author: Matthews: Goodexoh,

text:
    Canton Cotton Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 28986.
    Promulgated June 9, 1932.

      W. A. Sutherland, Esq., and J. R. Sherrod, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Matthews:

The only question to be decided is whether the petitioner is entitled to have its tax liability determined under the provisions of section 210 of the Revenue Act of 1917 and sections 327 and 328 of the Revenue Act of 1918, the pertinent provisions of which are set forth by the footnote.

The petitioner is claiming special assessment upon the grounds (1) that invested capital can not be determined; (2) that capital is abnormal, due to the very valuable trade brand “ Canton Denim ” and the good will attached to the same, no part of which has been or can be included in invested capital; and (3) that income is abnormal, due to the payment of inadequate salaries and the fact that the Jones Mercantile Company rendered services free of charge.

The record in this case presents a very interesting situation. The petitioner is a denim-manufacturing corporation with its principal place of business and plant in Georgia. The officers of petitioner were men who stood high in the community and who had a reputation for honesty and veracity. As a result of using only the best grade of cotton and of superior workmanship they built up a business with a reputation like their own. The denim which was produced in the petitioner’s plant was of an excellent quality. Instead of expending money in advertising the officers expended it in purchasing the best quality of cotton. They used this fact as selling talk and because the product was of the quality that they represented it to be they were able to sell it and to increase their sales from year to year. The denim produced by the petitioner is now considered as good as any in the country. Several witnesses testified that manufacturers of overalls wanted “ Canton Denim ” and that they had very few complaints on overalls made of this material.

The petitioner did not set np on its books any amount representing trade brand or good will and is not seeking to have any amount included in invested capital for these intangibles. Counsel for petitioner argue that the petitioner expended amounts to build up its trade brand and good will which can not be determined, and also that other items of a capital nature had been charged to expense and can not now be determined.

With regard to items of a capital nature being charged to expense, a former revenue agent who had examined the petitioner’s books and made a report thereon to the respondent, and Louis L. Jones, secretary of the petitioner, testified in a general way that the costs of certain small items of machinery, of installing machinery, and of excavation work had been charged to expense, and that it was impossible to determine the amounts of such charges. However, the evidence does not show that the charges were substantial in amount or that the costs for labor were erroneously charged to expense. See Duquesne Steel Foundry Co., 15 B. T. A. 467; and American Gut String Manufacturing Co., 19 B. T. A. 608. Counsel for the petitioner in. their brief contend that there were other items of a capital nature which did not appear in the invested capital, basing their contention upon the fact that the respondent in determining the basis for depreciation found that the gross reproduction costs as of March 1, 1913, were $639,992.11 and the gross actual cost, less depreciation at that date which was used for invested capital purposes, was $532,445.25. An engineer testified that machinery costs were 25 per cent to 30 per cent lower on March 1,1913, than at the time the petitioner equipped its mill, and in 1909, when it doubled its capacity. From this counsel argue that the machinery should have stood on the books at approximately 33% per cent more than its March 1, 1913, reproduction costs and then states:

* * * So it is plain that invested capital actually going into physical assets can not be satisfactorily determined within the meaning of section 210 of the Revenue Act of 1917 and section 327(a) of the Revenue Act of 1918. While it is impossible to determine the exact amount by which invested capital was thus understated, it is clear that it must have been understated to the extent of at least 33% to 50 per cent of the cost of the machinery.

This is all the evidence we have on this point. We do not know exactly what the books show or exactly how the respondent arrived at the figures used by him. The evidence is insufficient to show that the machinery account does not represent the full amount of capital invested in it, or that invested capital can not be determined.

As to the good will and trade brand counsel for petitioner argue that since the petitioner did not expend any money for advertising but. expended .large sujns ip buying a superior grade of cotton, and that since we have allowed special assessment in cases such as that of Northwestern Yeast Co., 5 B. T. A. 232, we should allow special assessment in this case. They seek to draw an analogy between the situation herein presented and the one where a taxpayer has expended large amounts for advertising, a part of which contributed to the building up of a capital asset and the amount attributable to capital can not be determined. They contend that the excess, or at least a part thereof, of the cost of petitioner’s cotton over that of cotton used by other manufacturers, contributed to building up the petitioner’s trade brand and good will and that, since the exact amount so attributable can not be determined, special assessment should be allowed. We can see no merit in this contention. In the Northwestern Yeast Co. case, and similar cases, a portion of the amounts expended for advertising in early years was held to be investments in a capital asset. Here the petitioner expended no amounts for advertising, and all of the amounts paid for the high-grade cotton used in the manufacture of the denim sold were a part of the cost of the goods sold. We know of no theory of accounting which would permit the capitalization of any portion of the cost of materials going into goods sold. Since the amounts which the petitioner claims can not be determined were not of a capital nature, it is clear that this is not a situation where section 327(a) is applicable.

The petitioner’s next contention is closely connected with the one just discussed. It contends that invested capital is abnormal in that the profits are largely due to the very valuable trade brand “ Canton Denim ” and the good will attached to the same, no part of which can be included in invested capital, using the same argument that a part of the cost of the cotton was the cost of building up its good will. Several witnesses computed the value of the good will at substantially $1,000,000 by using a formula which has been approved by the respondent and by this Board. We are convinced that the petitioner had built up a valuable good will and trade brand, which had been accomplished by using a superior grade of cotton and skillful workmanship. The reward for this was in the increase of gross sales, which showed that it paid to produce an excellent product, all the cost of which was reflected in the material and workmanship. However, neither this nor the fact that the petitioner had a large income in relation to invested capital results in an abnormal condition such as is contemplated by the statute. Good will in most cases results from the acquisition of a reputation for a good product acquired over a period of years and does not long retain its value if the quality of the product to which it attaches is not maintained. We have held repeatedly that the building up of a good will, the value of .wMph pan not be .included in invested capital, does not amount to an abnormality and we can not agree with counsel that the fact that the good will may have been of great value can make any difference. Enameled Metals Co., 14 B. T. A. 1392; and Gerlach-Barklow Co., 16 B. T. A. 201. In the cases where we have allowed special assessment where good will or intangibles were not included in invested capital it has been where they have been acquired for stock and the value.could not be determined, or where on account of statutory restrictions they could not be included in invested capital.

The situation is not the same as the one in the case of Clarence Whitman & Sons, Inc., 11 B. T. A. 1192, wherein we said:

* * * It was these intangible assets which were the principal cause of! the large income which petitioner enjoyed during the taxable years and on which the deficiencies in question are based. Because of its manner of organization these assets may not be included in the computation of its invested capital. We have held that a taxpayer does not fall within the provisions of sections 327 and 328 merely because assets are used in the business which may not be included in invested capital. Morris & Co., 1 B. T. A. 704. The exclusion must be such as to create an abnormal condition. Where, as here, the asset excluded is the most substantial part of its capital and is the principal contributing factor in the production of taxable income of the petitioner, it is our opinion that such an abnormality exists. Viscose Co., 3 B. T. A. 444; G. M. Standifer Construction Corporation, 4 B. T. A. 525; Pittsburgh & Bessemer Coal Co., 5 B. T. A. 45; Excelsior Motor Manufacturing & Supply Co., 5 B. T. A. 582; J. M. & M. S. Browning Co., 6 B. T. A. 914; Cushman Chuck Co., 8 B. T. A. 148.

The principle in the above case is not applicable in a case where the taxpayer has by ordinary good business methods built up a valuable intangible, which is not in any case a part of its statutory invested capital. See Coca-Cola Bottling Works of Pittsburgh, 19 B. T. A. 267; and Raymond Syndicate, Inc., 21 B. T. A. 600. We are therefore of the opinion that the petitioner’s invested capital is not abnormal due to the fact that the petitioner over a period of nearly twenty years had built up a valuable good will and trade brand.

