author: Phillips:

text:
    Ethel Hopkins McLarry, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8490.
    Promulgated November 5, 1927.
    1. Husband and wife were domiciled in Texas. The wife reported one-half of the income received in 1924 from services rendered by the husband and claimed such amount to be earned income within the provisions of section 209, Revenue Act of 1924. Held, such earnings of the husband are not earned income of the wife.
    2. Under the laws of Texas, the wife’s interest in community income arises from the marital relationship, irrespective of the performance of any services by her.
    8. Quaere, whether the decisions of the state courts need to be considered in determining what constitutes earned income under the Revenue Acts.

      Walter M. Yam, Nort, Esq., for the petitioner.

      George G. Witter, Esq., for the respondent.
    The Commissioner determined a deficiency of $31.53 in income tax for 1924, from which determination .the petitioner appealed to the Board. The facts were admitted in the pleadings or stipulated at the hearing.
    FINDINGS OF FACT.
    The petitioner is a resident of Texas and was such during 1924. Petitioner and her husband filed separate returns of income, the petitioner reporting as income $9,188, which was one-half of the earnings of her husband from personal services performed by him. In computing her tax liability, petitioner claimed said $9,188 to be earned income under the provisions of section 209 of the Revenue Act of 1924. The Commissioner held such amount was not earned income of the petitioner, reduced earned income to $5,000 and computed the deficiency here in question, no other adjustments being made.
   OPINION.

Phillips:

The sole question involved is whether the one-half of the amount earned by a husband from his personal services and reported by the wife as her income under the community property laws of Texas, is subject to taxation as earned income of the wife. Section 209 of the Revenue Act of 1924, so far as material, provides:

(a) For the purposes of this section—
(1) The term “earned income” means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered.

This section then goes on to provide in substance that such income shall be taxed at a lower rate than other income which is subject to normal tax.

It is contended by counsel for the petitioner that under the decisions of the Texas courts earnings of the husband, and the wife are the product of their joint labor and are community property. That such earnings are community property and that in Texas each acquires an interest in them seems beyond doubt. The basis for the interest, however, is not so clear. Does it arise because the earnings are deemed by the law to be the product of their joint efforts or does it arise because of the marital status?

Quotations may be had from the decisions of the Texas courts supporting either view. On examination of the cases, however, it will appear that the language used was not necessary to the decision, and that these conflicting statements of the theory behind the law are of little help in determining the question before us. Under either theory the result would be the same.

We pass then to a consideration of the facts in particular cases passed upon by the Texas courts.

In Merrell v. Moore, 104 S. W. 514, it appeared that Merrell abandoned his wife and never returned to her. Subsequently, she received information that he had divorced her and she married one Moore. Merrell subsequently died and after his death she learned that he had never divorced her. She brought suit for one-half of the property which Merrell had accumulated between the date of his marriage and his death. She was successful in her suit, the court saying:

The marriage relation when once established, continues until dissolved by death or judicial decree, and all property acquired by either the husband, or wife during the marriage, except such as is acquired by gift, devise or descent is by statute made their common property. This community of interest is not made to depend upon the acquisition of the property during the time the parties actually live together, nor upon the fact that there was an equal amount of labor or capital contributed by the husband and wife in its accumulation. It is the property acquired during the marriage that shall be deemed the common property of the husband and wife, and the right to an equality of enjoyment and division thereof, regardless of whether the one or the other contributed little or nothing in its acquisition. Therefore, had the separation of the wife from the husband been by mutual consent, it would not have affected her right in the community property, although derived solely from the efforts of the said husband.

In Chapman v. Chapman, 32 S. W. 564, it appeared that the deceased married Johanna and later married Emma, who was ignorant of the previous marriage. The court held that the only community estate was that of decedent and Johanna, that no community estate existed as to Emma and that Emma was not entitled to administer the estate. It suggested that if Emma had any interest in the estate, it was different from that given to a wife. In the course of its opinion the court says:

The community estate is created by law as an incident oí marriage and does not arise from contract between the parties. It is created by law only as between those who occupy towards each other the relation of husband and wife. If appellant (the putative wife) had an interest in any of the property, it was because she acquired right or title to it in some other way than by the mere operation of the statute under which the right to half of the property acquired by either husband or wife during marriage is vested in the wife. Such right is given by law to the wife, as such, because she is the wife, and not because of the performance of services to the husband, or because she is permitted by her companion to assume the station and enjoy the other privileges belonging-to a wife, where she is not such in law and fact.-

Under similar circumstances the Texas courts have held that the putative wife, who has acted in good faith, will be entitled to one-half of the property acquired by the joint labor of the two. Barkley v. Demke, 87 S. W. 1147; Morgan v. Morgan, 21 S. W. 154; Lawson v. Lawson, 69 S. W. 247. In Ft. Worth & R. G. Ry. Co. v. Robertson, 131 S. W. 400, it was held that this interest of the putative wife did not apply to all property acquired during coverture but only to so much as was the result of t-heir joint efforts.

From a consideration of these and other Texas decisions we reach the conclusion that the interest of either spouse in the earnings of the other arises as a matter of law from the marital relationship and as a matter of fact does not depend upon the existence of any joint effort.

The income-tax statute here under consideration defines earned income to mean “ amounts received as compensation for personal services actually rendered.” We find no basis in the facts here shown to hold that one-half of the income from the services rendered by petitioner’s husband was in fact, or in contemplation of the laws of the State of petitioner’s domicile, received as compensation for personal services actually rendered by this petitioner.

For the purposes of this opinion we have assumed that counsel for petitioner are correct in their contention that the decisions of the state court would be accepted as binding in determining whether or not the amount in question came to the wife as earnings from her services. It is by no means clear that the legal principle relied upon by counsel goes to any such extent, for it may well be that the statute grants the preferences only to the one who performs the services for the employer, without regard to the ultimate disposition of the proceeds under the state law. See United States v. Robbins, 269 U. S. 315. If such be the proper interpretation of the statute the petitioner would be without any ground on which to base her contentions.

Reviewed by the Board.

Decision will be entered for the respondent.


source: Caselaw Access Project

author: MoRRis:

license: Public Domain

text:
    A. G. & S. Mining Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9229.
    Promulgated November 7, 1927.
    Value of leasehold on coal lands at the date of acquisition for depletion purposes determined.

      H. A.. Eeilma/n, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
    This proceeding is for a redeterinination of income and profits taxes for the years 1918 to 1922, inclusive. The deficiency notice sets out the respondent’s determination as to the various years as follows:

    The question raised is the value of the leasehold for depletion purposes.
    FINDINGS OP FACT.
    The petitioner is a Pennsylvania corporation with its principal office in Kittanning. It succeeded a partnership composed of Joseph L. Apple, Arthur S. Gruskin, and Mark H. Snyder. The partnership was engaged in the coal business and prior to securing the leasehold hereinafter mentioned, the several partners had spent considerable time and money prospecting in various places for coal properties.
    On or about September 18, 1917, by a certain indenture entered into between Mark H. Snyder, for the partnership, and one J. H. Painter, the partnership became the lessee of the coal underlying approximately one hundred acres of land located some three-fourths of a mile from the outskirts of Kittanning, Pa. The lease granted “ to the lessee the right and privilege of mining and removing all the merchantable and workable coal lying and being in and under all that certain tract of land located * * together with the necessary rights for developments and operations. The consideration for the lease was a minimum royalty of $600 per year payable monthly after the first year, the lessor’s royalty per net ton to be 15 cents unless lessee should fail to make a profit of 25 cents per net ton in which event the royalty would be reduced to 10 cents per ton. The term of the lease was 10 years.
    The leasehold fronted on the Pennsylvania Railroad and the Allegheny River and was within the Buffalo shipping district, thereby securing a lower rate than Pittsburgh freight by 25 cents per ton. Labor was plentiful because the miners could live in Kittanning, and this fact saved the partners the expense of constructing a mine village. Transportation facilities were good as the mine had street car service from Kittanning and also was easily accessible by automobile. Power for operating was purchased from the West Penn Power Oo.
    The partners partially developed the property prior to incorporation, installing machinery, driving the entries, and building their own railroad siding. They put in mine cars, cutting machines, rails, pit mouths, an incline, tipples, a blacksmith shop, and certain other mine equipment. The total cost of preparing the mine for operation was $32,000. The respondent admitted that this amount represented such cost and used the same for depreciation purposes.
    On or about November 12, 1918, the partners incorporated, turning over the mine and the leasehold to the corporation for $75,000 in capital stock. The values allocated to the assets were $32,000 for the plant, equipment and development and $43,000 for the leasehold.
    In August or September of 1918, Wallwork, a coal operator, and his father, located two and one-quarter miles north of petitioner’s mine, investigated the property in question with the view of purchasing the same. After their investigation, they offered to purchase the property for $75,000. Their offer was made with full knowledge of the royalty terms of the lease and was based upon their own estimates of the merchantable coal available, the value of the mine equipment, the location of the mine, shipping, labor, and other facilities. Thereafter in August, 1919, the Wallworks again offered to purchase the property from the petitioner. Their last offer was for $97,000.
    The partners also received an offer to purchase the property just prior to incorporation from Davis, Kops & Co., a Pittsburgh brokerage house. This offer was for $75,000. About a year later, namely, on October 8, 1919, Davis, Kops & Co. advised petitioner that they would pay approximately $93,750 for the property, accompanying their letter with a certified check for $5,000.

