author: Goodeioh :

text:
    Annie Watts Hill, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53889.
    Promulgated November 16, 1932.

      Edmv/nd- B. Quiggle, Esq., and William W. Sledge, Esq., for the petitioner.

      W. B. Lansford, Esq., and Newton Montgomery, Esq., for the respondent.
   OPINION.

Goodeioh :

This proceeding involves the redetermination of a deficiency of $4,741.98 for the year 1927, of which the amount of $2,726.65 is in controversy. Only one issue is raised, namely, whether the amount of $25,000 received by the petitioner in 1927 in redemption of 250 shares of Union Bleachery, issued to her as a stock dividend in 1922, should be treated as essentially equivalent to the distribution of an ordinary dividend under section 201 (g) of the Revenue Act of 1926, or as a distribution in partial liquidation under section 201 (c) of that act. The facts were stipulated, and that stipulation we incorporate herein by reference as our findings of fact, but for the purposes of this report a brief statement will suffice.

In September, 1922, petitioner inherited 250 shares of the common stock of Union Bleachery. In December, 1922, she received a like amount of preferred stock from the company as a stock dividend and, again, in October, 1925, received as a stock dividend 250 shares of common stock. In July, 1927, she received $25,000 in cash in redemption of her preferred stock previously received as a stock dividend. We infer that at the same time she received a further stock dividend of 250 shares of common stock. While that fact is not stipulated, it does appear that such stock dividend was declared and issued by the company, and our inference is only that she received her proportionate share thereof. There is no dispute concerning the amounts here involved. Should respondent’s contention as to the applicability of section 201 (g) be upheld, it is conceded that his determination of deficiency is correct; should his contention be denied, it is conceded that petitioner’s return for 1927 discloses correctly her capital gain from this transaction.

Union Bleachery was organized as a corporation on or about July 1, 1922, with an authorized capital of $400,000, being all common stock of the par value of $100 a share. On December 29, 1922, its authorized capital was increased to $1,200,000, the increase of $800,000 being preferred stock, bearing dividends at 8 per cent, redeemable after two years, having a par value of $100 a share, and containing various protective provisions against encumbrance of property. The next day a dividend of 100 per cent upon the common stock, to be paid in the new preferred stock, was declared; consequently $400,000 of the preferred stock was issued immediately in payment of the dividend, the balance of like amount remaining unissued. On December 31, 1922, after the issuance of the stock dividend, the undivided profits of the company amounted to $432,284.68 without considering certain reserves established which may or may not have been proper appropriations of surplus.

On October 31, 1925, a dividend of 100 per cent upon the common stock, payable in common stock was declared and was thereafter paid. We assume that appropriate corporate action respecting the company’s authorized capital was taken in order that this common stock might be- issued, although the record before us is silent on the matter. On July 1,1927, in conformity with action of the directors at a meeting held on April 26, 1927, and following notification to the stockholders, the company redeemed its preferred stock outstanding in the amount of $400,000 and at the same time paid in common stock a dividend of 50 per cent (being $400,000) upon the common stock outstanding of $800,000. The action of the directors at their meeting mentioned is reflected on the minutes as follows:

Be it eesolved, That all the Preferred Stock of this corporation of the aggregate par value of $400,000.00 be redeemed and retired on July 1st, 1927, in accordance with the terms and provisions of the resolution authorizing the issue of such Preferred stock, and that the President be authorized and directed to give notice to this effect to all holders of record of such Preferred stock.
Be it resolved', That a stock dividend of 50% upon the Common stock of the corporation, payable in Common stock, to all Common stockholders of record as of July 1st, 1927, be and the same is hereby declared.
Be it resolved further, That the proper officers of this corporation be and they are hereby authorized to issue Common stock of this corporation of an aggregate par value of $400,000. in accordance with the foregoing resolution.

On December 31, 1926, the company’s undivided profits amounted to $731,584.52 and to $462,641.85 on December 31, 1927 (after the issuance of the stock dividend), without considering certain reserves established which may or may not have been proper appropriations of surplus.

Each year from 1922 to 1927, both inclusive, the company paid cash dividends. In 1922 it paid $36,000; in 1923, 1924, $72,000; in 1925, $76,000; in 1926, $80,000; and in 1927, $76,000. The corporation has . not been dissolved.

Section 201 (g) of the Revenue Act of 1926, and corresponding sections of prior revenue acts were enacted by the Congress in an attempt to prevent the avoidance of tax upon distributions of corporate earnings, ordinarily to be distributed as dividends and so taxable, by means of redemption and cancellation of stock. It leaves to the Commissioner, in the first instance, and to this Board and the courts to determine what circumstances surrounding the cancellation or redemption of stock shall constitute “ such time ” and “ such manner ” as to make those acts and the distribution essentially equivalent to a distribution of a taxable dividend.” Here the parties argue at length upon brief as to the intention with which the stock was issued as a dividend in the first instance; as to whether there was a continuing relation between the issuance and redemption of the stock; and whether those acts were designed and carried out as part of a unified plan to distribute surplus.

These matters are of importance, for, should it appear that it was intended when the stock was issued that the later redemption should be the means of distributing earnings which otherwise would be paid to the stockholders in the form of dividends, and that this plan continued over the interval during which the stock was outstanding so that the issuance and redemption are related to each other as a part of that plan, it would seem that the redemption was “ at such time ” and in “ such manner ” as to make it, and the resultant distribution, equivalent to a taxable dividend. In other words, such circumstances would indicate that a cancellation or redemption of outstanding stock had been employed as an artifice by which to avoid the ordinary tax upon a corporate distribution. Cf. Pearl B. Brown, Executrix, 26 B. T. A. 901; Harry A. Koch,, 26 B. T. A. 1025; Alfred A. Lawn, 26 B. T. A. 764; Robert R. Meyer, 27 B. T. A. 44.

But the search for a relationship between the issuance of the stock and its redemption, evidencing a continuing, unified plan to distribute surplus, is not the sole test to which a distribution, coupled with a redemption, may be subjected, and it may fall within the statute even in the absence of those elements. The statute invites scrutiny of the time and manner of the cancellation or redemption of stock. It makes no requirement that the issuance and redemption be related; indeed, under its terms, the manner of the issuance (whether or not as a dividend) is not material. Consequently, we must also scrutinize the redemption and distribution with respect to the time and manner when they occur, and the circumstances surrounding them at that time. With that in mind, it is quite apparent that a redemption and distribution may fall within the statute although at the time the stock was issued there was no intention to redeem it later as a means of surplus distribution, or plan to avail of such method as a device by which to circumvent the usual tax upon dividends.

. Thus a stock originally issued, either for payment or as a dividend, as a part of the financial plan of the corporation may be used afterward for the ends sought to be prevented by this section of the statute.

In the case at bar there is no proof of the existence of a relation between the issuance and redemption of the preferred stock evidencing a continuing, unified plan to distribute surplus, nor can we, as respondent urges, reasonably infer its existence from the facts before us, but scrutiny of the time and manner of the redemption or cancellation (in this case, both) of the stock convinces us that they, and the resultant distribution, were essentially equivalent to a taxable dividend. The preferred stock was redeemed at a time when it was supplanted (simultaneously) by an issue of common stock in like amount. Consequently, the company’s liability upon its outstanding capital stock was unchanged in amount. The manner of its redemption was by payment in cash, as was the manner of the distribution. The time of the distribution was when the substitution of stock classes occurred and when the company had a substantial amount of accumulated undivided earnings available, so far as this record discloses, for distribution. In our opinion, this case falls fully within the provisions of section 201 (g) and the cancellation and redemption of stock and the distribution to the stockholders are precisely of the sort the Congress intended this section of the statute to control; an opinion which finds support in the committee discussions, prior to enactment, concerning the wording of the section.

There is no evidence here concerning liquidation of the corporation from which we could find that the cash distribution was made in partial liquidation so that this transaction might be taxable under section 201(c) of the Revenue Act of 1926, as petitioner urges. The fact that the company’s stock outstanding was continued at the same figure would indicate to the contrary. It may be, as petitioner argues, that the redemption and cancellation of preferred stock and the substitution therefor of common stock was merely a refinancing of the corporation, but, in our opinion, the distribution, coupled with that substitution, was a “ definancing ” of the company, if we may com a term.

Judgment will he entered for the respondent.

“ The bill changes the existing law by providing for the case In which a corporation first redeems a portion of its stock <md then declares a stock dividend as well as the case In which the corporation first declares a stock dividend and then redeems a portion of its stock, thus preventing a method of evasion under present law.”

       If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall he treated as a taxable dividend. In the case of the cancellation or redemption of stock not issued as a stock dividend this subdivision shall apply only if the cancellation or redemption is made after January 1, 1926.

       Sec. 201 (f), p. 12, Rept. 179, Ways and Means Committee, 68th Cong.:


source: Caselaw Access Project

author: Trammell:

license: Public Domain

text:
    The Brooklyn City Railroad Company and Brooklyn & Queens Transit Corporation, as Successor by Merger and Consolidation to The Brooklyn City Railroad Company, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 20353.
    Promulgated November 16, 1932.

      E. B. GoodeTL, Esq., and S. B. OTney, Esq., for the petitioners.

      Chester A. Gwirm, Esq., for the respondent.
   opinion.

