author: Lansdon:

text:
    Appeal of H. C. HOFFMAN.
    Docket No. 6611.
    Decided July 28, 1926.
    Upon the evidence, the petitioner’s claim for deduction of bad debts for 1919 allowed, and disallowed for 1920.

      C. Parks, Esq., for the petitioner.

      Robert A. Littleton, Esq., for the Commissioner.
    Before SteRNHagen and Lansdon.
    The Commissioner has found a deficiency of $1,880.13 in taxes due for the year 1920 and $104.28 for 1921, arising from his disallowance of taxpayer’s deduction of $14,000 for 1920 and $1,500 for 1921 on account of bad debts.
    FINDINGS OF FACT.
    1. The taxpayer is a physician residing in the City of Connells-ville, Pa., where he has been engaged in the- practice of his profession since 1907.
    2. In the autumn of 1916, L. S. Brown, manager of the Underwriters’ Corporation of Pittsburgh, introduced to him W. S. Maher, at that time a field agent writing insurance for the Meridian Life Insurance Co. and fiscal agent for the sale of the stock of Hoffman’s, Inc. Maher established an office at Connellsville. Inquiries made by the. petitioner convinced him that Maher had good financial standing and was efficient in his business and reliable.
    3. During the years 1916 and 1917, the petitioner loaned Maher about $49,000, and took his promissory notes therefor. Seven such notes dated, respectively, September 10, October 29, November 5, November 28, December 3, December 4, and December 10, aggregating $22,400, and running from one to three months, were submitted in evidence at the hearing of this appeal. All but one of these instruments are simply promissory notes, payable to Hoffman, signed by Maher, and endorsed by Hoffman, and all were discounted by various banks and the proceeds thereof paid to Maher. The exception is a collateral-security note ip the amount of $2,400 with Maher and payee as above. There is nothing in the record to indicate that the specified collateral was not deposited by Maher. Another note in the amount of $3,500, made by Maher in favor of Hoffman, is dated August 28, 1919, payable in four months. This was renewal paper and was paid by Hoffman on December 29, 1919.
    4. During the year 1920, the taxpayer became convinced that Maher could make no further payments on his notes. At that time Maher was without employment, had no assets of value, and was sick. The taxpayer then assumed responsibility for the notes that he had endorsed and given to Maher for discount. He took up all such outstanding paper, paying cash to the extent of his ability at that time and giving his own personal notes, secured by ample collateral, for the balance. Such notes were submitted in evidence by the petitioner. Since making these notes, the petitioner has made substantial cash payments on them and has made no collection from Maher. The notes given by Maher to Hoffman were without value at December 31, 1920, and their worthlessness was ascertained during that taxable year,
   OPINION..

Lansdon:

Since only questions of fact are involved in this proceeding, it is only necessary for the Board to say that the petitioner was entitled to deduct the amount of $14,000 in making his income-tax return for 1920. -The evidence is persuasive that the paper in question was worthless at December 31, 1920, and that its worthlessness was ascertained in the taxable year in which it was charged off and deducted. Appeal of Mt. Vernon National Bank, 2 B. T. A. 581; Appeal of Edward F. Dalton, 2 B. T. A. 615.

The deduction of $9,500 claimed for 1921 was on account of a note ascertained to be worthless in 1920, and we approve the Commis.-sioner in his action in disallowing that claim. Appeal of Murchison National Bank, 1 B. T. A. 617; Appeal of West Virginia & Pennsylvania Coal & Coke Co., 1 B. T. A. 790; Appeal of Dover Iron Co., 1 B. T. A. 1123.

Order of redetermination will be entered on 10 days' notice, under Rule 50.


source: Caselaw Access Project

author: MaRQtjette

license: Public Domain

text:
    Appeal of M. J. RUDOLPH COMPANY, INC.
    Docket No. 2069.
    Decided July 28, 1926.
    The invested capital of the taxpayer can. not be determined and the tax should be computed under the provisions of section 328 of the Revenue Act of 1918.

      David Kamerman, O. P. A., for the petitioner.

      Robert A. Littleton, Esg., for the Commissioner.
    Before MaRquette and Moeeis.
    This appeal is from the determination of deficiencies in income and profits taxes for the years 1918 to 1920, inclusive, in the total amount of $33,097.43. The question presented is the amount of the taxpayer’s invested capital for the years mentioned.
    FINDINGS OF FACT.
    The taxpayer is a New York corporation with its principal office and place of business at Brooklyn, N. Y., and is, and has been since its organization, engaged in selling coal for use in steam vessels. It was organized in January, 1909, with a capital stock of the par value of $50,000, all of which was issued to members of the Rudolph family in exchange for the assets of a partnership which had been engaged in the coal business for many years. The assets so transferred had a net book value of $110,065.73 on January 1, 1909, the date of the transfer. The capital stock of the taxpayer remained at $50,000 during the period 1909 to 1920, inclusive, and all of it was during that period owned by members of the Rudolph family.
    The Commissioner was unable to determine the net income of the taxpayer for the years 1918, 1919 and 1920, by reason of the incomplete accounting records that were maintained by it, and computed the net income by use of comparatives of other companies engaged in a similar or like business. The computation resulted in the determination of the taxpayer’s net income as follows:
    19181_$32,290.77'
    1919_ 28, 341. 25
    1920_ 33, 727. 82
    The taxpayer, for the purpose of this appeal, accepted the determination of the Commissioner as correctly stating its net income for the years in question.
    The Commissioner determined the taxpayer’s invested capital to have been as follows:
    1918_:_1_$112,428.19
    1919_ 86,145. 74
    1920_ 81, 888.38
    In computing the taxpayer’s invested capital, the Commissioner did. npt include therein the cost of steamboats, real estate and other property actually owned by the taxpayer during the years 1918, 1919 and 1920, but which did not appear on the incomplete accounting records maintained by the taxpayer. The taxpayer attempted to prove the reproduction cost of this property by an appraisal made in the year 1925, and to establish thereby its invested capital for 1918, 1919 and 1920 in the respective amounts of $209,579.58, $217,108.76 and $200,814.98.
    Neither the net income nor the invested capital of the taxpayer for the years 1918 to 1920, inclusive, can be satisfactorily determined from its books of account or from any competent evidence now capable of being presented.
    The Commissioner upon audit of the taxpayer’s income and profits-tax returns for the years 1918, 1919 and 1920, determined that there are deficiencies in tax in the amounts of $15,764.56 for the year 1*918, $7,280.65 for the year 1919 and $10,052.22 for the year 1920.
   OPINION.

MaRQtjette

: The evidence in this appeal discloses that the accounting records maintained by the taxpayer are so inadequate and incomplete that they do not reflect either its net income or invested capital for the years involved. The Commissioner has determined the taxpayer’s net income to be that percentage of its gross sales that the net income of corporations engaged in a like or similar business is to their gross sales, and the taxpayer .has accepted that determination. However, it does not accept the Commissioner’s determination of its invested capital, but contends that the determination is incorrect.

It is clear to us that the Commissioner, in computing the taxpayer’s invested capital, did not include therein the cost of certain steamboats, barges, real estate and other property which the taxpayer actually owned during the years 1918, 1919 and 1920, but which did not appear on its books of account, and that, if the cost of this property could be ascertained and included in invested capital, the effect would be materially to reduce the tax liability for those years. The taxpayer made an earnest effort to establish the cost of this property by means of an appraisal made in the year 1925. The- figures used therein were described as “ reproductive cost ”, but they in fact represented opinions as to the value of the assets. Value is not the criterion, of invested capital. LaBelle Iron Works v. United States, 256 U. S. 377. Obviously, neither the invested capital determined by the Commissioner nor the invested capital claimed by the taxpayer is correct, and it is impossible at this time to produce any reliable or satisfactory evidence from which the true invested capital can be established.

Upon the entire record before us, we are convinced that we are confronted with exactly the kind of situation that Congress must have contemplated in enacting section 327 (a) of the Revenue Act of 1918, and that the tax liability of this taxpayer for the years 1918, 1919 and 1920 should be recomputed under section 328 of the Revenue Act of 1918, in comparison with such corporations as the Commissioner may find proper. See Appeal of H. T. Cushman Mfg. Co., 2 B. T. A. 39.

Order of redetermination will he entered on 10 days’ notice, under Bule 50.


text:
    Appeal of FIRST NATIONAL BANK OF PLATTSBURG, MO.
    Docket No. 674.
    Decided July 29, 1926.
    1. On the evidence, held, that the invested capital of the petitioner was correctly determined by the Commissioner.
    2. The Commissioner granted a refund claim filed by the petitioner and afterwards reversed that ruling and asserted a deficiency based on the facts involved in the claim for refund. Held, that the granting of the refund does not estop the Commissioner from reversing such action and asserting a deficiency.

