author: Black: Hareon,

text:
    John Preston Rice, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102124.
    Promulgated June 18, 1941.

      Faneuil Adams, Esq., for the petitioner.

      E. M. Woolf, Esq., for the respondent.
   OPINION.

Black:

Section 23 (a) of the Revenue Act of 1934 provides:

SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses.—All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *

Undoubtedly, petitioner’s principal business was that of investment banker, as a- partner in the firm of White, Weld & Co. However, in' 1934 Horatio Hathaway, an old customer of petitioner, died and left an estate valued at approximately $1,500,000, and petitioner was named as executor of the estate in decedent’s will. Petitioner qualified as executor of the estate. His duties as executor did not require all of bis time and he continued -his duties as a member of the firm of White, Weld & Co.

The testimony is that petitioner’s duties as executor of this large estate did require a considerable amount of his time and that he found it necessary to employ J. Thomas Baldwin to assist him This was done on account of Baldwin’s experience in dealing with estates in administration and trusteeship. Also he employed Miss Brennan to do clerical work which was incident to his duties as executor.

Petitioner received $15,000 for his services as executor in 1934 and $15,000 for his services in 1935. In 1935 he paid Baldwin $3,000 and Miss Brennan $350 for their services in assisting him. These payments were made from the compensation which petitioner received as executor.

On these facts petitioner contends that he was engaged in the business of being executor of a large estate, which required considerable time and responsibility, and that the $3,350 paid Baldwin and Miss Brennan represented ordinary and necessary expenses paid and incurred in carrying on a trade or business within the meaning of the applicable statute.

Respondent does not dispute that petitioner paid Baldwin and Miss Brennan the amounts in question nor that the amounts were reasonable for the services which they actually performed, but defends his disallowance of the deductions on the ground that petitioner’s activities as an executor did not constitute a business within the meaning of that term as used in section 23 (a) of the Revenue Act of 1934. Respondent cites Ames v. Commissioner, 49 Fed. (2d) 853, as his principal authority in support of his position. We think that Ames v. Commissioner is not controlling. In that case the estate of Charles W. Ames, deceased, was the taxpayer and the court held that an executor’s mere receipt of dividends and payment of testator’s contractual debts was not carrying on a trade or business.

In the instant case we do not have the question before us as to whether the estate of Horatio Hathaway, of which petitioner was an executor, was carrying on a trade or business in 1935. Our question is whether petitioner’s activities as executor of the estate of Horatio Hathaway for which he earned $15,000 in 1934 and $15,000 in 1935 constituted carrying on a trade or business, and we think that question must be answered in the affirmative. See Wallace’s Estate v. Commissioner, 101 Fed. (2d) 604. In the latter case the court pointed out that certain cases which had held that estates which were mere passive investors were not engaged in a trade or business, were not applicable. The court distinguished that line of cases from the one which it had before it, in the following language:

But these cases do not justify the holding that an executor or trustee when he performs the duties of his position for pay is not engaged in business. The distinction between the activities of an estate and the activities of the representatives of the estate are obvious. There are many capacities of a business nature in which an individual or a corporation may serve an estáte in the course of liquidation; and it is common knowledge that a substantial part of the business of certain corporations consists of the services which they render as executor or trustee for a specified compensation. The Board of Tax Appeals itself in Abbott v. Commissioner, 38 B. T. A. 1290, Case No. 167, has recently held that a lawyer in general practice, who derived a large part of his income for services rendered as executor or trustee, was engaged in business in so doing, and was entitled to deduct from his gross income as a business expense a sum paid to certain beneficiaries in settlement of a liability incurred in the administration of a trust. Cf. Tallman v. Commissioner, 37 B. T. A. 1060, Case No. 156.
The principle enunciated in this decision is applicable in the pending case, and no distinction arises because of the fact that the taxpayer was not regularly or continuously engaged in the business of performing the services of an executor. * * *

On the same grounds as stated by the court in the foregoing opinion, we think the instant case is distinguishable from such cases as City Bank Farmers Trust Co., Trustee, 39 B. T. A. 29; affd., 112 Fed. (2d) 457; affd., 313 U. S. 121; and George Vanderbilt Trust, 36 B. T. A. 967. Cf. also United States v. Pyne, 313 U. S. 127. Also we think we should point out that the instant case is distinguishable from cases where a taxpayer is serving as executor for some decedent relative, without compensation, and incurs certain losses or expenses in doing so. These we have held to be personal to the taxpayer rather than business expenses. See Stephen H. Tallman, 37 B. T. A. 1060.

We have no such state of affairs in the instant case. Petitioner was serving as executor for pay and as an incident to that employment he had to incur and pay certain ordinary and necessary business expenses. We think these are deductible under section 23 (a) of the Revenue Act of 1934. Upon this issue petitioner is sustained.

Reviewed by the Board.

'Decision will be entered wider Rule 50.

Hareon,

dissenting: Petitioner, himself, and through his agent Baldwin, did no more than carry out the traditional duties of an executor in managing the estate of the decedent and in carrying out the directions in the will, the terms of which are not set forth. ' The making of inventories, the attending of conferences, and the straightening out of trusts do not amount to carrying on a’ business, and the disposition of some stock and real estate, ordinarily, would amount to no more than managing and preserving the estate, or carrying out the terms of the will. There appears not to have been sufficient activity in the disposition of some property in the estate to constitute those transactions a carrying on of a business. Petitioner has failed, I believe, to show that he was engaged in a’ business as the term is used in section 23 (a). The Supreme Court has made it clear in United States v. Pyne, 313 U. S. 127, that estate administration per se is not a business, and has said, “Executors who engage actively in trade and business are the exception and not the rule.” • Therefore, petitioner must show that he did more than engage in the activities which are the “traditional duty of executors.” He must show that, in addition to such activities, he engaged in more extensive activities which constitute the carrying on of a business. Furthermore, the Supreme Court has stated that the very broad definition of “business” in Flint v. Stone Tracy Co., 220 U. S. 107, 171, is not controlling in the determination of what constitutes carrying on a business within the meaning of section 23 (a). Higgins v. Commissioner, 312 U. S. 212; United States v. Pyne, supra. Accordingly it is not determinative that petitioner received compensation for his services or that he engaged in the activities of an executor for profit. In as much as the court in Wallace's Estate v. Commissioner, 101 Fed. (2d) 604, held that an executrix was engaged in a business when she performed the duties of that appointment with intent to secure compensation therefor very largely because of the Flint v. Stone Tracy Co. case, definition of business, it appears evident that the rule in Wallace's Estate v. Commissioner, supra, is no longer good law; that it has been overruled by recent decisions of the Supreme Court. I believe we should not regard the case of Wallace's Estate v. Commissioner, supra, as controlling.

The holding reached appears to be that petitioner’s activities in administering the estate of the decedent, as carried on by himself and his agent, constitute the carrying on of a business, because petitioner performed services for fees. Most executors receive fees. If administering an estate per se is not a business, under the rule of the Pyne case, the conclusion reached above is wrong. If the holding is that the petitioner’s activities extended further than the traditional functions of an executor in administering and preserving the estate, so as to extend into the area of business activity, then I believe the facts here do not support the holding. There is much to indicate that the expenditures in question were made to suit the personal convenience of petitioner, who had to be away frequently. To the extent that such is true, the expenditures are personal and are not deductible. Miller v. Commissioner, 102 Fed. (2d) 476; Kane v. Commissioner, 100 Fed. (2d) 382. Petitioner was inexperienced and Baldwin, a lawyer, had experience. Baldwin’s services were of value, of course. But that is not sufficient to support the claimed deduction. In the Pyne case, the Court of Claims dwelt upon the fact that the executors were inexperienced and that an attorney who was engaged in business helped the executors. (See Pyne v. United States, 35 Fed. Supp. 81.) The Supreme Court did not agree that the fact that the counselor to the executors was engaged in business contributed to a holding that the executors were engaged in business. Under the facts, if petitioner had paid his counselor and secretary out of funds of the estate, instead of out of his fees received from the estate, and if he had claimed deduction therefor from the estate’s income in computing the estate’s net taxable income, I think we would have to deny the deduction under the rule of the Pyne case. See also, Estate of Mary R. Donald, 43 B. T. A. 1114; White Trust v. Commissioner, 119 Fed. (2d) 619. To say that under the facts petitioner, as an individual taxpayer, was engaged in business in doing what he did, as an executor, and, therefore, is entitled to the deduction as a business expense; but that petitioner as a fiduciary in doing what he did as executor, under the same facts, is not engaged in a business and that, therefore, the estate—a taxable entity—is not entitled to the deduction as a business expense, points out the illogic. Petitioner’s burden of proof is, in my opinion, exactly the same whether he claims as a fiduciary or as an individual that his activities as executor extended into the area of business activity for purposes of a business expense deduction.

I believe petitioner has failed to show that his activities as executor extended into the area of business activity and that, therefore, he is not entitled to the deduction for the expenditures in question. Therefore, I respectfully dissent.

Sternhagen, Van Fossan, and Arnold agree with this dissent.


source: Caselaw Access Project

author: Keen :

license: Public Domain

text:
    Little Gem Coal Company, Petitioner, v. Commissioner of Internal Revenge, Respondent.
    Docket No. 101112.
    Promulgated June 18, 1941.

      William B. White, Esq., for the petitioner.

      Frank M. Thompson, Esq., for the respondent.
   OPINION.

