author: Ahundell:

text:
    Estate of Leonard S. Waldman, Deceased, by the National Commercial Bank and Trust Company of Albany, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104898.
    Promulgated February 10, 1942.

      Robert G. Poskamer, Esq., for the petitioner.

      James G. Maddox, Esq., for the respondent.
   OPINION.

Ahundell:

The Commissioner determined a deficiency in estate tax of decedent’s estate in the sum of $956.09. The first issue is whether or not furniture, clothing, and an automobile set off to decedent’s widow in accordance with a New York statute is includible in decedent’s gross estate. The second issue is whether or not respondent correctly computed the amount of a deduction for a charitable bequest.

Most of the facts were stipulated and are hereby adopted as a part of our findings. Of the stipulated facts we set forth herein only such facts as are material to our discussion of the issues. Additional facts were adduced from evidence presented at the hearing.

Leonard S. Waldman, hereinafter referred to as decedent, died April 4,1937, leaving a last will and testament which provided, after several specific bequests, that “all the rest, residue and remainder” of decedent’s estate should be placed in trust for his wife, Eleanor Elsie Waldman, until her death or remarriage. The will further provided:

It is my will, and I hereby direct, that the devise and bequests herein made and given to my said wife, and the trusts created for her benefit, shall be free from any and all legacy, transfer, inheritance, estate or succession taxes, State or Federal; and that all taxes, which may be payable in respect to said devise and bequests to my said wife, and to the estate given in trust for her benefit, shall be paid by my Executor out of my residuary estate, and that my residuary estate be charged with the payment thereof.

The will provided that at the death or remarriage of decedent’s wife “all the rest, residue and remainder” of the estate should be placed in trust for the Albany Jewish Community Center, a charitable institution. At the time of decedent’s death his widow’s age was 53 years, 7 months, and 6 days. The will was duly admitted to probate and letters testamentary were duly granted on April 26, 1937.

The estate tax return for the estate of Leonard S. Waldman was filed with the collector of internal revenue for the fourteenth district of New York, at Albany, New York.

The appraisers appointed by the Surrogate’s Court for Albany County, New York, set apart to decedent’s widow items of household furniture valued at $634, an automobile valued at $450, and wearing apparel amounting to $25. In the account of proceedings of the estate rendered to the Surrogate’s Court by the executor the above items, aggregating $1,109, were reported as set apart to the widow pursuant to section 200 of the Surrogate’s Court Act of the State of New York. This account of proceedings was duly approved by the Surrogate’s Court of Albany County by decree entered July 28, 1938.

Pursuant to waiver of restriction on assessment and collection, a deficiency of $488.36 was assessed against decedent’s estate and was paid on September 6, 1939. This amount is a part of the deficiency under consideration in the present proceeding.

The first issue is whether or not the personal property set off to decedent’s widow, in accordance with state statute, constitutes a part of decedent’s gross estate. We think that there is no doubt that the amounts in question were a part of the gross estate of decedent as defined by section 302 (a) of the Revenue Act of 1926, as amended. Estate of Louis M. Faber, 40 B. T. A. 1070.

Nor are the items proper deductions from gross estate. Section 303 (a) (1) (E) of the Revenue Act of 1926, as amended by section 805 of the Revenue Act of 1932 and section 403 (a) of the Revenue Act of 1934, provides that there may be deducted from the value of the gross estate amounts “reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent * * *.” Petitioner contends that although the New York statutes provide for no such payments for support, the amounts set apart to decedent’s widow constitute payments in lieu of payments for support and should be deductible from the estate. We do not agree. It is difficult to comprehend that furniture, an automobile, and $25 of clothing might be “amounts reasonably required and actually expended for the support” of a widow. Respondent is sustained on this issue.

The second issue concerns the computation of the deduction from decedent’s gross estate "of the charitable devise made by decedent to the Albany Jewish Community Center. Petitioner contends that respondent erred in his application of section 303 (a) (3) of the Revenue Act of 1926, as amended by section 807 of the Revenue Act of 1932, to the charitable remainder here under consideration. That section provides that where, by terms of the will or local law, estate, succession, legacy, or inheritance taxes are payable out of bequests, legacies, or devises otherwise deductible under that section, the deductible amount is the amount of the bequests, legacies, or devises, reduced by the amount of such taxes. A provision similar to this was first inserted in the Revenue Act of 1924 as the result of a decision of the Supreme Court in Edwards v. Slocum, 264 U. S. 61, wherein it was held that a residuary bequest to charity was deductible in full from gross estate even though death taxes were actually payable out of the bequest. S. E. No. 398, 68th Cong., 1st sess. (Revenue Act of 1924). The provision was repealed by the 1926 Revenue Act and does not appear in the 1928 Revenue Act, but was restored to the law in 1932 by amendment to section 303 (a) (3) of the Revenue Act of 1926. The intendment of the statute is that an estate may not receive a deduction for an amount larger than the exempt institution actually receives. H. R. No. 708, 72d Cong., 1st sess.; S. R. No. 665, 72d Cong., 1st sess. (Revenue Act of 1932).

Decedent directed that the devise and bequests to his wife be free from burden of estate and inheritance taxes and that all taxes be paid out of his residuary estate. We interpret this to mean that the executor should pay the taxes out of what was left after debts, expenses, and specific bequests were paid. It seems apparent this could be accomplished only by payment of the taxes from that which formed the corpus of the trust for decedent’s widow and would later form the corpus of the trust for charity. In any event, the testamentary directions of decedent bring into play the provision of section 303 (a) (3), as amended, requiring the deduction for the amount of the charitable devise to be reduced by the amount of estate or inheritance taxes payable from such devise.

Eespondent contends that the proper method of computing the deduction is to value the charitable devise based upon a life interest in the widow aged 54 years and subtract from that amount the amount of the taxes payable. This approach, however, overlooks the fact that the taxes are actually payable from the residue which forms both the corpus of the trust for the widow and later the corpus of the trust for the charity. It must be apparent that the present case of a life estate imposed upon the amount which will eventually go to the charity differs from a case where there are specific devises or bequests not carved out of the estate as a whole.

In bis Eegulations 80, article 44, interpreting section 303 (a) (3) of the Revenue Act of 1926, as amended, respondent states that “if a life estate is bequeathed to an individual with remainder over to a charitable corporation, and by the local law the legacy tax upon the life estate is taken out of the corpus with the result that the charitable corporation will be entitled to receive only the amount of the fund less the tax, the deduction is limited to the present worth, as of the date of the testator’s death, of the remainder of the fund so reduced * * This regulation would seem to uphold petitioner’s view. It is interesting to note that prior to the determination of a deficiency against decedent’s estate an internal revenue agent computed the deduction from decedent’s estate for the charitable devise in the manner now advocated by petitioner. .While his action is not binding here, it at least indicates the absence of a uniform administrative treatment of the problem before us. There are no long existent rulings of respondent on this matter which might be given weight because of reenactment of legislation during their existence.

We are of the opinion that the intent of Congress may be carried out only by adopting petitioner’s view of this matter. We believe that the result reached is equitable and note no case or administrative ruling which would indicate the advisability of a contrary view. The residue which makes up the corpus of the trusts should be reduced by the amount of the taxes payable and then the value of the charitable devise as of the date of death of decedent should be computed. Petitioner is sustained on this point.

We now come to the actuarial problem of computation of the value of the charitable devise as of the date of death of decedent. Petitioner contends that the value of the devise should be determined by first valuing the life estate and then subtracting that value from the value of the total residuum at the date of death, the remainder being the value of the devise to charity. Inasmuch as the problem here is to compute the value as of the date of decedent’s death of the remainder to charity, we think it clear that the proper method, which was employed by respondent, is to compute the value of the charitable devise subject to the life estate. We have previously approved this treatment of the problem. William Nelson Cromwell et al., Executors, 24 B. T. A. 461; cf. Henry R. Ickelheimer et al., Executors, 14 B. T. A. 1317. Thus respondent was correct in employing a conversion factor of .52757, which under respondent’s tables represents the present value of one dollar due at the end of the year of death of a person aged 54 years.

Decision will he entered u/nder Rule 50.

       Sec. 303. For the purpose of the tax the value of the net estate shall be determined—
      (a) In the case of a resident, by deducting from the value of the gross estate—
      *******
      (3) The amount of all bequests, legacies, devises, or transfers * * * to or for the use of any corporation organized and operated exclusively for * * * charitable * * * purposes * * *. If the tax imposed by section 301, or any estate, succession, legacy, or inheritance taxes, are, either by the terms of the will, by the law of the Jurisdiction under which the estate is administered, or by the law of the jurisdiction imposing the particular tax, payable in whole or in part out of the bequests, legacies, or devises otherwise deductible under this paragraph, then the amount deductible under this paragraph Bhall be the amount of such bequests, legacies, or devises reduced by the amount of such taxes. The amount of the deduction under this paragraph for any transfer shall not exceed the value of the transferred property, required to be included in the gross estate; * * *


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    North Range Mining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102435.
    Promulgated February 11, 1942.

