author: Love:

text:
    Terre Haute, Indianapolis and Eastern Traction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Indianapolis, Crawfordsville and Danville Electric Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Terre Haute Traction and Light Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Indianapolis and Northwestern Traction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 33858-33861.
    Promulgated September 29, 1931.

      A. E. Jamos, Esq., and Harry A. Fellows, Esq., for the petitioners.

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

Love:

The principal question involved in these proceedings is whether the four petitioners were affiliated and, therefore, entitled to file consolidated returns of income for the calendar years 1922 and 1923. The applicable statute is section 240 (c) of the Revenue Act of 1921, which provides as follows:

For tlie purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one .corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

The respondent determined that petitioners were not affiliated within the meaning of the statute. Petitioners contend that they come within section 240 (c) (1), sufra. They do not claim affiliation under section 240 (c) (2).

A brief outline of the salient facts set forth in our findings is that the parent company owned directly all of the common stock of the three subsidiaries, which amounted to 85 per cent of the total outstanding capital stock of the Northwestern Traction and 66% per cent of the total outstanding capital stock of each of the other two. The balance of the outstanding capital stock of the three subsidiaries consisted of preferred stock which had equal voting rights with every other share. A small percentage of this preferred stock, namely, 18.16 per cent in the case of the Light Company, 9.93 per cent in the case of the Northwestern Traction, and 3.40 per cent in the case of the Electric Railway, was owned by common and preferred stockholders of the parent company. The greater percentage, namely, 57.28 per cent in the case of the Light Company, 40.55 per cent in the case of the Northwestern Traction, and 70 per cent in the case of the Electric Railway, was owned by interests who owned no stock whatever .in any of the other three companies. The balance of the preferred, namely, 24.56 per cent in the case of the Light Company, 49.52 per cent in the case of the Northwestern Traction, and 26.60 per cent in the case of the Electric Railway, was owned by stockholders who held no stock in the parent company, but who did own some preferred stock in two or more of the subsidiaries. The parent company’s stock was owned principally by interests who owned no stock whatever in any of the three subsidiaries. Only 6.29 per cent of the common and 7.24 per cent of the preferred stock of the parent company was owned by stockholders who owned preferred stock in one or more of the subsidiaries. The parent company voted by proxy about one-half of the preferred stock of the subsidiaries and about 99 per cent of all the stock that was voted. Each of the subsidiaries leased all of their properties to the parent company for a period of 999 years, during which period the latter, as part of the rental, promised to pay a fixed dividend to the holders of the preferred stock. With but few exceptions the board of directors and officers of the four petitioners were made up and consisted of the same persons. The four corporations were operated as a single economic unit.

The question of affiliation has been before this Board and the courts many times. At present there have been at least 32 court cases (exclusive of the Federal District Courts), and affiliation was allowed in 14 cases and denied in 18.

Petitioners practically concede that an ownership of 66% per cent and 85 per cent, respectively, of the outstanding stock is not sufficient, by itself alone, to justify holding the four companies affiliated, for the reason that such percentages do not meet the requirement of “ substantially all ” in the statute. With this proposition we agree. See Commissioner v. Adolph Hirsch & Co., 30 Fed. (2d) 645; United States v. Cleveland, P. & E. R. Co., 42 Fed. (2d) 413; and Denunzio Fruit Co. v. Commissioner, 49 Fed. (2d) 41. In the second case supra the Sixth Circuit said: “ This stock, however, constituted only 77 per cent to 84 per cent of the total issue, which cannot be deemed substantially all ’ * * ⅜.”

Petitioners’ real contentions may all be condensed and restated as one ultimate contention, namely, that during the taxable years in question the parent company controlled through closely affiliated interests dll of the preferred stock of the subsidiaries, and, since it owned all the common stock, it owned directly or controlled through closely affiliated interests, not only “ substantially all,” but 100 per cent of all the stock of all the subsidiaries. We will direct our consideration to petitioners’ ultimate contention, for, if that be true, it would follow unquestionably that petitioners were affiliated within the meaning of the statute and entitled to file consolidated returns.

Did the parent company in the instant proceedings control through closely affiliated interests the preferred stock of the subsidiaries? Petitioner’s, in their brief, argue that the facts present twelve major reasons why they should be held affiliated. Eleven of these are in substance a restatement of the facts and relate to (1) direct stock ownership by the parent company, which we discussed in paragraph four above; (2) a voting by the parent company of approximately 99 per cent of all the stock that was voted; (3) the election of interlocking directorates; (4) acquiescence by preferred stockholders in the parent company’s management; (5) the selection of directors of the subsidiaries who were either associated with the parent company or were agreeable or useful to it; (6) the existence of the same officers in all the companies; (7) the ownership by stockholders of the parent company of the relatively small percentage of the preferred stock of the subsidiaries; (8) the ownership of preferred stock in two or more of the subsidiaries by persons who held no stock in the parent company; (9) the fact that if all the stock of the subsidiaries which was owned directly by the parent company, or by stockholders of the parent company, or by persons who owned stock in two or more of the subsidiaries but no stock in the parent company, were added together as representing ownership by the parent company or by interests closely affiliated therewith, the total percentage of shares so owned or controlled would amount to 80.9 per cent of the total outstanding shares of the Light Company, 93.9 per cent of the total outstanding shares of the Northwestern Traction, and 76.6 per cent of the total outstanding shares of the Electric Railway; (10) the provision in the several leases whereby all the physical properties and in effect the management of the businesses of the subsidiaries were turned over to the parent company for a period of 999 years, and wherein the respective lessor covenanted with the lessee to do certain specific things such as maintaining its corporate organization, holding all necessary meetings, electing directors and officers, making and keeping records, reports and returns required by law, and doing all acts as sliall be proper for the full protection, preservation and full enjoyment by the lessee of all the leased properties, and not to do certain specific things such as not to issue any additional stock nor to authorize the creation of any mortgage upon the leased properties, nor create any debts, become a party to any contracts or incur any obligations of any kind whatsoever during the term of the lease except as therein authorized; and (11) the operation of all four companies as one economic unit.

The facts upon which the above reasons are based do not, in our opinion, bring the four petitioners within the affiliation provision of the statute. Eegarding reasons (1), (7), (8) and (9), we do not believe that, because a nonstockholder of the parent company happens to own stock in two or more of the subsidiaries, that fact makes such a person a closely affiliated interest of the parent company. And even if it did, it would not follow that the parent controlled such stock. Block Street Wharf & Warehouse Co., 2 B. T. A. 183. In a few cases we have held that a stockholder of a parent company who also owned stock in a subsidiary was a closely affiliated interest of the parent, through whom the parent controlled the subsidiary stock so held. See Hamilton & Chambers Co., 1 B. T. A. 694; and Boker Cutlery & Hardware Co., 12 B. T. A. 1405. But in tíie instant case the percentage of subsidiary stock held by stockholders of the parent company was so small that when added to the subsidiary stock directly owned by the parent company, it amounted to only 72.7 per cent in the case of the Light Company, 86.5 per cent in the case of the Northwestern Traction, and 67.8 per cent in the case of the Electric Railway. Such percentages do not constitute “ substantially all.” Commissioner v. Hirsch & Co., supra; United States v. Cleveland, P. & E. R. Co., supra; and Denunzio Fruit Co. v. Commissioner, supra. Regarding reasons (2) and (4), the weight of opinion is that acquiescence on the part of the minority does not prove control of their stock by the majority. Commissioner v. Hirsch & Co., supra; Commissioner v. Richfield Oil Co., 42 Fed. (2d) 360; Ground Gripper Shoe Co., 21 B. T. A. 646; Burnet v. Bank of Italy, 46 Fed. (2d) 629; certiorari denied, 283 U. S. 846; and Commissioner v. City Button Works, 49 Fed. (2d) 705. In Continental Products Co., 20 B. T. A. 818, we said:

It is true that each year the Sulzberger Products Co. executed proxies to officers of the Cattle Co. and/or the Brazil Railway Co. This, however, is not the control required by the statute. Tunnel Railroad of St. Louis et at., 4 B. T. A. 596; Central Auto Equipment Co., 7 B. T. A. 1068; Empire Safe Deposit Co., supra; News Publishing Co. v. Blair, supra. The Sulzberger Co. might, at any time, have asserted its right to vote its stock and it could not have been prevented from so doing. As stated in Tunnel Railroad of St. Louis, supra, “ the right of a proxy is not a relinquishment by the donor of any of the rights of ownership or control.”