      E. H. Whitcombe, Esq., for the petitioner.

      A. H. Fast, Esq., for the Commissioner.
    Before Sternhagen, Lansdon, and ARundell.
    The notice upon which this proceeding is based asserts deficiencies for the years 1917 to 1919, inclusive, in the total amount of $1,535.61. The controversy arises from the refusal of the Commissioner to include the total alleged value at date of acquisition of a certain tract of farm land, acquired in part as the result of legal action for the collection of a debt, in the computation of the petitioner’s invested capital for each of the taxable years. The petitioner also contends that a certain refund ruling made by the Commissioner estops the Government from the collection of the deficiencies herein involved.
    FINDINGS OF FACT.
    The petitioner is a corporation duly formed and operating under the banking laws of the United States and has been engaged in the banking business at Plattsburg, Mo., since the date of its incorporation.
    In the year 1898, the petitioner discounted an unsecured note for one of its patrons in the amount of $4,746. Shortly thereafter the maker of the note undertook to evade payment by deeding his property to creditors and members of his family, whereupon the petitioner began a legal action to secure collection of said note and attached certain parcels of real estate owned by the borrower. After litigation that continued for about 14 years, the petitioner prevailed in the Supreme Court of the State of Missouri. The land involved in this appeal was sold by the sheriff to satisfy the judgment awarded in the action to secure the collection of the unsecured note, and the petitioner bought it in on a single nominal bid, the amount of which is not disclosed by the record.
    In addition to the principal and interest of the original loan, the petitioner, in order to get a clear title to the land, paid off a mortgage thereon, extinguished the dower rights of the wife of the borrower, and paid attorney’s fees and other costs of litigation. The parties agree that, at the date an unincumbered title was acquired, the total cost of the land was $21,000, and that it was taken into the assets of the petitioner in that amount and so, carried on the books until January 3,1920, when it was sold at a price $14,325 in excess of book value. The petitioner included the profits from such sale in its income and profits-tax return for 1920.
    On or about January 3, 1920, the petitioner filed a claim for refund of taxes alleged to have been erroneously assessed and collected by the Commissioner for the years 1914 to 1918, inclusive. The basis of such refund claim was the taxpayer’s request that the amount of $14,325 be included in the computation of its invested capital for the years involved as an element of earned surplus resulting from the transaction in which land of an alleged value of $35,325 was obtained at a total cost of $21,000. On August 9, 1922, the Commissioner issued a notice of refund and certificate of over-assessment to the petitioner in which such claim, in material substance, including the claim for additional invested capital, was allowed.
    Resulting from a further audit of the petitioner’s income and profits tax returns for the years 1914 to 1919, inclusive, the Commissioner reversed his previous determination allowing refunds for the years 1914 to 1918, inclusive, and asserted deficiencies for the years 1917, 1918, and 1919, in the respective amounts of $181.61, $314.30 and $1,039.70.
   OPINION.

Lansdon:

The petitioner’s first contention is that the difference between the cost, $21,000, and the alleged fair market value, $35,325, of a certain parcel of farm lands averred to have been acquired in satisfaction of a debt should be included in the computation of its invested capital from the date of the acquisition of such land. To prevail on this point the petitioner must prove that the land in question was acquired in satisfaction of a debt, that at that time it had the value claimed, and that the difference between cost and value falls within the statutory definition of some one of the several elements of invested capital.

The Board is not convinced that the land in question was acquired in satisfaction of a debt. It is true that a debt existed, that the petitioner sued for recovery and prevailed in the Supreme Court of the State of Missouri. It is not true,' however, that the judgment of the court vested the title to the land in the petitioner. The judgment was that the land, upon which the petitioner had placed an attachment as part of the legal proceedings for recovery of the debt should be sold by the sheriff and the proceeds of such sale applied in the liquidation of the debt. To protect its interests the petitioner bought the land and received a sheriff’s deed therefor. To secure complete possession and eliminate all adverse interests in such land, the petitioner also paid off a mortgage on the land and extinguished dower rights of the wife of the prior owner at a cost of $1,500. To us it seems clear that the land in question was acquired by purchase, and that the debt involved was, in fact, only a part of the purchase price.

Upon acquiring title the petitioner took the land into its books of account as an asset at cost, which, it is agreed, was $21,000. If any greater amount is to be included in invested capital it is necessary for the taxpayer to prove the value in excess of cost that it acquired when title was taken. This it has not even attempted to do. The sheriff’s sale was a public proceeding at which anyone might bid. The fact that no one but the petitioner made an offer is a sound basis for the conclusion that others, knowing the total incumbrances to be removed before title could be cleared, did not believe that the land then had a value in excess of $21,000, which we find was the value of the farm when acquired by the petitioner. The taxpayer having failed to prove that the land was acquired in satisfaction of a debt or that it had any value in excess of cost at the date of acquisition, it is not necessary to discuss the petitioner’s contentions further as to merit.

The petitioner also contends that the Commissioner having once approved a claim for refund of taxes based on its demand for inclusion of the alleged market value over cost at acquisition, such approval may not afterwards be reversed to its prejudice. The evidence disclosed that, upon a review of all the facts, the Commissioner issued a certificate of ovérassessment and a notice of refund on or about August 9, 1922, and that on or about September 18, 1924, he reversed such action and asserted the deficiency here in question. The finding of an overassessment and the reversal of such finding were acts of the same Commissioner. We have heretofore decided this question against the petitioner’s contention in the Appeal of Dallas Brass & Copper Co., 3 B. T. A. 856; and Appeal of Warner Sugar Refining Co., 4 B. T. A. 5.

The deficiencies are: For 1917, $181.61; for 1918, $31f.30; and for 1919, $1,039.70. Order wül be entered accordingly.

Smith and SteeNhageN concur in the result only.


author: Teussell:

text:
    Appeal of F. MEYER & BROTHER CO.
    Docket No. 5384.
    Decided July 29, 1926.

      E. E. Batson, Esg., for the petitioner.

      B. H. Saunders, Esg., for the Commissioner.
    Before Smith, LittletoN, and Teijssell.
   Teussell:

This is an appeal from the determination of a deficiency in income and profits taxes in the amount of $3,518.67 for the year 1920, resulting from the disallowance by the Commissioner of a claimed deduction from gross income in the amount of $12,860.21, part of the cost of patent infringement litigation.

BINDINGS OB BACT.

1. The taxpayer is an Illinois corporation with its principal place of business at Peoria.

2. During the year 1920 the taxpayer was the defendant in a lawsuit in the United States District Court, the case being entitled Excelsior Steel Furnace Co. v. F. Meyer & Brother Co. The issue therein involved certain alleged patent infringements. In the course of the suit the court ordered an accounting to be made by the taxpayer to ascertain the amount of damages resulting from the alleged patent infringement. The pertinent parts of the order read as follows:

IT IS HEREBY ORDERED, that F. W. Nelson, a certified public accountant oí tlie State 'of Illinois, be, and be is hereby appointed to examine into the books and accounts of the defendant, F. Meyer & Brother Company, and to make and state under oath to be administered by the Master, on account in pursuance with the order of the Master, copy of which order is attached hereto; that said account shall be made and stated by September 30, 1920, unless said accountant shall at such time find it necessary to apply to the court for further time to make and complete the same.
IT IS FURTHER ORDERED, that the defendant, F. Meyer & Brother Company, shall pay the costs and charges of said accountant, for his services in making and stating said account, but that the defendant shall have the right to hereafter apply fon the retaxing of such charges upon a proper showing.

The foregoing order was made under date of August 2, 1920, and in pursuance of this order the petitioner employed auditors and accountants, the expense of which amounted to $12,860.21, which was paid by the petitioner during the taxable year 1920. The said accountants and auditors had no connection with the controversy in question other than the rendition of their services, which were contracted and paid for by the petitioner, and no part thereof was recovered by the petitioner during said year.

3. The petitioner, having paid the above-mentioned amount, caused the same to be properly entered upon its books of account as a business expense for the year 1920 and included it among its deductions from gross income in its income-tax return for that year. The Commissioner disallowed the deduction on the ground that the. amount should be treated as a clef erred charge until such time as the litigation was finally disposed of by the court. At the date of the hearing of this proceeding no final settlement of the petitioner’s liability in respect of patent infringement litigation had been had.

4. The item of $12,860.21 was an ordinary and necessary expense for the year in which paid.

Order of redetermination will be entered on 15 days’ notice, wider Rule 50.


author: Green:

text:
    Appeal of R. W. ARCHBALD, JR., and HARRY S. MESIROV, Executors of the Estate of FRANZ EHRLICH, Jr.
    Docket No. 4695.
    Decided July 29, 1926.
    The deceased was a member of a partnership. He reported his income on the basis of a calendar year and it reported its income on the basis of a fiscal year ending January 31. He died August 15, 1920. Held, that only his distributive share of its net income for its fiscal year ending January 31, 1920, should be included in his return for 1920.

      Harry ¡S. Mesirov, Esq., for the petitioners.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Marquette, MoRris, Green, and Lora.
    This appeal is from the determination of a deficiency in income taxes for the taxable period January 1, 1920, to August 15, 1920, in the sum of $1,116.68.
    FINDINGS OF FACT.
    Franz Ehrlich, Jr., a resident of Pennsylvania, died August 15, 1920. The petitioners herein are the executors of his estate. Prior to his death the deceased was a member of the partnership of Ehrlich & Archbald. This partnership’s accounts were kept on the basis of a fiscal year ending January 31. The partnership return for the fiscal year ending January 31, 1920, reported $15,164.84 as the' deceased’s distributive share of the partnership income for that period. The deceased had made his return upon a calendar year and cash receipts and disbursements basis. His return for 1920 was prepared by his executors, and therein they included as income from the partnership his distributive share of the partnership income for the fiscal year ending January 31, 1920.
    The surviving partner, for the purposes of liquidation, continued the business until January 31, 1921, at which time he credited the decedent’s estate with $11,266.32. This amount was returned by the executors así income for 1921.
    The Commissioner prorated the above amount to the period begin-ing January 31, 1920, and ending August 15, 1920, and added the amount so obtained to the deceased’s income for the year 1920.
   OPINION.

