author: Tkammell : Smith,

text:
    Samuel W. Weis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62126.
    Promulgated April 26, 1934.

      Fred 8. Weis, Esq., for the petitioner.

      Dean P. Kimball, Esq., and E. O. Adams, Esq., for the respondent.
   OPINION.

Tkammell :

The first and principal issue in this case is whether the petitioner was domiciled or had his legal residence in the State of Louisiana or in the State of Illinois during the taxable year 1929. In 1920 petitioner took up his abode in the city of Chicago, Illinois, and throughout the taxable year resided there with his wife, except for short periods of absence. Prior to 1920 petitioner was domiciled in Louisiana.

Petitioner and his wife filed their income tax returns for 1929 with the collector at New Orleans, and each reported one half of the total income. In auditing the returns respondent included in petitioner’s income certain amounts reported in the wife’s return, on the ground that during the taxable year petitioner was domiciled in Illinois, a noncommunity property state, and therefore the income could not be divided between petitioner and his wife, but the whole amount was taxable to him. Petitioner assigns this action of the respondent as error, contending that he never abandoned his original domicile in Louisiana, and that his residence in Illinois was only temporary. There is no controversy as to the amount of the gross income.

The respondent concedes that if the petitioner was domiciled in Louisiana during the taxable year, then all of the income in question was community income and as such could be reported one half by the petitioner and one half by his wife.

Change of domicile involves intention, coupled with a change of the place of actual abode. Intention is a state of mind, the satisfactory determination of which is often difficult, but certain general rules have been adopted by the courts as safe guides to follow in the solution of a problem such as we have here.

In determining the question of temporary residence or permanent domicile we are not limited to or necessarily bound by expressions of the party, but his intention is to be inferred rather from his conduct than declarations. “We may consider all fact's and circumstances that bear on the question at issue.” Rogers Hornsby, 26 B.T.A. 591, 593, and authorities cited. What, then, was petitioner’s intention, as evidenced by his conduct, in respect to changing his domicile in 1920 ?

In support of his contention that petitioner was domiciled in Illinois during the taxable year, respondent points to the following facts: (1) That when petitioner left Louisiana for Illinois in 1920 the reasonable expectation was that his residence in the latter state would be of indefinite duration; (2) he engaged in certain business activities there, including buying and selling securities, and furnishing money for the development of a chemical process for coating paper; (3) he sold his home in New Orleans; (4) he joined clubs in Chicago; and (5) he contributed extensively to charities there.

On the other hand, the evidence establishes the following additional, pertinent facts: (1) Petitioner clearly had no desire from personal choice to change his domicile from Louisiana to Illinois, and reluctantly took up his abode there for the sole purpose of placating his wife, and in the hope that he would be able, after a time, to pursuade her to return to Louisiana with him; his residence in Chicago was for an indefinite duration only in the sense that the exact date of his return to New Orleans to reside could not be definitely forecast; (2) his principal business interests were in Louisiana; (3) he qualified as a voter by paying his poll tax in New Orleans, and made no attempt at any time to acquire the right to vote or to engage in political activities in Illinois or elsewhere; (4) he contributed to Louisiana charities, retained membership in New Orleans clubs, and continued as trustee of a hospital there; he was born and reared in New Orleans, having made his home there until 1920; (5) it was his domicile of origin, it was the home of his parents to the time of their deaths, and his brothers and sisters were domiciled there; the old family home was there; (6) during the time he resided in Chicago with his wife he had occasion to execute deeds, leases, and other written instruments under seal, and in all such documents he described his legal residence as being in New Orleans, Louisiana; (7) in compliance with the provisions of the taxing statutes (see section 53 (b) (1), Kevenue Act of 1928, and similar provisions of prior acts) requiring individuals to make their returns to the collector for the district in which is located their legal residence, petitioner filed his income tax returns with the collector in New Orleans; and (8) petitioner did in fact return to New Orleans to continue his permanent residence there as soon as practicable after his wife obtained a divorce and there was no longer hope of conciliation.

The term “ legal residence ” as used in the taxing acts above referred to means “ domicile.” L. B. Peeples, 27 B.T.A. 879, 882.

In determining the question of what state was the domicile of the petitioner we must keep in mind that the respondent has determined that petitioner was domiciled in Illinois. That determination is presumptively correct. The petitioner has the burden of going forward to introduce testimony for the purpose of overcoming that presumption. On the other hand, all the facts and reasons upon which the respondent based his determination do not have the benefit of presumptive correctness attaching to them. If no testimony is introduced we must accept that determination as correct. When testimony has been introduced we must consider the weight thereof for the purpose of determining whether it overcomes the presumption of correctness attaching to the Commissioner’s determination. In determining the weight to be attached to testimony for the purpose of ascertaining whether it overcomes the presumption, we may take into consideration the fact that evidence has been introduced which carries with it another presumption, that is, that there is a presumption in favor of original domicile of birth against an acquired domicile in cases where the testimony is conflicting, as well as other rules of law as laid down by the courts in connection with the determination of domicile. Catlin v. Gladding, 4 Mason, 308; Prettyman v. Conaway, (Del.) 32 Atl. 15; Donaldson v. State, (Ind.) 78 N. E. 182; In re Lyon’s Estate, 191 N.Y.S. 260. The above rule proceeds from the view that abandonment or change of domicile is a matter of very serious nature, and an intention to make such a change requires proof by very satisfactory evidence. Delaware, etc., R. Co. v. Petrowsky, 250 Fed. 554. The courts have laid down the rule that proof of a change of domicile must be clear and convincing. In re Newcomb, (N.Y.) 84 N.E. 950, and in case of doubt, the presumption is that the domicile has not been changed. Ausbacher v. DeNevue, (La.) 13 So. 396.

While ordinarily the burden of proof as to change of domicile is upon the party who alleges it, in this case, the Commissioner having determined that the domicile was changed, the burden of proof is upon the petitioner to show that it was not. When testimony has been introduced for this purpose we can take into consideration the strictness of the proof required by the courts in connection with the change of domicile when once established and attach such weight to the testimony as we believe it is entitled to, considering all the facts, including the fact that Louisiana was the domicile of birth and the presumption against a change of domicile in cases of doubt or conflicting testimony.

The domicile of origin is not changed even by long continued absence if there is any intention of returning, United States v. Luria, 184 Fed. 643; aff'd., 231 U.S. 9, even though intention be doubtful, White v. Brown, 1 Wall. 217. And mere residence alone is neither conclusive nor sufficient evidence of a change of domicile, Mitchell v. United States, 21 Wall. 350; In re Barclay, (Pa.) 103 Atl. 274: White v. Stowell, (Mass.) 119 N.E. 121.

The rule is well stated, with abundant citation of authority, in Goodrich on Conflict of Laws, p. 31, as follows:

While exceedingly difficult questions may and do arise in settling the question of the acquisition of a domicile of choice, they come in the application of the rule, not the recognition of it. The domicile which a person once has, whether given by the law, or acquired through the exercise of choice, continues until another one is gained. Mere absence from a place does not lose it, however long that absence is continued, unless that absence is coupled with an intent to make a home in the new place. So an invalid, who has left home in search of health, with the hope of prompt return, may even give up all hope of returning, and yet retain the old domicile, if, upon examination of all the facts, he is not found to have settled upon some new spot as his home.

Considering all the facts and circumstances disclosed by the record before us bearing on the question of domicile, it is our opinion that the preponderance of the evidence is with the petitioner, and accordingly respondent’s action on this issue is reversed.

The next issue in order for consideration is whether the gain derived on the sale of stock of the Ilg Electric Ventilating Co. is taxable solely as ordinary income, or may at the petitioner’s election be taxed in part as ordinary income and in part as capital net gain.

The term u election ’’ in its legal sense means the choice of one of two rights or things, to each of which the party choosing has an equal right, but both of which he can not have, Carters Appeal (Conn), 22 Atl. 320; Hattersley v. Bissett (N.J.), 29 Atl. 187, as when a man is left to his oWn free will to take or do one thing or another, which he pleases, New v. Smith (Kan.), 145 Pac. 880; a choice between different things, Bowler v. Eisenhood (S.D.), 48 N.W. 136; the act of electing or choosing, State v. Hirsch (Ind.), 24 N.E. 1062.