The test of the statute requiring affiliation is ownership or control of substantially all the stock, and not such factors as emphasized in petitioners’reasons (3), (5), (6) and (11). See Madera Yosemite Big Tree Auto Co. v. United States, 49 Fed. (2d) 672. And neither does management of the business referred to in reason (10) amount to control of the stock. Commissioner v. Hirsch & Co., supra.

The twelfth and principal reason advanced by petitioners as a ground for granting affiliation is that because the parent company in its leases with the subsidiaries had agreed to pay the preferred stockholders of the subsidiaries a fixed annual dividend on their preferred stock, such promise or guarantee tied the interest of those stockholders to itself and to its own property rather than to their separate interests as stockholders of the respective subsidiary companies; that regardless of the financial success of the subsidiary companies the parent company so long as the lease endured guaranteed the fixed annual income of the preferred stockholders of all the ¡subsidiaries; that such stockholders look solely for their dividend to the parent company; and that, therefore, such preferred stockholders should be regarded as closely affiliated interests of the parent company, from which petitioners contend it follows that the parent company controlled all such preferred stock, and since it owned all the common stock, it owned or controlled all of the outstanding stock of all the subsidiaries.

The foregoing reason is similar in principle to reasons (8) and (9), which we have already considered and held insufficient to warrant the allowance of affiliation. It is, however, much broader in that it involves all of the preferred stockholders instead of only those who owned stock in two or more of the subsidiaries but no stock in the parent. But even if we were to hold such preferred stockholders as closely affiliated interests of the parent, we fail to see how it would follow from such a holding that the parent controlled the preferred stock. As we said in Block Street Wharf & Warehouse Co., supra, “A tail does not necessarily control a dog because closely affiliated with it.” And again in Ground Gripper Shoe Co., supra, “ Undoubtedly, all of the stockholders of the Ground Gripper Stores, Inc., had the interest of profits and successful operation in common. But this did not constitute control of substantially all of the stock * * The facts in the instant proceedings present a strong case of what might be termed an economic affiliation. The properties of all the corporations were operated as a single enterprise and by substantially the same individuals as officers and directors of the separate companies. But Congress has not made this the test for affiliation under the statute. It is the ownership or control of substantially all the stock that governs, and it is that requirement that we find lacking here. Petitioners have placed considerable reliance upon our decision in Hartford Connecticut Western Railroad Co., 2 B. T. A. 211. We followed that decision in Mahoning Coal Railroad Co., 4 B. T. A. 923, but our decision in the latter case was in effect reversed by the Sixth Circuit in United States v. Mahoning Coal Railroad Co., 51 Fed. (2d) 208. The case most nearly in point here as to facts is that of United States v. Cleveland, P. & E. R. Co., supra. The court in that case made a most thorough study of the question, both from the legislative and judicial standpoint, and, after a full and able discussion thereof, concluded with the following remarks:

After an intensive study of the history of Sec. 240 (b) of the Act of 1918 and the conflicting interpretations which have been given it, we have arrived at the following conclusions: While the underlying purpose was to incorporate the departmental regulation purporting to tax as an economic unit any group of companies so operated as to make arbitrary apportionment of income possible, nevertheless, Congress made determinative not actual control of the related companies, or of the subsidiary by-the parent company, but the substantial ovonerslvip or control of their stoclc, or of the stoclt of the subsidiary by the parent company. Under a reasonable interpretation of the statute, the aforesaid underlying purpose cannot be given full effect, although, of course, the elimination, in subsequent Acts, of the alternative of “ control ” would not affect the interpretation to be given to the Act of 1918.
Applying these conclusions to the case at bar: we find that the two corporations, alleged to have been affiliated and so found by the Board of Tax Appeals and the District Court, were cóncededly operated as a single interurban road, that there was a complete identity of control of the businesses, and that the joint operating expenses were arbitrarily apportioned. Defendant actually owned 70.9 per cent of the stock of the Ashtabula Company, and voted by means of solicited proxies, over 99 per cent of the stock that was voted at the annual meetings. This stock, however, constituted only 77 peí-cent to 84 per cent of the total issue, — which cannot be deemed “ substantially all ” of the sole class of stock issued by the subsidiary corporation, within the fair meaning of the Act.
We give no consideration to the proxy stock. Even if it might be thought that these proxies in this case constituted, pro tanto, such stock control as Sec. 240 (b) contemplates, yet, clearly, there was neither ownership nor control of any kind over the other 16 per cent to 23 per cent of voting stock. While the grant of proxies by some and the. failure by others to vote at the annual meetings might be deemed an acquiescence in defendant’s economic control of the Ashtabula 'Company, that in our judgment, and under the great weight of the decisions, does not suffice for affiliation.

We have carefully considered all of petitioners’ contentions in connection with the facts (most of which were stipulated) and are of the opinion that the respondent did not err in holding that petitioners were not entitled to file consolidated returns for the years in question. His determination on this point is, therefore, approved.

Regarding the second issue, the respondent concedes in his brief that the taxable income of the parent company for the year 1922, as determined by him, should be reduced by the amount in question for that year of $8,855.77. And as far as this issue relates to the year 1923, the parent company concedes in its brief that, if affiliation is denied, we do not have jurisdiction to consider it, for the reason that the respondent has determined no deficiency against the parent company for that year. Accordingly, since we have denied affiliation, we have no jurisdiction to consider this issue as far as it relates to the year 1923. Cornelius Cotton Mills, 4 B. T. A. 255.

The third issue is whether the respondent erred in including in the taxable income of the Light Company for the years 1922 and 1923 the respective amounts of $5,051 and $4,947.71 on account of the purchase by that petitioner of its own bonds at these amounts less than par. We have consistently held in a long line of decisions that where bonds are retired at less than issuing price, the obligor derives no taxable income from such transaction. See Independent Brewing Co., 4 B. T. A. 870; and Houghton & Dutton Building Trust, 20 B. T. A. 591, and cases therein cited. The respondent’s determination as to this issue is, therefore, reversed.

The fourth issue is whether, as a proposition of law, the subsidiary companies are entitled to a deduction for exhaustion, wear and tear of their physical properties which they had, several years previously, leased to the parent company for a term of 999 years with a condition in the lease that at the end of the term the properties, or their equivalent in value, be returned to the respective lessor in as good a condition as when leased. This issue remains by reason of the fact that we have denied the four petitioners an affiliation status under the statute. The facts and specific provisions of the respective leases which are material are set out in full in our findings.

It is now settled that in leases containing provisions similar to the ones here in question the lessee is not entitled to a deduction for exhaustion, wear and tear of leased property, payment for which has been made by the lessor. Weiss v. Wiener, 279 U. S. 333; 7 A. F. T. R. 8865. In that case Wiener was in the business of talcing long leases of property and subletting. He held 13 leases for 99 years, renewable forever. He undertook to keep the buildings up to their present condition, and to pay rent even if the buildings were destroyed, such obligations being sanctioned by a liability to forfeiture. Wiener contended that because- of these obligations he should be allowed a reasonable deduction for depreciation of such property. In rejecting Ms contention, tire Supreme Court said m part:

But it is very clear that as yet the capital of the lessee has not gone into it, and upon the considerations just mentioned it is not enough that* he has made a contract that very possibly may not be carried out to replace that capital at some future time. If, as we think, such a contract is not enough to cause the lessee a present loss by wear and tear, the fact, which may be assumed, that the property was used by him in his business, does not matter. Of course he must show an interest in the property and a present loss to Mm to make the statute apply. (Italics supplied.)

Further on in its opinion the Supreme Court also said:

It does not matter that in Ohio, where the properties lie, these long leases are treated as in many respects like conveyances of the fee.

It is also settled that where the lessee covenants to maintain the property in as good condition as when taken over from the lessor, the lessee is entitled to a deduction for all capital items so made, spread over the life of the particular property or remaining term of the lease, whichever is shorter. Duffy v. Central R. Co. of New Jersey, 268 U. S. 55. In the latter case the lessee sought to deduct as a rental expense in the year in which made, certain expenditures for additions and betterments which it was obliged to make under the there existing lease. The Supreme Court ruled as follows:

In respect of the 999-year leases, the additions and betterments will all be consumed in their use by lessee within a fraction of the term, and, as to them, allowances for annual depreciation will suffice to meet the requirements of the statute. In the case of the pier leases, the improvements may and probably will outlast the term, and, as to them, deductions may more properly take the form of proportionate annual allowances for exhaustion.

