author: Leech:

text:
    Mercantile Trust Company of Baltimore and Alexander C. Nelson, Trustees of the Estate of Charles D. Fisher, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68338.
    Promulgated February 19, 1935.

      J. Robert Sherrod, Esq., and James B. Diggs, Esq., for the petitioners.

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

Leech:

This proceeding seeks redetermination of an .income tax deficiency of $21,285.68 determined against petitioners for the calendar year 1929.

Petitioners assign as error, the respondent’s determination that they sold certain real estate, theretofore held for investment. Petitioners allege that such property was exchanged for cash and like property to be held for investment. In the alternative, if the transaction is held to be a sale and purchase and not an exchange, petitioners assign error in respondent’s determination of the March 1, 1913, value of the property, disposition of which was made in that transaction.

The stipulation of facts pertinent to the first issue, including the agreements, deeds, checks, and papers executed by the several parties to the 1929 transaction in controversy, is included herein by reference.

Petitioners are the duly constituted trustees of the estate of Charles D. Fisher, who died testate in 1905. On and before March 7, 1929, as trustees of the Fisher estate, they held title to two parcels of real estate known as 114-116 Bast Baltimore Street, Baltimore, Maryland, hereinafter referred to as the Baltimore Street property. Such properties were contiguous to the property known as the Emerson Hotel and were leased to and occupied by a restaurant. At the same time the estate of Annie E. O. Wylie owned real estate known as 223 West Lexington Street, Baltimore, Maryland (hereinafter referred to as the Lexington Street property), which was rented under a long term lease to F. W. Woolworth & Co.

On March 7, 1929, petitioners, as trustees of the Fisher estate, entered into a written contract with the Title Guarantee & Trust Co. (hereinafter referred to as the Title Co.) under the terms of which petitioners agreed with the Title Co. to exchange the Baltimore Street properties, as an entirety in fee simple, for the Lexington Street property in fee simple, subject to the outstanding' lease thereon, and $33,000 cash. The agreement further provided that in the event the Title Co. could not obtain ownership of the, Lexington Street property by purchase, the petitioners could require the Title Co. to pay $300,000 cash for the Baltimore Street properties in lieu of the above mentioned exchange. The Title Co. paid $4,000 to petitioners at the execution of this contract, which sum was to be credited to the Title Co. upon consummation of the transaction.

On March 11, 1929, the Title Co. entered into a written contract with the. trustee of the Wylie estate for the purchase of the Lexington Street property for a price of $267,000 cash. The Title Co. paid that trustee, at the execution of this contract, $1,000 to be credited to the Title Co. upon consummation of that transaction.

On March 11, 1929, the Title Co. entered into a written contract for the sale of the Baltimore Street property to the Emerson Hotel Co. for -a price of $300,000 cash. The Emerson Hotel Co. paid the Title Co. $5,000 upon execution of this contract, which was to be credited to the Emerson Hotel Co. upon consummation of this transaction.

On April 15, 1929, the parties to the several contracts simultaneously executed the following deeds of conveyance. The trustee of the Wylie estate deeded to the' Title Co. the Lexington Street property. The Title Co. deeded to the petitioners, as trustees of the Fisher estate, the Lexington Street property. The petitioners, as trustees of the Fisher estate, deeded to the Title Co., the Baltimore Street property. The Title Co. deeded to the Emerson Hotel Co. the Baltimore Street property.

On the same date, April 15, 1929, pursuant to the contracts and deeds, the following cash payments.were made. The Emerson Hotel Co. issued its cheek payable to the Title Co. in the sum of $294,416.67 representing the agreed purchase price of $300,000 for the Baltimore Street property less adjustments for the $5,000 paid by Emerson Hotel Co. upon execution of the contract of sale and rent for a half month. Such check was deposited in the Title Co.’s hank account. The Title Co. issued its check payable to the trustee of the Wylie estate in the sum of $265,478.42 representing the agreed purchase price of $267,000 for the Lexington Street property, less adjustments for the $1,000 paid by the Title Co. upon execution of the contract of sale and rent for a half month. The Title Co. issued its check payable to the petitioner, Mercantile Trust Co., trustee of the Fisher estate, in the sum of $28,938.25 representing that part of agreed purchase price to be paid in cash (in addition to the deed to the Lexington Street property) for the Baltimore Street property, that is, $33,000 less adjustments for the $4,000 paid by the Title Co. upon the execution of the contract and rent for a half month. The petitioners paid commissions and title fees amounting to $8,573.10, leaving the sum of $24,426.90 as the net cash received on the transaction.

In their return for the Fisher estate for 1929, the petitioners reported a capital gain of $24,426.90 as representing the net cash received on a transaction which was an exchange of real property for other like property, held for investment.

The respondent disregarded the form of the transaction and determined that petitioners sold the Baltimore Street property to the Emerson Hotel Co. for $300,000 cash and then purchased the Lexington Street property in two separate transactions. He computed a capital net gain of $179,621.10 as follows:

Sales Price Baltimore Street property-$300, 000.00
Less Commission and Title Pee_ 8, 573.10
$291,426.90
Pair Market Value on March 1, 1913-$125, 000. 00
Less depreciation on value of building $41,666 at 2% for 15 years and 10 months_ 13,194. 20
- 111,805.80
Capital net gain_$179,621.10
Capital net gain reported- 24,426.90
Increase_$155,194.20

Respondent contends that while there is no imputation of fraud, “ because no deception was practiced and means legal in themselves were used ”, the proposed exchange was a sham device for tax avoidance. He further contends that the Title Co. acted purely as an agent or dummy and not as a principal for the purchase and sale of either of the properties; that the governing factor in the transaction was a sale of the Baltimore Street property by petitioners to the Emerson Hotel Co. because the latter desired it, while petitioners objected to the realization of a large taxable profit; that the transaction was carried out in the form above outlined to prevent a straight sale of the Baltimore Street property by petitioners to the Emerson Hotel Co. for cash; that the whole device was so essentially fictitious, the form should be disregarded and the transaction held to be a sale of the Baltimore Street property by petitioners for cash and then, in a separate transaction, a purchase of the Lexington Street property by petitioners for cash.

Respondent argues that the Emerson Hotel Co. was the moving party and the Title Co. was its agent in acquiring petitioners’ Baltimore Street property. This may be true. But even if it were, respondent’s position is not helped thereby.

If the Title Co. were acting as agent for the Emerson Hotel Co., then clearly it purchased the Lexington Street property on behalf of the Emerson Hotel Co. and, pursuant to its agreement with petitioners, but acting for the Emerson Hotel Co., exchanged the Lexington Street property plus $33,000 for the Baltimore Street property. Certainly, the Title Co. as agent for the Emerson Hotel Co. did not purchase the Baltimore Street property for $300,000 cash as contended by respondent.

In our opinion, the respondent’s position cannot be sustained unless the Title Co. represented the petitioners as their agent, both in the transfer of the Baltimore Street property to the Emerson Hotel Co., and in the purchase of the Lexington Street property. The record, however, conclusively contradicts the existence of that status in either transaction. Petitioners’ only contract disclosed here was with the Title Co. alone. It was enforceable against that company as principal. In the event the Title Co. had not been able to secure title to the Lexington Street property, and thus comply with the exchange provisions of the contract, petitioners could have compelled the Title Co., individually, to pay $300,000 to petitioners for the Baltimore Street property. The Title Co. was the party acquiring the Baltimore Street property. The consideration was to be paid by the Title Co. and the latter did, in fact, pay to the petitioners, in its own behalf, $4,000 upon the execution of that contract. The balance due under the exchange provisions of the contract upon its consummation, namely, the remainder of the cash consideration and the transfer of title to the Lexington Street property, was received by the petitioners from the Title Co. in the performance of the individual obligation of that company.

It may be true, as urged by respondent, that the Emerson Hotel Co. desired the Baltimore Street property and was willing to pay a price which would have netted petitioners a large profit. In any event petitioners could have sold that property for cash, thus incurring a tax liability, and then invested the proceeds in other property as an investment, or, they could have effected an exchange of this investment property for property of a like kind and thus avoided tax liability by postponing the realization of recognized gain as provided by section 112 (b) (1) and (c) (1) of the Revenue Act of 1928.

Respondent admits that the transaction was carried out in a legal manner, and that no fraud was perpetrated. We cannot find that it was a mere device, essentially fictitious. The several agreements and deeds executed, and the cash payments made by the four interested parties were not simulated transactions. They were intended to and did constitute juristic facts — not fictions. The agreements created fixed liabilities. The deeds transferred legal title. The cash payments were real. Petitioners actually conveyed the Baltimore Street property to the Title Co. They likewise received from that company, in exchange, the Lexington Street property and $33,000. These real transactions must here be given their normal effect. So, our single inquiry is whether these facts bring the petitioners in the pending transaction within the scope of the quoted statutory provisions. Gregory v. Helvering, 293 U. S. 465; Royal Marcher, 32 B. T. A. 76.

