author: Mellott :

text:
    Pacific Southwest Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102605.
    Promulgated October 24, 1941.

      Bayley Kohlmeier, Esq., and Stuart Baron, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined deficiencies in income tax for the calendar years 1936 and 1937 in the respective amounts of $842.75 and $13,878.81. The petition alleges that there is no deficiency for either year and that petitioner overpaid its income taxes for the year 1936 in the amount of $53,900.53. The two general questions are: (1) Whether securities issued by petitioner and designated either 6% percent or 514 percent cumulative preferred serial stock represented an indebtedness rather than a proprietary interest in the corporation; and (2) whether an amount paid by petitioner is deductible as taxes.

The proceeding was submitted upon a stipulation of facts with attached exhibits and the testimony of three witnesses. We find the facts to be as stipulated and, from the testimony of the witnesses, find that the two classes of preferred stock issued by petitioner as hereinafter set out were not listed upon any stock exchange but were dealt in, in “over-the-counter” transactions, in which accrued dividends, prior to the actual declaration of a dividend, were generally taken into consideration in substantially the same manner and to the same extent as accrued interest upon bonds is usually taken into consideration upon purchase or sale. All other facts hereinafter set out are taken from the stipulation of the parties.

Petitioner is a corporation organized in 1923 under the laws of Delaware and is qualified to do business in the State of California. Its principal place of business is in Los Angeles, California, and its income tax returns for the taxable years were filed with the collector of internal revenue for the sixth district of California. Its books of account were kept and its returns of income were made on the cash basis.

Petitioner was incorporated by persons affiliated with the Pacific Southwest Trust & Savings Bank and the First National Bank of Los Angeles for the purpose of acquiring, and thereafter owning and operating, all of the real estate properties owned by the first mentioned bank and one parcel of real estate owned by the second mentioned bank, and for the further purpose of providing additional bank premises as the growth of the banks required. The principal reason for organizing petitioner was to avoid “the locking up of too great a proportion” of the capital and surplus of the banks in real estate owned by them.

The total authorized capital stock of the corporation was 100,000 shares^ divided into 50,000 shares of preferred of the par value of $100 each and 50,000 shares of common with no nominal or par value. The original articles of incorporation provided for the issuance of 23 series of 6y2 percent cumulative preferred serial stock, tó be designated by the letters A to W, both inclusive, each series to be for the number of shares shown (ranging between 1,100 and 3,950) and to bo “redeemable at their par value plus all unpaid, accrued, or accumulated dividends thereon.” Such cumulative preferred serial stock could be issued as and when the board of directors should determine, but it could not be issued except for the purpose of acquiring property suitable for one or more of the purposes of the corporation. The articles of incorporation also provided:

* * * The aggregate indebtedness of the corporation secured by mortgage, deed of trust, or otherwise, shall not exceed in amount Fifty per cent (50%) of the appraised value of the property subject thereto; The total amount of preferred stock of the corporation at any time outstanding shall not, together with the total bonded indebtedness of the corporation, exceed One Hundred per cent (100%) of the appraised value of the property of the corporation '* * *.

The 61/2 percent cumulative preferred serial stock was “entitled to receive in each year out of the surplus or net profits of the business of the corporation, dividends at the rate of 6%% per annum, and no more, upon the par value of said stock from date of issue, payable quarterly * * The dividends were cumulative and “if in any year or years the dividends * * * shall not have been paid, such dividends shall be paid in full before any dividends shall he paid or set apart upon the common stock. The amount of any serial redemption of said preferred stock, if overdue, shall be paid before any dividends shall be paid or set apart on the common stock.”

In the event of liquidation, dissolution, or winding up of the corporation, the holders of the preferred stock were entitled, before any distribution could be made to the holders of the common stock, “to be paid out of the surplus profits * * *, or in case such profits shall be insufficient, then from the general assets of this corporation, an amount equal to 105% of the par value of said stock.” Upon the maturity date specified in each series the shares were to “be redeemed at par, plus unpaid, accrued, and accumulated dividends thereon * * In the event the corporation should fail to redeem the stock at such time and place, the holders were to “have the right to enforce payment of the par value of said stock so agreed to be redeemed, together with the amount of any unpaid, accrued, or accumulated dividends thereon, the same as on any unconditional claim or debt against the corporation * * The preferred stock was to have no voting power, the sole voting rights being vested in the holders of the common stock. In the event that any dividend on the preferred stock should not be paid when payable and should remain unpaid for ninety days, then so long as such dividend or any part thereof should remain unpaid, the issued and outstanding preferred stock was to be exclusively entitled to the voting power.

All of the common stock of petitioner, except directors’ qualifying shares, was issued to the First Securities Co., an affiliate of petitioner. All of the stock of First Securities Co. and all of the stock of the two banks above named was owned by the Los Angeles Trust & Safe Deposit Co. as trustee in trust for the benefit of the owners of heneficial certificates issued by the trustee. All of the stock of the trustee was likewise owned by the First Securities Co.

Pursuant to the original articles of incorporation during the years 1923,1924, and 1925 petitioner issued and sold 6% percent cumulative preferred serial stock of the total par value of $4,500,000 in 23 series designated A to W, inclusive. Series A matured and became payable on July 1,1929, and one of the remaining series matured and became payable on July 1 of each year thereafter to and including the year 1951. The certificates were redeemable at par “plus all unpaid, accrued, or accumulated dividends thereon”, and entitled the owners “to receive in each year out of the surplus or net profits of the business of the corporation, dividends at the rate of 6%% per annum, and no more, upon the par value of said stock from date of issue * *

The certificates also contained the essence of article fourth of the original articles of incorporation, including the provisions quoted above. During the years 1924 and 1925 petitioner also issued and sold its 5y2 percent coupon bonds of a total face value of $3,000,000. The proceeds derived from the sale of the preferred stock and bonds were used for the purchase of real estate suitable for the purposes of the corporation.

In connection with the issuance and sale of petitioner’s 6y2 percent cumulative preferred serial stock in 1923 a prospectus was published by the First Securities Co. Therein it was stated that petitioner proposed to issue at that time $3,000,000 of 5y2 percent first mortgage bonds and $3,000,000 6y2 percent cumulative preferred stock and to hold in its treasury the balance of the authorized preferred stock for issuance from time to time as the needs of the company should require. The prospectus also stated: “it is the intention of the Eealty Company [petitioner] to finance its present needs by equal amounts of Preferred Stock and Bonds * * *. The annual maturities of bonds and stocks will serve to increase the original equity as the different series mature and are retired”, and “The 6y2% Cumulative Preferred Serial Stock is, in opinion of counsel, free from the Personal Property Tax in California and likewise free from the Normal Federal Income Tax.”

Series A of the 6y2 percent cumulative preferred serial stock matured and was redeemed on July 1, 1929. Series B to G, inclusive, matured and were redeemed respectively on July 1 of each year thereafter to and including 1935. At the beginning of the year 1936 6y2 percent cumulative preferred serial stock of a total par value of $3,766,500 was issued, outstanding, and unmatured. During the year 1936 all of said securities were redeemed and retired. During the year 1936 petitioner made payments to the holders of said 6y2 percent cumulative preferred serial stock at the rate of 6y2 percent per annum of the par value thereof, or $65,300.63 as provided in the certificates.

At the time the securities referred to above were issued petitioner had a lease agreement with the Pacific Southwest Trust & Savings Bank under which the bank had obligated itself to pay as rental a sum which, with the other income of petitioner, would be sufficient- to pay all of petitioner’s operating expenses and in addition all interest, dividend, and amortization charges on its outstanding bonds and preferred stock. The bank, as lessee, agreed to pay petitioner $420,000 pei’ annum for said property, the term of the lease being 30 years from and after July 1,1923.

On December 16, 1927, petitioner’s articles of incorporation were amended. A copy of article fourth as amended is attached to the stipulation of facts. There were no substantial changes made with respect to preferences, privileges, and other rights of the holders of preferred stock, but the amended article provided for a total authorized capital stock of 125,000 shares, divided into 75,000 shares of preferred stock of the par value of $100 each and 50,000 shares of common stock having no nominal or par value. During the year 1928, pursuant to the authority contained in the article as amended, petitioner issued and sold its securities designated 5 percent cumulative preferred serial stock of the total par value of $1,000,000. The proceeds derived therefrom were used for the purchase of real estate suitable for the purposes of the corporation. The certificates were issued in 22 series designated AA to W, inclusive, payable on July 1, 1939, and successively thereafter on July 1 of each year to and including the year 1960. Each certificate recited that on April 20, 1928, the board of directors “determined upon the issuance of $1,000,000 (10,000 shares) fixed dividend rate, 5%%, fixed redemption premium, 2% ($102.00 per share), designations and maturities as follows: [Schedule].”

The prospectus issued in connection with the 5% percent cumulative preferred serial stock stated:

With the completion of the present stock sale, the Pacific Southwest Realty Company will have outstanding $4,500,000 6%% Cumulative Preferred Serial Stock, and $1,000,000 5%% Cumulative Preferred Serial Stock, in addition to 50,000 shares Common Stock of np par value, owned by the First Securities Company.
With the completion of the present financing on or about July 2, 1928, there will be outstanding $5,100,000 of first mortgage bonds. The aggregate total par value of outstanding preferred stocks and bonds will then be $10,600,000.

