author: HakRon :

text:
    Resthaven Memorial Cemetery, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98427.
    Promulgated February 19, 1941.

      Max Wdldman, Esq., for the petitioner.

      T. F. Callahan, Esq., for the respondent.
   OPINION.

HakRon :

The basic question is whether the transactions involving the execution and delivery of deeds to cemetery lots and the issuance of repurchase certificates constituted sales of such lots or loans secured by mortgages on such lots.

On its corporation income and excess profits tax returns for its fiscal years ended November 30,1935 and 1936, petitioner included in income $12,240 and $25,380, respectively, the gross amounts received in connection with, the transactions in question. In a protest filed with respondent, petitioner contended that the amounts of $12,240 and $25,380 should not have been included in income on its returns for the taxable years because the transactions in question constituted loans. In the deficiency notice respondent denied these contentions on the ground that the transactions in question were sales. In its petition petitioner alleges that respondent erred in including in petitioner’s income for its fiscal years ended November 30, 1935, and 1936, respectively, $12,240 and $25,380 “payments received from customers upon the purchase of '’Repurchase Certificates.’ ”

Also, in its returns for the taxable years, petitioner deducted as “interest” $4,948.14 and $5,283.28, respectively, amounts paid as option fees on the repurchase certificates held by its perpetual care and endowment fund, and $1,142.95 and $2,199.40, respectively, amounts paid as option fees on repurchase certificates held by individuals. Respondent disallowed the deduction of the first two amounts (paid on the certificates held by the perpetual care and endowment fund), on the ground that such amounts were “paid to repurchase lots and should be capitalized as it will be the cost of such lots as may be acquired at the end of the eight-year period referred to in the repurchase certificate.” In an amended answer respondent alleges that he erred in not also .disallowing the deductions of the latter two amounts paid on repurchase certificates held by individuals, and he asserted a claim for increased deficiencies for the taxable years, under section 272 (e) of the Revenue Acts of 1934 and 1936, increasing the deficiencies to the amounts set forth at the outset.

Petitioner contends in its brief that the transactions in question were loans, that the amounts received by petitioner in the taxable years in connection with the transactions constituted borrowed moneys and should not be included in its taxable income for those years, and that the amounts paid by petitioner in the taxable years on the repurchase certificates constituted interest on borrowed moneys and were deductible in those years. Petitioner relies especially on United National Corporation, 33 B. T. A. 790.

On the other hand, respondent contends that the transactions in question were sales, that the amounts received by petitioner in connection with the transactions were properly included in petitioner’s income for the taxable years, and that the amounts paid by petitioner in the taxable years on the repurchase certificates did not constitute interest on borrowed moneys and were not deductible. Respondent relies on Irving Fisher, 30 B. T. A. 433; and William M. Davey, 30 B. T. A. 837.

In determining whether the transactions in question were actual sales of cemetery lots or loans secured by mortgages on the lots the governing factor is “the intention of the parties and this is to be gathered not only from the instruments themselves but all the attending facts and circumstances.” United National Corporation, supra; Tucker v. Witherbee, 130 Ky. 269; 113 S. W. 123; Vaughn v. Smith, 148 Ky. 531; 146 S. W. 1094; Jones, Mortgages (8th ed.), sec. 309. To determine the intention of the parties all instruments executed in connection with a deed absolute on its face are to be construed as a part of the deed. Jones, Mortgages (8th ed.), sec. 312, 315. “In order to convert what appears to be a conditional sale into a mortgage, the evidence should be so clear as to leave no doubt that the real intention of the parties was to execute a mortgage; otherwise the intention appearing on the face of the deed ought to prevail.” Jones, Mortgages (8th ed.), sec. 311. Parole evidence is admissible to show that a deed absolute on its face was intended as a mortgage. Peugh v. Davis, 96 U. S. 322; Hayward v. Mayse, 1 App. D. C. 133. However, the parole evidence must be clear and satisfactory. Hayward v. Mayse, supra; Stokeley v. Flanders, 128 S. W. 608; and it is not sufficient that the parole evidence “throw doubt upon the matter' or * * * raise suspicion as to the character of the transaction.” Hayward v. Mayse, supra. There is a presumption that an absolute deed is just what it purports on its face to be. Jones, Mortgages (8th ed.), sec. 409. Petitioner has the burden to establish the transactions in question as loans “not only because respondent has officially determined that the transactions were sales but also because they are expressly so designated in the contracts of the parties thereto.” Irving Fisher, supra. It should also be pointed out that an essential requisite of a mortgage is a debt. Jones, Mortgages (8th ed.), sec. 316; and that an obligation of the seller to repurchase the property sold does not per se create a debt owing from the seller to the purchaser. William M. Davey, supra.

In our opinion, the transactions in question were sales. The deeds to the lots were absolute on their faces. The agreement contained in the repurchase certificates was stated to be made between petitioner and the owner in consideration of the purchase of certain cemetery property. The monthly payments of $1 per lot were stated in the certificates to be for the privilege of retaining an option on the lots. The certificates expressly stated that petitioner’s “right and/or obligation to repurchase and to pay option charges shall forthwith cease and terminate, upon interment in or erection of a monument upon any Unit covered by this agreement, and as regards said Unit upon which interment has taken place or a monument has been erected, said agreement shall be deemed to have been fully discharged.” This provision in particular indicates that it was not intended that petitioner was to retain any right of redemption in the lots involved and is entirely inconsistent with petitioner’s theory that the transactions in question were loans secured by mortgages on the lots. Each certificate further provided that it contained the entire agreement between petitioner and the owner and that “both parties agree that no promises have been made and there are no oral understandings, representations or agreements between the parties hereto not herein set forth.” It is true that the certificates provided that petitioner was obliged to repurchase the lots sold at the selling prices from the owners at the expiration of eight years from the issuance of the certificates if the owners desired that petitioner do so and also that petitioner was entitled to repurchase the lots prior to the expiration of the eight-year period at prices slightly above the selling prices. However, the existence of this obligation and right to repurchase was entirely consistent with the theory that the transactions in question were sales on conditions subsequent. William M. Davey, supra. The peculiar phraseology of the repurchase certificates, read together with the absolute deeds, is entirely inconsistent with petitioner’s theory that the transactions in question were loans secured by mortgages on the lots and furnishes strong evidence that the parties intended that the transactions in question were conditional sales. Hanford v. Blessing, 80 Ill. 188, 189; Jones, Mortgages (8th ed.), sec. 312.

Moreover, the evidence introduced by petitioner to show that the transactions in question were loans secured by mortgages on cemetery lots is far from satisfactory and at most raises a mere doubt or suspicion.

The testimony of petitioner’s president lends but slight support to petitioner’s theory. He was asked many questions which were improper because calling for his conclusion rather than a statement of fact. He testified that in conducting petitioner’s business it was necessary to sell property in advance of need; that in the taxable years income was derived from the sale of cemetery lots and from the sale of “securities”; that the sale of each repurchase certificate represented a “unit sale.” Such fragmentary testimony indicates that he understood that sales were made by the completion of the transactions involving the issuance of the repurchase certificates and deeds to cemetery lots. He also testified that it was petitioner’s intention “to borrow money for eight years”; that each certificate sold was “secured” by a deed to property; that accounts were set up on petitioner’s books described as “loans.” The books were not introduced or offered in evidence and consequently the record, does not show how the real estate accounts were charged for the issuance of deeds to cemetery lots. One witness, a salesman, testified that he sold units (repurchase certificates) for investment to persons interested in a definite interest yield. All of such testimony taken together does not show clearly that the transactions were other than of the type defined by the terms of the repurchase certificates themselves.

There is no ambiguity in terminology. The transaction on the face of the “Deed to Burial Lot” and the “repurchase certificate” was clearly a transaction constituting a sale of a cemetery lot with simultaneous execution of a repurchase agreement as part of the consideration of the sale of the cemetery property. The repurchase agreement gave petitioner an option to repurchase the property within eight years, provided petitioner made payment of stated monthly “option fees.” The agreement created an obligation in petitioner to repurchase upon certain subsequent conditions the most important of which was preservation of the cemetery property in a condition for resale by the “Owner”, i. e., free from use as burial ground. It was outside the control of petitioner how the “Owner” would use the property deeded to him and covered by a repurchase agreement. Under such circumstances testimony that petitioner’s sole interest was “ to borrow money for eight years”, by virtue of the transactions in question, does not square with the realities of the transactions which were carried into effect. Under the facts, under the terms of the repurchase agreement, under the circumstances of delivery of absolute deeds to cemetery lots to persons described as purchasers, who in fact paid cash consideration, the realities of the transactions are that they were a method of selling cemetery property in advance of need, with a limited privilege in the purchaser to sell the property back to petitioner within eight years, as well as with a right in petitioner to repurchase, if option fees were paid, as required.

Petitioner has not introduced clear and convincing evidence that the transactions in question did not constitute sales. Clearly on the face of the transactions they did not involve loans to petitioner. Irving Fisher, supra. As was stated in the Fisher case, and equally applicable here, “We are unable to find from anything dehors the contract that the parties intended to and actually did contract only for a loan. As between the petitioner’s deliberate writing to express his intention and his oral statement of his intention, the writing must prevail.”

