author: Adams :

text:
    James Sweinhart, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54784.
    Promulgated February 23, 1934.

      J. Lee Boothe, O.P.A., for the petitioner.

      Owen W. SweoJcer, Esq., for the respondent.
   OPINION.

Adams :

This proceeding involves a deficiency of $235.79 in income tax for the calendar year 1928. The issue presented is whether respondent erred in disallowing a deduction of $3,239.

The facts are stipulated substantially as follows:

The petitioner, during tbe year 1928, derived income from bis employment as reporter on tbe staff of tbe Detroit News and also from the sale of capital stock. His principal income, however, was in tbe form of dividends on stock of domestic corporations.
The petitioner’s return was made on the basis of actual cash receipts and disbursements.
On August 31, 1925, tbe petitioner purchased from Oharles A. Fagg on a land contract Lot Seven of Highland View Addition to tbe Village of Birmingham, Michigan, for a consideration of $15,000.00. * * * Tbe contract provided :
* ⅜ * in consideration of the sum of Two Thousand Five Hundred ($2,500.00) Dollars paid to the Seller by the Purchaser prior to the delivery hereof, the receipt of which is hereby acknowledged, and the payment of the additional sum of Twelve Thousand Five Hundred ($12,500.00) Dollars by the Purchaser, together with interest on any part thereof at any time unpaid at the rate of six per cent per annum while the Purchaser is not in default, and at the rate of seven per cent per annum if the Purchaser is in default, while such default continues, payable monthly, all of which purchase money and interest shall be paid in installments of not less than One Hundred Twenty-Five ($125.00) Dollars per month payable October 1, 1925, and not less than the last named sum monthly thereafter; said payments to be applied (first upon interest and the balance on principal) : Provided, the entire purchase money and interest shall be fully paid within five years from the date hereof anything herein to the contrary notwithstanding.
A further payment of Two Thousand Five Hundred ($2,500.00) Dollars is to be paid on the principal on or before May 1, 1926.
Under the terms of the contract the petitioner had possession and use of the property but title was to remain in the vendor until such time as the full amount of the purchase price was paid.
On or about November 1, 1925, the vendor placed a mortgage on the said property in the amount of $6,500.00
By June 8, 1926 the petitioner had paid $7,713.43 on the principal amount of the contract, leaving an unpaid balance of $7,286.57. On this day the petitioner gave the vendor a check for $6,500.00 with the request that the funds be used to pay off the existing mortgage. This payment was duly entered, on the land contract, as a payment on the principal amount of the contract, which left an unpaid balance of $786.57. No further principal payments were made by the petitioners to reduce the balance of $786.57. The vendor did not pay off the mortgage in accordance with the verbal request of the petitioner.
On November 30, 1927 the vendor committed suicide by taking poison. The mortgagee and the petitioner immediately filed claims, in the amount of $6,500.00, against the estate of the deceased. After providing for a widow’s allowance, the net estate of $1,279.65 was given to the mortgagee as a part payment on the mortgage. At about the same time a further payment of $1,170.00 was made the mortgagee from sources unknown, which payment reduced the mortgage to $4,050.35.
On October 28, 1928 the Probate Court ordered and decreed that the property should be conveyed to the petitioner, subject, however, to the unpaid encumbrance of $4,050.35. To this the petitioner agreed and received the title to the property.

The land contract is included herein by reference. It carried the following provisions in addition to those hereinabove set forth:

It is Mutually Agreed: That the Seller may at any time encumber said land by mortgage or mortgages to secure not more than the balance owing hereon at the time such mortgage is executed nor more than fifty per cent of the purchase money paid and to be paid under this contract, which mortgage or mortgages shall be payable in not less than three nor more than five years with interest at the rates prevailing at the time of execution and may provide for payments of not more than five per cent of the principal semi-annually and shall be a first lien upon the land superior to the rights of the purchaser therein provided notice of the execution of such mortgage containing the name and address of the mortgagee or his agent, the amount of such mortgage, the rate of interest and maturity of principal and interest shall be sent to the Purchaser by registered mail promptly after execution thereof and the Purchaser will on demand execute any instrument demanded of the Seller reasonably necessary or requisite to execute or confirm the execution of the foregoing power.
⅜ * ⅜ * * * #
That if the title of the Seller is evidenced by land contract or now or hereafter encumbered by mortgage, the Seller shall meet the payments of principal and interest thereon as they mature and produce evidence thereof to the Purchaser on demand and in default the Purchaser may pay the same, which payments shall be credited on the sums matured or first maturing hereon with interest at seven per cent per annum and in event proceedings are commenced to recover possession or enforce the payment of such contract or mortgage because of the Seller’s default the Purchaser may at any time thereafter while such proceedings are pending encumber said land by mortgage securing such sum as can be obtained upon such terms as may be required and with the proceeds pay and discharge such mortgage or purchase money lien, and any mortgage so given shall be a first lien upon the land superior to the rights of the Seller therein and thereafter the Purchaser shall pay the principal and interest on such mortgage so given as they mature, which payments shall be credited on the sums matured or first maturing hereon, and. when the sum owing hereon is reduced to the amount owing upon such contract or mortgage or owing to any mortgage executed under either of the powers in this contract contained, a conveyance shall be made in the form above provided with a covenant by- the grantee to assume and pay the same.

The petitioner contends that from the nature of the loss it might be regarded either as an embezzlement or a bad debt. He urges that, since the payment of $6,500 in 1926 reduced his indebtedness to Fagg to only $786.57, Fagg was under a legal obligation to apply the payment against his indebtedness to the insurance company which was secured by a mortgage on the land sold, and his failure to so apply it upon request of the petitioner constituted an embezzlement of the funds.

Embezzlement may be defined as a fraudulent appropriation of another’s property by a person to whom it has been entrusted, or into whose hands it has lawfully come. At the time of the payment petitioner owed a balance in excess of $6,500 on the purchase price of the property. The funds received by Fagg were, therefore, lawfully due him; they became his and subject to his control. In our opinion his use of them for his own purposes did not constitute embezzlement. Under the terms of his contract he may have been under an obligation to petitioner to reduce the mortgage to an amount within the balance due him on the contract of purchase and sale, but this obligation, if it existed, was at most contractual.

The respondent contends that the additional sum of $3,239 was expended for the purpose of acquiring and protecting title to the property in question, and as such represented capital expenditures. We do not think the case is as simple as that. In order to determine whether an expenditure is deductible in computing net income, it is important not only to consider its purpose, but its character, the reasons for making it and any other facts material to its classification as a deductible item under the applicable sections of the revenue law. A proper classification can not be based upon an isolated fact; the whole transaction with all relevant facts must be considered.

The petitioner contracted with the deceased vendor for conveyance of certain lands for a consideration of $15,000, with certain conditions as to method and time of payment, the vendor to retain title until the payments were all made and then to convey the property to petitioner free from all encumbrances due to his acts and deliver a warranty deed. The parties started on the performance of this contract, and shortly thereafter the vendor encumbered the property with a mortgage of $6,500. On June 8, 1926, petitioner had paid upon the contract all that he would have to pay except the sum of $786.57. The vendor died in November 1927 without having performed his contract, which was not due until the entire purchase price should be paid. This obligation survived against his estate and the contract obligation of the petitioner to the estate still existed. The estate was unable to perform, due to its insolvency and the fact that the vendor failed to apply against the mortgage the $6,500, or a portion of it sufficient to bring the mortgage within the balance due him on the purchase price. The extent of its ability to perform was to make a conveyance subject to the mortgage of $4,050.35.

