author:
MoRRis:
      Black, Smith, McMahoN,

text:
    Coast Counties Gas & Electric Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 69843.
    Promulgated February 26, 1936.

      Granville 8. Borden, Esq., for the petitioner.

      George D. Brabson, Esq., for the respondent.

       The agreement with this dissent was noted during Mr. Trammell’s term of office.

   OPINION.

MoRRis:

In connection with the claimed deduction of $68,052.50 for bond premium, the case before us is this: In connection with the purchase of the assets of its four subsidiaries, several years prior to the taxable year, petitioner agreed to pay sellers’ outstanding bonds. In 1930, petitioner caused to be called all of the said bonds then outstanding and paid in redemption thereof $68,052.50 more than their face.

The case, as thus presented, is the direct converse of Helvering v. American Chicle Co., 291 U. S. 426. The facts in that case were summarized by the Court, as follows: “In connection with the purchase of the assets of another company, in 1914, respondent assumed— agreed to pay — more than $2,000,000 of the seller’s outstanding bonds. During 1922, 1924 and 1925 it purchased a considerable number of these bonds in the market at less than their face. The Commissioner assessed the difference between these two amounts as income.” Upon those facts, the Court held, as follows:

We know nothing concerning the nature of the assets acquired from the Sen Sen Company, have no means of ascertaining what has become of them, or whether any of them still exist. Nothing indicates whether respondent lost or gained by the transaction.
* * * * * * *
We find nothing to distinguish this cause in principle from United States v. Kirby Lumber Co., 284 U. S. 1, 52 S. Ct. 4, 76 L. Ed. 131. The doctrine there announced is controlling here. Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, 46 S. Ct. 449, 70 L. Ed. 886, is not applicable. The final outcome of the dealings was revealed — the taxpayer suffered a loss. Here, for aught we know, there was substantial profit — certainly, the record does not show the contrary. Doubtless, respondent’s books indicated a decrease of liabilities with corresponding increase of net assets.

Earlier, this Board had held in American Chicle Co., 23 B. T. A. 221, that the transactions in which the American Chicle Co. purchased the seller’s bonds were capital transactions — payments on the purchase price of assets — that in nowise impinged upon net income; and that view was upheld by the Circuit Court of Appeals, Second Circuit, in Commissioner v. American Chicle Co., 65 Fed. (2d) 454, but, as indicated above, was reversed by the Supreme Court.

It is clear from the above opinion that a gain does not necessarily result upon the discharge of an obligation for less than its face. That is clearly to be drawn from the Court’s statement that “Nothing indicates whether respondent lost or gained by the transaction”, when read in the light of the Court’s further statement that respondent “purchased a considerable number of these bonds in the market at less than face.” So, too, we read the earlier opinions of the same Court in Bowers v. Kerbaugh-Empire Co., 271 U. S. 170; and United States v. Kirby Lumber Co., 284 U. S. 1.

In Bowers v. Kerbaugh-Empire Co., supra, the taxpayer borrowed several amounts on its own promissory notes, repayable in German marks or their equivalent in gold coin of the United States. The several amounts borrowed were contemporaneously advanced to a subsidiary and were expended and lost in the performance of construction contracts. The losses, exceeding the subsidiary’s income by more than $684,456.18, were allowed as deductions in the subsidiary’s returns for 1913, 1914, 1916, 1917, and 1918. In 1921, on the demand of the Alien Property Custodian, the taxpayer made full settlement of principal and interest owing on its notes. Measured by United States gold coin the difference between the value of the marks borrowed at the time the loans were made and the amount paid to the Custodian was $684,456.18, and the Commissioner held that amount to be income. The Court held that looking at the entire transaction there was no gain, but a loss, stating as follows:

The transaction here in question did not result in gain from capital and labor, or from! either of them, or in profit gained through the sale or conversion of capital. The essential facts set forth in the complaint are the loans in 1911, 1912 and 1913, the loss in 1913 to 1918 of the moneys borrowed, the excess of such losses over income by more than the item here in. controversy, and payment in the equivalent of marks greatly depreciated in value. The result of the whole transaction was a loss.
* * * * * * *
The contention that the item in question is cash gain disregards the fact that the borrowed money was lost, and that the excess of such loss over income was more than the amount borrowed. When the loans were made and notes given, the assets and liabilities of defendant in error were increased alike. The loss of the money borrowed wiped out the increase of assets, but the liability remained. The assets were further diminished by payment of the debt. The loss was less than it would have been if marks had not declined in value; but the mere diminution of loss is not gain, profit or income.

If the intervening events be disregarded and the transaction treated as isolated therefrom, there was a clear gain to the taxpayer, due to the fact that at the time of payment the marks had fallen in value. But the Court concluded that the result could only be determined from an examination of the whole transaction — -the loans, the loss of proceeds of the loans, and payment in the equivalent of depreciated marks — and, upon such an examination, it was determined that the result was a clear loss.

In United States v. Kirby Lumber Co., supra, the taxpayer issued its own bonds for cash, at par, and in the same year purchased some of the bonds at $137,521.30 less than par. The Court held that amount to be income, stating as follows:

In Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, 46 S. Ct. 449, 70 L. Ed. 886, the defendant in error owned the stock of another company that had borrowed money repayable in marks or their equivalent for an enterprise that failed. At the time of payment the marks had fallen in value, which so far as it went was a gain for the defendant in error, and it was contended .by the plaintiff in error that the gain was taxable income. But the transaction as a whole was a loss, and the contention was denied. Here there \was no shrinkage of assets and the taxpayer made a clear gain. As a result < of its dealings it made available $137,521.30 assets previously offset by the ^obligation of bonds now extinct.

As we read these three opinions of the Supreme Court, the tax 'consequences of transactions like those under consideration are to Ibe determined with reference to the nature of the assets acquired, their value when acquired, their disposition, and amounts paid for the purchase or in redemption of the bonds; and if these factors, as a whole, reveal that the taxpayer actually has been enriched or suffered a loss by the transactions, the results must be recognized for tax purposes.

In the instant case, we know little or nothing about the circumstances under which petitioner acquired the assets of its four subsidiaries many years before the taxable year, nothing concerning the nature and value of those assets, and have no knowledge as to what has become of them, or whether any of them still exist. All we know is that the petitioner, in connection with the purchase of the subsidiaries’ assets, agreed to pay their bonds and actually paid $68,052.50 more than their par value in the redemption thereof. But if the fact of payment of the bonds at less than par was insufficient for the Court to conclude that there was a gain, in Helvering v. American Chicle Co., supra, so here, the fact of petitioner’s payment of the subsidiaries’ bonds at more than par is insufficient to support a deduction for the amount paid above par. We know, as a matter of general knowledge, that corporate bonds are frequently sold by the issuing companies at prices above par; and it is neither a harsh nor arbitrary suggestion here that the consideration received by petitioner for agreeing to pay the subsidiaries’ bonds may have been worth more than the face of the bonds and as much as petitioner paid in redemption of the bonds. Certainly, the record does not show the contrary. In that event, the petitioner’s loss would be less than the amount claimed and might be nil.

The petitioner argues, however, that the bonds were paid by the subsidiaries out of funds furnished by the petitioner, and, therefore, that deductions for the amounts paid above the face of the bonds are available to the subsidiaries in computing the consolidated net income. Of course, after all, what the petitioner here is seeking is the deduction of the amounts in the computation of consolidated net income; and it makes little or no difference whether the deductions be attributed to the petitioner or its subsidiaries. In either event, the effect upon consolidated net income would be the same. But in order that the deductions may be made in the consolidated return, they must be available, as a matter of statutory right, to one or the other. We do not agree that the subsidiaries may deduct the amounts paid in excess of the face of the bonds. The petitioner agreed to pay and actually paid the bonds; and the loss, if any, resulting therefrom was sustained by petitioner and not the subsidiaries. Cf. Helvering v. American Chicle Co., supra. The subsidiaries were merely conduits through which petitioner’s payments passed to the bondholders. But even if the petitioner’s contention in this respect could be conceded as correct in principle, the loss is not determinable, for the record does not show the considerations received by the subsidiaries for the bonds when issued.

It might be further argued that the subsidiaries actually sustained the losses resulting from the payment of the bonds at more than their face, since they conveyed their assets in consideration for petitioner’s promise to pay the bonds. But, in that event, their losses would be measured by the excess of the cost of the assets to them over the considerations they received for the bonds, and such excess is not shown by the record.

As to the claimed deduction of $18,419.60 for unamortized discount and expenses incurred by the Contra Costa Gas Co. in connection with the issuance of its bonds in 1914, the issue must be resolved against the petitioner. The reason for recognizing discount was stated in Pierce Oil Corporation, 32 B. T. A. 403, as follows:

The reason for recognizing discount is the anticipation of payment at maturity of the full amount of the obligation, which amount is greater than the amount originally received. Old Mission Portland Cement Co. v. Helvering, 293 U. S. 289. During the period of the obligation the supposition .is indulged that it will be paid in full, and this supposition is what supports the amortization of the discount. Helvering v. Union Pacific R. R. Co., 293 U. S. 282.

