author:
Matthews :
      Murdock,

text:
    Spring City Foundry Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 21169.
    Promulgated March 10, 1932.

      Richard H. Tyrrell, Esq., foi the petitioner.

      L. A. Luce, Esq., for tne respondent.
   OPINION.

Matthews :

1. The first issue before us is whether the petitioner is entitled to any deduction for the year 1920 on account of the debt owed by the Cotta Transmission Company on its notes and open account in the total amount of $39,983.27. The respondent has allowed $28,715.76, the amount of the debt less the amount received by the petitioner as dividends from the debtor’s trustee in bankruptcy, as a deduction in 1923.

The debt was charged off in its entirety on December 28, 1920, by the petitioner in good* faith and in the belief that little, if anything, would be paid by the receiver on its claim, and having charged off the entire amount in 1920, it returned as income in 1922 and 1923 the amounts received in those years as trustee’s dividends.

The evidence in this case convinces ns that the debt was not entirely worthless at the time of the charge-off on December 28, 1920. The citizens of Rockford had, on November 4, offered to purchase the plant and assets at 33% per cent of the creditors’ claims. This offer was declined and the citizens raised it to 40 per cent, payable on or before December 15, the time for payment being extended a week. They were not able, however, to raise the 40 per cent. The creditors then filed a petition in bankruptcy. The inability of the citizens of Rockford to raise the 40 per cent offer, which was accepted, raises doubt as to whether the same persons could have raised even the 33% per cent offer which was rejected. The fact that the creditors filed a petition in bankruptcy at the expiration of the time, as extended, in which the 40 per cent was to be raised indicates that the creditors shared this doubt. It also indicates that they hoped to realize more through bankruptcy proceedings than the citizens of Rockford could pay. However, assuming that the creditors’ claims were worth 33% per cent of their face value at the time of the first offer, the effect of the taking over of the property of the debtor by the receiver was to reduce the amount which the creditors would ultimately receive, at least to the extent of the receivership costs. The amount ultimately received — 27% per cent — is strongly confirmatory of this conclusion. Therefore, taking all facts into consideration as they existed at the time of the charge-off of the entire indebtedness, we think that a reasonable estimate of the cost of the receivership would have been at the least an amount equal to the difference between the 33% per cent and the 27% per cent of the creditors’ claims ultimately received. We conclude, therefore, that the debt was worthless to the extent of $28,715.76 at the time of the charge-off on December 28, 1920. As the debt was not wholly worthless when charged off, the question in controversy is whether the petitioner is entitled to any deduction within the taxable year.

Section 234(a) of the Revenue Act of 1918 provides that in computing the net income of a corporation

* * * there shall be allowed as deductions:
* * * * * * #
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
(5) Debts ascertained to be worthless and charged of£ within the taxable year ;
* * * * * • * *

The petitioner contends that if the whole debt is not deductible as such in 1920, it is still deductible as a loss under the doctrine of Sherman & Bryan, Inc. v. Commissioner, 35 Fed. (2d) 713, and Davidson Grocery Co. v. Commissioner, 37 Fed. (2d) 806; that, while the cases cited allowed a deduction as a loss of that part of the debt which was never collected, they did not so limit the rule; and that petitioner’s loss was established by the turning over of the Cotta Company’s business to the creditors in October, 1920, or, in any event, by the filing of the petition in bankruptcy and the appointment of the receiver in December, 1920.

As the debt was not wholly worthless in 1920, petitioner did not sustain a loss in that year equal to the total amount of the debt, and the Sherman & Bryan decision is not authority for the deduction of the full amount of the debt under such circumstances.

Petitioner further contends that the item of $39,983.27 never was income and should be eliminated from its gross income for 1920; that what is taxed is real and not supposed income. In support of this contention, petitioner quotes extensively from the opinion in Corn Exchange Bank v. United States, 37 Fed. (2d) 34, a case in which the question involved was whether interest accrued to December 31, 1918, on loans made by the Corn Exchange Bank to a company which went into receivership on December 31,1918, and of which the taxpayer was advised on December 31, 1918, was required to be included in the return for 1918 as an item of accrued income. The court held that the item should not be treated as accrued income. Petitioner argues that, regardless of questions of deductibility, the deficiency assessed must be set aside upon the ground that it is levied upon an item which never was income.

The item here in question represents the amount due petitioner for goods purchased by its debtor in 1920, and such amount includes the cost to petitioner of the goods sold as well as the expected profit on the sale. We think the cases are distinguishable on their facts.

Finally, petitioner submits that should the Board decide that the full amount of the debt is not deductible either as a bad debt or as a loss, and that the amount in question should not be excluded from gross income, it is entitled, under the decisions in Sherman & Bryan, Inc. v. Commissioner, supra, and Davidson Grocery Co. v. Commissioner, supra, to a deduction from 1920 income of at least $28,715.76, the difference between the principal amount of the claim and the dividends received from the trustee in bankruptcy.

The Treasury interpretation of section 234 of the 1918 Revenue Act is that no deduction is allowable under that act for a debt worthless only in part. Article 151, Regulations 45. This Board adopted the same construction in its earlier decisions, and it is urged upon us by the respondent’s counsel that the matter is concluded by those decisions, citing Steele Cotton Mill Co., 1 B. T. A. 299; Murchison National Bank, 1 B. T. A. 617; Toccoa Furniture Co., 12 B. T. A. 804; Milwaukee Lumber Co., 17 B. T. A. 163; and Minnehaha National Bank v. Commissioner, 28 Fed. (2d) 763.

AJI of the decisions cited by respondent were prior to the Sherman & Bryan decision and on their facts are distinguishable from Sherman & Bryan. In Minnehaha National Bank v. Commissioner, supra, notes either made or endorsed by an individual were written down because the bank officers believed they could not collect the entire amount of the notes. The individual was not in bankruptcy.

In the Sherman case the taxpayer, a corporation, was creditor of a motor truck company on an open account. The year involved was the petitioner’s fiscal year ending September 20, 1920. In November, 1919, an equity receiver was appointed for the debtor company and the taxpayer filed its claim as a general creditor. No dividend was paid in the taxpayer’s fiscal year 1920; and in that year the taxpayer, after investigation, charged off the debt as worthless. The Commissioner disallowed the deduction on the ground that the debt was worthless only in part. A dividend, the amount of which was not shown in evidence, was paid in 1921. The instant case, therefore, appears to be on all fours with the Sherman case, so far as all material facts are concerned.

The Circuit Court held that the taxpayer’s determination that the debt was wholly worthless in 1920 was not a reasonable conclusion of the taxpayer after an adequate investigation, on this point sustaining this Board’s decision in the same case, 9 B. T. A. 213. With respect to the ascertainment of worthlessness, the court said:

* * * While we have no doubt of the bona fides of Mr. Sherman’s belief that the debt was worthless, we are not convinced that he had ascertained it to be worthless, within the meaning of the statute. To ascertain is to make sure by investigation, and it is conceded that to justify charging off a debt for tax purposes the taxpayer must make a reasonable investigation of the facts and draw a reasonable inference from the information thus obtainable. * * *
While creditors are not required to be “ incorrigible optimists ”, they may not be unduly pessimistic when claiming deductions for worthless debts. We are not satisfied that the petitioning taxpayer’s determination that its debt was wholly worthless was a reasonable conclusion after adequate investigation. * * *

The other issue of law considered by the court in the Sherman case was the deductibility under the 1918 Act of so much of the debt as was proved worthless. The Government had contended that a debt worthless in part was not deductible under that act and that such construction was supported by the fact that Congress, in the 1921 Act, permitted a deduction for a partial charge-off. The court pointed out that subsequent legislation was not conclusive that the construction claimed for the earlier act must be accepted, and said that “ debts ascertained to be worthless ” might reasonably be construed to mean “ indebtedness ascertained to be worthless ” and to permit a charge-off of such part of a claim as was proven to be un-collectible by so definite an event as seizure of the debtor’s property by a receiver. The court held, however, that it was unnecessary to decide this point because “ if clause (5) does not permit a deduction, we think it may be made under clause (4).” The Government urged that clauses (4) and (5) were mutually exclusive and that since clause (5) covered losses arising from worthless debts, clause (4) must cover only losses otherwise arising. As to this contention, the court held that since the argument assumes that clause (5) does not permit the charge-off of a debt partially bad, there would seem to be no inconsistency in allowing the partial loss under clause (4), even if the two clauses were deemed mutually exclusive, pointing to the fact that it had not been authoritatively determined that they were mutually exclusive. After quoting from United States v. White Dental Co., 274 U. S. 398, to the effect that the statute contemplated the deduction of losses “fixed by identifiable events,” and “in the case of debts, by the occurrence of such events as prevent their collection,” the court said:

The seizure of the debtor’s property by a receiver prevents collection, and definitely fixes the loss to be the difference between the face of the debt and whatever dividend the receivership may pay. The Commissioner’s position leads to the conclusion that, if any dividend is likely, no loss can he deducted until the receivership is wound up, which may be many years later. Business men do not carry on their hooks at face value claims against a debtor in receivership, and it cannot be supposed that the Revenue Act of 1018 was intended to require them to do so. When a creditor’s debtor goes into receivership, and the creditor believes the debt to he worthless and charges it off, he recognizes that lie has sustained a loss at least to the extent that the receivership dividend which may thereafter be declared leaves the debt unpaid. Presumptively the taxpayer’s decision that a debt is worthless, and so charged off, measures his loss. If the Commissioner surcharges his return because of a mistake as to the amount of the loss, we think he should not surcharge for so much of the loss as he admits has been suffered. No judicial decision has been found which contradicts this view.