      The tonnage of merchantable coal available was approximately 120,000 tons and it was estimated that the coal would be worked out in six or seven years.
   OPINION.

MoRRis:

It appears from the deficiency notice that the only year in which respondent asserted a deficiency is the year 1920. As our jurisdiction is limited under the statute to the years in which a deficiency is asserted, it follows that the petition will have to be dismissed as to each and every year here involved except the year 1920. Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

The actual cash value of the leasehold has, in our opinion, been definitely established by the petitioner to have been $43,000 at the time acquired. Two offers to purchase the entire property for $75,000 were made just prior to incorporation by separate parties, and both parties subsequently offered still larger amounts for the property. The respondent admitted that the plant and equipment cost $32,000, being the value urged by the petitioner, which leaves $43,000 to be allocated to the leasehold. It is our opinion that the latter value should be used for depletion purposes.

Judgment will be entered on 10 days’ notice, under Rule BO.

Considered by Trammell, Murdock, and Sleeken.


text:
    Appeal of Morand Brothers.
    Docket No. 1351.
    Promulgated November 7, 1927.
    1. Obsolescence of intangible assets disallowed.
    2. Tbe deduction of an alleged loss of intangibles under section 234 (a) (4) of tbe Revenue Act of 1918, due to prohibition legislation, disallowed.

      James W. Good, Esq., for the petitioner.

      Briggs G. Simpieh, Esq., for the Commissioner.
    This is an appeal from the determination of deficiencies in income and profits taxes of $146,193.14 for 1918, and $7,051.69 for 1919. The deficiencies arise from the Commissioner’s action in disallowing deductions from gross income for each of the years because of an alleged obsolescence of good will and intangible assets such as trademarks, trade-brands, etc., due to the adoption of war-time prohibition, the eighteenth amendment, and the resulting prohibition enforcement acts.

      BINDINGS OB BACT.
    Morand Brothers began business as a partnership in 1884 in the City of Chicago, the business being the wholesaling and retailing of domestic and imported alcoholic beverages. On March 1, 1911, the business was incorporated as Morand Brothers, with a capital stock of $300,000. From and after the date of incorporation the accounts of Morand Brothers were kept on the calendar year basis. Prior to March 1, 1911, the books had been kept on a fiscal year basis ending September 30.
    Prior to 1905 Morand Brothers had employed traveling salesmen. In that year, in response to a questionnaire from the firm suggesting a change in selling policy, which was heartily approved by the trade, sales by traveling salesmen were discontinued. Thereafter Morand Brothers sold directly to the customer by means of wholesale price lists. These lists were mailed to all customers and prospective customers.
    The wholesale lists began circulation as a four-page pamphlet containing wholesale prices of domestic and imported stocks. Morand Brothers naturally pushed their own trade-brands and private stocks but listed other brands and importations which were carried in stock for the trade. The pamphlet increased in size and became very widely circulated. In 1908 the former four-page pamphlet had so increased in size and circulation that it was made a monthly publication and called “Morand Brothers Liquor Buyer’s Guide.” The June, 1909, edition of the Guide was a 52-page publication containing numerous two and three-colored cuts and printed in two-colored type. Liquor manufacturers and distillers had recognized it as the outstanding authority on wholesale liquor prices in the United States, and were buying considerable space in each edition to advertise their own goods. The publication was mailed to customers and prospective customers free of charge, the total circulation being between 20,000 and 30,000.
    For a number of years the publication netted Morand Brothers a nice profit besides advertising and pushing their own goods, as shown by the following table of gross income, expense and net income:

      The gross income represented receipts from advertising space sold, while expense represents the cost of publishing. By June 1916, the Guide had grown to be an 84-page publication. The losses sustained after 1915 resulted from several reasons. Morand Brothers were pushing their own brands and private stocks, the advertising, particularly of foreign goods which had to be imported, fell off due to the war, and the increased size of the publication resulted in a corresponding increase in the cost of publishing. Morand Brothers Liquor Buyer’s Guide was discontinued after March 31,1918.
    The principal customers of Morand Brothers were the Chicago department stores, saloohs, and hotels. This business was solicited by telephone and by the wholesale price lists. The department stores bought large quantities of Morand Brothers’ wines, and the petitioner established its own brands of wine and built up a very large business. The same was true of other brands of alcoholic beverages that Morand Brothers had fostered and established among the trade, such as Morand’s Mellow Bye, Morand’s Kentucky Bourbon, Morand’s Private Stock, and various brandies and wines specialized in by the petitioner. Imported liquors and well known brands of manufacturers and distillers that sold by their trade names, were carried by the petitioner.
    Morand Brothers sold the retail trade by means of wagons and retail stores. About 35 or 40 wagons were operated to sell to retail customers, while three retail stores were operated in Chicago. These three stores were owned outright and entirely by Morand Brothers, but operated under the name of A. L. Simmons & Co. A considerable amount of business was also secured outside of Chicago by correspondence and the wholesale price lists.
    The volume of business done by Morand Brothers is shown by the sales for the period October 1,1907, to December 31, 1922:

      Segregation of sales

      Due to the demand from the trade and particularly from department stores, Morand Brothers began handling ginger ale, mineral waters and other soft drinks. The soft drinks were handled as an
    accommodation and for the purpose of keeping its customers. The soft drinks were handled on a small margin which was barely sufficient to net a profit over actual costs. The groceries sold for the five years shown were principally coffee and tea.
    On July 1, 1919, when war-time prohibition became effective, the petitioner discontinued all sales of liquor. The department-store business, hotel, saloon, retail stores, wagon, and all other sales had to cease. The petitioner did continue to sell ginger ale and soft drinks, but sustained substantial losses in so doing. The sale of soft drinks, where made to a department store that had been a customer for wines and liquors, had to be made to different departments and to new people. New contracts for the sale of soft drinks had to be made, as many of the former customers had gone out of business because of prohibition.
    The books of Morand Brothers show invested capital for the years prior to March 1,1913, and subsequent thereto as follows:

    The amounts given for the fiscal years up to March 1, 1911, represent capital and surplus; after March 1,1911, the amounts represent the total of capital stock, $300,000, plus the surplus at the end of the year.
    Morand Brothers never carried a good will account on the books of the partnership or the corporation. The capital stock was issued for cash; no stock was ever issued for good will. The value of good will on March 1, 1913, was at least $250,000.
    The petitioner alleged no specific value for good will in the petition but for the years 1918 and 1919 took certain deductions for alleged obsolescence of good will due to prohibition. The disal-lowance of these amounts as deductions by the Commissioner resulted in the deficiencies asserted for 1918 and 1919.
   OPINION.

MoRRis:

The issue presented by this proceeding is whether petitioner is entitled, as a matter of statutory right, to deductions from the income of the years under consideration for obsolescence of intangibles alleged to-have been destroyed by prohibition legislation. The question has already been decided adversely to the petitioner; and the determination of the respondent must be approved. Red Wing Malting Co. v. Willcuts, 15 Fed. (2d) 626; Appeal of Manhattan Brewing Co., 6 B. T. A. 952; Appeal of Olt Bros. Brewing Co., 6 B. T. A. 974; Appeal of Standard Brewing Co., 6 B. T. A. 980; Appeal of Star Brewing Co., 7 B. T. A. 377; and Frederick C. Renziehausen v. Commissioner, 8 B. T. A. 87.

In a supplemental brief, petitioner presents the alternative proposition that it is entitled, under the provisions of section 234 (a) (4) of the Revenue Act of 1918, to deduct from income the loss, based on March 1, 1913, value, arising out of the destruction of its intangibles by prohibition legislation; although it contends that the loss should be spread over the years 1918 and 1919 in conformity with the same principle which would apply in the case of obsolescence. It is difficult to apprehend that the claimed deductions may be brought within the provisions of the statute upon which the petitioner relies. They provide for the deduction of only such losses as are “sustained during the taxable year”; and surely the facts do not support a finding that petitioner has sustained such a loss as to bring it within those provisions. A loss is sustained, within the meaning of the statute, only when it is a realized loss and is evidenced by a completed and closed transaction, Appeal of A. J. Schwarzler, 3 B. T. A. 535; Appeal of Old ’76 Distilling Co., 3 B. T. A. 1346; and A. H. Fell v. Commissioner, 7 B. T. A. 263; and until the investment is converted into terms of money by sale or other disposition, or its worthlessness otherwise demonstrated, there is neither loss nor gain and income is neither greater nor less. Marigold Garden Co. v. Commissioner, 6 B. T. A. 368. Petitioner continued in business after the advent of prohibition; and its good will continued as an inseparable part of the business. There could be no loss in respect of the good will until the business is terminated by sale or other disposition, and neither of those events occurred within the taxable years in question. Cf. Frederick C. Renziehausen v. Commissioner, supra. It is literally true that prohibition wholly destroyed the predominating and most lucrative feature of its business; and that after the advent of prohibition it carried on with a mere remnant of its former business, in new marts of trade. But the most favorable view to the taxpayer to be had in these circumstances is that the March 1, 1913, value of its good will was greatly diminished by prohibitory legislation; but a loss of this character is not within the statute.

