) 730.

The remaining issue is whether the dividends in excess of 7 per cent declared on the common stock held by the escrow agent and received by the petitioner or his wife along with such shares of stock in 1923, 1924, 1925, and 1926, are taxable to the petitioner as dividends at the surtax rate only, or as ordinary income at both the surtax and normal rates.

We can see no reason for treating the accrued dividends, which under the terms of the agreement went to the petitioner along with the shares of stock, in any different manner from the rights to buy the shares of stock themselves, that is, as compensation for services. The petitioner was not a stockholder in respect of the escrow stock until it was received by him. The dividends declared thereon during the escrow period were therefore not the petitioner’s dividends. It was not known at the time of the declaration of the dividends whether the petitioner would ever receive the stock or the dividends. In Roscoe H. Aldrich, 3 B. T. A. 911, we held under similar facts that certain amounts representing dividends declared on shares of stock held in escrow for payment to an employee as compensation for. services under a five-year employment contract were taxable to the petitioner as compensation. We are of the opinion that the amounts of the dividends received by the petitioner in each of the years as shown above are taxable to the petitioner as ordinary income and not as dividends.

It appears from the deficiency notices that the respondent has added to the petitioner’s income as compensation received in each year the difference between the amount of cash which the petitioner paid in acquiring the shares of stock and the fair market value of the stock received at that time, plus the accrued cash dividends in excess of 7 per cent which were turned over to the petitioner or his wife with the shares of stock. For illustration, the deficiency notice covering the year 1926 shows an addition to salary of $979,-176.56, with the explanation that “this amount is the excess value of compensation stock over amount paid by you, plus amount measured by excess of dividends of 7% paid into escrow account before ownership of the stock.” We assume that the respondent has correctly determined the fair market value of the shares of stock in question and of the rights to buy such shares upon the dates of their receipt by the petitioner and his wife, since no objection on this point has been raised. The amount thus determined in respect of the rights to buy the shares of stock received in each year plus the cash salary of $100,000 is the amount of compensation taxable to the petitioner in each of the years 1923 to 1926, inclusive.

Reviewed by the Board.

Judgment will be entered under Rule 50.


source: Caselaw Access Project

author: Matthews:

license: Public Domain

text:
    Twin Bell Oil Syndicate, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 29518.
    Promulgated May 25, 1932.

      John B. Millihen, Esq., George H. Roster, Esq., and Olaude I. Parlcer, Esq., for the petitioner.

      J. L. Baolcstrom, Esq., and Arthur Garndujf, Esq., for the respondent.
   OPINION.

Matthews:

The only issue which need be considered is whether the petitioner is a trust or an association taxable as a corporation.

The petitioner filed returns as a trust for 1922 and 1923, the 1922 return being filed on May 15, 1923, and the 1923 return on March 14, 1924. The petitioner contends that it is taxable as a trust for these years by virtue of section 704(a) of the Revenue Act of 1928, set out in the margin.- The rulings of the Commissioner referred to in this section are those cited in E. A. Landreth, 15 B. T. A. 655; Wilkens & Lange, 15 B. T. A. 1183; Woodrow Lee Trust, 17 B. T. A. 109; and Van Cleave Trust, 18 B. T. A. 486.

In actual practice, as well as under the terms of the trust instruments, the trustees had exclusive and complete control and management of the trust property. They kept the records of the trust; they determined the policy with respect to the declaration of dividends ; they fixed the amounts of reserves to provide for contingent liabilities; they negotiated and executed the contracts for the disposal of the oil and gas produced from the trust property, and in general conducted all the affairs of the trust, whatsoever they might be. The trustees alone could renew their numbers and alone (but unanimously) could alter or amend the trust. The beneficiaries had no voice in these matters, never held a meeting, and had no rights -in connection with the actual operation of the trust. All certificates of beneficial ownership declared on their face that they were issued subject to all the provisions of the original trust instrument as amended, and that the liability of holders was limited to the trust property.

The petitioner was organized to carry on actively, and did so carry on, the business of drilling for oil and selling oil from its wells. In doing so, however, it was controlled absolutely by the trustees. It bore no resemblance in this respect to a corporation which is controlled and directed by its stockholders acting through directors. The trustees were here the real masters of the situation, unchecked by the veto of the holders of the beneficial interest.

We held in the four decisions of the Board cited above that under the rulings of the Commissioner in force during the years 1922 and 1923, the Bureau was consistently holding that irrespective of whether the taxpayer was engaged in business under corporate forms, it was taxable as a trust in all cases where the shareholders could not control the actions of the trustees. The petitioner meets this test.

As the petitioner filed returns as a trust for the years 1922 and 1923, and is within the definition of a trust applied by the Commissioner in 1922 and 1923, it is taxable as a trust for such years. Our conclusion makes it unnecessary to consider the second issue.

Judgment will be entered for the petitioner.

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


text:
    Twin Bell Oil Syndicate, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45052.
    Promulgated May 25, 1932.

      John B. Milliken, Esq., George H. Roster, Esq., and Claude I. Parher, Esq. for the petitioner.

      J. L. Bael&strom, Esq., and Arthur Carnduff, Esq., for the respondent.
   OPINION.

Matthews:

1. The first question is whether in 1925, 1926 and 1927 the petitioner must be regarded as a trust or as an association. For the years here involved petitioner may not avail itself of section 704(a) of the Revenue Act of 1928 as it did in the proceeding for the prior years 1922 and 1923, Docket No. 29518, and the tests to be applied in distinguishing a trust from an association must be those which this Board and the courts have found applicable in 1925 and subsequent years.

The Commissioner amended article 1504 in his Regulations 65 (Revenue Act of 1924), distinguishing a trust from an association in accordance with the test laid down in the Supreme Court’s decision in Hecht v. Malley, 265 U. S. 144. The explanation of this volte-face is given in G. C. M. 6517, C. B. VIII-1, p. 152, at pp. 153, 154 (June 24, 1929).

The Reoht case has been so fully discussed in our prior decisions that it is unnecessary to consider it in detail here. As we pointed out in our decision in the Morris Realty Trust, 23 B. T. A. 1076, the Supreme Court put aside, apparently, the “ control ” test and substituted therefor business purpose, business operations and quasi-corporate structure.