The Sherman case was followed by the District of Columbia Court of Appeals in the Davidson case, that case presenting somewhat similar facts, the principal difference being the partial charge-off made by the taxpayer in the latter.

Although in terms the court allowed the deduction of so much of the debt as was determined to be worthless, as a loss, it made the basis of such allowance the ascertainment of worthlessness and the charging off which the statute requires in the case of bad debts, and made it clear that in its opinion the statute respecting the deduction of debts “ ascertained to be worthless ” did not prohibit the deduction of so much of the claim as was definitely determined to be worthless and charged off. The effect of the court’s decision is to hold that the Revenue Act of 1918 permits a taxpayer to charge off that part of a claim against a debtor in receivership which has been ascertained to be worthless. We agree with this construction and, further, think that the amount thus ascertained to be worthless and charged off in the taxable year is a loss deductible under (5) as a debt ascertained to be worthless and charged off.

A debt which becomes worthless in whole or in part is a loss to the extent of the worthlessness. Such a loss is deductible in the taxable year in which the debt is ascertained to be worthless and charged off. There is no provision in the statute under which such a loss may be deducted in any other year than the one in which the ascertainment of worthlessness and charge-off occur. The statute makes the allowance of a deduction for worthless debts mandatory: “ * * * there shall be allowed as deductions, * * * debts ascertained to be worthless and charged off within the taxable year.” To hold that the language used applies only to those debts ascertained to be totally worthless and charged off and not to debts ascertained to be worthless in part and charged off, would result in a discrimination between creditors with wholly worthless debts and those with debts worthless only in part. As was said by the court in the Sherman case, business men do not carry on their books at face value claims against a debtor in receivership, when it is definitely known that the claims can not be paid in full, and it can not be supposed that the Revenue Act of 1918 was intended to require them to do so until final liquidation of such claims in order to claim any deduction on account of such loss. The change in the Revenue Act of 1921 which allows the deduction of that part of a debt ascertained to be worthless and charged off may well indicate the unexpressed intention of the Revenue Act of 1918; that is to say, the new provision may well be regarded as declaratory of the meaning of the same provision of the 1918 Act. In this view of the matter, that part of a debt which the creditor upon a reasonable investigation of all the facts determines to be worthless and charges off is a “ debt ascertained to be worthless and charged off ” within the meaning of the statute, and is deductible as such.

In the instant case, as in the Sherman case, the petitioner was unduly pessimistic in determining that the debt was totally worthless. A reasonable inference from the facts available at the time of the charge-off justifies the inference that the debt was worthless at least to the extent of $28,715.16, and we think that this amount is deductible in the year 1920.

2. With respect to the second issue, we find, after a careful review of the facts and petitioner’s arguments predicated upon them, no abnormality and therefore no proper basis for special assessment. The petitioner has not established that any ground for special relief exists by reason of its officers’ salaries. The application rests, therefore, principally upon the petitioner’s allegation that so large a part of the capital employed in its business was borrowed and its statutory invested capital consequently so low as to be disproportionate to the volume of its sales and statutory net income. It was shown that petitioner had an average borrowed capital, based on monthly balances, in 1920, of $114,095.77, and of this amount $89,934.23 constituted “ two-name (discounted) paper.” Blair, president and treasurer of the petitioner, testified that the figures under this heading represented promissory notes made payable to the petitioner and given to it by its various debtors, which were discounted after indorsement by the petitioner at the bank.

This Board has held that the discounting of negotiable promissory notes does not constitute borrowing capital and is not a pledge of the notes for the amount so borrowed, but is in effect the sale of the notes to the indorsee. American National Bank of St. Paul, 14 B. T. A. 476. The Board stated its conclusion therein:

From the cases and texts above cited, it seems to be well settled that to discount negotiable paper is to sell it. "We have found no provision in the Reserve Banting Act which changes such generally accepted principle as to transactions between Federal Reserye Banks and member banks. It follows that petitioner sold its rediscounted paper to the Federal Reserve Bank and that such bank thereby became owner in exactly the same sense that petitioner owns the notes it discounts for its customers. The respondent’s determination is approved.

If we deduct, then, the amount of discounted paper, we find that the petitioner’s average borrowed capital in 1920 was approximately $24,000, or about 15 per cent of the statutory invested capital of $157,000, certainly not a sufficient amount to create an abnormal condition. In Higginbotham-Bailey-Logan Co., 8 B. T. A 566, it was shown that 40 per cent of the petitioner’s operating capital was borrowed, but the Board said:

* * * In many businesses this would not be regarded as unusual or abnormal and in the absence of any evidence that it is abnormal in the wholesale dry goods business, there is nothing on which we may base an opinion as to normality or abnormality.

We do not find in the petitioner’s situation any abnormality to justify the allowance of special assessment under section 327.

Reviewed by the Board.

Judgment will be entered wider Buie 50.

SteRnhagen dissents.

Murdock,

dissenting: The prevailing opinion allows the petitioner to deduct in the year 1920 a portion of a debt owed to it by the Cotta Transmission Company. The Board has consistently held in at least twenty-three cases that under the Revenue Act of 1918 no deduction may be taken where a taxpayer ascertains that a debt is recoverable only in part. It has held that under that act there may be no deduction for a bad debt prior to the time that the taxpayer ascertains that the debt is wholly worthless. The regulations of the Commissioner promulgated under revenue acts prior to the Revenue Act of 1921 have provided to the same effect. Decisions of the Board in which it has made such a ruling have been affirmed on appeal in at least three instances. See also Selden v. Heiner, 12 Fed. (2d) 474. In two instances such decisions of the Board have beeti reversed. One of the two cases in which the Board has been reversed on this question is Sherman & Bryan, Inec. v. Blair, 35 Fed. (2d) 713. There the court did not decide the question whether partial worthlessness could be deducted under the Revenue Act of 1918, but held that in any event the amount could be deducted as a loss. I believe that the bad debt and loss provisions of the revenue acts are mutually exclusive, even though I concede that in ordinary parlance a bad debt would be considered a loss. Cf. Lafayette Lumber Co., 20 B. T. A. 993. The other reversal was in Davidson Grocery Co. v. Lucas, 37 Fed. (2d) 806, where the court approved the reasoning in the Sherman & Bryan case. With all due respect to these courts, I find myself unable to agree with their reasoning and feel that until some more compelling reason appears, the Board should be consistent and follow its former decisions. Minnehaha National Bank v. Commissioner, 28 Fed. (2d) 763. Cf. Collin County National Bank v. Commissioner, 48 Fed. (2d) 207.

Van Fossan, McMahon, Goodrich, and Leech agree with this dissent.


source: Caselaw Access Project

author: MaRQuette:

license: Public Domain

text:
    Theron E. Catlin, Petitioner, v. Commissioner of Internal Revenue, Respondent. Irene C. Allen, Petitioner, v. Commissioner of Internal Revenue, Respondent. Daniel K. Catlin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 25413, 25414, 25421.
    Promulgated March 11, 1932.

      E. G. Curtis, Esq., and D. N. Kirby, Esq., for the petitioners.

      C. H. Curl, Esq., for the respondent.
   OPINION.

MaRQuette:

The first question here presented is whether under the trust agreement of October 31, 1916, the beneficiaries of the Catlin Estate may, as individuals, deduct losses sustained by the sale of capital' assets of the estate.