It is useless to argue the equities of a case in which a taxpayer’s business has been destroyed, either in whole or in part, by legislation. There are no equities save those that are founded upon the taxing statutes. Diminishing values, unrealized until converted into terms of money, are an ever present and necessary evil in our complex economic structure. Nothing of value, whether tangible or intangible, is immune to fluctuations in market values. The particular cause is of no importance whatever; and losses in value resulting from the acts of the sovereign have no preferred standing under the taxing statutes. As was said in Marigold Garden Co. v. Commissioner, supra—

In considering the principle, the particular cause of the claimed loss matters little, if at all. Uselessness to a taxpayer does not determine a deductible loss any more when attributable to a statutory prohibition than when attributable to any other extraneous cause over which the owner has no control.

Out of the whole value of the good will at March 1,1913, petitioner asks us to carve a lesser estate as assignable to the liquor business, and permit the deduction thereof as a loss in the years under consideration. This we may not do for reasons already stated; and even if we were to conclude, which we do not, that a part of the good will was severable from the whole and attached to the liquor business, there are no facts before us from which we could determine the value of that part. Cf. Appeal of Acme, Palmers & DeMooy Foundry Co., 3 B. T. A. 1126.

It is quite possible that certain of petitioner’s trade-marks and trade-brands, which were used exclusively in the liquor business, became obsolete with the advent of prohibition; but, as in the case of the good will, there are no facts before us from which we could determine whether or not the petitioner sustained a loss in respect of those assets.

Finally, if it were possible to hold that petitioner had sustained a loss in respect' of its intangible assets, as the result of prohibitory legislation, which could be deducted from income for the purposes of the tax, such loss would necessarily be based upon cost or March 1, 1913, value, whichever is lower; and as there are no facts before us from which we could determine the cost of these intangibles, we would have been unable to find that petitioner actually suffered a loss.

Judgment will be entered for the Commissioner.

Considered by TRAmmell, Murdock, and Sieekin.


author: Muedock:

text:
    Home Industry Iron Works, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7991.
    Promulgated November 7, 1927.
    1. Disallowance of a salary deduction, for tbe reason that it was not reasonable compensation for services rendered, approved.
    2. Commissioner’s determination that bonuses paid were in reality a distribution of profits approved.

      3. The fair market Value on March. 1, 1913, of the petitioner’s buildings determined.
    4. Rate for purpose of a deduction under section 234(a)(7), Revenue Act of 1918, determined. Deduction under section 234(a) (7), Revenue Act of 1918, on account of machinery and equipment and patterns disallowed for lack of evidence.
    5. Special assessment disallowed for lack of evidence.

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

      Harold Allen, Esq., for the respondent.
    The Commissioner determined deficiencies in income and profits taxes amounting to $13,305.51 for 1919, and to $2,882.48 for 1920. The petitioner alleges that there was error in (1) disallowing deductions for expenses incurred by officers in 1919; (2) disallowing a deduction of $3,900 as compensation paid to Mary Kling in each year; (3) disallowing a deduction of $21,000 as compensation paid to the officers and directors in 1920; (4) failing to allow depreciation in each year on the March 1, 1913, value of buildings, machinery and equipment, and patterns; and (5) denying special assessment for the year 1919 under section 328 of the Revenue Act of 1918. The first allegation of error was later waived.
    FINDINGS OF FACT.
    The petitioner is an Alabama corporation, with its principal office at Mobile. It was organized in 1902 for the purpose of taking over a business founded in 1885 and operated as a sole proprietorship by A. Kling, Sr. Machinists, molders, boilermakers, blacksmiths, and pattern-makers were employed for the most part, in connection with repairing and reconditioning ships. Vessels were not built, but the tasks of reconditioning were sometimes so substantial as to assume the character of rebuilding rather than of ordinary repair work.
    After the death of A. Kling, Sr., which occurred in 1917 or 1918, the petitioner remained a close corporation. The stockholders were his widow, Mary Kling, her two sons, C. W. Kling and A: Kling, Jr., and J. S. Bogue. The latter had been general manager for many years. Regular salaries totaling $16,399.55 were paid during the year 1919 to the above-named persons, all of whom were officers except Mary Kling, who was merely a director but received $3,900 of the above amount. In June, 1919, Mary Kling transferred 42 shares of stock to her daughter, Mrs. Goodman, and 42 shares to her son, Leo Kling. Thereafter, the stockholdings, the offices held, and the regular salary and bonus paid to the several officers and stockholders during the year 1920 were as follows:

    All stockholders were directors. Bogue and the three Kling sons devoted all of their time to the business. They did all of the office work during 1920, although a marked increase in business, evidenced by a gain in gross income from $329,606.62 in 1919 to $654,212.94 in 1920, multiplied their duties. Mrs. Goodman acted as a director, held no office, and had no regular appointed duties. She merely aided in a general way to obtain business for the petitioner. Mary Kling had assisted her husband in the development of the business and had become familiar with it. In August, 1920, she was 73 years of age and acted only in an advisory capacity during the years in controversy. She went down to the office several times monthly and her advice was sometimes obtained in business discussions at home.
    The additional compensation above listed as bonuses was agreed •upon and authorized during July of 1920 at a meeting, held informally in accordance with the usual practice. The bonus payments were made by checks a few days later. The petitioner had not theretofore paid compensation in the form of bonuses. Such payments, however, have been made in subsequent years. Dividends of $15,000 and $21,000, representing 50 per cent and 70 per cent of the outstanding capital stock, were declared in 1919 and 1920, respectively. The Commissioner disallowed the salary payments to' Mary Kling for both years, as not representing a return for services rendered, and determined that the bonus payments made in 1920 represented a distribution of profits rather than reasonable compensation for services.
    The petitioner’s buildings consisted of two large brick structures. Both were built prior to March 1, 1913. No additions or improvements have been made since that date. A large proportion of the machinery in use was installed in the early years of the petitioner’s business development. Repairs and replacements both prior and subsequent to 1913 were made by employees, the cost of labor and parts used being charged to expense. The machinery used in March, 1913, was substantially the same as that in use at present, save for some new machines purchased in the interim, at a cost of approximately $3,000.

      Equipment on hand included a large number of patterns. These had been made from time to time as needed and stored for possible future use. As patterns became obsolete, they were discarded to make storage room for others. The petitioner not only used these patterns, but occasionally rented them for use by others. The cost of pattern making was sometimes charged against the customer in connection with the job for which they were needed. At other times the cost was too great to be thus included and was charged to expense. No pattern account has ever been set up on the petitioner’s boobs and no cost records exist. The storage space devoted to patterns comprised three rooms, measuring 50 by 150 feet, 75 by 100 feet, and 45 by 100 feet. The number of patterns carried remained about the same from year to year. Some of those on hand on March 1, 1918, were still in use during the period in controversy, while others in storage then had been discarded from time to time during intervening years to provide room for others made during that time.
    No deduction for exhaustion, wear and tear, or obsolescence of buildings, machinery or equipment, including patterns, was claimed in the returns or allowed in computing the deficiencies.
    The Alabama Dry Dock & Shipbuilding Co., of Mobile, Ala., was engaged in a business similar in most respects to the one conducted by the petitioner. During 1919 and 1920 this company was a much larger organization than the petitioner and its volume of business' was correspondingly greater. The two businesses differed in that the petitioner’s work in the shipbuilding field was limited to repairs and reconditioning of vessels, while the other company built some new ships, including mine sweepers, during the years involved. The petitioner’s business also included several features not included in the business of the other company. The Commissioner determined the petitioner’s net income for 1919 to be $56,692.57, and its excess-profits-tax liability for that year to be $15,865.38, which is in excess of 27 per cent of the taxable income. The excess-profits tax paid by the Alabama Dry Dock & Shipbuilding Co. was 18.4 per cent of its net income in 1919, and 22.1 per cent of its net income in 1920. The Commissioner in his calculation of the deficiency for 1919 used $110,922.21 as the amount of the petitioner’s invested capital for the year.
   OPINION.

Muedock:

This Board is slow to reject the opinion of a corporation’s directorate as to the reasonableness of salaries. However, when the Commissioner has determined that a salary is unreasonable a certain burden of proof rests upon the petitioner to overcome the presumption in favor of the Commissioner’s determination. The determination herein denies the reasonableness of the salary of $3,900 paid to Mrs. Mary Kling in each of the years 1919 and 1920. The payment of such a salary to a woman 72 years old, who was merely a director giving occasional advice, is, to say the least, exceptional. Her services do not seem to exceed those that a principal stockholder might be expected to give to a corporation. It further appears that she is the mother of all but one of the other stockholders. In view of these circumstances we would require more convincing proof of the reasonableness of her salary than has been presented before we would hold that the Commissioner was in error as to this point.

It may well be that the officers of this corporation were deserving of more than their regular salaries as compensation for their extraordinary services in 1920. But the Commissioner has determined that the bonuses paid in that year were in reality a distribution of profits. They went to all stockholders in almost direct proportion of stockholdings without regard to services performed. Two of the stockholders rendered no services justifying the bonuses paid to them. These facts lead us to believe that the Commissioner was correct and we so hold.

The petitioner claimed that for the purpose of a deduction under section 234(a) (7) of the Revenue Act of 1918, its buildings had a fair market value on March 1, 1913, of at least $25,000 and that 2 per cent was a proper rate to allow for their exhaustion, wear and tear, and obsolescence. To support its contention it called two witnesses, each of whom knew the buildings in 1913. The one was an experienced contractor and the other was an architect. From their testimony we find that a value for the buildings of at least $25,000 has been established and that the deduction should be computed at the rate of one per cent for each year. The value and the rate might well be higher, but the burden of proof was upon the petitioner and the evidence does not justify any increase over these figures.

