author:
McMahon:
      StekNHAgeN,

text:
    Robert C. Roebling, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45935.
    Promulgated July 11, 1933.

      Arthur O’Brien, Esq., and J. W. Cushman, Esq., for the petitioner.

      John J. Pigg, Esq., for the respondent.
   OPINION.

McMahon:

We shall first determine the basis to be used in the computation of the gain derived by the petitioner upon the sale by him in 1925 for $69,746.87 of certain securities which had been delivered to him on September 22, 1925, the date petitioner came of age, by trustees in accordance with the terms of his father’s will. We are governed by section 204 (a) (5) of the Revenue Act of 1926, which provides that the basis in the case of property acquired by bequest, devise, or inheritance, shall be the fair market value of such property at the time of such acquisition. The respondent held that the securities were acquired by the petitioner at the date of the death of the testator, May 29, 1921, and that the proper basis is their value at that time, which value was $53,627.28. The petitioner, on the other hand, contends that he acquired them on September 22, 1925, the date they were delivered to him by the trustees, and that the proper basis is their value at that time, $67,926.67.

By the terms of the will the trustees were to take shares into which the residuary estate was divided and hold them in trust, one for the benefit of each surviving child of the testator who had not reached the age of 21 years, with the direction to pay over one such share, together with accumulated income, to each child upon his or her attaining the age of 21 years. It was provided, however, that if any child died before attaining the age of 21 years, leaving no living descendants, the share to which such child would otherwise have been entitled should be divided equally and added to the remaining shares.

Petitioner contends that at the date of his father’s death he received only a contingent interest in the share and that he did not receive a vested interest until September 22, 1925. Respondent contends that petitioner received a vested interest in the property at the date of the death of his father.

The will was probated in New Jersey and the law of that state is binding upon us in the interpretation of the will and in the determination of the character of interests created thereby. Uterhart v. United States, 240 U.S. 598; and E. K. Wood Lumber Co., 25 B.T.A. 1013.

We find nothing in any of the cases cited by the petitioner to sustain his contention that his interest in a share of his father’s estate was contingent at the date of the death of his father. The case of Uterhart v. United States, supra, cited by the petitioner in this regard is distinguishable. There the will provided “ that the whole of his residuary estate, real and personal, should, so far as necessary, be applied to the support and education of his minor children * * * during the minorities if Carl Stein survives such period.” It was clear there that the testator did not intend that any vested interest should pass, until Carl Stein reached the age of 21 years or until Carl Stein died, neither of which contingencies had occurred at the time in question in that case. Two of the cases cited by the petitioner fail to sustain petitioner’s contention. On the other hand, they support respondent’s position. Those cases are Dusenberry v. Johnson, 59 N.J.Eq. 336; 45 Atl. 103; and Neilson v. Bishop, 45 N.J.Eq. 473; 17 Atl. 962. In Dusenberry v. Johnson, supra, the court was concerned with a will which contained the following provisions:

* * * (1) I direct my executors to invest immediately upon my decease the sum of two thousand dollars, and to pay the income thereof at stated and convenient intervals to the guardian or guardians of Nathaniel Johnson and Charles S. Johnson, children of my son Nathaniel Johnson, until they respectively become of the age of twenty-one years, to be divided between said children in equal shares, or, if one shall die before reaching that age, to the guardian or survivor of them, and, when they respectively attain that age, to pay each of said children one thousand dollars of said principal sum; if one only shall live to attain that age, then that one to receive the entire sum of two thousand dollars; and, if both shall die before attaining said age, I direct that said sum shall be held and disposed of as is hereinafter provided. * * * and I further direct that, if the children of my said son both die before attaining the ¡age of twenty-one years, the sum of two thousand dollars above given to them Ibe paid to him. * * *

In regard to the above provisions, tbe court stated -.

As to the first question: I think it quite clear that the legacy vested in the two grandchildren, subject to be divested in favor of their father in case they ¡both died before attaining 21 years. The giving of the interest to the grandchildren during their minority shows that the testator, to use the language of .Lord Mansfield in Goss v. Nelson, 1 Burrows, 227; attached the contingency to the time of the payment, and not to the substance of the gift. *• * *

In Neilson v. Bishop, supra, upon facts substantially similar to those in Dusenberry v. Johnson, supra, the court held that the interest vested upon the date of the death of the testator. The court there stated:

According to well-established principles, the legacy in question must be held ¡to have vested in Alexander McC. Bishop. The general policy of the law and ¡the rules of interpretation require that legacies in all cases, unless clearly inconsistent with the intention of the testator, should be held to be vested, rather than contingent. Van Dyke’s Adm’r. v. Vanderpool’s Adm’r., 14 N.J.Eq. 198-207. Where the time specified in the bequest is annexed to the payment only, as where a legacy is given payable or to be paid when the legatee attains 21 years, ,(or on the happening of any other certain or uncertain event,) the legacy vests immediately on the death of the testator. It is a present gift. The time of payment only is postponed. But where the time of payment is annexed, not to the payment only, but to the gift itself, as when the legacy is given to the legatee at 21, or if or when he attains the age of 21, the legacy does not vest until the legatee attains that age. The gift is upon the condition that the legatee shall attain the age specified. Gifford’s Adm’r. v. Thorn, 9 N.J.Eq. 702-705. The fact that the enjoyment is uncertain never interferes with the vesting of an estate. Where the contingency is not in the person, but in the event, (when the enjoyment shall commence,) or in the time of the ¡enjoyment, the interest is vested. * * *

To the same effect are Fidelity Union Trust Co. v. Roland, 132 Atl. 673 (N.J. 1926); and Traverso v. Traverso, 133 Atl. 705 (N.J. 1926).

See also Hospital Trust Co. v. Moise, 126 R.I. 323; 58 Atl. 999, wherein the facts are similar to those of the instant proceeding, and wherein Dusenberry v. Johnson, supra, was cited with approval.

It is our opinion that the intention of the testator, as evidenced by the will, was that the various shares into which his estate was-divided should vest immediately upon his death, and that the time specified in the will was annexed to the payment only and not to the gift. It will be noted from Neilson v. Bishop, supra, that there is a presumption that legacies are vested rather than contingent, unless clearly inconsistent with the intention of the testator. We accordingly hold that at the time of the death of the petitioner’s father the petitioner received a vested interest in his share, which included the securities in question. The trustees took only a bare legal title. They held the securities for the benefit of the petitioner, and, upon the transfer of the property to him, the title which was received by the petitioner related back to the date of the death of the testator. In this situation the date of the death of the testator was “ the time of such acquisition ” within the meaning of section 204 (a) (5) of the Revenue Act of 1926. Brewster v. Gage, 280 U.S. 327; Ghandler v. Field, 58 Fed. (2d) 370; affd., 63 Fed. (2d) 13; and Security Trust Co. et al., Trustees, 25 B.T.A. 29. To the same effect are Rodmam, E. Griscom, 22 B.T.A. 979; Huggett v. Burnet, 64 Fed. (2d) 705; and George Emlen Roosevelt, 28 B.T.A. 194, all of which involved remainder interests.

The respondent’s determination that the value of the securities at the date of the death of the testator is the proper basis for the computation of gain or loss and his determination of the gain derived upon the sale are approved.

During the part of the calendar year 1925. when the petitioner was a minor, that is, the period January 1 to September 21, 1925, the income to the trust property amounted to $59,031.90. The will provided that the trustees might distribute to the use and benefit of the petitioner as much of this income as in their discretion they deemed advisable for the education, support and maintenance of the petitioner. During such period the trustees did, in their discretion, distribute to the petitioner’s use or benefit the amount of $21,657.70. The remainder of such income for such period, $37,374.20, was not distributed to the petitioner by the trustees during that period, but was transferred to him on September 22, 1925, the date upon which he reached his majority and the date upon which, under the will, the trustees were required to pay over to him all of the corpus and accumulated income. The respondent has included both these amounts in the gross income of the petitioner for the year 1925. It is petitioner’s contention that this action of the respondent was erroneous. There are' set forth in the margin provisions of section 219 of the Revenue Act of 1926.

It will be noted that section 219 (b) (3) of the Revenue Act of 1926 provides that in the- case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as a deduction to the trust “ the amount of income of the estate or trust for its taxable year which is properly paid or credited during such year * * * but the amount so allowed as a deduction shall he included in cornyuting the net income of the * * * beneficiary.” Clearly, under the provisions of section 219 (b) (3) the amount of $21,657.70 which was paid or distributed to the use or benefit of the petitioner in the discretion of the trustees is taxable to the petitioner and not to the trust. We hold that the respondent did not err in taxing this amount to the petitioner. The remainder of the income to the trust property during the period January 1 to September 21, 1925, was retained by the fiduciaries in the exercise of their discretion and was paid over to the petitioner when he attained the age of 21 years, on September 22, 1925. At that time the fiduciaries had no discretion in the matter but were required, under the terms of the will, to pay over such income, together with income accumulated in prior years and the corpus, to the petitioner. It is thus clear that the payment of $37,374.20 does not come within subdivision (3) of section 219 (b), which relates only to income which may be either distributed or accumulated in the discretion of the fiduciary.

