text:
    The F. G. Bonfils Trust, the Denver National Bank and the First National Bank of Kansas City, as Trustees under the Will of F. G. Bonfils, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93148.
    Promulgated December 8, 1939.

      James B. Grant, Esq., Stephen H. Hart, Esq., and John H. McEvers, Esq., for the petitioners.

      R. P. Hertzog, Esq., and L. 0. Mitchell, Esq., for the respondent.
   OPINION.

Van Fossan :

As to the first of the remaining issues, the petitioners base their contention on the proposition that they are entitled “to deduct any part of their gross income which, pursuant to the terms of F. G. Bonfils’ will was ‘to be used exclusively for religious, charitable, scientific, literary or educational purposes,’ ” citing section 162 (a).

It will be noted that the petitioners do not claim the deduction by virtue of section 162 (b) See Helvering v. Pardee, 290 U. S. 365, where the principle laid down hi Burnet v. Whitehouse, 283 U. S. 148, was applied and it was held that payments to the beneficiaries were not distributions of income but were in discharge of a gift or legacy and, hence, not deductible from income. See also Estate of William H. Block, 39 B. T. A. 338. Nor do they claim the deduction as an amount “paid or permanently set aside” for the purposes and in the manner specified in section 23 (o) as provided in section 162 (a). They suggest and urge that it comes within the last provision of section 162 (a) as an amount which “is to be used exclusively for * * * charitable * * * purposes,” the reasoning being that since the corpus ultimately will go to a charitable organization, the income used to pay the annuities frees the corpus of a proportionate burden and is to be used exclusively for charitable purposes within the meaning of section 162 (a).

We must confess that on careful study we are unable to follow the purported logic of petitioners’ argument. The payments were actually made to the annuitants and inured to their exclusive benefit. That they were in point of fact made out of income and not out of corpus can not be controlling. See Helvering v. Pardee, supra. The legal character of the payments is established by the provision of the will that the corpus might be invaded. We are unable to perceive how the payment of the annuities, which actually lessened the amount ultimately available for distribution to the charitable foundation, can by any stretch of logic or imagination be said to be payments “to be used exclusively for * * * charitable purposes.” The income which was used in payment of the annuities was thereby used in fact, and it can not be said in the language of section 162 (a) that it is “to be used” at some future time. Albeit the Congress and the courts agree that gifts to charity should be encouraged, it is equally well established that deductions are a matter of legislative grace and a taxpayer must bring his claim clearly within the permissive provision of the statute. This petitioners have not done. The respondent is sustained.

The second issue presents the same question as that decided by us in Helen G. Bonfils et al., Executors, 40 B. T. A. 1079, promulgated this day. There we held that capital gains which pursuant to the will became a part of the corpus and thus subject to the charge of annuities in case the ordinary income of the estate is insufficient to meet such charges, were deductible under section 162 (a), the facts proving that the probability of the invasion of corpus is so remote as to be negligible. Practically the same facts and figures are present in the case at bar as appeared in the estate case and, if anything, they are more favorable to the petitioners. Therefore, such capital gains are deductible from the petitioners’ gross income for the taxable years under consideration.

Decision will be entered under Bule 50.

       SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that — •
      (a) There shall be allowed as a deduction (in lieu of the deduction for charitable, etc., contributions authorized by section 23 (o)) any part of the gross income, without limitation, which pursuant to the terms of the will or deed creating the trust, is during the taxable year paid or permanently set aside for the purposes and in the manner specified in section 23 (o), or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit;

       (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year.


source: Caselaw Access Project

author: OppeR:

license: Public Domain

text:
    William C. Heinemann & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91190.
    Promulgated December 8, 1939.

      Herman M. Berman, O. P. A., for the petitioner.

      Leslie H. BusKbrooh, Esq., Sidney W. Hihen, Esq., F. B. Shearer, Esq., and Alvin B. Peterson, Esq., for the respondent.
   OPINION.

OppeR:

The issue in this proceeding is the year in which the bad debt loss of a holder of real estate mortgage bonds may properly be allowed where the property is foreclosed in one year and the period of redemption expires in the next. The point arises out of the disallowance of a deduction taken in the year 1935 and resulting in proposed deficiencies of $1,168.16 and $102.92, respectively, in income and excess profits taxes for that year. Strangely enough, the question appears to be one of first impression, at least so far as this Board is concerned.

The character and extent of petitioner’s loss is not in issue. Ee-spondent does not dispute that the claim is a bad debt under the instant circumstances, nor that petitioner’s share of the loss was properly calculated by apportioning the difference between the purchase price of the mortgaged property and the amount due. The principal facts appear by stipulation of the parties and are hereby found accordingly. The parties agree that petitioner held $54,000 worth of real estate mortgage bonds and that the mortgaged property was sold at foreclosure sale in May 1934 for an amount which was 53.62 percent of the total obligation, resulting in a loss to petitioner of $24,662.97. They also agree that this! amount was entered on petitioner’s books in 1935 as a charge against a reserve for losses that, at the time of the sale, the mortgagor had no other assets from which any part of the deficiency could be collected; and that the period of redemption of the foreclosed property, under the applicable Illinois law, expired in 1935, the privilege of redemption not having been exercised. It appears from the evidence that petitioner was the “house of issue” with respect to the mortgage bonds; that it made the loan to the debtor on which the bonds were issued; and that the bondholders’ committee consisted entirely of officers of the petitioner; so that it was at all times pertinent to this proceeding acquainted with the facts and circumstances outlined and with the condition of the debtor and of the mortgaged property.

It has several times been determined that a mortgagor is entitled to take a loss for income tax purposes in the year when the period of redemption expires. J. G. Hawkins, 34 B. T. A. 918; affd., 91 Fed. (2d) 354; Derby Realty Corporation, 35 B. T. A. 335. These authorities, however, are not necessarily dispositive of the present question. We are dealing here with a mortgagee rather than a mortgagor; and it is urged that the existence of a loss as respects the owner of the property may be in doubt until foreclosure is completed, while at the same time the transaction may be closed and completed and the loss definite and ascertainable as far as the creditor is concerned.

But before that question is disposed of a supplementary point should be decided. Petitioner was not technically the mortgagee. It was the owner of mortgage bonds issued under an indenture in connection with which a trustee held the mortgage and was authorized to act for the benefit of all bondholders. It appears from the stipulation of facts that foreclosure proceedings were instituted by the trustee at the request of the committee of bondholders; and that when the property was sold it was bid in by this committee on behalf of the bondholders, including this petitioner, payment being made not in cash but by delivery of all the outstanding bonds. Under these circumstances there was, in our opinion, no material difference between the situation of the present petitioner and the individual holder of a real estate mortgage. If we regard the trustee in the first instance and the bondholders’ committee thereafter as having acted throughout as agent and trustee for all of the bondholders, including petitioner, we arrive at the same result as though petitioner was the sole mortgagee and foreclosed and bid in the property for itself. That there were other participants similarly situated changes the quantity, not the character, of petitioner’s interest. No tenable distinction between the two situations has been suggested to us.

Under other circumstances it might be contended that the holder of a mortgage bond was not in as favorable a position to ascertain the facts as the outright owner of the entire mortgage. As we have pointed out, the record in this case is otherwise and no such contention is made. We need not consider here what the proper disposition of such a case would be and do not purport to pass upon it. Under the present facts the circumstance that this petitioner was not technically the mortgagee is immaterial in considering the year in which it is entitled to the bad debt deduction.

Assuming then that we may for all practical purposes treat the petitioner as the mortgagee, we come to a consideration of the principal question. This, in our view, requires that we determine the precise effect of the transactions giving rise to the present controversy. When the property was sold at foreclosure sale, the purchaser received and the mortgagor was deprived of no more than a contingent right, which, prior to the expiration of the period of redemption, could not be reduced to anything as definite or tangible as complete legal and equitable title. Rawson v. Bethesda Baptist Church, 221 Ill. 216; 77 N. E. 560. Since the position of mortgagor and purchaser is thus in a state of suspended animation pending redemption, and subject to unforeseeable contingencies, we have held that it is only upon the conclusion of the completed transaction, when the period of redemption has expired, that the mortgagor’s loss is sufficiently definite to permit its allowance. J. C. Hawkins, supra; Derby Realty Corporation, supra.