It is clear, we think, that the trust in question was revocable. The respondent so treats it, and the facts sustain that view. While the trust agreement did not contain an express power of revocation, in Tiaee verba, it did permit any or all of the beneficiaries to alienate his or her interest in the trust assets at any time. The settlors of the trust were the sole beneficiaries in exactly the same proportions as were their contributions to the trust, and they were also the re-maindermen. Throughout the taxable years the present petitioners were the only settlors and beneficiaries of the trust, in equal proportions ; two of them were trustees, while the third trustee was the husband of the third settlor-beneficiary, and the trust was revoked by the settlor-beneficiaries, the petitioners herein. These facts bring the present proceedings into close analogy with the cases of Stoddard v. Eaton, 22 Fed. (2d) 184; Selah Chamberlain, 19 B. T. A. 126, and Trudie T. Munger, 16 B. T. A. 168. Each of those cases dealt with a revocable trust and it was held in each that sales of securities which had been nominally placed in trust by the settlor-beneficiary were not sales of trust property within the meaning of the Revenue Acts of 1918 and 1921, and that losses sustained on such sales were deductible by the settlor-beneficiary from his personal income.

In support of his contention that the petitioners, as beneficiaries of the trust, are not entitled to make such deductions, respondent cites Baltzell v. Mitchell, 3 Fed. (2d) 428; Abell v. Tait, 30 Fed. (2d) 54; Arthur H. Fleming, 6 B. T. A. 900; Mary P. Eno Steffanson, 1 B. T. A. 979; George M. Studebaker, 2 B. T. A. 1020; Henry Stoddard, 3 B. T. A. 79; and Helene R. McConnell, 3 B. T. A. 260. Apparently none of those decisions, except that of Henry Stoddard, dealt with a revocable trust such as we are now considering, and the Board’s decision in the Stoddard case was virtually overruled by the United States District Court in Stoddard v. Eaton, supra. The court was there dealing with the Revenue Act of 1918, section 219; but, so far as it is here applicable, the language is identical with that in the Revenue Act of 1921. In reaching its conclusion in that case the court said:

After all, the word “ trust ” as used in section 219 of the Revenue Act of 1918 (Comp. St. Sec. 6336% ii), can hardly have been intended to comprehend every instance in which a trust is recognized in equity. A trust ex maleficio, a resulting trust, or a constructive trust are examples of trusts which do not fit into the frame of the statute. A trust, as therein understood, is not only an express trust, but a genuine trust transaction. A revenue statute does not address itself to fictions.
The policy of the law is now more clearly expressed in the language of the acts of 1924 and 1920, which provide (43 Stat. 275, and 44 Stat. 32 [(26 U. S. C. A. Sec. 960 subd. (g)] that, where a grantor of a trust reserves the power to revest himself with the title to any of the corpus of the trust, then the income of such part is the income of the grantor.
While the Act of 1924 is not applicable to the case at bar in the sense that the statute is not retroactive, nevertheless the action of Congress under the circumstances may well be regarded as a clarification of an originally obscure expression of legislative intent.

In view of the surrounding circumstances, we are unable to agree with respondent’s contention. Following the decisions in Stoddard v. Eaton; Selah Chamberlain; and Trudie T. Munger, supra, it is our opinion that the sales of securities during 1922 and 1923 were not sales of trust property within the meaning of section 219 of the Revenue Act of 1921, and that losses sustained by reason of those sales were properly deductible by petitioners individually and pro rata for the respective years, unless such losses were otherwise nondeductible.

The respondent contends that the stock-sale transactions between Justina G. Catlin, mother of these petitioners, and the trust estate, were not bona fide and that therefore the alleged losses were not deductible. There is no dispute as to losses from stocks sold on the market, nor as to the amounts of losses sustained.

We are unable to concur with the respondent’s view. While transactions of the sort in question may call for careful scrutiny, the record discloses actual sales, for cash, at the regular market prices of the stocks sold. After Justina G. Catlin purchased the securities from the trust estate she retained them as investments. There is nothing in the evidence to indicate that she was not fully competent to conduct business transactions, or that either she or the trustees were the victims of fraud, deceit or misrepresentation with respect to any of their mutual dealings in 1922 and 1923. We are not aware of any rule of law by which the stamp of bad faith attaches to a business transaction between parent and child, ipso facto, where each party is legally capable of conducting his affairs, as was the case here. Nor is there anything inherently wrong or contrary to the statute in so conducting one’s affairs that his income tax may be thereby reduced.

Our conclusion, therefore, is that each petitioner is entitled to deduct his proportionate share of the losses from the sales of stock in each year.

Decision will be entered v/nder Rule 50.


author: Van Fossan:

text:
    Lee Wilson & Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 33826.
    Promulgated March 11, 1932.

      George H. Goodner, Esq., and F. G. Rohwerder, O. P. A., for the petitioner.

      Eugene Harpole, Esq., and E. M. Niess, Esq., for the respondent,
   OPINION.

Van Fossan:

The first issue raises the question of whether the assessment and collection of deficiencies for the fiscal years ended January 31, 1922 and 1923, were barred by the statute of limitations prior to the date when tine final deficiency notice was mailed on November 17, 1927. Our findings set forth the facts that as to the said years waivers were executed prior to the expiration of the four-year period of limitations provided for by section 250(d) of the Revenue Act of 1921, and reenacted in the later revenue acts, and that such waivers, if valid, extended the period until December 3.1, 1927, which is subsequent to the date when the deficiency notice was mailed. The petitioner disputes the validity of these waivers and argues that the respondent has failed to establish that such waivers were signed by the Commissioner personally or by some one properly authorized to sign his name, and, further, that respondent has failed to establish the date on which the Commissioner’s name was signed on the waivers and whether they were signed before or after December 31, 1927. The signature of R. E. Lee Wilson, Sr., Trustee, affixed to each of the three waivers, is not disputed, nor is there any dispute as to the dates during the month of December, 1926, appearing at the head of the waivers. One waiver, pertaining to the year ended January 31, 1922, shows that it was approved by the Commissioner or his deputy on December 31, 1926. A waiver is not a contract and the Commissioner’s signature is required purely for administrative purposes and not to convert into a contract what is essentially a voluntary, unilateral waiver of a defense by a taxpayer, Stange v. United States, 282 U. S. 270, and Aihen v. Commissioner, 282 U. S. 277, and there can be no doubt that the Commissioner may authorize one or more persons to sign his name to meet the exigencies of such purely administrative duties. There is nothing in the requirement for the Commissioner’s signature which limits the period during which a waiver may be effectively given, Aiken v. Commissioner, supra, and the signature of a Commissioner to a waiver of limitations is presumed to have been placed there by his authority, Trustees for Ohio and Big Sandy Coal Co. v. Commissioner, 43 Fed. (2d) 782. Each of the waivers here in question is regular on its face and the petitioner has not proven any irregularity as to signature or date. The waivers are valid. Cf. Tameling v. Commissioner, 43 Fed. (2d) 814. Accordingly, assessment and collection of the deficiencies for the years ended January 31, 1922 and 1923 are not barred. Also cf. Pantages Theatre Co., 17 B. T. A. 82; affd., 42 Fed. (2d) 810; certiorari denied, 282 U. S. 890; Fruit Growers Supply Co., 21 B. T. A. 315. The case of Corn Products Refining Co., 22 B. T. A. 605, relied on by petitioner, is clearly distinguishable from the instant case on the facts.

The second issue has been disposed of by the stipulation of the parties to the effect that the net income of petitioner as determined by respondent for the fiscal year ended January 31, 1924, is overstated by the amount of $13,590.84.

The third issue involves the question of whether petitioner is entitled to deductions, in each of the years in question, of certain portions of taxes assessed by drainage, road and levee districts which extended through petitioner’s lands. We have briefly set forth in our findings of fact the allocation of the said taxes paid by petitioner in each of the years in question, which allocation is based upon the stipulation, testimony and records submitted in evidence.

Section 234 (a) (3) of the Revenue Acts of 1921 and 1924 provides that, in computing the net income of corporations subject to the tax imposed by section 230 of such acts, there shall be allowed as a deduction “ taxes paid or accrued within the taxable year except (c) taxes assessed against local benefits of a kind tending to increase the value of the property assessed.”

The Commissioner’s Regulations 62 and 65, articles 133 and 561, provide that taxes assessed against local benefits such as sidewalks, streets and other' improvements are not deductible under the above quoted section of the revenue acts, and also that:

* * * Assessments under the statutes of California relating to irrigation and of Iowa relating to drainage, and under certain statutes of Tennessee relating to levees, are limited to property benefited, and when it is clear that the assessments are so limited, the amounts paid thereunder are not deductible as taxes. When assessments are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct the assessments paid as an expense incurred in business, if tbe payment of sucb assessments is necessary to the conduct of his business. When the assessments are made for the purpose of constructing local benefits, the payments by the taxpayer are in the nature of capital expenditures and are not deductible. Where assessments are made for the purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the allocation of the amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so paid is deductible.