A business enterprise, such as the petitioner’s, created to drill for oil, and carrying on such operations, falls within the category of associations. The petitioner’s organization was accomplished by Lipps and. his cotrustees with a definite business purpose in mind, and the drilling of oil wells by the petitioner on its leased land, although by contract, was clearly a business operation. In the taxable years the petitioner was under the exclusive control of the trustees, but that is beside the point. It did not have in some respects a quasi-corporate form. The trust declaration had been amended again on March 14, 1925, and the annual meeting of the unitholders was left to the trustees to call at their discretion, by the substitution of “ may ” for “ shall ” in paragraph twelfth. Paragraph eighteenth prohibited the trustees, except by their unanimous consent, from acquiring new property or selling the old. But the unitholders held transferable certificates which might be transferred like corporation stock. Under paragraph fifth the trustees and unitholders disclaimed any liability beyond the trust corpus. Petitioner was empowered to act under a common seal. The trustees assumed the style of “ officers,” although Lipps testified their duties remained undifferentiated. The trustees received salaries during the years here involved. Aside from the exclusive control resident in the trustees, petitioner’s organization resembles in purpose and in form that of a corporation.

The instant case is very similar to that of Little Four Oil & Gas Co. v. Lewellyn, 29 Fed. (2d) 137; aff'd., 35 Fed. (2d) 149; certiorari denied, 280 U. S. 613, in which the court held the taxpayer an association taxable as a corporation, saying, “The real test is whether the stockholders or trustees, or both combined, carry on business for profit * * *." White v. Hornblower, 27 Fed. (2d) 777.

Petitioner relies strongly upon Extension Oil Co., 16 B. T. A. 1028; aff'd., 47 Fed. (2d) 65, in which under facts somewhat similar to those of the instant case we held a body to be a trust and not an association. But that case can be easily distinguished. There, the organizers combined for the sole and restricted purpose of drilling a single oil well for test purposes, and as soon as the value of the leased land was thus learned, of selling the lease. This purpose was promptly carried through in eleven months time. Here, the original trust agreement ran for twenty years and as amended for fifty, and the trustees were given full powers to develop the lease as they saw fit. They did, it is true, distribute the profits when made, but this fact of distribution does not, in our opinion, negative the petitioner’s obvious business purpose. It was carrying on a business enterprise and was fearful, as one of its trustees confessed, all the time of being treated for Federal tax purposes as an association. This fact accounts for the excessive circumspection apparent in the amendment of its trust declaration on March 14, 1925.

Quasi-corporate form is not an indispensable element of an “ association.” Sears, Roebuck & Co., etc., Fund v. Commissioner, 45 Fed. (2d) 506. But business purpose and activities are criteria which clearly bring the petitioner within the category of associations. Willis v. Commissioner, 58 Fed. (2d) 121, affirming 22 B. T. A. 564. Cf. Russell Tyson et al., Trustees, 25 B. T. A. 520.

We are of the opinion that petitioner was an association in 1925, 1926 and 1927 and taxable, therefore, as a corporation.

2. The authority for a deduction by a corporation for depletion in the case of oil and gas wells for the taxable years is contained in section 234(a) (8) of the Revenue Act of 1926, which reads as follows:

Seo. 234. (a) In computing tlie net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * * * * * *
(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;
* sis * * * *:« *

The above provision is mandatory in two respects; first, that there shall be allowed as a deduction a reasonable allowance for depletion, and, second, that such deduction shall, in the case of leases, be equitably apportioned between the lessor and the lessee.

The basis for determining depletion under the 1926 Act is prescribed in section 204.(c), paragraph 2, which reads as follows:

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, 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 basis of a depletion allowance, computed without reference to the above paragraph, would be cost or March 1, 1913, value. Sec. 204(a) and (b).

Reading the two sections together, that is, the one authorizing a deduction for depletion and the other prescribing the basis, it is clear that the reasonable allowance for depletion in the case of oil and gas wells on leased property, which- is to be equitably apportioned between the lessor and the lessee, is 27% per cent of the gross income from the property during the taxable year. If the portion of such allowance which is equitably apportioned to the taxpayer (lessor or lessee) is more than 50 per cent of the net income of such taxpayer, it is required to be reduced to an amount not in excess of 50 per cent of such net income, and if the amount apportioned to the taxpayer (the lessor or lessee) is less than it 'would be if computed without reference to paragraph 2, the allowance is to be based on the cost or the March 1,1913, value.

The petitioner, as lessee, had a three-fourths interest in the oil produced from the wells, the other one-fourth interest being in Batson, the lessor, and Andrews, the original lessee. The depletion allowance with respect to the oil and gas wells is 27% per cent of the gross income from the wells, equitably apportioned between petitioner, Batson, and Andrews.

The depletion allowance determined by the Commissioner is 27% per cent of the petitioner’s share of the gross income from the oil and gas wells, which amount is exactly the same as would have been determined if the Commissioner had taken 27% per cent of the total gross income from the property and apportioned three-fourths of such amount to the petitioner. The amount determined by the Commissioner is not in excess of 50 per cent of the net income of the taxpayer and is not less than the deduction would be if computed without reference to the provision in section 204(c) (2). The determination of the Commissioner as to the amount of depletion allowable is therefore approved.

3. The third issue is whether the petitioner should be allowed to take deductions for depreciation upon the total cost ox its wells, or whether the respondent is correct in determining that 60 per cent of the well costs should be charged to the capital account, returnable through allowances for depletion. The amount of additional deductions for depreciation to be allowed, if petitioner is correct, is stipulated. Section 234 (a) (8), Revenue Act of 1926, already quoted, provides in the case of mines, oil and gas wells, for “ a reasonable allowance for depletion and for depreciation of improvements.”

Respondent relies on article 223 of Regulations 69, which provides that incidental expenses such as wages, fuel for engines, repairs, and hauling may be charged to capital account, returnable through depletion, while the expense of physical property (such as derricks, machines, etc.) may be subject to depreciation.

It is admitted that petitioner drilled its wells on what is known in the trade as a “ turnkey contract,” that is, for a lump sum payable to the contractor, and that the petitioner, therefore, had no interest or concern with the apportionment of the costs of drilling, simply charging the whole to the well cost account. The question is whether the total cost of the wells represents an investment in an improvement which is subject to depreciation.

Since the hearing in the instant case, the same question was presented and decided in A. T. Jergins Trust, 22 B. T. A. 551. The same argument was there urged by the Commissioner, but we said, with respect to amounts expended for wages, fuel, repairs and hauling in connection with development and drilling, that “ amounts expended in development and drilling operations convey to us the impression of expenditures for improvement of the property upon which the statute permits the taxpayer to deduct depreciation.”

On this issue, therefore, we hold that the petitioner is entitled to the additional depreciation allowable for 1925, 1926 and 1927, in the sums stipulated.

Judgment will be entered under Rule 50.


author: Lansdon:

text:
    City and Suburban Mortgage Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 45658.
    Promulgated May 25, 1932.

      Henry Ra/oenel, Esq., for the petitioner.

