author: Opper,

text:
    Edith M. Greenwood, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92091.
    Promulgated March 26, 1940.

      Ferdinand Tannenbamn, Esq., for the petitioner.

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

Ttson : The income tax deficiency involved in this proceeding is in the amount of $1,582.65 for the calendar year 1935.

Petitioner assigns error in the respondent’s disallowance of $15,750 of a claimed bad debt deduction of $17,750, based upon his determination that, when the petitioner exchanged bonds in the face amount of $71,000 for new and different bonds of the same company in the face amount of $53,250, upon a reorganization of the company in 1935 under section 77 (b) of the Bankruptcy Act, she sustained a capital loss of $17,750, deductible only to the extent of $2,000 thereof, pursuant to the limitations of section 117 (d) of the Revenue Act of 1934.

The proceeding has been submitted upon a stipulation of facts, which is adopted as our findings of fact and is included herein by reference. Only such of those facts as are deemed necessary to the consideration of the issue involved will be set forth herein.

The petitioner is an individual, residing in New York City. Two years prior to 1935 and in a transaction entered into for profit, she purchased 71 first and refunding mortgage 7 percent gold bonds of the Woodruff Holding Corporation, due in 1946, at a cost of $71,000.

Prior to April 1935, the Woodruff Holding Corporation filed a petition in bankruptcy in the United States District Court for the Northern District of New York under the provisions of section 77 (b) of the Bankruptcy Act. Prior to April 1935 forms for consent to the plan of reorganization of that company, through recapitalization as subsequently approved by the court, were forwarded to the holders of its first and second mortgage bonds, its. preferred and common stockholders, and to the unsecured creditors holding its notes.

In the above mentioned proceeding in bankruptcy and for reorganization of the Woodruff Holding Corporation, the court entered an order dated April 28, 1935, directing a recapitalization of that company, referred to in the order as the debtor. It was ordered that the debtor’s first and refunding mortgage 7 percent gold bonds due in 1946 be called in by the debtor and exchanged for new 3 percent bonds due November 1, 1945, in 75 percent of the face amount of the old bonds; that the debtor’s first and refunding mortgage 7 percent gold bonds due in 1946 and the mortgage indenture securing them (referred to in the order as the second mortgage indenture and bonds) be canceled without liability for unpaid arrears of interest; and that there be executed a new mortgage indenture securing the new bonds but omitting a sinking fund provision contained in the canceled indenture. The court further ordered that the debtor alter the terms of its first mortgage indenture so as to reduce the rate of interest therein provided to 5 percent and to extend the maturity date thereof to 1945; that the claims of unsecured creditors and the 8 percent preferred stock of the debtor be merged and canceled and that the debtor issue in exchange therefor its new 5 percent preferred stock in 50 percent of the face of such canceled claims and 50 percent of the par value of the old preferred stock; that the debtor issue one share of new $1 par value common stock in exchange for each two old shares of its common stock; and that each share of new common and new preferred stock should be entitled to one vote at the stockholders’ meetings.

The terms of the court order of April 28, 1935, were carried out.

Under date of October 29, 1935, the president of the Woodruff Holding Corporation addressed a letter to the holders of first and refunding 7 percent gold bonds due in 1946, advising them that, pursuant to the reorganization plan approved by the court, the new securities were available and that in exchange for each $1,000 principal amount of old bonds with coupons attached the holders were to receive new 3 percent bonds in the principal amount of $750 due in 1945.

In November 1935 the petitioner surrendered to the Woodruff Holding Corporation 71 of its first and refunding mortgage 7 percent gold bonds in the face amount of $71,000, due in 1946, and received in exchange therefor first and refunding 3 percent mortgage bonds in the face amount of $53,250, due in 1945.

In 1935 the petitioner charged off $17,750 as a debt ascertained to be worthless in part.

On her return for 1935 petitioner reported a “net loss” of $17,750 in connection with the above described reorganization and exchange of bonds and claimed the full amount thereof as a deduction from gross income. In asserting the deficiency in controversy, the respondent determined that such exchange constituted a taxable transaction resulting in a capital loss deductible only to the extent of $2,000 thereof under section 117 (d) of the Eevenue Act of 1934. He now contends that the transaction was an exchange of securities in a recapitalization constituting a statutory reorganization, on which no gain or loss whatsoever is recognized under the provisions of sections 112 (b) (3) and 112 (g) (1) (D) of the Eevenue Act of 1934.

The petitioner contends that as a bondholder she was a creditor of the Woodruff Holding Corporation in the amount of $71,000 prior to April 28, 1935, and that such company’s indebtedness to her was reduced 25 percent by the court order entered on that date pursuant to the Bankruptcy Act, which specifically provides, in section 77 (b) thereof, that, upon the court’s confirmation of a plan of reorganization of the debtor company, “the provisions of the plan and of the order of confirmation shall be binding upon (1) the debtor, (2) all stockholders thereof, * * * and (3) all creditors, secured or unsecured, * * including stockholders and creditors who have not,-as well as those who have, accepted the plan. Petitioner also contends that, being bound by the court order of April 28, 1935, she could never thereafter collect more than 75 percent of the Wood-ruff Holding Corporation’s indebtedness of $71,000 to her; that consequently on that date such indebtedness became worthless in part, to the extent of $17,750; and that her subsequent exchange, in November 1935, of the old bonds for new bonds is immaterial in the instant proceeding because such action on her part merely preserved her right to receive, in the future, 75 percent of her original claim against that company. Petitioner further contends that, since she charged off that portion of a debt which became partially worthless in April 1935 and since the separate provisions of the revenue act for the deduction of bad debts and for losses sustained are mutually exclusive, she is entitled to the claimed deduction of $17,750 as a bad debt under section 23 (k) of the Eevenue Act of 1934.

While it has been held that under certain facts a bond represents a debt within the purview of the bad debt provision of the revenue acts and that upon the ascertainment of worthlessness thereof it may be deducted as a bad debt to the extent of the cost thereof, we can not, under the facts in the instant case, sustain petitioner’s claim for a bad debt deduction.

We do not have here simply the ascertainment of partial worthlessness of a debt. The court order of April 28, 1935, did not merely relieve the Woodruff Holding Corporation of a portion of its debts, but instead scaled down that company’s liabilities as a constituent part of a plan of reorganization of that company’s capital structure, resulting in the petitioner’s exchange of bonds. The partial worthlessness of petitioner’s old bonds resulted from a reorganization, under section 112 (b) (3), supra, in which no gain or loss may be recognized, and, in our opinion, section 23 (k), supra, is not applicable.

There can be no doubt that the recapitalization of the Woodruff Holding Corporation constituted a reorganization under the provisions of section 112 (g) (1) (D), supra. Nor can there be any doubt that the petitioner’s bonds constituted “securities” within the reorganization provisions. Helvering v. Watts, 296 U. S. 387. Here the plan of reorganization called for an exchange of stock as well as bonds thus providing a continuity of the proprietary interests in the company. We do not have here simply an exchange for bonds and cash, as was the case in LeTulle v. Scofield, 308 U. S. 415, wherein the Supreme Court held that, since there was no exchange of stock to provide for a continuity of the proprietary interests in the company there was no statutory reorganization and the one who received bonds and cash in the exchange there involved became, as to the bonds, a creditor of the issuing corporation rather than the recipient of “securities” within the reorganization provisions.

