text:
    Texas-Canadian Oil Corporation, Ltd. (Canadian Company), Petitioner, v. Commissioner of Internal Revenue, Respondent. Texas-Canadian Oil Corporation (Delaware Corporation), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 100183, 103852.
    Promulgated July 8, 1941.

      H&rvry Ravenel, Esq., and William A. Blakely, Esq., for the petitioners.

      Jaimes H. Yeatman, Esq., for the respondent.
   OPINION.

Disney:

The respondent in the deficiency notice added to petitioner’s income as reported $257,700.03 “profit on reorganization”, explaining that the reorganization was held to result in realization of taxable gain under the provisions of article 112 (i) — 1 of Regulations 86, and the assets transferred, and therefore the stock received therefor, had value in excess of cost basis of the assets transferred.. Our primary question, therefore, is whether the respondent erred in determining a profit on the reorganization by applying the provisions of the above regulation, based upon section 112 (i) of the Revenue Act of 1934. In addition, the petitioner urges that there was no profit realized by it in the reorganization, but that if it be said that profit was realized in the reorganization, it was not income from sources within the United States; that if it was from sources within the United States the profit was not to be recognized under the provisions of section 112 of the Revenue Act of 1934, regardless of subsection (i) thereof; and, finally, that the Board has authority to relieve it of the hardship involved in section 112 (i) if we conclude that the agreement of reorganization did not have as one of its principal purposes the avoidance of Federal income taxes.

The nature of the approach to the problem requires that we first resolve petitioner’s last argument, since if it be sustained the other questions become immaterial.

1. The petitioner urges that we hold that the agreement of reorganization did not have as one of its principal purposes the avoidance of Federal income taxes and therefore that the reorganization was not taxable, and that we reverse the Commissioner in holding that the reorganization was not'tax free under section 112 (i), which requires that prior to such reorganization a foreign corporation shall establish to the Commissioner’s satisfaction that the exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

The situation here is not essentially different from that in Riley Investment Co. v. Commissioner, 311 U. S. 55, where, as herein, the taxpayer was not advised as to a statutory provision—requiring an election to be made in the “first return.” When apprised ox the provision, the taxpayer filed an amended return, much as the petitioner here furnished the information called for by section 112 (i)., The Court, in affirming the Circuit Court, which had affirmed this Board in holding that the amended return did not comply with the statute, said that “to require the administrative branch to extend the time for filing on a showing of cause for delay would be to vest in it discretion which the Congress did not see fit to delegate”, and that “to extend the time beyond the limits prescribed in the Act is a legislative not a judicial function.” To the plea, which petitioner here also makes, that a hardship was imposed upon it, the Court further said: “That may be the basis for an appeal to Congress in amelioration of the strictness of that section. But it is no ground for relief by the courts from the rigors of the statutory choice which Congress has provided.” Various other statutes require, in a manner analogous to that of section 112 (i), affirmative action of the petitioner in order to have the benefits therein involved, e. g., consent prior to change of accounting method under section 46, and consent of affiliates prior to filing a consolidated return under section 141. The statute here involved provided for a determination by the Commissioner prior to the reorganization. It was not asked for at that time and was not made. In our opinion the Commissioner did not err in the view that he had no authority to make it upon application made after the reorganization. On this point we sustain the respondent and hold that he properly applied section 112 (i).

2. The petitioner argues that it realized no profit in the transaction with the Bahamas corporation, urging that the contract, taken as a whole, did not- represent an exchange of its assets for Bahamas’ stock, since the stock was issued directly to: petitioner’s stockholders and not to it. Suggestion is made that eithér the petitioner, in legal effect, liquidated its assets to its stockholders, who in turn transferred them to the Bahamas corporation in satisfaction of the subscription to its stock made on their behalf; or that, in effect, the stockholders transferred their stock to the Bahamas corporation for its stock, thus empowering it, as owner of such stock, to take the assets of the Canadian corporation in place of the stock. Cases are cited where substance and not form was controlling. We find none decisive here. Thus R. C. Kuldell, 34 B. T. A. 1116, involved agency of one company for another. Equal distinction from the instant matter appears to us in the other citations. Herein a corporation transferred its assets in considex-ation of stock in another, and directed the issuance thereof to its stockholders. Only the petitioner could convey its assets, and they were never conveyed to its stockholders. The fact that the stockholders received the consideration does not control. Boggs-Burnham & Co., 26 B. T. A. 988; First National Bank of Greeley v. United States, 86 Fed. (2d) 938; Nace Realty Co., 28 B. T. A. 467; Northwest Utilities Securities Corporation v. Helvering, 67 Fed. (2d) 619. We hold that the petitioner realized a profit on the exchange.

3. The petitioner also argues that section 112 (i) is not applicable to an exchange between two foreign corporations, that, assuming the Canadian corporation exchanged its assets for stock of the Bahamas corporation, there was reorganization under section 112 (g), and nonrecognition of gain; and that no reason exists for applying the provisions of section 112 (i) to foreign corporations and a transaction not affecting Federal income tax liability. Such contention requires us to ignore section 112 '(i). On its face, the statute expressly covers foreign corporations, and exchanges that are nontaxable when made between domestic corporations. It can not be ignored. That the transaction comes within the definition of reorganization under section 112 (g) is only preliminary. If within section 112 (b) (4), as here the transaction is, section 112 (i) must be applied, with the result of recognized gain. We see no merit in petitioner’s argument on this point.

4. There remains for consideration the question as to whether the profit from the exchange was from sources within the United States, or without the United States and nontaxable under the provisions of sections 231 and 119 (e) of the Kevenue Act of 1934, which in effect provide that a foreign corporation is taxable only upon profit from sources within the United States, and that if the profit is from sale or exchange of personal property, it is nontaxable if the sale or exchange takes place outside the United States. The petitioner points out, and we find, that the agreement was consummated outside the United States; but the respondent urges that the sale or exchange was of oil and gas leases, in Texas, and that, under the decisions of the courts of that state, such leases are real estate, so that under section 119 (a) (5), Revenue Act of 1934, the income is from sources within the United States. Though the exchange plainly included personalty, such as cash, accounts receivable, and equipment on leaseholds, the profit upon which the Commissioner determined the deficiency arose solely from the exchange of oil and gas leases in Texas. The answer turns upon whether they are real estate within the purview of section 119 (a) (5) of the Revenue Act of 1934. The respondent urges the binding effect of decisions of the Texas courts; the petitioner, that on, a question of Federal taxation the Board is not so bound.

The courts of Texas have in various cases construed oil and gas leases- to be real estate. As to that state this is a concept so well settled that citation of authorities seems unnecessary. R. E. Nail et al., Executors, 21 B. T. A. 33. Section 119 (a) (5) of the Revenue Act of 1934 does not define real property. In Metropolitan Life Insurance Co. v. United States, 107 Fed. (2d) 311, the court said: “Since the Federal Statutes do not define the term ‘property’ or the rights attaching thereto, we must turn to the state law -for their meaning. Poe v. Seaborn, 282 U. S. 101.” In Morrow v. Scofield, 116 Fed. (2d) 17, the court considered the question as to whether documentary stamp taxes need be affixed to assignments of oil and gas leases on lands in Texas, under section 800 and schedule A-8 of the Revenue Act of 1926, as amended, imposing tax with respect to any “Deed, instrument or right * * * whereby any lands, tenements or other realty sold shall be granted, assigned, transferred or otherwise conveyed * * Pointing out that the Texas decisions are uniform to the effect that mineral leasehold interests are interests in lands, tenements, or other realty, the court held that the statute required affixing of stamps. It was pointed out that Burnet v. Harmel, 287 U. S. 103, which the petitioner herein cites and relies upon, involved the question of whether a bonus received by the lessor for execution of an oil and gas lease was subject to capital gains provisions. The same question was involved in Hirschi v. United States, 67 Ct. Cls. 637, extensively cited by the petitioner here. It was held that such bonus was not capital gain. Obviously, these cases do not involve the question here presented, which is whether the owner of an oil and gas lease on land in Texas, in exchanging it, exchanges real property, within the text of section 119 (a) (5). In Helvering v. Elbe Oil Land Development Co., 303 U. S. 372, it was held that the amounts received for the sale by the lessee of an oil and gas lease was return of capital invested—which serves to distinguish a sale or exchange of an oil and gas lease by the owner from the receipt of bonus by the lessor, in the above cases cited by the petitioner here.

We are impelled by the above decisions to the conclusion that the petitioner, in the exchange of oil and gas leases constituting real estate under Texas law, derived income from sources within the United States within the intendment of section 119 (a) (5) of the Revenue Act of 1934.

Reviewed by the Board.

Decision will be entered for the respondent in Docket No. 100183, that there is a deficiency in income tax in the amount of $29,555.75 and in excess profits tax in the amou/nt of $8,682.86, and that the Texas-Qanadian Oil Gorporation of Delcmwe, petitioner in Docket No. 103852, is liable for said amounts at law and/or in equity as transferee from the Texas-Ganadian Oil Gor-poration, Ltd., petitioner in Docket No. 100183.

