author: Hill:

text:
    Harold Ingraham, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93365, 95153, 96554.
    Promulgated June 12, 1940.

      Raymond, M. Wansley, G. P. A., for tbe petitioner.

      E. A. Tonjes, Esq., for tbe respondent.
   OPINION.

Hill:

Petitioner assigned herein a number of errors, giving rise to corresponding issues, but all of such issues, save one, were specifically waived by the parties in a stipulation filed at the hearing. The single issue submitted for decision, which is common to all of the consolidated proceedings, is whether or not petitioner is subject to tax on income derived in the taxable years by the trust established by him in 1924 for the support of his wife and children.

The rule announced in Douglas v. Willcuts, 296 U. S. 1, has been interpreted and applied in many cases under varying facts. It is now settled law that the grantor of an alimony trust is not taxable upon income where state law and the trust agreement constitute “pro tanto a full discharge from his duty to support his divorced wife and leave no continuing obligation, contingent or otherwise.” Helvering v. Fuller, 310 U. S. 69, affirming 105 Fed. (2d) 903. In such circumstances, the trust income is to be treated the same as income accruing from property transferred by a debtor to a creditor in full satisfaction of his obligation. Helvering v. Fitch, 309 U. S. 149.

If either local law or the trust agreement imposes a continuing-obligation to support, even though contingent, the trust income is taxable to the grantor. Helvering v. Leonard, 310 U. S. 80, reversing 105 Fed. (2d) 900, which reversed 36 B. T. A. 563. Cf. E. T. Weir, 39 B. T. A. 400; affirmed on this point, 109 Fed. (2d) 996.

In the Leonard case, the Supreme Court referred to the fact that the taxpayer there was seeking to escape one of the normal incidents of the Federal income tax, and for that purpose invoked the aid of state law. The Court then pointed out that in Helvering v. Fitch, supra, it was stated that if the grantor of a trust seeks to avoid the general rule expressed in Douglas v. Willcuts, “he carries a distinct burden of establishing not by mere inference and conjecture but by ‘clear and convincing proof’ that local law and the alimony trust have given him a full discharge.” And because the taxpayer had failed to show by “clear and convincing proof” that the state courts lacked power to add to his personal obligation in the event that the income of the trust should be insufficient to support his wife, the Court held the non-guaranteed income taxable to him.

In the present proceedings petitioner asserts that the separation and trust agreements of 1924 and the decree entered pursuant to the divorce action instituted by his wife in 1926 constituted a complete and final discharge from his obligation to support his wife. He also cites certain decisions of the Connecticut courts to show that, after entry of the divorce decree under the circumstances of this case, it was beyond the power of those courts to add to his personal obligations. On the other hand, respondent contends that the question has never been directly decided by the Connecticut courts, and argues that contrary conclusions should be drawn from, the decisions cited by petitioner. We think petitioner has wholly failed to establish by “clear and convincing proof” within the rule of the Leonard case, supra, that local law and the trust created by him for the support of his wife and children gave him a final discharge.

At all events, a portion and possibly all of the trust income in controversy is taxable to petitioner on another ground. In 1937, the latest taxable year before us, one of petitioner’s children was 20 years of age, and one was 17. In the earliest taxable year one was 17 and the other 14 years of age. Therefore, during all of the taxable years here involved, petitioner’s children were minors, and he had a continuing obligation to support them, whether the trust agreement and divorce decree did or did not free him from further liability to contribute to the support of his former wife.

And to the extent that the income from the trust discharged petitioner’s obligation to maintain and support the children, it is taxable to him. Helvering v. Stokes, 296 U. S. 551; Helvering v. Schweitzer, 296 U. S. 551. And see Harry S. Blumenthal, 34 B. T. A. 994; affd., 91 Fed. (2d) 1009.

Neither the divorce decree, separation agreement, or other contract, nor the establishment of a trust for such purpose, could relieve petitioner of his parental obligation to support his children. This principle is so universally recognized that citation of authorities is unnecessary. In Leonard v. Helvering, 105 Fed. (2d) 900, referred to supra. while the Circuit Court of Appeals held that the income paid to the Avife AA'as not taxable to tlie grantor of the trust and on this point was rei^ersed by the Supreme Court; the Circuit Court also held (which holding was not affected by the decision of the Supreme Court) that the trust income payable to the grantor’s minor children was taxable to him, saying: “Pro tanto the trust was created in performance of Leonard’s paternal duty of support, which he could neither commute nor discharge.”

In the petitions filed in these proceedings, it is alleged that during each of the taxable years petitioner’s two minor children were supported by their mother from the income of the trust. This allegation ivas admitted in the answer of respondent in respect of the year 1934 and formally denied in respect of the other taxable years, but we think petitioner is not in a position to base any defense upon such denial. Petitioner argues that the record here does not disclose any continuing liability on his part for the support of his children; that so far as shoAvn they may not have been supported out of the income of the trust at all or may have died prior to the taxable years, in Avhich event petitioner’s liability for their support would have ceased. It seems to us quite obvious that if the children were supported .by their mother during each of the taxable years from the trust income, they could not have been deceased.

However, if petitioner’s paternal duty to support was in fact terminated for any reason prior to the taxable years, petitioner carries the distinct burden of establishing such fact “by clear and convincing proof.” Helvering v. Leonard, supra. But petitioner urges that in any event only the income required to support the children is taxable to him, and there is no .proof of what portion of the trust income, if any, was so used. Here again the rule of burden of proof operates to defeat petitioner’s contention. So far as we are informed by the record, the entire amount of the income derived from the trust in each of the taxable years may have been used for the education, maintenance, and support of the children. Certainly respondent has determined that the whole of the income is taxable to petitioner, and the burden is upon petitioner to show that such determination is erroneous. Lucas v. Structural Steel Co., 281 U. S. 264; Wickwire v. Reinecke, 275 U. S. 101; Helvering v. Taylor, 293 U. S. 507.

For the reasons indicated above, we hold that so much of the trust income as was used during the taxable years for the support and maintenance of the minor children is taxable to petitioner under authority of the Blumenthal decision and authorities therein cited. The remainder, if any, of the trust income in controversy we hold is taxable to petitioner under the rule stated in the Leonard case, supra.

Decision will Toe entered for resfondent.


source: Caselaw Access Project

author: Arundell:

license: Public Domain

text:
    Zander & Cia, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97263.
    Promulgated June 13, 1940.

      L. G. Lemle, Esq., for the petitioner.

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

Arundell:

The question presented for our decision is whether profits realized by the petitioner, a nonresident foreign corporation, from its dealing^ in futures contracts on the New York Coffee and Sugar Exchange were income from sources within the United States within the meaning of sections 119 and 231 of the Revenue Act of 1932.

The petitioner offers no evidence that the transactions involved were in the nature of hedges and therefore makes no claim to offset the income here involved against losses sustained by it in the business of coffee exporting. See G. C. M. 18383, 1937-2 C. B. 244.

We think it is plain that the income here in question arose within the United States. It was realized from futures purchase and sale contracts which the petitioner entered into and subsequently liquidated on the New York Coffee and Sugar Exchange. All of the transactions involved took place within this country and the income resulting therefrom clearly had its origin here. Hubert De Stuers, 26 B. T. A. 201; Carding Gill, Ltd., 38 B. T. A. 669. See also Helvering v. Boekman, 107 Fed. (2d) 388.

This conclusion is not affected by the principle that income realized on the sale of property) arises at the place where title to the property passes. See Campania General v. Collector, 279 U. S. 306; Commissioner v. East Coast Oil Co., 85 Fed. (2d) 322. The holding of these cases can not be applied to income realized on contracts under which delivery, by custom, is not made of the commodities specified. See United States v. New York Coffee and Sugar Exchange, Inc., 263 U. S. 611, 616.

The petitioner argues, nevertheless, that the income here involved, wherever arising, is not taxed by the statute, which specifies in section 119 (a) five categories of income to be treated as originating from sources within the United States, under none of which do the profits here in question fall. The case of Hubert De Stuers, supra, is authority for the view which we take here that no exclusive enumeration of the types of taxable income from sources within the United States was there intended and income other than that described which plainly arises within this country is to be taxed without reference to the enumeration. See also Helvering v. Suffolk Co., Ltd., 104 Fed. (2d) 505.

Finally, the petitioner contends that Congress has made plain that it did not intend to tax the income here involved by the enactment of provisions in the Revenue Act of 1936 which eliminate from taxation income of the type sought to be reached here. This argument has force only if it was the legislative intention that the later act should be utilized as a clarification of previously enacted statutes. The pertinent congressional reports disclose that it was not the object of Congress, in the enactment of the sections of the 1936 Act on which petitioner bases its argument, to clarify existent laws, but rather to accomplish, “a substantial change in our present system of taxing nonresident aliens and foreign corporations.” The reasons which are assigned therein for the change convince us further that a clean break with existent law was contemplated:

[Nonresident foreign corporations] will not be subject to the tax on capital gains, including gains from hedging transactions, as at present, it having been found impossible to effectually collect this latter tax. It is believed that this exemption from tax will result in additional revenue from transfer taxes and from the income tax in the case of persons carrying on the brokerage business. [Emphasis supplied.]

