author: Trammell:

text:
    Moore & Evans, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 29891.
    Promulgated September 17, 1931.

      E. B. Wilkinson, Esq., M. F. Gallagher, Esq., S. M. Rinaker, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
   OPINION.

Trammell:

We think that this case is controlled by the case of Lucas v. Ox Fibre Brush Co., 281 U. S. 115. The Commissioner undertook to distinguish this case upon the ground that the additional compensation was not authorized by the board of directors during the taxable year. He also takes the position that it is not shown that the additional compensation was reasonable in amount for services rendered.

We think from the evidence that Clark was in every substantial sense of the word authorized by the corporation to determine and fix the amount of compensation paid to Bitter. The usual practice and maimer of conducting the affairs of the corporation indicate that Clark had this implied authority. The corporation had uniformly, merely as a formality, approved his action. He owned substantially all of the stock of the corporation. The shares not owned by him were merely qualifying shares. The amount was not only determined, but credited on the books of the corporation in 1924. The action in 1924 was in pursuance of the regular course of conduct of corporate affairs. We think this action was sufficient to create an obligation in 1924 to pay the additional compensation. This conclusion is supported by previous decisions. See King-Parker, Inc., 6 B. T. A. 884; Archer Paper Co., 1 B. T. A. 634; Gordon Furniture Co., 3 B. T. A. 311.

In any event, the formal ratification of the board of directors, which consisted of the petitioner and those directors who merely held qualifying shares, relates back to the time of the act which was ratified, and this was in 1924. See Fletcher Cyc. Corporations, vol. 4, p. 3425; Flechner v. Bank of United States, 8 Wheat. 338; In re Grocers’ Baking Co., 266 Fed. 900.

On the question of the reasonableness of the compensation, we think that the evidence is sufficient to show that it was reasonable compensation for services rendered for 1924 and the two previous years. Fitter owned only qualifying shares in the corporation and it could, in no sense, have been said that it was a distribution of profits. He was general manager of the corporation and the success of the business depended upon his management. It was financially successful and we believe that the amount was reasonable. It was so considered by Clark, who owned substantially all of the stock, and by the board of directors.

In view of the foregoing, we are of the opinion that the amount is a proper deduction in computing net income for 1924.

Judgment will be entered wnder Bule 50.


source: Caselaw Access Project

author: Trammell :

license: Public Domain

text:
    Virginia H. Parmelee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Mary Reynale Rowlands, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 28072, 28111.
    Promulgated September 17, 1931.

      Samuel B. King, Esq., for the petitioners.

      J. E. Marshall, Esq., and W. F. Wattles, Esq., for the respondent.
   OPINION.

Trammell :

The petitioners having conceded that as distributees of the estate of the taxpayer they are liable as transferees, there are only two issues for our determination. In view of this concession we have not set out the facts relating to this issue or made a finding thereon. The first issue, while vaguely stated, is whether the collection of the tax is now barred by limitation. The statute of limitations applicable is:

Sec. 280. (b) (1) Within one year after the expiration of the period of limitation for assessment against the taxpayer; or
(2) If the period of limitation for assessment against the taxpayer expired before the enactment of this Act but assessment against the taxpayer was made within such period, — then within six years after the making of such assessment against the taxpayer, but in no case later than one year after the enactment of this Act.

On March 15, 1922, the taxpayer filed his return for 1921, reporting no tax due thereon. The Commissioner had four years to assess the tax against the taxpayer, which would be March 15, 1926. He therefore had, under section 280 (b) (1), until March 15, 1927, that is, one year after the period allowed for assessment against the taxpayer had expired, to assess the tax against these petitioners or to send a notice of deficiency to them. The notices of deficiency mailed on March 8, 1927, were timely and the statute does not bar assessment and collection from petitioners as transferees. Since the period of limitation for assessment against the taxpayer had not expired before the passage of the 1926 Act, section 280 (b) (2) is not applicable.

Petitioners allege that an assessment made against the estate on January 21, 1926, was ineffective upon several grounds, but in our opinion, it is immaterial whether that assessment was made at all or not, or, if made, whether it was properly made. Section 280 (c) provides as follows:

(c) For the purposes of this section, if the taxpayer is deceased, or in the case of a corporation, has terminated its existence, the period of limitation for assessment against the taxpayer shall be the period that would be in effect had the death or termination of existence not occurred.

The Commissioner had the same period to assess the tax regardless of ivliether the taxpayer had died. He was not required to assess against either the taxpayer or his estate in order to give him the one year after the expiration of the period of assessment against the taxpayer in which to proceed against the transferees.

The remaining issue is whether the respondent erred in disallowing the deduction of $15,000 taken by the taxpayer as a bad debt. In order to be deductible the amount must have been ascertained to be worthless and charged off during the taxable year. Since no question has been raised as to the amount being duly charged off, our discussion will be limited to the question of whether the indebtedness was ascertained to be worthless in 1921.

The indebtedness represented loans made by the taxpayer during 1915 to the Betsy Eoss Candy Company, which in that year surrendered its charter and went out of business. What its financial condition was at the time it went out of business we do not know, except that it was such that the taxpayer lost his investment in its stock. Whether the corporation before dissolution was in a position to have paid any part or all of the indebtedness is not disclosed by the record. All we know is that the indebtedness was not paid, and after the dissolution and surrender of its charter of course it could not pay. The Betsy Eoss Candy Manufacturing Company, which was formed about the time of the dissolution of the Betsy Eoss Candy Manufacturing Company of Illinois, gave to the taxpayer its notes for the indebtedness owing to him by the dissolved corporation.

The petitioners state in their brief that the Betsy Eoss Candy Manufacturing Company was under no legal obligation to pay the taxpayer for the money advanced by him to the dissolved corporation. If not, then the indebtedness became worthless in 1915 when the old corporation was dissolved. If it was liable, then there is no evidence that anything occurred in 1921 which would have warranted an ascertainment of worthlessness in that year any more than in any other year subsequent to 1915, or even subsequent to 1921. The taxpayer stated in his return that he had canceled the indebtedness and the amount was added to surplus of the corporation. If this be true and there is no evidence on the question sufficient to overcome such statement by the taxpayer, then, of course, no deduction is allowable.

Since the petitioners have failed to introduce evidence sufficient to overcome the presumption of correctness of the Commissioner’s determination, we think the action of the respondent in disallowing the deduction must be sustained.

Judgment will be entered under Rule 60.


author: Teammell :

text:
    John H. Stevens, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 29685.
    Promulgated September 17, 1931.

      Robert N. Holt, Esq., and O. F. Fuller, G. P. A., for the petitioner.

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

Teammell :

We have found as a fact that the petitioner created a parol trust making himself trustee for his son and daughter for two-thirds of the shares of stock owned by him in the Stevens Brothers Corporation. We think that all of the evidence supports this fact. The Commissioner relies upon the fact that the petitioner retained the stock in his own name, had control of it, and that the dividends were paid to him. The respondent also argues that the fact that the petitioner undertook to have the corporation make the checks payable to his son and daughter and the refusal to do so indicates that the corporation was not willing to accept the statement that a parol trust had been created. We think the explanation of the failure to do so made by the officer of the corporation to the effect that since the stock appeared in the name of the petitioner he could make the checks payable only in that name, is a good and sufficient reason, but we do not think that this indicates that the petitioner’s statement, supported by all the other evidence, that a parol trust was created, is Dot true. That a parol trust in personal property can be created is abundantly supported by authorities. The Illinois cases to that effect are as follows: Maher v. Aldrich, 205 Ill. 242; Walden v. Karr, 88 Ill. 49; Koch v. Streuter, 232 Ill. 594; Clapp v. Emery, 98 Ill. 523; Padfield v. Padfield, 68 Ill. 211; Burback v. Burback, 217 Ill. 547, and other cases.

It is equally well established by authorities that an individual may constitute himself trustee with respect to property owned by himself. Perry on Trusts, vol. 1, 6th ed., p. 95, states as follows:

When a person sui juris orally or in writing explicitly or impliedly declares that he holds personal property in praesenti for another, he thereby constitutes himself an express trustee. Under these decisions trusts may be created by parol in any mere personal property, as in the shares of corporation, although the corporations themselves own real estate.

This proposition is abundantly supported by decisions.

The Commissioner contends that there is a distinction between this case and the case of Lilian K. Blake, 23 B. T. A. 554. There is, of course, a difference in the facts and evidence by which the parol trust was established, but in principle there is no distinction. In this case the petitioner orally declared himself a trustee with respect to a certain portion of the stock owned by him. We have to rely upon oral testimony of the petitioner supported by that of his daughter and other testimony. In the Blake case there were facts and circumstances which corroborated the testimony of the witnesses, but in any event, it is merely a question of fact to be established by evidence as to whether the petitioner orally declared that he held the property in trust for others. The testimony supports this fact.

In view of the foregoing we think that the Commissioner erred in including the $23,640 dividends received by the petitioner in trust for his son and daughter.

