author: Van Fossan :

text:
      Sample-Durick Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83637.

      William W. Johnston, O. P. A. for the petitioner.

      E. G. Adams, Esq., for the respondent.

      Entered and copies served on parties May 13, 1937. Now published for general information.

   MEMORANDUM OPINION.

Van Fossan :

This proceeding involves a deficiency of $577.97, income taxes for the calendar year 1933. The issue presented is the-amount of depreciation on machinery to which taxpayer is entitled. The facts, partly stipulated, are undisputed.

The taxpayer is a New York corporation with its principal place of business at Indian Orchard, Massachusetts. Its income tax return for 1933, filed March 12, 1934, reported net income of $1,441.57 and a tax liability of $198.22. In computing this net income petitioner deducted $7,270.86 as depreciation.

Under date of February 14, 1936, respondent determined petitioner’s tax liability for 1933 to be $776.19, and asserted the present deficiency. One of respondent’s adjustments was the reduction of the depreciation allowance to $3,172.65.

The total original cost of machinery on hand at December 31, 1932, and in use in 1933 by the taxpayer, is $70,972.77. The accumulated depreciation to December 31, 1932, is $56,459.66, leaving an unde-preciated balance of $14,513.11. The respondent has allowed depreciation of $1,978.66 upon the items of machinery included in said $14,513.11. Machinery additions in 1933 cost petitioner $25,509.89,. and the depreciation allowance thereon is agreed to be $396.36.

In determining the 1933 depreciation deduction of $1,978.66 on machinery acquired prior to January 1, 1933, the respondent and petitioner agreed upon the estimated remaining life of each piece. There is no dispute as to depreciation of assets other than machinery.

On October 18, 1935, the taxpayer filed amended income tax returns for the years 1931 and 1932 despite the fact that the statute of limitations respecting assessment of additional taxes for 1931 and 1932 had expired prior to October 18,1935. The only change in the amended returns, from the originals, was a decrease in the item of depreciation of machinery. These decreases amounted to $6,-059.06 and $5,775.48, respectively. The taxpayer’s original return for 1931 reported a loss of $4,600.71. The amended return reported income of $1,458.35, but no tax liability due to the $3,000 exemption.

Taxpayer’s original return for 1932 disclosed a net loss of $7,-776.03, made up a net loss of $4,603.27 applicable to 1931 operations, and a net loss of $3,172.76 applicable to 1932 operations. Taxpayer’s amended return for 1932 reported net income of $2,602.72, (resulting from applying against the above-mentioned loss of $3,172.76 a depreciation deduction of $5,775.48 less than that taken upon the original return), and a tax liability of $357.87, which was voluntarily paid upon the filing of the amended return on October 18, 1935. Subsequently, respondent demanded and'petitioner paid interest of $7.34 on the $357.87 additional tax for 1932.

The taxpayer’s adjustment of depreciation on machinery is arrived at by going back two years from January 1,1933, to January 1, 1931. The petitioner adds two years to the January 1, 1933, life of each piece of machinery in order to obtain the estimated remaining life at January 1, 1931. The undepreciated balance of each machine at January 1, 1933, is then increased by the depreciation taken in 1931 and 1932. This gives a total undepreciated balance at January 1, 1931, of $31,581.39. Each piece of machinery is then depreciated by dividing the undepreciated balance at January 1, 1931, by its remaining life at that date.

The decrease in expense by way of depreciation and consequent increase in income for 1931 and 1932 of $6,059.06 and $5,775.48, respectively, subjects only $2,602.72 of said increase to the income tax. If this adjustment is projected into future years, the depreciable'base will be increased $11,834.54, being the decrease in the 1931 and 1932 depreciation allowances, and the depreciation deduction for 1933 and later years will be increased over the amounts allowable under respondent’s computation.

At the hearing respondent pleaded that the Board has no jurisdiction because the question herein is one “purely within the jurisdiction of the Commissioner of Internal Be venue.” In support of his plea respondent contends that the question of whether he must accept amended returns for years barred by the statute of limitations is a matter of internal administration within the Bureau of Internal Bevenue.

This plea to the jurisdiction must fail. All the jurisdictional facts necessary for the Board’s consideration of this proceeding are present. A deficiency was duly determined, a timely appeal was filed, and the issue raised by petition and answer is properly before the Board for consideration. In our view of this proceeding the internal administrative policies of the Bureau are not involved. We have to determine whether the respondent has correctly computed the depreciation deduction to which petitioner is entitled in 1933. In determining this question it is unnecessary to consider whether the Bureau should accept or reject amended returns for prior years filed after the running of the statute of limitations. We can not agree that our decision herein is controlled by Kunkel & Co., Inc., 3 B. T. A. 133, or by The Macmillan Co., 4 B. T. A. 251. The cited cases support the rule that erroneous computations in prior years can not justify a continuance of the error in the present taxable year. See also Union Metal Manufacturing Co., 1 B. T. A. 395, 399.

All the basic facts involved in this issue are agreed. The unde-preciated cost of the various items of machinery at January 1, 1933, is agreed to be $14,513.11. The cost of additions during 1933 is agreed. The remaining life of each piece of machinery at January 1,1933, and the additions are agreed. Petitioner agrees further that, if the adjustment requested is denied, the respondent’s computation is correct. Each computation proposes to secure only the return of the capital investment, thereby eliminating any question of double deduction.

It is the taxpayer’s contention that since the parties have agreed to a change in the remaining life at January 1, 1933, that this change can be carried back so as to become equally effective at January 1, 1931. The difference between petitioner’s and respondent’s methods of computing the depreciation allowance can be illustrated by taking the first item of machinery on the schedule submitted in evidence. This machine^ a Babcock cutter and creaser, was acquired in 1923 at a cost of $9,581.75. It had an estimated life at January 1, 1933, of 5y2 years, and an undepreciated balance at January 1, 1933, of $2,-302.41. The respondent allowed depreciation thereon of $418.62 for 1933. Petitioner, taking the same starting point, January 1, 1933, added thereto the depreciation allowances in 1932 and 1931 and determined an undepreciated balance at January 1, 1931, of $4,218.77. Spreading this unextinguished cost over a remaining life of 7y2 years, petitioner computed a depreciation allowance for each of the years 1931, 1932 and 1933 of $562.50.

Respondents computation is based upon T. D. 4422, which sets forth the method of computing the depreciation allowance. The reasonableness of the regulation is conceded by taxpayer, since its method of computing the depreciation deduction simply carries T. D. 4422 back to January 1, 1931. Taxpayer claims the right to do so because net losses resulted from its business operations in both years. Under its method of computing depreciation net income resulted for both 1931 and 1932 which would eliminate any net loss “carry over” in determining 1933 tax liability. Despite the fact that the statute of limitations barred the assessment of any deficiency for either year, taxpayer has waived this defense and paid the tax liability of $357.87 plus $7.34 interest on its 1932 income.

The reported cases reveal that this question has arisen principally in cases involving depletion allowances. Where the basis has proven to be materially erroneous the Board has allowed a revision of the estimated content in order to properly deplete the natural resource. The revised estimate is then depleted over the remaining life; it can not be carried back and the allowances for prior years revised. Sterling Coal Co., Ltd., 8 B. T. A. 549; James R. McCahill, 29 B. T. A. 1080; Big Four Oil & Gas Co., 28 B. T. A. 61, affd., Big Four Oil & Gas Co. v. Commissioner, 83 Fed. (2d) 891.

The same principle is applicable here although we are concerned with a depreciation allowance. This allowance is for the purpose of correctly reflecting a taxpayer’s net income, and if the depreciation allowance properly reflects net income or net loss under the known facts for the taxable year, the deduction should stand. Cf. Dusenberg, Inc. v. Commissioner, 84 Fed. (2d) 921, affirming 31 B. T. A. 922. Facts that are subsequently developed should be reflected in the allowances for subsequent years, but they should have no retroactive force or effect. Alpin J. Cameron et al., 8 B. T. A. 120; Firemen's Insurance Co., 30 B. T. A. 1004, 1011, and cases there cited.

In determining the deficiency for any taxable year the Board is entitled and required to consider facts relative to other taxable years that have a bearing on the correct tax liability of the year involved. Section 274 (g), Bevenue Act of 1926. In this proceeding the prior years’ tax liability is pertinent only if a net loss ivas used to reduce 1933 income. This was a matter of proof, which petitioner was bound to establish before being entitled to relief. Since the record does not establish that 1933 income was reduced by prior years’ net losses, respondent’s determination must be approved.

Decision will be entered for the respondent.

       Articles 205 of Regulations 77 and 74 are hereby amended to read as follows:
      Akt. 205. Method of computing depreciation allowance. — the capital sum to be recovered shall be charged off over the useful life of the property either in egual annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. Where the cost or other basis of the property has been recovered through depreciation or other allowances no further deduction for depreciation shall be allowed. The deduction for depreciation in respect of any depreciable property for any taxable year shall be limited to such ratable amount as may reasonably be considered necessary to recover during the remaining useful life of the property the unrecovered cost or other basis. The burden of proof will rest upon the taxpayer to sustain the deduction claimed. Therefore, taxpayers must furnish full and complete information with respect to the cost or other basis of the assets in respect of which depreciation is claimed, their age condition and remaining useful life, the portion of their cost or other basis which has been recovered through depreciation allowances for prior taxable years, and such other information as the Commissioner may require in substantiation of the deduction claimed.


source: Caselaw Access Project

author: Sternhagen:

license: Public Domain

text:
    Victor House, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81428.
    Promulgated June 4, 1937.

