author: Steenhagen :

text:
    Connally Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71140.
    Promulgated October 10, 1934.

      A. W. Clapp, O. P. A., for the petitioner.

      Philip A. Bayer, Esq., for the respondent.
   opinion.

Steenhagen :

The Commissioner determined a deficiency of $1,092.84 in petitioner’s income tax for 1930. The petitioner assails the disallowance of a deduction of part of the cost of remodeling a business building, occasioned by the city’s raising of the contiguous street level. The facts are stipulated in more detail than is needed for the purpose of this opinion.

The building was erected in 1916, at a cost of $312,933.17. It stood at the corner of 'two streets of different levels and had stores fronting on both. The construction, in 1929, of a new viaduct nearby necessitated raising one of the streets as an approach, thereby causing serious economic damage to the building. This the city settled in 1929 by paying petitioner $25,000, of which petitioner paid $6,250 to a lawyer. The alterations made in the building involved shifting the entrance, constructing an arcade, and substantially rearranging the store space and to some extent the elevators. They were completed in 1930, at a cost of $35,015.34, of which petitioner paid $20,315.45 in 1930. Of this amount, it deducted $9,376.47, said to be the excess over the city’s award, and this the Commissioner disallowed. “ The value of the property was not increased by the construction of the viaduct approach. The life of the property as a whole was not prolonged by the change in this small part of its structure.” The rents from the building were less in 1930 than in 1927, but-there is no evidence to show whether this is attributable to the foregoing facts, to general business conditions, or to something else.

Upon this foundation, the petitioner contends that so much of the cost of such of the alterations as are properly attributable to the change in street level as exceeds the award (minus attorney fees) is deductible. Deductibility can only be established by a showing that the outlay is within the statutory classification of “ ordinary and necessary expenses ” of carrying on the trade or business. Revenue Act of 1928, sec. 23 (a). This is attempted by petitioner by the indirect argument that because the value of the building was not increased • or its life prolonged, the expenditure may not be called capital. It has been said before that this argument does not prove its point. The idea that everything which is not strictly a capital investment must be a deductible expense is unsound. Deductibility must be affirmatively established in the terms of the statute invoked, and if the item does not fit into the statutory description it may not be deducted. New Colonial Ice Co. v. Helvering, 292 U.S. 435. If this results in making the item a nondescript before the law or puts it in a vacuum abhorrent to the accountant, so it must stand. Commissioner v. Field, 42 Fed. (2d) 820. The statute may not be strained to avoid a clash with a convention of accounting thought. If a taxpayer, adhering to his accounting system, has but the alternative of either capitalizing or charging off an outlay, nevertheless his tax return must conform to the statute even if it be different from the classification of his accounts.

Considering the language of the statutory deduction and the idea which it would be commonly thought to express, such an outlay as this is clearly not within it. The circumstances were exceptional, not ordinary, and they were more than a normal incident of carrying on petitioner’s business. Whether the inquiry be one of degree or of rule, the alterations can not be called mere repairs, from the standpoint of their nature, or of their relative cost, or of their duration. Treating them as a charge against the income of a single year is in disregard of. the obvious theory upon which their cost was based, which was to preserve the investment for its life at its greatest yield. Manifestly an expenditure almost as large as the year’s income would not have been justified unless it impinged advantageously on the operations of the future. These alterations were embodied in the whole investment. If they unduly expanded the cost beyond the hope of reasonable financial return, they were still part of the investment cost, for the character of a capital expenditure is not lost because it proves unfortunate. An unsuccessful investment may involve a loss, but it does not thereby become an expense; and as a loss it is only recognized when it is definitively realized.

Even, therefore, if we proceed along the line of petitioner’s argument to consider, not whether the expenditure was a statutory expense, but whether it .was capital, we should be compelled by principle to say it was, and that as part of the cost of the building it increased the depreciation base, as the Commissioner has held. The fact that value was not enhanced does not affect the principle. Many capital additions, improvements, replacements, or major renewals are necessary or compulsory despite their failure to increase the value. This does not characterize them as expense, even if the taxpayer chooses, as he may, to charge them off. Questions of accounting for the purpose of utility regulation involve different considerations, for it may be that a utility expenditure, although capital in principle, is so unwise that it may not be used to measure the reasonableness of the utility’s return to be gathered from its public rates.

The tests for determining a deductible expense are not easy to state, and consist perhaps more of negation than of definition. Nevertheless, individual decision can be guided by the purpose, result, relative cost and importance, and the duration of function of the item, rather than by' the inclination of the individual taxpayer to account for it as capital or to charge it off, or the fact that value or life has not been expanded. The accounting is often dictated by adventitious interests, value fluctuates with a multiplicity of elusive causes, and economic life is influenced by factors wider than cost. While such evidence may not be disregarded, it is not determinative of the application of the statute.

The Commissioner correctly disallowed the deduction claimed.

Eeviewed by the Board.

Judgment will be entered for the respondent.

TttkNER concurs in the result.

Adams dissents.

       See Harvard Law Review, note, Yol. XLYII, p. 669 (Feb. 1934).


source: Caselaw Access Project

author: GOODRICH:

license: Public Domain

text:
    Kelley-Dempsey & Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 66806.
    Promulgated October 16, 1934.

      H. A. Mihills, G. P. A., for the petitioner.

      George D. Brabsou, Esq., for the respondent.

      The statute (see. 23 (a), Revenue Act, 1928) provides for the deduction from gross income of “ ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

   OPINION.

GOODRICH:

The testimony tells a tale of graft. Petitioner was held up and had to pay. Until it did, the work under its contracts was impeded through harrassing tactics by gas company employees who demanded subsidies before they would honestly discharge their duties; it lost money. After it “ greased some palms ”, its work was accepted, promptly and without question; its contracts were completed within the allotted time or before; it made profits.

Payments made in 1929 to Evanoif and Gaston for so-called cooperation are not here in issue — why not, we are not told. The question presented for our determination is, whether payments, totaling $34,412.39, made in 1929 to Yan Hook in consideration of his promise to see “that we got our materials on the job promptly”, that “ the inspectors on the particular jobs were kept in line and would not be arbitrary but would cooperate ”, are deductible from petitioner’s income as a part of the expenses of its business. Our answer to that question is — -no.

Assuming (but not deciding) that these payments are “ expenses ” of petitioner’s business, clearly, they are not deductible for they are not ordinary expenses. Said Mr. Justice Cardozo in considering the meaning of the word “ ordinary ” as applied to expenses of a business (Welch v. Helvering, 290 U. S. 111) :

Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are common and accepted means of defense against attack. Cf. Kornhm.ser v. United States, 276 U. S. 145. The situation is unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part. At such times there are norms of conduct that help to stabilize our judgment, and make it certain and objective. The instance is not erratic, but is brought within a known type.
* * * * * *
Unless we can say from facts within our knowledge that these are ordinary and necessary expenses according to the ways of conduct and the forms of speech prevailing in the business world, the tax must be confirmed. But nothing told us by this record or within the sphere of our judicial notice permits us to give that extension to what is ordinary and necessary.

The question here comes down to this: Is it an ordinary thing to pay out money to induce the acceptance and approval of work well done, to induce the employees of another to promptly and honestly .perform the duties for which they were hired? We believe that it is not. And petitioner’s witness, its president, indicated clearly in his testimony that such was his opinion; that he regarded the demands as most unusual and unjust. The record does not tell us that such expenditures were common to the operation of a business such as petitioner’s in the Mid-Continent oil field. We know that petitioner made them during three years — never before — but as to the practice of other enterprises in the field we are not told. Eumors are prevalent concerning extortions, “ rackets ”, “ shakedowns ” in all lines of business, but veiled hints and “ understandings ” cannot serve as a ground for judicial notice that dishonesty, such as here disclosed, is a normal practice. Measured then by the norms of conduct of which we have notice (and this record fails to convince us that they have been changed), we must conclude that the payments made by petitioner to Van Hook were not ordinary, but, to the contrary, extraordinary.

Nor does it appear that they were necessary. Petitioner proves beyond dispute that its business was being ruined by groundless faultfinding and unjust practices until it acceded to the demands of those persons whose approval was necessary to the acceptance of work done under its contract. It shows that appeal to the chief engineer and to one of the directors of the company with which it had contracted and which had the troublemakers in its employ brought no relief; indeed brought only advice to pay up and avoid difficulty. And it shows that after it agreed to contribute as demanded, its impediments vanished; that it completed its contracts profitably and promptly, and obtained more, upon bids which included a spread sufficient to supply funds to be passed on.

