author: Murdoch : SteRNhagen, Hill, Disney,

text:
    Citizens State Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106122.
    Promulgated April 14, 1942.

      Ellis D. Berner, Esq., for the petitioner.

      Felix Atwood, Esq., for the respondent.
   OPINION.

Murdoch :

The Commissioner determined a deficiency of $595.94 in the income tax of the petitioner for the calendar year 1938. One of the adjustments which he made was to include in income $1,763.29 representing recoveries in 1938 on debts charged off in previous years. The propriety of that adjustment is the only issue for decision. The Commissioner explained in the notice of deficiency that the recoveries constituted taxable income in accordance with the provisions of article 23 (k) — 1 (5) of Regulations 101. That article contains the following provision:

* * * Any amount subsequently received on account of a bad debt or on account of a part of such debt previously charged off and allowed as a deduction for income tax purposes, must be included in gross income for the taxable year in which received.

However, the Board has held that recoveries of debts previously charged off and allowed as deductions are income only if, and to the extent that, the deduction had effected an offset of taxable income so that any excess deductions are tax-free when recovered. Central Loan & Investment Co., 39 B. T. A. 981; National Bank of Commerce of Seattle, 40 B. T. A. 72; affd., 115 Fed. (2d) 875; State-Planters Bank & Trust Co., 45 B. T. A. 630. See also Philadelphia National Bank v. Rothensies, 43 Fed. Supp. 923. Cf. Amsco-Wire Products Corporation, 44 B. T. A. 717; Kennedy Laundry Co., 46 B. T. A. 70. Those cases disapprove of the regulation, and the argument of the Commissioner that the question of benefit at the time of charge-off is immaterial. They point out that the recoveries would be of capital only and would not represent income except for the fact that they had offset income when previously deducted. They also hold that the recoveries are tax-free until their amount would produce taxable income in the year of the charge-off.

Counsel for the petitioner, in stating his contention at the hearing, said that the recoveries in this case were not income since they had not resulted in any tax benefits at the time the original deductions were taken. He said also: “The facts have all been stipulated.” Counsel for the respondent, in replying, did not challenge this latter statement and did not intimate in any way that there were any material facts in addition to those stipulated. He said the issues had been stated substantially correctly by counsel for the petitioner except that the respondent did not admit that the petitioner had received no benefit from the charge-offs. He recognized that the Board had theretofore decided a similar issue adversely to the respondent and he inquired whether, under the circumstances, a memorandum brief would be sufficient. He was told that it would be.

The stipulation of facts is hereby adopted as the findings of fact. The debts recovered in 1938 were a part of larger amounts charged off in the four years immediately preceding and in 1931. The following table shows for those five years the net loss sustained by the petitioner in each year, the amount of bad debts charged off and allowed as a deduction in each year, the total subsequent recoveries on those debts up to 1938, and the recoveries during 1938:

The recoveries made in 1938 were reported by the petitioner as nontaxable income on its return for that year.

The petitioner relies upon the decisions of the Board above referred to and claims that it has made out a prima facie case under those decisions which entitles it to judgment. The respondent, instead of filing a memorandum brief, filed an original brief of 23 pages and then filed a reply brief. His briefs for the most part are devoted to an argument that the regulations state the correct rule and the Board has been in error. This contention is rejected for reasons already stated in the cases cited.

The respondent also contends in his brief that the petitioner has failed in its proof, first, because the net loss for 1931 could have been carried over to offset gross income for 1932 under section 117 of the Revenue Acts of 1928 and 1932, and, second, because no proof has been offered to negative the possibility that the petitioner claimed losses or other deductions in each of the years for which the bad debt deductions were claimed and to negative the further possibility that subsequently there were recoveries on those losses and deductions which, if related back to those years, might wipe out the net losses for those years. These contentions were advanced for the first time in the respondent’s brief. The petitioner contends in this connection that it was the intention of the parties to stipulate all of the material facts known to either party; the stipulation was prepared after counsel for the respondent had benefited from a full examination of the petitioner’s records; the petitioner is not called upon to prove all of these negatives, particularly under the circumstances of this case; if it is called upon to prove the negatives, then, in fairness to it, it ought to have a further opportunity to do so, since the facts are that there was no benefit from a carry-over of the 1931 loss and there were no recoveries of other items which would support the respondent’s contention.

The Board entered a memorandum opinion in this proceeding holding that the amount recovered in 1938 was all taxable income to the petitioner because of a failure of proof to show that the petitioner had not received tax benefits from the charge-offs in the prior years. The Board there said:

* * * If during- the years 1935-37, petitioner recovered and did not report as income amounts charged off and deducted for expenses, taxes or other items, the deduction of the bad debts charged off in 1934 may have resulted in direct tax benefit, so that the recovery in 1938 would be taxable.

A decision for the respondent was entered pursuant to the memorandum opinion.

Counsel for the petitioner then filed a motion to vacate the decision and for reconsideration, and, in the alternative, for a rehearing to permit the submission of additional evidence and, in the further alternative, for a reference of the report of the division to the full Board. It is stated in the motion that additional evidence is available to show that the petitioner sustained a net loss for 1932 of $10,133.03 without deducting any part of the net loss for 1931 and that it did not recover or fail to report as income for any of the years 1931 to 1931, inclusive, any amounts previously deducted for expenses, taxes, or other items. After the Member who had originally heard and decided the case had denied the motion in all other respects, the Chairman of the Board granted the motion in so far as it asked that the report be reviewed by the full Board. The Board, after reviewing that report, rejected it.

The petitioner has made a prima facie case in so far as the amounts recovered in 1938 were of debts charged off in the years 1934 to 1937, inclusive. Where, as here, the respondent had never intimated in any way prior to the filing of his brief that recoveries had been made on other items previously deducted and had determined the deficiency on another ground, the petitioner was under no duty to negative the possibilities now referred to by the respondent. The notice of deficiency shows that the petitioner voluntarily reported the recoveries on the bad debts made in 1938, and there is no suggestion in the stipulation, in the determination of the Commissioner, in the statements of counsel, or in the respondent’s briefs, that recoveries were actually made of amounts previously deducted except in the case of the bad debts. Furthermore, it seems fair to assume in this case that the parties intended to stipulate and actually stipulated all of the facts bearing upon this question. The stipulation contains all of the facts required in the Board cases above cited. We may safely leave to another case the question of just how great a burden of proof the Commissioner could place upon the taxpayer. Suffice to say that here the taxpayer has sustained the burden that was fairly cast upon him. He had no reason to believe that his burden was any greater than that which he has sustained by the stipulation.

The net loss for 1931 could have been carried over and deducted from income of 1932 under section 117 (d) of the Revenue Act of 1932. The petitioner had the burden of proof to show whether or not and to what extent the net loss for 1931 offset income for 1932. The point should have been expressly covered in the stipulation. The stipulation makes no reference to it and, as a result, several alternatives are presented. Should it be held that the petitioner realized income of $300.88 in 1938 because it recovered that amount of the debts charged off in 1931 and there has been a failure of proof to show that the charge-off did not result in a tax benefit in 1932 ? The petitioner has run the risk of such a holding. Another alternative would be to give the petitioner an opportunity to prove the fact alleged in its motion for further hearing, that is, that there was a net loss of $10,133.03 for 1932 without deducting any part of the net loss for 1931. Or should judgment be given for the petitioner on the present record ?

The respondent has never contended and does not now contend that the net loss for 1931 actually offset any taxable income for 1932. The deficiency was not determined on that ground. Counsel for the petitioner knew that such a thing did not happen and may have been led to omit any reference to the point in the stipulation by the fact that the Commissioner never raised the point until after the stipulation was filed and the briefs were in. Although evidence was also available to the petitioner, nevertheless, the best evidence of whether or not the 1931 net loss actually was allowed as a deduction to offset income for 1932 is in the possession of the respondent. It would be an unnecessary safeguard to reopen this proceeding for further evidence on this point. If by any possibility the facts are contrary to the contention of the petitioner, the respondent may be counted upon to take proper steps to correct the record. In view of the special circumstances present in this case, we think the stipulation admits of the interpretation that the net loss for 1931 did not offset any taxable income for 1932. This should not be taken as a precedent in another case for omitting any relevant facts from a stipulation.

The respondent erred in including the $1,163.29 in the income of the petitioner for 1938.

Reviewed by the Board.

Decision will be entered wnder Rule 50.

