author: MuRdogh :

text:
    Raoul H. Fleischmann, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90305.
    Promulgated October 12, 1939.

      L. L. Hamby, Esq., ElcLen McFarland, Esq., and ETlmood W. Kemp, Jr., Esq., for the petitioner.

      George B. Sherriff, Esq., for the respondent.
   OPINION.

MuRdogh :

I. Income from the trust of March 19,1931. — The Commissioner, in determining the deficiencies, included the income of this trust in the income of the petitioner on the ground that the trust was a revocable trust within the provisions of section 166 of the Eevenue Acts of 1928, 1932, and 1934. He has now abandoned this contention, except as to the year 1934, and he no longer argues that section 166 of the Eevenue Acts of 1928 and 1932 has any application.

That section applies only where the grantor, or the grantor and certain others, had a power “during the taxable year” to revest title to a part of the corpus in the grantor. Since the deed of trust gave no such power, the Commissioner was obviously in error in applying section 166 of the Eevenue Acts of 1928 and 1932. The words “during the taxable year” were dropped from section 166 when it was incorporated in the Eevenue Act of 1934 and the Commissioner still contends that the income of the trust for 1934 is taxable to the petitioner under the provision of that section to the effect that where at any time the power to revest in the grantor title to any part of the corpus is vested in the grantor, then the income of such portion shall be included in his income.

He relies upon the provisions of the deed of trust giving the petitioner certain elections as each child became 21. Those provisions are quoted in extenso in the findings. The grantor, if alive, could then elect (a) to terminate the trust and give the principal and any accumulated income to his wife, if living, or, if she was dead, “to distribute the same in such manner as the Grantor may direct”; (b) to continue the trust and let the corpus be disposed of by the child at death; and (c) “such other final distribution or provision as the Grantor may at that time, namely, as each child or stepchild attains the age of twenty-one years, direct.” The second choice, of course, is not a power within section 166. Neither is the first, since the effective part of it was expressly contingent upon the prior death of the wife. Corning v. Commissioner, 104 Fed. (2d) 329; John Edward Rovensky, 37 B. T. A. 702. But the Commissioner contends that the third choice permitted the petitioner to distribute the principal and any accumulated income of each one-third to himself. A power to distribute as each child became 21 would be like a similar power exercisable after a certain date. Estate of A. C. O'Laughlin, 38 B. T. A. 1120. The force of the respondent’s argument might be irresistible if the provision of the deed stood alone. The intent of the grantor is controlling. That intent must be gathered from the entire deed and from all other relevant and admissible evidence. The deed when read as a whole indicates that the petitioner did not reserve any power to revest title to' any of the trust property in himself. This is shown not only by the general purpose of the trust (to provide permanently for the three boys) but by the unequivocal language of paragraph (5) stating that the petitioner reserved rights to nominate the ultimate recipients of the principal but “the transfer of principal hereunder shall be absolute and irrevocable.” He obviously meant that under no circumstances could he use any of his retained powers to take back the principal for his own. This interpretation of the deed is corroborated by his testimony as to his intent and purpose and by the action which he took when the first boy became 21. We conclude that under none of his reserved powers could the petitioner revest in himself, at any time, title to any of the trust property and section 166 does not apply.

The Commissioner makes arguments in his brief for the first time that the income of the trust is taxable to the petitioner on grounds other than the provisions of section 166. The petitioner complains of this change on the part of the Commissioner and argues that the Commissioner thereby raised an affirmative issue upon which he has the burden of proof. The Board has said many times that the real question for decision is the correctness of the action of the Commissioner and not the correctness of the reason which he assigned in his notice of deficiency. Edgar M. Carnrick, 21 B. T. A. 12; James P. Gossett, 22 B. T. A. 1279; affd., 59 Fed. (2d) 365; Richard L. McCann, Administrator, 30 B. T. A. 102; Charles J. O'Laughlin, 30 B. T. A. 1327; aff'd., 81 Fed. (2d) 269; Sand Springs Railway Co., 31 B. T. A. 392. Here he included the income of the trust in the income of the petitioner and still insists that that income was properly included in the income of the petitioner. He merely assigns a new reason for his action. The burden of proof does not shift under such circumstances although such a delayed reversal of reasoning is unfortunate and might justify a further hearing if the petitioner claimed surprise and desired to introduce further proof to meet the change. He has known of the present contentions of the respondent since about July 1, 1939, and has made no request to introduce additional evidence. He does not claim surprise, but attempts to answer all of the arguments of the respondent. The change made by the Commissioner in Tex-Penn Oil Co. v. Commissioner, 83 Fed. (2d) 518, was not a mere change in the reason assigned for a particular action and that case is not in point.

One of the new arguments made by the respondent in his brief is that there was no substance to the trust and it should be disregarded for income tax purposes in accordance with principles announced in Benjamin F. Wollman, 31 B. T. A. 37; William C. Rands, 34 B. T. A. 1107; appeal dismissed, 101 Fed. (2d) 1018; Warren H. Corning, 36 B. T. A. 301; reversed, 104 Fed. (2d) 329; and Estate of A. C. O’Laughlin, supra. The reasons assigned by the respondent are wholly inadequate for his purpose. This trust was created for a legitimate and laudable purpose and was used to carry out that purpose. The transfer was complete and the income was used for the benefit of others than the petitioner. The petitioner did not retain privileges and benefits so substantial as to justify treating the income and corpus as his own. Cf. Burnet v. Wells, 289 U. S. 670.

Another new argument made by the respondent in his brief is that one-third of the income of the trust was to be used for the support, education, and maintenance of the petitioner’s son and, therefore, was taxable to the petitioner under Douglas v. Willcuts, 296 U. S. 1, and Commissioner v. Grosvenor, 85 Fed. (2d) 2. The trustee was directed to apply the income from one-third of the trust “to the support, education, and maintenance” of the son during his minority “in such manner and amounts as she may in her sole discretion deem best.” Reference to possible accumulations does not change the fact that the income was to be used eventually and used only for the support, education, and maintenance of the son. That was the primary purpose of this part of the trust. Cf. Higgins v. White, 93 Fed. (2d) 357. Furthermore, the petitioner testified that, to the best of his knowledge, the income was used to support, educate, and maintain his son. Cf. E. E. Black, 36 B. T. A. 346; Martin F. Tiernan, Trustee, 37 B. T. A. 1048. This case is not distinguishable from Commissioner v. Grosvenor, supra. Thus, one-third of the income for each year was taxable to the grantor under the cases cited. The respondent recognizes that the petitioner was under no obligation to support the Botsford boys and does not contend that the principles of the above cases have any further application.

Another argument made by the respondent to support his determination is that section 167 applies, since the income of the trust could be accumulated and the petitioner could then take the accumulations for himself. Section 167 of the Revenue Act of 1928 refers only to income over which the grantor, alone or in conjunction with some other person, may exercise a discretion. Here the grantor could exercise no discretion as to the disposition of any current income, The sole discretion was lodged in the trustee. Sections 167 (a) (1) of the Revenue Acts of 1932 and 1934, upon which the respondent relies, are different in this respect. They provide that where any part of the income of a trust is, or, in the discretion of any person not having a substantial adverse interest in the disposition of such part of the income, may be held or accumulated for future distribution to the grantor, then such part of the income of the trust shall be included in computing the net income of the grantor. The discussion above in regard to the intent of the grantor and his rights of election is a complete answer to this contention of the respondent, since it led to the conclusion that he retained no right to take any of the accumulations for himself under any circumstances. Furthermore, the argument is unsound in other respects. It does not appear that the trustee ever accumulated any of the income or that she was authorized to accumulate any amount, except as a means of spreading current income over an appropriate period. She was eventually to use all of the income for the support, education, and maintenance of the boys. Cf. Higgins v. White, supra; Corning v. Commissioner, supra; Daisy Christine Patterson, Executrix, 36 B. T. A. 407. If no income was to be accumulated, none could ever get to the grantor under his power of election. Certainly the deed does not indicate an intent to have the trustee accumulate income so that the grantor could recapture it when a child became 21.

The income of the trust for the son has been held to be taxable on other grounds and only that of the trusts for the Botsford boys need be considered. The trustee was their mother, she had custody of them, was able to support, educate, and maintain them, and was obligated by the decree of divorce, if not otherwise, to provide for them.' It was to her interest to use the income of the trusts to defray the expenses which otherwise might have to be paid from her personal funds. Although she thus acquired no legal interest in the trust income, nevertheless, from a practical standpoint she had a very real and substantial interest in the disposition of the income adverse to any possible interest of the grantor in any accumulations. It is thus immaterial whether her interest in the accumulations under any of the elections of the petitioner might or might not be considered substantially adverse. Cf. John N. Fulham, 40 B. T. A. 48; Jane B. Shiverick, 37 B. T. A. 454. Section 167 (a) (1) of the Revenue Acts of 1932 and 1934 does not apply to the income of the trusts for the Botsford children.

We hold, in accordance with the foregoing discussion as to the trust of March 19, 1931, that only one-third of the income for the years before us is taxable to the grantor.

