author: Murdock :

text:
    Superior Engraving Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7949, 17814.
    Promulgated October 20, 1927.
    Personal service classification allowed.

      Paul E. Hutchinson, Esq., for the petitioner.

      J. Arthv/r Adamis, Esq., for the respondent.
    The Commissioner refused to allow the petitioner personal service classification and determined deficiencies in its income and profits taxes for the calendar years 1919, 1920, and 1921, in the respective amounts of $4,164.20, $3,978.73, and $1,967.32. The two appeals were consolidated for hearing and decision.
    FINDINGS OP PACT.
    The petitioner was incorporated in March, 1916, under the laws of the Commonwealth of Pennsylvania. During the years 1919 to 1921, inclusive, it conducted its business in a single room in the City of Pittsburgh.
    At the date of incorporation Harry E. Tracey, John H; Hartrauft, A. H. Girdwood and William S. Girdwood each paid in $500 and received 10 shares of stock. Later 15 additional shares were issued to each for services. They were the only stockholders and were all regularly engaged in the active conduct of the affairs of the corporation. In 1919, $4,500 was paid to each as salary. For 1920 and 1921, this was increased to $4,800. Each stockholder was an experienced man in his particular line of work.
    The petitioner by the use of drawings and photographs planned and created designs suitable for advertising articles or events, photographed the designs to obtain wet-plate negatives, by use of the negatives and supplementary hand processes etched the designs on metal, and finished the etched plates so that they could be used for printing advertisements.
    Each plate was made to order to conform to the special requirements of the customer. No plates were ever carried in stock. When finished, a plate consisted of a block of wood supporting a thin piece of metal on which there was an etched design. The cost of the wood and of the metal was small in comparison to the price charged for the finished plate. The time and skill required to make the plate were important factors in determining its price.
    Tracey met the customers and did or supervised all of the art work in connection with the planning and creation of the designs to meet their requirements. The designs were then turned over to Hartrauft who did or supervised all of the photographic work and made the wet-plate negatives of the designs reduced to the proper size for printing. W. S. Girdwood then etched or supervised the etching of metal plates from the negatives. 'A. H. Gird-wood finished and mounted or supervised the finishing and mounting of these plates which were then ready for use in printing. They were delivered to the customers and at the end of the month bills were sent out for the plates finished during that month.
    Each of these stockholders had one or more skilled assistants who were nonstockholders. Each assistant under the direct supervision of some one of the stockholders did the same sort of work as that done by that stockholder whom he assisted. There were eight such assistants. Other employees were a bookkeeper, a stenographer, and several messengers. The nonstockholding employees were not capable of carrying on the business.
    The petitioner’s income and allowable deductions for the years were as follows:

    The petitioner’s balance sheets were as follows:

      In the above balance sheets “ accounts receivable ” consisted chiefly of sales for the month preceding the date of the balance, “ machinery and tools ” consisted of two cameras, photographic equipment, hand engraving tools, routing machine, etching baths, printing frames, beveling machine, jig saw, drill, and the like; and “supplies” consisted of wooden blocks, sheets of zinc, copper, and other metals, acids, chemicals, photographic supplies, paper, brushes, ink and colors.
   OPINION.

Murdock :

A careful analysis of the balance sheets and yearly expenses made in connection with the other evidence in the case convinces us that capital was not a material income-producing factor with this corporation. All of its stockholders were regularly engaged in the active conduct of its affairs. Each was able to perform and each performed one of the necessary steps in the creation of a valuable and salable thing from an inexpensive raw material.

It is contended that when this finished product was sold the petitioner was trading as a principal and that therefore it can not receive personal service classification. We do not believe that the phrase “ trading as a principal,” used in section 200 of the Revenue Acts of 1918 and 1921, was ever intended as a bar to personal service classification where, as in this case, the customers of the petitioner in purchasing the finished product really purchased the skill, ability and service of the men who made it.

There remains for our consideration the only other question raised by the respondent, viz, Is the income of this corporation for the years in question to be ascribed primarily to the activities of the principal owners or stockholders? It employed eight skilled nonstock-holding workmen whose duties and whose abilities differed but little from the duties and abilities of the stockholders. The salaries of these men were steadily increasing in importance in the petitioner’s finances. However, the uncontradicted testimony is that the corporation, without these employees, had been able to function and produce an equal amount of income, whereas the corporation could not have functioned without the labor, skill and supervision of the stockholders. There was also testimony that a large part of the work of these assistants was to carry out details which required skill of a kind, but of a different kind and of a lesser degree than that of the supervising stockholders. Consequently we hold that the income of this corporation is to be ascribed primarily to the activities of the principal owners or stockholders, and that for each of the years 1919, 1920, and 1921, the petitioner was a personal service corporation within the meaning of section 200 of the Revenue Acts of 1918 and 1921. See Cocks-Clark Engraving Co. v. Commissioner, 8 B. T. A. 468.

Reviewed by the Board.

Judgment will be entered on notice of 15 days under Bule 50.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    John Wanamaker Philadelphia, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 12913.
    Promulgated October 20, 1927.
    The taxpayer filed a return for its fiscal year ended January 31, 1921, on June 10, 1921. After the enactment of the Revenue üct of 1921, on May 11, 1922, it filed a second return for the fiscal year ended January 31, 1921, which showed a larger tax due than was shown on the earlier return. Held, that the statute of limitations started to operate from the date of the filing of the second return and not from June 10, 1921, the date of the filing of the first return.

      A. W. Norman, G. P. A., for the petitioner.

      Thomas M. Wilkins, Esg., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the fiscal year ended January 81, 1921, in the amount of $56,245.43. The only error alleged in the petition is that the deficiency has been determined after the expiration of the limitation of time for the assessment for the taxable year ended January 31, 1921.
    FINDINGS OF FACT.
    Under date of June 10, 1921, John Wanamaker Philadelphia and affiliated corporations filed a corporation income and profits-tax return on Form' 1120 — United States Internal Revenue Service— with the collector of internal revenue, Philadelphia, Pa., covering the period February 1, 1920, to January 31, 1921, showing a total tax due in the amount of $42,668.69.
    On November 23, 1921, the Revenue Act of 1921 was passed.
    On May 11, 1922, John Wanamaker Philadelphia and affiliated corporations filed with the collector of internal revenue, Philadelphia, Pa., under the Revenue Act of 1921, its corporation income and profits-tax return, Form 1120, for the period begun February 1, 1920, and ended January 31, 1921, disclosing total tax in the amount of $42,685.36.

      A deficiency notice dated February 8, 1926, was addressed to the taxpayer by the Commissioner, determining a tax liability in the amount of $56,245.43 for the period February 1, 1920, to January 31, 1921. Under date of March 30, 1926, the petitioner filed its petition with this Board, raising only one issue, i. e., that the deficiency has been determined after the expiration of the limitation of time for the assessment of taxes for the taxable year ended January 31, 1921.
   OPINION.

Smith:

It is the contention of the petitioner that the statute of limitations with respect to the determination of a deficiency for the fiscal year ended January 31, 1921, began to run on June 10, 1921, the date when its return for that fiscal year was filed in accordance with the provisions of the Bevenue Act of 1918 and regulations issued thereunder by the Commissioner with the approval of the Secretary of the Treasury; that the applicable statute of limitations is the four-year period prescribed by section 250(d) of the Bevenue Act of 1921; that the deficiency letter was not mailed to the taxpayer until after the expiration of such four-year period, namely, February 8, 1926, and that consequently the assessment and collection by the Commissioner of any additional tax for the taxable year is barred.

Section 250(d) of the Bevenue Act of 1921 reads in part as follows:

The amount of income, excess-profits, or war-profits taxes due under any return made under this Act for the taxable year 1921 or succeeding taxable years shall be determined and assessed by the Commissioner within four years after the return was filed. * * * (Italics ours.)

It is the contention of the Commissioner that the return of the taxpayer, filed with the collector on June 10,1921, was not made under the Revenue Act of 1921, inasmuch as that Act did not become a law until November 23, 1921; that the above-quoted language of section 250(d) refers to a return required to be filed under the provisions of the Bevenue Act of 1921 and not under those of any prior act. In commenting on the identical language to which the Commissioner calls the Board’s attention, in Appeal of National Refining Co. of Ohio, 1 B. T. A. 236, this Board said, at page 241:

The phrase the return has a definite article and a singular subject; therefore, it can only mean one return, and that the return contemplated by the act under which it was filed.

The Commissioner also calls attention to the fact that this same reasoning was again followed by the Board in Appeal of Dallas Brass & Copper Co., 3 B. T. A. 856.

In Appeal of Mabel Elevator Co., 2 B. T. A. 517, the Board recognized the applicability to the statute of limitations of the principle that a fiscal year return prepared and filed under one act is not effective to start the running of the statute of limitations when a subsequent act nullifies the effectiveness of the return already filed and necessitates the filing of a return under and to comply with a subsequent act. In that case the taxpayer filed three returns for the fiscal year ended July 31, 1918, as follows: (1) on October 29, 1918, before the passage of the Revenue Act of 1918; (2) on April 21, 1919, after the passage of the Revenue Act of 1918; and (3) on August 12, 1921, which return was marked “amended.” As the Board had already held in Appeal of National Refining Oo. of Ohio, supra, that only one return could start the running of the statute of limitations, the question was which of these three returns was the one which operated to start the running of the statute of limitations. The Board said:

The deficiency letter from which this appeal was taken was mailed to the taxpayer more than five years after the return was filed on April 21, 1919, and the limitation of time within which taxes must be assessed had expired.

