author: Teammell:

text:
    Bolinger-Franklin Lumber Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8077.
    Promulgated June 17, 1927.
    1. At organization, petitioner issued certain certificates designated “ Class A Preferred Stock ” and “ Class B Preferred Stock ” respectively. On the facts, held that the Class A certificates were in effect certificates of indebtedness, representing borrowed capital, and may not be included in invested capital for tax purposes. The Class B certificates were certificates of stock, and constituted a part of the capital structure of petitioner.
    2. Certificates of preferred stock and certificates of indebtedness distinguished.

      W. W. Spalding, Esq., for the petitioner.

      J. Harry Byrne, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1918 and 1919 in the amounts of $16,156.66 and $5,277.73, respectively, a total of $21,434.39. The material facts were stipulated, and the only issue raised by the pleadings herein is one of law, namely, whether certain certificates designated Class A and Class B preferred stock constituted invested capital or borrowed capital.
    FINDINGS OF FACT.
    Petitioner is a Delaware corporation, organized in December, 1917, with its principal office at Zama, Miss. It succeeded a Mississippi corporation of the same name, which had theretofore operated a saw mill, built and owned by it. This predecessor corporation obtained its timber from the Winston Land & Timber Co., also a Mississippi corporation, under a contract which provided for the payment to the latter company of $3.50 per 1,000 feet for all timber cut.
    Because of financial difficulties in carrying on its operations, the officers and principal stockholders of the old Mississippi saw mill corporation began negotiations with the Winston Company with a view to the reorganization and refinancing of the saw mill company. These negotiations resulted in an agreement to organize a new corporation under the laws of Delaware to take over the assets of the saw mill company and the timber of the Winston Company. It was agreed that the new corporation should issue, for the assets to be thus acquired, three classes of stock as follows: 3,000 shares of common stock, without nominal or par value; 5,000 shares of Class A preferred stock, of a total par value of $500,000, or $100 per share; and 1,500 shares of Class B preferred stock, having a total par value of $150,000 or $100 per share. It was further agreed that the value of the Winston Company’s timber, on the basis of $3.50 per 1,000 feet, was $500,000, and that the Class A preferred stock in that amount should be issued therefor. It was also agreed that the value of the saw mill was $150,000, and that the Class B preferred stock in that amount - should be issued therefor. Pursuant to this agreement, petitioner was organized, and the different classes of so-called stock, designated as above set out, were duly issued in January, 1918.
    The common stock was apportioned equally to the Winston Company and the old saw mill company, with the exception of 40 shares which were sold on the open market at $100 per share. All of the so-called Class A preferred stock was issued to the Winston. Company for its timber, and all of the so-called Class B preferred stock was issued to the old saw mill company for its assets.
    Petitioner’s charter provided in paragraph six, with respect to capital stock as follows:
    The capital stock of this company shall be:
    A. 3,000 shares of common stock, without nominal or par value, which maybe issued by the corporation from time to time for such consideration as may be fixed from time to time by the Board of Directors.
    B. 5,000 shares of preferred stock, Class A, each share to be of a par value of one hundred dollars ($100), and each of said shares shall make express reference to the terms herein contained and shall be retired out of the pay- j ments to be made by this corporation upon the basis of Three and 50/100 ($3.50) Dollars per thousand feet, for each thousand feet of timber actually j cut and/or sold. Payment to be made on the first Three and 50/100 ($3.50) ■' Dollars per thousand feet, collected out of the purchase price, but not before, when any timber is sold on credit.
    When said Corporation shall sell or cut any timber, it will forthwith (except upon sales on credit and then as above provided) set aside and deposit said Three and 50/100 Dollars ($3.50) until said sum shall aggregate Five Thousand Dollars ($5,000) when it shall be distributed, without preference or priority, to and among said several shares credited in Class “A.” Should there be a failure for as much as two months upon the part of said Corporation to set aside Three and 50/100 Dollars ($3.50) per thousand feet upon the amount of timber cut, then said shareholders of Class “A” can, at their election, elect an executive committee who shall be vested with the management and control of said Corporation. The said Corporation for the benefit of said Class “A” Preferred Shares binds itself to cut an average of eighteen million feet log scale annually, but it shall cut sufficient to pay for at least one million feet per month, in accordance with the provisions of this section, unless the price of manufactured lumber should fall below an average of Twelve Dollars per thousand feet, f. o. b. cars as shown by the monthly statement of said Corporation, when said Corporation shall have the right to cease operation until such time as the market will yield an average of Twelve Dollars or more per thousand feet, and all timber payments hereunder made shall likewise cease until operations are resumed, and the annual cut required for the benefit of said Class “A” Preferred Stock shall be proportionately reduced, and said holders of Class “A” Preferred Stock, or any of them, shall have free access to the books and papers of said Corporation at all reasonable times and may hare them audited whenever said Class “A” Shareholders, or any of them, deem necessary, by paying the expenses of so doing. But said Corporation shall furnish to a representative of Class A share-holders a monthly and an annual statement of its affairs. Or said Corporation may cease cutting because of (a) strikes; (b) the act of God; (c) the public enemy; (d) car shortage, with the same effect as hereinbefore provided. Said Class “A” shall be preferred and constitute a preferred claim in, to and against the timber owned by said Corporation until all of said shares shall have been fully retired.
    C. 1,500 shares of the par value of $100 of Class B preferred which shall be retired at par, when, if and as the earnings of said Corporation shall permit. But said Class “ B ” shall be fully retired before the Common Shares are entitled to any dividend distribution or declared benefit. And said Class “ B ” shares until retired shall have preference and priority in, to and against the assets of said Company other than the timber. Said stock shall be retired by dividends to be paid in amounts of not less than Five Thousand Dollars ($5,000) at one time, and may be paid at such times as said Directors may from time to time determine. Said preferred stock, Class “A,” shall be retired in full from the timber, and if more than sufficient to retire said Class “A” then the residue shall be applied to retiring Class “ B ” Preferred before the Common Stock shall be entitled to receive any distribution whatever, except that when Class “ B ” shall have been retired, dividends may be paid upon said Common Shares, provided there is no default in the payments required to be made upon Class “A.” All voting power shall be vested in the holders of Common Stock.
    The rights of the Preferred Shares issued and to be issued shall not be divested without the unanimous consent obtained from every shareholder of stock issued and outstanding.
    The Class A and Class B certificates were the same in form, except for appropriate changes in designation, and both classes contained identically the same provisions. Class A certificates read as follows:
    No. —Incorporated under the Laws of Delaware - Shares
    Bolinger-Franiclin Lumber Combany, Ino.

      Common Stock, 3,000 Shares No Par Value.
    Class “A” Preferred Stock $500,000. Class “ B ” Preferred Stock $150,000.
    Class “A” Preferred Stock. Shares $100 Bach.
    This is to certify that-is the owner of-•— Shares of the
    Class “A” Preferred Capital Stock of Bomnger-Franklin Lumber Company, Ino., transferable only on the books of the Corporation by the holder thereof, in person or by duly authorized Attorney upon surrender of this Certificate properly endorsed.
    Each certificate then set forth at length the provisions of paragraph six of the charter, hereinabove set out in subparagraphs B and C, and concluded with the following:
    In case a default shall be made in the payment of the principal or interest upon any bonds of this Corporation, secured by mortgage that may be from time to tima issued and such default continue for a period of Thirty (30) days and/or in case of the appointment of a Keceiver of this Corporation and/or in case of a judgment of forfeiture of franchise, ouster or liquidation and/or in case of the judicial ascertainment of the violation of any law, State or Federal by this Company and/or in case of an adjudication in bankruptcy, then, at once the rights of both Common and Preferred Shareholders shall cease and determine and the sole right to elect Directors and manage, direct, and/or control this Corporation may be vested in the holders of the Mortgage Bonds that may be then outstanding — each bond to have an equal right with every other bond in such voting — together with right of cumulative voting in the election of Directors as now provided by law. This power shall continue until all of said bonds shall have been paid or discharged or until voluntarily relinquished by a majority vote of the bonds then issued and outstanding.
    Witness the seal of the Corporation and the signature of its duly authorized officers affixed this-day of-19 — .
    Subsequent to the issuance of the certificates designated as Class A preferred stock, the amount of $10,040.90 thereof was retired, leaving a balance of $489,959.10 of Class A and $150,000 of Class B, outstanding during the taxable years in question, or a total outstanding balance of $039,959.10.
   OPINION.