Section 219 (b) (2) of the Revenue Act of 1926 provides that there shall be allowed as a deduction in computing the net income of the trust the amount of income of the trust for its taxable yearwhich is to be distributed currently by the fiduciary to the beneficiaries * * * but the amount so allowed as a deduction shall he included in computing the net income of the beneficiaries whether distributed to them or not.” The word currently ” is defined in Webster’s New International Dictionary, 1929, as in a current manner.” The word “ current ” is there defined as “ now passing, as time, or belonging to the present time; as, the current month.”

Here the amount of $37,374.20, representing the part of the total amount of income accruing to the trust property during the period January 1 to September 21, 1925, which was not distributed during that period to the petitioner by the trustees in the exercise of their discretion, was, under the terms of the will, to be distributed to the petitioner in the year 1925 at the time the petitioner attained the age of 21 years, and it was actually paid over to the petitioner when that event occurred on September 22, 1925. As pointed out above this item of $37,374.20 does not fall within the provisions of subdivision (3) of section 219 (b). It is our opinion that such income should be considered income “ to be distributed currently ” within the meaning of section 219 (b) (2) and therefore, under the provisions of that section, it is income taxable to the petitioner and not to the trust.

A similar situation was presented in Jacob F. Brown, Trustee, 9 B.T.A. 521. There the testator had died on August 12, 1899, leaving a will providing that his property should go to trustees. The trust was to last for 20 years and 11 months after the death of the testator, the trustees to accumulate the income and distribute it and the corpus to certain beneficiaries at the expiration of the trust. In 1920 the current income to the trust property amounted to $82,686.56 and this amount, together with the principal and the income accumulated in past years, was distributed to the beneficiaries in accordance with the terms of the will. The last distribution was on November 18, 1920. The trustees and the beneficiaries filed returns on the calendar year basis. In that case we held that, under the provisions of section 219 of the Revenue Act of 1918, the income for the year 1920 which was distributed in 1920 to the beneficiaries at the expiration of the trust was taxable to the beneficiaries and not to the trustees. We there stated in part:

In Mary L. Barton, Trustee, 5 B.T.A. 1008, we said at page 1014:
It is also quite clear that the imposing clause contained in subdivision (a) provides that the- tax shall be paid by the fiduciary unless otherwise provided. From the general imposing clause the statute turns to the specific classifications that are to be included within subdivision (a),
at page 1015 we said:
The intention of the statute is to let the tax be imposed in accordance with what actually transpired * * *. Paragraph (3) treats of “ Income held for future distribution under the terms of the will or trust.” It could hardly be contended under this paragraph that income actually distributed by a trustee, who had the discretion to distribute or hold for future distribution, was taxable to the trustee as income being “ held for future distribution.” Also, it is to be noted, in such a case, the terms of the will or trust would have been complied with, as the trustee had the discretionary power to so distribute. Thus, the intention again seems to be to let the tax be imposed in accordance with what actually occurred.
If this be true of the income of a discretionary trust paid over to beneficiaries, a fortiori, it is true of the income distributed to the beneficiaries in the instant case, which income was distributed in accordance with the express provisions of the instrument creating the trust. We regard it as immaterial that the income of the trust fund was to be accumulated for a period of years, which period came to an end during the taxable year. The income received by the trustee in 1920 was not held for future distribution under the terms of the will or trust for the entire year. It was paid over to the beneficiaries during the year. The trustee was merely the conduit through which they received their income. The conduit should not be charged with income tax in respect of the income paid over to the beneficiaries during the taxable year.

To the same effect is Margaret B. Sparrow et al., Trustees, 18 B.T.A. 1. In that case we stated:

* * * In a case involving facts identical with those under consideration, Jacob F. Brotm, Trustee, et al., 9 B.T.A. 521, this Board held that the entire annual income of a trust which terminated during the taxable year was taxable to the beneficiary and not to the trustee. That case is controlling in these proceedings. * * *

The cases of Jacob F. Brown, Trustee, supra, and Margaret B. Sparrow et al., Trustees, supra, involve section 219 of the Revenue Act of 1918, whereas we are here concerned with section 219 of the Revenue Act of 1926, and while the provisions of the two acts are not identical, they are so similar that we consider the above cited cases as governing in the instant proceeding. Section 219 of the Revenue Act of 1926 provides for taxing to the beneficiary income “ which is to be distributed currently by the fiduciary to the beneficiaries ”, whereas section 219 of the Revenue Act of 1918 provides for the taxing to the beneficiaries of income “ which is to be distributed to the beneficiaries periodically, whether or not at regular intervals.” Each act provides for taxing income held for future distribution under the terms of the will or trust to the trustee. An examination of the Congressional Committee [Reports upon the Revenue Bill of 1924, which first set forth the provisions with which we are here concerned, fails to disclose that any significance was attached by Congress to this change of phraseology. We see nothing, in the difference in language between the two acts which requires, a holding in the instant proceeding different from the holding in Jacob F. Brown, Trustee, supra, and Margaret B. Sparrow et al., Trustees, supra. In Guitar Trust Estate, 25 B.T.A. 1213, the Board construed the language of these statutes as follows:

Plainly, under the provisions of section 219 of the applicable revenue acts, the income of a fiduciary may fall into several classifications:
* ***** *
(2) Income which the fiduciary is under a mandatory duty to distribute “ periodically, whether or not at regular intervals ” says the 1921 Act. “ Currently ” say the 1924 and 1926 Acts. So much of the income as falls within this classification is taxable to the beneficiaries and not to the fiduciary. And this is true, whether the income is actually distributed or not. Estate of Henry Mayer, 16 B.T.A. 1164.

There we held that the trust income for certain years was taxable to the fiduciary. However, there, although the fiduciary had authority to distribute the income in his discretion, he did not in fact distribute it. In that case the trust did not expire in the year in question before the Board as it did in the instant proceeding, and there was no requirement in the trust instrument for those years in. that case that the trustee in such year pay over the amount which he had elected to accumulate. We there held, with regard to other years, that since the trust deed required the fiduciary to distribute the trust income each year, the income was taxable to the beneficiaries.

The petitioner contends that under the law of New Jersey the amount of $37,374.20 was, when received by the petitioner, as much of a devise as the principal of the estate, for the reason that if the testator had neglected to devise the accumulated income to the petitioner, it would have become a part of the residuary estate and petitioner would never have received any part of it. Petitioner points out that under section 213 (b) (3) of the Revenue Act of 1926, gross income does not include the value of property acquired by gift. bequest, devise, or inheritance. However, it will be noted that in such section it is specifically provided that the income from property acquired by gift, bequest, devise, or inheritance shall be included in gross income, and we have hereinabove held that petitioner acquired a vested interest in his share of the corpus of the trust at the time of the death of his father. Furthermore, section 213 (a) of the Revenue Act of 1926 provides that the term “ gross income ” includes “income derived from any source whatever.” All of the income accruing to the corpus of the trust is taxable income within the meaning of section 213 (a). Irwin v. Gavit, 268 U.S. 161; Codman v. Miles, 28 Fed. (2d) 823; certiorari denied, 278 U.S. 654; and Heiner v. Beatty, 17 Fed. (2d) 743; affd., Beatty v. Heiner, 276 U.S. 598. State law is not binding upon the Federal Government in the determination of what is income for the purposes of taxation. Burnet v. Harmel, 287 U.S. 103; Bosenberger v. McCaughn, 25 Fed. (2d) 699; certiorari denied, 278 U.S. 604.

We hold that the respondent did not err in taxing the amount of $37,374.20 to the petitioner.

In its -return for the year 1925 the trust included in its taxable income the amount of $37,374.20 above referred to, and paid a tax of $1,497.73 thereon. It also appears that the respondent has determined that there was an over assessment of tax in the amount of $1,497.73 against the fiduciary who filed the return, and has prepared a certificate of overassessment in that amount in favor of such fiduciary. The petitioner contends that if we hold (as we have held hereinabove) that the respondent was correct in his determination that the amount of $37,374.20 is properly taxable to the petitioner, instead of to the trust, then the amount of the overassessment against the trust should be allowed as a credit against his deficiency in tax. However, the trust and the beneficiary are, for income tax purposes, entirely separate entities, Anderson v. Wilson, 289 U.S. 20, and the “Board can not require the Commissioner to credit one taxpayer’s account with a refund due another taxpayer.” Alexander Vayssie, 8 B.T.A. 587. To the same affect are H. B. Perine, 22 B.T.A. 201, and Pine Ridge Mines Co., 23 B.T.A. 21. In the last cited case we stated: “ Only the taxpayer Avhich pays a tax to the Government can be said to be entitled to a credit when it is determined that such tax so paid exceeds the correct tax liability.” Here we do not have the trust before us.

Reviewed by the Board.

Decision will be entered for the respondent.

TRAsoiell dissents.

StekNHAgeN,

concurring: While the earlier decisions in Jacob F. Brown, Trustee, 9 B.T.A. 521, and Margaret B. Sparrow et al., Trustees, 18 B.T.A. 1, support this decision, it is, in my opinion, contrary to the statute. Those decisions were not taken up for court review, and since the rule they announce has been effective and applied ever since, I should not now vote to upset it.