Mention should be made of oral testimony of two witnesses for petitioner other than petitioner’s president and a salesman. Both were aged women. One stated that her memory was leaving her; that she was getting old. Each appeared to understand from the terms of the agreement relating to a monthly payment of the “option fee” that petitioner was obligated to pay that. It is true that petitioner did obligate itself to pay option fees, but such obligation does not suffice to characterize such type of payment as a payment of “interest” as that term is understood for questions relating to statutory tax deductions. Petitioner’s selection of these two individuals, from all of its list of owners of cemetery lots, which must have included persons having a more apparent understanding of the terms and meaning of ordinary business transactions, made petitioner’s presentation of its case difficult. In a most real sense petitioner handicapped itself in its choice of witnesses whose testimony proved to be deserving of little weight. These witnesses, frail in every respect, were asked questions, repeatedly, which called upon them to make conclusions. While_ it is conceivable thakpetikien^r could have pre-sentejLjts case with greater strength if it had called more capable witnesses, or if questioning had"BgSTmore sSIlful7~it is nevertheless exceedingly aouBffuTiFeven more competent witnesses could testify in a way by which the terms of the written agreement involved could be shown to have been intended to be otherwise than is stated in writing. Accordingly, as to petitioner’s prayer in its brief that, in the event the present record leaves doubt as to the correctness of its contentions, petitioner should be afforded a further hearing, the opinion is here expressed that petitioner has had its day in court and no useful purpose would be served by opening the record for further hearing.

It is held that the transactions in the taxable years were sales; that the net receipts therefrom were properly included in taxable income; that the amounts paid as option fees are not deductible as interest paid on indebtedness. The payments were made “for the privilege of retaining” options to repurchase the lots sold and constituted capital expenditures. Respondent is sustained on disallowance of the deductions, as disallowed in the notice of deficiency and by the amended answer.

It is not clear whether or not respondent has computed petitioner’s taxable income in each year with allowance for deductions from gross receipts from sales of cemetery lots in question for cost of the lots to petitioner. It has been stipulated that the lots sold in the respective years had a cost to petitioner of $4,162.96 and $8,388.09, and that net gain, income, from the sales was $8,077.04 in 1935 and $16,991.91 in 1936. To remove doubt the deficiencies should be recomputed under Rule 50.

Decision will ~be entered under Rule 50.


source: Caselaw Access Project

author: KeRn: Mellott,

license: Public Domain

text:
    Morgan Jones Estate, Percy Jones, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100686.
    Promulgated February 19, 1941.

      J. Marvin Haynes, Esq., and W. O. MagatJicm, Esq., for the petitioner.

      Marguerite Bcmalt, Esq., for the respondent.
   OPINION.

KeRn:

The decedent died leaving an estate of nearly $8,000,000 invested in a railroad, cotton seed oil mills, ranches and farms aggregating 70,000 acres, and interests in several partnerships engaged in selling land and leasing for oil wells. The multiplicity of his business activities and the methods by which his executor conducted them need not detain us, in view of the question before us, and on that account we do not set them forth in our findings or consider them here. We are concerned only with the narrow question of whether certain legal expenses incurred and paid in somewhat unusual circumstances are deductible. It is apparently not disputed that the expenses were necessary, if they could be considered as ordinary. However, if the expenses were, as respondent contends they were, a part of petitioner’s cost of the tract involved and therefore in the nature of a capital expenditure, they are not deductible. In view of our conclusions on this impediment in the way of petitioner’s success, we leave the other issues on one side and proceed at once to the question to be first determined.

The facts are peculiar. Decedent had acquired in 1923 fee simple title, free of all encumbrances, to a tract of some 62,000 acres in Texas. In December 1936 the daughter of the former owner first asserted a claim to the oil rights and lease money received by the petitioner from these lands, basing her claim on a pretended mineral deed from her father given in 1916. No such deed had been found in the previous title searches made by petitioner and others, and the local title-abstract companies had no record of it. But on examination of the records the purported deed was found, apparently duly recorded. Further investigation showed that it was written by a typewriter in a font not used before 1927, and that the day of its purported recording was a Sunday and before that of certain authentic instruments previously recorded. The fraud, but not the agent or manner of its perpetration, was now obvious; and when petitioner as decedent’s executor brought a suit in the United States District Court to remove the cloud on his title he was granted the prayed for relief.

Was this a capital expenditure? The Commissioner’s regulations, set out in the margin, have been consistent in treating the cost of defending title as a capital expenditure. The court in Moynier v. Welch (1938), 97 Fed. (2d) 471, and Murphy Oil Co. v. Burnet (1932), 55 Fed. (2d) 17, affirming 15 B. T. A. 1195, on this point; affirmed on other issues, 287 U. S. 299, held, as this Board has held, that such fees are a capital expenditure, to be added to the cost of the land.

In the Murphy Oil Co. case, supra, the taxpayer company had acquired by assignment an oil lease on certain land. It drilled an oil well, but it was “capped” later as a dry well. One Bacon, the secretary of the company, purchased the fee to the land and a month later conveyed the fee to the company. Thereafter the company produced oil in paying quantities. The original owner of the fee and vendor to Bacon sued to rescind the contract of sale on the ground of fraud — the lessee’s false representation that the well first drilled was dry. A settlement was reached between the taxpayer company and Bacon’s vendor by which the sale was confirmed and a substantial sum paid to the vendor. The court said, at page 26:

* * * it does not alter the fact that, the payment made to the vendor was substantially a deferred payment for the property. It was therefore essentially a capital investment and not allowable as a deduction from income. * * *

And the court proceeded to quote with approval the opinion of this Board in disposing of the case:

To the extent that the expenses and payment were incurred and made in defense of the claim against the oil properties they were capital expenditures. We have repeatedly held that the cost of defending title, whether in the form of legal fees or compromise payments, is a capital expenditure representing additional cost of the property. Lincoln L. McCandless, 5 B. T. A. 1114; Gopher Granite Co., 5 B. T. A. 1216; Seletha O. Thompson, 9 B. T. A. 1342; Frederick McLean Bugher [9 B. T. A. 1155] supra; Forth American Oil Consoli dated, 12 B. T. A. 68; Phoenix Development Co., 13 B. T. A. 414. The decisions in Kornhauser v. U. S. [276 U. S. 145, 48 S. Ct. 219, 72 L. Ed. 505] supra, and the Superheater Co., 12 B. T. A. 5, which are relied upon by the petitioner, are not in conflict with these cases. In the Superheater case the contemplated litigation grew out of an action of the board of directors, acting as such. The claim settled did not involve title. In the Kornhcmser case the legal expenses were incurred to contest a claim against income received, differing fundamentally from the ordinary attack on title, even though the income in question consisted of shares of stock.

The facts and pertinent point in Moynier’s case, supra, may be stated briefly in the court’s language:

The plaintiff owned a ten acre lot in a subdivision called “Moynier Tract”, Los Angeles County, California, upon which an oil company, having leased the land, drilled a well. Oil was secured in paying quantities. The only business in which the plaintiff was engaged was that of collecting his oil royalties and paying the taxes on the property he owned in said tract. All of the income upon which he paid taxes came from such royalties. Serious litigation arose over his right to such royalties. The producing oil company sued to have settled whether it should pay the provided royalties wholly to plaintiff or divide it with others, who owned other lots in the same tract. The others claimed that the lease contemplated a division of the royalties. Appellant expended the sum of $36,937.10 in attorney fees and litigation costs in relation thereto. * * *
* *■ * * ■ * * •
The authorities leave no doubt in the matter. Attorney fees and litigation costs in such circumstances are capital expenditures and are not deductible. Such expenditures were not “ordinary and necessary expenses paid * * * in carrying on any trade or business.”

We think that the expenditure here was undoubtedly a capital expenditure, and therefore not deductible.

If the case of Bliss v. Commissioner, 57 Fed. (2d) 984, should be considered as contrary to the authorities above referred to, then we respectfully decline to follow it, but rather adhere to our own prior line of decisions which is supported by those authorities.

Holding, as we have, on this issue, it is unnecessary to consider the other grounds upon which respondent has based his determination.

Reviewed by the Board.

Decision will he entered for respondent.

Mellott,

dissenting: The parties stipulated that “On May 31, 1923 * * * the petitioner’s decedent acquired, in fee simple, free and clear of any liens or incumbrances whatsoever” the lands from which the rents and bonuses aggregating $63,864.75 were derived. Thirteen and a half years after the property was acquired, the daughter of a former owner asserted a claim to the rents and bonuses, basing it upon an alleged deed from her father to the oil and mineral rights. The court found that the deed was fictitious, fraudulent, and void and that it had been recorded in the deed records without the knowledge of any clerk or deputy at a date later than 1927, years after the decedent had acquired title to the property. At no time was any question raised as to the surface title.