The obvious purpose and effect of these provisions, as well as their predecessors, in the Revenue Act of 1921, section 202 (c) (l), (d)(1), and (e), and the amendment of the Act of March 4, 1923, was to permit the postponement of recognition of taxable gain or loss upon an exchange there described until the disposition of the property received in the exchange. In the ultimate analysis of the present transaction, this was all petitioners intended or accomplished.

The present exchange was not connected with a corporate reorganization. Neither in the last-quoted provisions nor in their successors, here applicable, does there appear any express or implied indication of a legislative intent to premise the nonrecognition of gain or loss there provided upon any other condition than that stated specifically therein. Compare Gregory v. Helvering, surpra, which construed subsections (g) and (i) (1) (B) of the same section (112) and Revenue Act (1928) here under consideration. Nonrecognition of gain or loss does not depend here upon the impossibility of a sale of the property by the taxpayer. The only condition precedent to that nonrecognition is the actual exchange of property held for investment for like property to be held for investment, with or without so-called “ boot.” Cf. John S. Garvan, 23 B. T. A. 817; George E. Hamilton, 30 B. T. A. 160; Loughborough Development Corporation,, 29 B. T. A. 95; W. H. Hartman Co., 20 B. T. A. 302; Sarther Grocery Co., 22 B. T. A. 1273.

In the cited case of Gregory v. Helvering, supra, the Supreme Court determined the taxable status of the questioned transaction “ by what actually occurred ” — the receipt of the taxed stock by the taxpayer. To sustain respondent upon the present record, we would be compelled to ignore the exchange that actually occurred, and tax, as received by the taxpayers, money never, in fact, received by or for them, in a sale that did not occur. We cannot here thus substitute fiction for fact.

If petitioners’ present alternative agreements to exchange or sell had been with the trustee of the Wylie estate and the Emerson Hotel Co., separately, clearly it could not be said that an actual exchange of petitioners’ investment property with the former party was an actual sale of it to the latter, merely because petitioners exchanged rather than sold the property for the purpose of postponing or avoiding income taxes. Since such agreements were with the same party, the Title Co., this admitted purpose does not convert petitioners’ actual nontaxable exchange into a taxable sale. Gregory v. Helvering, supra; Bullen v. Wisconsin, 240 U. S. 625.

The above mentioned agreement of March 7 evidenced an intention to exchange the Baltimore Street property, if certain conditions were met, and to sell it, if those conditions were not met. Those condi- • tions were met. The property was, in fact, exchanged. That fact is controlling here. United States v. Phellis, 257 U. S. 156; Sarther Grocery Co., supra.

We conclude that the petitioners exchanged real property held for investment, for like property to be held for investment, plus $24,426.90 net cash. So, pursuant to section 112 (b) (1) and (c) (1), supra, the recognized gain does not exceed the amount of cash received by them in the exchange. Cf. George E. Hamilton, supra; Loughborough Development Corporation, supra; W. H. Hartman Co., supra.

It is thus not necessary to determine the alternative issue of the March 1,1913, value of the Baltimore Street property.

Reviewed by the Board.

Judgment will be entered for the petitioners.

       Sec. 112 (b) (1) PBOpm-n held fob productive usb or investment. — No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.
      *******
      (c)(1) If an exchange would be within the provisons of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

       Seo. 202 (e) (1) When any such property held for investment, or for productive use in trade or business (not including stock-in-trade or other property held primarily for sale), is exchanged for property of a like kind or use.

       Sec. 202 (d) (1) Where property is exchanged for other property and no gain or loss is recognized under the provisions of subdivision (c), the property received shall, for the purposes of this section, be treated as taking the place of the property exchanged therefor, except as provided in subdivision (e).

       Sec. 202 (e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis, shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2), and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the money or the fair market value of such other property received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis, shall be taxable to the extent of the excess.


source: Caselaw Access Project

author: Van Fossan: Leech,

license: Public Domain

text:
    Bess Schoellkopf, Petitioner, v. Commissioner of Internal Revenue, Respondent. L. R. Munger and J. Fred Schoellkopf, Executors of the Estate of Laura D. Wilson, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 71974, 71975.
    Promulgated February 19, 1935.

      F. E. Yotmgman, Esq., and P. W. Phillips, Esq., for the petitioners.

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

Van Fossan:

The petitioners’ position is that the interest paid to them was interest upon the direct obligations of political subdivisions of the States of Texas and New Mexico and as such was exempt from Federal income tax on constitutional grounds and under the express terms of section 22 (b) (4) of the Revenue Act of 1928. They state, on brief, “ if these petitioners are taxable on the amounts in controversy it is because under the particular facts of the cases the amounts in issue do not constitute interest upon such obligations.”

The respondent contends that the interest so paid was simply interest on the trust certificates which were the obligations of the grantors of the trusts or of the trusts themselves.

The petitioners rely principally on the language of the trust instrument stating that “the owner or registered holder of each ownership certificate * * * shall * * * be a beneficiary in the series of securities sold and assigned to the trustee as the basis of the issuance of the ownership certificates * * * ” and of the certificate itself reading “ Realty Trust Company * * * does hereby certify that the bearer hereof is entitled to participation in the proceeds and avails of certain special assessment certificates, bonds and direct obligations issued by municipalities of the States of Texas and New Mexico.” If the cases at bar were to rest on the quoted phrases alone, the petitioners’ theory would be persuasive, but we must look to the entire situation with its varied rights and obligations to determine the true character and the correct legal status of the certificates of participation.

The grantors in the several trusts were corporations. The corporation purchased the direct obligations of political subdivisions of states. It then transferred those securities to a trustee “ absolutely ”, under an agreement which contained many features not usually found in a pure trust. The so-called beneficiaries of the trust, unknown and unnamed in the trust instrument, purchased “ Municipal Trust Ownership Certificates ” transferable by delivery, unless registered. The certificate was signed by the grantor, provided for a fixed rate of interest, matured in five years, and had interest coupons attached, the same being negotiable by delivery. The certificate provided on its face that the bearer or registered holder, “ particularly waives and releases all interest collected by the said Trustee upon the securities held by it under the said agreement of trust in excess of interest at the rate herein specified.”

• Under the trust agreement no definite municipal or state securities were made the corpus of the trust. The fund of such securities was a flexible and mutable portfolio subject wholly to the control and designation of the company. Withdrawals, eliminations, and substitutions were made at its will. Section 3 of Article III of the trust agreement specifically provided that the certificate holders should have no legal title or interest in the municipal securities themselves, but only in the proceeds from their sale and in a certain portion of the interest therefrom.

Though some provisions of the trust agreement and certificates, at casual reading, seem to indicate that the certificate owner was the direct recipient of interest from municipal and state securities, and though the cash payment of his semiannual coupons and, in part, the return of his capital in five years were presumed to arise from such a source, by the very terms of the plan in certain events those payments might be made from contributions made by the grantors or from previously received surplus interest. The certificate holder was concerned only with the regular payment of the interest due on the coupons and with the prompt payment of his capital upon maturity of the certificate. This payment bore no necessary relationship to the collection of the interest on any specific municipal securities. The company had guaranteed the payment of their principal and interest and had agreed to supply any amounts required by the trustee to pay such principal and interest when due.

The phrase “ the agreed semiannual interest rate ” found in the interest coupons is significant. The company had agreed and guaranteed that the certificate owner should receive that to which his certificate showed he was entitled. By guaranteeing the payment of the interest on the municipal and other similar securities, which apparently bore a much higher rate than the certificate coupon, the grantors thus made certain that the coupon owner would receive his interest. By reason of those assurances and other conditions on the part of the company, we are of the opinion that a new security, the “ Municipal Trust Ownership Certificate ”, was created, to which the petitioners looked and upon which security the interest in question was paid. Attention is called to the fact there is nothing in the trust instrument and certificate, or in the record, to show that the certificate holder knew the kind, amount, interest rate, maturity, name of the obligor, or any other pertinent fact relating to the direct obligations of the state political subdivisions which issued the underlying trust fund securities. By reason of the guarantee of the company, his return was assured in the fixed amount. We conclude that the interest received by the petitioners was not interest upon the obligations of a state or political subdivision thereof and that, therefore, the income accruing by virtue of the ownership of the “ Municipal Trust Ownership Certificates ” was hot tax-free under the law.

In Frances B. Eldredge et al., Executors, 31 B. T. A. 111, we held that the taxing of profits of a dealer in tax-exempt securities was too remote to interfere with the governmental function of a state. Willcuts v. Bunn, 282 U. S. 216. So in the cases at bar we can see no possible influence that the taxing of the interest received by the petitioners on the certificates of participation can have on the functioning of the unnamed political subdivisions whose securities were held by the trustee. The record discloses that in 1930 out of $154,337.63 collected by the trustee from the securities held under the trust agreements, the Texas Bitulithic Co. received and retained $38,912.63, while in the same year the Fain-Townsend Co. retained the sum of $22,913.12 out of $75,213.12 collected by the trustee. These facts cast a revealing light on the inward character of the plan.