Keen :

The question presented by this proceeding is whether under the facts above stated the original Little Gem Co. is entitled to a dividends paid credit, under section 27 of the Eevenue Act of 1936, in the amount of $15,000 representing a dividend declared by one of the corporations merged in petitioner in favor of its sole stockholder, a corporation which, was the other party to the merger, the declaration being made at the time of the merger and the form of payment being the cancellation of indebtedness arising by reason of advances made during the taxable year by the corporation declaring the dividend to its sole stockholder.

Respondent contends that the distribution in question must be considered as one in liquidation and nontaxable and, by reading section 27 (h) as a limitation on section 27 (f), concludes that no dividends paid credit should be allowed therefor.

We have recently ruled adversely to respondent’s ultimate contention in Credit Alliance Corporation, 42 B. T. A. 1020. On the authority of that case we decide the issue in favor of petitioner.

The case of Reed Drug Co., 44 B. T. A. 573, is not in point and does not impose any limitation on the rule laid down in Credit Alliance Corporation, supra, in so far as the latter is applicable to this proceeding. In Reed Drug Co., supra, there was a distribution by a corporation to its stockholders of stock in another corporation. Section 115 (h) of the Revenue Act of 1936 provided that such a distribution should “not be considered a distribution of earnings or profits.” We held that that section, entitled “Effect on Earnings and Profits of Distribution of Stock,” should be read in connection with section 27 (f) in determining whether a distribution is chargeable to earnings or profits accumulated after February 28, 1913. Since the distribution here in issue was not a distribution of stock, it is apparent that section 115 (h) has no application; and the Reed Drug Co. case, which is in no way concerned with section 27 (h), can not be considered as impairing the authority of Credit Alliance Corporation, supra, for the proposition that section 27 (h) will not be read as a limitation on section 27 (f).

It is, therefore, unnecessary to consider petitioner’s arguments to the effect that the dividend in question was, in reality, distributed at the time the advances were made which were later canceled; that the dividend, in any event, was an ordinary dividend taxable to the stockholder as distinguishable from a liquidating dividend; and that under the law of Alabama the mebger was not a liquidation.

Decision will he entered, for the petitioner.


author: Hill:

text:
    Juneau Dairies, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102832.
    Promulgated June 18, 1941.

      George. O. Kinnecer, Esq., and James O. Cooper, C. P. A., for the petitioner.

      E. C. Adams, Esq., for the respondent.
   OPINION.

Hill:

The question at issue is whether the amounts which petitioner distributed to its shareholders at the end of the taxable year constituted additional cost of goods sold or were in the nature of dividends. Petitioner contends that the payment of $4,000 to the shareholders was not a dividend, but an adjustment of the purchase price of milk products sold to petitioner by the shareholders. It maintains that the payments could not be dividends, since they were not in proportion to stockholdings but were computed in accordance with contracts which were binding upon petitioner. Respondent argues that the $4,000 distribution was in effect a dividend consisting of the net profits earned by petitioner on sale of goods purchased from the shareholders. He asserts that treatment of the payment as part of the cost of goods sold would free from tax the entire earnings of petitioner attributable to goods purchased from the shareholders.

Counsel for petitioner concedes that petitioner is not a cooperative exempt from tax under section 101 of the Revenue Act of 1986. The problem before us is whether the $4,000 distribution is a proper addition to the cost of goods. We are of the opinion that it is not.

The facts in the instant case are similar to those considered by us in Peoples Gin Co., 41 B. T. A. 343; affd., 118 Fed. (2d) 72. There the petitioner was a corporation organized for the purpose of purchasing and operating a public cotton gin. Petitioner ginned cotton for both stockholders and nonstockholders at the same charge. After the profits for the taxable year had been earned the stockholders adopted bylaws providing that the net profits of petitioner allocable to cotton ginned for its shareholders should be divided among the shareholders in proportion to the number of bales of cotton ginned for each shareholder. We held that that distribution constituted the payment of a dividend and was not deductible in determining the taxpayer’s net income.

The facts in the present proceeding differ from those in the Peoples Gim. case in that the basis for the distribution here was established by - contracts entered into between petitioner and the shareholders. We believe, however, that this distinction is not material. The contracts were made by the shareholders with an entity of their own creation, an organization operated and controlled by them. The contracts provided that the bonus should consist of the entire net profit of petitioner “as and when declared by the directors” of petitioner. This provision, like that in the bylaws of petitioner in Peoples Gin Co., supra, had the effect of authorizing a dividend. The contracts, although binding on petitioner, might be changed with the same ease as bylaws in the Peoples Gin case.

We consider that the distribution in question was made pursuant to the resolution of petitioner’s board of directors, but, even if it were made in accordance with provisions of the contracts, it would not be the less a dividend. In the recent case of Fontana Power Co., 43 B. T. A. 1090, we stated:

Neither are we impressed by petitioner’s argument that the payments involved here, made by petitioner to its stockholders for so many years, can not be considered as distributions in the nature of dividends because (1) they were made pursuant to a contract and not pursuant to the rights of the payees as stockholders, and (2) the distributions consisted of the net earnings and not the surplus profits technically available for dividends. We are persuaded that the contract was executed and the distributions were made for so many years pursuant thereto because the Fontana Co. and/or the Water Co. were the holders of all of the stock of petitioner (except qualifying shares). It was because of this latter fact that the arrangement proved so permanently satisfactory to petitioner’s controlling stockholders, and if we are to recognize the realities we must conclude that the ultimate reason for the distributions made to the Fontana Co. and/or the Water Co. was because, for all practical purposes, they were the sole stockholders of petitioner.

Here the distribution was made to tbe shareholders because they were shareholders. The nonshareholder who had a contract with petitioner was denied the advantages of the distribution and in fact received a smaller base price for her products under her contract than the shareholders. The distribution was a dividend despite the statement in the authorizing resolution to the contrary. A resolution of directors is not necessary for a distribution to have the effect of a dividend. Fontana Power Co., supra.

Petitioner argues that, since the distribution was not in proportion to shares held by the stockholders, it can not be considered a dividend. The authorities are clear, however, that a distribution of profits may be made on a basis other than stockholdings and still be a dividend distribution. Peoples Gin Co., supra; Lincoln National Bank v. Burnet, 63 Fed. (2d) 131; Kate Hudson, 34 B. T. A. 155; affd., 99 Fed. (2d) 630, certiorari denied, 306 U. S. 644. "We hold that the $4,000 distribution was in the nature of a dividend and hence can not be included as part of the cost of goods sold.

Decision will be entered for respondent.


author: Mellott : MuRBOok, Arnold,

text:
    Cannon Valley Milling Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96330.
    Promulgated June 19, 1941.

      Kenneth Taylor, Esq., for tbe petitioner.

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

Mellott :

The respondent determined a deficiency of $101,249.37 in petitioner’s income tax and a deficiency of $36,579.21 in its excess profits tax for the fiscal year ended June 30, 1935. The instant proceeding involves only the portion of the deficiencies attributable to the disallowance of a claimed deduction of $29,423.45 from gross income. It was submitted upon a stipulation of facts, all of which we find to be as stipulated.

Stated generally, the question is: May petitioner be allowed a deduction of $29,423.45 from its gross income in 1935, this being the aggregate amount paid to its vendees in 1937 in compromise of their claims for reimbursement of processing taxes included in the selling price of wheat products sold by petitioner to them during May and June 1935?

For present purposes the facts may be summarized as follows:

Petitioner, a Minnesota corporation, having its principal office at Minneapolis, duly filed its income tax return for the fiscal year ended June 30, 1935, with the collector of internal revenue for the district of Minnesota. Its books were kept on an accrual, as distinguished from a cash, basis.

During the taxable year and for many years prior thereto petitioner was engaged in the business of milling wheat and selling flour and other wheat products. As a first domestic processor of wheat it was subject to the provisions of the Agricultural Adjustment Act of 1933, as amended. Pursuant to the provisions of that act, it paid to the Federal Government a tax of 30 cents a bushel on the wheat processed from July 1, 1933, to April 30, 1935, inclusive.

In June 1935 petitioner instituted an action in the United States District Court for the District of Minnesota to enjoin the collector of internal revenue for the district of Minnesota from collecting processing taxes upon wheat processed during the months of May and June 1935. The court granted temporary injunctions upon the condition that- petitioner deposit with it the amount of taxes due on account of wheat processed during these months, pending final decision as to the constitutionality of the Agricultural Adjustment Act. Pursuant to the order of the court petitioner made the following deposits:

During subsequent months of 1935, under similar conditions, amounts aggregating $170,131.50 were deposited.

Following the decision of the Supreme Court of the United States in United States v. Butler, 297 U. S. 1 (Jan. 6, 1936), declaring the Agricultural Adjustment Act invalid, the injunctions were made final and on January 23,1936, there was returned to petitioner the sum of $222,998.24 ($223,279.50 less a deposit fee of $281.26 retained by the clerk of the court). On that date petitioner set up on its books a reserve account reading “Processing Tax Payable Special— $222,998.24.” No part of this sum was reported as income in petitioner’s returns either for the fiscal year ended June 30, 1936, or for the fiscal year ended June 30, 1937.