It is obvious that the claimant deliberately slandered decedent’s title to the real estate in order to deprive his estate of the income which had been, or should be, derived from the conduct of its oil business. The suit was instituted, not as a sword of offense to. add to the estate’s capital, but as a shield of defense to protect it against one who would deprive it of its income. Under somewhat similar circumstances the Court of Appeals for the Fifth Circuit, in Bliss v. Commissioner, 57 Fed. (2d) 984, said: “It seems reasonable to treat amounts expended for services rendered in ejecting or excluding trespassers after ownership has been acquired as expenses incident to the ownership of property and the acquisition and enjoyment of income from it, rather than as additions to the capital investment in the property.” This seems to be a sound rule and in accord with such cases as Kornhaiuser v. United States, 276 U. S. 145; Welch v. Helvering, 290 U. S. 111; Deputy v. Dupont, 308 U. S. 488, and others. I think the claimed deduction should be allowed.

Smith and Hill agree with this dissent.

       Akt. 24r-2. [Regulations 94.] Capital expenditures. — * * * The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not deductible expense. The amount expended for architects’ services is part of the cost of the building. Commissions paid in purchasing securities ara a part of the cost price of such securities. Commissions paid in selling securities, when such commissions are not an ordinary and necessary business expense, are an offset against the selling price. Expenses of the administration of an estate, such as court costs, attorneys’ fees, and executors’ commissions, are chargeable against the corpus of the estate and are not allowable deductions. * * *
      [Cf. Regulations 46 (Revenue Act of 1918), art. 293.]


author: SteRNHagen:

text:
    Bank of America National Trust and Savings Association, as Executor of the Last Will and Testament and of the Estate of William John McGowan, Deceased, and as Trustee under Trust Agreement Executed by William John McGowan in His Lifetime, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100967.
    Promulgated February 19, 1941.

      B. H. Hudson, Esq., for the petitioner.

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

SteRNHagen:

The Commissioner arrived at the deficiency by expanding the decedent’s gross estate to include the entire value at the time of his death of the personalty, the home place, and the Trafton tract. The petitioner assails this and points to the community property agreement of December 29, 1931, to support the contention that all of the property, real and personal, was the subject of this agreement and that only one-half thereof was properly in the gross estate.

As to the personal property, there is no doubt that the community agreement of 1931 covered it and that only one-half the value thereof is properly within the gross estate. The community property agreement was valid and effective under California law, In re Sill's Estate, 121 Cal. App. 202; 9 Pac. (2d) 243; Yoakam v. Kingery, 126 Cal. 30; 58 Pac. 324; covered property previously as well as subsequently acquired by either spouse, In re Henderson's Estate, 128 Cal. App. 397; 17 Pac. (2d) 786; Roberts Land & Improvement Co. v. Dallas, 124 Cal. App. 86; 11 Pac. (2d) 1103; In re Wahlefeld's Estate, 105 Cal. App. 770; 288 Pac. 870; and is binding upon the Federal Government •in the determination of the gross estate, United States v. Goodyear, 99 Fed. (2d) 523; Bank of America National Trust & Savings Association v. Rogan, 33 Fed. Supp. 183. As shown by the findings, this personal property consisted of the five items aggregating $26,300.28.

The home place was acquired by the decedent prior to his marriage, and it is stipulated by the parties that it was his separate property when it was transferred in trust in 1929. The trust was revocable and hence the home place is, by section 302 (d) of the Revenue Act of 1926, as amended by section 805 of the Revenue Act of 1936 (see sec. 811 (d), I. R. C.), within the gross estate to the extent of its entire value. Helvering v. City Bank Farmers Trust Co., 296 U. S. 85. This must be held, irrespective of the later community property agreement of 1931. Having made the transfer by a revocable trust, the decedent could not avoid the inclusion of the entire value thereof in his gross estate by subsequently executing a community property agreement. This can be readily seen by supposing an outright gift of the home place in contemplation of death. In such case the property would have been included within the gross estate in its entirety, notwithstanding any subsequent agreement converting his separate property into community property.

By the declaration of 1929, the Trafton tract was likewise transferred in trust, and by the same reasoning the decedent’s interest must be included in his gross estate, notwithstanding the community agreement of 1931. The extent of such interest is to be determined. It depends upon the proportions of the investment in the tract which decedent, his wife, and the marital community contributed. In re Fellow’s Estate, 106 Cal. App. 681; 289 Pac. 887. These proportions can not be determined with precision. As shown by the findings, the property was acquired in 1920 for a price of $45,000, of which the $5,000 paid in cash was contributed by the wife from her separate bequest. The remaining $40,000 was covered by a note given by both and secured by a mortgage on the combined home place and Trafton tract. Soon thereafter a payment of $2,500 was made on the note with money contributed by the wife from a separate bequest. Thereafter the remainder of the note was paid in several payments with money attributable to income from farming operations and rents of the combined properties. With some doubt, we think that the only part of the investment that can be clearly said to support a separate interest of the wife is the original $5,000 which she paid in the purchase of the Trafton tract. This was one-ninth of the entire purchase price of $45,000; the other eight-ninths was community property until the transfer in trust. The property transferred in trust by the decedent is one-half of this community estate, or four-ninths of the value of the Trafton tract. The other four-ninths is to be regarded as the remaining community property attributable to the wife and one-ninth is to be regarded as the wife’s separate property. This apportionment, it must be admitted, is mathematically less than satisfactory, but it is as precise as the evidence permits. The rents and income which were used to discharge the note can not be identified as to their source between the home place and the Trafton tract; and since the home place is stipulated to have been the husband’s separate property and by California law the income from separate property is itself separate property of the owner thereof, section 163, Deering’s Civil Code of California; In re Dargie’s Estate, 179 Cal. 418; 177 Pac. 165; Van Camp v. Van Camp, 53 Cal. App. 17; 199 Pac. 885, it would be a hopeless task to apportion among the husband, the wife, and the community the payments that were made of the purchase price before the 1931 agreement. Although the $2,500 payment by the wife in 1921 is specific, it is, since an approximation is necessary, fair to leave this item out of the account as a proper offset to the other uncertainties in the calculation.

To summarize, therefore, the decedent’s gross estate is held to include (1) one-half the value of the five items of personal property which are held to be covered by the community agreement of 1931; (2) the entire value of the home place at the date of death; and (3) four-ninths of the value of the Trafton tract at the date of death.

Decision will be entered imder Rule 50.


author: Black :

text:
    Lewis W. Hall, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100712.
    Promulgated February 19, 1941.

      E. M. Woolf, Esq., for the respondent.
   OPINION.

Black :

The Commissioner has determined a deficiency of $1,391.91 in petitioner’s income tax liability for the year 1936.

The deficiency results from the disallowance by the Commissioner of $15,348.96 of the loss claimed by petitioner on his income tax return for the taxable year. The Commissioner explained his adjustment of petitioner’s claimed loss in the following language in his deficiency notice:

As the result of a sale of the net assets of F. M. Hoyt Shoe Company 1931 to F. M. Hoyt Shoe Corporation, you elected to take 1,031 shares 2d preferred stock of the purchasing corporation in lieu of $1.00 'a share for the stock of the old company held by you. The exchange constituted a transaction giving rise to taxable gain or deductible loss at that time and the basis for the shares acquired in the exchange was $1.00 per share. Any loss to you, as the result of worthlessness of the 2d preferred stock, is limited to $1,031.00.

The petitioner by an appropriate assignment of error contests this action of the Commissioner. We adopt the stipulation of facts which has been filed as our findings of fact.

The following facts are stated herein for the purpose of a discussion of the only issue which is submitted to us for decision:

The petitioner is an individual with a residence at Auburndale, Massachusetts, and for the taxable year 1936 filed his income tax return with the collector of internal revenue at Boston, Massachusetts.

Among other deductions which the petitioner claimed in the return filed was one in the amount of $16,379.96 which the petitioner contended was a loss sustained by reason of 1,031 shares of second preferred stock of the F. M. Hoyt Shoe Corporation becoming worthless in 1936.

The F. M. Hoyt Shoe Co. (hereinafter called the old company) was a corporation organized in 1891, located in Manchester, New Hampshire, and engaged in the business of manufacturing shoes. It had both common and preferred stock outstanding. Sometime prior to 1931 the petitioner purchased 1,031 preferred shares of said company at a cost of $16,379.96. As a result of financial difficulties the company was placed in receivership in 1931 and the petitioner and one Charles H. Tobey were appointed trustees. During the same year John D. Murphy and other parties who had no financial interest in the F. M. Hoyt Shoe Co. offered to buy the assets of said company in order that the industry could be kept in New Hampshire.

In May 1931 a new corporation was formed under the name of F. M. Hoyt Shoe Corporation (hereinafter referred to as the new corporation). John D. Murphy and the other parties associated with him in the organization of the new corporation paid into the new corporation $200,000 in cash, for which there was issued to them 2,000 shares of first preferred stock and 12,000 shares of common stock of the new corporation. The capital of the new corporation consisted of the 2,000 shares of first preferred stock (par value $100 per share) with voting privileges, and the 12,000 shares of common stock (no par value but recorded on the books at $10 per share) with voting privileges, and 10,086 shares of second preferred stock (with no par value but recorded on the books at $10 per share) with no voting privileges. Part, but not all, of the 10,086 shares of second preferred stock remained unissued, as hereinafter explained. The consideration for the sale of the assets of the old company to the new corporation was that the latter was to assume all liabilities of the old company in exchange for its assets and was to give to the preferred stockholders of the old company one share of second preferred stock of the new corporation for each one share of preferred stock owned in the old company, or in lieu thereof $1 a share for each share of preferred stock held in the old company.