No doubt, that was the easiest and quickest way out of its difficulties, but it was not necessary for petitioner to adopt that course. The courts were open to it, wherein it could have proved the substantial performance of its contracts and demanded payment therefor. Moreover, the laws of Oklahoma afforded it protection against extortion — if the threats and solicitations of Van Hook and the others amounted to that — by the punishment provided for those attempting it. To be sure, the prosecution of proceedings against the gas company for the enforcement of petitioner’s rights under its contract would have been expensive, perhaps tedious, and probably would have resulted in the loss of any future business with that company. And the instigation of criminal prosecution of the gas company employees for such of their acts (if any) as were unlawful would be troublesome and disagreeable. But, for all this record tells us, the normal business conduct of the group, the community, would have made the doing of these things necessary, and not the adoption of the course chosen by petitioner — the “paying of tribute” as it is described on the record.

Moreover, to encourage the accession to demands of this sort, both morally and legally wrongful, by straining the common meaning of the words of the statute to permit such payments to be deducted as ordinary and necessary expenses of operating a business would be poor public policy. This Board and the courts have consistently refused to do so with respect to expenditures occasioned by somewhat comparable causes.

Reviewed by the Board.

Judgment will ~be entered for the respondent.

Smith concurs in the result.

       As to illegal expenses such as bribery, see United States v. Sullivan, 274 U. S. 259 ; as to expense incurred in defending an indictment for perjury, see Sarah Backer et al., Executors, 1 B. T. A. 214 ; as to fines, court costs, and' attorney fees incurred in connection with an indictment for violation of antitrust laws, see Columbus Bread Co., 4 B. T. A. 1126; Burroughs Building Material Co., 18 B. T. A. 101; affd., 47 Fed. (2d) 178; as to fines for violation of Federal statutes see Great Northern Ry. Co., 8 B. T. A. 225 ; affd., 40 Fed. (2d) 372; certiorari denied, 282 U. S. 855 ; Chicago, Rock Island & Pacific Ry. Co., 13 B. T. A. 988; affirmed on this issue, 47 Fed. (2d) 990 ; certiorari denied, 284 U. S. 618; Terminal R. R. Association of St. Louis, 17 B. T. A. 1135 ; affirmed on this issue, 61 Fed. (2d) 16G; certiorari denied, 288 U. S. 604, 607; B. E. Levinstein, 19 B. T. A. 99.


author: Adams:

text:
    Morning Sun Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62196.
    Promulgated October 17, 1934.

      Frank Mergenthaler, Esq., for the petitioner.
    /. Graff, Esq., for the respondent.
   OPINION.

Adams:

The sections of the Eevenue Act of 1928 applicable to this case are set out in the margin.

In this case the return of the taxpayer for 1928 was filed March 15, 1929. The two-year period of limitation expired on March 15,

1931. Prior to such expiration and on December 31, 1930, a waiver was signed by one of the trustees in dissolution and by the Commissioner extending the period for assessment of taxes for 1928 to December 31, 1931.

The single question before us is as to the validity of the waiver. The petitioner contends that the waiver is invalid and was, therefore, ineffective to extend the period of limitation as provided by section 275(a). The respondent contends that the waiver is valid, and, therefore, the statutory period for assessment of tax by such waiver was extended to December 31, 1931, and that the mailing of a notice of deficiency to the petitioner within that period by the Commissioner had the effect of extending the statutory period of limitation until such time as there is a final decision by the Board and for 60 days thereafter.

It is the contention of the petitioner that under the laws of the State of California relating to dissolved corporations all of the trustees must unite in any act which is binding upon the trust property ; that in the instant case the waiver was not signed by all- of the trustees, but by a single trustee who had no express authority from the other trustees to sign the waiver.

Section 400 of the Civil Code of the State of California, in force at the time the waiver in question was executed, provides as follows:

Unless other persons are appointed by the court, the directors or managers of the affairs of a corporation at the time of its dissolution are trustees of the creditors and stockholders or members of the corporation dissolved, and have full powers to settle the affairs of the corporation, collect and pay outstanding debts, sell the assets thereof in such manner as the court shall direct, and distribute the proceeds of such sales and all other assets to the stockholders. Such trustees shall have authority to sue for and recover the debts and property of the corporation, and shall be jointly and severally personally liable to its creditors and stockholders or members, to the extent of its property and effects that shall come into their hands * * *.

Under this statute the directors of the petitioner corporation became its trustees in dissolution.

Section 2268 of the Civil Code of California provides as follows:

Where there are several co-trustees, all must unite in an act to hind the trust property unless the declaration of trust otherwise provides. [Emphasis supplied.]

Petitioner contends this provision of the California Code makes the waiver in question invalid. We do not think so. As we construe that statutory provision, it was intended to prohibit the trustees from alienating the property of the trust except where all the trustees joined in and consented to such action. We think the authorities cited by petitioner on this question are not applicable. The signing of the waiver in this case imposed no new obligation on the corporation, nor alienated any of its assets. A waiver was necessary to postpone assessment until the corporation could by audit check the revenue agent’s report. Such waiver was for the benefit of the corporation. Its execution by a single trustee was a ministerial or clerical function of such trustee acting within the scope of his authority.

C. M. Jordan was elected secretary and treasurer of the trustees in dissolution. He signed the income tax return of the petitioner for the year 1928. He was the trustee who signed the protest on behalf of the corporation to the findings of the revenue agent in his original audit. All matters pertaining to petitioner’s income matters were referred to Jordan. The Board and the courts have repeatedly held that a secretary of a corporation has at least implied authority to sign papers in behalf of the corporation.

In United States v. Kemp, 12 Fed. (2d) 7, the validity of a waiver by a dissolved Texas corporation was before the court. The laws of Texas contain a provision relative to dissolved corporations similar to section 400 of the Civil Code of California. The waiver in that case was executed by the former president and the former secretary of the corporation, who constituted two of the four directors at the time of dissolution. The Circuit Court of Appeals for the Fifth Circuit in that case said:

When the president and secretary of tlie board of directors of a corporation acts and it is not shown that the other directors protested or objected, the presumption may be indulged that they acquiesce. That presumption is very strong in this case as the corporation received a substantial benefit by the audit following the execution of the waiver. At the time of the report of April, 1922, prescription against suit had not run as the Government liad five years after the filing of the 1917 return in which to adjust it and bring suit. Had the waiver not been signed, suit would have been filed at that time, based on the first audit.

Under tlie facts here we hold that Jordan was authorized to execute the waiver and the same is valid. Ho was authorized to execute it by all the trustees in dissolution, except A. C. Ripley, who was absent at the time.

The petitioner in effect admits that if the waiver is valid, the findings of the Commissioner should be affirmed. We having so found,

Decision mil be entered for the respondent.

       SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
      Except as provided in section 276—
      (a) General rul&. — The amount of income taxes imposed by this title shall be assessed within two years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.
      * * * * * * *
      SEC. 276. SAME — EXCEPTIONS.
      *******
      (b) Waivers. — Where before the expiration of the time prescribed in section- 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.
      * ‡ *

       See Welz & Zerweek, Inc., 11 B.T.A. 1416; Independent Ice & Cold Storage Co., 15 B. T. A. 52; affd., 50 Fed. (2d) 31; Carey Mfg. Co. v. Dean, 58 Fed. (2d) 737, affirming 43 Fed. (2d) 369; certiorari denied, 287 U.S. 623; Hammond v. Carthage Sulphite Pulp & Paper Co., 34 Fed. (2d) 105; L. J. Christopher Co., 13 B.T. A. 729 ; affd., 55 Fed. (2d) 530.

        Charles D. Jaffee, 17 B.T.A. 675 ; affd., 45 Fed. (2d) 679 ; certiorari denied, 283 U.S. 853; Commissioner v. Godfrey, 50 Fed. (2d) 79; Wells-Elkhorn Coal Co., 27 B.T.A. 198; J. A. McPherson, 22 B.T.A. 390; affd., 67 Fed. (2d) 751; J. C. Hunt, 15 B.T.A. 1388 ; reversed, 45 Fed. (2d) 781; Warner Collieries Co. v. United States, 63 Fed. (2d) 34; Monarch Mills v. Jones, 59 Fed. (2d) 002; California Iron Yards Co. v. Commissioner, 47 Fed. (2d) 514; Commissioner v. Angier Corp., 50 Fed. (2d) 887.


author:
Smith :
      Matthews,

text:
    The Autocar Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 60565.
    Promulgated October 17, 1934.

      J. Marvin Haynes, Esq., W. 0. Magathan, Esq., O. J. McGuire, Esq., and Albert B. Maris, Esq., for the petitioner.

      James 0. Maddox, Esq., for tbe respondent.
   OPINION.

Smith :

The petitioner contends that the income and losses of the members of the affiliated group should be redetermined for the years 1926, 1927, and 1928, and that the net losses as redetermined should be carried forward and allowed as deductions in 1928 in accordance with the provisions of section 117 of the Revenue Act of 1928. It contends that the net income of the several affiliated companies 'as shown in the deficiency notice is not the correct taxable income of such companies, since it includes the gains from intercompany transactions, viz., the sale of trucks and parts by the petitioner to the subsidiary companies; that the amounts at which such sales were made and entered in the accounts of the several companies were not true sale prices and did not reflect the true income or losses of the several companies; and that such transactions should be eliminated in computing the income and losses of the several companies and of the consolidated group for each of the years 1926, 1927, and 1928.

