author: Maequette :

text:
    W. A. Graeper, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46619.
    Promulgated January 31, 1933.

      Robert T. Jacob, Esq., for the petitioner.

      Owen W. 8'wecher, Esq., for the respondent.
   OPINION.

Maequette :

The respondent has charged the petitioner with having received, as owner, the entire amount of the sale price of the Union Avenue Theatre Company’s stock. We think the evidence does not justify that determination. It was not essential that petitioner’s wife should have a stock certificate in her own name in order to own an interest in the stock. The reason for having the certificate covering her interest issued to petitioner has been explained. Under the laws of Oregon the separate property of a wife remains hers until she, by her own consent, parts with it. Brummet v. Weaver, 2 Oreg. 128; Velion v. Carmack, 23 Oreg. 287; 31 Pac. 658. In the present instance we have positive testimony that petitioner did not acquire his wife’s interest in the stock of the Union Avenue Theatre Company. The certificates covering her interest, which were held by petitioner in his name, were held for her, on her authorization, as her agent. We conclude, therefore, that petitioner’s wife owned a one-half interest in the stock; that upon its sale one-half the proceeds belonged to her, and that petitioner is taxable only upon one-half the net gain realized from the sale.

From Augost 1922 to September 1924 petitioner and his wife withdrew an aggregate of $20,405 from the funds of the Union Avenue Theatre Company. The respondent has treated that amount as a loan to petitioner and has included it in petitioner’s income as a liquidating dividend received upon dissolution of the company in 1924. The record shows that petitioner and his wife were the sole owners of the company’s stock during the period in question. It shows that petitioner’s attorney was instructed to prepare the proper minutes authorizing such withdrawals as they were earned and that the amounts so withdrawn were reported as income for the years when received. Although the company’s bookkeeper entered the amounts withdrawn as loans to petitioner, he did so without instructions and in the absence of any resolution by the corporate directors authorizing such loans.

A very similar situation arose in Chattanooga Savings Bank v. Brewer, 9 Fed. (2d) 982. Two individuals owned all the stock of a corporation and from time to time they made withdrawals from the company’s surplus funds. The amounts withdrawn were entered on the company’s books as accounts receivable. In holding that such amounts constituted dividends, rather than loans, the court said:

* * * If these transactions constitute a loan or loans, then as a matter of fact the loan was made by Key to himself, which is, of course, an unthinkable thing, for a borrower necessarily implies a lender. * * *
He and Mr. James owned this fund; it in all equity belonged to them. No other director had any real interest in it, nor did any creditor. I assume that it is the law that, “ where the officers of a corporation distribute the profits among the stockholders, without authorization by either the directors or stockholders, the corporation may be bound by the acquiescence of all the stockholders; and where the rights of third persons are not thereby impaired, the
distribution of the profits of a corporation among its stockholders without any action on the part of the board of directors, but by consent or agreement of all the stockholders, is the equivalent of a dividend. Hence, an agreement between all the stockholders as to the manner in which the profits of the corporation shall be disposed of may be enforced, where the rights of creditors or of third persons dealing with the corporation are not thereby impaired.” 14 Corpus Juris, p. 807, Par. 1227. * * *

That decision was affirmed by the Circuit Court of Appeals, 17 Fed. (2d) 79, that court saying:

A formal declaration of the dividend was not necessary. Spencer v. Lowe, (C. C. A.) 198 F. 691; Smith v. Moore, (C. C. A.) 199 F. 689. Any distribution by the company to its shareholders out of earnings or profits accumulated since February 28, 1913, was a dividend within the meaning of *' * * the Revenue Act.

To like effect are the decisions in L. W. Guriby Go., 3 B. T. A. 714; Daniel Hunt, Sr., 6 B. T. A. 558; United Tailors <& Gleaners Go., 10 B. T. A. 172; F. G. Lamb, 14 B. T. A. 814.

The case before us is not distinguishable upon its facts from those cited above. In our opinion the amounts withdrawn from the company’s funds by the petitioner and his wife constituted dividends, taxable as income for the years when received. It follows that the respondent erred in his determination that the total amount of the withdrawals was a liquidating dividend upon the company’s dissolution.

The total amount withdrawn by petitioner and his wife in 1924 was $9,055, but only $8,718.48 of that amount was reported by them as income. Respondent allocated the entire amount received in proportion to the stockholdings of petitioner and his wife as shown by the corporate records, and increased petitioner’s income subject to surtax in the amount of $444.11. Petitioner now accepts that determination and it is sustained.

In June, 1925, petitioner received a lump sum covering rental of a theatre building from September, 1924 to June 30, 1925. During that time petitioner was in the employ of his lessee, the Multno-mah Theatres Corporation, and had in his hands sufficient of the company’s funds to pay the rentals as they accrued. He did not do so, but paid over the funds on hand from time to time and received his salary and rentals by check from the corporation. The delay in paying rent for petitioner’s theatre was due to delay in settling the terms of the lease. Petitioner filed his returns on the cash receipts basis and did not report any of the rentals as income for 1924. Respondent contends that as petitioner had on hand in 1924 sufficient funds of the lessee to cover the rentals for that year, the amount of such rentals should be included as part of his taxable income.

It does not appear that petitioner was authorized to pay his salary, or any rents due him, out of the corporation funds he might have in his possession. It does appear that the method followed in handling the funds and balancing accounts was prescribed by the company. The situation here differs from that in James W. Elwell & Co., 14 B. T. A. 671, where by the terms of the contract of employment the taxpayer was authorized to and did draw the amount of its earned commissions from funds in its hands belonging to the employer. In John A. Brander, 3 B. T. A. 231, in considering the doctrine of the constructive receipt of income, we said:

When taxable income is consistently computed by a citizen on the basis of actual receipts, a method which the law expressly gives him the right to use, he is not to be defeated in his iona fide selection of this method by “ construing” that to be received of which in truth he has not had the use and enjoyment. Constructive receipt is an artificial concept which must be sparingly applied, lest it become a means for taxing something other than income and thus violating the Constitution itself.

Although in that case we applied the constructive receipt doctrine, it was because the amount in controversy had been earned by Brander, was credited to him on the books of a corporation of which he was president, and could have been taken by him at any time. But that is not the situation in the present proceeding. The terms of the lease of petitioner’s theatre were not settled during the taxable year. While he was entitled to rental for the building in 1924, the amount of that rental was not fully determined until the middle of the year 1925. And although petitioner had in his possession funds of the lessee sufficient to cover the amount of rentals for 1924, he held those funds as agent for the lessee. With respect to them he was a fiduciary and had no authority to apply the funds to the payment of rentals due him, even if at that time the amount of such rentals had been determined. In our opinion the respondent’s determination of constructive receipt of rentals in 1924 was not justified, and the amount so added to petitioner’s taxable income for that year should be eliminated.

In his income tax returns petitioner deducted 4 per cent of the cost of his Egyptian Theatre for depreciation. Respondent allowed only 3 per cent. Petitioner now claims 5 per cent for depreciation and obsolescence.

The building is of reenforced concrete construction and should last for many years. But its usefulness as a theatre will be much less than its physical life. Already the character of its patronage has deteriorated and several newer theatres have become its competitors. One witness, a real estate appraiser of experience, limits the useful life of the theatre in question to twenty years from its date of construction. He also testified that any remodeling of the building for stores or offices would be impractical.

The respondent’s allowance of 3 per cent deductions was apparently for depreciation only. We think there should be some allowance in respect of obsolescence. As the evidence before us indicates that the building will become useless in twenty years’ time, in our opinion 5 per cent deductions, to cover both depreciation' and obsolescence, should be allowed.

Decision will be entered, under Rule 50.


source: Caselaw Access Project

author: Lansdon:

license: Public Domain

text:
    Forest Products Chemical Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46621.
    Promulgated January 31, 1933.