At a special meeting of the old company held May 27, 1931, it was voted to accept the offer of the new corporation and the following letter was sent to each preferred stockholder of the old company:

To the Preferred Stockholders
of F. M. Hoyt Shoe Company:
At a special meeting of the stockholders of F. M. Hoyt Shoe Company, held May 27, 1931, of which you were notified, it was voted to sell the assets of the Company to F. M. Hoyt Shoe Corporation, a corporation newly organized under the laws of New Hampshire. The consideration of the sale was the assumption of all the liabilities of your company by the new company and the payment of 10,086 shares of Second Preferred Stock to the undersigned as trustees to distribute to the Preferred Stockholders of the Old Company. This provides one share of the Second Preferred Stock of F. M. Hoyt Shoe Corporation for each outstanding share of Preferred Stock of F. M. Hoyt Shoe Company. An alternative offer of a cash payment of $1.00 per share on the Preferred Stock was made.
This sale has now been completed and you are entitled to receive one share of the Second Preferred Stock of F. M. Hoyt Shoe Corporation for each share of Preferred Stock of F. M. Hoyt Shoe Company, or if you prefer a check will be sent to you for $1.00 per share on your stock. The common stock has no value.
The alternative offer of cash expires June 27, 1931. Please indicate your choice on the enclosed form and indorse and send in your stock, upon receipt of which a check or stock will be sent you.
Yours very truly,
Chabees W. Tobey,
Lewis W. Haee,
Trustees.

Some of the preferred stockholders of the old company elected to take cash for their shares and others elected to take second preferred stock of the new corporation. The petitioner elected to take second preferred stock of the new corporation rather than $1 a share which he had the right to take in lieu thereof under the option.

The new corporation ceased business operations in 1936 and the stockholders voted to liquidate it and liquidation proceedings began at once.

It is not disputed that petitioner suffered a loss in 1936 or that this loss was caused by the 1,031 shares of second preferred stock of the F. M. Hoyt Shoe Corporation owned by him becoming worthless in that year. That the stock did become worthless in 1936 is admitted by respondent in his answer and agreed in the stipulation of facts.

The only question is what the measure of the amount of petitioner’s loss is; was it the amount which he paid for his preferred shares in the old company, or was it the $1,031, which respondent has determined in his deficiency notice?

Section 113 of the Revenue Act of 1936 specifies the basis as follows : *

(a) Basis (Unadjusted) op Property. — The basis of property shall be the cost of such property; except that—
****** *
(6) Tax-eree exchanges generally. — If the property was acquired, after February 28, 1913, upon an exchange described in section 112 (b) to (e), inclusive, the basis (except as provided in paragraph (15) of this subsection) shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. * * *

In article 113 (a) (6)-l of Regulations 94 it is provided that:

In the case of an exchange, after February 28, 1913, of property solely of the type described in section 112 (b), if no part of the gain or loss was recognized under the law applicable to the year in which the exchange was made, the basis of the property acquired is the same as the basis of the property transferred by the taxpayer with proper adjustments to the date of the exchange.

Pursuant, therefore, to the law and regulations applicable in the taxable year it is clear that the proper basis for determining the loss sustained by petitioner in 1936' must be determined under the Revenue Act of 1928, the law applicable in 1931 when the exchange was made. That act provides:

SEO. 112. RECOGNITION OF GAIN OR LOSS.
****** *
(b) Exchanges Solely in Kind.—
*******
(3) Stock for 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. * * * * * * *
(i) Definition of Reorganization. — * * *
(1) The term “reorganization” means (A) a merger or consolidation (including the asquisition by one corporation of * * * substantially all the properties of another corporation) * * *.

There can be no question of course but that the facts in the instant case show that the new corporation acquired all the assets of the old company and thus in that respect, at least, the transaction would fall within the provisions of section 112 (i) (1) (A), above quoted, but it is not every acquisition by one corporation of all the assets of another corporation that results in a reorganization. Where the transaction amounts to a mere sale by one corporation of its assets to another, there is no reorganization. Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462.

In order for a transfer by one corporation of all its assets to another corporation to result in a reorganization under the provisions of the statute above quoted, the transferring corporation or its stockholders must retain a continuing interest in the transferred assets, evidenced by stock ownership, either common or preferred, in the acquiring corporation. This ownership of stock by the transferring corporation or its stockholders need not amount to enough to give control over the acquiring corporation but it must be large enough to be substantial. Helvering v. Minnesota Tea Co., 296 U. S. 378; Nelson v. Helvering, 296 U. S. 374.

In Helvering v. Minnesota Tea Co., supra, which involved the acquisition of substantially all the assets of one corporation by another for cash and stock, stockholders of the old corporation held after the exchange only 7% percent of the shares in the successor corporation. In that situation the Supreme Court said:

* * * And we now add that this interest must be definite and material; it must represent a substantial part of the value of the thing transferred. This much is necessary in order that the result accomplished may genuinely partake of the nature of merger or consolidation.

In the instant case it is clear that the transfer by the old company of all of its assets to the new corporation was in the main a sale. The letter by the trustees of the old company to the preferred stockholders informing them of what was being done speaks of the transaction as a sale by the old corporation to the new. The principal consideration for the transfer was the assumption by the new corporation of all the liabilities of the old company. What the value of the assets transferred was and what the amount in dollars and cents of the debts of the old company assumed by the new corporation was, the stipulation likewise does not show. These are facts of more or less importance about which the stipulation does not inform us. In order to get capital with which to pay the debts of the old company and presumably to have liquid capital with which to operate, the new corporation issued 2,000 shares of first preferred stock of a par value of $100 per share and 12,000 shares of common stock of no par value to John D. Murphy and his associates for $200,000 in cash. These parties had no association with the old corporation. This was entirely new capital. But there was a continuing interest preserved by the preferred stockholders of the old company in the new.

Each of the holders of the 10,086 preferred stock of the old company had the privilege of exchanging his shares for an equal number of shares of second preferred stock of no par value in the new corporation. If the preferred stockholders did not care to make the exchange, they were offered $1 in cash for each share of their preferred stock in the old company. The facts, as stipulated, show that some elected to surrender their preferred shares for the $1 in cash and some elected to exchange them for the second preferred shares of the new corporation. How many shares were exchanged for cash and how many were exchanged for the second preferred stock, the record does not show.

Of course it requires no citation of authorities to support the proposition that those who elected to take cash did not retain any continuing interest in the new corporation. As to them the disposal of their stock was a completed and closed transaction. On the other hand it requires no citation of authorities, other than those we have cited, to establish the proposition that those preferred stockholders of the old company who elected to exchange their shares for the second preferred stock of the new corporation did retain a continuing interest in the assets of the old company which were transferred to the new. How substantive was such continuing interest? We know only in part. The stipulation says:

Some of the preferred stockholders of the old company elected to take cash for their shares, others elected to take second preferred stock of the new corporation. * * *

None of these are shown, except that petitioner transferred his 1,031 shares of preferred stock in the old company for 1,031 shares of second preferred stock in the new corporation. Did that give the transferring corporation or its stockholders a substantial continuing interest in the assets of the old corporation, which were transferred to the new within the meaning of the decision of the Supreme Court in Helvering v. Minnesota Tea Co., supra? We think not.

One of the definitions of the word “substantial” in Webster’s New International Dictionary, Unabridged, 2d ed., is: “Considerable in amount, value, or the like, large, as a substantial gain.”

It is plain from the stipulated facts that the second preferred stock of the new corporation had but little value. It was of no par value. However, it was set up on the books at $10 per share. But the owners of the preferred stock of the old company were offered only the election to take $1 per share for their old shares if they chose not to make the exchange for the second preferred of the new corporation. Some of them took the $1 per share, indicating that they regarded that as a better exchange than to take the second preferred stock. Therefore, we have nothing before us to indicate that these second preferred shares had a greater value than $1 per share. Hence, in any comparison that we make we must treat the 1,031 shares of second preferred stock which petitioner received in the new corporation as having a value of $1,031 at the time they were received. There is nothing to indicate that they had any greater value. As we have already pointed out, the new capital which was paid into the new corporation by its new stockholders was $200,000. Also we have already pointed out, the stipulation of facts does not give us any information as to the value of the assets which the old company transferred to the new corporation, but if we assume that the value of these assets was something like the $200,000 cash which the stockholders of the new corporation paid in, then by comparison the value of the stock which petitioner retained in the new corporation was less than 1 percent as compared to the value of the assets transferred.

We do not think this less than 1 percent which petitioner retained was a substantial continuing interest within the meaning of Helvering v. Minnesota Tea Co., supra. Of course it is true that in estimating whether or not the continuing interest retained by the old stockholders in the assets transferred to the new corporation was substantial we should not only consider the amount of stock received by petitioner but should also consider the amount of stock received by other stockholders who made the exchange for second preferred stock. However, as we have already pointed out, we have no information whatever as to how much stock these other stockholders who elected to make the exchange received. Therefore, we can only consider what we do know.

