text:
    J. Noble Hayes, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4611.
    Promulgated August 1, 1927.
    1. Expenses incurred and paid in prior years may not be deducted, though incidental to the earning of income received and reported within the year.
    2. No deduction may be claimed under section 214, Revenue Act of 1918, for a loss of a gain which has never been included in income.
    3. The fact that the portion of services rendered on a contingent-fee basis, to create a debt, were performed prior to March 1, 1913, does not alter the rule that the amount of a debt which has never been included in income, may not be claimed as a bad debt deduction, where the contingency, making the obligation due and payable, is not met until subsequent years.
    4. An obligation can not be held to be deductible as a bad debt while a legal remedy is being actively pursued to recover it.
    5. Neither forgiveness of a debt nor disinclination to enforce payment, constitute the debt worthless to permit of deduction.

      J. Noble Hayes pro se.

      J. E. Marshall, Esq., for the respondent.
    This proceeding involves the redetermination of a deficiency in income tax for the year 1919, in the amount of $1,833.14. The deficiency arises from the fact that respondent has refused to permit petitioner to take certain deductions. Petitioner also contends that respondent did not possess the authority to make a redetermination for the reason that respondent, prior to making such redetermination, and with all facts before him, had determined that petitioner had properly reported his income.
    FINDINGS OF FACT.
    Petitioner is an attorney and counsellor at law in the State of New York. He was admitted to practice in said State in the year 1880, and has been in the practice since that date. At all times hereinafter mentioned, petitioner kept no books of account as that term is understood in the business world. He kept an ordinary lawyer’s register or daybook in which was entered the daily history of the litigation in which he was employed and the disbursements which he made. He never entered a charge of any kind in this or any other books. If he received a retainer or a fee, he gave a receipt therefor and deposited the money in the bank. These, with his canceled checks and stub books, were the only record of the receipts of petitioner, with the possible exception of copies of letters of acknowl-edgement. All cases were accepted by him on a quantum meruit basis, except those cases in which he was to receive a contingent fee. In this latter class of cases, the agreement was generally evidenced by a written contract. When an employment other than on a contingent basis was closed, petitioner, by a purely mental operation, fixed his fee and requested payment. If the fee was paid, a receipt was given therefor and the money deposited in the bank, but if, after the use of persuasion, the fee was not paid, the matter was dropped, unless the client was guilty of fraud.
    In his income-tax return for the year 1919, petitioner reported as income from his profession, $32,545. From this he deducted the following items:
    Salaries and wages-J_$3, 837. 50
    Bent on business property_ 3, 810. 00
    Bepairs, wear, tear, obsolescence, etc_ 528. 94
    Bad debts arising from professional services_ 5, 650. 00
    Other expenses- 1, 919. 20
    15, 745. 64
    The amount of gross income, $32,545, included the following fees from two employments:

      Masury case_$30,000

      Fowler v. Westerhoff_ 2, 000
    32, 000
    Petitioner was employed in the Masury case in 1913 and prosecuted it to a conclusion in 1919, when he fixed his fee at $30,000, which his client paid in that year. In 1916, he was employed in the Fowler case. In this matter, he received a fee of $2,000 in 1919. These two matters comprised the greater part, if n,ot all, of petitioner’s business, from 1915 to 1920. During the greater part of this time, he ivas ill and in a hospital. Petitioner had no taxable income in the years 1913, .1914, 1915, 1916, and 1918.
    Respondent allowed petitioner, in determining the deficiency, the following deductions:
    Salaries-$1, 310.50
    Bent- 2,211. 00
    Bepairs, depreciation, etc_ 528.94
    Other expenses_ 836.20
    4, 886. 64
    He rejected claim for these items of deduction in the sum of $5,209, being the difference between the salaries, rents, repairs and other expenses reported and allowed, and the salaries, rents, repairs and other expenses reported and rejected. This amount of $5,209 represented expenses incurred and paid in years prior to 1919. Respondent also disallowed as a deduction claimed by petitioner for bad debts, the amount of $5,650. The bad debt item was made up of the following fees, which petitioner claims were due and owing him and which he found to be worthless and charged off in the year 1919:
    Fee in the case of Frear v. Lewis_$5, 000
    Fee for services, Paul Kruger_ 000
    Services to Clara Karibe- 150
    5, 650
    Petitioner, at the hearing and with the consent of respondent, amended his petition and now seeks to deduct the following additional amounts as worthless debts, which he asserts were found to be worthless and charged off in 1919:
    Professional services to Anna B. Williams-$5, 000
    Services to Hoosiek School- 1, 500
    Services to Frear in two suits other than the one above mentioned_ 500
    7, 000
    On May 24, 1909, petitioner was retained by Frear to represent him in a controversy between him and his partner, Lewis. Petitioner’s fee was to be paid on a quantum -fneruit basis. In January, 1910, petitioner, as attorney for' Frear, brought an action in the Supreme Court of Kings County, New York, against Lewis, for an accounting of the partnership affairs of the firm of Lewis & Frear. In the eight years preceding the bringing of the suit, this partnership had had an income of $185,000, and in the three years immediately preceding bringing of the suit, it had an income of $33,000 a year. This income had been divided equally between the partners. Lewis had ousted Frear from the partnership and formed a new partnership with one Gendar. The principal asset of the firm of Lewis & Frear' was good will, which was valued by plaintiff’s witnesses at approximately $100,000. After the suit had been pending for some time, and on the 5th day of January, 1912, the petitioner and Frear entered into the following contract:
    Tbis agreement, entered into tbis 5th day of January, 1912, witnesseth that, for and in consideration of professional services heretofore rendered in the above-entitled action pending in the Supreme Court of Kings County for a partnership accounting and services agreed to be rendered by J. Noble Hayes, Esq., as my attorney and counsel in the further prosecution of the said suit up to the trial and entry of judgment therein, I hereby assign to said Hayes one-fourth (Ü) of any sum that I may recover on account of said claim or suit against the defendants or either of them, howsoever, either by settlement or judgment.
    Dated this 5th day of January, 1912.
    J. Noble Haves.
    Frank B. Freak.
    Witness by Edwin Vandewater.

      The action was tried at the Special Term, Kings County, April, 1913, and judgment entered dissolving the partnership of Lewis & Frear but holding that the good will of the firm was of no value, and directing that the partners’ accounts be settled before a designated official referee in Kings County. The plaintiff appealed and on appeal succeeded in obtaining a modification of the interlocutory judgment and findings to the effect that the good will was of some value and awarding plaintiff costs, payable from the assets of the firm, if any. See Frear v. Lewis, 151 N. Y. S. 486.
    In 1915, the case was again before the appellate division on appeal by defendant Lewis from an order permitting inspection of the books and papers of the firms of Lewis & Frear and Lewis & Gendar, for the purposes of said reference, and the court reversed the order as unnecessary, in view of the fact that the books could be produced before the referee by subpoena duces tecum. See 156 N. Y. S. 794.
    Thereafter, hearings were had before a referee of Kings County and the referee ultimately held that the good will was worth only $1,100, being the average of one month’s profit during the latter part of the existence of the partnership, and that defendant was indebted to plaintiff Lewis in a large sum as a balance on account. The plaintiff consistently opposed the confirmation of this report at a special term of the supreme court, Honorable Russell Benedict, Justice, presiding. Judge Benedict wrote an opinion sustaining the plaintiff’s contentions regarding the proper method of obtaining the value of the good will of the partnership and ultimately an order was made referring the case to M. H. Hirschberg, official referee, to take and settle the accounts of the parties. This latter action was taken in the early part of the year 1919. While the matter was thus pending before an official referee, defendant or his counsel, secured from the plaintiff Frear, his written consent dated March 12, 1919, that the action be discontinued without costs to either party. On April 26, 1919, defendant Lewis, by his attorney, notified the petitioner, as attorney for the plaintiff, that he would, on May 2, 1919, move the court for an order discontinuing the action without costs to either party. This motion petitioner opposed, for the reason, among other grounds, that it was a fraud upon him. Hearing was had, and on the 29th day of June, 1921, the following order was entered:
    Ordered that the Report of the Official Referee finding “ that the consent to discontinuance of this action made, executed and acknowledged by the plaintiff on the 12th day of March, 1919, and delivered to the defendant Alfred H. Lewis, was given by the plaintiff and accepted by the said defendant in fraud of the rights of J. Noble Hayes, as attorney for the plaintiff and the rights of Paul Roder and Mrs. Mildred L. Weatherby, assignees of part of plaintiff’s cause of action, and that it will also impair the plaintiff’s wife’s chance of collecting accrued alimony on her judgment therefor against plaintiff” be and the same is hereby confirmed and adopted as the finding of this Court and the said Report in all respects confirmed, and
    Further and Accordingly Ordered that the motion made by the defendant to discontinue the said action be denied, with costs of the said motion to J. Noble Hayes, attorney of plaintiff and in person and for Mildred L. Weatherby, against the defendant.
    Further Ordered that the said action be continued under its present title for the protection of the lien of plaintiff’s attorney, J. Noble Hayes, and Mildred L. Weatherby, assignee, etc.
    Enter,
    Joseph Aspinall
    J. S. C.
    Granted June 29, 1921.
    William E. Kelly, Clerk.
    From the above order, the defendant Lewis filed appeal to the Appellate Division of the Supreme Court of New York, Second Department. The order appealed from was affirmed by the Appellate Division of the Supreme Court, June 9, 1922. See Frear v. Lewis. 195 N. Y. S. 3.
    Petitioner contends that when his client deserted him and breached the contract of employment, he was entitled to elect to recover a fee on a quantum meruit basis and on this basis he estimates that his services were worth from $5,000 to $7,000.
    Petitioner was employed by Paul Kruger, who was having trouble about a lease on a piece of property in Park Iiow and who was also having some financial trouble which resulted in his arrest. Petitioner went to the District Attorney’s office several times and got him out of his trouble and straightened out his affairs. Petitioner informed Kruger that his fee was $500. Kruger told petitioner that he would come in the next week and pay it. Petitioner has never sgen him since. Kruger’s fee fell due in 1919.
    Petitioner was employed by Clara Karibe to attend to certain legal matters for her, the nature of which does not appear, except to the extent that some one had her ejected from her house and she was put into the street. Plaintiff charged her $150 for his services. She was insolvent and did not pay. This fee was due in 1919.
    In 1916, petitioner was retained in the case of the Reformed Episcopal Church against the Hoosick Church & School. Plis client was successful in the action. He was employed in 1916, together with George B. Wellington. Wellington, after the action was over, wrote petitioner, asking what fee he was going to charge and stating that he, Wellington, had charged $1,500. Petitioner made up his mind at that time, that $1,500 was a reasonable fee and that he also would fix his fee at that amount. Thereafter, Mr. Tibbetts, who seems to have been the prime mover in employing petitioner, invited petitioner to Iloosick to a dinner on Thanksgiving Nay, 1919, at the school. Tibbetts introduced petitioner to the boys and girls and said '“Mr. Hayes is the man who saved the Hoosick School, and he has done it without compensation.” This surprised petitioner, but after the statement had been made, he did not feel that he should enforce the payment of his fee, and therefore, in 1919, petitioner determined not to collect the fee.
    In 1915 or 1916, Miss Anna B. Williams, who was about 78 years of age, employed petitioner in a matter, the details of which we do not know. There was quite a long litigation extending from 1916 to 1919. When the litigation was completed, it was found that Miss Williams had had to sell her cottage in the Adirondacks, that she had a sister who was incompetent, and who had a little money and with whom she lived, that while she, Miss Williams, had some money, she felt that she would not have enough to get through life and therefore, in 1919, petitioner wrote Miss Williams she need never pay anything for the services.
    In the year 1918 or 1919, Frear, the same person above mentioned, was sued by a man named Rogers, in the Supreme Court of New York, in two suits on two notes for $2,500 each. Petitioner defended these suits for Frear and told him that he would charge him $250 in each suit, to which Frear agreed. Nothing was paid on the notes. Frear was insolvent in both the year 1918 and 1919, having no assets whatever and only the expectancy of a recovery in the suit of Frear v. Lewis.

