author: Smith :

text:
    Elizabeth B. Wallace, Executrix under the Last Will and Testament of Emma A. Miller, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 59414, 59970.
    Promulgated March 11, 1933.

      Qedrie A. Major, Esq., for the petitioner.

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

Smith :

The sole issue presented by these proceedings is whether the value of the trust fund is to be included in the decedent grantor’s gross estate under section 302 of the Revenue Act of 1926 which, in so far as material hereto, is as follows:

The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
■c- * * * * * *
(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

The trust instrument here under consideration was irrevocable and created a life estate in the grantor (first clause), a remainder interest in the daughter (third clause), and a possibility of reversion in the grantor (fourth clause). The interest of the decedent in the property rights fixed by this trust instrument “must be determined by the laws of the place where the estate is to be administered.” See Commissioner v. Jones, 62 Fed. (2d) 496, citing Crooks v. Harrelson, 282 U. S. 55. The decedent’s estate was administered under the laws of the State of New York, where real property laws .are applied in .the determination of personal property rights. See Book 40, McKinney’s Consolidated Laws of New York, Annotated, p. 16, ei seq.; and see also note “Vested or contingent remainders of personal property,” p. 54, Book 49, McKinney’s, etc. Section 40 of the Real Property Law (Book 49, McKinney’s, etc.), is as follows:

When future estates are vested.; when contingent. A future estate is either vested or. contingent. It is vested, when there is a person in being, • who would have an immediate right to the possession of the property, on the determination of all the intermediate or precedent estates. It is contingent while the person to whom or the event on which it is limited to take effect remains uncertain.

The test of vesting applied by the New York courts has been stated as follows:

If you can point to a man, woman or child who, if the life estate should now cease, would, eo instanti et ipso facto, have an immediate right of possession, then the remainder is vested.

See Moore v. Littel, 41 N. Y. 66, and other cases cited oil p. 55 of Book 49, McKinney’s, etc.; and also Matter of Smith (1923), 205 App. Div. 499; 200 N. Y. S. 538.

The law of New York with respect to such estates was approved by the Supreme Court of the United States as early as Croxall v. Shererd, 5 Wall. (72 U. S.) 268, 287, wherein it was said:

The struggle with the courts has always been for that construction which gives to the remainder a vested rather than a contingent character. A remainder is never held to be contingent when, consistently with the intention, it can be held to be vested. If an estate be granted for life to one person, and any number of remainders for life to others in succession, and finally a remainder in fee simple or fee tail, each of the grantees of a remainder for life takes at once a vested estate, although there be no probability, and scarcely a possibility, that it will ever as to most of them, vest in possession.
Chancellor Kent says the definition of a vested remainder is thus fully and accurately expressed in the Revised Statutes of New York. It-is, “when there is a person in being who would have an immediate right to the possession of the lands, upon the ceasing of the intermediate precedent estate.”
It is the present capacity to take effect in possession, if the precedent estate should determine, which distinguishes a vested from a contingent remainder. Where an estate is granted to one for life, and to such of his children as should be living after his death, a present right to the future possession vests at once in such as are living, subject to open and let in after-born children, and *to -be divested as to those who shall die without issue. A remainder, limited upon an estate tail, is held to be vested, though it be uncertain whether it will ever take effect in possession. * * *

In Doe v. Considine, 6 Wall. (73 U. S.) 458, 474, 475, 476, is the following:

A vested remainder is where a present interest passes to a certain and definite person, but to be enjoyed in futuro. There must be a particular estate to support it. The remainder must pass out of the grantor at the creation of the particular estate. It must vest in the grantee during the continuance of the estate, or eo instanti that it determines.
A contingent .remainder is where the estate in remainder is limited either to a dubious and uncertain person, or upon the happening of a dubious and imcertain event.
$ ‡ )fi ‡ ‡ ‡ ‡
The law will not construe a limitation in a will into an executory devise when it can take effect as a remainder, nor a remainder to be contingent when it can be taken to be vested.
It is a rule of law that estates shall be held to vest at the earliest possible period, unless there be a clear manifestation of the intention of the testator to the contrary.
Adverbs of time — as where, there, after, from, &e. — in a devise of a remainder, are construed to relate merely to the time of the enjoyment of the estate, and not the time of the vesting in interest.
* # * * * * $
“When a remainder is limited to a person in esse and ascertained, to take effect by empress limitation, on the termination of the preceding particular estate, the remainder is unquestionably vested.”
This rule is thus stated with more fulness by the Supreme Court of Massachusetts. “ Where a remainder is limited to take effect in possession, if ever, immediately upon the determination of a particular estate, which estate is to determine by an event that nyast unavoidably happen by the effluw of time, th£ remainder vests in interest as soon as the remainder-man is in esse and ascertained, provided nothing but his own death before the determination of the particular estate, will prevent such remainder from vesting in possession; yet, if the estate is limited over to another in the event of the death of the remainder-man before the determination of the particular estate, his vested estate will be subject to be devested by that event, and the interest of the substituted remainder-man which was before either an executory devise or a contingent remainder, will, if he is in esse and ascertained, be immediately converted into a vested remainder.”
In 4th Kent’s Commentaries, 282, it is said: “ This has now become the settled technical construction of the language and the established English rule of construction.” It is added: “ It is the uncertainty of the right of enjoyment, and not the uncertainty of its actual enjoyment, which renders a remainder contingent. The present capacity of taking effect in possession — if the possession were to become vacant — distinguishes a vested from a contingent remainder, and not the certainty that the possession will ever become vacant While the remainder continues.”

Subsequent decisions of the Supreme Court have followed the above principles (see Cropley v. Cooper, 19 Wall. (85 U. S.) 167; McArthur v. Scott, 118 U. S. 340, 378, 379; Thaw v. Ritchie, 186 U. S. 519, 546; and Johnson v. Washington Loan & Trust Co., 224 U. S. 224, 237, 238), which were also followed by the lower Federal courts (see Pineland Club v. Robert, 213 Fed. 545, 556; Aetna Life Ins. Co. v. Moppin, 214 Fed. 928, 933; Anderson v. Anderson, 221 Fed. 871, 875. See also I Cooley’s Blackstone, Book II, Chap. XI), p. 424, et seq.; III Thompson on Beal Property, sections 2139, 2140, 2148. See also III Bouvier’s Law Dictionary (Bawles Third Bevision), p. 2869.

This same question was considered at some length by the Supreme Court in Coolidge v. Long, 282 U. S. 582, wherein the incidence of the Massachusetts succession tax upon certain remainder interests was involved. These remainder interests were created:

By voluntary deeds of trust, [by which] a husband and wife transferred real and personal property, owned by them severally in certain proportions, to trustees,- in trust to pay the income in those proportions to the settlors during their joint lives and then' the entire income to the survivor of them, and upon the death of the survivor to divide the principal equally among the settlors’ five sons, provided that, if any of the sons should predecease the Survivor of the settlors, the share of that son should go to those entitled to take his intestate property under the statute of distribution in force at the death of such survivor. The deeds reserved no power of revocation, modification or termination prior to the death of the survivor of the settlors. * * *

In holding that:

By the deed of each grantor one-fifth of the remainder was vested in each of the sons, subject to be divested only by his death before the death of the survivor of the settlors. It was a grant in praesenti, to be possessed and enjoyed by the sons upon the death of such survivor. * * *

And in further holding that the sons’ interests were not subject to the succession tax, the court adverted to numerous decisions relating to remainder interests and, inter alia, said:

By the deed of each grantor one-fifth of the remainder was immediately vested in each of the sons subject to be divested only by his death before the death of the survivor of the settlors. It was a grant m praesenti to be possessed and enjoyed by the sons upon the death of such survivor. Blanchard v. Blanchard, 1 Allen 223. Clarke v. Fay, 205 Mass. 228. McArthur v. Scott, 113 U. S. 340, 379, and cases cited. And see United States v. Fidelity Trust Co., 222 U. S. 158. Henry v. United States, 251 U. S. 393. The provision for the payment of income to the settlors during their lives did not operate to postpone the vesting in the sons of the right of possession or enjoyment. The settlors divested themselves of all control over the principal; they had no power to revoke or modify the trust. Coolidge v. Loring, supra, 223. Upon the happening of the event specified without more, the trustees were bound to hand over the property to the beneficiaries. Neither the death of Mrs. Coolidge nor of her husband was a generating source of any right in the remaindermen. Knowlton v. Moore, 178 U. S. 41, 56. Nothing moved from her or him or from the estates of either when she or he died. There was no transmission then. The rights of the remaindermen, including possession and enjoyment upon the termination of the trusts, were derived solely from the deeds. The situation would have been precisely the same if the possibility of divestment had been made to c-ease upon the death of a third person instead of upon the death of the survivor of the settlors. The succession, when the time came, did not depend upon any permission or grant of the Commonwealth. While the sons if occasion should arise might by appropriate suit require the trustees to account, it is to be borne in mind that the property was never in the custody of the law or of any court. Kesort might be had to the law to enforce the rights that had vested. But the Commonwealth was powerless to condition possession or enjoyment of what had been conveyed to them by the deeds. Barnitz v. Beverly, 163 U. S. 118, and cases cited.
The fact that each son was liable to be divested of the remainder by his own death before that of the survivor of the grantors does not render the succession incomplete. The vesting of actual possession and enjoyment depended upon an event which must inevitably happen by the efflux of time, and nothing but his failure to survive the settlors could prevent it. Blanchard v. Blanchard, supra. Moore v. Lyons, 25 Wend. 119, 144. Succession is effected as completely by a transfer of a life estate to one and remainder over to another as by a transfer in fee. Reinecke v. Northern Trust Co., 278 U. S. 339, 347-348. The recent case of Saltonstall v. Saltonstall, 276 U. S. 260, furnishes a good illustration of incomplete succession. There the remainder was liable at any time during the settlor’s life to be divested through the exertion of the power of alteration and revocation that was reserved in the instrument creating the trust. The decision sustaining a transfer tax went upon the ground that “the gift taxed is * * * one which never passed to the beneficiaries beyond recall until the death of the donor. * * * A power of appointment reserved by the donor leaves the transfer, as to him, incomplete and subject to tax. * * * The beneficiary’s acquisition of the property is equally incomplete whether the power be reserved to the donor or another.” P. 271. See also Chase Nat. Bank v. United States, 278 U. S. 327, 335, 338.
No Act of Congress Ras been held by this court to impose a tax upon' possession and enjoyment, the right to which had fully vested prior to the' enactment.

By the trust instrument executed in 1920, Elizabeth V. Bulen, the grantor’s daughter, was given “ an immediate right to the possession ” of the trust estate “ upon the ceasing of the intermediate precedent estate,” in which event she came into actual possession of the trust estate by reason of an event (the death of the grantor), “that must unavoidably happen by the efflux of time ” and nothing but her “ own death before the determination of the particular estate ” could have prevented her right to the possession and thereby divesting her right by that event. In the light of the above authorities, we conclude that Elizabeth Y. Bulen’s interest in the trust propery vested as soon as the trust instrument was executed in 1920, and that the mere postponement of the “ actual enjoyment” of the trust property did not render her remainder contingent. She took a vested remainder subject to being divested by her death prior to the death of the grantor, an event which did not happen.

The respondent, in effect, contends that Elizabeth V. Bulen took only a contingent remainder, which ripened into a vested interest' upon the death of the grantor in 1928, when the daughter for the first time acquired definite property rights from the decedent. In support of this contention the respondent cites Sargent v. White, 50 Fed. (2d) 410, affirming 46 Fed. (2d) 79; Klein v. United States, 283 U. S. 231; Chemical Bank & Trust Co. et al., Executors, 25 B. T. A. 1153. While those cases are compatible with the respondent’s position, they are distinguishable from the instant proceedings on their facts.

In Sargent v. White, supra, the District Court found that the decedent had “ transferred to trustees in 1921 certain property- to be held in trust during the joint lives of himself and his wife. On the death of either, the trust terminated and the survivor took the property.” The report of that case indicates that the court considered Bemick and his wife as joint tenants and that “ Remick’s death had, as was said in Tyler v. United States, supra, [281 U. S. 497], ‘ the effect of passing to the survivor substantial rights, in respect of the property, theretofore never enjoyed by such survivor. * * * Thus the death of one of the parties to the tenancy became the “ generating source ” of important and definite accessions to the property rights of the other.’ ” However, the District Court’s decision was based on Commissioner v. Morsman, 44 Fed. (2d) 902, which was reversed by the Supreme Court in Morsman v. Burnet, 283 U. S. 784. In affirming the District Court, the Circuit Court of Appeals for the First Circuit quoted from the trust instrument as follows:

* * * If I survive my wife, Mary H. Remiek, then upon the decease of my said wife, Mary H. Remiek, said trust shall cease and the Trustees shall pay over, transfer, deliver and convey the Trust Estate absolutely free and discharged of every trust to me, said Frank W. Remiek. If, however, my said wife, Mary H. Remiek, survives me, then the Trustees shall upon my death pay over, transfer, deliver and convey the trust estate absolutely free and discharged of every trust to my said wife, Mary H. Remiek.

The Circuit Court held that:

It was clearly the intent of the decedent that the trust funds should not become absolutely vested during his life, * * * Upon his death and as a result, the entire trust funds then passed to his wife. See Klein v. United States, 51 S. Ct. 398, 75 L. Ed., decided by the Supreme Court April 13, 1931, which differs from this case to this extent that the grantor by deed transferred a life estate in some real property directly to his wife,- expressly reserving to himself the fee, which, or as in this case the absolute title to the trust funds, passed to the wife at his death in case she survived him.

In Klein v. United States, supra, the Supreme Court quoted the clauses of the deed there under consideration and said:

The two clauses of the deed are quite distinct — the first conveys a life estate; the second deals with the remainder. The life estate is granted with an express reservation of the fee, which is to “ remain vested in said grantor ” in the event that the grantee “ shall die prior to the decease of said grantor.” By the second clause the grantee takes the fee in the event — “ and in that case only” — that she shall survive the grantor. It follows that only a life estate immediately was vested. The remainder was retained by the grantor; and whether that ever would become vested in the grantee depended upon the condition precedent that the death of the grantor happen before that of the grantee. The grant of the remainder, therefore, was contingent. See 2 Washburn, Real Property (4th Ed.) pp. 547, 548, 559, par. 1. The decisions of the Supreme Court of Illinois, the state where the deed was made and the property lies, support this conclusion. Howard, et al. v. Peavey, 128 Ill. 430, 439, 21 N. E. 503, 15 Am. St. Rep. 120; Baley v. Strahan, 314 Ill. 213, 217, 145 N. E. 359.
* 9 * Nothing is to be gained by multiplying words in respect of the various niceties of the art of conveyancing or the law of contingent and vested remainders. It is perfectly plain that the death of the grantor was the indispensable and intended event which brought the larger estate into being for the grantee and effected its transmission from the dead to the living, thus satisfying the terms of the taxing act and justifying the tax imposed. Compare Tyler v. United States, 281 U. S. 497, 50 S. Ct. 356 * * *

In Chemical Bank & Trust Co. et al., Executors, supra, the grantor gave to Ms estranged wife a life estate or until the trust was terminated in accordance with its provisions, after which the trustees were to convey the property to the grantor, but if he was not living upon the termination of the trust the property was to go to his children. The property was included in the husband’s gross estate on the ground that his children did not take a vested remainder interest in the trust property. It is obvious that the husband by the instrument had the right to the remainder or reversion of the trust property upon the termination of the life estate and that the children merely had an interest contingent upon their outliving their father. The children, though in esse at the creation of the trust estate, had no immediate right to possession upon the termination of the particular estate; so long as the grantor lived that “ immediate right to possession” was vested in him, subject to divesting by his death, an event which eo instanti gave to the children a vested interest in the corpus, theretofore the children had a mere contingent interest.

By the terms of the instruments involved in the cases relied upon by the respondent, the rights to the property included in the particular decedent’s gross estate could not and did not vest absolutely in the grantee until the grantor’s death — which was the “ generating source of important and definite accessions to the property rights of the survivor.” In each, the grantor reserved the remainder interest in the property; the grantee’s interest did not ripen into a vested interest until the death of the grantor; and in the Chemical Bank & Trust Co. case the grantor was the only person in esse who had the immediate right to the possession of the trust property upon the termination of the precedent estate. By the terms of the instrument involved in the instant proceedings the grantor took a life estate, the grantee took a vested remainder — subject to be divested by her death prior to the death of the grantor, who retained a mere possibility of reversion. The law and decisions of the courts of New York (referred to above), the state where the deed was made and the property lies, support this conclusion.” Cf. Klein v. United States, supra, p. 232.

