author: Black :

text:
    J. Cornelius Rathborne, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 83105, 84655.
    Promulgated April 5, 1938.

      Louis G. Guidry, Esq., for the petitioner.

      Allen T. Akin, Esq., for the respondent.
   OPINION.

Black :

These proceedings involve deficiencies in income tax for the years 1932 and 1933 in the amounts of $401.55 and $544.65, respectively. The principal issue is whether, under the stipulated facts, petitioner is taxable on any part of the $21,905.20 and $18,886.02 paid to him during 1932 and 1933, respectively, by the trustee of the trust estate created under the will of Joseph Rathborne, deceased, petitioner’s grandfather, and, if so, the determination of the respective taxable portions for the taxable years in question. In his income tax returns filed for the years 1932 and 1933, respectively, petitioner did not report as taxable income any part of the several amounts paid to him by the trustee. The respondent determined that of the amounts paid to petitioner, $4,987.66 should be included in petitioner’s taxable net income for 1932 and $6,652.59 for 1933. In his answer filed in Docket No. 83105, the respondent affirmatively alleged that of the $21,905.20 paid to petitioner during 1932 he should have included in his taxable net income for that year the amount of $8,328.05, and has made claim for an increased deficiency for 1932 upon that ground. The facts are set forth in a stipulation of the parties, which we adopt as our findings of fact. Only such of the facts as seem necessary to a discussion of the issues are stated herein.

Petitioner is an individual and a resident of Westbury, Long Island, New York, having formerly been a resident of Harvey, Jefferson Parish, Louisiana.

The will of Joseph Eathborne, dated June 14, 1921, probated, proved, registered, and ordered executed on August 24, 1923, before the Twenty-eighth Judicial District Court for the Parish of Jefferson, State of Louisiana, contained provisions as follows:

Fourth: : I direct that all my just debts and charges and the foregoing expenditures and legacies and the costs, expenses and taxes of my succession together with any estate or legacy taxes of my succession, together with any estate or legacy taxes upon the foregoing legacies against my estate or against the said legatees, as well as like charges against my heirs, shall he paid out of any funds X may have on hand and out of securities I may have at my death, and out of the earnings of my trust estate before touching or disposing of my holdings in the Parish of Tangipahoa, La., or in any corporation or business I may there be engaged in and before disposing of my timber holdings elsewhere. But I require that my said securities, if needed for the purpose first stated, shall be sold without haste and to realize as much as possible their true value.
Fifth : I give and bequeath the rest and remainder of my estate, wheresoever situated, to my two grandchildren, Joseph Cornelius Rathborne and Kathlyn George Rathborne, share and share alike, including herein their legitime, the whole in trust, however, as hereinafter set out.
I hereby create a trust for the said rest and remainder of my estate and for the universal legacy aforesaid and I give and bequeath the said residue of my estate wherever situated to Canal-Commercial Trust & Savings Bank and to any Trust Bank succeeding to the same, in trust however, for the use and benefit of the said universal legatees, my said grandchildren, Joseph Cornelius and Kathlyn George Rathborne, and within the limitations and under the conditions and restrictions hereinafter imposed to-wit: * * *

The language immediately following that just quoted gave directions to the trustee regarding the sale of the shares of stock owned by the testator and the preservation of the investment made in certain timber lands, and it has no special application to the present proceedings. The sixth article of the will reads as follows:

Sixth : The Trustee shall proceed to invest my estate with the exception noted in Paragraphs 2 and 3 of Article 5 of this will, in sound, safe, interest paying bonds, having regard at all times to the character of the security rather than to a high rate of return. * * * Within the limitation herein expressed the Trustee is authorized to sell, exchange or otherwise dispose of any securities belonging to my trust estate and to reinvest the same from time to time as opportunity permits. All sums received from sales of capital assets shall likewise be invested and reinvested under the authority hereinabove granted. All revenues in excess of the requirements of the several beneficiaries as hereinafter set out and in excess of the carrying charges and expenses of nay estate shall likewise be invested and reinvested and form part of the capital of my trust estate.
The Trustee may from time to time and as required take from and pay out of the capital of the estate any sums of money needed for any of the purposes contemplated by this will or to make up deficiencies in revenues and needed for the payment to beneficiaries as hereinafter set out.

Then article 7 reads in part as follows:

Seventh: Trustee shall pay out (of) the revenues of the trust estate and out of the principal, should it be necessary to trench upon the latter as authorized in Article 6th hereof: * * *

Then followed a special legacy of $5,000 per annum to W. W. Rathborne, brother of the decedent, a special legacy of $30,000 a year to his daughter-in-law, Georgie W. Rathborne, mother of the two beneficiaries, and certain provisions for payment of income to the petitioner, Joseph Cornelius Rathborne, and his sister, Kathlyn George Rathborne. The trustee was to pay to them through their mother for their care and education adequate sums until they should respectively reach the age of 21 years. The will then provided as follows:

4th. After my grandson reaches the age of twenty-one years, the Trustee shall pay him the income of his share in the trust estate in the following proportions : One-third thereof during the first three years; one-half thereof during the next three years, and the whole thereof during the ensuing four years of this trust, payable in quarterly installments.
Should my grandson marry after reaching the age of twenty-one years and before the expiration of this trust, Trustee may advance to him out of the accumulation of interest and revenue and if necessary out of the principal a sum to acquire a home and to establish the same not to exceed One Hundred Thousand Dollars and shall in case of such marriage increase the allowance from the income to one-half the same or the whole thereof in the discretion of the Trustee. If such marriage occurs before his twenty-seventh year, the Trustee may also advance out of the funds in the manner last provided a sum not to exceed two hundred thousand dollars, if same should be needed to set my said grandson up in business or to put him forward in life.
*******
6th. In case the revenues of my trust estate should not be sufficient at any time to meet the charges imposed thereon in this paragraph the several beneficiaries shall suffer a diminution and loss of their several allowances, allowances in proportion to the deficiency and in case the revenue shall thereafter increase the allowances shall be resumed as provided herein.

The duration of the trust is specified as follows:

Eighth : The trust estate here created and the trust herein established for my grandchildren shall subsist as to my grandson for ten years after he reaches the age of twenty-one years and for my grand-daughter for ten years after she reaches the age of twenty-one years.

The Canal-Commercial Trust & Savings Bank was named as one of three executors and also as sole trustee.

The executors have not been discharged, except that the Canal-Commercial Trust & Savings Bank, whose name was changed to Canal Bank & Trust Co., was placed in judicial liquidation May 20, 1933, and thereupon ceased to act as executor.

The National Bank of Commerce in New Orleans was in due course appointed in the place and stead of the Canal Bank & Trust Co.

During the calendar year 1932 the trust had a total income of $181,-923.33, consisting of $71,503.11 of taxable income and $110,420.22 of tax-exempt income. During said calendar year the trustee expended from the fund of the trust estate $92,981.59, representing a deficiency in the Federal estate tax of the estate of Joseph Rathborne, $2,466.29 in taxes, $1,615.86 for brokerage and commissions, and $2,495.00 for salaries of the advisory committee and caretakers. It also paid to Georgie W. Rathborne her annual legacy of $30,000, and to W. W. Rathborne his annual legacy of $5,000. In the sale of securities of the trust estate a loss of $103,699.72 was incurred. The trustee paid the sum of $21,-905.20 to the petitioner, pursuant to the terms of the will.

During the calendar year 1933 the trust had a total income of $170,400.06, consisting of $60,023.21 taxable income and $110,376.85 tax-exempt income. The trustee expended from the funds of the trust estate $2,433.41 interest paid, $3,978.57 taxes, $725.01 brokerage, and $2,520 for caretakers. It also paid to Georgie W. Rathborne her annual legacy of $30,000, and to W. W. Rathborne his annual legacy of $5,000, and to Marion and Betha Rathborne their annual legacy of $600, bequeathed to them in the codicil to the will. There were losses of $69.70 from the sale of capital assets and $5,150.36 from bad debts. The trustee paid the sum of $18,886.02 to the petitioner, pursuant to the terms of the will.

The petitioner, J. Cornelius Rathborne, became twenty-one years of age on June 12,1930.

Petitioner contends (1) that under the law of Louisiana the trust estate created by petitioner’s grandfather, Joseph Rathborne, was a mere agency, rather than a trust as the term “trust” is used in sections 161 to 164, inclusive, of the Revenue Act of 1932, with the result that petitioner was the actual owner of one-half of the property held in trust and, therefore, in determining his own net income he would be entitled to deductions for'one-half of the losses sustained by the trust from the sales of capital assets in 1932 and 1933 and from bad debts in 1933; (2) that if the trust estate is held to be a trust within sections 161 to 164, inclusive, then petitioner, as a beneficiary and remainderman under the trust, is entitled to deduct from his gross income an amount of the losses of the trust proportionate to the income received by him therefrom; and (3) that if the trust estate is held to be a trust within sections 161 to 164, inclusive, then in determining whether the amounts paid to petitioner by the trustee were from taxable or tax-exempt income, certain expenses of the trust, special annuities and the deficiency for Federal estate tax, should be regarded as having been paid by the trustee out of the taxable rather than the tax-exempt income of the trust estate. The respondent opposes contentions (1) and (2), and in connection with contention (3) argues that the deficiency in Federal estate tax of $92,981.69 is not an allowable deduction from trust income at all, and that the amounts paid to petitioner by the trustee should be allocated between taxable and tax-exempt income according to the authorized Eavenscroft to employ such legal and clerical assistants penses (exclusive of the annuities of $35,000 and $35,600, respectively) , bears to the total adjusted taxable and unadjusted tax-exempt income of the trust.

