author: Sternhagen:

text:
    Pelham Hall Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74352.
    Promulgated October 30, 1935.

      Robert H. Davison, Esq., and Robert H. Hopkins, Esq., for the petitioner.

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

Sternhagen:

The Commissioner’s determination that the correct depreciation base for the petitioner is $450,000, the price bid and paid by it at the foreclosure sale, is assailed by the petitioner, which demands the use of $809,500, which it claims to have proven as the fair market value. Its only supporting argument is a reliance upon Suncrest Lumber Co., 25 B. T. A. 375, which petitioner regards as upon all fours.

While the Simcrest case involves a similarity of principle, it is not upon the generality of purpose and plan that its decision rests, but upon the details of method of effectuating the purpose and carrying out the plan and the detailed evidence of valuation. The new Suncrest corporation exchanged its new bonds for the bonds of the old Champion corporation, and then exchanged the old bonds of a proven and found value for the property. Thus the property was held to have a cost to the new Suncrest corporation amounting to the actual value of the old Champion bonds, and it was held that such actual value of old bonds was equal to the actual value of the property, which latter value was found as a fact. The bid alone was held to be not conclusive of actual cost. In the present case, the new corporation issued its no par common shares to the old bondholders in the ratio of one share for each $10 of bond principal and accrued interest. Thus the old bondholders must be regarded as liquidating their old bonds and realizing gain or loss in the exchange measured by the cost to them of their old bonds and the value of the shares received. Correlatively, the cost to the new corporation of the old bonds received and the value of the new shares issued are likewise measured by the value of the old bonds.

These old bonds were in default and were worth no more than what the property mortgaged to secure them would bring upon foreclosure. This property, although it had been assessed at $806,000, was in 1930 earning a net income of less than $50,000 a year, and the estimated net income for 1931 was $25,000, before depreciation and income taxes, and after interest at 6 percent on a prospective new mortgage of $400,000. Although an experienced real estate dealer gave his opinion that the property was worth $809,500, his opinion is not conclusive upon the Board, Uncasville Manufacturing Co. v. Commissioner, 55 Fed. (2d) 893, and we are unable to give it full weight. It was arrived at by a formula of capitalizing earnings which was predicated upon figures at variance with the earning figures appearing on petitioner’s Exhibit No. 2 and read into evidence also by petitioner’s counsel. The correct figures seem to us to substantiate the bid price of $450,000 as reasonably approximating the performance and prospects of the property and representing its fair market value at the time of acquisition. The cost has therefore been found as a fact to have been $450,000.

The theory involved is that the depreciation base is actual cost to the taxpayer of the depreciable property and not the value of the property when acquired, for it is the taxpayer’s investment which is being preserved by depreciation. Were the property acquired by the issuance of the taxpayer’s shares, the cost would be the value of the shares issued. Ida I. McKinney, 32 B. T. A. 450, 456; Pierce Oil Corporation, 32 B. T. A. 403, 430. The property here was not acquired for shares, but for cash and the old bonds, which bonds were property in the hands of the taxpayer corporation. Thus the cost of the depreciable property acquired is the value of the property (bonds) and cash given up for it. Although the bid itself does not conclusively establish the amount of the price actually paid, the evidence does not establish that the price was in fact more than the bid. Cf. Newberry Lumber & Chemical Co., 33 B. T. A. 150.

There is no unfairness in computing the taxpayer’s annual deductions for exhaustion upon a capital base of $450,000, because the whole plan was to bring the capital investment in the building and the interests of the old bondholders down to a level of value consonant with earnings. Presumably both the old corporation and the old bondholders took their proper loss deductions. The new corporation started upon a new basis and its depreciation is measurable accordingly.

Judgment will be entered for the respondent.

       See Law of Federal Income Taxation, Paul and Mertens, vol. 5, § 52.04, Opinion Evidence,


source: Caselaw Access Project

author: Aeundell : McMahon,

license: Public Domain

text:
    The Prudential Insurance Company of America, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56641, 60884, 67238.
    Promulgated October 30, 1935.

      Ferdinand Tannenbaum, Esq., for the petitioner.

      Chester A. Cwinn, Esq., for the respondent.
   OPINION.

Aeundell :

The respondent determined deficiencies in income tax for the years and in the amounts as follows:

1927_$22,308.63
1928_ 20, 637. 53
1929_ 275,316.77
1930_ 341,763. 68

Petitioner contests only a part of these deficiencies. Several issues were originally raised, some of which petitioner concedes have been settled by decisions of the Supreme Court. One issue, raised by respondent’s answer, relating to a deduction for the mean of reserves for sickness and accident provisions in group insurance policies, has been settled by stipulation and respondent’s concession that the stipulated 4 percent of the mean of such reserves may be deducted.

The questions for decision are: (1) Whether or not income was realized by petitioner in the amount of interest in default on mortgage loans where the mortgaged property was acquired by petitioner either by foreclosure or voluntary conveyance by the mortgagor; (2) whether or not petitioner is entitled to' deductions for obsolescence of a building in the period March 27, 1929, to July 7, 1930. Some of the facts were stipulated and testimony was offered as to others.

The Interest Issue.

Petitioner is a life insurance company operating on a mutual basis. In the course of its business it loaned money on real estate and accepted mortgages as security for the loans. In addition it purchased certain mortgages.

Upon default by the mortgagors the petitioner, as mortgagee, instituted foreclosure proceedings on certain of the mortgages. In jurisdictions which allowed the mortgagor a redemption period the petitioner bid for the properties at foreclosure sales amounts equal to the principal of the mortgage plus accrued interest. Its purpose in doing this was to fix the redemption price at an amount equal to the principal and interest. On foreclosure sales at which petitioner was the successful bidder it received a certificate of purchase or a deed to the property in exchange for the obligation of the mortgagor to pay both principal and accrued interest.

The accrued interest to the date of sale on the foreclosed mortgages in each of the several years was as follows:

1927_$30, 898. 63
1928_ 88, 972.16
1929_ 91, 768.42
1930_ 178,445.88

The cases are uniform in holding that where a mortgage creditor bids in the property at foreclosure for the principal of the mortgage plus interest, the interest is to be treated as income to the creditors. Ewen MacLennan, 20 B. T. A. 900; National Life Insurance Co. v. United States, 78 Ct. Cls. 369; 4 Fed. Supp. 1000; Missouri State-Life Insurance Co., 29 B. T. A. 401; affirmed on this point, 78 Fed. (2d) 778; American Central Life Insurance Co., 30 B. T. A. 1182. Accordingly, we affirm the respondent’s inclusion of the above amounts in petitioner’s interest income.

In the case of other properties on which petitioner held mortgages, and there were defaults, petitioner secured title and possession by direct conveyance from the mortgagors and release of the mortgages in lieu of foreclosure proceedings. In such cases the indebtedness of the mortgagors was extinguished.

The accrued interest to the date of conveyance of the properties was as follows in each of the several years:

1927- $5,971.65
1928_._17, 716. 39
1929_ 26, 253. 21
1930_ 75,207.37

The question of treating as income accrued interest on property directly conveyed to the insurance company was involved in Missouri State Life Insurance Co., supra. The Circuit Court held:

The mortgagee in such a case exchanges the loan for the land. If the land is worth as much or more than the amount due upon the loan with accrued interest, the exchange results in the equivalent of payment in full, but not otherwise. Certainly, the accrued interest upon a mortgage is not paid by the acceptance of mortgaged property which is worth less than the principal of the loan. Such a transaction produces no income to the mortgagee.

In American Central Life Insurance Co., supra, promulgated prior to the hearing of these proceedings, we said:

If the properties were worth more than the loans, costs, and interest (and the record on this is silent), it could not be said that petitioner did not receive its interest. * * * We may assume, as the Commissioner did, that the mortgagee’s debt for the interest was discharged by the transfer.

In the present case there is no evidence as to the value of the land taken in satisfaction of the indebtedness. At the hearing of these proceedings the presiding Member directly pointed out the possibility that the solution to the question here might depend upon the value of the property taken over by the petitioner. Counsel for the petitioner took the view that the value was immaterial and stated that no proof thereof would be offered. We may not assume that the property was worth less than the principal of the mortgage debt plus interest; if we must indulge in assumption it must be that the respondent was right in treating the property as of sufficient value to satisfy both principal and interest. We accordingly sustain the inclusion in income of the amounts above set out.

The Obsolescence Issue.

On January 5, 1928, the petitioner purchased real estate and improvements thereon located at Nos. 86-88 Academy Street and Nos. 87-91 Bank Street, Newark, New Jersey, paying therefor the sum of $576,579.87. These properties adjoined and were in reality one parcel running through the block from Bank to Academy Streets, which were parallel, and will hereinafter be called the Academy Street property.

The Academy Street property was acquired pursuant to a resolution of petitioner’s directors adopted in December 1927, reciting that in their judgment the growth of the petitioner’s business “ requires present provision for additional office space ”, and ratifying the action of the president in contracting for the purchase of a number of parcels of land, including the Academy Street property, all of which were located within the block bounded by Washington, Academy, Plane, and Bank Streets. The improvements on the Academy Street property consisted of a warehouse building, five stories in height, of brick and heavy frame construction. The building had been used for a number of years prior to 1928 as a furniture warehouse by the owners, who conducted a retail furniture store a short block distant from the property. Because of the proximity of the warehouse to the retail store the owner did not desire to sell the warehouse property. There were other warehouses in the vicinity, and the fact of being close to the retail shopping district made the property desirable for warehouse purposes.