The prospectus also stated that the stock being offered was, “in opinion of counsel, free from the Personal Property Tax in California and likewise free from the Normal Federal Income Tax.”

During the year 1936 all of the 514 percent cumulative preferred serial shares of the par value of $1,000,000 were outstanding. All of them were redeemed and retired during the year 1937. During the years 1936 and 1937 petitioner made payments to the holders of said securities as provided in the certificates at the rate of 5y2 percent of the par value thereof or $55,000 during the year 1936 and $41,250 during the year 1937.

The payments made by petitioner to the holders of its 6% percent cumulative preferred serial stock and 5y2 percent cumulative preferred serial stock were authorized by resolutions of the board of directors of petitioner. A true copy of one of the resolutions is attached to the stipulation. It declares a “regular quarterly dividend of $1.31% a share on the 5%% Cumulative Preferred Serial Stock of this corporation, amounting to $13,750 * * * out of the earned surplus of the corporation” and directs “that the amount thereof be set aside and transferred to ‘Dividend Declared’ account.”

The 5% percent cumulative preferred serial stock had been sold by the petitioner at discounts of $3 and $5 per $100 par value, the discount aggregating $46,858. It is stipulated that if the discount at which said securities were sold ivas a deductible expense, it was an expense which it was proper to amortize and deduct over the life of the securities and $1,833.26 of said discount expense was properly allo-cable to the year 1936 and $31,275.39 was properly allocable to the year 1937.

During the year 1936 petitioner redeemed and retired all of its then outstanding 6% percent cumulative preferred serial stock for the face value thereof ($3,766,500) plus a total premium of $182,025. During the year 1937 it redeemed and retired all of its then outstanding 5% percent cumulative preferred serial stock for the face value thereof ($1,000,000) plus a total premium of $20,000.

During the year 1929 petitioner sold certain real property located in the city of Los Angeles, California, under a conditional sales contract. Under the provisions of the contract petitioner retained title to the property until the purchase price was paid. On November 15, 1935, by reason of the default of the purchaser of the property, petitioner canceled the sales contract and repossessed the property. At the time the property was repossessed by petitioner there were assessed but unpaid property taxes against it in the amount of $5,618.35. These taxes were payable one-half on or before December 5, 1935, and one-half on or before April 20,1936. During the year 1936 petitioner paid said property taxes in full. Petitioner deducted said sum of $5,618.35, under the provisions of section 23 (c) of the Eevenue Act of 1936, in computing its net taxable income for the vear 1936.

In its income tax return for the year 1936 petitioner failed to take deductions for the payments made on its securities designated 6% percent cumulative preferred serial stock and 5% percent cumulative preferred serial stock, failed to take deduction for the portion of the discounts at which its securities designated 5% percent cumulative preferred serial stock were issued and sold which was allocable to the year 1936, and failed to take a deduction for the premium paid upon the redemption of its securities designated 6% percent cumulative preferred serial stock. In its income tax return for the year 1936 petitioner reported net taxable income in the amount of $562,740.52 and a tax liability in the amount of $83,251.08. Petitioner paid this tax in installments as follows: $20,812.77 on March 15, 1937, and like amounts oil June 12, September 13, and December 13, 1937. Petitioner’s return for the year 1936 was filed on March 15, 1937.

Upon examination of petitioner’s income tax return for the year 1936 the Commissioner disallowed the deduction taken by petitioner for real estate taxes in the amount of $5,618.35 and determined the net income of petitioner for the year 1936 to be $568,358.87. The deficiency for the year 1936 in the amount of $842.75 resulted from the disallowance of said deduction and the consequent increase in petitioner’s net income. In redetermining petitioner’s net income for the year 1936 the Commissioner did not allow any deduotions for the payments made by petitioner during said year on its securities designated 6y2 percent cumulative preferred serial stock and 5y2 percent cumulative preferred serial stock, did not allow a deduction for any portion of the discount at which petitioner’s securities designated 5y2 percent cumulative preferred serial stock were issued, and did not allow a deduction for the premiums paid by petitioner upon the redemption of its securities designated Qyz percent cumulative preferred serial stock.

On March 6,1940, petitioner filed with the collector of internal revenue for the sixth district of California, at Los Angeles, California, its written claim for refund of income taxes overpaid by it for the year 1936 in the amount of $53,900.53, setting forth therein the same facts and grounds herein alleged and relied upon. A true copy of said claim for refund is attached to the petition herein.

In its income tax return for the year 1937 petitioner deducted as interest paid the payments made on its securities designated 5y2 percent cumulative preferred serial stock in the amount of $41,250, deducted the sum of $31,275.39 as the portion of the discount at which said securities were issued and sold which was properly allocable to the year 1937, and deducted the premium paid in the amount of $20,000 upon the redemption of the securities. The Commissioner refused to allow these deductions.

On May 22,1940, petitioner paid to the collector of internal revenue for the sixth district of California the deficiencies in income taxes proposed to be assessed against it for the years 1936 and 1937. The payments were as follows: $842.75 tax and $161.09 interest, or a total payment of $1,003.84 for the year 1936, and $13,878.81 tax and $1,820.21 interest, or a total payment of $15,699.02 for the year 1937.

Petitioner contends that the securities designated 6y2 percent or 5y2 percent “Cumulative Preferred Serial Stock” were not what they purported to be — evidence of a proprietary interest in the corporation— but that collectively they represented an obligation of the corporation to make repayment to the holders and in the meantime to pay them interest. It therefore argues that it is entitled to deduct, as interest, the amounts paid under and pursuant to the corporate resolutions as dividends. It also contends that it is entitled to deduct the portion of the discount properly allocable to the year 1936 and the premium paid during each of the years in connection with the' redemption of the two classes of stock. Inasmuch as the latter deductions are proper if the securities were in fact obligations and the amount paid was interest (art. 22 (a)-18, Regulations 94), the three contentions may be considered together.

Numerous cases have been decided by the courts or this Board involving the same general question. None of them attempt to lay down any “comprehensive rule by which the question presented may be decided in all cases, and ‘the decision in each case turns upon the facts of that case’.” Proctor Shop, Inc., 30 B. T. A. 721, 725, and cases cited. “If it be shown that dividends paid are, according to the intent of the parties, in fact interest, and the stock on which the dividends are paid is merely held by the creditor as security, it makes no difference what the reason was for paying in that form. The courts look to the real character of the payment * * Wiggin Terminals, Inc. v. United States, 36 Fed. (2d) 893, 898, quoted with approval by the Circuit Court of Appeals for the Ninth Circuit in affirming the decision of the Board in Proctor Shop, Inc., supra; 82 Fed. (2d) 792. Cf. Bolinger-Franklin Lurcher Co., 7 B. T. A. 402; Commissioner v. O. P. P. Holding Corporation, 76 Fed. (2d) 11, affirming O. P. P. Holding Corporation, 30 B. T. A. 337; Jewel Tea Co. v. United States, 90 Fed. (2d) 451; Helvering v. Richmond, F. & P. R. Co., 90 Fed. (2d) 971, affirming Richmond, Fredericksburg Potomac Railroad Co., 33 B. T. A. 895; Brush-Moore Newspapers, Inc., 37 B. T. A. 787; Commissioner v. Palmer, Stacy-Merrill, Inc., 111 Fed. (2d) 809, affirming Palmer, Stacy-Merrill, Inc., 37 B. T. A. 530; and Commissioner v. Schmoll Fils Associated, Inc., 110 Fed. (2d) 611, reversing Schmoll Fils Associated, Inc., 39 B. T. A. 411.

It is true, as petitioner points out upon brief, that the cited cases establish some general principles — the name given by the parties to a particular security or to the payments made thereunder is not conclusively determinative; the true nature and character are to be determined not only from the terms and conditions of the security, but also from a consideration of all the facts and circumstances surrounding its issuance, including evidence aliunde the contract; and in every case the basic difference between the relationship of corporation and stockholder on the one hand and debtor and creditor on the other must always be kept in mind. We therefore examine the evidence and the stipulated facts in the light of these principles.

The only evidence aliunde the contract in the instant proceeding is that upon which we have based our finding to the effect that generally, in the purchase and sale of the certificates, dividends, though not de-dared, were taken into consideration in substantially the same manner and to substantially the same extent as accrued interest upon bonds is usually taken into consideration upon purchase and sale. There was no evidence, as in Proctor Shop, Inc., and some of the other cited cases, indicating either that the issuing company desired to borrow money or that the holders were unwilling “to stand in the relation of a stockholder to the corporation.” The facts show quite the contrary. The letter sent to prospective purchasers of the preferred stock, inviting them to subscribe for it, advised that the company proposed to finance its “present needs through the issuance of approximately equal amounts of preferred stock and bonds.” The enclosed prospectus contained the same general statement, each indicating that the initial capital was to be obtained by borrowing 50 percent of the necessary amount through the issuance of bonds, while the remainder was to be obtained through the sale of preferred stock. This plan was carried out and $3,000,000'of each was issued and sold. Both were later increased, so that prior to April 1,1928, the company — in the language of its second prospectus — “had * * * sold for cash to institutions and investors an aggregate of $5,000,000 First Mortgage 5%% Bonds and $4,500,000 6%% Cumulative Preferred Serial Stock.” At that time $985,000 of its bonds had been retired. Then it was that the company decided to amend its articles of incorporation to permit it to issue $1,000,000 5% percent cumulative preferred serial stock so that “with the completion of the present stock sale” there would be, as there ultimately were, $5,500,000 outstanding cumulative preferred serial stock and $5,100,000 of first mortgage bonds.