The Supreme Court in the Wiener and Central R. Co. cases dealt with the problem as it affected the lessee. In the instant proceedings we are concerned with the question as it affects the lessor. In this connection the respondent has called our attention to our decision in A. Wilhelm Co., 6 B. T. A. 1. In that case the taxpayer (a lessor) had leased its plant for five years with an option to the lessee to purchase the plant at any time within that period at a stated price, or at the termination of the lease to return the plant “ in the same condition as the same now exists * * * the aggregate of which assets * * * shall be of at least as great book value and actual value when so returned as the aggregate of such assets as at present existing.” It also appeared in that case that the lessee, during the taxable year there involved, made additions and replacements at a cost considerably in excess of the depreciation claimed by the lessor. In denying the lessor a deduction, we said:

The Revenue Act provides that in computing net income a deduction may be taken for a reasonable allowance for exhaustion, wear and tear. What is a reasonable allowance must be determined irom all of tbe facts and circumstances. In the peculiar circumstances here involved, considering that the lessee was bound to make good all depreciation by replacements or additions, it is our opinion that no allowance could be justified as reasonable.

It is argued on behalf of the petitioners in the instant proceedings that the ’Wilhelm case is distinguishable from their cases by reason of the term of the lease, the option granted, and the large improvements placed on the Wilhelm property by the lessee. While these may be distinguishing facts, we think it is true that the underlying legal principle is the same in both cases. The statute only permits the owner of property used in the business to take a “ reasonable ” deduction for exhaustion, wear and tear. When property is leased with a provision in the lease that it is to be maintained by the lessee and the same property or its equivalent in value returned to the lessor at the expiration of the lease in as good a condition and value as when leased, we believe that it would be contrary to the meaning of section 234 (a) (7) of the Revenue Act of 1921 to find that the lessor had actually suffered any loss deductible under that section, for, as said in Weiss v. Wiener, supra, he must show “ a present loss to him to make the statute apply.”

Petitioners further argue that to deny the lessor the right to take the deduction is to deny the deduction to any one, since it is settled that the lessee is not entitled thereto. But such a situation is more apparent than real. The lessor is denied the deduction because it has not and will not suffer any loss for the reason that the lessee has promised to make good any loss that might occur on account of exhaustion, wear and tear. And the lessee, when it makes good the loss, is entitled to deduct the entire amount so expended either in the year in which made (if an ordinary repair), or (if a capital item), over the life of the property replaced or remaining term of the lease, whichever is shorter. In that manner the lessee will have returned to it its entire cost of maintaining the property which it is entitled to deduct, and the lessor, at the end of the term, will receive back its property or its equivalent in value in as good a condition and value as when leased. It might be added that in making such a contract the lessor would naturally receive a less rental than if it had agreed to maintain the upkeep of the property itself.

Petitioners’ position is that in leases of such long duration as the ones here in question, the proper application of section 234 (a) (7) should be to permit the lessor to deduct an amount commensurate with the actual exhaustion, wear and tear of the property until its entire capital siim has been so deducted and to include in the lessor’s income at the end of the term the value of the property turned over to the lessor at that time. We do not think, however, that this position gives full effect to the actual agreement existing between tbe lessor and lessee. The respective leases provided that the lessee would “ during said term renew, repair and replace the same, so as to maintain and keep the demised premises in as good order, repair and condition as the same are now and in their present state of efficiency * * The presumption is that the parties will perform in accordance with their agreement. This being true, we do not think it would be reasonable to allow the lessor a deduction for exhaustion, etc., when such exhaustion was constantly being arrested by the lessee. We, therefore, hold to our decision in A. Wilhelm Co., supra. The respondent’s determination on this issue is sustained.

The fifth and final issue is whether the respondent erred in adding to the taxable income of each of the subsidiary companies for each of the years 1922 and 1923, respectively, the amounts of additional taxes determined by him for those years, which, if finally sustained, will be paid by the lessee. Petitioners admit, in view of the decisions of the Supreme Court in Old Colony Trust Co. v. Commissioner, 279 U. S. 716; and United States v. Boston & Maine Railroad, 279 U. S. 732, that the additional taxes, if finally sustained, will constitute “ income ” to the respective lessors; but resist the respondent’s determination on the ground that since they are contesting the said additional taxes, such taxes can not “ accrue ” as income to the lessors until final adjudication has taken place. On the other hand, the respondent practically concedes in his brief that in view of our decision in Providence & Worcester Railroad Co., 5 B. T. A. 1186, and other similar cases, his position can not be entirely sustained, and that instead of including the additional tax for 1922 in 1922 income, as the respondent has done, the Board will probably hold the additional tax for 1922 to be income for 1923, the year it became due and payable, and therefore, accruable. In the Providence Worcester cáse we said:

The Commissioner has treated as income for each of the taxable years the amount of the tax which became due and was paid in the succeeding year. Under the decisions of the Board in the Appeals of Russell Milling Co., 1 B. T. A. 194; L. S. Ayers & Co., 1 B. T. A. 1135; and Norwich & Worcester R. R. Co., 2 B. T. A. 215, this appears to have been in error. In the last cited case it was held that a tax which became due and was paid by the lessee in 1919 upon 1918 income was not income for 1918, since the tax did not accrue until 1919 and the income could not have accrued prior to 1919. This decision of the Board was followed in the United States District Court, District of Massachusetts, when suit was brought by the United States to recover the amount of tax disallowed by the Board in its decision. United States v. Norwich & Worcester R. R. Co., 16 Fed. (2d) 944. Pursuant to those decisions the deficiency should be recomputed by including as income for 1921 the amount of the tax which became due and payable in that year upon 1920 income; * * *

Petitioners in tbeir brief cite tbe case of the American Telegraph & Cable Co., 2 B. T. A. 991, as standing for the proposition that “if the tax was paid by the guarantor on the original return it did not represent income accruing to the primary taxpayer until the tax became due and pay Able ” which petitioners argue “ in the instant proceedings would mean, that income would arise in the year and only in the year when a deficiency is -finally determined to be due from the primary taxpayer ” and that such meaning is confirmed in the instant proceedings by the last clause of article 10 of the respective leases set out in our findings.

We are unable to agree with petitioners that a tax does not become “ due and payable ” until it is finally determined. The several statutes specifically provide that the tax for a given taxable year becomes due and payable in the succeeding year. Section 250, Revenue Act of 1921; and section 270 of the Revenue Acts of 1924 and 1926. It is immaterial that the exact amount of the tax, if any, remains to be determined. The cited statutes further provide that, as soon as practicable after the return is filed, the Commissioner shall examine it, and if he finds that the taxpayer has overpaid the tax the excess shall be credited or refunded, and if he finds that the taxpayer has understated the tax, the deficiency, “ together with interest thereon at the rate of one-half of 1 per centum per month from the time the tax was due,” shall be paid upon notice and demand by the collector. And we think it immaterial that the respective leases provided that should the lessee contest the legality of a tax it should not be obliged to pay “ until thirty days after final adjudication.” The material provision is that regardless of when the exact amount of the tax, if any, is finally determined, the lessee is obliged to pay the.tax, together with interest from the due date specified in the statute.

We, therefore, hold that the additional tax of each subsidiary for the year 1922 which the respondent included in the 1922 income should be eliminated therefrom and added to its income for the year 1923; and that the additional tax of each subsidiary for the year 1923 which the respondent included in the 1923 income should be excluded from such year’s income.

Judgment will he entered under Bule 50.


source: Caselaw Access Project

author: Teammell :

license: Public Domain

text:
    Walter W. Rose Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43241.
    Promulgated September 29, 1931.

      W. H. Poe, Esq., for the petitioner.

      Eugene Harpole, Esq., for the respondent.
   OPINION.

Teammell :

This proceeding is for the redetermination of a deficiency in income tax of $3,054.89 for 1925. The only matter in controversy is the correctness of the respondent’s action in determining that certain purchase money mortgage notes received by the petitioner in connection with the sale of three parcels of its real estate had a fair market value of the amounts determined by the respondent.

The petitioner is a Florida corporation, with its principal office at Orlando. Upon organization in the latter part of 1925 it acquired from Walter W. Rose, in exchange for shares of its capital stock, three parcels of real property, hereinafter referred to as the 16-aere tract, the Rose Hill land, and the lots on Winter Garden Road.

