author: Adams:

text:
    John Bostick, Jr., Trustee, A. T. Byers Trust, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68382.
    Promulgated August 7, 1934.

      W. M. Short, Esq., and F. WSidles, Esq., for the petitioner.

      John D. Kiley, Esq., and R. B. Gannon, Esq., for the respondent.
   OPINION.

Adams:

The respondent determined a deficiency in income tax against the petitioner for the year 1930 in the amount of $412.68. It is alleged that the respondent erred (a) in including in the income of petitioner the amount paid Ida H. Byers during the taxable year; (b) in capitalizing the commissions and attorney fees paid in securing a 99-year lease on property owned by the trust. No evidence was offered on this latter issue and the action of the respondent must be affirmed thereon. The case was submitted on oral evidence and a stipulation of facts.

A. T. Byers died in Tarrant County, Texas, on the 30th day of January 1925, leaving a written will of date July 12, 1923, which will was thereafter, on or about March 1925, duly admitted to probate in the Probate Court of Tarrant County, Texas. A true copy of the will is in evidence and included herein by reference.

Under the terms of the will A. T. Byers apparently attempted to dispose of the entire interest of both himself and wife in and to all property owned by them in community at the date of his death, including particularly that certain property known and described as lots 1 and 2 in block 109 in the city of Fort Worth, Tarrant County, Texas; also all the vendor’s lien notes remaining unpaid at the time of his death, originally executed by P. L. Levy and assumed by the United Amusement Co., originally payable to the Byers Opera Co., and having been executed in part payment of the purchase price of the property known as the Byers Opera House. All property owned by A. T. Byers and his wife at January 30, 1925, was community property as defined by the laws of the State of Texas.

The will of A. T. Byers provided that the income from the trust estate should be distributed monthly as follows:

To my daughter, Gertrude Richardson, the sum of Two Hundred and Fifty ($250.00) dollars per month; to my granddaughter, Mary Elizabeth Richardson, the sum -of One Hundred and Fifty ($150.00) dollars per month, and to my granddaughter, Mary Jane Joyslyn, the sum of One Hundred and Fifty ($150.00) dollars per month; the balance of such net income to be paid by my said Trustee to my wife, Ida H. Byers, in monthly installments.

The will further provided:

It is my will and desire that all other of my property than that above named, Loth real and personal,’ that I may die seized and possessed of, after the payment of all my just debts, together with all the expenses incident to the probating of his will, shall pass to and vest in fee simple in my beloved wife, Ida H. Byers; and, after the payment of all my just debts, I give, bequeath and demise unto my beloved wife, Ida H. Byers, the remainder of all other property that I may now own or be interested in at the time of my death in fee simple, to manage, sell or dispose of as she may wish or see proper.

At the time of the death of A. T. Byers, deceased, the net value of the entire community estate of himself and wife was not less than the sum of $268,328.02, of which the value of the property bequeathed to John Bostick, Jr., was not less thwii $180,000.

Upon the probate of the will of A. T. Byers, Ida H. Byers accepted all the benefits given her thereunder, and has continued to accept such benefits to the present time.

On the 27th day of June 1925, Ida H. Byers, widow of A. T. Byers, executed and delivered to. John Bostick, Jr., trustee, an instrument in writing relating to lots 1 and 2, block 109, in the city of Fort Worth, Texas, a true copy of which instrument is in evidence and included herein by reference. The conditions set out in this instrument were substantially the same as those set out in the will of A. T. Byers as to the trust property. This instrument recited in part as follows:

Whereas, the property above described was a portion of the community estate of my said husband and myself, and it is my desire that my interest in the community property above described shall pass to said trust, estate, subject to the conditions hereinafter stated;
* * * * * * *
and provided further that one-half of the entire net income from the property hereby conveyed to said trustee, shall be paid to, me monthly by said trustee, hereby retaining for my use and benefit one-half of the income of the community property of myself and late husband, as above described, and also reserving to myself and not waiving the benefits accruing to me under the will of my said husband.

In the taxable year 1930 John Bostick, Jr., trustee, petitioner herein, received net revenues in the amount of $20,202.83 from the property described as lots 1 and 2, block 109, Fort Worth, Texas, and from that certain vendor’s lien note or notes originally executed by P. L. Levy, out of which revenues the sum of $6,600 was within the taxable year 1930 distributed to the daughter and granddaughters of A. T. Byers, deceased, pursuant to the terms of the testamentary trust created by the will of the decedent, and the sum of $13,602.83 was within the same year paid over to Ida H. Byers. ■ ‘

Since the death of A. T. Byers the total distributions or payments made by John Bostick, Jr., trustee, to Ida H. Byers-have not exceeded the aggregate sum of $30,702.45.

We are not impressed with petitioner’s argument that Ida H. Byers did not elect to take under her husband’s will. The facts in the record are, we think, opposed to that conclusion. The will gave Mrs. Byers something more than she would have had but for it. She not only had the residuary estate, but received more than one half the net income from the trust estate. Under such circumstances she was put to an election. She. could not accept the will in part and reject-it in part. One who accepts a devise or bequest under a will must adopt the whole instrument in so far as he is concerned. Parker v. De-Miranda, 146 S.W. 211; Slavin v. Greever, 209 S.W. 479. The fact that she executed an instrument purporting to convey to the trustee her one half interest in the community property constituting the trust estate is not inconsistent with her election to take under the will. Since one half of the property belonged to her, it became necessary for her, in order to comply with the terms of the will, to give the trustee title to her property. The conditions recited in the instrument were substantially identical with those recited in her husband’s will. We think she elected to take under the will. Cf. Lee v. McFarland, 46 S.W. 281; Farmer v. Zinn (Tex. Cir. App.), 261 S.W. 1073; Caddell v. Lufkin Land & Lumber Co. (Tex. Cir. App.), 234 S.W. 138.

Thereafter the provisions of the will were carried out as .to her. During the taxable year she received in monthly installments from the trustee, the petitioner here, not the income from her one half of the community property, but the balance of the net income from the trust estate after the specific bequests to the other beneficiaries had been paid.

The Commissioner ruled that the amount thus paid to the widow was a return of capital to her and was taxable to the trustee under the i-easoning in Warner v. Walsh, 15 Fed. (2d) 367 and related cases.

Since the hearing in this proceeding the Supreme Court, in Hel-vering' v. Butterworth, 290 U.S. 365, rejected the reasoning in Warner v. Walsh, supra, and held that a tvidow who accepts the provisions of her husband’s will, and receives a part of the income from an established trust in lieu of her statutory rights, is a beneficiary within the ambit of the statute. In its opinion, the Court said:

* * * It is unnecessary to discuss her rights or position under other circumstances. We are dealing with a tax statute and seeking to determine the will of Congress.
When she makes her election the widow decides to accept the benefits of the will with the accompanying rights and liabilities. In no proper sense does she purchase an annuity. * * *

We think this issue is controlled by the Butterworth case, supra, and that the petitioner is entitled to credit for the income paid to the widow during the taxable year.

Deoision 'will he entered under Rule 50.


source: Caselaw Access Project

author: Leech:

license: Public Domain

text:
    Smith Paper Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Export Leaf Tobacco Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. T. C. Williams Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61394-61396.
    Promulgated August 8, 1934.

      H. E. Shelton, Esq., and H. M. Robertson, Esq., for the petitioners.

      Allin H. Pierce, Esq., and Irvmg M. Toller, Esq., for the respondent.

      32
   OPINION.

Leech:

The sole issue here is whether the petitioners, together with Brown & Williamson and Brown & Williamson Sales, are entitled to have their income taxes for the calendar year 1928 computed on a consolidated basis.

The applicable statutory provisions are.practically identical sections, 240 (a) of the Revenue Act of 1926, and 142 (a) of the Revenue Act of 1928.

Since Export of New Jersey and Williams were affiliated throughout 1926, under the provisions of section 240 (d) of the Revenue Act of 1926, Regulations 69, article 632, each had the privilege to elect whether to file its income tax return for that year upon a separate or a consolidated basis.

Each filed upon and therefore elected the separate basis of return. This election was binding upon both for every return made thereafter for any taxable period, under either of the cited statutory provisions, during that affiliation unless permission to change such basis was had from the Commissioner. Lucas v. St. Louis National Baseball Club, 42 Fed. (2d) 984; certiorari denied, 282 U.S. 883; Dr. Pepper Bottling Co., 25 B.T.A. 1323; affd., 69 Fed. (2d) 768; Safety Electric Products Co. v. Helvering, 70 Fed. (2d) 439; Alameda Inv. Co. v. McLaughlin, 33 Fed. (2d) 120; Harbour-Longmire Co., 18 B.T.A. 33; Baird Machine Co., 19 B.T.A. 801; Peerless Pattern Co., 29 B.T.A. 767.