The case of Union Internationale De Placements v. Hoey, 96 Fed. (2d) 591, which, in interpreting a somewhat related provision of the 1932 Act (section 211 (b)) used the Revenue Act of 1936 as a guide, is cited by the petitioner in support of the argument with which we have last dealt. That case has no application here. The court there relied on the Congressional Committee reports dealing with the amendment of section 211 (b), which establish that the changed phraseology of the 1936 Act was intended to clarify a phrase used in earlier statutes. Contrasted with that purpose, we have pointed out above that the changed wording of section 231 in the 1936 Act was not intended to be retroactive. Accordingly, the holding of that case does not alter the conclusion which we have reached here.

Decision will be entered for the resyondent.

       See Revenue Act of 1936, see. 231 (a) ; Regulations 94, art. 231-3 (a).

       See Report of Ways and Means Committee, Revenue Bill of 1936, H. R. No. 2475, 74th Cong., 2d sess. (1936), p. 9; Report of Senate Finance Committee, Revenue Bill of 1936, S. R. 2156, 74th Cong., 2d sess. (1936), p. 21.

       Report of Senate Finance Committee, Revenue Bill of 1936, S. R. 2956, 74th Cong., 2d sess. (1936), p. 22. See also Union Internationale De Placements v. Hoey, supra, p. 593.


author: Leech :

text:
    Archibald R. Watson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 87873, 88048, 89650.
    Promulgated June 13, 1940.

      George B. OhanMess, Esq., Harold Dudley\ Greeley,, Esq., and 'William, R. Green, Jr., Esq., for the petitioner.

      Gormay Kitehen, Esq., for the respondent.
   OPINION.

Leech :

That a corporation and its stockholders are separate entities is too well established to require the citation of authorities. Likewise settled is the rule that only in exceptional cases, for tax purposes, will those separate entities be disregarded. Burnet v. Commonwealth Improvement Co., 287 U. S. 415; Burnet v. Clark, 287 U. S. 410; Dalton v. Bowers, 287 U. S. 404; Louis W. Gunby, Inc., 41 B. T. A. 884. One such exceptional case of which the taxpayer may take advantage is where his corporation is merely holding title to real estate, and he has consistently disregarded its separate entity in tax matters. North Jersey Title Insurance Co. v. Commissioner, 84 Fed. (2d) 898; Mark A. Mayer, 36 B. T. A. 117; Moro Realty Holding Corporation, 25 B. T. A. 1135; affd., 65 Fed. (2d) 1013.

We do not understand that the recent decision of the Supreme Court in Higgins v. Smith, 308 U. S. 473, intended to disturb the validity of the rule or that exception. See Carling Holding Co., 41 B. T. A. 493. Bather, it definitely adds a distinct class of cases to the exceptions. This class includes only certain cases where the Government, and not the taxpayer, may refuse to consider these entities as separate See Valuation Service Co., 41 B. T. A. 811.

The first issue is whether petitioner may deduct taxes and interest on the properties the title to which was held by the Nissequogue Bealty Corporation and the Meadow Boad Improvement Corporation. These properties constituted his summer residence. Title was so held only to facilitate transfer of title because his wife, who would otherwise have to join in the execution of the deed, spent most of her time abroad. This action was not motivated by any intent of the taxpayer to avoid, postpone, or reduce his taxes. He has consistently disregarded their separate entities in income tax matters. All the stock of these corporations was held by petitioner, and they performed no function save that of holding title. They were not doing business. See Chase National Bank, Trustee, 41 B. T. A. 430. The taxes and interest were actually paid by petitioner.

We think that the corporate entities of these two corporations may properly be disregarded, in the light of the recent case of Carling Holding Co., supra. In that case the corporation, whose entity was disregarded, was formed by a bondholders’ committee to hold title' to property in process of foreclosure. Its only activity was to receive rents from the property and transmit them to the committee to be used to defray expenses of the latter. The instant situation is even more appropriate for disregarding corporate entity in that the two corporations now under consideration received no income at all and had no bank accounts. The case of Burnet v. Commonwealth Improvement Co., supra, contains nothing at variance with our conclusion, for there tax advantages had previously been secured by the taxpayer’s treating the corporation and the estate as two separate entities, whereas here, petitioner has always been consistent in his disregard of corporate entities and has never obtained tax advantages by invoking an opposite theory. The Commonwealth Improvement case is also distinguishable in that the corporation there had income and bought and sold securities. Accordingly, we hold that petitioner may deduct amounts paid as mortgage interest and taxes on the land held by these tw'o corporations.

The other issues are whether petitioner may deduct losses incurred by his wholly owned corporations, the United States Review Corporation and Living Age Corporation, and whether petitioner is entitled to carry over a 1932 net loss thus determined, so as to deduct it from his 1933 income.

To sustain petitioner in the first of these two issues, requires us to disregard the corporate entities of the United States Review and Living Age corporations. Those corporations were doing more than just holding title to assets. They were publishing magazines for profit. They were doing business. It may be that the circumstances indicate that, for all practical purposes, the petitioner was the corporation. However, that was so in Burnet v. Commonwealth Improvement Co., supra. There, as here, the taxpayer voluntarily assumed the corporate form for carrying on business and then sought to avoid the tax consequences of that status by disregarding it for tax purposes. On the authority of that case, which was reaffirmed in Higgins v. Smith, supra, we must consider these corporations as having entities here separate from those of their stockholder. See also Burnet v. Clark, supra; Dalton v. Bowers, supra.

As an alternative contention, petitioner seeks to deduct the difference between the total of his advances to these corporations and the value of his liquidating interest therein as bad debts. Respondent urges that the debts thus sought to be charged off by petitioner and deducted in 1982, 1933, and 1934 were really worthless in 1931. He points to the facts that the Living Age Corporation had a deficit in 1931 of $7,232.42 as compared with $12,508.10 in 1932, that it had net losses of $8,096.11 in 1931 as compared with $5,275.68 in 1932, and that the value of its assets at the close of 1931 was $11,648.95 as compared with $10,907.22 at the close of 1932, whereas its liabilities exclusive of capital stock were, respectively, $44,288.87 and $48,822.82. He emphasizes the similar situation in respect of the United States Review Corporation. He thus contends that petitioner may not “close his eyes to the obvious” and deduct accounts as worthless in a year subsequent to the one in which he must be presumed to have ascertained their worthlessness, citing Avery v. Commissioner, 22 Fed. (2d) 6. Although under all the circumstances, implicit in this record, the validity of this position may be doubted, C. H. White, 15 B. T. A. 1375, we pass the point.

It may be that these contested advances were not loans, but capital investments. It seems unnecessary to decide that question. In any event, the action of petitioner in continuing to put money into these corporations year after year, in the face of steady losses, deficits, and book insolvencies, the perseverance of these corporations in the magazine publishing business and other evidence negative the existence in the tax years of any factual premise upon which to predicate a reasonable ascertainment of worthlessness of these advances, if they be such, John W. Sherwood, 8 B. T. A. 103; Squier v. Commissioner, 68 Fed. (2d) 25; Powers Manufacturing Co. v. Commissioner, 34 Fed. (2d) 255; Higginbotham-Bailey-Logan Co., 8 B. T. A. 566, 580; Rogers Peet Co., 21 B. T. A. 577, or to identify the occasion of a loss, if they were capital investments. Olds & Whipple, Inc. v. Commissioner, 75 Fed. (2d) 272; Sterling Morton, 38 B. T. A. 1270.

This conclusion renders unnecessary any decision on- the remaining issues.

Reviewed by the Board.

Decision will be entered under Rule 50.

Sterni-iagen, Murdock, and Mellóte dissent on the first issue.


author: Murdock:

text:
    Albert J. Alsberg, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96296.
    Promulgated June 13, 1940.

      Paul D. Sagers, Esq., for the petitioner.

      Francis S. Gettle, Esq., for the respondent.
   opinion.

Murdock:

The Commissioner determined a deficiency of $291.09 in income tax for the calendar year 1936. The petitioner assigns as error the action of the Commissioner in disallowing a deduction of $1,527.54 claimed as interest paid on account of money borrowed from life insurance companies. The facts have been stipulated and the stipulation is adopted by the Board as its findings of fact.

The petitioner kept his books upon a cash basis. He had borrowed money from insurance companies on thirteen policies of insurance on his own life prior to 1936. The total amount of his borrowings as of the beginning of the taxable year was $25,459. The insurance companies entered on their books during the year 1936 charges for interest in accounts bearing the name of the petitioner. The total amount of those charges was $1,527.54. The petitioner paid $2,740.51 to the insurance companies during the year, apparently as premiums on the policies. The cash surrender value of the policies at the beginning of the year was $26,502.70, and at the end of the year was $28,607.61, an increase of $2,104.91.