The petitioners rely on Norfolk National Bank of Commerce & Trusts v. Commissioner, 66 Fed. (2d) 48 (reversing 26 B. T. A. 1111), a case which grew “ out of the peculiar manner in which the Commonwealth of Virginia has borrowed money for the building of roads.” In that case the court observed that “ The Ridge Route Corporation was obviously formed and operated merely as an agency to facilitate the borrowing of money by the State.” The court concluded:

* * * that in reality the banks, and not the corporation, lent the money to the state, that the notes of the corporation were issued merely to indicate the extent of each bank’s participation in the transaction, and that the banks, and not the corporation, were the owners of the state and city obligations when the interest was paid.

The facts in these cases are so dissimilar that the cited case is no authority here.

The petitioners also cite Carson Estate Co., 31 B. T. A. 607, the facts in which, at casual reading, are somewhat similar to those in the cases at bar. There are, however, vital differences which serve to distinguish the cases.

In the case cited the certificate provided that the corporation sells to the certificate purchaser “ all of its right, title and interest in Municipal Improvement Bonds issued under the special assessment laws of the State of California ” and that the certificate owner “ is entitled at any time upon demand and surrender of this certificate * * * to receive bonds of unpaid face value equal to the principal sum * * The trust agreement provides for the payment of the principal sum as stated in the ownership certificate prior to maturity, upon demand, by delivery to the certificate holder of specific bonds, selected by the trustee, or at maturity by cash or unpaid bonds, at the holder’s option. The agreement further 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 value 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, * * *

None of the “ interest income ” in the Oarson case flowed to the petitioners by reason of any of the warranties of the corporation or of bonds bearing an interest rate of less than 7 percent.

In the cases before us the certificate states that the bearer (or registered holder) “is entitled to participate in the proceeds and avails of certain special assessment certificates * * * to the extent of the principal sum, payable from such proceeds and avails ” on a day certain. The trust agreement makes no provision for payment of the certificate prior to maturity nor does it permit the certificate holder, upon maturity, to receive specific bonds in lieu of cash. On the contrary, it states definitely that:

* * * Neither the Company nor the holder or owner of any outstanding ownership certificate issued hereunder shall have any legal title to or interest in any securities assigned and delivered to the Trustee hereunder, but the right of the Company and of such holder or owner shall be the right to receive from, and through the Trustee as herein provided the income, proceeds, and avails of such securities, and as to said Company the right to receive reassignment of portions of said securities, all in the manner in this agreement of trust provided, it being the intention hereof to vest the full legal title to said securities and all securities substituted therefor in said Trustee. * * *

Furthermore, after the ownership certificates of any series shall have been paid or provided for, all surplus of cash and securities shall belong to the grantors.

The comparison of the provisions quoted from the respective trust instruments and certificates demonstrates clearly that in the 0arson case the certificate holder was a beneficial owner of certain deposited bonds and could obtain a specific allocation of his share of those bonds on demand before or upon maturity. The petitioners here had no such right. They were entitled to only a definite semiannual interest return on the principal sum, which sum was to be repaid in cash at the maturity date of the certificate. They looked to the grantor for assurance as to both the interest and the return of principal.

Reviewed by the Board.

Decision will be entered for the respondent.

Leech,

dissenting: It seems to me that the result announced in the majority opinion is not supported therein by any sufficiently material distinction from the situation presented in Carson Estate Co., 31 B. T. A. 607, in which we reached a different conclusion. Accordingly, I respectfully dissent.

Black agrees with this dissent.

       (b) Binclusions from gross income. — The following items shall not be included in gross income and shall be exempt from taxation under this title:
      *******
      (4) Tax-pkee ineebest. — Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; or (B) securities issued under the provisions of the Federal Farm Loan Act, or under the provisions of such. Act as amended; or (C) the obligations of the United States or its possessions. Every person owning any of the obligations or securities enumerated in clause (A), (B), or (C) shall, in the return required by this title, submit a statement showing the number and amount of such obligations and securities owned by him and the income received therefrom, in such form and with such information as the Commissioner may require. In the case of obligations of the United States issued after September 1, 1917 (other than postal savings certificates of deposit), the interest shall be exempt only if and to the extent provided in the respective Acts authorizing the issue thereof as amended and supplemented, and shall be excluded from gross income only if and to the extent it is wholly exempt to the taxpayer from income taxes.


author: Matthews :

text:
    Walter T. Gudeon, Petitioner, v. Commissioner of Internal Revenue, Respondent. P. W. Cook, Petitioner, v, Commissioner of Internal Revenue, Respondent. Arthur P. Woodward, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 54739-54741, 60227-60229.
    Promulgated February 19, 1935.

      Henry Ravenel, Esq., and Lawrence A. Baker, Esq., for the petitioners.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Matthews :

The real question in this case is, what is the net income of the partnership consisting of Woodward, Cook & Gudeon for the taxable years before us ? Section 218 of the Revenue Act of 1926 and sections 181, 182, and 188 of the Revenue Act of 1928 provide that: “ Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity ”; that “ There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year * * * ”; and that the net income of the partnership shall be computed in the same manner and on the same basis as in the case of an individual except that the so-called “ charitable contribution ” deduction shall not be allowed.

Respondent in determining the deficiencies took the position that Goulden’s estate was not a member of the partnership, since it was not liable for partnership debts and had no voice in the partnership management, and held that the full amount of the commissions received by the partnership was includable in the distributive shares of the three partners surviving. He contends that the case is governed by Willard C. Hill, 14 B. T. A. 572; affd., 38 Fed. (2d) 165; Stephen J. Hallaban, 14 B. T. A. 578; affd., in part sub nom Pope v. Commissioner, 39 Fed. (2d) 420; Benedict v. Price, 38 Fed. (2d) 309; and Arthur G. Hilmer, 27 B. T. A. 1165.

The petitioners contend that under the statute the net income of the partnership distributable to the partners is that portion of the net commissions remaining after the payment to the Goulden estate of the amount required to be paid by the partnership agreement. Conceding that upon the death of Goulden there was a technical dissolution of the partnership composed of Goulden, Woodward, Cook & Gudeon, and the immediate formation of a new partnership composed of the surviving partners, they argue that it is necessary further to consider the rights of the deceased and the rights and obligations of the petitioners; that it is clearly established that upon Goulden’s death his estate became entitled to have paid to it a portion of the commissions paid by the insurance company on renewal premiums on insurance which had been written up to the time of his death; and that if the partnership agreement had not provided for payment through the surviving partners, the estate, in an appropriate proceeding, could have required the payment direct from the Connecticut General Life Insurance Co. and the money would not have gone through the hands of the petitioners.

Petitioners refer to that paragraph of the partnership agreement which provides that, upon dissolution of the copartnership by withdrawal or death, the surviving partners shall take and retain possession of all the books, papers, etc., collect all premiums and renewal premium commissions and have entire charge of the liquidation and winding up of the partnership affairs, and contend that in the absence of paragraph 14 in the agreement they would be collecting the renewal commissions but, having collected them as liquidating partners, would be under the necessity of making prompt and periodical payment of Goulden’s share under the partnership agreement to his estate. Petitioners further contend that the only difference between the acts now being done by them in liquidating the interest of the Goulden estate and what they would be doing on a strict dissolution is that they themselves are carrying on new business obtained by them since Goulden’s death; that it is clear from the testimony that the basis arrived at for liquidating a deceased partner’s interest was never contemplated by the partners to do anything other than pay a deceased partner’s estate exactly what he had earned although not received up to the time of his death; that the partners did not intend to buy anything from a deceased 'partner’s estate; and that so far as they were able to determine the agreement was working out in a practical manner in accordance with the intent.

Petitioners also contend that the facts in the cases relied on by respondent are easily distinguishable from the facts in the instant case.

We agree with the petitioners that the facts in the instant case are distinguishable from the facts in the cases cited by the respondent. The Hifoner case involved a stock brokerage business and the deceased partner owned the good will, furniture and fixtures, and seats on various stock exchanges. The partnership agreement provided that his estate was to be paid the amount of his interest in the firm, the amount of his furniture and fixtures account, the then market value of his membership and seats in exchanges and boards of trade, and in addition thereto “ annually an amount equal to 25% of the net profits of the business ” conducted by the new firm for three years from the date of death of the partner.