By the terms of the trust instrument and the practical construction of the trustee, the trust income in excess of the amount deemed advisable for the beneficiary’s education, support and maintenance was to be and was accumulated and held for future distribution. Thus, it was squarely within section 219 (a) (1) and taxable to the fiduciary. It was not to be distributed currently within section 219 (a) (2), even though the accident of the petitioner’s twenty-first birthday occurred within this taxable year and thus required final distribution of the trust res. Hence, the $37,374.20 which was not distributable currently in 1925, but was held for future distribution at the termination of the trust, was taxable to the trustee and not to the petitioner.

Maequette and Black agree.

       Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—

        *******

      (5) If the property was acquired by bequest, devise, or inheritance, the basis shall be the fair market value of such property at the time o'f such acquisition. * * *

       Sec. 219. (a) Tie tax imposed by Parts I and II of this title shall apply to the income of the estates or of any kind of property held in trust, including—
      (1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;
      (2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;
      (3) Income received by estates of deceased persons during the period of administration or settlement of the estate; and
      (4) Income which, in the discretion of the fiduciary may be either distributed to the beneficiaries or accumulated. ■
      (b) * * * the tax shall be computed upon the net income of the estate or trust,
      and shall be paid by the fiduciary. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, except that—
      ❖ ^ * * ❖ * *
      (2) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the ?iet income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under paragraph (3) in the same or any succeeding taxable year. [Italics supplied.]
      (3) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary. [Italics supplied.]

       Sec. 213. For tie purposes of this title, except as otherwise provided in section 233—
      *******
      (b) The term “gross income” does not include the following items, which shall be exempt from taxation under this title:
      *******
      (3) The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).


source: Caselaw Access Project

author: Marquette:

license: Public Domain

text:
    Fred Barker, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edward W. Thompson, Petitioner, v. Commissioner of Internal Revenue, Respondent. W. L. Thompson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket. Nos. 51102, 51103, 51104.
    Promulgated July 11, 1933.

      Robert T. Jacob, Esq., for the petitioners.

      ’William, E. Davis, Esq., for the respondent.
   OPINION.

Marquette:

The petitioners contend that the principal transaction, the organization of the Columbia River Packers Association, Inc., and the transfer to it of all the assets of the Columbia River Packers Association, in exchange for cash and all of its capital stock, constituted a reorganization; that the purchase of more than two thirds of the outstanding stock of the old company at an average price of $99.98 per share established the fair market value, and that the fair market value of the shares of stock of the new company was no greater than the value of the shares of the old, less the cash distributed.

The respondent takes the position that the disposition of the assets of the old company to the new company for $1,578,600 and 17,540 shares of no par value common stock of the new company constituted a sale by the old company of its assets to the new company, and also that the fair market value of the no par common stock of the new company, as of the date of incorporation, was not less than $148.82 per share.

The pertinent provisions of the Revenue Act of 1924 are section 203 (a), which reads as follows: “Upon the sale or exchange of property the entire amount of gain or loss determined under section 202 shall be recognized, except as hereinafter provided in this section ”, and the following subdivisions of section 203: (b) (3); (d) (1); (e) (1) and (2) ; (f); (g); and (h) (1) and (2).

In Pinellas Ice & Cold Storage Co., 21 B.T.A. 425; affd., 57 Fed. (2d) 188; 287 U.S. 462, we considered the reorganization sections under the Revenue Act of 1926, the provisions of which are the same as in the 1924 Act, and we there said:

Section 203 (a) provides that when there is a sale or exchange of property the entire amount of the gain or loss shall be recognized, with certain exceptions mentioned in the other subdivisions of that section. The question for decision is whether the transaction here comes within any of those exceptions.
Generally, upon the sale or exchange of property taxable gain or loss is recognized. This is true unless the transaction comes within an exception contained in the statute. So far as the provisions of the statute pertinent here are concerned, section 203 (b) (3) and 203 (e), the exception relates to exchanges and not to sales. Section 203 (b) (3) provides that no gain or loss shall be recognized, if a corporation a party to¡ a reorganization exchanges property, under the circumstances therein provided, and section 203 (e) provides that if an exchange would be within the provision of paragraph (3) subdivision (b) if it were not for the fact that money or other property were included in the transaction as a consideration. In other words, in order to come within the exception to the general provisions contained in section 203 (e) there must in the first place clearly be an exchange. This essential requirement must be met in any event, regardless of whether otherwise there might be a reorganization within the meaning of the statute or whether the other provisions of the statute have been met. We think it is clear that if property is sold the transaction would not come within the exchange provisions. A sale-does not come within either the words or the reason of section 203 (b) (3) or 203 (e). There is a clear legal distinction between a sale and an exchange, and section 203 (b) (3) and 203 (e) relate only to exchanges, and not to sales.
The United States Supreme Court has laid down a rule long recognized and well established in law as to what constitutes a sale. That court, in the case of Williamson v. Berry, 8 How. 495, 543, stated as follows:
* * * We remark that sale is a word of precise legal import, both at law and in equity. It means at all times, a contract between parties, to give and to pass rights of property for money, — which the buyer pays or promises to pay to the seller for the thing bought. Noy’s Max. ch. 42; Shep. Touch., 244.

The transaction before us may be summarized as follows: Thompson and Tyler learned that a large part of the stock of the old company could be purchased. They conferred with a bond house in Portland, Oregon, and were advised that a bond issue, secured by the old company’s assets in the possession of a new company, could be sold to the investing public. Through such a bond issue a substantial part of the cost of the old company stock could be raised, thus leaving Thompson and Tyler in control of the stock in the new company, with comparatively small expenditure of money. Through arrangements made with the Portland bond houses, Thompson and Tyler proceeded to buy the stock of the old company. The necessary cash w'as temporarily advanced by banks which held the old company stock as collateral. The new company was organized, and resolutions were passed by both companies which in their formal wording would indicate a sale and purchase of the assets. The assets were transferred, the bonds issued, and the old company was paid for its assets at the rate of $90 cash and one share of stock in the new company for each share of stock in the old company. The old company then distributed the cash and stock as a liquidating dividend.

The first question for us to decide is whether this transaction was a sale or an exchange. In discussing section 203 of the Revenue Act of 1926, which is the same as the similar section of the Revenue Act of 1924, the Circuit Court of Appeals, Second Circuit, in Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937, said:

When describing the kind of change in corporate structure that permits exemption from these taxes, section 203 does not disregard the necessity of continuity of interests under modified corporate forms. Such is the purpose of the word “ reorganization ” in section 203 (b) (3) of the act, 26 USOA § 934 (b) (3), where a corporation exchanges its property “solely for stock or securities ”. Such, also is the nature of the “ merger or consolidation ” described in subdivision (h) (1) (A) where a corporation acquires a majority of the stock of another, and such is the nature of the “ reorganization ” described in subdivision (h) (1) (B) of section 203, 26 USCA § 934 (h) (1) (B), where a corporation transfers assets to another corporation, and the transferor, or its stockholders, immediately thereafter are in control of the transferee. The words “A recapitalization ”, in subdivision (h) (1) (C) of section 203, 26 USCA § 934 (h) (1) (C), and “A mere change in * * * form * * * of organization, however, effected,” in subdivision (h) (1) (D) of section 203, 26 USCA § 934 (h) (1) (D), involve the same idea.
When subdivision (h) (1) (A) included in its definition of “merger or consolidation ” the “ acquisition by one corporation of * * * substantially all the properties of another,” it did this so that the receipt of property by the corporation surviving the merger might serve to effect a reorganization as does an acquisition of stock. Each transaction presupposed a continuance of interest on the part of the transferor in the properties transferred. Such a limitation inheres in the conventional meaning of “ merger and consolidation ”, and is implicit in almost every line of section 203 which we have quoted. In Pinellas Ice & Cold, Storage Co. v. Commissioner, 57 Fed. (2d) 188, the Court of Appeals of the Fifth Oireuit decided that a transaction almost exactly like the present was not a “ merger or consolidation,” but a mere sale carrying no exemption. Judge Groner’s opinion in Corbett v. Burnet, 60 App.D.C. 202, 50 F (2d) 492, is in accord. In defining “ reorganization,” section 203 of the Revenue Act gives the widest room for all kinds of changes in corporate structure, but does not abandon the primary requisite that there must be some continuity of interest on the part of the transferor corporation or its stockholders in order to secure exemption. Reorganization presupposes continuance of business under modified corporate forms.

In discussing the meaning of the words merger ” and “ consolidation ” as used in the statute, the Supreme Court, in the Pinellas case, supra, said:

The paragraph in question directs — “ The term ‘ reorganization ’ means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation).” The words within the parenthesis may not be disregarded. They expand the meaning of “ merger ” or “ consolidation so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words — so as to embrace circumstances difficult to delimit but which in strictness cannot be designated as either merger or consolidation.

Since in the instant case we have the acquisition of all the assets of the old company by the new company and the same interests immediately thereafter are in control of the transferee, we are of the opinion that the transaction falls within the statutory meaning of a reorganization and the respondent’s claim that it was a sale of assets should be denied.

