author: Mellott:

text:
    Francois Lang, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 102740-102758.
    Promulgated October 3, 1941.

      L. B. Brown, Esq., for the petitioners.

      Harry R. Horrow, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: David David-Weill; Esther Lazard Fould; Jean Lazard; Alphonse A. Lazard; Therese Lazard Thibault; Marie Louise Lazard; Christian Lazard; Elise Lazard Billaudot; Raymond Lazard; Jenny Cahn Raphael; Simone Lazard Petsche; Georgette Bertier Lazard; Isabelle Lang Gouin; Marguerite Cahn Raphael; Elisabeth Lazard Lang; Max Lazard; Marthe Bouwens de Boijen; and Robert Lazard.

   OPINION.

Mellott:

These proceedings, duly consolidated for hearing, involve deficiencies in income tax for the fiscal year beginning February 1, 1939, and ending January 31, 1940, in the aggregate amount of $70,839.61. After they were instituted and on May 22, 1940, petitioners paid the full amount of the various deficiencies to the collector of internal revenue and thereafter filed supplements to their petitions asking that it be determined that overpayments had been made.

The proceedings were submitted on a written stipulation of facts and documentary evidence. All of the facts are found to be as stipulated. For present purposes they may be summarized.

At all times herein mentioned. the petitioners were nonresident alien individuals not engaged in trade or business within the United States and not having an office or place of business therein. Each of them filed an individual income tax return for the fiscal year with the collector of internal revenue for the district of Maryland on the basis of cash receipts and disbursements. Each return contained a brief history of the litigation, hereinafter set out more fully, together with a recitation of the share and amount receiyed upon the judgment. None of the petitioners reported a taxable income, each return containing the following statement:

Said alien contends that no papt of the sum so received is annual or periodical gain, profit or income or subject to taxation under the Internal Revenue Code. Said alien denies any obligation to file this return and does so only to avoid the assertion of liability to penalty for failure to do so.

Petitioners, or their predecessors in interest, held title as tenants in common to several thousand acres of land located in Kern County, California. The Anglo California National Bank of San Francisco (hereinafter referred to as the bank) for several years had been the agent of the owners of the lands and had in its possession powers of attorney in respect to them. Herbert Fleishhacker was the president of the bank. In May of 1915 the bank, acting under the powers of attorney, caused 110 acres of the' land to be conveyed upon the receipt of $33,000. The land at that time had a market value of $260,000. In March of 1917 the bank and Fleishhacker, acting under the powers of attorney, sold 40 acres of the land for $13,500. This tract at that time had a market value of $40,000. The owners consented to the sales in reliance upon fraudulent representations made to them by the bank and Fleishhacker.

In 1931 an investigation was undertaken to determine whether the petitioners or their predecessors in interest had been defrauded by the bank and Fleishhacker. As a result of the investigation petitioners filed a bill of complaint in equity on January 31, 1933, in the United States District Court for the Southern District of California against the bank, Fleishhacker, and other named individuals and corporations. The bill asked for a rescission of the sales, a recovery of the lands, and an accounting of the profits. The trial was begun in the early part of November 1937 and in the latter part of the same month a motion was granted by the court dismissing the proceeding as to all defendants other than the bank and Fleishhacker on the ground that the cause of action was barred by the statute of limitations. Thereupon the proceeding was changed to an action at law against the bank and Fleishhacker for damages for deceit and transferred to the law side of the court. A jury was waived and the trial proceeded.

On January 10, 1938, the court signed its findings of fact and conclusions of law. One of the findings recites that:

By reason of the fraudulent acts and conduct of the Bank and Fleish-hacker * * * with respect to the * * * sale of the 110 acres on or about May 24, 1915, [the plaintiffs were damaged] in the amount of $227,000, representing the difference between the market value of said 110 acres on said date, $260,000, and the sum of $33,000 received therefor, together with interest on the said sum of $227,000 from the date of said sale; and, with respect to the * * * sale of 40 acres on or about March 22, 1917, the said plaintiffs had been damaged in the amount of $26,500, representing the difference between the market value of said 40 acres on said date, $40,000, and the sum of $13,500 received therefor, together with interest on the said sum of $26,500 from the date of said sale in 1917.

The court concluded that the plaintiffs were:

* * * entitled to judgment against [Fleishhacker and the Bank] in the sum of $253,500, together with interest from May 24, 1915, to date of judgment at the rate of seven percent (7%) per annum on the sum of Two Hundred Twenty Seven Thousand Dollars ($227,000) plus interest at the same rate from March 26, 1917, to date of judgment on the sum of Twenty-six Thousand Five Hundred Dollars ($26,500) and for their costs and disbursements in this action.

On January 11, 1938, judgment was entered in favor of the plaintiffs and against the bank and Fleishhacker “in the sum of $651,579.71, with costs taxed at $2,310.31-”

The bank and Fleishhacker appealed to the Circuit Court of Appeals for the Ninth Circuit which affirmed the judgment of the lower court on September 7, 1939. The opinion, admitted in evidence in these proceedings, is reported in Anglo California National Bank of San Francisco v. Lazard, 106 Fed. (2d) 693. Petition for certiorari was denied by the United States Supreme Court on January 2,1940.

On January 19, 1940, the full amount of the judgment, together with interest thereon in the sum of $92,644.93, or a total of $743,-925.60, exclusive of taxable costs, was received by the above named petitioners in satisfaction of the judgment.

The attorneys for the plaintiff were entitled under a contingent fee contract to 15 percent of any recovery. On January 19, 1940, petitioners paid to their attorneys the sum of $111,588.84. The interests of the petitioners in the judgment and the proportions of attorneys’ fees, costs, etc., paid by them ranged from 1/120 to 23/100 and are set out in the stipulation of facts.

Between April 1, 1931, and January 1, 1939, the petitioners collectively expended sums totaling $150,000 in addition to sums for which recovery was had as taxable costs in the action. Of this amount, $76,500 was paid to Lazard Freres et Cie, for loan of the services of Etienne Lang, and to Lang for expenses incurred in the investigation of facts leading to the institution of the suits and in the preparation for trial. The balance of said amount was paid to various attorneys, investigators, engineers, etc., the largest amount, $30,-000, being paid to the firm of Hanna & Morton, attorneys, as a retainer. Ño part of the sum of $150,000 has ever been claimed as a deduction in any income tax return filed by or on behalf of any of the petitioners or allowed by the Commissioner as a deduction in determining the income tax of any of th%m and no part of said amount was claimed by petitioners as deductions in their returns or allowed by the Commissioner as deductions in arriving at the deficiencies asserted in these proceedings. The Commissioner does not waive any right to disallow any part of said $150,000 as a deduction by reason of the provisions of section 215 (a) of the Internal Revenue Code, nor does he concede that any part of that amount is allowable as a deduction or excludible from gross income.

Nine of the petitioners were determined by the respondent to have had gross income for the taxable period of more than $21,600 and ten of them were determined to have had gross income not in excess of $21,600. Those in the group receiving gross income in excess of $21,600 were allowed deductions of their aliquot parts of the legal fee to the extent that it was properly allocable to gross income, while those in the group receiving less than that amount were not allowed any deductions for legal fees. A typical “Explanation of Adjustments”, as to those within the first group is contained in the proceeding David David-Weill, Docket No. 102741. It reads as follows:

(a) It is held that the amount of $743,925.60, received on January 19, 1940 as a result of a judgment obtained by you and several other plaintiffs against The Anglo California National Bank of San Francisco, et al., included interest of $490,425.60, which constitutes fixed or determinable annual or periodical income taxable under the provisions of section 211 of the Internal Revenue Code. Your share of this interest was 23% of $490,425.60, or $112,797.89.
(b) An amount of $111,588.84, representing 15% of $743,925.60, was paid to your attorneys as a legal fee in connection with the judgment referred to in (a) above. Inasmuch as .your gross income from sources within the United States was more than $21,600.00, you are entitled to a deduction of your share of the legal fee to the extent that it is properly allocable to said gross income in accordance with the provisions of section 211 (e) of the Internal Revenue Code.
The amount taxable as interest, $490,425.60, represents 65.924% of the total amount of $743,925.60 received. The allowable deduction for legal fee is therefore $65,924% of $111,588.84, or $73,563.83. Tour share of this deduction is 23% of $73,563.83, or $16,919.68.

A typical “Explanation of Adjustment” as to those in the second group is contained in the proceeding of Max Lazard, Docket No. 102756, reading as follows:

(a) It is held that the amount of $743,925.60 received on January 19, 1940, as a result of a Judgment obtained by you and several other plaintiffs against The Anglo California National Bank of San Francisco, et al., included interest of $490,425.60, which constitutes fixed or determinable annual or periodical income taxable under the provisions of section 211 (a) (1) (A) of the Internal Revenue Code. Tour share of this interest was 1/30 of $490,425.60, or $16,347.52.

