author: Leech:

text:
    Carson Estate Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47444, 53489.
    Promulgated November 15, 1934.

      Harvey J. Stevenson, O. P. A., and Joseph D. Brady, Esq., for the petitioner.

      Olay 0. Holmes, Esq., for the respondent.
   OPINION.

Leech:

These consolidated proceedings seek redetermination of income tax deficiencies in the amounts of $2,086,02 for the year 1926, $1,780.08 for the year 1927, and $1,815.31 for the year 1928. The total deficiencies for 1926 and 1927 are not in controversy.

The facts are stipulated. A rather full resume of them follows:

Petitioner is a California corporation It acquired certain certificates of ownership from Municipal Bond Co., hereinafter referred to as the corporation.

The form of ownership certificate issued by the corporation provides that the corporation “ does hereby sell and transfer to the purchaser of this certificate all of its rights, title and interest in Municipal Improvement Bonds issued under the special assessment laws of the State of California ”, of a specified unpaid face value; that the corporation certifies that such bonds and other like bonds are deposited with a named trustee to hold the same under a trust agreement made a part of the certificate as though incorporated therein; that the bearer or registered holder of the certificate “ is entitled to participate in the proceeds and avails of such bonds, so deposited, to the extent of the principal sum of-Dollars, payable from such proceeds and avails on the-day of-19 — , with interest on said sum from the date hereof at the rate of_Per Cent (_%) per annum, payable semi-annually on the first days of __and_in each year upon surrender of the coupons hereto attached, as they severally mature ”; that the owner of the certificate “ is entitled at any time upon demand and surrender of this certificate, together with its unmatured coupons, to said trustee, to receive bonds of unpaid face value equal to the principal sum herein mentioned, the accrued interest to be adjusted as of date of delivery on both this certificate and the bonds so delivered ”; that the certificate owner “ releases and waives ” all interest or other sums collected by the trustee upon such bonds, in excess of the principal sum and interest at the rate specified in the certificate. The corporation has deposited with the trustee, unpaid face value bonds equal to 110 percent of the principal sum stated in the certificate, “ for the purpose of better securing the distribution of the proceeds and avails of such bonds ”; that the corporation covenants “ that the principal and interest to become due upon said bonds, when and as the same matures, will be paid, such covenant to continue as long as such bonds remain on deposit with said Trustee.” The form of the coupon attached to the certificate provides that the certificate owner “ Is Entitled to Receive_Dollars from the avails of Bonds on deposit with said Bank in Trust No._, according to the terms of such Trust, and the Undersigned (the corporation) covenants that the avails from such Bonds will be paid.” The form of the trustee’s certificate provides that “ The undersigned hereby certifies that the within certificate and coupons attached, is one of the certificates executed by Municipal Bond Company under an Agreement of Trust with this Corporation, dated_” and further, that there has been deposited with it, bonds of the designated character and of the unpaid face value of 110 percent of the principal sum stated in the certificate.

The trust agreement sets out that the corporation desires to sell municipal improvement bonds which it owns or may acquire; that such bonds vary in amounts and dates of maturity; that the corporation, instead of selling specific bonds, desires to sell to the purchaser an interest in such bonds in even sums such as $100 or multiples thereof, and reinvesting for such purchaser the principal of such bonds as they mature to the end that the purchaser shall have his money invested in such bonds for a definite period such as five or ten years; that to accomplish such purpose, the corporation desires to deposit such bonds with the trustee “ for the use and benefit of such person as may purchase an interest therein ”; that the corporation desires to issue the above-mentioned certificates of ownership to such purchasers; and, further, that “ in consideration of the premises, the said Trustee hereby agrees to accept from said Corporation, such bonds and to hold the same for the benefit of the holders of such certificates, in trust upon the terms and conditions and for the purposes herein set forth.” The terms and conditions of the trust, the duties and obligations of the trustee and the corporation, and also the rights of the parties, including the purchaser, are set forth in great detail. Article II provides for the deposit of bonds with the trustee and section 3 thereof provides, “ Said Corporation shall transfer, assign and set over to said Trustee the absolute title to said bonds, to hold in accordance with the provisions of this Trust Agreement, and shall execute any and all transfers, assignments or other instruments necessary to pass the title in said bonds to said Trustee.” Article III provides that the corporation may withdraw any of the bonds upon delivery to the trustee of an equal amount of unpaid face value of bonds of the same character, provided the aggregate interest on the substituted bonds shall equal or exceed the interest specified in the certificates. Article IY provides that the trustee shall collect or cause to be collected, interest on the bonds for the benefit of the trust; that the corporation agrees to purchase for cash at face value any interest coupons due and uncollected; that the trustee shall sell to the corporation all installment coupons of principal falling due and maturing serial bonds, for which the corporation agrees to deliver to the trustee other bonds of the same character of an unpaid face value equal to the coupons and maturing bonds, such other bonds to be held for the benefit of the certificate holders; and that the purpose and intent is that trustee shall collect the interest accruing on all bonds for the benefit of the trust and as the bonds mature the principal to be immediately reinvested in like bonds for the benefit of the trust. Article Y provides that out of moneys received from the collection or sale of interest coupons on the municipal bonds, the trustee shall pay to the certificate owners the interest specified therein and, after deducting the trustee’s charges, pay the excess to the corporation as income on the excess 10 percent of bonds deposited and as compensation to the corporation for selling ownership certificates and collecting interest and principal for the trustee. The corporation is enti-tied to any bonus or penalty received by the trustee upon payment of any bond. Articles VI and VII provide for the payment of the principal sum stated in the ownership certificate, prior to maturity upon demand, by delivery to certificate holder of specific bonds, selected by the trustee, or at maturity by cash or unpaid bonds at the election of the certificate owner. The corporation agrees to repurchase bonds, at their unpaid face value, and equal to the face value of maturing certificates, at the maturity of the latter, with the proceeds of which sales to the corporation, the maturing certificates are to be paid. Article VIII, section 1, provides, “It is the intention of the parties hereto that the delivery to the purchaser thereof of a certified certificate, vests in the holder of such certificate the ownership of an amount in unpaid face value bonds, equal to the par Avalué of the certificate, subject to the implied agreement on the part of the purchaser of such certificate by the acceptance thereof, to allow the said bonds to remain in the hands of the Trustee for collection under the terms and conditions of this Trust, and also subject to the release and waiver by the holder thereof of all interest, bonuses, penalties or other sums collected by the Trustee upon the bonds so deposited with the Trustee, in excess of the principal sum mentioned in such certificate and the interest on such principal sum at the rate specified in said certificate.” Article IX provides that the certificates of ownership may be transferred, and also provides for the registration of such certificates. Article X provides that the corporation in joining in the execution of the trust agreement, warrants that the bonds deposited Avith the trustee are legal, valid and subsisting obligations, and that the installments of principal and interest specified in each bond will be paid as and when the same mature. Article XI sets forth the responsibility of the trustee under the terms of the trust, and Article XII fixes the amount of the trustee’s fees.

The petitioner received “ interest income ” pursuant to and in accordance with the terms and provisions of the above mentioned ownership certificates at the rate of 6 percent per annum, payable semiannually as follows;

Calendar year 1926_$9, 624. 01
Calendar year 1927 — __ 10, 327. 60
Calendar year 1928- 12,127. 51

During the taxable years here in controversy none of the “ interest income ” here involved flowed to petitioner by reason of any of the Avarranties or coi^enants of Municipal Bond Co. or from bonds bearing an interest rate of less than 7 percent.

All of the bonds which were deposited in the trust provided for in the above trust agreement were municipal improvement bonds. issued under special assessment laws of the State of California. The interest on these bonds was not subject to Federal income tax.

In its returns filed for the calendar years 1926, 1927, and 1928, petitioner treated the above amounts as interest received from municipal bonds and reported it as tax exempt.

Respondent restored the amounts in controversy to taxable income on the ground that such amounts constituted interest on obligations of the Municipal Bond Co. and not interest on tax exempt securities.

Thus, the only issue is whether the petitioner’s acquisition of the certificates of ownership constituted a sale to it by the corporation of the beneficial ownership in municipal bonds, the interest on which is admittedly exempt from income tax, or was a loan by petitioner to the corporation, and the “ interest income ” thus received by petitioner as interest on the obligation of the corporation, and subject to that tax. This question is answered by the intention of the parties to the transaction evidenced by the “ certificates of ownership ” and the “ trust agreement ” made part thereof, construed as a whole (Heryford, v. Davis, 102 U. S. 225), together with the actual treatment of the transaction by the parties thereto. First National Bank in Wichita v. Commissioner, 57 Fed. (2d) 7, affirming 19 B. T. A. 744; certiorari denied, 287 U. S. 636; Bank of California, National Association, 30 B. T. A. 556. Since it is stipulated that the disputed “ interest income ” was received in accordance with the terms of the certificates of ownership, which incorporated the “ trust agreement ” therein, we are concerned here only with the proper construction of those instruments. Cf. Frank Turner, 28 B. T. A. 91.