Teammell:

The material facts pertinent to the issue in this proceeding are not in dispute. Shortly after its organization petitioner issued certificates in the amount of $500,000 which it denominated “ Class A Preferred Stock,” and thereafter retired the amount of $10,040.90 thereof, leaving outstanding during the taxable years here involved, the amount of $489,959.10. At the same time, it issued other certificates in the amount of $150,000, which it designated “ Class B Preferred Stock.” Petitioner contends that these certificates represented invested capital, as defined in section 320 (a) of the Revenue Act of 1918, and that in the computation of its invested capital for the taxable years 1918 and 1919, it is entitled to have included therein the total outstanding balance of $639,959.10. Respondent contends that the certificates in question represented borrowed capital, and that under the express provisions of section 326 (b) of the Revenue Act of 1918, the entire amount must be excluded from invested capital. A single issue of law is thus raised for consideration here.

Were these certificates, when issued, certificates of stock in fact or were they in effect certificates of indebtedness ? Petitioner designated them as “ Class A Preferred Stock ” and “ Class B Preferred Stock ” respectively, and as we said in the Appeal of Kentucky River Coal Corporation, 3 B. T. A. 644, it is not lightly to be assumed that parties have given an erroneous name to their transaction. However, it is well settled that mere designation can not, in the last analysis, be a controlling factor in the determination of the true nature of an instrument. In the Appeal of I. Unterberg & Co., 2 B. T. A. 274, we held that the name by which an instrument is denominated, either on its face or on a corporation’s books, is not conclusive as to its character, and that its true nature will be determined by looking to its terms and legal effect. A mortgage creditor, although denominated a “ preferred stockholder ” is a mortgage creditor nevertheless, and interest is not changed into a “ dividend ” by calling it a dividend. Burt v. Rattle, 31 Ohio St. 116. Again, the Supreme Court of Ohio, in considering a similar situation, said: ‘ The question is not, what did the parties call it, but what do the facts and circumstances require the Court to call it ? ’” Miller v. Ratterman, 47 Ohio St. 141; 24 N. E. 496. We must, therefore, in order to determine the true character of these certificates, examine into the terms of the contracts under which they were issued, and consider the legal effects flowing therefrom. Since it appears that the contracts are materially different, the two classes of certificates will be discussed in their alphabetical order.

The holder of a corporation’s stock, whether common or preferred, can not by virtue of the ownership of such stock, be a creditor of the corporation. He can not be both a creditor and a debtor. And so the holders of the certificates under consideration were either stockholders of the corporation or creditors. This leads us then to inquire first into the fundamental difference between a stockholder and a creditor, or between certificates of stock and certificates of indebtedness. Obviously the difference lies in the relationships existing between the holders of the certificates and the corporation, which are fixed by the terms of the bertificates or the contracts under which they are issued. A stockholder of a corporation is one who has invested money or money’s worth in the enterprise, with hope or expectation of receiving income or profit from the operations of the company. If the venture be successful, he receives his proportionate part of the profit; otherwise, he may lose the amount of his investment represented by the certificates of stock. A creditor of a corporation is one who has loaned to it money or its equivalent, usually for compensation or interest, at a fixed rate, to be repaid at a designated time or in a designated manner. The creditor is in no wise concerned in the profits of the corporation or its property. If it prospers, he is not benefited thereby, and if it suffers a loss, he is still entitled to the return of his loan in accordance with the contract. The stockholder risks his money in the enterprise. The creditor assumes no such risk.

In Warren v. King, 108 U. S. 389, the Supreme Court said, at page 399:

Creditors may resort to th'e body of their debtor’s property for interest as well as principal. But these holders of preferred stock are limited, for any income or interest, to net earnings.
# * & & 9 $ >£
His [the stockholder’s] chance of gain, by the operations of the corporation, throws on him, as respects creditors, the entire risk of the loss of his share of the capital, which must go to satisfy the creditors in case of misfortune. He can not be both creditor and debtor, by virtue of his ownership of stock.

In Miller v. Ratterman, supra, the Supreme Court of Ohio states the difference between a preferred stockholder and a creditor as follows:

The question in the case is whether the certificates are certificates of stock or certificates of indebtedness. * * *
Tlie relation of a holder of preferred stock is, in some of its aspects, similar to that of a creditor; but he is not a creditor save as to dividends, after the same are declared. Nor does he sustain a dual relation to the corporation. He is either a stockholder or a creditor. He cannot, by virtue of the same certificate, be both. If the former, lie takes a risk in the concerns of the company, not only as to dividends and a proportion of assets on the dissolution of the company, but as to statutory liability for debts in case the corporation becomes insolvent. If the latter, he takes no interest in the company’s affairs, is not concerned in its property or profits as such, but his whole right is to receive agreed compensation for the use of the money he furnishes, and the return of the principal when due. Whether he is the one or the other depends upon the proper construction of the contract he holds with the company.

What is preferred stock? By preferred stock is to be understood stock which entitles the holder to receive dividends from the earnings of the company before the common stock is paid a dividend from such earnings. In other words, it is stock entitled to .dividends from the income or earnings of the corporation before any other dividend is paid. Cook on Corporations, 8th ed. vol. 1, § 267.

When the principles above set forth are applied to the provisions of the contract embodied in and under which the Class A certificates were issued, it is at once apparent that they are not, as they purport to be, certificates of preferred stock, but are in effect certificates of indebtedness. The holders of those certificates were absolutely and at all events entitled to have returned to them the total sum of $500,000, to be paid in sums of $5,000, at the rate of $3.50 for each 1,000 feet of timber sold or cut, and the corporation obligated itself to cut sufficient timber to pay for at least one million feet per month, subject only to the happening of certain contingencies beyond the control of the corporation. And it was further provided that should there be a failure for as much as two months upon the part of the corporation to set aside the sum of $3.50 for payment to the holders of such certificates, the holders might assume control of the corporation, a right frequently granted to bondholders similarly circumstanced. The holders of these Class A certificates, as such, had no interest in the profits of the corporation or in its property, as such. If the corporation made large profits, or no profit, or suffered a loss, it did not affect their rights, which were restricted to the payment to them of the amount of money stated, and in the manner set out, in the contract. They risked nothing thereby in the business ventures of the corporation. They assumed no risk not assumed by an ordinary creditor, and the payment of the money was not required to be made out of the income or profit, but the sum of $3.50 was to be paid for each 1,000 feet of timber sold or cut until the full amount of the certificates had been refunded.

But it is argued by the petitioner that, because the rights of the certificate holders were subordinated to those of the holders of mortgage bonds, this determined the status of the former as preferred stockholders. While it is true that this is an attribute of preferred stock, imputed by law, whether or not expressly provided by contract, it is also a provision often applied to issues of bonds, whereby one issue or series of bonds is given preference over another. The legal effect of such a provision in the case of bonds is merely to create a restricted indebtedness. This question was before us in the Appeal of I. Unterberg & Co., supra, in connection with which we said:

Examining the terms and effect of the instrument, we are unable to hold it to be a certificate of stock. It is evidence of a restricted indebtedness. The fact that the principal amount is subordinated to the claims of general business creditors is not sufficient to warrant this Board’s determination that it is stock for the purpose of invested capital * * *.
Applying the principle of invested capital, it is questionable whether these amounts were in fact risked in the enterprise. They were payable at maturity, subject to the claims of general creditors. They were an obligation of the corporation, enforcible in all respects except that the general creditors might insist that the assets should not be impaired below the amount of their claims. Thqy were of a lower degree than such claims, and yet fixed in amount and time so as to distinguish them from stock * * *.
We hold the instruments in question to represent borrowed capital, and hence that the amount thereof may not be included in invested capital.