The petitions in the second group of cases allege that the Commissioner erred in treating $490,425.60 of the sum of $746,354.95 as annual or periodical gain, profit, or income, within the meaning of section 211,,subsection (a) (1), of the Internal Revenue Code and in treating $281,588.84 (now conceded to be $261,588.84) of the said sum as gain, profit, or income of any kind within the meaning of said section. The petitions in the first group of cases contain the same allegations of error and in addition charge that the respondent erred in failing to deduct the aliquot part paid to the attorneys for their services in the action in determining the amount upon which the petitioner should be taxed under section 211, subsection (c), of the Internal Revenue Code contrary to the provisions of section 43 of the code. By amendment to the petitions the last charge is changed to one charging that the Commissioner erred in failing to deduct the amount paid by each petitioner in connection with the preliminary investigation and preparation for trial, the total amount paid by all being the $150,000 above referred to. Upon brief the last charge is abandoned, petitioners now contending that the $150,000 should be excluded from gross income. They also contend that the $111,588.84 paid to the attorneys should be excluded, rather than deducted, from gross income.

The parties discuss upon brief the following questions: (1) — (a) Was the amount of $398,079.71 received by petitioners interest, or damages measured by interest? (b) If it was not received as damages, was it received “from sources within the United States as interest” within the purview of section 211 (a) (1) (A) of the Internal Revenue Code? (c) Should section 211 (a) (1) (A) be construed as requiring, under the doctrine ejusdem generis, not only that the interest be received from sources within the United States as interest, but that it also be “fixed or determinable” and “annual or periodical” and, if so, does the amount in issue meet this requirement? (d) If the amount was not received as interest, is it nevertheless taxable under section 211 (a)r supra, as “annual or periodical gains, profits and income? ” (2)-(a) Was the amount of $92,644.93 received by petitioners “from sources within the United States as interest?” (b) If so, was it paid upon an interest-bearing obligation? (c) If (a) and (b) are answered in the negative, was the amount in issue nevertheless taxable under section 211 (a), supra, as “annual or periodical gains, profits and income?” (3)-(a) Did the amount of $261,588.84 constitute “gains, profits and income” of any kind? (b) Should $150,000 of it be excluded from gross income? and (c) Should the $111,588.84 have been excluded rather than deducted from gross income?

Several rather persuasive circumstances support the respondent’s contention that the $398,019.11 was received by petitioners as interest. The finding and conclusion of the District Court so characterized it. Moreover counsel representing petitioners in the court action seem to have insisted that “interest” was due their clients. In a hearing before the District Court upon the motion of Fleishhacker to vacate and alter the judgment and for a new trial, in connection with the charge that “under the circumstances * * * the awarding of interest as a part of the damages against * * * Fleishhacker was * * * an abuse of discretion”, counsel for Fleishhacker pointed out that there had never been any pleading mentioning interest or any prayer for it and said: * * the only possible invocation of your Honor’s discretion was the mere statement, the casual statement by counsel at the close of the trial that interest was in the discretion of your Honor.” Counsel for plaintiffs responded that he did not understand why he had been referred to as having made a casual request for interest and pointed out that he had said, not once but twice, while discussing the measure of damages “that your Honor must fix the value of the property, together with interest in the discretion of your Honor. * * * Under the authorities, there could be no real controversy as to our right to receive interest.” In ruling on this phase the court said: “So far as interest is! concerned that is a matter of discretion. I think the discretion was judiciously exercised.” In the assignment of errors upon appeal to the Circuit Court of Appeals it was charged that:

The court erred in including any interest as a part of the damages awarded plaintiffs, because such interest had not been prayed for, nor alleged as part of the damages, nor the discretion of the court in that regard invoked until plaintiff’s so-called “amendment to conform to proof” filed after oral decision pursuant to ex parte order made after oral decision, and the awarding thereof was not within the issues and plaintiffs were not entitled to such interest, either absolutely or as a matter of the court’s sound discretion.

In passing upon this charge of error the Circuit Court of Appeals said:

Appellants’ point four is that the judgment is erroneous in including approximately $400,000 in interest as part of the total damages. Under this point, appellants make two contentions. The first is that the discretion of the trial court was never properly invoked because it was not until the amendment to conform to proof was there any allegation before the court claiming interest; that in the amendment to conform to proof there was no prayer for interest as the allegations claiming interest were only contained in the ad damnum clause. The court did not err in allowing the amendment to conform to proof. The discretion of the trial court was properly invoked for the court could grant relief embraced within the issues including a judgment for interest though not prayed for. Perry v. Magneson, 207 Cal. 617, 279 P. 650; Cassacia v. Phoenix Ins. Co., 28 Cal. 628.
The second contention under Appellants’ fourth point is that the allowance of interest was an abuse of discretion. Appellees contend that the allowance of interest was not discretionary but a matter of right. We assume, however, that the recovery of interest in the case at bar was discretionary. See Cal. Civ. Code, Sec. 3288. Compare Boss v. Silent Drama Syndicate, 82 Cal. App. 109, 255 P. 225. Mary Pickford Co. v. Bayley Bros., Cal. App., 68 P. 2d 239, affirmed 12 Cal. 2d 501, 86 P. 2d 102, 114. The discretion was not abused. See Isaacs v. Frank Meline Co., 2 Cal. App. 2d 341, 37 P. 2d 1045. Compare Wilkinson v. Singh, 93 Cal. App. 337, 269 P. 705.

Respondent argues that the sum of $253,500 included in the judgment represented the amount of which petitioners and their predecessors in interest had been defrauded, the balance being interest. He says: They had been “deprived of the use of said $253,500 from the dates of sales to the date of judgment, and the court having found that Fleishhacker had obtained various and sundry awards [rewards] as a result of the sales for grossly inadequate prices, granted petitioners interest totaling $398,079.11.” Petitioners urge that the so-called interest was not conventional interest nor interest provided by statute such, as was considered in Helvering v. Stookholms Enskilda Bank, 293 U. S. 84; that it was merely an element of the damages awarded to them for the wrong done; that the use of a fixed rate per annum (7%) was merely a convenient method of measuring one of the factors of damage; and that the $398,079.71 was not awarded as a separable item of interest'.

Notwithstanding the several circumstances which tend to support respondent’s contention, we do not believe that the amount in issue was interest. Clearly, it was not interest in “the usual, ordinary and everyday meaning of the term.” Old Colony Railroad Co. v. Commissioner, 284 U. S. 552. Its use in a tax statute might be sufficient to “incline the scale to the construction most favorable to the taxpayer”, Old Colony Railroad Co. v. Commissioner, supra, though we prefer to ’rest our decision on other grounds. It was not interest provided for by statute, either Federal or state. Respondent argues that it was authorized by the California statute. The decision by the District Court and a cursory reading of the opinion by the Circuit Court of Appeals might seem to support this contention; but we do not believe that they do so. The state statute is not controlling, Morgan v. Commissioner, 309 U. S. 78, and, even if it were, the amount was not added as interest. The action was in tort. If the plaintiffs prevailed, the court’s jurisdiction did not extend beyond entering a money judgment. It did so, awarding damages, as shown in its judgment, “in the sum of $651,579.71.” Its findings indicate the method by which the damages were computed. This was perhaps wholly unnecessary, though it tends to establish the “reasonableness” of the award. The opinion of the Circuit Court of Appeals indicates that this was the view which it took. It referred to the court “including [in the judgment] approximately $400,000 in interest as pari of the total damages.” (Italics ours.) The inclusion was proper in order to compensate the plaintiffs for the loss which they had sustained; but the mere fact that the court referred to the state statute under which interest could be allowed does not have the effect of making interest of a portion of the damages.

The conclusion which we have reached accords with the rationale of such cases as Seaboard Air Line Railway Co. v. United States, 261 U. S. 299; Brooks-Scanlon Corporation v. United States, 265 U. S. 106; and Phelps v. United States, 274 U. S. 341; with our decisions in Consorzio Venesiano di Armamento e Navigazione, 21 B. T. A. 984; Joseph W. Bettendorf, 3 B. T. A. 378; and N. V. Koninklijke Hollandische Lloyd, 34 B. T. A. 830; and is also supported by the rule found to be applicable in connection with so-called “interest” upon awards in condemnation proceedings. Cf. Seaside Improve ment Co. v. Commissioner, 105 Fed. (2d) 990; certiorari denied, 308 U. S. 618; Estate of Edgar S. Appleby, 41 B. T. A. 18 (on appeal C.C. A., 2d Cir.).