The remaining question is, What was the fair market value, if any, of the no par value shares of the new company stock on October 31,1924, the date on which it was received by the petitioners ?

It is undisputed that the cost of the old company stock to Barker was $100 per share, and that the cost of the stock to W. L. and Edward W. Thompson was $99.98 per share. The respondent in his deficiency notice determined the new company stock to have a fair market value of $148.32 per share. This value reflects the book value of the new company stock after the assets had been transferred. These same assets reflected on the books of the old company immediately before the transfer show a book value of $183.32 per share.

The respondent contends that the book value of the stock of the new company more correctly reflects the value of the stock than did the sale of the stock of the old company immediately before the transfer of the assets. We are confronted with a situation where a group who had been in control of a corporation for a great many years sell about two thirds of the stock at an average price of $99.98 per share. The selling group were experienced in the industry and thought that they were getting an adequate price for their stock. The purchasing group were bankers, unfamiliar with the salmon-packing industry. Their first corporate step was to negotiate a $1,250,000 bond issue. An appraisal of the assets was made. We cannot help but feel that the appraisal was made primarily to support the sale of the bonds. All the assets were transferred directly from one corporation to another corporation, specifically organized for the sole purpose of taking over the properties, the business and the operations of the expiring company. There was no interruption in the continuity of existence, and no essential change in the corporate structure, except as was reflected by the flotation of a bond issue and the distribution of a cash dividend.

There was a sale of the old company stock at $99.98 per share when its book value was $183.32. The same assets burdened with a bond issue of $1,250,000 on the books of the new company show a value of $148.32 per share. A few random sales of stock were made several months after the basic date at an average price of $60 per share, but we do not think they are representative of the fair market value of the stock at the time of this transaction. We are of the opinion that the sale of the old company stock is more determinative of the fair market value than either the book value or the subsequent sales, and from a consideration of all the evidence we think that the fair market value of the stock of the new company at the time it was received was $10 per share, and we so hold.

Decision will be entered wnder Mule 50.


author: Black:

text:
    Drawoh, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent. Sredies, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rehtam, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 45014-45016.
    Promulgated July 18, 1933.

      Ward Loveless, Esq., Geo. M. Wolcott, Esq., and D. D. Stansbury, Esq., for the petitioners.

      O. E. Ourl, Esq., D. H. Greene, Esq., and T. M. Thom, Esq., for the respondent.
   OPINION.

Black:

The issues raised by the pleadings may be summarized as follows:

(1) The Commissioner erred in imposing the fraud penalties.

(2) The Commissioner erred in disallowing certain deductions taken by petitioners in 1926 and 1927, representing amounts which petitioners had paid certain of their officers and employees as alleged salaries and bonuses, said payments being alleged as reasonable compensation for services actually rendered.

(8) The Commissioner erred in adjusting and prorating certain expenses among the several petitioners in accordance with alleged agreements filed with the Commissioner by petitioners.

(4) To the above issues may be added the issue raised by the Commissioner in the affirmative allegations of his amended answer, wherein he asks that the deficiencies in the case of Seiders, Inc., Docket No. 45015, be increased because of certain allegations made in detail in said amended answer.

We will take up these issues separately and discuss them in their order.

(1) Fraud. — At the hearing the Commissioner conceded that the imposition of fraud penalties against Howard, Inc., was error. Effect to this admission will be given in a recomputation under Bule 50. The answer to the question whether fraud penalties should be imposed against Seiders, Inc., and Mather & Co., it seems to us depends upon whether the so-called Big Plan ” or “ Turnover Plan ” detailed in our findings of fact was entered into in good faith by the parties, or whether the whole thing was a mere scheme and a sham to evade income taxes. While it is of course lawful for taxpayers to use means and methods which are legal and not tainted with fraud to avoid taxes, Brillen v. State of Wisconsin, 240 U.S. 625; Isham, v. United States, 17 Wall. 496, it is never lawful for taxpayers to use methods of concealment and deception to evade taxes. It is in the use of the latter methods that taxpayers run afoul of the fraud penalties. In asserting fraud penalties the burden of proof to show fraud is placed .upon the Commissioner by section 907 (a), Bevenue Act of 1924, as amended by section 601, Bevenue Act of 1928. This burden of proof must be sustained by a preponderance of the evidence and by evidence which is clear and convincing. In re Locust Building Co., 299 Fed. 756. In discussing the rule applicable to fraud cases, the court there said:

The general rule is that fraud must be made out by a preponderance of evidence, which should be so clear and strong as to preponderate over the general and reasonable presumption that men are honest and do not ordinarily commit fraud or act in bad faith. 27 C.J. 62. And in Wigmore on Evidence, vol. 4, § 2498, alluding to the rule that in civil cases a preponderance of evidence is sufficient, he states that a stricter standard is applied in cases of fraud. He says:
“ But a stricter standard, in some such phrase as- ‘ clear and convincing proof,’ is commonly applied to measure the necessary persuasion for a charge of fraud and in a few related classes of cases.”

In several cases the Board bas applied and followed substantially the same rule as laid down by the court in the above quotation. Cf. George L. Richard, 15 B.T.A. 316; M. Rea Gano, 19 B.T.A. 518; L. Schepp Co., 25 B.T.A. 419.

In the instant case there appears to be no doubt that the members of Group I, officers and employees of petitioners, in good faith entered into a plan with Seth Seiders, acting for himself, and the three petitioner corporations, by which Seiders was to receive a million dollars from the businesses and then retire and turn the corporations over to the management of Group I. The object of this plan, as contended by petitioners, was to inspire all employees to render to the three corporations the most efficient services of which they were capable and to establish a definite means whereby the employees would be rewarded, within the bounds defined, in proportion to their loyalty and contributions to the success of the businesses — a definite system under which employees would progress through the organizations from the status of employees to that of owners, and thence to financial independence and retirement from active business. Whether Seth Seiders entered into this arrangement with the same good faith as these members of Group I is not so clear. He did not testify at the proceedings and his version of the arrangement is not before us.

Respondent’s contention that the “ Big Plan ”, or the “ Turnover Plan ”, as it was sometimes referred to in the testimony, or the “Automatic Estate Building Plan”, as it was-referred to in the written drafts of the plan which were drawn up by Tague and Seth Seiders’ father, but never signed by the parties, was a mere sham to help Seth Seiders evade his income taxes, was not borne out by the testimony. The evidence seems to establish with at least a fair degree of certainty that the members of Group I entered into this “ Big Plan ” in good faith. They evidenced this good faith by having elaborate details of the plan reduced to writing in two tentative drafts, both of which are in evidence in this proceeding, although neither was ever finally agreed upon and signed by the parties.

Also, the good faith of members of Group I is evidenced by their entering into insurance agreements with each other by which it was agreed that if any member of Group I should die or become incapacitated prior to the time that Seth Seiders had accumulated his million dollar estate out of the business, the estate of each of the parties so deceased or incapacitated should receive $100,000 as provided therein. These insurance agreements are referred to in our findings of fact. Other evidence of the good faith of members of Group I could be cited from the testimony.

Upon this issue of fraud, we must reach our conclusion not on isolated bits of testimony, but upon the whole record. As we said in L. Schepp Co., supra:

* * * The question is whether upon the entire record properly before the Board the conclusion is fairly to be drawn that fraud was committed. Doubts and omissions are to be held against respondent. His is the risk of failure— not of failure to bring forward enough witnesses or enough testimony through his own witnesses, but of failure to submit a record of persuasive evidence of fraud. His risk is only that the truth may be contrary to his determination, not that he or his organization may not have been aware of it. If the weight of all the valid evidence properly in the case is such as to establish fraud, his burden is discharged; and it matters not by which of the opposing parties the evidence was introduced or in what order it was received. Adjective considerations of convenience as to the order of proof may arise at the trial, but they do not affect the ultimate question whether the evidence adequately supports the respondent’s determination.

We think that, taking into consideration all the evidence, both that introduced by respondent and that introduced by petitioner, we must hold that respondent has failed to establish fraud by a preponderance of the evidence. Of course it may well be conceded that, looking back from a distance of seven or eight years, as we can now do, and after the castles in the air builded by Seth Seiders and his associates have collapsed, the so-called “ Big Plan ” appears more or less grotesque. No doubt the fruits of the “ Big Plan ” appeared in reasonable prospect at the time the parties designed it. Our task is to place ourselves where they then stood — to sit where they sat and not to judge by what has transpired after a lapse of seven or eight years. When we consider that the gross sales of these three petitioner corporations in 1926, the year when the so-called “ Big Plan ” was adopted, were $1,677,306.22, and large profits were being made, the “ Big Plan ” does not appear so ridiculous after all. On the issue of fraud penalties, we hold for petitioners.

