text:
    Hartford-Empire Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94788, 95673.
    Promulgated December 19, 1940.

      Edgar J. Goodrich, Esq., Arthur T. Safford, Esq., and Norman E. 'Webster, G. P. A., for the petitioner.

      Charles P. Reilly, Esq., for the respondent.
   OPINION.

Smith :

The question for decision in these proceedings is whether the petitioner is entitled to deduct, from the gross income of each of the years 1932, 1933, and 1934, $133,944.19 representing depreciation on the Empire patents and $27,811.56 depreciation on the Howard patents. The petitioner has claimed and been allowed in its tax returns like amounts for depreciation on the Empire and the Howard patents for each of the years 1923 to 1931, inclusive. The allowance was taken upon the .costs of the patents and patent riglits to the petitioner as stipulated in Hartford-Empire Co., 26 B. T. A. 134, which involved deficiencies determined for the years 1923 to 1928, inclusive. Petitioner has assumed that this was the correct basis for the computation of the allowance and the respondent has not questioned the correctness of the basis in the audit of the petitioner’s returns for those years. For the taxable years before us the respondent contends that the petitioner is not entitled to allowances for depreciation based upon the values of patents and patent ¡applications as of January 1, 1923, but upon the basis of cost to the predecessor owners. The respondent contends that the petitioner for years prior to 1932 has claimed and been allowed greater amounts for depreciation in respect of the Empire and the Howard patents than it was entitled to under the law; that it has already more than recovered the basis through deductions for depreciation; and, hence, that it is not entitled to any further deductions.

It is the position of the petitioner herein that the question of the proper basis for the computation of the allowances is res ad judicata; that the question has already been decided by the Board in Hartford-Empire Co., supra.

In Bouvier’s Law Dictionary it is stated :

The doctrine of res judicata is plain and intelligible, and amounts simply to this, that a cause of action once finally determined, without appeal, between the parties, on the merits, by a competent tribunal, cannot afterwards be litigated by a new proceeding either before the same or any other tribunal; Foster v. The Richard Busteed, 100 Mass. 409, 1 Am. Rep. 125.

In Sand Springs Railway Co., 31 B. T. A. 392, the Board said at page 394:

The doctrine of res judicata is so well fixed in the law that no useful purpose could be served here by further discussion. Cromwell v. County of Sac, 94 U. S. 351, 352, and 353; New Orleans v. Citizens Bank, 167 U. S. 371; Southern Pacific Railroad Co. v. United States, 168 U. S. 1; United States v. Moser, 266 U. S. 236; Tait v. Western Maryland Railway Co., 289 U. S. 620, 623; Mary Haller, 26 B. T. A. 395; Charles P. Leininger, 29 B. T. A. 874; Portage Silica Co., 29 B. T. A. 881; Edwin J. Marshall, 29 B. T. A. 1075.
Our inquiry, therefore, is as to the propriety of its application in bar of the pending proffer of evidence.
Since the parties to both proceedings are the same, but the causes of action different, the decision in the former cases is a bar here, if, and only if, “the point or question to be determined in the latter action is the same as that litigated and determined in the original action.” Tait v. Western Maryland Railway Co., supra.

The question here is whether the basis for the computation of depreciation on the Empire and the Howard patents was judicially determined by the Board in the proceeding at 26 B. T. A. 134.

The parties to the prior proceeding conceded that the basis for depreciation of the assets acquired by petitioner from the Hartford-Fairmont Co. was the same in the hands of petitioner as it had been in the hands of the Hartford-Fairmont Co. The only issue for decision by the Board in that connection was whether that basis was the cost of those assets to the Hartford-Fairmont Co. or their fair market value on March 1, 1913. The petitioner’s basis for depreciation on the assets acquired from the Empire Machine Co. and the Howard Co. was not in issue in that case, nor was the question whether the acquisition of assets from any one of the three companies by the petitioner constituted a reorganization or nontaxable exchange. Quite naturally in the recomputation of the deficiencies under Bule 50 the parties took cognizance of the agreement which they had made between themselves with respect to the correct amount of depreciation on the Empire and the Howard patents and the Board entered the agreed upon computation as its decision in the case.

The petitioner contends that in Arthur Gurtiss James, 31 B. T. A. 712, we held that a stipulation of facts filed by the parties in a prior proceeding made the question in the subquent proceeding res adjudí-cala. But in that case the question in issue before the Board was the amount of earnings or profits of the Phelps-Dodge Corporation accumulated since February 28, 1913, on hand and available for dividends on January 1, 1918. That was the precise question raised by the pleadings in the case of the same taxpayer, 13 B. T. A. 764. Since the Board had adjudicated that question by its decision in the earlier case (albeit the decision was entered pursuant to a stipulation of the parties), the Board held that the plea of res ad judicata was well taken. The James case differs from the instant proceedings in that here we have for the first time the question of the proper depreciation allowance on the Empire and the Howard patents. It was not raised by the pleadings in the proceeding at 26 B. T. A. 134, and, consequently, was not adjudicated by the Board in that proceeding.

An earlier judgment is conclusive only as to the precise facts, rights, questions or issues adjudicated in the earlier case that are again facts, rights, questions or issues presented for adjudication in the second case. Charles P. Leininger, 29 B. T. A. 874; D. F. Strickland, 32 B. T. A. 804; Terre Haute Electric Co., 33 B. T. A. 975, 983; (C. C. A., 7th Cir.), 96 Fed. (2d) 383; Hanby v. Commissioner (C. C. A., 4th Cir.), 67 Fed. (2d) 125; Tait v. Western Maryland Railway Co., 289 U. S. 620.

The res adjudícala plea of the petitioner can not be sustained.

The petitioner further submits that, wholly aside from the application of res adjudicaba, the respondent is at this time estopped to deny that the petitioner is entitled to deduct the same amount of amortization on the Empire and the Howard patents for the years in question as has been allowed for years prior to 1982. It states, and the respondent does not deny, that the respondent was in possession of the same facts with respect to the computation of the amortization allowance for the prior years as for the taxable years; that therefore 'the respondent can not equitably at this time reverse his position with respect to the basis for the allowance of amortization on the Empire and the Howard patents.

Nowhere does it appear that the respondent has in any wise misled the petitioner to its detriment in the determination of the basis upon which the amortization allowances should be made. The simple facts are that in the returns for years prior to 1932 the transferors, the Hartford-Fairmont Co., Empire Machine Co., and Howard Co., all proceeded upon the theory that the transfers of assets made by those companies to the petitioner, effective as of January 1, 1923, were tax-free exchanges involving them in no tax liability. The respondent acquiesced in such claims. The petitioner claimed that the basis for the computation of amortization on the Empire and the Howard patents was a fair market value of the patents and applications for patents transferred to the petitioner as at January 1,1923. The respondent acquiesced in such claim. We do not see, however, how the respondent is in any wise foreclosed from the computation of the correct amount of the amortization allowance for the taxable years 1932, 1933, and 1934 by such acquiescence. The theory of equitable estoppel has no application to this case. See James Couzens, 11 B. T. A. 1040, 1147.

The petitioner further submits that even though its plea of res adjudicaba and of equitable estoppel is not sustained, the basis for the computation of the amortization allowance is the fair market value of the patents and applications for patents on January 1, 1923; that under the provisions of the Revenue Act of 1921 the transactions by which the Empire Machine Co. and Howard Co. transferred assets to the petitioner were taxable transactions and that the basis to the petitioner for the amortization allowance is therefore the fair market value of the assets acquired.

The basis for depreciation of property for the years 1932 and 1933 is to be found in the Revenue Act of 1932 and the basis for 1934 in the Revenue Act of 1934. The pertinent provisions of the acts are identical. Therefore, reference will be made only to the 1932 Act.

Section 114 of the 1932 Act provides that the basis for depreciation of property shall be the basis provided in section 113 for determining gain or loss on sale or disposition of such property. Section 113 (a) provides in part as follows:

(7) TRANSFERS TO CORPORATION WHERE CONTROL OF PROPERTY REMAINS IN SAME persons. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 60 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration. in whole or .in part for the transfer.
(8) Property acquired by issuance of stock or as paid-in surplus. — If the property was acquired after December 31, 1920, by a corporation—
(A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (o) (including, also, eases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities) * * *
* * # * * * *
then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under, the law applicable to the year in which the transfer was made.

