author: Smith :

text:
    P-H Group, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98835.
    Promulgated March 19, 1941.

      Urban E. Wild, Esq., Milton Cades, Esq., and E. R. Cameron, C. P. A., for the petitioner.

      B. H. Neblett, Esq., for the respondent.
   OPINION.

Smith :

Considering the limited purpose for which the P-H Group was formed, the informal manner of its organization, its restricted business activities, and the absence of resemblance to corporations, we think that it lacked the essential features of an association taxable as a corporation.

The decided cases do not offer anjr uniform test for distinguishing-associations taxable as corporations from syndicates, joint adventures, trusts, partnerships, and other types of organizations. As stated in Morrissey v. Commissioner, 296 U. S. 344, 356:

* * * it is impossible in the nature of things to translate the statutory-concept of “association” into a particularity of detail that would fix the status of every sort of enterprise or organization which ingenuity may create. * * *

It is a question that must be determined on the facts and circumstances of each particular case.

Some of the “salient features” of the trust under consideration in Morrissey v. Commissioner, supra, which characterized it as an association, were that it was created and maintained as a medium for carrying on a business enterprise and sharing the gains; the trustee as a continuing entity held title to the property embarked in the undertaking; and there was centralized management, continuity of interests, and limitation of personal liability. Unquestionably the P-H Group embodied, more or less vagely, some of these features. It was organized and maintained for the purpose of making a profit, which was realized and shared by the participants, and was therefore a “business enterprise.” See Vernon J. Bert, Trustee, 34 B. T. A. 805; affd., 92 Fed. (2d) 491; Swanson v. Commissioner, 296 U. S. 362. It does not appear, however, that the P-H Group or any one acting for it ever acquired ownership of the shares of stock purchased on behalf of the individual members. Lee purchased the shares merely as agent for the other members and he never became the legal owner of the stock. Likewise, some of the certificates were issued to Owen and the others were endorsed to him but he acquired no legal title to them. He acted merely as agent for the members of the group. Apparently ownership of the shares remained in the individual group members, each owning a proportional undivided interest in the whole. Cf., in this respect, Commissioner v. Whitcomb Coca-Cola Syndicate, 95 Fed. (2d) 596, affirming 35 B. T. A. 1031.

Neither was there any centralized management of the business enterprise. No individual or group of individuals had any authority to purchase or sell any shares of stock for the group except as instructed by the group as a whole. The so-called officers of the group had no-general powers or authority and their duties were purely ministerial. Cf. Gibbs-Preyer Trust #1, 39 B. T. A. 492; affd. (C. C. A., 6th Cir.), 117 Fed. (2d) 619.

Although some of the members testified' that they did not consider that they had any personal liability beyond the amount of their subscription pledges, there was no expressed limitation of personal liability in their agreement and no apparent basis for the assumption that there was any such limitation. The facts in the instant case more nearly resemble those in Commissioner v. Whitcomb Coca-Cola Syndicate, supra, and W. S. Farish, 36 B. T. A. 1114, than any of the numerous cases cited' by counsel for the respondent in his brief. See also E. L. Cord, 38 B. T. A. 1372; Harry E. MacConaughey, 41 B. T. A. 408. As was held in those cases, we hold in the instant case that the P-H Group was not an association taxable as a corporation.

With this disposition of the principal issue, it is not necessary to. determine whether the petitioner is entitled to declare a value for its capital stock.

Decision of no deficiencies will be entered..

       the PH Geoup’s net worth at this time, by reason of the fact that you have paid $5,000.00 into the fund of $64,700.00, which is the total paid' in by the members of the Group.
      At this date the Group owns 16,503 shares of the Bacolod-Murcia Milling Company of Negros, Occidental, Philippine Islands. In addition to these shares there is a fund on hand on deposit in the Bishop National Bank of Hawaii at Honolulu amounting to approximately $2,000.00. This fund is held at interest and is the current working capital of the Group, and, of course, the amount changes from time to time as interest is received and expenses are incurred.


source: Caselaw Access Project

author: Hill:

license: Public Domain

text:
    Hugh Hodges Drilling Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94782, 99115.
    Promulgated March 20, 1941.

      Tom F. Carey, C. P. A., for tbe petitioner.

      J. E. Marshall, Esq., for tbe respondent.

       No lease, contract or assignment covering the Kicholson and Cary leases was offered in evidence, and we have found no facts pertaining to these leases. However, it would seem that any controversy between the parties involving these leases will be settled in principle by our decision in respect of the other leases.

   OPINION.

Hill:

The principal issue submitted for decision in this case involves the proper basis for determination of the amounts of taxable income derived by petitioner during thé years 1934 and 1935 from oil payments or interests in the production from oil and gas mining leases acquired by petitioner in consideration of the drilling of wells. Other questions arising in connection- with the main issue involve petitioner’s, right -to deductions for depletion, depreciation, and intangible drilling expense. .

In an, extended and detailed amendment to his original answer, respondent set up claims inconsistent-in many details with the computation of the deficiencies determined by him, and on brief has again changed his position in some respects. In his brief, respondent now contends that petitioner had a depletable interest in all of the leases or wells referred to in our findings of fact hereinabove, and must recover its capitalized costs of drilling and equipping the wells through depletion.

Petitioner’s contentions respecting the determination of taxable income and the recovery of costs are not uniform in respect of all the leases. As to some, petitioner concedes that it had a depletable interest; in others, petitioner contends that it had no depletable interest, and is entitled to recover costs through other methods, which will be referred to below.

As to the Buchanan, Burroughs, Davis, Knowles, Little No. 2, Little No. 3, Community No. 1, Pucker No. 8, Day-Koff, Hembree No. 1, Kicholson No. I, and Cary Nos. 4 and 5 leases, petitioner contends that it had no ownership in the oil and gas in place, but only the right to receive a fixed amount out of the proceeds of a portion of the oil produced by each; that its rights essentially were no more than those of a mortgagee; that as to these leases the amounts received from the so-called oil payments should first be applied against operating expenses incurred and paid in connection with the production of oil from which the payments were derived; that any amounts remaining should then be applied to the return of costs; in other words, that the amounts to be taken into gross income are only those remaining after deduction of expenses and costs.

As to the Davis lease, petitioner further contends that the assignment conveyed to it a fractional working interest - only as security for the payment of a specified sum of money. Substantially the same contention is made as to the Rucker No. 8 lease, and, in the alternative, that intangible drilling expense and depreciation sustained on drilling equipment should be deducted from gross income.

In respect of the Day-Roff lease, petitioner contends that, under its contract, it drilled and equipped a well for which it was to' receive a consideration of $75,600 net, payable out of oil from three-fourths of the seven-eighths working interest if, as, and when oil was produced, saved, and sold from the premises; that when the: full amount of the oil payment was paid out there should then vest in-petitioner an undivided three-eighths of the seven-eighths working interest and at that time petitioner would become a joint owner in the leasehold estate to such extent. Petitioner argues, therefore, that since the payments out of oil were wholly contingent, the amounts received from the “in oil payments” should first be applied to expenses and costs and only the excess over expenses and, costs constituted taxable income; further that the unreturned cost when the oil payment is finally paid out represents the cost to petitioner of its interest in the leasehold estate. In the alternative, petitioner says that if its interest in the Day-Roff lease was an interest in the leasehold, then petitioner is entitled to deduct intangible drilling expense, depletion, and depreciation on equipment.

As to the Hembree No. 1 lease, petitioner concedes that for the drilling of a well under its contract it acquired fifteen-sixteenths of the seven-eighths working interest until it had received $32,000 net, and seven-sixteenths of the seven-eighths working interest thereafter, and argues that it is entitled to deductions for depletion and intangible drilling expense.

In this connection, it is noted that both respondent and petitioner state in their respective briefs that for drilling the well on the Hem-bree No. 1 lease, petitioner acquired fifteen-sixteenths of the seven-eighths working interest until such interest netted $32,000, and seven-sixteenths of the seven-eighths working interest thereafter. However, the contract introduced in evidence recited that the owner of the lease agreed to assign and had assigned to petitioner an undivided fifteen-sixteenths of the seven-eighths working interest, and that it was understood by the parties that when the petitioner had received the sum of $32,000 out of the proceeds from the fifteen-sixteenths of the seven-eighths working interest, then petitioner should assign to the owner the seven-sixteenths of the seven-eighths interest. It seems apparent, therefore, that, if the fifteen-sixteenths of the seven-eighths working interest was first assigned, to petitioner, petitioner retained eight-sixteenths of such interest, and not seven-sixteenths, after it had assigned back to the owner seven-sixteenths of the seven-eighths working interest upon receipt in full of the $32,000 payment.

Petitioner admits that it is the owner of a depletable interest in the Jones-Brandenburg No. 1 and No; 3 leases, but says that it is entitled to deduct as expense its share of the intangible drilling costs. In respect of the Liddell lease, petitioner argues that it was the owner of an interest therein prior to the drilling of the wells, and is entitled to deduct intangible drilling expense and depreciation sustained on equipment. As to the Watson, Harris, and Harrod leases, petitioner contends that it is entitled to deduct intangible drilling expense from gross income.