The petitioner next contends that net income is abnormal in that it received valuable services at one-third of their value and that it received the benefit of the sendees of the Jones Mercantile Company free. The evidence shows that the salaries paid to its two officers, ft. T. Jones and Louis L. Jones, were inadequate, but we are of the opinion that this did not result in an abnormality. See Eagle Piece Dye Works, 10 B. T. A. 1360. Neither does the rendering of the services by the Jones Mercantile Company constitute an abnormality. D. D. Summey, engaged in the cotton mercantile business, testified that these services were worth from $3 to $4 per bale. There is no testimony that it is the usual practice of a cotton manufacturing company to obtain its cotton through a broker. We would not consider it unusual for a cotton mill to purchase its own cotton direct from the growers where, like the petitioner in this case, it is situated in a cotton growing district. A somewhat similar situation was presented in the case of the Continental Products Co., 24 B. T. A. 119. In that case we said:

While the services rendered to petitioner without charge or at nominal charges, set forth as contentions (1), (3), (5) and (7), may have affected petitioner’s income, we are of the opinion that no such abnormality has been established as contemplated by the statute. There cam be no doubt that because of such advantageous arrangemients and fortunate conditions petitioner’s income was greatly increased, but we do not understand that Congress intended to favor corporations merely because they were able to earn a large income, even though it resulted partly from their favorable connections with another corporation. * * *

The petitioner contends that, even if none of the factors above discussed constitutes an abnormality standing alone, the combination is such as to entitle it to relief. However, we have held, in Everett Logging Co., 19 B. T. A. 1098, that the aggregate of a number of conditions, each inadequate in itself to establish an abnormality, does not necessarily constitute a basis for special assessment. To the same effect is Primrose Tapestry Co., 20 B. T. A. 702.

We are, therefore, of the opinion that upon a consideration of all the evidence the petitioner has failed to establish that it is entitled to special assessment and the determination of the respondent in this respect is therefore sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Goodexoh,

dissenting: In my opinion, petitioner has proved, abnormalities in its income sufficient to entitle it to special assessment.

Trammell and Black agree with this dissent.

       [Act 1017.] Sec. 210. That if the Secretary of the Treasury is unable in any case satisfactorily to determine the invested capital, the amount of the deduction shall be the sum of (1) an amount equal to the same proportion of the net income of the trade or business received during the taxable year as the proportion which the average deduction (determined in the same manner as provided in section two hundred and three, without including the $3,000 or $6,000 therein referred to) for the same'calendar year of representative corporations, partnerships, and individuals, engaged in a like or similar trade or business, bears to the total net income of the trade or business received by such corporations, partnerships, and individuals, plus (2) in the case of a domestic corporation $3,000, and in the case of a domestic partnership or a citizen or resident of the United States $6,000.
      * $ * * * ¡is *
      [Act 1918.] Sec. 327. That in the following eases the tax shall be determined as provided in section 328:
      (a) Where the Commissioner is unable to determine the invested capital as provided in section. 326;
      * ***** #
      (d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply to any caso (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, * * *


source: Caselaw Access Project

author: Matthews : Goodrich,

license: Public Domain

text:
    Edmund R. Week, Petitioner, v. Commissioner of Internal Revenue, Respondent. H. J. Finch, Administrator, Estate of John Arthur Week, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 33796, 42544.
    Promulgated June 9, 1932.

      F. B. Morrill, Esq., for the petitioners.

      Eugene Meachmn, Esq., for the respondent.
   OPINION.

Matthews :

The only issue in this proceeding is the March 1, 1913, value of the property known as the Week site. We are of the opinion and have so found that such property did not have a value on March 1, 1913, in excess of $43,254.50, its cost. Accordingly, the action of the respondent in determining the deficiéncy herein was correct. We will briefly discuss the reasons upon which we base our conclusion as to the value of this property.

The petitioners are contending that on March 1,1913, the property in question had a fair market value at least equal to its sale price. There is no contention that the property as farming property had any value in excess of its cost. The claim of a larger value is based upon its value as a potential water-power site. It is evident that for property to have a value as a power site is must not only be a feasible place to 'erect a dam, but there must be a market for the power. There are doubtless many sites on rivers which are physically and geologically well suited for the erection of a dam, but where such sites are in unpopulated areas or where, on account of other power plants in the vicinity, there would be no market for the power, it can not be said that they have a “ market value.” The petitioners, therefore, must not only show that this was a feasible site for a dam, but that on March 1, 1913, there was a market for such sites or for the power developed therefrom, and then establish the actual fair market value thereof on the basic date.

The evidence introduced by the petitioners shows that the two Week brothers purchased the property because they thought that it would be valuable as a water-power site. E. R. Week, Jr., the son of petitioner Edmund It. Week, stated that he had made an investigation of the property in 1904 and from then until 1915 was employed at various times in connection with the property. He was of the opinion after such investigation that the site was a feasible one for the erection of a dam with a head of 55 feet and that a plant could be erected and operated economically. Upon cross-examination he admitted that he was not a graduate engineer and that he began the investigation of this site soon after he left college at a time when he had had very little experience in engineering-work. His testimony is in conflict with that of four expert witnesses called by the respondent. These witnesses were Eugene Logan, a consulting engineer, who had been an employee of the Washington Water Power Company from 1907 until 1926, and had been familiar with the Spokane River territory since 1912; R. K. Tiffany, a graduate hydraulic engineer in the employ of the United States Reclamation Service from 1910 to 1920, and State Superintendent of Hydraulics for the State of Washington from 1925 to 1930; Joseph Jacobs, a graduate civil engineer who had had occasion to examine the Spokane River in 1905, 1909 and 1925 in connection with proposed projects; and David C. Henny, a graduate of the University of Delft, Holland, in 1881, who had been a supervising engineer'on many notable dam and power projects. The two witnesses last named were often employed as consultants as to the practicability of proposed electrical projects. None of these witnesses had any interest in this case and their testimony can be regarded as wholly unbiased. They testified almost unanimously that they did not consider this site a feasible one for a dam or that it would be an economical place to erect a power plant. These opinions were based on their experience, on their knowledge of the geological formation at the site, the nature of the soil and of the river bed, and the fact that there was danger of considerable seepage.

The evidence further shows that due to the increased business around Spokane there had been between 1906 and 1913 considerable activity along the river with respect to water-power sites. However, this activity had lessened to a considerable extent by 1913, by which time the Washington Water Power Company had erected four power plants and dams which were capable of generating an amount of electricity which was 80 per cent in excess of the demand. Any company or individual erecting a dam and power plant at the Week site would have had to compete with this company. It was the opinion of the four expert witnesses mentioned above that electricity generated from a single plant would not be as satisfactory as that generated from a connected system of plants. Although there were two companies closely adjacent to the Week site, which were both users of electricity to a considerable extent, and also the city of Spokane was in the market for electric power for their pumping station, the evidence was insufficient to show that it would have been ■ feasible or more economical for these companies or anyone else to purchase this property and erect a dam than to purchase their electricity from the Washington Water Power Company. In fact, what little evidence there was on this point tended to show that such a project would have been more expensive.

As to the value of this property on March 1, 1913, the respondent’s experts testified that the property had no value on March 1, 1913, other than its value as farming property, and that they would not have recommended its purchase as a potential power site on that date. The petitioner’s only expert witness in hydraulic matters was not asked his opinion of the March 1, 1913, value and was careful to state that he would not say that the site was á feasible one for a dam. The only witness for the petitioners who was asked his opinion as to such value was Fred E. Baldwin, who owned real estate in this vicinity and had done appraisal work for water power companies. He stated that if the water-power site sold in 1923 for $200,000, he was of the opinion that its value on March 1, 1913, was fully as great. He had never examined the particular site and stated that he did not consider himself qualified to value a water-power site. Clearly, his testimony is of little or no value and is contradicted by that of the respondent’s witnesses.

There was other testimony introduced as to the costs to the Washington Water Power Company of the various sites upon which it had erected dams, various offers made for this property in 1911, and the nature of the property and amount of flowage at the various waterpower sites, which we have duly considered in reaching our conclusion, but which we do not deem necessary to discuss at any length. It is enough to say, in view of our finding and of the above discussion of the evidence, that the petitioners have failed to sustain the burden of proving that there was a market on March 1, 1913, for this water site or that it had a fair market value on that date in excess of cost. Such a conclusion is strengthened by the evidence introduced by the respondent which showed that there was no market for such a site on the basic date and that it did not have a value on that date in excess of cost.

Reviewed by the Board.

Judgment will be entered for the respondent.

Trammell dissents.

Goodrich,

dissenting: I can not agree that .a site which sold for $200,000 in 1923 had no market value in excess of its cost as farm land at March 1, 1913, when, according to the evidence, there was then a greater demand for power sites because of a larger population within the area to be served and more activity in the development of water power and in general business than existed at the time the sale was made.