The same affiliation continued until November 30, 1927, except for the addition of Brown & Williamson on March 16 of that year. But such addition, we have held, does not result in a new right of basis election, at least where the same parent existed, as here, Huntington Beach, Inc., 30 B.T.A. 731; Peerless Pattern Co., supra. Cf. Marvel Equipment Co. v. Commissioner, 67 Fed. (2d) 354, reversing 26 B.T.A. 515. In the first cited case, after carefully reconsidering the question, this Board respectfully refused to follow the decision of the Third Circuit Court of Appeals in Stonega Coke & Coal Co. v. Commissioner, 57 Fed. (2d) 1030, and reiterated its earlier decision.

Regulations 74, article 731, promulgated'under the Revenue Act of 1928, construes the “ return ” for 1927, authorizing the same basis of return for 1928, to mean a proper return. This construction does not change that approved under the cited and pertinent sections of the preceding revenue act. Peerless Pattern Co., supra; Albert Leon & Son, Inc., 29 B.T.A. 251.

The filing of consolidated returns is a right existing only by grant of Congress upon certain conditions set out in the revenue acts, following that of 1918, extending it. Huntington Beach, Inc., supra. Cf. section 141, Act of 1934, abolishing such returns except by railroad companies. Likewise is its complement — the right to change basis of return.

If the word as here used means anything other than proper return, this right, granted, by the cited provision, solely upon permission of the Commissioner of Internal Revenue, would not be a right, the existence of which depended wholly upon the law creating it, but where affiliation was present, as here, it would be an absolute and unconditional right, the exercise of which nothing but the pleasure of the taxpayer would control. Such construction would nullify the purpose of the act and render it meaningless — a result repugnant to the well established canons of statutory construction. Aluminum Castings Co. v. Routzahn, 282 U.S. 92; United States v. Katz, 211 U.S. 351.

The mere filing of a consolidated return did not establish the necessary permission to so file. Lucas v. St. Louis National Baseball Club, supra; Dr. Peffer Bottling Co., supra; Harbour-Longmire Co., supra.

Since no permission to change the 1926 basis of return was secured from the Commissioner of Internal Revenue, it follows that the consolidated return of Export of New Jersey and Brown & Williamson, for the period January 1 to November 30, 1927, had no other legal effect for tax-computing purposes than that of separate returns and, a fortiori, were not the returns contemplated by the cited provision necessary to base consolidated returns for the succeeding taxable period. Dr. Pepper Bottling Co., supra; St. Louis National Baseball Club, supra; Grant v. Rose, 24 Fed. (2d) 115; Harbour-Longmire, supra; Baird Machine Co., supra.

The same reasoning and precedents apply with equal force to the status of the affiliation existing from December 1 to December 31, 1927, and the consolidated returns filed by Export of Delaware and Brown & Williamson for that period.

Although unnecessary to these conclusions, it is observed that, under the cited statutory provisions, the rule is well recognized which prevents a consolidated return by an affiliation where one of the affiliates has filed a separate return for the same taxable period, as Williams did here for 1927, Southern Power Co. (now Duke Power Co.), 17 B.T.A. 962; affd., 44 Fed. (2d) 543; certiorari denied, 252 U. S. 903; Commissioner v. Hirsch & Co., 30 Fed. (2d) 645; Safety Electric Products Co., supra; Flambeau Public Service Co., 27 B.T.A. 299. True, this rule has been held not to include a case where such separate return was filed by a nonactive corporation without income (Whitman, Ward & Lee Co., 29 B.T.A. 670), but we think it doubtful on reasoning and authority to so treat the result of the 1927 return of Williams, an active corporation having a comparatively small but nevertheless substantial income.

The unavoidable result of these conclusions, under section 142 (a) of the Revenue Act of 1928, supra, is that the respondent was right in refusing to compute the income taxes of petitioners and their affiliates for 1928 upon a consolidated basis, as returned, unless, as argued by petitioners, (1) a new right of election of basis resulted to the affiliation from the addition in that year of Brown & Williamson Sales on J une 5, or Smith on October 8, British-American remaining throughout the year the parent corporation; or (2) the execution of agreements under section 606 of the Revenue Act of 1928 constituted retroactive permission by the Commissioner to change the basis of return for 1927 so as to make the return filed the proper return necessary to base the consolidated return made for 1928, or by reason of such agreements themselves the respondent is barred now from raising the question of propriety of the returns made for 1927.

The answer to petitioners’ first position is necessarily in the negative, based upon the same reasons and authorities as those upon which our conclusions as to the status of the affiliation and the returns therefor for 1927 were based.

Petitioners’ second contention is without merit also.

It must be remembered we are considering here the question of the existence of a statutory conditional right. Cf. Huntington Beach, Inc., supra, and petitioners, to enjoy its advantages, must bring themselves clearly within the specified conditions precedent to its grant. Rock Island, A. & L. R. Co. v. United States, 254 U.S. 141.

Since the filing of the consolidated returns for 1927 on June 15, 1928, without the permission .of the Commissioner, had the effect only of separate returns, at that date, obviously, under section 142 (a) of the Revenue Act of 1928, supra, the only legal method of computing the tax liabilities to which those returns were directed was upon a separate basis for each member of the affiliation. The obligations, thus definitely fixed by statute, could not thereafter be changed by any action of the Commissioner. George Freese’s Sons, 18 B.T.A. 416; Grant v. Bose, sufra; Deposit Trust & Savings Bank, Executor, 11 B.T.A. 706. Cf. Alameda Investment Co., 33 Fed. (2d) 120. The execution of the several agreements under section 606 of the Revenue Act of 1928, supra, occurred a year and a half after the consolidated return involved herein was filed. Cf. Patent Royalties Corp. v. Commissioner, 65 Fed. (2d) 580, reversing 25 B.T.A. 1032. :

These agreements, authorized only, as in the present case, by the Commissioner, with the approval of the Secretary of the Treasury, are localized and limited in their operations by the statute, through which, alone, they are possible, to tax liabilities for definite periods covered therein. Neither the cited statutory provision permitted nor the instruments executed thereunder here included any agreement binding either party thereto to recognize any element necessary to the computation of a tax liability for 1928, and thus permit the perpetuation of a palpable error. The present agreements closed certain tax liabilities for periods within 1927 and nothing else. The method used in computing the amounts of those liabilities for that year, whether proper or otherwise, could not and did not conclude the respondent in his computation of these disputed tax liabilities for 1928. W. C. Mitchell Co., 27 B.T.A. 645; Alabama Mineral Land Co., 28 B.T.A. 586; Phoenix Ins. Co., 29 B.T.A. 291; Wolverine Petroleum Co., 29 B.T.A. 1236. The contested deficiencies are approved.

Judgment will be entered for the respondent.

       Sec. 240. (a) Corporations which are affiliated within the meaning of this section may, for any taxable year, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. If return is made on either of such bases, all returns thereafter made shall be upon the same basis unless permission to change the basis is granted by the Commissioner.

       Sec. 142. (a) Consolidated returns permitted. — Corporations which are affiliated within the moaning of this section may, for the taxable year 1928, make separate returns or, under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which ease the taxes thereunder shall be computed and determined upon the basis of such return. If return for the taxable year 1927 was made upon either of such bases, return for the taxable year 1928 shall be upon the same basis unless permission to change the basis is granted by the Commissioner.

        Consolidated retwms of affiliated corporations for 1928. — Affiliated corporations as defined1 in section 142 (c) may for the taxable year 1928 make separate returns or make a consolidated return in which will be reported the consolidated net income of the affiliated corporations, except that if a return for the taxable year 1927 was properly made upon either of these bases, the return for the taxable year 1928 must be made upon the same basis unless permission to change is granted by the Commissioner. * * *

         SEC. 606. CLOSING AGREEMENTS.
      (a) Authorization. — The Commissioner (or any officer or employee of the Bureau of Internal Revenue, including the field service, authorized in writing by the Commissioner) is authorized to enter into an agreement in writing with any person relating to the liability of such person, (or of the person or estate for whom he acts) in respect of any internal-revenue tax for any taxable period ending prior to the date of the agreement.
      (b) Finality of agreements. — If such agreement is approved by the Secretary, or the Undersecretary, within such time as may be stated in such agreement, or later agreed to, such agreement shall be final and conclusive, and, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact—
      (1) the case shall not be reopened as to the matters agreed upon or the agreement modified, by any officer, employee, or agent of the United States, and
      (2) in any suit, action, or proceeding, such agreement, or any determination, assessment, collection, payment, abatement, refund, or credit made in accordance therewith, shall not be annulled, modified, set aside, or disregarded.
      (c) Section 1106 (b) of the Revenue Act of 1926 is repealed, effective on the expiration of 30 days after the enactment of this Act, but such repeal shall not affect any agreement made before such repeal takes effect.


author: ARTjndell :

text:
    Benjamin F. Wollman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71929.
    Promulgated August 8, 1934.