    Petitioner did not return for income tax, the fees which he claims as deductions as worthless debts and which total $12,650, or any part of them, in his return for the year 1919, or in his return for any previous year.
    Petitioner made his return for the year 1919, on Form 1040, and therein stated that it was made on the basis of income received. Petitioner attached to and filed with his income-tax return, the following statement:
    All payments received by me in 1919, for professional services, except about $500, were for services rendered in two cases, to wit, Masury v. Masury Go., and Fowler, Trustee, v. Westerhoff Bros. Go. The former I was retained in, in 1913, and the latter in 1916, about April; and 1 rendered continuous services in each until they were ended about July, 1918. My fees received at that time, for the whole services over the whole period were, $30,000 in the Masury case, and $2,045 in the Foioler case. These two cases constituted my principal business or the greater part of it from the years 1914 to 1920 and my office and professional expenses were principally incurred for them and a case entitled Matter of James (-which enabled me to make a return for 1917). Three other matters, to wit, Matter of Ringer, Karibe v. Marie, and Frear v. Lewis, which was begun in 1908 and continued down to date and my fees in which for services since May 11, 1913, are not secured and amount to $5,000. My client has become entirely impecunious and irresponsible, his wife is pursuing him for an alimony, .-judgment of about $7,000, and he resides in New Jersey and has kept away from me for nearly a year and has tried to settle the case of Frear v. Lems secretly, which, is his only asset. I regard my claim for my services in this suit since May 11, 1913, as utterly worthless, even if the contested fraudulent settlement is set aside; and the same is true of my claim of $500 against Henry Kruger, which he promised to pay over two years ago; he is insolvent and has gone out of the state. My bill against Mrs. Karibe rendered several years ago, is also uncollectible and I have this year determined that these claims to the amount of $5650 are utterly worthless, and bad debts written them oft accordingly. If recovered, or any portion thereof hereafter, the recovery will be put into my returns of subsequent years.
    In 1915, 1916 and 1917, I was sick and in 1916 and 1917, was in the hospital twice for major operations to save my life, from the effects of which I have but recently entirely recovered. My income in those years, with the exception of 1917, for which I filed a return, was not sufficient to pay my professional business expenses and leave an amount subject to tax. In 1918, I barely paid my office expenses out of income. In 1914, I had no taxable income and I have lived and carried on my profession during these lean and tight years on principal and some borrowed money.
    To earn the fees received in 1919, I have had to spend for my office and professional expenses, the amount which I have put into my return as reasonable charges to the two cases which constituted so large a part of my business from 1914 to 1920. Considering everything, I deem it fair to apportion my office expenses from 1914 to 1918 from these two cases at % of the total expenses for the period and % for 1918; which I am sure represents less than the aelua) share legitimately chargeable to these two cases, especially the Masury case.
    I have taken the greatest pains to figure it out as accurately as I could, and while it is troublesome matter I feel sure that the result reached is eminently fair to the Government which seeks to tax only just and actual Net income.

    Thereafter, on July 8,1921, he received a letter from E. H. Batson, Deputy Commissioner of Internal Revenue, which stated that an audit of his return disclosed a further tax of $888.67. This increase was occasioned by rejection by the Commissioner of the item of $5,650, representing a deduction made by petitioner as bad debts. Thereupon ensued a lengthy correspondence between petitioner and the respondent, relative to these deductions. In a letter from petitioner to respondent, dated July 12, 1921, petitioner stated:
    I think you are under some misapprehension in regard to this matter. In the first place, my return was not made on a cash basis but on an accrued basis, as you will see upon a careful reading of the statement accompanying the return.
    In a letter from petitioner to respondent, dated September 1, 1921, he said:
    I may say now that such law business as I have does not require any very extensive system of books, and does not justify a bookkeeper. For the last few years, it has been very difficult to make ends meet, with rents raised 200% as mine has been and everything in proportion.
    I keep an office Register in which my work in various cases and the proceedings in each are supposed to be recorded daily and are when I am at the office personally. My cheek book shows most of my disbursements, as does my office Register in part. I make up my bills from my Register, sometimes itemizing them at length, and sometimes merely stating the amount owed by letter, and if any honest client can’t pay my bill be is never prosecuted for it. I have lost a good deal of money in my 42 years practice, but have managed to get along, but not much more.
    To this and to other letters from petitioner, respondent replied in letter dated November 21, 1921, in which he advised the petitioner that a reexamination of his return would be made in connection with information furnished and that he would be later advised as to the result. On June 6, 1922, respondent wrote the following letter to petitioner :
    Reference is made to your letter in which you refer to the further tax liability of $888.67 on your 1918 (1919) income tax return, Form 1040.
    The assessment was based on the addition of $5650.00 to your taxable not income representing bad debts, since under the method of reporting on the cash receipts basis, such an amount has never been included in gross income.
    You state that the bad debts $5050.00 referred to above were incurred in connection with your business, and after being determined worthless and uncollectible, were charged off your books.
    In view of the additional information submitted, and in as much as it appears that your accounts were not kept on a strictly cash receipts basis, the proposed assessment will not be made, and you may disregard office letter of July 8, 1921.
    Thereafter respondent determined the deficiency here in controversy.
   OPINION.

Milliken:

Respondent did not err in refusing to permit petitioner to take as a deduction the amounts paid by him in previous years for salaries, rent and other expenses of his business. Section 214(a) (1) of the Revenue Act of 1918 permits as deductions in this respect, only “All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” None of the expenses which respondent denied as deductions was incurred or paid during the year 1919, the taxable year in question.

Setting on the side for the instant the vital question whether one can charge off that which he has never charged on, whether he can take as a deduction a worthless debt which he has not reported as income, we will consider whether the debts which petitioner claims he ascertained to be worthless in 1919 and charged off in that year, were otherwise deductible under section 214 of the Revenue Act of 1918.

Petitioner can not be held to have either charged off (if he could charge off that which he had never charged on) his fee in the case of Frear v. Lewis; nor can it be held that he ascertained that this fee was worthless during the year 1919. During the whole remainder of that year, after his client deserted him he was pursuing a legal remedy to recover this fee. He was resisting the dismissal of the Frear v. Lewis case and seeking the right to prosecute it for the purpose of recovering his fee. While it is true that a person can, by mental process both charge on and charge off a debt in those cases where the process of accounting is purely mental (see Appeal of Charles A. Collin, 1 B. T. A. 305), yet it can not be held that one can mentally charge off a debt while at (he same time he is persistently pursuing a legal remedy to recover it, and especially where he continues such prosecution for years afterward. Nor can it be held that petitioner ascertained this fee to be worthless in 1919, during which time he was expending time and effort to effect its recovery.

It is not shown that petitioner ascertained that the Kruger fee became worthless in 1919, or that Kruger’s debt was any more valuable w7hen the services were rendered than at any other time during that year. Petitioner merely testifies that after promising to pay, Kruger never came back.

It is not shown nor attempted to be shown that the Hoosick Church & School was insolvent in 1919. The same is true as to Miss Williams. In the first case, petitioner relinquished his fee because he felt disinclined to collect it and the last case he forgave the debt. Neither the forgiveness of a debt nor the disinclination of a creditor to enforce payment, makes a debt worthless. See Appeal of Joseph M. Byrne, 1 B. T. A. 996, and Appeal of G. C. Krack, 1 B. T. A. 1119.