The Board cited in its opinion the National Refining Co. appeal as authority for holding that the return filed August 21, 1921, did not toll the period of limitations. The first return, that is the one filed on October 29, 1918, having been filed before the passage of the 1918 Act, could not be considered any more than the so-called return of this petitioner which was filed on June 10, 1921, five months before the passage of the 1921 Act.

The imposing provisions of the Eevenue Act of 1918, namely, sections 230 of Title II, and 301 of Title III, and the provisions of sections 227 and 241 of Title II, requiring the filing of a return under the Eevenue Act of 1918, were expressly repealed by section 1400 (a) of the Eevenue Act of 1921, as of January 1, 1921, five months before the taxpayer filed its return under the Eevenue Act of 1918. The Eevenue Act of 1921 clearly required all corporations having a fiscal year ending during the calendar year 1921 to file a return in accordance with the provisions of that Act. Treasury Decision 3305 inferentially relieved taxpayers who or which had filed returns for a fiscal year ended in 1921 .under the provisions of the Eevenue Act of 1918 from filing second returns under the provisions of the Eevenue Act of 1921, provided such second returns would not show any additional tax payable. Treasury Decision 3310 clearly required the filing of such return where an additional tax was payable and the petitioner, acting under the provisions of law and of the regulations promulgated thereunder, filed such second return on May 11, 1922. The deficiency notice sent by the Commissioner was clearly within the four-year period of limitations prescribed for the making of an additional assessment and therefore the assessment and collection of additional tax is not barred by the statute of limitations.

The motion of the petitioner for judgment of no deficiency is denied. It furthermore appearing that the only question in issue is the question of whether the statute of limitations operated to bar the assessment and collection of the tax, such question must be decided in favor of the respondent.

Reviewed by the Board.

Judgment will be entered on 15 days’ notice, under Rule 50.


author: GeebN :

text:
    Evens & Howard Fire Brick Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6797.
    Promulgated October 20, 1927.
    1. Expenses. — Petitioner paid one of its salesmen $5,000, who in turn paid the money over to certain contractors for their use in obtaining certain municipal contracts for which the petitioner hoped to furnish to the contractors the material necessary in performing such contracts. Held, that the evidence is insufficient to allow the deduction claimed.
    2. Income and Deductions — Overlapping Items. — Petitioner for a period of more than 30 years consistently carried on its books an account captioned “ Current Surplus.” To this account it debited and credited items of income and expense and bookkeeping errors which, in its opinion, pertained to years other than the current year. At the end of each year it transferred the balance of the account direct to its regular “ Surplus.” After the enactment of the income tax laws it reflected whatever balance existed in the “ Current Surplus ” account in its income-tax return. If a debit balance existed, it was claimed as a deduction. Likewise, if a credit balance existed, it was reported as income. During 1919 and 1920,
    311 items were either debited or credited to this account. Held, that where the petitioner relies upon that part of article 111 of Regulations 62 dealing with “ overlapping items ” and the respondent concedes that at least 111 items should be treated as outlined in that article, and neither party questions the validity of the article, the Board will apply the same principles contained therein to the remaining 200 items. Eleven of the 200 items were excluded and passed upon separately.
    3. Improvement Taxes — Interest.—Petitioner in 1920 paid $290.59 for city improvement taxes and $21.42 interest in connection therewith, or a total of $312.01. Held, that only the interest in the amount of $21.42 was deductible from gross-income in 1920.
    4. Jurisdiction. — Deficiencies here involved are for 1919 and 1920. Held, that where an additional tax determined by the Commissioner for 1917 had not been paid prior to 1919 or 1920, the Board in determining the correct invested capital for 1919 and 1920 had jurisdiction to determine whether the alleged liability for additional taxes for 1917 was justified under the facts and law applicable to that year.

      5. Expenses. — During 1915, 1916, and 1917, the petitioner engaged the services of certain efficiency engineers for the purpose of studying conditions at its plant with the hope of increasing production at a reduced cost of operations. Held/, that such expenditures were deductible as ordinary and necessary business expenses and should not he capitalized as contended for by the petitioner.

      La/wrence A. Baker, Esq., and R. L. P. Wallace, Esq., for the petitioner.

      Philip M. Glark, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the calendar years 1919 and 1920, for which the Commissioner has determined deficiencies in the sums of $312.86 and $3,846.69, respectively.
    Four errors are assigned: (1) Erroneous disallowance as a deduction from gross income in 1919 of $5,000 as representing alleged commissions incurred and paid during 1919; (2) erroneous disallowance as deductions from gross income in 1919 and 1920, respectively, of the debit balance as of December 31, 1919, and December 31, 1920, of a special account carried on the books under the caption “ Current Surplus”; (3) erroneous disallowance as a deduction from gross income in 1920 of $290.59 as representing an alleged liability incurred for taxes; and (4) erroneous exclusion from invested capital for both 1919 and 1920 of $19,403.57 as representing an amount of an abatement claim for 1917 Federal income and excess-profits taxes rejected by the Commissioner.
    FINDINGS OF FACT.
    The petitioner is a Missouri corporation with its principal offices at St. Louis. During the taxable years 1919 and 1920 and jirior thereto, it was engaged in the business of manufacturing and selling fire brick and other clay products, including such products as sewer piping known as the Ferguson Segment Block.
    On August 19, 1919, the petitioner drew a check for $5,000 payable to the order of its secretary-treasurer, George W. Jones. Jones cashed the check and turned the money over to J. Y. Conrad, who was one of the petitioner’s traveling salesmen. Conrad in turn paid the money over to certain contractors to be used by such contractors in securing certain municipal contracts for which the petitioner expected to furnish to the contractors the Ferguson Segment Blocks necessary to complete the city contracts. No part of the $5,000 was for Conrad’s personal use.
    The disbursement of the $5,000 was charged to an account carried in the private ledger under the caption “ Sales Promotion.” During 1919 there were 35 other charges to this same account totaling $5,934.26, ranging all the way from $5 to $807.32. The account was kept by the petitioner for the purpose of segregating from the general sales expense, items used by the petitioner for the promotion of sales.
    The petitioner has no vouchers to show how the money was disbursed by Conrad and as a matter of record has nothing further than the canceled check cashed by Jones and the book entry that this amount was spent in St. Cloud, Minn. The petitioner did not render to the Commissioner any return under section 256 of the Revenue Act of 1918 setting forth the names and addresses of the person or persons to whom the $5,000 was paid. The Commissioner allowed as a deduction from gross income the 35 items totaling $5,934.26, but refused to allow the $5,000 spent by Conrad on the ground that sufficient information had not been furnished as to'the names of the recipients and the services performed by them.
    The petitioner in keeping its books employed the accrual method of accounting and rendered its income-tax returns upon that basis. Among the accounts which the petitioner kept in its ledger was an account captioned “ Current Surplus,” to which account was debited and credited all items which, in the opinion of the petitioner, were applicable to prior years. It maintained this account for the purpose of keeping out of the current year operations all items which, in its opinion, pertained to prior years. At the end of every year it would transfer the balance of this account to the regular “ Surplus ” account, charging surplus if a debit balance existed and crediting surplus if a credit balance existed. This method of handling items, which in the opinion of the petitioner pertained to prior years, has been consistently used by the petitioner for approximately 30 years. During 1919, “ Current Surplus ” was debited with 87 different items totaling $15,891.07 and ranging in amounts from one cent to $3,219.18. During the same year, “ Current Surplus ” was credited with 92 different items totaling $19,764.03 and ranging in amount from one cent to $11,470.07. During 1920 “ Current Surplus ” was debited with 87 different items totaling $10,374.47 and ranging in amounts from one cent to $1,290.81. During the same year, “Current Surplus” was credited with 45 different items totaling $4,252.49 and ranging in amounts from one cent to $934.22.
    In 1919, the “ Current Surplus ” account had a credit balance of $3,872.97 and in 1920, it had a debit balance of $6,121.98.
    After the passage of the income-tax laws, the amount of the debit or credit, as the case might be, carried to the regular surplus account at the end of each year, was reflected in the income statement reported on the current income-tax return. If a debit balance existed, the amount of the debit balance was claimed by the petitioner as a deduction from' gross income. Likewise, if a credit balance existed, it reported such credit balance as income.