It is our opinion that the certificates herein designated by the petitioner as “ Class A Preferred Stock ” were in the nature of certificates of indebtedness, which represented borrowed capital, and may not therefore be included in its invested capital under section 326 (b) of (.he Revenue Act of 1918. Accordingly, the action of respondent i excluding said certificates to the amount of $489,959.10 is approved.

An examination of the provisions of the contract relating to the Class B certificates discloses that they possessed all of the essential qualities of preferred stock. The fact that both the Class A and Class B certificates contained no provision for the payment either of interest or preferred dividends is not material in determining whether they represented invested or borrowed capital for tax purposes. The contract provided that the Class B certificates should be retired at par when, if and as the earnings of said corporation should permit, but prior to any dividend distribution or declared benefit on common shares. It further provided that said certificates should be retired by dividends to be paid in amounts of not less than $5,000 at one time, and should be paid from time to time as the directors might determine. Thus, it is clear that if the corporation had no net income or earnings out of which dividends could be declared, the holders of the Class B certificates, would receive no payments, since no other provision therefor was made, with the exception that after the Class A certificates had been fully retired from the timber, the residue of the proceeds, if any, from that asset, might be applied to retiring the Class B certificates. This, however, was also a contingency. The holders of the Class B certificates were not entitled at all events to the return of the amount represented by the certificates, either within a definite time or in a designated manner free of contingencies. The return of their money was dependent Upon the success of the enterprise. We conclude, therefore, that the Class B certificates represented shares of preferred stock, which may properly be regarded as a part of the capital structure of petitioner. The amount of these certificates in the sum of $150,000 should be reflected in the computation of petitioner’s invested capital for each of the years involved herein. The action of respondent in excluding the Class B certificates from the invested capital of petitioner is disapproved.

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

Milliken did not participate.

Aeundell, Phillips, Smith and Trussell dissent.


source: Caselaw Access Project

author: MoRitis:

license: Public Domain

text:
    Appeal of Albert M. Briggs.
    Docket No. 5288.
    Promulgated June 18, 1927.
    In 1917, the petitioner, a commission salesman, was authorized to and did form the American Protective League, an unincorporated organization, which operated under the direction of and in conjunction with the Department of Justice. During the year 1918, he devoted his entire time to the League and expended in its behalf a substantial sum of money which he claimed as a deduction either as an ordinary and necessary expense under section 214 (a) (1) or as a charitable contribution, under section 214 (a) (11). Held, that petitioner’s activities were not such employment as made it his trade or business, and that the American Protective League does not fall within the definitions of associations, contributions to which are deductible under the statute.

      Jomes L. Dohr, Esq., for the petitioner.

      M. N. Fisher, Esq., for the Commissioner.
    This is an appeal from a determination of a deficiency in income tax for the year 1918 in the amount of $3,589.94, arising from increasing the petitioner’s income from commissions to the extent of $11,725.47, and from dividends, $420.
    The petitioner also alleges that the Commissioner erred in disallowing a deduction of $20,095, representing payments, or contributions made to the American Protective League, in the year 1918, which resulted in an additional tax for that year of $4,403.35. This latter sum was paid under protest and application made for a refund.
    BINDINGS OB BACT.
    The petitioner is an individual who resides in New York City. During the year 1918 he was employed as a salesman by the Poster Advertising Co., Inc., a New York corporation. His only compensation for such employment was in the form of commissions based on the volume of business received by him for the company.
    He kept his books and made his income-tax return for the year 1918 on the cash receipts and disbursements basis, reporting thereon $31,030.92 as commission received from the Poster Advertising Co. The Commissioner increased his income from that source to $43,-356.39. The Commissioner also added $420 to the income as returned, representing dividends paid to the petitioner.
    In 1917 the Attorney General authorized the petitioner to organize the American Protective League to operate under the direction of, and in conjunction with the Department of Justice in various activities of a secret-service nature, which organization he formed. It^ was not incorporated, nor did it have any written plan of organization such as a charter. It did not have a president, although the petitioner was the directing head. It had no board of directors. It developed in the following manner. A man with the title “ Chief ” was appointed in a town in which a unit was to be organized. He then appointed inspectors to command certain portions. The inspector subdivided his territory into company zones and designated men in charge thereof and appointed operatives. The operatives covered every activity in that district. The organization grew to approximately 16,000 units throughout the United States, with a membership of more than 500,000 men. The petitioner as well as the other members, was sworn in as a Government agent and operated under the Department of Justice. As soon as anything was learned that might be of interest to the Department of Justice, the operative reported to his captain, the captain to the inspector and the inspector to the chief. The matter would then be taken up with the local agent of the Department of Justice if deemed to be of sufficient importance, and if he authorized a further investigation, such action was taken. A large number of cases were also handled for the Army and Navy. The work of the League consisted of the investigation of and dealing with alien enemies and enemy sympathizers within the ^ United States, and the rounding up of draft evaders, the investiga-»' tion of suspicious characters in activities detrimental to the interests ■ of the United States, the investigation of applicants for positions in ^ Government service and many other similar services. '
    In the beginning the petitioner paid all the expenses of the League. As it grew, the local organizations were able to finance themselves through the donations of the members and other citizens of the community. The larger cities contributed to the support of the national organization.
    The League disbanded about six or eight months after the close of the war, with two hundred and some odd dollars in the treasury, which is still in a bank in the League’s name. The League never paid anything by way of dividends.
    The petitioner devoted his entire time to the League during 1918. He served without pay, bore his own expenses and traveled from place to place throughout the United States to stimulate and keep up the organization. During the year 1918 he contributed directly in cash $4,000 and in addition paid hotel bills, office rent, railroad fare, stenographic services, operatives, etc., in connection with such work in the total amount of $19,032.89, making a total of $23,032.89. The Commissioner refused to allow the deduction or any part thereof.
   OPINION.

MoRitis:

The Commissioner conceded at the hearing that the petitioner correctly reported his taxable income, in so far as affected by his compensation from the Poster Advertising Co., Inc. The purported additional commissions of $11,725.41 should therefore be excluded in computing the petitioner’s net income.

The petitioner offered no evidence to sustain his assignment of error in regard to the $420 item alleged to have been dividends received by him. As to that item the determination of the Commissioner is approved.

This leaves, for our consideration whether the amount of $23,032.89 paid to or for the account of the American Protective League, is deductible. The petitioner contends that he is entitled to the deduction either as an ordinary and necessary business expense under section 214 (a) (1) or in the alternative, as a charitable contribution under section 214 (a) (11). The pertinent parts of section 214 of the Revenue Act of 1918 are as follows:

Sec. 214. (a) That in computing net income there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *
(11) Contributions or gifts made witbin the taxable year to corporations organized and operated exclusively for religious, charitable, scientific, or educational purposes, * * *

Although the petitioner devoted his entire time during the year 1918 to the American Protective League and its activities, it was not such employment as made it his trade or business in the contemplation of the statute here involved. In Thomas F. Sheridan v. Commissioner, 4 B. T. A. 1299, we quoted with approval the definition of “ trade or business ” as given in Bouvier’s Law Dictionary as, “ That which occupies the time, attention and labor of men for the purpose of a livelihood and profit.” That definition ivas adopted by the Supreme Court in the cases of Flint v. Stone Tracy Co., 220 U. S. 107, and Von Baumbach v. Sargent Land Co., 242 U. S. 503, 515. The Sheridan appeal involved the interpretation of the term “trade or business ” as used in section 214 (a) (4), but the definition adopted is equally applicable to that term as used in section 214 (a) (1). The petitioner is not entitled therefore to the deduction claimed as an ordinary and necessary expense.