We have discussed these amounts sought to be deducted as worthless debts as though they had been charged off by the petitioner after having been reported by him as income. However, petitioner has done neither of these things. The right to deduct the so-called worthless debts must be denied on the authority of Appeal of Charles A. Collin, supra, in which case it was held that a taxpayer could not take as a deduction, the loss of a gain which he had not charged on or reported as income. The fact that some of the services in the Frear case were rendered prior to March 1, 1913, does not alter the case, even if we were to concede that this fee became worthless in 1919. No part of that fee was due and payable prior to March 1, 1913. The fee on that date was contingent upon success. If the fee had been paid in 1919, the whole of it would have been income in that year. Cf. Woods v. Lewellyn, 252 Fed. 106, and Jackson v. Smietanka, 272 Fed. 970. By the same token, the Frear fee can not be separated into two parts for the purpose of deduction.

Petitioner’s last contention takes two forms: first, he relies on the doctrine of estoppel, and next, cites authorities to the effect that, subject to limitations not necessary to be enumerated here, where one official with all the facts before him settles a controversy between a citizen and the Government, the rule of departmental procedure is that his successor in office should not reopen the matter. Without discussing the general trend of authorities, to the effect that the Government can not be estopped by the acts or representations of its agents, it is only necessary to point out that the petitioner has not shown that he has in any wise been caused to change his position for the worse or to suffer any loss by reason of the acts of respondent. Eespondent has only determined that petitioner should pay a certain amount of tax. The Board has found petitioner’s objections to the deficiency are untenable. Eespondent has, therefore, determined that which the petitioner should have reported in the beginning.

Petitioner’s second contention, even if sound, under a proper state of facts, must fall since Mr. Blair was Commissioner when the letter of June 6, 1922 was written, continued in office, and was Commissioner when the deficiency was determined.

The same contentions were advanced in Appeal of Dallas Brass & Copper Co., 3 B. T. A. 856, and in Appeal of First National Bank of Plattsburg, 4 B. T. A. 478, and in those proceedings found to be without merit. See also Appeal of Boyne City Lumber Co., 7 B. T. A. 36.

Judgment will be entered for the resfondent.

Considered by Marquette and Phillips.


source: Caselaw Access Project

author: Milliken :

license: Public Domain

text:
    M. I. Wilcox Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7884.
    Promulgated August 1, 1927.
    Where a close corporation, desirous of acquiring additional capital, purports to purchase Liberty bonds from its stockholders at par for preferred stock, with the expectation of selling such bonds to obtain the needed capital, and the bonds are immediately sold, as contemplated, for less than par, the transaction amounts to a process of acquiring capital and does not constitute a purchase and sale of bonds by the corporation at a loss; and the invested capital allowable for such bonds, being measured by their value, was their actual value presumptively established by their selling price.

      Sigmund Sanger, Esq., for the petitioner.

      Robert A. Littleton, Esq., for the respondent.
    This proceeding involves a deficiency in income and profits tax for the fiscal taxable year ending August 31, 1920, in the amount of $4,311.93. This deficiency arises (1) from the refusal of the respondent to permit petitioner to take as a deduction an alleged loss of $8,147.04, arising from the sale by it of certain Liberty bonds, and (2) in decreasing its reported invested capital by the amount of $8,147.04, which is precisely the amount of the alleged loss.
    FINDINGS OF FACT.
    Petitioner is a corporation, organized under the laws of Ohio, with its principal place of business at 210-216 Water Street, Toledo. At the times herein mentioned, petitioner was a close corporation and the stock was held by five or six individuals. In the year 1918, petitioner purchased United States Liberty bonds to the extent of $65,000. On October 7, 1918, the following action was taken by petitioner’s board of directors:
    C. J. Stanley then offered a motion, seconded by F. F. Ingalls, that a dividend of 50% of the entire capital stock of the company, amounting to $62,500, being duly earned, be declared out of the surplus profits of the company, and paid to all stockholders of record. Said dividend to be paid in U. S. bonds of the 4th Liberty Loan issue.
    This motion was adopted without debate, and the Treasurer directed to pay said dividend out of the surplus of the Company on or before February 1st, 1919, on delivery of Bonds.
    On April 12, 1919, in pursuance of the above resolution, the corporation delivered to the following stockholders, United States Liberty bonds of the par value set opposite their names:
    O. S. Wilcox-$27,500
    A. J. Wilcox- 10, 000
    C. J. Stanley- 13, 750
    F. F. Ingalls- 10,000
    H. W. Wilcox_ 1,250
    62, 500
    In April, 1920, the stockholders of petitioner were O. S. Wilcox, A. J. Wilcox, C. J. Stanley, F. F. Ingalls, and R. B. Crane. Crane held one qualifying share, which in fact belonged to O. S. Wilcox. On April 6, 1920, at 3 p. m., a special meeting of the board of directors of petitioner was held, at which all directors were present. At that meeting, the following action was taken:
    Mr. O. S. Wilcox, President, stated that the meeting was called for the purpose of considering the matter of purchase by the M. I. Wilcox Company of Liberty Bonds now held by the stockholders of the company. He stated that on account of expansion due to the increase of business, it is necessary to put additional money into the business; that for this reason the company is about to issue $100,000.00 of preferred stock.
    Mr. C. J. Stanley then offered the following:
    Resolved : That the M. I. Wilcox Company purchase at their par value Liberty Bonds to the amount of $61,700.00, now held by the stockholders of the company. (These bonds representing dividends heretofore declared by the company, payable in Liberty Bonds at par.) That tbe company then convert these bonds into cash, using the money to meet the demands of business and pay the stockholders in preferred stock certificates, when issued.
    Mr. A. J. Wilcox moved the adoption of this resolution. The motion duly seconded, was unanimously carried, and the resolution adopted.
    In pursuance to the above resolution, on April 16, 1920, the following stockholders delivered to F. F. Ingalls, who was then secretary and assistant treasurer of petitioner corporation, United States Liberty bonds of the par value set opposite their respective names:
    O. S. Wilcox_$28, 700
    A. J. Wilcox_ 10, 000
    C. J. Stanley_ 13, 000
    F. F. Ingalls took from- his lock box United States Liberty bonds of the par value of $10,000, and brought them to the office. When F. F. Ingalls had collected the above bonds, which, together with his own, made a total par value of $61,700, he on the same day sold the bonds to the Citizens Security Co. for the sum of $53,552.96, which amount was on the same day entered on the books to the credit of petitioner. Each of the above parties had drawing accounts and on the same day, April. 16, 1920, the drawing account of each of the stockholders was credited with the amount set opposite their respective names:
    O. S. Wilcox_"_$28, 700
    A. J. Wilcox_ 10,000
    C. J. Stanley_ 13, 000
    F. F. Ingalls_ 10,000
    61,700
    Thereupon petitioner began to take proper steps, under the law of Ohio, authorizing it to issue $100,000 par value of preferred stock. On May 12, 1920, petitioner issued to the following persons its preferred stock of the par value set opposite their respective names:
    O. S. Wilcox_$28, 000
    A. J. Wilcox_ 10, 000
    C. J. Stanley_ 13, 000
    F. F. Ingalls- 10,000
    Katherine Wilcox_ 2, 000
    63,000
    On the same day the drawing accounts of the stockholders were charged with the amounts set opposite their respective names:
    O. S. Wilcox_$30,000
    A. J. Wilcox_ 10, 000
    C. J. Stanley_ 13, 000
    F. F. Ingalls_ 10, 000
    63.000

      The $2,000 par value of preferred stock issued to Katherine Wilcox was charged to the drawing account of her father, O. S. Wilcox.
    The value of the $61,700 par value Liberty bonds, when delivered to F. F. Ingalls, was $53,552.96.
   OPINION.

Milliken :

When the Liberty bonds were distributed to the stockholders, in April, 1919, they became the individual property of the respective stockholders, to the same extent as though they had purchased them from the Government, or from any third person. This was a completed transaction in the fiscal year ending August 31,1919, and has no bearing on the question involved in this proceeding.

There is no evidence in the record, bearing on the market value of the Liberty bonds sold on April 16, 1920, and the presumption is that the value at which they were sold was their value, both at the time of sale and the time of their delivery to F. F. Ingalls.

Petitioner contends that it made an outright purchase of the bonds from its stockholders for cash; that it paid for them par value, to wit, $61,700; that thereby its invested capital was increased by that amount; and that, having sold the bonds for $8,147.04 less than their par value, it thereby incurred a loss to that extent.

In support of its contention that its invested capital was increased by the amount of the par value of the bonds, petitioner points out that it agreed to purchase the bonds at par, that it entered on its books to the credit of the various stockholders, an amount equal to the par value of their bonds, and from these amounts, the purchase price of the stock was drawn. It should be observed that these were mere bookkeeping entries; that in fact no cash was paid; and what is more to the point, that none of the stockholders was entitled to withdraw from their account, any part thereof arising from the transfer of the bonds. Petitioner’s contention entirely overlooks the only corporate action taken, with reference to these transactions. This action was the resolution of April 6, 1920, which limited the corporation to payment in its preferred stock. So, whether it be held that the corporation issued its preferred stock in exchange for the bonds or for the proceeds of the bonds, all that it acquired in the way of invested capital was either the then value of the bonds or the proceeds arising from the conversion of the bonds into cash. Since these amounts were the same, it must be held that petitioner acquired additional invested capital in the amount of $53,522.96, the amount allowed by respondent.

When we come to the question of loss, it becomes difficult, in a case like this, where there were only four stockholders, all of whom were interested in the transaction, to separate the stockholders from the corporation. It is hard to perceive how these persons, dealing among themselves, could, out of such dealings, make a common gain or incur a common loss. However, we do not find it necessary to disregard the corporate entity. While giving that entity full recognition, we should look to all the facts of the case and endeavor to discover just what the transactions involved actually were. We should look to the necessity which gave rise to them, the real purpose of the parties, and what was actually done. The necessity referred to is disclosed by the following statement made by the president at the directors’ meeting of April 6, 1920:

He stated that on account of expansion due to the increase of business, it is necessary to put additional money into the business; that for this reason, the company is about to issue $100,000.00 of preferred stock.