LaNsdoN and Black agree with this dissent.


author: Lansdon :

text:
    H. Rothschild, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. Jacobstein, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 35140, 35141, 37629, 40244.
    Promulgated June 9, 1932.

      Phil B: Moreloch, Esq., for the petitioners.

      T.-M. Mather, Esq., for the respondent.
   OPINION.

Lansdon :

At Docket Nos. 35141 and 40244 the respondent asserts deficiencies in income tax against H. Rothschild for the years 1925 and 1926 in the respective amounts of $2,125.27 and $935.52, and at Docket Nos. 35140 and 37629 against J. Jacobstein for the same years in the respective amounts of $2,066.85 and $916.29. The same issue is involved in each proceeding, all of which were consolidated for hearing. There are no disputed facts and each of the proceedings was submitted on the pleadings.

The petitioners are individuals who were partners in the Union Clothing Company of Kansas City, Missouri, in the taxable years. The deficiencies result from the respondent’s increase of the distributable net profits of such partnership for each of the years involved, which converted reported losses for 1925 and 1926 into profits for each of such years and resulted in the deficiencies here in controversy.

Prior to 1925 the Union Clothing Company kept its books and rendered its income-tax returns on the accrual basis. At January 1, 1925, in conformity with the law and pursuant to the regulations of the Commissioner it changed its method of accounting for and reporting income to the installment basis. During the year 1925 it collected accounts receivable on merchandise sold in the amount of $161,716.53 and in 1926 it made similar collections in an amount not clearly disclosed in the record. All of such collections in the two years under review had been included in the partnership’s returns of gross income made on the accrual basis in years prior to 1925.

The petitioners contend that the procedure proposed by the respondent results in double taxation. This may be true, but, if so, it is not a unique situation and is not in violation of any law. Packard Motor Co. v. United States, 39 Fed. (2d) 991. This identical question has been before this Board and the courts in many instances and decisions have been consistently adverse to the contentions here. If there is any infirmity in the law which taxes the income here involved a second time, it can be cured only by legislation, which is not the province of this Board. The determinations of the respondent are approved. Blum's, Inc., 7 B. T. A. 737.

Decision will be entered for the respondent.


author: Matthews:

text:
    R. E. Anderson & Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 40878.
    Promulgated June 9, 1932.

      F. D. Metzger, Esg., for the petitioner.

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

Matthews:

The petitioner in this proceeding, while admitting that it erred in not including in its income the rentals and profits from the sale of the real estate in question, contends that it is entitled, after setting aside a part of such amounts for dividends and reserves, to a deduction of the remainder, amounting to $1,-202.21 for 1924 and $1,094.44 for 1925, as additional compensation paid to Miller and Van Horn.

The three stockholders of the petitioner entered into a written contract, by the terms of which they were each to be paid a percentage of the profits as salaries. The evidence shows that the respondent has allowed amounts paid under this contract to be deducted in previous years as salaries and also in the taxable years. There is no controversy as to these amounts. The only contention is whether the petitioner is entitled to deduct the additional amounts which were credited on the petitioner’s books to Miller and Van Horn. The respondent contends that these amounts are not deductible, (1) since there is no evidence as to whether they were actually •paid to the officers; (2) that such amounts did not constitute compensation, but a distribution of profits; and (3) that they were not reasonable compensation for services rendered.

On the other hand, the petitioner contends that, since these amounts were paid under the contract and according to a policy which it had followed for many years, they are deductible as reasonable compensation for services rendered, citing the case of Gray & Co. v. United States, 35 Fed. (2d) 968. With regard to this contention, it should be noted that the amounts in question were not paid under the written contract, but were credited to Miller and Van Horn under an oral agreement that Caesar should not share in the profits or be liable for losses on any investment which had been made prior to his becoming a stockholder. The amounts of the rentals and of the profit upon the sale were not carried through the petitioner’s profit and loss account but were credited directly to the accounts of Miller and Yan Horn. They were not included in any way in the petitioner’s gross income and were not deducted either on its 'books or on its returns as compensation. Neither the rent nor the profit on the sale of the property was income derived by the corporation from the activities of its stockholders. The manner of handling the amounts on the books of the corporation was an informal way of carrying out the oral agreement between all the stockholders that Miller and Yan Horn alone were to share in any profits from investments made prior to the time Caesar became a stockholder. It was a short-cut way of distributing certain profits to two stockholders.

Under such circumstances, it is unnecessary to consider the fur-. I her contentions of the respondent. We hold that the petitioner is not entitled to the deduction claimed.

Judgment will l>e entered for the respondent.


text:
    Walton Cotton Mills Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 25542.
    Promulgated June 9, 1932.

      J. G. Murphy, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Matthews:

In the instant proceeding the petitioner is claiming special assessment upon the grounds that invested capital can not be determined, due to the fact that capital expenditures had been charged to expense; that the petitioner had built up a valuable good will which was not reflected in its invested capital; that petitioner received substantial income from hedging contracts; that the net income for the pre-war period was abnormally low, thereby reducing the war-profits credit; and that salaries paid were abnormally low.

We are of the opinion that upon all the evidence presented the petitioner has failed to establish that its invested capital can not be determined, or that there were any abnormalities affecting its income or invested capital for the year in question. With regard to the claim that invested capital could not be determined, it was shown that certain capital items had been charged to expense. The bookkeeper testified that there were other items of the same nature charged.to expense; however, the books were not introduced in evidence and the petitioner has not shown that the amounts so charged to expense can not be determined. See Enameled Metals Co., 14 B. T. A. 1392; and Morris Coal Co., 15 B. T. A. 322; affirmed in 48 Fed. (2d) 810. The same situation exists with respect to the question of depreciation. Counsel for the petitioner contends that since the minutes show that depreciation was charged off the plant account in arbitrary amounts, a part of such amounts represented capital which should have been reflected on the petitioner’s books. However, there is no showing as to what was a proper amount of depreciation or that the correct amount could not be determined. If it could, the petitioner should have sought to have it restored to its capital account. See Morris Coal Co., supra. Moreover, we have no Avay of knowing how the respondent arrived at the figure used by him as the amount of invested capital. The thirty-day letter upon which the notice of deficiency is based shows the total amount allowed by the respondent, but does not show the items of invested capital entering into his computation.

In Duquesne Steel Foundry Co., 15 B. T. A. 461, we said:

In any event the record is wholly insufficient to enable us to hold that the respondent is unable satisfactorily to determine petitioner’s invested capital. No proof was submitted of the amount of invested capital allowed by respondent nor of the items or basis used in his computation. For aught that appears the respondent may have made due and proper allowance for the alleged infirmities of petitioner’s accounting methods and records.
Such matters are essential items of proof and can not be left to inference or conjecture. The presumption of correctness attaching to the respondent’s finding must be overcome by proof of such a character as will enable us definitely to say that respondent has erred. * * *

So, iu the instant proceeding, for aught we know the respondent may have made allowance for the infirmity ” of the petitioner’s bookkeeping and may have included some, if not all, of these amounts in his computation.

With regard to the good will, the petitioner introduced a public accountant as a witness, who, by using a formula, found a good will value of $68,631.13. The petitioner claims that since this good will was built up in the business and could not be included in its invested capital, an abnormality existed. In regard to such a situation, we said in Gerlach-Barklow Co., 16 B. T. A. 201:

* * * The first point it makes is that under the determination of the tax liability by the Commissioner there is not reflected in invested capital the appreciation in the value of its assets, principally good will. We have no doubt from the evidence that by 1912, and also by 1917, a valuable good will had been built up. We are of the opinion, however, that this is not an abnormal condition in the case of any prosperous, well managed corporation, especially one engaged in a business of the character of that conducted by the petitioner. The invested capital of the petitioner was not abnormal by reason thereof.

With regard to the other contentions of the petitioner, the facts are fully set forth in our findings of fact. There is some evidence that the salary paid to Tichenor was inadequate, but we are of the opinion that this does not constitute an abnormality under the circumstances in this case. Eagle Piece Dye Works, 10 B. T. A., 1360. We are unable to find any abnormality affecting either the income or invested capital of the petitioner upon the evidence presented, and in view of this we do not consider it necessary to discuss further the other contentions of the petitioner.