      F. E. Hagler, Esq., for the petitioner.

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

Lansdon:

The petitioner’s contention that for the year 1927 it was entitled to file a consolidated return for itself and a 100 per cent owned subsidiary is without merit. Affiliation after May 14, 1926, is admitted by the respondent, but the record shows that for that year each of the affiliated corporations filed a separate income tax return. That procedure was an election to file separate returns as provided in section 240 (c) of the Revenue Act of 1926 and article 632 of Regulations 69. Petitioner’s sole contention on this issue is that through conversations between one of its employees and a revenue agent it satisfied the requirements of the statute and the regulations. This is not sufficient. The Commissioner was never asked to grant the necessary permission to change to the consolidated basis, nor did he even delegate his discretion or authority to the revenue agent. On this issue the determination of the respondent is affirmed. Lucas v. St. Louis National Base Ball Club, 42 Fed. (2d) 984; certiorari denied, 282 U. S. 283; A. S. Siracusa Sons, Inc., 23 B. T. A. 53. Cf. Gustave Rader Co., 19 B. T. A. 12; L. V. Estes, Inc., 22 B. T. A. 806; M. Morgenthau-Seixas Co., 25 B. T. A. 1235.

On the second question it is clear that in the taxable year the petitioner spent the amount of $4,236.82 in an investigation of the Suide method of manufacturing acetic acid. It is equally clear that in subsequent years it erected a plant for the use of that method and that it eventually secured a license from the patentee of such method, permitting its use during the life of the patent. The cost of this investigation, of the plant additions and any other expenses incurred in securing such license and in the installation of machinery and equipment for the production of acetic acid were all capital expenditures which we think are deductible ratably from income during the

term of the license. Gillianrb Mfg. Co., 1 B. T. A. 967; Goodell-Pratt Co., 3 B. T. A. 30; Dempster Mill Mfg. Co. v. Burnet, 46 Fed. (2d) 604; United Profit-Sharing Gorp., 66 Ct. Cls. 171. We are of the opinion that this amount was properly accounted for on the books of the petitioner as deferred charges and that it is not deductible from income in the taxable year, as is now contended.

Upon the record we are convinced that the bonus credits of $500 and $5,000 made to Albin and Boisen in the taxable year were duly authorized and were corporate obligations at December 31 of such year. The officer authorized to make the contracts with the employees ordered the credits. The total amount received by each employee was reasonable compensation for services rendered in 1927. The fact that the stock certificates were not issued until some time in 1928 is not material, since the petitioner was on the accrual basis. Moreover, the credit made as of December 31,1927, vested the ownership of the specified amount of common stock in the employees as of that date, regardless of the time at which the certificates, which are no more than evidence of stock ownership, were issued. The uncon-tradicted evidence indicates that the stock was worth $100 per share when the credits were made. On this issue the determination of the respondent is reversed.

Decision will be entered under Bute 50.

       Por tlie purpose of this section two or more domestic corporations shall he deemed to be affiliated (1) if one corporation owns at least 95 per centum of the voting stock of the other or others, or (2) if at least 95 per centum of the voting stock of two or more corporations is owned by the same interests. This subdivision shall be applicable to the determination of affiliation for the taxable year 1925.

         Consolidated returns. — Affiliated corporations as defined in section 240 (d), irrespective of the basis upon which returns were filed prior to 1926 under section 240 (a) of the Revenue Acts of 1924 and 1926, may for 1926 elect to make separate returns or file a consolidated return in which will be reported the consolidated net income of the affiliated group. If return is made upon either of these bases, all subsequent returns must be made upon the same basis except as permission to change may be granted by the Commissioner. In applying for permission to change from one basis to the other there should be submitted a statement in the form of an affidavit executed by a person or persons qualified to sign the returns (see section 239) setting forth completely the reasons for making the request.


author: Lansdon :

text:
    Pidgeon-Thomas Iron Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46093.
    Promulgated January 31, 1933.

      Homer K. Jones, Esq., and Franle J. Albus-, Esq., for tRe petitioner.

      B. W. Wilson, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has asserted a deficiency in income tax for the period from February 1 to December 31, 1927, in the amount of $2,589.24. The only question involved is whether the respondent erroneously disallowed as a deduction from income in the taxable period, the amount of $20,000 paid out by the petitioner for legal services. At the hearing the parties filed the following stipulation:

That the petitioner was duly organized on February 1, 1927, under tbe laws of tbe State of Delaware, and is engaged in tbe wholesale and retail iron and steel business, with its principal office at Memphis, Tennessee.
That tbe Pidgeon-Thomas Iron Company, a corporation organized under tbe laws of tbe State of Tennessee, was incorporated in 1908 with capital stock of $100,000. That with tbe exception of a few qualifying shares the stock was owned by P. Pidgeon and George W. Thomas. That P. Pidgeon died in 1918 and bis stock went to the members of his family. That on December 28, 1922, George W. Thomas and the members of his family (who controlled the corporation) executed a contract with Philip Pidgeon, Frank Pidgeon and James Pidgeon, under the terms of which the members of the Pidgeon family were given an option to purchase the stock then owned by George W. Thomas and family within one year after the date of the death of George W. Thomas; said contract also provided the method to be used in computing the price to be paid. That George W. Thomas died during 1925.
That the members of the Pidgeon family failed to exercise the option to purchase the stock held by the Thomas family. That the question was then presented as to whether the corporation should liquidate or continue in business. That thereafter the plan agreed to by all the stockholders was that the Tennessee corporation would surrender its charter; a Delaware corporation of the same name would be organized with a capital of $600,000 to take over the business; and immediately thereafter all of the stock of the new corporation owned by the Thomas family would be taken up by the corporation as follows:
Par value Delaware corporation stock-$337, 000. 00
Premium on stock- 631, 258. 34
Total at $287.31 per share of_"- 968,258.34
Gash 2-21-27_$468, 258.34
Notes given_ 500, 000. 00
Total-968, 258. 34
That the plan thus agreed to by the stockholders of the Pidgeon-Thomas Iron Company (Tennessee) was carried out; on February 1, 1927, the certificates of the Delaware corporation were issued, that with the formation of the new company there were issued to the stockholders of the old company six shares of the new stock for one share of the old. The members of the Thomas family endorsed their new certificates back to the new corporation the same day, thus leaving the members of the Pidgeon family in control of the outstanding stock, to-wit, $263,000 of the Delaware corporation.
That the members of the firm of Holmes, Canale, Loch & Glankler are engaged in the practice of law at Memphis, Tennessee. That during the early part of 1926 this firm was engaged to represent the Pidgeon-Thomas Iron Company, Memphis, Tennessee. That the services of this firm were engaged after the officers of the Iron Company had had many conferences with the Bank of Commerce & Trust Company as Executor and Trustee under the will of G. W. Thomas, deceased, said G. W. Thomas having been a majority stockholder in said corporation.
That it at once became necessary for counsel to familiarize themselves with the financial condition of the corporation (Pidgeon-Thomas Iron Company (Tennessee)), going into full detail as to its items on its balance sheet such as inventory and nature thereof, accounts receivable and nature thereof, real estate and buildings and appraisals thereof, depreciation and- obsolescence, machinery and nature thereof, and all other items comprising the balance sheet, then checking up the liabilities of the company, the nature and maturities thereof, and, in a detailed way, going over the whole financial structure of said corporation. That the Bank of Commerce & Trust Company, as trustee, was charged with the responsibility for the proper conduct of the affairs of the corporation, and numerous conferences were held during 1926 between the officers of said trust and counsel, as to the policy to be pursued in the conduct of the company’s business,
That many months were devoted to conferences looking toward the corporation itself buying out the shares of stock of the Thomas Estate and the Thomas sisters. That conferences were held looking toward the basis upon which the Thomas stock could be purchased by the corporation. That numerous other conferences were held with the Bank and with representatives of the Thomases, wherein the amount of cash to he paid by the corporation and the period of time over which deferred payments were to be made were gone into; matters of rate of interest on deferred payments and other terms and provisions relating to a transaction of this character were gone into in minute detail, all over a period of months.
That in addition thereto, the building contracts of the corporation received careful consideration.
That in order to put into effect the agreement finally reached by all interested parties it was necessary to form a new corporation under the laws of the State of Delaware for the purpose of enabling such new corporation under its charter powers to purchase the stock out of its available surplus. That thereupon a new charter was devised under the laws of Delaware calling for an authorized capital of 6,000 shares of the par value of $1Q0 per share, aggregating $600,000. That minutes of stockholders’ and directors’ meetings, by-laws for the Delaware corporation and instruments conveying the assets of the old corporation to the new corporation in exchange for the stock of the new corporation had to be prepared and adopted at meetings of the old and the new corporation.
That n umerous contracts were drafted and re-drafted by counsel to carry into effect the negotiations of the parties.
That in addition to all of the foregoing there were numerous matters pertaining to the routine conduct of the corporation’s (Tennessee) affairs, tax matters, accounts, mechanics’ and material men’s liens, contracts with customers, and such other matters as could reasonably be expected to arise in the conduct of the affairs of a company of this character and size about which the officers necessarily had to be advised.
That the legal services rendered and performed by the members of the firm of Holmes, Canale, Loch & Glankler as hereinbefore set out in detail, extended over the period January 1926 to February 1927, inclusive.
That on March 25, 1927, the said firm of Holmes, Canale, Loch & Glankler tendered two bills of $20,000 and $5,000, respectively, to the petitioner for legal services thus rendered by it as hereinbefore set out. A copy of the bills for certain services is attached hereto, marked Exhibit A and expressly made a pai’t hereof.
That the petitioner duly paid to the firm of Holmes, Canale, Loch & Glankler during the year 1927, the sum of $25,000. That the whole of said amount was charged to expense on petitioner’s books of account, but $5,000 thereof was restored to income in filing petitioner’s return for 1927. That the petitioner has claimed a deduction of $20,000 of the amount so paid to the law firm as ordinary and necessary business expenses. That the Commissioner has disallowed said claimed deduction in its entirety, on the ground that the expenditure represented payment of organization expenses.