In each of the other three cases the business conducted by the partnerships was that of insurance brokers, but it does not appear from the facts stated in any of the cases that they were life insurance brokers or that the copartners were operating under a contract with the insurance company similar to the contract here involved. The Pope case involved fire insurance brokers, and for aught the record shows the partnerships involved in the Hill and Benedict cases may have been fire insurance brokers also. In fire insurance there is no true renewal premium, but the writing of a new policy which gives rise to a new claim of compensation. Certainly if the partners involved in these three cases had had any such rights under contracts with the insurance companies which they represented as the deceased agent of the Connecticut General Life Insurance Co. had in the instant case, such fact would have been brought out. In the Hill and Pope cases the record shows that there had been contributions of capital to the partnerships and that new members were taken in after the death of a partner and new partnership agreements were executed. In the Benedict case the partnership had assets and good will.

The instant casé cannot be decided solely by reference to the partnership agreement, but must take into consideration the agency contract. Furthermore, the partnership here in question had no good will and no capital. The only asset was the agency contract under which a deceased agent’s right to renewal commissions on business written up to the time of his death passed to his estate.

The surviving partners of Goulden continued to act as general agent of the Connecticut General Life Insurance Co. under the same contract with the insurance company and under the same partnership agreement at the same place. The partnership agreement was so drawn that such could be done. On Goulden’s death there was the dissolution of the partnership composed of himself and the three petitioners and the immediate formation of the continuing partnership consisting of the petitioners, the surviving partners.

Under the contract with the insurance company, the right to commissions on renewal premiums is earned when the business is written and the first premium paid. Commissions on renewal premiums do not accrue, however, until the renewal premium is paid to the insurance company. On all business written prior to Goulden’s death, his estate and the surviving partners were jointly entitled to the commissions on renewal premiums to be paid after his death. Under the partnership agreement, in case of dissolution by death, the surviving partners were to collect the renewal premiums and renewal commissions and have entire charge of the liquidation of the partnership affairs and also had the right to continue for their own benefit the business of the partnership under the existing name. Since none of the partners of the old partnership had contributed any capital to the partnership and the partnership had no assets other than the right under the agency contract to renewal commissions and collection fees on renewal premiums, and since under this agency contract a deceased agent’s right to renewal commissions passes to his estate, the continuing partnership collected the renewal commissions on business written during Goulden’s life subject to his interest therein.

The effect of the partnership agreement on a deceased partner’s rights under the agency contract was that if the surviving partners continued the business of the partnership for their own use and benefit, they could liquidate the deceased partner’s interest in the renewal commissions collected by paying to his estate the portion of the net profits set forth in paragraph 14.

Based on actuarial tables it had been determined that a diminishing portion of the net profits of the business each year for a period of 15 years would be equivalent to a deceased partner’s share of the renewal commissions and fees on renewal premiums which would be collected during each of the 15 years. Since there is no profit in the collection fee paid after the fifteenth renewal premium, the interest of a deceased partner in renewal commissions and fees would be liquidated at the end of the fifteenth year. This method of computing a deceased partner’s interest in the renewal commissions and collection fees simplified the accounting records to be kept by the insurance company and the partnership.

The evidence is clear that the provision in paragraph 14 was adopted by the partners as a simple method of determining a deceased partner’s share of the renewal commissions received on business written during such partner’s life and that it was not intended by such provision to purchase anything from the deceased partner.

After Goulden’s death, therefore, although his estate was not a partner in the new partnership, the share of the net commissions collected by the partnership to which the estate was entitled was computed the same as if it had been a partner and all commissions belonged wholly to the partnership. The profits of the new partnership to which the surviving partners were entitled were not the total net commissions, but the total net commissions less the amount which all agreed should go to the estate of a deceased partner. The continuing partnership therefore did not receive the total commissions as partnership income. It was entitled in the first instance to receive as partnership income only the net commissions remaining after paying to Goulden’s estate the equivalent of his share of the net renewal commissions collected. James Brown, 10 B. T. A. 1036. See also La Monte & Sons v. Commissioner, 32 Fed. (2d) 220; Louis C. Rollo, 20 B. T. A. 199.

We hold that the net income of the partnership consisting of the three petitioners, which is taxable to them, is the net profits.from all commissions collected less the amount required to be paid to Goulden’s estate.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Goodhich concurs in the result.


author: Smith :

text:
    Hazeltine Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68074.
    Promulgated February 20, 1935.

      Paul Armitage, Esq., 3. H. McDermott, Esq., and Willis E. Taylor, Jr., Esq., for the petitioner.

      Bruce A. Low, Esq., and L, EL. Rmhbrook, Esq., for the respondent.
   OPINION.

Smith :

The first question to be considered is the basis to be used in the determination of the amortization allowance for patents for the year 1930. The respondent contends that this basis is the same as would be available to the predecessor owner, the Hazeltine Research Corporation, if it had not transferred them to the petitioner, for, he argues, in its income tax return for 1924 the Hazel-tine Research Corporation treated the transfer which was made in that year as one under the reorganization provisions of the Revenue Act of 1924, and the Research Corporation accounted for no taxable profit arising from the transfer of its patents to the petitioner for that year. The respondent has proved by an exhibit of the return of the Research Corporation for 1924 that it included in its gross income only amounts received from the sale of the Hazel-tine Corporation stock acquired by it on the deal.

Section 113 of the Revenue Act of 1928 provides in part:

(a) Property acquires, after February 28, 1913. — 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—

The only exceptions necessary to consider are subdivisions (7) and (8), which are as follows:

(7) TRANSFERS TO CORPORATION WHERE CONTROL OF PROPERTY REMAINS IN SAME persons. — If the property was acquired after December 31, 1917, by a corporation in cownection with a reorganisation, miS immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands if the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. * * *
(8) Same — Corporation controlled by transferor. — If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities im, connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. [Emphasis supplied.]

Section 112 (b) (5) provides:

(5) Transfer to corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are im, control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. [Emphasis supplied.]

The term “ control ” is defined in section 112 (j) of the Revenue Act of 1928 as follows:

As used in this section the term “ control ” means the ownership of at least 80 per centum of the voting- stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

In this proceeding the petitioner contends that after the contract of February 2, 1924, was performed, the Research Corporation owned only approximately 12 percent pf the outstanding stock of the petitioner corporation; that it never was contemplated that the Research Corporation should have any substantial interest in the petitioner corporation. We think this is clear from the testimony of Louis A. Hazeltine. The transcript of his testimony upon this point is as follows:

Q. Did you request Mr. Taylor to enlist the aid of some concern in setting up a situation to handle these things and acquire an interest in these inventions?
A. It was not so much in the nature of a request, but I told him I would be glad to capitalize the situation, and then if I remember correctly, a short time after that Mr. McConnell and his associates were interested in the matter.
Q. Let me ask you this: Was it your purpose in doing that to retain control of these patents?
A. Absolutely not. The purpose was to get out of the commercial field, and realize what I could on my own work, and to relieve myself of the troubles incident to the business and to commercial organizations in regard thereto.

Under the contract of February 2, 1924, the Hazeltine Research Corporation was to dispose of the patents and other assets which were transferred to the petitioner by it for 155,250 shares of stock of the petitioner and the Research Corporation was immediately to transfer 135,000 shares of such stock to Foster, McConnell & Co. for $650,000 cash. The contract was carried out according to its terms. Looked at as a whole, we think that it can not be said that “ immediate,ly after the transfer an interest or control ” of 80 per centum or more of the petitioner’s capital stock remained in the Research Corporation. The transaction must be so viewed. Cf. West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77.

The facts in this case are substantially different from those which obtained in Samuel Insull, Jr., 32 B. T. A. 47, in which we held that where the petitioners exchanged certain securities for shares of stock of Insull Utility Investments, Inc., the Insulls were in control of the corporation immediately after the transfer. There the disposition of the shares of stock of Insull Utility Investments, Inc., soon after acquisition by the Insulls, was the result of an independent contract, and not, as here, in fulfillment of the contract which gave rise to the new corporation. See Hazeltine Corporation, 32 B. T. A. 4.

We are of opinion that under section 113 (a) of the Revenue Act of 1928 the “ basis ” for determining the claimed deductions for exhaustion and obsolescence of patents is the “ cost ” to the petitioner of the assets acquired under the contract.