The question here, however, is not what the mortgagor loses but what the creditor obtains. If the sale is for cash to a third person the proceeds normally are the property of the mortgage creditor. See Hallbert v. Turner, 233 Ill. 531; 84 N. E. 704. The mortgage, as such, is extinguished, Strause v. Dutch, 250 Ill. 326; 95 N. E. 286; Rawson v. Bethesda Baptist Church, supra. And the sole remaining recourse of the mortgagee is an action on the deficiency. Strause, v. Dutch, supra. If, as we are justified in concluding here, the petitioner was fully aware of the facts relating to the foreclosure, and the remainder of the debt was uncollectible and was known to be such in 1934, it would! follow that the worthlessness was then so definite in character and ascertainable in amount that we can not sustain petitioner’s contention that it was ascertained to be worthless in 1935. This result was suggested in J. C. Hawkins, supra, where the Board said (p. 923):

The extinction of the mortgage debt depends on the receipt of payment by the mortgagee, as such. See Ewen MacLennan, 20 B. T. A. 900; John Hancock Mutual Life Insurance Co., 10 B. T. A. 736. * * *
The debt may have then been satisfied. But that fact is not decisive or even significant in determining what title or what property of the mortgagor was then disposed of, from the proceeds of which, theoretically in this case, the mortgagee was paid.

The situation is no different where the mortgagee is the purchaser and the purchase price is paid by a credit against all or part of the mortgage debt. No material change in the mortgagee’s recovery can result from the mortgagor’s election to redeem. If the election is exercised, the amount paid on redemption will not exceed the purchase price at the foreclosure sale with interest. Ill. Stat. C. 77, § 18, L. 1921, p. 500. If it is not, the creditor will be left with property the fair market value of which we may assume to be the bid price. Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216. At least the parties do not contend otherwise here. In either event, the extent of petitioner’s collection and hence of the unrecoverable balance will be the same. We see no justification under the facts of this case for determining that the uncollectibility of the debt was ascertained by petitioner in a later year. On the contrary, we must conclude that under these circumstances the petitioner would have been justified in taking the bad debt deduction in the year when the foreclosure sale was held. This is in accordance with respondent’s regulations (art. 23 (k) 3 and 4, Regulations 86), which, for the reasons stated, appear to be a correct construction of the law.

In addition to the stipulation, petitioner introduced testimony describing certain negotiations carried on between petitioner and the president of the mortgagor corporation. We are justified in finding as a fact, as we do, that certain conversations were had during the year 1935 in which the possible redemption of the property was discussed with the mortgagor’s president and that the latter was heavily interested as its principal stockholder. He had, however, no legal or even moral obligation for the company’s shortcomings to warrant the expectation that he would assume any deficiency. This evidence might be significant if the issue were the probability or improbability of an exercise of the election to redeem. In our view of the principal question, however, this element is immaterial; and the evidence submitted is far from sufficient to indicate that the assets of the debtor were of such a character or the negotiations so conclusive that the creditor could without being an incorrigible optimist look forward to the payment of any portion of the deficiency. United States v. White Dental Manufacturing Co., 274 U. S. 398. From this point of view no facts appear which make it necessary to modify the conclusion reached above.

Reviewed by the Board.

Decision will he entered for the respondent.

       No question of the propriety of the deduction is raised on this ground, it being stipulated that “Petitioner is on the actual charge-off method.”

       The right of a creditor to redeem on the mortgagor’s failure to do so, which in Illinois inures to an unsatisfied mortgagee, Strause v. Dutch, supra, need not concern us even if it appeared to have a theoretical value, since the mortgagee was the purchaser and could not redeem the property from itself.


author: Leech:

text:
    Ralph H. Jackson and Mary J. Jackson (Husband and Wife), Petitioners, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 91780-91789, 95796-96798, 96225-96226, 96592.
    Promulgated December 13, 1939.

      F. E. Gleach, Esq., and E. A. Mihills, O. P. A., for tbe petitioners

      Harold F. Noneman, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Otis Hutchins; George H. Huntley and Estella D. Huntley (Husband and Wife) ; Henry P. Kirchner; Henry R. Power and Mary M. Power (Husband and Wife) ; Prank L. Buell and Emma A. Buell (Husband and Wife) ; Boyd H. Work and Jean H. Work (Husband and Wife) ; Ernest R. Baxter and Ethel A. Baxter (Husband and Wife) ; Lee P. Allen and Naomi S. Allen (Husband and Wife) ; Harry C. Martin; Charles ff. Geiger and Catherine M. Geiger (Husband and Wife) ; Edwin B. Porse; Boyd M. Johnson; Carl J. Steuber; William J. uirieh ; Irving Joseph Hawke.

   OPINION.

Leech:

These consolidated proceedings seek redetermination of deficiencies in income tax as follows:

The common issue is whether, under section 165 of the Eevenue Act of 1934, the excess of the value of certain stock in the Carborundum Co. upon the dates of its distribution pursuant to a trust agreement, over the amounts paid in by petitioners, is properly includable in petitioners’ income. The parties have submitted the proceedings on a stipulation of facts to which exhibits are attached and both the stipulation and exhibits are incorporated herein as our findings of fact.

All’ of the petitioners are employees of the Carborundum Co., a corporation. On September 18, 1928, the board of directors of the Carborundum Co. resolved to increase the company’s capitalization from 500,000 shares to 525,000 shares. The stated capital applicable to the increase was to be $1,250,000; but the shares were to be without par value. This action was approved at a special meeting of the stockholders of the company on September 11, 1928. On the same day the board of directors met and resolved that, of the 25,000 shares authorized to be issued, 12,500 shares should be sold at $50 a share and that the remaining 12,500 shares should remain unissued for the present. It was further resolved that the officers of the Carborundum Co. be authorized to execute a certain trust agreement involving the sale of 12,500 shares of the Carborundum Co. to trustees at $50 per share.

This trust agreement was executed on November 28, 1928, between the Carborundum Co., Power City Bank as lienor, and three trustees. The trustees were Frank J. Tone, George B. Bayner, and Frank H. Manley, all of them stockholders of the Carborundum Co. The preamble of the agreement recited that the Carborundum Co., hereinafter referred to as “the company”, desired to create a trust in 12,500 shares of the company’s capital stock “as a part of a profit-sharing plan for the exclusive benefit of some of the employees of the company, or of its subsidiaries, to which plan contributions are to be made by such employees for the purpose of distributing to such employees the earnings and principal of the fund to be accumulated by the trust.” In the operative part of the agreement, the trustees agreed to receive and accept the 12,500 shares of the company’s stock as and when issued to them in trust, and to hold the same and receive the dividends thereon for the benefit of the company’s employees pursuant to a plan which was then set forth in the body of the trust instrument. This plan was embodied in a letter set out in the trust instrument. The substance of the letter was that the stock was to be offered to certain employees at $50 per share and to be paid for by them in small monthly installments in limited maximum amounts.

It was further provided in the trust instrument that whenever an employee should fully pay up the balance owing on the stock which he desired to purchase under the plan, the trustees would obtain the stock which he was purchasing and would thereupon distribute it to him or to his personal representatives if he were dead. If one of the participants should cease to be employed by the company or if he desired to withdraw from the plan, the trustees would thereupon refund to him the amount of all payments already credited against the purchase price. The participants were to pay interest on the unpaid balance of the purchase price, plus the proportionate part of the trustees’ actual expenses allocable to each of them. The trustees were authorized to pledge the entire block of 12,500 shares with the lienor to secure the repayment of amounts borrowed by the trustees from the lienor to cover the unpaid balances due to participants on their purchases of stock under the plan. The trustees were further authorized to vote the stock held by them under the trust and to otherwise deal with it as if they were absolute owners.

Eighty-one employees of the company and its subsidiaries executed the “offer to purchase stock.”

When the trustees received offers to purchase stock, they borrowed money from the Power City Bank (lienor under the trust agreement) in an amount sufficient, when added to the initial payments of the participants, to purchase the required number of shares of stock from the company at $50 per share. The company thereupon issued the stock and credited $20, for each share so issued, to its capital stock account and the remainder of the proceeds for each share, $30, to its paid-in surplus account. A total of 9,265 shares out of the 12,500 shares made available under the plan were purchased from the company, the balance remaining unissued. When the purchase price of the stock, interest payable, and expenses had been paid, by deducting amounts necessary from the salary of the purchaser together with dividends paid on the stock, the stock certificate covering the number of shares purchased was delivered. When an employee requested release from his offer to purchase stock, his payments were ordinarily refunded. The offers to purchase stock by petitioners, the number of shares they contracted to buy, the initial payment per share, the deduction per share from salary, the date of distribution of the stock, the number of shares distributed, payments by the petitioners, the dividends credited, and the interest and transfer tax charged, the fair market value of the stock received by the petitioners at all dates material thereto in 1934 and 1935, are stipulated.

All of the petitioners, with the exception of Hutchins, Allen, Buell, and Jackson, in making their respective Federal income tax returns, included in income on account of the distribution of this stock, only the dividends declared thereon and credited on the purchase price thereof. Hutchins failed to include dividends so declared and credited, to the extent of $600. Buell, Allen, atad Jackson failed to report any amount on account of dividends declared or credited. The parties have also stipulated that the dividends declared on the stock distributed pursuant to the agreement and which were credited on the purchase price thereof are properly includable in income in the year in which distribution of the stock was made.