Attached to one policy is a document executed by the insured dated May 28, 1932, stating in part that the insured promised to pay on October 19, 1932, $1,550 with interest at 6 percent to the insurance company; the policy was assigned as collateral security for the repayment of the loan; the borrower might repay the loan with accrued interest at any time; the loan might be extended for annual periods upon payment of premiums then due and payment of interest accrued at maturity; and if no extension was made, the interest due was to be added to the existing loan on the due date of the loan and annually thereafter, the interest was to bear interest at the same rate as the loan, and the loan would thus be extended automatically, except that no extension would continue beyond a default in premium or beyond any date on which the amount of the loan, together with added and accrued interest, became equal to or greater than the cash value of the policy. Other policies bear a notation that the policy and the value thereof had been assigned to the company as sole security for a loan, which loan and interest thereon constitute an indebtedness against the policy.

The petitioner claimed on his return, as a deduction representing interest, $1,527.54, the amount of the interest charged on the books of the insurance companies during the year. The Commissioner in determining the deficiency disallowed that deduction, with the explanation that the amount was not paid by the petitioner during the year and, since he was on the cash receipts basis, it was not an allowable deduction, citing S. E. Thomason, 33 B. T. A. 576.

The petitioner argues that the cash surrender value of each policy, together with any increase therein, was a fund or credit balance belonging to him and from which he could have drawn; the insurer charged interest against his account during the taxable year and thereby reduced the fund or credit balance; and, therefore, the interest charged during the taxable year was constructively paid by the petitioner. The insurance companies expected to have the loans and interest repaid to them, either in cash or through a retention by them of a part of the amount which they were otherwise obligated to pay upon the policies. It is proper to assume from this record that the insurance companies did not credit the loan accounts with the payment of any interest during the year but considered the charges of interest as additions to the loans. Cf. United States v. Collier, 104 Fed. (2d) 420; Bailey v. Commissioner, 103 Fed. (2d) 448. The petitioner could have given the insurance companies cash during the year in payment of the interest item. Such a transaction would have represented a payment by one on the cash receipts basis. An actual payment might have been accomplished in other ways as, for example, by a cancellation of the debt and interest through surrender of the policy. Here, in contrast to those situations, there was, in fact, no payment whatsoever, either actually or constructively, during the taxable year. Instead, the interest was permitted to accumulate and to become a part of the loans. The insurance companies were sufficiently secured and did nothing except to keep account of the interest and the loans. The situation is not materially different for tax purposes from one in which a taxpayer, on a cash basis, who owes interest on a note, gives another note to cover the interest. It has been held that the giving of the note is not payment by one on a cash basis and, therefore, he is not entitled to a deduction on his income tax return for interest paid. Hart v. Commissioner, 54 Fed. (2d) 848; S. E. Thomason, supra; Eckert v. Burnet, 283 U. S. 140. Cf. Oscar G. Joseph, 32 B. T. A. 1192. The deposit of funds or collateral out of which a payment may be made in the future does not constitute payment by one on a cash basis. Solomon v. State Tax Commission of New York, 278 U. S. 484; Arthur T. Galt, 31 B. T. A. 930. The identical issue raised by the present petitioner has been decided against the petitioner by the Board in a case which is not distinguishable from the present case. Nina Cornelia Prime, Executrix, 39 B. T. A. 487. There was no payment and no deduction is allowable.

The petitioner, in his briefs, puts quotation marks around the word loan in referring to the amounts which he had obtained from the insurance companies and which are described in the stipulation as debts. The following is from his reply brief:

A “loan” transaction upon a life insurance policy lias quite different characteristics from those of an ordinary loan, and, therefore, gives rise to different situations. The insured actually is drawing against an asset belonging to him, consisting of a balance which has accumulated' on the books of the insurer to the credit of his account. In an ordinary loan situation upon the repayment of the loan the effect is the extinguishment of the debt. In the case of a life insurance policy “loan” transaction, upon the repayment of the “loáú” the debtor increases his assets or credit balance and wipes out no personal obligations, none ever having come into existence.

If the above statements are correct, then it would seem that the petitioner is not entitled to any deduction for a further reason. The statute allows him a deduction only for interest paid on indebtedness. Section 23 (b) of the Revenue Act of 1936. If he is drawing against an asset belonging to him and thereby merely reducing a credit balance which has accumulated on the books of the insurer to his account, then the amount called interest was not interest on an indebtedness. The so-called interest mentioned in connection with the so-called loans, would appear to be merely a convenient term for describing one of the factors used in the computation of the amount owed to the petitioner at any particular time by the insurance company.

Decision will be entered for the respondent.


author: Keen-:

text:
    F. W. Kellogg, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95135.
    Promulgated June 13, 1940.

      Vernon M. Brydolf, Esq., for the petitioner.

      Harrxj B. Borrow, Esq., for the respondent.

       SEC. 115. DISTRIBUTIONS BY CORPORATION.

      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment In exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income. * * »
      SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.
      * * * * * * *
      (a) Computation on Gain or Loss. — The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.
      (b) Amount Realized. — The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

   Ol’INION.

Keen-:

The question raised in this proceeding has to do with the valuation of a distribution to a stockholder made in liquidation of a corporation. The applicable sections of the statute are sections 115 (c), 111 (a), and 111 (b) of the Revenue Act of 1934, set out in the margin.

The property received in liquidation by the taxpayer here was an account receivable of the corporation. The peculiarities of the transaction consist of (a) the account being payable not presently but at some future time, (b) the account being payable by the petitioner — distributee, and (c) the account being made up of payments made by the corporation of premiums due on life insurance policies covering the life of petitioner and assigned to the corporation as a source for the repayment of other amounts owed by petitioner to the corporation.

Respondent denies that the account was payable only out of the proceeds of the insurance policies, and contends, therefore, that the account was presently payable and was not payable at some future time. However, a careful reading of the letter from petitioner to the corporation, which embodies the terms of the contract out of which the account arose, and particularly the first, third, and fifth conditions thereof, convinces us that the advances made by the corporation for the purpose of paying the premiums upon the insurance policies were to be repaid only from the proceeds of the policies, at least until the advances together with the interest on petitioner’s notes totaled $70,-000. This limitation as to the source of payment carried with it a limitation as to the time of payment. There would be no proceeds from the policies until petitioner’s death; therefore, the account was not payable until petitioner’s death. Treated as an asset of the corporation, it would obviously follow that its present value would be less than its face amount.

Respondent insists that the transaction be treated not as the receipt by the petitioner of a chose in action, but as the cancellation of an indebtedness which he owed. We question the accuracy of this position, Estate of Helen Gilmore, 40 B. T. A. 945; but even though we accept respondent’s contention in this regard as a correct basis for our reasoning, our conclusion must be contrary to that which he urges. The value to the petitioner of the cancellation of a debt not yet due is less than the value of a cancellation of a debt presently payable, if no interest is charged on the obligation to pay. A recent case which is squarely in point is Warren Service Corporation v. Commissioner, 110 Fed. (2d) 723, in which the Circuit Court of Appeals for the Second Circuit held: “The value of a release of an obligation to pay $125,000 in 1941, without interest, is obviously less than the value of the release of a debt for like amount presently due, or of an obligation to pay the sum in 1941 with interest.”

In that case the court directed the finding of the present worth in 1933 of an obligation to pay $125,000 in 1941 without interest. In this proceeding the stipulation discloses the method used by petitioner in determining the present value in 1935 of an account in the sum of $43,533.60 payable without interest on petitioner’s death. Respondent does not object either in the pleadings or on brief to this method on the ground of its mathematical inaccuracy, but because of his contention, discussed above, that the account was not limited as to source and time of payment, and because it should not be treated as a chose in action having a market value, but as the cancellation of an indebtedness. The argument of respondent as to this last point seems to be, in effect, as follows: Granting that the account is receivable by the corporation only on petitioner’s death, and, therefore, has a value to the corporation as an account receivable of less than its face amount, nevertheless, it does not follow that the value to petitioner of the cancellation of the account (an account payable as to him) is less than the face amount of the obligation canceled.

With this argument we can not agree. If the present value in 1935 to the corporation of an account receivable in the amount of $43,533.60, payable upon the death of petitioner, was only $26,424.94 (and there is nothing in the record to indicate a greater value), then it would follow that the present value in 1935 to petitioner of the cancellation of the same obligation would be the same amount. Cf. Warren Service Corporation v. Commissioner, supra.

The cases of Ida L. Dowling, 13 B. T. A. 787; Reginald Denny, 33 B. T. A. 738; and L. D. Coddon & Bros. Inc., 37 B. T. A. 393, cited by respondent, are not in point, because they involve the release of an obligation presently payable and not, as in this case, payable in the future.

We conclude that petitioner received in the taxable year, as a distribution in liquidation of the corporaton of which he held shares, the assignment of a chos6 in action in the face amount of $43,533.60, payable upon his death, the present value of which to petitioner in the taxable year was the sum of $26,424.90.

Reviewed by the Board.