We shall now consider petitioner’s first contention. Before the enactment of Act No. 107 of the Legislature of Louisiana of 1920 (La. Gen. Stat. 9815-9822) trusts were prohibited in Louisiana except for educational, charitable, or religious purposes. In re Liquidation of Canal Bank & Trust Co., 181 La. 207; 159 So. 325, and authorities therein cited. Section 1 of Act No. 107 (sec. 9815, La. Gen. Stat.) provides:

It shall he lawful for anyone to make a donation inter vivos or mortis causa of any kind of property, and of any amount, whereby an individual or indi-duals or, a bank or hanks now or hereafter organized under the laws of this state for the purpose of conducting savings, safe deposit and trust hanking business, or which have accepted the provisions of law relative thereto, and banks organized under the acts of the congress of the United States, are designated as trustee or trustees; provided, however, that nothing in this act shall he construed to affect the law in regard to the disposable portion, save that it shall he permissible to provide that the legitime or any portion thereof of any forced heir or heirs shall he administered in trust for his or their benefit by said trustee or trustees, the income to be paid annually or oftener to said forced heir or heirs, or his or their legal representatives.

Tbe policy of the state as expressed in Act No. 107, supra, was continued in force by the Louisiana Constitution of 1921, article IV, section 16. Wilbert v. Wilbert, 155 La. 197, 99 So. 36.

The trust estate in question became effective upon the death of Joseph Eathborne in August 1923. Pires v. Youree, 170 La. 986; 129 So. 552; Succession of Forstner, 186 La. 577; 173 So. 111.

Act No. 107, supra, was repealed by Act No. 7, Louisiana Acts, Third Extraordinary Session, 1935. This repeal did not have the effect of divesting any of the rights established by the trust estate in question. Succession of Manning, 185 La. 894; 171 So. 68; Succession of Forstner, sufra. The Louisiana courts have recognized as valid all trust estates which were duly created under Act No. 107 and became effective during the period that act was in force. Wilbert v. Wilbert, supra; Succession of Manthey, 159 La. 743; 106 So. 289; Succession of Manning, supra; Succession of Forstner, supra.

In Canal Bank & Trust Co. et al., Executors, 30 B. T. A. 390, one of the petitioners there was the trustee of the identical trust estate involved in the present proceedings. The petitioners there contended that the decedent, Joseph Rathborne, had created three separate trust estates rather than one. We held that only one trust was created and that the income thereof accumulated and held by the trustee pursuant to the provisions of the will was taxable to the trust. After quoting sections 9815, 9816, and 9818 of the Louisiana General Statutes in full, we said:

From the foregoing we think it is clear that the interests of minor heirs may te vested, in a trustee for them until they reach their majority and for a period of 10 years thereafter, as was provided for in the decedent’s will with respect to the grandchildren. [Italics supplied.]

We have carefully considered petitioner’s first contention and are of the opinion that the trust created under the fifth article of decedent’s will is not a mere agency, as petitioner contends, but is a trust within the meaning of that term as used in sections 161 to 164, inclusive, of the Revenue Act of 1932. It became effective while Act No. 107, supra, was in full force and effect. Under the decedent’s will the trustee acquired certain substantial rights and was charged with certain obligations which made him by far more than a free agent. Succession of Manning, supra. In so holding we have not overlooked certain language contained in Buck v. Larcode, 183 La. 570; 164 So. 593, which in effect overrules Buck v. Haas, 180 La. 188; 156 So. 217, cited by respondent in his brief. The alleged trust in Buck v. Larcade was not of the kind specifically provided for in Act No. 107, and was therefore without any statutory authorization. That is an entirely different situation from the one involved in these proceedings. We hold for the respondent on this point.

We shall now consider petitioner’s first alternative contention, namely, that, as a beneficiary and remainderman, he is entitled to deduct from his gross income an amount of the losses of the trust proportionate to the income received by him therefrom. Petitioner concedes at the outset that the cases of Anderson v. Wilson, 289 U. S. 20; T. Rosslyn Beatty, 28 B. T. A. 1286; and Baltzell v. Mitchell, 3 Fed. (2d) 428; certiorari denied, 268 U. S. 690, are apparently against him, but submits that in none of these cases was the question considered from the standpoint which he now proposes. Petitioner’s standpoint is that even though we regard the trustee as holding the legal title to the assets that were sold at a loss, the petitioner, nevertheless, had such an “economic interest” in the assets as would entitle him to a proportionate part of the losses within the doctrine of Helvering v. Falk, 291 U. S. 183, and that in this respect Eelvering v. Falk is distinguishable from Anderson v. Wilson and supports petitioner’s contention.

We do not believe that petitioner is in the same position as were the beneficiaries in the Falk case. There the governing instrument directed payment to the beneficiaries of the entire proceeds of certain mining property held in trust, less certain expenditures for taxes, expenses, etc., and the trustees were regarded by the Supreme Court as a “mere conduit” for passing such proceeds to the beneficial owners. In the instant proceedings, petitioner during the taxable years in question was not entitled to any of the proceeds from the sale of the corpus, as such, but only to that proportion of the income of his share in the trust estate provided for in the fourth paragraph of the seventh article of his grandfather’s will.' Under the sixth article the trustee was authorized to “pay out of the capital of the estate any sums of money needed for any of the purposes contemplated by this will or to make up deficiencies in revenues and needed for the payment to beneficiaries”, but, except for such purposes, the trustee was required to invest such proceeds in good bonds, which bonds were to form a part of the capital of the trust estate. Furthermore, under the laws of Louisiana the trustee in the instant proceedings was vested with substantial rights and was far from being a free agent or a mere conduit. Succession of Manning, supra. In Canal Bank & Trust Co. et al., Executors, supra, this identical trust was held by us to be a separate taxable entity. Under such circumstances it is our opinion that the losses in question are deductible only by the trust, and that there is no authority in the law for allowing any proportion thereof as a deduction from petitioner’s gross income. Anderson v. Wilson, supra; T. Rosslyn Beatty, supra. See also Selma Wertheimer et al., Executors, 31 B. T. A. 407, 411.

The next question is whether the payment during 1932 by the trustee, from the funds of the trust estate, of a deficiency in Federal estate tax of the estate of Joseph Rathborne, deceased, in the amount of $92,981.59 affects in any way the $21,905.20 which was paid to petitioner by the trustee during the same year. During 1932 the trust estate had a gross taxable income of $71,503.11 and a gross tax-exempt income of $110,420.22. Of the $21,905.20 paid to petitioner, the respondent determined that $4,987.66 was paid from taxable income of the trust and the balance from tax-exempt income. Under the fourth paragraph of the seventh article of the will of Joseph Rathborne, the trustee was required to pay petitioner one-third of the income of his share in the trust estate during the first three years after he reached twenty-one years of age. The amount of $4,987.66 was determined by the respondent as follows:

Total taxable income of tbe trust_$71, 503.11
Deduct:
Taxes_$2, 466.29
Annuity payments_ 35,000. 00
Commissions, etc- 1,615.86
Salaries, etc- 2,495. 00
- 41,577.15
Adjusted net income_ 29, 925.96
Petitioner’s one-sixth interest_ 4,987.66

The petitioner contends that under section 23 (c) of the Revenue Act of 1932, and the decisions of Commissioner v. Beebe, 67 Fed. (2d) 662, and Commissioner v. Pennsylvania Co. for Insurances on Lives & Granting Annuities, 83 Fed. (2d) 545, the trust was entitled to deduct the $92,981.59 allowed by the statute “as a deduction only to the estate”; that under the decisions of John H. Watson, Jr., et al., Trustees, 35 B. T. A. 706; and Rena S. McCahan, 35 B. T. A. 943, the trustee was entitled to pay the $92,981.59 out of the taxable income of the trust; that since the deficiency in estate taxes exceeded the taxable income, the entire $21,905.20 paid to petitioner was paid out of tax-exempt income; and that the respondent erred in determining that $4,987.66 thereof was paid from taxable income.

The respondent contends in part that since the executors of the-estate of Joseph Rathborne, deceased, have never been discharged, the taxes in question, if allowable at all, are allowable under section 23 (c), supra, to the executors rather than the trustee; and that in any event the payment of the $92,981.59 of taxes did not affect the $21,905.20 of income paid to petitioner under such decisions as Everett J. Esselstyn, Executor, 26 B. T. A. 181; affirmed per curiam, 65 Fed. (2d) 1015; certiorari denied, 290 U. S. 678; and Minnie L. Wolf, 32 B. T. A. 959; affirmed on another point, 84 Fed. (2d) 390, to which should be added the recent case of Anna F. Ardenghi, 37 B. T. A. 345.

Assuming, without deciding, that the petitioner is correct in his contention that, under the Beebe and Pennsylvania Oo. cases, the trust was entitled to deduct the deficiency in Federal estate tax paid in 1932 in determining its own net income for taxation, we think the respondent is correct in his contention that the payment of the tax did not affect the taxability or nontaxability of the $21,905.20 paid to petitioner during the same year as the part of the income of the trust he was entitled to receive under the terms of the will. The facts in tlie instant case, as they concern the point we are now discussing, are similar to the facts in the Minnie L. Wolf case.