      J. Marvin Haynes, Esq., and John McCullough, Esq., for the petitioner.

      DeWitt M. Evans, Esq., for the respondent.
   OPINION.

Smith :

This proceeding involves deficiencies in income and excess profits tax for the years 1934 to 1937, inclusive, as follows:

The sole issue for our determination is whether petitioner is entitled to depletion deductions, on a percentage basis, on the production of iron ore under an agreement with the Ford Motor Co. whereby a portion of the ore mined was sold to Ford Motor Co. and a portion to third parties.

The parties have filed a written stipulation of facts, with numerous exhibits attached, which we adopt as our findings of fact herein.

Petitioner is a corporation, with its principal office at 3600 Book Building, Detroit, Michigan. It filed its income tax returns for the years involved with the collector of internal revenue for the district of Michigan.

On November 1, 1933, the petitioner entered into a written agreement with the Ford Motor Co., hereinafter sometimes referred to as Ford, under which it acquired the right to operate, for a period of five years, certain mining properties known as the Blueberry mine, located in Marquette County, Michigan. Ford was the sublessee of the properties under a lease dated July 14, 1926, from the Palms-Book Land Co., which in turn was lessee of the fee owners under a lease dated August 4, 1925. The original lease to the Palms-Book Land Co. was for a term of 50 years from August 4,1925. The lease to Ford was for a term of 48 years. Under that lease Ford, lessee, agreed to enter upon the premises and to do everything necessary to conduct mining operations. It agreed to pay a ground rental of $10,000 for the first year, $20,000 for the second year, $30,000 for the third year, $40,000 for the fourth year, and $60,000 for the fifth year and each succeeding year thereafter for the term of the lease. It agreed also to pay royalties of 50 cents per ton on the ore mined, which royalties were to be applied to the ground rent each year. The lease was later amended as to the amount of rents and royalties to be paid by the lessee. The lessee agreed to mine and remove as much ore yearly as would be required for its own use, provided such ore could be mined profitably.

The contract of November 1,1983, between Ford and the petitioner provided in part as follows:

1. From November 1, 1933, and for a period of five (5) years thereafter, Operator [petitioner] agrees to mine and load for shipment from the Blueberry Mine ore of the grade specified by Ford to meet Ford’s requirements, during the period of this lease. Ford agrees to pay for ore so mined and loaded F. O. B. cars at the Blueberry Mine, $1.25 per gross ton. This price is based on the prevailing labor scale of July 1, 1933 used by the Oliver Iron Mining Company on the Marquette Range as shown on Exhibit “A” attached hereto and made a part hereof. It is understood and agreed that this basic price of $1.25 per gross ton shall be increased or decreased to the extent of sixty per cent (60%) of the percentage of the increase or decrease of the said Oliver scale. Such change in price shall be made in the month succeeding the change in the said Oliver wage scale.
2. The quantity of ore to be mined for Ford shall he specified by Ford in writing semi-annually and such specification may not he changed without the consent of Operator. Specifications shall be made as of January 1st and July 1st of each year.
3. The grades of ore to be mined during any calendar year for Ford shall be specified by Ford on January 1st of each year, and shall be subject to the following conditions:
* * * * * * *
4. Operator shall in each semi-annual period have the right to mine and sell on the open market such additional ore as the property can produce over and above the Ford requirements as specified in the manner hereinbefore provided.
For all excess ore so sold and shipped to other parties by Operator in the calendar year 1933, said Operator shall pay said Ford a royalty of 750 per gross ton; and in each calendar year after 1933 said Operator shall pay said Ford a royalty of 750 per gross ton for the first 50,000 tons so sold and shipped in such calendar year, and a royalty of $1.00 per gross ton for all such additional ore so sold and shipped to said other parties in such calendar year in excess of 50,000 tons. All such payments shall be made quarterly on the 15th day of January, April, July and October, for the ore so shipped during the preceding quarterly period.
5. Operator shall on January 15, 1934, pay said Ford an advance royalty of $6,666.67, and on April 15, 1934 an advance royalty of $10,000.00, and thereafter during the continuance of this agreement Operator shall make advance royalty payments of $15,000.00 quarterly, payable on the 15th day of July, October, January and April; provided, however, the advance royalties shall not exceed the ground rental payments which Ford is required to pay under said Ford-Palms Book lease, as amended.
6. Operator shall receive a credit of 500 per gross ton on advance royalty so paid by it on ore sold and shipped from the property to others than Ford; if such credit in any calendar year is not sufficient to liquidate the advance royalties so paid during such calendar year, then Operator shall receive a credit of or be paid 500 per gross ton on ore mined and shipped to Ford until said advance royalties have been liquidated. If shipments of ore in any year are not sufficient to liquidate advance royalty payments in that year, any balance remaining unliquidated shall be carried forward until such time as shipments are sufficient to liquidate such balances; provided, however, that any advance royalty payments remaining unliquidated at time of final termination of this agreement as provided in Paragraph Thirteen hereof shall be absorbed by Operator.

It was further provided that Ford would turn over the Blueberry mine property to the petitioner fully equipped for operation and that upon termination of the agreement the buildings and equipment on the property would be turned back to Ford in as good condition as when received, less ordinary wear, tear, and obsolescence; that petitioner would pay all taxes and assessments on the lands and the ore mined therefrom during the continuance of the agreement; that petitioner would assume all risk of damage or injury to property of others or persons upon or. about the premises, and would keep all of the property insured against fire, for the benefit of Ford; that petitioner would operate the property in a good, workmanlike manner and in accordance with the terms of the Ford lease with the Palms-Book Land Co.; that the agreement might be canceled by either party upon six months’ notice; and that upon cancellation or termination any ore then mined by the petitioner and still in the stock pile would be the property of the petitioner, subject to removal at any time within 114 years, or, at the option of Ford, it might be acquired by Ford at the price agreed upon in the contract. It was further provided that petitioner would furnish Ford with quarterly statements showing the amount of ore shipped and the parties to whom shipped and also monthly statements and maps of the drilling done on the property.

There was a further provision that the agreement could not be assigned by the petitioner without the written consent of Ford.

On April 25, 1934, Ford agreed to purchase 100,000 tons of “Hocking” ore from mines in the Mesabi and Cuyuna ranges from the petitioner and to deliver to the petitioner in consideration therefor tonnage of Blueberry ore containing equivalent natural iron units. Ford also agreed to purchase said tonnage of Blueberry ore from the petitioner. On April 30, 1934, the Inland Steel Co. agreed to deliver to petitioner 100,000 tons of “Hocking” ore and petitioner agreed to deliver to the Inland Steel Co. tonnage of Blueberry ore. Petitioner subleased part of the surface land to the Inland Steel Co. for stock pile purposes.

Petitioner entered into contracts involving Blueberry and Orwell ores, similar to that referred to above, with the same parties under date of April 29, 1936.

Petitioner entered into so-called term ore contracts, involving the sale and delivery of Blueberry ore over a period of years to a company other than Ford, during the calendar years 1934 to 1937.

On June 15, 1937, the Barnes Land Co., Palms-Book Land Co., Ford, and the petitioner joined in a conveyance to the board of county road commissioners of Marquette County, Michigan, of an easement for the construction and maintenance of a county road over the surface lands of the Blueberry mine.

During the years 1934 to 1937, inclusive, Ford requested suppliers of iron ore to make bids for its anticipated requirements. Petitioner was required to meet this competition and in doing so sold some ore to Ford at a price below that fixed in the contract of November 1, 1933.

The following tabulation shows the amounts in tons and gross sales of ore mined and sold by petitioner from the Blueberry mine:

In its returns for 1934 to 1937, inclusive, petitioner elected to take depletion deductions on a percentage basis and claimed such deductions on all of the ore sold during the taxable years. The respondent in determining the deficiencies herein has allowed depletion deductions on the ore mined by the petitioner under the agreement of November 1, 1933, and sold to third parties, but has ruled that the petitioner did not acquire any economic interest in the ore mined and shipped to Ford, and therefore is not entitled to the deductions claimed in respect of such ore. The amount of the depletion deductions claimed by the petitioner in each year and the amounts allowed by the respondent are shown as follows:

The parties submit that the question in issue hinges upon the construction of the agreement of November 1, 1933, and particularly that portion of the agreement relating to the iron ore to be mined and sold to Ford. The respondent contends that under the contract in question petitioner’s relationship to Ford, at least as to the ore to be sold to Ford, was that of an independent contractor and not a lessee, and that petitioner operated the mine merely as an agent of Ford, with the right to dispose of any excess ore over Ford’s needs on its own behalf. The parties devote a considerable portion of their briefs to a discussion of whether petitioner, under the agreement of November 1,1933, was a lessee, or a mere assignee, or an independent contractor.