Thus, it is disclosed that the necessity arose from expansion of business and the need for ready cash, and the purpose was to be accomplished by the issue of preferred stock. Petitioner was not seeking to acquire the bonds for investment purposes, or even for the purpose of holding them for a time. The ready cash was to be acquired, not by the sale of the bonds to the company, but by a sale of the bonds by the company. The bonds were to be sold and in fact they were sold immediately upon their receipt. All the various entries relative to receipt and sale of these bonds were made on the same day. The petitioner was not selling a mere corporate asset, but was selling bonds, the possession of which it acquired for the sole purpose of conversion into money.

Looking through all the forms of bookkeeping and the technical words of the' resolution, we find what the corporation needed was money; that what the stockholders desired to have was preferred stock; that in the end the corporation had money to the extent of $53,552.96, and the stockholders had their preferred stock. The fact that the word “ purchase ” was used in the resolution, did not convert into a sale to it what was merely a procedure to acquire cash. Cf. Heryford v. Davis, 102 U. S. 235. Nor can entries in books of account change facts or make or take from value. See Baldwin Locomotive Works v. McCoach, 221 Fed. 59, and Doyle v. Mitchell Brothers Co., 247 U. S. 179. Petitioner did not suffer a loss in these transactions. It received precisely what it expected to receive — the money arising from the sale of the bonds.

Judgment will he entered for the respondent.

Considered by Phillips and Maequette.


author: Milliken:

text:
    L. C. Heydrick, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 4120, 5503.
    Promulgated August 1, 1927.
    1. Where petitioner delivered a deed to a farm in the payment of commissions, the transfer not being acceptable to nor accepted by the transferee as payment, deductions claimed for a loss upon the realty transferred and for the commissions paid, denied.
    2. A loss sustained on the sale of an oil lease, allowed.
    3. The inclusion of profits derived from the sale of an interest in a railroad, approved.

      Robert Ash, Esq., and Thos. J. Reilly, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
    These proceedings result from the determination by respondent of deficiencies in income tax for the calendar years 1919 and 1920, in the amounts of $186,038 and $13,239.14, respectively. The proceedings for both years were consolidated for hearing and decision. Approximately one hundred adjustments to income are in controversy. The parties filed a stipulation on January 26, 1927, agreeing to the facts and the corresponding adjustment to income on all save four errors assigned. Only the issues now in controversy will be considered and the stipulation, will be followed by the parties in the redetermination of the deficiency under Rule 50. The four issues submitted for our determination are: (1) The petitioner avers that the respondent erred in his failure to allow as a deduction from income in 1919, a loss of $22,678, sustained on the sale of the Honaker Farm; (2) the petitioner avers that the respondent' erred in his failure to allow as a deduction for 1919 the sum of $12,818 paid as commissions; (3) the petitioner avers that the respondent erred in his failure to allow in 1920 a loss sustained on the sale of the Pearson Lease, in the sum of $2,431.01; (4) petitioner avers that the respondent erred in his inclusion in income for the year 1920 of a profit of $12,130.44 from the sale to Jake L. Hamon of petitioner’s share in a railroad.
    FINDINGS OF FACT.
    Petitioner is an individual residing at Wichita Falls, Tex., and during the years 1919 and 1920, was engaged in the oil and sundry other businesses. In the year 1919 and prior thereto, he had purchased many oil leases in the vicinity of Eastland, Tex., and had employed as his agents in the purchase of same, two lawyers, father and son, J. R. Frost and Cyrus Frost, respectively. He had no written contract with his agents concerning the compensation to be received for services, but there existed an oral understanding that when the leases were sold, the agents would receive a percentage of the profits in payment for their services.
    In the latter part of November or first part of December, 1919, the son went to Wichita Falls to secure a settlement from petitioner for services rendered to date. He was advised by petitioner that the latter had no funds with which he could make payment, but petitioner offered to deed to him property known as the Honaker Farm, in satisfaction of services rendered to date. Petitioner had purchased the Honaker Farm at a cost of $35,496 and believed its value when offered to his agent to be $12,818. Cyrus Frost, after investigating the value of the Honaker Farm, advised petitioner that he refused to accept the same in payment for his services. Subsequent to the conversation between petitioner and Cyrus Frost, the former caused a deed to be executed to the Honaker Farm, naming Cyrus Frost as grantee. The deed was recprded by petitioner in Wichita County, Tex., on January 5, 1920, and after being recorded, was returned to petitioner and mailed to J. It. Frost. The latter died in 1922, and the deed to the Honaker Farm was found among his papers by his son, Cyrus Frost. The deed to the Honaker Farm bore date of December 31, 1919.
    Cyrus Frost did not know petitioner had deeded him the Honaker Farm until some time in the year 1920, and did not get actual possession of the deed until after his father’s death. He has never taken possession of the property, has never collected or received any rents or revenue from it, and has not paid taxes thereon. Petitioner has received the rents and revenues and has paid the taxes that have been paid on the property.
    In 1920, petitioner was a member of the partnership of Heydrick & Shaw. The partnership maintained no books of account, its records consisting of canceled checks, copies of deposit slips, correspondence, and originals of leases and notes. From these sources, a public accountant obtained the information used by him in March, 1921, in opening a set of books for the year 1920.
    An oil and gas lease, known as the Pearson Lease, was acquired by the partnership in 1920, for a consideration of $10,000 cash and three promissory notes of $3,333.33 each, due November 1, 1920, January 1, 1921, and March 1, 1921, respectively. Oil was discovered on the Pearson Lease but in the fall of 1920, the wells became nonproducing. Subsequently, but in the year 1920, George L. Dobie, an employee of the partnership and petitioner, gave to the partnership his promissory note for $1,000, payable on demand, for the Pearson Lease, and same was assigned to him by the partnership. In June, 1921, the Pearson Lease wras sold to the Pan Handle Refining Co. for $1,000. The proceeds were paid, $500 to Sherwood and Spalding for their one-half interest, which they had acquired from Dobie, and the remainder, $500, was paid to Dobie. Dobie, upon receipt of the check for $500, endorsed the same over to the partnership in part payment on his note of $1,000. The balance of $500 remaining due on the Dobie note, was never paid and the partnership charged the same to profit and loss on the partnership books at the end of 1921.
    Prior to 1919, the Wichita Falls & Southern Ey. had built a road from Wichita Falls to Newcastle, Tex. Several individuals conceived the idea of extending the railroad from Newcastle to Dublin, Tex., thus providing that territory with a connection from Wichita Falls to Dublin, Tex., and with the Frisco lines at the latter place. Two partnerships were to be organized to carry the construction of the road into effect. Frank Kell and his associates, including the petitioner, agreed to bear one-half of the cost of construction of the line and one Jake Hamon and ]jds associates agreed to bear one-half of the cost of construction. The interests in the partnership headed by Kell were to be represented by twenty-four units or shares, and petitioner was the owner of one unit or a one twenty-fourth interest. By 1920, the construction of the road starting at Dublin, had progressed nearly to Jim Kurn, Tex., and, therefore, past Breckenridge, Tex.', when a disagreement arose between the Kell and Hamon interests, with the result that under an agreement dated September 1,1920, the Kell interests sold to the Hamon interests Liberty bonds of a par value of $150,000 and their 50 per cent interest in the railroad from Dublin to the point then completed, for $1,050,000 in cash, the common stock of the Wichita Falls & Southern Ey. Co., and the assumption by the Hamon interests of all liabilities of whatever nature, in connection with that part of the project then built. It was further agreed that the Kell interests would assume all liability under an agreement under a bond in the amount of $100,000, with the City of Breckenridge, relating to the construction of the road from Breckenridge to Newcastle. It was understood between the parties, that the Kell interests intended to construct a railroad from Breckenridge to Newcastle. Entries on the books of the partnership (Kell interests) are shown as follows, under date of September 1,1920:
    September 1, 1920—
    City National Bank_$1, 050, 000. 00
    Jake Hamon — Sale Banger By. interest subscription account- $1, 050, 000. 00
    September 1, 1920—
    For sale by Frank Kell and associates of tbeir interests in W. F. B. & F. W. B. B. to Jake Hamon as of September 1, 1920, including tbe Liberty Bonds placed with Frisco B. B. interests on L. B. to accrue to F. Kell and associates to August 31, 1920, inel.

      City National Bank_$1, 050, 000. 00
    W. F. R. & F. W. R. R_ $625, 000.00
    S. L. and S. F. R. R_ 150, 000. 00
    Profit and Loss_ 275, 000. 00
    A distribution at the rate of $10,000 per unit share was paid in cash to the several parties — amounting to $10,000 to the petitioner, with the oral understanding that the partners would be called upon for contributions, when the railroad construction from Breckenridge to Newcastle required capital.
   OPINION.

Milliken:

It is the petitioner’s contention, respecting the first and second issues, that he suffered a loss of $22,678, when he is purported to have deeded the Honaker Farm to Cyrus Frost, and that he is entitled to a deduction as commissions paid of $12,818. Petitioner did owe his agents for the services which they had rendered — the exact amount we are not advised, whether more than or less than the sum sought to be deducted. Cyrus Frost testified that he had a conversation with petitioner, in the fall of 1919, with regard to the payment for services, that he was offered a deed to the Honaker Farm, which he refused to accept. During the year 1920, he, for the first time, learned the farm had been deeded to him and for the first time found the deed when going through his father’s papers, in 1922. He has received no rents or revenue from the same and has paid no taxes thereon. Petitioner has collected the revenues and rents from the farm and has paid the taxes that have been paid. The record contains no evidence of even presumptive delivery of the deed to the property, earlier than January 5, 1920. After due consideration of all the facts of record, we are of the opinion that the respondent should be sustained on both issues.

