author: Yan Fossan: McMahon,

text:
    Richmond, Fredericksburg & Potomac Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68876.
    Promulgated January 9, 1936.

      E. Rmdolph Williams, Esq., and Leland L. Miller, Esq., lor the petitioner.

      E. G. Algire, Esq., for the respondent.
   opinion.

Yan Fossan:

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1929 in the sum of $11,220.59.

Two questions are at issue:

(1) The deductibility as interest of certain payments on “ guaranteed stock ” secured by first mortgage.

(2) The proper amount of retirement loss on certain roadway and structures.

The petitioner was incorporated by an act of the General Assembly of Virginia on February 5, 1834.

During the year 1929, 7 percent guaranteed stock of the petitioner of the par value of $481,000 and 6 percent guaranteed stock of the par value of $19,300 were outstanding. Such stock had been issued under authority of the General Assembly of Virginia in accordance with certain resolutions of the petitioner’s directors and stockholders. Two hundred thousand dollars of the 7 percent stock was issued under an act of the General Assembly of Virginia dated February 13,1856, and pursuant to a resolution of the petitioner’s stockholders passed on May 27,1857. The pertinent paragraph of that resolution follows:

Resolved,‘ That the said two thousand shares be and the same are hereby constituted a guaranteed stock, entitled; under any circumstances, to receive seven per cent, per annum, and that the President and Directors be, and they are hereby, instructed to pay semi-annual dividends on the said shares, on the first days of May and November of each year, of not less than three and a half per cent, any holder of the said guaranteed shares being privileged to receive any excess of semi-annual dividend beyond three and a half percent., which may be at any time paid on the common stock of the Company, without impairing the guaranty of seven per cent, per annum given-by this resolution.

The resolution further alithorized the execution of a mortgage or deed of trust “to protect the guaranty * * * by making the principal of the whole guarantied {sic) stock created by the above resolutions, and seven per cent, dividend on the same, part of a first lien on all property, rights, privileges and franchises of the Company, and a debt of the Company immediately payable in the event of any default in the punctual payment of the dividends hereby guarantied.” Of the remaining stock outstanding, 7 percent guaranteed stock to the amount of $127,100 and 6 percent guaranteed stock to the amount of $19,300 were issued under a similar act dated December 13, 1865, pursuant to resolution of the petitioner’s stockholders of November 21, 1866, like in import to the resolution of May 27, 1857.

Seven percent guaranteed stock amounting to $131,200 was issued to replace 6 percent certificates of debt of the petitioner due July 1, 1869, under an act of February 13, 1856, and pursuant to resolutions of the stockholders dated November 18, 1868, while the remaining 7 percent guaranteed stock of the par value of $22,800 was issued under a similar act pursuant to a resolution of the stockholders of May 8, 1871, and a resolution of the board of directors passed on March 30, 1875. The latter resolution recites that the guaranteed stock was:

* * * entitled under any circumstances to receive seven per centum per annum, free of all taxation, and that the Treasurer be and he is hereby instructed to pay semi-annual dividends on the said shares, on the first days of May and November of each year, of not less than three and a half per cent., any holder of the said Guaranteed Shares being privileged to receive any excess of semi-annual dividend beyond three and a half per cent., which may be at any time paid on the Common Stock of the Company; without impairing the guaranty of seven per cent, per annum, given by this resolution.

Each issue of the stock had individual certificates. The original certificates contained copies of the relevant resolutions. Later, the petitioner adopted new certificate forms on which appeared the words “ secured by mortgage dated ” (giving the appropriate date) and also a statement that the whole property, profits, and franchises of the petitioner were pledged for the payment of the dividends thereon. The certificates were transferable only on the books of the petitioner. All guaranteed stock carried full voting rights equal with the voting common stock of the petitioner.

After their issue both the 7 percent and 6 percent guaranteed stock were secured by two deeds of trust or mortgages dated May 21 and December 5, 1871. Both the dividends and principal of such stock were so secured. Upon foreclosure, the holders of the guaranteed stock and of certificates of debt and coupon bonds were to be paid from the proceeds, and the surplus, after payment of all debts and charges against the petitioner, was to be distributed among stockholders other than owners of guaranteed stock.

In two subsequent mortgages given to secure later bond issues, the petitioner recognized the priority of the liens securing the guaranteed stock, except as to specific stock issued in 1871.

During the year 1929 the petitioner paid to the holders of 7 percent guaranteed stock 7 percent on $481,000, or $33,677, and to holders of 6 percent guaranteed stock 6 percent on $19,300, or $1,158, a total of $34,835, which was paid and charged as in previous years to “Account 546, Interest on Funded Debt.” The petitioner also paid to holders of guaranteed stock the sum of $25,213, the amount necessary to bring payment to the holders of guaranteed stock up to 12 percent, which percentage was paid to the holders of common stock and dividend obligations, and this was charged to “Account 614, Dividend Appropriation of Surplus.” The petitioner claims as a deduction for interest paid the total of the above sums, $60,048. During the year 1929 the petitioner paid dividends on other than “ guaranteed stock ” in an amount of $1,480,128.

As of January 1, 1929, the accumulated net earnings of the petitioner as reflected in its “ Profit and Loss ” account amounted to $7,539,648.55. The total net earnings of the petitioner for the year 1929, as shown by its books of account, amounted to $2,565,305.02 before the payments on common stock, dividend obligations, and guaranteed stock other than the portion thereof which was charged to funded debt as aforesaid.

The guaranteed stock was carried on the petitioner’s balance sheet as a long-term debt.

’ The Commissioners of Internal Revenue for succeeding years have allowed as an interest deduction in all years from 1918 to 1928, inclusive, the amount paid on the minimum guarantee, as well as the additional payment made to equalize payments made to common stock. In five proceedings before the Board, all settled without hearing, which cases involved the proper determination of the taxable income of this petitioner, no question was raised as to the propriety of the deduction of the amount of payments made on the guaranteed stock as interest and such deductions were allowed.

In its income tax return for the year 1929 the petitioner claimed a deduction of $189,907.60 as a loss on retired roadway and structures. This sum was arrived at by taking a total cost of $215,770.06 (composed of an estimated cost of $196,686.95 plus an actual ledger value of $19,083.11), adding thereto $5,099.62 as the cost of effecting retirement, and subtracting $30,962.08 as salvage value of retired assets. The estimated cost figures were taken from the basic inventory of the property made by the Interstate Commerce Commission as of June 30, 1916, as the best available evidence of the original cost.

The respondent disallowed the deduction to the extent of $32,553.20, on the following ground:

The reproduction cost new which was determined by the Interstate Commerce Commission and used by you as a basis for computing, the deductible loss on retired road and structures is reduced 15% toi arrive at a cost basis in 1904 and 1905, the years in which most of the retired property was acquired. This is done because the cost of new construction increased approximately 15% between 1904 and 1905 and the years used by the Interstate Commerce Commission as a basis for determining its values.

The respondent has conceded an allowance of $5,407.64 representing a deduction for current amortization of discount.

The first issue presents the question whether the amounts paid by the petitioner semi-annually on its “ guaranteed stock ” are in reality dividends or interest. The Board has held in many cases that the solution of such a problem depends on the facts in evidence in the case at bar, it being impossible to lay down a general rule of universal applicability. Proctor Shop, Inc., 30 B. T. A. 721, and cases there cited. While the name given to an instrument will not be ignored, it is not conclusive. I. Unterberg & Co., 2 B. T. A. 274. The weight to be given to any fact must be determined by consideration of its relative importance with respect to all other facts in proof.

The petitioner has been in existence over 100 years. The oldest issue of “ stock ” with which we are concerned was created in 1857. All certificates designated the security as “ guaranteed stock.” The original certificate forms contain the words: “For the payment on which of dividends * * * the whole property, profits and franchises of the company are pledged”, and the underlying resolutions are printed thereon. On the later forms appears the phrase “ secured by mortgage.” Subsequent to the original issues mortgages were executed and recorded to secure the payment of the guaranteed stock and other types of indebtedness. The “ stockholder ” possessed voting rights and shared in the profits of the petitioner in excess of the guaranteed and secured return named on the face value of his certificate. Yet, upon the dissolution or liquidation of the corporation, he had no right to participate in the surplus. There was no definite time at which his money should be returned but there was a designated manner by which he could be assured of its payment in case the “ dividends ” were not paid as agreed. Thus, the security under consideration is unique in that it contains characteristics usually found in both certificates of indebtedness and certificates of stock.

It seems to us, however, that in this case the basic test to be applied is whether the stockholder invested his money with the view of receiving a return from its use dependent on the successful operation of the company, on the one hand, or, on the other hand, whether he invested with no regard to the profit or loss which the company might enjoy or sustain, but with a dependence on the regular payment of compensation for the use of the money and an assurance of its ultimate repayment. Though there are facts pointing to either interpretation, on a full study of the case we are convinced that the second characterization more aptly fits the situation and that the owner of the guaranteed stock should be classed as a creditor of the petitioner. True, he had the right to vote and was entitled to a share in the petitioner’s net earnings after the payment of its current liabilities, including the so-called “dividends”, but the primary consideration appears to have been the specified and certain income to the owner, coupled with an assured recovery of the principal by resort to the property if a default in the interest payment should occur.