Under order of the Probate Court on October 28, 1928, it was ordered and decreed that the property be conveyed to petitioner, subject to the unpaid encumbrance. In taking title to the property, the petitioner did not repudiate the contract, nor did he agree to any novation. He simply accepted such performance as a performance fro tanto of the obligations of the vendor. The decree of the court was a final settlement of anything and all things the estate is able to do towards performing its obligation. As a result of this settlement the property was transferred to petitioner, subject to the mortgage in the amount of $4,050.35. The difference between that amount and the balance due from petitioner on the purchase price represented an overpayment which petitioner had made on the property and became an obligation owing to him by the vendor’s estate, which, had the estate been solvent, he could have collected. In fact, had the estate been solvent the court would have provided for such settlement in its order and decree of specific performance of the contract by the executor. The estate being insolvent, petitioner sustained a loss in the amount of the debt at the time of the settlement under the court’s decree. This was in 1928, and is deductible in computing petitioner’s net income for that year. To say that this amount should be considered as an additional investment in the property is to close our eyes to the facts and legal consequences of the acts of the parties and fail to recognize the obligations arising from their contractual relationship. This we may not do. We are of the opinion that the additional expenditure here was not, in any proper sense, a part of the cost of the land. Cf. Leichner & Jordan Co., 4 B.T.A. 133; Lena C. Hill, 8 B.T.A. 1159; Pacific Novelty Co., 5 B.T.A. 1017; Kay Wood, 11 B.T.A. 740.

The cases cited by respondent may be distinguished from this on their facts, and are not controlling here. This is not a case of an expenditure to acquire title, as was the case in the Ravlin Corp., 19 B.T.A. 1112, cited by the respondent, nor an expenditure to defend title, as in North American Oil Consolidated, 12 B.T.A. 68; Chestnut Farms Dairy, Inc., 19 B.T.A. 192; Ida Wolf Schick, 22 B.T.A. 1067; nor an expenditure for the purchase of a lease, as in Ed Foster, 19 B.T.A. 958; nor the cost of additional assets, as in George W. Wetherbee, 20 B.T.A. 35. This is a case of a contract of purchase and sale where the seller obligated himself to deliver the property upon payment of the price, free from all encumbrances due to his own acts, and to give a warranty deed. Failing in this, he, his successors, or assigns became indebted to the purchaser in an amount equal to the resulting overpayment. The loss was sustained upon this indebtedness.

Reviewed by the Board.

Decision will be entered for the petitioner.

       [Seo. 23, Revenue Act of 1928.] In computing net income there shall be allowed as deductions:
      * * * * ip * *
      (e) Losses by individuals. — In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—
      (1) if incurred in trade or business; or
      (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or
      (3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft.
      *******
      (3) Bad debts. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.


source: Caselaw Access Project

author: Lansdon:

license: Public Domain

text:
    Ruth McNutt Brown and George L. Nye, as Executors of the Estate of David R. C. Brown, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67940.
    Promulgated February 23, 1934.

      Lewis A. Dick, Esq., for the petitioners.

      Nathan Gammon, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent has determined that the gift here in controversy was made in contemplation of death. The question is one of fact. United States v. Wells, 283 U.S. 102. The decedent made the transfer under review only a little more than two months before he died and at a time when he was much concerned as to his health. The weight of opinion, however, in such circumstances, is that neither the state of the donor’s health nor the time between the gift and death are factors that conclusively determine the purpose of such a gift.

The facts appear to indicate quite clearly that the decedent made the gift in question as a part of the disposition of his property in the event of his death. After returning from California in March 1930 he was suffering from indigestion and other ailments. In that month he told his wife that he proposed to give her some stock of substantial value. On April 1 he went to a hospital for observation and remained there for three days. He returned to his home while still under the care of a physician. On April 10 he made the transfer here in question. On April 11 he made a new will disposing of his entire estate and on the same day went back to the hospital for further observation and treatment, where he remained for a period not disclosed by the evidence. On June 13, feeling less well than usual, he went to Aspen, his former home, and there he died on June 29. We think these circumstances indicate that the gift was made in contemplation' of death and that it was in effect a testamentary disposition of a part of the donor’s estate. Edgar A. Igleheart et al., Executors, 28 B.T.A. 888.

Petitioners contend the gift of April 10 was in keeping with the decedent’s custom followed for many years for the purpose of providing his wife and children with independent means and incomes of their own. It is true that the decedent over a period of about 25 years made many substantial gifts to his wife and daughters, but, measured by his wealth, such gifts were no more than any generous man would make to a devoted wife and to daughters who were past their majority and anxious to establish homes and incomes in support thereof for themselves. On the evidence we affirm the determination of the respondent on this issue. Kengel v. United States, 57 Fed. (2d) 929.

During the administration of the decedent’s estate, the executors thereof, who are the petitioners here, paid certain general property taxes to the State of Colorado and municipal subdivisions of the state, as set out in our findings of fact. Respondent has determined that such payments are not deductible from the taxable corpus of the estate as administrative expenses. This issue must be determined under the provisions of section 308 (a) (1) of the Revenue Act of 1926.

The provisions of Regulations 70 relied on by both parties do not conclusively answer the question here, but inferences therefrom seem to sustain the determination of the respondent. The items enumerated- in the regulations are obviously expenses arising out of administration. This is not true of taxes, which accrue against property regardless of ownership and in this instance would have accrued in the same amount had the decedent been alive in the taxable year. It seems clear, therefore, that such taxes cannot be regarded as any part of the cost of administration.

In Hill v. Grissom, 299 Fed. 641, in discussing a similar claim by an estate the court said:

It would seem clear that the ad valorem tax paid by the executors of the county and city of Durham do not come within the terms of “ administrative expenses”, nor are such taxes claimed against the estate, at the date of the death of the testator, prior to the date at which such are assessed and levied. Claims against the estate, as defined by a number of cases cited by the defendant, are such demands or claims of a pecuniary nature which could have been enforced against the decedent during his life.

In Charles B. Shelton et al., Executors, 3 B.T.A. 809, we held that taxes accrued before the date of the death of decedent and a lien on his property at that time should be deducted from the corpus for Federal income tax purposes. In the instant proceedings the taxes in question had not accrued when the estate came into existence and so were not a lien against any property thereof at that time.

Counsel for petitioner relies on certain provisions of the statutes of Colorado and decisions of the courts of that and other states. A study of such laws and decisions fails to convince us that they control here. It is nowhere held that the taxes accrued and paid during the period of administration are administrative expenses. What is uniformly held is that such taxes, together with other items which it is not necessary to discuss, are obligations of the estate and that when paid by the executors credit may be taken for the amount thereof in the final settlement. There is nothing in the record or in the authorities relied on by the petitioners that overcomes the presumption that the determination of the Commissioner is correct.

Reviewed by the Board.

Decision will be entered for the respondent.

