author: Maequette:

text:
    Appeal of ERNEST WOODRUFF.

    Docket Nos. 2050, 2260-2267, 2501, 2572.
    Decided September 18, 1926.
    1. Held, that tlie transaction involved herein between the Trust Company of Georgia and certain stockholders of that company-constituted a joint venture.
    2. The amount of gain realized by the stockholders of the Trust Company of Georgia who participated in the joint venture, determined.

      Harold Hirseh, Esq., Robert N. Miller. Esq., John E. MoOlure. Esq., and J. Robert Sherrod, Esq., for the petitioners.

      M. N. Fisher, Esq., for the Commissioner.
    These appeals are from determinations of deficiencies in income and profits taxes for the year 1919, as follows:
    Ernest Woodruff — $51, 756. 71 Rufus C. Darby— $94.50
    W. S. Byck_ 755.59 David Woodward- 1,135. 62
    W. C. Wardlaw— 749.10 W. E. Chapin_ 668.05
    Thomas K. Glenn- 496.49 Edward H. Inman 978.37
    J. W. Conway_ 279.38 Puller E. Callaway 115. 50 Prank Hawkins_ 407. 70
    They involve the same facts and present the same questions, to wit, whether or not the taxpayers realized taxable income as a result of the transaction hereinafter set forth in the findings of fact. The appeals were consolidated for hearing and decision.
    FINDINGS OF FACT.
    The taxpayers herein were, during the year 1919, stockholders in the Trust Company of Georgia, a banking corporation having its principal office and place of business at Atlanta, Ga. The capital, surplus and undivided profits of the corporation were $2,571,053.30 on August 1, 1919, and $2,562,288.04 on September 1, 1919. Its capital stock issued and outstanding during the year 1919 consisted of 10,000 shares, of which 683 shares were owned by Ernest Woodruff, 100 shares by W. S. Byck, 78 shares by W. C. Wardlaw, 100 shares by Thomas K. Glenn, 25 shares by J. W. Conway, 10 shares by F. E. Callaway, 10 shares by Rufus C. Darby, 200 shares by David Woodward, 125 shares by W. E. Chapin, 102 shares by E. H. Inman, and 35 shares by Frank Hawkins.

      There was in existence during the times herein mentioned a Georgia corporation known as the Coca-Cola Co., with a capital stock of 500 shares of the par value of $100 each, which stock was, in the year 1918, placed in trust by the stockholders with the Central Bank and Trust Corporation, and against which beneficial ownership certificates in the amount of $25,000,000 were issued by such trustee. These beneficial ownership certificates were owned and held by divers persons.
    During the month of July, 1919, four parties, the Newmont Company, the Shermer Investing Corporation, Charles H. Sabin, and the Trust Company of Georgia, agreed orally that they would form a syndicate composed of the four parties, hereinafter known as the ■ Bankers Syndicate, and that the Trust Company of Georgia, acting for the syndicate, would cause to be organized a corporation under the laws of Delaware, or such other State as might be deemed advisable, for the purpose of acquiring all of the assets of the Georgia corporation known as the Coca-Cola Co. The new corporation was to issue preferred stock in the amount of $10,000,000 and 500,000 shares of nó par value common stock. The Bankers Syndicate was to acquire 83,000 shares of such common stock at $5 per share and the remaining shares were to be purchased from the new corporation at $35 per share. The interest in and responsibilities of the syndicate were to be divided as follows: the New-mont Co., 10 per cent; the Shermer Investing Corporation, 30 per cent; Charles H. Sabin, 30 per cent; and the Trust Company of Georgia, 30 per cent.
    As part of the plan to carry out the enterprise referred to, the Trust Company of Georgia, on behalf of the Bankers Syndicate, obtained on or about August 1, 1919, in the name of Eobert C. Alston, an option to purchase all of the beneficial ownership certificates in the Coca-Cola Co. The option carried no obligation unless. exercised, but if exercised required payment to the owners of the beneficial ownership certificates, within 30 days therefrom, 'of $15,000,000 in cash and the $10,000,000 of preferred stock of the corporation to be organized. The option was to expire August 29, 1919.
    The board of directors of the Trust Company of Georgia were of the opinion that the financial status of that company did not justify its entering into so large an obligation as 30 per cent of the liability under the option to purchase the beneficial ownership certificates in the Coca-Cola Co. and they therefore declined to let the Trust Company assume that liability, but by resolution adopted on August 2, 1919, they authorized the Trust Company to participate in the purchase of the beneficial ownership certificates, provided that one-half of the amount for which the Trust Company woidd be called upon to obligate itself in connection therewith would be underwritten by solvent persons, firms or corporations. The material portion of said resolution adopted by the board of directors of the Trust Company of Georgia on August 2,1919, is as follows:
    BE IT RESOLVED, tliat this Company do enter into the purchase of said participation certificates or of the assets of the Coca-Cola Company through a Syndicate or Syndicates, provided the unanimous opinion of Attorneys representing this Company, the Guaranty Trust Company, the Chase Securities Company, and the Coca Cola Company is favorable; and further provided that one-half of the amount for which this Company will he called, upon to obligate itself in this behalf he undemoritten hy solvent persons, firms or corporations.

    On August 2, 1919, or shortly thereafter, a number of the larger stockholders of the Trust Company of Georgia agreed orally that they would participate in underwriting the liability of that company under the option to purchase the beneficial ownership certificates of the Coca-Cola Co.
    On August 8, 1919, Robert C. Alston assigned to the Trust Company of Georgia the option obtained by him to purchase the beneficial ownership certificates in the Coca-Cola Co.
    On August 13, 1919, the board of directors of the Trust Company of Georgia adopted the following resolution:
    BE IT RESOLVED, That this Company do enter into a Syndicate for the purchase of the participation certificates representing the shares of The Coca-Cola Company, a corporation organized under the laws of the State of Georgia, upon the terms expressed in the outstanding options executed by the holders of said certificates, to Robert C. Alston, to the extent of four million, five hundred thousand ($4,500,000) dollars, and the President of this Company, or either - of the Vice-Presidents, is authorized to obligate this Company in said purchase to this extent, and to do all things necessary to be done to give full force and effect to this resolution.
    ALSO :
    WHEREAS, the Directors have authorized this Company to obligate itself to the extent of not exceeding four million five hundred thousand ($4,500,000) dollars, in participation in the Distributing Syndicate, which is to purchase the shares of stock of The Coca-Cola Company, the Delaware Corporation, which is to be formed for the purpose of taking- over the properties of The Coca-Cola Company, the Georgia Corporation, and
    WPIEREAS, it is desirable that this Company shall share the burden of financing said proposition with others,
    BE IT THEREFORE RESOLVED, That the Executive Committee is authorized to propose to each of the Stockholders of this Company that if he will deposit with this Company in cash, one hundred and ninety-five ($195) dollars for each share of stock owned by him in this Company, to be used in assisting this Company in financing said transaction, this Company will divide with him the stock of The Coca-Cola Company, the Deleware Corporation, retained by it under the original Bankers’ Syndicate in proportion to his holdings, not to exceed one share of stock in The Coca-Cola Company, for each share of stock held by the stockholders in this Company on the same basis at which this Company acquired said stock, returning to said Stockholder, upon the termination of said Syndicate, the amount of money deposited by him, less the cost of the stock on the basis that this Company acquired same.
    BE IT FURTHER RESOLVED, That upon the assumption by him of a proportionate part of the liability of this Company in committing itself to a participation in the Syndicate hereinbefore referred to, an interest in said Syndicate to the extent of twenty thousand (20,000) shares of the stock of The Coca-Cola Company, the Delaware Corporation, be transferred to Ernest Woodruff, in consideration of the time and services given by him in connection with this transaction.
    BE IT FURTHER RESOLVED, That the Executive Committee of the Company is hereby authorized to dispose of all other shares of stock in The Coca-Cola Company, the Delaware Corporation, which this Company may be entitled to receive by virture of its participation in such Distributing Syndicate at such prices, in such manner, and upon such terms as in its judgment may seem proper to serve the best interests of this Company, and to comply with its obligations to the Syndicate in connection therewith.
    RESOLVED, That the selling Syndicate to be organized in connection wth the underwriting mentioned above, be sponsored by the Trust Company of Georgia, and that securities of the Company being formed to take over the various properties of The Coca-Cola Company, of Atlanta, shall be offered to the public over the name of the Trust Company of Georgia.
    The option to purchase the beneficial ownership certificates in the Coca-Cola Co., obtained by Robert C. Alston and assigned by him to the Trust Company of Georgia, was exercised by the Trust Company of Georgia on August 21, 1919. On the same day the Trust Company of Georgia, the Newmont Company, Charles H. Sabin and the Shermer Investing Corporation formally executed a syndicate agreement as follows:
    New York, August 21, 1919.