       Aect. 112 (i)—1. Reorganization with, or transfer of property to, a foreign corpora⅛ Hon.—A foreign corporation will not be considered a corporation to which a tax-free transfer of property for stock or securities may be made, or a corporation a party to a reorganization with which a tax-free reorganization exchange may be made, unless, prior to the transfer or exchange, it has been established to the satisfaction of the Commissioner that such transfer or exchange is not in pursuance of a plan haying as one of its principal purposes the avoidance of Federal income taxes. The term “Federal income taxes” includes the excess-profits tax on the net income of a corporation referred to in sections 702 and 703 of the Act.
      Whether any of the exchanges or distributions referred to in section 112 (i), involving a foreign corporation, is in pursuance of a plan having as one of its principal purposes the avoidance of Federal income or excess-profits taxes, is a question to be determined from the facts and circumstances of each particular case. In any such case if a taxpayer desires to establish that the exchange or distribution is not in pursuance of such a plan, a statement under oath of the facts relating to the plan under which the exchange or distribution is to be made, together with a copy of the plan, shall be forwarded to the Commissioner of Internal Revenue, Washington, D. C., for a ruling. A letter setting forth the Commissioner’s determination will be mailed to the taxpayer. If the Commissioner determined that the exchange or distribution is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income or excess-profits taxes, the taxpayer should retain a copy of the Commissioner’s letter as authority for treating the foreign corporation as a corporation in determining the extent to which gain is recognized from the exchange or distribution. If the reorganization or the transfer is not carried out in accordance with the plan submitted, the Commissioner’s approval will not render the transaction tax free.

       SBC. 112. RECOGNITION OB’ GAIN OR LOSS.
      * * * id * * *
      (i) Foreign Corporations.—In determining the extent to which gain shall be recognized in the case of any of the exchanges (made after the date of the enactment of this Act) described in subsection (b) (3), (4), or (5), or described in so much of subsection (c) as refers to subsection (b) (3) or (5), or described in subsection (A), a foreign corporation shall not be considered as a corporation unless, prior to such exchange, it has been established to the satisfaction of the Commissioner that such exchange is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

       SBC. 13 9. INCOME EROM SOURCES WITHIN UNITED STATES.
      (a) Gross Income from Sources in united States.—The following items of gross income shall be treated as income from sources within the united States:
      ⅜ * ⅝ * * ⅜ , *
      (5) Sale op real property.-—-Gains, profits and income from the sale of real property located in the united States.


source: Caselaw Access Project

author: Black:

license: Public Domain

text:
    Francis A. Countway, Petitioner, v. Commissioner of Internal Revenue, Respondent. Arthur F. Bernhard, Petitioner, v. Commissioner of Internal Revenue, Respondent. William P. Jackson and Grace M. Jackson, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101499, 101500, 101501.
    Promulgated July 8, 1941.

      Alfred P. Lowell, Esq., for the petitioners.

      J. T. Hoslan, Esq., for the respondent.
   OPINION.

Black:

The question in these proceedings is the determination of the proper basis for computation of capital gain on the sale during the taxable year involved of the N. V. Unilever preference shares which petitioners acquired in 1930 in the manner set out in our findings. The applicable statute in the case of petitioner Countway is the Revenue Act of 1932; and in the case of the other two petitioners, the applicable statute is the Revenue Act of 1934. Section 113 of the Revenue Act of 1932 provides in part as follows:

SEO. 113. ADJUSTED BASIS 3TOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property.—The basis of property shall be the cost of such property; except that—
* * * * * * *
(2) Gifts after December 31, 1920.'—If the property was acquired by gift after December 31, 1920, the basis shall be the same as- it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift. * * *

Section 113 (a) (2) of the Revenue Act of 1934 is the same as the above quoted portion of the 1932 Act, except that the last quoted period is changed to a comma and is followed by the words “except that for the purpose of determining loss the basis shall be the basis so determined or the fair market value of the property at the time of the gift, whichever is lower.”

Petitioners primarily contend that they acquired the N. Y. Unilever preference shares on April 21, 1930, as a gift, and that their basis must therefore be determined under paragraph (2) of subsection (a) of section 113, supra. As an alternative, they contend that if it be held that the shares were not acquired as a gift, then it must be held that they were acquired in exchange for the partnership certificates; that the “cost” of the shares must be regarded as the fair market value of the partnership certificates at the time of the exchange on April 21, 1930, which value petitioners contend was equal to the value of the shares; and that petitioners are not estopped to use the “cost” thus contended for as their basis for determining capital gain or loss.

The respondent contends that petitioners did not respectively acquire the N. V. Unilever preference shares as a gift; that they acquired such shares in exchange for their partnership certificates; that these partnership certificates had been acquired by petitioners by virtue of their employment and were intended under the trust deed and scheme as a means of measuring additional compensation for faithful and loyal services performed; that, since the annual or periodical income received by petitioners on such partnership certificates had been considered by petitioners as income in the year received and had been so reported, the fair market value of the N. V. Unilever preference shares received by petitioners in 1930 was the equivalent of the then value of the aggregate of the anticipated future compensation receivable under such partnership certificates and should have been reported as taxable income in 1930, which petitioners did not do; and that, since petitioners did not report the receipt of the shares in 1930 or any taxable income therefrom, and the statute of limitations within which any deficiency might be assessed for 1930 has expired, the petitioners are estopped from claiming the fair market value of such shares on April 21, 1930, as their basis for computing gain or loss in the taxable years, respectively, and should be limited to a basis of cost, which was zero.

Were the transfers of the N. V. Unilever preference shares to petitioners on April 21, 1930, gifts of such shares to petitioners, or were the transfers made in consideration for and in exchange for the partnership certificates then owned by petitioners?

We are satisfied that the transfers of the N. V. Unilever preference shares to petitioners were not gifts but represented property received in exchange for the so-called partnership certificates, and that the fair market value of such shares when received by petitioners on April 21, 1930, was taxable income to them, since the exchange was a taxable one and not excepted from the recognition of gain or loss by section 112 of the Revenue Act of 1928 and the partnership certificates had a basis of zero for computation of gain or loss at all times. In Noel v. Parrott, 15 Fed. (2d) 669, the Fourth Circuit, among other things, said: “It is an essential characteristic of a gift, however, that it be a transfer without consideration. If there is a consideration for the transaction, it is not a gift. 28 C. J. 621.” .

Petitioners devote the greater part of their brief on the question of gift in support of the contention that there was no consideration for the transfers. They point to the provision of clause 7 of the trust deed wherein it was agreed between Lever Brothers Ltd., the first Lord Leverhulme, and the trustees that the partnership certificate holders would be entitled to participate “in the distribution of dividends as provided by the Articles of Association of the Company for the time being” and argue that in view of the phrase “for the time being” it was within the legal rights of Lever Brothers Ltd. to change its articles of association at any time so as to cut off all future benefits theretofore enjoyed by the holders of the partnership certificates, and that Lever Brothers Ltd. could do this without first securing the consent of not less than three-fourths of the total nominal amount of the outstanding partnership certificates, as provided by clause 13 of the trust deed. They further argue that such a change in the articles of association actually occurred when the second Lord Leverhulme and the executors of the will of the first Lord Leverhulme agreed to exchange the ordinary shares of Lever Brothers Ltd. for shares of Unilever Ltd.; that the stockholders of Lever Brothers Ltd. were under no legal obligation to transfer anything to petitioners; and that the transfer to petitioners of the N. V. Unilever preference shares was a pure gratuity.

Although petitioners argue this point in their brief persuasively, we are not convinced by such argument. After a careful consideration of all the facts, we have come to the conclusion that petitioners received the N. Y. Unilever preference shares of stock .in exchange for their so-called partnership certificates, together, with the dividend rights which these certificates carried.

On January 1, 1930, the second Lord Leverhulme and the executors caused an offer to be made to petitioners and others which was accepted by each of the petitioners. This offer was, in part, as follows:

In accordance with such valuation, Lord Leverhulme and the Executors are pleased now to be in a position to offer you the under-mentioned number of 7 per cent. Cumulative Preference Shares of 12 Florins each, fully paid, in N. Y. Margarine Unie (or N. V. Unilever, as will be the name of thte Company very shortly), and cash in lieu of a fraction of a share, in exchange for your Partnership interest which will be cancelled; * * *. You will, in addition, be entitled to the Co-Partnership dividend of 5 per cent, which is expected to he paid for the year 1929.
****** *
The Trustees of the Co-Partnership Trust consider that the above offer is a very favourable one to you, and they unhesitatingly recommend you to accept it by signing the form attached below and returning it in the enclosed envelope to your Company not later than seven days after receipt hereof by you.

The form of the acceptance was as follows:

I accept the offer contained in your circular of the 1st January, 1930, and I agree that on issue of the shares in N. V. Margarine Unie (1ST. V. Unilever) to which I am entitled under that offer, my rights to Co-Partnership dividends, whether under Partnership Certificates or Bonuses on 8 per cent. Preferred Ordinary Shares in Lever Brothers Limited, shall cease.

We, therefore, think the surrender by petitioners of their partnership certificates in exchange for the N. Y. Unilever preference shares was a good and valid consideration for such shares, and that, since there was a consideration for the transaction, it can not be said that petitioners acquired the N. V. Unilever shares as gifts. Noel v. Parrott, supra. We hold, therefore, that petitioners’ bases may not be determined under paragraph (2) of subsection (a) of section 113, supra.

Since not any of the exceptions to subsection (a) of section 113, supra, are applicable, it follows that the basis of each petitioner is “cost” of the N. Y. Unilever preference shares at the time of their acquisition. What was this cost? Where stock is received in exchange for properties, the cost of the stock is the value of the properties exchanged therefor, unless the transferor is required, under the statute, to retain as the cost of the stock the cost of the properties transferred. See Paul and Mertens, Law of Federal Income Taxation, sec. 18.18.

We have already pointed out that the exchange which took place in 1930 was not one excepted from the recognition of gain or loss under section 112 of the Eevenue Act of 1928. Therefore, the' cost to petitioners of the stock which they acquired in 1930 was the value of the property which they gave up in exchange for it. If we had no evidence as to what the value of the property given in exchange was, then the presumption would be that it had a value equal to the fair market value of the shares of stock which were received in exchange for it. Ambassador Petroleum Co., 28 B. T. A. 868; reversed on another point, 81 Fed. (2d) 474; Holmby Corporation, 28 B. T. A. 1092; affd., 83 Fed. (2d) 548, and cases there cited.