In order to allow any deduction under this section for machinery and equipment we must know not only the value or cost but also the proper rate to apply to that value or cost. There was some evidence from which we might find the March 1, 1913, value of the machinery and equipment, but there is no satisfactory or convincing evidence to establish the rate. It appears that exhaustion, wear and tear were offset to a very large extent by repairs charged to expense. The only rate mentioned was far from a proper one as shown by other evidence. Consequently we can not allow any deduction on account of this property. The same is true in regard to a deduction on account of patterns. The evidence gives us no idea of a proper rate.

The petitioner’s remaining allegation of error is based on the Commissioner’s refusal to give the benefit of sections 327 and 328 of the Revenue Act of 1918 in the computation of the petitioner’s excess-profits tax for 1919. To show that this was error it alleges that its tax was disproportional to the tax of its competitors, due partly to the fact that its salary deductions were disallowed. The evidence fails to disclose any abnormalities within the intendment of section 327 (d) of the Act.

iJudgment will be entered on notice of 15 days, wider Rule 50.

Considered by TRAmmell, Moerts, and Siefkin.


author: TRAmmell :

text:
    Estate of Ernest Gustav Hoffman, Deceased, William D. Sporborg, as Administrator, c. t. a., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7914.
    Promulgated November 7, 1927.
    - The value at March 1, 1913, of certain patents, for the purpose of determining the exhaustion allowance, determined.

      Thomas F. J. Connolly, Esq., for the petitioner.

      L. L. Sight, Esq., for the respondent.
    This proceeding is for the redetermination of deficiencies in income tax for the years 1920 and 1921 in the amounts of $1,590.96 and $106.19, respectively. Petitioner assigns the following errors: (1) That respondent made an error of addition in the amounts of the normal tax and surtax composing the asserted deficiency for the year 1920; (2) that respondent erred in spreading the allowance for exhaustion of the value of two certain patents, as determined by him, over a period of 15 years, for the reason that the patents in question had on March 1, 1913, an unexpired life of approximately 8% years and 9-/% years respectively; (3) that respondent erred in refusing to segregate the amounts of royalties received from the patents as to capital and income in the manner set out in the decree of the Supreme Court of the State of New York dated June 19, 1920; and (4) that the respondent erred in fixing the value of the patents on March 1, 1913, at $16,666.66.
    FINDINGS OF FACT.
    The petitioner is the administrator, with the will annexed, of the estate of Ernest Gustav Hoffman, deceased. He resides in the town of Rye, N. Y., and his office at Port Chester, N. Y. Hoffman died in 1908, possessed, among other things, of two certain patents relating to ball bearings, dated November 8, 1904, and August 6, 1905, respectively. Decedent left a last will and testament in which he created a trust of his entire estate for the benefit of his widow and daughter. The income from the trust was to be paid over to the widow for the support and maintenance of herself and child until the child attained the age of 21 years, when the capital or corpus of the estate was to be divided between them.
    Under date of August 1, 1910, the executors of the estate entered into a contract with the Norma Company of America for the manufacture of ball bearings under the patents above mentioned. The licensee agreed to pay a royalty equal to the amount of one cent for each ball bearing manufactured, sold, or used, and guaranteed a minimum. annual royalty of $2,500. The term of the contract was coextensive with the remaining life of the patents.
    The Supreme Court of the State of New York, at a term held in and for the County of lYest ches ter on June 19, 1920, in a proceeding wherein the administrator of the estate was plaintiff and the beneficiaries under the ivill were defendants, decreed that the sums received by way of royalties upon agreements permitting the use of the patents in question be treated as partly principal and partly income, to be determined in the following manner: The sum should be ascertained and determined which, invested at the rate of 6 per cent per annum, would produce the sums received from time to time as such royalties, and this amount should be deemed principal and the balance should be deemed income.
    The manufacture of ball bearings under the Hoffman patents was commenced in March, 1911, and thereafter they were manufactured in the quantities as follows:

    The petitioner kept his accounts on the fiscal year basis. During the fiscal year ended March 31,1912, there was manufactured a total of 27,623 bearings, and the royalty thereon at the rate of one cent each amounted to $276.23. Accordingly, the licensee for that year was required to pay the minimum royalty of $2,500. During ihe fiscal year ended March 31, 1913, the total number of ball bearings manufactured was 206,336, on which the royalty at one cent each amounted to $2,063.36. For that year also the licensee was required to pay the minimum royalty of $2,500. During the three succeeding fiscal years, the number of bearings manufactured and the royalties paid were as follows:

    A total amount of approximately $92,000 was paid by the licensee to the estate under the contract from March, 1911; to November, 1921, as royalties for use of the Hoffman patents. In 1913, the ball-bearing industry was still in an experimental stage, but shortly thereafter began to develop rapidly. The patents here involved covered valuable improvements and corrected defects in bearings then in use. The first ball bearings manufactured were placed on the market about 10 years prior to that date. At March 1, 1913, one of the Hoffman patents had an unexpired life of approximately 8% years and the other patent had an unexpired life of approximately 9-^ years.
    The books of the estate were kept on the cash receipts and disbursements basis.
   OPINION.

TRAmmell :

The issues involved in this proceeding are sufficiently set out in our preliminary statement above. The first two issues relating to a mathematical error and the life of the patents after March 1, 1913, have been admitted by the respondent and further reference thereto is unnecessary.

With reference to the third issue, the petitioner contends that the royalties received from the patents involved herein should be allocated in part to income and in part to capital, in the manner provided in the decree of the Supreme Court of the State of New York dated June 19, 1920. The respondent urges that the decision of a state court determining what is income and what is capital as between tenants for years and remainderman can not affect the character of a receipt as income under the laws of the United States.

Royalties, like rent, are inherently income and have been commonly so considered. Appeal of Nelson Land & Oil Co., 3 B. T. A. 315; Arthur H. Fleming v. Commissioner, 6 B. T. A. 900, Appeal of Mary E. McCahill, 2 B. T. A. 875. In Arthur H. Fleming v. Commissioner, supra, we said:

That royalties from mining ore are income and not the return of capital has been settled ever since the decisions in Stratton’s Independence v. Howbert, 231 U. S. 399; 34 Sup. Ct. 136; and Von Baumbach v. Sargent Land Co., 242 U. S. 503 * * *.

Royalties received from licenses to use patents are no less income than royalties received by lessors of ore deposits. The entire amount thereof constitutes gross income. The patents were not sold. The licenses merely provided for the right to use the patents and to manufacture articles thereunder. No part of the royalties represents, under the Revenue Act in question, a return of capital. The Revenue Act, however, does make provision for deductions from the royalties received of such amounts during the life of the patents so that their value on March 1, 1913, or their cost if subsequently acquired, is returned to the taxpayer by the time the patents have become exhausted. Appeal of Union Metal Manufacturing Co., 1 B. T. A. 395. Deduction for the exhaustion of the patents has been allowed. It is only by virtue of the deduction by statute that the entire amount thereof is not subjected to tax. Von Baumbach v. Sargent Land Co., supra; Stratton’s Independence v. Howbert, supra.

There remains for consideration only the question of the fair value of the patents at March 1, 1913. Petitioner contends that the value of the patents was greatly in excess of that determined by the respondent, and presented the testimony of two witnesses who were qualified by training and experience to express their opinions. One of them testified that in his opinion the value of the patents at the basic date was $60,000, and the other testified to a value of $65,000. The respondent took as the basis for determining the value of the patents, the minimum annual royalty of $2,500, which he capitalized, at 15 per cent, and thus fixed the value of $16,666.66.

In determining the value of assets, such as patent rights, the valuation should be based upon the facts known at the time as of which the valuation is being determined. Subsequent earnings can not be used in the determination, unless from past experience or known facts such future earnings might reasonably have been anticipated. Appeal of Dwight & Lloyd Sintering Co., 1 B. T. A. 179.

We are satisfied that the minimum royalty basis, under all the facts and circumstances of this case, is not the proper basis upon which to determine the value. We have evidence as to the superiority of the bearings made under these patents as compared to any in use at the time. The improvements made by these patents largely corrected defects which had existed in bearings made by others. It had been sought for some time to make more perfect and more endurable bearings. The sale of these bearings increased very rapidly from the time their manufacture commenced in March, 1911. For the remaining 9 months of that year 15,349 bearings were manufactured, while for the year 1912 the number increased to 161,321, more than ten times as many. In 1913 the number manufactured increased nearly three times over the number for 1912. There was a constant material increase each year. In 1916 the number reached 1,112,334. The continuing increase in the demand for these improved bearings, according to the testimony, could be reasonably anticipated on March 1,1913.

In view of all the evidence, it is our opinion that the patents had a value on March 1, 1913, of $40,000, which amount should be spread over the life of the patents.

Judgment will be entered on 15 days’ notice, wider Rule 50.

Considered by Morris, Murdock, and Siefkin.


author: Trammell:

text:
    Louis Chamansky, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11646.
    Promulgated November 7, 1927.

      Louis Ohamanshy pro se.