      Emily Marx, Esq., and Spencer Pinkham, Esq., for the petitioner.

      Edward A. Tonjes, Esq., and D. L. Shepard, Esq., for the respondent.
   OPINION.

Sternhagen:

The petitioner contends that the determination of deficiency was made after the expiration of the statutory period, which he contends expired June 15, 1934, which was two years after the return was filed. (Revenue Act of 1928, sec. 275 (a)). If correct, he escapes the deficiency (Revenue Act of 1928, sec. 601). The Commissioner answers with a waiver signed by the taxpayer on June 12, 1934, extending the period until June 30,1935, within which extended period the deficiency notice was mailed. The petitioner replies that the waiver is ineffective to extend the period because it was not executed or agreed to by the Commissioner before the expiration of the limitation period. This is the narrow issue to be decided. There is no substantial dispute as to the facts but only as to their legal effect.

Revenue Act of 1928 contains the following provision:

Sec. 276. Same—Exception's.
*******
(b) Waivers.—Where before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.
*******

It is not disputed that the taxpayer consented before the expiration of the limitation period and it is clear that the waiver was signed by Carter before that time. The petitioner says, however, that Carter’s signature of the Commissioner’s name was not the required “consent in writing” of the Commissioner. He says Carter was not authorized to sign, and that, if authorized to sign, the signature is still not the whole act of consent; that, under the required Or customary practice in the Bureau, there was no consent until the letter notifying him of acceptance was properly approved, which was not until after the period had expired. '

The argument must be rejected. Carter was authorized. Although the written authorization under which he acted was given before Helvering became Commissioner in 1933, there is no reason why Helvering could not adopt it. There is nothing in the evidence to show that he repudiated it, but on the contrary there is enough to show that Carter had been acting under the authorization for a year after Helvering became Commissioner.

Since we are dealing in attenuated technicalities, in which the petitioner seeks to identify the letter of notification with the consent, the answer is that there is nothing in this record to support the view that Carter’s authority to consent was subject to any condition, or more particularly to a condition precedent of someone else’s approval of the notification. There is more reason to treat the initialing by Carter’s subordinates as his own self-imposed condition subsequent than as Helvering’s condition precedent. The consent was not dependent upon notice of acceptance under the 1928 Act any more than was the consent under the earlier acts. Greylock Mills v. Commissioner, 31 Fed. (2d) 655; certiorari denied, 280 U. S. 566.

We hold that before the expiration of the limitation period there was a consent in writing by both the taxpayer and the Commissioner to assessment before June 30, 1935.

The petitioner urges further that the consent is by its terms limited to taxes “due under” the return; that this is not broad enough to include all tax which the statute imposes, but only includes such taxes as result from disallowance of deductions; that it excludes a deficiency resulting from adding to gross income an item discovered by the Commissioner to have been omitted from the return. The waiver in evidence is not a specially drafted document for this taxpayer, but is on the blank form widely and ordinarily used, and must be construed as a general administrative form. It is fantastic to believe that the Government intended so to limit the consent or that the taxpayer so understood it when he executed it. But more than that, the language does not warrant such a construction. The tax “due under the return” does not mean the tax “shown on the return” or “resulting from the items shown on the return.” It more reasonably means due under a correct return—due under the return contemplated by the statute. Here the Commissioner found that the taxpayer had omitted from his gross income a large amount said to have been derived from a partnership of which he was a member, and the petitioner now practically admits that there was such an omission. He now says that when he consented to extend the period of assessment he limited his consent to all but the most important item of the deficiency. In this he should not succeed unless the language used permits no other construction. Since the language is not so clear, the petitioner’s contention fails.

The deficiency which results from a proper recomputation on the merits is not barred by any statute of limitations.

Judgment will be entered under Rule 50.

       See “Is Form 872 a Complete Waiver of the Limitation Period”, by Emily Marx, The Tax Magazine, November 1936.


author: Morris:

text:
    E. Pennington Pearson, as Executor of the Last Will and Testament of Henry S. Ayer, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edward Pennington Pearson, Individually, and as Trustee under Deed of Trust Made by Henry S. Ayer, Dated September 25, 1928, Petitioner, v. Commissioner of Internal Revenue, Respondent. City Bank Farmers Trust Company and Edward Pennington Pearson, as Trustees under Deed of Trust Made by Henry S. Ayer, Dated May 17, 1926, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 78778, 79152, 79153.
    Promulgated June 4, 1937.

      Russell L. Bradford, Esq., George E. Graven, Esq., George S. Mittendorf, Esq., and Carl Taylor, Esq., for the petitioners.

      Frank T. Homer, Esq., and R. F. Staubly, Esq., for the respondent.
   OPINION.

Morris:

In order to correctly include the corpora of these trusts in the decedent’s gross estate under section 302 of the Revenue Act of 1926—it having been held that section 803 (a) of the Revenue Act of 1932 is not retroactive, Flora M. Bonney et al., Executrices, 29 B. T. A. 45; aff'd., 75 Fed. (2d) 1008—it must be found (1) that the transfers were made in contemplation of death or (2) that they were intended to take effect in possession or enjoyment at or after death. The pertinent provisions of the 1926 Act are as follows:

Sm 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, tangible or intangible, wherever situated—
(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

Section 302 (c) was amended, as follows, by a joint resolution of Congress of March 8, 1931:

(c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, including a transfer under which the transferor has retained for his life or any period not ending before his death (1) the possession or enjoyment of, or the income from, the property or (2) the right to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money’s worth.

Subsequently the Revenue Act of 1932 again amended section 302 (c) by section 803. The provisions thereof are substantially the same as the joint resolution just quoted.

Whether a gift is in contemplation of death, that is whether the inter vivos transfer of property, in trust, is motivated by contemplation of death, is not to be determined solely from the decedent’s age or his physical condition, particularly where the actual motive for the transfer is otherwise evidenced. See Real Estate Land & Title & Trust Co. v. McCaughn, 79 Fed. (2d) 602. Where a different motive is clearly shown, i. e., a motive associated with life, these factors become unimportant. That is our case. This decedent cared little or nothing for the exercise of ownership or dominion over great wealth. He demonstrated this by his action, as reflected in the several trust agreements entered into after his father’s death, in 1880 and 1883. He was content to receive only sufficient income from the wealth at his disposal to maintain him in a relatively modest fashion, under the circumstances. So little of that income did he use—$12,000 annually, in the beginning, and upward of $90,000 during the years under consideration—that the trust grew by several millions of dollars, solely by reason of accumulations from the excess and unused income. Having no profession and, indeed, not having been engaged in business at all since the death. of his father, and in fact being almost without interest in business affairs, he began early to relieve himself of all responsibility and burden incident to the ownership of his wealth by trusteeing his properties and reserving the income to himself for maintenance. For instance, in the trust which he created as early as July 30, 1883, he said: “I * * * am desirous of freeing myself from the care and management of my property and prefer instead thereof and of the income derived therefrom a fixed income adequate to my wants * * In his trust of May 17, 1926, he expressed the wish “* * * to be relieved from the care and anxiety of holding, managing and investing his property and collecting and disbursing the income therefrom * * and, finally, in his trust of September 25, 1928, he expressed the same wish and desire which had been Ms from the acquisition of his father’s estate. This appears to have been the sole motive for the creation of these two trusts. We find nothing in the history of the decedent’s physical condition nor in the other facts of record which would alter this conclusion in the slightest degree. See United States v. Wells, 283 U. S. 102. Becker v. St. Louis Union Trust Co., 296 U. S. 48.

The nest contention of the respondent in support of including the corpora of these two trusts in the decedent’s gross estate is that the trusts were intended to take effect in possession or enjoyment at or after death. Both trusts were created prior to any act or amendment taxing such trusts as those here involved. The tax is one imposed on transfers at death or made in contemplation of death and is measured by the value at death of the interest which is transferred. Reinecke v. Northern Trust Co., 278 U. S. 339; Helvering v. St. Louis Union Trust Co., 296 U. S. 39. But here no interest in the property held under the trust deeds passed from the decedent to the living. The trust property had passed completely from the control or possession of the decedent and, as to the 1926 trust, the enjoyment of the income had passed irrevocably from him. The transfers having been completed during the decedent’s lifetime, and prior to the amendment of section 302 (c), except those hereinafter discussed, the tax does not attach to’ the value of the corpora as transfers intended to take effect in possession or enjoyment at or after death. May v. Heiner, 281 U. S. 238. Nor does the fact that the income from the 1928 trust was payable to the settlor during his life make the value of the corpus of that trust taxable. May v. Heiner, supra.