Trammell:

This is a proceeding for the redetermination of a deficiency in income and profits taxes determined by the respondent for the calendar year 1921 in the amount of $154,227.38. In the “ amended and supplemental petition ” it is alleged that the respondent erred in his determination of the deficiency in that he has determined the income and excess profits tax without reference to the established fiscal year of The Brooklyn City Railroad Company and instead of determining the tax for the twelve months ending June 30, 1921, has based his determination upon the return filed by The Brooklyn City Railroad for the twelve months ending December 31,1921, and asserted a deficiency for that period.” It is also alleged in said petition (2) that the respondent erred in failing to allow as a deduction from gross income a reasonable amount for exhaustion, wear and tear of the physical properties of said railroad company, and (3) in denying an application for special assessment of the profits tax; all of said allegations of error being denied by the respondent.

Upon agreement of counsel that decision for the petitioners on the first issue above set out would render the second and third issues academic, and in such event it would become unnecessary to consider or decide in this case said last mentioned issues, the hearing was limited to the first issue.

The petitioners by this appeal specifically request “ a redetermination of the deficiency set forth by the Commissioner of Internal Revenue in his notice of deficiency * * * dated August 6, 1926,” which deficiency is for the calendar year 1921, but the amended petition concludes with the prayer, among other things, that this Board “ direct the Commissioner, pursuant to Rule 50, to redetermine the tax either for the fiscal year ending June 30, 1921, or for the calendar year ending December 31, 1921, whichever the Board may determine to be the taxable year of The Brooklyn City Railroad Company * *

At the hearing the respondent moved to dismiss the appeal as to “ any year other than the calendar year 1921,” on the ground that the Board has no jurisdiction to redetermine the tax liability of the petitioners for any year other than said calendar year. The motion was taken under consideration for decision upon submission of the case.

The Revenue Act of 1926 provides in section 274 (g) that, in redetermining a deficiency in respect of any taxable year, this Board shall consider such facts with relation to the taxes for other taxable years as may be necessary to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been overpaid or underpaid.

The deficiency which we are called upon to redetermine in the instant case is for the calendar year 1921, and the issue raised by the parties in that connection, as hereinabove set out, can be decided by us within the jurisdictional limitations of the statute. The petitioners have not appealed from the determination of a deficiency for any other taxable year, and hence it is unnecessary to dismiss this appeal in respect of' a year not before us. Respondent’s motion accordingly is denied.

The original petition in this proceeding was filed in 1926 by The Brooklyn City Railroad Company, hereinafter for convenience called the railroad company, which company was thereafter in 1929 merged with the Brooklyn & Queens Transit Corporation, and the latter corporation now appears as copetitioner.

The parties stipulated the following facts:

The Brooklyn City Railroad Company was organized as a corporation under the laws of the State of New York on December 16, 1863.
The Brooklyn City Railroad Company at all times prior to the year 1930 filed its Federal income tax returns upon the basis of the calendar year. It never at any time prior to 1929 filed an income tax return for a period of less than a year, nor did it ever request or receive permission of the Commissioner of Internal Revenue to file its return upon the calendar year basis or to change from a calendar year basis to a fiscal year basis.
The consolidated net taxable income of The Brooklyn City Railroad Company as determined by the Commissioner for the twelve months ending December 31, 1920 and 1921, was as follows:
12 months ending December 31, 1920, a loss of $662,633.98.
12 months ending December 31, 1921, a net income of $1,624,435.66.
The Brooklyn City Railroad Company filed on or about March 15, 1922, a consolidated income and profits tax return covering the twelve months ending December 31, 1921; said return showed income tax for that period of $125,905.15; said amount was assessed against The Brooklyn City Railroad Company and paid by it.
The only inventories taken by The Brooklyn City Railroad Company are of its materials and supplies, of which a running or continuous inventory is kept, which enters into the computation of net income for tax purposes only through deductions for costs of operation and maintenance.

In addition to the stipulated facts the evidence shows that in 1890, pursuant to a statute of the State of New York, the executive committee and board of directors of the railroad company adopted resolutions fixing its fiscal year as the year ending June 30, and the by-laws of the corporation were amended accordingly. The fiscal year so fixed and adopted by the railroad company was not changed prior to the year 1929.

From and after 1890, the said railroad company made annual reports on the basis of the fiscal year ended June 30 to the state regulatory body, designated variously as the Eailroad Commission, Transit Commission and Public Service Commission. The annual reports of the railroad company to its stockholders, including income statements and balance sheets, were during said years all on the basis of a fiscal year ending June 30. *Also, the books of account were closed and all possible adjustments made each year as of June 30.

In addition to the annual reports the railroad company made quarterly reports to the Transit Commission of certain of its operating figures. In connection with the rendering of those reports certain operating accounts were balanced quarterly, and the balances carried to profit and loss, but the profit and loss account was balanced annually on June 30. In making the reports above mentioned, the railroad company stated that its basis of accounting was the fiscal year ending June 30.

After introduction of much of the evidence offered at the hearing by the petitioner, counsel for the respondent made the following concession:

The Member : What I wanted to find out was, is there any controversy as to whether these books weje closed on a fiscal year basis, June 30?
Mr. Gwinn: I would not say there is a controversy about that. I concede that the books were ruled down, and that the books were closed as at June 30 of each year * * *.

That the basis of the railroad company’s annual accounting period for many years prior and subsequent to 1921 was the fiscal year ending June 30, we think, is clearly established by the evidence, as well as conceded by the respondent, and we so find the fact to be.

However, the respondent contends that, after having made its income tax return for 1921 on the basis of the calendar year, the railroad company could not thereafter change to the basis of a fiscal year without first having obtained from the Commissioner permission to make such change. The respondent further contends that the railroad company’s books of account were so kept that the income could be correctly and readily determined at the end of the calendar year, as well as at June 30, and that, since the return was made on the basis of the calendar year, the deficiency should be redetermined on that basis.

As we view the case, respondent’s position is untenable. If the basis of the railroad company’s annual accounting period had been the calendar year and on that basis it had properly made its annual tax returns, and subsequent to 1921 had changed to the basis of a fiscal year, without permission from the Commissioner, an entirely different question would be presented. But here we have no question of changing the basis of the annual accounting period. The railroad company did not request permission to make such a change, did not in fact make any change in its accounting period, and so far as the record discloses had no desire to change its basis, prior to 1929. The issue is whether or not the respondent, without a request for ¡su change of basis, has legal authority to determine the tax liability of the railroad company on the basis of a calendar year where the regularly established and long continued basis of its annual accounting period was a fiscal year ending June 30, and its tax returns were filed on the basis of the calendar year.

The pertinent provisions of the Revenue Act of 1921 read as follows:

[Sec. 212.] (b) Tbe net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or .if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a fiscal year * * * or if the taxpayer has no annual accounting period or does not keep books, the net) income shall be computed upon the basis of the calendar year.
(c) If the taxpayer changes his accounting period from fiscal year to calendar year, from calendar year to fiscal year, or from one fiscal year to another, the net income shall, with the approval of the Commissioner, be computed on the basis of such new accounting period. * * *
[Sec. 232.] That in the case of a corporation * * * the net income shall be computed on the same basis as is provided in subdivision (b) of section 212 * * *.

The respondent makes no contention that the method of accounting regularly employed by the taxpayer in this case did not correctly reflect the income, nor that the case comes within any of the other exceptions mentioned in the statute, and such contention could not be sustained by the facts of record. We must, therefore, consider the issue presented here in the light of the first provision of section 212 (b), supra, that “the net income shall be computed upon the basis of the taxpayer’s animal accounting period (fiscal year or calendar year as the case may be)In this connection we may point out that subdivision (c) of said section vests discretionary power in the Commissioner to authorize the computation of net income on the basis of a new accounting period only in the cáse where the taxpayer changes his accounting period. Here the taxpayer did not change its accounting period, and the sole question is what effect should be given to that provision of subdivision (b).

In our opinion the statute is mandatory, and, where none of the exceptions applies, as in the instant case, there is no discretion vested in the Commissioner or any one else to compute net income upon any basis other than the taxpayer’s annual accounting period. We think it is immaterial that the tax returns were improperly and without authority made upon a different basis. The statute does not require that the net income shall be computed upon the basis of the return, if the return is made upon a basis other than the annual accounting period of the taxpayer. The plain and explicit provision of the statute must be given effect.

In Great West Printing Co., 22 B. T. A. 346, we had before us substantially the same question as is involved here, except that the positions of the respective parties were reversed. The petitioner in that case closed its books and determined its income on the basis of a fiscal year ending May 31. Its tax returns were filed on the basis of calendar years. The respondent disregarded the calendar year return and determined from the books a deficiency in tax for the fiscal year ended May 31, 1921. We approved the respondent’s determination, saying:

Olearly the returns filed by the petitioner on the calendar year basis were not in accordance with the statute and they can have no effect upon the issue before us. * * * The deficiency before us has been determined from the books and for the fiscal year exactly as provided in sections 232 and 212 (b) of the Revenue Act of 1921. These facts are conclusive of the issue. Under the statute the determination must be approved.