All of the wheat products processed and sold by petitioner during the months of May and June 1935 were sold under written contracts fixing a definite price for the products, which included, but did not apportion nor separately state, the amount of processing tax payable by petitioner under the Agricultural Adjustment Act. These contracts contained a provision that if any increase in the processing tax should become effective while any portion of the commodities covered by the contract should remain undelivered, the amount thereof should be paid by the buyer. They also provided:

Any decrease in the processing tax as now or hereafter imposed by the United States shall inure to the benefit of the buyer and be credited against the contract price named in this contract to the extent—-and only to the extent—that the grain used in the manufacture of the product covered by this contract is milled after the decrease in the processing tax takes effect and to the extent that the seller is thereby relieved from the processing tax; * * *

All deliveries under contracts for the sale of products processed and sold by petitioner during the months of May and June 1935 were made by petitioner as required by the contracts referred to above prior to July 1, 1935, and the full purchase prices provided in the contracts were paid to the petitioner by the vendees thereunder prior to January 1, 1936. The contracts contained no provision for a refund to the vendees of all or any part of the processing tax in the event such tax should be held to be illegal.

From and during May and June 1935 and thereafter, and particularly after the decision in United States v. Butler, supra, numerous claims were made against petitioner by vendees to whom it had sold wheat products processed during the months of May and June 1935 and during the latter part of 1935, for reimbursement of the amount of processing tax upon the products purchased by them from petitioner during that period. Petitioner at all times refused to admit any legal liability, either under the provisions of the contracts of sale set out in the stipulation or upon any other ground. In order to avoid threatened litigation, to keep the good will of its customers, and to compromise the claims, however, petitioner, during its fiscal year ended June 30, 1937, refunded to its vendees amounts aggregating $134,190.91. Payments to the vendees were made upon the basis of $1 of the approximately $1.38 of processing tax applicable to a barrel of the product purchased. $29,423.45 of the amount refunded to petitioner’s vendees was paid in connection with wheat processed and sold during May and June 1935, the balance ($104,757.46) being in connection with wheat processed and sold during petitioner’s fiscal year ended June 30,1936, and prior to January 6,1936.

In petitioner’s Federal income and excess profits tax return for the year ended June 30,1935, it deducted the sum of $53,148 on account of processing taxes for the months of May and June 1935. In the notice of deficiency this deduction was disallowed by the respondent.

The petition alleges that the “respondent’s action in disallowing the deduction of processing taxes in the amount of $53,148.00 * * * is improper unless there be allowed as a deduction from gross income for the taxable year the amount of reimbursements made by the taxpayer to its customers on account of unpaid processing taxes with respect to .deliveries made during the taxable year * *

The following schedule summarizes many of the facts and indicates the contentions of the respective parties:

1935. ($577.31) $50,464.03 $21,040.58

1936. Not shown 154,540.69 49,773.23 154,540.69

1937. (18,032.22) (18,032.23) (18,032.22) (152,223.13)

The Department has ruled that amounts paid by processors in settlement of contracts containing the clauses set out above, which contracts were entered into during the “injunctive period”, are deductible as ordinary and necessary business expenses. The ruling concludes in the following language:

It is lield that the deductions on account of such reimbursements under the contracts here in question may be taken by the processors for the year in which reimbursements were actually made or, where the processors keep their accounts and file their returns on the accrual basis, for the year in which they agreed with the vendees to settle or compromise the disputed claims.

Obviously relying upon and giving effect to this ruling, respondent has stipulated that the payments to petitioner’s vendees in the total amount of $134,190.91 “are properly deductible from gross income in computing petitioner’s net income for some taxable year.” He claims, however, that under the stipulated facts the payments are deductible only in the return for the fiscal year ended June 30,1937.

Petitioner places its chief reliance upon section 43 of the Eevenue Act of 1934- It contends that the payments to its vendees, being proper deductions from its gross income for some taxable year, should be prorated and the proportion thereof allocable to the products sold in the fiscal year 1935 should be allowed as á deduction in computing its income for that period “in order to clearly reflect its income.” The section relied upon and related sections 41 and 42 are shown in the margin.

The first query that arises is: Are the payments deductions within the meaning of the revenue act? Apparently both parties consider them to be, though their stipulation to that effect is not controlling. Ohio Clover Leaf Dairy Co., 8 B. T. A. 1249; affd., 34 Fed. (2d) 1022; certiorari denied, 288 U. S. 588; William Ernest Seatree, 25 B. T. A. 396; affd., 72 Fed. (2d) 67. They were made, in the language of the stipulation, “in order to avoid threatened litigation, keep the good will of its [petitioner’s] customers, and compromise” the “numerous [disputed] claims * * * made against petitioner by vendees to whom it had sold wheat products processed during the months of May and June, 1935.” Such payments, we think, must be held to be ordinary and necessary expenses of carrying on a trade or business and hence “deductions” under section 23 (a) of the Revenue Act of 1934. Superheater Co., 12 B. T. A. 5; affd., 38 Fed. (2d) 69; O'Day Investment Co., 13 B. T. A. 1230; H. M. Howard, 22 B. T. A. 375; International Shoe Co., 38 B. T. A. 81, 95; Helvering v. Hampton, 79 Fed. (2d) 358; and Welch v. Helvering, 290 U. S. 111.

The income tax is assessed upon the basis of annual returns showing the net result of all the taxpayer’s transactions during a fixed period according to the method of accounting employed. Burnet v. Sanford & Brooks Co., 282 U. S. 359. Under an accrual, as distinguished from a cash, basis, the general rule is that income and deductions are accruable when all events have occurred fixing the liability and determining the amount. North American Oil Consolidated v. Burnet, 286 U. S. 417; United States v. Anderson, 269 U. S. 422; American National Co. v. United States, 274 U. S. 99; Helvering v. Union Pacific Railroad. Co., 293 U. S. 282. “As to both income and deductions it is the fixation of the rights of the parties that is controlling.” Commissioner v. Darnell, Inc., 60 Fed. (2d) 82. The cases applying the general rule referred to above are numerous. Many of them, and especially those which have held that a deduction can not be taken by a taxpayer on an accrual basis until the year in which its disputed liability is finally determined or admitted, are cited by respondent. Lucas v. American Code Co., 280 U. S. 445; Tomson & Co. v. Commissioner, 82 Fed. (2d) 398; Price Iron & Steel Co. v. Burnet, 45 Fed. (2d) 921; Central Trust Co. v. Burnet, 45 Fed. (2d) 922; New Process Cork Co., 3 B. T. A. 1339; Bump Confectionery Co., 4 B. T. A. 50; Louis Kratter, 4 B. T. A. 52; Hamler Coal Co., 4 B. T. A. 947; Empire Printing & Box Co., 5 B. T. A. 203; Lynchburg Colliery Co., 7 B. T. A. 282; Thorne, Neale & Co., 13 B. T. A. 490; Trippensee Manufacturing Co., 15 B. T. A. 15; Arabol Manufacturing Co., 26 B. T. A. 1068. In this connection he relies especially upon the fact that the 1935 sales contracts did not impose upon petitioner any legal obligation to make the reimbursements to its vendees.

Most of the cited cases arose under acts prior to the 1924 Act, which, through section 200 (d) thereof, first incorporated in the revenue law the provision set out in the concluding clause of the first sentence of section 48, supra. They involved the application of the general rule for the accrual and deduction of liabilities under the accrual method of accounting and the exception now under consideration was not involved or discussed.

Petitioner cites and relies principally upon William S. Linderman, Executor, 28 B. T. A. 113; reversed on rehearing, 84 Fed. (2d) 727; certiorari denied, 299 U. S. 589; Carondelet Building Co. v. Fontenot, 111 Fed. (2d) 267; K. Taylor Distilling Co., 42 B. T. A. 7 (on appeal C. C. A., 6th Cir.); Sanford Cotton Mills, Inc., 42 B. T. A. 190. The two last mentioned cases are distinguishable from the instant proceeding on their facts, and, since they do not involve any departure from the regular accrual method of accounting, it would serve no useful purpose to discuss them.

In the Lindermam, case, the books and accounts of a deceased incompetent had been kept and returns of her income had been filed on the cash basis. Expenses incurred prior to her death on November 13,1929, were not paid until subsequent thereto. This Board and the Circuit Court of Appeals for the Third Circuit held that the expenses incurred during the guardianship should be deducted from the gross income of that period rather than from the gross income of the estate in order that the net income of the guardianship should be clearly and properly reflected. Section 43 of the Kevenue Act of 1928 was cited, which is identical to the first sentence of section 43 of the Revenue Act of 1934, supra. On rehearing the deduction was disallowed by the court on the ground that the guardianship expenses were not business expenses, an issue which was not raised before the Board.

In Carondelet Building Co. v. Fontenot, supra, the taxpayer was on an accrual basis, its fiscal year ending September 30. On May 10, 1934, the day following its organization, it purchased a building and its income consisted almost entirely of rents therefrom. Prior to the purchase, the building had been assessed for 1934 taxes. City taxes amounting to $24,406 were paid on September 26, 1934, and state taxes amounting to $10,326 were paid on December 28, 1934. The taxpayer treated the aggregate taxes as an expense incurred in earning the monthly rents, prorated the taxes one-twelfth to each calendar month, and claimed a deduction for taxes accrued of $13,517 for the period May 10 to September 30,1934. The Circuit Court of Appeals for the Fifth Circuit approved the taxpayer’s method of proration on the ground that the rents ought to bear the monthly pro rata of the annual taxes in order fairly to reflect net income, although it held that the taxes did not, in strictness, become a liability of the taxpayer until it decided to assume and pay them.

The cases cited by the respective parties furnish but slight aid in determining the issue now before us. Despite the presence of the remedial provision in all of the revenue acts from 1924 to the present, few instances have arisen in which the courts or this Board have had occasion to consider it. Perhaps that is so because, in the great majority of cases, income is clearly reflected by taking the deductions and credits in accordance with the method of accounting employed. Yet the provision is not meaningless and its presence in the revenue act should not be ignored. Respondent does not contend that it should be; his principal argument is that no facts are shown justifying its application.