At the time the Academy Street property was purchased by the petitioner it was leased for a period of five years from January 5, 1928, at an annual rental of $20,000, the lessee to pay all taxes and expenses in connection with the property. The lease was subject to termination by the lessee on six month’s notice. On March 27, 1929, the lessee gave notice and the lease was terminated on November 1, 1929. The petitioner attempted to persuade the lessee to continue the lease and also made efforts to secure other tenants, but without success. On July 7, 1930, the petitioner demolished the building. It had never been occupied in whole or in part by the petitioner.

The gross rental income from the property and the taxes and expenses in connection therewith for the years 192'8 to 1931 were as follows:

Year Gross rents Taxes and expenses
1928-$24,405.65 $4,687.98
1929-21,182.79 5,397.86
1930-1,107.10 6,462.79
1931-4,408.91 1,940.44

The fact that the building was leased at the time the property was purchased was a factor that influenced the price paid by the petitioner. The petitioner intended at that time to lease it for a longer period if possible. In 1929 conditions became less favorable for rental of properties in that vicinity. The removal of the former owner of the Academy Street property from that warehouse was an unfavorable factor; the failure of a number of retail establishments in what was known as “ furniture row ” adversely affected rentals; the occupants of some of the warehouses moved to other sections more conveniently located. It became evident to petitioner in 1929 that it would not be able to secure a tenant who would pay a rental approximating that paid by the then lessee, and the taxes and expenses in connection with the building were so high that it would be to the advantage of the petitioner to demolish the building.

In its returns for the years 1928, 1929, and 1930 petitioner claimed and was allowed the following amounts as deductions for exhaustion, wear and tear of the improvements on the Academy Street property: $10,344.66 for 1928, $10,487.94 for 1929, and $5,402 for 1930. The amounts so claimed and allowed are at the rate of 3 percent of the amount set forth in the returns as cost of the improvements.

Petitioner now claims that the improvements on the Academy Street property had a cost to it of $349,598.04, and that $336,631.40 thereof should be allowed as deductions for exhaustion, wear and tear, including obsolescence, in the period from March 27, 1929, to July 7, 1930. The difference between the above sums represents the 3 percent depreciation deduction claimed and allowed for the year 1928 and the period in 1929 to March 27.

Petitioner’s view is that it purchased the Academy Street property for the purpose of leasing it; that at the date of the lessee’s notice of termination, March 27, 1929, it was justified in concluding that in the following year it would be impossible to lease the warehouse, hence it was proper to charge off the unexhausted cost in the years 1929 and 1930. The respondent argues that petitioner is not entitled to an obsolescence deduction because the petitioner’s acquisition of the property was primarily an acquisition of land and the building merely an encumbrance so far as petitioner’s use for the property was concerned, but that if obsolescence is in theory allowable the petitioner has failed to establish the cost of the building, so that in any event the amount allowable can not be determined.

Assuming economic worthlessness of a building, and demolition, a corporate owner other than a life insurance company could claim a loss deduction for the unrecovered cost. Whether such a loss would be allowable we need not decide, but see Liberty Baking Co. v. Heiner, 37 Fed. (2d) 705. A life insurance company may not take loss deductions. It may, however, take a deduction of “ a reasonable allowance for the exhaustion, wear and tear of property, including a reasonable allowance for obsolescence.” Sec. 203 (a) (7), Kevenue Act of 1928.

At the outset, it appears to us that petitioner’s alleged “ cost ” of the building, $349,598.04, is but little short of fantastic. The method of arriving at this figure, stated briefly, is that the value of the land was figured and that amount subtracted from the entire price paid by petitioner and the difference ascribed to the building. We see no sound basis for this method under the facts in this case. The petitioner unquestionably paid more for the property than its fair market value. This is established by the evidence, and was brought about by the petitioner’s desire for the land and the fact that the owner was an unwilling seller. Petitioner’s witnesses took into consideration this situation and by reason thereof added 100 percent to the basic front foot figure they used as a starting point in their calculations. Just why 100 percent was used, rather than some other figure, say 200 or 300, does not appear. There can be no doubt on the record that the vendor drove a hard bargain. But it did not bargain separately for the sale of the land and the building, and petitioner did not buy them separately. Petitioner’s primary need was for the land. This is shown by the resolutions adopted shortly before the purchase, and by the evidence, which shows, among other things, that petitioner acquired the entire block in which this particular property is located. Other parcels in the block had other kinds of improvements wholly unrelated in possibility of use to petitioner’s business or to the warehouse business conducted on the Academy Street property, which is at least an indication that the acquisition of the improvements was purely incidental to the purchase of the land. It is true that the fact that the building was leased influenced the price paid for the property. Nevertheless we are of the opinion that by far the major portion of the purchase price of the property should be allocated to the cost of the land.

The respondent offered the testimony of an experienced appraiser, who, on the basis of available data as to the type of construction of the warehouse building, computed the cost of reconstruction and the depreciated cost to the date of purchase by the petitioner.

Upon consideration of all the evidence, we are of the opinion that of the cost of the entire property the sum of $100,000 represents a reasonable amount to be allocated as cost of the building.

We still have the question of whether the petitioner is entitled to deductions for obsolescence. While the petitioner wanted and acquired the property primarily for the land, the building thereon was useful and was used as an income producer. The record does not establish to what extent the lease on the property affected the price paid by the petitioner, but the evidence is uncontradicted that it did exert some influence. Moreover, the evidence is that the petitioner at the time of acquisition intended to lease the building for a number of years before devoting the site to home office use, and there was reason to believe that the building would continue to be used for the purpose for which it was constructed. As above pointed out, the statute permits life insurance companies to take deductions for obsolescence. The statutory grant of allowances for exhaustion, wear and tear, and obsolescence is plain. These deductions are provided for in the same sentence and property subject to depreciation deductions is also subject to deductions for obsolescence if the fact of obsolescence is established. In this case deductions for exhaustion, wear and tear have been claimed and allowed.

The evidence establishes to our satisfaction the fact of obsolescence. We have pointed out above that the building when acquired was an asset of value, that it was useful and was used as an income producer, and that petitioner intended to continue to use it as rental property and there was every reason to believe that it would so continue. On March 27, 1929, petitioner was apprised of the fact that the then tenant intended to quit the premises. It does not appear that until that time petitioner had any reason to believe there would be difficulty in securing a tenant. But when it set out to find a tenant it found that changing business conditions made impossible the rental of the building for any sum sufficient to pay expenses and taxes. “ Obsolescence may arise from * * * shifting of business centers * * United States Cartridge Co. v. United States, 284 U. S. 511; Burnet v. Niagara Falls Brewing Co., 282 U. S. 646. In this case, according to the evidence, the furniture warehousing business was moving awajr in 1929 from the vicinity of the Academy Street property. In our opinion petitioner is entitled to deductions for obsolescence, based on an allocated cost of $100,000, spread over the period from March 27, 1929, to July 7, 1930, after adjustment for depreciation allowed for the period January 5, 1928, to March 27,1929.

Reviewed by the Board.

Decision will be entered vmder Rule SO.

McMahon,

dissenting in part: That “ the furniture warehousing business was moving away in 1929 from the vicinity ” of the property in question is not sufficient to establish that the business center in question had shifted, or, assuming (only for the purposes of discussion) that it had, that such shifting gave rise to obsolescence of the warehouse building in question. It was incumbent upon petitioner to establish both. It has established neither.

The business center in question remained substantially the same throughout the years before us. It is a matter of common knowledge that warehouses are common to business centers. There were other warehouses in the vicinity. It was close to the retail shopping district. Warehouses need not be close by and frequently are not. There is no showing that the warehouse in question could not have been used for general warehouse purposes by the petitioner in the condition it was in when acquired by it. There rests upon a petitioner a heavy burden to establish obsolescence of a warehouse building such as the one in question.

Furthermore, petitioner did not acquire the warehouse in question for its warehouse purposes. It acquired it and other adjoining parcels of land acquired at the same time for the purpose of ultimately demolishing it to put in its place an addition to its office building, which was also on adjoining land. All were in the same business center. It did, in fact, thus demolish it. There is no showing that the earlier demolition of the warehouse was not to the advantage of the petitioner, economically or otherwise, from the standpoint of the primary purpose of its acquisition by petitioner, which was that of expanding its office space to meet the requirements of its increasing business. There is some indication that it was. Viewed from the standpoint of obsolescence, any impairment of the usefulness as a warehouse of the warehouse building in question which occurred was not beyond petitioner’s control. It was brought about by it. An owner can not thus give rise to obsolescence of his own property.

Mere difficulty in finding a tenant is not sufficient to establish that a business center has shifted and thereby given rise to obsolescence. There is no finding that the rate of rent was reduced to attract other prospective tenants. Furthermore, reduction of value, rental or otherwise, can not give rise to obsolescence.

“ Changing business conditions ” of the character disclosed in this proceeding are not sufficient to give rise to obsolescence.