Obviously one can not at his election choose to do two inconsistent things or exercise two inconsistent rights, nor a part of the one and a part of the other; he must choose all of the one or all of the other. Thus, where a debtor is under the alternative obligation to pay one hundred dollars or deliver one hundred bushels of wheat, he has the choice to do one or the other until the time of payment; he has not the choice, however, to pay a part in each. Smith v. Sanborn, 11 Johns, (N.Y.) 59.

The facts show that the petitioner and his wife reported in their returns a total profit of $171;685.50 from the sale of stock of the Ilg Electric Ventilating Co. during the taxable year. The stock had been owned and held by the petitioner for more than two years, in fact for many years, some of it having been acquired prior to 1920. The profit was reported as follows: In the petitioner’s return, as capital net gain $35,337.88, and as ordinary income $50,504.87. Corresponding amounts were likewise reported in the wife’s return.

From these facts it is clear that the petitioner did not elect to have the entire capital net gain taxed as such, but that he split the total amount and reported $70,675.76 as capital net gain and $101,-009.74 thereof as ordinary income.

If the petitioner had reported as capital net gain the entire amount determined by him as derived from the sale of capital assets during the year, and the respondent had increased the amount of the capital net gain so determined and included such increase in ordinary income, a wholly different situation would be presented. It could not then be said that the petitioner had not elected to have the capital ;net gain taxed as such; but under the facts here before us, where the amount of the capital net gain actually derived and reported .is not in controversy, and where the petitioner included in his return a portion of such gain as capital net gain and a portion as ordinary income, we can not say that he has elected to have the entire amount taxed as capital net gain.

Respondent contends, first, that the stock in question did not constitute a capital asset in petitioner’s hands for the reason that he was a dealer in tbe stock, and hence the profit derived from its sale was not capital gain. In the view we take of the issue, it is ‘unnecessary to decide this question. Respondent further contends that in any event, even if the profit constituted capital net gain, petitioner is not entitled to have it taxed in part at the rate applicable to capital net gain and in part as ordinary income, but that the entire amount is taxable as ordinary income. On this point we sustain respondent’s contention.

The pertinent provisions of the Revenue Act of 1928 are as follows:

SEC. 101. CAPITAL NET GAINS AND LOSSES.
(a) Tax in Case of Capital Net Gain. — In the case of any taxpayer, other than a corporation, who for any taxable year derives capital net gain (as hereinafter defined in this section), there shall, at the election of the taxpayer, he levied, collected, and paid, in lieu of all other taxes imposed by this title, a tax determined as follows: a partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner as if this section had not been enacted and the toial tax shall be this amount plus 12% per centum of the capital net gain.
*******
(c) Definitions. — For the purposes of this title— *******
(5) “ Capital net gain ” means the excess of the total amount of capital gain over the sum of (A) the capital deductions and capital losses, plus (B), the amount, if any by which the ordinary deductions exceed the gross income computed without including capital gains.

A taxpayer may elect, under the above quoted statute, to have all of the capital net gain, computed on the basis of all the capital transactions of the taxable year, taxed at the special rate of 12% percent, but he may not have the net gain resulting from one capital transaction taxed at that rate and the net gain from another such transaction taxed as ordinary income. The entire amount of the capital net gain derived during the taxable year must be treated as capital net gain, or as ordinary income.

In DeLancey Nicoll, 16 B.T.A. 868; aff'd., 41 Fed. (2d) 1008, we held that a taxpayer could not return as capital net gain the profit realized upon the sale of one block of securities and deduct from ordinary income a loss sustained upon the sale in the same year of another block of securities. In that connection, we said:

Obviously, this definition of “capital net gain” (above quoted) must comprehend the net result of all transactions during any taxable year, involving the sale or exchange of capital assets, provided such result represents a net gain to the taxpayer. [Emphasis supplied.]

In Lu Frisk Thomas, 25 B.T.A. 810, and J. W. McCulloch, 29 B.T.A. 67, 73, we definitely held that under section 101 (a) of the 1928 Act, supra, and section 208 (b) of the 1926 Act, both of which contain the same provisions, the taxpayer might not elect to treat the gain derived during the taxable year from the sale of capital assets in part as capital net gain and in part as ordinary income. To that extent our decisions were correct. However, in each case the respondent included in capital net gain the entire amount of profit derived from the capital assets, and in each instance we approved his determination. On the latter point we now think our decisions in the two cases last cited were erroneous, and they will not be followed in the future. We should have reversed the respondent’s determinations and held that the entire amount of gain in each case should be included in and taxed as ordinary income in the absence of an election by the taxpayer to have it all taxed as capital net' gain.

The entire profit derived from the sale of capital assets, where the taxpayer does not elect to have such entire amount taxed as capital net gain, must be included in and taxed as ordinary income. It is obvious, we think, under the plain language of the statute, unless the taxpayer elects to have the entire amount taxed at the 12y2 percent rate it can not be said that he has elected to have the capital net gain for the tamable year so taxed, and in the absence of such an election the entire amount must be taxed as ordinary income.

In this connection respondent has raised the issue that, if we hold the profit above referred to is taxable as capital net gain, then the deduction for charitable contributions should be computed on the basis of the ordinary net income and should not take into account the capital net gain. The conclusion reached on the preceding issue renders it unnecessary to consider this question.

In his answer respondent raised an issue respecting the deduction by petitioner of the amount of $750 as charitable contributions representing donations of $200 to the Chicago Galleries Association, $300 to Wexler Child Education, and $250 to the Ravinia Guarantee Fund. The parties later stipulated that the first two items were not properly deductible in the income tax return of the petitioner for the year 1929, and apparently petitioner does not now contest respondent’s contention on the last item, since it is not referred to in petitioner’s brief. However, this last item represents a contribution to guarantee an opera and clearly, we think, does not come within the classification of a contribution to charity. Respondent’s contention on this point is sustained.

The remaining issue relates to the deduction of a bond commission. In 1929 petitioner paid $15,000 as a commission for the placing of a bond issue in the amount of $275,000, the proceeds being used to retire bonds of like amount maturing in that year. Petitioner deducted the entire amount of the commission in his return for the taxable year. Respondent allowed, that portion of the commission attributable to the loan period falling within 1929 and disallowed the balance, holding that the commission was not deductible in its entirety in the year of payment, but should be spread over the life of the loan.' Respondent’s action on this issue is approved. U.S. Playing Card Co., 15 B.T.A. 975; Julia Stow Lovejoy, 18 B.T.A. 1179; Sigmund Spitzer, 23 B.T.A. 776; Western Maryland Ry. Co. v. Commissioner, 33 Fed. (2d) 695.

Reviewed by the Board.

Judgment will be entered u/nder Rule 50.

Adams concurs in the result.

Smith,

dissenting: The majority opinion stands for the proposition that where a taxpayer files an income tax return and reports a part of the profit from the sale of capital assets as liable to ordinary income tax and the balance as capital net gain, the taxpayer has failed to elect that the gain should be taxable as capital net gain. In such a case I think the taxpayer has not failed to elect that the profits should be taxed as capital net gain and if it is more advantageous that the tax be computed upon the basis that the entire profit was capital net gain, the taxpayer is entitled to have his tax liability computed accordingly. The taxpayer should not be prejudiced by the fact that he was not aware that all of the profit should be treated as capital net gain instead of only a portion thereof.

AeuNdell agrees with this dissent.


source: Caselaw Access Project

author: Ahóndele :

license: Public Domain

text:
    William L. James, Petitionee, v. Commissioner of Internal Revenue, Respondent. Peerless Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 65302, 70278.
    Promulgated April 26, 1934.

      M. M. MattMessen, Esq., for the petitioners.

      Warren F. Wattles, Esq., for the respondent.
   OPINION.

Ahóndele :

In the case of petitioner James, the return was filed on March 15, 1929, and the deficiency notice was mailed on January 9, 1933. The respondent alleges fraud to remove the case from the operation of the two-year limitation period prescribed by section 2? 5 of the He venue Act of 1928. The evidence fails to convince us that there was fraud. Petitioner James testified and explained fully his failure to report the sale of stock of Pacific Stages, Inc. His testimony in part was as follows:

My method of reasoning on that, whether right or wrong, was simply that we received the contract and a certain amount of money that was to he turned over for stock in another company, and all we were doing was trading stock for money in one case and getting stock back, and there was no income, as far as that was concerned. That was my method of thinking of it, whether it was right or wrong.