What was the cost to the petitioner of the assets acquired from the Research Corporation and from Taylor in February 1924? The petitioner contends that such cost was the fair market value of the assets transferred to the petitioner and that such value was $3,500,-000, the value placed upon them by the board of directors of the petitioner in February 1924. The respondent, on the other' hand, contends that the cost was the fair market value of the shares .o.f stock issued by petitioner in exchange for those assets and that such fair market value was $4.81 per share, the price at which the Research Corporation sold to Foster, McConnell & Co. 135,000 shares of stock. The respondent submits that the fair market value of all the assets transferred is $817,700, computed as follows:

Consideration_$650,000_ Shares of stock sold- 135,000
Shares issued for patents, trade-marks, contracts,' good will, etc_ 170,000x$4.81=$817,700

We are of the opinion that the respondent’s method of determining the value of the assets acquired by the petitioner from the Hazel-tine Research Corporation is not a correct method to be applied in this case. In Seymour Manufacturing Co., 19 B. T. A. 1280, 1285, we said: “ The cost of property acquired for stock is the £ fair market value’ of the stock.” To the same effect see Ambassador Petroleum Co., 28 B. T. A. 868. In this proceeding we note that Foster, McConnell & Co. paid $10 per share for 5,000 shares o.f stock purchased from the petitioner. It further appears that Foster, McConnell & Co. was able immediately to sell approximately all of the 135,000 shares of stock which it had acquired from the Hazeltine Research Corporation at approximately $10 per share. We think that this is the fair market value of the stock as of February 19, 1924, the date when the Hazeltine Research Corporation transferred its assets relating to the neutrodyne inventions to the petitioner. We therefore have found the cost of the total assets acquired by the petitioner from Hazeltine Research Corporation and from Taylor to have’ been $1,700,000.

We have also determined from a consideration of all of the evidence that the fair market value of the exhaustible assets acquired by the petitioner upon the issuance of 170,000 shares of stock was $1,275,000.

Our next question relates to the rate of exhaustion applicable to the cost of the exhaustible assets. The general rule with regard to the exhaustion of the value or cost of a patent application or invention on a given basic date is that such value or cost is to be written off over a 17-year period dating from the issuance of the patent, unless obsolescence becomes a factor prior to the end of the 17-year period. Hershey Manufacturing Co., 14 B. T. A. 867; affd., 43 Fed. (2d) 298; Tennessee Fibre Co., 15 B. T. A. 133. Where the cost or value relates to an entire group of patents, patent applications and inventions, as is the situation here, exhaustion is allowed either over the average life of the patents, as in Prophylactic Brush Co., 25 B. T. A. 676, 686, or upon the life of the principal patent, as in Hyatt Roller Bearing Co. v. United States, 43 Fed. (2d) 1008, 1013; Individual Towel & Cabinet Service Co., 5 B. T. A. 158; and Hartford-Fairmont Co., 12 B. T. A. 98.

The petitioner contended that owing to the nature of the radio patents acquired by it, the rapid development in the radio art, and the many new devices that were being invented, the average useful life of the group of patents was not more than five years or, at the most, eight years. It introduced the testimony of numerous witnesses to the effect that the cost of the assets acquired should be amortized over an eight-year life.

The evidence further indicates that in 1929 or 1930 the Hazeltine neutrodyne patents lost much of their value by reason of a more general use of the screen grid tube in radio receiving instruments. It appears, however, that even though the value of some of the patents was greatly lessened in 1929 and 1930, the patents were not obsolete. The petitioner continued to receive some royalties upon the neutrodyne patents even after 1930. The record does not show upon just which patents royalties were received after 1930. The amount of royalties received in 1931 was $584,973.90 and in 1932, $382,797.18. The petitioner’s licensees had the authority to use many different patents owned by the petitioner. Some of the neutrodyne patents were used in connection with other and later patents taken out.

Upon a careful consideration of the entire record we are of the opinion that the petitioner is entitled to deduct from its gross income for the year 1930, one seventeenth of the basis hereinbefore indicated for the exhaustible assets acquired from the Eesearch Corporation and from Taylor. We conclude that the petitioner was entitled to deduct from its gross income for 1930, $75,000 representing depreciation of the exhaustible assets acquired from the Hazeltine Eesearch Corporation and from Taylor. In its notice of deficiency the respondent has determined that the petitioner was entitled to deduct from the gross income of 1930, $4,829.95 representing an amount for the “ amortization of patents purchased for cash.” This amount is in addition to the $75,000 representing the amortization of exhaustible assets acquired from the Hazeltine Eesearch Corporation and from Taylor. Therefore, the total depreciation deduction to which the petitioner is entitled for 1930 is $79,829.95.

In its income tax return for 1930 the petitioner deducted from gross income the following items: patent applications, $41,363.92; patent interferences, $36,681.26. These amounts were disallowed by the respondent in a computation of the deficiency. In its brief upon this point the petitioner states:

By contract, inventions made by engineers of the laboratory and research department of petitioner were assigned to petitioner. The retained attorneys for the company applied for patents on these. There were numerous cases, the service's were rendered simultaneously and charges lumped without segregation. Some of these applications ripened into patents, others were disallowed, others went into interference. The charges were all lumped and paid monthly as the services were rendered. .
There was no practical way to allocate each charge to each pending application. To require this would be to deny to petitioner this expense in its entirety and capitalize it.

This Board has held in numerous cases that the cost of developing patents, secret processes, etc., are capital expenditures and that the taxpayer has no option to treat such costs as deductible expenses. Gilliam Manufacturing Co., 1 B. T. A. 967; Goodell-Pratt Co., 3 B. T. A. 30; Beaumont Co., 3 B. T. A. 822.

The contention of the petitioner that the items referred to above constitute legal deductions from gross income as ordinary and necessary expenses is not sustained.

The petitioner offered no evidence with respect to the disallowance by the respondent of the deduction from gross income of $55,000 representing a reserve for bad debts. Neither is that item referred to in the briefs. For lack of evidence showing any error on the part of the respondent in disallowing this deduction the claim of the petitioner to the deduction is not sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: BlacK :

text:
    California Sanitary Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68655.
    Promulgated February 20, 1935.

      Glawde I. Parker, Esq., John B. Milliken, Esq., and George E. Rosier, Esq., for the petitioner.

      Thomm F. OallaJum, Esq., for the respondent.
   OPINION.

BlacK :

Under the tax laws of California both real and personal property are assessed to the persons by whom they are owned or claimed, or in whose possession or control they are, at twelve o’clock meridian of the first Monday in March. The Political Code of California, section 3628, reads as follows:

Seo. 3628. * * * The assessor must, between tlie first Mondays in March and. July of each year, ascertain the names of all taxable inhabitants, and all the property in his county subject to taxation, except such as is required to be assessed by the state board of equalization, and must assess such property to the persons by whom it was owned or claimed, or in whose possession or control it was, at twelve o’clock meridian of the first Monday in Ma¡rch next preceding * * *.

By section 3711 of the code it is provided that taxes due on personal property shall be a lien upon the real property of the owner thereof, from and after twelve o’clock noon of the first Monday in March in each year. Section 3718 provides that taxes due upon real estate shall be a lien and such lien shall attach as of the first Monday in March in each year.

Other provisions of the code relate to the procedure as to the assessment, proceedings before boards of equalization, levying of the tax, and methods of collection.

In the instant case the property was assessed as of the first Monday in March 1930 for the taxes for the fiscal year beginning July 1, 1930. Under the sections referred to above the lien for such taxes accrued and attached to the property as of the first Monday in March 1930. At such time the property was owned by and in possession of the partnership, California Sanitary Canning Co., and was assessed to it. When transferred to the petitioner on June 13, 1930, the property was encumbered with the lien for taxes, which were the taxes assessed, against the partnership.

The tax receipt which shows the payment in question was attached as an exhibit to the stipulation and it shows that the property was assessed to or owned by California Sanitary Canning Co., which, is the partnership and not the petitioner corporation. This same tax receipt contains certain printed matter on the back thereof entitled “ Important information.” Paragraphs 4 and 5 thereof read as follows:

4. Tames are levied on both real and personal property as it exists at 12 o’clock noon on tlie first Monday in March. Subsequent removal or change oí ownership does not relieve the real estate of the personal property tax lien and the Tax Collector cannot credit payments for real property taxes unless the personal property tax has been paid or tendered.
5. Tax Bills will be pre-niailed only to taxpayers who have filed a statement with the Qownty Assessor between the first Monday in March and the first day in June, each year, of all taxable property, real and personal owned by them, in their possession or under their control at 12 o’clock noon on the first Monday in March of that year. * * *

It seems clear that under these circumstances the taxes in question were accrued liabilities against the partnership, California Sanitary Canning Co., prior to the transfer of the property to petitioner, California Sanitary Co., Ltd.

The subsequent payment of the taxes by the petitioner corporation was a capital expenditure and an additional cost of the property.

We have had this question before us in several cases from different states and have uniformly decided that the owner of the property on the day of assessment and accrual of the lien is the taxpayer primarily liable therefor and that subsequent purchasers paying the taxes are not entitled to a deduction therefor. Texas Coca-Cola Bottling Co., 30 B. T. A. 736; Grand Hotel Co., 21 B. T. A. 890; Leamington Hotel Co., 26 B. T. A. 1004; First Bond & Mortgage Co., 27 B. T. A. 430; John Hancock Mutual Life Insurance Co., 10 B. T. A. 736. We find no substantial difference in the laws of California in this respect from those in the cases previously considered. The action of the respondent is sustained. Cf. Alden Anderson, 27 B. T. A. 980, a California case.