(2) Disallowance as deductions of so-called salaries and bonuses.— As has been pointed out in our findings of fact, the petitioners, Seiders, Inc., and Mather & Co., paid certain sums of money to members of Group I which the members of that group did not retain but turned over to Seth Seiders, president of all three corporations, as fast as received, as payments under- the so-called “ Big-Plan.” These sums the respective corporations paying them claimed as deductions for business expenses. As to these payments petitioners contend that they represented reasonable compensation for services performed by the five individuals to whom they were paid and should be allowed as deductions. Respondent in his determination of the deficiencies prorated these so-called salaries and bonuses to the three corporations in proportion to the amount of annual business transacted by each and then disallowed such payments as deductions. We approve respondent’s action in disallowing these deductions. The validity of respondent’s action in prorating a certain part of these so-called salaries and bonuses to Howard, Inc., although Howard, Inc., had paid none of them and had claimed none of them as deductions, will be discussed under issue (3).

Petitioners argue that these salary and bonus payments in question should be treated in the same way and allowed as deductions as were the $15,000 ($290 per week) payments which were paid to each of the members of Group I as salaries and retained by them. One of the principal arguments used by petitioners as to why this should be so, is that in 1925, the year prior to the putting into effect of the “ Big Plan ”, large bonuses were paid to members of Group I by the corporations in addition to their regular salaries. But again we say we must take facts as we find them and not as someone may suppose them to be, and the facts as we find them show that, when the so-called “ Big Plan ” was put into effect, it was agreed that overhead expenses would be kept as low as possible, so that Seiders could receive his pay-off under the “ Big Plan.” That members of Group I were resolved to hold down expenses so Seiders could be paid off as soon as possible is shown by section 2 of the tentative “ Big Plan ” or “ Turnover Plan ” drawn up by Tague. Section 2 of that tentative plan reads:

In order that the purpose of this plan may most quickly be realized, it shall be the policy of the members of the organization to do everything in their power to reduce and hold down to the minimum overhead and operating expense of the business so that net profits out of which all cash rewards must be paid, may be accumulated as rapidly as possible, consistent with good business practice.

To that end members of Group I held a meeting early in 1926 and agreed with themselves and with Seth Seiders, president of all three corporations, that they would accept $15,000 each as salaries for 1926. This arrangement also continued into 1927. The $15,000 salary due to each was paid during most of the time by the $290 a week which they received in cash and retained. The $210 a week which they received and immediately turned over to Seth Seiders and the bonus checks which were made out to them and immediately endorsed by them over to Seth Seiders, were in fact distributions by the respective corporations to Seth Seiders. Members of Group I were merely conduits through which these distributions were made to Seiders.

Whether we regard these distributions as ordinary dividends by the corporations to Seiders or as part of the pay-off to Seiders under the Big Plan ”, the effect is the same. For the purposes of taxation, they must be treated as dividend payments made by the corporations, and not as business expenses for which deductions may be taken. Cf. R. L. Heflin, Inc., 7 B.T.A. 1002; approved by the Court of Claims, 58 Fed. (2d) 482; Heath & Co. v. United States, 2 Fed. Supp. 637; Chattanooga Sav. Bank v. Brewer, 17 Fed. (2d) 79; certiorari denied, 274 U.S. 751. We hold that as to these particular items of claimed deductions, petitioners have not sustained their burden of proof for proving that the so-called salaries and bonuses were paid as reasonable compensation for services rendered, and not as mere gratuities or payments in the nature of dividends. Cf. Tumwater Lumber Mills Co. v. Commissioner, 65 Fed. (2d) 675.

(3) Proration to Howard Inc., by consolidation of accounts in fart. — As pointed out in our findings of fact, respondent made certain prorations of amounts paid during the taxable years as rent, postage, and so-called salaries and bonuses by Seiders, Inc., and Mather & Co. to Howard, Inc. He disallowed these items to Seiders, Inc., and to Mather & Co. and allowed them as deductions in part to Howard, Inc., and disallowed them in part. These prorations were made in accordance with certain agreements signed by the respective corporations and filed with respondent by duly authorized representatives of petitioners. The action of respondent as to these items is assigned by the petitioners, Seiders, Inc., and Mather & Co. as error. Respondent in his brief says: “ It is conceded that the respondent erred in increasing the net income of Howard, Inc., as shown by the schedules attached to the consolidated return for 1926, by the sum of $26,639.20, representing a portion of the so-called salary and bonus payments which were made by Seiders, Inc. and Mather and Company during 1926.”

But respondent says he “ did not err in holding that a portion of the bona fide payments for salaries, rents and postage made by Mather and Company and Seiders, Inc., which said payments were claimed as expense deductions in the consolidated income tax return filed for 1926 and 1927 should be allowed to Howard, Inc. and disallowed to Seiders, Inc. and Mather and Company.” These latter account adjustments, as to which respondent is affirming his correctness in making, amount to a deduction of $30,524.03 allowed to Howard, Inc., for 1926 which it did not take on its books or in the consolidated income tax return. At the same time these adjustments amount to a disallowance to Seiders, Inc., for 1926 of $10,169.04 and to Mather & Co. for 1926 of $19,154.99, both of which claim they are entitled to the deductions which respondent has disallowed to them and has allowed to Howard, Inc. Respondent made a similar adjustment in the return of income of Seiders, Inc., for 1927 amounting to $12,890.66. This adjustment Seiders, Inc., contests on the same grounds as above stated. Seiders, Inc., is the only one of petitioners which is before us for the year 1927.

Respondent, in justification of these adjustments, says that what he did was in effect a consolidation of the salary, rent, and postage accounts of petitioners, by allowing to Howard, Inc., as deductions, certain of the amounts expended for salaries, postage, and rent by Seiders, Inc., and Mather & Co. during 1926 and certain of the amounts expended for salaries and rents by Seiders, Inc., and Mather & Co. during 1927, and disallowing these amounts as deductions in the cases of Mather & Co. and Seiders, Inc. What appears to have been attempted by respondent was to consolidate accounts only in part, after having denied affiliation to the three corporations. Petitioners contend that this the respondent had no right to do and that if these petitioners were asking the Board to consolidate their accounts only in part, giving as a reason the fact that rent and postage were not charged on their books in proportion to their sales, the Board would rightly deny the request. They cite Broadway Strand Theatre Co., 12 B.T.A. 1052. In that case, in denying petitioner’s request for a consolidation of accounts, we said: “ Separate books of accounts were maintained in which were recorded the usual revenues and expenses. The mere fact that lump purchases may have been made for both businesses, especially when, as here, the purchases were allocated to each business, or the fact of an occasional exchange of an employee, without more, does not prove that this section should be invoked.” In Western Hide & Fur Co., 26 B.T.A. 354, we held that under section 240 (f) of the Revenue Act of 1926 a taxpayer invoking the provisions of the section must show the necessity for the consolidation of accounts and a method of “ accurate distribution or apportionment ” of the income and expenses of the two companies engaged in related trades or businesses and owned or controlled by the same interests. Cf. also Crossett Western Co., 27 B.T.A. 258; Flambeau Public Service Co., 27 B.T.A. 299; Abe Ackermam,, 27 B.T.A. 413.

In all of these cases we denied consolidation of accounts. In the instant case the books of account of each petitioner are in evidence and show a complete separation of accounts in which the income and the deductions of each petitioner can be clearly and accurately determined. There is no confusion as to the income of the respective corporations. Under such circumstances there is no necessity for a consolidation of accounts and we think that none is permissible under the statute, even if it be conceded that petitioners did request it. Petitioners are well within their rights in resisting respondent’s action in making a partial consolidation of their accounts. Bespond-ent has denied the entire consolidation of accounts which would result from affiliation, and, having denied the right to file consolidated returns as affiliated corporations, he cannot consolidate accounts piecemeal under the conditions proved in these proceedings. Bespondent has conceded error as to part of his action in consolidating accounts and we hold that the balance of his action in that respect was error. The deficiencies of all three petitioners should be recomputed accordingly.

(4) Commissioner’s affirmative allegations ashing increased deficiencies. — Bespondent in his amended answer asks for increases in the deficiencies in the case of Seiders, Inc. As reasons for such increases, respondent alleges in detail in his brief, but not in his amended answer, that $11,380 of the alleged salaries and bonuses paid to Group I in 1926, and by them immediately turned over to Seth Seiders, was paid by Seiders. Inc., and deducted as business expenses, whereas respondent increased the net income of Seiders, Inc., on account thereof in his deficiency notice by the sum of .only $43,185.06. Bespondent alleges that therefore, inasmuch as the payments in question were not allowable deductions, the Board should allow an increase in the deficiency in the case of Seiders, Inc., for 1926, which increase should be based on the further disallowance of the amount of $28,194.94 ($11,380-$43,185.06). Bespondent also concedes in this same connection in his brief, but not in his amended answer, that inasmuch as Mather & Co. made payments with reference to the so-called salaries and bonuses of only $36,960 during 1926, respondent should have disallowed this amount as a deduction to Mather & Co. instead of $41,515.73, which he did disallow. This concession by respondent will have the effect of reducing the income of Mather & Co. for 1926, as determined by respondent in the deficiency notice, by $4,555.73. Bespondent alleges in his brief, but not in his amended answer, with reference to 1927 in the case of Seiders, Inc., that respondent has shown that so-called bonuses and salaries totaling $39,010 were paid by Seiders, Inc., and deducted by it in determining consolidated net income for 192’6, and that respondent in his deficiency notice disallowed to Seiders, Inc., only $36,889.01 on account of these items and that the deficiency in the case of Seiders, Inc., for 1927 should be increased to the extent that will be represented by adding $2,120.99 ($39,010-$36,889.01) to income for 1927.