The 16-acre tract was located about nine miles from Orlando. On this property was an orange grove about three years old. The grove had not reached an income-producing stage and annual expenditures of from $40 to $50 per acre for a period of from two to three years would have been required to bring it to the bearing stage. Land in this vicinity with a three-year-old orange grove on it is classed as unimproved property by local real estate dealers, because it is not income-producing and because of the frost hazard on a three-year-old grove. Rose had owned this property for two or three years when he transferred it to the petitioner and had acquired it at a cost of $2,057.55. The petitioner issued to Rose $7,000 par value of .its capital stock for the property. About December 1, 1925, the petitioner sold the 16-acre tract to F. L. Andrews for $12,000, receiving $4,000 cash and two notes for $4,000 each, due in one and two years, respectively, from the date of the sale and secured by a first mortgage on the property.

The Rose Hill land was located about ten miles from Orlando and consisted of about 380 acres of undeveloped “ wild cut-over pine lands ” from which no income was being derived. Rose had previously acquired the property at a cost of $19,000 and he transferred it to the petitioner for $40,000 par value of its capital stock. About November 1, 1925, the petitioner sold the property to Cora Fidler for $57,000, receiving $19,000 cash and two notes for $19,000 each, due in one and two years, respectively, from the date of the sale and secured by a first mortgage on the land.

The lots on Winter Garden Road were located about nine miles from Orlando and consisted of acreage and wooded lands which it was contemplated would be cut into camp sites. These lots were not producing any income. Rose had owned these lots from seven to ten years and had acquired them at a cost of $2,045.10. The lots were transfered to the petitioner for $9,000 par value of its capital stock. On August 14, 1925, the petitioner sold this property to Emrick Cafeteria Company, Inc., for $12,000, receiving $4,000 cash and two notes for $4,000 each, due in one and two years respectively and secured by a first mortgage on the property.

When the petitioner was organized Rose acquired all of its capital stock, except two shares, in exchange for properties including those described above.

During 1925 there was no demand nor any market for purchase money notes secured by mortgages on the character of property here involved.

We have considered all the evidence, including the testimony of five persons familiar with the conditions and the facts as to the demand and market for such notes as are here involved and who were well qualified to express their opinion as to whether the notes had any market value, and we are convinced that they did not. See Ravlin Corporation, 19 B. T. A. 1112; C. L. Starr, 9 B. T. A. 886; Miami Beach Improvement Co., 14 B. T. A. 10; Woodmar Realty Co., 17 B. T. A. 88.

Reviewed by the Board.

Judgment will he entered under Rule 50.

SteRNHageN, Murdock, and Seawell dissent.


author: Smith:

text:
    Ida L. Kuhn, Petitioner, v. Commissioner of Internal Revenue, Respondent. John I. Cooper, Petitioner, v. Commissioner of Internal Revenue, Respondent. Laura M. Price, Petitioner, v. Commissioner of Internal Revenue, Respondent. W. E. Price, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 32609, 32610, 40115, 40267, 40659, 41072.
    Promulgated September 29, 1931.

      Edward Halloway, Esq., and Paul Armitage, Esq., for the petitioners.

      M. E. McDowell, Esq., for the respondent.
   OPINION.

Smith:

The sole question presented by these proceedings is whether the petitioners are entitled to deduct from their gross incomes any amounts representing allowances for depletion upon the property held in trust for their benefit created by John M. Cooper and from which they derived income. In their income-tax returns each of the beneficiaries under the trust omitted from gross income $15,000 which was received from the trustees. Laura M. Price and W. E. Price, making returns on a community property basis, each omitted $7,500. In the amendment of the income-tax returns the respondent has added to the gross incomes reported the amounts thus omitted and has refused to allow any amount as a deduction for depletion. The petitioners claim the right to deduct depletion.

The parties have stipulated that if, as a matter of law under the stipulated facts, depletion is an allowable deduction from gross income to these petitioners, then the amounts thereof are those shown in a memorandum and schedule of the engineering subsection of the audit review division introduced in evidence as Exhibit B.

The applicable statute is section 214 (a) (9) of the Revenue Act of 1926, which provides:

(a) In computing net income there shall be allowed as deductions:
⅝ * * ⅜ « sfc ⅛
(9) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In the case of leases the deduction allowed by this paragraph shall be equitably apportioned between the lessor and lessee.

The question presented by these proceedings is the same as was before the Board in Kate Fowler Merle-Smith, 11 B. T. A. 254, and Margaret B. Fowler, 11 B. T. A. 265, in which we held that the beneficiaries were not entitled to deductions for depletion on account of the removal of ore from property forming a part of the corpus of the trust. Here, as there, the beneficiaries of the trust were to receive not only the income of the trust, but had an interest in the corpus as well. The decision of the Board in Kate Fowler Merle-Smith, supra, was reversed by the Circuit Court of Appeals for the Second Circuit, 42 Fed. (2d) 837; certiorari denied, 282 U. S. 897. The facts in this case are also substantially the same as obtained in Mary Alphin et al., 21 B. T. A. 1101, where we held, following the decision of the court in Merle-Smith v. Commissioner of Internal Revenue, supra, that the beneficiaries were entitled to depletion deductions. In these proceedings we are also of the opinion that they are entitled to reasonable allowances for depletion in the computation of tax liabilities for the years involved.

Reviewed by the Board.

Judgments will l>e entered under Rule 50.


author: MuRdock :

text:
    Metropolitan Properties Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45032.
    Promulgated September 29, 1931.

      S. Leo Ruslander, Esq., Samuel Kaufman, Esq., and George R. Beneman, Esq., for the petitioner.

      T. M. Mather, Esq., and K. M. Morawslci, Esq., for the respondent.
   OPINION.

MuRdock :

We can not agree with the petitioner that the sale of its interest in the Keystone property took place in 1927. The petition contains an allegation that the sale was consummated in accordance with the terms of the contract. The respondent admitted this allegation and treated the conveyance as a sale made in 1926. The conveyance is dated December 31, 1926, and there is no evidence that it was not executed on that date. There is some evidence that another instrument dated December 31, 1926, construing a provision of the conveyance, was not executed until 1927, but this proves nothing in regard to the conveyance.

Counsel for the petitioner stated that there was no dispute as to the amount of the gross profit. He also stipulated that the sale price was $1,100,000 and that the basis for determining gain was $599,-663.12. Thus, the gross profit would be $500,336.88. The respondent agrees to this figure. Despite these circumstances the petitioner, by an amendment at the hearing, seeks to have us reduce the profit by $85,000 because of the alleged worthlessness of certain notes which were to be assigned to it as part of the consideration. But the notes were to be selected by the bank and delivered not at once, but within a year from December 31, 1926. Apparently they were not selected or delivered in 1926, and we do not know when they were selected or delivered. Furthermore, there is evidence that the notes as finally delivered were not worthless. This point seems to be an afterthought on the part of the petitioner’s counsel. We can not say that the petitioner knew in 1926 that it was to receive worthless notes. Nor can we hold that the purchase price should be reduced by the amount of the notes.

In the alternative, the petitioner contends that the sale was a sale or other disposition of property in which “ the initial payments do not exceed one-fourth of the purchase price ” within the meaning of section 212(d) of the Revenue Act of 1926, and the income to be reported on the basis of an installment sale is approximately five-elevenths of $100,000, the alleged initial payment. It claims that the fact that the purchaser took subject to the liens of two deeds of trust does not need to be considered in determining the “ initial payments ” and cites Schneider, Trustee v. Lucas, decided by a District Court. On its theory the entire profit will not be returned as income until such time as the liens are discharged. Counsel for the petitioner contends that the initial payment of $100,000 was not received” in 1926. An employee of the purchaser bank testified that he credited the $100,000 to the petitioner’s account on January 3,1927. But he was not present when the transaction took place on December 31, 1926, the deed acknowledges receipt of the amount on December 31, 1926, and in the return for 1926 there is the statement that the $100,000 was paid in cash in 1926. Therefore, if it is important, we hold that this payment wag received in 1926.

The respondent now contends that he made a mistake in treating this as an installment sale. He points to T. D. 4255, Cumulative Bulletin VIII-1, p. 165, which amended article 44 of Regulations 69, as follows:

In the sale of mortgaged property, the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the “ purchase price,” but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the “ initial payments ” or of the “ total contract price,” as those terms are used in section 212(d), in articles 42 and 45, and in this article.

Here the amount of the mortgage exceeds the basis to the vendor by $200,336.88, so the respondent insists that the “ initial payments ” include $100,000 in cash and $200,336.88; $300,336.88 is more than one-fourth of $1,100,000, the purchase price; therefore, section 212(d) has no application; and the petitioner, on an accrual basis, should be required to accrue and report as income in 1926 the full amount of the purchase price which the purchaser- agreed in 1926 to pay over a period of time. We agree with the respondent. See Lucas v. Schneider, 47 Fed. (2d) 1006, reversing the case relied upon by the petitioner and distinguishing several Board cases.