As to the construction of the agreement, it is not material to our purpose whether it is a sublease or some other form of contract. Whatever the form technically, if it conveyed to the petitioner an interest in the ore in place, depletion deductions on such ore are allowable to the petitioner. Burnet v. Harmel, 287 U. S. 103; Palmer v. Bender, 287 U. S. 551; Willis R. Dearing, 36 B. T. A. 843; T. W. Lee, 42 B. T. A. 1217. With respect to the application of the decision of the Supreme Court in Palmer v. Bender, supra, G. C. M. 11822, Cumulative Bulletin XII-1, p. 229, provides in part as follows:

Accordingly, the right to a depletion allowance does not depend upon the nature or character of the legal estate retained 'or acquired by the parties to an original oil and gas lease or their successors, but depends entirely upon whether any of such parties is entitled to share in the oil and gas produced from the properties. If any of such parties is entitled to a share of the oil and gas, he has the “economic interest” upon which the Supreme Court bases the right to a depletion allowance. In view of the foregoing, General Counsel’s Memorandum 8650 is revoked.

See also T. W. Lee, supra, and Rowan Drilling Co., 44 B. T. A. 189.

Petitioner was obligated under the agreement in question to produce annually as much ore as needed to meet the requirements of Ford, for which Ford was to pay it $1.25 per ton, with adjustments if necessary to conform to the so-called “Oliver scale.” It was obligated to pay advance royalties to Ford not in excess of ground rental which Ford was obligated to pay to its lessor. Petitioner had the right in any year to mine and sell to others as much additional ore as it might choose, for which it was to pay royalties to Ford of 75 cents per ton for the ore sold in 1983 and for the first 50,000 tons sold in any subsequent year, and $1 per ton for any additional amount. Petitioner was to receive a credit on advance royalties to be paid to Ford of 50 cents per ton on the ore sold to third parties and a further credit on any unliquidated portion of such advance royalties of 50 cents per ton on ore sold, to others. Any advance royalties not completely liquidated in any year were to be carried forward until there were sufficient ore shipments to liquidate them.

It is apparent from these provisions of the agreement that Ford retained no interest in the ore in place except the royalties which it was to receive from petitioner on bre mined and sold to others. Whatever additional benefit it was to receive from the purchase of the ore mined for its own needs at a price below market was a contractual right and not an economic interest in the ore in place. The question of apportionment of the interests of lessor and lessee in oil in place was considered by the Supreme Court in Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312. It was held in that case that the depletion deductions (on a percentage basis) of the lessee should be computed on the gross production less the one-fourth royalties paid to the lessor on which depletion was allowable to the lessor. The Court said that: “Such an apportionment has regard to the economic interest of each of the parties entitled to participate in the depletion allowance”, and a different rule does not apply where the lessee sells all the oil and pays the royalties in cash. See also Thomas v. Perkins, 301 U. S. 655. Under the decision of the Court in Helvering v. Twin Bell Oil Syndicate, supra, petitioner is clearly entitled to percentage depletion deductions on the gross receipts from the ore sold to third parties after deduction of the royalties paid to Ford, and the respondent has allowed such deductions, subject to the statutory limitation of 50 percent of the net income from the property without allowance for depletion. We see no justification for treating the agreement of November 1, 1933, as divisible and as requiring the ore sold to Ford to be treated in a different manner for depletion purposes from that sold to others. While this ore was sold to Ford at a price under market, the practical result, as petitioner suggests in its brief, was the same as if the ore had been sold to Ford at market and petitioner had paid royalties to Ford approximating the difference between the market price and the contract price. In that case Ford would have been entitled to depletion deductions on the royalty interest which it retained and petitioner would have been entitled to depletion deductions on the amounts received from Ford. Helvering v. Twin Bell Oil Syndicate, supra. In any event we think petitioner is entitled to depletion deductions on the proceeds of all of the ore sold during the taxable year, including the sales to the Ford Motor Co.

Decision will be entered under Buie 50.


author: Turner :

text:
    The L. A. Wells Construction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102554.
    Promulgated February 11, 1942.

      Meyer A. Oook, Esq., and Frank W. Koral, Esq., for the petitioner.

      W. W. Kerr, Esq., for the respondent.
   OPINION.

Turner :

The petitioner contends that it kept its books and filed its income tax returns on the accrual basis; that the Buffalo contract, which did not contemplate or require in excess of twelve months for completion, was not a “long-term” contract as defined by the respondent’s regulations, and that therefore the deduction of $61,031.40 taken in its 1937 return as a reserve for loss should be allowed in order to clearly reflect its income. The respondent contends that, since the petitioner has consistently reported its taxable income from contracts begun in one year and completed in the following year on the completed contract basis, and since the Buffalo project was not completed until 1938, the allowance of the deduction sought by the petitioner would result in a distortion of its taxable income for both 1937 and 1938.

The evidence shows that the first of the petitioner’s contracts on which work was begun in one year and completed in the following year was in 1935. So far as disclosed, none of petitioner’s contracts of that type covered a period in excess of twelve months from beginning until completion. The testimony of its secretary-treasurer, who had charge of its books, shows that under the petitioner’s method of accounting for and reporting income from such contracts it was its practice to report the income received and the costs incurred with respect to specific projects in its return for the year of completion. Such a practice contradicts the petitioner’s contention that it kept its books and filed its returns on the accrual basis. For as we said in H. Stanley Bent, 19 B. T. A. 181; affd., 56 Fed. (2d) 99:

* * * When, as here, the specific project accounts have been withheld from profit and loss until the completion of the project and this in disregard of any intervening annual period, it can not be said that the taxpayer’s accounting method is one of the annual accrual of net income.

From the evidence it is apparent that the petitioner accounted for and reported its income by the completed contract method. So far as disclosed, the respondent has consistently accepted such method as correctly reflecting the petitioner’s income and, we think, properly so. H. Stanley Bent, supra; Alfred E. Badgley, 21 B. T. A. 1055; affd., 59 Fed. (2d) 203; Russell G. Finn, Executor, 22 B. T. A. 799; Fort Pitt Bridge Works, 24 B. T. A. 626; affirmed on this point, 92 Fed. (2d) 825; certiorari denied, 303 U. S. 659; D. L. Wheelock, 10 B. T. A. 540.

With respect to the Buffalo project the petitioner, under the guise of a reserve for loss, seeks to depart from its established practice of accounting for and reporting income and to deduct in its 1937 return an amount representing a prorated portion of its total estimated loss on the project. Where, as here, the method of accounting employed by the taxpayer clearly reflects income, to permit such departure would not result in the petitioner’s net income being computed “in accordance with the method of accounting regularly employed in keeping the books of such taxpayer”, as is required by the statute. Sec. 41, Revenue Act of 1936. The allowance of such departure would, as respondent contends, result in a distortion of income for both 1937 and 1938. We are of the opinion that the action of the respondent with respect to this issue is correct, and it is therefore sustained. Russell G. Finn, Executor, supra.

The petitioner contends that the decisions in the H. Stanley Bent, Alfred E. Badgley, Russell G. Finn, Executor, and Fort Pitt Bridge Works cases, supra, cited by respondent, were predicated on article 36 of Regulations 45, relating to the 1918 Act, and did not specifically define “long-term contracts”; that article 42-4 of Regulations 94, relating to the 1936 Act, which is applicable here, defines “long-term contracts” as “building, installation, or construction contracts covering a period in excess of one year”; that the Buffalo contract did not cover a period in excess of one year and that to hold as applicable here the completed-contract method of reporting income involved in said decisions and specifically provided for in article 42-4 (b) of Regulations 94, would nullify the obvious intent of the regulation as disclosed in the definition of long term contracts. It is true that the decisions in the cases mentioned, except the Badgley case, involved taxable years controlled by the Revenue Act of 1918. However, the D. L. Wheeloch case involved years controlled by the 1918 and 1921 Acts and the Badgley case involved years controlled by the Revenue Acts of 1921, 1924 and 1926. The regulations under all acts since the Act of 1918 contain the same definition of long term contracts as appears in article 42-4 of Regulations 94. The rule in the above mentioned cases is grounded not on the length of time covered by the contracts, but- on the taxpayer’s method of keeping books and reporting income, and, as we said in the Bent case, “The fact that-some of the contracts were performed within a year and some took longer creates no inconsistency in the method and does not detract from a clear reflection of income.” The petitioner has consistently reported the income from the various projects in the year in which the particular project was completed and there is nothing in the facts to indicate that such method consistently followed does not clearly reflect income, and certainly there is no justification for according the Buffalo project any different treatment from that accorded to other contracts begun in one year and completed the year after.