There is no basis for petitioner’s conclusion, reached on March 27, 1929, that in 1930 “ it would be impossible to lease the warehouse.”

The majority opinion allows and by its precedent opens the door to deductions not provided for or contemplated by any provision of the applicable statutes or supported by precedent. On the other hand, it is contrary to such statutes and to principles enumerated in other precedents. See First National Bank of Key West, 26 B. T. A. 370, and Joseph E. Swanson et al., Trustee, 29 B. T. A. 1123.

United States Cartridge Co. v. United States, 284 U. S. 511, and Burnet v. Niagara Falls Brewing Co., 282 U. S. 646, are clearly distinguishable from the instant proceeding and do not sustain the result reached by the majority upon the. subject of obsolescence.

I, therefore, respectfully dissent from that portion of the opinion of the majority which allows deductions for obsolescence.


author: Aeundell :

text:
    Harry Lee Martin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68987.
    Promulgated October 30, 1935.

      Dan J. Chapin, Esq., for the petitioner.

      Ralph Smith, Esq., for the respondent.
   OPINION.

Aeundell :

The respondent determined a deficiency in petitioner’s income tax for the year 1929 in the amount of $21,541.47. The petitioner alleges error in the respondent’s disallowance of a claimed loss of $148,621.35 on the sale of two blocks of corporate stocks. The transaction resulting in the alleged loss was a transfer of the stocks by petitioner to his wife under the circumstances hereinafter set forth.

The petitioner, a resident of California, and Daisy E. Martin were married in 1901. For some eight or ten years prior to her marriage and for a year or two thereafter Mrs. Martin was employed by her father. She also took upon herself considerable of the responsibility of managing her father’s household and continued to do so during her father’s life. There were times when she drew no salary for the services rendered in her father’s business.

In 1903 the petitioner expressed to his wife a desire to participate in a syndicate being formed for the purpose of purchasing a tract of land. He did not have the funds necessary to participate. He also conferred with his father-in-law, informing him of the possibilities of the venture. Shortly thereafter the father purchased for himself an interest in the venture and gave the petitioner’s wife $5,000, which sum she turned over to the petitioner and he used it to purchase an interest.

In 1907 the petitioner was engaged in operating a mine. As bills were rendered for the mining operations they were paid by the petitioner’s father-in-law. Such payments were regarded as advances to the petitioner’s wife and in turn as advances by the wife to the petitioner. The total of such payments amounted to $26,000.

In 1923 the petitioner for the first time opened a set of accounts. In those accounts he made ledger entries showing an indebtedness to D. E. Martin, his wife, of $26,000 plus interest from July 1, 1907, and $5,000 plus interest from January 1, 1903.

The petitioner has never paid to his wife any sums to apply against the amounts advanced by the wife or any interest thereon. In 1912 the petitioner’s net worth was about $100,000, in 1923 it was between $200,000 and $225,000, and at the beginning of 1929 it was $300,000 or $400,000. He paid interest to others in amounts ranging upward from $6,200 in 1924 to $29,121.99 in 1928, and $12,331.43 in 1929.

In 1927 and 1928 the petitioner acquired 786,000 shares of Argentina Consolidated Mining Co. stock at a cost of $131,355.10. In September 1929 he acquired 850 shares of General Theatre Equipment stock at a cost of $54,236.25.

On November 13, 1929, the petitioner, after consultation with his wife, transferred to her all his Argentina and General Theatre shares. On that date he entered in the ledger account in the name of his wife the then market value of the shares transferred, those values being $15,720 for the Argentina and $21,250 for the General Theatre shares. In his income tax return for 1929 he reported the transfers as being sales resulting in a loss of $115,635.10 on the Argentina shares and a loss of $32,986.25 on the General Theatre shares. These claimed losses offset partially gains on other transactions in stocks. One half of the net gain, as computed by petitioner, was reported in his return and one half in the return of his wife.

Counsel for the parties both state the question in this case to be whether or not the sale by petitioner to his wife of the Argentina and' General Theatre stock was a bona fide sale. The respondent has determined that it was not.

There is no question of the sufficiency of the transfer in 1929. The Argentina certificates were delivered, and there was delivery of an assignment or bill of sale of the General Theatre stock which was then on deposit as collateral to secure a loan. These evidences of ownership have since remained in the possession of petitioner’s wife.

It does not follow, however, that the transfer was a sale. A sale needs the support of a consideration — a price. No doubt the cancellation of a debt may constitute a valid consideration; and this brings us to the real question here, namely, whether there was a debt owing by petitioner to his wife. The term debt denotes an obligation of the debtor to pay and a right of the creditor to receive and enforce payment. J. S. Cullinan, 19 B. T. A. 930; Twin Ports Bridge Co., 27 B. T. A. 346, 355. The transactions in this case, particularly when viewed in the light of the relation and conduct of the parties, do not impress us as imposing any obligation on the part of the petitioner to pay or establishing any right of the wife to enforce payment. The original transaction was in 1903. Twenty years elapsed before the petitioner made any written record of it. The next advance was in 1907 and sixteen years passed without a record of it. There is no evidence of any recognition of a debt before that except the very general testimony of petitioner and his wife that the advances were regarded as loans and that the petitioner would repay them (in his words) “ as soon as I was able ”, with interest which according to the wife’s testimony “ would be paid at some time.” After making a record of the advances six more years elapsed before there was any gesture toward satisfaction of any part of the account. In the meantime petitioner’s net worth had become a substantial sum and was increasing with the passing of the years; he paid substantial amounts of interest to others. These facts do not accord with his testimony that he regarded the advances as debts to be paid as soon as he was able.

Upon consideration of all the evidence we are not convinced that there was a debt owing by petitioner to his wife. Consequently there was no consideration for the transfer of the stock in 1929 and the transfer was not a sale and no deductible loss was sustained thereby.

Decision will be entered for the respondent.


author: Van Fossan:

text:
    John H. Hord, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61765.
    Promulgated October 30, 1935.

      Horace Andrews, Esq., for the petitioner.

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

Van Fossan:

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1929 in the sum of $10,580.15.

The sole issue is the deductibility of taxes on personal property claimed to have been paid by him or on his behalf to the State of Ohio.

The facts were stipulated and, so far as material, are substantially as follows:

John Huntington of Cleveland, Ohio, died in 1893, leaving a last will and codicil thereto which were probated in the Probate Court of Cuyahoga County, Ohio, on February 4, 1893, and executors were then appointed and letters testamentary issued. The will and codicil provided for certain specific bequests, the establishment of a museum of art and the disposal of the testator’s property under certain contingencies. The ultimate disposition of the remaining assets of the estate was covered by item 6, paragraph four, as follows:

Fourth: At the death of all my said children and my said wife, I give, devise and bequeath to my grandchildren then living three-fourths of all my said estate in the hands of my said trustee, share and share alike, to them and their heirs and assigns forever; but said three-fourths of my estate so given to them shall remain in the hands of my said trustees, to be held, managed and controlled by them, until the youngest of my grandchildren, living at the time of the death of the last sm-vivor of my said tcife and children, shall arrive at the age of twenty one years, when and at which time my said grandchildren shall come into the possession of the same. In the meantime said trustees shall pay to said grandchildren the entire net income arising from said portion of said estate so given to them, share and share alike, semi-annually or quarterly, in their discretion.
The remaining portion of my said estate in the hands of my said trustees; to wit: One fourth part, at the death of all of my said children and wife, I give, devise and bequeath to the trustees named in Item 5 of this will, of what I have designated as the “John Huntington Art and Polytechnic Trust”, and their successors forever, in trust for the same uses and purposes specified in said item. [Emphasis supplied.]

On March 25,1902, the executors of the estate of John Huntington filed their final report and settlement in the Probate Court, reporting that they had paid all the indebtedness of the estate and had turned over to themselves as testamentary trustees under the will all the remaining property in their hands. On April 5, 1902, the court approved the report and settlement, ratified the actions thereunder and discharged the executors. Thereafter the testamentary trustees held possession of the property under the terms of the will.

The widow of John Huntington died several years before 1928. Hannah Huntington Hord, daughter of the decedent and mother of the petitioner, died many years prior to 1928. After her death the petitioner received the entire income which would have gone to his mother, pursuant to the terms of the will.

The father of Lillian H. Bishop and son of John Huntington died before 1928. After his death his daughter received the entire income which her father would have received.

Margaret Huntington Smith, daughter of the decedent and mother of Margaret H. McCarthy, was the last survivor of wife and children of John Huntington. She died on June 8, 1928. At that time the three grandchildren of John Huntington, Lillian H, Bishop, Margaret H. McCarthy and the petitioner, being all of such grandchildren, were over 21 years of age. The entire property in the hands of the testamentary trustees before and at the time of the death of Margaret Smith consisted only of personal property.

In April 1928 the testamentary trustees appointed under the will of John Huntington duly made a tax return in accordance with the requirements of the statutes of Ohio, showing the trust property at that time in their possession under the terms of the will. No distribution nor disposition of the said personal property was made by the said testamentary trustees during the month of April 1928. The taxes provided for under the laws of Ohio upon the personal property for the year 1928 were assessed and levied upon the property included in the tax return made by the testamentary trustees.

