author: Leech:

text:
    Terre Haute Electric Company, Inc. (Formerly Terre Haute Traction and Light Company), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43767, 68897, 77066.
    Promulgated January 24, 1936.

      A. E. James, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   OPINION.

Leech:

The first issue is whether dividends paid by the lessee of petitioner’s property, directly, to the latter’s stockholders constitute rental income to petitioner. These payments, made in the three years here involved, were reported by petitioner, as income, on its returns filed for those years. Similar amounts were also reported, by petitioner as dividends paid. It now claims the inclusion of these amounts in its income for these years was erroneous because, under the facts existing, they did not represent income received by it.

Article 16 of the lease of March 25, 1907, provides that, in consideration for the use of the leased property the lessee will pay, “as rental”, the interest upon the bonded indebtedness of the lessor and, as “additional rental”, a sum “equal to three per cent, on the par value of the then outstanding preferred stock of the Lessor * * * and * * * a sum equal to two and one-half per cent., or $50,000, on the par value of said common capital stock of the Lessor.” (Emphasis supplied.) It further provided that the payments in question:

* * * shall be paid io the Lessor as folloivs: Ten (10) or more days before any such payment becomes due the Lessor shall declare a dividend of an amount equal to said payment to the holders of the shares of its common and preferred capital stock, and the Lessee, as agent of the Lessor, shall pay the amounts of such dividends thus declared to such persons and in such amounts to each as shall be certified to the Lessee under oath by the treasurer of the Lessor at least ten (10) days before the sum to be paid becomes due and payable, as entitled to receive the same on the day the same becomes due and payable by virtue of their respective holdings of the common and preferred capital stock of the Lessor. The Lessor, in the interest and for the benefit of the holders of its stock, being all of its common and preferred shares, hereby requests and directs the Lessee thus to pay for the benefit of the Lessor said sums of money, the payments of which are provided for in said subdivisions (a) and (b) of paragraph 2 of this article, directly to the holders of said common and preferred shares respectively, in such amounts to each as shall be certified to the Lessee under oath by the Treasurer of the I/essor at ¡east ten days before the sums to be paid under said subdivisions (a) and (b) o-f paragraph 2 of this article become due, and to accept the receipts of the persons to whom such payments shall be made in lieu of the receipt of the Lessor therefor, with the same effect as if such payments had been made to the Lessor and receipted for by it; and the Lessee, in pursuance of said request and direction, hereby agrees that it will make said payment of said sums, the payments of which are provided for in said subdivisions (a) and (b) of paragraph 2 of this article^ to said shareholders certified to it as aforesaid, in the amounts in each case so certified, it being agreed that said certificates so presented to it from time to time shall exempt it from all liability to inquire or be informed concerning the performance of prerequisite conditions. [Emphasis supplied.]

The lessee agrees under the lease “that it will, at the request of the Lessor, endorse upon each certificate of common and preferred capital stock of the Lessor its said agreement to make said payments to the holders thereof, in pursuance of and according to the terms herein stated.” A certificate which included this obligation was stamped upon the shares of original preferred stock of petitioner.

In each of the years here involved the petitioner has, by corporate resolution duly adopted, declared the payment of common and preferred dividends on its stock as provided by the lease and has furnished the lessee with, a certified list of the stockholders entitled to the payment of such dividends. During each of those years the lessee has paid the amounts in the manner provided in article 16 above referred to, directly to stockholders of the lessor. It has also paid direct to the holders of petitioner’s bonds the interest thereon as provided by the lease. However, petitioner raises no question as to the inclusion of such interest in its taxable income.

The question presented has been answered in Rensselaer & Saratoga Railroad Co. v. Irwin, 249 Fed. 726; certiorari denied, 246 U. S. 671; and West End Street Railway v. Malley, 246 Fed. 625; certiorari denied, 246 U. S. 671. See also Gold & Stock Telegraph Co., 26 B. T. A. 914; Northwestern Railroad Co. of New Jersey v. Lowe, 250 Fed. 856; Houston Belt & Terminal Railway Co. v. United States, 250 Fed. 1; Blalock v. Georgia Railway & Electric Co., 246 Fed. 387; American Telegraph & Cable Co., 17 B. T. A. 783; Hamilton v. Kentucky & I. Terminal R. Co., 289 Fed. 20; United States v. Boston & Maine Railroad, 279 U. S. 732; Burnet v. Wells, 289 U. S. 670, 677.

Petitioner relies upon the recent decision by the United States District Court for the District of Connecticut in the case of United States v. Northwestern Telegraph Co., 10 Fed. Supp. 708. This decision is contrary to those heretofore cited and to the conclusion reached by us in prior cases upon similar facts. It is also true that the courts in three cases, United States v. Western Union Telegraph Co., 50 Fed. (2d) 102, and Western Union Telegraph Co. v. Commissioner, 68 Fed. (2d) 16; and Harwood v. Eaton, 59 Fed. (2d) 1009, have expressed some doubt as to the correctness of the decision in the Rensselaer and West End Street Railway cases. The decisions in the latter cases, however, have not been overruled and we have not considered such expression of doubt as sufficient ground upon which to base a different view from that already expressed by us. Gold & Stock Telegraph Co., supra. It is further noted that in United States v. Northwestern Telegraph Co., supra, the lease in question did not, as here, expressly constitute the lessee as agent of the lessor for the payment to its stockholders of the dividends in dispute. Nor did it provide for the declaration of such dividends by the lessor prior to payment. We think those distinctions are material.

The court’s decision in the last cited case was predicated upon the condition established there, that no liability existed on the part of the lessor to its stockholders with respect to the payments made to them by the lessee. In the present case such liability existed. Dividends were regularly declared by the lessor and the payments to its stockholders by the lessee were in satisfaction of that liability.

We conclude that respondent did not err in including in petitioner’s income the payments in question as rentals accruing to it from its property.

The second issue is whether deductions for the exhaustion of its leased assets by reason of wear and tear are allowable- to petitioner for the several years in question.

By the present lease an obligation was placed upon the lessee to accept the properties of the lessor in the condition existing as of the beginning of the lease term and, during that term,

* * * renew, repair and replace the same, so as to maintain and keep tlie demised premises in as good order, repair and condition as tlie same are now and in their present state of efficiency; that it will from time to time at its own expense (except as otherwise provided in Article S hereof) make all extensions, additions, alterations, improvements, renewals and betterments which may be necessary or proper with reference to the premises or property hereby demised and for the use and operation thereof, and will do and perform all other things necessary to make and maintain said street and interurban street railroads, plants and systems as first class, modern and efficient street and interurban street railroads, electric lighting, power and steam heating plants and systems; that all lands, structures, improvements, betterments, and renewals added to or made upon the demised premises, and all rights, privileges and franchises acquired by the Lessee in connection with the demised premises shall, upon payment therefor, as hereinafter provided, become the property of the Lessor and be treated as'part of the demised premises and be subject to all the terms, conditions and provisions of this indenture in like manner as if they had been vested in the Lessor at the date of this instrument.

The lease also provided that the obligation of the lessor, at the expiration of the lease, to pay to the lessee for additions and better-ments made by the latter, did not apply to expenditures “made in the renewal of or substitution for property existing at the commencement of the term of this lease, and thereafter worn out or destroyed.”