One further contention of the petitioner remains to be considered. Eight hundred and twenty-eight thousand dollars was transferred to the 1928 trust after March 3, 1931, the date of the joint resolution of Congress amending section 302 (c) of the Revenue Act of 1926. With respect thereto, the petitioner contends that that amount is not subject to the tax in that the taxation of irrevocable transfers not made in contemplation of death is in violation of the due process of law clause of the Fifth Amendment. That the said amount came within the provisions of the joint resolution is not questioned. Nor can it be successfully argued as to the additions, made after the passage of the joint resolution, that the decedent was not upon notice of the law’s command, and there can be no claim that the statute is retroactive in its application to those transfers. Helvering v. City Bank Farmers Trust Co., 296 U. S. 85. In that case a similar contention was made under section 302 (d) of the Revenue Act of 1926. The Court, in holding the provisions constitutional, used the following language:

Congress may adopt a measure reasonably calculated to prevent avoidance of a tax. The test of validity in respect of due process of law is whether the means adopted is appropriate to the end. A legislative declaration that a status of the taxpayer’s creation shall, in the application of the tax, he deemed the equivalent of another status falling- normally within the scope of the taxing power, if reasonably requisite to prevent evasion, does not take property without due process.

The reasoning of the Court is equally applicable to the instant question. The respondent is, therefore, sustained in his determination as to this item.

Reviewed by the Board.

Judgment will he entered wider Rule 50.


author: Sternhagen :

text:
    Wallace Groves, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77324.
    Promulgated June 4, 1937.

      Hugh Satterlee, Esq., Albert S. Lisenby, Esq., and Philip Zimet, Esq., for the petitioner.

      John E. Marshall, Esq., and Alien T. Aikin, Esq., for the respondent.

       It was stated by petitioner’s counsel at the bar that petitioner or his brother was the principal holder of the common shares of the First Industrial Holding Corporation, and this has not been disputed, although there is no evidence of the exact ownership.

   OPINION.

Sternhagen :

1. The Commissioner added $713,000 to the petitioner’s income as “value of stock distribution”, and explained this determination as follows:

1. Information on file in this office indicates that in 1930 yon received from the Wagegro Corporation and/or the Firinbank Corporation 23,000 shares of Class A common stock of the Merchants and Manufacturers Securities Company without cost to you. It is held that the fair market value of this stock at the date of receipt was $31.00 per share, and your net income has accordingly been increased by $713,000.00, representing the fair market value of 23,000 shares of stock received.

This determination the petitioner assails, alleging that he did not receive the said shares and that their value was no more than $25 each, or $575,000. The value of the shares has been found from the only evidence to have been $575,000; and this the respondent no longer disputes, but expressly accepts. At the trial, respondent filed an amended answer adding an affirmative allegation:

* * * (in the alternative to his determination as set forth in the notice of deficiency) that the 23,000 shares * * * were subject to petitioner’s unfettered command on or about August 15, 1930 and he was then free to enjoy them at his own option, * * * .

Petitioner denies this in his reply.

The evidence seems to set forth all that occurred, and there is no substantial dispute' as to the facts. The argument turns upon whether Groves must in the circumstances be regarded as realizing income of $575,000 in 1930 upon which he may lawfully be taxed. If so, it is of minor consequence whether he be said to have received the shares, or to have been free to enjoy them, or to have had unfettered command over them. Nor is it determinative that substance is more important than form or that corporate entities may not be disregarded or confused with their shareholders.

The matter which is difficult to treat as having jural significance is not the legal existence of any of the corporations, but the Firin-bank-Groves employment contract and its assignments. When Groves, in June, made his agreement with the Securities Co. he was not under a contract of employment with. Firinbank, and was individually free to contract at once with the Securities Co. to serve that corporation. By the June agreement, Article IV * * * 3, he bound himself to do this either by a direct employment contract or by procuring the assignment of an employment contract made with another corporation. Being so bound, he was then in no position to make a bona fide contract at arm’s length to serve another corporation. Such a bona fide contract could only be made subject to a duty of the employer corporation to assign it, and this would have been an anomaly, for the corporation would have purported to gain the right to Groves’ services and at the same time agree to assign the right. It is impossible to imagine such a contract being knowingly made by an independent corporation.

But Groves did not make a contract at arm’s length. The contract which he purports to have made is with a corporation (Firinbank) , of which he owned all shares and was president and which he completely controlled. While the existence of this corporation as a legal entity may not be ignored, the ownership by one person of all its shares and his resulting control is a circumstance affecting the reality or intendment of a contract between the two. Their relation makes it necessary that the contract be subjected to the most careful scrutiny. Groves’ knowledge of the existing commitment to the Securities Co. must be imputed as well to the corporation, for his was the only mind it had; and it is too much to require the Government to treat the employment contract as a real and substantial creation of new rights and obligations merely because it was stated in writing and contained no provision for the specifically contemplated assignment to the Securities Co. If Groves had insisted upon the Securities Co. making an employment contract directly with him, his right to it and to the 28,000 shares or their value was clear. He chose instead to make a contract with Firinbank and to have Firinbank make a contract with him, well knowing that both the contracting parties were aware of the Securities contract and indeed the whole plan. In this employment contract it is impossible to find substance, irrespective of the legal existence of the Firinbank Corporation. Cf. Gregory v. Helvering, 293 U. S. 465; Chisholm v. Commissioner, 79 Fed. (2d) 14; certiorari denied, 296 U. S. 641.

The assignment of the employment contract to the Wagegro Corporation is in no better case. Greene was the shareholder and Groves held the proxy. Both knew of the Securities Co. contract, and Wagegro must, through either or both of them, have known of it when it took the assignment and turned it over to the Securities Co. for the 23,000 shares. Groves was at that time free to contract to serve the Securities Co., and receive the 23,000 shares, or have them go to such corporation as he might designate. Their going to the Wagegro Corporation must be regarded as one of those anticipatory arrangements, whereby the fruit is attributed to a different tree from that on which it grew. Lucas v. Earl, 281 U. S. 111. Therefore it was proper, despite the issuance of the shares to Wagegro, to tax Groves as if he had received them. Old Colony Trust Co. v. Commissioner, 279 U. S. 716; Corliss v. Bowers, 281 U. S. 376; see Helvering v. Gordon, 87 Fed. (2d) 663.

There is no occasion to discuss the part of the plan by which the 54,000 shares in First Industrial Bankers reached the Securities Co., and were paid for, for all the Commissioner seeks is that the $575,000 value of the 23,000 shares shall be taxed to Groves, and in this he is sustained. It might be that, looking at the entire transaction from the time of Greene’s first conversation with Groves, the $575,000 should be attributed to Groves upon still other theories. But it seems sufficient, after studying the events in their entirety, to consider petitioner’s case at the point where it is most vulnerable. For the reason stated, the Commissioner’s determination is sustained.

2. The Commissioner disallowed a deduction of $7,000 interest, saying:

2. The deduction of $7,000.00, representing interest paid to the Wagegro Corporation, does not appear to be a proper deduction from income and has therefore been disallowed.

The evidence is all one way to support the finding that petitioner paid the amount to Wagegro as interest on an existing indebtedness, which has since been discharged. The Commissioner’s determination must be reversed.

3. In the amended answer, the respondent sets up as new matter that in consideration of petitioner’s entering into a contract of employment with the Firinbank Corporation he received 5,000 shares of that corporation having a fair market value of $510,000. This the petitioner denies. The issue, is not pressed in argument. As appears from the findings, the 5,000 shares were not the consideration in the employment contract, but were issued for the options and $5,000 cash. There is, therefore, no ground for respondent’s contention, and it must fail.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: Murdock:

text:
    Lucien H. Tyng, Petitioner, v. Commissioner of Internal Revenue, Respondent. William Buchsbaum, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 74885, 74886.
    Promulgated June 8, 1937.

      Wayne Johnson, Esq., for the petitioner in Docket No. 74885.

      J. Robert Sherrod, Esq., and C. Edward Paxson, Esq., for the petitioner in Docket No. 74886.

      J. Arthur Adams, Esq., and Frank A. Surine, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined deficiencies in income taxes as follows:

The parties have agreed upon the proper adjustment of a number of their original differences. The first issue for decision is common to both proceedings. It is whether a transaction, whereby the Associated Gas & Electric Co. acquired the stock of two other corporations for cash and certain of its debentures, constituted a statutory reorganization so that the gain realized by the petitioners from the disposition of their stock was taxable only to the extent of the cash received. The second issue, likewise common to both proceedings, is whether all of the shares of stock disposed of by the petitioner were capital assets within the meaning of the capital net gain provision of the statute. The Commissioner contends that only part of the shares were capital assets. The third issue relates only to Tyng. It involves attorney’s fees paid by Tyng in connection with the disposition of his stock. Tyng contends in his brief that the amount-paid should be deducted as an ordinary and necessary business expense. The Commissioner contends that it should be apportioned between the shares which are admittedly capital assets and those which may be held not to be capital assets and deducted from the proceeds allocable to each class of shares in computing the capital gain and the ordinary gain. The fourth issue is whether Buchsbaum is entitled to deduct from his income for 1929, 1930, and 1931 certain losses sustained in the operation of a farm. The parties have stipulated or agreed upon all of the facts of record relating to issues 1, 2, and 3. A detailed statement of those facts would serve no useful purpose here. Instead, a summary will suffice.

First Issue.