Green:

The question thus presented is: Should the individual income of the deceased be increased by the amount of partnership income attributable to the period between the close of its fiscal year and the date of his death, his distributive share of the net income for the partnership fiscal year ending within his calendar year having already been reported as income? This is but another way of asking whether, by reason of death, the net income of the deceased should include his distributive share of the net income of the partnership for a period of eighteen and one-half months instead of his share of the income for twelve months.

Both parties to this appeal base their contentions upon paragraphs (a) and (d) of section 218 of the Revenue Act of 1918, which read as follows:

Sec. 218. (a) That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year, or, if his net income for such taxable year is computed upon the basis of a period different from that upon the basis of which the net income of the partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner’s net income is computed.
The partner shall, for the purpose of the normal tax, be allowed as credits, in addition to the credits allowed to him under section 216, his proportionate share of such amounts specified in subdivisions (a) and (b) of section 216 as are received by the partnership.
* * * * * * *
(d) The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (11) of subdivision (a) of section 214 shall not be allowed.

The deceased reported his income on the calendar year basis and the partnership reported its income on the fiscal year basis. The partnership’s regular accounting period ended January 31, 1920, which was prior to the date of the death of the deceased. Had he lived through the calendar year 1920 he would have reported as income from the partnership only his distributive share of its income for the period ending January 31,1920. His death in 1920 ended his accounting or taxable period. His executors reported as his income from the partnership only his share of its income for its fiscal year ending January 31, 1920. The Commissioner seeks to include also his share of the partnership income accumulated between January 31 and August 15, 1920. This he does upon the theory that the death of a partner dissolves a partnership and that the dissolution of a partnership terminates its taxable period. Both parties, of course, agree that the death of a partner dissolves a partnership, and the question is thus narrowed down to the correctness of the Commissioner’s second proposition; and the question is whether the dissolution of a partnership terminates its taxable period.

At the outset it is advisable to mention that, so far as returns of income from the partnership are concerned, the dissolution aifects the deceased and the surviving partner alike. • The partnership’s taxable period is the same for either.

The affairs of a partnership must be wound up either before or after dissolution. This process of liquidation may in itself require more than a year. Its debts must be paid, its accounts must be collected, its contracts must be performed, its assets must be sold or distributed in kind and all of its business affairs must be terminated and disposed of. All of this will have a material bearing, not only upon the income of the partnership, but upon the income of the individual partners as well. For example, the day following the dissolution the partnership may sell an asset with a resultant gain or loss sufficient to wipe out all loss or gain which it had had since the end of its last fiscal year.

The twelve-month accounting period is one of the cornerstones of our tax structure. In addition to the statutory provisions, the taxpayers have the protection of the regulations of the Commissioner of Internal Bevenue. These have uniformly adhered to the principle of a twelve-month accounting period, and exceptions have been made only for cases where the taxpayer himself seeks to change his accounting period or where he shows that no accurate computation of income from certain classes of transactions may be made. Section 218(a) was drafted in part to preserve to the individual partner the right to return, in any one year, as income from the partnership, only his distributive share of its income for one year, and this without regard to whether their taxable years begin and end at the same time.

If the dissolution of a partnership automatically shortens its taxable year to a taxable period, the surviving partner may be deprived of his right to report only his twelve months’ income from the partnership and be compelled to report as income his distributive share of its income for a longer period.

It is true, of course, that earnings of a partnership are the property of the individual partners as soon as earned. This legal theory has not, however, been applied in the computation of net income for the purpose of taxation. The statute expressly recognizes definite accounting periods for the partnership, for the partner, or for both, and has used the calendar or fiscal year as the measure. Calendar and fiscal years are but twelve-month accounting periods. During the existence of the partnership a partner’s taxable income therefrom is not measured by his share of the partnership earnings as they are earned but, on the contrary, the statute requires that it be measured by his share of its net income during its accounting period, computed at the dose of such period, and this entirely without regard to distribution or ownership. The principle of requiring and permitting the computation of income on the basis of a twelve-month accounting period was strictly adhered to.

The Solicitor of Internal Revenue has recognized that the dissolution of a corporation does not terminate its accounting period and that it is entitled to have its tax computed uq>on its net income for its regular accounting year even though it be dissolved during that period. It seems to us that the reasons for such a holding are equally applicable to the case of the dissolution of a partnership.

To adopt the construction of the statute contended for by the Commissioner would necessitate a departure from the twelve months principle. This would be true not only as to the income of the deceased partner but also as to the income of the surviving partner who carried on the affairs of the partnership during the period of liquidation. Under the Commissioner’s theory it would be entirely "possible for a partnership to have three accounting periods during a fiscal year, the income from each of which would have to be included in the calendar year return of the surviving partner. The first would be the fiscal year ending within the partner’s calendar year; the second would be the period commencing with the .opening of the new fiscal year and ending with the death of the partner; and the third, the period commencing at the death of the partner and ending with the liquidation of the partnership within its fiscal year.

It seems clear to us that the death of a partner does not shorten the partnership’s fiscal or calendar year to an accounting. period terminating at the death of the partner and that only a complete liquidation during the calendar or fiscal year terminates the accounting period. This partnership has but one accounting period ending in 1920. The statutory net income of the partnership could not in this instance be computed before the close of its fiscal year. This being our view, we must hold that there should be included in the deceased’s return of income for 1920 only his distributive share of the partnership net income for its fiscal year ending January 31, 1920.

Our conclusion does not dispose of any questions relating to the allocation and taxation of deceased partner’s distributive share of the partnership income for the period beginning at February 1,1920, and ending with the date of his death. The amount of the net income of this partnership for its year which includes that period. can not be determined until January 31, 1921, and we have before us only the year 1920.

Judgment for the petitioners.

Smith and Trammell dissent.


author: MoRRis:

text:
    Appeal of CAROLINE S. McLEAN.
    Docket No. 1534.
    Decided July 29, 1926.
    Under the Revenue Act of 1918, the March 1, 1913, value of certain shares of stock should not he reduced by the amount of a tax-free distribution made thereon in 1917, in determining the gain derived from the sale thereof in 1919.

      Perry Schwartz, Esq., for the petitioner.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before Marquette and Morris.
    This is an appeal from the determination of a deficiency in income taxes for the calendar year 1919 in the sum of $32,351.30. The taxpayer • alleges error in determining profit from the sale in 1919 of certain shares of stock in that the Commissioner reduced the 1913 value of such stock by the amount of a dividend paid in 1917 out of earnings accumulated prior to March 1, 1913.
    FINDINGS OP PACT.'
    On March 1, 1913, the taxpayer owned certain shares of stock in the Simpson Investment Co. which she had inherited prior thereto. Its value on that date ivas $351,280.63, which was in excess of its value at the date of acquisition. During 1917 she received a dividend on said stock of $60,000, which was declared and paid from earnings accumulated by the corporation prior to March 1, 1913, and held to be non-taxable by the Commissioner. During 1919 she sold the stock for $400,000. The Commissioner in computing the profit from the sale reduced the March 1, 1913, value of the stock by the $60,000 received in 1917 and found a profit of $108,719.37, while the taxpayer determined the profit to be the difference between the sale price and the March 1, 1913, value, or $48,719.37.
   OPINION.

MoRRis:

The only question involved is whether for the purpose of determining the gain derived from the sale of certain shares of stock in 1919, their March 1, 1913, value should be reduced by the amount of a tax-free distribution received by the taxpayer in 1917. Section 202 of the Revenue Act of 1918 reads in part as follows:

Sec. 202. (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be—
(1) In the ease of property acquired before March 1, 1913, the fair market price or value of such property as of that date; * * *

The provision of the Revenue Act of 1918 relating to tax-exempt dividends is as follows:

Sec.'201. (a) That the term “dividend” * * * means (1) any distribution made by a corporation * * * out of its earnings or profits accumulated since February 28, 1913, * * *.
(b) * * * but any earnings or profits accumulated prior to March 1, 1913, may be distributed in stock dividends or otherwise, exempt from tax, after the earnings and profits accumulated since February 28, 1913, have been distributed.

The taxpayer contends that, under section 202 of the Revenue Act of 1918, the gain must be computed on the March 1, 1913, value and that any event happening between that date and the date of sale can have no effect upon the value as of that date. The fallacy of that broad statement is apparent, however, when applied to the case of a capital expenditure made after March 1, 1913, on property owned on that date. To deny a taxpayer the right to increase the March 1, 1913, value by the amount of that expenditure in computing the gain on a subsequent sale of the property would result in the taxing of capital. The same contention has already been presented to us and denied in the Appeal of Even Realty Co., 1 B. T. A, 355, in which we used the following language:

We have no hesitation in holding that Congress in using the word basis meant nothing but starting point or primary figure in the computation of gain or loss and had no intention of restricting that computation to a simple subtraction of the basis from the selling price or vice versa. It expected the computation to include all adjustments necessary to a logical ascertainment of gain or loss. The only reason for using the word at all was to take care of the different situations arising when the property disposed of had been acquired (®) before and (6) on or after March 1, 1913. It fixed the starting point or primary figure of computation in the respective eases, but did not attempt to define every step of the computation under varying circumstances.

