author: Kern :

text:
    Lida E. Malone, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102669.
    Promulgated October 8, 1941.

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

      John B. Stivers, Esq., for the fesponcjpnt.
   OPINION.

Kern :

In this case the question is solely whether gain or loss to the stockholder-taxpayer may properly be recognized in the transaction before us. Keduced to its elements, the recapitalization was a surrender of one-half the bank’s capital stock by its stockholders and the receipt by them of $62.50 in cash on each share surrendered. Technically, this was carried out by a surrender of all outstanding shares in exchange for new shares and cash. After this was done, the bank’s capital stock had been reduced to an amount appropriate to its needs, as required by the Comptroller of the Currency; and the stockholders had the same proportional interest in the bank’s assets as before, and the same actual interest, less the $62.50 received on each share surrendered. The last circumstance is established by the fact that the bank stock’s book value before the transaction was $138; and that two shares at $138 equal $276, and this sum less $62.50, leaves $214 (in round figures, since the cents do not appear in testimony) , which was the stock’s book value after the deal was completed.

The issue before us is succinctly stated in the petitioner’s petition:

The petitioner in her return for said year, 1937, claimed a capital loss of $1912.50 on account of the retirement of 85 shares of the capital stock of the American National Bank of Pensacola, Florida, owned by her. She received in consideration of the cancellation of the said stock by said corporation the sum of $62.50 per share and she claimed a loss between the difference of $62.50' and the amount paid by her1 for each respective share; the total loss being $1912.50. The commissioner refused to allow said loss, claiming that the only effect of the retirement of the said 85 shares of stock in said corporation was an adjustment of the basis of the cost of the remaining 85 shares owned by the petitioner. Petitioner alleges that this was error and that in fact the retirement of the said 85 shares of Stock was a partial liquidation and that she was entitled to said deduction.

In stating the basis of rejection of the claim, petitioner has adopted the language of the respondent in his deficiency notice. This is significant, for no claim is made, therefore, by the respondent that the cash distributed ($62.50 the share) constitutes a distribution in the nature of a taxable dividend under section 115 (g) of the Revenue Act of 1936, and we, therefore, leave that question and confine ourselves to the sole question of whether any loss was realized in the transaction.

Respondent contends that there was an “exchange” here which would fall under section 112 (b) (2), as stock for stock in the same corporation, or under subsection (e) as an exchange not solely in kind, as to which no loss is to" be recognized.

The transaction here was obviously not an “exchange of stock” in the ordinary sense, for the issuance of one new share certificate for every two of old share certificates was merely the mechanical device employed to carry out reduction in the capital stock of the bank. At the same time there was a distribution of a small part of the bank’s assets, to the extent of $62.50 with each new share. The only question, then (the dividend question being waived), is whether the $62.50 thus received constituted a liquidation of those shares, or was merely to be taken into account in computing the basis on the liquidation or sale of the remaining shares at some future time. If it was the first, loss in the circumstances would have been realized. The applicable provisions of the Revenue Act of 1936, contained in section 115 (c) and (i), are set out in the margin.

Our decision in Orie R. Kelly, 36 B. T. A. 507, reversed as Kelly v. Commissioner, 97 Fed. (2d) 915, is practically on all fours and we think resolves the question here. There petitioner was a stockholder of a banking corporation with a paid-in capital stock of four million dollars, and a paid-in surplus of three and one-half million dollars, which, in 1932, retired 50 percent of its outstanding stock by returning to its stockholders $800,000 in cash and voting trust certificates representing stock in another corporation with a fair market value of $480,000. We held that the distribution was not a taxable dividend under section 115 (g), Revenue Act of 1932, Henry Babson, 27 B. T. A. 859; affd., 70 Fed. (2d) 304; Commissioner v. Quackenbos, 78 Fed. (2d) 156; but that, since the corporation did not distribute to its stockholders any of its paid-in or earned surplus, but actually increased its surplus by $100,000, and since there was no change in the proportionate interests of the stockholders in the surplus, petitioner sustained no recognizable loss on the cancellation of stock, following Hellman v. Helvering, 68 Fed. (2d) 763.

The only differentiating fact, and that is not a significant one, between our case and Orie B. Kelly, supra, is that there was there a distribution of stock in another corporation in addition to cash. We there said at page 515:

There remains for our consideration respondent’s alternative contention that * * * petitioner did not sustain any recognizable loss on the transaction. As to this contention we think the respondent is correct. Although the Trust Company reduced Us outstanding capital stoclc by exactly one-half, it did not distribute to its stockholders a lilce proportion of its assets. Not only did it not distribute any of its paid-in or earned surplus, but it actually increased its paid-in surplus to the extent of $100,000. Furthermore, petitioner and the other stockholders of the Trust Company retained the same proportionate interest in such paid-in and earned surplus after the reduction of the capital stock as they had before the reduction took place. Under such circumstances, we think the alleged loss claimed by petitioner was not in fact realized as he still owned the same proportionate interest in the undistributed assets as be had before. In our opinion, the alleged loss should be added to and be considered as a part of the basis of the remaining stock of the Trust Company, the benefit of which, petitioner will receive when he in some future year disposes of such remaining stock. See Hellman v. Helvering, 68 Fed. (2d) 763; Charles M. Haft, 20 B. T. A. 431; and Bed Rock Petroleum Co., 29 B. T. A. 118. Cf. Commissioner v. Wright, 47 Fed. (2d) 871; and Florence M. Quinn, 35 B. T. A. 412. [Italics added.]

And again at page 516:

* * * As pointed out supra there was not m fact “a partial liquidation of a corporation.” No part of the surplus or undivided profits account of the Trust Company was distributed to the stockholders. On the contrary, such account was augmented through the contribution by the stockholders of $100,000 to it.

With due respect to the holding of the Second Circuit, in reversing our decision above, we are unable to accept the reasoning of the opinion. We are unable to see how the distribution of cash and stock of an aggregate value of $1,280,000 can constitute a redemption of 50 percent of the stock of a corporation with a then outstanding paid-in surplus of $3,500,000. It is true that Hellma's case may be distinguished on its facts, in that the stockholder there was a sole stockholder, but the basic principle remains unaltered. In Quackenbos’s case, relied on by the court in Kelly's case, there was direct purchase by the corporation of its stockholders of one-third of its outstanding shares at a cost of $90 the share, which may be supposed to have had some reasonable relation to the then fair market value of the shares.

Subsection 115 (i), defining a “partial liquidation”, as used in subsection (c) is very clear that the term means “a distribution by a corporation in complete cancellation or redemption of a part of its stock.” Where the full capital value of each share, as represented by the corporation’s surplus, is redeemed, the redemption obviously complies with the statute, but where the distribution in cash, or assets, or both bears no reasonable relation to the fair market value of the stock redeemed, it is not such a return of his capital to the stockholder as to constitute a partial liquidation of his stock. Whether the stockholder’s holding after the distribution is proportionally the same can not be a final criterion, since any regular corporate distribution to all shareholders, whether a dividend or in partial liquidation, would leave the stockholders in the same relation to each other and the corporation as before; the corporation’s assets only would be diminished. In other words, we understand the word “partial” to mean the complete redemption, by a return of the full value of those shares which are redeemed; and not to mean a distribution of a part of the value of the shares said to be redeemed. See W. C. Robinson, 42 B. T. A. 725. To adopt the latter view, as followed by the Second Circuit, would leave the door open to distributions essentially in the nature of dividends which would wholly escape taxation merely by the corporation’s using the device of a partial reduction of its capital stock. We can not believe that the statute so intends and must therefore decline to follow the Second Circuit’s decision in Kelly's case here.

We are of the opinion that the distribution here was not a partial liquidation within the meaning of section 115, and consequently, that the petitioner is not entitled to deduct any loss on her shares measured by the difference between her (or her donor’s) cost and the cash distributed. We do not, therefore, discuss the facts in evidence as to cost and time of acquisition of these shares which are set out in our findings of fact.

Reviewed by the Board.

Decision will be entered under Rule 50.

Smith and Turner concur only in the result.

       SEC. 115. distributions BY CORPORATIONS.
      * * * * * * *
      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. Eor the purpose of the preceding sentence, “complete liquidation” includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two .years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits.
      *>!<*****
      (i) Definition of Partial Liquidation. — As used in this section the term “amounts distributed in partial liquidation” means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.


source: Caselaw Access Project

author: Murdock :

license: Public Domain

text:
    The Hartman Tobacco Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104919.
    Promulgated October 8, 1941.

      John 8. Murtha, Esq., for the petitioner.