SteRNhagen,

concurring: The petitioner, in my opinion, made out a 'prima facie case by proving a deduction in each of the earlier years without a tax benefit. Upon such a record, petitioner established that the subsequent recoveries in the tax year were not income and were not taxable according to the extant state of the law when the proceeding was heard. The failure of the respondent to go forward with evidence that a tax benefit had been derived which gave the recoveries the character of income necessarily results in a decision for the petitioner, and petitioner was not required to prove that in none of the intervening years was there in fact an absence of tax benefit.

Hill,

dissenting: The majority opinion appears not to have been based alone on the stipulated facts, but in part on representations in petitioner’s brief which are not covered by the stipulation. The discussion in the majority opinion intermingles the question of whether petitioner is entitled to a decision on the merits as the facts now stand with the question of whether it should have been granted a further hearing to enable it to adduce evidence of additional facts to meet its burden of proof. Such intermingling is so adroitly accomplished as to convert the sharp line of demarcation between the two questions into a zone of gradation from one into the other. The representations in petitioner’s briefs above mentioned are first set forth in the opinion as “contentions” of petitioner and later therein are apparently used as the basis of “fair” inferences or assumptions of fact to be considered in connection with the stipulated facts in resolving the merits of the controversy.

The only basis for a determination herein lies in the stipulated facts, nothing more. Representations of alleged facts by parties or their counsel outside the scope of the stipulated facts have no place in the consideration of the questions before us. We are not here considering whether a further hearing should have been or should be granted petitioner, but only tbe question of whether on the stipulated facts petitioner had a tax benefit which renders taxable the recoveries on bad debts previously charged off and deducted. On this issue the burden of proof is on petitioner, not just part way through the proceeding, but all the way. I think the burden has not been met. The extent of the burden is not dependent in any way upon the action of respondent. I can not subscribe the statement in the majority opinion that “We may safely leave to another case the question of just how great a burden of proof the Commissioner could place upon the taxpayer.” The law, not the Commissioner, imposes the burden, without any degrees in the scale of its weight.

Petitioner had this burden regardless of the limited character of the ground of deficiency stated in the deficiency notice. Jacob F. Brown, 18 B. T. A. 859, 867. Recoveries on bad debts, other losses, taxes, interest, and expenses deducted in an income tax return are “assumed” to be includable in income for tax purposes until the contrary is shown. Hurd Millwork Corporation, 44 B. T. A. 786. Respondent at no time has the burden of proof respecting such taxability. I have not overlooked Philadelphia National Bank v. Rothensies, 43 Fed. Supp. 923 (U. S. Dist. Ct., E. Dist. Penn.) which appears not to accord with this view.

The majority opinion construes the statement of petitioner at the hearing that “The facts have all been stipulated” as meaning that the parties agreed that all facts material to the issue presented were included in the stipulation because this statement was not there challenged by respondent. I think such construction is unwarranted. The . stipulation itself negatives such construction. It provides “that the following statement of facts be taken by the Board to be true, with the right reserved to both parties to introduce further testimony in addition thereto. * * *”

The fact that neither party chose to introduce testimony as to additional facts means only that each party was content to submit the case on the facts stipulated. Petitioner evidently deemed that the facts stipulated established its contention “that the debts, when charged off in prior years, did not accomplish a reduction of tax.” Respondent in his statement at the hearing challenged the sufficiency of the facts to establish such contention. Petitioner was, therefore, on notice that respondent was joining issue with it not only on the determinative issue presented by the petition, namely, whether a tax benefit resulted in the charge-off of bad debts, but also on the sufficiency of the facts stipulated to resolve the issue in petitioner’s favor. Furthermore, no duty rested on respondent to advise petitioner at or in advance of the hearing in what particular he deemed the stipulated facts insufficient to establish petitioner’s contention, or to suggest the materiality of facts additional to those stipulated. There is no reason to assume that the parties were not dealing at arm’s length in the preparation and execution of the stipulation. How then can it be claimed, as indicated in the majority opinion, that respondent’s failure, except in his brief, to state the grounds of his contention that petitioner failed to prove no tax benefit from the bad debt charge-off, unfairly placed petitioner at a disadvantage ? The brief is the vehicle in which the arguments are usually and properly carried.

Evidence to establish lack of tax benefit, if such was the case, does not appear to involve unusual difficulty and the information with respect thereto is peculiarly within the knowledge of petitioner. To enable respondent to acquire such information would require an audit of petitioner’s books over the period of years extending from a time antedating the first year of charge-off through and perhaps beyond the taxable year.

Recoveries on bad debts are not the only recoveries on prior deducted items that might effect a tax benefit from the deduction of bad debts. If net losses in years of bad debt deductions are recouped by recoveries of other deducted items, such as taxes, interest, operating expenses, loss by theft and loss by worthlessness of securities, etc., or, if net losses are eliminated by adjustment of depreciation allowance, it is obvious that a tax advantage would result from the bad debt deduction as of the year of such charge-off. To present the facts, if any, negativing such tax advantage is the burden of petitioner. It can not meet the burden merely by showing that in the year of the bad debt charge-off it had a net loss and that the recoveries thereon are less than such net loss. It can not lay its burden down at that point and force the respondent at his peril to shoulder the load thenceforward, for the patent reason that by stopping at such point petitioner has omitted the disclosure of facts (peculiarly within its knowledge) necessary to determine whether it had a tax benefit.

I submit that the facts do not show that petitioner had no tax benefit from the bad debt charge-off. To show that was its burden, under the law, despite the padding sought to be placed under its packsaddle by such expressions in the majority opinion as “the burden that was fairly cast upon him”, and “He had no reason to believe that his burden was any greater than that which he has sustained by the stipulation.”

Based solely on the data in the stipulated facts, it appears affirmatively that petitioner had a tax benefit from deductions for bad debts in each of the years 1931, 1934, 1935, and 1936, the taxability of the recoveries on which is involved in this proceeding. In the year 1931 petitioner deducted $37,092.67 for bad debts with a resulting net loss, of $24,304.46. Of this deduction $12,788.21 offset taxable income. In the years prior to the taxable year petitioner recovered $1,891.5.0 on such debts. In the taxable year petitioner recovered thereon $300.88. To the extent that such deduction offset income, petitioner had a tax benefit.

In the year 1934 petitioner deducted $65,276.45 for bad debts with a resulting net loss of $68,404.12. But for such bad debt deduction the net loss for that year would have been only $3,127.67. In the years prior to the taxable year petitioner recovered on such debts $5,731.97. Eelating such recoveries back and crediting them to 1934, the net loss for that year would be reduced to $62,672.15 with the result that $2,604.30 of the bad debt deduction for that year offset income. In the taxable year there was a further recovery on such debts of $513.12. To the extent that taxable income of $2,604.30 was offset by the bad debt deduction petitioner had a tax benefit.

In the year 1935 petitioner deducted $21,758.29 for bad debts resulting in a net loss of $9,915. Of the bad debt' deduction $11,843.29 offset taxable income and to that extent petitioner had a tax benefit. In the years prior to the taxable year petitioner recovered $1,654.48 on such bad debts. In the taxable year there was a recovery on such debts of $528.20.

In the year 1936 petitioner deducted $5,536.07 for bad debts, resulting in a net loss of $582.43. Of such deduction $4,953.64 offset income and to that extent petitioner had a tax benefit from such deduction. In the years prior to the taxable year petitioner recovered $290 on such debts. In the taxable year there was a recovery of $152.20 of such debts.

In the year 1937 petitioner deducted $2,708.70 for bad debts resulting in a net loss of $3,040.37. In that year the bad debt deduction served only to increase a net loss otherwise existing. The net loss before the bad debt deduction was $331.67. In the taxable year there was a recovery on such debts of $268.89. Hence, it does not appear from the data contained in the stipulated facts that petitioner had any tax benefit from bad debt deductions in the year 1937.

The grounds of my dissent are :

1. That it is not shown by the stipulated facts that petitioner had no tax benefit from the bad debt deductions, the recoveries on which are sought to be taxed by respondent.

2. That it is shown by the stipulated facts that petitioner received tax benefit from bad debt deductions in all but one of the years in which bad debt charge-offs are herein involved.

