author: Smith:

text:
    Central Auto Market, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8327.
    Promulgated August 2, 1927.
    On the evidence held that during the year 1920 the petitioner did not take over and operate the second-hand automobile business which prior to the inco-poration of the petitioner was conducted under the trade name Central Auto Market.

      Walter E. Barton, Esq., Thomas Watters, Jr., Esq., and R. W. Oolflesh, Esg., for the petitioner.

      George G. Witter, Esq., and J. H. Sherlock, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income and profits tax for the year 1920 in the amount of $6,250.56 plus a penalty of $1,562.64 for failure to file a return for that year. The sole question at issue is whether the petitioner was engaged in doing-business during the year 1920 and realized income therefrom.
    FINDINGS OF FACT.
    During 1919, J. Levitt owned and operated as an individual in Des Moines, Iowa, three distinct businesses under three distinct trade names as follows: Levitt Real Estate Co., State Loan Co., and Central Auto Market. The second-hand automobile business known as the Central Auto Market was commenced by him in the fall of 1919. Ellis I. Levitt, son of J. Levitt, worked for his father in an executive capacity in 1919 and had been so employed prior to that year. On January 1, 1920, Ellis I. Levitt entered into an oral partnership agreement with his father, and thereafter the three businesses were conducted on the basis of two-thirds of the profits to J. Levitt and one-third of the profits to Ellis I. Levitt.
    On February 17, 1920, J. Levitt and Ellis I. Levitt signed articles of incorporation for a corporation to be known as the Central Auto Market, the name of the corporation being the same as the trade name of the second-hand automobile business which they were then operating. The articles were filed for record in the office of the Secretary of the State of Iowa, and a charter was granted. The charter authorized the corporation to deal generally in automobiles and accessories. It also provided that J. Levitt and Ellis I. Levitt should constitute the board of directors until the election and qualification of their successors. Notice of incorporation was published in the Des Moines Daily Record on May 18, May 25, June 1, and June 8, 1920.
    On January 2, 1921, the first shares of stock of the corporation were issued. Certificate No. 1 for 140 shares was issued to J. Levitt as was also Certificate No. 2 for 40 shares. Certificate No. 3 for 70 shares was issued to Ellis I. Levitt. Certificate No. 2 was assigned to George D. Nelson on April 4, 1921, whereupon it was canceled and Certificate No. 4 in lieu thereof was issued the same day to George D. Nelson, who was the manager of the corporation. The par value of the shares was $100 each. No cash or property was paid in for the stock at the time it was issued, nor was any cash or property subsequently paid in therefor.
    On January 2, 1921, call and waiver of notice of the first meeting of the stockholders of the -corporation was made and on the same day the first stockholders’ meeting was held, at which time J. Levitt and Ellis I. Levitt were elected directors. After call and waiver of notice the first directors’ meeting was also held on January 2,1921, at which time J. Levitt was elected president and vice president and Ellis I. Levitt was elected secretary and treasurer.
    No transfer of the assets or book accounts of the business conducted under the trade name Central Auto Market was ever made to the incorporated Central Auto Market. The books of the business at all times from its inception were kept in the office of the Levitt Real Estate Co. During the year 1920, the capital accounts were kept in the name of J. Levitt and Ellis I. Levitt. Early in 1921 a new ledger was opened up as of January 1, 1921, in which the book accounts of the preexisting automobile business and a capital stock account were set up.
    In 1919 and in 1920, notes were signed “ Central Auto Market by J. Levitt.” In 1921 notes were signed “Central Auto Market by Ellis I. Levitt, Secretary,” and “ Central Auto Market by Ellis I. Levitt, Treasurer.” A bank account was opened in 1919 and the bank was authorized to honor checks signed “ Central Auto Market by Ellis I. Levitt ” or “ Central Auto Market by J. Levitt.” Checks were so honored in the year 1920. In 1921 only one check was drawn, which closed out the account. Credit for merchandise was extended to the Central Auto Market during the year 1920 on the personal representations of J. Levitt that he would be responsible for the bills. On December 30, 1920, a lease was entered into between Ellis I. Levitt, lessor, and Central Auto Market, a corporation, lessee, for a term beginning January 1,1921, and ending May 1,1922.
    No 1921 Federal capital-stock-tax return, which was due for filing on or before July 31,1920, was filed by the petitioner. The petitioner did file the 1922 Federal capital-stock return which was due for filing on or before July 31, 1921. No Federal income-tax return was filed by the corporation for the year 1920. The partnership Federal income-tax return for the year 1920 was filed, in which was reported the income from the three businesses which were operated during that year under the trade names of Levitt Real Estate Co., State Loan Co., and Central Auto Market. J. Levitt and Ellis I. Levitt each filed individual Federal income-tax returns for the year 1920, in which each reported his distributive share of the income of the three businesses for that year, including the income of the secondhand automobile business conducted under the trade name Central Auto Market. The annual corporation report to the Secretary of State for the State of Iowa provided for by the laws of Iowa was filed by petitioner for the year 1920 on August 5, 1920, and the report for the year 1921 on August 27, 1921.
    During the year 1920 chattel mortgage forms were printed with blank spaces for the insertion of the names of the mortgagor and mortgagee. On the reverse side of the forms the following words were printed: “ Copies of this form may be secured from Central Auto Market, Inc., dealers in used cars, 415-417 West Grand Avenue, Des Moines, Iowa.” Approximately 500 chattel mortgages were taken in the name of the Central Auto Market during the year 1920. Some of them were written on these printed forms, and some of them were written on forms on which “ Motor Finance Company ” and “ State Loan Company ” were printed on the reverse side. Some of the chattel mortgages were taken prior to February 20, 1920, the date of incorporation, but the majority of them were taken after that date.
    During the year 1920, three suits were brought by the Central Auto Market in the Municipal Court of Des Moines, Iowa, in connection with foreclosures of chattel mortgages. The petition alleged in each case that the plaintiff was a corporation existing under and by virtue of the laws of the State of Iowa, and that the defendant had executed and delivered to the plaintiff a certain mortgage and note. These suits were filed by George Harnagel, an attorney, at the instruction of George D. Nelson, an employee and agent of the Central Auto Market, who had charge of such matters. No instructions were given by either of the Levitts regarding the bringing of the suits, and no specific instructions were given the attorney by Nelson. The petition in each case was verified by George D. Nelson as agent for plaintiff. The first suit was filed April 24, 1920, and the chattel mortgage on which the suit was founded recited the Central Auto Market as mortgagee and was prepared on a Motor Finance Company form. The second suit was filed August 16, 1920, and the chattel mortgage recited the Central Auto Market, Inc., as mortgagee. The mortgage was prepared on a Central Auto Market, Inc., form. The date of filing the third suit does not appear. In each case no appearance was made for defendant and judgment was obtained by default.
    Suit was filed against the Central Auto Market in 1920 by the Lozier Automobile Co., the petition alleging that the defendant was either a corporation or a partnership, composed of Ellis I. and J. Levitt.
   OPINION.

Smith:

The record in the instant case presents the picture of a business enterprise passing through three phases of existence in less than two years. In the fall of 1919 it commenced doing business, and constituted the third unit of a group of three nonrelated business enterprises conducted by J. Levitt as sole proprietorships. On January 1, 1920, J. Levitt entered into an oral partnership agreement with his son Ellis I. Levitt, whereby the son acquired a one-third ir.terest in a partnership which continued the operation of the three businesses formerly conducted as sole proprietorships.

Early in 1920 it was decided to incorporate the second-hand automobile business conducted under the trade name of Central Auto Market. Articles of incorporation were prepared and filed with the Secretary of State for the State of Iowa and a charter was granted. The name of the corporation. — the petitioner here — was also the Central Auto Market.

The respondent claims that the second-hand automobile business known as the Central Auto Market was conducted by the corporation from February 20, 1920, the date of incorporation, whereas the petitioner claims that while it existed as a corporation from February 20,1920, it did not commen.ce doing business until January 1, 1921.

Counsel for respondent contends that the second-hand automobile business was held out to the public as being that of a corporation and in support thereof he shows that chattel mortgage forms were printed bearing on the back thereof the words “ Central Auto Market, Inc.”; that such forms were used by the business in taking mortgages; that an annual corporation report for the year 1920 was filed with the Secretary of State; that three suits were filed in the Municipal Court of Des Moines, Iowa, in each of which it was alleged in the petition that the plaintiff — the Central Auto Market— was a corporation existing under and by virtue of the laws of the State of Iowa and was entitled to the mortgage and note sued upon, and that judgment in each of the suits was taken by the corporation. It is further alleged on behalf of the respondent that by reason of the foregoing the business was conducted by petitioner at all times during the year 1920 subsequent to its incorporation.