The petitioner prepared his return himself, without assistance or advice from anyone versed in the tax law. He received no cash for himself out of the transaction and considered that he had not realized any income. We are unable to find in the evidence any indication of fraud with intent to evade tax, and we accordingly hold that respondent is barred from assessment and collection of the deficiency asserted against petitioner James. This holding makes it unnecessary to decide whether the petitioner was right or wrong in his conclusion that he had realized no income from the sale of his stock.

In the case of the Peerless Investment Co. the respondent determined that gain was realized to the extent of the difference between the value of the contracts, plus cash, turned in for stock and the cash received plus the discounted value of the notes received in 1929. He determined that the purchase contracts of the Transport Co. when turned in to petitioner had a value of $36,192.49. His computation, as explained by counsel at the hearing, is as follows:

Amount realized on contracts:
Cash paid in by James at organization_ $9,851.27
Cash paid by Transport Co_ 10,356.24
“ “ “ “ “_ 30.000.00
Notes of Transport Co., discounted_ 59,361.76
109, 569.27
Less:
Value of contracts_$36,192.49
Cash paid in—
By James_ 9, 851. 27
By Transport Co_ 10, 356.24
- 56,400.00
Taxable gain_ 53,169.27

The petitioner reported a profit of $39,069.29 which it arrived at by the following method:

Amount realized on contracts:
Cash paid by Transport Co_$10,356.24
“ “ “ “ “_ 30,000.00
Notes of Transport Co., discounted_ 59,361. 76
99,718.00
Less:
Value of contracts when received_ 60,648.73
Profit_ 39, 069.27

Petitioner subsequently filed claim for refund of a portion of the tax paid, and it now claims that it realized no income from the transactions with James and the Transport Co. We agree with petitioner in saying it is obvious that there was no gain to it in the original transaction with James and his associates who turned in their contracts and $9,851.27 cash for stock of petitioner. That was purely a capital transaction and respondent has not asserted a tax on it. It is the next step, the liquidation of the contracts by the Transport Co., that the respondent asserts gave rise to gain. Petitioner argues that this was not a sale or exchange, but a mere conversion of capital assets, and that even if it were a sale or exchange the contracts had a value of $90,000 when turned in to it, so that the receipt of that amount in cash and notes would give rise to no gain.

We are unable to agree with petitioner’s argument that the conversion of capital assets may not give rise to gain or loss. The disposition of capital assets for a sum in excess of their cost, or other basis, clearly results in income. Had the petitioner in the present case sold its contracts to outside interests, undoubtedly gain or loss would be recognized. Looking at the other side of the ledger, outstanding capital stock is a capital item, yet the receipt of it by the issuing corporation in satisfaction of an indebtedness may result in gain or loss. Commissioner v. Woods Machine Co., 57 Fed. (2d) 635; Commissioner v. Boca Ciega Development Co., 66 Fed. (2d) 1004. Where upon disposition of an asset, whether it be through sale, exchange, or redemption by the obligor, the amount received is in excess of the basis, income is realized. The result is an “ accession to income ” which is within the scope of the taxing act. United States v. Kirby Lumber Co., 284 U.S. 1.

The respondent has used as a basis in determining the amount of the gain a figure which he determined represented the value of the contract rights when turned in to petitioner for stock. It is urged by petitioner that the contract rights had a value of $90,000, which was the amount that the Transport Co. was obligated to pay. We assume that if the matter were seriously urged, petitioners would add to this the $10,356.24 which the Transport Co. withheld from the initial payment to meet contingent claims and released to petitioner in 1929. At the time the contracts were turned in for stock the Transport Co. was not obligated to pay $90,000. At that time it had an option to pay either that sum or one half of the profits from the operation of Pacific Stages, Inc., for a three-year period. Obviously the Transport Co. would elect to pay the lower of the two amounts, and at the time of petitioner’s receipt of the contract it was not known which election the Transport Co. would make. It was not until December 1929 that the Transport Co. elected to pay $90,000. The record contains no evidence directed toward establishing the value of the contracts. The respondent has determined a value which is presumptively correct, and the petitioner has failed to meet the burden which is upon it of establishing error in the respondent’s determination. Reinecke v. Spalding, 280 U.S. 227; Welch v. Helvering, 290 U.S. 111. Accordingly, decision in this case will be entered for the respondent.

Decision of no deficiency will be entered in Docket No. 70878. Decision for the respondent will be entered in Docket No. 65802.


author: Smith:

text:
    Walter L. Ross, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73282.
    Promulgated April 26, 1934.

      W. A. Eversman, Esq., E. H. McDermott, Esq., and Ellsworth 0. Al/oord, Esq., for tbe petitioner.

      A. H. Fast, Esq., and H. D. Thomas, Esq., for the respondent.
   OPINION.

Smith:

The respondent determined a deficiency of $12,948.25 for the calendar year 1931 against the petitioner. The petition alleges:

(a) The Commissioner erroneously held that all payments of commission installments made under a certain trust agreement dated June 1, 1922, were taxable to the petitioner despite the fact that five-tenths (5/10ths) of all commission installments payable under the said trust agreement were paid to assignees under assignments executed by the petitioner dated December 22,1923; and despite the fact that all payments of commission installments are taxable only in the year 1922.
(b) The Commissioner erroneously held that all interest accrued and paid during 1931 on the deferred commission installments, was taxable to the petitioner, although fifty per cent (50%) of all interest due and payable under the said trust agreement of June 1, 1922, was paid to the petitioner’s assignees under the aforesaid assignments dated December 22, 1923.

The facts were stipulated.

So far as is material the facts may be briefly stated as follows.

Petitioner Walter L. Ross resides in Cleveland, Ohio, and for many years was connected with the Toledo, St. Louis & Western Railroad Co., otherwise known as the Clover Leaf. He was its president for a number of years and acted as its receiver from October 1914 to January 1, 1928.

During the receivership stockholders in the Clover Leaf formed a stockholders’ protective committee and deposited their stock with the committee, which issued certificates of deposit therefor. . Thomas H. Hubbard and Edward F. Searles were the owners of certificates of deposit representing 46,515 shares of preferred stock and 31,885 shares of common stock. In February 1918 Hubbard and Searles entered into an agreement with the petitioner by which they empowered him to sell their certificates, or to enter into a reorganization of the Clover Leaf in their behalf, agreeing to pay him 50 percent of the proceeds of the sale or reorganization over and above any further capital investment by them, and Hubbard and Searles were to receive the remaining 50 percent of the proceeds.

Through petitioner’s efforts the Hubbard and Searles stock in the Clover Leaf was sold June 1, 1922, for $2,744,000 to the Clover Leaf Co., a holding corporation organized and owned by O. P. and M. J. Yan Sweringen, well known railroad promoters and operators. The Yan Sweringens at that time were in control of the New York, Chicago & St. Louis Eailroad Co. (Nickel Plate) and the Lake Erie & Western Eailroad, both of which were consolidated with the Clover Leaf in 1923 to complete their system from the Mississippi and Lake ports to the Atlantic seaboard. The consolidation was named “ The New York, Chicago and St. Louis Eailroad Company.”

Hubbard and Searles both died before the sale of the stock and before the transaction was consummated, but it was carried out by their personal representatives by contract dated June 1, 1922, to which the personal representatives, the petitioner, the Clover Leaf Co., and the Union Trust Co. of Cleveland, Ohio, as trustee, were parties.

It was provided in this contract in substance that the buyer, Clover Leaf Co., should pay to the sellers, the Hubbard and Searles estates, the sum of $1,372,000 by issuing and delivering to the sellers its serial coupon notes in that amount, maturing as follows: $34,300 par value of said notes shall be payable on the first day of June, and on the first day of December in each year commencing on the first day of June 1924, and ending on the first day of December 1943. For the first five years the notes were to bear interest at 314 percent per annum, for the second five years at 4% percent per annum, and for the balance of the period at 5 percent per annum. The contract further provided that the buyer, Clover Leaf Co., should pay the petitioner’s commission of $1,372,000 and that this should be accomplished by the buyer paying to the trustee for the benefit of the petitioner said sum in 40 equal semiannual installments of $34,300 each, the installments to be payable on the first day of June and the first day of December in each year, commencing on June 1, 1924, and continuing until December 1, 1943, with interest thereon at the same rates as provided in the notes given to the sellers. No notes or other negotiable instruments were given petitioner evidencing these payments, but this contract providing for the payment of his commission was accepted by the petitioner in full satisfaction of his rights against the sellers, the Hubbard and Searles estates, of his rights to the 50 percent commission under the contract of 1918.