Petitioner contends that the bills rendered to it by the law firm are sufficient evidence of the nature of the service rendered. In our opinion, even if material, this allocation made by the lawyers is not conclusive and can not be accepted as controlling unless supported by the stipulation of facts. The law firm was employed early in 1926 by the Tennessee corporation. The primary purpose for which legal services were required was to work out some plan whereby the stock owned by the Thomas interests could be purchased in order that the remaining stockholders might secure control of the business of the Pidgeon-Thomas Iron Company. Obviously the greater portion, if not all, of the work of the law firm was done prior to the incorporation of the petitioner on February 1,1927. No liability for the payment for such services occurred until the bills were rendered to the Delaware corporation on March 25, 1927. New Process Cork Co., 3 B. T. A. 1339; Associated Gas & Electric Co., 2 B. T. A. 263; Peter Frees, Jr., 12 B. T. A. 737. At that date the Tennessee corporation was either dissolved or was a 100 per cent owned subsidiary of the Delaware corporation, but the record does not disclose which condition existed. In either event the bills paid were not to any considerable extent for services rendered to the petitioner here, but were for work done for its predecessor or subsidiary, whichever relationship existed. This being true, we think the whole amount of $25,000 must be regarded as part of the capital cost incurred by the petitioner in securing all the capital stock of the Tennessee corporation. Cf. North Star Granite Corp., 21 B. T. A. 222; W. P. Brown cf. Sons Lumber Co., 26 B. T. A. 1192.

Decision will he entered for the respondent.

      Pidgeon-Thomas Iron Company, Memphis, Tennessee. To Holmes, Canale, Loch & Glankler.

        March 25, 1927.

      To fee for legal services and advice rendered for year 1926, subsequent to date of death of W. G. Thomas pertaining to corporate affairs, conferences, examination and revision of building contracts, and all other services rendered on behalf of said corporation during said year_$20, 000.00
      Received Payment,
      Holmes, Canale, Loch & Glankler.

        Morch 25, 1927.

      Pidgeon-Thomas Iron Co., Memphis, Tenn. To Holmes, Canale, Loch & Glankler.

      To fee for legal services and advice rendered in the matter of final draft of re-organization papers, transferring assets of Pidgeon-Thomas Iron Co., a Tennessee corporation to Pidgeon-Thomas Iron Co., a Delaware Corporation,
      -$5,000. 00
      Received payment,
      Holmes, Canale, Loch & Glankler By Phil M. Canale.


text:
    W. C. Mitchell Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 49986.
    Promulgated January 31, 1933.

      Frank W. Wilson, G. P. A., for the petitioner. ■

      B. M. Goon, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has asserted a deficiency in income tax for the fiscal year ended June 30, 1928, in the amount of $5,499.68. The only issue is whether petitioner’s taxable income for the year under review should be reduced by the application of a statutory net loss alleged to have been sustained either in 1926 or 1927. In its original petition the petitioner pleaded that its taxable income for 1928 should be reduced by the amount of $40,005.82, the amount of a net loss alleged to have been sustained in 1927. At the hearing it amended its petition to allege that such loss was sustained in the year 1926.

Petitioner is a Minnesota corporation, with its principal office at Duluth, where it is engaged in buying and selling grain on commission. On July 1, 1918, it sold its president, W. C. Mitchell, certain shares of its treasury stock and received therefor a promissory demand note of the face value of $40,000. On June 30,1920, payments on such note were acknowledged by endorsements on the back thereof in the amounts of $2,500 and $3,466.85, or a total of $5,966.85. Such endorsements left a balance of $34,095.75, on which no payments have ever been made. Under the laws of Minnesota the statute of limitations ran against such note on June 30, 1926. On March 15, 1927, the maker of the note died and immediately thereafter the petitioner was advised by its attorney that the note was outlawed and uncol-lectible and on June 10,1927, it was charged oif the petitioner’s books as worthless, but the amount thereof was not claimed as a deduction on the petitioner’s income tax return for that year.

The petitioner’s return for the fiscal year ended June 30, 1927, disclosed no taxable income, but upon audit thereof the Commissioner determined a deficiency in the amount of $1,472.07. After conference such deficiency was reduced to $93.92, based on a net corporate income in the amount of $2,695.69, reduced to taxable income of $695.69 by corporation credit of $2,000; and, thereafter, on January 28, 1929, the petitioner and the Commissioner entered into an agreement as authorized by section 606 of the Revenue Act of 1928, which in words and figures was as follows:

AGREEMENT AS TO PINAL DETERMINATION OF TAX LIABILITT.
This Agreement, made in duplicate under and in pursuance of Section 606 of the Revenue Act of 1928, by and between W. C. Mitoheel Company, a taxpayer residing at, or having its principal office or place of business at 307, Board of Trade Building, Duluth, Minnesota, and the Commissioner of Internal Revenue;
Whereas, there has been a determination of the tax liability of said taxpayer in respect of federal income tax for the fiscal year ended June 30, 1927, in the principal sum of ninety-three dollars and ninety-two cents ($93.92) ; and
Whereas, said taxpayer hereby agrees to this determination and consents to the assessment and collection of any deficiency in tax included in the amount of the principal tax liability so determined, together with any penalty or interest applicable thereto as provided by law, and/or to accept any abatements, credit, or refund made in accordance with such determination, together with any interest due thereon as provided by law;
Now, This Agreement Witnesbeth, that said taxpayer and said Commissioner of Internal Revenue hereby mutually agree that the principal amount of such liability so determined shall be final and conclusive if and when this agreement is approved by tiie Secretary of the Treasury or the Undersecretary.
In witness whereof, the above parties have subscribed their names to these presents in duplicate.
Signed this 12th day of December, 1928.
W. C. Mitchell Company,
Taxpayer,
By: Mrs. W. C. Mitchell,
Treas.
D. H. Blair,
Commissioner of Internal Revenue.
ATTEST,
C. Hastings,
Secretary.
The above agreement has been approved by the Secretary of the Treasury in accordance with the provisions of section 606 of the Revenue Act of 1928.