The Carborundum Co. and its subsidiaries claim no deductions in their respective corporate Federal income tax returns for the years 1934 and 1935 for compensation paid to petitioners on account of the dividends declared and credited upon the purchase price of their stock, or for the difference between the purchase price of $50 per share and the fair market value of the stock purchased by petitioners and distributed to them in the years 1934 and 1935. The company, however, has filed claims for refund, which are still pending, asking refunds on the ground that the company should have taken such deductions.

During the taxable years here involved, the company paid bonuses in cash in addition to stated wages and salaries. In 1934, a total of $23,665.44 was so paid, and in 1935 a total of $36,796.35 was so paid.

Bespondent seeks to tax petitioners on the difference between the value of the Carborundum Co. stock when distributed to them and the amounts paid in by the petitioners in order to acquire the stock. He predicates his action on section 165 of the Bevenue Act of 1934, which is set out in the margin. Petitioners’ answer to this contention is, first, that no trust was created as a part of a profit-sharing plan, and, second, that even if there were a plan it could not be for the sharing of profits in the sense in which that word is used in the statute, because dividends received on an investment in stock do not constitute statutory profit-sharing.

Plaving regard to the literal wording of the statute, it does not seem to us to be open to question that the trust created by the Carborundum Co. is precisely covered by section 165. The preamble of the trust contains the statement that it was the desire of the company to set up the trust as a part of a profit-sharing plan for the exclusive benefit of certain of its selected employees. Petitioners urge that the trust was not created as a part of such plan for the reason that the language of the trust instrument in this regard is merely precatory. In support of their contention they cite Herbert G. Goulder, 39 B. T. A. 670. Petitioners also urge that no stock was conveyed in trust and that the trust therefore lacked a res.

Answering the second contention first, it is very plain that the Carborundum Co. did convey the stock to the trustees. It is true that the stock was not issued except as each employee completed the payments due by him, but inasmuch as the trustees were given power to pledge and vote the entire block of stock and since that stock could not be used by the company for any other purpose during the term of the trust agreement, we think the rights of the trustees in that block of stock were sufficiently substantial to constitute a trust res and thus support the trust. See Carson Estate Co., 31 B. T. A. 607; affd., 80 Fed. (2d) 1007.

In regard to petitioners’ argument that the trust was not created as a part of a plan, we do not think that section 165 requires that the words “profit-sharing plan” be included in the operative clause of the trust agreement. It is evident from the corporate resolutions, the entire trust agreement, and the evidence that such a plan was both contemplated and carried out. It is worthy of emphasis that the statute covers a trust “for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan.” This purpose is indicated by the trust instrument in both the preamble and body of the trust, and the trustees are authorized to act only in pursuance of the purposes for which the agreement was drawn. The Carborundum Co. did not merely “desire” to carry out a profit-sharing plan, but actually did so.

The Goulcler case and the state authorities cited by petitioners are distinguishable because in all those cases the operative parts of the respective instruments failed to carry out the desires and wishes expressed in their preambles.

It is the plain intendment of section 165 that the amount actually distributed or made available to any distributee, pursuant to a plan of profit-sharing, shall be taxed to the distributee in the year of distribution to the extent that the amount of the distribution exceeds the amounts paid in. The amounts of these distributions were, of course, the respective values of the stocks distributed at the times of distribution. Schaefer v. Bowers, 50 Fed. (2d) 689. See Oscar A. Olstad, 32 B. T. A. 670, 675. Petitioners also contend that the plan of the Carborundum Co. could not possibly be one of profit-sharing, in that it merely afforded to employees the same opportunities to purchase stock as would be granted to any member of the public and that dividends received on a stock investment are not the type of profits contemplated by the statute. They cite Durkee v. Welch, 49 Fed. (2d) 339. The Dwrhee case, it is true, removed a taxpayer from the operation of section 219 (f) of the Kevenue Act of 1926 (substantially identical to section 165 of the 1934 Act) on the ground that he was merely an investor in the stock of a company and that the dividends from such investment did not constitute profit-sharing.' But there was no employees’ trust involved there and, furthermore, the case followed as a precedent the lower court’s decision of Schaefer v. Bowers, which was reversed on appeal. (See infra.)

In any event, we think that Schaefer v. Bowers, supra, disposes of petitioners’ contention. In that case, the employee’s ultimate receipt of the stock depended on his continuance in the employ of the company for a definite period of time. The situation here is the same, for the plan as set out in the trust instrument provides that the participating employee may make monthly contributions only up to a certain amount, and that if his employment is terminated he will receive his contributions back. In other words, before he can get the stock, he must work until the sum of the maximum payments he is permitted to make out of his wages equals the purchase price of the stock he has agreed to buy. It is this feature which, as the court held in the Schaefer case, differentiates petitioners from ordinary purchasing investors and makes them taxable under section 165.

In view of our conclusion that these petitioners all fall within section 165, and are taxable to the extent that the value of their stock at the time of distribution exceeds the amounts contributed by them, we do not now need to consider the alternative grounds for taxing them under section 22 (a) of the Revenue Act of 1934. Because of the concession by four of the petitioners that they have taken erroneous deductions in their returns as filed,

Decisions will he entered wnder Rule 50.

       SBC. 165. EMPLOYEES’ TRUSTS.
      A trust created by an employer as a part of a stock bonus, pension, or profit-sharing plan for the exclusive benefit of some or all of his employees, to which contributions are made by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of dividends and interest specified in section 25 (a).


author: Oppee :

text:
    Anheuser-Busch, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent. Melrose Ice Cream Corporation, a Dissolved Corporation, Adolphus Busch III, Charles D. Russell, Gus G. Kindervater, and William J. Landes, Surviving Members of the Last Board of Directors, and Trustees for the Creditors and Stockholders of Said Melrose Ice Cream Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 86450, 86453.
    Promulgated December 14, 1939.

      Daniel N. Kirby, Esq., Allen C. Omck, Esq., and Hwrry W. Kroe-ger, Esq., for the petitioners.

      W. H. Schwatka, Esq., R. E. Maiden, Jr., Esq., and Edward L. Updike, Esq., for the respondent.
   OPINION.

Oppee :

It is assumed by the parties that the agreement between Anheuser-Busch (petitioner) and Borden contained a “plan of reorganization” within the meaning of section 112 (i) (1) (A) of the Revenue Act of 1928. John A. Nelson Co. v. Helvering, 296 U. S. 374; see Groman v. Commissioner, 302 U. S. 82; but cf. Bus & Transport Securities Corporation v. Helvering, 296 U. S. 391. There remains to be considered the issue actually litigated in this proceeding, namely, whether Borden was a “party to a reorganization” within the meaning of section 112 (g) so that its securities, when distributed to petitioner, are free from the recognition of gain; and under section 112 (b) (4) so that no gain is to be recognized to Melrose upon receipt by it of the Borden shares or their equivalent.

From the controlling authorities bearing upon this question, three principles emerge which appear to dispose of the present issue. It seems evident that the first principle, enunciated in Groman v. Commissioner, supra, that the securities of a parent corporation are not those of a party to a reorganization where the property transferred is received by a subsidiary, would be unquestionably applicable here were it not for the two facts, first, that the transfer was made to the subsidiary indirectly through the parent (Borden), and, second, that the agreement embodying the plan did not specifically require the organization of or transfer to the subsidiary but made it optional with the parent.

The first distinction is disposed of by the second principle, established by Helvering v. Bashford, 302 U. S. 454, in the following language:

Any direct ownership by Atlas [the parent] of Peerless, Black Diamond, and Union [the subject of tbe transfer] was transitory and without real substance; it was part of a plan which contemplated the immediate transfer of the stock or the assets or both of the three reorganized companies to the new Atlas subsidiary.

If, as part of the plan, the assets of Melrose were transferred through Borden to Delaware, Borden’s ownership was equally transitory and without real substance, and its status as a party to the reorganization equally without foundation.

The second distinction is similarly met and refuted by the third principle exemplified by A. W. Mellon, 36 B. T. A. 977, 1078 et seq., and Gilbert D. Hedden, 37 B. T. A. 1082; affd., 105 Fed. (2d) 311 (C. C. A., 3d Cir.) ; certiorari denied, 308 U. S. 515. In each of these cases the transfer was actually made to a subsidiary nominee of the parent. There was no provision of the plan which required the participation of the subsidiary. In each case it was the privilege of the parent, the party to the contract of reorganization, to determine whether it or its subsidiary would receive the transferred property. In each case we may assume that, if the parent itself had elected to receive and hold the property, the rule of the Grornan and Bashford cases would have been inapplicable. In each case, however, the parent chose to avail itself of the optional provision and to have the property conveyed to its subsidiary. The transferor in those cases was not entitled to be consulted, and for all that appears was not. The conclusion to be gathered from these decisions is therefore that the intervention of a subsidiary will be treated as a part of the plan, if it is a contemplated possibility under the plan and actually eventuates.