In the printing company case, the petitioner contended, as the respondent contends here, that its books correctly reflected the income for the calendar year 1921, and its return having been made on the basis of the calendar year, the deficiency should be redetermined on the same basis. In affirming our decision, the United States Circuit Court of Appeals for the Eighth Circuit, at 60 Fed. (2d) 749, after quoting section 212 (b) of the Revenue Act of 1921, said:

Following the statutory requirements of the above quotation, it is clear that if this petitioner had an annual accounting period, either fiscal or calendar, and its method of accounting was such that this period clearly reflected the income, that period is mandatory. * * *
From the above outline of the accounting methods of petitioner, it is clear that not only is there substantial evidence to sustain the conclusion of the Commissioner and the Board of Tax Appeals to the effect that the books were kept on an annual basis ending May thirty-first, 1921, but such conclusion is compelled from the evidence.
* * * * # * ^
Also, petitioner argues that its books were so kept as to permit a showing of income at the end of any month and, therefore, the calendar year was mandatory for tax purposes under the statutory provision that where the taxpayer “ has no annual accounting period * * * the net income shall be computed on the basis of the calendar year The search here is not for what could have been done, but for what was done, and it is clear that petitioner did have an annual accounting period ending, May thirty-first, which clearly reflected annual income. * * *
Also it is argued that the books clearly reflected the income for the calendar year 1921, and the tax return was made on that basis. Since determination of the income depended, in part, upon the inventory as of December 31, 1920 (or January 1, 1921), * * * there is some question as to the books clearly reflecting the income for the calendar year 1921, but, be that as it may, the test is the year (fiscal or calendar) actually used in the business and shown in the books, and not the possibility of the use of some other annual period.

Considering all the evidence, we are convinced that the petitioners kept their books and records on a fiscal year basis and, under the statute, were not only permitted, but required, to report their income for taxation on that basis.

In his brief the respondent stated the following proposition and argument:

Even though the taxpayer had a legal right to file its return on a fiscal year basis in 1921, it is now estopped to assert such right. * * * A taxpayer can not change at will from a fiscal year to a calendar year or vice versa, as may appear, advantageous to him * * *. Consequently the law and regulations provide the manner and means of making such changes.

In support of his estoppel argument, the Commissioner relies upon the principle of estoppel and cites the case of Greylock Mills v. Blair, 298 Fed. 846. We do not think that this case is an authority for his position. The court did not discuss the question of estoppel.

In Howard Sheep Co., 1 B. T. A. 966, we stated the essential elements of estoppel as follows:

The doctrine of estoppel in pais is a rule of equity that the courts are reluctant to apply. In order to be allowed to invoke the doctrine one must show: (1) That there has been a false representation concerning material facts; (2) that the representation was made with the knowledge of the facts; (3) that the party to whom it was made must have been permissibly ignorant of the truth of the matter; (4) that the representation must have been made with the intention that it should be acted upon; and (5) it must have been acted upon to the damage of the party acting.

The question of estoppel was not raised in the pleadings and the petitioners were afforded no opportunity to rebut this issue or argument. There has heretofore been no suggestion or intimation that this question was involved in this proceeding. The argument is made in a brief not available to petitioners, there having been no exchange of briefs, upon the theory that the issues were understood by both parties. No evidence was directed to the question by either side. The defense of estoppel must rest upon facts and not upon argument alone. In the first place, there is no evidence to indicate that there has been a false representation concerning material facts. There is no evidence that the return stated that the taxpayer’s books and records were upon the fiscal year basis or a calendar year basis. While the filing of the return might indicate that they were kept upon the calendar year basis, there is no evidence that the petitioner represented such fact as a fact to the respondent. It may well be that the petitioner filed its return upon the calendar year basis because of a misunderstanding of the law. Certainly misconstruction of the law, and action based upon a legal theory rather than upon a factual theory, would not constitute a false representation concerning a material fact. Nor does the evidence disclose whether or not the respondent was permissibly ignorant of the basis upon which the books and records were kept. They had been kept on a fiscal year basis for more than forty years. Where the law required a return to be filed upon a fiscal year basis because the records were kept upon that basis, the filing of the return upon the calendar year basis might well have been known by the respondent to have been erroneous, within such a period of time as to enable him to act accordingly so that he would not have been prejudiced thereby. There is no evidence of this in the record. It might well be presumed that when the Commissioner sent out his deficiency notice he must have ascertained the facts upon which he acted, and must have known or was in a position to have known whether the return was required to be on the fiscal or the calendar year basis. There is no evidence that the Commissioner within the statutory period did not have ample opportunity not only to permit, but to require, the return to be filed upon a proper basis. Under the facts he should have required fiscal year returns.

Where a return was required to be filed on a fiscal year basis and was actually filed on a calendar year basis, the statute of limitations does not begin to run until a subsequent return is filed in which all of the income for the fiscal year is included. Paso Robles Mercantile Co., 12 B. T. A. 150; 35 Fed. (2d) 1012. Further, there is no evidence in this record that the respondent has acted to his damage by the action or any implied representations, or silence, or conduct on the part of the petitioners. In any event, in order to sustain the theory of estoppel as advanced by the respondent, it is necessary that these essential facts be shown by evidence. There is no presumption that the facts are true.

The respondent, instead of relying upon any representations or any conduct of the petitioners to his damage or prejudice, has relied upon the legal principle that the calendar year return, instead of being erroneous, was proper. He contends that, since the petitioners could have ascertained their income for the purpose of the return at the end of any monthly period, they properly reported their income upon the calendar year basis. This is a legal question. For all that the record discloses the Commissioner had ascertained all of the facts relating to the method of keeping books and with respect to the computation of income and all other material facts at some unascertained time when he could have acted upon the proper basis for returns, even if he can not do so now. However, in any event, it is not shown by the evidence that the Commissioner is in a different position now than he would have been in if the petitioners had in the first place reported their income on the fiscal year basis. The fact is that the petitioners had less taxable income upon a fiscal year basis for the fiscal year here involved because they had losses in the portion of another calendar year which fell in the fiscal year, but it is not shown that any taxable income properly to be reported on a fiscal year basis escaped taxation. It is agreed that on a fiscal year basis there would be no deficiency. That there would be a greater tax upon a calendar year than on a fiscal year basis is beyond the pale of the controversy.

Following the above decisions in Great West Printing Go., supra, we hold that the respondent was not authorized in this case to compute the net income, or to determine the consequent tax liability, of the railroad company on the basis of the calendar year 1921, and that there is no deficiency for that year. Cf. American Hide & Leather Co. v. United States, 284 U. S. 598.

Judgment of no deficiency for the calendar year 1921 will he entered.


author: Black:

text:
    Elmore Milling Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46768, 52972.
    Promulgated November 16, 1932.

      William Cogger, Esq., for the petitioner.

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

Black:

At the hearing of these proceedings, the parties entered into a stipulation by which it was agreed that the net income of petitioner for 1927, as shown by the deficiency notice, should be reduced $4,793.94 on account of certain repair expenses incurred by petitioner in that year, and that the net income of petitioner for 1928, as shown by the deficiency notice, should be increased by the sum of $1,049.84, being an adjustment made necessary by the allowance of $4,793.94 deduction from 1927 income. Effect should be given to this stipulation in a redetermination of the deficiencies.

The remaining issues for our determination are: 1. Did the Commissioner err in disallowing as deductions for the years 1927 and 1928 alleged depreciation in the amounts of $17,585.76, and $13,341.13, respectively, or any part thereof? 2. Did the Commissioner err in not allowing additional depreciation on machinery and construction used in petitioner’s power plant for both 1927 and 1928? 3. Did the Commissioner err in not allowing alleged losses in the aggregate amount of $71,019.08 for the year 1928? We will discuss these issues in their order.

1. On its income tax return for the year 1927 petitioner claimed depreciation of $30,710.15. Of this amount respondent allowed $13,-124.39 and disallowed $17,585.76. On its income tax return for the year 1928, petitioner claimed depreciation of $28,024.71. Of this amount respondent allowed $14,683.58 and disallowed $13,341.13. Petitioner in his petition assigned as error this action of the Commissioner, but at the hearing offered no evidence showing or tending to show that the base or rates used, or the amounts of depreciation determined and allowed by the Commissioner for either of the years 1927 or 1928 on the property claimed by petitioner, were wrong and, if so, what the correct base, rates and amounts should be. Therefore, the amounts determined and allowed by the Commissioner are presumed to be correct and should stand. Botany Worsted Mills v. United States, 278 U. S. 282; Reinecke v. Spalding, 280 U. S. 227.

2. and 8. But petitioner claims that it is entitled to additional depreciation other than that claimed in its returns filed for 1927 and 1928 on property which was used in its business during the tax years, but which was not carried as assets on its books, but was acquired by it from its predecessor, the partnership of Elmore Milling Company, and which was owned by said partnership on March 1, 1913, and had the value and remaining useful life on March 1, 1913, which we have found in our findings of fact. Before we discuss this contention of petitioner we must determine a very important factor in this case.

Petitioner is only entitled to' use the basis of cost (in this instance March 1, 1913, value) of its predecessor partnership, Elmore Milling Company, upon a showing that the transfer of assets from the partnership to the corporation, which took place January 2, 1926, was a nontaxable transaction under the Revenue Act of 1926. The same situation exists as to the losses claimed on bad debts transferred by the partnership to the corporation on that date. Petitioner has not shown the cost of the property in question to it at the time the partnership transferred it to the corporation, but has confined itself to showing the March 1,1913, value of certain physical assets owned by the partnership on March 1, 1913, and the amounts of money advanced by the partnership on the several accounts on which losses are claimed. This is all well enough in the event petitioner is entitled to take the same basis of cost or March 1, 1913, value that its predecessor partnership would be entitled to take, were it before us. In such a case we have sufficient evidence before us to determine the depreciation deduction to which petitioner is entitled on the additional assets now being discussed and to determine the losses incurred by petitioner by reason of the bad debts charged off in 1928.