The instant case is distinguished from Henry R. Huntting, 32 B. T. A. 495, in that there no reorganization occurred in the year in which partial worthlessness of bonds was ascertained by the owner thereof.

Since the petitioner during the taxable year exchanged her old bonds for new bonds pursuant to a statutory reorganization under a plan of reorganization, there is no recognized gain or loss in connection with that transaction, and she is not entitled to deduct the difference between the face amounts of her old and new bonds as a debt ascertained to be partially worthless during 1935. Rockford Dairy, Inc., 26 B. T. A. 501. Cf. Frederick L. Leckie, 37 B. T. A. 252; and Commissioner v. Kitselman, 89 Fed. (2d) 458, reversing 33 B. T. A. 494; certiorari denied, 302 U. S. 709.

Reviewed by the Board.

Decision will be entered for the respondent.

Opper,

dissenting: It seems to me the Board’s opinion results from an inadmissible extension of the scope of section 112. That section begins:

(a) Geneeal Rule. — Upon the sale or exchange of property the entire amount of the gain or loss, * * * shall be recognized, except * * *.

There follow successive provisions, each beginning “No gain or loss shall be recognized”, which define the breadth of the exceptions. One such provision, section 112 (b) (3), is presumably that on which the majority opinion rests.

It seems inescapable, however, that section 112 deals exclusively with sales or exchanges, both as to its statement of the general rule and with respect to the negations thereof contained in the exceptions. If petitioner were relying upon a sale or exchange as the justification for her claim, resort to the exceptions would be both necessary and appropriate. But petitioner’s position here is affected neither one way nor the other by the sale or exchange concept, because her assertion is not that a debt owed to her has been sold, but that it became partially uncollectible in the tax year. Her situation is no different than if the securities had remained at all times in her safe deposit box without change. If, under these circumstances, she could demonstrate that the debts they represent have become partially worthless, the deduction is proper to the extent of the charge-off. Revenue Act of 1934, sec. 23 (k). It is not necessary to resort to a sale or exchange to obtain this benefit. Ross v. Commissioner, 72 Fed. (2d) 122; Commonwealth Commercial State Bank v. Lucas, 41 Fed. (2d) 111. The retort that there was no sale or exchange, or that if there was one she is not entitled to rely on it under section 112 (b) (3) , thus falls wide of the mark. If petitioner would be in no better position because of section 112 (a) she can hardly be in a worse one because of 112 (b) (3).

It may be urged that there was an exchange here, later in the year, even though it lacks tax significance under petitioner’s claim; and hence that section 112 operates. But what would be the result if she had refrained from consummating the exchange of the physical securities? Would it then be said that there was an exchange, notwithstanding there was actually none; or that the mere postponement to the following year of the physical exchange would be sufficient to give the taxpayer the benefit of the deduction? See Henry R. Huntting, 32 B. T. A. 495. If the latter, the only effect of the Board’s decision is to force creditors to withhold their cooperation in a reorganization, so as to secure the benefit of the tax deduction. That Congress intended a result so contrary to public policy is difficult to believe.

Aetjndell, MttRdocK, Meleott, and HakRon agree with this dissent.

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

      (3) Stock tor stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * * * * * * *
      (g) Definition of Reorganization. — As used in this section and section 113—
      (1) The term “reorganization” means * * * (D) a recapitalization, * * *

       SBC. 23. deductions PROM GROSS INCOMB.
      In computing net income there shall be allowed as deductions :
      * * * * * * *
      (k) Bad Duets. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged oil within the taxable year, as a deduction.


source: Caselaw Access Project

author: Hill:

license: Public Domain

text:
    Morrison Bond Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93362, 95986.
    Promulgated March 28, 1940.

      Dana Latham, Esq., for the petitioner.

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

Hill:

In these proceedings, duly consolidated for hearing, petitioner appeals from the determination by respondent of deficiencies in income and excess profits taxes as follows:

The sole issue submitted for decision in each proceeding is whether or not certain interest received by petitioner during the taxable years from bonds issued by various California municipalities under various California improvement acts is subject to Federal income tax.

In the petition filed in Docket No. 95986, it was alleged that respondent erred in failing to deduct from net income in computing income tax for the year 1986 either the excess profits tax accrued in 1936 or the sum of $266.92 representing excess profits tax accrued for 1935 and paid in 1936. In that connection, the parties have now stipulated that petitioner’s taxable income for 1936, as determined by respondent, should be reduced by such sum of $266.92, and thus have settled the issue raised on that point. The stipulation will be given effect in the recomputation on final settlement.

The parties have also stipulated that the amount of $9,219.02 added to taxable income by respondent for the year 1935 as interest received on “California Street Improvement Bonds” should have been $9,331.03. This stipulation likewise will be reflected in the recomputation on final settlement.

All facts were stipulated by the parties in a written stipulation filed at the hearing, and the stipulation is here adopted in full as our findings of fact, but reference is made thereto only in so far as deemed necessary to a discussion of the issue presented.

Petitioner is a corporation organized under the laws of California, with its principal office at Los Angeles.

For the years 1934, 1935, and 1936 respondent included in petitioner’s income subject to the Federal income tax amounts representing interest received by petitioner in each of the respective years upon bonds issued by various California municipalities under various California improvement acts, which amounts petitioner had omitted from the income reported in its returns as subject to the Federal income tax on the theory that they were exempt from such tax. The total amounts so included by respondent and the amounts in controversy are as follows:

The question of whether or not interest received on bonds issued under certain of the California improvement acts involved in these proceedings was considered by us in District Bond Co., 39 B. T. A. 739, and it was there held that interest received on bonds issued under the Improvement Act of 1911, the Street Opening Bond Act of 1911, and the County Improvement Act of 1921 was subject to Federal income tax. In the same case it was held that interest received on bonds issued under the Hoad District Improvement Act of 1907, the Municipal Improvement District Act of 1915, the Improvement Bond Act of 1915, and the Acquisition and Improvement Act of 1925 was not subject to Federal Income tax. In Susanna Bixby Bryant, 38 B. T. A. 618, we held that interest on bonds issued under the California Improvement Act of 1893 was subject to Federal income tax. The California Boundary Line Act of 1911 provided for the issuance of bonds under the terms of the California Improvement Act of 1911, and the interest on such bonds was held subject to the tax in question in District Bond Co., supra, and in Milo W. Bekins et al., Executors, 38 B. T. A. 604. On authority of the cited decisions, we here make a like ruling in respect of the taxability of interest received by petitioner on bonds issued under the respective California improvement acts mentioned above in this paragraph.

There remains for consideration the question of whether or not interest is subject to the Federal income tax when received on bonds issued under the California County Water Works District Act of 1913, the California Drainage Improvement District Act of 1919, or the California County Sanitation District Act of 1923.

Petitioner contends, first, that the interest in controversy is exempt from Federal income tax under the provisions of section 22 (b) (4) of the Kevenue Acts of 1934 .and 1936. This contention can be sustained only if it appears that the bonds, on which the interest in controversy was received, constituted obligations of the State of California, or of any political subdivision thereof.