After the death of Margaret Huntington Smith on June 8, 1928, counsel for the testamentary trustees advised that the distribution of the securities which had been held by the testamentary trustees should be delayed for a brief period until it could be determined whether any estate or inheritance taxes might be assessed thereon by any of the various states in which corporations whose securities were held had been organized.

The beneficiaries consented thereto and such investigation was made in at least 20 states, most of them through personal visit, which required until November 1,1928, at which time the said counsel advised that the testamentary trustees could safely proceed with a distribution in kind of the securities, provided a portion thereof could remain subject to the control of the testamentary trustees until such time as all questions as to possible claims against the trust estate of whatsoever nature had been settled.

The beneficiaries consented thereto and thereupon and prior to December 31, 1928, the testamentary trustees arranged to have transferred to the beneficiaries all of the assets of the trust estate. They took from the beneficiaries powers of attorney covering a part of the certificates for stock included among such assets. This part of the certificates of stock, together with certain bonds, was placed with the Guardian Trust Co., of Cleveland, Ohio, under an arrangement whereby the beneficiaries were entitled to received the income thereon unless the income was needed in order to meet claims which might arise. That arrangement was made pursuant to the following authorization by petitioner:

November 1, 1928.
Messrs. Charles W. Bingham,
William B. Sanders,
Samuel Mather and Charles L. Mtjreey,
Trustees of the Estate of John Huntington, deceased,
Cleveland, Ohio.
Dear Sirs : Under even date herewith the undersigned joined with other beneficiaries of the Estate of John Huntington, deceased, in reguesting you to make distribution of said estate as promptly as possible.
In order to clear up all questions as to inheritance or succession taxes substantially at one time, you have been asked to transfer to the beneficiaries, pursuant to an agreement for distribution in kind which they have made, the bulk of the securities constituting the trust estate, upon the understanding that when so transferred a portion thereof shall remain subject to your control until such time as all questions as to possible claims against the lístate, of whatsoever nature, have been settled.
In accordance with this understanding I am delivering to you herewith powers of attorney covering certificates of the shares of stock to which I will become entitled under this division.
If at any time you may deem it necessary or advisable to have additional powers with respect to any or all of such shares and shall notify me thereof, I will promptly execute and deliver them.
I request that as soon as it is possible to determine what, if any, inheritance or succession taxes are payable to various taxing authorities, or if any other claim shall come to your attention which in your opinion cannot fully be met from the “ retained assets ” which you are then holding under the terms of said principal agreement of even date herewith, you notify me or my attorneys thereof. Upon receipt of this information I will promptly advise your attorneys, * * * as to the way in which funds will be provided to meet such taxes or other liabilities.
If at one time or from time to time I shall desire to make use of part of the securities above mentioned in order to obtain a loan thereon for the purpose of meeting such taxes or other liabilities relating to the trust, I understand that you will permit such use providing the amount so to be pledged meets with your approval and the conditions of the pledge or pledges are such as will in your opinion afford you proper opportunity to retain control of the equity in the pledged securities.
It is understood that I may from time to time substitute securities, approved by you or by such officers of The Guardian Trust Company as you may designate, for securities which I may desire to withdraw from this agreement.
If within two (2) weeks from the mailing of your notice as to the amount of any such inheritance or succession taxes, or other liabilities, I shall fail to advise your attorneys as to the way in which funds will be provided, or if, having expressed a desire to arrange a loan, I shall fail to consummate the same within thirty (30) days from the mailing of such notice, or if I shall advise you that it will be my wish to have funds for the payment of these taxes or other liabilities provided from the sale of such of the securities hereinabove mentioned, you are hereby authorized to take such steps as in your judgment rcay be necessary or proper in order to effect a sale which will produce the funds needed.
* * * * * * *
I shall be entitled to receive the income on the securities retained hereunder unless circumstances arise which in your opinion shall make it necessary that this income be conserved in order to make it possible to afford you the protection contemplated. The securities after being transferred to me shall be allowed to stand in my name unless for some reason now unforeseen you shall deem it necessary or advisable to have them placed in the name of an agent or representative.
*******
In view of the fact that a number of years will elapse before all of the matters hereinabove mentioned can finally be closed, I understand that at some time you may wish to vest in The Guardian Trust Company, of Cleveland, Ohio, or in your attorneys, Messrs. Squire, Sanders & Dempsey, authority to act on your behalf or in your stead upon matters requiring the exercise of discretion hereunder. Such a plan will be satisfactory to me.
*******

In June 1929 the petitioner, Lillian H. Bishop, and executors of the estate of Margaret H. McCarthy executed the following request form:

Messrs. Sqijibe, Sanders & Dempsey,
1857 Union Trust Building,
Cleveland, Ohio.
in re: Estate of John Huntington.
Dear Sirs : You are hereby requested, as attorneys for the Trustees of the Estate of John Huntington, deceased, to authorize The Guardian Trust Company to sell the remaining United States Government securities which it is holding under the agreement of indemnity, dated November 1, 1928, and also certain shares of the Youngstown Sheet & Tube Company preferred stock, to provide funds required to pay my portion of the Cuyahoga County Personal Property taxes for the last half of 1928.

The taxes due the State of Ohio upon the personal property included in the return of the testamentary trustees, as hereinabove set forth, during the year 1929 were paid from funds derived from the sale of certain of the securities held by the Guardian Trust Co., such sale and the application of the proceeds derived therefrom to the payment of said taxes being made at the request of the individual beneficiaries in order to pay their respective portions of such taxes. The total amount so paid as taxes was $145,393.59, of which amount $9,094.68 was charged to the trustees of the John Huntington Art and Polytechnic Trust, and of the remainder $45,432.96 was charged to John H. Hord in accounting for the proceeds from the said sale of securities.

The petitioner resided in 1929 at Cleveland, Ohio, and filed his Federal income tax return for the year 1929 with the collector of internal revenue .for the eighteenth collection district of Ohio. In his return he deducted from his gross income the amount of $45,-432.96, claiming that amount to be taxes upon personal property paid by him. The respondent upon audit disallowed the deduction. jSTo claim for such deduction was ever made by the testamentary trustees.

The only question presented is whether or not the petitioner is entitled to deduct county personal property taxes of $45,432.96 on securities paid in 1929. The respondent has disallowed such deduction on the ground that it represents a tax assessed against the John Huntington Estate.” Aside from this assertion of the respondent the record does not disclose in whose name the tax was assessed, but it is inferable that it was assessed against the estate of John Huntington, deceased.

It is obvious that the tax was not intended to be levied against the executors of the estate, who were discharged in 1902, but rather against the testamentary trustees, who actually made the return required by the Ohio statute. That uncertainty, however, is not oí vital importance, since we are concerned with determining who was the real taxpayer and, as such, entitled to the deduction for taxes paid, under the provisions of section 23 (c) of the Revenue Act of 1928.

Petitioner argues that upon the death of the last surviving heir of the former generation on June 8,1928, the trust ceased as a matter of law and he (petitioner) at once came into possession o.f the property. He argues from this that, since taxes do not “ accrue ” in Ohio until October 1 of any year and since he had acquired the property prior to that date, when the taxes accrued they were his liability and not that of the trustees. On these premises he contends that he is entitled to deduct the taxes paid by the trustees and charged to his account in 1929.

It may well be doubted whether, under the stipulated facts, petitioner at any time in 1928 ever had possession of the property. Conceding that he had a right to acquire possession at any time after June 8, 1928, it appears that the property was actually left in the hands of the trustees until after December 31, 1928. The stipulation is that “ prior to December 31, 1928, the testamentary trustees arranged; to have transferred to the beneficiaries all of the assets of the trust estate.” This is not a stipulation that the property was transfered. Moreover, the testamentary trustees were still functioning as such throughout the year 1928. Thus it could only be by applying a doctrine of constructive distribution and constructive possession that it could be held that the taxpayer acquired the property prior to 1929. But as we view the case it is unnecessary to this decision to rule on the question so presented.

We have had the more fundamental question, in its varying forms, on many occasions. The decisions have been uniformly to the effect that the ownership of the property on the date fixed by state law as the date of tax incidence determines the right of a taxpayer to a deduction under the Federal income tax law. The owner on such basic date is entitled to the deduction for taxes paid by him. A subsequent acquisition in the tax year carries with it no right to such a deduction even though the purchaser pay the taxes, See Grand Hotel Co., 21 B. T. A. 890; Leamington Hotel Co., 26 B. T. A. 1004; Texas Coca-Cola Bottling Co., 30 B. T. A. 736; California Sanitary Cog Ltd., 32 B. T. A. 122; American Laundry Machinery Co., 32 B. T. A. 793. Nor is it material that it is impossible on the basic date to fix the precise amount of the tax. United States v. Anderson, 269 U. S. 422.

Our question is thus resolved into a determination of the basic date for tax incidence in Ohio. The law of Ohio as it stood in 1928, section 5366, General Code, was in part as follows:

In order to facilitate the listing of personal property, moneys, credits, investments in bonds, stocks, joint stock companies or otherwise, each person required by law to list the same shall make a return thereof under oath to the county auditor on the second Monday in April, or on or before the first day of May of any year, the same to be made on the blanks prescribed by order of the state tax commission for such purposes, etc.