      G. P. Reilly, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined deficiencies of $14,781.36 and $9,058.87 in income tax for the fiscal years ended June 30, 1937, and 1938. Two issues are presented for decision:

1. What is the basis for depreciation on fixed assets acquired by the petitioner at the time of its incorporation in 1928 ?

2. Is the petitioner entitled to a dividends paid credit representing cash paid to preferred stockholders during the two taxable years? The facts have been stipulated.

The petitioner filed its corporate income tax returns for the taxable years with the collector at Hartford, Connecticut. The petitioner was organized on March 22,1928, pursuant to an agreement entered into on January 27, 1928. The petitioner was authorized to issue 25,000 shares of $100 par value 6% percent cumulative first preferred, 5,000 shares of $100 par value 6% percent cumulative second preferred, and 250,000 shares of $10 par value voting common stock.

Several organizations, engaged in the shade-grown tobacco business, desired to consolidate their businesses into one. They entered into an agreement in which they were joined by an investment securities firm. The investment firm was to furnish “possibly needed working capital.” The agreement was dated January 27, 1928. The parties to it were Steane, Hartman & Co. (hereinafter called Steane), a corporation, A. & S. Hartman, a partnership, Sol Kohn & Co., a partnership, and Thomson, Fenn & Co., the investment firm. A. & S. Hartman owned all of the stock of the Connecticut Sumatra Tobacco Co. (hereinafter called Connecticut), a corporation engaged in the shade-grown tobacco business, and Sol Kohn & Co. owned all of the stock of Kohn Brothers, Inc., a corporation engaged in that same business.

The three tobacco companies agreed to transfer to the petitioner, the new corporation to be formed, all of their good will and fixed assets, including the fixed assets of the two subsidiaries and current assets, including all merchandise current assets, in an amount not less than $1,125,000. The petitioner, in return, was to issue to the three parties 100,000 shares of its common stock and 5,000 shares of its second preferred stock and was to assume $1,340,000 of the liabilities of those three parties and was also to assume additional current liabilities equal in amount to all current assets received in excess of $1,125,-000. Thomson, Fenn & Co. agreed to purchase 15,000 shares of first preferred stock and 50,000 shares of common stock of the petitioner for $2,135,500, which it intended to sell to the public.

Transfers were made pursuant to the agreement on March 22,1928, at which time the petitioner assumed liabilities of the transferors in the amount of $2,188,141.22. The total value of the transferred assets was $3,857,629.16, not counting good will. The value of assets over liabilities was, thus, $1,669,487.94. The following table shows the basis of the fixed assets in the hands of the transferors and their values at the time they were transferred and the value of current assets transferred:

Stock of the petitioner was issued as follows:

Thomson, Fenn & Co. paid $2,135,500 on March 27, 1928, for the stock issued to it, including a few shares originally issued to incor-porators. About this same time it bought $1,295,000 par value of United States Treasury Certificates for and on the order of the tobacco companies, divided as follows:

Steane_$650,000
A. & S. Hartmán- 414,000
Connecticut_ 4, 000
Sol Kohn & Co_• 227,000
Total_1_ 1,295, 000

The petitioner paid to Thomson, Fenn & Co. $1,295,000 on account of the purchase price of the certificates, $650,000 for Steane, $413,383.33 for A. & S. Hartman, and $226,666.67 for Sol Kohn & Co. That payment represented discharge of a like amount of the total liabilities of $2,188,141.22 assumed by the petitioner, mentioned above. Steane and A. & S. Hartman each organized a corporation and transferred to it some excess current assets in exchange for its stock. Steane, Connecticut, and Kohn Brothers, Inc., were all dissolved in 1928, as were the partnerships of A. & S. Hartman and Sol Kohn & Co.

Thomson, Fenn & Co. accepted orders from the public for the first preferred stock of the petitioner at $98.50, beginning on March 15, 1928, and later filled the orders. It accepted orders for the common stock at $23.25, beginning March 21, 1928, and later filled the orders.

The petitioner contends that it is entitled to compute depreciation for the taxable year on fixed assets which it received at the time of its organization in 1928 upon the fair market value of those assets at that time, their cost to it, rather than upon the smaller basis of those assets in the hands of the transferor companies. The Commissioner, on the other hand, contends that the petitioner is not entitled to the stepped-up basis but must take the same basis as the transferor companies had. The Bevenue Act of 1936, which applies in the case of both of these fiscal years, provides in section 114 that the basis for depreciation shall be the same as the basis provided in section 113 for determining gain or loss. Section 113 ‘(a) (8) provides that if property was acquired after December 31, 1920, by a corporation issuing its stock or securities in connection with a transaction described in section 112 (b) (5), the basis shall be the same as it would be in the hands of the transferor, increased in the amount of any gain recognized to the transferor upon the transfer under the law applicable to the year in which the transfer was made. Section 112 (b) (5) provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such persons are in control of the corporation and have received stock and securities substantially in proportion to their interests in the property prior to the exchange. The Kevenue Act of 1928, which determined the tax consequences of the 1928 transfers, contained section 112 (b) (5), which was substantially similar to the same numbered provision of the Kevenue Act of 1936.

The petitioner contends that the 1928 transaction did not come within section 112 (b) (5) of the Revenue Act of 1928. Its first reason in support of this conclusion is that there was not the control in the transferors required by the statute, i. e., ownership of 80 percent of the stock of the petitioner. This argument is based upon the assumption that the transferors were the three tobacco companies only and the investment company may not be regarded as a transferor. This is a complete answer to the contention of the respondent if the investment company may not be regarded as one of the transferors.

Thomson, Fenn & Co., however, must be regarded as one of the transferors along with the three tobacco companies. It transferred money to the petitioner in exchange for stock, pursuant to the agreement of January 27, 1928. That money was property within the meaning of section 112 (b) (5). Portland Oil Co. v. Commissioner, 109 Fed. (2d) 479, affirming 38 B. T. A. 757. The petitioner argues that the requisite control was lacking, nevertheless, because Thomson, Fenn & Co. had already committed itself to sell the stock. The cases it cites are ones wherein a binding agreement to sell all, or a sufficient quantity, of the stock had been entered into prior to the completion of the transfer. The petitioner has failed to produce evidence that this is such a case. Thomson, Fenn & Co. intended and desired to sell their share of the stock, and had made some commitments to sell an undisclosed number of shares- The record does not show the number of shares involved in binding commitments made before the transfer was completed. Thus, it does not show that the requisite control in the four transferors did not exist immediately after the transfer. Nor does it show that the commitments were in sufficient volume to destroy the substantial proportion of stock received to property transferred, ih case that requirement could be affected by sales commitments, a point that need not be decided here. The conclusion is that the four transferors immediately after the exchange were in control of the petitioner, owning all or substantially all of the stock of the petitioner.

The petitioner’s second argument to show that section 112 (b) (5) of the Revenue Act of 1928 did not apply is that the properties were not transferred solely in exchange for stock or securities of the petitioner. Section 213 (f) (1) of the Revenue Act of 1939 is made to apply retroactively to a transaction like the 1928 transfer involved in this proceeding, which has never been litigated or closed by agreement. It provides that the assumption of liabilities of the transferors by the transferee, in exchanges otherwise coming within section 112 (b) (5), shall not be considered as “other property or money” and shall not prevent the exchange from being within the provisions of section 112 (b) (5). Paragraph (h) (1) of section 213 provides that, for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required, liabilities assumed shall be considered as stock or securities of the transferee received by the transferor. The petitioner, apparently recognizing the applicability of these provisions of the Revenue Act of 1939, contends that the petitioner did not assume liabilities of the transferor in the amount of $2,188,141.22, since the $1,290,-000 paid by the petitioner to Thomson, Fenn & Co. for United States certificates was in fact the equivalent of a cash payment to the trans-ferors as cost of the properties and was not in any true sense the assumption of liabilities of the transferor companies.