We are not convinced, however, that such was the case. The crux of the situation here is whether or not the corporation acquired the assets and took over the operation of the preexisting business during the year under review. The evidence shows clearly that such was not the case. No stock was issued by petitioner during the year 1920, and the capital accounts of the business known as the Central Auto Market were kept in the names of J. Levitt and Ellis I. Levitt throughout that year. A capital account was set up in the books of the corporation as of January 1, 1921, but no cash or property was paid in for stock at the time it was issued on January 2, 1921.

Evidence was presented tending to show that credit extended to the business during the year 1920 was not extended to the corporation but was based upon the personal credit of J. Levitt. Similarly money was loaned during the year on notes signed “Central Auto Market by J. Levitt,” there being no indication that the notes were those of a corporation, or that J. Levitt was not ultimately liable thereon. In the event of suit, we have serious doubts as to whether the Levitts could have relied on limited liability.

Although the petitions in each of the suits mentioned above alleged that the corporation was the owner of the chattel mortgage and the note involved, we can not find that such allegations show that the corporation had taken over the accounts receivable of the business. Judgment in each case was taken by default. Consequently, the question as to the identity of the party plaintiff was not raised. Nor does it appear that income was received by the corporation by reason of having obtained the judgments, it not having been shown that it obtained execution thereon. It is a fair presumption that eventually the judgments were either partially or wholly satisfied, but there can be no presumption that such satisfaction was obtained during the year 1920. Nor are we satisfied that the taking of chattel mortgages wherein the mortgagee was the Central Auto Market on forms bearing the words “ Copies of this form may be secured from Central Auto Market, Inc.,” demonstrates that said mortgages were taken by a corporation, especially in view of the fact that during the same period of time other mortgages were taken on forms of the Motor Finance Co. and the State Loan Co., in each of which the Central Auto Market was recited as mortgagee.

In view of the whole record, we are of the opinion that during the year 1920, the petitioner did not take over the assets and the operation of the second-hand automobile business conducted by the Central Auto Market, and the Commissioner did not determine that it received income during that year from other sources.

Judgment of no deficiency will be entered.

Considered by LittletoN and Love.


source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    Goodheart’s Broadway Laundry Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8406.
    Promulgated August 2, 1927.
    Special assessment denied.

      Walter E. Schwed, Esq., and Theodore J. Witting, O. P. A., for the petitioner.

      A. H. Fast, Esq., for the respondent.
    Petitioner appeals from the determination of a deficiency of $4,665.22 in income and profits taxes for the years 1919 and 1920. It is alleged that the Commissioner erred in denying to petitioner special assessment of its taxes under sections 327 and 328 of the Bevenue Act of 1918.
    FINDINGS OF FACT.
    Petitioner, a Colorado corporation with principal office in the City of Denver, ivas incorporated in April, 1918, with a capital stock of $100,000, in shares of $1 par value. It acquired the assets and businesses of two laundries operated as partnerships, the Broadway Laundry, owned by Luke and Harvey G. Goodhart, and the Queen City Laundry, owned by Fred and Leslie T. Aller, in consideration of which its stock was issued in equal portions to the Goodhearts and the Allers. The Broadway Laundry was established in 1902 and the Queen City Laundry prior thereto. The building occupied by petitioner was owned by Luke Goodheart, for the use of which it paid a rental of $275 per month. The fair rental of the building during the taxable years was $5,000 per annum, the owner paying the taxes and the tenant making repairs.
    Prior to 1915, the Broadway Laundry kept no system of books, its records consisting of a check book, a file of bills payable and receivable, and inventories of accumulated assets. In 1915 it installed a double-entry system of books. In the period from 1902 to 1915 it purchased two hand laundries, the Eureka and the Citizens Hand Laundry, at a cost of $4,000, and three “ wild cat ” laundry routes (routes built up by drivers) at a cost of $900, thereby acquiring valuable lists of customers, but no tangible assets of value. These routes were paid for on the basis of $10 for every dollar of business per week received. During this period certain routes that had become too large were divided, the drivers being compensated for the customers withdrawn from them at the rate of $1 for every dollar of business per week withdrawn. A total of approximately $1,000 was thus expended. Machinery and equipment costing approximately $75,000 was also purchased during this period. All these expenditures were carried on the records of the company as expense and were not set up on its records as a capital investment at any time.
    At the time petitioner was incorporated and the two partnerships merged therein, closing balance sheets of the two concerns were prepared, upon which no asset of good will was shown. An appraisal of petitioner’s assets was made by the Lane-Lyle Co., of Chicago, which was used as a basis for the issuance of the stock, 50 per cent to the Goodhearts and 50 per cent to the Allers. The appraisal showed no asset of good will.
    During the taxable years the officers of the corporation were: Luke Goodheart, president, whose duty was general supervision; Harry G. Goodheart, secretary and treasurer, in charge of the office, drivers, advertising and all outside business; Fred Allers, general manager, in charge of the actual laundry work; and Leslie Allers, vice president, in charge of one of the offices. All the officers devoted their entire time to their duties during the taxable years, except Leslie Allers, who was in France for a portion of the year 1919. The salaries paid to its officers by petitioner aggregated $9,160 for 1919 and $15,500 for 1920. Salaries paid to their officers by two other laundries of Denver, comparable to petitioner in size and volume of business done, aggregated $12,000 for 1919 and $16,000 for 1920, in one instance; and $9,540 for 1919 and $14,560 for 1920 in the other.
    Petitioner in its income-tax returns for the taxable years reported assets and liabilities as follows:
    1919
    Assets Liabilities
    Cash_ $6, 811. 94 Accounts payable_ $1,114. 91
    Accounts receivable_ 5, 858. 40 Notes payable_ 24. 86
    Inventory supplies_ 3, 511.26 Employees’ savings_ 83. 00
    Fuel_ 431.15 Rent_ 113.25
    Officers’ loans_ 150. 00 Reserve for depreciation __ 19, 869. 60
    Insurance stock_ 500. 00 Accrued items_ __ 1, 454. 03
    Machinery and equipment- 55,167.73 Capital stock_ __ 100,000.00
    Delivery equipment_ 9, 872. 09 Surplus_ - 9,164. 73
    Office equipment_ 2, 581. 63
    Equipment out of use_ 579. 85
    Power out of use_ 175.00
    Tools_ 57. 50
    Good will_ 45,287.38
    Deferred items_ 840. 45
    131, 824. 38 131, 824. 38
    1920
    Assets Liabilities
    Cash_ $4,251.36 Accounts payable_ $4, 935. 62
    Accounts receivable_'_ 10, 988. 29 Notes payable_ _
    Inventory supplies_ 1, 384. 83 Employees’ savings_ 84. 0i)
    Fuel_ 50. 00 Accrued items_ 1, 938.10
    Officers’ loans_ 1, 500. 00 Reserve for depreciation_32, 015. 65
    Insurance stock_ 500. 00 Accrued taxes_ 1, 724.37
    Machinery and equipment- 80, 321. 39 Capital stock_ 100, 000. 00
    Delivery equipment_ 10, 441. 72 Surplus_ 18, 618. 44
    Office equipment_ 3, 098. 03
    Tools_ 250. 90
    Good will_• 45, 287.38
    Deferred items_ 792. 28
    Liberty bonds_ 50. 00
    158, 916.18 158,916.18

      Upon audit of its returns and examination of its records, respondent made certain adjustments to invested capital claimed by petitioner, eliminating therefrom the item of “ Good will,” and determined deficiencies in the amounts of $2,775.56 for 1919 and $1,889.66 for 1920.
   OPINION.

Van Fossan:

The only issue submitted is whether or not the respondent erred in his refusal to assess petitioner’s taxes under section 328 of the Revenue Act of 1918, which provides for the relief of certain corporations by special assessment. That section, however, is applicable only to the particular cases designated in section 327 and any taxpayer seeking relief under section 328 must bring itself clearly within at least one of the four classes enumerated in section 327. Petitioner relies upon subdivisions (c) and (d) of section 327, alleging that there was paid in for stock a mixed aggregate of tangible and intangible property, the cost- of which is not reflected upon the books of the predecessor partnerships and is not ascertainable. Petitioner insists, therefore, that invested capital can not be determined in accordance with sections 326 and 331, and that further abnormalities existed by reason of the low salaries of its officers and the low rental paid.

The facts before us are insufficient to sustain the claims of petitioner in any respect. The evidence introduced relating to the assets and condition of the records of one of the partnerships is not convincing or conclusive that the cost or value of those assets can not be determined. No evidence whatever was offered as to the assets and records of the other partnership, nor is there any evidence of the value of the alleged good will eliminated by the Commissioner. The record also fails to establish that any abnormality existed in the salaries paid officers of petitioner, as compared with those paid by other laundries of similar size in the same locality or that the rental paid by petitioner was so low as to produce an abnormal condition affecting its capital or income.

Upon consideration of the whole record we must hold that petitioner has failed to establish that respondent erred in his determination of the deficiencies. See Appeal of Morris & Co., 1 B. T. A. 704; Appeal of Watt & Shand, Inc., 2 B. T. A. 1273.

Judgment will be entered for the respondent.