The cases cited by the respondent have not been ignored. Many of them, as he recognizes, involved the basic question of whether amounts received represented a recovery for loss of profits and constituted income or whether they were returns of capital. Miller v. Hocking Glass Co., 80 Fed. (2d) 436; Armstrong Knitting Mills, 19 B. T. A. 318; Liebes & Co. v. Commissioner, 90 Fed. (2d) 932. Petitioners do not contend that the sum here in issue was a return of capital (except to the extent claimed under the third question, which will be discussed later). Their contention is merely that the amount received is not the particular kind of income which Congress has seen fit to tax to nonresident aliens. The cases are therefore not particularly helpful. In other cases cited by respondent, for example, Charles S. Davis, Trastee, 35 B. T. A. 1001, the Board was not required to determine whether the so-called “interest” was really interest, or damages measured by interest. It was wholly immaterial which it was; for it was taxable in either event. Theodate Pope Riddle, 27 B. T. A. 1339, and Henri Chouteau, 22 B. T. A. 850, involved interest upon an award or judgment from the date it wras entered until the date of payment. They are respectable authority in support of respondent’s contention with reference to the $92,644.93, which will be considered under the second question; but they furnish slight aid in determining the taxability, under section 211, supra, of the $398,079.11.

The conclusion is inescapable and it is held that the $398,079.71 was damages rather than interest. It is unnecessary to decide questions 1 (b) and 1 (c) set out above; so we pass at once to 1 (d) — Is the amount taxable under section 211 (a) as “other fixed or determinable annual or periodical gains, profits and income?” Respondent refers to the quoted language as a “catch-all”, his contention apparently being that Congress intended — as indicated by the legislative history which he sets out — to include all of the gains, profits and income of a nonresident alien, except capital gains. We can not spell out of the language used any such result even if Congress had the intent which respondent contends that it had. The words “fixed or determinable annual or periodical” can not be ignored or expunged from the statute by construction. They qualify and limit the remainder of the sentence. Therefore it must be shown that the gains, profits, and income were both fixed or determinable and annual or periodical.

Respondent argues that the amount in' issue was “fixed” because it was paid in an amount “definitely predetermined”; that it was “determinable” because there was a basis of calculation by which it could be ascertained; that it was computed upon an “annual” basis; and that it was “periodical” in the sense that it was “due in respect of a specific period of time.” He also calls attention to the fact that the statute is in the disjunctive rather than in the conjunctive. These arguments have been considered. Though not conclusive upon us, it is not without significance that the department has apparently taken the view that the phrase “annual or periodical income” connotes income which is paid in more than one installment. Cf. sec. 19.143-2 of Regulations 103. In O. D. 907, C. B. 1921-1, p. 232, it was held that “the commission paid on account of a single transaction is not fixed or determinable annual or periodical income”, and in S. M. 975, C. B. 1, p. 184, it was held that amounts won in horse races in the United States by horses belonging to a nonresident individual did not constitute “fixed or determinable annual or periodical income” so as to be subject to the withholding provisions of the revenue act. The rulings were recently reviewed in G. C. M. 21575, C. B. 1939-2, p. 172, and opinion was expressed that prizes awarded by an institute to nonresident artists during the years 1936, 1937, and 1938 did “not come within the meaning of the term ‘fixed or determinable annual or periodical income.’ ”

We express no opinion as to the correctness of the rulings. Whether they were right or wrong, we believe that under the facts presently stipulated the amount in issue was not received by the petitioners as fixed or determinable annual or periodical income. We therefore hold that said amount should not have been included in computing their income under section 211 (a) (1), supra.

A different situation exists as to the $92,644.93. Petitioners admit it was received as interest on their judgment under R. S. 966 (28 U. S. C. A. 811), making applicable Article XX, section 22, of the Constitution of California. They contend, however, that the judgment was not an “interest-bearing obligation”, as such term is used in section 119 (a) (1) of the Internal Revenue Code because it was subject to reversal — if the defendants in the District Court action had filed in the Supreme Court of the United States a petition for a rehearing of their petition for certiorari and if it had been granted — and also that the interest upon the judgment was not received by them as “annual or periodical” income. We agree with neither of these contentions. The mere fact that the judgment debtors had not exhausted all of their remedies — if that were a fact — does not prevent the judgment from being an obligation. Certainly it was an obligation until and unless it was set aside. It was “interest-bearing” and the interest was paid. “An obligation upon which by express statutory direction interest must be paid is an interest-bearing obligation.” Helvering v. Stockholms Enskilda Bank, supra. Cf. Morley v. Lake Shore Railway Co., 146 U. S. 162; Theodate Pope Riddle, supra; Henri Chouteau, supra. The interest was also fixed or determinable. Petitioners apparently do not contend that it was not. They contend it was not “annual or periodical” because it was not oí a recurrent character or paid in installments from time to time. It will be noted the statute does not require that the income be both annual and periodical. Under the stipulated facts the interest upon the judgment was required to be, and was, computed upon an annual basis. When received, therefore, it was fixed or determinable, annual income. Thus it comes within the ambit of the statute. It follows that the respondent did not err in including this amount in petitioners’ gross income.

The remaining questions involve the two amounts aggregating $261,588.84 ($150,000 preliminary expense and $111,588.84 attorneys’ fees). Respondent included both of them in determining the deficiencies. He allowed the petitioners having gross incomes in excess of $21,600 from sources within the United States, deductions for attorneys’ fees properly allocable to their respective gross incomes in accordance with the provisions of section 211 (c) of the Internal Revenue Code. Under our holding apparently none of the petitioners had gross income in excess of $21,600. If so, no deduction for the attorneys’ fees can be allowed. Petitioners have abandoned their contention that they are entitled to deduct their aliquot parts of the $150,000 from their gross incomes. This contention, if not abandoned, could not have been sustained; for petitioners, in addition to the fact that their respective gross incomes were not in excess of $21,600, had never made any claim for such deductions in their returns — a condition precedent to the allowance of a deduction by a nonresident alien, Nicholas Roerich, 38 B. T. A. 561; affd., 115 Fed. (2d) 39.

Petitioners’ contention that the $261,588.84 should not have been included in gross income is partially covered in our discussion upon the first issue. In so far as this amount forms a part of, or is included in, the $398,079.71 or the $651,579.71, we agree with petitioners. We do not agree with their contention, however, that said amount “should be treated as a reimbursement for the expenditures concurrently payable by them to their attorneys.” They were on the cash receipts and disbursements basis. Out of the amount received they, in the language of the stipulation, “paid to said attorneys, for their services in said proceedings, the sum of $111,588.84.” In other words, they paid their attorneys out of the amount which they received. The Commissioner committed no error in determining that the petitioners having gross incomes in excess of $21,600 were entitled to deductions of their share of the legal fee to the extent that it was properly allocable to gross income in accordance with the provisions of section 211 (c), nor did he err in disallowing all deductions to those having an income of less than $21,600.

It is apparent we are approving, only in part, the deficiencies determined by the respondent. Recomputations must be made in accordance with the views herein expressed. Whether a finding should also be made with reference to overpayments is not clear. The parties will no doubt be able to agree; for they have stipulated that the amounts of the various deficiencies have “been received by the Collector of Internal Revenue, were treated by him as deposits, and were recorded on his books as items deposited in suspense accounts which are unidentified.”

Reviewed by the Board.

Decisions will be entered wader Rule SO.

TtjrneR and Kern dissent.

       SEC. 211. TAX ON NONRESIDENT ALIEN INDIVIDUALS.
      (a) No United States Business ok Ofpice.—
      (1) Genekal kule.—
      (A) Imposition op tax. — There shall be levied, collected and paid for each taxable year in lieu of the tax imposed by sections 11 and 12, upon the amount received, by every nonresident alien individual not engaged in trade or business within the United States and not having an office or place of business therein, from sources within the United States as interest (except interest on deposits with persons carrying on the banking business), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income, a tax of 10 per centum of such amount, except that such rate shall be reduced, in the case of a resident of a contiguous country, spell rate (pot less than 5 per centum) OS may he provided by treaty with such country.

       H. Rept. No. 2475, 74th Cong., 2d seas.; S. Rept. No. 2156, 74th Cong., 2d sess.

       SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES.
      (a) Gross Income from Sources in United States. — The following items of gross income shall be treated as income from sources within the United States :
      (1) Interest. — Interest from the United States, any Territory, any political subdivision of a Territory, or the District of Columbia, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise * *

       (c) No United States Business or Ofjbtce and Gross Income oe More Than $21,-600. — A nonresident alien individual not engaged in trade or business within the United States and not having an office or place of business therein who has a gross income for any taxable year of more than $21,600 from the sources specified in subsection (a) (1), shall be taxable without regard to the provisions of subsection (a) (1), except that—
      (1) The gross income shall include only income from the sources specified in subsection <a) (1) ;
      (2) The deductions (other than the so-called “charitable deduction’' provided in section 213 (c) shall be allowed only if and to the extent that they are properly allocable to the gross income from the sources specified in subsection (a) (1) ;
      (3) The aggregate of the normal and surtax under sections 11 and' 12 shall, in no case, be less than 10 per centum of the gross income from the sources specified in subsection (a) (1) * * *.


source: Caselaw Access Project

author: Arnold :

license: Public Domain

text:
    Don Barnes, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103840.
    Promulgated October 3, 1941.

      Don Barnes pro se.

      Felix Atwood, Esq., for the respondent.
   OPINION.