The petitioner in the Wolf case contended, just as the petitioner in the instant proceedings now contends, that the inheritance taxes paid by the estate should be considered as haying been paid out of the taxable income of the estate, thus leaving only tax-exempt income as available for distribution to the beneficiary. In denying this contention, we said:

* * * This, however, is contrary to the fact that the income of the estate was used in actual distribution to the several legatees enumerated in the schedule by way of interest upon their legacies, and there is no rule of law which requires that this fact shall be disregarded and the payment of the inheritance tax legally presumed to be made from the income acquired after the taxpayer’s death. As to Federal estate taxes, the decisions are to the contrary. Walter S. Gurnee et al., Executors, 13 B. T. A. 262; Everett J. Esselstyn, Executor, 26 B. T. A. 181; affirmed per curiam, 65 Fed. (2d) 1015; certiorari denied, 290 U. S. 678; Agnes Sitterding, 32 B. T. A. 506; cf. Jackson v. Price, 74 Fed. (2d) 707.

In the recent case of Anna F. Ardenghi, supra, after discussing Walter S. Gurnee et al., Executors, 13 B. T. A. 262; Agnes Sitterding, 32 B. T. A. 506; and the McCahan, and Wolf cases, we said:

In each of the foregoing cases the inheritance tax paid exceeded the gross income of the estate. With all due respect to the Circuit Court of Appeals for the Fourth Circuit, which reversed the Board in the Sitterding case, we think the question of whether or not a beneficiary is subject to tax must depend upon whether or not the beneficiary has received a distribution during the taxable year from the income of the estate or trust. If the estate had income and distributed a part of that income to the beneficiary, it is taxable to the beneficiary, regardless of the not inconsistent fact that inheritance taxes in an amount in excess of the income of the estate were paid either from other income and corpus, or solely from corpus.

The question of the taxability of the amount received by a beneficiary was not involved in John H. Watson, Jr., et al., Trustees, supra. In the other case relied upon by petitioner, namely, Rena, S. McCahan, supra, the Board “pointed out that the distributions there were made from corpus or from tax-exempt income and, therefore, would not be taxable to the beneficiary, either under the decision of the Board in the Sitterding case or under the decision of the court in that case.” Anna F. Ardenghi, supra. We think that upon the authority of Everett J. Esselstyn, Executor; Minnie L. Wolf; and Anna F. Ardenghi, all supra, this issue must be decided for the respondent.

The last question involves the proper allocation, as between taxable income and tax-exempt income, of the amounts of $21,905.20 and $18,886.02 paid to petitioner by the trustee of the trust estate during the years 1932 and 1933, respectively. In his deficiency notices the respondent determined that of the above amounts, $4,987.66 should be allocated to taxable income for 1982 and $6,652.59 (less $212.50 Liberty bond interest exemption) for 1933. In bis answer filed in Docket JSTo. 83105, the respondent affirmatively alleged that, of the amount paid to petitioner in 1932, $8,323.05 should be allocated to taxable income, and upon that basis he duly made a claim for an increased deficiency for 1932. In his brief the respondent makes certain concessions which would reduce the amounts allocated to taxable income to $8,110.84 for 1932 and $5,917.56 for 1933, computed as follows:

Calendar Year 1932
Gross taxable income of Trust_ $71,503.11
Deduct Operating Expenses:
Taxes_$2,466.29
Brokerage & Commissions_ 1,615.86
Salaries & Caretakers_ 2,495.00
- 6, 577.15
Adjuted taxable income_ $64,925.96 37.027%
Gross tax-exempt income- 110, 420. 22 62.973%
Totals $175, 346.18 100%
Amount of taxable income allocated to petitioner is 37.027% of $21,905.20, or $8,110.84.
Calendar Year 1938
Gross taxable income of Trust. $60, 023.21
Deduct Operating Expenses:
Interest_ $2, 433.41
Taxes_¡-3, 978. 57
Brokerage_ 725. 01
Caretakers_ 2, 520. 00
9, 656. 99
Adjusted taxable income- $50, 366. 22 31. 333%
Gross tax-exempt income_ 110, 376. 85 68. 667%
Totals_$160, 743. 07 100%
Amount of taxable income allocated to petitioner is 31.333% of $18,886.02, or $5,917.56.

Petitioner contends that in addition to the above amounts of $6,577.15 and $9,656.99, which the respondent now concedes are deductible from the taxable income of the trust before the allocations of the amounts paid to petitioner are made, the deficiency in Federal estate tax of $92,981.59 should also have been deducted from the taxable income of the trust for 1932, thus leaving no taxable income to be allocated to petitioner for 1932, and that the payments totaling $35,600 to Geprgie W. Rathborne, W. W. Rathborne, Marion Rath-bome, and Betha Rathborne should also have been deducted from the taxable income of the trust for 1933, thus reducing the adjusted taxable income for 1933 to $14,766.22 instead of $50,366.22 as shown in the above computations. We have already considered the contention relating to the deficiency in Federal estate tax. Regarding petitioner’s contention relating to the items totaling $35,600, the parties are in disagreement as to whether these amounts, under the will, were payable in any event, and therefore exempt from taxation to the recipients under Burnet v. Whitehouse, 283 U. S. 148, or whether they were payable only out of income, and therefore taxable to the recipients under Helvering v. Butterworth, 290 U. S. 365. We need not and do not decide this disagreement between the parties for the reason that it is our opinion that if the amounts were payable in any event, they would not be deductible at all by the trustee, and if the amounts were payable only out of income, the recipients would be in the same classification as petitioner, namely, beneficiaries under the trust estate, and the amounts received by them would be allocated between taxable and tax-exempt income on the same basis as the amounts paid to petitioner have been allocated in the computations above.

The deficiencies should be recomputed by including, in petitioner’s taxable net income for the years 1932 and 1933, $8,110.84 of the $21,905.20 paid to him in 1932 and $5,917.56 of the $18,886.02 paid to him in 1933, respectively.

Decisions will be entered wider Bule SO.


source: Caselaw Access Project

author: Ajrundell :

license: Public Domain

text:
    Nibley-Mimnaugh Lumber Company, by J. F. Ravenscroft, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85966.
    Promulgated April 5, 1938.

      Allan A. Smith, Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent.
   OPINION.

Ajrundell :

The question for consideration at this time is whether there is before us a proper petition to bring the proceeding within our jurisdiction. As set out in the findings of fact, the notice of deficiency was addressed to “Nibley-Mimnaugh Lumber Company, c/o J. F. Ravenscroft.” The petition was filed by Ravenscroft, purporting to be trustee for the corporation to whom the deficiency notice was sent. The corporation itself obviously could not file a petition, as it was dissolved on March 7,1924, and under the holding in G. M. Standifer Construction Co. v. Commissioner, 78 Fed. (2d) 285, its corporate existence completely terminated five years after that date. The Stan-difer case, like this, involved an Oregon corporation. More than five years after dissolution a review of the Board’s decision was sought in the Circuit Court of Appeals for the Ninth Circuit. The Circuit Court dismissed the petition for review. It was there pointed out that upon dissolution of a corporation the corporate existence is continued for five years for purposes of liquidation, winding up the business and disposing of property. After the expiration of that period of time the corporation was as if it did not exist and even suits commenced within that period abate upon the expiration thereof. In the present case the corporation became completely defunct five years after March 7, 1924, that is, on March 7, 1929. Consequently it could not file the petition that was filed herein purportedly in its behalf on August 1, 1936. The petition therefore is not the petition of the taxpayer against whom the deficiency was determined, and we have no jurisdiction to hear the proceeding. E. N. & O. M. Ennis, 21 B. T. A. 406; Estate of S. S. Hunter, Inc., 26 B. T. A. 259; affirmed March 11, 1933, by the Circuit Court of Appeals for the Fifth Circuit without opinion.

The contract of October 1,1923, between the corporation and Rav-enscroft does not give validity to the petition filed herein. It can not breathe life into the dead corporation, so as to make it the petitioner. If there are Oregon statutes that continue the existence of a corporation under such a contract, the petitioner has not brought them to our attention, and the petitioner has the burden of establishing jurisdiction. See First Bond & Mortgage Co., 21 B. T. A. 1.

The petitioner contends that section 272 (k) of the Revenue Act of 1934 gives the petition validity. That section provides as follows:

(It) Address for Notice of Deficiency. — In the absence of notice to the Commissioner under section 312 (a) of the existence of a fiduciary relationship, notice of a deficiency in respect of a tax imposed by this title, if mailed to the taxpayer at his last known address, shall be sufficient for the purposes of this title even if such taxpayer is deceased, or is under a legal disability, or, in the case of a corporation, has terminated its existence.

The quoted provision is designed to give validity to the notice of deficiency under certain circumstances and relates to a question not present here. Neither party questions the notice of deficiency; the question here is whether the petition is a proper one. For reasons given above, we hold that there is no proper petition before us. Accordingly, the order entered in this proceeding on March 29,1937, will be vacated and respondent’s motion to dismiss for lack of jurisdiction is granted.

Order of dismissal will be entered.


author: Black:

text:
    Mary H. Walton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90250.
    Promulgated April 5, 1938.

      W. Richardson Blair, Jr., Esq., for the petitioner.

      S. U. Hiken, Esq., for the respondent.
   OPINION.

Black:

Section 25 (b) (1) of the Revenue Act of 1934 reads in part as follows:

There shall be allowed for the purposes of the normal tax and the surtax the following credits against net income:
(1) Personal exemption. — In the case of a single person, a personal exemption of $1,000; or in the case of the head of a family or a married person living with husband or wife, a personal exemption of $2,500. * * *

Congress has not defined “head of a family”, but the Treasury in its various regulations promulgated under the several revenue acts has defined the term.