Judgment will he entered for the respondent.


author: Smith:

text:
    Western Hide & Fur Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44294.
    Promulgated June 9, 1932.

      Bussell D. Morrill, Esq., and Francis L. Casey, Esq., for the petitioner.

      J. M. Leinenkugel, Esq., and T. G. Histon, Esq., for the respondent.
   OPINION.

Smith:

Section 240 (d) of the Revenue Act of 1924 and section 240 (f) of the Revenue Act of 1926 are identical and are as follows:

In any ease of two or more related trades or businesses (whether unincorporated or incorporated and whether organized in the United States or not) owned or controlled directly or indirectly by the same interests, the Commissioner may and at the request of the taxpayer shall, if necessary in order to make an accurate distribution or apportionment of gains, profits, income, deductions, or capital between or among sueli related trades or businesses, consolidate the accounts of such related trades or businesses.

The respondent contends that the mandatory requirement upon him to make the reallocation applies only where the necessity exists because of inaccurate distribution or apportionment, asserting that the instant proceeding does not require a consolidation of accounts.

This Board considered the above provision of the Revenue Acts in Nowland, Realty Co., 18 B. T. A. 405, 414; affd., 47 Fed. (2d) 1018, and denied the consolidation of the accounts of that petitioner with another taxpayer on the facts presented in that proceeding. We there said:

* * * the statute specifically provides that the consolidation of the accounts as provided for therein shall be made “ if. necessary in order to make an accurate distribution or apportionment of gains, profits, income, deductions or capital between or among such related trades or businesses.” This requirement must be met in order for accounts to be consolidated. * * *

In affirming the Board’s decision in the above case, the Circuit Court of Appeals for the Seventh Circuit (Nowland Realty Co. v. Commissioner, 47 Fed. (2d) 1018, 1021) said:

It is not perfectly clear from a reading of section 240 (d), Act of 1924 (26 USCA § 993 note), to what extent a court may review the action of the commissioner to ascertain whether a fact situation exists which makes it necessary to consolidate accounts in order to make an accurate distribution of profits. What is meant by the word “ accurate ” as used in the statute? Who determines whether a consolidated statement depicts more accurately distribution or apportionment of gains than two independent statements? While we are not inclined to deny to the board or to this court the right to review the question presented by this test, yet obviously there is, we think, some discretion left in the commissioner, and the exercise of that discretion can only be disturbed when an abuse of it is shown.

Section 240 (d) of the Revenue Act of 1-921 is substantially the same as the provisions of the later acts now under consideration, and has been considered in Broadway Strand Theatre Co., 12 B. T. A. 1052, and Roessler & Hasslacher Chemical Co., 25 B. T. A. 915. In both cases the consolidation of accounts was denied. In the first case, we said:

* * * It has not been shown that there was such an intermingling of the accounts of the two businesses in question as would necessitate the consolidation of their accounts in order to make “ an accurate distribution or apportionment of gains, profits, income, deductions, or capital between or among such related trades or businesses,” or that the accounts should be consolidated to obviate the situation as pointed out in Report No. 275 of the Committee on Finance “ to prevent the arbitrary shifting of profits among related businesses.”

In Roessler & Hasslacher Chemical Co. the petitioner contended that certain expenditures it had made should be distributed or apportioned so that a part thereof may be used to offset Niagara’s [Electro Chemical Co.] income, another part used to offset the income of Perth Amboy [Chemical Works], and the remainder left to the ft. & H. Company.” The facts of that case show the amounts expended by that petitioner in conducting the businesses of the three chemical companies. That petitioner sought an apportionment of the expenses under one of three methods: first, a percentage based upon a witnesses’ opinion; second, on the basis of gross sales; or, third, on the basis of capital. In rejecting the proposed methods, we said:

The methods suggested by the petitioner are short cuts. They are less onerous as to proof. But there were obviously better and more accurate methods which anyone wanting to make a reasonably accurate distribution would adopt in preference. Where some allocation is-proper under section 240 (d), it is incumbent upon a petitioner before this Board to prove a more accurate method of distribution or allocation than those suggested by this petitioner, or at least to show sufficient justification for failure to do so. Even if every other question in this case were decided in the petitioner’s favor, nevertheless, we could not make any allocation. We need decide nothing more.

The petitioner contends that its income should be reduced and the income of the John Finnigan Company increased by “ an amount equal to at least 6% on the average monthly debit balances ” owing to John Finnigan Company bj'' reason of advances to the petitioner. The allocation contended for, in effect, amounts to, first, allowing petitioner a deduction for interest that was not paid in the taxable years and for which no liability has been shown to have been incurred in these years; and, second, crediting the John Finnigan Company with income which, according to the evidence, it neither received nor had any right to receive in these years. In this manner petitioner contends that the interest “ deduction ” should be allocated for the years under consideration in the following amounts:

1924_$7,284.01
1925_ 4, 389.78
1926_ 7,252. 55

• It is to be noted that the statute provides for the consolidation of accounts “ if necessary in order to make an accurate distribution or apportionment of * * * deductions.” We believe that Congress used the word “ deductions ” in this provision as meaning the deductions provided for in section 234 of the act. Obviously, the proposed method of allocating on amount representing 6 per cent of the petitioner’s average monthly debit balance on advances from the John Finnigan Company is not an accurate distribution of the deductions within the purview of the statute. No agreement for the payment of interest on these advances has been disclosed by the record, and no interest was in fact paid, but should we nevertheless consolidate the accounts of the two companies, there would have to be “ an accurate distribution or apportionment ” between them and we would still have no allowable interest deduction to apportion. Only “ interest paid or accrued within the taxable year on its indebtedness ” would be deductible by the petitioner (section 234 (2) of the Revenue Act of 1924); the amounts proposed are not within the purview of that provision of the statute, and are apparently not included in the accounts to be consolidated.

The instant proceeding is very much like Roessler & Hasslacher Chemical Co., supra, except that one comes under the 1924 and 1926 Acts and the other under the 1921 Act. However, this difference is not material. There, the three corporations had filed consolidated returns, just as here, and one had been held without the affiliated group, just as here. There, certain expenditures were made on behalf of three corporations, which that petitioner sought to have apportioned; here, certain expenditures were made by the John Finnigan Company, a portion of which petitioner contends should be apportioned to it to determine its true income. The petitioner contends that the John Finnigan Company “ paid for various services to Petitioner in 1924 and 1925, * * * and this expense was deducted in item 22 ‘ Other Deductions ’ of Finnigan’s Accounts in Central’s Consolidated Federal income tax return * * * in the amount of $103,457.57 in 1924 and $74,356.80 in 1925.”

These amounts appear on the return as “ Branch & Geni. Expense Hide Buying Cos,” The facts show that the John Finnigan Company performed services for and extended facilities to the petitioner and other organizations controlled by the Central Leather Company. Obviously, these amounts are not wholly attributable to the services of the John Finnigan Company on behalf of the petitioner. The parties stipulated, and we have made findings accordingly, the amounts of the expenses of the John Finnigan Companj'- and the petitioner for the years 1924 and 1925. Likewise, we have found from the stipulation the amounts of petitioner’s sales, the John Fin-nigan Company’s sales, and the sales of the John Finnigan Company for the petitioner. The petitioner contends that some portion of these expenses is properly deductible by it, and they should be allocated between the John Finnigan Company and petitioner on one of the following bases, or, in the discretion of the Board, on a combination of such bases :

The combination proposed is to use the average of the result of the three formulae. We are not impressed with such proposals. First, no showing is made respecting the sales and expenses of the other corporations controlled by the Central Leather Company and for which the John Finnigan Company rendered the same sort of services rendered to or for the petitioner; and, second, even assuming that all the amounts shown are attributable to the petitioner and the John Finnigan Company and that the other companies in the group may be ignored, the proposals do not accurately establish the expenses to be apportioned or allocated to each company. Here, as in the Roessler & Hasslacher Chemical Co. case, supra, “ there was no effort made to segregate accurately any of the expenses to determine the amount applicable to each company. It does not appear that such an attempt would have been futile or that it was necessary to rely upon an approximation.”