But the rule cited in the foregoing cases does not apply in the instant case because we do have evidence as to the value of the property which petitioners gave in exchange for the shares of stock which they received. It has been stipulated that the partnership certificates “had neither capital value nor market value at any time.” In view of this stipulation, we think we must hold that the N. Y. Unilever preference shares of stock which petitioners received in 1930 had no cost basis to them.

The situation would, of course, be different if they liad taken the fair market value of the stock into income in 1930 and had paid tax thereon. In that event, the cost basis of their stock in the years when they sold it would have been the fair market value of the stock which they took into income in 1930. But the facts show that petitioners did not take the fair market value of the stock into income in 1930 and pay tax thereon nor did the property which they gave in exchange for it have either capital value or fair market value. Under these circumstances we think petitioners have failed to prove that the shares of stock which they sold in the respective taxable years had any cost basis to them. Cf. Commissioner v. Farren, 82 Fed. (2d) 141; certiorari granted and subsequently dismissed by stipulation of counsel, 299 U. S. 617; Alamo National Bank v. Commissioner, 95 Fed. (2d) 622; certiorari denied, 304 U. S. 577, affirming 36 B. T. A. 402.

Because of the foregoing reasons and under the authorities cited, we sustain the Commissioner in his determination that the shares of stock in question had no cost basis to petitioners.

Decision will be entered for the respondent.


author: Disnet : Mult,pit,

text:
    Isaac W. Frank Trust of 1927, Wm. K. Frank, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98274.
    Promulgated July 9, 1941.

      S. Leo Ruslander, Esq., Samuel Kaufman, Esq., and Louis Capian, Esq., for the petitioner.

      Orris Bennett, Esq., Framh Donohoe, Esq., and J. Harrison Miller, Esq., for the respondent.

       SBC. 113. adjusted BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (Unadjusted) of Property.—The basis of property shall be the cost of such property; except that—
      * * * * * * *
      (13) Partnerships.—If the property was acquired, after February 28, 1918, by a partnership and the basis is not. otherwise determined under any of the paragraphs (1) to (12), inclusive, of this subsection, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. If the property was distributed in kind by a partnership to any partner, the basis of such property in the hands of the partner shall be such part of the basis in his hands of his partnership interest as is properly allocable to such property.

       Aet. 113 (a) (13)-1. [Regulations 86.] Property contributed in kind by a partner to a partnership.—The basis of property contributed in kind by a partner to partnership capital after February 28, 1913, is the cost or other basis thereof to the contributing partner. * * * On the sale or other disposition of such' contributed property by the partnership the gain or loss, determined on such transferred basis, adjusted as required by section 113 (b), shall be prorated in determining the distributive shares of the partners according to their gain or loss ratios on the disposition of a partnership asset under the partnership agreement.

   OPINION.

Disnet :

The respondent contends upon brief that the Frandel Partnership should be disregarded upon the ground that its sole purpose was tax avoidance and therefore it had no business purpose; that the trust agreements do not authorize the trusts to become members of a partnership; and that the Bevenue Act of 1936 does not recognize partnerships composed of trusts.

1. Was the formation of the partnership for the sole pwrpose of molding taxes?—It is apparent from the evidence of record that tax consciousness prompted some of the transactions preceding the 1936 distribution. The reports contain numerous cases in which the object of the transaction in controversy was tax reduction or complete avoidance within the limits of law. The right of a taxpayer to take advantage of lawful means to reduce the amount of his taxes or avoid them altogether is well recognized. Gregory v. Helvering, 293 U. S. 465, in which the Court said:

* * * It is quite true that if a reorganization' in reality was'effected within the meaning of subdivision (b), the ulterior purpose mentioned [motive of taxpayer to escape tax] will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. * * *

The creation of trusts for tax-saving purposes is not fatal, Elizabeth K. Lamont, 43 B. T. A. 61, and it is proper for trustees to perform their duties in such a way as to save taxes. John D. McKee et al., Trustees, 35 B. T. A. 239. The doctrine applies to partnerships. Chisholm v. Commissioner, 79 Fed. (2d) 14; certiorari denied, 296 U. S. 641. Higgins v. Smith, 308 U. S. 473, involving the deductibility of a loss on a sale of securities by Smith to a wholly owned corporation whose transactions were restricted largely to dealings with its stockholder, proceeds from the theory that substance may be followed by the Government in instances where the method adopted to carry the plan into effect was unreal or a sham. A similar case is Griffiths v. Helvering, 308 U. S. 355. The case of Campana Corporation v. Harrison, 114 Fed. (2d) 400, involved excise taxes and turned upon the fact that the sales to a corporation having the same stockholders were not arm’s length transactions. A like case is Continental Oil Co. v. Jones, 113 Fed. (2d) 557. The record discloses that the Frandel Partnership was not an organization created with tax avoidance as its primary or sole object.

2. Was it formed for a business purpose?—We think it was created for such a purpose and to relieve, in the opinion- of the trustees, the situation that had developed on account of distributions of capital to beneficiaries of the trust. The respondent argues, however, that the trustees could have solved the difficulties by obtaining releases from all of the parties in interest. The trustees decided upon the formation of a Delaware partnership as the best means of solving the problem. That a different course of procedure would have been just as effective, or simpler, is not controlling. Our decision must proceed from the facts as they exist, not from what might have been done.

3. Did the trustees have power tg organize the partnership?—The trustees of petitioner had power to invest and reinvest the principal of the trust “in the discretion of the trustees, in stocks, interest-bearing securities and/or first mortgages upon improved real estate,” without limitation to securities designated under Pennsylvania laws as trust investments. The other trusts, in addition to like authority, empowered the trustees “to do all things and make any and all contracts concerning this trust estate that I could do or make if I continued to own the same.” During the lifetime of the grantor the corpus of petitioner was transferred to I. W. Frank, Inc., for stock of the corporation and thereafter the assets, together with the corpus of the two trusts created by Isaac W. Frank and his wife on May 21, 1930, were exchanged for stock of the Frank Securities Corporation. The corporation at all times thereafter during the lifetime of the grantor held the original assets not only of petitioner, but of the other two trusts. This discloses intent on the part of the grantor to pool the corpus of his trusts with other assets in a single enterprise. The plan was in effect until the formation of the partnership in 1935, when the administration of the original assets was divided between the partnership and the corporation.

There was not at any time any actual delegation of power by the trustees. The grantor’s two sons and his son-in-law were throughout 1935 and 1936 the directors of the Frank Securities Corporation and trustees of the trusts, and consequently there was not any relinquishment or delegation of power in favor of other persons. Any delegation was to themselves serving in a like capacity in other trusts. The assets of petitioner were subject to losses sustained in the administration of the assets of the other trusts. Each trust, however, received the benefit of gains realized by the other trusts, and the pooling arrangement had been in force since 1930, partly during the lifetime of the decedent. The intervention of the partnership created no substantial change in the real nature of the pooling venture.

The segregation of the assets in common enterprises was regarded for the best, interests of the beneficial owners of the trust property, and we can not say that this was an abuse of discretion, or that the act was unreasonable. Cooperation with others is not a breach of a trustee’s duty to the beneficiary. Sec. 171, Restatement of Trusts.

It does not appear that the beneficiaries of the trusts ever questioned the power of the trustees to invest corpus in capital of a partnership. The respondent has recognized the Frandel Partnership as a partnership for purposes other than the distribution in question here. If the trustees had no authority to form the partnership, the respondent, not being a party in interest,- is in no position to question it. See Joseph F. Hindes, Trustee, 29 B. T. A. 498; Francis M. Camp, 21 B. T. A. 962; Lewis E. Smoot, 25 B. T. A. 1038; Joseph S. Finch & Co., 23 B. T. A. 1153; Alfred T. Wagner, 17 B. T. A. 1030; Albert G. Dickinson, 23 B. T. A. 1212.

4. Statutory authority for partnership.—The respondent cites sections 181 and 1001 (a) (1) to support his contention that a partnership which has trusts as partners is not recognized by the Revenue Act of 1936. The petitioner refers us to sections 161 and 162.

The respondent has recognized the estate of a decedent as a partner under sections 1 and 218 (a) of the Revenue Act of 1918, which read the same as sections 181 and 1001 (a) (1), supra. I. T. 2026, C. B. III-l, p. 213. He has also held a corporation to be liable under the same act on its share of the profits of a foreign partnership of which it was a member. O. D. 230, C. B. No. 1, p. 212. We have heretofore recognized New York partnerships having a trust as a member. M. A. Reeb, 8 B. T. A. 759; Charles E. Ives, 29 B. T. A. 822.

None of the revenue acts prior to the Revenue Act of 1932 contained a definition of the term partnership. Section 1111 (a) (3) of the 1932 Act reads as follows :

(a) When used in this Act—
*******
(3) The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial .operation, or venture is carried on, and which is not, within the meaning of this Act, a trust or estáte or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or organization.

The definition was continued in subsequent acts.. Sec. 801 (a) (3), Revenue Act of 1934; sec. .1001 (a) (3), Revenue Act of 1936; sec. 901 (a) (3), Revenue Act of 1938; sec. 3197 (a) (2), Internal Revenue Code.