The original agreement of January 27, 1928, expressly provided that the petitioner was to assume liabilities of the transferors aggregating $1,340,000, and it also provided that, if current assets in excess of $1,125,000 were transferred to the petitioner, the petitioner would assume liabilities of the transferors in an amount equal to the excess. The respondent points out that the $1,340,000 must necessarily have referred to a bank loan of $50,000 and the $1,290,000 now in question. Current assets in excess of $1,125,000 were transferred to the petitioner and the petitioner was complying precisely with the contract when it assumed the liabilities of the transferors in the amount of $1,290,000 for the debt which they contracted with Thomson, Fenn & Co. in the purchase of the United States Treasury certificates. The petitioner did not order, buy, or own the certificates. The minutes of the special meeting of the board of directors of the petitioner held on March 22,1928, at the very time of its organization, recite that the liabilities of the transferors assumed by the petitioner amounted to $2,188,141.22. Balance sheets attached to the 1928 return show the same. That amount included the $1,290,000 here in controversy. The original- agreement required the transfer of “all the current merchandise assets of all three transferors.” Current assets in excess of $1,125,000 were transferred to the petitioner and, in order to comply with the agreement, it had to assume current liabilities of the trans-ferors in an amount equal to the excess. The transaction in 1928 was regarded as a nontaxable one and no tax has ever been paid on any gain realized by anyone from that transaction. The petitioner, in order to get a stepped-up basis at this late date, argues now that the 1928 transaction was taxable because $1,290,000 was a payment in the equivalent of cash of a part of the cost of the assets and was not a liability assumed. We see no reason to conclude, contrary to the express terms of the agreement of January 27, 1928, to the minutes above referred to, to the 1928 balance sheets, and to the stipulation, that the petitioner did not assume a current liability of the trans-ferors in the amount of $1,290,000. This is so even if the transferors deliberately incurred a current liability of $1,290,000 in order to comply with the contract and permit the transfer of current assets in excess of $1,125,000. We, therefore, reject the contention of the petitioner in regard to this item and hold that the petitioner assumed liabilities of the transferor in 1928 in the total amount of $2,188,141.22.

The transferors, including the three tobacco companies and the investment company, acquired all of the stock of the petitioner at its incorporation. The assumption of liabilities is to be regarded under section 213 (h) (1) of the Revenue Act of 1939 as stock or securities of the transferee. The amount of the stock and securities received by each of the four transferors was substantially in proportion to its interest in the property prior to the exchange. The respondent in his brief has demonstrated this by a computation which it is not necessary to discuss here in view of the fact that the petitioner does not contend to the contrary if Thomson, Fenn & Co. is to be regarded as a transferor and if the $1,290,000 is to be regarded as a liability assumed. It follows that the transaction was within section 112 (b) (5) and the petitioner is not entitled to the stepped-up basis which it claims. The determination of the Commissioner on the depreciation issue is sustained.

A plan to recapitalize the petitioner was adopted on May 27, 1937. There was an accumulation of unpaid dividends on the first preferred stock of about $47.75 per share. The plan was to retire that stock by having each share exchanged for:

T share of new prior preference no-par-value stock paying dividends of $4 a year, callable at $100 and accrued dividends;
1 share of new no par value preference stock paying dividends of $3 a year, callable at $50. This was in lieu of the accumulated dividends of $47.75 on the retiring first preferred stock;
2 shares of common;
A cash payment of $4.

The plan was carried out and the cash payment was made by payment of $55,460 in 1937 and $1,280 in 1938. The earnings of 1937 and 1938 were more than sufficient to pay the above amounts.

The Commissioner argues that the above transaction was a recapitalization and a reorganization; the gain, if any, was not recognized except to the extent of the cash; the cash was not shown to have been taxable as a dividend to any shareholder; and, therefore, no credit is allowed. He says the petitioner must go into the case of each stockholder to show that it actually had gains and the $4 was taxable to it as a dividend. Section 27 (h) does not require such proof. It is sufficient if the distribution would have been taxable as a dividend to any stockholder who might have had a gain. The Commissioner, in a similar case, conceded that a dividends paid credit was proper to the extent of the cash distributed and the propriety of his action was recognized by the court. Skenandoa Rayon Corporation, 122 Fed. (2d) 268, affirming 42 B. T. A. 1287. Section 27 (a) allows the credit for dividends paid during the taxable year. Section 115 (a) defines “dividend” as including any distribution made by a corporation to its shareholders out of earnings of the taxable year and the distribution is presumed to have been made from those earnings. This petitioner distributed $4 in cash to shareholders during the taxable years and had sufficient current earnings for the purpose. The cash was a dividend and the credit is allowed by the statute.

Decision will be entered under Rule 50.


author: Murdock:

text:
    William W. Bolton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104299.
    Promulgated October 10, 1941.

      Robert A. B. Cook, Esq., for the petitioner.

      Martin M. Lore, Esq., for the respondent.
   OPINION.

Murdock:

The respondent attacks the credibility of the witnesses and the tona fides of the alleged gift of the 500 shares of preferred stock of John W. Bolton & Sons, Inc., in 1928 in an effort to show that the petitioner must be regarded as the true grantor of the trust. He would then have to contend that section 166 or 167 applied. He cites George H. Whiteley, Jr., 42 B. T. A. 402; affd., 120 Fed. (2d) 782, and some similar cases. The evidence shows that the gift in 1928 was absolute, complete, and not a sham to avoid taxes. The stock was transferred to the wife and became hers to do with as she pleased. She chose to place it with other property, about which there is no dispute, in a trust. The trust was changed several times. Although the petitioner was consulted about the formation of the original trust of 1928, he never influenced his wife to .make any provision for his benefit in any of the trusts. He was not made trustee until bank failure had eliminated the original corporate trustee. An employee of the bank apparently suggested most of the provisions of the trusts and had the instruments written for Ethel B. Bolton. But she, and not the petitioner, was the grantor who decided upon the trusts. The entire corpus of the trust of December 4, 1931, consisted of common stock which the petitioner had never owned. He was not the grantor of that trust and sections 166 and 167 could not apply for that reason alone.

The respondent says the petitioner was free to use the trust income. Although some of the wording of the instrument is inept, as if the individual trustee had been substituted at the last minute in a trust originally drawn for a corporate trustee, nevertheless, the petitioner was given no right to use any of the trust property except for the benefit of the children. He was not given sufficient control over the trust property to justify taxing the income to him under section 22 (a). Cases where a grantor “retained” substantial powers are not in point. The beneficiaries were named and their interests fixed. He could only manage the trust for their benefit. No authority is cited for taxing the income of a^rust to a trustee who was not a grantor, who could not benefit personally from the trust, and who could only manage the trust and use its income for named beneficiaries.

Decision will be entered for the petitioner.


text:
    Archer L. Bolton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104331.
    Promulgated October 10, 1941.

      Robert A. B. Oooh, Esq., and Henry O. Johnson, Esq., for the petitioner,

      Martin M. Lore, Esq., for the respondent.
   OPINION.

Murdock:

The respondent has tried to impeach the testimony of the Boltons in an effort to show that the alleged gift was lacking in bona fides. .They testified that a gift was made. The respondent does not attack on the ground that any essential element was missing but upon the broad ground that the whole thing was a sham, perpetrated to avoid taxes. The evidence does not support this contention and mere suspicion is not enough. The wife of the petitioner’s brother created a similar trust on the same day and the respondent says that both were schemes of the husbands. But each couple was unaware of what the other was doing. The similarity was due wholly to the voluntary activity of an officer of a bank who furnished the forms and suggested the trusts. He knew that the couples were not close and avoided mentioning any affairs of one to the other. The testimony is that the gift was absolute and the trust was a later decision of the wife. The petitioner was not the grantor in any sense of the word and sections 166 and 167 have no application.

The respondent says that the petitioner could use the income of the trust as he saw fit and he had such broad control over the trust as to require the taxation of the income to him under section 22 (a). The petitioner had no right to use any of the income except for the benefit of the sons. He was not a beneficiary. Cases where a grantor “retained” substantial control over a trust are not in point. This petitioner was to manage the trust for the benefit of others who were named and given fixed rights in the trust instrument. He was not given sufficient control to justify taxing the income to him. No authority is cited for taxing the income of a trust to a trustee who was not a grantor, who could not benefit personally from the trust, and who could only manage the trust for named beneficiaries.

Decision will be entered wader Bule 50.


author: Sternhagen :

text:
    Producers Livestock Marketing Association of Salt Lake City, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99706.
    Promulgated October 10, 1941.

      Hadlond P. Thomas, Esq., for the petitioner.

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

Sternhagen :

The claim for exemption is based upon section 101 (12) of the Bevenue Acts of 1934 and 1936. The important provision for present consideration is, “Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members.” This affirmative statement necessarily- implies the exclusion of the negative, so that exemption is denied to an association which markets the products of nonmembers in an amomit the value of which exceeds the value of products marketed for members.

Petitioner’s claim is based upon the view that all of the producers whose products are marketed by it are expected to share in profits and therefore are its members, and for this view it argues upon legislative and administrative history. The pleadings and the testimony show that more business in value and amount is done for non-stockholders than for stockholders; but petitioner says that, since the statute uses the word members and this has a different meaning from stockholders, this evidence is not as controlling as it appears to be. It says that it has always contemplated that, if ever it was in a position to declare and pay a patronage dividend, the distribution would be to everyone, proportionately to the business done, without discrimination between stockholders and nonstockholders. This, it says, is what the regulations and the legislation have been leading up to as the ground for exemption. Such a liberal application of the statute would be at variance with the condition so clearly expressed. For, if all those for whom business is done are to be regarded as ipso facto' members, then, there could be no business for nonmembers and the'statutory condition is completely overridden.