      Jamies A. O'*Callahan, Esq., for the respondent.
   Trammell:

This is a proceeding for the redetermination of a deficiency in income tax for the year 1921 in the amount of $417.91. There is in dispute only the amount of $75.26, which results from the action of the respondent in adding to petitioner’s income for 1921 the amount of $1,006.93, received from an endowment policy in excess of the total amount of premiums paid in.

This case was submitted on the pleadings, respondent in his answer having admitted the facts alleged in the petition to be true.

Petitioner alleged in his petition that the amount received on the endowment policy represented partly interest and partly dividends, and that under article 47 of Regulations 62 his tax liability should be computed as set out in his petition, which computation showed a 'deficiency of $342.65 instead of $417.91 as determined by the respondent.

In the computation set out in the petition, the amount of $66.19 was allocated by the petitioner to interest, subject to both normal and surtax, and the amount of $940.74 was allocated to dividends, subject only to surtax. The respondent contends that the entire amount of $1,006.93 was subject both to normal and surtax and so computed the deficiency.

While the respondent admitted in his answer the facts alleged in the petition, he specifically denied that the amount in question was a distribution on a paid-up policy of insurance and that the amount received by the petitioner should be treated and taxed as income from dividends. In view of the answer, we can not accept as an admitted fact the figures used by the petitioner in his computation.

On this state of the record, we can not determine that the respondent committed error. The determination of the respondent is approved. See Appeal of E. A. Armstrong, 1 B. T. A. 296.

Judgment will be entered for the respondent.

Considered by Moréis, Murdock, and Seefkin.


text:
    G. H. Hill and H. H. Hayes, Administrators, Estate of C. W. Goodin, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4420.
    Promulgated November 7, 1927.

      1. Held, that a note bad no value at the time of decedent’s death.
    2. Evidence held insufficient to support the contention that the net estate had a lower value than the specific exemption provided for in the statute.

      Perry TV. Shrader, Esq., for the petitioners.

      G. H. Curl, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in estate tax of $305.67. The deficiency results in part from the inclusion in the net estate of certain notes valued by respondent at $41,815.44.
    FINDINGS OF FACT.
    C. W. Goodin, a resident of Ottawa, Franklin County, Kans., died intestate on July 28, 1922.
    Prior to his death the decedent was engaged in the business of loaning money on second mortgages and unsecured notes. In order to carry on this business it was necessary at times for him to borrow money. At the time of his death, decedent held several hundred notes and mortgages ranging in amount from $5 to more than $37,000. Part of these were secured and part were not. An appraisal of decedent’s property including notes and mortgages was made by appraisers appointed by the probate court of Franklin County, Kansas, and a report filed with the court. In this report a note of John R. Wimmer for $21,000 and four notes of the City Securities Co. for $800, $500, $240, and $700, respectively, as well as a number of other notes, were shown to have been appraised as not having any value at the time of the decedent’s death. In the return filed for Federal estate-tax purposes by the petitioners the note of Wimmer and those of the City Securities Co., as well as other notes, were reported as having had no value at the time of the decedent’s death. The administrators have spent about $1,600 in an attempt to realize on the Wimmer note, but have found that nothing can be collected on it.
    In an audit of the return filed by the petitioners, the respondent deteimined that the Wimmer note had a value of $11,000, at the time of decedent’s death and that the face value of the notes of the City Securities Co. represented their actual value. The respondent alsg determined that certain other notes as well as other property had a greater value than that reported in the return.
   OPINION.

Trammell:

The petitioners contend that the respondent erred (1) in not excluding from the assets of the estate many worthless and unsecured notes, (2) in finding that the net value of the estate, if it had any value, was more than $25,000, and (3) in not finding that the net worth of the estate was less than the specific exemption of $50,000 allowed under the Revenue Act of 1921.

There were listed in the petition filed in this proceeding 64 notes which the- respondent determined had a total value of $41,815.44 at the date of decedent’s death. The petitioner contends that the respondent’s valuation is erroneous and that the notes had a total value of only $8,524.77.

The probate court of Franklin County, Kansas, appointed three competent and well qualified persons to make an appraisal of the decedent’s property. One of these, J. R. Findley, was produced as a witness in behalf of the petitioners and testified that in his opinion the Wimmer and the City Securities notes were worthless when the appraisal was made.

He had been in business in Ottawa for about 20 years and at the time of making the appraisal in 1922 was engaged in the real estate business. Prior to 1922 he had been engaged in the banking business for about 15 years and was familiar with the financial condition of the people in and around Ottawa. Upon oral instructions of the probate court the appraisers included in their appraisal at face value all the notes of persons whose financial standing was unknown to them and about which they were unable to obtain any information. In their report the Wimmer note and the City Securities notes were appraised as having no value. This appraisal was accepted by the probate court.

From all the evidence, considering the fact that the appraisers were familiar with persons living in the county, their financial standing and the values of securities, the fact that if they did not know the conditions, they reported them at face value, and other corroborating facts, we think that the return for estate-tax purposes was correct insofar as it returned the above notes as having no value. The action of the respondent with regard to these notes is therefore disapproved.

There was no preponderance of evidence that the value of the other notes was less than the amount determined by the respondent. The evidence in support of the contentions that the net value of the estate was not more than $25,000 and less than the $50,000 specific exemption provided for by the Revenue Act of 1921 is general and indefinite. It consists of the expressions of opinion by one of the administrators and by one of the appraisers that the valuation placed on the notes in the original appraisal was too high. Their opinions appear to have been so largely based or influenced by subsequent events and developments which affected the values that we attach no weight to them. It does not convince us that the values at the date of the death of the decedent were less than the values determined by the respondent.

Judgment will he entered on 15 day's1 notice, under Rule 50.

Considered by MoeRis, Muedock, and Siefkin.


author: Thammell :

text:
    Zenith Milling Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5454.
    Promulgated November 7, 1927.
    1. Value of buildings and maebinery on March 1, 1913, determined.
    2. Paid-in surplus at tbe time of incorporation in 1907 determined.
    3. Tbe profits of tbe petitioner credited to tbe accounts of tbe stockholders in proportion to their holdings without tbe formal declaration of dividends held not to constitute part of petitioner’s surplus for invested capital purposes.
    - perry W. Schrader, Esq., for the petitioner.

      G. H. Curl, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency of $4,448.13 income and profits tax for the year 1919. The deficiency results from the respondent’s refusal to accept as correct the amount of invested capital reported by the petitioner and in determining the March 1, 1913, values of certain assets for depreciation purposes at smaller amounts than the values at which they were included in the returns filed.