’ Applying those principles to the present situation it follows that Borden’s election to organize Delaware and utilize it for the receipt of the transferred property has the same legal effect as though the plan provided no other alternative, A. W. Mellon, supra; Gilbert D. Hedden, supra, that the transfer of the assets to Delaware through the temporary medium of Borden has the same legal effect as though the assets were transferred directly from Melrose to Delaware, Helver-ing v. Bashford, sufra; and that the transfer of property to Delaware, the subsidiary corporation, pursuant to the plan of reorganization, in exchange for securities of the parent, Borden, results in the taxable receipt by the transferor, Melrose, or its stockholders of “other property”, since Borden was not a party to the reorganization, Groman v. Commissioner, supra.

It is true petitioner had no voice in the decision that the property was to be received and held by Delaware rather than by Borden. Neither did those contracting on behalf of the transferors in the Mellon and Redden cases. It may also be true that through the exercise of volition by a third person petitioner and Melrose were placed in the position of having entered into a taxable transaction in lieu of one that would have been tax-free. But that is no more than to say that by their own act they put it within the power of another so to control the essential character of that transaction that the taxing provisions of the revenue act became operative. That is no justification for concluding that they did not become operative, nor for relieving petitioner and Melrose of the tax consequences of the transaction which actually eventuated. To hold otherwise would be tantamount to applying the tax law on the basis of what was hoped for rather than of what occurred.

We need not decide whether the result would be different if the . transfer to Borden’s subsidiary had occurred after a significant q interval. The question might then arise as an issue of fact whether > the subsequent transfer was part of the effectuation of the plan of reorganization or independent of it. Here there can be no question. ¡' Delaware was organized before the closing of title. It was created, for the express purpose of acquiring the property and with the co- j operation, as was required by the contract, of petitioner and Melrose. / It was entitled by the terms of a specific agreement with Borden to receive all of the assets transferred and did in fact immediately receive them. Some of the assets were actually transferred directly to the subsidiary without even the intervention of Borden. This would have been a technical noncompliance with the reorganization agreement except on the assumption that upon the exercise of Borden’s option both parties contemplated that the subsidiary and not Borden was the true party to the transfer. The step is characterized in petitioner’s brief as “confirmatory short-cuts for record purposes”, a statement consistent with the view that all of the transfers through Borden were merely the longer path to the contemplated result that the subsidiary was to be the recipient of all the transferred assets. Minnesota Tea Co. v. Helvering, 302 U. S. 609. And, if more were needed, the contract shows that it was intended that the subsidiary, if organized at all, would be created before the transfer of the assets, because the help of Melrose in its organization is stipulated for, and Melrose was to be dissolved immediately after the closing.

These considerations we believe to be unnecessary to reach the result that under the contract as it was actually carried out the Borden Co. was not a party to the reorganization within the meaning of section 112. But they furnish conclusive evidence, if that were required, that coincident with the consummation of the plan of reorganization it was definitely contemplated by the parties that the subsidiary and not the parent should be the transferee; and accordingly that under the doctrine of the Gromcm and Bash,ford, cases the subsidiary and pot the parent was a party to the reorganization.

The second issue involves the gain, if any, to be recognized as to Melrose by Borden’s payment to petitioner of Melrose’s $500,000 debt. On this point it has been held that the assumption and discharge of a transferor’s debt as part of the consideration for the transfer of its assets is taxable to it as “other property” received. United States v. Hendler, 303 U. S. 564; see also Helvering v. Blumenthal, 296 U. S. 552. The indebtedness was paid by the delivery of $300,000 in cash and 2,500 shares of Borden’s stock having a stipulated value of $184,687.50. Respondent has chosen to determine the deficiency on the basis of these combined amounts. It may be that the correct amount would have been $500,000, since that is the measure of the benefit to Melrose accruing from the discharge of its obligation. Since, however, respondent has elected to proceed upon a theory involving a smaller deficiency, we find it unnecessary to decide that point. At least to the extent of the figures stated, Melrose received a taxable consideration.

After the Board heard these proceedings and received the principal briefs the Revenue Act of 1939 became law. Section 213 (f) of that Act contains provisions obviously designed to limit the scope of the Hendler decision. The language of the section, however, and if more were necessary its legislative history, demonstrate that it was not intended to apply to such a case as this. Its operation is confined to a situation “where upon an exchange * * * the taxpayer received as part of the consideration property which would be permitted * * * to be received without the recognition of gain if it were the sole consideration * * Since we have already determined that no part of the present consideration may be so treated, nothing in this legislation need qualify the conclusion reached. So much is conceded by petitioner’s counsel.

Finally, as it may if necessary, the Board on its own motion ques-. tioned its jurisdiction to consider the proceeding in Docket No. 86453 brought on behalf of petitioner Melrose Ice Cream Corporation. This action was taken, not on the theory that that petitioner was a dissolved corporation, for it appears affirmatively from the pleadings that it is its surviving board of directors which brings the proceeding as trustee in liquidation, for which purpose the corporation retains a nominal existence; but rather to enable us to satisfy ourselves that there has been determined against that petitioner a deficiency from which it can appeal.

After further consideration, we are of the opinion that jurisdiction exists. Although the deficiency letter was addressed to its parent, it may nonetheless be regarded as sent to petitioner Melrose. Furniture Exhibition Building Co., 24 B. T. A. 1279, 1289. Since the corporations had joined in a consolidated return, “notice to either was notice to both.” American Auto Trimming Co. v. Lucas, 37 Fed. (2d) 801, 804 (App. D. C.). The letter proposed a deficiency in the parent’s “income tax liability and that of your affiliated companies.” And unlike the situation in American Creosoting Co., 12 B. T. A. 247, it went further and stated: “The deficiency will be assessed severally against each corporation.” Since there is no doubt of the liability of a subsidiary for a tax asserted against its parent under such circumstances, Mississippi River & Bonne Terre Railway, 39 B. T. A. 995, and since the notice unequivocally asserted a deficiency as to the subsidiary and proposed assessment against it, we see no reason why the letter should not be regarded as a notice of deficiency as to the petitioner, Melrose Ice Cream Corporation. That being so, it is entitled to prosecute an appeal to this Board. Revenue Act of 1928, sec. 272.

Reviewed by the Board.

Decision will be entered vmder Rule 50.

       See. 112 (d), Revenue Act of 1928,

       SEC. 213. ASSUMPTION OP INDEBTEDNESS.

      (f) Assumption of Liability Not Recognized Under Prior Acts.—
      (1) Where upon an exchange occurring in a taxable year ending after December 31, 1923, and beginning before January 1, 1939, the taxpayer received as part of the consideration property which would be permitted by subsection (b) (4) or (5) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts, to be received without the recognition of gain if it were the sole consideration, and as part of the consideration another party to the exchange assumed a liability of the taxpayer or acquired from the taxpayer property subject to a liability, such assumption or acquisition shall not be considered as “other property or money” received by the taxpayer within the meaning of subsection (c), (d), or (e) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts, and shall not prevent the exchange from being within the provisions of subsection (b) (4) or (5) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts; * * *

       76th Cong., 1st sess., House Rept. No. 855, p. 5,

         lUa, pp. 18-20.

        Herbert Brush Manufacturing Co., 22 B. T. A. 646.

       Cf. Herbert Brush Manufacturing Co., supra.

       New Xork General Corporation Law, sec. 29.


author: KeRN :

text:
    Apex Brewing Co. Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91977.
    Promulgated December 15, 1939.

      H.- B. Jones, Esq., and George O. Kinnear, Esq., for the petitioner.

      Edward Q. Adams, Esq., for the respondent.
   opinion-.

KeRN :

1. Our first question is whether there was any gain realized by petitioner on the transfer to it of the brewery and other assets. The respondent contends that petitioner realized a profit of $28,333.50 on the deal. This results, he argues, from a sale price of $72,063.45, from which is to be deducted the $1,000 cash paid at the sale plus the mortgage of $21,063.45 assumed by petitioner, leaving $50,000 as the sale price of the 2,500 shares of Hemrich Investment Co. stock. This sum of $50,000, less the cost base of the stock in the hands of individual shareholders of the Hemrich Investment Co. who became incorporators of petitioner, results, according to respondent’s determination, in a profit to petitioner of $28,333.50.

The principal difficulty in determining this issue is the interpretation of the facts and the ascertainment of their legal significance. Respondent contends that, in effect, the individual incorporators transferred their Hemrich Investment stock to petitioner corporation in return for all of its stock then issued, and that, thereafter, the petitioner exchanged the Investment stock with the Hemrich Brewing Co. in part payment for the latter’s physical assets. The conclusion which respondent urges is that the transfer of the Investment stock to petitioner by its incorporators is nontaxable by virtue of section 112 (b) (5), that the basis of such stock to petitioner was thereupon the same as it was to the incorporators by virtue of section 113 (a) (7), and that, therefore, the exchange of such stock by petitioner for the physical assets of the Hemrich Brewing Co. having a value in excess of such basis would result in taxable income to petitioner in the amount of such excess.