The stocks sold under the contract, together with other stocks, were deposited with the trustee as security for the performance by the buyer of its obligations under the contract. Many provisions were contained in the contract for other protective measures in behalf of petitioner or his assigns, and the sellers or the holders of the notes, but the use of these has been unnecessary as the installment payments and interest have been promptly made, up to and including the taxable year 1931.

On December 22,1923, the petitioner made, executed, and delivered separate written assignments to the following individuals (members of petitioner’s immediate family and their lawful offspring) of the following undivided portions of all his right, title, and interest in the commission, which was payable in installments, and of the interest which was to accrue on the installments remaining unpaid under the agreement of June 1,1922, together with all rights, powers, privileges, remedies, and benefits “ which an owner of a beneficial interest has or may have under said agreement” of June 1, 1922:

Assignee Portion
Mildred Ross Crow and Harker A. Crow_
George S. Ross and Lucille B. Ross_ -£v
Trustees for the benefit of the lawful offspring of Mildred Ross Crow_ fs
Trustees for the benefit of the lawful offspring of George S. Ross_ iV

Each of the assignments was identical in form except as to amount and name of assignee. The following is a copy of one of them:

For value received, I hereby give, grant, assign, transfer and set over to Mildred Ross Crow and Harker A. Crow, of Toledo, Ohio, all my right, title, and interest in and to an undivided three-twentieths (3/20ths) share of my commission and the interest accrued and hereafter to accrue thereon, under and by virtue of, and as specified in, a certain agreement dated June 1, 1922, among Arthur T. Walker, as domiciliary executor in Massachusetts of the will of Edward E. Searles, deceased, Arthur T. Walker and Lewis L. Delafield, as ancillary executors in New York of the will of Edward E. Searles, deceased, John Hubbard, Sibyl E. Darlington and Anna Weir Hubbard, as executors of the estate of Thomas H. Hubbard, deceased, therein referred to as “ Sellers ”, The Clover Leaf Company, therein referred to as “ Buyer ”, said Walter L. Ross, therein referred to as “Agent ”, and The Union Trust Company of Cleveland, Ohio, therein referred to as “ Trustee ”, and a supplementary agreement thereto dated October 25, 1923, among said The Clover Leaf Company, said Walter L. Ross and said The Union Trust Company, reference to which agreements is hereby expressly made, together with any and all rights, powers, privileges, remedies and benefits which an owner of a beneficiary interest in such share has or may have under said agreements or any other further agreements made or entered or to be made or entered into in respect of the subject matter of the same. Provided, however, that assignees shall pay federal income taxes, if any, which may be assessed against assignor or his estate upon the property or the interest herein assigned.
Dated at Toledo, Ohio, December 22nd, 1923.
[Signed] Waithb L. Ross.

These assignments were made without monetary consideration. The trustee, after notification, paid to each assignee his or her share of the semianimal installments and interest, and during the taxable year 1931 made payments to the assignees as follows:

Each of the assignees included the above, amounts in his or her income tax return for 1931 and paid the tax thereon. Petitioner did not include same in his income tax return for the taxable year, but they were included therein by the respondent, thus giving rise to the deficiency in controversy.

Petitioner did not include in his income tax return for 1922 the fair market Avalué of his interest in the contract of June 1, 1922, and for that year and 1923 included only the interest received on the deferred payments provided for in the contract. In the following years, including the taxable year 1931, he included in his income tax returns the amounts of installments and interest received by him from his remaining one-half interest in the contract of June 1, 1922. Petitioner at all times kept his books on the cash receipts and disbursements basis.

Petitioner contends (1) that the entire fair market value of his interest in the contract of June 1,1922, was taxable to him as income in 1922, and that it is erroneous to include any part thereof in his taxable income for 1931; (2) that petitioner is not taxable on any of the payments of installments made to the assignees in 1931; and (3) the interest paid to the assignees in 1931 is not taxable to him.

Relative to the first point it is true that petitioner’s interest in the contract may be considered as property and that it had considerable value, but under the circumstances of this case it may not be successfully claimed that it was taxable in 1922 only. Petitioner was on the cash receipts and disbursements basis and of his own volition returned his portion of the installment payments and interest in the years when received, and his assignees of the other 50 percent did likewise. Limitation has now run as to 1922, and petitioner will not now be permitted to change his theory of the time or manner of taxing his interest in said contract. A similar situation arose in the cases of Commissioner v. Moore, 48 Fed. (2d) 526, certiorari denied, 284 U.S. 620; Commissioner v. Garber, 50 Fed. (2d) 588; and Teck Hobbs, 26 B.T.A. 241.

In the Moore cage the Court of Appeals .for the Tenth Circuit said:

Conceding for the argument, that the statute and regulation afforded the taxpayers the election of treating the obligations of the purchaser as the equivalent of cash, the taxpayers otherwise elected; they may not now change that election, particularly since the result would be to throw all of the profit into a year where collection is barred by limitation.

Commissioner v. Garber, supra, is to the same effect.

The Board in the Tech Hobbs case, supra, quoted from Commissioner v. Garber, supra, as follows:

The facts and the law in the instant ease are identical with those in Commissioner of Internal Revenue v. M. C. Garter and related cases, decided by the Tenth United States Circuit Court of Appeals on March 14, 1931, 48 F. (2d) 526. The respondents in that case were the associates of the respondent in the present suit. In that ease, the court, holding, as we do, that the trilateral transaction whereby the taxpayers sold their Garfield oil stock for $500,000 cash and $2,500,000 in deferred payments, gave rise to no income in 1918 save as to the cash payment, said: [The court here quotes from the opinion of the Tenth Circuit].

With this holding we a/re in entire accord. Such a view is based upon sound public policy as well as upon written lano. It malees income takoable lohen it is received by the citizen. It precludes the possibility of a sudden change of theory after the statute of limitations has run. It does mathematical justice betioeen government and taxpayer. [Italics supplied.]

See also Commissioner v. Liberty Bank & Trust Co. (C.C.A., 6th Cir.), 59 Fed. (2d) 320; Askin & Marine Co. v. Commissioner (C.C.A., 2d Cir.), 66 Fed. (2d) 776; affirming 26 B.T.A. 409; Moran v. Commissioner (C.C.A., 1st Cir.), 67 Fed. (2d) 601; affirming 26 B.T.A. 1154; Crane v. Commissioner (C.C.A., 1st Cir.), 68 Fed. (2d) 640; affirming 27 B.T.A. 360; Swartz, Inc. v. Commissioner (C.C.A., 5th Cir.), 69 Fed. (2d) 633.

Upon this point our decision is' for the respondent.

The next question relates to the assignments by petitioner of parts of his interest under the contract. We stated in William Ernest Seatree, 25 B.T.A. 396:

It is well settled that an assignment of income does not relieve the assignor of the tax thereon, but that if property or property rights are assigned the income subsequently arising therefrom is not taxable to the assignor, for the reason that the property no longer belongs to him and therefore the income from such property belongs, not to him, but to the new owner. * * * [Citing cases.]

This is the general rule as established by Board and court decisions. The difficulty arises in its application. It is contended here by respondent that the commissions payable to petitioner were for personal services rendered by him and that this case is governed by the rule laid down in Lucas v. Earl, 281 U.S. 111, and like cases, while, on the other hand, petitioner urges that petitioner’s rights under the contract were property rights resulting from services already performed and completed and were assignable, and that this case is governed by the rule laid down in Hall v. Burnet, 54 Fed. (2d) 443.

In the instant case petitioner performed certain services between 1918 and 1922, entitling him to certain compensation. When the transaction was concluded a contract was entered into providing for the manner and time of the payment of the compensation.

The contract is an elaborate one and provides both for the payment of the purchase price to the sellers of the stock, and of the commission to petitioner. Both obligations are secured by the deposit of several millions of securities with the trustee, and for both the payments are the same, except that the seller’s interest is evidenced by negotiable notes, while that of petitioner is merely by the contract. There is no doubt that the interest of the sellers in the contract is a property right, and we see no reason why that' of petitioner is not also.

We think the case of Hall v. Burnet, supra, is applicable here. Counsel for respondent is mistaken in his assertion that this case was overruled by the subsequent case of Hall v. Helvering, 68 Fed. (2d) 399, involving the same facts. The latter case related to a question that was not considered in the former and its decision did not affect that in the former case.