Arnold :

This case involves an income tax deficiency for the calendar year 1937 in the amount of $182.47. The case was submitted on a stipulation of facts which we adopt as our findings. The question for determination is whether a $1,500 loss was sustained in 1937, and, if so, whether it was a capital or an ordinary loss.

The petitioner is engaged in the practice of law in Cedar Kapids, Iowa, and has been since 1901. He filed his 1937 income tax return with the collector of internal revenue for the collection district of Iowa.

On February 28, 1920, Park Chamberlain, William Chamberlain, and petitioner jointly purchased a farm in Jones County, Iowa, known as the French, farm for a cash consideration of $44,054.40, title to which was taken in the name of Park Chamberlain. During that year they purchased other farms, known as the Orr, Brady, Sieveka, and McNamara farms. These farms were purchased for the purpose of resale at a profit and it was understood that each had an equal interest therein, regardless of the name in which the title was held. On May 13, 1925, the above named parties, their wives joining, executed a mortgage on the French farm to secure the payment of a note of that date in the sum of $12,000, payable to Matilda Dennison, upon which they were jointly and severally liable. This mortgage was subordinate to a mortgage of $16,500 held by the Equitable Life Insurance Co. of Des Moines, Iowa, on which the parties were likewise jointly and severally liable.

On June 23, 1930, Park Chamberlain released all his interest in the-farms to petitioner and William Chamberlain by quitclaim deed, for a recited consideration of $1 which was understood not to be paid and was never paid. The deed was made to petitioner as grantee. Park Chamberlain was not thereby released from his obligation on the mortgages to Equitable Life Insurance Co. and Matilda Dennison.

In 1934, by agreement between petitioner and William Chamberlain, William Chamberlain was to take title and separate ownership of the French farm and pay the $16,500 mortgage to the Equitable Life Insurance Co. and one-half of the second mortgage to Matilda Dennison, and relieve petitioner of his obligation to that extent, and petitioner was to relieve William Chamberlain of any liability on the other half of the Dennison mortgage, then outstanding in the, amount of $12,000. It was further understood that a division would be made' of all the farms owned jointly by petitioner and William Chamberlain if a sale could not be made. In 1934 petitioner relinquished all his right, title, and interest to the French farm to William Chamberlain. To carry out his part of the agreement as to the Matilda Dennison mortgage. petitioner executed to Matilda Dennison an unsecured note in the sum of $3,000 and Park Chamberlain gave her an unsecured note in the sum of $3,000 for that portion of the mortgage to her which was not assumed by William Chamberlain. She canceled and released her mortgage against the French farm in 1934.

Conveyances were made in 1936 when petitioner, by quitclaim deed for a recited consideration of “One Dollar and other valuable considerations”, conveyed all his right, title, and interest in and to the French farm and the Orr farm to William Chamberlain’s grantee, and William Chamberlain at the same time by quitclaim deed conveyed all his right, title, and interest in the Brady and Sieveka farms to petitioner. The consideration of $1 recited in the deeds was not intended to be paid and never was paid. Title to the McNamara farm remained in joint ownership of petitioner and William Chamberlain.

In 1934, and at all times since, the value of the French farm did not exceed the sum of $16,500, and the fair market value of the five farms above mentioned was not in excess of the first mortgages outstanding thereon.

Petitioner paid $500 on his unsecured note to Matilda Dennison in 1934, $1,000 in 1936, and $1,500 in 1937.

In his return for 1937 petitioner claimed a deduction of the $1,500 paid on his note to Matilda Dennison in that year. The Commissioner disallowed the deduction, stating, under “Explanation of Adjustments” in the deficiency notice:

It is held that the payment in 1937 of $1,500.00 on your personal note given in 1934 for your share of the second mortgage on the French farm, owned jointly at that time hy yourself and William Chamberlain and on which you were liable, did not give rise to a deductible loss.

The points relied on by petitioner in his brief are as follows: Respondent erred (1) in holding that the $1,500 deducted in 1937 was a capital loss and only 30 percent thereof was deductible, and (2) in failing to allow the loss as an ordinary loss under the provisions of section 23 (e), Revenue Act of 1936. Petitioner’s contentions are premised on the assumption that he sustained a loss. This is precisely the question which we must determine before we can classify the loss.

The stipulated facts show that petitioner and the Chamberlains purchased certain farms in 1920 for the purpose of resale at a profit. In 1934 petitioner and William Chamberlain divided a portion of the jointly owned property between them so that the former would have two farms and the latter two farms. To equalize the division petitioner gave his unsecured personal note to Matilda Dennison, which was used in securing the release of the French farm from a. second mortgage. It is the payment on this note which petitioner says constituted a loss.

We think it is immaterial that the farms were worth less in 1934 than the first mortgages thereon. The normal inference is that petitioner expected to benefit or he would not have entered into the arrangements he did with his coowner. Until petitioner disposes of the farms there can be no identifiable event which would result in gain or loss. See United States v. White Dental Manufacturing Co., 274 U. S. 398; Lucas v. American Code Co., 280 U. S. 445. If it be said that the $12,000 borrowed from Matilda Dennison was not used in the purchase of the farms, and the record does not show that it was so used, then obviously the repayment of money borrowed results in no recognizable loss to the taxpayer. United States v. Little War Creek Coal Co., 104 Fed. (2d) 483.

The cases cited by petitioner involve capital or ordinary losses in closed transactions where the taxpayer had disposed of or abandoned his property lights and are not in point. This petitioner made no final disposition of the property received by him. He changed his undivided interest in four farms to the sole ownership of two farms and gave his $3,000 note in connection therewith. We know of no principle upon which a repayment of borrowed money can be claimed as a deduction. United States v. Little War Greek Coal Co., supra.

Decision will be entered for the respondent.


author: Murdock:

text:
    Estate of Ozro Miller Field, The Merchants National Bank of Boston, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 105004, 105005.
    Promulgated October 7, 1941.

      Edward G. Thayer, Esq., for the petitioner.

      John T. Haslam, Esq., for the respondent.
   OPINION".

Murdock:

The estate tax law allows a deduction for the amount of all bequests or legacies to corporations organized for charitable purposes and the income tax law allows a similar deduction for any part of the gross income which is permanently set aside for such purposes. The remainder interest in the decedent’s estate, including the amount realized from the sale of securities (the capital gains), was to go to charitable corporations, hospitals. The Commissioner contends, however, that no deduction is proper because the corpus could be invaded and it is impossible to determine how much might be used up by the widow. He does not suggest that the entire corpus might be used by her, yet he has allowed no deduction. He does not question the fact that the capital gains became a part of the corpus of the trust.

The corpus could be invaded only in case the trustee concluded, in the exercise of its discretion, that income was insufficient for the “comfort, support, maintenance, and/or happiness” of the widow and the use of principal would be “wise and proper.” Cases where the beneficiary was not restricted in any way and cases where annuities for after-born children might consume the corpus are not in point. Cf. Mercantile Trust Co., Executor, 13 B. T. A. 85; affd., 43 Fed. (2d) 39. The problem is similar to that involved in Ithaca Trust Co. v. United States, 279 U. S. 151. The income and such part of the principal as might be “necessary to suitably maintain” her “in as much comfort as she now enjoys” was to go to the life tenant and the remainder was to go to charity. The Court said :

* * * The case presents two questions, the first of which is whether the provision for the maintenance of the wife made the gifts to charity so uncertain that the deduction of the amount of those gifts from the gross estate under section 403(a)(3), supra, in order to ascertain the estate tax cannot be allowed. * * * This we are of opinion must be answered in the negative. The principal that could be used was only so much as might be necessary to continue the comfort then enjoyed. The standard was fixed in fact and capable of being stated in definite terms of money. It was not left to the widow’s discretion. The income of the estate at the death the testator and even after debts and specific legacies had been paid was more than sufficient to maintain the widow as required. There was no uncertainty appreciably greater than the general uncertainty that attends human affairs.

The same principles apply in an income tax case. Helen G. Bonfils et al., Executors, 40 B. T. A. 1079; F. G. Bonfils Trust, 40 B. T. A. 1085; affd., 115 Fed. (2d) 788. The standard fixed by Field was also capable of being stated in fairly definite terms of money. The income of the estate at the death of the testator was more than sufficient to maintain the widow as required and there was no uncertainty as to future sufficiency appreciably greater than the general uncertainty that attends human affairs. There is evidence of the amount of income which could be expected and of the probable expenditures of the widow. The former was about 1.8 times the latter. The actual living expenses of the widow were about one-third of the average income. There is evidence that the widow would be most reluctant to invade the corpus of the trust. The contention of the respondent that there was a “trend” of declining income and ascending expenditures is not borne out by the evidence. The income has been uniform in amount since the sale of the Kennedy 7 percent preferred stock. The expenditures of the widow have increased somewhat as she found some new uses for a part of her excess income, but there is reason to believe that she will never want more than income from the trust. This may be a borderline case, but the possibility of corpus being invaded is sufficiently remote to justify the deductions claimed.