       Sbc. 303. For the purpose of the tax the value of the net estate shall be determined—
      (a) In the case of a resident, by deducting from the value of the gross estate—
      (1) Such amounts for funeral expenses, administration expenses, claims against the estate, unpaid mortgages upon, or any indebtedness in respect to, property (except, in the case of a resident decedent, where such, property is not situated in the United States), to the extent that such claims, mortgages, or indebtedness were incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth, losses incurred during the settlement of the estate arising from fires, storms, shipwreck, or other casualty, or from theft, when such losses are not compensated for by insurance or otherwise, and such amounts reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent, as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered, but not including any income taxes upon income received after the death of the decedent, or any estate, succession, legacy, or inheritance taxes.

       Art. 37. Taxes. — The deduction of property taxes upon realty and personalty is governed by the following provisions :
      (1) Where such taxes became a personal obligation of the decedent in his lifetime, the entire amount thereof is deductible. (See Art. 29.)
      (2) Where assessed during the administration of the estate, and the taxes are a proper administration expense, deduction of the entire amount may be taken. (See Arts. 32 and 35.)
      Federal taxes upon income received during the decedent’s lifetime are deductible, but taxes upon income received after death are not deductible. No estate, succession, legacy, or inheritance tax is deductible.
      Art. 32. Administration, expenses. — The amounts deductible from the gross estate as “ administration expenses ” are such expenses as are actually and necessarily incurred in the administration of the estate; that is, in the collection of assets, payment of debts, and distribution among the persons entitled. The expenses contemplated in the law are such only as attend the settlement of an estate by the legal representative preliminary to the transfer of the property to individual beneficiaries or to a trustee, whether such trustee is the executor or some other person. Expenditures not essential to the proper settlement of the estate, but incurred for the individual benefit of the heirs, legatees, or divisees, may not be taken as deductions. Administration expenses include (1) executor’s commissions; (2) attorney’s fees;' (3) miscellaneous expenses. Each of these classes is considered separately in Articles 33 to 35, inclusive.
      Art. 35. Miscellaneous administration expenses. — This includes such expenses as court costs, surrogates’ fees, accountants’ fees, appraisers’ fees, clerk hire, etc. Expenses necessarily incurred in preserving and distributing the estate are deductible, including the cost of storing or maintaining property of the estate, where it is impossible to effect immediate distribution to the beneficiaries. Expenses for preserving and caring for the property may not include additions or improvements; nor will such expenses be allowed for a longer period than the executor is required to retain the property. A brokerage fee for selling property of the estate is deductible where the sale is necessary in order to pay the decedent’s debts, the expenses of administration, or to effect distribution. Other expenses attending the sale are deductible, such, as the fees of an auctioneer, where it is reasonably necessary to employ one.


author: Seawell :

text:
    Heywood Boot & Shoe Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50108.
    Promulgated February 23, 1934.

      F. R. Oarnagie Steele, Esq., R. Kemp Slaughter, Esq., and Hugh C. Bichford, Esq., for the petitioner.

      Prew Savoy, Esq., for the respondent.
   OPINION.

Seawell :

Petitioner in this proceeding seeks a redetermination of a deficiency asserted by the Commissioner against it for the fiscal year ended October 31, 1926, in the sum of $16,253.83. The whole amount results from the action of respondent in disallowing a deduction of $125,000 paid as extra compensation to petitioner’s officers and claimed by the petitioner in its income tax return for that year as an ordinary and necessary expense of its business.

Most of the facts involved are stipulated, and the stipulations are accepted as our findings of fact by reference, and only so much thereof as is considered necessary for the understanding of this opinion is quoted. The facts stipulated are in some minor particulars contradictory, and these we have reconciled as far as possible. The facts deduced from the oral evidence on the hearing are also stated in this opinion.

Petitioner is a Massachusetts corporation located at Worcester in that state, and is a manufacturer of men’s shoes. The business was founded in 1864 by Samuel E. Heywood and operated by him individually until 1884, when he caused it to be incorporated with an authorized and issued capital stock of 1,000 shares of a total par value of $100,000, which has never been changed. Bertram S. Newell was employed by the corporation in 1887, and served in the office and factory in various capacities before 1900, when he became an executive officer. In 1913 he was promoted to the position of vice president and treasurer. In 1900 Albert S. Heywood, son of Samuel E. Heywood, became an executive officer of the corporation, and, upon the death of his father in 1913, became president of the corporation. In 1911 Chester D. Heywood, a nephew of Albert S. Heywood and grandson of Samuel E. Heywood, wras employed by the corporation as a factory worker, later as a salesman, and in 1913 in an executive position as assistant treasurer. Since 1913, and including 1926, Albert S. Heywood has been president, Bertram S. Newell has been vice president and treasurer, and Chester D. Heywood has been assistant treasurer, the three constituting the board of directors, and the corporation has employed no other executive during that time. The corporation in 1926 and prior thereto had an average of 375 factory employees, 8 office clerks and 10 salesmen. The salesmen sold about 90 percent of the output of the factory and each received compensation in amounts ranging from $7,000 to $8,000. Net sales per books of petitioner for the taxable year 1926 were in the amount of $1,604,687.27.

During the taxable year 1926 the executives held the stock of the corporation as follows:

Albert S. Heywood- 539 shares
Bertram S. Newell- 25 shares
Chester D. Heywood-103 shares

The other 333 shares were held by the children of Albert S. Heywood (45 shares) and the brothers and sister of Chester D. Heywood (288 shares).

Albert S. Heywood graduated in 1892 from tbe Massachusetts Institute of Technology, with the degree of Bachelor of Science in electrical engineering, and served as a district engineer for the General Electric Co. from 1892 to 1899. In 1900, upon assuming charge of the factory of petitioner, he found the plant was using gas illumination and a small, inefficient sliding-valve engine for power. Using his engineering knowledge and experience, he installed a modern electric lighting plant more efficiently arranged, and a new steam power plant, and from that time has handled the engineering and architectural work of the corporation, making unnecessary the employment of an engineer for such purpose. He also has handled since that time the credit and financial operations of the petitioner’s business, and has built up its credit so that money could be borrowed without personal endorsement and in amounts needed. He also caused the petitioner to purchase, after 1913, the real estate which it was using, but which belonged to the estate of Samuel R. Heywood, the founder. Albert S. Heywood, while so serving the petitioner corporation, was a trustee of the Peoples Savings Bank and a vice president and member of the finance board and a director of the Mechanics Rational Bank, which later became the Worcester County Rational Bank and was affiliated with the Worcester Bank & Trust Co. He was also a director of the State Mutual Life Insurance Co. These positions lent prestige to him and were of advantage to petitioner in securing low interest rates on its loans, which were in his charge. How much of his time in 1926 was taken by his duties in these corporations was not shown in evidence, but there was no evidence of neglect of duties to petitioner,

Bertram S. Rewell, after service in various departments, became superintendent of petitioner’s factory in 1901. He had supervision of buying, at first consulting with foremen in purchasing leather; he waited on customers who came to the factory; he did cost accounting and fixing of prices of the manufactured products of the factory; he built up a wide range of styles and lasts which he designed and which became an important factor in the success of the business; he had charge of the labor, and maintained friendly relations with the laborers, and saw that group insurance was carried and the employees pensioned or their wages paid in case of disability or sickness. Ro labor trouble occurred while he was in charge.