Considered by Maequette, Millieen, and Phillips.


text:
    Innes-Behney Optical Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3368.
    Promulgated August 2, 1927.
    Classification as a personal service corporation granted.

      James D. Benedict, Esq., for the petitioner.

      W. E. Lawder, Esq., for the respondent.
    This is an appeal from the determination of deficiencies in income and profits taxes for the calendar years 1919 and 1920, aggregating $3,075.89. The errors assigned are that (1) the Commissioner denied petitioner personal service classification, and (2) the Commissioner refused to allow the deduction of sums paid to the two stockholders, in excess of amounts specifically designated on the books as salaries, as reasonable compensation for services rendered.
    FINDINGS OP PACT.
    Petitioner is a Colorado corporation doing business in the City of Denver, and was organized in October, 1918, with an authorized capital of $10,000. All the capital stock was issued in equal proportions to Albert E. Innes and Fred L. Behney in consideration of all the assets and business of a partnership known as the Innes-Behney Optical Co., owned and conducted by them in the City of Denver. Innes and Behney have been at all times the sole owners, in equal shares, of all the capital stock of the corporation. The officers of the corporation were Albert E. Innes, president, Fred L. Behney, vice president and treasurer, and Katherine J. Vandermeulen, secretary, all of whom devoted their entire time to the business of petitioner.
    Petitioner’s business was that of optometrists and opticians, consisting of the examination of the eyes of patients, and the making and fitting of eyeglasses. It prepared and manufactured glasses for patients upon prescriptions from oculists and also made examinations of the eyes of. customers and prepared the glasses from such examinations. Innes and Behney made all examinations, did all the grinding of lenses, prepared the glasses and made all fittings of glasses. One assistant was employed who did some of the roughing or finishing of the lenses and other minor details requiring no technical knowledge or skill, all the work of a technical character being performed by Innes and Behney. The only other employees were a bookkeeper and a janitor (part time), no salesmen being employed. The petitioner carried a small stock of merchandise (goggles, field glasses and opera glasses) for sale. In addition, a supply of lenses and frames from which glasses were made was kept on hand as a matter of convenience. Lenses and frames were not sold, or kept for sale, as such.
    As of the close of the taxable years the cost value of petitioner’s fixed assets, consisting of merchandise inventory, furniture and fixtures, and tools and machinery, was $8,445.48 for 1919 and $11,894.32 for 1920. The opening merchandise inventory for 1919, taken at cost, was $3,136.15, of which amount $503.47 covered goggles, etc., and $2,632.68 represented lenses and frames. The outstanding capital stock for each taxable year was $10,000. The gross receipts were $26,491.05 for 1919 and $32,054.72 for 1920, and were derived from the following sources:

    Prior to incorporation of petitioner, Innes and Behney, as partners, had agreed between themselves that they would each draw a minimum salary and that if the business justified it they might draw additional sums as compensation for their services, but no record of the agreement was made upon the partnership books. On the books the agreed minimum salary paid each partner was entered as expense and the remaining profits of the business were credited to the accounts of the partners, against which further withdrawals were charged. When the business was incorporated the same books were used without change therein, except that a new account, called “ Innes-Behney Optical Co.” was established and the credit balance in the accounts of the partners transferred thereto. No resolution or other action was adopted or taken by the corporation relative to salaries of Innes and Behney nor was any formal authorization of such salaries made, but the agreement between the parties as partners was continued by them as sole stockholders of the corporation, and all withdrawals by them in excess of the agreed minimum salary were charged to the new Innes-Behney Optical Co. account, while the salaries were recorded as expense. Pursuant to said agreement, Innes and Behney were each paid a minimum salary during the taxable years, and in addition thereto each drew such sums as the business justified, such withdrawals being made practically each month. For the year 1919 Innes received a total of $4,164.82 and Behney received a total of $4,164.82, of which sum in each case $1,710 was charged as expense and $2,454.82 was charged to the Innes-Behney Optical Co. account. The net income reported for 1919, computed by deducting all expenses, including salaries charged thereto, was $7,581.68, distributed equally to the two stockholders. For the year 1920, Innes received the total sum of $5,247.01 and Behney received the total sum of $5,247.01, of which sum in each case $2,510 was charged as expense and $2,737.01 was charged to the Innes-Behney Optical Co. account. The net income reported for 1920, computed by deducting all expenses, including salaries charged thereto, was $8,689,33, distributed equally to the two stockholders.
    Petitioner made income-tax returns for the years 1919 and 1920 as a personal service corporation. The respondent denied classification as a personal service corporation and petitioner thereupon requested permission to file amended returns with the allowance of additional compensation to the two stockholders as salaries. This was also denied by respondent and the deficiencies asserted.
   OPINION.

Van Fossan:

The petitioner raises but two questions: (1) Was petitioner a personal service corporation in 1919 and 1920 within the meaning of section 200 of the Revenue Act of 1918? and, in the alternative, (2) Are the total sums paid to Innes and Behney reasonable allowances for salaries or other compensation for personal services actually rendered and allowable as a deduction under section 234(a)(1)?

Three essential conditions must be met to bring a corporation within the personal service classification provided by section 200 of the Revenue Act of 1918 — (1) the principal stockholders must be regularly engaged in the active conduct of the business, (2) the income must be primarily attributable to their activities, and (3) capital must not be a material income-producing factor. The statute also expressly excludes any corporation 50 per cent of whose income is derived from trading as a principal or from Government war contracts. Confronted with this definition, each case must be considered and determined upon its own peculiar facts and circumstances. See Appeal of Bryant & Stratton Commercial School, Inc., 1 B. T. A. 32.

A reference to the findings of fact will suffice to demonstrate that this petitioner fully satisfies all the conditions of the definition. Innes and Behney, owners of all the stock, devoted themselves exclusively to the business of the petitioner, and through their efforts and reputations produced substantially all, if not all, of the business. Such capital as was employed in the business was principally invested in furniture, fixtures, machinery, tools, and supplies essential to the production of eyeglasses. The small amount invested in salable merchandise was negligible and produced only about 3 per cent of the total income. The machinery and tools while necessarily involving the use of capital, were not, of themselves, income producers. They were no more than the implements with which Innes and Behney exercised the skill of their profession. The lenses and frames were not kept for sale as such and had little value until made up as eyeglasses through the services performed upon them by Innes and Behney. Even then they were of no practical value to anyone except the persons for whom they were specifically made. Independently of the personal services of Innes and Behney, the exercise' of their judgment and skill, the capital employed in this business was useless as a producer of income to the petitioner. See Appeal of Rhoades, Brownson & Kampman, Inc., 2 B. T. A. 194.

It is not essential to a compliance with the Act that no capital whatever be employed in the business. Few modern businesses are conducted without the use of capital in some form or other, and it can not be assumed that Congress intended any such narrow limitation. The business of the petitioner is essentially the sale of the services of Innes and Behney as skilled optometrists and opticians of high reputation. It is their ability to make and fit eyeglasses satisfactorily to the individual needs of its customers that the petitioner sells and from which it derives its income. It is a dealer in the experience and technical knowledge of these two men, just as the lawyer, the doctor and the artist, with large capital investments in libraries and tools and equipment, are dealers in the technical knowledge and service of their professions.

We are of the opinion that petitioner is a personal service corporation within the meaning of section 200 of the Revenue Act of 1918, and so hold. In view of our conclusion on the first issue, it is unnecessary to consider the second issue raised on this appeal.

Judgment will be entered for the petitioner.

Considered by Maeqnette, Mllliken, and Phillips.


text:
    Denver Live Stock Commission Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4527.
    Promulgated August 2, 1927.
    Personal service classification denied.

      Ralph B. Mayo, G. P. A., Leslie E. Greene, G. P. A., and F. Tillman Browrme, G. P. A., for the petitioner.