The statutory provision authorizing such a closing agreement is section 606 of the Revenue Act of 1928, as follows:

(a) Authorisation. — The Commissioner (or any officer or employee of the Bureau of Internal Revenue, including the field service, authorized in writing by the Commissioner) is authorized to enter into an agreement in writing with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal-revenue tax for any taxable period ending prior to the date of the agreement.
(b) FinaUty of agreements. — If such agreement is approved by the Secretary, or the Undersecretary, within such time as may be stated in such agreement, or later agreed to, such agreement shall be final and conclusive, and, except upon a showing of fraud or malfeasance, or misrepresentation of a material fact—
(1) the case shall not be reopened as to the matters agreed upon or the agreement modified, by any officer, employee, or agent of the United States, and
(2) in any suit, action, or proceeding, such agreement, or any determination, assessment, collection, payment, abatement, refund, or credit, made in accordance therewith, shall not be annulled, modified, set aside, or disregarded.
(e) Section 1106 (b) of the Revenue Act of 1926 is repealed, effective on the expiration of 80 days after the enactment of this Act, but such repeal shall not. affect any agreement made before such repeal takes effect.

The respondent argues that in view of the closing agreement set out above, the Board is foreclosed from receiving proof of an alleged net loss sustained in 1927 and applicable to petitioner’s tax liability for 1928. We are unable to agree with this contention since the petitioner is not now asking for any redetermination of its tax liability for 1927. It does contend, however, that for the purpose of applying the provisions of section 117 of the Revenue Act of 1928, in the computation of its taxable income for 1928, it should be permitted to- prove a statutory net loss for 1927, when such loss was not claimed in that year and formed no part of the basis upon which tax liability therefor was determined. It argues that the only thing finally determined by the closing agreement is the tax liability for the year involved and that there are ample precedents for considering items of income and deductions relating to years not before the Board when such matters are necessary to the determination of the true tax for the year involved.

Section 274 (g) of the Revenue Act of 1926 is as follows:

The Board in redetermining a deficiency in respect of any taxable year shall consider such facts with relation to the taxes for other taxable years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been over paid or under paid.

The closing agreement notwithstanding, we are of the opinion that the provision set out above is applicable to the situation here. Whether or not there was a net loss in either of the two preceding years is a fact in relation to the tax for the year here under review. That the petitioner has agreed to a determination of tax liability for 1927 which was computed without consideration of the net loss now pleaded is not material. The limitation effected by such agreement bars only the reopening of tax liability for the year covered thereby and in no way estops the petitioner from pleading and proving any fact overlooked in such year but related to the tax of a subsequent year. To hold otherwise would permit the perpetuation of an error to affect tax liability for subsequent years, a result quite as likely to be prejudicial to the revenue as beneficial to taxpayers and one which, in our opinion, was not within the intention of Congress when section 606 of the Revenue Act of 1928 was enacted.

Petitioner’s contention that the amount of the note in question was deductible, as a bad debt, from its income for the fiscal year ended June 30,1926, is without merit. The running of the statute of limitations does not extinguish a debt or render it worthless, but merely provides the debtor with an affirmative defense which may be .pleaded against forcible collection. Bank of the United States v. Donnally, 8 Pet. 361; Leo Stein, 4 B. T. A. 1016; Warner L. Colvert, 6 B. T. A. 623; and Ralph H. Cross, 20 B. T. A. 929. More-)ver, as a condition precedent to deductibility, a taxpayer, under the provisions of section 234 (a) (5) of the Revenue Act of 1926, must ascertain the debt to be worthless and charge the amount thereof off its books in the taxable year. The petitioner did neither in the year ended June 30, 1926. It follows, therefore, that the note was not deductible in that year.

The petitioner also contends, presumably in the alternative, that die note in question was ascertained to be worthless and charged off its books in the fiscal year ended June 30, 1927. The maker of the note died on March 15, 1927, and his estate passed into the hands of an executor. In the State of Minnesota the executor of an estate can not waive the statute of limitations. Mason’s General Statutes, §8814. It is apparent, therefore, that, unless the petitioner had a lien against Mitchell’s stock on account of the debt due it that could be enforced either in law or at equity, despite the running of the statute of limitations, the debt was worthless at June 30, 1927, and the petitioner was entitled to deduct the amount thereof from its income in that year.

The statutes of Minnesota provide that “ stock shall not be transferred upon the books of the corporation while any installment thereon remains delinquent nor while any indebtedness of the record holder thereof to the corporation remains unpaid.” Mason’s Minnesota Statutes, §7463. The record fails to disclose whether the stock in question was ever issued to Mitchell, but under the language of the statute this is not material, since the law prohibits the transfer whether the debt is for an installment of the purchase money or for any other purpose. If the stock was ever actually transferred to Mitchell on the books of the petitioner, clearly the transaction was ultra vires under the laws of Minnesota. If it was not so issued the situation is squarely within the law above cited.

There still remains, however, the very important question as to whether the provisions above cited create a lien in favor of the corporation on stock owned by a debtor. The Supreme Court of Minnesota, in United States & Canada Land Co. v. Sullivan, 113 Minn. 27; 128 N. W. 1112, held “ that the statute now in force is sufficient to create a lien in favor of the corporation.” The provision of law construed in that opinion is in the identical language cited above. We think that opinion is controlling. The petitioner had a lien on the stock in question so long as Mitchell’s debt to it for any purpose was unpaid. In the same opinion the court said: “ It (such a lien) may be enforced in equity.” Cf. Benson v. Saffert-Gugisherg Cement Const. Co., 161 Minn. 269; 201 N. W. 424.

In the instant proceeding it appears, however, that the statute of limitations had run against Mitchell’s debt to the petitioner prior to the date at which deduction on account of worthlessness is now claimed. It remains, therefore, for us to determine whether that fact made it impossible for the petitioner to enforce its lien against Mitchell’s estate by an action in equity for the recovery of the stock. In George A. Hormel Co. v. First National Bank of Le Boy, 212 N.W. 738, the Supreme Court of Minnesota held that the statutory lien on stock for indebtedness due a corporation by the owner thereof can be lost only by waiver, surrender or estoppel. This opinion, however, does not definitely decide that a suit to enforce a lien of the nature here involved can be maintained after the statute of limitations has run against the debt. The court does say: “ But unless the corporation has waived or surrendered its lien or by its acts has estopped itself from asserting it, the lien is valid and enforceable against all the world and prior and paramount to the rights of any purchaser or pledgee, claiming under or through the stockholder.” In the circumstances herein there was neither waiver, surrender, nor estoppel, unless the neglect of the petitioner to enforce its right prior to the expiration of the statutory period is to be regarded as one or another. In the same opinion it is held that “This statutory lien is never lost by mere negligence, only by waiver, surrender or estoppel,” but as the statute of limitations was not at issue in that case it can hardly be said that the use of the word “ only ” is sufficient to dispose of this question.

In other jurisdictions where there was no statute providing expressly that such a lien is voided by the statute of limitations, the courts have held that a lien on stock created by a statute or charter is good, notwithstanding the statute of limitations has run against the debt. In United Cigarette Machinery Co. v. Brown, 119 Va. 818; 89 S.E. 850, the Supreme Court of Virginia said in its syllabi, “ That where a corporation reserved a lien on shares of stock for all claims due the corporation from its shareholders, the lien is not destroyed because limitations have run against enforcement of the claims due from the stockholders.” In the body of its opinion, in the same case, the court said:

There is a very marked distinction between an action at law to recover judgment for a legal demand and a proceeding in equity to enforce an equitable lien for the same demand. The remedy at law may be barred by the statute of limitations, but the statute of limitations does not extinguish the debt, and a lien therefor may be enforced in equity although the debt is barred.