Section 112 (b) (5) provides:

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

It is quite clear that (1) if the acquisition by the petitioner of the Empire and the Howard patents and patent rights was in a transaction of the type described in section 112 (b) (5), even though the consideration for the transfers of the properties included money,- in addition to stock of the petitioner, or (2) if the acquisition was in connection with a reorganization and after the transfer of the property an interest or control of 50 percent or more remained in the transferors, or any of them, then, in either event, the basis for depreciation is the same as it would have been in the hands of the transferors, adjusted for the amount of gain or loss recognized to the transferors upon such transfers under the Revenue Act of 1921. In our opinion the transactions here under consideration fit within not merely one but both of the above requirements.

It is admitted that no gain or loss was recognized to the transferors, the Empire Machine Co. and the Howard Co., for the year in which the transfers were made. The respondent contends that such nonrecognition of gain or loss to the transferors was entirely proper under the Revenue Act of 1921.

Section 202 of the 1921 Act provides in part:

(c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized—
*******
(3) When (A) a person transfers any property, real, personal or mixed, to a corporation, and immediately after the transfer is in control of such corporation, or (B) two or more persons transfer any such property to a corporation, and immediately after the transfer are in control of such corporation, and the amounts of stock, securities, or both, received by such persons are in substantially the same proportion as their interests in the property before such transfer. For the purposes of this paragraph, a person is, or two or more persons are, “in control” of a corporation when owning at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

As to the meaning of the term “reorganization” as used in section 202 (c) (2) of the 1921 Act, that paragraph provides:

(2) * * * The word “reorganization,” as used in this paragraph, includes a merger or consolidation (including the acquisition .by. one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form, or place of organization of a corporation (however effected) ; * * *

We consider first the question whether the exchanges of assets made by the stockholders of the Hartford-Fairmont Co. and by the Empire Machine Co. and the Howard Co. for shares of stock of the petitioner in 1922 were tax-free exchanges as claimed by the transferors and allowed by the respondent. The facts bearing upon this issue are that the petitioner issued all of its common stock (100,000 shares) in the acquisition of all the shares of stock of the Hartford-Fairmont Co. and of most of the assets of the Empire Machine Co. Under the formation agreement the petitioner assumed the liabilities of the Hartford-Fairmont Co. The net value of the assets of that company is arrived at as follows:

Assets___$3, 758,470. 50
Less depreciation reserves and liabilities:
Total of depreciation reserves-$460, 479. 42
Due Empire Machine Co_ 17, 548. 79
Notes payable_ 361, 000. 00
Due employees_±— 48, 700.00
- 887, 728.21
Assets (net)_ 2, 870,742.29

The outstanding notes of $361,000 were payable in cash or preferred stock of Hartford-Fairmont Co., or its successor. The petitioner acquired these notes from the noteholders by issuing in exchange therefor 3,610 shares of its own preferred stock.

Included in the amount “Due employees $48,700” listed as a liability of the Hartford-Fairmont Co. were warrants in the amount of $33,000. The warrant holders were employees of that company and most of them were also stockholders. The petitioner acquired these warrants by issuing to the warrant holders in exchange for their warrants 330 shares of the petitioner’s preferred stock.

As of January 1, 1923, the petitioner acquired all of the assets of the Howard Co., consisting of patents, patent rights, and contract rights valued at $500,000. As consideration therefor it paid $50,300 cash and issued 4,497 shares of its preferred stock.

It will thus be seen that the petitioner issued all of its common and preferred stock outstanding at January 1, 1923, in the acquisition of assets from the Hartford-Fairmont Co., Empire Machine Co., and Howard Co., and in the acquisition of the notes payable and warrants which the Hartford-Fairmont Co. had outstanding.

The petitioner contends that the noteholders and warrant holders of the Hartford-Fairmont Co. were not transferors within the meaning of the statute; also that the assets of the Howard Co. were acquired in a separate transaction from that relating to the acquisition of the assets of the Hartford-Fairmont Co. and Empire Machine Co., and, accordingly, that it can not be held that there was a reorganization of the three companies mentioned within the meaning of the Eevenue Act of 1921.

The respondent submits that the recipients of all of the issued common and preferred stock of the petitioner were transferors; that they transferred assets to the petitioner for shares of stock of the petitioner; and that such transferors correctly claimed, in 1922, that they had exchanged such assets for shares of stock of the petitioner in tax-free exchanges.

We are of the opinion that there is no merit in the contention of the petitioner that the noteholders and warrant holders of the Hartford-Fairmont Co. were not transferors within the meaning of the taxing statute. The notes and warrants were clearly property. We think that they fall in the same category as any other property, as, for instance, patents and applications for patents.

The petitioner further contends that the acquisition by it of the Howard Co.’s assets was separate and distinct from the acquisition of the shares of stock of the Hartford-Fairmont Co. and of the assets of the Empire Machine Co. It is true that the formation agreement is silent with regard to the proposed acquisition of the Howard Co.’s assets. It is also true that negotiations for the acquisition of the assets of all three companies were going on at the same time. That the acquisition by the petitioner of the assets of the Howard Co. was a part of a plan for the formation of the petitioner is indicated by the following statement from the “Agreement for Purchase of Stock of Howard Automatic Glass Feeder Co.” entered into on June 23, 1922:

WITNESSETH THAT :
Section 1. Whjsrkas, the said Fairmont Company and interests associated with it are now in the course of organizing under the laws of the State of Delaware, a new corporation which shall be called the Hartford-Empire Company, hereinafter referred to as the Hartford Company, which Company, it is intended, shall take over the majority of stock of said Fairmont Company and the majority of the assets of the Empire Machine Company, a corporation organized under the laws of the State of Maine, * * * ' !

The petitioner corporation had an authorized capital of 100,000 no par value common shares and 15,000 preferred shares of a par value of $100 each. The formation' agreement was concerned only with the acquisition of assets of the Hartford-Fairmont Co. and Empire Machine Co. for the 100,000 no par value common shares. It is apparent, however, that a part of the preferred shares was for the acquisition of other properties. In fact, 3,940 shares of the preferred stock had been issued to the noteholders and warrant holders of the Hartford-Fairmont Co. prion to the date of the formation agreement and 4,497 shares of the preferred stock were issued to the Howard Co. only a few days after the date of such agreement and in fulfillment of the agreement of the petitioner with that company dated June 23, 1922. It is furthermore to be noted that the petitioner was organized to consolidate the ownership of independent and complementary devices and processes for feeding and forming molten glass’. The acquisition of the Howard Co.’s patents and applications for patents was necessary in carrying out the plan. In its brief the petitioner states that “petitioner had to buy the Howard patents at whatever cost and was forced to pay the price Howard regarded as their full market value.” The Howard Co. was unquestionably a transferor of property to the petitioner. Where several transfers are made pursuant to a plan it is not even necessary that the several transfers be effected simultaneously. Portland Oil Co. v. Commissioner, 109 Fed. (2d) 479. In that case was involved the question whether after a transfer wherein no gain or loss was recognized the transferee corporation was entitled to a stepped-up basis upon the transferred property. The transfer occurred in 1929. The tax year in which the stepped-up basis was sought was 1931. The new corporation in that case had acquired a certain valuable contract from the old corporation for bonds of the new company and 75 percent of its stock. No gain or loss was recognized by the old corporation, but the shareholders reported their gains on the liquidation distributions when the old corporation was liquidated and dissolved. The other 25 percent of the stock of the new company had been previously issued for cash to the wives of the stockholders of the old corporation. Relying on section 113 (a) (7) of the Revenue Act of 1928, the new company contended that, because the old corporation had only a 75 percent interest in the new company, it was not limited to the old company’s basis for the property transferred. The court, however, found it unnecessary to consider section 113 (a) (7) of the Revenue Act of 1928 or the reorganization status. Its conclusion was based on sections 112 (b) (5) and 113 (a) (8) of the statute. Th¿ court held that the wives’ payment of cash to the new corporation for its stock must be considered as one transaction with the old corporation’s transfer of the contract; that the cash was “property”; and that therefore there was a transfer by the wives and the old corporation to the new corporation for all its stock (100 percent), and, therefore, the trans-ferors, taken collectively, were in-control of the new corporation. Similarly,- here, the acquisition by the petitioner of the Hartford-Fairmont Co. stock, of the Empire patents, of the Howard patents, and of the Fairmont notes and warrants were all steps in a single plan The owners of these assets were transferors of property to the petitioner- and they were the owners not only of 80 percent of the common and preferred shares of the petitioner but of 100 percent.