    The Newmont Company,
    The Shebmer Investing Cokp.,
    Mr. Chaebes H. Sabin.
    Dear Síes : We have accepted a transfer of options covering all of the participation certificates representing all of the outstanding shares of the capital stock of said The Coca-Cola Company of Georgia, which options we are to hold and exercise for the benefit of ourselves and others, in the following proportions:
    The Newmont Company, a New York Corporation M Q
    The Shermer Investing Corporation_ CO O
    Charles H. Sabin_ CO o
    Ourselves_ CO O
    All responsibilities incurred by us in connection with the exercise of the said options and carrying out the intent and purposes thereof and of the matters herein referred to shall be for account of ourselves and yourselves in the proportions above stated.
    ■ For such account, in the proportions stated, we are to cause a corporation to be organized under the laws of Delaware or such other state as may be deemed advisable, and to vest in it in the name, good will and other property, rights and interests now owned and held by the said The Coca-Cola Company of Georgia, which corporation is to issue $10,000,000 par value preferred stock with the rights and in accordance with the terms and provisions of said options, and 500,000 shares of common stock without par value. Por ourselves and yourselves, in the proportions stated or their nominee or assigns, we are to acquire 88,000 of said non-par value shares of common stock at $5. per share.
    We are undertaking to organize a syndicate which is to purchase from the new company the remaining 417,000 shares of said common stock at $35. per share.
    All of the common stock of the new company so acquired shall be deposited with the Guaranty Trust Company of New York as Agent for Ernest Woodruff, S. C. Dobbs and E. W. Stetson, as voting Trustees under a Voting Trust Agreement, which shall continue for not less than five years. In the event of the death, incapacity or refusal to act of any of the Voting Trustees, the successor to Mr. Dobbs shall be designated by Mr. Albert H. Wiggin or by his personal representatives, and the successor to Mr. Stetson shall be designated by Mr. Charles H. Sabin or by his personal representatives.
    If the foregoing is in accordance with your understanding please so signify by signing the acceptance thereof subjoined hereto for the purpose and returning the same to us. By so doing, it is understood that you will become responsible to us for your proportion of all obligations and responsibilities to be assumed by us as transferees of said options and in carrying out the terms and conditions of this letter in the proportions hereinabove stated.
    If deemed advisable in carrying out the purposes of this agreement, by mutual consent, the options hereinabove may be assigned to the new Company.
    Very truly yours,
    TRUST COMPANY OP GEORGIA.
    By W. C. Wardlaw Vice-President.
    The foregoing accords with our understanding and is hereby accepted.
    Newmont Company By Theodoee Schuyler, Pi.,
    Shermer Investing Corporation By W. T. Wiles, Treasurer,

    Charles H. Sabin By Harold Stanley.
    Immediately after the exercise of the option and prior to August 26,1919, the Trust Company of Georgia sent circular letters to about six hundred bankers and stockbrokers throughout the United States and Canada, inviting them to become members of a selling syndicate which was to be organized by the Trust Company of Georgia, and to participate in the purchase of 417,000 shares of the common stock of the new corporation to be formed, at $35 per share. The part of the circular letter pertinent here is as follows:
    It is proposed to organize under the laws of the State of Delaware, or of such other State as may be selected, a corporation, (hereinafter called the New Corporation), for the purposes of acquiring, subject to current liabilities other than Federal taxes accrued to date of transfer, all of the assets, business and good will, except a possible rebate on account of Federal taxes for 1918, of the present The Coca-Cola Company, which is a Georgia corporation. The name of the New Corporation is, if possible, to be the same or similar to that of the Georgia corporation and it is proposed that the New Corporation shall issue $10,000,000 of 7% Cumulative Preferred Stock having a par value of $100. per share, and 500,000 shares of Common Stock without par value. The Preferred stock is to be acquired by the stockholders of the present The Coca-Cola Company of Georgia, is to be non-voting unless default be made in the payment of dividends for six months, and any or all thereof may be retired at any time at par and accrued dividends upon ninety days’ notice. All of the Common stock is to be deposited under a Voting Trust Agreement which is to continue for not less than five years.
    We are organizing a Syndicate, of which we are to act as Syndicate Manager and in which we shall have the right to participate, to purchase from the New Corporation, when, as and if issued and accepted by us, subject to the approval of our counsel, at $35. per share, all or any part of voting trust certificates representing 417,000 shares of the Common stock of the New Corporation, in which Syndicate we have reserved for you a participation of-shares.
    Syndicate participants shall not transfer or otherwise dispose of all or any part of their participation without the consent in writing of the Syndicate Manager.
    The Manager will duly notify participants if and when subscription books for the voting trust certificates are to be opened, whereupon, but not before, participants may then take subscriptions for certificates, subject to allotment, on a “ when, as and if issued and received by us, subject to approval of counsel”, basis, at $40., per share, and will be entitled to a commission of $1. per share on confirmed allotments, from which commission participants may allow 50 cents per share to dealers and financial institutions. No further concessions or commissions shall be allowed. All subscriptions are to be received for Syndicate account and should be reported to the Manager by wire. To avoid duplication, when orders are sent by telegram and confirmed by mail, the letter of confirmation should definitely refer to the telegram and state that it is in confirmation thereof.
    No replies to any of these circular letters were received prior to August 26, 1919.
    On August 22, 1919, the Trust Company of Georgia sent to the taxpayers and to all other stockholders of the company a letter reading—
    STRICTLY CONFIDENTIAL.
    Dear Sir : As you are probably aware, we,, associated with strong New York interests, will share in the profits to be derived from the acquirement of the Coca-Cola Co. assets and business. This is a large transaction, involving a large sum of money, and we have made a large commitment in connection with the financing' of the enterprise.
    We made this commitment expecting to offer to our stockholders the privilege of participating in the profits of the enterprise on the same basis that the Trust Co. will share in such profits, provided such stockholders will contribute to the financing of the enterprise in proportion to the number of shares which they hold in the Trust Co.

      It is impossible, at this time, to explain to you the details of the transaction, since they hare not yet been definitely agreed upon and are subject to change, but it will be necessary to make the financial arrangements immediately and before the details can be worked out.
    You hold - shares of stock in the Trust Company and to enable you to participate in this transaction the amount of money it is necessary for you to place with us is-. On the dissolution of the syndicate which we anticipate will be not later than October 1, you will be advised regarding its operation and a distribution promptly made.
    We think it is to your interest to take advantage of this offer, and we recommend it to you. If we do not receive your cheek, however, for the amount above stated on or before 12 o’clock noon on the 27th day of August, 1919, we will assume that you do not desire to participate.
    The rights you acquire hereunder, if accepted, are not transferable before the dissolution of the syndicate.
    Please sign the acceptance below, on the inclosed duplicate, and return with cheek.
    Yours very truly,
    Geo. B. Pendleton, Treasurer.

    The owners of 9,233 shares of the capital stock of the Trust Company of Georgia accepted the offer to participate in the enterprise. To cover their share of the liability, they deposited with the Trust Company of Georgia $195 for each share of their stock in that company. The taxpayer, Ernest Woodruff, also put into the enterprise an additional amount equal to $195 on 2,000 shares. The record does not show the exact date the several stockholders of the Trust Company deposited the money to cover their share of the enterprise, but it was paid some time prior to August 26, 1919. As is shown by the acceptance letter of W. C. Bradley, one of the stockholders, dated August 23, 1919, some of the stockholders had agreed to participate in the enterprise prior to August 22, 1919. Mr. Bradley’s letter of acceptance was as follows:
    Eagle & Phoenix Mills, Oolwnibus, (7a., August S3, 1919.

    Tbust Go. oe Georgia,

      Atlanta, Ga.