Judgment will be entered under Rule 50.


author: Love:

text:
    Nichols & Cox Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 23601.
    Promulgated September 19, 1931.

      J. S. Seidman, Esq., and F. E. Seidman, O. P. A., for the petitioner.

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

Love:

Respondent concedes that the proposed deficiencies for the years involved in this appeal are barred from assessment unless the waivers filed by and for the Nichols & Cox Lumber Company are valid, and, at the hearing, the entire evidence submitted was confined to that issue.

We are of the opinion, however, that the question of jurisdiction intervenes and must be decided.

We have found that the first company was dissolved on December 28, 1922, and that on the previous day, December 27, articles of association were executed incorporating the Charles Dregge Lumber Company with an entirely different capitalization from that of the first company, although at the time of the dissolution of the first company, and the organization of the Charles Dregge Lumber Company, the stockholders in each appear to have been identical. On December 28, the first company, prior to its dissolution, sold, transferred, and conveyed to the Charles Dregge Lumber Company for a valuable and valid consideration, all its assets, properties, and franchises, tangible and intangible, of every kind and nature, and thereupon dissolved. Thereafter, but on the same day, December 28, the Charles Dregge Lumber Company executed a certificate of amendment to its articles of association, which certificate it filed with the Secretary of State on December 29, 1929, changing its name to Nichols & Cox Lumber Company, thereby becoming what we have designated as the second company.

In his brief respondent confines himself to an argument for the validity of the waivers. He contends that when the Dregges signed the waivers in question they were in effect and in fact acting as officers of the first company; he questions the validity, as to legal effect of the dissolution; he raises the question of estoppel; blit he does not throw any light upon the question of the Board’s jurisdiction, which was raised by the parties for the first time at the hearing-after the evidence in regard to the waivers was all in.

The matter of jurisdiction is the fundamental question here to be first determined, for if we have not jurisdiction in this case, obviously we are without authority to pursue this inquiry further. And we do not believe that we have that jurisdiction and the authority that would be conferred thereby.

The contentions advanced by respondent we regard as beside the point we are now considering, because we must first determine whether petitioner here has any standing before this Board, and for that purpose it makes no difference whether or not the first company had even a technical existence at the time the waivers were signed, the deficiency notice issued, and the petition filed, if, as a matter of fact, the deficiency was against the first company and the notice was mailed to it, and the petition was filed by the second company.

That the deficiency notice was mailed to the first company we believe to be placed beyond controversy by the wording of the notice itself. The Revenue Act of 1926 provides in:

Sec. 274 (a) If in the case of any taxpayer, the Commissioner determines that there is a deficiency in respect of the tax imposed by this title, the Commissioner is authorized to send notice of such deficiency to the taxpayer by registered mail. Within 60 days after such notice is mailed (not counting Sunday as the sixtieth day), the taxpayer may file a petition with the Board of Tax Appeals for the redetermination of the deficiency, * * *

The deficiency notice mailed December 10, 1926, to Nichols & Cox Lumber Company, reads:

An audit of your income and profits tax returns for the years 1919 and 1920 has resulted in the determination of a deficiency in tax amounting to $48,809.12, as shown in the attached statement.
In accordance with the provisions of Section 274 of the Revenue Act of 1926, you are allowed 60 days from the date of mailing of this letter within which to file a petition for the redetermination of this deficiency. * * *

Clearly the Commissioner, in his letter, was addressing the first Nichols & Cox Lumber Company, for no other Michigan corporation of that name rendered tax returns for 1919 or 1920, nor was any other in existence during those years. That corporation was the “ taxpayer ” to whom only was the Commissioner authorized under section 2tá of the Revenue Act of 1926 to send the notice of deficiency; and who alone is authorized by the Act to “ file a petition with the Board of Tax Appeals for a redetermination of the deficiency.”

The Nichols & Cox Lumber Company which came into existence in 1922 through an amendment to the articles ox association of the Charles Dregge Lumber Company is certainly not “ the taxpayer ” referred to in the Act, or in the Commissioner’s notice of deficiency. Admittedly, the second company is the successor of the first, but it is a distinct legal entity; and since it is not “ the taxpayer ” authorized by the Act to “ file a petition with the Board of Tax Appeals for the redetermination of the deficiency,” it can have no standing here. The answer “ yes ” to question 8, on page 4, of the 1923 return, was incorrect. It should haye been “no.” A return in the same name had been filed for 1922, but it was a return of the first company.

The officers who signed the waivers swore that they executed them without consulting with other officers, directors, or stockholders of either the first or second company, or with each other. They signed them in the regular course of business of the second company, or what they regarded as such business. Charles Dregge testified that “the new corporation, Nichols & Cox Lumber Company, had purchased the assets of the old Nichols & Cox Lumber Company, and I assumed that I could sign as an official of the new company, and that matters of that nature simply carried on.” Martin J. Dregge testified that the waiver “ which bears my signature came to my desk from a source I do not recall at the present time. In signing it, I knew the fact that the old Nichols and Cox Lumber Company had been liquidated and gone out of business. I signed it as secretary and as an officer of the new company.”

The Board has consistently held in a large number of cases, though the circumstances in each case may have differed widely, that it has no jurisdiction where a notice of deficiency has been mailed to a taxpayer, and the petitioner is neither that taxpayer nor his authorized representative. W. A. Sheaffer Pen Co., 21 B. T. A. 661, and cases therein cited; Bisso Ferry Co., 8 B. T. A. 1104; Bond, Inc., 12 B. T. A. 339; Weis & Lesh Manufacturing Co., 13 B. T. A. 144; American Arch Co., 13 B. T. A. 552; Engineers Oil Co., 14 B. T. A. 1148; San Joaquin Fruit & Investment Co., 16 B. T. A. 1290; Van Cleave Trust, 18 B. T. A. 486; Hamilton Web Co., 19 B. T. A. 199; Carnation Milk-Products Co., 20 B. T. A. 627.

Accordingly, we hold that we have acquired no jurisdiction in the proceeding before us.

Beviewed by the Board.

Order of dismissal will be entered accordingly.

ARUNdell and Matthews dissent.


author: Lansdon:

text:
    G. F. Sloan, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. E. Adams, Petitioner, v. Commissioner of Internal Revenue, Respondent. C. O. Middleton, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. A. Anderson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lazzette H. Barnhart, Petitioner, v. Commissioner of Internal Revenue, Respondent. J. H. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 40380, 40381, 40396, 40491, 40516, 40517.
    Promulgated September 21, 1931.

      Melvin D. Wilson, Esq., for the petitioners.

      J. A. Lyon, Esq., and E. L. Updike, Esq., for the respondent.
   OPINION.

Lansdon:

The petitioners contend that the sole function of the trust herein was to liquidate a certain parcel of real property which came into the possession of one of the beneficiaries in a manner and at a cost not clearly disclosed by the record. In support of this theory they rely on Blair v. Wilson Syndicate Trust, 39 Fed. (2d) 43; Lucas v. Extension Oil Co., 47 Fed. 65; Lansdowne Realty Trust, 50 Fed. (2d) 56; C. H. Atherton et al., Trustees, 50 Fed. (2d) 740; Mex Wolf et al., Trustees, 10 B. T. A. 835; Gonzolus Creek Oil Co., 12 B. T. A. 310; Myers, Long & Co., 14 B. T. A. 400; Terminal Properties Co., 19 B. T. A. 584; Royal Syndicate, 20 B. T. A., 255; Dauphin Deposit Trust Co., Trustee, 21 B. T. A. 1214.

A careful study of these cases indicates that the real test applied in each was not that there was a liquidation of real estate, but that there was no continuing business operation carried on for profit. This is the rule laid down in Hecht v. Malloy, 265 U. S. 144, in which it is clearly set forth that a trust transacting business for profit is liable to excise tax as a corporation. Upon this principle the courts and this Board have uniformly held that a trust operating a business for profit is an association taxable as a corporation. Little Four Oil & Gas Co. v. Lewellyn, 29 Fed. (2d) 1137; White v. Hornblower, 27 Fed. (2d) 777; E. A. Landreth Co., 11 B. T. A. 1; Alexander Trust Property, 12 B. T. A. 1226; Durfee Mineral Co., 7 B. T. A. 231; J. W. Pritchett et al., 17 B. T. A. 1064; Rochester Theater Trust Estate, 16 B. T. A. 1275; Woodrow Lee Trust, 14 B. T. A. 1420.

In the light of the opinions and decisions cited above, it remains only for us to determine whether the trust was engaged in business for profit. The petitioners contend that its operation had no other purpose than the liquidation of the real estate involved. Liquidation means realization or conversion of property for the benefit of its owners. If such a liquidation is effected through a trust, the owners of the property are the beneficiaries of the trust and certificates of beneficial interest issued to them represent their former ownership of assets that have become the corpus of the trust. Up to the date of the declaration of trust, only two, if any, of the beneficiaries herein were owners of any interest in the parcel of land. The others came into the trust by invitation or solicitation and presumably paid for their certificates of beneficial interest with cash which was used to purchase the land from its original owners or from the receivers in charge of the liquidation of their affairs. Everything in the record indicates that the beneficiaries herein entered into a voluntary association for the purpose of acquiring, subdividing, improving and selling Dominguez Harbor Tract No. 2, with the expectation of realizing a profit therefrom. Through a period of ten years or more they engaged in tbe activities necessary to accomplish their purposes. This state of facts discloses a situation far different from the institution of a trust merely to conserve or liquidate property already owned by the beneficiaries.