Section 214 (a) (11) provides for the deduction of donations made to corporations organized and operated for certain purposes. Section 1 of the Act provides that the term “ corporation ” includes associations. The first prerequisite is that the donation shall have been made to a corporation or association. As the American Protective League was not incorporated, it must fall within the class of associations for the donation in question to be deductible, assuming it was organized and operated for one of the designated purposes. In the United States, the term association “ is used to signify a body of persons united without a charter but upon the methods and forms used by incorporated bodies for the prosecution of some enterprise.” 1 Bouvier’s Law Dictionary (Rawle’s 3d Rev. 269). Other definitions are, “ In the United States, as distinguished from a corporation, a body of persons organized for the prosecution of some purpose, without a charter, but having the general form and mode of procedure of a corporation.” Webster’s Few Int. Diet. “The term ‘association’ usually means an unincorporated organization composed of a body of men, partaking in its general form and mode of procedure of the characteristics of a corporation.” 1 Words and Phrases 584. See also Hecht v. Malley, 265 U. S. 144; Appeal of Philadelphia & Reading Relief Association, 4 B. T. A., 713. In our opinion, the American Protective League does not fall within those definitions. The donations made to and for the benefit thereof are not, therefore, deductible under section 214 (a) (11).

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


author: GRIoen:

text:
    Live Stock National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2467.
    Promulgated June 18, 1927.

      W. G. Dorsey, Esq., for the petitioner.

      John D. Foley, Esq., for the respondent.
   GRIoen:

In this proceeding the petitioner seeks a redetermination of its income and profits-tax liability for the year 1920, for which the respondent has determined a deficiency in the sum, of $349.50. The sole issue in the case is the right of the petitioner to deduct as an ordinary and necessary business expense the amount contributed by it during the taxable year to a so-called “ pension fund.”

FINDINGS OF FACT.

On February 9, 1917, the board of directors of the Live Stock National Bank, the petitioner herein, at a special meeting adopted the following resolution:

Whereas, the stockholders of this bank are desirous of adopting some permanent method of rewarding the employees of this bank for the past and future continued faithful performance of their duties as such employees; and whereas various methods and means of effecting such purpose have been considered:
Now, therefore, Be it Resolved, That the Board of Directors of this Bank is hereby authorized, empowered and directed to organize and put into effect a pension fund for the benefit of the present and future employees of this bank, and adopt, ratify and approve such rules and regulations for the management and control of such pension fund and from time to time to make such gifts and donations by this bank to such pension fund as may in the judgment of the Board of Directors seem fit and proper; and whereas, the Board of Directors of this Bank have carefully considered and investigated the best methods for effectuating the purpose therein set forth, Now therefore, Be it Resolved, that there is hereby created a fund which shall be known as the bank pension fund of the Live Stock National Bank of Omaha, and that the said fund shall be controlled and managed in accordance with the following rules and regulations.
And be it further resolved, that on this date, this Bank donate the sum of twenty-five hundred ($2500) dollars to said bank pension fund, namely, that the entire balance of the hospital and disability fund heretofore carried as Savings account B-1000, amounting to $849, be credited to said bank pension fund, and also that the amount of $1,651 be charged from contingent fund, making a total of $2,500 donated to said bank pension fund.

The scheme or plan adopted by the resolution resulted from the suggestion of the president of the bank. It had been found difficult to procure and retain desirable employees and it was deemed advisable to create the fund in order that there be a stronger incentive on the part of the employees to remain in the service of the bank. The fund was operated and controlled by a committee of three, all of whom were associated with the bank in one capacity or another. Three per cent of the salary of each employee was withheld by the bank and paid into the fund. The bank itself from time to time made contributions thereto. In the year in question its contribution was $3,159. The money thus paid in or contributed was invested in notes, stocks of the petitioner bank, or deposited in a separate account in the bank, which account was treated the same as the account of any other depositor. The securities thus owned by the fund were not listed as assets of the bank and were treated by the bank as the property of the employees entitled to participate therein pursuant to the rules and regulations adopted by them. In 1922, by unanimous consent of those entitled to participate in the distributions thereof, the fund was dissolved and the amounts paid in or contributed, together with the earnings properly attributable thereto, were returned to those who made the payment or contribution.

The petitioner corporation had no interest in the securities or other property owned by the fund. The various contributions thereto were made for the purpose of encouraging desirable persons to become employees of the bank and to retain the services of such employees. See Hibbard, Spencer, Bartlett & Co. v. Commissioner, 5 B. T. A., 464.

Judgment will be entered on 15 days'1 notice, wnder Bule 50.


author: Geeen:

text:
    Homer M. Preston, Fletcher Goodwill, and Robert H. Jackson, Administrators with the Will Annexed of Sheldon B. Broadhead, Petitioners, v. Commissioner of Internal Revenue, Respondent. William A. Broadhead, Administrator, Estate of Almet N. Broadhead, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3896, 3897.
    Promulgated June 18, 1927.
    Upon the evidence, held, that certain stock in a public utility electric railroad corporation became worthless in 1919, thereby entitling the petitioners to a deduction for losses under section 214(a) (5) of the Revenue Act of 1918.

      Marion N. Fisher, Esq., Nomnan G. Chambers, C. P. A., and Harold C. Anderson, C. P. A., for the petitioners.

      Brice Toole, Esq., for the respondent.
    This proceeding results from the determination by the Commissioner of a total deficiency of $116,157.86 against Sheldon B. Broad-head for the calendar years 1917, 1918, 1919, and 1921, and a total deficiency of $120,202.06 against Almet 1ST. Broadhead for the same years, both deficiency letters being dated March 10, 1925. Both the petitioners died in 1925 after the petitions were filed. At the hearing motions for the consolidation of the appeals and the substitution of the administrators were granted. The issue in each appeal is identical. Two errors were originally assigned: (1) The disallowance of an alleged loss in 1919 of an investment in the capital stock of the Chautauqua Traction Co.; and (2) the disallowance in part of deductions for depreciation. The error respecting depreciation was waived by the petitioners at the hearing.
    FINDINGS OF FACT.
    Sheldon B. Broadhead and Almet N. Broadhead were citizens of the State of New York. They were brothers and from 1910 to 1925 the sole and equal partners in and owners of the assets of the co-partnership of William Broadhead & Sons. Prior to 1910, the date of their father’s death, the partnership had consisted of William Broadhead and his two sons, Sheldon and Almet, who had, since 1875, been engaged in the City of Jamestown in the operation of a worsted mill known as the Broadhead Worsted Mill. In addition, the petitioners, as such partners, had organized and owned practically all the stock and the major portion of the bonds of various local public utility companies, including the Chautauqua Traction Co., the Jamestown Street Railway Co., the Jamestown, Westfield & Northwestern Ry. Co., and the Jamestown Lighting & Power Co. The petitioners also owned the majority of the common stock of the Jamestown Worsted Mill and were engaged individually or jointly in various other business enterprises in the City of Jamestown. Sheldon B. Broadhead was 79 years old and Almet N. Broadhead 74 years old at the time of their respective deaths in 1925.
    The Chautauqua Traction Co., the capital stock of which forms the basis of this proceeding, was incorporated under the laws of the State of New York on February 25, 1903, with an authorized capital stock of $500,000 having a par value of $100 per share, and an authorized bond issue of $600,000. It entered into a contract with the partnership of William Broadhead & Sons whereby the latter agreed to build its road and provide its equipment in exchange for $480,000 par value of its capital stock and $500,000 par value of its first mortgage 5 per cent gold bonds.
    At a later date, in part payment of advances made, the partnership received $100,000 first mortgage 5 per cent gold bonds, which, together with the aforementioned $500,000 bonds received for consideration of the contract to build the road and furnish the equipment, represented the entire bonded debt of the company.