Petitioners point out in their brief that the respondent did not by his amended answer, nor did he at the trial of the case, ask that the amounts disallowed by him, as discussed in the aforesaid allegations from respondent’s brief, be changed to conform to the proof. “ Therefore ” say petitioners, “ the Board will be required to find that the amount disallowed to Mather & Co. was excessive to the extent of $4,555.73, because the amount disallowed was excessive to that extent; and that the amount disallowed to Seiders, Inc., should stand as made by the Commissioner in his deficiency notice at $43,185.06.” If the allegations of respondent’s amended answer had been as full as the allegations in the brief concerning the particular transactions we are now discussing, they would have been sufficient to meet the test required by the rules of the Board with reference to affirmative allegations necessary to serve as a basis for an increased deficiency, but they are not sufficiently specific on these matters. In Cascade Milling & Elevator Co., 25 B.T.A. 946, we held that the prayer of respondent’s answer, claiming “ the increased deficiency, if any ” resulting from a redetermination, unsupported by particular aver-ments upon which an increased deficiency could be based, was bad and should be stricken. Cf. Moise v. Burnet, 52 Fed. (2d) 1071. In Cascade Milling & Elevator Co., supra, we said:

* * * While, as indicated by the Moise decision, it is necessary for the respondent’s pleadings to include an appropriately framed prayer for relief if an additional deficiency is sought, it is our understanding of the intent of the revenue act that the prayer must have the support of specific claims in each case based on specific grounds.
The undoubted purpose of section 274 (e) was to put the taxpayer on notice of any demand that the Commissioner proposed to make for an increase in the deficiency determined. The respondent’s determination when it comes before us is presumptively correct. He can not consistently rely on that presumption and at the same time urge that the determination is wrong by asking for an increase. If the determination is wrong in any particular, the respondent should be required to allege particularly wherein it is in error and state the facts relied on, as required by our Rule 14. [Italics supplied.]

We do not regard the allegations in respondent’s amended answer as sufficiently specific to justify the Board in finding an increased deficiency in Seiders, Inc., Docket 45015, by reason of respondent’s making insufficient disallowances in 1926 and 1927 for so-called bonuses and salaries paid to employees of Seiders, Inc., and by them immediately turned over to Seth Seiders. Kespondent’s claim for increased deficiencies on these grounds is denied.

Respondent requested that the deficiency determined against Seiders, Inc., for 1927 be increased by the disallowance of certain bonuses which Seiders, Inc., paid to members of Group I in that year, to enable them to pay their increased income taxes due to 1926 income, and also be further increased by certain bonuses paid to certain employees to enable them to take stock in three Canadian corporations which were formed in that year. We think the bonuses paid by Seiders, Inc., in 1927 to members of Group I to reimburse them for the differences in their income taxes for 1926 income over what such taxes would have been if the so-called salaries and bonuses paid over to Seth Seiders had not been included, should not be allowed as deductions. They fall in the same category as the so-called salaries and bonuses disallowed as deductions for 1926. They are in the nature of dividends to reimburse members of Group I for income taxes on income which was really not theirs, but was promptly paid over to Seth Seiders as part of the pay-off under the “ Big Plan.” The disallowance by respondent of these tax bonuses to Seiders, Inc., for 1927 will not result in any increased deficiency for that year. The respondent, however, did not include such disallowances in his original deficiency notice and it was therefore necessary for respondent to make affirmative allegations with reference to these tax bonuses in his amended answer, and sustain the burden of proof as to them, both of which we hold he has done.

We think respondent has failed to meet the burden of proof required of him to sustain the additional disallowances which he claimed in his amended answer as to the bonuses paid in connection with the organization of the Canadian corporations. These disallow-ances were not made by respondent in the original deficiency notice to Seiders, Inc., but were set up by affirmative allegations in an amended answer filed in Docket No. 45015, part of which are quoted in our findings of fact. As to these affirmative allegations on which increased deficiencies are asked, the burden of proof is on respondent. Board’s Rule 30. Cf. Security First Nat. Bank of Los Angeles et al., Executors, 28 B.T.A. 289.

In connection with this issue, the facts show that the taxpayer corporation charged these bonuses to salary expense and took deductions therefor in determining its net income for 1927. The petitioner Seiders, Inc., makes the contention that all the individuals to whom these bonuses were paid were employees of the company; that they had rendered valuable services to the company; and that if the president and principal stockholder of petitioner decided that the services rendered by these employees merited the reward of permitting them to participate in the stock ownership of subsidiary corporations, that was a matter within his reasonable discretion and there is no evidence to show that this discretion was abused; that the respondent offered no adequate evidence to show that these bonuses given to employees with which to purchase stock in the Canadian subsidiaries were not as reward for services actually rendered and were reasonable in amount for services performed. We think these contentions of petitioner must be sustained. The bonuses in question were comparatively small in amount and do not belong in the classification which we have already discussed, where the so-called salaries and bonuses were not retained by the recipients but were immediately turned over to Seth Seiders and used by him as a part of the pay-off under the “ Big Plan.” Of course these employees should have and, so far as we know, did include these Canadian corporation bonuses in their individual income tax returns for 1927. Charles Bispham Levey, 26 B.T.A. 889. As to respondent’s motion for an increase in the deficiency of Seiders, Inc., on account of these particular bonus payments, we hold for petitioner.

This disposes of all the issues raised by the pleadings, so far as we have been able to ascertain them from the mass of pleadings.

Decision will be entered wader Rule 50.


author: Goodrich:

text:
    Carter, Rice & Company Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53733.
    Promulgated July 18, 1933.

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

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

Goodrich:

Respondent determined a deficiency in income tax for 1928 of $232.70. Petitioner contends that it is not liable for the deficiency, but moreover, has already overpaid its income tax liability for 1928, and that the amount in controversy is $2,620.65. Petitioner alleges that respondent’s determination is in error in the following particulars: (1) Failing to allow as a deduction from the consolidated net income for 1928 of an affiliated group of corporations the whole of the statutory net loss for 1927 of the Nashua Youngblood Co., which became affiliated with the group in 1928; (2) failing to allow as a deduction from income for 1928, the sum of $5,965.22 as accrued excise taxes owing to the Commonwealth of Massachusetts, in addition to such taxes already allowed as a deduction in respondent’s computation of income as disclosed by his deficiency notice; (3) failing to allow as a deduction from income for 1928, the sum of $902.23 paid in that year to the Dominion of Canada as additional income taxes due that Government for prior years.

The facts were stipulated by counsel, and it is unnecessary for the purposes of this report to recite them in full. Respondent concedes error with respect to issue number 2; consequently, upon settlement there should be deducted from petitioner’s income as disclosed by the deficiency notice, $5,965.22, as excise taxes accrued in 1928.

The facts material to the first issue are that the Nashua Young-blood Co. sustained a statutory net loss in 1927 in the amount of $19,118.02. Early in 1928 it became a member of an affiliated group which included petitioner, and in that year its income was $1,799.35. Respondent has permitted the application of the 1927 net loss against, and in the amount of, the 1928 income, but has refused to apply the balance of the net loss against the consolidated income of the group for 1928. In this we sustain him, for this issue has heretofore been decided adversely to petitioner’s contention. Woolford Realty Co. v. Rose, 286 U.S. 319; Delaware & Hudson Co., 26 B.T.A. 520; affd., 65 Fed. (2d) 292; Sailors Brothers Co., 26 B.T.A. 700; Marlin-Rockwell Corp., 26 B.T.A. 884; California Wharf & Warehouse Co., 28 B.T.A. 509.

Respecting the third issue, the stipulation discloses that in 1928 the Nashua Package Sealing Co., one of the members of the group, for the first time received notice of a demand by the Dominion of Canada for additional income taxes for the years 1925 to 1927, inclusive, totaling $902.23, which it paid in 1928. This amount it claims, and respondent has disallowed, as a credit against its taxes due this Government for the year in which paid. It is conceded that the limitations on such credits provided in section 131 (b), Revenue Act of 1928, would allow the deduction of that amount, but respondent contends that the taxes accrued during the prior years and, despite the payment in 1928, are properly deductible from income, or to be credited against the domestic tax, only in the years when accrued, since the company’s accounts were kept on an accrual basis. The law of the Dominion under which these particular liabilities arose was not introduced into this record. We assume, therefore, that the matter of the accrual of Canadian tax liabilities is controlled by statutes similar to our own, and that the events fixing the liability occurred in the respective years to which these additional assessments relate, were determined in amount by reference to the corporate earnings in each of those years, and therefore, represented proper accruals for each of those years. Columbian Carbon Co., 25 B.T.A. 456; United States v. Anderson, 269 U.S. 422.