    Gentlemen :
    Your circular letter of August 22, to Mr. W. O. Bradley, concerning the underwriting syndicate for handling the purchase of the Goea-Oola Company, has been received in the absence of Mr. Bradley on a business trip to New York.
    Before leaving, Mr. Bradley went into this matter fully with me, and anticipating that a call for funds might be made prior to his return, he instructed, and fully empowered me to handle the matter for him in his absence.
    You will accordingly find inclosed, as requested, the carbon copy of the above-mentioned letter from you, dated August 22, 1919, to which, by authority I have signed Mr. Bradley’s name, accepting for Mr. Bradley the offer of participation made in said letter.
    Also further acting for Mr. Bradley, I attach hereto check of the W. O. Bradley Co. No. 1739, dated August 23, 1919, drawn upon the National City Bank, of New York, in favor of the Trust Co.' of Georgia, for $9,750, same being the amount specified' in the above-mentioned letter of August 22.
    I know that it is Mr. Bradley’s desire and intention to participate in this matter fully in all respects, and if there is anything else necessary to he done by him, or for his account to that end, kindly communicate promptly by telegraph, telephone, or letter.
    Yours very truly,
    J. D. Massey.
    Immediately after August 21 and prior to August 26, 1919, the Trust Company of Georgia, as manager of the common stock syndicate, offered 417,000 shares in the new Coca-Cola Co. to the public on an “ if, as and when issued ” basis, at $40 per share, and on August 26,1919, closed the subscription on account of such syndicate, the offer being then oversubscribed 143,000 shares. On August 29, 1919, notices of the allotment of shares were sent to the common stock syndicate subscribers by the Trust Company of Georgia, as syndicate manager, and on or before September 5, 1919, payments were received on the entire allotment of 417,000 shares. On the same date, the new corporation, called the Coca-Cola Co., was organized under the laws of the State of Delaware. On September 8,1919, the Coca-Cola Company of Delaware, by resolution of its board of directors, authorized the sale to persons not named of 83,000 shares of its common stock, at $5 per share. On September 9, 1919, by resolution of the board of directors of the same company, 417,000 shares of its common stock were sold to the Trust Company of Georgia, as manager of the common stock syndicate, at $35 per share, payment therefor to be made on or before September 16,1919.
    The 83,000 so-called $5 shares of stock were in fact sold by the Coca-Cola Company of Delaware to the Bankers Syndicate herein-before mentioned, and they were divided as follows: The Newmont Co., 8,300 shares; the Shermer Investing Corporation, 24,900 shares; Charles H. Sabin, 24,900 shares; and the Trust Company of Georgia, 24,900 shares.
    Of the 24,900 shares which the Trust Company of Georgia received by virtue of its 30 per cent interest in the Bankers Syndicate, 13,677 shares were retained by it and 11,223 shares were distributed among the taxpayers herein and the other stockholders of the Trust Company, who, as above set forth, participated with it in the enterprise, each of such persons receiving one share for each $195 he had put into the deal. The stock which the taxpayers and the other stockholders of the Trust Company of Georgia received was issued direct to them by the Coca-Cola Company of Delaware. The Trust Company of Georgia also, at the conclusion of the transaction, returned to the taxpayers and the other stockholders who participated in the transaction $100 for each $195 they had contributed. They were informed of the conclusion of the deal and of the results thereof by letters dated October 1, 1919, which read as follows:
    Trust Company op Georgia, Atlanta, Ga., October 1, 1919.

    Dear Sir:
    Under date of August 22, 1919, we extended you an invitation to Join us in the financing of the purchase of the Coca-Cola Co. of Atlanta.
    You availed yourself of this invitation by placing with us $-. The deal has now been consummated and we are inclosing you treasurer’s check for $-- — ■ covering the amount to be returned to you.
    We are inclosing you herewith 50 shares of Coca-Cola common stock, represented by
    Voting Trust Certificate No.-
    issued in your name which, as the result of your participation, we are able to sell you at $5 per share, and we have deducted $250 from the funds mentioned above to cover the purchase price of the shares.
    Please sign and return to us the carbon copy accompanying this letter, also our participation receipt which was issued to you when you made this payment.
    We are glad to have had you with us in this transaction. The result has been gratifying to us and we trust that it is equally so with you.
    And now may we add a personal word to you as a shareholder? Our company is doing well and forging ahead steadily. It is the ambition of the officers to make the Trust Company of Georgia the greatest financial institution in the South, and with your help we can do it.
    Considering our strength and the liberal interest we pay, our deposits are not large and we need your assistance in building them up. Let us have the benefit of any funds for which you have no immediate use. Open with us an inactive account. We will pay you 3 per cent thereupon. On certificates of deposit, payable on demand, we will pay the same rate, and on time certificates, running for a period of three months or longer, 4 per cent. On savings deposits we allow 4 per cent.
    If you already have funds on deposit with us, be assured of our appreciation. Speak to your friends regarding us and invite them to make use of the services we offer in our various departments.
    Yours very truly,
    George B. Pendleton, Treasurer.

    The net result of the entire transaction, so far as the taxpayers and the other stockholders of the Trust Company of Georgia who participated therein are concerned, was that each of such stockholders, for each $195 he had put into the enterprise, received $190 in cash and one share of the capital stock of the Coca-Cola Company of Delaware.
    The Commissioner upon audit of the taxpayers’ returns for the year 1919 determined that the fair market value of the common stock of the Coca-Cola Company of Delaware received by the taxpayer was $40 per share; that they, as a result of the transaction involved herein, had realized a profit equal to $35 on each share of such stock received by them, and that there are deficiencies in tax in the amounts hereinabove set forth.

       The following were heal'd with the above and are decided herewith : Appeals of W. S. Byck, No. 2260; W. C. Wardlaw, No. 2261; Thomas K. Glenn, No. 2262: J. W. Conway, No. 2263 ; Fuller E. Callaway, No. 2264; Rufus C. Darby, No. 2265 ; David woodward, No. 2266; W. E. Chapin, No. 2267; Edward H. Inman, No. 2501; and Frank Hawkins, No. 2572.

   OPINION.

Maequette:

The transaction which gave rise to the income involved in this appeal is the identical transaction which was before ' the Board in the Appeal of W. C. Bradley, 1 B. T. A. 111. In that appeal we held that the receipt by Bradley, upon the completion of the financing of the Coca-Cola Company of Delaware by the Trust Company of Georgia and the other members of the Bankers Syndicate, of 50 shares of the common stock of the new company for $5 per share, constituted a taxable dividend to him to the extent of the;, difference between the alleged purchase price and the fair market! value of such shares; which difference was found to be $1,750. However, the evidence presented in that appeal did not as fully disclose the nature of the transaction as does the evidence herein, and we are constrained to a different conclusion here.

First, we are of the opinion that whatever income the taxpayers realized from the transaction in question came to thém not as a dividend from the Trust Company of Georgia, but as a direct result of their participation in the transaction. The evidence establishes that the Trust .Company of Georgia, under the agreement forming the Bankers Syndicate, was obligated to the extent of $4,500,000. The directors of the Trust Company were of the opinion that the financial strength of the Trust Company did not warrant it in assuming the obligation of $4,500,000, and they therefore authorized the Trust Company’s participation in the syndicate only in the event that at least one-half of its obligation thereunder would be assumed by others. The stockholders of the Trust Company were given an opportunity to come into the enterprise and many of them, but not all, accepted. With the exception of Woodruff, they were permitted to participate according to their holdings in the Trust Company, that is, for each share of stock they owned in the Trust Company they were permitted to put $195 into the financing of the Coca-Cola Company of Delaware. Woodruff, however, in addition to investing in the enterprise $195 for each share of stock owned by him in the Trust Company of Georgia, assumed an additional obligation of several hundred thousand dollars. Some of the stockholders of the Trust Company declined to participate in the transaction and they received nothing therefrom. While it is obviously true that the taxpayers were given the opportunity to engage in the transaction because they were stockholders of the Trust Company, it is equally true, we think, that they shared in the profits of the transaction not as stockholders receiving a dividend, but because they participated in and contributed money to the transaction. We think the evidence presented here cleaiiy establishes that the taxpayers were joint venturers with the Trust Company of Georgia, and that they shared in the profits due to the Trust Company under the original syndicate agreement to the extent and in the proportion that they assumed and shared the liability of the Tr'ust Company under that agreement.

The only remaining question is what profit, if any, was realized by the taxpayers as a result of their participation in the organization of the Coca-Cola Company of Delaware. The taxpayers contend that the Bankers Syndicate in reality purchased the entire issue of 500,000 shares of the common stock of the Coca-Cola Company of Delaware for $15,010,000, paying $35 per share for 417,000 shares and $5 per share for 83,000 shares; that the 417,000 shares were sold by the Bankers Syndicate to the Common Stock Syndicate for $35 per share, no profit thereon being realized by the Bankers Syndicate; that at the conclusion of the transaction, the various members of the Bankers Syndicate simply retained the 83,000 shares of stock for which they had paid $5 per share and that only upon the sale thereof could there be any profit or loss.

We are unable wholly to agree with the taxpayers’ contention. We are of the opinion, however, that the Bankers Syndicate was in reality the purchaser of all of the common stock of the Coca-Cola Company of Delaware. At the time of the several steps in the stock selling campaign, outlined in the findings of fact, the Coca-Cola Company of Delaware was not in existence but, under the terms of the original syndicate agreement, was later to be brought into existence by the Bankers Syndicate, which had obligated itself to the extent of $15,000,000 for the organization and financing of the new corporation. The Bankers Syndicate was in fact at that time the corporation and in its dealings with the corporation in regard to the issues of stock was in reality dealing with itself. It could arrange the sale and set the price to suit itself. However, for the purpose of determining its profit therefrom we are unable to hold that it could properly fix a price of $35 per share for part of the common stock and $5 per share for the remainder thereof.