The petitioner also contends that the amounts of stock received by the transferors were not in substantially the same proportions as their interests in the property before the transfer. We think, however, the evidence shows that they were. The basis for determining this fact is the value of the assets at the date of transfer in comparison with the value of the stock received by each transferor. United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. The following table shows the value of the assets to each transferor (or group of trans-ferors) at the time of the transfer, the percentage of each in the total assets transferred to the petitioner, the percentage of stock in the petitioner corporation received by each in the exchange, and the differences between the percentages of interest before and after:

Had it not been for the fact that the Howard Co. received $50,300 in cash as part consideration for the transfer of its assets to the petitioner there would be an absolute equivalence between the percentage of the total assets of each transferor and the percentage of the value of the shares received by each. The respondent argues that under the opinion of the court in United Carbon Co. v. Commissioner, supra, the value of the assets transferred by the Howard Co. should be reduced from $500,000 to $449,700, in which case there would be an absolute equivalence between the two columns of percentages in the above table. We think, however, that the variation in percentage by including the value of the Howard assets at $500,000, which was the agreed purchase price, makes the substantial equivalence required by the statute.

Even if the transaction by which the petitioner acquired the shares of stock of the Hartford-Fairmont Co. and assets of the Empire Machine Co. be treated separately from that by which it acquired the assets of the Howard Co. we nevertheless think that the amortization allowance on the “Empire” and “Howard” patents is subject to the provisions of section 113 (a) (7) of the Revenue Acts of 1932 and 1934, for after the transfer of the former the transferors of the Fairmont-Hartford Co. stock and of the assets of the Empire Machine Co. had more than a 50 percent interest in the stock of the petitioner and, since the petitioner acquired substantially all of the assets of the Howard Co., those assets were acquired in a reorganization of that company. (See sec. 202 (c) (3), Revenue Act of 1921.)

It is clear that under the provisions of the Revenue Acts of 1932 and 1934 it was not the intention of Congress that transferees acquiring assets on a tax-free exchange should be entitled to compute depreciation upon a different basis from that of the transferors. If this were so a taxpayer would receive taxable income which would be offset by allowances for depreciation, and, hence, never subject to income tax. The Revenue Acts of 1932 and 1934 are specific that a transferee receiving property in a tax-free exchange shall not have a stepped-up basis for the purpose of allowances for depreciation. See Fairbanks Court Wholesale Grocery Co. v. Commissioner (C. C. A., 7th Cir.), 84 Fed. (2d) 18, affirming Durand-McNeil-Horner Co., 30 B. T. A. 769; certiorari denied, 299 U. S. 582; Portland Oil Co. v. Commissioner, supra. In the Fairbanks Court Wholesale Grocery Co. case the statutory provision relied upon by the court is section 204 (a) (7) of the 1924 Act, which section corresponds with section 113 (a) (7) of the 1932 Act except that the 80 percent control required by the 1924 Act is changed to 50 percent in the 1932 Act. The court in its opinion stated: “We think it was tbe purpose of the section in question to prevent any so-called £stepped-up’ basis of valuation where no substantial amount of new capital was introduced.”

In accordance with the stipulations of the parties, the petitioner is not entitled to any deduction for amortization of the patents and patent rights acquired by it from the Empire Machine Co. and the Howard Co. for the years 1932,1933, and 1934.

Reviewed by the Board.

Decisions will be entered under Rule 50.


source: Caselaw Access Project

author: Oppbe:

license: Public Domain

text:
    Jordan Creek Placers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 98057, 99210.
    Promulgated December 19, 1940.

      Clyde C. Sherwood, Esq., John V. Lewis, Esq., and Albert H. Davidson, Esq., for the petitioner.

      Arthw L. Murray, Esq., for the respondent.
   OPINION.

Oppbe:

Petitioner first contends that, having been organized as-a “mining partnership” under Idaho law, it is a partnership, and not an association taxable as a corporation. For this conclusion it relies principally upon Joe Gilovich & Co., 6 B. T. A. 864. It seems to us, however, that the distinction from that case will readily appear from a quotation taken from the opinion at page 867. “Petitioner in this case did not conduct its business upon the methods and forms used by incorporated bodies. It had no capital stock or certificates of interest in its ownership; no officers, trustees or directors; it had no charter and was not created by declaration of a trust or writing of any kind. All of the members of the petitioner actively engaged in the operation of the business and each had a voice in its management.”

In the present case petitioner had certificates of interest which it is specifically provided must be canceled and new certificates issued before any transfer of ownership in the enterprise is to be recognized. It had officers consisting of a “managing partner” and a treasurer. It was created by a formal written document setting forth the relationship of the parties to each other and to the enterprise. And only the managing partner was actively engaged in the operation of the business, although, it is true, the other participants had a right to be heard on questions relating to the conduct of the business and were kept advised of its progress.

On the other hand, the conclusion that petitioner is taxable as a corporation is necessitated by more recent cases dealing with the subject, particularly that of Del Mar Addition v. Commissioner (C. C. A. 5), 113 Fed. (2d) 410. There all of the essential characteristics of the petitioner were present. Here, as in that case, title to the property was taken by one of the individuals “to be held in trust for the partnership.” The interest of the parties was represented by shares or certificates which were transferable without terminating the enterprise. There was centralized control. And death of the participants did not effect a dissolution. It is true that complete limitation of personal liability, which is a normal attribute of the corporate form, is not necessarily present here, but neither was it in Del Mar Addition v. Commissioner, supra. Both this Board, 40 B. T. A. 833, and the court concluded that this was insufficient to remove the taxpayer from the corporate class.

In the present case a perhaps more simple criterion presents itself. The participants in the enterprise expressly constituted themselves a mining partnership under Idaho law. In order to determine the characteristics of such an entity it is hence not unreasonable to be guided by the provisions of Idaho statutes and the pronouncements of Idaho courts as to their meaning. For this purpose one reference will suffice. In Hawkins v. Spokane Hydraulic Min. Co., 3 Idaho, 650; 33 Pac. 40, 42, these statutory provisions were analyzed in detail. The court said:

* * * In short, a mining partnership, by virtue of our statute, in all its essential elements is precisely like a corporation. To make this fact perfectly apparent, let us paraphrase out statute. * * * Let us suppose a corporation owning a woolen factory, and regularly organized. Compare the principles announced with our mining partnership.

The court then proceeds to paraphrase the sections of the Idaho Revised Statutes dealing with mining partnerships, substituting “the word ‘corporation’ for ‘mining partnership’ and the words ‘corporate property’ for ‘mine’ ” and concludes “They are the same principles that govern all corporations, to the extent of the control and management thereof.”

Since the parties must be considered to have imported this decision, as an authoritative interpretation of Idaho law, into their contract which set up the enterprise under these very statutory provisions, we conclude that the agreement of the parties alone would be sufficient to demonstrate that this was more nearly like a corporation than other forms of organization. On this issue respondent is sustained.

The second point involves the effectiveness of capital stock tax returns filed by the petitioner after the deficiency notice had been sent but before these proceedings were instituted by the filing of petitions. Allegations of petitioner’s action in filing the returns are set forth in the petition and their efficacy is placed in issue by appropriate denials in the answer. Under these circumstances we are of the opinion that the returns, although late and subject to delinquency penalty, were effective in the absence of a prior filing either by petitioner or by respondent in petitioner’s behalf. See Del Mar Addition v. Commissioner, supra.