By article 3 of the lease the lessee is permitted to dispose of any of the real or personal property leased which is worn, damaged, or no longer necessary for its proper purposes or to alter, change, or replace such property with the obligation that, in case of the sale of property, the proceeds must be applied to the substitution of property equal in value to that sold, or expended to increase the value of the other leased property.

It has been held repeatedly by the courts and this Board that, in cases involving long-term leases of this character, imposing an obligation upon the lessee to maintain the property and to make, at its own expense, repairs and renewals necessary for this purpose, the lessor is not entitled to deductions for depreciation resulting from physical exhaustion, wear and tear. Weiss v. Wiener, 279 U. S. 333; Ohio-Cloverleaf Dairy Co., 13 B. T. A. 1320; affd. 41 Fed. (2d) 1009; Terre Haute Electric Co. v. Commissioner, 67 Fed. (2d) 697; certiorari denied, 292 U. S. 624; Georgia Railway & Electric Co. v. Commissioner, 77 Fed. (2d) 897; Tunnel Railroad of St. Louis v. Commissioner, 61 Fed. (2d) 166; certiorari denied, 288 U. S. 604; Michigan Central Railroad Co., 28 B. T. A. 437; Atlantic Coast Line Railroad Co., 31 B. T. A. 730.

In Terre Haute Electric Co. v. Commissioner, supra, this Board considered the same lease upon the question as to whether this same petitioner was entitled to allowance of deductions for exhaustion, wear and tear of the same property here involved. Such deductions were denied. Respondent contends that, aside from his position that petitioner is not entitled to deductions for wear and tear, upon the present facts, it is also estopped to be heard again on this question by reason of the judgment rendered in the cited case. We are in agreement with that contention. The issue submitted in that case was identical to that presented here in the claim for deductions for exhaustion by reason of wear and tear of the leased property. The parties to both of the proceedings are the same. Although the issue here has to do with a later year and thus constitutes a new cause of action, the question there litigated is identical with that now before us and was submitted upon the same material facts.

Petitioner argues in vain that this result is avoided because “the real party in issue” here is the Public Service Co. of Indiana, the petitioner’s present lessee, which acquired the lease by assignment.

The lessee, Public Service Co. of Indiana, is not a party to these proceedings. Here, as in the earlier case, we are determining the rights of the lessor under one lease. The lessee became such by purchase, approved by a proper court order, under both of which it became subrogated to the rights and assumed all the obligations of the original lessee. The rights of petitioner, lessor, under that lease, are not affected by the identity of the lessee, at any time. The Circuit Court of Appeals for the Seventh Circuit, in that prior proceeding under this lease, denied any depreciation allowance for physical exhaustion “because of the lease.” This concludes petitioner on that issue here. Nachod and United States Signal Co. v. Helvering, 74 Fed. (2d) 164; Cromwell v. County of Sac, 94 U. S. 351; Keokuk & Western Railroad Co. v. Missouri, 152 U. S. 301; Tait v. Western Maryland Railway Co., 289 U. S. 620; Portage Silica Co., 29 B. T. A. 881.

The conclusion just reached applies with equal force to the third issue submitted. Respondent is likewise sustained on this issue.

The fourth issue is raised by petitioner’s claim for a reasonable allowance for exhaustion of the leased assets by reason of obsolescence of three of the lines of interurban railroad.

Respondent contends that petitioner is not entitled to deductions for obsolescence for three reasons: First, that the question is res adjudicaba because “obsolescence” is included in the general term “depreciation.” Consequently, he argues, this question has been finally determined against petitioner in the former proceeding discussed under the second issue; second, that, under the terms of the lease in dispute, obsolescence is not subject to deduction by the lessor, and, third, that even were obsolescence allowable to petitioner the latter has failed to prove the necessary basis for its computation.

We do not agree with the first contention. Depreciation is “the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost.” United States v. Ludey, 274 U. S. 295, 300-301.

Although obsolescence may not he a deduction allowable in addition to depreciation, it is a possible additional element in that computation. Kaltenback v. United States, 66 Ct. Cls. 581.

And, the denial of an allowance for physical exhaustion of assets does not, necessarily, foreclose an allowance for obsolescence. Terminal Realty Corporation, 32 B. T. A. 623. Physical depreciation, alone, was in dispute in the earlier case, the decision in which is here pleaded in bar. No obsolescence occurred during the years there involved. It is a fact not there litigated. So, the right of .petitioner here, to an allowance for obsolescence is not res adjudicóla. Tait v. Western Maryland Railway Co., supra.

Respondent’s second contention is not so easily answered. The lease here is for a term of 999 years from March 1, 1907. Under its terms the lessee is required to maintain, repair, and replace the leased assets and to return them, at the conclusion of the lease term, in the same operative condition as when received. Under such a lease the lessor is not entitled to physical depreciation since the lessee is obligated to maintain the assets in an undepreciated condition, physically. (See cases cited on second issue, supra.) This argument, however, does not apply to obsolescence, which is a loss of economic value during the physical life of the property, and not compensated by repair, or by replacement with a similar asset.

If petitioner is denied an allowance for leased assets which it has shown have become obsolete during their physical life, that disal-lowance must be supported by some condition or lease provision other than those which preclude an allowance for physical depreciation.

Article 3 of the lease provides:

The Lessor covenants that in case the Lessee considers any part of the real or personal property hereby leased to be worn, damaged, or no longer suitable or necessary for its proper purposes, it may sell, alter, change or replace such, property, and the Lessor will act with the Lessee in any sale thereof, and in executing and delivering such instruments as may be necessary to transfer its title therein to the vendee, provided that such sales shall always be in accordance with the terms of the mortgages at that time existing upon the property, and provided further that in the absence of mortgage provisions for such a transaction, the proceeds of any such sale or sales shall be applied to the substitution of property of value at least equal to that sold or shall be expended to increase the value of the other property hereby leased.

It will be noted that the above provision applies to property “worn, damaged, or no longer suitable or necessary for its proper purposes.” We do not think that those provisions have application to a component part of the leased railway systems which, though still operative, are abandoned because they can be operated no longer at a profit.

This conclusion is supported by the fact that under a subsequent clause of the lease, section 14, the lessee covenants to operate the street and interurban railways leased and the electric light, power, and steam heating plants. In the event that it becomes unprofitable to operate the steam heating plant, it is granted the right to discontinue such operation. The fact that the abandonment of operation of one of the facilities leased, is expressly authorized, indicates that it was not intended, by section 3 above set out, to authorize abandonment of the leased facilities because of unprofitable operation, subject only to an obligation to account to the lessor for the proceeds of any salvage. If section 3 was intended by the parties to include such right there would be no need for the limited right of abandonment granted by section 14. It would seem that under the provisions of the lease the lessee now stands obligated to account to the lessor of the three lines of railroad here in controversy, by restoring them at the conclusion of the lease, in the same condition as when received March 1, 1907, if required by the lessor.

Assuming that obligation exists, which it denies, petitioner argues that the performance of that obligation at the end of this 999-year lease can not be presumed, and that, if performed, the lessor would not be compensated for the cost of those lines to it.

Certainly, on this record, we can not presume that existing obligation will not be performed. But, in any event, it is the obligation, not the length of its life, which is controlling here. Cf. Terre Haute Electric Co. v. Commissioner, supra; Georgia Railway & Electric Co. v. Commissioner, supra.