All of the shares of common stock were of the same issue and each share had the same actual value. The effect of the arbitrary fixing of the price of $35 per share for 417,000 shares was that it enabled the syndicate to make a sale of the 417,000 shares at more than their real cost, yet without any apparent profit, and to retain the remaining 83,000 shares at their apparent cost of $5 per share, which was in fact much less than their real cost. '

■In our opinion, the whole transaction involved in this appeal may be resolved into this: the Bankers Syndicate obligated itself to form the Coca-Cola Company of Delaware and to put up $15,000,000, in consideration of which it was to acquire the entire issue of common stock, the cost to it of such common stock being $30 per share. Four hundred and seventeen thousand shares of the common stock were sold by the Bankers Syndicate to the Common Stock Syndicate for $35 per share, which in turn sold it to the public for $40 per share. ' The Bankers Syndicate therefore realized a profit of $5 per' sharé on the 411,000 shares and retained 83,000 shares for which it had actually paid $30 per share but for which it fixed an apparent price of $5 per share. The profits realized by the Bankers Syndicate from the sale of 417,000 shares together with the 83,000 shares retained by it were distributed among its members. The taxpayers herein, for each $195 invested by them in the enterprise, received on-the completion thereof $190 and a share of stock which cost them $30. * In other words, for each $195 they invested, they realized a cash profit of $25. The so-called $5 shares of stock received by them in fact cost them $30 per share and on the sale thereof a gain or loss would be realized or sustained, depending on whether the sale price was greater or less than $30 per share.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.

Littleton, Milliken, Philmbs. and Smith dissent.


source: Caselaw Access Project

author: MaRquette

license: Public Domain

text:
    Appeal of STANDARD MARINE INSURANCE COMPANY, LTD.
    Docket No. 4822.
    Decided September 18, 1926.
    1. Tbe interest on Anglo-French Loan bonds and British Government bonds, owned by a foreign corporation, but held within ■ the United States, is not income from sources within the United States within the meaning of the Revenue Act of 1918.
    2. A foreign insurance company doing business within the United States is entitled to deduct, in computing its net income "from sources within the United States, the cost of the reinsurance " of risks written within the United States, whether such reinsurance is effected within or without the United States.
    3. An. amount in the nature of a reserve, set up by the taxpayer on its books, at the end of the taxable year, to cover liability accrued but undetermined in amount, arising under contracts to refund to policyholders portions of premiums paid by them, held, hot to be a proper deduction in computing net income for that year.

      Randolph E, Paul, Esq., and Charles B. McIrmLs, Esq., for the petitioner.

      A. E. Fast, Esq., for the Commissioner.

      William H. Hotchkiss, Esq., as amicus curiae.

      This appeal is from the determination of deficiencies in income and profits taxes for the years 1917 and 1918 in the amounts of $93,-632.14 and $36,262.79, respectively.
    FINDINGS OF FACT.
    (1) The taxpayer is a corporation organized under the laws of Great Britain, and is engaged in the business of marine insurance in Great Britain, the United States, and other countries. Its business in the United States is transacted through branch ofiices located at 60 Beaver Street, New York, N. Y.
    (2) During the years 1917 and 1918, the Insurance Department of the State of New York prohibited the taxpayer’s United States branch from remitting funds to its home office at Liverpool, England, except for reimbursing the home office for losses paid on risks assumed by the United States branch, and for interest collected by the United States branch on investments held within the United States. As a result of the requirements of the Insurance Department of the State of New York, the United States branch of the taxpayer kept in the United States funds which it would otherwise have remitted to the home office in Liverpool, part of which funds were invested in United Kingdom of Great Britain and Ireland 6% per cent convertible collateral notes, and Anglo-French five-year 5 per cent External Loan bonds. The United States branch of the taxpayer received as interest on these bonds, $14,373.25 in the year 1917 and $23,750 in the year 1918, all of which was remitted to the home office at Liverpool.
    (3) The system used by the taxpayer in the conduct of its business is the one under which nearly all of the exports and imports of the United States are insured under marine insurance. It is as follows:
    The shipper of merchandise takes out an insurance policy, usually with one company, covering all imports or exports, wherever and however made. These policies are known as “open contracts” and under them insurance automatically attaches to all shipments made by the insured, during the life of the policy, from the time they leave the warehouse of the insured until they arrive at the warehouse of the consignee. In many cases the policyholder does not know until after the vessel has sailed exactly how much cargo belonging to him is loaded on such vessel, because, having shipped his merchandise from the interior under through bills of lading, particulars as to the name of the vessel, etc., can only be furnished after the cargo is loaded and often only after a vessel has sailed. This being so, the insurance company may find that a number of its policyholders have shipments on the same vessel, and it can not ascertain the extent of its liability until after the vessel is at sea and in some cases until after the property has actually been destroyed. The same conditions apply to insurance on imports from foreign countries.
    It is and has been the custom of the taxpayer and other marine insurance companies, in order to avoid too great a liability under their policies, to protect themselves by reinsurance. The reinsurance resorted to by the taxpayer during the years 1917 and 1918, was as follows:
    (a) Share reinsurance, whereby the reinsurer agrees to cover a fixed proportion of taxpayer’s risk on each policy; as each declaration of risk is made to the taxpayer by the assured the reinsurer automatically takes the agreed share of it.
    (b) Excess of line reinsurance, whereby the reinsurer agrees to take a certain proportion of any risks in excess of what the taxpayer . wishes to retain. Under this method the reinsurer has no liability until the taxpayer has filled its own net retained lines.
    (c) Cotton shore fire reinsurance, whereby the reinsurer agrees to cover a portion of the taxpayer’s cotton shore fire risks. This class of reinsurance applies only to loss of cotton by fire before being loaded on the vessel; and
    (d) Specific reinsurance (rarely resorted to by this taxpayer), whereby the taxpayer reinsures a portion of its risk on a particular vessel after having found that the vessel was a poor risk or that the taxpayer had an aggregation of risks on the vessel in excess of what its automatic reinsurance contracts would cover.
    In the event that property covered by insurance is lost or destroyed, the company that assumed the original risk pays the amount of the loss to the insured, and looks to the reinsurer for the amount for which the reinsurer has assumed liability under the contract of reinsurance.
    During the year 1918, the taxpayer reinsured a portion of the risks written by its United States branch. A part of this reinsurance was placed by the United States branch with other marine insurance companies in the United States and the remainder was placed with foreign companies in England by the home office of the taxpayer. On the books of the home office the United States branch was charged with the cost of reinsurance and credited with the amount recovered from the reinsurer. The reinsurance entries were transmitted to the United States branch and entered on its ledger accounts.
    The larger part of the reinsurance effected by both the home office and- the United States branch on the risks assumed by the United States branch was on blanket reinsurance contracts with other marine insurance companies made prior to the assumption of the risk by the United States branch, whereby a certain proportion, of the entire business or the excess of loss on shore over a certain amount, or of any one vessel or of excess of loss in any one locality passed to the reinsurer. .
    During the year 1917, the home office of the. taxpayer paid to foreign insurance companies, for the reinsurance,of risks written by the United States branch, the amount of $740,107.11 and recovered $560,503.86 as losses on such contracts of reinsurance. -In. addition, the United States branch paid directly to the Cotton Insurance Association for reinsurance the amount of $42,275.58,: which, was charged to and entered on the books of the home office. On this reinsurance recoveries were made in the amount of $10,551.55. The net costs of reinsurance of risks assumed by the United States branch, effected by or on behalf of the home office during the year 1917, was $211,257.23. ,
    During the year 1918 the home office of the taxpayer paid to foreign insurance companies, for reinsurance of risks written by the United States branch, the amount of $846,712.39 and recovered $765,561.05 as losses on such contracts, the excess of the amount paid for reinsurance over recoveries thereon being $81,151.34. The taxpayer included in its gross income for the years 1917 and 1918 the entire amount of premiums received by it on policies written within the United States, and deducted therefrom as an ordinary and necessary business expense the net cost of the reinsurance of the risks covered by such policies effected by the home office..
    (4) During the year 1917, there was paid on behalf of the taxpayer by the obligors on so-called tax-free covenant bonds the amount of $186. The Commissioner included said $186 in the taxpayer’s income for the year 1917. ‘
    (5) The taxpayer’s open policy contracts on the cotton business protected the insured, among other things, from loss or damage by reason of exposure to the elements Avhile being loaded on the train or while at the compress. This is commonly known as “ country damage.” In order to induce the shippers to protect their cotton from “ country damage,” the taxpayer during the years 1917 and 1918 offered to return to each shipper a portion, of the premium representing the difference between the losses paid on country damage and a certain percentage of the total liability covered for him during an entire season. During the years 1917. and 1918, the cotton season, during which the taxpayer’s open contracts on the cotton business usually remained in force, was one year, beginning September 1st and ending August 31st. In order to avoid paying a return premium until the taxpayer was certain the insured was entitled to. it, the taxpayer provided that the return premium would not be paid until four months after the insured’s last shipment had been made -for a .particular season and until all of the insured’s outstanding country damage losses had been settled. As a result of this provision,- the taxpayer usually had a liability at the end of the calendar year to return premiums earned by the shippers but not paid. In many instances the amount to be returned was not actually determined, but an estimate was made of what the refund was likely to be and- that amount was entered on the taxpayer’s books as a liability. The taxpayer’s accrued liability under the country-damage provision of its cotton insurance contracts at December 31, 1917, computed as herein set forth, represented an increase of $39,458.-55 over the amount accrued as of December 31,1916; and the amount accrued at December 31, 1918, represented, a decrease of $4,765.50 from the amount accrued at December 31, 1917. The amount of $39,458.55 was- deducted by the taxpayer from the gross income of the United States branch for the year 1917 and the amount of $4,765.50 was included in the gross income of the United States branch for the year 1918.
    (6) The taxpayer is compelled by the Insurance Department of the State of New York to maintain a reserve for unpaid losses and claims. The reserve for unpaid losses and claims maintained by the taxpayer at December' 31, 1916, under compulsion of the Insurance Department of the State of New York, was $378,948, and the amount of the same reserve maintained by the taxpayer under compulsion of the Insurance Department of the State of New York at December 31, 1917, was $470,087, the increase in such reserve during the calendar year 1917 being $91,139.
    (7) The taxpayer is also compelled by the Insurance Department of the State of New York to maintain a reserve for unearned premiums. The unearned premium reserve so maintained by the taxpayer at December 31, 1916, was $359,494.04, and the amount of the same reserve at December 31, 1917, was $323,222.94, the decrease in such unearned premium reserve during the calendar year 1917 being $36,271.10.
    (8) The expenses incurred by the taxpayer’s home office during the year 1918 applicable to the United States branch and properly deductible from its gross income for the year 1918, were $33,636.49.
    (9) The Commissioner upon audit of the taxpayer’s returns for the years 1917 and 1918—
    (a) Included in its gross income from sources within the United States, the amounts of $14,373.25 and $23,750, received by it in the years 1917 and 1918, respectively, as interest on the United Kingdom of Great Britain and Ireland bonds and Anglo-French External Loan bonds held in the United States.