The facts referred to above indicate that petitioner intended the holders of the certificates to become, and to be, stockholders rather than creditors. It is apparent from the articles that petitioner never intended to “borrow” more than 50 percent of its funds. Thus it is stated: “The aggregate indebtedness of the corporation secured by mortgage, deed of trust, or otherwise, shall not exceed in amount Fifty per cent (50%) of the appraised value of the property subject thereto. The total amount of preferred stock of the corporation at any time outstanding shall not, together with the total bonded indebtedness of the corporation, exceed One Hundred per cent (100%) of the appraised value of the property of the corporation.” If the preferred stock be held to be indebtedness, “secured by mortgage, deed of trust or otherwise”, and unless the appraised value of the property was greatly in excess of its actual cost, which we hesitate to assume, then this provision of petitioner’s charter was violated; for while the aggregate of the admitted bonds, plus the “so-called” preferred stock was $10,600,000, “the aggregate cost of the Company’s properties including those heretofore owned, with those now being purchased, and including the new buildings which have been erected, [according to the prospectus] will be in excess of $11,200,000.”

Moreover, there are several other circumstances which collectively convince us that both the issuing corporation and those who ultimately became holders of the securities intended that the relationship between them was to be that of corporation and stockholder rather than debtor and creditor. Each prospectus contained in its heading, in bold type, “In opinion of counsel, exempt from Normal Federal Income Tax,” and a more detailed statement to the same effect in the body of the document. No evidence was introduced to show whether the holders of the securities so treated the income derived from the securities— i. e., as dividends and subject only to surtax (see for example section 25, Revenue Act of 1928) — but it may be assumed, in the absence of any proof to the contrary, that they relied upon the statements contained in the prospectuses. In any event it is not wholly without significance that petitioner treated the payments as dividends upon its books and in all of its returns of income prior to 1937. Manifestly the representation that the income was “free from Normal-Federal Income Tax” would be true only if the securities were preferred stock. In determining whether they were, or were not, what they purport to be, we must look, not only to the language of the certificates, but to the articles and amended articles of incorporation. They specify, in considerable detail, not only that preferred stock be issued, but also require that “Before the issuance of any such stock, the President of the Corporation shall file a certificate in the office of the corporation setting forth in detail the property purchased or to be purchased with the proceeds of the sale of such stock.” The stock so issued was to “be entitled to receive in each year out of the surplus or net profits of the business of the corporation, dividends at the fixed dividend rate” specified in the certificates. If in any year “the dividends” on such stock have not been paid “such dividends shall be paid in full before any dividends. shall be paid or set apart upon the common stock.” The use of the word “dividends” many times in the articles of incorporation and the requirement that payment of such be made “out of the surplus or net profits” can not be ignored. Wholly absent from the articles is any requirement that the annual payments upon the certificates be made regardless of earnings, except for the provisions which we shall now discuss and upon which petitioner places its chief reliance.

Each series was to “be redeemed at par, plus unpaid, accrued, and accumulated dividends thereon.” “In the event that the corporation shall fail to redeem * * * at such time and place, the holders thereof shall have the right to enforce payment of the par value of said stock so agreed to be redeemed, together with the amount of any unpaid, accrued, or accumulated dividends thereon, the same as on any unconditional claim or debt against the corporation * * “In the event of any liquidation, dissolution, or winding up of the corporation, * * * the holders .* * * shall be entitled, before any distribution shall be made to the holders of the_ common stock, to be paid out of the surplus profits arising from the business of this corporation, and then remaining intact, or in case such profits shall be insufficient, then from the general assets of this corporation, an amount equal to 105% of the par value of said stock.” These provisions, petitioner contends, make the securities an “indebtedness.” Respondent denies that they have any such effect, points out that the right to enforce the payment as an unconditional claim or debt appears to be limited to the holders of any series then in default, which, so far as this record shows, never occurred, and argues that “the interest of any person in the assets of a corporation must necessarily be either as a creditor or as a proprietor”, but can not be both at the same time.

In practically every case decided by the courts or this Board it has been pointed out that each case must be decided on its own particular facts. Dayton & Michigan Railroad, Co., 40 B. T. A. 857; Trianon Hotel Co., 44 B. T. A. 1073. “The authorities afford us no very certain guide in solving the difficult problem before us, but vary with the particular facts of each case.” Commissioner v. Schmoll Fils Associated, Inc., supra. Many facts and circumstances in the instant proceeding indicate that the corporation and the purchasers of the securities intended that the relation should be proprietary rather than that of a creditor and debtor. Some of the significant facts and circumstances upon which we have relied in reaching our conclusion have already been referred to. Others are: The name given to the securities by petitioner in its articles of incorporation, .in its letters and prospectuses, and in the securities themselves. While the name given is not determinative, it should not lightly “be assumed that the parties have given an erroneous name to their transaction.” Schmoll Fils Associated, Inc., supra; I. Unterberg & Co., 2 B. T. A. 274; Kentucky River Coal Corporation, 3 B. T. A. 644; H. R. DeMilt Co., 7 B. T. A. 7. There is no evidence in the record indicating that either petitioner or the holders prior to the taxable years ever contended that there was any misnomer. Nor should it be overlooked that the certificates specifically referred to the holders as “stockholders” and to the payments as “dividends”, that no payments were ever made except following the declaration of a dividend, and that all payments were made from profits. The dividends, after declaration, were set aside and transferred to “dividend declared” account.

Meridian & Thirteenth Realty Co., 44 B. T. A. 865, decided since briefs were filéd in the instant proceeding lends some support to petitioner’s contention. It was there held that a security designated preferred stock, having a fixed maturity date, and requiring the payment of the agreed 6 percent regardless of profits represented an indebtedness. The proceedings are distinguishable in that in the cited case there was no evidence that any bonds had been issued by the corporation or that it had any other outstanding evidence of debt; a conclusion that the securities were in fact obligations did not require a holding that the corporation had violated its articles of incorporation; no representations were made that the securities were free from the normal Federal income tax; the company had not represented in connection with the issuance of such stock that it proposed to finance its needs through the issuance of equal amounts of preferred stock and bonds; and the issuing company had not, as in the instant proceeding, given the holders of the preferred stock a right to vote in the event of default in the payment of dividends, though withholding from the bondholders such privilege. Moreover, we think it is quite doubtful, in spite of the provision contained in the articles of incorporation and in the certificates purporting to give the holders of the preferred stock rights which they might enforce as creditors, that any such rights could be enforced under the stipulated facts to the detriment of general creditors or bondholders.

We are of the opinion and hold that the securities were what they purported to be. Compare Brown-Rogers-Dixson Co. v. Commissioner (C. C. A., 4th Cir.), 122 Fed. (2d) 347. It follows that the respondent committed no error in denying the claimed deductions for interest, discount, and premiums.

The petitioner’s next contention is that it is entitled to a deduction of $5,618.35, for real estate taxes paid by it in 1936. The amount in question was assessed on May 1, 1935, when the real estate was in the possession of petitioner’s vendee under the conditional sales contract. Petitioner repossessed the property on November 15, 1935, the vendee having defaulted in the payment of the purchase price. The taxes were payable one-half on or before December 5,1935, and one-half on or before April 20, 1936. Petitioner paid the entire amount during 1936 and in its income tax return for that year claimed a deduction in that amount as “taxes.” Respondent disallowed the deduction on the ground that the amount paid constituted additional cost of the property repossessed.

The petitioner contends that it was the legal owner bf the property and, as such, legally responsible for the payment of the taxes at the time of assessment. It argues, therefore, that it should be allowed the deduction since the amount represented taxes paid after, but which accrued before, repossession of the property. In support of its contention it cites and relies upon two unreported memorandum decisions of this Board wherein lessors of property were allowed to deduct taxes assessed during the time repossessed property was in the possession of the, lessees. The conclusion that a lessor may deduct the taxes paid by him upon his property, notwithstanding the fact that a lessee may have covenanted to pay them as part of the consideration for the occupancy of the property, is not particularly helpful in determining the question now before us.

Kespondent concedes that petitioner retained the legal title to the property which it sold in 1929. He takes the-position, however, that it was a bare, naked legal title; that the equitable title was in the purchaser from the time of the sale in 1929; that it remained in him until the property was repossessed by the petitioner in November 1935; and that petitioner, having sold the property, had no alternative except to give the purchaser legal title upon payment of the agreed purchase price. He therefore contends that petitioner was holding the legal title to the property more in the nature of a trustee for the benefit of the purchaser than as an owner of the property as that term is ordinarily understood. He insists that, inasmuch as the taxes in question were assessed and became a lien against the property in March 1935, petitioner was paying an obligation, or an accrued liability, of its vendee when it, in 1936, paid the 1935 real estate taxes.