Undoubtedly the. “ certificate of ownership” on its face purports to sell and transfer to the purchaser of this certificate all of its rights, title and interest in the Municipal Improvement Bonds ”, deposited with the trustee under the trust agreement ” made a part thereof. That agreement contains all the essentials of a valid irrevocable declaration of trust. In unmistakable terms, it states that “ It is the intention of the parties hereto that the delivery to the purchaser thereof of a certified certificate, vests in the holder of such certificate ownership of an amount in unpaid face value, bonds equal to the par value of the certificate ”, subject to the conditions of the agreement.

Respondent argues that the qualifications attached to this purported transfer of beneficial ownership, in the express and implied conditions of these instruments, are inconsistent with the transfer of any interest in the municipal bonds by the corporation to petitioner, and characterize the transaction as a loan from petitioner to the corporation, secured by a lien on escrowed guaranteed municipal bonds.

The absence of control by petitioner over the deposited bonds was a natural and not peculiar incident of a valid trust. Nor was the conditional right of the corporation to substitute bonds with the trustee inconsistent with such a trust. Campbell v. Campbell, 207 Ky. 17; 268 S. W. 588; Leland v. Collver, 34 Mich. 318; S. A. Lynch, 23 B. T. A. 435. The spread between the interest rate on the deposited bonds and that of the certificates of ownership, while of some possible significance, is certainly not controlling (cf. First National Ba/nk i/n Wichita v. 0om/missioner, supra, and Bank of California, National Association, supra), particularly since the certificate rate was not the legal loan rate. Sec. 1, Act No. 3757 of the State of California, approved Nov. 5, 1918.

The corporation’s repurchase agreement did not invalidate the trust by making incomplete the otherwise completed transfer, nor did it divest the ownership then conveyed. Lyons v. Snider, 136 Minn. 252; 161 N. W. 532; Paulson v. Weeks, 80 Or. 468; 157 Pac. 590. Although the fact that the repurchase price" was par value, which was the basis upon which petitioner purchased, has been considered as some, though not compelling, indication of a loan (cf. First National Bank in Wichita v. Commissioner, supra, and Bank of California, National Association, supra, it has been held to evidence the transfer of an entire interest and thus imply sale. Chase & Baker Co. v. National Trust & Credit Co. (Dist. Ct., N. Dist. Ill.), 215 Fed. 633.

The warranty of the deposited bonds and the interest payable thereon, with the auxiliary 10 percent excess deposit of bonds, is at least equally consistent with an intended separate contract from that of sale or transfer in trust, as it is with a loan secured by guaranteed collateral. Chase & Baker Co. v. National Trust & Credit Co., supra.

The corporation’s right to any premiums or penalties on the deposited bonds, said to be evidential of its failure to transfer beneficial ownership therein, loses its value in the presence of petitioner’s right upon its demand to specific bonds, and thus to secure such profit. This right of petitioner, while possible of construction as an option if the transaction under consideration were a loan, is just as consistent with a condition terminating the trust as to petitioner if the transaction was a sale of a beneficial interest. Cary v. Slead, 220 Ill. 508; 77 N. E. 234; Tuck v. Knapp, 85 N. Y. S. 1001; 42 Misc. Rep. 140; In re Ames, 22 R. I. 54; 46 Atl. 47. Nor is that consistency lost by the mandatory selection by the trustee of bonds to satisfy such demand as the class for which the selection is to be made, is certain. In re Dewey's Estate, 45 Utah, 98; 143 Pac. 124.

The existence of a beneficial interest in the deposited bonds to the extent of the excess deposited, the premiums and penalties to be received on the bonds and the difference in interest received thereon and that paid on the certificates, in the corporation, and the remaining beneficial ownership in the deposited bonds in petitioner, is likewise consistent with a valid trust. Certainly the creator of a trust may also be a beneficiary thereof, either alone or jointly. Reginald Brooks, 31 B. T. A. 70; Iola Wise Stetson, 26 B. T. A. 390; 27 B. T. A. 173.

The argument that if a valid trust was created it was “ in the avails of the bonds ” and not the bonds themselves, is of little, if any weight, generally, in itself, and fails here particularly because upon termination of the trust as to -petitioner it had the right to demand specific bonds. This right at maturity, as well as its alternative, the right to the “ avails of the bonds ” at the full par value of the certificate of ownership, contradicts the deposit of bonds as a mere escrow transfer to secure a primary obligation of the corporation. Cf. Frank Turner, supra; Frank P. Welch, 12 B. T. A. 800.

In short, the “ certificate of ownership ” and “ trust agreement ” disclose nothing inconsistent with the stated intention of creating an irrevocable trust in municipal bonds and selling the beneficial ownership therein. Neither document contains any primary obligation of the corporation to petitioner, certificate holder. The only obligation of the corporation was its secondary liability on its covenant of warranty, from which none of the questioned amounts flowed. The necessary complement of respondent’s present position would permit the pending disputed exemption to the corporation — certainly a difficult result to sustain.

Then again, and of emphatic if not compelling persuasion here, we have the uncontradicted background and purpose of the transaction.

This record contains no history or suggestion branding the corporation as at any time a borrower and petitioner as a lender. It indicates only that they were seller and purchaser. Cf. First National Bank in Wichita v. Commissioner, supra; Bank of California, National Association, supra; Frank Turner, supra.

The business of the corporation was the sale of these municipal bonds of odd face values and maturities. The present uncontradicted purpose of increasing the marketability of such bonds by eliminating these unfavorable features and the means chosen to effect it, are both credible and legal. Cf. Reginald Brooks, supra.

We conclude that the corporation created a valid irrevocable trust in municipal bonds, the interest on which, admittedly exempt from income tax, constituted its only income; that petitioner was a beneficial owner of those bonds and received the controverted “ interest income ” as such, thereon, free from income tas. Cf. Norfolk National Bank of Commerce & Trusts v. Commissioner, 56 Fed. (2d) 48; reversing 26 B. T. A. 1111.

Reviewed by the Board.

Decision will he entered wader Rule 50.


source: Caselaw Access Project

author: Matthews :

license: Public Domain

text:
    Milo R. Maltbie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43618, 48344.
    Promulgated November 16, 1934.

      Leonard M. Wallstem, Esq., for the petitioner.

      L. W. Creason, Esq., for the respondent.
   OPINION.

Matthews :

Petitioner seeks exemption from Federal tax of income received by him as a public utility consultant from various states and municipalities in the years in question. He does not claim to have been an officer, but does contend that the facts show him to have been an employee, that he was employed in the performance of essential governmental functions, and that a tax on his income would be a direct interference with the exercise of these functions by the several states and cities involved.

The petitioner is a man well trained as an expert in public utility matters, has had a large experience in such matters, and is a high authority in tha field. His testimony was full, exact, and candidly given. Pie has served as a public official' and was at the time of the hearing chairman of the New York Public Service Commission. He was able, consequently, to appreciate the attitude of mind of the hiring state official as well as that of the hired expert. Few cities, he testified, not even the largest like New York and Chicago, are able to maintain permanent staffs adequate to cope with the work arising out of rate regulation proceedings and franchise matters. One reason is that rate cases arise irregularly and franchise grants at long intervals, around twenty years. The mayor, corporation counsel, or other city official, or the public service commission, is accustomed, therefore, to augment its staff on such occasions, to deal with the problem in hand. Often the work that may be done is strictly limited, as in the New Hampshire case here, by the amount of the legislative grant, and the officials in charge must see that the money spent will go as far as possible.

There are various methods of compensation used in hiring the experts needed. Some are hired on a contractual basis to do a certain piece of work for a fixed sum, and often, where the case is concluded before all the work planned has been finished, a certain minimum sum is guaranteed. The per diem basis is the method most frequently-used by public utilities officials, since it insures elasticity in the conduct of investigations and does not require work which the corporation counsel has initiated but has since decided to abandon, to be completed and paid for. On the per diem basis only work actually wanted is done and the employment is terminable at the will of the commission or city.