Except for the net loss provision of the statute, the allocation among the several companies of the income or losses of the affiliated group would not affect the consolidated income or, loss or the tax liability of the consolidated group, because the increase in the income of one company would be offset by an increase in the loss of another. Since, however, the net losses of the several companies can be availed of as a deduction in subsequent years only by the separate companies sustaining such prior net losses, Woolford Realty Co. v. Rose, 286 U. S. 319, it becomes necessary to determine the correct income or loss of each company for 1926 and 1927 in order to ascertain tbe correct separate incomes and losses and the correct consolidated net income or loss for the year 1928.

According to the books kept by the petitioner and its subsidiary companies and the income tax returns filed by them, the petitioner had a large income in each of the years 1926, 1927, and 1928, while three of the subsidiaries had large losses in each of the years and one of them had a loss in 1926 and a small income in 1927 and 1928. The respondent has determined the same amount of consolidated income or loss as that reported in the returns for the years 1926 and

1927, but has made a reallocation of the separate income and losses for the several companies for each of the years 1926, 1927, and 1928, as shown above. In his deficiency notice the respondent states that such reallocation was made in ■ accordance with General Counsel Memoranda Nos. 8132 and 8618, by eliminating from the income and deductions of each company only the unrealized intercompany profits and losses. The respondent stated in his deficiency notice that the petitioner’s contention for the elimination of all intercom-pany transactions was denied. The petitioner contends in this proceeding that all intercompany transactions, consisting, in so far as here material, of only the sales of trucks and parts by the petitioner to the subsidiary, companies, should be eliminated, with the result that the petitioner would show no net income or loss for any of the years 1926, 1927, and 1928, and the consolidated net losses or incomes would all be allocated to the subsidiary companies. If this were done, all or a large part of the consolidated net loss for 1926 might be carried forward and deducted in computing the net incomes of the subsidiary companies and the consolidated income for 1928.

The petitioner argues that the intercompany transactions should be eliminated for the reason, among others, that the subsidiary companies are merely sales agencies of the petitioner and that the inter-company transactions were not conducted at arm’s length so as to reflect true profits and losses to any of the companies. This is substantially the contention that was made by the taxpayer in Post & Sheldon Corporation, 28 B. T. A. 26. We there held, in accordance with the taxpayer’s contention, that in computing consolidated net income for 1928 of affiliated corporations having prior net losses, intercompany transactions which in any way affect the total net income or the separate net income or apportioned tax of any member must be eliminated. That case, however, was reversed by the Circuit Court of Appeals for the Second Circuit in Helvering v. Post & Sheldon Corporation, 71 Fed. (2d) 930. The court there held that article 734 of [Regulations 74, which provides that the consolidated taxable income of affiliates shall be .their combined income, subject to the elimination of intercompany transactions, “ must be read in subjection to the limitations already imposed upon the 1 carry-over ’ sections; and that the position of the Treasury is a corollary of the decision in Woolford Realty Co. v. Rose, supra, (286 U. S. 319).”

The instant case is not distinguishable, in principle from the Post & Sheldon case and in the circumstances we feel constrained to follow the court in its reversal of our former position. The petitioner’s contention that the intercompany transactions for all of the years involved should be eliminated in computing the taxable income of the affiliated group for 1928 is not sustained.

The petitioner contends, in the alternative, that the income of the several affiliated companies should be redetermined in accordance with the provisions of section 45 of the Revenue Act of 1928. This section reads as follows:

SEC. 45. ALLOCATION OP INCOME AND DEDUCTIONS.
In any case of two or more trades or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such trades or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order í o prevent evasion of taxes or clearly to reflect the income of any of such trades or businesses.

We think that this contention must likewise be denied. Even if this provision of the statute were construed as intending to apply to a situation such as the one under consideration, the evidence of record does not offer any basis for a reallocation of the income or deductions of the several companies. It seems to us that it would be entirely unreasonable and arbitrary to allocate all of the income and losses to the subsidiary companies, as the petitioner would have us do. No facts are given us from which we can determine that the income or losses of the several affiliated companies were other than those shown in their books and reported in their income tax returns. It appears that the respondent has computed the tax liability of the several companies and of the consolidated group in accordance with those figures, with, in some instances, a reallocation of the income and losses among the several companies. The evidence before us does not show that the respondent’s reallocation of income and losses or his determination of the petitioner’s tax liability for the year 1928 was in error. See Broadway Strand Theatre Co., 12 B. T. A. 1052; Western Hide & Fur Co., 26 B. T. A. 354; Flambeau, Public Service Co., 27 B. T. A. 299; and Drawoh, Inc., 28 B. T. A. 666.

Reviewed by the Board.

Judgment will be entered for the respondent.

Matthews,

dissenting: I think this is clearly a case where section 45 of the Revenue Act of 1928 and section 240 (f) of the Revenue Act of 1926 should be applied. The real profit to the business in this case is the difference between the cost of manufacture plus the cost of selling and the selling price. The subsidiaries were wholly owned by petitioner and had a nominal capitalization. They were used by petitioner as sales and service branches. The accounts of the subsidiaries were guaranteed by petitioner and at the end of the years 1926, 1927, and 1928 the accounts receivable of the subsidiaries due the parent corporation were considerably over $11,000,000. The purpose of the list price at which trucks were charged to the subsidiaries was to obscure the cost of manufacture from the sales department, and to form the basis on which such department might figure a price to the customer. But the price to the customer had to be finally approved by the petitioner.

There were no real sales between the parent corporation and its subsidiaries. The real sales were to the customers. Petitioner did not expect, and subsidiaries could not have paid the parent, any more than was charged the customer. The difference between the cost of manufacture and operation of the subsidiaries and the selling price represents the profit or loss of the whole enterprise. And as the receipts of the branches, over expenditures for pay roll and supplies needed for operation, are transferred to petitioner in units of $1,000, as balances are accumulated, whatever profit there is in the sales of the trucks to customers, is in fact received by petitioner. For these reasons I think the income for 1926 and 1927 should be determined after consolidation of accounts, and for 1928 in accordance with section 45. Cf. Roessler & Hasslacher Chemical Co., 25 B. T. A. 915.

Goodkich and Leech agree with this dissent.


author: Smith :

text:
    New York, Ontario and Western Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52693.
    Promulgated October 17, 1934.

      Hermon J. Wells, Esq., for the petitioner.

      James T. Haslam, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax for 1926 of $57,885.15. The proceeding raises the question as to whether intercompany transactions should be excluded from income accounts of members of an affiliated group prior to computing the statutory net losses of the individual members and also excluded in computing the net income of the subsequent year prior to deducting the statutory net loss of the preceding year.

During the calendar years 1925 and 1926 the petitioner was the principal or parent corporation of a group of affiliated corporations which filed consolidated Federal income tax returns for those calendar years. The subsidiary companies filed for those years information returns on Form 1122, containing a stipulation that the tax should be assessed against the petitioner.

The corporations that were included in the consolidated returns for the above years were as follows:

New York, Ontario & Western Railway Oo.
Port Jervis, Monticello & Summitville Railroad Oo.
Pecksport Connecting Railway Oo.
Wharton Valley Railway. Oo.
Ontario, Carbondale & Scranton Railway Oo.
Ellenville & Kingston Railroad Oo.
Elk Hill Ooal & Iron Oo.
Anthracite Valley Water Oo.
Scranton Ooal Oo.
Scranton Ooal Co. is the owner of 100 percent of the Pricebnrg Water Oo., a Pennsylvania corporation.

All of the aforesaid corporations were held by the respondent to be affiliated for the entire calendar years 1925 and 1926 and' satisfied all the requirements of affiliation under the law.

In the consolidated return for 1925 no tax liability was reported and the respondent has found none.

The following intercompany transactions occurred between the various affiliated companies during the years 1925 and 1926.

(a) Property of the Ontario, Carbondale & Scranton Railway Co. was operated by the petitioner under lease for an agreed rental of $75,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. The payment of the rental and the receipt of the interest are recorded in the accounts of the petitioner and of the Ontario, Carbondale & Scranton Railway Co.

(b) The property of the Ellenville & Kingston Railroad Co. was operated by the petitioner under lease for an agreed rental of $26,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. The payment of the rental and tbe receipt of the interest was recorded in the accounts of the petitioner and of the Ellenville & Kingston Railroad Co.

(c) The property of the Port Jervis, Monticello & Summitville Railroad Co. was operated by the petitioner under lease for an agreed rental of $18,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. Payment of the rental and the receipt of the interest was recorded in the accounts of the petitioner and of the Port Jervis, Monticello & Summitville Railroad Co.

(d) The Scranton Coal Co. paid to the petitioner $193,500 in 1925, and $161,493.05 in 1926, as interest on its bonds held by the petitioner.