The petitioner has alleged that the respondent erred in disallowing the deduction of $7,537.35 taken as repairs to the dredge, Gala Water. The petitioner now concedes that $5,500 of the amount in question represented cost of raising the dredge and is not deductible. It is contended that the remaining amount of $2,066.19 is deductible because expended in reconditioning and restoring the hull and the motor to the condition they were in prior to the time the dredge sank, citing Zimmern v. Commissioner, 28 Fed. (2d) 769.

Assuming, as petitioner contends, that $2,066.19 was expended for the purpose alleged, the Zimmern case is not authority for the allowance of the deduction claimed. In that case the taxpayer owned and was using in its business a coal barge which sank during a storm in 1918. The court held that an expenditure made by the taxpayer in 1920 for restoring the barge to the condition it was in at the time it sank was an ordinary and necessary expense and therefore deductible for the year in which made. The facts in the instant case are materially different. Here the petitioner purchased a dredge which had been lying on the bottom of Lake Erie for three months and was in an unusuable condition. It was for the dredge in that location and in that condition that the petitioner paid $200. Without further expenditures the dredge would have continued in the same location and in the same condition. Clearly what the petitioner had after making the expenditures here involved was not a sunken dredge in its then useless condition, but one that was afloat and serviceable. So far as disclosed, the expenditures made by the petitioner gave the dredge a useful life of many years beyond the taxable year. Under these circumstances we are unable to hold that the portion, now claimed, of the amount deducted by the petitioner constituted an allowable deduction. Cf. H. Wilensky & Sons Co., 7 B. T. A. 693. The situation here presented is entirely different from that of a taxpayer who repairs damage which has occurred to property owned and being used by him and who after such repairs has no greater asset than he originally owned.

Decision will be entered for the respondent.


author: Mellott■:

text:
    Helms Bakeries, Petitioner, v. Commissioner of Internal Revenue, Respondent. Paul H. Helms and Pearl E. Helms, Petitioners, v. Commissioner of Internal Revenue, Respondent. Paul H. Helms, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 102603, 102604, 102602.
    Promulgated February 11, 1942.

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

      E. A. Fonjes, Esq., for the respondent.
   OPINION.

Mellott■:

The petitioner contends it is entitled to a credit for dividends paid in an amount equal to its adjusted net income of $71,675.52, under.section 26- (c) (1) or (2) of the Bevenue Act of 1936, either by reason of a contract restricting the payment of dividends or by reason of a pontract requiring a portion of its earnings and profits of the taxable year to be paid in discharge of a debt. It also contends that, in the event the preferred stock dividends declared and distributed by it during 1936 are held to be taxable, it is entitled to a credit for the purposes of the undistributed profits tax to the extent of the fair market value thereof under section 27 of the Revenue Act of 1936. The respondent concedes that the latter contention is sound.

Section 14 of the Revenue Act of 1936 imposes a surtax on the net income of a corporation not distributed in the taxable year. Section 26 (c) (1) allows as a credit, in computing the surtax, the adjusted net income which can not be distributed as dividends within the taxable year without violating a provision of a written contract executed by the corporation prior to May 1, 1936, expressly dealing with the payment of dividends. Section 26 (c), under which petitioner claims, grants a special exemption from tax and should, therefore, be strictly construed. Pacific Co. v. Johnson, 285 U. S. 480; Helvering v. Intermountain Life Insurance Co., 294 U. S. 686; Deputy v. DuPont, 308 U. S. 488; Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. It is necessary for petitioner to bring itself squarely within the statute if the claimed credit is to be allowed.

Petitioner was operating a rapidly expanding business and it was necessary to borrow large sums of money to carry on. In December 1935, it owed a bank a substantial sum and opened negotiations for an additional loan of $50,000. About December 5,1935, Helms, president of petitioner, had a conference with a representative of the bank and an agreement was reached concerning the terms of the additional loan. The agreement made at that time was confirmed in writing and petitioner agreed to liquidate the total loan at the rate of $10,000 per month plus interest. It also agreed “that no cash dividends will be paid until this loan is liquidated on the above terms.” A portion of the loan was outstanding throughout the calendar year 1936. Payments at the agreed rate were made regularly during 1936.

Respondent contends that petitioner’s contract with the bank only prohibited the payment of “cash dividends”; that it could (and did) distribute a stock dividend in 1936 without violating a provision of its agreement; and that under such circumstances the provisions of the law and the regulations have not been met.

Petitioner contends that, since its preferred stockholders were entitled to cumulative cash dividends of $7 per share, as evidenced by the provisions as to dividends printed on the stock certificates, before any dividends could be paid on its common stock and since, in 1936, the accumulated dividends on its preferred stock exceeded its surplus, only “cash dividends” could be distributed without the consent of the preferred stockholders. It insists that since it could not distribute cash dividends in 1936 without violating its agreement with the bank, it is entitled to the credit granted in section 26 (c) (1).

The fact that the stockholders were the beneficial owners of the corporation and their interest was its interest can not be overlooked. Cf. Henry Mill & Timber Co., 43 B. T. A. 1073. The preferred stock certificates did not constitute written contracts restricting the payment of dividends within the meaning of section 26 (c) (1). Bishop & Babcock Manufacturing Co., 45 B. T. A. 776; Helvering v. Northwest Steel Rolling Mills, Inc., supra. The consent of petitioner’s stockholders to receive a dividend in stock instead of cash in settlement of accumulated dividends was merely an assent to corporate policy by members of the corporate group. Whether such consent was necessary before petitioner could distribute stock dividends instead of cash is not material in determining whether petitioner’s ■agreement with the bank is within the requirements of section 26 (c) (1). The fact that petitioner obtained such consent and distributed dividends in preferred stock, after refusal of tbe bank to waive the agreement prohibiting the payment of “cash dividends” until the loan was paid, is some evidence petitioner considered the agreement with the bank restricting dividends to extend only to “cash dividends.” Petitioner construed its contract with the bank as not restricting its right to distribute additional stock to its stockholders and additional stock was distributed. To say that its contract prohibited the payment of all dividends within the meaning of section 26 (c) (1) in the face of its admitted action, is, to say the least, somewhat inconsistent. Moreover, since petitioner had outstanding in the taxable year both preferred and common stock it could have distributed a taxable stock dividend if it chose to do so. Cf. Koshland v. Helvering, 298 U. S. 441; Sprouse v. Commissioner, 122 Fed. (2d) 978. It, therefore, is not within the rule recognized by the Board in Paraport Theatre Leasing Corporation, 44 B. T. A. 108. Cf. Regulations 94, art. 26-2 (b).

Petitioner relies on Columbia River Paper Mills, 43 B. T. A. 263 (appeal pending C. C. A. 9th Cir.). In that case the taxpayer could not have made any distribution to its stockholders except in cash. In the opinion it was said: “We agree with the respondent that if a dividend could have been paid by the petitioner during 1936 in any form other than cash the petitioner has not brought itself within the letter of section 26 (c) (1) of the Taxing Statute.” In the instant proceeding petitioner not only could have distributed a dividend in a form other than cash without violating a provision of a written contract, but it actually did so. It is obvious that Columbia River Paper Mills is distinguishable upon its facts and can not be regarded as controlling here. Petitioner has failed to bring itself within the letter of section 26 (c) (1) and its claim for credit under that subsection must be denied.

Petitioner’s contention that it is entitled to a credit under section 26 (c) (2) is also untenable. Its letter to the bank in confirmation of the oral agreement, is the only written agreement in evidence and it provides only for the stepping up of payments on the loan from $8,000 to $10,000 per month, plus interest. It does not expressly deal with the disposition of earnings or profits of the taxable year, nor does it require that the monthly payments be made out of earnings and profits, or that earnings or profits be irrevocably set aside for the discharge of a debt. Cf. G. B. R. Oil Corporation, 40 B. T. A. 738; Michigan Silica Co., 41 B. T. A. 511; affd., 124 Fed. (2d) 397; Strong Mfg. Co., 41 B. T. A. 1273; affd., 124 Fed. (2d) 360; Magnus Beck Brewing Co., 46 B. T. A. 78. The agreement to pay $10,000 per month merely fixed the amount of the monthly payments. It had nothing to do with the source from which the payments would be made. A mere probability that a part or all of the monthly payments would be derived from earnings and profits is not sufficient to meet the requirements of the statute. Belle-Vue Manufacturing Co., 43 B. T. A. 12; Campbell Transportation Co., 43 B. T. A. 417 (on appeal C. C. A., 3d Cir.); Van Ameringen-Haebler, Inc., 45 B. T. A. 1085. It is immaterial, therefore, that petitioner did in fact make payments out of current earnings. In order to be entitled to credit under section 26 (c) (2) it must bring itself precisely within the statute. This it has failed to do. Cf. Helvering v. Moloney Electric Co., 120 Fed. (2d) 617; Lamm Lumber Co., 45 B. T. A. 1; Eastern Building Corporation, 45 B. T. A. 188. The claimed credit under section 26 must therefore be denied.