Any doubt as to the meaning of sections 181 and 1001 (a) (1), supra, is dispelled by the statutory definition of the term partnership as used in revenue acts commencing with the 1932 Act. The provision does not require the members of the organization to be individuals. If the Frandel Partnership is not an ordinary partnership, it is a partnership within the statutory definition. Joseph L. Selling, 22 B. T. A. 920; affd., 64 Fed. (2d) 712, relied upon by respondent, involved the Revenue Act of 1921, and Burk-Waggoner Oil Association v. Hopkins, 269 U. S. 110, cited therein, related to tax liability under the Revenue Act of 1918. We think the Frandel Partnership is a partnership within the meaning of the Revenue Act of 1936. Dolores Crabb, 41 B. T. A. 686.

5. Basis for computing gaim, or loss.—The contention of the petitioner is that, since the combined basis of the stock of the Frank Securities Corporation contributed by the three trusts to the partnership is in excess of the value of the property distributed by the corporation to the partnership in 1935 and 1936, as determined by the respondent, no gain was realized. In his determination of the deficiency the respondent computed gain of $542,802.07 by allocating to petitioner a pro rata share of the distribution of securities in 1935 and 1936 based upon its 34.78 percent interest in the partnership, the amount being $1,113,191.06, and deducting therefrom petitioner’s adjusted basis of $570,388.99. The point of difference between the parties is whether gain or loss to the partnership on the distributions should be computed on an aggregate basis of -all of the stock or the separate basis of each partner.

No cases are cited by either party in which the precise question was presented for decision. Petitioner argues that, while section 113 (a) (13) of the Revenue Act of 1936 requires a partnership to use the trans-feror’s basis, it is silent as to situations such as in the instant case, where there were simultaneous contributions in kind by several partners of identical property, and, since section 183 requires that the net income of a partnership be computed in the same manner and on the same basis as an individual, the rules applicable to individuals would apply to partnerships. The cases of Standard Fuel & Material Co., 29 B. T. A. 51; Cyrus S. Eaton, 37 B. T. A. 715: and Raoul H. Fleischmann, 40 B. T. A. 672, cited by petitioner, involved different facts and are not decisive of the question.

Prior to the Bevenue Act of 1934 there was no statutory provision specifying the basis to be used by a partnership for a computation of gain or loss on the sale of property contributed by a partner. The Commissioner contended that the basis should be cost to the partner. G. C. M. 10092, C. B. X-l, p. 114. This Board and the courts declined to adopt the view of the Commissioner and held that the basis was the value of the property at the time of its contribution to the partnership. Edward B. Archbald, 27 B. T. A. 837; affd., 70 Fed. (2d) 720; certiorari denied, 293 U. S. 594; Helvering v. Walbridge, 70 Fed. (2d) 683; certiorari denied, 293 U. S. 594; Chisholm v. Commissioner, 79 Fed. (2d) 14; certiorari denied, 296 U. S. 641; United States v. Flannery, 106 Fed. (2d) 315; Carroll E. Donner et al., Guardians, 32 B. T. A. 364. The Commissioner adhered to the rule set forth in G. C. M. 10092 pending the outcome of further litigation of the question. Mim. 4311, C. B. XIV—1, p. 208. This Board continued to follow the Archibald, Walbridge, and Chisholm decisions. Cyrus S. Eaton, supra.

While this conflict existed between decisions of the Board and the courts, and rulings of the Commissioner, changes in the partnership provisions of the existing revenue law were being considered by the Treasury Department and committees of Congress to prevent evasion of tax by the use of the partnership form of doing business. Hearings before the Committee on Ways and Means, Bevenue Bevision, 1934. The consideration resulted in the enactment of section 113 (a) (13), sv/pra.

The new provision in question provides in unambiguous language that, upon the sale of property contributed by a member of a partnership, gain or loss shall be determined not upon the basis of the fair market value of the asset at the time of its contribution, as had been held by the Board and the courts, but upon the basis of cost or other basis of the contributing partner, adjusted for gain or loss to the contributor at the time of transfer, in accordance with the method outlined in-G. C. M. 10092, sufra. The object was to prevent stepped-up basis resulting for contributions of property which had appreciated in value. The intent of section 113 (a) (13), aside from its clear language, is shown by reports of committees of Congress. In Beport No. 704, on the Bevenue Act of 1934, the Committee on Ways and Means, said:

The subcommittee and the committee have máde a careful study of the taxation of partnerships. It has been strongly contended that many large partnerships, particularly those engaged in the banking and security business, have been the vehicle of wide-spread tax avoidance. It has been pointed out that wealthy partners have applied partnership losses against their individual incomes, with the result that in some of the past few years they have paid no individual income taxes. If any avenue of escape from the income tax through the use of the partnership provisions has been left open in the past, it is important that it should be completely closed at this time.
* * * ⅜ ⅜ * *
The committee also proposes two important changes in connection with the basis provisions, for the purpose of making it entirely certain that there can be no use of the partnership as a medium of tax avoidance in cases of sales of property, which has appreciated in value. The result of the provisions of section 113 (a) (13) is that if property is purchased by a partnership the basis of such property to the partnership shall be its cost; but if the property is paid in by a partner then the basis to the partnership shall be the cost or other basis to the partner. The committee believes that this provision simply makes specific the correct interpretation of the general provisions of the present law. * * * ■

Identical language appears in the report of tbe Finance Committee of the Senate. Bept. No. 558, p. 18.

If a partnership sold the specific asset contributed by one of its members, there can be no doubt that the gain or loss to the partnership under section 113 (a) (13) would be measured by the difference be- • tween the selling price and the basis the property had in the hands of the transferor. Accordingly a sale by the partnership of the shares of stock contributed by petitioner would have resulted in gain or loss to the firm computed on the basis of the stock in the hands of petitioner.

We fail to see how the result could be different under the circumstances herein, where there were simultaneous contributions of like property. The formation of partnerships generally involves concurrent transfers of assets by the members and the property of the firm is frequently of a like kind. There is no indication that Congress intended to exclude such transactions from the general terms of the provision in question.

The regulations under the provision recognize no basis other than the one to the contributing partner. This obviously excludes a basis representing the combined bases of all the contributing partners, as contended, by the petitioner. Subsequent revenue acts and regulations promulgated thereunder contain like provisions. Sec. 113 (a) (13), Revenue Acts of 1936 and 1938, and Internal Revenue Code; article 113 (a) (13)—1, Regulations 94,101,103.

It seems clear that Congress intended that no contribution of property to a partnership by a member of the firm should result in a change of basis of the asset in the hands of the partnership. Combining the bases of the partners would work such a change. The reenactment by Congress of’section 113 (a) (13) in subsequent revenue acts without change discloses legislative approval of the regulations. Brewster v. Gage, 280 U. S. 327.

We do not regard as important the consolidation on the date of receipt by the partnership of the six stock certificates, two from each partner, into one certificate for 10,260 shares. The purpose of the statute to continue in the hands of the partnership the basis of the contributing partner may not .be defeated by a simple transaction of that nature having no substance. The respondent committed no error in using as a basis for the computation of gain the basis the stock had in the hands of the transferor, the petitioner. He did err, however, in the method he used to allocate the' distribution against such trans-feror’s base. He allocated thereto 34.78 percent of the distribution, because 34.78 percent was petitioner’s distributive share of the partnership income. The distributions were made pro rata on all of the 10,260 shares of outstanding stock. He should have allocated to the base of the 3,521 shares 3521/10260 of the distribution, i. e., in proportion to the transferor’s contribution of 3,521 shares to total partnership capital of 10,260 shares of stock in the Frank Securities Corporation. The petitioner’s distributive share of partnership income does not determine allocation of distribution to base. It does, under section 182, Revenue Act of 1936, determine the amount of the partnership net income.arising from profit in the distribution which should be included in petitioner’s income. Therefore, 34.78 percent of the partnership profit from the distribution, which the parties seem to agree is the same as its net income, should be included in computing petitioner’s net income.

6. Character of the distributions.—In view of our holding on the issue as to the proper basis, it will be necessary to decide the alternative question raised by the petitioner concerning the character of the distribution.

The petitioner contends that the property received by the partnership was not a liquidating dividend and that section 115 (d) applies. The respondent contends that the distributions were made under section 115 (c) .

In T. T. Word Supply Co., 41 B. T. A. 965 (980), we said:

* * * The liquidation of a corporation is the process of winding up its affairs by realizing upon its assets, paying its debts, and appropriating the amount of its profit and loss. It differs from normal operation for current profit in that it ordinarily results in the winding up of the corporation’s affairs, and there must toe a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. A mere declaration is not enough, and the question whether a corporation is in liquidation is one of fact. W. E. Guild, 19 B. T. A. 1186; Fred T. Wood, 27 B. T. A. 162. * * *

The decisive factor has been said to be “whether the distribution was made with the intent to maintain the corporation, as a going concern or with the intent to liquidate the business.” Horn & Hardart Baking Co. v. United States, 34 Fed. Supp. 89.

The respondent contends that the intent during and after 1935 was to liquidate the corporation, and that, accordingly, the 1935 and 1936 distributions were two of a series of distributions in liquidation. The evidence here does not support such a finding.

The uncontradicted evidence of petitioner’s witnesses is that the 1935 distribution was not part of a plan to liquidate the corporation at that time or in the future, but for the purpose of giving the partnership assets of a character to enable it to actively engage in business and earn income available for distribution to life beneficiaries without incurring additional liability of the trustees for distributions out of capital. Thereafter the partnership carried on a business of dealing in. investments and the corporation continued its usual business affairs with less assets. A further distribution was made in 1936 for similar reasons. Some consideration was given to liquidation under provisions of the Revenue Act of 1936, but they were not regarded as favorable, from a tax viewpoint, and no action to that end was taken. No plan of liquidation was adopted until the passage of the Revenue Act of 1938, and the decision was made at that time because of beneficial provisions of the statute. We find no connection, direct or indirect, between the distribution in 1938 and the distributions made in 1935 and 1936.