In Brent v. Bank of Washington,. 10 Pet. 598; 9 Law. Ed. 547, the Supreme Court said:

But they allege that the debt is extinguished by the verdict in their favor, rendered on a plea of the statute of limitations. We cannot take this ease out of the established rule; the legal remedy is barred, but the debt remains as an unextinguished right, and the bank when called into a court of equity, may hold to any equitable lien, or other means in their hands until it is discharged.

We are unable to see that the fact that the debt was due for treasury stock that had been redeemed for cash at the date of sale to Mitchell and was held as an asset of the corporation removes the question here from inclusion in the rule established by the cases above cited. Whatever may be the status of such stock in the hands of a corporation, its reissue to a purchaser brings it within all the provisions of law applicable to outstanding stock, since thereafter it is indistinguishable from similar stock issued to subscribers therefor or the transferees of such subscribers. The purchasers of treasury stock acquire no privileges therewith that are not common to other stockholders. In the light of the law of Minnesota and the various decisions above cited and discussed, we are of the opinion that at June 30, 1927, the petitioner had a lien enforceable in equity against the stock in question. Its claim for the deduction thereof as a bad debt is therefore denied.

Reviewed by the Board.

Decision will be entered for the respondent.

Matthews concurs in the result.


author: TRAmmell : Smith,

text:
    Dallas Transfer & Terminal Warehouse Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 51536, 60182.
    Promulgated January 31, 1933.

      Percy W. Phillips, Esq., Bichard B. Barher, Esq., and J. B. Y. Ivins, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
   OPINION.

TRAmmell :

The principal issue in this case is whether or not petitioner realized taxable income in 1928 from the transactions with its landlord, the Terminal Corporation, whereby the petitioner transferred the Alamo Street property to the Terminal Corporation and the latter canceled the balance of the petitioner’s indebtedness.

In 1928 the petitioner owed the Terminal Corporation $107,880.77 for unpaid rent and interest thereon. It was then insolvent and unable to pay this indebtedness. An agreement was reached by which the petitioner was enabled to continue its business and the Terminal Corporation to rent its warehouse, but at a reduced rental.

The petitioner’s indebtedness was discharged by its transferring to the Terminal Corporation the Alamo Street property, which had a depreciated cost to petitioner of $39,513.42, and was subject to a mortgage of $25,000, which the creditor corporation assumed. At the time of the transfer, the petitioner’s equity in the property was $14,513.42. The Terminal Corporation canceled the balance of the indebtedness in the amount of $93,367.35, which amount the respondent contends constitutes taxable income to the petitioner.

In our opinion, the legal effect of the transaction, whereby the petitioner transferred real estate to the principal creditor in full satisfaction of its indebtedness, was to constitute such transfer a sale of the real estate, on which sale the petitioner realized taxable profit in an amount equal to the difference between the depreciated cost of the real estate and the aggregate amount of indebtedness canceled. See Abe Ackerman, 27 B. T. A. 413; also Twin Ports Bridge Co., 27 B. T. A. 346.

Petitioner contends that the gain is the difference between the depreciated cost of the property and the fair market value when transferred in cancellation of the debt. But as we view the transaction the property was transferred in cancellation of the debt, not applied to the extent of its fair market value and the balance of the debt forgiven. Our view is in accordance with written instruments of the parties. It is not shown that these instruments did not fairly set out what was done. The contract does not refer to a forgiveness of a debt, but to a cancellation thereof in consideration of the transfer. In a sale of property the taxable gain is the difference between the selling price and depreciated cost, when acquired after March 1, 1913, not the difference between the cost less depreciation and the value of the property. What the acquiring company laid out for the acquisition of the property would be the basis in its hands on a subsequent sale.

This case does not involve a cash payment of a part of a debt and the forgiveness of the balance, a general composition of creditors, nor bankruptcy, nor a situation where the debtor was still insolvent or left without assets after the debt cancellation or forgiveness, but a transfer of property in cancellation of the entire debt, leaving the taxpayer solvent. The bookkeeping entries of the creditor, in which it set up the appraised value of the property on its books as being a pro tanto satisfaction of the debts, are contrary to the agreement of the parties that the entire debt was to be canceled by the property transfer. In any event it is the debtor before us, not the creditor. The petitioner, being the debtor, treated the excess over cost of property less depreciation as being taxable income.

We see no valid distinction between this case and our decision in the case of Twin Ports Bridge Co., supra, in which we held that where a corporation pays its debts with stock, the difference between the cost of the stock and the amount of debts satisfied constitutes income. It is true that in this case the taxpayer was insolvent prior to the transaction, but solvent afterwards. In that case the taxpayer was solvent both before and after the transaction. However a corporation while insolvent may still have income. The fact that a taxpayer may in prior years have operated at a loss and its debts exceed its assets does not prevent it in the taxable year from making a taxable gain by disposing of property for more than its cost.

But even treating the case for the sake of argument on the principle upon which the taxpayer relies, that is, a partial forgiveness of debt, in our opinion the taxpayer can not prevail. Assets were left cleared of debts to the extent of the amount forgiven and the taxpayer was enriched to that extent. If a taxpayer had real estate worth $10,000, with a mortgage thereon of $5,000, it would seem that by canceling the mortgage, leaving the property free, it would be equivalent to the receipt of cash to the extent of the mortgage, whether the taxpayer then be solvent or insolvent. The case of United States v. Kirby Lumber Co., 284 U. S. 1, and the case of Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, as explained in the Kirby Lumber Co. case, support this view. The use of the capital asset, to wit its property which it used in having its indebtedness canceled or reduced, involves the use of capital in securing its enrichment to the same extent, in our opinion, as the use of money by the Kirby Lumber Company in buying back its bonds issued at par for less, thus giving rise to taxable gain.

See also the recent decision of the United States Circuit Court of Appeals for the First Circuit in Commissioner v. Coastwise Transportation Corp., 62 Fed. (2d) : 332, rendered after the Kirby Lumber Co. case, supra, and which reversed the decision of the Board at 22 B. T. A. 373, that the taxpayer derived no income from the purchase of two of its serial notes at less than face value.

In the view we take that the canceled indebtedness in excess of the depreciated cost of the real estate constituted income to the petitioner for the year 1928, it becomes unnecessary to consider the petitioner’s allegations in respect of the application of its net losses for 1926 and 1927, based upon the theory that the cancellation of the indebtedness did not constitute income, since the respondent applied said net losses against 1928 net income before computing the deficiencies.

The parties have stipulated that the petitioner is entitled to an additional deduction from gross income for 1929 on account of expenditures for club dues, as set out in our findings of fact. Said stipulation will be given effect in redetermining the deficiency for that year.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Smith,

dissenting: I can not agree that the transaction by which the petitioner transferred the Alamo Street property to its principal creditor constituted a sale of that property upon which the petitioner realized a taxable profit of $93,367.35. The facts do not warrant that conclusion. The petitioner had operated at large losses from the date of its organization. Its capital of $200,000 had been entirely wiped out. At December 31, 1927, it had on hand assets of a value of $152,470.16 and had accounts payable of $178,941.01. In order that the petitioner might continue in business its principal creditor agreed to cancel a part of its claim. The petitioner owned property on Alamo Street, which had a depreciated cost to the petitioner of $39,513.42 and which was subject to a mortgage of $25,000. The agreed fair market value of the property in 1928 was $42,507.20. The principal creditor took over this property, assumed the mortgage thereon, and canceled the balance of its claim against the petitioner. To hold that the petitioner realized a taxable profit of $93,367.35 does violence to the principle that the income tax law shall be interpreted in accordance with truth and. substance.