Though the amount of an allowance for loss therefrom may be measured by proper estimates, the fact of obsolescence must be “actual.” That it is “merely contemplated as more or less sure to occur in the future” is not sufficient to support such allowance. Cf. Weiss v. Wiener, supra; New York Central Railroad Co. v. Commissioner, 79 Fed. (2d) 247; certiorari denied, 296 U. S. 653.

Whether these facilities, if restored, at the termination of this lease, almost a thousand years in the future, or the undoubtedly valuable right to demand that restoration, will then have a value less or more than the cost of these three lines to petitioner, clearly can not now be answered. This uncertainty, under the present circumstances, may well defeat petitioner’s contention. New York Central Railroad Co. v. Commissioner, supra. At all events those conditions contradict any suggestion that petitioner will have nothing representing its basis for the leased assets unless that basis is ratably deducted from its income during the remaining years of the lease. Cf. Terminal Realty Corporation, supra.

Here we have a lease term of about a thousand years, at the end of which time the lessee is to return the leased property, including these abandoned lines of interurban railways, in the same operative condition as when received. During that period the lessor is to receive the rental fixed by the lease, despite the abandonment of any portion of the leased property or of its obsolescence. It is obvious under these conditions that the economic value of the leased property to the lessor is, during this long period, unchanged by reason of any obsolesence sustained and that, if there be any loss because of obsolescence, it can be measured only in terms of the lessor’s rever-sionary interest, the determination of the value of which must await termination of the lease. Cf. Old Colony Railroad Co., 18 B. T. A. 267; affd., 50 Fed. (2d) 896.

The term of this lease exceeds the physical life, not only of all the depreciable assets leased, but that of many repeated replacements and renewals. To permit the substantial deductions claimed as obsolescence sustained, not upon the street and interurban railway lines, leased as such, but upon a collection of distinct assets with separate costs, and computed upon a reversionary interest, now, and for many years, practically valueless, would seem to result in a clear distortion of income for those years. That result would condemn the allowance. New York Central Railroad Co. v. Commissioner, supra.

Apparently, the question as to whether a lessor of property under such a lease, for a term of approximately one thousand years, is entitled to obsolescence has not been decided by the courts or this Board. However, for the reasons stated, it seems, at least, doubtful that this petitioner could deduct any allowance for obsolescence of the three interurban lines under the conditions imposed by the lease in dispute. But, aside from that question, no obsolescence is allowable in the absence of a basis for its computation. The basis for the allowance of obsolescence is the same as that to be used for determining gain or loss. That basis is fair market value or .cost of the obsolescing assets, whichever is higher, on March 1, 1913. Revenue Act of 1926, secs. 234 (a) and 204 (a) and (b); Revenue Act of 1928, secs. 113 (b) and 114 (a). This record fails to disclose either that depreciated cost or fair market value.

The three lines in question were constructed prior to March 1, 1913. The exact date of that construction is not shown. It is indicated to have occurred about 1900. We have found that these railway lines, for transportation purposes, became obsolete over a period beginning in 1927 and ending, as to two of them, in their abandonment for those purposes in 1931 and as to the third on the date of its abandonment, in 1932.

Petitioner has established the original investment in these lines, the increase of that investment to the time of the lease in 1907 and the increases between 1907 and March 1,1913, by reason of additions and betterments installed by the lessee which became the property of the lessor with the obligation upon the latter to reimburse the lessee for their value at the conclusion of the lease. It has also proved the cost to reproduce these three lines, new, on March 1, 1913. But, without proof of the depreciation sustained, we are unable to determine the depreciated cost which is the limit of the cost which may be recovered. Nor is the proof of cost of reproduction, new, on March 1, 1913, unsupported by other evidence, a measure of the fair market value of these lines on that date. Paducah Water Co., 5 B. T. A. 1067; affd., 32 Fed. (2d) 559; Henry A. Cleland Estate Co., Ltd., 29 B. T. A. 436; National Packing Corporation, 24 B. T. A. 952. The burden is unquestionably upon petitioner to establish the amount of the deduction. Burnet v. Houston, 283 U. S. 223; New Colonial Ice Co. v. Commissioner, 292 U. S. 435; Helvering v. Independent Life Insurance Co., 292 U. S. 371.

It is true that the parties have agreed as to the amount of physical depreciation sustained by the leased assets during the three years here in dispute. We have held petitioner is not entitled to deduct that depreciation under a lease of this character. But that depreeiation does not establish the basis of fact here necessary. That depreciation includes such as was sustained upon all of the present leased properties of petitioner, without segregation. The amount applicable to the three lines is not disclosed. This is fatal to petitioner’s position. Georgia Railway & Electric Co. v. Commissioner, supra. Statements of purported earnings of the three obsolete railway lines appear in the record. But, although earnings may be competent evidence of fair market value, that is not true where those earnings do not, necessarily, reflect such value. Newton Cotton Mills, 12 B. T. A. 176. The three railway lines here involved were being operated by the lessee as a part, not only of the railway lines, power generating plants and transmission systems, included in the particular lease from the petitioner, but also as a part, only, of other railway lines, power generating plants and transmission systems, operated by the Indiana Public Service Co. JSTo appraisal or expert testimony of those values was offered here. In such circumstances, operating costs and earnings of these three railway lines, even if properly computed, in the absence of testimony as to the fair market values of those lines at the critical date, are not sufficient upon which to predicate an appraisal of such values as a fact.

Again, even if a basis for the computation of obsolescence were disclosed here, if the leased properties in question were railway lines and not just aggregates of physical assets, including real estate, this record does not establish abandonment of any of those lines. True, some of the equipment and facilities have been discarded. But the transmission lines, leased and maintained on the rights-of-way for the distribution of power are neither obsolete nor abandoned. They are still in use. Certainly the real estate has not been abandoned. Greenleaf Textile Corporation, 26 B. T. A. 737; affd., 65 Fed. (2d) 1017.

If treated as a group of separate physical assets, we think neither the remaining useful life of the assets upon which obsolescence is claimed, nor their respective bases have been established. These are essential facts to the allowance (Georgia Railway & Electric Co. v. Commissioner, supra), and it was petitioner’s responsibility to establish them. New Colonial Ice Co. v. Helvering, supra. Difficulty or even impossibility of proving necessary facts may be unfortunate, but that circumstance does not relieve petitioner from the burden of establishing those facts. In such situation, it is merely without a remedy. Burnet v. Houston, supra.

In addition to its fatal failure to prove a basis to support the asserted obsolescence allowances, petitioner has not established either the remaining useful life of the pertinent assets, or their salvage value. Both of these facts are necessary elements for a computation of the disputed allowance. Vogue Silk Hosiery Co., 27 B. T. A. 131, and cases therein cited.

We conclude that the petitioner has failed to sustain his claim for obsolescence on the leased properties.

In the last issue, petitioner claims the right to deduct a loss on the alleged abandonment of two of the three railway lines involved. This is an alternative issue controlled by the Revenue Act of 1928, sections 23 (f) and (g) and 113.

Petitioner relies wholly upon Commissioner v. Providence, W. & B. R. Co., 74 Fed. (2d) 714, for support in this position. It is untenable. Since there was no abandonment here, no identifiable event occurred to support a loss. United States v. White Dental Manufacturing Co., 274 U. S. 398.