The petitioners, Tyng and Buchsbaum, were among the business associates of William S. Barstow. The group specialized, among other things, in managing and financing public utilities. The members of this group, their employees, and one other person in 1929 owned all of the outstanding stock of the Barstow Securities Corporation (hereinafter called Securities of Delaware). Securities of Delaware in the early part of 1929 owned 94,005 shares of the common stock of W. S. Barstow & Co. (hereinafter referred to as Barstow of Delaware). Buchsbaum owned 1,800 shares of the same kind of stock and others owned the remaining 9,960 shares of common. There were also 8,981 shares of preferred outstanding. Barstow of Delaware owned about 55½ percent of the voting stock of General Gas & Electric Corporation. ' The Associated Gas & Electric Co. (hereinafter called Associated), was seeking control of the General Gas & Electric Corporation and offered to pay $50,000,000 in cash for all of the common stock of Securities of Delaware and Barstow of Delaware. Barstow and the petitioners refused to accept the offer unless part of the consideration would be paid in securities of Associated. One of their purposes in requiring that part of the consideration be paid in securities of Associated was to avoid income taxes. Associated, in order to frustrate attempts being made by other interests to acquire control of the General Gas & Electric Corporation, insisted that Barstow and his associates sign a contract at once which would bind them to the bargain but, at the same time, would permit the parties to work out the details of the form of the consideration. Barstow and the other stockholders of Securities of Delaware and of Barstow of Delaware on February. 5, 1929, signed a contract for the sale of their stock to Associated for $50,000,000 in cash. They signed that contract only after an oral agreement that it would be modified by one providing for payment of a part of the consideration in securities of Associated as soon as the parties could agree upon the classes and amounts of securities. Associated deposited an initial cash payment of $10,000,000. The parties entered into another contract on February 11, 1929, pursuant to the oral agreement of February 5, 1929. The- later agreement provided that the selling stockholders should accept certain issues of debentures, or evidences of indebtedness, of Associated as a part of the consideration for their stock. A final settlement was made on April 12, 1929. The stockholders had the right at that time to make further designations of specified debentures of Associated which they would take in exchange for their stock and to elect to take a part of the consideration in such securities and a part in cash, or all in cash. Associated actually paid $34,699,528.54 in cash and issued certain of its obligations as the balance of the consideration for all of the stock of Securities of Delaware, and the 11,760 shares of the common stock of Barstow of Delaware owned by Buchsbaum and others. The obligations so issued were as follows:

Some of the stockholders took all cash, some no cash, but most took a combination of cash and debentures.

The amounts received by Tyng and Buchsbaum, exclusive of their shares of the interest on the initial deposit of $10,000,000 made February 5,1929, were as follows-:

The contract of February 11, 1929, further provided for the acquisition by Associated of all of the preferred stock of Barstow of Delaware, and Associated actually acquired most of those shares for about $980,000 par value of its debentures and a small amount of cash.

Barstow and Buchsbaum were elected directors of Associated in 1929. Barstow resigned in November 1929, and Buchsbaum in January 1933. Buchsbaum also served as vice president of Associated from April 19, 1932, to January 16, 1933. None of the other associates of Barstow who were stockholders of Securities of Delaware or of Barstow of Delaware ever became a director or officer of Associated.

Thus it appears that Tyng surrendered his shares in Securities of Delaware for cash and evidences of indebtedness of Associated, and Buchsbaum surrendered his shares in Securities of Delaware and also his shares in Barstow of Delaware for cash and evidences of indebtedness of Associated. There is no dispute as to each taxpayer’s basis for gain or loss, nor is there any dispute as to the amount of gain realized by each. The Commissioner contends that the entire gain is recognized, but the petitioners claim that they exchanged their stock pursuant to a plan of reorganization, received for it cash and securities of a corporation a party to the reorganization, and, therefore, their gain is recognized only to the extent of the cash received. See sections 112 (b) (3) and 112 (c) (1) of the Revenue Act of 1928. Although there was not a merger or consolidation by operation of law, the transaction comes precisely within the language contained in parenthesis in section 112 (i) (1) (A) of the Revenue Act of 1928. Associated acquired all of the voting stock and a majority of the total number of shares of all other classes of stock of the two Delaware corporations. Nevertheless, it is necessary to examine the transaction more closely before holding that it is a reorganization. Gregory v. Helvering, 293 U. S. 465; Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462.

The transaction was obviously a bona fide business deal in which Associated, for business purposes, was acquiring a controlling interest in a large public utility, the General Gas & Electric Corporation. Neither the transaction nor the use of the debentures was in any sense a sham. The stipulated facts do not show whether Securities of Delaware and Barstow of Delaware were dissolved, but the implication is that Associated continued those corporations and through them controlled the stock of the General Gas & Electric Corporation. Previously, Barstow and his associates, through their control of the General Gas & Electric Corporation, had taken quite an active part in the management and affairs of that corporation. The Commissioner, although conceding that the transaction falls within the words of section 112 (i) (1) (A), contends that the transaction was in fact a sale for cash or its equivalent and did not result in the retention by the selling stockholders of a definite substantial and continuing interest in the property transferred.

Associated was apparently willing and desirous of making a purchase of the stock for cash. A consideration of $50,000,000 was agreed upon in the original contract of February 5, 1929. But the sellers never agreed to accept that amount in cash and both parties understood at all times material hereto that a substantial portion of the total consideration was to be paid in securities of Associated. The agreement as finally carried out is controlling, regardless of who insisted that it be that way. It is immaterial that the sellers were motivated by tax considerations in demanding that a part of the purchase price be paid in securities of Associated. Not all of the sellers made this demand and some of them received their entire consideration in cash. But the petitioners before the Board were among the majority in number and interest who demanded and received a substantial part of the consideration for their shares in securities of Associated. If, under the statute, a part of their profit is not recognized, it seems immaterial that the entire profit of other sellers was recognized. Cf. Miller v. Commissioner, 84 Fed. (2d) 415, reversing 29 B. T. A. 1061.

In deciding whether or not there was a plan of reorganization, we must look at the whole agreement of the parties as made and performed. Watts v. Commissioner, 75 Fed. (2d) 981; aff'd., 296 U. S. 387. That shows that Associated was a party to the agreement; Associated acquired under that agreement the stock of Securities of Delaware and of Barstow of Delaware in exchange for cash and securities of Associated; the two Delaware corporations were both parties to the reorganization under section 112 (i) (2); the petitioners surrendered their stock for securities of Associated in pursuance of the single plan whereby Associated was to acquire that stock; consequently, if there was a reorganization, the petitioners exchanged stock in a corporation a party to a reorganization in pursuance of the plan of reorganization for securities in another corporation a party to the reorganization. See section 112 (b) (3). Since the exchange was not only for such securities but also for money, the gain to the recipient is recognized in an amount not in excess of the sum of money received. Section 112 (c) (1). It was an essential part of the plan that the securities of Associated should be used in the exchange.

In the-foregoing discussion we have assumed that the evidence of indebtedness'of Associated received by the petitioners was “securities.” The Commissioner contends, however, that the obligations of the purchaser received by the sellers were not “securities” which gave the sellers a definite, material, and substantial interest in the property transferred. It can not be said that the securities actually received were not substantial in amount, and the real question is whether the sellers who received these debentures received securities within the meaning of section 112 (b) (3) and thereby retained a definite, material, and continuing interest in the property transferred. The debentures and obligations of the purchaser received by these sellers were not short term purchase money notes. Cf. Pinellas Ice & Cold Storage Co. v. Commissioner, supra. It is also interesting to note that some of the securities in the present case were convertible into stock. Cases decided prior to December 16,1935, on the question of what evidences of indebtedness of a purchaser constitute securities and give the required continuity of- interest must now be considered in light of the decisions of the Supreme Court in Helvering v. Minnesota Tea Co., 296 U. S. 378; Nelson Co. v. Helvering, 296 U. S. 374; and Helvering v. Watts, 296 U. S. 387. Following those cases, particularly the Watts case, the Board has held in a situation quite like the one here present that bonds of the purchaser received by the sellers are not like cash or short term notes, but are securities, and give a sufficient continuity of interest. Kaspare Cohn Co., Ltd., 35 B. T. A. 646. Following that decision we now hold that there was a sufficient continuity here. Cf. Commissioner v. Kitselman, 89 Fed. (2d) 458, reversing 33 B. T. A. 494 (a report promulgated by the Board before the Supreme Court decided the Minnesota Tea, Nelson, and Walts cases). All of the requirements of the statute have been met. It follows that the gain realized by these petitioners is recognized only to the extent of the cash received.

Second Issue.