      A. G- Bouchard, Esq., for the respondent.

      This is an appeal from the determination of a deficiency of $7,000.96 in income and excess-profits taxes for the fiscal year ended May 81, 1920. The petitioner alleges that the Commissioner erred in denying it classification as a personal service corporation under the Kevenue Act of 1918.
    BINDINGS OB BACT.
    Petitioner is a Colorado corporation with principal offices at Denver and is engaged in buying and selling live stock on commission. It owns no stock and neither buys nor sells on its own account.
    The stock is shipped on consignment to petitioner and placed in pens allocated to it at the stockyards. In the yard offices of all the railroads bulletins are posted showing the cattle received, to whom consigned and the pens in which they are herded. Each morning petitioner’s yardman ascertains the cattle consigned to it and a representative of the stockyards, after counting them, delivers the cattle to petitioner. They are then fed and watered by petitioner and classified for marketing, and sold in the market to various classes of buyers. They are then weighed to the account of the owner and delivered to the purchasers. Petitioner collects the purchase price and after deducting freight, feed and stockyard charges, and its commission remits the balance to the owner or consignor. The commission received by petitioner is a fixed sum per head, with a maximum per carload, and is not based upon the sale price.
    Prior to the taxable year petitioner also engaged in a loan business, but early in the calendar year 1919 it determined to withdraw therefrom. In January, 1919, there was incorporated the Stockmen’s Loan Co. with 1,000 shares of capital stock, for the purpose of taking over the loan business. Pursuant to a verbal arrangement with petitioner, as the loans matured renewals or further loans were made by the loan company direct to the borrower when they were considered satisfactory. By this arrangement and the liquidation of loans the amount of loans carried by petitioner in the taxable year was considerably less than that carried in prior years, the loans carried over being those that were unacceptable to the loan company.
    During the taxable year petitioner made loans and advances aggregating $167,444.74 to its customers, with some of whom one or more of its stockholders were associated in outside business deals. Of this total amount loans were made to only twelve customers having no interest in petitioner, either as stockholder or employee. At the beginning of the taxable year petitioner held notes receivable in the amount of $335,596.41, and at the close of the year its notes receivable aggregated $195,500.47. Of the notes receivable on hand at the close of the year $23,619.63 represented loans to customers not connected with its business, and $171,880.84 represented loans or advances to an employee and customers with whom one or more of its stockholders' were associated in outside business.
    The stockholders of the petitioner and the shares held by each in the taxable year, were:

    Five of the stockholders were regularly and actively engaged in the conduct of the business and devoted the entire business day to the affairs of petitioner. Kemper was in charge of the Cattle Department, Lutz the Hog and Sheep Department, Coyte the Feed Department, Murray the Yard Department, and Allen the Bookkeeping Department. Petitioner had seven employees, not stockholders, performing the duties of stenographer, assistant bookkeeper and yardmen. It had two salaried salesmen, not stockholders, K. W. Johnston and Hoy Standish, who' assisted Kemper in the Cattle Department and were under his supervision. The active stockholders produced practically all of the commission business, only a small portion being attributable to the two salesmen. The nonactive stockholders, McWilliams and Kendle, were large owners of cattle and through their influence directed some business to the petitioner.
    During the taxable year petitioner made sales and purchases of live stock for 2,200 customers, amounting to $10,600,000, upon which it received gross commissions aggregating $84,246.25, of which $985 was attributable to sales and purchases made for customers, not associated with stockholders. From other sources, including interest on loans, it received gross income in the amount of $22,334.34. The expenses incurred in the production of commission income amounted to $50,848.54, leaving a net commission income of $33,397.71, and the expenses incurred in the production of income from other sources amounted to $27,828.71, including interest paid, leaving a net loss of $5,494.37. The total gross income from all sources was $106,580.59 and the total expenses incurred in the pro-ducfcion thereof amounted to $78,677.25, leaving a net income from all sources of $27,903.84. Petitioner filed a return for the taxable year as a personal service corporation and reported commission income in the amount of $84,246.25 and income from other sources in the amount of $6,723.60, or a total income of $90,969.85, from which it made deductions in the amount of $61,665.48, showing a net income of $29,304.37. Upon examination and audit respondent found the true net income to be $27,903.34 and denied petitioner classification as a personal service corporation. In schedule A-14, attached to the return, petitioner made the following statement:
    The income of this corporation is due to the activities of its members in purchasing and selling live stock for its customers from whom commissions on purchases and sales are received. The employment of capital is entirely incidental to the main business, which is buying and selling of live stock for commissions. It is found necessary in the conduct of the business to accommodate customers by certain loans and advances, which in the main are financed by discounting customers’ notes or by borrowing; but is partly financed by our own capital.
    The resources and liabilities of petitioner as of the beginning and the close of the taxable year were:

    The surplus account was carried to cover loans made and discounted at the banks, and as a fund upon which stockholders might draw.
    Kespondent, having denied petitioner personal service classification, determined a deficiency of $7,000.96 in income and profits taxes for the taxable year.
   OPINION.

Van Fossan:

We have for consideration here the single question of whether or not petitioner is entitled to classification as a personal service corporation under section 200 of the Revenue Act of 1918.

The Act specifies three essential elemeiits that must concur to constitute a corporation one of personal service — (1) the principal owners or stockholders shall be regularly engaged in the active conduct of the affairs of the corporation; (2) its income must be ascribed primarily to their activities, and (3) capital (invested or borrowed) must not be a material income-producing factor. The absence of any one of these elements is fatal to a claim for personal service classification. The statute also expressly excludes any corporation 50 per cent or more of whose gross income is derived from trading as a principal or from Government war contracts.

Petitioner calls attention to the fact that the statute does not define income as used in the general definition of personal service corporations, and insists that it means “ net income.” There is nothing in the Revenue Act to indicate that Congress intended to give the term such a restricted meaning. Words of a statute are to be taken in their ordinary, commonly accepted meaning in the absence of a clear intention to the contrary appearing in the statute. The Supreme Court has succinctly expressed the meaning of the term as used in the Sixteenth Amendment and the income tax acts:

Income may be defined as tbe gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets * * *. Eisner v. Macomber, 252 U. S. 189, 207.

We are of the opinion that the term, as used in section 200, means gross income as it is commonly understood.

In the case at bar we find that five of the seven stockholders of petitioner owning 86 per cent of the capital stock, devoted the entire business day to the active conduct of petitioner’s affairs. Every department or phase of the business was under the active supervision of one of these five stockholders. There were, it is true, a number of nonstockholder employees, but, with the exception of two, their duties were clerical and not of an income-producing nature. Two of the employees were salesmen, serving as assistants to one of the stockholders and under his direct supervision, but a very small portion of the income, if any, can be ascribed to their activities. There may be some question as to whether or not petitioner satisfies the statutory requirement as to these qualifications, but in view of our decision as to its use of capital, it is unnecessary to rule thereon.

It appears from the record that petitioner not only found it necessary to employ capital in the conduct of its business, but that such capital produced more than 20 per cent of its income. Under such circumstances it can not be said that capital was not a material income-producing factor.

We conclude that in the business as conducted by petitioner, capital (invested or borrowed) was a material income-producing factor, and lacking one of the essential elements of a personal service corporation, petitioner must be denied classification as such. Appeal of C. N. Merritt & Brother, Inc., 1 B. T. A. 927; Appeal of Kossarr & Co., 4 B. T. A. 1164; Appeal of Seaboard Mills, Inc., 5 B. T. A. 575; Hubbard-Ragsdale Co. v. Dean, 15 Fed. (2d) 410; affd. 15 Fed. (2d) 1013.

Judgment will be entered for the respondent.

Considered by Maeqxjette, MxllikeN, and Phillips.


author: Sternhagen:

text:
    C. Hossfeld & Son Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7039.
    Promulgated August 8, 1927.

      Andrew T. Smith, Esq., and Virgil T. Moore, Esq., for the petitioner.

      F. O. Graves, Esq., for the respondent.
   Sternhagen:

Deficiency of $2,687.19 income and excess-profits taxes for 1918. Respondent disallowed a deduction of alleged obsolescence of good will.

FINDINGS OP PACT.

The petitioner was an Ohio corporation with its principal place of business at 122 South Second Street, Hamilton, Ohio. It was engaged in the business of selling liquors at wholesale and retail. The business was established in 1865. Except as hereinafter set forth, the petitioner engaged in no other business from 1905 to. June 30, 1919. It went out of the liquor business not later than June 30, 1919. The petitioner’s existence is being maintained pending a determination of its tax liability.

The petitioner constructed a 65-room hotel building on South Second Street which was completed in 1908 or 1909. Immediately upon completion it was leased to others for operation. The hotel was never operated by the petitioner at any time.

In 1905 the petitioner occupied a store at Second and Court Streets for which it paid $75 per month. Upon completion of the hotel building petitioner moved into space therein on the ground floor which had been reserved when the property had been leased, and for the use of which no payment was made by the petitioner. The space in the hotel building occupied by the petitioner covered about the same area as the space it had occupied at its former location. The new location was not so desirable as the old, being more than half a block farther from the business section of the city.

There was no entrance from the space occupied by the petitioner into the hotel proper. A bar was operated in the hotel by the lessee thereof, with which the petitioner had no connection.

The petitioner borrowed money for the construction of the hotel building, but never borrowed any money for the liquor business.

The petitioner owned three brands for whiskey sold by it, “ June-mont,” “ Belle of Miami,” and “ Town Hill.” These brands were registered shortly after 1905, and nothing was paid therefor aside from the registry fees. The whiskey sold under the brands “ June-mont ” and “ Belle of Miami ” was bottled at the petitioner’s place of business. The “ Town Hill ” whiskey was bottled at a distillery in Louisville, Ky. “ Junemont ” was sold by petitioner for 65 cents a quart, and “ Belle of Miami ” for TO cents a quart. Whiskey of like quality and age as that sold under these two brands was drawn from the barrel and sold by petitioner unlabeled for 5 to 10 cents less a quart. “ Town Hill ” was sold by petitioner for $1 a quart. Whiskey of like quality and age was drawn from the barrel and sold by petitioner unlabeled for 65 cents a quart. There was no appreciable difference between the cost of the branded and of the unlabeled whiskey of like quality and age, the only element of difference being the cost of the labels, which was very slight.

