author: HaeROn:

text:
    Estate of Louis D. Markwell, Deceased, B. J. Birk, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91854.
    Promulgated June 9, 1939.

      Alex P. Greenthal, Esq., for the petitioner.

      Owen W. Sweelcer, Esq., and Emil J. Nelson, Esq., for the respondent.
   OPINION.

HaeROn:

Petitioner contends that property rights vested in Euth M. Birk in 1909, transferring property of decedent to her as of that date. Petitioner argues that the estate tax law is not applicable therefore to property received by Euth M. Birk after decedent’s death upon the theory that no estate tax may be levied upon transfers of property made prior to the enactment of Federal estate tax laws. In the alternative, petitioner contends that section 804 of the Eevenue Act of 1932, defining the term “money or money’s worth” in section 303 of the Eevenue Act of 1926 as amended, is not applicable and that petitioner is entitled to deduct the amount of a claim awarded to Euth M. Birk and paid to her under section 303. Petitioner contends that the claim was founded on an agreement for adequate consideration in money or money’s worth.

We find little merit in petitioner’s first contention. The agreement in 1909 was only that decedent’s daughter should receive, upon his death, at least one-half of all property of which decedent should die seized. In 1909 it was not possible to ascertain what that property would be and no property was described or defined in the agreement. The promise was contingent upon compliance with other provisions in the agreement by the other parties and upon decedent’s owning any property at his death. It is not material that decedent agreed, also, that he would not intentionally diminish substantially the amount of property that otherwise would go to his daughter at his death. This was no more than a promise not to defeat or nullify the main promise, i. e., not to disinherit at law his daughter by conveying title to property to others. Unquestionably decedent retained full title to all property he owned or acquired after 1909 until his death. On the other hand, if he died possessed of no property through no fault of his own or deliberate scheme to prevent property passing to his daughter, she would receive nothing. During decedent’s life, the daughter had no present right to receive any property. Her right to receive property accrued at the death of decedent and not before. It is concluded that no property passed to Ruth M. Birk in 1909. There is no question in this proceeding as to the application of the Federal estate tax laws. They clearly apply to decedent’s estate.

The agreement made in 1909 was essentially testamentary in nature. The agreement that Ruth should receive one-half of decedent’s property upon his death could have been carried out by devise by will of Louis D. Markwell. He made a will but did not include in it a bequest directly to Ruth of one-half of his property. Having so failed to provide, decedent did not comply with the agreement made in his lifetime. The obligation to so provide for Ruth was a contractual obligation, and in consideration therefor the mother of Ruth relinquished all marital claims she had in the property of Louis D. Markwell. She relinquished her dower rights and decedent acquired rights he would not have had otherwise. That was the only consideration material here; at least, Ruth, not a party to the contract but a third party beneficiary, did not give any separate consideration. At the time decedent died he was not indebted to Ruth in any way. Clearly, then, Ruth had a claim against decedent’s estate arising out of a breach of contract. She sued for specific performance after decedent’s death. The Milwaukee County Court in probate recognized the claim and directed satisfaction either by distribution of property or by payment in cash, at the claimant’s option. It is concluded that, after decedent’s death, Ruth M. Birk had a claim against the estate which she acted upon by way of a suit for specific performance. We are satisfied that the claim was against the estate within the meaning of the term “claim” as used in section 805, recognizing the distinction to be made between a claim to a distributive share in an estate and a claim against an estate, as pointed out in Latty v. Commissioner, 62 Fed. (2d) 952. The distinction between that case and this proceeding is that, here, the claimant brought a suit on a contractual right where the contract obligation was not carried out. We think that, here, Ruth M. Birk’s claim was adverse to the estate.

This brings us to the main question, whether the claim is such claim as Congress has allowed to be deducted from gross estate. It has been decided tbat the enactment of section 804 in the Revenue Act of 1932, set forth below, operated only to define by limiting the term “money or money’s worth” already in the statute in section 303 (a) (1) of the Revenue Act of 1926 as amended by section 805 of the Revenue Act of 1932. Sheets v. Commissioner, 95 Fed. (2d) 727. Under that decision, unquestionably, the amendments enacted in the Revenue Act of 1932 apply to decedent’s estate, decedent having died subsequent thereto. It follows that the claim of Ruth M. Birk against decedent’s estate was not one for which there was consideration in “money or money’s worth” within the intendment of the statute. It is held that the claim was not deductible and respondent is sustained.

The cases of Schwab v. Doyle, 258 U. S. 529; Nichols v. Coolidge, 274 U. S. 531; Coolidge v. Long, 282 U. S. 582, and related cases, relied upon by petitioner, are plainly distinguishable. In those cases there were irrevocable transfers of property antedating the statutes and it was held by the Court that the estate tax statutes could not be applied retroactively. The cases of Estate of Eben B. Phillips, 36 B. T. A. 752, and Estate of George Tuttle Brokaw, 39 B. T. A. 783, are also distinguishable. In those cases section 804 of the Revenue Act of 1932 was held not to be controlling. In each of those cases the child of the decedent was a minor at the date of his death, and part of the consideration for transfer of property was release of the legal obligation of decedent to support his child. The right of the wife and child was of value and so was the discharge of the obligation, and claims against the estate were held deductible. Here, Ruth M. Birk had attained her majority at the date of her father’s death and all his legal obligation to support her had since terminated.

The deficiency should be reduced by giving credit for state taxes paid upon recomputation under Rule 50.

Decision will be entered under Rule 50.

       SEC. 804. RELINQUISHMENT OE DOWER, ETC., AS CONSIDERATION.
      Section 303 (d) of the Revenue Act of 1926 is amended by adding at the end thereof a new sentence to read as follows :
      “For the purposes of this title, a relinquishment or promised relinquishment of dower, curtesy, or of a statutory estate created in lieu of dower or curtesy, or of other marital rights in the decedent’s property or estate, shall not he considered to any extent a consideration ‘in money or money’s worth’.”

       SEC. 805. DEDUCTIONS.
      Section 303 (a) (1) of the Revenue Act of 1926, as amended, is amended to read as follows:
      “(1) Such amounts—
      “(A) for funeral expenses,
      “(B) for administration expenses,
      “(C) for claims against the estate,

      * * * The deduction herein allowed in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded upon a promise or agreement, be limited to the extent that they were contracted bona flde and for an adequate and full consideration in money or money’s worth. * * *


source: Caselaw Access Project

author:
Keen:
      Leech,

license: Public Domain

text:
    The National Bank of Commerce of Seattle, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89720.
    Promulgated June 9, 1939.

      Thomas N. Fowler, Esq., and O. L. Stone, G. P. A., for the petitioner.

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

Keen:

The primary question presented by this proceeding is whether the recoveries of debts charged off as worthless in previous years by a bank on its own initiative constitute taxable income in the year of their recovery by such bank, even though the prior charge-off accomplished no reduction in tax liability in the year in which they were charged off.

It is now well settled that where amounts previously deducted from income for losses, expenses, bad debts, taxes, etc., which effect an offset of taxable income, are recovered in subsequent years, such recoveries “should be reported as a part of gross income for the year in which * * * recovered.” Estate of William H. Block, 39 B. T. A. 338; Dixie Margarine Co., 38 B. T. A. 471. The converse of this proposition is also true — that if such amounts so deducted did not effect an offset of taxable income for the year in which deducted, then recoveries in subsequent years should not be included in gross income in the years of recovery. Central Loan & Investment Co., 39 B. T. A. 981. Therefore, regardless of whether the debts were charged off, in the instant proceeding, on the bank’s own initiative or on the order of a bank examiner, if the charge-off accomplished) no reduction in tax liability in the year in which they were charged off, the recoveries of such debts in a subsequent year would not constitute income in the year of their1 recovery.

As pointed out in Central Loan & Investment Co., supra, this conclusion accords with the views expressed by the General Counsel of the Bureau of Internal Revenue in G. C. M. 18525 (C. B. 1937-1, p. 80) and G. C. M. 20854 (1939 Int. Eev. Bui. No. 9, p. 2).

A question is involved in this proceeding which was not present in the Central Loan & Investment Co. case, in that here a large paid of the debts upon which recoveries were made by petitioner had been charged off in a prior year from the books of other corporations which were then the owners of the debts and deducted by them without offsetting any tax liability on their part. The debts were later transferred to petitioner. Will our conclusion be the same as to the recoveries made on these debts thus transferred to petitioner prior to the taxable year?