(e) The Scranton Coal Co. paid to the Elk Hill Coal & Iron Co. $70,788.83 in 1925, and $128,128.91 in 1926, as rent for the use of its properties.

(f) The Scranton Coal Co- paid to the Priceburg Water Co. $50 in each year for water. This amount represented profit to the Priceburg Water Co. in each year.

(g) The Scranton Coal Co. sold fuel to the petitioner for $60,861.96 in 1925, and for $138,167.03 in 1926, which amounts included no profit to the Scranton Coal Co.

(h) The Elk Hill Coal & Iron Co. paid to the petitioner $55,625 in 1926 as interest on its bonds held by the petitioner.

(i) The Elk Hill Coal & Iron Co. paid to the Scranton Coal Co. $56,000 as interest on its bonds held by the Scranton Coal Co.

In computing the deficiency of $57,885.15 for the year 1926, the respondent included as income to the recipient members of the affiliated group and as deductions to the payor members all items representing transactions, between the various members of the group. Based upon such a computation the respondent computed statutory net losses for certain members of the affiliated group for 1925, which he deducted from the income of the respective members for the year 1926 in the determination of the above named deficiency. The respondent states that in computing the consolidated net income for the year 1926 he erroneously disallowed a deduction of $600.

The parties have stipulated as follows:

(a) If all intercompany transactions whether or not resulting in any profit or loss to the separate corporation should be eliminated in computing the statutory net loss of each company for 1925, and all intercompany transactions should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its-1926 income, the deficiency for the year 1926 is $30,068.38.
(b) If only intercompany profits and losses should be eliminated in computing the statutory net loss of each company for 1925, and only intercompany profits and losses should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926- is $8,531.75.
(c) If intercompany transactions should not be eliminated in computing the statutory net loss of each company for 1925 and intercompany transactions should not be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income- the deficiency for the year 1926 is $56,234.96.
(d) If intercompany transactions should not be eliminated in computing the statutory net loss of each company for 1925, but all intercompany transactions should be eliminated in computing the separate income of • each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $43,341.79.
(e) If intercompany transactions should not be eliminated in computing' the statutory net loss of each company for 1925 and only intercompany profits and losses should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $24,689.24.

Tbe portions of tbe Revenue Act of 1926 material to tbe determination of the issue presented are as follows:

Sec. 233. (a) In the case of a corporation subject to the tax imposed by section 230 the term “ gross income ” means the gross income as defined in sections 213 and 217 * * *.
Sec. 213. (a) The term “gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid * * *; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. The amount of all such items shall "be included in the gross income * * *.
Sec. 206. (a) As used in this section the term “ net loss ” means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:
* $ * * s)c 4c 4s
(4) The deduction provided for in paragraph (6) of subdivision (a) of section 234 of amounts received as dividends shall not be allowed;
(5) There shall be included in computing gross income the amount of interest received free from tax under this title, decreased by the amount of interest paid or accrued which is not allowed as a deduction * * *.
(b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year * * *.
Sec. 240. (a) Corporations which are affiliated * * * may, * * * under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. * * *

Regulations 69, prescribed by tbe respondent under this statutory authority, contain the following provisions:

Abt. 631. Affiliated corporations. — Consolidated returns are based upon the principle of levying the tax according to the true net income of a single enterprise, even though the business is operated through more than one corporation. Where one corporation owns the capital stock of another corporation or other corporations, or where the stock of two or more corporations is owned by the same interests, a situation results which is closely analogous to that of a business maintaining one or more branch establishments. In the latter case, because of the direct ownership of the property, the net income of the branch forms a part of the net income of the entire organization.
Akt. 635. Consolidated net income of affiliated corporations. — Subject to the provisions covering the determination of taxable net income of separate corporations, and subject further to the elimination of intercompany transactions (whether or not resulting in any profit or loss to the separate corporations), the consolidated taxable net income shall be the combined net income of the several corporations consolidated. * * *

This provision concerning intercompany transactions has been carried through the respondent’s regulations without change since 1921 (Eegulations 65, art. 636; Eegulations 62, art. 636) and, except for the matter in parentheses, was included in regulations promulgated under the Eevenue Act of 1918 (Eegulations 45, art. 637).

It has been judicially determined that an affiliated corporation remains a taxpayer, the affiliated group being really a tax-computing unit. Woolford Realty Co. v. Rose, 286 U. S. 319; Swift & Co. v. United States (Ct. Cls.), 38 Fed. (2d) 365; Sweets Co. of America v. Commissioner, 40 Fed. (2d) 436; Commissioner v. Ben Ginsburg Co., 54 Fed. (2d) 238; Delaware & Hudson Co. v. Commissioner, 65 Fed. (2d) 292.

In support of its contention that all intercompany transactions should be eliminated both for the year in which the net losses were sustained and in the succeeding year or years for which the different members were entitled to carry forward the net losses, the petitioner relies upon Post & Sheldon Corporation, 28 B. T. A. 26. That decision was reversed by the Circuit Court of Appeals for the Second Circuit in Helvering v. Post & Sheldon Corporation, 71 Fed. (2d) 930. The court there held that the net'loss of each member of an affiliated group should be applied against each member of the group and computed separately, and in computing such income inter-company transactions may not be disregarded or excluded. A like result was reached in a decision of the Court of Appeals for the District of Columbia in affirming an unreported Board of Tax Appeals memorandum opinion in the case of Gorco Oil Refming Corporation v. Helvering, 72 Fed. (2d) 177. The reasoning of the courts in both cases was that separate members of an affiliated group preserve their identity in the computation of their individual net incomes and that in computing such net incomes inter-company transactions may not be disregarded when not closed within the year. We are persuaded that the conclusions reached by those courts are correct. Cf. Remco Steamship Co., 30 B. T. A. 579. In accordance therewith the contentions of the respondent in this proceeding are sustained.

This opinion is substituted for the opinion of the Board promulgated in this proceeding April 17,1934, 30 B. T. A. 408.

Reviewed by the Board.

Judgment will be entered for the respondent for a deficiency for 1926 of $66,231¡..96.


author: Smith:

text:
    The Greif Cooperage Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44789.
    Promulgated October 23, 1934.

      Henry J. Biehardson, Esq., for the petitioner.

      Philip M. Ciarle, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Smith:

This proceeding involves a deficiency in petitioner’s income tax for 1925 in the amount of $21,020.29. The petitioner alleges that the respondent erred in disallowing deductions claimed in its consolidated return for 1925 on account of losses sustained by it in that year upon dissolution of two of its subsidiary companies. The essential facts have been stipulated substantially as follows:

For the calendar year 1925 the petitioner (a parent and non-operating company) filed a consolidated return for itself and 23 other affiliated operating companies, among which number were the Sandpeeco Yeneer Co. and the Tuscaloosa Cooperage Co., wholly owned subsidiaries of the petitioner. Petitioner, then, or thereafter, agreed to pay income tax legally due and payable by it or any of the affiliated companies for 1925.

The consolidated return of petitioner and affiliated companies for the year 1925 showed net income of $419,875.34 and income tax due thereon of $50,331.22. The respondent has increased the net income of the affiliated group included in the consolidated return to $581,-569.88, and the tax thereon to $71,351.22. This increase was brought about by the respondent’s refusal to allow losses in the sum of $100,000 on stock of the Sandpeeco Veneer Co. and $77,560.03 on stock of the Tuscaloosa Cooperage Co., claimed to have been sustained upon the liquidation of those companies in 1925.

During the period of affiliation for which consolidated tax returns were filed by the petitioner for itself, the Sandpeeco Yeneer Co., the Tuscaloosa Cooperage Co., and other companies of the affiliated group, the income of the affiliated group outside of Sand-peeco Veneer Co. was lessened by net losses of the latter company in the aggregate amount of $104,413.19 and enlarged by the net income of that company in the aggregate amount of $16,070.24 as follows:

During the period of affiliation for which consolidated returns were filed by the petitioner for itself and other companies of the affiliated group the net income of the affiliated group outside of the Tuscaloosa Cooperage Co. was lessened by net losses of the latter company in the aggregate amount of $111,649.68 and enlarged by net income of that company in the aggregate amount of $26,223.98 as follows:

During the same period petitioner’s individual net income or loss as distinguished from the income or losses (exclusive of losses of $177,560.03 arising from the liquidation of Sandpeeco Yeneer Co. and Tuscaloosa Cooperage Co. in 1925) of the affiliated group was as follows:

During the same period the consolidated current net income and losses of the petitioner and affiliated companies (exclusive of losses of $177,560.03 arising from the liquidation of the Sandpeeco Yeneer Co. and Tuscaloosa Cooperage Co. in 1925) were as follows:

Both the Sandpeeco Yeneer Co. and Tuscaloosa Cooperage Co. were fully liquidated and dissolved during the calendar year 1925.

The petitioner acquired the stock of the Sandpeeco Veneer Co. at a cost of $100,000, and received nothing in liquidation thereof, the cost of the investment being duly charged off by petitioner as a loss during the year 1925.