      Among the 87 items debited to “ Current Surplus ” during 1919 appear the following items:
    Key No. 10, March, DV 93_$1,133.05
    Key No. 26, June, PJ_ 2,178.01
    Key No. 39, October, DV 288_ 1, 593.36
    4,904.42
    The first item above, in the amount of $1,138.05, represents an amount paid to one Otto Rollin in March, 1918, for machinery. Instead of debiting the machinery account at the time of the purchase in 1918, the petitioner’s bookkeeper, through error, debited “Accounts Payable ” in the amount of $1,133.05. In December, 1918, the error had not yet been discovered except to the extent that machinery inventory was discovered to be undervalued in the amount of $1,133.05. Machinery inventory was therefore debited in December, 1918, with the amount of $1,133.05 and “ Profit and Loss ” credited with a like amount. In March, 1919, the error was discovered, and to correct the error the petitioner credited .“Accounts Payable ” with the amount of $1,133.05 and debited “ Current Surplus ” with the same amount.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the second item above, in the-amount of $2,178.01, is as follows:
    This entry was necessary to adjust an error in taking inventory of No. 3 Works coal at December 31, 1918. When the adjustment was made it was charged to profit and loss instead of to current surplus.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the third item above, in the amount of $1,593.36, is as follows:
    This amount writes off an old balance which had appeared as a debit on the general time check account for some years. Upon investigation of the account, it was found that time checks had been given out to the men by the timekeeper without proper care having been exercised to see that credit appeared for them as deductions from payrolls. This state of affairs which was the result of the careless method of handling time checks, can be easily explained by the fact that when the factory men were paid twice a month many were hired and fired or quit between paydays, time checks being given them for the time worked. These time checks were not included as deductions from pay rolls, the names not being sent to the general office on cards. At the beginning of 1919 a new method was instituted, the old account being rendered inactive, and a new account for each factory created. These new accounts are kept in balance from an analysis kept by a clerk and they are audited monthly.
    Among the 92 items credited to “ Current Surplus ” during 1919 appear the following items:
    Key No. 63, March, DV 12_$1,034.19
    Key No. 66, March, DV 15- 1,282.24
    Key No. 91, November, JV 5621_ 1, 000.00

      Key No. 92, November, DV 353_$1,031.14
    Key No. 93, November, PJ___ 290. 59
    Key No. 94, December, PJ_ 11,470.07
    16,108.23
    The explanation contained in petitioner’s Exhibit No. 2 respecting the first item above, in the amount of $1,034.19, is as follows:
    Our ledger showed that we owed the St. Louis Merchants Bridge Terminal $785.98 more than was actually the case and the Commercial Electric Company $248.21 more than was actually the case. As these items were of the years 1917 and 1918 this voucher was made crediting current surplus and debiting accounts payable.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the second item above, in the amount of $1,282.24, is as follows:
    $1,280.74 of this amount was credited to the Missouri Pacific Railroad twice in error in the year 1918 and when the account was adjusted in 1919 the item was credited to current surplus, with the corresponding charge to the railroad company. The balance of $1.50 is similar in explanation to the above.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the third item above, in the amount of $1,000, is as follows:
    Sales promotion or commission had been twice credited on our records to a customer when the agreement was for once only. As this was not discovered until the close of the year 1919 the credit on our records had to be to current surplus with the charge to the customer.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the fourth item, in the amount of $1,031.14, is as follows:
    Unclaimed wages of workmen at plants carried on our books for a few years and written off.
    The explanation contained in petitioner’s Exhibit No. 2 respecting the fifth item, in the amount of $290.59, is as follows:
    A liability on our records stood in the name “ special tax bill account.” Checking of this account developed that the liability no longer existed, so the account was closed with a credit to current surplus.
    The sixth item above, in the amount of $11,470.07, represents the writing off of a reserve for income taxes previously set up on the books.
    Among the 87 items debited to “Current Surplus” during 1920 appear the following items:
    Key No. 117, April, JV 211_$1,290. 81
    Key No. 138, July, JV 475_ 1, 059.03
    2, 349.84
    The explanation contained in petitioner’s Exhibit No. 2 respecting the first item above, in the amount of $1,290.81, is as follows:
    This was written off from our records. It was an amount covering uncol-lectible railway claims filed December 22, 1906.

      The explanation contained in petitioner’s Exhibit No. 2 respecting the second item above, in the amount of $1,059.03, is as follows:
    This entry cancels from our records railroad claims which were found to be worthless. These claims are listed in detail in the journal. They all apply to years prior to 1920.
    The petitioner’s gross sales in 1919 and 1920 were $1,205,406.68 and $2,095,744.22, respectively.
    The petitioner carried in its ledger a “ Special Tax Bill Account.” This account was credited with liabilities for city improvement taxes. As the liabilities were paid, the account was debited. At the close of 1919 this account had a credit balance of $290.59, but at that time the petitioner was unable to find any record of liability for that amount. On December 31, 1919, it closed out the account by means of the following journal entry.

      Dr. Or.

    Special Tax Bill Account_$290. 59
    Current Surplus-$290.59
    Our records show all Special Tax bills Paid. This Liability no longer exists.
    In 1920, however, it received a statement for $290.59 plus interest-in the amount of $21.42 or a total of $312.01. It claimed the latter amount as a deduction from gross income in 1920. The Commissioner disallowed the full amount.
    During the years 1915, 1916, and the early part of 1917, the petitioner paid the following amounts to certain efficiency engineers for the installation in its plant of what is known as the Emerson Efficiency System:
    Year: Amount
    1915. $12,750. 00
    1916. 15, 707.15
    1917. 1, 502. 21
    Total- 29,959.36
    The purpose of this system was to increase the earning capacity of the petitioner. It involved the sending of efficiency engineers to the petitioner’s plant where they made a survey of conditions and spent time in studying the workmen. With the information gained from this process the “ time study men ” of the Emerson System endeavored to improve conditions and thus increase earnings of the petitioner.
    There were no tangible additions to the petitioner’s plant as a result of this system. The employees of the petitioner down as far as the foreman received instructions from the agents of the Emerson Efficiency System. It was very much the same as though the petitioner had conducted a school for its higher-grade workmen.
    During 1917, a great number of the petitioner’s employees, who had received this instruction, resigned and enlisted in the armed forces of the United States. It was not possible for tbe petitioner to secure other employees who would fit into the Emerson System, whereupon it became necessary to abandon it altogether, which it did during 1917.
    After careful discussions in 1915, the officers of the petitioner determined that the amounts expended on the Emerson Efficiency System should be capitalized and charged off over a period of five years. During 1915 and 1916, it charged off 20 per cent of the balance in the account at the end of each year, or amounts of $2,550 and $5,181.45, respectively. During 1917, it charged off the balance remaining in the amount of $20,725.70 plus the addition of $1,502.21 made during the early months of 1917. It claimed the total amount charged off in 1917 of $22,227.91 as a deduction from gross income in that year. The Commissioner allowed $1,502.21 of the deduction claimed in 1917 but disallowed the balance on the ground that in his opinion the expenditures were deductible as an ordinary and necessary expense in the year in which incurred and accordingly allowed the full amounts of $12,750 and $15,707.15 as deductions in 1915 and 1916, respectively. On that basis, the Commissioner determined an income and excess-profits-tax liability against the petitioner for 1917 of $71,283.26 which he has excluded from the petitioner’s invested capital for the years 1919 and 1920.
   Opinion.

GeebN :

The issues are set forth above and will be discussed in the order given.

The first issue involved is whether the Commissioner erred in refusing to allow as a deduction from gross income in 1919 an item of $5,000 paid by the petitioner to one of its salesmen, who in turn paid the money over to certain contractors for their use in enabling themselves to obtain certain municipal contracts, for which the petitioner hoped to furnish to the contractors the material necessary to perform the contracts obtained by them with the use of the petitioner’s money. We do not have sufficient evidence upon which to base a determination that this is an ordinary and necessary expense of the taxable year. This issue is very similar to the issue involved in the Appeal of National Concrete Co., 3 B. T. A. 777, wherein we said in part:

By not furnishing sufficient evidence of the alleged expenditures, the taxpayer has failed in its proof of ordinary and necessary business expense; also, as is pointed out, the Commissioner is unable to check up or compute the income of the unknown persons alleged to have received this money, as the taxpayer has failed to comply with section 256 of the Revenue Act of 1918 * * *.

We, therefore, sustain the Commissioner’s determination on the first issue.

Respecting the second issue, the petitioner carried on its books an account under the caption of “ Current Surplus.” It debited and credited to this account all items which, in its opinion, were applicable to years other than the current year. This account was established approximately 30 year's prior to the years here involved. It had been the consistent practice of the petitioner to close out this account at the end of each year direct to surplus but after the enactment of the income-tax laws, the petitioner adopted the practice of reflecting the net balance of the Current Surplus ” account in the net income for the current taxable year. If a debit balance existed in the account at the close of the year, it was claimed as a deduction from gross income and likewise, if a credit balance existed, it was reported as a part of the gross income. After eliminating a credit item to this account in 1919 of $11,470.07, representing a restoration to surplus of a reserve for Federal income taxes of prior years and therefore clearly not an item of income in any year, the remaining debit balance to the “ Current Surplus ” account in 1919 is $7,597.10. In 1920 a debit balance existed in the account of $6,121.98. It is the petitioner’s contention that these debit balances of $7,597.10 and $6,121.98 should be allowed as deductions from gross income in 1919 and 1920, respectively, in accordance with that part of article 112 of Regulations 69 and 65 (and article 111 of Regulations 62) reading as follows

It is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income, they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts.

There was no such provision in any of the regulations prior to Regulations 62.