Petitioner’s contention is in effect that its incorporators had a contract with the Hemrich Brewing Co. whereby they had the right to obtain the physical assets of the Brewing Co. for $12,063.45 and to satisfy $50,000 of this amount by transferring to the Brewing Co. 2,500 shares of Investment Co. stock which they then owned; that these incorporators thereupon approached petitioner corporation which they had had formed and proposed the assignment of this contract to petitioner after it had been partially executed by the incor-porators, i. e., after they had transferred the Investment stock to the Brewing Co., and that petitioner’s stock was issued to them in consideration for the assignment of this partially executed contract. Therefore, petitioner contends, the question of the basis of the Investment Co. stock is not pertinent, and the basis of petitioner’s assets would be the fair market value of those assets when received in exchange for its stock.

The difficulty with respondent’s contention is that the incorpora-tors of petitioner did not transfer their Investment Co. stock to petitioner in return for petitioner’s stock and petitioner did not exchange the Investment Co. stock for the physical assets of the Brewing Co. The transfer of the Investment Co. stock was made by the incor-porators to the Brewing Co. and nothing in the record indicates that petitioner ever had title of any kind to this stock. Nor does it appear that there were two separate transactions, as respondent contends — a transfer of Investment Co. stock to petitioner and an exchange of this stock by petitioner to the Brewing Co. Rather, it appears that the transactions between the petitioner, its incorporators, and the Brewing Co. were simultaneous and legally interdependent.

The difficulty with petitioner’s contention is that the record discloses no contract executed between petitioner’s incorporators and the Brewing Co., and no assignment of any such contract partially executed to the petitioner. While the minutes of the petitioner’s board of directors, set out in our findings, mention a contract with the Brewing Co. to be executed by petitioner’s incorporators on its behalf, and the assignment of such contract to petitioner, the only contract introduced in evidence was the contract to which petitioner itself was a party, named together with the individual incorporators as “purchasers.”

We are disposed to treat the facts in the following manner: Petitioner’s incorporators and their associates made an oral deal with the Brewing Co. prior to petitioner’s incorporation, whereby it was understood that the incorporators could purchase the assets of the Brewing Co. on the terms and at the figure set out in the contract later executed, to which we have referred, including the privilege of transferring to the Brewing Co. 2,500 shares of Investment Co. stock in lieu of a payment of $50,000 on the initial cash payment. After this deal or understanding petitioner corporation was formed, not for the purpose of acquiring the Investment Co. stock held by its incorporators, but for the purpose of acquiring and operating the assets of the Brewing Co. The entire plan had been fully formulated by the incorporators in the beginning, but it was now necessary that petitioner should take formal corporate action. Petitioner, therefore, by appropriate resolution determined that the purchase of these assets at the price and on the terms previously understood between the incorporators and the Brewing Co. was advantageous, and the incorporators thus formally agreed that they would transfer their Investment Co. stock to the Brewing Co. in lieu of the cash payment of $50,000. Immediately a written contract was executed between the Brewing Co. as “seller” and petitioner and the individual incorporators as “purchasers”, which recited the receipt of such stock by the “seller.” As a result of these transactions, petitioner acquired its assets from the Brewing Co., the Brewing Co. acquired the Investment Co. stock from petitioner’s incorporators, and the latter acquired petitioner’s stock.

The result of this single triangular transaction was the same as would have been the result if the petitioner’s incorporators had acquired the assets of the Brewing Co. in exchange for the Investment Co. stock and had then, in a later transaction, transferred these assets to the petitioner in return for its stock. In such a case the basis to petitioner’s transferors would not be the original basis to them of the Investment Co. stock, but would be their basis as to the Brewing Co. assets, which would be greater as a result of this taxable exchange. Petitioner by taking these assets in return for the issuance of its stock would not realize a gain or receive taxable income. It would result tbat petitioner’s incorporators in sucb a view of tbe case realized a gain resulting in taxable income by tbeir exchange of Investment Co. stock for assets of tbe Brewing Co., but it is they who should be taxed thereon and not petitioner. A consideration which especially persuades us to view the legal effect of the transactions in this way is the fact that petitioner was organized for the purpose of acquiring and operating the assets of the Brewing Co., which consisted of a going brewery and its inventory of beer and manufacturing supplies. It was not formed for the purpose of acquiring or holding the Investment Co. stock and it never did, in fact, acquire or hold that stock. Since the sole object of the plan was to get the brewery into the hands of the new corporation formed to operate it, and since petitioner’s stock had no market value apart from the assets which it should acquire, the means of acquisition adopted were immaterial both to the corporation and to its promoters; and the most careful scrutiny of their several acts can reveal nothing of significance unless sight is kept of this controlling fact, which dominates the whole transaction. Both the sequence and significance of those acts must be read in the light of this ultimate object, and in applying this test we do not find that petitioner realized any gain.

We are not persuaded that the relationship between a corporation and its promoters is so close as to necessarily result in considering the corporation as realizing a taxable gain from the disposition of property which it never owned in a transaction which, of necessity, preceded its possession of any property and its transaction of any of the business for which it was formed.

On this issue our decision is in favor of petitioner.

2. We now pass to the second issue, of the proper basis for depreciation of certain of petitioner’s physical assets. Both parties have treated the aggregate of petitioner’s fixed assets and beer in the process of manufacture as acquired for a total price of $72,063.45. The purchase contract fixed no specific sum for the separate assets transferred and the respondent, therefore, allocated the purchase price to the several assets by apportioning it according to the original cost of those assets to the transferor, the Hemrich Brewing Co., as follows:

Petitioner complains that its beer in vats and barreled (4,949 barrels) was current inventory, with a readily realizable cash value, and this assertion appears to be sustained on the sales which petitioner made as soon as it took over. If this is so, petitioner continues, the beer’s inventory value, cost or market, whichever is lower, can not arbitrarily be written down to the allocated figure such as is here employed, of $25,291.08. Moreover, since inventory “cost” has been found to be $10.12 a barrel on the basis of Hemrich’s prior book value and at least $7 as the basis of Hemrich’s offer to buy back petitioner’s beer for that amount, and since inventory market value on the basis of actual sales has been ascertained to be $6 a barrel, obviously inventory market value is lower than cost and should be employed. This would give an inventory value to the beer of $29,700. The remaining inventory (manufacturing supplies) would have to be included at cost value.

We can see no very valid objection to petitioner’s contention. It is true, as respondent argues, that this would mean that the remainder of the purchase price of $72,063.45 would have to be reallocated to the fixed assets, but we can not see that this would raise any particular difficulty, since the same method of allocation as respondent originally employed here can be used again. ISTor do we think it material that petitioner has adduced no new evidence of material import in regard to the value of the fixed assets, beyond showing that the brewhouse was obsolescent. If, as we think, the inventory value has been satisfactorily established, the readjustment can be made as to it in fairness to petitioner without the necessity of its establishing also all values of its fixed assets on new evidence; and we so hold.

3. As to the rates of depreciation which should be applied, we are unable to concede the petitioner’s contention in full. Petitioner originally took a deduction for annual depreciation of 3% percent on its building and 10 percent on its cooperage. The evidence shows that the building was frame and was becoming obsolescent for modern steel brewing vats on that account, but we do not think that the evidence on the whole is clear enough to allow us to overturn respondent’s determination and to fix, as petitioner contends we should, a useful life of twenty years for the building. We therefore leave that depreciation rate unaltered. Petitioner contends that the evidence shows that the cooperage was so inferior that a useful life of not more than six or seven years should be found, and a deduction allowed accordingly of 15 percent for 1934. As we think the evidence does support this contention, we allow it.

4. We now pass to the last question in issue, which involves petitioner’s reserve for bad debts of $10,000, set up at the end of its fiscal year January 31,1935, of which reserve respondent allowed only $5,000 as a deduction for tax purposes.

In view of the provisions of the statute on this subject (section 23 (k), Revenue Act of 1934), it is necessary for petitioner, in order to prevail on this issue, to show clearly that the respondent acted unreasonably in disallowing as a deduction a part of the bad debt reserve set up by petitioner. Cf. C. P. Ford & Co., 28 B. T. A. 156. See, also, Treasury Regulations 94, article 23 (k)-5, for pertinent provisions on this subject.

The respondent justly points out that when the reserve was set up, January 31, 1935, the petitioner had had gross sales during the ten months of its existence of over $311,000, had outstanding accounts at the time of over $35,000, and going accounts receivable of more than $30,000; so that the claimed deduction represented about one-third of its accounts receivable. He also calls attention to the actual write-off of bad debts by the petitioner at this time, which was only $598.68. And respondent correctly insists on the rule that the later experience of the petitioner in setting up reserves or additions thereto can not be availed of to justify the reasonableness of the reserve in the year in question, which must be determined on the facts then known to him.