The petitioner acquired the stock of the Tuscaloosa Cooperage Co. at a cost of $113,100 and received in liquidation thereof $35,539.97, leaving a balance of $77,560.33 which was duly charged off as a loss in the year 1925.

The petitioner, pursuant to agreement under section 240 of the .Revenue Act of 1926, has become obligated for the payment of any legal income tax that may ultimately be determined to be due and payable by it or any of the affiliated companies as listed in respondent’s 60-day letter dated April 12, 1929, upon which the petition is based.

The questions- to be determined are whether the petitioner sustained a deductible loss in 1925 upon the liquidation and dissolution of the Sandpeeco Yeneer Co. and the'Tuscaloosa Cooperage Co., and, if so, whether, in determining the amount of such loss, allowance should be made for the operating losses sustained by the subsidiary companies in prior years which were deducted in the consolidated returns for such prior years.

The respondent has determined that the liquidation and dissolution of these subsidiary companies were intercompany transactions upon which no deduction may be taken for gains or losses. This question was carefully reviewed by the Board in W. M. Ritter Lumber Co., 30 B. T. A. 231, wherein we stated, after discussing Remington Rand, Inc. v. Commissioner, 33 Fed. (2d) 77; certiorari denied, 280 U. S. 591; Burnet v. Riggs National Bank, 57 Fed. (2d) 980; Aluminum Goods Mfg. Co. v. Commissioner, 56 Fed. (2d) 568; United Publishers Corporation v. Anderson, 42 Fed. (2d) 781; Burnet v. Aluminum Goods Mfg. Co., 287 U. S. 544; Hernandez v. Ilfeld Co., 66 Fed. (2d) 236, and others, that:

Our conclusion is that the total loss sustained upon the complete liquidation of an affiliate, including the investment in its stock and advances made to it and properly deductible from income upon tbe termination of affiliation by dissolution, must be reduced by tbe total losses sustained by sucb affiliate in prior years for which consolidated returns were filed and on which such losses were taken as a deduction from consolidated income in those years.

Since our opinion in that case was promulgated, the Supreme Court has decided Ilfeld Co. v. Hernandez, 292 U. S. 62, affirming 66 Fed. (2d) 286. The court there held that a loss sustained by a parent corporation in 1929 upon the liquidation and dissolution of its two subsidiary companies was not deductible, since they were intercom-pany transactions and, further, that since the operating losses of the subsidiaries, deducted in the consolidated returns from 1917 to 1929, exceeded the parent company’s investment in the subsidiary companies, to allow the deduction of the loss on liquidation would result in a double deduction, which is contrary to the intendment of the statute. The taxable year there under consideration was 1929 and the provisions of the Revenue Act of 1928 applied, whereas in the instant case the liquidation and dissolution of the subsidiary companies occurred during the year 1925, and the transactions are controlled by the provisions of the Revenue Act of 1926. Walker Products Corporation, 30 B. T. A. 636. The Supreme Court said in the Ilfeld Co. case:

3. The allowance claimed would permit petitioner twice to use the subsidiaries’ losses for the reduction of its taxable income. By means of the consolidated returns in earlier years it was enabled to deduct them. And now it claims for 1929 deductions for diminution of assets resulting from the same losses. If allowed, this would be the practical equivalent of double deduction. In the absence of a provision of the Act definitely requiring it, a purpose so opposed to precedent and equality of treatment of taxpayers will not be attributed to lawmakers. Cf. Burnet v. Aluminum, Goods Co., 287 U. S. 544, 551. United States v. Ludey, 274 U. S. 295, 301. There is nothing in the Act that purports to. authorize double deduction of losses or in the regulations to suggest that the commissioner construed any of its provisions to empower him to prescribe a regulation that would permit consolidated returns to be made on the basis now claimed by petitioner.
* * * * * * *
The weight of authority is against petitioner’s contention. Burnet v. Riggs Nat. Bank, 57 E. (2d) 980. Commissioner v. Apartment Corp., 67 F. (2d) 3. Summerfield Co. v. Commissioner, 29 B. T. A. 77. National Casket Co. v. Commissioner, 29 B. T. A. 139. No decision other than that of the district court in United Publishers' Corporation v. Anderson, supra, gives any support to its claim. Cf. Burnet v. Imperial Elevator Co., 66 F. (2d) 643. McLaughlin v. Pacific Lumber Co., 66 F. (2d) 895.

The petitioner contends that the above observations of the Supreme Court have no application to it, for the reason that the petitioner has never had its own taxable income reduced by the operating losses of the two subsidiaries in question. It submits that it had no taxable income for the years 1920 to 1925, inclusive, except for the years 1922 and 1923; that the aggregate amount of such net incomes was only $4,536.11; and that such net incomes were offset by its net loss for 1921 in the amount of $37,712.50. It further contends that even though the net losses of the two liquidated subsidiaries were availed of in some years by the other affiliates and even though an indirect benefit accrued to it from such source, it never directly had the benefit of reducing its own taxable income for any year by the net losses of the two subsidiaries liquidated.

If the net losses of the Sandpeeco Veneer Co. and of the Tuscaloosa Cooperage Co. had been apiplied directly against the net incomes of the petitioner for prior years for which it filed consolidated returns there could be no question but that the deductible loss should be reduced by the operating losses of the two companies above named. Burnet v. Riggs National Bank, supra; Commissioner v. Apartment Corporation, 67 Fed. (2d) 3; Summerfield Co., 29 B. T. A. 77; National Casket Co., 29 B. T. A. 139; W. M. Ritter Lumber Co., supra; Ilfeld Co. v. Hernandez, supra; Walker Products Corporation, supra.

The question here is whether a different rule should obtain where the 'operating losses of the liquidated subsidiaries have been applied not. against the net incomes of the petitioner corporation, but against the net incomes of other subsidiaries. The question in any event is the actual loss which was sustained by the petitioner from the liquidation of the two subsidiaries. If the liquidating losses should be reduced by the operating losses availed of by the parent corporation in reduction of its own net incomes in prior years, we think that they should be reduced by the operating losses which have been availed of in the reduction of the net incomes of other subsidiaries in prior years. In either event the benefit of offsetting net incomes by the operating losses redounded to the parent corporation — in the one case directly and in the other indirectly. At the hearing of this proceeding counsel for the respondent stated that ‘the petitioner owned all of the stock of all of the subsidiaries the same as it owned all of the stock of Sandpeeco Veneer Co. and of the Tuscaloosa Cooperage Co. The stipulation of facts does no.t make this plain, but the deficiency notice, upon the basis of which the petition was filed, indicates the truth of the statement. The stipulation does show that the petitioner was a nonoperating holding corporation of the shares of stock of all the subsidiaries, and that showing is sufficient for present purposes.

In ruling as above, the Board does not overlook the fact that an affiliated corporation joining with others in filing a consolidated return does not lose its character as an individual taxpayer; that the affiliated group simply constitutes a tax-computing unit. Sweets Co. of America v. Commissioner, 40 Fed. (2d) 436; Swift & Co. v. United States, 38 Fed. (2d) 365; Commissioner v. Ben Ginsburg Co., 54 Fed. (2d) 238. We are of opinion, however, that in the computing of the deductible loss sustained by a parent corporation from the liquidation of a wholly owned subsidiary, adjustment must in every case be made for operating losses of such subsidiary which have been availed of by members of the af&liated group in reducing their taxable incomes during the period of affiliation for which consolidated returns have been filed. Cf. W. M. Ritter Lumber Co., supra; Walker Products Corporation, supra. If this were not so the double deduction of losses condemned by the Supreme Court in Ilfeld Co. v. Hernandez, supra, would result. The principles of the computation of adjustment invoked by the Board in Walker Products Corporation, supra, apply here.

Reviewed by the Board.

Judgment will be entered umder Rule 50.


author: Sea well :

text:
    Old National Bank in Evansville, as Executor of the Last Will and Testament of William H. McCurdy, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67681.
    Promulgated October 23, 1934.

      Henry H. Hombrook, Esg., Charles D. "Hamel, Esg., and John Enrietto, Esg., for the petitioner.

      L. S. Pendleton, Esg., for the respondent.
   opinion.

Sea well :

This proceeding involves the redetermination of a deficiency in estate tax in the amount of $17,898.28. The issue is whether there should be included in the gross estate of William H. McCurdy, who died June 15, 1930, certain securities' and accrued income thereon of a fair market value of $495,093.99 at the date of death of the decedent. The facts were stipulated.

' Title to the securities in question was transferred by the decedent on July 25,1929, to the Central Hanover Bank & Trust Co., a banking corporation in the city of New York, in trust, with directions, among other things, to pay the net income from the trust estate to the grantor during his life, unless sooner terminated. Upon his death, if the trust continued that length of time, 126/360 of the income under $36,000 per year was payable to Lillie E. McCurdy, grantor’s wife; 90/360 to Lynn H. McCurdy, grantor’s son, and Charlotte McCurdy, his wife, jointly, or to the survivor if one be dead; and 72/360 each to Alice Hazel McCurdy Mumford and Lena Jane McCurdy Chiles, daughters of the decedent, subject, however, to the following provisions.