[Respondent contends that all of the debts involved herein were acquired by purchase from the banks whose assets were taken over by petitioner; that the purchase price was allocated by petitioner solely to the sound or ledger assets, which included the debts of unquestioned value, and not to the debts of questionable value which had been charged off as worthless by the transferor banks and which were not carried as assets on petitioner’s ledger; and that, therefore, the nonledger assets cost petitioner nothing and could have no basis in the accounts of petitioner. It follows, respondent argues, that the recoveries made by petitioner upon the debts which were not carried as assets upon petitioner’s ledger must be considered as income.

Petitioner contends that these debts were acquired by petitioner in the course of a reorganization and not by purchase, regardless of how the transaction was treated on the books of petitioner. In 1933 the Marine Bancorporation owned from 88 percent to 94.5 percent of the stock of certain small banks located in the vicinity of Seattle. In that year it was decided by the Marine Bancorporation that the business of these banks should be carried on as branches of petitioner. Pursuant to a plan of reorganization, and in order to accomplish this purpose, these banks transferred all of their assets to petitioner in 1933 subject to their liabilities. Immediately after each of these transfers the Marine Bancorporation was the owner of over 99 percent of the stock of petitioner. Therefore, petitioner contends, these transactions constituted a reorganization within the meaning of section 112 (i) (1) (B) of the Revenue Act of 1932 (section 112 (g) (1) (C), Act of 1934), and the basis of the accounts to petitioner was the same as to the transferors; that is, cost.

We agree with petitioner that these transactions do constitute a reorganization within the definition of the statute set out in section 112 (i) (1) (B) of the Act of 1932. However, that particular section is only a definition and does not provide that in all transactions which may be classified as reorganizations no gain or loss shall be recognized. Section 112 (a) states the general rule that upon the sale or exchange of property the gain or loss shall be recognized “except as hereinafter provided in this section.” Subsections (b) to (h) inclusive of section 112 set out the exceptions to which subsection (a) refers. These subsections are not applicable to a reorganization such as the one consummated in the instant proceeding. Therefore, we must conclude that gain or loss shall be recognized in the transactions resulting in the reorganization involved here. Those transactions may be briefly stated as follows: The small trans-feror banks charged off prior to the reorganization certain of their assets. They then transferred all of their assets to petitioner, and in return, petitioner assumed all of their liabilities. The liabilities thus assumed equaled the amount of assets remaining on the books of the small transferor banks and were set up by petitioner on its books as the purchase price allocated to the assets which remained on the books of the transferor banks at the time of transfer and which, after the transfer, were carried on the books of petitioner. Petitioner did not carry as assets on its books the items which had been charged off by the transferor banks. Since these transfers were made in connection with a reorganization (even though not a tax-free reorganization) and immediately after the transfers a control in the property transferred remained in the same persons (i. e., the Marine Bancorporation), section 113 (a) (7) of the Act of 1934 is applicable. Cf. Piedmont Financial Co., Inc., 26 B. T. A. 1221. The pertinent provisions of that section are as follows:

If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 50 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. * * *

Applying that section to the facts of the instant proceeding, it becomes necessary to determine whether a gain or loss was recognized to the transferors upon such transfers. We are of the opinion that there was a loss to the transferors upon such transfers. The trans-ferors received from the petitioner an assumption of their liabilities equivalent to the value of their ledger assets which, we must con-elude from the evidence, were worth the amount at which they were carried on the books of the transferors. In return petitioner acquired all of the assets of the transferors, including the nonledger assets which had been charged off the books of the transferors. As to these nonledger assets there is evidence that the transferor banks and petitioner considered them to be of some value, but there is no evidence as to what that value was. The transferor banks, by charging off these assets prior to the transfers and deducting them as bad debts in their income tax returns, treated them as of no value, and petitioner, after the transfers, treated them in the same way by not carrying them as assets on its books and allocating the liabilities assumed as the purchase price of the ledger assets. We are of the opinion that whatever value the nonledger assets had was lost to the trans-ferors at the time of the transfers and, therefore, the basis of such assets to them at that time was zero. It follows, pursuant to section 113 (a) (7), that the basis of such assets to petitioner, the transferee, would also be zero. Since petitioner acquired by purchase accounts which had as to it a basis of zero, any collections made by petitioner on such accounts would constitute income. Cf. Chatham & Phenix National Banks, 1 B. T. A. 460; Madison & Kedzie State Banks, 1 B. T. A. 922. On this issue our decision is for respondent.

One more question remains for our decision. In 1933 petitioner and three of the smaller transferor banks deducted as bad debts some 16 items in a total amount of $4,357.44 which had been charged off in that year, but which had not been ascertained to be worthless in 1933. As set out in our findings, 4 of these items were charged off by petitioner while 12 were charged off by the transferor banks and then transferred to petitioner. The deduction of these items did not effect an offset against the taxable income of the banks to which these debts were owed. In that year the petitioner acquired all of the debts in connection with the reorganization which we have already described. In 1934 petitioner ascertained these debts to be worthless and claimed them as a deduction in that year. They were not charged off the books of petitioner in 1934, since they had been charged off the books of petitioner and its transferors in 1933. Since we have just decided that the debts which were charged off by the transferor banks in 1933 and then transferred to petitioner had a basis in the hands of petitioner of zero, it is obvious that the 12 items thus transferred to petitioner in 1933 can not be deducted by it under any circumstances because no loss has been sustained by it. However, the 4 items which were at all times the property of petitioner are properly deductible under the rule of George H. Fraser, 6 B. T. A. 997, and Georgia Engineering Co., 21 B. T. A. 532.

Reviewed by the Board.

Decision will be entered wnder Rule 50.

Leech,

dissenting on the last issue: The tax effect involved in the decision of this issue is slight. However, the rule laid down seems to me to be important enough to warrant comment.

The four debts in question under this issue were charged off the books of the taxpayer in 1933. Deductions were claimed therefor as worthless debts in its return for that year. This resulted in an addition in that amount to its net loss for such year, which would have been carried over to 1934 had it not been for the elimination of the right to carry over net losses, by the Revenue Act of 1934, section 117. The debts were ascertained to be worthless in 1934 but no charge-off then occurred — since, of course, they had already been charged off once and were never thereafter restored to petitioner’s asset account.

The majority holds the amount of these debts was deductible for 1934 under the rule of George H. Fraser, 6 B. T. A. 997, and Georgia Engineering Co., 21 B. T. A. 532.

It is possible both those cases are distinguishable from this case. But, in any event, I disagree with the conclusions of the Board in both of them and with that of the majority here. The opinions in the two cited cases stem from Mason Machine Works Co., 3 B. T. A. 745. In that case the Board found as a fact that a constructive charge-off occurred during the taxable year. Neither in the present case nor in the Fraser and Georgia Engineering Co. cases, supra, was there a charge-off of any kind.

The controlling statutory provision, section 23 (k) of the Revenue Act of 1934, allows as deductions “debts ascertained to be worthless and charged off within the taxable year * * The meaning thus expressed is clear and unambiguous. I think Congress meant exactly what it said. To entitle a taxpayer to the reduction there authorized, he must perform two affirmative acts — and they must both occur “within the taxable year.” To hold otherwise seems to me requires a rather flagrant violation of the statutory bounds of our jurisdiction and a trespass upon the constitutionally exclusive legislative function of Congress.

The Circuit Court of Appeals for the Second Circuit, in deciding Ludlow Valve Manufacturing Co. v. Durey, 62 Fed. (2d) 508, after our decisions in the Fraser and Georgia Engineering Go. cases, concisely states my position here:

Presumably so much, of those debts as were charged off in 1915 and 191© were ascertained to be worthless in those years, else they would not then have been written off, but we merely suggest that. The important fact is that, having previously been charged off, they could not be written off again in 1918. Darling v. Commissioner (C. C. A.) 49 F. (2d) 111; Avery v. Commissioner (C. C. A.) 22 F. (2d) 6, 55 A. L. R. 1277; Stephenson v. Commissioner (C. C. A.) 43 F. (2d) 348. To permit that would leave a taxpayer free to charge off bad debts whenever they were ascertained to be worthless and the exigencies of Ms business required the entry and to let him take the deduction then or in a later year as he preferred. This would give him the opportunity to wait before claiming the deduction until there should be a year in which his income would be sufficient to allow him the maximum benefit, instead of taking it as the statute required in the year when the debts were both ascertained to be worthless and charged off. * * * [Emphasis supplied.]


author: Leech::

text:
    William H. Donner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93602.
    Promulgated June 13, 1939.