Regulations 86 (Revenue Act of 1934) is applicable to the taxable years under consideration. Article 25-4 of those regulations reads in part as follows:

A Read of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. * * *

In support of her contention petitioner cites Alfred E. Fuhlage, 32 B. T. A. 222, whereas the Commissioner relies upon our decision in W. E. Massey, 14 B. T. A. 407; affirmed on this point, Massey v. Commissioner, 51 Fed. (2d) 76. We think the facts in the instant case bring it more within the scope of the Massey case than the Fuhlage case.

In the Massey case the facts briefly were these: During 1919, 1920, and 1921, the taxpayer was a single man and maintained a home. During 1919 and a part of 1920 his mother lived with him, and during 1919,1920, and 1921 his sister also lived with him and supervised the running of the household. The taxpayer paid the expenses of the home and also his sister’s expenses. The sister was 42 or 43 years of age. On these facts we held that the taxpayer, W. E. Massey, was not the head of a family within the meaning of the applicable statute. The court in affirming our decision on this point, said:

The Board of Tax Appeals took the view that the taxpayer’s adult sister had the status of an employee rather than a dependent, and that contributions to her support were in return for the performance of the duties of a housekeeper rather than by reason of any legal or moral obligation of support. Because of paucity of evidence upon this subject we are unable to say that the Board was wrong. Its order is therefore affirmed.

We do not think it can be said that the support which petitioner’s son, Crawford, received from her during the taxable years was due to the fact that he was dependent upon her for support. Rather do Ave think it was because he felt that his mother, on account of her advanced age, required his assistance in attending to her affairs, acting as her chauffeur and as her companion. Hence he placed himself at her service. These duties and services which he performed for her were praiseworthy on his part, yet we do not think they put him in the status of a dependent but rather bring him within the rule announced by the Board and approved by the court in the Massey case. A reading of the applicable regulation which we have quoted above shows that the individual or individuals whom the taxpayer must maintain and support in one household in order to constitute him the “head of a family” must be dependent upon him for support. The language of the regulation is, among other things, “and whose right to exercise family control and provide for these dependent individuáis is based upon some moral or legal obligation.” (Italics ours.)

An identical regulation under the Revenue Act of 1928 was approved by us in Alfred E. Fuhlage, supra. One who has independent means of his own or whose status is that of an employee earning his own support by his services is not classed as a dependent even though he is a member of the taxpayer’s household and has a close blood relationship to the head of the household. Hannah D. Stratton, 5 B. T. A. 1025; Chester F. Morrow, 9 B. T. A. 448; Louise Kingsley, 11 B. T. A. 296; Louise C. Ball, 16 B. T. A. 785; W. E. Massey, supra.

We sustain the Commissioner in his allowance to the petitioner of a credit of $1,000 personal exemption in each of the taxable years and in disallowing the claimed credit of $2,500 as the head of a family.

Decision will he entered for respondent.


author: HabRon:

text:
    George D. Graham, Petitioner, v. Commissioner of Internal Revenue, Respondent. Neva B. Graham, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 87570, 87571.
    Promulgated April 8, 1938.

      J. E. Hammond, Esq., for the petitioners.

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

HabRon:

Two questions for decision are presented — (1) whether the transaction in which the Illinois Pacific Coast Co. (the Coast Co.) disposed of approximately 95 percent of its assets to the Owens Illinois Pacific Co. (the Owens Co.) was a sale giying rise to gain or loss, or a reorganization under the statute; (2) whether the transaction in which the Illinois Pacific Coast Co. transferred all its remaining assets in the amount of $302,000 to the Container Securities Co. (the Container Co.) in exchange for all the capital stock of the Container Co. was a reorganization under section 112 (i) (1) (A) or (B) of the Revenue Act of 1932.

In his original determination of the deficiency here in question the respondent treated the transaction between the Coast Co. and the Owens Co. as a sale and allowed a loss assignable to common stock in the amount of $4,160.45 to petitioner George D. Graham and $300.37 to petitioner Neva B. Graham, citing Pinellas Ice & Cold Storage Co. v. Commissioner, 57 Fed. (2d) 188. At the hearing the respondent changed his position as to this transaction, and he now contends that since a substantial part of the property received by the Coast Co. for its assets and distributed to its stockholders consisted of debentures of the Owens-Illinois Glass Co., there was a continuity of interest, and the transaction was a reorganization and no loss from the exchange can be recognized under the Revenue Act of 1932.

The petitioners contend that both transactions taken as a whole constituted a sale of the major portion of the corporate assets and the subsequent distribution of the properties in liquidation and therefore the loss should be recognized under section 115 (c) of the Revenue Act of 1932.

The Coast Co. disposed of approximately 95 percent of its assets to the Owens Co. for $1,500,000 in cash, $1,625,000 in Owens-Illinois Glass Co.’s 10-year debentures, and the assumption by the Owens Co. of its bonded indebtedness in the amount of $2,500,000.

The Owens-Illinois Glass Co. was not a party to the transaction, but the Owens Co. was its wholly owned subsidiary. The debentures in question matured January 1, 1939, but were called in 1933, within a year from the time they.were distributed by the Coast Co. to its stockholders in dissolution.

The Commissioner relies on Lucien H. Tyng, 36 B. T. A. 21. We think that case may be distinguished from the case before us on the facts. In the Tyng case A acquired all the voting stock and a majority of the shares of all other classes of stock of B and C in exchange for cash and its long term debentures. We there held, following Kaspare Cohn Co., Ltd., 35 B. T. A. 646, that there was a plan of reorganization; that the long term debentures gave a sufficient continuity of interest; and that the transaction resulted in a reorganization under section 112 (i) (1) (A) of the Revenue Act of 1928. Here, the debentures received were not the evidences of indebtedness of the Owens Co., the party which acquired the assets, but of the Owens-Illinois Glass Co. Moreover, it does not appear that the parties intended the stockholders of the Pacific Co. would retain a continuing interest. In the Tyng case, on the other hand, there was an intention expressed in the agreement that a part of the consideration for the transfer of the stock would be long term debentures which would permit a continuing interest.

The transaction here comes within the language of section 112 (i) (1) (A) of the Revenue Act of 1932. The Owens Co. acquired substantially all the properties of the Pacific Co. While this may appear to be a merger of the two corporations within the literal definition of the reorganization provisions of the statute, it is not necessarily so, and the transaction must be further examined to determine whether it is a reorganization within the meaning of the statute, Gregory v. Helvering, 298 U. S. 465, or whether it was in reality a sale in which the securities must be regarded as cash. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462.

When we examine the record before us there does not appear to have been a plan of reorganization, but rather a plan to sell and liquidate the assets of the Coast Co. The transfer of a large portion of its assets to the Owens Co. for cash and debentures of the Owens-Illinois Glass Co. was a part of that plan. The transaction was referred to by the board of directors of the Coast Co. in their resolution of March 15,1932, as a sale of the assets and business of the corporation, and the acts of the parties are thoroughly consistent with their expressed intention of a sale of the assets and a distribution of the proceeds in liquidation. It can hardly be said the plan contemplated that the Coast Co. or its stockholders would retain a “continuing interest” in the assets transferred for cash and debentures which matured in the short term of about six and one-half years and were in fact called within a year. Moreover, the debentures were not the securities of the Owens Co., a California corporation, which acquired the assets, but of the Owens-Illinois Glass Co., an Ohio corporation which, although undoubtedly interested in the transaction through its stock ownership of the Owens Co., was, nevertheless, not a “party to a reorganization” within the ordinary meaning of that term or the statutory definition in section 112 (i) (2) of the Revenue Act of 1932. Groman v. Commissioner, 302 U. S. 82; Helvering v. Bashford, 302 U. S. 454. Considering all the facts and circumstances of the case, we are of the opinion that the transaction was not a merger and a reorganization according to a plan of reorganization within the meaning of the statute, but must be considered a sale for a definite sum of money and certain debentures. These debentures must be treated as cash to the extent of their fair market value when distributed in liquidation and applied in payment in exchange for petitioners’ common stock. The resulting gain or loss must be determined as provided in section 115 (c) of the Revenue Act of 1932. Cf. Pinellas Ice & Cold Storage Co. v. Commissioner, supra.

The second question in issue is whether the transfer by the Coast Co. of the remainder of its assets of the value of $302,000 in exchange for all the stock of the Container Co. was a reorganization within the intendment of the statute. Clearly it was not a reorganization under section 112 (i) (1) (A), as contended by the respondent. The transaction was neither a merger nor a consolidation as therein defined. It can not be seriously contended that $302,000 was “substantially all the properties” of the Coast Co. Nor do we think it was a reorganization within section 112 (i) (1) (B). The Container Co. was organized to liquidate the remaining assets of the Coast Co. and not to carry on any business enterprise. It was only a means used by the Coast Co. to this end. It was not created pursuant to a plan to reorganize any corporate business, but pursuant to a plan to facilitate the liquidation of a corporation. We think that the statute was not intended to include such a transaction under section 112 (i) (1) (B), even though it may come within the definition of the statute, and that the question must be answered in the negative. Gregory v. Helvering, supra; Helvering v. Elkhorn Coal Co., 95 Fed. (2d) 732; A. W. Mellon, 36 B. T. A. 977,1070.

In Gregory v. Helvering, supra, the Supreme Court said:

When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made “in pursuance of a plan of reorganization” (section 112 (g)) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. * * *

Under the facts before us, we hold for the petitioners on both issues. This disposition of the case makes it unnecessary to discuss petitioners’ contention that the additional deficiency claimed by respondent at the hearing was not sufficiently definite to comply with section 272 (e) of the Eevenue Act of 1926. It will suffice to say that we think it was sufficiently definite to fix the amount of the deficiency determined.

