author: Van Fossan: Black,

text:
    Aluminum Company of America, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103316, 106514.
    Promulgated August 13, 1942.

      Paul G. Rodewald, Esq., and David B. Buerger, Esq., for the petitioner.

      William A. Schmitt, Esq., for the respondent.
   OPINION.

Van Fossan:

The main issue presented in these proceedings is whether section 3 (e) of the Vinson Act of March 27,1934 (amended June 25, 1936, 49 Stat. 1926, with no effect on the issue) requires the petitioner as a subcontractor to pay into the Treasury all its profits in excess of 10 percent of the contract price of the materials furnished to prime contractors or to fabricators from whom prime contractors eventually obtained them. The petitioner argues that by all recognized standards of definition, custom, and law it is a material-man and can not be considered a subcontractor subject to the Vinson Act.

The respondent’s position is that the primary purpose of the Vinson Act was to limit profits on materials going into Government vessels and that, for that reason, the word “subcontractor” as found in the act took on a different and broader meaning, comprehensive enough to include a materialman therein.

The respondent confesses that, for the purposes of the Vinson Act, he makes no attempt to define a materialman as distinguished from a subcontractor. Fie contends that both are comprehended in the term “subcontractor.” He likewise does not try to disprove the petitioner’s contention that there is a well defined and universally accepted distinction in the meaning of the two words and that they can not be used interchangeably.

The respondent argues that article 2 of regulations promulgated January 6,1937 (T. D. 4723, C. B. 1937-1, p. 519), propounds a correct interpretation of the Vinson Act.. His argument is largely in support of the validity of the broadened definition of a subcontractor as set forth therein. We note that previous regulations (T. D. 4434, XIII-1 C. B. 540) contain no such language.

In so far as we can ascertain, the present issue presents a new aspect of the Vinson Act, its scope and effect. We are asked to adopt either the view urged by petitioner that the provisions of the act must be interpreted according to the usual meaning of their component words, or the theory urged by respondent that the act itself sets up new criteria which must be substituted in order to conform to what the respondent terms the prevention of profiteering in constructing combat vessels and “limiting profits on national defense projects.”

We believe the first view to be the correct one. Much might be said for the desirability of restricting profit on naval vessels and aircraft to a maximum of 10 percent on every individual article and all labor and raw material directly or indirectly required to construct and service the completed craft. However, much also can be said against the practicability of such a limitation. Many common articles, materials, and supplies ordinarily purchased on the open market might, because of the attendant uncertainty of ultimate profit, become practically unobtainable in the market because of the fear of a later forced return of profits over 10 percent. Thus, the Navy might be hampered, not helped, by the respondent’s construction of the law.

In the respondent’s “explanatory statement” he states that the materials under consideration “found their way” into a complete naval vessel or aircraft constructed under the Vinson Act. He thus includes all articles and materials furnished by the petitioner as they are governed by the first issue. Assuming that such articles and materials were destined to become a part of a naval vessel or aircraft, we still are unable to conclude that the terms of the Vinson Act control the amounts of the producer’s profit thereon. The act specifically states that the contractor must agree to make no subcontract unless the subcontractor agrees to the conditions specified in the act. Thus, unless the petitioner is a subcontractor or can be construed to be one, he is not subject to the act.

We deem it unnecessary to enter into a lengthy discussion of the differentiating characteristics and attributes of materialmen and subcontractors. Many state and other decisions make the distinction plain.

The act does not define the word “subcontractor.” Webster’s Dictionary defines the noun “subcontract” as “a contract under, or subordinate to, a previous contract”, and the verb as “to contract under, or for the performance of a part or all of another contract.” The same dictionary defines a “materialman” as “one who supplies both labor and material in the construction of buildings, ships, etc.” It is obvious from the record that the petitioner was strictly a material-man except as to those contracts in which it was a prime contractor.

The petitioner .did not undertake to perform all or any part of the Navy contracts in question. It merely furnished materials suitable for use by the prime contractor. 1 The respondent stresses the fact that in the various orders and memoranda describing the sales made to the prime contractor the Vinson Act and its provisions were specifically mentioned. These notations obviously were either printed or stamped as a matter of routine and were so indicated in order to assure the purchaser that the material would meet the tests established by the Navy Department. The record further shows that such orders were possibly subject to the Vinson Act. The excess percentage was to be paid over only if that act required it — the precise issue which we must decide.

Performance according to a “specification governing the original contract” does not mean that the contractor may not buy in the open market articles which meet the required tests. Inspection at the plant may be a convenient method of accelerating the completion of the contract. The inspection of articles in the stock pile of a prospective furnisher of raw material or parts serves the same purpose, but does not make such seller to the contractor his subcontractor.

In the case at bar, meeting the Navy specifications does not impute a Navy contract. Articles may be made of prescribed size, strength, and consistency under an agreement between a Navy contractor and a materialman. Such articles may be used on a Navy contract, at the contractor’s option, as appears here. Their quality may or may not make them satisfactory for use on other jobs.

The petitioner’s stock, including both raw materials, sheet and plate aluminum, and articles catalogued for commercial use, thus must meet at least the requirements of Navy specifications. It is possible that aluminum articles or parts may be made for certain types of private consumption under specifications which require greater precision of manufacture and fineness of quality than those demanded by the Navy. The publication of Navy specifications, the inspection of stock material by Navy inspectors, and the notation of such requirements on orders do not serve to transform a materialman into a subcontractor. Nor does a regulation declaring a subcontractor and materialman to be in the same category make them so. The “enlargement of the ordinary routine definition” by T. D. 4723, as the respondent denominates the effect of that Treasury decision, is not warranted.

In view of what we have said concerning the distinguishing features of the concepts of “materialman” and “subcontractor”, we conclude that Congress intended to confine the' effect of the Vinson Act restrictions to subcontractors in the commonly accepted legal meaning of the word and thus to exclude materialmen, such as the petitioner. Old Colony Railroad Co. v. Commissioner, 284 U. S. 552. See Matzinger v. Harvard Lumber Co., 115 Ohio St. 555; 155 N. E. 131 (and cases cited); Baker v. Yakima Valley Canal Co., 77 Wash. 70; 137 Pac. 342; Marsh v. Rothey 117 W. Va. 94; 183 S. E. 914.

Tn other instances of Federal legislation both subcontractors and materialmen have been specifically mentioned. In the District of Columbia Mechanic’s Lien Act of March 3, 1901, 31 Stat. 1384, and in the National Industrial Eecovery Act of June 16, 1933, 48 Stat. 195, both are mentioned. In the Buy American Act on March 3, 1933, 47 Stat. 1520, the following language is used:

Every contract for the construction, alteration, or repair of any public building or work in the United States * * * shall contain a provision that in the performance of the work the contractor, subcontractors, material men, or suppliers shall use only such unmanufactured articles, materials, and supplies as have been mined or produced in the United States * * *.

The legislation most nearly parallel to the Vinson Act is the Merchant Marine Act of June 29, 1936, 49 Stat. 1998. That act has features resembling both the Vinson Act and the Buy American Act. Its section 505 (b) reads:

No contract shall be made for the construction of any vessel under this act unless the shipbuilder shall agree * * * (5) to make no subcontract unless the subcontractor agrees to the foregoing conditions.

Section 505 (a) provides:

* *. * jn all such construction the shipbuilder, subcontractors, material men, or suppliers shall use, so far as practicable, only articles, materials, and supplies of the growth, production, or manufacture of the United States * * *.

Likewise, various rulings of tire Navy and War Departments recognize a sharp difference between materialmen and subcontractors. Among those in point is the ruling of the Bureau of Yards and Docks of the Navy Department dated September 11, 1940, which states in part:

* ⅜ ⅜ it is desired that the distinction between subcontracts and material purchases be kept in mind in order that the making of subcontracts will be confined to cases which involve the employment on the site of supervision and labor in excess of what is ordinarily required to fix or install the material in place. While it is impracticable to lay down a general'rule, the procedure can be indicated by examples * ⅜ *.