Becent decisions of the Supreme Court of the United States, we think, have definitely established the basic principles applicable under the facts to the issues presented in respect of all of the oil and gas leases involved in these proceedings.

In Palmer v. Bender, 287 U. S. 551, the Court said:

It will be observed that the statute directs that reasonable allowance for depletion be made as a deduction in computing net taxable income, “in the case of * * * oil and gas wells, * * * according to the peculiar conditions in each ease.” The allowance to the taxpayer is not restricted by the words of the statute to cases of any particular class or to any special form of legal interest in the oil well. * * * The language of the statute is broad enough to provide, at least, for every case in which the taxpayer has acquired, by investment, any interest in the oil in place and secures, by any form of legal relationship, income derived from the extraction of the oil to which he must loolc for a return of his capital. [Italics supplied.]

Thomas v. Perkins, 301 U. S. 655, held that where oil and gas leases were assigned for a consideration payable partly in cash and an additional sum out of proceeds from the production of oil, such part of the proceeds from the production as was paid to the assignors was not taxable income to the assignees. It was further held that an assignor was entitled to deduct depletion from income received from his interest in the oil, and that an assignee was not entitled to deduct from income received from his share an allowance for depletion attributable to the assignor’s interest.

In Anderson v. Helvering, 310 U. S. 404, the facts show that the Oklahoma City Co. in 1931 entered into a contract for the conveyance of certain royalty interests, fee interests, and deferred oil payments in properties in Oklahoma to one Pritchard, acting for himself and one Anderson. The agreed consideration for the conveyance was $160,000, payable $50,000 in cash and $110,000 from one-half of the proceeds derived from oil and gas from the properties and from the sale of the fee title to any or all of the land conveyed. The Oklahoma City Co. was to have in addition a first lien and claim against “that one-half of all oil and gas production and fee interest * * * from which the $110,000” was payable. The Court held that the purchasers were taxable upon the gross proceeds from the oil production, notwithstanding their obligation to pay a part of such proceeds to the seller, for the reason that the seller had reserved an interest in the fee as well as an interest in the oil production, and was not required to look solely to the oil production for payment. Such reservation of an interest in the fee was considered similar to a reservation in a lease of oil payment rights together with a personal guarantee by the lessee that the payments should at all events equal the specified sum. It was further held that, in the interest of a workable rule, Thomas v. Perkins, supra, must not be extended beyond the situation in which, as a matter of substance, without regard to formalities of conveyancing, the reserved payments are to be derived solely from the production of oil and gas. In that connection, the Court said:

It is settled that the same basic issue determines both to whom income derived from the production of oil and gas is taxable and to whom a deduction for depletion is allowable. That issue is, who has a capital investment in the oil and gas in place and what is the extent of his interest. * * * The holder of a royalty interest — that is, a right to receive a specified percentage of all oil and gas produced during the term of the lease — is deemed to.have an economic interest in the oil in place which was depleted by severance. * * *
The holder of an oil payment right, as an original proposition, might be regarded as having no capital investment in the oil and gas in place. * * * Yet it does depend upon the production of oil, ordinarily can be realized upon only over a period of years, and permits of a simple and convenient allocation between lessor and lessee of both the gross income derived from production and the allowance for depletion. * * * Accordingly, this court in Thomas v. Perkins decided that the provision in the lease for payments solely out of oil production should be regarded as a reservation from the granting clause of an amount of oil sufficient to mate the agreed payments, and should be given the same tax consequences as a provision for oil royalties. * * * Similarly, the retention of a lien, if it were construed as a lien only upon the oil and gas production, and nothing more, would not make Oklahoma Company any the less dependent upon such production for payment of the amounts reserved.
The reservation of an interest in the fee, in addition to the interest in the oil production, however, materially affects the transaction. Oklahoma Company is not dependent entirely upon the production, of oil for the deferred payments; they may be derived from sales of the fee title to the land conveyed.

The principles enunciated in the foregoing decisions, so far as pertinent here, may be briefly summarized as follows: (1) A lessor or the owner of oil payment rights, who is required by the terms of the contract to look solely to the oil and gas or the proceeds from production for the agreed payments, has an economic interest in the oil and gas in place, is taxable upon the gross income derived from his interest, and is entitled to an allowance for depletion thereon. This rule is applicable in all cases where, as a matter of substance, without regard to formalities of conveyancing, the reserved or deferred payments are to be derived ¡solely from the production of. oil and gas. (2) The retention of a mortgage or other lien, if it be a lien only upon the oil and gas production, and nothing more, does not prevent application of the stated rule, since the owner of the oil payment is not thereby made any the less dependent upon the oil production for payment of the agreed amounts.

Without attempting to discuss in detail the provisions of the several drilling contracts and assignments in evidence in these proceedings relating to the leases involved, it seems apparent to us that all the leases come within the rules above stated. In some of them, as the consideration for drilling and equipping a well or participating therein jointly with the owner, petitioner acquired ownership of a fractional interest in the leaseholds; as to others, petitioner acquired an oil payment right, that is, the right to receive a specified sum out of the oil production if, as, and when oil was produced, saved, and sold.. Some of the drilling contracts contained words of assignment, while- in other cases separate assignments were executed. In some instances petitioner acquired an oil payment of an agreed amount, and also the ownership of a lesser undivided fractional interest in the leasehold thereafter. In some contracts it was stated that the assignment of the fractional interest was intended as security for the payment of the agreed amount. However, in respect of all of the leases involved, petitioner was required to look solely to the oil production for payment. While it is true, as argued by petitioner, that the owners agreed to pay specific amounts, as consideration for drilling the wells, yet the fact remains that the owner in each case agreed to pay only out of the oil if, as, and when produced. So far as disclosed by the record, in no instance was there a personal guarantee by an owner that the payments should at all events equal the specified sum. Nor is it shown in any case that petitioner was given a lien on anything other than the oil and gas production. In the contract covering the Davis lease it was affirmatively provided that there should be no personal liability upon the owner in respect of the oil payment, and a like intention of the parties, we think, may be fairly inferred from the provisions of the contracts relating to the other leases.

The right of petitioner to share in the oil produced under the various contracts and assignments constituted interests in the oil in place. Ortiz Oil Co., 31 B. T. A. 656; affd., 102 Fed. (2d) 508. Such interests represented capital investments, consisting of the costs and expenses of drilling and equipping the wells, which costs and expenses are not allowable deductions from current gross income, but are returnable only through deductions for depletion. United States v. Sentinel Oil Co., 109 Fed. (2d) 854; Dearing v. Commis sioner, 102 Fed. (2d) 91, affirming 36 B. T. A. 843; State Consolidated Oil Co. v. Commissioner, 66 Fed. (2d) 648; Nunn-Stubblefield Oil Co., 31 B. T. A. 180.

In two of the leases here involved petitioner acquired undivided fractional interests in the working interests until it had received specified amounts from oil production and lesser fractional interests in the leaseholds thereafter. These are the Day-Boff and Hembree No. 1 leases. Petitioner contends that the first undivided fractional interest in each such lease represented an “in oil” payment and that it acquired no interest in the oil in place until such payments had been made in full out of oil; hence, that it is entitled to deduct from gross income the amounts of its intangible drilling expenses and depreciation on equipment.

Petitioner’s contention on this point can not be sustained. In our opinion, petitioner did not acquire two separate and distinct interests in each lease, but acquired a single right measured by the two undivided fractional interests. Under the contract covering the Day-Boff lease such interest consisted of three-fourths of the seven-eighths working interest until $84,000 (later reduced by assignment to $75,600) had been received by petitioner,' and a three-eighths interest in the leasehold thereafter. Similarly, for drilling a well on the Hembree No. 1 lease, petitioner acquired fifteen-sixteenths of the seven-eighths working interest until such interest netted $32,000, and eight-sixteenths of the working interest thereafter. Cf. Kiesau Petroleum Corporation, 42 B. T. A. 69. In both cases, petitioner looked only to the oil to satisfy its contractual rights, and the costs and expenses of drilling the wells constituted the consideration paid by petitioner for those rights. Petitioner, therefore, is not entitled to deduct either intangible drilling costs or depreciation on equipment, which constituted component elements of its capital investment, returnable through depletion.

Petitioner makes substantially the same contention in respect of the Liddell lease, but based upon a different ground. Petitioner argues that it owned an interest in this lease prior to the drilling of the wells, and that, since it drilled the wells on land in which it owned an interest, it is entitled to deduct intangible drilling expense and depreciation on lease equipment.

The rule applicable on this point, we think, is correctly stated by the court in United States v. Sentinel Oil Co., supra. In that case it was held that expenditures made by the taxpayer in drilling a dry hole on land in which it owned an undivided interest were not deductible as a loss but constituted a capital investment, where it appeared that the consideration for the transfer of the undivided interest to the taxpayer was the taxpayer’s agreement to drill. Since the cost of drilling was the purchase price paid for the conveyance of the undivided interest in the land, and since tbe land was not worthless, it was held that no deductible loss had been sustained. The court pointed out that, in such a case, it was immaterial whether title to the undivided interest was not to pass until the owner or vendor had received a specified sum from the proceeds of the well, or whether the undivided interest passed to the purchaser upon execution of the contract. “In both cases the drilling expenditures were the consideration for the passing of title to the land.”