In Taylor Securities, Inc., 40 B. T. A. 696, the Board had before it the question whether a foreign corporation could obtain the benefits of filing an income tax return for the first time after the proceeding had been commenced and the pleadings completed, and where no issue as to the filing of the returns was raised by an amendment prior to the hearing. In ruling that it could not, the first ground relied upon by the Board (p. 702) was that “ * * * the controversy between the parties respecting the effect of the filing of the returns does not represent an issue presented by the pleadings.” It was on this ground alone that two Members concurred in the prevailing opinion. There can be no question that the case at bar is distinguishable in this respect, since, as has been noted, the present pleadings leave no doubt that the parties have properly joined issue on the question. The Board’s decision in the Taylor case, however, is not limited to that phase of the controversy but also rules that the return was too late since it was filed subsequent to the deficiency notice. In reaching that conclusion the opinion states (p. 703) :

* * * By section 233 the allowance to foreign corporations of the credits and deductions ordinarily allowable is specifically predicated upon such corporations filing returns. In view of such a specific prerequisite it is inconceivable that Congress contemplated by that section that taxpayers could wait indefinitely to file returns and eventually when the respondent determined deficiencies against them they could then by filing returns obtain all the benefits to which they would have been entitled if their returns had been timely filed. Such a construction would put a premium on evasion, since a taxpayer would have nothing to lose by not filing a return as required by statute.

We think that this reasoning is not applicable to the proceeding at bar. The purpose of the requirement of a capital stock tax return is not so much to advise the Commissioner of the true facts as to the taxpayer’s income, as in the case of a foreign corporation, as it is to record the taxpayer’s election of the value to be placed upon its capital stock. See Haggar Co. v. Helvering, 308 U. S. 309. Petitioner had already filed returns of income as a partnership. The failure to file the capital stock tax returns was the result of a bona fide belief that, since petitioner was not an association taxable as a corporation, the returns were not called for by the statute. When it was advised that respondent’s position was to the contrary, it filed the returns as the only method open to it of protecting its position should respondent be sustained in his claim. There had been no previous return of this nature by petitioner. Cf. Riley Investment Co. v. Commissioner, 311 U. S. 55. We see no reason, therefore, why Congress should have intended that under the circumstances here present the capital stock tax return should not be treated as petitioner’s “first return” under the section. See Haggar Co. v. Helvering, supra.

A capital stock tax return, even though delinquent by many months, is effective in the absence of a prior return, at least if filed previous to the deficiency notice. Flomot Gin Co., 40 B. T. A. 689. It seems anomalous to conclude that the notice, which has the effect of apprising the taxpayer for the first time of the Commissioner’s position that a return is permissible, should be the very instrument which precludes it from taking action to file one.

There is, on the other hand, ground for concluding that some such privilege is necessary if we are not to impute to the lawmakers an intention to impose an unbearable burden upon taxpayers who have been guilty of no more than an innocent mistake. For the effect of the declaration of value in the capital stock tax return for the first year is to fix that value, subject to certain adjustments here immaterial, for all time to come. Absent some provision in a later act permitting the declared value to be changed, a future development of which that Congress could have had no assurance, a taxpayer would be permanently bound by a declaration of value made in the first return. If we were to hold here that petitioner’s erroneous but honest belief that such a return was not called for from it is sufficient to bar it forever from filing a return when respondent’s contrary view is brought to its attention, we should be imputing to the Congress an intent to penalize such an error by barring the taxpayer for future years as well from the advantages conferred on other taxpayers similarly situated. This we are unwilling to do. “By the rejection of the delinquent return on the ground that it was filed too late, petitioner was denied the right to make a declaration of value which it was the obvious purpose of the statute to give. The words of the statute require no such harsh and incongruous result.” Del Mar Addition v. Commissioner, supra. For the reasons stated we conclude that effect may be given in these proceedings to the capital stock tax returns filed by petitioner subsequent to the deficiency notice but prior to the filing of the petitions which brought the controversy before this Board.

Finally, petitioners have treated certain payments made by them as ordinary and necessary business expenses and on that theory have taken deductions thereof on their tax returns. The disallowance of these deductions by respondent creates the remaining contested issue.

The payments in question ai’e those made by petitioner as the result of its acquisition of the mine property. They are called for by a contract between petitioner and the holders of an option on the property, to whom we shall refer as the optionors. It appears that these optionors never at any time owned a proprietary interest in the property. Their participation in the transaction consisted merely of acquiring an option to purchase from the original owners and making the contract we have mentioned, which was in effect a conditional assignment of the option to petitioner. This contract provided in substance that if petitioner determined to exercise the option it would pay to the owners the purchase price of the property as fixed in the original option, the owners would deliver a deed to the optionors, “and thereupon and as part of the same transaction” the optionors would deliver one to petitioner. When the transaction actually occurred, this provision was effectuated by an escrow under which the two deeds were placed with a bank and delivered to petitioner upon its payment of the purchase price to the original owners. It is apparent that thus far no proprietary interest ever vested in the optionors, for by the same transaction in which they obtained title they transferred it.

The payments to be made to the optionors — those giving rise to the present question — are specified in the agreement between them and petitioner and are percentage payments continuing apparently so long as mining operations are carried on. It seems to be recognized by both parties that if these are capital expenditures paid for the acquisition of petitioner’s capital asset they are not deductible in the form of business expenses. Respondent refers to Imperial Type Metal Co. v. Commissioner (C. C. A., 3d Cir.), 106 Fed. (2d) 302, as authority for the statement that payments will be construed as capital items if no interest in the property was retained by the payee. See Helvering v. Elbe Oil Land Development Co., 303 U. S. 372, 375. See also Marrs McLean, 41 B. T. A. 565. For all that appears petitioner does not question this principle but maintains that here an interest was retained by the optionors by virtue of the provision of the assignment contract which permits the petitioner to “terminate and annul this agreement in which event the sellers [optionors] shall be entitled to a reconveyance of the property from the buyers [petitioner] and may retain as rental and liquidated damages all royalty or cash theretofore paid to them.”

It seems to us that this is a provision for acquisition by the option-ors, rather than for retention by them, of an interest. Since, as we have seen, they obtained none in the first instance and since such rights as were conferred upon them by that provision were conditioned upon a termination of the agreement at the election of petitioner, an event which has not happened and may never happen, we can not conclude that the payments to the optionors were the result of any interest retained by them.

But even if this were not so, the payments would still fail to furnish the basis for a deduction as ordinary and necessary expenses. Section 23 (a), of the Revenue Acts of 1934 and 1936 provides for the deduction of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including * * * rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken * * * title or in which he has-no equity * *

If petitioner can be considered to have made these payments to the optionors in order to prevent them from demanding a conveyance of the property, which seems to be the furthest extreme to which petitioner’s contention could reach, and if it be granted therefore that these payments were “required to be made as a condition to the continued use or possession” of the property; there would still be no escape from the incontestible fact that petitioner has an “equity” in the property. Title was taken for it in the usual course by deed duly delivered and for all that appears it continues to be held in the same way. Under such circumstances the deduction specified is not available to petitioner. See Monroe Sand & Gravel Co., 36 B. T. A. 747, 751.

Whether, therefore, the payments in question are thought of as the consideration for the transfer to petitioner of title to the mining property, in the first instance, or as a condition precedent,, to its retention of that title, the result is the same. When the option was exercised its province as the medium of acquisition of title disappeared. In its place petitioner had acquired a capital asset the cost of which was the original purchase price, together with the payment for the option. The amounts paid to acquire this capital asset are capital expenditures and may not be deducted in the form of business expense. Upon this issue respondent is sustained.

A further issue involving payment of state license tax need not be considered since it is now conceded by petitioner.

Reviewed by the Board.

Decision will he entered under Rule 50.


author: Dtsnet:

text:
    William H. C. Pletz and Anna E. Pletz, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99694.
    Promulgated December 20, 1940.

      Edmund 0. Austin, Esq., for the petitioners.

      L. A. Spalding, Jr., Esq., for the respondent.
   OPINION.

Dtsnet:

The only question left for our consideration here (after certain concessions made which will be reflected under Kule 50) is one of constructive receipt of income. The petitioner in 1936 closed his executorship of the Daniel estate and received commissions to which the law entitled him, in the amount of approximately thirty thousand dollars. These he reported as income, but he later filed amended returns for 1936 and for the other years of his executorship, and allocated the income largely to the earlier years, upon the theory that the law entitled him to retain the commissions as earned, that he could have paid himself such commissions, and that therefore there was constructive receipt by him in the earlier years.