But if petitioner is not entitled to take the same basis of cost or March 1, 1913, value that the predecessor partnership was entitled to take, then we must disallow petitioner any depreciation on the particular assets in question, because it has failed to offer any evidence as to the cost of such depreciable assets to petitioner, and we must also disallow the loss claimed on the bad debts in question to the extent of the amounts due at the time the debts were transferred to the corporation by the partnership, because petitioner has not offered any evidence of cost to the corporation of these debts at the time they were transferred to it by the partnership. It is the general rule under the Revenue Act of 1926 that the basis of depreciation on assets acquired by a taxpayer after March 1, 1913, is cost. Likewise, the basis for loss on accounts and notes receivable and investments acquired after March 1, 1913, sold or otherwise disposed of, is cost. There are certain exceptions to this general rule. These exceptions are contained in sections 203 and 204 of the Revenue Act of 1926.

If the facts in the instant case present an exception to the general rule above stated, it is because the transfer from the partnership to the corporation, which took place January 2, 1926, falls within the provisions of section 203 (b) (4) of the Revenue Act of 1926, which reads:

No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control of the corporation; but in the ease of an exchange by two or more persons this paragraph shall apply only if the amount of the stoclo and securities received by each is substantially in proportion to Ms interest in the property prior to the exchange. [Italics supplied.]

If the foregoing section of the 1926 Act, as applied to the facts of the instant case, gives an exception from the ordinary rule governing the recognition of gain or loss, then petitioner is entitled to use the transferor’s basis of cost or March 1, 1913, value in 1927 and 1928 in determining depreciation and losses, because section 204 (a) (8) of the Revenue Act of 1926 reads:

If the property (cither than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 * * *, then the basis shall be the same as it would be in the hands of the transferor * * *.

To the same effect is section 113 (a) (8) of the Revenue Act of 1928, which, of course, governs the taxable year 1928.

It will be noted that there is a provision in section 203 (a) (4) which says that the paragraph shall apply only in the event that the amount of the stock and securities received by each of the trans-ferors is substantially in proportion to his interest in the property prior to the exchange. The transferors of the property in the instant case were the three partners of the Elmore Milling Company, viz., Edwin W. Elmore, Florence C. Elmore and Earl P. Elmore. Each of these transferors did not receive an amount of stock in the newly organized corporation, Elmore Milling Company, Inc., substantially in proportion to his interest in the property prior to the exchange. The evidence shows that 4,495 shares of stock were issued to Edwin W. Elmore, 500 shares to Earl P. Elmore, and 5 shares to Harry M. Goldsmith (not a partner). hTo shares of stock were issued to Florence P. Elmore, one of the partners making the transfer. Hence, we hold that petitioner has failed to prove that the transfer of assets from the partnership to the corporation on January 2, 1926, was a nontaxable transaction under the quoted provision of the Eevenue Act of 1926. This being true, it follows that petitioner is not entitled to take transferor’s basis of cost for purposes of determining depreciation and the calculation of losses for the years 1927 and 1928 under the provisions of sections 204 (a) (8) of the Eevenue Act of 1926 and 113 (a) (8) of the Eevenue Act of 1928. If petitioner is not entitled to take depreciation and to calculate losses on the basis of cost to its transferor, the partnership, then the only basis on which these can be allowed is that of cost to petitioner. We have no evidence on that point.

When debts are acquired by one person from another and subsequently have to be charged off as worthless, the basis is not the amount of the debts, but their cost to the taxpayer, and, there being no proof of such cost, no deduction, either as a loss or a bad debt, can be allowed. O. N. Townsend, 13 B. T. A. 386; Skinner v. Eaton, 34 Fed. (2d) 576; Ayer v. Blair, 26 Fed. (2d) 547.

We, therefore, hold that petitioner has failed to show itself entitled to take the additional depreciation claimed by it on certain depreciable assets owned by its predecessor at March 1, 1913, and to show itself entitled to take as losses or bad debt deductions the accounts hereinbefore referred to, to the extent of the amounts that existed at the time they were transferred to petitioner on January 2, 1926.

To the extent that said accounts were increased by additional advancements made by petitioner, after it acquired them, the situation is different. The cost of these advancements would be the additional amount of money, which petitioner expended, and we have evidence as to these amounts. Petitioner advanced on the G. H. Elmore personal account, after the transfer, $1,560; on the E. W. Eucker special account, $4,261.18; and on the Oneonta Storage Battery Co. investment account, $840.45. We will now take up these accounts and rule on them separately.

The account carried as G. H. Elmore, personal, represented advancements made to G. H. Elmore with reasonable expectation that he would be able to repay same. A letter received from him in 1928 by petitioner was introduced in evidence, which shows that he recognized and admitted the validity of the debt and was making bona fide efforts to pay it. Petitioner’s officers were in constant touch with the situation and had hopes of the ultimate success of G. H. Elmore’s inventions, and did not lose such hopes until his breakdown in health in 1928, and his cessation from business activities, when they determined that the account was worthless and charged it off. To the extent of $1,560, this bad debt deduction should be allowed. Jones v. Commissioner, 38 Fed. (2d) 550.

What we have said above concerning the G. H. Elmore personal account largely applies to the E. W. Rucker special account. When Rucker quit the employment of Elmore Milling Company in 1924, he went with G. H. Elmore in the marketing of his various inventions and continued with him through the taxable years. As long as G. H. Elmore was in good health and active, there seemed to be some prospect that E. W. Rucker would be able to pay. True, E. W. Rucker was the son-in-law of E. W. Elmore, president of petitioner, and the brother-in-law of Earl P. Elmore, vice president of petitioner, and family transactions of this kind should be carefully scrutinized. That has been done in this case and we think the evidence is sufficient to show that these advances made to Rucker were not gifts, but loans, and that up until 1928, there was an expectation on the part of petitioner that it would be repaid these loans. We hold that the evidence is sufficient to show that petitioner ascertained that its E. W. Rucker special account was worthless in 1928, and that it charged the account off its books in that year. To the extent that the E. W. Rucker special account represented advances made to Rucker since petitioner began business in 1926, the deduction should be allowed. This deduction we find to be $4,261.18. Gross R. Scruggs, 24 B. T. A. 1174.

The Oneonta Storage Battery Company account represented loans for business purposes and did not represent gifts. E. W. Elmore was largely interested in it as a stockholder, as was petitioner, and the account represents an effort on their part to make the company and their stock investment a financial success, and their hopes in that regard were not abandoned until the company went into bankruptcy in 1928, in which year the account was charged off.

In Wheeler-Fisher Co. v. Commissioner, 54 Fed. (2d) 294, it was held that where during the taxable year there has been an identifiable event, such as bankruptcy, fixing the loss, the taxpayer is entitled to take the. loss in that year. We hold that petitioner is entitled to a loss on the Oneonta Storage Battery Company investment account to the extent of $840.45 in 1928.

Reviewed by the Board.

Decision will he entered wader Rule 50.


author: Lansdon:

text:
    J. C. Carlson and G. L. Elkin, Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45613.
    Promulgated November 16, 1932.

      E. T. Oormy, Esq., for the petitioners.

      James K. Polk, Esq., for the respondent.
   OPINION.

Lansdon:

The petitioners contend that during the taxable year they were engaged in the discharge of a liquidating trust and that the resulting income was merely incidental to said efforts. The respondent contends that the petitioners were engaged in a business for profit, and that their relationship made them an association, taxable as a corporation.

We think the record fairly supports the view that the purpose of the conveyance to the petitioners was to expedite liquidation of the assets of their corporation, but no time limit was fixed and they were not to sell the assets when it would cause “ sacrifice or injury ” to the beneficiaries. In the meantime they were required to continue operation of the properties. Something of their methods of operation during the eleven years is shown by one of the petitioners in his testimony before the Board. When asked by his counsel to state briefly just what they did, he testified as follows:

We let it out on shares to raise rice, which we continued until * * * for rice growing you have to have lots of water, and we continued with that, year after year, until the land played out. It grows what you call water grass on it and kills off the rice, and then the rice season came and the river got dry, so you could not raise rice without water, and it was a failure. And then we discovered that rice was a gambling speculation and we bought cattle to feed there, as I have stated, and stock-raising, because farmers in that country, in that neighborhood down there, Mr. Borden, for one, had a big stock farm, and had done well on that. So we profited from him and the Pierce estate, different ones who do the same thing, which brought us some income from the land, because it laid vacant and run out on account of this water grass, so we could not raise rice profitably.

Some of the lands were sold, but the petitioners claim that the bulk of the property at no time in the eleven years following could have been sold except at a sacrifice, and for this reason they continued operation of the properties, with loss in some years and substantial profit in others. The schedule set out in our findings of fact shows something of the scope those operations assumed in the taxable year.

Whether it was due to their inability to sell the trust assets, or their desire to improve and develop the property for a higher market price, it would seem clear from this record, that after the first few years of their trusteeship the petitioners temporarily, at least, aban-cloned the idea of liquidating. Their investments in cattle, and changing from rice-growing to livestock-raising, along with other investments and improvements, show an intent, we think, to defer liquidating indefinitely.