The next question is whether the dividends in first and second preferred stock distributed by petitioner to the holders of its first and second preferred shares were taxable dividends within section 115 of the Revenue Act of 1936.

Petitioner contends that the agreements of the preferred stockholders to exchange the certificates representing shares of the corporation for new certificates representing the same shares, to accept first and second preferred shares in satisfaction and payment of certain accumulated dividends, and to purchase one share of common stock for each share of first or second preferred stock received as a dividend, amounted to a recapitalization of the company and hence a reorganization and there was a nontaxable exchange of stock under section 112 (b) (2) or (3) of the Revenue Act of 1936. This contention is without merit. Skenandoa Rayon Corporation, 42 B. T. A. 1287; affd., 122 Fed. (2d) 268; and South Atlantic Steamship Line, 42 B. T. A. 705, cited by petitioner in support of this contention are distinguishable upon their facts. In each there was a recapitalization and reorganization in pursuance of a definite plan. Here there was no plan of reorganization, but only a plan to distribute a dividend in first and second preferred stock in lieu of accumulated cask dividends. It is true that the old certificates were exchanged by the shareholders for new ones; but the question here is not whether there was any gain upon an exchange of shares. It is simply whether the distributions which were made are taxable as dividends under section 115 of the Revenue Act of 1936. We think that they were and accordingly so hold.

But, says petitioner, no substantial change was made in the proportionate interests of the stockholders and the distribution resulted in a mere proliferation within the rationale of Eisner v. Macomber, 252 U. S. 189. The cited case held that a dividend in the corporation’s common stock distributed to the then common stockholders, which did not give such stockholders an interest in the corporation’s assets different from that which they already had, was not income within the Sixteenth Amendment. The decision was based upon a broad perspective of the relations between a corporation and its stockholders. Following it, Congress, in the Revenue Act of 1921 and subsequent revenue acts, up to and including the Revenue Act of 1934, incorporated in the law a provision that: “A stock dividend shall not be subject to tax * * In 1936 the Supreme Court in Koshland v. Helvering, 298 U. S. 441, laid down the rule that where a stock dividend gives the stockholder a proportionate interest in the net assets of the corporation different from that which his former stockholdings represented, he receives income which is taxable under the Sixteenth Amendment. Following the decision in the Koshland case, the Revenue Act of 1936 was enacted providing, in effect, that a stock dividend is taxable if it constitutes income to the shareholders within the meaning of the Sixteenth Amendment to the Constitution. (Sec. 115 (f) (1), Revenue Act of 1936.)

In Helvering v. Gowran, 302 U. S. 238, the Court had before it a case arising under the Revenue Act of 1928, where a dividend, payable in preferred stock, had been declared on common stock. It held that the common shareholder had received an interest different in character from that which his common stock represented and that the dividend was constitutionally taxable, although under the law as it existed at that time it was not subject to tax.

In Sprouse v. Commissioner, 122 Fed. (2d) 973 (C. C. A., 9th Cir.), a corporation distributed a 10 percent stock dividend in nonvoting common stock to holders of voting common and nonvoting stock. The petitioner owned only voting common stock prior to the declaration of the dividend. The court held that the real test whether such a distribution constitutes income is not “differences in such characteristics as preference in interest in assets and in dividends, and in the right to vote”, but “whether the distribution effects a change in the proportionate interests of the stockholders”; for example, “where the corporation has more than one class of stock outstanding, and distributes a stock dividend to one class only, then the proportionate Interests in the corporation are changed, because the class of stockholders who receive the dividend then have a greater interest in the assets of the corporation than those who did not receive the stock dividend, Koshland v. Helvering, supra. There being a change in the proportionate interests, the recipients of the stock dividend have derived income.”

In Strassburger v. Commissioner, 124 Fed. (2d) 315, affirming memorandum opinion of this Board, the court held that distribution of preferred stock to the sole owner of the common stock, which was the only class of stock outstanding, was income within the meaning of the Sixteenth Amendment. The rationale of the decision seems to be that the stockholder received property rights of actual and exchangeable value representing an interest different from that which his common stock represented.

In the instant proceeding there was outstanding first and second preferred and common stock. The corporation distributed first preferred stock to the owners of first preferred shares and second preferred stock to the owners of second preferred shares. No distribution was made to the owners of common shares. It' is obvious the preferred stockholders received property rights of actual and exchangeable value which changed the proportionate interest in the net assets of the corporation as between the preferred and the common stockholders. This distribution was in' our opinion a dividend and constituted taxable income to the shareholders within the meaning of the Sixteenth Amendment and under section 115 (f) of the Revenue Act of 1936. Petitioner is, therefore, entitled to a dividends paid credit under section 27 (e) of the Revenue Act of 1936 in the amount of the fair market value of the preferred stock distributed to its stockholders.

Docket No. 108604.

The respondent included in the income of Helms and his wife for 1936 $50,900 representing the value of the first and second preferred stock distributed to them by Helms Bakeries, computed at $100 per share. Helms contends that the preferred stock was not income within the meaning of the Sixteenth Amendment. If it is held to be income, however, then he contends that the amount thereof should be determined to be the fair market value of the preferred stock which he received. This has been stipulated to be $90 per share for the first preferred and $25 per share for the second preferred.

It has been held that the preferred stock distributed by Helms Bakeries in 1936 was taxable income to the shareholders within the meaning of the Sixteenth Amendment and under section 115 (f). The corporation is being allowed a dividends paid credit equivalent to the fair market value of the stock at the time it was distributed. The respondent concedes that, if taxable as a dividend to the recipients, it should be included in their gross income at its fair market value at the time it was received by them rather than at par. This concession accords with our view of the law. The deficiency in this proceeding should therefore be recomputed, including in the income of Helms and his wife only the fair market value of the stock at the time it was received.

Docket No. 102602.

The issues in the proceeding of Helms, trustee, are: (a) Was taxable income realized in 1936 through distribution to the trustee of the first and second preferred stock of Helms Bakeries? and (b) did respondent err in failing to find there were three separate trusts —one for each of the three children — instead of one trust for the three of them?

Issue (a) has already been discussed. For the reasons set out above it is held that the preferred stock was income for the taxable year to the extent of its fair market value at the time received.

The answer to the remaining question may be found by ascertaining the intention of the settlors of the trust. Green v. Green, 23 Wall. (90 U. S.) 486. The instrument which they signed is the best evidence. It should be examined from its “four corners.” McGinley v. Commissioner, 80 Fed. (2d) 692; Huntington National Bank v. Commissioner, 90 Fed. (2d) 876. Evidence aliunde may be received to aid in the construction but not to contradict the plain and unambiguous language used. 65 C. J. 248. The only evidence offered or received in the instant proceeding bearing upon this issue was the testimony of Helms and his attorney upon which finding has been made that instructions were given to prepare three trusts, one for each of the children, and that the attorney, who drew up the instrument, advised Helms it created three separate trusts. Notwithstanding this evidence we choose to rest our conclusion chiefly upon the instrument itself; so it will be discussed at some length.

The trust estate (Two (b)) was to “be apportioned, segregated and divided into three equal shares”, one for each child. The net income from each (Two (c), (d) and (e)) was to be “apportioned and segregated to and for the use and benefit of” each of the three named children. Under Two (f) “the share of the Trust Estate apportioned” to each child was to be treated separately in the event of his or her decease and under Three, if “the income from the respective shares to which the respective beneficiaries may be entitled” should be insufficient for the purposes contemplated by the settlors, the trustee was to use “so much of his or her share up to and including the whole thereof, as the trustee may deem advisable.” All of these provisions indicate that three separate trusts were created. The trustee so interpreted the trust instrument, signing separately, as trustee for each of his children, the consent to accept stock and, after it was received, allocated one-third of it to each of the children. Separate returns were filed by him for each of the children, listing therein one-third of the stock received as “stock dividends on stock held in trust for the beneficiary.” Some of the circumstances set out above are only self-serving and have been given little weight. We are convinced, however, from an examination of the trust instrument, that three separate trusts were created and we so hold.

Decision in each of the proceedings will he entered nmdeP Rule SO.