Certainly, from the viewpoint of common creditors, the guaranteed stock must be considered as an indebtedness of the petitioner. Proper and adequate provision was made in the petitioner’s charter for the creation of the security. Thus, the public was put on notice that such a debt would have priority over common debts. Deeds of trust or mortgages were executed and recorded in 1871 to provide lien security. Later mortgages specifically recognized the priority of the guaranteed stock as a lien debt. During the year 1929, therefore, no creditor could challenge successfully the prior right to the guaranteed stockholder as a creditor. By the authority of the Assembly of Virginia the petitioner was granted the right to secure the guaranteed stockholder in the payment of semi-annual interest and, under certain conditions, the principal in preference over all other creditors, preferred or common. Acting under that authority, the petitioner created the type of security called “guaranteed stock”, secured it by mortgage or deed of trust, and gave ample notice to both stockholder and public that the interest thereon and principal were to be paid before all other debts and charges.

We conclude that the guaranteed stock constituted a debt of the petitioner and that the “dividends” of 1 percent and 6 percent paid thereon during the year 1929, aggregating $34,835, were in reality, interest. It follows that this was a deductible item.

As to the balance of the payments, aggregating $25,213, we are of the opinion it was correctly disallowed. This payment was a distribution of profits and differs essentially from the fixed payments. It was clearly a dividend. Penn Mutual Life Insurance Co., 32 B. T. A. 839.

In the second issue the petitioner asserts that the respondent erroneously applied a 15 percent reduction in the allowance for the retirement loss on roadway and structures. It also claims that the respondent erred as a matter of law in that he ignored as the best evidence of the original cost the estimated cost taken from the basic inventory of the petitioner’s property, made by the Interstate Commerce Commission as of June 30, 1916.

From the facts it is obvious that the loss of $19,083.11, based on actual cost of physical assets installed since June 30, 1916, as disclosed by the petitioner’s books, should be allowed, reduced by the amount of salvage values applicable thereto. Likewise, the cost of effecting the retirement of such assets should be allowed.

The remaining portion of the retired assets, whose “ estimated cost ” is $196,686.85, presents quite a different question. The petitioner contends that the finding of the Interstate Commerce Commission to the effect that for rate-making purposes the assets in question had a certain value as of June 30, 1916, based on their estimated costs, should be accepted by this Board as proper evidence of the actual cost of structures and roadway constructed in 1904, 1905, and 1906. The petitioner cites Finance Docket 3839, 170 I. C. C. 467, and Texas Midland Railroad, 75 I. C. C. 1 (p. 140).

The respondent accepted as a measure of cost the amount fixed by the Interstate Commerce Commission as the estimated cost as of June 30, 1916, but made an arbitrary reduction of 15 percent on the theory that the cost of construction increased approximately 15 percent between 1904 and 1905 and the years used by the Interstate Commerce Commission as the basis for determining values. We do not know by what means the respondent arrived at the 15 percent differential in cost but neither has it been shown that the rate is erroneous. The burden is on the petitioner so1 to prove.

The explanation made by the Interstate Commerce Commission of its determination of value is couched in the most general terms. The duty of the Commission was to find some definite value for rate-making purposes. The condition of the books of railroad companies and their methods of bookkeeping were such that, in many cases, it was impossible to arrive at any accurate cost figures. Such a condition existed with respect to. the petitioner’s records. Consequently, the Commission struck a fair average of replacement costs “ at normal prices as of 1914 ” and adopted a general rule that such estimated costs approximated the original cost of construction. In other words, the Commission did the best it could with the data at hand.

The petitioner has produced no evidence to. show that the cost of constructing the roadway and structures retired had not advanced 15 percent during the period from 1904 to the basic years used in arriving at the Commission’s estimated cost figures. If the respondent was in error in using such rate the petitioner should have proved that fact.

We note, however, that the respondent has erred in applying his own ratio of 15 percent to the assets having an estimated cost of $215,770.06. He used that ratio “ because the cost of new construction increased approximately 15 percent.” Hence, the base of the 15 percent increase is the estimated cost in 1904 and not the appreciated cost as of 1916. The correct amount of retirement “ loss ” is of $196,686.95, less the proportionate amounts of salvage values applicable to the items to which no ledger value was assigned. The cost of effecting retirement, $5,099.62, is a proper deduction as a loss.

[Reviewed by the Board.

Decision will be entered under Bule 50.

Murdock dissents.

McMahon,

dissenting: In my opinion the payments in question in this proceeding were in truth “ dividends ”, correctly denominated as such, and not interest. See the discussion in the second dissenting opinion, and the citations therein set forth, in Great Southern Life Insurance Co., 33 B. T. A. 512. Hence, the deduction of such payments from income should not be allowed.


source: Caselaw Access Project

author: Mellott:

license: Public Domain

text:
    George A. Hellman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 72730.
    Promulgated January 9, 1936.

      George A. Hellman, pro se.

      Paul D. Page, Jr., Esq., for the respondent.
   opinion.

Mellott:

Petitioner in this proceeding contests a deficiency in income tax determined by the respondent in the amount of $7,301.46 for the calendar year 1931. The sole issue presented for our determination is whether the gain derived from the surrender of two combined annuity and insurance policies is taxable as ordinary income or as a capital gain. The case was submitted upon the following stipulation of facts:

1. Petitioner is an individual, a citizen of the United States and an inhabitant and resident of the City of Chicago, State of Illinois.
2. Petitioner has always filed and during the taxable year 1931 did file his income tax return upon the cash receipts and disbursements basis
3. During the year 1928 petitioner took out two combined life insurance and annuity contracts, one on May 11, 1928, with the Penn Mutual Life Insurance Company for a consideration of $105,200 and the other on August 12, 1928, with the Equitable Life Assurance Society for a consideration of $105,000. Both policies were surrendered in December 1931. The petitioner received a total of $117,136 and $116,605.56 from the Penn Mutual Life Insurance Company and Equitable Life Assurance Society, respectively, including payments received in the intervening period from 192S resulting in a profit of $11,936 from the former company and $11,605.56 from the latter or a total profit of $23,541.56.
4. Petitioner contends that the total profit of $23,541.56 was realized in the year 1931 when the contracts with the Penn Mutual Life Insurance Company and the Equitable Life Assurance Society were surrendered and that said profit should be taxed as a capital gain within the meaning of Section 101 (c) (1) of the Kevenue Act of 1928.

Section 101 of the Revenue Act of 1928, insofar as it is here pertinent, provides as follows:

(a) Tax in case of capital net gain. — In the case of any taxpayer, other than a corporation, who for any taxable year derives a capital net gain (as hereinafter defined in this section), there shall, at the election of the taxpayer, be levied, collected, and paid, in lieu of all other taxes imposed by this title, a tax determined as follows: a partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner as if this section had not been enacted and the total-tax shall be this amount plus 12% per centum of the capital net gain.
# % Hi * * * *
(c) Definitions. — Eor the purposes of this title—
(1) “ Capital gain ” means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921.

We have heretofore decided that the payment of the amount specified in a bond, either at maturity or pursuant to an authorized call prior to maturity, is not a “ sale or exchange ” of such a bond, but is merely the payment of an obligation according to its fixed terms. John H. Watson, Jr., 27 B. T. A. 463; Arthur E. Braun, Trustee, 29 B. T. A. 1161. In our opinion the surrender of the life insurance and annuity contracts in the instant case, does not differ in any material respect from the bond transactions in the cases above cited. As we said in John H. Watson, Jr., supra, “ The words ‘ sale or exchange ’ are ordinary words of well established meaning.” They do not include the surrender of a life insurance or annuity contract wherein the insured receives a payment of an obligation according to the terms of the insurance policy. We must therefore hold that the gain realized by the petitioner upon the surrender of the policies here involved may not be treated as capital gain under the provisions of section 101 of the Revenue Act of 1928, but must be treated as ordinary income.

Judgment will he entered for the respondent.


author: Murdock :

text:
    J. Darsie Lloyd, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71445.
    Promulgated January 10, 1936.

      Lee I. ParJc, Esq., and George M. Thompson, Esq., for the petitioner.

      Dewitt M. Evans, Esq., and John Moroshy, Esq., for the respondent.
   OPINION.

Murdock :

The petitioner completely disposed of 2,499 shares of Harold Lloyd Corporation stock in 1930. The question is whether he realized from the transaction any gain taxable in 1930. Section 111 of the Revenue Act of 1928 provides that the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis. The basis here has been stipulated. The amount realized is defined in section 111 (c) as “ the sum of any money received plus the fair market value of the property (other than money) received.” The petitioner received no money on April 16, 1930, when he parted with his stock. He received $75,000 in cash later in 1930 under the agreement. Unless the amount realized included property (other than money) having a fair market value, there was no taxable gain for 1930 from the transaction, since the cash did not equal the basis of $122,567.68. The petitioner received the promise of his son, Harold, expressed in the contract, to make certain annual payments of money in the future. Did that represent property having a fair market value within the meaning of section 111 (c) ?