Disney,

dissenting: The deduction for bad debts can be said to have no tax benefit only where there is no gross income against which to apply it. If there is gross income it seems mathematically inescapable that each class of deduction contributes proportionately to any net loss and that one category of deductions, for instance bad debts, should not be arbitrarily singled out as causing the net loss, contrary to fact and logic. A rule of allocation would, moreover, be more easily administrable, as is evidenced by the questions raised by the opposite rule applied by the majority opinion. I dissent.


source: Caselaw Access Project

author: Black:

license: Public Domain

text:
    Lillian Seeligson Winterbotham, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of J. M. Winterbotham, Deceased, Lillian S. Winterbotham, Independent Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95533, 95534.
    Promulgated April 17, 1942.

      Thomas W. Lain, Esq., for the petitioners.

      Frank B. BcMosser, Esq., for the respondent.
   OPINION.

Black:

In Docket No. 95533, Lillian Seeligson Winterbotham, petitioner, is involved a deficiency oí $1,728.22 in gift tax for the year 1936 which, the Commissioner has determined against petitioner and respondent’s claim for an increased deficiency. In Docket No. 95534, estate of J. M. Winterbotham, Lillian S. Winterbotham, independent executrix, petitioner, is involved a deficiency of $1,191.51 in gift tax for the year 1936 which the Commissioner determined against J. M. Winterbotham, now deceased and respondent’s claim for an increased deficiency. Both deficiencies were due to the action of the Commissioner in allowing only one $5,000 exclusion in the determination of each gift tax liability instead of the $15,000 which each taxpayer had deducted on his gift tax return for the year 1936. In the determination of each deficiency the Commissioner explained his action in the deficiency notice as follows:

Only one exclusion, in the amount of $5,000 is allowed against the gifts made by you in trust for the benefit of your three children, for the reason that the gifts are made to one trust. (See Commissioner vs. Wells, 88 Fed. (2d) 339, and Commissioner vs. Krebs, 90 Fed. (2d) 880.)

The petitioners by appropriate assignments of error assail the correctness of the Commissioner in his determination of the deficiencies. Prior to the entry of any decision by the Board in either of the proceedings, the Supreme Court decided Commissioner v. Hutchings, 312 U. S. 393; United States v. Pelzer, 312 U. S. 399; and Ryerson v. United States, 312 U. S. 405, whereupon the Commissioner, by a timely motion filed, moved to vacate prior memorandum opinions which the Board had entered in each proceeding herein, to amend his answer and ask for increased deficiencies in each proceeding, and that the proceedings be set down for rehearing at Houston, Texas.

Respondent’s motion was granted and amended answers were filed in each proceeding. The amended answers alleged that the gifts were of future interests and set out in detail the grounds upon which the Commissioner relied for affirmative relief and in each case asked for an increased deficiency.

The proceedings have been consolidated.

Rehearing was held at Houston, Texas, on the amended pleadings and a supplemental stipulation of facts was filed. We adopt as our findings of fact the facts which were stipulated in the original stipulation of facts filed January 15,1940, and in the supplemental stipulation of facts filed at the rehearing January 12, 1942. From the facts so stipulated we state the following facts for the purpose of this opinion:

During the year 1936 petitioners were husband and wife, residing at Galveston, Texas, and as such were entitled to file gift tax returns on the community property basis.

By an instrument dated July 19, 1933, petitioners without valuable consideration transferred to themselves as trustees certain properties to be held in trust for the use and benefit of their three children under the terms and conditions set forth in the trust instrument. During the years 1934 and 1935 additional properties were transferred by petitioners to themselves as trustees under the terms of the aforementioned trust instrument.

On November 2, 1936, without valuable consideration petitioners by an indenture of trust transferred to themselves as trustees certain real estate to be held in trust for the benefit of their three children under the terms and conditions as set forth in the trust indenture. The gift added to the trust created July 19, 1933, without any substantial variation of its terms and conditions.

J. M. Winterbotham, one of the petitioners, died on or about April 5, 1940, leaving a will in which he named his wife, Lillian Seeligson Winterbotham, independent executrix of his estate and she duly qualified and is still acting as such.

The following are the dates of birth of the beneficiaries named in the trust instrument of July 19,1933:

George Seeligson Winterbotham, born June 24, 1905
Maria Meade Winterbotham (now Mrs. Maria Meade Eastham) born February 14, 1907
J. M. Winterbotham, Jr., born February 6, 1909

The trust instrument of 1936 contained the same provisions as the 1933 instrument for each beneficiary, and pertinent parts of it are as follows:

2. The trust hereby created shall continue until the death of the last survivor of our three children, George Selligson Winterbotham, J. M. Winterbotham, Jr. and Maria Meade Winterbotham, and the corpus of the trust property shall be held together until the death of such last survivor.
3. The trustees shall pay over or deliver to our son, George Selligson Winter-botham, at such periods as they deem best, not longer than annually, such portion of one-third (%) of the net interest, income and revenue derived or arising from the trust property as to them shall seem fit and proper and for the best interest of our said son (such portion to be determined solely in the judgment and discretion of the said Trustees, and without any control over them in the exercise of such judgment or discretion) until our said son shall reach the age of forty (40) years, or until his death, should that event sooner occur. From and after the time when our said son shall reach the age of forty (40) years, the entire net interest, income and revenue arising from one-third (Vs) of the trust property shall be paid over or delivered by the Trustees to him until his death.
In the event our said son shall die leaving surviving him a child or children, the share in the interest, income and revenue which would have been paid or delivered to him, if he had survived, shall be paid or delivered by the Trustees to the said child or children of our said son surviving him equally, share and share alike, until the final termination of this trust.
[Paragraphs 4 and 5 refer in the same terms to the two other beneficiaries.]
6. In the event any of our said children named in the foregoing paragraphs numbered 3, 4 and 5 hereof shall die unmarried prior to reaching the age of forty (40) years, his or her share in the income and corpus of the trust property shall pass to the survivors or survivor of them, or to the other beneficiaries who would take Tinder said numbered paragraphs, and the income therefrom shall be paid to such survivor or survivors, or other beneficiaries, and the corpus of such share in the trust fund shall be delivered and turned over to such survivor or survivors, or other beneficiaries in the same manner as provided in the next succeeding paragraph hereof.
7. Upon the death of the last survivor of our three children above named, the trust hereby created shall end and the Trustees then acting shall divide and distribute the then corpus of the trust fund among the lineal descendants of our 'three children above named per stirpes and not per capita.

In the determination of the gift tax liability of each of the petitioners for the years 1933, 1934, and 1935, the respondent allowed three exclusions of $5,000, or a total of $15,000 for each year, with respect to the gifts made during those years pursuant to the trust indenture of July 19,1933. No other gifts were made during 1933,1934, and 1935. Petitioners accepted the foregoing determinations of the respondent and no appeals were taken therefrom.

In each of the deficiency notices for the taxable year 1936, the amount shown as “Net gifts, preceding years” represents the total gifts made during the years 1933,1934, and 1935 after the deduction of a specific exemption of $40,000 and the exclusions, totaling $45,000, referred to above.

At the close of each year here involved each beneficiary’s share of the net income of the trust created by the instruments dated July 19,1933, and November 2,1936, was credited to his or her account on the books of the trustees. Against the amounts so credited each beneficiary was permitted by the trustees to withdraw amounts from time to time, as requested by the beneficiary. The beneficiaries included the amounts so. credited to their accounts in their Federal income tax returns and paid taxes thereon.

It is of course well established, since the Supreme Court decisions above mentioned, that the beneficiaries of the trust were the donees of the gifts and petitioners are entitled to the three $5,000 exclusions which they took on their gift tax returns filed for the taxable year unless the gifts were of future interests. The respondent in an amended answer filed in each proceeding alleges that the gifts were of future interests and that he erred in allowing any $5,000 exclusions, and he asks for increased deficiencies. It is of course true that if the gifts were of future interests petitioners are not entitled to any $5,000 exclusions. See sec. 504 (b), Eevenue Act of 1932.

With respect to this affirmative issue, the burden is on the respondent. The trust instruments executed in 1933 and 1936 are in evidence and speak for themselves. We have quoted in this opinion the pertinent parts of them. In the original stipulation of facts, it is agreed that one exclusion of $5,000 was allowed each petitioner for the year 1936. Likewise, it is stipulated in the supplemental stipulation of facts that three exclusions, totaling $45,000, were allowed for 1933, 1934, and 1935 and accepted by each of the petitioners without appeal, and that those allowances were given effect in arriving at the amounts used in computing “Net gifts, preceding years” in determining the gift tax liabilities for the taxable year 1936. It would, therefore, appear that all facts necessary for a decision are in evidence. That being true, the Board need only decide one question, to wit: Were the gifts of present interests entitling petitioners to three exclusions of $5,000 each for not only the taxable year but also for the three preceding years, or were the gifts of future interests, in which case no exclusions would be allowable for any year ?