The Supreme Court, in the recent decision of United States v. Flannery, 268 U. S. 98, held that the March 1, 1913, value was . merely a limitation upon the amount of the actual gain or loss that would otherwise have been taxable or deductible.

The rejection of this contention does not lead ipso facto to the Commissioner’s conclusion. The question is not so easily disposed of. The theory upon which the Commissioner applies the amount of the tax-free distribution against the March 1, 1913, value of the stock is that such distribution is in effect a return of capital to the stockholder. Article 1549 of Regulations 45, as amended by T. D. 3557, provides:

In general, any distribution made by the corporation other than out of earnings or profits accumulated since February 28, 1913, is to be regarded as a return to the stockholder of part of the capital represented by his shares of stock, and upon a subsequent sale of such stock his gain will be the excess of the selling price over tlie cost of the stock after applying on such cost the amount of such capital distribution. However, if such shares were acquired prior to March 1, 1913, and the fair market value as of such date was greater than the cost thereof after applying on such cost and value the amount of any such capital distribution, and was less than the sum received in distribution, the amount which is taxable is the excess over such value of the sum received in distribution.

Earnings accumulated by a corporation prior to the incidence of the income-tax law are capital to the corporation for the purposes of taxation, but that fact does not make such earnings capital to the stockholders as of March 1, 1913. The ownership of stock does not create an ownership in the assets of the corporation. The Supreme Court in Rhode Island Hospital Trust Co. v. Doughton, 270 U. S. 69, held:

The owner of the shares of stock in a company is not the owner of the corporation’s property. He has a right to his share in the earnings of the corporation as they may be declared in dividends arising from the use of all its property. In the dissolution of the corporation he may take his aliquot share in what is left, after all the debts of the corporation have been paid and the assets are divided in accordance with the laws of its creation, but he does not own the corporate property.

The Commissioner ascribes two meanings to the term return of capital.” One, he says, represents a return to the stockholder of his original investment, the actual amount of capital advanced by him; the other and the one which he contends is the correct meaning and applicable to this tax-free distribution, the return to the stockholder of the value of what he owned on March 1, 1913. He argues that what the stockholder owned on that date is capital (article 87, Regulations 45) and cites the Appeal of James Dobson, 1 B. T. A. 1082, in which the Board held that, after a corporation in liquidation has distributed all its earnings accumulated subsequent to March 1,1913, any further distribution in 1918 must have been out of capital. It does not follow, upon the adoption of the second definition, however, that the receipt of such a tax-free distribution as is involved in this appeal is a return of capital. We are not here dealing with a partial or complete liquidation as was the Supreme Court in Lynch v. Turrish, 247 U. S. 221, in which it held that the amount received by a stockholder in liquidation of a corporation was not taxable to him where such amount did not exceed the March 1, 1913, value of the stock, although the distribution included cash from the realization after that date of appreciation in assets existing prior thereto; nor does the Appeal of James Dobson, supra, sustain the proposition contended for by the Commissioner in the instant appeal, as a liquidation was involved therein. The Commissioner has recognized the distinction in article 1548, of Regulations 45, as amended by T. D. 3206, between a liquidating dividend and an ordinary dividend, wherein it is provided:

A distribution in liquidation oí the assets and business of a corporation, which is a return to the stockholder of the value of his stock upon a surrender of his interest in a corporation, is distinguishable from a dividend paid by a going corporation out of current earnings or accumulated surplus when declared by the-directors in their discretion, which is in the nature of a recurrent return upon the stock.

This appeal involves a cash dividend paid by a going concern in the ordinary course of its business which, by the provisions of the Revenue Act in effect at the time of its distribution, was tax exempt. The question narrows itself down to the proposition whether such a distribution is a return of capital to the stockholder. If it is, the March 1, 1913, value of the stock should be reduced by that amount in determining the gain from a subsequent sale; if not, such reduction should not be made under the Revenue Act of 1918, which contains no provision relative thereto.

That an ordinary cash dividend is inherently income to a stockholder does not need extended argument. It is a gain derived from capital and as such is income within the meaning of that term as defined in Eisner v. Macomber, 252 U. S. 189. In United States v. Phellis, 251 U. S. 156, 171, the court used the following language:

It is the appropriate function of a dividend to convert a part of the surplus thus accumulated from the property- of the company into property of the individual stockholders; the stockholder’s share being thereby released to and drawn by him as profits or income derived from the company. That the distribution reduces the intrinsic capital value of the shares by an equal amount is a normal and necessary effect of all dividend distributions — whether large or small and whether paid in money or in other divisible assets — but such reduction constitutes the dividend none the less income derived by the stockholder if it represents gains previously acquired 6y the corporation.

A dividend is none the less income to the stockholder though a distribution of earnings accumulated by the corporation prior to March 1,1913, and is taxable in the absence of express statutory exemption. In Lynch v. Hornby, 247 U. S. 339, the court said:

Dividends are the appropriate fruit of stock ownership, are commonly reckoned as income, and are expended as such by the stockholder without regard to whether they are declared from the most recent earnings, or from a surplus accumulated from the earnings of the past, or are based upon the increased value of the property of the corporation. The stockholder is, in the ordinary case, a different entity from the corporation, and Congress was at liberty to treat the dividends as coming to him ab extra, and as constituting part of his income when they came to hand.
Hence we construe the provision of the act that “the net income of a taxable person shall include gains, profits, and income derived from * * * interest, rent, dividends, * * * or gains or profits and income derived from any source whatever ” as including (for the purposes of the additional- tax) all dividends declared and paid in the ordinary course of business by a corporation to its stockholders after the taking effect of the act (March 1, 1913), whether from current earnings or from the accumulated surplus made up of past earnings or increase in value of corporate assets, notwithstanding it accrued to the corporation in whole or in part prior to March 1, 1913.

See also Eisner v. Macomber, supra; and Peabody v. Eisner, 247 U. S. 347.

It was argued in the Hornby case that the dividends were not taxable because the 1916 Act had excluded such dividends apparently on the theory that they were capital and not income. Upon that interpretation the court said:

In short the word “ dividends ” was employed in the act as descriptive of one kind of gain to the individual stockholder; dividends being treated as the tangible and recurrent returns upon his stock, analogous to the interest and rent received upon other forms of invested capital.
In the more recent Income Tax Acts, provisions have been inserted for the purpose of excluding from the effect of the tax any dividends declared out of earnings or profits that accrued prior to March 1, 1913. This originated with the Act of September 8, 1916, and has been continued in the Act of October 3, 1917. We are referred to the legislative history of the Act of 1916, which it is contended indicates• that the new definition of the term “dividends” was intended to be declaratory of the meaning of the term as used in the 1913 Act. We cannot accept the suggestion, deeming it more reasonable to regard the change as a concession to the equity of stockholders granted in the 1916 Act, in view of constitutional questions that had been raised in this case, in the companion case of Lynch v. Turrish, and perhaps in other cases. These two eases were commenced in October, 1915; and decisions adverse to the tax were rendered in the District Court in January, 1916, and in the Circuit Court of Appeals September 4, 1916.

The provisions in the 1916 and subsequent Acts exempting such dividends did not have the effect of changing their fundamental nature and converting into capital that which was income. Tax exemption on certain kinds of income does not change that income into capital. The taxpayer’s capital in the instant appeal consisted of shares of stock having a certain value on March .1, 1913. The proposition that the receipt of income derived from that capital constitutes a return of capital is self-contradictory. As the distribution was income, the amount thereof can not be applied against the basis in determining the gain on a subsequent sale in the absence of express statutory authority. The criterion whether the March 1, 1913, value of property should be reduced by the receipt of income can not be the taxability or non-taxability thereof; otherwise it would follow that such reduction should be effected by the receipt of interest or rent where the recipient’s personal exemption exceeds his net income, a conclusion which is at variance with our understanding of the principles of income-tax legislation.