The controlling issue here is not related to what the petitioners could have done, but rather what they did do to produce the income sought to be taxed. United States v. Emery-Bird Thayer Realty Co., 237 U. S. 28. The cases cited by the petitioners in their brief support the views thus announced. In Zonne v. Minneapolis Syndicate, 220 U. S. 187, cited by petitioners, the powers given to the trustees of a dissolved corporation were almost identical with the powers given these petitioners in their trust instrument; but, in that case the only acts of the trustee in the year were confined to the collection and disbursement of rent upon leases of property of the trust estate. Operation was not involved. The s.ame facts obtained in Lansdowne Realty Trust v. Commissioner, 50 Fed. (2d) 56, which the petitioners say is “close in point.” In the case at bar the petitioners have continued the operation of the properties of the dissolved corporation in the same manner and along the same lines as did the corporation and there is nothing in the record to indicate, even remotely, when they intend to liquidate them. We think that a reasonable latitude respecting operation should be given the liquidators of a corporation so as to avoid sacrificing the assets upon a low market, as well as to increase their sale price; but operations continued beyond a reasonable time, as we think the facts here show, must be treated as a continuation of the business of the dissolved corporation by the trustees. Willis v. Commissioner, 58 Fed. (2d) 121; Little Four Oil & Cas Co. v. Lewellyn, 35 Fed. (2d) 149.

Reviewed by the Board.

Decision will be entered for the respondent.


text:
    Hoffer Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 47364.
    Promulgated November 18, 1932.

      Percy W. Phillips, Esq., for the petitioner.

      Henry A. Cow, Esq., for the respondent.
   OPINION.

Leech: Petitioner contends that, for purposes of computing its allowance for depletion, it must be considered as the taxpayer who made the discovery of oil and is entitled to use discovery value as a basis under section 204 (c) of the Revenue Act of 1924, because it acquired this property in a nontaxable corporate reorganization and stands as a successor to the actual discoverer with no break in the corporate life when considered for purposes of Federal income taxation.

This precise question- was decided in Darby-Lynde Co., 20 B. T. A. 522; affd., 51 Fed. (2d) 82, and in Rialto Mining Corp., 25 B. T. A. 980. The former case involved the right of a corporation to depletion on discovery value of property, allowable to the predecessor owner, a partnership. In the latter, a similar situation obtained, except both predecessor and successor owners of the property to be depleted were corporations of different states and par value of stock, but otherwise identical. The transfer of the property from the actual discoverer, to the petitioner, in both cases occurred in nontaxable transactions. In both cases the right to depletion on discovery value was denied the petitioner, on the ground that it was a different legal entity from the actual discoverer, and was not “ the taxpayer” to whom, alone, section 204 (c), above cited, grants the controverted right.

The case of Commissioner v. Sansome, 60 Fed. (2d) 931, the circuit court cited by counsel for petitioner, is not in point. Although the transaction there present was nontaxable, the issue decided was not the identity of the entities involved, but the legal character of the accumulated earnings of the predecessor corporation in the hands of its successor.

Even if the reasoning of the Circuit Court in that opinion might be extended, a fortiori, to effect a change in the rule applied here, we do not deem that to be a sufficiently compelling reason to reverse this rule, affirmed, as indicated above.

Judgment will be entered for the respondent.

       Tlie basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that in the case of mines, oil and gas wells, discovered by the taxpayer after February 28, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the basis for depletion shall he the fair market value of the property at the date of discovery or within thirty days thereafter, but such depletion allowance based on discovery value shall not exceed 50 per centum of the net income (computed without allowance for depletion) from the property upon which the discovery was made, except that in no case shall the depletion allowance be less than it would be if computed without reference to discovery value.


text:
    Oscar Mitchell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 41680, 41874, 54673.
    Promulgated November 22, 1932.

      Frank W. Wilson, O. P. A., and Oscar Mitchell, Esq., for the petitioner.

      B. M. Goon, Esq., for the respondent.
   OPINION.

Lansdon:

The petitioner’s first contention is that the assignment to his wife for life of rentals from a parcel of real estate owned by him effected a transfer of title to the income-producing property. In support of this theory he cites a long line of decisions and many sound text book authorities dating back to the enactment of the Statute of Uses in the reign of Henry the VIII. A careful scrutiny of all such cases and of the textbooks indicates quite clearly that this principle applies only when all the “ rents, issues and profits ” from real property are assigned in perpetuity. In the instant proceeding the assignment does not include any profit which might be realized from the sale of the property prior to the termination of the trust, which is not perpetual, but terminates with the death of the assignee. We conclude, therefore, that the instrument in question effected nothing more than a gift of income to be received in the future. There was no effective transfer of the property and the income therefrom is taxable to the petitioner. Leydig v. Commissioner, 43 Fed. (2d) 494; affirming 15 B. T. A. 124.

A careful study of the instrument in question discloses also that there is no basis for the theory that it transferred a life interest in income-producing property to the petitioner’s wife. There is here nothing more than the creation of a trust to receive income after it accrues to the owner. It was within the petitioner’s power to transfer a life interest in the property by proper procedure, but this was not done. As title to the property with power to sell at any time and realize resulting capital gains remains in the petitioner, the income is taxable to him as determined by the respondent.

At March 1, 1913, the petitioner owned a chose in action against Coates and Tweed. On January 3, 1914, he settled with his debtors by the execution of a contract under which he was to receive a percentage of the profits from the operation of certain mining properties. That contract was property which would produce income in the event of the successful operation of the mines. On December 29, 1919, for a consideration, he assigned such property to his wife and divested himself from any right to it or to any income therefrom. The determination of the respondent on this issue is reversed. Marshall Field, 15 B. T. A. 718; affd., 42 Fed. 820. William Ernest Seatree, 25 B. T. A. 396.

The record discloses that petitioner’s son was employed by the law partnership of which his father was a member and that in addition to his duties as such employee he also attended to many .business matters for his father, whom he also personally assisted in his work as a member of the firm. In the circumstances herein we are of the opinion that the amounts which the petitioner paid to his son were reasonable compensation for services rendered to him in his business and, therefore, deductible from his gross income as ordinary and necessary expenses in the year when paid. Lillian M. Goldsmith, 1 B. T. A. 151; Alfred Le Blanc, 1 B. T. A. 256; Estate of K. Threefoot, 9 B. T. A. 499; Samuel Rottenberg, 20 B. T. A. 589.

In 1926 the petitioner paid the City of Duluth $20.90 for sprinkling the street in front of a residential property which he owned. Such charge was assessed by ordinance under the following provisions of the charter of the city:

Section 61. The council may, by a four-fifths vote, order the construction of any sidewalk or sewer, or the sprinkling of any highway which it deems necessary for public convenience or safety, and may cause the cost of such construction or sprinkling or any portion of such cost, to be assessed against the property specially benefited.

The petitioner claims that such payment was a tax and deductible from income under the provisions of section 214 (a) (3) of .the Revenue Act of 1926. The respondent disallowed this payment as a deduction, on the ground that it was a special tax and not deductible under the following exception in that section: “(C) taxes assessed against local benefits of a kind tending to increase the value of property assessed.” In support of his determination he cites and relies on Caldwell Milling Co., 3 B. T. A. 1232 and/or article 133 of Regulations 69. In the Caldwell proceeding and all other proceedings in which it is cited as authority, the special tax was imposed to meet the costs of permanent improvements such as street paving, sidewalks, and sewers and was assessed against property adjacent thereto in proportion to the benefits of such improvements, and the measure of such tax in all cases was the estimated addition to the value of the property against which it was levied. Since sprinkling a street in front of a residental property is not an improvement intended to increase the value thereof, we are of the opinion that the payment in question is not within the exception above quoted and that it is a tax levied by the proper authority to pay one of the incidental expenses that are incurred by the municipality for the public interest. On this issue the determination of the respondent is reversed.

Decision will be entered under Rule 50.


author: Love: Black,

text:
    Farmers Cotton Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42679.
    Promulgated November 23, 1932.

      Percy W. Phillips, Esq., for the petitioner.

      John E. Marshall, Esq., for the respondent.
   ■ OPINION'.

Love:

Regarding the first issue, we have consistently held that the net loss of a predecessor corporation was not deductible, under the “ net loss ” provisions of the statute, by the successor corporation, on the ground that the two corporations were separate and distinct “ taxpayers ” whose separate entities could not be disregarded. See Maytag Co., 17 B. T. A. 182; Plumber's Supply Co., 20 B. T. A. 459; Standard Silica Co., 22 B. T. A. 97; Athol Mfg. Co., 22 B. T. A. 105; affd., 54 Fed. (2d) 230; Industrial Cotton Mills Co., 22 B. T. A. 648; aff'd., 61 Fed. (2d) 291; Clark Dredging Co., 23 B. T. A. 503 (on appeal to C. C. A., 5th Cir.); Overbrook Nat. Bank of Philadelphia, 23 B. T. A. 1390; and New Colonial Ice Co., 24 B. T. A. 886 (on appeal to C. C. A., 2d Cir.). In the Athol case, supra, the Circuit Court of Appeals said:

We fail to see how we can add anything to what was stated by the Board of Tax Appeals in its opinion. We are in full accord with its ruling and finding that the petitioner was an independent entity from the old corporation whose assets and business it took over; that the losses sustained by the old company in conducting its business during 1922 and a part of 1923 were not the petitioner’s losses; and that it was not entitled to deduct the same in its tax return.