Decision of no deficiency will be entered.


author: Kern : AíttRdock,

text:
    Kiesau Petroleum Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95760.
    Promulgated June 13, 1940.

      Jonah, Jones, Jr., Esq., for the petitioner.

      John H. Bigg, Esq., for the respondent.
   OPINION.

Kern :

The primary question before us is whether 80 per centum of petitioner’s gross income for the taxable years was derived from “royalties” as the word is used in section 351 (b) (1) of the Revenue Acts of 1934 and 1936, set out in the margin. If it was so derived, then petitioner must be considered as a personal holding company within the meaning of those acts.

Petitioner concedes that the income derived from the oil well which it owns “is derived from royalties”, but contends that its interests in the other eight oil wells were merely participating interests and the income which petitioner derived from them pursuant to the contracts described in our findings, and constituting more than 80 per centum of its gross income, can not be considered as being derived from royalties. These Contracts were executed between petitioner and the owners of various oil leases, and provided that, in consideration of certain equipment furnished by petitioner, the owner of the lease would give petitioner a certain percentage of the proceeds received from the sale of oil produced from the well situated on the property. Is the interest in the oil thus acquired by petitioner a “royalty” within the meaning of the revenue acts ?

In construing the words contained in a statute our first resort should be to the natural, ordinary, and familiar meaning of the words used, unless Congress has definitely indicated an intention that the words should be construed otherwise. We, therefore, turn to the definitions of the word “royalty” as found in the'following dictionaries:

Webster’s New International Dictionary defines the word “royalty” as “(a) A share of the product or profit (as of a mine, forest, etc.) reserved by the owner for permitting another to use the property, (b) A duty or compensation paid to the owner of a patent or a copyright for the use of it or the right to act under it, usually at a certain rate for each article manufactured, used, sold, or the like; also, a percentage, as an output, paid to the owner of an article, especially a machine, by one who hires the use of it.”

In Black’s Law Dictionary, 3d ed., the word “royalty” is defined as “A payment reserved by the grantor of a patent, lease of a mine, or similar right, and payable proportionately to the use made ,of the right by the grantee.”

Ballentine’s Law Dictionary defines the word “royalty” as “Kent based upon the amount of mineral or oil taken from the ground; * * * As applied to oil and gas leases the term signifies the compensation provided in such a lease for the privilege of drilling on the premises for oil and gas, and consists of a share in the oil and gas produced under the lease. The royalty interest does not consist of a perpetual interest in the oil or gas as they lie in the ground, but, on the expiration of the lease, the right of the owner of the royalty expires.”

It is apparent from these definitions that the word “royalty” refers to an interest reserved by the owner in return for permission to use the property owned. To take examples from the oil industry, the interest reserved by the otvner of the fee to be paid by the lessee out of oil produced would be a royalty, as would also be the interest reserved by the owner of the leasehold to be paid by a sublessee from the oil produced. In J. T. Sneed, Jr., 33 B. T. A. 478, 482, we referred to “royalty” in the following language:

* * * Thg word “royalty” as used in a gas lease generally refers to “a share of the product or profit reserved by the owner for permitting another to use (he property.” Hill v. Roberts, 284 S. W. 246; National Gas Co. v. Stewart, 90 N. E. 384. It is compensation for the privilege of drilling and producing oil and gas and consists of a share in the product. Bellport v. Harrison, 255 Pac. 52.

In the instant case the petitioner, by the contracts referred to, did not reserve an interest in the oil producing properties; it acquired such an interest for the first time. It acquired a percentage of the interest of the lessees and was to share with them in the oil produced from the leased properties. Certainly the interests of the lessees in the oil produced from the properties held by them on lease could not be considered royalties.

We conclude that the ordinary meaning of the word “royalties” does not embrace the interest held by petitioner under the various contracts with lessees of oil producing properties.

Does the word “royalties” have a technical meaning peculiar to the oil industry which would embrace petitioner’s interests? If it does, it may be that Congress was using the word in this special sense. The record in this case contains uncontradicted testimony to the effect that according to the terms used in the oil industry, petitioner’s interest was known as a “participating interest” and not as a “royalty,” and that the word “royalty” was only used to describe the interest of the owner of the fee of oil producing land reserved upon lease (“a landowner’s royalty”), and the interest of a lessee in cases of sublease (“an overriding royalty”). Therefore, we must conclude that the word “royalties” has no technical or commercial meaning different from its ordinary and normal meaning.

Nor is there anything in the revenue acts which would indicate that Congress intended this word to have any meaning other than ordinary and normal.

Petitioner here acquired by contract for a consideration an interest in the natural resources of oil producing property. This was not a royalty. Respondent lays great stress on the fact that the contracts lefer to petitioner’s interest as a “royalty interest.” However, if petitioner’s interest was not in fact a “royalty” in the sense that that term was used by Congress, it matters not what label is given it by a contract between individuals. We are concerned with the rights created by the contract, and with the labels used only to the extent that they may be helpful in a construction of the contract. Here the contract is unambiguous, and, therefore, the label attached by the scrivener to petitioner’s interest is immaterial.

For the reasons, above stated, we conclude that 80 per centum of petitioner’s income was not derived from royalties within the meaning of section 351 (b) (1), and petitioner is not a personal holding company.

Respondent argues in the alternative that no depletion is allowable to petitioner in the event that we conclude, as we have concluded, that petitioner’s income is not derived from royalties. He says in his brief: “To place the income received by petitioner beyond the bounds of royalty income must of necessity remove it from its classification of income subject to depletion.” For this proposition of law he cites no authority. With it we can not agree. The right of a lessee of oil producing property to a depletion deduction can not be based upon any concept of royalty. The right to depletion depends upon an economic interest in oil in place acquired as a capital investment. See Palmer v. Bender, 287 U. S. 551; Helvering v. Bankline Oil Co., 303 U. S. 362; Cook Drilling Co., 38 B. T. A. 291; Rocky Mountain Development Co., 38 B. T. A. 1303. From an examination of the contracts introduced in evidence in this proceeding we are of the opinion that petitioner had such an interest and is entitled to depletion.

Certain provisions present in the contracts persuade us to this result. Among them are the following: “After said Second Party [petitioner] has been reimbursed as aforesaid, its interest shall be a permanent 7½% of 100% of the said production from said well”; “* * * First Party shall have the right to contract for the sale of the Second Party’s oil * * “* * * First Party * * * hereby does give the Second Party twenty-five percent (25%) of one hundred percent (100%) of the oil * * * produced from the said premises * * ; and “After said Second Party has been so reimbursed, its interest shall be ten percent (10%) of one hundred percent (100%) of the said production of the said well.” These provisions indicating the acquisition by petitioner of oil in place as a capital investment being present in the contracts before us, the decision of Rocky Mountain Development Co., supra, is not applicable to the facts of the instant proceeding.

Since we have concluded that petitioner is not a personal holding company, it follows of course that it was not obliged to file a return as such, and is not liable for the payment of any penalty for failure to do so.

Reviewed by the Board.

Decision of no deficiency will be entered.

Melloit and AbNOld dissent.

AíttRdock,

dissenting: I dissent from the holding of the majority that the petitioner is not a personal holding company.

       SEC. 351. surtax ON PERSONAL HOLDING COMPANIES.
      *******
      (b) Definitions. — As used in this title—
      (1) The term “personal holding company” means any corporation * * * if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals, * * *


author: Meixott: Leech,

text:
    Moloney Electric Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96076.
    Promulgated June 13, 1940.

      O. M. Trammell, Esq., Donald McGovern, Esq., and James O. Thompson, O. P. A., for the petitioner.

      Oarroll Walleer, Esq., and R. P. Hertzog, Esq., for tbe respondent.
   OPINION.

Meixott:

The first question is: Did the Commissioner err in disallowing the deduction of $4,150.52? Petitioner, like the taxpayer in Robert Gaylord, Inc., 41 B. T. A. 1119, claims that the deduction should be allowed as a loss not compensated for by insurance or otherwise ; as an ordinary and necessary expense paid or incurred during the taxable year in carrying on its business; or as a debt ascertained to be worthless and charged off. These allegations are denied in the respondent’s answer and he makes substantially the same argument as advanced by him in the Gaylord case.

It is unnecessary to repeat what was said in that case. The same conclusion must be reached under the facts before us and it must be, and is, held that the claimed deduction should be allowed under section 23 (a) of the Revenue Act of 1936 as an ordinary and necessary business expense. Brief reference may appropriately be made, however, to some of the evidence relied upon by this petitioner which is not identical to that which was before us in the Gaylord, case.

Petitioner’s president testified that he attended some of the meetings being held in connection with the contemplated absorption by First National of Franklin-American. He stated that the president of the Clearing House Association “presented a very gruesome picture of what was happening here in reference to the Franklin-American * * *”; that his company had on deposit in three banks in St. Louis $295,000; and “we wanted those deposits safe-guarded * * *” “We did not want a calamity to happen in the Cityof St. Louis if the Franklin Trust Company closed its doors the following morning ⅜ * “Another thing was that it would materially affect our business in the city of St. Louis and surrounding territory.” “The greatest consideration that I had was to protect my own interests that I had in the banks of St. Louis and I had in my business.”