According to the articles of incorporation and the bylaws, no one can be a member until he becomes a shareholder. No one can vote unless he is a common shareholder, and he must have signed all agreements and fulfilled the requirements of membership. No one can participate in the management unless he is a common shareholder. While the officers testified that there is an intention that any distribution shall be proportionate and that records are kept as data for the apportionment, there is some doubt whether there is authority for this in the articles or bylaws.

The administrative interpretation is found in Regulations 86 and Regulations 94, article 101 (12). It contains this:

An association will not be denied exemption because it markets the products of nonmembers, provided the value of the products marketed for nonmembers does not exceed the value of the products marketed for members. Anyone who shares in the profits of a farmers’ cooperative marketing association, and is entitled to participate in the management of the association, must be regarded as a member of such association within the meaning of section 101 (12).

Thus the statutory word member is recognized as qualified not only by the sharing of profits but also by participation in management.

Petitioner is not supported by Mim. 3886, C. B. X-2, p. 164 (7/9/31). The paragraph which it cites must be read with its introductory clause, as follows:

However, where a cooperative marketing association has otherwise complied with the provisions of the statute respecting exemption, but defers the payment of patronage dividends to nonmembers, exemption will not be denied—
*******
2. Where the by-laws provide for the payment of patronage dividends to members but are silent as to the payment of patronage dividends to nonmembers, and a specific credit to the individual account of each nonmember is set up on the books of the association.

Thus the claimant for exemption must have complied with the provisions of the statute. This means that its marketing may not be greater for nonmembers than for members; and “members” means persons who share in profits and participate in management. This is made clear later in the ruling, as follows:

However, under the Revenue Acts of 1926 and 1928 farmers’ cooperative marketing associations may market the products of nonmembers only in “an amount the value of which does not exceed the value of the products marketed for members * *
Membership in a cooperative association is, generally speaking, acquired in the same manner as membership in any other stock corporation — through the ownership of one or more shares of stock. However, as heretofore stated, the statutes of a number of States provide that farmers’ cooperative associations must be organized without capital stock. Therefore, as the exemption statute is silent as to the qualifications of members in farmers’ cooperative marketing associations, it follows that anyone who shares in the profits of such an association, and is entitled to participate in the management of the association, must be regarded as a member within the meaning of that statute.

It must, therefore, be concluded that in the taxable years in question the petitioner marketed the products of nonmembers in an amount the value of which exceeded the value of the products marketed for members, and that it was not entitled to exemption.

Keviewed by the Board.

Decision will he entered for the respondent,

       The following organizations shall be exempt from taxation under this title—
      * # * * * ^ *
      (12) Farmers’, fruit growers’, or like associations organized and operated on a cooperative basis (a) for tbe purpose of marketing the products of members or other producers, and turning back to them the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them, or (b) for the purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock (other than nonvoting preferred stock, the owners of which are not entitled or permitted to participate, directly or indirectly, in the profits of the association, upon dissolution or otherwise, beyond the fixed dividends) is owned by producers who market their products or purchase their supplies and equipment through the association; nor shall exemption be denied any such association because there is accumulated and maintained by it a reserve required by State law or a reasonable reserve for any'necessary purpose. Such an association may market the products of nonmembers in an amount the value of which does not exceed the value of the products marketed for members, and may purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 per centum of the value of all its purchases. Business done for the united States or any of its agencies shall be disregarded in determining the right to exemption under this paragraph.


text:
    Doris D. Havemeyer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104576.
    Promulgated October 10, 1941.

      William M. Sperry, 2nd. Esq., for the petitioner.

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

Murdock:

The Commissioner determined a deficiency of $1,311.19 in income tax for 1937. The Board adopts the stipulation of the parties as its findings of fact.

The petitioner filed her individual return for 1937 in the second district of New York. She was one of four equal owners of a bond and mortgage secured by real estate in New York. The mortgage was foreclosed in 1937 because the mortgagor was in default. Judgment was obtained and the property was sold in 1937 to the mortgagees for $15,500. The fair market value of the property at that time was $12,000. The court determined a deficiency due to the mortgagees in the amount of $6,349.09, of which $2,014.41 represented interest. The deficiency was not collectible. The petitioner claims the right to deduct $1,083.67 (her share of the deficiency after eliminating interest), as an ordinary loss.

The Commissioner, in determining the deficiency, disallowed “Foreclosure loss — $1,050.34” and explained that “The loss of $1,500.49, sustained upon the -foreclosure of property * * * is deductible in the amount of $450.15, as provided by section 117 of the Revenue Act of 1986.” His figures are not explained in the record, but he contends now that the loss of $1,083.67 was a capital loss within sections 23 (j) and 117 (a), although he fails to point out just what capital asset of the petitioner was sold or exchanged at that loss. Cf. Hale v. Helvering, 85 Fed. (2d) 819; Bingham v. Commissioner, 105 Fed. (2d) 971; James B. Stewart, 39 B. T. A. 87; Charles T. Carlson, 39 B. T. A. 185; John H. S. Lee, 42 B. T. A. 920; affd., 119 Fed. (2d) 946.

The petitioner accepts the bid price as the amount received on the debt and makes no claim for the larger loss measured by the fair market value of the property. Cf. Bingham v. Commissioner, supra; Commissioner v. Spreckels, 120 Fed. (2d) 517; Hottel v. Nicholas, - Fed. Supp. - (July 23, 1941). She was owed a debt before foreclosure. She héld, as evidence of that debt, a bond and mortgage. They were capital assets which she could have sold or exchanged, but she did neither. Cf. Ralph Perkins, 41 B. T. A. 1225, 1231. Instead, she pursued the property securing her debt and forced its sale through foreclosure. She credited the bid price to the debtor, but it did not cancel the debt in full. A deficiency was left, a debt still due her. It was worthless. She knew that and claimed a deduction on her return for her share of the deficiency, excluding the interest. Thus her acts were sufficient to entitle her to a deduction under section 23 (k) for a debt ascertained to be worthless and charged off during 1937.

The parties have cited no case on all fours. Cases involving a loss by the owner of real estate, through foreclosure, threat of foreclosure, or tax sales, are not the same as this case. See cases cited above. The taxpayers in those cases actually exchanged their property or had it sold for them by sovereign authority. Here the taxpayer was owed a debt which was never sold or exchanged but was simply unpaid and ascertained to be worthless.

Decision will be entered under Rule 50.


author: Van Fossan :

text:
    Fort Pitt Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103829.
    Promulgated October 10, 1941.

      John F. White, Esq., for the petitioner.

      J. Harrison Miller, Esq., for the respondent.
   OPINION.

Van Fossan :

On the facts as stipulated we sustain the respondent. The parties agree that no dividend was declared or paid by the petitioner during the taxable year, and that no portion of the corporation’s earnings was credited to the individual stockholders. It can scarcely be argued in the face of these facts that there was a constructive declaration or payment or any other action sufficient to satisfy the statute. The fact that the stockholders returned for taxation their proportionate shares of the earnings of the corporation and were not held liable for surtax under section 351 is not enough. The corporation, and not the stockholders, is the taxpayer presently before us. The statement in section 351 (d) that “any amount so included in the gross income of a shareholder shall be treated as a dividend received” does not carry the corollary that the corporation shall be entitled to a dividends paid credit.

The resolution authorizing the auditor to prorate the net income between the two stockholders did not purport to authorize payment of a dividend and in fact no payment was made. The fact that the petitioner was able to pay a dividend is, in these circumstances, immaterial.

The case of Valley Lumber Co. of Lodi, 43 B. T. A. 423, on which petitioner relies, is very different in its facts. There the dividends were declared and credited and, though not withdrawn, were subject to the demand and control of the stockholders. See Hustad Co., 43 B. T. A. 446, where dividends paid credit was denied under facts much more favorable to petitioner than those here present.

Decision will be entered for the respondent.

       SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
      (a) Dividends Paid Credit in General. — For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.


author: Leech :

text:
    Acer Realty Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102119.
    Promulgated October 14, 1941.

      B. Shad Bennett, for the petitioner.

      Garroll Walleer, Esq., for the respondent.
   OPINION.

Leech :

The first issue presents only the question of the propriety of respondent’s disallowance of the deduction of a portion of the salaries paid by petitioner to its president and secretary-treasurer, respectively, during the tax years, as ordinary and necessary expenses.