Of the same effect is the War Department construction contract form, approved June 19, 1941, and the construction of the terms by the Federal Emergency Administration of Public Works, transmitted to contractors by the Engineer Corps of the War Department, May 23, 1934, stating:

The term “Subcontractor” as used herein shall be understood to refer to a person or firm who furnishes or proposes to furnish labor and material, or labor only, on the site of the work for a specified purpose as part of a construction contract, or persons or firms who furnish or propose to furnish for a particular project, equipment, appliances or materials required to be constructed, processed, manufactured or fabricated especially for that particular project. Persons or firms who furnish or propose to furnish standard materials or equipment but no labor at the site are not to be considered as subcontractors but áre to be considered as material men, sellers or vendors.

The record amply shows that, with the exception of special quilting bolt nuts and screw machine products, all of the aluminum materials sold by the petitioner under its orders and contracts with prime contractors or fabricators were either regular commercial products or required additional fabrication, treatment, alteration, or reformation. The two exceptions each aggregate less than $10,000 in price and therefore are automatically excluded from the operation of the Vinson Act. (Sec. 3(c).)

The second issue raises the question whether the cost of materials used in performing the contract should be computed at their market value or at their original cost. For this issue also wo find no precedent in adjudicated Vinson Act cases.

The point turns upon a proper interpretation of the words “the cost of performing the contract” appearing in section 3 of that act. The method of ascertaining the amount of excess profit to be paid to the Treasury is determined by the Secretary of the Treasury in agreement with the Secretary of the Navy. Pursuant to that authority, T. D. 4434 (C. B. XIII-1, p. 540), was issued jointly by the Acting Secretary of the Treasury and the Acting Secretary of the Navy.

T. D. 4434 states in part:

The method of ascertaining the amount of excess profit to be paid to the. United States in respect of contracts entered into under the Vinson Act shall be as follows:
The excess profit shall be determined on each contract separately upon the completion or other termination of the contract. The amount of such excess profit shall be the amount of the profit on the contract in excess of 10 per cent of the total contract price. The amount of the profit on the contract shall be the difference between the total contract price and the cost of performing the contract. The cost of performing the contract shall be the direct costs, such as material and labor, incurred by the contractor in performing the contract, plus a reasonable proportion of any indirect costs (including overhead or general expenses) appertaining to the contract which are not usually directly allocated to the cost of performing the contract. No general rule may be stated for ascertaining the reasonable proportion of the indirect costs to be allocated to the cost of performing a contract which would be applicable to all cases. * * *

We believe that the language of the statute means precisely what it says. The “cost” of performing the contract is what the operation actually cost the petitioner, not what it would have cost it assuming it had purchased its materials at market price. The petitioner’s theory, carried to its logical conclusion, would require that all computation of cost should be made on a fair market value of all materials — and even labor — irrespective of the actual cost thereof to it.

Under petitioner’s contention, if, through quantity purchases by or forced sales to the contractor, materials were acquired under terms of great advantage to the contractor, he would not be compelled to pay any part of such excess profit to the Treasury. Furthermore, a corporate contractor might “departmentalize” its various processes of manufacture or fabrication through its subsidiaries or allied corporations. By this means a profit would attach to all of the principal constituent parts of the finished products. The fundamental purpose of the Vinson Act would thereby be defeated.

Funk & Wagnalls’ New Standard Dictionary defines cost as “that which has been given for a thing in order to procure it; especially the price paid; outlay of any kind; expense.” In 20 Corpus Juris Secundum, p. 241, we find this definition, “the amount originally expended in performing a particular act or operation or for production or construction as of a building.” See Black’s Law Dictionary, 3d ed., p. 446; Buck v. Buck, 18 N. Y. 337; Kempf v. Ranger, 132 Minn. 65; 155 N. W. 1059; Hoggson Bros. v. Spiekerman, 161 N. Y. Supp. 930; 175 App. Div. 144.

The second quoted definition closely follows the language of the Vinson Act. That act does not undertake to define the word “cost” nor the expression “the cost of performing the contract.” As in the first issue, we must construe the word and the phrase in their commonly accepted legal meaning. Therefore, we are led to the conclusion that the profit which the petitioner derived from its prime contracts with the Navy Department must be measured by the original cost of the material to it, as contended by the respondent.

The petitioner cites several cases which it claims are persuasive of the correctness of its theory. However, none of those cases relates to the exact question before us and, therefore, the citations have only a referential bearing on the issue. The petitioner also quotes the standard form of contract prescribed by the Navy Department covering “cost-plus” contracts. In that form the “material from stock” supplied by the cost-plus contractor for a specific job order is computed at the market price. The cost-plus contracts were authorized by the National Defense Act of June 28, 1940. 54 Stat. 616. That legislation contains an entirely different fundamental purpose from that of the Vinson Act and is in no way comparable thereto or controlling. The contractor on a cost-plus basis acts merely as a supervisor, superintendent, or manager of the project and his fee for such service is termed a “handling charge.” A contractor governed by the provisions of the Vinson Act furnishes the finished product, which he manufactures in any way he sees fit, subject, of course, to the requirements of given specifications and to inspection by Navy authorities. His position, therefore, is quite dissimilar to that of a “cost-plus” contractor.

In view of our disposition of the first issue, it becomes unnecessary for us to decide the third and fourth issues. But see Pressed Steel Tank Co., 46 B. T. A. 52; and Douglas Aircraft Co., 46 B. T. A. 1025.

The computation of the deficiencies, if any, may be made under Bule 50 pursuant to the stipulated figures.

Reviewed by the Board.

Decisions will be entered umder Rule 50.

Smith dissents.

Black,

dissenting: In all three of the taxable years, 1936, 1937, and 1938, the petitioner completed certain prime contracts, that is to say contracts made by the petitioner directly with the Government of the United States which by their terms were subject to the provisions of the Vinson Act. As to these no issue is raised as to petitioner being liable for whatever excess profits tax is due. The only issue as to these is whether, in the computation of the profit made on a contract, petitioner is entitled to use “schedule cost,” as petitioner contends, or must use “original cost,” as determined by the Commissioner. The majority opinion holds that “original cost” must be used, and with this holding I agree.

In addition to these prime contracts which petitioner had with the United States Government, which petitioner concedes come under the provisions of the Vinson Act, petitioner delivered aluminum materials under certain “job contracts” to prime contractors engaged in the construction of complete naval vessels. Also in addition to these petitioner sold and delivered aluminum materials pursuant to orders received from customers who were engaged in the performance of prime contracts with the Navy. As to these sales and deliveries under job contracts and under orders received from customers not under job contracts, petitioner contends that it is not subject to the provisions of the Vinson Act. The majority opinion sustains this contention and with this holding, in so far as job contracts are concerned, I do not agree.

The kinds of transactions to which I am now referring are described in the Board’s findings of fact as follows:

During the years 1937 and 1938 the petitioner, pursuant to several job contracts, delivered aluminum materials to prime contractors engaged in the construction of complete naval vessels. Under the typical job contract the petitioner agreed to furnish; and the prime contractor (described as the “purchaser”) agreed to buy 200,000 pounds or more, not to exceed 400,000 pounds, of described aluminum material for use in the construction of a named naval vessel or vessels. Such aluminum material was to be sold at prices stated in the contract for particular classes of material, reference being made for prices to pages of the petitioner’s regular published price list incorporated in the contract, but the purchaser was not required to buy any quantity of any particular class of material.

I think the “job contracts” referred to in the foregoing paragraph are subcontracts within the meaning of section 3 of the Vinson Act, quoted in the majority opinion.

It may well be that, as to the transactions described in the Board’s findings of fact as follows:

The petitioner sold and delivered commercial aluminum and materials on orders received from customers. The petitioner received an order for listed materials, acknowledged such receipts on its printed form, and proceeded to fabricate and ship the materials so ordered.

the petitioner was not a subcontractor and was only a materialman and was not subject to the provisions of the Vinson Act. The opinion so holds, and I agree. True, under article 2 of Treasury Regulations promulgated January 6, 1937 (T. D. 4723, C. B. 1937-1, p. 519) mere materialmen are included within the provisions of the Vinson Act but I agree with the majority opinion that the regulation in that respect goes beyond the law and is to that extent invalid.