      William Sabine, Esq., for tbe petitioner.

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

ARTjndell :

Petitioner claims that the instrument of May 27, 1930, created a valid trust, irrevocable within the year 1930, and that the income from the trust property was taxable to the beneficiary under section 162 (b) of the Revenue Act of 1928. The respondent has taxed the income to the petitioner on the ground that the so-called trust was not a genuine trust transaction.

The statute is concerned with genuine trusts, and a proper administration of it permits inquiry into the motives prompting creation, the relation of the parties, and other circumstances surrounding the transaction. In Stoddard v. Eaton, 22 Fed. (2d) 184, it is said:

After all the word “ trust ” as used in section 219 of the Revenue Act of 1918, can hardly have been intended to comprehend every instance in which a trust is recognized in equity. A trust ex maleficio, a resulting trust or a constructive trust are examples of trusts which do not fit into the frame of the statute. A trust, as therein understood, is not only an express trust, but a genuine trust transaction. A revenue statute does not address itself to fictions.

In Burnet v. Wells, 289 U.S. 670, the Court, speaking of trusts for the benefit of wife or kin, said: “ The relation between the parties, the tendency of the transfer to give relief from obligations that are recognized as binding by normal men and women, will be facts to be considered. * * * We do not go into their bearing now.”

The reason for petitioner’s setting aside securities and paying the income to his wife, as testified to by petitioner was “ to not pay too much income tax.” It further appears from petitioner’s testimony that the income was to be paid to his wife in lieu of the allowance he had theretofore given her for personal expenses. He continued thereafter to give her sums of money from time to time, but not at regular times or as a stated allowance.

It thus appears that the petitioner is attempting to do indirectly • what he can not do directly, namely, to deduct from his income the the expense of supporting his wife. The Revenue Act of 1928 specifically prohibits the deduction, of “ personal, living, or family expenses.” Sec. 24 (a)(1). Obviously deductions so clearly prohibited are not to be allowed in some other guise unless the taxpayer can bring himself clearly within other provisions of the statute which support his claim.

Petitioner argues that section 162 (b) governs his case and sanctions his claim. As pointed out above, the statute is concerned with genuine trusts and not with all cases where a resulting or equitable trust might be declared by a local court. It might, for instance, in this case be declared upon suit by Mrs. Wollman that petitioner’s retention of title to the securities was for her benefit. But for Federal tax purposes we think his retained interest and powers were so substantial that the securities may properly be regarded as his property and the income taxable to him. The Supreme Court in Reinecke v. Smith, 289 U.S. 172, recently said:

Decisions of this court declare that, where taxing acts are challenged, we look not to the refinements of title but to the actual command over the property taxed — the actual benefit for which the tax is paid.

Also, in Burnet v. Wells, supra:

Government in casting about for proper subjects of taxation is not confined by the traditional classification of interests or estates. It may tax, not only ownership, but any right or privilege that is a constituent of ownership. [Cases.] Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis.

In the case before us the petitioner retained title to the securities, kept them in his possession, received the income, and in every way enjoyed “privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner.” “ Here the grantor did not divest himself of title in any permanent or definitive way, did not strip himself of every interest in the subject matter of the trust estate.” DuPont v. Commissioner, 289 U.S. 685.

While the eases cited deal with situations where the statute specifically directed the taxing of trust income to the grantor, the language of the Supreme Court seems to us broad enough to indicate that the general provisions of the statutes will support the taxation of income to the grantor where he retains powers as broad as in this case. The revenue acts tax the income “ of ” every individual. “ The use of the word ‘ of ’ denotes ownership.” Poe v. Seaborn, 282 U.S. 101. Bearing in mind that taxation is not to be controlled by refinements of title (cf. Weiss v. Wiener, 279 U.S. 333; Corliss v. Bowers, 281 U.S. 376), it is difficult to see wherein the petitioner here parted with the ownership of his securities so as to escape taxation on the income. They continued to stand in his name; they were kept in his possession; he had the right to sell or exchange and reinvest “ without regard to any limitations imposed by law ”; he had the right to keep in his individual account any income or proceeds of any sale and as to any such moneys his liability was to be that of a debtor rather than that of a fiduciary. All of these extensive powers were expressly reserved to petitioner. The line that separates petitioner’s rights under these powers from those of complete ownership is too faint to be distinguishable.

We are of the opinion, and so hold, that the execution of the instrument of May 27, 1930, did not create a valid subsisting trust so as to relieve petitioner of liability for tax on the income from the property described in the instrument.

Decision will be entered for the respondent.


author: Black :

text:
    Mollie Netgher Newbury, Trustee of the Estate of Charles Netcher, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42435.
    Promulgated August 9, 1934.

      Joseph R. Little, Esq., and Laurence Graves, Esq., for the petitioner.

      Mason B. Leming, Esq., for the respondent.
   OPINION.

Black :

The principal question involved herein is one of fact, viz., whether or not the stock received by petitioner in the new Delaware corporation had a readily realizable market value when petitioner acquired it. The respondent determined that the stock in the Delaware corporation had a readily realizable market value at least of equal value with the March 1, 1913, fair market value of the stock in the old Illinois corporation, which he fixed at $4,768,965.64; and that consequently the entire cash payment of $3,655,518.75 constituted profit and taxable income to the petitioner. Petitioner, on the other hand, claims that the stock in the.Delaware corporation did not have a readily realizable market value when she received it in exchange for the stock in the Illinois corporation, and that inasmuch as the $3,655,518.75 cash was less than th.e March 1,1913, fair market value of $4,768,965.64 of the stock in the Illinois corporation, no taxable income resulted. Petitioner claims that the amount of cash received, under the applicable provisions of the revenue act, goes to reduce the basis.

The applicable provisions of the Revenue Act of 1921, as amended by the Act of Congress of March 4, 1923, effective January 1, 1923, are printed in the margin.

The statute quoted in the margin, which provides that “ no gain or loss shall be recognized unless- the property received in exchange has a readily realizable market value ’Vdoes not define the meaning of “readily realizable market value.” Under such circumstances it becomes the duty of the Commissioner to define the meaning of the term in the administration of the law, and if his definition is a reasonable one it is our duty to give it effect. The Commissioner, in his Regulations 62, article 1564, defines the term as follows:

Property lias a readily realizable market value if it can be readily converted into cash or its equivalent substantially equal to the fair value of the property. In other words, the property received in exchange must be readily marketable at substantially its fair value in order that a gain or' loss be recognized. * * * Stock in a close corporation may or may not have a readily realizable market value, depending upon all the facts .in each particular case. Thequestion whether property has a readily realizable market value, and if so, the amount thereof, is one of fact to be determined in each case in the light of all the surrounding circumstances.

In Edwin W. Eisendrath, 28 B.T.A. 744, we thoroughly considered the question of the meaning and application of the term “ readily realizable market value ” as used in the quoted section of the Revenue Act of 1921, and it would serve no useful purpose to again review the authorities therein cited. It is sufficient to say that our interpretation of the term was substantially the same as the Commissioner has defined it in his regulations.

In the Eisendrath case an Illinois corporation, with a capital stock of 500 shares of the par value of $100 each, was engaged in the tanning business in Chicago, Illinois. It had been very prosperous from its organization in 1904 until after the World War, when the tanning business began to decline. The March 1, 1913, fair market value of its shares was $1,410.03 for each share. In 1923 a reorganization was effected, by which a Delaware corporation was organized with a capital stock of 25-,000 shares;of the par value of $100 each and exchanged its entire issue of 25,000 shares and $700,000 cash in addition for the 500 shares of stock in the old Illinois corporation. Each stockholder in the old Illinois corporation received in exchange for each share of his stock therein 50 shares of stock in the new Delaware corporation and $1,400 . in cash. The respondent in that case determined that the shares of stock exchanged were of equal value and that the stock of the Delaware corporation had a readily realizable market value, and that the entire additional cash payment was profit and constituted taxable income to the recipients. We held, however, that the stock of the new Delaware corporation did not have a readily realizable market value, and as the cash received of $1,400 per share did not equal' or exceed the March 1, 1913, value of $1,410.03 per share, no taxable gain resulted.