Petitioner took no oath of office, gave no bond, held no statutorily defined position with incidents of tenure, and had no fixed salary. He was hired, or “ employed ”, by the state public service commissions of New Hampshire and Pennsylvania, for the investigation of public utility rates; by the cities of Lexington, Kentucky, and Chicago, Illinois, in connection with the granting of new franchises to public utility companies; and by various cities in New York, including New York City, for investigations arising out of court litigation and other proceedings regulatory of public utilities. Petitioner ordinarily entered into a very simple and elastic form of agreement and the terms of his employment were almost identical in each instance. Petitioner wrote a letter to the city or state official in charge of the matter to be investigated and informed him that he, petitioner, would work for $100 a day, plus necessary expenses, and that his staff, including engineers, accountants, and routine assistants, would also work for so much a day, generally much less than petitioner got. The contract was to be terminable at will of the officer, and all investigations were to be under his direction. This agreement was generally accepted by letter, or endorsement on the offering letter, and petitioner’s work proceeded. Sometimes the contract was even more informal, being simply an oral understanding. All of petitioner’s work here in question was done on a per diem basis. Petitioner’s counsel laid great stress on the fact that petitioner received more or less detailed directions from the corporation counsel or the public service commission in each instance, as to the institution, continuance, abandonment, or completion of any particular line of investigation. There is no doubt on the record that the work of petitioner and his staff was wholly under the commission or city officer in, charge, subjected, that is, as much as that of any expert employee can reasonably be, to supervision. Petitioner was expected to make reports on his investigations, to comb the record in court or commission hearings and analyze the testimony, and to assist by giving testimony himself or by cross-examination. He did all these things.

This, in substance, was the nature and scope of petitioner’s employment. He used his own staff all the time. He throughout maintained his own office, did work for others than public service commissions or cities, and received income from such work. That income is not claimed here as exempt, but the fact goes to show petitioner’s methods. All his staff were paid through him, and sometimes the city’s employees also, when the city was anxious to keep tab on particular project expenditures. Finally, he was simultaneously working for two state public utility commissions and about a dozen municipalities.

The question is, Was petitioner in such circumstances a state or city employee? In no case did he make any final decision as to the rate to be applied. This was done by the city officer or by the commission. In only one, the Lexington, Kentucky, franchise case, was he called upon to establish such a rate. In that case he was drafting a new franchise, and the positive formulation of policy on the basis of his investigations was necessary to complete the work assigned him. He was obviously a technical expert of a high order, whose professional knowledge and opinion were valuable and for which various cities were willing to pay well. Does this make him an “ employee ” of a state or a political subdivision thereof, within even the vague contours of that word, for purposes of Federal taxation? We think not.

Ho useful purpose would be served by an extended review of the numerous cases dealing with this problem. The Supreme Court has spoken in Metcalf & Eddy v. Mitchell, 269 U.S. 514, the inferior Federal courts and this Board in many other cases. “ Employee ” is not susceptible of exact definition and can be interpreted intelligently only by keeping in mind the underlying reason for the exemption. The line must be drawn in each case, therefore, according to the peculiar circumstances present. The situation here is so like that in the Metcalf case that a recital of the facts of that case is pertinent:

All of the items of income were received by the taxpayers as compensation for their services as consulting engineers under contracts with states or municipalities, or water or sewage districts created by state statute. In each case the service was rendered in connection with a particular project for water supply or sewage disposal, and the compensation was paid in some instances on an annual basis, in others on a monthly or daily basis, and in still others on the basis of a gross sum for the whole service.

The Supreme Court held these engineers neither officers nor employees, but independent contractors. Touching on the question of Federal interference with state governmental functions by imposing on these engineers an income tax, the Court said:

And as was said in Fidelity & Deposit Company v. Pennsylvania,, supra, in holding valid a state tax on premiums collected by bonding insurance companies on surety bonds required by United States officials:
“But mere contracts between private corporations and the United States do not necessarily render the former essential government agencies and confer freedom from state control.”
These statements we deem to be equally applicable to private citizens engaged in the general practice of a profession or the conduct of a business in the course of which they enter into contracts with government from which they derive a profit. * * *

The petitioner here was a “ public utility consultant ” who performed all his services for state subdivisions on the basis of per diem contracts for himself and his staff, which often númbered a score or more experts and routine assistants. We can not find any satisfactory basis of distinction between this and the Metealf case. Certainly a technical expert temporarily employed by a state does not thereby clothe himself with state immunity.

In Lucas v. Reed, 281 U. S. 699, the Supreme Court reversed the Circuit Court, 34 Fed. (2d) 263, in a per curiam decision, on the authority of the Metcalf case. The Attorney General of Pennsylvania, under statutory authority to “ employ ” additional counsel to aid the state in the Frick inheritance tax case, hired Reed. The collection of a state’s revenue and the maintenance of its constitutional authority to levy and collect taxes is unquestionably a governmental function, but Reed’s relation to the state government was deemed too remote to affect materially this vital interest of a state. See also Lucas v. Howard, 280 U. S. 526, the case of an attorney hired by a city to conduct cases involving railroad grade crossings, and the like. A more recent case following the Reed case is Commissioner v. Murphy, 70 Fed. (2d) 790, in which the Circuit Court reversed this Board; certiorari denied, 293 U. S. 596, and held taxable the fee paid a lawyer hired by the State of New York as “ deputy attorney general ” to defend its interests in the Cayuga Indians case before the American-British Arbitral Tribunal. Cf. Edgar N. Finn, 31 B. T. A. 439.

In the brief filed on behalf of petitioner it is strongly urged that the instant case is in many respects upon all fours with the case of Donald R. Richberg, Docket No. 38723, in which case this Board rendered an unreported decision dated December 17, 1932. To state the facts of that case will suffice to show its variance. We said:

Petitioner herein was employed in an official position by the City of Chicago during the taxable years in controversy, under and by virtue of an Ordinance enacted May 27, 1918, creating the office of “ Special Counsel for the City of Chicago in Gas Matters ”. * * *
The duties of the petitioner herein were prescribed in Section 2 of the aforesaid Ordinance and constituted work of a permanent and continuing nature and character involving a representation of the Gity of Chicago in all legal proceedings then pending between the City of Chicago and the People’s Gas Light & Coke Company, the sole manufacturer and distributor of gas in the City of Chicago and extended to representation “ in charge of the City’s interests with regard to all gas matters “ past, present and future rates, standards or service for the supply of gas in the City of Chicago.”

We Reid the petitioner therein to be an officer of the city of Chicago and decided that the income derived by him from such office was tax-exempt. The differences between the two cases are apparent and we should not refer to them here except for the petitioner’s insistence on their similarity. The prescribed duties, the permanence and continuity of the petitioner’s position in the Richberg case, his representative character, all distinguish that case.

We do not regard the petitioner’s admission in 1931 to the benefits of the New York State Employees’ Retirement System as in any way determinative of the issue presented herein, although we have considered it as evidence. The retirement of officers and employees under the civil service is provided for by articles 4 and 5 of the Civil Service Law of Yew York, being ch. 741, Laws 1920, and ch. 591, Laws 1922, with subsequent amendments in 1932. We find nothing in the provisions of this law which would indicate that the petitioner was entitled to membership in the Employees’ Retirement System by reason of the service he rendered to municipalities of the state during the taxable years involved herein. It was in 1931 that he applied for and was admitted to membership and at that time he was Chairman of the Public Service Cohiejíssion of New York. He was, therefore, engaged in state service, which is defined in subdivision 8 of section 50 of article 4 of the Civil Service Law as “ service, whether appointive or elective, as an official, clerk, or employee of the state of New York, or municipality participating in the system.” The fact that he was permitted to, and did, pay to the state comptroller a percentage of the compensation received by him in prior years for services rendered to certain municipalities in the state, in order to receive prior service credit, does not furnish any basis for holding that he was an employee of the state of New York, or a political subdivision thereof, during those prior years.

After a careful consideration of all the evidence introduced herein we are of the opinion that the petitioner is not entitled to exemption from Federal income tax on account of the compensation received by him for services rendered to the several state public service commissions and municipalities, and we hold that such compensation is includable in his gross income for the taxable years.

No question as to the amount of income involved is raised.

Judgment will be entered for the respondent.


author: Adams :

text:
    William Fleming, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mrs. William Fleming, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61042, 61043, 65676, 65677.
    Promulgated November 16, 1934.

      George 8. Atkinson, Esq., .for tlie petitioners.

      Jokn D. Kiley, Esq., and F. B. S'ehlosser, Esq., for the respondent.
   OPINION.