The Commissioner’s position is not only unsound in principle, but the legislative history of the dividend and gain and loss provisions of the several revenue acts supports the conclusion hereinabove set forth. The 1913 Act did not provide for the exemption of dividends declared and paid after March 1, 1913, out of earnings and profits accumulated prior thereto. Such distributions were held taxable under that Act in Lynch v. Hornby, supra. Beginning with the 1916 Act and continuing through the various acts up to and including the Revenue Act of 1926, the term “ dividends ” was held to mean any distribution made by a corporation out of its earnings or profits accumulated since February 28, 1913, and starting with the Revenue Act of 1916, as amended by section 1211 (5) of the Revenue Act of 1917, earnings and profits accumulated prior to March 1, 1913, might be distributed exempt from tax after the earnings and profits accumulated since February 28, 1913, had been distributed. Prior to the Revenue Act of 1921 there was no provision relating to the reduction of cost or March 1,1913, value by the amount of a tax-free distribution in determining the gain or loss on a subsequent sale of the stock. When the bill which later became the Revenue Act of 1921 was first introduced in the Senate as passed by the House, section 201 (c) was practically the same as the 1918 Act and provided that amounts distributed in liquidation of a corporation should be applied against the basis and any excess treated the same as other gains. During the course of its consideration, an amendment was made proposing to apply against the basis provided in section 202 any tax-free distribution for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of the stock. In the discussion which followed it was pointed out that the purpose of the amendment was to stop a leak in the 1918 Act. Senator Kellogg-discussed the proposed change in connection with his understanding of the 1918 Act in the following language (61 Cong. Rec., pt. 6, p. 6482) :

In other words, if profits made prior to March 1, 1913, were thereafter distributed, they would be automatically charged against the value of the stock on March 1, 1913, by the amount of dividends he receives from profits without any regard to the market value of the stock. If the stockholder sold his stock he would necessarily pay a tax on the distribution of profits made prior to March 1, 1913. That is all there is of it. It does not make any difference in the market value of the stock as the law now stands, if the stockholder owns stock, whether he buys it or has owned it for many years. They take the market value of his stock on March 1, 1913, and if he thereafter sells that stock at a profit he has to pay the tax on it and that is perfectly proper.
But the amendment proposed automatically reduces the market value of his stock on March 1, 1913, by the amount of dividends he receives from profits made before that date so as to automatically increase his taxes to that extent. In other words, as to the stockholder who must sell his stock, it taxes his income made prior to March 1, 1913; as to the stockholder who is able to keep his stock, it is not taxed. It seems to me that is all there is of it. I do not think that should be the rule of law.

The proposed amendment was voted down and the bill as finally passed provides:

Sec. 201. * * * (t>) * * * If any such tax-free distribution has been made the distributee shall not be allowed as a deduction from gross income any loss sustained from the sale or other disposition of his stock or shares unless, and then only to the extent that, the basis provided in section 202 exceeds the sum of (1) the amount realized from the sale or other disposition of such stock or shares, and (2) the aggregate amount of such distributions received by him thereon.

The Revenue Act of 1924 added the additional provision, which has been carried into the Revenue Act of 1926, that such tax-free distributions shall be applied against and reduce the basis of the stock lor the purposes of determining gain as well as loss. Section 201 (b). This provision appears for the first time in the Revenue Act of 1924 and its absence in the prior Acts, particularly in the Revenue Act of 1921, when a persistent effort was made to have it included therein, and the overwhelming vote by which it was defeated could have carried an express provision prohibiting such reduction had it been the opinion that the prior Act required the reduction without any reference thereto, indicates to our minds that Congress did not intend that subh a reduction should be made under those Acts, otherwise the provision in the two most recent Acts would have been unnecessary.

Order of redetermination will be entered on 15 days’ notice, under Bule 50.


author: TRAmmell

text:
    Appeal of ART METAL CONSTRUCTION CO.
    Docket No. 4943.
    Decided July 29, 1926.
    1. 'Value of patent determined on the evidence.
    2. The taxpayer is entitled to have its taxes assessed under section 210 of the Revenue Act of 1917, on the ground that its invested capital can not be determined.

      John Lord OBrian, Esq., for the petitioner.

      J. K. Moyer, Esq., for the Commissioner.
    Before Phillips and Teammell.
    This is an appeal from the determination of a deficiency in income and profits taxes for 1917 in the amount of $6,488.54. The deficiency results from reduction of' invested capital and the disallowance of an amount claimed for the exhaustion of a patent for 1917. The taxpayer also claimed the benefit of having its taxes assessed under section 210 of the statute, on the ground that the invested capital could not be determined.

      FINDINGS OF FACT.
    The taxpayer is a Massachusetts corporation organized in 1899, with its principal office at Jamestown, N. Y. Its business has increased from year to year until 1917, when it employed approximately 1,100 persons, of whom 25 to 35 were women.
    The taxpayer manufactures metal and wooden, furniture, principally office furniture and furniture for libraries. The manufactured articles were partly covered by patents. Some of the patents covering the manufactured articles were obtained by purchase and others, including the patent on the Amco suspension device, which was issued on April 14, 1908, were developed in its own plant by its employees. The Amco suspension patent was taken out in the name of its employees who developed it and was assigned by them to the taxpayer in 1908. The cost of developing this patent was charged to expense, but on account of the method of bookkeeping and inadequate records the amount of expense incurred in developing the patent can not be determined. In 1917 another patent was issued on the Amco suspension device, slightly improving it. The total patent account appeared on the boobs of the taxpayer on February 28, 1913, at $250,000, and on January 1,1917, at $175,000.
    The net profits for five years prior to 1908, when the patent was obtained, and for five years subsequent to 1908, as they appear on the books of the taxpayer, were as follows:
    1903_$122,078.87
    1904_ 186, 859. 94
    1905_ 172, 558. 85
    1906_ 575, 748. 43
    1907_ 412, 708. 87
    1908_$141, 550. 00
    1909_ 121,158. 24
    1910_ 39, 279. 80
    1911_ 148,461. 90
    1912_ 390, 298. 20
    The Amco suspension patent covers an invention which permits the free movement of filing drawers, etc., in filing cabinets so as to reduce the amount of friction, and at the same time simplifies the construction by doing aw;ay with rollers mounted on studs which wear out and work loose. The invention also permits the drawer to be extended at full length without dropping or sagging. Prior to 1908 there was used on metal cabinets what is known as a pan suspension. There was considerable friction in this suspension device and it did not permit the drawer to be drawn out at full length while in use. Several years were required to develop a new suspension which would stand up with the metal filing case. The taxpayer was the original manufacturer of metal furniture and was the largest manufacturer at the time of the development work on the new suspension device. The Amco suspension was the most advanced device for its purpose at the time it was patented and in 1913.
    This suspension system has been a great factor in the taxpayer’s commercial history. It has made possible the manufacture of certain. tilings which had previously been found impracticable. It was only through it that the vertical filing system for papers as large as 24 inches by 18 inches was made practicable. It also saved considerable space. The Amco suspension is also more durable than the pan suspension. The cost of the Amco suspension is slightly in excess of the cost of the pan suspension. The Amco suspension costs $1.89 per pair, while the pan suspension costs 35 cents per pair, making a set of four pairs of Amco suspension devices cost $5.56, while the cost of four pairs of the pan suspension is $1.40, the increased cost of the Amco suspension over the pan suspension being $4.16. The selling price, however, of the filing cases with Amco suspension was $38.00, while the price of the same filing case without above suspension was $32.50, making an increase in price due to the Amco system of $5.50, making a profit per case assignable directly to the Amco suspension of $1.34.
    As soon as the Amco suspension was patented, it was featured in catalogues and otherwise by the taxpayer and has been an outstanding feature since the issuance of the patent.
    The sets of stock goods manufactured by the taxpayer from 1908 to 1913 are shown below:
    1908 11, 650
    1909 15, 956
    1910 23,108
    1911 44,340
    1912 38, 922
    1913 58, 416
    After the acquisition of the Amco patent and prior to March 1, 1913, the taxpayer was establishing new markets for,its goods.' It had to overcome opposition to metal furniture which, to some degree, was caused by its imperfections, which the Amco suspension overcame. On March 1, 1913, the outlook for the future was bright. The indications were that there would be a continuous increase in its business due largely to the use of the Amco suspension. The value of the patent on March 1, 1913, was $225,000.
    The Commissioner used as a basis for computing the deduction on account of the exhaustion of depreciable assets other than patents for 1917, the following values:
    Land- $61, 070.75
    Buildings- 454, 989. 58
    Power plant- 70, 792. 42
    Light, heat, etc- 23, 779. 93
    Machinery- ' 172, 981.63
    Factory fixtures- 86, 375. 05
    Special tools, etc- 162, 362.11
    Office furniture and fixtures- 74, 529.41
    Forges, ovens, etc_ 9, 770. 54
    Patterns of stock_ 10, 417. 83
    1,127, 069.15

      Taxpayer and. the Commissioner have stipulated that the value of the assets on January 1, 1917, was $1,240,110.43, instead of $1,127,-069.15; that depreciation for 1917 should be computed on the basis of the above amount, less value of land; that $194,213.84 should be restored to invested capital on account of the Commissioner’s adjustment for insufficient depreciation for prior years; and that invested capital as computed by the Commissioner should be reduced $81,172.56 on account of appreciation of assets by the taxpayer.
    The taxpayer’s buildings were of brick, except three frame buildings, which were 27, 23 and 20 years old, respectively, and were in good condition owing to extraordinary repairs. Three men were engaged almost exclusively in repairing buildings and floors. Their wages and the material used were charged to expense.
    The rates claimed for depreciation by the taxpayer and the rates allowed by the Commissioner on the disputed ítems are as follows:

    The power plant consisted of four 150-horsepower McEwen tubular boilers, two boiler feed pumps, one Cochran open-feed water heater and two return feed pumps, one 250-horsepower Alburger tandem gas engine directly connected with a 175-kilowatt Crockwheeler generator, one 150-horsepower twin cylinder gas engine belted to a 100-kilowatt generator, one 50-horsepower steam engine, an Inger-sol Randall air compressor, an exciter for alternating current generator, and two high pressure air tanks used for starting gas engines.
    The machinery is used for stamping, forming and blanking cold steel. The greater part of the machinery consists of knotching presses and forming presses; also welding equipment and forming machinery, shears, brakes and bending brakes.
    Factory fixtures consisted of benches, racks, bins, boxes for carrying material, and trucks.
    Patterns of stock consisted of metal and wood patterns, 65 per cent of which were metal.
    In 1916 and 1917 a program was carried out by the taxpayer to put the plant assets in good condition. Old machines were repaired and new equipment bought, particularly welding equipment.
    The Commissioner reduced invested capital by $118,589.68, on the ground that insufficient depreciation had been taken in prior years.
   OPINION.