The testimony submitted in this proceeding upon this issue was not as extended as the evidence adduced in the Gaylord and other cases involving a similar issue tried at substantially the same time. However, we think judicial notice may be taken of the fact that the period was a very critical one in the banking situation generally. As stated by us in the Gaylord case, bank failures in 1931 were twice as numerous as they had been during the preceding year, four times as numerous as during the year 1929, and six times as numerous as during the average year in the predepression era. All of this was known to the St. Louis business men and was forcefully brought to their attention by the president of the, clearing house at the hastily called meetings which the president of this petitioner attended.

The expenditure of the relatively small sum of money by the petitioner under the circumstances disclosed by the present record, supplemented by the matters as to which we have taken judicial notice, constituted, we think, an ordinary and necessary expense of carrying on its trade or business. We hold, therefore, that the respondent erred in denying the claimed deduction.

Tlie remaining question is: May petitioner be allowed any “credit” under section 26 (c) (2) of the Revenue Act of 1936, against its “undistributed profits tax?”

The deficiency notice indicates that petitioner’s net income for 1935, as disclosed by its return, was $183,667.02 and, after giving effect to the adjustments made by the Commissioner, was $205,569.16. The principal adjustment — the disallowance of $22,650.12 of the amount claimed as depreciation — is now conceded by the respondent to have been erroneous; so the net income as adjusted (after giving effect to a deduction of $747.98 allowed by the Commissioner but not claimed by petitioner in its return) was $184,415. The amount of the “net earnings” for said year, as defined in the trust agreement, was not shown. The deficiency notice also indicates — the returns not having been introduced in evidence — that petitioner’s net income for 1936 was $477,633.31. Giving effect to the adjustments made by the respondent, other than the disallowance of a portion of the depreciation, it seems that petitioner’s net income for 1936, as adjusted, was $482,105.83.

It is alleged in the petition that the largest amount of bonds at any time outstanding during the year 1936 was $690,500; that 2 percent thereof, or $13,810, was “required to be paid to the trustee or set aside out of earnings ahd profits of the taxable year 1936 by virtue of the provisions” of the trust agreements; that the “net earnings for the taxable year 1936” amounted to $477,633.31; that 20 percent of the excess over $320,000 ($157,633.31) or $31,526.66 “is required by the provisions of said Trust agreement * * * to be paid or set aside within the taxable year for the purpose of retiring said outstanding debenture bonds”; and that petitioner is therefore entitled to an aggregate credit under section 26 (c) (2), supra, in the amount of $45,336.66. These allegations are denied in the respondent’s answer.

Consideration will first be given to petitioner’s contention that it is entitled to credit in the amount of $31,526.66. It will be noted that the statute requires: (1) That there be a written contract executed prior to May 1, 1936; (2) that it contain a provision expressly dealing with the disposition of earnings and profits of the taxable year; (8) that it require a “portion of the earnings and profits of the taxable year” (a) to be paid within the taxable year in discharge of a debt, or (b) to be irrevocably set aside within the taxable year for the discharge of a debt; and (4) when the above conditions are met then the credit may be given to the extent that such amount (a) has been paid, or (b) has been set aside. The first requirement has been met. It is doubtful, however, if the second has; for, as pointed out by the respondent, it deals with the disposition of earnings and profits of a preceding year rather than of the taxable year. Assuming arguendo (though not deciding) that the second requirement has been met, we pass to a consideration of the others.

It would require a strained construction to hold that either the third or the fourth requirement has been met. Petitioner contends that the facts bring it “within the letter and the spirit of the section.” It may be that it is within the spirit; but that is not sufficient. “A taxpayer seeking a deduction must be able to point to an applicable statute and show that he comes within its terms.” New Colonial Ice Co. v. Helvering, 292 U. S. 435. Nothing that was said in G. B. R. Oil Corporation, 40 B. T. A. 738, can be construed as putting any lighter burden upon a taxpayer seeking the credit under the statute in question. It is our duty to construe the statute precisely as written; and unless the petitioner brings itself within its terms it can not prevail.

There is nothing in the trust agreement requiring “a portion of the earnings and profits of the taxable year” either to be paid or to be set aside “within the taxable year for the discharge of a debt.” Petitioner does not contend that payment was required. Upon brief it says: “The provisions of the agreement certainly did not require payment out of 1936 net earnings to be made until June 1, 1937. Therefore 3 (a) (which it has phrased substantially as set out above) is not met.” It contends, however, that the contract “did require the company to irrevocably set aside within the taxable year 20% of the net earnings in excess of $320,000 for the discharge of the bonded indebtedness.” We do not agree. The contract requires that when the net earnings are determined from the audit (which is “to be made at the close of each calendar year”) “which, in no event, shall be later than the first day of April, said amount shall forthwith be set aside in a separate fund.” This provision of the contract is clear and unambiguous and is susceptible of no other construction than that no irrevocable setting aside was required to be made earlier than April of the succeeding year. We think it is clear, therefore, that neither requirement 3 (a) nor 3 (b) is met.

It has been pointed out that when all of the requirements have been met, credit is to be allowed to the extent that the earnings and profits have been paid or set aside within the taxable year. Petitioner argues that the contract required an irrevocable setting aside and that it has gone even further than required. It says: “Besides being set aside, the sum was actually paid to the Trustee under the agreement.” Our holding to the effect that the contract did not require an irrevocable setting aside within the taxable year of any portion of the earnings of the taxable year leaves no major premise upon which the minor may be based. But if we have erred in so holding, still petitioner can not prevail. There is no evidence upon which to base a conclusion that any portion of the amount paid in 1936 was paid because of petitioner’s obligation to apply 20 percent of its net earnings in excess of $320,000 toward the reduction of its indebtedness. The record does not disclose whether the payment was made near the close of the year when it was apparent that the earnings would be in excess of $320,000 or whether it was made earlier in the year when the earnings were much less than that amount. It seems to be obvious that the payment was made under the option contained in section 3 of article III rather than because of any requirement of the contract that it be made. In any event, in the absence of any showing as to when the payment was made and in the absence of any showing as to the amount of net earnings at that time, it is impossible to find that the payment was made because of the requirement that 20 percent of the net earnings in excess of $320,000 be applied upon the debt.

The instant proceeding is distinguishable upon its facts from Strong Manufacturing Co., 41 B. T. A. 1273. In the cited case-it was found that “compliance with * * * [the] conditions” of the statute was questionable in only one respect. It was held that “the ‘application’ of the designated portion of the earnings and profits required by the contract” was “to be considered as operative ‘as of’ the taxable year and therefore as the irrevocable setting aside contemplated by the statute.” The contract in that case required the taxpayer to “apply forty percent (40%) of its net earnings ⅝ * * upon the unpaid balance of said purchase price.” The findings show that “since it appeared (in October of 1936) that petitioner’s profits would be such that 40 percent thereof would be in excess of the amount required to discharge the mortgage in full, it was decided to make the payment at that time.” In other words, the taxpayer recognized that under its contract its creditor had an equitable lien, during the taxable year, upon 40 percent of its net earnings. But in the instant proceeding the creditor had no equitable lien upon petitioner’s earnings until and unless they should be in excess of $320,000. It has been pointed out above that the evidence is not sufficient to establish this fact; and without it the rationale of Strong Manufacturing Co. can not be applied. It is thei’efore held that tbe Commissioner did not err in denying petitioner’s claim for a credit of $31,526.66 under section 26 (c) (2), supra.

Petitioner’s claim for credit in tbe amount of $13,810 is in a different category. Tbe contract required it to “pay to the Trustee on tbe first day of June * * * a sum equal to 2% of the largest amount of debenture bonds at any time outstanding.” Petitioner has given this expression tbe construction least favorable to it, construing it as if it read “the largest amount * * * at any time during the taxable year outstanding.” Here, then, was a contract executed by the corporation prior to May 1, 1936, requiring a definite amount to be paid within the taxable year in discharge of a debt and the amount was so paid. Can it be said that the provision “expressly deals with the disposition of earnings and profits of the taxable year”? If so, was it incumbent upon petitioner to show that payment was actually made out of “the earnings and profits of the taxable year”? If the last question be answered in the negative, then it is unimportant; but if in the affirmative, then it must be held that petitioner has made the required showing, for its president testified that $240,000 of its earnings for 1936 was used in liquidating its bonded indebtedness. But the first suggested question can not be answered so readily.

In Michigan Silica Co., 41 B. T. A. 511, it was pointed out that bonds evidence a debt within the meaning of the section now under consideration. It was therefore held that a provision of the trust indenture requiring the taxpayer to pay to the trustee a definite amount for each ton of sand produced and sold by it should be construed as a provision expressly dealing with the disposition of earnings and profits of the taxable year even though the provision did not expressly use the term earnings and profits. The cited case, though not determinative of the present issue, makes a “practical” application of the section. Cf. United States v. Kirby Lumber Co., 284 U. S. 1. A similar application should be made in the instant proceeding, though the burden upon petitioner to show that it comes within the precise language of the statute must be met. New Colonial Ice Co. v. Helvering, supra.