Chester D. Heywood, since becoming a director in 1918, has worked in conjunction with Albert S. Heywood and Bertram S. Rewell, assisting in the work of inspection and modernization of the plant, managing petitioner’s retail store at Worcester, looking after and directing the advertising, keeping in contact with certain customers, and in directing the general policies of the petitioner. He was a trustee of the Peoples Savings Bank and a director of the Mechanics National Bank, which connections aided petitioner in obtaining low rates on loans. What part of his time was required by these connections was not shown; but there was no evidence of neglect of petitioner’s business.

The three executives ran the whole business of petitioner. They formed a fixed policy in reference to their salaries. At their first meeting of the year they would vote the amounts of their respective fixed salaries, with an understanding among themselves that at the end of the year, if the results of their labors showed profits, they would be paid accordingly; that is, after the declaration of liberal dividends on the outstanding capital stock and the payment of their fixed salaries, they would take the profits and make what in their judgment they considered a fair distribution of them between the three executives, the amount allotted to each under this program added to his fixed salary being considered by them as fair compensation for the services rendered by such payee. This distribution did not include the exact amount of all the profits and was not limited by the profits, as provision in earlier years was made for the accumulation of ample reserves which on occasion could be invaded. Previous to the taxable year 1926 petitioner had built up and during that year had an earned surplus of about $1,000,000.

During the year 1926 the three executives were industrious and efficient and usually reached the office of petitioner at about 8 o’clock in the morning and remained until about 5 o’clock in the afternoon, taking time out for lunch. For some time Newell was in a sanitarium during the year. Petitioner’s accounting was on an accrual basis.

On January 11, 1926, the directors of petitioner corporation by resolution fixed the salaries of the respective officers for the fiscal year ending October 81, 1926, which were paid by petitioner as follows:

Albert S. Heywood_$16,150
Bertram S. Newell_ 18, 900
Chester D. Heywood_ 11, 050

On December 27, 1926, at the annual meeting of the directors following the close of the fiscal year ended October 31, 1926, the board of directors declared a 56 percent dividend on the capital stock of the corporation, payable in four installments at stated times, and also by resolution voted extra compensation to themselves as executive officers of the corporation for that year in the following amounts which were paid by petitioner: To Albert S. Heywood and Bertram S. Newell, each $45,000; and to Chester D. Heywood, $85,000, a total of $125,000. In petitioner’s income tax return for that year this amount, together with $46,100 fixed salaries, making a total of $171,100, was reported and taken as a deduction from, gross income as an ordinary and necessary expense of petitioner’s business during the year. Upon audit of the return respondent disallowed $125,000, the whole deduction for extra compensation to the executives.

During the fiscal year ended October 31, 1926, petitioner had an operating loss of $9,669.46, but a net profit from securities of $24,-661.89, and reported a net loss of $3,853.41. The disallowance by respondent of the $125,000 extra compensation to the executives left petitioner with a net gain for the year of $121,146.59.

Under section 234 (a) (1) of the Revenue Act of 1926, applicable here, among the deductions allowed corporations in computing their net incomes is included “ a reasonable allowance for salaries or other compensation for personal services actually rendered.” Reasonableness of the salary or compensation is the test of deductibility. Becker Bros. v. United States, 7 Fed. (2d) 3; United States v. Philadelphia Knitting Mills Co., 273 Fed. 657.

Petitioner, in undertaking to show that the extra compensation allowed its executives in the fiscal year 1926 was reasonable, offered in evidence, over the objection of respondent, the stipulation of facts filed herein, which disclosed that for the years 1923 and 1924 and the first ten months of 1925 (the year in which petitioner changed from a calendar to a fiscal year basis for accounting) extra compensation of $125,000 for each of these periods was paid said officers and not contested by respondent. However, those periods are not before us, and the reasonableness of extra compensation paid the officers in the year here under review cannot be determined by what may have been done or omitted in other years.

Petitioner, for the same purpose, offered the evidence of Ward Melville, president of a corporation operating 490 retail shoe stores, “ the largest retailers in leather shoes in the country.” He testified that in his opinion the extra compensation here in question was reasonable and proper as such for the services performed. His opinion was not based on any peculiar or expert knowledge of salaries or other compensation usually paid individual executives in the shoe-manufacturing business, but was apparently based upon a philosophy of his own to the effect that, as petitioner’s business was practically a family business, owned principally by the three directors, when proper provision had been made for the payment of liberal dividends on the capital stock of the corporation and the reserves were ample and previous earnings had been “ salted away ”, all of which he understood had been done in this case, the directors, having caused the earnings by their skill and ability, were entitled to what remained to be taken up as salaries without regard to the amount thereof, unless there was a large body of outside stockholders who might object. We are unable to subscribe to this philosophy as applied to the taxing statute under review. Reasonable compensation deductible as an ordinary and necessary expense of carrying on a business, as allowed by the statute, is “ such as the taxpayer would expect to give to a stranger equally qualified for similar services.” Meyer Hecht, 2 B.T.A. 319, 323. In affirming the Board’s decision on appeal in the Heoht case, the court said:

* * * jpjje intent and meaning of the statute is plain that a deduction of the hind sought to be taken cannot be made unless the expense is reasonable and ordinary, and the statute does not permit the deduction to be made under some other guise. [Hecht v. United States, 54 Fed. (2d) 968; certiorari denied, 268 U.S. 560.]

Petitioner also offered as witnesses its president, Albert S. Heywood, and vice president, Bertram S. Newell, who each testified that in his opinion the extra compensation of $125,000 for the executives in 1926 was reasonable under all the circumstances. They professed no knowledge or information as to compensation usually paid to others under like circumstances. Heywood testified that he “ did not know a thing about ” the usual compensation paid executives in the shoe industry except in his own company. Their testimony in the main coincided with the philosophy and deductions of Melville. The burden is on the petitioner and that burden is best carried by those who labor without prejudgment or self-interest. Chester I). Heywood, who received $10,000 less extra compensation than either Albert S. Heywood or Bertram S. Newell, and several thousand dollars less in fixed salary for the year, did not testify.

Petitioner stressed before us “ the fact that since these executives have had charge of the business they have earned the dividends for such stockholders which aggregate a return of that investment eight times over.” Prom the amount of dividends referred to this contention of petitioner seems to date the incumbency of the present executives from the year 1901. The evidence shows that for some ten or twelve years after that date the founder of the business, Samuel R. Heywood, was alive and to some extent, at least, in charge. Respondent also suggests that the 56 percent dividend paid stockholders in 1926 on the capital stock ($100,000) of petitioner is no more than a 5½ percent dividend on the petitioner’s capital stock and surplus ($1,108,223.03) at that time in actual use in petitioner’s business. From the stipulated facts it further appears that the combined compensation to petitioner’s executives from 1901 to 1926 increased 41 times; that petitioner’s capital and surplus increased 8½ times and the dividends paid increased 5% times. If the executives’ salaries had increased no faster than the amount of the dividends, the salaries for 1926 would have been just $23,240, only slightly more than one half of the fixed salaries alone for the year (which are not contested by respondent). If the dividends had increased in amount as rapidly as the fixed salaries (not including extra compensation) the dividends for 1926, instead of amounting to $56,000, would have amounted to $110,000; .and if as rapidly as the combined fixed salaries and extra compensation, the dividends for 1926 would have been not $56,000, but $410,000. If the dividends had kept pace with the increase of the combined capital and surplus they would have amounted in 1926 to $83,300. These figures and calculations are not intended as furnishing any rule for determining correct salaries which will meet the statutory requirements as to what are ordinary and necessary expenses in carrying on a business; they possibly point out how easily a well meaning board of directors can depart from equitable dealings with minority stockholders when their own interests are involved and their action is without restraint.