O. Upon tlie death of said Lynn H. McCurdy or Ms wife, Charlotte McCurdy, the entire portion of said income theretofore paid to the two shall be paid to the survivor, and upon the death of such survivor or the death of either of said other named children of the Grantor leaving issue surviving, thei share of said net income which would otherwise have been paid to the parent shall be paid to such issue, share and share alike, per stirpes and not per capita.
D. Upon the death of said Lillie E. McCurdy, wife of the Grantor, within the period of the trust hereby created but after the death of the Grantor, then the portion of said income which would otherwise have been paid to her shall be paid as follows:
One-third (Vg) thereof to Evansville College, in Evansville, Indiana;
One-third (%) thereof to the ten (10) charitable beneficiaries hereinabove named, and in the proportions there fixed, but subject to the same provisions in event any thereof shall cease to function.
One-third (Vs) thereof to the three (3) children of the Grantor above named, Lynn H. McCurdy, Alice Hazel McCurdy Mumford, and Lena Jane Chiles (as to the said Lynn H. McCurdy, such share to be paid to him and his wife, Charlotte, jointly, and to the survivor of them), and to Helen Hess Hughes and Reuben Paul Hughes, grandchildren of the Grantor, or to such of said children and grandchildren as may be then living (the issue of any of them theretofore dead to take the share which the parent would have taken if living), in the proportions of one (1) part to each child so living or the issue of such as may be dead, and one-half (%) part to each of said Hughes grandchildren, or if either be dead leaving issue surviving, then to such issue; or if one be dead without issue and the other surviving, then to such issue; or if one be dead without issue and the other surviving or if not surviving but leaving issue, then one (1) whole part shall go to such survivor, or such issue, as the case may be.
E. Upon the death of the survivor of said Lynn H. McCurdy and Charlotte McCurdy, his wife, without issue surviving, or upon the death of all such issue following the death of the parents, provided this trust be still continuing, or upon the death of either of said Alice Hazel McCurdy Mumford and Lena Jane McCurdy Chiles without issue surviving, then the share of such income which would otherwise have been paid to such one so dying shall be distributed, as follows:
One-third (%) thereof to Evansville College, in Evansville, Indiana;
One-third (%) thereof to the ten (10) charitable beneficiaries hereinabove named, and in the proportions there fixed, and subject to the same provisions in event any thereof shall cease to function; and,
One-third thereof to the children of the Grantor above named, Lynn H. McCurdy, Alice Hazel McCurdy Mumford and Lena Jane McCurdy Chiles, and to Helen Hess Hughes and Reuben Paul Hughes, grandchildren of the Grantor, or to such of said children and grandchildren as may be then living (the issue of any of them theretofore dead to take the share which the parent would have taken if living), in the proportions of one (1) part to each child so living or the issue of such as may be dead, and one-half (y%) part to each of said Hughes grandchildren, or if either be dead leaving issue surviving, then to such issue; or if One be dead without issue and the other survive, or if not surviving but leaving issue, then one (1) whole part shall go to such survivor, or such issue, as the case may be.

The income of the trust in excess of $36,000 was to be paid to certain charitable organizations specified in the trust deed.

The instrument contains additional pertinent provisions reading as follows:

Article Second.
Said trust shall continue, unless sooner terminated under the provisions therefor hereinafter set forth, until a period fifteen (15) years from the date of the death of the Grantor, provided either said Lillie E. McCurdy, wife of the Grantor, or said Lynn H. McCurdy, son of the Grantor, be still living; and otherwise the same shall terminate on the death of - the last survivor of said Lillie E. McCurdy and said Lynn H. McCurdy; and on the termination of said trust period the principal then constituting the Trust Estate shall be distributed as follows:
A. In the event the Grantor be still living, all thereof shall be paid over to the Grantor.
B. In the event the Grantor be not then living, the same shall be distributed as follows:
(1) In event said Lillie E. McCurdy, wife of the Grantor, be still living there shall be transferred and set over to the Old National Bank in Evansville, Indiana, as Trustee, one hundred twenty-six three hundred sixtieths (126/360) of the securities then constituting the Trust Estate (division to be made in kind by the Trustee so far as is practical, and otherwise to be made so as to approximate as nearly as possible one hundred twenty-six three hundred sixtieths (126/360) in value of the entire Trust Estate, which securities shall be held by said Old National Bank in Evansville, as Trustee, on the following trusts:
The income thereof shall be paid to said Lillie E. McCurdy, wife of the Grantor, so long as she shall live, and upon her death the principal shall be distributed as follows:
(a) Twenty-five thousand Dollars ($25,000) in value thereof shall be paid over to such person or persons as the said Lillie E. McCurdy may by her will designate, or failing such designation the entire principal shall be distributed as provided for the remainder in paragraph (b) next following;
(b) The remainder thereof shall be divided as follows:
One-half (%)' thereof to Evansville College, in Evansville, Indiana;
One-fourth (%) thereof to the ten (10) charitable beneficiaries herein-above specified, subject to the same conditions in event any thereof shall have ceased to function; and
One-fourth (%-) thereof to those of the three (3) children of the Grantor, Lynn H. McCurdy, Alice Hazel McCurdy Mumford and Lena Jane McCurdy Chiles, and to Helen Hess Hughes and'Reuben Paul Hughes, grandchildren of the Grantor, or to such of said children and grandchildren as may be then living (the issue of any of them theretofore dead to taire the share which the parent would have taken if living), in the proportions of one (1) part to each child so living or the issue of such as may be dead, and one-half (%) part to each of said Hughes grandchildren, or if either be dead leaving issue surviving, then to such issue; or if one be dead without issue and the other survive, or if not surviving but leaving issue, then one (1) whole part shall go to such survivor, or such issue, as the case may be.
(2) The remaining two hundred thirty-four three hundred sixtieths (234/360) part of said Trust Estate, or all thereof in event said Lillie E. McCurdy, wife of the Grantor, be not then living, shall be distributed as follows:
Ninety two hundred thirty-fourths (90/234) thereof shall be assigned and paid over to Lynn H. McCurdy, son of the Grantor, if he be then living;
Seventy-two two hundred thirty-fourths (72/234) thereof shall be assigned and paid over to Alice Hazel McCurdy Mumford, daughter of the Grantor, if she be then living, and
Seventy-two two hundred thirty-fourths (72/234) thereof shall be assigned and paid over to Lena Jane McCurdy Chiles, daughter of the Grantor, if she be then living.
If any of said three (3) children of the Grantor be then dead leaving issue surviving, such issue shall receive the same portion which the parent would have received if then living.
(3) If any of said children of the Grantor be dead leaving no issue surviving at the termination of said trust period, then the portion of said Trust Estate which would otherwise have been paid to such child of the Grantor, or to such child’s issue had there been issue them surviving, shall be distributed as follows: [The remaining terms of the article provide for the same gifts over as the preceding paragraph (b).]
Artiolh Fourth.
The Grantor shall have the right at any time during his life, with the con- • sent of his wife, Lillie E. McCurdy, if she be living, or if she be dead with the consent of any one of the living children of the Grantor, to revoke this indenture of trust or to alter or amend any term or provision thereof in any way or to any extent, except that the Grantor shall have no power to alter or diminish the compensation of the Trustee. Upon delivery to the Trustee by the Grantor of written notification thereof, this indenture of trust shall, be deemed to have been revoked, altered or amended, as set forth in such notification.
Artiom Seventh.
This indenture shall be construed according to the laws of the State of New York, where it is made, and where it is to be enforced.

The decedent had no right, title, or interest in any of the securities forming the corpus of the trust at the time of his death, except such as might appear under the indenture of trust. The trust was not revoked or modified in any way prior to decedent’s death.

The decedent left surviving him his wife, Lillie E. McCurdy, a son, Lynn H. McCurdy, two daughters, Alice Hazel McCurdy Mumford and Lena Jane McCurdy Chiles, and four grandchildren, Helen Hess Hughes and Beuben Paul Hughes and Lynn McCurdy and William H. McCurdy, the latter two being children of Lynn H. McCurdy and his wife.

The parties have stipulated that the transfers were not made by the decedent in contemplation of death. The respondent filed no brief. At the hearing his counsel contended that the value of the property should be included in the decedent’s gross estate under the provisions of either section 302 (c) or (d) (prior to amendments) of the Eevenue Act of 1926, reading in part as follows:

The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
* * * * * * *
(c) To the extent of any interest therein of which the decedent, has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *
- (d) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

The respondent’s contentions respecting the applicability of section 302 (c) are that the remainder interests set forth in the trust instruments were contingent and not vested. He does not question ..the right of petitioner to have the trust instrument construed according to the laws of New York as provided for therein.