If the accounts of the petitioner and the John Finnigan Company were consolidated under section 240 (d) of the 1924 Act, and section 240 (f) of the 1926 Act, we would nevertheless be confronted with the problem of breaking up the accounts and segregating the items attributable to each in order to determine the petitioner’s correct tax liability. We have no sufficient evidence on which to make such a segregation. Separate accounts were kept by or for each company and the detailed expense of each is shown. We can not determine ’bat the method used does not accurately distribute or apportion the items of income and expenses; certainly the proposed methods would not more accurately distribute or apportion these items between the petitioner and the John Finnigan Company. Furthermore, no showing is made with respect to expenses for 1926.

Although the evidence establishes that the petitioner and the John Finnigan Company were engaged in related trades or businesses, owned or controlled by the same interests, the evidence does not disclose an abuse by the respondent of the discretion reposed in him by refusing to consolidate the accounts of these two corporations. His action is sustained.

Judgment will he entered for the respondent.


author: McMahon :

text:
    Marian B. Pringle, Petitioner, v. Commissioner of Internal Revenue, Respondent. Phyllis B. Brunson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 34943, 34944.
    Promulgated June 9, 1932.

      Ralph W. Smith, Esq., for the petitioners.

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

McMahon :

In computing the profit on the sale by the petitioners in 1923 of certain property which they received under the will of their mother, Ida Wilcox Beveridge, referred to as the decedent, the respondent used as the basis the value of the property at August 7, 1914, the date of the death of the decedent, to wit, $76,600. The question here presented is whether that figure is the proper basis to be used or whether there should be used as the basis the value at July 25, 1923, the date of the termination of the trust, the value at which time was equal to the selling price of the property. In the latter event, the petitioners are not chargeable with any profit upon the sale. Section 202 of the Revenue Act of 1921 provides in part as follows:

(a) That the basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall be the cost of such property; except that—
>|t «fr sic
(3) In the case of such property, acquired by bequest, devise, or inheritance, the basis shall be the fair market price or value of such property at the time of such acquisition. * * *

Petitioners contend that what they received at the date of death of the decedent was simply a contingent remainder and that they did not acquire the property in question until the date of the expiration of the trust period. They argue that the trustees held an estate comparable to an intervening life estate and that the petitioners simply had a contingent remainder. None of the cases cited by petitioners hold that trustees take a beneficial interest in real property. They simply sustain the proposition that a testamentary trustee takes legal title to real property immediately upon the death of the testator.

Petitioners cite the following provision of the laws of California, which was in effect at the date of the death of the decedent:

Trustees of express trusts to have whole estate. Except as hereinafter otherwise provided, every express trust in real property, valid as such in its creation, vests the whole estate in the trustees, subject only to the execution of the trust. The beneficiaries take no estate or interest in the property, but may enforce the performance of the trust. [Sec. 863 of the Civil Code of California, 1927, legislation enacted March 21, 1872.]

However, in In re Fair's Estate, 132 Cal. 523; 60 Pac. 442, the Supreme Court of California stated in regard to that section:

* * * The provision in section 863, Civ. Code, that, “ except as hereinafter otherwise provided, every express trust in real property, valid as such in its creation, vests the whole estate in the trustees, subject only to the execution of the trust,” is limited by the succeeding sections to the estate given to the trustee for the purposes of the trust, and does not include any estate in the property which is not required by the trust. Morffew v. Railroad Co., 107 Cal. 587, 40 Pac. 810. * * *

From a reading of the will it is clear that the decedent did not intend to vest in the trustees any interest except the legal title to the property, to hold in trust for the beneficiaries.

The law of California that was in effect at the date of the death of the decedent provided in part as follows:

§ 768. Reversions. — A reversion is the residue of an estate left by operation of law in the grantor or his successors, or in the successors of a testator, commencing in possession on the determination of a particular estate granted or devised.
§ 769. Remainders. — When a future estate, other than a reversion, is dependent on a precedent estate,- it may be called a remainder, and may be created and transferred by that name. [Sections 769 of the Civil Code of California, 1927 — legislation enacted March 21, 1872.]

Clearly, the interest which the petitioners obtained upon the death of the decedent was not a remainder. Their interest under the trust was not dependent on a precedent estate.

In In re Blake's Estate, 157 Cal. 448; 108 Pac. 287, cited by petitioners, the Supreme Court of California stated:

The cardinal rule in the interpretation of a will is that “ it is to be construed according to the intention of the testator.” Civ. Code, § 317. As said in Estate of Young, 123 Cal. 337, 55 Pac. 1011: “ The purpose of construction as applied to wills is unquestionably to arrive, if possible at the intention of the testator; but the intention to be sought for is not that which existed in the mind of the testator, but that which is expressed in the language of the will.” It is not the business of the court to say, in examining the terms of a will, what the testator intended, but what is the meaning to be given to the language which he used. Where the terms of a will are free from ambiguity, the language used must be interpreted according to its ordinary meaning and legal import, and the intention of the testator ascertained thereby. It is true that presumptions are to be indulged in which will prevent intestacy (Le Breton v. Cools, 107 Cal. 410, 40 Pac. 552), and that testamentary devises are presumed to vest at the death of the testator (Civ. Code, § 1341) ; but these presumptions, like the auxiliary rules of construction relied on by appellant, are subordinate to the cardinal rule just stated.

See also Henry J. Faulkin et al., 13 B. T. A. 1200

Under the laws of California there was a presumption that the property vested in the beneficiaries at the testator’s death. The following provisions of the laws of California were in effect at the time of decedent’s death:

■ § 1341. When devises and heqtiests vest. Testamentary dispositions, including devises and bequests to a person on attaining majority, are presumed to vest at the testator’s death.
§ 1342. When cannot he divested. A testamentary disposition, when vested, cannot be divested unless upon the occurrence of the precise contingency prescribed by the testator for that purpose. [Sections 1341 and 1342 of the Civil Code of California, 1927' — legislation enacted March 21, 1872.]

Even aside from the statutory presumption, we believe, from a reading of the 'will, that it was the intention of the decedent that her children should receive a vested interest under the trust immediately upon her death. The statutory presumption is augmented by the intention of the testator as evidenced by the provisions of the will, particularly the following provision :

Should any or either of my trusts hereinbefore provided for be adjudged null by the final decree of any court, then it is my will that the property covered by such trust shall be and become the property of my children who may be living at my death.

In Brewster v. Gage, 280 U. S. 327, the Supreme Court held that Upon the death of the owner of personal property, there vests in his heirs or legatees immediately the right to respective distributive shares of so much as might remain after proper administration, and the right to have that share delivered upon entry of the decree of distribution, but that legal title vests in the executors or administrators. The title to real estate, however, as pointed out in that case, passes to the owner’s heirs or devisees immediately upon the owner’s death. The court there stated :

Petitioner's right later to have his share of the residue vested immediately upon testator’s death. At that time petitioner became enriched by its worth, which was directly related to and would increase or decline correspondingly with the value of the property. And, notwithstanding the postponement of transfer of the legal tille to him, Congress unquestionably had power and reasonably might fix value at the time title passed from the decedent as the basis for determining gain or loss upon sale of tb° right or of the property before or after the decree of distribution. And we think that, in substance, it would not be inconsistent with the rules of law governing the descent and distribution of real and personal property of decedents to construe the words in question to mean the date of death.

In the instant proceeding legal title to the property in question vested immediately upon the death of the decedent in the trustees by virtue of the jorovisions of decedent’s will. Thus, although the instant proceeding involves realty, the situation herein closely resembles that in Brewster v. Gage, supra, since the legal title did no* vest immediately in the petitioners herein upon the death of the decedent. In the instant proceeding, under the principles enunciated in Brewster v. Gage, supra, there vested in the petitioners the right to their distributive shares of so much of the property as might remain at the end of the trust period, and the right to have it delivered at the end of that period. In Brewster v. Gage, supra, the executors were in the position of trustees. • The court pointed out, and the same is true in the instant proceeding, that the trustees did not take title for themselves, but on behalf of the beneficiaries. Here also, as in Brewster v. Gage, supra, the decree of distribution conferred upon the beneficiaries no new right. It merely identified the property remaining, it evidenced the right of possession in the beneficiaries, and required the trustees to deliver the property to the beneficiaries. The legal title so given related back to the date of the death of the decedent. The petitioners’ right to distribution of the property to them would be defeated only in the event of their death.