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

Lansdon:

The petitioner contends that the capital investment in its corporate organization became a loss in 1927, when it was determined to liquidate. It argues that the corporation was organized to buy and sell second mortgages and that in 1927 it ceased to do business and put forth every effort to liquidate; that thereafter it merefy held the property until liquidation could be effected. The respondent contends that no part of the amount was a loss in the taxable year, since petitioner has not dissolved and has not abandoned its corporate franchise. He also contends that the commissions paid for the sale of capital stock, in the amount of $2,985.66, could not be a loss in any event, inasmuch as such expenditures were not properly capitalized, but were in the nature of discount on the stock sold.

We have repeatedly held that organization expenses are capital expenditures. Logan-Gregg Hardware Co., 2 B. T. A. 647; Holeproof Hosiery Co., 11 B. T. A. 547; Grain King Manufacturing Co., 14 B. T. A. 793, and others. We have also held that such capital expenditures may not be recovered by deductions for exhaustion over the life of the corporation. Hershey Mfg. Co., 14 B. T. A. 867. In Malta Temple Association, 16 B. T. A. 409, we held that organization expenses theretofore capitalized constitute a deductible loss upon dissolution of the corporation and abandonment of the corporate franchise. The facts of the instant case, however, do not come within the rule of the Malta Temple Association case. Here the petitioner is still using the corporate structure acquired in return for its organization expenditures. The franchise is still in use, the corporation owns property and is active in its management. We think the petitioner sustained no loss in 1927 as a result of its determination to liquidate.

Our conclusion above makes it unnecessary for us to discuss the respondent’s contention that commissions paid for the sale of stock were in the nature of discount on the stock sold and were therefore improperly capitalized.

Decision will be entered for the respondent.


author: Seawell:

text:
    Everett J. Esselstyn, Executor of the Last Will and Testament of Sophia Curtiss, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 33661.
    Promulgated May 25, 1932.

      Donald Home, Esq., for the petitioner.

      William E. Davis, Esq., for the respondent.
   OPINION.

Seawell:

Much confusion exists in the record as to the specific action of the Commissioner which is complained of by the petitioner, but from an analysis of the data submitted the following computations will show the situation as we understand it. In the first place, the income of the estate which was considered distributable and taxable to the petitioner is shown as follows:

Income:
Interest_ $2, 331. 90
Dividends_ 109,024. 90
- $111,356. 80
Expenses:
Interest_ $2,134.75
Massachusetts income tax- 3, 862.51
Administration expenses- 1,140. 88
- 7,138.14
Total distributable income_ 104, 218. 66

Since under the terms of the will in question one-half of the income was distributable to the petitioner, the income upon which the Com-issioner determined the deficiency with which we are concerned is shown as follows:

Total income (y2 of $104,218.66)_ $52,109.33
Less:
Interest_ $82. 50
Taxes_ 609.14
- 691.64
Net income (subject to surtax)- 51,417.69

A comparison of the distributable income as determined above for the estate with that shown by the petitioner’s decedent in her return shows, in effect, only two changes, namely, the item referred to as “ Profit from sale of rights ” in the amount of $3,238.34 is eliminated from the income items, and the deduction claimed in the amount of $25,723.54 on account of Addl. Federal estate tax” has been disallowed. The parties are agreed that the former item was properly eliminated from the distributable income, since it represented a capital gain which became a part of the corpus and therefore was not distributable as income of the estate.

The disagreement relates entirely to the latter item, and the parties are agreed that the sole question to be answered is whether in determining the distributable income for 1923 from the residue of the estate of Frank Curtiss such income should be reduced by an additional Federal estate tax which was paid by the executor of the said estate in 1923. The contention of the Commissioner is that the petitioner is taxable upon the income distributable to her under the terms of the will and that since the Federal estate tax is deductible only by the estate, the amount distributable can not be reduced on account of the payment of such tax. The petitioner controverts the position of the Commissioner and says the executor could deduct from income estate taxes paid by him, and that to the extent that he did so the distributable net income to the beneficiaries was legally and properly reduced, and the “ net interest and income ” under the will is the amount remaining of income after payment of the estate tax and deductions not contested.

At the outset it should be observed that we are concerned with the return of a beneficiary and not with that of a fiduciary. Admittedly, where during the process of administration we are seeking to determine the income of an estate which is subject to income tax, estate tax paid or accrued during a given year is a proper deduction from the gross income of the estate. It is a charge on the estate and is to be paid by the administrator or executor in a similar manner to that in which other charges are paid, that is, out of any available funds, or if there be none, from money secured by the conversion of other property for that purpose. United States v. Woodward, 256 U. S. 632.

But does the fact that the fiduciary is entitled under the revenue acts to a deduction of estate tax for income-tax purposes necessarily affect or serve to reduce the distributable income to which the beneficiary is otherwise entitled and on which he is required to pay an income tax? We think not. Of course, in the instant case the payment of the estate tax reduced the residue or remainder from which income would be derived, but what we are concerned with is income which has been earned by the remainder or residue of the estate, As to this income, the will specifically provides that such income, after deducting all necessary and proper charges and expenses, shall be paid over to the beneficiaries named, one of whom was the petitioner’s decedent. The Federal estate tax paid was not a charge or expense incident to the earning of the income which would be distributed, but was a tax imposed on the transfer of the estate and as such was a charge against the estate rather than a charge against the income which the will provided should be distributed to the beneficiaries.

The principle involved is not unlike that heretofore considered by the courts and the Board on many occasions where conclusions adverse to that contended for by the petitioner have been reached. Baltzell v. Mitchell, 3 Fed. (2d) 428; Matthiessen v. United States, 67 Ct. Cls. 571; O. Ben Haley, 6 B. T. A. 782; James B. Waller, Jr., 8 B. T. A. 935; and Walter S. Gurnee et al., Executors, 13 B. T. A. 262. The action of the Commissioner in refusing to allow the Federal estate tax as a deduction in determining the income distributable and taxable to the petitioner’s decedent is accordingly sustained.

Judgment will be entered for the respondent.


text:
    John F. Degener, Jr., and August W. Degener, as Executors of the Last Will and Testament of John F. Degener, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 38500.
    Promulgated May 26, 1932.

      Otto 0. Wierum, Esq., for the petitioners.

      Ralph F. Staubly, Esq., for the respondent.
   OPINION.