      The stock and bond investment of the partnership in the Chautauqua Traction Co. was made in the manner described above. In addition to the foregoing bond and stockholdings the partnership advanced considerable sums on open account, some of which remained unpaid.
    Between 1903 and March 1, 1913, certain minor changes occurred in the amount of stock and bonds of the Chautauqua Traction Co. owned by the petitioners, so that on March 1, 1913, the partners owned 4,974 shares of stock and $530,000 par value of bonds. They continued to hold these amounts until their deaths in 1925. It was stipulated and agreed between counsel for the petitioners and counsel for the Commissioner that the 4,974 shares of stock had cost the petitioner $289,885.20; that the $530,000 bonds had cost them par; that the March 1,1913, value of the 4,974 shares of stock was $325,223.31; and the March 1, 1913, value of the bonds was $530,000. The petitioners contend that by 1919 the stock had become worthless, and that therefore they were entitled to a deduction from gross income on account of losses in the amount of $289,885.20. The respondent has denied this contention.
    Messrs. A. 1ST. Broadhead and Sheldon B. Broadhead were president and treasurer respectively of the Chautauqua Traction Co. Both were also directors. No salaries were ever paid to them.
    The traction line of the Chautauqua Traction Co. is a single track of approximately 30 miles, and runs west from Lakewood (located at the southern end of the Chautauqua Lake in Chautauqua County in the State of New York) to Ashville, thence northwesterly along the western shore of the lake to Mayville, the county seat of Chautauqua County, and then on in the same direction to Westfield and Barcelona. The distance between Lakewood and Ashville is approximately 2 miles; between Ashville and Mayville, 18 miles; between Mayville and Westfield 9 miles; and between Westfield and Barcelona, 1 mile. Barcelona is a small hamlet and borders on Lake Erie. The cities of Lakewood and Jamestown are connected by about 3 miles of track owned by the Jamestown Street Railway Co.
    Between 1914 and 1918 an improved state highway was constructed on the eastern shore of Lake Chautauqua from Jamestown through Mayville to Westfield. Mayville is located at the northern end of Lake Cha'utauqua. Between 1914 and 1922 an improved state and county highway was constructed on the western shore of Lake Chautauqua from Jamestown to Mayville.
    Connections were made along the route with four railroads and one traction line, including the Erie Railroad at Jamestown and Lakewood, the Pennsylvania Railroad at Mayville, and the New York Central and Nickle Plate Railroads, and the B. & L. E. Traction Co. at Westfield.
    The following table shows the number of pleasure and commercial automobiles for which licenses were issued to residents of the County of Chautauqua, New York, during the years hereinafter specified:

    In addition to the above, automobiles licensed by other States appeared at the lake resorts, after 1915, in substantial and increasing-numbers during the summer seasons.
    The population of the Chautauqua Lake region was increased materially during the summer season by visitors at the various lake resorts and by cottage owners. For example, the winter population of the Chautauqua Assembly Institution was only 1,200, while its summer population during July and August varied from 15,000 to 25,000. This population was further augmented on special days (such as Grange and G. A. R. day) when as many as 12,000 people entered the Assembly gates.
    The business of the Chautauqua Traction Co. was largely passenger, with incidental freight business. The summer resort traffic produced a heavy peak load during July and August. Prior to 1918 the company operated 15 cars in the summer, making 27 regular round trips daily, while during the balance of the year 5 cars making about 17 round trips sufficed to handle the business.
    Due to the improved highways and the privately owned automobiles, the number of passengers carried by the Chautauqua Traction Co. decreased materially during the years 1914 to 1919, as is shown by the following table, which gives the number of passenger fares collected, tickets or cash, during the 12-month period ended June 30 in the years stated:

      Number of passengers carried

      The result of operations of the Chautauqua Traction Co. for the years 1908 to 1921 is shown by the following schedule:

    ‘ The balance sheets showing the financial condition of the Chautauqua Traction Co. for the years ended December 31, Í917, to 1921, inclusive, are as follows:
    Assets: Current-Cash.. Accounts receivable_ Material and supplies. Total current assets.... Fixed-Plant and equipment (at depreciated value). Advances_ Total fixed assets_ Passive suspense.. Deficit_ Liabilities: Current-Bills and accounts payable. Fixed-Bonded debt... Affiliated company debts— Win. Broadhead & Sons__ Jamestown St. By. Co. Others. Total fixed liabilities.. Capital stock_ 1917 1918 1919 1920 $6,086.78 59, 232. 48 3,359.69 $4,795.18 55,346.49 C, 635.20 $24,074.36 45, 160.04 5,298.11 $21,992.29 61,142.02 10,393.88 $5,673.55 72,904.51 3,766.95 68, 678.95 66,776.87 74,532.51 93,528.19 1,097,572.92 15,944.34 1,074,473.75 18,190.13 991,069.05 16,157.09 964,496.49 15,565.88 1,113,517.26 7,800.00 406,399.40 1,092,663.88 7,800.00 490,882.88 1,007,226.14 7,800.00 590,630.54 980, 062.37 7,800.00 648,762.91 1,596,395.61 1,658,123.63 1,680,189.19 1,730, 153.47 187,560.53 191,869.74 115,068.34 132,936.37 600,000.00 80,110. 51 228,724.57 600,000. 00 108,637.41 257,018.44 598.04 600,000.00 171,002.99 293,519.82 598.04 600,000.00 196,572. 73 300,046.33 598.04 908,835. 08 500,000.00 966,253.89 500,000.00 1,065,120. 85 600,000.00 1,097,217.10 500,000.00 1,596,395.61 1,658, 123. C 1,680,189.19 1,730,153.47 82,345.01 936,339.55 15,442.42 951,781.97 7,800.00 719,067. 83 1,760,994.81 110,581.54 600,000. 00 223,571.91 326, 243.32 598. 04 l, 150, 413. 27 500,000.00 1,760,994.81

      The Chautauqua Traction Co., was required to keep its books, records and operating statistics in accordance with certain uniform rules and classification of the Public Service Commission of the State of New York.
    The rates of fare adopted in 1908 consisted of a base rate of 2% cents a mile on through tickets, with a minimum rate of 5 cents, and with mileage books furnishing transportation as cheap as 1 y2 cents a mile. These rates were continued until June, 1918, at which time, with the approval of the United States Railroad Administration, the mileage books were discontinued; the minimum rate was raised from 5 cents to 10 cents, with a base rate of 3 cents per mile on through tickets. The result of this increase was a 45 per cent falling off in the number of passengers carried and a 2 per cent increase in receipts, although the company had anticipated a 20 per cent increase in revenue with only a 10 per cent loss in the number of passenger's.
    In July, 1918, the road was relinquished by the United’States Railroad Administration. The rate increase was then contested by various municipalities along the route and hearings had before the Public Service Commission, which rendered its decision, cited as VIII P. S. C. Rep. 484, on November 25, 1919. The commission ordered a few minor changes, but in substance held that the rates complained against were not unreasonable. It analyzed the records of the Chautauqua Traction Co., covering revenues, expenses and passengers carried, investment and returns, pointed out by tables and figures cited, and the progressive loss of patronage suffered, and then suggested in its opinion that the Chautauqua Traction Co. “should without delay give careful consideration to the facts disclosed in this proceeding.” The petitioner construed the above opinion of the commission as a “ direction ” that they should charge off and reduce the capital assets and investment accounts of the Chautauqua Traction Co., whereupon, during the year 1919 the partnership wrote off of its books the amount of $23,184, being a part of its investment in the Chautauqua Traction Co., and claimed this amount as a deduction on its partnership income-tax return for 1919. At the time of closing the 1919 books of the partnership a further sum was written off from the account of the traction company, but not at that time claimed as a deduction on the partnership return. In the year 1921 the sum of $77,670.62 was Avr'itten off from the account of the Chautauqua Traction Co. and claimed as a deduction for the year 1921. The Commissioner has not allowed any deduction in any year on account of the alleged worthlessness of the stock of the traction company.
    During 1919, the petitioners had conferences with other officers and directors of the Chautauqua Traction Co., and with officials of the neighboring Warren and Jamestown traction line in connection with negotiations relating to a possible sale to the Warren and Jamestown line, or a merger or joint operating arrangement, but no agreement could be reached for the reason that in the opinion of the officers of the Warren and Jamestown line the road of the Chautauqua Traction Co. was not worth the bonds outstanding against it. Joint terminals for the two roads were then considered as a possible reduction of the cost of operations, but the petitioners rejected this suggestion for the reason that it would hare caused an outlay of money.
    In 1915 and 1916 negotiations were had with one Joseph Mayer of New York, by the petitioners looking to a sale of the Chautauqua Traction Co. property, and again in 1921 with the Niagara Power Co., but nothing resulted therefrom.
    The petitioners realized in the summer of 1919 that the changes in rates and service, adopted in June, 1918, had entirely failed to remedy or substantially affect the situation of the company, and further conferences were had by them with the officers and directors of the company, at which various plans and suggestions, including the question of “ complete abandonment ” of the traction line were seriously considered.
    It was finally determined to abandon the portion of the traction route extended from Westfield to Barcelona, and in September, 1919, a declaration of abandonment of that portion of the route was adopted and a petition for the approval thereof filed with the Public Service Commission. The limited abandonment policy adopted was one of expediency dictated by the financial situation of the traction line and the Broadhead partnership, rather than by the operating record and prospects of the traction company.
    On February 26,1920, the Public Service Commission for the Second District of the State of New York approved the petition of the Chautauqua Traction Co. requesting, under section 184, Railroad Law, that it be permitted to abandon that portion of its road between Westfield and Barcelona. The decision (Case No. 1264, cited as IX P. S. C. Rep. 107) reads in part as follows:
    In 1918, increased rates were allowed by the commission and are now in effect, but without satisfactory results. The railroad as a whole is highly unprofitable and it is absolutely necessary that all leaks must be stopped if the property is to survive. The greatest proportionate loss is on the Barcelona branch.
    During 1919, the general superintendent of the Chautauqua Traction Co. arrived at the conclusion, after considering every possible resource for improving the operating conditions of the company, that there was no way in which the company could ever earn a return on its investment. It was also during 1919 that officials of the Warren-Jamestown line reached the conclusion that the properties of the Chautauqua Traction Co. were not worth the outstanding bonds. In February, 1924, the Chautauqua Traction Co. made application to the Public Service Commission for the abandonment of the line between Mayville and Westfield, consisting of about nine miles. The record is silent as to the action taken on such application by the commission. In March, 1926, the entire line ceased operating, and at the date of the hearing before this Board the Chautauqua Traction Co. was in process of liquidation.
    The general manager of the Chautauqua Traction Co. testified that the entire road could not have been salvaged in 1919 for more than $200,000.
    Payments and advances by the partnership to the Chautauqua Traction Co. during 1911 to 1926, inclusive, were as follows:
    April 26, 1917, paid John A Olson — lumber bill_ $796. 08
    June 29, 1918, loan--- 3,300.00
    Feb. 28, 1921, New York Central R. R. Co. — draft for interline ticket collections_ 2, 502. 32
    May 19, 1921, loan_ 1, 400. 00
    During the same period the following amounts were received by the partnership from the Chautauqua Traction Co.:
    May 12, 1917, cash-$10, 000. 00
    Sept. 8, 1919, on account of bond interest_ 2, 300. 00
    There were no sales or offers for sale of the stock during 1919 or the years subsequent thereto. On and after December 31, 1919, the stock of the Chautauqua Traction Co. had no market value.
   OPINION.