The petitioner did not give his stock to his son. The transfer was supported by a valuable consideration, the promise and agreement to make payments in the future. We are not called upon to determine the cost of the stock to Harold but rather to determine whether the petitioner received any property having a fair market value on April 16, 1930, upon which an immediately taxable gain should be computed. Sometimes it is necessary to determine a value for a certain tax purpose but not for another, and sometimes the two sides of a transaction do not receive parallel tax treatment. Logan v. Commissioner, 42 Fed. (2d) 193, and the same case affirmed by the Supreme Court, Burnet v. Logan, 283 U. S. 404; Alexander D. Falck, 26 B. T. A. 1359; affd., 71 Fed. (2d) 656; certiorari denied, 293 U. S. 608. Cf. Steinbach Co., 3 B. T. A. 348; John C. Moore Corporation, 15 B. T. A. 1140; Florence L. Klein, 6 B. T. A. 617; Scott v. Commissioner, 29 Fed. (2d) 472; Simpson v. United States, 252 U. S. 547. Where marketable exchangeable promises to pay are accepted as a part of a purchase price, their fair market value is included in the “ amount realized ” and a taxable gain is realized immediately. Cf. Ruth Iron Co., 4 B. T. A. 1151; affd., 26 Fed. (2d) 30; and Kosmerl v. Commissioner, 25 Fed. (2d) 87. But promises to make future payments do not always have an exchangeable value (Eisner v. Macomber, 252 U. S. 189) and are not always income when received. Bedell v. Commissioner, 30 Fed. (2d) 622; Dudley T. Humphrey, 32 B. T. A. 280. In such cases the actual payments as made are taxed as income when received in excess of the basis. The petitioner reported his profit in that way.

The fair cost of an annuity based upon experience tables giving-life expectancies can be determined by actuaries. A similar method would have to be used in order to estimate the present value of an annuity to the annuitant. But here a new element enters the computation, the uncertainty as to whether or not the one agreeing to make payments will be able to make them as agreed when the time for payment actually arrives. This difficulty might not be so great in the case of a sound insurance company regularly engaged in granting annuities or, perhaps, in the case of a bank. Cf. Guaranty Trust Co. of New York, Executor, 15 B. T. A. 20. Laws have been enacted to safeguard investors of such institutions. But that kind of an annuity is not involved in this case. Harold C. Lloyd was an individual. He was wealthy in 1930 but he was not engaged in the business of granting annuities, and his investments were not subject to restrictions and supervision as are those of insurance companies and banks. The evidence shows that the contract of April 16, 1930, whereby Harold C. Lloyd promised and agreed to make future payments to his father, the petitioner, had no fair market value within the meaning of section 111 (c) when received by the petitioner on April 16, 1930. Cf. Helvering v. Louis, 77 Fed. (2d) 386, reversing 29 B. T. A. 1200; Commissioner v. Newbury, 80 Fed. (2d) 631. The Commissioner erred in including any gain from the transaction in the petitioner’s income for 1930.

Decision will be entered under Rule 50.


author: Murdock: AeuNdell,

text:
    Terminal Railroad Association of St. Louis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 49832, 53429, 63699.
    Promulgated January 14, 1936.

      J. T. Haslam, Esq., for tbe respondent.
   OPINION.

Murdock:

The Commissioner determined the following deficiencies in the petitioner’s income tax:

. AH of the issues raised in the pleadings relating to the above deficiencies have been settled by a stipulation of the parties. The only matter now in controversy is an issue in each proceeding, raised by the respondent, whereby he claims that the amounts which he allowed as deductions for depreciation for each year were erroneously allowed. The facts of record bearing upon this issue have been presented by a stipulation.

The stipulation may be summarized for present purposes as follows:

The petitioner is a corporation organized under the laws of Missouri. Its principal office is at St. Louis, Missouri. It kept its books on an accrual basis and in accordance with the classification, of accounts prescribed by the Interstate Commerce Commission. The petitioner owned all of the outstanding capital stock of St. Louis Merchants Bridge Terminal Railway Company and of Wiggins Ferry Company. Wiggins Ferry Company owned all of the outstanding capital stock of St. Louis Transfer Railway Company and of the East St. Louis Connecting Railway Company. The petitioner, for itself and affiliated companies, filed consolidated income tax returns for all of the years here involved. Those returns included the income and deductions of the companies above mentioned. The returns were filed on an accrual basis. The petitioner, as lessee, leased the properties of St. Louis Merchants Bridge Terminal Railway Company, of East St. Louis Connecting Railway Company and of the St. Louis Transfer Railway Company for a period of 99 years beginning January 1, 1926. These leases were approved by the Interstate Commerce Commission in 1925. The properties leased consisted of railways, bridges, structures, depots, shops, locomotives, ears and all other properties owned comprising the entire railroad systems of the lessors. The rental which the petitioner was required to pay under the leases consisted of taxes, assessments and other like charges imposed upon the lessor companies and interest on bonds of one of the companies. Each lease contains the following provision:
The Lessee Company shall and will maintain and keep the premises hereby delivered, and every part thereof, in good condition, and make all necessary repairs and renewals of the same, and operate and use the same for the purposes for which the Lessor Company holds the same, and shall and will indemnify and save harmless the Lessor Company from any and all claims for damages arising out of such operation and use.
The petitioner operated the properties during the taxable years in accordance with the terms of the leases. The properties leased were constructed with funds of the lessor companies or their predecessor companies. The various expenditures to be made by the petitioner in the payment of interest, taxes, assessments, repairs, renewals, maintenance, etc., were made as required by the terms of the leases and the amounts thereof were deducted from the gross income of the petitioner as expenses. Those deductions have been allowed by the Commissioner in determining the deficiencies. The petitioner, in the consolidated returns, claimed the following amounts for depreciation of the properties, and the deductions were allowed by the Commissioner in determining the deficiencies:
For 1926_$30, 871. 48
For 1927_ 30,404. 80
For 1928_ 30,488. 65
For 1929_ 29,054. 06

The notice of deficiency for the years 1926 and 1927 contains the following statement:

In accordance with the agreement for the allocation of tax executed under date of April 16, 1929, the deficiencies for the years 1926 and 1927 are assessable against your company.

The following statement appears in the notice of deficiency for the year 1928:

The entire tax is allocated to your company, in accordance with agreement signed under date of September 3, 1930, by you and the subsidiary companies listed above.

The following statement is from the deficiency notice for 1929:

In accordance with article 16 (a) of Regulations 75, the deficiency will be assessed severally against each corporation named- above.

The Commissioner is the moving party on the single issue left for decision by the Board. He is asking that his action in determining the deficiencies be changed so as to disallow deductions which he says he erroneously allowed. If, under such circumstances, he fails to establish by a preponderance of the evidence that his determination of the deficiencies was erroneous, he must lose the point. He contends that the petitioner has no capital investment in the properties, and, therefore, has nothing to recover by way of depreciation. He further states that the petitioner has been allowed all deductions to which it'is entitled, including all expenses of repairing and maintaining the property in good condition and all costs of renewals. He further states that the lessors will not suffer loss from depreciation on their properties and are not entitled to deductions for depreciation. His argument in support of this statement is that the loss from depreciation can not fall upon the lessors since the petitioner, as lessee, is required to maintain every part of the properties in good condition and make all necessary repairs and renewals of the same. Therefore he concludes that, since neither the petitioner nor the lessors are entitled to depreciation, he erred in allowing any depreciation in determining the deficiency.

Section 214 (a) (8) of the Revenue Act of 1926 and section 23 (k) of the Revenue Act of 1928 authorize the deduction of “ a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a l’easonable allowance for obsolescence.” This provision in the latter act is captioned “ Depreciation.” The basis for computing the deduction, as provided in these statutes, is the same as the basis for gain or loss upon the sale or other disposition of the property. Sec. 204, Revenue Act of 1926; secs. 23 (m) and 114 (a), Revenue Act of 1928. That basis is cost, if the property was acquired by the taxpayer after March 1, 1913, or cost or value on March 1,1913, whichever is greater, in case the property was acquired by the taxpayer before March 1, 1913. Sec. 204, Revenue Act of 1926; sec. 113, Revenue Act of 1928.

The petitioner is not entitled to any deduction for depreciation on the properties under these statutes. Weiss v. Wiener, 279 U. S. 333. It does not own the properties and they have no basis for gain or loss and, consequently, no basis for depreciation in its hands. The lessors are the owners and, if any one is entitled to depreciation on the properties, it is the lessors and not the petitioner. Ohio-Clover Leaf Dairy Co., 13 B. T. A. 1320; affd., 41 Fed. (2d) 1009; Belt Railway Co. of Chicago, 9 B. T. A. 304; affd., 36 Fed. (2d) 541; certiorari denied, 281 U. S. 742; Tunnel Railroad Co. v. Commissioner, 61 Fed. (2d) 166; certiorari denied, 288 U. S. 604.

However, it appears that the lessors joined with the petitioner in a consolidated return for each of the years and the petitioner is liable for the total tax including the deficiencies. The Commissioner may not succeed in having the deficiencies increased unless the evidence shows that the lessors are not entitled to deductions for depreciation of the properties, that is, if the Commissioner’s only mistake was to allow the deductions for depreciation to the petitioner instead of to its subsidiaries, then that mistake is not a sound reason for increasing the deficiencies computed on a consolidated return basis. If the situation were reversed, that is, if the Commissioner, in the determination of the deficiency, had added an item to income as shown on the consolidated return, the petitioner could not have the deficiency reduced by merely showing that it had had no such item of income, particularly if the evidence left a possible inference that the item might have been income to the subsidiary companies included in the same consolidated return. The Commissioner, the moving party here, is under no less a burden to show that the deficiency should be increased. The evidence does not go so far as to show that the lessors were not entitled to some deduction for depreciation.

