author: Arundell :

text:
    John B. Atkins, Joseph Foster Atkins, Alma Atkins, Lucile Atkins Hamilton and Miriam Atkins Dykes, as Heirs of the Estate of John B. Atkins, Petitioners, v. Commissioner of Internal Revenue, Respondent. Alma Foster Atkins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3377, 15485.
    Promulgated November 18, 1927.

      Walter E. Barton, Esq., and J. D. Wilkinson, Esq., for the petitioners.

      A. B. Marrs, Esq., for the respondent.
   OPINION.

Arundell :

Whatever doubt may have existed as to the taxability of a profit made by the exchange of property for property under the circumstances herein has been removed by the decisions in the cases of Marr v. United States, 268 U. S. 536; Cullinan v. Walker, 262 U. S. 134; Appeal of Burge, 4 B. T. A. 732; Appeal of Minal E. Young, Executor, 6 B. T. A. 472; and Reibert v. Commissioner, 7 B. T. A. 1198. The test seems to be whether the taxpayer received in exchange something different from what he theretofore had and there is no doubt that the bonds received by petitioner from the New York corporation were securities of a radically different character from shares of stock in the Louisiana corporation and from his ownership of the Christman process and a one-half interest in the Noel lease. We have no difficulty in reaching the conclusion that a transaction such as took place here may give rise to taxable income.

But petitioners contend that the Marr and Cullinan cases, supra, have little application to the present case as they were decided under the earlier revenue acts, which contained no provision with reference to exchange of property for property or securities of one corporation for those of another organized to take over the old. There might be some merit in the contention made if income under the 1918 Act were a different thing from the income referred to in, and taxed by, the earlier Acts. Such is not the case, at least in so far as section 202(b) is concerned. Bourn v. McLaughlin, 19 Fed. (2d) 148; 6 Am. Fed. Tax Rep. 6681. In that case the court, after quoting the definition of income from Eisner v. Maconiber, 252 U. S. 189, 207, says:

Gains arising out of dealings in property are not taxable unless they fall within the above definition of income. This is true whether the statute under which the tax is levied is that of 1916 or 1926. The explicit recognition of the principle that income is not realized unless it is received in a form which has an equivalence in cash, a realizable market value, found in the 1918 and subsequent statutes is not a restriction of the incidence of the income tax. It is merely an express statement of a principle inherent in the nature of income as recognized in Eisner v. Maconiber, supra, in the statement that income must be “a gain, a profit, something of exchangeable value, proceeding from the property.”

Petitioners, however, raise the very fundamental question that in the case of one reporting on a cash receipts and disbursements basis promises to pay do not constitute income and as the bonds were mere promises to pay on the part of the New York corporation, decedent was in receipt of no taxable income until those promises were in fact fulfilled and cash payment was received. So far as we have been able to ascertain, a promise to pay evidenced solely by an open account has never been regarded as income to one reporting on a cash basis by the Bureau of Internal Revenue. Certainly this is true ' in the absence of any showing that the amount was immediately available to the taxpayer. The Board has further held that income was not constructively received by the mailing of a check, Louis Titus, 2 B. T. A. 754, or the entry on the books of a corporation of the amount of salary due when in fact money was not available to make payment, A. L. Englander, 1 B. T. A. 760. On the contrary, we have held notes to be income even though the taxpayer was on a cash basis. J. S. Cullinan, 5 B. T. A. 996.

Petitioners place great reliance on the case of United States v. Schillinger, 14 Blatch. 71; Federal Case No. 16228, in which it is held in part:

In tbe absence of any special provision of law to tbe contrary, income must be taken to mean money and not tbe expectation of receiving it or tbe right to receive it at a future time.

That decision has been cited in numerous cases. See Rensselaer & Saratoga Railroad Co. v. Irwin, 249 Fed. 726 (dissenting opinion) ; United States v. Christine Oil & Gas Co., 269 Fed. 458; Pitney v. Duffy, 291 Fed. 621; In re Sheiman, 14 Fed (2d) 323. It will be noted from the quotation taken from the Schillinger case that the court predicates its ruling on “ the absence of any special provision of law.” ■ Section 202 of the Revenue Act of 1918 provides a method of taxing gains resulting from the exchange of property. That provision makes no distinction between taxpayers on the cash basis and those on the accrual basis, but lays down the rule that:

When property is exchanged for other property, the property received in exchange shall, for the purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair market value, if any.