Reviewed by the Board.

Decision will be entered under Rule SO.

Black, Turner, Kern, and Opper dissent.

       Income was about five times the amount needed for the annuities in the Bonflls case. The deduction was disallowed in Boston Safe Deposit & Trust Co. v. Commissioner, 26 B. T. A. 486; affd., 66 Fed. (2d) 179; certiorari denied, 290 U. S. 700, where income was only about 1.4 times the amount needed for annuities and there was a possibility that more annuitants would be born.


author: Smith:

text:
    Theodore D. Buhl and Anastasia R. Buhl, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102489.
    Promulgated October 7, 1941.

      Louis G. Wurzer, Esq., and John T. Higgins, Esq., for the petitioners.

      Homer J. Fisher, Esq., for the respondent.
   OPINION.

Smith:

The only question for our determination is whether the petitioner individually, or the trust entity is entitled to the deductions allowable under the statute on account of such losses. Apparently it has been assumed by both parties, and we likewise so assume, that the assessment made on thé bank stock held in the trust was a charge against the corpus of the trust.

The petitioner’s contentions are that the trust which he created under the agreement of October 13, 1927, should be disregarded for tax purposes and that all the deductible losses of the trust, including the capital losses under consideration, should be allowed to him in his individual return.

It is now firmly established in the tax law that a trust may be disregarded as a separate tax entity for the purpose of determining gross income under the broad provisions of section 22 (a) if it lacks sufficient substance to change materially the economic position of the settlor. Douglas v. Willcuts, 296 U. S. 1; Helvering v. Clifford, 309 U. S. 331. Usually, the rule is invoked as a means of preventing the diversion or diffusion of taxable income. It rests upon the broad principle that with this type of trust the settlor remains in substantial ownership of the property or interests purportedly conveyed to the trustees.

There is no impelling reason why the rule should not apply with the same force, in an appropriate case, in determining deductions from gross income under section 23 as in determining the inclusions in gross income under section 22; for a trust could hardly be said to be without sufficient substance for legal recognition as to income which it receives and yet fully recognizable as to the deductions permitted against such income.

The Commissioner’s regulations seem to be in accord, generally, with this view. Article 166-1 of Regulations 94, promulgated under section 166 of the Revenue Act of 1936, which deals with revocable trusts, reads in part as follows:

Aist. 166-1. Trusts, with respect to the corpus of which, the grantor is regarded as remammg in substance the owner. — (a) If the grantor of a trust is regarded, within the meaning of the Act, as remaining in substance the owner of the corpus thereof, the income, therefrom is not taxable in accordance with the provisions of sections 161, 162, and 163 but remains attributable and taxable to the grantor. This article deals with the taxation of such income. * *' *
(b) Section 166 defines with particularity instances in which the grantor is regarded as in substance the owner of the corpus by reason of the fact that he has retained power to revest the corpus in himself. For the purposes of this article the grantor is deemed to have retained such power if he, or any person not having a substantial interest in the corpus or the income therefrom adverse to the grantor, or both, may cause the title to the corpus to revest in the grantor. * * *
* * * * * * *
* * * The grantor is regarded as in substance the owner of the corpus, if, in view of the essential nature and purpose of the trust, it is apparent that the grantor has failed to part permanently and definitively with the substantial incidents of ownership in- the corpus.
In determining whether the grantor is in substance the owner of the corpus, the Act has its own standard, which is a substantial one, dependent neither on the niceties of the particular conveyancing device used nor on the technical description which the law of property gives to the estate or interest transferred to the trustees or beneficiaries of the trust. In that determination, among the material factors are: The fact that the corpus is to be returned to the grantor after a specific term; the fact that the corpus is or may be administered in the interest of the grantor; the fact that the anticipated income is being appropriated in advance for the customary expenditures of the grantor or those which he would ordinarily and naturally make; and any other circumstance bearing on the impermanence and indefiniteness with which the grantor has parted with the substantial incidents of ownership in the corpus.
Thus the grantor is regarded as being in substance the owner of the corpus if, in any case, the trust amounts to no more than an, arrangement whereby the grantor, in the ordering of his affairs, finds it expedient to entrust for a period the title to, and custody or management of, certain of his property to a trustee, the income from such property to be used by the trustee during such period to make those expenditures which the grantor would customarily or ordinarily or naturally make and to which the grantor chooses to commit himself in advance, while the corpus is to be held intact, for return in due course to the grantor. * * *
****** *
(d) If the grantor is regarded as remaining in substance the owner of the corpus the gross income of such corpus shall be included in the gross income of the grantor, and he shall be allowed those deductions with respect to the corpus as he would have, been entitled to had, the trust not been created. [Italics supplied.) ■

Unquestionably, under the quoted regulation, the grantor here must be regarded “as remaining in substance the .owner of, the corpus” of the trust and therefore entitled to the deduction of the losses to the trust corpus. At all times the trustees, the petitioner himself being one of the two trustees in the taxable year before us, had the power to revest in the petitioner any part or all of the trust corpus. Petitioner’s cotrustee had no interest in the trust corpus adverse to that of the petitioner. Reinecke v. Smith, 289 U. S. 172. The petitioner retained all of the income of the trust as well as the remainder interest in the corpus, and there was no other interested party, either as to the income or the corpus of the trust. The trust was plainly revocable, notwithstanding the provisions of the trust agreement that it was to be irrevocable. See Silverthau v. United States, 26 Fed. Supp. 242. Cf. Antoinette K. Brown, 42 B. T. A. 693. See also Restatement of the Law of Trusts by the American Law Institute, vol. 2, § 339.

On facts similar to those in the instant case capital losses of trusts were allowed to the grantors of the trusts in the following cases: Stoddard v. Eaton, 22 Fed. (2d) 184; N. H. Boynton, 11 B. T. A. 1352; Cleveland Trust Co., Executor, 24 B. T. A. 132; Theron E. Catlin, 25 B. T. A. 834; Mary E. Wenger, 42 B. T.A. 225.

The respondent argues, in reliance upon Higgins v. Smith, 308 U. S. 473, that the petitioner, having elected to have the management and investment of his property conducted in a trust form, must accept the tax consequences of the trust. In Higgins v. Smith, supra, the United States Supreme Court denied the taxpayer’s claim for a loss deduction on the transfer of securities to a wholly owned corporation, The taxpayer had made the contention, based on Burnet v. Commonwealth Improvement Co., 287 U. S. 415, that he and the corporation should be treated as separate tax entities. The Court in its opinion said:

* * * In the Commonwealth Improvem-ent Company case, the taxpayer, for reasons satisfactory to itself voluntarily had chosen to employ the corporation in its operations. A taxpayer is free to adopt such organization for his affairs as he may choose and having elected to do some business as a corporation, he must accept the tax disadvantages.

Under the Commissioner’s regulations, article 166-1 (d), quoted above, the right of the petitioner to the deductions claimed does not rest upon any nonrecognition of the trust entity. Section 166 of the statute under which the regulation was promulgated presupposes the existence of a valid trust and provides for the taxing of the income of the trust to the grantor under the conditions therein prescribed. It applies generally to “Trusts, with respect to the corpus of which, the grantor is regarded as remaining in substance the owner.”

It is to be noted, too, that article 161-1 of Regulations 94, promulgated under section 161 of the act, provides that:

The provisions of sections 161, 162, and 163 (relating to estates and trusts, fiduciaries, and beneficiaries) contemplate that the corpus of the trust, or the income therefrom, is, within the meaning of the Act, no longer to be regarded as that of the grantor. If, by virtue of the nature and purpose of the trust, the corpus or income therefrom remains attributable to the grantor, these provisions do not apply. Thus the provisions of sections 168 and 167 deal with certain trusts which are excluded from the scope of sections 161, 162, and 163. * * *

The respondent cites Edith W. Balch, 44 B. T. A. 269, as being conclusive against the petitioner in his contention that the trust was one over which the grantor had the power to revest title to the corpus in himself. We held in that case, relying chiefly upon Anderson v. Wilson, 289 U. S. 20, that the grantor of a trust, who was the sole beneficiary of the income for life but had no interest in the remainder, was not entitled to the deduction in her individual income tax return of an assessment made upon bank stock held by the trustee and paid by the trustee with funds furbished by the taxpayer. The facts in that case are readily distinguishable from those in the instant case. The most important of the distinctions is that the grantor there reserved no interest in the corpus and no question was raised as to whether the grantor remained in substantial ownership of the corpus. In our opinion in that case we said:

* * * We have here no case of naked trust or mere conduit to the beneficiary, but a taxable entity which the petitioner’s brief expressly concedes is separate from that of the petitioner. We conclude and hold that the provisions of section 167 (a) (2) do not entitle the petitioner to deduct the bank stock assessment as capital loss. * * *
* *. * In our opinion Anderson v. Wilson, supra, plainly indicates that the petitioner herein has no beneficial ownership in the corpus such as to cause disregard of the trust entity, or permit deduction by the petitioner of its capital losses. * * * .