II. Income from trusts of September 22,19S2, and May 21¡., 1931¡,.— The Commissioner included the income of these trusts in the income of the petitioner upon the theory that section 167(a) (2) of the Revenue Acts of 1932 and 1934 applied. He abandoned 167(a) (2) in his brief as a basis for his action and attempts to justify that action upon other grounds. The petitioner does not complain of this change upon the part of the Commissioner; nevertheless, the discussion under the first issue relating to a similar change is equally applicable here.

One of the contentions of the Commissioner is that a close scrutiny discloses a lack of substance in the trusts, a mere scheme to reduce income taxes, and trusts which should be disregarded for income tax purposes in accordance with the principles announced in Benjamin F. Wollman, supra; William C. Rands, supra; and Estate of A. C. O’Laughlin, supra. These transactions were within the family of the petitioner and should be closely scrutinized to see what their purpose was and to determine how much substance was in them for income tax purposes. Joseph E. Uihlein, 30 B. T. A. 399; affd., 82 Fed. (2d) 944; Thomas W. Mehan, 32 B. T. A. 1088; affd., 90 Fed. (2d) 609; Edmund S. Twining, 32 B. T. A. 600, 604; affd., 83 Fed. (2d) 954; certiorari denied, 299 U. S. 578.

The petitioner testified that he created the trusts to prevent himself from losing his property through his tendency to make unwise investments, to safeguard his property from influences of the prevailing unsettled financial conditions of the times, and to provide for his family and relatives who might have to call upon him for assistance. He did not explain why he created four trusts instead of one.

The first reason is not very convincing in view of the provisions of the trust deeds reserving to the petitioner the absolute power to direct the disposition and acquisition of all trust property and relieving the trustee of all responsibility in such matters. Furthermore, it is not at all clear that “The Settlor’s equity” in the shares, which was all that was assigned, had any substantial value. Counsel for the petitioner concede in their reply brief that the petitioner was in error when he testified that the shares were not pledged as collateral in 1932,1933, and 1934 for the benefit of the petitioner. The record does not show the extent to which the shares were encumbered or the ability and intention of the petitioner to relieve the shares from the lien or liens. Seizure of the shares to satisfy the liens might have left nothing for the trusts. The trusts did not free the property from the danger of unwise investments by the petitioner. Nor does the evidence disclose how the creation of the trusts was a safeguard against the dangers of the times. The trusts might have been used to assist relatives, but in fact all of the income for these years and all except an undisclosed amount in later years was distributed to the petitioner. The trusts were designed to last for short periods only. The first was actually revoked at the will of the petitioner at a time when it was said to be irrevocable. The relatives, other than the wife, were not consulted. These circumstances and others weaken the force of the testimony of the petitioner as to the purpose of the trusts.

The evidence indicates that the petitioner must have had other purposes in creating the trusts. One was a purpose to save taxes. If the income from the shares could he divided among four trusts, instead of being all taxed to one or to the petitioner, the result would be a saving in tax. No other reason for the creation of four trusts instead of one has been suggested. If the trustee could refrain from distributing the income of each year to the petitioner until a few days after the close of the year, section 162 (c) might not require that the income be taxed to the petitioner instead of to the four trusts. The original trusts were designed to avoid the application of section 166 of the Revenue Act of 1932. When the change in that section was made by the Revenue Act of 1934, approved on May 10, 1934, the trusts were promptly revoked and new ones created to avoid the application of the new section 166. These circumstances and others indicate that the petitioner and his wife were fully advised and conscious of the tax consequences of their acts. While legitimate methods of avoiding tax are entirely proper, nevertheless, a purpose to avoid tax is not without significance here, since it may be the real purpose back of the transactions and it may be some evidence of a lack of substance for tax purposes in the trusts. William, C. Rands, supra.

The petitioner testified that he had no agreement or understanding with his wife that she would pay the income of the trusts to him. She actually paid all of the income of the trusts for these years to him. She was even careful to pay it to him after the close of the year so he might not be taxable under section 162 (c). His testimony is that she discussed the distributions with him and he knew before the end of the year that she intended to distribute to him.

It is apparent that these trusts were quite thin. The doubtful value of the equity, the fact that the shares were pledged for the benefit of the petitioner, the short duration, the ease of revocation, the power of control in the grantor, the actual receipt of all income by the petitioner, the lack of any real purpose except to reduce taxes, and the absence of any indication that the interests or needs of any other “beneficiary” was considered during these years, all go to show that the petitioner lost little, if any, actual control over and benefit from his property by the two sets of instruments. Cf. Burnet v. Wells, supra; Corliss v. Bowers, 281 U. S. 376; DuPont v. Commissioner, 289 U. S. 685; Lucas v. Earl, 281 U. S. 111. The Commissioner’s argument does not require a holding that no trusts existed in equity. Stoddarrd v. Eaton, 22 Fed. (2d) 184. The Supreme Court said in the Wells case that “liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner, and to tax him on that basis.” The Board held in the Wollman case, supra, that the principle thus stated could apply even to income from property placed in trust. It said in the O'LcmghUn case that “The Government is not required to tax trusts as separate taxable entities where the terms of the trust instrument and the manner of conducting the trusts indicate that they are not entitled to be distinguished from the grantor for tax purposes.” This is another case like that of Benjamin F. Wollman, supra; William C. Rands, supra; and Estate of A. C. O'Laughlin, supra, where the trust was so lacking in substance and the grantor retained such powers and benefits that the trust may be disregarded for tax purposes and the income taxed to the grantor.

III. Loss on investment m the National Gift Guild. — The respondent contends that the petitioner did not enter into' this transaction for profit, but the evidence clearly shows that he did enter into the transaction with the intention and for the purpose of profit. There is no question as to the fact that a loss occurred in 1981 or as to the amount lost.

IV. Loss on sale of stock of General Baking Co. — The question here is confined to that of the basis to be used. The Board held in H. B. Leary, Sr., 34 B. T. A. 1206; affd., 98 Fed. (2d) 826, that a statutory reorganization occurred and the gain to the stockholders was taxable only to the extent of the cash received. The parties have stipulated all of the facts on this issue, including a statement that, upon the exchange of the preferred stock for stock and debentures of the General Baking Co., 92.1589 percent of the basis is to be allocated to the stock received in exchange. The petitioner contends that 92.1589 percent of the basis of the 1,900 old preferred shares in street names should be divided among the 2,850 new common shares taken in street names because the 2,850 shares are identified as shares received in exchange for the 1,900 preferred shares. The record, even including as it does the facts set forth in the opinion of the Board in the Leary case, fails to show any details of the exchange made on April 1, 1931. The ratio of exchange of old preferred or old common for new common, debentures, and cash is not disclosed. It is not clear that the 1,900 preferred shares were separately exchanged for 2,850 new common shares or that the plan permitted any such separate exchange. But even if that fact were clearly shown, it might not be important. In Helvering v. Stifel, 75 Fed. (2d) 583, the stock of two corporations was exchanged for the stock of one new corporation and the court said that “any calculation of the cost of the shares sold [new shares], based upon the original cost of thq shares of only one of the two companies, would be fallacious” and held a correct basis was the cost of all old shares divided equally among the new shares received in exchange. See also P. L. Wheeler, 32 B. T. A. 917.

The respondent contends that the correct basis is obtained by adding the total cost of the old common to 92.1589 percent of the total cost of all old preferred owned by the petitioner and dividing that total basis equally among all of the 8,463 new shares received in the exchange. It is now well established that where stock of one corporation is exchanged for stock of another, in pursuance of a plan of reorganization, the basis of the shares surrendered (after adjustment for any recognized gain or loss) must be allocated equally to the shares acquired, and the cost of some particular lot of the old shares may not be allocated to some particular lot of the new shares. Christian W. Von Gunten, 28 B. T. A. 702; affd., 76 Fed. (2d) 670; Olive Hume Oliver, 30 B. T. A. 1381; affd., 79 Fed. (2d) 561; Helvering v. Stifel, supra; Commissioner v. Bolender, 82 Fed. (2d) 591; Alvan T. Fuller, 31 B. T. A. 154; reversed, 81 Fed. (2d) 176; Jacob Epstein, 36 B. T. A. 109; Henry M. Runkle, 39 B. T. A. 458; Henry Hudson, 39 B. T. A. 1075, 1100. There was in some of the cited cases as much justification for identification and separate allocation of cost as is shown here, yet the holding was that the only practical and proper method was to average the total old bases among all the new shares. The method urged by the respondent is in accordance with those decisions and will be followed here.

V. Loss on sale of stock of General Holding Co., Ltd. — The loss on this stock was $19,280. The respondent contends that the petitioner did not enter into this transaction for profit and the stock became worthless prior to 1932. The facts disprove both of these contentions. The sale was a complete and final disposition of the stock. The purchaser was one who was familiar with the affairs of the company and that circumstance is some corroboration of the other evidence that the stock had not become worthless even in 1932.

VI. Loss on Barbour patent. — The dispute was as to the year in which this loss was sustained. The respondent concedes in his brief that 1933 was the year, the petitioner says the same, and the evidence §hows that the loss of $17,500 was sustained in that year.

Decision will be entered umder Rule 50.


source: Caselaw Access Project

author:
Blaok :
      TtjRNee,

license: Public Domain

text:
    Flomot Gin Company, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93102.
    Promulgated October 17, 1939.