In Elisabeth B. Wallace, Executrix, 27 B. T. A. 902; affirmed per curiam, 71 Fed. (2d) 1002, on authority of McCormick v. Commissioner, 283 U. S. 784, and May v. Heiner, 281 U. S. 238, a case involving the laws of New York, the decedent transferred certain securities, in trust, with directions to the trustee to pay the income therefrom to herself for life and upon her death to assign and deliver the corpus to her daughter, if living. In case the daughter predeceased her, the trust estate was to revert to the grantor. After reviewing the authorities at length, we held that the daughter took a, vested remainder by the execution of the indenture of trust. We have the same situation here. The grantor reserved a life estate in the income from the trust and provided for the transfer of the corpus to himself in case he survived his wife and son. In the event the grantor predeceased his wife and son the income under $36,000 per year was to be paid to bis wife, son and his wife, jointly, and two daughters for a period of 15 years. Upon the termination of the trust at the end of the 15-year period, the grantor’s wife was to receive a beneficial interest in a portion of the corpus for life, with a power of appointment over $25,000, the remainder of the shares to go to others upon her death, and his son and his wife, jointly, and two daughters were to get the remainder of the estate in specified proportions. There were at all times remaindermen to take upon the termination of the grantor’s life estate. The remainder interests created by the instrument were-vested, not contingent.

The respondent may not include the value of the securities in the decedent’s gross estate on the ground that the property was transferred to take effect in possession or enjoyment at or after decedent’s death. Elizabeth, B. Wallace, Executrix, supra; Flora M. Bonney et al., Executrices, 29 B. T. A. 45; Louis C. Raegner, Jr., et al., Executors, 29 B. T. A. 1243.

In claiming that the trust property is includable in the gross estate under the provisions of section 302 (d), the respondent contends for a literal construction of the words “ any person ” appearing in the statute. The words “ any person ” as used in section 302 (d) have been interpreted to mean “ any person not a beneficiary of the trust.” David J. Lit et al., Executors, 28 B. T. A. 853; affd., 72 Fed. (2d) 55; City Bank Farmers Trust Co., Trustee, 29 B. T. A. 1141.

In Reinecke v. Northern Trust Co., 278 U. S. 339, four of a group of five trusts involved in the case were subject to modification by the grantor and the sole beneficiary of each trust, acting jointly, and the grantor was required to act jointly with a majority of the beneficiaries of the remaining trust to bring about a change of its provisions. In holding that the corpus of all of those trusts was not in-cludable in the gross estate of the grantor under the provisipns of section 402 (c) of the Revenue Act of 1921, the Court remarked:

* * * If it be assumed that the power to modify the trust was broad enough to authorize disposition of the trust property among new beneficiaries or to revoke the trusts, still it was not one vested in the settlor alone, as were the reserved powers in the case of the two trusts. [Ones in which the settlor alone could revoke trusts.] He could not effect any change in the beneficial interest in the trusts without the consent, in the case of four of the trusts, of the person entitled to that interest, and in the case of one trust without the consent of a majority of those so entitled. Since the power to revoke or alter was dependent on the consent of the one entitled to - the beneficial, and consequently adverse, interest, the trust, for all practical purposes, had passed as completely from any control by decedent which might inure to his own benefit as if the gift had been absolute.

The case of Cyrus H. McCormick et al., Executors, 13 B. T. A. 423, involved a trust in which the grantor reserved the power to terminate the instrument in whole or in part with the written consent of one or more of the three other beneficiaries of the trust. The question of whether this reservation of power was sufficient to make the transfer one to take effect in possession or enjoyment at or after death, within the meaning of section 402 (c) of the 1921 Act, was not presented to or specifically passed upon by this Board. Power reserved by the grantor to revoke the trust was urged by the Government before the Circuit Court of Appeals as ground for reversing the Board’s decision. In reversing the decision on other grounds, the court said:

* * * Notwithstanding the possibility of tax evasion lurking in such an agreement, we are inclined to the view that the trust agreement here under consideration is, so far as the revocable clause is concerned, within the class considered in May v. Heiner. In other words, the condition upon which revocation might take place did not of itself establish an intention to have the trust take effect after settlor’s death. [Commissioner v. McCormick, 43 Fed. (2d) 277.]

In a per ouriam decision the Supreme Court reversed the Circuit Court upon the authority of May v. Heiner, supra, in which the reasoning of the Northern Trust Co. case was followed. McCormick v. Commissioner, supra.

In Reinecke v. Smith, 289 U. S. 112, the Court used the following language with respect to the conclusions it reached in the Northern Trust Co. case:

* * * The tax was upheld as applied to. the corpus of trusts over which the grantor had sole power of revocation. It was, however, condemned as to those where revocation was dependent upon joint action of the grantor and the beneficiary, for the reason that the interest of the beneficiary was adverse and the grantor unable at will to alter or destroy the trust. * * *

The same Court in Porter v. Commissioner, 288 U. S. 436, a case arising under the 1926 Act, said that the transfers in the Northern Trust Co. case were held nontaxable because the “ title was put beyond his [grantor’s] control.”

These cases establish that where the power to revoke a trust instrument is vested in the grantor acting in conjunction with one or more beneficiaries having interests adverse to him, the transfer is one taking effect with the execution of the instrument rather than in possession or enjoyment at or after his death.

While the Northern Trust Co. and McCormick cases were decided under the Bevenue Act of 1921, which contains no provision such as section 302 (d) of the 1926 Act, they point to the proper interpretation of the latter provision. See Burnet v. Guggenheim, 288 U. S. 280; Estate of Irving Lee Stone, 26 B. T. A. 1; Edna T. Stevens et al., Executors, 29 B. T. A. 641; David J. Lit et al., Executors, supra.

Here the grantor reserved the power to revoke, alter; or amend the trust instrument with the consent of his wife, and in case of her 'death', with the consent of any one of his three .children. As already pointed out, the decedent’s wife and children were to enjoy the. fruits of the trust property for a period of 15 years after his death.. Upon the termination of the trust at that time the wife was to. receive a life estate in 126/360 of the property, with a power of appointment over $25,000 of such interest, the remainder of the share to go to specified beneficiaries upon the death of the wife. The remaining 234/360 of the corpus was to be divided among the son and daughters, if living, otherwise to their issue, if any, and if no issue, then to others. We think our answer here is controlled by the Northern Trust Co. and McCormick cases, supra, and, accordingly, hold that no part of the trust property should be included in the decedent’s gross estate under the provisions of section 302 (d) of the Revenue Act of 1926.

Reviewed by the Board.

Judgment will he entered wider Rule 50.


author: Morris:

text:
    A. Levy & J. Zentner Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 67107, 68352.
    Promulgated October 23, 1934.

      Joseph O. Meyersiein, Esq., for the petitioner.

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

Morris:

These consolidated proceedings are for the redetermination of deficiencies of $2,981.83 and $3,506.50 for the calendar years 1929 and 1930, respectively, presenting for consideration two; errors alleged to have been committed by the respondent, (1) the finding of the respondent that certain amounts claimed as deductions in both of the controverted years constituted dividends, not additional compensation, and his disallowance of deductions therefor, and (2) his disallowance of a claimed deduction in 1930, representing a proportionate part of an amount paid to the Pacific Fruit & Produce Co. in connection with the purchase of that company’s leases, merchandise, fixtures, equipment, and' business.

Petitioner is now and at all times since 1907 has been a corporation organized and existing under the laws of the State of California engaged in the wholesale produce business, with its principal office and place of business at San Francisco, California.

Under the bylaws of the corporation, duly and regularly adopted and in full force and effect during the years 1929 and 1930, a stockholder could sell or dispose of stock owned or held in petitioner corporation only after first offering the same .to the directors of the corporation for appraisal and sale, with the intent that the stock of the corporation should be owned only by officers and employees of the corporation actively engaged in the business. Its stock .certificates have a printed notation to that .effect.

On the dates of March 4,1924, January 22, 1927, February 8, 1929, ánd November 25, 1929, permits and/or supplemental permits were issued by the State Corporation Commissioner of the State of California authorizing petitioner corporation to sell and issue to its stockholders and employees shares of its capital stock for cash, so as to net the corporation the full amount of the sale price thereof, which was $100 a share, $100 a share, $109 a.share, and $112 a share, respectively, under the four permits referred to.

From time to time the capital of the corporation has been increased and additional stock issued as aforesaid. This stock was offered in part to the old stockholders of the corporation and certain employees who had been with the corporation for a long time and had rendered efficient service. The latter were allowed to subscribe to a limited number of shares of the stock. The number of shares such employees were allowed to subscribe for was fixed at an amount which, in the opinion of the officers and directors of the company, was merited by the work performed and services rendered. Some employees paid cash in full for their stock. Other employees were permitted to subscribe and pay a small amount of cash or no cash on the stock and give their personal notes for the balance. The stock would thereupon be issued in the name of the employee, endorsed by such employee, and held by the corporation as security for the note. These notes were usually paid out of dividends declared on the stock. The stock was treated by the corporation on its books as issued and outstanding, and dividends were voted and paid on such stock.