There is no question raised here that any of the improvement districts referred to were not political subdivisions of the State of California within the meaning of the taxing acts, but the issue is whether or not the bonds in controversy were obligations of such districts. ■

The bonds issued under the California County Water Works District Act of 1913, we think, are shown clearly enough to have been obligations of the respective water districts. These bonds contained the following pertinent provisions:

For value received, _ Water District situated or principally situated in the County of_, State of California, promises to pay the holder hereof at the office of the treasurer of said district, on the-day of_, 19_, the sum of_dollars in gold coin of the United States, with interest in like gold coin at the rate of-per centum per annum, payable at the office of the said treasurer semi-annually, on the — day of _, and the_day of_in each year, on presentation and surrender of the interest coupons hereto attached.
* » * * * * *
In witness whereof the said district, by its board of directors, has caused this bond to be signed by the president of said board and attested by the secretary of said district, with the seal, of the district attached, this- day of _ 19—

Since tbe bonds issued under tbe California County Water Works District Act of 1913 represented direct and unconditional obligations of a political subdivision of tbe State of California, respondent erred in including in petitioner’s income tbe interest received by it on sucb bonds in 1936.

The bonds issued under tbe California Drainage Improvement District Act of 1919 recited that under and by virtue of such Act, the County of -, State of California, would pay to tbe bearer, out of tbe fund thereinafter designated, at the office of tbe treasurer of the county on tbe date stated, a specified sum in gold coin of tbe United States, with interest payable semiannually at a stated rate. It was further provided that:

This bond is payable out of Drainage District Improvement No. __interest and sinking fund exclusively, as the same appears on the books of the treasurer of said county, and neither said county nor any officer thereof shall be holden for its payment otherwise.

Thus, these bonds created an obligation on the part of the county to pay the amount stated in each bond, subject only to the qualification that payment should be made out of a designated fund, and neither the county nor any officer thereof should be holden for payment otherwise. It will be noted that the holder of a bond was given no right to proceed against any of the property benefited, or the owners thereof, to enforce payment in case of default. The qualifications mentioned do not take the bonds out of the classification of real obligations of the county. Cf. Michael Pontarelli, 35 B. T. A. 872; affd., 97 Fed. (2d) 793.

We are therefore of the opinion, and so hold, that bonds issued under the Drainage Improvement District Act of 1919 constituted obligations of a political subdivision of the State of California. The provisions of these bonds, as shown by the stipulation of the parties, were in all material respects substantially similar to those contained in bonds issued under the California Acquisition and Improvement Act of 1925, interest on which we have heretofore held to be not subject to Federal income tax. For a more extended discussion of the facts and reasons leading to such conclusion, see Milo W. Bekins et al., Executors, supra, (38 B. T. A. 604, at pages 613-616). Respondent’s action in including in taxable income interest received by petitioner in 1934 and 1936 on bonds issued under the California Drainage Improvement District Act of 1919 is disapproved.

The bonds issued under the California County Sanitation District Act of 1923 contained the following material provisions:

County Sanitation District No._of Los Angeles County, * * * for value received, hereby acknowledges it is indebted and promises to pay to the bearer of this Bond on the first day of June at the office of the County Treasurer in the county of Los Angeles, State of California, * * * the sum of_ dollars ($-) in lawful money of the United States, with interest thereon at the rate of three and one-half per cent (3%%) per annum * * * on presentation and surrender of the interest coupons hereto attached until this Bond is fully paid.
* * * * * * *
This Bond is in the form prescribed by the resolution of the Board of Directors of County Sanitation District No. of Los Angeles County, and the money for the redemption of this Bond and the payment of interest thereon shall be derived from the annual tax upon the taxable real property in said district and all of the said property in said district shall be and remain liable to be taxed for such payments. This Bond shall be a lien upon the real property in County Sanitation District No. of Los Angeles County.

We encounter no difficulty in concluding that the bonds issued under the County Sanitation District Act of 1923 constituted direct obligations of a political subdivision of the State of California. Bonds containing similar provisions were considered at length in our prior decisions hereinabove cited, which require no elaboration here. We hold, therefore, that respondent erred in including in petitioner’s taxable income interest received by it on such bonds in the years 1934 and 1936.

Petitioner urges the further contention that if any provision of the applicable revenue acts requires the taxation of any of the bond interest involved in these proceedings, such provision is void as offending the Constitution of the United States. Counsel for petitioner complains that the constitutional question was argued at length on brief in the Bekins case, supra, but in its opinion the Board made no reference to such argument.

As petitioner assumes our view to be, it is apparent that if the bonds in question were “obligations” of the issuing municipalities within the meaning of the taxing acts, the interest is exempt from taxation under such statutes and it is unnecessary to consider the question of any implied constitutional exemption; and if the bonds are not such “obligations” the implied constitutional limitation on the power of the Federal Government to tax an obligation or instrumentality of a state, or political subdivision thereof, does not apply. But petitioner argues that the interest on all of the bonds involved here is exempt from Federal income tax regardless of whether or not such bonds are “obligations” of the issuing municipality within the strict meaning of the term as used in the statutes.

Obviously, of course, this question is purely academic in respect of the bond interest hereinabove held not subject to income tax. As to all other interest above held taxable, since the bonds were not obligations of the state or any of its political subdivisions, the tax lays no burden directly upon a state instrumentality. However, it is the substance of petitioner’s contention that to sustain the tax would be to impose indirectly a burden upon political subdivisions of the state in the construction of public improvements. The assertion that a Federal tax casts an indirect burden on the borrowing power of the state can not be sustained unless it clearly appears that the burden is real and substantial. Willcuts v. Bunn, 282 U. S. 216. No such showing in respect of the tax involved is made or attempted to be made in the present case. Where the effect of the tax is remote and indirect, its validity is not impaired by reason of any implied constitutional restriction. See Standard Investment Co., 36 B. T. A. 156, 159, and authorities cited. “There are cogent reasons why any constitutional restriction upon the taxing power granted to Congress, so far as it can be properly raised by implication, should be narrowly limited.” Helvering v. Gerhardt, 304 U. S. 405. We are not impressed by petitioner’s argument on this point.

Decisions will be entered wider Bule 50.

       SEC. 22. GROSS INCOME.
      * * # * *
      (b) Exclusions feom Geoss Income. — Tbe following Items shall not be included in gross income and shall be exempt from taxation under this title :
      * >»- * id * * *
      (4) Tax-febb intbeest. — Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; * * *


author: Leech:

text:
    Davison-Joseph Campau Realty Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97366.
    Promulgated March 29, 1940.

      Victor W. Klein, Ksg., and Elorion Plante, O. P. A., for the petitioner.

      W. W. Kerr, Esq., for the respondent.
   OPINION.

Leech:

The two issues submitted are: (1) Whether petitioner is entitled to any credit under the Revenue Act of 1936, section 26 (c) (l), the amount of the credit not being contested, and (2) whether petitioner is entitled to deduct from gross income for the taxable year the actual amount of interest accrued on its indebtedness in that year, despite a deduction of a lesser amount on its return for the year.

The inquiry upon which decision of the first issue rests is whether the bylaw of the petitioner, quoted in the- findings of fact, supported by the quoted resolution of the directors, is “a written contract executed by the corporation” within the meaning of section 26 (c) (1) of the Revenue Act of 1936.