In Reinecke v. Northern Trust Co., 278 U. S. 339, the Government argued that:

* * * the transfers of the remainder interests were all subject to the tax because, * * * they were “ intended to take effect in possession or enjoyment at or after his [the grantor’s] death.”

The court pointed out that even if the grantor had made himself the trustee:

* * * the transfer would not for that reason have been incomplete, The shifting of the economic interest in the trust property which was the subject of the tax was thus complete as soon as the trust was made. His power to recall the property and of control over it for his own benefit then ceased and as the trusts were not made in contemplation of death, the reserved powers [of management] do not serve to distinguish them from any other gift inter vivos not subject to the tax.

In holding that the trust property in the Reinecke v. Northern Trust Co. case was not subject to Federal estate tax, the Supreme Court said:

In its plan and scope the tax is one imposed on transfers at death or made in contemplation of death and is measured by the value at death of the interest which is transferred. * * * One may freely give his property to another by absolute gift without subjecting himself or his estate to a tax, but we are asked to say that this statute means that he may not make a gift inter vivos, equally absolute and complete, without subjecting it to a tax if the gift takes the form of a life estate in one with remainder over to another at or after the donor’s death. It would require plain and compelling language to justify so incongruous a result and we think it is wanting in the present statute.
* * * In the light of the general purpose of the statute and the language of section 401 explicitly imposing the tax on net estates of decedents, we think it at least doubtful whether the trusts or interests in a trust intended to be reached by the phrase in section 402 (c) “ to take effect in possession or enjoyment at or after his death,” include any others than those passing from the possession, enjoyment or control of the donor at his death and so taxable as transfers at death under section 401. That doubt must be resolved in favor of the taxpayer. * * *

Reineche v. Northern Trust Co., supra, was followed in May v. Heiner, 281 U. S. 238; wherein it was held that property transferred to a trustee with “ a life estate in one with remainder over to another at or after the donor’e death ” was not to be included in the donor’s gross estate. In the May case the Supreme Court pointed out that:

* * * At the death of Mrs. May [the donor] no interest in the property held under the trust deed passed from her to the living; title thereto had been definitely fixed by the trust deed. The interest therein which she possessed immediately prior to her death was obliterated by that event.

May v. Heiner, supra, was followed per curiam in Burnet v. Northern Trust Co., 283 U. S. 783; McCormick v. Burnet, 283 U. S. 784; and Morsman v. Burnet, supra. These per curiam decisions affirm the Board’s decisions reported at 9 B. T. A. 96; 13 B. T. A. 423; and 14 B. T. A. 108, respectively. In the McCormich case, as in the instant proceedings, there was a possibility of the trust property reverting to the grantor in the event that the beneficiaries predeceased her. That event did not happen and apparently made no difference in the Supreme Court’s decision, although some point was made of this possibility of reversion before the Circuit Court of Appeals which reversed the Board, 43 Fed. (2d) 277, and which in turn was reversed by the Supreme Court.

On March 3, 1931 (the day following the announcement of the above per curiam decisions), Congress amended section 302 (c) by passing House Joint Resolution 529, which is as follows:

Resolved, etc., That the first sentence of subdivision (c) of section 302, of the revenue act of 1926, is amended to read as follows:
(c) To the extent of any interest therein of which the decedent has at any time made a transfer by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, including a transfer under which the transferor has retained for his life or any period not ending before his death (1) the possession or enjoyment of or the income from the property, or (2) the right to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money’s worth.

In proposing this resolution in the House, Mr. Hawley, Chairman of the Ways and Means Committee, said:

Mr. Speaker and gentlemen, the Supreme Court yesterday handed down a decision to the effect that if a person creates a trust of his property and provides that, during his lifetime, he shall enjoy the benefits of it, and when it is distributed after his death it goes to his heirs — the Supreme Court held that it goes to his heirs free of any estate tax.
This resolution is to provide that hereafter such shaE not be the law. This decision will cost the Treasury of the United States $25,000,000. That is, itwiU necessitate refunds in that amount. The Treasury does not know how many such trusts will be found before Congress meets again, but the opinion is that a great many will be, and it will take a very large sum from the Treasury unless this corrective legislation is enacted.
* * * * * * *
Yesterday afternoon the Supreme Court of the United States handed down decisions in three cases — Burnet against Northern Trust Co., Morsman against Burnet, and McCormick against Burnet — in which the court held that where an owner of property had made a transfer in trust reserving the income of the property, or the right to dispose of the income therefrom, to himself for his life, with remainder to others after his death, the value of the property should not be included in the estate of the donor for purposes of Federal estate tax upon his death.
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It had generally been considered that this provision of the statute covered cases such as those referred to above. The Treasury Department had so construed the statute since the first Federal estate tax law in 1916 and its regulations so provide. If, for example, the owner of property transferred the title to his house to a trustee for the benefit of his children after his death, but in the meantime reserved the use, income, and enjoyment of the house to himself during his own lifetime, it was supposed that the value of the property at the date of his death should be included in his estate for purposes of estate tax. Under the decisions rendered yesterday the property would not be included in computing the Federal estate tax.
It is entirely apparent that if this situation is permitted to continue, the Federal estate tax will be seriously affected. Entirely apart from the refunds that may be expected to result, it is to be anticipated that many persons will proceed to execute trusts or other varieties of transfers under which they will be enabled to escape the estate tax upon their property. It is of the greatest importance therefore that this situation be corrected and that this obvious opportunity for tax avoidance be removed. It is for that purpose that the joint resolution is proposed.

Similar statements were made in the Senate by Senator Smoot, Chairman of the Finance Committee, in presenting this joint resolution. See pages 7017 and 6933 of Volume 74 of the Congressional Kecord, Seventy-First Congress, Third Session. Thus, Congress undertook, without retroactive application, “ to stop up the gap ” and prevent trust estates (such as the one now before the Board) from escaping the incidence of the estate tax; however, this amendment not being retroactive has been applied only to transfers “ made after 10:30 P. M. * * * March 3, 1931.” See Treasury Decision 4314; see also Charles H. W. Foster et al., Executors, 26 B. T. A. 708.

There is no contention in the instant proceedings that the transfer made by the decedent in 1920 was made in contemplation of death. Elizabeth V. Bulen’s interest in the trust property vested upon the execution of the trust instrument in 1920, and the death of the grantor was not the generating source of definite accession to the survivor’s property rights but merely the obliteration of the decedent’s life estate, upon which event the daughter came into possession of property, to which her rights had been fixed and vested upon the execution of the trust instrument in 1920. There was no transfer from the dead to the living upon which to levy the estate tax. The value of the trust property was incorrectly included in the decedent’s gross estate. May v. Heiner, supra; McCormick v. Burnet, supra; Nanaline H. Duke et al., Executors, 23 B. T. A. 1104; affd., 62 Fed. (2d) 1057; Stephen Peabody et al., Executors, 24 B. T. A. 787. Cf. Charles H. W. Foster et al., Executors, supra.

Reviewed by the Board.

Judgment will be entered for the petitioner.


source: Caselaw Access Project

author: SteRnhagen : Black,

license: Public Domain

text:
    Tillotson Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44167.
    Promulgated March 11, 1933.

      William D. Bonthron, O. P. A., for the petitioner.

      O. R. Marshall, Esq., for the respondent.
   OPINION.

SteRnhagen :

The respondent determined a deficiency of $16,187 20 in petitioner’s income tax for 1926, by treating as a stock dividend the distribution in 1926 to petitioner, a preferred shareholder in the Willys-Overland Company, of some of that corporation’s common shares, with consequent reduction of cost as the basis of gain on subsequent sale in 1926 of the original shares. A stipulation and accompanying exhibits contain the facts npon which the case was submitted.

The petitioner, an Ohio corporation, acquired from time to time between November 1, 1922, and December 31, 1924, 6,500 shares of the 7 per cent cumulative preferred stock of the Willys-Overland Company, having a par value of $100 a share, which it owned on December 2, 1925, and January 2, 1926. The aggregate cost of these shares was $418,575. No dividends had been declared or paid on such preferred stock from July 1, 1921, to September 30, 1925, and the accumulation for such period was $29.75 a share, which amounted to $193,375 upon petitioner’s 6,500 shares.