When all this is said, however, we are still unpersuaded that the reserve, in the peculiar circumstances of the times in petitioner’s trade, was unreasonable or that respondent acted reasonably in disallowing any part thereof. We think that the reserve was proper in the light of the facts known to the petitioner and to his auditors, a reputable firm of certified public accountants, at the time when it was set up. We shall state our reasons for believing so, after looking at the authorities.

In Rhode Island Hospital Trust Co. v. Commissioner, 29 Fed. (2d) 339, the Court of Appeals for the First Circuit considered a situation in banking not unlike that here presented in the brewing trade. It said, at page 342:

Very few, if any, banks would, in the fall of 1921, have acted wisely if they had taken the “experience as to losses over a period of years” as then a basis for a reserve for bad debts. Unusual conditions call for unusual measures. The Board of Tax Appeals in effect ruled that the unusual conditions of 1920-21 should be disregarded, and that this bank was entitled to make no increase in its reserve except on the basis of experience as to losses over a period of years. That was plainly error.

To the same effect, sustaining the taxpayer’s right to apply a different rule in changed economic conditions, is our decision in National Mill Supply Co., 23 B. T. A. 1363, 1375; affd., 62 Fed. (2d) 420. In the instant case the evidence is clear that petitioner, like other breweries with which its competition was sharp, sought all the “outlets” for retail trade possible. The retailers which had sprung up in abundance after repeal of the Liquor Prohibition Amendment a few months before were in very many cases without financial reserves and obtained credit easily only because of the newness of the trade and the keenness of the brewers’ competition. These facts were fully known to petitioner’s officers at the time and to their auditors, when they came to set up the reserve. The evidence also indicates that the state liquor control board discouraged the charge-off of bad debts on beer accounts until it should be able to issue formal rules regulating these matters, which was eventually done on November 1, 1935. This fact explains in part the very small charge-off made by petitioner at the close of its fiscal period in question. Moreover, petitioner’s later credit history, although it can not be received in evidence for determining the basic fact before us, does substantiate the reasonableness of the petitioner’s determination in that it indicates the business sagacity displayed in setting up a reserve sufficiently large at the time to anticipate the results of its overexpansion of credit. We need not review these facts which we have set out in our findings, but their import can not be properly overlooked. The reserve, with relatively small annual additions, was completely absorbed by charge-offs in the next few years. The evidence shows, moreover, that certain specific accounts still carried as good on the basic date thereafter proved bad and might properly have been considered bad on January 31, 1935. Doubtless but for the loss by fire of many of petitioner’s records, this story could have been amplified in detail. We have sufficient evidence, however, to feel convinced that the reserve, in the unusual conditions here present, was in all respects reasonable and that respondent acted unreasonably in disallowing any part of it as a deduction.

It is significant that the ratio of bad debts to total accounts receivable was approximately the same in the case of a neighboring competitor of petitioner as in the case of petitioner for this period, indicating that the credit problem of this period was not peculiar to petitioner, but was widespread and acute enough to be recognized, studied, and provided for. Also, we stress the fact that petitioner created this bad debt reserve in the taxable year, and that the taxable year was immediately after the repeal of the Eighteenth Amendment to the Federal Constitution, so that neither the petitioner nor the industry in which it was engaged had a credit history for prior years which could have been helpful in determining the amount to be set up as a reserve for bad debts. Because of this fact, and the fact that the industry as a whole faced an unusual credit condition, it was necessary for petitioner to make a careful analysis of the available facts, and this the petitioner, in our opinion, did.

Reviewed by the Board.

Decision will be entered under Buie 60.

Black and Mellott dissent on the first point.


author: TueneR :

text:
    Marguerite Hyde Suffolk & Berks, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 81417, 93257.
    Promulgated December 15, 1939.

      Calvin F. Self ridge, Esq., for the petitioner.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

TueneR :

Thé petitioner contends that no part of the income of the Leiter estate added to the corpus of the estate in 1932 and 1934, pursuant to court decree, constituted income distributable or taxable to her in the respective years. The respondent’s position is that the petitioner is taxable on her proportionate share of such income on the ground that said income was distributable to her under the terms of the will, and the court decree did not effect a departure from the terms thereof.

Section 162 of the Eevenue Acts of 1932 and 1934 provides as follows:

SEO. 162. NET INCOME.
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *

Under the will of the decedent the trustees were directed to pay out of the trust income the expenses of managing the trust estate and were authorized and empowered to use and apply such portions of net income derived from the trust estate as they deemed best, either in payment of mortgages or incumbrances upon the property or in making any improvements thereon. The remainder of the income was currently distributable to the named beneficiaries. A number of years prior to the years here in question the trustees expended substantial sums with respect to real estate owned by the trust and located in Chicago and Wyoming. The petitioner in 1923 instituted proceedings in the Superior Court of Cook County, Illinois, for the removal of her brother as trustee, for an accounting of the affairs of the estate, and a construction of the provisions of the will with respect to the development and management of the parcels of real estate mentioned. As a result of this proceeding, the court on May 14,1931, entered its decree construing the will and fixing the amounts of such expenditures properly chargeable to income and the amounts chargeable to corpus. There is no contention by either party to -this proceeding that the amounts chargeable to income and the amounts chargeable to corpus were incorrectly determined. The court found that a portion of the amount which had been expended from corpus with respect to the two parcels of real estate and should have been expended from income, had been repaid from income to corpus, and further found that there still remained unpaid the total amount of $779,084.03, of Vhich $422,746.82 should be paid immediately and the remainder, amounting to $356,337.21, should be amortized and repaid from income to corpus in equal installments over a period of nine years commencing January 1, 1931. The court further directed that such amortization be effected “by charging against the share of each income beneficiary, and crediting and paying over to corpus, such proportion of each annual installment as the distributable share of such income beneficiary bears to the total distributive income of said trust estate * * *; that the right to have the payments necessary to carry out the amortization directed by this decree is hereby imposed against those who are now, or may hereafter become, entitled to the income, and upon the income to which they are, or may be, so entitled, and in favor of those who are now, or may hereafter become, entitled to the corpus of the estate * *

There is no showing or claim that the income beneficiaries did not previously receive distributions of income which they , would not have received if the expenditures in respect of the Chicago and Wyoming properties had been charged as they should have been, and we accordingly conclude that, to the extent the decree so charged the distributive shares of the income beneficiaries, they did receive distributions from the estate in excess of the income to which they were entitled. The court by its decree directed that corpus should be reimbursed for the amounts so expended which should, under the terms of the will, have been expended from income. It directed that this reimbursement should be effected by direct charge ■ against the current distributable share of the income of each income beneficiary, stating specifically that the charge was “imposed against those who are now, or may hereafter become, entitled to the income, and upon the income to which they are, or may be, so entitled, and in favor of those who are now, or may hereafter become, entitled to the corpus of the estate.” The situation here is similar to that considered by us in Mary V. Pyle, 16 B. T. A. 218. In that case the trustees of an estate created by will made an excessive distribution to the life tenant during the year 1920. In 1921 the error was discovered and for the purpose of correcting the error'the trustees withheld in that year from distribution to the life tenant an amount equal to the excessive distribution in 1920. Subsequently the court approved the 1921 account of the trustees in which the withholding described was reflected. Finding that the will under which the estate was created provided for the payment of the income of the estate to the life tenant in quarterly installments, we held that the entire income of the estate for 1921, undiminished in any amount whatsoever, was distributable to the life tenant and should have been included in computing her taxable net income for 1921. Our holding in that casé is applicable here, and the respondent’s action 'on this issue is sustained. Compare Susan B. Armstrong, 38 B. T. A. 658, wherein wej concluded that the facts did not justify the conclusion that the withholding from the income of the beneficiary was in settlement of an obligation on her part to replace the impaired capital. In this case the court, by its decree, specifically made the obligation a direct charge on the shares of income currently distributable to the'beneficiaries. Compare Freuler v. Helvering, 291 U. S. 35, in which it was held that where during a given taxable year an income beneficiary of a trust was actually paid an amount in excess of the amount to which he was entitled, he was taxable in such year only on the .amount that was properly receivable by him in that year.

With respect to the item of $20,000 representing the rent due the Leiter estate on the Quinlan property for 1934, we do not have a case where the taxpayer had previously reported an item as income and is now claiming as a bad debt deduction the amount previously accrued and reported as income. The respondent has determined that the omission by the estate of the said item from gross income was erroneous and has increased rents in that amount, thereby determining that the petitioner’s income should be increased pro rata. Such an increase by the respondent of the rental income of the estate is claimed as error in the petition.