In 1926 the petitioner issued $3,300,000 par value of its bonds, which were secured by liens on certain of its property, including the Keystone Building property. The purchaser of these bonds paid 10 per cent less than the par value. The Keystone Building property could be released from the lien of these bonds by payment of $800,000, eight thirty-thirds of the total par value of the bonds. The petitioner contends that, if it sold the property in 1926, it should be entitled to deduct, for 1926, $19,345.46 as unamortized discount on these bonds. The Commissioner has already allowed $2,750 of the amount claimed. Following S. & L. Building Corporation, 19 B. T. A. 788, which is not distinguishable in principle, we hold that the portion of the unamortized discount allocable to the Keystone Building should be deducted when that building was sold subject to the lien of the mortgage.

The petitioner had agreed to pay interest on some amount beginning April 1, 1926. A dispute arose as to the payment of this interest, which was compromised by the petitioner giving its note for $150,000, dated December 21, 1926, in full payment of all interest due under the agreement. This amount is a proper deduction for 1926 under section 234(a) (2) for interest accrued.

Keviewed by the Board.

Judgment will he entered under Rule 50.


author: GoodRICh: Murdock,

text:
    Utah Home Fire Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 21673, 28942.
    Promulgated September 29, 1931.

      Benjamin H. Saunders, Esq., for the petitioner.

      John D. Foley, Esq., for the respondent.
   OPINION.

GoodRICh:

That the amount of the net decrease in reinsurance or unearned premium reserve disclosed by a fire insurance company at the close of a taxable period, or, in other words, the actual amount of premiums earned during the period, is to be included in gross income for that period is too well' established to merit further discussion here. The method to be followed in computing the taxable income of an insurance company, and the various provisions of the statutes under which its tax liability arises, have likewise previously been determined. See Union Underwriters of New York et al., 4 B. T. A. 472; Massachusetts Fire & Marine Insurance Co., 16 B. T. A. 625; Central National Fire Insurance Co., 22 B. T. A. 1054; Maryland Casualty Co. v. United States, 251 U. S. 342, and cases there cited.

This petitioner does not quarrel with the principal laid down in the cases above cited, but contends that, of the net decrease in its reinsurance reserve for the year 1921, the amount of $115,832.74 represented the return of capital or surplus which, in the year 1920, it had been forced to transfer to its reinsurance reserve because its income for the year 1920 lacked that much of meeting its required increases, to that reserve; that, of the net decrease in its reinsurance reserve for the year 1925, the amount of $61,451.87 represented the return of capital or surplus which, in the year 1924, it had been forced to transfer to its reinsurance reserve because its income for the year 1924 lacked that much of meeting its required increases to that reserve; and that to include these amounts in its income for the years 1921 and 1925, respectively, as a part of the funds released from the reinsurance reserve in those years, would be to tax, not income, but capital. In short, it contends that these amounts, when added to its reserve, were not derived from premiums received upon insurance written, but were transferred or borrowed from capital account and should be permitted to return to that source without tax.

We can not accept petitioner’s views of the case, because we are not convinced that these amounts, or any part of them, came from capital or surplus when added to petitioner’s unearned premium reserve. On the contrary, we believe there is no doubt but that they were derived from premiums received upon insurance written and that, therefore, when released from that reserve they are to be included in gross income. This must be so because of the very nature of the unearned premium reserve. Huebner, in his work on Property Insurance, p. 217, says:

The reserve in fire insurance has its origin in the fact that the insurer collects the whole premium in advance, whereas protection can only be given as time elapses during the one, two or five-year policy period. It may be defined as that portion of the premium which the Company has not yet had time to earn.
This unearned portion of the premium constitutes the reserve. * * *

And this reserve, the unearned premium or reinsurance reserve, is the only true reserve of a fire or marine insurance company within the meaning of the Federal statutes imposing taxes upon net income. United States v. Boston Insurance Co., 269 U. S. 197; McCoach v. Insurance Co. of North America, 244 U. S. 585.

How, then, can it be said that the income of a fire insurance company is insufficient to provide for the requisite additions to its unearned premium reserve? It would seem that its income would always be sufficient to provide for this reserve, for the reason that the reserve, and all additions thereto, comes into existence only when premiums are actually received, paying in advance for protection over a future period. The unearned portion of such premium necessarily is added to the reserve, and since the whole premium has been received before the addition is made, certainly the reserve has been provided for from income. It is true that as a result of its bookkeeping, by giving priority to other entries and charges, by first charging its expenses, its claims or losses against its receipts, a company may show that transfers must be made, on its books, from capital, from surplus, or from nontaxable income, to account for the required additions to its reserve because the remaining portion of its receipts is insufficient for this purpose, but bookkeeping methods can not gainsay the fact that the income was sufficient to provide for the necessary additions to the reserve, for the funds for that purpose were actually received.

So with the case at bar. If petitioner preferred to first pay its expenses from funds received and then accrue its losses and claims against the unearned premium reserve, and then replace the reserve from nontaxable income and surplus, it may not for that reason claim a deduction from the amounts released from reserve in a subsequent year because that reserve represents income received, either in cash or by credits, but not taxed in a prior year and not a combination of income and various capital accounts as petitioner contends.

Since we hold that no part of petitioner’s reinsurance reserve was in fact derived from capital, surplus, or nontaxable income, it is unnecessary to consider the amendment made to its petition alleging that section 246 of the Bevenue Act of 1924 is unconstitutional if construed as permitting the inclusion in income of such items, temporarily set aside into reserve as required by law, when released from such reserve.

-Beviewed by the Board.

Judgment will he entered for resfondent.

Murdock,

concurring: I believe that the correct result has been reached in this case. The only question in the case is, IIow much, by way of premiums, did the company earn during the year ? This being so, it seems to me unnecessary to discuss the question of where the actual dollars came from which went into the reserve or which were released from the reserve. If in prior years, surplus had to be reduced in order to set up the reserve, that fact has no effect upon income for the current year.


text:
    West Virginia-Pittsburgh Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 20337, 25030.
    Promulgated September 30, 1931.

      Sidney P. Simpson, Esq., and Wm. B. Hubbell, Esq., for the petitioner.

      John D. Foley, Esq., for the respondent.
   OPINION.

Smith:

The principal issue in these proceedings is whether the petitioner may deduct from gross .income in the tax years involved amounts paid for additional machinery and equipment to maintain the normal output of its mines. This issue is decided in favor of the petitioner, upon the authority of United States v. Roden Coal Co., 39 Fed. (2d) 425; Marsh Fork Coal Co. v. Lucas, 42 Fed. (2d) 83; Commissioner of Internal Revenue v. Brier Hill Collieries, 50 Fed. (2d) 777, inconsistent with or reversing decisions of the Board which held that such expenditures were not deductible from gross income as ordinary and necessary expenses. In view of the above cited cases, the decision of the Board in Union Collieries Co., 3 B. T. A. 540, and numerous other cases denying the deduction of such items, will not be followed in the future.

This disposition of the claimed deductions for additional items of machinery and equipment necessarily changes the computations of invested capital. Other questions relating to invested capital may be shortly disposed of. They are:

(1) Whether the full value of the coal lands and other physical property and the receivables and the amount of cash acquired by the petitioner for stock in 1912 are to be included as part of the petitioner’s invested capital for 1917, 1918, and 1920;

(2) Whether the petitioner’s invested capital for 1918 and 1920 should be reduced by allowances for depletion or depreciation alleged to have been sustained in prior years; and

(3) Whether the petitioner’s invested capital for 1918 and 1920 should be reduced by amounts in respect of taxes for prior years.

In addition, the facts of record raise two other issues which must be determined before there can be a recomputation of the deficiencies involved.

(4) Whether the reduction of the petitioner’s outstanding stock in 1915 had any effect upon its invested capital for 1917, 1918, and 1920; and

(5) Whether the dividends paid by the petitioner in 1920 had any effect upon its invested capital for that year.

The last two points will be disposed of first. The reduction of the petitioner’s outstanding stock in 1915 from $1,500,000 to $1,000,000 did not operate to reduce the allowable invested capital. Cf. Penn Chemical Works, 7 B. T. A. 442; Arizona Commercial Mining Co. v. Casey, 32 Fed. (2d) 388.