It should be kept in mind that the assignments were not of future earnings or salary which were not in existence, but were of an interest in an existing contract given in payment for past services. Cf. Copland v. Commissioner, 41 Fed. (2d) 501; Commissioner v. Field, 42 Fed. (2d) 820; Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 286 U.S. 565; Rose v. Commiissioner, 65 Fed. (2d) 616; William Ernest Seatree, supra.

We think the language of the assignments is sufficient to indicate an irrevocable assignment of a part of the corpus and that the payments made to the assignees are not inclüdable in the taxable income of the petitioner.

In view of the conclusions we have reached it is not necessary to determine the fair market value, if any, of the June 1,1922, contract, nor the third point raised by petitioner that in no event is the interest received by the assignees taxable to him.

Judgment will be entered under Rule 50.


author: Van Fossan: Sternhagen,

text:
    Great Western Power Company of California, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 48617.
    Promulgated April 26, 1934.

      Thomas B. Dempsey, Esq., for tbe petitioner.

      F. B. Shearer, Esq., for the respondent.
   OPINION.

Van Fossan:

This proceeding was brought to redetermine defi'ciencies in the income taxes of the petitioner for the years 1924,1925, and 1926 in the amounts of $26,293.40, $187,883.90, and $133,333.99, respectively.

Several allegations of error were disposed of by stipulation, leaving for decision the following questions:

(1) The proper treatment of the sum of $245,363.02 claimed as a deduction from income for 1924, the item representing unamortized bond discount, expenses, and premiums paid in connection with a bond issue retired in 1924 before maturity, in part by payment of cash and in part by the exchange of the bonds for bonds of a later issue.

(2) The similar question as to a sum of $868,189.12 applicable to a second bond issue redeemed for cash and retired in 1925 before maturity.

The petitioner also asserts that the adjustments covered by stipulation and the second assigned error will result in an operating loss which should be carried forward as a deduction in determining its net taxable income for the year 1926.

The facts were stipulated, and, so far as material to the issues, are substantially as follows:

1. At all times herein material the Great Western Power Company of California, hereinafter called the petitioner, was a public utility corporation engaged in the generation of electricity and its distribution in and about the cities of San Francisco, Oakland, Sacramento, and others in central California. As a public utility the petitioner was subject to the jurisdiction of the California State Railroad Commission and kept its books on the accrual basis in accordance with the classification of accounts prescribed by the said commission. The petitioner’s income tax returns for the years herein involved were made on the accrual basis.
2. On March 1, 1919, the petitioner executed a trust indenture entitled “ First and Refunding Mortgage ”. Pursuant to the said indenture the petitioner has issued four series of its “ First and Refunding Mortgage Sinking Fund Gold Bonds”. The individual series of these bonds have been styled “ Series A 6% ”, “ Series B 7% ”, “ Series C 6% ”, and “ Series D 5%% ” respectively, but hereinafter for the sake of brevity the various issues will be referred to merely as the “ Series A 6’s ”, “ Series B 7’s ”, etc. Likewise the indenture will hereinafter be referred to as the “Refunding Mortgage”. All of the Series B and Series D bonds which may be material to the present controversy were authorized as set forth in certain resolutions of the petitioner’s board of directors dated December 7, 1920, April 8, 1921, June 21, 1921, February 5, 1925, February 5, 1925, May 15, 1925, and September 25, 1925.
3. On August 1, 1920, the petitioner executed a second trust indenture, hereinafter referred to as the “ Mortgage Indenture ”.
4. During the year 1920 the petitioner, pursuant to the terms of the Mortgage Indenture, issued and sold $5,000,000 face value of its General Mortgage 8 per cent Gold Bonds dated August 1, 1920, and due August 1, 1930. These bonds, which will hereinafter be referred to as the “ General Mortgage 8’s ”, were, under the provisions of the Mortgage Indenture, convertible under certain conditions into Series B 7’s, and in 1922 the holders of $4,671,100 face value, thereof actually made such conversion.
5. On February 1, 1921, the petitioner executed a third trust indenture, hereinafter referred to as the “ General Lien Indenture.”
6. During the year 1921 the petitioner, pursuant to the provisions of the General Lien Indenture, issued and sold $2,500,000 face value of its Genez'ai Lien 8 per cent Gold Bonds dated February 1, 1921, and due February 1, 1936. These bonds, which will hereinafter be referred to as the “ General Lien 8’s ”, were sold at a discount of $150,000 and the expense of issuance was $22,283.54. The General Lien 8’s were convertible under certain circumstances into Series B 7’s, and on August 1, 1924, the holders of $2,354,500 face value thereof actually made such conversion.
7. Prior to December 31, 1923, the petitioner had purchased and retired $11,000 face value of the General Lien 8’s and the unamortized discount and expense of issuance applicable thereto was charged off as a loss in the year of retirement.
8. On August 1, 1924, pursuant to a resolution adopted by the petitioner’s board of directors on May 8, 1924, the holders of $2,354,500 face value of the General Lien 8’s exchanged them for a like amount of Series B 7’s and received, in addition to the Series B bonds, a cash premium of $117,725. Such exchange was made in accordance with the provisions of the option granted by the General Lien Indenture. The unamortized discount and expense applicable to such converted bonds was, on August 1, 1924, $126,176.97 and the expense of conversion was $1,461.05. The sum of the three items named: The pz'emium paid, unamortized discount and expense of conversion, was $245,363.02, of which the respondent has allowed as a deduction for the year 1924 only $2,027.96 and for the year 1926 only $8,735.78.
The petitioner contends that the full amount of $245,363.02 is allowable as a deduction for the year 1924, whereas the respondent contends that such amount should be amortized over the life of the Sei’ies B 7’s which were exchanged for the General Lien 8’s. If the $245,363.02 be allowed in full as a deduction for the year 1924, the petitioner’s net income for the year 1926 as shown in the deficiency letter may be increased by the sum of $8,735.78.
9. As of August 1, 1924, the petitioner purchased for cash and retired all of the General Lien 8’s which remained outstanding after the conversion referred to in paragraph 8. These outstanding bonds, which were of a face value of $134,500, were purchased by the petitioner at a premium of $6,725; the unamor-tized discount and expense applicable to such bonds on August 1, 1924, was $7,207.82 and the expense of retirement was $83.46. The sum of the three items named: to wit, premium paid on retirement, unamortized discount and expense, and expense of retirement, is $14,016.28, of which the respondent has allowed as a deduction for 1924 only $5,464.08. The respondent now concedes that the balance of $8,552.20 is also an allowable deduction for the year 1924.
10. During the year 1921 the petitioner issued its second series of bonds under the refunding mortgage. These bonds, the Series B 7’s, were dated August 1, 1920, and were due August 1, 1950. ,
11. The said Series B 7’s were issued to a face value of $8,500,000 and were disposed of as follows:
Par value Disposal
$5, 000, 000 Delivered to the trustees under the General Mortgage Indenture and held by them as additional security for the General Mortgage 8’s.
$2, 500, 000 Delivered to the trustees under the General Lien Indenture and held by them as additional security for the General Lien 8’s.
$1, 000, 000 Sold to the public in 1921 for cash at a discount of $100,000.
$8,600, 000 Total issued.
The expense of issuing the entire Series B was $49,548.14.
12. The $5,000,000 face value of Series B 7’s delivered to the General Mortgage trustees were disposed of by them as follows: $4,671,100 face value were exchanged in 1922 for a like amount of General Mortgage 8’s outstanding in the hands of the public and the remaining $328,900 were returned to the petitioner by reason of the cash redemption after the call date of a like amount of General Mortgage 8’s. None of the Series B 7’s so returned to the petitioner were thereafter re-issued.
13. The $2,500,000 face value of Series B 7’s delivered to the General Lien trustees were disposed of by them as follows: $2,354,500 were exchanged on August 1, 1924, for a like amount of General Lien 8’s outstanding in the hands of the public and of the remainder, $145,500 face value, $11,000 face value were returned to the petitioner by reason of the latter’s retirement and delivery to the trustees for cancellation of a like amount of General Lien 8’s which the petitioner had purchased from the public for cash, and $134,500 were returned to the petitioner by reason of the cash redemption after the call date of a like amount of General Lien 8’s. None of the Series B 7’s so returned to the petitioner were thereafter reissued. In addition to the $474,400 face value of Series B 7’s which were reacquired by the petitioner as indicated above, $603,000 face value of the Series B 7’s were reacquired by the petitioner prior to June, 1925, and as to such bonds there is no dispute.
14. In 1925 the petitioner began and consummated a program of partial refinancing which resulted in the retirement of its outstanding Series B 7’s and the issuance of a fourth series of bonds under the “ Refunding Mortgage ”. These new bonds, the Series D 5%’s were dated February 1, 1925, were due February 1, 1955, and bore interest at the rate of 5% per cent per annum. The following is a tabular analysis of the retirement of the Series B 7’s:

The following is a tabular analysis of the issuance of the Series D 5^’s:

All of the Series B 7’s were redeemed for cash. The amounts necessary for the June, 1925, and July, 1925 redemptions and for the payment of the expense item of $9,447.92 were taken from the general funds in the petitioner’s treasury. The amount of cash necessary for the August 1, 1925, redemption was $7,420,500. This amount was derived from the following sources:

By the previous issuance and sale of $7,000,000 face value of Series D S^’s at a discount of 5%_$6, 650,000
Petitioner’s general funds (including $141,803.32 representing interest accrued on the $7,000,000 of bonds from February 1, 1925, to date of issuance)_ 770,050
$7,420, 050

The amounts of $6,650,000 and $141,808.82 indicated above as derived from the sale of Series D 5^’s were not received by the petitioner, but were paid by the purchasers to the Bank of America and held in escrow until August 1, 1925, and were then paid directly to the trustees under the “Refunding Mortgage.”

During the year 1925 the Railroad Commission of California, pursuant to application filed by the petitioner, issued its opinions and orders dated February 5, 1925, May 27, 1925, and October 21, 1925, and numbered respectively 14541, 14979 and 15544, granting permission to the petitioner to issue and sell the several installments of Series D 5% per cent refunding mortgage bonds.

15. The petitioner contends that the sum of $S6S, 189.12 representing the items “ Premiums Paid ” — $728,828.72, “ Unamortized Discount and Expense $129,912.48 and “ Expense of Retirement ” — $9,447.92 shown above in connection with the retirement of the Series B 7’s constitutes an allowable deduction for the year 1925.

The respondent contends (a) that said sum of $868,189.12 (including also the unamortized portion of the amounts referred to in paragraph (8) hereof) should be treated as part of the capital cost of refinancing and refunding the petitioner’s bonded indebtedness, and should be treated in its entirety as applicable to the Series D 5%’s maturing February 1, 1955, and amortized over the remaining life of the Series D 5%’s; (b) that $7422600 sa^ sum ^011^ treated as applicable to the Series D 5%’s to be amortized over their remaining $6 745 500 life; (c) that the sums of $674,550, $117,989.72, 42,2506 exPense °i retirement and the unamortized portion of the amounts referred 'to in paragraph 8 hereof should be treated as applicable to the Series D 5y2’s and amortized over their remaining life; or (d) that at least 17420050 amount referred to in (c) should be treated as applicable to the Series D 5%’s and amortized over their remaining life.

16.In determining the deficiencies for the years 1924, 1925 and 1926 the respondent allowed deductions in respect to the petitioner’s General Lien 8’s, Series B 7’s and Series D 5%’s as indicated below:

17. In addition to the adjustments to the petitioner’s tax liability which may result from the foregoing facts, the petitioner is entitled to the following deductions from the amounts of net income indicated in the notice of deficiency: [Here follows a list of deductions, aggregating $1,220 for 1924, $26,558.76 for 1925, and $11,92S.18 for 1926, to which it is agreed petitioner is entitled and which will be allowed in settlement under Bule 50.]
18. The amounts of unamortized discount and expense, premiums paid, and expense of retirement applicable to the General Lien 8’s (referred to in paragraph 8 hereof) were not charged to profit and loss on the petitioner’s books, but were transferred to “ Discount and Expense Series B Account General Lien ” to be amortized over the remaining life of the Series B 7’s. The amounts of unamortized discount and expense (including the unamortized portion of the amounts referred to above), premiums paid, and expense of retirement applicable to the Series B 7’s (referred to in paragraph 14 hereof) were not charged to profit and loss on the petitioner’s books, but were transferred to “Discount and Expense Series D 5%’s Account Series B 7’s” to be amortized over the remaining life of the Series D 5%’s.
19. In the event that it be determined that the petitioner sustained an operating loss for the calendar year 1925, the petitioner and respondent stipulated that for the purpose of computing the net loss under- section 206 of the Revenue Act of 1926 to be deducted from the petitioner’s net income for the calendar year 1926, such operating loss should be adjusted on account of the following items:
Dividends of domestic corporations_ $50.00
Non-tasable interest on obligations of the United States- 2,087.21
Total adjustment___2,137.21

Petitioner’s po*sition as to the premiums paid, unamortized discount, and expenses attaching to the bonds retired for cash in 1925 is amply supported by the decisions of the Board and the courts. S. & L. Building Corp., 19 B.T.A. 788; East Ninth Euclid Co., 26 B.T.A. 32 (affirmed on rehearing, 27 B.T.A. 1289); Indiana Lamp Corp., 28 B.T.A. 491; National Tile Co., 30 B.T.A. 32; San Joaquin Light & Power Co. v. McLaughlin, 65 Fed. (2d) 677; Union Pacific R.R. Co. v. Commissioner, 69 Fed. (2d) 67. The deduction should have been allowed in 1925 when the bonds were redeemed and retired.

As to the year 1924 petitioner has been allowed previously, or respondent at the hearing has conceded the propriety of, a deduction for all unamortized discount and expense attaching to bonds retired by the payment of cash. The only question remaining for solution is the treatment of similar items of premium paid, unrecovered discount, and expense attaching to the $2,354,500 General Lien 8’s which were exchanged by the holders for a like number of Series B 7’s, plus a cash premium.

In 1921 petitioner issued $2,500,000 par value of General Lien 8’s for the purpose of acquiring new capital. The discount and other selling expenses were incurred at that time and constituted a cost of acquiring such new capital. Such cost related solely to the issue of the $2,500,000 General Lien 8’s and by accepted practice was amortizable over the life of the bonds. Western Maryland Ry. Co. v. Commissioner, 33 Fed. (2d) 695; Union Pacific R.R. Co. v. Commissioner, supra.

When in 1924 the General Lien 8’s were reacquired and retired in part by payment of cash and in part by exchange of the outstanding General Lien 8’s for Series B 7’s, plus a cash premium, the process of amortization was interrupted. The Series B 7’s issued August 1, 1920, were a part of a totally different bond issue, and though both were related to the First and Refunding Mortgage of 1919 in that they looked to that mortgage for security, they constituted wholly separate steps in petitioner’s financing. Each issue had its own costs and was entitled to amortize such costs over the life of its bonds. Respondent conceded by his treatment of the same that the unrecovered costs attaching to the bonds of the General Lien 8’s issue reacquired for cash constituted a deductible loss in 1924 when so purchased and retired. We can see no proper basis for distinguishing in principio the bonds retired after reacquisition by exchanging for Series B 7’s plus a cash premium. The General Lien 8’s bond issue was pro tanto wiped out and there were no longer any bonds to which the unrecovered costs were kin or to which they could adhere. These costs were not part of the cost of floating the Series B 7’s, nor were they related to the bonds of that series in any other way. In our opinion there was no such interissue relationship as to permit us to say that when part of the General Lien 8’s were exchanged for a like number of Series B 7’s the incidents of the General Lien 8’s were separated therefrom and attached to the Series B 7’s. The General Lien 8’s paid 8 percent and matured in 1936. The Series B 7’s paid 7 percent and matured in 1950. Assuming a contrary holding, the query would at once arise as to the period over which the unrecovered costs should be spread. Should the same amount allowed as a proportionate annual deduction under the old issue be permitted until exhaustion, or would only a lesser amount proportioned to the entire term of the new issue be deductible? The answer which we have reached as to the major question obviates the necessity of considering this question and other practical obstacles consequent on a contrary decision.

We believe the matter is to be determined from the standpoint of the issuing corporation and its action in the premises rather than from the position of the bondholders and the fact that some of the bondholders chose to exercise their option and accept the new bonds and a cash premium in exchange for the old bonds. In other words, the case should be determined on the basis of principle rather than on the ground of circumstance. The Board and the courts have approved the deductibility of unrecovered costs in the instance of cash redemption and here the respondent concedes the same. We can not distinguish in principle the situation where, in the same transaction, part of the bondholders exchange their bonds for those of the new issue plus a cash premium.