The petitioner admits that it realized a profit upon the transaction represented by the difference between the depreciated cost of its equity in tbe Alamo Street property and its fair market value at the date of transfer, or a profit of $2,988.78. It contends, however, that the difference between $2,988.78 and $93,367.35 was a cancellation of indebtedness from which it derived no taxable income. I think its contention is well founded. A reduction of debt liability is not necessarily a realization of taxable income. Bowers v. Kerbaugh-Empire Co., 271 U. S. 170; Meyer Jewelry Co., 3 B. T. A. 1319; United States v. Oregon-Washington R. R. & Nav. Co., 251 Fed. 211; Commissioner v. Simmons Gin Co., 43 Fed. (2d) 327; Burnet v. John F. Campbell Co., 50 Fed. (2d) 487; Commissioner v. Rail Joint Co., 22 B. T. A. 1277; affd., 61 Fed. (2d) 751.

In each case the facts must be considered. In United States v. Kirby Lumber Co., 284 U. S. 1, the facts are that the Lumber Company had gained $137,521.30 in cash within the taxable year by redeeming certain of its bonds for that amount less than it had received for the bonds upon the issuance earlier in the year. By the transaction the company’s cash assets were increased by $137,521.30. The Supreme Court said that the amount was an accession to income ” which was “ realized within the year.” No facts obtain in the instant proceedings which bear a close analogy thereto. The proper interpretation of the Kirby Lumber Go. decision is in my opinion indicated by the decision of the Circuit Court of Appeals for the Second Circuit in Commissioner v. Rail Joint Co., supra, in which the decision of this Board at 22 B. T. A. 1277, was affirmed. It was held in that case both by the Board and by the Court that the reduction of the liability was not an “ increment to its [petitioner’s] assets.”

Manifestly if a debtor turns over to his creditor all of his property, which is only a fractional part of the debt owed by him, in settlement of his debt, the debtor derives no taxable income from the transaction. Nothing is received which answers to the definition of “ income ” laid down by the Supreme Court in Eisner v. Macomber, 252 U. S. 189. I can not see, in the instant proceedings, that the petitioner has had any “ increment to its assets ” through the cancellation of a portion of its indebtedness in 1928. At most it realized only a profit measured by the difference between the depreciated cost of its equity in the Alamo Street property and the fair market value of that property at the date of sale.

In my opinion the petitioner’s accounts should be restated for the years 1926, 1927, and 1928, and the net losses for the years 1926 and 1927, to the extent that they were caused by the accrual of unpaid rent which was canceled in 1928, should be restated in accordance with section 272 (g) of the Itevenue Act of 1928.


author: Black :

text:
    Margaret A. Holmes, Petitioner, v. Commissioner of Internal Revenue, Respondent. Carl F. Holmes, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 48631, 51473, 51570, 53394, 53395
    Promulgated January 31, 1933.

      Charles B. Mclnnis, Esq., for the petitioners.

      G. H. Gwinn, Esq., for the respondent.
   OPINION.

Black :

In these proceedings the Commissioner has determined deficiencies against petitioners as follows:

The cases were consolidated for hearing and all the facts have been stipulated. The stipulation of facts as to petitioner Margaret A. Holmes, omitting formal parts, was as follows:

(1) The petitioner is an individual whose legal residence .is No. 2 East 86th Street, New York, New York, and whose mailing address is care Willard A. Mitchell, No. 141 Broadway, New York, New York.
(2) Under date of March 23, 1926, the petitioner, as settlor, entered into a trust agreement with Hugo A. Oswald, as trustee.
(3) The 39,308 shares of the capital stock of the Fleischmann Company, specified in the schedule attached to the said trust agreement, were duly transferred to the name cf Hugo A. Oswald, trustee, on the stock books of the ETeischmann Company and the new certificates for the said 39,308 shares were delivered to Hugo A. Oswald in accordance with the terms of the Trust, under date of March 25, 1926.
(4) The said Hugo A. Oswald, as trustee of the said Trust, duly filed with the Collector of Internal Revenue, Newark, New Jersey, federal income tax returns on Form 1040, on behalf of the said Trust for the years 1926, 1927 and 1928, reporting therein all income received by the said Trust during the said years respectively.
(5) The said Hugo A. Oswald, as trustee, duly , paid to the Collector of Internal Revenue, Newark, New Jersey, the amount of federal income taxes shown to be due on the above mentioned returns for the years 1926, 1927 and 1928. The said amounts of taxes shown to be due on the said returns for 1926, 1927 and 1928 are still retained by the United States Government although the said Hugo A. Oswald, trustee, has duly filed claims for refund of the said taxes, which claims are now pending before the Commissioner of Internal Revenue.
(6) The petitioner, Mrs. Margaret A. Holmes, duly filed with the Collector of Internal Revenue for the Second District of New York, at 17 Battery Place, New York, New York, individual federal income tax'returns for the years 1926, 1927 and 1928 and reported therein all individual income received by her during the said years respectively, not including income received and retained by the said trustee uuder the said indenture of trust.
(7) The Commissioner of Internal Revenue has added to the taxable income reported by the petitioner in her individual income tax returns for the years 1926, 1927 and 1928 all of the income received and retained by the said Trust during the said years 1926, 1927 and 1928, respectively, and which was reported in the returns filed on behalf of the said Trust for the said years 1926, 1927 and 1928, respectively.
(8) The Trust created by the instrument was in full force and effect during the period from March 23, 1926 to December 31, 1928, and all terms and conditions of the said Trust were duly observed and followed by all persons who were affected by the same during the said period from March 23, 1926 to December 31, 1928.

The stipulation as to Carl F. Holmes was in all essential respects the same as the foregoing stipulation, except as to names, amounts of securities transferred to the trustee, etc. Said stipulation as to Carl F. Holmes is incorporated herein by reference, together with the exhibit which is attached thereto.

The pertinent provisions of the trust instrument, omitting the formal parts, executed by petitioner Margaret A. Holmes to Hugo A. Oswald, trustee, are as follows:

To Have and to Hold the said personal property and each and every part thereof unto the Trustee so long as the Settlor shall live or until the earlier revocation of this instrument as hereinafter provided, In Trust nevertheless for the following purposes, that is to say:
(A) To collect and receive all income, dividends and profits payable out of or arising from or accruing to the said property or other property which may pursuant to the terms hereof be added to or substituted for the property hereby assigned and held pursuant to this Indenture and all moneys arising from the proceeds of the sale of any such property.
(B) To accumulate and invest said income and moneys and retain tiie same as part of the Trust Fund until the termination or revocation of this trust, excepting as to such part thereof, if any, as, in accordance with a provision hereinafter contained, may, during the term of said trust, be paid over to the Settlor or to any other person or persons. All moneys which the Trustee may be required to pay to the Settlor hereunder in accordance with such provision shall be deposited to the credit of her account with the Garfield National Bank in New York City or otherwise paid as the Settlor shall from time to time request, and all moneys which the Trustee may be required to pay Over during the term of said trust to said Oarl F. Holmes hereunder in accordance with such provision shall be deposited to the credit of his account with said Garfield National Bank in New York City or otherwise paid as he shall from time to time in writing request.
(O) Upon the expiration of the term of this trust to pay over the principal of the Trust Fund and all undistributed income thereof to said Oarl F. Holmes, or in case of his death then to such person or persons and in such proportions as the Settlor shall by her Last Will and Testament designate, or in the absence of such designation, then to such person or persons as according to the then existing laws of the 'State of New York would have been entitled to take the Same in distribution as the next of kin of said Oarl F. Holmes, if at the time of the termination of said trust said Oarl F. Holmes had been a resident of the State of New York, without father or mother living, and had died intestate owning said principal as personalty, said person or persons to take said principal in such shares and proportions as they would have been entitled to take the same in that event.
* * * * * * *
11. Provided Always and it is expressly agreed that the Settlor may with the consent in writing of said Carl F. Holmes, if living, and if not then of any other beneficiary hereunder, and also of any of the following, viz., Julius F. Holmes, Bettie F. Holmes, Willard A. Mitchell or Hugo A. Oswald, but not otherwise, by writing under the hand of the Settlor, require the payment to her or for her account of any part of the principal or income of said trust fund, or revoke and make void the trusts hereby declared and may, if thought fit declare, for a term not longer than the life of the Settlor, any other trusts of the Trust Fund or any part thereof and of the subsequent income therefrom and so that in the event of such revocation and of failure on the part of the Settlor to declare any other trusts of the Trust Fund or of any part thereof the Trustee shall forthwith upon such revocation pay, endorse and deliver over the money and investments for the time being representing the Trust Fund or such part thereof as shall not be the subject of such other trusts as aforesaid, including all undistributed income, if any, to the Settlor.
12. At the end of each period of one year from the date hereof all income from the Trust Fund remaining in the possession of the Trustee, whether invested or not invested, shall be added to and deemed to be part of the principal of said Trust Fund.
# # # # * * *
Schedule
The property assigned to the Trustee by the foregoing Deed of Trust consists of Thirty-nine thousand three hundred and eight (39,308) shares of the capital stock of The Fleischmann Company, a corporation of the State of Ohio.