The law of New York, section 285, chapter 928, Laws of New York, 1920, as amended by chapter 649, Laws of 1923, provides in part and in effect that (1) if an executor acting as trustee is required to and does receive and pay over income, and “renders an annual account to the beneficiary * * * of all his receipts and disbursements on account thereof, he shall be allowed, and may retain, the same commission on the amount so accounted for as he would be allowed upon principal on a judicial settlement”; also (2) that if an executor or testamentary trustee is “required to collect the rents of and manage the real property, he shall be allowed and may retain five per centum” as commissions. There is no disagreement hers as to the amount of the commissions, and it is agreed that the commissions for receiving and paying out principal were properly included in gross income in 1936, the year of the judicial settlement. The argument arises upon the treatment of commissions, first, for receiving and paying out income and, second, for managing and collecting rents on real property. These amounted during the period during which petitioner acted as executor and trustee (about which there is also no dispute) to a total of $36,920.03, as reported upon the settlement in 1936, of which the petitioner retained $12,000 during the years 1931-1935, leaving $24,920.03. The petitioners contend that thereof $21,639.38 was constructively received in 1931-1935. Amended returns, accordingly, were filed for those years and additional tax accordingly paid; while for 1936 overpayment is claimed, one-fourth of the tax having been paid upon the return as originally made, which included the $24,920.03 of commissions.

It is to be noted that commissions for collecting rents and managing real property are provided upon the performance of such duty; while commissions for receiving and paying over income are provided only if such service is performed and an annual account of all receipts and disbursements on account thereof is rendered the beneficiary. In either case the executor-trustee may then “retain” the commissions. Was the petitioner so entitled to retain both classes of commissions in the years 1931-1935 on the theory that ho was in constructive receipt thereof, even as to amounts not actually paid to himself until 1936 ?

The respondent has determined a deficiency on the basis that there was no constructive receipt prior to 1936. The burden of proof is upon the petitioner and the doctrine of constructive receipt is to be sparingly applied. William A. Hines, 38 B. T. A. 1061; Samuel Keller Jacobs, 22 B. T. A. 1166; Helvering v. Gordon, 87 Fed. (2d) 663. In Hal E. Roach, 20 B. T. A. 919, 925, we said that the invocation of the doctrine is to be approved “only in unique circumstances and a clear case.” "The amounts here in question were not credited to the petitioner by the Daniel estate, of which he was executor and trustee, earlier than 1936. In Samuel Keller Jacobs, supra, we said:

The test as to constructive receipt is whether the debtor has funds standing to the credit of the taxpayer which the debtor is able to pay and which are available and unqualifiedly subject to the taxpayer’s demand. Here we do not find such a case. \a

In Eisner v. Macomber, 252 U. S. 189, income is defined as that gain which is “received or drawn by the recipient for his separate use, benefit, and disposal.”

We said in William Parris, 20 B. T. A. 320 (324) :.

* * * The test as to constructive receeipt is whether the debtor has funds standing to the credit of the taxpayer which the debtor is able to pay and which are available and subject to the taxpayer’s demand. * * *

Regulations 86, article 42-2, cited by the petitioner, reads :

Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to. be made, and must be made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. * * *

The petitioner occupied a double status with respect to the Daniel estate. He was executor. He was trustee for the two sons as beneficiaries. Perhaps the best indicia of recognition of his right to, withdraw commissions would be credits thereof to him upon the books of the estate. There were no such credits. In J. O. W. Gravely, 29 B. T. A. 29, we considered a situation where one who was president and in practical control of a corporation withdrew only portions of his salary for four years. He was not credited with the remainder until the fifth year, 1927. He contended that there was constructive receipt in the earlier years. We held otherwise and said (p. 31) :

* * * The fact that the petitioner owed the corporation enough to have taken up his back salary does not show payment. It was only when he got the credit against such indebtedness by application thereto of his deferred salary that he received payment to that extent, and that was not until 1927.

This was despite the fact that we also said that he had the power to receive an actual payment of his entire salary in each of the earlier years.

Petitioner’s contention is in effect that as executor-trustee he was holding the moneys for himself. Mere receipt by a trustee does not determine constructive receipt by cestui que, trust. Lyle H. Olson, 24 B. T. A. 702. In Alice H. Moran, Executrix, 26 B. T. A. 1154; affd., 67 Fed. (2d) 601, we took the position that where one on a cash basis has consistently excluded from income reported amounts which he could have received, but did not, he is taxable in the year of actual receipt. The petitioner says that the case is founded on estoppel because of statutes of limitation having run. From perusal of our language it is apparent that the ratio decidendi was requirement of consistency of practice on the part of the taxpayer rather than estoppel; for it appears that limitation statutes may not have run as to some of the years involved, yet we denied constructive receipt as to all years. In Raleigh v. United States, 5 Fed. Supp. 622, the Court of Claims held that a taxpayer, having in previous years reported as income only amounts actually withdrawn from sums credited to him, was taxable in a subsequent year on the amount withdrawn, though it was more than the amount actually credited to Ids account. The taxpayer had, as does petitioner here, contended that he had constructively received the income in the earlier years. The statute of limitations appears in that case to have iun. The court, however, notices that the plaintiff “manifestly acted on the theory that salaries and dividends credited to his account on the books of the two companies were not received by him until withdrawn and reduced to possession, and that, since he was on the cash receipts and disbursements basis, amounts not actually received should not be reported as income.” This seems to have been the theory of the petitioner here, until the filing of amended returns.

The case of Freeman v. United States, 71 Fed. (2d) 969; certiorari denied, 293 U. S. 621, is strongly relied upon as parallel by the respondent. Therein the plaintiff was executor. Under Pennsylvania law he could obtain payment for his services by presenting a bill, since the estate had funds with which to pay; or he could wait until preparation of accounts. He did the latter and presented no bill in 1916, and no amount was credited to him by the estate in 1916. In 1917 he filed accounts, caused payment to be made to himself, returned the amount as income, and subsequently filed claim for refund on the theory of constructive receipt — all just as did the petitioner here. It was held that there was no constructive receipt in 1916 and that he was taxable on the amount received in 1917. The petitioner strongly urges that the case has no analogy to this, contending that therein presentation of a bill for services or rendering accounts was a condition precedent to right to payment, and that such condition was not performed. This argument we consider without merit. The basis of the theory of constructive receipt is the “unfettered command” of the taxpayer. Corliss v. Bowers, 281 U. S. 376. Obviously that command is unfettered if the taxpayer has it in his power to act or desist from acting, as in the filing of a bill for services or a report. Filing thereof is by no sound logic a condition, as petitioner urges, but merely something within the taxpayer’s power. If it were, the same idea would we think defeat the petitioner here, so far as fees for receiving and paying out income are concerned, for the statute required him to receive and pay the income and render an annual account “of all his receipts and disbursements.” An annual account was rendered, for 1933 and later years, but not for 1931 and 1932, but the account failed to show either the amount of commissions to which petitioner was entitled, or the amount he had actually withdrawn. Obviously this was not an annual account of all receipts and disbursements, as contemplated by the statute. This is indicated by the fact that the Fifth Avenue Bank, rendering its account to the beneficiaries for the remainder of 1936, included a showing as to its commissions.

The petitioner here is in no essentially different position than the plaintiff in the Freeman case, supra. The court there pointed out, what is here true, that the income was not credited to the taxpayer in 1916. Both the District Court and the Circuit Court point out the lack of credit entered. In rendering his report to the Surrogate’s Court in 1936 the petitioner did not itemize by years either the rental income, the income from interest and dividends received, or the commissions which he claimed, and the books of account of the Daniel estate do not show the commissions by years, but only in gross at the end of the period, June 12, 1936. Plainly, no credit of earned commissions appeared on the books of the estate. Freedom to draw money, even if credited, does not in all cases indicate constructive receipt. Massachusetts Mutual Life Insurance Co. v. United States, 288 U. S. 269. We consider the Freeman case parallel to the present proceeding.

The petitioner urges that under Freuler v. Helvering, 291 U. S. 35, the decree of the Surrogate’s Court, reciting that the petitioner “has retained” the commissions, is binding upon us and that therefore the ■commissions were constructively received in the earlier years. We think, however, that the decree on its face is susceptible only of interpretation as holding that, at a time not shown, the petitioner had retained the commissions; and that therefore it is not a holding that there had been retention of commissions in 1931-1935. The estate rather than the petitioner retained the commissions involved until 1936, for it was in that year that he paid himself. We think the surrogate’s decree does not determine the question here.