Decision will be entered for the respondent.


author: Love :

text:
    The W. W. Sly Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 31156.
    Promulgated September 21, 1931.

      E. A. Mihills, O. P. A., for the petitioner.

      John E. Marshall, Esq., and O. B. Marshall, Esq., for the respondent.
   OPINION.

Love :

Petitioner was the owner of a patent under which it was manufacturing certain devices. The Pangborn Corporation was guilty of an infringement upon petitioner’s patent rights. In an equity proceeding in a Federal court in Maryland petitioner obtained a decree awarding it, in effect, the acquisition from the Pangborn Corporation of $20,017.72 with interest until paid. In 1923, with accumulated interest, there was paid to petitioner as a result of that decree $30,108.94, which the Commissioner determined was taxable income to petitioner in 1923.

Patent infringements give rise to actions in damages. The cause of action sounds in tort, and is, technically, legal, as distinguished from an equitable cause of action. See R. C. L., vol. 20, pp. 1174-1175, and cases there cited.

The measure of damage in such cases is the amount of profits which the owner of the patent has failed to realize by reason of the wrongful act of the infringer. It does not always or necessarily follow that the owner has suffered any damage whatever by reason of sxich infringement. The amount of damage, if any, is a matter of proof.

The courts, however, have recognized a procedure in equity by which the owner may sue the infringer and ask not a payment for damages which he has suffered, but a decree for the profits which the infringer has realized. See R. C. L., vol. 20, p. 1176, and cases there cited.

The last mentioned procedure is the one adopted by petitioner in its suit against the Pangborn Corporation.

There was some evidence before the Board at the hearing of this proceeding to the effect that petitioner had suffered some damage by reason of the infringement of its patent rights, but evidently no such evidence was submitted in the case against the Pangborn Corporation. The amount of such damage, if any, was not an issue in that case. The sole issue there was the amount of profits realized by the Pangborn Corporation out of the use by it of petitioner’s invention, or one so nearly like it as to constitute an infringement. It follows, therefore, that we are not concerned in this proceeding with reference to the amount of petitioner’s damage, if any, caused by such infringement.

It was income to petitioner in 1923. The inquiry presented by petitioner is, was it ever taxable income ? Petitioner contends that it does not come within the ambit-of the definition of income given by the Supreme Court in Eisner v. Macomber, 252 U. S. 189. It is useless to quote that definition here. It is concise, and yet very comprehensive.

We believe that the income here involved comes within the definition referred to.

No income tax has been paid by petitioner on the $30,108.94 which was received by it in 1923. It was not legally entitled to that money prior to 1923, and never became legally entitled to receive from the Pangborn Corporation any more or any less than $30,108.94. That amount was not an accruable item prior to 1923 and was not accrued on its books prior to that year and, hence, is taxable income for 1923.

Judgment will he entered for the respondent.


text:
    Houston Baseball Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43985, 45430.
    Promulgated September 21, 1931.

      Walter E. Barton, Esq., and J. L. Bloch, O. P. A., for the petitioner.

      Harold Allen, Esq., for the respondent.
   OPINION.

Love :

Issue numbered 1 hereinabove has been expressly abandoned by the petitioner and need not be considered.

With respect to the issue numbered 4, the parties have stipulated that $110 is the proper amount allowable as a deduction from gross income in 1926.

Therefore, our considerations may be confined to issues numbered 2 and 3.

Petitioner contends, as set forth in issue numbered 2, that it is entitled to deduct the cost of players’ contracts which it purchased prior to each of the taxable years in question and which were sold in said years, irrespective of the fact that such cost had been deducted as ordinary and necessary business expenses in prior years.

The contracts, and in fact the issues presented, are for all practical purposes identical with those involved in the Dallas Athletic Association, 8 B. T. A. 1036. There the Board denied petitioner’s contention that the costs of such contracts were deductible as ordinary and necessary business expenses and it held, because of the renewal clause in such contracts, giving petitioner or its assignee the right to renew from year to year throughout the professional life of the player, and notwithstanding the initial engagement of the contracting parties was only one year, that the costs thereof were capital expenditures instead. With the nature of these contracts thus defined by the Board, clearly the petitioner is entitled to compute its gain or loss upon the future sale thereof in the same manner as any other capital asset.

The respondent’s counsel concedes that “ This allowance, as well as alloAvance for exhaustion, would be proper under the Dallas Athletic Association decision, but the petitioner has already teen allowed deduction of the full cost of all Players' contracts purchased in prior years; as current business expenses.” This we can not concede. The mere fact that an error was committed in prior years, which ax>pears to have been in perfect good faith, does not justify the commission of additional' errors. This same state of affairs has been found to exist in innumerable cases heretofore prosecuted before this Board, and we have repeatedly held in accordance with Gilliam Manufacturing Co., 1 B. T. A. 967, wherein we said:

If the amounts expended were actually paid out in acquiring patents, the deduction of such amounts as ordinary and necessary expenses of carrying on a trade or business was not proper. The fact that a taxpayer did deduct such items or considered them as expenses does not alter the situation. Such treatment was erroneous. The taxpayer has no option to treat expense items as capital or capital expenditures as ordinary and necessary expenses of carrying on a trade or business and had a right, as it did, to change its erroneous accounting methods. The patents, when acquired, formed a part of the capital investment of the taxpayer and the costs thereof were not ordinary and necessary expenses of carrying on its trade or business.

See also Old Farmers Oil Co., 12 B. T. A. 203; R. S. Newbold & Son Co., 7 B. T. A. 471; Great Bear Spring Co., 12 B. T. A. 383; and Goodell-Pratt Co., 3 B. T. A. 30.

We are, therefore, of the opinion that petitioner should be sustained as to the second issue.

The third and final issue for determination is with respect to the exhaustion of players’ contracts.

The respondent concedes that normally this issue, too, would be controlled by the Dallas Athletic Association case, but he contends, as he did with respect to the preceding issue, that deduction has already been allowed for the full cost of players’ contracts as current expenses and therefore no exhaustion should be allowed. For the same reason already given respecting the said preceding issue, we can not concede the respondent’s contention. In Dallas Athletic Association, supra, we said:

Having concluded that the amounts paid for the contracts represent capital expenditures, can it be said that these contracts were exhausted by the lapse of time? Each contract covered only the playing season the year in which or for which it was made, but was according to its terms renewable by the club or its assignee for the succeeding year. By virtue of the renewal provisions, the rights acquired under each contract extended beyond the year when the contracts were acquired. The ultimate result would have been the same if a single contract had been made with each player for an indefinite or undetermined period, subject to an annual salary adjustment under the conditions stated. While under certain facts and conditions contracts for an indefinite period may in fact become exhausted over a reasonably ascertained or estimated period of time, no evidence has been introduced in this case from which it can be ascertained when the contracts will become exhausted for the purpose of determining the allowance with respect thereto. The determination of the respondent must, therefore, be approved.

The evidence found missing there has been supplied here by the stipulation of the parties by which they have not only agreed that the exhaustion of such contracts should be calculated upon the basis of the useful playing life of a professional baseball player of 10 years, but they have actually determined and stipulated the amounts deductible in each of the taxable years in question. We are of the opinion, therefore, that this issue should also be resolved in favor of the petitioner.

Decision will be entered wider Rule 50.


text:
    Salathiel R. Fletcher, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 33041.
    Promulgated September 21, 1931.

      F. E. Seidman, G. P. A., and J. S. Seidman, Esq., for the petitioner.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Love:

The only question involved in this proceeding is whether the respondent erred in disallowing the deduction claimed by petitioner of $7,921.62 expended by him as his share of the cost of platting, surveying and preparing the real estate for sale in accordance with the terms of the agreement referred to in our findings. The respondent contends that the amount in question is a capital expenditure and, therefore, not deductible under section 214 (a) (1) of the Bevenue Act of 1921 as “ ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Petitioner concedes that expenditures made by an owner of property for platting and surveying such property are not deductible as business expenses by the owner, but become a part of the cost of the property. Section 215 (b), Revenue Act of 1921. But in the instant proceedings petitioner was not the owner of the property for which the expenditures were made. His status was that of agent for the owners. He and three others had agreed with the owners to pay the cost of platting, surveying and preparing the property of the owners for sale, to sell the same, and, after the owners had received $400,000 in cash, together with certain interest, to receive “ in full payment of all1 services rendered and disbursements made by them ” under the agreement, all lands then remaining unsold together with all contracts, notes, mortgages, and other “ proceeds of the venture.” Petitioner contends that under such circumstances the amounts expended by him are nothing more than ordinary and necessary expenses paid in the course of carrying on his business.