Decision will be entered for the petitioners.

      (i) Definition of Reorganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation).


text:
    Collateral Mortgage and Investment Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88991.
    Promulgated April 12, 1938.

      Morris Drob, Esq., for the petitioner.

      T. F, Gallaban, Esq., for the respondent.
   OPINION.

Black:

Petitioner in its income tax return claimed the $1,482.25 deduction here involved as a bad debt deduction. However, in the petition which has been filed the petitioner claims a loss of that amount on real estate which it claims was surrendered to the mortgagee during the taxable year. Respondent in his answer denied not only the allegations of error but also the allegations of fact upon which petitioner relied. In this state of the pleadings the burden of proving all elements necessary to establish its loss is upon petitioner.

We do not think petitioner has met that burden of proof. So far as the evidence shows there was no foreclosure of the first mortgage of $2,000 in 1934, and neither petitioner nor its nominee, Drob, deeded the property to the holder of the first mortgage. It is true that on April 19, 1934, Philadelphia Co. for Guaranteeing Mortgages, which was apparently the owner and holder of the first mortgage, notified Morris Drob, petitioner’s nominee, that it was entering into possession of the property due to default in payment of November 6,1933, interest amounting to $60 and nonproduction of 1933 tax and water receipts. The letter notified the addressee that: “We shall be obliged to take action against your Association unless the defaults are cured immediately.” (Italics supplied.) The evidence indicates that petitioner did not cure the defaults and has not since undertaken to have anything to do with the property, but what “action” the mortgagee has taken is not clear.

As we have already stated, the record does not show there has been any foreclosure, nor does it show that Morris Drob, the holder of the legal title to the property as the nominee of petitioner, has deeded it back to the mortgagee. This being the state of the record, we do not think petitioner has proved such an identifiable event as would fix its loss. A taxpayer can not take a loss on real estate where he continues to hold title to the real estate and no identifiable event has occurred by which the claimed loss becomes a closed transaction. Greenleaf Textile Corporation, 26 B. T. A. 737; affd., 65 Fed. (2d) 1017. Cf. Frederick Krauss, 30 B. T. A. 62; Herman M. Rhodes, 34 B. T. A. 212. On the strength of these authorities we sustain the Commissioner in disallowing petitioner’s claimed loss of $1,482.25.

We shall next take up petitioner’s alternative contention, which is that the Commissioner erred in imposing upon petitioner a surtax of $516.97 under the provisions of section 351 of the Revenue Act of 1934.

Petitioner does not contend that it is not a personal holding company as defined by section 351 (b) (1) of the Revenue Act of 1934, but contends that, by reason of paragraph (d) of that section, provision is made for the inclusion in the returns of the company’s shareholders on a pro rata basis of the “adjusted net income” of the company and thus relieve the company from the payment of any surtax.

As has already been stated, Morris Drob was petitioner’s only stockholder during the taxable year, and no showing has been made that in his individual income tax return he reported as a part of his gross income the “adjusted net income” of petitioner for such year. His willingness now to do so would be Immaterial. Under these circumstances, petitioner would not be entitled to be relieved from the payment of the surtax, if it is otherwise liable. Cf. Automobile Loan, Inc., 36 B. T. A. 809.

The next and final contention of petitioner is that the Commissioner erred in the imposition of a penalty of $129.24. Petitioner’s assignment of error in this 1’espect is as follows:

(c) Petitioner contends that the penalty of $129.24 should be cancelled for the reason that there was no fraud with intent to evade tax, in fact petitioner avers there was no additional tax.

It is plain that the Commissioner has not determined a fraud penalty against petitioner. What he has done is to impose a penalty of 25 percent of the surtax of $516.97 which he has determined under the provisions of section 351, for failure to file a return on form 1120 H as required by article 351-8, Regulations 86.

As shown in our findings of fact, petitioner first filed a tentative return on form 1120, March 15, 1935, and secured an extension of time until July 15, 1935, to file a completed return. On July 15, 1935, a completed return on form 1120 was filed by petitioner. Form 1120 is the one customarily filed by corporations in reporting their income and deductions for income tax and excess profits tax purposes. This return filed by petitioner showed income from profits, interest, rents, capital gains, and dividends aggregating $7,059.48 and deductions aggregating $7,193.92, showing a loss of $134.44 on the return and no tax due.

As has already been stated, petitioner filed no return on form 1120 H, required of personal holding companies, and this return was filed for petitioner by the Commissioner of Internal Revenue, in which he reported that petitioner had an adjusted net income for 1934 of $2,154.02. The question is whether petitioner’s failure to file a return on form 1120 H justified the Commissioner in imposing the 25 percent penalty.

Section 291 of the Revenue Act of 1934 provides a 25 percent penalty for failure to make and file a return required by Title I. Section 351 (c) provides that all laws applicable to Title I shall also be applicable to Title I-A, including imposition of penalties.

In the case of corporations coming under the classification of personal holding companies under section 351 of the Revenue Act of 1934, the regulations seem to require two returns. One on form 1120, for imposition of the tax under Title I, and the other on form 1120 H, for the surtax imposed under Title I-A. Petitioner filed a return on form 1120, and the Commissioner in determining a deficiency of $194.76 under Title I did not add any penalty. However, the Commissioner determined a surtax of $516.97 under Title I-A added a penalty of 25 percent of the surtax.

Since article 351-8 of Regulations 86 requires that a separate return be filed for the surtax imposed under section 351 and that such return be made on form 1120 H, and since petitioner has not filed any such separate return for the surtax imposed by section 351, the imposition of the 25 percent penalty imposed by section 291, made ápplicable by 3'51 (c), would seem mandatory. Cf. Paul L. Case, 37 B. T. A. 365; John Brown, 35 B. T. A. 111; Harry D. Kremer, 31 B. T. A. 566.

Decision will be entered for respondent.

      (d) Payment oír Subtax on Pro Rata Shakes. — The tax imposed by this section shall not apply if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire pro rata shares, whether distributed or not, of the “adjusted net income” of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of earnings or profits for such taxable year shall, if distributed to any shareholder who has so included in his gross income his pro rata share, be exempt from tax in the amount of the share so included.

       Aut. 351-8. Return and Payment of Taw. — A separate return Is required for the surtax imposed under section 351. Such return shaU be made on Form 1120H. In the case of a personal holding company which is a domestic corporation, the return is required to be made within the time prescribed in section 53 and in the case of a foreign corporation within the time prescribed in section 235. The tax shown by the corporation on its return must be paid in the case of a domestic corporation within the time prescribed in section 56 and in the case of a foreign corporation within the time prescribed in section 236. The same provisions of law relating to the period of limitation for assessment and collection which govern the taxes imposed by Title I also apply to the surtax imposed under Title IA. However, since the surtax imposed under Title IA is a distinct and separate tax from those imposed under Title I, the making of a return under Title I will not start the period of limitation for assessment of the surtax imposed under Title IA. If the corporation subject to section 351 fails to make a return, the tax may be assessed at any time. If the Commissioner finds a deficiency in respect of the tax imposed by section 351, he is required to follow the same procedure which applies to deficiencies in income tax under Title I. The penalties applicable to the income taxes imposed under Title I, as well as the provisions of Title I relating to interest and additions to the tax, also apply to the surtax imposed by section 361. The administrative provisions applicable to the surtax imposed by section 351 are not confined to those contained in Title I but embrace all administrative provisions of law which have any application to income taxes.

       SEC. 291. FAILURE TO FILE RETURN.
      In case of any failure to make and file a return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, 25 per centum of the tax shall be added to the tax, except that when a return is filed after such time and it is shown that the failure to file it was due to reasonable cause and not due to willful neglect no such addition shall be made to the tax. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which cáse the amount so added shall be collected in the same manner as the tax. The amount added to the tax under this section shall be in lieu of the 25 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended.

      (c) Administrative Provisions. — AU provisions of law (including penalties) applicable in respect of tbe taxes imposed by Title X of this Act, shall insofar as not inconsistent with this section, be applicable in respect of tbe tax imposed by this section, except that the provisions of section 131 of that title shall not be applicable.


author: Mellott :

text:
    Courtney Burton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75846.
    Promulgated April 12, 1938.

      Earl W. LeFever, Esq., and Thomas F. Veach, Esq., for the petitioner.

      S. B. Pierson, Esq., for the respondent.
   opinion.

Mellott :

Petitioner concedes that he is not entitled to the deduction claimed in his return. The law is well settled that a deduction for estate, inheritance, legacy, or succession taxes may be allowed “only to the estate.” (Sec. 23 (c), Revenue Act of 1928) Gillette v. Commissioner, 76 Fed. (2d) 6, affirming 29 B. T. A. 561; Martz v. Commissioner, 82 Fed. (2d) 110. The sole issue submitted for our determination, as set out in the petition and argued upon brief, is whether or not the amount was properly included in petitioner’s gross income for the taxable year.

The applicable statute is section 162 of the Revenue Act of 1928, a portion of which is shown in the margin.

The gist of petitioner’s argument is that since the $23,710.48 came into the hands of petitioner’s guardian for the agreed and specific purpose in part to apply on the inheritance tax and in part to repay a loan applied on said tax as a method of paying said tax out of the income from said stock trust, none [of it] * * * came into said guardian’s hands as income to petitioner’s estate because all thereof went through the guardianship estate merely as an instrumentality for getting the tax paid out of the trust stock income”, the trust instrument (1927 trust) having provided that the trustees should pay all taxes levied or imposed upon the principal or income of the trust estate, including inheritance, succession, and estate taxes which might be levied against it.