The petitioner, as lessee, was required to maintain and keep the premises and every part thereof in good condition and to make all necessary repairs. But such a requirement, even if fulfilled, would not completely offset the gradual wearing out of the properties. Terminal Realty Corporation, 32 B. T. A. 623. The petitioner was also required to make all necessary renewals of the leased premises. The meaning of this term “renewals”, as used in the lease, is not entirely clear. It may have been intended by the parties to refer to ordinary renewals of a more or less minor character Avhich clearly would not completely offset depreciation. The Commissioner allowed deductions as ordinary and necessary expenses for the actual expenditures made by the lessee, which would indicate that the renewals were of a minor character. One of the properties involved was a bridge over the Mississippi Biver. It seems at least doubtful whether the use of the word “renewals” in the lease would require the petitioner to replace the present bridge. The Commissioner has not shown that the lessors were not entitled to deductions for wear and tear. But, however that may be, there is no provision in the lease which would obviously completely compensate the lessors for the loss growing out of the obsolescence of their properties. There is nothing in the evidence to show that the deductions in question were not in proper amounts. Neither the cost nor the probable useful life of any property has been shown. The evidence does not show that in the consolidated returns the deductions for depreciation were improper. Consequently, the evidence does not show that the deficiencies were too small on this account.

Beviewed by the Board.

Decision unit Toe entered under Rule 50.

AeuNdell,

dissenting: The petitioner herein is the lessee of property of another railroad, all of whose stock it owns and with whom it has joined in the filing of a consolidated return. The petitioner deducted in its returns depreciation on the leased property and originally the Commissioner allowed the deduction. In these proceedings the Commissioner has raised as an affirmative issue the validity of this deduction. The majority opinion, while conceding the correctness of the Commissioner’s position that the petitioner as the lessee of property is not entitled to a deduction for depreciation thereon (Weiss v. Wiener, 279 U. S. 333), nevertheless refuses to allow the resulting deficiency because, as it is stated, the Commissioner does not carry his burden further and establish that the lessor likewise is not entitled to depreciation. The petitioner did not contend originally and does not contend in these proceedings that the lessor is entitled to depreciation and in view of the decisions in Georgia Railway & Electric Co. v. Commissioner, 77 Fed. (2d) 897, and Commissioner v. Terre Haute Electric Co., 67 Fed. (2d) 697, it would seem at least doubtful whether the lessor would be entitled to deductions for depreciation. At any rate, there is no showing that the deductions, if allowable, would be in the same amounts as claimed by the lessee. The respondent has met his burden of proof when he shows that the petitioner is not entitled to the deductions claimed and allowed, and the majority opinion carries the burden too far. The Commissioner should prevail.

Leech, TüeneR, and Tyson agree with this dissent.


author: Mobris : Black,

text:
    Bankline Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56484, 72502.
    Promulgated January 16, 1936.

      A. L. Weil, Esq., for the petitioner.

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

Mobris :

The petitioner seeks total exemption of the income derived during the taxable year 1930 from “Lease #89”, between itself and the State of California, under the doctrine of implied immunity, relying primarily upon Burnet v. Coronado Oil & Gas Co., 285 U. S. 393. The respondent, on the other hand, relies upon Burnet v. Jergins Trust, 288 U. S. 508.

Burnet v. Coronado Oil & Gas Co., supra, arose out of a lease entered into between the State of Oklahoma and Coronado Oil & Gas Co. “By the Enabling Act Congress required' as a condition precedent to the admission of Oklahoma into the Union that her Constitution should make provision for common schools; and for their benefit it granted certain lands to the state with the proviso that those valuable for minerals, gas, and oil should not be sold prior to January 1,1915, but might be leased. Act of June 16, 1906, 34 Stat. 267, 270, 272, 273. The State Constitution (article 11, §1) established a common school system and pledged her faith to preserve the lands so conveyed by the United States as a sacred trust, and to keep the same for the uses and purposes for which they were granted. The Legislature prescribed regulations for leasing and directing payment of the proceeds into the school fund.” Burnet v. Coronado Oil & Gas Co., supra. Some of those lands were leased to Coronado Oil & Gas Co., by which the state was to, and did, receive a certain percentage of the gross production of oil and gas produced thereunder. The Court there held that the lease was an “instrumentality of the state for the purpose of carrying out her duty in respect of public schools.”

In Burnet v. Jergins Trust, supra, the city of Long Beach, California, had acquired and held certain acreage for water supply purposes until, in 1922, oil was discovered in the vicinity thereof, when A. T. Jergins Trust was organized under the laws of California to obtain an oil and gas lease upon such lands. It was stipulated in such lease that the city should receive 40 percent and A. T. Jergins Trust, 60 percent of the proceeds of oil and gas recovered. The taxpayer in that proceeding relied upon Gillespie v. State of Oklahoma, 257 U. S. 501 and Burnet v. Coronado Oil & Gas Co., supra. But the Court said, holding the income taxable, “ In both of those cases the sovereign was acting as the trustee of an express trust with regard to the lands leased. In both the burden upon the public use was more definite and direct than in the present case. As said in the Coronado case, the doctrine of Gillespie v. Oklahoma is to be applied strictly and only in circumstances closely analogous to those which it disclosed.”

We find nothing, in principle, to distinguish the instant case from Burnet v. Jergins Trust, supra. The proposed tax is upon the net income of an independent private corporate entity from any and all sources, not upon the property of the municipality, upon its share of the oil recovered, the lease itself, nor the gross income therefrom. This income is just as remote from any governmental function as it was there. Certainly there is no close analogy between the circumstances of this case and those found in Burnet v. Coronado Oil & Gas Co., supra. Upon this issue we sustain the respondent’s determination.

The petitioner alleges and contends that it is entitled to depletion under its casinghead gas contracts and in support of such contention it relies upon Signal Gasoline Corporation v. Commissioner, 66 Fed. (2d) 886, reversing the Board at 25 B. T. A. 861.

Sections 234 and 204 of tlie Revenue Act of 1926, applicable to allowable deductions and the basis for determining depletion, etc., are as follows:

Seo. 234. (a) In computing tlie net income of a corporation subject to tbe tax imposed by section 230 there shall be allowed as deductions:
****** *
(8) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner with, the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee;
* :fc * * * * *
Sec. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that—
* * * * * * *
(2) In the case of oil and gas wells the allowance for depletion shall be 27% per centum of tlie gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

The applicable provisions of the Revenue Act of 1928 are substantially the same as those of the Revenue Act of 1926 quoted above.

In Signal Gasoline Corporation, supra, the petitioner acquired a number of already existing casinghead gas contracts for which it assumed certain obligations, aggregating in excess of $50,000, and it paid cash of $107,488.41, and 450,000 shares of its common capital stock, par value $1 a share. There, as here, the petitioner, under its contracts — in many respects similar in terms to the contracts of this petitioner, but differing in many other vital respects — acquired wet gas from producers in the State of California. The contracts here are similar in their aims and objects but they differ widely in their scope of performance. The aims and objects, in both instances, were to produce wet gas and by a process of manufacture to render that wet gas a salable, useful commodity. They were similar in that the petitioner, in each instance, was to acquire, by purchase, leases, or otherwise, all of the natural gas produced at a specified well for the purpose of extracting the gasoline therefrom and disposing of it, together with the dry gas1 — that is, such dry gas as was not consumed in the manufacture or blown to air, for the benefit of the parties concerned in proportion to their contractual interests. In both cases the petitioner was required to lay the necessary pipe lines from the well to the absorption plant and, of course, such rights of ingress and egress as were necessary to the upkeep of such pipe lines were provided for. One noteworthy distinction, however, appears in the fact that in the instant case the producer, not the petitioner, was required to furnish necessary casingheads and gas traps to which the producer agreed to deliver the wet gas and from which the petitioner agreed to convey, through its pipe line, to its plant for treatment. In that case there appears to have been a much greater obligation on the part of the petitioner. Its duties respecting the production of gas did not cease with the delivery of wet gas to the casinghead or gas traps but it was required “ whenever it became feasible and advisable, to install a vacuum upon the wells ” and furthermore, “ that it would install the necessary equipment and maintain such vacuum as was desired ” by the producer “ for regulating the pressure to be exerted in the operation.” The petitioner there “ assisted in drilling wells by furnishing separators, casing, derricks, boilers, other drilling equipment on the outcome of the well ”, for which it “ received no payment, if the well was dry.” Not only were the producers there bending their efforts toward the production and delivery of gas to the petitioner, but “ producers and the petitioner were both engaged in continuous steps to win oil and casing-head gas from their position in the earth.” In that case “After a well had ceased flowing in commercial quantities from the natural pressure, it was necessary, in the case of most of the wells, for petitioner to take direct means by the introduction of high pressure dry gas into the well to induce a larger flow of oil and gas.” In the instant case the petitioner was only required to return to the producer such quantity of gas as was necessary for injection purposes — it was required to take no “ direct means ” to bring about the production of gas— what means it took were indirect and merely incidental to its contractual obligation.

So much for the distinctions between the instant case and the case relied upon by the petitioner to support its claim. Let us examine a contract of this petitioner and see if we are able to find, as the court did there, that the interest of the petitioner was in the nature ,of a profit a prendre. Unless there was, of course, the petitioner would have no depletable interest. It is clear to our minds that it was intended by these contracts to establish an independent relationship between the parties, the producer, producing wet gas, on the one hand, and the manufacturer, converting that wet gas into salable commodities on the other. The preamble of this typical contract recites that the producer “ is the owner of the natural gas produced ” under that contract; that the petitioner has erected a plant for the extraction of gasoline; that in order to obtain “ an adequate supply of gas for said plant ” the petitioner “ desires to receive from Producer all of the natural gas which may be produced ” under such contract; that the “Producer is desirous of having the gas produced ” under that contract “ treated for the extraction of gasoline therefrom ”, and “ as an inducement to Bankline to operate a plant capable of treating the natural gas produced ” the producer “ is •willing and desires to deliver to Bankline all of the natural gas produced.”