The determination of the Commissioner that the exchange was one which gave rise to gain or loss is presumed to be correct, and the burden of proof is on petitioner- to show otherwise. This burden we do not think petitioner has sustained. We, therefore, decide the only issue involved for the respondent.

Decision will he entered for respondent.


author: Disney:

text:
    Maurice Falk, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100542.
    Promulgated February 25, 1941.

      Louis 0apian Esq., for the petitioner.

      J. Harrison Miller, Esq., for the respondent.
   OPINION.

Disney:

The principal question here presented to us is whether the petitioner suffered capital loss or ordinary loss. The deficiency was asserted on the former theory. The petitioner contends for the latter, on the ground that he made no capital investment, but merely took over property to save himself loss as guarantor of the mortgage and bond upon such property; and in the alternative he argues that he is subrogated to the rights of the mortgagee and bondholder, to the extent he paid thereon, and therefore this loss was ordinary and not capital. The respondent points out that the petitioner had treated the property as a capital investment in previous tax years, and that if the loss was ordinary, it occurred only in 1933 when the guaranty was paid and the property was taken over.

Upon review of the facts here involved, we are impressed with the way the petitioner has throughout treated this matter; and we come to the conclusion that it is consistent only with the theory of capital investment on his part. Had he merely paid up the obligations accrued to 1933 by the Victors, he might well be truly in the position of being subrogated to the rights of the mortgagee and bondholder. But he went further, and took over the property, taking deeds reciting valuable consideration from both of the Victors and the corporation. It is true that he was not experienced in running a boys’ camp, and that the property would have deteriorated if not operated. Yet, the petitioner had been placed in a position to profit by any increase in value of the property. For income fax purposes it was treated as his, for depreciation was allowed thereon. True, the record shows that as to the year 1934 he was allowed such depreciation without claim, but the same does not appear as to 1935, and petitioner appears in the position of having the benefit of a capital investment. Moreover, the figure $17,876.76 which the petitioner claims as a loss includes $1,425.11 which constituted no part of the obligation to the mortgagee and appeal’s to be properly includable in loss only on the theory of investment in property. For the years 1934 and 1935 large net losses upon the operation of the property were allowed as deductions in the determination of petitioner’s income tax. During the period of about two and one-half years after acquisition of the property petitioner made improvements to the property, including equipment in the sum of $13,934.29. This amount, in comparison with the' obligation as guarantor, seems to be large and to indicate investment rather than mere desire to escape loss. Upon review of all of the facts we conclude that the petitioner was in the position of an investor in the property involved.

Petitioner argues, however, that he in effect abandoned the property in 1936, and that therefore the provisions of section 117, limiting loss, do not apply. This view can not be sustained, in our opinion, for the reason that the property was not abandoned, but sold, for a very substantial consideration — $1,000 plus the assumption of $37,500 liability, which was paid by the grantee. We find it impossible to call such a sale an abandonment of title.

We conclude and hold that the petitioner has not shown error in the deficiency as determined by the respondent.

Decision will be entered for the resfondent.


author: Mellott: Hill,

text:
    V. V. Harris, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99027.
    Promulgated February 26, 1941.

      Charles E. Garnett, Esq., for the petitioner.

      Wilford E. Payne, Esq., for the respondent.
   OPINION.

Mellott:

Petitioner contends that his stock in the Arcade Co. became worthless during the calendar year 1935, as a result of which he sustained a loss, deductible in full as an ordinary loss, in an amount equal to the cost of the stock. In his income tax return he deducted, as an ordinary loss, the difference between the cost of the stock ($32,220) and the aggregate of the liquidating dividends ($1,985.94) or $30,234.06. The respondent determined that the loss was a capital loss, deductible only to the extent authorized by sub-paragraphs (a) and (d) of section 117 of the Revenue Act of 1934. •The amount so computed ($9,956.74) was allowed as a capital loss.

In tlie original petition it is alleged the respondent erroneously determined that the loss was a capital loss. In an amended petition it is alleged that petitioner “is entitled as a matter of law to deduct the full sum of his cost * * * as a loss due to said stock having become worthless * * that “when the Prudential Life Insurance Company began proceedings to foreclose its mortgage on the Main Street Arcade Building, which was the only asset of value the corporation had, and the fact became apparent that said mortgagee intended to enforce its mortgage lien by foreclosure and a sale of that property, it was then established that the * * * company was insolvent and its stock worthless, for that its indebtedness then greatly exceeded the actual or any reasonably possible value of all of its assets; that all dividends distributed by the * * * company to its stockholders after that date were liquidating dividends, for that they were necessarily paid out of the corporation’s capital; and that the amount of such dividends received by the petitioner were not his property, but were so received in trust for creditors of the corporation, for by operation of law he became a trustee, and the amount of such dividends a trust fund in his hands, for the benefit of the creditors of the corporation.”

Respondent denies that he erred in determining the deficiency in tax. In an amended answer he alleges that if the loss is not a capital loss resulting from the liquidation of the corporation then petitioner is entitled to no deduction from gross income for the year 1935 on account of his investment in the stock because it did not become worthless during that year.

It is doubtful if the mere institution of the suit to foreclose the mortgage and the appointment of a receiver to collect the rents constituted an “identifiable event” (United States v. White Dental Manufacturing Co., 274 U. S. 398) establishing worthlessness of the stock of the corporation which owned the real estate. Cf. Peter Doelger Brewing Co., 22 B. T. A. 1176; William H. Redfield, 34 B. T. A. 967; Olds & Whipple v. Commissioner, 75 Fed. (2d) 272. The corporation itself sustained no deductible loss until the property was sold. Helvering v. Hammel, 311 U. S. 504. This did not occur until 1936. It is not contended that there was any abandonment of the property by the corporation. Collateral Mortgage & Investment Co., 37 B. T. A. 630. Indeed the contrary appears. The corporation directed its attorneys to represent it “in the foreclosure proceedings and endeavor to delay the final sale of the property with the hope that there might be a considerable advance in real estate before that time” Had the hoped for advance occurred, it is possible that no loss would ever have been sustained by the corporation.

But our question is not whether the corporation sustained a loss in 1935. It is: Did petitioner’s stock become worthless during that year ? The test to be applied is a practical rather than a legal one (Lucas v. American Code Co., 280 U. S. 445) and petitioner has the burden of proof.

In support of his contention that the dividends received by him were not his property but were received in trust for creditors of the corporation, petitioner cites several Oklahoma cases applying the rule enunciated by Justice Story in Woods v. Dummer, 3 Mason, 308; 30 Fed. Cases 435, and by the Supreme Court in Sanger v. Upton, 91 U. S. 56. It is thus stated by the Supreme Court of Oklahoma:

Equity regards the property of a corporation as Reid in trust for the payment of the debts of the corporation, and recognizes the right of creditors to pursue it into whosesoever possession it may be transferred, unless it has passed into the hands of a bona fide purchaser. * * * if the fund has been distributed among the stockholders * * * leaving debts of the corporation unpaid, the established rule in equity is that such holders take the fund charged with the trust in favor of creditors, which a court of equity will enforce * * *. Kramer v. Eysenbach, 186 Okla. 234, 96 Pac. (2d) 1049.

The rule is sound and will be applied in proper cases. Thus in Benjamin E. May, 35 B. T. A. 84, it was held that stockholders receiving the assets of a corporation upon its liquidation were liable, as transferees, for its unpaid income taxes. In O. B. Barker, 3 B. T. A. 1180, it was held that a taxpayer need not include in his gross income the portion of a liquidating dividend which he had been compelled to pay out on account of taxes assessed against the liquidating corporation. A similar conclusion was reached in E. F. Cremin, 5 B. T. A. 1164; J. G. Tomlinson, 7 B. T. A. 961, and Edward F. Harkness, 31 B. T. A. 1100. In Carey Van Fleet, 2 B. T. A. 825, it was held that a lawyer, keeping his books and making his return of income upon a cash basis, need not include in gross income his portion of a fee collected by the partnership of which he was a member where the firm had acknowledged that it was not entitled to the fee at the time it was paid.

It will be noted that in each of the cited cases the taxpayer either had paid out the amount which had been received or, as in the Van Fleet case, had acknowledged that the amount was being held in trust. This petitioner, however, received the $1,985.94 “under a claim of right and without any restriction as to its disposition.” Burnet v. Sanford & Brooks Co., 282 U. S. 359. He commingled it with his other property, still retains it (or in any event was still retaining it at the date of the hearing), and has always treated it as belonging to him. In his return of income for the year in which, it was received he considered it to be a partial return of his capital investment in the stock of the corporation, computing his loss to be the difference between the cost of the stock and the aggregate of the dividends. In his petition he alleges that the corporation had no earnings or surplus from which ordinary dividends could be declared and that the amount distributed consisted of the cash on hand and collections on notes and accounts. It may be that the corporation itself or its creditors could, in an appropriate action, compel petitioner to pay over the amount distributed to him; but no attempt has been made to do so. Petitioner touched the whole -question only very generally at the hearing. His testimony was directed primarily to the value of the real estate. Under cross-examination, however, he admitted that between $1,900 and $2,000 was received by him; that the entire amount was retained; and that so far as he knew he would never be required to pay over any portion of it to anyone. We know of no reason why we should not consider the payments precisely as they were considered by the corporation and its stockholders — as liquidating dividends. Incidentally it may be pointed out that only if we do so can petitioner be allowed any deduction from gross income during the taxable year; for in our opinion the evidence indicates that the stock had as much value in 1935 as it had in 1934; and, if it were not worthless at the beginning of 1935, it is questionable if it became entirely worthless earlier than 1936.