Implicit in the argument of the parties and, we think, in the section itself, is the conclusion that each case must be considered upon its facts in order to determine if the method of accounting regularly employed should be disregarded “in order to clearly reflect the income.” The legislative history likewise supports this view. It is appropriate, therefore, that the facts be examined carefully.

It will be noted that, whether petitioner’s income is computed by the method which it insists should be used, or by the method used by the respondent, the result of the three years’ operations is the same, viz., a net income of $52,781.59 or an average of approximately $17,593 per year. This amount is much larger than petitioner’s net income for any of the five years immediately preceding, or for either of the two years immediately succeeding, the period set out in the computation, though the number of barrels of flour produced did not vary greatly. (Petitioner’s net income from 1930 to 1934 ranged from a net loss of $21,354.43 in 1932 to a net income of $7,305.14 in 1933. Its net loss was $22,192.59 in 1938 and $33,657.72 in 1939.) But petitioner is not asking that the three years be consolidated and its income be computed upon that basis. Manifestly that could not be done. Burnet v. Sanford & Brooks Co., supra. It urges only that, in computing its income for the year's 1935 and 1936 (only 1935, however, is involved in this proceeding), it should be permitted to deduct the reimbursements actually made in 1937 to its vendees upon the products purchased by them in such years.

It is obvious from an examination of the computation made by the respondent that petitioner is being taxed upon an income of $50,-464.03 in 1935 and $154,540.69 in 1936, a total of $205,004.72, whereas in fact—if the subsequent reimbursements to its vendees upon, and applicable to, the sales in those years be considered—the actual result of its operations was a net income of $21,040.58 for 1935 and a net income of $49,773.23 for 1936, or a total of $70,813.81. Under respondent’s computation a similar distortion of petitioner’s true income for 1937 also results. Thus, the business actually transacted by it during 1937 resulted in a net loss of $18,032.22 (assuming in this connection that the amount reported by it in its return is correct). If the amounts paid to its vendees which have no relation whatever to the sales made in that year are deducted, the result of its operations is a loss of $152,223.13.

The real issue here is: What is the correct amount of petitioner’s taxable income for its fiscal year ended June 30, 1935? We now know that it is not entitled to the deduction for processing taxes which it accrued upon its books and claimed in its return. We also know that it made certain deductible reimbursements in a later year of part of the proceeds of the sales made during the period covered by the return. Obviously the disallowance of the deduction for the processing taxes and a disallowance of the deduction now claimed for reimbursements will result in petitioner being taxed upon a greater profit than was realized from its 1935 sales.

“Taxation ⅛ an intensely practical matter, and laws in respect of it should be construed and applied with a view of avoiding, so far as possible, unjust and oppressive consequences.” Farmers Loan & Trust Co. v. State of Minnesota, 280 U. S. 204, 212. The objective of all accounting methods is to “clearly reflect income.” The ideal method would be to charge against income earned during a taxable period the expenses attributable to the earning of it. The computation of net income upon the basis of a taxpayer’s annual accounting period in accordance with the method of accounting regularly employed does not always accomplish the desired objective. Section 43 was intended to aid in accomplishing it. While no limitation was placed upon its application, we are of the opinion that it was intended to apply to unusual and exceptional situations such as we have here. It is quite unlikely that this petitioner will ever again make, or be called upon to make, any reimbursements of the kind here involved. They were of a nonrecurring nature and resulted primarily from a judicial decision that the act imposing the processing tax was invalid. They could not have been foreseen on June 30, 1935, the end of petitioner’s fiscal year. They, however, represented payments under claims relating to 1935 sales. If such sales had not been made there would have been no basis for the claims and no reimbursements. They were not in any sense of the word related to sales made in 1937 and were not proper charges against the income of that year.

Upon brief respondent urges that petitioner can not be given the relief sought because of the provisions of article 43-1 (a) of Regulations 86. He points out that a similar regulation has been in effect for many years; that the regulations have always required his decision “as to whether the special treatment of section 43 is applicable”; that he has determined it is not applicable in the instant proceeding; and that “the regulations, making [his] decision final, having stood through many reenactments of the statute, now have the force and effect of law.” Helvering v. Reynolds Tobacco Co., 306 U. S. 110, is cited in support of this contention.

Section 41 provides that if no method of accounting has been employed by a taxpayer, or if the method employed does not clearly reflect the income, “the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income.” This section, however, is not applicable here and no such language is used in section 43. It authorizes deductions or credits to be taken in a different period if necessary “to clearly reflect the income.” The Commissioner’s decision is not made a prerequisite and the statute does not provide that any decision made by him is ■fmal. If the regulation should undertake to do so (though we do not so interpret it) it would, to that extent, be a nullity; for the Department can not, by regulation, either extend or limit an act of Congress. Helvering v. Powers, 293 U. S. 214. The power to prescribe rules and regulations “is not the power to make law * * * [but] * * * to carry into effect the will of Congress as expressed by the statute.” Manhattan General Equipment Co. v. Commissioner, 297 U. S. 129; Commissioner v. Winslow, 113 Fed. (2d) 418. But in the view which we take, it is unnecessary to determine whether the regulation is, or is not, a proper one. No doubt it is desirable, from an administrative standpoint, that the Commissioner determine if a taxpayer shall be permitted to take his deductions in a different period, just as he determines “what is carrying on a business, subject to reexamination of the facts by the Board of Tax Appeals and ultimately to review on the law by the courts on which jurisdiction is conferred.” Higgins v. Commissioner, 312 U. S. 212. So applied, the regulation would no'doubt be valid, especially in a situation where a taxpayer has made payments in an earlier year which should appropriately be deducted from the income of a later year. Here, however, the payments, which we believe should appropriately be deducted from the income of an earlier year, were not made until a later year. The regulation was not designed to take care of the latter situation. But that need not disturb us; for the statute makes no distinction. It is to be applied whenever such application is necessary “in order to clearly reflect income.”

We are of the opinion that the claimed deduction should be allowed in recomputing petitioner’s income for the taxable period before us.

Reviewed by the Board.

Decision will he entered wider Rule 50.

Disney, KeRN, and OpeeR concur only in the result.

MuRBOok,

dissenting: The prevailing opinion recognizes that this is not a case under section 41 involving an improper system of accounting for and reporting income. It also recognizes that the amounts in controversy were not actually accrued and could not have been accrued during the taxable year because no events had occurred during that year fixing a liability or determining the amount of any liability. The opinion is based entirely upon the proposition that the peculiar facts in this case require a deduction under section 43 in order to clearly reflect income, even though the item was not paid, accrued, or incurred during 1935, and even though, in all other respects, the accounting method of the taxpayer was entirely satisfactory.

The Board apparently finds that the item is deductible under section 23(a), which allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” This item was not paid or incurred during the taxable year. Since it was not an accruable expense of that year, it can not be allowed as a deduction for 1935 unless section 43 applies. The prevailing opinion does not demonstrate to my satisfaction that section 43 applies. The only relation which the item has to 1935 is that it grew out of transactions which occurred in that year. In so far as it was paid in 1937 to retain the good will of customers, it could not be justified under any theory as an ordinary and necessary expense of 1935. The petitioner earned a certain amount in 1935 which it thereafter retained as its own. Although as time went on vendees began to make claims, the petitioner consistently denied liability on those claims and no liability js established. After thus denying liability, and after paying only a part of the sums claimed by the vendees, the petitioner asks for relief under section 48. So far as the evidence shows, the petitioner might never have paid anything to the vendees had it not desired to retain their good will after 1987. I see no justification for relating back to 1935 under section 43 an amount thus paid in 1937. This case presents no exception to the general rule that deductions must be taken only when they are paid, accrued, or incurred in accordance with the accounting system regularly used. Cf. Estate of William H. Block, 39 B.T.A. 338; affd., 111 Fed. (2d) 60.

Tyson agrees with this dissent.

Arnold,

dissenting: I do not agree with the conclusion of the majority because in my opinion it errs in two respects. In the first place, the justification for the conclusion reached rests solely upon the exception contained in section 43, the application of which, it is held, will more clearly reflect petitioner’s income for the taxable year. Secondly, while the majority opinion relies upon section 43, it ignores the reasonable requirement contained in the Commissioner’s regulations dealing with the application of the exception.

In my opinion petitioner’s income is more clearly reflected by a computation in accordance with the method of accounting regularly employed in keeping its books than by the departure therefrom approved by the majority. Petitioner’s 1935 sales of flour were closed and completed transactions of that year. No obligation, express or implied, existed during 1935 to make reimbursement of any part of that year’s gross sales. The liability to vendees was first “paid or accrued” or “paid or incurred” in 1937 under agreements voluntarily entered into in that year, and, under the accrual system of accounting regularly employed by petitioner, such disbursements should properly be accounted for in that year. Accounting for 1937 liabilities in 1935 will not clearly reflect 1935 income; it distorts the income of both years. This Board should not permit a remedial provision of the statute to be used to distort income merely because the net result of shifting the deduction is to- lessen a taxpayer’s liability for taxes.

Section 43, so far as pertinent, appeared first in the Revenue Act of 1921, and provided that losses should be deducted in the year sustained, “unless, in order to clearly reflect the income, the loss should, in the opinion of the Commissioner, be accounted for as of a different period.” Sec. 234 (a) (4).