The petitioner made special efforts to sell the branded whiskey because of the greater profit, and the sales of whiskey under these brands constituted more than 50 per cent of its sales of whiskey.

The petitioner sold other bottled-in-bond brands of whiskey comparable in age and quality to “Town Hill.” The profit on such brands ranged from 9 to 12 cents a quart.

The net tangible assets (the excess of the tangible assets over the liabilities) directly employed in the liquor business, and the net profits of the liquor business for the years from 1907 to 1912, inclusive, are stated below. These figures exclude all assets used in the hotel enterprise and all profits and losses therefrom.

The net profits have been reduced by $50 a month, representing the amount arbitrarily fixed by petitioner as the rental value of the space occupied by it in the hotel building.

The net tangible assets directly employed in the hotel enterprise, and the losses sustained therein, for the period from 1908 to 1912, are:

An amount of $50 for each month has been deducted from the loss corresponding to the deduction from the income from the liquor business.

The net profits from the liquor business for the years 1913 to 1918, inclusive, are:

1913_$4,222.44 1916_$5,091.15
1914_ 987.43 1917- 17,256.84
1915_11, 313. 61 1918_57, 812. 38

The net tangibles used in the liquor business in 1917 were $66,659.30, and in 1918 were $96,805.11.

The net sales of liquor for the years from 1907 to 1918, inclusive, are:

1907_ $78, 952. 00 1913_$121,017.47
1908_ 78, 659. 67 1914- 107, 762. 45
1909_ 87, 370.19 1915_ 99, 904. 05
1910_ 97, 343. 34 1916_ 112, 943. 72
1911_ 91, 712. 56 1917_ 126, 307.12
1912_ 97,138. 74 1918_ 311, 896.20

The petitioner, on its income-tax return for 1918, deducted $18,282.23 for obsolescence of good will based upon a good will value of $21,496 as of March 1, 1913. It determined this value by capitalizing at 20 per cent the average earnings from the liquor business for the period from 1907 to 1912, inclusive, which were in excess of 10 per cent of the average net tangibles employed during the same period. The respondent disallowed the deduction.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: SteRnhagen :

text:
    Ernest M. Bull, Executor, Estate of Archibald H. Bull, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6888.
    Promulgated August 8, 1927.
    1. Estate tax accrues at time of death and not when payable.
    2. The word “ accrue ” has no definite meaning but must be interpreted in accordance with the statutory requirement that the accounts must clearly reflect income.
    3. Estate tax and income tax are different in kind and incidence and are not mutually exclusive because imposed in respect of the same matter. Such double tax is not invalid.

      Oonover English, Esq., for the petitioner.

      A. R. Marrs, Esq., for the respondent.
    Deficiency of $261,212.55 income tax for the period February 13, 1920, to December 31, 1920. Respondent (1) disallowed the deduction of estate tax, and (2) included in gross income an amount which, by virtue of testator’s partnership agreement, was received at the end of the period equal to the amount of testator’s share in partnership earnings had he lived.
    findings of fact.
    Archibald H. Bull was a member of the partnership of A. H. Bull & Co., ship agents and brokers. The partnership had been in existence since 1900, and made a profit each year. It was agent for several steamship companies and also for the United States Shipping Board in the operation of some of its ships. Its business was done on a commission basis. Its books were kept on the cash receipts and disbursements basis.
    The partnership agreement provided that in the event of the death of any partner his estate should receive the proportionate share of the partnership profits which the partner would have received had he lived for the remainder of the year in which he died.
    Archibald H. Bull died February 13, 1920. The executors of his estate immediately placed the accounts of the estate “upon the accrual basis.”
    The decedent’s share in the profits of the partnership which had been earned before his death was $24,124.20. This amount appeared to his credit on the accounts of the partnership at the date of his death. The share of the profits from the date of his death to December 31, 1920, calculated in accordance with the above agreement was $200,117.09. The executors, on the original return of the income of the estate, without consulting counsel, included in the income of the estate for the period from February 13 to December 31, 1920, the amount of $200,117.09. The respondent has included this amount in income in computing the deficiency here involved.
    In making return of the Federal estate tax the executor included $24,124.20 in the gross estate as the value of decedent’s undivided interest in the partnership. The respondent increased the value to '$235,202.99, which included the above amount of $200,117.09.
    Subsequent to the filing by the estate of its income-tax return for the period from February 13 to December 31, 1920, A. H. Bull & Co. received stevedore commissions for work done during that period, the decedent’s share of which was $12,601.70. This was paid to the estate. After an investigation, a report by a revenue agent was made eliminating this amount from income for the year 1921, in reliance on the action of respondent in including the amount of $235,202.79 as part of the estate.
    Federal estate tax was paid as follows: June 17, 1921, $250,000; August 10,1921, $86,264.66; total, $336,264.66.
    The amount of estate tax was finally determined to be $312,127.17, and the difference was refunded. The respondent has not allowed the amount of the estate tax as a deduction from the income of the estate for the period from February 13 to December 31, 1920.
   OPINION.

SteRnhagen :

The testator died on February 13, 1920, and his executor immediately placed the accounts of the estate “ upon an accrual basis.” The estate tax was not paid until 1921. The first of the two issues is, whether the net income of the estate for the period February 13, 1920, to December 31, 1920, inclusive, should be determined by deducting the Federal estate tax imposed under Title IY, Revenue Act of 1918. The petitioner says it should, and that the respondent has erroneously held that the estate tax accrued in 1921 and hence should not be deducted in 1920.

When the petition alleged and the answer admitted that the books of the estate were immediately placed “ on an accrual basis,” we construe this to mean a method of accounting other than that of actual receipts and disbursements which clearly reflected the income, as provided by section 212 (b), Revenue Act of 1918. Although the statute omits recognition of any so-called “ accrual ” basis or method, United States v. Anderson, 269 U. S. 422; 5 Am. Fed. Tax Rep. 5674, it will be clear from what follows that no issue is made except to determine whether under such a method the date of death fixes the time of deduction.

The estate tax was levied under the Revenue Act of 1918. Section 401 imposes the tax upon the transfer of the net estate of every decedent dying after the passage of this Act.” Section 404 provides for a return to be filed by the executor at a time required by regulations, which time was fixed by article 77 of Regulations 2,7 at within one year after death. Section 406 provides “ That the tax shall be due one year after the decedent’s death * * (Article 90 of Regulations 2,7 provided, “ The tax is due and payable one year from the date of death.”)

The Revenue Act of 1918 imposed the income tax in Title II. By section 219 (a) (1) it was imposed on “ income received by estates of deceased persons during the period of administration or settlement of the estate,” which income was, by section 219 (b), to be “ computed in the same manner and on the same basis as provided in section 212,” (with unimportant exceptions) i. e., applicable to individuals. Thus the estate was entitled to the deduction provided by section 214 (a) (3), “Taxes paid or accrued within the taxable year imposed (a) by the authority of the United States, except income, war-profits and excess-profits taxes * * The estate tax is within the last-quoted provision, and its deductibility is settled, United States v. Woodward, 256 U. S. 632; 3 Am. Fed. Tax Rep. 3119; but it must now be decided whether the estate tax accrued, for the purpose of the statutory deduction, in the income-tax period for which the executor made his first return for the estate or the period within which the estate tax became due under the statute.

A study of the multitude of decisions, treatises, and variously expressed views, and our experience in the consideration of many cases presented to this Board in which the word is either carefully or loosely used, disclose that the word “ accrue ” is fraught with confusion because it expresses no certain concept. In law, it has long been used in respect of rights and obligations which are said to accrue when they become enforceable. In accounting, it may be variously used with equal authority to refer to a right or liability fixed in amount, or certain in all respects except amount, or to an apportionment of a right or liability which runs hand in hand with a matter upon which it depends, or to a reserve in anticipation of an event, sometimes certain and sometimes uncertain. Other connotations will occur, but these are sufficient to indicate that there is little in common among the significations recognized. One thing is clear — that the word implies the exclusion of “ received ” or “ paid,” or a right or liability discharged. But short of this, what is meant when an item is accounted for as accrued depends upon the system of accounting in which it appears and the breadth of the accountant’s concept.

When, therefore, it becomes necessary to interpret the word as it appears in the revenue act, the interpretation can not be fixed by definition, for this would imply a precision of congressional intention at variance with the more fundamental purpose to tax that which a proper system of accounting should clearly reflect as net income. In the Revenue Act of 1918 Congress sanctioned the determination of net income in accordance with the taxpayer’s regular method of accounting, subject however to the necessary safeguard that the method should clearly reflect income. No method which fails to clearly reflect income has any justification or sanction under the law. The determination of income is a complex problem, and the question whether the method of accounting clearly reflects income is likewise a complex problem; and in neither case is the solution simplified by attributing any magic to the word “ accrue.” Given a method which, as concededly in this case, on the whole clearly reflects income, it is necessary, when determining whether an item accrued, to determine in essence whether its deduction during the period under consideration is consistent with the clear reflection of income or would bring about a distortion.