The statute does not allow “ extravagant amounts paid by a corporation to its officers in the guise and form of compensation for their services ” to be deducted from gross income as ordinary and necessary expenses of its business. This appears to be an apt designation of what has taken place in this case. Petitioner, at any rate, has failed to sustain the burden of proof showing that the amount for additional compensation to its officers disallowed by the Commissioner was in fact part of its ordinary and necessary expense of carrying on its business, and we so hold. Botany Worsted Mills v. United States, 278 U.S. 282.

Judgment will be entered for the respondent.


author: Abundell : Van Fossan, Trammell,

text:
    Allyne-Zerk Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 34826.
    Promulgated February 23, 1934.

      John S. Watson, Jr., Esq., for the petitioner.

      Arthur H. Fast, Esq., for the respondent.
   OPINION.

Abundell :

This proceeding was brought to redetermine a deficiency in income tax of the petitioner for the year 1924 in the sum of $27,362.89.

A bad debt issue was settled by stipulation. The remaining issue is whether or not the sale by a corporation of its property and assets for cash, and the surrender for cancellation of a portion of its own outstanding shares of capital stock resulted in taxable income to petitioner.

The facts were stipulated and so far as material they are as follows:

The petitioner is a corporation, organized under the laws of the State of Ohio, with its principal office in the city of Cleveland, Ohio. The petitioner filed a certificate of dissolution with the Secretary of State of the State of Ohio on February 9, 1925, but under the laws of the State of Ohio it retains and has the right to institute and prosecute this proceeding in its corporate name.

On December 29, 1924, the petitioner and the Bassick Manufacturing Co., hereinafter called the Bassick Co., entered into a contract which provided for the sale to the Bassick Co. of all the property and assets of the petitioner. The Bassick Co. agreed to pay the sum of $410,066.67, to assume and pay all of the petitioner’s liabilities (except taxes and assessments for 1928 and preceding years and claims against the petitioner not appearing on the petitioner’s books and also income taxes due from the petitioner by reason of the said sale) and “ to surrender or cause to be surrendered (to petitioner) for cancellation ” 5,640 ¾3 shares of the petitioner’s capital stock. The assets of the petitioner cost and were of the value of $597,044.65. Its liabilities were $130,047.41. Therefore, the net cost or value of the assets so sold was $466,997.24. The contract was duly and fully performed during the year 1924. The Bassick Co. paid $410,066.67 in cash and surrendered the 5,640 ⅛ shares of the petitioner’s capital stock, which thereupon were canceled at the same time as the transfer of the property and assets of the petitioner and the delivery of the said shares of stock, as a part of the closing of the transaction.

On December 29, 1924, and up to the time of the closing of the transaction, shares of the capital stock of the petitioner were issued and outstanding to the number of 12,533, all of one class.

Apart from the profit or loss incident to the sale provided for in the contract of December 29, 1924, the petitioner’s net income for the year 1924 was $248,003.99. In its income tax return for that year the petitioner deducted $61,214.83 as representing its loss in the above transaction.

In his deficiency notice dated December 12, 1927, the respondent computed the petitioner’s profit from the sale of its assets by adding to the cash price of $410,066.67 the value of 5,640¾3 shares of its stock at $37.40 per share, or $210,961.89, making total receipts of $621,028.56, from which, he deducted a net cost of assets at $468,747.24 (instead of $466,997.24 as stipulated). There is no issue as to the value of the stock.

The first matter requiring consideration is whether the transaction was a unified whole and so to be considered, or whether the parts thereof Avere susceptible of separate and individual treatment. More concretely, did the surrender for cancellation of 5,640 ¾3 shares of petitioner’s stock form part of the consideration for the sale ?

On study of the contract it is evident that all of the commitments of the Bassick Co. — to pay $410,066.67, to assume petitioner’s liabilities, and to surrender the stock — were integral parts of the consideration moving to petitioner and inducing the sale. To hold otherwise would be to hold that the surrender of the stock was a gift, which is contrary both to fact and reason. Undoubtedly the surrender of the stock was a vital part of the consideration. It follows that the transaction was not divisible and was such as may give rise to gain or loss. It was an ordinary sale of property for cash and other considerations, among them, the surrender for cancellation of a block of petitioner’s stock.

Various views have been expressed on the question here presented, but the latest pronouncements arc to the effect that the receipt by a corporation of its own stock as consideration upon the sale of property or in satisfaction of indebtedness may result in gain or loss. See Houghton & Dutton Co., 26 B.T.A. 52; Walville Lumber Co. v. Commissioner, 35 Fed. (2d) 445; Spear & Co. v. Heiner, 54 Fed. (2d) 134; affd., 61 Fed. (2d) 1030; Commissioner v. S. A. Wood Machine Co. 57 Fed. (2d) 635; certiorari denied, 287 U.S. 613; Commissioner v. Boca Ciega Development Co., 66 Fed. (2d) 1004. True, in the cases cited, the stock surrendered was the sole consideration, but the decisions do not rest on that fact. They treat the stock as but a medium of payment for the property sold or the debt satisfied. The fact that part of the consideration is cash does not change the character of the stock as consideration.

On authority of the above cases we hold that petitioner realized income to the extent of the difference between cost of the assets sold and the consideration received, consisting of cash plus stock at its then value.

Reviewed by the Board.

Decision will be entered wider Rule 50.

Murdock: dissents.

Van Fossan,

dissenting: I agree with the holding of the majority that the contract in this case was indivisible and that the entire transaction was one on which gain or loss may be predicated. I must dissent however from the conclusion that under the facts in this case the petitioner realized a gain from the surrender for cancellation of a block of its own stock.

The whole theory of income taxation is based on the concept that, where the taxpayer has acquired an increment, a gain, a profit, he should pay a tax thereon. Whereas he formerly had 100 units of value, now he has 100 units plus 10. The 10 units are taxable.

In this case we are looking at the situation solely as to the tax liability, i.e., the gain in money or property, of the corporation. We are not here concerned with the tax problems of the stockholders. So viewing the picture, wherein under the facts is petitioner richer than before the sale? How does the number of units of value possessed by petitioner after the sale compare with the number possessed before the sale? The answer to these questions seems simple when we resort to the figures in the case. Whereas petitioner had $466,997.24 in property available for distribution to stockholders, it now has $410,066.67 in property so available. The fact that the $410,066.67 is all cash while the $466,997.24 was part cash and partly other propery is beside the question. It was agreed that $466,997.24 represented the net cost and value of all assets, cash or otherwise. Therefore, for the purposes of this case it must be treated as equal to cash. Similarly, it would seem to be wholly immaterial to the question of gain to the corporation that whereas before the sale it would, on distribution, have divided the $466,997.24 among 12,533 shares, after the sale it would divide the $410,066.67 among 6,892 %s shares. The number of stockholders is immaterial so far as the corporation in liquidation is concerned.