The record is not clear as to the action taken by the Commissioner on this point. Both parties in their briefs make statements to the effect that because the Commissioner was of the opinion that most of these debit and credit items in 1919 and 1920 were adjustments pertaining to 1918 and 1919, respectively, the Commissioner in determining the deficiencies here in question allowed the debit balance of 1920 of $6,121.98 as a deduction for the year 1919, and allowed the debit balance which existed in 1921 of $2,741.66 as a deduction for the year 1920. The deficiency letter attached to the petition, however, contains the following statement:

EXPLANATION OF ITEMS UNCHANGED
The information furnished regarding the following items has been given careful consideration but has not been considered sufficient to allow them as deductions in arriving at the taxable net income.
Adjustments to current surplus account, net decrease-$6,121.98
***** * *
Adjustment to Surplus account-$2, 741.66

But regardless of the action taken by the Commissioner in his deficiency letter, he now concedes in his brief that 111 of the 311 items in question were the kind of items contemplated by article 112, swpra. Neither party questions the validity of the article itself. Under such circumstances the Board will do no more than examine the remaining 200 items still in dispute between the parties with a view of ascertaining which, if any, of such items were of the kind contemplated by the respondent’s regulations. The question thus narrows itself to a determination of which items, if any, of the remaining 200 would not “ materially distort the income ” if permitted to be included as deductions or income “ in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts.” In determining this question we have given consideration to the nature, size, and quantity of the items together with the kind and magnitude of the petitioner’s business. We have set out in our findings of fact 3 debit items to “ Current Surplus ” during 1919 in the amount of $4,904.42, 6 credit items to “ Current Surplus ” during 1919 in the amount of $16,108.23, and 2 debit items to “ Current Surplus ” during 1920 in the amount of $2,349.84 which in our opinion are not the kind of items contemplated by article 112, sufra. These 11 items should in our opinion be excluded from the “ Current Surplus” account and treated as separate and distinct issues by themselves. A tabulation of our findings in connection with the “ Current Surplus ” account is as follows:

It now remains to be considered whether any of the 11 items excluded from the “Current Surplus” account should either be allowed as deductions or included in income for either the year 1919 or 1920. The first item of $1,133.05, key No. 10, is clearly not an allowable deduction in either 1919 or 1920. The record with respect to items bearing key numbers 26, 39, 63, 66, 91, 92, 117, and 138, does not contain sufficient evidence to enable the Board to pass upon them other than that in our opinion they are not the kind of items contemplated by article 112, supra. Item bearing key No. 93, in the amount of $290.59, is not income. It was a liability existing on the petitioner’s books at the close of 1919 which the petitioner paid in 1920. The last item, in the amount of $11,470.07, key No. 94, is clearly not income in any year. It was merely the restoration to the regular surplus account of a reserve previously set up for income taxes which does not constitute the realization of taxable income.

For the taxable year 1919, the amount of $3,655.80 should be included in gross income and the amount of $10,986.65 should be allowed as deductions. Likewise, for the taxable year 1920, the amount of $4,252.49 should be included in gross income and $8,024.63 allowed as deductions.

In connection with the third issue, the petitioner is entitled to a deduction in 1920 of interest incurred in the amount of $21.42. The street improvement tax of $290.59 is not deductible. Appeal of Caldwell Milling Co., 3 B. T. A. 1232.

The question presented in the fourth issue is whether the expenditures made in connection with the Emerson Efficiency System were capital expenditures or ordinary and necessary expenses. Before answering this question, it is necessary first to dispose of a jurisdictional question. As a step in determining the correct invested capital for the years involved in this proceeding, namely, 1919 and 1920, has the Board jurisdiction to determine the correct tax liability for the year 1917 ?

Section 274(g) of the Revenue Act of 1926 reads as follows:

The Board in redetermining a deficiency in respect of any taxable year shall consider such facts with relation to the taxes for other taxable years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been overpaid or underpaid.

The petitioner contends that the amounts expended for the Emerson Efficiency System were capital expenditures, having a useful life of five years; that by reason of the abandonment of the system in 1917 the Commissioner should have allowed as a deduction in that year the amount of $22,227.91 instead of only $1,502.21; that by reason of that error, the tax liability for 1917 should have been $19,403.57 less, or $51,879.69 instead of $71,283.26; and that this difference of $19,403.57 should be included in invested capital for 1919 and 1920.

In Appeal of Hamilton Manufacturing Co., 3 B. T. A. 1045, the redetermination of a deficiency for 1919 was involved. The petitioner there contended that it had overpaid its taxes for the years 2912, 1913, 1917, and 1918, and that the Board should determine the correct taxes for those years in order to arrive at the correct invested capital for 1919. The Board in denying the petitioner’s contention in that case said:

The Board finds no merit in the taxpayer’s contention that the amount of claims for refunds of Federal taxes pending unadjusted before the Commissioner should be included in its invested capital for the taxable year. It may be that eventually such refunds will be paid, and if so it may then become necessary to readjust invested capital and tax liability for the years affected by such payments. Determinations of tax liability by the Commissioner are prima facie evidence that the amounts so determined are due, and until reversed by him or by competent tribunals must be accepted as final ascertainments as to the matters involved. To adopt the rule suggested by the taxpayer would establish an endless-chain system of readjustments of tax liability equally unsatisfactory to the Government and to taxpayers.

In the instant case, however, the petitioner did not pay the $19,403.57 additional tax for 1917 until some time after April 16, 1923, the date its abatement claim for that amount was rejected by the Commissioner. Under such circumstances, we think that under section 274(g), supra, the Board had jurisdiction to determine, for the purpose of arriving at the correct invested capital for 1919 and 1920, the question whether a liability existed for additional 1917 taxes in the amount of $19,403.57.

On the merits of the question as to whether the efficiency system expenditures were of a capital nature or merely ordinary and necessary business expenses, we decide in favor of the respondent. The expenditures are analogous to several classes of business expenses which the statute allows as deductions from gross income. The engaging of the engineers may be likened to the employment of a more efficient management or to the installation or revision of an accounting system or to the conducting of a school for the training of employees. The compensation paid the engineers under any of such circumstances would be deductible as an ordinary and necessary business expense. See Appeal of Schlosser Bros., Inc., 2 B. T. A. 137. We conclude that the liability for the tax existed, that the amount thereof should have been accrued, and that the Commissioner’s action with reference thereto was correct.

The deficiencies should be recomputed in accordance with the foregoing opinion.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.

Smith dissents on the second point.


author: Teammell :

text:
    State Bank of Alcester, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5913.
    Promulgated October 20, 1927.
    . On the evidence, held, that notes were ascertained to be worthless and charged off within the year.

      Ralph H. Case, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes of $2,660.88 for the year 1920. The deficiency results from the disallowance by the respondent of a deduction of $6,781.19 taken by the petitioner as a loss sustained on notes determined to be worthless in 1920.
    FINDINGS OF FACT.
    The petitioner is a South Dakota corporation with its principal office at Alcester. In 1919 G. N. Slocum contracted to purchase 240 acres of land in Lincoln County, S. Dak., at a price of $63,846.45. At the time of making the contract he made a payment of $1,000.45 and on March 1, 1920, he made an additional payment of $10,046 and assumed mortgages for the balance of the purchase price. The petitioner loaned Slocum $10,000 of the amount paid on the land and in connection therewith received from him his note for $4,000, dated May 27, 1920, and due January 1, 1921.
    In addition to his equity in the 240 acres of land referred to above, Slocum owned an equity in 40 acres of land located in the Rio Grande Valley of Texas. During the summer of 1920 Slocum’s equity in that land was destroyed as the result of a flood.
    About April, 1920, land in the region surrounding Alcester and in which Slocum’s 240 acres was located began to decline in value due to deflation. By the end of 1920 the value of Slocum’s land had declined to about $40,000, which was less than the indebtedness represented by mortgages against the property. Both Slocum and the petitioner tried to sell the land, but neither could get any offers for it. Slocum had no other property than that mentioned above. He was employed by a farmers’ cooperative association at a salary of $100 per month. At various times Slocum indicated a willingness to pay if he could get the money. Suit was not brought on the note, nor was it ever contemplated.
    On December 24, 1920, Mrs. Annie Ofstad, a widow, gave the petitioner her unsecured note for $1,635.09 due on demand. This note represented a renewal of five other' small notes of Mrs. Ofstad held by the petitioner which grew out of transactions in 1919. In March, 1920, the petitioner acquired Mrs. Ofstad’s secured note for $6,013. This note was secured by her small equity in 80 acres of land in Northern Minnesota and all her personal property which consisted of farm chattels. Some time in the early part of 1920 the president and cashier of petitioner bank checked Mrs. Ofstad’s personal property and her equity in the land and ascertained that its value was decreasing and at that time was less than the amount of the note for which it was given as security. Since 1920, the farm chattels have been sold for $8,600 but the land was found not to have any value in excess of indebtedness against it. During the years 1919 and 1920, in which she was engaged in farming, Mrs. Ofstad was unable to make money.
    At the close of 1920, the petitioner held an unsecured note of Mathias Anderson for $350 dated July 24, 1920, due October 1, 1920, and which represented a renewal of two notes given by Anderson on April 13 and 15, 1920. Anderson had 80 acres of land which was heavily encumbered and which he subsequently lost under foreclosure proceedings. At the time the loans were made, the officials of petitioner bank were of the opinion that Anderson had certain hogs which he would be able to sell in midsummer, but it later developed that the hogs were the property of his son. Anderson had no property out of which petitioner could make collection.
    On May 26, 1920, the petitioner made a loan of $40 to Peter Walters, accepting his unsecured note. Walters was an old man, married, working as a farm laborer and had no property out of which to make collection. About 1924 or 1925 the bank turned over some of its “ poor paper ” to one Robinson who brought suit on the Walters note and obtained judgment, but never collected the note.
    At the end of 1920, the petitioner held three unsecured notes given by Frank Knight. One for $100 was dated June 11, 1920, and due December 11, 1920; another for $25 dated October 19, 1920, and due in that year. The other note was for $280.29 dated October 23, 1920, and due on demand. Some of these notes constituted renewal notes given in connection with former transactions. In October, 1920, the petitioner attempted to obtain from Knight security for the notes. He refused, but promised to make payment in the early part of December out of money he expected to receive from the sale of his corn. In December he sold his corn but refused to meet his obligations, not only to the petitioner but to all other of his creditors. Suit was not brought on the notes since the officers of petitioner believed Knight had a large number of other creditors and that he was likely to go into bankruptcy. An additional reason for not bringing suit was that Knight had already disposed of most of his property.