Whether the dividends paid in 1920 affected the invested capital for 1920 depends upon the question as to whether the earnings of the company up to the date of each dividend payment had served to wipe out the operating deficit and to equal the dividend payment. Willcuts v. Milton Dairy Co., 275 U. S. 215. For 1920 the respondent found an invested capital of $1,092,373.63. Petitioner contends that the invested capital should be $1,319,262.20, the same as for 1818. It admits, however, that the determination of this question depends upon whether the petitioner had a sufficient surplus available for the payment of the dividends at the time they were paid in 1920. Whether there was a sufficient surplus will be determined on the recomputation made in conformity with this opinion.

In the computation of the deficiency for 1917, the respondent has used an invested capital of $1,000,000, which represented the par value of the stock outstanding at January 1, 1917. Counsel have stipulated that the assets acquired by the petitioner in exchange for its capital stock in 1912, had a cash value at the date of acquirement as follows:

Coal lands and other physical property_$2,201,139. 00
Receivables_ 78, 533.05
Cash_ 93, 619.16
Total assets acquired- 2,373,291.21
Less:
Total liability assumed_ 1, 054, 029. 01
Original paid-in capital_ 1, 319, 262.20

The stipulation further shows that the actual cash value of the coal lands and other physical property acquired as above on January 1,1914, was $2,170,064.42. The petitioner contends that the invested capital for 1917 is to be based upon the full value as of January 1, 1914, of the physical property and receivables acquired by the petitioner on May 1, 1912, together with the amount of cash then acquired (the company having no earned surplus but instead an operating deficit), which amount is found to be $1,288,187.62. The contention of the petitioner is sustained upon the authority of West End Consolidated Mining Co., 3 B. T. A. 128.

For 1918 the respondent computed an invested capital of $1,018,-812.06. The petitioner had no earned surplus at the beginning of the year. It contends that the paid-in capital should not be reduced by allowances for depletion or depreciation alleged to have been sustained in prior years, nor by amounts in respect of taxes for prior years, nor by the fact that its capital stock outstanding was reduced by from $1,500,000 to $1,000,000 in 1915, there being in that year no distribution of assets or earnings to its stockholders. The Board has repeatedly distinguished between earned surplus and paid-in capital and surplus for invested capital purposes. Thus, paid-in capital or surplus is not reduced by an operating deficit. Kenny Brothers Co., 1 B. T. A. 1019; Guarantee Construction Co., 2 B. T. A. 1145; Simmons Co., 8 B. T. A. 631; Archibald Sherrod, 16 B. T. A. 622. The contention of the petitioner upon this point must be sustained. In Carbo Petroleum Co., 12 B. T. A. 166, the Board stated:

* * * There is no distinction, in so far as concerns invested capital, between impairment resulting from an operating deficit and impairment resulting from depletion where adequate provision has not been made therefor. If the depletion actually sustained is not charged against surplus, to that extent there is no true earned surplus. * * *

In the same opinion we stated at page 115:

* * * The amount originally invested is not involved here. When the mine is purchased the investment ordinarily represents paid-in capital which is not reduced by depletion and which amount remains in invested capital unless and until withdrawn in whole or in part by the stockholders in the way of dividends or otherwise. * * *

The parties have stipulated that at January 1, 1917, the petitioner had an accumulated operating deficit of $311,600.62. The net incomes, as found by the respondent for 1917 and 1918, were not sufficient to wipe out the operating deficit. The petitioner contends that the invested capital for 1918 should be $1,319,262.20, which as above shown, was the excess of the fair market value of the assets paid in to the corporation in 1912 for shares of stock over the liabilities assumed. The contentions of the petitioner with respect to the computation of invested capital for 1918 are sustained.

Reviewed by the Board.

Judgments will be entered, under Rule 50.


text:
    Lucinda Pitman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 18493.
    Promulgated September 30, 1931.

      J. D. Simms, Esq., for tbe petitioner.

      Bruce A. Loto, Esq., for the respondent.
   OPINION.

Love:

The ultimate question involved in this proceeding is what portion, if any, of the cash bonus of $132,500 is taxable income to petitioner in 1922. The respondent determined-.that $36,370 was taxable, but now contends that $121,750 is taxable and has moved for an increased deficiency. .

We do not have before us the respondent’s computation showing how he arrived at the amount of $36,370, but that fact is not now material to the present disposition of the case, since the respondent now contends that $121,750 of the cash bonus is taxable instead of $36,370. The respondent bases his contention for the larger amount on our decision in Murphy Oil Co., 15 B. T. A. 1195, wherein we held that a cash bonus payment by- the lessee for an oil and gas lease represents taxable income and, having no relation to exhaustion of resources, does not reduce the depletable base of the lessor, which holding is contrary to article 215 of the respondent’s Regulations 62, as amended by T. D. 3938.

As set out in our findings, the $132,500 was a cash bonus paid to petitioner in 1922 by three lessees as part consideration for certain oil and gas leases covering the 160 a<. of which her son was seized and possessed on the date of his death. In the original allotment deeds given under Act of Congress approved March 1,1901 (31 Stat. 861), 40 acres of the 160 acres were designated as a “ homestead ” and the balance of 120 acres was known as “ surplus lands.” The cash bonus of $132,500 was paid to petitioner by lessees of the two respective classes of lands, as follows:

Homestead (40 acres)-$21,500
Surplus lands (120 “ )_111,000
Total_ 132,500

The respondent concedes that petitioner inherited from her son, Robert Pitman, Jr., one-half of the above allotment of 160 acres, and that by reason of such inheritance, one-half of the cash bonus of $21,500 applicable to the homestead, or $10,750, is exempt from taxation under the laws applicable thereto, leaving $121,750 ($132,500 minus $10,750) subject to tax under our decision in Murphy Oil Co., supra. The respondent contends that the remaining one-half of the 160-acre allotment was acquired by petitioner by purchase from her divorced husband; that all restrictions had been removed from the surplus lands prior to the death of Robert Pitman, Jr.; that where an allotment once becomes nonrestricted, it forever afterwards remains nonrestricted; that the one-half of the homestead which respondent contends petitioner purchased, became nonrestricted when it was inherited, as respondent contends, by a white person, namely, Robert L. Pitman, Sr.; and that, under section 4 of the Act approved May 27, 1908 (35 Stat. 312), “ * ⅜ * all land from which restrictions have been or shall be removed shall be subject to taxation * *

On the other hand, the petitioner has assumed without contending that the leases executed on or about March 7, 1922, were sales of property and that the gain or loss resulting therefrom should be determined in accordance with section 202 of the Revenue Act of 1921, and article 1563 of Regulations 62. She contends that she inherited the entire allotment of 160 acres from her deceased son, Robert Pitman, Jr.; that the basis for determination of gain or loss is the value of the property when inherited; that this value was $159,120.35; and that comparing that amount with the $132,500 received, there was no taxable income. As an alternative, she again contends that she inherited the entire allotment of 160 acres, and, being a full-blood Indian, the entire inheritance is restricted in her hands and is free from tax.

We, however, do not regard it necessary for a proper disposition of this proceeding to determine the questions whether petitioner inherited or purchased the one-half of the allotment which respondent contends she purchased, or whether the said allotment was or was not restricted in her hands. We think the cash bonuses received from the leases in connection with both the homestead and surplus lands are subject to the Federal income tax, but for reasons different from those given by the respondent.

Sections 210 and 211 of the Revenue Act of 1921, levy a tax upon the “net income of every individual.” Section 212 defines net income as gross income less the deductions. Section 213 (a) includes within the term gross income “ gains or profits and income derived from any source whatever.” The bonus money was in the nature of royalties and hence income. Work v. Mosier, 261 U. S. 352, 357. We know of no Federal statute exempting such income from Federal taxation. The following remarks by the United States Supreme Court in the recent case of Chotean v. Burnet, 283 U. S. 691, are apposite here:

The language of Sections 210 and 211 (a) (Note No. 9) subjects the income of “ every individual ” to tax. Section 213 (a) (Note No. 10) includes income “ from any source whatever.” The intent of Congress was to levy the tax with respect to all residents of the United States and upon all sorts of income. The act does not expressly exempt the sort of income here involved, nor a person having petitioner’s status respecting such income, and we are not referred to any other statute which does.