The trust instrument attached to the stipulation filed in Carl F. Holmes, petitioner, Docket Nos. 51473 and 53395, is in all respects the same as the trust instrument executed by petitioner Margaret A. Holmes, from which the above quotations are made, except as to names, and the amounts of securities transferred by said instrument. The reasons prompting the action of the Commissioner in adding to the income of the petitioners the income of the respective trusts, which they had created is stated by him in one of the deficiency notices mailed to petitioner, Carl F. Holmes, as follows:

It is your contention that with the exception of the sums which you received under the requests which were honored hy the trustee, the net income of the Carl F. Holmes trust need not be included in net income for the reason that under the trust agreement provisions you must secure the consent of the beneficiary named in order to revest in yourself any part of the corpus of the trust.
You are advised that it is held in this office that under the trust instrument executed by you on March 24, 1928, Margaret A. Holmes can not be regarded as a bona fide beneficiary within the meaning of section 219 (g) or section 219 (h) of the Revenue Act of 1926, but instead she must be considered as being not a beneficiary of the trust. Since you, in conjunction with Margaret A. Holmes, who is not a beneficiary of the trust, had authority at all times during the year 1927 to have revested in yourself title to all of the corpus or to have distributed to yourself, all of the income of the trust, the entire net income of the Carl F. Holmes trust must be included in your personal income tax return for the year in question.

It will be seen from the foregoing stipulation of facts and the statement taken from the Commissioner’s deficiency notice that the question involved is whether the income representing the profit on the sede of certain stock in the trusts, and certain dividend income of the trusts, is to be taxed, by virtue of section 219 (g) and (h) of the Revenue Act of 1926, and sections 166 and 167 of the Revenue Act of 1928, to the grantor of the trust or to the trust itself. The petitioners rely upon the fact that they, severally, as to the trust created by each of them, had absolutely no power to “revest” in himself title to any part of the corpus of the trust “ either alone or in conjunction with any person not a beneficiary of the trust,” and also upon the fact that no part of the income of the trust may, in the discretion of the grantor, “ either alone or in conjunction with any person not a beneficiary of the trust,” be distributed to or accumulated for future distribution to the grantor. It is the contention of petitioners that in the case of each trust the power of revocation is made absolutely dependent upon the consent of the beneficiary of the trust, nor may any income of either trust be distributed to the grantor or held or accumulated for future distribution to him, either alone or in conjunction with any person not a beneficiary of the trust. The distribution or accumulation of income to the grantor, as well as the revocation of the trust itself, are both, by express language, made subject to the consent of the beneficiary named in the trust, and others.

If the instant case had arisen prior to 1924, no controversy would likely have arisen between the petitioners and the respondent. The trusts of March 23, 1926, and March 24, 1926, clearly turned over certain principal or corpus to a trustee who held the title thereto. The income upon such principal or corpus, under the laws prior to the 1924 Act, would plainly have been taxable to the trusts.

Realizing that the law, as it then stood, permitted the avoidance of tax liability in a considerable number of cases without affecting the substantial rights of taxpayers, Congress inserted in the Revenue Act of 1924, at the end of section 219, two entirely new subdivisions, which have been reenacted in identical terms in subsequent statutes.

For the purpose of ascertaining the intendment of Congress in adding these subdivisions to the statute the proceedings in Congress antedating the enactment of the Revenue Act of 1924 may he consulted.

It will be found that subdivision (g) underwent considerable change in the course of its passage. In its first form (the first House Bill) the section applied broadly to any power of revocation which, if exercised, would revest title to the corpus. The Senate amended the bill by adding the phrase “ at any time during the taxable year, either alone, or in conjunction with any person.” In Conference the section was further amended by adding the phrase “ not A beNefigtARx on the TRUST ” in description of the word “ person.” These changes are not explained, but may have been for constitutional reasons. However that may be, the changes clearly show that the act, as finally passed, expresses the definite purpose that the provision shall not be applicable if revocation is dependent upon the consent of the beneficiary.

What has been said with respect to subdivision (g) applies with respect to subdivision (h), the same language, “ not a beneficiary of the trust,” having been inserted at the insistence of the Senate in that subdivision.

In order to permit the inclusion in the income of the grantor of the income of a trust under sections 219 (g) and 166, there must be a power to revest title of the corpus of the trust in the grantor, and that power must exist (a) “ at any time during the taxable year ” and (b) the power must exist in the grantor “ either alone or in conjunction with another person not a beneficiary of the trust.” We are not concerned in the instant case with the condition stated in (a), since any power which did exist to revest title in the grantor existed during the taxable year. We are concerned rather with the interpretation of the clause “ either alone or in conjunction with another person not a beneficiary of the trust.”

The purpose of Congress seems to be clear. Congress recognized the justice and propriety of taxing not only income derived from property the title of which was held by the taxpayer, but also that income “ subject to a man’s unfettered command and that he is free to enjoy at his own option ” might properly be taxed to him as his income. Congress recognized that the mere transfer of legal title to a corpus or principal fund producing income should not be sufficient to transfer, for taxation purposes, the ownership of the income and thus permit minimization of tax liability. The real purpose of the provisions under question is plainly to reach with taxation that income which, in a technical sense, is transferred to another but which the transferor is free to appropriate (Corliss v. Bowers, 281 U. S. 376). A taxpayer who creates a revocable trust is in the position of being free to appropriate the income of the trust at any time. Accordingly, it is reasonable to say that such a taxpayer should be regarded as in receipt of that income which by his own voluntary action he chooses not to appropriate. The Supreme Court says that it does not matter “ whether the permission is given by assent or by failure to express dissent.” The point is that in reality and substance, as distinguished from mere form, the income belongs to the taxpayer and should be taxed to him.

Applying these considerations to the facts of the instant case, it would seem that the trusts in question were not “ revocable trusts ” within the meaning of section 219 (g) and (h) of the Revenue Act of 1926 and sections 166 and 167 of the Revenue Act of 1928. Before petitioner Margaret A. Holmes could revoke the trust which she created, she would have to secure the consent of the beneficiary Carl F. Holmes. Before Carl F. Holmes could revoke the trust which he created, he would have to secure the consent of the beneficiary Margaret A. Holmes. This being true, we hold that respondent was in error in holding that the trusts were revocable trusts under the applicable statutes.

The respondent in his deficiency notices seems to have adopted the theory that because petitioners were husband and wife, that fact created an exception to the general language of the statute, but we find no authority for so holding. Husband and wife are separate taxpayers and they have the right to have the tax on their incomes computed separately and, when they elect to exercise that right, the Commissioner has no authority to tax the income of one to the other.

In the very recent case of Hooper v. Tax Commissioner of Wisconsin, 284 U. S. 206, the Supreme Court held that a provision of the Wisconsin statute was void which provided for the addition of a wife’s income to her husband’s income in computing the husband’s tax liability.

In the instant case we do not have to decide whether an act of Congress would be void if it undertook to except from the provisions of section 219 (g) and (h) and sections 166 and 167 of the Revenue Acts of 1926 and 1928, respectively, trusts in which the husband or wife were made the beneficiaries.