The parties have stipulated that the property was sold by petitioner during 1929 under a conditional sales contract. The contract was not introduced in evidence. A “conditional sale” has been defined to be a contract for the sale of property under which possession is delivered to the buyer, but title is retained in the seller until the performance of some condition, usually the payment of the purchase price. 55 C. J. 1192. The rights of the vendor and vendee under such a contract have been discussed by the courts of California in a number of cases. In Oaks v. Kendall, 73 Pac. (2d) 1255; 23 Cal. App. (2d) 715, the court pointed out that the vendor under such a contract retains an absolute right to hold the property as security for the payment of the purchase money according to the express terms of the contract, and quoted with approval the following excerpt from 25 California Jurisprudence, p. 762, sec. 930:

* * * In the ordinary executory contract for the sale of real property the vendor retains title as security for the payment of the purchase money and as trustee for the purchaser, who has only an equitable estate in the land. The position of the vendor is similar in some respects to that of a mortgagee. He has no greater rights than he would possess if he had conveyed the land and taken back a mortgage for unpaid purchase money, or than is held by a mortgagee who takes for his security a conveyance absolute in form instead of a formal mortgage, except that he is not restricted to a remedy by foreclosure. A vendor is frequently said to have a lien on the property so long as he retains title, though properly speaking he has no lien, nor any need of one, since he has the complete legal title which he holds as a pledge for payment of the purchase money.

In San Diego County ex rel. Whelan v. Davis, 33 Pac. (2d) 827, involving the question of liability for property tax on an automobile, the Supreme Court of California, per curiam, said:

The tax must be levied on the owner of the property, but this does not necessarily mean the holder of the legal title. In a conditional sale, the title in the seller is for security only, to assure the payment of the purchase price. It carries with it none of the ordinary incidents of ownership. The buyer has the possession and use of the property to the complete exclusion of the seller subject only to the seller’s remedies in case of default. Both in a practical and. a legal sense the buyer is the beneficial owner.

In Thompson on Eeal Property, vol. 5, sec. 4526, the author states: “There can be no sensible distinction between the case of a legal title conveyed to secure the payment of a debt and a legal title retained to secure payment.” While there are some points of difference between the relation of vendor and vendee under a conditional sales contract and that of equitable mortgagee and mortgagor where the vendee holds an equity which is subject to foreclosure by the vendor, we do not think the difference is of such a substantial nature as to warrant the allowance of a deduction for taxes when paid by the vendor after the property is repossessed although such allowance would not be granted following foreclosure of the mortgage by the equitable mortgagee.

Under the laws of California, the liability for county and city taxes is determined by the ownership of property on the first Monday in March. California Sanitary Co., Ltd., 32 B. T. A. 122; Crown Zellerbach Corporation, 43 B. T. A. 541 (on appeal C. C. A., 9th Cir.). (Sec. 3628, Political Code of California.) Petitioner’s vendee was the beneficial owner and had possession and control of the property on that date, and thus became liable, for the payment of the real estate taxes here involved. Petitioner’s payment of such taxes in 1936, after it had repossessed the property in November of 1935, does not in our opinion make such taxes its taxes or entitle it to the claimed deduction. Cf. Commissioner v. Coward, 110 Fed. (2d) 725; Lifson v. Commissioner, 98 Fed. (2d) 508; certiorari denied, 305 U. S. 662; Estate of Lucy S. Schieffelin, 44 B. T. A. 137; Helvering v. Missouri State Life Insurance Co., 78 Fed. (2d) 778; John Hancock Mutual Life Insurance Co., 10 B. T. A. 736.

Finding no error in the deficiencies determined by the respondent, they must be approved. It follows that petitioner’s claim for overpayment can not be allowed.

Decision will he entered for the respondent.


source: Caselaw Access Project

author: Hill :

license: Public Domain

text:
    Roosevelt Investment Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. First Realty Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101453, 101558.
    Promulgated October 24, 1941.

      Edward L. Bosling, Esq., Harold L. Scott, G. P. A., Charles T. Donworth, Esq., and Pearce G. Davis, G. P. A., for the petitioners.

      B. H. Néblett, Esq., for the respondent.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      *******
      (g) Definition of Reorganization. — As used in this section and section 113—
      (1) The term “reorganization” means * * * (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the trans-feror or its stockholders or both are in control of the corporation to which the assets are transferred, * * *

   OPINION.

Hill :

The first issue is whether the basis to Eoosevelt Investment for purposes of depreciation is the adjusted cost basis of the corporations which transferred their properties to Eoosevelt Investment or the actual cost to the transferee. Petitioner Eoosevelt Investment contends that the properties were transferred to it solely in exchange for stock and that the transaction in which it acquired the properties was either a tax-free exchange under section 112 (b) (5) of the Eevenue Act. of 1934 or a statutory reorganization under section 112(g) (1) (C) of the Eevenue Act of 1934. It maintains that, since the properties were acquired pursuant to a reorganization within the meaning of section 112 (g) (1) (C), the basis remains the same as in the hands of the transferors. Eespondent argues that the securities received from Eoosevelt Investment by the transferors were not “substantially in proportion” to the transferors’ interests in the property prior to the exchange and contends that such disproportion disqualifies Eoosevelt Investment from the benefits of section 112 (b) (5). He contends that the continuity of interest necessary for the application of section 112 (g) (1) (C) was not present, so that section 113 (a) (I) is not applicable.

We first inquire whether petitioner Eoosevelt Investment acquired the hotel property in the course of a reorganization as defined by section 112 (g) (1) (C) of the Eevenue Act of 1934. In order to qualify under this section there must be a continuity of interest in the transferors. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; Le Tulle v. Scofield, 308 U. S. 415. Immediately after the transfer the transferors or their shareholders must be in control of the transferee. Control within the meaning of the reoganization provisions is defined by section 112 (h) of the Eevenue Act of 1934 as the ownership of at least 80 percent of the voting stock and 80 percent of all other classes of stock of the corporation.

In the instant case Realty Investment transferred a lease valued at $25,000 and $25,000 in cash to petitioner Roosevelt Investment in exchange for 50 percent of all of Roosevelt Investment’s common voting stock. No stock other than common was issued by the new corporation. First Realty subscribed in behalf of First Hotel for 25 percent of the new corporation’s shares, paying $25,000 cash therefor and causing First Hotel to transfer its interest in the hotel property to the new corporation. Maltby-Thurston subscribed for the remaining 25 percent of the new corporation’s stock, paying $25,000 cash and causing the operating company to transfer its interest in the hotel property to the new corporation. Immediately after the transfer the control of the new corporation was in the hands of the trans-ferors. Realty Investment then owned 50 percent of Roosevelt Investment’s entire capital stock, First Hotel or its sole shareholder, First Realty, owned 25 percent, and Maltby-Thurston and the other stockholders of the operating company owned 25 percent of the shares of Roosevelt Investment. Realty Investment, First Hotel, and the operating company were the transferor corporations and they or their stockholders were in control of the new corporation by virtue of ownership by them or their shareholders of 100 percent of all shares, voting and otherwise, of Roosevelt Investment.

We have found as a fact that Edris subscribed for stock of the new corporation in behalf of Realty Investment and the cash thus paid must be deemed to be that of Realty Investment. Respondent has argued at length regarding alleged disproportion of interests transferred to Roosevelt Investment to value of stock received. It is sufficient answer to this argument for purposes of discussion here that the proportionate interest required under section 112 (b) (5) is not required for a statutory reorganization under section 112 (g) (1) (C). The transfer under consideration was pursuant to a reorganization, and, by virtue of coming within the terms of section 112 (g) (1) (C), Roosevelt Investment’s basis for purpose of computing depreciation is that of its transferors, increased by the gain or decreased by the loss recognized to the transferors upon the transfer. Sec. 113 (a) (7).

No gain or loss was recognized on the transfer of the various properties to the new corporation in exchange for the new corporation’s stock. Sec. 112 (b) (4), Revenue Act of 1934. Although a liability of the operating company and a portion of the mortgage indebtedness of First Hotel and First Realty were assumed by Roosevelt Investment, such assumption is not to be considered as “other property or money” received by the taxpayer within the meaning of section 112 (c), (d), or (e) of the Revenue Act of 1934 and does not prevent the exchange from being within the provisions of section 112 (b) (4) of the Revenue Act of 1934. Sec. 213 (f) (1) and (2), Revenue Act of 1939.

Respondent next contends that, even though the transfer was in the course of a reorganization, the basis in the hands of Roosevelt Investment must be reduced in the amount of indebtedness of which the transferors were relieved at the time of the transfer. We see no reasonable ground for this contention. Respondent has cited no authority in behalf of his argument and given no valid reason for the adjustment of the basis in the manner which he suggests. The statutory provisions for adjustment of basis will be found only in section 113 (b) of the Revenue Act of 1934 and, after giving effect to gain or loss recognized on the transfer, no adjustment to basis other than as authorized by section 113 (b) may be made. While section 113 (a) (6) of the Internal Revenue Code, relating to basis of tax-free exchanges in general, has been amended by section 213 (d) of the Revenue Act of 1939, so that for all taxable years beginning after December 31, 1938, assumption or taking subject to liabilities will affect the basis in the hands of the transferee, that section can not be applied retroactively. Moreover, section 113 (a) (6) is specifically not applicable when the transferee corporation acquires property by issuance of its securities. Accordingly, we hold for petitioner on this issue. Upon our disposition of the issue we need not consider petitioner’s argument that the transfer was in the course of a tax-free exchange under section 112 (b) (5) of the Revenue Act of 1934.