The holders of preferred shares had the right to a cumulative dividend of 7 per cent per annum, payable quarterly, “ out of the surplus profits of the company for each year in preference to all other stockholders.”

Paragraph A I of the articles of incorporation provided:

Out of the surplus profits arising from the business of the Company, the holders of the preferred stock are entitled to receive dividends as aforesaid at the rate of seven per cent, per annum, and no more, payable quarterly on the first day of January, April, July and October in each year, before any dividends shall be declared, set aside or paid upon' the common stock, and such dividends on the preferred stock shall be cumulative as from October 1, 1912, so that if in any year or years dividends thereon at the rate of seven per cent, per annum shall not have been paid, the deficiency shall be paid before any dividends shall be paid upon or set apart for the common stock.

The preferred share certificate provided:

VII. The holders of the preferred stock shall have no right as such holders to subscribe for or to acquire from the Company any stock, either preferred or common, which the Company may from time to time issue or offer for subscription or sale.

Paragraph D of the articles of incorporation provided:

The holders of the common stock shall exclusively possess voting powers for the election of directors and for all other purposes, and the holders of the preferred stock shall have no voting power, except as above stated; provided that in case the Company shall have failed in respect of four quarterly periods to declare and pay the full regular quarterly dividend on the preferred stock, then and in every such case so long as there shall be any arrears of dividends upon the preferred stock the holders of the common stock shall have no voting power and the holders of the preferred stock shall exclusively possess voting powers for the election of directors and for all other purposes. If, however, all such accrued installments and arrears shall be paid by the Company at any time, then and thereupon all power of the preferred stockholders to vote, as in this paragraph provided, shall cease, subject, however, to being again revived upon any subsequent failure of the Company in respect of four quarterly periods to declare and pay the full dividend on the preferred stock. At all times each holder of either class of stock of the Company which shall at the time possess voting powers on any matter, shall be entitled to one vote on such matter for each share of such class of stock then standing in his name on the books of the Company, except as otherwise required by law.

On December 2, 1925, the directors of the Willys-Overland Company adopted the following:

Whereas surplus profits of this Company, The Willy-Overland Company, in excess of the dividend hereinafter declared have been from time to time invested in extensions and betterments to the plant and property of the Company, and in providing additional facilities for its business, and in that manner a large addition has been made to the value of the assets of the Company but which is not available for the declaration and payment therefrom of a cash dividend, though same at a fair valuation is in excess of the dividend hereinafter declared, and
Whereas this Company has on hand a large amount of cash assets and inventory which it is now deemed advisable to conserve for the legitimate business requirements of the Company; and
Whereas it is deemed advisable by the Board of Directors to declare a dividend on the outstanding preferred stock of the Company payable in unissued common stock as hereinafter set forth;
Now, Therefore, Be it Resolved, that 262,389 shares or the unissued Common Stock of this Company be and hereby are appropriated by the Board of Directors for the purpose of paying the dividend hereináfter declared on the preferred stock of the Company; and,
Now, Therefore, Be it Resolved, that from the surpius profits of this Company, a dividend of Twenty-nine Dollars and Seventy-five cents ($29.75) on each share of the present issued and outstanding preferred stock of this Company be and is hereby declared, payable on the 2nd day of January, 1926, to preferred stockholders of record, at the close of business on the 19th day of December, 1925, in the common capital stock of this Company to be taken at the price of Twenty-five ($25.00) Dollars per share, * * * ; that the dividend hereby declared shall be and is for the quarterly dividends now in arrears and unpaid, being those quarterly dividends beginning with the one payable October 1, 1921, for the quarter ending September 30, 1921, and ending with and including the one payable October 1, 1925, for the quarter ending September 30, 1925; * * *

Pursuant thereto petitioner, on January 2, 1926, received 7,735 shares of such no-par common stock, the market value of which on that date was 31% a share, aggregating $242,685.53. The “ declared value ” [sic] was $5 a share and the book value $13.51.

Some of the preferred shareholders insisted upon and received the $29.75 dividend in cash.

The market value of the preferred stock on January 2, 1926, was $93 a share, or $604,500 for petitioner’s 6,500 shares.

On February 8, 1926, petitioner sold its 6,500 shares of preferred stock for $599,906.67.

Petitioner treated the receipt of 7,735 common shares as an ordinary property dividend, and in its 1926 return it included the value of $242,685.63 with other dividends in its gross income and in its deductions [see Revenue Act of 1926, section 234 (a) (6)]. It also reported on said return a profit of $181,331.67 from the sale of the preferred shares, based on their original cost of $418,575.

The respondent treated the receipt of 7,735 common shares as a stock dividend, and apportioned the original cost of $418,575 among the old preferred and the new common in the ratio that the total market ..value on January 2,1926, of each bore to the combined total market value of both, resulting in an assigned cost of $298,669.81 to the preferred shares. This figure he used as the basis for determining a gain of $301,286.86 upon the sale. By thus increasing the profit, he determined the deficiency.

There is no doubt that if the dividend of common shares to preferred shareholders was such a stock dividend as was not subject to tax (Revenue Act of 1926, section 201 (f)), the Commissioner’s method of using it to reduce the basis for determining gain or loss upon sale of the original preferred shares is correct. George T. Smith, 21 B. T. A. 782. For the characteristic which gives it immunity from tax, not alone under the statute, Towne v. Eisner, 245 U. S. 418, but also under the Constitution so long as the income tax is un-apportioned, Eisner v. Macomber, 252 U. S. 189, is that it represents nothing new or different from the original investment but only a further subdivision of its tokens. So much the taxpayer would admit, if it agreed that this was such a stock dividend. But it insists that the dividend was not inherently free from tax as a stock dividend, since it lacked the very characteristics and effects which give substance to the exemption. While to this corporate petitioner the dividend is tax free, whether it be a stock dividend or not, it is nevertheless of primary importance to determine whether the immunity is found in the exemption of section 201 (f) or the deduction of section 234 (a) (6), because the effect in tax when the stock thus received is disposed of is different, a stock dividend dividing the basis and an ordinary dividend, whether in cash or property, leaving the basis unaffected.

Any idea that the distribution of the common shares to the preferred shareholders was in discharge of a debt must be dismissed. Cumulative preferred dividends do not become a debt of the corporation until they have been properly declared. Before that there is a right to preference, but this is not a chose in action. When the dividend is declared it is still a dividend. So the taxpayer’s former concession that the difference between the $29.75 cumulative dividends regarded as a debt and the $31,375 value of the share when received was taxable profit would not stand against it. But the concession was withdrawn by an amended pleading, and the respondent not only seeks nothing from it but opposes the view that there was a liquidation of debt. We pass to the essential question.

Whether there has been a tax-free stock dividend is to be determined not by the terms used but by an analysis of the legal effect of what was done in the name of a stock dividend. Not every dividend in stock is a stock dividend, Peabody v. Eisner, 247 U. S. 347; United States v. Phellis, 257 U. S. 156, nor is every stock dividend a dividend in stock, Harry A. Brown, 26 B. T. A. 901; cf. W. Q. Wright, 10 B. T. A. 806. Indeed a dividend declared in cash has been held to be in substance a tax-free stock dividend. United States v. Mellon, 279 Fed. 910; 281 Fed. 645; United States v. Davison, 1 Fed. (2d) 465; 9 Fed. (2d) 1022; Irving Trust Co. v. United States, 44 Fed. (2d) 246; cf. W. J. Hunt, 5 B. T. A. 356; George T. Smith, 21 B. T. A. 782. The tax exemption is also applicable to stock rights, Miles v. Safe Deposit & Trust Co., 259 U. S. 247. While this does not apply to a dividend in debenture bonds from surplus, Doerschuck v. United Stages, 274 Fed. 739, a distribution of rights to convertible bonds has recently been held to produce no income, T. I. Hare Powel, 27 B. T. A. 55.

Analyzing the facts in this proceeding in the manner prescribed in Eisner v. Macomber, supra, the want of essential similarity is immediately apparent. This was not a proportional redistribution of existing or inchoate rights. There was a substantial change in the shareholder interests not only of this petitioner but of all other shareholders as well. Whether the adventitious effect of this at any given time to any one shareholder be for better or worse may serve to measure the gain or loss, but it leaves the change no less substantial. This petitioner as a preferred shareholder not only enjoyed the benefits of its preference and the assurance which the provision for cumulative dividends might give, but it also was subject to the limitations of a fixed dividend and a contingent right to vote. By this dividend, it acquired new and separate rights of a common shareholder to participate in unlimited dividends and liquidations and unqualifiedly in the shareholders’ meetings.