Concerning the third issue, we are of the opinion that the partnership of Heydrick & Shaw is .entitled to an allowance of the loss claimed on the sale in 1920, of the Pearson Lease to Dobie.

The remaining issue relates to the determination by respondent that the petitioner received income attributable to his share accruing to the partnership of which he was a member, by reason of the sale made to the Hamon interests. The record does not disclose the events which led up to disagreement and the dissolution of the partnership, which existed between the Kell and Hamon interests. We do know that the construction of the railroad was halted, that the Kell interests sold $150,000 par value of Liberty bonds and relinquished all right and title to the railroad as far as had been constructed, extending from Dublin to a point beyond Breckenridge, and were relieved of all liabilities of whatever nature attaching to the railroad project, and upon settlement in 1920, were possessed of the entire common capital stock of the Wichita Falls & Southern By. Co., and the sum of $1,050,000 in cash.

Petitioner contends that he should not be charged with income by reason of the transaction with the Hamon interests, because there still existed a liability to extend the railroad from a point beyond Breckenridge to Newcastle, and that in subsequent years, Kell and associates were sued for some of the debts of the Hamon interests incident to the construction of the railroad from Dublin to Breckenridge.

An entirely changed state of affairs existed after the sale to the Hamon interests. Kell and his associates were engaged in an undertaking of their own, in which they were entirely responsible, i. e., the building of the railroad from Breckenridge to Newcastle. As a partnership, they had sold their right, title and interest in the railroad thus far constructed, and upon receipt by Kell, his associates received income to the extent of their distributable interest therein. It may well be that in the construction of the railroad from Breckenridge to Newcastle, they were called upon for contributions in excess of the sums received from the partnership arising out of the Hamon transaction, but, if so, that was another transaction requiring the investment of capital with which we are not here concerned. Neither should we be concerned with the suits instituted against Kell and his associates, in years subsequent to 1920, by reason of the failure of Hamon to pay all claims which he agreed to pay by the contract of September 1, 1920. In the first place, no losses have in fact been shown to have resulted, by reason of the suits, and in the second place, Kell and his associates believed Hamon to be fully solvent when the sale was made and did not contemplate that any liability would ever result. We are of the opinion that the evidence concerning this issue does not prove the error alleged.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by Marquette and Phillips.


text:
    Golconda Oil Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10176.
    Promulgated August 1, 1927.
    Depreciation on equipment of an oil well allowed on a unit-of-production basis, rather than a straight-line basis, as useful life and value depend upon the rate of extraction of oil content.

      Harry 0: Weeks, Esq., for the petitioner.

      Thomas M. Wilkins, Esq., for the respondent.
    This proceeding results from a determination by respondent of a deficiency in income and profits tax for the calendar year 1919, in the amount of $3,328.11. The issue involved is whether the petitioner is entitled to an allowance for depreciation upon the unit-of-production basis as opposed to depreciation on a straight-line basis.
    FINDINGS OF FACT.
    Petitioner is an unincorporated joint-stock association, with its principal office at Wichita Falls, Tex., and during the year 1919, was engaged in the business of producing oil. It filed an income-tax return for the year 1919, on or about March 15,1920, in which alleged depreciation of physical property was deducted in the amount of $5,000. Attached to the return, was a schedule entitled “ List and Original Cost of Physical Assets,” which read as follows:
    A reasonable depreciation on these assets we estimate to be about $5,000.00. These assets were purchased during the first part of 1919.
    For the calendar year 1919, the respondent has determined the net income of the petitioner to be $87,505.60, its invested capital to be $65,000, and its total tax liability to be $35,912.58. Petitioner owned an oil and gas lease on 10 acres of land in Block 83, Red River Valley lands, Wichita County, Texas, upon which it made a discovery of oil in 1919. It owned and operated one well upon this tract, including the casing in the well and the equipment used in operating the well. The remainder of the lease was sublet upon an overriding royalty basis and the petitioner owned no interest in the equipment in and appertaining to the other wells. Petitioner has been allowed depletion based upon discovery value upon its interest in this property, including both its working interest in one well and its royalty interest in the remaining wells. In determining this depletion allowance, the value of the equipment in and used with the well owned and operated by the company was not taken into consideration. The investment in equipment in and used with the said well, at the close of 1919, was $19,148.78, all of which was purchased in 1919. The respondent has allowed depreciation upon this equipment at the rate of 25 per cent per annum for seven months, in the amount of $2,792.53. Petitioner contends that the depreciation to which it is entitled should be arrived at by dividing the estimated oil reserves recoverable from the well in question during the life of any particular piece of equipment into the investment for such equipment at the close of the year 1919, and multiplying the unit thus obtained by the number of barrels of oil produced from that well in the year 1919. If calculated on that basis, the allowance for depreciation for 1919 would amount to $7,900.35. The equipment in question consisted of casing in the well, pipe, tank, engines, rods, etc., of a kind ordinarily used in producing oil from a depth of about 1,600 feet. The useful life of no part of this equipment was longer than the life of the oil deposit from which the oil was produced. The well in question, like all other wells in the vicinity of Wichita Falls, after having been fully completed and started to producing, would gradually decline in daily output to a point at which it would no longer be profitable to operate it and would then be abandoned. An expert would fix its probable profitable life at from six to ten years. Salvage value would then be negligible. Such a well would ordinarily produce one-half of its total ultimate production within from one to two years after its completion.
   OPINION.

Milliken :

This proceeding was submitted on the pleadings and a stipulation of facts. Only one issue is involved. The respondent has allowed a deduction for depreciation on a straight-line basis and petitioner contends it should be permitted to take a deduction for depreciation on the unit-of-production basis. The statutory provision under which petitioner is entitled to a deduction for the year 1919, is found in section 234(a) (7) of the Bevenue Act of 1918. It should be noted that the statute prescribes no hard and fast or exact and precise rule for a determination of the allowance to which a taxpayer ' may be entitled. The limitation of the statute is that the deductions shall represent a “reasonable allowance.”

It is not possible to lay down a general definition of depreciation that can be universally applied and at the same time be of value in the determination of the question in each specific case. Nor is it possible to tabulate with preciseness the causes and effects of depreciation. Any such definition or tabulation, if given, would be decidedly more suggestive than definitive. Authorities may be found who adhere to either the straight-line method, the reducing-balance method, sinking-fund method, the annuity method, the unit-cost method, or the composite method, as the proper method to be followed and as the one most accurately reflecting a correct result. The facts in each particular case must be carefully weighed, as well as the circumstances surrounding them, and under proper and given conditions any of the methods suggested might conceivably be said to be accurate and result in a reasonable allowance. There should be no slavish adherence to any particular method to the exclusion of all other methods in a given case and under given circumstances, lest we lose sight of the statutory provisions that the deduction allowed by law shall represent a reasonable allowance.

In the case at bar, respondent takes the element of time as deciding the reasonable allowance to which petitioner is entitled and that to the exclusion of all other factors and elements. .He has taken a period of four years, in spite of the fact that at the end of two years all the oil may have been extracted and the equipment thus have become worthless. Petitioner, nevertheless, would be required to take depreciation for two succeeding years, when, as a matter of fact, the equipment had served its useful life at the end of the first two years. Time may be an important element and perchance the deciding factor in the given case. Time, however, is not the only factor to consider. The United States Supreme Court in the case of United States v. Ludey, 274 U. S. 295, stated that depreciation, based upon the useful life of the plant in the business, would provide a sum equal to the return of the cost o.f the equipment, when it stated:

The amount of the allowance for depreciation is the sum which should be 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.

A determination, therefore, of the useful life of the plant in- the business, is a factor that must and should be determined ‘if it is possible to do so. If the business be limited to one particular purpose, as in this case, the extraction of oil from particular wells, and the equipment has no useful life after the oil is extracted, it- would seem to follow that the useful life of the equipment should bear some resemblance to the content of the oil wells to be exhausted. If the equipment is of no value after the oil is extracted, it also seems that any system of cost accounting would consider the depreciation of the equipment to accrue at the rate concurrent with the rate of extraction of the oil.

There can be no question of the simplicity of the straight-line method, advocated by respondent, to determine theoretical depreciation. It is based, of course, on the assumption that the investment in dollars and cents is divided by the number of years or periods of the lifetime of the property and when relevant and necessary facts are lacking, it may be, in a given case, an acceptable basis, but we are of the opinion that it should not be applied in view of the facts of record in this case. The oil content has been stipulated (at least we must presume so, when depreciation, based on the unit-of-production basis, is stipulated) as well as the value of the equipment for depreciation purposes, and the fact that after the extraction of the oil content, the equipment has no remaining useful life or value. We are of the opinion that a reasonable allowance is measured by a depreciation of the equipment at the same rate as that at which the oil was depleted in the year, which results in an allowance of $7,900.35, pursuant to the facts stipulated.

Judgment will be entered on 15 days’ notice, wider Bule 50.

Considered by Maeqtjette and Phillips.


author: Sternhagen:

text:
    Davis-McGee Mule Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7135.
    Promulgated August 1, 1927.