This provision grants credits, under certain conditions. As such, it is to be strictly construed. Helvering v. Inter-Mountain Life Insurance Co., 294 U. S. 686; Crane-Johnson Co. v. Commissioner, 105 Fed. (2d) 740, affirming 38 B. T. A. 1355.

A bylaw of a corporation may be defined as a rule or regulation established by the corporation as one of the incidents of its existence, for its internal government or for the government of its officers or members in the management of its affairs as among themselves. Hayes v. Canada, Atlantic & Plant S. S. Co., 181 Fed. 289. The general rule is that a proper bylaw may operate as a contract and thus bind the shareholders in their relations with each other and with the corporation. Columbia Building & Loan Association v. Jungquist, 111 Fed. 645; New England Trust Co. v. Abbott, 162 Mass. 148; 38 N. E. 432; Burden v. Burden, 159 N. Y. 287; 54 N. E. 17; Commissioner v. Vandegrift, 232 Pa. 53; 81 Atl. 153. It has been held to be “in effect” a contract between the different members of a corporation. Bushway Ice Cream Co. v. Bean Co., 284 Mass. 239; 187 N. E. 537. The shareholders may thus be bound in their relations with the corporation and with each other by a reliance upon the existence of that law or declared policies of the corporation. But a bylaw seems to us to lack the essence of a formal contract in that it is “adopted” and not “executed.” There is only one party, the corporation, acting through its stockholders, to the adoption of the law and the declaration of its policy. It thus becomes a part of the fundamental law of the corporation. Commissioner v. Vandegrift, supra.

In the Crane-Johnson case, supra, the Circuit Court, in affirming 38 B. T. A. 1355, said:

We are here considering a tax law, and the question is not whether for any purpose a charter or a state law may be treated as a contract, but rather whether they together may be considered a written contract executed by the corporation within the meaning of Section 26 (e) (1) of the Revenue Act of 1936. * * * Clearly, this provision relates to a corporate undertaking to discharge a certain obligation out of earnings, and not to any statutory provisions. * * * [Emphasis supplied.]

We think that any contract existing here by virtue of the bylaw was in the nature of an implied contract, which arose, not from any statutory obligation, it is true, but from a similar obligation imposed by the “law” of the corporation. But, there was no “written contract executed by the corporation” within the meaning of the cited section, preventing the payment of dividends. Crane-Johnson Co. v. Commissioner, supra.

In our judgment, the wording of the resolution of the board of directors supports this conclusion in that it declared the “policy” of the corporation in reference to the payment of dividends. Cheney v. Canfield, 158 Cal. 342; 111 Pac. 92 (1910).

The second issue arises from the respondent’s refusal to allow petitioner to correct an error made on its 1937 return in its petition.

Bespondent’s position on this point is not clear. He contends that petitioner employs a nonpermissible “hybrid” system of accounting, that there is a conflict in the evidence respecting the facts of the accounting system actually used, and that under these circumstances, the Commissioner’s determination should be sustained and that petitioner should not be allowed to rectify its mistake.

We think that the only “conflict” in the evidence has been satisfactorily explained by petitioner’s bookkeeper and accountant, who testified from the books that petitioner’s books have always been kept on an accrual basis, that its returns, which he prepared, were always filed on an accrual basis, and that the statement in the questionnaire on the 1936 return, that it was filed on the cash basis, and the omission to make any statement on the 1937 return, were erroneous and inadvertent. We have found that both returns were filed on the accrual basis.

It is to be noted, furthermore, that respondent has raised no objection whatever to the balance of the deduction taken for interest accrued on the mortgage, which amounts to $5,911.30.

We do not think his objections to the correction of the error are well founded. Appeal of E. J. Barry, 1 B. T. A. 156; Appeal of Gutterman Strauss Co., 1 B. T. A. 243; Appeal of Hickory Spinning Co., 1 B. T. A. 409. Accordingly, we find an overpayment of tax to the extent represented by petitioner’s understatement of its deduction for mortgage interest accrued. Therefore,

Decision will be entered wnder Buie SO.

       SEC. 26. CREDITS OP CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      * * * * * * *
      (c) Contracts Restricting Payment of Dividends.—
      (1) Prohibition on Payment of Dividends. — An amonnt equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.


author: Black :

text:
    J. Willis Gardner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92115.
    Promulgated March 29, 1940.

      Robert Ash, Esq., for tbe petitioner.

      A. B. Peterson, Esq., for tbe respondent.
   OPINION.

Black :

Inasmuch as the Board has recently held that the trust is not the donee of gifts, but that the beneficiaries of the trust are the donees, see Wilton Rubinstein, 41 B. T. A. 220, we have omitted any findings of fact as to whether the trust indenture dated May 4, 1926, created one trust or ten trusts. A finding of fact as to this matter is immaterial and therefore, unnecessary. Much of the discussion in petitioner’s brief and in respondent’s brief is devoted to this question, but in view of our decision in the Rubinstein case, it is unnecessary to discuss it further.

Petitioner’s assignments of error (a) and (d) involve the same issue and will be treated together. Assignment of error (a) involves transfers made to a trust for the benefit of ten of petitioner’s grandchildren in 1938 and assignment of error (d) involves transfers made to the same trust in 1936 for the benefit of eight of petitioner’s grandchildren.

For the respective taxable years petitioner claimed an exclusion of $5,000 for each grandchild to whom a gift was made,, under section 504 (b) of the Revenue Act of 1932. Respondent disallowed any exclusions on the ground that under the terms of the trust indenture petitioner’s grandchildren did not have the immediate right to the unrestricted use, possession, or enjoyment of the income and/or principal of the trust estate. Under such circumstances, the Commissioner said in his deficiency notice: “The gifts therefore, are considered to be gifts of future interests against which no exclusions are allowable.”

The case of Charles W. Deeds, 37 B. T. A. 293, involved facts which it seems to us are not distinguishable from those in the instant case. In that case we held that, although the donees did not have the immediate right to the unrestricted use, possession, or enjoyment of the property, the gifts were nevertheless gifts of a present interest in property rather than of future interests and that the taxpayer should be sustained in his contention.

To the same effect, on facts which though not identical with the facts we have here are somewhat similar, is our decision in Thomas E. Wells, 34 B. T. A. 315; affd., 88 Fed. (2d) 339; and Edwin Goodman, 41 B. T. A. 472, as to fund “C” and fund “D” involved in that proceeding. On the strength of these authorities, we decide issues (a) and (d) in favor of petitioner.

We next consider assignments of error (b) and (c). These assignments involve the issue of whether or not transfers to a trust for the benefit of Gilford V. Leece were in part gifts of future interests in property. We think the action of the Commissioner in determining that the exclusions allowed with respect to the property placed in trust for the benefit of this individual are limited to the present value of his right to receive income therefrom for 25 years must be sustained. Under the terms of the trust, the income from the property was to be paid to Leece either for life or the term of 25 years, whichever was the shorter. Then if he were living at the end of 25 years the remainder interest in the property held by the trustees, together with all undistributed net income therefrom, should be transferred and conveyed, free of trust, to said Gifford V. Leece. Thus it seems a completed gift of the remainder interest in the trust corpus was to be made to Gifford Y. Leece only in case he was living 25 years from the date of the trust. This we hold to be' a gift of a “future interest” in property under section 504 (b) of the Revenue Act of 1932. On this point we think the Commissioner must be sustained, under authority of Edith Pulitzer Moore, 40 B. T. A. 1019.