      William E. Foulh, Esq., for the petitioner.

      E. G. Smith, Esq., for the respondent.
   OPINION.

Leech::

This is a proceeding to redetermine a deficiency in income tax of $44,749.47 for the calendar year 1984. It involves the question of the taxability to petitioner of the income of a charitable trust, created by him in 1929, either under sections 166 and 167 of the Revenue Act of 1934, or upon the theory that no valid trust was created by him. The pertinent facts are found pursuant to a stipulation and attached documentary evidence.

On September 26, 1929, petitioner transferred 15,090 shares of the capital stock of the Donner Steel Co. in trust to the Union Trust Co. of Pittsburgh, a corporation located in and organized under the laws of Pennsylvania. Subsequent transfers to the corpus of the trust were made by him as follows (the first item represents the original transfer as of the date it was converted into cash):

Such portions of the trust instrument as are material in this proceeding follow:

To Have and To Hold the said money, properties and securities, and the investments and re-investments into which they may hereafter be converted, In Trust, Nevertheless, for the following uses and purposes and none other, to-wit:
To invest and re-invest the same from time to time in safe interest-bearing securities or first mortgages upon improved real estate, irrespective of any statutes now or hereafter in force limiting the investments of trustees; and to collect, recover and receive the interest, income and dividends thereon when the same become due and payable, and, after paying thereout the expenses of the management of the trust, including the Trustee’s compensation, the net income, together with so much of the corpus cf this fund, shall be paid over to such corporation trust, community chest, fund, foundation or association organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual, as the Donor or the Research Committee appointed by him under the provisions hereof may at any time, and from time to time, determine and direct.
After the decease of the Donor, if he shall have failed to appoint a Research Committee or, having appointed one, both the Donor and all members of the Research Committee shall be deceased, or for any reason refuse or fail to function, the Trustee hereunder shall have unlimited power to determine, from time to time, the portions and amounts of this trust fund and the income therefrom which shall be applied as aforesaid to such uses, objects and purposes.
The Donor reserves the right by proper instrument in writing in his lifetime, or by testamentary appointment after his decease to name a Research Committee consisting of seven (7) individuals who shall meet at such time and place each year as shall be designated by the Donor during his lifetime and after his death as shall be designated by the Research Committee appointed by him for that purpose, and in ease of the Donor’s failure to appoint such a Committee for the future management of this trust, the Trustee shall have the right to appoint such Committee, not exceeding seven (7) in number, who shall exercise the same powers as might be done if such appointments were made by the Donor, the purpose of this Committee being to offer or award prizes, and to direct the disbursement of the corpus and income of this trust fund in accordance with the intentions of the Donor.
Subject to tbe approval of tbe Donor, tbe Research Committee may use and apply tbe said income of this trust fund from time to time, or may use any part of tbe principal thereof, and in case there is no urgent necessity for tbe application of tbe income, it may allow tbe same to accumulate and it may be invested in like securities with tbe corpus until the time arrives for its use for any one or all of tbe purposes hereinbefore described and set forth.
The Donor reserves tbe right, by proper instrument in writing in bis lifetime or by testamentary appointment after his decease, to name an Advisory Committee to act with tbe corporate Trustee, and when so appointed shall have all tbe powers reserved to tbe Donor herein, including the right to authorize the sale of securities and the re-investment of the proceeds thereof.
The Donor reserves the right at any time during his lifetime, by proper instrument in writing delivered to the Trustee, to modify, alter or amend the terms of this Agreement by changing the time or manner of payment of the income or corpus, or the manner in which the beneficiaries of this fund shall be selected, but he may not change the general purposes to which this trust and the income therefrom shall be applied so that the same is to be used for any purposes not included in those hereinbefore enumerated, nor shall the Donor have the power to revoke or alter this trust in such manner that any part of the corpus or income shall inure to the benefit of himself or any other private individual or corporation.

On July 28, 1933, petitioner amended the original trust deed and provided for an “Advisory Committee” of from four to seven persons to take the place of the “Research Committee” and “Advisory Committee” originally specified. Its duties and membership were as follows:

(4) The Advisory Committee shall have the right to designate the particular beneficiary or beneficiaries embraced within the classes set forth in the original trust agreement, to which the interest and any portion of the corpus of the trust fund shall be appropriated and paid, and fix the amounts thereof. Provided, however, that no such designation during the lifetime of the Donor shall be valid and effective without the written approval of the Donor. And provided further, that any designation of a particular beneficiary or beneficiaries directed in writing by the Donor to the Trustee in his lifetime or by testamentary disposition after his decease, in whatever amount, whether interest or corpus of the trust fund, shall not be changed, altered or withdrawn by said Advisory Committee, and it shall be the duty of the Trustee to carry out the directions and designations of the Donor in such cases unless revoked by the Donor himself in writing in his lifetime or by testamentary disposition. Any interest or corpus not allocated to particular beneficiaries designated by the Donor, shall be applied and paid as the Advisory Committee shall in writing to the Trustee designate.
(6) Further, I, the said William H. Donner, Donor, do hereby designate, constitute and appoint as said Advisory Committee my wife Dora B. Donner, Robert N. Donner, Elizabeth D. Roosevelt and Dora B. Donner, Jr., they as members of such Advisory Committee to have all the rights, duties, powers and privileges set forth in said original trust agreement and this amendment. I, as Donor, however, reserve the right to fill vacancies and add to the said Committee other members and to change the members from time to time.

In 1934 the trust received $94,414.31 in income, $9,261.40 of which was disbursed to various charities selected by the advisory committee and the remainder, apparently along with additional sums, transferred to principal. None of it went to petitioner or to any private individual or corporation designated by him, except $2,125.98 in trustee’s commissions, in accordance with the trust deed.

From time to time, additional donations to charities were made out of corpus; none were made, however, in 1934.

Eespondent has sought to tax petitioner on the income of this trust under either of two main heads: First, under sections 166 and 167 of the Kevenue Act of 1934, and, second, because (a) it is not a valid, legal, irrevocable trust, (b) it is not operated exclusively for religious, charitable, scientific, literary, and educational purposes, (c) no actual distribution is required, (d) no beneficiary has been named or is subject to selection without the written approval of petitioner; (e) the income of the trust has been allowed to accumulate until the fund has become approximately $3,000,000; (f) only from 10 to 15 percent of the income has been distributed.

Eespondent has filed no brief, and, with commendable frankness, his counsel has stated that he can find no support for his positions. We have examined the several contentions advanced in the deficiency letter and the answer, and have come to the same conclusion.

The trust instrument plainly states that the donor shall not have the power to revoke or alter the trust in such a maimer that any part of the corpus shall inure to the benefit of himself or any other private individual or corporation. The extent of his power over both corpus and income is to select or approve the selection of the beneficiaries and to pass on the time and manner of payments to them. This power of selection is limited to the general class of objects for the benefit of which the trust was created: “corporation trust, community chest, fund, foundation or association organized and operated exclusively for religious, charitable, scientific, literary or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.” While income, as to which there might be no pressing need, was to be accumulated, such accumulation could not by any possibility be applied for grantor’s benefit. Moreover, the trust was directed to be continued after his death.

Section 166 can not apply, for there is no power to revest the corpus vested in the grantor alone or in conjunction with a person not having a substantial adverse interest or in such a person alone. Section 167 can not apply because the income was not and could not be accumulated for future distribution to the grantor, is not distributable to the grantor, and is not to be applied to policies of insurance upon his life.

The power to select the beneficiaries does not benefit the grantor, nor give him a taxable control over the trust income or corpus, for whatever income or corpus is paid out, must be paid to a charity. In Phebe Warren McKean Downs, 36 B. T. A. 1129, we held that the power retained by a grantor to alter the distribution of income among beneficiaries, did not make such income taxable to the grantor where all the income had to be paid, in some way, to beneficiaries other than the grantor. Nor is there any possibility of a resulting trust in this case, for whatever is paid out must be paid out to charities, and whatever remains must be held in trust solely for charitable purposes. Cf. Fanny M. Dravo, 34 B. T. A. 190.