The same reasoning applies to the recognition of expenses incurred in connection with the issuance of bonds. From 1914 to 1923, Contra Costa Gas Co. was entitled to amortize the discount and expenses incurred in connection with the issuance of its bonds, and to deduct a pro rata part thereof in each of its tax returns, upon the hypothesis that it would pay the bonds at maturity. When in 1923, however, the petitioner, as part consideration for the assets of Contra Costa Gas Co., agreed to pay the latter’s bonds, the hypothesis which theretofore supported the deductions available to Contra Costa Gas Co. failed and its right to the amortization and deductions ceased. Nor is this petitioner entitled to any deductions with respect to the unamortized discount and expenses. Turner-Farber-Love Co. v. Helvering, 68 Fed. (2d) 416; American Gas & Electric Co., 33 B. T. A. 471. There was no merger or consolidation of the two companies, but an outright sale of the assets of the one to the other. The Contra Costa Gas Co. continued its existence after the sale of its assets, and that was its status in the taxable year under consideration. Upon those facts, this case is distinguishable from Western Maryland Railway Co. v. Commissioner, 33 Fed. (2d) 695.

As to the claimed deduction of $3,018.46 for expenses incurred by petitioner in the redemption and retirement of the subsidiaries’ bonds, which it agreed to pay, the petitioner is right. These were ordinary and necessary expenses of carrying on petitioner’s business, and their deduction is proper in computing petitioner’s net income.

Beviewed by the Board.

Judgment will be entered under Rule 6G.

Black,

dissenting: I dissent on the first point wherein the opinion holds that the taxpayer may not deduct as a business expense, the amount of bond premiums paid in redemption of bonds issued by petitioner’s subsidiaries, which bonds petitioner had assumed and agreed to pay in the purchase of the assets of the subsidiaries. I think that a correct interpretation of article 68, Regulations 74, sustains petitioner’s contention with respect to the items of bond premiums and that the deductions claimed with respect thereto should be allowed.

Arundell and Leech agree with this dissent.

Smith,

dissenting: It is obvious that all that a borrower pays to a lender of money in excess of the loan constitutes the cost of the loan to the borrower. Such excess is a legal deduction from the gross income of the borrower whether in the form of interest, as amortization of discount, or as a premium paid on the retirement of the loan. This fact is recognized by the Commissioner’s regulations (article 68 of Regulations 74) and by many decisions of this Board and of the courts. East Ninth Euclid Co., 26 B. T. A. 32; 27 B. T. A. 1289; Indiana Lamp Corporation, 28 B. T. A. 491; National Tile Co., 30 B. T. A. 32; Commissioner v. Coastwise Transportation Corporation, 62 Fed. (2d) 332; San Joaquin Light & Power Corporation v. McLaughlin, 65 Fed. (2d) 677; Helvering v. California Oregon Power Co., 75 Fed. (2d) 644; Commissioner v. Great Western Power Co. of California, 79 Fed. (2d) 94; Helvering v. Union Pacific Railway Co., 293 U. S. 282. In Commissioner v. Great Western Power Co. of California, supra, the Government at the hearing of the appeal conceded that a corporate obligor calling and retiring its bonds for cash was entitled to deduct unamortized discount and the premium paid in connection with the retirement.

• The stipulated facts in this case are that the obligors on bonds, the petitioner’s subsidiaries which joined with the petitioner in the filing of the consolidated return for 1930, “called and retired” the bonds involved in this proceeding and paid the cash which is claimed as a deduction from gross income on the consolidated return. The amounts are deductible within the plain terms of the Commissioner’s regulations. If separate returns had been filed by the several corporate obligors, the amounts of the deductions here in question would unquestionably have been allowed by the respondent- in the audit of the returns. Such corporate obligors have not lost their right by joining with the parent company in filing a consolidated return. Each corporation in the affiliated group is severally liable for the total tax owed by the group. See art. 15 of Reg. 75.

It should be noted that in the determination of the deficiency herein the respondent did not, contrary to his regulations, rule that the petitioner was not entitled to deduct the amounts here in question. In the consolidated return filed a deduction for amortization of bond discount, expense, and premiums was claimed in the amount of $6,445.46. The amortization was spread over the life of the new bond issue and such part thereof as was allocable to 1930 was claimed as a deduction in the return. In the audit of the return the respondent determined that the correct amount of the amortization allocable to 1930 was $6,241.04. He therefore disallowed the deduction of only $204.42 of the amortization deduction claimed on the return. Only a small part of the deficiency in tax is attributable to such disallowance. Against the deficiency the petitioner claims the deduction of the items here in question. As a defense thereto, the respondent contends that the parent company of the affiliated group “called and retired” the bonds in question and that all that it paid to the bondholders, including the premium paid on the retirement of the bonds, constitutes a part of the cost to the parent company of assets taken over from the subsidiaries at some prior date, in consideration of which the parent company “assumed and agreed to pay the bonds.” This contention may not validly be made under the stipulated facts; for they are to the effect that the original obligors of the bonds called and retired them and paid the moneys in controversy here. It is immaterial from what sources the obligors paying the moneys in question acquired them. National Tile Co., supra. But even if it might be assumed, contrary to the stipulated facts, that the parent company called and retired the bonds of its subsidiaries, there is no warrant for the assumption that the premium paid on such retirement represents a part of the cost to the parent company of the assets acquired from the subsidiaries. In assuming the bonds of the subsidiaries the parent company assumed no obligation to call the bonds before maturity and pay a premium upon such retirement. Its obligation was merely to pay interest upon the bonds and to pay them off at face value at maturity. If the condition of the money market and its credit was such as to make it advantageous for the parent to call the bonds and pay a premium in order to get rid of paying a high rate of interest on borrowed money for a term of years and it called the bonds and paid the premium, there appears to me to be no warrant for considering the payment of the premium as a capital expenditure representing additional cost of assets acquired. With equal logic it might be argued that every payment of interest on the assumed bonds was a capital expenditure and represented an additional cost of assets acquired. No such argument can validly be predicated on Helvering v. American Chicle Co., 291 U. S. 426.

Trammell agrees with this dissent.

McMahoN,

dissenting in part and concurring in part: In American Chicle Co., 23 B. T. A. 221, we originally held that no income was derived on the retirement of either taxpayer’s own bonds or assumed bonds of another corporation. However, we thereafter entered an order modifying our opinion to hold, under United States v. Kirby Lumber Co., 284 U. S. 1, decided subsequent to our original decision, that petitioner derived income on retirement of its own bonds for less than face, but we adhered to our holding as to the bonds of the predecessor, made upon the authority of New York, Chicago & St. Louis Railroad Co., 23 B. T. A. 177, on the ground that the payments of such bonds at their retirement were payments on the purchase price of assets acquired by taxpayer from the other corporation. In Commissioner v. American Chicle Co., 65 Fed. (2d) 454, the Court of Appeals for the Second Circuit affirmed our holding, and in part stated:

The question depends for its answer upon the scope of the decision of the Supreme Court in United States v. Kirby Lumber Company, 284 U. S. 1. * * *

The Supreme Court in Helvering v. American Chicle Co., 291 U. S. 426, reversed the decision of the Second Circuit and stated in part:

Assessments by petitioner which treated as realized income the difference between the face value of certain bonds assumed by respondent in 1914 and the amount at which it purchased them in 1922,1924 and 1925, were disapproved by the Board of Tax Appeals. The court below affirmed this action, and the matter is hereby certiorari. The meager stipulated facts presented only a narrow point; and to that our decision must be limited.
$ * # ‡ ‡ * *
The case before us is this:
In connection with the purchase of the assets of another company, in 1914, respondent assumed — promised to pay — more than $2,000,000 of the seller’s outstanding bonds. During 1922, 1924 and 1925 it purchased a considerable number of these bonds in the market at less than their face. The Commissioner assessed the difference between these two amounts as income.
We find nothing to distinguish this cause in principle from United States v. Kirby Lumber Co., 284 U. S. 1, 52 S. Ct. 4, 76 L. Ed. 131. The doctrine there announced is controlling here.

Anything else said by the Supreme Court in deciding that case was primarily for the purpose of showing the distinction between that case and Bowers v. Kerbaugh-Empire Co., 271 U. S. 170; and, under the doctrine of the Kirby case as expressly interpreted and adhered to by the Supreme Court in the American Chicle case, the result reached in the latter case followed irrespective of any reference to the Bowers case. Hence, under the doctrine of the American Chicle case, there is no escape from the principle that, for Federal income tax purposes, one who assumes the payment of obligations of another, figuratively speaking, steps into the shoes of such other, gets into the same position, as to such obligations and thereafter, with respect thereto, is in the same position as such other would have been in if there had been no such assumption, and he is also thereafter in the same position as the one assuming such obligations would be in if he issued similar obligations of his own instead of thfis assuming another’s obligation; and in the instant proceeding it is immaterial whether petitioner or its subsidiaries called and retired the bonds. When the assuming corporation meets expense of this character it is expense to it just as much as it is expense to the obligor if the obligor meets it. Under either view the unamortized discount and premiums in question here are deductible. In American Chicle Co., 23 B. T. A. 221, we held that the taxpayer had the right to deduct in the year of retirement of bonds issued by it the unamortized discount. This holding was not challenged or disturbed upon review of the case by the United States Circuit Court of Appeals or the Supreme Court. Following American Chicle Co., 23 B. T. A. 221, the Board, in National Tile Co., 30 B. T. A. 32, held that the taxpayer was entitled to deduct unamortized discount, expense of issuance, and premium paid in connection with the retirement of bonds issued by it. Neither of these cases has been overruled or reversed and they are binding upon us as precedents. If there is anything in any of the precedents which calls for a different result here it is in principle contrary to the final decisions in the American Chicle case, to sound reasoning, and to good practice; and they should not be followed.