We conclude and hold that the petitioner did not constructively receive the income here involved prior to 1936. We find no error on the part of the Commissioner with respect to the inclusion in income for 1936 of the amounts of commissions reported by the original return.

Decision will he entered under Rule 50.


author: Murdock :

text:
    Martin Beck, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99439.
    Promulgated December 20, 1940.

      Ben Herzberg, Esq., for the petitioner.

      Arthur W. Oarnduf, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $7,172 in gift tax for the calendar year 1935. The Board adopts as its findings of fact the facts as stipulated by the parties.

The petitioner created an irrevocable funded insurance trust on August 6, 1935, and transferred to the trustee securities having a value in excess of $172,000, together with seven policies of insurance upon his life. The deed of trust provided that the net income of the trust should be applied during the lifetime of the petitioner to the payment of the net premiums, after deducting dividends, upon the policies. Any additional income was to be distributed among the wife of the petitioner and his two daughters. They were also to receive all of the income after the petitioner had died. The proceeds of the policies were to be held in the trust. The trust was to continue during the lives of the wife and the two daughters, with remainders over and no possibility of reverter in the grantor. One of the policies assigned to the trustee was fully paid. The other six were ordinary life policies calling for the payment of annual premiums during the life of the petitioner. There were no loans against the policies when they were assigned to the trust. The total net annual premiums on the six policies amounted to $6,779.37. The anticipated income from the securities was slightly in excess of that amount. The petitioner filed a gift tax return in which he reported the value of the securities and the policies as of the date of the gift and deducted $48,926.65. He explained that the latter amount was the capitalized value of the income necessary to pay the premiums during his life, and, since he had to include in his income that portion of the income of the trust, the amount mentioned had to be deducted in order to arrive at the net taxable gift. The Commissioner, in determining the deficiency, disallowed the deduction of $48,926.65.

The Commissioner contends that he did not err in including the entire value of the securities and the policies in the taxable gift. The petitioner contends that the taxable gift was a lesser amount, arrived at by deducting from the total used by the Commissioner, an amount representing the value at the date of the gift of the amounts which would subsequently be required to pay the annual premiums on the policies during the life of the petitioner. The method of computing that value is not in dispute. The petitioner points out that the income necessary to pay the annual premiums on the policies during his life will be recognized as his income and will be taxed to him as his income. Sec. 167 (a) (3), Revenue Act of 1934; Burnet v. Wells, 289 U. S. 670. It is unbearably inconsistent, he argues, to tax the value of that income as a gift from him in 1935 and thereafter to tax those payments as his income. He concludes that the 1935 value of the payments must be excluded from the taxable gift.

Although the income tax and the gift tax should not be interpreted with indifference to their double application, nevertheless, they are quite different, one from the other, and Congress has not achieved such mutual exclusiveness in the two taxes as the petitioner would1 find ideal. The petitioner in the case of Katherine S. Rheinstrom, 37 B. T. A. 308; affd., 105 Fed. (2d) 642, provided, inter alia, that 10 percent of the income of a trust which she created was to be held by the trustees as a fund from which they, in their absolute discretion, might make payments to her. The Board rejected her argument, that she had made no gift of that 10 percent of the income but had reserved a life estate in it, and held that the value of the 10 percent should be included in the net taxable gift. The case of Edward Rayne McComb Herzog, 41 B. T. A. 509, is similar. Yet income, which in the discretion of a trustee may be paid to the grantor, is taxable to the grantor under section 167. The petitioner in the case of Commissioner v. Krebs, 90 Fed. (2d) 880, was held liable for gift tax upon property transferred to a trust, the income of which was to be used for the support, maintenance, and education of his three children, while in the cases of Commissioner v. Grosvenor, 85 Fed. (2d) 2, and Schweitzer v. Commissioner, 296 U. S. 551, reversing 75 Fed. (2d) 702, the income from similar trusts was held to be taxable to the grantors. See also the remarks of the court in the last paragraph of Commissioner v. Prouty, 115 Fed. (2d) 331. The argument of the petitioner that the value of the payments must be excluded from the taxable gift because it would be inconsistent to so tax them and later include them in his taxable income is too broad. See, however, the second paragraph of the Board’s opinion in Jay C. Hormel, 39 B. T. A. 244; reversed, 111 Fed. (2d) 1; certiorari granted, 311 U. S. 626.

The petitioner made an absolute transfer of title to the securities and the insurance policies. However, not all transfers of title without consideration are taxable gifts. The gift tax is aimed only at transi-fers of title which have the quality of a gift. Burnet v. Guggenheim, 288 U. S. 280. The Commissioner has consistently recognized that the quality of a gift is lacking wdiere the transferor retains a definite interest for himself, such as a life estate or a remainder in the property ivhich he has transferred, and the Commissioner does not attempt to tax as a gift interests retained and not donated by the transferor. Ada Small Moore, 39 B. T. A. 147; Harriet W. Rosenau, 37 B. T. A. 468; William T. Walker, 40 B. T. A. 762; Emily Trevor, 40 B. T. A. 1241; Edward Rayne McComb Herzog, supra; Katherine S. Rheinstrom, supra; Cushman v. Hoey (U. S. Dist. Ct., S. Dist. N. Y., Nov. 26, 1938); Rasquin v. Humphreys, 308 U. S. 54. Congress, in enacting the gift tax, was aware that “the essence of a transfer had come to be identified more nearly with a change of economic benefits than with technicalities of title.” Burnet v. Guggenheim, supra. Therefore, this transfer must be examined to see whether the petitioner retained an interest in the use of the income for the payment of premiums on his life insurance so that there was no more than a technical change of title in regard to that income without a sufficient change in economic benefits to constitute a taxable gift.

Section 219 (h) of the Revenue Act of 1924, like section 167 (a) (3) of the Revenue Act of 1934, provided that any part of the income of a trust which was to be applied to the payment of premiums upon policies of insurance on the life of the grantor was to be included in the income of the grantor. The Supreme Court in Burnet v. Wells, supra, held that that provision was constitutional. Wells created irrevocable funded insurance trusts similar to the one involved herein and transferred to those trusts income producing securities and insurance policies on his own life. The premiums on the policies were to be paid from the trust income. The Government argued that Wells had not made an outright gift of the income. The Court stated that a policy of insurance is a contract to which the insured is a party and in which he retains certain rights and interests. It further said:

Income permanently applied by the act of the taxpayer to the maintenance of contracts of insurance made in his name for the support of his dependents is income used for his benefit in such a sense and to such a degree that there is nothing arbitrary or tyrannical in taxing it as his.

The Court pointed out that Wells might have created a trust for the payment of all of the items in his family budget, in which case there would be no doubt about taxing the income as his, but, instead, he picked out one item of the budget, the cost of continuing his contracts of insurance. The Wells trusts, created before the passage of the Revenue Act of 1924, were not subject to gift tax. But the Court, in a footnote, had this to say in that connection:

Whether they would have been subject to that tax if they had been created at a later date is a question not before us. There is no inconsistency between a gift to take effect in enjoyment upon the death of a grantor and the reservation of benefits to be enjoyed during his life.

The Court in the Wells case reached the conclusion that the insured in such cases, by providing that the income of the trust shall be used to pay premiums on policies of insurance on his own life, has reserved to himself economic benefits in the property. If those benefits are of sufficient importance to justify taxation to him of the income used to pay the premiums, then it is difficult to see why they are not of sufficient importance to prevent the imposition of a gift tax. In other words, the petitioner in effect reserved to himself a life estate in the income sufficient to pay the premiums on his contracts of insurance. Cf. Federal Taxation of Personal Life Insurance Trusts, 44 Yale Law Journal 1409, 1420-23; The Federal Gift Tax, 40 Columbia Law Rev. '773. We have seen that the value of a retained life estate must be subtracted before the value of the taxable gift can be determined. It follows that the present petitioner made a gift of less than the total value of the securities and insurance policies at the time of the transfer. Cf .Jay C. Hormel, supra. Since the respondent does not contest the petitioner’s method of computing his retained interest in the trust property, we shall adopt it for the purposes of this case.