The paragraph of the trust agreement set out in our findings does expressly deal with the disposition of earnings and profits of the taxable year even though the provision requiring the payment of a sum equal to 2 percent of the largest amount of outstanding bonds, taken from its setting, makes no specific reference to earnings and profits. It is apparent, however, the parties intended that petitioner’s net earnings and profits should be applied as follows: The first $320,000 toward the payment of the bonds and as dividends upon the outstanding stock; 20 percent of the excess over that amount toward the payment of the bonds; and that the balance should be added to surplus or paid out as additional dividends. This, we believe, is a practical interpretation of the whole paragraph. So construed, it must be held that the payment was made out of the earnings and profits of the taxable year, pursuant to the provision of a -written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year, and that therefore it comes literally within the terms of the statute.

The Commissioner should have allowed petitioner a credit of $13,810 under section 26 (c) (2), supra.

Reviewed by the Board.

Ueoision will be~ entered wider Buie 60,

Disney dissents.

Leech,

dissenting: I do not think that the facts here permit the application of any rule other than that recognized by the Board in Strong Manufacturing Co., 41 B. T. A. 1273, and Michigan Silica Co., 41 B. T. A. 511. That rule requires that petitioner be sustained on the second issue.

Murdock agrees with this dissent.

       SBC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      s + * * ⅜ * *
      (e) Contracts Restricting Payment of Dividends.—
      * ⅜ # ⅛ * * tf*
      (2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. Por the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.


author: Arundell :

text:
    Richard H. Baumbach, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99895.
    Promulgated June 14, 1940.

      L. J. Lwwbemchlaeger, Esq., and Marry P. Gamble, Jr., Esq., for the petitioner.

      D. D. Smith, Esq., for the respondent.
   OPINION.

Arundell :

The petitioner claims a credit of $2,500 for the year 1937 under section 25 (b) (1) of the Revenue Act of 1936. He claims that by reason of supporting his son in his household he was the “head of a family” within the meaning of that statutory term as it has been defined in article 25-4 of Regulations 94 as follows:

A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation.

Unquestionably the petitioner meets the majority of the elements enumerated in the regulation. He actually supported and maintained in one household an individual closely connected with him by blood relationship. There may be some question as to the existence and extent of the petitioner’s “right to exercise family control” over his adult son. We need not decide that. The regulation has for its main premise the maintenance by a taxpayer in one household of “dependent individuals.” The question here thus narrows down to whether or not the petitioner’s son was a “dependent.” The son was 26 years old, in good health, a college graduate with a professional degree, and engaged in practicing his profession. Ordinarily, we do not think of an adult who is mentally and physically sound as a dependent, and to so classify the son in this case would require an abrupt turn in common thought and speech. To hold that an adult individual under the facts here is a dependent would make that term applicable in a variety of situations that were surely not contemplated when the regulation was drafted. To carry the petitioner’s view to its logical conclusion would be to say that every adult who continues to reside at the family abode and who does not earn in full a sum equal to his living expenses is a dependent, without regard to mental and physical capacity and the possibility of earning a living in another field of endeavor. Petitioner’s view would also involve the application of a highly variable standard, varying according to each individual’s ideas as to the sum necessary for his proper support and maintenance.

It is our opinion that the word “dependent” in the regulations can not properly be extended to a case like this where the individual is an adult, well educated, in good health, engaged in a profession, but simply fails to earn enough in his practice to fully support himself. The respondent’s determination is sustained.

Decision will be entered for the resfondent.


author: Mukdook :

text:
    Josephine S. Pearce, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96158.
    Promulgated June 14, 1940.

      Gordon 8. P. Kleeberg, Esq., for the petitioner.

      Leonard A. Bfcdding, Jr., Esq., for the respondent.
   OPINION.

Mukdook :

The Commissioner determined deficiencies of $310.20 and $327.96 in the income tax of the petitioner for the calendar years 1935 and 1936. The Commissioner, in determining the deficiency for each year, added to the income disclosed on the return $6,000 representing an amount received by the petitioner during the taxable year under an annuity contract purchased for her benefit by her divorced husband. The propriety of the addition of the $6,000 is the only issue for decision by the Board. The Board adopts as its findings of fact the stipulation of the parties.

The petitioner and William G. Pearce were married in Missouri and lived as husband and wife until the latter part of 1913, at which time they separated. The husband then set up a trust for his wife’s support and maintenance, under which she was to receive $350 a month. He guaranteed the payments in case the income of the trust was insufficient. Their agreement was changed in December 1916 to provide a monthly income for the petitioner of $500 and to provide that, should the husband purchase for the petitioner an annuity in one of six named insurance companies paying her $500 per month for the remainder of her life, she would agree to the termination of the trust and thereafter her husband would be under no personal obligation to pay or cause to be paid to her any further sum. The petitioner obtained a divorce in Texas in January 1917. The divorce was absolute. They had no children. She sought no alimony and none was provided. The divorce decree made no mention of the agreements between the petitioner and her husband. It contained no provision reserving jurisdiction to later grant alimony or modify the decree in any way. The former husband purchased an annuity in May 1917 from the Travelers Insurance Co., which was one of the six companies named. The annuity was for the payment of $500 monthly to the petitioner for her life. The annuity was transferred to her and she gave the release which she had agreed to give. The trust was terminated and the corpus was returned to the husband. The petitioner is still in possession of the annuity and received during the taxable years $500 a month.

The sole contention of the petitioner is that the amounts in controversy are not taxable to her because they are taxable to her former husband. The respondent has conceded that the income is not taxable to the former husband. See William G. Pearce, Docket No. 98004, heard at the same time this case was heard. He contends there that the law of Texas, the agreement of the parties, and the annuity have given the divorced husband full discharge and leave no contingent obligation upon him with respect to his wife. He concludes that, under the recent decision of the Supreme Court in Helvering v. Fitch, 309 U. S. 149, the amounts are taxable to the wife, the present petitioner. See also Helvering v. Fuller, 310 U. S. 69.

Counsel for the petitioner contends that it has not been established in the present record upon clear and convincing proof and beyond mere inferences and vague conjectures that the husband was completely discharged under the laws of Texas by the arrangement made with his wife. He says it may not be assumed that under the laws of Texas the Texas court could not step in, upon failure for some reason of the annuity payments, and require the husband to support the petitioner. This case is different from the Fitch case, supra, and also from Helvering v. Leonard, 310 U. S. 80, in one respect which is quite important in so far as this contention of the petitioner is concerned. The difference is that in the Fitch and Leonard cases the taxpayer seeking to escape the tax was the husband, and any failure of proof or uncertainty was to his disadvantage, whereas here the taxpayer seeking to escape the tax is the wife, and any failure of proof or uncertainty is to her disadvantage. She has failed to show that the determination of the Commissioner is incorrect. The facts, on the contrary, tend to support the determination of the Commissioner.

Decision will be entered for the 'resfondent.


author: Him:

text:
    Murray Innes, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92821.
    Promulgated June 18, 1940.

      Irve O. Boldman, Esq., and Bertrcmd L. Gomfaret, Esq., for the petitioner. w

      E. A. Tonyes, Esq., for the respondent.
   OPINION.

Him:

The question presented is whether under the facts the income of the trust was devoted to the discharge of a legal obligation of petitioner and therefore taxable to him.

Consideration of petitioner’s contentions involves the questions: (1) The validity of that part of the decree of divorce providing for payment of alimony; (2) assuming such validity, whether the obligation thus created was fully extinguished by executed agreements inter partes; and (3) whether such agreements in themselves constituted a continuing obligation of petitioner to contribute to his former wife’s support or constituted a complete discharge of such obligation.

Under the law of California, as elsewhere, the obligation of a husband to support his wife ceases when the marital relation is terminated by absolute divorce, unless otherwise provided in the decree of divorce or by agreement of the spouses.

On the basis of the stipulated facts that there was no service of summons on petitioner in the divorce action and no appearance by him or authorized appearance for him therein, petitioner contends that that part of the decree of divorce which provided for the payment of alimony was absolutely void for lack of jurisdiction and subject to collateral attack in this proceeding. He maintains that in all other respects the decree is valid. In other words, petitioner’s contention is that the decree in question terminated the marriage relation but did not create an obligation of petitioner to contribute to the support of his former wife and that hence there existed no such obligation from and after the date of such decree. The respondent, on the other hand, says that if such decree was valid in part it was valid as to all of its terms and provisions and that the obligation imposed thereby on petitioner was being discharged by creation of the trust and the payment of the income thereof to petitioner’s former wife. Respondent contends in the alternative that if such decree was void as to the provisions for the payment of alimony it was void in tobo/ that Katherine D. Innes, therefore, never ceased to be petitioner’s wife and that under the law of California there was a continuing legal obligation on him to support her which was being discharged by the payment of the trust income to her.