When we ask the question: How is petitioner corporation better off financially by the cancellation?, we find the picture to be as follows : Before the sale there were 12,533 shares of stock entitled to share in net assets of an agreed value of $466,997.24. After the sale and cancellation there are 6,892 ¾8 shares of stock entitled to share in net cash assets of $410,066.67. Undoubtedly each remaining shareholder is in a better position than before the sale, — his stock is worth more because there are fewer shareholders entitled to share in the distribution. But wherein is the corporation in a better financial position? If it be said that it is pro tanto released from the liability created by the right of the shareholders to share in the distribution of the assets, it should be rejoined that as the liability of each share of stock was wiped out a new and proportionately equal additional right or liability was-created as to the remaining stockholders. The cancellation of part of the stock merely transferred the rights formerly held by some of the stockholders to those remaining.

It is of no moment that the stock surrendered for cancellation was valuable. True, it was valuable in the bands of the stockholders before surrender, but on surrender and cancellation its value passed, not to the corporation, but to the other stockholders, whose shares were made proportionately more valuable. The assets of the corporation were not affected by the transmutation.

Respondent held that the receipt of the shares represented a gain of $210,961.89 to petitioner, or that the total receipts from the sale were $621,028.56. Obviously if petitioner received this sum, it was then available for the distribution which shortly followed. The simple fact is however that the corporation received only $410,066.67 and this amount and no more was available for distribution.

Taxation is a practical matter, it has 'been said, and, looked at practically, I am unable to see any basis for holding that the surrender and cancellation of part of petitioner’s stock added one cent to the income, the assets, or the net worth of the petitioner corporation. There was nothing additional available for distribution to shareholders on the liquidation of the corporation.

This case differs in its vital facts from any heretofore considered by the Board. In S. A. Woods Machine Co., 21 B.T.A. 818, the stock was the sole consideration received in satisfaction of an obligation arising from a compromise settlement of litigation. The effect of our decision was to hold the transaction nontaxable. The Circuit Court of Appeals, in Commissioner v. S. A. Woods Machine Co., 57 Fed. (2d) 635, reversed our decision, but in their opinion observed: “ Whether the acquisition or sale by a corporation of its own capital stock gives rise to taxable gain or deductible loss depends on the real nature of the transaction involved.” Here we hold the transaction to be one on which gain or loss may be recognized, but I am unable to perceive that the stock phase of the transaction made for either gain or loss. The learned court observed further: “ If it was in fact a capital transaction, i.e., if the shares were acquired or parted with in connection with a readjustment of the capital structure of the corporation the Board rule (neither gain nor loss) applies.” In the instant case the “ surrender * * * for cancellation ” of the block of stock would seem to be within this observation. Continuing further the court stated: “ But where the transaction is not of that character, and a corporation has legally dealt in its own stock as it might in the shares of another corporation and in so doing has made a gain or suffered a loss, we perceive no sufficient reason why the gain or loss should not be taken into account in computing the taxable income.” (Italics supplied.) In the case before us we have seen that the stock was surrendered for cancellation. It was not “ dealt in ” in any way “ as it might in the shares of another corporation.” Whether it made a gain or suffered a loss (tlie whole transaction being held to be taxable) is the very question for decision.

The majority also relies on Houghton & Dutton Co., 26 B.T.A. 52, in which the Board followed the Circuit Court of Appeals in S. A. Woods Machine Co., the instant case arising in the same circuit, and Commissioner v. Boca Ceiga Development Co., 66 Fed. (2d) 1004, in which the Third Circuit Court of Appeals followed the S. A. Wood Machine Co. case. Neither of these cases is, in my judgment, adequate contrary authority to the position I would take here.

Petitioner contends that not only was the Commissioner in error in finding a gain from the transaction (the gain being based on the value of the stock), but he erred further in not allowing petitioner as a loss the difference between the agreed cost of the assets sold and the cash realized.

Having concluded, as the Board has (in which I agree) that the transaction was indivisible and might give rise to gain or loss, and having reached the further personal conclusion that no gain arose from the surrender for cancellation of the block of petitioner’s stock, it follows that the petitioner should be sustained in its contention as to loss suffered.

As above pointed out, the agreed cost and value of the assets was $466,997.24. The total amount received by the corporation in payment was $410,066.67. In my judgment the difference represents a deductible loss of the corporation.

McMahon and GoodRich concur in this dissent.

Sternhagen agrees with the conclusion of this dissenting opinion.

Trammell,

dissenting: In my opinion, when the corporation gives up its assets for cash and a portion of its own stock for cancellation, there should be an allocation between the value of the assets to the extent cash was paid therefor and the value thereof represented by the exchange of stock, and that portion for which stock was received for cancellation only should be held to be a limitation to that extent. This would reduce the basis for the assets sold for cash. It is difficult to see how the corporation has acquired any gain by the acquisition for cancellation and the cancellation of stock. In so far as any value of the assets may be attributable to the stock received is concerned, that is, that portion of the value of the assets which was in excess of the cash received, might fairly be considered to be a turning back by the corporation to the stockholders of a proportionate part of assets. The assets actually left the corporation and did not come into it. The certificates of stock merely represented the pro rata share of the stockholder in the earnings of the corporation after the payment of debts. When stock is surrendered for cancellation and for nothing else, the other stockholders may possibly receive a larger pro rata share in the earnings, but the corporation has no additional assets to take the place of what left the corporation in exchange for the stock to be canceled.

This seems to me, in so far as the stock is concerned after an allocation has been made, merely to be capital readjustment brought about by the cancellation of stock and the receipt thereof for that purpose. In my opinion this is not a case where a corporation was dealing in its own stock as an outsider would deal, but a mere corporate readjustment of capital.

It would seem clear that if three individuals contributed to a corporation three buildings and for those buildings so contributed received certificates of stock representing their pro rata contribution to the capital of the corporation, and thereafter one of the individual stockholders desired to receive his building back and the corporation gave it back and the individual surrendered his stock, the corporation would have nothing on which to base a capital gain — it would be simply a capital adjustment. This case differs from the example stated, it seems to me, only in the fact that a certain amount of cash was paid in for the corporate property transferred to its stockholders, but I see no reason why a proper allocation could not be made and treat one part of the transaction as being a mere capital adjustment and the other part as a sale of assets. I do not agree, however, that the stock transaction should be disregarded entirely.


text:
    Cora K. Louis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 49179.
    Promulgated February 23, 1934.

      Theodore B. Benson, Esq., for the petitioner.

      James H. Yeatman, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent has determined a deficiency in income tax for the year 1925 in the amount of $1,107.09, from which the petitioner appeals on the allegation that a loss sustained in that year has been erroneously disallowed as a deduction from gross income. Tlie parties have filed a stipulation, -which is accepted and incorporated herein by reference. The following is a summary of the material facts:

Petitioner is an individual who resides at Los Angeles, California. Her father died testate on December 28, 1912, and in his will, probated in Cook County, Illinois, on January 2, 1913, disposed of an estate of the net value of $2,80S,442.39. The estate was left in varying proportions to the widow, two sons and three daughters of the decedent. Among other things each of the daughters was to receive $75,000. The petitioner and her sisters were not satisfied with their shares of their father’s estate under the will and, on April 19, 1913, entered into an agreement with their brothers whereby each was to receive one-third of certain personal properties included in the estate inventory, and, in addition thereto, an annuity of $5,000 during the life of their mother, Rosalinda Klein, in lieu of all their interests under the will. Under this agreement the annuity to the sisters was expressly specified as the joint and several obligations of the brothers. At the date of such agreement the life expectancy of the mother was fifteen years, one month and nine days. The present worth of an annuity of $5,000 per year, payable semi-annually over that period, is $57,753.50. Rosalinda Klein died in 1925, at which date the petitioner had received annuity payments under the agreement in the amount of $00,000. Such total payments discounted back to April 1913 had a then value of $48,568.94. If Rosalinda Klein had lived out her expectancy, petitioner could have received six additional payments of $2,500 each, or a total of $15,000. That amount had a capital value as on April 1913, of $9,184.56, which is claimed by the petitioner as a deductible loss in the taxable year.