      (b) Refused to allow as deductions from gross income the net cost of reinsurance effected by the home office, of risks written by the United States branch.
    (c) Added to the taxpayer’s income for the year 1917, $186 paid on its behalf by obligors of so-called tax-free covenant bonds.
    (d) Refused to allow as a deduction from gross income for the year 1917 the amount of $39,458.55, representing the increase of accrued liability in that year on account of the country-damage clause of the taxpayer’s insurance contracts, and refused to increase income for the year' 1918 by the amount of $4,765.50, representing the decrease in said accrued liability during the year 1918.
    (e) Refused to allow as a deduction from gross income for the year 1917 the amount of $91,139, representing the increase in that year of the taxpayer’s reserve for unpaid losses and claims.
    (f) Increased the taxpayer’s income for the year 1917 by $36,-271.10, the amount of the decrease in that year of its unéamed premium reserve.
    (g) Refused to allow as a deduction from gross income the amount of $33,636.49, representing expenses incurred by the home office of the taxpayer and properly attributable to the United States branch.
    Deficiencies in tax in the amounts of $93,532.14 for the year 1917, and $36,262.79 for the year 1918, were determined by the Commissioner.
   OPINION.

MaRquette

: The Commissioner in his answer to the taxpayer’s petition herein concedes that the amount of $186'paid on the taxpayer’s behalf in the year 1917 by the obligors of tax-free covenant bonds should not be included in the taxpayer’s income for that year and that the taxpayer, in computing its net income for the year 1917, is entitled to deduct the amount of $33,639.49 on account of expenses incurred by the home office in that year, which were applicable to the United States branch. Since the hearing, the taxpayer has abandoned its contention that the reserve maintained by it for unpaid losses and claims is a reserve required by law within the meaning of the Revenue Act of 1916, as amended by the Revenue Act of 1917, and that it is entitled to deduct, in computing its net income for the year 1917, the net addition to that reserve made within the year 1917. This leaves for determination four questions which will be discussed in the order in which they are set forth in the findings of fact.

The first question is whether or not there should be included in the taxpayer’s income for the years 1917 and 1918 the amounts received by it in those years as interest on certain United Kingdom of Great Britain and Ireland bonds and Anglo-French External Loan bonds owned by the taxpayer and actually held by it within the United States. It is admitted by the parties to this appeal that the bonds in question were obligations of the Governments of Great Britain and France and that the interest thereon was paid by them.

The Revenue Acts in force during the years 1917 and 1918 respectively were the Revenue Act of 1916, as amended by the Act of October 3, 1917, and the Revenue Act of 1918. Section 10 of the Revenue Act of 1916, as amended by section 1206 of the Act of October 3,1917, provided —

Sec. 10. (a) That there shall he levied, assessed, collected arid paid annually upon the total net income received in the preceding calendar year from all sources by every corporation, joint-stock company or association, or insurance company, organized in the United States, no matter how created or organized, but not including partnerships, a tax of two per centum upon such income; and a like tax shall be levied, assessed, collected, and paid annually upon the total net income received in the preceding calendar year from all sources within the United States by every corporation, joint-stock company or association, or insurance company, organized, authorized, or existing under the laws of any foreign country, including interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, and including the income derived from dividends on capital stock or from net earnings of resident corporations, joint-stock companies or associations, or insurance companies, whose net income is taxable under this title.

Section 12 of the Revenue Act of 1916 provides in part—

Sec. 12. (a) In the case of a corporation, joint-stock company or association, or insurance company, organized in the United States, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources—
* * * ❖ * * *
(b) In the case of a corporation, joint-stock company or association, or insurance company, organized, authorized, or existing under the laws of any foreign country, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources within the United States * * *.

The parts of the Revenue Act of 1918 pertinent here are sections 230 and 233, which provide among other things—

Seo. 230. (a) That, in lieu of the taxes imposed by section 10 of the Revenue Act of 1916, as amended by the Revénue Act of 1917, and by section 4 of the Revenue Act of 1917, there shall be levied, collected, and paid for each taxable year upon the net income of every corporation a tax at the following rates: * * *.
Sec. 233. (a) That in the case of a corporation subject to the tax imposed by section 230 the term “ gross income ” means the gross income as defined in section 213, except that:
* * * . * * * * *
(b) In the case of a foreign corporation gross income includes only the gross income from sources within the United States, including the interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, dividends from resident corporations, and including all amounts received (although paid under a contract for the sale of goods or otherwise) representing profits on the manufacture and disposition of goods within the United States.

It is apparent from a reading of the foregoing provisions of law that, during the years 1917 and 1918, foreign corporations doing business within the United States were subject to tax only on their net income from sources within the United States, such net income being gross income from sources within the United States, less certain deductions not material here, and it therefore follows that, since the taxpayer is a foreign corporation, the interest received by it in the years 1917 and 1918 on the United Kingdom of Great Britain and Ireland bonds and the Anglo-French External Loan bonds in question should be included in its income only if it was from sources within the United States.

The Commissioner in support of his contention that the interest involved herein was income to the taxpayer within the meaning of the Revenue Acts mentioned relies on the case of DeGanay v. Lederer, 250 U. S. 376. The facts of that case were that Emily R. DeGanay, a citizen and resident of France, was the owner of certain stocks and bonds of corporations organized under the laws of the United States and of bonds and mortgages secured upon property in the United States, the stocks, bonds and mortgages being actually held in the United States by the Pennsylvania Company for Insurance on Lives and Granting Annuities, as agent for Mrs. DeGanay. The Supreme Court of the United States held that the income from these stocks, bonds and mortgages was subject to tax as income from “ property owned * * * in the United States by persons residing elsewhere,” under the Revenue Act of 1913, Par. A, subdivision 1, which provided among other things—

That there shall be levied, assessed, collected and paid annually .upon' the entire net income arising or accruing from all sources in the preceding calendar year to every citizen of the United States, whether residing at home or abroad, and to every person residing in the United States, though not a citizen thereof, a tax of 1 per centum per annum upon such income, except as hereinafter provided; and a like tax shall be assessed, levied, collected, and paid annually upon the entire net income from all property owned and of every business, trade or profession carried on in the United States by persons residing elsewhere.