Tyng exchanged 21,665 shares of stock of Securities of Delaware and Buchsbaum exchanged 7,540 shares of the stock of Securities of Delaware and 1,800 shares of the common stock of Barstow of Delaware in the transaction discussed in the first issue. The Commissioner determined and still agrees that 15,000 of the shares of Securities of Delaware exchanged by Tyng and the 1,800 shares of Barstow of Delaware exchanged by Buchsbaum were capital assets. But he resists the claim of the petitioners that the remaining 6,665 shares exchanged by Tyng and the 7,540 shares exchanged by Buchsbaum were capital assets within the meaning of section 101 (c) (8) of the Revenue Act of 1928. He points out that Securities of Delaware was organized in December 1927, the petitioners acquired the 6,665 and the 7,540 shares from Barstow for cash under contracts entered into in December 1927, and from December 1927 to the time of the disposition in February 1929 was less than two years. The petitioners contend, however, that to that period there should be added prior periods during which they held property later exchanged for the shares of Securities of Delaware. They say that they acquired property as of October 9, 1925, either in the form of stock of W. S. Barstow & Co. (hereinafter called Barstow of New York), contract-rights to such stock, or an interest in a syndicate. Section 101 (c) (8) (A) provides:

In determining the period for which the taxpayer has held property received on an exchange there shall be included the period for which he held the property exchanged, if under the provisions of section 113, the property received has, for the purpose of determining gain, or loss from a sale or exchange, the same basis in whole or in part in his hands as the property exchanged.

Barstow of New York owned 99,685 voting shares of General Gas & Electric Co. in October 1925. Barstow, who owned more than one-half of the common stock of Barstow of New York, wished to prevent his stock in Barstow of New York, in case of his death, from falling into the hands of persons who might dispense with the services of his five close business associates (including Tyng and Buchsbaum). He therefore organized Barstow Securities Corporation (hereinafter called Securities of New York) and transferred to it the stock of Barstow of New York in exchange for all of the common stock of Securities of New York, 14,400 shares. He then placed the 14,400 shares of Securities of New York in the possession of a depositary, with a reservation that the stock should remain in his name and ha should have voting rights and the right to receive all dividends on the stock. He entered into a contract on October 9, 1925, to sell some of these shares to his five associates, called therein the “syndicate.” The contract was re-executed in modified form in January . 1926, but again was dated October 9, 1925. Barstow agreed, in that contract, to sell 7,850 of the 14,400 shares to his five associates for $600,000, payable in semiannual installments of $40,000 each. The associates agreed upon how many shares each would purchase. Tyng and Buchsbaum were each to get 1,470 shares. The depositary was authorized to deliver to the purchasers 7,190 shares on August 1, 1938 (six months after the last installment was to be paid), and to deliver the remaining 160 shares then or later, as Barstow should direct, or, if he died after August 1, 1933, without having directed, then the shares were to be delivered at the date of his death. In case Barstow died before August 1, 1933, the associates could obtain immediate delivery of the 7,350 shares upon payment of $735,000 less payments theretofore made. The associates were also given an option to purchase the remaining 7,050 shares upon Barstow’s death. The purchasers paid four installments aggregating $160,000. The fourth installment was paid on August 1, 1927.

Barstow of Delaware was organized in June 1927, and during that year acquired all of the stock of Barstow of New York, partly for cash and partly in exchange for its own stock. Barstow and his associates organized Securities of Delaware on December 8, 1927. That corporation issued 79,005 shares of its common stock to Barstow on December 13, 1927, for the 14,400 shares of Securities of New York. The 14,400 shares of Securities of New York were released by the depositary with the consent of the associates so that they could be exchanged for the 79,005 shares of Barstow of Delaware. Securities of Delaware at the same time issued 15,000 shares to Tyng in exchange for shares of Barstow of Delaware. Securities of Delaware issued no other stock at that time. Securities of New York was then dissolved and its assets, consisting of 79,005 shares of the common stock of Barstow of Delaware, were distributed to its sole stockholder, Securities of Delaware. Barstow and his associates, on December 13, 1927, and “as of December 1, 1927”, terminated the contract of October 9, 1925. Barstow then entered into separate contracts with each of his five associates, seven employees of Barstow of Delaware, and one other person in which he sold to them a total of 41,326 of the 79,005 shares of common stock of Securities of Delaware which had been issued to him on December 13, 1927. Tyng purchased 6,665 shares and Buchsbaum 7,540.shares. New certificates for the number of shares purchased were issued in the name of each purchaser. The $160,000 paid under the contract of October 9, 1925, was applied in payment of the purchase prices fixed in the new contracts. The balance due under each of the contracts was payable in eleven semiannual installments. The purchase price, applied payments, balance due and semiannual installments, under the contracts of Tyng and Buchsbaum, were as follows:

Tyng and Buchsbaum made the final payments of the balances of the purchase prices on March 15, 1929. They exchanged the 6,665 and the 7,540 shares thus acquired, together with other shares which they owned, in the transaction with Associated, in 1929.

The following argument is essential to the petitioner’s case: The transaction whereby Securities of Delaware issued 79,005 shares of its stock in exchange for the entire capital stock of Securities of New York was a reorganization within the definition of section 112 (i) (1); the 14,400 shares of Securities of New York were exchanged for 79,000 shares of Securities of Delaware pursuant to a reorganization; under section 112 (b) (3) no gain or loss is to be recognized from that exchange, and under section 113 (a) (6), the basis for the 79,005 shares is the same as the basis for the 14,400 shares exchanged; the petitioners owned or had an interest in the 14,400 shares and because of that interest they had a basis for gain or loss on the 14,400 shares; they acquired an interest in the 79,005 shares by reason of the exchange and their old basis carried over and became the basis for gain or loss of their interest in the 79,005 shares; consequently, section 101 (c) (8) (A) applies and there should be added to the period during which they actually held the shares of Security of Delaware the prior period from October 9, 1925, when they first acquired their interest in the 14,400 shares of Securities of New York.

One fatal defect in this argument is that the facts do not support it. The outstanding stock of Securities of New York, 14,400 shares, was owned by Barstow immediately prior to the exchange whereby they were acquired by Securities of Delaware. Barstow exchanged them for 79,005 shares of the stock of Securities of Delaware. If any basis remained the same after that exchange, it was his basis. But he is not a petitioner and the question need not be decided. The contract of October 9, 1925, between Barstow and his five associates, including the petitioners, was a contract to sell rather than a contract of sale. The intention of the parties as shown by their agreement was that title was not to pass until after certain events had occurred. The stock, with voting rights and the right to dividends, was to belong to Barstow until the $600,000 had been paid. Barstow wanted to protect his associates. As long as the stock was his, they were assured of continued employment; if he died before August 1, 1933, they could protect themselves by paying the balance due and securing control of a majority of the 14,400 shares. The conditions of time and payment of the purchase price, which were conditions precedent to the passing of title, were never fulfilled. Title to the 14,400 shares, the subject matter of that contract, never passed from Bar-stow to the prospective purchasers. Cf. Charles W. Dahlinger, 20 B. T. A. 176; aff'd., 51 Fed. (2d) 662; certiorari denied, 284 U. S. 673; Theodore J. Swift, 20 B. T. A. 1099; aff'd., 54 Fed. (2d) 746. Before the time for passing of title, the entire contract was terminated by mutual consent. Barstow was permitted to exchange the shares for other shares. After that exchange, he entered into new contracts with the petitioners and others whereby he sold, to the petitioners and the others, stock of Securities of Delaware for cash. The new group included a number of persons who had no interest whatsoever in the contract to purchase the 14,400 shares. The terms of, and the interests acquired under, the new contracts were wholly different from those contracted for under the old contract. The $160,000 paid under the former contract was merely credited as partial payment under the new contracts. Thus the exchange of the 14,400 shares of Securities of New York for 79,005 shares of Securities of Delaware was not an exchange by the petitioners, cf. Helvering v. San Joaquin Fruit Co., 297 U. S. 496, and, as to them, effected no carry-over of basis from property transferred to property received. Consequently, it gave them no additional period of ownership applicable to the shares of Securities of New York. Cf. McFeely v. Commissioner, 296 U. S. 102.

These petitioners purchased shares of Securities of Delaware from Barstow in 1927 for cash. Their bases for gain or loss on those shares was the amount of cash which they paid for them. Certainly they did not exchange stock or securities in a corporation a party to a reorganization in pursuance of the plan of reorganization solely for stock or securities in another corporation a party to the reorganization within the meaning of section 112 (b) (3). The contract of October 9, 1925, gave them rights which were no doubt valuable. But those rights cost them nothing -and had no basis for gain or loss in case they disposed of them. Their consent to the exchange of the 14,400 shares of Securities of New York for the 79,005 shares of Securities of Delaware was necessary because they had an executory contract to purchase some of the shares of Securities of New York. Since they had no title to any of the shares of Securities of New York, and section 112 (b) (3) does not apply, the exchange of property would be material only if section 112 (b) (5) applies. Their rights under the contract of October 9, 1925, were, in a sense, property, yet that property was not transferred by them to a corporation solely in exchange for stock or securities of the corporation, and, furthermore, immediately after the transfer of December 13, 1927, the five associates of Barstow, parties to the agreement of October 9, 1925, were not in control of Securities of Delaware. Section 112 (b) (5) does not, apply. Thus the conditions under which sections 113 (a) (6) and 101 (c) (8) (A) become applicable do not exist in this case.