In the instant case the very conditions which were said to be lacking in the Balch case are present.

We are of the opinion that the losses to the trust corpus are deductible in determining the amount of the net income of the petitioner just as though the trust were nonexistent. See Mary E. Wenger, supra. For purposes of recomputation of the deficiency they consist of the assessment on the bank stock of $17,260.31 and of capital losses of $1,436.31. The last named amount is the deductible portion of the net capital losses of the trust ($3,172.23) limited to $2,000 by section 117 (d) of the Revenue Act of 1936, less $563.69 capital loss deduction claimed on the return in respect of sales of capital assets not connected with trust transactions and allowed by the respondent in the determination of the deficiency. This is the amount of the capital loss deduction in issue in' this proceeding.

Reviewed by the Board.

Decision will he entered wider Bule 50.

TURNER, Kern, and Opper concur only in the result.


text:
    T. Eugene Piper and Lily B. Piper (Also Known as Lilly B. Piper), Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101766.
    Promulgated October 7, 1941.

      Ferris D. Stone, Esq., and Emmett E. Eagan, Esq., for the petitioners. .

      Homer J. Fisher, Esq., for the respondent.

       [Sec. 44.] (d) Gain or Loss Upon Disposition of Installment Obligations. — If an Installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange — the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange — the fair market value of the obligation at the time of such distribution, transmission, or disposition. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which wpiild be returnable were the obligation satisfied in full. * * *

   OPINION.

Smith:

Petitioners’ contentions are that their entire gain or loss on the foreclosure transaction described above is to be determined in accordance with section 44 (d) of the Eevenue Act of 1936 and article 44-3 of Eegulations 94, as amended by T. D. 4832, 1938-2 Cumulative Bulletin 155. They contend that the doctrine of Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216, has no application to this proceeding. The Supreme Court held in that case that where a life insurance company as mortgagee bid in at a foreclosure sale property upon which it had loaned money at a price equal to the amount of the accrued interest plus the principal due under the mortgage, it realized interest income to the extent of the interest due. To the same effect are Reserve Loan Life Insurance Co., 18 B. T. A. 359; Missouri State Life Insurance Co., 29 B. T. A. 401; Prudential Insurance Co. of America, 33 B. T. A. 332; Great Southern Life Insurance Co. v. Commissioner, 89 Fed. (2d) 54. The Board had previously applied that rule to taxpayers other than life insurance companies. Manomet Cranberry Co., 1 B. T. A. 706; Ewen MacLennan, 20 B. T. A. 900.

Petitioners’ argument is that the doctrine of Helvering v. Midland Mutual Life Insurance Co., supra, should be limited to life insurance companies, whose tax liabilities are computed under special provisions of the act and to which section 44 (d), supra, does not apply. Petitioners contend, in other words, that their entire gain or loss from the foreclosure transaction is to be determined under section 44 (d) of the Revenue Act of 1936 and under the rule of Boca Ratone Co. v. Commissioner (C. C. A., 3d Cir.), 86 Fed. (2d) 9, without any separate determination as to interest income. The court held in the Boca Ratone case that, where the taxpayer as mortgagee repossessed property which it had previously sold on the installment basis and discharged the vendee from the installment obligation, and the fair market value of the property was then less than the unpaid balance of the contract price, as well as taxpayer’s cost, the transaction resulted in a satisfaction of the installment obligation at other than its face value and that a deductible loss was sustained under section 44 (d). The Boca Ratone Co. case was followed in Eggerman, Investment Co., 36 B. T. A. 1196; Walter F. Haass, 37 B. T. A. 948; Walker v. Thomas, 119 Fed. (2d) 58; and Edward Barron Estate Co. v. United States, 38 Fed. Supp. 1017.

In Hadley Falls Trust Co. v. United States (C. C. A., 1st Cir.), 110 Fed. (2d) 887, the court distinguished the Midland Mutual Life Insurance Co. case, supra, holding that the taxpayer was entitled under section 23 (f) and (j) of the Revenue Act of 1928 and the Commissioner’s regulations promulgated pursuant thereto, article 193 of Regulations 74, to a loss deduction equal to the difference between the portion of the mortgage obligations applied to. the purchase price and the fair market value thereof at the time of the sale. Referring to the Midland Mutual Life Insurance Co. case, the court said:

We do not find in Helvering v. Midland Mutual Life Ins. Co., supra, anything requiring a different conclusion. The only question before the court in that case was whether an insurance company should include in its gross income, as interest, the amount of interest included in the hid price for real estate acquired by it at foreclosure sale, the fair market value being less than the bid price. The court held that the interest was taxable income.
»t« sje si* # % * .sfc
Although the language of the court is very broad, we cannot believe that it was intended to preclude examination into the fair market value of property under all circumstances, especially in a case where the agency required to engage in the process of valuation, viz., the Treasury Department, has itself been responsible for the rule making valuation necessary. We do not see why an interpretive regulation requiring the Treasury Department to engage in valuation should not be treated just like any other regulation interpreting a statutory provision. Upon reenactment of the statute without change, such a regulation should be given the force and effect of law. Surely if the Supreme Court had been faced, in the Midland Mutual case, with a statutory provision making determination of the fair market value necessary, it would not have disregarded such a mandate. Similarly, we are faced here with a regulation which has become imbedded in the statute. We may not disregard it simply because we may feel that, in its absence, we would not be inclined, because of the severe administrative burden which would be thereby imposed on the Treasury, to interpret the statute in the same way.

Neither in Hadley Falls Trust Co. v. United States, supra, nor Boca Ratone Co. v. Commissioner, supra, was any issue raised as to liability of the mortgagee for interest income.

Section. 44 (cl) of the Revenue Act of 1936 is a reenactment without change of section 44 (d) of the Eevenue Acts of 1934 and 1932, which continued, without change which is here material, the provisions of section 44 (d) of the Revenue Act of 1928. The Treasury Department regulations promulgated under each of the above revenue acts are substantially the same. Each contains a provision that the fair market value of the property repossessed shall be presumed to be the amount for which it was bid in by the vendor in the absence of clear and convincing proof to the contrary. See art. 353, Regulations 74, under the Revenue Act of 1928; art. 353, Regulations 77, under the Revenue Act of 1932; art. 44-3, Eegulations 86, under the Revenue Act of 1934; and art. 44-3, Eegulations 94, under the Revenue Act of 1936. All of these regulations were amended by T. D. 4832, 1938-2 Cumulative Bulletin 155, to accord with the decision in Boca Ratone Co. case, supra. That case held that the regulations were invalid to the extent that they required different tax consequences for installment sales in which title was retained by the vendor and sales in which the vendor merely retained a lien. The clause calling for determination of fair market value of the property was not affected by the Boca Ratone Co. case and was included without change in the amended regulations. This long standing administrative interpretation of section 44 (d) must now be given the force, and effect of law.

There can be no question but that the petitioners are entitled, under the cited cases and under the quoted provisions of section 44 (d) and article 44 — 3 of Eegulations 94, to a deductible loss on the satisfaction of their installment obligation in the transaction by which they reacquired the property at the foreclosure sale, measured by the difference between the fair market value of the property at the date of such acquisition and the basis of the installment obligation, as defined by statute (section 44 (d)).

It is to be noted, however, that the gain or loss to be computed under section 44 (d) is “upon Disposition of Installment Obligations.” The installment obligation in the instant case was the sum of the payments due on the principal of the installment contract, amounting to $162,289.97. The interest due on the contract was $53,126.01. We do not think that this interest can be treated as a part of the installment obligation. It was not a part of the sale price and was not taken into account in the computation of petitioners’ gain to be realized on the installment contract.

In Helvering v. Midland Mutual Life Insurance Co., supra, the Supreme Court said:

* * * A mortgagee who, at foreclosure sale, acquires the property pursuant to a bid of the principal and accrued interest is, as purchaser and grantee, in a position no different from that of a stranger who acquires the property on a bid of like amount. It is true that the latter would be obliged to pay in cash the amount of his bid, while the formality of payment in cash is ordinarily dispensed with when the mortgagee acquires the property on his own bid. But the rights acquired qua purchaser are the same in either case; and, likewise, the legal effect upon the mortgage debt is the same. In each case the debt, including the interest accrued, is paid. Where the stranger makes the purchase, the debt is discharged by a payment in cash; where the mortgagee purchases the property, the debt is discharged by means of a credit. The amount so credited to the mortgagor as interest paid would be available to him as a deduction in making his own income tax returns. It would be strange if the sum deductible by the mortgagor debtor were not chargeable to the mortgage creditor as income received. Where the legal effect of a transaction fits the plain letter of the statute, the tax is held payable, unless there is clearly revealed in the act itself or in its history a definite intention to exclude such transactions from the operation of its applicable language. * * *

In the Midland Mutual Life Insurance Co. case, as in the like cases cited above, the fair market value of the property at the time of the foreclosure sale was deemed immaterial in determining whether the taxpayers received income in respect of such interest. We see no grounds for a distinction here.