In principle, cases involving mergers and consolidations, wherein the continuing or resulting corporation, by operation of law, is required to assume and subsequently discharge bonds of the merged or consolidated corporation, and wherein it has been held that the former may deduct unamortized discount on bonds issued by the latter, support the foregoing conclusion herein set forth as to un-amortized discount, Western Maryland Railway Co. v. Commissioner, 33 Fed. (2d) 695; New York Central Railroad Co. v. Commissioner, 79 Fed. (2d) 247; and Illinois Power & Light Corporation, 33 B. T. A. 1189; and there is no sound reason in principle for differentiating, in this respect, between unamortized discount and premiums. Illinois Power & Light Corporation, supra. The reasons for permitting deductions of such unamortized discount are even stronger when applied to such premiums. Too, the reasons for allowing both such types of deductions to such continuing or resulting corporations are even stronger when applied to an assuming corporation, such as we have here, since there is on its part a binding contract to discharge based on a consideration, and hence a resulting closer relationship between it and the original obligors, in addition to the operation of law, which is the only basis of close relationship or proximity in the foregoing cases involving continuing or resulting corporations.

American Gas & Electric Co., 33 B. T. A. 471, testing its doctrine by the result there reached, is distinguishable from the instant proceeding. There the situation presented is as if corporation B assumed the liabilities, including outstanding bonds, of corporation A, corporation C in turn assumed such liabilities from corporation B, and corporations C and D then combined to form the taxpayer, corporation E; and it was held that the taxpayer, the last corporation in the chain, was not entitled to amortize over the remaining life of the bonds the unamortized discount and the expenses incidental to the original issuance of the bonds. There it could not be said that the taxpayer stepped into the shoes of the corporation which issued the bonds, or that there was a direct connection or close relationship between it and such corporation, or that there was any proximity between them; the contrary being true in the instant proceeding as between petitioner and its subsidiaries, the only corporation with which we are here concerned.

New Colonial Ice Co. v. Helvering, 292 U. S. 435, is not in point since it involves a net loss deduction under the provisions of statutes which are expressly limited in their application to net losses of “the taxpayer.”

I concur in the allowance by the majority of all deductions allowed by them herein and agree with the dissenting opinions of Members Black and Smith; and, by a parity of the reasoning which led to the allowance of such deductions by the majority and of the reasoning which leads to the conclusions reached in those dissenting opinions and to the conclusions reached in this dissenting opinion upon the subjects of premiums and unamortized discount, upon the showing here made, deductions of all other expenses in question here should be allowed as well as unamortized discount, premiums, and those allowed by the majority. See also Helvering v. Taylor, 293 U. S. 507.

The majority approaches and disposes of the premiums disallowed by them from the standpoint of losses; we are not here concerned with losses; we are concerned only with the deductibility of expenses as to all items.


source: Caselaw Access Project

author: Aeundell:

license: Public Domain

text:
    Schumacher Wall Board Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61602, 69719.
    Promulgated February 26, 1936.

      Herman Phleger, Esq., and T. R. Meyer, Esq., for tbe petitioner.

      H. B. Thomas, Esq., for the respondent.
   OPINION.

Aeundell:

These proceedings involve deficiencies in income tax for the fiscal years ended April 30, 1929 and 1930, in the respective amounts of $1,879.68 and $14,988.45. The issues concern the basis for gain or loss and depreciation of assets, and depreciation rates on machinery, buildings, and patents. Petitioner contends for a basis of cost to it, whereas the respondent urges that the proper basis is that of the petitioner’s transferor.

The predecessor of the .petitioner was incorporated in 1924 under the laws of Delaware and was engaged in the manufacture of wall board, with its principal office in Los Angeles, California. At the beginning of 1926 its outstanding stock consisted of 10,000 shares common and 790 shares preferred stock. The common stock was all owned by a group of seven persons known as the Schumacher individuals. Three of the Schumacher individuals also owned a group of patents relating to the manufacture of wall board.

On June 24, 1926, Hunter, Dulin & Co., a bond and underwriting house, entered into a contract with the attorney for the Schumacher individuals wherein it was agreed that the Schumacher individuals would transfer all of their common stock and the patents to Hunter, Dulin & Co. or to a corporation then in existence or one thereafter to be formed. The consideration for these properties was the sum of $1,546,300, of which $50,000 was to be paid within 30 days. Of the balance of the purchase price, $86,900 was to be withheld by Hunter, Dulin & Co. and used to retire the outstanding preferred stock, and $100,000 was to be withheld and placed in trust to pay the expenses of any litigation that might arise concerning the patents.

On. July 6, 1926, Hunter, Dulin & Go. caused the petitioner to be incorporated under the laws of Delaware with the same name as its predecessor company. The authorized capital stock of petitioner consisted of 30,000 shares of preferred and 60,000 shares of common stock, all without par value. The petitioner was organized for the purposes, among others, of acquiring the assets, business, and good will of the old Schumacher Corporation and the right to use the group of patents then owned by the Schumacher individuals.

On August 16, 1926, Hunter, Dulin & Co. notified the Citizens Trust & Savings Bank of Los Angeles, California, that within 48 hours it would hand the bank voting trust certificates representing 59,990 shares of the common stock and 18,750 shares of the preferred stock of the petitioner. The bank was directed to issue voting trust certificates representing 49,075 shares of the common stock and 18,750 shares of the preferred stock to three other companies against cash payments aggregating $1,190,334.

In order to effect the purposes for which the petitioner was organized, formal offers and acceptances passed between the various interested parties on August 17, 1926. They need not be set out in detail here. The several transfers and exchanges were made pursuant to the offers and acceptances and were all consummated on August 17, 1926, and as far as material here, they are set out in the following paragraph.

The Schumacher individuals transferred to Hunter, Dulin & Co. their 10,000 shares of stock in the old Schumacher Corporation and assigned to Hunter, Dulin & Co. their patents and certain licenses and received a net amount of $1,309,400. The petitioner issued all its 30,000 shares of preferred stock and 59,990 shares of its common stock to the old Schumacher Corporation in consideration of all the old corporation’s assets and of the old corporation’s procuring the assignment to the petitioner of the aforesaid patents and licenses. The old corporation transferred 19,200 shares of the preferred stock and 38,390 shares of the common stock of the petitioner to Hunter, Dulin & Co. in consideration of Hunter, Dulin & Co. assigning the patents and licenses to the petitioner. The balance of the stock, 10,800 shares of preferred and 21,600 shares of common, was transferred by the old corporation to Hunter, Dulin & Co. for the promissory note of the latter in the amount of $545,762.85. The old corporation then dissolved and Hunter, Dulin & Co.’s note was acquired by Hunter, Dulin & Co. in the dissolution. No payment was ever made on the note. Hunter, Dulin & Co. placed the common stock in a voting trust, against which voting trust certificates representing 49,075 shares were issued and sold for cash to three other companies. The same three companies also purchased from Hunter, Dulin & Co. 18,750 shares of the preferred stock of the petitioner.

Upon completion of the transactions set out in the preceding paragraph, neither the Schumacher individuals nor the old Schumacher Corporation had any interest in the petitioner, in Hunter, Dulin & Co. or in any of the companies that purchased preferred stock and voting trust certificates.

The net value of the assets acquired by the petitioner at August 17, 1926 was $1,800,000. The market value of the stock of the petitioner at the time of its issue and for at least six months thereafter was $1,800,000. The cost to the petitioner of the assets acquired from the old corporation and the patents acquired through Hunter, Dulin & Co. was $1,800,000. The patents acquired by the petitioner on August 17, 1926, had a value at that time and a cost to the petitioner of $712,000, and the average remaining life of the patents at that time was 10.9136 years. None of them expired prior to March 21, 1933.

Among the assets acquired by the petitioner from the old corporation was a plant at Los Angeles equipped for making wall board by what was known as the short belt method. By 1929 a process of manufacturing known as the long belt method had become established, which rendered the petitioner’s short belt plant obsolete. In the fiscal year ended April 30, 1929, the petitioner scrapped part of the equipment of this plant and transferred part to a new plant. The cost of the equipment scrapped less depreciation was $152,177.83 and the petitioner received a salvage price of $250, making a loss to it of $151,927.83. Depreciation on the equipment scrapped was computed at the rate of 9 percent, which rate gives a reasonable allowance for depreciation. The buildings of the Los Angeles plant were not scrapped. They had a value when acquired by the petitioner of $81,525.50 and a useful life of from 15 to 18 years. A rate of 6 percent gives a reasonable allowance for depreciation of the buildings.

In determining the deficiencies in these proceedings, the respondent’s theory was that the petitioner’s basis for depreciation and gain or loss in respect of the properties acquired in 1926 was limited to the cost of the properties to the petitioner’s predecessor. On this theory he held that cost to the predecessor of the assets abandoned or scrapped in 1929 had been fully depreciated prior to that time. He also scaled down the claimed basis for the patents from $712,000 to $574,781.27.