We can see no controlling distinction between the situation considered in the cited case, where the cost of drilling a well constituted the consideration paid for an undivided interest in the land, and the present case, where the cost of drilling constituted the consideration paid for an undivided interest in the oil production. In our opinion, the reasoning of the court compels application of the rule in both situations. ■

In respect of the Rucker No. 8 lease, petitioner states that this is the same property that is referred to as the “Hugh Hodges Drilling Co. No. 1” in the Board’s decision in I. A. O’Shaughnessy, Inc., Docket No. 98151 (memorandum opinion entered May 17, 1940). It appears that I. A. O’Shaughnessy, Inc., acquired by assignment one-half of petitioner’s interest in this lease, and in the decision of the Board just mentioned it was held that the petitioner there did not have a “capital investment in the mineral deposit which suffered depletion.” It was further held that the petitioner was not entitled to depletion, but to recover its costs from receipts, and was taxable on only the excess of such receipts over cost. Petitioner in the present proceedings urges that the same rule should be made here on the same property, now designated as Rucker No. 8. Our opinion in the O’Shaughnessy case was entered prior to the decision of the Supreme Court in Anderson v. Helvering, supra, and to the extent that it is in conflict therewith must be regarded as overruled. It will, therefore, not be followed here.

For the reasons indicated above, we hold, in respect of the 18 oil and gas mining leases set out or referred to in our findings of fact, that petitioner acquired in each an oil payment right, overriding royalty, or ownership of a fractional interest in the leasehold, representing an economic interest in the oil in place; that the respective amounts i*eceived therefrom during the taxable years constituted gross income to petitioner, upon which it is entitled to statutory allowances for depletion; that the consideration paid by petitioner for such interests consisted of the aggregate costs of drilling and equipping the wells, and constituted capital investments in depletable assets; and that hence petitioner is not entitled to deduct intangible drilling expense, cost of equipment, or depreciation on lease equipment sustained or incurred prior to completion of the wells.

Considerable discussion appears in briefs of both, parties concerning deductions allowable for depreciation and depletion, the differences between the parties arising mainly from their respective interpretations of the legal principles applicable under the facts. It is not apparent from the record that there is any serious controversy as to the proper method of computing such amounts, and, under the views expressed herein, neither the amounts allowed by respondent in determining the deficiencies, nor the amounts claimed by petitioner may be allowed in whole. In any event these are matters which may be settled properly under Rule 50, and they do not require consideration here.

Petitioner contends, finally, that the deficiencies in excess profits taxes were determined by respondent under an Act of Congress which is arbitrary and void, in that it is violative of the Fifth Amendment, to the Constitution. Sueh taxes were imposed by section 702 (a) of the Revenue Act of 1934. The validity of this and similar statutes has been sustained both by this Board and the .courts. See Chicago Telephone Supply Co. v. United States (Ct. Cls.), 23 Fed. Supp. 471; certiorari denied, 305 U. S. 628; Patrick McGovern, Inc., 40 B. T. A. 706; Brockway Glass Co., 43 B. T. A. 267.

The deficiencies in controversy will be redetermined in accordance with the foregoing opinion.

Decisions will be entered under Rule 50.


text:
    Henry Mill & Timber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98284.
    Promulgated March 20, 1941.

      A. E. Blair, Esq., and George J. Busch, G. P. A., for the petitioner.

      B. M. Goon, Esq., for the respondent.
   OPINION.

Hill:

This proceeding is for the redetermination of a deficiency-in income tax for the year 1936 in the amount of $536.88. The sole issue submitted for decision is whether or not petitioner is entitled, under section 26 (c) of the Revenue Act of 1936, to a credit of at least the amount of its adjusted net income for purposes of computation of the surtax on undistributed profits.

Petitioner is a corporation, organized under the laws of the State of Washington, with its principal office at Tacoma. It filed its income tax return for the year 1936 with the collector of internal revenue for the district of Washington, disclosing a net loss of $2,104.37, and no income tax was paid. Petitioner’s balance sheet at December 31,1936, indicated an operating loss for the taxable year in the amount of $2,169.87, but in computing the deficiency, respondent made certain adjustments to income, not in controversy here, which resulted in a taxable net income of $3,485.23, instead of the net loss reported on ¡petitioner’s return. In the determination of surtax liability, respondent allowed no dividends paid credit or credit for contracts restricting payment of dividends under section 26 (c), supra, resulting in an adjusted undistributed net income of $3,170.27.

Petitioner’s capital stock consisted of common, preferred, and prior preferred shares, and at all times material here, one-half of the common and preferred stock was held by W. Yale Henry, president of petitioner, and his wife or members of his family, and one-half was held by the estate of John C. Buchanan. The prior preferred stock was held by the Henry interests and others, none being owned by the Buchanan interests.

Prior to the taxable year, a controversy arose between the Henry and the Buchanan interests respecting the making of further capital investments in petitioner’s mill, the Henry stockholders opposing the making of any such additional expenditures, while the Buchanan interests desired to make further improvements. At a meeting of the stockholders held on December 12,1935, a compromise was reached under which it was agreed that petitioner should borrow $85,000 from a bank and that the fund should be expended for certain specified purposes, as set out in the minutes of a stockholders’ meeting reading as follows:

Present: W. Yale Henry and John F. Buchanan. Paul Billings, one of the executors of the estate of John C. Buchanan, deceased, was also present. Mr. Henry represented Adeline S. Henry, his wife, a substantial holder of common stock and also a preferred stockholder.
Mr. Henry outlined the policy proposed by the stockholders to be carried out in view of the fact that the Company had negotiated a present loan aggregating $85,000.00 from The National Bank of Tacoma, of which $70,000.00 is to be presently advanced, inclusive of the present indebtedness of the Company to the Bank, and $15,000.00 is to he advanced within six months. Mr. Henry’s statement was as follows:
The $85,000.00 is to be apportioned approximately as follows:
Taxes due-----$26, 000. 00
Bills due- 12,000. 00
Logs due- 12,000. 00
Bank loan in force- 18, 500. 00
Repairs and improvements- 13; 000. 00
The item of $13,000.00 is to he divided approximately as follows: Approximately $2,500.00 to renew the crane track, with ties and rails; approximately $4,500.00 to repair the bulkheads on the north and west fronts of the mill property; approximately $7,000.00 to install Simondson Turner and extend carriage track; these improvements probably to be in 1936.
It is understood that the retirement plan of the Company shall he along a line permitting the necessary action to be taken in order to, as soon as possible, put the Company in a position to pay dividends from earnings, with the understanding that these surplus funds shall first be used toward making the necessary retirement according to the terms of the mortgage. Net earnings over and above this shall be divided approximately as follows: First, the interest on the prior preference stock shall be paid, the remaining surplus to be divided equally, one-half going to retire prior preference stock and the other half going to the further retirement of the mortgage. When the prior preference issue is retired, the same procedure shall apply to the preferred stock.
It is understood that after the consummation of the above repair and improvement program, there will be no further capital investment in the plant, except as Mr. Henry and Mr. Buchanan are agreed otherwise.
The stockholders will cause to be set up certain accounts on the books so that at all times they may know the distribution of the money under this mortgage.
There being no further business to come before the meeting, it was adjourned.

Petitioner negotiated a mortgage loan of $85,000 from the National Bank of Tacoma, the mortgage and note each bearing the date of December 12, 1935. Neither the mortgage nor the note contained any provision restricting the payment of dividends or disposition of earnings by petitioner, but did provide for the payment of $6,000 on account of principal on August 1, 1936, in addition to interest!

- Petitioner contends that the agreement of the stockholders embodied in the minutes of their meeting, above set out, constituted a written, contract of the corporation with its stockholders and the mortgagee, executed prior to May 1, 1936, expressly dealing with the payment of dividends and the disposition of earnings and profits of the taxable year and prohibiting the payment of any dividends in 1936, by reason of the fact that the amount of earnings otherwise available for the payment of dividends in that year was less than the amount required by the contract to be applied upon the mortgage debt. Petitioner argues, therefore, that such agreement comes within the provisions of both subdivisions (1) and (2) of section 26 (c), quoted above.

Petitioner’s contention that the mortgagee was a party to the so-called agreement is wholly unsupported by the record,. John F. Buchanan, vice president and secretary of petitioner in 1935, who signed the minutes of the stockholders’ meeting, testified that one Hayden, who was attorney for petitioner, for the bank, and for the Buchanan estate, was present at the stockholders’ meeting, but that he was acting more as a referee between the two factions of stockholders as to what should be done with the mortgage money, how dividends should be paid, and what capital investments should be made.. The witness further stated that there was no one at the stockholders’ meeting, other than Hayden, to insist on behalf of the bank what action should be taken. No other witness testified on this point.