The only question here is whether the petitioner sustained a loss in the year in which the death of her mother terminated the annuity payments provided for by contract with her brothers on April 19, 1913. The answer to this question involves (1) whether an annuity contract is property; (2) the amount of petitioner’s capital investment as the cost of the annuity; (3) the amount of such investment recovered by her prior to the taxable year; (4) whether the annuity contract was a transaction entered into for profit; and (5) whether the termination of such contract by the death of petitioner’s mother was a disposition thereof within the meaning of section 204 (a) of the Revenue Act of 1926.

The amount of $75,000 was devised to the petitioner in her father’s will, but the record is not clear that the annuity was based thereon or in lieu thereof. After the will was probated, the three sisters and two brothers agreed among themselves to a distribution of that portion of their father’s estate left to them which was materially different from the terms thereof. As part of the compromise settlement with her brothers and sisters, petitioner acquired the right to receive $5,000 a year during the life of her mother, whose life expectancy on April 19, 1913, was something over fifteen years. What she surrendered was an interest in her father’s estate sufficient to purchase the annuity in question and if that interest was the capital basis of such annuity it was equal to the present worth thereof computed on the mother’s life expectancy of fifteen years, one month and nine days, which the parties agree was $57,753.50. In Florence L. Klein, 6 B.T.A. 617, in a proceeding involving the taxability of the income received under this same annuity contract, we said: “ The significant fact now before us is that the value of what petitioner acquired by contract on April 19, 1913, became the capital basis for measuring any subsequent gain or loss in respect thereof.” We are of the opinion that such amount was the cost of the petitioner’s annuity at April 19, 1913.

The contention of the petitioner is that the annuity contract was property which cost her at least $57,753.50 and that, when her interest therein was terminated by the death of her mother, she sustained a loss under the provisions of section 202 (a) of the Revenue Act of 1924, measured! by the difference between her capital investment and the amounts thereof recovered in the annual payments. That an annuity contract is property is too well established to require any discussion or citation of authorities. Here the annuity is not payable out of either the corpus or income of the estate of petitioner’s father, but is created by contract between petitioner and her brothers, and there is therefore no question as to whether she received the annual payments as a beneficiary of the estate. If the termination of the contract by the death of the petitioner’s mother was a disposition of such property within the meaning- of the taxing statute, it follows that the whole amount of the difference between the basis at acquisition and the recoveries of capital prior to such disposition is a deductible loss in the taxable year.

In William P. Blodgett et al., Executors, 13 B.T.A. 1243, we held that the right of an estate to receive its decedent’s share of the profits of a partnership for one year was a chose in action transmitted to the estate by such decedent and its capital cost was the present worth of such interest at the date the right to receive vested in the estate. The Commissioner determined that the entire amount of the partnership profits received by the estate during such first year was taxable income. We held that the chose in action was a capital asset of the estate and that realization therefrom was income only to the extent of the excess thereof over capital value at date of acquisition.

In Guaranty Trust Co. of New York, Executor, 15 B.T.A. 20, the petitioner in the year 1919 exchanged certain leaseholds for an annuity of $100,000 per year and the next two years received the respective amounts of $100,000 and $99,999.96 in conformity with the contract under which the exchange was made. The Commissioner undertook to tax the total of each payment as income in the year in which it was received. In that proceeding we held that the present worth of the contract computed on the annuitant’s life expectancy should be regarded as the fair market value of the annuity and as the starting point from which to determine the taxability of amounts received under the contract and that the owner is entitled to recover such value free from tax. On the authority of Florence L. Klein, supra, we also held that each annual payment constituted in part a recovery of capital and in part a gain.

In Florence L. Klein, supra, involving the identical contract now under consideration, we said that “ when actually received in each year the annual payment consists of the principal of such payment, plus the discount, the latter being the gain taxable as income.” This is the rule that was later applied in the cases above cited and discussed. None of the proceedings cited has been overruled by the Board or reversed on appeal, and as to the question therein decided they are controlling on similar issues.

In conformity with the decisions above cited and upon the stipulated facts, it follows that petitioner sustained a loss of $9,184.56 in the taxable year if the termination of her annuity contract by the death of her mother in 1925 can be regarded as the closing of a transaction entered into for profit as provided in section 214 (a) (5) of the Revenue Act of 1924. In George M. Cohan, 11 B.T.A. 743, a very similar question was involved. In that proceeding the facts disclose that prior to the taxable year the petitioner had purchased an annuity contract and had made several substantial payments thereon. In the taxable year he decided that he had made a poor investment and forfeited the contract by nonpayment of installments then due. In his petition he claimed the right to deduct the sum of all payments theretofore made from his gross income as a loss sustained in the taxable year in a transaction entered into for profit. In our decision we held that an annuity contract is a transaction entered into for profit, that payments thereon are investments in property, and that the sum of such payments is a deductible loss in the year in which the contract is voluntarily forfeited for nonpayment of installments then due.

In Pioneer Cooperage Co., 17 B.T.A. 119, the petitioner claimed a deductible loss in the taxable year resulting from the destruction of timber by storm and the ravages of insects. In our decision we held that the facts brought the petitioner’s contention within the loss provisions of the statutes. Upon appeal by the petitioner for increase in the amount of loss allowed by the Board, our decision was affirmed on all points in Pioneer Cooperage Co. v. Commissioner, 53 Fed. (2d) 43; certiorari denied, 284 U.S. 687. In its opinion in that case the Circuit Court, in discussing the precedents relied on by the parties, said:

These decisions refer to sale of property. The act includes not only sales, but other disposition of property. A loss of property, such as occurred in this case, is a disposition within the meaning of the act, although it is involuntary. The property is disposed of so far as the owner is concerned, and there is no reason, in the absence of a positive statute, in determining a loss why a different rule should be adopted than in the case of a voluntary sale. The purpose of the act is to allow the owner to deduct what he has actually lost in the transaction. The depletion and exhaustion statutes were not intended to cover losses such as are involved here.

On brief the respondent relies on Warner v. Walsh, 15 Fed. (2d) 367; United States v. Bolster, 26 Fed. (2d) 760; Allen v. Brandeis, 29 Fed. (2d) 363; Logan v. Commissioner, 42 Fed. (2d) 193; affd., Logan v. Burnet, 283 U.S. 444; and Mary W. B. Curtis, 26 B.T.A. 1103. In our opinion these cases are all distinguishable from the present proceeding. In each the income in question was payable from an estate and the issue was whether, in accepting the terms of a will providing for annual payments from a testamentary trust, a widow bought an annuity at the cost of her relinquished interest in the estate’ to which she was entitled under the law. There is no such question here. This annuity is based on a contract between the petitioner and her brothers. The payments were not made from the estate, but from the personal resources of the brothers, who, after April 19, 1919, were obligated to pay, entirely regardless of the amounts received by them from the estate. In the cases cited the payments were made either by the estate or by a testamentary trust and apparently involve no rule applicable to the present proceedings. In any event they have been so greatly modified by the Supreme Court in Helvering v. Butterworth, 290 U.S. 365, that they are no longer controlling as to the principal question therein involved.