      H. A. MiMlls, G. P. A., for the petitioner.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

Blaok :

If the capital stock tax return filed by petitioner on July 21, 1936, for the capital stock tax fiscal year ended June 30, 1936, was a proper return under the provisions of section 105 (a), (d), and (f) of the Revenue Act of 1935 as amended by section 401 of the 1936 Act, then any amendment of such return is not permissible even though a substantial mistake was made in the original declaration of the value of the capital stock. See Scaife & Sons Co. v. Driscoll, 18 Fed. Supp. 748; affd., 94 Fed. (2d) 664; certiorari denied, 305 U. S. 603; William A. Webster Co., 37 B. T. A. 800; Chicago Telephone Supply Co. v. United, States, 23 Fed. Supp. 471; certiorari denied, 305 U. S. 628; Rosoff Tunnel Corporation v. Diggins, 28 Fed. Supp. 880; Daggar Co., 38 B. T. A. 141; affd., 104 Fed. (2d) 24; A.J. Crowhurst (St Sons, Inc., 38 B. T. A. 1072; and Blake & Kendall Co. v. Commissioner, 104 Fed. (2d) 679. In two cases where the second return was tendered within the time allowed for filing a first return, the second return was accepted as if it were the first return. Oertel Co. v. Glenn, 13 Fed. Supp. 651; affirmed by the Sixth Circuit, 97 Fed. (2d) 495; Philadelphia Brewing Co. v. United States (Ct. Cls.), 27 Fed. Supp. 583. In the instant proceeding the second return was not tendered within the time allowed for filing a first return. For this reason, the two last named cases would not be applicable.

Therefore, it seems clear that if the capital stock tax return filed by petitioner July 21, 1936, was a proper return, .then the second or delinquent return which petitioner sent to the Commissioner April 30, 1937, accompanied by a check of $156.75, covering tax liability and interest and penalty could not be legally filed and the Commissioner was correct in refusing it and should be sustained in his determination of petitioner’s excess profits tax on the basis of the valuation fixed in the first return. Whether the first return filed by petitioner was a proper return depends upon the applicable law and regulations promulgated thereunder. Section 105 (a), (d), and (f) of the Revenue Act of 1935, as amended by section 401 of the 1936 Act, is the applicable law and is printed in the margin.

Articles 31 and 44 of Regulations 64 (1936 ed.), which are deemed pertinent to the issue here involved, are printed in the margin.

It will be ndted that section 105 (f) of the Revenue Act of 1935 as amended requires that “the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended), as of the close of its last income tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section.”

Petitioner was on a fiscal year basis which began May 1 of a given year and ended April 30 in the following year. Therefore, its last income tax taxable year ending prior to the close of the capital stock year ended June 30, 1936, was the fiscal year ended April 30, 1936. Petitioner, therefore, under the mandatory requirement of section 105 (f) above cited, should have declared the value of its capital stock as of April 30, 1936. If it liad done this, the return would have been a proper first return under the applicable act and regulations and, even though a mistake had been made in the declared value, it could not have been corrected by a subsequent amended return. See cases above cited.

But petitioner did not value its capital stock as of'April 30, 1936. That fact seems perfectly clear when one examines the first capital stock tax return, which was filed July 21, 1936. It shows on its face that the valuation which was intended must have been as of June 30, 1936, which was one day after petitioner had been dissolved and its assets liquidated. The capital stock was reported as having no value, evidently on the basis that there was no capital stock in existence after the liquidation and dissolution of the corporation. This interpretation is borne out by the fact that the return gave the date of the dissolution of the corporation and made the statement that there was no outstanding capital stock, conditions which did not exist on April 30, 1936.

Article 31 of Treasury Regulations 64 (printed in the margin, supra) provides among other things, that, “if a return form is incomplete to the extent that it is not in substantial compliance with the Act, the form will not be regarded as a proper return and therefore its filing will not preclude the application of penalties for a delinquent return.”

It seems clear to us that a return which undertakes to value the capital stock of a corporation at the end of the capital stock year at a time when the corporation has been dissolved and its assets entirely liquidated and which, therefore, reports the value of capital stock as “None,” is not in “substantial compliance” with an act which requires the valuation to be made “as of the close of its last income taxable year ending at or prior to the close of the year for which the tax is imposed by this section.” See section 105 (f) printed in the margin, supra.

As we have already pointed out, petitioner’s last income taxable year, within the meaning of the above quoted statute, was the fiscal year which ended April 30,1936, at which time petitioner was actively engaged in business and had capital stock outstanding of $20,000 par value (200 shares common stock at $100 par value per share). This capital stock had been valued for the capital stock year ended June 30, 1935, at $34,957.36. Therefore, for reasons already stated, we think the return filed by petitioner July 21, 1936, was clearly not in substantial compliance with the statute and we so hold. The Commissioner should have disregarded it, as provided by article 31 of Regulations 64, and petitioner’s capital stock tax return filed April 30, 1937, should be accepted as petitioner’s delinquent capital stock tax return for the capital stock tax year ended June 30,1936.

Suppose, instead of having been dissolved on June 27, 1936, petitioner had increased its capital stock on that date from $20,000 to $100,000 and had filed its capital stock tax return for the capital stock year ended June 30, 1936, on July 21, 1936, as it did do and had declared the value of its capital stock to be $100,000 and had shown in that return that it was declaring the value of its capital stock not as of April 30,1936, its last income tax year, but as of June 30, 1936, the close of its capital stock tax year. Would not the Commissioner have been justified in rejecting the return as no return at all under the law and the applicable regulations and in requiring petitioner to file a delinquent capital stock tax return? We think he would have been so justified and, if we are correct in that assumption, then we think that by the same reasoning the return which petitioner filed on an erroneous basis on July 17,1936, must be rejected.

The capital stock tax return filed by petitioner April 30,1937, being petitioner’s first return under the provisions of said act, it had the right to declare any value that it saw fit. See section 105 (f) printed in the margin. Petitioner declared $120,000 as the value of its capital stock as of April 30,1936, and tendered the Commissioner a check in payment of its capital stock tax for the year ended June 30, 1936, plus interest and delinquent penalty. Petitioner’s excess profits tax, if any, should be computed upon a basis of $120,000 as the value of its capital stock on the basic date.

Respondent’s counsel points out in his brief that there were printed instructions from the Commissioner’s office which accompanied form 707, “1936 Return of Capital Stock Tax”, and if petitioner had carefully read and heeded them it would not have made the error which is now in question. Counsel for respondent is doubtless correct in this statement. Nevertheless, the error clearly was made and it appears to have been innocently made, and we think under section 105 (f) and article 31 of the regulations cited above the return filed July 21,1936, must be disregarded as a “first return.”

The Commissioner does not contend that there is any element of estoppel present in the facts of the instant case. He simply relies upon that provision in section 105 (f) of the statute which says that a first return, once filed by a taxpayer corporation, can not thereafter be amended. For reasons we have already stated, we do not think this provision of the statute is applicable to the facts of the instant case.

Reviewed by the Board.

Decision will be entered wider Bule 50.

Arnold dissents.

TtjRNee,

dissenting: I am unable to conclude, as the majority opinion apparently does, that the petitioner did not file a capital stock tax return until April 30, 1937, for its capital stock tax year ended June 30, 1936. Prior to that date and within the period prescribed by statute, it had filed a capital stock tax return for that capital stock tax year, and the fact that the first return filed was “erroneous” does not permit the construction that it was “incomplete” as that latter term is used in the regulations. Scaife & Sons Co. v. Driscoll, 94 Fed. (2d) 664. Compare William A. Webster Oo., 37 B. T. A. 800, and Glenn v. Oertel, 97 Fed. (2d) 495, for contrary views where the second return was filed within the period prescribed by the statute. For the reasons stated, I accordingly note my dissent.

Disney and Opper agree with this dissent.

       (a) For each year ending June 30, beginning with the year ending June 30, 1936, there is hereby imposed upon every domestic corporation with respect to carrying on or doing business for any part of such year an excise tax of $1 for each $1,000 of the adjusted declared value of its capital stock. [As amended by Sec. 401, 1936 Act.]

      (d) Every corporation liable for tax under this section shall make a return under oath within one month after the close of the year with respect to which such tax is imposed to the Collector for the District in which is located its principal place of business * * *. Such return shall contain such information and be made in such manner as the Commissioner with the approval of the Secretary may by regulations prescribe.

      (f) For the first year ending June 30 in respect of which a tax is imposed by this section upon any corporation, the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended), as of fhe close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section. * * *
      [Italics ours. ]

         Art. 31. Incomplete return. — In view of the finality of the value declared in the “first return under this section” as provided by section 105 (f), the filing of a tentative return of this tax by a corporation for the first year in which it is taxable under this Act is not permissible for any purpose. In the event a definite and unqualified value is not declared, or if a return form is incomplete to the extent that it is not in substantial compliance with the Act, the form will not be regarded as a proper return and therefore its filing will not preclude the application of penalties for a delinquent filing. [Italics ours.]
      Aet. 44. Original declared value. — (a) In its first return a corporation must declare a definite and unqualified value for its capital stock. “First return” means the first capital stock tax return filed by a corporation for its first taxable year under section 105. Extreme care should be exercised in making this original declared value, for the reason that if a return has been filed disclosing a declared value, such value cannot be changed, amended, or corrected, either by the corporation or by the Commissioner. A subsequent return declaring a different value, even though filed before the expiration of the prescribed period, is therefore not acceptable under the statute. The importance of the original declared value may be seen from the fact that such original declared value forms the basis for the computation of the tax on capital stock in years subsequent to the first taxable year, and constitutes a prime factor in determining the amount of tax imposed on excess profits under section 106 of the Revenue Act of 1935, as amended by section 402 of the Revenue Act of 1936. * * *


author: Hill: Leech, Disney,

text:
    Taylor Securities, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89499.
    Promulgated October 17, 1939.