In the Revenue Act of 1924, Congress extended the principle in the 1921 Act relating to deduction of losses to all deductions and credits.

In section 200 (d) thereof it provided that “The deductions and credits provided for in this title shall he taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the method of accounting upon the basis of which the net income is computed under sections 212 or 232, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period.”

Section 212 of the Eevenue Acts of 1924 and 1926 and section 41 of each succeeding revenue act delegate to the respondent the power to determine whether the method of accounting employed by a taxpayer clearly reflects its income, and, “if the method employed does not clearly reflect the income”, the statute provides that “the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income.” Sec. 41, Eevenue Acts of 1934 and 1936.

Eespondent’s regulations have consistently construed section 43 and its prototypes as requiring compliance with certain formalities as a prerequisite to shifting a deduction to a different period. Art. 146, Eegulation 62; art. 43-1, Eegulations 86 and 94. See also T. D. 3261 (1921), 1-1 C. B. 148. The regulations have always required a taxpayer to take the deduction in the year “paid or accrued” or “paid or incurred” and to submit with the return a complete statement of facts upon which it relies to take deductions as of a different taxable year. The Commissioner would then have the information before him and the years affected, from which it could be determined whether income would be more clearly reflected by shifting the deduction to the period requested. The requirement in the regulations is, in my opinion, a reasonable one and imposes no hardship upon a taxpayer. The successive reenactments of the statutory provisions without alteration must be taken as an approval by Congress of the administrative construction and to have imparted to the regulations the force and effect of law, Helvering v. Reynolds Tobacco Co., 306 U. S. 110, and unless petitioner has complied with the distinct method provided for in the regulations, it can not avail itself of the exception contained in section 43. Stokes v. United States, 19 Fed. Supp. 577, 580.

The record here does not show that petitioner deducted the repayments on its 1937 return or submitted a statement of facts upon which it relies, or requested that such deductions be taken as of a different period. Had the petitioner complied with the requirements of the regulations and had the Commissioner disallowed the deduction from 1935 gross income, it would be the province of the Board to determine whether or not petitioner’s income would be more clearly reflected by allowing the deduction as of the period claimed. Any shifting of credits and deductions from the year in which they are “paid or accrued” or “paid or incurred” to another taxable period changes the net income of both periods. Unless the information called for in the regulations is furnished the Commissioner, he can not determine whether the income will be more clearly reflected or not, nor can the Board on review of the Commissioner’s; determination.

The majority opinion computes net income upon the net result of a transaction or series of transactions spread over two or more taxable years. Such an interpretation will lead to endless delays and! confusion in determining and closing tax liabilities. While here the exception works to the taxpayer’s advantage, taxable income, to be clearly reflected, can not be determined upon the basis of advantage or disadvantage either to the taxpayer or the Government in any one particular year.

       The figures in parentheses indicate losses.

       Petitioner deducts from its net income as shown in column B the $29,423.45 paid to its vendees on account of wheat processed and sold during May and June 1935, and the $104,757.46 paid to its vendees in connection with wheat products sold during its fiscal year ended June 30,1936, and prior to January 6,1936, thus arriving at the above amounts.

       Respondent has not yet audited or revised petitioner’s return for 1937. He claims, however, that the payments to petitioner’s vendees, aggregating $134,190.91, are deductible only on its income and excess profits tax returns for the year 1937.

       G.C.M. 20134, C. B. 1938-1, p. 122.

       SEC. 41. GENERAL RULE.
      The net income shaU 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 in accordance with such method 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 as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (Eor use of inventories, see section 22 (c).)
      SEC. 42. PERIOD IN WHICH ITEMS OP GROSS INCOME INCLUDED.
      The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.
      SEC. 43. PERIOD FOR WHICH DEDUCTIONS AND CREDITS TAKEN.
      The deductions and credits provided for in this title shall be taken for the taxable year in which “paid or accrued” or “paid or incurred”, dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. In the case of the death of a taxpayer there shall be allowed as deductions and credits for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior neriod.

       When the amendment incorporating the exception in the act was being considered in Congress the Ways and Means Committee in its report said :
      “* * * The necessity for such a provision arises in cases in which a taxpayer pays in one year interest or rental payments or other items for a period of years. If he is forced to deduct the amount in the year in which paid, it may result in a distortion of his income which will cause him to pay either more or less taxes than he properly should.” Kept. No. 179, Committee on Ways and Means, 68th Cong., 1st sess., p. 11.

       Abt. 43-1. “Paid or incurred” and “paid or accrued."—(a) The terms “paid or incurred” and “paid or accrued” will be construed according to the method of accounting upon the basis of which the net income is computed by the taxpayer. (See section 48 (c).) The deductions and credits provided for in Title I must be taken for the taxable year in which “paid or accrued” or “paid or incurred,” unless in order clearly to reflect the income such deductions or credits should be taken as of a different period. If a taxpayer desires to claim a deduction or a credit as of a period other than the period in which it was “paid or accrued” or “paid or incurred,” he shall attach to his return a statement setting forth his request for consideration of the case by the Commissioner together with a complete statement of the facts upon which he relies. However, in his income tax return he shall take the deduction or credit only for the taxable period in which it was actually “paid or incurred,” or “paid or accrued,” as the case may be. Upon the audit of the return, the Commissioner will decide whether the case is within the exception provided by the Act. and the taxpayer will be advised as to the period for which the deduction or credit is properly allowable.


author: Disnet :

text:
    William R. Todd, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101312.
    Promulgated June 19, 1941.

      James O. Coates, Esq., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Disnet :

The question for our determination is whether the $6,500.94 capital gain realized, as stated in stipulation filed by counsel, is distributable to and taxable to the petitioner, William It. Todd, in the year 1937, as contended by the respondent and denied by the petitioner.

The determination of that issue is dependent primarily on the construction of Elizabeth Pogue Todd’s will, the material and pertinent portions of which' have been stated in our findings of fact. The burden is of course upon the petitioner. Many authorities have been cited and relied on in briefs of counsel, touching their respective contentions, and though we have considered them, we will not undertake to discuss them in detail.

(1) The respondent contends, and petitioner denies, that the will of Elizabeth Pogue Todd bestowed upon her husband, William E. Todd, an absolute title or fee to her property. A careful reading of the provisions of the will of the decedent and a proper construction thereof, we think, clearly disclose that it was not the purpose or intention of Mrs. Todd to give or devise and bequeath to her husband an absolute fee or title to her property. The will gives the husband, petitioner herein, only “a life estate and interest” in the decedent’s estate, “he to have the income thereof for and during his life” with the “right and authority, in his absolute discretion, to use any part of the principal * * * for his support and maintenance or for the support and maintenance” of any of their children or their issue. The foregoing and other expressions in the will, in our opinion, indicate that decedent intended and expected that the principal of her estate would not be invaded or encroached upon by her husband, unless his support and maintenance or that of their children should require it.

The will gave the husband, William E. Todd, the right to deal with the decedent’s estate as he might “in his absolute discretion deem best, and collect, recover, and receive the rents, issues, profits, dividends and income thereof, the same to be for his benefit during his life.” That he was not by the will given an absolute fee in the property bequeathed and devised is also indicated by its provisions touching remainder interests in the fee after the life estate of the petitioner ended. The record shows the petitioner himself, although under the will given full power to deal with the estate property as in his absolute discretion he deemed best, subject to certain limitations imposed, as above indicated, recognized that he did not have an absolute fee thereto, which is indicated by the fact that he repaid to the estate all moneys withdrawn or advanced to him individually from the estate and not made as a distribution of income to him.

The respondent in support of his contention cites In re McClelland’s Estate, 257 S. W. 808 (Mo.), and National Surety Co. v. Jarrett, 121 S. E. 291 (W. Va.). We consider those cases distinguishable from the instant case and not controlling herein, in view of the fact that it was evidently not the intent and purpose of Mrs. Todd, as expressed in her will, to give her husband an absolute fee to her property, since the right and power given her husband to invade the principal of the estate and make use of it as he deemed best were limited to certain purposes and objects set forth in the will, which clearly contemplated remainder interests in fee after the life estate of the petitioner should end. Furthermore, the decisions in the two cases appear not to be in accord with the law of Ohio, the situs of this matter, as decided by the Supreme Court of Ohio in Johnson v. Johnson, 51 Ohio St. 446 ; 38 N. E. 61, wherein a husband, after directing in his will that all his just debts, expenses of his last sickness, and funeral expenses be paid out of his estate, gave and devised to his wife “all the remainder” of his property, “with full power to bargain, sell, convey, exchange, or "dispose of the same as she may think proper. But if, at the time of her decease, any of my said property shall remain unconsumed, my will is that the same be equally divided between my brothers and sisters and their children, if deceased.” He appointed his wife executrix and desired that she might not be required to give bond.

The court held, in substance, as expressed in syllabus 2, as follows:

The widow under this will was, by implication, a quasi trustee for those in remainder, and the interest of the brothers and sisters of the testator, in the unconsumed property, was a vested right which could not be destroyed by the act of the widow in disposing of the property by gift to a third party, or otherwise than for her support or the benefit of the estate.

To the same effect, see Baxter v. Bowyer, 19 Ohio St. 490.

We hold that the petitioner took no absolute title or fee to the decedent’s property, and that taxability of income to the petitioner can not be based upon that ground.

(2) The next question is whether, under section 161 (a) (2) and (8) and section 162 (b) of the Revenue Act of 1936, the capital gains were “to be distributed currently” to the petitioner, and therefore taxable as income to him.