A partial liquidation is defined as “a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.” Sec. 115 (i).

There was no cancellation or redemption of a part of the corporation’s stock in 1935 or 1936. The one certificate held by the partnership for all of the corporation’s stock remained outstanding until the dissolution of the corporation in 1938,

The reduction of capital at the close of 1935, resulting in the conversion of a deficit into surplus, and the change made in' 1936 in the face value of the corporation’s stock from no par value to a value of $1 per share, are not decisive. Neither had any connection with a plan of liquidation or in any wise altered the investment of petitioner. The partnership continued to be the holder of all of the corporation’s stock. Hellman, v. Helvering, 68 Fed. (2d) 763; Rheinstrom v. Conner, 33 Fed. Supp. 917; John B. Stewart, 29 B. T. A. 809; W. K. Holding Corporation, 38 B. T. A. 830.

In Tecla M. Straub, 29 B. T. A. 216; affd., 76 Fed. (2d) 388, there was proof that the corporation had been winding up its affairs for four years and in Dill Manufacturing Co., 39 B. T. A. 1023, there was a retirement of stock. Such facts are not present here.

We conclude that the distribution made in 1936 was not a liquidating dividend and that it is taxable under section 115 (d).

7. Fair market value of the distributions.—The valuations determined by the respondent for the securities distributed by the corporation to the partnership in 1935 and 1936 are based upon market or quoted prices without regard to blockage. The 1935 distribution consisted of about 35,000 shares of stock of eight corporations, not less than 1,000 shares of any corporation. The distribution in 1936 consisted of about 26,000 shares of stock of 36 corporations in blocks of from 25 to about 2,500 shares, and bonds of a face value of about $500,000, of which $450,000 were real estate bonds and the remainder were bonds of the New York Central & Hudson Railroad. The railroad bonds and most of the stocks were listed on the New York Stock Exchange and some of these were also traded in on other exchanges. The real estate bonds were unlisted securities. The values found by the respondent are, in general, the mean between the high and low selling prices on the basic dates or the bid and asked prices on unlisted securities.

The petitioner offered testimony of three witnesses to establish lower valuations. In some instances the valuations of these witnesses agree with the values determined by the respondent. Their aggregate value for the stocks and railroad bonds is only about $190,-000 less than the total value determined by the respondent. Only one of the witnesses testified on the value of the real estate bonds and his valuation is about $13,000 lower than the total value found by the respondent. All of them valued the securities at a discount on account of the volume involved. The two witnesses who testified concerning the stocks admitted that their values were speculative and conjectural.

Many of the stocks discounted by the witnesses on account of the number of shares involved were bought and sold in large volume. The effect on an active market of an offering of a large block of stock is a matter of proof, not of assumption. Safe Deposit & Trust Co. of Baltimore, Executor, 35 B. T. A. 259. The proof is lacking here. Market prices are the best evidence of the value of the stock. Estate of Leonard B. McKitterick, 42 B. T. A. 130. The evidence here as to value does not overcome, in our opinion, the prima fade presumption existing in favor of the respondent’s valuations, and we have, accordingly, found values for the securities in accordance with his determination.

Reviewed by the Board.

Decision will he entered under Rule SO.

Mult,pit,

dissenting: I respectfully dissent from the holding of the majority to the effect that the Frandel Partnership is a partnership within the meaning of the Revenue Act of 1936. In the trust agreement the settlor granted, bargained, sold, transferred and set over unto the Bank of Pittsburgh National Association and to Isaac W. Frank, as joint trustees, certain securities “to have and to hold the said moneys and securities and the investments into which the same may be hereafter converted and to invest and reinvest the same from time to time, in the discretion of the trustees, in stocks, interest bearing securities and/or first mortgages upon improved real estate * * They were to “collect, recover and receive, the interest, income and dividends upon said securities, money and investments, when due and payable” and to pay over not to exceed the sum of $60,000 annually to the donor. After the death of the donor “the trust shall continue as theretofore” and all of the net income is to be paid to the donor’s sons and daughter. The trust is to end when the last surviving child of the donor is deceased and the donor’s daughters-in-law and son-in-law shall have died or remarried. Any funds held by the trustees “arising from the sale or maturity of securities, or otherwise, shall be invested pursuant to the terms hereof in such securities as the trustee shall deem wise, such investments not being limited to such securities as are designated under the laws of Pennsylvania as ‘trust investments’.”

In my judgment the trustees had no power or authority to enter into such a partnership agreement as that shown in the findings or to “contribute” to the partnership the shares of stock held by them in trust. This would be a delegation of their trustee powers and duties to the other partners and subject the assets of the trust to the payment of partnership debts, contrary to the clear intent of the grantor. Moreover, an examination of the record indicates quite clearly not only “that tax consciousness prompted some of the transactions”, as set out in the majority opinion, but that the sole purpose of the organization of the partnership was to minimize or altogether avoid Federal income taxes. Under such circumstances, even if the partnership were a valid entity, which I do not concede, it should be disregarded under the rationale of such cases as Higgins v. Smith, 308 U. S. 473; Gregory v. Helvering, 293 U. S. 465; and Griffiths v. Helvering, 308 U. S. 355.

       SBC. 182. TAX OF PARTNERS.
      There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

      (d) Other Distributions Prom Capital.—If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not a dividend, then the amount ■ of such distribution shall be applied against and reduce the adjusted basis of the stock provided in section 113, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property.

       (c) Distributions in Liquidation.—Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall, be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. For the purpose of the preceding sentence, “complete liquidation” includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two .years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a dis tribution of earnings or profits.

       (i) Definition of Partial Liquidation.—As used in this section the term, “amounts distributed in partial liquidation” means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in" complete cancellation or redemption of all or a portion of its stock.


author: Van Fossan : TURNER,

text:
    Helen Whitney Gibson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100433.
    Promulgated July 9, 1941.

      Frederick E. Winkler, Esq., for the petitioner.

      George R. Sherriff, Esq., for the respondent.
   OPINION.

Van Fossan :

The sole issue is whether or not the petitioner, owner of common stock of Manufacturers, is taxable on the fair market value of pro rata rights, evidenced by warrants, to subscribe to the preferred stock of Manufacturers, when such rights were received.

It is unnecessary to indulge in an extended discussion of the case of Eisner v. Macomber, 252 U. S. 189, or its history, interpretation, and effect upon the taxability of stock dividends. It is sufficient to state that, following that decision, it was generally accepted that all stock dividends were exempt from taxation. See Koshland v. Helvering, 298 U. S. 441. Ensuing Revenue Acts (those of 1921, 1924, 1926, 1928, 1932, and 1934) specifically reflected that theory by providing that “a stock dividend shall not be subject to tax.”

While Congress was considering the Eevenue Act of 1936, the decision in the Koshland case was rendered. The Supreme Court there said:

Although Eisner v. Macomber affected only the taxation, of dividends declared in the same stock as that presently held by the taxpayer, the Treasury gave the decision a broader interpretation which Congress followed in the Act of 1921. Soon after the passage of that Act, this court pointed out the distinction between a stock dividend which worked no change in the corporate entity, the same interest in the same corporation being represented after the distribution by more shares of precisely the same character, and such a dividend where there had either been changes of corporate identity or a change in the nature of the shares issued as dividends whereby the proportional interest of the stockholder after the distribution was essentially different from his former interest. . [Citing United States v. Phellis, 257 U. S. 156; Rockefeller v. United States, 257 U. S. 176; Cullinan v. Walker, 262 U. S. 134; Marr v. United States, 268 U. S. 536.] Nevertheless the successive! statutes and Treasury regulations respecting taxation of stock dividends remained unaltered. We give great weight to an administrative interpretation long and consistently followed, particularly when the Congress, presumably with that construction in mind, has re-enacted the statute without change. The question here, however, is not merely of our adopting the administrative construction but whether it should be adopted if in effect it converts an income tax into a capital levy.
We are dealing solely with an income tax act. Under our decisions the payment of' a dividend of new common- shares, conferring no different rights or interests than did the old—the new certificates, plus the old, representing the same proportionate interest in the net assets of the corporation as did the old,—does not constitute the receipt of income by the stockholder. On the other hand, where a stock dividend gives the stockholder an interest different from that which his former stock holdings represented he receives income. The latter type of dividend is taxable as income under the Sixteenth Amendment. Whether Congress has taxed it as of the time of its receipt, is immaterial for present purposes.

Thereafter Congress enacted section 115 (f) (1) of the Revenue Act of 1936, which reads as follows:

SEO. 115. DISTRIBUTIONS BX CORPORATIONS.
* * * * * * ⅜
(f) Stock Dividends.—
(1) Genebal Rule.—A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.

Article 115-7 of Regulations 94 states the matter in' positive, rather than negative, form and interprets that section as follows:

Abt. 115-7. Stock dividends.—A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall be treated as a dividend to the full extent that it constitutes income to the shareholders within the meaning of the sixteenth amendment to the Constitution. * * *

Dividends are includible in gross income under the broad provisions of section 22 (a) of the Revenue Act of 1936. Subdivision (d) of that section is as follows: “Distributions by Corporations.— Distributions by corporations shall be taxable to the shareholders as provided in section 115.” Section 115 (a) defines the term “dividend.” We agree with respondent’s interpretation of section 115 (f) (1) that, while exemptive in phraseology, its effect is to include in taxable dividends rights to acquire stock (represented here by assignable warrants), provided only they are not exempt on Constitutional grounds. That this interpretation was intended by the Congress is clearly evident when we read section 27 (e) of the Revenue Act of 1936 dealing with dividends paid credits. It reads:

SEO. 27. CORPORATION CREDIT POR DIVIDENDS PAID.
* * * * * ⅝ *
(e) Taxable Stock Dividends.—In case of a stock dividend or stock right which is a taxable dividend in the hands of shareholders under section 115 (f), the dividends paid credit with respect thereto shall be the fair market value of the stock or the stock right at the time of the payment.