Passing that difficulty, the lessee in the cited case had no obligation to account to the lessor for the cost of the asset sold — only for its sale price. Here the lessee was obligated to restore tbe physical equivalent of the assets leased. Thus, not only the fact, but the amount of any present loss is undeterminable. (See discussion and authorities in fourth issue, supra.) Further, as stated above, this record establishes no basis for the computation of any loss. Revenue Act of 1926, sec. 204; Revenue Act of 1928, sec. 113.

And, finally, in our opinion, the decision of the Board in Old Colony Railroad Co., supra, disposes of this issue here. In that case, the inquiry was whether the lessor, under a 99-year lease much similar in its terms to the pending one, received taxable income in the amount of the excess over cost received by the lessee in its sale of leased assets. In refusing to consider this gain as then realized by and thus taxable to the lessor, we said:

To consider them sales of property by petitioner, and the proceeds as gross income to petitioner, is to overlook not only the fact that the proceeds were received and used by the New Haven with no obligation upon its part except to replace the property at the expiration of the lease period of 99 years, but the fact that the property conveyed represents both the reversion of petitioner in such property and the leasehold interest therein belonging to the New Haven — its right to use for a remaining period of more than 70 years, which right would have a present value many times that of the reversion. Petitioner’s participation in or use and enjoyment of any gain realized is necessarily postponed until the termination of the lease. It receives no increased rental by reason of the transactions.

We refused there to consider a change in the leased assets as giving rise to gain to the lessor. Here we have the converse — an asserted loss by such change. Although the Old Colony case had to do with the question of an inclusion in income, while we are concerned here with a statutory deduction from income, the rationale supporting the exclusion of the income item in the Old Colony case would deny the loss deduction here.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Teammell:

license: Public Domain

text:
    Henry F. Jaeger, Executor of the Estate of Henry Jaeger, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61608.
    Promulgated January 28, 1936.

      Qerarrd A. Connor, Esq., for the petitioner.

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

Teammell:

In determining the deficiency in controversy in this case respondent included in the gross estate the value of the bank stocks and certificates of beneficial interest, referred to in our findings of fact, on the theory that delivery of the certificates by decedent to his son on January 26, 1921, constituted transfers intended to take effect in possession or enjoyment at or after decedent’s death, within the purview of section 302 (c), Revenue Act of 1926. Petitioner contends that the transfers constituted valid and completed gifts inter vivos, and therefore are not taxable as part of the gross estate. The correctness of respondent’s action is the sole issue for decision here.

Respondent’s determination is presumed prima facie to be correct, and petitioner has the burden of establishing by competent proof the alleged error, that is, that the transfers constituted valid gifts in praesenti and were not transfers intended to take effect at or after decedent’s death. From a careful consideration of the record before us, we think petitioner has wholly failed to meet this burden.

In Max R. Bardach, 32 B. T. A. 517, 520, we stated the characteristics of a valid and completed gift as follows:

It is well established that the requirements of a gift inter vivos are (1) an intention on the part of a competent donor to give; (2) an acceptance by a competent donee; and (3) a transfer of title with complete relinquishment by the donor of dominion and control of the property [citing authorities].

See also Chauncey L. Landon, 16 B. T. A. 907; Edwin J. Marshall, 19 B. T. A. 1260, affirmed in part material here, 57 Fed. (2d) 633; certiorari denied, 287 U. S. 621; Louis Schoen, 30 B. T. A. 1075; Oscar G. Joseph, 32 B. T. A. 1192.

The evidence in our opinion fails to establish any of the characteristics of a completed gift inter vivos, above stated. Obviously decedent had no definite intention of making gifts effective at the time he endorsed and delivered the stock certificates to his son, for the reason that he then stated that his son could make transfer or delivery of the property to the donees whenever he saw fit to do so. At the hearing, petitioner (decedent’s son) testified that he understood that he was authorized by his father to transfer or deliver the property at any time he wanted to; and again he stated that his father presumably delegated to him discretionary power as to the time of delivery of the securities to the donees because he, decedent, desired to have his son handle the matter for him. Whatever the motive, it seems plain that decedent then had no present intention of making completed gifts effective at the time of the delivery of the certificates to his son. It further appears as a fact that the son, in the exercise of his discretion and for reasons satisfactory to himself, did not see fit to deliver the property to the donees until after his father’s death.

In the second place, it is not shown that there was any acceptance of the gifts by the donees, actual or constructive, at least until after decedent’s death. So far as disclosed by the record, the daughters were not informed of the transfers. We can not assume in the absence of proof that they accepted the gifts or that petitioner was authorized as their agent to accept for them, particularly when it is not shown that they had knowledge of the matter. To indulge in such presumption would be to relieve petitioner of the burden of proof in respect of the very issue which he must sustain in order to prevail.

As to the third characteristic of a gift inter vivos above mentioned, it is not shown that there was a complete relinquishment by the decedent of dominion and control of the property. On the other hand, it is shown that he received and appropriated to his own use all dividends from the stocks until his death, and exercised control over the voting of the stock by proxies given to his son.

Petitioner’s own evidence clearly establishes that none of the donees did in fact exercise any dominion and control over the property or derive any benefit therefrom prior to decedent’s death. Petitioner was the specifically appointed agent of and acted for his father in determining when delivery of the property to the donees should be made. In the exercise of such delegated discretion, he did not in fact make delivery until after his father died nearly three years later. In the light of these facts, we can only conclude that the transfers of 1927 were intended to take effect both in possession and enjoyment at or after decedent’s death. Respondent did not err in including the value of the property in the gross estate.

Judgment will be entered for the respondent.

       Sise. 302. The value of the gross estate of the decedent shall he determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      * * * * # * *
      (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *


author: Matthews :

text:
    Elkhorn Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. William C. Atwater, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent. David H. Atwater, Petitioner, v. Commissioner of Internal Revenue, Respondent. John J. Atwater, Petitioner, v. Commissioner of Internal Revenue, Respondent. Margaret A. Olds, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lena C. Hutchins, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles P. Hutchins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 49064-49070.
    Promulgated January 28, 1936.

      John L. Steinbugler, Esq., Leo H. Hoffman, Esq., and Robert W. Knox, Esq., for tlie petitioners.

      R. W. Wilson, Esq., and Arblrnr dark, Esq., for the respondent.

       Vacated by Board order of March 6, 1936, and re-referred to Division.

   OPINION.

Matthews :

These proceedings, which have been consolidated, arise under section 280 of the Revenue Act of 1926 and involve a deficiency in income tax determined against the Elkhorn Coal & Coke Co., a corporation, for the year 1925 in the amount of $74,332.44, which the respondent is seeking to collect from the petitioners as transferees of the assets of that corporation, which was dissolved under date of August 25, 1926.

This deficiency of $74,332.44, which is outstanding and unpaid, grows out of the respondent’s determination that the Elkhorn Coal & Coke Co. made a profit of $567,787.99 on the transfer of certain assets for 1,000 shares of stock of the Mill Creek Coal & Coke Co., which stock was valued by the respondent at $720,710. The petitioners contend that this exchange of assets for stock constituted a tax-free reorganization, under the provisions of section 203 of the Revenue Act of 1926, and that no taxable gain was realized thereon by the Elkhorn Coal & Coke Co. Other questions raised by the parties herein will be answered, or their significance destroyed, by the determination of this principal issue. The petitioners have waived all issues involving the statute of limitations.