      J. Alex Neeley, Jr., Esq., for the petitioner.

      F. 0. Graves, Esq., for the respondent.
    Deficiencies in income tax of $627.77 and $136.68 for 1919 and 1920, respectively. The only question involved is the amount of the gross sales for both years.
    FINDINGS OF FACT.
    Petitioner is engaged in the business of selling automobiles, feed, mules and other live stock, and wagons, at Anderson, S. C. It filed income-tax returns for 1919 and 1920, in which it reported gross sales for those years of $353,862.05 and $489,873.52, respectively. These returns were prepared by the bookkeeper from such accounting records as were maintained during the years in controversy, consisting of memorandum books, check books, and check records. The amount of the gross sales reported for 1919 was arrived at by adding the accounts receivable, at the close of the year, of $23,541.30, to the total cash collections of $330,321.75, making a total of $353,863.05. The amount reported as gross sales for 1920 was arrived at in the same manner.
    During 1919 petitioner discounted, at the Bank of Anderson, three of its own notes and two accommodation notes of individuals obtained as loans. The discount date, maker, and the proceeds of each discounted note, are as follows:

    The proceeds of the first three notes, totaling $7,185.05, were included by the bookkeeper in the total cash collections of $330,321.75, in arriving at gross sales for 1919. The proceeds of all five notes were borrowed funds.
    The accounts receivable, at the close of 1919, were $23,541.30.
    All of the cash funds received in the course of business were deposited at the Bank of Anderson. The petitioner had no other depositary during the years under review. The records of the Bank of Anderson show that the petitioner made total deposits in 1919 and 1920 of $358,791.89 and $521,184.53. The total deposits for 1919 include the proceeds of the five above described notes discounted in that year.
    The gross sales reported in the returns for 1919 and 1920 were accepted as correct by the respondent. The deficiencies asserted are based upon adjustments of net income which are not contested by petitioner.
    The Commissioner made a jeopardy assessment of $627.77 for 1919 which the petitioner has not paid, but has covered with a claim in abatement accompanied by bond. The claim in abatement is rejected by the respondent in the deficiency notice.
   OPINION.

Sternhagen:

Petitioner alleges overstatement of the gross sales reported in the returns of the two years in controversy, with corresponding overstatements of net income for those years. It computes the overstatement for each year in the following manner:

1919
Total cash deposits at Bank of Anderson_$358, 791. 89
Less: Proceeds of discounted notes (borrowed funds)- 37,120.72
Cash receipts from sales and collections_ 321,671.17
Add: Increase in accounts receivable for tbe year:
Accounts receivable at Dec. 31, 1919-$23, 541. 30
Accounts receivable at Jan. 1, 1919- 14,210. 55 $9,330. 75
Gross sales for 1919_ 341, 001.92
Gross sales reported in return_ 353, 862.05
Overstatement of gross sales in return_ 12, 060.13

There is a mathematical error of $10,000 in adding the increase in accounts receivable to the cash receipts from sales and collections, in arriving at gross sales, and an error of $800 in substracting gross sales for 1919 from gross sales reported in the return. If the basic figures are correct, the gross sales should be $331,001.92, and the overstatement should amount to $22,860.13.

1920
Total cash deposits at Bank of Anderson-$476', 563.95
Less: Proceeds of discounted notes (borrowed funds)_ 25, 000. 00
Cash receipts from sales and collections- 451, 563. 95
Add: Increase in accounts receivable for the year:
Accounts receivable at Dec. 31, 1920-$45, 532. 41
Accounts receivable at Jan. 1, 1920- 22, 894. 01 22,638. 40
Gross sales for 1920- 474,202.35
Gross sales reported in return_ 489,873. 52
Overstatement of gross sales in return- 15, 671.17

The petitioner’s computations to arrive at the gross sales for both years assume the figures relating to the increase in accounts receivable for both years, and borrowed funds for 1920. These have not been proven. Furthermore, the evidence indicates that the total deposits for 1920 were $521,184.53 instead of $476,563.95. The allegation in the petition that the accounts receivable at the beginning of 1919 and at the close of 1920 were $14,210.55 and $45,532.41, respectively, was denied in respondent’s answer, and petitioner offered no evidence in support of its allegation. The person who kept the petitioner’s books of account and prepared the returns for the years under review testified that the proceeds of discounted notes, for 1920, amounted to $20,000, while the later bookkeeper, testifying from the same books, stated that they amounted to $54,999. We are unable to determine from the record which is the correct amount.

Judgment will be entered for respondent on 15 days’ notice, under Rule 50.

Considered by GreeN and AeuNdell.


text:
    J. G. Tomlinson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7068.
    Promulgated August 1, 1927.
    Where liquidating dividends are received over a period of years from a corporation in process of dissolution and liquidation, and a stockholder is subsequently required, by reason of a tax deficiency of the corporation, to repay a portion of the dividends so received, the amounts repaid are properly set off first against the dividend last received.

      Lawrence Graves, Esq., for the petitioner.

      L. G. Mitchell, Esq., for the respondent.
    This proceeding involves deficiencies in income taxes for 1919 and 1920 of $205.06 and $1,237.22, respectively. Of the issues raised by the pleadings, some have been withdrawn by the petitioner and others have been agreed upon, leaving only for decision the question of whether certain liquidating dividends received by petitioner during the year 1920 are properly reducible by repayments subsequently made by him.
    FINDINGS OF FACT.
    The petitioner is an individual residing at Troy, N. C.
    He was the owner of 96 shares of stock of the Capelsie Cotton Mills, a North Carolina corporation. In 1920 the corporation sold all its property, consisting principally of a mill, mill property, land, and machinery. It retained only a safe, an office, desk, some accounts receivable, and some Government bonds. Petitioner received in. 1920 a liquidating dividend of $49,492.80,. another liquidating dividend of $2,592 in 1921, and a further .liquidating dividend, ,of,,$2,5†£.76 in 3922. . . A „,, -
    On March 6, 1924,,,the, petitioner, repaid $267.65 because the company had insufficient .funds to, pay certain Federal, taxes., In 1926 the petitioner received from the secretary-treasurer of the corporation the.following notice: , .,
    -.Final assessment. - has been made, against the, C.apelsie Cotton .Mills for the, additional income tax due. .The amount necessary.to be,paid by ea,ch stockholder is $14,133 per share.
    Your 96 shares figure that you will be due to pay back--,-- $.1, 356. 76
    Tess amount already advanced' by' you, including interest on same — _ 3‘04. 51
    ; ... . 7 J ., , j , ,•. ,. ; ,, ;i , ,1.052.25 '
    Kindly let us have your check for this amount. '
    Qn Allgust 20, .1926, the petitioner paid.,the.,amou,nt( of $1,052.25.
    fhq, corporation wqs dissolved ’ shortly after. rtlie .of. its assess in mo. c'-77 77 ...77,,7 .•777- ■7.-77: 777"

      The petitioner owned 30 shares of stock of the Francis Cotton Mills, Inc. In 1920 that company sold its assets and in the same year the petitioner received liquidating dividends of $12,660. No dividends were received thereafter.
    Petitioner received a notice from the secretary-treasurer of the corporation dated November 14, 1923, advising him that the liability of the company for income taxes had been determined to be $111,000, that only $46,387 was on hand to pay the taxes, that it would be necessary to raise by assessment $65,505, and that petitioner’s share was $1,650. This amount was paid by petitioner on January 6, 1924.
    The Francis Cotton Mills, Inc., was dissolved in 1920 or 1921.
    The respondent determined that the amount received by petitioner on liquidation of the Francis Cotton Mills, Inc., was $374.74 a share.
   OPINION.

Sternhagen:

The petitioner assigns the following errors on the part of the respondent in determining the deficiencies here involved:

1. That for 1919 he disallowed the deduction of $2,809.51 expended for fertilizer, and $830.65 expended for repairs.

2. That for 1920 he failed to include in income rents of $3,535, and also failed to allow the deduction of $8,547.26 expended for fertilizer.

3. That he incorrectly determined the gain realized in 1920 on liquidating dividends received from the Capelsie Cotton Mills by reason of using an incorrect value as of March 1, 1913.

4. That he erroneously determined that petitioner received income in 1920 from the Troy Garment Manufacturing Co., a partnership.

5. That he refused to reduce the amount of a liquidating dividend received in 1920 from the Capelsie Cotton Mills by amounts subsequently repaid to the corporation to enable it to pay Federal income tax.

6. That he refused to reduce the amount of liquidating dividends received in 1920 from the Francis Cotton Mills, Inc., by an amount subsequently repaid to the corporation to enable it to pay Federal income tax.

With regard to the first assignment of error, the parties have agreed that the petitioner is entitled to a deduction of $1,777.50 for expenditures for fertilizer and repairs in 1919. This amount shall be allowed as a deduction in computing the deficiency for that year.

With regard to the second assignment of error, the parties have agreed that the rents of $3,535 shall be added to the petitioner’s income for 1920, and that he is entitled to a deduction of $3,207.94 on account of expenditures for fertilizer, instead of $8,547.26 as alleged.

The third and fourth assignments of error were withdrawn, and the action of the respondent complained of in these assignments of error is sustained.

The only matter remaining for consideration is the question whether the income derived from liquidating dividends in 1920 should be reduced by the amounts repaid in subsequent years. The question has already been decided. In O. B. Barker, 3 B. T. A. 1180, it was held that stockholders receive liquidating dividends impressed with a trust to the extent that the amounts received encroach upon the equity of the corporation’s creditors, and it was held that in computing tax on such dividends they should be reduced by the amount the stockholder returns to the corporation to satisfy claims against the corporation. This was followed in E. F. Cremin, 5 B. T. A. 1164, and E. M. F. Leflang, 6 B. T. A. 4.

This petitioner received $12,660 from the Francis Cotton Mills, Inc., as liquidating dividends in 1920, and no further dividends were received thereafter. In 1924 he was required to and did repay $1,650. These facts are clearly within the principle laid down in the Barker and other cases supra, and in recomputing the deficiency for 1920 the liquidating dividends should be reduced to $11,010.

The conclusion in respect of the liquidating dividends received in 1920 from the Capelsie Cotton Mills mu'st be for the respondent. The petitioner received three liquidating dividends, $49,492.80 in 1920, $2,592 in 1921, and $2,513.16 in 1922. He repaid $261.65 in 1924, and $152.25 in 1926, to enable the corporation to pay its Federal taxes. He now seeks to apply these two payments, aggregating $419.90, against the first dividend of 1920. It will be readily seen that this can not be. There is no trust impressed upon the first liquidating dividend since it did not impair the equity of creditors. Clarence LeBus, 1 B. T. A. 733. In O. B. Barker, supra, it was held consistently with this that the amount returned is to be set off against the last distribution received.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Green and Arundell.


author: Sternhagen :

text:
    Takamine Laboratory, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3199.
    Promulgated August 1, 1927.