The issue will turn on the provisions of the trust instruments which, in so far as applicable in this case, are identical. In fact, the indenture of November 2, 1936, provides that the gifts made thereunder are to be added to the trusts created by the instrument dated July 19, 1933, to be held and administered under the terms and conditions specified in the latter.

In so far as the remainder interests in the trust corpus are concerned, it seems entirely clear that the gifts were of future interests. We do not understand that petitioners contend otherwise.

Under no circumstances were the beneficiaries entitled to the present use, possession, and enjoyment of the corpus of the trust. On the contrary, the distribution of the corpus was not to take place until after the death of the last survivor of the three children named as beneficiaries.

We shall next take up the question as to whether the gifts by petitioners to their three children of the income from the trust corpus were of future interests. By reading the provisions of the trust indenture which we have quoted herein, it will be seen that the trustees were directed to pay over to each of the beneficiaries at such periods as they might deem best, not longer than annually, such portion of one-third of the income as the trustees might in their sole judgment and discretion determine until the beneficiary should reach the age of forty years. Since none of the beneficiaries were forty years old in either 1933 or 1936, the payment of any of the income to them rested solely within the discretion of the trustees and the beneficiaries were in no position to demand payment. Moreover, should a beneficiary die before attaining the age of forty years his or her share of the income was payable to the heirs of that person and, should there be none, then to the surviving beneficiaries.

Helvering v. Blair, 121 Fed. (2d) 945, is a case which we think is in point in the decision of the instant case. In that case the trustees were to apply the income of the trust “to the use of any one or more of the following who may be living (his wife and his seven children) and to the lawful issue of any of my said children in such proportions as shall * * * seem proper to the Trustees in their absolute discretion.” (Italics supplied.) After stating the arguments of the taxpayer to the effect that the gifts of income were of present interests, the court said:

The difficulty with this reasoning is that it ignores the continued power of the trustees to change the original division, during the wife’s life in the case of the first trust; and during the trusteeship of Montgomery and William D. in the case of the second. It was the. prime purpose of the trusts that the trustees should have this power, and presumably that they should exercise it. How then is it possible to compute the value of any beneficiary’s share at the time of the original division? The allocation might be changed the next day, and the interest which succeeded the interest first awarded would he a “future interest” within § 504 (b). In order to calculate the value of an interest subject to .such a condition, we should have to have some actuarial basis for the probability that trustees who had once made such a division would not disturb it. Obviously nothing of the kind is available or would in all likelihood be a sound basis for inference if it was compiled. [Citing authorities.] * * *

In the instant case, as we have already pointed out, there is a provision in the trust indenture as to each beneficiary as follows:

The Trustees shall pay over or deliver to [naming the beneficiary] at such periods as they deem best, not longer than annually, such portion of one-third (%) of the net interest, income and revenue derived or arising from the trust property as to them shall seem fit and proper and for the best interest of our said son (such portion to be determined solely in the judgment and discretion of the said Trustees and without any control over them in the exercise of sxtch judgment or discretion) until our said son shall reach the age of forty (40) years, or until his death, should that event sooner occur. * * * [Italics supplied.]

Thus it will be seen that the trust indentures in the instant case vested the trustees with the sole discretion to determine what part of the income should be distributed to the beneficiaries. They could withhold or distribute in any particular year as in their judgment and discretion they saw proper.

“How then,” as the court pointed out in the Blair case, “is it possible to compute the value of any beneficiary’s share at the time of the original division?” In our judgment it could not be done in the instant case, as it could not be done in the Blair case.

Petitioners lay considerable stress in their brief upon the fact that at the close of each of the years 1933 to 1936, inclusive, each beneficiary’s share of the net income of the trust was credited to his or her account on the boots of the trustees and that against the amounts so credited each beneficiary was permitted to withdraw sums from time to time as requested by the beneficiary. This arrangement is nothing more than the exercise of the discretion granted the trustees by the trust instruments. As said by the court in Commissioner v. Brandegee, 123 Fed. (2d) 58:

* * * Where the absolute right of the beneficiaries to enjoyment of the income is postponed until the happening of a future event, a $5,000 exclusion in respect of each donee is not allowable to the donor under § 504 (b) merely because he has invested the trustee with an immediate discretionary power to mate advancements. Welch v. Payne, supra; Commissioner v. Taylor, supra; Helvering v. Blair, supra. And this is so whether or not the trustee happens to pay over income to the beneficiaries during the year in which the gift is made. The nature of the interest of the donees is determined as of the date of the gift, not by what the trustee may subsequently choose to do in the exercise of his discretionary power. See Helvering v. Blair, supra, at page 947.

We, therefore, hold that the gifts of both the income interests from the corpus of the trusts and the remainder interests in the corpus of the trusts were gifts of future interests and petitioners are not entitled to any $5,000 exclusions in the determination of their gift tax liability for the taxable year 1936.

They were also not entitled to any such exclusion in the determination of their gift taxes for the years 1933,1934, and 1935. Those years are not before us for the determination of any deficiencies and we have no power to determine petitioners’ gift tax liabilities for those years and we make no attempt to do so.

However, in the determination of petitioners’ gift taxes for the taxable year 1936 it becomes important to determine the aggregate sum of petitioners’ net gifts in former years. See sec. 502, Revenue Act of 1932; also art. 5 of Regulations 79, as amended by T. D. 4996, C. B. 1940-2, pp. 295, 296; also paragraph 15.16, Paul’s Federal Estate and Gift Taxation.

In the instant proceedings, there is no issue as to the value of the gifts made by petitioners to the trusts in the years 1933,1934, and 1935. The only issue in determining the net gifts for those preceding years is as to whether petitioners were each entitled to three exclusions of $5,000 each in each of those years, as petitioners contend, or whether the gifts were of future interests and petitioners were not entitled to any exclusions of $5,000 in the years in question. For reasons already stated, we decide that question in favor of the Commissioner.

Decision will Toe entered wnder Bule 50.


author: Akundell:

text:
    Bonwit Teller, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105793.
    Promulgated April 17, 1942.

      OTuurles H. Lieb, Esq., for the petitioner.

      Olay O. Holmes, Esq., for the respondent.
   OPINION.

Akundell:

The question before us is whether or not petitioner is entitled to depreciation on certain leasehold improvements made by petitioner’s predecessor. Petitioner contends that the right to depreciation depends upon the right to the continued use and enjoyment of the property. It maintains that the old company made improvements and was entitled to depreciate the amounts expended on the basis of the probable useful life of the improvements and that petitioner stands in the shoes of the old company for purposes of determining petitioner’s right to depreciate the cost of the improvements. Kespondent argues that upon cancellation of the lease of April 7,1930, the old company lost possession of the property and, in consequence thereof, lost its right to depreciate the improvements.

It is clear that depreciation may be taken by a taxpayer on its capital investment in property used in its trade or business even though title to the depreciable property is vested in another. Helvering v. Lazarus & Co., 308 U. S. 252. We are of the opinion, however, that petitioner is not entitled to depreciation, regardless of whether we look to title of the property or to the right to its continued use and enjoyment.

Careful analysis will demonstrate that petitioner’s contention has no sound basis. Petitioner is attempting to use in the taxable year the basis of the old company. Petitioner did not make or pay for the improvements. Only property transferred in a nontaxable reorganization may be taken up on the new company’s books at the old basis. See sec. 113 (a) (7), Revenue Act of 1938. Here petitioner received no property from the old company which would entitle petitioner to the claimed depreciation. Admittedly, title to the improvements vested in the original lessor under the 1930 lease. Thus, it was not title which passed to petitioner. The right to use property which is subject to lease obviously must be derived from the lease agreement. The lease under which the improvements were made by the old company was not the lease in effect at the time the old company transferred its assets to petitioner. The lease of December 14, 1932, effectually canceled the 1930 lease. The 1932 lease gave petitioner’s predecessor the right of use of the premises, but contained a clause which would permit the lessor to cancel the lease upon 90 days’ notice. It was this provision which caused the reorganization of the business so that petitioner received all the assets of the old company, with the exception of the lease, and liabilities thereunder and certain other leases. The instrument transferring the assets to petitioner specifically stated that the lease was not part of the transfer. Thus petitioner did not receive the lease. Since the lease is essentially tied up with the right to use the improvements, it necessarily follows that petitioner did not receive the right to use the improvements other than at the sufferance of the lessor.