Reviewed by the Board.

Decision will he entered under Rule 50.

HaRbon concurs only in the result.

Arundell dissents.

       The ease of Commissioner v. Krebs, supra, would appear on Its face to be to the contrary, but the question now decided and the possible effect of the Wells case were not considered in the Krebs ease. See also Jay C. Hormel, supra, where the Commissioner conceded that the gift tax was due only in case the income was not taxable to the grantors.

       Premiums paid by the insured upon policies of life insurance upon his own life, which he had transferred to a trust, were taxed as gifts when made in the case of Jack L. Warner, 42 B. T. A. 954. See also Regulations 79, art. 2, ¶(6), as amended. The payments by the present petitioner, when made, may be taxable gifts. Thus the entire transfer would be subjected to gift tax eventually.


author: Smith :

text:
    Honokaa Sugar Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101358.
    Promulgated December 20, 1940.

      A. D. Castle, Esq., and E. R. Cameron, C. P. A., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for tlie redetermination of a deficiency of $17,103.18 in income tax for 1937. The petition alleges that the respondent erred in the determination of the deficiency (1) in including in gross income an estimated amount to be received on a shipment of sugar during December 1937 instead of the correct amount which was determined in 1938, and (2) in denying a credit under section 26 (c) (1) of the Revenue Act of 1936 for the amount of the adjusted net income which could not be distributed to stockholders without violating a written contract executed by the petitioner.

Most of the facts material to this proceeding are contained in a written stipulation of facts with exhibits attached, which are incorporated herein by reference.

The facts pertinent to the two issues presented may be briefly stated as follows:

The petitioner is a corporation organized and existing under and by virtue of the laws of the Territory of Hawaii, and is primarily engaged in the cultivation, manufacture, and sale of sugar. Its principal office is at Honolulu, T. H.

The petitioner’s books of account are kept and its income tax returns are made on the accrual basis and for the calendar year.

During December 1937 the petitioner shipped 1,272.81 tons of raw sugar to the California-Hawaiian Sugar Refining Corporation (hereinafter sometimes called the buyer), a marketing organization which was incorporated under the laws of the State of California and owned and operated a sugar refinery at Crockett, California. The sugar arrived at the refinery on December 28, 1937. According to the contract which the petitioner had with the buyer, title to the sugar passed to the buyer on arrival. The amount to be paid for the sugar was to be determined in accordance with the terms of a written contract.

The fiscal year of the buyer ends on November 30. The sugars of any contract year are sugars shipped on or before November 30 of the contract year. The contract provides that within a few days after the arrival of the sugar at the refinery the shipper, in this case the petitioner, is to be paid 75 percent of the “average market price”, such average market price being tire average price at which raw sugar is selling within a short time before and after the date of arrival. Supplemental payments are to be made after the initial payment and from time to time throughout the contract year, and final payment is to be made not later than December 15 following the close of the contract year. The exact amounts depend upon a number of factors which it is not necessary to set forth here.

During the month of December 1937 the petitioner was paid a gross of $63,133.33 ($55,841.54 net after deduction of freight and various charges), representing the initial payment. This amount was duly incorporated in the petitioner’s income and excess profits tax return for 1937. The balance to be received by the petitioner upon its shipment could not be determined until after the refinery closed its fiscal year on November 30, 1938. Since, however, the petitioner had charged as expenses of 1937 the cost of producing the 1937 crop, it reported as taxable income not only the net amount of $55,841.54: referred to above, but also an amount which it estimated that it would later receive on its shipment of 1,272.81 tons. That amount was a net of $17,882.67 or a gross amount of $18,341.19 less expenses of $458.52. These amounts of $18,341.19 and $458.52 were included in gross income and deductions, respectively, in the petitioner’s original and amended returns for' income and excess profits taxes for the calendar year 1937.

During the calendar year 1938 the petitioner received as final payment on its 1,272.81 tons of raw sugar so sold and delivered on December 28, 1937, $11,887.46 less expenses of $297.16, or- $6,453.73 and $161.36, respectively, less than .the amounts estimated by the petitioner and included in its original and amended income and excess profits tax returns for 1937.

The respondent in his determination of petitioner’s gross and net income for the calendar year 1937 has failed to substitute for the estimated amounts of $18,341.19 and $458.52 the above stated amounts of $11,887.46 and $297.16.

In 1932 the petitioner had outstanding a bond issue in the amount of $320,000. The bonds matured in 1933. The petitioner proposed to the bondholders an extension of the maturity date and submitted for their approval a bond extension agreement. The owners of $251,000 of the bonds readily gave their written consent to. the extension agreement. The largest individual bondholder was the William G. Irwin Estate Co., of San Francisco, California, which held $52,000 •of the bonds. Under date of January 16, 1933, it wrote a letter to F. A. Schaefer & Co., Ltd., of Honolulu (attention of J. W. Waldron), the agent of the petitioner, stating therein:

Referring to the letter from the writer to Mr. Waldron dated November 21, 1932, to previous correspondence and to the conferences held here between Mr. Waldron and the writer, regarding a proposal to extend the maturity of the bonds of Honokaa Sugar Company, — we have executed and acknowledged and now hand you agreement dated December 19, 1932, between Honokaa Sugar ■Company, First Party, Bishop Trust Company, Limited, Second Party and the undersigned, Third Party, as the holder of Fifty-two thousand Dollars of Bonds issued under the Deed of Trust from the First Party to Second Party, as Trustee, dated June 30, 1908.
This agreement is in the same form as the agreement signed by the holders ■of Two Hundred and Fifty-one Thousand Dollars of the said bonds and which you exhibited to the writer. This agreement is to become binding upon the undersigned and you are authorized to deliver the agreement to Honokaa Sugar Company, or otherwise make use of the same, only upon the conditions that:
a. We shall receive a legal opinion from Messrs. Robertson & Castle, stating in substance that the signature to the extension agreement by bondholders will not prejudice their security in any way, and that the bonds as so extended will constitute the enforcible obligation of the Honokaa Sugar Company, and will be secured by the mortgage deed of trust as a first lien upon the property therein described.
b. The execution by Honokaa Sugar Company of an agreement in favor of those bondholders who signed the extension agreement, and specifically stated to be enforcible by the Trustee under the mortgage deed of trust, covenanting that the Sugar Company will not declare any dividends while any of the bonds remain unpaid.
e. An agreement by the Honokaa Sugar Company and/or the Trustee under the mortgage deed of trust, that when amounts are available in the Sinking Fund for the redemption or purchase of bonds, that invitations shall be extended to bondholders generally to offer bonds to the Sinking Fund so that there will be no preference as between the several bondholders with respect to the opportunity to secure payment of bonds in advance of the new maturity.
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In the event that the above mentioned conditions are not carried out, the accompanying extension agreement is to become void and you are to return the same to the undersigned.

At a meeting of the board of directors of the petitioner held January 24, 1933, the conditions stated in the above entitled letter were accepted by the petitioner. The minutes of that meeting provide in part as follows:

Mr. Castle then stated that a legal opinion would be furnished by Robertson & Castle to cover condition (a).
In regard to condition (b) it was the understanding of the bondholders executing the said agreement of December 19, 1932, that the Company would not pay or declare any dividends while any of the bonds remain unpaid; that although not specifically set forth in said agreement it was understood and agreed, and as part of the consideration for the execution of said agreement, the Company would by proper resolution provide against the payment of dividends while bonds were still outstanding.
Mr. M. B. Henshaw thereupon offered the following resolution, and moved1 its adoption:
“Whereas it was understood and agreed by and between the Bondholders executing the Bond Extension agreement of December 19, 1932, and as a part of the consideration of said extension, that this Company would not declare or pay any dividends while any of the Company’s bonds remain unpaid, and that the Company would by proper resolution record such understanding and agreement, and
Whereas it is to the best interests of this Company that said bonds be extended and that no dividends be declared or paid until all of said bonds are paid,
Therefore Be It Resolved that this Company in consideration of the extension of its bonds until December 31, 1940, subject to the terms of a certain Bond Extension agreement dated December 19, 1932, will not declare or pay any dividends while any of its bonds remain unpaid;
And Be It Further Resolved that in the event of any such declaration and/or payment of dividends in violation hereof, any bond or bonds then outstanding shall, at the option of the holder or holders thereof, become at once due and payable, and the lien of said bond may be enforced in the same manner and form as is set forth in paragraph (5) of said agreement of December 19, 1932.”
The resolution was seconded by Mr. R. W. Shingle, and unanimously carried.