Where an account has been properly accrued and later becomes un-collectible, the taxpayer’s remedy is by way of a deduction and the requirements of the specific statutory provision must be met, and it may not be claimed that the item so accrued should not have been included in income in the first instance. Spring City Foundry Co. v. Commissioner, 292 U. S. 182. With respect to inclusion in income in the first instance, however, it has been held that where the facts are such that the item in question is not collectible when due and its collection in the future is highly improbable, the taxpayer, even though on the accrual basis, is not required to report such income in his return. American Fork & Hoe Co., 33 B. T. A. 1139; Oregon Terminals Co., 29 B. T. A. 1332; Emanuel Solomon Ullmanm, 30 B. T. A. 764; Atlantic Coast Line Railroad Co., 31 B. T. A. 730, 749; Great Northern Railway Co., 8 B. T. A. 225, 269. From these cases, however, it is apparent that a taxpayer is justified in failing to accrue an income item which has become due only where the facts are such as to show that it is uncollectible when due and there is little or no likelihood of collection in the future.

In the instant case the petitioner called as a witness one of the officers of the real estate firm which acted as agent for the building to establish by opinion testimony the uncollectibility of the rent item at the time it became due and at all times subsequent thereto. The petitioner also relies on the financial condition of the lessee. The respondent claims that the rent item was properly accruable in 1934 and that the record is not sufficient to sustain, the allowance of a deduction for a bad debt. He supports this contention by pointing to the right of the estate to declare a forfeiture of the lease and to repossess the real estate on which the lessee, or its assignor, had constructed the office building previously described. While we are not impressed with the argument of petitioner that the half of- the building standing on the Leiter property had no value, neither do we think it follows, as argued by the respondent, that the existence of the right of the lessors to declare a forfeiture of the lease and to repossess the property, including the building thereon, establishes a value in or the collectibility of the claim for rent. Obviously the building on the Trude and Leiter properties did have value. It consistently in all of the years shown by the record produced income in excess of its operating expenses, maintenance charges, and taxes. The petitioner bases its claim of no value on the testimony of the witness previously mentioned and on the fact that the entrance to the building was located on the Trude property and that the part of the building located on the Leiter property probably could not be cut off from that portion located on the Trude property and operated profitably as a separate building. Obviously there was no thought or intention of such action. The Trude and Leiter estates had leased their properties to the same interest undoubtedly with the understanding that the building to be erected on both properties should be a single operating unit. The estates had proceeded jointly with their efforts to collect rent during the period described by the record and there is nothing to indicate or suggest that there was any likelihood that they would not continue to operate jointly if the leases should be forfeited. On the other hand, a forfeiture of the leases would merely result in the reacquisition by the lessors of real estate which had been enhanced in value by the erection of a building and not only would not effect the payment of rent past due but would in this instance eliminate all possibilities of subsequent collection of the rent items. The question as to whether gain is realized by a lessor upon repossession of its property where the lessee has erected a valuable building thereon is an entirely different question.

For the answer to the issue here we must look to the condition of the lessee corporation at the time of accrual and its prospects for the future. Prior to 1933 the lessee had apparently paid ground rents in full. It had become delinquent, however, with respect to real estate taxes and the interest on its bonds. At June 30, 1933, it owed real estate taxes as far back as 1928 and in the amount of $194,985.08, and by that time was in arrears with respect to ground rent in the amount of $16,666.67. There was accrued and unpaid bond interest in the amount of $267,480.23 and the books disclosed an operating deficit of $307,862.01. The existence of unpaid interest, although substantial in amount, is of no concern here. Regardless of whether or not under other circumstances the claim of the bondholders for the unpaid interest might be on a parity with the claim for ground rents, the claim of the bondholders was secured only by the lease and the building, and the existence of the right in the lessors to forfeit the lease and to take over the property, including the building, clearly put the lessors in the position of being preferred with respect to their claims for ground rent over the claims of the bondholders for unpaid interest. The bondholders recognized that fact in 1934, when they abandoned efforts to reorganize under the Bankruptcy Áct. Apparently unpaid real estate taxes had accrued to such an extent that by June 1, 1933, it was necessary to devote all" of the income over and above operating expenses and necessary maintenance charges to the payment of such taxes until they were paid. The facts show that the building was not producing over and above operating expenses and maintenance costs an amount sufficient to meet the current requirements for real estate taxes and ground rents. Accordingly, in order to avoid a loss of the property for taxes, it was necessary to apply such amounts as might otherwise be available for the payment of ground rents to the payment of taxes which had become due but were unpaid. If it was reasonable to assume that the profits would increase to the. extent that an excess over current requirements might be realized in the future, there would be no merit in the claim of the petitioner here. Prior to the taxable year, the lessors had agreed in May 1933 to permit the lessee to continue for the fiscal year ending May 31, 1934, even though it was delinquent in the payment of its ground rent, and to continue operations thereafter if the net income from operation's for that period was $95,000 or more, which amount would have been sufficient to meet current needs for taxes and ground rents and leave a small balance over. The profits realized were not sufficient in amount to equal current requirements, however, and a special committee composed of representatives of the two lessors and the lessee took over supervision of operations. At no time up to June 1, 1938, had the building produced an amount sufficient to meet its current requirements. The lessors had received nothing ■ with respect to ground rents since June 30, 1933, and on that date, as we have noted, there was already outstanding an unpaid balance of $16,666.67. It is true that by that time real estate taxes and the interest thereon had been paid in full up to and including the year 1934 and a substantial portion, if not all, of the taxes for 1935 had been paid, but in the meantime an additional $160,000 in ground rents had become due and remained unpaid. There had been an increase in operating profits, but there had been also a gradual increase in real estate taxes, and on June 30, 1938, one month after the operation of the building under supervision of the special committee was to come to an end, the Leiter estate, and presumably the Trude estate, served notice of default on the lessee. In face of such notice of default, the only ■ payment shown on delinquent ground rent was the amount of $1,000 paid to the Leiter estate on July 12, 1938.

Taking into consideration the financial condition of the lessee in 1934, when the rent here in question became due, and the prospective receipts from operation of the building for the future, as corroborated by the actual figures covering operations for some three years thereafter, it is our opinion, under decisions previously cited, that the claim of petitioner, that ground rents which became due and payable in 1934 should not be included in the income of the Leiter estate, should be sustained.

The remaining issue involves the deductibility by the Leiter estate in 1934 of $16,592.55 representing real estate and personal property taxes of the estate for that year. The portion of the stipulation relating to this issue is set out verbatim in the last paragraph of our findings of fact. An examination of the exhibits mentioned in that paragraph discloses that in 1934 the estate accrued real estate taxes in the amount of $178,201.21 and deducted that amount in its return for that year, but respondent allowed only $116,809.65 of the deduction taken, the latter amount representing the total of such real estate taxes for 1934 as .were paid by the estate in November 1935 and May 1936. According to the stipulation the estate, subsequent to such payments, has made payment of additional real estate and personal property taxes for 1934 in the amount of $16,592.55. This amount the petitioner contends was deductible by the estate in determining the net income distributable to the income beneficiaries. Despite the fact that the respondent has stipulated that “Said taxes paid over and above the taxes allowed reduce the petitioner’s share of the income of the Leiter estate $5,195.38 (being 31.3115% of said $16,592.55)”, and the fact that it is specifically determined in the deficiency notice for the 1934 deficiency that the Leiter estate keeps its books on the accrual basis, the respondent, on brief, urges that we should find that the amount is not deductible because of failure of the petitioner to prove a number of other facts not touched upon in thé stipulation. Suffice to say that, since the respondent determined that the estate kept its books on the accrual basis and all the evidence of record relating to the point is to the same effect and since the parties have stipulated that the taxes of $16,592.55 were for 1934 and that their payment reduced the petitioner’s distributable share of the estate income by $5,195.88 (31.3115 percent of said amount of taxes), we think the evidence of record is sufficient to sustain the conclusion that the amount of taxes in controversy was deductible by the estate in 1934 in determining its net income distributable to the beneficiaries and that the petitioner’s share of such income as determined by the respondent is to be reduced by $5,195.38. Accordingly the petitioner is sustained on this issue.

Decision will he entered, wnder Buie SO.


author: Black:

text:
    J. T. Sneed, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94400.
    Promulgated December 15, 1939.

      H. C. Pipkin, Esq., Chas. H. Keffer, Esq., and Harry C. Weeks, Esq., for the petitioner.

      Paul E. Waring, Esq., and Elizabeth B. Fegan, Esq., for the respondent.
   OPINION.

Black:

In our findings of fact, no emphasis is laid on the facts that petitioner was married in 1926, a portion of the lands leased was community property, his wife, Zella Sneed, died prior to 1936, and other related matters. The parties are in agreement that the Commissioner has given proper effect to these facts in his determination of the deficiency, if it is otherwise correct.

The petition, as we have already stated, contains only one assignment of error, to wit, that the Commissioner erred in restoring to petitioner’s income in 1986, depletion which, was deducted in 1926 from lease bonuses, where, upon the expiration of leases, there- had been no oil or gas production thereon. The petitioner, in pressing this assignment of error, raises several points which we think merit separate consideration and we shall take these points up in their order.