Decision will be entered for the respondent.


author: Van Fossan :

text:
    The Texas Pipe Line Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59457.
    Promulgated February 20, 1935.

      Thomas K.Schmuek, Esq;, and James T. Dortsoh, Esq., for the petitioner.

      J. B. Johnston, Esq., for the respondent.
   OPINION.

Van Fossan :

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1927 in the sum of $51,374.26.

The issues are:

(1) Whether or not the Texas Co. (of Delaware), an affiliate of the petitioner, is entitled to deduct an allowance for the depletion of a sulphur mine based on the discovery value thereof created by its predecessor in title, also an affiliate of the petitioner.

(2) Whether or not the Texas Co. may deduct as an expense the sum of $315,518.52 representing the excess cost of certain stock pur-, chased under an employees’ stock allotment plan, above the allotment price to the employees.

The second issue was raised by the respondent upon his amended answer, an increased deficiency being claimed.

Counsel for the petitioner and respondent have stipulated by written agreement that the following' constitutes a correct statement of facts. We adopt such stipulation as a portion of the facts pertinent to this proceeding:

(1) For the calendar year 1927, the Texas Corporation, a Delaware corporation, (hereinafter called the “Holding Company”), The Texas Company, a Texas corporation, (hereinafter called “Texas”), The Texas Company, a Delaware corporation, (hereinafter called “Delaware”), The Texas Pipe Line Company, a Texas corporation, (hereinafter called “the petitioner”) and other corporations, filed a consolidated corporation income tax return and have been held by the Commissioner to have been affiliated for the period of operation of each of said corporations within said calendar year, under the provisions of section 240 of the Revenue Act of 1926.
(2) The tax, including any deficiency due from the above stated affiliated group for the year 1927, was allocated to the petitioner in accordance with an allocation agreement to such effect executed by each of the affiliated companies within the consolidation for said year, and accepted by the Commissioner, all in accordance with the provisions of section 240 of the Revenue Act of 1926.
(3) In the summer of 1926, the officers and directors of Texas, acting in concert with certain other shareholders thereof, concluded that it was desirable to reorganize the business of Texas in view of the difficulties theretofore encountered in managing and operating a corporation organized under the laws of the State of Texas.
The terms “ reorganize ” and “ reorganization ” are agreed to by the petitioner without regard to such peculiar meanings as may be attributed to them by the Revenue Act of 1926.
(4) After reaching the decision stated in paragraph (3) above, the said officers, directors and stockholders determined on a plan of reorganization which was carried out whereby (a) all the assets and liabilities of Texas as a going concern were to be transferred to a corporation organized under tbe laws of a state more favorable than, those of Texas, as respects the management and operations of corporations, and (b) the shares of that corporation to be organized were to be held by another corporation also to be organized as the Holding Company.
(5) The Holding Company was organized under the laws of Delaware on August 25, 1926. The Delaware Company was organized under the laws of Delaware on January 24, 1927.
(6) Between August 30, 1926 and April 12, 1927, the Holding Company by exchanging its stock, share for share, for shares of Texas, acquired more than 99 per centum of Texas’ issued and outstanding capital stock and between said dates, the Holding Company acquired by subscription and payment of the subscription price all of Delaware’s issued and outstanding capital stock of a total par value of $10,000. From April 12, 1927 to and including the dissolution of Texas, the Holding Company owned the stock of Texas mentioned in the preceding sentence. From April 12, 1927, to and including April 20, 1927, the Holding Company owned that stock of Delaware above mentioned in addition to other stock of Delaware acquired as hereafter set forth.
During the period from April 12, 1927, to the date of the dissolution of Texas (both dates inclusive), all of the capital stock of Texas was voting stock of one class, and during the period from April 12, 1927 to April 20, 1927 (both dates inclusive), all of the capital stock of Delaware was voting stock of one class.
(7) During the period from April 18, 1927 to April 20, 1927 (both dates inclusive), the same persons owned in the same proportions more than 99 per centum of the Holding Company’s capital stock. On April 18, 1927, and at all times thereafter, all of the capital stock of the Holding Company was and has been voting stock of one class.
(8) As part of the plan pursuant to which the Holding Company acquired the stock mentioned in paragraphs (6) and (7) above, the Holding Company caused the following acts and things to be done on the dates mentioned below:
(a) On April 12, 1927, Delaware increased the amount of - its authorized capital stock, and
(b) On April 12, 1927, the Holding Company offered, first, to subscribe for the entire amount of said increase in Delaware’s capital stock and, second, to pay for the same by assigning to Delaware that liquidating dividend to which the Holding Company, as the owner of more than 99 per centum of Texas’ issued and outstanding capital stock, was to be entitled on Texas’ dissolution, and (e) on April 14, 1927, Delaware accepted the Holding Company’s said offer to subscribe, and
(d) On April 19, 1927, Texas agreed to and did transfer to Delaware all its assets and liabilities for a consideration, which was the net book value of the same as shown by Texas’ books and without the recognition of gain or loss to either party under the Revenue Act of 1926. Among the assets so transferred was such right, title and interest, if any, which Texas, as stated in paragraph (10) below, retained in and to that lease of mineral rights, mentioned in paragraph (9) below, of realty hereinafter referred to as Hoskins Mound. Insofar as concerned said right, title and interest, such net book value thereof was the cost to Texas thereof less allowances that were taken for depletion and depreciation, if any, and
(e) Pursuant to the agreement mentioned in subparagraph (d) above, the amount of the liquidating dividend assigned by the Holding Company to- Delaware as aforesaid, was applied in payment of the cash consideration therein mentioned, and
(f) On April 19, 1927, the shareholders of Texas duly resolved that Texas should be dissolved, and
(g) On April 20, 1927, there was duly filed with the Secretary of State of the State of Texas, as required by the laws of said State, a certificate showing the due adoption of said resolution to dissolve Texas and on that day, the Secretary of State of the State of Texas issued a certificate showing that Texas had been dissolved.
(h) On May 2, 1927, the final liquidating dividend of Texas was paid to non-assenting stockholders in the sum of $1,732,536.
(9) In the year 1921, Texas acquired by lease the mineral rights in and to certain realty in Brazoria County, Texas, known and hereinafter referred to as “ Hoskins Mound ” and, thereafter, in that same year, discovered a sulphur mine in Hoskins Mound.
(10) Texas assigned and transferred to Freeport Sulphur Company its interest in and to the sulphur rights covered by said lease by instrument dated March 14, 1922 the material portions of which are as follows:
(a) Freeport Sulphur Company promised and agreed to pay to Texas, its successors and assigns, royalties based on the amount of sulphur mined from Hoskins Mound and sold,
(b) In event of Freeport Sulphur Company’s failure to observe and perform any one of eighteen or more covenants on its part to be observed and performed, Freeport Sulphur Company’s interest in said lease revested in Texas, its successors and assigns,
(c) Freeport Sulphur Company promised and agreed not to assign without the written consent of Texas, its successors and assigns, that interest by Texas assigned and transferred. Such interest, if any, reserved to and retained by Texas in said sulphur mine assigned and transferred to Freeport Sulphur Company, was among the assets of Texas when the transfer and conveyance of all of its assets was made to Delaware on April 19, 1927.
■(11) For the period from January 1, 1927 to and including April 19, 1927, Texas, for the reasons stated above, was entitled to deduct from its net income for the year 1927, taxable under the Act, an allowance for depletion, based on the discovery value of said sulphur mine, at the rate of $2,075 per ton of sulphur mined therefrom and sold, or a total of $235,103.73.
“ Discovery value ” as used herein means that basis for depletion provided by section 204-C-l of the Revenue Act of 1926.
(12) From and after April 19, 1927 to and including December 81, 1927, 258,178 tons of sulphur were mined from said sulphur mine and were sold.
(13) If Delaware is entitled to compute its depletion on the discovery value of said mine, then and in such case, Delaware is entitled to deduct from its net income for the year 1927 taxable under the Act, an allowance for depletion of said sulphur mine at the rate of $2,075 for each ton of sulphur mined therefrom and sold during the period from April 19, 1927 to and including December 31, 1927, or a total of $535,719.35. Such depletion, if allowed, is separate and distinct from that depletion allowance to which as stated in paragraph (11) above Texas is entitled.
(14) The cost to Texas of said sulphur mine was $633,000.
(15) The value and unit rates of depletion stated above are based upon a tonnage of 6,000,000 tons and a discovery value of $17,784,566.
(16) On the consolidated return for the calendar year 1927, the taxpayer claimed a deduction for depletion on sulphur at Hoskins Mound, Texas, in the sum of $999,808.92. The Commissioner, in computing the deficiency of $51,374.26 proposed in the 60-day letter attached to the petition allowed total depletion on sulphur at said Hoskins Mound, Texas, in the sum of $619,258.83, without making any allocation of depletion allowable on discovery value or otherwise prior to April 19, 1927, inclusive and for the period April 20, 1927 to December 31, 1927.
(17) On or about May 17, 1927, the following plan was adopted by the Texas Company (Delaware) :
“1. Time and Basis of Allotment. — From time to time during the continuance of this plan, employees of The Texas Company and its subsidiary corporations and affiliated corporations all the stock of which is owned by or held for The Texas Corporation will be given opportunity to purchase stock of The Texas Corporation. Allotments will be made to employees who at the date of allotment shall have been two years or longer in the active and continuous service of these companies exclusively, and they will be based ordinarily upon salary or wages earned during the year preceding allotment. The number of shares and the price will be fixed in each instance by the board of directors of The Texas Company. And the amount will be payable in monthly installments deductible from salary or wages.
“For the purpose of determining the right to stock allotments, neither temporary lay-offs ordered by the company resulting from shut-downs or lack of work nor periods of an employee’s temporary illness will be deducted from the employee’s time of service.
“ The decision of the Board of directors shall be final and conclusive in regard to an employee’s right to a stock allotment and the quantity thereof.
“ Corporate officers, if not inactive, will be deemed employees' for the purposes of this plan.
“An employee may, if he so desires, file with the company a written designation of a beneficiary or beneficiaries to whom stock may be issued and delivered in event of the employee’s death before receiving the same. Such designation shall be subject to revocation or change by the employee at his discretion, the revocation or change to be in writing and filed with the company.
“ 2. Trustee — Power and Authority. — Title to all stock taken by employees under this plan will be placed in a trusted designated by The Texas Company, and while the title so remains the trustee shall have full power and authority to vote upon the stock; to advance or borrow money for the purpose of paying for or carrying the stock, and to hold, pledge or hypothecate the stock to secure the repayment of such money with interest and other charges; to subscribe on behalf of employees but in the name of the trustee for shares of new issues of stock when the privilege of so subscribing may be accorded to stockholders as an incident to their stock ownership; to sell or otherwise dispose of subscription warrants or stock rights in such new issues for account of employee; and to exercise any or all of the powers herein enumerated in connection with every such, new issue. But after an employee shall have paid up his stock in full, which may be done at any time, the same shall not thereafter be pledged or assigned by the trustee for any purpose. And any employee after so paying up his stock shall be entitled to receive promptly any dividends collected by the trustee thereon and the proceeds of any subscription warrants or stock rights sold by the trustee for account of such employee.
“ 3. Accounting. — Employees will be charged on the books of the trustee with the amount or amounts owing by them respectively for stock. They will be credited with all payments received by the trustee for their respective accounts, including dividends so received and the proceeds of any subscription warrants or stock rights sold. Interest at the rate of six per cent per annum, computed quarterly, will be charged on debits and allowred on credits from the proper dates. And where payments are refunded as provided for in succeeding clauses interest will be allowed at the same rate but in such cases employees will have no credit for dividends or subscription warrants or stock rights or the proceeds thereof.
“4, Defaults. — Failure of an employee to make or cause to be made any payment when due may, at the option of the trustee or the company, work a forfeiture of all right and claim to the stock, the employee thereupon becoming entitled to receive from the trustee a sum equal to the amounts theretofore actually paid by the employee with interest thereon.
“ 5. Tenvination of Employment. — Any employee ceasing to be such before becoming entitled to pay the balance, if any, owing by him and receive his stock certificate, and being no longer in the service of The Texas Company or any of its subsidiary corporations or affiliated corporations all the stock of which is owned or held for The Texas Corporation, whether such cessation be due to his own volition or to discharge (with or without cause), shall cease to have any right or claim to the stock but shall be entitled to receive from the trustee the amount of all payments actually made by him with interest thereon.
“ 6. Death. — Upon the death of an employee his estate or if a beneficiary has been designated, the person or persons so designated to receive the stock may pay to the trustee the unpaid balance of his indebtedness, and thereupon the estate or the person or persons designated to receive the stock will be entitled to receive forthwith from the trustee a stock certificate for the shares held for such employee, or at the election of the estate or the person or persons designated to receive the stock, in case such designation has been made by the employee, there will be paid over by the trustee to the estate or the person or persons designated to receive the stock the full amount actually paid in by the employee together with interest thereon.
“ 7. Disability. — In case of the total and permanent disability of an employee he or the person or persons designated to receive the stock may, if The Texas Oompany shall be satisfied in regard to the disability and its total and permanent nature, exercise the same rights as are extended to the estates of deceased employees in the immediately preceding clause.
“ 8. Gcmoellation and Refund. — At any time before acceptance of stock certificate an employee, or in case of his death his estate or the person or persons designated to receive the stock, may waive the right to stock and thereupon become entitled to receive from the trustee the amount of all payments actually made by such employee with interest thereon.
“9. Three Years Restriction. — Except as hereinbefore stated, no employee can obtain his stock certificate from the trustee until after the expiration of three years from the date when the stock is allotted to him, nor can he then unless and until payment in full has been made; and stock of any increase issue, subscribed for by the trustee for account of an employee, for the purpose of the three years restriction, shall be deemed allotted on the same date as the stock on account of which the right to the increase accrued.
“ 10. No Fractions. — Stock certificates will not be issued for fractional shares. Claims for fractional shares must be consolidated. This can be done by arrangement with the trustee or the trustee may dispose of fractions for account of employees.
“11. Successors in Trust. — The trustee or any successor in the trust may resign at will, or may be superseded at the will of the board of directors of The Texas Company, and thereupon in either event the board of directors by resolution may designate a successor, who shall succeed to all of the rights and powers of the original trustee, and this the board may do also in case of the death of any trustee.
“ 12. Discontinuance or Change of Plan. — Nothing herein shall be construed as giving an employee a right to be retained in the service, and the company reserves the right at any time in its discretion to discontinue this plan, or to modify or change it in respect to future allotments.”