Walker v. Commissioner, 91 Fed. (2d) 297, is distinguishable. There the taxpayer gave $10,000 in trust to be used for such religious or educational purposes as he might direct. The “trustee” was, in fact an agent, functioning under revocable authority. In affirming a memorandum decision of the Board, the court held that since the taxpayer had not parted irrevocably with the $10,000, but had retained control over it, he could not take a charitable deduction for that amount. In the instant case, as has been pointed out, petitioner lacked the power to revest either corpus or income in himself, either by powers of revocation or otherwise. The only benefits he could receive from the trust were the satisfactions of his charitable impulses. As to those he is not to be taxed. Sec. 23 (o), Eevenue Act of 1934.

Eespondent also pleads that this is not a valid trust, assigning various reasons, some of which are not within the province of the Board. He objects in his answer, for instance, to the fact that the income of the trust has been allowed to accumulate until the fund has reached $3,000,000. There is no basis for this objection unless it be the size or possibly the unlawfulness of the accumulation. If these accumulations are unlawful, that is a matter only for the courts of Pennsylvania. The revenue acts do not provide for taxing them except when made by a corporation for the purpose of avoiding a surtax on its shareholders (see section 102, Eevenue Act of 1934), or when they are held for future distribution to the grantor. The latter is not the situation here, as we have already indicated, and the former is not in issue. It may well be true that only 10 to 15 percent of the trust income has been distributed. However, ordinarily, the trustee would report such a fact in its fiduciary return, and presumably that was done here. See sections 142 and 162 (a), Eevenue Act of 1934. In' any event, that fact is not material here.

The validity of this trust is, of course, governed by the laws of Pennsylvania. Erie Railroad Co. v. Tompkins, 304 U. S. 64; A. W. Mellon, 36 B. T. A. 977. Cf. Lyeth v. Hoey, 305 U. S. 188. At all times here involved, the following statute was in force in that state:

No disposition of property heretofore or hereafter made for any religious, charitable, literary or scientific use shall fail for want of a trustee, or by reason of the objects being indefinite, uncertain or ceasing, or depending upon the discretion of a last trustee, or being given in perpetuity or in excess of the annual value hereinbefore limited, but it shall be the duty of any orphans’ court, or court having equity jurisdiction in the proper county, to supply a trustee, and by its decrees to carry into effect the intent of the donor or testator, so far as the same can be ascertained and carried into effect consistently with law or equity; for which purpose the proceedings shall be instituted by leave of the attorney general of the commonwealth, on the relation of any institution, association, corporation not for profit or individual, desirous of carrying such disposition into effect, and willing to become responsible for the costs thereof, subject to an appeal as in other eases in said courts respectively, and to be reviewed, reversed, affirmed or modified by the supreme court of this state; but if the objects of the trust be not ascertainable, or have ceased to exist, or such disposition be in excess of the annual value permitted by law, or in perpetuity, such disposition, so far as exceeding the power of the courts to determine the same by the rules of law or equity, shall be taken to have been made subject to be further regulated and disposed of by the legislature of this commonwealth, in manner as nearly in conformity with the intent of the donor or testator and the rules of law against perpetuities as practicable, or otherwise to accrue to the public treasury for the public use: Provided, That this act as amended shall not apply to any case which has been adjudicated prior to the adoption of this amendment. (1855, April 26, P. L. 828, § 10; 1895, May 23, P. L. 114, § 1.)

From the literal wording of this statute, it is seen that charitable trusts are valid in Pennsylvania, despite indefiniteness of beneficiaries and that their provisions may be enforced by suits brought with the leave of the attorney general by charities interested in such enforcement. The Pennsylvania courts have often upheld the validity of trusts similar to the one before us. In the case of In re Thompson’s Estate, 282 Pa. 30; 121 Atl. 446, the highest court of that state held: “The fact that no fixed charity is described, the power of selection having been given by the decedent to another, does not render the trust uncertain, if some tribunal has been designated for the naming of those who shall benefit.” Such a tribunal was afforded in the instant proceeding by the “Advisory Committee.” In re Jordan’s Estate {Pa.), 197 Atl. 150, holding that a provision in a will leaving a part of the estate to “charity” created a valid, enforceable charitable trust, contains this language: “Nor is the gift rendered void because of the testatrix’ neglect to specify particular charitable objects.” Similar holdings have been made in Ould v. Washington Hospital for Foundlings, 95 U. S. 803; Gossett v. Swiwney, 53 Fed. (2d) 772; cer-tiorari denied, 286 U. S. 545, which held: * * Uncertainty as to the individual beneficiaries is characteristic of a charitable use”; United States v. First National Bank of Birmingham, 74 Fed. (2d) 360; A. W. Mellon, supra. Tested by these authorities, this trust is clearly valid.

Respondent charges in his answer that this trust was not operated exclusively for charitable purposes. This allegation is contradicted positively by the record. An examination of the trust deed and the trust accounts plainly indicates that the trust was not and could not be operated, for any but charitable ends.

As already said, the fact that some of the trust income was allowed to accumulate here is of no concern to the Board. But, in passing, it may be added that accumulations in a charitable trust, which we have here, are entirely lawful in Pennsylvania. The case of In re Archambault's Estate, 308 Pa. 549; 162 Atl. 801, holds as follows: “* * * In regard to appellant’s argument that the direction to accumulate the income from the trust fund to pay these bequests is in violation of the law against accumulations (Act April 18,1858, P. L. 503), it is sufficient to say that the statute expressly excludes accumulations for charitable purposes from its operation.”

There being no basis upon which to hold the income of the present trust taxable to its grantor,

Decision will be entered, for the 'petitioner.


author: Mellott :

text:
    Omaha Flour Mills Company, and Burlington Mill & Elevator Company, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 86414, 87320.
    Promulgated June 13, 1939.

      J. A. G. Kermedy, Esq., Tale G. Holland, Esq., and Edward J. Svoboda, Esq., for the petitioners.

      R. P. Hertzog, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined deficiencies in petitioners’ income tax in the following amounts:

Fiscal year ended June 30, 1932_$6,423.06
Fiscal year ended June 30, 1933_ 8,882.11
Fiscal year ended June 30, 1934^._-- — ,— 10,468.35

One of the two issues raised by the pleadings with respect to depreciation allowed has been waived by petitioners. The remaining issue is whether or not the respondent erred in denying petitioners and the National Baking Co. the right to file consolidated returns for the taxable years under the provisions of section 141 of the Bevenue Act of 1932.

We find the facts to be as stipulated. They may be summarized as follows:

The Omaha Flour Mills Co. (hereinafter referred to as the Omaha Co.) is a corporation, incorporated in 1906 under the laws of the State of Nebraska. Its name was subsequently changed on July 11, 1936, to Omar Mills, Inc.

The Burlington Mill & Elevator Co. is a corporation incorporated under the laws of the State of Nebraska on or about February 1929. .All of its outstanding capital stock was owned by the Omaha Co. during the fiscal years herein involved.

By amendment to the articles of incorporation of the Omaha Co. filed March 3, 1920, its total authorized stock consists of 7,500 shares of 7 percent cumulative preferred stock of the par value of $100 each, and 3,000 shares of common stock of the same par value. On July 1, 1931, the outstanding capital stock of the Omaha Flour Mills Co. was held as follows:

On or about August 31, 1932, 10 of the 1,33514 preferred shares held by minority interests were purchased by the Omaha Co. and placed in its treasury. On May 16, 1933, the National Baking Co. purchased an additional 50 shares of this preferred stock, and on October 4, 1933, purchased another 50 shares. Thereafter during the fiscal years 1933 and 1934 the said stock was held as follows:

The Omaha Co. issued to preferred stockholders certificates which had printed thereon article IV of the articles of incorporation as amended from time to time, these amendments, varying only as to the amount of authorized common and capital stock. Article IY as amended on September 2, 1919, and filed March 3, 1920, provided as follows:

The authorized Capital Stock of this Corporation shall be the sum of $1,050,000 and shall be divided into shares of the par value of $100.00 each. Seven thousand five hundred (7,500) shares of said Capital Stock shall be seven (7) per cent cumulative preferred non-voting stock of the par value of One Hundred ($100.00) Dollars each, and shall take priority over all other stock as to assets and dividends; no mortgage shall hereafter be placed on any of the property of the Company without the written consent of the owners of not less than two-thirds of the outstanding stock of this class and issue. This stock shall receive seven (7) per cent annual dividends, payable one and three quarters (1?4) per cent quarterly, to-wit: January 1st, April 1st, July 1st, and October 1st of each year; and in the event of liquidation of the Company shall be paid at par, plus any accumulated dividends before any payment is made on any other class of stock; this preferred stock shall be non-voting, with the understanding, however, that in ease the Company shall pass three consecutive annual dividends of seven (7) per cent per annum, then and in that event said stock will automatically become the sole voting stock of the Company and shall have the sole voting rights in the management and conduct of the business until all accrued dividends shall have been paid in full.