The second issue, which involves the rate of depreciation on the hotel building, must be decided for respondent. Petitioner has failed to give convincing proof that respondent erred in determining that the proper rate of depreciation is 2 percent. Respondent’s determination of a 2 percent depreciation rate is supported by the fact that Roosevelt Investment deducted depreciation on the hotel building on its 1935 and 1936 returns and carried a reserve for depreciation on the hotel on its books at that rate. Testimony adduced at the hearing did not demonstrate that the 2 percent rate of depreciation was unreasonable nor that the proper rate should be other than 2 percent.

The third issue is whether or not respondent erred in determining the proportion of the dividend from Roosevelt Investment received by First Realty which was attributable to earnings and profits. Petitioner First Realty contends that a large proportion of the dividend represents return of capital, which consequently is not taxable to the recipient. The disposition of this question is directly dependent upon our determination of the first and second issues. We have held that the basis of Roosevelt Investment was that of its transferors and have upheld respondent’s determination of rate. The amount of dividend paid by Roosevelt Investment which was attributable to earnings and profits will be determined upon recomputation under Rule 50.

The fourth issue is whether or not First Realty is entitled to a bad debt deduction for the year 1936 for the amount of its investment in debentures of Community. Petitioner First Realty contends that its board of directors directed a revaluation of the assets of the corporation, which resulted in the ascertainment that the debentures were worthless. Petitioner contends further that the debentures were ascertained to be worthless and charged off in the taxable year. Respondent claims that there was no true ascertainment of worthlessness and that nothing constituting a charge-off occurred in the taxable year. He stresses the fact that the alleged bad debt was not claimed as a deduction on the return.

We are of the opinion that petitioner First Realty properly ascertained the debentures to be worthless and charged them off in the taxable year. The fact that they might have been worthless before that year will not necessarily deny the deduction. Commissioner v. MacDonald, Engineering Co., 102 Fed. (2d) 942. The test is that of a reasonable man having a knowledge of the facts available to the taxpayer. Avery v. Commissioner, 22 Fed. (2d) 6.

In the taxable year certain officers of First Realty experienced in real estate matters made independent valuations of the assets of the corporation. Each of these officers valued the debentures and stock of Community at nominal value. The new valuations were adopted by the board of directors and shareholders of First Realty during the taxable year and the debentures and stock of Community were reduced on the books of the corporation as of December 31,1936, to a nominal value of $1. The revaluation of the assets amounted to an ascertainment of worthlessness and the reduction on the books amounted to a charge-off under the statute. See Commissioner v. MacDonald Engineering Co., supra, at p. 945.

The fact that the deduction was not claimed in the First Realty return is not material since the return showed a net loss. Nor is the fact that the debentures were later exchanged for worthless securities pursuant to the reorganization important. Coon Valley State Bank, 13 B. T. A. 132. We bold that respondent erred in disallowing First Realty’s claimed bad debt deduction in the sum of $12,510 representing its investment in debentures of Community.

The final issue is whether or not petitioner First Realty may deduct the sum of $25,000 representing its investment in common stock of Community. Petitioner claims that a number of identifiable events, such as the trustee’s ultimatum to Community to reorganize and the suit by Deibler to cancel the lease on property on which the hotel kitchen is situated, show that the stock actually became worthless in the taxable year. Respondent argues that there has been no proof that the stock became worthless in the taxable year and contends that during the year the stock actually increased in value due to the reorganization plan.

We are of the opinion that the petitioner has failed to prove an essential fact necessary for a finding by us that the stock became worthless in the taxable year, namely, that the stock had value at the beginning of the taxable year. Frank C. Rand, 40 B. T. A. 233. Unless the stock had value at some time in the taxable year there could be no loss sustained due to the stock becoming worthless in that year. For failure of petitioner First Realty to sustain the burden of proof in this matter we uphold respondent on this issue.

Decision will be entered under Rule 50.

       SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (unadjusted) of Property. — The basis of property shall be the cost of such property ; except that—
      *******
      (7) Transfer to corporation where control of property remains in same persons. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after, the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.


author: Tyson:

text:
    R. H. Bouligny, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104207.
    Promulgated October 24, 1941.

      F. A. MoOleneghan, Esq., and Robert Lassiter, Jr., Esq., for the petitioner.

      E. L. Gorbin, Esq., for the respondent.
   OPINION.

Tyson:

The question presented for decision is whether the Commissioner erred in failing to allow a dividends paid credit of $11,500 in computing the petitioner’s surtax on undistributed profits for the year 1936. The dividends paid credit allowed to corporations by section 27 of the Revenue Act of 1936 is a factor in the computation of the undistributed net income of the corporation on which the surtax is imposed, section 14 (a) (2), and (b); and it “shall be the amount of dividends paid during the taxable year”, section 27 (a).

The point of difference between the parties is whether the dividend of 50 percent declared on December 28, 1936, and immediately credited to the accounts of its stockholders was paid during the taxable year within the meaning of section 27 (a). The evidence shows that this dividend was duly declared without restriction, was credited to (lie personal accounts of the stockholders, and thereafter was under their absolute control, but that during the taxable year no portion thereof was actually withdrawn by the stockholders or paid to them in money or property. The Commissioner contends that the statute contemplates actual payment by the corporation to the stockholders and that, since this’ was not done, the credit claimed should be disallowed. On the contrary, the petitioner contends that it became obligated unconditionally to the stockholders for the dividend on December 28, 1936; that on that date the dividends became immediately available to the stockholders and subject to their absolute control; and that such facts are sufficient to constitute payment within the meaning of section 27 (a).

Recently decided cases recognize that dividends may be declared and credited to stockholders in such manner and under such circumstances as to constitute the equivalent of actual payment. The test in such cases is whether the right of the stockholder has so matured as to subject the dividend credited on the corporation’s books to the complete control of the stockholder and remove it from the control of the corporation. Whenever that test is satisfied, the book credit is regarded as the equivalent of cash and constitutes payment of the dividend for the purpose of the dividends paid credit, under section 27 (a). Valley Tractor & Equipment Co., 42 B. T. A. 311; Atlantic Land Co., 43 B. T. A. 74; Valley Lumber Co. of Lodi, 43 B. T. A. 423; John Gerber Co., 44 B. T. A. 26; Interstate Transit Lines, Inc., 44 B. T. A. 994.

We think that the best test established in the cited cases has been met and the petitioner is entitled to the credit in the amount of $11,500. The evidence shows that on December 28,1936, the petitioner’s directors intended to, and the petitioner did in fact, pay a dividend in the amount of $11,500, and that the amounts credited to the stockholders were removed on that day from the control of the petitioner and came within the complete control of the stockholders. The petitioner on that date had both an earned surplus and cash on hand in excess of the dividend declared, the resolution imposed no restriction on the right of withdrawal, each of the stockholders had the authority to draw checks against the petitioner’s funds, and there is no evidence whatever of any collateral understanding that the amounts would not be withdrawn. The payments on that date of the dividends by the corporation were real and the dividends were constructively received by the stockholders on that date.

With reference to the assessment of $40 per share levied upon the stock two days, after the declaration of the dividend and the crediting of the amount thereof to the stockholders, we think the evidence is conclusive that such action was what it purported to be, namely, a bona fide assessment against the stock. The circumstances under which it was brought about and the reasons for making it do not warrant the conclusion that it was a diminution in the amount of the dividends previously declared and credited to the stockholders’ accounts, or that it was a renunciation by the stockholders of their right to any part of such dividends. It was not until December 30 and after the right of the stockholders to the dividend had attached unconditionally that the question of levying the assessment arose. It was then, for the first time, that the petitioner and its stockholders, through the advice given them by the petitioner’s accountant, became aware of the fact that the petitioner’s credit standing had been impaired and that some remedial action was necessary to restore it. The accountant advised that, as such remedial action, some amount be contributed by the stockholders to the corporation as paid-in surplus to create a proper ratio of current assets to liabilities, and the stockholders thereupon consented to an assessment of $40 per share, which was duly made by the corporation. The adoption of this procedure was not intended as a cancellation or restoration to the petitioner in part of the dividend which had been declared and credited. The finality of such declaration and credit was fully recognized by the petitioner and the two stockholders, both of whom were informed by the accountant at the time he gave his above mentioned advice, that the stockholders would be required, despite the assessment, to report in their personal income tax returns the full amount of the dividends declared and credited to them, and they gave due effect to their understanding of the transaction by including the full amount of the dividends in their gross income for the year 1936. By such inclusion in the income of the stockholders, the purpose of sections 14 and 21 (a) was fulfilled. See Atlantic Land Co., supra; Valley Lumber Co. of Lodi, supra; and concurring opinion in Valley Tractor & Equipment Co., supra.