In our opinion petitioner correctly computed the amount of his loss upon the Arcade Co. stock in his return of income for the calendar year 1935. He erred, however, in failing to treat it as a capital loss. White v. United States, 305 U. S. 281; Helvering v. Weaver Co., 305 U S. 293; Martin General Agency v. Commissioner, 101 Fed. (2d) 165; Inter-State Grocery Co., 39 B. T. A. 182. The Commissioner committed no error in determining the deficiency.

Reviewed by the Board.

Decision will be entered for the resyondent.

Hill,

dissenting: I respectfully dissent from the conclusion reached in the majority opinion. The evidence establishes, I think, that petitioner’s loss was sustained in the taxable year 1935, not as a result of the liquidation of the corporation, as the majority holds, but from the fact that petitioner’s investment in the corporation’s stock became wholly worthless in that year when suit was instituted to foreclose the mortgage and sell the real estate which constituted the sole asset of substantial value owned by the corporation.

It is true that the corporation was wholly insolvent, the value of its assets being far less than the amount of its liabilities, in the years immediately preceding the taxable year, and its stock therefore had no liquidating value either in 1934 or 1935. Nevertheless, it can not be said that petitioner sustained his loss prior to the taxable year merely because the stock had no liquidating value. Undoubtedly the stock had a substantial potential value up to the time the foreclosure proceeding was instituted. Cf. Sterling Morton, 38 B. T. A. 1270; affd., 112 Fed. (2d) 320.

The corporation’s only business was the operation of the Arcade Building in Oklahoma City. It had no other source of income, but it had been able to meet all semiannual installments of principal and interest due "on its mortgage indebtedness up to July 1, 1932, and it also had paid $1,538.01 on the interest installment due July 1, 1933. Its net earnings, for 1935 increased materially over its net earnings for 1934. At the beginning of the taxable year the corporation was actively engaged in carrying on its business, and there was a reasonable hope and expectation that if it could continue in possession of its property and operate its business, its profits might further increase to the benefit of the stockholders. Also, there was the hope that real estate values would increase so that ultimately the value of its assets might exceed its liabilities and its stock would have a liquidating as well as potential value. However, when the foreclosure proceeding was instituted on May 2, 1935, these hopes and expectations were definitely terminated. Under the conditions existing, the corporation’s real estate could not be sold for enough to satisfy the mortgage debt; in fact, the mortgagee obtained a deficiency judgment in excess of $25,000. The filing of the foreclosure suit, in my opinion, was the “identifiable event” which established worthlessness of the corporation’s stock and the incidence of petitioner’s loss.

Since petitioner’s loss resulted from the stock having become worthless in 1935, the amount is allowable in full as an ordinary loss, and is not subject to the limitations of section 117 of the Revenue Act of 1934. I am impelled to this conclusion for the further reason that the so-called liquidating dividends were not such" in fact. So much appears to be admitted, at least by inference, in the majority opinion. It is true that the distributions made by the corporation in 1935 were designated by the directors as liquidating dividends, but the name by which they were called is immaterial; we must look to the facts to determine their true nature. The distributions were necessarily made out of capital, since the corporation was wholly insolvent. Its capital in such circumstance constituted a trust fund for the benefit of its creditors, and could not be legally distributed to the stockholders in liquidation or otherwise. See section 9763, Oklahoma Statutes, 1931. And upon distribution the funds did not become the property of the stockholders but in their hands an involuntary or constructive trust by operation of law, payable upon demand to the beneficial owner, the insurance company creditor. This doctrine is so well established and so universally applied that citation of authorities in addition to those referred to in the majority opinion is not deemed necessary here.

The fact that prior to the hearing of this case the insurance company had not made any demand for repayment to it of the funds distributed is wholly immaterial. Under the Oklahoma statute the right of a creditor to demand repayment of such funds is not barred by limitations, and may be made at any time. In view of the apparent emphasis laid by the majority opinion on the fact that prior to the hearing of this proceeding no demand had ever been made upon petitioner by the Arcade Co. or the insurance company to repay any portion of ¡the amounts distributed to him, it is interesting to note that on brief counsel for petitioner states that “Since the trial, and no doubt because of facts developed at the trial, the Prudential Insurance Company has demanded of petitioner and other stockholders, the amounts they received in those dividend distributions in 1935. Petitioner’s counsel knows of no defense to that demand.”

In the majority opinion the trust fund doctrine is recognized as a sound rule, and that it should be applied in proper cases. In that connection, the following decisions of this Board, among others, are cited. In Benjamin E. May, 35 B. T. A. 84, it was held that stockholders receiving the assets of a corporation upon liquidation were liable as transferees for its unpaid income taxes, a fund left for payment of creditors having been dissipated. In O. B. Barker, 3 B. T. A. 1180, it was held that a taxpayer was not subject to tax on that portion of a liquidating dividend paid on taxes assessed against the corporation. To the same effect see E. F. Cremin, 5 B. T. A. 1164; J. G. Tomlinson, 7 B. T. A. 961; and Edward S. Harkness, 31 B. T. A. 1100. The cited cases are sought to be distinguished on the ground that in each of them the taxpayer had actually paid out the amount received, while in the instant proceeding the petitioner received the amount of the so-called liquidating dividends under a claim of right and without restriction as to its disposition; further that petitioner commingled the amount so received with his other property, still retained it at the date of the hearing, and has always treated it as belonging to him. With a single exception, precisely the same statements may be made in respect of each, of the cases above cited. In each of them, so far as disclosed by the reports, the taxpayer received the corporate distribution under a claim of right and without restriction as to its disposition, commingled the fund with his other property, treated it as belonging to him, and retained it until compelled to pay it over in discharge of tax liability of the corporation.

The only material ground upon which the cases referred to may be distinguished from the case at bar lies in the fact that up to the date of the hearing, no demand had been made on this petitioner, to pay over to the corporation or its creditor the amounts received as liquidating dividends. Must the application of the trust fund doctrine in favor of the taxpayer, then, be held to depend solely upon the fortuitous circumstance of repayment of the fund to a creditor prior to hearing of the tax proceeding before the Board? Would the rule have been applied differently in the majority opinion if it had been made to appear that the amounts received by petitioner had been repaid to the insurance company, or a demand therefor had been made prior to the hearing? And does it follow that because such repayment or demand was not so made, notwithstanding liability therefor still existed, that the so-called liquidating dividends received by petitioner must be regarded for tax purposes as his property? The rule has never been so interpreted in its application against taxpayers in the numerous decisions of this Board involving transferee liability for corporate taxes, of which Benjamin E. May, supra, is an example. Uniformly we have held in such cases that liquidating dividends did not constitute property of the tranferee, but trust funds to the extent of the unpaid taxes, and no inquiry was made, it being obviously immaterial, whether such distributions were received under claim of right and without restriction as to disposition, whether or not commingled with other funds, or whether or not treated by the transferees as belonging to them. And it is apparent, of course, from the nature of such proceedings that the recipients had not prior thereto parted with the funds in payment of creditors’ claims or tax liability of the corporations. In the absence of any elements of estoppel, I can find no sound reason for applying the doctrine differently in the present case, in favor of the taxpayer, than it is applied generally in transferee cases in favor of the Government.

In my opinion, the decision here should be for petitioner.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
      *******
      40 per centum if the capital asset has been held for more than 5 years but not for more than 10 years;
      30 per centum if the capital asset has been held for more than 10 years.
      *******
      (d) Limitation on Capital Losses. — Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. * * *


author: SteRNHAgen:

text:
    California Brewing Association, Petitioner, v. Commissioner of Internal Revenue, Respondent. Acme Breweries, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101295, 101296.
    Promulgated February 26, 1941.

      Norman A. Eisner, Esq., and Myrtile Oerf, O. P. A., for tlie petitioners.

      Harry B. Morrow, Esq., for the respondent.
   OPINION.

SteRNHAgen:

1. In the notice of deficiency, which was dated November 3, 1939, determining a deficiency of $3,095.69 for the calendar year 1936, reference is made to earlier reports of examination, a protest and a conference, but there is no intimation of a protest or controversy as to the use of the calendar year as the period under consideration. Adjustments were made in four deductions and a dividends paid credit was disallowed. The petition assails none of the deduction adjustments; it assails the disallowance of the dividends paid credit. It' alleges that “the tax in controversy is deficiency in income tax in the amount of $3,095.69 as set forth in the notice of deficiency for the taxable year ended December 31, 1936.” It puts in issue the authority of the Commissioner to adopt the calendar year 1936 as the tax year and to determine any deficiency for the entire year and thus it seeks a decision of no deficiency for want of a valid determination.