      Randolph E. Paul, Esq., and Charles Mclmvis, Esq., for the petitioner.

      H. D. Thomas, Esq., for the respondent.
   OPINION.

Hill:

Every corporation subject to income taxation is required to make a return, stating specifically the items of its gross income and deductions and credits allowable. The returns of a corporation having no principal office or principal place of business in the United States are required to be filed with the collector at Baltimore, Maryland, and in the case of a foreign corporation which has no office or place of business in the United States and files its returns on the calendar year basis, the returns are to be filed on or before June 15 following the close of the calendar year. In case of failure to file the return within the time prescribed by law or by the Commissioner, which is not due to reasonable cause, an addition of 25 percent of the amount of the tax is imposed. Secs. 52, 53, 235, and 291, Revenue Acts of 1928, 1932, and 1934. Where a return is not made within the time prescribed by law or by regulation, the Commissioner is authorized to make such return from such knowledge as he has or from such information as he can obtain, and the return so made is prima facie good and sufficient for all legal purposes. Sec. 3176 of the Revised Statutes as amended. “Gross income” includes gains, profits, and income derived from sales or dealings in property, interest, and dividends. Allowable as deductions from gross income in computing the net income of a corporation are ordinary and necessary expenses paid or incurred in carrying on business or trade, interest paid or accrued during the taxable year except on indebtedness incurred to purchase or carry obligations the interest upon which is wholly exempt from the income tax, losses sustained during the taxable year and not compensated for by insurance or otherwise (subject to such limitations as are otherwise prescribed), and dividends received from domestic corporations. In the case of foreign corporations gross income includes only the gross income from sources within the United States and the deductions are allowable only as and to the extent that they are connected with income from sources within the United States. Secs. 22, 23, 232, and 233, Eevenue Acts of 1928,1932, and 1934.

Eespecting the allowance of deductions and credits in the case of foreign corporations, section 233 of the Eevenue Acts of 1928, 1932, and 1934 provides:

A foreign corporation shall receive the benefits of the deductions and credits allowed to it in this title only by filing or causing to be filed with the collector a true and accurate return of its total income received from all sources in the United States, in the manner prescribed in this title; including therein all the information which the Commissioner may deem necessary for the calculation of such deductions and credits.

The petitioner not having filed a return for any of the years 1930 through 1935, the respondent on March 23, 1937, consistent with the provisions of section 233 of the applicable acts, determined the deficiencies in controversy on the basis of the returns made by him. At that time the petitioner’s returns for those years were from approximately one to six years delinquent. The petitioner on June 16, 1937, filed with the Board its petition from the respondent’s determination. Thereafter in due course the respondent filed his answer. On December 13, 1938, and under the circumstances set out in our findings of fact the returns mentioned therein were filed by the petitioner.

The petitioner concedes that under the provisions of section 233, supra, no deductions or credits are allowable to a foreign corporation which does not file a return showing total income from all sources in the United States. However, it contends that as soon as such a return is filed, even though after its due date, the foreign corporation is entitled to the deductions and credits ordinarily allowed and urges that the returns filed by it for the respective years in controversy constitute a sufficient compliance with the provisions of said section to entitle it to such deductions and credits as it would have been entitled to if its returns had been timely filed, citing our decisions in Anglo-American Direct Tea Trading Co., Ltd., 38 B. T. A. 711, and Mills, Spence & Co., Ltd,, (not published), which followed our decision in the Anglo-American Co. case. The respondent makes no contention that the returns filed by petitioner were so deficient in the information contained therein as to bring them within our decision in Gladstone Co., Ltd., 35 B. T. A. 764, where it was held that the return in controversy failed to include “all the information which the Commissioner may deem necessary for the calculation of such deductions and credits” as required by section 233 of the Revenue Act of 1928. However, he does contend that such returns are ineffective to bring the petitioner within the ambit of the Board’s decisions relied on by it or to entitle it to the deductions and credits ordinarily allowed corporations.

Neither at the time the petition was filed in this proceeding nor at the time the answer was filed had any returns been filed by the petitioner. In neither the petition nor in the answer was any question presented as to the effect of the belated filing of returns on the allowance to the petitioner of the credits and deductions ordinarily allowable. On the contrary, in the statement of facts in the petition relied on by the petitioner in support of its assignments of error the petitioner specifically alleged that no returns had been filed by it for the years in controversy (which was admitted by respondent in his answer) for the reason that its officers and directors were unaware that it was required to file returns or to pay any tax for the respective years and further that they had been informed that the petitioner was not liable for a return or for any tax for said years (which was denied by the respondent in his answer). At no stage in the proceeding were the pleadings of either party amended to present any question respecting the effect on the respondent’s determination of the returns filed in December 1938. Under such circumstances the controversy between the parties respecting the effect of the filing of the returns does not represent an issue presented by the pleadings. However, assuming that the pleadings had been amended to present such an issue, we think it would have to be decided adversely to the petitioner.

In the Anglo-American Co. case, it was held that the phrase in section 233 of the Revenue Acts of 1928 and 1932, “in the manner prescribed in this title”, did not mean within the time prescribed in the titles of the respective acts and that the allowance of the credits and deductions otherwise allowable by such acts was not dependent under section 233 on the filing of returns within the time prescribed by said acts. Although in that case a revenue agent prepared certain returns for the taxpayer, they apparently were never submitted to or accepted by the Commissioner, since returns filed by the taxpayer with the collector three days later were the subject of an audit by the Commissioner and formed the basis of his determination of deficiencies. Under the circumstances thus presented we held that dividends received by the taxpayer from domestic corporations, reported in income and taken as deductions in the taxpayer’s returns, were allowable deductions in determining taxable net income. No such factual situation as existed in that case is presented here, nor did we there decide the question raised on argument here.

Here the question is whether the petitioner, by filing returns after the respondent made his determination of deficiencies under the circumstances presented, relieved itself of the adverse condition in which it was situated by reason of section 233 and is entitled to the benefits to which it would otherwise have been entitled by the timely filing of returns. In our opinion it may not.

While taxpayers may contest before the Board the correctness of the respondent’s determination of deficiencies predicated on returns prepared by him under section 3176 of the Revised Statutes, Fred Taylor, 36 B. T. A. 427; Joe Goldberg, 14 B. T. A. 465; Mrs. Carmen V. Green, 11 B. T. A. 184, any redetermination of such deficiencies must be made on the basis of evidence adduced as to facts existing at or prior to the time of the respondent’s determination and the law applicable thereto. The petitioner cites no provision of law or decision, nor are we aware of any, which authorizes a taxpayer, subsequent to the respondent’s determination, to enter upon a course of conduct which will materialize into the happening of a fact or set of facts that will operate in and of themselves to nullify the respondent’s determination. Such an authorization would reduce the administration of the tax laws to mere idle activity. In view of the foregoing we are unable to conclude that in enacting section 233, supra, it was the intention of Congress that delinquent returns filed by a foreign corporation after the respondent’s determination should constitute the returns required as a prerequisite to the allowance of the credits and deductions ordinarily allowable to the corporations. Aside from the provisions of section 233, supra, the allowance of deductions and credits is not a matter of right, but of legislative grace and statutory grant, and the taxpayer must bring himself strictly within the provisions of the statute to be entitled to them. Gladstone Co., Ltd., supra. By section 233 the allowance to foreign corporations of the credits and deductions ordinarily allowable is specifically predicated upon such corporations filing returns. In view of such a specific prerequisite it is inconceivable that Congress contemplated by that section that taxpayers could wait indefinitely to file returns and eventually when the respondent determined deficiencies against them they could then by filing returns obtain all the benefits to which they would have been entitled if their returns had been timely filed. Such a construction would put a premium on evasion, since a taxpayer would have nothing to lose by not filing a return as required by statute.

Being unable to find that tbe petitioner bas brought itself within the provisions of section 283 of the applicable acts, we conclude that it is not entitled to the deductions and credits that it would otherwise have been entitled to. Accordingly, we sustain the action of the respondent (1) in not allowing a deduction for any of the years in controversy for business expenses, (2) in not offsetting losses sustained on sales of securities in the United States against gains on similar transactions in determining the amount of the petitioner’s taxable income from such transactions for the years in controversy, and (3) in not allowing as a deduction for the respective taxable years dividends received by the petitioner from corporations organized in the United States. The deductions sought for business expenses are subject to the further infirmity that no evidence has been submitted to show that they are allowable.