Decision will he entered under Bule SO,


author: Black: Sternhagen and Leech,

text:
    Dolores Crabb, Petitioner, v. Commissioner of Internal Revenue, Respondent. Madeline Welder Smith, Petitioner, v. Commissioner of Internal Revenue, Respondent. Elizabeth Wood, Petitioner, v. Commissioner of Internal Revenue, Respondent. James F. Welder, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95002, 95003, 95004, 95005.
    Promulgated March 29, 1940.

      Wright Morrow, Esq., and Harry O. Weelcs, Esq., for the petitioners.

      James H. Yeaiman, Esq., and J. O. Frey, Esq., for the respondent.
   OPINION.

Black:

We shall first consider assignment of error (b). In approaching this issue a brief review of what the parties have done and are now contending may be helpful. A partnership return for Jas. F. Welder Heirs was filed for 1936 showing a net income of $399,-183.50, on which return each petitioner was listed as being entitled to a one-fourth distributive share in its net income. Petitioners in their individual returns reported their so-called distributive share as if the net income of $399,183.50 was composed of the difference between separate net income of $409,089 and a convrmmity loss of $9,-905.50. This classification as between separate and community is identically the same as determined by the respondent except that the respondent added $72,875 as restored depletion to the separate income, which is the subject of assignment of error (a) (1), and treated the $5,000 commission paid as a deduction from separate income rather than as a deduction from community income, which treatment of the $5,000 petitioners do not question. Accordingly, each petitioner in reporting his or her so-called distributive share of Jas. F. Welder Heirs reported on the basis of a separate net income of $102,272.25 and a community loss of $2,476.38. The respondent, as indicated in our findings, determined that each petitioner should have reported on the basis of a separate net income of $119,241 and a community loss of $1,226.38. Petitioners now contend that the respondent erred in restoring the $72,875 item to income (which contention we shall consider when we take up assignment of error (a) (1)); that petitioners and respondent all erred in treating any of the income of Jas. F. Welder Heirs as separate income; that all of the income of Jas. F. Welder Heirs was partnership income and therefore community income; that each petitioner should have reported as his or her taxable income only one-half of one-fourth of $399,183.50, or $49,897.94; and that each petitioner is, therefore, due a refund instead of a deficiency. The respondent contends that his determinations are correct.

Is any of the income from Jas. F. Welder Heirs separate income to these petitioners, or is it all community income? We must look to the laws of the State of Texas for the answer. Poe v. Seaborn, 282 U. S. 101; Hopkins v. Bacon, 282 U. S. 122. It is petitioners’ position that under the Federal taxing act Jas. F. Welder Heirs has been properly classified as a partnership and that also under Texas laws Jas. F. Welder Heirs was a partnership, but if, because the wives had not had their coverture disabilities removed, Jas. F. Welder Heirs, can not be considered a partnership under Texas law, nevertheless all of the income in question must be classed the same as partnership profits and, as such, community income, citing as authority for the latter proposition 32 Texas Jurisprudence 228, par. 6. As shown in the above quoted statement from the deficiency notices the respondent’s position is that the question at issue is controlled by Commissioner v. Wilson, 76 Fed. (2d) 766.

At the outset we think it should be made clear that from the Federal tax standpoint Jas. F. Welder Heirs must be.classified as either a partnership, trust, or corporation, as those terms are defined in section 1001 (a) (1), (2) and (8) of the Revenue Act of 1936. This classification is controlled by Federal and not state law. Burk-Waggoner Oil Association v. Hopkins, 269 U. S. 110; Pierce Oil Corporation, 32 B. T. A. 403, pp. 429, 430. If classed as a partnership, it would not be taxed as a separate entity, but there would be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership. See secs. 181, 182, 183, and 187, Revenue Act of 1936. If classed as a trust, it would be taxed as a separate entity unless all of its income by the terms of the trust instrument was to be distributed currently by the fiduciary to the beneficiaries, or unless it was a revocable trust or one relating to income for the benefit of the grantors. See secs. 161, 162, 166, and 167, Revenue Act of 1936. If classed as a corporation, all of its net income would be taxed to it as a separate entity, and only the amounts actually distributed to the petitioners, namely, 95,000 to each petitioner, would, after being classed as either community or separate property, be taxed to petitioners as dividends. See secs. 13 and 115, Revenue Act of 1936. From this Federal tax standpoint the record clearly shows that Jas. F. Welder Heirs filed a return for 1936 and prior years as a partnership, and that this classification was accepted by the respondent in arriving at his determinations of the deficiencies, notwithstanding statements made by counsel for the respondent, both at the hearing and in his brief, to the effect that the respondent has not determined that Jas. F. Welder Heirs was a partnership. Moreover, we think respondent was correct in determining that Jas. F. Welder Heirs was a partnership as defined by section 1001 (a) (3) of the Revenue Act of 1936. He has so treated it in his determination of the deficiencies. Petitioners agree to that much of the treatment, and no sufficient reason why we should hold otherwise in these procedings has been pointed out.

If we should hold, as respondent’s counsel now contends in his brief, that Jas. F. Welder Heirs should not be treated as a partnership for Federal taxation, then that would mean that it must be classed either as an association taxable as a corporation or as a strict trust under the applicable revenue act. That would in turn mean that each petitioner would be taxable on only $95,000 which was distributed to him in the taxable year and respondent’s whole case would fall. Petitioners, however, make no such contention and freely concede that Jas. F. Welder Heirs should be taxed as a partnership under section 1001, and that each petitioner is taxable on his part of the gains and profits, whether actually distributed or not, but upon the community property basis. As we have already said, the fact that Jas. F. Welder Heirs is properly classed as a partnership for taxation under Federal law does not mean that Jas. F. Welder Heirs was a partnership under the laws of Texas. For reasons which we shall later point out, we think it is clear that Jas. F. Welder Heirs was not a partnership under Texas laws and the. property rights of the respective petitioners in the income received from Jas. F. Welder Heirs are not governed by Texas laws relating to partnerships but by its general property laws.

The Bevised Statutes of Texas in effect during the taxable year define the separate property of the husband and wife and their community property in the following language:

Article 4613: Ail property of the husband, both real and personal, owned or claimed by him before marriage, and that acquired afterwards by gift, devise, or descent, as also the increase of all lands thus acquired, shall be his separate property. * * *
Article 4614: All property of the wife, both real and personal, owned or claimed by her before marriage, and that acquired afterward by gift, devise, or descent, as also the increase of all lands thus acquired, shall be the separate property of the wife. * * *
Article 4619: All property acquired by either the husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife * * *.