•While this did not take anything from the corporation nor anything directly from the other common shareholders except a proportionate part of the value of their shares, it is the petitioner’s situation ■which is now being considered and the effect of the dividend-upon ■its income alone. United States v. Phellis, 257 U. S. 156. There need be no mutuality in the effect of such a dividend upon the several taxpayers who may be in one way or another affected by it. Some attempt is made by the petitioner to show a significant change in the corporation’s accounts. But this arises from the discrepancies between the book value, the adopted dividend value and the par value of the shares, and they do not control the character of the transaction, whatever the corporation may have voluntarily entered upon its books and records.

'Although much is said in the opinion in Eisner v. Macomber, supra, about a stock dividend taking nothing from the corporation and being the opposite of a distribution of earnings, it seems to us a perversion of the esssential reasoning of that opinion to regard this as the more important of the considerations. The case presented the question whether the plaintiff could constitutionally be subjected to the income tax in respect of a pure proportional common stock dividend. The primary concern was to ascertain what such dividend brought to her and whether it could be said to be income. This question was thoroughly explored, and finding that the shareholder received nothing of substance and that the corporation parted with nothing but only modified its accounts, the conclusion was drawn that she had derived no income. With a simple stock dividend, both propositions support the conclusion; but it is a plain fallacy to give them equal weight, or to infer that the effect upon the corporation would alone have induced the result reached if the effect upon the shareholder had been to give Her additional rights so separate and substantial as to afford different prospects, yield different fruit, and be salable with different market considerations from those formerly existing as to her. Cf. Marr v. United States, 268 U. S. 536. As between the claims of life tenant and remainderman, the latter could hardly deny that such a dividend as that now before us was an accession which could be given to the life tenant without impairing the remainderman’s interest. For to him would still be preserved the same rights and possibilities which the preferred shares represented, notwithstanding the corporation’s manner of liquidating the cumulative dividend by the distribution of common shares which represented subordinate rights.

When it is realized that the occasion for the original prototype of section 201 (f), namely, section 201 (d) of the Revenue Act of 1921, exempting stock dividends from tax, was the decision of the Supreme Court in Eisner v. Macomber, supra, annulling so much of section 2 (a) of the Revenue Act of 1916 as included stock dividends among those taxable, it becomes clear that the subsequent statutory exemption was only as broad as the decision, and hence that the intention was not to exempt stock dividends by any general or loose concept but only such as could not constitutionally be taxed because they were not income. The term “ stock dividend ” is not of itself so free from ambiguity as to preclude construction, and hence the statutory exemption must be construed to promote the intendment disclosed by the history and circumstances of its enactment. This requires that it be confined to such as have the attributes which distinguished them from the receipt of income by the shareholder. Only those which place the shareholder in no essentially different position are exempt.

The respondent erred in treating the petitioner’s receipt of the common shares as if it were a nontaxable stock dividend which operated to reduce the cost basis of the 6,500 shares of preferred. The petitioner correctly measured its profit from the sale of the 6,500 shares upon the basis of the entire original cost of such shares, $418,575.

Reviewed by the Board.

■Judgment will be entered under Rule 50.

Black,

dissenting: I dissent from the conclusions reached in the majority opinion. It is my view that the Commissioner has treated the transactions involved in this proceeding in accordance with the applicable statute and his regulations promulgated thereunder, and moreover that these regulations are correctly interpretative of the law. The statute which must be construed is section 201 (a), (f) of the Revenue Act of 1926, which reads:

Sec. 201. (a) The term “ dividend ” when used in this title * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913, * * *
(f) A stock dividend shall not be subject to tax.

In pursuance of the foregoing statute, the Commissioner has promulgated articles 1547 and 1548 of Regulations 69, which read as follows:

Abt. 1547. Dividends paid in property. — Dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders. (See, however, section 203 (g) and article 1576.) Where a corporation declares a dividend payable in stock of another corporation, setting aside the stock to be so distributed and notifying the shareholders of its action, the income arising to the recipient of such stock is its market value at the time the dividend becomes payable. (See article 52.) Scrip dividends are subject to tax in the year in which the warrants are issued. [Italics supplied.]
Abt. 1548. Stock dividends. — The issuance of its own stock by a corporation as a dividend to its shareholders does not result in taxable income to such shareholders, but gain may be derived or loss sustained by the shareholders from the sale of such stock. The amount of gain derived or loss sustained from the sale of such stock, or from the sale of the stock with respect to which it is issued, shall be determined as provided in articles 1561 and 1599. [Italics supplied.]

Similar regulations are found in articles 1547 and 1548 of Regulations 62 under the 1921 Act, and articles 1547 and 1548 of Regulations 65 under the 1924 Act, and articles 627 and 628 of Regulations 74 under the 1928 Act. The substantial reenactment in later acts of the provisions theretofore construed by the Bureau is persuasive evidence of legislative approval of the regulation. Brewster v. Gage, 280 U. S. 327; National Lead Co. v. United States, 252 U. S. 140.

It seems clear to me from a reading of the foregoing regulations that the dividend distribution involved in this proceeding was a nontaxable one under the terms of these regulations. The Commissioner has consistently given such interpretation to his regulations. For example, in I. T. 2538, C. B. IX-1, p. 465, the M Company had outstanding preferred stock, the dividends on which were payable in cash or at the election of the stockholders in common stock. In December, 1929, a dividend was declared payable in cash on February 15, 1930, in respect of each share, the record holder of which on January 15, 1930, had not on or before such date filed a certificate of election to receive dividends in common stock. If a certificate of election was filed, the dividend was payable in common stock. It was held under such circumstances that the stockholders who filed certificates of election and received their dividends in common stock, received a stock dividend and therefore received no taxable income.

The error, as I see it, of the majority opinion in holding that such dividend was not a stock dividend is that it assumes that the only kind of a stock dividend exempted from taxation by section 201 (f) is such a stock dividend as was present in Eisner v. Macomber, supra. In that case the Standard Oil Company of California, having only one class of stock, to wit, common stock, had declared and paid out of surplus and profits an ordinary stock dividend by distributing to its several stockholders common stock of the corporation in proportion to the common stock holdings of each. The Government determined that such distribution was taxable, but the Supreme Court held to the contrary.

The fundamental question which the Supreme Court decided in that case was stated by the court in the beginning of its opinion, as follows:

This case presents the question whether by virtue of the sixteenth amendment Congress has the power to tax as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith • against profits accumulated by the corporation since March 1, 1913.

It is my view that in the instant case we have before us a “ stock dividend ” made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913, just as much as was present in Eisner v. Macomber. The only difference is that in the instant case we have no constitutional question involved because, in my view, Congress has made no attempt to tax such a dividend as we have here. True it is that the stock dividend involved in Eisner v. Macomber was the ordinary stock dividend where all stockholders were treated alike by receiving a dividend in common stock in proportion to their common stock holdings and when the dividend distribution was completed each stockholder still owned the same proportional interest in the corporation as he did before.

But that kind of a stock dividend is not the only kind that is free from tax. The Government made that kind of a contention in the following cases, but its contention was denied by the courts. United States v. Mellon, 279 Fed. 910; affd., 281 Fed. 645, and United States v. Davison, 1 Fed. (2d) 645; affd., 9 Fed. (2d) 1022; certiorari denied by the Supreme Court. More will be said about these cases later on in this dissent.

Ballentine’s Law Dictionary defines a stock dividend as a “dividend payable to the stockholders of a corporation in shares of stock of the corporation, which dividend a corporation having power to increase its capital may in the absence of statute declare, and which represents earnings of the corporation invested by . the board of directors in the enlargement and extension of its work or its plant or both.”

The dividend in the instant case, it seems to me, fits almost exactly into the foregoing definition.

The Willys-Overland Company had certain authorized but unissued common stock. It was in arrears in dividends on its preferred stock. It had sufficient accumulated profits and surplus to pay these dividends, but such surplus and profits were not in cash. The situation was fully described in the dividend resolution of December 2, 1925, which has been quoted in the majority opinion and to which reference is hereby made. The distribution which it made to its preferred stockholders in pursuance of said resolution was not in cash or other property belonging to the corporation, but only in common stock of the corporation, up until that time, unissued. There was in no sense a severance from the corporation assets of the subject of the dividend.