Section 5372-1 provided:

Listing of property held in trust capacity or fiduciary relationship. — Personal property, moneys, credits, investments in bonds, stocks, joint stock companies, or other wise in the possession or control of a person as parent, guardian, trustee, executor, administrator, assignee, receiver, official custodian, factor, agent, attorney or otherwise, on the day preceding the second Monday of April in any year, on account of any person or persons, company, firm, partnership, association or corporation, shall, except as otherwise provided, be listed by the person having the possession or control thereof and be entered upon the tax lists and duplicate in the name of such parent, guardian, trustee, executor, administrator, assignee, receiver, official custodian, factor, agent, attorney or other person, adding to such name words briefly indicating the capacity in which such person has possession of or otherwise controls property, and the name of the person, estate, firm, company, partnership, association or corporation to whom it belongs; * * *

Section 5671, General Code, provided that the lien of the state for taxes should attach to all real property subject to such taxes on the day preceding the second Monday of April. It provided further that “ all personal property subject to taxation shall be liable to be seized and sold for taxes.” Section 2583, General Code, provided for a tabulation of such listed property by the county auditor, with description thereof. Section 2585 provided that, after being officially advised of the amount of taxes to be levied, the county auditor should determine the amount to be levied on each tract of land and against the personal property listed. Section 2475 provided that on or before October 1 of each year the county auditor should deliver to the county treasurer (the tax-collecting officer) a duplicate of the tax list.

Conforming to the law of Ohio, the testamentary trustees returned the property in question for taxation in April. At that time they unquestionably held the property in their capacity as trustees and were liable for taxes thereon. The question arises whether anything that occurred subsequently could cause the tax burden on such property to shift to another. We believe not. As we view the Ohio law, the purpose is to impose a tax on the owner of property on the day preceding the second Monday in April. Shotwell v. Moore, 129 U. S. 590 (an Ohio case). As to real estate, this is made doubly certain by the provision that the tax lien shall be effective from the day preceding the first day for listing. Moreover, the Ohio Supreme Court has held that the assessment when later made as required by law dates back to the date when the lien became effective. State ex rel. Donahey v. Rose, 90 Ohio St. 345; 107 N. E. 760. We see no basis in principle for a holding that the Ohio law contemplated the taxing of the owner of real estate as of the April date but that as to personal property the tax applied as of the later date when the amount of the tax was determined or became due and payable. It has often been said that taxation is a practical matter. It is equally true that taxation should be administered with a view to consistency of treatment. We believe that under Ohio law as it stood in 1928 the ownership of personal property on the day preceding the second Monday of April fixes the tax incidence for the year and that such incidence was not subject to the uncertainty of subsequent transfer of the property.

It may be observed in passing that by amendment of the Ohio General Code, effective June 27,1931, “ * * * all taxable property shall be listed with respect to ownership or control, valuation and taxing districts as of the beginning of the first day of January annually * * *.” One half of the tax is payable at the time the return is filed and the balance on September 20. (Secs. 2656 and 5671-1, General Code.)

Our conclusion is that the taxes for 1928 were the taxes of the trustees who listed the property and were not deductible by petitioner.

Reviewed by the Board.

Decision will ~be entered for the respondent.

       SBC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (c) Tdwes generally. — Taxes' paid or accrued within the taxable year except * * *.


author: Sea well :

text:
    The Security Central National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73554.
    Promulgated October 31, 1935.

      H. Glerm Duds, Esq., and Jesse Knapp, O. P. A., for the petitioner.

      Philip M. Clark, Esq., for the respondent.
   OPINION.

Sea well :

Evidence was offered by the petitioner to prove that it sustained a loss of $42,379.79 under the Security Bank trust and a joint loss of $40,386.89 under both trusts. It also sought to prove that, in the alternative, it is entitled to a deduction of $41,388.32, the face amount of the notes substituted for cash and good assets, for bad debts. We have determined the gross income and deductions, including losses and bad debts, of the Central Bank trust to be the amounts claimed by the petitioner. No similar findings are necessary respecting the Security Bank trust under the view we take of the issue presented for decision.

Among the points relied upon by the petitioner to support its claims are that it is the grantor of both trusts; that the trusts are not separate taxable entities from it; that the withdrawn assets constitute reserves for bad debts; and that the cash and notes transferred to it by the trustees in exchange for worthless notes and notes of doubtful value were additional contributions to capital. The respondent’s position is that the petitioner as it has existed since the merger never acquired title to the withdrawn assets conveyed to the two groups of trustees, and that the loss, if any, was sustained by the certificate holders, not the petitioner.

The question in the final analysis turns upon whether the petitioner created both trusts and whether the “ merging ” banks are the same taxable entity. Obviously, if the petitioner was not the grantor of the trust created to liquidate withdrawn assets of the Security Bank, the state bank, or is a taxpayer separate from that association, it is not entitled to deduct any of the state bank’s losses or bad debts.

The objective of the merger was to increase the combined capital, surplus, and undivided profits of the petitioner under its present name to $1,100,000 by contributions of sound assets, two fifths by the shareholders of petitioner and three fifths by the shareholders of the state bank, secured for a period of two years to the extent of withheld assets conveyed in trust by the respective banks for that, purpose. The burden of proving the date of transfer of assets to the trustees was on the petitioner. It did not attempt to prove the point by testimony and such evidence as there is in the record indicates that the assignments were made prior to the effective date of the merger.

The “ agreement. of consolidation ” executed December 4, 1929, specifically provided for the transfer by each “ merging ” bank to trustees, in trust, “ before the effective date of the consolidation ”, of assets not contributed in the merger. The merger occurred February 1, 1930, but there is testimony that the assets and books of the banks were not consolidated until February 5, 1930. The trust agreements were executed in January 1929, and recited provisions in the “ agreement of consolidation ” for the transfer of withheld assets to trustees before the merger was effected. The inference to be drawn from the fact that the capital, surplus, and undivided profits of the bank resulting from the merger were to aggregate $1,100,000, no more or less, is that the assets unnecessary to make up such an amount were not to be taken into the merger. The transaction contemplated the transfer of the withheld assets to trustees prior to the date of merger and, in the absence of proof to the contrary, we must assume that the intention of the banks was carried out.

One of the requisites for the creation of an enforceable trust is an interest in property. The petitioner never acquired legal title to the withheld assets of the state bank and accordingly had none when the trust was created. Its interest in the property was limited to the right to substitute worthless assets contributed by the state bank for property held by its trustees. We hold that the petitioner was not the grantor of the trust established by a conveyance of withheld assets of the state bank.

The merger here was effected under the provisions of an amendment enacted February 25, 1927, to the National Banking Act. 44 Stat. 1225. Prior to the enactment of the amendment no authority existed for the union of state banks with national banks. McRoberts v. Menier, 270 Ill. App. 1. The amendment provides that upon such a “ consolidation ” “All the rights, franchises, and interests of each of such constituent banks * * * in and to every species of property * * * thereto belonging, shall be deemed to be transferred to and rest in such consolidated national banking association without any deed or other transfer” and that “No such consolidation shall be in contravention of the law of the State under which said bank is incorporated.”

The amendment has been interpreted by the courts on several occasions. In Ex Parte Worcester County National Bank, 279 U. S. 347, a Massachusetts trust company had been executor of an estate prior to its merger with a national bank, and the surviving bank claimed that it became executor by operation of the merger. At the time of the merger a statute of Massachusetts provided that upon the merger of a trust company with another bank its charter “ shall be void except for the purpose of discharging existing obligations and liabilities.” In denying the claim the Court agreed with the conclusion of the state court that the word “ franchise ” appearing in the amendment did not mean the charter of the trust company; that the trust company had gone out of existence and that the national bank “ was not a newly-created organization, but an enlargement of the continuously existing national bank.” The Court further construed the effect of the amendment in Massachusetts “ to be only to transfer the property and estate from the trust company to the national bank, to be managed and preserved as the state law provides, for administration of estates.”

In Commonwealth v. First Nat. Bank & Trust Co. of Easton, 303 Pa. 241; 154 Atl. 379, a trust company of Pennsylvania merged under the charter of a national bank. At the time the merger took place there was no law in Pennsylvania preventing the merger or recognizing that such a merger operated to dissolve the state bank. The national bank contended that the contract of “ consolidation ” and provisions of the amendment to the National Banking Act extinguished the trust company. The court held that the merger did not extinguish the charter of or dissolve the trust company, and directed that a decree of dissolution be entered in the proceeding. Other decisions are to the same effect. Stevens v. First National Bank & Trust Co., 160 S. E. 243; 173 Ga. 332; Hofheimer v. Seaboard Citizens National Bank of Norfolk, 154 Va. 392; 153 S. E. 656; affd., 154 Va. 896; 156 S. E. 581; certiorari denied, 283 U. S. 855. Cf. Adams v. Atlantic National Bank of Jacksonville, 155 So. (Fla.) 648; Bayer v. Barrett, 71 Cal. App. 620; 15 Pac. (2d) 801.