In support of its contentions, petitioner cites a number of decisions by state courts holding that the minutes of the directors of corporations constituted a contract, or a written instrument, or a promise in writing to pay an obligation, in connection with questions involving the application of statutes of limitation or the statute of frauds. These, cases obviously are not in point.

The question here is whether or not the action of the stockholders of petitioner, as recorded in the minutes of their meeting, constituted “a written contract” within the meaning of the Federal taxing act. We think it did not. The stockholders were the beneficial owners of the corporation, and whether or not the corporation can be said to have been a party to the stockholders’ agreement and bound thereby is wholly immaterial. The action taken was purely unilateral; the interest of the stockholders was the interest of the corporation ; no party having an adverse interest was involved. The creditor bank was not a party, and did not require such action as a condition to the making of the loan. The agreement merely evidenced the compromise of the conflicting views of the two groups of stockholders respecting distribution of the borrowed funds and the policy to bo pursued by the corporation as to dividends. Such policy might have been changed at any time by further agreement of the stockholders. It was not a legally enforceable contract which the corporation through its stockholders could not revoke.

Respondent’s Regulations 94, issued under the Revenue Act of 1936, provides in article 26-2 (b) that the credit authorized bisection 26 (c) (1) is allowable only with respect to a written contract (1) executed by the corporation prior to May 1, 1936, which (2) expressly deals with the payment of dividends, and (3) operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. This regulation, we have held, is reasonable, and correctly interprets the statute. Honokaa Sugar Co., 43 B. T. A. 151. The same rule likewise must apply to subdivision (2) of section 26 (c). upon which petitioner also relies.

In Thibaut & Walker Co., 42 B. T. A. 29, which involved facts substantially similar to the present case, we said at page 31:

Congress intended to give a credit to a corporation only wliere the corporation had bound itself not to pay a dividend. This is reasonably clear from the language of the section. The legislative history indicates that Congress was trying to relieve situations in which a corporation had contracted with creditors to retain its earnings for their protection, but did not have in mind contracts such as this one, entered into by parties inside the corporate group to refrain from declaring dividends for their own mutual benefit.

In the absence of a contract which meets the requirements of section 26 (c), it is immaterial that petitioner didi in fact pay $6,000 on its indebtedness during the taxable year, which amount was in excess of its adjusted net income for computation of surtax on undistributed profits. Hub Clothing House, Ltd., 39 B. T. A. 900.

The deficiency determined by respondent is approved.

Decision will be entered for respondent.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case óf a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      # * * * * * *
      <c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS.-
      (1) Prohibition on payment of dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 3, 1936, which provision expressly deals with the payment of dividends. * * *
      (2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written ■contract executed by the corporation prior to May 1, 1936, which provision expressly ■deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount ■equal to a percentage of earnings and profits shall be considered a requirement to pay .or set aside such percentage of earnings and profits. * * *


author: Opper :

text:
    A. E. Levit, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of Leo J. Clayburgh, Deceased, Virginia A. Clayburgh, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent. Virginia A. Clayburgh, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99651, 99875, 99937.
    Promulgated March 21, 1941.

      Lloyd 8. Ackerman, Esq., and Philip 8. Mathews, Esq., for the petitioners.

      E. A. T on jes, Esq., for the respondent.
   OPINION.

Opper :

It has been frequently asserted that solution of the question presented here — whether a distribution in partial liquidation is such in time and manner as in substance to approximate a dividend — must rest upon the particular facts of each individual case. E. M. Peet, 43 B. T. A. 852. It is thus of less than the usual value to attempt an extended discussion of the precedents. Even the general rules established are no more dispositive than the language of the statute itself.

All that may be, done is to examine with care the circumstances surrounding the transaction for the purpose of determining the extent of essential equivalence, which is the only test the statute describes. It is sometimes urged, as petitioners do here, that our attention should be focused on the original issuance of the stock and not on its redemption, so that if we can find no scheme or plan relating the two, the equivalence must be absent without further investigation. See Patty v. Commissioner (C. C. A., 2d Cir.), 98 Fed. (2d) 117. Even this helpful simplification of the problem, however, is unacceptable, since the rule of the Patty case has been found to be too broad for adoption by other courts or by this Board. See e. g. Annie Watts Hill, 27 B. T. A. 73; affd. (C. C. A., 4th Cir.), 66 Fed. (2d) 45; L. B. Hirsch, 42 B. T. A. 566; J. Natwick, 36 B. T. A. 866; Flanagan v. Helvering (App. D. C.), 116 Fed. (2d) 937; E. M. Peet, supra.

One of the tests which is more favored is whether the redemption was apparently dictated by the reasonable needs of the business or whether, on the other hand, it originated with or was designed for the benefit of the stockholders who received its fruits. W. & K. Holding Corporation, 38 B. T. A. 830; Flanagan v. Helvering, supra. Cf. Henry B. Babson, 27 B. T. A. 859; affd. (C. C. A. 7th Cir.), 70 Fed. (2d) 304; certiorari denied, 293 U. S. 571; Bona Allen, Jr., 41 B. T. A. 206. It is true that most, if not all, of the cases applying that test have found other circumstances as well to support the result. But essentially we think the test applicable by its own weight and that if applied it will be decisive of the present controversy.

Without reiterating in detail the circumstances surrounding the redemption, which appear fully in the findings of fact, it is we think sufficient to quote here a portion of petitioners’ proposed findings which seem to us to summarize fairly the immediate background of the transaction:

* * * there was considerable apprehension on the part of the Clayburghs [petitioners] with respect to the large indebtedness of Mr. Clayburgh to the corporation representing monies loaned to him over a period of years, only a part of which had been repaid. (Stip. par. xvi) This presented a constant threat to Mr. Clayburgh’s investment which Mr. Ackerman [the Clayburghs’ lawyer] felt should be eliminated and resulted in his proposal that Leo J. Clayburgh surrender sufficient preferred stock to satisfy this indebtedness.
After further negotiations a plan was evolved which * * * provided first for the redemption of 25% of the outstanding preferred stock, the redemption price to be applied first in each case to the satisfaction of the stockholder’s indebtedness to the company, * * *

It thus appears that the initiative for the redemption in question originated with the stockholders who were to receive the distribution ; and that its purpose was primarily to benefit them by furnishing a means of paying off their debts to the corporation.

Petitioners’ proposed findings also assert that “in determining the amounts of the reduction to be made in the preferred stock there was taken into consideration the amount of capital required by the business as well as the amounts necessary to discharge the indebtedness of stockholders to the corporation.” This may be so as far as it goes, but an examination of the record demonstrates that the consideration given to the needs of the business was a negative and not an affirmative factor. There is nothing to indicate that those actively interested in the corporation’s management were proponents of the redemption plan. Their concern was merely to safeguard the venture by assuring that the plan, if agreed to, would not unduly weaken the corporation’s capital structure. This supplies the distinction from such cases as Bona Allen, Jr., supra.

If the indebtedness, which struck the stockholders as so precarious that a means should be found to pay it, had been merely forgiven by the corporation, it is clear a taxable dividend to the stockholders would have been the result. Allen v. Commissioner (C. C. A., 1st Cir.), 117 Fed. (2d) 364. And cf. William C. Huntoon, 14 B. T. A. 459. That course was impossible here for two reasons. The first was that the debtor stockholders were not the only interested parties. Any plan designed to cancel the indebtedness had at the same time to preserve the interests in the corporation of all of the stockholders in their proper proportions. This result the pro rata redemption of the preferred stock accomplished. The second difficulty was that there was at the time no surplus available for distribution. This, however, was due in part to an earlier capitalization of earnings, which took the form of a reorganization of a predecessor company, “the effect” of which, as petitioners observe in their brief “is recognized to be the same” as a stock dividend. And see Commissioner v. Sansome (C. C. A., 2d Cir.), 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667. This absence of available surplus could be overcome, as it was, by reversing the process of capitalization and freeing the captured earnings for distribution to the stockholders by means of redeeming the stock which had originally capitalized them.

Both of the factors, therefore, which characterized the plan in its final form were those which are familiar in situations of this kind, and which emphasize rather than dim the aspect of a dividend. That the distribution was pro rata to the stockholders is one of the characteristics of cases found to fall within the section. See 49 Harvard Law Review, 134T. And that a taxable distribution may involve a reversal of the process of capitalization of earnings is a possibility which the parenthetical phrase at the opening of the section itself recognizes. Giving full weight to the origin, purpose, and development of this redemption, we think the circumstances as a whole bring it within the terms of section 115 (g) and that it was, considering its time and manner, essentially equivalent to the distribution of a taxable dividend. J. Natwick, supra; L. B. Hirsch, supra; William C. Huntoon, supra; Flanagan v. Helvering, supra.

It is true there were other phases of corporate action taken at the same time which were quite clearly dictated by the necessities of the corporation’s position. Elimination of the cumulative provision of the preferred stock, renunciation by the stockholders of the accumulated preferred dividends, and reduction of a nonessential salary item fall into that category. But none of these steps was connected, except indirectly, with the stock redemption. They could have been accomplished! without it and by themselves they would not have achieved the purpose sought by redeeming the stock. It is that phase of the entire transaction with which we are concerned and as to that the other aspects mentioned are insufficient to overturn the considerations already discussed.