These proceedings were submitted upon the oral testimony of one witness with respect to the physical merger or consolidation of the operating properties of the Mill Creek Coal & Coke Co. and those of the Elkhorn Coal & Coke Co., and on a stipulation of facts which, together with exhibits thereto attached, is made a part of this report by reference.

The Elkhorn Coal & Coke Co. was organized under the laws of the State of West Virginia in 1889. It was actively and continuously engaged in coal mining from the date of its incorporation until December 31, 1925, after which date it did no business whatsoever. Its total capital stock issued and outstanding during December 1925 and until it was liquidated in 1926 was 7,540 shares of common stock. Its stockholders from prior to January 1925 to January 22, 1926, were as follows:

Name: Shares
William G. Atwater-' 5
William O. Atwater, Jr_1, 598
John J. Atwater-1, 598
David H. Atwater-1, 604
Margaret A. Olds-1,170
Charles B. Smith- 143
John L. Steinbugler- 5
Charles P. Hutchins- 050
Lena O. Hutchins- 741
Jos. H. SpafCord- 13
Estate of W. H. Wheeler_ 13
Total shares issued and outstanding--7, 540

On December 9, 1925, there was organized under the laws of the State of Delaware a corporation known as Elkhorn Coal Co., which is one of the petitioners herein. On organization 10 shares were issued as qualifying shares and additional shares were issued until on January 22, 1926, its total outstanding capital stock consisted of 7,540 shares of common stock.

Pursuant to a plan of reorganization and in accordance with the authority conferred by regular corporate action, as set forth in the minutes of the meetings of the stockholders and directors of the corporations, the Elkhorn Coal Co. assumed all the liabilities and acquired certain assets of the Elkhorn Coal & Coke Co. in exchange for 6,100 shares of stock, which were promptly distributed among the stockholders of the Elkhorn Coal & Coke Co. The only assets not thus conveyed to the Elkhorn Coal Co. were certain operating properties consisting of a mine, mining plant, and mining- equipment located at Maybeury, West Virginia, which were retained by the Elkhorn Coal & Coke Co.

The Mill Creek Coal & Coke Co., organized under the laws of the State of West Virginia in 1891, was engaged in the business of mining coal on certain tracts of land which were contiguous to the operating properties of the Elkhorn Coal & Coke Co. at May-beury, West Virginia, referred to in the preceding paragraph. The Mill Creek Coal & Coke Co. was desirous of acquiring these properties in order that a physical merger might be effected whereby all the properties could be more economically operated as a single mine. On December 31, 1925, pursuant to a plan of reorganization and in accordance with the authority conferred by the regular corporate action of both companies, the Elkhorn Coal & Coke Co. conveyed these operating properties to the Mill Creek Coal & Coke Co. in exchange for 1,000 shares of common stock, which constituted 25 percent of the total outstanding capital stock of the Mill Creek Coal & Coke Co. After this transfer the Elkhorn Coal & Coke Co. had no assets except these 1,000 shares of stock of the Mill Creek Coal & Coke Co. which had a fair market value on December 31, 1925, of $550,000.

On January 22, 1926, the remaining 1,440 shares of stock of the Elkhorn Coal Co. were issued in exchange for all of the capital stock of the Elkhorn Coal & Coke Co., which shares were received by the stockholders of the Elkhorn Coal & Coke Co. pro rata in proportion to their stock holdings. These 1,440 shares of stock had a fair market value on that date of $224.01 per share. Thereupon the Elkhorn Coal Co. became the sole stockholder of the Elkhorn Coal & Coke Co. and those individuals who had owned 7,540 shares of common stock of the Elkhorn Coal & Coke Co. owned in the same proportions 7,540 shares of common stock of the Elkhorn Coal Co. On this same date the Elkhorn Coal Co., the then owner of 100 percent of the stock of the Elkhorn Coal & Coke Co., caused the Elkhorn Coal & Coke Co. to transfer to it the 1,000 shares of stock of the Mill Creek Coal & Coke Co., which had been received in exchange for the above-described operating properties and which had a fair market value in excess of the deficiency at issue herein, and proceeded to dissolve the Elkhorn Coal & Coke Co. The Elk-horn Coal & Coke Co. was completely liquidated and its certificate of dissolution was issued on or about August 25, 1928.

There is no question that the transactions between the Elkhorn Coal & Coke Co. and the newly organized Elkhorn Coal Co. resulted in no taxable gain. But the respondent has determined that the acquisition by the Mill Creek Coal & Coke Co. of those operating properties of the Elkhorn Coal & Coke Co. which were located at Maybeury, West Virginia, in exchange for stock was not a reorganization within the meaning of the language used in section 203 (h) (1) (A) of the Revenue Act of 1926, reading as follows: “the acquisition by one corporation of * * * substantially all the properties of another corporation”; and seeks to collect the asserted deficiency from the petitioners as transferees of the assets of the Elkhorn Coal & Coke Co.

Statutory provisions which are applicable hereto are set out in the margin.

It is argued by the respondent that the several steps taken by the three corporations prior to the dissolution of the Elkhorn Coal & Coke Co., as set out in the minutes and which we have summarized above, should not be viewed separately but as a part of one continuous, unified plan; that the Elkhorn Coal Co. was created merely to hold those assets of the Elkhorn Coal & Coke Co. which were not desired by the Mill Creek Coal & Coke Co., which assets were retained by the successor corporation in such manner that the beneficial ownership therein remained unchanged; and that the transaction with the Mill Creek Coal & Coke Co. did not constitute a transfer of all the property of the Elkhorn Coal & Coke Co. but actually amounted to a sale of only a part of its property.

We are of the opinion that the respondent’s determination can not be sustained. The instant case falls squarely within the ruling laid down in Helvering v. Minnesota Tea Co., 296 U. S. 378, affirming 76 Fed. (2d) 797, which had reversed this Board’s decision reported at 28 B. T. A. 591, in which case the Supreme Court held, upon facts practically on all fours with those contained herein, that there was a reorganization within the provisions of the statute. Although it was argued on behalf of the Commissioner that in construing section 112 (i) (1) of the Bevenue Act of 1928, the provisions of which are identical with the provisions of the corresponding section of the Bevenue Act of 1926, clause (A) should be narrowly interpreted so as to necessitate something nearly alan to technical merger or consolidation, the Court specifically held that clause (B) was not intended to modify clause (A) or any part thereof. It may be noted that in the Minnesota Tea Co. case a large part of the consideration- was paid in cash and the transferor was not dissolved (which is not true in the instant proceedings), but these facts did not change the conclusion that the transaction involved therein partook of the nature of a reorganization and did not amount to a sale out of which a taxable profit arose. The Supreme Court has succinctly stated that to be within the exemption allowed by the statute in the case of a reorganization the transferor must acquire a definite and material interest in the affairs of the transferee, which interest must represent a substantial part of the value of the transferred assets. Clearly this test, when applied to the facts herein, necessitates a ruling adverse to the position of the respondent on the main issue.

The notices of deficiency indicate that other adjustments have been made by the respondent with respect to the income for 1925 which was reported by the Elkhorn Coal & Coke Co. and a recompu-tation will be made in accordance with this opinion. The parties have stipulated that the net income should be reduced by minimum royalties which were disallowed by the respondent in the amount of $4,000.