The body of the contract repeatedly speaks in language of separate and independent obligations of the parties leaving not the slightest suggestion of an intention to create a right of profit a prendre. Speaking of this right, the court in Signal Gasoline Corporation, supra, said: “ Considered by themselves, the contracts may not specifically convey any title to gas in the ground, but the contracts confer upon petitioner the right to enter upon the land and connect its pijDes directly with the oil wells, install meters, and petitioner is required to maintain vacuums on the oil wells. These provisions, together with the method of operation sanctioned by the parties whereby petitioner, by means of gas lifts, rodless pumps, and the use of compressors to create vacuums, extracted the gas that would otherwise not be produced from the premises, conferred upon it an incorporeal right to be exercised in the land in relation to the gas which was in the nature of a grant of a profit a prendre.” The only provision for the use of vacuum, found in only two of these contracts (there being seven), one of which, entered into between the petitioner and the General Petroleum Corporation on June 9, 1922, says:

The first party [General Petroleum Corporation] hereby agrees to deliver to the second party [petitioner] at the traps or easing-heads of the wells in said Signal Hill District during the life of this agreement as hereinafter set forth, all gas which is now or which may be hereafter produced by the first party from any or all wells located in said Signal Hill District, and the said second party shall have the right to apply such vacuum if any as the first party shall hereafter indicate, and the vacuum to be applied to such wells may be changed from time to time as conditions in such wells warrant, but such change can only be made upon the sanction and consent in writing of said first party.

This provision., however, falls far short of establishing an absolute duty upon the petitioner or an absolute right in it to apply a vacuum without the approval of General Petroleum Corporation. At any rate there is really no proof of record that this contract, which was to continue so long as General Petroleum Corporation had available gas in the Signal Hill District, was actually in force during the years in question. Nor does the other contract in which it is provided for, dated March 23, 1926, alter our conclusion.

The court there was convinced that the contracts under consideration and the “ methods employed in reducing the wet gas to possession ” created “ an interest in the gas in place or a right to share in the gas produced.” It concluded that the petitioner has the “ requisite economic interest which, under the statute entitled it to reasonable allowances for depletion.” We are not so convinced.

There is not sufficient evidence for us to find here, as the court did there, that when the wells were drilled down to sand, only a small portion of the gas rose sufficiently to be caught in the casing-head, nor may we conclude from the evidence before us, as the court did, that “ This would amount to such an insignificant quantity we would not have justified the erection of a plant to reduce it.” There is some evidence of record from which we may conclude that difficulties were encountered from time to time in forcing the gas to the surface, but we can not conclude that this difficulty was of such magnitude as the court there was able to find. Nor may we conclude, assuming the petitioner to have been cognizant of such factors at the outset, that it would not have installed such an extensive plant had not its contract with the producer granted it an interest in the mineral in place or assured it of a portion of the gross proceeds therefrom. It is safe to say, we believe, that this petitioner had no enforceable rights whatsoever under its contracts prior to the time the wet gas was actually placed in its pipe line, i. e., after it had passed beyond the casingheads and gas traps supplied by the producer and into the pipe line, except the right, perhaps, to demand that the producer deliver whatever was produced through its pipe lines for treatment during the period of contractual relationship.

Upon the record, the petitioner has wholly failed to establish a depletable interest under the statute.

Even if all other facts, to which we have referred, pointed to a favorable conclusion for the petitioner, we are of the opinion that the proof upon the subject of rates falls short of the mark for reasons which we need not discuss. See Lomita Gasoline Co., 33 B. T. A. 385.

Becomputation of the deficiencies, if any, should be in accordance herewith and the stipulation of the parties.

Reviewed by the Board.

Judgment will be entered under Bule 50.

Smith and Murdock concur in the result.

Teammelo, Van Fossan, and Arnold dissent.

Black,

concurring in the result: I agree without reservation as to the first point. I concur in the result which has been reached in the majority opinion on the second point, but I do so on the ground stated in the concluding paragraph of the opinion to the effect that petitioner has failed to show that the value of wet gas at the mouth of the well purchased under casinghead gasoline contracts was in excess of the royalties paid therefor and therefore has not shown any proper basis for depletion deductions. Signal Gasoline Corporation, 30 B. T. A. 568; affd., 77 Fed. (2d) 778; Lomita Gasoline Co., 33 B. T. A. 385.

I do not concur in that part of the discussion in the majority opinion which holds that the casinghead gas contracts in the instant case are sufficiently different from those present in Signal Gasoline Corporation v. Commissioner, 66 Fed. (2d) 886, as to make the two cases distinguishable and to justify the holding in the majority opinion that petitioner in the instant case has no depletable interest arising out of the casinghead gas contracts. Petitioner’s failure of proof to show what amount of depletion deductions, if any, it is entitled to take, appears to be similar to that in the cases above cited. As the court said in Signal Gasoline Corporation v. Commissioner, 77 Fed. (2d) 778, “Since the taxpayer is seeking a deduction for depletion from its otherwise taxable income, the burden of proof is upon it not only to prove that it is entitled to the deduction but also to prove the correct amount thereof.”

Akundell and Leech concur in the above.


author: McMahon:

text:
    Vancoh Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52340.
    Promulgated January 17, 1936.

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

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

McMahon:

It has been repeatedly held by the Board and the courts that where the books of a taxpayer, engaged in the business of making mortgage loans, are kept on a cash receipts and disbursements basis, discounts or commissions on such mortgage loans deducted from the principal o.f such loans at the time made constitute income in the year the notes secured by mortgage are either paid in full or sold. Cosmopolitan Bond & Mortgage Co., 30 B. T. A. 717, and cases relied on therein, dismissed on motion of the Commissioner, 77 Fed. (2d) 994; Commissioner v. Central Republic Trust Co., 75 Fed. (2d) 708; Helvering v. Martin-Stubblefield, Inc., 71 Fed. (2d) 944 — both affirming unpublished memorandum decisions of the Board.

Where the books of a taxpayer engaged in the business of making loans are kept on an accrual basis, it has been held that discounts or commissions deducted from the principal of the loans at the time such loans are made constitute income in the j^ear the loans are made. Columbia State Savings Bank, 31 B. T. A. 685, and cases relied on therein.

As appears from our findings in the instant proceeding, on the extension or renewal of a loan a new note and deed of trust was executed and the commission or discount charged for each such extension was paid in cash or was added to the unpaid principal of each loan, the unpaid principal representing in part cost and in part unrealized or unearned discount. The respondent included the amount of such unrealized discount in taxable income in the year the extension or renewal was made. Since each extension or renewal was in effect a new loan made by petitioner, on authority of the principle of Columbia State Savings Bank, supra, this action of respondent is approved.

In the instant proceeding the petitioner purchased existing loans through brokers at a discount. The petitioner contends- that, although its books were kept on an accrual basis, no part of the discount should be included in income until the entire cost of each loan has been paid in full, since it had no reasonable assurance that the notes would be paid in full or that the discounts at which such notes wore purchased would be recovered. In so far as the record discloses the loans purchased were all definitely fixed obligations of the borrowers or makers of the notes and mortgages and were not subject to any contingency of payment before due date or otherwise. The possibility of nonpayment of a debt is inherent in every obligation to pay but this does not change a fixed obligation to pay into a con-lingent liability. Columbia State Savings Bank, supra. While the principle of Higgins Estate, Inc., 30 B. T. A. 814, cited by the petitioner, that an item is accruable when events have occurred necessary to fix the liabilities of the parties and the amount thereof is applicable here, that case otherwise is distinguishable. Payment of the mortgages involved herein, in so far as shown 'by the evidence, was not contingent upon any future event as were the payments under the contract involved in that case. Furthermore, the loans were purchased by the petitioner here with the expectation of payment in full.

Great Northern Railway Co., 8 B. T. A. 225, 269; Turner Falls Power & Electric Co., 15 B. T. A. 983, 992; Sowers Manufacturing Co., 16 B. T. A. 268, 274; and Oregon Terminals Co., 29 B. T. A. 1332, cited by the petitioner, are distinguishable on the facts. It is therein stated that a taxpayer on an accrual basis is not required to report as income that which in all probability may -never be received. There is no evidence here, as there was in such cases pertaining to the items therein involved, that the mortgage loans held by the petitioner were uncollectible or that payment thereof in the future at the time fixed in the mortgage notes was highly improbable.