Smith:

The first issue is whether the respondent has correctly valued the interest of the decedent in the partnership “ at the time of his death.” (Section 402 (a), Revenue Act of 1921.) The articles of copartnership provided that the “ surviving members of the firm ” conduct the business of the firm to the end of the fiscal or accounting period in which the decedent died, and that upon “ any accounting * * * with his estate, they shall be required to account for and pay over only the value of the deceased partner’s interest, as shown by the books of the partnership.” The petitioners have interpreted the articles of copartnership as providing that the decedent’s estate should receive a share of the profits of the firm, and contend that such profits could not be ascertained until the end of the accounting period, and that no part of such profits should be considered in computing the value pf the- decedent’s interest in the firm. By way of argument, they further contend that to include such profits in the corpus of the decedent’s estate would be to subject the profits to double taxation. As we said in Walter B. McCarthy, Executor, 9 B. T. A. 525, 527:

In tlie decision of this case we are not disturbed by the fact that an estate tax and an income tax may impinge upon each other in their ultimate incidence. George D. Widener et al., 8 B. T. A. 651. * * *

We think the respondent has correctly determined the value of the decedent’s interest in the partnership; no attack is made upon the correctness of the amounts used in that determination. In determining the “ value of the deceased partner’s interest ” the surviving partners included a share of the profits of the firm for the fiscal year in which the decedent died. For income-tax jrarposes the petitioners have allocated a portion of these profits to the period in the fiscal j^ear prior to the date of the decedent’s death and reported the amount thereof as income to the decedent, and allocated the remainder to the period in the fiscal year subsequent to his death and reported the amount thereof as income to the estate. The difference between the amounts of these profits in the respondent’s computation and the petitioners’ returns for .income-tax purposes is explained, on petitioners’ brief, as being as “ between profits and income — the latter, of course, including interest.” We are not called upon to decide any question respecting the income tax upon these amounts.

The respondent in his computation properly included interest on the decedent’s investment in the firm up to' the time of his death. Cf. William G. Frank, Administrator, 6 B. T. A. 1071; E. S. Heller et al., 10 B. T. A. 53; William K. Vanderbilt et al., 11 B. T. A. 291; Frank H. Clark, Executor, 12 B. T. A. 425; Jackson B. Kemper, Administrator, 14 B. T. A. 931; Ella C. Loose, Executrix, 15 B. T. A. 169; Mellie Esperson Stewart, 18 B. T. A. 1010. The decedent’s share of the profits up to the time of his death was income to him and passed to the executors of his estate as an asset of the estate. Cf. Maurice L. Goldman et al., 15 B. T. A. 1341; Clarence B. Davison et al., 20 B. T. A. 856; aff'd., per curiam, C. C. A., 2d cir., Nov. 16, 1931; John L. Hall et al., 25 B. T. A. 1. See also G. C. M. 7678, C. B. IX-2, p. 360.

As interpreted by the surviving partners, the decedent’s estate had a right to receive a share of the firm’s profits for the remainder of the fiscal year in which the decedent died. A similar situation was considered in William P. Blodget et al., Executors, 13 B. T. A. 1243, 1246, wherein we said:

The right of the estate of William Blodget to receive the year following the death of William Blodget the same share of the net profits of Blodget & Co. which William Blodget would have been entitled to receive had he survived was a valuable contractual right or chose in action constituting a part of the assets of William Blodget which passed on his death to the executors of his estate. * * * The right which the executors received to collect these profits was a capital asset of the estate and the value of such asset received by the executors constituted the basis for determining a gain or loss upon the- disposition thereof. Only the excess received on the disposition of the asset constituted taxable income. Walter R. McCarthy, Executor, 9 B. T. A. 525; Estate of A. Plumer Austin, 10 B. T. A. 1055. * * *

The petitioners have failed to show that the respondent erred in determining the value as of the date of the decedent’s death of the right to receive a share of the firm’s profits for the remainder of that fiscal year, and we accordingly sustain the respondent’s determination. Cf. Ernest M. Bull, Executor, 7 B. T. A. 993; Walter R. McCarthy, Executor, supra; James Brown et al., 10 B. T. A. 1036; George Nichols et al., 10 B. T. A. 919; Alexander W. Smith, Jr., Executor, 20 B. T. A. 27; United States v. Carter, 19 Fed. (2d) 121; Nichols v. United States, 64 Ct. Cls. 241; certiorari denied, 277 U. S. 584.

The respondent’s disallowance of the claimed deduction for executors’ commissions is based upon the fact that there had been no decree of the New York surrogate’s court awarding commissions to the executors and that no such commissions had been paid. In support of this action, the respondent cites Ordway v. United States, 37 Fed. (2d) 19, wherein the question decided was the timeliness of a claim for refund of an estate tax, and Braun v. Lewellyn, 38 Fed. (2d) 477, wherein a fee for services in managing an estate after administration and paid out of income was held not deductible from the gross estate for estate-tax purposes. Such, cases are not dispositive of the issue before its.

Section 403 (a) (1) of the Revenue Act of 1921 provides that the net estate of a decedent shall be determined by deducting from the gross estate, among other items, such amounts for administration expenses as are allowed by the laws of the jurisdiction under which the estate is being administered. The New York Surrogates’ Court Act (ch. 928, Laws of 1920, as amended by ch. 649, Laws of 1923) provides in section 285 for the allowance of executors’ commissions and the computation of the amount thereof upon the rates prescribed. There is nothing in the record to indicate that the executors’ commissions will not be allowed and paid out of the decedent’s estate. In James D. Bronson et al., Trustees, 7 B. T. A. 127, 132 (aff'd, 32 Fed. (2d) 112), we said:

In the Appeal of Samuel E. A. Stern, et al., Executors, 2 B. T. A. 102, the Board held that in allowing deductions from the gross estate in computing estate taxes, Congress did not intend that determination of the tax should await final settlement of the estate and a reduction to absolute certainty of all claims against it, and that deductions for executors’ commissions might be based upon a reasonable estimate of the amount allowable by the lex domicilia and it is not essential that such commissions be first allowed by order of court or paid. Compare Appeal of Grace M. Knox, et al., Executors, 3 B. T. A. 143; Appeal of Henry Riffel, 3 B. T. A. 436; Appeal of Salina Bell, Executrix, 3 B. T. A. 1172; Mrs. Browning Coleman Moore, Executrix, 5 B. T. A. 255; William W. Mead, et al., Executors, 6 B. T. A. 752.

The petitioners are entitled to deduct from the gross estate the amount allowable as executors’ commissions, computed under the rates prescribed by the New York Surrogates’ Court Act upon the valuation of the gross estate as determined as of the date of the decedent’s death. Cf. Samuel E. A. Stern et al., 2 B. T. A. 102; Estate of Jacob Voelbel, 7 B. T. A. 276; John A. Loetscher et al., 14 B. T. A. 228 (reversed on other points, 46 Fed. (2d) 835) ; Georgette Goldschmidt et al., Executors, 14 B. T. A. 1010; Irving Bank-Columbia Trust Co. et al., 16 B. T. A. 897; Allie E. Nicholson, Executrix, 21 B. T. A. 795.