At the hearing the respondent filed an amended answer, in which he admitted that in determining the gain from those sales of securities which resulted in gains he erroneously determined the amounts for 1934 and 1935 at $4,425.38 and $16,165, respectively, whereas the correct amounts were $3,136.42 and $10,132.51, respectively. Also, in his amended answer he alleged with respect to the gains from such sales that the correct amounts were, for 1930, $10,732.86; 1931, $117.65; 1932, $515.02; and 1933, $8,396.61; instead of the amounts determined by him, and that the correct amount of dividends received by the petitioner in 1934 was $2,885 instead of $2,610 used in making his determination, and moved for an increase in the deficiencies for the respective years. Since the evidence sustains the respondent’s allegations, the motion is granted. In a recomputation of the deficiencies the correct amounts of such gains and dividends will be included in taxable income instead of those determined by the respondent and the deficiencies will be increased or reduced accordingly.

Although in its petition the petitioner assigns as error the respondent’s determination that it was liable for excess profits tax for 1933 through 1935 and for surtax for 1934 and 1935, no evidence was submitted on these matters nor is any argument made on brief with respect to them. We therefore conclude that the petitioner has abandoned them and accordingly sustain the respondent’s action.

Where a taxpayer fails to file a return the imposition of the 25 percent penalty is mandatory. Fidelity & Columbia Trust Co. v. Commissioner, 90 Fed. (2d) 219; certiorari denied, 302 U. S. 723; John Ernest Goldring, 36 B. T. A. 779. “It does not matter why he failed to file a return.” Harry D. Kremer, 31 B. T. A. 566. Having concluded that the returns filed by the petitioner were insufficient to relieve it of the effect of the respondent’s denial under section 233 of credits and deductions which are ordinarily allowable, we are of the opinion that the returns are insufficient to relieve it of the mandatory operation of the statutory provisions imposing a 25 percent penalty. Assuming that we are mistaken in this and that the returns are to be considered merely as delinquent returns, the position of the petitioner is not improved. It has furnished no evidence as to why the returns were delinquent, and therefore we have no basis for determining whether there was reasonable cause for the delinquency which would relieve it of the penalty. The determination of the respondent, therefore, must be sustained.

Reviewed by the Board.

Decision will be entered wider Bule 50.

Aettndell, Smith, and Black dissent.

Leech,

concurring: I concur with the conclusion of the Board that respondent was correct in disallowing the contested deduction, solely on the ground that the validity of the purported amended delinquent returns is not raised by the pleadings.

Disney,

concurring: I concur only in the result reached by the majority opinion. I think that the returns filed by the petitioner after petition was filed with the Board and after the proceeding had been set for hearing and continued, without amendment of the petition which was based upon the fact of no returns filed, should not have been considered by the Board. No attempt was made even to amend to conform to proof. The returns, were admitted in evidence over objection, so such amendment if asked should not have been granted. A fair respect for the reasons which form the basis for orderly pleading forbids that returns filed after the pleadings are settled should be regarded as evidence. Anglo-American Direct Tea Trading Co., Ltd., 38 B. T. A. 711, did not present the present question, for there the returns were filed prior to deficiency determined and shortly after filing of returns by the Commissioner. I think the filing of a return “in the manner prescribed in this title” under section 233 of the Revenue Acts herein applicable must be considered in connection with those provisions of the same acts providing for adjudication by the Board of Tax Appeals of the matters arising from the returns and deficiencies determined, and that the Board, in adherence to sound rules of evidence and trial procedure, which make for justice, should not consider returns filed during the pendency of proceedings filed before it in accordance with statute.


author:
Hill:
      Leech,

text:
    Patrick McGovern, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91846.
    Promulgated October 17, 1939.

      J. Marvin Haynes, Esq., Harry 8. Bamdler, Esq., and Oonrad B. Taylor, G. P. A., for the petitioner.

      D. Hurd Hudson, Esq., and L. O. Mitchell, Esq., for the respondent.
   OPINION.

Hill:

The petitioner contends that the New York State franchise tax and the Federal capital stock tax incurred by it during the years 1931 through. 1934 are of such a character as to be properly allocable to the water tunnel contract and that under the completed contract basis of reporting income are allowable deductions in determining the net income from the contract when completed in 1935. The respondent takes the position that said taxes are not properly allo-cable to any one or more particular activities of the petitioner, but, having been incurred and accrued in the years 1931 through 1934, respectively, they constituted proper deductions for the respective years in which incurred and therefore are not allowable deductions in determining the net income from the contract on the completed contract basis. There is no controversy between the parties as to the right of the petitioner to report the income from the water tunnel contract on the completed contract basis in 1935. Nor is there any controversy as to the New York State franchise tax and Federal ¡capital stock tax constituting deductible items by petitioner. The controversy is as to the year or years in which such items were deductible.

The completed contract method of reporting income is a modification of the strict accrual method and differs from it in that items of income and expense, though recorded in primary accounts when accrued or incurred, are not carried into profit and loss as earnings of the business until the contract to which they relate is completed. A separate account is kept for each contract. Any debit balance in the account represents the investment in the contract and any credit balance represents unearned income until the contract’s completion. A characteristic of the method is that income earned in one accounting period may not be accounted for until a later period. Fort Pitt Bridge Works, 24 B. T. A. 626; affirmed on this point, 92 Fed. (2d) 825; certiorari denied, 303 U. S. 659.

The New York State franchise tax was for the respective fiscal years begun on November 1, 1931, 1932, 1933, and 1934, and was accruable by petitioner in its calendar years during which said fiscal years began, even though the tax was not required to be paid until as late as January 1 following the close of the calendar years. Par. 209 of the Tax Law of the State of New York; Jamestown Worsted Mills, 1 B. T. A. 659; Kossar & Co., 16 B. T. A. 952; petition for review dismissed by the Circuit Court of Appeals for the Second Circuit, April 2,1932. The capital stock tax for the year ended June 30, 1933, was accruable by petitioner on, June 16, 1933, the date of the enactment of the National Industrial Kecovery Act, which by section 215 imposed the tax. The capital stock tax imposed by the National Industrial Kecovery Act for the year ended June! 30, 1934, was ac-cruable by petitioner on July 1, 1933. Cf. I. T. 2726, C. B. XII-2, p. 42. On May 10, 1934, the Revenue Act of 1934 was enacted. Section 703 (d) of that act amended the National Industrial Kecovery Act so as to provide that the capital stock tax imposed by section 215 thereof should not apply to any taxpayer in respect of any year except the year ended June 30, 1933, thereby extinguishing all liability of petitioner for capital stock tax for the year ended June 30,1934, under the National Industrial Kecovery Act. Cf. I. T. 2827, C. B. XIII-2, p. 130. The provisions of section 701 of the Revenue Act of 1934 imposed a capital stock tax for the year ended June 30, 1934, and for subsequent years. Under those provisions the capital stock tax for the year ended June 30, 1934, was accruable by petitioner on May 10, 1934, and the capital stock tax for the year ended June 30, 1935, was accruable on July 1, 1934. Cf. G. C. M. 13681, C. B. XIV-1, p. 58; G. C. M. 17340, C. B. XV-2, p. 81.

Article 42-4 of Regulations 86, pertaining to the Revenue Act of 1934, provides as follows:

Long-Term. Contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used! herein the term “long-term contracts” means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon either of the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion'. In such case there should accompany the return certificates of architects or engineers showing the percentage of completion during the taxable year of the entire work to be performed under the contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If, upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return.
(b) Gross income may be reported for tbe taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.

Were the New York State franchise tax and the Federal capital stock tax in controversy properly allocable to the water tunnel contract? The respondent has determined that they were not and the burden is upon the petitioner to show that such determination is erroneous. The New York State franchise tax was imposed on petitioner for the privilege of exercising its franchise in that state in a corporate or organized capacity and the Federal capital stock tax was imposed with respect to carrying on or doing business. The petitioner takes the position that the only business it was carrying on from 1931 through 1935 was the completion of the water tunnel contract and that therefore the taxes were allocable in their entirety to that contract under the foregoing regulations. The respondent contends that, since the New York State franchise tax was computed upon the basis of petitioner’s entire net income as reported in its Federal income tax returns for the respective preceding years plus certain other income from its large holdings of securities which was nontaxable income in petitioner’s Federal income tax returns, and since the petitioner had dealings in substantial volume in securities the ownership of which was not essential to the completion of the water tunnel contract, no portion of either the New York State franchise tax or the Federal capital stock tax is properly allocable to the water tunnel contract. Since the New York State franchise tax was imposed for the privilege of petitioner’s exercising its franchise in that state, we think it is immaterial that the amount of that tax should be computed on or measured by income, either taxable or nontaxable, in petitioner’s Federal income tax returns that did not relate to the water tunnel contract. Respondent does not contend that such tax was an income tax.