In Hayes v. St. Louis Union Trust Co., 298 S. W. 91, the court said:

A stock dividend, which is really nothing more than a process in corporation bookkeeping, is not in any sense a real “ dividend ”, which implies a severwnoe from the corporate assets of the subject of the dividend and a distribution thereof among the stockholders. [Italics supplied.]

The distinction between the title of a corporation and the interest of its members or stockholders in the property of the corporation is familiar and well settled. The ownership of that property is in the corporation'and not in the holders of shares of its stock. The interest of each stockholder consists in the right to a proportionate part of the profits whenever dividends are declared by the corporation, during its existence under its charter, and to a like proportion of the property remaining upon the termination or dissolution of the corporation after payment of its debts. Gibbons v. Mahon, 136 U. S. 557.

The dividend declaration of the Willys-Overland Corporation made it quite apparent that the corporation did not intend to part with any of its cash or property. 'All of that it needed to keep in the business. All of that it did keep in the business and paid dividends to its preferred stockholders, not in money or property, but in the unissued common stock of the corporation. I think such a stock dividend fits squarely into the description of what a stock dividend is, contained in Eisner v. Maoomber and quoted by the court in United States v. Mellon, supra, as follows:

“A ‘ stock dividend ’ shows that the company’s accumulated profits have been capitalized, instead of distributed to the stockholders or retained as a surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution. The essential and controlling fact is that the stockholder has received nothing out of the company’s assets for his separate me and benefit; on the contrary, every dollar of his original investment, together toith whatever accretion and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subje'ct to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance, and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.” [Italics supplied.]

In the majority opinion in the instant case there is this statement: “ Some of the preferred stockholders insisted upon and received the dividend in cash.” I wish to point out that such fact has no significance. In United States v. Mellon, supra, and United States v. Davison, supra, the Government contended that the dividend in question was not a stock dividend because, among other reasons, stockholders of the Gulf Oil Corporation holding 1,740 shares of stock received their dividend in cash, amounting to $174,000. The court in its opinion said that as to these particular stockholders it was of course a cash dividend and taxable as such, but as to the other stockholders who went along with the plan, it was a stock dividend. On that point the court said:

It is conceded that some of the stockholders took cash. As to them, it was a cash dividend, and taxable as such. But as to the defendant, and the other stockholders who received stock, it would appear under the facts to be a stock dividend, and not taxable. The question is to be determined from the result to and the effect upon the individual stockholder.

Much emphasis is laid in the majority opinion upon the fact that in Eisner v. Maoomber the stock dividend was such that after it was paid, all stockholders continued to own the same proportional interest in the corporation as before; that this was the sole basis of the court’s decision; that other expressions of the court should be disregarded; and that the exemption prescribed by section 201 (f) should not be extended beyond the scope of the kind of a stock dividend present in Eisner v. Macomber. In pointing out why the dividend in the instant case was not a “ stock dividend ” the majority opinion says, “ This was not a proportional redistribution of existing or inchoate rights. There was a substantial change in the shareholder interests not only of this petitioner but of all other shareholders as well.”

So there was also in United States v. Mellon, and United States v. Davison. It does not take a mathematician to figure out that when the owners of 1,740 shares of Gulf Oil Corporation stock declined to accept a stock dividend but insisted upon and received their dividend in cash, and the balance of the stockholders received a stock dividend, there was a substantial change in the shareholder interests not only of the stockholders who owned 1,740 shares and received their dividends in cash, but of the shareholders who received their dividends in stock.

A simple illustration will serve to exemplify. Suppose we have corporation M with 100 shares of common stock. A owns 40 shares which is 40 per cent of the capital stock. B owns 40 shares, which is 40 per cent of the capital stock. O owns 20 shares, which is 20 per cent of the capital stock. A stock dividend of 100 per cent is declared, but C insists upon and receives his dividends in cash. Thereafter the capital stock is 180 shares owned as follows: A owns 80 shares, which is 444/9 per cent of the capital stock. B owns 80 shares, which is 444/0 per cent of the capital stock. C owns 20 shares, which is 11% per cent of the capital stock. The above illustration is just the sort of thing that happened in United States v. Mellon and United States v. Davidson, as I understand it, yet the courts held in those cases that the dividends to the stockholders who accepted the plan were “ stock dividends ” and exempt from taxation and the Supreme Court denied a writ of certiorari.

Therefore in view of these facts, I am forced to conclude that the essential fact in Eisner v. Macomber is not as the majority opinion holds, that the stock dividend must be of the kind which, after it is paid, leaves all the stockholders with the same proportional interest in the corporation as they had before, but is as the court says: “ The essential and controlling fact is that the stockholder has received nothing out of the company’s assets for his separate use and benefit.” In other words, there has been no severance of anything from the corporation’s assets or payment to the stockholder.

The kind of case which we have before us here should not be confused with those cases where a corporation pays a dividend by distributing stock which, it owns in some other corporation or even its own stock, which at one time was issued, and later bought up with the corporation’s funds and held in its treasury. In dividends of this sort there is a real severance from the corporate assets. That kind of case was the subject of the court’s opinion in Leland v. Hayden, 102 Mass. 542.

In the instant case the dividend was not declared from stock already paid for in full to the corporation and repurchased by it, but was from stock previously unissued. The stipulation shows that the common stock of the Willys-Overland Company was duly increased from $50,000,000 to $75,000,000 in May, 1920. The board of directors was authorized to appropriate 262,309 shares of the unissued common stock for the payment of dividends to the preferred stockholders.

It was out of these 262,309 unissued shares of Willys-Overland Company’s common stock that petitioner’s dividend was paid. For reasons which I have stated, I believe that such a dividend distribution is a stock dividend within the meaning of section 201 (f) of the Revenue Act of 1926, and that respondent’s treatment of it in arriving at petitioner’s tax liability for the year in question was correct.

Smith agrees with this dissent.


author: Black.

text:
    Roger Morris Realties, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 63313.

    Promulgated March 11, 1933.

      Arthur B. Sinclair, G. P. A., for the petitioner.

      J. M. leinenleugel, Esq., for the respondent.
   OPINION.

Black.

In this proceeding the petitioner seeks a redetermination of its tax liability for the year 1929, for which year the respondent has determined a deficiency of $674.64.

The petitioner is a corporation, organized under the laws of the State of New York, with its principal office at 369 East 167th Street, New York, New York. A. J. Schwarzler was president of the petitioner and another corporation, known as the A. J. Schwarzler Company. Schwarzler was the sole stockholder, save for one share in each corporation issued to his brother to qualify him as an officer of ten corporations, of which petitioner was one, through which he conducted his business operations. The stock of these corporations held by him was in excess of 95 per cent of the outstanding stock of each corporation.

The deficiency in this case arises from the respondent’s denial of affiliation to the petitioner, whose income for the year 1929 was included in the consolidated return filed by A. J. Schwarzler Company. The respondent in the sixty-day letter stated: “Your company has been ruled not affiliated for the reason that it does not belong to an affiliated group as defined by Section 141 (d) of the Revenue Act of 1928.” Section 141 (d) reads as follows:

SEC. 141. CONSOLIDATED RETURNS OE CORPORATIONS-1929 AND SUBSEQUENT TAXABLE TEARS.
*******
(d) Definition of “ affiliated group.” — As used in this section an “ affiliated group ” means one or more chains of corporations connected through stock ownership with a common parent corporation if—
(1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and
(2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations.
As used in this subsection the term “ stock ” does not include nonvoting stock which is limited and preferred as to dividends.

The record establishes conclusively that A. J. Schwarzler individually owned at least 95 per cent of the stock of the petitioner and nine other corporations. This type of individual control was not sufficient for the year 1929 to authorize affiliation. Section 141 (d) of the Revenue Act of 1928, for the year 1929 and subsequent years, provides in effect that chains of corporations may be affiliated only when 95 per cent of the stock of the subsidiaries is owned by the parent corporation.

Petitioner in brief says: “ These corporations have always operated as affiliated and it has been held so in the past by the Internal Revenue Department.” No doubt that statement is true, but it should be noted that the law governing affiliation for prior years is entirely different from that prescribed in section 141 of the Revenue Act of 1928, which was to be effective for 1929 and subsequent years.