Petitioner is here attempting to derive a tax advantage from the depreciation of property which it never acquired and for which it never paid. The transfer of the old company’s assets to petitioner in exchange for petitioner’s stock did riot cause the depreciable property to pass to petitioner. We are struck by the fact that the controlling powers of the old company, and subsequently of petitioner, went to great length to absolve petitioner from liabilities under the lease. We are of the opinion that petitioner can not, on the one hand, for purposes of bargaining with the lessor, disavow the lease and, on the other, assert its validity. Petitioner can not derive any rights of use under a lease which specifically was not transferred to it.

Petitioner relies upon the case of Cogar v. Commissioner, 44 Fed. (2d) 554; rehearing denied, 51 Fed. (2d) 501. That case is authority for the proposition that an assignee who pays valuable consideration for a lease may depreciate the cost or purchase price of improvements. The case is clearly distinguishable from the instant one in that here nothing was transferred.

The lease of December 14, 1932, suggests a further ground for sustaining respondent’s determination. That lease effectually terminated the original lease between 721 Fifth and the old company. The Supreme Court has laid down the rule that a lessor may realize income upon improvements to realty made by the lessee, upon cancellation or termination of the lease. Helvering v. Bruun, 309 U. S. 461. Thus, at the time the lease of December 14, 1932, was entered into, 721 Fifth may have realized income on the improvements to the realty. See Lewis v. Pope Estate Co., 116 Fed. (2d) 328, 330. It is difficult to find any right to a basis for depreciation in the lessee after that time. It should be noted that in the taxable year a third lease was in effect under which petitioner was lessee and the Fifty Six & Fifth Corporation was- lessor. Thus, all parties to the lease in force during the taxable year were different from those of the original lease.

The record of this proceeding is not sufficient for us to determine that the amounts paid by petitioner for building improvements in 1933 and 1934, aggregating $3,741.61, should have a treatment differing from the sum of $618,964.64 expended, by the old company in 1931. Respondent’s determination that petitioner is not entitled to depreciation on the amounts expended for building improvements is sustained.

The parties have stipulated that petitioner is entitled to deductions not claimed on its return for the taxable year for New York City business taxes in the sum of $645.73, New York City sales taxes in the sum of $840.04, and an additional deduction for New York City franchise taxes in the sum of $7,409.40. These adjustments will be reflected upon recomputation.

Decision will be entered under Bule 50.


author: Sternhagen :

text:
    Capital Estates, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104036.
    Promulgated April 17, 1942.

      James B. Howe, Esq., for the petitioner.

      Harry R. Horrow, Esq., for the respondent.
   OPINION.

Sternhagen :

1. Petitioner demands a dividends paid credit under Revenue Act of 1986, section 27 (e) , and to that end seeks to establish that the dividend paid by it in January 1937 was not such a nonincome dividend as is covered by section 115 (f) (1), but a taxable dividend in the hands of the shareholders, as set forth in section 115 (f) (2) , Although the shareholders are not here, their duty to include the dividend in their income must be determined as the foundation for the petitioner’s case, since its dividends paid credit can only exist if to the shareholders the dividend is taxable. The credit of the corporation is correlative with the taxability of the shareholders. To prove that the dividend “constitutes a taxable dividend in the hands of all shareholders” under section 115 (f) (2), petitioner seeks to prove that it was, at the election of the shareholders, payable either in its stock or in money.

We are of opinion that the payment of the dividend in the alternative was not permissible but that as to 90 percent it was required to be made only in stock. The shareholders had no election. The dividend was in fact paid in stock, but petitioner says that this was because all the shareholders exercised an election to have it so payable, and that the company’s intention was that they should have such an election. We think that this has not been supported. The intention was that petitioner should have a dividends paid credit, as the Brewing Co. had, and petitioner was ready to go a long way to get it; but for some reason it failed to give the election, as the Brewing Co. had. Wien the dividend was declared by the directors, the resolution described it as payable 90 percent in stock and 10 percent in cash, i. e., one share and 66(4 for each 6yz shares held. Not a word was said about an election or which would give a shareholder a right to demand anything other than one share and 66(4 for each 6% shares held.

The earlier notice to the shareholders was not the declaration of the dividend, but was an inquiry which turned out to be without substance. It was couched with extreme subtlety. It stated first, in the subjunctive, that if the shareholder were to elect to take a cash dividend he would be entitled to receive one dollar per share, and then, Hf you elect to take stock you will receive one share for each shares held.” He was then told that an election to take cash would frustrate the dividend altogether, since, as he already knew, “the company has no means of paying the dividend except by a dividend in stock.” Even if these had been the terms of the actual declaration, they would have presented but a Hobson’s choice — an “or else” — which was not a true election between two available dividends, but a choice between a stock dividend and no dividend at all. Cf. Skenandoa Rayon Corporation v. Commissioner, 122 Fed. (2d) 268; certiorari denied, 314 U. S. 696. Since a true stock dividend in the present state of the law is not income, Eisner v. Macomber, 252 U. S. 189, it would be frivolous to attempt to compel the shareholders to include the dividend in income merely because the corporation had made this hypothetical statement and asked them to sign a paper which it called an “election”, recognizing in terms that the dividend was only available in shares. Cf. Pacific Grape Products Co., 42 B. T. A. 914; Humphryes Manufacturing Co., 45 B. T. A. 114.

No force can be given to the shareholders’ resolution of November 18, 1936, giving their approval to the directors’ proposal of a stock dividend, even though it was passed in response to the directors’ wish for a “clear mandate” and recited the importance of the shareholders’ option of taking cash or stock. Shareholders have nothing to say in control of the kind of a dividend; they must abide by the action of the directors, who alone are responsible for the choice of its terms. Gibbons v. Mahon, 136 U. S. 549; Long v. Rike, 50 Fed. (2d) 124. The shareholders’ resolution was merely hortatory.

Petitioner recognizes the devastating effect of the language of the declaration in the resolution as set forth in its minute book, and has introduced oral testimony of the recollection of three of the directors who attended the meeting. Such evidence might conceivably serve to disclose the action of the directors’ meeting better than the formal minutes, and its tendency to do so is enough to justify its admissibility. But the testimony must be weighed with the other evidence to find the facts. The recollections of the witnesses several years after the meeting were not clear and their testimony was not convincing. The other evidence indicates that the tentative thought of making the dividend elective was not in fact carried out because the corporation was not in a cash position to enable it to incur the risk of carrying it out. The corporation was in a dilemma and resolved it by foregoing the tax credit and having the assurance that it would not distribute cash; it kept the cash and let the credit go (to borrow from the Bubaiyat).

Since we hold that no election was given the shareholders, it is unnecessary to discuss the meaning of the parenthetical provision permitting an election to be exercised before or after the declaration of the dividend. It is enough to say that it assumes that by the declaration an election will be given, and permits its exercise to be made either before or after the declaration.

The respondent’s disallowance of dividends paid credit is sustained.

2. The petitioner, failing in the claim for a dividends paid credit, demands that the deficiency be reduced by the amount of tax on the stock dividend which was erroneously withheld by it and paid as withholding agent to the collector at Wilmington. The respondent, without disputing the error of petitioner’s withholding and payment, contends that the Board has no jurisdiction to apply such an offsetting credit, and that section 143 (f) prohibits the credit.

In Houston Street Corporation v. Commissioner, 84 Fed. (2d) 821, it was held that the Board has jurisdiction to redetermine a deficiency in income tax for which a withholding agent is in the first instance liable. Thereafter the Commissioner, in G. C. M. 17274, C. B. XVI-1, p. 159, adopted the view, arising from the Houston Street opinion, that the administrative provisions and jurisdiction of the Board relating to an ordinary deficiency of a primary taxpayer were equally applicable to a tax collectible from a withholding agent. We can see no reason why the jurisdiction of the Board, which is now sufficient to comprehend a petition by a withholding agent assailing a deficiency in the withheld tax, should not also be sufficient to comprehend a claim by the same withholding agent that an erroneous withholding and payment of a purported tax should reduce a deficiency otherwise determined under the same title of the act.