Decision will be entered under Rule 50.

       SEC. 115. [Act 1936.] DISTRIBUTIONS BY CORPORATIONS.

      (g) Redemption op Stock. — If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at, such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

       The witness Epstein, manager and moving spirit of the corporation, testified on cross examination:
      “The part of the plan was to — the consideration was that by doing this we would accomplish the liquidation of the monies that were owed by the parties mentioned.”


author: Leech :

text:
    Samuel Goldwyn Incorporated, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent. United Artists Studio Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 100768, 100786.
    Promulgated March 21, 1941.

      Mark Eisner, Esq., for the petitioners.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

Leech :

In this proceeding the petitioner, Samuel Goldwyn Inc., Ltd., admits transferee liability in respect of any deficiency that may be determined against the petitioner, United Artists Studio Inc. The word “petitioner” as hereinafter used refers to the latter. Respondent has determined a deficiency of $4,055.82 in petitioner’s personal holding company surtax for the fiscal year ended June 30,1936, and a penalty of $1,013.96. The issues are whether petitioner is entitled to deduct $16,600 from its adjusted net income as an amount used to retire indebtedness incurred prior to January 1,1934, under section 351 (b) (2) (B) of the Revenue Act of 1934, and whether petitioner is liable for the penalty imposed under section 406 of the Revenue Act of 1935 for failure to file its return within the time prescribed by law.

The cases, duly consolidated, were submitted on a lengthy stipulation of facts which is hereby adopted as our findings of fact. Only such facts as are necessary to a decision will be referred to herein.

In December of 1933, Twentieth Century Pictures, Inc. (hereinafter referred to as Century) and Samuel Goldwyn became interested in buying all the stock of the United Artists Studio Corporation, Ltd. (hereinafter, referred to as Studio Corporation). On December 7, 1933, Century executed purchase contracts with all the stockholders of the Studio Corporation except Samuel Goldwyn, Inc. A contract with the latter as of December 7, 1933, was executed on April 27, 1934. By the terms of these contracts, the purchase price was to be paid partly in cash and partly by deferred payments represented by promissory notes maturing at various times in 1934. By another agreement dated December 7, 1933, Century and Samuel Goldwyn agreed that the purchases would be for the joint account of both, that each would pay one-half of the price, and that each would have a 50 percent interest in the stock so acquired.

At the start of the negotiations between Century and Samuel Goldwyn it was contemplated that a corporation would be formed to take over the stock of Studio Corporation and to carry out the agreements of purchase. On May 18, 1934, petitioner corporation was organized under the laws of the State of California. Its stock was issued to Century, Goldwyn, and one Giannini. By appropriate resolutions and transfers, petitioner acquired rights and title to all the stock of the Studio Corporation and became bound to pay all indebtedness incurred by Century; and Goldwyn on account of the stock purchase contracts. The resolution by which petitioner became obligated- on the indebtedness of Goldwyn and Century was adopted on June 15, 1934.

During the fiscal year ended June 30,1936, petitioner received from the Studio Corporation a dividend of $16,924.25, which was the only income received by petitioner during that fiscal year. After its receipt, petitioner paid out $16,600 on the notes which it had given pursuant to its agreement to assume the indebtedness of Goldwyn and Century.

On June 29, 1934, Samuel Goldwyn sold and conveyed, with the consent of Century, to his wholly owned corporation, Samuel Goldwyn Inc., Ltd., his interests in the agreement which he had entered into with Century. On August 22,1935, Samuel Goldwyn Inc., Ltd., acquired from Century all of the latter’s stock of the Studio Corporation, and from and after that date more than 50 percent of the outstanding stock of petitioner was owned directly or indirectly by or for not more than five individuals during the taxable year ended June 30, 1936.

On February 9,1937, all the assets of petitioner were transferred to and all of its liabilities were assumed by Samuel Goldwyn Inc., Ltd., in exchange for capital stock and petitioner was dissolved.

The officers of petitioner believed that it was not liable as a personal holding company for the reason that its stock was wholly owned by a corporation having an extensive business in the production of motion pictures. They did not consider the fact that, inasmuch as Samuel Goldwyn Inc., Ltd., had no more than five stockholders, the status of petitioner would be that of a personal holding corporation. At the same time the officers of petitioner believed that the payment of $16,600 on account of indebtedness was payment on an indebtedness of petitioner incurred prior to January 1, 1934. Predicated upon the foregoing misunderstanding as to the ownership and belief as to indebtedness, no return Form 1120-H was filed.

On April 8, 1940, petitioner filed with collector of internal revenue at Los Angeles, California, a return for a personal holding company on Form 1120-H, covering the taxable year ended June 30, 1936.

The first issue is whether petitioner is entitled to a deduction from adjusted net income for amounts used to retire indebtedness incurred prior to January 1,1934. The applicable statute, section 351 (b) (2) (B) of the Revenue Act of 1934, reads as follows:

(2) The term “undistributed adjusted net income” means the adjusted net income minus the sum of:
* ♦ * * * * *
(B) Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934 * * *

The dispute between the parties in its essence is whether the indebtedness here involved was incurred prior to January 1, 1934. As we understand it, petitioner’s position is that petitioner’s indebtedness was a mere continuation of indebtedness incurred by Goldwyn and Century in December of 1933 and that the deduction is hence allowable.

We think there is no merit in petitioner’s contention. The concept of indebtedness is inextricably associated with a particular obligor— an obligor that here must occupy such legal status prior to a certain date. Section 851 imposes a surtax upon the undistributed adjusted net income of every personal holding company. “Undistributed adjusted net income” is defined as above set out. We think the conclusion inescapable from the statutory language that the indebtedness must have been incurred prior to January 1, 1934, by the taxpayer, i. e., the personal holding company. The statutory language and the use of a critical date would otherwise be devoid of meaning.

The record here is clear that this taxpayer incurred no indebtedness until June 15,1934 — indeed that it was not even in existence until May of that year. The only indebtedness incurred prior to January 1, 1934, was that of two taxable entities entirely separate from petitioner, namely, Goldwyn and Century. In Sim Pipe Line Co., 42 B. T. A. 1413, we pointed out that the way to give effect to the statutory date and to effectuate the Congressional intent is to deny “credit to indebtedness which is new in an economic sense to the taxpayer.” The present indebtedness was new in every sense of the word to this taxpayer. We think the contested deduction must therefore be disallowed. Especially is this so in view of the well-known requirement of strict compliance with statutory provisions permitting deductions. New Colonial Ice Co. v. Helvering, 292 U. S. 435.

The second issue is 'whether petitioner is subject to the penalty imposed by section 406 of the Revenue Act of 1935 for failure to file a personal holding company return within the time prescribed by law. By its terms, section 406 applies wherever the 25 percent penalty is imposed by existing law. Existing law, or section 291 of the Revenue Act of 1934, provides that if a return is filed late, the penalty must be imposed unless it is shown that the failure to file was due to reasonable cause. No explanation reasonable to us has been offered. The reasons given for late filing merely reduce themselves to a plea of ignorance of law. The record shows that petitioner waited until after the issuance of a notice of deficiencies before lodging its return. No reasonable excuse is shown for this long delay and the penalty must be imposed. Cf. Ardbern Co., Ltd., 41 B. T. A. 910.

Decisions will be entered for the respondent.


author: Kern :

text:
    Fontana Power Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99767.
    Promulgated March 21, 1941.
    Georgei Hellyer, Esq., and Jamies W. Bontems, G. P. A'., for the petitioner.

      Samuel Taylor, Esq., for the respondent.
   OPINION.

Kern :

In the original petition filed with this Board the taxpayer claimed that the amounts paid to the Water Co. under the agreement were deductible as “rentals or other payments” within the meaning of section 23 (a) of the Kevenue Acts of 1934 and 1936. Petitioner has apparently abandoned that theory, and properly so, inasmuch as title to the properties conveyed was passed to the taxpayer, whereas section 23 (a) applies only to properties to which the taxpayer has not or is not taking title or in which he has no equity. Petitioner, however, does assert that the payments to the Water Co. should be considered as analogous to the payments of Maryland and Pennsylvania ground rents, which, if the ground rent is irredeemable, should be deductible to the extent they constitute a proper business expense pursuant to the general language of section 23 (a) and without regard to the specific clause having to do with rentals. This ingenious argument is without validity. The contract does not call for the payment of ground rents. It provides for a method by which a purchase price for the property granted to petitioner may at some future time be determined if the parties should choose to do so, and, pending such determination, provides for payment to the grantors, who held all of petitioner’s stock (with the exception of qualifying shares), of all: of petitioner’s net earnings. We are not disposed to construe such a contract, executed in California by California corporations and having as its subject matter California real estate, in a way which introduces into that commonwealth the feudal relics of real property law which have happened to survive because of historical reasons in the two states of Pennsylvania and Maryland. We are equally unwilling to draw analogies in any interpretation of the revenue laws from “distinctions spun out of the tenuosities of surviving feudal law”, to use a phrase of Mr. Justice Frankfurter in his opinion in Helvering v. Hallock, 309 U. S. 106.