Adams :

These consolidated cases involve deficiencies for the following years and amounts:

The facts were stipulated and are incorporated herein by reference. In addition, the individual returns of each of the petitioners for the taxable years were introduced in evidence.

The petitioners in their original petitions alleged that the respondent had erroneously failed to allow certain losses which they claimed to have sustained on sales of real estate, an oil royalty, and a block of bank stock. These losses amounted to about $33,000 for 1928 and to $3,557.40 for 1929. At the hearing, however, petitioners waived their claims for these losses and filed a supplemental petition alleging an entirely new cause of complaint, which was that the respondent had failed to make a deduction for depletion on oil bonuses and payments made from oil runs. It was further claimed that because of this omission the petitioners had overpaid their taxes and were entitled to refunds as follows: William Fleming, 1928, $4,386.18; 1929, $2,243.32; Mrs. William Fleming, 1928, $4,907.98; 1929, $2,259.21.

The petitioners are husband and wife and reside in the State of Texas, where community property laws prevail. They made individual returns, dividing the community income equally between them, but made no claims for the alleged depletion as such, and no allowance was made as depletion.

Briefly stated, the facts as to the claim of depletion are these. In 1928 petitioner William Fleming, the F. H. E. Oil Co., and Kay Kimbell sold to Naphen & Co. certain interests held by them in oil and gas leases in Howard County, Texas, known as Koberts “ B ”, “ D ”, and “ E ” leases, for part cash and the balance to be paid out of oil, if, as, and when produced. In the year 1928 petitioners received $250,000 cash and from payments made from oil they received $2,471.05, being a total of $252,471.05 received in 1928. The petitioners’ investment in the Koberts B, D, and E leases at the date of transfer in 1928, after adjustment for depletion and depreciation sustained to date of sale, was $57,939.66.

In 1929 they received in oil payments from the Koberts B, D, and E leases the sum of $70,593.22; $1,425.48 in other oil income; and $896.81 from fuel oil and gas sold, or a total payment from such sources of $72,915.51.

In 1929 petitioner William Fleming, the F. H. E. Oil Co., and Kay Kimbell sold to the California Co. their interests in an oil and gas lease known as the Koberts “A” lease for part cash and the balance to be paid from oil runs, if, as, and when produced. The petitioners in 1929 received $43,750 cash and $9,578.17 from oil runs, or a total of $53,328.17 from both sources from the Koberts A lease. The petitioners’ investment at the date of transfer of the Roberts A lease, adjusted for depletion and depreciation sustained to date of saie, was $11,254.90.

The petitioners in their individual income tax returns for the calendar year 1928 reported an amount of cash and oil payments received in 1928 from the Roberts B, D, and E leases! totaling $252,471.05, and took as a deduction therefrom their computation of the remaining cost at date of sale in the amount of $58,161.61, thereby reporting a community profit from the transaction of $194,309.37. No depletion was claimed by the petitioners on the returns for the year 1928 on any part of the $252,471.05. The respondent did not allow the petitioners or either of them any depletion deduction on any part of the item of $250,000 cash received in 1928 or the item of $2,471.05 paid out of oil produced in that year.

In their individual income tax returns for the year 1929 petitioners reported the amount of $72,915.51, made up of $70,593.22 from oil runs, $1,425.48 from other oil income, and $896.81 from fuel oil and gas sold as set out above. Neither of the petitioners in their separate returns deducted any amount for depletion with respect to such income and the respondent did not allow any depletion deduction with respect thereto.

The petitioners also reported in their income tax return for the year 1929 the amount of the gas and oil payments received in that year from the Roberts A lease referred to above, namely, $43,750 cash and $9,578.17 from oil runs, totaling $53',328.17, and took as a deduction the computation of the remaining investment at date of sale in the amount of $11,786.39, thereby reporting a community profit from the transaction of $41,541.78. JSTo depletion was claimed by the petitioners on any part of the $53,328.17. The respondent did not allow any depletion deduction on any part of the items of $43,750 and $9,578.17 reported by petitioners.

It is now contended by the petitioners that under the cases of Murphy Oil Co. v. Burnet, 287 U. S. 299, and Palmer v. Bender, 287 U. S. 551, they are entitled to depletion on both the cash payments and the payments received from oil runs. They contend in the alternative that they are entitled to depletion on the cash payments and oil runs reduced by their remaining investment in the property at the date of transfer in the respective years.

The respondent contends that the petitioners effectively disposed of their interest in the oil by sale, and that the payments in cash and those made out of oil are part of the purchase price of the oil and, therefore, not subject to depletion. The allowance claimed by petitioners is that provided for in section 114 (b) (3) of the Revenue Act of 1928, as follows:

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

It is true that in the cases above referred to the Court held that taxpayers selling or transferring interests in oil-bearing properties for a cash bonus and retaining an interest in oil in place, which is to be paid to them when extracted, are entitled to depletion for a return of their capital investments. It should be kept in mind, however, that those cases arose under the Revenue Acts of 1918 and 1921, and that under those revenue acts deductions for depletion are allowed for the purpose of permitting a return of the taxpayers’ capital investment, United States v. Ludey, 274 U. S. 295; Palmer v. Bender, supra; Murphy Oil Co. v. Burnet, supra, and are not based on income. The cases cited by petitioners do not support their contention in this proceeding, which differs from those cases as to its facts and, moreover, is controlled by the applicable sections of the Revenue Act of 1928, wherein the basis for depletion is the income received from the property during the taxable year

In Macon Oil & Gas Co., 23 B. T. A. 54, we had the question of whether the profit on the sale of leases is a part of the gross income from the property within the scope of section 204 (c) (2) of the Eevenue Act of 1926 (which section is substantially the same as section 114 (b) (3) of the Eevenue Act of 1928). We there held that depletion as to oil and gas properties may not be based on the profits received from the sale of the properties. See also Lester W. Fritz, 28 B.T.A. 408; Darby-Lynde Co. v. Alexander, 51 Fed. (2d) 56; certiorari denied, 284 U. S. 666. In the latter case the court held that “ gross income ” as used in section 204 (c) (2), swpra, means income derived from the sale or other disposition of oil and gas produced and not income derived from the sale of oil and gas properties. Applying this construction, which we think sound, we hold the cash payments received by petitioners in 1928 and 1929 from the sale of their oil and gas leases are not subject to depletion under section 114 (b) (3) of the Eevenue Act of 1928. Such cash receipts must be .treated as cash received upon the sale of property and gain or loss determined upon the basis of petitioner’s capital investment adjusted for depletion and depreciation sustained to the date of sale.

The respondent’s contention would treat the income derived from the sale of oil produced in the taxable years in the same manner as the cash received on the sale of the properties. We do not think such treatment is correct. It is true that, in a certain sense, the amounts received from the sale of the oil produced might be regarded as a part of the sale price, but on examination of the terms of the contract of sale, we think this point of view is not strictly correct. The agreement between the parties with respect to the Eoberts B, D, and E leases provides (and the agreement with respect to the Eoberts A lease contains substantially the same provision) in part as follows:

It is expressly understood and agreed between the parties hereto that the payment of said One Million Dollars out of said one-fourth of the oil, gas and other minerals, as aforesaid, is not, and never shall be, a personal obligation or liability against the Second Party, its successors, assigns or nominees, but shall be paid only out of the said products, if, as and when produced and sold from said premises. And to secure the payment of any unpaid amounts to become due First Parties from the oil, gas and other minerals produced and sold from said undivided one-fourth interest, the said First Parties shall be entitled to reserve and retain in said instruments of conveyance a lien upon an undivided one-fourth interest of said working interest. All payments from oil to be paid to First Parties by the pipe line company which may run the oil produced from said leases.

It is evident that the income from oil produced in the taxable years was not merely deferred payments of the sale price which the buyers were obligated to pay, but was derived from oil reserved to petitioners and payable to them by the purchasers of the oil if, as, and when produced. Any limitation or exhaustion of the oil prior to their receiving the quantity reserved would in proportion limit or exhaust their ability to receive the quantity reserved. In this situation we think they had a very real interest in the oil itself and the gross income received by them during the taxable years from the sale of oil must be regarded as subject to depletion under section 114 (b) (3) of the Revenue Act of 1928. Palmer v. Bender, supra; Chester Addison Jones, 31 B. T. A. 55.

The case of Comar Oil Co. v. Burnet, 64 Fed. (2d) 965, on which the respondent relies, is distinguishable from the instant case on the facts and questions involved, and is not.controlling here. In the Comar case, which arose under the Revenue Act of 1921, the question was whether the income from the oil and gas produced, in the amount of the deferred payment, was income to the assignee of the lease. There it appears that the assignee and his assigns were liable for the deferred payments and the assignor had a lien on one-eighth of the oil produced from the property until the amount of deferred consideration was paid. Here the question is whether the assignors or vendor retained an interest in the oil in place which was subject to depletion under the Revenue Act of 1928. We hold that they did.