In the instant case the Commissioner has determined, as he did in the Eisendrath case, that the stock of the Delaware corporation which petitioner received in exchange, for the stock which the estate owned in the Illinois corporation had a readily realizable market value at least equal to the March 1, 1913, value of the stock in the Illinois corporation and that hence all. the cash received in the transaction was taxable gain. This determination, of respondent is presumed to be correct, and so many decisions have held that to be true that it is unnecessary to cite authorities. Petitioner recognizes this to be true and has offered much evidence to rebut the determination made by respondent.

Petitioner has made no effort to prove that the stock did not have value. Indeed it is quite clear that the stock did have value — much value — because it unquestionably had large assets behind it, but that is not saying that under the circumstances existing at the time of exchange it had a readily realizable market value. As we said in Alexander D. Falok, 26 B.T.A. 1359, “ Before such a transaction is considered to give rise to taxable gain under the statute, the property received in the exchange must have a readily realizable, market value, i.e., be practically the equivalent of cash.” We do not think we can hold that the stock of the Delaware corporation to the extent of its fair value was practically the equivalent of cash at the time it was received. We feel constrained to hold that the weight of the evidence is against the conclusion .that the stock of the Delaware corporation had a readily realizable market value at the time of the exchange. Under these circumstances the cash which petitioner received in the transaction will go to reduce the basis of the Delaware corporation stock and any gain in the transaction to be taxable will have to await the future disposal of the -stock. Such we believe was the intent of the-statute which we have quoted in the margin.

Seven qualified witnesses testified for the petitioner relative to the marketability of the stock in the Delaware corporation, some of whom were participants in the reorganization and loan transactions. The stock was not listed on any exchange and there had been no sales of any shares.

All of these witnesses testified that the stock did not have a readily realizable market value at the time- of' the exchange. They gave various reasons, for their opinions and we do not deem it necessary to report their testimony in detail in this discussion. We think it will suffice to give a summary of their reasons and this summary may be stated briefly, as follows: Under the trust indenture of April 1, 1923, which the Delaware corporation had to give to secure its gold note issue of $3,750,000, it was .prohibited from paying any dividends out of anything except earnings which might accrue to the company after April 1, 1923. ' .

It had a principal obligation, plus interest; to meet under that indenture, in excess of $4,704,000 over a period of eight years. Current assets of $4,000,000 at all times had to be maintained. Therefore the $4,704,000 which had to be paid over this term of eight years could only be paid out of future profits after April 1, 1923. The person who would want to buy the stock as of April 26, 1923, would therefore have, to agree to pay off $4,704,000 out of future earnings, which would, make the chances for any distributable dividends- during that time very slim. The stock was not salable unless the person buying it could in a manner satisfactory to Mrs. Newbury, indemnify her and save her harmless from the personal guaranty which she had given to the purchasers of the $3,750,000 gold notes of the Delaware corporation. Under the leases the rentals and taxes amounted to approximately $1,250,000 annually and were burdensome, considering the volume off annual sales of the corporation, and constituted a prior lien against the assets of the corporation in addition to the heavy payments on the note issue before anything was available for distribution as profits.

One witness, who was a negotiator for the sale or purchase of large department stores, testified he had attempted to interest Isaac Gimbel of Gimbel Bros, of New York, Jesse Straus of Macy & Co. of New York, Samuel Mundheim of Kaufman’s of Pittsburgh, S. S. Kresge of the S. S. Kresge Stores, and Morton May of the May Department Stores of St. Louis, in purchasing the Boston Store of Chicago (Delaware corporation), but without success. He testified that the shares of stock in the Delaware corporation did not have a readily realizable market value, nor a fair market value, and gave as reasons substantially the same reasons as we have set out in detail in the foregoing summary.

In view of this testimony we think that petitioner has overcome the presumptive correctness of respondent’s determination and that it was incumbent upon the Commissioner to offer evidence in rebuttal which would have satisfactorily established that the stock of the Delaware corporation did have a readily realizable market value at the time of the exchange. This we do not think he has done. Therefore, on this issue, we find in favor of petitioner.

The respondent in determining the deficiency added 25 percent thereof, amounting to $85,616.22, as a penalty for failure to file a return on time. Apparently this was imposed under section 3176, Revised Statutes, as amended by section 1103, Revenue Act of 1926, which provides in part as follows:

In ease of any failure to make and file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the Collector in pursuance of law, the Commissioner of Internal Revenue shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax.

It is not disputed that the petitioner did file a fiduciary return on Form 1041 in time, but on advice of tax accountants no report was made of the transaction herein involved, on the theory that it was not taxable and no profit for taxation on Form 1040 was returned.

Since we have held that there is no tax due from the petitioner on the transaction, it follows that the imposition of the penalty was improper.

Reviewed by the Board.

Decision 'will he entered for the 'petitioner that there is no deficiency and no penalty.

       Sec. 202. (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 tble cost of such property; except that—

        at at at a< at * a

      (b) The basis for ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, acquired before March 1, 1913, shall be the same as that provided by subdivision (a) ; but—
      (1) If its fair market price or value as of March 1, 1913, is in excess of such basis, the gain to he included in the gross income shall he the exeess of the amount realized therefor over such fair market value or price; [Italics supplied].
      * v • * # # * ‡
      (c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no- gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized—
      * * * at , * a a

      (2) When in the reorganization of one or more corporations a person receives in place of any stock or securities owned by him, stocks or securities in a corporation a party to or resulting from such reorganization. The word “ reorganization,” as used in this paragraph, includes a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form or place of organization of a corporation, (however effected) ; * * *
      (e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2) and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the amount of the gain resulting from such exchange shall be computed in accordance with subdivisions (a) and (b) of this section, but in no such caso shall the taxable gain exceed the amount of the money and the fair market value of such other property received in exchange.


author: Murdock:

text:
    United States Trust Company of New York and Clarence C. Pell as Trustees under Deed of Katherine L. K. Pell for the Benefit of Herbert C. Pell, Jr., Petitioners, v. Commissioner of Internal Revenue, Respondent. United States Trust Company of New York and Herbert C. Pell, Jr., as Trustees under Deed of Katherine L. K. Pell for the Benefit of Clarence C. Pell, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 60987, 60988.
    Promulgated August 9, 1934.

      E. Sheldon Stewart, Esq., for the petitioners.

      Frank Thompson, Esq., for the respondent.
   OPINION.

Murdock:

Deficiencies for the year 1929 of $792.83 (Docket No. 60987) and $792.58 (Docket No. 60988) are in controversy. The cases were consolidated and in each the sole issue presented is whether or not the Commissioner erred in increasing the gain from the disposition of a piece of real estate by reducing the taxpayers’ basis by depreciation on the improvements. There is no question raised as to any figures. The facts have been stipulated.

Katherine L. K. Pell in 1917 created two trusts, to which she transferred a piece of real estate. One half was to be held by the one trust and the other one half was to be held by the other trust. The two halves were of equal value. . The net income from the one trust was to be paid to Herbert C..Pell, Jr., during his lifetime and after his death the net income and. principal .of that trust was to go to others. The other trust was similar and named Clarence C. Pell as life beneficiary. The property held by these trusts was taken by the city of New York and the two .trusts received in 1929 a total of $227,500 as compensation for the taking. The expenses of the two trusts incident to the disposition of the property amounted to $6,875. The total basis of the property to the two trusts for determining gain was $144,000. Section 111 (b) (2) of the Revenue Act of 1928 requires that in computing the amount of gain “ The basis shall be diminished by the amount of the deductions for exhaustion, wear and tear * * * which have since the acquisition of the property been allowable in respect of such property under this Act or prior income tax laws * * The Commissioner reduced the basis by $10,800, representing depreciation allowable on the improvements on the property since its acquisition by the trusts, and consequently increased the gain of each trust by $5,400. The petitioners complain of this adjustment. They point to section 23 (k) of the Revenue Act of -1928, which provides that “ In the case of property held in trust the allowable deduction' [for depreciation] shall be apportioned between the income beneficiaries and the trustee * * * on the basis of the trust income allocable to each ”, and argue that since under this provision they were not entitled to any deduction for depreciation and since under prior acts they received no benefits of depreciation, their basis for gain should not be diminished under section 111 (b) (2). However, the provisions of section 111 (b) (2) are clear. If deductions for exhaustion, wear, and tear have been allowable in respect of such property since its acquisition by the taxpayer, all of those deductions must be used to diminish the basis. Cf. United States v. Ludey, 274 U.S. 295; Fidelity-Philadelphia Trust Co. v. Commissioner, 47 Fed. (2d) 86, affirming 18 B.T.A. 43. Thus it matters not that there was no income to.be offset by the deductions allowable nor is it material to know whether a particular deduction was allowable to the trustee or to the beneficiary.