But when petitioner entered into these “job contracts” with a prime contractor as described in the Board’s findings of fact, I think it becomes more than a mere materialman and becomes a subcontractor within the meaning of the act. For example, the Board’s findings are that:

One of the said job contracts, entered into with the Bethlehem Shipbuilding Corporation, petitioner’s contract No. J-5499, called for the furnishing and purchase of standard aluminum products for use in the construction of eleven described naval vessels. Two of these vessels were completed by the Bethlehem Shipbuilding Corporation in 1937 and two in 1938. * * *

Of course, it goes without saying that the Bethlehem Shipbuilding Corporation, as the prime contractor, was subject to the provisions of the Vinson Act. As the job contractor obligated to furnish to Bethlehem Shipbuilding Corporation the aluminum material which was to go into the vessels, I think petitioner was a “subcontractor” as that term is used in the act, and, therefore, liable to the excess profits provision of the act.

The majority opinion holds to the contrary and to that holding I respectfully dissent.

ARNOLD agrees with this dissent.

       Sec. 3. The Secretary of the Navy is hereby directed to submit annually to the Bureau of the Budget estimates for the construction of the foregoing vessels and aircraft; and there is hereby authorized to be appropriated such sums as may be necessary to carry into effect the provisions of this Act: Provided, That no contract shall be made by the Secretary of the Navy for the construction and/or manufacture of any complete naval vessel or aircraft, or any portion thereof, herein, heretofore, or hereafter authorized unless the contractor agrees—
      (a) To make a report, as hereinafter described, under oath, to the Secretary of the Navy upon the completion of the contract.
      (b) To pay into the Treasury profit, as hereinafter provided shall be determined by the Treasury Department, in excess of 10 per centum of the total contract prices, of such contracts within the scope of this section as are completed by the particular contracting party within the income taxable year, such amount to become the property of the United States, but the surety under such contracts shall not be liable for the payment of such excess profit; * * *.
      (c) To make no subdivisions of any contract or subcontract for the same article or articles for the purpose of evading the provisions of this Act, but any subdivision of any contract or subcontract involving* an amount in excess of $10,000 shall be subject to the conditions herein prescribed.
      * * * * * * «
      (e) To make no subcontract unless the subcontractor agrees to the foregoing conditions.
      The report shall be in form prescribed by the Secretary of the Navy and shall state the total contract price, the cost of performing the contract, the net income, and the percentum such net income bears to the contract price. A copy of such report shall be transmitted to the Secretary of the Treasury for consideration in connection with the Federal income tax returns of the contractor for the taxable year or years concerned.
      The method of ascertaining the amount of excess profit to be paid into the Treasury shall be determined by the Secretary of the Treasury in agreement with the Secretary of the Navy and made available to the public. The method initially fixed upon shall be so determined on or before June 30, 1934: Provided, That in any case where an excess profit may be found to be owing to the United States in consequence hereof, the Secretary of the Treasury shall allow credit for any Federal income taxes paid or remaining to be paid upon the amount of such excess profit.
      The contract or subcontracts referred to herein are limited to those where the award exceeds $10,000.

       Art. 2. Contracts and subcontracts wider which excess 'profit liability may be incurred. — Except as otherwise provided with respect to contracts or subcontracts for certain scientific equipment (see article 3 of these regulations), every contract awarded for an amount exceeding $10,000 and entered into after the enactment of the Act of March 27, 1934, for the construction or manufacture of any complete naval vessel or aircraft, or any portion thereof, is subject to the provisions of the Act relating to excess profit liability. Any subcontract made with respect to such a contract and involving an amount in excess of $10,000 is also within the scope of the Act. If a contracting party places orders with another party, aggregating an amount in excess of $10,000, for articles or materials which constitute a part of the cost of performing the contract or subcontract, the placing of such orders shall constitute a subcontract within the scope of the Act, unless it is clearly shown that each of the orders involving $10,000 or less is a bona fide separate and distinct subcontract and not a subdivision made for the purpose of evading the provisions of the Act.


source: Caselaw Access Project

author: Kern:

license: Public Domain

text:
    Tennessee Egg Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 109195.
    Promulgated August 18, 1942.

      Albert W. Taber, Esq., for the petitioner.

      John R. Stivers, Esq., for the respondent.
   OPINION.

Kern:

The question presented in this proceeding is whether losses sustained by petitioner as a result of the purchase and sale of futures contracts covering eggs are capital losses and, therefore, subject to the limitation of section 117 (d) (1) of the Revenue Act of 1938, as respondent has determined, or are losses resulting from hedging transactions or losses from the sale of “property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year”, as petitioner contends, and, therefore, not subject to any capital loss limitation.

Upon the general subject of hedging attention is called to our recent opinion in Kenneth S. Battelle, 47 B. T. A. 117. The evidence with regard to the transactions here in question and the reasons given for them by petitioner’s witness do not warrant us in characterizing them as hedges. There is no evidence that petitioner was ever obligated to sell eggs at a future date to any of its customers at any contract price, and, therefore, no risk is shown of loss through price changes to which a counter-balancing of operations could constitute a hedge. Inasmuch as the petitioner has failed to prove that its futures transactions were entered into for the purpose of hedging, the losses sustained therefrom can not, on that account, be considered as other than capital losses. Commissioner v. Covington, 120 Fed. (2d) 768.

Nor do we agree with petitioner that these futures contracts were property of a kind which would properly be included in its inventory. See A. R. M. 100, 3 C. B. (1920), p. 66; A. R. M. 135, 4 C. B. (¡1921), p. 67; Staerker v. United States (Dist. Ct., N. Dist. Tex., Sept. 23, 1938). We can not say that the eggs covered in the futures contracts were property held primarily for sale to customers, since the record shows that in only a few instances petitioner ever took delivery of those eggs. For the same reason we can not say that they constituted stock in trade or property of a kind which would properly be included in its inventory.

We conclude, therefore, that the losses in question were from the sale of capital assets and, therefore, subject to the limitation on capital losses. Accordingly,

Decision will he entered for respondent.


author: OppeR :

text:
    Martin Thomas O’Brien and Helen Mills O’Brien, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 108648.
    Promulgated August 19, 1942.

      Louie Marks, Esq., for the petitioner.

      L. M. Ponder, Esq., for the respondent.
   OPINION.

OppeR :

It advances us little in determining the extent to which petitioner can sustain her claim to deduct real and personal property taxes to resort to the principle that such deductions are permissible only if the taxes were levied against petitioner. Lone Fine Lawn Corporation, 41 B. T. A. 638, 641; affd. (C. C. A., 2d Cir.), 121 Fed. (2d) 935. For certainly a personal liability to pay the taxes is not a prerequisite to a deduction. It is sufficient if they are assessed as taxes against property which the taxpayer then owns, and could be collected out of it. Boy J. O'Neil et al., Administrators, 31 B. T. A. 727. Nor is there any satisfaction to be drawn from the ruie that where property changes hands, taxes which are already a lien become additions to the purchase price rather than income deductions if paid by the vendee. Lifson v. Commissioner (C. C. A., 8th Cir.), 98 Fed. (2d) 508; certiorari denied, 305 U. S. 662. For here the change in ownership which intervened between the time of lien and that of payment was in the legal title only. Petitioner was the beneficial owner when the lien arose, as she was when the payment was made.

We conclude that under these circumstances the principle of Hord v. Commissioner (C. C. A., 6th Cir.), 95 Fed. (2d) 179, and Estate of John Edgerly Morrell, 43 B. T. A. 651, is applicable. “It seems clear enough that in the event the taxes were not otherwise paid the beneficiaries were required to pay or suffer the sale of the property”, here exactly as much as in the Hord case. The principle of that decision has been stated by the same court to be that it “involved the payment of taxes on a trust estate by the beneficiary, who was at the time of the incidence of the tax the' beneficial owner of the estate.” Walsh-McGuire Co. v. Commissioner (C. C. A., 6th Cir.), 97 Fed. (2d) 983.

If while the trust continued to exist and under threat of a foreclosure of the tax lien petitioner had paid these taxes to save property of which she held the equitable title, we think there would be little plausibility to any suggestion that the beneficiary thereby became a pure volunteer. How much more that is true where in the year when the taxes were paid the beneficiary had become the legal as well as the equitable owner.

It is true that in the Hord, case the court was at some pains to note its conclusion that the laws of Ohio impose upon the beneficiaries a secondary liability because of the requirement that trust property be listed separately together with “the name of the person, [or] estate, * ⅜ * to which it belongs.” But since, as we have seen, personal liability for taxes is in any event a nonessential consideration and since in all trust cases the beneficiary must “pay or suffer the sale of the property”, this hardly seems a satisfactory test or distinction. Furthermore, the language upon which the court relied refers to the “person” to whom “the property belongs.” Once we can satisfy ourselves that this property actually belonged to this petitioner, we think it follows by hypothesis that taxes levied upon the property were her taxes.