The respondent’s theory rests upon his view that the assets were acquired “in connection with a reorganization” and therefore the petitioner must use the transferor’s basis. Sec. 204 (a) (7), Revenue Act of 1926, and sec. 113 (a) (7), Revenue Act of 1928. The cited statutory provisions limit the basis to that of the transferor only in those instances where “immediately after the transfer an interest or control in such property of 80 percent or more remained in the same persons.” If the required 80 percent interest or control does not persist, it does not matter whether or not there was a statutory reorganization. Both elements prescribed by the cited sections must be present if those sections are to apply. Spang-Chalfant & Co., 31 B. T. A. 721; Metropolitan Ice Co., 32 B. T. A. 588. In these cases the physical assets were acquired from the old Schu-macher Corporation. That corporation, it is true, received all the stock of the petitioner, but its receipt was only for the purpose of passing the stock on to Hunter, Dulin & Co. “The interest or control referred to in Section 113 (a) (7), Bevenue Act of 1928 [and 204 (a) (7),BevenueActof 1926] * * * means beneficial ownership.” Metropolitan Ice Co., supra. “* * * the question of control is to be determined by the situation existing at the time of the completion of the plan rather than at the time of the fulfillment of one of the intermediate steps.” Wilbur F. Burns, 30 B. T. A. 163, 172. Cf. Omaha Coca-Cola Bottling Co., 26 B. T. A. 1123; Charles Hall, 31 B. T. A. 125. The facts here are much like those in Hazeltine Corporation, 32 B. T. A. 4, and 32 B. T. A. 110. In those cases the old corporation received more than 96 percent of the stock of the new corporation but it was under contract to, and did, transfer all but 12 percent to the investment firm that promoted the deal. We there held, citing West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77, that the new corporation was not limited to the basis of the old, but was entitled to use cost as the basis. Applying the principles of the above cases, we hold here that the petitioner’s basis applicable to the assets acquired from the old corporation is not governed by the cited statutory provisions, but that its basis is cost. Sec. 113 (a), Bevenue Act of 1928. The same situation applies with respect to the patents. While they came to the petitioner ostensibly from Hunter, Dulin & Co., the real transferors were the Schumacher individuals, who had no interest in or control over the patents upon completion of the transactions on August 17, 1926. But even if Hunter, Dulin & Co. be regarded as the transferor of the patents, it did not, under the principles of the cases cited above, retain an 80 percent interest. On the same day that it acquired the stock of the petitioner, and as a part of the general plan, it sold the majority of preferred stock and voting trust certificates against 49,075 shares of the common stock to three other concerns for cash. Consequently, the petitioner’s basis for the patents, as for the other assets, is cost.

The consideration paid by the petitioner for the assets of the old corporation and the patents was stock, and the cost is the value of the stock. Hazeltine Corporation, 32 B. T. A. 110, 120. Petitioner’s claim of a value for the stock of $1,800,000 is supported by sales of substantial amounts of stock, preferred and common, on the San Francisco Stock Exchange beginning with August 1926 and for several months thereafter. It is also supported by evidence of the value of the assets acquired. Qualified witnesses testified as to the values of the properties here involved, the useful life, and the proper rates of • depreciation. The respondent offered no evidence to the contrary.

We find as the ultimate facts material to the decision of the issue here that the patents acquired by the petitioner on August 17, 1926, cost it $712,000 and that they had an average useful life of 10.9136 years; that the cost to the petitioner of equipment .scrapped in 1929, less depreciation to date of scrapping was $152,177.83; that the buildings of the Los Angeles plant had a cost to petitioner of $81,525.50 and that a proper rate of depreciation is 6 percent per annum.

The foregoing facts will permit a recomputation to be made by the parties, of the petitioner’s tax liability for each of the years.

An issue raised by the pleadings concerning claimed deductions for payments to Buttress Manufacturing Co. was treated indifferently at the trial and is not argued on brief. In their reply brief counsel for petitioner says “it is not of particular importance.” We do not decide it.

Judgment mil be entered under Rule 50.


author: Black. : TcjrneR,

text:
    General Machinery Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70449.
    Promulgated February 28, 1936.

      Allen R. Smart, C. P. A., and R. F. Smart, C. P. A., for the petitioner.

      Clay C. Holmes, Esq.^ for the respondent.
   OPINION.

Black. :

It is the contention of respondent that under the law and regulations applicable to the year 1929 the period .from January 1 to March 26, 1929, constitutes a “taxable year” and that the loss of the Niles Tool Works C'o. for the year 1927 can not be applied beyond that “taxable year.”

It is the contention of petitioner that the balance of the statutory net loss of the Niles Tool Works Co. for the year 1927, over and above the amount applied as a deduction to the period January 1 to March 26, 1929, may be applied as a deduction from consolidated net income to the balance of the year 1929 on the theory that the two periods, January 1 to March 26, 1929, and March 27 to December 31, 1929, constitute one “taxable year” under the decision of the Supreme Court in Helvering v. Morgan’s, Inc., 293 U. S. 121, and the Board’s decision in Lefcourt Realty Corporation, 31 B. T. A. 978. And if it happened that the same corporation continued to have net losses in the two next succeeding years no one received the benefit of the net loss deductions. Woolford Realty Co. v. Rose, 286 U. S. 319.

All this has been changed by the Commissioner’s regulations under the 1928 Act. Article 41 (c), Regulations 75, provides:

A net loss sustained by a corporation prior to the date upon which, its income is included in the consolidated return of an affiliated group (including any net loss sustained prior to the taxable year 1929) shall be allowed as a deduction in computing the consolidated net income of such group in the same manner, to the same extent, and upon the same conditions as if the consolidated income were the income of such corporation; but in no case in which the affiliated status is created after January 1, 1929, will any such net loss be allowed as a deduction in excess of the cost or the aggregate basis of the stock of such corporation owned by the members of the group.

These changes we feel we should point out as appropriate to a discussion of the issue we have here to decide.

It may be appropriate to point out at this juncture that the net loss carry-over of a corporation in a consolidated return under the 1926 Act and prior acts is different from the way it is treated under the Commissioner’s Regulations 75, promulgated under the 1928 Act, applicable to the year 1929 and subsequent years. Under the 1926 Act and prior acts, the net loss of the Niles Tool Works Co. for the years 1927 and 1928 could have been applied only as a deduction against the net income of the same corporation, even though it was joined in a consolidated return with other corporations for the next succeeding two years, and if any such net losses were not absorbed by the net income of the same corporation, no further deduction could be taken by reason of such net losses.

Petitioner contends that respondent’s Regulations 75, 1928 Act, went beyond the authority given in section 141 (b) in issuing article 41 (d), which states:

Any period of less than 12 months for which either a separate return or a consolidated return is filed, under the provisions of Article 13, shall be considered as a taxable year.

We held in Lefcourt Realty Corporation, supra, that article 41 (d) was invalid as to the taxpayer in that case, basing our holding upon the decision of the Supreme Court in Helvering v. Morgan’s, Inc., supra. In Lefcourt Realty Corporation, supra, among other things, we said:

Under section 141(b) of the Revenue Act of 1928, the respondent is given authority, with the approval of the Secretary, to prescribe such regulations for consolidated returns as he deems necessary “to reflect the income and to prevent avoidance of tax liability.” The authority does not extend to prescribing regulations which shall deny to corporations deductions from income and have the effect of increasing the taxable income. The statute prescribes that the net loss of a “taxable year” may be deducted from the net income of the succeeding taxable year and any excess from the following taxable year. Clearly if Regulations 75 did not prescribe a different definition for “taxable year” from that contained in the statute the petitioner’s subsidiaries would be entitled to deduct from their net incomes of the fiscal year ended November 30, 1928, the net losses of the 12-month period ended November 30, 1927, and any excess from their net incomes of the fiscal year ended November 30, 1929. Helvering v. Morgans, Inc., supra. To the extent that Regulations 75 are in conflict with the statute and deny to corporate taxpayers deductions to which they are entitled under the taxing statute they are invalid. Morrill v. Jones, 106 U. S. 466; Utah Power & Light Co. v. United States, 243 U. S. 389; Ramsey v. Commissioner, 66 Fed. (2d) 316; certiorari denied, 290 U. S. 673.
It should be noted that Regulations 75 were promulgated prior to the decision of the Supreme Court in Helvering v. Morgans, Inc., supra. Had the respondent had the benefit of the interpretation placed upon the term “taxable year” contained in the above cited decision of the Supreme Court, presumably he would not have provided in his regulations that “any period of less than 12 months for which either a separate return or a consolidated return is filed * * * shall be considered as a taxable year.”

Although, as we stated in Lefcourt Realty Corporation, supra, the Commissioner is given broad authority under section 141 (b),Kevenue Act of 1928, to make regulations governing the filing of consolidated returns by affiliated corporations, he is not given authority to make regulations which deprive a taxpayer of rights granted to him by the statute.

This fact is made plain by the court’s opinion in Corner Broadway-Maiden Lane, Inc. v. Commissioner, 76 Fed. (2d) 106. In that case the court, after quoting the particular regulation which it was there considering, said:

This attempts to enact as a regulation the commissioner’s contention that an affiliated group does not include any corporation which under section 141 cannot be included in a consolidated return. It is directly contrary to the statutory definition of an affiliated group, and to that extent it must be regarded as invalid. A decision by the Board has so held in a well-reasoned opinion. Travelers Indemnity Co. v. Com’r., 31 B. T. A. —, No. 102 [par. 407]. Although section 141 (a) conditions the making of a consolidated return on consent to regulations prescribed under subsection (b), this requirement must be limited to regulations not inconsistent with the statute, or otherwise invalid.

Cf. American Gas & Electric Securities Corporation, 33 B. T. A. 245.

It is true that the Court of Appeals for the District of Columbia, on rehearing in Wishnick-Tumpeer, Inc. v. Helvering, 77 Fed. (2d) 774; certiorari denied, 296 U. S. 628, has held that where an affiliated corporation joins a group, it must file or be treated as having filed a separate return between the end of its former separate return period and the commencement of the taxable year of the group, and that under article 41 (d) of Regulations 15, the separate period return means a taxable year for the purpose of net loss carry-over and that as the acceptance of such regulations was optional with the taxpayer, there was no reason to justify a claim that the regulations were invalid.