Decision will he entered wader Bule 50.


author: MoeRis :

text:
    Alanson Weeks, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 63916.
    Promulgated November 16, 1934.

      Homer H. Tooley, C. P. A., for the petitioner.

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

MoeRis :

The respondent having determined a deficiency in income tax of $9,355.58 for the calendar year 1929, the petitioner brings this proceeding for the redetermination thereof, alleging that the respondent erroneously increased taxable income for 1929 by $43,387 and $7,837.50, representing a profit realized and dividends received, respectively, during said year, which said profit and dividends were community income and reported for income tax purposes in his wife’s return.

The petitioner, an individual, was a practicing physician and surgeon, and throughout the year 1929 was married and living with his wife within the State of California.

During the year 1929 the petitioner was the owner of both separate and community property and in his return for that year reported dividends of $9,169.32 on noncommunity stocks owned by him and dividends of $8,356.25 on community stocks owned as shown by petitioner’s return.

On January 26, 1928, the petitioner borrowed funds from the Crocker First National Bank of San Francisco, California, which funds were used in the purchase of 500 shares of Packard Motor Car Co. stock. The note evidencing the indebtedness to the bank was signed only by the petitioner, his wife not joining therein. The shares of stock so acquired were deposited with the bank as security for the loan. On November 14, 1928, the petitioner borrowed sufficient funds from the same bank to purchase an additional 1,000 shares of Packard Motor Car Co. stock. The note evidencing the indebtedness in this case was likewise signed by the petitioner only and the stock was likewise deposited with the bank as security for the money borrowed. On August 17, 1929, the entire block of 1,500 shares was sold, the petitioner realizing a profit of $86,774. The bank loans were paid out of the proceeds from the sale of the stock. There was no security given the bank for the moneys borrowed other than the shares of stock purchased with the moneys. During the year 1929 the petitioner received dividends of $7,837.50 from the shares of stock herein mentioned.

In his income tax return for the year 1929 the petitioner reported one half of the profit realized from the sale of Packard Motor Car Co. stock and one half of the dividends received from said stock, the balance being reported by his wife, upon the theory that both profit and dividends constituted community income. In the audit of petitioner’s return the respondent transferred said one half of the profit returned by his wife, increasing the petitioner’s income accordingly, and eliminated the same amount from the wife’s income.

Our question is whether or not the profit realized from the sale and the dividends received during the ownership of Packard Motor Car Co. stock became community income.

The respondent cites, inter alia, In re Ellis' Estate, 203 Cal. 414; 264 Pac. 743, wherein it appears that Ellis, among others, purchased certain shares of capital stock under the following circumstances:

That in December, 1923, an arrangement was entered into between four parties, Mr. Fishburn, Mr. Heffley, Mr. Ellis, and Mr. Judkins, whereby they had issued by the Associated Telephone Company 843 shares of its capital stock; that those shares of stock were issued in three certificates and were issued in tile names of three banks, the First National Bank of Long Beach, the First National Bank of Los Angeles, and the Heilman Commercial Trust & Savings Bank of Los Angeles; that, as a part of the same transaction and consummated at the same time, these four men either executed as makers or as guarantors three promissory notes to these banks; that the stock was pledged or held as security for these notes; that none of these men paid anything to the Associated Telephone Company for the stock except the money they received from the banks by signing their notes and putting this stock up as collateral; that that situation remained until the death of Mr. Ellis, and that at no time from the date in December, 1923, until Mr. Ellis died, were any payments made on those notes except that the money which was derived from dividends paid on the stock was credited to the payment of the interest on the notes and in a very slight degree to reduce the principal; that these three notes were signed by Mr. Heffley and guaranteed by a separate instrument by the other three gentlemen named; that there was a verbal agreement between these four men to the end that they would use this stock to make some money out of.

Upon Ellis’ death, a dispute arose over the proceeds of the sale of his 210 shares of said stock, it being contended by the appellant therein that such proceeds were community property and not separate property as contended by the respondents. The trial court found that the loan “ was made upon the faith and credit ” of Ellis’ “ separate property, and his financial standing with said banks, at the time of entering into said agreement for the purchase of said stock.” The appellants contended upon appeal that such finding was not supported by evidence sufficient to overcome the presumption that property acquired by a . spouse after marriage is community property, citing Estate of Holbert, 57 Cal. 257, and Moulton v. Moulton, 182 Cal. 185; 187 Pac. 421. The court, observed, however, that in those cases there was no evidence showing that the loan was made upon the personal credit of the spouse owning the separate property and finding, as it did, that there was evidence to support the trial court’s finding that the loan was made upon the faith and credit of Ellis’ separate property, it affirmed the trial court’s judgment, saying:

In the present case there is evidence to support the trial court’s finding. The appellant was not known in any way in the transaction. All of the property owned by the decedent was his separate property. In addition to the impelling inference from other .portions of the record that his guaranty was accepted on the faith and credit of his separate property, there is direct evidence that the guaranty was accepted on the financial standing of the decedent. One of the officers of the First National Bank of Long Beach testified:
I had a guaranty with this note signed by J. E. Fishburn and George B. Ellis. * * * We took the note of Sam It. Heffley; inasmuch as we loaned practically the market value, we took the guaranty of Mr. Ellis and Mr. Fishburn as security. * * * At the time we loaned Mr. Heffley this large sum of money, he was manager and I think vice president of the Associated Telephone and had been for years. He was a man on a salary down at the city of Long Beach, and the people we had guarantee these notes were men of large financial interests, Mr. Fishburn and Mr. Ellis.
It is clear from tlie record that the credit was extended on the faith of the separate property of the decedent existing at the time the loan was made. The court was therefore correct in finding that the cash item in the estate and over which this controversy arose was the separate property of the decedent.

The petitioner, however, contends that the Ellis case is distinguishable, that it does not support the respondent’s determination, and, furthermore, that the rule in Schuyler v. Broughton, 70 Cal. 282; 11 Pac. 719, should be adopted and followed.

In that case, a wife, in California, purchased the property there in question for a total consideration of $900, $200 of which consideration was acquired by gift and $700 she borrowed from her sister for the express purpose of making the purchase, and she gave her promissory note and a mortgage upon the property for the amount borrowed. Her husband signed neither the note nor the mortgage. The court there laid down the rule that:

* * * Where real property has been conveyed to a married woman by a deed which shows on its face a consideration paid by her, the legal presumption is that the property was purchased by community funds, and became community property of the husband and wife; and as such, it is liable for the debts of the husband. Riley v. Pehl, 23 Cal. 70; Ramsdell v. Fuller, 28 Cal. 38; Peck v. Vandenberg, 30 Cal. 11; Peck v. Brummagim, 31 Cal. 488; Vassault v. Austin, 36 Cal. 691.
It is true that the legal presumption which arises from the face of the deed may be overcome by extrinsic proof that the consideration paid was the separate funds of the wife, (McDonald v. Badger, 23 Cal. 393; Tustin v. Faught, Id. 241; Landers v. Bolton, 26 Cal. 393;) but, in the absence of such proof, the presumption is absolute and conclusive, (Pixley v. Ruggins, 15 Cal. 129.) Presumptively, therefore, the land in controversy was the common property of the husband and wife, and subject to the judgment and execution against the husband.

After summarizing the evidence oifered before the trial court to overcome the presumption in favor of community property, the court said:

There is no doubt that property acquired after marriage, by either husband or wife, by gift, bequest, devise, or descent, with its rents, issues, and profits, is the separate property of the spouse who acquires it, (Deer. Ann. Civil Code, §§162, 163,) and that all other property acquired after marriage by either husband or wife, or both, is community property (sections 164, 687, Id.). The sum of $200, which the plaintiff, as the wife of W. H. Schuyler, acquired by gift, was therefore her separate property, and the land in which she invested that money was, to the extent of the investment, her separate real property. But the sum of $700, which she borrowed, was not acquired by gift, bequest, devise, or descent, nor was it rents, issues, or profits of property so acquired; it was money acquired by contract.
By the Code law a married woman is qualified to enter into contracts as freely as if she were unmarried, (section 158, Civil Code,) and the obligation which springs from any contract she makes is enforceable against her out of her separate property, (section 170 Id.). It follows that a married woman may borrow money to invest in real property, but money borrowed by her for that purpose, during marriage, will be regarded in law as community property, unless it be borrowed by her upon the faith of existing separate property belonging to her, which she mortgages or pledges as security for its payment, or against which her contract may be enforced. In this case the money borrowed by the wife was not secured by mortgage lien, or otherwise, upon existing separate property of the wife. It appears that she had no separate property other than the $200 before she purchased the land. Under these circumstances, she borrowed the $700 “ for the purpose of paying a part of the purchase price of said real property.” The money borrowed was therefore common property, and, to the extent of the common fund, the land in which she invested it was also common property, against which her separate contracts could not be enforced.