An examination of the statutes of Ohio in effect when the merger here was accomplished discloses no law forbidding or authorizing the merging of Ohio banks with national banking associations. There are state laws defining the rights and powers of local banks united by merger. None of these recognize a continuation of the corporate identity of the merging bank in the surviving bank. See sec. 710-87, 88, Page’s Annotated Code of Ohio. Furthermore, they contemplate the consolidation of all of the assets of the merging banks. Here by express agreement the state bank withheld a portion of its property from the merger.

We conclude that the merger did not work a dissolution of the state bank; that the existence of the state bank was not continued in the petitioner; and that the petitioner was not the grantor of the trust to which the state bank’s withheld assets were transferred. From these conclusions it follows that the petitioner, being a taxpayer separate and distinct from the state bank, is not entitled to loss or bad debt deductions of the state bank or of the trust created by it. It was fully reimbursed for such of the contributed assets of the state bank as became worthless during the taxable year.

It is unnecessary to decide the status of the petitioner after the merger; that is, whether it is a new corporation or whether its corporate identity continued without any break. See Northwest Bancorporation, 38 B. T. A. 160. The operations of the trust created by the Central National Bank resulted in net income of $1,992.90; consequently, there is no loss to deduct from gross income of the petitioner, irrespective of whether it is the same or a different taxpayer from the Central National Bank. It was fully reimbursed for its bad debts and there is nothing to deduct for debts ascertained to be worthless and charged off during the taxable year.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Murdock :

text:
    Edward G. Swartz, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56634.
    Promulgated October 31, 1935.

      doseph K. Moyer, 'Esq., Craig L. Reddish, Esq., and Wilmer D. ZirMe, C. P. A., for the petitioner.

      L. B. RushbroóJe, Esq., and Bruee A. Low, Esq., for the respondent.
   OPINION.

Murdock :

The evidence shows quite clearly that gains or profits of the petitioner were permitted to accumulate beyond the reasonable needs of the business and that this situation existed in the taxable year. The principal business of the petitioner, from the time of its incorporation up to and through the year 1927, was to receive the payments due from the Cypress Co. under contract of August 25, 1919. That business was almost completed. As a matter of fact, Swartz received those payments as well as all other amounts due the petitioner and made all disbursements on behalf of the petitioner. Later, some bookkeeping entries were made to record these transactions as transactions of the petitioner. The petitioner had no other business in 1927 which required the accumulation of any gains or profits. The capital, including paid-in surplus, of the petitioner consisted of the property which Swartz put into it, i. e., $25,000 of stock and the contract with the Cypress Co. The latter was an exhausting asset having a basis to the petitioner of $524,778.56. The timber had all been cut and the petitioner had recovered through deductions for exhaustion of the contract the entire basis prior to 1927. The stock of $25,000 was still on hand in 1927. Thus in 1927 the petitioner had its entire capital available for any needs of its business. Not only was its capital ample for the reasonable needs of the business of the petitioner in 1927, but, so far as this record shows, that amount exceeded the reasonable needs of all business in which the petitioner was then engaged. Furthermore, its capital would have been ample for all reasonable needs of the petitioner’s business, even if that business were to include the making of all additional investments which Swartz was then considering. As a matter of fact, by far the larger part of the petitioner’s capital was uninvested in 1927. These funds were being used by Swartz individually without the payment of interest and were represented by an account receivable from Swartz. Even if the funds had been fully invested by the petitioner, that fact would not show that gains had not been permitted to accumulate beyond the reasonable needs of the business. A mere intention. to make some further investments is of less importance. In addition to its capital the petitioner also had on hand during all of 1927 a very substantial accumulation of gains and profits. This earned surplus amounted to $269,017 at the beginning of the year and $368,803.84 at the end of the year. These were real earnings accumulated in excess of the tax-free recovery of the correct basis for the contract. No part of this accumulation of gains and profits was reasonably needed in the business of the petitioner in 1927. Section 220 (b) makes this fact prima facie evidence of a purpose to escape the tax. Furthermore, the Commissioner has determined that the corporation was formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. His determination is presumed to be correct and the deficiency must be approved unless the petitioner has shown affirmatively by the evidence that it was neither formed nor availed of for the purpose mentioned in section 220. Purpose is not easy to determine.

Swartz was really the only stockholder in the petitioner and counsel for the petitioner has made a strenuous effort to show that Swartz had no purpose in 1927 to avail of the petitioner in order to prevent the imposition of surtax upon himself through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. Swartz specifically testified that he never had had any such purpose. Counsel for the petitioner argues that the truth of that statement is demonstrated in other ways. His contention is that Swartz believed in 1927 that all of the gains and profits of the petitioner had been distributed and it did not have on hand any accumulation of gains or profits from which to declare any further dividends. He argues that Swartz was of the opinion in 1927 that the petitioner was entitled to use as a basis for exhaustion of the contract the fair market value of the contract at the time it was entered into; Swartz believed in 1927 that that fair market value was about $1,000,000; the corporation had received up to 1927 about $1,500,000 under the contract and had paid out about $500,000 to Swartz in dividends; Swartz believed in 1927 that the corporation had no earnings available for dividends; thus Swartz in 1927 did not believe that he was using the petitioner to prevent the imposition of surtaxes on himself, which demonstrates that he had no purpose at that time to avail of the petitioner to prevent the imposition of surtaxes on himself by permitting the petitioner to accumulate its, earnings.

Counsel for the petitioner now concedes that the basis for exhaustion of the contract in the hands of the petitioner was not $1,000,000, was not the fair market value of the contract at the time it was entered into, but was $524,778.56 (the fair market value on March 1, 1913, of the properties acquired by Swartz prior to that date plus the cost of the properties acquired by him after that date, less the exhaustion prior to the effective date of the incorporation). He further concedes that the petitioner had in 1927 an accumulation of gains and profits. He makes these concessions in view of the decision of the Board in the case of this same petitioner relating to the year 1926. The opinion of the Board in that case is reported at 25 B. T. A. 1065. The Board’s decision was affirmed. See 69 Fed. (2d) 633. Counsel argues, however, that in 1927 Swartz believed to the contrary, his belief was not an unreasonable one, and his error was not demonstrated until long afterwards when the opinion of the Board was promulgated on April 6, 1932, and the opinion of the appellate court was promulgated on March 15, 1934. He says that the fact that Swartz really had such opinions in 1927 is shown by the appeal for 1926 and by the vigor and persistence with which that appeal was prosecuted. Swartz testified that the corporation received about a million and a half under the contract and, in his opinion, about $500,000 of that amount was profit and the balance was the value of the contract, and he also testified that he thought there were no accumulated profits from which to declare a dividend in 1927. Thus, although much support for the above argument can be drawn from Swartz’s testimony, nevertheless a number of his statements are not convincing when examined in the light of other evidence in the case.

Swartz discussed with two accountants the question of whether or not a dividend should be declared in 1927. Those three persons testified in this case in regard to their recollections of those discussions. Although Swartz has testified that he believed in 1927 that the petitioner had no accumulation of profits from which a dividend could be declared in 1927, yet the testimony of the two accountants indicates that they knew that the corporation had accumulated earnings from which a dividend could be declared. Neither accountant, in assigning reasons for the failure to declare a dividend in 1927, mentioned the lack of accumulated earnings. Each assigned other reasons for the decision to declare no dividends in that year.

The corporation in its income tax returns never claimed exhaustion of the contract on the basis of the fair market value of the contract at the time it was entered into. It never claimed that the proper basis was as large as $1,000,000. Instead, it claimed deductions on a much smaller basis. Originally, it claimed deductions on the basis of the cost of the various properties to Swartz. Later it claimed the right to use the somewhat larger figure representing the fair market value on March 1,1913, of those portions of the property acquired prior to that date. The original petition in the prior proceeding relating to the year 1926 was filed on March 22, 1928. The petitioner there made no contention that it was entitled to use as a basis the value of the contract either at the time it was entered into by Swartz or at the time it was received by the petitioner. Its only contention in regard to the basis for exhaustion of the contract was that it was entitled to use $137,000, representing the fair market value of some of the timber on March 1, 1913. An amended petition was filed in the latter part of November 1929, wherein for the first time the petitioner contended that it was entitled to use as a basis for exhaustion of the contract' the fair market value of the contract at the time it was entered into by Swartz. Thus it appears that between March 22, 1928, when the original petition in that proceeding was filed, and November 1929, some one, interested in the petitioner, for the first time formed the opinion that it might claim as a basis for exhaustion of the contract an amount in excess of the figure theretofore used.

If Swartz had actually believed in 1927 that the correct basis for exhaustion of the contract in the hands of the petitioner was larger than $599,513.58, or $524,778.56, he and his accountants were sufficiently tax-conscious that they undoubtedly would have discussed that matter and would have indicated his belief in making out the return for 1926, in the negotiations and communications with the Bureau of Internal Revenue relating to the 1926 tax liability, in the original petition filed with the Board for that year, or in the records of the petitioner. Yet neither Swartz nor the accountants mentioned having discussed the matter, none of the returns reflect such a belief, and the first indication that any such belief was entertained by any one on behalf of the petitioner is in the amended petition filed in November 1929, long after the taxable year 1927. Changes were made in the books of the petitioner at some time after 1926 (the exact time is not disclosed in this record), to make the books conform with the final determination of the Commissioner of Internal Revenue for the years 1921 to 1924 and to show a consistent procedure for the years 1925 and 1926. Apparently these changes included an increase in the basis from cost to show a slight increase due to the use of the March 1, 1913, value. But a larger basis was never used in those books.