      FINDINGS OF FACT.
    The petitioner is a Missouri corporation with its principal office at Kansas City.
    In 1880 the Zenith Milling Co. was incorporated under the laws of Missouri with a capital stock of $50,000, and took over the milling business, theretofore conducted by L. M. Miller, C. A. Young and L. S. Mohr, as a partnership. Miller and Mohr were brothers-in-law and Mohr and Young were cousins. The company took over the real estate and machinery previously belonging to the partnership, set these up on its books at a value of $50,000, and issued therefor all of its capital stock to the partners.
    The original mill, which had a capacity of 150 barrels a day, was enlarged from time to time until in 1907 it had a daily capacity of 1,000 barrels.
    On June 19, 1905, the charter expired. However, the business was carried on and continued in the same manner as had been done previous to the expiration of the charter. Miller on November 10, 1906, assigned and delivered to his wife Mabel A. Miller, the certificate for his 167 shares of stock in the company. About the first of 1907 and shortly before the death of Miller, trouble arose between Mohr and Mabel A. Miller, in regard to her withdrawal of certain amounts of money from the business. It was then discovered by counsel for Mohr and Young that the company’s charter had previously expired.
    The company was reincorporated under the same name on February 8, 1907, with a capital stock of $50,000 divided into 500 shares of a par value of $100 each. The .incorporators and the number of shares subscribed for by each were:
    Shares
    L. S. Mohr_ 249
    O. A. Young- 250
    Paul M. Mohr_ 1
    There was no reorganization of the business, which continued as before. No change was made in the books and all that was done was to obtain a new charter. Balance sheets were not prepared at this time.
    The board of directors on March 1, 1907, adopted the following resolution:
    Upon motion of Charles A. Young, seconded by Paul M. Mohr, the following resolution was unanimously adopted: “Resolved that the company purchase all the property and assets of the Zenith Milling Company, a corporation whose charter expired on the 19th day of June, 1905, from the surviving trustees of said corporation, the consideration of said purchase to be, with the consent of the stockholders of this corporation, and the Directors present at this meeting, being all the stockholders, that there shall be issued to each holder of stock of said defunct corporation, the same number of shares of the same par value in this company, and. that this company shall further assume, and it does hereby assume all the liabilities of whatsoever character of said defunct Zenith Milling Company, and that the President and Secretary of this company be and they are hereby ordered to deliver to the surviving trustees of said defunct company the following certificates of stock in this company — -One in the name of Mabel A. Miller of One Hundred and Sixty-seven (167) shares, one in the name of Charles A. Young of One Hundred and Sixty-seven (167) shares, one in the name of Lewis S. Mohr of One Hundred and Sixty-five (165) shares, and one in the name of Paul M. Mohr of One (1) share, for the use and benefit of the persons named respectively.
    Mabel A. Miller declined to accept the 167 shares of stock for which a certificate had been issued in accordance with the foregoing resolution, and threatened legal action against the corporation. Negotiations were entered into for the purchase of her interest in the property and on September 12, 1907, the following resolutions were adopted at a meeting of the board of directors:
    Whereas, Louis M. Miller on the 10th day of November 1906 assigned in writing and delivered to' Mabel A. Miller a certificate for One Hundred and Sixty-seven Shares of the Zenith Milling Company organized June 19, 1880 and
    Whereas the period of existence of said Zenith Milling Company expired June 19, 1905 and the transfer of stock made Mabel A. Miller the owner of an undivided interest in both the real and personal property of said Zenith Milling Company in proportion to the shares of stock owned by her and
    Whereas the Zenith Milling Company a corporation organized July 8, 1907 desires to purchase her interest in said property and she is willing to accept the sum of Fifty Thousand Dollars therefor, on motion of C. A. Young seconded by Paul M. Mohr, the President of this Company is directed to purchase the interest of said Mabel A. Miller, at and for the suni of Fifty Thousand Dollars and to pay for the same as follows:
    Twenty-five Thousand Dollars in a certified cheek of this Company payable to the order of Mabel A. Miller at the First National Bank of Kansas City, and to execute on behalf of this Company its two promissory notes, one for the sum of Ten Thousand Dollars and payable on or before six months from date with interest at the rate of six per cent per annum, and one note for the sum of Fifteen Thousand Dollars payable on or before twelve months after date with interest at'six per cent per annum, payable semi-annually, both of said notes shall be payable to Mabel A. Miller at the office of Barber & Barber in Kansas City, Missouri, and said cash is paid and notes executed and delivered to said Mabel A. Miller for the purpose of paying said Mabel A. Miller for her interest in as well as for her stock in the Zenith Milling Company a corporation organized June 19, 1880 and whose assets and property of every kind and description were sold and transferred by said Lewis S. Mohr and Charles A. Young as trustees to this Company of date March 1st, 1907.
    Mabel A. Miller having this day sold to this Company her interest in the Zenith Milling Company, a corporation organized June 19, 1880, and the corporate existence of which expired June 19, 1905, and whose assets have been purchased by this Company, and to whom Certificate No. 3 for 167 shares of this Company was issued for the purpose of paying for her interest in said Zenith Milling Company organized June 19, 1880, having declined to accept the same, it is now ordered that Certificate No. 3 for 167 shares of the capital stock of this ' Company standing in the name of said Mabel A. Miller and Raving been issued for said purpose but not delivered to said Mabel A. Miller, be and the same is now cancelled and for naught held.
    Lewis S. Mohr and Charles A. Young being now desirous of purchasing the stock heretofore issued to said Mabel A. Miller, it is now ordered that said 167 shares of said capital stock be sold to said Lewis S. Mohr and Charles A. Young, and that they pay to this Company the value thereof, and that said sum of money be placed to the credit of the capital stock of this Company on its books, so that the entire capital stock of this Company as it appears from this date is as follows:
    Lewis S. Mohr 249 shares, Charles A. Young 250 shares and Paul M. Mohr 1 share, and all of which said capital stock is now fully paid up.
    Pursuant to the above resolution, Mabel A. Miller was given a check for $25,000 and two notes of the company, one for $15,000 and the other for $10,000, both of which were subsequently paid. Of the total of $50,000 represented by the check and notes, $25,000 was in payment of the credit to which she was entitled, and the remaining $25,000 was for her stock. On September 14, 1907, L. S. Mohr and C. A. Young entered into the following agreement:
    Whereas, Lewis S. Mohr, and Charles A. Young are the equal owners of the entire capital stock of the Zenith Milling Company, a corporation; and
    Whereas, Lewis S. Mohr desires that Paul M. Mohr shall purchase seventy (70) shares of said stock:
    Now, It is agreed between said Lewis S. Mohr and Charles A. Young, that said Paul M. Mohr may purchase seventy (70) shares of said stock at and for the sum of One Hundred and Fifty ($150) Dollars per share, and for the payment thereof he shall execute and deliver to said Lewis S. Mohr and Charles A. Young his promissory note of even date herewith for the sum of Ten Thousand Five Hundred ($10,500) Dollars, due one day after date with interest thereon at the rate of six per cent per annum until paid, at which time we agree to issue or cause to be issued to said Paul M. Mohr certificate for seventy (70) shares; and
    Whereas, Charles A. Young desires that Nathan Young, when he reaches his majority, shall purchase seventy (70) shares of said stock:
    Now, It is agreed between said Lewis S. Mohr and Charles A. Young that upon the happening of said event, they will sell to said Nathan Young seventy (70) shares of said capital stock at the same price and upon the same terms as they have this day sold said seventy (70) shares to said Paul M. Mohr, but if said Nathan Young should not upon attaining his majority purchase said stock, then said Charles A. Young shall not be called upon to furnish any stock to said Paul M. Mohr, but said Charles A. Young shall repay to said Paul M. Mohr any sum or sums of money together with the interest thereon that he may have received from said Paul M. Mohr by reason of his purchase of said stock, it being the understanding and purpose of this agreement that said Lewis S. Mohr, together with Paul M. Mohr and Charles A. Young together with Nathan Young shall be the owners of two hundred and fifty (250) shares each in said corporation, and both said Lewis S. Mohr and Charles A. Young at any meeting of the shareholders shall be entitled to vote two hundred and fifty shares each.
    No dividend earned on said stock shall be paid at any dividend-paying time to any shareholder in said corporation until said Lewis S. Mohr and Charles A. Young shall each have received a credit of Fifteen Hundred ($1500) Dollars per annum each, the same being for interest on said working capital that said Lewis S. Molir and Charles A. Young have respectfully furnished to said corporation.
    It is further agreed between said Lewis S. Mohr and said Charles A. Young that in ease of the death of either, the survivor thereof shall have the privilege of purchasing the stock of the deceased within one year thereafter at the price of Two Hundred ($200) Dollars per share, and that the running capital now to the credit of said Lewis S. Mohr and Charles A. Young or what may be to the credit of each at that time, cannot he withdrawn from said corporation within one year thereafter. All of the capital stock of said corporation, together with the note of Paul M. Mohr is now deposited with B. F. Swinney, President of the First National Bank of Kansas City, Missouri, to be by him held and shall not be delivered or withdrawn by any person or persons except upon the written consent of both of said parties hereto.
    It is further agreed that said Paul M. Mohr shall be entitled to all dividends on the stock this day by him purchased and that may be hereafter declared, but for the six months ending December 31, 1907 he shall only recover his proportionate share of said earnings from the date hereof. Aud the dividend arising upon the remaining Four Hundred and Thirty Shares of said capital stock, until said Nathan Young shall have purchased the seventy shares aforementioned, shall be equally divided between said Lewis S. Mohr and Charles A. Young.
    Paul M. Mohr purchased 70 shares of the company’s stock and gave therefor one note to L. S. Mohr for 35 shares at $150 per share and another note to C. A. Young for an equal number of shares at the same price. The notes were payable out of the earnings of the company or from any other money he might obtain from outside sources.
    At no time was a dividend ever declared nor did the company have a surplus account on its books, but twice each year profits were determined and the amount thereof credited to the individual accounts of the stockholders in proportion to their holdings. Whenever the company purchased machinery or other fixed assets the amount of such purchases was charged against the accounts of the stockholders in proportion to their holdings. During 1898 and 1899 the company remodeled its mill and installed new machinery and equipment at a total cost of $29,715.68 and in 1902 added a new boiler plant at a cost of $9,108.53. These amounts were charged to the accounts of the stockholders in proportion to their holdings of stock. Some time after incorporation in 1880 the stockholders L. M. Miller, C. A. Young, and L. S. Mohr agreed among themselves that each would keep to his account a minimum credit of $25,000 for the company’s use as an operating fund, and prior to Miller’s death the credit was never reduced much below that amount. The credit of $1,500 to be made to the accounts of O. A. Young and L. S. Mohr as provided for in the agreement between them dated September 14, 1907, was interest on the amounts kept by them as credits to their accounts.

      The minutes of the meeting of the board, of directors on April 6, 1908, contain the following:
    Minutes of previous meeting read and approved, there being no further business the meeting adjourned, after instructing the secretary to spread upon the minutes the following: “Because of differences in the matter of the holdings of the widow of Lewis M. Miller, our former President, it stems best that there should be a statement spread upon the minutes of the company, regarding the running capital of the company which is clearly understood by us to wit: ‘ That the amounts standing to the credit of L. S. Mohr and O. A. Young, constitutes our running capital and in no manner removable, without the joint consent of both parties, and that the interest credited before profits are divided is in no sense interest for borrowed money, but for the purpose of equalizing our respective interests in the capital referred to.’ ”
    The corporation’s books show that on February 28, 1907, and on December 31, 1918, the stockholders’ accounts had credit balances as follows:

    The petitioner’s machinery and equipment, including power plant and foundations, on March 1, 1913, had a value of $81,000. Its buildings, which consisted of a “ main ” building, an office building, engine room, boiler room, warehouse, and crib elevator had a value of $30,000 on March 1, 1913.
    The following is from petitioner’s balance sheet as at December 31, 1918:

   OPINION.