The evidence shows that if petitioner had not entered into the water tunnel contract and had had no other business, but had continued to exist and exercise its franchise in the handling of its securities and the collection of the income therefrom during the years 1931 through 1935, it would have paid the same franchise tax that it did pay. The petitioner’s practice in deducting New York State franchise tax in its Federal income tax returns has not been consistent. In its returns for 1928 and 1929, when it was reporting income on the completed contract basis, as in later years it took deductions for the franchise tax but reported no income from completed contracts. The evidence further shows that at the end of 1930 there was outstanding against the petitioner a large number of property damage claims which had arisen from the construction of the subway, which was completed in that year, and that the disposition of those claims required a great deal of time, effort, and expense in later years. The evidence further indicates that possibly some of the claims are still pending. In addition, the petitioner’s Federal income tax returns for the years 1931 through 1935 show that it took deductions during that period totaling approximately $100,000 as costs of contracts completed in prior years. What portion, if any, of such amount represented payments in settlement of subway damage claims we do not know. It may well be that such expenditures were made for repairs to and the servicing of construction jobs which it had done in years prior to 1931 and for which it was liable under the contracts for those jobs.

At the end of the indicated years the petitioner owned Federal, state, municipal, and corporate securities as follows, of which the indicated amounts were on deposit with the New York City and/or with the State of New York in connection with the percentages re-tainable by the city under contracts and/or in connection with the petitioner’s self-insurance under the Workmen’s Compensation Law of New York State, and from which petitioner received income as indicated:

The petitioner points to the fact that the completion of the tunnel was a large, hazardous undertaking and contends that this made it necessary that it have substantial financial reserves and further that the requirements respecting its self-insurance and obtaining payment of the retainable percentage of current monthly estimates made necessary the deposit of substantial amounts of securities. It urges that its securities were only working capital used in the performance of the water tunnel contract and that their handling and management did not constitute a business activity separate and apart from the performance of the water tunnel contract. The amount of the securities on deposit with the city and with the State of New York was only a fractional part, ranging from approximately one-fifth to one-third, of those owned by petitioner at the end of the respective years 1930 through 1935. So far as the record shows, the deposit of securities was not necessary to the performance of the water tunnel contract, but, by making deposit of them as it did, petitioner was enabled to receive the interest on substantial sums of money which otherwise would have been tied up on the contract, with no interest receivable therefrom. While the evidence shows that in 1932 the city was having difficulty in selling its bonds and was not able currently to make payment of the monthly estimates, thus making it necessary that the petitioner use other of its funds in the carrying out of the contract, that fact does not appear to have affected the amount of petitioner’s security holdings. Between the end of 1931 and 1932 those holdings decreased by $5,435,424, which was approximately $640,000 less than the amount distributed by petitioner to its stockholders during that time. Furthermore, between the end of 1932 and the end of 1933 the petitioner’s holdings of securities increased approximately $375,000. The balance sheets accompanying petitioner’s Federal income tax returns for the years 1930 through 1934 show that at the end of all years during that period petitioner’s holdings of Federal, state, municipal and corporate securities were well in excess of one-half of its total assets and at the end of 1931 such holdings were in excess of two-thirds of its total assets. While we are not informed as to the various activities that petitioner’s charter authorized it to engage in, the evidence would indicate that the purchase, sale, and holding of securities and the receiving of the income therefrom must have been one. In view of this and of the petitioner’s activities with respect to other prior contracts, we do not think that the petitioner has established that the only business it was engaged in from 1931 through 1934 was the performance of the water tunnel contract. Pertinent to the situation here is the following statement from Argonaut Consolidated Mining Co. v. Anderson, 52 Fed. (2d) 55:

Just what activities bring a corporation within the statutory definition the decisions, as is almost inevitable, do not certainly declare. That there is a degree of quietude which will exempt it, is indeed well settled (Zonna v. Minneapolis Syndicate, 220 U. S. 187, 31 S. Ct. 361, 55 L. Ed. 428; McCoach v. Minehill, etc. Co. 228 U. S. 295, 33 S. Ct. 419, 57 L. Ed. 842; U. S. v. Emery, etc. Co., 237 U. S. 28, 35 S. Ct. 499, 59 L. Ed. 825; Eaton v. Phoenix Securities Co., 22 E. (2d) 497, (CCA 2); Rose v. Nunnally Co., 22 F. (2d) 102 (CCA 3)) ; but how far it may be active and still maintain its exemption, is in the nature of things impossible of statement in general terms. In most of those cases in which the corporation has succeeded its activities have been confined to holding the title of property, whose usufruct it receives and distributes in dividends. When this is the whole scope of its dealings, it does no business within the meaning of the statute.
However, it takes little to bring it from behind this shield. * * *

In Harmar Coal Co. v. Heiner, 34 Fed. (2d) 725, the test was stated as follows:

* * * when a corporation is organized for one definite purpose, the ultimate object of which is profits, and it engages in the business of effectuating that purpose and then stops the business by reason of sale, lease, or other action, and thereafter simply hangs on, in a corporate sense, receiving and distributing the avails of its re-organized affairs, it is not doing business. On the other hand a corporation, organized for a definite though limited business purpose involving profits, that pursues activities to carry out that purpose, no matter how few or small they may be, is carrying on or doing business within the meaning of the statute. * * *

Since the petitioner has not shown that its only business during the years 1931 through 1934 was the performance of the water tunnel contract and since the New York State franchise tax and Federal capital stock tax in controversy related to all of petitioner’s activities and not solely to its work on the water tunnel, the entire amount of such taxes is not properly allocable to the water tunnel contract. These taxes having accrued in years prior to 1935, only such portion of them as is allocable to the water tunnel contract may be brought forward and deducted in 1935. The portion allocable to petitioner’s remaining activities, however, may not be so brought forward. Cf. Norton Construction Co., 21 B. T. A. 443.

Apparently for the purpose of showing how, in accordance with good accounting practice, the franchise and the capital stock taxes in controversy should be allocated, if it should be determined that petitioner’s work on the water tunnel during 1931 through 1934 did not constitute its sole business activity, the petitioner submitted the opinion testimony of two reputable certified public accountants. In substance their testimony is that where a corporation is engaged in two types of business activity, the franchise and the capital stock taxes paid by it should be apportioned between the kinds of business activity on the basis of the proportion that the net income resulting from each activity bears to the total net income from both activities. On the record before us we think such a method of apportioning the franchise and the capital stock taxes in controversy between the water tunnel contract, on the one hand, and the petitioner’s other activities on the other, is fair and reasonable and properly applicable here. We hold, therefore, that there should be such apportionment.

The remaining issue is) as to the correctness of the respondent’s action in determining the excess profits tax exemption to which petitioner was entitled at $200,802.68, or 12% percent of $1,606,421.47, the value declared by petitioner for its capital stock in its capital stock tax return for the year ended June 30, 1935. The petitioner’s position is that, since in its 1935 Federal income tax return iti reported the entire income from the water tunnel contract earned over the seven-year period from 1929 to 1935, its excess profits tax exemption for 1935 likewise should be determined on the value of its capital stock for the seven-year period. By multiplying $8,000,000, the value declared for its capital stock in its capital stock tax returns for the years ended June 30, 1933 and 1934, by seven, representing the number of years involved in completing the contract, from that product subtracting $6,496,000, representing the distributions in liquidation made in 1934, and taking 12% percent of the remainder, the petitioner computes the excess profits tax exemption at the amount of $6,188,000, which it contends is the proper amount.

Respecting capital stock and excess profits taxes, the Revenue Act of 1934 provides as follows:

SEC. 701. CAPITAL STOCK TAX.
(a) For each year ending June 30, beginning with the year ending June 30, 1934, there is hereby imposed upon every domestic corporation with respect to carrying on or doing business for any part of such year an excise tax of $1 for each $1,000 of the adjusted declared value of its capital stock.
(f) For the first year ending June 30 in respect of which a tax is imposed by this section upon any corporation, the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value cannot be amended), as of the close of its last income-tax taxable year ending at or prior to thei close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income-tax; taxable year ending at or prior to the close of the year for which the tax is imposed by this section). For any subsequent year ending June 30, the adjusted declared value in the case of a domestic corporation shall be the original declared value plus (1) the cash and fair market value of property paid in for stock or shares, (2) paid in surplus and contributions to capital, (3) its net income, (4) the excess of its income wholly exempt from the taxes imposed by Title I over the amount disallowed as a deduction by section 24 (a) (5) of such title, and (5) the amount of the dividend deduction allowable for income tax purposes, and minus (A) the value of property distributed in liquidation to shareholders, (B) distributions of earnings or profits, and (C) the excess of the deductions allowable for income tax purposes over its gross income, adjustment being made for each income-tax taxable year included in the period from the date as of which the original declared value was declared to the close of its last income-tax taxable year ending at or prior to the close of the year for, which the tax is imposed by this section. The amount of such adjustment for each such year shall be computed (on the basis of a separate return) according to the income tax law applicable to such year. * * *
SEC. 702. EXCESS-PROFITS TAX.
(a) There is hereby imposed upon the net income of every corporation, for each income-tax taxable year ending after the close of the first year in respect of which it is taxable under section 701, an excess-profits tax equivalent to 5 per centum of such portion of its net income for such income-tax taxable year as is in excess of 12% per centum of the adjusted declared value of its capital stock * * * as of the close of the preceding income-tax taxable year (or as of the date of organization if it had no preceding income-tax taxable year) determined as provided in section 701. If the income-tax taxable year in respect of which the tax under this section is imposed is a period of less than 12 months, such adjusted declared value shall be reduced to an amount which hears the same ratio thereto as the number of months in the period bears to 12 months. For the purposes of this section the net income shall be the same as the net income for income tax purposes for the year in respect of which the tax under this section is imposed.
(b) All provisions of law (including penalties) applicable in respect of the taxes imposed by Title I of this Act, shall, insofar as not inconsistent with this section, be applicable in respect of the tax imposed by this section, except that the provisions of section 131 of that title shall not be applicable.