Judgment will be entered under Rule 50.


text:
    Junius Beebe, Trustee of Estate under Will of Marcus Beebe, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52707.
    Promulgated May 27, 1932.

      Thomas H. Rag, Esq., for the petitioner.

      James K. Polk, Jr., Esq., and Harold, F. Noneman, Esq., for the respondent.
   OPINION.

MoeRis

: Section 23 of the Revenue Act of 1928 provides that:

In computing net income there shall be allowed as deductions:
(c) Taoses generally.- — Taxes paid or accrued within the taxable year, except—
*******
For the purpose of this subsection, estate, inheritance, legacy, and succession taxes accrue on the due date thereof, except as otherwise provided by the law of the jurisdiction imposing such taxes, and shall be allowed as a deduction only to the estate.

The contention of the respondent is, in effect, that since the statute provides that the deduction “ shall be allowed * * * only to the estate,” and since the petitioner is a trust estate it is not entitled to the deduction. He argues that the term “ estate ” as used in section 23 should be construed in the “ technical sense ” which includes only those estates administered by executors and administrators and not by testamentary trustees.

We find no authority in the general law nor do we find the slightest suggestion associated with the purpose for the enactment of the provision in question which would so restrict the term. Statutes must be construed so as to give full effect to the purpose of their enactment and the intention of the body enacting them. It seems clear that the primary intention of the Congress was to allow a deduction, unqualifiedly, for “ estate, inheritance, and succession taxes,” which might be at any time imposed upon property of deceased persons falling within the estate, inheritance, legacy and succession tax statutes of the various states. Can it be said to have made such an allowance on the one hand and on the other to have restricted the deduction to only certain classes of fiduciaries charged with the testamentary distribution of such property, namely, executors and administrators? We think not.

The word estate ” was used in a sense sufficiently broad to include any and all fiduciaries required by the laws of the state to respond in the payment of estate, legacy, inheritance or succession taxes, whether it be a trust estate or an estate presided over by executors and administrators, usually and commonly referred to as legal representatives.

The Massachusetts statute under which this sum was paid imposed the tax upon “ property or interests therein, passing by will or by laws regulating interstate succession * * * payable by the executors, administrators or trustees in office when such right of possession accrues * * (General Laws of Massachusetts, ch. 65, sec. 7.) It so happened that the party in office when this tax became payable was a trustee, the petitioner here, who had, however, already served in the capacity of executor and had filed his final accounting with the court as such officer. It would be a forced and unreasonable construction of the taxing statute to hold, by reason of the fact that the tax did not fall due against the estate during the term of office of the executor or administrator, the deduction being imposed nevertheless upon the testamentary trustee by the state statute, that the trustee could not take the deduction in the computation of net taxable income of the decedent’s estate.

Furthermore, although section 23 specifies to whom the deduction for estate, inheritance, legacy and succession taxes shall be confined, the really substantive purpose of that particular provision was not to define the class or classes of taxpayers entitled to the deduction of such taxes in the computation of net income, but to avoid a confusion which had theretofore existed as to whether the estate or beneficiaries were entitled to the deduction, based upon the conclusion whether the state tax was levied on the right to transmit or the right to receive the decedent’s property.

Therefore, it is our opinion that the term “ estate ” as used in section 23, supra, is broad enough to include all estates deriving their powers from the will of a decedent which are required by the statutes of the state to pay inheritance, estate, legacy, and succession taxes upon property of deceased persons, whether the person charged with its administration be an administrator, executor, or a testamentary trustee. Any other interpretation would defeat the clearly intended purpose of the statute, and would in the instant case preclude any deduction whatsoever.

Decision will be entered, under Rule 50.


author: Smith:

text:
    Luhrig Collieries Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40048.
    Promulgated May 27, 1932.

      Lloyd Anderson, Esq., and Charles D. Hamel, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   OPINION.

Smith:

The only question at issue in this proceeding is whether the assessment and collection of the deficiency of $23,250.78 determined against the petitioner for the fiscal year ended March 31, 1921, is barred by the statute of limitations. The answer to this question depends upon whether the consolidated return or returns filed by the petitioner and the Cincinnati Mining Company in 1921 and 1922 for the period under consideration started the running of the statute. All of the material facts have been stipulated by the parties and are substantially as follows:

The petitioner and the Cincinnati Mining Company were affiliated corporations within the meaning of section 240 of the Revenue Acts of 1918 and 1921 during the fiscal year ended March 31, 1921, with their principal office at Columbus, Ohio. ■ On June 14, 1921, the petitioner and the Cincinnati Mining Company filed with the collector at Columbus a so-called tentative consolidated return on Form 1120, for the fiscal year ended March 31, 1921, containing the following notation:

Year Ended March 31, 1921
Tentative Report. Check for $11,500. Estimated First Quarterly payment, Enclosed with this report, June 14th, 1921. Extension 30 days time for filing has been granted.

The return contained no other information.

On July 13, 1921, the petitioner and the Cincinnati Mining Company filed a consolidated return on Form 1120 for the period stated, showing various items of gross income totaling $626,394.18, and items of deductions totaling $470,986.42, and a total tax liability for the period of $43,733.17. Other and more detailed information commonly required by the Commissioner was furnished in certain schedules attached to the return. There was also filed an information return on Form 1122, executed by the petitioner.

The total tax shown to be due on the consolidated return filed on July 13, 1921, was paid by checks of the petitioner, the final payment being made in March, 1922.

In May, 1922, after enactment of the Revenue Act of 1921, the petitioner and the Cincinnati Mining Company filed a supplemental or amended consolidated return showing the same items of gross income and deductions as shown on the return previously filed on July 13, 1921, and disclosing an additional tax of $50, computed under the 1921 Act. The amount of the additional tax was paid by check of the New York Coal Company.

The figures upon which the respondent has finally determined the tax liability of the petitioner and the Cincinnati Mining Company after a field examination and review audit, are as follows:

Under date of June 6, 1928, the respondent mailed the petitioner a deficiency notice disclosing a deficiency in its income and profits tax for the fiscal year ended March 31, 1921, of $23,250.78. In such deficiency notice the respondent states:

It will be observed from the decision (8. B. T. A. 79) that the only taxable net income involved for the fiscal year ended March 81, 1921, is properly assignable to the Lnhrig Collieries Company. As stated by the Board, a consolidated return for the two companies was filed. However, the return did not state specifically the items of gross income and the allowable deductions of the Luhrig Collieries Company and the return was not signed and sworn to by the officers of that corporation, but only by the officers of the Cincinnati Mining Company, the officers of the two corporations being entirely different.
Section 239 of the Revenue Act of 1921 provides:
“ That every corporation subject to taxation under this title * * * shall make a return, stating specifically the items of its gross income and the deductions and credits allowed by this title. The return shall be sworn to by the President,' Vice-President, or other principal officers and by the Treasurer or Assistant Treasurer. * * * ”
Based upon the above, the Bureau holds that the consolidated return which was filed in this ease is not such a return as is required by Section 239, above quoted, and, therefore, the filing of same did not start the running of the statute of limitations against assessment and collection of any deficiency of the Luhrig Collieries Company.