Thammell :

The petitioner contends that the respondent has erred with respect to the following: (1) Failure to find that certain buildings, machinery, and equipment owned by the petitioner and used in its business in 1919 had on March T, 1913, a value in excess of the cost as carried on petitioner’s books and to use such value as a basis in determining the deductions allowable for depreciation. (2) Failure to allow a paid-in surplus for the value of tangible property, including stockholders accounts paid in to the corporation at the date of incorporation, February 8, 1907, in excess of the par value of the stock issued therefor. (3) Failure to determine invested capital and to use such invested capital as a basis for computing petitioner’s profits tax. (4) Failure to include in invested capital as surplus as, at December 31, 1918, the stockholders’ accounts on the books of the petitioner.

The respondent denies the commission of any error in the determination of the proposed deficiency.

With respect to the petitioner’s contention that a greater value as at March 1, 1913, than shown by its books as cost should have been allowed in computing the deduction for depreciation on its buildings, machinery and equipment, we are unable to determine from the record what amount was shown by the books and used by the respondent as the value at March 1,1913, of these properties. The petitioner urges that on March 1,1913, its buildings had a value of $30,000 and in support thereof introduced testimony of two witnesses. One of the witnesses, L. S. Mohr, testified to a total value of the buildings of $30,000. He stated that the values used by him were based on the construction prices on March 1,1913, considering the condition of the buildings. The other witness testified to a reproduction cost of the buildings in 1913 of $35,660. He testified that the fair market value of the buildings on March 1, 1913, was $32,100. In determining this value, he began with the reproduction cost, considered the state of the buildings and their suitability for the work of the company, taking into account how much less the buildings might be worth than new buildings of the same character. This witness was both an architect and builder, and had had some experience in valuing property that was being bought and sold.

We have heretofore held that the replacement cost of buildings alone gives no dependable index to their actual value, but in this case the witnesses testified that the reproduction cost was merely considered by them in determining the March 1, 1913, value.

They were competent to express an opinion as to that value, and in the absence of other evidence we must give it due weight and consideration. The preponderance of the evidence is that the buildings were worth $30,000 on March 1, 1913, and we so hold.

In support of its contention that the allowance for depreciation on machinery and equipment had been computed on an improper value as on March 1, 1913, the petitioner submitted the testimony of a milling engineer who in 1913 was a salesman of the particular kind of machinery owned by the petitioner and was employed by the same company which sold the machinery to petitioner. He testified to a value on March 1, 1913, of $81,000. This value was ascertained by reducing the replacement cost on March 1, 1913, of $91,000 by $10,000, representing depreciation. He further testified that he saw this machinery in operation several times during 1913, had observed its condition, and was familiar with the prices at which such machinery was then being sold. We think that his testimony, which was not contradicted, is sufficient to warrant us in holding that the value on March 1, 1913, was $81,000.

The petitioner’s second assignment of error is that the respondent failed to allow a paid-in surplus for the value of tangible property including stockholders’ accounts claimed to have been paid in to the corporation at the date of incorporation in February, 1907, in excess of the par value of the stock issued therefor.

In connection with this contention, the petitioner urges that not only did the physical assets paid into the corporation have a value in excess of the $50,000 par value of its capital stock, but that in addition to the physical assets paid in there were also paid in by the stockholders their credit balances totaling $84,992.47.

The evidence does not show.of what all the property and assets ” referred to in the resolution of the board of directors on March 1, 1907, and taken over by the petitioner consisted. For does it show the extent or amount of the “liabilities” referred to in the resolution and assumed by the petitioner. The evidence does not show that any list or any appraisal was made of the assets at the time they were taken over, but does show that balance sheets were not prepared at that time.

While we do not know the value in 1880 of the real estate and machinery taken over by a predecessor corporation of the petitioner for $50,000 of capital stock, we have found that during 1898 and 1899 the mill was remodeled and new machinery and equipment was installed at a total cost of $29,715.98, that in 1902 a new boiler plant was added at a cost of $9,108.53, and that the foregoing amounts were charged to the accounts of the stockholders in proportion to their stockholdings. There is also uncontroverted evidence that the mill which in 1880 had a capacity of 150 barrels a day had been enlarged from time to time so that in 1907 it had a daily capacity of 1,000 barrels. In 1880 the assets were carried on the books at $50,000. We have also found that the petitioner paid Mabel A. Miller $25,000 for the 167 shares of its stock issued to her for her one third interest in the assets taken over by the petitioner, which did not include the amounts credited to her account.

It also appears that Paul M. Mohr, the son of L. S. Mohr, in September, 1907, purchased 70 shares of the stock of the petitioner at $150 per share; that in the same month L. S. Mohr and O. A. Young entered into an agreement whereby it was provided that in the event of the death of either the survivor should have the privilege of purchasing the stock of the deceased within one year at $200 per share.

All of these facts taken and considered together convince us that the actual cash value of the tangible assets was at least $25,000 in excess of the par value of the stock issued therefor in 1907.

In further support of the contentions for a paid-in surplus, the petitioner urges that at the time of incorporation in 1907 the stockholders contributed to the corporation as paid-in surplus the credit balances of their accounts totaling $84,992.47.

In regard to this, the evidence indicates that Mabel A. Miller was not agreeable to the plan of turning in to the company after its incorporation in 1907 her interest in the predecessor business and that during the year she was paid the amount of the credit to which she was entitled. We also find that on September 14,1907, L. S. Mohr and C. A. Young entered into an agreement which provided that before any stockholder should receive any of the earnings of the corporation Mohr and Young should receive a credit of $1,500 per annum, the same being for interest on working capital that they had furnished to the corporation. In addition to the $1,500 credited to Mohr’s account, the evidence shows that other amounts were credited as interest to his account, as the credit balance of his account was in excess of that of Young. The amounts credited to the shareholders’ accounts represented earnings of the corporation which were taken from the corporate assets. They then became separated from corporate assets and became the property of the stockholders. It was available to them. This is not a case of mere bookkeeping entries, but the actual earnings were available for distribution and were credited to each stockholder as his separate property. In order to be included in the corporate assets, therefore, such earnings so distributed must be turned back to the corporation.

From all the evidence, we are unable to find that the stockholders’ credits were paid in to the corporation so as to constitute paid-in surplus within the meaning of the Act.

The petitioner’s remaining contentions are that the respondent erred in failing to determine its invested capital, to include in its invested capital as surplus at December 31, 1918, the credit balance of the stockholders’ accounts and to use such invested capital as the basis for computing petitioner’s profits tax.

We have found that on December 31, 1918, the credit balances of the stockholders’ accounts totaled $194,887.55, which amount the petitioner insists should be included in its invested capital as surplus since no distributions have ever been made by the corporation to the stockholders by the declaration of dividends.

We have heretofore held that the crediting of a corporation’s profits to the stockholders’ accounts in proportion to their holdings without the formal declaration of a dividend represents a distribution. Appeals of Electrical Supply Co., 1 B. T. A. 658; Kelly-Buckley Co., 1 B. T. A. 1154; and Lobsitz Hardware Co. v. Commissioner, 5 B. T. A. 295. In the instant case, we are of the opinion that the semiannual crediting of petitioner’s profits to the accounts of its stockholders constituted such a distribution thereof as to prevent their being a part of the corporation’s surplus and as such a part of its invested capital. In the light of the facts in this case, we- are of the opinion that the credit balances of the stockholders belonged to them and not to the corporation. When used by the corporation they constituted borrowed capital and therefore under the Act may not be included in invested capital. To the extent that the stockholders contributed any amounts from their credit balances to the corporation in payment for assets bought by the corporation they constituted paid-in surplus.

We are of the opinion that the petitioner’s invested capital for 1919 should include at least the amount of $75,000 which represents the actual cash value of assets paid in in 1907.

Judgment will be entered on 16 days' notice, under Bule 50.

Considered by MorRis, Murdock, and Siefkin.


text:
    M. S. Engleman, Petitioner, v. Commissioner of Internal Revenue, Respondent. F. J. Engleman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5981, 6193.
    Promulgated November 7, 1927.
    1. Tbe iair market value of stock on March 1, 1913, determined.
    2. Value of assets transferred by corporation on dissolution to a partnership determined.