      Louis E. Edil, Esq., for the petitioner.

      Charles E. Curl, Esq., for the respondent.

      Deficiency of $112,768.92, income tax for 1918. The respondent added to petitioner’s gross income an amount alleged to represent profit on an exchange of property for stock.
    FINDINGS OF FACT.
    Petitioner, a corporation, was organized under the laws of New York on December 21,1914, with its principal office at 120 Broadway, New York City. Dr. Jokichi Takamine, now deceased, was president of the petitioner, his son, Jokichi Takamine, Jr., its secretary, and another son, Eben T. Takamine, treasurer. Petitioner was capitalized at $10,000; 100 shares at a par value of $100 a share were issued, 97 shares to the father, Jokichi Takamine, and two shares and one share to the sons, Eben and Jokichi, Jr., respectively. They were the sole stockholders and directors of petitioner. Petitioner was engaged in the manufacture, importation, exportation., and sale of chemicals and pharmaceutical supplies in bulk, its principal trade being with Japan.
    Some time prior to August, 1918, Dr. Takamine and his son, Eben, were in Japan and discussed the formation, of a separate company under the laws of Japan, which would carry on for petitioner its business in Japan. Previously the Sankyo Company had acted as petitioner’s agent in Japan. The assets of the petitioner’s business department, that is to say, that branch of the concern which carried on the importation and exportation of chemicals, were to be transferred to the new Japanese company, and a certain number of shares of stock of the new company were to be issued to the Taka-mines. At this time the war with Germany was 'in progress and apparently substantial profits were to be made from this trade in “heavy chemicals.”
    Accordingly, on August 19, 1918, the contemplated new company was incorporated in Japan under the name of the Takamine Industrial Co., Ltd., hereinafter called the “Japan Company.” It had its principal office at 444 Tokyo Marine Building, Tokyo, and a branch office at 120 Broadway, New York City. Dr. Takamine was president of the company and director authorized to represent it. Its capitalization was 3,000,000 yen, which at the 1918 exchange value of the yen (49.8 cents) amounted to approximately $1,500,000. The par value of a share was 50 yen ($25), and 60,000 shares were issued. Dr. Takamine subscribed for 14,000 shares, and each of his two sons to 10,000 shares, making 34,000 shares, or an interest of 56.66 per cent of the stock in the Takamines. The par value of the stock was not, however, paid in full to the Japan Company. Twelve and one-half yen per share, or one-quarter of the par value was paid in by other stockholders than the Takamines, twenty-seven in all, who held 26,000 shares, the remaining three-fourths being left subject to call by the corporation’s directors. Of the 34,000 shares held by the Takamines, one-half of the par value, or $425,000 was paid in. But this sum was not paid to the new company in cash.
    On October 29, 1918, an agreement was signed by Dr. Takamine as president of the Japan Company and by Dr. Takamine again as president of the petitioner, by which an assignment was made of all the assets and liabilities, with a single exception, of petitioner’s “ business department,” as of August 31, 1918, to the Japan Company. This property of petitioner was worth $250,000 and consisted of merchandise and property on contract, in transit and in Japan, and was received by the Japan Company as one-half payment on the stock subscribed by the Takamines. The names of the Takamines, and not that of petitioner, were entered on the Japan Company’s stock subscription list. The petitioner accepted the stock of the Japan Company and an entry was made on petitioner’s books, setting up an investment of $425,000 in the Japan Company. The Takamines originally intended to receive this stock as individuals but later, on the advice of counsel, decided that petitioner should receive it. No certificates of stock were ever issued to or received by the petitioner, or its nominees, nor by any other shareholders of the Japan Company. No sales of stock by stockholders were made after original subscription.
    After the Armistice, November 11, 1918, there was an immediate decline in the market value of drugs and chemicals. Contracts were repudiated all over Japan. The value of the commodities transferred to the Japan Company dropped. At this time the Japan Company was under contracts involving large sums of money for the purchase of chemicals. Some of these the Japan Company sought to cancel, and in doing so became in one instance involved in a lawsuit which resulted in a loss to it of $30,000. The company ceased doing business on February 10,1919, but goods under order continued to arrive in Japan after this date. It was the practice of the Japan Company’s New York office to draw drafts covering shipments, without letters of credit, on Tokyo banks, including the Yokohama Specie, the Sumitomo, and the Taiwan Banks, for the amount of the expected sale price, and to cash these drafts in New York. The shortest time of shipment between New York and Tokyo was 60 days, and often as long as 4 or 5 months elapsed while goods were in transit.
    In November, 1918, the New York office of the Japan Company had instructed the main office at Tokyo to procure no further orders and in February, 1919, the Tokyo office instructed the New York branch office to ship no more goods. Under the conditions indicated above, however, goods arrived, consigned to the Japan Company, as late as March, 1919.
    By February, 1919, Dr. Takamine had returned to Japan. On March 18 or 19, 1919, all the assets and liabilities of the Japan Company were assigned to Dr. Takamine. At this time the liabilities of the company exceeded its assets by about 1,100,000 yen. Dr. Taka-mine then in turn assigned part, or all, of the Japan Company’s assets to Sankyo on consignment, the proceeds to be applied against indebtedness of the Japan Company on account of drafts honored by it. He also sold in March, 1919, certain personal property in order to procure a loan of 468,433.88 yen for the Japan Company, which that company never repaid him. Dr. Takamine bought, after February, 1919, a majority of outstanding shares of the Japan Company. No call was made by the Japan Company on unpaid stock subscribed, and it was Dr. Takamine’s object in buying outstanding-shares of the company to prevent further losses to his friends who had subscribed this stock. He assumed and paid all liabilities and the creditors of the company were paid in full.
    Formal dissolution proceedings were instituted on August 21,1919, in accordance with resolutions of a general shareholders’ meeting. A report of liquidation of the company was made in November, 1919, with a statement of assets and liabilities as of September 30, 1919, as follows:
    Assets
    Capital unpaid-$1, 825, 0U0.00
    Good will-^-350,000.00
    Furniture_ 6,161.85
    Due from customers_ 4,377.73
    Bills receivable_i-17,114. 59
    Advanced payments-13,472.49
    Deposit in bank and cash on hand_ 53.42
    Due from New York Branch Office_ 130,689.48
    Unsettled accounts with New York Branch Office_ 218.52
    Loss by Tokyo Head Office-1, 042,458.73
    Loss by New York Branch Office-82, 825. 52
    Total. 3,472,372.33
    Liabilities
    Capital stock- 3,000, 000.00
    Legal reserve fund- 2, 600.00
    Suspense account_ 1,338.45
    Loan from Dr. Takamine_ 468,433.88
    Total. 3, 472,372. 33

      The entire loss on ultimate liquidation, which was completed on March 10, 1924, was 1,272,776.13 yen.
    No dividends on the stock were ever declared and the stockholders never received any dividends on the company’s dissolution. The stock of the Japan Company became worthless in 1919.
    The books and records of the Japan Company were destroyed in the earthquake and fire of September 1, 1923.
    The deficiency notice to petitioner, in addition to stating the deficiency for 1918, states there is no deficiency or overassessment for 1919, and shows a net loss of $27,162.76 sustained in 1919. In computing the deficiency for 1918, the respondent has allowed this net loss for 1919 as a deduction.
   OPINION.

Sternhagen :

From a record far from certain as to the facts, some of which appear in testimony and documentary evidence given in Japan on written interrogatories, the foregoing findings have been made. They are not satisfactory because the absence of clear detail requires inferences of fact to serve as premises for conclusions of law. Perhaps it was necessary, or at least justifiable, that a closely held business should be reorganized with as little regard for detail or legal formality as is shown by this record; but if so, when the matter becomes of legal significance in litigation such as this, the tribunal can only take the evidence as it finds it, make such inferences as are necessary, as reasonably as possible, and from this reach its decision. In such a decision there can be little value by way of precept. Numerous issues are raised in the pleadings but in view of our decision it is unnecessary to consider them all.

Considering all the evidence, we find no foundation upon which to rest a conclusion other than that the stock of the Japan Company here in question was worth $425,000 as found by the Commissioner and was taken by the petitioner for assets which had cost $250,000, thus establishing a gain of $175,000 as part of petitioner’s 1918 income. This stock was not entirely worthless in 1918, although probably of doubtful value. In 1919 it became totally worthless and in that year petitioner sustained a loss of $425,000 by reason thereof. This loss should be included in the computation of petitioner’s admitted net loss of 1919 and applied against its 1918 income to redetermine the 19Í8 deficiency in question.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Green and Artjndell.


author: Aeundell :

text:
    Carl G. Fisher, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7594.
    Promulgated August 1, 1927.
    1. Amounts withdrawn by petitioner from a corporation held, to have been the repayment of loans and not dividends.
    2. Evidence does not establish that claimed losses were sustained in 1920.