In Albert W. Russel, 35 B. T. A. 602, we had before us the question whether or not the amount of the inheritance and succession taxes paid by the trustees of the 1927 trust was taxable to the beneficiaries as income received by them during the year in which the payment was made. We ruled that such amount was not income because of the fact that the trust instrument did not give the beneficiaries a present right to the portion of the income required for the payment of such taxes. But we have no such question here. The real estate trust did not require that the income from it be used to pay the inheritance and succession taxes and the payment in question was not made by the trust which acquired the property, the transmission of which gave rise to the tax. Nor was the tax in question paid by the 1927 trust. It owed none of the additional tax, the entire amount thereof being assessed against the estate by reason of the inclusion of the real estate in it. Petitioner, not as a beneficiary under the 1927 trust, but only as a beneficiary under the real estate trust and as a legatee under his mother’s will, was interested in having the additional tax paid in order to protect his real estate. The executors did not wish to use the funds in the general estate to pay the additional tax, since to do so would have necessitated either the deferring of, or the reducing of, the payments to the specific legatees under the will of the decedent. The 1927 trust, having paid the inheritance and succession taxes due by virtue of including the corpus in the estate of the decedent, naturally did not wish to pay the additional tax upon the real estate. The most reasonable thing to do was just what was done, namely, to call upon the one who was most interested in preserving the corpus of the real estate trust to pay the tax due. The modus oferandi adopted for that purpose is fully shown in our findings.

Under the circumstances we think it must be held that the amount distributed to petitioner’s guardian constituted income. The whole scheme of the taxing act, as pointed out by the Supreme Court in Helvering v. Butterworth, 290 U. S. 365, is “to tax in some way the whole income of all trust estates. If nothing was payable to beneficiaries, the income without deduction was assessable to the fiduciary. But he was entitled to credit for any sum paid to the beneficiary within the intendment of that word, and this amount then became taxable to the beneficiary. Certainly, Congress did not intend any income from a trust should escape taxation unless definitely exempted.” The 192T trust had an income of $161,447.86. It reported and included in its taxable income $38,197.61, deducting not only the amounts paid to the beneficiaries Russel and Oglebay, each of whom received 15 percent, but also the $79,799.83 paid to petitioner’s guardian. The act (sec. 162, supra) clearly justifies the inclusion of the entire amount received by petitioner in his gross income, and, since he is not entitled to the deduction claimed, the deficiency determined by the respondent must be approved.

It would serve no useful purpose to discuss or decide what the tax situation would have been if the executor of the decedent’s estate, the trustee of the 1927 trust, or the trustee of the real estate trust had paid the additional taxes. Cf. Albert W. Russel, supra; Blanch A. Bagnall, 35 B. T. A. 1; Junius Beebe, 26 B. T. A. 190; affd., 67 Fed. (2d) 662; the Pennsylvania Co. for Insurances on Lives & Granting Annuities, Executor, 32 B. T. A. 449; affd., 83 Fed. (2d) 545; Robert P. Scripps, 33 B. T. A. 963 (on appeal to C. C. A., 6th Cir.); Arma F. Ardenghi, 37 B. T. A. 345.

Judgment will be entered for the respondent.

       The net income of the estate or trust shaR be computed in tbe 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, and the amount of the income collected by a guardian of an infant which is to he 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;
      (c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, 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 properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.


author: Txson :

text:
    John W. Burdan, Clara M. Kulp, Elsie S. Burdan, the Security Trust Company, Executors, Estate of C. C. Burdan, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87506.
    Promulgated April 13, 1938.

      Harold D. Baylor, Esq., and John B. Peery, O. P. A., for the petitioners.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Txson :

The question to be decided is whether C. C. Burdan actually sustained in 1933 a loss of $118,400, the cost to him of 3,200 shares of class A common stock of the Products Corporation. Petitioners contend that the loss was sustained by reason of the fact either (1) that said shares became worthless in that year, or (2) that it became certain in 1983 that those shares, which had been pledged as collateral, would never be returned to him and that as a consequence his entire investment therein then became lost.

A loss upon worthless stock is deductible only in the year in which the stock actually becomes worthless, and the burden is upon the petitioners to establish by reasonably convincing evidence that the claimed loss herein was sustained in the taxable year of 1933. Royal Packing Co. v. Commissioner, 22 Fed. (2d) 536; Forbes v. Commissioner, 62 Fed. (2d) 571; United States v. White Dental Manufacturing Co., 274 U. S. 398.

In this proceeding the evidence establishes that, while the Products Corporation was experiencing some financial difficulties during 1933, the extent of which is not fully disclosed, it was a going concern which had sales in excess of $16,000,000 during that year and had assets in excess of $25,000,000 at the close of 1933, valued on a going concern basis. There is no evidence of insolvency of the Products Corporation during 1933 even though it did sustain an operating loss of approximately $602,000 during that year and experienced difficulty in the collection of the subscriptions made under the 1932 plan of reorganization of the Operators Co. During 1933 the Products Corporation collected approximately $180,000 of such subscriptions and there is no evidence of what portion, if any, of the unpaid subscriptions, amounting to approximately $719,000, carried as an asset at the end of 1933, was definitely uncollectible. The fact that there had been a shrinkage in the value of the Products Corporation common stock owned by C. C. Burdan and that the conditions existing at the end of 1933 may have been such as to lead him to his conclusion that, without a change for the better, he probably would sustain a loss on his investment in such stock, is not sufficient to establish actual worthlessness in that year. Upon this record we conclude that the class A common stock of the Products Corporation did not actually become worthless in 1933. Cf. C. A. Goding, 34 B. T. A. 201; appeal dismissed February 11, 1938; Daniel J. Ryan, 19 B. T. A. 52; H. H. Moyer, 12 B. T. A. 429.

The 3,200 shares of class A common stock of the Products Corporation which C. C. Burdan loaned to the Operators Co. in the spring of 1932, for the latter’s use as collateral, were to be returned to him in kind. Under the 1932 plan of reorganization the Products Corporation assumed the obligation to return such shares in kind after its repayment of the bankers’, brokers’, and Burdan’s loans out of collections on the subscriptions made under the plan of reorganization, but it was further provided that, if after three years such collections were insufficient to reimburse the Products Corporation to the extent of its obligation to repay those loans, then such shares were to stand as security to the Products Corporation for any deficiency.

At the close of the year 1933 the loans on which C. C. Burdan’s shares had been pledged as collateral had not been fully repaid and accordingly he was not then entitled to have his shares returned to him. During the year 1933 the Products Corporation had collected approximately $180,000 on the subscriptions and had reduced the loans by that amount. The record discloses that there was a decline in the amount of subscriptions collected, but there is no evidence establishing the fact that as of the close of the year 1933 future collections on such subscriptions would be wholly insufficient to repay the loans.

The testimony of a witness to the effect that he believed that in 1933 the stock had been transferred to the name of a bank as trustee is too vague and indefinite to constitute any proof that the stock had been appropriated or converted by the Products Corporation. Consequently there is no proof of the creation of a debt due Burdan, in any amount, on account of an appropriation or conversion of his 3,200 shares of Products Corporation stock in 1933. However, petitioners do not press a claim for a deduction of any amount as a worthless debt. The petitioners’ effort to establish that the stock had been appropriated in 1933 was made in support of their contention that Burdan sustained a loss of his entire investment of $118,400 in the 3,200 shares of Products Corporation stock, because it became certain in 1933 that the stock would never be returned to him.

Upon this record we conclude that in 1933 it was not established that C. C. Burdan’s 3,200 shares of class A common stock of the Products Corporation would never be returned to him by the parties to whom it had been loaned. Therefore, there is no basis in fact to support the claimed loss of $118,400 on that ground.

Decision will be entered for the respondent.


author: Leech:

text:
    Bertha M. Bailey and W. C. Bailey, Jr., Executors of the Estate of Walter C. Bailey, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent. Bertha M. Bailey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 75993, 75994.
    Promulgated April 13, 1938.

      George R. Beneman, Esq.,. D. Hays Solis-Oohen, Esq., and D. Benjamin Kreseh, Esq., for the petitioners.

      I). A. Taylor, Esq., for the respondent.
   OPINION.

Leech:

The two issues presented for decision are (1) whether Walter C. Bailey and his wife were taxable on their receipt of Rey-burn Corporation stock in 1931 and the proper measure of that tax if they are taxable, and (2) the correctness of the imposition of the tax on the sale of the New Jersey building by Walter C. Bailey to Reyburn Corporation, which has been paid.

The respondent treated Walter C. Bailey, deceased, and his wife, as being in receipt of ordinary taxable dividends in their receipt of Reyburn Corporation stock, and so taxed them under the provisions of the Revenue Act of 1928, section 115. The petitioners contend that the receipt of that stock was not so taxable because of the provisions of section 112 (g) of the same revenue act.

Respondent argues that the transaction constituted a mere subterfuge by which Bailey and his wife, in effect, secured the distribution of a dividend from the Manufacturing Co., consisting of $365,000 of the surplus of that corporation which Bailey had borrowed from the corporation on his own notes.

Obviously, since Bertha M. Bailey was not a party to that borrowing and did not receive any part of it, she can not now be taxed on the theory that she did, unless we refuse to recognize Walter C. Bailey and his wife as two separate taxpayers. That premise would be unsound. Frank B. Gummey, 26 B. T. A. 894; Joseph E. Uihlein, 30 B. T. A. 399; sec. 51 (b), Revenue Act of 1928.