Though the doctrine of Schuyler v. Broughton, supra, has been several times questioned, first in Flournoy v. Flournoy, 86 Cal. 286; 24 Pac. 1012, and later in Heney v. Pesoli, 109 Cal. 53; 41 Pac. 819, and Dyment v. Nelson, 166 Cal. 38; 134 Pac. 988; “ It can not be stated positively that it has been overruled.” Community Property- — -McKay, 2d Ed., sec. 454. On the contrary it has since been cited as authority in a great number of cases, the most recent being Hiatt v. Seyster, 10 Pac. (2d) 473, decided April 18,1932.

The court in Flournoy v. Flournoy, supra, said:

* * * The case of Schuyler v. Broughton * * * gives some countenance to the respondent’s claim, to the extent that it is there held that money borrowed by a married woman to- invest in real estate, during her marriage, is community property, unless it be borrowed by her upon the faith of her existing separate property, which she mortgages or pledges as security for its payment, or against which her contract may he enforced. That part of the doctrine announced in the case cited which appears in italics m'ay well be doubted but, in any event, we are not inclined to apply it to a case of this kind, where the question arises between the husband, who made the loan, and the wife, who received it, and where such a construction of the contract between them would defeat the intention of the only persons who were parties to the transaction, and who alone can be affected by a decision of the question. * * *

In Heney v. Pesoli, supra, the court observed that while Schuyler v. Broughton was doubted in Flournoy v. Flournoy, it was “ not overruled ” and, while questioning the doctrine of that case, the court added, “We think Schuyler v. Broughton may be differentiated from the present case.” The court further observed that “ In that case, so far as appears, there was no showing by extrinsic evidence that it was the intention of the spouses that the wife should purchase and take the title and enjoyment as her separate estate, and hence the court held that, as to the purchase money borrowed by the wife, but not secured by any lien or mortgage upon the property, the money so borrowed, and the estate so far as paid for therewith, became the community property of the spouses. In the present case, the extrinsic evidence tended to show the intent to purchase the property by plaintiff as her separate estate, which intent was acquiesced in by her husband.” The court concluded there that because of the intention of the parties so shown the money borrowed and secured by mortgage upon her separate property became also her separate property.

In Dyment v. Nelson, supra, the court merely reiterated that “ The latter part of this doctrine [the doctrine in Schuyler v. Broughton] has been doubted and criticized by this court in Flournoy v. Flournoy * * *; but even applying the strict rule of Schuyler v. Broughton to the case at bar, the findings of the trial court are justified.”

In Moulton v. Moulton, supra, the court stated that the question of the character of money realized from a loan made by a wife had been considered by it in, several decisions, and, after citing the various cases hereinbefore discussed, including Schuyler v. Broughton, it said :

* * * The principle established in the cases cited is to the effect that a married woman may borrow money to invest in real property, but money borrowed by her during marriage for that purpose will be regarded in law as community property, unless it be borrowed by her upon the faith of existing separate property belonging to her. If, therefore, the loan was made to plaintiff and the credit extended to her upon the faith of her existing separate property, there can be no doubt it constitutes her separate property under the rule announced by this court, and that a resulting trust was created in the property in her favor pro tanto to the extent that the portion of the consideration furnished by her bears to the whole.

. We are satisfied, therefore, from the above decisions that the law of California is that money borrowed by either spouse during the existence of the marriage relationship constitutes community property unless the separate estate of the spouse is pledged for the debt, and that the results reached in the Ellis and Sohuyler cases, one holding the property to be separate, and the other holding the property to be community, are founded upon the same rule of law, differing only in their evidentiary aspects. In the one the presumption attaching to property acquired by the spouse with borrowed funds was overcome by the evidence, while in the other it was not.

So that, whether or not the property in question was separate or community, i. e., whether or not the Ellis case, cited by the respondent, or the Schuyler case, relied upon by the petitioner, should be followed, depends upon whether or not that presumption that the borrowed funds with which the stock was purchased were community funds, has been successfully overcome. We are of the opinion that it has not.

The petitioner here, as did the spouses in those cases, purchased the property in question with funds borrowed upon his personal note and, as in those cases, the property purchased was pledged as security for the loan. But has it been shown whether such funds were borrowed upon the faith and credit of his separate property? Or is there any evidence — aside from the fact that he procured the funds upon his personal note — that he was not, in fact, acting in behalf of the community ?

There is nothing in the stipulated facts from which to conclude that the Crocker First National Bank made the loan upon the petitioner’s personal credit standing in the community or that it did so upon the strength of his separate estate. Indeed, it is not shown that the bank even knew that he had a separate estate or that he enjoyed any personal credit standing. Cf. Moulton v. Moulton, supra. The mere fact that the funds were procured upon the petitioner’s personal note and that he actually owned a separate estate does not, in our opinion, overcome the well established presumption that he was acting for and upon the faith and credit of the community. That presumption not having been overcome by the evidence, we must hold that the amounts of profit and dividends arising from the ownership and sale of Packard Motor Car Co. stock purchased with such funds were income to the community.

The respondent, it now appears, has changed his position upon the subject matter of this case since the hearing in California on July 6, 1934. See G. C.M. 13620, Yol. XIII, Internal Revenue Bulletin, No. 41, October 8, 1934, page 8, following the rule in Schuyler v. Broughton, supra, and reaching the same conclusion under a similar statement of facts.

Judgment will be entered v/nder Bule 50.


author: Seawell:

text:
    Lillian T. Savage, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70221.
    Promulgated November 16, 1934.

      Colman Gray, Esq., and Philip J. Marón, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
   OPINION.

Seawell:

Respondent determined a deficiency in the income tax of petitioner for the year 1930 in the sum of $2,630.01, for a rede-termination of which this proceeding is prosecuted. The deficiency results from the action of respondent in adding to petitioner’s reported income $17,542.69, the amount of income for 1930 derived from a trust created by petitioner on May 10, 1926.

The facts for the most part are stipulated. In so far as necessary to understand the conclusions and determination reached in this proceeding, they are hereinafter set out.

The petitioner is an individual, residing at Mendham, New Jersey. During the year 1909 she married one Russell L. McIntosh, and in 1918, there being no issue of the marriage, they adopted a boy and girl, born May 5, 1914, and September 25, 1916, respectively. The names of the children are Lachlan Bruce McIntosh and Martha Jean McIntosh (hereinafter called the children). In 1925 marital troubles developed between the petitioner and her husband. They separated and on September 2, 1926, were divorced, and in November of the same year petitioner married Albert O. Savage.

On May 10,1926, prior to the divorce, petitioner created a trust for the benefit of the children, with her husband, Russell L. McIntosh, and the Fidelity Trust Co. of New York as trustees. The trust property consisted of the following:

100 snares Atchison, Topeka & Santa Fe common stock.
100 shares Southern Railway Co. common stock.
100 shares Royal Dutch Co., New York.
10O shares American Tobacco Co. common stock.
100 shares Con. Gas Co. of N. Y. common stock.
100 shares American Smelting & Ref. Co. common stock.
1400 shares National Biscuit Co. common stock.
100 shares Radio Corporation of America preferred stock.
TI. S. Liberty bonds of face value of $1,350.
Debenture bonds of Georgia Southern & Florida Railway Co., face value $14,800.