We need not consider a situation, if it could conceivably exist, in which a subsequent issue by its terms takes the place of a former issue, both being parts of a general plan, and the exchange being mandatory. Here the right to exchange was optional with the bondholders. As to whether an exercised right of conversion could have the effect of extending the term of bonds, see Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381; certiorari denied, 284 U.S. 690.

In an almost identical situation the Circuit Court of Appeals for the Ninth Circuit held, in San Joaquin Light & Power Co. v. McLaughlin, supra, that unrecovered costs attached to bonds which were redeemed in part in cash and in part by exchange for a new series were all deductible from income in the year of redemption. We are of the opinion that the premiums paid, unamortized discount, and other financing costs related to the bonds of the series General Lien 8’s retired in 1924 were deductible in that year.

Reviewed by the Board.

Decision will be entered under Rule 50.

Sternhagen,

dissenting: In my opinion, the proportionate un-amortized discount and costs of the General Lien 8’s, dealt with in the second point, should not be deducted in 1924 when they were converted, as originally provided, into 7’s; but should be spread over the term of the Y’s. I agree with Judge Mack’s dissenting opinion in San Joaquin Light & Power Co. v. McLaughlin, 65 Fed. (2d) 677, that the obligation of the Y’s should be regarded as a continuation pro tanto of the indebtedness of the original issue.


author: Matthews:

text:
    John Thatcher & Son, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56888, 65545.
    Promulgated April 26, 1934.

      Benjamin Wiener, Esq., and Herman Goldman, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Matthews:

These proceedings are for the redetermination of deficiencies asserted against the petitioner for the years 1928 and 1929 in the respective amounts of $6,190.12 and $3,039.64. With respect to the year 1928 it is alleged in the petition filed in Docket No. 56888 that the respondent erred in disallowing as a deduction from income for the taxable year the sum of $63,785.60 representing losses which the petitioner claims to have sustained in carrying out certain contracts. Had this deduction been allowed petitioner alleges that it would have sustained a net loss for the year in the amount of $20,767.75, and the sole issue raised in Docket No. 65545 is whether this alleged net loss for 1928 in the amount of $20,767.75 may be allowed as a deduction in computing the petitioner’s net income for 1929.

The facts have been stipulated by the parties as follows:

The petitioner is a corporation, organized under the laws of the State of New York in December 1907. During the years 1928 and 1929 it was engaged in the building construction business.

In March 1917 it entered into a contract with the Benevolent Association of Elks, a domestic corporation, in the city of New Orleans, Louisiana, for the construction in that city of an Elks Lodge, which was completed in 1919.

The petitioner entered into subcontracts for the performance of certain parts of the work. Each of the subcontracts contained the following provision:

Article XIII. Should the Sub-contractor at any time refuse or neglect to supply a sufficiency of proper shilled workmen, or of material of proper quality, or fail in any respect to prosecute the work with promptness and diligence, or fail in. the performance of any of the agreements herein contained, the Contractor shall be at liberty, after three days’ written notice to the Sub-contractor, to provide any such labor and materials, and to deduct the cost thereof, from any money then due or thereafter to become due to the Sub-contractor under this agreement; and if the Architects shall certify that such refusal, neglect or failure is sufficient ground for such action, the Contractor shall be at liberty to terminate the employment of the Sub-contractor for said work and to enter upon the premises and take possession of all materials thereon, and employ any other person or persons to finish the work, and to provide the materials therefor: and in case of such discontinuance of the employment of the said Sub-contractor, said Sub-contractor shall not be entitled to receive any further payment on this contract until the work is wholly completed, at which time, if the unpaid balance of the amount to be paid under the contract shall exceed the expenses incurred by the Contractor in finishing the work, such excess shall be paid by the Contractor to the Sub-contractor, but if the expense shall exceed the balance, the Sub-contractor shall pay the difference to the Contractor. The expenses incurred by the Contractor as herein provided, either for furnishing the material or for finishing the work, and any damage incurred by such default, shall be audited and certified by the Cashier of said Contractor, whose certificate thereof shall be conclusive upon the parties.

It was further provided in these subcontracts that the subcontractor should furnish a bond with a surety company, as surety in behalf of the contractor, “ for the faithful performance of this contract, as well as for the payment of all liquidated damages or other damages which may be sustained by said Contractor by reason of the default of said Sub-contractor, or of his violation of any part of the terms and conditions of this contract * *

Subcontracts were let to H. W. Bond & Brother, W. T. Carey, T. Carey, and J. J. Swiler, who were bonded by the petitioner with the Fidelity & Deposit Co. of Maryland.

The subcontractors defaulted in their contracts and the petitioner as the main contractor was obliged to carry out the contracts at a cost to it of $63,785.60 in excess of what it received for completing the work, as follows:

H. W. Bond & Brother_$1, 398. 57
W. T. Carey_ 18,273.83
T. Carey_ 17, 992. 32
J. J. Swiler_ 26,120. 88
Total_ 63, 785. 60

The petitioner sought to recover these amounts (aggregating $63, 785.60) from the bonding company, which refused to pay, whereupon legal proceedings were instituted in the courts of Louisiana, which proceedings culminated in a decision by the Supreme Court of that State (rendered in 1928) and reported in 117 Southern, page 729.

On its original return for 1928 the petitioner deducted under the heading bad debts ” the amount of $63,785.60, claiming a net loss for the year of $20,767.75, which was disallowed by the Commissioner. For the year 1929, the petitioner claimed as a deduction from income the amount of $20,767.75 as a statutory net loss carried forward from the year 1928, which was disallowed by the Commissioner.

The books of the petitioner were kept on the accrual basis for all of the years involved herein.

The respondent does not deny that a loss was sustained by the petitioner in the amount claimed, which loss grew out of the failure of the subcontractors to carry out their contracts, but it is the respondent’s position that such loss occurred between 1917 and 1919 and can not be allowed as a deduction from petitioner’s income for 1928. The petitioner urges that, until the court rendered its decision in the action brought against the subcontractors and the surety company, the amount of the loss was not determinable because, if the court had decided against the surety company and the surety company had been obliged to compensate the petitioner for the damages sustained by reason of the default of the subcontractors, no loss at all would have been sustained by the petitioner. The petitioner has pointed out that the Supreme Court of Louisiana denied the defendants’ motion to dismiss the appeal, holding that the petitioner had a right of action against the subcontractors and the surety company on the bonds which had been furnished pursuant to the provisions of the subcontracts, but decided the case against the petitioner on the merits on the ground that the petitioner had not kept proper records and had failed to prove its cause of action against the surety company in accordance with the provisions of the surety bonds.

We must determine, therefore, in what taxable year the petitioner’s loss is deductible under the provisions of the applicable statute, which provides that in computing the net income of a corporation there shall be allowed as deductions “ losses sustained during the taxable year and not compensated for by insurance or otherwise.”

It is contemplated by the statute that a deduction shall be allowed when a loss has actually been sustained. As was said by the Supreme Court of the United States in the case of Lucas v. American Code Co., 280 U.S. 445: “ Generally speaking, the income tax law is concerned only -with realized losses, as with realized gains.” But the establishment of a deductible loss is a question of fact in each case and may not always depend upon the happening of any particular event. In the instant case, it is clear that when the subcontractors defaulted in their contracts, which default took place within the period from March 1917, when the main contract for the construction of the Elks Lodge in New Orleans was entered into by the petitioner, and that date in 1919 when the building was completed, there was merely the possibility of a loss. The petitioner was entitled to bring suit against the subcontractors for breaching their contracts, and even if it failed to recover against the subcontractors the petitioner had an additional right of action against the surety company on the bonds. Suit was instituted against the surety company in good faith and the litigation was not settled until in 1928. Upon its settlement, the possibility of loss became a reality.

The case of Lucas v. American Code Co., supra, is cited and relied upon by both parties to these proceedings. In that case the Supreme Court refused to allow a deduction for loss on account of breach of contract for the year in which the breach occurred. The Court rejected the theory that a loss is sustained when the events occur which fix it, so as to preclude a deduction for it in a later year when in a practical sense it is determined by litigation brought to a final conclusion. This principle has also been applied in Burnet v. Huff, 288 U.S. 156, where the Supreme Court said:

We find it unnecessary to discuss the question whether HufiE was bound to make good the amount taken from the funds of the association by his co-partner. We may assume that he was. But the mere existence of liability is not enough to establish a deductible loss. * * * And whether a taxpayer will actually sustain a loss through embezzlement of trust funds of which he is trustee will depend upon a variety of circumstances. If there is liability on his part for the misappropriation, it does not create a certainty of loss, as the defalcation may be made good by the one who caused it, or the liability of the taxpayer may be enforced only to a limited extent or not at all. The requirement that losses be deducted in the year in which they are sustained calls for a practical test. The loss “must be actual and present.” Weiss v. Wiener, 279 U.S. 333, 335; Lucas v. American Code Co., supra; Eckert v. Burnet, 283 U.S. 140, 141, 142.