In our opinion the weight of authority supports the contention of the petitioner. There is no controversy of the present worth of the annuity at date of the contract or that of the payments received thereunder. Accordingly, we hold that petitioner sustained a loss in the taxable year in the amount of $9,184.56. The determination of the respondent is reversed.

Reviewed by the Board.

Decision will be entered for the petitioner.

MaRQuette and Leeob: dissent.

       Sue. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall he the excess of the amount realized therefrom over the basis provided in subdivision (a) or (h) of section 204, and the loss shall be the excess of such basis over the amount realized.


author: Van Fossan :

text:
    Hewitt Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73109.
    Promulgated February 23, 1934.

      Francis J. Sweeney, Esq., for the petitioner.

      George D. Brdbson, Esq., for the respondent.
   OPINION.

Van Fossan :

The respondent determined a deficiency of $1,141.94 for the year 1931. The only error now urged is the inclusion in income of $10,312.89 representing a prorated part of the depreciated cost of a building erected by a lessee on land belonging to taxpayer-lessor.

The parties stipulated the facts substantially as follows:

The petitioner was at all times during the calendar year 1931 a corporation duly organized and existing under the laws of the State of New York, with its principal office at 50 Church Street, New York, New York.

Under date of May 1, 1929, the petitioner (hereinafter referred to as lessor) leased to the Tishman Realty <⅞ Construction Co., Inc., of 285 Madison Avenue, New York, New York (hereinafter referred to as lessee) a certain parcel of real property owned by the lessor and located at the corner of 57th Street and Lexington Avenue, New York, New York.

The written agreement between the lessor and lessee showed all the terms agreed upon by tnose parties and contained a legal description of the property concerned. Among its provisions were the following:

To Have and to Hold said premises (subject as aforesaid) unto the Lessee from the first day of May, 1929, for and during the full term of twenty-one (21) years thence next ensuing, that is to say, to and including the 30th day of April, 1950, unless sooner terminated as hereinafter provided;
* ⅜ * ⅜ ⅜ * *
Twenty-second : In case, but only in case, this lease shall be in full force and effect, and the Lessee shall have erected the new building referred to in Paragraph number “ Twentieth ” hereof, and the Lessee shall not be in default under any of the conditions, covenants and agreements herein contained on its part to be kept and performed and complied with as hereinabove provided, the Lessor will at the expiration of the term hereinabove demised grant and execute unto the Lessee a renewal of- this lease for a further term of twenty-one years from the expiration thereof, that is to say, until the 30th day of April 1971, provided the Lessee shall have given written notice to the Lessor of its election to exercise its option of such renewal thereof, by the service of such notice on the Lessor not less than one and not more than two years before the expiration of said original term, that is to say, after the first day of May, 1948, and on or before the first day of May 1949. In case of such renewal the annual basic rent, exclusive of all the items of additional rent as hereinabove provided shall be an amount equivalent to six (6%) per centum of the fair market value of the land considered as vacant and unimproved as follows, namely: For the first seven years of said renewal period, of the fair market value of the land as of the first day of May 1950, and for the second seven years thereof, of the fair market value of the land as of the first day of May 1957, and of the last seven years thereof, of the fair market value of the land as of the first day of May 1964. In the event of the failure of the parties to agree on the fair market value of the land as aforesaid by the first day of September preceding the first day of any such seven year period, such valuation shall be determined by arbitration in the manner hereinafter provided; provided, however, that irrespective of such valuation such annual basic rent shall be not less than the annual basic rent applying to the next preceding seven year period. Except for the increase in the amount of the annual rent which may result from such valuation and revaluations, such renewal lease shall contain each and all the conditions, covenants and agreements as contained in this lease, except the provision for the erection of a new building.

All the provisions of the written lease were in full force and effect during the entire year 1931.

Pursuant to the terms of the lease agreement the lessee during the year 1931 caused to be erected on the leased property a modern office building at a total cost to the lessee of $559,842.32, which amount was also the fair market value of said building on May 1, 1931, the date of its completion.

The new building in question was of steel and stone construction and had a depreciable life of 40 years.

By May 1, 1931, title to the new building mentioned above had passed to the lessor subject to the lease in question.

The lessor in its income tax return for 1931 reported no income by reason of the erection of said building and the acquisition of title thereto.

Respondent in his audit of the lessor’s income tax return increased lessor’s net income by the sum of $10,312.89, which represented the proper 1931 portion of the depreciated value of such building, as of May 1, 1950, computed on the basis of a 40-year life and spread over the period from May 1, 1931, to May 1, 1950.

There were similar provisions for two further extensions of 21 years each.

Petitioner contends that it realized no income from the erection of the building by the lessee. It argues that the lessor had only the title without enjoyment or beneficial use of the building, but cites no pertinent cases in support of its position.

In Cryan v. Wardell, 263 Fed. 248, where the Government attempted to tax to the lessor the entire value of a building erected by a lessee, at the termination of the lease, the court said: “ It results that whatever accession of value resulted to plaintiff’s property from the erection of the building in question accrued and became vested in her in 1910 (the date of its completion) and not upon the termination of the lease.” To the same effect is Miller v. Gearin, 258 Fed. 225. In United States v. Boston & Providence R.R. Corp., 37 Fed. (2d) 670, the court said:

A building erected on leased land under a covenant in the lease that it shall become and remain a part oí the realty and the property of the lessor is treated by the Revenue Department, and properly so, as income of the lessor, presumably upon the ground that, on becoming a part of the realty, it has enhanced the value of the lessor’s property to the amount it has added to its fair market value; and, while its cost as to the lessee may be treated as so much rental and be spread over the entire term of the lease in computing his income tax, the fair market value it has added to the lessor’s property is taxable to the lessor in the year in which the building was constructed. Miller v. Gearin, supra; Cryan v. Warden, supra.

Though the case before the court did not involve the specific question, the observation of the court indicates its view of the rule of law which should govern. See also Joseph L. B. Alexander, 13 B.T.A. 1169; W. H. Martin, 24 B.T.A. 813.

The respondent is not contending for the literal application of the above rule of law, but under the ameliorating provisions of article 63 (5) of Regulations 74 would allow the taxpayer to spread over the life of the lease the estimated depreciated value of the building, at the termination of the lease reporting an aliquot part each year of the lease. He thus would prorate the depreciated value over the original term, disregarding possible renewals.

We are of the opinion respondent’s action should be sustained. The provisions of article 63 (5) of Regulations 74 are fair and equitable, and their application entirely justified in this case.

At the expiration of the 21-year original term there will remain on lessor’s land a valuable building, the title to which was vested in petitioner in 1931. That the lease may not be considered as extending over possible renewal terms is well established. Bonwit Teller & Co., 53 Fed. (2d) 381; Bowman Hotel Corp., 24 B.T.A. 1193.

Decision will be entered for the respondent.