No question has been raised as to the fact that the amounts paid to the said districts by petitioner constituted taxes duly assessed and collected by the several districts pursuant to the statutes of Arkansas. Our only question is whether that portion of such taxes used for interest, maintenance, repairs and expenses is deductible for the purpose of determining petitioner’s net income. In the case of Andrew Little, 21 B. T. A. 911, we held that a tax, assessed and paid to an Idaho irrigation district for the purpose of meeting interest on that district’s bonds, was not a tax of a kind tending to increase the value of the property assessed, and, therefore, was deductible as a tax under section 214 (a) (3) of the Revenue Act of 1921. Under authority of that decision we hold that the portion of taxes paid by this petitioner 'and allocated to interest for each of the years is deductible, namely, the amounts of $20,517.04, $22,259.22 and $23,381.49 for the years ended January 31, 1922, 1923 and 1924, respectively.

The Commissioner’s regulations have provided for the deduction of that portion of such local benefit taxes as may be allocated to maintenance and repair of local improvements such as irrigation works, levees and drainage ditches. We agree that such amounts should be allowed as deductions. Respondent has arbitrarily classed such items as expenses incurred in business, although in fact they were paid out as taxes. Since either is allowable as a deduction it is unnecessary to decide which is the correct terminology. We are of the opinion that the portion of taxes paid by this petitioner and allocated to maintenance, repairs and expenses for each of the years is deductible, namely, the amounts of $9,764.28, $11,668 and $4,539.46, for the fiscal years ended January 31, 1922, 1923 and 1924, respectively.

The fourth issue involves the question of deduction for each of the years for depletion of timber. The respondent in his determination of the deficiencies in question has allowed certain deductions for each of the years for depletion of timber on the Wilson tract and also has allowed deductions of $2,568.69 and $1,957.74 for the fiscal years ended January 31,1922 and 1923, respectively, for depletion of timber on the Chapman and Dewey tract. The petitioner contends that respondent has not allowed sufficient depletion, while respondent, by amendment to bis answer to conform to the proof, avers that he erred in allowing any deductions for depletion of timber on the Chapman and Dewey tract.

The record in this proceeding discloses that the Chapman and Dewey tract of timberland was purchased in 1916 by R. E. Lee Wilson, Sr., as an individual, that it was never owned by the corporation which transferred all of its property to Wilson on February 5, 1917, and that Wilson, in creating this petitioner, declared that he held in trust all of the property transferred to him by the corporation. .The record does not disclose any proof that the Chapman and Dewey tract ever became a part of the trust property, but, on the contrary, shows that Wilson remained the individual owner thereof and that during the years in question the petitioner purchased from Wilson the logs which it cut from the said tract. Accordingly, upon the facts of record, it is clear that petitioner is not entitled to any deductions for depletion of timber on the Chapman and Dewey tract and that respondent erred in allowing such deductions for the years ended January 31, 1922 and 1923.

The petitioner was created on February 5, 1917, as an operating trust and the certificates of interest were issued in equal amounts to Wilson, his wife, and their three children. On that date petitioner acquired numerous assets, by a transfer in trust, among which was a large tract of timberland known as the Wilson tract. There is no question but that for each of the three years in question petitioner is entitled to a deduction for depletion of its timber on the Wilson tract pursuant to section 234 (a) (9) of the Revenue Act of 1921 and section 234 (a) (8) of the Revenue Act of 1924, based upon the fair market value of the timber standing on said tract on February 5,1917. Magdaline McKinney, 16 B. T. A. 804; section 204 (a) (4), Revenue Act of 1924.

The record includes both opinion and documentary evidence as to value. The opinions of petitioner’s witnesses were strikingly harmonious in the values fixed for saw timber and make slight reference to bolt timber. Certain of this testimony was materially weakened by cross-examination, when the values were translated into acreage and residual values. Of more than ordinary importance are the values fixed by petitioner itself in the year 1922 in a sworn statement supplied to the bureau of internal revenue before the present tax controversy arose. See Portage Silica Co., 11 B. T. A. 700.

Respondent’s witnesses fixed a higher value than that employed in the computation on which the notice of deficiencies was based.

After careful consideration of all the evidence we have found as a fact that the fair market value of such timber on February 5, 1917, was $5 per thousand feet of saw timber and $3 per thousand feet of bolt timber. We have set forth in onr findings the number of feet of saw timber and bolt timber cut from the Wilson tract during each of the years in question and the allowable deduction for depletion should be computed on such amounts at the unit rate of $5 per thousand feet of saw timber and $3 per thousand feet of bolt timber.

Decision will be entered under Rule 50.


author: Love:

text:
    Alameda Park Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8355.
    Promulgated March 11, 1932.

      George E. FI. Goodner, Esq., for the petitioner.

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

Love:

The question now under consideration is whether the collection of the deficiency for the calendar year 1917 is barred by the statute of limitations.

In view of the findings of the Court of Appeals that “ It appeared prima facie by the undisputed facts in the record that at the date of the hearing the collection of the alleged deficiency was barred by the statute of limitations,” there was some question at the later hearing whether there was any burden upon petitioner to proceed further until the respondent had offered evidence in rebuttal. This question arose by reason of the fact that up until the date of the later hearing the filing date of petitioner’s return for 1917 had not been received in evidence. It was held that the burden was upon petitioner to establish the filing date of its return. Petitioner then offered the return, including the filing date of April 1,1918, stamped thereon which was received in evidence. Upon the establishment by petitioner that its return was filed on April 1, 1918, the importance of the above contested question disappeared, for at that stage of the proceeding the petitioner had established a prima facie case that the collection was barred by the statute of limitations. It is true that the assessment of the deficiency in question which was made in March, 1923, was within the five years provided for in section 250 (d) of the 1918 and 1921 Acts, section 277 (a) (2) of the 1924 Act, and section 277 (a) (3) of the 1926 Act, but in the absence of a valid consent in writing provided for in section 250 (d) of the 1921 Act and section 278 (c) of the 1924 and 1926 Acts, or certain other exceptions not here material, the collection of such deficiency was barred on April 1, 1923. Bowers v. New York & Albany Lighterage Co., 273 U. S. 346. Russell v. United States, 278 U. S. 181.

We have held consistently that the burden is upon the respondent to prove that valid consents in writing have been filed if such consents are necessary to extend the time provided for in the general statute as to determinations, assessments and collections. See Farmers Feed Co., 10 B. T. A. 1069; Bonwit Teller & Co., 10 B. T. A. 1300; H. G. Stevens, 14 B. T. A. 1120; Philadelphia Lawn Mower Co., 16 B. T. A. 435; Frank E. Harris Co., 16 B. T. A. 469; Annie P. Kountze, 17 B. T. A. 928; Southwestern Investment Co., 19 B. T. A. 30; and Continental Oil Co., 23 B. T. A. 311. In T. W. Warner Co., 19 B. T. A. 872, after stating the rule that the burden of proving an extension was upon the respondent, we said: “ and he [the respondent] 'takes the risk of any defect in the documents upon which he relies as waivers.”

The so-called waiver introduced and relied upon by the respondent, which we have set out in full in our findings, was undated and unlimited as to its effective duration. If this instrument had been filed prior to April 11,1923, it would have expired on April 1, 1924, which is prior to the mailing of the deficiency notice on August 24, 1925. Wirt Franklin, 7 B. T. A. 636; Cunningham Sheep & Land Co., 6 B. T. A. 652; Henry M. Leland, 8 B. T. A. 974; Theodore H. Wickwire, Jr., et al., 10 B. T. A. 102; National Tool Co. v. Routzahn, 28 Fed. (2d) 914; and Aiken v. Burnet, 282 U. S. 277. We dot not know when the alleged consent in writing relied upon by the respondent was filed other than that, since it recites that it was executed in pursuance of the Revenue Act of 1921, it must have been filed after the passage of that act, which was on November 23,1921, and which is prior to April 11, 1923. The date of October 28, 1925, can not be taken as the filing, date for the reasons that there was written alongside this date, “ Not filing date,” and the special assessment section is only one of the several sections embraced in the income tax unit of the bureau of internal revenue of the Treasury Department. The stamp with the above notation in fact indicates that the alleged consent was filed in some other section before it was received in the special assessment section.

As stated in our third paragraph above, the burden was upon the respondent to show when the instrument relied upon by him was filed. Having failed to sustain this burden, we hold that the collection of the alleged deficiency of $4,457.69 for the year 1917 is barred by the statute of limitations.

Judgment of no deficiency will he entered.


text:
    Abraham I. Effron, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42505.
    Promulgated March 14, 1932.

      Alfred Mach, Esq., for the petitioner.