Geeen:

The issue presented in this appeal is whether the petitioners, the sole and equal partners of William Broadhead & Sons, sustained a loss in 1919 of the cost to the partnership of its investment in the stock of the Chautauqua Traction Co. The stock was acquired prior to March 1, 1913, at a cost of $289,885.20. Its fair market value on March 1,1913, was $325,223.31.

The section of the statute under which the loss is claimed is section 214 of the Revenue Act of 1918, which provides in part as follows:

Sec. 214. (a) That in computing net income there shall be allowed as deductions:
$ * $ * 4* $ #
(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *

We think the facts as set out in the findings clearly show that the stock in question became worthless during 1919. Its cost is, therefore, a proper deduction from the gross income of the partnership for that year. Appeal of Remington Typewriter Co., 4 B. T. A. 880; Henry M. Jones v. Commissioner, 4 B. T. A. 1286; J. J. Melick v. Commissioner, 6 B. T. A. 70; Joslyn Manufacturing & Supply Co. v. Commissioner, 6 B. T. A. 749.

The respondent vigorously contends that if any loss can be held to have been sustained, it was not sustained until 1926, at which time the Chautauqua Traction Co. ceased operating its road and went into liquidation. In our opinion there are many reasons why the loss was sustained in 1919.

The company was fairly prosperous from its beginning in 1908 until the close of 1916. Beginning in 1917 it sustained losses during the remainder of its existence. During 1919, its deficit increased to $590,680.54, or $90,630.54 in excess of its outstanding capital stock. The company was then insolvent. The stockholders’ equity was entirely extinguished. Had it salvaged its property in that year the bondholders would not have realized more than 33% cents on the dollar, leaving nothing for the general creditors or the stockholders. We do not say that this fact alone would warrant a finding of the worthlessness of the stock in 1919. The company continued to operate and it is not an unusual thing for businesses to survive a temporary depression. The facts, however, in the instant case clearly show that by 1919 it became definitely known that the Chautauqua Traction Co. could not possibly survive. The increasing number of automobiles, together with the improved highways which ran parallel to the traction company’s line, resulted in reducing, with the exception of 1917, the number of passengers carried. In 1919 it became apparent that this condition would continue. The company, in 1918, took steps to increase its passenger rates but after a year’s trial this proved to be no cure for its financial ills. The decision of the New York Public Service Commission rendered on November 25, 1919, was reasonably construed by the petitioners as a direction that they should charge off and reduce their investments in the traction company. The general superintendent testified at the hearing that by 1919 he had exhausted all ideas of how to improve conditions, and said “ I could not figure out where there could be a return earned on the investment.” Officers of adjoining roads made investigations of the traction company’s affairs in 1919 with a view of possibly consolidating, but abandoned all such considerations as, in their opinion, the traction company was so hopelessly insolvent that its property was not worth the bonds outstanding against it.

The Commissioner cites the case of the Appeal of E. O. Walgren, 4 B. T. A. 1066, as being on all fours with the facts in the instant case. In that cáse, the evidence showed that during the year in which the loss on the worthlessness of stock was claimed, the identical stock was traded on the market at 15 cents on the dollar. It had not yet become worthless. We have repeatedly held that mere shrinkage in securities does not constitute a basis for a deduction on account of losses sustained. W. P. Davis v. Commissioner, 6 B. T. A. 1267. That is not the situation here.

In Joslyn Manufacturing & Supply Co., supra, the petitioner claimed that certain stock which it owned in the Southern Electric Supply Co. became worthless in 1920 although the latter company continued to operate until July, 1921. The opinion reads in part as follows:

Prom tlie foregoing facts it is apparent that at the close of the year 1920 the financial and commercial position of the Southern Electric Supply Co. was valueless and hopeless. * * * Its financial statements showed that it was insolvent and a verification of this later disclosed that there was not during the year 1920 anything for the stockholders and no hope that anything would be left for them after liquidation. Not only were the officers bona, fide convinced of the worthlessness of the venture, but the true condition of the business fully substantiated their judgment. The only reason why the petitioner continued any relations with the Southern Electric Supply Co. was its desire to bear its full share of the burdens of the mismanagement and misfortune of the company.

The situation of the petitioners in this proceeding is unusual in that they occupy the dual position of stockholders and bondholders, and in that the bonds held by them were pledged as collateral security for loans made to secure funds necessary for the operation of their other business activities. These bonds served as the keystone of the petitioner’s credit and the desire of the petitioners to preserve and maintain their value as collateral, and this desire alone prevented the complete abandonment of the operation of the traction company in 1919, with the consequent recovery by way of salvage of an amount far from sufficient to liquidate the bonds. In 1919 the petitioners recognized the worthlessness of their stock and the total inadequacy of the assets to satisfy the bonded indebtedness and were ready and willing then and there to take their losses, not only upon the stock but upon the bonds, and refrained from doing so only because of the effect that it would have upon their credit standing as the result of the diminution in value of the bonds pledged as collateral.

As was said in the Appeal of Remington Typewriter Co., supra—

The fact tbat the shell of a worthless corporation continues in business is no bar to the deduction of an investment in that corporation’s stock when all facts clearly indicate the stock to be worthless.

We are satisfied from all of the evidence that the stock of the Chautauqua Traction. Co. became' worthless in 1919. The investment in such stock was therefore a loss sustained during 1919, which loss was not compensated for by insurance or otherwise. It was incurred in a transaction entered into for profit. The Commissioner was therefore in error in refusing to allow the cost of such stock as a deduction in the partnership’s return.