During the taxable years 768% shares of the preferred stock of the Omaha Co. outstanding and held by the minority interests were represented by certificates issued subsequent to July 18, 1919. Of the aforesaid 768% shares, 254% shares represented original issues of such preferred stock subsequent to July 18, 1919, and 514 shares represented certificates issued subsequent to July 18, 1919, at the request of certain shareholders in exchange for a like number of shares originally issued prior to July 18, 1919. All other preferred stock held by minority interests was of the original issue made prior to July 18,1919. The Omaha Co. did not pass three consecutive annual dividends of 7 percent per annum, and its preferred stockholders did not vote at any stockholders’ meeting or otherwise either during or prior to the taxable years here involved.

Consolidated corporation income tax returns for the fiscal years ended June 30, 1932, 1933, and 1934 were filed with the collector of internal revenue at Omaha, Nebraska, by the National Baking Co., as parent corporation, including therein the net income of the petitioners. The respondent determined that the petitioners and the National Baking Co. were not during the taxable years members of an affiliated group as defined in section 141 (d) of the Revenue Act of 1932 and that they were not therefore entitled under the provisions of section 141 (a) of that act to the privilege of making consolidated returns for these years.

Under the provisions of section 141 (a) of the Revenue Act of 1932 petitioners and the National Baking Co. are entitled to the privilege of filing consolidated returns of income if during tbe taxable years they were members of an “affiliated group” as defined in section 141 (d) of that act. The latter section reads as follows:

(d) Definition of “Affiliated Gkotjp”. — As used in this section an “affiliated group” means one or more chains of corporations connected through stock ownership with a common parent corporation if—
(1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly hy one or more of the other corporations; and
(2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations.
As used in this subsection the term “stock” does not include nonyoting stock which is limited and preferred as to dividends.

As heretofore pointed out, all of the capital stock of the Burlington Mill & Elevator Co. during the taxable years was owned by the Omaha Co. The parties agree that these corporations are members of an “affiliated group” and thus entitled to the privilege of filing consolidated returns with the National Baking Co., their parent company, if the latter owns at least 95 percent of the voting stock of the Omaha Co. The parties differ as to what constitutes the voting stock, petitioners contending that only the common stock has the right to vote, while respondent contends that both the common and preferred stock have this right. If petitioners are correct in their contention, they are entitled to the privilege of filing consolidated returns with the National Baking Co. as it owned all of the common stock of the Omaha Co. If on the other hand respondent’s contention is sustained, they are not entitled to this privilege as the National Baking Co. did not during the taxable years own 95 percent of the outstanding common and preferred stock of the Omaha Co.

In support of their contention, petitioners rely upon article IY of the articles of incorporation of the Omaha Co. providing that the preferred stock shall be nonvoting, and the decision of the Supreme Court of Missouri in State v. Swanger, 190 Mo. 561; 89 S. W. 872. In support of his contention, respondent relies upon the Constitution and statutes of the State of Nebraska, and the decision of the Illinois Supreme Court in People ex rel. Watseka Telephone Co. v. Emerson (1922), 134 N. E. 707.

Section 5 of Article XII of the Constitution of the State of Nebraska, in effect at the date of the organization of the Omaha Co. and for many years prior thereto, reads as follows:

The legislature shall provide by law that in all elections for directors or managers of incorporated companies, every stockholder shall have the right to vote in person or proxy for the number of shares of stock owned by him, for as many persons as there are directors or managers to be elected, or to accumulate said shares and give one candidate as many votes as the number of directors multiplied by the number of shares of stock, shall equal, or to distribute them upon the same principal among as many candidates as he shall see fit; and such directors or managers shall not be elected in any other manner.

Pursuant to tbis constitutional provision, the legislature of Nebraska enacted the following statute in 1915 (now section 24r-117 of the Compiled Statutes of Nebraska for 1929):

24-117. Corporation voting by prosy. In all elections for directors or managers of incorporated companies, every stockholder shall have the right to vote in person or proxy, for the number of shares of stock owned by him, for as many of shares of stock owned by him, for as many persons as there are directors or managers to be elected, or to accumulate said shares and give one candidate as many votes as the number of directors multiplied by the number of his shares of stock, shall equal, or to distribute them upon the same principle among as many candidates as he shall think fit, and such directors or managers shall not be elected in any other manner. Provided, the right of cumulative voting in this act shall not apply to stockholders of a corporation who own stock in another corporation engaged in competing line of business, nor to anyone who holds stock, the equitable owner of which is a stockholder in a corporation and engaged in a competing line of business, nor to their agent or representative.

In 1919 there was enacted by the Nebraska legislature, as a part of the Nebraska “Blue Sky Law”, a provision with respect to the issuance of stock by corporations (ch. 259, sec. 11, Session Laws of 1919), which became effective July 18, 1919, reading in part as follows: “All common and preferred stock shall have equal voting power.”

In 1921 the same legislature, in section 81-5408 of the Compiled Statutes of Nebraska for 1929, among other things, provided as follows: “All stock in the same corporation shall be of equal par value and all classes of stock shall have equal voting power.”

Neither petitioners nor the respondent has invited our attention to any decision of the Nebraska Supreme Court deciding whether or not the above quoted provision of the Constitution of that state prohibited the issuance of nonvoting preferred stock, and apparently that court has never considered this question. Missouri and Illinois have similar constitutional provisions but the decisions of the Supreme Courts of these states construing these provisions are in conflict.

In State v. Swanger, supra, the Supreme Court of Missouri held that the purpose of the constitutional provision of that state was a guaranty to stockholders having the right to vote of cumulating their votes, that it had no reference to the contractual right of the stockholders inter sese of providing that preferred stockholders shall, or shall not, have the right to vote such stock, and that a law enacted by the General Assembly of Missouri permitting the stockholders themselves in their articles to issue preferred stock, and fix “its preferences, priorities, classification and the character thereof”, was not in violation of the Constitution and laws of that state.

In People ex rel. Watseka Telephone Co. v. Emerson, supra, the Supreme Court of Illinois reached a contrary conclusion and held that under a similar provision of the Illinois Constitution a corporation could not in its bylaws and articles of incorporation deprive the owners of preferred stock of the right to vote for directors or managers of the company. In reaching this conclusion the court pointed out that the Illinois Legislature had enacted several laws before the Constitution of 1870 was passed, and that these enactments and the provision of the Constitution showed that it was the public policy of that state to secure to each of the stockholders of a corporation the right to vote.

The conflict in the decisions relied upon by the respective parties renders them of little value in interpreting the provision of the Nebraska Constitution here involved. Whether or not it was the intention of the framers of that Constitution to give preferred stockholders the right to vote despite the fact that a corporation’s charter contained a provision that they should have no voting rights and the preferred stock certificates contained a similar statement in our opinion can best be determined by considering the constitutional provision itself and subsequent legislation enacted by the legislature of Nebraska.

We are unable to agree with the argument of petitioner that the sole purpose of the constitutional provision was simply to abrogate the common law rule that a stockholder had only one vote irrespective of the number of shares held by him, could not cumulate his vote, and could not vote by proxy, and to define the voting rights of such stockholders as had the right to vote. We may concede that one of the purposes of the framers of this constitutional provision was to abrogate the above mentioned rule. Our problem, however, goes beyond this to another rule of the common law which permits a corporation to issue preferred stock and impose the condition that such stock should not have the right to vote, and we must determine whether the framers also had this rule in mind when they provided that “every stockholder shall have the right to vote * * We are of the opinion that they did. If they merely intended to define the voting rights of such stockholders as had the right to vote, they could easily have inserted words to disclose this intention. In the absence of such words, we believe it reasonable to presume that when they provided that every stockholder shall have the right to vote, they understood the meaning of the words used and intended to include all of the stockholders of a corporation and not the common stockholders alone. Lincoln Gas & Electric Light Co. v. Watkins, 204 N. W. 391; 113 Neb. 619; Berens v. Byram, 26 Fed. (2d) 953. The language used by the framers of the Nebraska Constitution is in our opinion plain and unambiguous, and there is therefore no occasion for construction or interpretation. United States v. Missouri Pacific R. Co., 278 U. S. 269; Commissioner of Immigration of Port of New York v. Gottlieb, 265 U. S. 310; State v. Heupel, 210 N. W. 275; 114 Neb. 797; State v. Marsh, 187 N. W. 810; 108 Neb. 267.