In the instant case the petitioners’ bid price at the foreclosure sale was more than sufficient to cover both principal and interest due on the installment contract. We therefore hold that petitioners are taxable on the amount of such interest.

As to the question of petitioners’ gain or loss on the disposition of their installment obligation, we are of the opinion that the rule of Midland Mutual Life Insurance Co. and like cases does not control and that a computation must be made under section 44 (d) on the basis of the fair market value of the property at the time of the foreclosure sale rather than the bid price. Hadley Falls Trust Co. v. United States, supra.

Reviewed by the Board.

Decision will te entered wider Bule 50.

       Art. 44-3. * * *
      * ' * * * * * *
      If the purchaser defaults in any of his payments, and the vendor returning income on the installment basis reacquires the property sold, whether title thereto had been retained by the vendor or transferred to the purchaser, gain or loss for the year in which the veaequisition occurs is to be computed upon any installment obligations of the purchaser which are satisfied or discharged upon the reacquisition or are applied by the vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the difference between the fair market value of the property reacquired (including the fair market value of any fixed improvements placed on the property by the purchaser) and the basis in the hands' of the vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in connection with the reacquisition. (See also article 44-5.) The basis in the hands of the vendor of the obligations of the purchaser satisfied, discharged, or applied upon the reacquisition of the property will be the excess of the face value of such obligations over an amount equal to the income which would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of any portion of the obligations of the purchaser which are treated by the vendor as not having been satisfied, discharged, or applied upon the reacquisition of the property, unless it is clearly shown that after the property was reacquired the purchaser remained liable for such portion; and in no event shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the obligations with respect to which the purchaser remained liable after the reacquisition. (See article 23 (k)-l.) If the property reacquired is bid in by the vendor at a foreclosure sale, the fair market value of the property shall be presumed to be the purchase or bid priee thereof in the absence of clear and convincing proof to the contrary. If the property reacquired is subsequently sold, the basis for determining gain or loss is the fair market value of the property at the date of reacquisition (including the fair market value of any fixed improvements placed on, the property by the purchaser).


author: Murdock :

text:
    Dixie Pine Products Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103015.
    Promulgated October 7, 1941.

      T. J. Wills, Esq., R. G. Wooton, G. P. A., and II. B. Kelleher, Esq., for the petitioner.

      Donald P. Moyers, Esq., for the respondent.
   OPINION.

Murdock :

This case is similar in some respects to J. A. Dougherty's Sons, Inc., 42 B. T. A. 892, and Estate of David Davies, 42 B. T. A. 965. The Dougherty's Sons, Inc., case has recently been reversed, 121 Fed. (2d) 700. However, the present case has points of difference from the Dougherty's case and is like some other cases of the Board which have been affirmed by other Circuit Courts. It is not a case of an unconstitutional tax, but one of mistake in thinking that a taxing act applied to this petitioner. Inland Products Co., 10 B. T. A. 235; affd., 31 Fed. (2d) 867. Cf. Mary W. Leach, 16 B. T. A. 781; affd., 50 Fed. (2d) 371. The tax was never due and the efforts to collect it were all a mistake, as the court finally decided the law did not apply. The collector admitted his doubt after the decision on the demurrer. The petitioner, believing that no tax was due, ceased and refused to pay, and only made a closing accrual upon advice of counsel. The Commissioner determined that the 1937 taxes were not deductible from income as a properly accrued expense of that year. We hold, upon authority of the cases cited above, that he did not err.

Reviewed by the Board.

Decision will be entered for the respondent.

Smith dissents.


text:
    Mary E. McLeod, Petitioner, v. Commissioner of Internal Revenue, Respondent. Keith McLeod, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104573, 104574.
    Promulgated October 7, 1941.

      H. B. Holland, Esq., for the petitioners.

      T. G. Histon, Esq., for the respondent.
   OPINION.

Murdock :

The statute allows a debt to be deducted in the year in which it is ascertained to be worthless and charged off. No argument is made that these were not debts or that they were not charged off in 1937. The parties disagree only on the question of ascertainment. That question must.be decided upon the facts in this case and not upon those in other cases in no proper way incorporated in this record. Isaac L. Merrill, 31 B. T. A. 530. “Ascertained” means ascertained by the taxpayer, or in the case of the mother, by her son acting in her behalf. Thus the statute allows some latitude, since one person may ascertain a fact at one time while another person may ascertain the same fact at another time. Cf. the Russian bond cases, Murchison National Bank, 1 B. T. A. 617; Samuel Bird, 4 B. T. A. 259; and Anna Bissell, 23 B. T. A. 572. The Commissioner has recognized this principle in regard to these American certificates. 1935 C. C. H. Federal Tax Service, vol. 3, ¶ 6223. The taxpayer must act in good faith and must not close his eyes to that which is obvious to a reasonable person. But within those limits it is his ascertainment which is decisive, not what someone else would have done under the circumstances. Avery v. Commissioner, 22 Fed. (2d) 65 Moore v. Commissioner, 101 Fed, (2d) 704; Commissioner v. MacDonald Engineering Co., 102 Fed. (2d) 942.

The petitioner, Keith McLeod, concedes that the certificates were in fact worthless in 1932 and, had he been able to obtain earlier the total information which eventually came to him, an earlier charge-off and deduction would have been proper. He has shown that he was attentive and was obtaining promptly such definite information as was obtainable through the press and through, the Lee Higginson Trust Co. about the extremely confused and doubtful situation which was gradually revealed following the suicide of Kreuger in 1932. He rightly believed that he and his mother would recover something if their claims were not subordinate to those of general creditors. The record shows that a substantial amount was paid to general creditors, beginning with the dividend proposed in 1936 and paid in 1937. There was. real doubt as to whether or not the claims of certificate holders were to be subordinate, despite the provision on the debentures. It does not appear that the petitioner ever saw that provision or knew about it. But the referee knew about it and still held in 1937 that there was no subordination.. The petitioner was certainly not unreasonable, so far as this record shows, in being unconvinced of the worthlessness of the certificates until the District Court overruled that order of the referee. He has testified that he was unconvinced until that time. He has made a strong prima fade case. The respondent has not shown knowledge by the petitioner prior to 1937 of facts which should have led to an earlier ascertainment. Nellie Kenefick, 3 B. T. A. 659. Facts in regard to stock exchange quotations relied upon by the Commissioner in his argument are not in the record. See on this subject Isaac L. Merrill, supra. Nor are the facts which justified the deductions for 1932 in Robert Ridgway, 35 B. T. A. 122, and Cammack v. United States, 113 Fed. (2d) 547, present in this record. The respondent put in evidence the returns of the petitioners for 1932 through 1937 to show that the petitioner made the charge-offs in 1937 because that was the first year they would be of benefit. The returns fail to show that the petitioners were influenced in that way. They had substantial income in other years and paid tax for some years, particularly 1936. Income was offset by credits, principally credits for dividends, in the years for which no tax was paid. The evidence preponderates in favor of the petitioners and we hold that they are entitled to the deductions.

[Reviewed by the Board.

Decision will be entered wnder Rule 50.

Kern concurs only in the result.

Smith dissents.


author: Black :

text:
    Julius C. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102985.
    Promulgated October 8, 1941.

      Samuel D. Royse, Esq., for tlie petitioner.

      Donald P. Moyers, Esq., for tlie respondent.
   OPINION.

Black :

In support of his contention that the Board should allow the full amount of his claimed loss of $20,000, the petitioner- cites City Builders Finance Co., 21 B. T. A. 800, and Peabody Coal Co. v. United States, 8 Fed. Supp. 845. We have examined these cases and we do not think they are in point.

In the City Builders Finance Co. case, the taxpayer was the owner of 32y2 shares of stock in another corporation and had a cost basis therefor which was not in dispute. The 32y2 shares which it owned was a one-eighth interest in the other corporation. In the taxable year a 100 percent stock dividend was declared and paid in order to give an interest to an outside party which was to render certain aid to the corporation. The taxpayer had to turn in its part of this stock dividend for issuance to this outside party. When all this was finished the taxpayer owned only a one-sixteenth interest in the corporation, whereas prior to the transaction in question the taxpayer owned a one-eighth interest in the corporation. Under these circumstances we allowed the taxpayer to deduct the full cost allocated to the shares which it turned in for issuance to the outside party. In that case none of the stock was turned in to the issuing corporation for cancellation and retirement by it, and the book value of the taxpayer’s remaining stock in the corporation was not increased.

In the instant case, the 200 shares of stock in the shoe company were not reissued to some outside party, as was the case in City Builders Finance Co., supra, but were canceled by the shoe company. To the same effect as was our decision in City Builders Finance Co., supra, was the decision of the Court of Claims in Peabody Coal Co. v. United States, supra.