In John M. Keister, 42 B. T. A. 484, a case arising under the 1936 Act, we held that a stock dividend paid in preferred stock to holders of common stock was a taxable dividend. Koshland v. Helvering, supra. The stockholder’s right to purchase new stock is essentially analagous to a stock dividend. Miles v. Safe Deposit & Trust Co., 259 U. S. 247.

In Palmer v. Commissioner, 302 U. S. 63, addressing itself to this general question, the Supreme Court said:

On the other hand, such a sale, if for substantially less than the value of the property sold, may be as effective a means of distributing profits among stockholders as the formal declaration of a dividend. The necessary consequence of the corporate action may be in substance the kind of a distribution to stockholders which it is the purpose of section 115 to tax as present income to stockholders, and such a transaction may appropriately be deemed in effect the declaration of a dividend, taxable to the extent that the value of the distributed property exceeds the stipulated price. * * *

In the case at bar the new stock to be purchased was the preferred stock .of Manufacturers. The purchasing of that stock by the common stockholders at less than its fair market value would have resulted in income to them measured by the excess of such fair market value over the amount paid by them for the stock. The fair market value of the warrants represented a portion of that excess value. See sec. 115 (j), Revenue Act of 1936. See also sec. 27 (e), Revenue Act of 1936.

The warrant received by the petitioner represented a property right, salable and actually sold by its owner. That it had a fair market value is agreed. Under the Koshland decision and under the provisions of section 115 (f) (1) it was free from taxation only if it came within constitutional prohibitions.

The warrants under consideration are of a different type from common stock. They are more closely related to the convertible preferred stock. In our opinion, they represent inherently taxable dividend distributions as contemplated by section 22 (a) and (d), defined and delimited by section 115, and as determined by controlling decisions. Their constitutional immunity to taxation has not been established.

The petitioner cites and relies upon Palmer v. Commissioner, supra. That case was quite different. It arose under the 1928 Revenue Act, which had no section comparable to section 115 (f) (1). The Supreme Court sustained the holding of the Board that the distributions of rights to subscribe to the stock of another corporation were sales of such stock by the issuing corporation to its stockholders and were not dividends. The facts in that case were treated from the viewpoint of the selling corporation and on the basis of a sale. They did not bring the decision within the ambit of section 115 (f) (1) and thus the discussion there is not in point.

Reviewed by the Board.

Decision will be entered for the respondent.

TURNER,

dissenting: Reasoning from the language of section 115 (f) (1), of the Revenue Act of 1936, and applying to stock rights what was said by the Supreme Court in Koshland v. Helvering, 298 U. S. 441, as to the nature and character of stock dividends, the Board has concluded that the issuance by the Manufacturers Trust Co. to its common stockholders of rights to acquire preferred shares constituted the payment of a dividend on the common stock. In my opinion, the Board has drawn inferences from section 115 (f) (1) that are not justified, and has attempted to apply the views expressed in Koshland v. Helvering to matters of an entirely different-character and substance from that dealt with in that case.

The term “dividend” is defined by section 115 (a) of the statute, and the language of section 115 (f) (1) does not in any way indicate an intention on the part of Congress to extend the term “dividend” beyond the confines of section 115 (a). It merely provides that to the extent that stock rights do not constitute income within the meaning of the Constitution they are not to “be treated as a dividend.” It appears, therefore, that section 115 (f) (1) does not expand but limits the scope of section 115 (a). Section 115 (a) defines a dividend as “any distribution made by a corporation to its stockholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.” Accordingly, the issuance of stock rights must first be found to be a distribution by a corporation to its stockholders in money or in other property and out of the earnings for the taxable year or earnings accumulated after February 28, 1913. Until and unless the issuance of stock rights is found to be such a distribution, there is no occasion to consider the applicability of section 115 (f) (1).

Citing Miles v. Safe Deposit & Trust Co., 259 U. S. 247, for the proposition that a stockholder’s rights to purchase new stock are “essentially analogous to a stock dividend”, the Board concludes that the income tax effect of the issuance of stock rights parallels that of the payment of a stock dividend. In so doing, however, it has failed to consider the fundamental differences between stock rights and stock dividends or to show how the mere issuance by a corporation to its stockholders of a right to subscribe for and acquire additional shares, even though they be of a different class from the stock on which the rights were issued, effects any distribution “in money or in other property * * * out of its earnings or profits.” Speaking of the effect of the issuance of stock rights, the Supreme Court, in that same Miles v. Safe Deposit & Trust Co. case cited in the majority opinion, said: “It is evident, we think, that such a distribution in and of itself constituted no division of any part of the accumulated profits or surplus of the company, or even of its capital.”

The Board also cites and quotes from the opinion of the Supreme Court in Palmer v. Commissioner, 302 U. S. 63, to the effect that a sale of property by a corporation to its stockholders “if for substantially less than the value of the property sold, may be as effectively a means of distributing profits among stockholders as the formal declaration of a dividend.” While our case does not involve the sale of any property by a corporation to its stockholders and that case did not involve the issuance by a corporation to its stockholders of rights to acquire additional shares of its own stock, but involved instead a distribution by a corporation to its stockholders of rights which it held to purchase shares of stock in an entirely different corporation, the Court in its opinion did discuss the nature and character of stock rights, and the views there expressed are in my opinion clearly applicable here. The Court said:

The mere issue of rights to subscribe and their receipt by stockholders is not a dividend. No distribution of corporate assets or diminution of the net worth of the corporation results in any practical sense. Even though the rights have a market or exchange value, they are not dividends within the statutory definition. Cf. Miles v. Safe Deposit & Trust Co., 259 U. S. 247, 42 S. Ct. 483, 66 L. Ed. 923; Helvering v. San Joaquin Co., 297 U. S. 496, 56 S. Ct. 569, 80 L. Ed. 824; Helvering v. Bartlett, supra. They are at most options or continuing offers, potential sources of income to the stockholders through sale or the exercise of the rights. Taxable income might result from their sale, but distribution of the corporate property could take place only on their exercise. * * . *

It is to be noted in the instant case that, even though the stock rights here in question were later sold and the petitioner thereafter realized $13,728.04 from the sale thereof, we are not here determining the income effect of the sale of the rights or of their exercise, but the income effect of their issuance by Manufacturers Trust Co. and their receipt by the petitioner. What was said by the Supreme Court in Palmer v. Commissioner, supra, as to the nature and character of stock rights, it seems to me, is fundamental. They were at the most options or continuing offers to the petitioner until sold or exercised, or until their expiration without sale or exercise, and in no sense of the word may be said to have been a distribution of corporate assets, earnings or capital, or to have resulted in the diminution of the corporate worth. These characteristics in my opinion make the pronouncements in Koshland v. Helvering, supra, wholly inapplicable, in that the issuance of the rights alone could in no sense give “the stockholder an interest different from that which his former stockholdings represented”, and, as was said in Miles v. Safe Deposit & Trust Co., supra, “the subscription right of itself constituted no ganq profit or income taxable without apportionment under the Sixteenth Amendment.” Accordingly, I desire to note my dissent.

Arundell, Smith, Black, Leech, and Mellott agree with this dissent.

       SEC. 22. GROSS INCOME.
      (a) General Definition.—“Gross Income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.


author: Leech:

text:
    Interstate Transit Lines, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101692.
    Promulgated July 9, 1941.

      Henry W. Clark, Esq., and Joseph F. Mann, Esq., for the petitioner.

      Henry C. Clark, Esq., for the respondent.
   OPINION.

Leech:

The petitioner seeks to deduct $28,100.66, the amount of the operating deficit of Stages for the year 1936, as shown on the respective books of petitioner and that company, as an ordinary and necessary expense in carrying on its business during that year. Sec. 23 (a), Revenue Acts of 1934 and 1936.

Respondent, by his contested determination, denies not only the right of the petitioner to deduct the item as an ordinary and necessary business expense, but apparently says also that the mechanics used do not constitute an accrual in fact of these items, since no cash settlement of the accounts between petitioner and Stages was made until the dissolution of the latter in a year subsequent to 1936. We decide the issue on the first ground and pass the second.

Deductions are permissible, of course, only by legislative grace and, to avail itself of their benefit, the taxpayer must conform squarely with the legislation authorizing them. New Colonial Ice Co. v. Helvering, 292 U. S. 435. It is not necessary that either respondent or we characterize this accrual from an accounting standpoint. Connally Realty Co., 31 B. T. A. 349; affd., 81 Fed. (2d) 221; Baltimore & Ohio Railroad, Co., 29 B. T. A. 368. Thus, to succeed here, petitioner has the burden of establishing that the contraverted accrual was an ordinary and necessary expense of its business.

Stages was a separate, juristic taxable entity. Higgins v. Smith, 308 U. S. 473; Burnet v. Commonwealth Improvement Co., 287 U. S. 415. Its business was that of furnishing intrastate transportation within California. That was not and could not have been the business of petitioner, which, so far as California was concerned, was restricted to interstate business. The bus business of Stages, limited as it was to the State of California, did not become that of petitioner by virtue of petitioner’s sole ownership of the stock of Stages. All Russian Textile Syndicate, Inc. v. Commissioner, 62 Fed. (2d) 614; certiorari denied, 289 U. S. 752; Alexander M. Bing, 30 B. T. A. 429; Mary E. Cappon, 28 B. T. A. 357. Stages was not organized, its stock was not acquired, and the contested accrual thereunder was not made by petitioner to increase the profits of the business of petitioner. Those facts were deliberately brought about by petitioner to augment its income by increasing the income of Stages, its wholly owned subsidiary, from the intra-California business of the latter company in which petitioner could not engage. The accrual in controversy thus may well have been in the nature of a capital expenditure and not an expense at all. Cf. Welch v. Helvering, 290 U. S. 111.