Pursuant to the above plan Delaware and the Holding Co. and certain of the Holding Co.’s subsidiaries, on or about May 17, 1927, executed an agreement with T. J. Donoghue, as trustee, which agreement incorporated substantially all of the foregoing provisions. Among other provisions of the agreement were the following:

Whereas the Companies desire to create a trust as a part of a stock investment or profit sharing plan for the exclusive benefit of some or all of their employes, and are willing to make payments to the Trustee for the purpose of said trust; and
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1. That the Trustee will, from time to time, as directed by the Companies, purchase shares of stock of The Texas Corporation, a Delaware corporation which owns the stock of The Texas Company, for the purposes of said trust, at a price or prices agreed to by the Companies.
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4. That the Companies shall pay all of the expenses of administering this trust, and shall save the Trustee harmless by reason of any and every obligation he may enter into or assume pursuant to the terms of this agreement, and upon demand of the Trustee, shall advance him funds, by way of loan, with which to pay any and every obligation assumed by him hereunder. All amounts received by the Trustee from the sale of said stock shall be applied on the indebtedness of the Trustee incurred hereunder, including interest and other proper charges and whether owing to the Companies or others, until the same is fully discharged or cancelled.
5. That the Trustee, from time to time with the consent of the Companies, may sell said shares or any of them to others than the employes at a price or prices agreed to by the Companies, but all profits arising from such sales or otherwise arising in any manner in connection with the administration of this trust shall be held by the Trustee for the exclusive benefit of this trust, and the Companies shall not have the power to take for themselves title to any part of the corpus of this trust.
6. That the companies shall have the right at any tinfe to terminate this trust, but in that event all the property affected thereby, after payment of the Trustee’s indebtedness, shall be distributed to employes of the Companies, or some of them, in such manner and upon such terms as the Companies may prescribe, and the Companies shall in no event have the right to any part thereof.
7. Corporate officers, if not inactive, shall be deemed employes; but the decision of the board of directors of the companies shall be final and conclusive in regard to the rights of any particular employee in respect either to stock or proceeds of this trust.
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(18) During the year 1927 said T. J. Donoghue, acting under the aforesaid agreement, purchased stock of the Texas Corporation at $47,066 per share for the purpose of allotment to employees under the plan above stated. The sale price of this stock purchased as aforesaid to employees, under said plan, was during said year, fixed by the Board of Directors of the Delaware Company at $40.00 per share, and said T. J. Donoghue, trustee, billed the Delaware Company for $315,51S.52, which was arrived at in the following manner as shown by the accounts of the trustee:
Earnings:
Interest received-$334, 445. 03
Excess dividends received overpaid. 57,316.50
$391, 761. 53
Deductions:
Interest paid-$277, 854. 95
Transfer tax paid_ 204. 98
Loss on stock sold to employees pursuant to allotment of July 1, 1927- 429, 220.12
707, 280. 05
Net amount billed. $315, 518. 52
In the consolidated return of income for the year 1927, the Texas Company (Delaware), deducted said amount of $315,518.52 from income as an expense of doing business. The Commissioner in this proceeding has raised the affirmative issue that such amount is not an allowable deduction.