      On October 21, 1920, the petitioner made a loan of $350 to Carl Famestad on his unsecured note due December 1, 1920. Before the end of the year it was ascertained that all of Famestad’s property was mortgaged to two other banks for a total amount which was twice its value. The banks subsequently took large losses on the property. Suit was not brought on the note as such means of collection was “cancelled by bankruptcy.” However, about two years later, in connection with another loan, the bank obtained from Famestad a renewal of the note.
    At the end of 1920 no suit had been brought on any of the notes. However, demand for payment had been made on all those past due. With the exception of the Knight and Famestad notes, none of the notes were ever collected, adjusted or realized upon.
    The minutes of the meeting of the board of directors of the petitioner bank of January 11,1921, contain the following:
    All notes carried in the bank, including #10,085 to #10,809, inclusive, were examined and approved, by unanimous vote.
    Included in the notes carried in the bank on January 11, 1921, were those previously described herein.
    The action of the directors in passing the foregoing resolution was intended to be a formal compliance with the requirements of the State Banking Department that the directors give their approval to all the assets owned by the bank. It was not intended as an expression of their opinion that all the notes held by the bank were good, but was a formal confirmation of the action of the officers. The president of the bank had authority to ascertain the worthlessness of and charge off as a matter of bookkeeping such notes as he found were worthless in 1920. The following is a copy of the entries in petitioner’s Day Book relative to the notes here involved:
    MARCH 7, 1921.
    Notes Charged Off as December 31, 1920

      In an audit of the petitioner’s income tax return for 1920 the respondent disallowed a deduction of $6,781.19 taken by the petitioner as representing a loss on the following notes:

    At the end of 1920, the petitioner properly ascertained the above notes to be worthless and charged them off.
   OPINION.

Teammell :

The petitioner contends that it is entitled to the deduction of $6,781.19 taken since it sustained during 1920 a loss of that amount on the notes. The respondent contends that the deduction is not allowable either as a loss sustained during the year or as debts ascertained to be worthless and charged off during the year.

While Slocum’s note for $4,000 was not due until January 1, 1921, yet we find that at the end of 1920 it was ascertained that his liability on the 240 acres of land which constituted his only asset and for which there were no buyers, was greatly in excess of its value. His only income was his salary of $100 per month from a farmers cooperative association.

On December 24, 1920, the petitioner accepted Mrs. Ofstad’s unsecured note for $1,635.90 as a renewal of five other small notes given in connection with transactions that had occurred in 1919. The testimony shows that Mrs. Ofstad’s property in 1920 was insufficient to pay her secured note for $6,013 held by the petitioner, and that her success as a farmer was not such as to afford any hope for collection of the secured note, much less the one that was unsecured, which is the note involved here.

The evidence in the case consisted chiefly of the testimony of the president of the petitioner bank who was familiar with the financial condition of the persons who gave the notes. His testimony regarding the worthlessness of the notes in 1920 was supported by the president of another bank located in Alcester, who was also well acquainted with the financial condition of the parties. After carefully considering all the evidence in the case, we are of the opinion that the notes were ascertained to be worthless in 1920.

While it appears that the petitioner did not make the bookkeeping entries charging off the accounts until after the end of the year it did so as of December 31, 1920, before the books were closed. The petitioner treated the matter as a part of the year’s transactions and determined its profits for the year on the basis of the elimination of the accounts. In our opinion the petitioner is entitled to the deductions claimed on account of the said debts.

Reviewed by the Board.

Judgment will be entered after IB days’ notice, under Rule 50.


author: Tettssell :

text:
    Seminole Hills Land Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5723.
    Promulgated October 20, 1927.
    Invested Capital. — Petitioner acquired for its stock certain land which had been sold approximately two months prior thereto for $100,000. Held, that for purposes of invested capital the value of the land was $100,000 and that the evidence does not establish a greater value.

      Don F. Reed, Esq., for the petitioner.

      D. H. Green, Esq., for the respondent.
    This action has been brought for a redetermination of deficiencies asserted by the respondent in the amounts and for the calendar years as follows:
    1919_$4, 324.45
    1920_ 2,175.10
    1921_ 739.37
    Total_ 7,238.92
    The petitioner alleges that the respondent erred in refusing to allow as the cost or value of property on May 29, 1916, the sum of $124,000 for purposes of invested capital in computing taxes for each of the years in controversy.
    FINDINGS OP PACT.
    The Seminole Hills Land Co. was organized on May 29, 1916, under the laws of the State of Michigan, for the purpose of buying and developing as building lots a certain tract of land acquired as hereinafter set forth. Since incorporation the petitioner has been engaged in the real estate business in Pontiac, Mich.
    Some time near April 1, 1916, Frederick C. Shipman and F. Floyd Kent, for $500 in cash, secured an option for the purchase of 185 acres of farm land located in the southwestern part of the City of Pontiac, from Etta E. Roberts, for the sum of $100,000, payable as follows: $20,000 on or about June 1, 1916, upon the execution of a land contract to be dated the time of execution; subsequently, $15,000 to be paid 6 months from date of contract; $15,000, 12 months from date of contract; thereafter, $5,000 annually with the privilege of paying the whole amount at any interest date; interest to be paid at the rate of 6 per cent per annum, payable semiannually and the above-mentioned $500 to apply upon the purchase price as part of the first payment.
    At the time the said option was secured, both the prospective vendor and the vendees knew that a paved road was being constructed between Birmingham and Pontiac which gave promise to a rapid growth in Pontiac, and also that the purpose of the vendees was to develop and subdivide the property into building lots.
    Shipman and Kent, not being able to handle the property without financial assistance, associated with themselves Henry Wineman, Jr., and Fred C. Harvey. The said four parties paid the balance of the $20,000, the amount of the first payment required by the option, and agreed to form a corporation for the development of the property. This agreement is not in evidence. The petitioner was then organized with an authorized capital stock of $100,000. Shares in the amount of $56,000 were issued on July 7, 1916, as follows: 175 shares to Henry Wineman, Jr.; 175 shares to Frederick C. Shipman; 175 shares to F. Floyd Kent; and 35 shares to Fred C. Harvey. Of the $56,000 capital stock issued, .$32,000 was paid for in cash, including the $20,000 paid on the 135 acres of land, and $24,000 which was distributed among the four stockholders was issued for the alleged appreciation in the value, of the said land, between the dates-of the securing of the option and the acquisition of the property by the corporation. The paved road had not been completed at that time.
    A contract dated June 26, 1916, was entered into between Etta E. Roberts and the Seminole Hills Land Co. for the purchase of the 135 acres of land upon the terms set forth in the option, the receipt theretofore of the $20,000 first payment being acknowledged by the vendbr.
   OPINION.

Tettssell :

The only question presented for redetermination in this proceeding, is the cost or value of the 135 acres of land on the date of acquisition by the petitioner.

For the purpose of proving that the land involved had a value in May, 1916, of at least $124,000, two witnesses, each of whom was at the date of the hearing on this proceeding a vice president of a Pontiac bank, testified that in their opinion the land in question was worth $1,000 per acre in May, 1916. However, those two witnesses gave no facts upon which their opinions were based. Such opinion evidence is not entitled to much, if any, weight, for the Board must have before it sufficient facts to enable it to arrive at its own independent conclusions.

The record shows that approximately 60 days prior to the time when petitioner acquired this property, two of the promoters of the petitioner corporation had contracted to purchase the same property for $100,000. In the case of Ruppert v. McArdle, 42 App. D. C. 392, the court said:

Had there been no sale, the appraisements would have been a proper basis for judicial computation. But in the last instance, there was a judicial sale, which, we think, should be taken as conclusive evidence of the value of the property. An appraisement is merely prima facie evidence of the value of the property, and may be accepted in the absence of the better evidence of its market value. But a fair sale is the best evidence of the market value of the property sold.

The sale of the land in question for $100,000 near April 1, 1916, established the value of the land on that date and the period of time elapsing between said sale and the date on which the same land was transferred to the petitioner for its capital stock, was too short a time to permit a natural increase in value and from the evidence we are not warranted in finding that the land had a value greater than $100,000 on May 29, 1916.

The deficiencies against this petitioner are in the amounts of $4,324-46 f°r the year 1919; $2,176.10 for the year 1920, and $739.37 for the year 1921. Judgment will he so entered in due course.

Considered by Littleton, Smith, and Love.


text:
    Frederick A. Stearns, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frank F. Spaulding, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Charles Stearns, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rachael L. Stearns, Petitioner, v. Commissioner of Internal Revenue, Respondent. George W. Haven, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. Charles Thomas, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8373, 8454, 8497, 8517, 8521, 8522.
    Promulgated October 21, 1927.
    An inventory taken upon the basis of cost or market, whichever is lower, may not later be revised to accord with the market price established subsequent to the inventory date.