       SEC. 26. CREDITS OF CORPORATIONS.
      *******
      (c) Contracts Restricting Payment of Dividends.—
      (1) Prohibition on Payment of Dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
      (2) Disposition of Profits of Taxable Year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within thp taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.

       Article 26-2 (b) of Regulations 94 provides:
      (b) Prohibition on payment of dividends. — The credit provided in section 26 (c) (1) is allowable only with respect to a written contract executed by the corporation prior to May 1, 1936, which expressly deals with the payment of dividends and operates as a legal restriction upon the corporation as to the amounts which it can distribute within the taxable year as dividends. If an amount can be distributed within the taxable year as a dividend—
      (1) in one form (as, for example, in stocks or bonds of the corporation) without violating the provisions of a contract, but can not be distributed within the taxable year as a dividend in another form (as, for example, in cash) without violating such provisions, or
      (2) at one time (as, for example, during the last half of the taxable year) without violating the provisions of a contract, but can not be distributed as a dividend at another time within the taxable year (as, for example, during the first half of the taxable year) without violating such provision—
      then the amount is one which, under section 26 (c) (1), can be distributed within the taxable year as a dividend without violating such provisions.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      (a) Definition of Dividend. — The term “dividend” when used in this title (except in section 203 (a) (3) and section 207 (c) (1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. *******
      (f) Stock Dividends.—
      (1) Geneeal rule. — A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.
      *******
      (j) Valuation of Dividend. — If the whole or any part of a dividend is paid to a shareholder in any medium other than money the property received other than money shall be included in gross income at its fair market value at the time as of which it becomes income to the shareholder.


author: Disney:

text:
    Everett N. Crosby, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104252.
    Promulgated February 18, 1942.

      Todd W. Johnson, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Disney:

The petitioner concedes his taxability upon $3,032.61 as one-half of the community income prior to the separation agreement, and upon $10,000 of the $51,052.42, received thereafter, since $10,000 was received for services performed after February 11, 1938. Therefore the only question to us presented is whether he is taxable upon $41,052.42, received after February 11, 1938, which is stipulated to have been “for services performed by him prior to February 11, 1938, in negotiating contracts for the services of Bing Crosby.”

This conclusion depends upon the effect of the property settlement upon income from services performed before such settlement, but received thereafter. Upon brief the petitioner agrees (and the law is well settled) that the husband and wife could by the property settlement make the commissions in question the property of the petitioner when received, and that they did so. They were not paid to the wife. The question is therefore, whether, though received by the husband and not the wife after the property settlement, the amounts are, as contended by the petitioner, taxable to him only to the extent of one-half because earned during the marital community. Cases cited to the effect that the character of income as to whether community or not, is to be determined as of the date of inception of the contract from which they are derived, do not here apply, for the question here is as to the effect of a property settlement.

On that question the petitioner’s argument in substance is, first, that the petitioner purchased the right to the income from his wife and had not in the taxable year recovered his basis of cost and was therefore not taxable; second, that if not a purchase and sale, the transaction was a division or partition of property, analogous to distribution in kind by a partnership, and that, applying the law as to partnerships, petitioner has not recovered his base; and third, that if there was no consideration for the assignment by the wife, then under Helvering v. Horst, 311 U. S. 112, and other cases, the wife was for tax purposes unable to assign income and was still taxable on her community one-half of what petitioner received in the taxable year. The respondent’s view is in effect that after the property settlement separating the community property rights, both the parties and the Government are bound thereby, rendering later receipts taxable in accordance with ownership.

We conclude, first, that there was consideration for the transaction agreement, and that the theory underlying the Horst case does not apply. The mutual agreements and covenants, specifically stated in the agreement to be the consideration therefor, and the division of the community property, plainly constitute ample consideration. Mutual consent is sufficient consideration. Sec. 160, Cal. Civ. Code. A gift is not involved. Wren v. Wren, 100 Cal. 276; 34 Pac. 775. Nor can we apply Mrs. Len Langston, 23 B. T. A. 991, cited by the petitioner, for that proceeding involved a mere donation of right to receive income, unconnected with any division or conveyance of property.

Petitioner’s theory that there was distribution of partnership property calling for application of the basis of a partner, so that under section 113 (a) (13), Revenue Act of 1938, no tax would be payable by him, is in our opinion untenable; and in any event no basis is shown. A marital community can not soundly be viewed as so completely a partnership as to require application of the Federal statutes as to income tax relative to that entity, as petitioner alternatively asks. The nature of the wife’s interest in the community estate has been the subject of much discussion, with conclusions various; but we think it clear that the power of management in the husband, the grave question as to ownership in the wife, and her limited powers, well indicate that such relation was not contemplated by Federal income tax statutes as to partnership. Indeed, this is shown by section 113 (a) (13), relied on by petitioner, for that section gives the partner, in case of distribution in kind to him, a basis of “such part of the basis in his hands of his partnership interest as is properly allocable to such property.” Though, as petitioner argues, the allocation is to be in proportion with property values held and distributed at the time of distribution, yet the petitioner errs in finding a basis in cost to the partnership, thereby demonstrating the inapplicability of the partnership theory to a community estate. As shown by G. C. M. 20251, O. B. 1938-2, p. 169, cited in part by petitioner, a partner’s base is not cost to the partnership, but his contribution to the partnership, proportioned to the property distributed in the ratio of its value to the value of all partnership assets. Here there was no contribution to a partnership, or to the community estate. At approximately the date of marriage, the petitioner’s assets were nothing, as shown by his testimony, so that petitioner had no “basis in his hands of his partnership interest”, in the words of section 113 (a) (13), to allocate to the property distributed to him. This indicates that to a marital community, to which as such there is no contribution of property or money, should not be applied the statutes as to partnership. A husband and wife might form a partnership and contribute money or property thereto, but they do not do so merely by marrying and living in a community property state. But in any event, as above set forth, petitioner has shown no basis to allocate in proportion to values at the date of contract.

This leaves for consideration petitioner’s theory that he purchased from his wife the right to the income involved, and has not recovered his base therein. Though we have above held that consideration was involved in the contract, that fact alone does not demonstrate that there was a sale, within the purview of the Federal income statutes. The parties may, in California, agree to divide community by a contract not amounting to a conveyance. The California statute, section 159, Civil Code, merely provides that a husband and wife may by contract alter their legal relations as to property. A sale is not required. Was there in fact a sale herein? The petitioner relies in part upon the fact that he received the greater portion of the community property, assumed the community debts, and agreed to pay $22,000, and contends that the $22,000 was not for alimony, but for the wife’s interest in the property rights. We find no assumption of the community debts, except certain items. Petitioner asserts that he received all of the community property, except the promissory note of $7,016.17. The record shows that other community property was received by the wife, and, further, by a blind reference in the agreement of February 11, 1938, to division to the wife of personal property covered by a previous division of property on February 3, 1938, fails to show what proportion of the entire community property was received by the wife. Though the petitioner testified that the $22,000 was not paid for alimony, the agreement specifically in a separate paragraph, covers the matter; states that it is paid “as and for alimony and her support and maintenance”; and earlier, after reference to settlement of property rights reads: “and to provide for alimony and the support and maintenance of said Second Party * * Moreover, the money payments upon the $22,000 total were to be cut down in case of remarriage of the wife, she in that event thereafter to receive payments of only $100 per month, only until 73 months from the date of the agreement. Elsewhere the agreement provides a release by the wife of “all claims for alimony pendente lite or permanent alimony, excepting as herein provided.” The contracting parties particularly agreed that the agreement had been read and explained by counsel, and was fully understood. From all this we must and do conclude, notwithstanding petitioner’s statement that payment of the $22,000 (or lesser amount, if the wife had remarried) was not for alimony, that it was, and was particularly so made and understood.

That the petitioner had evidence of such grounds for divorce as would preclude alimony to the wife is not controlling. The divorce was not sought or obtained on such grounds. Moreover, we can not anticipate whether a divorce court would have believed the evidence; therefore, we can not say that alimony to the wife was impossible. It was • particularly in the minds of the contracting parties, and a plain part of the consideration.