Furthermore, the contract to purchase the shares of Securities of New York in no other way justifies including in the period of the ownership of the shares of Securities of Delaware by these petitioners any period prior to the date upon which they purchased the shares of Securities of Delaware. If they had actually acquired some of the 14,400 shares of Securities of New York under the contract of October 9, 1925, their period of ownership of those shares would not have begun on October 9, 1925. On the contrary, their period of ownership of those shares would have begun only on the date or dates upon which they acquired title. They had paid only four-fifteenths of the purchase price and had not acquired title to any of the shares in December 1927. Consequently, their period of ownership had not then begun. The fact that Barstow, the owner of the shares, exchanged them in December 1927 for other shares which he thereafter sold to the petitioners, is certainly no reason for holding that the period of ownership of the shares subsequently acquired by the petitioners began prior to December 1927. The 6,665 and the 7,540 shares of Securities of Delaware disposed of by these petitioners in the exchange discussed under the first issue were not capital assets in the hands of these petitioners because they had not been held for more than two years and there are no prior periods to be added under any of the provisions of the statute.

Third Issue.

The assignment of error in the Tyng petition raising this issue is as follows:

The Commissioner has erroneously disallowed as a deduction from the cash received by the petitioner on the exchange of his 21,665 shares of the Barstow Securities Corp. (Del.) in 1929, the sum of $25,118.88, being the legal expenses, necessarily incurred and paid by the petitioner in connection with the said exchange.

The stipulated facts show that Tyng was not able to be present at all times during the negotiations with Associated which finally resulted in the disposition by him of 21,665 shares of Securities of Delaware. He employed an attorney who represented him while he was absent during a part of the negotiations. He paid the attorney $25,000 in 1929 for his services, but the amount was not allowed as a deduction or as an offset against “the income derived from this transaction.” The Commissioner, in determining the deficiency, treated 15,000 shares as capital assets, taxed the gain under the capital gain provisions, and taxed the gain on the disposition of the 6,665 shares as ordinary gain. He now concedes and contends that the $25,000 is deductible as a part of the cost of the 21,665 shares, and that 15,000/21665 should be deducted in computing the gain from the disposition of the 15,000 shares which were capital assets, and the remainder should be deducted in computing the gain from the disposition of the 6,665 shares which were not capital assets.

The petitioner contends in his brief that the $25,000 should be allowed as a deduction for ordinary and necessary expenses of his business. Not only do the facts fail to show that this was an ordinary and necessary expense of any business which he regularly carried on, but the assignment of error is hardly sufficient to raise such an issue. “Stipulations concerning facts and any other evidence properly are accommodated to issues adequately raised”, General Utilities & Operating Co. v. Helvering, 296 U. S. 200, 206, but issues not properly raised will not be decided. Commissions and other expenses incurred in selling or disposing of securities are generally treated as an offset in computing the gain from the sale or disposition. The $25,000 paid by Tyng to his attorney was paid in connection with the disposition of his shares. Such expenditures are properly an offset, either as a part of the cost or in reduction of the amount realized, in computing the gain from the disposition of the shares, rather than an ordinary and necessary expense of a business regularly carried on. Cf. Helvering v. Union Pacific Railroad Co., 293 U. S. 282; Marjorie Post Hutton, 12 B. T. A. 265; aff'd., 39 Fed. (2d) 459; Florence G. Baldwin, 23 B. T. A. 512; Mrs. E. A. Giffin, 19 B. T. A. 1243; Briarcliff Investment Co., 30 B. T. A. 1269; Pidgeon-Thomas Iron Co., 21 B. T. A. 642; Alice G. Kales, 34 B. T. A. 1046. The allocation between the capital assets and the shares which were not capital assets finds support in Florence G. Baldwin, 23 B. T. A. 512, 521. The treatment now urged by the Commissioner is the best suggested and will be followed.

Fourth Issue.

There was no stipulation in regard to this issue. The following facts are found from the testimony and other evidence presented at the hearing.

Buchsbaum, after disposing of his shares in the two Delaware corporations, ceased his business activity in connection with public utilities. He decided to breed, develop, and sell high grade saddle horses. For this purpose he purchased a farm in New Jersey in April 1929. The original tract consisted of 97 acres. By the end of 1930 he had purchased additional tracts containing 80 acres. The total cost of the farm was $68,502.53. There was a very old house on the property and a new cow barn. These buildings were worth about $17,000 in 1929. The petitioner began to make substantial improvements to the properties. He remodeled the house at a cost of $12,388.65 and transformed the cow barn into a horse stable at a cost of $28,201.35. He also made other substantial expenditures for improvements during the taxable years. He had had some experience in farming and with horses. The farm was in a good locality for breeding, training, and selling saddle horses. The market for saddle horses was good at that time. The petitioner spent most of his time at the farm during 1929 and practically all of his time thereafter. The only produce raised on the farm was that required for the use of the stables. He employed a farm superintendent and a number of other persons. The house was occupied by some of these employees. The following table shows the number of horses purchased, foaled, sold or disposed of, and the cost and amount realized from the sale or death of horses, including insurance.

Year Purchases Poaled Sold or died Cost Amount realized Gain or loss

1929-$1,289.28 $2,010.00 +$720.72

1930-5,668.00 4,279.13 -1,388.87

1931-6,997.20 3,206.50 -3,790.70

1932-1,030.50 50.00 -980.50

1933-1934-20,222.12 350.00 8,679.75 500.00 -11,542.37 +150.00

1935-11,395.90 11,650.00 +254.10

At the close of 1935 the petitioner owned 13 horses which had cost $33,130.30 and 6 horses which had been foaled at the farm. The cost of the petitioner’s fixed assets, including horses purchased, at the close of the year, as shown by his books was as follows:

The petitioner trained his horses, exhibited them at shows and advertised them. He instructed an accountant in his employ to open a set of books covering the operation of the farm. The accountant was engaged in other matters and did not actually open the books until 1930. Records were kept of all expenditures and income for the year 1929 and entries were made for 1929 when the books were opened. Thereafter, the books, were regularly kept. Expenses were paid through a separate bank account. The following table shows the income, expenses and losses of the farm for the years involved.

Losses for later years were as follows:

The income included horse show prizes, amounts received for boarding horses, profits from sales of horses, and interest on the farm bank account. The operating expenses and losses were principally horse show expenses, stable expenses, pay roll, advertising, repairs, insurance, taxes, board paid for horses, and losses on sales of horses. The petitioner in his income tax returns claimed deductions for losses for 1929, 1930, and 1931 as shown above. The Commissioner disallowed the losses.

The farm was about three or four miles from the petitioner’s home in Spring Lake, New Jersey. His son was in poor health and the petitioner decided in 1930 to build a home on the farm because he believed the location there would be better than Spring Lake for his son. He set aside 6 acres and completed a home thereon in 1931 at a cost of about $225,000.

The petitioner entered into the operation of the farm for profit and he operated the farm during the years 1929, 1930, and 1931 as a business with the intention of making a profit.

The Commissioner does not question the amount of the losses, but has determined that they are not deductible in computing the petitioner’s income because the petitioner did not enter into the transaction and did not operate the farm during these years as a business for profit. The Commissioner contends that the petitioner operated the farm as a hobby or pastime for his own pleasure or amusement, rather than for the purpose of making a profit. The case must turn upon the intention of the petitioner. There is some evidence to support the Commissioner’s determination. The petitioner was a rather wealthy man who had just retired from the business activity which had occupied most of his time, and it is possible that he operated the farm as a pastime and without the primary purpose of making a profit. The fact that there were losses during all of the years from 1929 to 1935, inclusive, is some evidence to indicate that the Commissioner was right. But the weight of the evidence is the other way. The farm was not used for social purposes nor was it a show place. It was operated in a business-like manner. The expenses were honest and legitimate expenses of conducting the farm upon a business-like basis. They were exclusive of any personal or living expenses of the petitioner. It appears that the depression was partly responsible for his failure to realize profits. Some of the losses came from the disposition of undesirable stock. He refused to sell some of his horses at a profit because he desired to retain and train those horses in his efforts to build up the reputation of his horses. This was all a part of his plan. He argues that he had to build up his business and the reputation of his farm for producing desirable horses before a failure to realize profits could be taken as a reasonably clear indication of failure. He testified that he entered into the transaction for profit, and during all of these years operated the farm with the hope and intention of realizing profit. A similar question has been dealt with in a number of cases. The deduction, when allowed, has been allowed on the basis of a finding that the transaction was entered into and carried on as a business with the expectation of a profit. Cf. George D. Widener, 8 B. T. A. 651; aff'd., 33 Fed. (2d) 833; Margaret E. Amory, 22 B. T. A. 1398; James Clark et al., Executors, 24 B. T. A. 1235; Marshall Field, 26 B. T. A. 116; aff'd., 67 Fed. (2d) 876. The showing made by this petitioner is at least as strong as that made by some of the petitioners in the foregoing cases. The Commissioner erred in disallowing these losses.

Reviewed by the Board.

Decision will be entered under Rule 50.

       SEC. 112. RECOGNITION OE GAIN OR LOSS.
      * * * * * * *
      (i) Definition of reorganisation.—As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation) * * *.

       Cost is of horses which were sold or which died, but does not include any amount for cost of horses foaled or selling costs.


author: Smith:

text:
    Carey-Reed Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83936.
    Promulgated June 8, 1937.

      Jesse I. Miller, Esq., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Smith:

The respondent determined a deficiency in petitioner’s income tax for 1933 in the amount of $1,394.75, a part of which resulted from adding to the income reported by the petitioner interest received on the bonds of municipalities which were payable, interest and principal, exclusively out of collections of special taxes levied against the benefited property. The petitioner contends that the amount is tax exempt as interest received on obligations of a political subdivision of a state.