Be that as it may, we find that in the states concerned the provisions are sufficiently similiar to the Ohio and Iowa statutes relied upon in the Hord and Morrell cases to eliminate any reasonable ground for distinction. For example, in Indiana (11 Burns Indiana Stats. Ann. 1933, par. 64-412), the provision is:

Persons required to list property on behalf of others shall list it separately from their own, specifying in such case the name of the person, estate, company or corporation to whom it belongs.

In Illinois (24 Jones Illinois Stats. Ann., Kev. 1940, par. 119.555), the following is called for, at least with respect to personal property:

Persons required to list property on behalf of others * * * shall list it separately from their own, specifying in each ease the name of the person, estate, company or corporation to whom it belongs.

And in Florida, as respondent concedes, the statute (ch. 4322, Acts of Florida 1895, sec. 17; ch. 5596, Acts of Florida 1907, sec. 14) is comparable if not identical:

Assessment as trustee, guardian, executor, etc. — When a person is assessed as a trustee, guardian, executor, or administrator, a designation of his representative character shall be added to his name, and such assessment shall be entered upon a separate line from the individual assessment.

We are consequently of the opinion that the taxes in question were properly deductible.

The interest paid, however, is another matter. There is no showing that petitioner or her property was responsible directly or indirectly for the debt upon which the interest accrued or for the interest itself. For all that appears, therefore, this was a voluntary payment of interest owed by another. No deduction on its account is therefore permissible. Automatic Sprinkler Co. of America, 27 B. T. A. 160; Helen B. Sulzberger, 33 B. T. A. 1093, 1099.

A similar conclusion appears appropriate with respect to the deduction for attorney’s fees. These apparently involved income tax liability, though the details are not before us. Payments to attorneys for services connected with income tax claims are ordinarily personal and not business expenses unless the claims arise out of a trade or business carried on by the taxpayer. Malcolm G. Gibbs, 34 B. T. A. 1028; Robert J. Harbison, 43 B. T. A. 1098. Even if we could say that petitioner was carrying on the trust’s activities, there is no showing that the trust was engaged in a trade or business. John amd Pauline Towning sen Trust, 43 B. T. A. 37; affd. (O. C. A., 9th Cir.), 126 Fed. (2d) 48. We do not think the deduction should be permitted. As to the sundry operating expenses, the amount is apparently conceded in respondent’s brief by inference from the deficiency notice.

Reviewed by the Board.

Decision will be entered wnder Rule 50.


author: Hill :

text:
    The Philad Company of Delaware, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106896.
    Promulgated August 19, 1942.

      M. E. Newcomer, Esq., for the petitioner.

      Thomas F. Callahan, Esq., and Walter K. Wood, Esq., for the respondent.
   OPINION.

Hill :

The first issue of this proceeding is whether or not petitioner is entitled to a deduction, as a necessary and ordinary business expense or as an ordinary loss, in the amount of accounts canceled in a settlement made with Realistic. A second issue (alternative to the first) is whether petitioner must include the royalties which became due and payable during the first six months of the taxable year in gross income. A third issue is whether delinquency penalties should be imposed for failure to file returns within the time prescribed by statute.

Petitioner contends the action of the respondent in not allowing the deduction as an ordinary and necessary business expense or as an ordinary loss is erroneous. It also claims that, even if this action were not in error, respondent ought not to have included in gross income the amount of royalties due from Realistic for the first six months of the taxable year. In support of its argument on the first contention petitioner cites and relies chiefly upon Helvering v. Community Bond & Mortgage Co., 74 Fed. (2d) 727, and Olinger Mortuary Association, 23 B. T. A. 1282. Petitioner also cites several cases which allow compromise settlements to be deducted as ordinary and necessary business expenses. As authority for its position that the royalties accrued for the first six months of the taxable year should not be included in gross income petitioner cites Stern-Slegman-Prins Co. v. Commissioner, 79 Fed. (2d) 289; Huntington-Redondo Co., 36 B. T. A. 116; Albert W. Russell, 35 B. T. A. 602.

Petitioner’s position that the royalties for the first six months of the taxable year should not be included in gross income is premised upon the cases set forth above, in which it was held that a readjustment of an item prior to the end of a taxable year should be given effect in the computation of gross income for that year. In most of those cases the items which were adjusted were annual items such as salary for the full year which was readjusted prior to the end of the year. In the Himtington-Redondo Go. case, the only adjustment made was a bookkeeping entry. In the instant case there was no readjustment by a change in the rate nor reversal of bookkeeping entries but rather a complete cancellation of the accrued royalties which had become due and payable at all events. These royalties were not computed in regard to any definite period but rather upon the amounts of machinery manufactured. Thus, we hold that the royalties which had accrued to petitioner in the first six months of the taxable year were includable in gross income.

The only question left for our consideration is whether the cancellation of all the debts was a capital expenditure or not. The respondent contends that the cancellation of the various debts owed by Eealistic to petitioner was a capital expenditure and therefore is not deductible from gross income either as an expense or a loss.

If we hold that such cancellation was in effect a capital expenditure, petitioner is entitled to no deduction as an ordinary and necessary business expense nor to any deduction as an ordinary loss. The facts show that petitioner had received from its predecessor certain assets which consisted of patents and patent rights. In order to collect income on these patents and rights petitioner or its predecessor had licensed about ten manufacturers under licenses containing a clause limiting to ten the number of licenses outstanding at any one time and containing a “favored nation” clause. Most of the licenses contained these two clauses, which limited petitioner’s full use of the patents and effectively stopped petitioner from issuing other licenses. In order to secure the abolition of such restrictions petitioner entered into an agreement with Eealistic by which petitioner was released by Eealistic from the restrictive covenants in the latter’s license agreements. In consideration of that release petitioner canceled the debts owing to it by Eealistic and also released Eealistic from the payment of royalties in the future under its license agreement. Such release was an important initial step in securing similar releases from petitioner’s other licensees, which when accomplished restored to petitioner property rights in respect of its patents which it had previously surrendered in its license agreements. This restored right was a capital asset which petitioner did not have prior to the releases secured first from Eealistic and subsequently from its other licensees. The consideration paid to acquire such right was a capital expenditure and such consideration consisted, at least in part, of the cancellation of the debts which it seeks herein to deduct either as ordinary and necessary business expenses or otherwise. We hold that such cancellation constituted a capital expenditure and is not deductible for tax purposes.

Petitioner contends that if such expenditure is held to be a capital expenditure it should be entitled to an amortization deduction in respect thereof. Since we have so held, the amount of the capital expenditure should be added to petitioner’s basis for depreciation.

Petitioner’s evidence upon the question of penalties is rather meager. However, upon due consideration of all of the evidence we feel warranted in finding as a fact that petitioner’s failure was due to reasonable cause. In the recomputation of the deficiency, no penalties shall be included. Sec. 291, Eevenue Act of 1986.

Decision will be entered v/nder Rule SO.


author: Black:

text:
    Cornett-Lewis Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100487.
    Promulgated August 20, 1942.

      Chas. I. Dawson, Esq., for the petitioner.

      Wm. V. Crosswhite, Esq., and George H. Mitchell, Esq., for the respondent.
   OPINION.

Black:

The issue presented is controlled by section 501 of the Revenue Act of 1936. The deficiencies in question were determined under subsection (a) (1) of section 501.

The Commissioner in his deficiency notice determined the extent of the shift of the burden of the Guffey tax under section 501 (e) (1) and method I of article 13 of Regulations 95, and concluded therefrom that petitioner had shifted to others the entire 1935 tax of $1,579.41 and $3,526.81 of the 1936 tax of $3,962.59. This was the method used in Tennessee Consolidated Coal Co., 46 B. T. A. 1035.