The other arguments of the petitioner to show a lack of purpose in 1927 to avail of the corporation to escape tax are not persuasive. All of the evidence has been carefully considered, but it does not fairly preponderate in favor of the petitioner. The presumption of correctness attaching to the Commissioner’s determination and the prima facie evidence of purpose which must be taken from th'e fact that the gains and profits of the petitioner were permitted to accumulate beyond the reasonable needs of the business have not been overcome.

Reviewed by the Board.

Decision, will be entered for the respondent.


author: Seawell; Van Fossan,

text:
    The Brush-Moore Newspapers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73673.
    Promulgated November 1, 1935.

      William H. Vodrey, Esq., and. William E. Vodrey, Jr., Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Seawell;

We will consider the two questions presented in their order.

Payments to Warren G. Harding estate. — Petitioner contends that these payments are deductible as ordinary and necessary expense of the Harding Publishing Co., its wholly owned subsidiary, under section 23 (a), Revenue Act of 1928. It is not claimed that they are deductible as salary paid to President Harding for personal services actually rendered by him. Fifteenth & Chestnut Realty Co., 29 B. T. A. 1030. The claim is that the contract under which the expenditures were made was entered into by way of compromise to buy the peace of the Harding Publishing Co. and to save it from threatened litigation which might have caused damage to or loss of good will and the circulation of its newspaper.

The respondent contends that the payments were not ordinary and necessary business expense, that they were rather to be characterized as capital expenditures for the acquisition of the Harding Publishing Co. stock, or gratuities to enable Brush and. Moore to obtain the stock; and, in any event, they are not deductible from gross income of petitioner in computing its income taxes.

The fact that the payments were made by way of compromise of a supposed doubtful liability under the old contract is, we think, immaterial. It was said in Colony Coal & Coke Corporation v. Commissioner, 52 Fed. (2d) 923, that “ The fact that a payment is made voluntarily or involuntarily, in the course of legal proceedings or as a result of a compromise settlement, does not change the nature of the transaction. The real test is the character of the transaction that occasions the payment.”

The history of negotiations leading up to the old contract executed June 18, 1923, shows that the purchasers (Brush and Moore) offered to pay the vendor (President Harding) $500 per share for his 605 shares of .stock of the Harding Publishing Co., but, as the minority stockholders had been offered $600 a share for their stock, President Harding required payment at the same rate for his. The agreement to pay $600 a share for the 605 shares was arrived at when Brush and Moore and President Harding conceived the plan for President Harding to become a contributing editor of the Marion Star when he should retire from the White House to his Ohio farm. This provision was in substance incorporated as article fifth of the contract. Subsection (c) in that article provides, in effect, that death of President Harding should not decrease the amount to be paid by the purchasers. President Harding died before any services as contributing editor were or could have been performed. Subsection (c) goes far to establish the contention of respondent that what the purchasers bought was not the contract for services as contributing editor to the Marion Star, but the 605 shares of stock of the Harding Publishing Co. owned by President Harding. The fact that a separate contract for services had not been written as was provided for does not alter the situation, as all the terms of such contract were embodied in the main contract of June 18, 1923. President Harding’s writings would doubtless have been very valuable to the purchasers of the newspaper property if he had lived. He himself expressed the desire to have the facility of the paper for his own use in making public his views on matters of interest after he left the White House, but this matter was a mere incident in the transaction. The real transaction was the sale of the stock, the consideration for which included the payments under the so-called employment contract. The contract price for the full 800 shares of the stock was $480,000. The old contract, providing for the sale and purchase of the stock and the performance of service as contributing editor, was an indivisible contract. The further fact remains that if the ten yearly payments of $13,300 were not to be included in the price of the stock the average price for the Harding stock would have amounted to less than $435 per share, or $65 less per share than the purchasers at first offered to pay and $165 less per share than Brush testified they were to pay for the stock under the contract.

After the death of President Harding, and on December 8, 1923, Brush and Moore each signed a contract guaranteeing the payments of $13,300 per year for ten years in accordance with the provisions of article fifth of the contract of June 18, 1923 (the old contract), in which contract it is recited with reference to the said payments, “ the same being part of the original purchase price of the-said six hundred and five (605) shares of stock in the Harding Publishing Company purchased under said agreement ” (of June 18, 1923, the old contract). If this statement is true the expenditures were for a capital asset and not deductible. Warren Steam Pump Co., 13 B. T. A. 721. But petitioner in its brief now says that these payments were not made “ as part of the purchase price for the shares in The Harding Publishing Company owned by President Harding.” It is admitted in the brief though that that statement and the statement in the contract of December 8, 1923, are inconsistent. The fact that the words quoted from the contract were placed therein by the attorney for the Harding-family, as contended, could not render them nugatory. Even though they do not now represent the views of Brush and Moore, as they testified, they can not be removed to accommodate their present views. No evidence was offered to show any undue influence, coercion, fraud, or incapacity of the makers of the contract or any wrongdoing in the inclusion of said words in the contract or any reason sufficient to remove or rescind them. They harmonize and accord with the whole evidence of the case. Greene & Greene, 11 B. T. A. 643.

The facts of this case differentiate it from the line of cases cited in petitioner’s brief, all of which we have reviewed with care. Upon the conclusion we have reached, that the payments sought to be deducted were made as part purchase of the corporate stock owned by President Harding, it follows that they are not deductible as ordinary and necessary expenses of the business of petitioner. The evidence offered fails to convince us that in any other way the payments are deductible. Burnet v. Houston, 283 U. S. 223. We sustain the Commissioner on this point.

Contributions to charitable organizations. — Petitioner claims that it and its subsidiaries made contributions to various charitable and related agencies and that its.payments .therefore are deductible, under section 23 (a) of the Revenue Act of 1928, as ordinary and necessary expenses. It relies on the case of Evening Star Newspaper Co., 28 B. T. A. 762.

The decision in the Evening Stew case, however, was reversed cm June 10, 1935 (after petitioner’s brief was filed), by the United States Circuit Court of Appeals for the Fourth Circuit, 78 Fed. (2d) 604-, and the court said:

The taxpayer contends the contributions were, a “ consideration for a benefit flowing' directly to the donor as an incident of its business.” The manager and the associate editor in substance stated that they do not know whether the Star sold any more papers because of its support of the Community Chest; nor do they have definite information as to how much advertising resulted from the contribution; but, while they have no way of showing, they think definitely the result was a larger sale of papers; the prestige of the paper was enhanced and, having urged others to give until it hurt, its prestige would have suffered if it had not contributed in a liberal- manner.
Whether .the contributions resulted in 'an increase in the circulation or advertising of the Star, and, if any, to what extent, is of necessity, mere conjecture. The evidence falls far short of establishing either proposition. If any benefit, in either respect, did' accrue, it is so indirect and remote that it can not rise to the dignity of being substantial, nor warrant a finding that the donations involved were, in a genuine sense,, necessary and ordinary expenses within the meaning of section 23 of the Revenue Act of 1928, or of the Treasury Regulations 74. It is riot enough that the expense be necessary; it must be ordinary and necessary. Welch v. Helvering supra.].
The facts in. the case at bar are quite similar to those in the Evening Star case. Roy D. Moore, vice president and general manager of the petitioner, could not distinguish between contributions made “ for charity’s sake ” and those made for the benefit of circu-látion and advertisement. The petitioner' has failed to show any specific benefit, actual or potential, arising from its contributions. We are unable to* find that the donations made by the petitioner were made for business reasons and were cálculated to produce a commensurate return. We sustain the Commissioner on this issue.

Reviewed by the Board.

Decision will be entered under Rule 50.

Van Fossan,

dissenting: I am obliged.to dissent from the ruling of the majority. . The facts of the case show clearly that the payment were not made under the provisions of the original contract, but arose solely from the subsequent agreement. The record, also proves beyond any doubt tbat the motivating cause which resulted in this contract — the cause, except for which the contract of December 8, 1928, would never have come into existence — was the threat of a lawsuit with possibly damaging consequences to the business' of petitioner.

The fallacy in the reasoning of the majority opinion is the assumption, for which I can find no foundation in fact, that the payments made under the second contract were in part payment for the stock. Petitioner’s subsidiary received nothing in the way of a capital asset as a result of the payments. It already had the stock. President Harding was dead and his services as an associate editor were not available. The only thing received, .and it .was the thing purchased, was the assurance- that- petitioner’s subsidiary would not be injured in its business by a lawsuit. ' -

Had President Harding lived and the supplemental contract originally contemplated been executed, can it be doubted these annual payments would have constituted income to him, or, to state it conversely, in that event, could it successfully have been contended that such payments were in part, payment for the stock? A reading of the contract entirely negatives such a suggestion. The original contract contemplated two things — the purchase of the stock and the acquisition of the services of President Harding as an associate editor, the latter to be the subject of a supplemental agreement. President Harding died and the supplemental contract for services became impossible of execution. Thus, the original contract became a contract for the purchase of the stock only. The majority opinion says this contract was indivisible. It was nevertheless complete, although by subsequent events it became impossible of fulfillment in part. It seems to me to- be pure fiction to say that the' payments in question were part of the original purchase price of the stock.