In our opinion the petitioner’s position is correct. He did not own the property for which the expenditures were made. His business was that of acting as agent for others. An agent usually receives compensation for his services which compensation is gross income under section 213 (a) of the statute. Petitioner’s income here was his proportion (one-sixth) of what was left after the owners had been paid $400,000 in cash. The excess over the $400,000 was in fact compensation for services rendered as truly as if the owners had agreed to pay petitioner a straight salary or set commission. The expenditures made by petitioner in producing such income were m substance no different in principle from expenditures made by a lawyer in prosecuting his client’s case on a contingent basis, which in the case of the lawyer are admittedly deductible. A taxpayer on the cash basis deducts his expenses when paid and reports his income when received. If, after petitioner receives his share of the property remaining unsold after the owners have been paid their $400,000, he makes further expenditures of the same nature as the ones in question, such further expenditures must be capitalized and considered a part of the cost of the property received. But this is because he is then acting on his own account and not as the agent for others. The same rule applies in the case of the lessee of property. If the lessee makes improvements having a life in excess of the term of the lease, the lessee is entitled to deduct as additional rental the cost of such improvements spread over the remaining term of the lease, Duffy v. Central R. Co. of New Jersey, 268 U. S. 55; whereas, if such improvements were made by the owner of the property, a deduction to the owner would be based on the life of the improvements. In the instant proceedings we hold that petitioner is entitled to deduct the amount of $7,921.62 as an ordinary and necessary expense. The deficiency should be redetermined in accordance with this opinion.

Judgment will be entered under Rule 50.


text:
    J. Hampton Hoult, Petitioner, v. Commissioner of Internal Revenue, Respondent. Martin J. Dregge, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 45782, 45783.
    Promulgated September 21, 1931.

      F. E. JSeidman, O. P. A., and J. JS. Seidmcm, Esq., for the petitioners.

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

Love :

The principal question in these proceedings is whether under the contract with Brewer petitioners in substance exchanged their stock in the old company solely for stock in the new, or, whether the actual sale by petitioners to Brewer of their stock in the old company and the investment by them of the proceeds in the stock of the new company constituted the substance as well as the form of the transactions set out in our findings.

The respondent contends that these proceedings are governed by the following provisions of section 203 of the Revenue Act of 1926:

Sec. 203. (b) (2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
Sec. 203. (li) As used in this section and sections 201 and 204^—
(1) The term “ reorganization ” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which (he assets are transferred, or (G) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
(2) The term “ a party to a reorganization ” includes a corporation resulting from a reorganization and includes both corporations in the case of an 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.

There can be no question as to what was actually done. The facts were stipulated. Petitioners actually sold their stock in the old company to Brewer, and with the proceeds purchased preferred and no par value common stock in the new company. But, since petitioners were contractually bound to subscribe for the new stock, should we disregard the sale and say that was a mere matter of form and an act entirely unnecessary to bring about the ultimate result? The respondent urges us to do so and to hold that the substance of the execution of the contract with Brewer was that of exchanging old stock solely for new. We can not so disregard the real and actual things that occurred and hold the petitioners to have done something which in fact they did not do. They actually sold their stock in the old company and with the proceeds purchased stock in the,new. True, it may be that the same ultimate result might have been accomplished if petitioners had exchanged directly their stock in the old company solely for stock in the new. But this is not what actually occurred. Income-tax liability must be determined by what actually takes place, rather than by what might have taken place.

In C. W. Ray, 19 B. T. A. 1154, we held that where three individuals transferred certain assets to a newly organized corporation and received the corporation’s check, which they immediately indorsed and turned back to the corporation in payment for its capital stock, the transaction was a sale resulting in profit at the time the check was received, rather than in substance a transfer of assets to the corporation for stock, which would have been nontaxable under section 202 (c) (3) of the 1921 Act. The Seventh Circuit affirmed our decision in this case from the bench and without opinion. In the course of our opinion in the Bay case we said:

It is contended that the substance of the whole transaction was that assets were issued for stock, and that substance should control over the form. The Supreme Court has frequently said that it would look to substance and not form. Eisner v. Macomber, 252 U. S. 189. But we do not believe in a case such as this that what a person actually does should be ignored, and that one be held to do one thing when another thing was done. What is actually done fixes the tax liability and not what might have been done, even though the same result in the end might have been reached in another way or by another process.

To the same effect see our holdings in John G. Lonsdale, 11 B. T. A. 659; affirmed by the Eighth Circuit at 32 Fed. (2d) 537; Edward A. Langenbach, 2 B. T. A. 777; B. F. Saul et al., 4 B. T. A. 639; James F. Shea et al., 11 B. T. A. 557; affirmed by the Court of Appeals of the District of Columbia at 36 Fed. (2d) 546; and William, H. Mullins, 14 B. T. A. 426. In United States v. Phellis, 257 U. S. 156, the Supreme Court, inter alia, said: “In such matters, what was done, rather than the design and purpose of the participants, should be the test.”

It is, therefore, our opinion that petitioners are entitled to the capital net losses of $56,375 and $53,875 referred to in our findings. It thus becomes unnecessary to consider petitioners’ alternative assignment of error.

Judgment will be entered rnider Bule 50.


author: Yan Fossan:

text:
    Mamie R. Oakman et al., Union Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42917.
    Promulgated September 22, 1931.

      J. Marvin Haynes, Esg., and O. J. McGuire, Esq., for the petitioner.

      Arthur Garnduff, Esq., for the respondent.
   opinion.

Yan Fossan:

The primary question for determination is whether or not petitioner is a trust the income of which is taxable to the beneficiaries thereof pursuant to section 704 (b) of the Act of 1928. That section is as follows:

For the purpose of the Revenue Act of 1926 and prior Revenue Acts, a trust shall, at the option of the trustee exercised within one year after the enactment of this Act, be considered as a trust the income of which is taxable (whether distributed or not) to the beneficiaries, and not as an association, if such trust (1) had a single trustee, and (2) was created and operated for the sole purpose of liquidating real property as a single venture (with such powers of administration as are incidental thereto, including the acquisition, improvement, conservation, division, and sale of such property), distributing the proceeds therefrom in due course to or for the benefit of the beneficiaries, and discharging indebtedness secured by the trust property, and (3) has not made a return for the taxable year as an association.

The two instruments dated, respectively, April 14, 1922, and January 16, 1924, which are substantially set forth in the findings of fact, must be read together and, so read, their provisions are determinative of the characteristics of the trust involved in this proceeding. Except as to the provisions of Article III the instrument of April 14, 1922, is an ordinary deed of trust to secure bondholders which, in legal effect, created between Eobert Oakman and the Union Trust Company the relationship of mortgagor and mortgagee. Ferry v. Miller, 164 Mich. 429; 129 N. W. 721; Schmidt v. Barclay, 161 Mich. 1; 125 N. W. 729; Ruch v. Ruck, 159 Mich. 231; 124 N. W. 52. So far as the relationship of mortgagor and mortgagee is concerned, the trust created is a passive trust and not a taxable entity. But Article III of the trust indenture, which is set forth in full in the findings of fact, created an active trust, which is taxable. That article provides, among other things, that until Eobert Oakman shall default in the payment of principal or interest of the bonds issued by him, as stated in the instrument, or in any other covenant or agreement by him to be performed, the Union Trust Company shall continue to possess, manage, operate and develop the lands conveyed to it by the instrument, to plat and subdivide unplatted lands, to undertake such building operations as in its judgment might be desirable and “ in general to care for and operate said lands as a going liquidating real estate business.” Article III of the instrument dated April 14, 1922, also provides for the disposition by the trustee of interest and of principal funds collected from land contracts, mortgages, and sales of the property conveyed in trust, and it further provides that any interests not necessary for the requirements of the sinking fund created by the terms of the article are to be subject to withdrawal by Eobert Oakman.

The agreement dated January 16, 1924, executed by Eobert Oak-man and the Union Trust Company, the petitioner, is supplemental to the deed of trust dated April 14, 1922. It recited that the major portion of the properties conveyed to the Union Trust Company by Eobert Oakman by the trust indenture of April 14, 1922, had been sold on contract, that an additional loan of $280,000 had been made by the Union Trust Company to Eobert Oakman, secured by the properties conveyed by the first instrument, and that Eobert Oakman desired to make a gift to his wife and to certain nephews and nieces of all his interest in such trust properties. Eobert Oakman’s interest under the trust indenture of April 14, 1922, which he desired to transfer to his wife and certain nieces and nephews was his equity in the property conveyed in trust and his right to certain excess interest. The second instrument, namely, that of January 16, 1924, in explicit terms directs the trustee to continue to “ manage, handle and administer ” the properties conveyed by the first instrument “ as a going liquidating real estate business ” and to continue the same general policy of operation as theretofore in force with a view to the conservation and firm establishment of the trust estate. These purposes and policies are declared to be of paramount importance in determining the “ amount of any current distribution to be made to the beneficiaries hereunder.” The second agreement further directs that all of the net funds and avails realized in liquidation of the land contracts and properties in excess of the requirements of the trust indenture of April 14, 1922, and of the requirements of the additional loan of $280,000 shall be paid to the beneficiaries named in the agreement in specified proportions, except that no principal funds shall be paid to any beneficiary who is a minor and that any minor’s distributive share of principal funds shall be held in trust by the Union Trust Company for such minor’s benefit and account until the minor reaches his or her majority. In order fully to effectuate the purposes of the agreement Robert Oakman granted, sold, assigned and conveyed to the trustee, the petitioner herein, all his right, title and interest to the properties and land contracts covered by the trust indenture of April 14,1922, and all his equity thereunder and the trustee was directed to continue the collection and liquidation of the properties until the purposes of the trust indenture and “ of the trusts herein created be accomplished and all of said properties turned into cash or the equivalent thereof and distributed as herein provided.”