The petitioner is a corporation, with its principal office at Lexington, Kentucky. It was organized in 1911 for the purpose of engaging in the business of street and road contracting. Prior to 1933 the petitioner contracted to make certain street, paving, and sewer improvements in the municipalities hereinafter mentioned and prior to 1933 received in part payment for said improvements, and owned during 1933, bonds of the following descriptions and in the following amounts, these bonds representing the balances of the total issues of such bonds:

During 1933' interest on the above described bonds was received by the petitioner in the amount of $10,143.64, none of which interest was reported by the petitioner as taxable income for 1933.

The cities of Marion, Princeton, Winchester, and Wilmore are political subdivisions of the Commonwealth of Kentucky, the first three being cities of the fourth class and the last named a city of the fifth class, as defined by the Kentucky statutes.

Street and paving improvement bonds of the cities of Marion and Winchester were issued pursuant to the provisions of sections 3563, 3574, 3575, and 3577 of the Kentucky statutes.

By section 3563 it is provided, so far as is here material, that the city council may by ordinance provide for improvements of streets and sidewalks, which improvements shall be made at the exclusive cost of the abutting property owners, such cost to be apportioned and assessed against the abutting real estate on a front foot basis and that:

* * * a tax shall be levied upon such lots or parcels for the payment of the cost assessed thereon, which tax shall be due and payable at the city treasurer's office upon the completion of the work and acceptance thereof by the board of council, unless otherwise provided in the ordinance ordering such improvement, and no property shall be exempt from such improvement tax. * * *

If the tax is not paid within 30 days after it has become due a 10 percent penalty is added and “There shall be a lien upon such lots or parcels of real estate” for the tax thus assessed.

Any assessment for street improvements which exceeds one-half of the value of the real estate is void as to any excess and the council “shall provide for the payment of any such excess out of the general fund.”

The city treasurer is required to keep a record of all assessments of local improvement taxes, showing the location and character of each and the names of the persons against whose property the assessments have been made. Upon-payment to the city treasurer of any such assessment he must make a proper entry on his records, whereupon the lien for such assessment stands released. All local taxes thus paid “shall, from time to time, be paid over to the contractor or other person entitled thereto, upon order of the board of council.

The treasurer must keep a separate account of the funds arising from each improvement and no special taxes for one improvement can be diverted to the payment of any other improvement, the taxes in each case constituting a separate special fund for the payment of the particular work or “for the security and payment of improvement bonds, if any are issued, as provided in section 3577 for such improvement.”

The board of council of any city of the fourth class “may provide by general ordinance that such city shall pay part, and if so, what part of the cost” of any such local improvements, such provision, however, not to be changed except at intervals of 10 years or more.

Section 3574 provides for hearings prior to the city’s acceptance of any improvement when completed and for the apportionment and assessment of the special tax and the creation of a lien to secure it. “Such liens may be enforced, as other liens on real estate, by action brought in the name of the city or the contractor entitled thereto.”

Section 3575 provides for the payment for special improvements on the 10-year plan. After the tax has been assessed the abutting property owners are given the option of paying the tax in cash within 30 days or in 10 annual installments with interest. Written acceptance of the 10-year plan must be filed within a specified time and, after it is filed, all defenses to the tax are thereafter precluded. If any installment is not promptly paid: :

* * * the tax bills for such special assessments may, in addition to the other remedies given in this act, be sold and collection thereof enforced in the manner provided by law for the collection of municipal taxes. * * *

If the fund accumulated for any particular improvement is more than sufficient to pay the principal and interest on the bonds which may be issued in anticipation of the collections the board of council may ratably reduce the property owner’s assessments.

* * * Should there be any deficit, the council may provide for payment of same out of the general fund. Failure on the part of the city to collect any such local tax or installment thereof, when due, shall create no liability against such city, but the person entitled to such tax, or the owner of any such bonds, shall have the right to proceed in any court of competent jurisdiction to foreclose the lien for such unpaid assessments, recovering interest and costs, and may have the proceeds of the property applied in settlement thereof.

Section 3577 provides:

* * * In order to provide a fund for the immediate payment of the cost of any improvement made on the installment payment plan as provided in section 3575, the council may issue and sell improvement bonds in anticipation of the collection of such part of the local taxes assessed and levied therefor as may not be paid within thirty days from the time of the assessment, pledging such taxes and the liens on the property for the payment of the principal and interest of such bonds, and apply the proceeds thereof exclusively to the payment for the particular improvement in anticipation of the' assessment for which the bonds are issued. * * * . [Italics ours.]

This section further provides:

* * * Said bonds and interest thereon shall be payable exclusively out of funds actually paid to and collected by the city on account of the improvement taxes in anticipation of which the bonds are issued, and except as provided in this section, the city shall in no event be liable on any such bond except to the extent of funds actually paid to it as above set out. * * * After the issue of such bonds no suit shall lie to enjoin or resist the collection of any assessment or tax in anticipation of which the bonds are issued, and the validity of the same shall not be questioned, but all property owners shall be conclusively estopped and precluded from in any manner assailing the effectiveness or validity thereof. Such bonds shall convey and transfer to the owners thereof all lien, right, title and interests in and to the assessments, taxes and liens upon the respective lots and parcels of ground, * * * which liens shall stand as security for such bonds and coupons until they are paid, with full power to enforce the collection thereof, if such bonds or coupons be not paid on presentation to the treasurer, by foreclosure in any court of competent jurisdiction as provided in section 3574. * * * [Italics ours.]

The sewer improvement bonds of the fourth class cities of Marion and Princeton involved herein were issued pursuant to section 3579 a-2 of the Kentucky statutes, which authorizes sewer improvements by cities of the fourth class and payment therefor by the same procedure and in the same manner as provided for street and paving improvements as above set out. The street improvement bonds of the city of Wilmore, a city of the fifth class under Kentucky statutes, were issued pursuant to sections 3643-1 to 3643-9, inclusive, of the Kentucky statutes. In substance they make the same provisions as to improvements and payments therefor as in the case of cities of the fourth class, with the two following exceptions:

(a) Section 3643-1 permits special improvements to be paid for entirely out of general funds and not out of special assessments “as the board of council may in each case determine”, whereas fourth class cities may pay for such improvements out of general funds only when all such improvements are to be paid for out of general funds. The city of Wilmore bonds involved herein are payable only out of special taxes.

(b) Section 3643-7 provides that when there is any default in payment of a bond issued by a fifth class city, the court action to enforce payment “shall be prosecuted in the name of the city.” The corresponding provision relating to fourth class cities (section 3577) provides inferentially that either the city or a bondholder may institute a suit to enforce payment, but that the proceeds of the suit “shall be paid into the city treasury to be applied to the redemption of matured bonds in the same manner as if the same had been paid without suit.”

The material provisions of all the bonds, whether issued by fourth or fifth class cities, are substantially identical. Each bond of a fourth class city provides that, on a date certain:

The City of_, a municipal corporation of the State of Kentucky promises to pay to the bearer the sum of $-in lawful money of the United States, with interest thereon from and after the date hereof at the rate of 6% per annum payable semi-annually on-on the presentation and surrender of the interest coupons hereto attached as they severally become due, the first payment of interest being due_ This bond is issued in anticipation of the collection of special taxes duly levied and assessed by ordinance of the City of-adopted by the City Council on_upon and against the several lots and parcels of real estate abutting on [here is a description of the location of the abutting property against which the assessment is made] as set out in an ordinance adopted by the City Council on_ordering certain improvements and an ordinance adopted by the City Council on_ approving certain improvements and assessing certain taxes in said city, for the payment of the cost of the construction of [here is stated the nature of the improvement] and the payment of the principal and interest hereof is secured by pledge of said special assessments and taxes and the liens therefor.
The principal and interest of this bond are payable at the office of the Treasurer of the City of-exclusively out of funds actually paid to and collected by the City on account of said special taxes. If any installment of the special taxes on account of which this bond is issued is not paid when due, the City agrees to file suit for the collection thereof and to use reasonable diligence in prosecuting said suit * * *.
This bond and the coupons hereto attached are issued pursuant to the provisions of Section - of Carroll’s Kentucky Statutes, 1980, edition and pursuant to the provisions of the ordinance of the City of-adopted by the City Council on-.
All proceedings for the issuance of this bond have been had in due form as required by law essential to the validity thereof and been duly complied with.

Each bond is signed by the mayor and city treasurer, the municipal seal is affixed thereto, and it is attested by the city clerk.

.The city of Wilmore (fifth class city) bonds are the same except that the paragraph relating to suits to enforce payment is omitted.