By amendment to bis original petition, tbe taxpayer now makes the further claim that the amounts in controversy are deductible as interest payments by virtue of section 23 (b). It appears from the stipulation filed in this proceeding that the Water Co. has been held by the Bureau of Internal Revenue to be exempt under section 101 of the Revenue Acts of 1934 and 1936 from income and capital stock taxation, but petitioner has not claimed exemption under section 101 (14); nor could such a claim be sustained had it been advanced. The issue before us is whether the disputed payments must be called interest payments or distribution of profits in the nature of dividends.

Both parties to this proceeding have cited numerous cases in their briefs in support of their respective contentions. The cited cases do not lay down any comprehensive rule which may be applied in all cases; and in each proceeding of this nature it must be determined on the facts presented whether the real transaction was that of an investment in the corporation or a loan to it. Proctor Shop, Inc., 30 B. T. A. 721; affd., 82 Fed. (2d) 792. On this question the designation of the instrument and the terms therein incorporated, while not to be ignored, are not conclusive. I. Unterberg & Co., 2 B. T. A. 274. The real intent of the parties is to be ferreted out and for this latter purpose evidence aliunde the contract is admissible. Proctor Shop, Inc., supra. In a majority of the cases of this nature which have come before this Board the instrument issued by the corporation has been some form of stock certificate. In the instant proceeding the provision for payment of petitioner’s earnings to the Water Co. is not found on the capital stock certificates, but in the same agreement under| which petitioner issued the 100 shares of capital stock to the Water Co.

The Water Co. advanced properties and property rights to the petitioner. It was not money which was advanced, but assets which had a monetary value. Had the Water Co. wanted to treat the transaction merely as a loan, with a definite annual income, in the nature of interest, from the transaction, it could have demanded a certain fixed payment from the petitioner each year until a certain fixed date, when the principal should become unconditionally due. The value of the properties transferred was, however, not agreed upon at the time of the transaction.

Let us look at petitioner’s condition at the time of the transaction. It had a charter and an option to purchase certain piping, but these appear to have been its sole assets. It was desirous of securing a franchise and for this purpose needed the assets which the Water Co. transferred pursuant to the agreement in question. It, in turn, borrowed from the bank in order to purchase and erect the building, pipe lines, etc., on the properties, and, in exchange for this loan, issued $350,000 worth of 6 percent first mortgage bonds. The bonds were specifically secured by all the interest of petitioner in and to any of its properties held at that time, or property interests to be acquired in the future, including the benefits to be received from a 30-year lease which petitioner made with the Edison Co., under which all its properties were turned over for that term to the Edison Co.

The basic transaction was the one between the Fontana Co. and Water Co. and petitioner. Unless petitioner could have acquired some assets to start with, it would not have been able to carry out either of the other two transactions. The president and treasurer of the Water Co. and the Fontana Co. had become the president and treasurer of petitioner. To say that all three corporations were on friendly terms would be a gross understatement. The central management thought of the newly formed corporation merely as another source of profit. By the issuance of the 100 shares of capital stock (the entire (issue except for the qualifying shares), the other two corporations secured control over petitioner’s profits and were assured of an 8 percent annual dividend on the stock. No amount equivalent to the value of the properties transferred could have been paid in cash by petitioner at that time, inasmuch as it had neither cash nor unpledged assets; nor could it ever be paid in the future if the Water Co. held petitioner to the terms of the agreement, because so long as the annual net income had to be paid over to the Water Co. the petitioner never could amass cash or free assets with which to repay the Water Co. at any time for the propei’ties transferred. If there were no profits in any year, then the Water Co. and the Fontana Co. would get nothing. If the profits were enormous, then the Water Co. and the Fontana Co. would get them all. The Water Co. chose to gamble. The mere fact that the aggregate net income paid over to the Water Co. approximates in amount legal interest on the unpaid balance of a loan estimated at ' $350,000 is merely coincidental. The transaction was strictly an investment from 1916 up to and including the taxable years.

As we said in Bakers’ Mutual Cooperative Association of Newark, New Jersey, 40 B. T. A. 656; affd., 117 Fed. (2d) 27:

* * * a creditor is one who has loaned money or its equivalent to his debtor, the contract giving the creditor not only the unconditional right to demand payment of the principal sum at a definite maturity date, but usually, also, the right to demand, and receive, compensation for its use or retention, i. e., interest. A stockholder, on the other hand, is one who risks his money in an enterprise, participates in its profits and management, shares its losses, and is entitled to receive an aliquot portion of its assets in the event of liquidation. Northern Fire Apparatus Co., 11 B. T. A. 355; Elko Lamoille Power Co., 21 B. T. A. 291; affd., 50 Fed. (2d) 595.

It may be true that the agreement of 1916 indicated a possibility of the creation of a debtor-creditor relationship and the method to be followed if such a relationship were to be created in the future, but the mere existence of this possibility, which was never fulfilled, can not affect our conclusion that, in reality, during tbe years in question the relationship of the Water Co. to petitioner was that of an investor and not that of a creditor.

Certain other factors lend further weight to this conclusion. From the facts it appears that in all the years from 1917 until the present time there was no attempt made to agree on a valuation of the properties and thus carry out that clause of the agreement and the order of the Railroad Commission of California which provided for payment of principal. We must assume that the reason for this was that, since the Water Co. during the years in question was the sole stockholder, that company and the petitioner were satisfied with an arrangement whereby all the profits went to the Water Co. under the agreement, and were not interested in creating any debtor-creditor relationship.

That part of petitioner’s argument to the effect that the annual payments by petitioner were payments of interest which is based upon a supposed analogy to Pennsylvania and Maryland ground rents is no more convincing than its argument based on the same analogy to the effect that these payments were ordinary and necessary business expenses, the fallacy of which we have already discussed.

Neither are we impressed by petitioner’s argument that the payments involved here, made by petitioner to its stockholders for so many years, can not be considered as distributions in the nature of dividends because (1) they were made pursuant to a contract and not pursuant to the rights of the payees as stockholders, and (2) the distributions consisted of the net earnings and not the surplus profits technically available for dividends. We are persuaded that the contract was executed and the distributions were made for so many years pursuant thereto because the Fontana Co. and/or the Water Co. were the holders of all of the stock of petitioner (except qualifying shares). It was because of this latter fact that the arrangement proved so permanently satisfactory to petitioner’s controlling stockholders, and if we are to recognize the realities we must conclude that the ultimate reason for the distributions made to the Fontana Co. and/or the Water Co. was because, for all practical purposes, they were the sole stockholders of petitioner. As to them, by the peculiar arrangement present in this proceeding, it made little difference whether the distribution consisted of petitioner’s net earnings or surplus profits. By the contract which they imposed on their wholly owned subsidiary they were entitled to the former. Without the contract they would have been entitled to the latter. The amount to be received by them would be the same. The practical effect of the transactions was to distribute an amount equivalent to the net profits of petitioner to its stockholders.

We conclude that the payments made by petitioner to the Water Co. according to the agreement in the taxable years were distributions in the nature of dividends, and, accordingly, were not payments of interest, or ordinary and necessary business expenses.

Decision will be entered for the respondent.


text:
    Robert J. Harbison, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101326.
    Promulgated March 21, 1941.

      H. A. Mihills, O. P. A., for the petitioner.

      Bernard D. Daniels, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency of $15,443.57 in income tax for 1937. The petition alleges that the respondent erred in the determination of the deficiency by disallowing:

* * * a deduction in the amount of $23,543.10, representing ordinary and necessary business expenses incurred in connection with petitioner’s business and paid by him in 1937.