Whether Bailey’s borrowings from the Manufacturing Co., under the circumstances, might have been taxed as dividends to Bailey on their receipt, is not the question here. Because the business of the Manufacturing Co. under its charter did not include the loaning of money does not alter the fact that, on this record, it did loan money and that the notes evidencing those loans were assets of the company. Not only that, but the respondent did not consider these loans as dividends then and he does not do so now. The pending deficiencies involve a year after those in which the loans were made. Respondent supports these deficiencies against Bailey’s estate and his widow by treating Bailey’s notes as corporate assets distributed in the tax year as ordinary dividends, not only to him but to his wife, who was not a party to the loans and did not receive any part of them.

[Respondent agrees that the distribution of Reyburn Corporation stock to Walter C. Bailey and his wife, Bertha M. Bailey, falls literally within the provisions of section 112 (i)(l)(B). He admits that if this distribution occurred “in pursuance of a plan of reorganization” within the meaning of section 112 (g), no taxable gain resulted to the Baileys by reason of the receipt of the Reyburn Corporation stock. Respondent rests his position solely on the proposition that the Manufacturing Co.’s exchange of part of its assets in the form of the Bailey notes for all of the stock of the Reyburn Corporation was not “in pursuance of a plan of reorganization” as construed by the Supreme Court in Gregory v. Helvering, 293 U. S. 465.

The facts in the Gregory case were briefly as follows: In 1928, G owned all of the stock of TJ corporation. Among the assets of TJ corporation were 1,000 shares of the stock of M corporation. For the sole purpose of diminishing the amount of income tax on the sale of the M corporation stock, G caused the Averill Corporation to be organized. The Averill Corporation then acquired from the TJ corporation the stock of M corporation in return for the issuance to G of all of the stock of Averill Corporation. Six days after it was organized, Averill Corporation was dissolved and liquidated by distributing all of its assets, namely, the stock of M corporation, to G. No other business was ever transacted or intended to be transacted by Averill Corporation. G immediately sold the M shares. In reporting the gain from the sale for tax, G apportioned to the M shares part of the cost to G of the stock of TJ corporation. The issue was whether the entire gain from the sale of the M shares was taxable to G as an ordinary dividend from the TJ corporation. The Supreme Court decided that it was. In so holding, the Court held that while the transaction literally complied with section 112 (g) of the Revenue Act of 1928, the exchange of the stock by TJ for Averill stock was not within the meaning of the statutory term, “in pursuance of a plan of reorganization.” The Supreme Court, inter alia, said:

* * * When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made “in pursuance of a plan of reorganization” (section 112 (g)) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either * * *.

Undoubtedly included within the “plan of reorganization” here were the organization of Reyburn Corporation, the exchange by the Manufacturing Co. of Bailey’s notes for the stock of Reyburn Corporation, the distribution of that stock, pro rata, to the shareholders of the Manufacturing Co. without the surrender of their stock in that company, and the purchase by Reyburn Corporation of Bailey’s New Jersey building, and its subsequent operation. See Edison Securities Corporation, 29 B. T. A. 483; affd., 18 Fed. (2d) 85; 34 B. T. A. 1188

If the plan was motivated solely by a purpose to escape tax, it would bave had “no relation to the business of either [corporationJ.” Gregory v. Helvering, supra; Helvering v. Minnesota Tea Co., 296 U. S. 378. But the fact that tax avoidance or postponement was considered incidentally with a proper purpose or that such tax consequences followed is not material. Gregory v. Helvering, supra.

The Gregory case is readily distinguishable on its facts. The Manufacturing Co. was organized in 1895. Its reality and validity have not been and can not be questioned. Its dissolution was neither planned nor effected. It still exists. Nor was it planned that the Beyburn Corporation dissolve, nor did it do so, as a part of the “plan.” See Robert R. McCormick, Executor, 33 B. T. A. 1046.

Bespondent has disregarded that latter fact here and has imposed the tax upon receipt of the Beyburn Corporation stock in 1931 by Walter C. Bailey and his wife. He does this on either of two theories. The first is that Beyburn Corporation is not to be recognized as a legal entity. The second position, apparently, is that even if Beyburn Corporation is to be so recognized, “the plan”, in pursuance of which the Manufacturing Co. exchanged part of its assets for all of Beyburn Corporation’s stock, was prompted solely or primarily by a desire to avoid income taxes.

We disagree with both theories. There is no more reason to disregard the entity of Beyburn Corporation than that of the Manufacturing Co., the entity of which is admitted. Gregory v. Helvering, supra; Burnet v. Commonwealth Improvement Co., 287 U. S. 415; Jones v. Helvering, 71 Fed. (2d) 214. In the Gregory case the Supreme Court specifically recognized the valid corporate entity of even the Averill Corporation, and there is much more substance and reality to Beyburn Corporation here. Undoubtedly it was organized for a business purpose. Whether the holding of the Bailey notes was such a purpose or not, the ownership and operation of the office building which it proposed to and did purchase from Walter C. Bailey, was. Thus, instead of dissolving and liquidating immediately after its receipt of assets from the Manufacturing Co. and the distribution of its stock to the stockholders of the latter company, Beyburn Corporation fulfilled its business purpose by owning and operating that building for a period of three years.

It was not until the end of that period, when foreclosure became imminent, that it then deeded the building to a corporation representing the owners of the second trust, rather than permit foreclosure. After that foreclosure and the death of Walter C. Bailey, Beyburn Corporation did dissolve and liquidate by offsetting its assets in the form of the Bailey notes against its own purchase money obligations in the same amount which the estate of Bailey held. It was then and not when the Beyburn Corporation stock was distributed to the Baileys that they received Manufacturing Co. assets in the form of Bailey’s notes. Until that liquidation occurred, petitioners were no closer to the exchanged assets than they were before and even then they were not received by them as a liquidating distribution.

Assuming, without deciding, the propriety of extending the rule announced by the Supreme Court in the Gregory ease to a situation where, as here, dissolution and liquidation of the transferee corporation did not occur as part of “the plan”, we think the rule can not be applied here. The elimination of the Bailey notes from the accounts receivable of the Manufacturing Co. was imperative to the maintenance and protection of its credit. The disposition or elimination of that item could have been accomplished in many ways. Undoubtedly the tax results of the plan as adopted and executed were considered. But this record convinces us that the motivating reasons for that plan were the necessary preservation of the credit of the Manufacturing Co. by the elimination of Bailey’s notes from its accounts receivable and the segregation of those notes in the Beyburn Corporation with the New Jersey building which had been purchased by Bailey with the proceeds of those notes.

The owning and operation of the New Jersey building by the. Beyburn Corporation may not have been related to the business of the Manufacturing Co. However, the transfer of the Bailey notes to Beyburn Corporation was thus related. The maintenance and protection of its own credit, thus accomplished, was directly and necessarily related to the business of the Manufacturing Co. That, in itself, is sufficient to characterize the plan which included the exchange by the Manufacturing Co. of the Bailey notes, a part of its assets, for all the Beyburn Corporation stock, as a “plan of reorganization” within section 112 (i) (1) (B), supra, as construed by the Supreme Court in the Gregory case, supra.

It follows that the distribution of the Beyburn Corporation stock to Walter C. Bailey and his wife, Bertha M. Bailey, without the surrender of their Manufacturing Co. stock was within the provisions of section 112 (g), supra, and was, therefore, not taxable. Gregory v. Helvering, supra; Helvering v. Minnesota Tea Co., supra; Bremer v. White, 10 Fed. Supp. 9; Bruce v. Helvering, 76 Fed. (2d) 442; Ballwood Co. v. Commissioner, 84 Fed. (2d) 733.

We decide the second issue for respondent. We can not agree with petitioners’ contention that the payment for the account of the late Walter C. Bailey of $5,781.25 as additional tax and interest upon a claimed profit accruing from his sale of the New Jersey property to Beyburn Corporation constituted an overpayment of tax to a refund of which his estate is entitled. The property in question was sold to Beyburn Corporation for a consideration in excess of its cost to Walter C. Bailey. This consideration was paid in notes of the purchaser. It is now argued by the executor that the property thus conveyed had no value. Consequently, they say it did not constitute an asset in the hands of the purchaser, that the only assets possessed by Eeyburn Corporation standing back of its notes for $365,000 given to Bailey in the purchase were the notes in the same amount due from Bailey, which had been acquired by Eeyburn Corporation in exchange for its stock and that these latter notes were uncollectible.

We are not impressed with this argument. It is not contended that Bailey was insolvent and the evidence shows that he was receiving a very large yearly income. Moreover, the notes of the face value of $365,000 received by him from Eeyburn Corporation were usable to their full face value by his estate as an offset to notes in the same amount due from him and held by that corporation. Since the Eey-burn Corporation notes received could have been used at any time by Bailey to save or offset the payment by him of $365,000, we think these notes had a value in his hands equal to their face value in view of the fact that his insolvency is not only not established but is contradicted. The record does not sustain the payment of this item as an overpayment of tax.

Decision will he entered, wider Bule 50.


author: Hill:

text:
    Ortiz Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86112.
    Promulgated April 13, 1938.

      Harry O. Weeles, Esq., for the petitioner.

      Ralph E. Smith, Esq., for the respondent.
   OPINION.