Under section 23 (a) of the Revenue Act of 1936, there are allowed as deductions “All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * *

Petitioner has the burden of showing that the salaries of its officers were “ordinary and necessary” expenses in carrying on its business. Wickwire v. Reinecke, 275 U. S. 101; and in determining this a strict application of the statute is required. See Welch v. Helvering, 290 U. S. 111.

Petitioner does not contend that prior to the start of its building program its activities were such as to justify the payments made by it to its two officers as salaries in the three taxable years here in question. In fact, the evidence presented by it is directed to establishing the fact that the services rendered by these two in supervising and directing the building were equivalent to and in the nature of the services which would have been rendered by a general contractor and supervising architect and that by the employment of these two individuals that cost, which would have exceeded the salaries paid, was saved. Petitioner seeks to justify the amount paid as salary to each, wholly on the ground of the value of these particular services in the building program. ' That the payments were made for these services is further shown by the fact that they were discontinued as soon as the building program was finished. Moreover, the payments to these two officers were substantially proportionate to their respective stock ownership in petitioner. Each time such salaries were increased this proportion was maintained and, although we are not advised as to the income of the corporation for the first two of the three years here in question, it is established that for the fiscal year 1938 these salaries were largely in excess of the gross income reported by petitioner for that year.

Had petitioner employed a general contractor and supervising architect in its construction, there is no question but that expense would have constituted a building cost, not deductible in computing taxable income. If, instead of this, it employs and pays its two officers to perform that service, is such payment to be considered different in character? We think not. In Federal Plate Glass Co., 6 B. T. A. 351, we held as capital expenditures amounts paid by the taxpayer to its general manager and plant superintendent for services over and beyond their usual and customary duties and analogous to services of designing and supervising engineers in the completion of its plant.

We see no reason here to question the amounts paid in each year as reasonable compensation for the services rendered. However, it is clear that these payments were not made as compensation of these two officers, as such. They were made for unusual, nonrecurrent services, the cost of which is represented now in the value of the capital assets thus acquired and now owned by petitioner. Compensation paid individuals for services incidental to the construction or improvement of buildings, or in connection with the acquisition of capital assets, is a capital expenditure and not an ordinary and necessary expense of carrying on business. Welch v. Helvering, supra; W. P. Brown & Sons Lumber Co., 26 B. T. A. 1192; Columbia Theatre Co., 3 B. T. A. 622; Houston Natural Gas Corporation, 34 B. T. A. 228; affd., 90 Fed. (2d) 814; certiorari denied, 302 U. S. 722. Respondent is affirmed on this issue.

Petitioner contends that the respondent, in arguing for the first time on brief that the proof indicated, the expenditures in controversy to be capital, has injected a new issue in the case. This position has no merit. The issue here is whether these payments, in fact, represented reasonable allowances for services performed in carrying on business, and the burden of establishing that fact rests upon petitioner. Respondent contends merely that petitioner’s proof not only fails to establish the fact necessary to sustain his deduction, but, on the other hand, shows affirmatively that the expenditures, even if ordinary and necessary, are nondeductible in character. That deductibility has always been the issue.

The second issue is whether or not petitioner was in constructive receipt of rent due it from its principal tenant, the sanatorium. Petitioner maintains its accounts upon a cash basis and in the fiscal year 1938 owed the sanatorium $10,500 for advances made it by the latter. In that year the sanatorium was obligated to petitioner for a rental of $18,000, but after paying $9,300 of this amount it ceased to make further payments, leaving a balance of rent due in the amount of $8,700. It is respondent’s position that petitioner was in constructive receipt of this latter amount since it had the right to offset it on its books against the amount it owed the sanatorium, although no such book entry was actually made during that year.

The doctrine of constructive receipt is an “artificial concept which must be sparingly applied”, John A. Brandar, 3 B. T. A. 231; and then only under “unique circumstances”, Hal E. Roach, 20 B. T. A. 919. Its “primary function is to bring about a fair and reasonable application of the income tax” and “its application may vary with varying circumstances”, Southern Pacific Co., 21 B. T. A. 990; and the test as to its applicability is “whether the debtor has funds standing to the credit of the taxpayer which the debtor is able to pay and which are available and unqualifiedly subject to the taxpayer’s demand”, Samuel Keller Jacobs, 22 B. T. A. 1166.

Does this case come within the principles applicable to constructive receipt? In our opinion it does. It is true that the debts of the sanatorium and petitioner to each other were carried as separate obligations on their respective books. Although there is no evidence that an offset was not entered on its books by the sanatorium in the tax year, petitioner made no offsetting entry.

The evidence here in connection with this mutual indebtedness is contained in the testimony of the present president of petitioner, who is the husband of Amia M. Bennett, and one Rothweiler, who was at all times here involved a director of petitioner and auditor for both petitioner and the sanatorium. Both of these witnesses were familiar with all the conditions surrounding the transactions between petitioner and the sanatorium. Bennett in bis testimony admits that petitioner had the right to make the offset but contends that it was not required to do so but could, if it desired, postpone the credit to a future period. Rothweiler testifies that it was intended that the balance due petitioner from the sanatorium was to be offset against petitioner’s indebtedness to the latter and that the offsetting entry was not immediately made because of the fact that it was anticipated that certain of the new buildings would be ready for occupancy before the close of the year, requiring an increase in the rent due for that year from the sanatorium. His testimony is that petitioner delayed making the offsetting entry until the determination of the exact amount which would be due. But the buildings in question were not completed for occupancy until some months after the tax year.

It is true that, at least under some circumstances, “mutual debts do not fer se extinguish each other.” But here, we think, the intention of the parties was that these mutual debts were to be treated as parts of one transaction. The offset of one debt against the other was intended and petitioner had an absolute right to make it during the tax year. Cf. Bailey v. Commissioner, 103 Fed. (2d) 448. We think that the requirements of constructive receipt are satisfied and that petitioner could not, by merely delaying the making of a book entry, postpone this rent receipt to a future period. [Respondent is affirmed.

The remaining issue upon the imposition of a 5 percent negligence penalty under section 293 of the [Revenue Act of 1936 we have disposed of by finding that there was no negligence or intentional disregard of rules and regulations. [Respondent is reversed on this issue.

Decision will be entered tmder Rule 50.


author: Van Fossan:

text:
    Charles V. Burghart and Mabel Burghart, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105020.
    Promulgated October 14, 1941.

      J. II. Gilby, C. P. A., for the petitioner.

      David Altman, Esq., for the respondent.
   OPINION.

Van Fossan:

The sole question for decision is whether the gains received during 1938 by petitioners on liquidation of the Bates & Rogers Construction Co. are to be taxed under the 1936 Act or under the 1938 Act. Petitioners contend that the 1936 Act governs and tha.t under section 117 (a) of that act 30 percent of the liquidation gain of $36,331.94 should be included in computing petitioners’ net income. Respondent determined that the 1938 Act should govern and in accordance with section 117 (b) of that act included 50 percent of the gain.

Petitioners first argue that the legislative history of section 115 (c) of the Revenue Act of 1936, which deals with distributions made in complete liquidation of a corporation, shows an intent that the 1936 Act should govern all distributions under a plan of complete liquidation if the first distribution was made under the 1936 Act. We have searched the legislative history and are unable to find any such intent manifested. The report of the House Ways and Means Committee states that the change from recognition under the 1934 Act of the entire gain on liquidation to recognition on a percentage basis was made to encourage liquidations. There is nothing to indicate an intention on the part of the legislators that the 1936 Act should apply to all liquidations begun under it. Nor do we believe that such an interpretation would be reasonable.

Petitioners argue further that a reasonable interpretation of section 115 (c) of the Revenue Act of 1938 makes the 1936 Act govern distributions made pursuant to a plan of liquidation promulgated prior to the effective date of the 1938 Act. That argument must be rejected. The portion of section 115 (c) of the 1938 Act which draws a distinction between liquidations begun before January 1, 1938, and those begun after December 31, 1937, as regards the length of time within which distribution and liquidation must be completed, was added by amendment on the floor of the Senate. The explanation given does not indicate an intent that .the 1936 Act should apply throughout the liquidations commenced under it.

Not only did Congress fail to indicate an intent that the provisions of the 1936 Act should apply, but it was within the power of Congress to apply the increased percentage of gain on distributions made during 1938. It is well established that a taxpayer has no vested right in existing rates of taxation. As we pointed out in Prudential Tobacco Co., 42 B. T. A. 518, 520:

* * * That case [Welch v. Henry, 305 U. S. 134] and United States v. Hudson, 299 U. S. 498, indicate that taxpayers must be deemed to be forewarned of the possibility of changes in rates, classifications, deductions, and credits in the income tax laws. * * *

See also Milliken v. United States, 283 U. S. 15.