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


author: Murdock:

text:
    Morris Belowsky, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9656.
    Promulgated June 18, 1927.
    In each of the taxable years the petitioner filed an income-tax return which showed his correct income-tax liability for that year.

      T. EZUs Allison, Esq., for the petitioner.

      J. K. Moyer, Esq., for the respondent.
    The Commissioner made the following determination in regard to the petitioner’s income-tax liability for the following calendar years:

    The deficiency letter indicates that the penalty was assessed because the petitioner had not filed any returns for these years and the letter states that an investigation of the petitioner’s books of account and records disclosed that he received income of $20,500 in 1919, $10,500 in 1920, and $8,500 in 1922.
    The petitioner contests the correctness of any and every part of the deficiency and penalty. He alleges that he filed returns which correctly stated his income.
    FINDINGS OP PACT.
    The petitioner is an individual residing at 605 Sixth Street, Brooklyn, N. Y. He can neither read nor write any English, except his signature.
    Petitioner came to this country from Russia in 1904 and purchased a grocery store in Brooklyn. Six months later his wife came with the proceeds of the sale of their property in Russia. She kept this money as her own and added to it from time to time. In 1908, the petitioner sold his grocery store and moved to a newly purchased farm in Connecticut. In 1912, he sold the farm, returned to Brooklyn with about $7,500 in- cash and mortgages, and purchased another grocery business for $2,500. He conducted this business in a rented store room. The sales from this store were made mostly to ships and barges. Stock consisted of canned and dried goods suitable for the ship trade, but not much in demand by resident trade. He carried stock worth about $8,000.
    This grocery business was successful until in the year 1919, when sales fell off due to the fact that there were fewer ships and barges in the vicinity. The petitioner then ceased to purchase new stock, closed out his old stock, tried to collect his accounts, sold his store fixtures at auction for $2,500 in August, 1920, and went out of business. He did not again engage in business during the taxable years.
    In October, 1919, the petitioner, in partnership with a man named Hanford, bought an apartment house in Montrose Extension, Brooklyn, 1ST. Y. .The total purchase price was $75,000, of which $58,000, was represented by mortgages. For a while Hanford collected the rents, gave the petitioner his share and then collected from the petitioner his share of all expenses.
    After four or five months the petitioner purchased Hanford’s share in this property. This building accommodated 40 tenants. The gross income from it amounted to about $12,000 a year. Taxes on it amounted to $1,700 a year.
    In October, 1920, he purchased his residence at 605 Sixth Street, Brooklyn. He paid $7,000 in cash and executed .mortgages for $10,000. He owns no other real estate. His wife owns an interest in a property on Third Avenue, Brooklyn. She paid $5,000 or $6,000 for her share in 1916. During the taxable years she received about $1,200 net income from this property. The gross rents amounted to about $7,250 a year.
    During 1920, the petitioner’s property consisted of the Montrose property, two automobiles, $2,000 in the State Bank, $500 in Liberty bonds, $300 in War savings stamps, and his residence.
    He kept no books or records, except his bank account in the State Bank. While in business he cashed many checks for customers. He loaned money to different people and at times borrowed money. Frequently people gave him money for safe keeping. In every such instance he deposited the cash and gave his check for the amount. His brother-in-law sometimes gave him as much as $1,000 in this way. An Italian woman also gave him substantial sums for safe keeping. The proceeds from sales of groceries were deposited in this account.
    During all of the taxable years he lived with his wife and supported his 7 daughters. The latter were all under 18 years of age during all 3 years, except that the oldest reached 18 before the end of the year 1922.
    On or about March 8, 1920, the petitioner went to the second floor of the post office at Brooklyn, to make his income-tax return for 1919. He got in line and finally came to a man who asked him questions in regard to his business and his income. He answered these questions to the best of his ability and the man wrote as he answered. The man then gave him a paper on which the former had been writing. It was a work sheet of Form 1040-A “ For individual income tax return for net incomes of not more than $5,000 for calendar year 1919.” Omitting blank spaces it showed the following entries and answers in ink:
    WOKE SHEET FOB INDIVIDUAL INCOME TAX BETTJBN (1919)
    Page 1.
    Name, Morris Belowsky.
    Street and number, 823 Third Ave., Brooklyn.
    1. Did you make a return for 1918? Yes.
    3. To what collector’s office was it sent? Brooklyn Post Office Bldg.
    4. Were you married and living with wife Dec. 31, 1919? Yes.
    6. How many dependent persons under 18 (or mentally or physically defective) were receiving their chief support from you on Dec. 31, 1919? 7 children.
    8. Did you pay during the calendar year to any individual rent, wages, salaries or other fixed or determinable income amounting to $1,000 or over? Yes. Rent of $1,080 for store to Mr. Spiro, same address.
    9. Did your wife or minor child make a separate return? No.
    10. Did you, your wife or minor children receive any interest on U. S. Liberty Bonds or any other income not reported elsewhere in this return or in a separate return? No.
    12. Enter in this table details concerning repairs, wear and tear, and property losses, claimed as deductions in Schedules A, E and I on page 2 of return (see instructions) : If property was acquired prior to March 1, 1913, attach statement explaining how value as of that date was determined.

      Calculation of tax

    M. Net income shown on page 2, Item J_$3, 940. 00
    N. Less personal exemption (See Instruction VII)_ 3, 400. 00
    O. Balance (income taxable at 4%)_ 540. 00
    P. Tax due (4% on amount of Item O)_ 21. 60
    Q. Less normal tax of 2%- on amount of Item F_
    R. Balance of tax due_
    S. Amount of tax paid on submission of return. $21. 60

      Page 2.
    A. Income from business or profession:
    1. Kind of business, Retail Grocer.
    2. Business address, 823 Third Ave., Brooklyn.
    3. Total sales and income from business or professional services_ $48, 000
    Cost of goods sold—
    4. Labor_$1, 560. 00
    5. Material & supplies_
    6. Merchandise bought for sale_ 39, 840. 00
    7. Other costs_
    8. Plus inventories at beginning of year_
    9. Total_ $41, 400. 00
    10. Less inventories at end of year_
    11. Net Cost of Goods Sold___
    Other business deductions:
    12. Salaries and wages not reported as “Labor” under “Cost of Goods sold”_
    13. Rent on business property in which taxpayer has no equity_ $1, 260. 00
    14. Interest on business indebtedness to others_
    15. Taxes on business and business property_
    16. Repairs, wear and tear, and property losses (for auto)_ 500. 00
    17. Bad debts arising from sales or professional services_ 305. 00
    18. Other expenses (attach classified statement) Electricity & Insurance & Tele-phone_ 595. 00
    19. Total (Items 12 to 18 inclusive)_$2, 660. 00
    20. Net Cost Plus Total Deductions (Item 11 plus Item 19)_ 44, 060
    21.Net Income from Business or Profession (Item 3 minus Item 20)_ $3, 940
    He then paid the tax of $21.60 and received a mimeographed paper of which the following is a copy:
    Form 1107 D. S. Internal Revenue
    NOTICE TO TAXPAYER
    Before presenting payment to cashier enter on this form
    (a) Name
    (b) Address
    (c) Form number of return
    (d) Amount of tax paid
    Taxpayer’s Receipt for Income and Profits Tax for 1919
    OFFICE COLLECTOR INTERNAL REVENUE
    Form No. of return, 1040 A Tax, $21.60
    Name, Morris Belowsky
    (Stamped
    Address, 823 3rd Ave., PAID
    Brooklyn, N. Y. 1 Mar 8
    9 HH
    2 1st Dist.
    0 N. Y.
    At about the same time the next year he returned to the same place and in the same way received a work sheet Form 1040-A “ Individual Income Tax Return for Ret Incomes of Rot More than $5,000 or Joint Return of Husband and Wife if Combined Ret Income Does Not Exceed $5,000 for Calendar Year 1920.” Omitting the blank spaces it showed the following entries and answers:
    INDIVIDUAL INCOME TAX RETURN FOR CALENDAR YEAR 1920
    Name, Morris Belovsky
    Street and number, 605 6th St., Brooklyn, Kings County, N. Y.
    1. Are you a citizen of the United States? Yes.
    2. If not, are you a resident of the United States? Yes.
    4. Did you file a return for 1919? Yes.
    5. If so, what address did you give on that return? 823 Third Ave., Brooklyn.
    6. To what Collector’s office was it sent? Brooklyn.
    7. Were you married and living with wife on the last day of your taxable period? Yes.
    How many dependent persons under 18 (or if 18 or over, incapable of self-support because mentally or physically defective) were receiving their chief support from you on the last day of your taxable period? -7. 9.
    Was a separate return filed by your wife? No. 10.
    Write “R” if you kept no books, or books on a cash basis; or “A” if you kept books on an accrual basis. R. A. 11.
    Net loss (from page 2, Schedule L)_'_ $2, 896. 00 14.
    Less personal exemption_ 3, 400. 00 15.
    16. Balance (income taxable at 4%)_
    Enter in this table details concerning repairs, wear and tear, property losses, etc., claimed as deductions in schedules A, E, and I, on page 2 of return.