It is apparent from the provisions of the two instruments under discussion that the properties conveyed by the trust indenture dated April 14, 1922, constituted what is commonly called a “ real estate development,” and the purpose of the active trust created by Article III of the trust indenture was to continue the development of the properties by the methods described in that article to the end that pending the maturity of the bonds secured by the properties conveyed those properties might be turned into cash or its equivalent as expeditiously and advantageously as possible for distribution under the terms of the indenture. All the provisions of both instruments with reference to the handling or investment of surplus principal funds are subordinate and incidental to this main purpose. It is also apparent that under the indenture of April 14, 1922, the Union Trust Company, the petitioner herein, had two capacities, namely, that of a mortgagee for the benefit of bond owners and that of managing and operating a going liquidating real estate business as trustee. Under the first of these capacities no taxable entity was created. The active trust, however, is a taxable trust.

The instrument dated January 16, 1924, which is supplemental to and became a part of the first instrument, does not in any way alter the characteristics of the active trust created by such first instrument. The second instrument shows that the major portion of the trust properties had been sold on land contracts and were, therefore, in process of due liquidation. It also extended the benefit of the security to the holders of an additional loan. But it did not effect any material change in the purposes of the active trust. On the contrary it ratified and continued those purposes. In ultimate effect it simply changed the beneficial ownership of the equity arising under the trust indenture and directed distribution of the surplus of principal funds and interest to the new beneficial owners. It is true that the second instrument directs that any amount of principal funds distributable to beneficiaries who were minors, of whom there were two, should be held in trust for the benefit of such minors until they, respectively, arrived at majority. But this direction related simply to the method of distributing principal funds. It had no effect upon the characteristics of the trust in question.

In our opinion the trust created for the beneficiaries named in the second instrument is within the conditions and limitations of section 104 (b) of the Revenue Act of 1928. That trust has a single trustee who, within a year after the passage of the statute referred to, exercised the option therein provided by notifying the respondent that it elected to have the trust considered as a trust, the income of which is taxable (whether distributed or not) to the beneficiaries thereof. The trust has not made a return as an association for the respective taxable years. It was created and operated for the sole purpose of liquidating real property as a single venture. The powers of administration as set forth in the instruments creating the trust are incidental to its purpose and the trustee is authorized to distribute the proceeds of the trust properties to or for the benefit of the beneficiaries and to discharge the indebtedness secured thereby.

Therefore, for the taxable years in question, the income of the trust involved in this proceeding, whether distributed or not, is taxable to the beneficiaries and not to the petitioner. In view of this decision of the principal issue, it is unnecessary to discuss the alternate issues alleged by the petitioner.

Reviewed by the Board.

Decision will he entered under Rule SO.


author: VAN Fossast:

text:
    Eliza J. Wray, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 25881.
    Promulgated September 22, 1931.

      Fraoik 0. Miller, G. P. A., and W. A. Seifert, Esq., for the petitioner.

      E. A. Tonjes, Esq., and J. E. Mather, Esq., for the respondent.
   OIUNION.

VAN Fossast:

In his brief the petitioner’s counsel does not discuss the first two allegations of error, but does not abandon them. The United States Supreme Court in Phillips v. Commissioner of Internal Revenue, 283 U. S. 589, affirming 15 B. T. A. 1218, held that section 280 of the Revenue Act of 1926 is not unconstitutional. We perceive nothing in the facts indicating that the statute of limitations barred the assessment or collection of the proposed deficiency against the petitioner.

There remains for our consideration, therefore, the sole issue of whether or not the respondent has sustained the burden of proof imposed upon him under section 602 of the Revenue Act of 1928, which provides:

Title IX of the Revenue Act of 1924 as amended, is further amended by adding at the end thereof two new sections to read as follows:
“ TBANSEEREE PROCEEDINGS-.
“ Sec. 912. In proceedings before the Board the burden of proof shall be upon the Commissioner to show that a petitioner is liable as a transferee of property of a taxpayer, but not to show that the taxpayer was liable for the tax.”
* # * * * * *

The respondent contends that he has met the burden of proof required of him when he has established that the tax in question was assessed against the Falconer Mirror Company; that it has not been paid; that the said company was dissolved; that the petitioner was the owner of 15 shares of stock of that corporation; and that it distributed to its stockholders a liquidating dividend of 46 per cent. The law and the facts in the case at bar do not support his view. As we said in Continental Oil Co., 23 B. T. A. 311: .

Tlie provisions of section 280 constitute an extraordinary method of collecting the taxes of the person who is primarly liable therefor, and consequently they must be construed strictly against the respondent.

And in Annie Temoyan et al., Trustees, 16 B. T. A. 923, we said:

It is evident that the statute places a real burden on the Commissioner. He must establish the liabilty of the transferee against whom he proposes to proceed. He must establish all facts necessary to show that there is a liability at law or in equity on the part of the transferee for the payment of the whole or a part of the liability.

The mere facts that a corporation is dissolved and that its assets wore distributed are not of themselves sufficient to hold the dis-tributee. Ludwig Vogelstein, 16 B. T. A. 947. Section 221 of the General Corporation Law of the State of New York (McKinney’s Consolidated Laws of New York), provides, so far as material, as follows:

Sec. 221. Dissolution of stoolc corporation T)efore empiration of time limit.— Any stock corporation, except a moneyed or a railroad corporation, may be dissolved before the expiration of the time limited in its certificate of incorporation or in its charter as follows:
1. The board of directors of any such corporation may at a meeting called for that purpose, upon at least three days’ notice to each director, by a vote of a majority of the whole board, adopt a resolution that it is in their opinion advisable to dissolve such a corporation forthwith, and thereupon shall call a meeting of the stockholders for the purpose of voting upon a proposition that such corporation be forthwith dissolved. Such meeting of the stockholders shall be held not less than thirty nor more than sixty days after the adoption of such resolution, and the notice of the time and place of such meeting so called by the directors shall be published in one or more newspapers published and circulating in the county wherein such corporation has its principal office at least once a week for three weeks successively next preceding the time appointed for holding^ such meeting, and on or before the day of the first publication of such notice, a copy thereof shall be served personally on each stockholder, or mailed to him at his last known post-office address. * ⅜ *
2. The secretary of state shall thereupon issue to such corporation, in duplicate, a certificate of the filing of such papers and that it appears therefrom that such corporation has complied with this section in order to be dissolved, and one of such duplicate certificates shall be filed by such corporation in the office of the clerk of the county in which such corporation has its principal office; and thereupon such corporation shall be dissolved and shall cease to carry on business, except for the purpose of adjusting and winding up its business. The board of directors shall cause a copy of such certificate to be published * * * and at the expiration of such publication, the said corporation by its board of directors shall proceed to adjust and wind up its business and affairs with power to carry out its contracts and to sell its assets at public or private sale, and to apply the same in discharge of debts and obligations of such corporation, and, after paying and adequately providing for the payment of such debts and obligations, to distribute the balance of assets among the stockholders of said corporation, according to their respective rights and interests.
3. Said corporation shall nevertheless continue in existence for the purpose of paying, satisfying and discharging any existing debts or obligations, collecting and distributing its assets and doing all other acts required in order to adjust and wind up its business and affairs, and may sue and be sued for the purpose of enforcing such debts or obligations, until its business and affairs are fully adjusted and wound up.

It is obvious that the corporate existence of the Falconer Mirror Company continued after its dissolution. Indeed, the statute expressly authorizes such continuance for the very wise purpose of paying its creditors, collecting debts due to it, and doing such other acts as might be necessary in concluding its business. The taxes due from the Falconer Mirror Company are such debts as might have been collected from that corporation subsequent to its dissolution if there were funds available for their payment.

From the unsatisfactory condition of the record we are unable to determine whether or not the Falconer Mirror Company had in its possession funds or other assets from which the alleged additional taxes might have been paid. There is no evidence whether the “ liquidating dividend ” of 46 per cent was a complete or only a partial distribution of the funds of the corporation. The plant and equipment were sold for over $46,000. The liquidating dividends aggregated $27,600. We do not know what debts, if any, the corporation owed on October 16, 1922, but we do know that on January 1, 1922, it possessed in cash $261.01 and notes and accounts receivable, $16,626.01. Among the assets sold to the Falconer Plate Glass Company, notes and accounts receivable are not included. Therefore, it would seem that after paying the 46 per cent liquidating dividend the Falconer Mirror Company was able to pay the additional taxes assessed against it. The assessments were made in 1925. The record does not show that at that time the corporation or its representatives were unable to pay its alleged tax obligation or that respondent exhausted his resources in an attempt to collect from the corporation.