      Henry Herrick Bond!, Esq., for the petitioners.

      Henry Bavenel, Esq., for the respondent.
    The above-entitled appeals were consolidated for the purpose of the hearing and decision. The appeals are from deficiencies in income tax for the year 1919 as follows:
    Frederick A. Stearns-$365. 68
    Frank F. Spaulding- 58.17
    Estate of Charles Stearns- 408. 43
    Rachael L. Stearns- 317. 34
    George W. Haven- 56. 28
    J. Charles Thomas- 206. 01
    The petitioners were the holders of partnership interests in 1919 in the partnership of Blake & Stearns. The sole question presented by these proceedings is the proper inventory figure for the close of the fiscal year of the partnership, November 80, 1919.
    FINDINGS OF FACT.
    Petitioners held partnership interests in 1919 in the partnership of Blake & Stearns, which was engaged in the buying outright of manufacturers woolens and selling them in cuts of all lengths from 2 or 3 yards up to 300 yards or more. Its place of business was Boston, Mass. It took its inventory at November 30, 1919, upon the basis of cost or market, whichever was lower. The market for woolens had been good during the fiscal year ended November 30, 1919, and prices were exceedingly high on November 30, 1919. Since the market was generally above cost on November 30,1919, the inventory reflected cost figures except in some few instances where certain lots of goods were priced at slightly less than cost. The inventory was taken by members and employees of the firm after consultation and after endeavoring to ascertain what the market was.
    The business of the partnership was to a large extent seasonal; few goods were sold in November and December of each year. The inventory was taken during this dull period. Only small amounts of goods were sold during the two or three months following the close of the fiscal year and there was a sharp break in prices in the spring of 1920.
    When the petitioners consulted an attorney with respect to certain income-tax liabilities involving the year 1919, the attorney suggested that in the light of the fact that the market was stagnant at November 30,1919, the inventory was possibly overstated and that it should be revised. The partnership then addressed letters to manufacturers, from whom it purchased goods, as to the prices of goods on November 30, 1919, and based upon such replies the partnership revised its inventory at November 30,1919. The amount reported on the return was $146,546.17. The partnership determined, upon the information which it had received in 1923, that the correct amount of the inventory as of November 30, 1919, was $90,443.36. The Commissioner has refused to recognize the revised inventory as the correct inventory upon the basis of cost or market, whichever is lower.
   OPINION.

Smith:

Although the evidence is clear that the inventory at November 30, 1919, shown upon the return of the partnership of Blake & Stearns for the year ended November 30, 1919, at $146,546.17, was taken upon the basis of cost or market, whichever was lower, as could best be determined by the partnership at that date, it is nevertheless contended herein that the inventory was overstated as of that date and that the correct amount of the inventory was $90,443.36. Petitioners claim the right to make such adjustment in the inventory by virtue of article 1584 of Regulations 45, revised in 1921, which article reads as follows:

Inventories at Marhet. — Under ordinary circumstances, “market” means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which ordinarily purchased by the taxpayer, and is applicable in the cases (a) of goods purchased and on hand, and (6) of basic elements of cost (materials, labor and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost. Where no open market quotations are available, the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory as may be available, such as specific transactions in reasonable volume entered into in good faith, or compensation paid for cancellation of contracts for purchase commitments. Where, owing to abnormal conditions, the taxpayer has regularly sold such merchandise at prices lower than the current bid price as above defined, the inventory may be valued at such prices, and the correctness of such prices will be determined by reference to the actual sales of the taxpayer for a reasonable period before and after the date of the inventory. Prices which vary materially from the actual prices so ascertained will not be accepted as reflecting the market and the penalties prescribed for filing false and fraudulent returns may be asserted. Goods in process of manufacture may be valued for purposes of the inventory on the lowest of the following bases: (1) the replacement or reproduction cost previtiling at the date of the inventory; or (2) the proper proportionate part of the actual finished cost; or, under abnormal conditions, (3) the proper proportionate part of the sales price of the finished product, account being taken in all cases of the proportionate part of the total cost of basic elements (materials, labor and burden) represented in such goods in process of manufacture at the stages at which they are found on the date of the inventory. The inventories of taxpayers on whatever basis taken will be subject to investigation by the Commissioner, and the taxpayer must satisfy the Commissioner of the correctness of the prices* adopted. He must be prepared to show both the cost and the market price of each article included in the inventory.

Particular attention is called to the following sentence of the regulations:

Where no open market quotations are available, the taxpayer must use such evidence of a fair market value at the date or dates nearest the inventory as may be available * * *.

Petitioners also call attention to article 1584 of Regulations 62, 1922 Edition, which provides in part:

Where no open market exists or where quotations are nominal, due to stagnant market conditions, the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory as may be available.

The evidence before us all goes to show that the big break in the woolen market came several months after the close of the partnership’s fiscal year under consideration. In reply to a communication sent to Strong, Hewat & Co., Inc., of New York City, from which the partnership had purchased goods which were in its inventory at November 30, 1919, the partnership was advised in December, 1923:

Re your request for information as to the market value on November 30th, 1919, of such merchandise as you purchased from us during the year 1919.
It is difficult at best to answer any such inquiry,' as a smash in the market immediately following that time was of such proportions that the prices that could be obtained for this same merchandise were ludicrous.

Letters from other manufacturers are of the same tenor. The break in prices occurred subsequent to the inventory date. There is no evidence that the goods included in the inventory at November 30, 1919, could have been replaced at a less cost on November 30, 1919, than the prices at which they had been purchased. The evidence is simply to the effect that the market was stagnant at that time owing to the seasonal character of the partnership’s business and that when the partnership would ordinarily have sold its merchandise, prices had broken and it could not sell them even at cost. There is no evidence that the market for the partnership’s goods on November 30, 1919, was less than the prices at which such goods were carried into the inventory by the partnership at the date of the taking of such inventory, which was within a very few days after the close of its fiscal year. The action of the respondent in refusing to revise the inventory reported in the partnership return for the fiscal year in question is approved.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by Littleton, Love, and Trttssell.


author: Tiummell :

text:
    Percy K. Hexter, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7878.
    Promulgated October 21, 1927.
    1. A corporation issued its stock under a contract in part payment for services to be rendered. Tbe contract provided that if tbe party to whom tbe stock was issued ceased to be employed by tbe corporation through no fault of bis own then the stock was to become unconditionally the property of tbe party to whom issued. Tbe party was discharged without fault of bis own. In proceedings by tbe corporation to recover tbe stock a decision adverse to tbe corporation was rendered by tbe lower court and tbe appellate court. Held, under tbe contract the stock was not income during tbe year in which tbe final court decision was rendered.
    2. Where petitioner’s books are kept and bis income-tax returns are made on the cash receipts and disbursements basis, held, that notes received in compromise of a damage suit which did not have a market value do not constitute taxable income for tbe year in which received.

      Harry W. Made, Esq., for tbe petitioner.