Petitioners and the respondent agree that under the Texas law oil and gas bonuses and royalties as distinguished from rents and revenues received from leases on the separate land of either husband or wife, constitute increase of lands and as such the separate income of the owner of the land rather than community income. Cf. Stephens v. Stephens, 292 S. W. 290; E. Michna, 24 B. T. A. 715, 719; Chesson v. Commissioner, 57 Fed. (2d) 141; Turbeville v. Commissioner, 84 Fed. (2d) 307; certiorari denied, 299 U. S. 581. But petitioners argue that this doctrine has no application here for the reasons that they conveyed away their separate lands to a partnership; that from then on. they owned no specific interest in the lands, but had with respect to them, as well as all other partnership property, only , a chose in action; and that when the lands were so conveyed away and invested in the partnership, under 32 Texas Jurisprudence 223, “Such separate property becomes community property and the profits become community property.” We think this would probably be true, although respondent argues strongly to the contrary, if Jas. F. Welder Heirs is properly classed as a partnership under Texas laws.

The only agreement that petitioners had regarding their relationship was the trust instrument executed on February 15, 1932. Nowhere in this lengthy instrument was it ever suggested that the parties intended to enter into any partnership relation. It is stated in 32 Texas Jurisprudence 221, par. 5, that “A partnership at com. mon law is only a contractual status which exists in respect of the several persons who compose the firm-and who create it by their contract”, and in 32 Texas Jurisprudence 234, par. 13, that “As between the parties themselves there must be a voluntary agreement and an actual intention to become partners. Their actual intention determines as among themselves the question as to whether a partnership or some other relation has been formed by their agreement. What they call their agreement and make it determines their relation unless their actual intent is nevertheless to be partners.”

Furthermore, three of the grantors were married women who had never made application for removing their disabilities of coverture, and could not, therefore, under the Texas law, enter into a partnership with their husbands or with anyone else. Wright v. State, 71 S. W. (2d) 352. Neither did the instrument of February 15, 1932, indicate in any manner that James F. Welder, Jr., and the respective husbands of his three sisters were to enter into a partnership among themselves, with the three sisters as creditors. The instrument plainly indicates an intention that for a period of 10 years the properties conveyed to the trustees “be managed, handled, controlled and conducted as a ranch and farm business as an entirety, without partition of any kind” and upon the termination of “this trust * * * said trustees shall reconvey to said respective beneficiaries, or to the person or persons entitled thereto, their respective shares in said properties.” The main idea which the parties had in mind was to hold the lands together as their mother had requested them to do when she deeded them the Duval ranch in October 1931. Provision was made for successor trustees in case either Kate B. Welder or James F. Welder, Jr., or both, became incapacitated, and the trust was not to terminate by reason of the death of any of the parties thereto, but was to continue to the end of the ten-year term. One does not find such provisions in a partnership agreement, it being fundamental in partnership law that the death of a partner dissolves the partnership. We think J as. F. Welder Heirs was, under the Texas law, a joint venture, group, or pool rather than a partnership.

We think that under these circumstances the question as to whether the oil and gas bonuses and royalties in question (including whatever restored depletion we hold to be income in our discussion of that issue below) constitute community or separate income is controlled by Commissioner v. Wilson, supra. Petitioners attempt to distinguish that case from the instant case on the ground that the beneficiaries of the trust involved in the Wilson case did not create the trust, as was the case here, and that there was no contention made in the Wilson case that the trust there was a partnership. We have already held that in the instant case the petitioners were not partners under Texas law but members of a group or joint venture or pool. In either such event petitioners were the equitable owners of the properties held by the trustees. Cf. Commissioner v. Terry, 69 Fed. (2d) 969; Eva Lavino Griffiths, 30 B. T. A. 852. The moneys paid as lease bonuses and royalties represented the conversion into cash of a portion of the corpus of their separate estate. The separate estate may undergo mutations, but it still retains its separate character so long as it can be traced and identified. Cf. Stanolind Oil & Gas Co. v. Simpson-Fell Oil Co., 85 S. W. (2d) 325; affirmed by the Supreme Court of Texas, 125 S. W. (2d) 263. It was so traced and identified in the instant proceedings. It, therefore, remained the separate estate of these petitioners, and is taxable to them as their separate income. The respondent’s determination as to this issue is sustained. Commissioner v. Wilson, supra.

We shall now consider assignment of error (a) (1). Ás far as this issue concerns the restored depletion of $68,750 in connection with the lease to the Humble Oil & Refining Co. for a cash bonus of $250,000, it is controlled by our decisions in Grace M. Barnett, 39 B. T. A. 864, and J. T. Sneed, Jr., 40 B. T. A. 1136, and upon the basis of those decisions we hold for the respondent. There was no production whatever from the Humble lease prior to its surrender in 1936.

As far as this issue concerns the restored depletion of $4,125 in connection with the oil and gas lease to the Circle W. Oil Corporation for a cash bonus of $15,000, the undisputed evidence shows that Circle W. Oil Corporation drilled a well upon the tract in 1934 and that well produced oil sufficient that Jas. F. Welder Heirs received therefrom royalties amounting to $13.81 and payments out of oil to apply on the reserved oil payment amounting to $23.17. It was also definitely established by the evidence that the well so drilled was capable of producing substantial quantities of gas which could not then be utilized profitably in that field but at the present time could be utilized with a substantial profit.

Under these circumstances we do not think that article 23 (m)-10 (c) of Regulations 94, upon which respondent relies, authorizes a restoration to income in 1936 of the $4,125 depletion deducted in 1934 because of the Circle W. Oil Corporation bonus. Percentage depletion is not based on cost and has no relationship to cost. There has been actual depletion, though small in amount, from this 150-acre tract, and this depletion took place under the Circle W. Oil Corporation lease. Under the respondent’s own ruling as contained in G. C. M. 14484, C. B. XIV-1, p. 98, the depletion allowed in 1934 with respect to this particular lease should not be restored to income, because there has been actual production from the lease. As to this part of the Commissioner’s determination, petitioners’ assignment of error is sustained.

Reviewed by the Board.

Decisions will be entered wnder Bule 50.

Sternhagen and Leech,

dissenting: We are of opinion that the consideration and decision should not proceed upon the postulate that “Jas. F. Welder Heirs” is a partnership within section 1001 (a) (3) of the Revenue Act of 1936, even though that postulate was apparently adopted by the parties. To us the facts found indicate more probably that the organization is an association, taxable as a corporation within section 1001 (a) (2), the income of which is taxable to it and the distributions from which are taxable to the recipient members as dividends. Pierce Oil Corporation, 32 B. T. A. 403, at page 429. Since in the present posture of the proceeding that proposition has not been' litigated, we do not reach a conclusion upon it.

       SEC. 1001. DEFINITIONS.
      (a) When used in this Act—
      (1) The term “person” means an individual, a trust or estate, a partnership, or a corporation.
      (2) The term “corporation” includes associations, joint-stock companies, and insurance companies.
      (3) The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this Act, a trust or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or organization.

       See footnote 1, p. 2.


author: Smith: Mellott, Harron,

text:
    Theodore R. Plunkett, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94017.
    Promulgated March 29, 1940.

      Bennett Sanderson, Esq., for the petitioner.

      Charles P. Reilly, Esq., and Davis Hashin, Esq., for the respondent
   OPINION.

Smith:

The principal issue in this case is whether the petitioner is liable to income tax for 1934 in respect of the $70,000 which the Probate Court ordered the trustee on October 9, 1934, to pay to him “forthwith.” The petitioner contends that this amount was a payment of principal and not of distributable income; that he received this amount by virtue of his rights under the will of his father as construed by the Probate Court, and that the amount was property acquired by bequests, devise, or inheritance and as such is not liable to income tax in his hands.