In Kinnett-Odom Co., 19 B. T. A. 1124, we held that where the petitioner purchased from the taxpayer its tangible assets only and the taxpayer retained its cash, bills and accounts receivable and stock on hand, and the respondent did not prove that the value of these retained assets was less than the amount of the tax and there was no evidence of bad faith, there was no liability of the petitioner under section 280 of the Revenue Act of 1926. So far as we can gather from the record, a similar situation exists in the case at bar. Consequently, respondent has not proven liability on the part of the petitioner for the deficiencies asserted.

Reviewed by the Board.

Judgment will ~be entered for the 'petitioner.


author: MuRDOCK:

text:
    William S. Phillips, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 24446, 31769.
    Promulgated September 22, 1931.

      J. B. Grice, Esq., for the petitioner.

      O. J. Tall, Esq., for the respondent.
   OPINION.

MuRDOCK:

The petitioner is not entitled to deduct the insurance premiums. Julius S. Rippel, 12 B. T. A. 438; J. H. Parker, 13 B. T. A. 115; Rieck v. Heiner, 25 Fed. (2d) 453; certiorari denied, 277 U. S. 608. But he is entitled to deduct $7,560.66, instead of $1,000, as a loss sustained in 1920. Section 214 (a) (4) of the Revenue Act of 1918.

The only other issue relates to the proper way of reporting the profit from 22 sales of real estate made in 1920. The Commissioner included certain notes in the computation at full face value. The petitioner contended that these notes were not worth full face value, and should only be included in the computation of profit at their fair market value, which was, he claims, 75 per cent of their face value. After some testimony had been received, counsel for the respondent, as an alternative in case any change was made in this connection, made claim for increased deficiencies for 1922 and 1923, based upon collections made in those years on notes taken in the 1920 transactions. He stated that it would then make little difference in the total deficiencies whether the notes were included in 1920 at face or less than face value. The presiding Member suggested that the parties consider the figures and settle the whole case by agreement. They have not filed any such agreement. No brief has been filed and no argument has been made on behalf of the petitioner. Perhaps he is satisfied with the Commissioner’s treatment of these notes.

The petitioner did not sell or part with any of the notes in question in 1920. He said he did not have to and would not sacrifice them in that year. He preferred to hold them and collect on them. They were secured by the properties sold. The purchasers had substantial equities in the properties by the end of 1920. Over 50 per cent of the unpaid balance of the second and third trust notes at the end of 1920 was paid in 1921 and by the end of 1923 over 76 per cent of this balance had been paid. Some were not then due. As payments were made, the equity of a purchaser increased and the security for the note improved. We do not know that the petitioner ever lost one cent on any of the notes in question. The evidence is not convincing that under the Revenue Act of 1918 the computation made by the Commissioner of the profits on these sales was erroneous.

Judgment will be entered under Rule 50.


author: MoRRis:

text:
    Harry Wardman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 22348.
    Promulgated September 23, 1931.

      Meredith M. Daubin, Esq., for the petitioner.

      L. A. Luce, Esq., and F. L. Van Haafton, Esq., for the respondent.
   opinion.

MoRRis:

Section 229 of the Eevenue Act of 1921, which petitioner asserts is applicable to the facts herein, provides:

That in the case of the organization as a corporation within four months after the passage of this act of any trade or business in which capital is a material income-producing factor, and which was previously owned by a partnership or individual, the net income of such trade or business from January 1, 1921, to the date of such organization may at the option of the individual or partnership be taxed as the net income of a corporation is taxed under Titles II and III; in which event the net income and invested capital of such trade or business shall be computed as if such corporation had been in existence on and after January 1, 1921, and the undistributed profits or earnings of such trade or business shall not be subject to the surtaxes imposed in section 211, but amounts distributed on and after January 1, 1921, from the earnings or profits of such trade or business accumulated after December 31, 1920, shall be taxed to the recipients as dividends; and all the provisions of Titles II and III relating to corporations shall so far as practicable apply to such trade or business : Provided, That this section shall not apply to any trade or business, the net income of which for the taxable year 1921 was less than 20 per centum of its invested capital for such year: Provided further, That any taxpayer who takes advantage of this section shall pay the tax imposed by section 1000 of the Revenue Act of 1918 as if such taxpayer had been a corporation on and after January 1, 1921.

The above section sets up three essential requirements for the taxing of individual or partnership income for the year 1921 at corporate rates; that is, capital must be a material income-producing factor, there must be an organization as a corporation within four months after the passage of the Eevenue Act of 1921, and the provisions of the above section shall not apply to a trade or business, the net income of which is less than 20 per centum of its invested capital for 1921. We have found as a fact that capital was a material income-producing factor in the petitioner’s business, leaving two remaining essentials which must be satisfied in order to entitle him to the benefits of the said section. A failure to meet either of these essential requirements will bar petitioner from the relief sought.

The question of whether petitioner’s business was organized within four months after the passage of the Revenue Act of 1921 is one of law, which must be determined from an examination of the laws of the State of Virginia wherein the Wardman Construction Company, Incorporated, was organized. It can not be denied that this corporation ultimately came into legal existence and was organized within the meaning of the Revenue Act, but our question is whether that organization was so far perfected on March 23, 1922, four months after the passage of the Revenue Act of 1921, that there was at that time an “ organization as a corporation ” within the meaning of section 229, supra.

Title 35 of the Virginia Code of 1924, chapter 148, relating to the creation of corporations other than public service corporations, section 3849 thereof, provides that any three or more persons may by executing, filing and recording a certificate of incorporation, associate themselves together under the provisions and subject to the requirements of this chapter to establish a corporation. Section 3850 states that the certificate of incorporation shall set forth the name of the corporation, which shall contain the word “ corporation ” or the word “ incorporated,” and shall be such as to distinguish it from any other corporation engaged in a similar business or promoting or carrying on similar objects or purposes in the State of Virginia; the name of the county, city or town wherein the principal office of the corporation is to be located; the purpose for which the corporation is formed; the maximum and minimum amount of its capital stock, the division of the shares, and a description of the different classes of stock, if any, and the terms on which such different classes are created; the duration of the corporation; the names and residences of its officers and directors who “ unless sooner changed by the stockholders, are for the first year to manage the affairs of the corporation ”; the amount of real estate to which its holdings at any time are to be limited; etc. Section 3851 provides for the signing of the certificate by at least three persons, who shall acknowledge the said certificate before an officer of the State of Virginia authorized to take acknowledgments of deeds, and present it to the judge of the circuit court of the county or of the circuit, corporation or chancery court of the city wherein the principal office of the corporation is to be located. The said judge is to certify thereon whether the certificate is duly signed and acknowledged and if not, in what respect it is faulty. Upon indorsement by the judge and the payment of any fee or tax, the certificate of incorporation is presented to the corporation commission of Virginia, which ascertains and declares whether the applicants have entitled themselves to a charter by compliance with the law. Upon issuance of the certificate by the State corporation commission showing a compliance with the law, the secretary of the Commonwealth records the charter in the' charter records of his office and certifies the same by registered mail or personal messenger to the clerk of court wherein the corporation’s principal office is to be located, etc. This section further provides that:

As soon as tlie charter shall have been lodged for recordation in the office of the secretary of the Commonwealth, the persons who signed and acknowledged said certificate, and such other persons as may be associated with them according to the provisions of law, or of their charter and their successors, shall be a body, politic and corporate, by the name set forth in the said certificate, with the powers and upon the terms set forth therein, so far as not in conflict with law; and in addition shall have all the general powers and be subject to all general restrictions and liabilities conferred and imposed by this chapter and by the general laws of this State applicable thereto.

Title 34 of the said code, entitled “ General Provisions Applicable to Corporations,” chapter 147 thereof, provides in section 3788 as follows:

§ 3788. How subscriptions to capital stock may be paid; liability of subscriber; financial organization and disposition of stock; statement to be filed with the commission; penalty. — Subscriptions to the capital stock of any corporation may be paid in money, land, or other property, real or personal, leases, options, mines, minerals, mineral rights, patent rights, rights of way, or other rights or easements, contracts, labor, or services; and there shall be no individual or personal liability on any subscriber beyond the obligation to comply with such terms as he may have agreed to in his contract of subscription; and any corporation may adopt such plan of financial organization and may dispose of its stock or bonds for the purposes of its incorporation at such prices, for such consideration, and on such terms and conditions as it sees fit; but, before making any issue of its stocks or bonds it shall file with the State corporation commission a statement (verified by oath of the president or secretary of the corporation, and in such form as may be prescribed or permitted by the commission), setting forth fully and accurately the basis or financial plan upon which such stock and bonds are to be issued; and where such basis or plan includes services or property (other than money) received or to be received by the corporation, such statement shall accurately specify and describe in the manner prescribed or permitted by the commission the services and property, together with the valuation at which the same are received, or to be received, and’the judgment of the directors as to the value of such land or other property, real or personal, leases, options, mines, mineral rights, patent rights, rights of way, or other rights or easements, contracts, labor, or services in the absence of fraud, participated in by both parties to the transaction shall be conclusive.
For any violation of this section the offending corporation shall be liable to a fine of not less than ten or more than one thousand dollars, to be imposed and judgment entered therefor by the State corporation commission, and shall be enforced by its process.