Judgment will Toe entered under Rule 50.

       RECOGNITION OF GAIN OR LOSS FROM SALES AND EXCHANGES.
      Sec. 203. (a) Upon tlie sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
      # # * * * # *

      (b) (3) No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
      * a * at * * #
      (h) As used in this section and sections 201 and 204—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.


author: Mttedock : Smith,

text:
    Palomas Land & Cattle Co., Petitioner, v. Commissioner of Internal Revenue, Respondent. Grand Canyon Cattle Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56779, 56780.
    Promulgated January 30, 1936.

      M. F. Mitchell, Esq., and. Robert M. L. Baker, Esq., for the petitioners.

      Arthwr L. Mwrray, Esq., for the respondent.
   OPINION.

Mttedock :

The Commissioner determined a deficiency of $15,-474.48 in the tax liability of Palomas Land & Cattle Co. (hereinafter called Palomas) “for the eleven months fiscal period ended November 30, 1928” and a deficiency of $245.23 in the tax liability of Grand Canyon Cattle Co. (hereinafter called Canyon) for the same period. The petitioners contend the Commissioner erred in using the period of 11 months as a taxable period for which tax is due and in failing to allow a deduction of $130,000 against income of the first 11 months of 1928. The facts have been stipulated but the stipulation need not be set forth in full.

Palomas purchased all of the capital stock of Canyon in 1915 for $200,000. This basis was reduced to $150,000 by a distribution of $50,000 received by Palomas from Canyon on November 30, 3928, and on that same day Palomas sold all of the capital stock of Canyon to third parties for $20,000, “thereby sustaining a loss of One Hundred Thirty Thousand ($130,000) Dollars.” The two corporations kept their accounts on a calendar year basis and had filed consolidated returns for several years prior to 1928. No other corporations were included in the affiliated group. Palomas filed a return for the full calendar year 1928 “and included in said return the net income of” Canyon for the period January 1 to November 30, 1928, “to wit, the sum of $2,044.55.” The net income shown on the return amounted to $432.48. Canyon filed a separate return for the period December 1 to 31, 1928. The Commissioner split the calendar year into two taxable periods, one of 11 months (consolidated) and one of one month (separate), and required a return for each. He disallowed the $130,000 as a deduction from the gross income of Palomas for the full calendar year and from income for the period of 11 months, but allowed it to Palomas as a deduction for the period December 1 to 31, 1928. He determined deficiencies for the period of 11 months only. The income of Palomas for the calendar year, excluding the loss of $130,000, was a little less than $130,000. Its operation during December resulted in a loss of $565.11. Its net income for the first 11 months, excluding the $130,000 loss item, amounted to $128,953.04. The correct net income of Canyou for the period of 11 months is not shown by the record.

The petitioners filed a consolidated return for 1927 and made no request to change to a separate return for 1928. Sec. 142(a), Revenue Act of 1928. There were only two corporations in the affiliated group. Affiliation was broken by the sale on November 20. The applicable regulations required the two corporations to make “ordinarily * * * a consolidated return including the income of both corporations to the date of the change in stock ownership”, and a separate return for each for the remainder of the year. Regulations 74, art. 738. The Commissioner has acted in accordance with those regulations in this case. The question of taxable years for the purpose of carrying forward a net loss is a different question from the one here involved. Cf. Wishnick-Tumpeer, Inc. v. Helvering, 77 Fed. (2d) 774; certiorari denied, 296 U. S. 628. Taxable periods requiring returns may be shorter than 12 months. The loss was not deductible from the income of the affiliated group but only from the separate income of Palomas for the period following affiliation. Remington Rand, Inc. v. Commissioner, 33 Fed. (2d) 77; certiorari denied, 280 U. S. 591; Riggs National Bank, 17 B. T. A. 615; affd., 57 Fed. (2d) 980. The taxpayers chose to accept the benefits of consolidated returns. This disadvantage follows. The requirement is not an obvious injustice or hardship and in some cases may be an advantage. Net loss provisions permit the loss, unabsorbed by income of December, to be carried forward. Cf. Helvering v. Morgan’s, Inc., 293 U. S. 121.

Affiliation in S. Silberman & Sons, 27 B. T. A. 1207; affd., 76 Fed. (2d) 360, was ended by a sale of the stock of the subsidiary on December 28,1925. The Commissioner held that the loss from the sale could not be deducted from income of the affiliated companies for the period prior to the sale but could be deducted only from the separate income of the seller for the short period of a few days following the sale. The Board affirmed the Commissioner and the Circuit Court affirmed the Board. The present case is not distinguishable and may present a somewhat stronger case for the Commissioner, since the sale took place one month prior to the end of the calendar year instead of only a few days prior as in the Silberman case. Cf. Houghton & Dutton Co., 26 B. T. A. 1420. The present case is distinguishable from the Houghton & Dutton Co. case by the fact that the subsidiary, Canyon, continued its corporate existence.

The only period for which the Commissioner determined a deficiency and consequently the only period as to which the Board has jurisdiction was a proper taxable period. The figures are not disputed. The Commissioner did not err in determining the deficiencies for that period.

Reviewed by the Board.

Decision will be entered for the respondent.

Van Fossan, Matthews, Turner, and Tyson dissent.

Smith,

dissenting: The Palomas Land & Cattle Co. kept its books of account and made its income tax returns for 1928 and prior years upon a calendar year basis. It filed a return for the full calendar year 1928 “and included in said return the net income of the Grand Canyon Cattle Company, its only subsidiary, for the period January 1, 1928, to November 30, 1928, to wit, the sum of $2,044.55.” For the full calendar year 1928 Palomas had a net loss. It is stipulated, however, that it had a net income up to the time it sold its shares of stock in Grand Canyon Cattle Co. of $128,953.04, a loss upon the sale of its shares of stock of Grand Canyon Cattle Co. of $130,000, and an operating loss for the month of December 1928 of $565.11.

The respondent, purporting to act under his regulations, has split the operations of Palomas for 1928 into two periods, namely, January 1 to November 30, 1928, and December 1 to December 31, 1928. A loss sustained upon the sale of the shares by Palomas was sustained on November 30, 1928. The respondent has disallowed the deduction of this loss in the determination of the deficiency.

The Board has repeatedly held that where a corporation makes a return or returns for a 12-month period, its reporting period, the respondent may not determine deficiencies upon the basis of operations for a fractional part of the year. Mrs. Grant Smith, 26 B. T. A. 1178; Elgin Compress Co., 31 B. T. A. 273; Pittsburgh & West Virginia Railway Co., 32 B. T. A. 66; Forest Glen Creamery Co., 33 B. T. A. 564.

In Helvering v. Morgan’s, Inc., 293 U. S. 121, the Supreme Court said:

Tlie definition of “taxable year” in section 200 (a) [Revenue Act of 1926] is therefore incomplete unless it be understood that the period for which a return is made, whether it be for a year or a fractional part o-f it, is to be related to the twelve months’s accounting period of the taxpayer. Where the return is for a period of less than twelve months, the year of which it is a fractional part is the annual accounting period of the taxpayer, which is his taxable year. * * *

The “taxable year” of each of the petitioners involved in these proceedings was the taxable year 1928. The observation of the Supreme Court in the above cited case is equally applicable to the proceedings at bar; for the definition of “taxable year” contained in section 48 of the Revenue Act of 1928, with which we are here concerned, is not different from that considered by the Supreme Court. I am, therefore, of the opinion that the observation made by the Supreme Court in the above cited case is equally applicable here.