The case of Estate of Francis Abeles et al., 24 B. T. A. 435, although involving personal property, is also helpful in the instant proceeding. There certain stock was transferred by the testator in trust for a period not to exceed five years, at the end of which time it was to be distributed to certain beneficiaries. In that case we stated:

We can see no essential difference, as to the principle involved, between that case [Brewster v. Gage] and the present proceedings. There, possession and dominion by the legatees was deferred during an indeterminate period of administration; here, possession is postponed for not to exceed a five-year trust period, the legatees meanwhile receiving the income earned by the stocks. We hold, therefore, that the stocks in question were acquired upon the death of Julius D. Abeles on August 15,1920.

Cf. Security Trust Co. et al., Trustees, 25 B. T. A. 29.

At the death of the decedent these petitioners “ acquired ” the property within the meaning of the revenue act.

In view of the fact that there is no remainder involved in the instant proceeding, we are not concerned with the cases dealing with remainders, such as William Huggett, 24 B. T. A. 669.

We hold that the respondent did not err in using the value of the property at the date of the death of the decedent as the basis for the computation of gain derived by petitioners upon the sale of the property.

We find nothing in the cases relied upon by the petitioners which leads to a different conclusion.

Judgment will he entered for the respondent.


author: McMahon:

text:
    First National Bank of Key West, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45186.
    Promulgated June 10, 1932.

      Frederick L. Pearce, Esq., for the petitioner.

      O. J. Tall, Esq., for the respondent.
   OPINION.

McMahon:

Petitioner assigns as error the respondent’s failure to deduct from its income for the years 1925, 1926 and 1927, any allowance for obsolescence of its banking building, alterations and fixtures. Section 234 of the Revenue Act of 1926 provides for the deduction by corporations of a “ reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.”

The petitioner contends that, due to the beginning of the shifting of the business center of Key West, Florida, away from the location of the petitioner’s building in the latter part of 1925, its officers were justified in determining at that time the petitioner’s building would become obsolete at the end of five years and that it is entitled to deductions in each of the years 1925, 1926 and 1927 of a pro rata portion of its capital investment in the bank.

Obsolescence, we have held, is the state or process of becoming obsolete, and the state of obsolescence is reached when the property is no longer useful for the purpose for which it was acquired. Columbia Malting Co., 1 B. T. A. 999; Manhattan Brewing Co., 6 B. T. A. 952; Frederick C. Renziehausen et al., 8 B. T. A. 87; and Tennessee Fibre Co., 15 B. T. A. 133.

In the last cited case we stated:

Webster’s New International Dictionary defines “ obsolescent ” or “ obsolescence,” “ to wear out gradually; to fall into disuse,” and the word “ obsolete ” is defined to mean “ no longer in use; disused; neglected; as, an obsolete word; an obsolete statute.” Obsolescence as used in the statute is the state or process of becoming obsolete and the provision allowing a deduction therefor is intended to care for losses of capital which take place over a longer period than the taxable year. WilUam Zahón, 7 B. T. A. 687. The state of obsoleteness is reached when the property which can not be used for any other purpose is no longer economically useful for the purpose for which it was acquired, Frederick G. Renziehausen et al., 8 B. T. A. 87, and is therefore abandoned. * * *

In Frederick C. Renziehausen et al., supra, we stated:

The right to an obsolescence deduction must be based upon substantial reasons for believing that the assets would become obsolete prior to the end of their ordinary useful life; and it must have been known, or believed to have been known,, to a reasonable degree of certainty, under all the facts and circumstances, when that event would likely occur.

In the instant proceeding, consideiing all the evidence, we conclude that the petitioner was not justified in concluding that the bank property would have to be abandoned and would become obsolete as claimed by petitioner. The petitioner was the only bank in Key West and the shifting of the business center would not deprive petitioner of its business, since all businesses requiring banking services would have to continue patronizing petitioner. There was no showing that in the latter part of 1925 there was any likelihood that any other bank would be established there or that petitioner "would lose any of its business. We do not believe that there was any probability that a new bank would be established, particularly since in 1913 another bank had failed. The evidence discloses that the petitioner did not at any time actually lose any of its business due to the moving of the business center.

Furthermore, from the evidence it appears that petitioner made additions to its building in 1926 at a cost of $2,630.91. This is inconsistent with the petitioner’s claim that its building was becoming obsolete.

At the time of the hearing in this proceeding, which was on November 12,1930, the petitioner was still occupying the same bank building and for all we know may still be occupying it. Thus, at about the end of the claimed obsolescence period the property in question had not become obsolete and there was no showing that it would become obsolete or if so, when it would do so. It is true that petitioner had purchased a lot in the new business center, only five blocks or 2,000 feet from the bank building in question, but at the time of the hearing no steps had been taken toward erecting a new building and it was not shoAvn when, if ever, petitioner would construct a new building.

There was testimony offered for the purpose of showing that the bank building in question could not be sold at public auction for $10,000, but even if this be so, it does not necessarily give rise to a right to an obsolescence deduction. We have heretofore held that mere decline in value of the property does not give rise to a right to a deduction. Washington Catering Co., 9 B. T. A. 743, and United Business Corporation of America, 19 B. T. A. 809.

The petitioner relies upon Burnet v. Niagara Falls Brewing Co., 282 U. S. 648, wherein the Supreme Court stated that obsolescence may arise as the result of the shifting of business centers. However, as stated hereinabove, the petitioner has not shown that its property was becoming obsolete. Obsolescence is a question of fact, to be determined from the evidence in each case. Columbia Malting Co., supra; Corsicana Gas & Electric Co., 5 B. T. A. 565; and Conley Tin Foil Corporation, 17 B. T. A. 65. In Burnet v. Niagara Falls Brewing Co., supra, the taxpayer, as held by the Supreme Court, was abundantly justified in the early part of 1918 in concluding that its property would become useless for the purpose for which it was acquired, but this is not true in the instant proceeding. In that case the taxpayer had claimed deductions for obsolescence in the years 1918 and 1919 on account of the imminence of national prohibition. At the time the taxpayer determined the obsolescence period it could not foresee the definite date that prohibition would go into effect. The Supreme Court in 1931 took judicial notice that the Eighteenth Amendment to the Constitution took effect on January 16, 1920, which was after the obsolescence period claimed by the taxpayer, and used that fact in arriving at its conclusion that the taxpayer’s property did become obsolete, and also in determining that the obsolescence period consisted of the years 1918 and 1919.

We appreciate that in Burnet v. Niagara Falls Brewing Co., supra, the Supreme Court by way of dicta recognizes that a shifting of the business center may give rise to obsolescence; but it is obvious that it is not sufficient to merely show that a business center has shifted; and that in addition it must be shown that it was reasonable to expect that the shifting of the business center would cause the obsolescence. This latter the petitioner has failed to show.

On the other hand, it has produced proof which supports the inference that it was not reasonable to expect that the shifting of the business center would actually cause obsolescence within the alleged five-year period.

Mere inconvenience to petitioner and its patrons occasioned by added distance of a few blocks of driving or walking, under the circumstance herein, is not sufficient to establish obsolescence.

After carefully considering all the evidence, we hold that petitioner is not entitled to the claimed deductions in the years 1925, 1926 and 1927 for obsolescence of its property, and the respondent’s determination in this regard is approved.

Petitioner contends that it is entitled to a deduction in the amount of $15,000 from gross income for the year 1927, representing that portion of the Florida Lightbourne debt which was ascertained to be worthless in that year.

Section 234(a) (5) of the Revenue Act of 1926 provides:

(a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * * ♦ * * • *
(5) Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

From the evidence it clearly appears that the petitioner did ascertain that debt to be worthless to the extent of $15,000 in the year 1927. The petitioner has followed the practice of charging off actual bad debts rather than employing the reserve method. During the year 1927 the petitioner charged off specific debts in the approximate amount of $16,000, but did not include therein the item of $15,000, but set up a reserve for loss in the amount of $15,000 on account of the Lightbourne debt. It is the contention of the respondent that since petitioner has failed to show that it had permission from the Commissioner to use the reserve method, petitioner is not entitled to deduct from gross income the item of $15,000 which was charged to a reserve.