We are of the opinion that the consolidated return or returns filed by the petitioner and its affiliated company in 1921 and 1922 substantially comply with the requirements of the law and were sufficient to start the running of the statute of limitations. The issue presented is, we think, controlled by previously decided Board and court cases. See Mabel Elevator Co., 2 B. T. A. 517; United States v. Mabel Elevator Co., 17 Fed. (2d) 109; Stetson & Ellison, 11 B. T. A. 397; aff'd., Commissioner v. Stetson & Ellison, 43 Fed. (2d) 553; Peerless Iron Pife Exchange, Inc., 23 B. T. A. 900.

Each of the returns in question, that is, the return filed on July 13, 1921, under the 1918 Act, and the amended return filed in May, 1922, under the 1921 Act, contains a statement of the essential items of each company’s gross income and deductions. In the cases cited we have pointed out that the law does not require the filing of a return correct in every detail as a condition for the operation of the statute of limitations against the assessment and collection of additional taxes after the expiration of the statutory period.

Since no contention has been made in this proceeding that the return or returns in question were false or fraudulent, or that any waivers have been executed or any suit begun, and since the deficiency notice herein was mailed to the petitioner after the expiration of the statutory period for assessment and collection of any additional taxes on either of such returns, we hold that the deficiency determined by the respondent is barred.

Judgment will be entered for, the petitioner.


author: ÁRundell :

text:
    Hennessy Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Whitegourt Construction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Greycourt Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 45328, 45329, 45333.
    Promulgated May 31, 1932.

      Louis Gosswein, Esq., for the petitioners.

      P. A. Bayer, Esq., for the respondent.
   OPINION.

ÁRundell :

As stated above, the question for decision is whether the 1923 net loss of the 46 West 83rd Street Corporation may be deducted in computing consolidated net income for 1924 and 1925. The salient facts of the stipulation are that the three corporations in existence in 1923 filed separate returns for that year; that in Í924 and 1925 the stock of all four corporations was owned by the same interests, and for those years consolidated returns were filed. In this situation it must be held, following Woolford Realty Co. v. Rose, 286 U. S. 319, that the net loss of the 46 West 83rd Street Corporation for 1923 may not be deducted in computing consolidated income for the subsequent years.

At the hearing counsel for the respondent conceded the possibility of error in making no allowance for the 1923 net loss of the 46 West 83rd Street Corporation based on its own net income in subsequent years. See Swift & Co. v. United States, 38 Fed. (2d) 365; Sweets Co. of America v. Commissioner, 40 Fed. (2d) 436. The parties were agreed that this matter could be settled by stipulation and for this purpose the proceedings will be left open for settlement under Rule 50.

Decision will he entered under Rule 50.


author: Arundell:

text:
    Margay Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44891.
    Promulgated May 31, 1932.

      George E. E. Goodner, Esq., and Frederick O. RowTierder, G. P. A., for the petitioner.

      T. G. His ton, Esq., for the respondent.
   opinion.

Arundell:

The respondent disallowed as a deduction in computing petitioner’s net income for 1926 a net loss sustained in 1924, which with other adjustments resulted in a deficiency of $1,411.90. The only error assigned is the disallowance of the net loss deduction. The facts were stipulated and we incorporate by reference the stipulation filed as our findings of fact.

According to the stipulated facts, petitioner, a domestic corporation, was not affiliated with any other corporation during 1923 and 1924 and up to April 16, 1925. On April 8, 1925, petitioner caused to be incorporated a subsidiary, the Franchise Oil Corporation, and on April 16, 1925, it acquired 197 shares of the subsidiary’s authorized capital stock of 200 shares of no par value. Petitioner continued to own the stock throughout the remainder of the year 1925 and through the year 1926.

Neither the petitioner nor its subsidiary was affiliated with any other corporation from April 16, 1925, to December 31, 1926. Petitioner filed timely income-tax returns for the calendar years 1923, 1924, 1925 and 1926. The returns for 1925 and 1926 were consolidated returns of petitioner and its subsidiary.

The income and statutory net losses of petitioner were as follows:

Petitioner’s subsidiary had neither net income nor loss in either of the years 1925 or 1926.

Petitioner contends that in computing net income for 1926 it is entitled to deduct the net loss sustained in 1924. The respondent has refused to allow the deduction on the ground that the 1924 net loss “ may be applied only against income in the next two succeeding taxable periods, both of which fall in 1925.”

We are of the opinion that, under the decided cases, the respondent’s action in splitting up the year 1925 into two taxable periods is erroneous. In Automatic Fire Alarm Co., 13 B. T. A. 1195, one corporation was in existence throughout the year 1920. A new corporation was organized on December 15, 1920, and on that date the two became affiliated. We held that income for the two companies should be computed on the basis of a consolidated return for the full year, pointing out that there was no period in that year for which the new company was liable to file a return of its separate income, but that at all times during its existence in that year it was affiliated with the old company. We followed that case in Hutt Contracting Go., 17 B. T. A. 818, in which the new corporation was organized in May, 1922, holding as follows:

We have previously held that where a corporation is organized during the taxable year, its first return is a return for the entire year, Carroll Chain Co., 1 B. T. A. 38; United States v. Carroll Chain Co., 8 Fed. (2d) 529; and that where, upon organization, it became affiliated with another corporation, there being no period for which the new corporation is required to file a separate return, a single consolidated return is to be filed for the two corporations for the taxable year. Automatic Fire Alarm Co., 13 B. T. A. 1195.

The above decisions were cited with approval in American Paper Exports, Inc. v. Bowers, 54 Fed. (2d) 508, involving a situation wherein a new corporation was organized in April, 1918, and in June of that year it became affiliated with a corporation that was in existence throughout the year. The court held:

The regulation [Art. 634, Regulations 62] certainly countenances, if it does not prescribe, a single return, whenever an affiliate comes in during the year. At least, if it had had no earlier existence we see nothing to invalidate the requirement; we need hold nothing more. In similar situations the rulings have been uniform, so far as there have been any. The Board has so held twice (Appeal of Automatic Fire Alarm Co., 13 B. T. A. 1195; Appeal of Hutt Cattle Company, 17 B. T. A. 818).