TRAmmell

: The stipulation of the taxpayer and the Commissioner set out in the findings of fact disposes of the asset values on January 1, 1917, the amount upon which depreciation should be computed, and, in part only, the amount to be restored to invested capital on account of the Commissioner’s adjustment for depreciation for prior years.

The questions in dispute are: (1) The amount taxpayer is entitled to take as deductions from gross income for 1917 on account of the exhaustion, wear and tear of certain assets; (2) whether depreciation taken by the taxpayer in prior years should be increased in determining invested capital; and (3) the March 1, 1913, value of the Amco suspension patent on which the deduction on account of the exhaustion thereof should be computed.

The rates at which depreciation has been computed by the Commissioner on various assets and the rates claimed by the taxpayer are set out in the findings of fact. The evidence submitted by the taxpayer in support of the rate of 4 per cent on frame buildings consisted principally of the testimony of its master mechanic, who stated that the principal frame buildings were known as buildings 3, 4 and 5; that in 1917 the oldest building would be 27 years old, the others 23 and 20; that extraordinary precaution was taken in repairing buildings, and in his opinion the rate of depreciation should be 5 or 6 per cent per annum. The opinion of this witness is inconsistent with demonstrated facts, since the buildings are all over 20 years old and in good repair. The evidence discloses that all buildings were carried in one account and no segregation was made as to the amount of brick and frame buildings separately. It may be that the Commissioner considered the character, construction, use and other relevant facts relating to the frame buildings when he determined that a composite rate of 2 per cent on all buildings was proper. Even if we were of the opinion from the evidence that the frame buildings taken alone suffered exhaustion at a greater rate than that allowed by the Commissioner, the taxpayer has not established that the composite rate on all buildings taken together is not fair and reasonable.

With respect to the deduction on account of the exhaustion, wear and tear of the power plant, machinery, factory fixtures and patterns, we are not convinced from the evidence that such assets had a shorter useful life than that determined by the Commissioner.

No evidence was introduced with respect to depreciation for prior years further than that the Commissioner determined that the taxpayer had not made adequate deductions therefor. If the taxpayer actually charged betterments and replacements to expense so as to practically balance proper deductions for depreciation, we have been furnished no evidence thereof. The taxpayer claims that the depreciation determined for prior years is excessive and that determined for the taxable year is inadequate. The Commissioner appears, however, to have used the same rate throughout. In the absence of any evidence we must approve the determination of the Commissioner with respect to the depreciation for prior years.

The second issue involved is the value of the Amco suspension patent for depreciation purposes. The taxpayer contends that this patent had a March 1, 1913, value of $600,000, on which the deduction for exhaustion, wear and tear should be computed for 1917. The taxpayer had other patents in addition to the Amco suspension patent and all were carried on the books of the taxpayer at $250,000 at March 1, 1913.

The bookkeeping entries are not conclusive as to values which are shown therein. They are only evidentiary at most and may be overcome by evidence. There is no evidence that the bookkeeping entries even pretended to reflect actual values or costs as they existed on that date. If the assets appearing on the books had increased in value since the date of acquisition the taxpayer is entitled to revalue them as of March 1,1913, for the purpose of taking a deduction on account of the exhaustion, wear and tear thereof.

In determining what the March 1, 1913, value was we should consider all the facts and circumstances as they existed at that time, including the reasonable prospects for the future. It is not necessary to set out here the facts which are contained in the foregoing findings of fact, but from a consideration of all the facts, including the testimony of persons who were qualified to express their opinions with respect thereto, we are of the opinion that the Amco suspension patent, on March 1, 1913, had a value of at least $225,000, on which the taxpayer should be allowed to take a deduction on account of the exhaustion.

Since the invested capital can not be determined due to the fact that the cost of the acquisition of the patent herein referred to and the other patents of the taxpayer can not be determined, the tax should be computed under the provisions of section 210 of the Revenue Act of 1917, and the tax so determined by the Commissioner will be considered final.

Order of redeterrrdnation will be entered on 10 days’ notice, under Rule 50.


author: Littleton:

text:
    JAY N. DARLING, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
    Docket No. 6302.
    Decided July 29, 1926.
    1. Upon the evidence, Held, that the value of 50 shares of stock, received in 1923 as compensation for services rendered, constitutes income in that year.
    2. Evidence held' insufficient to show error in the Commissioner’s determination of the deductons to which petitioner was entitled for the years 1918, 1920, 1922 and 1923, on account of expenditures for traveling, supplies, periodicals, telephone, telegraph, office salaries and club dues.
    3. Petitioner was not entitled to a deduction on account of amounts expended for the upkeep, operation and depreciation of an automobile not used in carrying on his business.
    4. The useful life of a building used in petitioner’s business determined from the evidence.
    5. Under the provisions of section 274 (g) of the Revenue Act of 1926, the Board is without jurisdiction to change the Commissioner’s determination of overassessments for any year. Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

      Clifford Tewdall, C. P. A., for the petitioner.

      L. C. Mitchell, Esq., for the respondent.
    Before Littleton and Teammell.
    This proceeding involves the questions of whether the Commissioner correctly held that 50 shares of stock received by petitioner in May, 1923, for services rendered, constituted income; and whether certain alleged expenditures in the years 1918 to 1923, inclusive, for traveling, entertaining, supplies, magazines and periodicals, telephone, telegraph, office salaries and expense, club dues, and the upkeep and operation of an automobile, together with depreciation of such automobile, and of a studio erected in 1921, constituted proper deductions from gross income for such years.
    In the notice mailed to the petitioner on June 13, 1925, the Commissioner determined deficiencies and overassessments as follows:

      FINDINGS OF FACT.
    The petitioner is a resident of Des Moines, Iowa, where he is engaged in business as a cartoonist. On May 9, 1913, he entered into a contract with the president and treasurer of the Register and Leader Co., a newspaper published at Des Moines, the name of which was subsequently changed to the Register-Tribune. In addition to an annual compensation, the contract provided as follows:
    As further compensation for the ten years of service as contracted for, Gardner Cowles agrees with the said Jay. N. Darling to pay him a stock bonus as follows, conditioned upon satisfactory service being rendered by the said Jay N. Darling during the term of this contract. * * * On April 1, 1923, provided at that time the said Jay N. Darling has rendered the full ten years of satisfactory service and completed this contract, the said Gardner Cowles agrees to transfer $5,000 (50 shares) of the common stock of the Register and Leader Company to' said Jay N. Darling. The total amount of stock bonus covered by this contract, including the first $1,000, is to be $10,000 (100 shares).
    * J¡: s¡« ❖ s¡: *
    So long as the said Gardner Cowles or his heirs own a controlling interest in the Register and Leader Company,' the said Jay N. Darling agrees not to dispose of any of his stock to any other buyer without first offering the stock to the said Gardner Cowles or his heirs on the same terms offered by the other buyer, that is, the said Gardner Cowles or his heirs are to have the first right to purchase any stock owned by the said Jay N. Darling in case he wishes to dispose of it.
    The petitioner received certain shares of stock in the years 1913 to 1918, and 50 shares of stock in 1923. No question is raised, however, as to the stock received other than 50 shares received in 1923. The Commissioner held that the 50 shares constituted income to the petitioner and determined the value thereof to have been $7,000 at the time received.
    On February 2, 1917, the petitioner entered into a contract with the Tribune Association, a newspaper published in New York, to furnish that newspaper with cartoons. The contract provided for a fixed annual salary to be paid by the Tribune to the petitioner in weekly installments. It further provided as follows:
    It is understood that the party of the second part, [the petitioner herein], will coiné to New York City whenever the circumstances render it necessary or advisable and that he will make certain of said cartoons and illustrations in the City of New York and certain other of said cartoons and illustrations in the City of Des Moines, Iowa. * * » The party of the first part [the Tribune Association] will repay to the party of the second part the cost of the preparation of said mats and of the mailing thereof and will also repay to the party of the second part his traveling expenses in traveling from Des Moines, Iowa, to New York City, and from New York Ci(y to Des Moines, Iowa.
    This contract remained in force until January, 1921, when another contract was entered into between the same parties which, so far as material to this proceeding, provided as follows:

      Tlie party of the first part [the Tribune Association] agrees to pay to the party of the second part the sum of Twenty Six Thousand ($26,000) Dollars per year during the term of this agreement, in equal payments of ($500) Dollars each, together with the additional compensation hereinafter referred to. * * * The party of the first part agrees that when in any quarter of the term of this agreement the gross amount of billings through the syndicating of the cartoons and illustrations furnished to the' party of the first part by the party of the second part in accordance with this agreement shall exceed Eleven Thousand Seven Hundred ($11,700) Dollars, it will pay to the party of the second part as the additional compensation above referred to, an amount equal to 50 per centum of the excess of such gross quarterly billing over Eleven Thousand Seven Hundred ($11,700) Dollars per quarter. * * * The said additional compensation shall be computed at the end of each quarter year of the term of this agreement * * *.
    * * # * * * *
    The party of the first part will repay to the party of the second part the cost of the preparation of said mats and of the mailing thereof and will also repay to the party of the second part his traveling expenses in traveling from Des Moines to New York City, and from New York City to Des Moines, and hotel bills while in New York City.
    During the taxable years petitioner made numerous trips from Des Moines to New York City and return,' spending considerable time in New York on each occasion, drawing cartoons and attending conventions and gatherings, for the purpose of obtaining information necessary in his business. Petitioner’s traveling expenses for the taxable years were as follows: 1918, $1,781.32; 1919, $4,925.33; 1920, $6,081; 1921, $5,763.19; 1922, $5,695.65; 1923, $2,609.74.
    Petitioner expended for entertaining and club dues certain amounts, entirely for business purposes, as follows: 1918, $985.54; 1919, $1,054.11; 1920, $740.00; 1921, $584.89; 1922, $462.79; 1923, $789.76.
    He also expended amounts for supplies, magazines, periodicals, telephone, telegraph, office salaries and expenses, as follows: 1918, $741.57; 1919, $1,400.24; 1920, $1,651; 1921, $151.98; 1922, $1,511.61; 1923, $1,688.19. . '
    During the years 1918 to 1923, petitioner engaged in sculptural work for the purpose of equipping himself for the profession of a sculptor when the time should come when he would be unable longer to carry on that of a cartoonist. In this work he.used almost exclusively one of two automobiles owned by him. . This automobile was also used to some extent in his business as a cartoonist. During this period he expended the following amounts in maintaining and operating this automobile: 1918, $498.17; 1919, $822.40; 1920, $1,423.82; 1921, $1,081.77; 1922, $1,008.60; 1923, $345.92.
    In 1921, petitioner constructed a studio in:which to carry on his business as a cartoonist, at a cost of $6,500. This building was used entirely in his business and was not suitable- for use for any other purpose. At the time of its construction it had a useful life in the petitioner’s business of 15 years.
   OPINION.

Littleton:

The petitioner alleges that the 50 shares of stock of the Eegister and Tribune Co. were not income for the reason that, under the terms of the contract, he was restricted in the sale thereof, and it therefore had no readily realizable market value.

It was stipulated that, if the Board should hold that the petitioner was not prevented by the terms of the contract from selling the stock, the value as fixed by the Commissioner would be correct. The agreement between the petitioner and Cowles did not provide that the petitioner might not sell the stock, but merely that Cowles, the president and controlling stockholders of .the newspaper should first be given the opportunity of purchasing the stock in case the petitioner wished to dispose of it. Had the petitioner desired to sell the stock and had Cowles declined to purchase it, he would have been free to dispose of it in any manner he might have deemed proper. Under these circumstances the Commissioner properly held that the value of the stock, amounting to $7,000, was income.

The total amounts expended by the petitioner for the various purposes set forth in the findings of fact, not including amounts claimed as exhaustion, wear and tear of the automobile and studio, and the total amounts allowed by the Commissioner in each of the years, are as follows: '

1918 1920 1921 1922 1923 Total amounts claimed.-. Total amounts allowed by Commissioner.. $3,508.43 2,257.19 $7,379.68 2,313.50 58,472.00 2,407. 28' $6,500.06 4,517.77 $7,670.05 5,239.40 $5,087. C9 3, 615.88

The contract between the petitioner and the Tribune Association, dated February 2, 1917, provided that the Tribune should repay to the petitioner “his traveling expenses from Des Moines to New York and from New York to Des Moines.” The contract of January, 1921, also provided that the petitioner should be repaid his traveling expenses and also his hotel bills. '

' The Board is unable to determine from the evidence whether or not under the contract of 1917, which remained in force until 1921, the petitioner was reimbursed by the Tribune Association for his hotel expenses, or what amount, if any, the Commissioner has allowed as a deduction on account thereof. Any amounts paid by the petitioner for traveling expenses and repaid to him by the Tribune would not constitute legal deductions from gross income unless the amounts so received in reimbursement were included by him in gross income. We have no evidence that this was done. It was not necessary that amounts received as reimbursement for traveling or hotel expenses should have been reported as income.

The evidence does not show what portion of the total amount claimed as a deduction on account of amounts expended for club dues and entertaining was allowed or disallowed as a deduction by the Commissioner. The Board can not therefore determine whether the Commissioner committed error in connection with these items, nor can the Board determine, from the evidence, whether the Commissioner has denied petitioner the right to deduct any portion of the amounts expended for supplies, periodicals, telephone, telegraph, office salaries and expenses.

After eliminating the amount claimed as hotel and traveling expenses, and the upkeep of the automobile, the total of the deductions allowed by the Commissioner for each year, in the opinion of the Board, adequately cover the amounts to which the petitioner was entitled for expenditures for club dues, supplies, periodicals, telephone, telegraph, office salaries and expenses. The operating expense and depreciation of the automobile is not, in the opinion of the Board, a proper deduction in any event under the evidence submitted. It appears that the petitioner, when not otherwise engaged, studied and practiced the art of sculpturing for the purpose of equipping himself for the day when he would be no longer able, because of his age, to carry on the business of a cartoonist. The automobile in question was used for the most part in connection with this work in going from place to place and in transporting materials. This work was purely educational and was not carried on for profit. The expenses incident thereto were not, therefore, a proper deduction from gross income derived from his business as a cartoonist. The automobile was occasionally used in connection with his regular business, but the evidence as to the extent of such use is not sufficient to enable the Board to determine what portion of the expense or depreciation should be allocated thereto. •

Upon the evidence submitted, the Board is convinced that the studio erected in 1921 had a useful life in petitioner’s business not exceeding 15 years. The annual allowance for exhaustion, wear, tear and obsolescence thereof should, therefore, be computed upon that basis. The Commissioner allowed a deduction for exhaustion at the rate of 4 per cent per annum.

The Commissioner included in his answer to the petition a motion to dismiss the appeal in so far as it related to the year 1918, on the ground that the deficiency for that year was assessed on May 15,1925, and that he had not thereafter made a final determination upon a claim for abatement. Further, that the Board is without jurisdiction to consider the years 1919 and 1921, inasmuch as he has determined overassessments'for those years. -

The evidence shows that on May 27, 1925, the taxpayer filed claim for abatement of the deficiency for 1918,- assessed without giving him the benefit of the hearing as provided by law, and that he also executed at the same time a bond with surety approved by the collector of internal revenue. .Thereafter, he was granted a hearing upon his claim for abatement of the amount assessed for 1918 in connection with his protest of the amount of the deficiencies and overassess-ments for the years 1919 to 1923, inclusive. The notice of the deficiency mailed to the taxpayer on June 17, 1925, was stated by the Commissioner to be his final determination of the deficiencies and overassessments for the years 1918 to 1923, inclusive, and it is from that notice that this appeal was filed. No notice other than the notice of June 17,T925, has ever been mailed to the taxpayer concerning any deficiency for the year 1918.

We are of the opinion that the notice from which this appeal was taken was a final determination of the taxpayer’s claim for the abatement of the deficiency for 1918, and the Commissioner’s motion to dismiss as to that year is denied.

The position of the Commissioner that the Board is without authority to make a redetermination for the years 1919 and 1921 is well taken and his motion to dismiss the appeal in so far as it relates to his determination of overassessments for the years 1919 and 1921 is sustained. Section 274(g) Revenue Act of 1926. Appeal of Cornelius Cotton Mills, 4 B. T. A. 255.

Order of redetermination will be entered on 15 days' notice, under Rule 50.


text:
    Appeal of EDWYNA APPLEBYE ROBINSON.
    Docket No. 5305.
    Decided July 29, 1926.
    1. An attempted assignment of tlie rents, issues, profits, interest and income from a trust created under a will, to be paid to the use of the taxpayer, held invalid und'er the laws of New York.
    2. The amount paid by a wife to her husband under an agreement providing that, in consideration of his giving up the sea-faring profession, she would divide her income with him equally, and each would bear all expenses equally, is not deductible as a business expense.

      George W. Smythe, Esq., for the petitioner.