      William 8. Hammers, Esq., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1920. The issues are: (1) Whether .withdrawals from a corporation constituted dividends to the extent of the corporate earnings, or were the repayment of loans; (2) whether petitioner sustained a loss in 1920 in respect of an investment in corporate stock and certain loans.
    FINDINGS OF FACT.
    The petitioner is an individual residing at Miami Beach, Fla.
    In 1920 he owned, except for qualifying shares, all of the capital stock of the Continental Realty Co., which was capitalized at $10,000. Prior to and during the year 1920 the petitioner advanced to the company large sums of money for the purpose of enabling it to conduct operations for which its capital was insufficient. The advances so made were credited to the petitioner in the ledger of the company in an account headed “ Carl G. Fisher, Investment.” The account was so designated to distinguish it from the company’s capital stock account. At the beginning of 1920 the credit to the petitioner in the investment account was $399,478.40. During the year he made further advances of various sums aggregating $23,255.99 and withdrew from time to time amounts totaling $260,727.85, leaving to his credit at the close of the year a balance of $162,006.54. The withdrawals made were debited against the petitioner in the investment account.
    The net earnings of the Continental Realty Co. for the year 1920 amounted to $26,267.80. The respondent in determining the deficiency held that to the extent of the earned surplus of the company, which he determined to be $26,876.97, the withdrawals of the .petitioner constituted dividends. The ledger of the’company shows no dividends paid at any time.
    In 1920 the petitioner owned 26 shares of stock in the Purdy Boat Co., which had a total capital stock of 50 shares of the par value of $100 each. E. D. Purdy and J. D. Purdy held 23 shares of stock purchased with money loaned them by the petitioner and for which the petitioner held their note in the amount of $2,300. The petitioner also held a note of the company in the amount of $21,000 for money loaned it.
    The Purdy Boat Co. was organized at the instance of the petitioner for the purpose of building and repairing boats for him and for others. Its operations were not successful financially and in 1920 or 1921 its assets were turned over to the Alton Beach Realty Co. to apply on its indebtedness to that company. The indebtedness was incurred through loans made by the Alton Company to the Purdy Company for the purchase of machinery and supplies and for operating expenses. The assets turned over were subsequently sold by the Alton Company for an amount less than the amount of the indebtedness to it of the Purdy Company.
    The amount of $25,900, representing petitioner’s investment in the Purdy Boat Co., his loans to the company, and his loans to the Purdys individually, was included in the amount charged off in his profit and loss account in his ledger under date of December 31, 1920, and entered in his journal as an item of profit and loss under date of January 1,1921. The respondent disallowed the amount claimed as a loss for 1920 on the ground that it was not possible to ascertain the amount of the loss until 1921.
   OPINION.

Aeundell :

The dispute between the parties as to the money withdrawn by the petitioner from the Continental Realty Co. during 1920 is whether, to the extent of the earnings of the company, the withdrawals constitute dividends or the repayment of loans. If the former, they are taxable to the petitioner; if the latter, they are not. The advances made by the petitioner to the company were clearly loans. They were so regarded by him and were carried in the company’s accounts as separate and distinct from its capital account. When the petitioner withdrew money in 1920 he considered the withdrawals as partial repayments of his loans. The company never paid any dividends and we fail to see how the money withdrawn by the petitioner could be regarded as anything other than the repayment of petitioner’s loans. On this point we must find for the petitioner. Appeal of Benjamm J. Schiff, 3 B. T. A. 640.

The amount of $25,900 claimed as_ a loss for the year 1920 is made up of three items, viz., Purdy Boat Co. stock, $2,600; Purdy Boat Co. note, $21,000; E. D. and J. D. Purdy note, $2,300. The respondent admits that the petitioner sustained a loss on the Purdy transaction but denies that it was a 1920 loss and holds that the loss was sustained in 1921. We agree with the respondent to the extent of holding that no deductible loss was sustained in 1920. We might rest our decision on any one of several grounds. First, the evidence is not clear as to when the Purdy Company transferred its assets to the Alton Company. The record leaves us in doubt as to whether it was in 1920 or 1921. In the second place a mere showing that the Purdy Company transferred its assets to another is not sufficient to support a claim for a loss on its stock and notes and certainly it is not evidence on which we can allow a claim for loss on the notes of the Purdys as individuals. Finally, we do not know by what right the Alton Company took over the assets and whether the petitioner was precluded thereby from his claim, as a creditor, against them.

■Judgment will be entered on 15 days’ notice, imder Rule 50.

Considered by Green and Sternhagen.


author: Van Fossan:

text:
    The Boston Store, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4216.
    Promulgated August 2, 1927.

      Lcmrence Lewis, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
   Van Fossan:

This proceeding is for the redetermination of a deficiency of $1,558.76 in income and profits taxes for the calendar year 1920. It is alleged that the Commissioner erred in denying petitioner affiliation with the Greeley Dry Goods Co., and in increasing its taxable income by the sum of $514.45. At the hearing the correct taxable net income was stipulated.

FINDINGS OP PACT.

Petitioner is a Colorado corporation with principal offices at Colorado Springs. The officers were Clem Melancon, president; Julius C. Fischer, vice president; Floyd L. Kelsey,secretary-treasurer. These parties and Fischer Brothers Co. owned all of the stock.

In June, 1920, the Greeley Dry Goods Co. was incorporated with an/ authorized capital stock of 400 shares, par value $100 per share. The owners of the stock and the number of shares held by each from the respective dates of issue were:

The directors of the corporation were W. C. Brooks, Floyd L. Kelsey, and Clem Melancon, the last named being also the president. The company began actual operations October 26,1920.

Prior to incorporation of the Greeley Company, petitioner, pursuant to a plan of expansion, secured W. C. Brooks as manager of the store it contemplated opening at Greeley, Colo. It was then decided to organize a new company in which Brooks should be permitted to purchase 132 shares of stock, and thereafter the Greeley Dry Goods Co. was incorporated. It was agreed orally that petitioner should have control of the general policy and operation of the business of the new company. Brooks agreed, also orally, to exercise no control over his stock and to authorize some officer of petitioner to vote the same, as and when necessary, until such stock was fully paid for, and, in the event he desired to dispose of his holdings, to first offer the same to petitioner.

The original issue of 150 shares of the Greeley Company stock was paid for in cash, by Brooks for his 50 shares and by petitioner for its 98 shares and for the two shares held by Melancon and Kelsey. The 82 additional shares issued to Brooks were paid for with the proceeds of a loan obtained from the Union National Bank'of Greeley upon his note, endorsed by Melancon and Fischer. All stock issued to Brooks was endorsed in blank immediately upon issue and deposited either with the bank as collateral security for the loan or with petitioner and was in Brooks’ possession only long enough to be so endorsed.

Petitioner and the Greeley Company dealt in the same class or character of merchandise and in most instances purchases were made in bulk for both stores and the shipment later divided. Practically all purchases, as well as all banking and credit arrangements, for both stores were made by Melancon, and all notes executed by the Greeley Company were endorsed by officers of petitioner. All purchases were either charged to or paid for by petitioner or the payment therefor guaranteed by it. The books of the Greeley Company were kept in the offices of petitioner. During the taxable year the Greeley Company made no profit.

In February, 1921, petitioner paid Brooks’ note to the Union Bank, repaid to Brooks his $5,000 original investment, and took over all his stock in the Greeley Company. During his ownership thereof Brooks exercised no control over his stock and no occasion arose necessitating his authorization to officers of petitioner to vote the same. Brooks did not participate in determining the policies of the company, but merely executed the orders given to him by petitioner.

The petitioner and Greeley Dry Goods Co. were affiliated in the year 1920.

The correct taxable net income of petitioner for the year 1920 was $10,285.62.

Judgment will he entered on 15 days’ notice, under Bule 50.

Considered by MaRquette, MillikeN, and Phillips.


text:
    Western Zinc Oxide Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8604.
    Promulgated August 2, 1927.

      O. J. Walker, Esq., for the petitioner.

      A. G. Bouchard, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency of $9,997.26, in income and profits taxes for the calendar year 1918. The questions involved are (1) the value for invested capital purposes of a zinc oxide plant paid in for stock at the time of incorporation in 1915; (2) the value of certain mining property paid in to the corporation for stock in 1918; (3) the cost of tangible assets for depreciation purposes.
    FINDINGS OF FACT.
    Petitioner is a Colorado corporation with principal offices at Leadville, Colo., and was incorporated in the year 1915. Upon incorporation it acquired a zinc oxide plant from J. B. McDonald, a Mr. Burton, John Eberville, Alf Hoffman and A. B. Augustine in consideration of the issue to them of $23,000 of its capital stock. On petitioner’s books the transfer of the stock and the transfer, of the plant were each set up as a cash transaction in the amount named,.
    The plant was constructed in 1914 by the Western Zinc Mining Reducing Co., which contracted to purchase from McDonald and Burton 1,500 tons of zinc ore per month. Because pi financial ¿jiffi-culties the Western Zinc Mining & Redjucing Co.^aftep a. few' months’ operation, closed the plant and offered it for sale to Augustine for $40,000 cash. Augustine, with whom McDonald, Burton, Eberville. and Hoffman were associated in negotiations for the purchase of the plant, rejected this offer. After further negotiations the plant was offered to Augustine and his associates in consideration of $23,000 cash and the cancellation of the McDonald-Burton ore contract. This offer was accepted by the purchasers, the McDonald-Burton contract was canceled and the plant transferred to the above named individuals. Subsequently, in 1915, the above individuals transferred the plant to petitioner.
    In the year 1918 petitioner acquired certain property in fee, known as the Kennebec Mine, and leases on certain other property, known as the Yak, for which it paid $250,000 par value of its capital stock.
    The actual cash value of the property acquired in 1918, known as the Kennebec Mine and the Yak leases, was $25,000.
   OPINION.

Van Fossan:

The evidence fails to establish a cash value of the original plant in excess of $23,000, the amount of stock issued therefor. This figure also properly represents the cost of the original plant for depreciation purposes. There was some evidence of additional plant investment during 1915-1918 but the testimony as to the cost of same and the dates thereof was so indefinite as to make it impossible for us to determine, with any accuracy, a proper amount in excess of the figure of $23,000 as a basis for depreciation or to fix a rate of depreciation therefor.

Judgment will he entered on 15 days’ notice, under Rule 50.

Considered by Makquette, Milliken, and Phillips.