Decision will be entered vmder Rule 50.


text:
    Frances M. Parkford, Petitioner, v. Commissioner of Internal Revenue, Respondent. E. A. Parkford, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 96459, 102987.
    Promulgated October 24, 1941.

      John G. Altman, Esq., and Louis E. Goodman, Esq., for the petitioners.

      Samuel Taylor, Esq., for the respondent.
   OPINION.

Mellott :

Petitioners contend that the fair market value of the Universal shares, if income at all, became income when the right to receive them accrued to Parkford, which, they say, occurred in 1935 rather than 1936. They point out that all of the services had been rendered prior to the stockholders’ meeting on December 23, 1935; argue that the corporation had “bound itself by the resolution, unconditionally, to deliver” the shares to Parkford; contend that his right to receive them then became absolute; and insist that the statement in the resolution to the effect that delivery to him was to be made “out of the 186,778 * * * and the 1,000 shares” was merely descriptive — a designation “of the place from which the shares were to come.” We do not agree. While Parkford’s services had been largely rendered in bringing about the agreement of November 19, 1935, it is clear that he was to receive nothing unless the corporation succeeded in acquiring the stock. Even then he was more or less dependent upon the munificence of the corporation; for his contract was only with Starr. When it became probable that the corporation would secure the possession of the stock the Universal stockholders then authorized 9,000 shares to be turned over to Parkford, 8,000 to the attorney and 12,675 to Starr. The minutes of the corporation show that Starr had “explained that both contracts [with Parkford and the attorney] were entirely contingent and that the parties wrere to receive nothing in the event that they were unsuccessful and were to receive the number of shares specified only in the event that their efforts were successful.” In our judgment the corporation had not “bound itself, unconditionally, to deliver the shares of Parkford” merely by adopting a resolution agreeing to deliver to him 9,000 shares “out of” the 186,778. It knew that it would have no shares to deliver unless and until the court should approve the proposed settlement. The agreement contemplated and required that the receiver “endeavor diligently to secure the approval by” the court “and by such other persons, firms or corporations as the Court should deem necessary.” The approval of the trustee was absolutely necessary; and it would agree only provided a modification of the proposals should be made and only then if the court should direct it to do so. The order of the'court, therefore, was a necessary concomitant to securing the stock out of which petitioner, Starr and the attorneys were to be paid. The order was. not entered until January 15, 1936. Then, and not until then, did petitioners’ right to receive the stock “become fixed and unconditional.” H. Liebes & Co. v. Commissioner (C. C. A., 9th Cir), 90 Fed. (2d) 932; Continental Tie & Lumber Co. v. United States, 286 U. S. 290; North American Oil Consolidated v. Burnet, 286 U. S. 417. See also Frost Lumber Industries, Inc., 44 B. T. A. 1249, and cases therein cited. The fair market value of the stock, in our opinion, then constituted income to petitioners and should have been accrued upon their books. That is apparently the view which they took; for they did not accrue it in 1935. While this is not controlling, United States v. Anderson, 269 U. S. 422; Commissioner v. Union Pacific R. Co., 86 Fed. (2d) 637, it is at least an indication that they felt an “unconditional right to receive it” had not arisen in that year.

Petitioners place considerable reliance upon the testimony of the attorney for the minority stockholders, the gist of which was that a partial hearing was had before the court on December 23,1935, at which time it was indicated approval of the plan would be granted, after which the stockholders repaired to the office of the company and held the series of meetings shown in our findings. Petitioners’ contention seems to be that since the court indicated its willingness to approve the proposed plan — subject only to hearing upon the petition of the trustee-bank for instructions — the corporation was then willing to bind itself, unconditionally, to deliver the 9,000 shares to Parkford and Bering. We are of the opinion, however, that the testimony of this witness does not justify us in reaching such conclusion. The court records do not indicate that the court approved the proposed agreement on that date. They are the best evidence. Moreover, the minutes of the stockholders’ meetings show that the corporation never intended to give the stock to Starr, Parkford, or the attorney unless it was received. Since the order of the court was not entered until January 15, 1936, and since petitioners’ right to receive the stock did not become absolute until then, we are of the opinion, as stated above, that the fair market value of the stock on that date then accrued to them as income.

The facts with reference to the $7,500 are not seriously in dispute. Parkford had been employed to render services which would ultimately entitle him to receive $15,000. Some of them were rendered before and some were rendered after the filing of the petition in bankruptcy. A compromise of the dispute between him and the trustee resulted in $7,500 being paid to each of them. . The parties agree that it is impossible to allocate any particular portion of the fee to* the services rendered before and to the services rendered after the adjudication. They also agree that the approval of the bankruptcy court to the compromise was valid. Respondent included the whole amount in petitioners’ income upon the theory that the right to receive it accrued within the calendar year. Petitioners contend that “the right to receive the full sum of $15,000 never at any time accrued to Parkford, and since the amount of compensation payable to him was by order of court limited to $7,500, it follows that only $7,500 accrued to him and the action of respondent in treating the additional $7,500 as taxable income to Parkford cannot be justified upon any theory.”

Petitioners argue that the right to receive the sum of $15,000 did not accrue to Parkford prior to the bankruptcy. We agree. North American Oil Consolidated v. Burnet, supra. But that is not determinative of the present controversy. The right to receive it did accrue during the year 1936. It resulted from services rendered by him. The services were completed and the money became available (except for the intervention of the trustee) on February 7, 1936. Does the fact that a petition in bankruptcy was then on file, that the receiver was claiming the fee, and that Parkford was shortly thereafter adjudicated a bankrupt prevent the fee from accruing to him? We think not.

Under the Bankruptcy Act (sec. 70 as amended; 11 U. S. C. A., sec. 110) the trustee of the estate of a bankrupt is “vested by operation of law with the title of the bankrupt as of the date of the filing of the petition in bankruptcy * * * ” to all property of the bankrupt (except exempt property), “including rights of action, which prior to the filing of the petition he could by any means have transferred or which might have been levied upon and sold under judicial process against him, or otherwise seized, impounded, or sequestered * * *.” As to all property in the possession or under the control of the bankrupt at the date of bankruptcy or otherwise coming into the possession of the bankruptcy court, the trustee “shall be deemed vested as of the date of bankruptcy with all the rights, remedies and powers of a creditor then holding a lien thereon by legal or equitable proceedings * * *; and as to all other property, the trustee shall be deemed vested as of the date of bankruptcy with all the rights, remedies and powers of a judgment creditor then holding an execution duly returned unsatisfied * *

It has frequently been stated that a trustee in bankruptcy “stands in the shoes of the bankrupt” for most purposes. Cf. Schultz v. England, 106 Fed. (2d) 764. If the bankrupt could not have transferred the property at the time of the filing of the petition, or if it was not subject to seizure under judicial process at that time, then no title vested in the trustee. In re Baxter, 104 Fed. (2d) 318. Perhaps there is some substance to, or reason for, the “doubt” expressed by the respondent* as to whether the trustee was entitled to any part of the $15,000; but that need give us no concern. If the trustee was entitled to the fee under the above section of the bankruptcy act, it was probably because it was “property” of the bankrupt. This would undoubtedly be true if he had done all that he was required to do prior to the bankruptcy in order to be entitled to the compensation. In re Leibowitt, 93 Fed. (2d) 333; certiorari denied, Stein v. Leibowitt, 303 U. S. 652. If, on the other hand, petitioner’s right to receive the fee accrued to him after the bankruptcy and he voluntarily released a portion of it to the trustee, it is obvious that all of it must be included in his gross income.

Much that has been said with reference to the $15,000 fee is apposite to the $48,000 fee represented by the Universal stock. The last event entitling petitioners to receive this fee — approval of the contract by the court — occurred on January 15, 1936, nine days prior to the adjudication in bankruptcy. In re Leibowitt, supra; Lucas v. North Texas Lumber Co., 281 U. S. 11; Edwards Drilling Co., 35 B. T. A. 341, and cases cited; affd., 95 Fed. (2d) 719. A “practical construction” of the taxing act would probably justify the inclusion in gross income of the assigned income, under the rationale of Lucas v. Earl, 281 U. S. 111; Burnet v. Leininger, 285 U. S. 136; Helvering v. Horst, 311 U. S. 112; Helvering v. Eubank, 311 U. S. 122; and Harrison v. Schaffner, 312 U. S. 579, even though it was an involuntary assignment. It is unnecessary to place our decision on this ground, however. The income should have been accrued upon petitioners’ books when all of the events occurred entitling them to receive it. It is idle to contend it is inequitable to tax them upon it because they did not personally receive it. All of it was used to pay their debts, and, if equities were to be weighed, it would be far more inequitable to the fiscus to permit the income to escape taxation altogether. That would be the result if it is not included in petitioners’ gross income.