The income from the trust for the taxable year 1930 amounted to $17,542.69 and comprised the following items:

Interest_ $6. 60
Interest on tax-free covenant bonds_ 740. 00
Dividends_ 16, 439.75
Profit on sale of stock rights_ 38. 09
Dividends from foreign corporations_ 321. 65
Total_ 17,546.09
Less: Interest paid- 3. 40
Net income_ 17,542. 69

The trust instrument provided in part that the parties of the second part (the trustees) were:

To hold the said securities and property and to collect and receive the interest, income and profits thereof, and after deducting their commissions and all proper charges and expenses to pay the net income upon receipt to the said Russell L. McIntosh, * * * to be devoted by him to the support, education and maintenance of Lachlan Bruce McIntosh and Martha Jean McIntosh, adopted children of the said Russell L. McIntosh and Lillian T. McIntosh, as directed by said Russell L. McIntosh and in his discretion * * *

There were further provisions relating to the disposition of the income and principal of the fund after the children became of age. In case of the death of either of said children leaving issue it was provided:

* * * one half of the principal of said trust fund shall be paid and delivered to such issue of said child so dying, to be divided among said issue per stirpes or shall be paid and delivered to the said Lillian T. McIntosh, her executors or administrators, as determined by Russell L. McIntosh, he to have the option as to whether said portions of said trust fund shall be paid and delivered to the issue of said children or re-delivered to Lillian T. McIntosh.
If either of said children shall die without issue, the share of said trust fund which might otherwise in the discretion of said Russell L. McIntosh be paid to the issue of said child so dying, if such child had issue, shall be repaid and redelivered to Lillian T. McIntosh, her executors or administrators.

The trust instrument contained the following provision:

This indenture and the trust thereby created can, at any time, be vacated, set aside or modified by the consent and agreement in writing of the said Lillian T. McIntosh and Russell L. McIntosh, their executors or administrators, and without the consent of the said Fidelity Trust Company or of any beneficiaries hereunder vested or contingent.

It was also provided in the trust instrument that the corporate trustee should account annually to petitioner as to the amount o.f income turned over by it to Russell L. McIntosh, the other trustee, and that Russell L. McIntosh should not account to the Fidelity Trust Co. or anyone else for expenditure of income by him.

Petitioner insists that under all the facts existing Russell L. McIntosh was a beneficiary of the trust which could be revoked only with his consent; and that therefore the trust was irrevocable under section 166 of the Revenue Act of 1928 and decisions, and the income not taxable to her. It is not contended, as we understand it, that Russell L. McIntosh was a beneficiary of the trust by reason of having been named as such in the instrument either individually or as one of a class, but because in the operation and administration of the trust certain advantages flow to him. Under the law of ISTew Jersey, where he lived, it was his duty under penalty of law to support and provide for the children, the primary beneficiaries of the trust, and to the extent that the trust provided such support he was relieved and himself therefore benefited. So it is argued that one who receives a benefit, however remote and aside from the direct intentions of a trust, must be a “ beneficiary.” It is easy to extend such argument to a point that would disclose its fallacy. If a trust should provide, for example, support for those who without such support would necessarily become inmates of a home for the poor supported by public taxes, under the theory and logic of petitioner, every taxpayer of the county would be a “ beneficiary ” of the trust because relieved of a portion of the tax. We are persuaded Congress did not mean to include in the term beneficiary ” one who might enjoy such an incidental and remote benefit under a trust. Beneficiary, as the word is used in the statute, means: “ He for whose benefit another person is enfeoffed or seized of land or tenements, or is possessed of personal property.” The term is synonymous with eestwi que trust, according to Bouvier’s Law Dictionary. (See Reinecke v. Smith, 289 U. S. 172.) It is said a person whose confidence creates a trust is called a “ trustor ”, the person in whom the confidence is reposed is called a “ trustee ”, and the person for whose benefit the trust is created is called the “ beneficiary.” The trust here was created not for the benefit of Bussell L. McIntosh. He had neither a vested nor contingent interest in the trust property under the trust instrument. To make him a beneficiary he must have had some such interest in the income or principal derived and arising out of the trust instrument. (See Smith v. Commissioner, 59 Fed. (2d) 56.)

We can not agree that the case of Mary R. Spencer, 20 B. T. A. 58, relied upon by petitioner, is in point. Petitioner in that case was not the trustor, as seemingly erroneously implied in petitioner’s brief. As the wife of Lorillard Spencer, she was equitably entitled to certain interests in his estate which were secured to her in a trust created by him. What she received, though paid by the trust, was held not to be income to her. It was not held that the income of the trust was not all taxable to the husband, for he was not before the Board.

In the instant case it is true the terms of the trust were most liberal in not requiring the. trustee husband of petitioner to render accounts for his trusteeship; but if there had been waste of the trust estate' by him or other misconduct with reference thereto, it will not be contended that the courts did not stand ready nevertheless to require such accounts or that they did not have the power to remove him as trustee to protect the interests of the beneficiaries or to punish him for misapplication or conversion had he been guilty of such offenses.

The trustee husband had the power under the terms of the trust instrument, in case one of the children beneficiaries died leaving issue, to decide whether the half of said estate held in trust for such one dying should go to his or her issue or to petitioner, but he, did not have the right or power to allot it to some other person or to take it for himself, whether the child died with or without issue.

After fully considering the contentions and argument of petitioner and the facts appearing in evidence on this point, we conclude, and so hold, that Russell L. McIntosh was not a beneficiary under the trust and the trust was revocable under the statute, and we sustain respondent’s determination with reference thereto.

It is alleged in the petition and contended in the brief that the two items of U. S. Liberty bonds and Georgia Southern & Florida Railway Co. debenture bonds belonged to the children — beneficiaries — independently of the trust instrument, and that income from these securities could in no event be taxed against petitioner. On January 12,1920, Charles L. Taylor, father of petitioner, gave to her in trust for the children “ Twenty-thousand ($20,000) dollars Hawk-insville and Florida Southern Railway Company First Mortgage Gold Bonds 5% due April 1st, 1952.” There was no evidence in reference to the ownership by the children of any U. S. Liberty bonds, and none to identify the mortgage bonds given by Charles L. Taylor with the Georgia Southern & Florida debenture bonds of the face value of $14,800 mentioned in the petition. Authority was given petitioner by Charles L. Taylor, the donor, to sell the mortgage bonds and to reinvest the proceeds for the children, but no evidence was offered to show that this authority had been exercised. There is likewise no evidence to identify any part of the items of income, stipulated and set out above, as having been derived from the donated mortgage bonds. Apparently none of the income was so derived. We must, therefore, sustain the respondent on this point.

The last issue raised under the pleadings is to the effect that respondent in the years 1926 to 1929, inclusive, made no claim that the income of the trust was taxable to petitioner herein, and that on that account respondent is now estopped to make such determination. It is argued in the brief that if the respondent had made such determination prior to 1930, in which year “a large profit resulted from the sale of trust securities ”, the trust would have been dissolved before the taxable year and a “most inequitable result” could have been avoided. We are not sufficiently impressed with this argument and no authority in point is cited. The respondent is sustained. Harriton v. Lucas, 41 Fed. (2d) 429.

Judgment will ~be entered for the respondent.


author: Ahundell: Smith,

text:
    Albert Fried, Petitioner, v. Commissioner of Internal Revenue, Respondent. Benjamin Einhorn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 73876, 73877.
    Promulgated November 21, 1934.

      Israel M. Poqash, G. P. A., for the petitioners.

      H. F. Morton, Esq., Thomas N. Mather, Esq., and John T. Koehler, Esq., for the respondent.
   OPINION.

Ahundell:

Petitioners concede that the firm of which they are members is not a dealer as to the stocks other than those in which it specializes. They claim that the firm is a “ dealer in securities ” as to the 13 ’specialty stocks within the meaning of article 105, Regulations 74, and consequently may inventory those stocks in computing income.

In a consideration of cases involving the question presented here it should be remembered that the taxing statute deals primarily with realized gains or losses. Lucas v. American Code Co., 280 U. S. 445. In order for a taxpayer to use some other method of computing gain or loss he must show clearly that he comes within statutory provisions which allow a departure from the fundamental aim of the statute. If a departure is permissible here it is under section 22 (c) of the Revenue Act of 1928, reading as follows:

Whenever in the opinion oí the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

The application of this section is, by its language, confined to rather narrow limits. It does not extend to all cases in which taxpayers think that income can be reflected on an inventory basis. Only in the class of cases where in the opinion of the Commissioner the use of inventories is necessary can the inventory method be used. We have heretofore had occasion to say that the inventory method of computing income “ has always been regarded as special and as involving problems of general administration peculiarly cognizable by the Commissioner.” Alfred E. Hamill, 30 B. T. A. 955. In that case, after quoting the statute as set out above, we further said:

Fortified with such a clear sanction in the statutory grant of power, the administrative determination in such a case must survive all but the strongest attack. Short of being arbitrary or capricious or based on a clear demonstration of error, the determination in any single instance ought not to be disturbed. This is not a matter of jurisdiction, for the Board clearly has the power of review, Blair v. Oesterlem Machine Co., 275 U. S. 220, but is rather an attitude of the Board in the exercise of its jurisdiction not to interfere lightly with general administrative matters which the Congress has entrusted to the Commissioner’s discretion. * * *

The question ultimately presented for decision here is whether the petitioners have made a strong enough case to show that the respondent erred in refusing to classify the firm as a dealer. _ The burden of so doing, we said in the Hamill case, is “ undoubtedly heavier than that of overthrowing a purely factual determination upon which the ultimate determination must stand.”