It is also true that the decision of the court on rehearing in the Wishnick Tumpeer, Inc., case was after the decision of the Supreme Court in Helvering v. Morgan’s, Inc., supra, and discussed it and distinguished it. We have given the court’s opinion in the Wishnick-Tumpeer, Inc., case our most respectful and careful consideration and we think that the facts which we have before us in the instant case are distinguishable from those which were present in the Wishnick-Tumpeer, Inc., case.

In the latter case there was present a change by both the parent corporation and the subsidiary corporation in their accounting periods. The importance of this change in accounting periods as it affected the question before the court, was emphasized in its opinion, as follows:

In Morgan’s case the taxpayers’ taxable year (parent and affiliate), both before and after the year of affiliation, was the calendar year, and the filing of returns for fractional parts of the year did not involve any change in either of the taxpayers’ accounting years and, so far as the question here involved is concerned, had no effect upon the actual net income, or the amount of tax. In the instant case, Tumpeer’s previous taxable year was the calendar year, and Pioneer’s the fiscal year ending October 31.
The application of Tumpeer involved a complete change in accounting periods of hoth parent and affiliate. The consent was a concession for which the Commissioner had the right to demand terms. The conditions were that Pioneer should file a separate return for the period prior to affiliation and that such return should be considered as covering a tax-year. In effect, he said to petitioner — If the returns of Pioneer for the two months prior to affiliation and the six months of affiliation be considered as a single return, the result will be to permit its entire loss carry-over to be set off against earnings of only eight months; and this will not correctly reflect its tax for the reason that a return for that period will not correctly reflect its income. — True, to this it may be said — neither does the regulation; but, since the regulation must apply generally, it is not enough to say that in a particular case — where it is optional and not coercive — it is invalid because, it deprives a taxpayer of something which otherwise he would be entitled to. An occasional hardship is inescapable. It was the recognition of this fact, doubtless, which induced Congress in 1928 to enlarge the power of the Commissioner to make specific rules to apply when a change of accounting period like that involved here is asked as a matter of grace. It is true that in this case, as was true in Morgan’s case, if Pioneer had not taken advantage of the provision authorizing consolidated returns, it would have been permitted to carry over its net loss of 1927 for the next two succeeding years; but, even in that event — the two succeeding years would have embraced two full years and not, as in the present case, a materially shorter time.

Ill the instant case there has been no change in accounting periods as was present in the Wishnick-Tumpeer, Inc., case. The facts in the instant case in that respect are similar to what they were in Lefcourt Realty Corporation, supra, where we emphasized that there had been no change in the accounting period of the corporations such as was present in the Wishnick-Tumpeer, Inc., case and which distinction we there discussed.

Therefore, following our decision in Lefcourt Realty Corporation, supra, which in turn followed the Supreme Court’s decision in Helvering v. Morgans, Inc., supra, as we interpret it, we sustain petitioner on the sole issue involved in this proceeding.

Reviewed by the Board.

Decision will he entered under Rule 50.

Smith dissents.

TcjrneR,

dissenting: The holding of the majority is briefly stated in the concluding paragraph of the opinion, as follows:

Therefore, following our decision in Lefcourt Realty Corporation, supra, which in turn followed the Supreme Court’s decision in Helvering v. Morgan's Inc., as we interpret it, we sustain petitioner on the sole issue involved in this proceeding.

Neither of the cases relied on is in point. The Supreme Court in Helvering v. Morgan's, Inc., supra, specifically stated that the question there under consideration did not come within the regulation involved herein, and it is equally apparent that the question in Lefcourt Realty Corporation, supra, was also outside the regulation. An examination of the facts in the latter case clearly indicates that our discussion of article 41 (d) was not in point and not m any way determinative of the question there before us. There each of the returns covering less than a 12-month period was filed under the provisions of the Revenue Act of 1926 and regulations promulgated thereunder. The application of article 41 (d), by its own terms, is limited to returns filed under article 13 of the same regulations, and article 13 has to do only with returns filed for the year 1929 and subsequent years. I dissented in Lefcourt Realty Corporation, supra, for the reason that on the facts it was governed by the decision of the Supreme Court in Helvering v. Morgans, Inc., supra, in which consideration of the provisions of the Revenue Act of 1928 and the regulations thereunder was specifically excepted. Accordingly, we could not have properly considered the validity of article 41 (d) in Lefcourt Realty Corporation, supra, since the returns there were not filed under the Revenue Act of 1928 but under the Revenue Act of 1926.

Here for the first time we have a case which calls for consideration of the validity of article 41 (d) of Regulations 75. Section 141 (a) of the Revenue Act of 1928 extends to an affiliated group of corporations the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year in lieu of separate returns, but allows this privilege only upon the condition that all of the corporations consent to all regulations made under section 141 (b) and prescribed prior to the making of such a return. Under section 141 (b) referred to, it is provided that the Commissioner shall prescribe such regulations as he may deem necessary in order that the tax liability of such an affiliated group, where the privilege of making a consolidated return is exercised, “may be determined, computed, assessed, collected, and adjusted in such manner as clearly to reflect the income and to prevent avoidance of tax liability.” Under this provision of the statute article 41 (d) was promulgated, and our inquiry here is as to whether or not the regulation is unreasonable and inconsistent with the provisions of the statute and therefore invalid.

In the first place it should be remembered that the filing of a consolidated return is not compulsory but voluntary. It is a privilege granted by Congress, and if the privilege is exercised, the return must conform to the regulations promulgated by the Commissioner, full power having been granted by Congress to him to prescribe- such regulations as may be deemed necessary for the determination, computation, assessment, and collection of the tax of the affiliated group, with such adjustments as will clearly reflect the income and prevent avoidance of tax liability. For the purposes of this case, the majority opinion has pointed out the articles of regulations with which we are here concerned. Article 41 (d) states that any period of less than 12 months for which a separate return is filed “shall be considered as a taxable year”, while article 41 (c) permits the net loss of a corporation sustained prior to affiliation to be brought forward and applied against consolidated income instead of limiting the application of such a net loss to the income of the corporation which had sustained the loss. It will be noted that acceptance of these regulations and the filing of a consolidated return thereunder bring about two results that would not be present if tbe returns were filed under a prior revenue act. Helvering v. Morgan's, Inc., supra, and Woolford Realty Co. v. Rose, 286 U. S. 319.

The Court of Appeals for the District of Columbia, in Wishnick-Tumpeer, Inc. v. Helvering, 77 Fed. (2d) 774, had before it the question we have here, and sustained the respondent, affirming our opinion in the same case at 27 B. T. A. 548. Considering the effect of the decision of the Supreme Court in Helvering v. Morgan's, Inc., supra, the court said:

The ambiguity which the Supreme Court found in the 1926 Act, and resolved in favor of the taxpayer, is wholly absent in the 1928 Act and Treasury Regulations, when considered together; for in the latter there is the express and positive command that the fractional part of the year for which the return is made “shall be considered as a taxable year.” And if Congress had the right to limit or restrict the carry-over privilege, as to which there can be but one answer, it had the same right to confer that power on the Commissioner. Congress unquestionably inserted the new provisions in the 1928 Act to clarify administrative procedure under the former act and to substitute, in place of a definite provision, rules to be made by the Commissioner which would be optional in the case of corporations changing from separate to consolidated returns and, sometimes, involving in the change wholly different tax periods; and, in this view, petitioner’s case is brought precisely within the scope of the purpose. * * *
* * * since the regulation must apply generally, it is not enough to say that in a particular case- — -where it is optional and not coercive — it is invalid because it deprives a taxpayer of something which otherwise he would be entitled to. An occasional hardship is inescapable. It was the recognition of this fact, doubtless, which induced Congress in 1928 to enlarge the power of the Commissioner to make specific rules to apply when a change of accounting period like that involved here is asked as a matter of grace. It is true, that in this case, as was true in Morgan’s case, if Pioneer had not taken advantage of the provision authorizing consolidated returns, it would have' been permitted to carry over its net loss of 1927 for the next two succeeding years; but, even in that event — the two succeeding years would have embraced two full years and not, as in the present case, a materially shorter time.
All of this we mention as giving substance to our assumption that Congress, in the 1928 provisions, had a definite purpose in view. The regulations authorized to carry out the purpose were intentionally made optional. An affiliated corporation could take them or leave them, as appeared to it advantageous. This was as nearly a fair and equitable arrangement as the difficulties inherent in the situation made possible; and we can think of no reason, and certainly can find none in Morgan’s case, to justify our saying that the regulations so made are. invalid.

The majority opinion undertakes to distinguish the instant case from that of Wishnick-Tumpeer, Inc. v. Helvering, supra, by pointing out that there a change of accounting period was involved, while no such change was present in the instant case. Although the Supreme Court in its concluding paragraph in Helvering v. Morgan's, Inc., supra, indicated that it was not deciding a case which involved a change of accounting period and the Court of Appeals, in Wishnick-Tumpeer, Inc. v. Helvering, supra, mentioned that comment of the Supreme Court, there is nothing whatever in either opinion which suggests or points to any distinction between the case we have here and that of Wishnick-Tumpeer, Inc. v. Helvering, supra, in so far as the Revenue Act of 1928 or the regulations thereunder are concerned, and, in my opinion, no such distinction can be made. A change of accounting period is voluntary and where such change is made the filing of a return for a period of less than 12 months is required. This is necessary for the proper reflection of the taxpayer’s income from and after such change. The filing of consolidated returns is also voluntary by specific terms of the statute. But if an affiliated group does file a consolidated return and a member .thereof has become affiliated within the taxable year of the parent corporation, a return is required of such new member for a period of less than 12 months, since only the income received by such new member from and after the date of affiliation may be included in the consolidated return. Summary consideration only of the purpose and effect of consolidated returns is needed to show that a return for less than 12 months, in the case of such a corporation, is also necessary for the proper reflection of income. There is nothing whatever in the language of the revenue act itself or in the language of article 41 (d) of the regulation which suggests or intimates that any distinction is made or intended between returns for periods of less than 12 months in either of the cases just described, and from an administrative standpoint and for the proper reflection of income, no reason has been advanced to indicate that such returns are not as essential in one case as in the other.