Moreover, whether any or all of the operating deficit of Stages for the taxable year was attributable to the intra-California business of that company is not disclosed. Whether that business was neo essary to profitable operation of petitioner’s interstate business in California does not even appear. In fact the opposite conclusion is at least inferable. Profit to its subsidiary in the California intrastate business was the motive which moved petitioner. The contested accrual was made pursuant to the contract of February 7, 1932. All the capital stock of Stages, one party to that contract, was owned by petitioner at the time of the acquisition of that contract and throughout the life of the former company. Stages was therefore always entirely under the control of petitioner. Assuming therefore that the item in question was an expense of petitioner’s business, on this' record, including the absence of evidence as to the ordinary and necessary expense of furnishing interstate transportation to and from within California, we do not think the petitioner has sustained its burden of establishing that any part of the operating deficit of Stages for the taxable year was an ordinary and necessary expense of the petitioner in the operation of its interstate business. Maine Central Transportation Co., 42 B. T. A. 350. Cf. Welch v. Helvering, supra.

Respondent is sustained.

Decision will he entered for the respondent.


author: Sternhagen :

text:
    Fred M. Harden and Esperanza P. Harden, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98073.
    Promulgated July 9, 1941.

      Eugene Meaehaan, Esq., and Daniel J. Hanlon, Esq., for the petitioners.

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

Sternhagen :

The primary question is whether during the three-year period ending with the close of each taxable year, as provided in section 251 (a), Revenue Acts of 1934 and 1936, petitioner, a citizen of the United States doing business in the Philippine Islands, derived 50 percent or more of his gross income from the active conduct of trade or business in the Philippine Islands. Petitioner argues that Ms gross income from the active conduct of a wholesale tobacco business in the Philippines must be computed without reference to the Philippine tobacco taxes, since those taxes are a deduction in computing net income and are not a factor of gross income. If the petitioner is correct, Ms taxable income includes only the income from sources within the United States and excludes the income from sources in the Philippines.

The petitioner filed no returns for the taxable years, and therefore returns were filed by the collector. In computing a taxpayer’s net income, taxes are ordinarily taken as a deduction under section 23 (c) of the statute. Regulations 86 and 94, article 23 (c)-l, recognized this statutory deduction, and article 23 (c)-2 added the qualification “provided they are not added to and made a part of the expenses of the business or the cost of articles of merchandise with respect to which they are paid, in which case they can not be separately deducted.” The collector’s return must be regarded as the taxpayer’s return and the taxpayer is bound by any statutory elections, Sarah Briarly, 29 B. T. A. 256; Joe Goldberg, 14 B. T. A. 465. If the taxpayer had filed returns and had used his taxes as business expenses or inventory costs, such returns would be binding upon him, Lebolt & Co. v. United States, 67 Ct. Cls. 422; and if the returns varied from his bookkeeping treatment of the taxes, this variation would not have defeated his right to the method which he used in his returns, Pathe Exchange, Inc. v. Commissioner, 77 Fed. (2d) 306. The taxpayer, however, failed to file returns and can not, therefore, be said to have exercised an election to treat these taxes as business expenses or inventory costs for United States income tax purposes. He did not actively take the step which, according to the Commissioner’s regulations, impairs his right to the statutory deduction.

Looking at the collector’s return and treating it as for all purposes the return of the taxpayer, it still does not appear that this return demonstrates the use of the Philippine taxes as inventory cost. Indeed, the collector’s return is so poorly prepared that it can not be reliably used as a basis for the decision. It is said to be prepared in accordance with returns filed by the petitioner with the Philippine Government under the Philippine income tax law. The scheme of these Philippine returns is wholly unrelated to the United States tax and varies so widely from its requirements that it is difficult, if not impossible, to bring it into correlation. Upon the basis of this collector’s return, the Commissioner’s notice of deficiency was predicated. The facts stated in the notice of deficiency, which ordinarily would serve as the presumptively correct determination, have been put aside by the parties and instead most of the facts have been stipulated. The facts of the stipulation are not the same as the facts in the Philippine return which are imported into the notice of deficiency. This is an unsatisfactory record, and the Board must do the best it can.

The evidence does not require the treatment of Philippine tobacco taxes other than as a normal deduction. The statute provides for such deduction and the Commissioner’s regulation is similar, save only where the taxpayer has for tax purposes treated the taxes as expenses of the business or cost of merchandise, “in which case they can not be separately deducted.” Plainly this regulation is intended to prevent a double benefit, and prohibits a deduction only if the taxes have already been used as a factor of reducing taxable income. Unless the item has been so used, there is no reason why taxes should not be treated as the usual statutory deduction. There is evidence that in the journal taxes were accounted for in a separate column, and that this column was, like the other two columns of merchandise and expenses, treated as a factor of inventory for the petitioner’s private accounting purposes. But it was not transferred to a United States income tax return. On the Philippine returns, deductions for taxes appear clearly, although the amount can not be identified or related to the items now in question. It can not be found that, as the regulations say, the petitioner has for tax purposes made the taxes a part of the cost of merchandise. They would therefore be separately deductible if a return had been filed.

It is held, therefore, that the stipulated amounts of tobacco taxes shall not be used as a factor in the computation of petitioner’s gross income for the purpose of determining whether in each three-year period the ratio of gross income from the active conduct of trade or business in the Philippines is more or less than 50 percent of total gross income.

As to 1934, it appears that the petitioner had no gross income from sources within the United States, and therefore there would be no deficiency unless the ratio of gross income from active Philippine business proved to be less than 50 percent. This appears not to be so. As to 1935, the factor of 5*84,793.47, derived by the petitioner in 1933 from the sale of mining stocks, which factor is later discussed, may result in the ratio being either more or less than the statutory 50 percent. As to 1936, the ratio of gross income from the active conduct of trade or business in the Philippines is apparently greater than 50 percent.

In the present state of the record, a definitive redetermination can not be made. A recomputation should be prepared upon the basis of the foregoing decision by omitting from the computation of gross income the stipulated amounts of Philippine tobacco taxes and treating those taxes as if they were factors of deduction in arriving at net income.

In one week of 1933 the petitioner sold shares in Philippine -mining corporations and realized a profit of 3*64,793,47, He argues that this amount is properly to be regarded as an item of gross income from the active conduct of trade or business in the Philippines, the effect of which would be to improve his 1935 ratio under the 50 percent clause. The evidence, however, does not support his contention. He was not engaged in the business of buying and selling mining shares, and these shares were apparently bought as investments for the sake of the income which they yielded. It does not appear that they had any relation to the conduct of any of his several businesses. These were the only shares which he sold during the entire five years in evidence, and the sales occurred in a single week. They had no relation to the petitioner’s activities in connection with the several mining leases and claims, but were isolated instances incidental to investment, cf. Higgins v. Commissioner, 312 U. S. 212; United States v. Pyne, 313 U. S. 127; City Bank Farmers Trust Co. v. Helvering, 313 U. S. 121. The P64,793.47 shall in the computation for the three-year period be omitted from 1933 gross income from the active conduct of trade or business in the Philippines.

While in California the petitioner received six dividend checks, amounting to $109,452.90, from corporations in the Philippine Islands, which had been mailed to him in 1935. He deposited the checks in a bank in California. Plainly they were “amounts received by such citizen * * * within the United States”, and were, therefore, properly within his taxable gross income under section 251 (b). As shown by the findings, although all of the checks were mailed in 1935, two for amounts aggregating $36,529.05 were received by him in 1936. It must be held, therefore, that this amount is to be treated as taxable income of the year 1936 and the remainder as taxable income of the year 1935.

The stipulated amounts of interest are within the petitioner’s income from sources within the United States for the respective years, viz., $163.28 in 1935 and $248.90 in 1936.

At the hearing the respondent withdrew his determination of fraud penalties, and the recomputation will therefore exclude such penalties. The respondent insists, however, that delinquency penalties should be applied. It is admitted that the petitioner failed to file returns, and the penalty, if any, is therefore mandatory for 1934 and 1935. Were there any showing that the failure to file a return for 1936 was due to reasonable cause, the penalty prescribed by section 291 would not apply. There is, however, no evidence that the failure was due to reasonable cause and not due to willful neglect, and the 25 percent penalty should therefore be added for that year.

Decision will he entered under Rule 50.


author: Arnold :

text:
    Astorian-Budget Publishing Company, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100629.
    Promulgated July 10, 1941.

      Charles E. McCulloch, Esq., and Thomas B. Stoel, Jr., Esq., for the petitioner.

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

Arnold :

The respondent contends that Dorothy Engle performed no substantial services for the petitioner which would entitle her to compensation of $2,340 for 1936. It is his contention that the $600 allowed is more than adequate for the services rendered. Petitioner contends that $1,040 represents compensation fixed by the directors for her services, and that the $1,300 paid her is in the nature of a pension pursuant to the agreement between Chessman, Aldrich, and Lamkin.