There is nothing in the will of Elizabeth Pogue Todd specifically directing, authorizing, or requiring that the capital gains of $6,500.94 included by respondent in petitioner’s 1937 net income (which petitioner assigned as error) be currently distributed to the life beneficiary by the executor.

In Commissioner v. First Trust Deposit Co., 118 Fed. (2d) 449, affirming 41 B. T. A. 107, the court approvingly referred to the decision in Commissioner v. Stearns, 65 Fed. (2d) 371, stating that therein the court had said: “ ‘Income to be distributed currently’ is income directed by a will or deed to be currently distributed and that the words presuppose a periodic duty on the part of the trustee. The situation here resembles that of an estate in the course of administration where the income pending settlement is returnable by the Executor and is not regarded as the income of legatees or next of kin. * * * In a case like the present, where no provision for periodic payments of income coming into the trustee’s hands was made in the trust deed, the income was not to be imputed to the beneficiary either as credit allowable to the trustee in his account or otherwise.” Certainly there is not, in the instant matter any provision for periodic payment of capital gains to the petitioner.

The petitioner contends, in sum, first, that the provisions of the will give him, under Ohio law, no right to capital gains, and, secondly, that if he has received them in anywise other than as executor, he holds them as fiduciary for remainderman, as is shown by his actions.

(a) Does the will confer upon the petitioner the right to capital gains ? The text first and primarily grants “a life estate”; next, the petitioner is to have the “income for and during his life.” After a provision for use of principal for support and maintenance of the husband, children or their issue (already considered, and not, we think, of great weight on the immediate question), it is provided, in short, that the husband may receive control of and sell the property in his discretion, and “collect, recover and receive the rents, issues, profits, dividends and income thereof, the same to be for his benefit during his life.” The difference of opinion between the parties hereto hangs primarily upon the inclusion of the word “profits” in the language just quoted, the petitioner denying the respondent’s view that such inclusion indicates that he is entitled to receive more than the ordinary income, that is, may receive, and is taxable upon, capital gain from sale of principal of the estate. We of course look to the law of Ohio for authority.

We find no Ohio cases and none has been cited us in which the exact words used in the decedent’s will in the instant case have been interpreted by the Supreme Court of Ohio. However, that court, in the case of Devenney v. Devenney, 74 Ohio St. 96; 77 N. E. 688, said that the generally accepted rule of law respecting accretions is that:

* * * in the absence in the will of an expressed intent otherwise, the increase in the value of the corpus held by a trustee from natural causes is principal and not interest. As given approvingly in the opinion in Graham’s Estate, 198 Pa. 216, 47 Atl. 1108, quoting from In re N. Y. L. I. & T. Co. (Sur.) 53 N. Y. Supp. 382: “The loss or gain in the value of securities purchased by the trustee in the exercise of his sound discretion should go to the diminution or accretion, as the case may be, of the capital, and not to the income, unless a contrary intention must be inferred from the trust instrument.” The principal case above cited holds: “Where a trustee invests moneys of the trust estate in bonds, and subsequently sells the bonds at an advance, and invests the proceeds in other securities, the profit on the bonds is part of the principal of the estate and should be so held by the trustee.”

Words in effect identical to those used in the will in the instant (Ohio) case have been used in wills in other states and therein have been held not to entitle a life beneficiary to receive capital gains.

In Chase v. Union National Bank of Lowell, 275 Mass. 503; 176 N. E. 508, the will read in part: “I give, devise, and bequeath * * * the sum of ten thousand dollars in trust, nevertheless, to be invested and to pay over to my daughter, Laura J. Chase, all the net income, proceeds and profits to her sole use, during the term of fier natural life.” The trustee invested the funds in various securities, some of which subsequently were sold at a gain. The court held that the gain constituted part of the corpus of the trust and belonged to the remaindermen, even though the will provided that the life beneficiary should receive “all the net income, proceeds and profits to her sole use.” After reviewing various authorities, the court concluded:

The use of the words “net income, proceeds and profits” does not seem to indicate an intention that the trustee was expected to pay the beneficiary any-tning more than the net income of the trust property. They do not naturally mean that gains on the sale of the trust property or from the proceeds of the sale of rights were also to be paid to her. * * *

That the words “income and profits” ordinarily mean no more than “income” alone is supported by decisions in the following cases, in some of which it was held that profits from the sale of securities did not belong to the life beneficiary, but passed to the remaindermen as part of the corpus of the estate. In re Eger's Will, 247 N. Y. S. 527; 139 Misc. Rep. 59; In re Booster's Estate, 297 N. Y. S. 885; 164 Misc. Rep. 183; Stewart v. Phelps, 75 N. Y. S. 526; 71 App.Div. 91; Boardman v. Mansfield, 79 Conn. 634; 66 Atl. 169; Wood v. Davis, 168 Ga. 504; 148 S. E. 330; Fifty-Third Union Trust Co. v. Davis, 55 Ohio App. 377; 10 N. E. (2d) 4. See also the American Law Institute, Restatement of the Law of Trusts, vol. 1, sec. 233, p. 691, wherein it is said:

Where it is provided by the terms of the trust that the “income and profits” of the trust estate shall be paid to the life beneficiary, it is a question of interpretation whether the life beneficiary is to receive more than he would receive if it were provided that the “income” should be paid to him. Ordinarily the inference is that he is not to receive more, and if trust property is sold at a profit, the profit is principal.

In 17 Ruling Case Law, under the heading, “Rights, Duties and Liabilities of Life Tenant,” this statement is made on page 632:

22. Increase m Value of Estate.—Any increase in the value of the principal fund during the existence of the life estate is as a rule the property of the re-mainderman and not of the life tenant. Thus, an increase in the value of securities while in the hands of the life tenant belongs to the remainderman, as does also a profit made by the purchase and sale of securities, and the same is true of an increase in the value of real estate.

The respondent on this particular question seems to rely in the main upon Amy H. DuPuy, 32 B. T. A. 969, where a will like that being interpreted here bequeathed a life estate and gave a right to “profits” as well as income, rents, and issues, during the life of the beneficiary, and we held that capital gains from the sale of securities were taxable as income to the beneficiary. Two considerations, however, seem to us to render that decision not applicable herein. First, the will there gave the “rents, issues, income and profits thereof” to the beneficiary “as her absolute property”, while here the will provided that the petitioner could “collect, recover, and receive the * * * profits, dividends and income” “the same to be for his benefit during his life.” It seems plain that a provision bequeathing profits as absolute property differs essentially from the one herein, giving right to “collect, recover, and receive” profits and have the benefit thereof during life, particularly where prior language granted a life estate and interest and “the income thereof for and during his life.” On the facts we think the DuPuy case does not govern, and is not helpful on this point. Secondly, the DuPuy case arose in Pennsylvania and is rather carefully based upon the particular provisions of the law of that state, and they are somewhat peculiar and do not appear to be included in the law of Ohio. As pointed out in the DuPuy case, there is in Pennsylvania a rule, sometimes referred to as the “intact value” rule, under which, in case of securities passing by will, the value at the date of death is preserved intact as corpus, requiring apportionment between beneficiary and remainderman. It appears, moreover, that in that state the life tenant in case of such property as we have involved herein is not considered as a fiduciary for, but only the debtor of, the remainderman-. In the light of the rule as generally accepted in Ohio, as indicated in Devenney v. Devenney, supra, and the general tenor of the law on the subject as above set-forth, it is obvious, we think, that the decision here can not safely he based upon the DuPuy case and the Pennsylvania law.

(b) The petitioner also contends, in effect, that the administration of the decedent’s estate is still in existence, and that he holds the capital gains as fiduciary for the remainderman.

Counsel for the respective parties are in accord on the proposition that there is no difference as to the applicability of the provisions of section 162 (b) of the Revenue Act of 1936 to trusts and to estates during the period of administration or settlement thereof.

The petitioner, as executor of the Elizabeth Pogue Todd estate, maintained but one bank account, in which both ordinary and capital income were deposited and intermingled. The record, however, shows, and it is so stipulated, that the capital gain was not distributed to him nor withdrawn by him in the taxable year. The fact that he did not actually receive and appropriate it to his own use in 1937, however, is not important, if it was, in fact, then currently distributable to him and he was entitled to receive it. Under such circumstances he would be taxable with it. Freuler v. Helvering, 291 U. S. 35.

Regulations 94, article 162-1 (3), provides in part:

* * * The period of administration or settlement of the estate is the period required by the executor or administrator to perform the ordinary duties pertaining to administration, in particular the collection of assets and the payment of debts and legacies. It is the time actually required for this purpose, whether longer or shorter than the period specified in the local statute for the settlement of estates. If an executor, who is also named as trustee, fails to obtain his discharge as executor, the period of administration continues up to the time when the duties of administration are complete and he actually assumed his duties as trustee, whether pursuant to an order of the court or not. * * *

We have here a situation in which the will of the decedent gave her husband not only a life estate and interest in all her property and “income thereof for and during his life”, but appointed him executor of her will and directed that no bond be required of him, and stated therein, as heretofore set out: “He shall have the right to make such investments and reinvestments as he deems fit or proper and shall not be subject to the control of any court or of any other person or authority, for the exercise of his judgment and discretion in this respect.”

During the few years usually required for the “administration or settlement” of an estate, one serving simply as executor ordinarily does not make “investments and reinvestments.” In the circumstances of the instant case, the fact that the will did not specifically designate William R. Todd trustee as well as executor is not material, in our opinion, since the provisions of the will itself imposed fiduciary duties upon him which he accepted and discharged in the handling and investing of the funds of the estate, etc., as indicated in our findings of fact.