However, as stated in Ewald & Co., 18 B. T. A. 1130, 1132, “ The right of a taxpayer to the deduction provided in the statute above quoted is not to be destroyed because of its initial failure to put its claim on the technically proper ground.” If the amount of $15,000 was charged off within the meaning of the statute, then the petitioner is entitled to the claimed deduction. Whether a charge-off has been effected is not dependent upon any special form of bookkeeping, but must be determined from the circumstances in each case. Ewald & Co., supra.

At the hearing the president of petitioner testified as follows:

Q. In other words, the amount of $15,000 was not claimed as a deduction from taxable net income in this return?
A. I do not think so. The Lightbourn matter was like this: We knew we had the loss, but we had $16,000 to charge off that year, and I did not want to make it thirty-two or thirty-three, so we transferred that $15,000 to a reserve account to take care of that specific loss.
I personally was misinformed that we could do that, otherwise we would have charged it right into the bad loss, because it was not anything else but a bad loss.
*******

Under substantially similar circumstances we have heretofore held that a charge-off was effected. O. S. Stapley Co., 13 B. T. A. 557; Dillon Supply Co., 20 B. T. A. 404; McMinnville Manufacturing Co., 19 B. T. A. 486; and Poel da Kelly, Inc., 19 B. T. A. 1317. Upon the authority of those cases we hold that the petitioner is entitled to deduct the amount of $15,000 from its gross income of 1927.

The petitioner alleges that the respondent erred in adding to its income for the years 1925, 1926, and 1927, respectively, amounts of $2,375, $980.02, and $1,965.27, collected in those years upon the principal of loans written off in previous years as uncollectible. From the evidence we can not determine that these amounts were not properly charged off in the prior years, and therefore, under our decisions in Excelsior Printing Co., 16 B. T. A. 886, and Iberville Wholesale Grocery Co., Ltd., 17 B. T. A. 235, we hold that the respondent properly included such amounts in gross income in the years in which they were collected.

Judgment will be entered under Bule 50.


author: MaRquette:

text:
    Charles Kaplan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43472.
    Promulgated June 10, 1932.

      Allison L. H. Newton, Esq., for the petitioner.

      Dean P. Kimball, Esq., and Edward G. Adams, Esq., for the respondent.
   OPINION.

MaRquette:

Petitioner was both the grantor and the trustee of a trust of which his wife was the primary beneficiary. Under the fourth provision of the declaration of trust the trustee is given full power to deal with the trust property as if he were the beneficial owner thereof, and to reserve a reasonable portion of the income. The same provision also declares that:

Any income accumulated by the Trustees under this Trust shall be held for the benefit oí the particular persons whoi were entitled to such income, and on their death for the benefit oí the person or persons who under this Trust become entitled to the share that such individual would have received if living.

By the first provision in the trust declaration the income of the trust property was to be paid to the petitioner, the grantor of the trust, if he survived his wife.

Section 219 (h) of the Revenue Act of 1924, so far as pertinent, provides:

Where any part of the income of a trust may, in the discretion of the grantor of the trust, * * * be distributed to the grantor or be held or accumulated for future distribution to him, * * * such part of the income of the trust shall be included in computing the net income of the grantor.

In our opinion the power reserved by petitioner to himself as trustee to accumulate the trust income for future distribution to himself as the grantor in case he survived his wife, brings the trust income within the scope of section 219 (h), supra. The word “ may ” as used in that section clearly is used in a permissive sense only and is not equivalent to “ shall.” It contemplates a trust wherein the grantor retains dominion over the trust income to the extent of diverting it to himself. The declaration of trust before us reserves to the petitioner, as grantor and trustee, full power to bring about exactly the possibility contemplated by the statute. We find no error, therefore, in the respondent’s determination that the trust income was taxable to the petitioner individually.

The remaining question is whether petitioner’s loss of $20,000 is deductible in its entirety, or is to be treated as a capital net loss, with deductions accordingly.

In 1919 petitioner paid to the Eliot Mills, Inc., $25,000. In return he received 20 per cent of the common stock of the company, but none of the preferred stock. By mutual agreement petitioner’s interest in the net earnings of the company., was to be 20 per cent of the amount available for common stock. It was also agreed that at the end of five years, at the option of either party, petitioner would surrender his stock and receive $25,000 plus so much of one-fifth of the company’s net earnings or minus so much of one-fifth of its net losses for the five-year period as had not already been paid to or by petitioner. It appears that the arrange-ent was terminated in 1924, pursuant to the agreement, with a net loss for five years in the amount of $100,000. Petitioner received $5,000 in cash and was charged with $20,000 of the loss.

Eespondent contends that the deduction to be allowed is controlled by the following provisions of the Bevenue Act of 1924.

Sec. 208. (a) For the purpose of this title— *******
(2) The term “capital loss” means deductible loss resulting from the sale or exchange of capital assets; * * *
* * * * * * *
(8) The term “capital assets” means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business.
*******
(c) In the case of any taxpayer * * * who for any taxable year sustains a capital net loss, there shall be levied, collected and paid * * * a tax determined as follows:
A partial tax shall first be computed upon the basis of the ordinary net income * * * and the total tax shall be this amount minus 12% per centum of the capital net loss.

The provisions of the contract between the petitioner and the corporation were perhaps unusual, but the fact remains that petitioner purchased the company’s capital stock under the contract fixing a price for its resale to the company at a future date. The contract was carried out and petitioner received the price agreed upon when five years later he resold the stock in 1924. A loss of $20,000 was sustained. Throughout the five years during which petitioner was a stockholder he was the owner of a definite property right in the company, evidenced by his shares of stock. That property right clearly constituted a capital asset, the character of which was not changed by the provisions of the contract guaranteeing to petitioner a market for his stock at the end of five years. As that capital asset was held by the petitioner for more than two years, it clearly comes within the scope of the statute, section 208, swpra,. In our-opinion the respondent was right in computing petitioner’s loss upon the basis of that provision of the statute.

Decision will he entered for the respondent.


author: Aiiundell:

text:
    Isidore Garnets, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 36598, 45707.
    Promulgated June 10, 1932.

      Joseph Getz, Esq., for the petitioner.

      Frederick K. /Slan7eer, Esq., for the respondent.
   OPINION.

Aiiundell:

This proceeding involves section 209(a) of the Revenue Act of 1926, which, as far as material here, provides:

(1) The term “earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered * * *. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income.

The statute quoted lays down two classifications in respect of the source of the income that is treated as earned. The first class is that in which the income is compensation for personal services actually rendered. Tlie second includes situations where, in addition to the personal services rendered, capital is a material income-producing factor. Petitioner contends that he comes within the first classification, whereas the respondent has determined that he comes under the second group. The descriptions of the two groups are contained in the same section of the statute, and the provisions regarding each group must be considered as being in pari materia. Neither one is to be regarded as an exception, but in each case it must be decided on the facts which classification is applicable.

In the present case the respondent has determined that the source of petitioner’s income was the operation of a “ trade or business in which both the personal services and capital are material income-producing factors.” Under our procedure that determination is presumptively correct.

The evidence establishes that petitioner rendered personal services to the Alpha School and that at least a part of the income of the school was attributable to his services. We have no doubt that it may be possible to conduct a successful school entirely by means of personal service and without the use of capital. But in our opinion this is not such a case. Here we have a school for the conduct of which a building of substantial size is required, and in which there was used equipment valued at over $15,000 in 1925 and over $28,281.58 in 1927. These substantial investments can not easily be dismissed from view. The equipment owned by petitioner and used in the operation of the school included about 400 desks, 100 typewriters, a number of calculating machines, mimeographs, multigraphs, and other equipment necessary to teach commercial subjects, and one or two automobiles. Even the slightest knowledge of the operating methods of modern business or commercial schools makes it obvious that the possession of such equipment as petitioner had is more than a mere incident in the successful operation of the school. On the contrary, it is indispensable. The theory of bookkeeping might well be taught without extensive equipment, but modern schools realize that theory alone will not produce a practical bookkeeper and so they provide desks on which the student may spread his practice materials. It is equally plain that no amount of theory can produce a proficient typist or operator of machines used in modern business, but that machines for demonstration and practice are necessary. In Atlanta-Southern Dental College, 15 B. T. A. 1325; aff'd., 50 Fed. (2d) 34, one of the elements necessary for the taxpayer to establish was that capital was not a material factor in the production of income, which consisted largely of tuition fees. On this phase of the case the Circuit Court said:

* * * As to the tuition fees, it is perfectly plain that they were earned and produced by the use of a plant and equipment without which, no matter how eloquent the teaching of the stockholding professors might have been, no matter how magnetic the influence and drawing capacity of the stockholders, no single student could have been drawn to the school, or if drawn, kept and instructed there.