We have carefully considered the arguments advanced by. the Commissioner and the effect of the case of DeGanay v. Lederer, supra, on the question presented in the instant appeal. We do not agree, however, that the decision in that case is controlling here. Under the Revenue Act of 1913, foreign corporations were taxed on “ income accruing from business transacted and capital invested within the United States,” and nonresident alien persons were taxed on the income “ from all property owned and of every business, trade, or profession carried on in the United States.” (Act of October 3, 1913, Pars. G (a), A (1), 38 Stat. 166). It was under the last-quoted provision of the Act that the tax involved in the case of DeGanay v. Lederer arose. Here we are concerned with taxing statutes that are materially different from the Revenue Act of 1913. Both the Revenue Act of 1916, as amended by the Revenue Act of 1917, and the Revenue Act of 1918 provide that foreign corporations shall be taxed on net income from sources within the United States, suchmet income being gross income from sources within the United States including “ interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise ” less certain allowable deductions. It may be noted that while they expressly include in income from sources within the United States, “interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise,” they do not in terms include interest from bonds, notes, or other interest-bearing obligations of nonresidents. Since interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, is expressly included in income from sources within the United States, and interest on bonds, notes, or other interest-bearing obligations of nonresidents is not mentioned as being included therein, it may well be held, “ expressio unius est exolusio dlterius,” and that Congress intended to exclude interest of the latter class from income from sources within the United States.

But it is not necessary for us, in holding that interest on bonds, notes, or other interest-bearing obligations of nonresidents is not income from sources within the United States within the meaning of the Revenue Acts of 1916, 1917, and 1918, to rely entirely on the fact that it is not expressly included by the statutes as being from such sources. The word “sources” as defined by Webster means “first cause; origin; that which gives rise to anything; the first producer; one who or that which originates,” and unless the contrary appears, which it does not, it must be presumed to be used in the statute under consideration herein in its ordinary and usual sense, and with the meaning commonly attributable to it. DeGanay v. Lederer, 250 U. S. 376. What is the source of the income here in question ? Con-cededly it was paid because certain governments foreign to the Government of the United States found it necessary to borrow and did borrow money from persons who were willing to lend, giving to such persons their promise to pay, the promises being in the form of bonds. Pursuant to the tenor of their promises, these foreign governments paid interest. It is apparent that the source of the interest was the foreign government that paid it. We are of the opinion that the interest received by the taxpayer during the years 1911 and 1918 on the bonds referred to herein, was clearly not income from sources within the United States within either the spirit or the letter of the Eevenue Act of 1916, as amended by the Act of 1917, or the Revenue Act of 1918.

The second question presented is whether or not the taxpayer, in computing its net income for the years 1917 and 1918, is entitled to deduct the cost of reinsurance effected by the home office of risks written by the United States branch. The taxpayer contends that since it is required to include in its gross income from sources within the United States the entire amount of premiums on risks written by the United States branch, it must, in order correctly to reflect its net income from such sources, deduct the cost of reinsuring such risks. The contention of the Commissioner is in substance that the cost of reinsurance effected by the home office is not deductible, since it would be possible for the taxpayer or any other company engaged in a similar business to reinsure abroad with an affiliated company all of the risks written within the United States, thereby avoiding taxation under the revenue laws of the United States.

The provisions of law pertinent to this issue are section 12 of the Revenue Act of 1916 and section 234 of the Revenue Act of 1918, which were in effect during the years 1917 and 1918, respectively. Section 12 of the Revenue Act of 1916 provides in part that—

(b) In tbe case of a corporation, joint stock company or association, or insurance company, organized, authorized, or existing under the laws of any foreign country, such net income shall be ascertained by deducting from the gross amount of its income received within the United States—
First. All the ordinary and necessary expenses actually paid within the year out of earnings in the maintenance and operation of its business and property within the United States * * ♦.

Section 234 of the Revenue Act of 1918 provides among other things as follows:

(a) That in computing the net income of a corporation subject to the tax [including foreign corporations] imposed by section 230 there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *.
(14) * * * (b) In the case of a foreign corporation the deductions allowed in subdivision (a), except those allowed in paragraph (2) and in clauses (a), (b), and (c) of paragraph' (3), shall be allowed only if and to the extent that they are connected 'with income arising from sources within the United States * * *.

From the above-quoted sections of the Bevenue Acts, it is apparent that the taxpayer, being a foreign corporation, is entitled to deduct from gross income from sources within the United States, among other things, all ordinary and necessary expenses paid during the year 1917 “in the maintenance and operation of its business and property within the United States ” and all necessary and ordinary expenses, paid in carrying on its business during the year 1918, to the extent that the expenses are “connected with income arising from sources within the United States.”

The taxpayer claims the right to deduct from its gross income from sources within the United States, the “ net cost ” of all reinsurance effected by the home office during the years 1917 and 1918 of risks written by the United States branch. This “ net cost ” represents the excess of the amount paid for reinsurance over recoveries thereon. The effect is the same as if the taxpayer had included in its gross income from sources within the United States all recoveries made on the reinsurance of risks written by the United States branch and deducted the entire cost of the reinsurance. We are of the opinion that this is a proper method of determining the net income of the taxpayer’s United States branch and that it could not be correctly determined by any other method. The taxpayer is required to include in gross income from sources within the United States the entire amount of premiums on risks written therein. From this gross income it is obviously entitled to deduct losses on the risks written, and the expense of doing business. If a loss is sustained on any risk, the actual loss of the taxpayer thereon is the entire amount of the loss compensable under the original policy less the amount recovered by the taxpayer on the reinsurance of that policy. It reduces its deductible losses by the amount of recoveries on reinsurance, or, in other words, it, in effect, includes in gross income from sources within the United States the total amount recovered on the reinsurance of risks written in the United States, and it clearly should be entitled to deduct from gross income the cost to it of the amount so recovered. In this connection it may be pointed out that the amount of recoveries on reinsurance in any year might exceed the cost of such reinsurance.

It is not necessary to enter into an extended discussion of the methods by which the business of marine insurance is carried on. It is sufficient to state that the evidence establishes that reinsurance of risks is a vital phase of the business and that it is necessary that marine insurance companies reinsure a portion of their risks in order to spread their liability and minimize their losses. Otherwise it would be difficult or perhaps impossible for them to continue in business. Since reinsurance is a vital and necessary phase of the marine insurance business, the cost of such reinsurance must be regarded as an ordinary and necessary expense of that business. The taxpayer during the years 1917 and 1918 wrote certain risks within the United States, and a portion of these risks was reinsured either directly by the United States branch with companies doing business in the United States, or by the home office under its blanket reinsurance contracts with other foreign companies. The Commissioner has permitted the taxpayer to deduct as a business expense the net cost of reinsurance effected directly by the United States branch with companies doing business in the United States, but has refused to permit the deduction of the cost of the reinsurance effected by the home office of risks written by the United States branch. We can perceive no distinction between the reinsurance effected by the home office for the United States branch and the reinsurance effected directly by the United States branch. In each case the taxpayer was simply purchasing insurance in order to protect itself against the possibility of too great a loss on the risks written by the United States branch. We are of the opinion that the cost of the reinsurance in question was an ordinary and necessary expense in the maintenance and operation of the taxpayer’s business in the United States and that it is connected with income arising from sources within the United States.

The third question is whether or not the taxpayer in computing its net income for the year 1917 is entitled to deduct the increase in its accrued liability as at the end of that year on account of the country-damage clause in its cotton contracts and to increase its income for the year 1918 by the amount of the decrease of the same liability as of the end of that year. The evidence relative to this question establishes that the taxpayer, in order to induce shippers to protect their cotton against loss resulting from exposure, offered to return to them a portion of the premium paid, representing the difference between the losses paid on country damages and a certain percentage of the total liability covered during the entire season, payment of the return premium not to be made until four months after the insured’s last shipment and until after all of the outstanding country damage losses had been settled. As a result of this provision, the taxpayer usually had a liability at the end of the calendar year to return premiums earned by the shippers. These amounts appear to have been estimated and set up on the taxpayer’s books at the close of the year. The increase during the year 1917 of the liabilities so set up was deducted from gross income for that year. During the year 1918 this liability decreased by $4,765.50 and that amount was added to the taxpayer’s income for that year.

We are of the opinion that the amount of payments made or incurred by the taxpayer in any year on account of the liability to return, under the country-damage clause of cotton insurance contracts, a portion of its premiums to the insured, is a proper deduction from gross income for that year. However, the evidence fails *to show that the items^ involved herein represented liabilities either paid or actually incurred. On the other hand, the account in question appears to have been a mere estimate, an undetermined liability in the nature of a reserve, and we are of the opinion that the Commissioner’s action in respect thereto should be approved.