      J. A. Johnston, Esq., for the respondent.
   OPINION.

Van Fossan:

The question in this proceeding is whether, in determining both the cost to the petitioner of the perpetual leasehold with privilege of purchase referred to in the findings of fact and the price for which he agreed to convey to Payton all his interest in that perpetual leasehold, there should be included as part of the cost and of the sale price an item of $60,000, the same being the amount to be paid if the option to purchase was exercised. The petitioner contends that, under the law of the State of Ohio, in which the property leased is situated, the agreement between The F. H. Lawson Company and the Seton Realty Company set forth in the findings of fact was in legal effect the conveyance of the fee of the property described therein, subject to a mortgage to secure the purchase price of $60,000, the amount stated in the agreement as the sum to be paid by the lessee in the event of the exercise of the privilege of purchase granted in the agreement. The petitioner also contends that when he and his purchaser assumed all the terms and conditions of the agreement between The F. H. Lawson Company and the Seton Realty Company they assumed a mortgage to secure $60,000 and consequently that amount must be included in the cost to the petitioner of the perpetual leasehold with privilege of purchase and also must be included in the amount agreed to be paid by Payton, the purchaser.

The record contains some testimony to the effect that the sums paid by the Seton Realty Company, by the petitioner, and by Payton for the perpetual leasehold with privilege of purchase, included the sum $60,000, the option price, secured by a mortgage, but these statements were more in the nature of the witness’ interpretation of contract obligations than statements of fact. Such evidence must be tested in the light of a proper construction of the actual terms and conditions of the various instruments set out in the findings of fact.

For some purposes the courts of Ohio have construed perpetual leases with privilege of purchase of the character of the one in question in this proceeding as conveyances of a freehold. Cf. Weiss v. Wiener, 279 U. S. 333. In Stephenson v. Haines, 16 Ohio St. 478, the court said, of such a perpetual lease with privilege of purchase, that it is a deed of conveyance in fee subject to a condition of defeasance and is equivalent to a sale and conveyance with a mortgage to secure payment of a purchase price. To the same effect is Worthington v. Hewes & McCann, 19 Ohio St. 66. But the later cases decided by the Supreme Court of Ohio do not go so far as to hold explicitly that the perpetual leases with privilege of purchase are conveyances in fee simple subject to a mortgage to secure the purchase price. In Smith v. Harrison, 42 Ohio St. 180, the court said: “ A perpetual leasehold estate is not a fee simple. * * * The fee simple remains in the lessor, his heirs and assigns.”

Construing the application of an Ohio statute the court said, in Village of St. Bernard v. Kemper, 60 Ohio St. 244; 54 N. E. 267, that: “A lessee in possession under a lease of real property for 99 years renewable forever, the property standing in his name for taxation, is so far the owner [italics ours] of such property as to authorize him to subscribe a petition for street improvements ” under a section of the statutes of Ohio.

In Rawson v. Brown, 104 Ohio St. 537; 136 N. E. 209, the court decided that a perpetual leasehold with privilege of purchase is subject to partition. The option clause in the lease agreement in the Rawson v. Broton case was substantially similar to the clause in the lease from The F. H. Lawson Company to the Seton Realty Company granting the privilege of purchase on payment of the sum of $60,000. In discussing the question whether or not the perpetual leasehold with privilege of purchase was subject to partition, the court said:

We think that where the owner of a fee in land leases it for 99 years, renewable forever, he is still the owner of the fee. * * * The possession of the le^s^e is the possession of the lessor. * * * So far as the option to purchase, which is included in the perpetual lease, is concerned we do not think that until it is exercised it would affect the right of the parties as involved in this proceeding. The parties, by the inclusion of the option to purchase, recognized that the fee still resided in the lessor, his heirs and devisees.

The case of Ralston Steel Car Co. v. Ralston, 112 Ohio St. 306; 147 N. E. 513, involves the question of whether or not, under the Ohio statutes, the right of dower attaches to a perpetual leasehold with privilege of purchase, and in that case it was held in substance that a permanent leasehold is real property because it is an estate of inheritance and that it is, therefore, subject to dower under the statutes of Ohio. In the Ralston Steel Car Co. case the court quoted with approval the opinion in Stephenson v. Haines, supra, but also stated as follows:

Tlie estates and interests of both grantor and grantee are inheritable and descend to the heirs, and neither is subject to the laws of distribution. The grantee has a corporeal hereditament and the grantee has the right to receive the rents forever * * *.

The court also stated that the usual and ordinary “ permanent lease ” in Ohio contains an option of purchase clause upon the exercise of which the grantee “ becomes invested with the full fee simple title.”

In none of the cases which have come to our attention is it held, or said by way of dicta, that the estate granted by the respective perpetual leases with privilege of purchase is subject to defeasance by reason of failure to exercise the option to purchase. On the contrary, it appears that the estate granted by the leasehold agreements is subject to defeasance only because of failure to pay the annual rent reserved, taxes, insurance, etc., or by reason of failure to keep and perform the covenants to be performed by the lessee such as to keep buildings in repair, not to commit waste, etc. Moreover, neither in the various instruments set out in the findings of fact nor in the cited decisions is there any indication that there is any obligation on the part of the lessee of' the perpetual leasehold with privilege of purchase to exercise the option to purchase. This privilege of purchase is coterminous with the duration of the perpetual leasehold. It need never be exercised. The lease may prove improvident and purchase undesirable. If the perpetual lease with privilege of purchase be, as is contended, a conveyance of a fee subject to a mortgage to secure the purchase price, then it follows that the so-called mortgage never need be satisfied, since the purchase price need never be paid. It is apparent, too, that the lease provision creating what petitioner’s counsel contends is a mortgage does not secure any obligation of the lessee. It is collateral to no debt due or to grow due, and if a mortgage exists, it is the creature of judicial construction.

The taxing statutes deal with facts and not with subtleties. It is obvious that in determining questions involving the amount of initial cost and purchase price received and to be received we may include only amounts actually or constructively paid and amounts which the seller or the purchaser are under actual obligation to pay. Since neither the seller, the petitioner in this proceeding, nor the purchaser of the perpetual leasehold ever actually paid or was under any obligation to pay the sum of $60,000 in question, this amount should not be included either in the cost of the leasehold to the petitioner or in the purchase price received and to be received by him from Payton. We, therefore, approve the respondent’s exclusion of the sum of $60,000 in question from these amounts.

The above holding is dispositive of the entire proceeding. Since the payment of $25,000 was in excess of 25 per cent of the selling price, it follows that petitioner must report the entire profit in the year 1923.

Decision will be entered for the respondent.


author: Lansdon :

text:
    Signal Gasoline Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 47621.
    Promulgated March 14, 1932.

      Melvin D. Wilson, Esq., for the petitioner.

      J. A. Lyon, Esq., and E. L. Updike, Esq., for the respondent.
   opinion.

Lansdon :

- The respondent has asserted deficiencies in income taxes for the period May 1 to December 31, 1924, and for the calendar years 1925 and 1926, in the respective amounts of $14,137.05, $19,-340.18 and $40,804.19. The following issues raised by the pleadings will be discussed in the order stated: (1) Has the statute of limitations barred assessment and/or collection of the deficiencies asserted for 1924 and 1925? (2) Is the petitioner entitled to deductions for depletion of certain natural gas producing property for 1925 and 1926? (3) If the Board denies deductions for depletion, is the petitioner entitled to amortization deductions for certain casing-head gas contracts? (4) What is the basis for computing profit or loss on the sale of certain casinghead gas contracts?

The petitioner is a dissolved California corporation, acting through its statutory trustees. It filed income-tax returns for the period May 1 to December 31, 1924, and the calendar year 1925 on May 13, 1925, and May 15, 1926, respectively. Section 277(a) of the Revenue Act of 1926 provides that any income taxes imposed by the Revenue Act of 1924 shall be assessed and collected within four years from the date the return was filed and that income taxes imposed by the Revenue Act of 1926 shall be' assessed and collected within three years from the date the return was filed. The respondent had, then, until May 13,1929, to assess and collect any additional taxes for 1924 and until May 15, 1929, to assess and collect any additional taxes for 1925. Pursuant to section 278(c) of the Revenue Act of 1926, the petitioner executed a written agreement under date of November 21, 1928, by which it consented to the assessment of any income taxes due for 1924 and 1925 at any time on or before December 31, 1929. Such writing was filed with the respondent on December 3, 1928, and was thereafter signed for him by one of his employees. On December 28, 1929, which was within the statutory period as extended, the deficiencies involved herein were asserted. The petitioner contends, however, that the agreement extending the statutory period was ineffective, since it was not signed personally by the Commissioner. We have heretofore held contrary to such contention. Frederick T. Fleitmann, 22 B. T. A. 1223. The deficiencies are not barred by the statute of limitations.