For example, the definition of affiliation for the taxable year 1928, provided in section 142 (c) of the Revenue Act of 1928, was as follows:

(c) Definition of affiliation. — For tire purpose of tliis section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subsection the term “ stock ” does not include nonvoting stock which is limited and preferred as to dividends.

The definition of affiliation prescribed in section 141 (d), to govern 1929 and subsequent years, left out entirely the phrase “or (2) if at. least 95 per centum of the stock of two or more corporations is owned by the same interests.” Of course it is manifest that if the latter phrase had been left in section 141 (d), to govern 1929 and subsequent years, petitioner would be affiliated with the A. J. Schwarzler Company, for the undisputed facts are that more than 95 per cent of the stock of each of said corporations was owned by A. J. Schwarzler as an individual and that would be ownership of at least 95 per centum of the stock of two corporations by the “ same interests.” But when Congress dropped out entirely from the definition of affiliation for 1929 and subsequent years “ ownership by the same interest,” an entirely different stuation obtains and we see no basis for holding under the evidence in this case that petitioner was affiliated in 1929 with the A. J. Schwarzler Company.

Decision will ~be entered for the respondent.


author: Goodkich:

text:
    The Capital Traction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 60431.

    Promulgated March 15, 1933.

      George E. Hamilton, Esq., and John F. MeOa/rron, Esq., for the petitioner.

      Carl R. Perleins, Esq., for the respondent.
   OPINION.

Goodkich:

The Revenue Act of 1928 contains no provision specifically allowing as a deduction in computing net income amounts contributed by corporations to charitable, educational and related social welfare agencies. Such corporate contributions, to be deductible from gross income, must fall within the provisions of section 23 (a), 1928 Act, and article 262 of Regulations 74, as “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” They must be an expense directly connected with or proximately resulting from the business; must bear a reasonable relation to the business within its ordinary scope, and be reasonably incidental to its proper operation. These requirements are so well established by the numerous decisions treating of this problem by this Board and the courts that discussion thereof seems unnecessary. Poinsett Mills, 1 B. T. A. 6; Thomas Shoe Co., 1 B. T. A. 124; Killian Co., 20 B. T. A. 80; Yamhill Electric Co., 20 B. T. A. 1232; Lenore Ulric, 27 B. T. A. 666; American Rolling Mills Co. v. Commissioner, 41 Fed. (2d) 314 (reversing 14 B. T. A. 529); Niles Bement Pond Co., 67 Ct. Cls. 693; affd., 281 U. S. 357. See also article 262, Regulations 74, and I. R. B. XI-44-5819, I. T. 2653.

The record before us is regrettably inadequate for it contains no facts respecting the business of petitioner. We are not told whether petitioner was an operating or a holding company, nor the business in which engaged, if it was so engaged. We are not told what medical, financial or social care petitioner was required or undertook in the operation of its business to give its employees, nor the amount it expended for those ends.

The sole witness testified that the company’s employees had the right to go to the various hospitals listed by the Community Chest and receive treatment. Whether they had a legal right to demand medical care, based upon some contract or special arrangement made in their behalf by the company with the Community Chest, or whether they had only the same privilege of requesting aid possessed by all other citizens of the community, does not appear. He testified also that, generally, the result of the care given by visiting nurses was that the employees recovered from illness more quickly than they would have without it and, consequently, lost less time from work. His conclusion was entirely unsupported, nor was it shown what effect, if any, the return of an ill employee to his duties, might have upon the company’s operations. Such testimony alone reveals but little of the cause or necessity for the contribution made by petitioner and, obviously, without some knowledge of the business and affairs of this corporation it is impossible for us to adjudge whether the contribution it made was so related and connected to its business as to be an ordinary and necessary expense of operation.

Perhaps it was assumed, because trial of this case was held in Washington, D. C., where petitioner’s principal office is located and where the offices of this Board are maintained, that we should take notice of these matters concerning itself and its business which petitioner has failed to prove. If such an assumption was made, it was ill-founded. In the determination of praceedingshefojs.us-we-.are bound strictly to the evidence of record, save as to such matters as may be properly a subject of judicial notice. The statement of this fundameñtaTrülFneeds'ñó'elaboraEbiTandTclearly, however inclined we might be to reach voluntarily beyond the record for extraneous facts necessary to a consideration of the character of a donation probably prompted in part by laudable motives of community interest, we are not permitted so to do. And we are so restricted no matter where the residence of the taxpayer; consequently, extraneous facts are no more available to us because petitioner is located in Washington than if it were located in Abanda, Alabama, or Zenith, Wyoming, or elsewhere.

Since the facts concerning petitioner’s business, necessary to proof under the issue, are not contained in the record and are not matters of which we properly may take judicial notice, we are forestalled from any consideration of the deductibility of the contribution made by petitioner and, perforce, must sustain respondent’s determination.

We do not decide whether contributions made by corporations to the Community Chest of Washington, D. C., are or are not deductible from income as ordinary and necessary expenses of business. We say only that in the case at bar petitioner has failed to produce facts respecting itself, its business, and the relation thereto of its contribution from which we can determine whether the donation may be so classified.

Judgment will be entered for the respondent.


author: McMahon:

text:
    Wheeling Mold and Foundry Company (Delaware), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 23410.
    Promulgated March 15, 1933.

      W. M. Smith, Esq., for the petitioner.

      J. A. Lyons, Esq., for the respondent.
   OPINION.

McMahon:

We are here called upon to determine whether the petitioner is liable as a transferee for the taxes of the West Virginia corporation for the year 1919. The parties are in agreement that the entire amount of $48,077.86, determined by the Board in Docket No. 19096 as the amount of unpaid taxes due from the West Virginia corporation for the year 1919, is in controversy. The respondent has proceeded against the petitioner under section 280 and contends that the petitioner is liable both at law and in equity. The petitioner does not question the correctness of the tax liability of the West Virginia corporation, but contends that it is not liable for such tax liability as a transferee either at law or in equity.

In a transferee proceeding before this Board the burden is upon the respondent to show that the petitioner is liable as a transferee. Section 912 of the Revenue Act of 1924, as amended by section 602 of the Revenue Act of 1928.

In support of his contention that petitioner is liable in equity for the liabilities of the West Virginia corporation, respondent cites Signal Gasoline Corp., 25 B. T. A. 532; Waterproofed Products Co., 25 B. T. A. 648; and West Texas Refining & Development Co., 25 B. T. A. 1254. Those cases, however, are not in point. In Signal Gasoline Corp., supra, and in Waterproofed Products Go., supra, the transferor corporations received in exchange for their assets only stock of the transferee corporations. In West Texas Refining & Development Co., supra, the. transferee corporation transferred to the transferor corporation in exchange for assets, both cash and stock, but the cash was insufficient to satisfy the liabilities of the transferor. Each of the above cases cited by respondent was decided primarily upon the well established principle that a creditor may not be forced to give up tangible assets as security for his debt and thereafter look for payment to shares of corporate stock.

In the instant proceeding, the stipulated facts show that the petitioner, in consideration of the transfer of the assets of the West Virginia corporation to it, transferred to the West Virginia corporation, stock, cash, and demand notes of the total value of $2,631,308. Of this amount $1,300,000 was cash. The petitioner, also in consideration of such transfer, assumed liabilities of the West Virginia corporation in the amount of $1,009,693.91.

The doctrine that the assets of a corporation are a trust fund for the benefit of creditors applies only where the withdrawal of assets from the corporation renders it insolvent. In McDonald v. Williams, 174 U. S. 397, the Supreme Court stated:

* * * When a corporation is solvent, the theory that its capital is a trust fund upon which there is any lien for the payment of its debts has in fact very little foundation. No general creditor has any lien upon the fund under such circumstances, and the right of the corporation to deal with its property is absolute so long as it does not violate its charter or the law applicable to such corporation.