The petitioner argues that if the capital of a corporation reporting income for a period of less than 12 months is to be reduced to an amount which bears the same ratio thereto as the number of months in the period bears to 12 months, as provided in section 702 (a), then the capital in the case of a corporation reporting income earned over a period greater than 12 months is to be increased in a corresponding ratio. Although the act contains no specific provision which upholds the petitioner’s conclusion, it urges that such was the intention of Congress and points to certain statements contained in the report of the Committee on Finance of the Senate (Senate Keport No. 558) in reporting the Bevenue Act of 1934 to the Senate and in the Conference Beport (No. 1385) to the House on the act, to the effect that the primary purpose of the excess profits tax was to induce corporations automatically to declare a fair value for their corporate stock for capital stock tax purposes and the secondary purpose was to subject to a somewhat higher rate of tax abnormal profits which are out of proportion to the capital of the corporation. Conceding that such were the purposes of Congress in enacting the excess profits tax provisions of the act, we are unable to find anything in such statements or in the act itself indicating that to effect those purposes it was the intention of Congress to go to such a length as the petitioner requests here and pyramid capital stock values for a period of seven years. While in section 702 (a) Congress definitely has provided that, in cases where the income tax taxable year in respect of which the excess profits tax is imposed is a period of less than 12 months, the declared value of the capital stock shall be reduced to the proportion that the number of months in such taxable period bears to 12 months, it has failed to provide that the capital is to be increased in a corresponding ratio in cases where the. income reported was earned over a period greater than 12 months. Congress having failed to make such provision in the act, we are without authority to supply the omission, graft on something that is not there, and allow the petitioner’s contention. Iselin v. United States, 270 U. S. 245; Smietanka v. First Trust & Savings Bank, 257 U. S. 602.

The petitioner urges that, if we find that the act does not authorize the allowance of its contention, then we must find that the act is unconstitutional as being violative of the Fifth Amendment, because it imposes a tax that is arbitrary, unreasonable, and capricious. For reasons satisfactory to itself the petitioner at the beginning of its existence elected to report its income from long term contracts on the completed contract basis. Under that method no income received from such contracts was reported and taxed until the completion of the contracts even though, as in the case of the water tunnel contract, several years elapsed between receipt of a substantial portion of the income from the contract and the year in which such income was subjected to tax. Conceivably the receipt and use of such income for several years prior to its taxation might be an advantage enjoyed by petitioner over other taxpayers who were currently reporting income from long term contracts as accrued or received. It may well be that it was for this reason that Congress failed to provide that the excess profits tax exemption in the case of corporations reporting income on the completed contract basis should be computed on the pyramided capital of such corporations during the period they were engaged on the long term contracts. The distributions in liquidation made by petitioner in 1984, the year prior to the completion of the contract and the reporting of the income therefrom, contributed very materially to the reduction of petitioner’s capital, thereby reducing the excess profits tax exemption and consequently increasing the amount of its excess profits tax in 1985. Where a taxpayer voluntarily chooses his own course of action, he may not thereafter avoid its results. Cf. Pacific National Co. v. Welch, 304 U. S. 191; Chicago Telephone Supply Co. v. United States, 23 Fed. Supp. 471; certiorari denied, 305 U. S. 628.

We fail to see that the act, by providing that the amount of the petitioner’s excess profits tax exemption be computed in the manner employed herein by the respondent, results in an arbitrary and capricious confiscation of the petitioner’s property or is otherwise in violation of the Fifth Amendment.

Finding no error in the respondent’s determination of the amount of petitioner’s excess profits tax exemption, his determination of such exemption is approved. However, our decision as to the deductibility of an allocable portion of the New York State, franchise tax and the Federal capital stock tax will result in a reduction of the amounts of the deficiencies determined by respondent as to both the income tax and the excess profits tax.

Reviewed by the Board.

Decision will he entered under Rule 50.

Sternhagen dissents.

Leech,

dissenting on the first issue: It seems to me petitioner has established that the only business in which it was engaged from 1931 through 1931 was the performance of the water tunnel contract. Therefore, I think, the state franchise tax and Federal capital stock tax, for such years, are allocable, in their entirety, to 1935, the year in which the water tunnel long term contract was completed.


author: Kern:

text:
    Austin Leigh Claiborne, John L. Claiborne, and Jay C. Allen, Executors of the Last Will and Testament of Laura Allen, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89703.
    Promulgated October 18, 1939.

      Jay O. Allen, Esq., and Edgar B. Bombauer, Esq., for the petitioners.

      Edward G. Adams, Esq., for the respondent.
   OPINION.

Kern:

1. The first and primary question involved is whether the respondent erred in allocating to the estate two-thirds of the aggregate of all property of both spouses. The respondent’s argument, briefly put, is that the decedent declared in her will that “Mr, Allen has no community interest in my property”; that decedent was engaged for years in real estate deals and through her own efforts and earnings amassed the property in question; that Allen’s capital contributions are unknown but if assumed to be equal with those of his wife, her contributions in personal services would offset this advantage, and that the same would be true even if his capital contributions were greater than decedent’s; that in these circumstances for the respondent to have followed decedent’s will and have treated all the property as her separate property would not have been unreasonable, and by so much the more was the action equitable which he did take, of treating only two-thirds of the property as decedent’s in accordance with the terms of the agreement between Allen and decedent’s two sons which took the place of the will; and, finally, regardless of whether the petitioner should have been satisfied or not, the respondent’s determination has a statutory presumptive correctness which petitioner has not overcome.

We are unable to accept this reasoning. The evidence is clear that the only separate property of decedent which she held before her marriage to petitioner and still held at death was the lot at Second and Pine Streets; that, of the money owned by decedent prior to her marriage, $100,000 was invested by her in worthless second mortgages and wholly lost; and that most of the money which went into the purchase of the realty left at death came from the $154,000 received on the sale of certain tidelands to the Ames Terminal & Dry Dock Co., from decedent’s gains on later sales, and/or from petitioner’s capital contributions. Now the amount of the capital contributions made by petitioner has not been clearly established, but he is shown to have made as a lawyer from $25,000 to $40,000 a year and to have contributed a large part of this to his wife’s investment account. The checks put in evidence show a contribution of over $66,000, and had it not been for the destruction of his records he doubtless could have shown a much greater contribution. That, of course, is speculation, but the evidence on why the records were destroyed by his wife as well as why she drew a will seeking to deprive him of his interest in the marital community property is uncontroverted. In any event, whatever the source of the money with which the “investment account” was started, and whatever the amount of each spouse’s contribution thereafter, the facts are clear that both made substantial contributions to this account and treated it throughout as a fund held in common. Most significant of all, we have the evidence of how the two spouses regarded the property in question, in the income tax returns filed by them from 1923 to 1932, inclusive: all the property except the “2nd and Pine” lot was returned as the property of the marital community. It is reasonable, therefore, to conclude that all such property was the property of the marital community, and that decedent’s acts in throwing a cloud over this fact in her will moved from a combination of reasons, the strongest of which were the momentary spitefulness of an often sick, nervous, and jealous woman against her husband and her fear that the manner in which the joint enterprise had been conducted, with its inextricable intermingling of the funds of the two spouses, would deprive her two sons of the interest which she wished to leave them. The decedent’s description of certain property in her will as her separate property is obviously not binding on us. Commissioner v. Burke, 62 Fed. (2d) 7, 12. The resulting agreement between petitioner and the two sons, which obviously in its apportionment of property interests has no bearing on the question before us, recognized clearly, it seems to us, these motives and fears and sought to reach a solution which, if not strictly just on the basis of legal rights, was at least equitable, considering petitioner’s advanced age and needs.

Our conclusion, therefore, apart from any question of legal presumptions, would be that the petitioners have overcome the presumptive correctness of respondent’s determination and have sustained the burden of proof on them of showing that the property in question was that of the marital community. When we appeal to the local law, we find that it raises presumptions which fortify this conclusion.

The relevant sections of the Washington statutes, Remington’s Compiled Statutes of Washington (1922), vol. 2, are set out in the margin. The property here was admittedly acquired after marriage. The decisions of the Washington Supreme Court, it appears, treat the earnings of the wife while living with her husband as community property, Abbott v. Wetherby, 6 Wash. 507; 83 Pac. 1020; and raise a definite presumption, in the absence of countervailing evidence of a convincing character, that property acquired by either spouse during coverture is that of the marital community. Rawlings v. Heal, 111 Wash. 218; 190 Pac. 237; Seaton v. Smith, 186 Wash. 447, 456; 58 Pac. (2d) 830. Under the law of Washington, had all the property been contributed during coverture by the husband, the wife would nevertheless have acquired a one-half interest in it; and the same would be true as to the husband had all the contributions been made by the wife. We can see no reason to adopt a different rule where the two spouses both contributed to build up a common estate, or to speculate on how much either contributed, as respondent does, apparently forgetting that the marital community rule’s very object is to put an end to all such speculations. Eespondent refers to an earlier decision of this Board in Laura Allen, 14 B. T. A. 223 (1928), saying that in that case decedent “successfully resisted efforts to include one-half the community income in her separate return for 1924.” In that case we held on the authority of United States v. Robbins, 269 U. S. 315, that all of the community income, which had been returned by the husband as such together with the income from his separate property, was, because of the power of control over it given him by statute, properly taxable to him, and not as respondent contended, one-half to the decedent. We are unable to see any bearing which that decision has on, the present question beyond the recognition which the spouses themselves gave, already adverted to, to the existence of a substantial community estate.