Discount deducted from the principal of a mortgage note by a mortgagee on the accrual basis, as in the case of Columbia State Savings Bank, supra, is in substance a commission charged for services performed in the making of the loan and is earned when such services are -performed. Having been earned and the obligation of the borrower therefor having been established by the execution of the note and mortgage, the commission, where the books are kept on the accrual basis, is accruable on the books as income when the loan is made. The interest charged on the loan represents payment by the borrower for the use of the money loaned and is payable so- long as the loan is unpaid. Here the petitioner did not perform any services in the making of these loans. It purchased loans made by others and paid therefor the principal of the note less an agreed percentage thereof, the difference between the face value and the amount paid being the discount. ' In purchasing a mortgage loan at a. discount it acquired the fixed obligation of a third person to pay an amount in excess of the amount paid therefor by petitioner, the excess representing the discount allowed to petitioner. The discount is paid by the borrower or the maker of the note as a. part of his principal obligation. Such discount, like interest, is earned with the lapse of time. The amount paid upon the. purchase of a mortgage loan represents as a practical matter the present value of an obligation to pay in the future, which, in part, is based upon the extent of the unexpired term of the mortgage note, the financial responsibility of the obligor, the adequacy of the security, and the supply thereof and demand therefor. The undisputed proof shows that competition and the risks of the business were factors which affected the amount of the discount. The difference between the present value or purchase price and the face value of the obligation or note represents the discount. As the maturity of the obligation draws nearer, the value ordinarily increases. As the value increases with the lapse of time and the approach of the maturity date, the discount is being earned. Hence, where books are kept on an accrual basis, the discount should be accrued as thus earned, whether paid or not. As stated in Chicago Acceptance Co., 12 B. T. A. 150, 152, only the amount of discount actually earned in each taxable year should be included in the taxable income of that year. By this method the greater risk involved in the business of dealing in second mortgages is recognized. Cf. Columbia State Savings Bank, supra.

In Shafpa Realty Corporation, 8 B. T. A. 283, the taxpayer, in 1920, sold a building and received in part payment a second mortgage with a face value of $300,000. For the purpose of arriving at the profit or loss sustained from the transaction in 1920, the taxpayer and the Commissioner agreed upon the market value of the second mortgage at $240,000. During 1921 the mortgagor made a payment of $10,000, which the taxpayer1 considered as a return of principal, and the Commissioner held that $2,000 of the $10,000 represented income. The Board held that, since the Commissioner, in computing the gain, discounted the mortgage 20 percent, only 80 percent of the face value represented the basis for computing the gain upon the payments made on the mortgage, that each payment made was a payment on the face of the mortgage, and that 80 percent thereof represented a return on the principal and 20 percent a realization of discount or of income. It is obvious that this case is distinguishable from the instant proceeding on the facts. The taxpayer therein was not engaged in the business of buying and selling mortgage loans at a discount, and it does not appear whether the books were kept on the accrual basis or cash receipts and disbursements basis. Missouri Life Insurance Co. v. Helvering, 78 Fed. (2d) 778, and Prudential Insurance Co. of America, 33 B. T. A. 332, are distinguishable.

The respondent determined the amount of discount includable in taxable income for each year by allocating thereto a certain pro-rata portion of each payment of principal received by the petitioner. This method is not correct where the books are kept on the accrual basis, as the discount is accruable as earned and not as paid and some of the payments in one year allocated to discount may be applicable to discount earned and accrued as income in a prior year. His computation of the amount of discount includable in income for each year involved is therefore disapproved, and a recomputation must be made under Rule 50.

As to the commissions earned by the petitioner on account of endorsing loans of its clients made at banks, it appears from the evidence that the petitioner received payment of its commissions by checks or time certificates, that it endorsed the checks or time certificates, and that such time certificates or checks covering the commissions were held by the banks merely as additional security or collateral for the loans. Such certificates or checks were held by the bank in the name of the petitioner and belonged to the petitioner. Such commissions represented income when the loans were made by the bank and were properly accruable on petitioner’s books of account as income in the year the endorsements were made. That petitioner permitted the bank to retain such items as security for the payment of the loans has no bearing upon the character of the payments as income. The action of respondent in so treating these commissions is therefore approved.

The amounts of the unrealized discounts on extensions or renewals and commissions for endorsing loans to be added to income have been stipulated and in the recomputation under Rule 50 effect will be given to such stipulation in accordance with our conclusions herein pertaining to such discounts and commissions. ■

No evidence was adduced by petitioner pertaining to the amount of $1,574.78 representing “Loss on foreclosures” in 1926 as adjusted by the respondent. The adjustments pertaining to this item must therefore be approved.

In 1927 the petitioner bid in three properties on foreclosure. It contends that the loss to which the petitioner is entitled on these transactions is reflected in the net loss of $5,372.25 reported in its return and disallowed by the respondent. There is no evidence to show how the petitioner computed such net loss. In the revenue agent’s report (respondent’s Exhibit A) it is stated, in substance, that the reported loss on sale of foreclosed property in the amount of $5,372.25 was disallowed on account of erroneous manner of computation, and that a recomputation had been made and the amount of $17,886.47, representing “Profit on Resale of Foreclosed Property” substituted therefor. The petitioner claims that it is entitled to a loss deduction on these transactions of the difference between the balances unpaid on the loans of $7,540.06 and the bid price of $1,500, or $6,040.06. Under article 163, Regulations 69, a deficiency on foreclosure may be deducted as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off; and in addition a loss may be deducted for the difference between the fair market value of the property and the amount of the face value of the obligations of the debtor which are applied to the purchase or bid price, to the extent such obligations represent capital or an item the income from which has been returned. A mortgagee may foreclose the mortgage upon default or bring suit upon the note or may foreclose and bring suit on the note at the same time. In O. D. 687, 3 C. B. 166, it is stated that:

* * * since tlie mortgagee may maintain an action against the mortgagor for the amount of the debt, it is not sufficient, in order to deduct the amount as a bad debt that he show only a foreclosure of the security as the mortgagor may be solvent and the debt collectible; but he must also- show that legal action against the mortgagor resulted in no recovery, or that such action would in all probability not result in the satisfaction of execution on a judgment.

No evidence was adduced as to whether the unsatisfied balance could be collected without a deficiency judgment, as to whether or not a deficiency judgment could have been or had been obtained, as to whether or not such deficiency judgment, if any, was uncollectible, or as to any other essential facts bearing upon the deductibility of the loss, if any, except the amount of the bid price, $1,500, the total amount of the indebtedness remaining undischarged, $7,540.06, and the total of the unrealized discounts, $1,180.50. There is no showing that the unrealized discounts had been theretofore reported as income. Since the respondent disallowed the claimed losses, the burden of proof rested upon the petitioner. The evidence is insufficient to overcome the prima facie correctness of the respondent’s determination.

The petitioner contends that it contracted to pay Julius Yan Raalte as compensation a certain percentage of its net earnings “be fore deduction of officers’ salaries” and that in computing such compensation the respondent used the net earnings after deduction of officers’ salaries. (Emphasis supplied.)

The contract of employment as amended, entered into between the petitioner and Julius R. Van Raalte, provides that Van Raalte is to receive 25 percent to July 1, 1926, and thereafter 33y3 percent, of the net earnings of the petitioner, net earnings to be determined by “deducting all legitimate expenses of whatever kind or character, including taxes”, from the gross earnings and a sum equal to 6 percent per annum on petitioner’s actual capital and surplus, except that “any salaries paid to Stockholders''’ of the petitioner shall not be taken into the accounting of deductible expenses. There is no reference whatever in the contract to officers' salaries. (Emphasis supplied.)

The evidence shows that the respondent, in computing the salary of Van Eaalte for the years involved, used the net income of petitioner after deduction of officers' compensation. Under the contract of employment any salaries paid to stockholders should not be deducted from gross income for the purpose of determining Van Eaalte’s compensation. The evidence shows that the petitioner had three stockholders: Simon Van Eaalte, Abe Cohn, and Lou Cohn; that Simon Van Eaalte was the president of petitioner during the years involved; and the total amount of salaries paid annually to the officers of petitioner. There is no evidence as to the amount of salary paid annually to the stockholders of petitioner, or as to who the other officers of petitioner were during such years and whether such officers were stockholders also. The evidence merely discloses the total amount paid annually to officers as salary without identifying such officers as stockholders. In the absence of proof we can not assume that all the officers were stockholders and that the salaries paid to officers were, in fact, paid to stockholders. Under the contract of employment all “legitimate expenses of whatever kind or character, including taxes”, except “salaries paid to Stockholders" were to be deducted from gross income to determine such compensation. (Emphasis supplied. ) As officers’ salaries come within the classification of “all legitimate expenses of whatever kind or character”, which were deductible, and there is no evidence showing 'the amount of “salaries paid to Stockholders”, which were not to be deducted, we 'are unable to determine that the respondent erred in deducting salaries of officers as an expense in determining the net income of the petitioner for the purpose of computing the salary of Julius E. Van Eaalte, and therefore must approve his action in this respect. The compensation of Julius E. Van Eaalte allowable as a deduction'must, of course, be recomputed by the method used by the respondent upon the net income of petitioner as recomputed under Rule 50 in accordance with this opinion.

Decision will be entered v/nder Rule 50.

         Art. 153. Uncollectible deficiency upon sale of mortgaged or pledged property. — Where mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. In addition, where the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of the face value of those obligations of the debtor, which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquisition.
      Accrued interest may be included as part of the deduction only when it has previously been returned as income.


author: Trammell :

text:
    C. W. Titus, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42268.
    Promulgated January 17, 1936.

      W. Leo Austin, Esq., and L. E. Gakill, Esq., for the petitioner.

      R. P. Eertzog, Esq., for the respondent.
   SUPPLEMENTAL OPINION.

Trammell :

This case has been reconsidered in so far as it relates to the taxable gain for 1926 derived from the sale of oil and gas leases in that year. After reconsideration we think that we were in error.