In the Peabody Coad Co. case the taxpayer transferred a part of the stock which it owned in a subsidiary corporation to some investment bankers in consideration of their lending their services in financing the subsidiary. Under those circumstances the Court of Claims allowed the taxpayer as a loss in the taxable year the full amount of the cost of the stock which it transferred to the investment bankers. In its opinion the Court of Claims distinguished the facts in the Peabody Coal Co. case from those present in Helene Baldwin Burdick, Executrix, 20 B. T. A. 742; affd., 59 Fed. (2d) 395. In discussing the Burdick case, the Court of Claims said:

The case of Burdick, Ex’x, v. Commissioner, supra, was appealed to the Circuit Court of Appeals for the Third Circuit and, by that court, affirmed. In that case the principle involved in the Wright Case, and here contended for by plaintiff, was applied but the loss allowed was measured by the total cost of the stock surrendered reduced by the definite and determined increase in value attaching to the remainder of the stock held by the stockholder through the surrender by him to the corporation for cancellation of a certain number of shares of outstanding preferred stock. With that result we entirely agree, but the same situation is not present here.

We think the facts of the instant case fall within the ambit of the Burdick case. A brief review of the facts of the instant case will show why we think the instant case should be decided in accordance with the principles of the Burdick case. The Grossman Shoe Co., in which petitioner owned a very substantial interest, had fallen into serious financial difficulties and it seemed doubtful that it could continue in business. Petitioner and Ahner were the principal stockholders, but Ahner refused to put up any more money for the corporation. He did agree that he would surrender all his 450 shares in the corporation for $1,000 and the release by petitioner of a guaranty which Ahner had given petitioner to stand good for one-half of $30,000 indebtedness which the corporation owed to petitioner. This Ahner transaction was cleared through petitioner, but it was for the benefit of the corporation and petitioner claims no gain or loss by reason therefor. Neither does the respondent. But at the same time as the Ahner transaction was made, petitioner turned in 200 shares of his own stock in the shoe company for cancellation by the corporation, for which he received no monetary consideration. He claims a loss of the full cost of this stock, $20,000.

Petitioner was the owner of 550 shares in the shoe company just prior to the time he surrendered these 200 shares for cancellation. Thereafter he remained the owner of 350 shares in the corporation and the book value of these 350 shares was very materially increased by the cancellation of the 200 shares in question, as was also the book value of stock owned by the other stockholders. This increase in the book value of petitioner’s remaining 350 shares must be deducted from the total cost of the 200 shares surrendered to arrive at the loss which petitioner is entitled to take under the rule of the Burdick case. We ñnd that the book value of petitioner’s remaining 350 shares was increased by $10,178 by reason of the cancellation of the 200 shares. By deducting this $10,178 from $20,000, the stipulated cost to petitioner of the 200 shares canceled, we arrive at a loss of $9,822 on the stock canceled. The latter amount should be allowed as a deduction to petitioner in a recomputation of the deficiency under Bule 50, instead of the $20,000 loss which he claimed on his income tax return.

Petitioner in his brief arrives at a figure of $11,288.50 for the claimed loss instead of the $9,822 which we have named above. The reason for this difference is that petitioner has excluded from his computation in arriving at the loss $8,933.92 deferred charges included as assets in petitioner’s balance sheet on the basic date. We know of no warrant in law for excluding this $8,933.92 and there is nothing in the facts which justifies this exclusion in making the apportionment.

The $10,178 of the $20,000 loss wliich petitioner claims, which is disallowed for the reasons above stated, will of course be added to the cost basis of petitioner’s remaining stock in the shoe company and will be recovered by petitioner when his remaining stock is sold or otherwise disposed of.

In support of his contention that when petitioner surrendered 200 shares of his stock to the shoe company it was a capital contribution to the corporation and petitioner is not entitled to take any loss by reason thereof, respondent cites Charles M. Haft, 20 B. T. A. 431, and Bed Rock Petroleum Co., 29 B. T. A. 118. We think both of these cases are distinguishable on their facts. In the Charles M. Haft case all the stockholders surrendered and had canceled 50 percent of their stock. We held that in view of the fact that all stockholders had made a ratable contribution of their stock to the corporation their relative positions in the corporation remained the same, and therefore there was no deductible loss.

To the same effect was the Bed Rock Petroleum, Co. case, supra.

We have no such situation here. After the Ahner stock was turned in and canceled for $1,000, petitioner was the only one of the remaining stockholders who turned in stock for cancellation. Under these circumstances we think that the rule of the Burdick case applies, instead of the rule followed by the Board in the Haft case and the Bed Rock Petroleum Co. case.

Decision will be entered wider Rule 50.


author: Hill:

text:
    Charles F. Mitchell and Cora B. Mitchell, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102736.
    Promulgated October 8, 1941.

      Hiram 0. Griffin, Esq., for the petitioners.

      Oliarles Oliphant, Esq., for the respondent.
   OPINION.

Hill:

The issue for decision in this case is whether or not the shares of so-called preferred stock received by petitioners in 1937 as a stock dividend on the common stock of the Regal Laundry, Inc., under the facts and circumstances set out above, constituted taxable income. If so, the parties have stipulated that the deficiency determined by respondent is correct; otherwise, there is no deficiency due.

At the conclusion of the hearing, counsel for respondent moved to strike from the record “all oral evidence offered by petitioners which is contrary to the written records of the corporation”, and “all evidence offered as to any agreement or transaction subsequent to December 31, 1937.” The presiding member took the motion under advisement and stated it would be passed on in connection with the decision on the merits of the case as a whole.

On brief respondent argues in support of his motion that the minutes of the corporation set forth a clear and direct recital of the declaration of a dividend to the common stockholders, payable in both common and preferred stock; that the oral evidence objected to is not explanatory of the written minutes but in contradiction thereof, and should, therefore, not be admitted or considered because it is in violation of the parol evidence rule.

Whether the evidence in question contradicts the corporate records, as argued by respondent, or might properly be said to be only explanatory thereof, as contended by petitioners, we think is not of controlling importance here. In any event,’ there are other and more substantial grounds upon which we prefer to rest our decision.

The evidence relating to the terms and extent of the agreement whereby the stockholders limited or waived their rights in the so-called preferred stock, is clear and uncontradicted. The facts so established vitally affect the nature of the transaction and bear directly on the question of whether or not the preferred shares constituted taxable income to petitioners. Must we, however, exclude such evidence on the ground that it violates the parol evidence rule, and look only to the bare form of the transaction as recorded in the corporate minutes, without explanation? To do so obviously would result in a redetermination of tax liability on a basis utterly at variance with the true facts, and, if under such facts no tax is imposed by the statute, respondent would nevertheless be permitted to collect as a tax the amount of the deficiency determined by him. This may not be done. In circumstances such as are present here, we have repeatedly held that the parol evidence rule has no application. Macon, Dublin & Savannah Railroad Co., 40 B. T. A. 1266, and authorities there cited. See also Combs Lumber Co., 41 B. T. A. 339, 342.

Respondent’s motion to strike is overruled and exception noted.

The second point for consideration is whether or not under the oral agreement of the stockholders the shares of so-called preferred stock received by petitioners in 1937 constituted income taxable to them. The stock dividend, payable in both common and preferred stock, was declared and paid pursuant to this agreement. Prior to declaration of the dividend, all of the stockholders had agreed (1) that they would exchange the preferred stock, share for share, for common stock as soon as the charter could be amended to permit issuance of additional common stock; (2) that until such exchange could be effected no dividends would be accrued or paid on the preferred shares; (3) that they would not sell or otherwise dispose of the preferred shares; and (4) that to insure performance of the agreement the preferred certificates would be held by the company. The agreement was fully carried out and performed within 11 days from its date, which also was the date of issuance of the preferred stock certificates.

From these facts, we think it is apparent that the stockholders did not at any time have dominion or control over the preferred stock. They did not at any time have the right to receive this stock for their own separate use, benefit, and disposal. In fact, the very purpose of the agreement was to deprive the stockholders of any rights of control, possession, or disposal. The preferred stock therefore did not constitute taxable income to the recipients, under the Sixteenth Amendment to the Constitution. Eisner v. Macomber, 252 U. S. 189.

There is an additional reason which also requires disapproval of the respondent’s determination. It is now settled that no stock dividend is constitutionally taxable unless it (1) works a change in the corporate entity, or (2) gives the stockholder an interest different in character from that which his former holdings represented. United States v. Phellis, 257 U. S. 156; Weiss v. Stearn, 265 U. S. 242; Koshland v. Helvering, 298 U. S. 441; Helvering v. Gowran, 302 U. S. 238.

No suggestion appears in the present case that the stock dividend in controversy worked any change in the corporate entity, and we think it is clear that, under the agreement of the stockholders pursuant to which the dividend in preferred stock was declared and paid, they thereby acquired no interest in the corporation substantially different in character from that represented by their former holdings. In effect, the rights of the stockholders in the preferred stock were limited by agreement to the privilege of exchanging each share of such stock for one share of common stock, which latter stock, after the exchange, was held without limitation or restriction.

Decision will be entered for petitioners.