The parties agree, however, that the statutory presumption of the extent of the shift should be determined under section 501 (e) (2) and method II of article 13 of Regulations 95. This is apparently due to the fact that petitioner in filing its unjust enrichment tax returns had elected to compute its net income under section 501 (c) (2). In this connection article 13, among other things, provides:

The extent to which a Federal excise tax burden was shifted to others and therefore the extent to which net income computed pursuant to article 7, 8, or 9 may be subject to tax is presumed to be an amount computed in accordance with one of two alternative methods. The first method is provided in section 501 (e) (1) and the second in section 501 (e) (2). If the taxpayer elects under section 501 (c) to compute net income under paragraph (2) of that section, then in computing the extent to which Federal excise tax burdens were shifted, the method provided for in section 501 (e) (2) should be followed. Similarly, if the method of computing net income provided for in section 501 (c) (1) was adopted, then in computing the extent to which Federal excise tax burdens were shifted, section 501 (e) (1) should be followed.

The article then sets out in considerable detail how the computations should be made under method I and method II, respectively. The latter method was used in Norwood-White Coal Co., 45 B. T. A. 638.

Although the parties agree that method II should be used in the instant proceeding, they do not agree upon the proper “unit of commodity” that should be used in making the computations. Petitioner contends that the proper unit of commodity is the “sales dollar,” whereas the Commissioner contends it is the “ton of coal.” If tons of coal mined are to be used as the units in respect of which the tax was imposed, the resulting prima facie showing is, as set out in our findings, that petitioner shifted the entire burden of the tax for both years. If, however, in making the computation the sales dollar is used as the unit in respect of which the tax was imposed, the resulting presumption is, as shown by petitioner’s Exhibit 10, admitted in evidence, that petitioner shifted the burden of $1,328.35 of the tax for 1935 and of $3,753.24 of the tax for 1936. On this point we agree with the Commissioner, and we have made a computation of the margin in our findings of fact. Section 501 (e) (2) of the Revenue Act of 1936 reads in part as follows:

* * * from the aggregate selling price of all articles with respect to which such Federal excise tax was imposed and which were sold by him during the taxable year (computed without deduction of reimbursement to purchasers with respect to such Federal excise tax) there shall be deducted the aggregate cost of such articles, and the difference shall be reduced to a margin per unit in terms of the basis on which the Federal excise taw was imposed. The excess of such margin per unit over the average margin (computed for the same unit) shall be multiplied by the number of such units represented by the articles with respect to which the computation is being made; * * * [Italics ours.]

The words which we have italicized above are the provision of the statute upon which petitioner relies as a basis for its contention that in the instant case the unit for margin comparisons should be sales dollars instead of tons of coal. In this connection petitioner says:

It is perfectly apparent, therefore, that the excise tax imposed by the Guffey law was imposed on the basis of selling price or sales value, and that under the express provisions of Section 501 (e) (2) in order to reduce the gross margin to margin per unit, sales dollars rather than tonnage sold is the correct divisor. * * *

We think petitioner misconstrues the purpose of the use of the words “in terms of the basis on which the Federal, excise tax was imposed.” For example, in E. W. Stockton, 44 B. T. A. 514, the taxpayer was not selling barrels of flour, he was selling baking products such as bread, pies, and cakes. But the margin comparison was not made in terms of sales dollars of bread, pies, and cakes. It was made in terms of “barrels” of flour. Therefore, what the taxpayer was selling in that case had to be, in accordance with the statute in question, “reduced to a margin per unit in terms of the basis on which the Federal excise tax was imposed.”

Article 17 of Regulations 95, relating to the tax on unjust enrichment, is in line with our understanding of this particular provision of the statute. That article reads in part as follows:

Articles expressed in terms of units on the basis of which the Federal excise tax was imposed. — Articles, for example, handkerchiefs, cigars, hams, flour, cornstarch, may be expressed in terms of the commodity or material from which they were manufactured or produced. Thus, handkerchiefs, cigars, or hams may be expressed in pounds (or fraction of a pound) of cotton, tobacco, or hog, respectively; and flour and cornstarch may be expressed in bushels or pounds (or fraction of a bushel or pound) of wheat or corn, * ⅜ *.

Petitioner was producing and selling coal. The unit of measurement of that commodity is the ton, and it was tons of coal that petitioner sold. The Guffey tax was imposed upon the sale of coal, and was measured by a given percentage of the sale price at the mine, or, in the case of captive coal, the fair market value of such coal at the mine. It seems reasonable that the margin unit should be tons of coal and that is what the Commissioner has used in making the margin computations here. We hold, therefore, that the statutory presumption, as shown by the margin computations, is that petitioner shifted the entire burden of the Guffey tax for both years, and, unless this presumption is rebutted, the deficiency for 1935 will stand and the Commissioner’s claim for an increased deficiency for 1936 will be allowed if any increased deficiency is shown to be due.

Section 501 (i) provides that either party may rebut the presumption established by subsection (e) by proof of the actual extent to which the taxpayer shifted to others the burden of the tax, and that “Such proof may include, but shall not be limited to” the character of proof set out in subsections (i) (1) and (i) (2).

We think that petitioner has proven that it did not shift any of the Guffey tax applicable to the sales made to L & N, the Buddeke Co., and Bonnie Bros., Inc. The tax applicable to such sales for the period November 1 to December 31, 1935, is $323.97, and is computed as follows:

The tax applicable to such sales for the 20-week period January 1 to May 18, 1936, is $734.70, and is computed in the same manner as the tax applicable to the period in 1935. These sales were made on contracts entered into prior to the enactment of the Guffey Act and during the effective period of that act petitioner did not increase the price of or lower the grade of coal sold to these customers. To the extent of the tax applicable to such sales the presumption has been rebutted. Tennessee Consolidated Coed Co., sv.pra.

We do not think, however, that petitioner has rebutted the statutory presumption attaching to the Guffey tax applicable to its remaining sales. These were spot sales and were made at the daily market price of coal prevailing as of. the date of sale, and, until proven otherwise, the prices received for such sales must, under the marginal computations made under section 501 (e) (2), be presumed to include the Guffey tax imposed but not paid. In other words, petitioner’s “selling price less cost of material” for the taxable years 1935 and 1936 exceeded its “selling price less cost of material” for the six prior years by $0.3908797 per ton for 1935 and by $0.3360688 per ton for 1936<. A part of this excess was due to the increased cost of labor during the taxable years over the cost of labor for the base period. During the taxable years petitioner’s cost of labor per ton was $1,227 for 1935 and $1,207 for 1936. During the base period of six years it was an average of $0,973 per ton. This represented an increase per ton for the taxable years over the base period of $0,254 and $0,234, respectively, which would still leave unexplained a substantial part of the statutory excess of margin per unit as follows:

The Federal excise tax imposed by section 3 of the Guffey Act for 1935 and 1936, when reduced to a per ton basis, amounts to approximately 3 cents per ton for both years, computed as follows:

$1,579.41 divided by 51,579.40 (tons) equals $0.0306209
$3,962.59 divided by 183,125.85 (tons) equals $0.0297657

It is at once apparent that the excess of margin per unit in this proceeding for both years is large enough to absorb the entire increased cost of labor, and in addition thereto the Guffey tax, with a remaining unexplained balance of excess of margin per unit of $0,107 for 1935 and $0,072 for 1936.

Petitioner has offered no proof of other increases in costs of production except labor, and, even assuming that the entire increased cost of labor was shifted to others, there is a considerable excess of margin per unit or “cushion” left for absorption of the tax. Cf. Tennessee Consolidated Coal Co., supra.

Petitioner in its brief makes the point that the average realization price per ton of coal was less during the months immediately following the effective date of the Guffey tax than it was in the month of October 1935, just prior to the effective date of the tax. From this premise petitioner strongly argues that the presumption which follows the marginal computations under the statute has been rebutted. If this decrease in the average realization price per ton during the period named had been due to decreases in price which petitioner put into effect during such period, it would indeed be strong argument to support petitioner’s contention that it did not pass on to its customers the Guffey tax. Cf. Clinchfield Coal Corporation, 47 B. T. A. 151, a case where the taxpayer corporation proved that it decreased the selling price of its coal 20 cents per ton on November 25, 1935, a short time after the Guffey tax went into effect. But petitioner has not shown that the decrease in the average realization price per ton oí coal during the period named was due to decreases in price which it put into effect, but, on the contrary, we think the evidence shows that this decrease was due to a higher percentage of the smaller sizes of coal being sold during the months in question than during the month of October 1935. This being the state of the evidence, we do not think that petitioner has successfully rebutted the presumption raised by the marginal computations made under the statute.