This is substantially in accordance with the process by which the Supreme Court arrived at its decisions in United States v. Anderson, supra, and American National Co. v. United States, 274 U. S. 99, as we understand those decisions. In the Yale c% Towne case the court expressly put aside any technical significance of accrual, and in effect held that a tax on income from munitions should, under the method employed, be accounted for during the period of the derivation of the income to which the tax was directly related. In the American National case, bonuses incurred were held deductible as expense in the same year as the income to which they were attributable. In both these cases the Supreme Court, although expressly recognizing that the word “ accrued ” had been in law applied to an item “ due and payable,” yet held that this signification should properly give way to the clear reflection of income under the accounting method employed.

For the purpose of the-present case, however, these decisions are relevant principally because they put aside any technical definition of accrual, for they both involve situations of a kind heretofore referred to where the deduction in question is directly related to the continuing process of earning the income taxed. In the present case the deduction is of an isolated item not connected with the gross income either as necessary to its earning, (as an expense) or as resulting from it (as an income tax). The reasoning by which the deductions were offset against the correlative gross income so as to clearly reflect the net, is to a substantial degree absent from the case at bar. The estate tax, being an excise or death duty, measured by the value of the decedent’s net estate and imposed by reason of the transmission from the dead to the living, is in its nature isolated from the income of any period, and hence the considerations which determine the period of its accrual must rest on other grounds than those found in the two cases cited.

The decision of the Supreme Court in United States v. Woodward, supra, contains a statement that the estate tax of the 1916 Act “ not only ‘ accrued,’ which means became due * * This has sometimes been looked upon as a decision that “ accrue ” means to become due and payable. But in two later cases in which the decision was urged as authority on the point, the court has expressly held this language to be obiter dictum. United States v. Anderson, supra, and United States v. Mitchell, 271 U. S. 9; 5 Am. Fed. Tax Rep. 6008. It may reasonably be likewise inferred that no authority is to be attributed to the statement at the beginning of the opinion in United States v. Mitchell, supra, that “The Federal estate tax accrued one year after her death,” for in that case the question directly raised was whether the time of payment of the estate tax determined its deductibility in computing the income upon the basis of actual receipts and disbursements. The Appeal of Henry Reubel, 1 B. T. A. 676, is distinguishable for the same reason. Other decisions of the Board such as Russell Milling Co., 1 B. T. A. 194; L. S. Ayers & Co., 1 B. T. A. 1135; Guarantee Construction Co., 2 B. T. A., 1145, are also readily distinguishable from the case at bar because they involve the deduction of taxes of a correlative nature, like income and profits taxes, and not isolated or occasional taxes. Charles L. Harris, Administrator, 5 B. T. A. 41, and Catherwood v. United States, 291 Fed. 560; 2 Am. Fed. Tax Rep. 2002, are not germane because for the purpose of the decision it was only necessary to consider whether the estate tax could be regarded as imposed or accrued before the death which was the occasion for its exaction. In E. T. Earl, 4 B. T. A. 322, the estate in computing income on the accrual basis sought to deduct the estate tax when paid in a tax period later than that including the statutory “ due ” date one year after death. The Board held against the estate, and it was unnecessary to consider the question now submitted.

Hertz v. Woodman, 218 U. S. 205; 5 Am. Fed. Tax Rep. 5534, under the Revenue Act of 1898, involved a question strikingly similar to that before us. A legacy tax was imposed by section 29 and was by section 30 made due and payable one year after death. The testator died March 15, 1902. Effective July 1, 1902, section 29 was repealed, although the taxes “ imposed ” prior to the effective date of the repeal were saved from repeal. It was contended for the taxpayer that in view of the fact that the tax was due and payable in one year after the death of the testator, namely, March 15, 1903, it could not be regarded as imposed until that time and hence was not saved from repeal. The Government contended that the tax was imposed simultaneously with death and was therefore not affected by the repealing statute. The legacy in question clearly vested at death, which caused the court to distinguish Mason v. Sargent, 104 U. S. 689; 5 Am. Fed. Tax Rep. 5545, and Vanderbilt v. Eidman, 196 U. S. 480; 5 Am. Fed. Tax Rep. 5525. The court said:

* * * The law, then [at death] unrepealed and in full force, operated to fasten, at the moment this right of succession passed by death, a liability for the tax imposed upon the passing of every such inheritance or right of succession. The time for scheduling or listing was practically identical with the time for payment, and the listing or scheduling was required to be done by the executor charged with payment, but might be and was postponed for reasons of grace and of convenience. That is almost universal under any taxing system. The liability attaches at some time before the time for payment. But the liability for the payment of the tax exacted under section -29 of the act of June 13, 1898, accrued or arose the moment the right of succession by death passed to the defendants in error, and the occurrence of no other fact or event was essential to the imposition of a liability for the statutory tax upon the interest thus acquired.

The court then considered the structure and history of the statute and held that the separate provision making the tax due and pay-able one year after death was remedial or procedural only and did not affect the liability, which was fixed at the time of death by section 29.

Under the Revenue Act of 1918 the same situation might arise, in respect of an estate tax upon the estate of a decedent dying within one year prior to the repeal of Title IY on November 23, 1921, by section 1400 of the Revenue Act of 1921. Subsection (b) saved from repeal the assessment and collection “ of all taxes which have accrued under the Revenue Act of 1918 at the time such parts cease to be in effect.” Whatever may be said of the use of the word “ imposed ” in the repealing Act of 1902 and the word “ accrued” in 1400 (b), Revenue Act of 1921, it seems clear that the logic of the decision in Hertz v. Woodman, supra, is essentially applicable to a situation arising under the- latter provision. The fact that the 1898 Act imposed a legacy tax and the 1918 Act imposed an estate tax is unimportant, Knowlton v. Moore, 178 U. S. 41; 3 Am. Fed. Tax Rep. 2684; New York Trust Co. v. Eisner, 256 U. S. 345; 3 Am. Fed. Tax Rep. 3110. The 1918 Act is similar to the earlier act in that the one year for collection was provided in a separate section (§406) from that of imposition (§401), and hence may likewise be regarded as adjective rather than substantive. The Hertz case has been followed in Cochran v. United States, 254 U. S. 387; 3 Am. Fed. Tax Rep. 3092, and in many decisions of lower Federal courts, and in view of the removal of any doubt which may have been suggested by the obiter dictum of United States v. Woodward, supra (see Catherwood v. United States, supra), it remains authority for the view that death duties are imposed at death, become a liability and accrue at that time, and survive a subsequent repeal of the taxing statute, notwithstanding that they become payable thereafter.

A situation sufficiently similar to be of interest is found in New Jersey v. Anderson, 203 U. S. 483. Under the Federal Bankruptcy Act of 1898, section 64 (a), preference was given to “ taxes legally due and owing.” The contention was made that a State franchise tax the amount of which was based upon capital stock outstanding January 1, return of which was required in May, payment in June, upon failure of which an assessment in July, was not due and owing until after April, the date of bankruptcy. The court held that the tax was legally due and owing although not collectible, and said:

The amount claimed for the year 1903, it is insisted, had not accrued at the time of the adjudication in bankruptcy, which was on April 23, 1903, the return being made on May 2, 1903, and the assessment was not made until July 1, 1903; but the annual return required to be made to the board, on or before the first Tuesday in May, is upon the basis of the capital stock issued and outstanding the first of January preceding the making of the return. The bankrupt act requires the payment of all taxes legally due and owing. We think the tax thus assessed upon that basis was legally due and owing, although not collectible until after the adjudication.

It will be noted that the court made no distinction between the use of the word “ accrued ” and the words “ legally due and owing,” and tacitly recognized that by deciding the question in one form it was likewise deciding it in the other. The franchise tax was determinable by a fact at a time certain. The time of payment or collection although expressly fixed at a later date was held not to be a factor of its accrual. This was approved in New York v. Jersawit, 263 U. S. 493.

Since a tax fixed as to time and occasion, such as the estate tax, is certain enough to survive either repeal or bankruptcy, irrespective of its collection later, and the time it becomes payable is merely a remedial or procedural matter of sovereign grace, there is no clear reason in the Revenue Act to say that the emphasis should be shifted to the time fixed for payment so as to require its deduction only at that time.

The suggestion arises that it is difficult to determine the amount of the estate tax within the period when the first income tax of the estate must be computed and the return audited. This might well give pause. But it is usually no more difficult than the computation of the munitions tax involved in the Yale & Towne case or that required by section 1207 of the Revenue Act of 1926 and the earlier regulations, and such difficulty as there may be is not sufficient to counterbalance the considerations already set forth.