What then is the dividing line? While no categorical answer is available and the facts in each case must be closely scrutinized, we believe that in the case of one reporting income on the receipts and disbursements basis only cash or its equivalent constitutes income. Does a bond have a fair market value; has it a readily realizable market value ? If it has, we must presume a market for the security wherein its fair market value is obtainable. A Government bond is, in its essential character, no different from any other bond, for it is merely the Government’s promise to pay, but the market is so broad that Government bonds may be said to be equivalent to cash, for to the extent of their fair market value cash may be readily realized for them. Bonds and shares of stock of many of the leading corporations of the country have a ready market whereby cash may be realized for them at any time. On the contrary, shares of stock and other securities in closely held corporations frequently have no fair market value for they are unknown and there is in effect no market for them. Article 1563 of Regulations 45, promulgated under the 1918 Act, giving effect to section 202, recognizes this principle. It is there stated:

Gain or loss arising from the acquisition and subsequent disposition of property, is realized when as the result of a transaction between the owner and another person the property is converted into cash or into property (a) that is essentially different from the property disposed of, and (&) that has a market value. In other words, both (a.) a change in substance and not merely in form, and (b) a change into the equivalent of cash, are required to complete or close a transaction from which income may be realized. By way of illustration, if a man owning ten shares of listed stock exchanges his stock certificate for a voting trust certificate, no income is realized, because the conversion is merely in form; or if he exchanges his stock for stock in a small, closely held corporation, no income is realized if the new stock has no market value, although the conversion is more than formal; but if he exchanges his stock for a Liberty bond, income may be realized, because the conversion is into independent property having a market value.

The difficulty is not in announcing the underlying theory, but in its application, and in determining whether a promise to pay is the equivalent of cash we must examine into all the facts and circumstances and if the promise to pay has a readily realizable market value, i. e., so that cash may be readily substituted for it, then it is, in the eyes of the law, cash income and returnable as such. The evidence here establishes that the bonds received by petitioner in the New York corporation had a fair market value and that the fair market value was 64.43 cents on the dollar.

Petitioners argue in the alternative that the bonds received by Atkins were received as a result of a reorganization, and being of no greater par value than the property given in exchange, are not taxable under section 202(b) of the Revenue Act of 1918, which provides in part:

* * * When in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater aggregate par or face value, no gain or loss shall be deemed to occur from the exchange, and the new stock or securities received shall be treated as taking the place of the stock, securities, or property exchanged.

The facts, briefly, are that the New York corporation was organized for the purpose of taking over the assets of the Louisiana company. Atkins turned in his Louisiana company stock, his interest in the Noel lease, and his right to receive royalties under the Christ-man process, receiving therefor bonds of the New York company. Clearly, his exchange of the Noel lease and Christman process for the New York company bonds does not come within section 202(b). As to his exchange of stock for bonds, we think that transaction does come within the statutory provision. R. D. Musser, 2 B. T. A. 1031, 1041. As the aggregate par value of the bonds received by Atkins was less than that of the stock exchanged therefor, the transaction, under section 202(b) resulted in neither taxable gain nor deductible loss.