By contract dated May 1, 1924, the petitioner acquired the assets of the Signal Gasoline Company, subject to all outstanding obligations and liabilities not exceeding the total amount of $51,076.89, in exchange for 400,000 shares of petitioner’s common capital stock having a par value of $1 per share. Included in the assets acquired were some 40 casinghead gas contracts which the Signal Gasoline Company had entered into directly or had acquired by assignment from its principal stockholder, R. E. Bering. Under contract of the same date the petitioner purchased the assets of the Huntington Gasoline Company, subject to all liabilities, for $107,488.41, to be paid in cash, plus interest at 8 per cent per annum until paid and 50,000 shares of petitioner’s common stock. Included in the assets acquired were certain casinghead gas contracts which the Huntington Gasoline Company had entered into directly or had acquired by assignment.

All of the casinghead gas contracts thus acquired by the petitioner as above set forth covered oil and gas-producing properties in the Signal Hill field. While the contracts were not identical in their terms, the differences are not important in determining the issues raised. Each contract follows the same general form and creates similar obligations and benefits. The material portions of a typical contract follow:

Whereas : said party of the first part, is the lessee of certain property located in Los Angeles County, State of California, and more particularly described as follows, to-wit:
* * * *-s*t $ *
and has developed or is developing and intends to further develop said property for oil and gas by drilling thereon, and
* * * * * * *
Whereas, said second party, in order to augment his supply of gas for said plant or plants, desires to purchase and receive from said first party, all of the natural gas which may be produced from its above described property, for the purpose of manufacturing and extracting gasoline therefrom;
Now, therefore, in consideration of the mutual covenants herein contained and other good and valuable consideration, receipt of which is hereby reciprocally acknowledged, the parties hereto hereby covenant and agree to and with each other as follows, to-wit :
1. The said party of the first part hereby lease and agree to furnish and deliver to said party of the second part, for the purpose of manufacturing and extracting gasoline therefrom, all of the gas produced by it from the above described property, for and during the entire period of time it shall produce gas therefrom, the said party of the second part having and being hereby given the sole and exclusive right to treat all gas produced by said party of the first part as aforesaid. * * *
2. Said party of the second part agrees to erect, equip and put into operation a plant having a capacity to handle and treat three million cubic feet of gas a day within ninety days from and after the date hereof. When said plant is completed and ready to commence operations, said party of the first part agree to commence the delivery of the gas being produced from the above described property, into the lines of the party of the second part; said lines being carried to each producing well of the party of the first part on said property, by and at the expense of the party of the second part. * * *
3. In full consideration of the rights herein granted, said party of the second part agrees to pay to said party of the first part, thirty-three and one-third per cent (33%) of the gross proceeds received by him from the sales of gasoline manufactured or extracted by him from said gas. Party of the second part agrees to pay for said royalty gasoline as follows: Two and one-half cents (2%) per gallon under retail price of Red Crown gasoline in Los Angeles, California, when gravity is over 70° Baume; three cents (3) per gallon under retail price of Red Crown gasoline in Los Angeles, California, when gravity is under 70° Baume.
***•»*#
6. After said gas Ras been treated by said party of the second part and the gasoline content extracted therefrom, the remaining dry gas shall belong to and be the property of the party of the first part; the party of the second part having, however, the right to use free of charge such of said gas as is necessary for fuel in his aforesaid operations. * * *
7. Party of the second part shall have the right to lay necessary pipe lines upon and across the property of the party of the first part, subject to lease or leases affecting said property, and at all times shall have full right of ingress and egress.
8. Said party of the first part shall provide and maintain all necessary and proper equipment and facilities for separating the oil and gas produced on said premises in order to save and render available all of said gas for the aforesaid treatment by said party of the second part, and said party of the second part shall have the right to inspect such equipment at all reasonable times.
*******
10. Party of the second part shall provide and maintain such apparatus as shall be necessary to meter or measure the quantity of gas produced from said property, and returned to said property.
11. This agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, successors and assigns of the party of the first part, and to the heirs, administrators, executors and assigns of the party of the second part.

The casinghead gasoline plant called for in the contracts was constructed by the Signal Gasoline Company and was included in the assets acquired by petitioner from that company. During the taxable periods the petitioner was engaged in the manufacture and sale of casinghead gasoline and in the sale of dry gas.

The petitioner claims an allowance for depletion under section 204(c) of the Revenue Act of 1926 on its interest under the casing-head gas contracts. It contends that it acquired a property interest in the nature of a fro-fit a frendre. The respondent contends that petitioner was a purchaser of gas after it had been produced and that it acquired no property interest which is subject to depletion.

Deductions for depletion are allowed by the statute “ in respect of property.” They contemplate a consumption and reduction of the mineral value of the land and are allowable to every person whose property right therein has been depleted by the extraction and js ale of the product. Lynch v. Alworth Stephens Co., 267 U. S. 364; United States v. Ludey, 274 U. S. 295; and Burnet v. Thompson Oil & Cas Co., 283 U. S. 301. If the petitioner has a property interest in the mineral reserves of the land covered by the contracts, it is entitled to the deduction claimed.

While petitioner had the right to go upon the land to install necessary equipment, lay pipe lines, test the gas and had full right of ingress and egress, which rights constitute an interest in real estate, it had no property right or interest in the mineral reserves. It had no equitable or legal ownership of the minerals in place, nor did it have the right to explore and drill for such minerals. It was a purchaser of gas if and when discovered and produced. The purchase price of the gas taken under each contract was a certain percentage of the finished product. The petitioner received the remainder in consideration of its services in treating the raw product. The lessor and lessee of the mineral land covered by the contracts are entitled to depletion on the full production of gas, based upon a market price therefor to be determined under the contract. The petitioner is not entitled to an allowance.for depletion. Cf. Arthur J. Coyle, 17 B. T. A. 368.

The petitioner contends in the alternative that it .is entitled to amortization of its casinghead gas contracts on the basis of their fair market value when acquired in exchange for stock. The respondent has held that the transactions by which petitioner acquired the assets and liabilities of the Signal Gasoline Company were in connection with a reorganization within the meaning of section 203 (b) of the applicable revenue act and has allowed amortization on the basis of cost to the Signal Gasoline Company in accordance with the provisions of section 204 (a) {1) of the act. The petitioner was organized to acquire the assets of the Signal Gasoline Company and it did acquire such assets, subject to the liabilities, in exchange for common stock. Immediately before and after the transaction the directors and officers of the two corporations were identical. All of the 400,000 shares of stock exchanged for the assets were held by the Signal Gasoline Company. We think the respondent’s determination must be approved as to amortization of the casinghead gas contracts acquired from the Signal Gasoline Company.

The petitioner alleges that sections 204 (a) (7) of the Revenue Acts of 1924 and 1926 are unconstitutional, in so far as they deny to petitioner the fair market value of the contracts at the date of acquisition as a basis for amortization. We find no court decisions holding that such sections are invalid. In our opinion there is not sufficient doubt as to their constitutionality to warrant a discussion in this report. The statutory provisions should be applied.

The respondent has allowed amortization and computed profit upon sale of the contracts acquired from the Huntington Gasoline Company on the basis of cost, which he determined to be $45,547.51. He has allowed amortization on the contracts in a total amount of $22,611.89 and determined the basis for computing profit on the sale to be $23,935.62. There is no controversy as to the fact of sale or as to the selling price. The petitioner contends that cost of the contracts was their fair market value at the date acquired, which he alleges was $194,476.92. He contends that the contracts were acquired in exchange for stock and that the value of the stock is the value of the assets received in exchange therefor.

There is nothing in the record to show what assets were acquired by petitioner from the Huntington Gasoline Company other than the casinghead gas contracts or what portion of the purchase price is allocable to the contracts. We do not know whether all of the cash was paid for assets other than the contracts and all of the 50,000 shares of stock was exchanged for contracts or whether part of the cash and part of the stock was paid for the contracts. The petitioner had assets other than those acquired from the Huntington Company and its stock had a value apart from the value of the assets received in exchange. On the evidence presented we are unable to say that the respondent’s determination is incorrect. Compare memorandum opinion in Atlas Rock Co., Docket No. 34951, of August 31, 1931.

Decision will be entered for the respondent.


text:
    G. E. Cotton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46673, 51456, 59655.

    Promulgated March 14, 1932.