The Superior Court of California is a court of general jurisdiction. Jurisdictional infirmity of a judgment of a court of general jurisdiction can not be exposed in a collateral proceeding by evidence exclusively outside of the judgment roll. If the judgment or the judgment roll did not disclose such infirmity, the judgment is binding until vacated in a proceeding for that purpose. “Where a court of general jurisdiction is required to exercise its powers upon facts proved before it, the proof is presumed to have been made, and such facts can not be collaterally attacked.” 21 L. R. A. 854, Note (see cases cited).

No part of the judgment roll in the divorce action is in evidence herein, but, in view of the stipulated fact that an attorney appeared for petitioner in the divorce action, although without authority so to do, it is fair to assume in the absence of a showing to the contrary that the divorce decree or the judgment record contained recitals or entries of facts necessary for jurisdiction of the person of petitioner in that action, or at least that the judgment roll therein did not disclose absence of such jurisdictional facts. “The general doctrine as established by the cases is that the attorney appearing in any action or suit is presumed to have full authority to do so until the contrary is proved.” Williams v. Johnson, 112 N. C. 424; L. R. A. 848, Note. “And such presumption exists in all collateral proceedings.” Osburn v. Bank of United States, 22 U. S. 737, 828. Cases cited in the above “note” support the text “That in the case of a decree judgment rendered against a party wbo has no notice of the action, never appeared therein nor submitted to the jurisdiction of the court, the courts hold the judgment to be conclusive and free from collateral attack inter -partes upon all matters mentioned in the record, until reversed or set aside on a writ of error.” Also “Where there is want of jurisdiction in a decree judgment, the attack may be either by direct application to the court itself or by way of appeal.” “Note”, supra. McCahill v. Equitable Life Assurance Society of the United States, 26 N. J. Eq. 531. “The decision of a court will not be incidentally impeached by extrinsic evidence showing that the record was false in regard to a material fact positively asserted, necessarily implied by it.” “Note”, supra, at page 854.

We have found nothing to indicate that the rule in California is different from that above stated. Chaplin v. Superior Court, 81 Cal. App. 367; 253 Pac. 954, is cited by petitioner to the point that a judgment in personam, without jurisdiction of the person of the judgment debtor is void and subject to collateral attack in another proceeding. In that case the Supreme Court of California issued a writ of prohibition directed to the Superior Court enjoining the latter from enforcing a judgment for the payment of alimony, on the ground of the lack of jurisdiction of the person petitioning for the writ. Apparently the judgment record in that case either showed affirmatively lack of jurisdictional facts or that the judgment record failed to disclose facts upon which jurisdiction of the person of the defendant therein was based. As summarized in syllabus, the court held in that case that:

Defendant, who was not served and did not appear in divorce suit, may bring prohibition to obtain relief from order for payment of counsel fees and alimony, pending outcome, without making objection in court issuing order, since no preliminary objection is necessary where want of jurisdiction is apparent on the face of proceeding.

Under the state of the record and the facts in the instant proceeding we hold that petitioner can not in this proceeding impeach the validity in whole or in part of the judgment of the Superior Court of California in the divorce action and that for the purposes of this proceeding the judgment in question is in all respects valid and that the provision therein for the payment of alimony was an enforceable legal obligation of petitioner.

We have next for determination the question of whether the petitioner is taxable on the income during 1935 of the trust established in that year which was paid over to his wife for her support and maintenance. It results from our holding above that during the taxable year the divorce decree providing for the payment of $300 per month was valid and outstanding, representing a continuing obligation of the petitioner to pay out that amount. The effect on that obligation of tbe agreement entered into by petitioner and his divorced wife in that year must be determined first under the applicable state law.

The following is provided in the California Civil Code:

Sec. 139. Support of children and wife on divorce for husband’s offense: Modification of orders: Remarriage of wife, effect. Where a divorce is granted for an offense of the husband, the court may compel him to provide for the maintenance of the children of the marriage, and to make such suitable allowance to the wife for her support, during her life or for a shorter period as the court may deem just, having regard to the circumstances of the parties respectively; and the court may from time to time modify its orders in these respects.
Remarriage. Upon the remarriage of the wife, the husband shall no longer be obligated to' provide for her support but such remarriage shall not affect his duty to provide for the maintenance of the children of his marriage.

The courts of California construing this statute have held that they are not bound in their allowance of alimony or any modification thereof by an agreement entered into by the parties fixing their obligations in this respect. In Moog v. Moog, 203 Cal. 406; 264 Pac. 490, the taxpayer and his wife had entered into an agreement in contemplation of divorce by which the wife had consented to accept alimony in a specified amount. The divorce court rejected the provisions of the contract and set the allowance for alimony at a greater sum than that agreed. On appeal from a judgment for the wife based on the amount allowed in the divorce decree the Appellate Court affirmed the judgment, even though the amount recovered in accordance with the decree exceeded that which the wife by contract had agreed to accept.

The case of Smith v. Superior Court, 89 Cal. App. 322; 264 Pac. 573, is particularly in point. There the husband and wife on the day of the granting of their decree of divorce, which fixed alimony at $100 per month, entered into an agreement by which the husband abandoned his plans for an appeal in return for his wife’s relinquishment of her claims to alimony and support as provided in the decree. Approximately one year later, on October 21,1927, the wife applied to the court for and received an increase to $175 per month of the alimony allowance. The wife instituted proceedings to enforce the increased alimony decree. The lower court adjudged the husband in contempt for his failure to make the payments required by the decree of October 21, 1927, notwithstanding the agreement reached on the day of the divorce. This judgment was affirmed by the Appellate Court, which said:

Agreements between tbe spouses relative to alimony or fixing by and between themselves tbe amount which the Court may allow are subject to the power of the Court, under sec. 139 of the Civil Code, to modify or wholly reject, as provided in said section [omitting citations].

See also Roberts v. Roberts, 83 Cal. App. 345; 256 Pac. 826; Ex Parte Weiler, 106 Cal. App. 485; 289 Pac. 645; Ettlinger v. Ettlinger, 3 Cal. (2d) 172; 44 Pac. (2d) 540.

From the holdings of these cases we draw the conclusion that the petitioner in the instant case could not by the agreement entered into with his wife in 1935 discharge in any final way his obligation to pay alimony, and this is so even though the wife agreed to consent to the entry of an order striking from the decree the provisions relative thereto. It yet remained within the power of the court to reject the agreement of the parties if it considered the arrangement unfair and to make any alterations in the decree which the changed conditions of the parties required. This power of the court in the instant case remained in force during 1935 and at least down to the entry of the order in 1937. Cf. Ettlinger v. Ettlinger, supra. In this guise the situation before us is controlled by Helvering v. Fitch, 309 U. S. 149, and Helvering v. Leonard, 310 U. S. 80. In each of those cases, under the applicable state law, it appeared that the court granting the divorce retained sufficient power to make later modifications in the decree and thereby to alter the obligation which the taxpayer sought to discharge by the establishment of a trust. The taxpayer did not meet his burden of proof to show otherwise. The taxation of the income of the trusts to the settlor-taxpayer was sustained in both cases on the ground that the establishment of the trust was not shown to discharge absolutely and irrevocably the obligation of the taxpayer to support his divorced wife and that the trust income therefore was applied to his¡ continuing obligation. Cf. Helvering v. Fuller, 310 U. S. 69. We think that is the situation in the present case.

It appearing that under the law of California the Superior Court has the power to enforce the existing provisions of its decree in respect to alimony, Moog v. Moog, supra, or to modify such provisions notwithstanding the agreement of the parties, Smith v. Superior Court, supra, it must be held that the provisions of the trust agreement did not operate to discharge petitioner’s obligation to pay alimony, but that such obligation continued until its termination by the modification of the decree in the year 1937. The trust, therefore, operated in the taxable year as an instrumentality in the performance of petitioner’s continuing obligation to pay alimony, thus rendering the income thereof taxable to petitioner under the authorities hereinabove cited.

In Helvering v. Leonard, supra, the Supreme Court said:

In Helvering v. Fitch, supra, we stated that where the divorced husband desires to avoid the general rule expressed in Douglas v. Willcuts, supra, he carries a distinct burden of establishing not by mere inference and conjecture but by “clear and convincing proof” that local law and the alimony trust have given him a full discharge. We do not think that respondent has sustained that burden.

We, therefore, hold that petitioner is taxable on the 1935 income of the trust in question.

Decision will be entered for the respondent.


author: Leech:

text:
    Otto Peterson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edward M. May, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lynn L. Hosier, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95168, 95171, 95172.
    Promulgated June 18, 1940.

      Edward A. Smith, Esq., and Ralph W. Barbier, Esq., for tbe petitioners.

      Philip M. Olarle, Esq., for tlie respondent.
   OPINION.

Leech:

Eespondent taxed to the respective petitioners the dividend of $50 per share, paid during the taxable year on the treasury stock issued to the members of their respective families. He did this upon the premise that these shares of stock thus issued were then actually owned by the respective petitioners. He cites Higgins v. Smith, 308 U. S. 473, and Helvering v. Clifford, 309 U. S. 331, as authority for his determination of the existence of this premise here.