The ordinance of the board of council covering the sewer improvements at Marion, Kentucky, provided that the improvements should be made at the expense of abutting property owners; that bonds would be issued in order that assessment might be made on the 10-year installment plan in accordance with section 3577 of the Kentucky statutes; that bonds should be issued and sold in anticipation and collection of the special assessments and the interest and principal payable exclusively from such fund; that payment thereof was secured by pledge of the special assessments and liens against property abutting the improvements; and that in the event of nonpayment of any installment of the special assessments the city would prosecute with due diligence and suit for the collection thereof. The ordinance further provided:

5. * * * Such bonds shall not pledge the full faith and credit of the City of Marion, Ky., for the payment thereof, but shall pledge only the local taxes levied and assessed by this ordinance and the lien created by the same on the property described herein. * * *
6. A sum sufficient to pay the amounts hereinbefore assessed against the City of Marion as its part of the cost of the improvement is hereby appropriated and made payable out of the general fund of the City and the Mayor and City Clerk are hereby authorized and directed to draw warrants upon the City Treasurer in favor of Carey-Reed Co. or his assignees for said amounts against the City.

Section 22 of the Revenue Act of 1932 provides in subdivision (b) as follows:

(b) Exclusions From Gross Income.—The following items shall not be included in gross income and shall be exempt from taxation under this title:

(4) Tax-free interest.—Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; * * *

In the deficiency notice upon which this proceeding is based the respondent states, as his reason for including in the petitioner’s taxable income for 1933 $10,143.64 interest received on the special assessment bonds owned by the petitioner, that “the bonds and interest are not direct obligations of the various cities issuing them but are liens against the private property benefited by the improvements.”

Upon the basis of 30 Op. Atty. Gen. 252, the respondent until recently has uniformly held that interest upon bonds of political subdivisions of a state payable out of special assessment funds is exempt from tax. In 1920 he promulgated O. D. 447 and O. D. 491, Cumulative Bulletin No. 2, p. 93. In 1921 he promulgated O. D. 999, Cumulative Bulletin No. 5, p. 102; in 1923, I. T. 1606, Cumulative Bulletin II-l, p. 69; in 1924, I. T. 2074, Cumulative Bulletin III-2, p. 79; in August 1934, G. C. M. 13469, Cumulative Bulletin XIII-2, p. 125. In the last mentioned memorandum the respondent revoked O. D. 999 and I. T. 1606, relating to tax warrants and similar evidences of indebtedness. This memorandum did not overrule O. D. 447 and O. D. 491, the memorandum stating with regard to them that they involved “the taxability of the interest upon lands issued by a city as distinguished from tax bills and similar liabilities, [and] are not controlling in the instant case.” O. D. 447 and O. D. 491 were expressly revoked by G. C. M. 16861, Cumulative Bulletin XV-29, p. 11, on the grounds that the bonds there considered were not obligations of the city and the interest thereon accordingly was not exempt from income tax.

On February 4, 1937, the Attorney General, in 38 Op. Atty. Gen. 72, at the request of the Secretary of the Treasury, reconsidered his opinion delivered in 1914 (30 Op. Atty. Gen. 252) in which he had held that the interest on special assessment bonds was exempt from Federal tax.

After such reconsideration the Attorney General declined to modify the earlier opinion and stated:

I (Jo not feel, therefore, that the Attorney General’s former opinion should be disturbed * * * and I suggest that any change in policy should be made only in accordance with legislative direction or judicial decision.

The phrase “the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia” contained in section 22 (b) of the Revenue Act of 1932 was unquestionably designed to safeguard the borrowing power of the states and to prevent taxation which might impair its efficacy or burden the property or instrumentalities of the states. In Denman v. Slayton, 282 U. S. 514, where the deductibility from the gross income of a taxpayer of interest on indebtedness incurred to purchase tax exempt “obligations or securities” was discussed and held not allowable, the Supreme Court plainly had in mind securities to borrow money.

In American Viscose Corporation v. Commissioner (C. C. A., 3d Cir.), 56 Fed. (2d) 1033; certiorari denied, 287 17. S. 615, the United States had refunded in 1926 income taxes illegally collected for the years 1917 to 1919 and had added, pursuant to the statute, interest on the amount so collected. The taxpayer claimed that the interest was exempt from Federal income tax because it was “upon obligations of the United States.” The court held, however, that it was not exempt, saying:

* * * exemptions of Congress were evidently meant to aid in the flotation of government bonds and securities by making them tax free and, therefore, more attractive to investors. We see no reason why the construction of the statute should be so broadened as to cover a transaction which had no relation to the flotation of securities, but was one where the government had wrongfully collected money, and, in righting the wrong, had, pro tanto, compensated therefor by paying interest. * * *

In United States Trust Co. of New York v. Anderson, 65 Fed. (2d) 575, it was held that the statutory exemption from income tax of interest on “obligations” of a state or political subdivision thereof was not applicable to interest received pursuant to law on an award in a city’s condemnation proceeding.

In Kansas City Southern Railway Co., 16 B. T. A. 665, this Board held that interest paid by the United States to the Kansas City Southern Railway Co. upon deferred payments, due as compensation for leasing its railroad properties while operated by the Railroad Administration, was not exempt from taxation as interest on obligations of the United States and its possessions. The Board’s decision was affirmed by the Circuit Court of Appeals for the Eighth Circuit, Kansas City Southern Railway Co. v. Commissioner, 52 Fed. (2d) 372. To the same effect see Missouri Pacific Railway Co., 22 B. T. A. 267. Cf. Leo M. Klein, 26 B. T. A. 745.

The interest received by the petitioner upon its special assessment bonds was upon bonds issued by cities of the fourth and fifth class of the Commonwealth of Kentucky. For the payment of the bonds, assessments had been made against the benefited property. The property owners were required to pay the taxes assessed into the city treasury. They were required to do that even if Suit was brought against the property owners for the collection of the assessment either by the city or by the contractor or bondholder. The judgment made against the property owner had to be paid to the city treasurer. The city treasurer was required to pay the moneys received from the special assessments to the bondholders.

The bonds in the first instance were offered to the public for sale at par. Such bonds as were not taken by the public were issued to the contractor in payment of the cost of the improvements. The bonds involved in this proceeding were bonds thus issued to the contractor.

The full faith and credit of the city issuing the special assessment bonds was not pledged for their payment. The interest and principal of the bonds were payable exclusively out of collections of assessments made against the benefited property.

In Castle v. City of Louisa, 187 Ky. 397; 219 S. W. 439, the court made a clear distinction between bonds pledging the faith and credit of the city and those not so pledging. It'held that the bonds issued to cover improvements, the cost of which is borne by the abutting property owners, which bonds did not pledge the faith and credit of the city, formed no part of the indebtedness of the city, saying:

Where street improvement bond ordinance, under Ky. St. sec. 3643, subdivs. 1, 3, and 7, provided that the bonds should not be issued upon the faith and credit of the city, but that the faith and credit of the city should be pledged for the payment of the sums realized upon the assessment on the improved property, the indebtedness provided for was not an “indebtedness,” within Const, secs. 157 and 158, fixing the limit of city’s “indebtedness.”
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It is the established rule in this and other jurisdictions that contracts for local improvements, the cost of which is to be borne wholly by the property benefited, form no part of the indebtedness of the municipality, within the meaning of sections 157 and 158 of the Constitution. The reason for the rule is that the contractor or holder of the bond must look alone to the fund created by the collection of the assessments on the abutting property, and the city is a mere agency for collecting the assessments and custodian of the fund when the assessments are collected. * * *

In City of Mt. Sterling v. Montgomery County, 152 Ky. 637; 153 S. W. 952, the court, in holding that the city was not liable for the cost of street improvements similar to those involved herein, said:

* * * -where the city directs, as it may, that such improvement be made at the exclusive cost of the abutting property, and the statute requires it to be borne in such event exclusively by the abutting property, the liability for the cost of the improvement is in no sense a personal one upon the city. The contractor must look alone to the property designated by the ordinance directing the improvement for pay for his work and materials. * * *

See also Shaw v. City of Mayfield, 204 Ky. 618; 265 S. W. 13.

Although the courts of Kentucky have held that the special assessment bonds issued by a city are not a part of the city’s indebtedness within the limitations placed thereon by sections 157 and 158 of the Constitution of the Commonwealth of Kentucky, it does not necessarily follow that they are not obligations of the cities issuing them. The fact that the city acts as a trustee for the bondholders does not relieve the city from its obligation to pay to the bondholders the special assessments which are collected. They are obligations of the city to the extent that there is any money in the special assessment fund for the payment of the interest and principal of the bonds.

As indicated above, special assessment bonds must be first offered for sale to the public at not less than par value. In the sale of such bonds the city is exercising its borrowing power. As to bonds thus sold to the public we are of the opinion that they must be held to be obligations of the city selling them, within the meaning of section 22 (b) (4) of the Revenue Act of 1932, and we are of the opinion that no distinction can be made between the special assessment bonds purchased by the public and those issued to the contractor in payment for the improvements.

There is no requirement in the statute that a state or political subdivision thereof shall pledge its full faith and credit for the payment of interest and principal of the bonds. Where it has a limited liability for payment there is an obligation on the part of the city to pay them, albeit out of collections of special assessments. There was clearly such limited liability in the case of the special assessment bonds here in issue.

In Michael Pontarelli, 35 B. T. A. 872, we held that interest on special assessment bonds issued by the city of Chicago was exempt from tax upon the ground that the interest was received on obligations of a political subdivision of a state within the meaning of section 22 (b) (4) of the Revenue Act of 1928. No distinction can be made between the proceeding at bar and that case.

Reviewed by the Board.

Judgment will be entered under Rule 50.