      M. A. Matlock, Esq., for the petitioner.

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

Lansdon :

It is obvious that the respondent properly rejected the petitioner’s method of reporting income from his short loan business. That method took no account of capital gains retained in the business through outstanding loans at the beginning and end of each tax year, or for actual losses through bad debts. All collections, whether of principal or interest, were treated as income and all loans as expenses of the business. Petitioner concedes the novelty of his system, but insists that it is one consistently employed by him over a number of years and that it is justified under article 323 of Regulations'74 and 75, which provides that “each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purposes.” It is true that the regulation cited contemplates that a liberal latitude be allowed to the taxpayer in keeping his books, but it does not waive the requirement that any system adopted must truly reflect income. Where the system used does not do this the regulations require the Commissioner to reject it and to make his own computation in such a manner as in his opinion shall so do. The Commissioner has made such computation of the petitioner’s income in respect of this business for the years involved. The petitioner has offered no proof to show that such determinations are incorrect. In such circumstances we must sustain the determination of the respondent. Ella Pipes Cline, 15 B. T. A. 934.

Respecting the deductions claimed by the petitioner of expenditures made in prospecting his mineral lease, such, this Board and the courts have uniformly held, must be classed as capital expenditures and added to the cost of the mine when brought to production. If the development results in discovery of commercial ores, the cost may be recovered through depletion and depreciation deductions; if the prospect is abandoned, loss should be claimed in the year of the abandonment. The respondent’s action in rejecting petitioner’s claim for the deductions from his income as expenses is in accord with Regulations 69, article 222, and is approved. Illinois Central R. R. Co. v. Interstate Commerce Commission, 206 U. S. 441.

We think the petitioner’s venture in the Pump and Well Company resulted in a deductible loss which he was entitled to take in the year claimed. The petitioner and Moody undertook to supply the necessary cash to start this company in business in payment for their respective interests. Moody failed to fulfill his part of the agreement and the petitioner voluntarily supplied the entire amount in order to save his own interest. This was tantamount to a voluntary assessment against himself as a contributor to the capital of the corporation. Fairview Co., 13 B. T. A. 743. Respecting the loss, the record shows that the corporation could live only so long as the petitioner continued his contributions, and when these ceased it ceased to function. When the receiver was appointed in that year its only visible assets consisted of some castings in the possession of the foundry which had cast them and held claims against it for the cost thereof. It is true that the receiver brought suit against Moody, which deferred final liquidation of the corporation until 1931, but the petitioner was no party to that suit and could in no way be benefited-by its outcome. Being the sole financial supporter and entirely familiar with all of its affairs, the petitioner realized that his investment in the corporation was a loss in 1929 and decided to abandon it in that year. The result of the court proceedings which followed only confirmed his judgment respecting his loss as a stockholder. Obviously, to continue further advances would have increased his loss; and, we think, in the circumstances, that he was justified in facing the facts and charging the sum of his advances off as a loss in 1929. In respect to this claim for deduction the contention of the petitioner is sustained. Remington Typewriter Co., 4 B. T. A. 880; J. J. Melick, 6 B. T. A. 70; Joslyn Mfg. & Supply Co., 6 B. T. A. 749; Homer M. Preston et al., 7 B. T. A. 414; Floyd E. Poston et al., Administrators, 17 B. T. A. 921; and In re Harrington, 1 Fed. (2d) 749.

Decision will be entered under Ride 50.


text:
    Iten Biscuit Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket Nos. 43667, 45164.
    Promulgated March 15, 1932.

      Ferdinand Tannebawm, Esq., for the petitioner.

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

Lansdon :

The first and most important question for consideration is whether the petitioner is entitled to a deduction, in computing taxable net income of each of the years in controversy, for depreciation of returnable cans in which its products are sold and shipped to its customers. If so, the amounts of such deductions have been agreed upon and stipulated by the parties.

The pertinent provisions of the Revenue Acts of 1921, 1924 and 1926 are as follows:

Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
*******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.

The depreciation allowance is limited, by the express provisions of the statutes, to property used in the trade or business. “ It represents the reduction, during the year, of the capital assets through wear and tear of the plant used.” United States v. Ludey, 274 U. S. 295. Merchandise held for sale, and, therefore, constituting a part of the taxpayer’s stock in trade, is not property used in the business and a taxpayer is not entitled to a deduction for depreciation, specifically as such, in respect thereof. Munishing Motor Co., 1 B. T. A. 286; and Burton Coal & Lumber Co., 22 B. T. A. 133. Obviously, a taxpayer is not entitled to a deduction for depreciation in respect of property disposed of through sale, and in which it has no further capital investment.

The petitioner contends that, whether in or out. of its physical possession, the returnable cans in which it sold and shipped its products to customers are its property, are used in the business, and that it is entitled 'to the depreciation deductions provided by the statutes, in respect thereof. The respondent says that the returnable cans are a part of the petitioner’s stock in trade; that the petitioner actually sells the cans as well as their contents, obligating itself only to repurchase the cans, if and when they are returned by the customers; and, therefore, the petitioner is not entitled to the depreciation deductions contended for.

A sale is the “ transfer of the property in a thing for a price in money.” 35 Cyc. 25; Mansinger v. Steiner-Medinger Co., 4 Nebr. (unoff.) 392; 94 N. W. 633. It involves “ an agreed price, a vendor, a vendee, an agreement of the former to sell for the agreed price and of the latter to buy for and to pay the agreed price, are essential elements in a contract of sale.” In re Columbus Buggy Co., 143 Fed. 851. The transactions here involved were either bailments or sales, the distinction between which is stated in Sturm v. Boker, 150 U. S. 312, as follows:

The recognized distinction between bailment and sale is that when the identical article is to be returned in the same or in some altered form, the contract is one of bailment and the title to the property is not changed. On the other hand, where there is no obligation to return the specific article, and the receiver is at liberty to return another thing of value, he becomes a debtor to make the return and the title to the property is changed; the transaction is a sale.

In all cases involving the distinction between bailment and sale the courts have endeavored to determine and give effect to the intention of the parties as expressed in their agreements. In our opinion the facts herein fail to support the petitioner’s theory. The so-called returnable packages were billed to the customers to be paid for as “ other merchandise.” There was no reservation or stipulation in the invoice that title remained in the seller, which parted with the article at an agreed price. When the returnable package was paid for by the purchaser -his rights of ownership were complete. He could sell it for cash or retain it in his store for the display of crackers or other merchandise not purchased from the petitioner. He could, and the testimony is that in some cases he did, include it in his own inventory at the price paid the petitioner. The returnability of the package was a right conceded by the petitioner, but was in no sense an obligation enforceable at law. Every essential element of a sale and transfer of title is present in the practice of the petitioner and every attribute of ownership exists in the purchaser upon his receipt of the containers and payment therefor.

On the other hand the characteristics of bailment as defined by the Supreme Court in Sturm v. Boker, supra, are not in_ the transaction here involved. There is no obligation to return the identical article in same or altered form. Any old container originally sold by the petitioner will do, even if it is picked out of a junk heap or acquired by purchase from another dealer. “ There is no obligation to return the specific article.” “ The receiver is at perfect liberty to return another thing of value,” namely, 50 cents in money, and when he has 'done so his title as owner is complete.

Petitioner relies on the evidence that it was always anxious to have the containers returned as soon as possible. Doubtless this is true, and for the very obvious reason that it was highly undesirable to increase its investment in the returnable packages while so many were outstanding under an agreement to repurchase. The returnable cans were a convenience, a method of advertising, and a means for retaining the trade of customers once secured, but the petitioner, very' properly, through its efforts to secure returns, sought to minimize appropriations from its operating funds for such purposes. It was also necessary to stress returnability to overcome sales resistance created by competitors who, doubtless, often pointed out the wastefulness of paying almost as much for the cans as for the merchandise they contained. All this theory, however, is in no way overcome by the facts. The returnable package was invoiced and sold to the customer at an agreed price, with an understanding by petitioner to repurchase at the same price. Since the returnable packages, while out of the possession of the petitioner, were not its property and not at such times in use in its trade or business, the claim for depreciation thereon is disallowed. Cf. La Salle Portland Cement Co., 4 B. T. A. 438; La Salle Cement Co., 19 B. T. A. 806.

The conclusion reached above in no wise prevents the petitioner from recovering, without tax, his entire investment in returnable cans that became worthless and unusable in its hands. This recovery is effected not through depreciation, but by charges against the returnable package account, each year, of the cost of the cans that have become useless. The parties have stipulated that for the years 1922 and 1923 the petitioner is entitled to deduct losses on such account in the respective amounts of $22,454.82 and $43,114.28, which have not been allowed in the respondent’s computation of the deficiencies for such years, and that for the years 1924, 1925 and 1926 such losses have heretofore been deducted in the respective amounts of $64,673.45, $53,005.98, and $70,069.40.