The petitioner entered into a contract in writing with the Tidal Oil Co. on February 27, 1926, the pertinent portions of which are as follows:

Therefore, for and in consideration of tile sum of one dollar ($1.00) and other good and valuable considerations in hand paid by second party, (Tidal Oil Oo.) the receipt whereof is hereby acknowledged by first party, and the mutual covenants and agreements hereinafter contained, It Ib Understood, and Agreed by and between the parties hereto as follows: * * *
Upon the approval of said titles and the execution and delivery to second party of the assignments, conveyance, orders and other papers referred to in the preceding paragraph, second party will pay to first party, as consideration for said properties, the sum of two million dollars ($2,000,000), payable as follows:
$500,000.00, in cash, upon the approval of titles and delivery of the papers above referred to;
$500,000.00 on or before September 1,1926;
$500,000.00 on or before March 1,1927; and
$500,000.00 on or before September 1,1927.

Titus agreed to furnish abstracts to the property described in Exhibits A, B, C, and D, that is, the leases, within 10 days from the date of the contract. Upon approval of titles by the attorneys for the Tidal Oil Co., Titus was to immediately execute and deliver proper assignments, together with orders on the pipe line companies which might have been running the oil from said properties, and such orders and other papers as might be required or might be necessary in order to obtain the approval of the Secretary of the Interior of the assignments covering the oil leases from the Osage Indian Tribe, and when these things had been done the purchaser agreed to make the payments. The contract also provided that certain real estate would be conveyed. It also contained the following paragraph:

It Is Understood and agreed that the leases covering the lands described in Exhibits “A”, “B” and “O” are being operated by the first party: (Titus) and that, upon the consummation of this transaction by the approval of titles and delivery of assignments and other papers as herein provided, possession of said leases is to be delivered to second party; (Tidal Oil Company) and that, pending the consummation of this transaction by the approval of titles and the delivery of possession, first party shall continue to operate said leases and will, upon delivery of possession thereof to second party, account to second party for all the oil and gas belonging to the interest in said oil and gas mining leases set forth in Exhibits “A”, “B” and “C” run from said premises or sold from said premises on and after March 1, 1926, less operating expenses — it being understood that March 1, 1926, shall be construed to mean “midnight” on the date of February 28, 1926.

The agreement also provided that certain mining equipment on the property should be included in the sale. It also contained the following paragraphs:

It Is Understood that five (5) wells are now drilling on said northwest quarter (NW%) of section twenty-nine (29), township twenty-two (22) south, range ten (10) east, being at locations Nos. 7, 9, 12, 17 and 22 on said lease; and that the conveyances provided for herein shall include the interest of first party in all equipment on the premises on March 1, 1926, for use in the drilling and equipping of said wells; but it is agreed that second party shall assume the amount agreed to be paid by first party to the contractor for the drilling of said wells, it being understood that the same shall not be in excess of two dollars and twenty cents ($2.20) per foot.
It Is Understood and agreed that the interest in said leases shall be conveyed free and clear of all and liens and encumbrances of whatsoever nature, including all taxes, general or special, for all years prior to 1926, and that any ad valorem taxes required to be paid for the year 1926, on account of said interest in said leases or any of them, shall be prorated by the parties hereto in proportion of one-sixth (1/6) by the first party and five-sixths (5/6) by second party. First party shall also pay all gross production taxes chargeable on its interest in all oil or gas produced from said properties during the months of January and February, 1926.

The contract had no fair market value.

In the previous opinion we held that a taxpayer keeping its books and records on the accrual basis is required to report the.income represented by the deferred payments, regardless of the fair market value of the deferred payments. We also held that the petitioner had failed to show that the obligations in controversy had no fair market value or a fair market value less than the amount of the face thereof. We now think that we were in error in holding that the fact that the taxpayer kept its books on the accrual method of accounting was determinative of the issue, and also think we were in error in holding that there was no evidence that the deferred payments did not have a fair market value.

The regulations of the Commissioner, approved by the Secretary, under the Revenue Act of 1921 and all subsequent revenue acts have provided in the case of the sale of real estate on a deferred payment plan, not on the installment basis, where the obligations received by the vendor have no fair market value, that the payments in cash or other property having a fair market value shall be applied against and reduce the basis of the property sold and any excess of such basis shall be taxable to the extent of the excess, and that gain or loss is realized when the obligations are disposed of or satisfied, the amount being the difference between the reduced basis above mentioned and the amount realized therefor. These regulations have met the approval of the courts in the following cases: Burnet v. S. & L. Building Corporation, 288 U. S. 406; Waukesha Malleable Iron Co., 67 Fed. (2d) 368; Commissioner v. Moir, 45 Fed. (2d) 356; and were followed by the Board in Woodmar Realty Co., 17 B. T. A. 88. See Davis v. United States (Ct. Cls.), 46 Fed. (2d) 377; Georgia-Florida Land Co., 16 B. T. A. 1253.

See also the reports of the Committee on Finance and the Ways and Means Committee in connection with the 1926 Revenue Act in the course of its passage through Congress. (69th Cong., 1st Sess., p. 19).

The Board has decided many cases of deferred payment sales of realty and casual sales of personal property without considering on what method the taxpayer kept its books. See Morrow, Becker & Ewing Co., 21 B. T. A. 1013; Charles C. Ruprecht, 16 B. T. A. 919; S. L. Meyer, Executor, 23 B. T. A. 1201; H. J. Kelly, 3 B. T. A. 257; Watson McMasters et al., Executors, 18 B. T. A. 1119; affd., 62 Fed. (2d) 81, and other cases.

In view of the foregoing, it is our opinion that a taxpayer which keeps its books generally upon the accrual basis has the right to report and have its income computed upon the basis of the deferred payment plan not on the installment basis as provided in the regulations. In this case the respondent has raised no question as to this. The only real question is whether the deferred payments had a fair market value. The Commissioner contends that they did have. The question of the accrual basis was interjected, by the Board and we now think that we were in error in doing so.

On the question of the fair market value of the deferred payments not represented by notes or other obligations of the purchaser, the Bureau ruled in G. C. M. 1387 (VI-1 C. B. 48) that in a case of a casual sale of personal property like a sale of real estate .on the deferred payment plan, not on the installment basis, where the deferred payments are not represented by notes or other obligations of the purchaser, the cash received by the taxpayer should be applied against and reduce the basis of the property sold, and if it is in excess ,of such basis, the excess should be reported as a profit. When the deferred payments are received they should be applied against the reduced basis if the initial payment was not in excess of the basis, and the excess over the reduced basis or the total amount received, as the case may be, should be included in income for the year received.

This ruling was modified in G. C. M. 3350 (VII-1 C. B. 62), wherein it was stated:

Tlie conclusion reached in that memorandum (G. O. M. 1387) should be limited to cases in which the facts are similar to those therein considered where there is involved only a preliminary contract of sale such as is not ordinarily sold or dealt in and which can not be said to have any fair market value.

In the case at bar the only instrument in writing evidencing the fact that the future payments were to be made was the executory or preliminary contract, for the making of which the purchaser did not pay anything, and the obligation to make any payments did not arise until later during the taxable year when the petitioner had carried out the terms thereof.

In the case of Charles C. Ruprecht, 16 B. T. A. 919, we held as follows:

We do not consider, however, that the respondent’s views with respect to the deferred payments are correct, for the reason that the obligation of the Standard Oil Oo. to pay was not so evidenced that it could have been converted into cash, the only record thereof being in the deed of conveyance signed by the grantors. * * * In short, the obligation of the Standard Oil Co. amounted to nothing more than a more noninterest-bearing account receivable.

We held in that case that the deferred payments to be made by the Standard Oil Co. did not have a fair market value and the Court of Appeals, in 49 Fed. (2d) 458, affirmed our decision.

In the case of Commissioner v. Moore, 48 Fed. (2d) 526, the taxpayer sold some stock for $500,000 in cash and the delivery of oil and gas income certificates entitling the taxpayer to 20 percent of the gross income in certain oil property, and it had another contract with the Sinclair Oil Co. by which the Sinclair Co. guaranteed that if the seller received less than $2,500,000 from the oil income it would make up the difference and bound itself to purchase the certificates for $2,500,000. The court read the two contracts together, holding that the taxpayer sold its stock for $3,000,000, $500,000 in cash and $2,500,000 in deferred payments which were guaranteed by the Sinclair Oil Co. The court held that, the sales on the deferred payment plan being casual sales, the taxpayer had the right to report it, as it did, as the income came in. The court said that the taxpayer returned the income from the sale in the gross income for the taxable year in which received by the taxpayer, proportioning the income from the sale as the cash was received.

The obligation of the Sinclair Co. to take the certificates at a fixed amount overcame any contingency which might have resulted from the agreement to take oil, so the decision was not based on the principle of the case of Burnet v. Logan, 283 U. S. 404.

The case of Commissioner v. Garber, 50 Fed. (2d) 588 (C. C. A., 9th Cir.), involved the same transaction as was involved in the Moore case, supra. The court, quoting from the Moore case, said:

In 1918 the taxpayer had not realized all the profit from this sale. The profit was realized as they received the deferred payments. Aside from the $500,000, they received nothing in. 1918 but a share in oil produced in later years and an agreement of the Sinclair Company. While the Sinclair Company was then, and now is, a solvent corporation, the fact still remains that the taxpayers did not realize the profit from the sale in 1918, but realized the profit during the ensuing years; and it is the general contemplation of the statutes that a tax shall be levied on profits which are realized! and not deferred. * * * he has not actually received that profit; he has received no income out of which to pay the tax; the statute and. the regulations give him the right to spread the tax; to deny him the right would, in our opinion, result in a hardship to taxpayers generally. [Italics supplied.]