Petitioners say that their firm is a dealer within the following definition contained in article 105:

* * * For the purpose of this rule a dealer in securities is a merchant of securities, whether an individual, partnership, or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived therefrom.

In the case of James B. Lowell, 30 B. T. A. 1296, we had before us a specialist in three stocks traded in on the New York Stock Exchange. In our opinion in that case we said in part:

Some of the transactions in these stocks consisted of matching purchase orders against sales orders, the orders on both sides of the book being received from brokers, and for this service a commission was paid by the brokers. It is obvious that in such transactions no securities would need be carried in stock if the buy and sell orders matched up evenly each day. To what extent they were even is not shown, but the testimony of petitioner James B. Lowell is that he endeavored to come out as nearly even as possible. Transactions of this kind in our opinion cannot be classified as the “ purchase of securities and their resale to customers.” Art. 105, Regulations 74. The petitioner in such cases was not selling securities previously purchased, but was rather acting as a broker on a commission basis. A dealer or merchant gains or loses directly in proportion to fluctuations in the market price of the commodity in which he deals; not so with petitioners in their matching operations, for no matter how much the spread in prices their commission was the same on each 100-share lot cleared on their books.
The other transactions in the specialty stocks were not such as to come within the generally accepted understanding of the terms of merchant or dealer. They were purchases or sales, sometimes short sales, made when there were no matching orders on the books. These transactions, according to the testimony, were for the purpose of creating or maintaining a market; they were speculative, as explained by the witness, in that he was betting on a rise oh fall in the market according to whether he was long or short of the stock. An effort was made to even up on each transaction within the day though this was not always accomplished. These transactions were engaged in to maintain the market only for the day; they were engaged in on margin with Wrenn Brothers; no certificates were issued in the names of petitioners or the partnership; and neither the petitioners nor their partnership could deal directly with the public. These matters demonstrate the width of the gap between the petitioners and a dealer or merchant, who is generally understood to be one who carries a stock of his wares and stands ready to deal directly with all who wish to trade in that commodity. * * *

The essentials in the Lowell case and these are the same, and what we said in the former case controls our decision here. The facts in the instant cases were stipulated and the stipulation omits some of the detailed evidence presented in the Lowell case as to the operating methods of specialists on the stock exchange. But this lack of evidence may not be availed of by petitioners, for on them rests the burden of overcoming the prima facie correctness of the respondent’s determination. Their claim is that the activities of the firm as a specialist bring it within the definition of a dealer, without describing the operating methods of the specialist or even explaining the specialist’s function. When we refer to the reported cases, the descriptions given of the activities and operating methods of specialists fall far short of bringing them within the meaning of “ dealers ” as defined by article 105. See James B. Lowell, supra; People v. Goldfogle, 213 App. Div. 702; 211 N. Y. S. 107.

Referring to some of the confused facts stipulated, it is set forth in the stipulation that the firm always had on hand some of the securities in which it specialized. ■ This, standing alone, is incomplete and possibly misleading, for it is a matter of general knowledge and is indicated by the cases above that it is neither the function nor aim of a specialist to carry on hand at all times a sufficiently large stock of his specialty stocks to meet all demands. His ability to supply the demand depends largely on his ability to match orders rather than upon the quantity of stock on hand. Again, there is a reference in the stipulation to the firm’s buying and selling “ for its own account.” The statement is not explained. If such transactions were for investment or speculation they are outside the activities of a dealer. See Adirondack Securities Corporation, 23 B. T. A. 61; Northeastern Surety Co., 29 B. T. A. 297. Moreover, under the rules of the stock exchange, a member while acting as broker, whether specialist or otherwise, is prohibited, with certain specified exceptions, from buying or selling for his own account securities for which he has accepted orders to buy or sell. See Charleg H. Meyer, The Law of Stock Brokers and Stock Exchanges, § 51.

It is unnecessary to consider whether other brokers with or through whom the firm dealt were “ customers.” That was the principal point involved in the Estate of Harry E. R. Hall, 29 B. T. A. 1255, upon which petitioners rely. Even if it be conceded that a broker may be a customer, it does not follow that every one with whom a broker deals ig a dealer or merchant. One who is admittedly a broker, or a speculator, may have customers — indeed he must have in the sense of having some one to sell to — but that does not make him a merchant.

We are accordingly of the opinion, and so hold, that petitioners have not sustained the burden of establishing that the respondent erred in refusing to classify their firm as a dealer within the meaning of the regulations.

Reviewed by the Board.

Decision will be entered for the resyondent.

Murdock concurs in the result.

Smith,

dissenting: In Estate of Harry E. R. Hall, 29 B. T. A. 1255, we held that specialists on the Hew York Stock Exchange who were engaged in the business of buying securities and reselling them to customers, principally members of the Hew York Stock Exchange, were entitled under article 105 of Regulations 74 to compute net income upon the basis of inventories at market. I think there are no material differences between the facts in this case and those which obtained in the above cited case. Furthermore, I am of the opinion that the petitioners here substantially met the requirements of article 105 to qualify them as dealers in securities. They have an established place of business; they are regularly engaged in the purchase of securities and their resale to customers, and those purchases and sales are made with a view to the gains and profits that may be derived therefrom. If the regulation was intended to apply only to underwriters or distributors of securities that fact is not made plain by the terms of the regulation, nor can I understand why such merchants of securities should be favored by the respondent over brokers who make a practice of buying for their own account and selling to customers the securities thus bought with a view to gains and profits to be derived therefrom.

Substantially the question presented here was considered by the Circuit Court of Appeals for the Second Circuit in Harriman National Bank v. Commissioner, 43 Fed. (2d) 950. It was there held that a bank, maintaining a separate department for the buying and selling of securities, which sold securities when it thought the prices were reasonable, was a dealer in securities within the contemplation of article 1585 of Regulations 45, which corresponds with article 105 of Regulations 74.

As I see it, the only question which we have here is whether the petitioners qualify as dealers in securities as defined in the regulation. I think they do.

Black, McMahon, and Leech agree with this dissent.

        [People v. Goldfogle, supra.] * * * The “ specialist ” is a floor broker, who undertakes to specialize in a limited group of stocks, and a firm conducting a “ specialist ” business is one which is represented by one or more such floor brokers. For the convenience of brokers and to expedite the execution of orders, all the stocks listed on the Stock Exchange are around different “ posts ” located on the floor. * * *
      The specialist stations himself at one of the posts on the floor, where he remains from 10 a. m. to 3 p. m., accepting orders coming from other Stock Exchange members in the stocks .listed at his post. He is always at his post, and the orders he receives are usuaUy those impossible of execution at the time they are given out, but which come into force as the market advances or declines. The necessity for specialists arises from the rigid responsibility to which Stock Exchange members are held for the execution of orders when market conditions .permit. At times, great loss would result to brokers doing business around the room, unless they could pass this responsibility on to the specialist.
      When a specialist accepts an order from another member, he assumes responsibilities and liabilities which are recognized and ruled upon by the governors of the Exchange under the rules of the Exchange. In some cases, the specialist, when he buys and sells for a Stock Exchange house, “ gives up ” on a transaction — i. e., discloses the name of his principal. These transactions are cleared and settled by the Stock Exchange firms for whom the purchases or sales are made, and the specialist neither makes payment for the securities bought nor receives payment for the securities sold. He remains liable as a principal, however, to the party to whom he sold or from whom he bought until the due date of the settlement of the contract, although he takes no further part in the handling of the details pending the closing of the contract. He is responsible for the carrying out of the contract. In many cases, the specialist does not disclose the name of his principal, but gives either his own name or the name of the firm with which he is associated, in which case his liability remains as above. In a few cases a specialist may avoid liability where he specifically states at the time of the purchase or sale that he is buying or selling for the account of some other broker. The other broker then becomes liable, and the specialist steps out. Such a case is exceptional; as a general rule the specialist remains liable.
      *******
      The specialist who executes orders received from other members of the Stock Exchange receives a certain proportion of the commission paid to the other Stbck Exchange members by their customers; for instance, where stock has a par value of fpiOO, the broker’s commission is $15 per 100 shares. Of this $15, the specialist receives $2.50.