The petitioner is a resident of Philadelphia, Pennsylvania, and made his income tax return for 1937 to the collector at Philadelphia. In such return he deducted from gross income $23,543.10 which he claimed represented ordinary and necessary expenses of carrying on a trade or business. The deduction was disallowed by the respondent in the determination of the deficiency. In his deficiency notice the respondent stated:

(b) The item, of $23,543.10, claimed as a deduction from gross income for the year 1937 and alleged to represent attorneys’ and accountants’ fees alleged to have been incurred in connection with the protest of additional Federal income taxes for prior years, has been disallowed. The deduction claimed, or any portion thereof, does not represent an ordinary and necessary expense of carrying on a trade or business. <

The essential facts have been stipulated as follows:

3. For the years 1932 to 1937, both inclusive, the petitioner was president and a director of Harbisons’ Dairies, Inc., a corporation organized in the year 3924 under the laws of the Commonwealth of Pennsylvania, and devoted substantially all of his time to its affairs.
4. Harbisons’ Dairies, Inc., a corporation, is engaged in the business of milk distribution in the City of Philadelphia, Pennsylvania, and its principal office is located at Front and Diamond Streets, Philadelphia, Pennsylvania.
5. The petitioner has owned a substantial number of shares of stock of Harbi-sons’ Dairies, Inc., since its incorporation in 1924.
6. During the year 1937 petitioner received a salary in the amount of $15,364.59, as president from Harbisons’ Dairies, Inc., and in said year 1937 he received -dividends on stock owned by him of said corporation in the amount of $84,450.00.
7. During the years 1932, 1934 and 1935 petitioner transferred to Harbi-sons’ Dairies, Inc., for substantial considerations, a number of shares of his holdings in said corporation, in connection with which the Commissioner of Internal Revenue proposed deficiencies in individual income tax against petitioner for said years 1932,1934 and 1935 in the respective amounts of $47,987.18, $27,732.90 and $26,168.22.
8. The aforesaid deficiencies proposed for the years 1932, 1934 and 1935 were contested by the petitioner. A petition for redetermination of petitioner’s tax liability for the year 1932 was filed with this Board (Docket !No. 83141).
9. After various conferences and discussions between the representatives of the petitioner and the Commissioner of Internal Revenue the proposed ■deficiencies for the years 1932, 1934 and 1935 were settled upon an agreed basis, no hearing on the merits being held on the petition filed with the Board for the year 1932.
10. In connection with settlement negotiations with respect to his individual income tax liability for the years 1932, 1934 and 1935 an amount of $7,614.30 was paid by petitioner during the year 1937 for legal and accounting fees.
11. In the return filed by petitioner for the year 1937 and in the petition filed with the Board, the amount of legal and accounting expenditures claimed as a deduction by petitioner for the year 1937 is shown as $23,543.10. Petitioner now concedes that $15,928.80, being part of the deduction of $23,543.10 ■claimed, was properly disallowed as a deduction by respondent in computing petitioner’s net income for the year 1937.
12. The petitioner reports his income on the basis of actual cash receipts and disbursements, and his return for the year 1937 was filed on sueh basis.

The applicable statute is section 23 of the Revenue Act of 1936, which provides in material part as follows:

In computing net income there shall be allowed as deductions:
(a) Expenses. — All the ordinary and necessary expenses paid or incurred ■during the taxable year in carrying on any trade or business, * * *

The evidence before us does not show that the $7,614.30 paid by the petitioner during the year 1937 for legal and accounting fees was in any wise connected with the carrying on of a trade or business. The disallowance of the claimed deduction is approved upon the authority of Higgins v. Commissioner, 312 U. S. 212; Van Wart v. Commissioner, 295 U. S. 112; Malcolm G. Gibbs, 34 B. T. A. 1028; Monell v. Helvering (C. C. A., 2d Cir.), 70 Fed. (2d) 631; Hutchings v. Burnet (App. D. C.), 58 Fed. (2d) 514, affirming 20 B. T. A. 1227.

Decision will be entered for the respondent.


author: Aenold :

text:
    Arthur M. Slavin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94768.
    Promulgated March 25, 1941.

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

      Angus R. Shannon, Jr., Esq., for1 the respondent.
   OPINION.

Aenold :

The petitioner’s only source of income was gambling, While he received some money as salary for operating gambling games for Baughman and others and a substantial amount of cash passed through his hands in operating the casino, the issues relating to the correctness of the deficiencies are confined to two items, namely, the income charged to him as a result of the dealings in cashier’s checks, and the income charged to him as unexplained bank deposits. The latter item involved deposits by petitioner in his own name with the Baltimore Bank and the Home Trust Co. The Commissioner treated $10,474.71 of the 1929 deposits and $13,018.00 of the 1930 deposits as income. The petitioner asks us to find that these deposits represented transactions by him as agent for the Cuban Gardens, or for McNamee. However, he testified that the accounts were his own, that he deposited therein money which he won by gambling, and that he made withdrawals for his personal use. The ledger sheets of the banks show all deposits and withdrawals, but the petitioner was unable more definitely to identify any item except to state that on some occasions he had drawn checks in payment of items purchased for the Cuban Gardens, and that, when he did so, he replaced the money by depositing a cashier’s check from the bank roll. He recalled that he had purchased a roulette wheel for $1,000. McNamee testified that the petitioner paid $1,900 for a heating plant in 1929, and was reimbursed. The deposit slips disclose that the petitioner deposited $3,000 in 1929 and $5,000 in 1930 in the form of cashier’s checks, and the remaining deposits consisted of cash and personal checks. The ledger sheets disclose a deposit of $1,995 on October 17,1929, and withdrawal of the same amount on October 18, 1929. The Commissioner treated this item as an unidentified deposit, but the evidence clearly shows it was not income of the petitioner. The Commissioner made allowance for the identified deposits of $3,000 in 1929 and $5,867 in 1930 — more than the amount of cashier’s checks deposited. The evidence further shows that, when the petitioner left Kansas City in 1931, he withdrew the balances in these accounts, and there is no evidence that he accounted for any of the money to McNamee or any one else. We hold that $8,479.71 of the deposits of 1929, and $13,018 of the deposits of 1930 were profits from gambling, and constituted income of the petitioner in those years. Robert Burd, 19 B. T. A. 734; Pincus Brecher, 27 B. T. A. 1108; Russell C. Mauch, 35 B. T. A. 617; Leonard B. Willits, 36 B. T. A. 294.

The Commissioner reduced the total amount of cashier’s checks purchased by amounts which he considered as having been used to acquire other cashier’s checks or to pay gambling losses and expenses, and treated the remainder, together with minor amounts of cash received in the exchange of checks, as profits from gambling. The amount included in income as profits was $58,611.13 for 1929 and $107,917.24 for 1930. Several hundred checks were introduced in evidence. Many of them, in an amount exceeding the amount which the Commissioner included in income, contained the endorsement only of the petitioner, and, in some instances, the endorsement of a bank other than the issuing bank at which the check was cashed. The Commissioner relies on this evidence, and the testimony of a re^nue agent who made an audit of the checks and bank records, to support his determination. The petitioner makes no attempt to demonstrate error in the Commissioner’s computation of the profits, but contends that no part of the money represented by the checks is taxable to him as income, because he was a mere money handler or agent for Lazia and McNamee, who contributed the capital and were the sole owners and operators of the Cuban Gardens.

The record shows conclusively that the petitioner was not the sole owner and operator of this enterprise, but that he was jointly interested with others, and was entitled to a portion of the profits. The petitioner was to share in the profits to the extent of 15 percent in 1929 and 25 percent in 1930. While McNamee testified that the petitioner was to participate in profits only after McNamee and Lazia had recovered their advances, the petitioner in his testimony placed no such limitation upon the agreement. McNamee and the petitioner testified that the Cuban Gardens was not operated for a sufficient iength of time to enable them to realize any profit, and that the petitioner did not in fact retain any of the funds entrusted to him or receive any payment as his share of the profits. They kept no written records of their daily receipts and expenses, and have not informed us of the amount thereof or the amounts advanced by McNamee in excess of $6,000.

It was the duty of petitioner to produce facts upon which we might make our own determination whether there were any profits. W. M. Buchanan, 20 B. T. A. 210; Leonard B. Willits, supra. The documentary evidence shows not only that the operation of the Cuban Gardens was profitable, but also that a substantial part of the funds represented by the cashier’s checks was in fact received and used by the petitioner. It also appears that the petitioner had a wide experience in handling enterprises of this character and that other gamblers paid him well for such services. His services and experience were an important and necessary factor in the operation of the business, and it is unreasonable to suppose that he would give his entire time to it for over a year without sharing in the profits which passed through his hands from day to day. His testimony, together with the documentary evidence and the surrounding facts and circumstances, warrants the conclusion that he shared in all profits from the inception of the enterprise. Since his share was fixed at 15 percent in 1929 and 25 percent in 1930, it is obvious that the Commissioner erred in so far as he included any greater proportion of the profits in the petitioner’s income.

The evidence indicates that not all of the amounts represented by the cashier’s checks were funds of the Cuban Gardens. Some items may be segregated as individual profits of the petitioner, and, by charging the petitioner with 15 and 25 percent of the remainder of the profits as computed by the Commissioner, his income from the Cuban Gardens may be approximated as closely as is possible on this record. Cohan v. Commissioner, 39 Fed. (2d) 540; Robert McCarthy Bullington, 38 B. T. A. 754.

The severable items are as follows:

During 1929, and before the opening of the Cuban Gardens and the setting up of the initial bank roll of $6,000, the petitioner purchased and cashed $3,879.55 of cashier’s checks. These clearly were not funds of the Cuban Gardens. They were acquired in July and. August 1929, while the petitioner was operating for Baughman and' Lazia. Baughman was paying him $10 per day and 10 percent of the profits. The record is silent as to such profits and as to any income received from Lazia. These checks with many others purchased after September 12 were exhibited to the petitioner, who said they constituted funds of the Cuban Gardens. Under the circumstances, and in view of the petitioner’s inability at any time to state facts concerning any particular check, we think the checks purchased prior to September 1929 constituted profits of the petitioner from gambling other than that conducted for Cuban Gardens, and that the Commissioner properly included them in income for 1929.