In determining the deficiency for 1919 the Commissioner held that Atkins had realized a profit of $65,000 on the exchange of the Noel lease and a profit of $130,000 on the exchange of the Christman process for New York company bonds. In so doing he found that the bonds had a fair market value of 65 cents on the dollar. Tb@ petitioners contend that such segregation should not be made as the transfer of the stock and other properties of Atkins for cash and bonds was all one transaction; that bonds were issued on the basis of $35 per share of stock, mailing $291,480 face value of bonds issued to Atkins for his stock, and that the balance, $133,440, should be attributed to the Noel lease and Christman process. The evidence does not support those contentions. In the general letters addressed to the stockholders the basis of exchange was outlined on the basis of $35 per share of stock, but the telegrams between Smith and Atkins show clearly that Atkins was to come in to the reorganization on a basis different from that of the others. It is true that the books of the Fidelity Trust Co. show bonds issued to Atkins at the rate of $35 per share of stock, but we can not but believe that this was done merely for bookkeeping, purposes. An examination of the exchange of telegrams between Smith and Atkins as set forth in the findings of fact shows that from the beginning of the negotiations the interests who were financing the reorganization refused to give Atkins the same amount for his stock as was to be given other stockholders. Throughout the negotiations Atkins offered his stock, the Noel lease, and the Christman process as separate items and they were so accepted by Clark & Co. The bonds issued by the New York corporation had a market value of 64.43 cents on the dollar. The market value of the $100,000 in bonds received by Atkins for his interest in the Noel lease was, therefore, $64,430, to which should be added the sum of $85,000 received in cash, and the depreciated cost of $14,828.95 should be deducted. The $200,000 in bonds received for the Christman process had a market value of $128,860, all of which was taxable income as the process cost Atkins nothing.

In 1919 the investment of Atkins in the Atkins-Cooney lease amounted to $9,184.29. For each of the years 1919 and 1920 he claimed as deductions for depreciation amounts approximating 20 per cent of the investment. We are unable to determine from the evidence what portion of the investment represented the cost of either the lease or equipment, and we must, therefore, sustain the respondent’s disallowance of the amounts claimed. Error in respect of the disallowance of these items was alleged in each of the appeals and our holding applies to each.

In each of the petitions complaint is made against the disallowance of $472.31 said to be taxes paid by Atkins. In the Atkins Estate case claim is also made for a deduction of $4,126.23 said to be taxes paid in the year 1921. There was testimony to the effect that some taxes were paid, but the evidence was so vague and unsatisfactory that we are unable to determine the amount actually paid in either year, and, accordingly, we can find no error in the respondent’s disallowance of the amounts claimed.

No evidence was offered concerning the respondent’s disallowance of $478 alleged in each of the petitions to represent taxes paid at the source on interest on bonds of the Caddo Central & Refining Co. of New York, and we are unable to make any finding in respect to such item.

A deduction in the amount of $10,500 is claimed for 1920 as representing Atkins’ loss on stock in the Commercial Oil Co. While that company was dissolved and a liquidator appointed in 1920, it appears that the company at the close of the year had on hand some leases, the value of which is not shown by the record. In the absence of such showing we are unable to find that a loss in the amount claimed, or any amount, was sustained.

The respondent included in Atkins’ income for 1920 the sum of $4,788.31 as dividends received from the Cedar Grove Construction Co. The evidence shows that the company had no earnings or profits in 1920 or any other year to distribute as dividends and the amount paid stockholders was a partial return of their capital investment. The respondent, therefore, erred in holding that the amount of $4,788.31 represented dividends.

The remaining errors alleged are that for the year 1921 the Commissioner failed to find that Atkins sustained a net loss and declined to allow as a deduction from 1922 income such claimed net loss. No evidence was offered on these allegations.

Reviewed by the Board.

Judgment will be entered on 15 days' notice, under Rule 50.


source: Caselaw Access Project

author: GREEN:

license: Public Domain

text:
    T. C. Phillips, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 12802.
    Promulgated November 18, 1927.

      Hubert L. Bolen, Esq., for the petitioner.

      D. H. Green, Esq., for the respondent.
   OPINION.

GREEN:

The petitioner herein contends that he is entitled to have his income determined and his tax computed upon the basis of the separate returns filed by him for the taxable year 1923, and that the respondent’s action in combining his income with that of his wife, and computing the tax upon the whole thereof, is erroneous.

It appears that the petitioner, some time before March 15, 1924, filed with the collector of internal revenue for the Oklahoma district, where he then resided, separate income-tax returns for himself and wife. These returns were subsequently destroyed and a single joint return was filed. Section 223 of the Eevenue Act of 1921 provides two ways in which returns for husband and wife living together may be filed. Each has a right to file a separate return or the income of each may be included in a single joint return. Either is a correct and proper return, but the return that is filed is the return, and the only return, recognized by law. Having once made the election and filed separate returns, the petitioner could not be compelled to file a return or pay tax on the other basis. See R. Downes, Jr. v. Commissioner, 5 B. T. A. 1029.