      W. H. Gloud, Esq., and O. B. Able, O. P. A., for the petitioners.

      John D. Foley, Esq., for the respondent.
    These proceedings, which were consolidated for the purpose of trial and decision, are for the redetermination of deficiencies in income taxes for the year 1920. The deficiency in the case of M. S. Engleman, Docket No. 5981, is $494.43, and arises from the respondent having refused to consider good will in determining the book value of certain shares of stock on March 1, 1913, which value was used as a basis for computing profit from the liquidation in 1920 of the corporation in which the stock was owned. The deficiency in the case of F. J. Engleman, Docket No. 6193, is $2,089.90, and also results from the same action of the respondent.
    FINDINGS OF FACT.
    The Central Boarding & Supply Co. was incorporated under the laws of Illinois on February 14, 1907. The company was organized with a capital stock of $15,000, divided into 300 shares of a par value of $50 each. Among those who acquired stock in the corporation at the time of organization were the petitioners herein and E. D. Crawley. F. J. Engleman was vice president and E. D. Crawley was secretary and treasurer.
    The corporation operated a railroad commissary contracting business under a contract previously negotiated by F. J. Engleman with the St. Louis & San Francisco Railroad Co. After the Central Boarding & Supply Co. was incorporated a written contract embodying the agreement resulting from the negotiations of Engleman was signed on behalf of the railroad company by a vice president and on behalf of the Central Boarding & Supply Co. by F. J. Engleman as vice president, and E. D. Crawley as secretary. Under the contract the Central Boarding & Supply Co. was to supply board, bedding and other equipment necessary to provide in cars furnished by the railroad company temporary living quarters to such employees of the railroad company as were engaged in construction work on its lines away from cities and towns. The supply company was also to maintain a commissary at each place where cars were kept and was to sell from the commissary to the employees at reasonable prices clothing, shoes, and other necessary and suitable supplies. The contract contains no limitation as to how long it should continue, except that it could be terminated by either party upon 30 days’ written notice.
    The contract with the railroad company was capitalized by the Central Boarding & Supply Co. at $5,000, at which amount it remained on the company’s books until dissolution on March 31, 1920.
    Prior to the organization of the Central Boarding & Supply Co., F. J. Engleman and E. D. Crawley had had several years’ experience in the work to be performed under the contract with the railroad company. In the work to be carried on under the contract, these two persons served as the principal officers and were the principal ones engaged in carrying on the corporation’s business until E. D. Crawley retired from the company in 1919, when the principal burden of the business was assumed by F. J. Engleman. All dealings between the Central Boarding & Supply Co. and the railroad company were carried on by him, and it was due to his ability, previous experience, and his connection with the boarding and supply company that the railroad entered into the contract which continued in effect throughout the existence of the boarding and supply company.
    A boarding contract was acquired from the C. H. & D. R. R. prior to 1913 and another was obtained from the C. & E. I. R. B,. during the winter of 1912 and 1913. No other contracts of importance were acquired prior to the dissolution of the boarding and supply company and the contracts between the C. H. & D. and C. & E. I. railroads were not being operated at that time.
    The earnings of the Central Boarding & Supply Co. for the five-year periods ended February 28, 1913, and March 1, 1920, were as follows:
    Year ended Feb. 28:
    1909- $5,503.22
    1910- 12,246.16
    1911- 15,500.00
    1912- 21,388.30
    1913- 11,524.81
    Total- 66,162.49
    Average earnings- 13,232.50
    Year ended:
    Feb. 28, 1916- $80,813.15
    Feb. 28, 1917_ 32,127.72
    Feb. 28, 1918- 25, 683. 62
    Feb. 28, 1919- 12,419.18
    Dec. 31, 1919- 11,120.72
    Mar. 31, 1920- 3,327.39

      Surplus, capital stock and assets for the five-year period ended February 28,1913, were as follows:

    Balance sheets of the company from February 28, 1916, to March 31, 1920, were as follows:

    The Central Boarding & Supply Co. as a corporation was dissolved March 31,1920, and its assets, which were carried on its books at a total value of $98,190.50, were transferred to and its liabilities of $4,062.39 as shown by the books were assumed by a partnership of the same name as of April 1, 1920. The partnership began business with a capital of $94,128.11, which amount represented the difference between the amount of the assets and the liabilities of the corporation as shown by its books. The partnership was composed of the same persons who were stockholders in the corporation. Its capital of $94,128.11 was apportioned to the partners on the basis of the stock holdings in the corporation. It continued the business conducted by the corporation and, without advising the St. Louis & San Francisco Bailroad Co. of the change in form of organization, operated under the contract entered into between the corporation and the railroad company.

      On March 31, 1920, the date of dissolution of the Central Boarding & Supply Co. as a corporation, F. J. Engleman owned 146% shares of the stock of the corporation, of which 66% shares had been acquired prior to March 1, 1913, while the remaining 80 shares had been purchased in July, 1919, from E. D. Crawley at a cost of $453.33 per share. On the basis of his holdings in the corporation, F. J. Engleman was credited with a 44/90 interest in $94,Y28.ll representing the capital of the partnership, or $46,311.32. M. S. Engleman owned 16% shares of stock at the date of dissolution, all of which had been acquired prior to March 1, 1913, and on the basis of his holdings he was credited with a 5/90 interest in the capital of the partnership, or $5,262.67. The stock of the corporation was never listed on any stock exchange and was never traded in with the exception of the few infrequent transfers between the original incor-porators and stockholders.
    At the date of dissolution the real estate owned by the corporation consisted of a hotel building and lot at Eastland, Tex. This property was carried on the books at $25,000, but in fact had a fair market value of only $15,000. An item of equipment representing stoves, dishes, kitchen utensils, and bedding was carried on the books of the corporation at $9,647.23. The fair market value of this equipment at the time of dissolution was $5,000. When the corporation was dissolved it owed Federal taxes of $1,317 which had not been entered on the books, but which were subsequently paid by the partnership.
    In computing the taxable profit resulting to the petitioners from the dissolution and liquidation of the corporation and the acquisition of the business by the partnership the respondent used the book value on March 1, 1913, of the stock acquired by them prior to that date or $82.21 per share. Hs also considered the amount of the partnership capital apportioned to each petitioner on the basis of his stock holdings in the corporation as the amount received in payment for the stock.
   OPINION.

Trammell:

The petitioners contend (1) that the fair market value on March 1, 1913, of the capital stock of the Central Boarding & Supply Co. was $275 per share; (2) that the value of the entire net assets of the corporation transferred to the partnership on dissolution was $78,763.88; (3) that M. S. Engleman’s share in such assets was of a value of $4,375.77; and (4) that F. J. Engleman’s share had a value of $38,506.78.

In support of the contention that the stock had a fair market value of $275 on March 1, 1913, the petitioners introduced evidence as to the amount of earnings of the corporation for the preceding five years and the amount of capital stock and assets both tangible and intangible during that period to show that the corporation had good will to the amount of $57,657 on March 1, 1913, which was not taken into consideration by the respondent in his determination of the value of the stock on that date. In addition, F. J. Engleman testified as to an unaccepted offer made by a third person in his presence to E. D. Crawley during 1912 to purchase for $250 per share the 150 shares of stock held by her in the corporation. He also testified that in view of the previous earnings of the corporation, the contracts it held on March 1, 1913, and the prospects for future earnings, the stock in his opinion had a value of $275 per share on that date.

It may well be, as contended by the respondent, that under the particular facts and circumstances, apart from F. J. Engleman the corporation did not have any good will; that personal qualifications, experience, ability and skill of an individual do not constitute good will as an item of property. Providence Mill Supply Co., 2 B. T. A. 791; Northwestern Steel & Iron Co., 6 B. T. A. 119. But here we are not so much concerned with the question of good will as an item of property. The question here is the value of the stock. All the evidence that has any bearing on that question should be considered. In the absence of sales the value of the assets may be resorted to. It makes no difference by what name an asset is called. Clearly the corporation had an asset in the form of the contract. It was capitalized at $5,000. It clearly had a value in excess of that amount. Considering the earnings and the value of the tangible assets, the corporation had some intangible assets in excess of $50,000. We have a record of earnings for several years prior to basic date and the testimony as to the prospects for the future. We also have an offer to purchase the stock at $250 a share which offer was declined. Considering all the evidence, we think that the stock had a value of $250 a share on March 1, 1913.

In March, 1920, a partnership was formed by the stockholders of the corporation with the same name as the corporation. This partnership continued the same business without any change, except the form of the organization, with the same assets without any interruption. Before the assets could be paid into the partnership, however, they became the property of the stockholders who formed the partnership. The organization of the partnership and the transfer of the Assets to it was contemporaneous with the dissolution of the corporation. It was the purpose to carry on the same business in partnership form instead of corporate form without interruption.

In view of all the facts and circumstances, the assets, both tangible and intangible, belonging to the corporation were transferred to the partnership. The contract with the railroad owned by the corporation did not lose its value merely because of the fact that in transferring it to the partnership it was included among assets which temporarily became the property of the persons who were stockholders, although they did not actually receive the assets themselves. The contract when the corporation was dissolved was of value. The question is, then, what was its value in March, 1920, when the corporation was dissolved and its assets distributed. Considering the earnings over the years from 1916 to March, 1920, it appears that 1916 was a year of abnormally high earnings. They constantly decreased from that time until 1920. Considering the earnings and the value of the tangible assets in connection with all the other facts, a value of at least $42,000 is arrived at. This value added to the net value of assets owned by the corporation as shown by the books on March 1, 1920, gives approximately $127,000 as the value of all assets, using the values of other assets as shown by the books. This value is substantially corroborated by the sales price of $453.33 a share paid by F. J. Engleman for 80 shares of the stock in July, 1919. At that value per share the assets would have had a value in-July, 1919, of approximately $135,000. But other factors than asset values may have entered into the stock transaction. The company had the prosperous years of 1916, 1917, and 1918. The year 1919 had not ended and the smaller earnings of the full year 1919 and the year 1920 had not been realized. In view of all the evidence we think that the value of all the assets should be determined by including the contract at a value of $42,000 in March, 1920.

Since we have found that the value of the net assets transferred by the corporation to the partnership was not correctly reflected on the books of the corporation, a reduction of $10,000 should be made in the amount of real estate and a reduction of $4,647.23 should be made in the amount of the equipment.

As an item of $1,317 representing unpaid Federal taxes was not taken into consideration at the time of the transfer, the amount of the net assets should be further reduced by this amount. The gain taxable to each of the petitioners is the difference between the March 1, 1913, value of the stock, which was greater than cost, and the value of the assets to which each was entitled by virtue of his stock ownership.

Judgment will be entered on 10 days' notice, v/nder Rule 50.

Considered by MoRRis, Murdock, and Siefkin.