Accordingly, in my opinion, the reasoning of the court in Wishnick-Tumpeer, Inc. v. Helvering, supra, is equally applicable to the facts present in this case. I can see no reasonable basis for distinction and think that it should be followed here.

It is my further opinion that if Congress did not and could not confer upon the Commissioner the power to promulgate a regulation such as that found in article 41 (d) and which, as prescribed, provides a departure from the rule under the Revenue Act of 1926, as interpreted by the Supreme Court in Helvering v. Morgan's, Inc., supra, we must also find that Congress did not confer upon the Commissioner the power to promulgate a regulation such as that found in article 41 (c), which grants to affiliated corporations accepting the regulations and filing returns thereunder the privilege of applying the net loss of one of its members against the consolidated income, which is contrary to the rule under the Revenue Act of 1926 as interpreted by the Supreme Court in Woolford Realty Co. v. Rose, supra. Insofar as both of the cases mentioned are concerned the statute is the same in the 1928 Act as in the 1926 Act, except for the power conferred upon the Commissioner by the 1928 Act to make the regulations of which article 41 (c) and article 41 (d) are a part.

For the reasons stated, I respectfully dissent from the opinion of the majority herein.


author: Tyson :

text:
    Guaranty Trust Company of New York, Rachel Lustig, Elias Lustig, and Leonard J. Obermeier, as Executors of the Estate of David L. Lustig, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70582.
    Promulgated February 28, 1936.

      Leonard, J. Obermeier, Esq., for the petitioners.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Tyson :

Petitioners, the duly qualified and acting executors of the estate of David L. Lustig, deceased, who died in November 1929, seek a redetermination of the deficiency of $2,387.69 in estate tax asserted by respondent.

The sole issue is whether respondent, in determining the value of the decedent’s gross estate, erred in including therein the proceeds of three life insurance policies, under section 302 (g) and (h) of the Revenue Act o.f 1926. No issue has been raised as to the correctness of the amounts representing the proceeds of the three policies paid to the decedent’s surviving wife as beneficiary or assignee, as follows:

The decedent was a resident of the State of New York at the dates those policies were issued upon his application therefor and, also, at the time of his death.

, The Home Life Insurance Co. policy No. 106190, when executed and delivered in the State of New York on December 17, 1901, was made payable to David L. Lustig, his executors, administrators, or assigns. It contained im reservation to the insured of the right to change the designated beneficiary. The policy contained provisions regarding the conditions and benefits thereof, including the right of assignment, loan value, and paid-up insurance value. Attached to the policy was an assignment executed by the insured in the State of New York on December 10,1907, on a form of the Home Life Insurance Co., whereby the insured assigned and transferred unto Rachel Lustig, his wife, the policy No. 106190 and all dividends, benefits, and advantages to be had or derived therefrom. The assignment further provided: “In the event of my surviving the said Rachel Lustig this instrument shall be null and void”, but contained no other conditions or reservations.

The Northwestern Mutual Life Insurance Co. policy No. 349219, when issued on June 6, 1896, was made payable to Rachel Lustig, wife of the insured, if she survived the insured, otherwise to the insured’s executors, administrators, or assigns. The policy contained no reservation to the insured of the right of revocation of the beneficiary. It provided for paid-up insurance under certain conditions, but did not provide for loan or cash surrender values.

The Penn Mutual Life Insurance Co. policy No. 588805, when issued on August 15, 1912, was made payable to Philip H. Lustig, “brother of the insured, if he survive the insured, otherwise to the insured’s executors, administrators or assigns”, without reservation of the right of revocation by the insured. The policy contained provisions regarding the conditions and benefits thereof, including the right of assignment, paid-up insurance, loans, and cash value. Attached to the policy was an assignment executed in the State of New York in July 1919, by the insured and his brother, Philip H. Lustig, on a form of the Penn Mutual Life Insurance Co., whereby they assigned and transferred all their right, title, and interest in and to policy No. 588805 to “Rachel Lustig, wife of the insured (the beneficiary), if she survive the insured, otherwise to the insured’s executors, administrators or assigns”, subject to the condition that, “The right to change the beneficiary is * * * reserved to the insured.”

It thus appears that for several years prior to and at date of decedent’s death, all three policies were payable to the insured’s wife as assignee or as beneficiary, if she survived the insured. It is now definitely settled that the phrase as to the beneficiary surviving the insured does not constitute a condition precedent to the vesting of the beneficiaries’ interest in the policies. Instead, the title and possession of the beneficiary were fixed by the terms of the policies and assignments thereof beyond the pow.er of the insured to affect prior to his death, which merely ended a possibility which might have occurred. Accordingly, such designation of the beneficiary or assignee is not a ground for the inclusion of the proceeds of the three policies in the decedent’s gross estate. Bingham v. United States, 296 U. S. 211 and Helvering v. St. Louis Union Trust Co., 296 U. S. 39 and Becker v. St. Louis Union Trust Co., 296 U. S. 48.

The Home Life Insurance Co. policy, having been executed and delivered in the State of New York, was a New York contract. Northwestern Mutual Life Insurance Co. v. McCue, 223 U. S. 234. The insured’s wife held the entire beneficial interest in that policy by an unconditional assignment and under the laws of New York her consent was necessary to his control, possession, or enjoyment of the privileges contained in the policy, such as loan and cash surrender values and the right of assignment. Levy's Estate v. Commissioner, 65 Fed. (2d) 412; Anderson v. Northwestern Mutual Life Insurance Co., 261 N. Y. 450; 185 N. E. 696. Cf. John R. Robinson v. United States, 12 Fed. Supp. 160. The Northwestern Mutual Life Insurance Co. policy irrevocably designated the insured’s wife as the beneficiary and the policy did not provide for loans thereon or the surrender thereof for cash. So far as this record shows that policy was a Wisconsin contract, since the only evidence as to where the policy was executed and delivered is shown on the face of the policy itself to have been in Wisconsin. The property right of the insured’s wife in that policy could be defeated by assignment, or otherwise, only with her consent, under the law of Wisconsin; Boehmer v. Kalk, 155 Wisc. 156. Accordingly, the death of the insured did not terminate such incidents of ownership of those two policies by the decedent (that is, control, possession, or enjoyment of the policies or the proceeds thereof) as would constitute an appropriate subject of the estate tax and respondent erred in including such proceeds in decedent’s gross estate. Levy's Estate v. Commissioner, supra; Pennsylvania Co. for Insurances on Lives and Granting Annuities, Executor v. Commissioner, 75 Fed. (2d) 719; Edith Huggard Sharp et al., 33 B. T. A. 290.

The Penn Mutual Life Insurance Co. p.olicy, when issued, wag made payable to the insured’s brother without the right of revocation by the insured. A life insurance policy, being a nonnegotiable chose in action, is assignable, Johnson v. Scott, 137 N. Y. S. 243, the assignment constitutes a contract, Eisenback v. Mutual Life Insurance Co., 147 N. Y. S. 962; affd., 212 N. Y. 593; 106 N. E. 1033, and the assignee acquires an interest in the policy only to' the extent of the specified terms of the assignment, Schoenholz v. New York Life Insurance Co., 234 N. Y. 24; 136 N. E. 227; Palmer v. Mutual Life Insurance Co., 77 N. Y. S. 869; New York Mutual Life Insurance Co. v. Armstrong, 117 U. S. 591. The assignment may be absolute or conditional, including a reservation to change or cancel the assignment, Penn Mutual Life Insurance Co. v. Union Trust Co., 83 Fed. 891, and where, as in this proceeding, the beneficiary is irrevocably named in the policy, the insured and the beneficiary may by their concurrent act effect an assignment of the policy to a third party, Aetna Life Insurance Co. v. Kimball, 112 Atl. 708; Ogletree v. Ogletree, 127 Ga. 232; 55 S. E. 954. In the latter case the life insurance policy designated A as the beneficiary without reservation to the insured to change the beneficiary and subsequently A, in writing, released his interest in the policy to the insured who assigned the policy to B with reservation to the insured to change or cancel the assignment. Thereafter, the insured assigned the policy to C. The court held that B’s interest in the policy was, by virtue of the terms of the assignment, subject to the insured’s right to change or cancel the assignment to him. Also, cf. Penn Mutual Life Insurance Co. v. Union Trust Co., supra.

We conclude that by the assignment concurrently executed by the insured and his brother in the State of New York in July 1919, the brother released all of his interest in the Penn Mutual Life Insurance Co. policy as beneficiary and that Bachel Lustig became the assignee of the beneficial interest therein subject, however, to the insured’s reserved right to change the beneficiary. By that reservation to change, the insured, until the moment of death, retained a legal interest in the policy which gave him the power of disposition of the policy and the proceeds thereof, as completely as if he were named the beneficiary. The termination, by death, of such power or incidents of ownership is a transfer subject to estate tax, Chase National Bank v. United States, 278 U. S. 327; Newman v. Commissioner, 76 Fed. (2d) 449; Scott v. Commissioner, 69 Fed. (2d) 444; and Cook v. Commissioner, 66 Fed. (2d) 995; and this is so notwithstanding the fact that the Penn Mutual Life Insurance Co. policy was issued prior to 1918, because he had reserved the power to change the beneficiary and he died subsequent to the enactment of the broad retroactive provisions of section 302 (h), supra. Levy's Estate v. Commissioner, supra; Newman v. Commismissioner, supra, and Sampson v. United States, 1 Fed. Supp. 95. Accordingly, the proceeds of the Penn Mutual Life Insurance Co. policy No. 588805 in the amount of $50,574.78 are includable in the decedent’s gross estate, pursuant to the provisions and limitations (as to amount) of section 302, supra.