Decision will be. entered for the respondent.


author: Adams :

text:
    Chester Addison Jones, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50206.
    Promulgated August 9, 1934.

      Eustis My res, Esq., and J. D. Anderson, G.P.A., for the petitioner.

      Brrne A. Low, Esq., for the respondent.
   opinion.

Adams :

This proceeding involves proposed deficiencies in income taxes for the calendar year 1927 in the amount of $11,738.54, and .for the calendar year 1928 in the amount -of $4,4Í5.91.

Petitioner alleges that the respondent erred (a) in failing to compute the tax on income for 1927 on the basis of separate returns for petitioner and his wife; (b) in failing to allow as a deduction from gross income for the year 1927 traveling expenses in the amount of $4,774.90; and (c) in failing to allow as a deduction from gross income for the year 1927 depletion upon the sale of producing oil property and payments for oil at the rate of 27y2 percent. Petitioner has introduced no evidence relative to the proposed deficiency for 1928, and the respondent’s determination for that year is approved. At the hearing petitioner waived his assignment of error for failure to allow a deduction of $4,774.90 for traveling expenses for 1927.

This leaves for our consideration (1) the question of whether petitioner was entitled to have his income computed on the basis of a separate return or a joint return for himself and wife; and (2) the question as to whether he has a right to depletion. Both of these questions refer to the year 1927.

The petitioner was a married man, a resident of the State of Texas, where the law recognizes community property between husband and wife. During the year 1927 petitioner and his wife separated and on July 28, 1927, entered into a separation agreement and marriage settlement which provided a division of their community property interests. This agreement is included herein by reference. By the terms of this agreement certain real property was transferred to petitioner’s wife and petitioner agreed to pay her $20,000 ($15,000 in cash and $5,000 within six months). Petitioner’s wife conveyed to him all her “ right, title, claim and demand ” in and to all other property owned or possessed by him. It was further provided:

That from and after the execution of this agreement that neither of the parties hereto shall have any right, claim or demand to any property acquired by the other, and that the property herein and above conveyed to the said Mrs. C. A. Jones shall be her separate property and any other property acquired by her shall be her separate property, and the rents and revenues to be derived therefrom shall be her separate property, and that all the property now owned and that may hereafter be acquired by the said O. A. Jones shall be his separate property; it being our intention that from and after this date, that neither of the parties hereto shall have claim or demand any interest in or to any property of the other, and that neither party hereto shall participate in any way in the management, control, sale or disposition of the respective properties so owned by us. * * *
This partition agreement is made with the further agreement and understanding that the property hereinbefore set apart to Mrs. O. A. Jones is situated in Eastland County, Texas, and that the property set apart to C. A. Jones consists mostly of personal property and is situated in the oil fields of western Texas, and while the same is not itemized herein, it includes all the automobiles, trucks and machinery, notes and accounts, as well as any money that he may have on hand, and that from and after this date the said Mrs. C. A. Jones shall have no interest therein, and C. A. Jones shall handle same independent of the said Mrs. C. A. Jones, and that the property set apart to Mrs. C. A. Jones as above described shall be hers and managed and disposed of by her, and in addition thereto the said C. A. Jones also disclaims any interest in and to her personal property, such as her automobile, household goods, diamonds and wearing apparel. * * *

Petitioner and his wife have not lived together since their separation agreement of July 28, 1927, and were not living together on December 31, 1927. On November 19, 1928, they were divorced by a judgment of the District Court of Eastland County, Texas, which further ordered, adjudged, and decreed that the marriage settlement of July 28, 1927, be affirmed and binding on the parties. In the settlement of the divorce proceeding, petitioner was required to pay to his wife an additional sum of $2,500 and the costs of the action.

Prior to March 10,1927, the petitioner and others were owners of the oil and' gas rights on certain lands in Crane County, Texas. On that date they entered into a contract, included herein by reference, with certain other parties, which provided, among other things, for the assignment by the petitioner and others of all their right, title, and interest in and to the oil and gas rights on these lands. It further provided that the transferees should take over the operation and continue the drilling of a well on the property and pay certain obligations incurred by the petitioner and his associates and do additional prospecting and drilling.

In consideration for such assignment and transfer, petitioner and his associates received the sum of $110,000, of which the petitioner received $50,000 ($40,000 in cash and $10,000 in Texon stock).

It was further provided that if oil in commercial quantities was produced from the well, out of seven eighths of the first oil produced the purchasers should retain for their exclusive benefit the sum of $160,000 derived from the sale of the oil, and then:

* * * as soon as, but not before, the parties of the third part shall have received from the gross sales of seven-eighths (%) of said oil, the sum of one hundred sixty thousand ($160,000.00) Dollars, as hereinabove provided, then and in such event only, the parties of the third part agree to pay to the parties of the first part one-half of seven-eighths (%) of the proceeds of the sale of the next oil produced from said lands if, as and when said oil is sold and paid for, until the parties of the first part shall receive the sum of one hundred ninety-two thousand five hundred ($192,500.00) Dollars (being eleven-sixteenths of $280,000.00) to be pro-rated among the parties of the first part as follows:
Five-Elevenths (5/11) thereof amounting to $87,500.00 to C. A. Jones
Four-Elevenths (4/11) thereof amounting to $70,000.00 to Clayton W. Williams
Two-Elevenths (2/11) thereof amounting to $35,000.00 to Boscoe Copen
Payment shall be made by the parties of the third' part directly to the parties of the first part, in the proportions above set forth, on the tenth day of the month for oil sold and paid for during the last half of the preceding month and on the twentyrfifth day of the month for all oil sold and paid for during the first fifteen days of the month.

Petitioner in- his income tax return for the year 1927 included $40,000 from the cash consideration and $27,372.11 from the oil payments. He deducted from his return as an amount paid Mrs. C. A. Jones from income of the sale the sum of $22,000.

In making out his return for the taxable year 1927 on Form 1040, petitioner answered the printed interrogations thereon as follows:

1. Are you a citizen or resident of the United States? Yes.
2. If you filed a return for 1926, to what Collector’s Office was it sent? Dallas, Teosas.
3. Is this a- joint return of husband and wife? No.
4. State name of husband or wife if a separate return was made and the Collector’s office where it was sent. None.
5. Were you married and living with husband or wife on the last day of your taxable year? 1 No.
6. If not, were you on the last day of your taxable year supporting one or more persons living in your household who are closely related to you?
Yes.
7. If your status in respect to questions 5 and 6 changed during the year, state date and nature of change. Separated! from wife.
8. How many dependent persons (other than husband or wife) under 18 years of age dr incapable of self-support because mentally or physically defective were receiving their chief support from you on the last day of your taxable year? Two.

The respondent contends that the return was a joint return for both husband and wife and that petitioner, having elected to file a joint return, cannot now claim'a return on a separate basis. The petitioner urges that he filed an individual income tax return for the calendar year 1927. 'He admits in his brief that the method used in arriving at his part of the community income was erroneous and now contends that to correct the same the total community net income for the taxable year should be equally divided between himself and wife and taxed to them accordingly.

From the applicable statutes and regulations, it appears that a husband and wife may elect to file a joint return only when they were living together at the close of the taxable year.

Section 223 of the ¡Revenue Act of 1926 provides:

(b) If a husband and wife living together have an aggregate net income for the taxable year of $3,500 or over, or. an aggregate gross income for such year of $5,000 or over—
(1) Each shall make such a return, or
(2) The net income of each shall be included in a single joint return, in which ease the tax shall be computed on the aggregate income.

Regulations-69, article 401, provides that a joint return of husband and wife may be filed only if they are living together at the close of the taxable year.