Respondent also relies on the decision of the Circuit Court of Appeals for the Ninth Circuit affirming this Board, 30 B. T. A. 1265, in Shea v. Commissioner, 81 Fed. (2d) 937, for the proposition that the presumptive correctness of the respondent’s determination can not be overcome by any presumption of state law. In that case, the court after setting forth the presumptions of California law upon which the taxpayer relied, continued as follows, at page 939:

These four propositions are thoroughly established as the law of California by its statutes and by the decisions of its courts. They are not applicable here, however, for the reason that the source of the income derived by the taxpayer is definitely ascertained to have been in large part the income derived from his separate property. The income derived from this capital investment is taxable to the husband as his income. The presumption that it is community property acquired after July 29, 1927, so far as applicable in a tax case, has been overcome.

It will be seen, therefore, that the fact that the husband had separate property which was the source of income to him was there “definitely ascertained.” The court went on to point out that, where the existence of such separate property had been factually determined, the fact that its precise amount could not be ascertained would not justify this Board or itself in indulging the presumption of state law that all income was therefore community income, and the Commissioner’s segregation of separate and community income must, therefore, be overcome, by positive proof and, lacking such proof, must stand. To state these propositions is sufficient to show that they have no application here, where the separately held land still retained at death was proved, and where any capital gain originally derived from the conversion of other property held separately at marriage had long since been merged in a community investment which was regularly treated by both parties as community property for 10 years preceding the decedent’s death.

In these circumstances, we are of the opinion that the property in question was the property of the marital community, and that only one-half of it, therefore, was properly includable in the decedent’s gross estate.

2. Deductions for taxes. — Decedent died on January 21, 1934. Be-spondent contends that the lien of taxes on decedent’s land did not attach until the first Monday in February 1934, that is to say, after her death, and consequently was not a burden on her estate at the moment of death and subject to deduction from the gross estate.

The applicable statutory provision is as follows (Remington’s Compiled Statutes of Washington, 1922) :

§ 11272. [9235.] Lien, When Attaches.
The taxes assessed upon real property shall be a lien thereon from and including the first d'ay of March in the year in which they are levied until the same are paid, but as between a grantor and grantee such lien shall not attach until the first Monday of February of the succeeding year. The taxes assessed upon personal property shall be a lien upon all the real and personal property of the person assessed, from and after the date upon which such assessment is made, and no sale or transfer of either real or personal property shall in any way affect the lien for such taxes upon such property.

§ 11267 constitutes “all taxes and levies” “lawfully imposed or assessed” a lien on the real estate on which imposed or assessed, and gives the lien priority against all mortgages, judgments, debts or obligations. By § 1366, Remington’s Compiled Statutes, title to real property of a deceased person vests in the heirs or devisees immediately upon the death. By section 303 of the Revenue Act of 1926, as amended by section 805 of the Revenue Act of 1932, the amount of state property taxes paid or payable is included by implication as a deduction allowable under “claims against the estate”, and by Treasury Regulations 80 (1934 Ed.), article 37, “The deduction for property taxes is limited to such taxes as accrued prior to the date of decedent’s death.”

Petitioner relies on certain decisions of this Board which have since been distinguished as inapplicable to the present circumstances in Theodore Plestcheeff, 35 B. T. A. 508; affirmed in Commissioner v. Plestcheeff, 100 Fed. (2d) 62 (C. C. A., 9th Cir., Nov. 18, 1938). We think that that case is conclusive here and resolves the question in respondent’s favor. There the taxpayer had received certain realty by devise on April 5, 1931, and we held that the lien for taxes assessed for 1931 did not attach until October of that year. We there said (p. 512):

In Puget Sound, Power & Light Co. v. City of Seattle, 201 Pac. 449, 451, referring to State of Washington v. Snohomish County, 71 Wash. 320, the Supreme Court of Washington again emphasized the principles of that case by referring to it as follows:
* * * It was pointed out that in giving a lien for a real estate tax the statute contemplates a levy as well as an assessment, while as to personal property only an assessment is required; and it was decided that as the levy had not been made at the time of the purchase the estate took the real property free of any lien for taxes. * * *
The question for our determination therefore is the basic date for tax incidence in the State of Washington.
In our opinion, the taxes assessed on real estate for the year 1931 did not. under the statutes of Washington as construed by its courts, attach and become a perfected lien on said realty prior to October 1931, in which month the tax levy is made in that state.

The Circuit Court of Appeals for the Ninth Circuit reached the same result, but rested its decision on the narrower ground that the case fell within the express provision of § 11272, supra, dealing with the situation of grantor and grantee. The instant case, it will be seen, does not fall within the Board’s decision, but clearly falls within the decision of the Circuit Court, which held that the Washington courts had construed “grantee” to include a devisee, such as was there involved, and consequently “As thus construed, we think the lien did not attach until the February after respondents acquired the property, and they are entitled to the deduction.” The assumption was made by the Circuit Court in that case that the lien would have attached on March 1 (before the testator’s death) but for the statutory provision postponing that attachment between grantor and grantee, and the Commissioner apparently adopts the same view, see G-. C. M. 21373, so that that case in all respects covers the situation here, and is binding upon us.

In these circumstances, we think that the deduction for all land taxes for 1933 should be denied, and do not consider, therefore, what decision, on a contrary view, would be proper in respect of the deductions claimed for taxes on the so-called Curtis block and the Sorrento Hotel. It would seem that the vesting of the realty in the devisees, with its consequent tax burden, was not suspended, as petitioner contends, by the decedent’s provision in her will postponing distribution of her estate (see § 1366, cited above), and even if we are wrong about this, such a postponement would not create a tax burden existing before the decedent’s death, and such alone under the statute may be deducted.

As to the $626.36 for 1933 taxes on personal property, the Sorrento Hotel furniture and fixtures, respondent points out that this was no longer the property of decedent at the time of death. Since the lien for taxes on personalty attaches on assessment on all personalty and realty of the taxpayer, § 11272, Bemington’s Compiled Statutes, quoted above, a different result would be necessary here. We agree with respondent, however, that, since we have held the property to have been community property, the principle of Lang’s Estate v. Commissioner, 97 Fed. (2d) 867; cf. Lang v. Commissioner, 304 U. S. 264; would apply, and only one-half of this sum would be deductible.

3. Executors’ fees and attorneys'1 fees. — Bespondent makes no objection to the amount of these fees. His only objection appears to be that the executors’ fees would be paid to the heirs of the estate, and that consequently “there are no adverse .interests.” Granted that the fixing of the fees would in the circumstances not he an arm’s length transaction, we think that' this objection would go only to the reasonableness of the amount of the fees, and, since coneededly that is reasonable and the managing executor stated under oath that he would pay them in full, we can see no reason to disallow them. The same applies to the attorneys’ fees, with added force, since Jay C. Allen’s former and present law partners also have an interest in them.

We hold that the executors’ and attorneys’ fees claimed should be allowed in one-half the amount claimed, under the principle of the decision of the Circuit Court of Appeals for the Ninth Circuit in Lang’s Estate v. Commissioner, supra.

Decision will he entered under Bule 50.

       § 6890. [5916.] Separate Property of Husband.
      Property and pecuniary rights owned by ,the husband before marriage, and that acquired by him afterward by gift, bequest, devise or descent, with the rents, issues, and profits thereof, shall not be subject to the debts or contracts of his wife, and he may manage, lease, sell, convey, encumber, or devise, by will, such property without the wife joining in such management, alienation, or encumbrance, as fully and to the same effect as though he were unmarried.
      § 6891. [5916.] Separate Property of Wife.
      The property and pecuniary rights of every married woman at the time of her marriage or afterward acquired by gift, devise, or inheritance with ¡the rents, issues, and profits thereof, shall not be subject to the debts or contracts of her husband, and she may manage, lease, sell, convey, encumber or devise by will such property, to the same extent and in the same manner that her husband can, property belonging to him.
      § 6892. [5917.] Community Property Defined — Husband’s Control of Personalty.
      Property, not acquired or owned as prescribed in the next two preceding sections, acquired after marriage by either husband or wife, or both, is community property. The husband shall have the management and control of community personal property, with a like power of disposition as he has of his separate personal property, except he shall not devise by will more than one-half thereof.
      § 6895 [5920.] Separate Earnings of wife, etc.
      A wife may receive the wages of her personal labor, and maintain an action therefor in her own name, and hold the same in her own right, and she may prosecute and defend all actions at law for the preservation and protection of her rights and property as if unmarried.
      § 6896. [5921.] Earnings of Wife and Minor Children.
      The earnings and accumulations of the wife and of her minor children living with her, or in her custody while she is living separate from her husband, are the separate property of the wife.