Petitioners also argue that the legislature of the State of Nebraska recognized that the constitutional provision under discussion and the enactment of 1915 made pursuant thereto did not give preferred stock a voting power when it provided in chapter 259, section 11, Session Laws of 1919, that all common and preferred stock shall have equal voting power, and in 1921 enacted a similar provision. In other words, ,it is the position of petitioners that the enactments of 1919 and 1921 changed the existing law of Nebraska. Having concluded that the constitutional provision and enactment of 1915 gave every stockholder the right to vote, we obviously can not agree with petitioners. It is our best judgment that the laws of 1919 and 1921 were merely declaratory of the existing law and demonstrate the uniform and consistent policy of the Legislature of Nebraska to give every stockholder of a corporation the right to vote, thus carrying out the mandate given to it in section 5 of Article XII of the Constitution of Nebraska, supra.

It is our conclusion that under the Constitution and laws of the State of Nebraska, preferred stock is voting stock, and since during the taxable years the National Baking Co. did not own 95 percent of the outstanding common and preferred stock of the Omaha Co., the petitioners and the National Baking Co. were not members of an “affiliated group” and were not entitled to the privilege of filing consolidated returns permitted by section 141 of the Revenue Act of 1932. Cf. Rudolph Wurlitser Co., 29 B. T. A. 443; affd., 81 Fed. (2d) 971.

Judgment will be entered for the respondent.


author: Murdock:

text:
    Lena P. Wheeler (Formerly Curtiss), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84992.
    Promulgated June 15, 1939.

      W. S. Hammers, Esq., for the petitioner.

      Arthur H. Fast, Esq., for the respondent.
   OPINION.

Murdock:

Glenn H. Curtiss owed the petitioner over $900,000 at the date of his death. The debt had accumulated over a period of years and was entirely genuine. Although the petitioner no doubt knew in 1931 that her debt would not be paid in full, nevertheless the amount of the loss was not determinable until the estate was closed in 1933. A proper charge-off was made in 1933. Since the extent of worthlessness could not have been determined prior to 1933, that is the year in which the deduction, if any, is allowable.

The petitioner took dower in accordance with her legal right. She next settled the largest claim against the estate for a cash payment of $565,000. The remaining assets of the estate were insufficient to pay the remaining debts and expenses. The petitioner paid those items, other than the debt due her, in full. She used the remaining assets to pay a part of tbe debt due herself. That left $509,-718.81 due her unpaid. The amount was legally due her but in fact was never paid, even though, to close the estate and to relieve the real estate from any cloud, she filed a release of her claim. The argument of the Commissioner that the debt was paid is not supported by the facts. The cancellation of the stock of National Investment Holdings, Inc., did not serve to ameliorate her loss in the slightest. The fact that the debt was allowed in full for estate tax purposes is unimportant. Bourne v. United States, 2 Fed. Supp. 228; Commissioner v. Strauss, 77 Fed. (2d) 401; Union Guardian Trust Co., 82 B. T. A. 996; affirmed by dismissal on stipulation of counsel, March 3, 1938; Baer v. Milbourne, 13 Fed. Supp. 998; Mary Q. Hallock et ad., Trustees, 34 B. T. A. 575; a fid., 102 Fed. (2d). 1; Edna F. Rayes et ad., Executors, 34 B. T. A. 808; Edith M. O'Donnell, 35 B. T. A. 251; affd., 94 Fed. (2d) 852; Commissioner v. Ames, 88 Fed. (2d) 338; Commissioner v. Windrow, 89 Fed. (2d) 69; Helvering v. Northwestern National Bank, 89 Fed. (2d) 553; Commissioner v. Lyne, 90 Fed. (2d) 745.

The Commissioner argues that the petitioner could have shared pro rata with the other creditors and to the extent that she failed to do so her loss was voluntary. This point might be troublesome were it not that the petitioner needs only $120,285.47 of her loss to wipe out the deficiency. The remainder of her loss is far more than sufficient to absorb any voluntary loss on the theory suggested.

The respondent raises the question of whether a dowager may sustain a deductible loss from a bad debt where, by her own act in claiming dower, she prevents her claim as a creditor from being recovered in full. He does not argue that her claim is not equal to that of any other creditor or that she could not enforce her claim like any other creditor. He gives as an example a case where the wife loaned $100,000 to her husband; he promptly died with no other asset; and the wife elected to take dower of $50,000. He argues that the wife would not be entitled to deduct $50,000 as a bad debt. He cites no authorities in support of his argument. The facts in the present case are unlike those in the example. If the large claim of the Herring-Curtiss Co. had been allowed in a sufficient amount, this estate would have been insolvent even though dower had not been taken. The settlement of that claim for the smaller amount was probably influenced by the election of the widow and by her willingness to pay in full all debts save that due herself. We are unwilling to say at this time on this record that the petitioner sustained no loss on her debt merely because she exercised her dower right. Theoretically her loans to him may have increased his estate and the value of her dowry. The same would have been true had the estate been solvent. In the latter case the share of the heirs or those taking under the will would be reduced, yet the law permits her to take both dower and debt. It seems no more startling that she should deduct for a bad debt when the debt is not paid.

A portion of the debt sufficient to wipe out the deficiency is deductible for 1933. The alternative contention of the petitioner requires no consideration here.

Decision will be entered for the petitioner.


author: Tyson:

text:
    The Welworth Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90897.
    Promulgated June 15, 1939.

      Henry 3. Gottfried, Esq., and George H. Drickamer, 0. P. A., for the petitioner.

      DeWitt M. Evans, Esq., for the respondent.
   OPINION.

Tyson:

This proceeding involves an income tax deficiency of $1,607.27 for the fiscal year ended July 31, 1935/

The petitioner assigns as error the respondent’s disallowance of a $12,000 adjustment, at the end of the taxable year, of its parent company’s accrued rent of $24,000 for space occupied, during that year, in two buildings owned by the petitioner.

The question presented is whether the respondent properly exercised the authority granted him by section 45 of the Revenue Act of 1934 in determining that the sum of $12,000 should be allocated from the gross income of the L. N. Gross Co. to its subsidiary, the petitioner, in order to clearly reflect the latter’s income.

The petitioner, a corporation, owns a four-story building containing 100,000 square feet of floor space, located at West 3rd Street and Lakeside Avenue, Cleveland, Ohio (hereinafter referred to as the Cleveland Building) and, also, a building at Kent, Ohio (hereinafter referred to as the Kent Building). During the taxable year and for several years prior thereto, 65 percent of the Cleveland Building and all of the Kent Building were rented to and occupied by the L. N. Gross Co., which owned and controlled 99.4 percent of the petitioner’s capital stock. The other 35 percent of the Cleveland Building, comprising part of the basement, the first floor, and part of the second floor, was rented to the Newspaper Enterprise Association. During the taxable year petitioner’s sole business activity was that of owning, renting, and managing the Cleveland Building and the Kent Building.

The L. N. Gross Co. is a close family corporation, engaged in the dress manufacturing business. The same individuals were the officers of that company and of petitioner. Both companies occupied the same office and had the services of the same bookkeeper.

The petitioner had no original books of entry. All of its receipts and disbursements were handled by the L. N. Gross Co. and entered on the latter’s books to petitioner’s account and then posted in a ledger of the petitioner. The L. N. Gross Co. collected the rent paid by the Newspaper Enterprise Association for space in the Cleveland Building, deposited such rent in its own bank account, and credited it to the account of petitioner. The rentals for the space in the Cleveland Building and Kent Building occupied by the L. N. Gross Co. were not paid in cash, but were merely entered on the books to petitioner’s credit. The accounts of the L. N. Gross Co. and of the petitioner were kept on the accrual basis of accounting and their respective income tax returns have been filed on that basis.