Suffice it to say that Congress did not write into said sections any such exception and we have no authority to write into such sections, by construction, any such exceptions. Cf. Iola Wise Stetson, 27 B. T. A. 173; Bessie R. Jones, 27 B. T. A. 171; Sydney R. Bliss, 26 B. T. A. 962.

Decision will he entered for the petitioners'.


author: Seawell :

text:
    Lenore Ulric, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 48973, 53431.
    Promulgated January 31, 1933.

      Meyer Kurz, Esq., for the petitioner.

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

Seawell :

Entertainment to be a business expense and allowable as a deduction from gross income should have some definite, reasonable purpose connected with the business in hand and tending to its aid (Thomas Shoe Co., 1 B. T. A. 124), and be of a nature reasonably calculated to accomplish the end sought. Entertainment expense of this kind has been allowed as such deduction, Indiana Harbor Belt Ry. Co., 16 B. T. A. 279; Edward A. Miller, 20 B. T. A. 379; A. F. Rees, 21 B. T. A. 698; Eitingon-Schild Co., 21 B. T. A. 1163. Where the expense is not incurred in the exercise of prudent business judgment and the business benefits are not direct and reasonably to be expected, such deductions are held not allowable. Climax Spinning Co., 8 B. T. A. 970, and National Yarn Mills, 10 B. T. A. 1102. If no definite line of demarcation exists, then it would seem “the rule of reason” should apply. (United States v. American Tobacco Co., 221 U. S. 106, 180.)

When giving her testimony on the hearing in this proceeding petitioner was asked by her counsel what business benefit she sought to derive from these expenses for entertainment, and replied: “ It was my idea to establish a contact, to have people with me, because our profession makes it necessary for us to know people personally and to know their emotional reactions and their angles on our business, our profession which is built of emotions, and in order to have them understand from our angle, our idea of a play. * * * if you are selecting a cast, it is necessary to find out their viewpoint, their reaction, their angle on a certain character, * * * whether it is an author, a newspaper man, a man who writes special stories, special features to be given to the public, it is practically the same thing. It is necessary to establish a contact in order to understand the right interpretation of a play or the role or various roles in the play.”

When she was asked the “ specific value ” from a business point of view of maintaining contacts with prominent and successful authors, her reply was: “ Well, in order to give them ideas, * * * if the author finds the general idea interesting, he writes a character or a play for this particular star. * * * A successful play may come of it, and a successful play may not come of it. It is an experiment, you see.” Similarly, as to “ critics,” unless they have the “ viewpoint ” of the actress they may give to the public their own unaided impressions; as to “ feature writers,” they should know the kind of “ sports ” the actress likes and her “ hobbies ” so that this information may be conveyed to the public in their writings, if any; as to “ directors,” “ it is the same idea as it would be with an author”; and as to a manager, he “is also another angle.” There was no testimony to fit the entertainment, expense for which is here under investigation, to the general purposes of entertainments mentioned in the petitioner’s evidence. Nowhere in the evidence were we shown that during the years 1927 or 1928 petitioner made contact by means of entertainment with an author to give him her ideas or to discuss details of a play to be written for her by him; or that she was engaged in selecting a cast for any play, making necessary contact with other actors or actresses. The general purposes of the entertainment provided by her during the taxable years appear not only remote in their relation to her business, but of a character not reasonably to be expected to benefit the business. There was no more than a bare possibility of business benefit as disclosed by the evidence.

In Cohan v. Commissioner, 39 Fed. (2d) 540, relied on by petitioner, the main controversy was as to traveling expenses and there were only two small items of “ entertainment ” involved. One was when Cohan, a theatrical producer, supplied coffee and sandwiches to a cast rehearsing his play in Chicago. The cast so. supplied were evidently in his employ. The other was when he entertained four or five critics and some city hall employees when promoting his play. In remanding the cause to the Board, the Circuit Court of Appeals made this entry: “ The cause is remanded to make some allowance for the expenses of travel and the like; otherwise it is affirmed.” In the instant case the petitioner’s traveling expenses have been allowed and are not here involved; and also her expenses at hotels and for meals and tips for herself, her maid and her secretary have been allowed by the Commissioner as claimed by her.

Unfortunately, in this proceeding we were provided with no evidence as to the attendant circumstances of these entertainments, showing the amount or necessity of expense incurred. The nearest approach to such evidence was with reference to the entertainment in honor of the famous German producer, Max Reinhardt, in New York in 1927. This was an elaborate affair, with hired caterers, musicians, and decorators, and with cut flowers and automobiles for the use of more than a hundred guests. The cost is not mentioned or segregated from other similar expense claimed for the year. If the Board, in the performance of its duties, is required judicially to determine that claimed deductions do or do not fall within the scope of the statute, it must first know the facts in each particular instance and as to each item of the expense, in order to ascertain that it is or is not an ordinary and a necessary expense and such as has been incurred in carrying on the taxpayer’s business. Paciic Bone, Coal & Fertilizer Co., 10 B. T. A. 77. An expense out of all proportion to the business and larger than any possible direct benefit to be derived therefrom could hardly be adjudged an ordinary and necessary business expense in accordance with the provisions of the statute. To permit the petitioner or her witnesses to decide that the expenses are ordinary and necessary and incurred in carrying on her business is for the Board to abdicate its duty.

The same observations apply in this case with reference to theatre tickets. Not only the expense for that purpose, amounting to $1,-956.86 in the month of February, 1927, alone, should be explained in detail, but every item, however small. Generalities do not supply the rigid individualistic requirements of the law. Donations of one’s stock in trade are not an ordinary method of increasing business; certainly the delegation of authority to others to make such donations would appear far removed from prevailing business practice; and if the donations of theatre tickets are claimed to be in the theatrical world an ordinary and necessary expense of business, it should be shown not in a general way, but in each instance in which the claim is made.

When the custom arose of entertaining other theatrical people by stars of the stage with complimentary tickets and dinners is not shown in the evidence. Legend tells us that Shakespeare died on his fifty-second birthday (April 23,1616), and that his death was hastened, if not caused, by partaking of hospitality supplied by himself in entertaining his friends, Ben Jonson and another poet. The potency of donated favors, especially of food, in securing adherents is recognized. Francis Marion held together his dispirited troops by adding to their love of home and country some ash-baked sweet potatoes. Cannibals have been turned from a hostile to a friendly attitude by a cup of salt. Arabs, it is said, will not attack those with whom they have broken bread. Men, women and children have always been willing to follow a leader who can provide food in a desert place, if for no other reason than because of the loaves and fishes.

Friends are of great assistance to petitioner; but so they are to all others in whatever business they may be engaged. But they can not be purchased in a business way, even indirectly. Every expense from which some incidental business advantage may flow is not a business expense under the statute; and every business expense is not necessarily an ordinary ” expense, and even when it is such it may not be “necessary.” There may be court suggestion that the word “ and ” which connects the words ordinary ” and “ necessary ” in the statute here involved (section 214 (a) of the Revenue Act of 1926) should be given the meaning of “ or,” but we prefer to leave the statute as enacted by Congress. Even though the word “ ordinary ” might be considered as synonymous with “ customary ” (with which we do not agree), and even though it be admitted that it is customary for some stars to entertain as petitioner claims to have done, such entertainment has not been shown in this proceeding to have been reasonable in amount or extent, or necessary in fact to any extent. David Belasco, petitioner’s manager, and one most eminent in the theatrical profession, according to the evidence of the petitioner herself, never entertained; and other actors and actresses, including stars, follow Mr. Belasco in this practice without, it appears, diminution of income or prestige.

Considering that there have been allowed as deductions to petitioner all her advertising expenses and all her other expenses connected directly and reasonably with the prosecution of her business as an actress, as hereinbefore and in our findings of fact pointed out, we must hold that the respondent was not in error in his determination of the deficiencies herein.

Judgment will be entered for the respondent.