The court further stated:

With this holding we are entirely in accord. Such a view is based upon sound public policy as well as upon written law * * *. It precludes the possibility of a sudden change of theory after the statute of limitations has run. It does mathematical justice between the government and taxpayer.

In the case of Bedell v. Commissioner, 30 Fed. (2d) 622, the court said:

But if land or a chattel is sold, and title passes merely upon a promise to pay money at some future date, to speak of the promise as property exchanged for the title appears to us a strained use of language, when calculating profits under the income tax. Section 202 (b) of the Act of 1918 provided for an exchange of property and made the profit depend upon “the amount of its (the property received) fair market value, if any” — a phrase which was amended in the law of 1921 * * * to “readily realizable market value.” There is a difference between the two, but it is absurd to speak of a promise to pay a sum in the future as having a “market value”, fair or unfair. Such rights are sold, if at all, only by seeking out a purchaser and higgling with him on the basis of the particular transaction. Even if we could treat the case as an exchange of property, the profit would be realized only when the promise was performed.

In the case of Calvin T. Graves, 17 B. T. A. 1318, the petitioner sold certain lots to purchasers for a down payment, receipt of which was acknowledged in the written contract and the agreement to make certain payments in the future with interest at the rate of 6 percent per annum. The written instrument also contained the following:

It is further agreed that if the party of the second part defaults in the monthly payments herein provided, for a period of thirty days after any of said payments shall become due and payable, that then the balance remaining unpaid, together with the interest thereon as above provided, shall immediately become due and payable, anything herein contained to the contrary notwithstanding, or the said parties of the first part may, at their option, declare this agreement at an end, and thereupon the said party of the second part agrees, upon receipt of written notice from the said parties of the first part of their election to declare this agreement at an end to surrender possession of said premises and to surrender the duplicate of this agreement properly cancelled without foreclosure proceedings or other process of law.

The agreement also provided for the payment of all taxes against the property which were due and payable at the date of the instrument. No note or any kind of security was received by the vendor for the unpaid part of the purchase price. We held that those sales in which the initial payment did not exceed 25 percent should be reported on the installment basis, and where the initial payment exceeded 25 percent, upon the deferred payment plan, not on the installment basis in which deferred payments had no readily realizable market value (this being under the 1921 Act), notwithstanding the fact that the deficiency was determined on the accrual basis. We did not inquire into the solvency of the purchaser. The obligation to pay on behalf of the purchaser was just as much a binding obligation in that case as in the case at bar, notwithstanding the fact that the seller had the option in case of default to declare all payments made in case of default as forfeited and to recover the property. This was not a right or option on the part of the purchaser and he would have been held to his legal liability on the written contract for the deferred payments.

In the case of A. W. Henn, 20 B. T. A. 1133, the petitioner sold certain leaseholds. He had an interest with another person. There was a contract in writing between the vendors which provided that the vendee should assume certain obligations of the third party to the vendors and should pay that obligation, $10,000 in cash, $10,000 in 60 days, $10,000 in 120 days, and $12,441.41 in 180 days, the deferred payments to draw interest at 6 percent. The vendor agreed that upon completion of the payments he would transfer and deliver the property to the purchaser. This contract was entered into in 1923. We held that only the cash received in 1923 was taxable in that year, and, the cash received in 1924 was taxable in that year. We said:

Tfie evidence is that no promissory notes or other evidences of indebtedness were received from the 1600 Prospect Co. in connection with the transaction under consideration. * * *
The assumption and payment by the George W. Stone Co. of the 1600 Prospect Co.’s indebtedness to the petitioner was the consideration for the assignment of that indebtedness and the transfer of 50 shares of common stock of the 1600 Prospect Co. by the petitioner to the George W. Stone Co. Thus it appears that as the indebtedness was paid by the George W. Stone Co., there was a realization upon (1) the indebtedness of the 1600 Prospect Co. amounting to $42,441.41 ($41,487.29 assumed indebtedness of the Prospect Avenue Account and interest of $954.12), and (2) the selling price, if any, of the 50 shares of stock of the 1600 Prospect Oo. * * *
Based upon the evidence and the admissions of counsel for the respondent at the hearing, there are findings of fact that the net incomes reported by the petitioner in his returns for 1923 and 1924 were computed upon the cash receipts and disbursements basis, and that the respondent’s determination of deficiencies for those years is based upon net incomes computed upon the same basis. Under these findings, it is clear that the respondent erred in holding that the entire profit from the sale of the Hatch and Dagleisch leaseholds was realized in 1923, because a substantial part of the consideration involved in that transaction was not received until 1924.

In the case of W. A. Hoult, 23 B. T. A. 804, the petitioner exchanged his stock in one corporation .for stock and securities in a new corporation and in a separate transaction sold part of the stock and securities of the new corporation. The contract of sale wag in writing. A part of the consideration was in cash and the balance was to be paid in the year following the sale. The first payment was made on December 8, 1925, and the balance was paid in 1926 in accordance with- the contract. Basing our decision upon the case of Charles C. Ruprecht, supra, and A. W. Henn, supra, we held that only the cash received in 1925 was subject to taxation in that year. We said:

Only the cash received in 1925 should be considered as “realized” in determining the gain taxable to petitioner for the year 1925.

In both of the above cited cases there were written contracts setting forth the payments to be made.

In the case of Dudley T. Humphrey, 32 B. T. A. 280, there was evidence that the nonnegotiable promissory notes did not have a fair market value. This evidence consisted, of the testimony of the petitioner, himself, to the effect that the notes received were nonnegotiable and, being nonnegotiable, did not have any fair market value. On the other hand, financial statements were introduced showing that the purchaser, that is, the maker .of the notes, had net assets in excess of the amount of the notes even by using the book values of the securities owned by the purchaser, which had greatly increased in value. The basic evidence in the case as to the fair market value of the notes consisted of the fact that the notes were nonnegotiable, and, being so, had no fair market value. We said “A mere promise to pay in the future which is not accepted in payment, but only as an evidence of indebtedness, is not ordinarily the equivalent of cash”, and the Bedell case, supra, was cited and relied on. Here the contract itself obviously only represented the evidence of the indebtedness and was not, itself, accepted in payment for the property.

In none ,of the foregoing cases was there any evidence introduced directed to the question of the fair market value of the promise to pay, except in the case of Dudley T. Humphrey, supra, discussed above.

In all of the court decisions above discussed the courts took the position that, when evidence was introduced showing that the deferred payments were evidenced only by contract, where no notes, bonds, or other evidences of indebtedness other than the contract were given, such contract had no fair market value, and that the amounts of the deferred payments should be included in income when received. In the Ruprecht case, supra, the only evidence of the deferred payments was contained in the deed of conveyance. Based on this finding we held that the deferred payments did not have a fair market value. Our conclusion was based on the fact that the vendor had nothing that he could take to anyone to sell; he had nothing except an account receivable. In this case, while the petitioner had a written contract, there was nothing in the contract itself to indicate when, if ever, the purchaser would become bound to make the payments. To show that the purchaser had become bound to make the payments would have required extrinsic evidence. There were certain things required to be done by the vendor under the terms of the contract before the delivery of the deed or before the vendor was obligated to accept it. Evidence of delivery and acceptance of the deed was a sine qua non to any liability. When this was established there would have been a prima facie obligation to make the full payments as provided in the contract, yet an assignee would have been entitled to know beyond a prima facie case that all the obligations of the purchaser had definitely arisen, that is, that all titles were good, all transfer orders were made, approval of the Secretary of the Interior secured as to the leases from Indian tribes, and other things required had been done. After the delivery of the deed there was still an accounting to be had between the vendor and vendee for all the oil produced since the execution of the contract, and other adjustments were required. In any event, the petitioner, itself,, after the delivery of the deed, was possessed of nothing in writing to show that it had fully complied with the executory or preliminary contract to make it obligatory on the purchaser’s part to make the payments, except possibly its books and records, which would show the account receivable, but the record is silent as to whether any liability was' ever shown on the books. We think, therefore, that the principle of the Ruprecht case, supra, as well as the court decisions and other Board cases herein referred to, are applicable in this case. In the cases of Henn, supra, and Hoult, supra, where the deferred payments were evidenced by contracts in writing, we followed the Ruprecht case.

In order for the petitioner to bé able to convert the promise to pay into cash it would have had to produce and deliver to a purchaser the evidence of liability to pay. Only a conditional or contingent liability is shown by the instrument itself. The real liability in this case could be shown only by oral testimony, and, while we have assumed from the record that the sale was consummated in 1926, there is no direct and conclusive evidence to that effect. An obligation to pay in the future which depends so largely on oral evidence to support it, in our opinion, can not be said to have a fair market value, aside from the reasoning of the courts and the Board as to written contracts, and in this case, even after the sale had been consummated, there was still an accounting to be had for oil produced since the making of the executory or preliminary contract. The purchaser would have had an offset for an undetermined amount after the delivery by petitioner of all papers required to be delivered until such time as petitioner fully settled on the basis of such accounting. This fact, in connection with all the facts and circumstances, convinces us of the lack of any fair market value of the deferred payments.

Upon reconsideration, therefore, it is our opinion that the petitioner had the right to include in its taxable income for 1926 only the cash received. Petitioner had the right to have his tax computed upon the basis of the deferred payment plan, not on the installment basis. We think we were in error in our previous decision and it is, therefore, modified in accordance with the opinion herein.

Judgment will be entered under Rule 50.