    Schedule A. Income from Business or Profession:
    1. Kind of business, Retail Grocer.
    2. Business address, 823 Third Ave., Brooklyn.
    3. Total sales and income from business or professional services—
    During 8 months and sold in auction_$12, 850
    Cost of goods sold:
    4. Labor_
    5. Material and supplies_ $160. 00
    6. Merchandise bought for sale_ 15, 000. 00
    7. Other costs_
    8. Plus inventory, etc_
    9. Total_ $15, 160. 00
    Other' business deductions:
    12. Salaries and wages not reported as “Labor” under “Cost of Goods Sold”_ 846. 00
    13. Rent on business property in which taxpayer has no equity_ 840. 00
    Interest on business indebtedness to others_
    Taxes on business and business property_ 27. 0Ó
    Repairs, wear and tear, obsolescence, deple-
    Bad debts arising from sales or professional services_ 600. 00
    Other expenses (list principal items and amounts at foot of page)_ 355. 00
    Total (Items 12 to 18, inclusive)_$2, 668. 00
    Net Cost Plus Total Deductions (Item 11 plus Item 19)- - 17, 828
    Net Income from Business or Profession (Item 3 minus Item 20)_ (Loss) $4. 978

      Schedule E. Income from Rents and Royalties:

    Net Income from Rents and Royalties (total of column 3 minus total of columns 4 and 5)_:_ $2, 082
    Schedule H. Total Net Income from Above Sources. (Total net income less total deficits, shown in above Schedules)_ (Loss) $2,896
    Explanation of Deductions claimed in Schedule A, Items 7 and 18; Schedule B, Column 5; Schedule E, column 5; Schedule I, Item 4; and Schedule K.
    E-5 Ins. 546.; % on 1st and 2nd mort. loan 4080; Tax 1877; fuel and electr 1005; Janitor 1000; small expense 100.
    A-18 fuel & elect 120; phone 64; Ins. 40; carfare & post. 96; tips etc. 35.
    He paid no tax at that time but later he was notified to and did appear at the post office, was again interrogated, and was told that, as he had used groceries from the store to supply his family, he owed additional tax of $40. A blank check was produced, and filled out and he signed it. The following is a copy of that check with its endorsement :
    Mat 11, 1921.
    State Bank
    Williamsburg Branch Graham Av. & Vaset St. Bklyn.
    Pay to the order of Collector of Internal Revenue Forty and No/_Dollars
    (signed) Mokris Belowskt
    $40.00 (Perforated “Paid 5-14r-21”)
    Endorsed: Pay to the Order of Federal Reserve Bank of N. X. Income and Excess Profits Tax Account. This check is in payment of an obligation of the United States and must be paid, no protest. T May 13 192
    Bertram Gardner

      Collector of Internal Revenue First District of New Yorlc.

    Pay to the Order of Any Bank, Banker or Trust Go.
    Prior endorsements guaranteed.
    Federal Reserve Bank oe N. X.
    L. H. Hendricks, Cashier.

    Also stamped on back—
    Received Payment through the New York Clearing House.
    Prior Endorsements guaranteed.
    May 14 1921 1 xxx
    Federal Reserve Bank oe New York E
    L. H. Hendricks, Comptroller of Collections.

    In 1923, he had an accountant make up his return for 1922. This return was signed and sworn to and was mailed to the Collector of Internal Revenue, Custom House, New York City, prior to March 15, 1923. The accountant retained a copy which shows on a joint return a net income of $2,962 before the deduction of personal exemption and credit for dependents, and no tax due after deducting $3,200 for these two items.
   OPINION.

Murdock:

This case presents two questions of fact in relation to each of the three years involved. The first is, Was a return filed for the year by the petitioner ?; the second, What was the petitioner’s taxable income for the year?

Without any hesitation we decide the first question in the affirmative. The petitioner and an accountant both testified that a return for 1922 was filed before March 15, 1923. The petitioner alone testified that he filed a return for 1920 and offered the work sheet in evidence to corroborate his statement. If the evidence in regard to these two years stood alone we might have some doubt about it. But it does not stand alone. The proof'in regard to the filing of a return for 1919 is so convincing that it lends credence to the evidence relating to the other two years. The petitioner testified that he filed a return for 1919, and again he produced the corroborating work sheet, but as to this year he also produced a tax receipt stamped “ paid ” with the stamp of the collector. The respondent offered no evidence in the case, but has made the same determination in regard to each year. Clearly he was in error as to the failure to file a return for 1919 and under all of the evidence we hold that each of the penalties was erroneously assessed.

The evidence is not so satisfactory in regard to the correct taxable income for these three years. The petitioner had no books of account or records, except his bank account. The latter was no criterion of his income. Yet the deficiency letter states that an examination of his books of account and records disclosed income of $20,500 for 1919, $10,500 for 1920, and of $8,500 for 1922. We are satisfied that the Commissioner’s determination of the petitioner’s income-tax liability for each of these years was incorrect, but before we can cast aside that determination we must be shown something better to tie to.

The only other available figures in this case are the taxable incomes for 1919 and 1920, as disclosed by the work sheets, and for 1922 as shown on the accountant’s copy of the 1922 return. The work sheets were made while the matters recorded thereon were fresh in the petitioner’s mind. They were made by an agent of the respondent as the petitioner replied to his questions. We think that he then knew about what his true expense and income items were and that he correctly stated them. Considering the circumstances surrounding the origin of these figures and testing them in connection with all of the testimony and the reasonableness or unreasonableness of the entire situation we are inclined to believe that the income as disclosed by these sheets represented approximately this petitioner’s taxable income for the respective years.

We are mindiul of the fact that in 1919 there were fewer ships and barges to give this petitioner their trade, that consequently he allowed his stock to be depleted and in the latter half of 1920 he closed his store. He testifies that his average weekly sales from this store during his good years did not run over $700, which would make yearly gross sales of $36,400. The 1919 sheet shows gross sales of $48,000. Applying the respondent’s average percentage table to the latter amount of gross sales, merely as a text, we get a probable net income from the grocery business of $1,900.80, whereas the work sheet shows a net profit from this source of $3,940.

The apartment on Montrose Avenue brought in gross yearly rentals of about $12,000. During 1919 the petitioner owned a one-half interest only. The purchase price was $75,000. There were mortgages against this property drawing interest on $58,000. Taxes were $1,700 a year. There were many other expenses to be paid before a net income was realized from the gross rents. Depreciation at a minimum rate would reach a substantial amount.

During 1920, this building was the chief source of the petitioner’s income. He then owned the entire equity in it. In addition to the taxes, interest and expenses .of this building he had to pay other taxes and interest as indicated in our findings of fact. His personal exemption and credits amounted to at least $3,400 in each of these years and in 1922, they amounted to at least $4,400. His wife received about $1,200 rent from her Third Avenue property which does not appear on either the 1919 or 1920 sheets and there are certain other inconsistencies between the sheets and the testimony. Nevertheless, if we use the proven expenditures and minimum amounts where we have no proof of the proper expenditures or deductions, we find that our results are within the amount of net taxable income as shown by the sheets. Therefore, we hold that this petitioner has no unpaid income tax liability for the three years here in question.

Judgment will be entered for the fetitioner.