Petitioner concedes that on or about October 1, 1935, it increased its price on spot sales of coal by an amount sufficient to pass on to its customers an estimated increase of 15 cents per ton in the cost of mining and loading coal by reason of wage increases put into effect at that time.

Petitioner’s president, D. B. Cornett, who was the moving spirit in the conduct of petitioner’s business, testified however that in making this increase in the selling price of its spot coal, it was not intended to include anything for the Guffey coal tax. We have no reason to doubt the good faith of this testimony. The fact remains, however, that the price increases which were put into effect on the selling prices of spot coal appear to have been in excess of what was required to take care of the increased labor costs. These price increases seem ample to cover the Guffey coal tax as well. The margin computations, as we have already pointed out, seem to well establish that fact.

Therefore, it seems immaterial to us that in making these increases in price in the sales of its spot coal it was only the intention of petitioner to shift to its customers the increased wage cost and not the small increase per ton which resulted from the imposition of the Guffey tax. In the recent case of United States v. Poindexter & Sons Merchandise Co., 128 Fed. (2d) 992, the taxpayer was making a similar contention as to the product which it was selling.

The court, in ruling against the contention of the taxpayer that it had succeeded in rebutting the presumption that it had shifted the tax to its customers in the form of an increase in the selling price of the articles sold (in that case cotton-content merchandise), among other things, said:

The concrete definitely controlling consideration therefore is the established fact that the inventory valuations and the prices were raised coincident with the tax, and by the collection of the increased prices the tax was passed on. Though the plaintiff is persuaded that it did not intend to pass the tax on, and that it raised its inventory and prices solely to re-establish normality and to offset its increased expenses and bad debts and because the rise in the market permitted it to do so, its proof was insufficient to establish that it had not been' relieved of the tax burden, nor reimbursed therefor, nor that such burden had not been shifted directly or .indirectly within the intendment of the statute. Anniston Mfg. Co. v. Davis, 301 U. S. 337; Luzier’s, Inc. v. Nee, 8 Cir., 106 F. (2d) 130; Honorbuilt Products Co. v. Commissioner, 3 Circ. 119 F. (2d) 797; C. M. McClung & Co. v. United States, C. Clms. 35 F. Supp. 464.

So, to sum up, except as to the tax on coal sold to the L & N, the Buddeke Co., and Bonnie Bros., Inc., we hold that petitioner has not successfully rebutted the presumption raised by the margin computations.

Petitioner’s claim that the tax imposed by title III of the Revenue Act of 1936 is unconstitutional because of its indefiniteness and uncertainty can not be sustained. Tennessee Consolidated Coal Co., swpra.

The deficiencies should be recomputed accordingly.

Decision will be entered v/nder Rule 50.


author: Van Fossan :

text:
    Louis E. Stoddard, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99387.
    Promulgated August 20, 1942.

      George E. H. Goodner, Esq., for the petitioner.

      Charles P. Reilly, Esq., and Darois HasMn, Esq., for the respondent.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      * # * * A * *
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock for stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

   OPINION.

Van Fossan :

The first question presented is whether or not petitioner is entitled to deduct as an ordinary and necessary business expense the payments made to accountants for services rendered in connection with,a controversy over petitioner’s 1932 and 1933 Federal income taxes.

Petitioner’s argument that the decision of this Board in Loim E. Stoddard, Jr., Docket No. 92977, memorandum opinion entered December 14, 1939, is res judicata as to this issue must be rejected. A finding that petitioner was engaged in business during the year 1934 does not establish that he was engaged in business during the year 1936. Moreover, such a holding would not dispose of the issue. There remains the question of the nature of the expense.

As to the nature of the expense the proof is insufficient to enable us to hold that the tax controversy which gave rise to the expenditure arose from business transactions. For aught that appears it may have arisen from petitioner’s personal, as contrasted with his business, relationships.

The second issue arises from respondent’s determination that the transaction in which the first mortgage bonds and the second mortgage notes of the Taft Realty Co. were exchanged for first mortgage bonds, second mortgage bonds and stock of the Taft Realty Corporation was a nontaxable exchange upon which no gain or loss may be recognized. The applicable statutory provisions are contained in sections 112 (b) (3) and 112 (g) (1) of the Revenue Act of 1936, as amended by section 213 (g) (1) of the Revenue Act of 1939; and section 112 (g) (2) and (h), Revenue Act of 1936.

Petitioner exchanged his interest in the first mortgage bonds of the old corporation for bonds and stock of the new corporation and he exchanged his interest in the old second mortgage note for new second mortgage bonds. These exchanges were within the scope of section 112 (b) (3). Hence, no gain or loss may be recognized if there was a reorganization to which both corporations were parties.

One of the statutory definitions of a reorganization is the acquisition by one corporation of substantially all the properties of another solely in exchange for all or a part of its voting stock. In the case at bar Taft Eealty Corporation acquired all the properties of Taft Realty Co. by virtue of an exchange of its voting stock and bonds for bonds of the old company. The fact that the new company’s stock was issued to the old bondholders rather than to the old corporation is immaterial. Helvering v. New Haven & Shore Line R. R. Co., 121 Fed. (2d) 985.

In Harden F. Taylor, 43 B. T. A. 563; affd., 128 Fed. (2d) 885, this Board held that the issuance of debentures of the new corporation in exchange for debentures of the old corporation constituted an assumption of indebtedness. We are of the opinion that the issuance of the first and second mortgage bonds in the case at bar likewise constituted an • assumption of indebtedness. The bonds were issued in recognition of the indebtedness of the old corporation. The indebtedness antedated the reorganization and did not arise out of it. Cf. Helvering v. Southwest Consolidated Corporation, 315 U. S. 194. Since the bonds are eliminated from consideration, the property was acquired solely for voting stock, within the meaning of the first part of section 112 (g) (1) (B) of the 1936 Act, as amended.

An essential factor which distinguishes a reorganization from a sale is the existence of a continuity of interest. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462 Helvering v. Minnesota Tea Co., 296 U. S. 378. The Supreme Court has recently held that the continuity of interest requirement is satisfied where a proprietory interest in the new corporation is retained by the creditors of the insolvent old corporation. Helvering v. Alabamia Asphaltic Limestone Co., 315 U. S. 179. Cf. Helvering,v. Southwest Consolidated Corporation, supra. In the case at bar the continuity of interest requirement was satisfied by issuance of stock to the first mortgage bondholders. We are not convinced by petitioner’s argument that a different result should be reached by reason of the fact that the shares of stock were issued to voting trustees. We deem this fact immaterial. See Helvering v. New Haven & Shore Line R. R. Co., supra.

In keeping with the above, we hold that the second mortgage bonds were acquired in a nontaxable reorganization.

The record shows that petitioner charged off his interest in the second mortgage note of the old corporation subsequent to the exchange. He claims a' deduction either as a bad debt or as a loss. Since the exchange was nontaxable, no gain or loss may be recognized, nor may petitioner take a bad debt deduction on account of the same. Edith M. Greenwood, 41 B. T. A. 664; Daniel MacDougald, 44 B. T. A. 1046.

It also follows that in determining the deficiency respondent correctly excluded from petitioner’s income the gain reported on the exchange of a part of petitioner’s first mortgage bonds and correctly disallowed the loss claimed on the exchange of the remainder of petitioner’s first mortgage bonds.

Reviewed by the Board.

Decision will he entered for the respondent.

Kern dissents on the second issue.

       (g) Definition of Reorganization under Prior Acts.—
      (1) Section 112 (g) (1) of the Revenue Acts of 1938, 1936, and 1934 are amended to read as follows:
      “(1) The term ‘reorganization’ means (A) a statutory merger or consolidation, or (B) the acquisition hy one corporation, in exchange solely for all or a part of its voting stock, of substantially all the properties of another corporaton, but in determining whether the exchange is solely for voting stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded; or the acquisition by one corporation in exchange solely for all or a part of its voting stock of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the tranfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E) a mere change in identity, form, or place of organization, however effected.”
      (See Wilgard Realty Go. v. Commissioner, 127 Fed. (2d) 514, upholding the constitutionality of the retroactive application of section 213 (g).)

       (g) (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.
      (h) Definition of Control. — As used in this section the term “control” means the ownership of stock possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corpoiation.


author: Disney:

text:
    Barnhart-Morrow Consolidated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105859.
    Promulgated August 20, 1942.