      L. G. Mitchell, Esq., for tbe respondent.
    This is a proceeding for the redetermination of a deficiency in income tax of $44,541.34 for 1920. Tbe deficiency results from tbe respondent having increased the petitioner’s taxable income by the amount of $116,650, representing cash and the market value of notes received by the petitioner on December 31, 1920, and the value of certain corporate stock, certificate for which was on that date in the possession of the petitioner. The cash and notes were received in connection with the settlement and compromise of a damage suit instituted by the petitioner and then pending.
    FINDINGS OF FACT.
    On December 26, 1916, the petitioner entered into a contract with the Day-Elder Motors Co., whereby he was to act as its sales manager for a period of three years commencing on that date. The contract provided that should the company sell or receive orders for at least 1,400 motor truck chassis within the said three years the contract was to be renewed for a further period of five years, and if during the said period of five years the company should receive orders for 4,000 motor truck chassis the contract was to be renewed for an additional period of five years.
    In addition to providing for the remuneration of the petitioner, it was further agreed that the corporation should at once deliver to the petitioner as further payment for the services to be rendered by him 5,000 shares of the common stock of a par value of $10 per share of the Day-Elder Motors Corporation, a corporation about to be organized subject to certain conditions to be annexed to the certificate of stock, of which the following are pertinent:
    1. That all dividends paid on the stock should be paid to the petitioner so long as he should be employed by the corporation.
    2. That should the petitioner not be entitled to a renewal of the contract as provided or in the event of the breach of any of the terms by the petitioner, the stock should revert to the corporation except as otherwise provided therein.
    3. That should the petitioner perform all of the terms and conditions of the agreement to be performed by him and the corporation sell or receive within the first 3-year period orders for at least 1,400 motor truck chassis, then such proportional part of the shares of stock issued to the petitioner should thereupon become his property unconditionally as the number of motor truck chassis sold and delivered bore to 10,000.
    4. That should the petitioner cease to be employed by the corporation without any fault of his own, all the stock which had not theretofore become his property unconditionally should immediately and upon such event become his property unconditionally.
    In accordance with a provision contained in the contract it was subsequently assigned to the Day-Elder Motors Corporation.
    Pursuant to the agreement, the petitioner received in January, 1911, a certificate for 5,000 shares of stock of the Day-Elder Motors Corporation.
    On the certificate appeared an endorsement declaring that it was not assignable or transferable except in accordance with the terms of the contract of December 26, 1916. The petitioner retained the certificate until January, 1921, when in accordance with another contract he exchanged it for a new certificate for the same number of shares.
    On September 21, 1918, the petitioner and the Day-Elder Motors Corporation entered into a contract, which after reciting that the contract between the petitioner and the Day-Elder Motors Co. had been assigned to the Day-Elder Motors Corporation and that as the petitioner had received a commission in the Army of the United States, modified the contract of December 26, 1916, by providing that from October 1, 1918, and so long as the petitioner remained in the Army he should be relieved of active service to the corporation, should"receive reduced compensation, and that certain expenses of the sales organization of the corporation previously borne by him would during the time he remained in the Army be borne by the corporation. It was also provided that with the foregoing exceptions the contract of December 26, 1916, should remain in effect and that upon the petitioner’s separation from the Army the contract as originally made should go into full force and effect, and the modification come to an end.
    When the petitioner sought to reenter the employ of the corporation after his separation from the Army in 1919, a controversy arose between the parties and in July, 1919, the petitioner was discharged by the corporation without any fault on his part. The Day-Elder Motors Corporation thereupon brought an action against the petitioner to recover the 5,000 shares of stock theretofore delivered to him and the petitioner brought suit against the corporation for damages in the amount of $1,000,000 because of alleged breach of contract. The first action was decided in the petitioner’s favor and on April 19, 1920, there was filed in favor of the petitioner in the Court of Chancery of New Jersey a decree which contained the following:
    * * * And it further appearing that the defendant has ceased to be employed by the complainant without any fault on the part of the defendant, and the defendant is entitled to relief upon his counterclaim as hereinafter granted:
    It is, * * * ordered, adjudged and decreed that the complainant’s bill of complaint be and the same is hereby dismissed with costs;
    And it is further ordered/, adjudged and decreed * * * that the shares of common capital stock of the complainant, Day-Elder Motors Corporation, represented by certificate No. 8 for five thousand shares of ttoe par value of Ten Dollars ($10) each dated January tenth, Nineteen hundred and seventeen, and now in the possession of the defendant, having become the property of the defendant unconditionally, and that the limitations relative to the assignment and transfer of said shares of stock endorsed upon said certificate, be and the same are hereby cancelled, declared null and void and of no effect whatsoever.
    The corporation took an appeal to the Court of Errors and Appeals, where a decision was rendered in 1920 in favor of the petitioner herein. Subsequently and while the petitioner’s suit against the corporation was still pending, the following agreement was entered into about six o’clock in the afternoon of December 31, 1920, between the petitioner and the Day-Elder Motors Corporation:
    Agbeement, made this 31st day of December, 1920, between Day-Elder Motors Corporation, a corporation organized and existing under the laws of the State of New Jersey, of the first part, and Percy K. Hexter, of Mamaro-neek, in the State of New York, of the second part;
    Whereas the parties hereto entered into a contract on December 26, 1916, whereby the corporation employed and engaged the said Hexter as its sales-manager for a period of three years, to commence on the 26th day of December, 1916, which contract by reason of certain provisions therein was subject to renewal for two further periods, the last of which will expire the 26th day of December, 1929; and
    Whereas certain differences arose between the parties resulting in a breach of said contract, and extended litigation thereover in the Court of Chancery of New Jersey and in the District Court of the United States for the District of New Jersey, in which last mentioned court there is now pending at issue an action at law brought by the said Hexter against the said corporation; and

      Whereas the parties hereto have negotiated a settlement and compromise of their differences arising out of said contract, on the terms and conditions hereinafter set forth:
    Now, This Agreement, in consideration of the premises and the payments, promises and agreements hereinafter set forth and contained, Witnesseth as follows:—
    1. The said corporation agrees to pay and the said Hexter agrees to accept in full settlement and eomi>romise of all claims under or by reason of said contract on the part of the said Hexter against the said corporation to the day of the date hereof, the sum of One hundred thousand dollars ($100,000), to be paid as follows:
    Ten thousand dollars ($10,000) in cash on the execution and delivery of this agreement.
    Fifteen thousand dollars ($15,000) on January 4, 1921.
    Twenty-five thousand dollars ($25,000) on the 31st day of January, 1921, to be evidenced by the promissory note of the corporation of this date, payable on January 31, 1921, with interest at 6%.
    Fifty thousand dollars ($50,000) in eight quarterly payments of $6,250 each, on April 1, 1921, July 1, 1921, October 1, 1921, January 1, 1922, April 1, 1922, July 1, 1922, October 1, 1922, and January 1, 1923, to be evidenced by eight nonnegotiable promissory notes of this date payable on the dates above mentioned, carrying interest at 6% from date to maturity.
    2. The said corporation agrees to pay to the said Hexter 2% on the list price on all motor truck chassis sold and delivered, assembled or unassembled, during the period terminating December 26, 1929; said 2% shall be paid by the corporation to the said Hexter on the sales of each month, beginning with January, 1921, on the fifteenth day of the following month, and the said corporation will render to the said Hexter a monthly statement of all sales and deliveries during the month.
    3. It is agreed between the parties hereto that the said corporation may at any time satisfy and extinguish the obligations of this contract to the said Hexter by the payment to him of a sum of money to be arrived at as follows: For the purposes of this clause the contract shall be valued at $40,000 per year, payable in twelve monthly installments at the end of each month, to expiration, and the said amount of $40,000 shall be multiplied by the number of years and parts of years this contract may still have to run, less a discount from the amount so arrived at at the rate of 6% on the respective installments to their maturity.
    On the payment of the amount so ascertained this contract shall be ended.
    4. As a part of this compromise and settlement the said Hexter hereby gives and grants to the said corporation an option to purchase 5000 shares of the common stock of the said corporation belonging to said Hexter for $30,000 in the event that the said corporation shall satisfy and extinguish the obligations of this contract as in the last paragraph provided. The terms of this option shall be noted on the certificate of stock for said shares held by the said Hexter and on any subsequent certificate or certificates therefor.
    5. As a further part of this compromise and settlement the said Charles P. Day and Fred G. Elder hereby pledge the stock respectively held by them of the said corporation, and of another corporation known as Day-Elder Realty Corporation, subject to the existing pledge thereof to the Union National Bank of Newark, N. J., to secure, in the event of the Day-Elder Motors Corporation being decreed insolvent or adjudicated bankrupt during the existence of this contract, any claim that in such event may be established by the said Hexter against the corporate estate, the said stock now pledged, in such event, after-satisfaction of the prior pledge to the Union National Bank, to be transferred on the books of the said corporation to said Hexter. A notation that the said stock, which is the subject of this pledge, is subject to this provision of this contract shall be endorsed on the certificates therefor now in possession of the Union National Bank, or on any other certificates at any time issued for said shares of stock or any part thereof. No transfer of the certificates out of the names of said Charles P. Day and Fred G. Elder, or their transferees, shall be made by reason of this pledge except in the event of decreed insolvency or adjudicated bankruptcy as aforesaid, and the voting rights in the stock shall not be affected by this pledge. Nothing herein shall interfere with the substitution of another bank or banks in place of the Union National Bank as prior pledgee of said stock to the same extent as now.
    6. Tiie said Plexfer hereby discharges and releases the said corporation of and from any and all obligations of the said corporation to him by reason of the said contract of December 26, 1916, or otherwise, to the day of the date hereof.
    7. This contract shall bind the successors of the said corporation and the heirs, executors and administrators of the said Hexter, and shall not be affected by the death of the said Hexter.
    8. The pending suit of Percy K. Hexter against Day-Elder Motors Corporation, in the District Court of the United States for the District of New Jersey, shall be discontinued without costs to either party. ,

    In accordance with the foregoing agreement, the petitioner on December 81, 1920, received $10,000 in cash and the notes provided for in said agreement. The payment, which was to be made on January 4,1921, instead of being made in cash as was contemplated, was also evidenced by a negotiable promissory note. All payments of the $100,000 were made in accordance with the contract. As the petitioner did not have his stock certificate with him at the time the agreement was made,'the notation relative to the option as provided in paragraph 4 of the contract was not entered thereon. In January, 1921, the petitioner- surrendered the certificate for 5,000 shares that had been issued to him in 1917, and in exchange received a new certificate dated December 31, 1920, for the same number of shares of the same class of stock having the same par value, and upon which was made a notation relative to the option as provided for in the agreement of December 31, 1920.
    The petitioner kept his books and made his income-tax returns on the cash receipts and disbursements basis. In his return for 1920 the petitioner included the $10,000 cash paid him on December 31, 1920, in pursuance of the agreement of that date. The petitioner reported in his 1921 return the receipt of $15,000 paid him on January 4, $25,000 paid to him on January 31, and $18,750 representing three payments of $6,250 each made to him in April, July, and October of that year. The petitioner reported in his return for 1922 the money received by him from the Day-Elder Motors Corporation in that year and in his 1923 return the money received during that year.

      Prior to the making of the settlement on December 31, 1920, the petitioner had made an oral agreement with his attorneys in regard to their fees in connection with his litigation. The terms of the agreement were as set forth in the following letter:
    P. K. Hextee,

      Uf57 Broadway, New York, January 10, 1921.