It appears from tbe foregoing summary of the Virginia enabling statutes that'on March 23, 1922, the Wardman Construction Company, Incorporated, had complied with all the requirements of law relative to certification by the circuit judge and by the State corporation commission. These certifications, together with the recordation, made the construction company a body politic and corporate, endowing it with all the general powers and subjecting it to all the general restrictions and liabilities conferred and imposed by the said statutes. So far as the State of Virginia was concerned, the structural formation of the corporation was completed with the recordation of the charter in the office of the secretary of the Commonwealth, and thereafter the officers and directors named in the certificate of incorporation were empowered to manage the affairs and business of the corporation for the first year of its existence unless sooner changed by the stockholders.

It is unquestionably true, as shown by the facts, that at March 23, 1922, there were certain internal proceedings which -had not then taken place, such as the first meetings of the stockholders and directors, the filing of statements with the State corporation commission showing the basis or financial plan to be adopted by the corporation upon the issuance of its stocks or bonds, as required by section 167 of the constitution of Virginia and section 3788 of the Virginia Code, supra, and the formal taking over of the business and assets by the officers and directors selected by the stockholders. However, these steps, in our opinion, were not necessary under the laws of Virginia in order that there may be an organization as a corporation. The corporation as it existed on March 23, 1922, was fully capable of conducting its business and transacting its affairs for one year after the charter was issued, without further action by the incorporators or stockholders, section 3850. The statements that the incorporators were required to file showing the basis or financial plan upon which its stocks or bonds were to be issued, section 3788, were for the purpose of doing away with the common law liability of stock subscribers, and protecting them from any-future redress by creditors of the corporation on their subscriptions. Monk v. Barnett, 113 Va. 635; 75 S. E. 185. Even though the facts herein show that the said statements had not been filed by March 23, 1922, such a provision does not in our opinion preclude a corporation from being formally organized, although failure to comply might lay it open to a penalty by way of fine. Likewise, in view of the general powers given to corporations under the said enabling statutes, the incorporators were perfectly capable of transacting the construction company’s business without the necessity of formal minutes showing the action of the stockholders in turning over the petitioner’s business and assets to the officers and directors.

The respondent relies on the requirements of section 3788 of the Virginia Code, and the fact that the statements therein provided for bad not been filed with the State corporation commission by March 23, 1922, as showing that petitioner’s organization was unperfected. Upon examining the above section and the instructions accompanying the blank forms, which have been set forth in our findings of fact, it is our opinion that the filing of said statements was not a condition precedent to the organization of the corporation. One set of instructions stated that the report must be filed “ as soon as the corporation is organized,” which indicates that the corporation did not remain in an unorganized condition until the statement was filed. We believe that any reasonable time after the organization, but before issuance of stock, was sufficient as to the one report, and that any reasonable time after organization was sufficient as to the other.

We have examined the authorities cited by respondent in support of his contention that petitioner’s organization as a corporation was unperfected at March 23, 1922, but we are unable to agree that these authorities are controlling. In Welch v. Old Dominion Mining Railroad Co., 10 N. Y. S. 114; 56 Hun. 650, the question presented was whether an attorney could recover for services which he had rendered to assignees of a charter originally granted by the State of Virginia to certain incorporators. That particular portion of the opinion upon which the respondent relies is the statement of the court that “ under the laws of which state [Virginia] the corporation must be organized within two years after the charter is granted, else the grant will be absolutely void * * In that case the grant of the charter was originally made in 1882, and after a purported assignment of the said charter an organization was attempted thereunder in New York in 1886, and the plaintiff attempted to recover for his legal services to the assignees as their counsel. The court held that the charter was not assignable, that an attempted organization by persons to whom the charter was attempted to be assigned was void, and that a corporation de facto can not be created by user under such organization. In our opinion the above statement of the Welch case clearly distinguishes it from the question which we have presented herein.

In Ward-Truitt Co. v. Bryan & Lamb, 144 Ga. 769; 87 S. E. 1037, two partners attempted to deny their individual liability to creditors upon the strength of securing a charter and agreeing verbally between themselves that they would occupy certain official positions in a proposed corporation. There was no organization of the corporation, no subscription to its capital stock and no minutes of meetings of the alleged stockholders. The court in its opinion pointed out that this was not merely the case of a defective or imperfect organization of a corporation, or some irregularity in the formation of a corporation, but that the alleged corporation was actually nonexistent. We believe that this case is likewise distinguishable as to its facts, and, furthermore, it appears that the laws of Georgia relating to incorporation disclose no such provisions as are found in sections 3850 and 3851 of the Virginia Code, which we have summarized above.

The laws of Georgia provide that the power to create a corporation is vested solely in the general assembly and the courts, Park’s Annotated Code of Georgia, 1914, section 2192. In Georgia the organization of a corporation is not completed until the charter is issued and organization under the charter has been perfected. The law is stated in Michael Brothers Co. v. Davidson & Coleman, 3 Ga. App. 752; 60 S. E. 362, as follows:

A corporation is not a person in law until after the grant of its charter (Bartram, Hendricks & Co. v. Collins Mfg. Co., 69 Ga. 751) ; and, after a charter is granted, it has no authority to transact business until legal organization. Without charter and organization, “it could do no corporate act, could receive no corporate property, could incur no corporate liability, and against it no corporate judgment could be legally rendered.” Rau v. Union Paper Mill Co., 95 Ga. 212, 22 S. E. 146.

In Planters Insurance Co. v. Tennessee, for the use of Memphis, 161 U. S. 193, the legislature of the State of Tennessee incorporated an insurance company in 1860 with a provision in the charter limiting its taxation to one-fourth of one per cent of its capital stock. In 1870 that State adopted a new constitution forbidding such limitation. From 1860 down to January 30, 1884, the incorporators of the said insurance company took no action toward organizing a corporation to accept the aforesaid charter. On January 30, 1884, the then surviving incorporators met and organized the insurance company originally chartered, subscribed to its capital stock, held stockholders’ and directors’ meetings, elected its officers, and thereafter functioned continuously as a corporation. In 1885 the insurance company changed its name to Planters’ Fire and Marine Insurance Company, increased its capital stock, and since then has paid taxes on the increased capital stock at the rate named in the 1860 Act. Suit was brought by the State of Tennessee to recover taxes at the regular rate, which was in excess of the above limitation. The Supreme Court held that, since the organization of the corporation had been made subsequent to the adoption of the constitution of 1870, the corporation was subject to the provision thereof regulating taxation.

The last mentioned case, we think, is distinguishable because the corporation grew out of a legislative enactment which required an acceptance and an organization under the terms of the said act. The corporation was not created under enabling statutes, such as appear in the Virginia Code. Furthermore, the court found as a fact that the corporation had not been organized prior to the adoption of the constitution of 1870, and that, as its organization occurred thereafter, it must have been with clue regard to the constitution then in force.

In our research we have failed to find any decisions by Virginia courts determinative of this question, but we do find support for our decision in certain cases arising in jurisdictions other than Virginia involving the terms “ organization,” “ organizing,” and “ to organize.” In Morrison v. Clark, 24 Mont. 515; 63 Pac. 98, the court was confronted with the question of whether a certain mining company, incorporated under the general laws of Montana, had sufficiently completed its organization so that it became invested with title to certain property that had been conveyed to it. The court, after summarizing the general laws of Montana relative to incorporation, which laws are similar to the laws of Virginia, stated:

* * * Failure to hold any meeting of the stockholders or directors and omission to commence business in no wise prevented the Golden Gate Mining Company from becoming a- corporation; nor did either omission, or both of such omissions, operate to dissolve the corporation, or invalidate its acts or proceedings already taken, under which it had become a corporation. By the conveyance it became invested with whatever title the plaintiff possessed.

The- court then goes on to state that corporations organized under authority of general laws are organized by a compliance with the provisions of such general laws permitting corporations to be formed, and that such compliance results, of itself, in the organization of the corporations. Organization, according to the opinion, has no reference to the internal proceedings of the corporation, such as a meeting of the stockholders and the like, but means “ the formation or birth of the body corporate.” In Commonwealth v. William Mann Co., 150 Pa. St. 64; 24 Atl. 601, the court said: “ To organize is to furnish with organs.” In First National Bank of Detroit v. Board of Commissioners of Beltrami, Canada, 77 Minn. 43; 79 N. W. 591, the court stated that “ organizing ” a county is the vesting of the people of such territory with corporate rights and powers. In Daily v. Marshall, 47 Mont. 377; 133 Pac. 681, the court stated, “ The requirements to be observed for the perfection of the organization, the election of officers, and the like pertain exclusively to its private affairs, of which the public can have no information, and in the absence of statutory provisions to the contrary, or of inquisition at, the instance of the state, are to be deemed directory only. 10 Cyc. 223; Mechem on the Law of Corporations, § 163.”