The outstanding bonds of the petitioner were either purchased and canceled or redeemed and canceled as follows:

Of the foregoing bonds, those canceled December 31, 1932, were redeemed in the manner provided in the deed of trust, and the remaining bonds that were canceled up to and including June 19, 1935, were purchased below par, after invitation and notice to the bondholders generally, without preference, as set forth in condition (c) of the Irwin Estate Co. letter. After June 19, 1935, there were no offers on the part of the bondholders to sell below par, so the remaining bonds were redeemed at par in the manner provided in the deed of trust.

The bonds belonging to the William G. Irwin Estate Co. were purchased, after invitations extended to the bondholders generally, on July 31, 1933, and October 11, 1934.

On August 20, 1936, petitioner declared a dividend of 50 cents per share on its capital stock, payable September 30, 1936, and on November 25, 1936, it declared a like dividend, payable December 10,1936; no dividend was declared or paid in 1937.

In its original income and excess profits tax return for 1937 the petitioner in the determination of its undistributed net income claimed as a subtraction from its adjusted net income the credit provided in section 26 (c) of the Revenue Act of 1936, as amended, relating to contracts restricting dividends, in an amount sufficient to offset the adjusted net income reported in its return. The amended return for 1937 showed no adjusted net income.

The respondent in his determination of petitioner’s income tax liability for 1937 denied as a subtraction from petitioner’s adjusted net income the credit claimed under section 26 (c) of the statute relating to contracts restricting dividends on the ground “that there was no such contract in force and effect during the year 1937.”

The first question presented is whether the petitioner is entitled to adjust its gross income for 1937 to accord with the sale price of its sugar raised during that year. The petitioner admits that it is liable for income tax for 1937 upon any profit derived from the sale of that crop. It submits, however, that under its contract with its vendee it did not know until some time in 1938 just how much it was to receive for the crop. In the absence of actual knowledge it made an estimate of the amount that it was to receive. When it learned late in 1938 that its estimate was excessive in the net amount of $6,292.17, it sought to have the error corrected in the determination of its tax liability.

The respondent contends that this can not be done; that the petitioner keeps its books of account and makes its returns on the accrual basis; that the adjustment made necessary by the fact that the petitioner received for its 1937 crop $6,292.17 less than was anticipated is not a ground for adjusting the 1937 accounts, but that such adjustment should fall in the year 1938.

In United States v. Anderson, 269 U. S. 422, it was said that the purpose of Congress in permitting taxpayers to make income tax returns upon the accrual basis was to enable them:

* * * to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period; and, indeed, to require the tax return to be made on that basis, if the taxpayer failed or was unable to make the return on a strict receipts and disbursements basis.

In Spring City Foundry Co. v. Commissioner, 292 U. S. 182, the Court said:

* * * Keeping accounts and making returns on the accrual basis, as distinguished from the cash basis, import that it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues. * * *

In Commissioner v. Old Dominion S. S. Co. (C. C. A., 2d Cir.), 47 Fed. (2d) 148, it was said: “Income and deductions are to be included for the period to which they are truly attributable irrespective of the time of payment.” In that case it was held that just compensation paid for use of a railroad’s property during Government operation constituted accrued income for years in which it was earned, even though the amount was not determined or determinable until long after the taxable year had closed.

The question here is whether the amount receivable by the petitioner from the California-Hawaiian Sugar Refining Corporation in respect of the petitioner’s shipment in December 1937 of 1,272.81 tons of raw sugar became “fixed” in 1937. It plainly did not. The petitioner’s deductions for 1937 relate in large part to the production of the crop that was shipped and sold in 1937. Those deductions should be from the proceeds of the sales in 1937 as nearly as may be. The facts are before us for the determination of the actual proceeds. We see no reason why the error in the estimated amounts should not be corrected. The respondent erred in failing to substitute for the estimates (income and deductions therefrom) the actual amounts stated above.

The second question is whether the petitioner is entitled to the credit provided for by section 26 (c) of the Revenue Act of 1936. That section, so far as material, provides as follows:

(c) Contracts Restricting Payment op Dividends.—
(1) Prohibition on payment op dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1986, which provision expressly deals with the payment of dividends. * * *

In Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46, it was said:

* * * The natural impression conveyed by the words “written contract executed by the corporation” [§ 26 (c)] is that an explicit understanding has been reached, reduced to writing, signed and delivered. True, obligations not set out at length in a written contract may be incorporated by specific reference, or even by implication. But Congress indicated that any exempted prohibition against dividend payments must be expressly written in the executed contract. It did this by adding a precautionary clause that the granted credit can only result from a provision which “expressly deals with the payment of dividends.”

The respondent has disallowed the claimed credit upon the ground that there was no contract in force and effect during 1937 with respect to the payment of dividends.

We think that the respondent’s position must be sustained.

Article 26-2 (5) of Regulations 94 provides in part as follows:

(b) Prohibition on 'payment of dividends. — The credit provided in section 26 (c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. * * * [Italics ours.]

We think that this regulation correctly interprets the statute. Was there outstanding in 1937 any written contract executed prior to May 1, 1936, which operated as a legal restriction upon the corporation as to the amounts which it could declare and pay as dividends in 1937?

The minutes of the meeting of the board of driectors of the petitioner declare that it was the understanding of the bondholders executing the written bond extension agreement of December 19,1932, that the petitioner would not pay or declare any dividends while any of the bonds remain unpaid. But it is pertinent to note that the written agreement contains no provision dealing in any manner with the declaration or payment of dividends.

From the stipulated facts it appears that one of its bondholders, the William G. Irwin Estate Co., owning $52,000 of the petitioner’s bonds, refused to consent to the bond extension agreement except upon condition that the petitioner would agree not to pay dividends on its stock while any of its bonds were outstanding. The agreement of the petitioner to the condition stipulated undoubtedly was binding upon the petitioner so long as the Irwin Estate Co. was an owner of any of petitioner’s bonds. But its bonds were purchased and canceled prior to 1985. So far as the record shows the consent of none of the other bondholders was upon the condition that no dividends should be paid on the company’s stock while bonds were outstanding. There was no consideration for any contract between the petitioner and them. It is impossible to see what right they would have to restrain the petitioner in case it saw fit to declare a dividend while some of its bonds were outstanding.

It is further to be noted that the financial condition of the petitioner improved so rapidly after 1932 that by June 19, 1935, it had purchased and retired all of its outstanding bonds which could be purchased at a discount, and in 1935 and 1936 it retired at par all but $21,000 of its bonds which the owners failed to present for redemption until December 30, 1939. That the petitioner was ready and willing to redeem those bonds at par in 1936 and thereafter is apparent from the fact that in 1936 the petitioner paid two cash dividends of 50 cents each upon its 100,000 shares of stock outstanding, or the amount of $99,385, as shown by its capital stock tax return in evidence.

Furthermore, the resolutions of the board of directors upon which the petitioner relies specifically provided that if any dividend should be paid, while any of the bonds were outstanding the bonds would immediately become due and payable. This indicates quite clearly that the board of directors never intended that the resolutions adopted should be an absolute bar to a future declaration of dividends where as here one or more bondholders elected to hold their bonds beyond the period when the company was able and ready to redeem them.

In support of its contention the petitioner cites Sutcliffe Co., 41 B. T. A. 1009. In that case a corporation contracted with a bank from which it secured a loan that it would not pay any dividends on its shares of stock while the indebtedness continued. A new agreement was substituted for the original agreement. We held upon the evidence that the provision of the original contract carried over to the new one and that the taxpayer was entitled to credit under section 26 (c) (1) of the Revenue Act of 1936 equaling the amount of its undistributed net income. We fail to see the applicability of the legal principle enunciated in that case to the proceeding at bar.

From all of tbe evidence we are of tbe opinion that tbe respondent did not err in disallowing the claimed credit under section 26 (c).

Reviewed by the Board.

Decision will be entered under Rule 50.