First, petitioner makes the broad general contention that the sums which respondent has restored to petitioner’s income for 1936 under the circumstances narrated in our findings of fact do not come within the definition of gross income contained in the Revenue Act of 1936 and that respondent’s regulations upon which he relies do not purport to require their inclusion as income.

Petitioner presents forceful arguments in his brief in support of these contentions. However, substantially the same arguments and reasoning were used in behalf of the taxpayer in Grace M. Barnett, 39 B. T. A. 864, and we rejected them. Petitioner urges that our decision in that case was wrong and that we should reconsider the whole question and reverse our position. We are not convinced that our decision in that case was wrong and so we adhere to it. We do not consider that it is necessary to repeat in this opinion the reasons which we gave for reaching our conclusions in the Barnett case. Inasmuch as we adhere to the same conclusions on the general proposition involved as we expressed in the Barnett case, we refer to the reasons which we gave in that case without restating them.

Second, petitioner, although questioning the ' soundness of our decision in the Barnett case, further contends that it is not controlling in the instant case because the facts in the instant case are distinguishable from those in the Barnett case.

Petitioner contends that although separate leases were made in 1926 covering separate tracts of land, nevertheless, since petitioner’s ranch was “one property” as defined in the Commissioner’s regulations, and since that property has sustained a substantial amount of depletion during the period 1926 to 1936, inclusive, from wells drilled on other leases located on the Sneed ranch, the petitioner is entitled to retain the benefit of all the depletion allowed to him in prior years. In other words, petitioner contends that he is entitled to an aggregate of percentage depletion allowance over the entire productive life of his property, equal to 2714 per centum of his gross income therefrom, and that the right to this does not depend upon the existence or nonexistence of any particular lease. We do not agree with this contention. Petitioner, in support of his contention, points out that the statutory language granting the depletion refers not to leases, but to property. The language is: “The allowance for depletion * * * shall be 27% per centum of the gross income from the property.”

Article 23 (m)-l (j) of Regulations 94, following substantially similar regulations under earlier acts, defines “the property” as follows:

“The property”, as used in section 114 (b) (2), (3) and (4) and articles 23 (m)-l to 23 (m)-19, inclusive, means tile interest owned by the taxpayer, freehold or leasehold, in any mineral property. The taxpayer’s interest in each separate mineral property is a separate “property”; but, where two or more mineral properties are included in a single tract or parcel of land,- the taxpayer’s interest in such mineral properties may be considered to be a single “property”, provided such treatment is consistently followed.

In order to better understand the meaning of the foregoing regulation, we think it will be well to consider article 23 (m)-l, (&), which defines the meaning of the, words, “mineral property” as follows:

A “mineral property” is the mineral deposit, the development and plant necessary for its extraction, and so much of the surface of the land only as is necessary for purposes of mineral extraction. The value of a mineral property is the combined value of its component parts.

We think paragraphs (b) and (j) of article 23 (m)-l, when construed together, mean that where a taxpayer is operating two or more separate mineral properties included in a single tract or parcel of land as a common enterprise, the two or more mineral properties may be considered as a single property. In Vinton Petroleum Co. of Texas, 28 B. T. A. 549; affd., 71 Fed. (2d) 420, the taxpayer was contending that it was entitled, under law and regulations similar to those quoted above, to combine the gross income from wells located on several different leases and compute the depletion deduction as if there were one single property. We denied this contention and held that the depletion deduction should be made with respect to each property separately.

Petitioner contends that in the Vinton Petroleum case, supra, there was no contention that the several tracts were part of one single tract, such as is present in the instant case in the Sneed ranch, that they were being operated by the taxpayer as one common enterprise. The facts show that Sneed was operating the cattle ranching business as one single business enterprise, but he was not operating any oil or gas wells at all. What he did do was to lease the land included in his ranch to various individuals and corporations by separate leases and received a separate bonus for each separate lease. In such circumstances we have heretofore treated each separate lease as a separate property.

See Allie M. Turbeville, 31 B. T. A. 283, at pages 292, 293. In that case, the taxpayer was the owner of the Copper Mine Ranch and leased the several tracts included in the ranch to various parties. Bonuses were received as well as agreement to' pay royalties from each separate lease. The taxpayer claimed percentage depletion on all the bonuses received. The Board granted percentage depletion on bonuses received from those leases where oil and gas had been produced during the taxable year and denied it as to those leases where there had been no production, following Lizzie H. Glide, 27 B. T. A. 1264. That was before the Supreme Court decided in Herring v. Commissioner, 293 U. S. 322, that percentage depletion was allowable on leasehold bonuses even where there had been no production during the taxable year. In the Turbeville case, the taxpayer argued that the Copper Mine Banch should be treated as one single property for the purpose of determining percentage depletion on the bonuses and that the several different leases should' not be treated as separate properties. Discussing the point raised by the taxpayer in that case, we said:

Kespecting leases made after the discovery of oil on the ranch but under which no production was obtained in the year the bonuses were paid, petitioner argues that an allowance for depletion should nevertheless be made since there was production from “the property”, being the whole ranch, which, it is stipulated, was one tract. With this we disagree. The term “the property” applies to the particular acreage covered by each of the several leases. [Citing Vinton Petroleum, Co., supra.]

While it is true that we were in error in the Turbeville case in denying percentage depletion on the bonuses where there had been no production from the particular leases during the taxable year, it was not because of our holding that the acreage covered by each separate lease must be treated as a separate property. It was because of the Supreme Court’s later decision in the Herring case. So far as the point we are now discussing is concerned, the Turbeville case still stands. It was in no way affected by the Supreme Court’s decision in the Herring case. Therefore, following the Turbeville and the Vinton Petroleum Co. cases, we hold against petitioner’s contention that all the tracts and parcels of land covered by the several leases must be treated as one single property because they are parts of the Sneed ranch.

Third, petitioner also contends that although the 26 leases involved in this proceeding had terminated without oil or gas having been produced therefrom, nevertheless, by virtue of production on other leases on his land (not here, involved) as well as by production on adjoining lands belonging to others, the leases in question have sustained depletion through drainage. “Therefore” says petitioner, “the percentage deductions granted petitioner in 1926 should not be restored to income in 1936, because the lands involved have been actually depleted though not by any oil or gas wells drilled on the particular leases.” We do not think the contention of petitioner on this point can be sustained.

The testimony shows that quite a number of producing wells, mostly. gas wells, have been drilled on lands which petitioner leased in 1926, and large amounts of commercial gas have been extracted therefrom. The Commissioner has not restored to petitioner’s income any of the percentage depletion deductions granted petitioner in 1926 by reason of bonuses received from these leases. These particular deductions not only remain deducted but petitioner is receiving percentage depletion deductions from the royalties which he receives annually from these wells, as he properly should. It is only in case of the leases which reverted to petitioner in 1936, without any production having been had thereon, and were surrendered to petitioner by their hitherto owners in that year, that the Commissioner has restored to income the depletion deductions granted petitioner in 1926. If the Commissioner’s action in this respect is sound from the point of view discussed by us in the Barnett case, supra, then we do not think the action of the Commissioner is affected by the fact that there has been some incidental drainage of gas from under the lands because of wells drilled on other leases adjacent to those involved in this proceeding.

Experts, who apparently were well qualified to testify on the subject, testified that by reason of gas production on petitioner’s ranch and the Panhandle Field in general, the gas pressure had been lowered on petitioner’s land and that this lowering of the gas pressure meant a diminution of the gas which underlies the ranch. By means of computations which these experts made, they reached the conclusion that the gas underneath the leases here involved had been drained off on an average of 11 percent between 1926 and 1936, inclusive, by production from adjoining lands including those of petitioner, and from the field in general.

We have no independent knowledge of our own on the subject and we have made findings of fact in accordance with the testimony of these experts. However, as we have already stated, these facts, in our opinion, should not affect our decision. Accepting as true that certain diminution of gas has actually occurred by drainage from wells on other properties, it has not occurred from any production on any of the leases here involved. Neither the revenue laws nor the regulations provide for a depletion deduction based on drainage from wells drilled on contiguous tracts. Depletion, we think, is the term commonly used to describe the exhaustion of natural deposits by the extraction and sale of a part thereof. Fundamentally, the depletion allowance is granted for the purpose of allowing a return of capital, tax free. With respect to the leases here involved, there had been no extraction of oil or gas up to the date of their surrender in 1936. Only by accepting petitioner’s theory that his entire ranch should be treated as one property could we grant his contention on this point. That theory we have rejected in Allie M. Turbeville, supra, on the authority of Vinton Petroleum Co., supra. Petitioner’s contention on this point is therefore rejected.

Eeviewed by the Board.

Decision will be entered u/nder Bule 50.

ARTTNDell and Van Fossan dissent.