The gains received by petitioners by reason of distributions made during 1938 were taxable under the 1938 Act and respondent properly included 50 percent of such gains in determining petitioners’ net income.

Decision will be entered for the respondent'.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) General Rule. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be talcen into account in computing net income:
      100 per centum if the capital asset has been held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years;
      40 per centum if the capital asset has been held for more than 5 years but not for more than 10 years;
      30 per centum if the capital asset has been held for more than 10 years.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      *******
      ' (b) Percentage Taken Into Account. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income :
      100 per centum if the capital asset has been held for not more than 18 months ;
      66% per centum if the capital asset has been held for more than IS months but not for more than 24 months ;
      50 per centum if the capital asset has been held for more than 24 months.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      * * * * * * *
      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall bo treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. Eor the purpose of the preceding sentence, “complete liquidation” includes any one of a series, of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. * * *

         SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      * * * 4
      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117, the gain so recognized shall be considered as a short-term capital gain, except in the case of amounts distributed in complete liquidation. Por the purpose of the preceding sentence, “complete liquidation” includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding, from the close of the taxable year during which is made the first of the series of distributions under the plan, (1) three years, if the first of such series of distributions is made in a taxable year is beginning after December 31, 1937, or (2) two years, if the first of such series of distributions was made in a taxable year beginning before January 1, 1938. * * *


author: Opper :

text:
    The Saven Corporation, a Delaware Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97649.
    Promulgated October 14, 1941.

      A. L. Evely, Esq., Raymond H. Berry, Esq., and Prewitt B&nwnes, Esq., for the petitioner.

      Thomas F. Gcdlahcm,, Esq., for the respondent.
   OPINION.

Opper :

In general terms the question is petitioner’s liability to surtax under section 104 of the Revenue Act of 1928. Respondent charges that petitioner’s returns were fraudulent and unless he is sustained in this contention we shall not be required to decide the substantive question, for the deficiencies would be barred by the statute of limitations.

Although the years involved are 1928 and 1929, the case must be considered against a historical background dating from 1923. In that year Edward S. Evans, the sole stockholder of petitioner, brought about the typical series of complicated corporate transactions to the end of effecting a sale of a part of his stock interest in E. S. Evans & Co. without the payment of any tax on the gain resulting.

Avoiding unnecessary detail, the operation consisted of the organization of two new corporations, one of which, the Evans Corporation — which, for convenience, we shall hereinafter call the Corporation — became the owner of the stock of the second new corporation which, in turn, through intermediate ownership of Evans’ stock in E. S. Evans & Co., acquired the latter’s assets. A part of the second corporation’s stock was then sold by the Corporation for cash, which it retained.

In four years the Corporation’s earned surplus grew to over $600,000 and by the end of 1928 it had reached nearly $1,400,000. During all this period no dividends had been declared. At about that time respondent notified the Corporation of his intention to proceed against it, under Revenue Acts of’ 1924 and 1926, for the undue accumulation of surplus in 1924, 1925, and 1926.

Thereupon petitioner was organized and Evans transferred to it all of his stock in the Corporation, taking in exchange the stock of petitioner. Within a few months, during the latter part of 1928 and the early part of 1929, the Corporation declared in dividends which were received by petitioner a total of over a million and a half dollars. Petitioner’s returns for those two years contain no reference to these payments. It is this omission to which respondent refers in the charge of fraud.

. Petitioner does not deny its failure to disclose the receipt of the dividends, but seeks to excuse its action in substance upon the dual ground that the omission was immaterial since the dividends were not taxable, and that it was proper because their payment out of the Corporation’s surplus correspondingly reduced the value of the Corporation’s stock and left petitioner’s total assets and liabilities in the same balance as they were when it was organized.

A survey and consideration of the entire record makes it impossible to escape the conclusion that the charge of fraud has been sustained. Giving the greatest possible weight to all inferences in petitioner’s favor and the most sympathetic consideration to its explanations, there yet emerges the inescapable concealment of the receipt of enormous items of income. Petitioner’s attempted justification, even were it more persuasive, could scarcely support so flagrant an omission to report the facts. Louis Ginsburg, 13 B. T. A. 417. We have accordingly found as a fact tfiat petitioner filed false and fraudulent returns for both years with intent to evade tax.

We think this conclusion may be demonstrated to a mathematical certainty as follows: If the 1928 return had been prepared and filed with as much information as was called for there would have been shown on the. first page under the heading “gross income”: *

.1. Gross sales from trading or manufacturing_$12,571.00
2.Less cost of goods sold:
(a) Inventory at close of preceding year (open-
ing inventory)_$2,500,000.00
(b) Merchandise bought for sale_ 12,112.50
(c) Cost of manufacturing or otherwise producing goods_ 0.00
(d) Total of lines a, b and c_$2, 512,112. 50
(e) Less inventory at end of year_ 2,222,819.47
3. Gross profit from trading or manufacturing (loss)_ 289,293.03
4. Interest_ 578. 96
9. Dividends on stock of domestic corporations_ 575, 000. 00
11. Total income_$298, 856.93
Deductions :
15. Interest_ $677.81
19. Dividends (From Schedule H)_ 575,000.00
23. Total deductions_$575,677.81
24. Net income (loss)-$276,820.88

These are all the transactions which the proof shows were effected in 1928. The comparatively small items of interest and of goods bought and sold did not appear upon the 1928 return. For its omission petitioner offers the explanation that so little was done in 1928 as to make it virtually true that no business was transacted in that year. “Petitioner corporation, although organized in 1928, was substantially not in business until 1929.” We feel justified in assuming, therefore, and it would be contrary to petitioner’s assertions if we did not, that nothing more need be inserted opposite the entry “merchandise bought for sale” or costs or other expenses of purchases, sales or operations. On petitioner’s theory, therefore, the foregoing would have been the correct entries on the 1928 return. They did not appear on that return. And although some of the items could b¿ deducted from a careful examination of the return, that does not apply to the $575,000 received by petitioner in cash as dividends from the Corporation which, of course, is the crux of the present proceeding.

As far as normal tax is concerned that item might make no difference; for ordinary dividends were not subject to normal tax in the hands of corporate recipients. But under section 104 they must be included in corporate income. And without some indication on the return there was no manner in which respondent could gather that this large sum had been received or could determine for himself whether section 104 was applicable and, if so, the amount of the income chargeable thereunder.

It might be possible for a taxpayer to be innocently unconscious of this possibility and, without knowledge of the significance of section 104 and of the receipt of dividends in connection therewith, to omit a dividend item without fraudulent intent, even one so large as that presently involved. It would, it seems to us, even then be negligent and dangerous, but perhaps a case could be made under such circumstances for the good faith of the action. Here, however, the organization of petitioner took place within a few weeks after the time that its predecessor and subsidiary had been charged by respondent under the old section 220, the forerunner of section 104. The year ended soon thereafter and the return was due in the following March. Petitioner was evidently organized to receive the dividends which its predecessor corporation was about to pay, with the result, if not for the purpose, of precluding the application to the latter of that section.

This history seems to us to give the concealment of the dividend a more sinister aspect. Not only does it remove any possible contention by petitioner that its officers and agents were unaware of the significance of the receipt and payment of dividends for purposes of section 104, it also establishes a motive for the concealment which is not reconcilable with innocent mistake. For by declaring a dividend the Corporation was enabled to frustrate, at least for 1928 and 1929, respondent’s attempt to apply to it the penalty provisions of section 104. By concealing the fact that petitioner was the recipient of that dividend, it was made equally impossible for him to follow the process through and to enforce against this petitioner the penalty which its affiliate had avoided. The ultimate result was that the earnings of the Corporation no more found their way into the personal income of its erstwhile individual stockholder than they would have if the dividends had not been declared; while at the same time the penalty devised for this result was successfully avoided.

The record thus demonstrates conclusively that there was a concealment of an item of income of such proportions that the authors of the return could not have overlooked it, M. Rea Gano, 19 B. T. A. 518; that it must therefore have been intentional; that it was material; that its materiality was known; and that its omission prevented the computation, assertion, and exaction of the tax for which the facts actually, called.