For several years prior to, and during the fiscal year 1935, it had been the practice of the L. N. Gross Co. and the petitioner to accrue on their books of account the amounts of $2,000 per month, totaling $24,000 per year, as rental for the 65,000 square feet of space in the Cleveland Building and the entire Kent Building occupied by the L. N. Gross Co. That rental of $24,000 per year was fixed without any relation to what would be a fair rental value for that space, but was considered by the L. N. Gross Co. to be a very “excessive” rental. It was “just a stab at a figure” representing a “sizable amount of money” which, if the L. N. Gross Co. had a good year and could afford to pay such amount to petitioner, the latter would thereby have sufficient income to reduce its debt to the L. N. Gross Co. by such amount. That debt consisted of advances by the L. N. Gross Co. used to make payments of principal and interest on a mortgage of petitioner on the property involved. Such advances to petitioner were carried on the L. N. Gross Co.’s books as an account receivable, amounting to approximately $50,000 in the taxable year, and the L. N. Gross Co. desired to have such account retired for the purpose of its credit rating. No interest was ever charged to or paid by petitioner on account of those advances.

At the end of each year, for a number of years, it had been the practice of the L. N. Gross Co. and the petitioner to make some adjustment of the accrued rental, based on the results of the L. N. Gross Co.’s business for the particular year, that is, in general, the amount of its earnings or losses. The adjustment was not made upon a definite ratio to the L. N. Gross Co.’s current earnings nor was it based upon any investigation of actual fair rental values, but was determined by the officers of the two companies, in a round table discussion, based on what they thought represented a fair rental for the year, considering the relationship of the two companies and the fact that the L. N. Gross Co. paid all of the heating, elevator service, and ordinary maintenance expenses of the two buildings. Such expenses were approximately the same for the taxable year and several prior years and were taken and allowed as deductions on the income tax returns of the L. N. Gross Co. For the fiscal years ending July 31, 1932 to 1935, inclusive, the adjustments in the accrued rentals for each of those years for the space in the Cleveland Building and the Kent Building occupied by the L. N. Gross Co. resulted in reductions of $20,000 for 1932; $8,000 for 1933; none for 1934'; and $12,000 for 1935, in such rentals.

Between the years 1933 and 1936 there was no material change in the rental value of industrial properties in Cleveland similar to the Cleveland Building involved in this proceeding. Nevertheless, varying adjustments were made in the L. N. Gross Co.’s accrued rental of $24,000 per annum except for the fiscal year ended July 31, 1934. For the taxable fiscal year ended July 31, 1935, the accrued rental of $1,500 per month, or $18,000 per annum, for the 65,000 square feet of space in the Cleveland Building, and of $500 per month, or $6,000 per annum, for the Kent Building, was adjusted by cutting those figures in half, representing a total reduction of $12,000, due to the fact that the L. N. Gross Co. could not afford to pay a high rental for that year from current earnings.

The uncontradicted evidence establishes that the adjusted rental of $9,000 per annum for 65,000 square feet of space in the Cleveland Building, or between 13 cents and 14 cents per square foot, without heat, elevator service, and ordinary maintenance expenses, was the fair rental value of that space for the taxable year ended July 31, 1935. No showing has been made as to the fair rental value of the Kent Building for that year.

The L. N. Gross Co.’s income tax return for the fiscal year ended July 31, 1934, showed, inter alia, a deduction of $24,000 for “Rent on Business Property” and a net income of $3,464.33. That company’s return for the fiscal year ended July 31, 1935, showed, inter alia, a deduction of $12,000 for “Rent on Business Property” and a net loss of $1,790.59.

The petitioner’s return for the taxable fiscal year ended July 31, 1935, reported a gross income of $12,000 less than that shown on its previous year’s return, due to the downward adjustment of its accrued rentals as hereinbefore stated.

The deficiency in controversy is due to the respondent’s determination, made under authority of section 45 of the Revenue Act of 1984, that the petitioner’s gross income as reported should be increased by the amount of $12,000 as a necessary allocation of gross income between the L. N. Gross Co. and the petitioner to clearly reflect the latter’s income.

Section 45, sufra, is similar to section 45 of the Revenue Act of 1928, the history and purpose of which was discussed at considerable length in Asiatic Petroleum Co. (Delaware) Ltd., 31 B. T. A. 1152; affd., 79 Fed. (2d) 234; certiorari denied, 296 U. S. 645; rehearing denied, 296 U. S. 664. The purpose of that section is to prevent the arbitrary shifting of gross income and/or deductions among businesses owned or controlled by the same interests. The statute vests in the Commissioner the discretionary power to make allocations of gross 'income and/or deductions of such businesses when warranted in order (1) to “prevent evasion of taxes” or (2) “clearly to reflect the income” of any of such businesses. Furthermore, when the Commissioner, in the exercise of his discretion, determines that an allocation is necessary, the taxpayer has the burden of showing that such determination was arbitrary.

In the instant case a small group of individuals, through ownership of the stock of the L. N. Gross Co., controlled that company and its subsidiary, the petitioner, and they would be the beneficiaries of the combined profits realized from the businesses of those two companies. As stated by the secretary of both of those companies, “after all, the ownership was the same.” The rental of $24,000 per annum was arbitrarily accrued on the books of both companies for each year and arbitrarily adjusted at the close of each year, for several years including the taxable year, for the purpose of showing favorable financial statements for the L. N. Gross Co. and without regard to the actual fair rental value of the petitioner’s premises. At the close of the fiscal year ended July 31, 1934, which was a good year for the L. N. Gross Co., $24,000 of its gross income was arbitrarily shifted, as rental, to the gross income of petitioner. For the fiscal year ended July 31, 1935, the L. N. Gross Co. reported a net loss of $1,790.59 after taking a deduction of $12,000 as rental paid for the space it occupied in the Cleveland Building and Kent Building. At the close of the taxable year ended July 31, 1935, only $12,000 of the L. N. Gross Co.’s gross income was shifted, as rental, to the gross income of petitioner, thereby arbitrarily reducing the petitioner’s accrued rental income. The result, for the taxable year, was to reduce the petitioner’s taxable net income by the amount of $12,000.

However, despite the method of adjusting the accrued rental on the Cleveland Building, the record establishes that the adjusted rental of $9,000 was the fair and reasonable rental for that space and, in our opinion, clearly reflected petitioner’s correct income from that source. Accordingly, we conclude that the respondent’s determination increasing petitioner’s rental from the Cleveland Building from $9,000 per annum as reported, to $18,000 per annum was arbitrary and erroneous and his application of section 45, supra, is to that extent disapproved.

With respect to the Kent Building there has been no showing that the adjusted rental of $3,000 per annum was the fair and reasonable rental value thereof. Accordingly, we conclude that the record fails to establish as arbitrary the respondent’s determination increasing the petitioner’s Kent Building rental income to the accrued amount of $6,000 per annum, but instead substantiates the propriety thereof. The respondent’s application of section 45, supra, in his determination of petitioner’s income from the Kent Building is approved.

Decisión will be entered under Bule 50.

       SEC. 45. ALLOCATION OF INCOME AND DEDUCTIONS.
      In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.


author: ÁRnold:

text:
    Charles Laughton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88104.
    Promulgated June 15, 1939.

      John B. Milliken, Esq., Eerschel B. Green, Esq., and Harriet Geary, Esq., for the petitioner.

      Alva O. Baird, Esq., for the respondent.
   OPINION.

ÁRnold:

This proceeding involves the question of whether petitioner or Industries, Ltd., shall be taxed upon sums paid to the corporation by various moving picture producers. The respondent contends that we should look through the corporate form under which petitioner’s business was alleged to be conducted to the actual and substantial facts and determine that Industries, Ltd., was organized as a tax avoidance scheme. The respondent asserts that Industries, Ltd., was merely the agent and alter ego of the petitioner, that it served as a conduit or passageway for his Hollywood earnings to his London bank account, and that the agreements between Industries, Ltd., and the Hollywood film producers were anticipatory arrangements for the deflection of income. The answer to respondent’s contentions turns upon whether the corporation should be recognized or disregarded as an entity separate and apart from the petitioner.

In New Colonial Ice Co. v. Helvering, 292 U. S. 435, 442, the Supreme Court stated:

As a general rule a corporation and its stockholders are deemed separate entities [citing eases] and this is true in respect of tax problems [citing eases]. Of course, the rule is subject to the qualification that the separate identity may be disregarded in exceptional situations where it otherwise would present an obstacle to the due protection or enforcement of public or private rights [citing cases].

See also Groves v. Commissioner, 99 Fed. (2d) 179; Commissioner v. Griffiths, 103 Fed. (2d) 110; Belle G. Loewenberg, 39 B. T. A. 844. In our opinion, however, the facts herein fail to bring this proceeding within any recognized exception to the above stated general rule.