The fourth question presented for determination is whether or not the decrease in the taxpayer’s unearned premium reserve during the year 1917 constituted income to it for that year. The Commissioner added the amount of the decrease to the taxpayer’s income oil the ground, as alleged in his answer herein, that the , decréase resulted in an increase of the same amount in the taxpayer’s free assets. The Commissioner in his answer also denied that the reserve for unearned premiums is a reserve required by law within the meaning of the Revenue-Act of 1916 which provides—

Sec. 12. (b) In the case of a corporation, joint-stock company or association, or insurance company, organized, authorized, or existing under the laws of any foreign country, such net income shall be ascertained by deduct- ' ing from the gross amount of its income received within :the year from all sources within the United States—
First. All the ordinary and necessary expenses actually paid within the year out of earnings in the maintenance and operation of its business and , property within the United States, including rentals or other payments required to be made as' a condition to the continued use or possession of property to which the corporation has not taken or is not taking title', or in which it has no equity.-
Second. * * * (c) In the case of insurance companies, the net addition, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts * * * .

A similar provision relative to reserves which insurance companies are required by law to maintain is found in the Revenue Act of 1913.

The reserves for unearned premiums maintained by insurance companies are reserves known to the general law of insurance and are usually required by the laws of the several States regulating the insurance business. The reserve under consideration here was specifically required by the laws of the State of New York and by regulations promulgated thereunder. That reserves of this character are required by law within the meaning of the Revenue Acts of 1918 and 1916 is clear and seems to have been so recognized by the courts, although the question, so far as we can find, has never been directly raised. McCoach v. Insurance Co. of North America, 244 U. S. 585; Maryland Casualty Co. v. United States, 251 U. S. 342. We are of the opinion that the reserve for unearned premiums maintained by the taxpayer was a reserve required by law within the meaning of the Revenue Act of 1916.

The facts as to the decrease in the year 1917 in the taxpayer’s reserve for unearned premiums are disclosed by the pleadings, but no evidence thereof was presented by either party to this appeal. The taxpayer alleged that the amount of the decrease did not go into the free assets of the company but was used to pay policy losses. The Commissioner alleged that the decrease in the reserve resulted in an increase of .the same amount in the taxpayer’s free assets, and that it therefore constituted income to the taxpayer.

The rules of this Board provide that the burden of proof is on the taxpayer. This means that unless the Commissioner in his answer admits the material allegations of the taxpayer’s petition, the taxpayer must produce sufficient evidence to make a prima facie showing that the allegations of the petition are true and to overcome the proof submitted by the Commissioner. As to the issue here presented, the Commissioner has determined that the decrease in the taxpayer’s unearned premium reserve resulted in an increase of its free assets and therefore constituted income. The taxpayer alleged in its petition that the decrease in the reserve did not result in an increase of its free assets, and the Commissioner denied that allegation. The issue has been squarely joined, the burden of proof being placed .thereby on the taxpayer to establish its contention by evidence. It has failed to produce any evidence in support of its contention as to this point and, in the absence of such evidence, we must approve the determination of the Commissioner. Appeal of J. M. Lyon, 1 B. T. A. 378.

The taxpayer in its petition alleges that a computation of its income or loss from sources within the United States for the year 1919, on the basis which we have herein set forth for computing its income for the years 1917 and 1918, results in a net loss which it is entitled to apply against its net income for the year 1918. However, no evidence was introduced by the taxpayer to support,this contention.

Order of redetermmation will be entered on 10 days1 notice, under Rule 50.


author: Marquette

text:
    Appeal of MARINE INSURANCE COMPANY, LTD.
    Docket No. 2242.
    Decided September 18, 1926.
    1. The interest on Anglo-French Loan bonds and British Government bonds owned by a foreign company but held in the United States is not'ineome from sources within the United States within the meaning of the Revenue Act of 1918.
    2. A foreign insurance company doing business within the United States is entitled to deduct, in computing its net income from sources within the United States, the cost of the reinsurance of risks written within the United States, whether such reinsurance is effected within or without the United States.

      Albert 0. Wall, Esq., for the petitioner.

      A. H. Fast, Esq., for the Commissioner.
    . William, H. Hotchkiss, Esq., as amicus curiae:

    This appeal is from the determination of a deficiency in income and profits taxes for the year 1918 in the amount of $26,048.31. The deficiency arises from the inclusion by the Commissioner in the taxpayer’s income of the amount of $25,042.78,. received by it in the year 1918 as interest on English and French Government bonds, and the disallowance as a deduction from gross income of the cost of reinsurance or risks written by the United States branch.
    FINDINGS OF FACT.
    (1) The taxpayer is a corporation organized under the laws of Great Britain, and is engaged in the business of marine insurance in Great Britain, the United States, and other countries. Its business in the United States is transacted through branch offices located at Nos. 5-7 South William Street, New York, N. Y.
    (2) Some time prior to the year 1918, the taxpayer, for the protection of its policyholders, deposited with the Guaranty Trust Company of New York, as trustee, certain Anglo-French Loan 5 per cent bonds and British Government 5y2 per cent bonds. During the year 1918, the Guaranty Trust Co.,' as such trustee, collected and paid over to the taxpayer, interest on these bonds in the amount of $25,042.78.
    (3).The system used by the taxpayer in the conduct of-its business is the one under which nearly all of the exports and imports of the United States are insured under marine insurance. It is as follows:
    The shipper of merchandise takes out an insurance policy, usually with one insurance company, covering all of his imports or exports wherever and however made. These policies are known as “ open contracts ” and they require the insurance company to take charge of every shipment made by the insured thereunder. In many cases the policyholder does not know until after the vessel has sailed exactly how much cargo belonging to him is loaded on such vessel, because, having shipped his merchandise from the interior under through bills of lading, particulars as to the name of the vessel, etc., can only be furnished after the cargo is loaded and often only after the vessel has sailed.. This being so the insurance company may find that a number of its policyholders have shipments on the same vessel, and it can not ascertain the extent of its liability until after the vessel is at sea and in some cases until after the property has actually been destroyed. The same conditions apply to insurance on imports from foreign countries.
    It is and has been the custom of the taxpayer and other marine insurance companies, in order to avoid too great a liability under their policies, to protect themselves by reinsurance contracts. The reinsurance is effected as follows:
    (a) Before going into a particular line of business an insurance company enters into contracts with other insurance companies whereby either a certain proportion of the entire risk assumed by it, or the excess over a certain amount on any one vessel or in any one locality automatically passes to the reinsurer. The contracts are usually made prior to the acceptance of the business which will ultimately be reinsured thereunder, and are known in the maritime insurance business as “ excess coverage.”
    (b) Where a policy with a very large limit is accepted it is usual, at the time such policy is accepted, to place reinsurance covering a certain named percentage of the total risk. In this way the original company guards against the probability of having a line in excess of that provided for by contract protection arranged as provided in paragraph (a).
    (c) Special reinsurance is placed on a named vessel either before the vessel sails or in other cases shortly after she has sailed. This special reinsurance is to take care of the excessive lines of which the original underwriter has knowledge, and where the amount is so excessive that the precautions taken under the clauses provided for in paragraph (a) and (b) have been insufficient. In the event that property covered by insurance is lost or destroyed, the company that' assumed the original risk is directly liable to the insured. It in turn looks: to the reinsurer for the amount for which the reinsurer is liable under the contract of reinsurance.
    During the year 1918, the taxpayer reinsured a portion of the risks written by its United States branch. A part of this reinsurance was placed by the United States branch with other marine insurance companies in the United States and the remainder was placed with foreign insurance companies, in England, by the home office of the taxpayer. On the books of the home office the United States branch was charged with the cost of the reinsurance and credited with the amounts recovered from the reinsurers as losses. These reinsurance entries were transmitted to the United States branch and entered on its journal and carried to the ledger accounts in the same manner as entries relating to transactions in the United States.
    During the year 1918, the home office of the taxpayer paid $183,-761.43 to foreign insurance companies for reinsurance of risks written by the United States branch, and recovered $134,413.02 as losses on such contracts of reinsurance, the excess of the amounts paid for reinsurance, over the recoveries thereon, being $49,348.41. The taxpayer included in its gross income for the year 1918 the entire amount of premiums on policies of insurance sold by it in the United States in that year, and it deducted therefrom, as an ordinary and necessary business expense, the net cost of the reinsurance of the risks covered by such policies, placed by the home office.
    ■ The Commissioner, upon audit of the taxpayer’s income and profits-tax returns for the year 1918, added to its net income the amount of $25,042.72 received by it in that year as interest on the Anglo-French Loan and British Government bonds hereinbefore mentioned, and disallowed the deduction from gross income of the net cost of reinsurance with foreign companies of risks written in the United States and determined a deficiency in tax in the amount of $26,048.31.
   OPINION.