Hill:

Issue (1). — Petitioner complains of the action of respondent in determining that it derived a profit from drilling the Hale No. 3 well. Petitioner owned a one-half interest in the Hale lease, the other half being owned by three individuals. Petitioner drilled a well on the property under an agreement whereby the other joint owners were to pay the sum of $5,750 as their share for drilling and equipping a well. One-half of the actual cost to petitioner was $4,122.23, and the difference between this amount and $5,750 received by petitioner from the other joint owners, or $1,627.77, respondent included in gross income as profit derived from the transaction.

It cost the petitioner $8,244.46 to drill and equip the well and it claims the total amount thereof as its development cost and endeavors to capitalize it as such. This claim is apparently based on the theory that the well and equipment were the property solely of petitioner until its coowners paid for an interest therein after the well was drilled and equipped. Accordingly, petitioner charged the amount of $8,244.46 to development cost and credited thereon the $5,750 paid by its coowners, thus reducing its claimed development cost to a net of $2,494.46. We can not accept this theory. The development was a joint enterprise of petitioner and its coowners of the lease under the agreement that petitioner would drill and equip the well in consideration of the payment to it by the coowners of the flat sum of $5,750 for their one-half of such development. This was a turnkey agreement as to the interest of the coowners in the development. The well with the equipment was a development of which the petitioner owned an undivided one-half interest and its coowners a like interest from the inception of the development. Notwithstanding that it cost $8,244.46 to drill and equip the well, the burden of only one-half of such cost was upon petitioner. Its development cost in this connection was applicable to only a one-half interest in the equipped well and was $4,122.28 instead of $8,244.46, or instead of the latter amount less the credit of $5,750 as claimed by petitioner. Petitioner at no time owned more than a one-half interest in the well and equipment and acquired no capital investment and incurred no development cost in respect of its coowners? one-half interest therein. The sum of $5,750 paid to petitioner by its coowners was, under the turnkey agreement, development cost of such coowners, applicable to their one-half interest in the equipped well, and no part of that sum should be credited to petitioner’s development cost. Under the turnkey agreement with its coowners petitioner realized a profit in the amount of the difference between $5,750 and $4,122.23, or $1,627.77, which should be included in its gross income. Accordingly, upon this issue we sustain the respondent.

Issues (0) and (3). — The transactions between petitioner and Westbrook and Thompson and between petitioner and C. H. Staley were substantially similar, differing only as to properties and amounts. Both were treated by the respective parties hereto in the same manner. For convenience our discussion will be limited principally to the transaction with Westbrook and Thompson. However, the conclusions reached will apply equally to the transaction with Staley.

The transaction with Westbrook and Thompson petitioner treated on its books as a loan. ‘ In its income tax return, petitioner included in gross income the total proceeds from the sale of oil in the taxable year, and claimed as a deduction for interest approximately four-sevenths of the amount paid in such year to Westbrook and Thompson, approximately three-sevenths of that amount being regarded as repayment of borrowed principal. In computing the deficiency, respondent disallowed the deduction for so-called “interest expense”, and treated the total amount received by petitioner from Westbrook and Thompson as proceeds from the sale of “oil payments”, but included the amount thereof in petitioner’s gross income from the properties, subject to depletion, and without deduction of any cost basis. Neither treatment of the transaction, we think, is correct.

Substantially, the situation involved here may be summarized as follows: During the taxable year petitioner owned certain oil and gas leases and had an opportunity to acquire certain other oil and gas leases, but did not have the required capital to make the purchase and to develop and operate the properties. It obtained options and then entered into negotiations with Westbrook and Thompson to acquire the necessary funds to finance the deal. The latter individuals paid $154,000 to make such purchase by petitioner, to drill two wells on leases already owned by petitioner and to pay some' of its outstanding obligations. The money was not furnished as a loan, to be repaid by petitioner at all events, with interest, as it was treated by petitioner, but as a cash consideration for the purchase by Westbrook and Thompson of certain specified proportions of the oil production, to the extent of $359,333.34 in value, if, as, and when same should be produced, saved, and sold from certain lands and leases, including, among others, those so purchased and drilled.

Such portions of the production belonged to and constituted property of Westbrook and Thompson, and petitioner was obligated only to pay over and account to them therefor, when produced. The lien given to Westbrook and Thompson was not intended to secure the repayment of a loan, but to insure that petitioner would adhere to and perform the conditions of the contract and “pay and account” to them for their share of the oil when produced.

Petitioner was to develop and operate the properties, and pay all expenses. Westbrook and Thompson acquired an “overriding interest”, their portions of the oil runs being net to them. Westbrook and Thompson paid the money in exchange for an agreed interest in any oil and gas or other minerals that might be “produced, saved and sold” from petitioner’s properties. If none were produced, they lost their money, and petitioner was under no obligation to repay it. The transaction constituted a sale by petitioner of oil in place and it realized taxable gain thereon in the amount of $154,000 less the amount of the cost bases allocable to the oils required to discharge the oil payments as set forth in our findings of fact. Westbrook and Thompson were entitled to receive the specified proportions of the proceeds of sales, or to take their share of the oil and gas production in kind, at their election. The balance of the proceeds or prodnction belonged to petitioner. Therefore, petitioner was not entitled to deduct as interest or otherwise any part of the proceeds of oil paid to Westbrook and Thompson.

The right to share in the oil produced constituted an interest in the oil in place. Hence, the right of Westbrook and Thompson to their proportion of the oil and gas, or proceeds from sales, upon production, constituted an economic interest in the properties, to the extent of the amount agreed upon. Likewise, the right of petitioner to the balance of production constituted an economic interest in the properties. Proceeds from sales of production, therefore, constituted income to Westbrook and Thompson to the extent of the proportion received by them, and the balance only constituted gross income to petitioner. Thomas v. Perkins, 301 U. S. 655; Commissioner v. Elliott Petroleum Co., 82 Fed. (2d) 193; Commissioner v. Fleming, 82 Fed. (2d) 324; Commissioner v. Williams, 82 Fed. (2d) 328. Petitioner is entitled to a deduction for depletion computed on the basis only of the income received by it as its portion of the production in the taxable year. Palmer v. Bender, 287 U. S. 551. It is not entitled to allowance for depletion on the proceeds of the sale to Westbrook and Thompson. Cf. Commissioner v. Fleming, supra, which affirmed 31 B. T. A. 623; Darby-Lynde Co. v. Alexander, 51 Fed. (2d) 56; and Lester W. Fritz, 28 B. T. A. 408.

The facts in the Staley transaction are so nearly like those in the Westbrook and Thompson transaction, except as to names and amounts, that the discussion on the latter is applicable to the former and the same conclusions of law must be reached in both. Accordingly, we hold that the Staley transaction constituted a sale by petitioner of oil in place and that petitioner realized taxable gain in the amount of $12,500, less the amount of the cost basis allocable to the oil required to discharge the oil payments as set forth in our findings of fact; that petitioner is not entitled to deduct as interest or other-, wise any part of the proceeds of oil paid to Staley; that it is entitled to a deduction for depletion computed on the basis only of the income from the property received by it as its portion of the production in the taxable year; and that petitioner is not entitled to an allowance for depletion on the proceeds of the sale to Staley of an interest in the oil production.

Issue (4)- — During the taxable year petitioner paid to Farrell and Moncrief the sum of $9,301.82 on account of the interest retained by them in the oil production from the Giles lease, and in the same year paid the trustees of the Kilgore Independent School District the sum of $1,122.05 pursuant to the terms of the lease by which the school district retained an interest in any oil produced from its land. In computing the deficiency, these amounts were included by respondent as part of petitioner’s gross income from the properties. The precise question presented here was decided in Thomas v. Perkins, supra. The amounts in controversy constituted income to the respective parties receiving them, since the payments were made under rights which represented retained economic interests in the properties. It follows that respondent erred in including such amounts in petitioner’s gross income. Respondent in his brief concedes error on this point.

Issue (5). — In 1932 petitioner drilled a dry hole on the Hale lease at a cost of $9,231.45, which amount it deducted on its return in computing taxable net income. Respondent allowed the deduction claimed by petitioner in determining its taxable income, but deducted the amount from gross income from the property in computing the limitation on the amount of depletion allowable under section 114 (b) (3), of the Reven'ue Act of 1932.

Development cost is not operating cost, and may not be deducted from gross operating income in determining the net income from the property for the purpose of applying the 50 percent limitation on the allowable deduction for depletion provided by the above cited statute, even though such cost has been deducted by petitioner from gross income in computing its taxable income. Respondent’s action on this point is reversed. Rocky Mountain Oil Co., 36 B. T. A. 365. See also Wilshire Oil Co., 35 B. T. A. 450; Mountain Producers Corporation, 34 B. T. A. 409; Ambassador Petroleum Co. v. Commissioner, 81 Fed. (2d) 474.

On brief, petitioner asserts that respondent in determining the net income from the property, before deducting depletion, took into consideration overhead expense and depreciation on physical equipment, in addition to the cost of drilling a dry hole, and contends that “operating profit” does not include such items as overhead expense and depreciation. This question not having been raised in the original pleadings or amendments thereto but raised on brief only, we decline to consider it in this proceeding. North American Coal Corporation, 28 B. T. A. 807; Jean Conrad, 27 B. T. A. 741, 743; H. Milgrim & Brothers, Inc., 24 B. T. A. 853, 856; American Industrial Corporation, 20 B. T. A. 188.

The deduction for depletion to which petitioner is entitled will be recomputed on the basis of the gross income and the net income from the various properties of petitioner, determined in accordance with the foregoing opinion.

Judgment will b& entered under Rule 50.