In Metropolitan Business College, 24 Fed. (2d) 176, in which the taxpayer was seeking classification as a personal service corporation, the court after referring to the taxpayer’s investment in desks, typewriters and other teaching paraphernalia, said:

* * * That all this was capital can not be gainsaid, and that it was “ income-producing ” is as certain as the fact of its employment in the process of conferring education upon the students who were paying the price. The things represented by this capital investment constituted the “plant” which, directly operated by the teaching force, under the general direction of the management, conferred the education which produced the income.

The burden of proof in this proceeding is on the petitioner to show .that capital was not a “ material income-producing factor ” within the meaning of that phrase as interpreted and applied by the courts in personal service corporation cases. The evidence here is mostly devoted to showing what petitioner’s personal activities were in the operation of the school, and is insufficient to overcome the presumption that respondent was correct in classifying petitioner as one whose earned income is subject to the 20 per cent limitation.

Viewing the case from another angle, we are of the opinion that petitioner’s income from the school does not come within the statutory definition of earned income as “ amounts received for personal services actually rendered.” Aside from the use of capital in the business, it is plain that the income was not due alone to petitioner’s personal services. He employed about twelve teachers, to whom he paid annual salaries of approximately $30,000. Clearly, those instructors would not have been engaged if petitioner could have conducted the school on the same scale without them. Petitioner testified that the faculty was composed of the most experienced teachers he could get and that they were all graduates of institutions of higher learning. It is difficult to believe that teachers of the high caliber indicated by petitioner’s testimony were merely incidental to the operation of the business.' It is pointed out in Metropolitan Business College, supra, that teachers in a business school are in a very different class from messengers and others serving the principal owners in a personal capacity, and that it is mainly' through the contact between teachers and students that tuition is earned. '

On the evidence we see no error in respondent’s limitation of earned income by the 20 per cent provision of the statute.

Decision will loe entered under Bule 50.


text:
    W. L. Shore, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 06187, 59785.
    Promulgated June 13, 1932.

      Ray G. Ransom, G. P. A., and H. L. 'Washington, Esq., for the petitioner.

      T. M. Mather, Esq., and R. II. Transue, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent asserts deficiencies in income tax for the years 1928 and 1929 in the respective amounts of $1,763.51 and $375.79. The only issue involved is whether the respondent erroneously increased the petitioner’s income by adding thereto in each of such years an amount alleged to have been received by his wife as royalty on her interest in a certain oil and gas lease.

Petitioner is an individual, residing at Oxford, Kansas, where he is the owner in fee of 21.0 acres of land. In the years 1923 and 1926, he executed oil and gas leases on such lands in the usual terms of such instruments, reserving therein one-eiglith of all oil and gas produced therefrom as his royalty.

Attached to the first lease was an additional provision as follows: “ One-half of all the rentals for oil and gas and other rentals to be paid to Hattie M. Shore and the other half to W. L. Shore.”

The following provision in addition to the usual terms was attached to the lease executed in 1926: “ One-half of all rental to be paid to William L. Shore and the other half to Hattie M. Shore, his wife.”

During the taxable years 1928 and 1929 the respective amounts of .$19,672.77 and $11,559.72 were paid to Hattie M. Shore in conformity with the provisions above set out, and such amounts were reported by her on her separate income-tax returns for such years as elements of her gross income. Upon audit the Commissioner allowed deductions for each year on account of depletion that reduced royalties received to the respective amounts of $14,262.72 and $4,273.72, and added such amounts to the income reported by the petitioner for the respective taxable years. He also made other small adjustments not at issue here and determined the deficiencies in controversy.

The only question submitted to the Board is whether the language in the lease contracts quoted above conveys a present interest in income-producing property or is a mere direction to govern the lessee in distributing the royalties accruing during the term of the lease. Although each lease contains the names of W. L. Shore and Hattie M. Shore as lessors and each is signed by both husband and wife, it is nowhere contended that Hattie M. Shore owned any interest in the "fee of the land and the action of the petitioner is in no way based on what may be the rights of a wife in land owned by her husband when both are domiciled in Kansas. In our opinion the language relied on can not be regarded even as a constructive transfer of income-producing property and effects no other result than an assignment of petitioner’s income to one who has no interest in the productive asset. Julius Rosenwald, 12 B. T. A. 350; Rosenwald v. Commissioner, 33 Fed. (2d) 423; Hazel T. Power, 23 B. T. A. 428.

Decision will be entered under Rule 50.


author: Sea well:

text:
    Iola Wise Stetson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 41743.
    Promulgated June 13, 1932.

      George S. Jones, Esq., Fred L. Van Dolsen, Esq., and Scott Russell, Esq., for the petitioner.

      S. B. Anderson, Esq., for the respondent.
   .OPINION.

Sea well:

The issue here presented is whether the income from the trust created by the petitioner is taxable solety to her, as determined by the respondent, or is taxable equally to her and her four stepchildren, as contended by petitioner.

The applicable law is found in section 219 (g) of the Revenue Acts of 1924 and 1926 and is as follows:

Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

In behalf of the petitioner it is insisted that her husband, made trustee under the trust which she created, is also a beneficiary thereunder, within the meaning of the section of the law quoted and that, if such a beneficiary, the trust was irrevocable and the respondent erred in treating it as revocable and taxing the entire income to petitioner. The trust instrument in which the petitioner made her husband trustee provided that during his lifetime, and with his consent, she expressly reserved the right to revoke, cancel, annul, amend, alter or modify the same, in whole or in part, from time to time, by an instrument in writing, duly executed and acknowledged by both, and it was further provided therein that should her husband predecease her the trust agreement “shall be irrevocable and unalterable,” but that should she predecease him he might cancel and terminate the said agreement by an instrument in writing, duly executed and acknowledged and filed with the trustee or trustees then acting and that he would then be entitled to receive absolutely as his own the corpus of the trust fund and any undistributed income. It was only upon her death occurring before his that he would be entitled to receive as a beneficiary of the trust the corpus of the trust or the undistributed income therefrom. During the taxable years .involved he was not, under the terms of the trust, entitled to receive any part of the corpus or income therefrom. It is evident from the terms of the trust instrument itself that he might never become a beneficiary of the trust to the extent of ever receiving any part of either corpus or income. There was, it is true, the possibility of his becoming such a beneficiary at some indefinite time in the future and the fact that the trust instrument so provided did not make the happening of the contingency upon which he might become such beneficiary any less doubtful or the possibility of such any less remote.

It is, however, contended in behalf of the petitioner that her husband was in fact a beneficiary of the trust she created and was such during the taxable years in issue, in the sense that he received benefits therefrom, since the insurance policies on his life (which policies he had transferred to her as trustee, reserving, however, “ the right to receive personally all disability benefits payable by the insurance companies ” under the policies) were kept alive by the premiums thereon being paid by direction of the petitioner from the income of the trust she created. The record, however, shows that neither the trust she created nor the trust he created required that such payment of premiums should be made from the funds or income arising from the trust she created. The payment thereof in the manner made was a voluntary act on her part and whether so made was left by the terms of her trust to her discretion. Furthermore, there is no evidence in the record that he at any time received, or was entitled to receive, any disability benefits from said insurance companies, the premiums on whose policies had been paid out of income of the trust the petitioner created. It is evident from the terms of the trust he created that he might never actually receive any disability benefits from the insurance companies and to receive such was the only interest or right he had in said policies.

In Emma Louise Smith, 23 B. T. A. 631, we said: “As we read the revenue statute, it has reference to a present beneficiary of a trust, not to one who has only a remote possibility of becoming a beneficiary in the future.” The facts in that case and in the instant case are not identical, but the reasoning in the former is, in our opinion, applicable and controlling in the latter and we are therefore of the opinion that the petitioner’s husband is not a beneficiary of the trust she created, within the meaning of the said section of the Revenue Acts of 1924 and 1926, and the trust created by her is revocable, the entire income therefrom being taxable to her, as the respondent determined.

Judgment will be entered for the respondent.