Petitioner, however, attempts to distinguish the instant proceeding from the above cases, on the ground that in each of those cases the change from predecessor to successor corporation occurred prior to the enactment of the Kevenue Act of 1924; that in the case of changes which took place prior to the 1924 Act, the successor company took a new basis for subsequent determination of gain or loss and depreciation; that petitioner was a reorganization of the Farmers Oil & Fertilizer Company within the provisions of section 203 (h) (1) (A), (B) and (D) of the Kevenue Act of 1924; that under the 1924 and later revenue acts the reorganized company takes the same basis for subsequent determination of gain or loss and depreciation as was available to its predecessor; and that petitioner should, therefore, be permitted to take the place of the old corporation for the purpose of obtaining the benefit of the net loss deduction provided for in section 206 (b) of the Kevenue Act of 1926, which reads in part as follows:

If, for any taxable year, it appears * * * 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 * * *.

The fact which petitioner contends distinguishes the instant proceeding from the above cited cases, namely, whether the reorganization occurred prior or subsequent to the enactment of the Kevenue Act of 1924, was present in the recent case of Elliott-Granite Linen Corp., 26 B. T. A. 936, promulgated August 31, 1932. In the last mentioned case there was a reorganization, which took place under the Revenue Act of 1926. Nevertheless, we continued to hold that the new corporation was not the same taxpayer as the old corporation and, hence, not entitled to deduct from its net income the net loss of the old.

In the instant proceeding, as will appear in our discussion of the second issue, we are of the opinion that there was, in 1924, no “ reorganization ” as that term is all-inclusively defined in section 203 (h) (1) of the Revenue Act of 1924. But in view of our holding in Elliott-Granite Linen Corp., supra, we do not regard it necessary to decide this point in connection with the first issue, for the reason that even if there were a reorganization, as petitioner contends, that conclusion would not entitle petitioner to the benefit of the net loss of the predecessor taxpayer, namely, the Farmers Oil & Fertilizer Company. The respondent’s determination on this issue is approved.

The second issue is whether petitioner is entitled to a basis greater than $100,000 for determining depreciation and gain or loss from the sale or other disposition of the property acquired at the time of its organization.

The salient facts are that on July Y, 1924, 19 of the old stockholders, owning 66.2 per cent of the capital stock of the old company, agreed to form a new corporation, to subscribe and pay for stock therein in the total amount of $100,000, and to “ appoint W. T. Murphy as Trustee to act for them and to purchase for them ” all the properties of the old company; that on July 12, 1924, Murphy, as trustee, purchased the assets of the old company at public auction for $100,000 in cash; that on July 19, 1924, petitioner was incorporated ; that on August 1,1924, petitioner, as the primary obligor, executed new notes for the remaining indebtedness of the old company in the amount of $139,522.33; and that on August 4, 1924, Murphy, as trustee, directed the liquidating agent of the old company to convey the property of the old company directly to petitioner “ instead of to the said W. T. Murphy, said property having been put into said corporation by us, and for which we have received stock of said corporation * *

Section 204 (a) of the Revenue Act of 1926, provides that the “ basis for determining gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property ” subject, however, to 11 exceptions, none of which apply here unless it be (Y) thereof. Whether exception (Y) applies depends upon whether petitioner acquired the properties “ in connection with a reorganization * * The properties were acquired in 1924 while the Revenue Act of 1924 was in effect. Section 203 (h) (1) of that Act provides:

The term “ reorganization ” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.

Petitioner contends that it comes within the provisions of (A), (B) and (D) of the above definition. In so contending, it entirely disregards the sale which took place on Jnly 12, 1924. Petitioner did not acquire the properties of another corporation; it acquired the properties of 19 individuals for whom Murphy was acting as trustee. The properties that were transferred to petitioner were the properties of the 19 individuals, and not the properties of the old corporation. Both in substance and in form, the transaction was a sale by the old corporation of its properties to 19 individuals, and a transfer by them of such properties to petitioner in exchange for the latter’s stock and the assumption by petitioner of certain indebtedness for which the individuals were themselves liable. What thus occurred was more than “ a mere change in identity, form, or place of organization * * See Pinellas Ice & Cold Storage Co., 21 B. T. A. 425; affd. 57 Fed (2d) 188; and Cortland Specialty Co., 22 B. T. A. 808; affd. 60 Fed. (2d) 937.

Section 204 (c) of the Revenue Act of 1926 provides that the basis upon which depreciation is to be allowed “ in respect of any property shall be the same as is provided in subdivision (a) * * * for the purpose of determining the gain or loss * * Since we have found that none of the exceptions under subdivision (a) were applicable, the basis to petitioner for determining depreciation and gain or loss from the sale or other disposition of the properties acquired at the time of its organization is the cost of such properties to petitioner. Cf. Olean Sand & Gravel Corp., 24 B. T. A. 324.

What, therefore, was the cost to petitioner of the properties it acquired at the time of its organization? This depends upon what it gave in return for such properties. One thing is certain, it assumed an indebtedness of $139,522.33, which was later reduced to $124,522.33 by reason of recoveries in suits against certain of the old stockholders of at least $15,000. What did petitioner give in addition to the indebtedness assumed? Did it give its capital stock, or did it give $100,000 in cash ? If it were the former, we must determine the value, if any, of the stock; if it were the latter, the cost of the properties to petitioner would clearly be $224,522.33.

The opening journal entry on petitioner’s books records the transactions as if the 19 individuals paid in to petitioner $100,000 in exchange for all of petitioner’s capital stock, and that petitioner later paid out the $100,000 in part payment for the properties. But this is not in accord with what actually happened. What actually took place was that on July 12, 1924, which was a week before petitioner was incorporated, the 19 individuals purchased the properties at public auction for $100,000; that the $100,000 was never paid in to petitioner for its stock, but was deposited in a bank to the credit of Bradshaw, the liquidating agent for the old company; and that Bradshaw, on August 4,1924, acting under direction of Murphy as trustee for the 19 individuals, Murphy having stated “ said property having been put into said corporation [meaning petitioner] by us, and for which we received stock of said corporation,” conveyed the properties direct to petitioner. We, therefore, find that in payment for the properties petitioner gave its capital stock in addition to the indebtedness assumed.

What, then, was the fair market value of petitioner’s capital stock? Since the assets received by petitioner were worth considerably less than the amount of the indebtedness assumed by petitioner, we can not find that the stock had any value. Finding, as we do, that the stock of petitioner had no value, it follows that the cost to petitioner of the properties it acquired at the time of its organization was limited to the amount of the indebtedness which it assumed.

The respondent argues that, because of the notation in petitioner’s journal that the liabilities of the old company were assumed only upon subrogation to F. C. O. Co. of contracts and rights of recovery against stockholders,” the indebtedness could not be considered as a part of the consideration paid for the properties. Notwithstanding this notation, petitioner actually issued its promissory notes in the amount of $139,522.33 and thereby became primarily liable to that extent, and, so far as the record shows, petitioner was not reimbursed in any amount greater than the amount recovered in the suits against certain of the old stockholders.

The deficiencies should be computed upon a basis of $124,522.33 for determining depreciation and gain or loss from the sale or other disposition of the properties acquired by petitioner at the time of its organization. This basis should be allocated among the separate assets in accordance with the same method used by the respondent in allocating the basis of $100,000 in his deficiency notice. In this connection, see Seymour Mfg. Co. v. Burnet, 56 Fed. (2d) 494.

Reviewed by the Board.

Judgment toill he entered wnder Bule 50.

Black,

concurring in the result: I dissent from the majority opinion wherein it holds that petitioner was not a reorganization of the Farmers Oil and Fertilizer Company, but I concur in the result reached for other reasons, which I will later state herein. It seems to me that the facts of this case show a reorganization within the meaning of section 208 (h) (1) of the Revenue Act of 1926.

I do not think the view above expressed is in conflict with Pinellas Ice & Cold Storage Co., supra, or Cortland Specialty Co., supra. Those cases are now pending in the Supreme Court, writ of certi-orari having been granted, and, assuming that the Board and the Circuit Courts will be affirmed in both cases, I do not think it will follow that there was no reorganization in the instant case. The facts of the instant case are entirely different from the facts of the above cited cases. In the Pinellas Ice & Gold Storage Co. case there was an outright sale of assets by one corporation to another and it was not argued by the taxpayer that there would be a reorganization except for the parenthetical clause contained in (A) of section 203 (h) (1).

The Board, and the Circuit Court, in affirming the Board, held that the parenthetical clause had no reference to such a state of facts as was present in that case. To the same effect is Cortland Specialty Co., supra. In the latter case the court points out the general meaning of the word “reorganization.” Bays the court, “ Reorganization in the most ordinary sense suggests the formation of a new corporation that is in financial difficulties for the purpose of purchasing the company’s works and other property, after the foreclosure of a mortgage or judicial sale. Morowietz Corp., 812; Symmes v. Union Trust Co., 60 Fed. 870.” The court, in the concluding part of its opinion, said, “ In defining ‘ reorganization,’ section 203 of the Revenue Act gives the widest room for all kinds of changes in corporate structure but does not abandon the primary requisite that there must be some continuity of interest on the part of the transferor corporation or its stockholders to secure exemption. Reorganization presupposes continuity of business under modified corporate form.” (Italics supplied.)

In the instant case the transferor corporation did not continue. It was dissolved and faded out of the picture, but its stockholders carried on through the entity of a new corporation to take the place of the old. Nineteen of its stockholders, owning 66 per cent of the stock of the old corporation, because the only stockholders of the new corporation. And the same business with the same assets and liabilities, except the addition of $100,000 new capital, was carried on under the name of the new corporation, with no one as a stockholder except those who were stockholders of the old corporation.