The petitioner asks us in his brief to find that a cashier’s check for $2,000, issued by the National Bank of North Kansas City on May 7,. 1930, represented money loaned to him by one Donegan, who operated the restaurant, and that he repaid Donegan in 1981 when the check was cashed. His testimony is that he borrowed the money which went into this check from Baughman, for use in the petitioner’s individual gambling operations, but that he never used it, and the check remained in his possession until April 15,1931, when he cashed it and repaid Baughman. The records of the issuing bank show that the-petitioner purchased the check with a check drawn on his personal bank account. The checking account at the Home Trust Co. discloses a withdrawal of $1,000 on May 7,1930, while that at the Baltimore Bank discloses a balance on hand at that date of only $234.84.. The inference is that the petitioner had a checking account at the National Bank of North Kansas City and the check was paid from that source. The petitioner made no attempt, upon being recalled, to explain the conflict between his testimony and the bank records. We are of the opinion that the money used to purchase this check represented profits of the petitioner from gambling other than that conducted for Cuban Gardens, and that the Commissioner properly included the-amount thereof in income for 1930.

The Commissioner included in the petitioner’s income 12 cashier’s checks issued in 1929, totaling $4,000, which were endorsed in the name of the petitioner and the Gregg Tire Co., and cashed at a Topeka bank by George K. Gregg. The evidence shows that Gregg gambled at the Cuban Gardens and won and lost money. Gregg is deceased, and the Commissioner sought to prove by his widow that Gregg borrowed this money from the petitioner. Mrs. Gregg denied any knowledge of such a transaction. Some of the checks were endorsed not by the petitioner but by McNamee. We are of the opinion that these checks came to the hands of Gregg as winnings from gambling. They should therefore be treated as gambling losses in computing petitioner’s share of the profits from the Cuban Gardens.

The exclusion of the above items of $3,879.55 and $4,000 in 1929■ and the item of $2,000 in 1930 from the profit from dealings in cashier’s checks, as computed by the Commissioner, leaves $50,731.58 in 1929 and $105,917.24 in 1930 as the total profits realized by the Cuban Gardens and we hold that 15 percent of the former and 25 percent of the latter amount constitutes taxable income of the petitioner.

■ The determination of the Commissioner that a profit was realized from the operation of the Cuban Gardens is supported by the huge amount of cashier’s checks handled over a period of approximately one year and by the endorsements indicating that a substantial portion of them were cashed by no one other than the petitioner. It also appears that on some days the profits were as high as $8,000, and that during the first three and a half months they were sufficient to reimburse Lazia and McNamee to the extent of more than $18,500. The documentary evidence shows that the petitioner from time to time made deposits in his personal checking accounts varying from $500 to $1,500; that soon after the Cuban Gardens had closed and his arrangement with McNamee had been terminated, he received the proceeds of $8,000 of the cashier’s checks purchased in 1930 and, in addition, that he purchased over $30,000 of cashier’s checks; and that in 1931 he deposited $6,577 in his personal accounts. The record further shows that he loaned $2,500 to another gambler and that he took funds to New Orleans and invested an undisclosed amount in some business. During all of this period he supported his family. In the light of these facts and the absence of proof of the actual receipts and disbursements, we are unable to give any credence to the testimony of the petitioner and McNamee that there were no profits and that the petitioner. received none of the proceeds of the cashier’s checks which passed through his hands or none of the profits from the operation of the Cuban Gardens.

We conclude that the petitioner received income in the taxable years from gambling activities in the following amounts:

The next issue is whether any part of the deficiencies is due to fraud with intent to evade tax. Sec. 293 (b), Revenue Act of 1928. The' statute imposes the burden of proof on the Commissioner. The evidence adduced shows that taxable income in substantial amounts was realized during both years. The nature of this evidence is indicated in our previous discussion and in our findings of fact. We have carefully weighed and considered the evidence and have given petitioner the benefit of the doubt as to certain disputed items. But ■dewing petitioner’s whole course of conduct, his various acts and transactions, together with the inferences to be drawn therefrom, it is our opinion that his failure to file any return of income for 1929 evidences a fraudulent intent, M. Rea Gano, 19 B. T. A. 518, 533, and that the understatement of Iris income for 1930 was due to fraud with intent to evade tax. Charles E. Mitchell, 32 B. T. A. 1093; affd., 303 U. S. 391. Respondent’s determination of fraud for both years is therefore approved.

Since petitioner had taxable income for 1929 of not less than $19,969, and since he did not file a return for that year, the imposition of the 25 percent penalty under section 291 is mandatory, Douglas L. Edmonds, Administrator, 31 B. T. A. 962; affd., 90 Fed. (2d) 14; certiorari denied, 302 U. S. 713; Kathryn Lammerding, 40 B. T. A. 589; and constitutes a separate liability from the fraud penalty under section 293 (b). Pineras Brecher, supra.

Decision will be entered under Rule 50.


text:
    Joseph Spatola, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100815.
    Promulgated March 25, 1941.

      Charles M. Trammell, Jr., Esq., for the petitioner.

      Bernard D. Daniels, Esq., for the respondent.
   OPINION.

Smith :

The question presented by this proceeding is whether there shall be included in the net income of the petitioner for the period October 1 to December 31, 1936, his proportionate share of the profits of the partnership of Felix Spatola & Sons for the entire calendar year 1936. The petitioner admits that no part of such profits was included in his return filed for the fiscal year ended September 30, 1936. He argues, however, that the profits of the partnership were nearly all earned during the first nine months of the calendar year and that the profits for the last three months of the calendar year were only trivial and that his share of such part of the profits was only a few hundred dollars, which he claims is all that should be included in the short return.

Section 181 of the Revenue Act of 1936 provides that “Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity.”

Section 182 provides:

There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year.

Section 188 provides:

If the taxable year of a partner is different from that of the partnership, the distributive share of the net income of the partnership to be included in computing the net income of the partner for his taxable year shall be based upon the net income of the partnership for any taxable year of the partnership (whether beginning on, before, or after January 1, 1936) ending within the taxable year of the partner.

Section 47 provides in material part as follows:

SEO. 47. RETURNS FOR A PERIOD OF LESS THAN TWELVE MONTHS.
* « # * :Jf * *
(b) Income Computed on Basis of Shokt Period. — Where a separate return is made under subsection (a) on account of a change in the accounting period, and in all other cases where a separate return is required or permitted, by regulations prescribed by the Commissioner with the approval of the Secretary, to be made-for a fractional part of a year, then the income shall be computed on the' basis, of the period for which separate return is made.
(c) Income Placed on Annual Basis. — If a separate return is made (except returns of the income of a corporation) under subsection (a) on account of a change in the accounting period, the net income, computed on the basis of the period for which separate return is made, shall be placed on an annual basis by multiplying the amount thereof by twelve and dividing by the number of months included in the period for which the separate return is made. The tax shall be such part of the tax computed on such annual basis as the number of months, in such period is of twelve months.

Article 183-1 of Regulations 86, promulgated under the provisions of the Revenue Act of 1936, provides in material part as follows:

* * * The distributive share of the net income of the partnership which a partner is required to include in his return is his proportionate share of the net income of the partnership, either—
(a) For the taxable year upon the basis of which the partner’s net income is computed, or
(b) If the partner’s net income is computed upon the basis of a taxable year different from that upon the basis of which the net income of the partnership is computed, for the taxable year of the partnership ending within the taxable year upon the basis of which the partner’s net income is computed.

Under all of tlie income tax acts a partner has been held to be taxable upon his distributive share of the income from the partnership for its fiscal year ending within the partner’s taxable year. J. E. Asbury, 4 B. T. A. 1244; W. J. Woodruff, 11 B. T. A. 477; F. E. Malm, 11 B. T. A. 859.

The petitioner argues that by being required to include in his income for the three-month period ended December 31, 1936, his share of the profits of the partnership for the calendar year he is being subjected to an intolerable burden and that it could not have been the intention of Congress to impose such burden upon him. He does admit, however, that if the tax is not computed as the respondent has computed it he will never be required to pay income tax upon his share of the partnership’s earnings for the first nine months of 1936. His argument is, therefore, that there should be included in his income for the short period only the earnings of the partnership for the last three months of 1936, which he contends upon the basis of evidence submitted amounted to only a few hundred dollars.

It can not be denied upon the basis of the evidence submitted that the tax liability of the petitioner for the three-month period ended December 31, 1936, is high. It results, however, from a literal application of the language of the statute, which is unambiguous. If the fiscal year of the partnership of Felix Spatola & Sons had ended on January 31 instead of on December 31, no part of the profits of the partnership would have been included in the short return filed.

In support of his determination the respondent cites Cohan v. Commissioner (C. C. A., 2d Cir.), 39 Fed. (2d) 540, and Harris v. Commissioner (C. C. A., 2d Cir.), 39 Fed. (2d) 546. Both cases are in point, although they involved the provisions of ¿i prior income tax act. In accordance with them and with the law and the Commissioner’s regulations, the determination of the respondent is approved.

Decision will be entered for the respondent.