      B. W. Bwrkhead, Esq., and Harold O. Morton, Esq., for tlie petitioner.

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

       SEC. 14. SURTAX ON UNDISTRIBUTED PROFITS.
      *******
      (d) Exemption From Surtax. — The following corporations shall not be subject to the surtax imposed by this section :
      *******
      (2) Domestic corporations which for any portion of the taxable year are in bankruptcy under the laws of the united States, or are insolvent and in receivership in any court of the united States or of any State, Territory, or the District of Columbia.

   OPINION.

Bad Debt Issue.

Disney:

The respondent disallowed' the item of $16,500.10 as a bad debt deduction upon the ground that the debt was not ascertained to be worthless and charged off during the taxable year. The substance of respondent’s argument upon brief is that the promise of C. C. Julian ceased to have any value in 1934, when he died leaving no-estate, and that the “loss”, if any, was sustained in that year.

It was stipulated that the amount was charged off in 1936, leaving for decision only the question of whether the debt was ascertained to-be worthless in the same j^ear. Both parties refer to the undertaking of C. C. Julian as a contract of indemnity and we will assume that it. was such an agreement. Under it the indemnitor obligated himself to reimburse petitioner in- the event petitioner was compelled to pay to another any amount paid to him or his agent under his claim of right, to receive a portion of the proceeds of production of Well No. 16. This promise did not ripen into a claim against the indemnitor until 1936, when the courts of California decided that J. A. Smith was the owner of the interest under which C. C. Julian’s nominee had received! the sum in question. Howell v. Commissioner, 69 Fed. (2d) 447. Thus there was not at any time prior to 1936 a debt against C. C. Julian to ascertain to be worthless. When it did come into existence, it was. worthless and petitioner so ascertained it. Then, for the first time,, there was a debt to collect, and if ascertained to be worthless, to charge off as uncollectible.

Respondent cites no authority for his statement that the obligation of C. C. Julian was discharged by his death. We find none. It was-not a personal covenant, incapablfe of being performed by any other person. On the contrary, his obligation was one which survived him and for which his estate was liable. Elliott v. Garvin, 166 Fed. 278 Brownfield v. Holland, 63 Wash. 86; 114 Pac. 890. His estate was insolvent when the debt came into existence. We hold that the petitioner is entitled to deduct the amount in controversy as a debt ascertained to be worthless and charged off in 1936.

Salary Issue.

The respondent makes the general contention under the second issue-that, where salary is accrued and deducted from income and the liability is satisfied in a subsequent year for less than its face amount, the difference between the liability and the amount for which it was-satisfied constitutes taxable income. The rule laid down by the Board-in and since Central Loan & Investment Co., 39 B. T. A. 981, has bee that such an amount is not income unless the deduction made in a prior year served to offset taxable income. Estate of James N. Collins,. 46 B. T. A. 765; Estate of Charles H. Robinson, 46 B. T. A. 943; Citizens State Bank, 46 B. T. A. 964.

Here the petitioner had a net loss in 1931 of $90,116.67 and no contention is made that the compensation canceled in 1936 was not deducted in arriving at the net loss. Accordingly we sustain the petitioner on this issue.

Insolvency Issue.

In his determination of the deficiency for 1936 respondent held that petitioner was not insolvent at any time during the period of its receivership in that year and therefore was not exempt from surtax on $89,476.51 of undistributed net profits under the provisions of section 14 (d) (2) of the Eevenue Act of 1936.

The difference between the parties is whether petitioner was insolvent in 1936 during the period of receivership. They agree that if it was insolvent at any time during that period the statute exempts petitioner from surtax.

In Artesian Water Co., 43 B. T. A. 408, we said that the word “insolvent” as used in section 14, supra, “was intended by Congress to carry the meaning used” by the Supreme Court in Dutcher v. Wright, 94 U. S. 553. In that case the Court said that “Insolvency, in the sense of the Bankrupt Act, means that the party whose business affairs are in question is unable to pay his debts as they become due, in the ordinary course of his daily transactions.” We thought this was evidenced by the Senate Finance Committee Eeport on the provision, in which the committee said:

The Finance Committee Bill also avoids tbe possibility of tax avoidance by collusive Receiverships by limiting tlie provision to eases in which the corporation is in bankruptcy under the Federal bankruptcy laws, and to cases in which it is insolvent, i. e., its liabilities are in excess of its assets or it is unable to pay the claims of creditors as they mature — and in receivership in Federal or State Courts.

In holding that the petitioner did not come within the exemption provided by the statute, we referred to proof that during the taxable year its assets were about ten times its liabilities, exclusive of capital stock and surplus, and that it had made payments on some of its obligations.

Eegulations 94, promulgated for the Eevenue Act of 1936, does not define the meaning of insolvent. See art. 14-1. Article 13-4 of Eegulations 101, Eevenue Act of 1938, defines the term insolvent as meaning “insolvency in the sense of excess of liabilities over assets and in the sense of inability to meet obligations as they mature.”

Eegulations 103, applicable to the Internal Eevenue Code, defines the term insolvent as meaning “insolvency either in the sense of excess of liabilities over assets or in the sense of inability to meet obligations as they mature.” Sec. 19. 13-4. A definition that “insolvency is established if liabilities exceed assets or if the debtor corporation is unable to meet its obligations” was. agreed upon by the parties in United States v. Anderson, 119 Fed. (2d) 343. In that case the court said that in determining insolvency “the court should allow for reasonable use of the debtor’s credit.”

The United States Circuit Court of Appeals, in reversing Artesian Water Oo., supra, said that as the taxpayer’s assets exceeded its liabilities and it was not, therefore, insolvent in a bankrupt sense, solvency or insolvency turned upon whether “the taxpayer was able to meet its obligations as they matured, in the usual course of trade or business.” 125 Fed. (2d) 17. It decided that the taxpayer was unable to meet its obligations, “either from its current assets or with ‘the reasonable use of the debtor’s credit’ (United States v. Anderson Co., supra.)”

We think a corporation is insolvent within the meaning of section 14 (d) (2), supra, if at any time during receivership it is unable to meet its obligations as they mature in the ordinary course of business, with a reasonable use of its credit.

All of petitioner’s oil and gas property was in the possession and control of trustees appointed by the court in the Julian v. Schwarts litigation. The remaining assets were in the possession and control of a receiver appointed in the litigation instituted by D. E. Morrow in 1931. The balance sheets of petitioner at the close of the years 1932, 1933, 1934, and 1935 reflect, exclusive of the oil and gas properties, no cash on hand. Other assets on which something might have been realized consisted of supplies in the amount of $594.09, patents $1,000, stock issued for service and leases $219,120.50, and accounts receivable of $35,507.19. Its liabilities, consisting of notes and accounts payable, accrued expenses and amounts due stockholders, were $55,-611.12, $43,580.75, $43,111.14, and $43,789.66, respectively, at the close of 1932, 1933, 1934, and 1935. The balance sheets of petitioner as of the termination of the receivership and at the close of 1936 were not introduced in evidence. Testimony, however, established that there were no substantial changes before the termination of the receivership in 1936.

Though the final accounting of the receiver disclosed obligations incurred as early as 1931, the record does not disclose whether any of the debts shown by the balance sheets, except salary accrued in 1931 in favor of Guy L. Hardison in the amount of $14,000, but which was involved in the litigation instituted by D. E. Morrow in 1931, matured during the receivership. No evidence was offered as to the arrangements made, if any, with the creditors for payment of these debts.

The burden was on petitioner to establish its insolvency and any deficiency of proof must operate against it. No attempt was made to show inability to meet maturing debts by a reasonable use of credit. It is true that the oil and gas properties were in the possession and control of the trustees and for that reason could not have been used by the receiver as collateral for a loan, but he had under his control stock of a book value of about $220,000. Nothing of record is opposed to the idea that this stock could have been used as security for a loan or sold to pay debts. Neither-does it appear that an application was ever made to the court for permission to sell receiver’s certificates or otherwise raise funds to meet matured obligations.