      J. W. Fisher, Esq., for the Commissioner.

      Before Marquette, Moeeis, unci GREEN.
    This is an appeal from the determination of a deficiency of $551.62 in income taxes for the year 1920.
    FINDINGS OF FACT.
    The taxpayer is a resident of New York State. In 1900 she married William Applebye Robinson, who was a sea captain. Before their marriage they entered into a written contract, the substance of which was that, in consideration of his giving up his sea-faring profession and sharing his income and property with her, she would share equally with him all of her income. The written contract was destroyed by fire in 1912 or 1913: Each- party performed his part of the contract down to the conclusion of the World War. Then the husband, his sea-faring proclivities having been revived as a result of having been in the United States Navy during the War, again felt an urge for the sea. The taxpayer thereupon reminded him of their agreement. They then signed the instrument set out below which re-expresses their former agreement as nearly as it could be remembered.
    I hereby agree, for value received and on condition that my husband William' Applebye Kobinson gives up the sea faring profession, and takes up no other that will take him away from home, to‘divide all monies coming to me from any source whatever, share and .share alike, he to take half, and I to take ha If, as long as we live together; all home and other expenses to be shared equally.
    January 25, 1919.
    The taxpayer is the beneficiary of a trust created by the will of her mother which was probated in 1891. By its terms one-third of the residuary estate was devised and bequeathed to trustees, in trust, to pay and apply the net rents, issues, profits, interest and income to the use of the taxpayer during her life, and upon her death to transfer the principal to her issue. The estate held a mortgage on property which several years prior to 1920 was.taken by the State of New York through condemnation proceedings for a public use. This interrupted the income of the estate from .the mortgage. In 1920 the award in the condemnation proceedings was paid, which included the accumulated interest on the mortgage, and the trustee then paid to the taxpayer the share to which she was entitled under the will, which amounted to $12,645.50.
    The income from the trust estate was paid by the trustee to the taxpayer. During their entire married life it has been her practice to turn over to her husband the checks which she received from the trustee. He deposited them in a bank account in his own name and drew checks thereon to the order of the taxpayer for one-half thereof, and he also paid therefrom his one-half share of the expenses in accordance with the terms of their agreement.'-

      The taxpayer reported her income on the cash receipts and disbursements basis.
    For 1920 each made a separate income-tax return and reported one-half of the income from the trust estate received in that year. The Commissioner determined that the entire amount was income to the taxpayer.
   OPINION.

MoRRis:

The taxpayer contends the agreement with her husband was an assignment of a one-half interest in the income from the trust estate created by her mother’s will. It is unnecessary to determine whether the instrument amounted to an assignment, for, even though it otherwise may have, it would be invalid under the statutes of New York.

Section 15 of the Personal Property Law provides: '

The right of the beneficiary to enforce the performance of a trust to receive the income of personal property, and to apply it to the use of any person, cannot be transferred by assignment or otherwise. * * *

Section 103, Real Property Law, contains substantially the same provision relating to trusts of real property. The courts of New . York in numerous decisions have held these provisions applicable to a trust such as the one in this case. Central Trust Co. v. Gaffney, 157 App. Div. 501; 142 N. Y. S. 902; affd. 215 N. Y. 740; 109 N. E. 1069; Slater v. Slater, 114 App. Div. 160; 99 N. Y. S. 564; affd. 188 N. Y. 633; 81 N. E. 1176; Dale v. Guaranty Trust Co., 168 App. Div. 601; 153 N. Y. S. 1041; Stringer v. Young, 191 N. Y. 157; 83 N. E. 690.

It is also argued that, in case the entire amount of the trust income is determined to be income to the taxpayer, the part thereof going to the husband was under the contract a business expense to the taxpayer. We think it plain enough without discussion that this agreement between them was purely a family arrangement arising out of the marital relation, and that it was not entered into by the taxpayer for pecuniary profit.

Order of redetermination will be entered on 10 days’ notice, under Rule 50.


author: Maequette:

text:
    Appeal of THE UNIVERSAL MILKING MACHINE CO.
    Docket No. 4780.
    Decided July 29, 1926.
    Payments by tbe taxpayer to its stockbolders, held to constitute a distribution of profits.

      W. W. Ross, Esg., and H. Evans, C. P. A., for the petitioner.

      George G. Witter, Esg., for the Commissioner.

      Before Marquette, Green, and Love.
    This appeal is from the determination of a deficiency in income and profits tax for the ten-month period ended October 31, 1919, in the amount of $10,141.07. The deficiency arises from the disallowance by the Commissioner of a deduction of $21,292.85 taken by the taxpayer on account of alleged ordinary and necessary business expenses,
    FINDINGS OE FACT.
    The taxpayer is an Ohio corporation, organized in the year 1916 with a capital stock of $100,000, with its principal office and place of business at Columbus, and is engaged in the business of manufacturing milking machines.
    In the fall of 1918 the taxpayer was in need of money and credit to carry on and expand its business, but was unable to obtain them in sufficient amounts. ' Finally, in December, 1918, at a meeting of the stockholders of the company, they agreed that they would jointly and severally guarantee the payment of any and all loans or other obligations that the company might obtain or incur from or to any bank or other financial institution, and in consideration therefor the company agreed to pay to the stockholders an amount equal to 6 per cent of its “ net annual business ”, the same to be paid at the end of each fiscal year so long as the agreement should remain in force. The agreement was reduced to writing on December 9, 1918. The stockholders, at the same time agreed to divide among themselves in proportion to their stock holdings the amount to be paid them by the company. A few days later the stockholders guaranteed in writing to the National Bank of Commerce, Columbus, Ohio, the payment of any and all loans that might thereafter be made by the bank to the taxpayer to the extent of $100,000. At the same time the stockholders furnished to the bank,a statement of their net worth. The stockholders did not deposit any collateral with the bank nor were they ever called upon to pay any amount on account of their guarantee. At the time the contracts mentioned were made, the notes payable to the taxpayer amounted to only $10,447, and on October 31, 1919, they amounted to only $14,200. The contracts were canceled on October 31, 1919. On December 31, 1918, the stockholders were indebted to the taxpayer in the amount of $27,347.80 on notes given for stock, and on other accounts in the amount of $5,544.80. On October 31, 1919, they were indebted to the taxpayer on notes given for stock in the amount of $28,047.80.
    The taxpayer’s gross sales for the ten-month period ended October 31, 1919, were $346,314.23. In its income and profits-tax return for that period it rex>orted its gross sales as $346,314.23, its gross income as $174,409.08, and its net income as $18,490.79.
    At the close of the ten-month xseriod ended October 31, 1919, the taxpayer credited its stockholders, in x>roportion to the amount of stock held by them, with the amount of $21,292.85, as compensation to them under the contract of December 9, 1918, and also charged that amount on its books as an item of exxiense. The amounts so credited to stockholders were actually x>aid to them in the year 1920.
    The amount actually credited and x>aid to the stockholders as condensation under the contract of December 9, 1918, the amount of their stock holdings, and their respective net worth as represented to the bank were as follows:

    In computing its net income for the ten-month period ended October 31, 1919, the taxxiajrer deducted, as an ordinary and necessary business expense, the amount of $21,292.85 credited or paid to its stockholders as above set forth. The Commissioner upon audit of the return disallowed the deduction and determined that there is a deficiency in tax for that period in the amount of $10,141.07.
   OPINION.

Maequette:

The taxpayer contends that in December, 1918, the necessities of its business were such that it was justified in entering into a contract with its stockholders to pay'them 6 xier cent of its “ net annual business ” in consideration of their guaranteeing its loans and credits; that by the words “ net annual business ” the parties to the contract meant gross sales less dealers’ commission, and that 6 per cent of the gross sales for the ten-month period ended October 31,1919, rexiresented a reasonable compensation to the stockholders for the services rendered by them and constituted an ordinary and necessary business expense of the taxpayer, which should be deducted in computing its net income. The taxpayer concedes, however, that 6 per cent of its gross sales for the period mentioned amounted to only $20,778.85 and that it was in error in paying to its stockholders the amount of $21,292.85 for their services and in deducting that amount from its gross income for the period involved. The Commissioner contends that the payments to the taxpayer’s stockholders, involved herein, are not proper deductions in computing the taxpayer’s net income, for the reason that they are not reasonable compensation for services rendered but are in fact a distribution of profits.

Upon consideration of the evidence presented, we are of the opinion that the determination of the Commissioner should be approved. Conceding, for the purpose of argument, that the taxpayer is correct in construing the words “net annual business” in the contract as meaning gross sales less dealers’ commission, and that its stockholders rendered services under that contract, we think that the compensation is out of all proportion to the value of the services. So far as the record shows, the taxpayer did not borrow any considerable amount of money under the line of credit guaranteed by its stockholders, and they were not called upon to pay anything on account of their guarantee. Payment of approximately $21,000 to them for guaranteeing loans which actually amounted to less than $100,000 is, it seems to us, entirely unreasonable. Furthermore, it appears that, with the exception of R. J. and W. W. Stevens, the stockholders owned little or nothing except their stock in the company, and that when they guaranteed the company’s credit, they in fact risked nothing, since the assets of the company, which gave whatever value the stock had, would first be subject to the payment of the company’s debts. In addition, it may be pointed out that the stockholders, during the entire period under consideration, were indebted to the taxpayer in the amount of more than $28,000, which, so far as the record shows, was more than the amount the taxpayer borrowed under the credit guaranteed. In view of these facts, and of the further fact that the payments in question were made to the stockholders in proportion to their stock holdings, we are of the opinion that they in fact constituted a distribution of profits and not reasonable compensation to the stockholders for services rendered by'them.

The deficiency is $10,lfl.07. Order will be entered accordingly.

Smith and SteRNHAgen concur in the result only.