    Mr. HaiíRY W. Mack,

      111 Broadway, New York Oity.

    Deas Harey : In order that there may he no misunderstanding regarding the arrangement for your fees and those of Mr. Lum and Judge Warren in connection with the litigation between me and the Day Elder Motors Corporation, I am writing this letter to confirm my understanding of the arrangement.
    Of the $100,000 in cash which I am to receive, part of which has been paid and part evidenced by notes, the attorneys are to receive 25%, of which I have already paid $2500.00. Of this 25% Judge Warren is to receive $2500, and you and Mr. Lum are to divide equally the balance. Judge Warren is to have no further interest in the fees beyond the $2500 mentioned. Payments of this 25% are to be made when, as and if the money is paid to me by the Day Elder Motors Corporation.
    Of the 2% which I am to receive monthly under the terms of settlement on sales made subsequent to the 1st of January of this year, I am to pay tV to you and Mr. Lum, each of you to receive -¿¶. These payments are also to be made to you and Mr. Lum when, as and if received.
    It is understood that the payments above mentioned are in full settlement not only for all services heretofore rendered, but are to cover also any services necessary on the part of Mr. Lum and yourself to enforce the agreement of settlement with the Day Elder Motors Corporation.
    I am forwarding a copy of this letter signed to Mr. Lum and Judge Warren and have asked them to write confirming the correctness of my understanding of our agreement.
    Very truly yours,
    (Signed) P. K. Hextee.
    Copies sent to—
    Mr. Lum
    Judge Warren.
    The foregoing was the only \.. g executed by the petitioner in regard to attorney fees.
    Pursuant to the agreement with his attorneys, the petitioner on December 31, 1920, after receiving the payment of $10,000 paid them $2,500, issuing to each of them a check for one-third of the amount. Thereafter, when the petitioner received payments under the settlement, he would cash the check and then draw a check or checks in favor of his attorneys.
    At the time of the settlement the Day-Elder Motors Corporation owed the Union National Bank of Newark, N. J., -about $300,000. The corporation undertook to borrow $100,000 from the bank to pay the petitioner and prior to the date of the settlement had approached the officials of the bank in regard to a loan of that amount. The bank had a capital stock of $3,000,000, and as the corporation already owed it $300,000, the loan was denied. The bank, however, was merging with another bank on the first working day of January, 1921, and advised the corporation that it would assist it at that time. In loaning money to the Day-Elder Motors Corporation the bank insisted that the president and treasurer of the corporation endorse the notes and also that those officers pledge as security stock owned by them in the corporation, together with the stock they owned in another corporation known as the Day-Elder Realty Corporation. The corporation in 1920 attempted to borrow money on its notes in the open market but was unable to borrow even the amount of $15,000 which was to be paid in cash to the petitioner under the contract.
    Late in 1920 a revenue agent audited the boobs of the Day-Elder Motors Corporation and advised its officers that his audit showed that the corporation owed the Government about $110,000 additional tax. Prior to the settlement on December 31, 1920, the corporation communicated this information to the Union National Bank of Newark. The petitioner at the time of the settlement had information from his attorneys regarding the financial condition of the Day-Elder Motors Corporation.
    In issuing the common stock of the Day-Elder Motors Corporation to the public, it was not sold, but was given as a bonus with the sale of preferred stock.
    The corporation sold about 400 trucks in 1911, between 900 and 1,000 in 1918, and 1,044 in 1919,1922,1923, and 1924.
   OPINION.

Tiummell :

The respondent has increased the income reported by the petitioner for 1920 by $116,650. Of this amount $16,650 represents the value at $3.33 per share of the 5,000 shares of the common stock of the Day-Elder Motors Corporation, the certificate for which was issued to the petitioner in January, 1917. The remaining $100,000 is composed of $10,000 cash, the face value of two negotiable notes for $15,000 and $25,000, respectively, and eight nonnegotiable notes of $6,250 each.

In regard to the stock, petitioner contends that it became his absolutely prior to 1920, that there was no transaction in 1920 regarding the stock which would make it taxable to him in that year, and that all that was done in 1920 was the rendering by the court of a decision that the conditions and limitations appearing on the certificate of stock were null and void.

We have found that in January, 1917, in accordance with the contract of December 26, 1916, between the petitioner and the Day-Elder Motors Co. the petitioner received a certificate for 5,000 shares of stock. Two of the conditions under which the stock was issued were: First, that should the petitioner perform all of the terms and conditions of the agreement to be performed by him, and the corporation sell or receive within the first 3-year period orders for at least 1,400 motor truck chassis, then such proportional part of the shares of stock issued to the petitioner should thereupon become his property unconditionally as the number of motor truck chassis sold and delivered bore to 10,000; second, that should the petitioner cease to be employed by the corporation without any fault of his own, the stock which had not theretofore become his property unconditionally should immediately and on such event become his property unconditionally. About July, 1919, the petitioner was discharged by the corporation without any fault on his part. The corporation brought an action to recover the stock. In April, 1920, a decree was entered in favor of the petitioner. The corporation appealed and subsequently during the year the decision of the lower court was affirmed.

Since the contract contained the provision whereby upon the petitioner’s separation from the service of the company without fault, on his part, the stock was to become his and in view of the decree and decision of the courts, we are of the opinion that the stock was income to the petitioner in a year prior to 1920. The situation in regard to this point is the converse of that in Farmers National Bank of Rome, N. Y., Executor, v. Commissioner, 6 B. T. A. 1036, and also that in the case of the Malleable Iron Range Co. v. United States, 62 Ct. Cls. 425. Prior to 1920 the petitioner had the stock. It became his absolutely under the terms of the contract when the company discharged him without any fault on his part. There was a contingency that the court would hold that he was not entitled to it, but this contingency never happened. On the other hand, the court held it was rightly his when the company, without fault on his part, discharged him. The stock belonged to the petitioner prior to 1920.

Belative to the $10,000 in cash received by the petitioner on December 31, 1920, the respondent admits that it was reported in the petitioner’s returns filed. The addition of this amount by the respondent to the income reported in the returns was therefore erroneous.

In regard to the notes, the controversy resolves itself into the question of whether the notes received by the petitioner under the circumstances involved here constitute taxable income for the year 1920. The petitioner concedes that the actual cash he received as a result of the settlement of December 31, 1920, is income. The $10,000 in cash received in 1920 was reported by him in his return for that year, and the moneys received by him during 1921, 1922, and 1923 in payment of the notes have been included by him in his returns as income for the years in which received. His contention is that inasmuch as he keeps his books on the cash receipts and disbursements basis, he received income from the settlement only when and to the extent that he received cash.

Section 213 of the Revenue Act of 1918 provides:

That for the purposes of this title (except as otherwise provided in section 233) the term “gross income”—
(a) Includes gains, profits, and income * * * of whatever kind and in whatever form paid * * *. The amount of ail such items shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under subdivision (b) of section 212, any such amounts are to he properly accounted for as of a different period * * *.

Section 212 (b) of the same Act provides:

The net income shall he computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income.

We have heretofore considered the question as to what time property received in compensation for personal services constitutes income. In the Appeal of Minal E. Young, Executor, 6 B. T. A. 472, we said:

We have held that the question whether the receipt of property as compensation for services results in taxable gain at the time received is dependent on the fact whether such property has a market value at that time. If it has no market value when received, no taxable gain results from its receipt. Appeal of William J. Conlin, 1 B. T. A. 472; Appeal of M. J. Sullivan, 2 B. T. A. 1012. In such eases the gain subject to tax i-s realized when the property is sold or exchanged for other iDroperty that has a market value. The transaction resulting in taxable gain or profit is not completed until such time. If the property had a market value when Curtis received it for services, the transaction would then have been completed and would have resulted in gain at that time.

We have also had occasion to consider the question of whether notes constituted property, and in the Appeal of Aaron W. Wolfson, 1 B. T. A. 538, we held that promissory notes are property.

When a taxpayer keeps his accounts and renders his returns on the basis of cash receipts and disbursements, the tax is levied only upon gains, profits and income received in money or in that which is the equivalent of money, that is, something having an exchangeable or reasonable market value.

On the question of the market value of the notes, the evidence, briefly summarized, is as follows:

The Union National Bank, which by the end of 1920 had loaned an amount equal to 10 per cent of its capital stock to the corporation, declined to make further loans in that year. The bank declined to make loans to the corporation unless the corporation’s notes were endorsed by its president and treasurer and accompanied by security. In 1920 the corporation was in need of funds and attempted to borrow money on its notes in the open market but was unable to do so. The corporation in 1920 undertook to borrow the $100,000 to pay the petitioner but was unable to do so and was unable to borrow even the $15,000 to make the payment due in January, 1921. Not only was the corporation in need of funds in addition to the money it sought with which to pay the petitioner, but late in 1920 it received a notice from the collector of an additional income-tax liability of $119,000 which it did not have the cash to pay. There was also evidence to the effect that in 1920 the corporation was insolvent, although this fact was not ascertained until 1926 when it went into the hands of receivers.

We have considered all the evidence and, in our opinion, the preponderance of the evidence is to the effect that the notes did not have a market value when received in 1920 and were not the equivalent to cash. The receipt thereof in 1920 therefore did not constitute taxable income.

In view of our opinion that the notes did not constitute taxable income, it becomes unnecessary to decide the remaining question with respect to the attorney fees.

We think that the manner of reporting the income adopted by the petitioner, under the facts of the case, was correct.

Reviewed by the Board.

Judgment will be entered after notice of 15 days, under Rule 50.