The case of Summerfield Co., 24 B. T. A. 829, cited by respondent, is not in point. In that case the corporations that became affiliated in 1925 had both been in existence prior to the time of affiliation. In such a case, as we said in the Automatic Fire Alarm case, and as held in American Paper Exports, Inc., supra, separate returns may be required for the period prior to affiliation and a consolidated return thereafter. In the last mentioned case the court, on this phase of the question said:

If both affiliates are in existence and active before affiliation, obviously more than one return becomes therefore necessary, and so it has been held, Appeal of American La Dentelle, Inc., 1 B. T. A. 575; Appeal of Green River Distilling Co., 16 B. T. A. 395. At least for the period of its separate activity each must file a separate return.

In the present case the petitioner’s subsidiary had no separate existence for tax purposes in 1925 and there was no occasion for the filing of a separate return. The petitioner operated throughout the year and the filing of a consolidated return by it was proper under the cases above cited. Consequently, as to petitioner, there was no fractional part of a year which could be taken to be a “taxable year” under section 200(a) of the Revenue Acts of 1924 and 1926. In relation to the year 1924, petitioner’s “ succeeding taxable year ” was the calendar year 1925, and the “ next succeeding taxable year ” was the calendar year 1926. We accordingly hold that respondent erred in refusing to allow the 1924 net loss as a deduction in computing net income for 1926. There does not seem to be any controversy as to the amount that may be deducted, but if there is any difference, we will settle it under Rule 50.

Decision will be entered under Buie 50.


author: Murdock:

text:
    Hubert De Stuers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46015.
    Promulgated May 31, 1932.

      Charles B. Fernuld, Esq., for the petitioner.

      James K. Polk, Jr., Esq., and Harold Noneman, Esq., for the respondent.
   OPINION.

Murdock:

The provision of the Act of March 3, 1919, 40 Stat., part 1, p. 1311, under which the petitioner claims exemption from tax is as follows:

Sec. 4. That section 3 of the Fourth Liberty Bond Act is hereby amended to read as follows:
Sec. 3. That, notwithstanding the provisions of the Second Liberty Bond Act or of the War Finance Corporation Act or of any other Act, bonds, notes, and certificates of indebtedness of the United States and bonds of the War Finance Corporation shall, while beneficially owned by a nonresident alien individual, or a foreign corporation, partnership, or association, not engaged in business in the United States, be exempt both as to principal and interest from any and all taxation now or hereafter imposed by the United States, any State, or any of the possessions of the United States or by any local taxing authority.

The statute under which these bonds were issued required that they be issued at par. Act of September 24, 1917, 40 Stat. 288, ch. 56. Most of them were purchased on behalf of the petitioner at less than par and all were redeemed prior to maturity at par. The difference between the amount paid and the amount received on behalf of the petitioner was neither, interest nor in lieu of interest. Willcuts v. Bunn, 282 TJ. S. 216. Old Colony Railroad Co. v. Commissioner, 284 U. S. 552. It was income within the accepted definition of that term. Therefore the question is, Would a tax on this difference be a tax on the principal of the bonds? There is a distinction between a tax on the principal of bonds, such as an estate tax (see Farmers Loan & Trust Co. v. Bowers, 22 Fed. (2d) 464), and a tax on profit obtained from purchase and sale of bonds. Willcuts v. Bunn, supra. Cf. Hibernia Savings Society v. San Francisco, 200 U. S. 310. The petitioner, however, seeks to distinguish this case because the purchased bonds were not sold, but were redeemed by the Government, a special qualifying circumstance not present in the above case and not distinct from the contracts made by the Government in the bonds themselves. The return in question, he argues, came “ to the owner of the security according to the provisions of the obligation and without any further transaction on his part.”

An exempting statute such as this one should be strictly construed and the exemption allowed only where founded on plain language. Hoge v. Railroad Co., 99 U. S. 348; Bank v. Tennessee, 104 U. S. 493; Bank of Commerce v. Tennessee, 161 U. S. 134; Lewellyn. v. Harbison, 31 Fed. (2d) 740; The Cordon v. United States, 46 Fed. (2d) 719; Riverdale Co-operative Creamery Ass’n v. Commissioner, 48 Fed. (2d) 711. We do not believe that a government, issuing its obligations at par, would have sufficient interest in the purchase and sale of those obligations below par to provide tax exemption in any case for the profit derived from a purchase below par and subsequent redemption at par. The benefits, if any, which the government would thus derive, would be unreasonably remote. Probably Congress never intended to exempt a profit such as this petitioner had. O. F. 729, C. B. No. 3, July-December, 1920, pp. 123-124,’ was cited with apparent approval in Willcuts v. Burm, supra. It is as follows:

In the case of Treasury certificates of indebtedness which are offered by the Government at par and accrued interest and not at a discount, only the coupon interest can be considered exempt from normal tax, and from surtax to the extent provided by the act approved September 24, 1917. Where such certificates are subsequently purchased at a discount, the difference between the purchase price and the par value of the certificates received at maturity is profit subject to both normal tax and surtax. The subscriber for Treasury certificates who sells them at a discount sustains a deductible loss, which is the difference between the par value of the certificates and the selling price. Any gain or loss on the sale of Treasury certificates of indebtedness prior to maturity should be determined in accordance with section 202 of the Revenue Act of 1918.

The Willicuts v. Bunn case is not direct authority for the decision of this case. The questions involved are quite different. In the present case there is no question of the power of Congress to tax. The obligations are its own and may be taxed. Furthermore, the facts in the two are different. But the principals laid down in that case may apply here nevertheless. The profit in this case was not paid as such by the United States, but resulted from purchases at low prices and retention until the bonds were redeemed when worth par. This profit resulted from a combination of several factors, including capital investment and probably some measure of sagacity. If profit results from these factors where there has been both purchase and sale in the ordinary sense, we see no reason to hold otherwise where there has been either an ordinary purchase or an ordinary sale, as where bonds subscribed for and obtained at par are later sold at a premium or where bonds have been purchased at less than the amount at which they are redeemed. In all such transactions capital has been invested and generally some measure of sagacity has been a factor in the purchase as well as in a sale. The gain may be regarded as “ the creation of capital, industry, and skill ” and a tax on it is not on the obligation of the United States.