We then come to a consideration of the question as to whether Palomas has any liability for income tax for the calendar year 1928, for which it made its return. Clearly, if Palomas had made a separate return for 1928 (assuming that it was not barred from making a separate return for the reason that consolidated returns had been filed for prior years) Palomas would have had no tax liability for 1928; for the loss sustained by it upon the sale of its shares of stock in Canyon was a loss deductible from gross income under the statute.

I do not think that it was the intention of Congress that a tax should be imposed upon Palomas for its “taxable year” 1928 when in fact it had no net income for 1928. Such a result seems to me to be repugnant to the reasoning of the Supreme Court in Helvering v. Morgan's, Inc., supra.


author: Seawell :

text:
    F. Coit Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent. F. Coit Johnson and Stuart Holmes Johnson, Executors of the Estate of Florence D. Johnson, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 75968, 75969.
    Promulgated January 30, 1936.

      Bean Emery, Esq., for the petitioners.

      Garroll Walker, Esq., for the respondent.
   OPINION.

Seawell :

Section 23 of the Revenue Act of 1928 provides:

In computing net income there shall be allowed as deductions:
& # sjc
(b) Interest. — All interest paid or accrued within the taxable year * * *.

Petitioner Johnson contends that he borrowed $400,000 from the City Bank Farmers Trust Co., trustee, and gave the trustee his demand note for that amount bearing 6 percent interest, and that during the taxable year paid said trustee $24,000, the amount of interest accrued on the note during the year.

Interest is defined to be “compensation which is paid by the borrower to the lender or by the debtor to the creditor for its use”— Bouvier.

[Respondent contends on the other hand that there was no bona fide gift by Johnson to his wife and no bona fide borrowing by Johnson from the trustee; that the trustee had lent Johnson no money, and Johnson was not a debtor to the trustee on any account; and that the payment of $24,000 to the trustee was in no sense compensation for the use of money or for -the postponement of a debt satisfaction. In short, respondent says the trustee was a mere agent or factor for the payment of the insurance premiums on Johnson’s insurance; that Mrs. J ohnson was a figurehead set. to act her part in the drama set up for the benefit of her husband; and that the whole fabrication of the borrowing, pretended gift, and the setting up of trusts ivas simply a device to make payments of life insurance look like payments of interest whereby Johnson might escape payment of taxes on that much of his income.

[Respondent insists further that all the acts and things done and performed by Johnson and his wife were the direct consequence of the suggestion of the lawyer and insurance man of a way for J ohnson to escape tax in a sum equal to' his insurance premiums; that the devious ways of these actions were merely to create appearances; that instead of actually borrowing $400,000. from the bank, and performing the other acts mentioned, Johnson could have handed over his unsecured demand note to the trustee and immediately upon demand borrowed it back and the trustee would have had a trust fund just as real and substantial as that which he secured. In either case, however, respondent contends, the provisions of the trust instrument effectually removed his note to the trustee from any negotiable instrument law.

These contentions of the parties have their application also to Mrs. Johnson’s case. She did not testify as a witness in the proceedings.

The facts and circumstances herein make pertinent the comment of the Court in its opinion in Burnet v. Wells, 289 U. S. 670, wherein it is said: “The solidarity of the family is to make it possible for the taxpayer to surrender title to another and to keep dominion for himself, or, if not technical dominion, at least the substance of enjoyment.” And in Willcuts v. Douglas, 73 Fed. (2d) 130, it is stated: “Among the devices employed to avoid income and estate taxes none has been more used than trusts dealing with members of a family, and the courts have been alert to> prevent such avoidance by this means.” In Corliss v. Bowers, 281 U. S. 376, Mr. Justice Holmes, delivering the opinion of the Court, said in part: “But taxation is not so much concerned with the refinements of title as it is with actual command over the property taxed — the actual benefit for which the tax is paid.”

In Elizabeth Bruce v. Helvering, 76 Fed. (2d) 442, the United States Court of Appeals of the District of Columbia, in reversing this Board, said:

The case we have would he wholly different if it appeared the plan was one designed to defeat the payment of taxes. In such a case it would be just as subject to condemnation as was the fictitious transfer of assets by one corporation to another, and thence to the sole stockholder, which, though accomplished in strict conformity with the statute, the Supreme Court denounced in Gregory v. Helvering (January 7, 1935).

The $400,000 delivered to Mrs. Johnson by her husband is shown to have been with the understanding of both that it was to be put in trust with the limitations and conditions attached, which made it exceedingly easy for him to have the amount immediately returned to him to use as he might wish, upon his merely agreeing to pay to the trustee 6 percent interest thereon, from which interest, if paid, the trustee was to pay insurance premiums on the aforesaid policies. It was understood by all three, his wife, the trustee, and himself, that the trustee was not to force collection of either interest or principal unless Mrs. Johnson should “specifically” so direct in writing during her life or such direction should be given by her executor after her death, and it was also a part of the trust agreement that the trustee was “expressly prohibited” from disposing of her husband’s notes for such indebtedness except upon condition above stated. Under such limitations and conditions, so understood by all three, it is not surprising that Johnson in testifying felt justified in stating: “I knew there was no way the trustee could force payment.” His alleged gift of $400,000 to his wife, therefore, does not appear to have been an absolute and unconditional bona fide gift, in view of the testimony taken in connection with the trust instruments themselves. He had complete confidence in his wife and was apparently warranted in feeling there would never be any specific direction on her part or by her executor to the trustee to enforce collection of either interest or principal of his note during her or his life. That his confidence in his wife as to her action with reference to the debt was not misplaced is further forcibly indicated by the fact that no demand for payment of the debt, so far as shown by the record, was ever directed by the wife during her life and the provisions made for her husband in her will — as quoted in our findings of fact— fully protect him against any demand for payments during his life.

Johnson desired to continue in force the policies of insurance on which he had been paying premiums, and the trusts created, while not directly established by him, were, in our opinion, created at his instance and by his direction and intended for his benefit by enabling him to take as a deduction in computing his taxable net income what he would pay on his obligations, which he still recognized, to the insurance companies. The situation makes applicable the principle enunciated by Mr. Chief Justice Hughes in Douglas v. Willcuts, 296 U. S. 1 (affirming 73 Fed. (2d) 130, supra), wherein he said: “The creation of a trust by the taxpayer as the channel for the application of the income to the discharge of his obligation leaves the nature of the transaction unaltered.”

It is stated in both trust instruments that the laws of the State of New York were to govern their provisions. Numerous decisions of the courts of the State of New York are cited and relied on by counsel for the petitioners to sustain their contention that, notwithstanding the specific provision in the funded trust that the trustee therein was “expressly prohibited from disposing of” the notes of Johnson during his life or “taking any action whatsoever to collect or looking to the collection of the same or of the interest thereon, or to enforce any of the provisions thereof * * *”, except as the trustee should be “specifically directed in writing by the Donor during her lifetime, or after her death by her executor or administrator”, the trustee might disregard the provisions of the trust and enforce collection against Johnson, contrary to his wife’s direction and desires. However, we do not think such conclusion, in the circumstances of the instant proceedings, justified by the authorities cited.