We hold that for the purpose of the deduction allowed in section 214 (a) (3) of the Revenue Act of 1918, the estate tax of Title IV accrued at the date of the death of testator and may be deducted by the estate in the taxable period of the death, if this is in accordance with its method of accounting, so as clearly to reflect its income. In view of the agreement of the parties as to the method of accounting, we reverse the holding of the respondent on this issue.

The second question when correctly stated is whether the amount received by the estate from the partnership, in lieu of the distributive share of the testator, if living, in the partnership earnings for the period February 13, 1920, to December 31, 1920, is income of the estate. The difficulty inherent in this question has caused both parties to shift their views at one time or another since the original return was filed. The estate at first returned the amount as income, which the respondent now contends was in accordance with the correct view. Then the Commissioner held that the amount was within decedent’s gross estate subject to estate tax. Later he was inclined to hold it to be income, but when petitioner protested and said that it had already been taxed as corpus of the estate, he said he would adhere to the view that it was corpus. But some time thereafter he decided it was income and so determined the present deficiency. The petitioner complains bitterly of this. Deplorable as it may be, this can not be determinative of petitioner’s statutory liability, and since the jurisdiction of the Board is properly invoked we must proceed to apply the statute to the facts in evidence and redetermine the deficiency as a matter of law. Nor is it decisive that the petitioner’s time for refund may have expired as to a possible overpayment. Whether refund is barred by limitation is not clear from the evidence.

The petitioner takes it as clear in principle that the amount in question can be only either corpus of the estate transferred at death or income of the estate after death, and that it can not be both. From this it is argued that since it was properly held to be corpus, it can not be income. But there is no warrant for the assumption of mutual exclusion. The two taxes are different in kind and incidence, and if when properly applied they each produce revenue in respect of the same matter, that fact alone does not militate against either levy. Double tax is of course not to be presumed (see Nichols v. United States, Court of Claims, April 4, 1927; 6 Am. Fed. Tax Rep. 6592) and ought to be avoided if doubtful, but if clear it is not invalid. This may be illustrated by the plain overlapping of the capital stock tax and the income tax. The former is measured by the actual value of capital stock. Such value frequently reflects earnings which, at the same time measure the income tax. But the earnings when derived are not less subject to income tax because they have given taxable value to capital stock. A similar impinging of the inheritance tax and the income tax upon the same factor of value will be found in the two decisions of the Supreme Court in United States v. Fidelity Trust Co., 222 U. S. 158, and Irwin v. Gavit, 268 U. S. 161; 5 Am. Fed. Tax Rep. 5380. In the former case, decided under the 1898 Legacy Tax Act, Mr. Justice Holmes held that a legacy of a vested life estate in a fund the clear value of which could be determined by mortality tables and a discount rate, was taxable to its full value at the date of death. In the latter case, under the Revenue Act of 1913, the same learned Justice held the income subject to tax notwithstanding the right to it was an equitable interest in the fund and the statute expressly exempted bequests from income tax. It may thus be entirely possible that a tax in one form is imposed upon the present value of a right of expectancy and a tax in another form is imposed upon the income when derived, — that income may be subject to income tax even though its expectation had a value which was otherwise taxed. Ernest P. Waud et al., Executors, 6 B. T. A. 871. See also Bowers v. Taft, 20 Fed. (2d) 561, indicating that a gift when sold may be taxed as income even though its value may be expressly exempt at the time of gift.

So while the issue is approached in full realization of the presumption against the hardship of double tax, United States v. Supplee-Biddle Hardware Co., 265 U. S. 189; 4 Am. Fed. Tax Rep. 3989, it is necessary to determine whether, the facts considered, the estate is subject to income tax by reason of the $200,117.09 received from the partnership in view of the testator’s agreement. The estate tax is not here under review and is not decided. The agreement itself is not in evidence, nor is the will, and the facts must be taken as they appear from the admitted allegation of the petition, as follows:

The decedent, Archibald H. Bull, was a member of the firm of A. H. Bull & Co., steamship agents and brokers. The agreement among the partners was that in the event of the death of any of the partners, his estate should receive his proportionate share of the profits of the firm which he would have received had he lived for the balance of the year from the date of death. The share of the decedent, Archibald H. Bull, for the period from February 13, 1920, to December 31, 1920, calculated on this basis was $200,117.09.

There are several nice questions to be found in this apparently simple statement of fact. It would be interesting to consider the nature of the right or interest, if any, of the testator during his life in the partnership earnings to be derived after his death, and also the nature and source of the right of the estate after his death. Assuming that each, the testator and his estate, had a right by virtue of the contract, it may be, either, that there was a transfer at death, or a ceasing of one and a springing up of the other, such as in respect of life insurance or the exercise of a power of appointment.

These questions, however, need not be decided, because at best for the petitioner, such a decision would fall for lack of evidence to support it. Clearly the estate could in no event escape income tax on more than so much of the $200,117.09 as represented the capital at the date of death in the property therein which was transferred by decedent as part of his gross estate. The excess, at least, would be income. It can not be as a matter of law that the exact amount subsequently received measures the value of the capital transferred at death. Even if the amount to be received were definitely known, it would require discount; and certainly where indefinite and subject to the uncertainties of business earnings after the death of an active partner, its value at the time of death would, if measurable at all, be substantially different from the amount finally received. These uncertainties in valuation would appear immediately after any decision favorable to petitioner on the foregoing questions of law. Value is a matter of evidence and can not be decided otherwise. There is no evidence of such value, and hence no way of determining that any of the $200,117.09 is other than income as determined by respondent. The case of United States v. Carter, 19 Fed. (2d) 121, is different in at least one respect, that the amount held to be corpus of the decedent’s estate'was his share in business acquired during his lifetime in which at his death there was an unquestioned right of his estate.

It is held that the estate tax is a proper deduction to clearly reflect income for the period February 13, 1920, to December 31, 1920, and that the full amount of $200,117.09 is within gross income of such period.

Reviewed by the Board.

Judgment will ~be entered on 15 days’ notice, under Bule 50.

Milliken concurs in the result only.


author: Smith :

text:
    R. L. Heflin, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8100.
    Promulgated August 8, 1927.
    The payment by tbe petitioner of one-balf of its net profits in equal parts and in proportion to tbeir stock boldings to its two principal stockholders, in return for tbe pledging by tbe stockholders of private securities for tbe petitioner’s credit, constituted a distribution of profits and not an ordinary and necessary expense of carrying on tbe business.

      William S. Hammers, Esq., and H. D. Underwood, Esq., for the petitioner.

      William H. Lawder, Esq., for the respondent.

      The petitioner appeals from a determination of deficiencies in income and profits taxes for the fiscal years ended July 31, 1920, and July 31,1921, in the respective amounts of $9,316.18 and $9,530.75. For each year the respondent has refused to allow the petitioner to deduct as an operating expense one-half of its net income paid out to its principal stockholders under agreements whereby the stockholders pledged their personal securities for the petitioner’s credit in return for such portion of the petitioner’s net income.
    FINDINGS OF FACT.
    The petitioner is a Texas corporation with its principal office at Galveston. It is engaged in the business of purchasing cotton seed products for export tradé. The corporation was organized early in the year 1919 and began operations August 1, 1919. The capital stock authorized and outstanding during the years in question amounted to $20,000. It was all owned in equal shares by Kate Heflin and G. H. Gymer. The former was the widow of It. L. Heflin, who had conducted the business individually for a number of years prior to its incorporation. G. H. Gymer was, for many years, an employee and business associate of It. L. Heflin. During the years 1920 and 1921 he served as manager of the business and received as compensation for his services a salary of $3,600 for the first year and $5,000 for the second year.
    The business in which the petitioner was engaged was generally considered a hazardous one. There was often required the use of considerably more capital than was available to the corporation in order to operate to the best advantage. To obtain the necessary additional credit the petitioner entered into agreements with its two principal stockholders whereby the latter were each to assign over an equal amount of private securities to the petitioner’s bank for the credit of the petitioner and were to receive in return a one-fourth part each of the net profits of the business. Pursuant to these agreements the following instruments of assignment were executed:
    Whereas, it is contemplated that the corporation of E. L. Heflin, Inc. of Galveston, Texas, in the conduct and management of its business of exporting cottonseed products, etc., will require loans and advances of funds from its bankers, Hutchings, Sealy & Co. of Galveston, Texas, in excess of its capital stock and said capital stock being owned largely by Geo. H. Gymer of Galveston, Texas, and myself, and it being desirable that said bankers should be secured as far as possible in any loans or advances made said corporation of E. L. Heflin, Inc.
    Now, therefore, in consideration of the premises, and as a pledge to secure the said Hutchings, Sealy & Co. in any loans or advances which may be made by said firm of Hutchings, Sealy & Co. to the corporation of E. L. Heflin, Inc., during the season of 1919-1920, beginning August 1, 1919 and ending July 31, 1920, I have this day deposited with said Hutchings, Sealy & Co., the following deeds, documents, papers and securities, conditioned that the said Geo. H. Gymer shall deposit or cause to be deposited with said firm of Hutchings, Sealy & Co., securities, papers and documents of equal value as those now deposited by me, as a pledge also to secure any and all loans and advances which may be made to said corporation of R. L. Heflin, Inc., and under the same terms and conditions as the securities so deposited by me with said Arm of Hutchings, Sealy & Co.
    I further agree and bind myself that of such securities now deposited by me with Hutchings, Sealy & Co. as may not be negotiable, I will, upon demand of said Plutchings, Sealy & Co. to make them so, and further agree to execute any and all papers, deeds, releases, etc. as may be necessary to put the title to the property mentioned in any such papers or deeds, in Hutchings, Sealy & Co. should there be any default in the payment of any or all advances so made by said Hutchings, Sealy & Co. to said corporation, of R. L. Heflin, Inc., and should the same become necessary. And in the event I shall fail to do so, I hereby constitute and appoint John Sealy of Galveston-, Texas, my true and lawful attorney, to execute, in my name, all deeds, papers and other documents which may be necessary to accomplish the purpose of this agreement, hereby ratifying and confirming any and all lawful acts which my said attorney may do by virtue thereof:
    The deeds, documents and papers and securities mentioned above and which are now deposited with said Hutchings, Sealy & Co. are as follows:
    95 shares of the capital stock of the American Indemnity Co. of Galveston — value 186.6 per share-$17, 727.00
    100 shares of the capital stock of R. L. Heflin, Inc., par value_ 10,000. 00
    Total - 27, 727. 00
    (Signed) Mrs. Kate B. Heflin
    The first three paragraphs of the agreement executed by Geo. H. Gymer were identical with the first three paragraphs of the foregoing. The agreement then provided—
    The deeds, documents and papers and securities mentioned above and which are now deposited with said Hutchings, Sealy & Co. are as follows :
    100 shares of the capital stock of R. L. Heflin, Inc. of the par value of_$10,000.00
    Liberty bonds of the face value of $4300.00 but of estimated value of_ 4,050.00