Article 162-1 (3) of Regulations 94, supra, implies that an executor who is also named as trustee may, after completing his duties of administration and without obtaining his discharge as executor, actually assume his duties as trustee, whether pursuant to an order of court or not. The record shows that the estate of Elizabeth Pogue Todd, deceased, has never been closed, but, from the time of his appointment as executor to the date of the hearing herein, William R. Todd, acting under the power and authority given him in the will of Elizabeth Pogue Todd, has had in his possession and control all the assets of her estate and has dealt with them not simply as a life tenant or beneficiary, but also as a fiduciary or trustee. The provisions of the will of Mrs. Todd, in our opinion, .make necessary the existence of a fiduciary or trustee to carry them out.

After consideration of the will and in particular the fact that it first granted a life estate, secondly, granted the income therefrom during life, and, thirdly, instead of making a bequest of profits as absolute property, only provided for the collection, recovery, and receipt of profits, with income, fqr benefit during life, and remembering the doctrine of ejusdem generis, impelling us to believe that the word “profits” was not intended to be in a different category from ordinary “income”, we come to the conclusion and hold that, fairly interpreted under the law of Ohio, the will of Elizabeth Pogue Todd did not grant to the petitioner the right to capital gains as income. Considering further the provisions of the will, the manner in which the estate has been administered by the petitioner as affording some light by way of construction of the instrument by a party interested, and the regulations, we come to the conclusion and hold that the petitioner was in the taxable year in a fiduciary position with reference to the remaindermen, and that he did not receive as his individual income the capital gains involved herein, but that they remained part of the principal of the estate. We therefore hold that the respondent erred in including in petitioner’s income the $6,500.94 capital gains herein involved.

Decision will ~be entered under Rule 50.

       SEC. 161. IMPOSITION OP TAX.
      (a) Application op Tax.—The taxes imposed by this title upon individuals shall apply to the income of estates or of any hind of property held in trust, including—
      * ******
      (2) Income which Is to he distributed' currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;
      (3) Income received by estates of deceased persons during the period of administration or settlement of the estate.
      SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
      * ******

      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which Is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year.


author: Tyson :

text:
    Hurd Millwork Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101956.
    Promulgated June 24, 1941.

      Alden Losby, Esq., and G. A. Bertelson, O. P. A., for the petitioner.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Tyson :

As to the petitioner’s delinquent taxes in excess of the $1,000 paid by petitioner in 1936, the mayor of Medford, testifying from recollection and with an evident lack of exact knowledge as to what actually had transpired, stated that such excess in the sum of $5,903.22 was charged back by Taylor County against the city of Medford, which, he presumed, was still paying such delinquent taxes out of the above mentioned $2,000 annual appropriations. However, the documentary evidence of record clearly establishes that Taylor County “owned and held” the tax certificates covering petitioner’s delinquent taxes; that the board of supervisors of that county, by formal action and in their official capacity, determined the value of such certificates to be $1,000 in 1936 subsequent to the fire, and accepted the $1,000 in cash offered by petitioner’s president “in full payment of said certificates”, which were sold and assigned to petitioner.

Accordingly, we conclude, and have found as a fact, that the petitioner’s liability totaling $6,903.22 for delinquent taxes, penalties, and interest for years prior to 1936, was fully discharged in consideration of petitioner’s payment of $1,000 on account thereof in 1936. At that time petitioner was solvent and its liability for delinquent taxes, which constituted one form of indebtedness incurred in the conduct of its business for profit, was canceled' to the extent of $5,903.22 by its creditor, Taylor County. Such cancellation was in consideration of the payment of $1,000 of the indebtedness and the cancellation was not gratuitous nor a capital contribution to petitioner.

The amount of $6,336.30 of petitioner’s delinquent taxes was accrued, but not paid, and deducted from income on its tax returns filed on the accrual basis for years prior to 1936. There is no showing that it did not thereby derive a tax benefit and we must assume that it did. Only $1,000 of such accrual was actually paid in 1936 and in the same year it became definitely certain that by reason of such payment, the surrender to petitioner of the delinquent tax certificates, and the release of the tax lien on its property, petitioner would never have to pay the balance in the sum of $5,336.30. The question then is, Did this latter amount constitute taxable income to petitioner in 1936, as contended by respondent?

In numerous prior cases where a taxpayer had been allowed a deduction for taxes, bad debts, losses, or expenses in the year in which paid and in a subsequent year the taxpayer, through refunds or collections, actually recovered all or a part of the amount theretofore deducted, it has been held that where the amount recovered had been previously deducted to offset income resulting in a tax benefit, it should be reported as part of the gross income for the year in which recovered. Burnet v. Sanford & Brooks Co., 282 U. S. 359; Chicago, R. I. & P. Ry. Co. v. Commissioner, 47 Fed. (2d) 990; Nash v. Commissioner, 88 Fed. (2d) 477; certiorari denied, 301 U. S. 700. Cf. Commissioner v. Central United National Bank, 99 Fed. (2d) 568, affirming 33 B. T. A. 588; Beacon Auto Stores, Inc., 42 B. T. A. 703; Estate of William H. Block, 39 B. T. A. 338; affd., Union Trust Co. v. Commissioner, 111 Fed. (2d) 60; certiorari denied, 311 U. S. 658; Central Loan & Investment Co., 39 B. T. A. 981; Houbigant, Inc., 80 Fed. (2d) 1012, affirming 31 B. T. A. 954; certiorari denied, 298 U. S. 669, and the various authorities cited in those cases.

In the instant case there was no actual recovery in the taxable year of money paid out in previous years. However, petitioner’s deductions from income for real estate taxes in prior years rested upon the accrual of its liability to actually pay such taxes at some subsequent date and for income tax purposes such accruals were properly treated as if payment had been made in the years the deductions were allowed. Having been so treated, we think the cancellation in part of the liability represented by such accruals was, for tax purposes, the equivalent of a recovery in the taxable year of the amount of the cancellation.

In Helvering v. Jane Holding Corporation, 109 Fed. (2d) 933 (reversing 38 B. T. A. 960); certiorari denied, 310 U. S. 653, interest on a loan was accrued, but not paid, and deducted from income on the taxpayer’s returns over a period of years prior to the taxable year there involved. In the taxable year, while the taxpayer was solvent, the accrued interest debt was canceled and forgiven for a consideration and not as a gratuity or a contribution to capital. The court held that the interest indebtedness theretofore deducted from income constituted taxable income in the year it was canceled. The court reviewed and discussed some of the above cited cases and numerous other prior decisions involving an analogous principle and said:

The above eases recognize the principle that an obligation, once deducted but not paid, represents income when, because of subsequent circumstances, it is cancelled or it may be determined with reasonable certainty that it will never be enforced. None of the cases attach any importance to the means by which the cancellation is effected. That is immaterial, the controlling factors being the previous deductions offsetting income otherwise taxable and the subsequent release of the indebtedness before payment.

In the instant case the petitioner, having derived the benefit of deductions for its liability for accrued but unpaid real estate taxes in the amount of $5,336.30, to offset income subject to tax in years prior to 1936, and having been relieved, through cancellation' in 1936, of its liability to pay such real estate taxes, that amount of $5,336.30 constituted a part of its gross income for the year 1936. Elsie S. Eckstein, 41 B. T. A. 746.

The second issue herein involves the question of whether respondent erred in disallowing a deduction of $1,772, claimed as real estate taxes accrued as a liability of petitioner for the year 1936, but not paid in that year.

The record herein fails to show that the amount of $1,772 taxes assumed and paid by the city of Medford has been included in petitioner’s gross income for 1936, either as reported by petitioner on its return or as determined by respondent in his deficiency notice, and no issue has been raised by this proceeding as to whether this item of $1,772 should now be included in petitioner’s gross income for the taxable year 1936. Accordingly, we express no opinion as to whether this amount constituted a nontaxable business subsidy to petitioner under the principles announced in Edwards v. Cuba Railroad, 268 U. S. 628, as contended by petitioner.

The respondent’s disallowance of the claimed deduction did not have the effect of including the amount of the alleged nontaxable subsidy in gross income for 1936, as contended by petitioner, for his determination resulted merely in the disallowance of a claimed deduction from petitioner’s gross income derived from its own; operating revenues, exclusive of the alleged subsidy.

The sole question herein is whether respondent erred in disallowing the claimed deduction of $1,772 as real estate taxes accrued as a liability of petitioner for the year 1936. The facts disclose that prior to the end of the taxable year 1936 it was determined, with reasonable certainty, by the favorable vote on the city’s appropriation of $2,000 annually to pay petitioner’s real estate taxes and also by the guaranty contained in the petition of the 266 citizens of Medford, that petitioner’s accrued liability for 1936 real estate taxes would never be enforced against it, that is, that petitioner would never have to pay such taxes out of its own operating revenues. Accordingly, we hold that petitioner’s 1936 real estate taxes were not a proper accrual deductible from its gross income for 1936 under section 23 (c) of the Revenue Act of 1936.

Decision, will be entered under Rule 50.


author: Black:

text:
    Boston Consolidated Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102050.
    Promulgated June 24, 1941.

      John E. McOlure, Esq., for the petitioner.

      W. Herdman JSchwatka, Esq., and Edward L. Updike, Esq., for the respondent.
   OPINION.

Black:

The respondent determined a deficiency in income tax against petitioner for the taxable year ended December 31, 1935, in the amount of $32,242.13. The petitioner brings this proceeding for a redetermination of his tax liability for that year. The respondent admitted at the hearing that petitioner was entitled to an additional deduction of $517.42 representing electrical energy tax which accrued in 1935. Certain other adjustments made by the Commissioner in his determination of the deficiency are not contested.