The facts and circumstances involved in the instant proceedings are distinguishable from those in the cases cited in behalf of the petitioners, and the decisions therein, therefore, are not controlling. None of those cases goes to the extent of holding that the trustee may disregard the mandatory provisions of the trust, as in the instant case, wherein the maker of the note is the husband of the donor of the trust, created after his explanation of the scheme to her and in accordance with his desires and interest. Where the provisions of the trust are not illegal and the powers of the trustee are defined and limited by clear and express language of the trust instrument, the trustee is bound thereby. See McArthur v. Gordon, 27 N. E. 1033; 126 N. Y. 597; In re Watson, 142 N. Y. S. 1058; affd., 148 N. Y. S. 1020.

We agree substantially with the contentions of the respondent as to the reasons for the denial to Johnson of a deduction of the $24,000 alleged interest payment. We hold that the alleged $400,000 trust fund in the ultimate reality was not to be provided from the assets or capital of either Johnson or his wife nor from any loan negotiated by either which was intended to constitute any binding obligation on either of them to repay. Johnson was to secure a temporary loan of $400,000, turn it over to his wife there in the bank where they were assembled with the other participants in this matter. She was to return the money immediately to her bank. She was then to give her check to the nominal trustee who was required upon Johnson’s request (predetermined) as soon as practicable, to lend it to Johnson, under circumstances negativing any real obligation or intention ever to repay it. Johnson would then under the plan use the amount to pay off and discharge the original temporary loan from the National City Bank. The trustee, under the trust instrument, was forbidden to assign any obligation of Johnson given by him for the loan, or to enforce in any way the return of any part of the loan or interest to the trustee without the written direction of Mrs. Johnson or her executor. The executor was Johnson himself (albeit his son was co-executor) and he was also the legatee of the trust fund. It matters not that the executor was named later in a will thereafter executed. The facts, which speak clearly, indicate this circumstance was not overlooked. Under all the facts we find and hold that the transactions of the parties above detailed were all executed with the primary and dominating purpose and intention of avoiding or evading taxes, and there was no bona fide gift made by Johnson to his wife or loan secured by Johnson from the trustee; and the $24,000 paid by Johnson to the City Bank Farmers Trust Co. is not deductible. Accordingly, we affirm the determination of the respondent as to Johnson’s case, Docket No. 75968.

It follows, in accordance with respondent’s contention in the cause and his statement above noted, that we should sustain Mrs. Johnson, petitioner in Docket No. 75969, which we do.

Reviewed by the Board.

Judgment in favor of the respondent will be entered in Doehet No. 75968, and in favor of petitioner in Doehet No. 75969.

Leech concurs in the result.


text:
    John R. Thompson Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 51765.
    Promulgated February 6, 1936.

      Edward, H. McDermott, Esq., John L. Hopkins, Esq., Ellsworth G. Ahvord, Esq., Charles G. Parker, Esq., and O. John Rogge, Esq., for the petitioner.

      Chester A. Gwirm, Esq., and Hugh R. Dowling, Esq., for the respondent.
   OPINION.

Leech:

Petitioner contends that the basis for determining gain or loss on its disposition of securities acquired on May 18, 1923, in the transaction heretofore detailed, is their fair market value on that date. It has so computed its gain reported in its returns for the years in question. Respondent contends that the acquisition of these securities by petitioner was under conditions which bring the transaction within section 204 (a) (8) of the Revenue Act of 1926 and that the proper basis to petitioner for computing gain or loss on resale is the basis of such securities, in each instance, to the parties from whom they were acquired.

Section 204 (a) of the Revenue Act of 1926 provides that the basis for determining gain or loss from sale or other disposition of property after February 28, 1913, shall be the cost of such property, with certain exceptions set out in detail. It is stipulated that the fair market value of the assets conveyed to petitioner on May 18, 1923, by John R. Thompson, his wife, daughter, and a trustee holding certain of the securities in exchange for all of its capital stock, was the sum of $9,599,222.50. It necessarily follows that this is the fair market value of petitioner’s stock issued in exchange and therefore the cost to petitioner of these securities. If another basis than such cost is to be used in determining gain or loss on resale, the circumstances of the acquisition must be such as to bring the transaction within one of the exceptions declared in the cited section.

In the transaction the tax results of which are now in dispute, this petitioner acquired more than 50 percent of the preferred and more than 50 percent of the common stock of the John R. Thompson Co. It also acquired, in the same transaction, securities in other corporations, but representing, in no case, a majority of the stock of any such corporation. The consideration paid by petitioner for the acquisition of this property was all of its stock, held thereafter by the sellers.

The transaction, in which the stock of the John R. Thompson Co. was transferred to petitioner constituted a “reorganization” within the definition of section 203 (h) (l) of the Revenue Act of 1926. Helvering v. Minnesota Tea Co., 296 U. S. 378; Helvering v. Watts, 296 U. S. 387; G. & K. Manufacturing Co. v. Commissioner, 296 U. S. 389, all decided December 16, 1935.

It necessarily follows that the John E. Thompson Co. was a “party to a reorganization” under section 203 (h) (2) of the Eevenue Act of 1926.

An examination of section 204 shows that subsections (6), (7), and (8) embody the only exceptions controlling voluntary exchanges for a consideration as was the one here in question. It is apparent that subparagraph (6) is not applicable to the acquisition of the John E. Thompson Co’s, stock since it excludes “property acquired by the corporation by issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it.” Furthermore, subsections (7) and (8) are not applicable because each exempts specifically “stock or securities in a corporation a party to a reorganization.”

Thus, since the acquisition by petitioner of the stock of the J ohn E. Thompson Co. constituted a reorganization and such stock was that of a party to the reorganization, it is excluded from the exceptions set out in section 204 (a). Consequently, the basis for determining gain or loss from its sale or other disposition by petitioner is its cost to the latter.

In addition to the stock of the John R. Thompson Co. petitioner acquired, in the transaction set out in the stipulation, certain other securities as a consideration for stock issued to John R. Thompson. The circumstances of this acquisition appear to bring it- squarely within the provisions of section 20é (a) (7), heretofore set out in the margin.

We think it clearly established that these securities were acquired by petitioner in connection with a reorganization, and that they did not represent “stock or securities in a corporation a party to a reorganization.” Immediately after the transfer of such securities by Thompson to petitioner he was the owner of approximately 90 percent of the stock of petitioner.

We hold that petitioner’s basis for determining gain or loss upon its disposition of these securities is the basis of such securities to the transferor, John R. Thompson. Stires Corporation, 28 B. T. A. 1; Holmby Corporation, 28 B. T. A. 1092.

The deficiencies should be redetermined in accordance with the conclusions herein reached and with the stipulated adjustments.

Judgment will be entered under Rule SO.

       Sec. 204 (a). The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall he the cost of such property; except that—
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      (6) If the property was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203, the basis! shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the property so acquired consisted part^gf the type of property permitted by paragraph' (1), (2), (3), or (4) of subdivision “(b) of section 203 to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph shall be allocated between the “properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it;
      (7) If the property (other than stock or securities in a corporation a party to the reorganization) was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was 'made;
      (8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph,' (4) of subdivision (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in. the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.

       Sec. 203 (h) as used in this section and sections 201 and 204—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the tranferor or its stockholders or both are n control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identify, form, or place of organization, however effected.

       Sec. 203 (h) (2). The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.