The parties have also stipulated that the respondent erred in his determinations as to 1922 and 1923 in adding to the net income of those years the sums of $42,293.97 and $28,885.72, respectively, representing adjustments in the can liability account. In view of this stipulation, the net income shown in the deficiency notice for those years should be reduced accordingly.

The respondent claims an increased deficiency for 1922, or, alternatively, for 1926, alleging that he either allowed an excessive deduction for 1922 for a loss sustained by the petitioner in the liquidation of a subsidiary corporation, or that he has understated the net income for 1926, the allegation being predicated upon the fact that in 1926 there was refunded to the petitioner an overpayment of income taxes by the Shelby Biscuit Company, in the sum of $7,657.73, a fact which he failed to take into consideration in determining the amount of the loss sustained in 1922 or in computing the net income for 1926. The hearing developed nothing in addition to the stipulated facts. We see no reason for holding that the petitioner realized income in 1926 as the result of the refund which it received in that year of an overpayment of taxes by its subsidiary which had been dissolved. If it was income at all, it was income for 1922, in which year the petitioner, through the liquidation and dissolution of its subsidiary, succeeded, by virtue of being the sole stockholder thereof, to all the assets, rights and choses in action of the Shelby Biscuit Company. Though making an earnest attempt to do so, the respondent failed to prove that in determining the amount of the loss, which he allowed for 1922, as the result of the liquidation of the Shelby Biscuit Company, he did not give proper effect to this item. The respondent’s claim for an increased deficiency for 1922, and the alternative claim for an increased deficiency for 1926, must be denied.

Decision will be entered wider Rule 50.


author: Lansdon:

text:
    Iten Biscuit Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 16429, 20899.
    Promulgated March 15, 1932.

      Ferdinand Tannebaum, Esq., for the petitioner.

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

Lansdon:

The petitioner contends it is within the provisions of section 827 of the Revenue Act of 1918, and that its profits taxes for the years in controversy should be redetermined under the provisions of section 328 of that act; but should it be wrong in that contention, then it is contended that the respondent has understated invested capital, for each of those years, by excluding therefrom a substantial portion of intangibles admissible under the limitations of section 326 (a) (4) of the act. The claim to special assessment is premised upon (1) respondent’s inability satisfactorily to determine the invested capital, because of the manner and form of organization and the impossibility of ascertaining the cost of intangibles developed in the business; (2) an abnormality in capital resulting from the inclusion of tangible property at less than the actual cash value thereof, as of the date of acquisition, and the exclusion of valuable income-producing intangibles developed in the business; and (3) an abnormality in income, resulting from thé payment of salaries to executive officers which were abnormally low and inadequate considering the qualifications of such officers and the nature of the services rendered.

We are satisfied from the record before us that there is an abnormality in capital within the meaning of subdivision (d) of section 327 of the Revenue Act of 1918, due to the exclusion of valuable intangibles which were substantial contributing factors in the earning of the income of the years in controversy. The history of sales promotion and development work and the record of gross sales and earnings over the period of corporate existence denote the creation and rapid enhancement in value of an intangible structure. We think the evidence warrants the conclusion that in 1916, when the petitioner acquired the Iowa and Oklahoma companies, the value of the petitioner’s intangibles alone was at least $1,000,000, an amount in excess of its investment in the tangible properties of the business; and there is nothing in the history of the business subsequent to 1916 which indicates any diminution in the value of those intangibles. For the five-year period 1912 to 1916, inclusive, the average net tangibles employed in the petitioner’s business amounted to $621,661.17, and the average earnings of the business amounted to $252,244.48. If a return of 10 per cent be ascribed to the net tangibles, the earnings attributable to the intangibles were more than three times the earnings attributable to the tangibles. No part of the value of the intangibles may be included in invested capital under the provisions of section 326 of the act, except to the extent of the actual cash expenditures in building up the intangible structure, and the amount of these expenditures, which represent but a very small portion of the whole intangible value, can not be determined from the books of account. It is unnecessary to discuss the other grounds advanced by the petitioner as the basis of its claim for special assessment. In our opinion, the exclusion from invested capital of the intangibles developed in the petitioner’s business creates just such an abnormality as is contemplated by section 327 and makes mandatory the application of the provisions of section 328 for the determination of the petitioner’s profits taxes for the years in controversy.

Our decision on the issue of special assessment makes it unnecessary to consider the alternative issue raised by the petitioner at this time. Unless the profits tax under section 328 is greater than the tax when computed under section 301, the matters pertaining to invested capital and the war-profits credit raised in the petition are moot questions and adjudication thereof is unnecessary.

The remaining question for consideration is whether the petitioner is entitled, in computing taxable net income, to deductions for depreciation of can containers, so-called “ returnable packages.” This is the same question as was raised by the petitioner in Dockets 43667 and 45164, decided this day; and upon the authority of the decision in those proceedings, we hold that the petitioner divested itself of the ownership of returnable cans in which it shipped its products to customers; that such returnable cans were not used in the petitioner’s business; and that it is not entitled to deductions representing reasonable allowances for wear, tear and exhaustion of the returnable cans, in computing the taxable net income of each of the years in controversy. The amounts of such allowances are not in controversy. Accordingly, the respondent’s claim for an increased deficiency for each of the years in controversy, based upon the grounds that he erred in allowing deductions for depreciation of returnable cans, and that he failed to include the gains from sales of returnable cans in gross income, is approved.

In view of the stipulation of the parties that the respondent has erroneously allowed a deduction of $3,073.87 for 1919 on account of real' estate taxes which were also allowed as a deduction for 1918, the net income for 1919 as determined by the respondent in the deficiency notice should be increased by that amount.

Decision will be entered after other hearing wnder Rule 62.


author: Seawell :

text:
    Emil Ries, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 26423.
    Promulgated March 15, 1932.

      Frederick D. SiTber, Esq., for the petitioner.

      W. R. Lansford, Esq., for the respondent.
   OPINION.

Seawell :

The evidence shows there were two corporations organized largely for the same purposes. The Post Graduate Medical School of Chicago, herein termed the first corporation, was organized as a profit-making corporation. The second corporation, the Post Graduate Hospital and Medical School, was organized as a nonprofit-making corporation.

The record shows the first corporation was not operated very successfully and on that account and to escape payment of taxes, which as a corporation for profit it had to pay, it was deemed advisable to organize another corporation, a nonprofit-making corporation which would acquire the property of the first, and to dissolve the first corporation.

Resolutions passed by the stockholders of the Post Graduate Medical School of Chicago stated that they were “ willing and anxious to sacrifice considerable parts of their moneys invested in stock ” of such school “ for the purpose of increasing its usefulness and improving its standing ” and were, therefore, ready to accept and did accept the proposition made by the Post Graduate Hospital and Medical School, which resulted in the stockholders of the first corporation, holding $69,000 of its stock, receiving therefore $23,000 of debenture bonds of the latter corporation, the petitioner herein receiving for his stock in the first corporation, which stock cost him $11,000, debenture bonds of the second corporation of the face value of $3,666.66. Prior to the acceptance of the proposition made the first corporation by the second corporation, there was no attempt made to sell the assets of the first corporation. What might have been realized by such a sale or what was then the value of the stock in such corporation is not shown.

The net result of the transaction is that the petitioner, having before March 1, 1913, purchased shares of the first corporation for $11,000, received in 1922 a liquidation thereof in the form of debentures having a face value of $3,666.66. What their fair market value was at the time of their receipt by the petitioner is not in evidence.

The applicable law in the circumstances of the instant case is the Revenue Act of 1921, which makes it necessary for March 1, 1913, value of the shares of stock in the Post Graduate Medical School of Chicago, purchased by the petitioner prior to that date, to be shown before any loss can be allowed petitioner because of the receipt by him of debentures of the face value of only $3,666.66. The evidence failing to show the March 1, 1913, value of shares which cost petitioner $11,000, no loss can be reckoned nor allowed. Burnet v. Houston, 283 U. S. 233.

If the petitioner’s shares on March 1, 1913, were worth not more than $3,666.66 (the maximum value of the debentures he received) he would have no recognizable gain or loss. United States v. Flannery, 268 U. S. 98; McCaughn v. Ludington, 268 U. S. 106.

In view of the fact that the March 1, 1913, value of petitioner’s shares is not in evidence, it is unnecessary to discuss or decide whether there was in law a reorganization or an exchange.

The Commissioner determined there was no loss and there is no evidence adduced overcoming the presumption of the correctness of such determination. Such determination is, therefore, approved. As to the deficiencies for both years, 1922 and 1923,

Judgment mil be entered for the respondent.