Both section 23(c) of the 1928 Act, providing for the deduction from income of foreign taxes, and section 131(a), allowing as a credit against the tax imposed thereunder, the amount of the liability for foreign taxes, use the term “ paid or accrued.” We have previously held in cases wherein deductions were claimed that the construction of that term depends upon the basis on which the taxpayer keeps his accounts. If on a cash basis, amounts paid in the taxable year may be deducted; if on an accrual basis, liabilities accruing within the year may be deducted. However, the right to the deduction is in the alternative; both bases may not be used in the same return. Henry Reubel, Executor, 1 B.T.A. 676. This construction of the term is applicable where, as here, the allowance of the foreign tax is sought as a credit, as well as in those cases where the foreign tax is sought as a deduction since, as already pointed out, the identical term is used in both statutory provisions. Here, the taxpayer kept its accounts on an accrual basis. Nothing has been suggested concerning the Canadian law or the nature of these tax claims indicating that the liability therefor was not fixed within or at the close of each of the taxable periods for which the demands ivere asserted, nor any other reason indicating that these taxes were not proper accruals for each of those years, beyond the fact that the taxpayer was not advised of the Dominion’s claim against it until 1928. That fact is not controlling, and we sustain respondent as to this issue. A.R.R. 1153, I-2 C.B. 92; O.D. 388, 2 C.B. 116; American Cigar Co., 21 B.T.A. 464; Armstrong Cork Co., 24 B.T.A. 1.

This same conclusion was reached in the case of Ruud Mfg. Co., 15 B.T.A. 819, under facts very similar to those in the case at bar. That decision was reversed on this point (45 Fed. (2d) 63), but arose under the Bevenue Act of 1921, which provided (sec. 238 (a)) that the tax of the domestic taxpayer should be credited with the foreign tax paid within the taxable year. Under the Act of 1928, which is here controlling, the credit is the amount of foreign tax paid or accrued. The extended qualification in the later act thus provides the credit in the alternative in accordance with our construction of the term “ paid or accrued ”, whether the foreign tax be applied as a deduction from income or as a credit against tbe domestic tax. Consequently, it seems clear that the reasoning of the learned judge upon which was bottomed the earlier decision is not controlling of the case at bar.

Judgment will Toe entered wider Rule 50.


author: MaRquette:

text:
    Standard Island Creek Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 35260, 35617.
    Promulgated July 18, 1933.

      G. F. Taflin, Esq., and Leo H. Eoffmcm, Esq., for the petitioner.

      Alim H. Pierce, Esq., and Irving M. Fuller, Esq., for the respondent.
   OPINION.

MaRquette:

The respondent has not determined any deficiencies for 1921 and 1923; hence, we have no jurisdiction of the issues raised in respect of those years. Wolf Mfg. Co., 10 B.T.A. 1161, and Lowe & Campbell Athletic Goods Co., 18 B.T.A. 1134. The proceedings are dismissed, so far as they relate to those years.

Only two issues remain for decision at this time: (1) Whether petitioner’s profits tax for 1917 should be computed under section 209 of the Revenue Act of 1917, at the rate of 8 per centum; and (2) whether respondent erred in allowing the deduction from 1922 income, of certain wages which, at the close of that year, were unclaimed by the persons entitled thereto.

Section 209 of the Revenue Act of 1917 provides:

That in the case of a trade or business having no invested capital, or not more than a nominal capital there shall be levied, assessed, collected, and paid, in addition to the taxes under existing law and under this act, in lieu of the tax imposed by section two hundred and one, a tax equivalent to eight per centum of the net income of such trade or business in excess of the following deductions: In Ihe case of a domestic corporation $3,000; * * *

We have made findings of fact based upon the evidence which conclusively indicates that the petitioner had no invested capital in 1917. Any lengthy discussion of the evidence is entirely unnecessary and would add nothing to what has already been stated in those findings. The petitioner is entitled, therefore, to have its 1917 excess profits tax computed at the rate of 8 per centum upon the net income in excess of the deduction of $3,000, as provided in the above quoted provisions of section 209.

The other issue to be considered arises from the affirmative alienation in the respondent’s amended answer, which is as follows:

Petitioner reduced its income for the year 1922 by setting up, as an account payable, unclaimed wages in the amount of $3,9S2.31. Respondent alleges that petitioner’s liability for said item was contingent and based upon conjecture; that no claim for any part of said wages hag been filed with petitioner; and that the time within which any creditor might sue for recovery of any part of said wages has expired. Respondent alleges that said item is not a proper charge against the income of the petitioner for the year 1922; that the book entries covering said item should be reversed; and that petitioner’s income for the year 1922 should be increased accordingly. Respondent has claimed, in the alternative, that said item should be included in income for the year 1928 and said claim is now pending before the Board in the case of North American Coal Corporation v. Commissioner, Docket No. 52492.

The stipulation which the parties orally made at the hearing sets forth that of the amount in question, $3,982.31, only $1,128.52 was deducted by the petitioner, and allowed by the respondent, in computing taxable net income for 1922, the remainder having been deducted in prior years. There is nothing in the stipulated facts which would indicate that the amount of $1,128.52 representing accrued and unpaid wages at the close of the year was improperly allowed by the respondent in computing the taxable net income for 1922.

The proceeding in Docket No. 35860 will be restored to the general calendar for hearing in due course, under Buie 68 (b), on the special assessment issues, unless the petitioner files a waiver of such issues within 30 days after the promulgation hereof, in which event, jjudgment 'will be entered under Rule 50. Judgment will be entered in Docket No. 35617 in accordance with Bule 50.


author: Murdock :

text:
    E. C. O’Rear, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 32335.
    Promulgated July 18, 1933.

      Elwood Hcmnilton, Esq., and J. G. W. Beckham, Esq., for the petitioner.

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

Murdock :

The Commissioner determined deficiencies of $16,880.04, $2,281.58, $427.85 and $319.16 in the petitioner’s income tax for the calendar years 1922, 1923, 1924 and 1925, respectively. The petitioner has assigned the following errors:

(1) The Commissioner of Internal Revenue erroneously included in income $50,000 received by the petitioner for a two-thirds interest in the practice of his profession, to-wit, attorney at law, for the year 1922.
(2) The Commissioner of Internal Revenue erroneously refused to allow the petitioner a fire loss of $53,313.54 for the year 1922.
(3) The Commissioner erroneously reduced depreciation $1,986.17 and refused to allow $1,200 expense of operating an automobile in business for 1924.

Other errors were assigned but are no longer urged.

The material facts are as follows:

The petitioner is an individual who resides near Frankfort, Kentucky. In 1900 he became a member of the Court of Appeals of Kentucky. In December, 1911, he resigned from the Court and resumed the practice of law at Frankfort.
On January 2, 1922, the petitioner entered into an agreement with W. D. Fowler which provided that the two should become partners in the practice of the law. The petitioner was to have a two-thirds interest in the firm and Fowler a one-third interest, including all fees thereafter collected upon new or former employments of either on which any additional work was to be done. The agreement provided in part as follows:
As further differential in division of fees and income of the firm business, due to the conceded excess value of good will and unearned fees of said O’Rear put into the firm, said Fowler agrees to pay said O’Rear Twenty-five ($25,000) thousand dollars * * *.
On June 1, 1922, the petitioner entered into an agreement with William L. Wallace, which provided that Wallace should become a member of the law firm of O’Rear and Fowler and should receive one-third of the income from the law business of that firm and should hear a like portion of its expenses. The partnership between O’Rear and Wallace was to continue for five years unless sooner dissolved by the consent of Wallace or the death of either. This agreement provided in part as follows:
Said Wallace, as a differential in division of fees and income of the said firm, due to the conceded excess value of good will and unearned fees of said O’Rear put into the firm, is to pay said O’Rear twenty-five thousand ($25,000) dollars * * *.
In 1922 Fowler and Wallace each paid the petitioner $25,000 as provided in the agreements. The petitioner did not report in his income-tax return for 1922 the $50,000 received from Fowler and Wallace. The Commissioner included this amount in his income for that year, with the explanation that the amount represented the estimated present value in 1922 of a two-thirds interest in the petitioner’s expected future profits from his profession.
In 1922 the petitioner’s house was almost completely destroyed by fire, together with most of its contents. The house was insured for $15,000 and tlie contents were insured for $6,000. The petitioner received these amounts as the only compensation for his loss. On his return for 1922 the petitioner claimed a deduction of $53,287.26 as his loss on his house and its contents from fire. The Commissioner disallowed all of this loss except $1,386.18 on household goods. The cost of the property acquired after February 28, 1913, added to tie fair market value on March 1, 1913, of the property acquired prior thereto, all of which property was destroyed by the fire, was $55,000.
During 1924 the petitioner spent at least $600 in operating an automobile in connection with his law practice away from his office in Frankfort, Kentucky. The Commissioner disallowed a deduction of $1,200 claimed as cost of operating this automobile.

We know of no theory upon which the petitioner can escape taxation on the $50,000 which he received in 1922 from Fowler and Wallace. The entire amount was, in our opinion, income, gain or profit within the meaning of section 213 (a) of the Revenue Act of 1921. The act provides for no offsetting deduction. The petitioner in his brief contends that “ the sale of the right to share in the business and profits of a law practice is the sale of a capital asset, and any profit therefrom should be computed on that basis.” He says the asset sold was good will ” or “ more accurately * * * the good will of his business, with the right to share in future profits.” Next he claims that the good will had a value on March 1, 1913, greater than the amount realized from its sale in 1922. Therefore he concludes there was no gain to report in 1922. This argument is specious as applied to the facts in this case.