      Second, Liberty Loan:

    Bonds Nos. 1,338,087, 1,338,088 and 1,338,089 each for $100.00_ $300.00
    Bond #191,107- 500. 00
    Bond #191,108- 500. 00

      Fourth Liberty Loan:

    Bonds Nos. 117,861 to 117,870, ten bonds of $100.00 each_ 1,000.00
    Bond #702669- 1,000.00
    Bond #2,761,733_ 1,000.00
    Total Liberty Bonds. 4,300.00

      My life insurance policy in the Great Western Life Insurance Oo. of Kansas City, Mo., now International Life Insurance Co., #GW 894, of the cash value of_ $1,503.00
    My life insurance policy in the Franklin Life Insurance Co. of Springfield, Ill., #89043, of the cash value of- 382.00
    15 shares of the capital stock of the American Indemnity Co. of Galveston, of the value of $186.66 per share, valued at- 2, 800.00
    2 shares of the capital stock of Dickinson State Bank, Dickinson, Texas_ 200. 00
    20 shares of stock of the Caldwell Oil Mill Co., Caldwell, Texas, of the par value of $100.00 per share, cost me_ 3, 000.00
    Deeds :
    Deeds to 9-13/100 acres of land out of Perry & Austin League, north bank of Dickinson Bayou, addition to town of Dickinson, Galveston County, Texas, and improvements, of the value of_ 4,100. 00
    Total_ 26, 035.00
    (Signed) Geo. H. Gymeb.
    The agreements were formally adopted by the petitioner at a stockholders’ meeting held July 31, 1919. The minutes of such meeting read as follows:
    Galveston, Texas, July 31st, 1919.

    At the Annual meeting of the Stockholders of R. L. Heflin, Inc. this day held in Galveston, the President stated:
    “ That in negotiating credit with the Company’s bankers, Hutchings, Sealy & Co., they had declined to extend to the company sufficient line of credit to enable it to transact a profitable business, stating that the Company’s capital of $20,000.00 was not sufficient to justify more than a moderate line of credit; that in attempting to arrive at a solution of the difficulty, he and Mrs. Kate E. Heflin had decided to make a proposition to the company which would properly finance it for the ensuing year; That he and Mrs. Kate E. Heflin would deposit with Hutchings, Sealy & Company personal collateral in such an amount as demanded by Hutchings, Sealy & Co. to secure line of credit needed by the Company for the transaction of its business, provided that he and Mrs. Kate E. Heflin -would receive 50% of the profits earned in the operation of R. L. Heflin, Incorporated, during the twelve months next succeeding, commencing August 1st, 1919 and ending July 31st, 1920, less necessary expenses, and that the company would receive 50 per cent of the profits during stated period.”
    Motion was made and unanimously adopted as follows:
    “ That the proposition made the Company by Mr. Geo. H. Gymer and Mrs. Kate E. Heflin to finance the business of the Company for twelve months, they 1o receive one-half of the profits earned in the transaction of the business of the company, less necessary expenses.”
    For the next fiscal year ended July 31, 1920, the stockholders executed similar instruments assigning approximately the same assets, and the agreements were duly approved by the petitioner at a stockholders’ meeting held July 31, 1920. The firm of Hutchings, Sealy & Co. with whom the securities were pledged, advanced to the petitioner the credit that was needed to carry on its business during the years 1920 and 1921. The petitioner gave to the bank its demand notes for the amounts advanced and paid interest thereon to the bank. These notes were usually paid when the petitioner realized upon the particular transaction for which they were given. Each note purported to be secured by a lien upon the bill of lading covering the shipment of the goods described therein, but the bills of lading were at all times in the possession of the petitioner. The credit with Hutchings, Sealy & Co. was increased by the assignment to it of the private securities of the stockholders at least to the extent of the value of such securities, exclusive of the capital stock of the petitioner which was pledged by the stockholders.
    For the fiscal years ended July 31, 1920, and July 31, 1921, the petitioner paid over to the stockholders one-half of the net income of the business amounting to $19,722.82 and $20,516.76 for the respective years. These amounts the petitioner charged to expenses and deducted from gross income upon its income-tax returns for those years. The respondent has refused to allow the deduction in computing the petitioner’s net taxable income.
   OPINION-.

Smith :

The only question to be decided in this appeal is whether the amounts paid out by the petitioner to its principal stockholders under the agreements above described come within the deductions permitted by section 234(a) (1) of the Revenue Acts of 1918 and 1921. The section, which is identical in both Acts, reads as-follows:

Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. * * *

There is no question raised as to the legality or the bona fides of the agreements entered into between the petitioner and its stockholders. Presumably the securities deposited with Hutchings, Sealy & Co. were, during the years involved, subject to the uses and purposes stated in the agreements.

We are of the opinion, however, that the payment of 50 per cent of the net profits of the business for the use shown to have been made by the petitioner of the additional credit provided by the pledging of the securities did not constitute an ordinary and necessary expense of carrying on the petitioner’s business. We do not know, in the first place, to what extent the additional credit was really necessary or was actually used by the corporation. The evidence is to the effect that the credit needed to carry on the business to the best advantage was at times greatly in excess of the company’s capital. There is not shown, however, any specific instance of the use of the credit provided by the pledging of the securities. As to the general method of conducting the business, G. H. Gymer deposed as follows:

Q. Now, the money that you borrowed for the corporation, Mr. Gymer, was practically all on short loans, wasn’t it, demand notes?
A. Most of it, averaging.
Q. Not over 10 days after payment?
A. No, they were indefinitely.
Q. Weren’t they demand notes?
A. They were demand notes, but at the same time we were never called upon to pay them, until we had shipped the goods, and were able to satisfy the notes.
Q. The fact is, in that ease, the bank was willing to hold those notes for you?
A. Yes, sir.
Q. And then accept payment from the goods that they held the notes against?
A. Yes, sir, exactly.
*******
Q. When you gave the notes with this memorandum to the bank, showing the cars it covered as security, did you furnish something to Hutchings, Sealy to indicate that they had a lien on that property?
A. Oh, the receipt itself states so.
Q. The trust receipt?
A. The trust receipt, yes, sir, and the ear numbers are cited on this trust receipt, together with the number of pounds contained, and the amount, the amount of the draft.

The total face value of the securities pledged including the $20,000 of capital stock of the petitioner was approximately $54,000. The petitioner paid to the stockholders approximately $20,000 for each of the years 1920 and 1921. This was not an ordinary expense.

The two stockholders to whom the money was paid owned all of the petitioner’s stock in equal shares and received proportionate parts of the money. The result would have been precisely the same if the company had paid out the money by regular dividends. In the light of the evidence before us the transaction was simply a distribution of the earnings of the corporation. Cf. Appeal of Universal Milking Machine Co., 4 B. T. A. 506.

Reviewed by the Board.

Judgment will be entered for the respondent.