In Daniels & Fisher Stores Co. v. United States, 56 Fed. (2d) 477, 480, the court said:

We think: that losses which depend on the result of a contested action in court cannot be said to be definitely fixed prior to the rendition of judgment therein. In Lucas v. American Code Co., 280 U.S. 445, 50 S. Ct. 202, 203, 74 L. Ed. 538, a somewhat similar case, it is said with reference to a loss arising on a breach of contract: “ The mere refusal to perform a contract does not justify the deduction, as a loss, of the anticipated damages. For, even an unquestionable breach does not result in loss, if the injured party forgives or refrains from prosecuting his claim. And, when liability is contested, the institution of a suit does not, of itself, create certainty of loss.”

In Malleable Iron Range Co. v. United States, 62 Ct. Cls. 425, the court held that where a taxpayer made its income tax returns on the accrual basis for the years 1918 and 1919 it could not deduct therein from its gross income the amount of a judgment decreed against it on January 15, 1918, by a District Court of the United States as damages for patent infringement where the taxpayer’s appeal to the Circuit Court was affirmed and the judgment increased, in a decision rendered March 15, 1920. The court said, at page 432:

It would seem plain from the foregoing that when there is a question of whether or not there is any liability, no amount can accrue until it is determined that a liability exists. When the amount in question is in litigation it cannot be determined until the litigation is ended. If any other rule were adopted it would inevitably result in confusion and there would be no certainty at any given time as to when the liability should be allowed for. * * *
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* * * Until all the events occurred which fixed the amount to be deducted, and determined the liability of the taxpayer to pay it, there was no method by which the Commissioner of Internal Revenue could assess the amount of the tax.

On certiorari the case was remanded to the Court of Claims for additional findings. It was found that in 1918 the taxpayer pledged in trust United States bonds in a sum sufficient to guarantee the payment of the judgment should the judgment of the higher court be adverse. In an opinion reported at 65 Ct. Cls. 441, the court held that since the taxpayer would undoubtedly have been entitled to accrue the amount paid, if it had paid the judgment in 1918 and taken an appeal, the taxpayer properly accrued the amount of the judgment in 1918. It was pointed out that the bonds were the equivalent of and readily convertible into cash so that their availability as an asset in the taxpayer’s business was destroyed as completely as if their value in cash had been withdrawn from its treasury. Thus, it was decided that the taxpayer could take a deduction in 1918, although the judgment was not paid until in 1920, but this decision was grounded on the fact that United States bonds in excess of the amount of the judgment were deposited in 1918 as security pending the outcome of the appeal.

In Douglas County Light & Water Co. v. Commissioner, 43 Fed. (2d) 904, reversing 14 B.T.A. 1052, it was held:

Claimed deductions for doubtful debts or incboate losses are not to be encouraged, and therefore the taxpayer ought not to be penalized for deferring his claim for deductions until he has in good faith resorted to reasonable measures for avoiding or minimizing a threatened loss.

In Lewellyn v. Electric Reduction Co., 275 U.S. 243, the Supreme Court refused to allow the deduction of a loss in 1918, since in such case there was “nothing in the findings from which we could conclude that the respondent in 1918 had ceased to regard his rights under the contract as having value or that there was then reasonable ground to suppose that efforts to enforce them would be fruitless.” In that case the terms of a contract were .breached by the seller in 1918 and it was this breach of contract which gave rise to the loss claimed by the taxpayer, as buyer, but the Supreme Court stated:

But we do not think that a loss resulting from a buyer’s prepayment to a seller who proves to be irresponsible is necessarily sustained, in the statutory meaning, as soon as the money is paid. The statute was intended to apply not only to losses resulting from the physical destruction of articles of value but to those occurring in the operations of trade and business, where the business man has ventured on a course of action in the reasonable expectation that the promised conduct of another will come to pass. Not only the future success of the business but its present solvency depends on the probable accuracy of his prophecy. Only when events prove the prophecy to have been false can it be said that he has suffered.

See also Highway Trailer Co., 28 B.T.A. 792, on appeal to the Circuit Court of Appeals for the Seventh Circuit, and cases cited therein; North American Coal Corp., 28 B.T.A. 807.

On authority of the above decisions we hold that the petitioner is entitled to a deduction from its income for 1928 in the sum of $63,785.60, and that the resulting net loss, if any, for the year 1928 should be allowed as a deduction in computing the petitioner’s net income for 1929.

Judgment uMl be entered wader Rule 50.


author: SteRnhagen :

text:
    Muriel Oakes Ames, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71811.
    Promulgated April 26, 1934.

      L. L. Hamby, Esq., for the petitioner.

      D. H. Flagg, Esq.,'for the respondent.
   OPINION.

SteRnhagen :

The respondent determined deficiencies of $1,195.07 for 1930 and $1,445.48 for 1931, in petitioner’s income tax. She complains because respondent added to her taxable income half of her since-divorced husband’s salary for each year as community income. The facts are all stipulated, as follows:

1. On November 13, 1930, there was entered in the Superior Court of the State of California in and for the County of Los Angeles in a certain suit in that court entitled Helen Muriel Ames, plaintiff, vs. Robert Ames, defendant, No. D-89484, an interlocutory judgment, judging that the said plaintiff was entitled to a divorce from the said defendant, the said plaintiff being the same person as the petitioner herein. The said interlocutory judgment contained such other provisions and orders as are set forth in a certified copy thereof attached hereto as Exhibit A. [Omitted as unnecessary.]
2. On November 16, 1931, the aforesaid court in the aforesaid suit did, upon its own motion, adjudge that the plaintiff therein, who is the petitioner herein, be and she was thereby granted a final judgment of divorce from the defendant therein and that the bonds of matrimony between them be and the same was thereby dissolved; and the said court made such further or other orders as are set forth in a certified copy of its judgment attached hereto as Exhibit B. [Omitted as unnecessary.]
3. The aforesaid Robert Ames in his income tax return for the calendar year 1930 included within his gross income as salary the sum of $36,571.74, being the same sum one-half of which in the deficiency letter herein has been included by respondent in the gross income of petitioner.
4. On, to wit, the 9th of October, 1930, the aforesaid Robert Ames and your petitioner entered into a written agreement, a true copy of which is annexed hereto as Exhibit O.
5. Eor the calendar year 1931 up to the 16th of November thereof there was included within the gross income of the aforesaid Robert Ames the sum of $40,177.34 as salary, one-half of which the respondent has, in the deficiency letter herein, included within the gross income of petitioner.
6. Petitioner, in her income tax returns ior each of the calendar years 1930 and 1931, did not include within her gross income any part of any salary earned or received by the aforesaid Robert Ames.
7. Prom January 1 to October 9, 1930, petitioner received no money from Robert Ames. Prom October 9, 1930 to December 31, 1930, petitioner received $3,045.33 from Robert Ames. During the calendar year 1931 petitioner received $4,526.82 from Robert Ames.

The agreement (Exhibit C) of October 9, 1930, provides for the separation thenceforth of community property between the parties.

The petitioner urges that because of the agreement any salary received by Kobert Ames after October 9, 1930, was his separate property. She properly concedes in her reply brief that Ames’ earnings prior to that date were community income, taxable one half to her, United States v. Malcolm, 282 U.S. 792. Since there is nothing in the record from which it could be determined how much of his 1930 earnings were received before October 9 and how much after, the Commissioner’s determination for that year must be sustained on the evidence.

As to 1931, during which the separation agreement was operative and the divorce decree became absolutely effective November 16, it has already been held that such an agreement operates to relieve the wife from tax upon any part of the earnings of the husband. Edith Page Skewes-Cox, 29 B.T.A. 167; Helen E. Grant, 29 B.T.A. 760; Cf. Edna Smart Sherman, 29 B.T.A. 616. A fortiori, after the absolute divorce. Therefore petitioner’s 1931 income includes no part of Robert Ames’ earnings or salary, and the Commissioner’s determination is to that extent reversed.

Judgment will T)e entered v/nder Bule 50.