.Section 161 (a) of the Revenue Act of 1934 provides in part:

(a) Application of Tax. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property .held in trust, * * *

Section 162 provides in part:

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
*******
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to he distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * . * *

All of the income of a trust is taxable either to the trust or to the beneficiary. Freuler v. Helvering, 291 U. S. 35. The beneficiary of the income of a testamentary trust is taxable upon the income of the trust. It is not exempt from income tax as a bequest or inheritance. Irwin v. Gavit, 268 U. S. 161. The question for decision is whether the $70,000 which the Probate Court ordered the trustee in 1934 to pay “forthwith” to the petitioner constituted income “which is to be distributed currently by the fiduciary.” The respondent argues that it is.

The rule of law in Massachusetts, as in many other states, is that the proceeds from the sale of securities owned by a trust forms a part of the principal of the trust and that the gain on such sale is not distributable to the income beneficiary. Chase v. Union National Bank of Lowell, 275 Mass. 503; 176 N. E. 508; Old Colony Trust Co. v. Comstock, 290 Mass. 377, 384; 195 N. E. 389.

.Under the law in force in Massachusetts, as interpreted by its courts, a court having jurisdiction of a testamentary trust is permitted to allocate a certain part of trust corpus to the income beneficiary, if, in the court’s opinion, that is necessary to accomplish the intent of the testator. In the early case of Parsons v. Winslow, 16 Mass. 361, a trustee held an investment which had defaulted so that the total recovery was less than the amount of principal invested. The court stated that it would be' unjust and contrary to the manifest intent of the testator if the tenant for life, on the one hand, should continue to receive the whole amount of the interest on the original fund after the principal had been reduced, or if, on the other hand, the income should be applied to replace the principal. To remedy such an injustice the court applied the doctrine of apportionment.

In Kinmouth v. Brigham, 5 Allen, 270, a Massachusetts case, the trustee had invested in a partnership enterprise and in a short time had received over $100,000 profits from a $50,000 investment. Although the will directed the payment of income to a life beneficiary, the court determined that the testator never intended the life beneficiary to receive such a return. In order to accomplish the substantial intent of the testator, as found by the court, the apportionment formula was applied limiting the income to the amount which at the normal rate of return would have yielded the fund held by the trustee. The court in its opinion stated:

* * * upon a just construction of tbe will, equity will require that the profits * * * should not be regarded or treated exclusively as income, but that they he treated when received from time to time, as property belonging to the estate, a part of which is to be invested as capital and a part distributed as income.

There are numerous other Massachusetts cases in which the court speaks of “principal treated as if it were income” or “income treated as if it were principal.” See Sargent v. Sargent, 103 Mass. 297; Edwards v. Edwards, 183 Mass. 581; 67 N. E. 658; Loring v. Thompson, 184 Mass. 103; 68 N. E. 45.

The purport of the above cited Massachusetts cases is that, although ordinarily income of a trust realized from the sale or other disposition of securities owned by a trust belongs to the remaindermen and not to the life beneficiary, the court having jurisdiction of the trust may determine what part, if any, of the profit belongs to the life beneficiary. In the proceeding at bar the petitioner was entitled to receive only the income of the testamentary trust. But the Probate Court for Berkshire County held that $70,000 of the $500,000 received by the trustee from the Old Colony Trust Co. of Boston, the former trustee, should be paid to the life beneficiary. By its decree of October 9, 1934, it ordered the payment of that amount to the petitioner “forthwith.” There is no question in this proceeding but that the Probate Court had authority to enter such decree. The effect of the decree was to make the $70,000 distributable income of the trust for 1934.

The petitioner argues that the $70,000 received by him from the trust in 1934 and 1935 constituted a bequest under the interpretation of his father’s will by the Probate Court and that the amount is exempt from income tax under section 22 (c) of the Revenue Act of 1934, which exempts from income tax “the value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).” In support of this contention the petitioner cites Burnet v. Whitehouse, 283 U. S. 148; Burdick v. Commissioner, 76 Fed. (2d) 672; and Lyeth v. Hoey, 305 U. S. 188. We are of the opinion that the legal principles established by the above cited cases have no application to this case. The petitioner is the life beneficiary of a testamentary trust created by the terms of his father’s will. By the decree of the Probate Court $70,000 of the $500,000 received by the trust from the Old Colony Trust Co. was made distributable income of the trust. That income is taxable income of the petitioner. Irwin v. Gavit, supra.

The petitioner also argues that the entire gain, if any, received by the trust from the receipt of the $500,000 was taxable income of the trust and that what the petitioner received was income which should have been tax paid by the trust, citing Helvering v. Falk, 291 U. S. 183; Spreckels v. Commissioner, 101 Fed. (2d) 721; Weigel v. Commis sioner, 96 Fed. (2d) 387; and Anna M. Chambers et al., Trustees, 33 B. T. A. 1125. The above cited cases are not in point, however, if j as. we hold, the $70,000 was made “distributable income” of the trust by virtue of the Probate Court’s decree entered October 9, 1934.

The petitioner further argues that, since he received only $66,000 from the trust in 1934, and since he made his income tax return upon the cash receipts and disbursements basis, he can not be held to be liable to income tax upon more than $66,000 of the $70,000 covered by the court’s decree. If, however, as we hold, the $70,000 constituted “distributable income” of the trust in 1934, it is immaterial whether the petitioner received the entire amount in 1934 or not.

We think that the respondent did not err in including the entire $70,000 in petitioner’s taxable income for 1934.

The petitioner claims that he is entitled to a deduction from gross income of 1934 of $25 paid to the American Bed Cross. He testified, however, that this was the amount of the contribution that he had made in a number of years and he could not swear positively that the contribution was made in 1934. For lack of proof the deduction is disallowed.

The petitioner has, however, proved that he is entitled to the deduction of $61.61 automobile excise taxes paid to the town of Adams and $60 paid as gasoline taxes representing the tax imposed by Massachusetts, I. T. 2512, VIII-2 C. B. 112. The petitioner is not entitled to deduct the gasoline tax collected for the United States, Mim. 3888, XI-2 C. B. 25.

The petitioner also claims the right to deduct $7,636.66 interest paid to his father-in-law, A. B. Daniels, in October 1934. The evidence shows that the petitioner owed this interest. It was included in a total indebtedness of the petitioner to Daniels in the amount of $72,957.64. The petitioner made only a partial payment of the account in 1934, namely, $68,485.57, leaving a balance owing of $7,472.07. Nothing was said by either debtor or creditor as to how the partial payment should be credited. The respondent contends that the partial payment should be credited, first, against the principal, and then against the interest. Upon this basis the respondent contends that the petitioner is entitled to a deduction for interest of only $164.59. The law is plain, however, that where a partial payment is made on an interest-bearing debt the payment is to be credited first to the interest and then to the principal. 33 Corpus Juris 168. This is clearly the law in Massachusetts. See Dean v. William, 17 Mass. 417; Fay v. Bradley, 1 Pick. 194; Downer v. Whittier, 144 Mass. 448; 11 N. E. 585. We hold that the petitioner is entitled to deduct from his gross income of 1934 interest in the amount of $7,636.66.