We are not unaware of the decisions of the Circuit Court of Appeals for the Tenth Circuit in Mary Blackbird v. Commissioner, 38 Fed. (2d) 976, and the Federal District Court for the Western District of Oklahoma in United States v. Homeratha, 40 Fed. (2d) 305. The latter case was decided upon the authority of the former. The Blackbird case involved “ a restricted full-blood member of the Osage 'Tribe of Indians.” The Circuit Court, in reversing this Board’s opinion, reported at 14 B. T. A. 1247 based its decision upon three principal grounds, namely, (1) that to tax a ward of the Government “ would be contrary to the almost unbroken policy of Congress in dealing with its Indian wards and their affairs ”; (2) that general acts of Congress are not applicable to Indians unless expressly made so; and (3) that whatever value the Cherokee Tobacco Case, 11 Wall. 616, had as a precedent in support of upholding the tax “ seems to have been nullified by what is said in United States v. Forty-three Gallons of Whiskey, 108 U. S. 491.” The second proposition was developed by the court mainly in support of the first. Yet on the same day, the same court in Chotean v. Commissioner, 38 Fed. (2d) 976, recognized what must at least be regarded as an exception to the proposition that general acts of Congress are not applicable to “ Indians ” unless expressly made so, by holding that where an Osage Indian had received his certificate of competency issued under the authority of paragraph 7 of section 2 of the Act of June 28, 1906 (34 Stat. 539, 542), he was then subject to the Federal income tax. The Choteau decision was affirmed by the United States Supreme Court (already referred to herein) and we again quote therefrom as follows:

But it is said that as to the income here taxed petitioner is exempt because of his status as an Indian. This assertion requires a reference to the policy of the government with respect to the Indians. No provision in any of the treaties referred to by counsel has any bearing upon the question of the liability of an individual Indian to pay tax upon income derived by him from his own property. The course of legislation discloses that the plan of the government has been gradually, to emancipate the Indian from his former status as a ward; to.prepare him for complete independence by education and the gradual release of his property to his own individual management. This plan has included imposing upon him both the responsibilities and the privileges of the owner of property, including the duty to pay taxes.

We recognize, of course, that the facts in the Choteau case differ from the facts in the instant case in so far that Henry Choteau had received a certificate of competency and was nonrestricted as to his surplus lands, whereas petitioner contends she was restricted as to her surplus lands by section 9 of the 1908 Act (35 Stat. 312) in that she had to have any conveyance of any interest in her land approved by the proper court. But Choteau was a restricted Indian as to his homestead. We have searched the United States Statutes at Large pertaining to the Five Civilized Tribes (of which petitioner was a member) and -have been unable to find any provision similar to paragraph 7, section 2, of the Act of June 28, 1906 (34 Stat. 539, 542), relating to the granting of certificates of competency to the Osages. Petitioner was “ declared to be a citizen of the United States ” by section 6 of the Act of February 8, 1887 (24 Stat. 388, 391), as amended by Act of March 3, 1901 (31 Stat. 1447). The Osages were not declared to be citizens until 1921. See sec. 3, ch. 120, Act of March 3,1921 (41 Stat. 1249,1250). But, as was said in Tiger v. Western Investment Co., 221 U. S. 286, “ there is nothing in citizenship incompatible with this guardianship over the Indian’s lands inherited from allottees.” So the only material difference between petitioner and Choteau is that Choteau was not restricted as to his surplus lands and petitioner contends she ivas restricted as provided in section 9, supra. We do not think that this difference alone should exclude petitioner from tax. “ The intent to exclude must be definitely expressed, where, as here, the general language of the act laying the tax is broad enough to include the subject matter. Heiner v. Colonial Trust Co., 275 U. S. 232; Shaw v. Oil Corporation, supra.” (Choteau v. Burnet, supra.)

In Heiner v. Colonial Trust Co., 275 U. S. 232, the Supreme Court held that a non-Indian lessee of restricted Indian lands was taxable on the income derived from such leases. The argument was made by counsel for the lessee in that case that to tax the lessee would have an adverse economic effect upon the Government’s wards; that general acts of Congress are not applicable to the Indians where to apply them would affect the Indians adversely; and that Congress can not be held to have intended by the general provisions of the revenue acts to tax the incomes of the Indians themselves, nor by taxing that of their lessees to do itself what the States are forbidden to do. In deciding in favor of the tax, the Supreme Court said:

The power of the United States to tax the income is undoubted. * * * The disposition of Congress has been to extend the income tax as far as it can to all species of income, despite immunity from state taxation. * * *
Assuming that the Indians are not subject to the income tax, as contended, the fact that they are wards of the government is not a persuasive reason for inferring a purpose to exempt from taxation the income of others derived from their dealing with the Indians. Tax exemptions are never lightly to be inferred (Vicksburg, etc. R. R. v. Dennis, 116 U. S. 665, 668, 6 S. Ct. 625, 29 L. Ed. 770; Philadelphia & Wilnington R. R. v. Maryland, 10 How. 376, 393, 13 L. Ed. 461), and we think amj implication of an exemption of the income of the Indians themselves, if made, must rest on too narrow a has-is to justify the inclusion of the income of other persons merely because the statute, if applied as written, may have some perceptible economic effect on the Indians. [Italics supplied.]

Referring to the third principal ground of the Circuit Court’s decision in the case of Mary Blackbird v. Commissioner, supra, the only reference to the Tobaeoo case by the Supreme Court in the Whiskey case was in the last paragraph of its opinion, which reads as follows:

The case of the Cherokee Tobáceo Tax, 11 Wall. 616, cannot be treated as authority against the conclusion we have reached. The decision only disposed of that case, as three of the judges of the court did not sit in it and two dissented from the judgment pronounced by the other four.

See also Leah Brunt, Administratrix, 5 B. T. A. 134, 145, and Mary Blackbird, 14 B. T. A. 1247, 1251.

A further comparison of the facts in the instant case with those in the Choteau case discloses that they are alike in that no Federal restriction was placed upon the income of either petitioner or Choteau after it was paid to them. Although petitioner may have been restricted by section 9 as to her conveyance of any interest in her land, we know of no Federal statute and have been referred to none which restricts her in any manner whatsoever as to her ownership in and enjoyment of the $132,500 cash bonus received. In the Ghoteau, case the Supreme Court said:

His share of the royalties from oil and gas leases was payable to him, without restriction upon his use of the funds so paid. * * * In the process of gradually changing the relation between the Indian and the government he has been, with respect to the income in question, fully emancipated. (Compare United States v. Waller, supra.) It is true, as petitioner asserts, that as to his homestead he still remains a restricted Indian. But this fact is only significant as evidencing the contrast between his qualified power of disposition of that property mid his untrammeled ownership of the income in controversy. The latter was clearly heyond the control of the United States. The duty to pay it into petitioner’s hands, and his power to use it after it was so paid, were absolute. Work v. Mosier, 261 U. S. 352; Work v. Lynn, 266 U. S. 161. The claim that with respect to this income the petitioner was restricted, and therefore exempt from tax laid by sections 210 and 211 (a) must fail. [Italics supplied.]

It may be pointed out that there is no Federal statute that exempts any Indian, of any class, from taxation. The exemptions that are made pertain to and run with certain allotments of land under certain circumstances and conditions. In so far as the statutes are concerned, an Indian may own land that is exempt from taxation, and yet if he own cattle or other personal property, or even land that is not exempt, he may be taxed in the same way as other citizens are taxed.

-Since oil royalties, and especially bonuses, are held to be income, and not a part of the realty (as we will later point out below), no authority may be found in the statutes for holding such income exempt.

It may be true that the State of Oklahoma is prohibited from levying a tax upon either petitioner’s homestead or surplus lands. See section 16, Act approved June 30, 1902 (32 Stat. 500); and Marcy v. Seminole County, 45 Okla. 1; 144 Pac. 611. But it does not follow that by reason of that fact the Federal Government can not tax the income received from such lands. Once more we quote from Choteau v. Burnet, supra, as follows:

It is further insisted that since the royalties are not taxable, so long as they remain in the hands of the government in trust for the tribe and undistributed to members, income derived by the individual member from this fund comes from an exempt source and must therefore also he held to he exempt. (See Pollock v. Farmers’ Loan & Trust Co., 157 U. S. 429; 158 U. S. 601.) Royalties received by the government from mineral leases of Indian lands have been held to be beyond a state’s taxing power, (Gillespie v. Oklahoma, 257 U. S. 501; Shaw v. Oil Corporation, supra) on the ground that, while in the possession of the United States they are a federal instrumentality, to be used to carry out a governmental purpose. It does not follow, however, that they can not he subjected to a federal tax. [Italics supplied.]

It may also be true that expressions may be found in súme of the decisions of some of the courts indicating that it is not the policy of the Government to tax its own wards, but certainly it may not reasonably be contended that the Government is under any obligation, morally or legally, to refrain from collecting a tax on such income, simply because the recipient of that income is its ward— its ward by reason of a voluntary assumption of the duties and responsibilities of a guardianship for the purpose of protecting such ward from exploitation by designing and avaricious persons.