I agree that (A) of section 203 (h) (1), which has reference to mergers and consolidations, as interpreted by the Board and the courts, does not apply. It was this clause which was involved in the Pinellas Ice & Cold Storage Co. case and the Cortland Specialty Co. case. But I believe the facts of the instant case fall within the provisions of (B) of the above section, which reads:

(1) The term reorganization means: * * * (B) a transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred. [Italics supplied.]

It seems to me that in order to determine whether there was a reorganization within the meaning of the above quoted language, the whole picture must be viewed together. What happened was this: The Farmers Oil & Fertilizer Company found itself in financial difficulties and its stockholders decided to liquidate and dissolve and use the money obtained from the liquidation ■ to pay as far as it would go and if by chance the assets sold for more than enough to pay creditors, then to distribute the proceeds to stockholders. There of course was not the slightest prospect that anything would be left for the stockholders. Before this plan was carried into effect certain stockholders decided they would save something out of the wreckage, if they could. So they called a meeting of the stockholders for this purpose, urging all stockholders to be present. Notice was sent to everyone. At this meeting it was determined to organize a new company, with the same capital stock as the old company; to buy the assets of the old company at the sale which had been advertised; and then to convey the assets to the new corporation in consideration of its capital stock and certain assumption of indebtedness. This was done. It is true that not all the stockholders of the old corporation participated in the plans of reorganization, but there is nothing peculiar about that.

It frequently happens that, when a corporation becomes insolvent and finds it necessary to reorganize, some of the stockholders, for financial reasons or otherwise, are unable to participate in the plans and have to drop out. Sometimes they drop out of their own accord, because they do not care to hazard any more money in the enterprise, but the reorganization, none the less, takes place, even if some of the old stockholders do become weary of the fight and drop out. Another thing which I think makes no difference is that the property was sold at auction to the 19 individual stockholders as the highest bidders instead of to the petitioner corporation. The majority opinion seems to lay emphasis on that point, saying, “ Petitioner did not acquire the properties of another corporation; it acquired the properties of 19 individuals for whom Murphy was acting as trustee.” In my judgment it should be held that the 19 individuals were acting for the corporation which they had agreed they would organize under the laws of the State of Texas. See Garel Robinson, 19 B. T. A. 751.

So it seems clear to me that the facts of the instant case show a reorganization within the meaning of section 208 (h) (1) (B) of the Bevenue Act of 1926.

But, in order that a transferor corporation take the same basis for gain or loss and the same basis for depreciation as its predecessor corporation, it is necessary that it do more than show that a reorganization has taken place. It must meet the conditions of section 201 (a) (7) of the Bevenue Act of 1926, which reads:

If the property (other than stock or securities in a corporation a party to the reorganization) was acquired after December 31, 1917, by a corporation in connection with a reorganization and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons, or any of them, then the basis shall he the same as it would he in the hands of the transferor * * *. [Italics supplied.]

I take it that the clause of the foregoing section which I have italicized means that if not more than 20 per cent of new blood is taken into the reorganized corporation, then it shall be entitled to take the same basis of-cost as its predecessor corporation, provided these same stockholders owned 80 per cent control in the predecessor corporation. If however more than 20 per cent of new blood is taken into the reorganized corporation, it loses the right to take the same basis.

I also call attention to the fact that the 80 per cent control which is to remain in the hands of the old interests need not remain in the same persons in the same proportion. The statute says that it may remain “ in the same persons or any of them.” In the instant case 100 per cent control remained in the hands of, not all of the same persons who were stockholders of the old corporation, but 19 of them, and no new blood was taken in.

But even this is not enough to give the transferee corporation the same basis for gain or loss and for depreciation as the old corporation had. The same group of old stockholders which now holds 100 per cent control in the new corporation must have owned at least 80 per cent control in the old corporation. And it is at this point that petitioner falls down in its effort to show that it is entitled to take the same basis of cost as its predecessor corporation. The group of 19 stockholders of the old corporation who agreed to the plans of reorganization, and did in fact carry them through, owned only 66.2 per cent of the stock of the old corporation, and that is not enough.

The question involved may be stated as follows: Where, before the transfer, a person or group of persons have less than 80 per cent interest or control and, after the transfer, such person or group of persons, have more than 80 per cent interest or control, and no new blood is taken in, does section 204 (a) (7) apply? I do not think it does.

In the case of Monarch Electric & Wire Co. v. Commissioner, 38 Fed. (2d) 417; affirming 12 B. T. A. 158, section 331 of the Revenue Act of 1921 was involved. This section, except as to percentages, contained language the same as the section involved here. Nevertheless, the judges in their discussion assumed that the same group of stockholders owning 50 per cent control after the reorganization (that was the percentage involved in section 331) must have also owned 50 per cent control in the old corporation.

For example, Judge Alschuler, in a concurring opinion, said:

To my mind tlie evident intent of the section is, that if, after any such change, any person or persons, singly or collectively, shall hold in the reorganized business as much as 50 per cent of the entire interest or control therein and are the same person or persons who, singly or collectively, held, as much as 50 per cent interest or control in the old business. * * * [Italics supplied.]

I think the above language of Judge Alschuler represents a correct construction of the language there involved and applies in this proceeding to section 204 (a) (7) of the Revenue Act of 1926.

Therefore, because these same 19 stockholders who owned 100 per cent control in the new corporation did not own as much as 80 per cent control in the old corporation, petitioner is not entitled to take the same basis of cost as its predecessor corporation. I therefore concur in the result reached by the majority opinion, but I dissent from the ground upon which it was based, to wit, that the facts do not show a reorganization within the provisions of section 203 (h) (!)•


author: McMahon:

text:
    Perfex Corporation (Formerly Racine Radiator Company), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44581.
    Promulgated November 23, 1932.

      Frederic Sammond, Esq., and Thomas A. MoOormack, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

McMahon:

The principal question here presented relates to the proper basis to be used in computing the depreciation deductions to which the petitioner is entitled in the year 1925 upon the depreciable assets of the Perfex Radiator Company. The respondent has held that the proper basis is the price at which such assets were sold at the receiver’s sale on April 21, 1923. The petitioner contends that when Alexander bid the properties in at the receiver’s sale he was acting on behalf of MacLeod Young, the American Brass Company and the National Lead Company, that those parties in interest later transferred such assets to petitioner in exchange for stock and other securities, and that the proper basis for the computation of depreciation deductions is the value of such assets at the time petitioner actually acquired them, which value petitioner contends was in excess of the price at which they were sold at the receiver’s sale. Petitioner arrives at this conclusion by reasoning that the cost of the assets to the petitioner was the value of the stock and securities issued therefor by the petitioner, which in turn is governed by the actual value of the assets.

The respondent held that the assets in question were purchased by the petitioner directly from the receiver. From a consideration of all the evidence we conclude that the petitioner has not overcome the presumption in favor of the respondent’s determination in this respect. On the contrary, there is persuasive evidence which tends to support the respondent’s determination. The property was bid in by Alexander, who, in a written declaration to the receiver designated the petitioner as the party to receive the property, and stated that the bid made by him was for and on behalf of the petitioner. In an agreement entered into between the receiver and the petitioner it was stated that the highest bid received at the sale was from Alexander, for and on behalf of the petitioner. In the minutes of the meeting of the subscribers to the capital stock of petitioner held on April 26,1923, it was stated that “ this corporation was organized primarily for the purpose of acquiring from Willis E. Keats, receiver appointed in the United States District Court for the Eastern District of Wisconsin, the property and assets of the Perfex Radiator Company.” A reading of the escrow agreement discloses that the formation of a corporation was contemplated by the parties and it was therein provided that title to the assets should be transferred directly to the corporation, but that, in the event Young and Mac-Leod should fail to arrange to have title transferred direct to the corporation, then title should go to the Manufacturers National Bank of Racine, Wisconsin, the escrow agent, and should then be transferred to either the corporation or the American Brass Company and the National Lead Company, in which event MacLeod and Young were to be paid $35,200, or $4,800 less than the amount they had advanced. Nowhere in the escrow agreement was there any provision for the vesting of title to the assets in Young or MacLeod. Furthermore, title to the property in question did pass directly from the receiver to this petitioner. The fact that the remainder of $5,500 of the escrow funds unused in the purchase of the assets was transferred to the petitioner indicates that such funds were placed in escrow for the use of the corporation and were, in fact, advances to it. The fact that the petitioner was not in existence on April 21, 1923, at the time Alexander bid upon the property, is not inconsistent with this view, since the petitioner, in an agreement with the receiver dated April 26, 1923, ratified the action of Alexander in acting on its behalf at this sale.

The rule is well established that a contract made in behalf of a corporation before it is formed becomes the contract of the corporation so that it is both entitled to the benefit thereof and is liable thereon if it expressly or impliedly ratifies or adopts the same after it comes into existence, provided the contract is within its charter or corporate powers. In re Quality Shoe Shop, Inc., 212 Fed. 321; Hinkley v. Sagemiller, 210 N.W. (Wis.) 839, 841; Myers, Inc. v. Ogden Shoe Co., 181 N. W. (Wis.) 307; Pratt v. Oshkosh Match Co., 89 Wis. 406; 72 N. W. 84; cases cited in note 48, I Fletcher Cyc., Corporations, p. 211; and in note 63, 14 C. J. 257. See Carel Robinson, 19 B. T. A. 751. See also Whitney v. Wyman, 101 U. S. 392, wherein the Supreme Court stated in part:

But it is said the corporation at the date of these letters was forbidden to do any business, not having then filed its articles of association, as required by the statute.
To this objection there are several answers.
The corporation subsequently ratified the contract by recognizing and treating it as valid.
This made it in all respects what it would have been if the requisite corporate power had existed when it was entered into. * * *

Cf. Petree v. United States, 34 Fed. (2d) 568; affd., 41 Fed. (2d) 517; certiorari denied, 282 U. S. 877.