Since petitioner and his wife were not living together at the close of the taxable year, they could not file a joint return, but each was required to file an individual return. That petitioner intended to do this is, we think, evidenced by his answers to the questions above quoted and by his letter of transmittal in which he says “ Enclosed find individual income tax return for Mr. C. A. Jones.” The' fact that in his return he took the personal exemption of the head of a family and credit for dependents is not determinative of the issue. He was obliged to support his minor children even though living apart from his wife and he may have regarded himself as head of the family and entitled to the full exemption, even though he was not so entitled under the revenue laws. In such a situation, he should only be allowed the exemption to which he was entitled.

The cases cited by the respondent to the effect that petitioner had elected to file a joint return are not in point. Those cases are based on the right of a taxpayer to choose which Of two legal courses he will follow and are to the effect that, having made an election and filed a joint return, he may not thereafter file a separate return for that year. That is not the case here, and we hold that petitioner’s income and tax should be determined on the basis of a separate return. Cf. I.T. 2650 (C.B. XI-2, p. 101); Gertrude H. Thompson, 30 B.T.A. 30.

We do not, however, agree with petitioner’s contention that the total net income for the taxable year should be divided equally in arriving at the amount to be reported by him. This contention, which is based on the fact that the community is dissolved on dissolution of the marriage, does not take into consideration the effect of the marriage settlement of July 28, 1927, which was affirmed by the court and held binding on the parties.

Spouses in the State of Texas may legally enter into a contract of separation if they have already separated, or have determined upon an immediate separation, and as a part of such contract may agree upon a separation of property. See Community Property, McKay, sec. 867, et seq. And as a part of a valid separation agreement, the spouses may dissolve the community of property. Rains v. Wheeler, 76 Tex. 390; 13 S.W. 324; Corrigan v. Goss (Tex. Civ. App.), 160 S.W. 652. In the latter case, the court said:

It is clear that this agreement and partition deed were not intended to convey property by one spouse to another, but an equitable division in view of final separation, that is, in view of no longer acting together in the acquisition of property, which the law fixes as community, or separate, according to its manner of acquisition, but each to take in the future such property as he may acquire as his own, unincumbered by the marital relation.
Hence it follows that property acquired by either spouse after separation, brought about by such an agreement,' becomes the separate property of the one who acquired it, free from the claims of the other, because they are no longer, in law, acting together in their legal capacity of husband and wife. And this partition deed being valid and binding, it settled all property rights between the parties, including the homestead rights of appellant.

In our view of the case, there was no community of property between petitioner and his wife after July 28, 1927, and petitioner should include the entire income from the sale of his oil interests after that date. Cf. Muriel Oakes Ames, 30 B.T.A. 516. Where the husband has filed a separate return his tax should be computed by including in' his gross income only his one half of the community income for the year, plus his separate income. Cf. E. H. Stanton, 21 B.T.A. 1380. The payment to his wife was a division of property in pursuance of the marriage settlement agreement and cannot be regarded as a distribution of income to her. As such it is not deductible from the income of the petitioner.

Petitioner claims deduction. for depletion on the deferred payments from the proceeds of oil provided for in the above quoted contract. The Bevenue Act of 1926, section 204 (c) (2) provides:

In the case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

Section 214 (a) (9) of the act provides:

In the ease of mines, oil and gas wells, other natural deposits, and timber a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under, rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee.

It is contended by the respondent that the transfer and assignment by petitioner and his associates of their oil and gas rights was an absolute sale and that they retained no interest in the property or its products. It is further argued that, having no interest in the property, it followed that petitioner was not entitled to depletion.

Petitioner, on the other hand, submits that, under the quoted section of the contract providing for deferred payments to be made exclusively from the proceeds of the sale of oil if, as, and when produced, he has an interest in the oil in place and it is immaterial whether the contract was a sale, lease, or an assignment. We think the petitioner’s position is correct and that he is entitled to the depletion. According to the terms of the contract petitioner’s interest in the deferred payments was to be paid and was paid from the proceeds of the oil. This gave him an interest in the oil.

In Palmer v. Bender, 287 U.S. 551, lessees of an oil lease sold, assigned, set over, transferred, and delivered to the Ohio Oil Co. the leased premises in consideration of a payment of a cash bonus, a future payment to be made “ out of one-half of the first oil produced and saved ” to the extent of $1,000,000, and an additional “ excess royalty ” of one eighth of all the oil produced and saved. There, as in the instant case, it was argued on behalf of the Government that there was an absolute sale of the lease and that the assignors retained no depletable interest, but the Supreme Court held otherwise. The Court said in part:

* * * The language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the oil in place, and secures, by any form of legal relationship, income derived from the extraction of the oil, to which he must look for a return of his capital.

The Court further said:

Similarly, the lessor’s right to a depletion allowance does not depend upon his retention of ownership or any other, particular form of legal interest in the mineral content of the land. It is enough if, by virtue of the leasing transaction, he has retained a right to share in the oil produced. If so he has an economic interest in the oil, in place, which is depleted by production. Thus, we have recently held that-the lessor is entitled to a depletion allowance on bonus and royalties, although by the local .law ownership of the minerals in place passed from the lessor upon the execution of the lease. See Burnet v. Harmel, supra; Bankers Pocahontas Coal Co. v. Burnet, ante, 308.
In the present case the two partnerships acquired, by the leases to them, complete legal control of the oil in place. Even though legal ownership of it, in a technical sense, remained in their lessor, they, as lessees, nevertheless acquired an economic interest in it which represented their capital investment and was subject to depletion under the statute. Lynch v. Alworth-Stephens Co., supra. When the two lessees transferred' their operating rights to the two oil companies, whether they became technical sublessors or not, they retained, by their stipulations for royalties, an economic interest in the oil, in place, identical with that of a lessor. Burnet v. Harmel, supra; Bankers Pocahontas Coal Co. v. Burnet, supra. Thus, throughout their changing relationships with respect to the properties, the oil in the ground was a reservoir of capital investment of the several parties, all of whom, the original lessors, the two partnerships, and their transferees, were entitled to share in the oil produced. Production and sale of the oil would result in its depletion and also in a return of capital investment to the parties according to their respective interests. The loss or destruction of the oil at any time from the date of the leases until complete extraction would have resulted in loss to the partnerships. Such an interest is, we think, included within the meaning and purpose of the statute permitting deduction in the case of oil and gas wells of a reasonable allowance for depletion according to the peculiar conditions in each case.

Under the principles enunciated in that case it is clear that petitioner retained a right to share in the oil when produced and is entitled to a deduction for depletion on the deferred payments which he received from the proceeds of oil.

Decision will be entered vmder Bule SO.


author: Aeundell :

text:
    Montana, Wyoming & Southern Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71486.
    Promulgated August 9, 1934.

      Henry J. Richardson, Esq., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Aeundell :

The taxes in controversy here relate to the year 1930 and amount to $1,820.10. An original deficiency of $4,367.52 for the year 1930 was determined by the respondent, of which sum the petitioner paid $2,547.42. In its petition the petitioner states that it reserves the right to claim and recover refund of this sum paid, but fails to make further issue respecting it, either at the hearing or in its brief. This part of the tax will, therefore, be disregarded in this report.

This case has been submitted upon a stipulation of facts filed by the parties at the hearing, and we set forth so many as are necessary to a disposition of the question for decision.

The petitioner is a railroad corporation, organized under the laws of the State of New Jersey in 1909, for the purpose of acquiring and operating railroad properties then owned and operated by the Yellowstone Park Railroad Co., a corporation. Its books and accounts are kept on the accrual basis.

At the time of its organization on September 1, 1909, petitioner acquired all of the property and assets of the Yellowstone Park Railroad Co., paying therefor $1,000,000 par value of its capital stock and $900,000 par value of first mortgage bonds, maturing 30 years after date of issuance. These bonds were part of an authorized issue of $5,000,000, the remainder of which, was never issued.

At the time of the purchase of the Yellowstone Park Railroad properties, the. petitioner set them up on its property account at a cost equivalent to the par value of the stock and bonds given in payment, and has, at all times since,'carried them at that figure, to wit, $1,900,000, in its books. The cost so entered has never been questioned by the respondent.

At the time the bonds were authorized in 1909 and a part thereof issued, an option was given by petitioner in connection with the issue of any additional bonds to an underwriter by which, in the event of an additional issue of the bonds covered by the mortgage, the company would receive $820 per $1,000 bond.

During the year 1930 the petitioner purchased $55,000 par value of its said bonds for the cash price of $39,832.50. These bonds were carried in petitioner’s books under the caption “ Investments in Securities Issued ”, and no adjustment was made on its books reducing the amount of the outstanding bonds due to this purchase, none of the bonds were canceled and none have been resold or otherwise disposed of.