There are other respects in which concealments in the 1928 return would tend to mislead the respondent. The balance sheet attached to the return shows a comparatively insignificant item of cash in the amount of about $34,000. The Evans’ dividends were paid in cash during the latter part of the year, $250,000 having been disbursed on December 20. As we have noted, petitioner, an investment company, emphatically denies that it transacted any business of consequence during the year 1928 — “petitioner had, substantially speaking, no transactions during the balance of the year 1928.” It is therefore impossible for it to contend that it invested a sum as large as $575,000 within that brief period. The conclusion is inescapable that the great preponderance of the dividend receipts remained on hand in cash at the end of the year. A reference to so large a sum oh the balance sheet with no indication of the transaction of any business could reasonably lead to inquiry on the respondent’s part, but this fact does not appear on the return.

Again, the question is asked on the return: “Was the corporation in any way an outgrowth, result, continuation, or reorganization of a business or businesses in existence during this or any prior year since December 31, 1917?” This question is unanswered. It is followed by the requirement: “If answer is ‘yes’ give name and address of each predecessor business, and date of change in entity.” No such name is given. Petitioner’s brief states: “Evans Corporation had been in business for some years as a dealer in securities and it is apparent that Saven Corporation was formed for the purpose of taking over the business of the Evans Corporation.” A reference to the relationship of the Evans Corporation at this point could well have called to respondent’s attention the connection between the two corporations. While, taken by itself, the failure to answer-can perhaps not justifiably be treated as a misrepresentation, there is no explanation for it, and it seems to us, in connection with the other circumstances, an added indication of petitioner’s concern that no telltale clue appear which would disclose the true significance of the dividends declared by the Evans Corporation and their receipt by petitioner.

We are satisfied that petitioner’s 1928 return was deliberately conceived to mislead the respondent; that it was false in material and in carefully and consciously calculated respects; that it was purposely and intentionally executed and filed with intent thereby that petitioner should be enabled to escape Federal taxes; and that the deficiency here determined was due to that fraudulent design.

Similar conclusions follow with respect to the 1929 return. It also failed to disclose a dividend, in that case of over a million dollars. Its balance sheet carried forward the closing balance sheet of the previous year and failed to indicate the possession of a large amount of cash. Perhaps in one sense it was even more flagrant than the previous return, in that a line referring to dividends is not left blank, as was that for 1928, but contains a figure of insignificant proportions and affirmatively fails to disclose the truth as to the total dividends received. The same conclusion must follow on the fraud question with respect to the 1929 return.

Much is made of the fact that the returns were prepared by petitioner’s accountant under the direction of its tax consultant, but were signed and sworn to by its president and treasurer, Evans; that the latter claims to have relied largely on the advice of the two former individuals in executing the returns; and that, since they are now dead and can not testify and, inferentially, since Evans had no personal knowledge of the falsity of the returns, the conclusion of fraud can not be supported. Evans is also shown to have been a man of many business interests and of some consequence in the community. We may say in passing that the testimony shows nevertheless that Evans “would read what had been written and discussed it [the tax return] at the time I [he] signed it” and that, as to the payment of the dividend “I probably knew it at the time, if it was done.” But be that as it may, what we consider the short and final answer is that the charge of fraud is here leveled at the petitioner, which is a corporation. Like any other corporation, it could act only through its officers, employees, and agents. Commercial Credit Corporation v. Wells, 228 (N. Y.) App. Div. 402; 240 N.Y. S. 139, 142. Its action can be viewed only as the sum of the acts performed in its name by such of these individuals as were concerned. If petitioner had knowledge through the mind of one of its authorized agents of a fact, as we think it unquestionably did, and through the same or another agent deliberately and fraudulently made a contrary statement which was signed and sworn to by still another, all that knowledge and all those acts would nevertheless be attributable to petitioner. New YorK Central & Hudson River Railroad v. United States, 212 U. S. 481, 492-495; Philadelphia, Wilmington & Baltimore Railroad Co. v. Quigley, 62 U. S. 202, 211; Hill v. Associated Almond Growers (Cal.), 265 Pac. 813, 875; Summerill Tubing Co., 36 B. T. A. 347. In no other manner, it seems to us, would, it ever be possible to determine that fraud had been committed by a corporation, although it can not be doubted that a corporation is capable of committing fraud. 10 Fletcher on Corporations, Perm. Ed., 384; L. Schepp Co., 25 B. T. A. 419. It follows in our view that no exculpation of petitioner’s purposely deceitful conduct can be drawn from this aspect of the transaction.

Petitioner offered no evidence against the application of section 104, independent of the issues it raises with respect to fraud. Since, however, two of its contentions under the latter question would also be material in a discussion of the application of section 104, they require disposition.

In the first place it is asserted that petitioner’s stockholders avoided no tax because under W. S. Farish & Co., 38 B. T. A. 150; affd. (C. C. A., 5th Cir.), 104 Fed. (2d) 833, petitioner’s balance sheet was such that it had no accumulated earnings and profits and therefore section 104 is deprived of any force. This follows from petitioner’s argument that, since the dividends were declared out of the surplus of its subsidiary corporation, there was an equivalent reduction in the value of its asset, consisting of the subsidiary’s stock. The difficulty is that there is no evidence extrinsic of the books to indicate the value of the subsidiary’s stock .at the close of the year. The Corporation was an active functioning company and it seems apparent that for other reasons this stock could have increased in value due to earnings or appreciation in assets to an extent which might offset or at least diminish the reduction caused by payment of the dividend. There is nothing anywhere in the record from which it may even be inferred that such was not the fact. We think that in this phase of the case petitioner had the burden of going forward and that evidence should have been produced if it was available that the market value of the stock had correspondingly declined.

But even if we are wrong in this, and if the burden upon the respondent goes so far as to require that the evidence on this point also appear affirmatively in denial of petitioner’s assertions, it happens that petitioner’s own statements supply that evidence. It is furnished by the balance sheet, presumably reflecting the condition of its books, which petitioner attached to its return for both years. B. F. Edwards, 39 B. T. A. 735. The balance sheet shows that the decrease in inventory was less by several hundred thousand dollars than the dividends received in 1928; and in 1929 the inventory increased rather than the reverse. If the $515,000 in cash which petitioner received in dividends, but did not show, be added to the assets, at least the difference would have been available for distribution in 1928; and, not having been distributed in 1928, it would have remained to increase petitioner’s surplus and leave an equivalent amount subject to distribution in 1929. And see R. L. Blaffer & Co., 37 B. T. A. 851; affd. (C. C. A., 5th. Cir.), 103 Fed. (2d) 487. Nor are we impressed by petitioner’s citation of Corporate Investment Co., 40 B. T. A. 1156, 1171. To say, as the Board said there, that a surplus carried over from prior years does not constitute an accumulation of earnings and profits of the current year is fundamentally different from the conclusion we should have to reach here that dividends received in the current year are not earnings and profits of the recipient merely because they may represent a prior year’s earnings of the declaring corporation.

Second, the argument is made that petitioner was a dealer in securities and as such, entitled to inventory its stock on hand; and that since it treated the dividends as received in liquidation any income was offset by the loss in the inventory account, with the result that the dividends did not increase its net worth. Without deciding whether petitioner can be considered a dealer — see O. A. Burnett, 40 B. T. A. 605; affirmed on this issue (C. C. A., 5th Cir.), 118 Fed. (2d) 659 — or whether in principle or practice it actually operated on the inventory method, what we have said on the previous point will also dispose of this one. If the dividends received be added to the inventories which petitioner itself shows on the tax returns, the increase in net worth follows automatically. This argument of petitioner may have some weight in answer to respondent’s assertion that if this was in fact a liquidating dividend, petitioner’s basis was so small that a sizeable gain resulted which should have been reported for normal tax purposes in both years. On this question we express no opinion, for the case is not so presented as to raise any issue on petitioner’s taxable income, except under section 104. We may mention in passing, however, that petitioner now concedes that the amounts it received were not liquidating dividends. If they were not and are not in consequence to be viewed as a payment in exchange for the stock, petitioner’s treatment of them in that manner on its books was another instance of lack of due regard for accuracy in recording the transaction.

Since petitioner has offered no evidence to rebut the presumption of correctness attaching to the deficiency notice, it has not sustained its burden of showing that section 104 is inapplicable. We need not, however, rest our decision upon that point, for petitioner was characterized by its president at the hearing as a “holding company”; what evidence there is indicates its only business was investments; so that it was clearly “a mere holding or investment company”, and we have so found as a fact. There is no evidence to rebut the presumption which the statute creates when this appears. Similarly, petitioner concedes the applicability of the 25 percent penalty for delinquent filing of the 1928 return, if there should be any deficiency to which it could attach. Having found that respondent has sustained the burden of proving fraud, the remaining issues must accordingly likewise be decided in his favor.

Reviewed by the Board.

Decision will be entered wider Bule 50.