The attack upon the deficiency notice as a proper foundation for a deficiency must fail. The taxpayer, it is true, liquidated and dissolved on March 31, 1936, and had it chosen to act upon that fact as a basis for a final income tax period and return, it might have had the right to do so, cf. Elgin Compress Co., 31 B. T. A. 273; Pittsburgh & West Virginia Railway Co., 32 B. T. A. 66. That would have réquired the taxpayer to file a return for that period within three months thereafter, or before July 1, 1936. Had the taxpayer filed such a return, it might have been entitled to have its tax liability or any deficiency determined for the short period. But it did not do so, and there is nothing in the statute requiring the taxpayer in such circumstances to treat the short final period as its taxable period and to file a short period return. Nothing requires the Commissioner to recognize a short closing taxable period before he has knowledge of dissolution, cf. Mrs. Grant Smith, 26 B. T. A. 1178; and in this case the earliest date when the Commissioner had such knowledge was when the complete return was filed on April 15, 1937. This return was ambiguous; its heading showed it to be “For CaleNdae Year 1936 or Fiscal Year begun January 1, 1936, and ended March 31, 1936.” Upon the basis of such return the Commissioner carried on the audits, and in 1938, after a revenue agent had prepared an additional tax for the short period of 1936, the taxpayer paid the additional amount and reserved its right to claim refund or otherwise proceed “for the year 1936.” Cf. Commissioner v. Forest Glen Creamery Co., 98 Fed. (2d) 968.

Under such circumstances it is now too late for the taxpayer to stand upon a short period as the necessary basis of its tax and resist the assessment of a correct deficiency because the adjustments were stated in a notice covering the entire year, which it had itself treated as its tax period. However troublesome may be the scope of the doctrine of estoppel, there should be no doubt of its applicability here to hold the taxpayer to the taxable period which it has so clearly led the Commissioner to recognize. To permit the taxpayer to escape the correct deficiency would be offensive to the practice of voluntary returns upon which the income tax system is founded. The Commissioner’s use of the calendar year 1936 is sustained.

2. The petitioner contends that assessment is barred by the statute -of limitations, Bevenue Act of 1936, section 275. There is no express or direct written request by the petitioner or in its behalf for prompt assessment. The statement on the face of the return that the corporation was dissolved March 31, 1936, clearly was not a request for assessment, and there is no reason to construe it as such. The Acme Breweries, called the “parent company”, was stated in the return to have taken over all petitioner’s assets in complete liquidation, and in this proceeding the Acme Breweries concedes its liability for petitioner’s deficiency. Nothing, therefore, supports an inference that early assessment was important or desirable, for whenever in ordinary course a deficiency assessment should occur, its payment by the Acme Breweries was apparently provided for.

The deficiency determination was timely, and the petitioner’s attack on this ground must fail, Esperson v. Commissioner, 49 Fed. (2d) 259; certiorari denied, 284 U. S. 658; Mary Lee Winger, Executrix, 30 B. T. A. 357; dismissed, 79 Fed. (2d) 1022; cf. Maffit v. Becker, 65 Fed. (2d) 880; White v. United States, 22 Fed. Supp. 821; Beverly Wall Paper Co. v. Commissioner, 98 Fed. (2d) 211.

3. The petitioner claims a dividends paid credit under section 27 (f) of the Kevenue Act of 1936. It will result in wiping out the surtax on undistributed profits determined by the Commissioner. The reason for the disallowance stated in the deficiency notice was that the liquidation distribution was not a dividend taxable to the recipient. This reason has since been carefully considered in Credit Alliance Corporation, 42 B. T. A. 1020 (on review C. C. A., 4th Cir.), and has been held inadequate to support the disallowance. The dividends paid credit was held to rest on section 27 (f) and was sustained. The respondent here recognizes the force of the decision as a matter of law, but turns to the evidence in this record, which, it is said, does not prove what part, if any, of the liquidation distribution is properly chargeable to earnings and profits accumulated after February 28, 1913, and what part is chargeable to capital account.

The evidence is meager. The petitioner’s tax return shows a balance sheet at the beginning and end of the taxable year 1936; on it is an item (20) called surplus, which is $49,526.59 at the beginning and $63,555.06 at the end of the year; the next item (21), called undivided profits, shows the same figures in the extended, or total, column. On the face of the return, the net income is shown as $16,876.55. The answer admits that on March 31, 1936, the earnings and profits were distributed in complete liquidation, and that since then petitioner has had no assets whatever. It is difficult to understand why this evidence is not adequate to prove petitioner’s point. The corporation was not organized until after February 28, 1913, so the date is without significance — all earnings and profits were accumulated after February 28, 1913. It is not proved what the figures of surplus and undivided profits embrace, and if the deficiency notice or the answer had suggested that they included, say, paid in surplus or a valuation write-up, there would be reason to hold petitioner to a breakdown or analysis of the figure. But the controversy was as to the applicable statute, and in that posture of the case it may fairly be inferred that the balance sheet figures of surplus or undivided profits represent earned surplus and realized profits or, as the statute calls them, earnings and profits.

The Commissioner was in error in disallowing the dividends paid credit, and the determination on this point is reversed, Credit Alliance Corporation, supra.

4. The petitioner complains of a ruling at the opening of the trial denying its motion for leave to amend its petition, and the exclusion of proper evidence to support the allegations of the proposed amended petition. The respondent objected and the motion was denied.

The proposed amendment contained a new assignment of error assailing the failure of the respondent to allow a deduction for California franchise tax, most of which is alleged to have been paid May 20,1940. The deficiency notice was mailed to the taxpayer on November 3, 1939, which was before the alleged last payment of franchise tax on May 20, 1940. The petition was filed January 26, 1940, and contained no assignment of error or allegation of fact relating to California franchise tax. The answer was filed March 12, 1940, and was likewise silent on the subject. Notice of hearing was sent to petitioner August 13, 1940, showing that the proceeding was on a circuit calendar set for hearing at San Francisco, California, beginning October 7, 1940. Not until October 8, 1940, after the session in San Francisco had begun, was the motion for leave to amend filed with the clerk and served. The motion was presented when the case was called for trial on October 11, and respondent objected on the ground that the proposed amendment raised an entirely new issue the subject of which had not theretofore been presented to the Bureau of Internal Revenue, and that he was wholly unprepared to make a proper defense.

The petitioner’s argument has been renewed in its brief, and after full consideration the denial of the motion must be reaffirmed. Although such rulings are matters within the discretion of the Board, this discretion may never be arbitrary and must be controlled by sound reason and fairness. Neither side may take undue advantage of the other, whether purposely or not. The discretion of the Board may not be exercised to permit one party to proceed unless the other has been given a fair opportunity to meet the issue. No reason is shown why the petitioner did not move soon after the payment in May to amend its petition. So far as appears, this could have been done before the case was set for hearing. Even if the proposed amendment had been tendered after the notice of hearing, it might have met with no objection or with an unfounded objection if the respondent had been afforded ample time in the circumstances to investigate and consider the new issue proposed. But no such opportunity was afforded. The session of the Board in San Francisco began October 7, 1940, the calendar carrying some eighty odd cases. It was entirely unreasonable, therefore, that petitioner, having known the facts more than four months, should, on the day of trial, after three days’ notice, present an issue requiring an entirely new investigation and consideration.

There are occasions when amendments of the pleadings may be permitted if, without inconvenience, the trial can proceed without undue delay and without actual unfairness. Here, however, a postponement of the trial to enable the respondent to meet the issue would have required that the case be taken from the calendar of the session and postponed to a later session in San Francisco. Such a substantial delay is a factor necessarily affecting the discretion of the Board. Such considerations are substantially different from those involved in local practice. The ordinary requirement of diligence has greater force in practice before the Board, when more than 90 percent of its cases are heard on its circuit calendar with the attendant difficulties of distance and delay.

It results that the deficiency must be recomputed by restoring the dividends paid credit and adhering to the other adjustments made in the Commissioner’s determination.

Decision will he entered under Bule 50.


author: Mellott:

text:
    Thompson Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99854.
    Promulgated February 27, 1941.

      John L. Connolly, Esq., for the petitioner.

      Jonas M. Smith, Esq., for the respondent.
   OPINION.

Mellott:

The question is the narrow one: Was the loss sustained through the sale of capital assets, as such term is defined in section 117 (b) of the Revenue Act of 1936, or was it an ordinary loss, deductible from gross income in its entirety? There is no dispute as to the amount of the loss.

It can not be gainsaid that the real estate constituted “property held by the taxpayer.” Petitioner does not contend that it was “stock in trade” or “properly of a kind which would properly be included in * * * inventory * * * if on hand at the close of the taxable year.” It argues only that it was “property held * * * primarily for sale to customers in the ordinary course of * * * [its] trade or business.”

The words “to customers” and “ordinary” were first incorporated in the provisions of the revenue act dealing with capital gains and losses by the amendment made in 1934. (Cf. section 101 (c) (8), Revenue Acts of 1928 and 1932.) They tend to narrow the deductions which may be taken as ordinary losses, O. L. Burnett, 40 B. T. A. 605, or, as pointed out by the Supreme Court in Helvering v. Hammel, 311 U. S. 504, “to enlarge the class of deductible losses made subject to the capital assets provisions * * The section as amended must be construed precisely as written and unless the particular property in question was held by petitioner “primarily for sale to customers in the ordinary course of *• * * [its] trade or business” the loss is limited as provided in section 117 (d) of the Revenue Act of 1936 to $2,000, plus the gains from sales or exchanges of capital assets.