In Fogg v. Blair, 133 U. S. 534, the Supreme Court stated in part:

* * * That doctrine [the trust fund doctrine] only means that the property must first be appropriated to the payment of the debts of the company before any portion of it can be distributed to the stockholders; it does not mean that the property is so affected by the indebtedness of the company that it cannot be sold, transferred, or mortgaged to bona jiHe purchasers for a valuable consideration, except subject to the liability of being appropriated to pay that indebtedness. Such a doctrine has no existence. * * *

To the same effect see also Jones v. Bailey, 242 Fed. 255; United States v. Armstrong, 26 Fed. (2d) 227; Joseph A. Steinle, 19 B. T. A. 325; Samuel Keller, 21 B. T. A. 84; affirmed in Commissioner v. Keller, 59 Fed. (2d) 499; Charles Havard, 25 B. T. A. 1161; M. H. Graham, 26 B. T. A. 301; and Western Union Telegraph Co., 27 B. T. A. 265. Here the West Virginia corporation was not insolvent after the transfer. The actual cash paid by the petitioner to the West Virginia corporation was in the amount of $1,300,000, which was more than sufficient to pay the then liabilities of the West Virginia corporation as recorded on its books and the taxes here involved. No creditor of the West Virginia corporation was forced to look to corporate stock for his security, as was the case in the authorities cited by the respondent, but could look to actual cash.

We are not here concerned with the liability of the stockholders of the West Virginia corporation for these taxes of the West Virginia corporation. Those stockholders are not before us.

In the instant proceeding, there is no indication whatsoever that the transaction was consummated for the purpose of perpetrating a fraud upon creditors. See Joseph A. Steinle, supra. While it is true that the petitioner was organized for the purpose of acquiring the assets and business of the West Virginia corporation, the evidence does not establish that the petitioner was not a bona fide purchaser, for value, of the assets of the West Virginia corporation. Under the facts we conclude that the petitioner is not liable in equity as a transferee for the unpaid taxes of the West Virginia corporation.

We now turn to a consideration of the respondent’s contention that petitioner is liable at law for the taxes due from the West Virginia corporation.

In the contract between the petitioner and the West Virginia corporation there was the following provision:

4. As tbe balance of the consideration for the said sale, the Company [petitioner] hereby assumes and hereby agrees to undertake and carry out all contracts of the Vendor in connection with its business in force at the time of this sale whether for the purchase of materials and supplies or for the sale of manufactured products or otherwise, and the Company hereby agrees to undertake, pay, satisfy and discharge all the lawful debts of the Vendor, including the reasonable expenses of the Vendor incurred and to be incurred in connection with the pending reorganization, and to indemnify the Vendor, its successors and assigns against all actions, claims and demands in respect thereof.

It is claimed by the respondent that under this provision, the petitioner is liable at law for the taxes of the West Virginia corporation for the year 1919.

Tlie agreement, which was effective as of October 1, 1919, was entered into on October 7, 1919, at which time the calendar year 1919 had not expired, and apparently neither party to the contract considered the question of Federal taxes, since such taxes are not mentioned in the agreement. As appears from the resolution of dissolution of the West Virginia corporation, it recognized that there were some debts, liabilities and obligations remaining for it to pay, in addition to those assumed by petitioner. It will be noted from the quoted portion of the contract that this petitioner assumed only “ lawful debts ”. Under such an assumption, the petitioner can not be held liable for taxes of the West Virginia corporation. It is well settled that a tax is not a “ debt.” In Meriwether v. Garrett, 102 U. S. 472, 513, it is stated in part:

* * * Taxes are not debts. It was so held by this court in the case of Oregon v. Lane County, reported in 7th Wallace. Debts are obligations for the payment of money founded upon contract, express or implied. Taxes are imposts levied.for the support of the government, or for some special purpose authorized by it. The consent of the taxpayer is not necessary to their enforcement. They operate m invitum. * * *

See also to the same effect In re Duryee, Bankrupt, 2 Fed. 68; Western Union Telegraph Co., supra, and cases cited in 37 Cyc. 710.

Furthermore, the stipulation sets forth the amount of $1,009,-693.91 as the amount of liability of the West Virginia corporation which the petitioner assumed. In such stipulation it is specifically stated that the figure $1,009,693.91 did not include any liability of the West Virginia corporation for Federal income taxes for the year 1919. Since the evidence establishes that the petitioner did not assume in its contract any liability for the Federal taxes of the West Virginia corporation for the year in question, this second issue must be resolved against the respondent, upon whom rests the burden of proof in this respect.

We hold that the petitioner is not liable, either at law or in equity, for the Federal tax liability of the West Virginia corporation for the year 1919.

Judgment of no liability will be entered.

       Sec. 912. In proceedings before the Board the burden of proof shall be upon the Commissioner to show, that a petitioner is liable as a transferee of property of a taxpayer, but not to show that the taxpayer was liable for the tax.


text:
    John E. Greenawalt, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50793.
    Promulgated March 15, 1933.

      Kenneth W. GreenawaM, Esq., for the petitioner.

      R. N. McMillan, Esq., for the respondent.
   OPINION.

Smith :

The petitioner contends that he is entitled in the computation of his tax liability for 1928 to the maximum earned income credit of $30,000, as provided in section 31 of the Eevenue Act of 1928. This section of the act reads in part as follows:

Siso. 31. Earned income credit.
(a) Definitions. — Eor the purposes of this section—
(1) “Earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the 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.
* * * * *
(3) * * * In no case shall the earned net income be considered to be more than $30,000.

The respondent has determined that the petitioner was engaged in a business in which both personal services and capital were material income-producing factors and that the petitioner’s earned income credit is therefore limited to 20 per cent of his net profits for that year. Our question is whether the income which the petitioner received in 1928 in the form of royalties from his contracts with licensees (he had no other income in that year) was in the nature of compensation for personal services actually rendered or whether it was, to any material extent, a gain from capital. The petitioner in his brief relies upon De Laski & Thropp Circular Woven Tire Co. v. Iredell, 268 Fed. 377; affd., 290 Fed. 955. It was held in that case that a corporation whose sole business was the granting of licenses under its patents and collecting the income therefrom was taxable under section 209 of the Eevenue Act of 1917 as a “ corporation having only a nominal capital.” In its opinion, the District Court said:

Taking this last definition, which embodies the thought of all the others, it seems clear that patents do not fall within the term “ capital ”; and it also seems to be clear that this is what was in mind when Congress made the distinction between “invested capital,” which is defined under section 207 to include the actual cash value of patents paid for in stock or shares, and also such other intangible property, which had been paid for in money or stock, and also what was in mind when the word “ capital ” is used alone in section 209, preceded by the word “ nominal ”; that is, in the sense of something in name only employed in or available for production. * * *

From this point, the petitioner argues, in effect, that since patents are not capital and since his income was all attributable to the use of his patents and his personal services combined, the entire amount of the income constitutes compensation for personal services or “ earned income.”

We can not agree with this contention. It is the clear intent of the statute that the term “ earned income ” shall include only the compensation for services actually performed such as “ wages,” “ salaries,” and “ professional fees.” These terms are too well understood to require any exposition by way of legal interpretation. “ Wages ” commonly denotes the price paid for labor by the day or week, or other short intervals; “ salary,” a fixed compensation for labor or services for a longer period, such as a month or year; and professional fees,” the fixed compensation for specific services performed by a doctor or other professional person. In all cases these forms of compensation are impliedly based on the value of the services actually performed. It seems to us that royalties received from several licensees under contracts for the use of patents and computed upon the basis of the quantity rather than the value of personal services performed bear but little resemblance to either wages, salaries, or professional fees.

In construing this section of the statute, we are not so much concerned with the technical definition of “ capital ” or “ invested capital ” as these terms are used elsewhere in the revenue acts. Granting, as held in the De Laski <& Thro'pf case, that for some purposes patents may not be considered “ capital,” still the courts all recognize that patents do embody property rights of great potential value capable of producing unlimited income, and that they sometimes represent a substantial capital investment in the hands of their owner. There can be no doubt that in the instant case the patents were the principal source of the petitioner’s income, notwithstanding that under the contracts with the licensees the petitioner was required to perform, and did perform, certain personal services. The only necessity for his services was to see that his patented devices functioned to the best advantage. Such part of the royalties as is attributable to their use is clearly not “ compensation for personal services actually performed ” by the petitioner.

The record indicates, too, that the contracts under which the licensees agreed to use the patents may have had considerable capital value in the hands of the petitioner. Such contracts, being intangible property, are subject to limitation in their inclusion in statutory invested capital but nevertheless may constitute the chief income-producing asset in the hands of their owner. See Dwight & Lloyd Sintering Co., 1 B. T. A. 179; J. M. and M. S. Browning Co., 6 B. T. A. 914.

We are of the opinion that the respondent has allowed the petitioner the full benefits to which he is entitled under the law.

Judgment will he entered for the respondent.