In view of the above discussion of cases and the summary of the Virginia enabling statutes, we are,of the opinion that the petitioner’s business was sufficiently organized, on March 28, 1922, to come within the provisions of section 229 of the Kevenue Act of 1921. On that date the officers and directors named in the certificate of incorporation were empowered by the State to carry on its business as a corporation. The fact that its internal affairs had not at that time been completely adjusted is, in our opinion, immaterial so far as the Federal statute in question is concerned, which provides only that, “ in case of the organization as a corporation * * * ” of any trade or business, the petitioner shall have the option of having its net income taxed at corporate rates.

The second test which a taxpayer must meet to be entitled to have the net income of his trade or business taxed as a corporation is taxed is that the net income must not be less than 20 per centum of the invested capital. The petitioner contends that it meets this test, asserting that the evidence proves the net income of the business, computed upon a corporate basis, to be $77,495.48, and the invested capital to be $362,986.47. The respondent contends the petitioner does not meet the test, asserting that when correctly computed the net income is $62,495.48 and the invested capital is $760,437.59.

The difference in the net income as computed by the parties is $15,000, and this is due to the difference between them as to what constitutes a reasonable allowance for compensation to the petitioner for services rendered the business during the taxable year. The respondent says that a reasonable allowance is $50,000, while the petitioner contends that $35,000 was a reasonable compensation for the' services he rendered. We think the petitioner is right. The fact that the petitioner withdrew a net amount of $51,025.23 from the business, in 1921, is not ipso facto conclusive that such a sum is a reasonable compensation for his services. Obviously, if a sole proprietorship is sufficiently fortunate as to realize net earnings which are not entirely needed in the further conduct of the business, the proprietor will convert the excess earnings into other investments or appropriate them to his personal needs and welfare. Withdrawals under such circumstances bear no relation to a reasonable compensation for services, since they involve in addition to compensation the taking of profits no longer necessary in the business. While the evidence as to what is a reasonable compensation to the petitioner for services rendered in the taxable year is quite meager, it is sufficient to enable us to make a finding in that respect. Wardman’s testimony is in the record without objection and stands unrefuted or unweakened by cross-examination. In addition, we have the fact of payment to Wardman in the following year, by the successor corporation, of $50,000 as compensation for that year when the earnings of the corporation were approximately three and one-half times those of the business for 1921. The evidence indicates that $35,000 was a reasonable compensation to the petitioner for 1921, and we have made a finding that such is the case. Accordingly, we conclude that the net income of the petitioner’s business, for the taxable year 1921, computed upon a corporate basis, is $77,495.48.

This brings us to the determination of what is the petitioner’s invested capital for 1921. His books of account show a net worth of $824,142.56 and $218,926.59, as of January 1 and December 31, 1921., respectively. The facts, however, indicate quite clearly that these amounts are incorrect, because of errors of omission and commission in recording, or in failing to record, certain transactions on the books. In the first place, the respondent determined that the net worth as of January 1 was overstated by $20,000, because of an understatement of a like sum in the accounts payable, and that the net worth as of December 31 was overstated by $4,298.40, because of an understatement of $20,000 in the accounts payable, an arbitrary write-down of $3,763.22 in the book value of stocks and bonds, and an Understatement of $11,938.38 in the asset account “ Construction.” The determination of the respondent in respect of these items, winch reduces the net worth as of January 1 and December 31 to $804,142.56 and $214,628.19, respectively, is not contested by the petitioner. There are also the further facts revealing the petitioner’s failure to record on his boobs, prior to 1921, the gift to his daughter in 1917 of certain stock of the Swartzell, Rheem & Hensey Company, of the book value of $160,000; his failure to record on his books, prior to 1921, the disposition before December 31, 1920, through gifts to his wife and daughters and sales, of 6,738 shares of preferred and 202 shares of common stock of the Wardman Park Hotel Company; and the charging against surplus, in 1921, in recording the disposition of the hotel company stock, of an amount in excess of the actual cost of that stock as determined by the respondent.

The Swartzell, Rheem & Hensey Company stock, which was carried on the petitioner’s books, at December 31, 1920, at a value of $160,000, was given outright by the petitioner to his daughter, Alice Wardman Rheem, in 1917, and it should have been charged off against surplus on the petitioner’s books at the time of the gift. Accordingly, the net worth as of January 1,1921, should be reduced by $160,000.

The petitioner disposed of the Wardman Park Hotel to the Ward-man Park Hotel Company for 10,000 shares of the preferred and 173,080 shares of the common stock of that company. The cost of the hotel property to the petitioner was $758,235.02. The respondent determined that the value of the stock received in exchange was equal to the cost of the hotel, and he allocated the value to the preferred and common stock on the basis of a value of $27.76 per share of preferred and $2.77 per share of common. The respondent’s determination in these respects is not contested by the petitioner. Prior to December 31, 1920, the petitioner disposed of 6,000 shares of the preferred by gifts to his wife and daughters, and 738 shares of the preferred and 202 shares of the common by sales. The petitioner did not make any record of the disposition of these shares on his books until 1921, and, consequently, his net worth as of December 31, 1920, as shown by his books, is overstated to the extent of the cost of the shares so disposed of. The cost of these shares, based upon the respondent’s allocated per share value of $27.76 for the preferred and $2.77 for the common, is $187,606.42, and the net worth as of December 31, 1920, should be reduced by that amount.

As of December 31, 1921, the petitioner reduced the “ Stocks and Bonds ” account, by a credit thereto and a charge to surplus, by $516,180.45, to record the disposition of the shares above referred to. Since the cost of these shares to petitioner was but $187,606.42, stocks and bonds account and surplus (net worth) were erroneously reduced $328,574.03, and the net worth as of December 31, 1921, should, accordingly, be increased by that amount.

The petitioner contends that the net worth at January 1 and December 31, 1921, should be further reduced by $15,000, because of appreciation of that amount in the book value of the Braddock Heights Hotel, but the evidence presented by the petitioner is wholly inadequate to support that contention.

In view of the adjustments which we have directed be made in the net worth as reflected by the books of account, we find that the correct net -worth of petitioner’s business at January 1 and December 31,1921, is $456,536.14 and $543,202.22, respectively; that the total assets of the business, at the same dates, are $3,526,006.84 and $4,130,-139.14, respectively; that the inadmissible assets of the business, at the same dates, are $655,972.19 and $655,570.31, respectively; and that the percentage which the amount of inadmissible assets is of the amount of admissible and inadmissible assets held during the taxable year is 17.13. A computation of invested capital based upon these facts discloses that the net income of the petitioner’s business for the taxable year 1921 is more than 20 per centum of such invested capital.

At the rehearing respondent amended his answer by alleging that since petitioner had filed an individual return, computed the tax on the income reported thereon, and paid the tax returned, that his acts constituted an election and/or ratification of the option granted by section 229, and that he can not now change to a corporate basis. In support of this allegation respondent points to petitioner’s individual return for 1921, his quarterly payments of the tax returned, and the intention and efforts of petitioner to incorporate his business prior to the due date of the return. .Respondent asserts that the language of section 229 stating that “the net income * * * may at the option of the individual or partnership be taxed as the net income of a corporation is taxed * * *,” is to be determined in the light of equitable principles, and that the interested party may not exercise the option back and forth at his whim or caprice, but that, having once elected to report his income as an individual, he must now abide by the election which he made.

Respondent’s argument would be much more forcible if as a matter of fact petitioner had an election on March 15, 1922, the due date for 1921 returns, filed on a calendar year basis. But actually petitioner had no such election, because there was no corporation then in existence which would have entitled Wardman to make an election. The final condition precedent to legal organization was not satisfied until March 23, 1922, and naturally at any time prior thereto the petitioner would have no election as to how he would report his income for 1921. We have not overlooked the fact that petitioner might have asked for an extension of time in which to file his return, but as this possibility was either unknown to him or else ignored, we see no benefit to be derived from -considering what might have happened if he had acted differently. Furthermore, in view of the positive evidence that petitioner was incorporating his business to secure the benefits of a reduced tax rate, we are unable to agree that subsequent payments on the tax shown on his original return constituted an election to be taxed at rates applicable to individual incomes or a ratification of the only course that was open to him on March 15,1922.

In view of the foregoing, we find that all of the requirements of section 229 of the Revenue Act of 1921 are satisfied in this case, and, accordingly, the petitioner is entitled to have the net income of his business for the taxable year 1921 taxed as the net income of a corporation is taxed, as provided by that section.

Judgment will he entered wider Rule 50.