Under these circumstances the respondent has held that the petitioner, in the purchase of its bonds in 1930, has realized taxable income equal to the difference between the price paid and their par or face value.

The principle applicable here is that of United States v. Kirby Lumber Co., 284 U.S. 1, and Helvering v. American Chicle Co., 291 U.S. 426, in both of which the taxpayers bought in bonds at less than face value. In the Kirby Lumber case the sale and purchase were for cash; in the American Q'hicle case the bonds were those of a predecessor and had been assumed by the taxpayer, which purchased them for cash. Here the bonds were issued for property and the purchase was for cash. The property acquired for the bonds was entered on the books at a cost equal to the face value of the bonds, and that cost has ever since been regarded as correct by both parties. Referring now to the transaction in 1930, at the beginning of the year petitioner had $55,000 in assets on its books against which were outstanding liabilities (bonds) of an equal amount. Upon the acquisition of the bonds its assets were reduced by $39,832, and its liabilities by $55,000. The net result of this, when assets are weighed against liabilities, was an increase in assets of $15,167.50. This, as we understand it, is the basis upon which the Kirby Lumber and American Chicle,cases are grounded; that is, that by reason of the transaction there were “ made available * * * assets previously offset by the obligation of bonds now extinct ” and this resulted in an accession to income.” Kirby Lumber Co., supra.

A difference suggested by petitioner between this case and the American Chicle Co. case is that here the bonds were not retired. The Board has held that this distinction is immaterial. Garland Coal & Mining Co., 28 B.T.A. 348; Virginia Iron, Coal & Coke Co., 29 B.T.A. 1087.

It is also suggested by petitioner that the stipulated facts establish an issued price for the bonds less than that determined by the respondent, relying presumably upon the option given for additional bonds in 1909. The option, however, related to additional bonds that were ■ authorized but were never issued, and this is insufficient to change the respondent’s determination as to the cost of those bonds that were issued. .

We find no fundamental distinction in the facts here from American Chicle Co. that would permit us to reach a contrary conclusion. Commissioner v. Coastwise Transportation Corp., 71 Fed. (2d) 104; Consolidated Gas Co. of Pittsburgh, 24 B.T.A. 901; Woodward Iron Co., 24 B.T.A. 1050; and Garland Coal & Mining Co.., supra.

Decision -will be entered, for the respondent.


author: Arundell:

text:
    Liberty Hosiery Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 66546.
    Promulgated August 9, 1934.

      Richard E. Thigpen, Esq., for the petitioner. •

      Harold Allen, Esq., for the respondent.
   OPINION i

Arundell:

On the facts as related the Commissioner charges fraud with intent to evade tax. He bases his charge primarily on the erroneous reduction of sales in the amount of $19,291.27, and also the improper treatment of machinery sales, whereby petitioner took an unauthorized deduction of $5,000. The Southern Commission Co. had a running account with petitioner and payments thereon were being made in due course, with a substantial payment of over $2,000 made on the last day of December 1929. Around the close of the year petitioner’s stockholders, among whom were its officers, met one evening in their office to discuss the petitioner’s general situation and the making of its income tax report. They invited to the conference an accountant, who testified, however, that he was a listener rather than an adviser at the meeting. The account of the Southern Commission Co. was discussed and the accountant was asked if it might be charged off as a bad debt. At the instance of Foster the accountant called up an internal revenue agent to inquire as to the proper method of charging off a bad debt. But neither the revenue agent nor the accountant were advised of the true condition of the Southern Commission Co.’s account, and their advice to petitioner was simply that, if a debt is ascertained to be worthless and is charged off, it constitutes a proper deduction from gross income. With this advice before them the officers of petitioner did not charge off the account as a bad debt, and in fact it is very clear from the evidence that the account was not bad, for not only were payments made thereon regularly as late as December 1929, but the account by the time the return was filed in March 1930 had been further reduced some $9,000. The same end was achieved by petitioner by resorting to the device of reducing the amount of its sales in an amount equal to the debit balance of the Southern Commission Co. account as it stood on the books on the last day of December 1929. Clearly there was no justification for such procedure. In view of the discussions had by the officers of the corporation with reference to this account, and in view of the advice sought not only of their own accountant but of a revenue agent, both of whom had advised that the account could only be charged off if in fact the debt was worthless, we cannot but regard what was done as a deliberate attempt to avoid the tax. The fact that Foster, the principal stockholder and manager, testified that he did not know that such action was taken is not a sufficient answer in the .light of what was done and the facts surrounding the entire transaction. It is also an important consideration that for the following year, when substantial sums were collected on this account, totaling over $15,000, only one payment of $1,050 was ever returned for- tax purposes, despite the advice of both the accountant and the revenue agent that subsequent collections should be reported as income.

The Walton Hosiery Mills transaction did not belong in a report of 1929 income at all. The petitioner was on the accrual basis and the evidence is that the sale of machinery was made in 1928. It appears that there was a $5,000 item on. petitioner’s books which should have been charged to notes payable when that sum was paid to petitioner’s bank and applied against its notes. Failure to make a proper entry at the time and the necessity of a later correcting entry might of course be attributed to faulty bookkeeping. But petitioner did not stop with that. It split the $5,000 into two amounts, one of $4,000 and one of $1,000, and charged both to accounts bearing misnomers. No commission of $4,000 was incurred or paid on the sale and there was no $1,000 tax in connection with it. No attempt was made to explain these improper entries, and the evidence convinces us that they were made and deductions taken with fraudulent intent to evade tax. The imposition of the fraud penalty is accordingly sustained.

What has been said above indicates our view on the claimed bad debt deduction. Payments were received in substantial amounts in December 1929, and more than $9,000 was received in 1930 prior to the filing of petitioner’s 1929 return. Petitioner’s only witness was its secretary-treasurer, Foster, and his testimony establishes that there was no ascertainment of worthlessness. The substance of his testimony is that he and other officers discussed the account after being advised that the debtor was going to discontinue business, and, quoting Foster, “ We did not know whether we would be able to collect it or not. * * * We did not think we would be able to collect it all, that is what we decided.” No facts are given to support even the doubt expressed by Foster, much less to affirmatively establish worthlessness. The bad debt deduction claimed is accordingly disallowed.

We have pointed out above that petitioner’s method of treating the sale of machinery to the Walton Hosiery Mills as a 1929 transaction was erroneous. The net result of the erroneous bookkeeping entries was to overstate commissions and taxes by $5,000 and notes payable by $5,148.05 for 1929. The respondent has restored the $5,148.05 to income for that year. Obviously $5,000 was an erroneous deduction from income and was properly restored to income. The $148.05 item is not so clear, but it appears from the revenue agent’s report in evidence that 1929 income was reduced by that amount and petitioner has Dot shown why it should not be restored to income. The respondent is sustained on this issue.

The amount of $430.85 which petitioner paid in settlement of royalty claims is an allowable deduction. The payment was not made to obtain the machines nor to secure title thereto, and respondent erred in treating it as a part of machinery cost.

The amount of $186.35 paid for hosiery and distributed to employees as a Christmas bonus is allowable as a deduction for additional compensation. It was originally claimed as part of a larger deduction for contributions and as such was disallowed by the respondent. The evidence satisfactorily establishes the amount of $186.35 paid for the purpose stated and that amount is allowable.

Reviewed by the Board.

Decision will be entered, wider Rule 50.


author: Goodeich:

text:
    Reginald Brooks, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68560.
    Promulgated August 10, 1934.

      Jacob Mertens, Jr., Esq., Marshal Stearns, Esq., and Charles B. Mclnnis, Esq., for the petitioner.

      George D. Brdbson, Esq., for the respondent.
   opinion.

Goodeich:

Petitioner, a resident of New York City, assails respondent’s determination of a deficiency of $2,433.80 in income tax for 1930, raising two issues — first, whether he is taxable on the income of an irrevocable trust established during the pendency of divorce proceedings and intended as a settlement of the property rights as between himself and his wife, arising from the marriage relationship ; and, second, whether he is entitled to receive, tax-free, a part, representing return of capital, of the income received by him in 1930 as a beneficiary of a testamentary trust.