The claim, for offsetting credit is, however, met by the last clause of section 143 (f). The credit is to be made, under the section, to a withholding agent who makes an overpayment “unless the amount of such tax was actually withheld by the withholding agent.” This means actually withheld from the primary taxpayer. Pauker v. United States, 23 Fed. Supp. 821. The evidence shows that the amount of tax paid by petitioner to the Wilmington collector was in fact withheld, and there is nothing to justify an inference that the petitioner has counteracted this withholding by paying or distributing the amount to the shareholders. Indeed it appears that the additional amount of $9,519.29, which, after the amendment of the Canadian Treaty, was released from the charge of half (5 percent) of the original 10 percent tax, is still withheld by the petitioner from the shareholders, and from this it may be inferred that the $10,253.54 is likewise withheld from the shareholders. Manifestly, if the withholding agent is given a refund or a credit against its own deficiency and is able to withhold the refunded amount from the shareholders, it may be benefiting by the credit in precisely the way that the restrictive clause of the section was intended to prevent. We are of opinion that no refund or credit may be made.

Decision will be entered wider Bule 50.

       SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
      *******
      (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 payment.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

      (f) Stock Dividends. — •
      (1) General 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.

       (2) Election ok shareholders as to medium op payment. — Whenever a distribution by a corporation is, at the election of any of the shareholders (whether exercised before or after the declaration thereof), payable either (A) in its stock or in rights to acquire its stock, of a class which if distributed without election would be exempt from tax under paragraph (1), or (B) in money or any other property (including Its stock or in rights to acquire its stock, of a class which if distributed without election would not be exempt from tax under paragraph (1)), then the distribution shall constitute a taxable dividend in the hands of all shareholders, regardless of the medium in which paid.

       SEC. 143. WITHHOLDING OP TAX AT SOURCE.
      ***★*##
      (f) Refunds and Cbedits. — Where there has been an overpayment of tax under this section any refund or credit made under the provisions of section 322 shall be made to the withholding agent unless the amount of such tax was actually withheld by the withholding agent.


author: Van Foss an :

text:
    Helen E. Hyman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 107504.
    Promulgated April 21, 1942.

      Robert G. Polach, Esq., and M. M. Dienes, G. P. A., for the petitioner.

      Homer J. Fisher, Esq., for the respondent.
   OPINION.

Van Foss an :

The respondent determined a deficiency of $572.55 in petitioner’s income tax for the year 1938. This determination was based chiefly on the holding that in the absence of administration of petitioner’s separate property by her husband, such property maintained its separate character and income therefrom could not be reported as community income.

At the hearing petitioner admitted the correctness of respondent’s adjustment as to an item of $873.91 “dues disallowed” and $107.97 capital gain. Respondent conceded error in adding to petitioner’s income an item of $217.05 as “other income.”

Petitioner is an individual residing in New Orleans, Louisiana, and during the taxable year was married and living with her husband, Harris Hyman. Louisiana is a community property state and petitioner and her husband filed their tax returns on that basis of reporting income.

During the taxable year petitioner received income from certain property consisting of stocks and bonds which she owned as her separate or paraphernal property, as it is called in the law of Louisiana. It was agreed that the only question presented by the record is whether, in fact, the separate property of petitioner was managed and administered by her husband.

Pertinent provisions of the Louisiana Civil Code are as follows:

Art. 2383. Definition. — -All property which is not declared to be brought in marriage by the wife, or to be given to her in consideration of the marriage or to belong to her at the time of the marriage, is paraphernal.
Art. 2384. Wife’s right to administer. — The wife has the right to administer personally her paraphernal property, without the assistance of her husband.
Art. 2385. Wife failing to administer paraphernal property. — Management by husband. — The paraphernal property, which is not administered by the wife separately and alone, is considered to be under the management of the husband.
Art 2386. Fruits of paraphernal property. — Ownership.—When the parapher-nal property is administered by the husband, or by him and the wife indifferently, the fruits of this property, whether natural, civil, or the result of labor, belong to the conjugal partnership, if there exists a community of gains. If there do not, each party enjoys, as he chooses, that which comes to his hands; but the fruits and revenues, which are existing at the dissolution of the marriage, belong to the owner of the things which produce them. [As amended, Acts 1871, No. 87.]
Art. 2387. Wife. — Assumption of administration of paraphernal property.— The wife who has left to her husband the administration of her paraphernal property, may afterwards withdraw it from him.
*******
Art. 2402. Property forming community. — * * *. This partnership or community consists of the profits of all the effects of which the husband has the administration and enjoyment, either of right or in fact, of the produce of the reciprocal industry and labor of both husband and wife, and of the estate which they may acquire during the marriage, either by donations made jointly to them both, or by purchase, or in any other similar way, even although the purchase be only in the name of one of the two and not of both, * * *

In Succession of Andrus, 131 La. 939; 60 So. 623, the Supreme Court of Louisiana enunciated the rule as follows:

The profits of all the effect of which the husband has the administration and enjoyment, either of right or in fact, fall into the community. O. C. art. 2402. Hence the community quoad such effects, whether owned by the husband or the wife, occupies a position similar to that of an usufructuary. This is the jurisprudence of this court, and the rule of stare decisis forbids the reopening of the same question.

It has been held specifically that dividends from stock and interest from bonds owned by the wife fall into the community of acquets and gains where the husband has control of the property and collects the income therefrom. In re Lynch (W. Dist. La.), 3 Fed. (2d) 82.

The law of Louisiana is thus established that income from property belonging to the wife but managed or administered by the husband is community income.

The present record fully establishes that the management and administration of petitioner’s separate property were entirely in the hands of her husband. Her husband had entire charge of all business affairs relating to such property and conducted all correspondence in reference to the same without conference with taxpayer unless it was necessary to have her signature to some legal document. The husband made purchases and sales and borrowed money on his wife’s securities, often acting without her knowledge. He paid all bills, using the income from petitioner’s property when necessary. The accountant who kept the records of petitioner’s business transactions had no contact with petitioner and never met her or communicated with her until the day of the hearing, all of his instructions being received from the husband. The husband did not act as a mere agent of his wife (cf. Risher v. Risher (1934), 179 La. 1; 153 So. 1; Guss v. Matthews (1934), 179 La. 1033; 155 So. 765), nor did he act under a power of attorney.

The conclusion is inevitable that the administration of petitioner’s separate property was entirely in the hands of her husband and that, accordingly, the income therefrom was community income.

Respondent advances the argument that even if the administration of the taxpayer’s property was by the husband, she could reestablish her administration at any time and, therefore, she retained the real and ultimate control of the property and its enjoyment, citing Helvering v. Clifford, 309 U. S. 331. We are unmoved by this contention. We do not believe that the rule of the Clifford case should be so stretched as to comprehend the present situation.

Decision will be entered under Bule 50.


author: Kern :

text:
    El Dorado Oil Works, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 102247, 102248.
    Promulgated April 21, 1942.

      Richard P. Norton, Esq., for the petitioner.

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

Kern :

Petitioner, with its main office at San Francisco, had a purchasing department at Manila through which it bought copra. The Manila agents bought from many small traders in the South Seas, but in later years mainly from those in the Philippine Islands, and at varying prices. The petitioner would name a certain price and send the Manila agency cash advances sufficient to meet purchases made at this price. The agent would buy at a price around that named, sometimes above but more often below. The named price, in short, was only a norm, and the petitioner’s advances did not therefore conform, except in a general way, with the cost prices paid. But the named price was treated as cost on petitioner’s boohs and in its income tax returns. The result was that for all the years from 1932 to 1937, inclusive, except 1936, the cost of copra was determined by petitioner at a higher figure than actual cost, and the resulting profits on petitioner’s sales were reported proportionately lower in its returns.

Respondent did not know what the actual situation was until 1936, when the petitioner transferred $30,000 from its account called “Manila Reserves” to its San Francisco surplus account. Petitioner’s method then transpired. On the other hand, petitioner knew what its actual costs were for the preceding calendar year before it had to file its return on March 15. Notwithstanding this fact, it made no effort to make a correct return when originally filed, to make an amended return, or to show actual cost for the preceding year when it filed its return for the next succeeding year. The statute of limitations has now run for all years before 1936.

In Docket No. 102247 respondent determined a deficiency in petitioner’s income and excess profits taxes for the year 1937 by reason of petitioner’s understatement of income arising from its overstatement of the cost of goods sold by $11,811.92. At the hearing herein petitioner conceded this overstatement and has filed no brief under this docket number. We decide this issue in favor of respondent.

However, in Docket No. 102248, which involves the deficiency determined for the year 1936, in which there was an understatement of the cost of goods sold, petitioner earnestly urges error on the part of respondent in treating as income for that year the amount shown on petitioner’s books as the balance in the “Manila Reserve” account, which represented the accumulation of overstatements of the cost of goods sold in the years 1932 to 1935, inclusive.