The testimony and our findings of fact show that Dorothy Engle rendered no clerical or supervisory services to the petitioner. Her services were limited by her physical condition to advising and consulting with the other directors two or three times a month. Aldrich was an experienced newspaper man and his advice and opinions were undoubtedly valuable, but this is not so as to Dorothy Engle. Unlike Aldrich, she had no substantial business experience upon which to formulate opinions. According to the testimony she took over and operated two small drug stores after her husband’s death, and lost a large part of her inheritance. Thereafter, she attempted to operate an apartment house and while so engaged she suffered the broken hip which has since incapacitated her. We do not feel that such business experience qualified her to advise and consult on the major policies of a daily newspaper. She had had no previous experience in the newspaper business, and, despite the resolution of the board of directors, which allocated $20 a week to her as a salary, and despite the testimony of Chessman and Aldrich that they believed the salary voted her was reasonable, we are not convinced that respondent erred in Ms determination. In our opinion a tax deduction of $600 per year constituted a reasonable allowance as compensation for the personal services actually rendered by Dorothy Engle. Home Industry Iron Works, 8 B. T. A. 1267; Monte Glove Co., 44 B. T. A. 539.

This allowance amounts to $25 per directors’ meeting, based on an average of two meetings a month, and we can not say that the services rendered by a person of Dorothy Engle’s limited experience entitled her to a larger compensation.

Petitioner contends that, if it is not allowed to deduct the entire $1,040 as salary or compensation, the difference, $440, should be treated the same as the $1,300 paid pursuant to the agreement with Lamkin. Under the agreement Chessman and Aldrich were obligated to see that Lamkin’s next of kin received $45 per week so long as such next of kin continued to hold petitioner’s stock. The agreement did not contemplate or provide for contingencies that might arise, such as disposition by the heir of part of the stock inherited, inability of the heir to serve as a director or officer, or other possible contingency. The agreement was between petitioner’s stockholders as individuals, and not between Lamkin and the petitioner as a corporate entity. Formally, therefore, petitioner was not obligated to make these payments, but since its stock was so closely held and the three principal stockholders had been associated together in business for years, petitioner was operated more like a partnership than a separate legal entity. This fact, no doubt, influenced Chessman and Aldrich to consider their agreement with Lamkin as a corporate obligation.

Petitioner relies upon our decision in Seavey & Flarsheim Brokerage Co., 41 B. T. A. 198, 202, 203; art. 23 (a) (9), Regulations 94; and L. T. 3329, C. B. 1939-2, p. 153, to justify the $1,740 deduction. In the cited case there was a written contract between the employee and the taxpayer therein, whereby the latter obligated itself to pay the employee’s widow $12,000 per annum if he would continue with the firm and not establish a competing business. Subsequent to the employee’s death $12,000 per annum was paid to his widow, and the Board held that this was additional compensation for the employee’s services, and therefore deductible. No comparable situation exists here, as there was no agreement between petitioner and Lamkin that the former would pay the latter’s heir a salary or a pension of $45 a week. Factually, the two cases are distinguishable.

Article 23 (a) (9), supra, permits amounts paid “by a taxpayer for pensions to retired employees or to their families or others dependent upon them”, to be deducted “as ordinary and necessary expenses”, where taxpayer is not compensated by insurance or otherwise. It also provides that, where the salary of an officer is paid for a limited period after his death to his widow or heirs, in recognition of services rendered, such payments may be deducted. Strictly speaking, no part of the $45 paid Dorothy Engle was a pension, nor does petitioner so contend. Its contention is that the payment is in the nature of a pension. The payment more nearly complies with the second provision above, because it is the amount of salary that Lamkin received, it was paid to his heir, and the agreement clearly indicates that it was in recognition of services rendered by Lamkin. However, the only limitation of time on the payment is the period that Dorothy Engle continues to hold the stock. Such a provision bears more earmarks of a special provision for the distribution of profits to an officer-stockholder than it does of a pension payment. Laudable as we deem the disbursements made, we can not subscribe to petitioner’s contention that the payments were pensions or sufficiently in the nature of pensions to be deductible as ordinary and necessary expenses.

In I. T. 3329, supra, it is obvious from the facts set forth that the period of time was limited to designated amounts for the calendar years by action of the board of directors, and the amounts paid were not conditioned upon continued stock ownership.

. In view of the foregoing we must affirm respondent’s determination.

Decision will he entered for the respondent.


author: Harron :

text:
    William P. T. Preston, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101762.
    Promulgated July 10, 1941.

      Allin H. Pierce, Esq., for the petitioner.

      Allen T. Akin, Esq., for the respondent.
   OPINION.

Harron :

The sole question is whether petitioner is entitled to a deduction for interest paid on indebtedness with respect to the payments totaling $5,000 which were made by him in the taxable year to the United States Trust Co. The deduction in question was not taken by petitioner on his return for the taxable year, but was claimed by him in his petition.

Under section 23 (b) of the Revenue Act of 1936 a deduction is allowed for all interest paid within the taxable year on indebtedness. The term “indebtedness”, as used in section 23 (b), is not defined in the revenue acts. The Board and the courts have defined “indebtedness”, as used in section 23 (b), as “an unconditional and legally enforceable obligation for the payment of money.” See Paul Autenreith, 41 B. T. A. 319; affd., 115 Fed. (2d) 856; William Park, 38 B. T. A. 1118; affd., 113 Fed. (2d) 352; W. S. Gilman, 18 B. T. A. 1277; affd., 53 Fed. (2d) 47.

In the present case, the basic question is whether or not the so-called bond in which petitioner covenanted to pay $125,000 to the United States Trust Co. was a legally enforceable obligation. The law of New York, where the bond was executed and delivered, is in large part determinative of this question. See William Park, supra, at p. 1120. In the final analysis, the answer to this question depends upon whether or not the bond was supported by sufficient Consideration. Petitioner argues, first, that the bond was supported by an actual consideration of $125,000 loaned to him by the United States Trust Co. and, second, that in any event the seal affixed to the bond conclusively imported a consideration under New York law. In support of his second argument he cites Cochran v. Taylor, 273 N. Y. 172; 7 N. E. (2d) 89, and William Park, supra. Eespondent argues, first, that the United States Trust Co. did not loan $125,000 to petitioner and that the bond was not supported by any actual consideration; and, second, that under New York law the seal' affixed to the bond was only presumptive evidence of the sufficiency of the consideration and that the record clearly overcomes the presumption of sufficiency. He cites Johnson v. Commissioner, 86 Fed. (2d) 710, and Guaranty Trust Co. of New York v. Commissioner, 98 Fed. (2d) 62, in support of his first argument and Alexander v. Equitable Life Assurance Society, 233 N. Y. 300; 135 N. E. 509, in support of his second argument.

In our opinion, the bond was not a legally enforceable obligation under the law of New York. On October 18,1934, petitioner borrowed $125,000 from the Central Hanover Bank & Trust Co. and delivered that amount to the United States Trust Co., as trustee under the trust indenture for the benefit of his sister-in-law, Alice. On October 19, 1934, the very next day, petitioner executed and delivered the bond, the United States Trust Co. paid him $125,000, and he used that amount to satisfy his loan from the Central Hanover Bank & Trust Co. These various steps were taken at the same time and as part of one transaction. See Johnson v. Commissioner, supra; Guaranty Trust Co. of New York v. Commissioner, supra. The only reasonable inference to be drawn from the various steps taken and the carefully drafted provisions of paragraph third of the trust indenture is that it was agreed between petitioner and the United States Trust Co. that the $125,000 which he delivered to the trust company was to be returned to him almost immediately as a “loan.” See Johnson v. Commissioner, supra; Guaranty Trust Co. of New York v. Commissioner, supra. The payment to petitioner “of money which he himself supplied to the trustee for the very purpose can not be a loan to him or furnish consideration for his” bond. See Johnson v. Commissioner, supra. The practical effect of what was done was to set up a trust composed solely of petitioner’s bond. See Johnson v. Commissioner, supra.

It is true that petitioner’s bond was under seal. The letters “L. S.” appeared opposite his signature on the bond. This was sufficient to constitute a seal under New York law. See New York General Construction Law, sec. 44. However, under the New York law which was in effect at the time when the bond was executed and delivered, the seal was “only presumptive evidence of a sufficient consideration”, which might be rebutted as if the bond were not sealed. See New York Civil Practice Act, sec. 342; Cochran v. Taylor, supra; Alexander v. Equitable Life Assurance Society, supra; Harris v. Shorall, 230 N. Y. 343; 130 N. E. 572; In re Greene, 45 Fed. (2d) 428; Jessie W. Donahue, 44 B. T. A. 329. The record clearly shows that petitioner’s covenant contained in the bond was a wholly gratuitous promise. Thus the presumption as to sufficiency of consideration was amply rebutted. See Alexander v. Equitable Life Assurance Society, supra; In re Greene, supra. Cochran v. Taylor, supra, is distinguishable because in that case the sufficiency of the consideration was not in question. See Helmick v. Probst, 170 Misc. 284; 9 N. Y. S. (2d) 975. William Park, supra, is not in point because in that case the question of whether or not there was a legally enforceable obligation was determined by Pennsylvania law, rather than New York law. See Julius G. Day, 42 B. T. A. 109.

Petitioner’s gratuitous promise contained in the bond was “unenforceable either by the trustee or by the beneficiary” and was “no more than a promise to make a gift in the future.” Johnson v. Commissioner, supra. The payments totaling $5,000 which were made by petitioner in the taxable year to the United States Trust Co. were simply gratuitous payments for the benefit of his sister-in-law, Alice. It follows that petitioner is not entitled to a deduction for interest paid on indebtedness with respect to such payments. Johnson v. Commissioner, supra.

Petitioner concedes that respondent correctly determined that the amount of petitioner’s distributive share of the taxable net income of a partnership was understated on his return by the amount of $1,276.76. Respondent concedes that petitioner is entitled to a deduction, which was not taken on his return, in the amount of $152.16 for taxes paid by him to the State of New York in respect to unemployment insurance. Effect will be given to these concessions on computation under Rule 50.

Decision will be entered under Rule SO.