We do not think either case is in point except as they support the fundamental concept, recognized here, that substance and reality shall prevail in tax matters over form and unreality.

Our sole inquiry is whether, in fact, this stock was owned by petitioners after its issue to the members of their families. If it actually belonged to the members of petitioners’ families to whom it was issued — regardless of whether they acquired it by gift or purchase — then it did not belong to petitioners and the dividends thereon, basing the deficiencies, are not taxable as income of petitioners.

It is true the alleged purchases of some of this stock were necessarily financed by the petitioners, individually, or by the corporation which they controlled. See Estate of Eliot W. Mitchell, 37 B. T. A. 161; Thomas W. Behan, 32 B. T. A. 1088; affd., 90 Fed. (2d) 609. It may be that an obligation to “purchase” such stock arose upon receipt of these finances. See Madeira v. Commissioner, 98 Fed. (2d) 556; Empire Trust Co. et al., Executors, 41 B. T. A. 839. But those facts establish only that the transactions were gifts of the stock and not sales. They do not contradict the ownership of this stock by the persons to whom it was issued.

Nor does the absurdly low price at which the stock was issued do so. That fact, in view of the close family relationship, may have indicated an intention to make a gift at least of the excess value. See Luella Hoyt Slayton, 29 B. T. A. 931; affd., 76 Fed. (2d) 497; see also sec. 503, Revenue Act of 1932. But the existence of the option to buy this newly issued stock, under specified conditions, not at that low figure but at approximately book value, is evidence of the acquisition of real ownership of the stock by the record holders and not contradictory of that fact. Carson Estate Co., 31 B. T. A. 607; affd., 80 Fed. (2d) 1007; Bank of California, National Association, 30 B. T. A. 556; affd., 80 Fed. (2d) 389; Helvering v. San Joaquin Fruit & Investment Co., 297 U. S. 496. Similar options were outstanding against petitioners’ stock and there is no dispute as to its ownership.

That some of the recipients of this stock and the dividends in dispute deposited these dividends in accounts to which the respective petitioner to whom they were related were parties, is of little significance. Those moneys were .never used except as the funds of the recipient.

This stock, after appropriate legal procedure, was issued to the several members of petitioners’ families and has remained there. None of the petitioners have exercised nor attempted to exercise any control over the stock except by proxies voluntarily executed — a circumstance certainly not unusual in view of the family relationship. See Henry A. B. Dunning, 36 B. T. A. 1222. These record stockholders received not only the contested dividends but other dividends in later years — all of which they returned as their own income and paid the income tax thereon. See Elizabeth Berthold et al., 12 B. T. A. 1306.

Though this record may disclose that, as a bona fide sale and purchase, this stock issue to the members of petitioners’ families is heavily tainted with sham and unreality, the same evidence convinces us that the transfer of title to that stock to those record owners was actual and absolute. That conclusion disposes of our only inquiry in these proceedings. It follows that there are no deficiencies and therefore m> fraud penalties.

It would appear from this record that the petitioners or the corporation are taxable on the transfer of this stock as gifts (see Revenue Act of 1932, sec. 503), but that question is not before us.

Reviewed by the Board.

Decisions will he entered for the 'petitioners.


text:
    Julius G. Day, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96835.
    Promulgated June 18, 1940.

      George E. H. G-oodmer, Esq., for the petitioner.

      Dams HasJein, Esq., for the respondent.
   OPINION.

Leech :

Petitioner contends that inasmuch as the note given by him to the trustee is secured by an instrument under seal, it is a valid and enforceable obligation and the interest payments are consequently deductible. He states that under controlling Connecticut law (see Sterling Morton, 38 B. T. A. 1270), the consideration given for an instrument under seal may not be questioned, but must be conclusively presumed to exist. Hence, he says, the instant situation is controlled by William Park, 38 B. T. A. 1118, which held that, where by the law of a state the consideration for a note may not be questioned because the note is under seal, the note must be deemed evidence of an enforceable debt and the interest paid thereon must be allowed as a deduction.

This note is not, however, under seal. But even if it were, absence of consideration could be shown under the laws of Connecticut. See St. Paul's Episcopal Church v. Fields, 81 Conn. 670; 72 Atl. 145. The fact that the mortgage and the trust deed were sealed instruments, and the further fact that, in Connecticut, a seal imports consideration in such instruments as a release (Dwy v. Connecticut Co., 89 Conn. 74; 92 Atl. 883), an option (Hartford-Connecticut Trust Co. v. Divine, 97 Conn. 193; 116 Atl. 239) or a quitclaim deed (Monski v. Lukomske, 118 Conn. 635; 173 Atl. 897), do not foreclose our inquiry into the existence of consideration for the note here.

There is no promise to pay contained in either the mortgage or the trust instrument. The mortgage constitutes the security for the note, but it is the note itself which evidences the debt, if any. It is the general rule, moreover, that there can be no valid mortgage without a valid debt, and if the note is unenforceable, the mortgage falls with it. Hendrie v. Hendrie, 94 Fed. (2d) 534; Lee v. Macon County Bank, 233 Ala. 522; 172 So. 662; Rogers v. Snow Bros. Hardware Co., 186 Ark. 183; 52 S. W. (2d) 969; Western Loan & Building Co. v. Scheib, 218 Cal. 386; 23 Pac. (2d) 745; Guaranty Title & Trust Co. v. Thompson, 93 Fla. 983; 113 So. 117; Thorin v. Marchi, 287 Ill. App. 513; 5 N. E. (2d) 292; Hoover v. Pennington, 19 La. App. 779; 141 So. 517; Sanger v. Bancroft, 78 Mass. 365; Spielman v. Albinson, 183 Minn. 282; 236 N. W. 319; Donovan v. Boeck, 217 Mo. 70; 116 S. W. 543; Shriver v. Sims, 127 Neb. 374; 255 N. W. 60; Pierson Co. v. Freeman, 113 N. J. Eq. 268; 166 Atl. 121; Title Guarantee & Trust Co. v. Nessle, 296 N. Y. S. 270; Red River National Bank v. Latimer, 110 S. W. (2d) 232 (Tex. Civ. App.); Tesdahl v. Collins, 97 Pac. (2d) 649 (Wash.); Doyon & Rayne Lumber Co. v. Nichols, 196 Wis. 387; 220 N. W. 181. Consequently, we are here concerned only with the question of whether the note itself is enforceable.

Petitioner first urges that love and affection constitute valid consideration. Such is not the law. Estate of Hugo Goldsmith, 36 B. T. A. 1201; Shriver v. Danby, 12 Del. Ch. 84; 106 Atl. 122; Bainbridge v. Hoes, 149 N. Y. S. 20; Shugart v. Shugart, 111 Tenn. 179; 76 S. W. 821; In re Smith's Estate, 226 Wis. 556; 277 N. W. 141. Petitioner’s second argument is that the trustee’s agreement to accept and perform the trust was consideration for the note. But there is no evidence that the note was given in exchange for such services. In fact, there was no agreement that the trustee would receive anything for his services and no compensation was paid him. The record is also clear that petitioner intended to give his son $30,000 and that the note, mortgage, and trust were the means adopted for that end.

We think that this case is controlled by Johnson v. Commissioner, 86 Fed. (2d) 710. That case held that where a trust was set up composed solely of a note given without consideration, payments of interest on the note were wholly gratuitous and not allowable as deductions from gross income. See also Jamie A. Bennett, 40 B. T. A. 745; Sand Springs Railway Co., 21 B. T. A. 1291. The instant note was not backed by any valid consideration whatever. Our conclusion is that it constitutes an unenforceable obligation.

Petitioner contends, however, that the note is enforceable in any event to the extent of the collateral securing it, citing William Park, supra (now on appeal, C. C. A. 3d Cir.). It is true that in the Park case the Board stated that “a collateral note is enforceable, at least to the extent of the collateral, regardless of whether or not it is under seal. Dando's Appeal, 94 Pa. 76.” However, the Park case was rested specifically on Pennsylvania law, whereas we are now concerned with Connecticut law. In the latter state it has been held that no action lies on a note and mortgage given without consideration. Kane v. Kane, 120 Conn. 184. In any event, we have been cited to no authority for, and decline to adopt, the position that a gratuitous promise is rendered enforceable by the promisor's act in giving security therefor. See Restatement of Contracts, § 75.

Respondent’s determination that the interest is not deductible is sustained. In view of this conclusion, it will not be necessary to pass upon the other grounds advanced by him in support of his position.

Decision will be entered for the respondent.

       (1) Consideration for a promise is (a) an act other than a promise or (b) a fore-bearanee, or the creation, modification or destruction of a legal relation, or a return promise, bargained for and given in exchange for the promise.
      (2) Consideration may be given to the promisor or to some other person. It may be given by the promisee or by some other person.
      [Implicit in this definition is the thought that the promisor can not give consideration for his own promise.]