The record, when read in its entirety, effectively refutes and explains the implications of the clause added at the insistence of-the attorney for the estate. The reason for such insistence on his part is obvious. By characterizing the payments as part of the purchase price of the stock, his client might avoid the income tax that would otherwise attach to the receipt of the payments.

Tax liability should be determined by considering the entire record, not on the basis of the single fact just alluded to and thus readily explained.

On the facts before us it is clear that the circumstance which compelled the petitioner’s subsidiary and officers to agree to the terms imposed by the settlement of December 8 was the threat of an attack on its standing and reputation in the community .of Marion. The majority opinion rightly suggests that the successful operation of a newspaper is singularly dependent upon the good will and favor of its readers and of the community. Particularly is this true when it is owned by nonresidents. We may well conclude that a suit brought by the widow of a President in his own home town, and the controversial issues raised thereby and exposed to public view for discussion and possible condemnation, might have injured severely the petitioner’s reputation and might have had a disastrous effect on its business. Petitioner was fully justified in considering the execution of the settlement agreement compulsory and the payments made thereunder to be necessary.

In Welch v. Helvering, 290 U. S. 111, Justice Cardozo said:

* * * Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack. Cf. Kornhauser v. United States, 276 U. S. 145, 72 L. ed. 505, 48 S. Ct. 219. * * *

In Helvering v. Community Bond & Mortgage Corporation, 74 Fed. (2d) 272, affirming 27 B. T. A. 480, the situation was quite similar to that in the case at bar. There, an expenditure was made to cancel an agreement with an agent whose activities were causing damage to the taxpayer’s reputation. In allowing the deduction the court said:

* * * It is not an unusual occurrence of business for a business enterprise, burdened with an unprofitable contract, to secure its cancellation by payment of money, and it is difficult to see why an expense thus incurred is not an “ ordinary and necessary expense according to the ways of conduct and forms of speech prevailing in the business world.” Welch v. Helvering [supra].
* * * The money paid in the instant case was to save the reputation of the respondent, to make possible its future earnings. * * * In the instant case, the taxpayer’s reputation was being injured by the conduct of its agent, and its primary motive in seeking the cancellation of the contract was to prevent the loss of earnings. Its contract with the agency proved to be unprofitable. This we think was an expenditure ordinary and necessary in carrying on the business, and deductible from the respondent’s gross income.

I am of the opinion that the money expended to prevent an event which would impair, or might even destroy, the petitioner’s most valuable asset, its reputation and standing in the community, is deductible as an ordinary and necessary expense. The Board has so held in numerous cases. See North American Investment Co., 24 B. T. A. 419; W. R. Hervey, 25 B. T. A. 1282, and cases therein cited, See also Louisiana Jockey Club, Inc., 13 B. T. A. 752.

Trammell agrees with this dissent.


author: Matthews:

text:
    William H. Albers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74759.
    Promulgated November 6, 1935.

      O. J. McGuire, Esq., W. O. Magathan, Esq., and 8. Lester McOor-mich, Esq., for the petitioner.

      F. D. Strader, Esq., and F. 8. Gettle, Esq., for the respondent.
   OITNIOir.

Matthews:

The issues presented herein will be discussed in the inverse order in which they are set out above.

The respondent’s disallowance of the deduction claimed by the petitioner on account of contributions made by him in the taxable year was predicated on the premise that such deduction should be limited to 15 percent of the ordinary net income, excluding capital net gains. This question of law has been decided adversely to the respondent’s contention by the Supreme Court of the United States in Helvering v. Bliss, 293 U. S. 144, affirming 68 Fed. (2d) 890, and we accordingly hold in favor of the petitioner on this issue.

With respect to the sale by the petitioner to Alberly, Inc., of 11,800 shares of stock of the A. Nash Co., the respondent admits the apparent regularity thereof but argues that the sale was not a bona fide transaction made at arm’s length. The petitioner was the president of Alberly, Inc., and owned 84 percent of its entire capital stock, the balance being owned by his wife and his brother. Petitioner frankly testified at the hearing that one of his motives for making this sale was to enable him to take a deduction from income for 1980. But the fact that the stock was transferred to the corporation which the petitioner controlled for the avowed purpose of reducing his income tax did not invalidate the transaction when the price received was equal to what could have been obtained from others. Commissioner v. Hale, 67 Fed. (2d) 561.

The petitioner herein is claiming a loss on the sale of stock of the A. Nash Co. in the amount of $668,234, representing the difference between the cost to him in 1929, when he bought the stock on the open market for $1,612,234, and the total sale price of $994,000. It is important to note that this stock was sold by the petitioner on December 31, 1930, at $80 per share, which price represented its fair market price on that date. The petitioner completely dispossessed himself of the stock. He did not receive any cash, but he did receive full and adequate consideration. An entry was made on the books of Alberly, Inc., crediting his account in the amount of $438,245, which wiped out petitioner’s outstanding indebtedness to the corporation, and notes were executed by the corporation for the balance of the purchase price, which notes were given to the petitioner and substituted for his personal notes to secure loans previously obtained by him in the total amount of $505,000. The corporation’s purchase of the stock was authorized by formal directorate action. The corporation has continued to own the stock and has pledged it as collateral against a loan to the corporation.

Under these circumstances we hold that the sale was bona fide and, inasmuch as the price received by the petitioner was neither more nor less than the fair market value of the stock at the time, we are of the opinion that the petitioner is entitled to the deduction claimed by him on this transaction.

A different situation is presented with respect to the sale of 18,652 shares of stock of the Kroger Grocery & Baking Co. These shares had been purchased by Alberly, Inc., in 1928 at a cost of $1,105,284.56, and since October 27,1928, they had been held as collateral to secure the petitioner’s personal trading account with Lehman Brothers. On May 2, 1930, Lehman Brothers sold these shares on the open market for the petitioner’s account for $602,646112. Petitioner maintains that he sustained a loss of $502,638.44, representing the difference between the sale price of $602,646.12 and $1,105,284.56, which was the cost of the stock to Alberly, Inc., it being the petitioner’s position that he took over the stock on April 15, 1930, at the same figure at which the stock had been purchased by Alberly, Inc. In the alternative, it is claimed by the petitioner that he is entitled to a deduction of $143,433.88, representing the difference between the price at which the stock was sold and the fair market value thereof on April 15,1930, which was $746,080.

We are of the opinion that the petitioner is not entitled to any deduction on account of this transaction and we sustain the respondent’s action on this point. There is no evidence of any sale of this block of the Kroger stock to the petitioner. This stock was among the securities purchased by Alberly, Inc., in 1928, shortly after this company was organized by the petitioner, and was promptly loaned to the petitioner as “ a considerable favor to him ”, on condition that the stock would be returned “ as soon as the loan had served its purpose.” The petitioner pledged the stock as collateral security for his personal trading account. In April 1930, after the market had declined sharply and he was being pressed to liquidate his account with Lehman Brothers, the petitioner told his secretary that he would have to “ take over ” the stock which was owned by Alberly, Inc., in order to settle the claim of Lehman Brothers against him personally. The petitioner has taken April 15, 1930, as the date he made the decision to acquire this stock, and on that date the fair market value of the Kroger stock was approximately $40 per share. The petitioner testified that it was because he did not wish Alberly, Inc., to sustain a loss that he determined to pay $60 per share for the Kroger stock which he had borrowed from Alberly, Inc. It was admitted by the petitioner that he was under no obligation to buy this stock and that it was merely a personal feeling that he should assume the loss occasioned by the sale of this stock on the open market under date of May 2, 1930, when it brought only approximately $32.50 per share. The stock was never transferred to the petitioner on the books of the Kroger Grocery & Baking Co. No entry was made on the books of Alberly, Inc., with respect to the price at which this stock was taken over by petitioner until after the stock was sold by the brokers on May 2,1930. The entry was made as of April 15,1930, and the price was listed at $60, though the stock was worth only $40 on that date. The petitioner testified that on any date from October 27, 1928, when he borrowed the stock from Alberly, Inc., until April 15, 1930, when he decided to take it over, he could have had appropriate entries made on the books to show that he was the owner of the stock. When the stock was loaned to the petitioner he became a gratuitous bailee and his only agreement was to return the stock. The sale of the stock for his personal account amounted to a conversion and the measure of damages therefor is the value of the stock at the time the conversion took place. 6 C. J. 1164; Hubbell v. Blandy, 87 Mich. 209; 49 N. W. 502. The stock having been sold in the open market on May 2, 1930, for $602,646.12, which amount represented its fair market value on that date, the petitioner was under obligation to turn over this sum to Alberly, Inc. There is nothing to show that Alberly, Inc., was entitled to a greater amount. Under these circumstances, we hold that the petitioner never purchased the Kroger stock from Alberly, Inc., and, since he did not owe the corporation any more than he received when the stock was sold, no loss was sustained by the petitioner on account of this sale. Cf. Fremont C. Peck et al., Executors, 31 B. T. A. 87; and Frank Kell, 31 B. T. A. 212.

Judgment will be entered under Rule 50.