       SEC. 104. ACCUMULATION OF SURPLUS TO EVADE SURTAXES.
      (a) If any corporation, however, creates or organizes, is formes or availeS of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation as a mere holding or investment company or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
      (c) As used in this section the term “net income” means the net income as defined in section 23, increased by the sum of the amount of the dividend deduction allowed under section 23 (p) and the amount of the interest on obligations of the United States issued after September 1, 1917, which would be subject to tax in whole or in part in the hands of an individual owner.

       “* * * Petitioner corporation, on the contrary, was formed for the purpose of taking over the going business of a predecessor corporation, which was accomplished not through a tax free reorganization, but through what amounted to a transfer of the earned surplus, in property, of the Evans Corporation to petitioner as a dividend * * (Petitioner’s brief.)

       From the end of 1927 to tile end of 1928 there was an apparent increase in earned surplus of almost $800,000 and the dividends declared in 1928 and 1929 totaled almost $200,000 more than the surplus shown in the latter part of 1928.

         Thus, as reiterated in petitioner’s brief, it “was formed for the purpose of taking over the going business of a predecessor corporation” which, as its president testified, had in turn been “engaged dn the investment banking business dealing in securities, particularly bonds.”


author: Smith :

text:
    The Detroit Edison Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103379.
    Promulgated October 14, 1941.

      Edward H. Green, Esq., and Harvey A. Fischer, Esq., for the petitioner.

      Paul A. Sebastian, Esq.,' for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of deficiencies in income tax for the years 1936 and 1937 in the amounts of $4,031.04 and $6,267.94, respectively. The single issue raised is whether the respondent erred in disallowing deductions for depreciation in the respective amounts of $40,273.11 and $41,786.26 for the taxable years.

All of the facts material to the issue are covered in a signed stipulation of facts which we adopt as our findings of fact.

The petitioner is a corporation, organized and existing under and by virtue of the laws of the State of New York, but duly admitted and licensed to do business in the State of Michigan. It filed its income tax returns for 1936 and 1937 with the collector at Detroit, Michigan.

The petitioner is a public utility corporation engaged, among other things, in the generation and sale of electric energy in the city of Detroit, Michigan, and surrounding territory, and operates under the jurisdiction of the Michigan Public Service Commission.

Petitioner, in connection with the distribution and sale of electric energy, from time to time receives applications for the extension of its transmission or distribution lines to places which in the opinion of the petitioner are situated too far from existing transmission or distribution lines to warrant the expenditure of amounts necessary to make such extensions.

Upon payment by the applicant of a sum fixed by the petitioner, the latter agrees in writing to make the necessary expenditures for the construction of the desired line extension. The agreement between the petitioner and each applicant is evidenced by one of five types of agreements, copies of which are made a part of the stipulated facts.

The petitioner has from time to time required the applicant to pay varying sums ranging from $500 per mile to $1,500 per mile of line extension. These amounts as fixed by the contracts represent the estimated cost per mile of line construction.

The amount of the payment made by the applicant is the estimated cost, and not the actual cost, but it never exceeds the actual cost of constructing the requested line extension, and no increase or decrease is made in the amount fixed in the contract upon the completion of the line extension by reason of the actual cost thereof. The amount paid by the applicant is in all cases final as to such applicant. The applicant may, however, in accordance with the agreement in writing providing for refunds, become entitled to receive all or part of such payment upon the happening of the events provided for therein.

The material and property used in the construction of the line extension and the cost of labor are in all cases paid from the general working funds of the petitioner. The records of the petitioner set forth and identify all work performed and to be performed under the provisions of any given contract.

Upon the completion of the line extension, the petitioner, in accordance with standard practice, enters upon its books as a “property item” (such as poles, lines, etc.) the cost of the line extension, including labor and material, and does not subtract from that sum the amount of the payment made by the applicant.

Depreciation is claimed by the petitioner for income tax purposes for the years 1936 and 1937 upon the cost to the petitioner thus arrived at, at rates approved by the Commissioner.

The cash payment made by the applicant in those contracts providing for refunds is not earmarked for the building of any given line extension, but upon its receipt becomes a part of the free working capital of the petitioner. The cash account is debited with the full amount of the payment and a like amount is credited to a liability account entitled “Customers’ Deposits for Line Extensions”, classified under account No. 261, “Miscellaneous Unadjusted Credits”, as required by the Uniform Classification of Accounts for Electric Utilities prescribed by the Michigan Public Service Commission. After the expiration of the period during which refunds may be made to the customers under the terms of the written contract pursuant to which line extensions have been constructed, petitioner is then required by account No. 255 to transfer the unrefunded balance, if any, from account No. 261, “Miscellaneous Unadjusted Credits”, to account No. 255, “Contributions for Extensions.” With respect to those contracts which do not provide for refunds, the cash payments are debited to cash and credited to account No. “255 — Contributions for Extensions.”

At the expiration of the five-year period during which refunds may be made to depositors, the petitioner credits to surplus the amount of the unrefunded balance with respect to each agreement expiring during the taxable year. During the years 1936 and 1937 the petitioner thus credited to surplus $36,065.81 and $47,500.67. In its income tax returns for 1936 and 1937 petitioner did not report in taxable income the above amounts credited to surplus. The respondent did not in the determination of the deficiencies subject such sums to Federal income tax.

In lieu thereof the respondent held that the petitioner was not entitled to deduct depreciation upon such part of the cost of line extensions covered by the agreements as was represented by the unrefunded balances of deposits. The unrefunded balances of the deposits at the close of each of the years 1935,1936, and 1937 were as follows:

1935_$1,148, 679. 86
1936___ 1.184, 745. 67
1937 _ 1,232,246.34

In the determination of the deficiencies the respondent has disallowed a depreciation deduction upon the mean of those balances between the beginning and close of each of the years 1936 and 1937. These media were for $1,166,712.77 for 1936 and $1,208,496.01 for 1937. The depreciation disallowed for 1936 and 1937 was $40,273.11 and $41,786.26, respectively.

In its income tax returns for 1936 and 1937 the petitioner claimed a depreciation allowance upon the total cost of its depreciable properties, including the full amount of the cost of line extensions, a part of which was paid for by its customers. In the determination of the deficiencies the respondent has disallowed depreciation upon such portion of the cost of its depreciable properties as was represented by the unrefunded balances of deposits referred to above.

The respondent’s argument is that the petitioner is not entitled to a depreciation allowance except upon the cost of depreciable properties borne by it. He admits that under the principle of Edwards v. Cuba Railroad Co., 268 U. S. 628; Liberty Light & Power Co., 4 B. T. A. 155; Great Northern Railway Co., 8 B. T. A. 225; Frank Holton & Co., 10 B. T. A. 1317; and Baltimore & Ohio Railroad Co., 30 B. T. A. 194, the petitioner is not taxable upon the gain realized by it from the unrefunded deposits credited to surplus in 1936 and 1937 of $36,065.81 and $47,500.67, respectively. He contends, however, that if the petitioner is entitled to deduct depreciation upon the cost of extensions borne by its customers it obtains a double benefit, which is not warranted by the statute.

We think that the contention of the respondent upon this point must be sustained. In United States v. Ludey, 274 U. S. 295, the Supreme Court said:

* * * The amount of the allowance for depreciation is the sum which should he set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost. The theory underlying this allowance for depreciation is that by using up the plant a gradual sale is made of it. The depreciation charged is the measure of tint cost of the part which has been sold. * * * [Italics supplied.]

It is fundamental that the depreciation deduction is allowed upon a capital investment. Where a taxpayer has no capital investment in property it is not entitled to a depreciation allowance in respect of the capital asset. The essential requirements of a capital investment are the laying out of money or money’s worth and the acquisition of something of permanent use or value in the business. La Belle Iron Works v. United States, 256 U. S. 377. The mere ownership of property which cost the owner nothing does not give rise to the right of a depreciation allowance.

Petitioner, in effect, claims that we must treat the deposits as mere contributions to its capital, and that the building and ownership of the lines must be treated as a separate transaction. The petitioner’s argument is that the statute does not permit us to “trace the funds” with which the power lines were built and that the mere facts that the lines are owned by the company, are used in its business, and have a limited useful life require us to sustain its position. The difficulty with this argument is that it overlooks the very substance of the transactions involved. The contracts can not be broken down as suggested, for they are in essence contracts the very purpose of which is to permit the company to avoid the cost of constructing new lines. If we were to sustain the petitioner’s argument it would be to permit the petitioner to recover through depreciation allowances the cost of line extensions which was not borne by itself. The respondent’s determination of deficiencies is approved.

Decision will be entered for the respondent.