Respondent argues that the situation is analogous to those cases in which a reserve has been set up for certain liabilities and, the liabilities proving less than expected, the balance is then credited to profit and loss; citing Charleston Railway v. Burnet, 50 Fed. (2d) 342 (App. D. C.), affirming 17 B. T. A. 569; Chicago Railway v. Commissioner, 47 Fed. (2d) 990 (C. C. A., 7th Cir.), affirming 13 B. T. A. 988; Northwestern States Portland Cement Co. v. Huston, - Fed Supp. — (Jan. 16, 1941); and that the reserves may be added to income by the Commissioner although not transferred to profit and loss by the taxpayer, citing North American Coal Corporation v. Commissioner, 97 Fed. (2d) 325 (C. C. A., 6th Cir.); Boston Consolidated Gas Co., 44 B. T. A. 793.

The difficulty with respondent’s contention is that the sums in question were not reserves in any sense and were not even analogous to reserves. In all of the cases cited by respondent there was some obligation either existent or contingent for the satisfaction of which sums were set aside either actually or by bookkeeping entries. In the instant proceeding there was no obligation of any kind on the part of petitioner on account of which or for the satisfaction of which this so-called “Manila Reserve” account was set up. The account merely represented accumulations of the excess of sums forwarded to petitioner’s purchasing agents over the sums actually expended for the purchase of copra. This excess belonged absolutely to petitioner and at no time was it set aside for the payment of any obligation actual or contingent. Even if it could be considered as a reserve it would be a reserve of a kind not recognized as a proper deduction from income and thus it would have to be restored to petitioner’s income in the year or years when made. Peabody Coal Co., 18 B. T. A. 1081, 1091; affd., 55 Fed. (2d) 7 (C. C. A., 7th Cir.); Creamette Co., 37 B. T. A. 216. See Northwestern States Portland Cement Co. v. Huston, 126 Fed. (2d) 196 (C. C. A., 8th Cir., Mar. 12, 1942).

On the facts shown we can see no way in which the amount of the overstatements of goods sold in prior years can be considered as income of petitioner in 1936.

The respondent makes a further argument in his brief on the subject of estoppel. The petitioner made representations of fact in its income tax return which were false, were known by the petitioner to be false, and were relied upon by the respondent in allowing deductions which would not otherwise have been allowed. It is immaterial that the petitioner may not have intended to mislead the respondent. The latter had no duty in unsuspicious circumstances to go beyond the returns to the books of the petitioner. Lofquist Realty Co. v. Commissioner, 102 Fed. (2d) 945. However, there must be more than this to support an estoppel. An estoppel means that a party is estopped to deny as a fact a state of things which he has led another party to believe to be true. The estoppel must be specifically pleaded. Bamberg Cotton Mills Co., 8 B. T. A. 1236, 1244; Tide Water Oil Co., 29 B. T. A. 1208, 1221. The petitioner misled the Commissioner into believing that certain sums were a part of cost of goods sold in prior years, but obviously it does the respondent no good to estop the petitioner to deny that the amounts were cost of goods sold, if the estop-pel proceeds no further. The respondent filed an amended answer in which he makes reference to the fact that the cost of goods sold was overstated and too large deductions were taken in prior years, all of which was known to the petitioner and misled the Commissioner. But that is as far as his allegations go, and even in his brief he does not point out precisely what it is that the petitioner is estopped to deny which will result in some amount being income for 1936. An estoppel must be definite and certain and not vague and uncertain. Thirty thousand dollars was transferred at the end of 1936 from an account known as the “Manila Reserve” to the surplus account of the petitioner. But that transfer created no income. The respondent has failed to point out wherein there is any estoppel in connection with those transfers or where, in connection with the entire case, there is any estoppel which would make the $30,000 income. Since the estoppel was not pleaded and is not even demonstrated, we are unable to consider that there is any issue of estoppel in the case or if there is such an issue, that it may be decided to the respondent’s advantage.

With regard to the deficiency determined for the year 1936 our decision is in favor of petitioner.

In Docket No. lO&lfl decision will be entered, for respondent. In Docket No. 10%%i¡8 decision will be entered for petitioner.


text:
    Jacob Fischer, Petitioner, et al.
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 102878, 102879, 102880, 102881, 102945, 102946, 102973.
    Promulgated April 28, 1942.

      Chas I. Dawson, Esq., for tbe petitioners.

      DeWitt M. Evans, Esq., and Frank M. Cavanaugh, Esq., for tbe respondent.

       Proceedings of the following petitioners are consolidated herewith: Carl T. Fischer; John It. Allgeier; Henry Fischer; Ed. J. Roppel; Herman Hornung; and Regina (Mrs. Henry) Fischer.

   OPINION.

Black:

The question in all of these proceedings is the same, namely, whether the preferred stock received by the petitioners during the taxable year 1936 is taxable to them as a dividend, or whether the receipt by petitioners of the preferred and new common in exchange for the old common was a transaction upon which no gain or loss shall be recognized. If the Board determines that petitioners received the preferred stock and new common stock in a nontaxable reorganization, then the Commissioner concedes that the gains of petitioners on the sale of the stock are taxable as capital gain and that petitioners have correctly computed the gains on the stock which was sold in the taxable year.

The respondent contends, however, that when petitioners exchanged their old common stock for new* preferred and new common the fair market value of the preferred represented a taxable stock dividend to petitioners under section 115 (a) and (f) (1) of the Revenue Act of 1936, or, in the alternative, was “essentially equivalent to the distribution of a taxable dividend” under section 115 (g) of the same act. These provisions of the statute are set out in the margin.

On the other hand, the petitioners contend that the readjustment in question was not a distribution of a preferred stock dividend on common stock, but was in fact and reality an exchange, in pursuance of a plan of reorganization, of old common stock in a corporation a party to a reorganization solely for new common and new preferred stock in such corporation, and, that under section 112 of the Revenue Act of 1936 no gain or loss shall be recognized on such an exchange. The material provisions of section 112 are in the margin.

The real question, therefore, is whether the readjustment outlined in our findings of fact was in substance the distribution by the corporation of a “dividend”, and controlled by section 115 of the Revenue Act of 1936, or was an “exchange” of stock for stock and controlled by section 112 of the same statute.

If the readjustment was a distribution by the corporation of a stock dividend, as respondent contends, our decision would have to be for the Commissioner upon the authority of Koshland v. Helvering, 298 U. S. 441; Helvering v. Gowran, 302 U. S. 238; Helvering v. Pfeiffer, 302 U. S. 247; Frank J. and Hubert Kelly Trust, 38 B. T. A. 1014; Eighth Circuit opinion affirming Board withdrawn, 106 Fed. (2d) 1002; Albert E. Smith, 39 B. T. A. 80. For reasons hereinafter given, we do not think that the said readjustment can be held to be a distribution of a stock dividend or a distribution essentially equivalent to the distribution of a taxable dividend under section lio (g). Therefore, we do not think that the above cases cited by respondent are in point.

We do not think it can reasonably be disputed that both in form and in substance there was an “exchange” of old stock for new stock in the same corporation. In Baltimore & Ohio Railroad Co. v. Western Union Telegraph Co., 241 Fed. 162; affirmed per curiam, 242 Fed. 914, the District Court (S. Dist. N. Y.), at p. 170, said:

(a) “Exchange” has a well-settled meaning in common acceptation. Webster’s definition is:
“The act of giving or taking one thing for another which is regarded as an equivalent; as an exchange of cattle for grain.”
*******
This popular meaning of “exchange” used and understood in the common speech of people has been accepted and defined by Codes and courts. * * *

Petitioners in fact delivered to the corporation their old common stock in the corporation of a par value of $100 per share, and for each share so delivered they received five new shares of common stock of a par value of $10 per share and two new shares of preferred stock of a par value of $25 per share in the same corporation. We hold that this was an “exchange” of stock for stock in the same corporation.

In order for petitioners to avoid recognition of gain or loss under section 112 (b) (3), supra, in connection with their exchange of stock solely for stock in the same corporation, it must appear that there was a “reorganization” and that the exchange of stocks was “in pursuance of the plan of reorganization.” Section 112 (g) (1), supra, defines the term “reorganization” to mean, among several things, “(D) a recapitalization.” Under a statute similar to section 112 (g) (1) (D), we held in H. E. Muchnic, Administrator, 29 B. T. A. 163, that, where the petitioner in that case exchanged a part of the outstanding common stock of a corporation for previously authorized but then unissued preferred stock of the same corporation, the exchange effected a recapitalization of the corporation constituting a statutory reorganization and was a transaction upon which no gain or loss was recognizable. Our observations in that case are likewise applicable here. Cf. Walter F. Haass, 29 B. T. A. 900; affirmed without opinion January 14, 1936.