In its petition the petitioner alleges that the taxes in controversy are in the amount of $29,886.78, based on the following errors:

(1) In adding to income unclaimed amount of deposits made in the distant past by inactive customers, credited to surplus in 1935— $102, 871.16
(2) In adding to income unclaimed amount of cash deposited in meters in the distant past by inactive customers who purchased gas through the quarter meter device_ 53,453. 55
(3) In disallowing as a deduction cash shortage arising from alleged embezzlements in years prior to 1935- 61, 033. 70

The facts were all stipulated and we adopt the facts as stipulated as our findings of fact. We state herein only such of the facts as we deem necessary for an understanding of the issues to be decided.

Petitioner is a corporation organized and existing under the laws of the Commonwealth of Massachusetts, with its principal office in Boston. It filed its income tax returns for the year 1935 with the collector of internal revenue for the district of Massachusetts.

Facts with Respect to the First Issue.

The petitioner was incorporated in 1903 in Massachusetts for the purpose of acquiring the assets and assuming certain liabilities of eight preexisting gas companies. Its business was and is that of manufacturing, producing and selling gas for light, heat, and power, supplying Boston and suburban territories.

To insure payment of gas bills, certain customers were required to make cash deposits when meters were first installed. These deposits, by the terms of the deposit agreement, were returnable to such customers at the termination of the contracts to supply them with gas.

From prior to 1905 to the taxable year in question, numerous amounts of such deposits had been accumulated either by petitioner’s predecessors or by petitioner itself, all of which were accounted for in a general ledger account which totaled $431,014.44 at December 31, 1935. Up to that date the general ledger account was not supported by a detailed customers’ ledger account. On December 31, 1935, petitioner set up a detailed customers’ ledger which showed a balance of $328,143.28. The general ledger account of $431,014.44 was brought into balance by crediting the difference of $102,871.16 to petitioner’s profit and loss (surplus) account.

Subsequent to December 31, 1935, and up to December 31, 1939, petitioner returned to former customers upon demand or credited to the detailed customers’ ledger established in 1935 an aggregate net amount of $3,108.93 on account of payments of the kind mentioned above and charged the same to profit and loss (surplus). No part of this amount was included in the aggregate balance of $328,-143.28 shown by the detailed customers’ ledger on December 31,1935. The cash payments received from customers as deposits in the manner above stated were mingled by petitioner with its other cash funds.

Facts with Respect to the Second Issue.

Another method of collecting gas revenue was through the use of quarter meters, whereby a customer deposited a 25-cent piece in a meter, which then automatically delivered a measured quantity of gas. These meters were furnished to those customers who preferred purchasing gas in small quantities. Notwithstanding the difference in the methods employed in selling gas, the same rates were charged to all customers.

The quarter meters were read monthly and the petitioner’s books of account were adjusted accordingly. Often the customer had moved away and the petitioner, failing to locate the customer, carried the unused amount on its books as a liability.

Similar to issue No. 1, the general ledger account, amounting to $163,089.60 on December 31, 1935, was not supported by a detailed customers’ ledger account. On that date, the petitioner set up a detailed customers’ account of $109,636.05, and brought the general ledger control account into balance therewith by crediting the difference of $53,453.55 to profit and loss (surplus). The respondent has added the $53,453.55 in question to income.

Facts with Respect to the <Third Issue.

During 1935 the petitioner discovered a loss of $99,139.09 in its cash account which occurred through embezzlement by its treasurer. The loss through embezzlement in the cash account of $99,139.09 was discovered through an audit of the petitioner’s books by certified public accountants. The audit disclosed that on December 31, 1934, the loss through embezzlement was $98,323.35 and that on January 31, 1935, the embezzlement loss was $99,139.09. In the annual audit of petitioner’s books of account by certified public accountants made early in 1934, covering the calendar year 1933, no sueli cash shortage was discovered..

The taxpayer recovered a part of the shortage as follows: from a bonding company, $25,000; from the treasurer’s beneficiaries, $10,000; and cash found in the safe, $2,599.15; making a total of $37,599.15. The balance, $61,539.94, was charged off on the books in 1935 and claimed as a deduction by the petitioner on its 1935 tax return. The respondent allowed as a deduction only $506.24, on the ground that this amount was embezzled in 1935. He arrived at this $506.24 in the following manner, as stated in his deficiency notice:

The audit also disclosed that on December 31, 1934 the cash shortage was $98,323.55 and on January 31, 1935 the cash shortage was $99,139.09, indicated that only $815.54 of the shortage in question occurred in 1935.
In accordance with the method of allocating recoveries on the basis of the amounts recovered and the years in which the shortage occurred as employed in the case of Granada, BanJc, 82 B. T. A. 1290, it has been determined that the amount of allowable deduction in 1935 is $506.24, and that the balance of the shortage (i. e. $61,033.70) is not applicable to 1935. The following illustrates the allocation of the loss:

The petitioner claims that the $61,033.70 disallowed by the Commissioner constituted a loss in 1935 and should be allowed as such.

Issues (1) and (2).—These issues involve substantially the same question and may be considered together. Both the petitioner and the Commissioner, in their briefs, treat the basic question involved in issues (1) and (2) as the same.

It is the respondent’s contention that the amounts involved in these issues are includible in income for the year 1935 as a result of the credit of such amounts to petitioner’s surplus in that year, making them available for dividends and other corporate purposes and thus realizing within that year an accession to income within the intendment of section 22 (a) of the Bevenue Act of 1934.

The petitioner contends that the crediting of the amounts in question to surplus was for the purpose of facilitating the keeping of its accounts and not for the purpose of appropriating the sums as its own property, and that it was still liable to repay any claims of former customers for refunds of deposits or overpayments of their gas accounts if established to be payable from these funds.

In Chicago, Rock Island & Pacific Railway Co., 13 B. T. A. 988; affimed on this point, 47 Fed. (2d) 990, overcharges by the railroad resulting from errors in computing passenger fares and credited to profit and loss were field, as a practical matter, to be a part of the income of the railroad company for the year during which they were credited to income. In its opinion the court, among other things, said:

In case petitioner were required, to refund any of such overcharges to a passenger, who identified the transaction, we have no doubt that such refund would be a proper deduction for the year in which it was made.

In Charleston & W. C. Ry. Co. v. Burnet, 50 Fed. (2d) 342, affirming 17 B. T. A. 569, unclaimed wages earned by employees prior to January 1, 1922, were credited to profit and loss in December 1924. In holding that the amounts thus restored to profit and loss were income for the year in which the restoration was made, the court said that, though the company intended paying proper claims on the fund if and when sought: '

* * * the effect of the bookkeeping was to make available for general uses the particular moneys impressed in 1921 with the particular obligation * * *.
It thus became as much a part of the gross revenue in 1924 as though paid in that year for carriage charges.

To the same effect is Atlantic Coast Line Railroad Co., 23 B. T. A. 888.

We think the principle governing the decisions in the above cases is applicable here. It is true that subsequent to 1935 petitioner paid out the sum of $3,108.93 against the amount of $102,871.16 and there is a possibility more claims may be presented and paid. If so, such payments should be deducted from income in the year in which paid. Obviously they do not affect the status of the $102,871.16 and $53,-453.55 which petitioner transferred to profit and loss (surplus) in 1935 and made available for general uses including the payment of dividends.

On issues (1) and (2) we sustain the respondent.

Issue (3).—An audit of petitioner’s books in 1935 disclosed that on December 31, 1934, funds in the amount of $98,323.55 had been embezzled in that and prior years and that on January 31, 1935, the amount of the loss had increased to $99,139.Q9. This indicated that only $815.54 of the total amount was embezzled in 1935. Of the total amount embezzled, petitioner recouped $37,599.15 from a bonding company and other sources. The respondent allocated the amount recovered as between the amount embezzled prior to 1935 and the amount embezzled in 1935, and allowed as a loss in 1935, not compensated for by insurance or otherwise, and deductible in that year, the amount of $506.25. The petitioner contends that the entire amount of $99,139.09 is deductible in 1935, the year in which it was discovered.

The statute (sec. 23 (f), Revenue Act of 1934) provides that in computing net income there shall be allowed as deductions,' “In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.”

It is well settled that embezzlement does not raise a debtor-creditor relation between the parties, but results in a loss in the year the embezzlement occurs. National Sash & Door Co., 5 B. T. A. 931; Peterson Linotyping Co., 10 B. T. A. 542; Bank of London & South America, Ltd., 17 B. T. A. 1263; Bank of Wyoming, 22 B. T. A. 1132; Piggly Wiggly Corporation, 28 B. T. A. 412; First National Bank of Sharon, Pa. v. Heiner, 66 Fed. (2d) 925; Grenada Bank, 32 B. T. A. 1290.

In First National Bank of Sharon, Pa. v. Heiner, supra, an employee of a bank embezzled funds during the years 1922 to 1928, inclusive. The Circuit Court of Appeals for the Third Circuit held that the funds embezzled constituted a loss and not a bad debt and could only be deducted in the year in which it occurred.

We hold, therefore, that the respondent próperly limited the loss deductible to the loss sustained in 1935 and that his allocation of the amounts recovered between the loss sustained in 1935 and the loss sustained in prior years was proper. Grenada Bank, supra.

Decision will he entered u/nder Rule 50.