Petitioner’s principal business was buying and selling lumber, building materials, air conditioning equipment, and similar property. According to its income tax returns its gross sales of such materials at its three yards aggregated approximately three-quarters of a million dollars annually. The testimony of its president indicates that the acquisition of real estate was only incidental to its lumber and material business. In response to a question whether the purpose of the company in acquiring the properties in question was to secure a debt he responded: “Absolutely”; and when asked if the properties had been taken over in lieu of payment for an account of merchandise, he replied in the affirmative.

Petitioner points out that its corporate charter empowers it to acquire, hold, and dispose of all kinds of real estate. Whether this power is merely incidental to its lumber and material business or whether it authorizes it to conduct a general real estate business is probably immaterial. In our opinion the evidence fails to show that it was engaged in the real estate business to any extent. It never purchased real estate for the purpose of selling it at a profit. Cf. Julius Goodman, 40 B. T. A. 22. As stated by its counsel at the hearing, “it didn’t have sufficient funds to go outside and buy investments purely for an investment purpose, but only as conducting its business.” True it occasionally sold a piece of real estate; but it is interesting to note that in most, if not in all, of the sales made by it during the taxable years the usual real estate agent’s commission was paid.

Several cases have been decided by tlie courts and this Board in-which the question was substantially the same as that now before us — whether a sale was, or was not, a sale of a capital asset. Petitioner places considerable reliance upon Harr v. MacLaughlin, 15 Fed. Supp. 1004, decided under the Revenue Act of 1928 (sec. 101 (c) (8)), which only required that the property be “held by the taxpayer primarily for sale in the course of his trade or business.”' In that case a title and trust company, authorized to transact a. banking, trust, and1 title business and to engage in the real estate-business, had purchased some property at foreclosure. It was shown that such property, including other pieces similarly acquired, “was held solely for the purpose of sale, and that it was continually offered for sale by the usual real estate methods.” The court held that the bank did not hold it as an investment or for other permanent use and that the loss upon its sale “was properly a deductible one from the income reported.” The respondent, basing his opinion largely upon the cited case, subsequently ruled (G. C. M. 21497, C. B. 1939-2, p. 187; I. T. 3336, C. B. 1939-2, p. 189) that gains derived, or losses sustained, by building and loan associations, mortgage finance companies, banks, and insurance companies other than life-insurance companies in disposing of real estate which had been taken over by such institutions on default of mortgage loans, are to-be treated as ordinary and not as capital gains or losses.

Whether the ruling is correct or not need not be decided. It suffices to point out that petitioner, unlike the plaintiff in the Harr case, did not maintain a real estate department and was not actively engaged in buying and selling real estate. As pointed out above, it made no purchases of such property for sale to customers. Its real estate (other than lumber yards) appears to have been acquired solely for the purpose of minimizing or preventing loss upon lumber and building materials sold by it. The time devoted by petitioner’s officers and employees to disposing of its real estate was infinitesimal in comparison with the time devoted to the lumber or material business. So far as the record shows, petitioner never held itself out to be engaged in the real estate business to any extent. It never secured any license from the county, city, or state to engage in such business. In its income tax returns it stated that it was engaged in the wholesale and retail lumber business. This clearly was its real business and its “customers” in the “ordinary course of its trade or business” were, we think under the evidence before us, only the purchasers of lumber, hardware, building materials, air conditioning equipment, and similar property.

It is true, as petitioner points out upon brief, that a taxpayer may be engaged in more than one trade or business. Richards v. Commissioner, 81 Fed. (2d) 369; Ben L. Carroll, 21 B. T. A. 724; affd., 70 Fed. (2d) 806; Julius Goodman, supra; Snell v. Commissioner, 97 Fed. (2d) 891. But business, says the court in Snell v. Commissioner, supra, “means busyness; it implies that one is kept more or less busy, that the activity is an occupation.” An occasional sale is not enough. The “taxpayer must, to defeat his claim to a capital gains rate, have been in the business of selling his land.” Cf. Kales v. Commissioner, 101 Fed. (2d) 35. Petitioner has failed to show that it was in the business of selling its lands. Cf. Carroll v. Commissioner, supra; Louise C. Slack et al., Executors, 35 B. T. A. 271. In reaching this conclusion we have not overlooked the testimony to the effect that petitioner, after acquiring the various properties, endeavored to sell them, placed for sale signs upon them, advertised them in the papers, listed them with various real estate agents, and furnished lists of them to its own officers and agents. This evidence, though no doubt showing a bona fide effort to dispose of the property, falls far short of proving that petitioner was in the real estate business or that the property was held as prescribed by the statute. Since no such finding can be made, it follows that the deficiencies determined by the Commissioner must be approved.

Decision will he entered for the respondent.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      *******
      (b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.


author: Hill:

text:
    Estate of William J. Garland, Deceased, Harry C. Mabry, Executor, and Grace O. Garland, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93589, 95547.
    Promulgated February 27, 1941.

      Melvin D. Wilson, Esq., and Joseph D. Peeler, Esq., for the petitioners.

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

Hill:

The ultimate question in this case is whether petitioners are taxable on all or any part of the income of the trust involved herein which was distributable to decedent’s former wife, Alzoa Garland, during the years 1934 and 1935. The respondent seeks to tax such income to petitioners, first, on the ground that it whs paid in discharge of decedent’s continuing obligation to support his divorced wife. His argument sustaining this action is based on Douglas v. Willcuts, 296 U. S. 1, and Helvering v. Leonard, 310 U. S. 80, in each of which cases the settlor of a trust, entered into in contemplation of divorce, was held taxable on the income used to discharge a continuing obligation to support a divorced spouse. On this point, however, the present case is controlled by Murray Brookman, 41 B. T. A. 557, where in a substantially similar situation we held that, since remarriage of a divorced spouse in California closed out the obligation of the husband to continue to support his wife, trust income used for that purpose could not be taxed to him. This disposition of the first argument makes it unnecessary to consider the contention of the petitioners that the trust here involved was not established in contemplation of divorce.

As a second ground for taxing to petitioners the income in dispute respondent argues that the trust here falls within the principles laid down in Helvering v. Clifford, 309 U. S. 331, where it was held that the income arising frota, a trust corpus, the substantial control and benefits of which, other than income, the trustor had reserved to himself, was taxable to the trustor as though arising from his own property or enterprise. In the instant case, however, we find no such an illusory trust. The decedent-trustor did not designate' himself a trustee nor reserve powers of management in the corpus. The trust corpus was transferred out of the settlor and the control given to others.

Decedent did, however, reserve rights to have specified portions ■of the corpus applied to his own use and benefit and on this basis we held in our former opinion that to the extent decedent retained the right to reach and apply to his own use the corpus of the trust it was revocable despite formal irrevocability. The trust income to that extent was thus held taxable to petitioners under section 166 •of the Revenue Act of 1934. Petitioners have now shown, however, that prior to the beginning of the taxable year, all these powers, save two, ceased to exist and that one of them, the right to borrow $100,000 from the trust corpus, was terminated on January 17, 1934. The other power, the right to have the loan or cash surrender value -of the insurance policies held by the. trust, could be exercised as to •only a very limited part of the trust corpus, the extent of which the parties have stipulated.

We think that our holding must still be held applicable to the limited extent of the decedent’s rights to reach the corpus of the trust. The statute is specific that where the settlor’s power extends “to any part of the corpus of the trust * * * then the income of such part of the trust shall be included in computing the net income of the grantor.” See Sarah A. W. Coursey, 33 B. T. A. 1068; Charles T. Fisher, 28 B. T. A. 1164; 34 B. T. A. 1215; affd., 108 Fed. (2d) 707.

To the extent of decedent’s right to secure the surrender value •of the insurance policies throughout the two taxable years and of his ■right to borrow $100,000 from the trust corpus during the first 17 days of 1934, petitioners must accordingly be held taxable on the income of the trust in question.

In addition to the reservations of right in the corpus already considered the decedent retained rights to have certain of his obligations paid out of the trust income. Thus his minor children were supported and his insurance premiums were paid out of trust income. The petitioners do not deny their taxability on these amounts. We think that the additional amounts paid by the trust as interest on decedent’s insurance loans must also be placed in this category and taxed to petitioners. See Helvering v. Blumenthal, 296 U. S. 552; Louis W. Hill, 33 B. T. A. 891; affd., 88 Fed. (2d) 941; James L. Knight, 39 B. T. A. 436.

The parties have stipulated the sums to be taxed to petitioners in the event we reached the decision which we have indicated above. In accordance with the stipulation petitioners’ income should be reduced below the amounts shown in the deficiency letter by the sum of $5,547.04 for the year 1934 and $3,268.60 for the year 1935.

Decision will he entered under Bide 60.

       SEC. 166. REVOCABLE TRUSTS.
      Where at any time the power to revest in the grantor title to any part of the corpus •of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a ■substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
      then the income of such part of the trust shall be included in computing the net income of the grantor.