Counsel for the petitioner argues, irrespective of statutory exemption, that the profits arising from these transactions are not taxable to the petitioner under the provisions of section 211 (a) of the Revenue Act of 1926, which defines income from sources within the United States, but does not include profits such as arose in this case. However, the provisions of section 217 (a) are not an all inclusive definition of income from sources within the United States for the purpose of determining the net income of nonresident alien individuals. This is apparent from section 217 (e), which provides that items of gross income, other than those specified in subdivision (a), shall be allocated or apportioned to sources within or without the United States, under rules and regulations prescribed by the Commissioner with the approval of the Secretary. Subdivision (e) contains also some specific provisions in regard to gains from the purchase and sale of personal property. When section 217 is read as a whole and the rules and regulations prescribed by the Commissioner with the approval of tbe Secretary considered, articles 324 and 328 of Regulations 69, it is apparent that the profit from the transactions in question in this case must be considered to be income from sources within the United States. Cf. De Ganay v. Lederer, 250 U. S. 376. Income upon the disposition of personal property is not in any case income from sources without the United States unless there has been a sale outside the United States. The bonds here involved were purchased within the United States and never were outside the territorial limits of the United States. Every act with reference to them which gave rise to the profits, took place in this country pursuant to an order of a court of the State of New York. Nor can the fiction of law that the situs of the personal property is presumed to be the domicile of its owner, save the profits here involved from tax. De Ganay v. Lederer, supra.

Judgment will be entered for the respondent.


author: Aeundell:

text:
    Manati Sugar Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 36815.
    Promulgated May 31, 1932.

      B. B. GoodeTl, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
   OPINION.

Aeundell:

There is no dispute between the parties as to the deduction allowed for the 1921 net loss. The controversy arises out of the amount of the 1922 net loss allowable as a deduction for 1923, which, according to computations of the parties will depend upon the treatment to be given the Cuban income tax. Income for 1924 will be affected by the amount of the 1922 net loss which is not ^absorbed by 1923 income.

Petitioner contends that in determining its net income for 1923, the Cuban income tax should be applied as a credit rather than allowed as a deduction and that the computation should be made as follows:

Net income before deduction of Cuban income tax or prior years’
losses_$1, 017, 526. 07
Deduct:
Cuban income tax___ Nil
Five-sixths of net loss for fiscal year 1921_$206,529.14
Portion of net loss for fiscal year 1922_ 4, 541. 09
-— 211, 070.23
Balance subject to tax_ 806,455. 84
Tax at 12%%_ $100,806.98
Credit for Cuban income tax_ 100, S06. 98
Amount of tax- Nil

As set out in the findings of fact, respondent allowed as a deduction for the 1921 net loss the same amount as contended for by petitioner and in addition allowed as deductions the 1923 Cuban income tax in the amount of $100,806.98 and $710,189.95 of the 1922 net loss. The effect of the petitioner’s method is to carry over as a deduction for 1924 an amount of $811,691.81 as the portion of the 1922 net loss unabsorbed by 1923 income, as against $106,042.95 carried over under respondent’s computation, a difference of $705,648.86.

Section 238(a) of the Revenue Act of 1921, as far as material here provides as follows:

That in the case of a domestic corporation the tax imposed by this title, plus the war-profits and excess-profits taxes, if any, shall be credited with the amount of any income, war-profits, and excess-profits taxes paid during the same taxable year to any foreign country, or to any possession of the United States * * *.

As the parties have raised no question as to whether the Cuban income tax here involved is of the character referred to in the statute quoted, we will assume that it is such a tax. Section 200 (4) of the Revenue Act of 1921 defines paid ” as meaning “ paid or accrued ” for the purposes of deductions and credits, and so there is no question as to whether the tax was “ paid ” within the meaning of section 238(a).

Under section 204(b) of the Revenue Act of 1921 the petitioner’s net loss for 1922 was allowable as a deduction “ from the net income ” for 1923. Burnet v. Moore Cotton Mills Co., 49 Fed. (2d) 59. Section 238(a) alloAvs the foreign tax to be applied as a credit against the tax which our Federal statute imposes on net income. Thus the question here is, Shall the net loss deduction or the foreign tax credit be given precedence? That is, shall the net loss be allowed as a deduction to the extent of the net income, or shall the net loss be disregarded for the moment and a tax computed equal to the foreign tax and then only a sufficient amount of the net loss be deducted so as to result in no tax?

It would seem to be entirely logical and in accordance with the plan of the statute first to deduct the net loss and thus determine whether there is any tax against which to apply the foreign tax credit. The plan of the taxing statute is to impose an income' tax on net income. Beginning with the Revenue Act of 1921, taxpayers have been permitted to reduce net income for any given year on account of net losses sustained in prior years. It is on the net income for the year, as so reduced, that the tax is computed, and it is not until then, that is, after the computation is made, that the credit for foreign taxes can be applied. Until that stage in the computation is reached there is nothing against which to apply the credit. The method proposed by petitioner is just the reverse of this. Under it sufficient Federal tax is computed to be absorbed by the application of the credit for the foreign tax, and then working backward, from this the amount of net income necessary to produce this tas is calculated, to which is added only a sufficient amount of the prior year’s net loss to equal net income before deduction of the net loss.

Petitioner’s defense of its method is that it thereby obtains a credit which the statute clearly was designed to give it. We construe section 238(a) to mean merely that where a calculation under other provisions of the statute produces a tas, then the foreign tax credit may be applied. It certainly was never intended that arithmetical gymnastics should be indulged in so as to produce a wholly artificial tax against which to apply the credit for foreign tases. Counsel for respondent aptly states in his brief that “manifestly the statute [section 238(a)] applies only to corporations which have a tas liability.”

We do not see wherein the recent decision of Burnet v. Chicago Portrait Co., 281 U. S. 1, cited by petitioner, has any bearing on the question before us. The question for decision there was whether New South Wales was a “ foreign country ” within the meaning of the statute and the court was not asked to determine the method of applying the credit. Petitioner quotes parts of the opinion wherein the court says that “ the primary design of the provision was to mitigate the evil of double taxation ” and that “ in relation to income taxes paid outside these borders [of continental United States], the provision as to credits was enacted to give greater and not less relief.” Under the respondent’s computation petitioner has no tax to pay to the United States for 1923 and there is no room for invoking any condemnation against double taxation. The latter quotation from the opinion merely states the reason for allowing a credit for foreign taxes as distinguished from deductions allowed for taxes paid to the States of the Union. It does not say that a credit is somehow to be allowed even though there is no tax when other provisions of the statute are applied, which seems to be petitioner’s construction of it.

We accordingly find no error in respondent’s refusal to allow a credit for the year 1923 on account of the Cuban tax as contended for by petitioner. We do not understand petitioner to be claiming that in any event the Cuban tax should not be allowed as a deduction and so we do not pass on the propriety of the respondent’s allowance of the tax as a deduction from gross income. It follows that no adjustment will be made in the amount of the net loss carried forward to 1924, and the respondent’s determination for that year is affirmed.

Decision will be entered for the respondent.