Under the terms of the agreement between petitioner corporation and each employee, referred to above, in the event of the resignation or discharge of the employee by the petitioner corporation, he was not entitled to receive the unpaid-for stock by making payment of the balance due thereon, but merely to' receive the net amount credited to his account on the boobs of petitioner corporation.

In each instance where stock was sold to an employee under the circumstances hereinabove referred to, an agreement of sale was entered into between petitioner corporation and such employee, and in each instance, such employee executed and delivered to petitioner corporation a note for the amount of the purchase price of the stock as fixed by the permit of the Corporation Commissioner, then in force, and in each such instance the certificate of stock so issued by petitioner corporation was immediately endorsed by the employee and held by petitioner corporation as trustee, with the note, as security for the payment of such note until the note was-finally paid in full.

For many years prior to 1929 petitioner corporation treated dividends credited on the stock which was the subject of agreements with employees, as hereinabove referred to, as additional salary paid to such employees, and claimed same as deductions from income for such years. An opinion from the Commissioner of Internal Revenue as to the method of treating said dividends was requested in the year 1927 by petitioner corporation, to which a response was made by the Commissioner under date of July 13, 1927, his conclusion being as follows:

With, reference thereto yon are advised that although the employee entering into such contract will not receive the stock in case he severs his connection with the corporation prior to completing payment of the purchase price, he will in any event receive the amount which has been credited to him and applied in payment of the purchase price of the stock less interest due on his account. He, therefore, acquires at the time an enforceable right to the amount so credited less interest on the account and has realized the amount as income by having it applied to the payment of the purchase price of the stock in accordance with the contract entered into by him for that purpose. The entire amount so credited should, therefore, be treated as if it had been actually received by him and applied in payment of the purchase price of the stock. The amounts so credited accordingly constitute taxable income to the employee as additional compensation for the period in which such .amounts are credited and should be so reported by him. The amount of interest concurrently charged to his account similarly constitutes an allowable deduction to him from his gross income for the purpose of the income tax.

The amounts so credited to employees having agreements as here-inabove referred to during the year 1929 were $14,690.76, and during the year 1930, $15,007.69, which are the amounts that petitioner corporation now claims should be allowed as a deduction from petitioner corporation’s gross income for the years in question.

Most of the employees of the petitioner were salesmen who were employed from 2:30 to 3 a.m. until 4 p.m,, and whose weekly salaries were between $30 and $35. The average dividends credited to their accounts were from $200 to $300 annually. In one of the years here in question, which was exceptional, the dividend was $19 a share, and in the following year amounted to $10 a share. The number of shares carried in the name of each employee varied from 15 to 25.

Eespondent in his deficiency notice disallowed the sums of $12,-416.74 for the year 1929 and $4,696.80 for the year 1930 representing dividends which petitioner had credited to the account of treasury stock which had been previously issued and repurchased by the corporation. The sums of $14,690.76 for the year 1929 and $15,-007.69 for the year 1930 were disallowed as representing dividends which petitioner had credited to the account of newly issued capital stock to its employees, other than its officers or directors.

Petitioner corporation on or about January 28, 1929, entered into several agreements with the Pacific Fruit & Produce Co. for the purchase by petitioner corporation of leases, merchandise, furniture, fixtures, automobiles, and trucks at the three places of business of the Pacific Fruit & Produce Co. located at Peno, Nevada, and Chico and Sacramento, California, together with the business conducted by the Pacific Fruit & Produce Co. at the three named places. Under the terms of this transaction petitioner corporation agreed, among other things, to pay the market price of all merchandise and the net book value of the furniture, fixtures, automobiles, and trucks, and to pay in addition the sum of $20,500 in cash. At the time of this transaction the Pacific Fruit & Produce Co. was conducting its business at the places mentioned, and had been so conducting its business at said places for some time prior thereto at a heavy loss.

Whether the amounts claimed as deductions under the first allegation of error hereinabove set forth were dividends or additional compensation must be determined by the facts and circumstances of this particular case, and finding, as we do, that such facts and circumstances are not comparable with those in Hudson Motor Car Co. v. United States, 3 Fed. Supp. 834, and Kreamer v. United States, 66 Ct. Cls. 308, cited by the petitioner, we need only confine ourselves to the applicable sections of the statute and the record made in support of the errors alleged.

The petitioner alleges and contends that the amounts sought to be deducted were additional compensation to its employees for services rendered within the taxable years. In order for it to succeed in establishing its contention under the statute it must appear from the record that such payments were in fact “ salaries or other compensation for personal services actually rendered ” and, in addition, that such amounts were “ reasonable ” under the circumstances. Sec. 23, Revenue Act of 1928.

The petitioner argues that because the employees could under no circumstances compel delivery of their stock until full payment therefor and because of the condition that if they failed to make such payment in full or if they were discharged or left the' service of the corporation, all that they were entitled to was the amounts of their respective credits upon the books of account, such distributions should be characterized as additional salaries. These considerations are unimportant, however, in our opinion, when we realize that the transaction between the petitioner and its employees was one of absolute purchase and sale of stock, carrying, admittedly, certain contractual limitations upon the acquisition and future sale thereof, but which limitations in no sense of the word alter the significant fact that a purchase and sale actually occurred between the parties, and that each employee entering into the contract of purchase with the petitioner became and continued to- be a stockholder so long as he complied with the conditions of the contract. The stock when purchased was issued in the name of 'the employee and was merely held as collateral security for the payment of the note, where the transaction was one of credit. Where the purchase price was paid immediately there was, of course, an immediate delivery of the stock. The stock was treated on the books as issued and outstanding, dividends were paid thereon, and such stockholders were entitled to the same voting privileges as all other stockholders.

' Petitioner points to the fact, however, that the shares were “ limited ” in number and that the' subscriptions therefor were “ fixed at an amount which, in the opinion of the officers and directors of the company, was merited by the work performed and services rendered.” The fact that the amount of stock which an employee could purchase was determined by his worth to the company does not alter the legal effect of the transaction and lends no support to the petitioner’s contention that the dividends declared on' the stock were compensation for services.

Aside from the foregoing considerations we are nevertheless of. the opinion that the petitioner has wholly failed in its proof in that, even assuming that the amounts so credited or paid constituted additional compensation, we have no satisfactory proof that ¿hey were “ reasonable ” within the meaning of the statute. Some slight effort was made, it is true, at the hearing of the proceeding, to establish the reasonableness of the amounts in question, but it was so slight and so wholly ineffective that a review of the record bearing upon the question seems useless. Therefore, for this, if for no other reason, we would be compelled to sustain the respondent’s determination upon the first alleged error.

Upon the second issue we regard the record as even more incomplete. The petitioner argues that the $20,500 paid to the Pacific Fruit & Produce Co. was in consideration of that compamy withdrawing from competition with it, at certain points, over a period of 10 years, and that it should be permitted to deduct 10 percent annually from its gross income in the computation of its net taxable income, at the same time conceding that its former claim of 20 percent was incorrect.

The only witness offered in substantiation of this claimed deduction, after testifying to some extent about the subject matter of the acquisition of the Pacific Fruit & Produce Co. under the contract in question, finally admitted, upon examination by the respondent’s counsel, that he had no knowledge of the contract whatsoever, thus rendering his testimony — which, incidentally, bore little or.no significance — absolutely worthless for the purposes of the case. Petitioner relies upon the provisions of the contract itself, a copy of one of which, there having been several, we have in evidence.

The portion of the contract relied upon reads:

That the said party of the second part shall pay unto the said party of the first part the sum of twenty thousand five hundred (20,500.) dollars on the signing of this agreement, the receipt whereof is hereby acknowledged :by the said party of the first part, and in addition thereto the party of the second part shall pay to the said party of the first part a sum equivalent to the wholesale market price of all merchandise sold and delivered to the said party of the second part and the book value of all furniture, fixtures, automobiles, trucks, machinery and other equipment and leases and buildings on leased premises hereby agreed to be sold and transferred, which sum, together with interest thereon at the rate of six per cent per annum computed from the dates on which possession of said branches was taken, as herein provided, shall be paid to the said party of the first part in three equal installments on March 1 June 1 and September 30,1929, respectively.

The petitioner would have us infer, from the fact that the consideration for the purchase, as shown in the foregoing excerpt, was provided for in two parts, that the $20,500 payment was in consideration of the Pacific Fruit & Produce Co. withdrawing from competition for a period of 10 years in certain localities, notwithstanding the contract before us shows not the slightest intention of the parties thereto to set this amount aside as anything other than the initial cash payment forming a part of the total consideration for the purchase price of the vendor’s business. Nor is there anything in the contract to show that any part of the consideration, much less the amount in question, was specifically intended to stifle competition. For lack of evidence bearing upon the second issue, we must sustain the respondent’s determination thereon.

Reviewed by the Board.

Judgment will entered for the respondent.