We do not regard as helpful to petitioner the statement appearing in the court order of November 12,1936, that petitioner was no longer insolvent by reason of the litigation. It does not appear that the court ever had before it the question of solvency or insolvency of petitioner. Neither does it appear that any of the parties in interest ever alleged such a fact in pleadings before the court. On the contrary, the complaint filed by D. E. Morrow, which resulted in the appointment of the receiver, alleged, among other things, that the corporation had been in a prosperous condition and was then operating at a profit, but that the profits were being diverted from the stockholders and petitioner. The receiver does not appear to have received any funds until the latter part of 1936, when his expenses were paid out of receipts from the trustees, but inability to pay due to impounding of assets in a receivership, not based upon grounds of insolvency, is not proof of insolvency in the sense of inability to meet maturing debts. The receivership of itself does not prove insolvency.

The petitioner has failed to prove that it was insolvent at any time during the period of receivership in 1936. Accordingly we sustain the respondent on this issue.

Depletion Issue.

In his determination of the deficiency for 1936 respondent allowed depletion on $142,989.99, representing the amount received by petitioner in cash and credits in that year out of the funds impounded by the trustees in the Julian v. Schwartz litigation. He contends here that that amount constitutes petitioner’s gross income and net income during the taxable year from the operation of the wells by the trustees. Petitioner contends that it is entitled to depletion on not only the $142,989.99 thus received, but on the additional amount of $223,352.83, representing expenses incurred by the trustees in the operation of the properties, all of which was chargeable to and charged to petitioner. Thus petitioner seeks depletion on $366,342.82 and respondent asks us to restrict it to the net amount. The facts are not in dispute. Depletion on the production of the wells in 1936 after petitioner acquired possession of the wells and in 193? is not in controversy.

Petitioner insists that its economic interest in the production of all of the wells was $488,903.65 and that it could not actually or constructively receive the net economic interest of $265,550.82 ($488,-903.65 less operating expenses of $223,352.83) without constructively receiving the $223,352.83 charged to it for operating expenses.

The parties agree that under the rule of North American Oil Consolidated v. Burnet, 286 U. S. 417, no part of the proceeds of production constituted taxable income to petitioner until received by it. They also reached an agreement in 1937 that no income tax liability would be assessed against the trustees for the years 1931 to 1936, but that the recipients of the proceeds of production would be liable for income taxes in the year or years in which the funds were distributed.

We think the question is controlled by Crews v. Commissioner, 89 Fed. (2d) 412, affirming, on the point involved herein, 33 B. T. A. 441. In- that case in 1922, while certain litigation, relating to failure to drill offset wells was pending, the lessors of oil property entered the undeveloped section of the leased land and began development thereof. The Sinclair Oil & Gas Co., operator of the developed portion of the property as assignee of the lease, served notice that it claimed a right to such production as might be obtained by the lessors. To provide an outlet for their production, the lessors entered into an escrow agreement under the terms of which seven-eighths of the proceeds of production was to be deposited in escrow in a bank, subject to payment to the proper parties in interest when the litigation was settled, the escrow agent to pay to the lessors in the meantime such sums out of the escrow funds as were necessary for them to use in further developing the land. The litigation was settled in October 1930. Prior thereto there was expended out of the escrow funds the sum of $849,544.37 for drilling, equipping and operating wells and for miscellaneous purposes incident to the production of oil and gas. While this arrangement was in effect the lessors produced from the property entered by them oil and gas in the amount of $1,462,504.02. Aside from the moneys expended for development and operating purposes, no part of the escrow funds was actually paid to the lessors, due, among other things, to misappropriation of funds by officials of the bank and worthlessness of an indemnity agreement executed in connection with the matter and the giving of a release by the lessors in favor of the bank.

The question involved in the proceeding was the amount of depletion to which the lessors were entitled, in connection with which it was necessary to determine tbe amount of gross income from the property. We held that gross income from the property was $1,462,-604.02 less $514,000 representing bonds purchased with escrow funds by the bank, no part of which, however, was ever received by the lessors, plus $355,000 received from Sinclair in 1930, the taxable year, in settlement of the litigation, a total of $1,303,504.02. Upon appeal the court held that the gross income from the property was $1,204,-544.37, being $849,544.37 plus $355,000. Subsequent consideration of the proceeding by this Board and the Circuit Court of Appeals did not in any wise alter the conclusion thus reached that upon settlement of the litigation and the termination of the escrow agreement in 1930, the taxable year, the amount of $849,544.37 paid out of production for development and operating purposes constituted gross income.

In that case, as already indicated, there was nothing in the escrow fund in 1930 to pay over to the lessors. Hence none of the proceeds •of production were actually received, except for the $849,544.37 expended for development and operating purposes. Here the proceeds •of production during the pendency of the Julian v. Schwartz litigation were in excess of operating expenses paid by the trustees out of production and upon the final termination of the litigation in 1936 only a part of the net proceeds was paid to petitioner. We do not think this point of difference in the facts of the two proceedings requires a different conclusion. The expenditures were made out of production of oil and gas for the benefit of petitioner. Under North American Oil Consolidated v. Burnet, 286 U. S. 417, we must consider the petitioner as having received no income until its right thereto was determined and receivership terminated, which was in 1936, and that the fact that the money was earned in previous years does not control; and the Grows case applies the principle there enunciated squarely to gross income, arising from oil production in years earlier than the year of receipt, for the purpose of computing depletion. This is consistent with the agreement of the parties that taxation would fall in the years when the funds were distributed. We hold the item of $223,352.83 to be gross income in 1936 from the property and that the Commissioner erred in refusing to allow petitioner depletion thereon. Depletion will accordingly be recomputed on the basis of $488,903.65 as the gross income from the property, the amount of depletion on the entire property for the year 1936 not to exceed, however, 50 percent of the net income from the property. There appears to be no difference of opinion between the parties on the facts necessary to compute the net income from the property.

Loss, Well No. 16, Issue.

The respondent is contesting the allowance of petitioner’s claim for a' loss of $43,151.96 upon the relinquishment in 1937 to J. A. Smith of its one-half interest in Well No. 16 upon the ground that the petitioner has failed to prove the cost or other basis of the property. Petitioner relies upon its Exhibit No. 57 to establish the amount of its loss. This exhibit is a statement prepared from petitioner’s books showing entries made therein for the cost of tangible well equipment, less depreciation, and intangible drilling cost, less depletion and depreciation on drilling equipment.

In his determination of the deficiency the respondent disallowed a loss of $38,984.02 claimed by petitioner in its return upon the ground that the alleged loss did not fall within the provisions of section 23 of the Revenue Act of 1936. During the course of the hearing in this proceeding respondent’s counsel announced that the amount of the loss was in dispute. Exhibit No. 57 was offered by the petitioner “for the purpose of showing the method and the manner in which petitioner arrived at the figure of $43,151.96 * * * and not for the purpose of showing that it is evidence of the fact that they did' sustain that, but to show how we arrived at that figure, to show our method of computing.” Counsel for the respondent objected to the introduction of the document in evidence “in the form offered as being immaterial.” The objection was overruled and the exhibit was admitted in evidence “for the purpose stated by counsel.”

The method employed in determining the amount of a loss is not in every instance proof of cost or other basis. It does not prove the cost in this proceeding. Respondent never agreed that petitioner’s books reflected actual cost of the well. Petitioner deducted from the book costs of tangible equipment a total of $17,889.48 for depreciation. Whether this amount represents the “amount allowed (but not less than the amount allowable)” within the meaning of section 113 (b) (1) (B) of the Revenue Act of 1936 does not appear. Depreciation in the amount of $3,604.26 on drilling equipment was included in a total of $74,167.31 for intangible drilling costs. No evidence was offered to prove whether the item of $3,604.26-represents the correct figure for depreciation and the record is devoid of any evidence to show that these intangible drillings costs were not deducted as ordinary and necessary business expense in the year in which they were incurred, as permitted by article 243, Regulations 74. The balance sheet as of the close of 1935 has an item of $60,908.31 for intangible drilling costs of the well, but that does not, without more, prove that petitioner has not had tax benefit from the expenditure. No allowance was made by petitioner in the computation for the salvage value of the well.

The evidence of record fails to prove the amount of any loss sustained by petitioner in connection with the transfer of its interest in Well No. 16. Accordingly we sustain the respondent on this issue.

Decision will Toe entered, under Rule 50.

         For a complete history of the proceeding see also 30 B. T. A. 615; 31 B. T. A. 187; 37 B. T. A. 387; 108 Fed. (2d) 712; 120 Fed. (2d) 749; 33 B. T. A. 36.