After briefs were filed in these proceedings, Strassburger v. Commissioner, 124 Fed. (2d) 315, and Edith B. Bass, 45 B. T. A. 1117; on review, C. C. A., 1st Cir., were decided, and the Commissioner by permission amended his brief and cited those two cases, urging them as authorities supporting his position. We think the Strass-bwrger case is clearly not in point. It was simply a case where admittedly a dividend on common stock had been paid in preferred stock and the question was whether such dividend was taxable. The Board held that it was and the Second Circuit affirmed. No question of an exchange in reorganization was raised in that case or was in any way involved. The Strassburger case is similar to the several cases cited by respondent in his brief which we have already held not to be in point.

The Bass case requires more attention. We have carefully considered it and all its facts, and we think it is distinguishable on its facts from the instant case. In the Bass case, prior to the alleged reorganization of Bird & Son, Inc., by recapitalization there were outstanding 600,000 shares of no par value common stock. The capital stock account of the corporation showed a stated capital stock of $6,000,000 represented by these 600,000 shares of no par value common stock. When the plan of alleged recapitalization was complete the capital account of the corporation showed $3,000,000 represented by 600,000 shares of no par value common stock and $3,000,000 represented by 30,000 shares of preferred stock. The taxpayer was the owner prior to the alleged reorganization of a voting trust certificate representing 54,510 shares of common stock of the corporation. She surrendered that certificate and received a certificate for 54,510 shares of common stock of no par value and a. certificate for 2,72514 shares of preferred stock. We held that the 2,7251/2 shares of preferred stock which the taxpayer received were received as a dividend on her common stock and were taxable to her. in the amount of the fair market value of such preferred shares. 1'n thus holding, we said, among other things:

* * * The record fails to disclose any business purpose or substance in the surrender of the original certificate for 600,000 shares of no par common, the issuance of a certificate for 300,000 shares of that stock, the cancellation of that certificate, and the issuance of another certificate for 600,000 shares of the same kind of stock. The same result could have been reached, so far as this record shows, by merely issuing a certificate for 30,000 shares of preferred stock, allowing the voting trustees to retain the original certificate for 600,000 shares of no par common, and making book entries showing that 30,000 shares of preferred represented $3,000,000 of capital and the 600,000 common shares without par value had henceforth a stated value of $3,000,000. The stated value of the common stock could have been reduced without changing the certificate. All semblance of an exchange disappears if the steps taken in regard to the certificates for the common stock are disregarded.

- In the instant case the facts, unlike those present in the Bass case do show a business purpose in the recapitalization. We think this business purpose has been definitely established by competent evidence. Prior to the recapitalization the stock of the corporation was closely held by members of the Fischer family and a few key employees of the corporation. It was desired to have the stock of the corporation more widely held and to establish a ready market for it and at the same time not lose control by those who had built the corporation from a very small beginning and were responsible for its notable success.

Therefore, after consultation among the stockholders themselves and with an established bond company of Kentucky, the plan of recapitalization of the corporation was agreed upon and arrangements were made with the bond company to market the preferred stock along with certain shares of the new common stock. Full details of these plans and their execution are embodied in our findings of fact and need not be repeated here. Suffice it to say that, when the sales of the new stock which it had planned to sell were completed, the corporation had approximately 300 shareholders residing in different parts of the State of Kentucky, instead of 11 shareholders prior to the recapitalization. As a result of these efforts, the business of the corporation became more widely extended in the State of Kentucky and a wider market for the stock of the corporation was established.

In view of these facts, we think respondent’s contention that the recapitalization of the corporation was not bona fide and was lacking of any business purpose, and was effected merely to disguise a taxable stock dividend, can not be sustained. We think the facts cited just above and others in the record make the instant case distinguishable from Edith B. Bass, supra, and they cause us to reach a conclusion different from the one reached in that case.

The record establishes, we think, that the exchange of the old common stock in the cases at bar for the new common and preferred was in pursuance of a plan of reorganization theretofore agreed upon. The Henry Fischer Packing Co. was a party to its own reorganization as that term is defined in section 112(g)(2), supra. We hold, therefore, that under section 112(b) (3), supra, no gain or loss shall be recognized upon the exchange made by petitioners, in pursuance of the plan of reorganization, of their old common stock in the corporation a party to the reorganization solely for new common and new preferred stock in the same corporation. From this holding it necessarily follows that the preferred stock received by petitioners did not represent a taxable dividend to petitioners under section 115(a) and (f)(1) of the Revenue Act of 1936 and its issuance was not “essentially equivalent to the distribution of a taxable dividend” under section 115(g) of the same act. Cf. South Atlantic Steamship Line, 42 B. T. A. 705; Skenandoa Rayon Corporation, 42 B. T. A. 1287; affd., 122 Fed. (2d) 268.

The parties have stipulated that “if the stock was received in a nontaxable reorganization” and we have held that it was so received, then, “the computation of tax in each of said returns was properly made except as indicated in paragraphs 15 and 16, and the note to paragraph 3 hereof.” Effect will be given to this part of the stipulation under Bule 50.

Decisions will Ice entered under Bule 50.

       SEC. 115. distributions BY CORPORATIONS.
      (a) Definition of Dividend. — Tlie term “dividend” when used in this title (except in section 203 (a) (3) and section 207 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, 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.
      ***•#* *
      (f) Stock Dividends.—
      (1) General 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.

        *******

      (g) Redemption of Stock. — If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

         SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) General Rule. — upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall he recognized, except as hereinafter provided in this section.
      (b) Exchanges Solely in Kind.—

        (3) Stock foe stock on iieoeganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of tile plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * * # * lit * *
      (g) Definition of Reoeganization. — As used in this section and section 113—
      (1) The term ’’reorganization” means * * * (D) a recapitalization, * * *
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.


author: Oppee :

text:
    Athens Roller Mills, Inc., Petitoner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99055, 104071.
    Promulgated April 28, 1942.

      George E. H. Goodner, Esq., for the petitioner.

      Wm. V. Crosswhite, Esq., for the respondent.
   OPINION.

Oppee :

That processing taxes accrued in one year and paid in the next are proper deductions in the year of accrual is now concurred in by the parties. Cartex Mills, Inc., 42 B. T. A. 894.

It is also clear that taxes accrued but never paid because of a subsequently determined invalidity are not to be treated as deductible items if the year of accrual remains open for adjustment. Elsie S. Eckstein, 41 B. T. A. 746; Security Flour Mills Co., 45 B. T. A. 671; E. B. Elliott Co., 45 B. T. A. 82. Respondent’s determination in this respect was proper and is approved.

The final question is whether a waiver of the statute of limitations applicable to the year 1934 and signed on behalf of petitioner by its secretary and treasurer is invalid because lacking the corporate seal or an annexed certification of action by the board of directors. This requirement appears neither in statute nor regulations but only as a footnote on the form itself. There is no showing that the action was unauthorized nor that the officer was acting outside the scope of his duties, but, on the contrary, it appears that he had previously signed petitioner’s income tax return for 1935 and that a subsequent waiver also for 1934, which he executed, was authorized by the board of directors. Nor does it appear that such action on behalf of a corporate officer would have been ineffectual to bind the corporation under state law. Cf. Concrete Engineering Co. v. Commissioner (C. C. A., 8th Cir.), 58 Fed. (2d) 566. Absent any evidence that this action was opposed or forbidden by the board of directors or others authorized to act on petitioner’s behalf, the failure to annex an authorizing resolution, like the omission of the corporate seal for which it is merely a substitute, can not be anything more than an inconclusive formality. Rowan Drilling Co., 44 B. T. A. 189, 194; Crown Willamette Paper Co. v. McLaughlin (C. C. A., 9th Cir.), 81 Fed. (2d) 365; Panther Rubber Manufacturing Co., 17 B. T. A. 310 (reversed other grounds, C. C. A., 1st Cir., 45 Fed. (2d) 314). We conclude that the waiver was valid and that the 1934 deficiency is not barred by the statute of limitations.

Decision will be entered under Rule 50.