Decision will he entered u/nder Rule 50.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated — ■
      * 1 * Sfc * * * *
      (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.
      (h) Except as otherwise specifically provided therein subdivisions (b), (c), (d), (e), (f), and (g) of this section shall apply to the transfers, trusts, estates, interests, rights, powers, and relinquishment of powers, as severally enumerated and described therein, whether made, created, arising, existing, exercised, or relinquished before or after the enactment of this Act.


text:
    Robert E. Ford, Petitioner, v. Commissioner of Internal Revenue, Respondent. Sara C. Ford, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lina Y. Ford, Petitioner v. Commissioner of Internal Revenue, Respondent. Allyn K. Ford, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 68704-68707, 70738-70740.
    Promulgated February 28, 1936.

      E. F. Hoeschen, Esq., and O. G. Goodson, Esq., for the petitioners.

      Arthur Clark, Esq., and George W. Young, Esq., for the respondent.
   OPINION.

Murdock.:

The parties state that the only question in issue in these proceedings is whether the shares sold are sufficiently identified as from particular lots purchased so as to take the basis of shares from those particular lots, or whether, because of insufficient identification, the “first in, first out” rule is applicable. Neither party invokes the rule first amiounced by the Board in Olive Hume Oliver, 30 B. T. A. 1381 (affd., 79 Fed. (2d) 561), and followed in Alvin T. Fuller, 31 B. T. A. 154 (reversed 81 Fed. (2d) 176). The Board held in those cases that there could be no identification after a split-up of shares due to a reduction in their par value, the first in, first out rule would not apply, and the average cost would have to be used. Those cases on that particular issue were not like the case of Christian W. Von Gunten, 28 B. T. A. 702; affd., 76 Fed. (2d) 670, where the shares sold were all acquired at one time in a reorganization. The Fuller case has now been reversed and the court has rejected the averaging rule. To the same effect see Skinner v. Eaton, 45 Fed. (2d) 568; certiorari denied, 283 U. S. 837; William P. Jenks, 22 B. T. A. 910; Solomon Kraus, 33 B. T. A. 1088. The court held in the Fuller case that the shares sold were sufficiently identified as those which the taxpayer intended to sell. Each of the present taxpayers sold shares of stock from lots purchased at different times and at different prices. If .any of the shares sold are identified in this record as shares purchased at some particular cost, then the gain from that sale must be computed by use of the basis applicable to those particular shares. Skinner v. Eaton, supra. Otherwise the determination of the Commissioner in which he applied his first in, first out rule can not be disturbed. Towne v. McElligott, 274 Fed. 960; Helvering v. Rankin, 295 U. S. 123.

The petitioners, at the time of each sale, selected the lot from which they desired to make the sale. They delivered certificates which, according to their books, represented shares from the lot from which they desired to make the sale. The decision of the court in the Fuller case is authority for the proposition that the identity of the lots need not necessarily be lost when the old certificates are surrendered for the purpose of a stock split-up. These petitioners might possibly have obtained a statement from the transfer agent as to just what new certificates were issued for each of the old certificates, but we think that their method of arbitrarily assigning the lowest numbered new certificate to the earliest lot purchased was sufficient under the circumstances to preserve the identity and avoid the effect of the first in, first out rule.

Reviewed by the Board.

Decision will he entered under Bule 50.


author: Teammell :

text:
    Illinois Central Railroad Company and Yazoo & Mississippi Valley Railroad Company, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62023, 62991.
    Promulgated March 4, 1936.

      R. G. Beckett, Esq., and Edward G. Oraig, Esq., for the petitioners.

      E. G. Algire, Esq., and Lloyd B. Harrison, Esq., for the respondent.
   OPINION.

Teammell :

The opinion of the Board in these proceedings, 30 B. T. A. 1107, was promulgated on June 29, 1934. On September 24, 1934, petitioner filed a motion for further hearing of the proceedings, for the purpose of (a) filing an amended petition in Docket No. 62023, in order to claim a deduction for each of the years 1926 to 1929, inclusive, of the liability of the Yazoo & Mississippi Valley Railroad Co. arising out of retirements of leased equipment in those years; (b) introduction of evidence to prove the amount of the said liability for each of said years; (c) modification of the opinion so as to include appropriate findings of fact based on the amendment and proof; (d) correction of the findings in the said opinion with respect to the amount of the deduction allowed by respondent for 1928 for replacement of leased properties; and (e) correction of the findings and modification of the opinion with respect to the cost of tie replacements on leased tracks and the quantum of the allowable deduction therefor for 1928. On March IS, 1935, respondent filed a motion for further hearing of the proceedings, for the purpose of (1) the introduction of additional evidence with respect to the issues of (a) the deduction in 1928 of cost of tie replacements on leased tracks, and (b) the deduction, in each of the taxable years, of the liability of the Yazoo & Mississippi Valley Railroad Co. arising out of retirements of leased equipment; and (2) reconsideration of the opinion with respect to those issues. These motions were duly granted on September 25, 1934,. and March 20, 1935, respectively, and a further hearing, limited to the matters set forth in the motions, was accorded the parties on May 15, 1935. Upon reconsideration of the entire record, we are now convinced that our earlier opinion is wrong in several respects and should be set aside. Accordingly, the following opinion is substituted for the earlier one promulgated on June 29, 1934.

Respondent determined deficiencies in petitioners’ income taxes, of $27,088.88 for 1926, $84,611.39 for 1927, $46,663.09 for 1928, and $29,463.82 for 1929. In the original petitions, the petitioners alleged that the respondent’s determination is erroneous as to each taxable year, in that he did not deduct from the income of the Yazoo & Mississippi Valley Railroad Co., the cost of making replacements of leased railroad properties which that company retired from service. In the amended petitions, which were filed to conform the pleadings with the Board’s earlier opinion, the petitioners, while maintaining the allegations of error of the original petitions, further allege that the determination is erroneous, in that respondent did not deduct from the income of each year, the amount of the Yazoo & Mississippi Valley Railroad Co’s, liability to replace leased properties which it retired within the year. The respondent claims increased deficiencies for all of the taxable years, on the ground that he erred in allowing certain deductions from the income of the Yazoo & Mississippi Valley Railroad Co., which deductions will be pointed out as they are considered. The parties submitted written stipulations embodying substantially all of the material facts, which are incorporated herein by reference. The proceedings were consolidated for hearing and decision.

Petitioner Illinois Central Railroad Co. is an Illinois corporation, with its principal office at Chicago. It filed consolidated returns for the taxable years, which included the net income of, among others, petitioner Yazoo & Mississippi Valley Railroad Co. It is liable for any .and all deficiencies, and is entitled to recover any overpayment for 1929 based upon the consolidated returns.

On March 31, 1925, the Yazoo & Mississippi Valley Railroad Co., herein called the lessee, entered into separate agreements with the Alabama & Vicksburg Railway Co., and the Vicksburg, Shreveport <& Pacific Railway Co., herein called the lessors, by the terms of which it leased the properties of the two last mentioned companies until July 1,2282, with options to renew the leases for an additional period of 999 years. The lessee agreed that it would keep up, maintain, repair, replace, and renew the leased properties during the terms of the leases, so that such properties would at all times be in substantially as good repair, working order, and condition as they were at the effective date of the lease agreements; and that, whenever during the terms of the leases any part of the leased properties, including rolling stock and equipment, should be damaged, destroyed, or otherwise become unfit for its appropriate use and purpose, it would cause the same to be repaired, renewed, rebuilt, or replaced by property of equal value. These covenants were to be performed at the lessee’s sole cost and expense. The agreements also provided that the lessee should have the right to make such additions and extensions to, and betterments and improvements of, the leased properties as it deemed necessary, for which it was to be reimbursed by the lessors. The leases became effective on June 2, 1926, and the lessee took over the leased properties on that day.

(a) In computing the lessee’s net income, the respondent allowed deductions of $229,119.10 for 1926, $293,019.01 for 1927, $285,528.91 for 1928, and $232,102.40 for 1929, representing, in each instance, the lessors’ cost, less salvage recovered, of properties retired and replaced by the lessee during the taxable year. Respondent urges that he erred in allowing these deductions and makes claim to any increased deficiencies that may result from the correction of his error. Petitioners concede that the lessee is not entitled to these deductions, because it was not the owner of, and had no capital investment in, the retired and replaced properties. We agree with this concession; it is in line with the authorities on the question. Duffy v. Central Railroad Co., 268 U. S. 55; Weiss v. Wiener, 279 U. S. 333; Brevoort Hotel Co. v. Reinecke, 36 Fed. (2d) 51; Belt Railway Co. of Chicago, 9 B. T. A. 304; aff'd., 36 Fed. (2d) 541; certiorari denied, 281 U. S. 742; and Michigan Central Railroad Co., 28 B. T. A. 437. The respondent’s action in allowing the deductions is reversed, and his claim to the resulting increased deficiencies is allowed.