We think that we have before us here a mere agreement, within the California statute, to alter the legal relations of the parties as to property, which includes income, not essentially dilferent from that involved in Frances R. Walz, Administratrix, 32 B. T. A. 718. The petitioner seeks to distinguish that case because he says therein no money was paid to the wife. This is-error, since there the husband executed his promissory note, just as the petitioner here agreed to pay in the future. No real difference can be seen in the cases. Yet we held that there was “no sale or exchange of the property in question, but a division of property.” Here the parties agreed that the execution of the agreement “is intended to be and is a full, complete and final adjustment and settlement of all the property interests and rights of the parties hereto.” Such, and not sale, we consider the nature of the transaction to be, and consider the right to income included. In Kaltschmidt v. Weber, 79 Pac. 272, it was said that the parties to a marital community may agree that “future as well as past earnings” shall be separate property and that “the effect of such an agreement will be to convert such earnings from the status of community property to that of separate property of the wife.” In F. Eldred Boland, 41 B. T. A. 930, an attorney and wife, a marital community in California, agreed that his earnings should be separate, and we held that the agreement served to make the husband taxable upon his earnings. Though the taxable year was several years after the agreement, earnings as an attorney may have included those from services performed prior to the agreement, and no distinction was made. Very recently in Johnson v. United States, 124 Fed. Supp. 518, the United States District Court for the Southern District of California had the present question before it, that is, whether a property settlement between husband and wife covered past earnings collected after the agreement. The Government contended, and the plaintiff conceded, that the transaction between husband and wife constituted division or partition of property, and not a sale or exchange of properties. The court held that under sections 158 and 159, California Civil Code, the agreement rendered the collections upon past earnings the sole property of the husband and that he was taxable upon the full amount thereof, no capital transaction being involved. We agree with the conclusion there set forth. Though in a sense the parties were disposing of property rights, the right received by the petitioner was merely contractual, and can not soundly be considered to have a base, as petitioner argues, in the amount of the value of the property and money which passed to the wife, not only because the money was “as and for alimony”, but because there was division, and not sale, of the community rights, with no basis, of cost or otherwise, in the contract as to the services of Bing Crosby. The right received by the petitioner was one to receive ordinary earnings, and not property acquired through capital expenditure.

We therefore conclude and hold that the petitioner received ordinary income in the entire amount of the earnings collected after February 11, 1938.

Decision will he entered wnd&r Rule 50.


text:
    John Sherwin, Petitioner, v. Commissioner of Internal Revenue, Respondent. The Mid-Continent Securities Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Francis M. Sherwin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 106728-106730.
    Promulgated February 18, 1942.

      Benjamin F. Fiery, Esq., for the petitioners.

      Thomas F. Oallahan, Esq., for the respondent.
   OPINION.

Smith :

These proceedings, consolidated for hearing, are for the re-determination of deficiencies in tax for 1938 as follows:

The questions in issue are: .

(1) Whether the Mid-Continent Securities Co. must include in its gross income for 1938 $82,250 paid as dividends upon certain shares of stock which that company claims to have sold to its two principal stockholders on December 20, 1937, by whom the dividends were actually received.

(2) Whether petitioners John Sherwin and Francis M. Sherwin are each entitled to deduct from his gross income for 1938 interest paid to the Mid-Continent Securities Co. pursuant to the contract for the purchase of the shares of stock above referred to.

The material facts have all been stipulated. We adopt the stipulation as our findings of fact.

The individual petitioners are residents of Willoughby, Ohio. The company also has its principal office in Willoughby, Ohio. All of the petitioners filed their income tax returns for 1938 with the collector at Cleveland, Ohio.

The Mid-Continent Securities Co. was incorporated under the laws of the State of Ohio on August 17, 1922. It has an authorized capital stock of 20,000 shares of class A stock of a par value of $100 per share, and 500 shares of class B stock of no par value. John Sherwin and Francis M. Sherwin each acquired 250 shares of class B stock of the company by purchase in 1922 and each acquired by inheritance 2,875 shares of class A stock from the estate of their father, John Sherwin, on January 16, 1934. On December 31, 1937, and during the year 1938, there were outstanding 500 shares of class B stock and 5,750 shares of class A stock. Each of these individuals, together with members of his family, owned during 1938 one-half of the issued and outstanding shares.

The voting power of the company is vested in the class B stock. The class A stock may be retired at any time at a price of $Í00 per share by unanimous action of the board of directors.

For many years the company was actively engaged in the buying and selling of securities. Under recent revenue acts the company has been classified as a personal holding company.

The company has always maintained a separate office, owns its own office furniture and fixtures, conducts its business on its own letterhead stationery, owns a vault, and rents a safety deposit box. The books and records of the company have always been maintained in the most detailed manner by a competent accountant employed on a full-time basis by the company. The records and accounts of the company are checked each year by the Bureau of Internal Bevenue. The company has its own deposit accounts with banks for the deposit of its funds. All funds and deposit accounts of the company have been kept completely separate from the funds and deposit accounts of its stockholders and officers.

The income tax returns of all of the petitioners for the years 1937 and 1938 were made on the cash receipts and disbursements basis.

The company had prospered and by the end of 1936 had accumulated an earned surplus in excess of. $1,000,000. By a letter dated June 12, 1937, John B. Kirk, revenue agent in charge of the Cleveland division, advised the Midland Bank of Cleveland, Ohio, that the United States Treasury Department had determined: “that the loss on stock of The Midland Bank should be allowed as a deduction to stockholders on their income tax returns for the year 1937.” The Mid-Continent Securities Co. owned 5,357.74 shares of that stock at a cost of $1,434,998.76. With the deduction of this loss its return for 1937 would show a very large net loss.

In December 1937 the company owned 57,300 shares of the Bich-man Bros. Co. stock and 12,803 shares of the common stock of the Valley Mould & Iron Corporation. The stock of the former company was listed on the Cleveland Stock Exchange. There was only a thin market for the shares, the total number of shares being sold on the exchange during 1937 amounting to 29,602 shares. The largest number of shares sold in any month was in March, when 3,367 shares were sold.

During December 1937 the stock sold on the stock exchange at prices ranging from 36i/g down to 30. The fair market value of the shares on December 20,1937, was $33 per share.

The shares of stock of the Valley Mould & Iron Corporation were not listed on any exchange. There were some “over-the-counter” transactions in the common stock and the fair market value of the shares on December 20,1937, was $20 per share.

The Mid-Continent Securities Co. desired to sell some of its holdings of stock of the Bichman Bros. Co. and of the Valley Mould & Iron Corporation, in which it had a large paper profit. This profit could be used to reduce a part of its net loss for 1937. It decided to sell 27,000 shares of Bichman Bros. Co. stock and 5,000 shares of Valley Mould & Iron Corporation. It was impossible to obtain the fair market price for the stock on a sale of such large blocks. It considered selling them to its two principal stockholders, John Sher-win and Francis M. Sherwin, but before doing so consulted the revenue agent in charge as to whether there was any provision of law or regulation of the respondent to the effect that such a transaction would not be recognized. The question was raised as to whether such “self dealing” had any bearing upon the tax question. The revenue agent knew of no such provision of law or regulation in a case where a taxpayer sold shares of stock at the market and realized a gain therefrom.

On December 20,1937, there was a meeting of the board of directors of the company at which the sale of 13,500 shares of no par common stock of the Rdchman Bros. Co. and of 2,500 shares of common stock of the Valley Mould & Iron Corporation was authorized to each of the petitioners John Sherwin and Francis M. Sherwin. The purchasers were not in a position to pay the full amount of the purchase price in cash at once. Each entered into a contract with the company by which he was to acquire the shares by a down payment of $5,000 and pay the balance on or before December 1, 1942, together with interest at the rate of 4 percent per annum, payable quarterly. The agreement provided that each purchaser should pay to the company at least 50 percent of all dividends received by him upon the shares acquired and that if the amount of dividends received was not sufficient to pay the interest due for any year it should be paid on or before the 10th day of January of the succeeding calendar year. The contract further provided that:

The Buyer shall have the right on or before December 1, 1942, to surrender to the Seller the aforesaid Stocks in full payment and satisfaction of the unpaid purchase price and all accrued interest thereon. Upon the delivery and surrender to the Seller of said Stocks the Buyer shall thereby be released and discharged of all liabilities hereunder and the Seller shall retain all payments received by it hereunder.

Following the meeting of the board of directors of the company a memorandum of sale dated December 20, 1937, was executed by each of the purchasers and the Mid-Continent Securities Co. Certificates for 13,500 shares of the Bichman Bros. Co. stock were endorsed and transferred to the name of John Sherwin under date of December 21,1937. Likewise, 2,500 shares of Valley Mould & Iron Corporation stock were transferred to John Sherwin on December 21, 1937, and registered on the corporation’s stock record books of Valley Mould & Iron Corporation in his name on December 22, 1937. The same procedure was followed with respect to the transfer of shares to the name of Francis M. Sherwin.

On December 20, 1937, the Mid-Continent Securities Co. paid a total sum of $1,600 cash for United States documentary stamps for the transfer of the Bichman Bros. Co. stock and Valley Mould & Iron Corporation stock to the name of John Sherwin and Francis M. Sherwin, respectively.

Since December 22, 1931, the certificates covering the shares of stock set forth in each of the aforesaid “Memorandum of Sale” stood in the name of John Sherwin and Francis M. Sherwin, respectively, on the stock record books of the respective companies.