In reaching the conclusion that the $132,500 bonus received from the leases in connection with both the homestead and surplus lands is subject to the Federal income tax, we appreciate, as previously indicated herein, that there are expressions in Blackbird v. Commissioner, supra, that might incline to support an opposite holding, yet in view of our references to the Choteau decision, of which decision the Circuit Court of Appeals did not have the advantage, we believe that the mere fact that petitioner may have been restricted in her conveyance of any interest in her lands should not have the effect of exempting from the income tax either petitioner as an individual or the oil and gas royalties she derived from the leasing of such lands, wdiich income was subject to no Federal restrictions in her hands whatsoever. While it is true that the United States Supreme Court has never specifically passed upon the exact question here presented, we think its expressions in Heiner v. Colonial Trust Co., supra, and Choteau v. Burnet, supra, lead almost inevitably to support the conclusion here reached.

Having decided that the bonuses received from the leases in connection with both the homestead and surplus lands are subject to the Federal income tax, we shall now consider the remaining contentions of the parties as set out at the beginning of this opinion.

Petitioner’s contention that the taxable amount, if any, of the cash bonus of $132,500 should be determined in accordance with section 202 of the Eevenue Act of 1921, is based upon the assumed premise that the instruments executed on or about March 7, 1922, were “ sales ” of property. The courts and the Board hold such instruments to be oil and gas leases and not sales of property. See Henry L. Berg et al., 6 B. T. A. 1287; affd., 33 Fed. (2d) 641; certiorari denied, 280 U. S. 598; John T. Burkett, 7 B. T. A. 560; affd., 31 Fed. (2d) 667; certiorari denied, 280 U. S. 565; Bankers Pocahontas Coal Co., 18 B. T. A. 901, and cases therein cited; Henry Harmel, 19 B. T. A. 376; Hirschi v. United States, 67 Ct. Cls. 637; W. P. Ferguson, 20 B. T. A. 130; and Alexander v King, 46 Fed. (2d) 235; certiorari denied, 283 U. S. 845. Petitioner’s assumed premise was, therefore, erroneous. The instruments were leases and not sales of capital assets. See contra, however, Ferguson v. Commissioner, 45 Fed. (2d) 573. It follows that petitioner’s contention that no portion of the cash bonus is taxable because it was less than the value of the allotment when inherited by petitioner, must be denied.

The cash bonus, being subject to taxation as set forth above, we hold that in accordance with Murphy Oil Co., supra, pages 1202 and 1203, the entire amount of the $132,500 received by petitioner from leases in connection with the surplus lands in 1922 is taxable income for that year. See also Mary Alphin et al., 21 B. T. A. 1101. But since the respondent, in his motion for an increased deficiency made under the authority of section 274 (e) of the Revenue Act of 1926, moved “ that the Board in its final decision and order determine that the petitioner’s taxable income from the bonus of the 160-acre tract for 1922 was $121,750.00,” we hold that in redetermining the deficiency under Rule 50, only $121,750 of the cash bonus of $182,500 be included in petitioner’s taxable income. We do not have jurisdiction to determino a greater deficiency than that for which a claim is asserted by the respondent. Section 274 (e), supra.

The deficiency should be redetermined by including, in petitioner’s taxable income, $121,750 of the cash bonus of $132,500, instead of the $36,370 included by the respondent in his deficiency notice.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Matthews :

text:
    William A. Hodgson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44280.
    Promulgated October 1, 1931.

      J. R. Little, Esg., for the petitioner.

      S. B. Pierson, Esg., for the respondent.
   OPINION.

Matthews :

The petitioner in this proceeding is claiming the right to deduct from his gross income for 1925 as a net loss the amount of $23,473.08, which loss resulted from the sale of stocks and securities in 1924. Section 206 (a) of the Revenue Act of 1924 provides:

As used in'this section the term “net loss” means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:
(1) Deductions otherwise allowed by law not attributable to the operation of a trade or business regularly carried on by the taxpayer shall be allowed only to the extent of the amount of the gross income not derived from such trade or business;

And section 206 of the Revenue Act of 1926 provides:

(b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called “second year”), * * *
* * *. * * * *
(e) * * * or if for the taxable year 1924 a taxpayer sustained a net loss within the provisions of the Revenue Act of 1924, the amount of such net loss shall be allowed as a deduction in computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.

Since the petitioner sustained a loss in the year 1924 as the result of sales of securities in the amount of $38,353.04, which is in excess of the amount of gross income not derived from such transactions, it is necessary to decide whether the petitioner’s activities in buying and selling stocks and securities constituted a trade or business regularly carried on.”

Upon consideration of all the evidence, we are of the opinion, and so hold, that such activities did constitute a trade or business regularly carried on. The petitioner never practiced his chosen profession, engineering. After 1900 he devoted all his time and energies, in so far as business activities were concerned, to trading-in stocks and other securities. From a small investment of about $50,000 in 1900 he had increased his holdings until they were worth about $200,000 in 1924. Only a small part of this was in investment securities. During most of this time and during 1925 he was not actively interested in any other occupation. He was a member of a partnership, but took no active part therein and derived no income in 1924 and 1925 from this partnership. He spent a considerable part of his time at his brokers — sometimes nearly all day, depending upon the activity of the mai'ket. He derived the greater part of his income in 1925 from sales of securities. See Harry F. Harper, 20 B. T. A. 143; Lehigh Carroll, 20 B. T. A. 1029; and Washburn v. Commissioner, 51 Fed. (2d) 949.

In accordance, therefore, with the provisions of section 206(b) and (e) of the Revenue Act of 1926 the petitioner is entitled to deduct the net loss in the amount of $23,413.08, sustained in 1924, from his gross income for 1925.

Judgment will be entered under Ruis 50.


text:
    J. W. Brackman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45714.
    Promulgated October 1, 1931.

      E. L. Hog sett, Esq., for the petitioner.

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

Matthews :

The sole issue presented in this proceeding is whether the petitioner and his wife were partners so that only one-half of the income derived from the business conducted by them jointly is taxable to the petitioner. The petitioner’s wife from the time they were married always assisted in the business and gave him advice as to what investments to make. They orally agreed to share the profits and .losses equally. The profits were not distributed to them, but were invested in real estate, which was taken in their joint names.

Stevenson, who was credit manager of a company which advanced supplies for the lunch wagon, testified that in extending credit he looked to Brackman and his wife for payment and presumed that they were in partnership. He knew that the real estate stood in their joint names. Grohen, a bank official, testified that in lending money to them and in accepting their notes it was recognized that they were jointly interested in the business conducted by them. While the testimony of the parties concerned that there was such an oral agreement is not sufficient to establish a partnership,' when taken into consideration with their actions, the activities of the wife and the investment of their surplus in joint property, and the testimony of Stevenson and Gohen, we are of the opinion that the petitioner has established the existence of a partnership between himself and his wife during the taxable year. See Thomas F. Kelley, 9 B. T. A. 834; John T. Newell, 17 B. T. A. 93.

We do not believe that the fact that the returns were made for prior years on the basis of a -partnership between the petitioner and his son Howard is material. The petitioner’s wife did not know that returns weré being made in this way and the petitioner testified that he merely signed them when they were made out, not realizing their significance. Both of them testified emphatically that Howard -was not a partner in the business and the respondent did not introduce any evidence to rebut this testimony.

The respondent contends, however, that under the law of West Virginia a partnership between husband and wife is not valid. In the case of J. E. Biggs, Sr., 15 B.T.A. 1092, we held that where a husband and wife entered into a partnership in West Virginia the husband was not taxable on the wife’s distributive share of the partnership’s earnings.

A similar decision was reached by the District Court for the Southern District of West Virginia in the case of Pugh v. United States, 48 Fed. (2d) 600. That court referred with approval to the Biggs case and held that, in accordance with the case of Bolyard v. Bolyard, 79 W. Va. 554, although in law in that State a partnership contract between a husband and wife is not recognized, such a partnership is not void and rights arising thereunder could be enforced in equity. The court further held that where a husband, after acquiring 95 per cent interest in a partnership business, transferred as a gift to his wife the ownership of a 40 per cent interest therein, the income of the wife from such 40 per cent interest was taxable to her and not to her husband. See also Leininger v. Commissioner, 51 Fed. (2d) 7. In accordance with these decisions we hold that the petitioner is not taxable on the share of the partnership earnings which were distributable to the wife, and reported by her on her return.

Judgment will he entered for the 'petitioner.