The final question for consideration is wh.eth.er the petitioner is liable to the 25 percent delinquency penalty imposed by section 291 of the Revenue Act of 1934 for delinquency in filing his income tax return for 1934. That section of the statute provides in part:

In case of any failure to make and file a return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, 25 per centum of the tax shall be added to the tax, except that when a return is filed after such time and it is shown that the failure to file it was due to reasonable cause and not due to willful neglect no such addition shall be made to the tax. * * *

Section 51 (a) provides for the filing of a return “under oath” by any person required to file an income tax return. Such return must be filed with the collector on or before the 15th day of March where the return is made on a calendar year basis.

The evidence in this case shows that the petitioner had prepared an income tax return for 1934. He testified that it has been his practice to send his income tax returns to the collector by mail; that he has usually done this on the 14th or 15th day of March of each year and that no question of delinquency has ever been raised with respect to such filing prior to the filing of the return for 1934; that his return for 1934 was mailed from Adams, Massachusetts, addressed to the collector at Boston, on Friday, March 15, 1935, accompanied with a check for the amount of the tax shown by his return to be due. He supposed that his return was signed and sworn to. Failure to sign and verify the return was inadvertant.

During the summer of 1935 the collector wrote the petitioner for an explanation as to why his return was' delinquent, the same not having been received in the collector’s office until Monday, March 18, 1935. Apparently nothing was said in the letter with respect to the failure of the petitioner properly to execute his return.

On March 5, 1938, the respondent sent out. the deficiency notice involved in this proceeding. In such notice it was stated:

Form 1040A filed for the year 1934 was neither signed nor sworn to, the latter being required by the provisions of section 51 (a) of the Revenue Act of 1934. Inasmuch as you failed to file an acceptable income tax return within the time prescribed by law, 25 per centum of the tax for the year 1934 has been added thereto in accordance with the provisions of section 291 of the Revenue Act of 1934.

The petition in Docket No. 94017 was filed with this Board on June 1, 1938. On July 15, 1938, the respondent filed an answer and the case was then at issue. Thereafter, on October 10, 1938, the petitioner, at the suggestion of his counsel, filed a properly executed income tax return for 1934. It has been many times held by this Board and the courts that, where a taxpayer fails to file an income tax return as required.' by' law, the imposition of the 25 percent penalty is mandatory. John B. Nordholt, 4 B. T. A. 509; John T. Sline, 9 B. T. A. 1222; E. M. Green, 11 B. T. A. 185; Scranton, Lackawanna Trust Co., Trustee, 29 B. T. A. 698; affd., 80 Fed. (2d) 519; Harry D. Kremer, 31 B. T. A. 566; John Ernest Goldring, 36 B. T. A. 779; Taylor Securities, Inc., 40 B. T. A. 696; Fidelity & Columbia Trust Co. v. Commissioner, 90 Fed. (2d) 219; certiorari denied, 302 U. S. 723.

In Lucas v. Pilliod Lumber Co., 281 U. S. 245, the Supreme Court held that a corporation income tax return which was not verified by its proper officers was not a return required by statute and not such a return as would set in operation the time for the running of the statute of limitations. The purported income tax return of the petitioner for 1934 mailed by the petitioner from Adams, Massachusetts, on March 15,1935, was not a return required by the statute. It was no return at all. The first return which was filed was filed on October 10, 1938. That return was filed after all pleadings in this case had been filed and issue joined. It was filed too late to avoid (he attachment of the penalty. Taylor Securities, Inc., supra.

The action of the respondent in adding to the tax the 25 percent penalty for delinquency is approved.

Reviewed by the Board.

Decision will be entered under Rule 50.

Disney concurs only in the result.

Mellott,

concurring and dissenting: I concur in the holding to the effect that the $70,000 constituted taxable income to the petitioner but am of the opinion that the 25 percent delinquency penalty should not be imposed. The document filed by petitioner with the collector on March 18, 1935, was treated as a return, though not signed by him. It was audited by the department, and the collector “requested a statement from the petitioner as to why his return was delinquent.” The check, which petitioner enclosed, was cashed and the amount thereof, together with' interest, was refunded to petitioner about a year later because he had included in his gross income his salary as state senator, which was not then taxable. Apparently no question was ever raised because the return was unverified until several years later, when the present deficiency was determined. Shortly thereafter petitioner “filed a properly verified income tax return for 1934.” The penalty, in the language of the statute, is not to be imposed “when a return is filed after' * * * [the time prescribed by law] and it is shown that the failure to file it was due to reasonable cause and not due to willful neglect * * Being of the opinion that petitioner’s late filing was not due to willful neglect, I respectfully note my dissent to the imposition of the penalty.

Murdock and Hakron agree with the above.

Harron,

concurring: While it is unnecessary in this case to decide a related question, namely, whether the trust realized any gain from the receipt of $500,000 from the first trustee, I believe it should be concluded from the facts, in determining the main question which is involved in this case, that the $500,000 represented a recovery from the trustee for a breach of trust. There is in evidence, as petitioner’s Exhibit 5, a copy of the decree (entitled “Summary”) of the judge of the Probate Court of Massachusetts which heard the complaint regarding the first trustee’s accounts. This “Summary” shows that questions were raised by the complainants as to the propriety of the trustee’s actions. It was alleged that the trustee improperly retained in the trust the investment in stock in Greylock Mills and Berkshire Manufacturing Co. As to this, the court found that the retention was proper. But the court found that it was not proper for the trustee to vote the shares of stock in Berkshire and Greylock in the exchange of those stocks for stock of Berkshire Fine Spinning Associates, Inc., and that the investment by the trustee in stock of Berkshire Fine Spinning Associates, Inc., was not a proper investment by the trustee, under the terms of the testamentary trust. The court found that in the entire matter the trustee failed to exercise the required “care and consideration of a fiduciary under like circumstances.” The court was asked to surcharge the trustee for its failure to sell the Greylock and Berkshire stock sometime prior to the merger of those companies with Berkshire Fine Spinning Associates, Inc. The court found that the trustee must be charged with the inventory value of the Berkshire and Greylock stocks. The above indicates clearly that the Massachusetts court found that the trustee committed a breach of trust and surcharged the trustee $500,000. From the above, it would seem to follow that there was no “sale or exchange” of securities in the trust for $500,000 as that term is used for income tax purposes, and that the question in this case does not involve any realization of gain by the trust.

The $500,000 represents a recovery from the trustee for a breach of trust. It is a rule that property recovered from a trustee, under such circumstances, should be apportioned between trust income and trust capital so as to put the income beneficiary and the corpus beneficiary in as nearly the position as each would have been in if there had not been a breach of trust. That is what the court ordered in the Parsons v. Winslow case. See Bogert, Trusts and Trustees, vol. 4, p. 2385, and comment on the Parsons case at p. 2384. In this case the local court, somewhat belatedly, ordered distribution of the sum recovered to trust income and trust principal. It could have done this in its first decree surcharging the trustee. Nevertheless, by court order, $70,000 was income, and $430,000 was principal. Petitioner could not at any time receive any distribution of trust principal. His rights were limited to receipt of trust income. The $70,000 was income distributable to petitioner in 1934, and it is taxable to petitioner under section 162 (b).