We find the following additional facts:

The sum of $315,518.52 was billed to the petitioner by the trustee and entered on its books as a loss “ by reason of stock allotments under the Trustee plan.” An account in the books of the Texas Co. captioned “ Miscellaneous special T. J. Donoghue, trustee ” was credited with the said amount and its “ profit and loss suspension ” account was debited with it.

The stock on which the above “ loss ” was incurred was purchased by the trustee to cover an allotment of shares to employees made as of July 1,1927. For that year 84,486 such shares were allotted.

The said sum of $315,518.52 was paid by the Delaware Co. to the trustee during the year 1927.

The first issue is whether or not a corporation is entitled to compute depletion on the basis of the discovery value granted to its predecessor owner. The pertinent statutory provision is section 204 (c) (1) of the Revenue Act of 1926. Under essentially similar facts we decided this question in the negative in Rialto Mining Corporation, 25 B. T. A. 980. See also Darby-Lynde Co., 20 B. T. A. 522. The petitioner admits that these cases are indistinguishable, but argues that the cited cases are wrongly decided. The statute is explicit. The petitioner acquired proven property, valuable by reason of prior discovery. The facts reveal no basis for disregarding the separate corporate entities of petitioner and its predecessor in title. On the contrary, there are special reasons why the distinction should be preserved. The officials of the Texas Co. organized the Delaware company to supersede it in order to avoid certain burdens imposed on Texas corporations. Obviously, the benefits of such a procedure were deemed to outweigh the disadvantages. The loss of discovery value as a basis of depletion which would have been available to the predecessor is a disadvantage which must be accepted, along with the advantages which the Texas Co. has enjoyed through the revamping of its corporate structure. We see no reason to alter the conclusion reached in the cases cited and hence hold that the petitioner is not entitled to the benefits of the section relating to discovery value.

The second issue involves the deductibility of the cost to petitioner of maintaining a “ stock investment or profit-sharing plan ” by which part of its employees were permitted, through a trustee, to purchase stock in the Texas Co. at less than its fair market value. The petitioner deducted the sum in question in its return for 1927 and the Commissioner allowed it. It comes before us by virtue of an affirmative allegation in respondent’s answer and a claim for an increased deficiency. The burden of proof is accordingly on the respondent.

The Board and the courts have been called on frequently to determine the deductibility of amounts paid under various forms of such plans. Hibbard, Spencer, Bartlett & Co., 5 B. T. A. 464; Haskell & Barker Car Co., 9 B. T. A. 1087; Package Machinery Co., 28 B. T. A. 980; Gardner Governor Co., 27 B. T. A. 1171; William Ritter Lumber Co., 30 B. T. A. 231; Robinson v. Commissioner, 59 Fed. (2d) 1008. The plans involved in the cited cases differ in many respects, but substantially all present the same question, i. e., whether the amount in question constitutes an allowable deduction. Despondent argues on brief that it does not appear affirmatively that the purpose of the plan was the payment of additional compensation. We may properly observe that, as to this phase of the matter, the Commissioner having allowed the deduction, the presumption, if any arises, is that the deduction was proper and it is for the respondent to offer proof demonstrating that it was unallowable. This is not accomplished by merely raising a doubt or by pointing to the fact that there is no proof to sustain certain elements. Here the situation is the converse of that usually met, in which the petitioner carries the burden and must bear the consequences of absence of essential facts. In the instant situation the respondent undertook to prove that the item was not allowable. It was for him to introduce testimony, if such there be, proving that the purpose of the plan was not the paying indirectly of additional compensation to selected employees. Similar observations apply as to bis contention that the proof does not show that such additional compensation was reasonable. In answer it may be rejoined, the proof does not show that it was unreasonable.

Respondent urges that there was no sale of stock to the employees completed in 1927 and that the employees could not acquire the stock allotted in 1927 until the fulfillment of conditions impossible of performance in that year. It is to be remembered that the petitioner was on an accrual basis and, moreover, actually spent the money in question. The expenses were not all cost differential, but embraced other charges and costs incurred as a consequence of the plan. To withhold accounting for these items until the actual delivery of the stock in a later year would distort the true income condition. See Haskell & Barker Car Co., supra.

On the record before us we are unable to hold that the Commissioner has sustained the burden of proof in his claim for an increased deficiency.

Decision will be entered wider Rude 50.

       Sec. 204. (c) The basis upon vhich depletion, exhaustion, wear and toar, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or oither disposition of such property, except that—
      (1) In the case of mines discovered by the taxpayer after February 28, 1913, the basis for depletion shall be the fair market value of the property at the date of discovery or ■within thirty days thereafter, if such mines were not acquired as the result of purchase of a proven tract or lease, and if the fair market value of the property is materially disproportionate to the cost * * *.


author: MoeRis :

text:
    Walter Thiele, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67506.
    Promulgated February 26, 1935.

      Knowlton Durham, Esq., for the petitioner.

      Ralfh E. Smith, Esq., for the respondent.
   OPINION.

MoeRis :

The respondent’s original position in this matter appears to have been that the stocks which the petitioner sold were not those already held by him in his margin account when his orders to sell were executed in December 1929, but were those shares which he purchased on the same day that the said sales were executed. While the ultimate effect of that point of view survives, the respondent’s position now seems to be, not that the petitioner sold the stock which he purchased on the same day, but that because of the clearing house regulations requiring that purchases made within the same trading period be “ off-set ” by sales of similar stock, thereby obviating the necessity for physical delivery of the certificates purchased or sold, thus leaving the petitioner’s broker in the possession of the same shares which he already held and which he was not required to deliver because of such rules, he was in the same “ long ” position as he had been theretofore. The effect being, of course, to preclude him from deducting a loss measured by the cost of the shares then owned and the selling price.

The stipulation of facts refutes the original proposition advanced by the respondent. It shows clearly that all sales by the petitioner were required to be and that they in fact were executed prior to the repurchase by him of similar shares. Although the sales were admittedly made in order to claim the accrued “ paper ” losses for tax purposes the parties have stipulated that they were made in perfect good faith and without reservation. Nor is there any contention on the part of the respondent that such sales constituted “ wash sales ” under the provisions of section 118 of the Revenue Act of 1928. In fact the parties agree that the petitioner was engaged in the business of buying and selling securities, rendering that provision inapplicable.

The respondent’s position, viewed from any angle whatsoever, seems wholly untenable. The facts which justify the deduction in our opinion, are that the petitioner carried a large amount of securities during 1929 upon which there had accrued large paper losses but which he had no right to take as a deduction for tax purposes. Being desirous of taking his said losses for tax purposes, he instructed his broker to sell certain of them. At or about the same time he placed orders with specialists, to be executed through his brokers, for the purchase of an equal number of the same shares sold. He instructed his brokers that the orders to purchase should not be executed prior to the execution oí his orders of sale, which we are satisfied was done. There is no contention by the respondent that the petitioner chose an erroneous basis for the computation of his aggregate loss by reason of having chosen the wrong stocks already on hand upon which to compute his loss. Indeed, the respondent admits that if the purchases and sales in question had been executed on different dates there would have been no question about the de-ductibility of the loss here claimed. His basis being, as we have already shown, the mechanical handling of the sales by the, clearing house, i. e., because his sale order was, in effect, negatived by his purchase order, hence no> change in his position.

A simple illustration, if, indeed, such be necessary, will serve to bear out that losses were sustained. Granting that the petitioner was “ long ” the same number of shares of the same stock at the close of the day upon which the sales and purchases were made, and granting also that because of the clearing practices it became unnecessary to “ deliver ” the certificates evidencing the shares purchased or shares sold, his position, from an economic or financial viewpoint, was very materially changed. For instance, assuming the stock owned on January 1, 1929, to have cost $5,000 — that would be the amount he would be charged with on the books of his broker when the purchase was made. On December 5 of that year, his stock having declined in value from the original purchase price to $3,000, he instructed his broker to sell said shares, which he did, at that price. His account was, accordingly, credited with $3,000. After this transaction, if nothing else had transpired, he would have, as the respondent confesses, sustained a deductible loss of $2,000. But, at or about the same time, he instructs his broker to repurchase a like number of those shares, after the sale has been completed, at the same figure, $3,000, which he does. His brokerage account is now charged with that amount. After the completion of those transactions his account reads:

Debit Credit
$5,000_
3,000_$3,000

which, when analyzed, shows a debit balance of $5,000,.representing:

Present market value of security purchased_$3,000
Deficit in account occasioned by sale at less than cost- 2, 000
Balance of account_ 5,000

We are of the opinion that the respondent’s determination is incorrect and we so hold. See Benjamin T. Britt, 2 B. T. A. 530.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Turner dissents.