In the first place it is at least doubtful whether a professional man can sell or dispose of any good will which may attach to his practice except perhaps by contracting to refrain from practicing. Cf. Menefee v. Rankins, 158 Ky. 78; 164 S.W. 365; Cowan v. Fairbrother, 118 N.C. 406; 24 S.E. 212; Brown v. Benzinger, 118 Md. 29; 84 Atl. 79; Kremelberg v. Thompson, 87 N.J. Eq. 655; 103 Atl. 523. The petitioner no doubt enjoyed a good reputation as an able lawyer. This he had built up through the skill with which he rendered personal services to clients. It was probably of value to him. But it attached to his person. He could not transfer it piecemeal to two others. Cf. Metropolitan Bank v. St. Louis Dispatch Co., 149 U.S. 436; MeFarlan v. Stewart, 2 Watts, (Pa.) 111. They could not acquire part of his reputation or ability. Furthermore the proof in this case does not justify or permit a separate valuation of any good will or other intangible asset which attached to the petitioner’s practice of law on March 1, 1913. The value of any such intangible asset would depend upon the existence of an excess of his earnings over and above proper compensation for the services which he actually rendered. Cf. Victor J. McQuade, 4 B.T.A. 837. So far as we know there was no such excess prior to March 1, 1913. But the most damaging defect in the petitioner’s argument is the fact that the portions of the agreement with which we are concerned do not even purport to be sales contracts. They do not have the effect of sales contracts. If the petitioner had any “ good will ” theretofore, obviously he disposed of none of it by entering into these contracts. Thus the provisions of the statutes relating to gain or loss upon the sale or disposition of property do not apply. He was not to refrain from practicing; on the contrary, he was to use every talent and every asset which he had for practicing law successfully. The agreement recognized that he would contribute more to the success of the firm than the others and therefore he should be favored in some way in the compensation which he Avould receive. The desired result might have been accomplished by a provision that he should have more than one third of the annual earnings. Instead he agreed, in consideration of an immediate cash payment, to relinquish his right to a part of future earnings. These payments were income to him. The contracts called them “ a differential in division of fees and income of the firm business.” Compensation for personal services is income regardless of whether it is paid directly by clients or whether it is received through an arrangement with partners whereby they advance certain amounts for the privilege of taking a larger share of the partnership profits than their personal contribution would otherwise justify.

The petitioner really seeks to capitalize his reputation, ability, industry, and prospects for rendering personal services for profit on March 1, 1913. On the same theory every professional man and probably every other person might be entitled to offset his income after March 1,1913, with some part of his prospective worth on that date. We do not think Congress intended any such capitalization.

The deduction for fire loss must be computed upon the cost of the property acquired subsequent to February 28, 1913, and upon the fair market value on March 1, 1913, of the property acquired before that date. Sec. 214(a) (6), Revenue Act of 1921. In Tracy V. Buckwalter, 20 B.T.A. 1005, (affirmed on other points 61 Fed. (2d) 571) the Board erred in using value at the time of destruction. The cost and value should not be reduced by depreciation or obsolescence. Deposit Trust & Savings Bank, Executor, 11 B.T.A. 706; W. B. Brooks, 12 B.T.A. 31, affirmed on other points, 35 Fed. (2d) 178. Cf. J. A. Talbot, 23 B.T.A. 792. We have found the total cost and March 1, 1913, value from a consideration of all of the evidence. A separate finding for each is not possible, but under the Board’s decisions our finding is adequate for a decision of the case.

The petitioner failed to show the cost of his automobile, when it was purchased, or the amount of depreciation applicable to the year 1924. He drove it on his daily trips between his home in the country and his office in Frankfort. The part of the cost, upkeep, and operation allocable to this use is not deductible from his income, but represents a personal expense. Frank H. Sullivan, 1 B.T.A. 93, and many later cases. Some of these expenditures were deductible from income because to some extent the car was used in the petitioner’s business. We are unable to make an accurate allocation of the expense of operation. The amount allowed has been approximated, in accordance with the opinion of the court in Cohan v. Commissioner, 39 Fed. (2d) 540.

Decision will ~be entered wider Rule 50.


author: Murdock:

text:
    Christian W. Von Gunten, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61278.
    Promulgated July 18, 1933.

      J. T. Kennedy, Esq., for the petitioner.

      F. A. Surine, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency in income taxes for the year 1929 in the amount of $2,754.25. The assignment of error is as follows:

In determining- the profit on the sale of corporate stock by the petitioner, the Commissioner erred in the cost basis he adopted, and in denying to petitioner any election respecting- the lots from which said stock should have been deemed to have been sold, or any election to use the average share cost of said stock as the basis for determining said profit.

The stipulated facts may be summarized as follows:

The petitioner is an individual. He held common stock in the Averill Dairy Co. at the beginning of 1929. On or about June 6, 1929, pursuant to a reorganization, the Borden Co. exchanged some of its capital stock for all of the capital stock of the Averill Dairy Co. Thus the petitioner received SYs shares of Borden stock for each share of Averill stock which he had owned, or 3,750 shares of Borden for 450 shares of Averill stock. The following table shows certain details relating to the acquisition of the 450 shares of Averill stock:

He held separate stock certificates for each lot shown above. In 1929 he sold 800 of his 3,750 shares of Borden Co. stock for $62,147.50. The Commissioner in determining the deficiency computed the profit on the sale of the 800 shares by using as a basis for gain thereon a cost of $2,133.33, determined in this way: The total cost of the earliest block of 50 shares of Averill stock purchased was divided by 225, the number of shares to which this block grew by stock dividends; the result was divided by 8ys to get the cost of one share of Borden stock; and the result thus obtained was multiplied by 800. In this way the Commissioner computed a profit of $60,-014.17. The petitioner in his return deducted $22,576.76 as the cost of the 800 shares sold. This cost was based upon the average cost of each share of Averill stock.

The question is, What basis should be used? The respondent has not referred us to any applicable regulation. He cites section 113 (a) (9) of the Revenue Act of 1928 and Regulations 74, article 600, promulgated pursuant to authority contained in that subsection. The subsection relates only to stock or securities distributed to a taxpayer in connection with a transaction described in section 112 (g). Section 112 (g) covers an entirely different kind of distribution from the one involved in the present case. It deals with a distribution of shares to a former shareholder “ without the surrender by such shareholder ” of his old shares. Here the petitioner surrendered his Averill shares and received only Borden shares. Thus the respondent finds no support in the provisions of the statute or the regulations upon which he relies.

Nor is he aided by the rule of “ first in, first out.” See Regulations 74, article 58 and similar provisions of earlier regulations. The courts and this Board have approved of this rule when properly applied because some simple and uniform rule was needed and the Commissioner by his regulations supplied one. Cf. Burdett Stryker, 21 B.T.A. 561; David Stewart, 17 B.T.A. 604; Snyder v. Commissioner, 54 Fed. (2d) 57, affirming John A. Snyder, 20 B.T.A. 778. The situation to which the regulations apply is where there has been a sale “ from lots purchased at different times and at different prices and the identity of the lots can not be determined.” In such cases the regulations charge the earliest sales against the earliest purchases. There is no analogy between cases expressly covered by those regulations and the present case, which is not covered by any regulation. Here the petitioner sold Borden stock. He had acquired all of his Borden stock at one time. Thus the sale was not made “ from lots purchased at different times and at different prices.”

Furthermore, there is no need for any rule in a case like this except the rule that the basis for all shares acquired at one time shall be prorated equally among tbe shares. The petitioner disposed of all of his Averili stock at one time by exchanging it for Borden stock. This exchange was in pursuance of the plan of reorganization” and section 112 (b) (3) expressly provides that no gain or loss shall be recognized in such an exchange. Were it not for this provision the general rule of section 112 (a) would apply. That rule is that “ upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized.” The gain or loss upon that exchange would have been the difference between the total cost of the Averili stock and the fair market value of the Borden stock at the date received. The basis for subsequent gain or loss on the Borden stock would have been its fair market value at the time received. This basis would have been allocated pro rata to each Borden share. But because of other provisions no gain or loss was recognized on that exchange. Consequently the basis for subsequent gain or loss on the Borden stock “ shall be the same as in the case of the property exchanged.” Sec. 113 (a) (6). This means in the present case that the basis for the 3,750 shares of Borden stock shall be $105,833.33, the cost of the 450 shares of Averili stock to the petitioner. Since all of the Borden shares were acquired at one time, and since collectively they have a basis of $105,833.33, each share has a basis of 1/3750 of $105,833.33, or $28.2222. The basis for 800 shares would be $22,577.76. We can see no justification for holding that these 800 shares bore any relation to any particular Averili shares or for holding that they should be allotted only that portion of the cost of the Averili shares which represented the cost of the earliest shares purchased.

Decision will he entered wider Rule 50.