Upon brief petitioners argue that a recent unpublished memorandum opinion of the Board, in which it was held that a lawyer who in an earlier year had assigned to one of his creditors his right to receive certain fees was not in receipt of income when the fee was paid to the assignee, supports their contention that they can not be taxed upon the income unless it is personally collected by them. The cited case does not hold, as petitioners upon brief state, “that an insolvent taxpayer is not chargeable with income where he does not have the use or enjoyment thereof but instead the income is paid directly to his creditors.” It was pointed out in the cited case that the effect of the loan in tbe earlier year was not before us. Our conclusion in the instant proceeding is not in conflict with the holding in the cited case. In addition it may be pointed out that, even if the holding in the cited case had been as set out in petitioners’ brief, that could not aid them; for they in effect had “the use” of the income when their debts were paid with it. We are of the opinion and hold that both the $48,000 and the $7,500 must be included in petitioners’ gross income for the year 1936.

Petitioners’ final contention is that by reason of the seizure and permanent retention of all of Parkford’s assets by the trustee in bankruptcy they sustained a deductible loss for the year 1936 in a sum far in excess of the entire net income determined by the respondent. They point out that the total cost of the property turned over to the trustee was approximately $609,000 and approved claims $793,000 and say: “* * * * there obviously was no possible surplus remaining to go to the bankrupt and the difference between the total cash cost * * * and the total amount realized in the bankruptcy proceeding, far exceeded the net income for 1936 of Parkford * * * of $113,713.14. Such excess amounted to several hundred thousand dollars. It follows therefore that taxpayer had a loss, as a result of the seizure and retention of his assets * * * in an amount far in excess of the net income claimed to have been received by him, by respondent in his deficiency notice. That this is a proper deductible loss was held in Stuart v. Commissioner, 38 B. T. A. 1147.”

The contention is fallacious. A. casual reading of the cited case might indicate that such a holding was made; but the holding was: “* * * petitioner sustained a loss in 1934 as the result of acting as a director of the Guaranty Building & Loan Association. The loss sustained, in the amount of at least $12,621.06, is a legal deduction from gross income.” The taxpayer had been sued and judgment had been rendered against him for more than $7,000,000. He filed a voluntary petition in bankruptcy and turned over all of his property to the trustee. It was pointed out that the judgment had been rendered against him “by reason of his having been a director and vice president of” the building association; that “This was a business undertaking * * * and the loss was one- sustained in trade or business.” Opinion was expressed “that the bankruptcy proceeding has nothing to do with the deductibility of the loss.”

The Stuart decision, supra, is the only authority cited by petitioners in support of their contention. No statute or court decision under which any such alleged loss could be allowed is called to our attention and we know of none. The allowance of deductions “ ‘depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed.’ New Colonial Ice Co. v. Helvering, 292 U. S. 435, 440.” Deputy v. DuPont, 308 U. S. 488. Moreover it is difficult, if not impossible, to see bow Park-ford could have suffered a “loss” when, through the bankruptcy proceedings, he was discharged from liabilities greatly in excess of the actual cost — and basis — of the property which he turned over. Petitioners have not proved that they sustained any deductible loss.

Some evidence was introduced by petitioners in support of their charge that the respondent erred in denying a loss of $21,000 on 95 shares of the capital stock of the Kern County Realty Co. The contention was ultimately abandoned. We have accordingly refrained from making any findings of fact on this issue.

The deficiencies shall be recomputed, including in petitioners’ income $55,500 instead of $82,500 as salaries and commissions, and

Decision will Toe entered under Rule SO.


author: Leech:

text:
    Edison Brothers Stores, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104424, 104425.
    Promulgated October 24, 1941.

      Peter H. Husch, Esq., for the petitioner.

      Felix Atwood, Esq., for the respondent.
   OPINION.

Leech:

These proceedings, consolidated for hearing, involve deficiencies in income tax for the years 1935 and 1937 in the amounts of $1,553.74 and $10,312.15, respectively. Petitioner is claiming an overpayment in 1935 in the amount of $673.75. The issues are (1) whether petitioner realized taxable income from the sale of its own stock to its employees in 1935 and 1937; (2) whether it is entitled to a deduction in 1935 for the payment of a debt with its own stock based on the cost of such stock to petitioner or on the fair market value thereof at the time of the payment of the indebtedness; and (3) whether the difference between the fair market value of certain of petitioner’s stock and the price at which it was sold to its employees represents an allowable deduction for 1935 as additional compensation to its employees.

We find the facts as stipulated.

Petitioner was incorporated on March 13, 1925, under the laws of Delaware by the five Edison brothers, who subscribed for and acquired the entire issue of its no par value common stock of 100,000 shares. Its principal office is located in St. Louis, Missouri. It filed tax returns for the years 1935 and 1937 with the collector of internal revenue for the first district of Missouri.

In 1929 petitioner reacquired from the Edison brothers 5,000 shares of its stock at $15 per share for the purpose of sale and distribution to its employees. The 5,000 shares were held by petitioner in its treasury and were designated in its annual statements as “Capital stock purchased for resale to employees.”

Thereafter, in 1929, a total of 1,360 shares of the stock so acquired and held by petitioner, was allotted to certain of its key employees at a cost of $15 per share. Those employees were permitted to make installment payments, with the provision that interest on unpaid balance was to be charged to their respective subscription accounts and dividends were to be credited thereto at the rate declared and paid on common stock. Certificates of stock were not transferred until the respective accounts were paid in full. Due to the termination of employment and other reasons, certain accounts of the employees were canceled upon their request. These cancellations were made upon a cost basis and involved a total of 635 shares of the 1,360 shares allotted.

The employees’ subscription price of $15 per share was adjusted to $7.50 per share as of January 31, 1932. This adjustment was made on all shares originally subscribed for, except subscriptions theretofore canceled. Those employees who had overpaid accounts as a result of this adjustment were given the election of receiving cash or additional shares of stock at $7.50 per share. Consequently, 195 additional shares of the aforementioned stock of petitioner were issued to these employees.

In 1933 petitioner purchased an additional 100 shares of stock, which was the only acquisition made by it of its common stock other than the original acquisition of 5,000 shares. The only other stock transactions made by it prior to 1935 involved a sale of 500 shares to a director of the company at $15 per share and the issuance of 760 shares in the form of bonuses to employees.

On January 1,1935, petitioner still had on hand 2,920 shares of this common stock,' and in July of that year transferred 100 shares of it to George Frankenthaler, a New York attorney, in payment of his bill of $3,000 for legal services rendered. Frankenthaler acted as general counsel for petitioner from its incorporation and also has been a director thereof since May 9, 1934. He was reelected and served as a director each year since that time. At the time of this transfer, this stock had a fair market value of $30 per share, or an aggregate market value of $3,000. Petitioner claimed a deduction of this amount in its tax return for 1935, but respondent allowed a deduction of only $1,500, the cost to petitioner of the 100 shares purchased by it and transferred to this attorney in discharge of this $3,000 indebtedness.

During July and August of 1935, a total of 980 shares of its common stock was allotted and sold by petitioner to certain of its key employees at a price of $25 per share. The fair market value of this stock during these months was $30 per share. The respondent determined that petitioner realized a gain for 1935 of $9,800, the difference between the price at which petitioner purchased this stock and the price at which it was sold to its employees. This stock was sold pursuant to an “Employees’ Stock Subscription Plan”, the provisions of which are as follows:

Purchase Price
The purchase price in effect until August 1, 1935, shall be Twenty-Five ($25.00) per share; thereafter the purchase price of any subscription shall be determined from the open market quotation, being the last quoted sale on the New York Curb prior to the date of subscription less an allowance of $6.00 per share, which allowance shall be considered a contribution by the Company to all employees taking advantage of the allotment.
Method op Payment
Payment shall be made in cash or by monthly installments paid by the employee either by remittance or by deduction from salary, if so designated, provided that any installments in arrears 15 days shall be, at the option of the Company, deducted from salary.
Minimum monthly installments shall amount to at least Fifty Cents (50‡) per share subscribed.
Monthly installments shall be payable the 15th day of each month following date of subscription.
Subscriptions paid by minimum installments shall not be permitted to have reduced or lapsed installments except by approval of the Board of Directors,
Interest Charges and Dividend Credits
Interest on unpaid balances shall be charged semi-annually on June 30th and December 31st of each year at the rate of 5% per annum, but not exceeding the annual rate of dividends on all outstanding Common stock; such rate of dividends to be determined by the purchase price.
Dividends earned on the stock subscribed shall be credited to the account of the subscriber on the respective dates declared payable. However, no dividend shall be credited if on such dividend dates monthly installments are to arrears for fifteen (15) days or more.
CAjsrcasiXATiON Peovision
It shall be understood by the subscriber that the subscription shall not be cancellable at any time while the subscriber is employed by the Company, except and unless approved under such conditions as are determined and prescribed by the Board of Directors.
In the event that the employment of the subscriber is terminated for any reason whatsoever except death, the employee shall receive such number of shares as are fully paid for at such time, and shall be reimbursed in cash for any amount representing credits to the account in excess of the even number of shares fully paid for. Subscription for the remaining number of shares unpaid for shall automatically become null and void.
In case of the death of the employee, any beneficiary named shall receive at the option of such beneficiary, refund of all cash payments made by the employee, plus interest at the rate of 5% per annum, or the number of shares fully paid for at the time of employee’s death.