(b) The lessee expended $394,875.75 in 1926, $427,166.24 in 1927, $399,714.22 in 1928, and $320,032.73 in 1929, in replacing rail and other track materials on the leased roadways. Most, if not all, of the rail and other materials used in making the replacements were heavier than the rail and materials replaced, and, to that extent, the replacements were betterments or improvements. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $61,974.23 in 1926, $68,453.73 in 1927, $58,942.51 in 1928, and $50,672.52 in 1929, as the cost of the betterments or improvements. No part of the lessee’s material expenditures in any of the taxable years has been allowed as a deduction by the respondent.

The labor costs incurred and borne by the lessee in making the above replacements were $32,439.33 for 1926, $41,492.71 for 1927, $27,615.87 for 1928, and $22,984.56 for 1929. One half of these labor costs were incurred in taking up the replaced rail and materials and one half in laying the replacements. These labor costs were allowed as deductions by the respondent, but he now asserts that he erred in this respect and makes claim to any increased deficiencies that may result from the correction of his error.

There can be no doubt that these expenditures for both material and labor under the facts of this case, to the extent they were actually borne by the lessee, constitute ordinary and necessary expenses of its business and are deductible in computing taxable net income, unless the respondent shows that some portion thereof related to better-ments and improvements. The burden of proof on this issue is on the respondent and he has failed to show what portion, if any, should be allocated to capital. The maintenance engineer of the petitioners testified that the replaced rail was from 12 to 18 years old and in poor condition; that the replacements were made in pursuance of the maintenance program adopted and followed by the Illinois Central, of which the lessee is a subsidiary line; and that such replacements were necessary to the proper upkeep and maintenance of the leased properties. There is nothing in the record to the contrary. The expenditures are ordinary in the business in which the lessee is engaged and they are necessary, because the lessee was required to make them in the performance of its covenants to keep up and maintain the properties. To the extent indicated, that is, to the extent that these expenditures for labor and material were borne by the lessee, the expenditures did not contain anything of a capital nature; the cost of all additions, betterments, and improvements Avas charged to and borne by the lessors. Obviously, the deductions must be limited to the lessee’s burden of the expenditures; for the statute will not permit the deduction of amounts for which it was reimbursed, or to be reimbursed, by the lessors. New York, Chicago & St. Louis Railroad Co., 26 B. T. A. 1229, 1289, and cases therein cited. The respondent’s claim that he erred in allowing the labor costs as deductions is disallowed. The lessee is entitled to deductions of $332,901.52 for 1926, $358,712.51 for 1927, $340,771.71 for 1928, and $269,360.21 for 1929, these being the expenditures actually borne by the lessee and not shown to have been of a capital nature, that is for improvements and betterments.

(c) The lessee expended $65,500.82 in 1926, $50,321.05 in, 1927, $181,115.43 in 1928, and. $268,126.92 in 1929, in replacing 57, more or less, bridges and trestles on the leased roadways. Most, if not all, of the replacements were improvements over the removed structures. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $27,904.76 in 1926, $40,916.79 in 1927, $128,773.28 in 1928, and $190,689.90 in 1929 as the costs ’of the better-ments or improvements.

Also, the lessee expended $23,665.41 in 1926, $355,855.39 in 1927, $127,393.98 in 1928, and $152,971.38 in 1929, in replacing other parts of roadways and roadway structures, extending and rearranging existing trackage, constructing new facilities, installing tie plates, and otherwise making changes on the leased properties. Most, if not all, of these changes were betterments or improvements. Of the amounts so expended by the lessee, there were charged to and borne by the lessors $20,974.38 in 1926, $282,126.57 in 1927, $106,155.71 in 1928, and $121,238.20 in 1929, as the costs of the betterments or improvements.

The respondent did not deduct any part of these expenditures in computing the lessee’s taxable net income.

While expenditures for ordinary upkeep and maintenance, such as those for rail and other track material replacements referred to under (b), are proper deductions from income, the lessee may not deduct expenditures made primarily for adding to and improving the leased properties. Duffy v. Central Railroad Co., mfra. The latter must be charged to capital and written off over the terms of the leases or the life of the property, whichever is shorter, by annual pro rata charges against income. As to all but three items covered by the expenditures here considered, the evidence is insufficient to enable us to determine whether or not they may be deducted from income, even to the extent that they were borne by the lessee. Petitioners’ maintenance engineer, without stating his reasons therefor and apparently basing his opinion on the meager facts in the stipulation, expressed the opinion that all of the expenditures were necessary to the proper maintenance of the leased properties. If by that he meant that they were necessary in order to keep the properties in good repair and good running condition, and no more than that, the inaccuracy of his opinion is clearly disclosed by the stipulated facts. The depression and rearrangement of existing tracks, the construction of concrete subways where none existed before, the extension of yard leads, and the application of more than a hundred thousand additional tie plates to the roadways are clearly betterments or improvements and can not be ascribed categorically to that kind of upkeep and maintenance that may be deducted from income. Further, it is to be noted that some of the bridges and trestles replaced in the taxable years were constructed or erected, as late as 1917 and 1918, and, as to them, while we have been given no evidence as to the usual normal life of this type of structures, there obviously must be some doubt that their replacement was due to normal upkeep and maintenance and not to betterment or improvement of the leased properties.

The three excepted items are $283.80 expended in 1926 for replacement of a worn-out cypress shingle roof on a section house; $36,174.22 expended in 1927 for replacing 17 miles of main track that had been washed out by flood conditions; and $6,470.90 for replacing 36,292 tie plates in 1928. These three items are proper deductions in computing the lessee’s taxable net income. Deduction of all other expenditures here considered must be denied for lack of proof that they are ordinary and necessary expenses.

(d) The respondent contends that the deductions allowed under (b) and (c) should be reduced by the amounts of salvage recovered in the taxable years from retired and replaced leased properties. We disagree with this. The lessors, being the owners of the retired and replaced properties, were likewise the owners of the materials salvaged therefrom and the proceeds of any sales of such materials, unless, by virtue of some provision of the lease agreements, the materials and proceeds were to belong to the lessee. We find no such provision in the lease agreements; and that it was the intent of the parties that materials salvaged from retired properties and the proceeds from the sale thereof should belong to the lessors, and not the lessee, is deducible from the fact that the lessee consistently credited its lessors, on its books of account, with the value of such salvaged materials and any proceeds from the sale thereof.

(e) During the taxable years and 1930, the lessee retired 1,464 units of leased equipment, such as locomotives and freight train cars, having a depreciated book value as of June 2, 1926, as agreed upon by the lessee and lessors, of $1,157,752.92. These retirements took place as follows: 1926, 81 units valued at $72,785.86; 1927, 757 units valued at $497,295.33; 1928, 389 units valued at $356,371.48; 1929, 164 units valued at $161,026.82; and 1930, 73 units valued at $70,273.43. Under the lease agreements, the petitioner was required to replace these units with units of like values. As each equipment unit was retired, the lessee recorded its liability for replacement thereof on its books, in an amount equal to its depreciated book value at June 2, 1926, by a credit to the account of the lessor owning the unit. These retired units were replaced by the lessee with equipment furnished by the Illinois Central, as guarantor under the lease agreements, as follows: 577 units in 1929, and 29 units in 1930, a total of 606 units; but title thereto was not conveyed to the lessors at the times of replacement. The value of these replacement units on the petitioner’s books, which was cost less depreciation previously allowed, was $1,020,121.99, but for the purposes of the replacements, the lessee and lessors agreed upon values of $1,103,579.22 for the 1929 replacements, and $60,408.60 for the 1930 replacements, a total of $1,163,987.22. In August 1929, it was agreed that the lessee should convey to the lessors title to all such equipment replacements and to such other equipment as was necessary to replace all units of leased equipment that had been and would be retired up to December 31 of that year, in order that all such equipment might be brought immediately within the liens of the lessors’ mortgages. By reason of the delay in agreeing upon the values and classes of replacement units that were to be conveyed to the lessors, the conveyances of titles were not formally made to the lessors until 1932. The accounting for the transfer of the replacement units was made on the books of the lessee and lessors in 1932.

The expenditures represented by these replacements were not “ordinary and necessary expenses paid or incurred during the taxable year[s] in carrying on any trade or business”, within the meaning of section 214 (a) (1) of the 1926 Act and section 23 (a) of the 1928 Act, but were for permanent additions and betterments to the leased properties, such as would, if made by the owners of those properties, come within the provisions of section 215 (a) (2) of the 1926 Act and section 24 (a) (2) of the 1928 Act, “that no deduction shall in any case be allowed in respect of any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property.” “They constituted, not upkeep, but investment; not maintenance or operating expenses, but capital, subject to annual allowances for exhaustion or depreciation.” Duffy v. Central Railroad Co., supra. The petitioners’ contention that they are deductible, in computing the lessee’s taxable net income, is, therefore, denied.

(f) The last issue for consideration is respondent’s alternative claim that he erred in deducting $74,774.05 from the lessee’s income for 1929, for depreciation of the equipment replacement units conveyed to the lessors in 1932, and asking for an increased deficiency for 1929 on this account. He urges it only if the Board holds that the lessee is entitled to deduct from the income for 1929, the entire amount of its liability to the close of that year for replacement of leased equipment which it retired. We have already held that the lessee is not entitled to deduct the cost of its replacements of retired leased equipment. Consequently, respondent’s alternative claim needs no further consideration.

Reviewed by the Board.

Judgment xvill he entered u/nder Rule 50.

       This decision was prepared during Mr. Trammell’s term of office.