The parties submitted an agreed statement of facts, which we adopt as our findings. It appears that on June 5, 1930, a decree of divorce was entered in one of the courts of the State of Florida in an action brought against petitioner by his then wife, Mary Elizabeth Brooks. No provision was made in the decree respecting the property rights of the complainant, but the day before, on June 4, 1930, the parties had agreed upon a trust indenture which was intended as a settlement of property rights arising from the relationship of marriage. The trustee named, which was the United States Trust Co. of New Tork, accepted the trust on June 11, 1930, and on that day petitioner transferred to it certain securities named in the indenture. The trustee was authorized in its unlimited discretion to manage, sell, invest, and reinvest the property, to collect the income, and to pay therefrom, in addition to the charges of management, $12,000 a year in quarterly installments, to Mary Elizabeth Brooks during her life, and to pay all income in excess of that amount to petitioner. It further provided that should Mary Eliza-béth Brooks die while petitioner still lived, the entire income was to be paid to him, and that upon his death, should he survive her, and upon her death subsequent to his the trust should terminate and the trustee should transfer the trust property to petitioner’s residuary estate, to be disposed of by his will. No power was reserved to petitioner to administer, modify, or revoke the trust. During 1930 the trustee collected income from the trust property in the amount of $7,871, which it divided, $6,866.67 to Mary Elizabeth Brooks, and $1,004.33 to petitioner. Respondent has included- in petitioner’s income for 1930 the entire sum so collected by the trustee. Petitioner contends the amount paid to his former wife should not be included in his income.

With' respect to the second issue the facts are that under the will of his grandmother, who died in 1890, petitioner was made beneficiary of a testamentary trust, receiving for life the income of the trust property, which, upon his death, was to go to his children or, in event of failure of issue, to his sisters or their children. This trust is still in existence. On March 1, 1913, when petitioner was 41 and had a life expectancy of 27 years, the trust corpus had a value of not less than $482,599.37, and the annuity value of the income was $288,045.79. From that date to and including December 31, 1930, petitioner received from the trust payments totaling $498,-091.20, of which $36,162.06 was paid him in 1930. Tn his return petitioner reported $33,932.22 of the payments so received (the difference of $2,229.84 consisting of certain nontaxable items), but now contends that a part of the trust -income (the petition claims $10,-668.36) represented a return of capital — that is, a recovery of the value of his annuity as of March 1, 1913. — and should not be included in! his income. •

As to. the first issue respondent maintains that because this trust was created as a means of settlement of the property rights of the parties arising from the marital relation and perhaps to provide . payments in lieu of alimony, the income from it was applied to the discharge of petitioner’s obligations and therefore must be treated as his income. He relies upon Gould v. Gould, 245 U.S. 151; Frank P. Welch, 12 B.T.A. 800; Mary R. Spencer, 20 B.T.A. 58, and calls attention to article 281 of his Begulations 74, : ruling that alimony or allowances paid under a separation agreement are not deductible from income of the taxpayer making the payments.

We disagree with his view. The cited portion-of the regulations we need not discuss, for- we are concerned here not with deductions from income, but with what constitutes income.. The fundamental inquiry is whether this petitioner made a valid transfer of certain of his property to an irrevocable trust and, if he did, whether the income thereafter arising from that property belonged to him.

That petitioner did make a valid and irrevocable disposition and divested himself of the property forming the corpus of the trust seems indisputable. The -trustee took over the title, possession, and control of the securities and continued to hold and deal with them in its discretion. Petitioner had- no power to change the investments or otherwise administer the trust, or to modify or revoke it. True, the property was to revert to his residuary estate upon the termination of the trust when both Brooks and his divorced wife should be dead, and was then to be disposed of by his will, but. by the indenture he had divested himself for the rest of his -life of all the incidents of ownership save the right to receive such revenues from the property as there might be in excess- of $12,000 a year, -and to receive the whole income in the event Mrs. Brooks predeceased him. Consequently, petitioner having transferred the property, it would seem to follow that the income thereafter arising therefrom, except- as to the excess over the stated amount, would not belong to him.

But respondent contends -that petitioner’s motive in establishing the trust was such that, despite his transfer of the property from which the income arose, that income is taxable to him., He points out that by creating this trust Brooks has arranged for his divorced wife to receive sums in discharge of- her claims arising from the marriage relation, which, without the trust, would have been paid to her as alimony or separation allowance; that Brooks has thus managed to exclude from his taxable income $12,000 a year which otherwise he would have received and which the law would not permit him to deduct, with the result that the tax on that amount has been avoided.

We are not prepared to say that the reasons and intentions motivating the creation of a trust are immaterial, even though the rule that ownership' of the income, and the .burden of thé tax thereon, follows ownership of the property from which it arises, has been adhered to and restated in so many decisions of this Board and the courts. But we do say that in the case at bar, being satisfied that a valid and irrevocable trust was established in good faith, and property transferred to it by petitioner,. we see no- adequate reason for holding otherwise than that the revenues from that property thereafter should not be included in his income. So far as the record before us shows, this trust indenture was not submitted to the court having jurisdiction of the divorce suit and was not taken into consideration in its decree. We do not know what valid claim Mary Elizabeth Brooks had against petitioner or his property; we do not know the circumstances underlying the divorce proceedings, nor whether the plaintiff therein was entitled to or would have been awarded alimony. Those considerations are here immaterial. It must be recognized that the proceeds of many transactions are taxable or nontaxable according to the method and means by which the transaction is consummated; that receipts which in one form may be taxable income are, in another, not subject to the levy; that funds which, if received, constitute taxable income and are not deductible therefrom though applied to a particular end, may still be so used without coming into income and' the purpose served, tax-free. Here petitioner chose a tax-saving means of making payments to Mrs. Brooks. Had he undertaken to pay alimony or separation allowance his payments would not be deductible from his income, but that he did-not do.' He created án irrevocable'trust, and transferred to it certain of his property, divésting himself of all ownership save the right to receive the income above a certain amount until the death of the trust beneficiary. Individually, he undertook no payments to Mrs. Brooks, and the fact is that the amounts she received were not payments of alimony or separation allowance, but earnings of the trust property. It is apparent that by this arrangement petitioner avoids tax on returns from property which otherwise would be included in his income. That result is neither morally nor legally wrong, provided he accomplished it by lawful means, and there is no suggestion here that he did not. We conclude that respondent erred in including in petitioner’s income the $6,866.67 paid to Mrs. Brooks by the trustee. As to the $1,004.33 received by petitioner, no dispute is raised concerning the propriety of respondent’s action in taxing it.

This result is in accord with our decision in S. A. Lynch, 23 B.T.A. 435. The opinion in that case distinguishes it from Frank P. Welch, supra, and Gould v. Gould, supra, and those comments are applicable here (cf. also Frank Turner, 28 B.T.A. 91; and John M. Longyear, Jr., 28 B.T.A. 1086, where, as in the Welch case, the securities were deposited as collateral to assure payments previously agreed to). Nor is the decision in Mary R. Spencer, supra, in point, for that case involved quite a different question, namely, the tax-ability of the beneficiary of a trust upon payments received thereunder in lieu of either alimony or dower rights. Here, we do not have before us the question of the taxability of the trust income so far as concerns the fiduciary or Mrs. Brooks and we do not decide upon whom that tax, if any, should fall. We point out, however, that this question is readily determinable under section 161, in conjunction with its exceptions in section 166 and 167, Revenue Act of 1928; see Margaret A. Holmes, 27 B.T.A. 660; Helvering v. Butterworth, 290 U.S. 365.

Petitioner’s second contention is that he should be permitted to receive tax-free, prorated over the period of his life expectancy from March 1,1913, the value as of that date of his right to receive income from the Higgins trust, and that the amount received from the trust in 1930, and included in his income, should be reduced accordingly. This same contention, made in connection with his demand for refund of taxes paid in prior years upon income received by him from this trust, was decided recently against him by the Court of Claims; see Brooks v. United States, 6 Fed. Supp. 844. With the decision in that case we are in accord, and see no necessity for here enlarging upon the discussion set forth in the opinion of the court.

Judgment will be entered under Rule 50.

       An assignment of income does not relieve.the assignor of the tax thereon, but if property or property rights are assigned the income subsequently arising therefrom is hot taxable to the assignor, for the reason that the property no longer belongs to him, and, therefore, the income from such property belongs, not to him, but to the new owner. William Ernest Seatree, 25 B.T.A. 396; affd. (App.D.C.), 72 Fed. (2d) 67. Leonard Marshall Wright, 26 B.T.A. 21; Emily Gale Lowery, 27 B.T.A. 137.

       See Stoddard v. Eaton, 22 Fed. (2d) 184 ; Anderson v. Wilson, 289 U.S. 20; Burnet v. Wells, 289 U.S. 670.

        Lucy A. Blumenthal, 30 B.T.A. 591.