Thereafter, in 1935, 75 shares of petitioner’s common stock were transferred and issued by it in conversion of 25 shares of its preferred stock, and in 1936 another 15 shares were so transferred and issued in conversion of 5 shares of its preferred stock, in accordance with the conversion privilege of such preferred stock. On January 1, 1937, petitioner still had in its treasury 1,750 shares of its common stock.

On or about March 1, 1937, pursuant to a reorganization of its capital structure, petitioner exchanged its common stock on a basis of three shares of new $2 par value common stock for one share of old no par value common stock, making the petitioner’s cost basis on such new stock $5 a share; and thereafter, during that year, it allotted and sold to certain of its employees 3,660 shares of this new common stock at a price of $15 per share. This allotment and sale were made pursuant to another employees’ stock subscription plan. The respondent determined that petitioner realized a gain for 1937 of $36,600, the difference between the price at which petitioner purchased this stock and the price at which it was sold to its employees.

In September 1937 petitioner paid an additional income tax for the calendar year 1935 in the amount of $5,204.54; and its petition in which it is claiming an overpayment for 1935 in the amount of $673.75 was filed with this Board on August 28, 1940.

Respondent has included as additional taxable income for the years 1935 and 1937 the amounts by which the price at which petitioner resold shares of its stock to its employees in those respective years exceeded its cost of such stock. That action bases the first issue. Respondent contends that these respective amounts were taxable to petitioners under the definition of “gross income” under section 22 (a) of the Revenue Acts of 1934 and 1936, as respectively construed by the similar articles, 22 (a)-16 of Regulations 86 and 94.

The earlier cited regulation was not a valid construction of section 22 (a) of the Revenue Act of 1934 and the petitioner realized no taxable gain from its stock transactions occurring in 1935. R. C. Reynolds, Inc., 44 B. T. A. 356; National Home Owners Service Corporation, 39 B. T. A. 753. But the last cited regulation is a valid and effective interpretation of section 22 (a) of the Revenue Act of 1936 in its application to the stock transactions occurring in 1937. Brown Shoe Co., 45 B. T. A. 212; Trinity Corporation, 44 B. T. A. 1219. The petitioner argues further, however, that, assuming our last conclusion to be sound, that regulation is not applicable here since, as to the transactions in its own stock in 1937, it was not dealing “in its own shares as it might in the shares of another corporation.” These transactions did not affect the capital structure of the petitioner. The stock was purchased for the purpose of resale and was actually sold. The fact that the sales were limited to petitioner’s employees is not controlling. We think petitioner is taxable on the gains realized from such transactions in 1937. Brown Shoe Co., supra; Trinity Corporation, supra.

The second issue is whether petitioner is entitled to a deduction for the payment of a debt for legal services with its own treasury stock based on the cost of such stock to petitioner or the fair market value thereof at the time of the payment of the indebtedness in 1935. Petitioner purchased this stock with the other stock here involved at $15 per share and used 100 shares of it to pay this indebtedness, adopting as a basis for such payment its stipulated fair market value, $30 per share. Accordingly, petitioner deducted $3,000 on its 1935 return covering this expense, of which amount the respondent allowed only $1,500 on the ground that the difference between the cost of $1,500 of the stock and its value of $3,000 at the túne of payment of the indebtedness constituted a gain which had not been included in taxable income.

Petitioner satisfied a fixed indebtedness of $3,000 by transfer of its capital stock having a fair market value in that amount. That transfer is effective here as a sale of such stock for that sum. This is admitted by respondent, since the premise of his contested action is that a gain of $1,500 was realized by petitioner upon this transfer. This being so, petitioner’s taxable income may be increased by this amount only if such gain were taxable. But it was not taxable, as we have already decided. Respondent may not thus indirectly tax this income by reducing in that amount the deduction to which petitioner is entitled.

The third issue is whether the difference between the fair market value of petitioner’s stock and the price for which it was sold to its employees in 1935 constitutes an allowable deduction as additional compensation to its employees under section 23 (a) of the Revenue Act of 1934. It is stipulated that petitioner sold this stock to its employees for $25 per share and that it then had a fair market value of $30 per share. Petitioner contends that this difference of $5 per share, or $4,900, for the 980 shares sold to its employees in 1935 was additional compensation to them for services rendered.

Respondent argues on brief, for the first time, that petitioner has not established a fact essential to this deduction — that its amount, the difference between the fair market value of and the price at which the stock was sold to its employees, was a “reasonable allowance for salaries or other compensation.” Wagegro Corporation, 38 B. T. A. 1225; Brown & Haley, 21 B. T. A. 752. However, that may be, petitioner is otherwise foreclosed. The answer to this issue, at all events, depends upon whether the agreement between petitioner and its purchasing employees, as to the amount of money to be paid by such employees in the acquisition of stock in the employer, was “fixed or controlled by services rendered or to be rendered” and whether the employees were to receive payment of their compensation in such stock. Chrysler Corporation, 42 B. T. A. 795; Gordon M. Evans, 38 B. T. A. 1406; Delbert B. Geeseman, 38 B. T. A. 258. In view of the contested determination, petitioner has the burden of establishing the existence of that premise of fact. We think it has failed so to do. That a provision of the contract between the petitioner and its employees provided that the amount by which the market value of the stock exceeded the purchase price should “be considered a contribution by the Company to all employees taking advantage of the allotment” is not sufficient evidence here to establish the intention of the parties to consider such differential as “fixed or controlled by services rendered or to be rendered” or that this purchased stock was to constitute compensation of the employees. Delbert B. Geeseman, supra. Respondent is affirmed on this issue.

Decision wild be entered wnder Rule SO.


author: Hill:

text:
    Pauline Ickelheimer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103425.
    Promulgated October 24, 1941.

      Arthur J. Hogan, Esq., for the petitioner.

      Henry O. Clark, Esq., for the respondent.

       SEC. 301. DISALLOWED DEDUCTIONS.
      (a) Section 24 (a) of the Revenue Act of 1936 is amended to read as follows:
      * * . * * * * *
      “(b) Losses from Sales or Exchanges of Property.—
      “(1) Losses disallowed. — In computing net income no deeduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly—
      * * * * » * *
      and of such trust.”

   OPINION.

Hill:

The only question for our determination is whether or not petitioner sustained a deductible loss on the sale of certain bonds. Petitioner contends that the bonds were sold through her broker on the open market and that no sale or exchange of those bonds, direct or indirect, was made to the trust of which she was beneficiary and her husband trustee. Respondent argues that petitioner is not entitled to the loss deduction because the sale was an indirect sale to the trustee of the trust of which she was beneficiary, losses on such transactions being nondeductible under section 24 (a) (6) of the Revenue Act of 1936 as amended by section 301 (a) of the Revenue Act of 1937.

There is no question that the loss was sustained. The issue is whether the deductibility of the loss is prohibited by section 24 (a) (6) of the Revenue Act of 1936 as amended. If the sale of the bonds was a sale, direct or indirect, to the fiduciary of the trust of which petitioner is beneficiary, the loss is not deductible. It is patent that the sale of bonds by petitioner was not a direct sale of the bonds to her husband as trustee of the trust. The bonds were sold through a broker to undisclosed purchasers. Petitioner’s husband as trustee purchased similar bonds from undisclosed vendors.

Respondent urges, however, that the sales of the bonds by petitioner closely followed by purchases of similar securities by her husband as trustee of the trust were indirect sales from petitioner to the trustee. The authorities cited by petitioner and respondent are of little assistance to our determination of the.cause; to our knowledge the problem of what constitutes an indirect sale under section 24 (a) (6) of the Revenue Act of 1936 as amended has not been determined by the Board or the courts.

While the parties have stipulated that the transactions were handled with due regard to the effects of section 118 of the Revenue Act of 1936 (relating to “wash sales” of securities) and for the purpose of obtaining a loss deduction, we are of the opinion that the facts herein do not disclose an indirect sale from petitioner to her husband as fiduciary of the trust. It is apparent that the sales of the bonds were made to purchasers other than the trustee of the trust. The fact that petitioner’s husband as trustee purchased the'bonds from the open market shortly thereafter does not convert the sales by petitioner and the purchases by her husband as trustee into indirect sales between petitioner and her husband as trustee. Nor does the fact that the transactions were carried out with a view to obtaining a loss deduction and to avoid the effects of section 118 so color these transactions that sales to others may be termed indirect sales from petitioner to her husband as trustee.

Eespondent contends that, since petitioner’s husband acted for petitioner under power of attorney and for the trust as its trustee, one directing mind controlled the sales and purchases of the bonds so that the sales must be considered to have been indirectly made between petitioner and her husband as trustee. He asserts that the presence of a preconceived plan to permit a loss deduction for petitioner and yet obtain the bonds for the trust, plus the fact that the sales and purchases were directed by petitioner’s husband, indicates that the bonds were sold, indirectly, by petitioner to her husband as trustee for the trust. We can not agree. We find no authority in the law or the decided cases for the position taken by respondent. Nor do statements in Congressional Committee reports shed any light on the question.

Reviewed by the Board.

Decision will Toe entered under Rule BO.

SteeNiiageN, Mellott, Arnold, TysoN, and OpfeR dissent.