Marquette

: The identical questions presented for determination by the record in this appeal have been decided by the Board in the Appeal of Standard Marine Insurance Co., Ltd., 4 B. T. A. 853. Upon the authority of that decision, we hold that the interest received by the taxpayer herein during the year 1918 on the Anglo-French Loan bonds and British Government bonds, mentioned in the findings of fact, did not constitute income to it from sources within the United States within the meaning of the Revenue Act of 191&, and that the taxpayer in computing its net income from sources within the United States for the year 1918, is entitled to deduct the amounts paid by the home office for the reinsurance of risks written by the United States branch.

Order of redetermination will loe entered on 15 days1 notice, •under Rule 50.


author: Smith

text:
    Appeal of INDEPENDENT BREWING COMPANY OF PITTSBURGH.
    Docket No. 3242.
    Decided September 18, 1926.
    1. Payments by a brewery corporation of dues to a brewery association organized and legally conducted for the- purpose of furthering the interests of its members are ordinary and necessary expenses deductible from gross income in the corporation’s income-tax returns.
    2. The taxpayer corporation purchased 476 of its own bonds in 1919 at less than the issue price. EelA, that it received no taxable income from such purchase.

      B. H. Feldstein, Esq., for the petitioner.

      E. G. Bailee, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits tax for the year 1919 in the amount of $20,610.48. The questions in issue are (1) whether the taxpayer is entitled to deduct from gross income in its income-tax return for ,1919 amounts paid as dues to various brewery associations, and (2) whether the taxpayer received any income from the purchase of its own bonds which it did not retire or cancel during the year.
    FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation with its principal office in Pittsburgh. In its income-tax return for the year 1919, it deducted from gross income amounts paid brewery associations as follows:
    Western Pennsylvania Brewers Association-$1, 896.88
    Westmoreland County Brewers Association- 524.12
    United States Brewers Association- 6, 236. 00
    United States Brewers Association (attorneys’ fees)— 8,340.16
    16, 997.16

      The Western Pennsylvania Brewers Association was a trade organization carried on by brewers of Western Pennsylvania. During 1919, it maintained an office in Pittsburgh where the brewers from the vicinity of the city met and discussed matters of interest to them. It was not used or intended to be used in lobbying for the promotion or the defeat of legislation. The Westmoreland County Brewers Association was a small trade organization maintained by the brewers of Westmoreland County; no part of the money paid to it was expended in lobbying for the promotion or the defeat of legislation. The United States Brewers Association was a large organization to which the principal brewers throughout the United States belonged. Its income was used for the promotion of the interests of the brewery industry. It maintained an office at Washington, D'. C. It was interested in contesting the constitutionality of the Prohibition Amendment to the Constitution of the United States and the contribution of the taxpayer to this association during the year 1919 of $8,340.16 for attorneys’ fees was in connection with this litigation.
    The taxpayer corporation was organized in February, 1905, at which time it executed a first mortgage to the Colonial Trust Company of Pittsburgh, as trustee, securing an issue of $4,500,000 of bonds, 4,500 in number of the par value of $1,000 each. The original mortgage contained no sinking-fund agreement. A supplement thereto was duly made and executed by the taxpayer on July 28, 1909, which provided for a sinking fund for the retirement of the bonds issued under the mortgage, the taxpayer agreeing to pay to the trustee not less than $50,000 in each year, payments to begin on December 1, 1911.
    From December 1, 1911, to December 31, 1918, inclusive, the taxpayer made payments to the trustee of its sinking fund in accordance with the supplemental agreement of July 28, 1909, and the trustee acquired bonds of the taxpayer which it kept alive in the sinking fund. Most, if not all, of these bonds were acquired directly from the taxpayer at par. All of the bonds so sold to the trustee were rubber stamped “ Not Negotiable.” The coupons on the bonds, however, were not marked in any manner and in all cases the taxpayer’s books of account show the payment upon each interest-paying date of the full amount of interest accrued upon its $4,500,000 of bonds issued. The trustee has never sold or parted with any of the bonds which have been acquired by it.. ■
    During the year 1919, the market price of the taxpayer’s bonds became very much depressed and, in order to support the price, the taxpayer purchased in the open market 476 of its bonds,. paying therefor $251,825.69. These bonds were not cancelled and the taxpayer’s books of account show interest paid on them the same as on the bonds held by the trustee of its sinking fund and those held by the public.
    During the year 1919, the taxpayer sold to the trustee for the sinking fund 30 of its bonds which it purchased from the public during the year 1919 at a cost of $14,351.17, receiving therefor $30,000 cash. The difference between the $30,000 received from the trustee and the amount paid by the taxpayer for the bonds was $15,648.33.
    In the making of its income-tax return for 1919, the taxpayer reported $1,400 profit upon bonds purchased and sold to the trustee during the year. The Commissioner has determined that the profit to the taxpayer upon the purchase of the bonds was the difference between the par value, $476,000, and $251,825.69, the amount paid therefor, or $224,174.31, and since the taxpayer accounted for only $1,400 profit in its income-tax return, the Commissioner has added to the gross income reported $222,774.31. The Commissioner has. determined that the net income of the taxpayer for the calendar year 1919 was $223,128.53. The taxpayer had no net income for 1919 if the assumed profit of $224,174.31 upon the purchase of bonds from the public be eliminated from the gross income.
    In 1920' and' subsequent years, the taxpayer was from time to time the successful bidder for the sale of bonds to the trustees of its sinking fund, and in 1921. and 1922 it sold to the trustee many bonds at less than the price at which it had acquired them from the public in 1919. Of the 476 Independent Brewing Company bonds purchased by the taxpayer from the public during the year 1919, 372 were sold by the taxpayer to the Colonial Trust Company of Pittsburgh, as trustee of its sinking fund, and no bonds, have been sold to any other purchaser. On June 30, 1925, 104 of the bonds purchased by the taxpayer during the year 1919 were still owned by it.
   OPINION.

Smith

: In the year 1919, the taxpayer paid dues to the Western Pennsylvania Brewers Association, the Westmoreland County Brewers Association, and the United States Brewers Association. In addition it paid to the last named association $8,340.16 as its pro rata share of the fees of attorneys employed by the United States Brewers Association to test the constitutionality of the Prohibition Amendment to the Constitution. In its income-tax return for 1919, the taxpayer deducted the payment of these dues and attorneys’ fees as ordinary and necessary expenses and the deduction has been disallowed by the Commissioner.

We think that the amounts paid constituted ordinary and necessary expenses. All of the brewers associations mentioned were, so far as the record indicates, performing lawful services for their members and such services were in furtherance of the members’ business. It does not appear from the record that the taxpayer was under any legal obligation to make a contribution for the attorneys’ fees but it was perfectly legal for the brewers association to test 'the constitutionality of the Prohibition Amendment and the payment by the taxpayer of its proportion of the fees was an ordinary and necessary expense of doing business.

The Commissioner has added to the taxpayer’s gross and net income for the year 1919, $222,774.31 alleged profit on the. purchase by it of its own outstanding bonds. This amount plus $1,400 returned by the taxpayer as income constitutes the difference between the par value of the bonds purchased and the amount paid therefor. The Commissioner has treated this difference as profit under article 544 of Kegulations 45, which provides that where a corporation “purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the'purchase price is gain or income for the taxable year.” The taxpayer denies that it derived any taxable income as a result of the purchase of its bonds from the public during the year 1919, or from the sale of 30 of the bonds to the trustee of its sinking fund during that year, but that in any event the only income which it received was a profit of $15,648.33 upon the 30 bonds sold to the trustee at par during 1919.

The facts in this case are undeniably that the brewery properties of the taxpayer had greatly depreciated in market value as a result of national prohibition. As a result of such depreciation in value large blocks of its bonds were thrown upon the market at any price that they would bring. When the quotation got below 40 per cent of the face value of the bonds, the taxpayer went into the market to support it. The Commissioner contends that, inasmuch as these bonds were issued many years ago at the face value, the taxpayer derived an income in 1919 from the purchase of these bonds equal to the difference between the issue price and the purchase price and contends that the transaction is analogous to a short sale.

In our opinion the taxpayer derived no taxable income from the purchase of its own bonds at less than the issue price. Certainly the transaction was not analogous to a short sale. The facts are simply that during the taxable year the taxpayer used a portion of its cash on band to pay a portion of its debts. ' Whether it will ever be able to pay the balance of them is uncertain. We think that the principle laid down by the court in Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, is controlling here.

Judgment for the petitioner.

Green, Love, Sternhagen, and Trammell dissent.