We have found as a fact that Industries, Ltd., was a business organization, managed by business men, and created for business reasons. Its failure to engage extensively in the production of motion pictures during the taxable years was reasonably explained as due to a lack of capital. Subsequent events support this explanation. The contract of May 4,1934, indicates that the directors of Industries, Ltd., and the petitioner contemplated that Industries, Ltd., would be engaging in motion picture or theatrical activities. The testimony of one of its directors and the minutes of the directors’ meetings of Industries, Ltd., establish that as soon as sufficient capital was accumulated the company actively engaged in production.

The loan agreements whereby petitioner was to act for Hollywood producers were in accordance with the general practice in the industry, where one studio or producer had a long term contract for the services of an actor. Industries, Ltd., had such a contract for petitioner’s services, and the amount which it could realize therefrom depended upon his continued popularity with the public and the use of his services by the producing companies. While Industries, Ltd., had the right to petitioner’s exclusive services, it was obligated to pay him a salary of more than $3,000 per month for five years. By virtue of its loan agreements with studios and its rights under the assignment by petitioner of his percentage of the gross receipts from “The Private Life of Henry VIII,” the directors were able to provide the company with sufficient capital to embark upon production in their own right. This, in our opinion, was the ultimate aim and purpose for which the company was organized.

We agree with petitioner that this proceeding is in many respects comparable to the situation in Fontaine Fox, 37 B. T. A. 271. Laugh-ton’s only relationship with the contracts for the loaning of his services was to consent to the performance of the services provided for in such loan contracts. The amounts sought to be taxed as petitioner’s earnings were received by Industries, Ltd., under contracts between it and the studios. There was no assignment of future earnings or future income such as existed in Lucas v. Earl, 281 U. S. 111, and there is here no occasion to apply the doctrine of that case.

The fact that petitioner is a nonresident alien and that Industries, Ltd., is a foreign corporation is immaterial so far as the present question of law is concerned. Given the same circumstances with respect to a citizen of the United States and a domestic corporation, the principle of law would apply with equal force. The principal difference between the two classifications is that nonresident aliens and foreign corporations are subject to the withholding provisions of sections 143 and 144 of the Revenue Act of 1934 with respect to income from sources within the United States, which generally speaking have no application to citizens of this country or domestic corporations.

Considering the entire situation, we are of the opinion that Industries, Ltd., is an entity separate and apart from the petitioner, and that its income should not he taxable to him. This determination removes the necessity of considering any of the alternative issues presented by the pleadings, particularly, in view of the statements in the briefs of both parties to the effect that the sole question presented was whether the income of Industries, Ltd., was taxable to the petitioner. Since other adjustments were made by the respondent, the deficiencies should be recomputed in accordance herewith.

Decision will be entered umder Rule 50.


author: Leech :

text:
    Stockholms Enskilda Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87351.
    Promulgated June 15, 1939.

      Russell W. JacJcson, Esq., Trumam, Henson, Esq., and Robert E. Lawther, Esq., for the petitioner.

      G. R. Sherriff, Esq., for the respondent.
   OPINION.

Leech :

This is a proceeding to redetermine a deficiency in income tax of $13,600.74 for the calendar year 1933. An additional deficiency in excess profits tax for the same period in the amount of $4,945.72 has been stipulated not to exist. Petitioner also requests a finding that it has overpaid its tax for 1933, in an amount of $2,809.31.

The issue presented is whether petitioner, a foreign corporation, may dieduct losses, sustained by the sale in this country of foreign and domestic securities, from its gross income arising from sources within the United States.

The facts, which are set out in the course of this opinion, were stipulated.

Petitioner is a foreign corporation, organized and existing under the laws of the Kingdom of Sweden, with its principal office in Stockholm, Sweden. It has no place of business in this country, nor does it carry on any business here. During 1933, it received $20,431.35, consisting of interest on bonds, notes, and other interest-bearing obligations of residents of the United States. In that year it sold, in this country, through independent brokers, the following securities, for the prices shown below. The cost basis of each is also indicated.

As a result of the above transactions, petitioner sustained a net loss of $25,363.97, which it took as a deduction in its 1933 return. The item of $20,431.35, interest, previously mentioned, was also included in the return and, on such interest, an income tax of $2,809.31 was withheld and paid for petitioner at the source. Petitioner has filed a claim for refund of this amount.

Respondent disallowed the deduction of the losses sustained from the sales of securities on the ground that the losses were not connected with income from sources within the United States, within the meaning of section 232 of the Revenue Act of 1932. In his brief he advances the additional ground that petitioner was not doing business in this country. He has also included in petitioner’s income from United States sources, the sum of $77,682.50, representing the profit on the sale of United States Steel Corporation preferred stock referred to above.

Section 231 (a) of the Revenue Act of 1932 provides that in the case of a foreign corporation gross income includes only the gross income from sources within the United States; and section 119, in enumerating the items to be included in such gross income, mentions income from the sale of personal property only in subsection (e), which reads as follows:

SEO. 119. INCOME PROM SOURCES WITHIN UNITED STATES.
(e) Income From Sources Partly Within and Partly, Without United States. * * *
(2) * * * Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property without and its sale within the United States, shall be treated as derived entirely from sources within the country in which sold. * * *

Section 232, so far as here material, provides that “In the case of a foreign corporation the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States * * Respondent argues that the only'way in which petitioner could have had the benefit of this section would be to have used the proceeds of the sale of one security for the purchase of another. We do not think that contention is sound. Bo ill income and the loss which is sought to be deducted were realized by the act of selling each security, That income was in United States dollars and cents and, since the sales took place in the United States, the source of income was the United States. Sec. 119 (e), supra; Carding Gill, Ltd., 38 B. T. A. 669.

The casé is controlled, in our opinion, by Boyal Insurance Co., Ltd., 38 B. T. A. 955, in which we held that a loss sustained by a foreign insurance company upon the liquidation of certain American securities was so connected with income within section 232 of the 1928 Act (identical with the section here controlling) as to be deductible by that company. We there said :

The investment, from which the loss occurred, was made for the purpose of deriving income from United States sources. Any income resulting from this investment, whether in dividends or in profit from resale of the securities purchased, would constitute gross income from such source. * * *

It is not of any consequence that three of the securities here sold were foreign. They were sold for the purpose of deriving income from United States sources — income produced by the sale or conversion of a capital asset. Doyle v. Mitchell Brothers Co., 241 U. S. 179. The report of the Senate Finance Committee for the Revenue Act of 1918, filed in connection with the previous and identical counterpart of section 232, shows that Congress intended no differentiation as between foreign and domestic securities:

In the case of nonresident alien individuals and foreign corporations, expenses, losses, debts, depreciation, amortization, and depletion are, under the language of the House bill, allowed only to the extent that they are connected with a trade or business carried on witbin tbe United States, and tbe depreciation, amortization, and depletion deductions are allowed only with respect to property witbin tbe United States. In many cases, however, property outside of the United States is directly concerned in the production of income taxable in the United States. Accordingly, tbe limitation with respect to nonresident aliens and foreign corporations has been modified so that the specified deductions shall be allowed to tbe extent that they are connected with income arising from a source witbin the United States (sec. 214 (b) and sec. 234 (b)). [Emphasis supplied.]

That petitioner maintained no business office and was not engaged in business here likewise makes no difference. The case of Anglo-American Direct Tea Trading Co., Ltd., 38 B. T. A. 711, implicitly disposes of this point. (See section 232, supra.) There the petitioner was a Scotch holding company doing no business here and having no office in this country. Its gross income from United States sources consisted wholly of dividends received from its American subsidiary. These dividends it was allowed to deduct because they came from a domestic corporation subject to tax.

Finally, the legislative history of section 282 indicates that the prototype of that section, as originally drafted, allowed losses only in so far as connected with a trade or business carried on within the United States, and that this was changed to the present form precisely because property outside, the United States is often directly concerned in the production of income here. See Royal Insurance Co., Ltd., supra.

Since incomes are taxed on an annual basis, the four transactions here involved can not be split up and the taxable effect of each considered separately. Burnet v. Sanford & Brooks Co., 282 U. S. 359; Heiner v. Mellon, 304 U. S. 271. The net loss which petitioner sustained on the four transactions, considered as a whole, is deductible from its gross income from United States sources. It is found that there was an overpayment of tax in the amount of $2,809.31.

Decision will be entered under Rule 50.