Under the evidence it does not appear that the respondent erred in holding that the petitioner purchased the assets in question from the receiver as of April 21, 1923. It follows that the determination of the respondent, that the cost of such assets at such receiver’s sale is the basis for the determination of depreciation deductions thereon, must be approved. See section 204 (a) and (c) of the Revenue Act of 1926, which is set forth in part in the margin.

Furthermore, even if petitioner were correct in its contention that it purchased the assets from the American Brass Company, National Lead Company, Young and MacLeod and that the cost of the assets to the petitioner is to be determined by the value of the assets themselves at the time acquired, the respondent’s basis for computation of depreciation deductions would still prevail.

By the provisions of section 907 (a) of the Revenue Act of 1926, as amended by section 601 of the Revenue Act of 1928, the Board is bound by the rules of evidence prevailing in the courts of equity in the District of Columbia. In Ruppert v. McArdle, 42 App. D. C. 392, the court was called upon to determine the value of certain property at the date of the termination of a life tenancy. An appraisal had been made of the property subsequent to the termination of such tenancy and thereafter the executor had sold such property under court order. The court held that the appraisement was merely prima facie evidence of the value of the property, and that the subsequent judicial sale, which was a fair sale, was better evidence of the value of the property at the date in question. Here, appraisers appointed by the court valued the assets in question as of February 9, 1923, and the valuation placed thereon by them was greatly in excess of the price at which such assets were subsequently sold on April 21, 1923, at the receiver’s sale. Obviously the appraiser’s report fixing the value of the property in question herein at $351,504 was before the court, and notwithstanding the appraised value the receiver informed the court that such property was worth $175,000, and the court set the latter figure as the minimum selling price. A receiver’s sale was attempted, but no bids were received, and thereupon the court postponed the sale and fixed no minimum price for the property. Thereafter the receiver’s sale was consummated on April 21,1923, and, it being a fair judicial sale, we conclude that the value established by that sale should be taken as the value of the property on that date and also on April 26, 1923, the date it was actually transferred to petitioner by the receiver. In the instant proceeding, one of the appraiser’s testified at the hearing that the appraisal made represented the best judgment of the appraisers as to the fair market value of the property on February 9, 1923. In the absence of such showing this would be assumed, and this proof adds little, if anything. In Ruppert v. MoArdle, supra, there is no indication that any of the appraisers did testify before the court, but we deem this difference between the two cases insufficient to justify a different result. Under these circumstances, we can not disturb the value of the assets as determined by the respondent as of the date they were acquired by the petitioner, which is the price at which they were sold at the judicial sale on April 21, 1923. See also Hazelton v. Le Duc, 10 App. D. C. 379; and Andrews v. Commissioner, 38 Fed. (2d) 55; affirming Estate of Effie Andrews. 13 B. T. A. 651; and cf. Belridge Oil Co., 26 B. T. A. 810.

There is no proof in the record sufficient to overcome the presumption in favor of the correctness of the respondent’s determination as to value based on the judicial sale of April 21, 1923.

The contention of the petitioner that it should be allowed, as a deduction from gross income of the year 1925, the amount of a net loss in 1924 also fails, since at the hearing it was stipulated between the parties that if the Board should approve the depreciation basis as determined by the respondent, then the petitioner sustained no net loss in 1924.

Reviewed by the Board.

Judgment will be entered for the respondent.

GoodRICh concurs in the result.

       Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition, of property acquired after February 28, 1913, shall he the cost of such property ; except that [exceptions immaterial]' — ■
      ****** *
      (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that — [exceptions immaterial].


author: Lansdon :

text:
    The Vogue Silk Hosiery Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51107, 64632.
    Promulgated November 23, 1932.

      George J. Edwards, Jr., Esg., and Hiram B. Calkins, Esq., for the petitioner.

      Arthur Carnduff, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent had determined to the extent of $20,000 the salaries paid to officers of the petitioner in the year 1928. The amount of such disallowance represents stock issued to such officers as bonuses, in addition to cash paid for the services of Samuel Tait, John Tait and Ernest Tither, in the amounts of $17,709.25, $6,776.14 and $14,269.59, respectively. In addition to such amounts the petitioner paid a cash salary to Walter Tither, who became an officer and stockholder to the extent of 100 shares on May 1,1928, in the amount of $10,438.28. On the record we are of the opinion that the cash salaries paid the officers of the petitioner in 1928 were reasonable compensation for services rendered.

The distribution of stock of the par value of $20,000 to Samuel Tait, John Tait and Ernest Tither, as an alleged bonus or additional salary, was in exact proportion to their respective holdings. Petitioners contend that the purpose of such allocation of the stock bonus was to preserve the relative original shareholdings of the officers. This is not a proper measure of the value of services, which must be based in work done rather than interest in the business. In Twin City Tile & Marble Co., 6 B. T. A. 1238; affd., 32 Fed. (2d) 229, this Board said:

Tlie value of services of an individual is not dependent upon tlie amount of stock owned. Tlie value of services and tlie amount of stock owned have no necessary relationship to each other. The measure used in determining the increases in this case was stock ownership, regardless of the fact that certain stockholders may have been entitled to a greater or lesser amount if the value of their services were solely considered. In order to be compensation for services, the value of the services must measure the amount and not stock ownership. Conceding for the sake of argument that the services of individuals in this case were fairly worth the amounts they received, this fafct alone is not sufficient to constitute the amounts compensation. They must have been intended and paid as such.

The rule in the opinion above cited has been followed in substance by the Board and the Federal courts in many subsequent decisions. G. S. Ferry & Son, Inc., 18 B. T. A. 1261; Gould-Mersereau Co., 21 B. T. A. 1316; and Marble & Shattuch Chair Co., 13 B. T. A. 657; affd., 39 Fed. (2d) 393. In conformity with the evidence and the above cited authorities, the determination of the respondent on this issue is affirmed.

As its second cause of action the petitioner contends that it has been allowed insufficient depreciation on the legging machines in each of the taxable years. Under the provisions of section 23 (a) of the Revenue Act of 1928, taxpayers are entitled to “ a reasonable allowance for exhaustion, wear and tear for property used in trade or business.” To determine such reasonable allowance it is necessary to know the cost of such property, the useful life and the salvage value at the termination of usefulness. In the Hailey-Ola Coal Co., 24 B. T. A. 895, we said:

In this record there is no evidence whatever as to the remaining useful life or the salvage value of petitioner’s depreciable assets, which are necessary elements for a computation of deductions for depreciation on either a unit-of-production basis or by the straight method. Kehota Mining Co., 3 B. T. A. 885; Grand River Gravel Co., 22 B. T. A. 1124. The respondent’s determination must be approved. Bishoff v. Commissioner, 27 Fed. (2d) 91; Rouse v. Bowers, 30 Fed. (2d) 628; certiorari denied 49 Sup. Ct. 348; Relelo v. Seiner, 25 Fed. (2d) 453; Atlanta Casket Co. v. Rose, 22 Fed. (2d) 800. [Italics supplied.]

In the instant proceeding there is no controversy over the cost of the machines involved in the question of depreciation. The petitioner contends that the useful life of such equipment is not more than three and one-third years and asks for an allowance from income on that basis. The evidence in support of this contention is not convincing. The record discloses that at the date of the hearing the oldest of these machines had been in service almost exactly five years and was still in use. No evidence was adduced to show at what date its use would no longer be profitable to its owner. Officers of the petitioner testified that in their opinion none of the machines had a fair market value in excess of $2,000 at the close of the last taxable year here involved. If this was intended to establish salvage values at the termination of useful life, it falls far short of that purpose, since the record discloses that all of such machines were in regular use at least three years subsequent to such date. In our opinion salvage value is an element that appears only when property can no longer be used profitably in a trade or business and has no relation whatever to the market value of a secondhand machine still in profitable use by its owner, which is the situation here.

If the testimony as to market value of the legging machines involved was adduced for the purpose of proving actual depreciation determined by a survey of the property in question, in our opinion it also fails for that purpose. It is no more than the opinion of stockholders of the petitioner which is not supported by sufficient evidence to indicate that one-third of the value of each such machine was exhausted each year. Here again is the fact that at the date of the hearing one of the machines had been in use for five years and all the others in excess of three years. The very fact that the claimed depreciation is in round numbers and is exactly the same for each of the years involved justifies our conclusion that the rate claimed by petitioner is not based on actual valuation of the machinery ascertained by expert physical survey. Nor is there any evidence that petitioner has consistently used the actual valuation method in determining the additions to depreciation reserve on its own books. We think, therefore, that the evidence here does not bring the question within the rule applied in Cleveland Home Brewing Co., 1 B. T. A. 87, and other proceedings relied on by the petitioner. We think the petitioner has failed to prove either the useful life or the salvage value of the property here involved and therefore has not overcome the presumption that the determination of the respondent is correct. We are also of the opinion that the respondent has failed to show cause for any increase in the deficiency as requested in his motion duly made at the hearing.

Decision will be entered for the respondent.