Pursuant to the provisions of each memorandum of sale each respective “buyer” executed stock transfer powers covering the certificates representing the stock transferred in his name and delivered the same, together with the certificates covering said shares of stock, to the Mid-Continent Securities Co. in pledge to secure the payment of the balance shown to be due on these securities.

Since December 21, 1931, John Sherwin and Francis M. Sherwin have each exercised the voting rights of the shares of stock standing in his name at all annual meetings of stockholders of both corporations up to the present time.

Also, since December 21, 1937, John Sherwin and Francis M. Sherwin have received the dividends upon the shares of stock standing in their respective names.

During 1938 each of the purchasers received $41,125 in dividends upon the stock referred to above. They paid the entire amount of the dividends over to the Mid-Continent Securities Co. $30,680.92 being in payment of interest due from each and $10,444.08 being credited to them upon the principal of their indebtedness.

In subsequent years at least 50 percent of the dividends received by the purchasers upon their shares of stock have been paid to the seller of the stock in payment of interest upon their obligations and the excess has been credited to them on the principal of their indebtedness.

In its income tax return for 1937 the Mid-Continent Securities Co. deducted from gross income as a loss upon the 5,357.74 shares of Midland Bank stock the sum of $1,434,998.76. It also included $960,645.69 in its gross income as a gain upon the sales made to John Sherwin and Francis M. Sherwin of Bichman Bros. Co. stock and Valley Mould & Iron Corporation stock and reported a net loss for 1937 of $170,153.55.

In its income tax return for 1938 the Mid-Continent Securities Co. reported the receipt of interest from John Sherwin and Francis M. Sherwin in the aggregate amount of $61,361.84. It did not, however, include in its gross income the $82,250 dividends upon the shares of stock referred to above which were received by John Sherwin and Francis M. Sherwin. In the determination of the deficiency for 1938 the respondent has included in the company’s gross income, in addition to the amounts returned as interest, the dividends of $82,250 received by John Sherwin and Francis M. Sherwin, and has refused the company a dividends paid credit of $82,250 upon those shares upon the ground that they were preferential dividends.

In their income tax returns for 1938 John Sherwin and Francis M. Sherwin each reported the receipt of dividends upon the shares of stock above referred to standing in their respective names and deducted from gross income the amount of interest paid to the Mid-Continent Securities Co. in that year upon their obligations to that company.

The parties have stipulated that “The issues presented do not involve any question of fraud or tax evasion on the part of any of the taxpayers.”

The crucial point to be decided in these proceedings is whether the sale of the shares claimed to have been made by the Mid-Continent Securities Co. to John Sherwin and Francis M. Sherwin on December 20, 1937, may be “recognized for income tax purposes.” The respondent contends that they may not by reason of the fact that the company is a personal holding company and that each of the alleged purchasers of the stock, together with their families, had a 50 percent interest in the stock of the company. On brief the respondent states: “It is the position of respondent that the transaction was not in substance a sale, but was merely a device for the petitioners to escape income tax consequences.” He further states: “The various steps taken by the petitioners were anticipatory arrangements entered into for the purpose of avoiding taxation.”

There can be no question but that the alleged sale by the Mid-Continent Securities Co. of 27,000 shares of Eichman Bros. Co. stock and 5,000 shares of Valley Mould & Iron Corporation stock was a sale under the Uniform Sales Act of the State of Ohio. The respondent does not contend otherwise. By reason of the contracts entered into between the company and the purchasers the ownership of the shares was transferred from the company to John Sherwin and Francis M. Sherwin. They paid a portion of the purchase price in cash and obligated themselves to pay the balance of the purchase price on or before December 1, 1942, with interest at 4 percent per annum. The shares of stock were actually transferred to their names and thereafter they received the dividends upon the shares and exercised all voting rights with respect to the stock. The provision of the contract of sale by which the buyer might be relieved from the payment of the balance of the purchase price by forfeiting all payments made thereunder within a given period does not vitiate the contract of sale. See Paulson v. Weeks, 80 Or. 468; 157 Pac. 590; William M. Davey, 30 B. T. A. 837; James H. Torrens, 31 B. T. A. 787; Resthaven Memorial Cemetery, Inc., 43 B. T. A. 683.

We do not doubt that the contracts for the sale of the shares of stock were entered into on December 20, 1937, with an object of reducing taxes — if not for the year 1937, for subsequent years. The company had a very large paper profit on its holdings of Eichman Bros. Co. stock and Valley Mould & Iron Corporation stock. It foresaw that if it could sell those shares in 1937 and realize these profits it would not have to pay a tax for 1937, since that profit would merely offset a part of the loss sustained by it upon its Midland Bank stock. It was conceived that if John Sherwin and Francis M. Sherwin acquired the shares of stock from the company in 1937 at the stipulated fair market price of $33 per share for the Eichman Bros. Co. stock and $20 per share for the Valley Mould & Iron Corporation stock they could in a subsequent year, if desired, sell those shares and the gain or loss would be computed upon the purchase price; whereas if those shares of stock were sold by the company after 1937 it might realize a very large profit which would be subject to income tax.

A taxpayer has a right to decrease the amount of his taxes and to avoid them in toto by lawful methods. United States v. Isham, 17 Wall. 496, 506; Gregory v. Helvering, 293 U. S. 465; Johnson v. Commissioner (C. C. A., 2d Cir.), 86 Fed. (2d) 710.

The respondent argues, however, that “where evasion or avoidance of taxes is the intent and purpose of a transaction the forms used for its accomplishment will be scrutinized. Morsman v. Commissioner [90 Fed. (2d) 18]”, citing Continental Oil Co. v. Jones (C. C. A., 10th Cir.), 113 Fed. (2d) 557.

It should be noted, however, that the parties have stipulated that the issues presented by these proceedings “do not involve any question of fraud or tax evasion on the part of any of the taxpayers.”

The facts are that the company saw an opportunity to realize large profits upon the sales of a portion of its holdings on Eichman Bros. Co. stock and Valley Mould & Iron Corporation stock without having to pay an income tax upon such profits. In our opinion this was a legitimate business purpose.

In an attempt to show that the sales of stock made by the company to its two principal stockholders on December 20, 1937, were in good faith, the petitioners have submitted evidence to the effect that before the sales were made the matter was discussed by John Sherwin with the revenue agent in charge at Cleveland, Ohio, and that he expressed the opinion that there was no provision of the law or the regulations which would raise any question as to the bona fide character of such a transaction, that is, provided the stock was sold at its fair market value. The respondent submits that any opinion expressed by the revenue agent in charge is immaterial to these proceedings. We agree. Whether the revenue agent correctly advised John Sherwin is beside the point.

The law is well settled, however, that transactions between a corporation and its stockholders are usually to be given full faith and credit. Thus, in Continental Oil Co. v. Jones, supra, the court said:

Ordinarily a corporation and its single stockholder or multiple stockholders are deemed separate entities, and generally that separateness is preserved when dealing with matters relating to taxes. Klein v. Board of Supervisors, 282 U. S. 19 * * * Dalton v. Bowers, 287 U. S. 404 * * * New Colonial Ice Co. v. Helvering, 292 U. S. 435 * * *. But extraordinary circumstances sometimes require the disregard of such separateness of entity in the solution of tax problems. Southern Pacific Co. v. Lowe, 247 U. S. 300; * * *

Under section 24 (a) of the Revenue Act of 1934, as amended by section 301 of the Revenue Act of 1937, there is a limitation upon the deduction of losses from sales or exchanges of property. But that limitation does not refer to gains from the sale of property. The Mid-Continent Securities Co. made an enormous profit from the sale of shares of stock to John Sherwin and Francis M. Sherwin. Clearly the limitation with respect to the deduction of losses from sales or exchange of property was never intended to limit the taxation of the gains.

From a consideration of the entire record we are of the opinion that the respondent erred in failing to recognize the tona fides of the sales of shares of stock made by the Mid-Continent Securities Co. to John Sherwin and Francis M. Sherwin on December 20,1937. In our opinion John Sherwin and Francis M. Sherwin are taxable upon the dividends received by them in 1938 upon the shares of stock acquired by them from the company, as contended by them. They are also entitled to deduct from gross income the interest paid by each in 1938 upon their obligations to the company. The company, on the other hand, is liable to income tax upon the interest received by it from John Sherwin and Francis M. Sherwin, as it contends, but is not liable to tax upon the dividends received upon shares of stock of the Rich-man Bros. Co. and Valley Mould & Iron Corporation standing in the names of John Sherwin and Francis M. Sherwin and received by those individuals in 1938.

Dédsions will te entered under Rule 50.