The record shows that the petitioner was a resident of the State of Texas from 1889 until January, 1923, at which time he moved to Oklahoma City, Okla. He was married in 1906, at which time his estate consisted entirely of personal property, part of which was invested in bank stock, some of the banks being located in the State of Oklahoma, which said Oklahoma bank stock he still owned during the taxable year. His taxable income for the year in question came partly from dividends on the Oklahoma bank stock and partly from his share of the community estate built up by the reinvestment of the income from the personal property owned by him prior to his marriage. The only reference in the record to property other than the Oklahoma bank stock owned prior to marriage is of Texas bank stock which was unproductive during the year 1923. Article 4621, Vernon’s Anno. Civ. Stats., Sup. 1918, declares:

All property, both real and personal, of the husband owned or claimed by him before marriage, and that acquired afterwards by gift, devise or descent, as also the increase of all lands thus acquired, and the rents and revenues derived therefrom, shall be his separate property.

It accordingly follows that the stock in the Oklahoma banks at all times remained his separáte property and that upon his removal to the State of Oklahoma the income from said stock was his separate income and properly so returnable.

The remainder of the income is derived from the estate that was built up during the period of residence in Texas, in which State the income from personal property was community income. See Willcutt v, Willcutt, 278 S. W. 236.

It appears to be well established by the Texas courts that the interests of the spouses in the community property are beneficially equal, but the legal title is in the husband, the wife’s interest being vested but equitable. See 35 Harvard Law Review, p. 62; Burnam v. Hardy Oil Co., 108 Tex. 555. When property is brought from one State to another, rights vested by the law under which it was acquired are recognized and protected. Abraham B. Johnson et al. v. Commissioner, 7 B. T. A. 820.

The income other than that from the Oklahoma bank stock which was derived in 1923, comes from a source, the legal title to which was in the petitioner, with a vested equitable interest of one-half in his wife. A similar situation may be illustrated by the following hypothetical case. A and B, residents of Texas, each invest $1,000 in a Texas oil lease, the title to which is taken in the name of A. Oil is discovered and the property sold for $100,000. A invests the proceeds in securities, taking title in himself, and subsequently they both move to Oklahoma, where they reside when the dividends are paid. In the illustration given there is no question that both A and B should report their share of this income in their separate returns. To refuse to allow the wife to report income from property in which she had a vested equitable interest would be depriving her of such rights. It is held, therefore, that the income from the husband’s separate property in the amount of $4,500 is his separate income, the tax upon which should be paid by him, and that the remainder of the income was the joint income of both the husband and the wife, one half of which was properly returnable by each.

Reviewed by the Board.

Judgment will be entered after 15 days’ notice, under Rule 50.

MillikeN dissents.


author: Tkussell :

text:
    Middlesex Ice Co., Fresh Pond Ice Co., and Cambridge Ice Co., Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7282.
    Promulgated November 18, 1927.

      Henry Herrick Bond, Esq., for the petitioners.

      Joseph E. Moyer, Esq., for the respondent.
   OPINION.

Tkussell :

Under requirements made by the Treasury Department one of the early steps in ascertaining the consolidated invested capital of a group of affiliated companies is the preparation of a consolidated balance sheet. Each member of the affiliated group enters the consolidation with its invested capital as defined by section 326 of the Revenue Acts of 1918 and 1921. From this preliminary exhibit there is then eliminated such items or amounts as are shown to be duplications either of investment or of earned surplus and undivided profits. The law does not specifically provide for, and we are unable to find, that it in any sense contemplates any reduction or elimination of actual assets not appearing as duplications. In the instant case, it appears that on May 1, 1919, the Cambridge Ice Co.’s surplus was in excess of the amount existing at the date when the holding company acquired the Cambridge Ice Co.’s stock. That surplus, not having been distributed to the stockholders or dissipated in operations, may not be eliminated from the consolidated invested capital by reason of any exchange of stock shares among the owners thereof.

Reviewed by the Board.

The deficiencies may he recomputed in accordance with the foregoi/ng opinion upon 15 days' notice, pursuant to Rule 50, and judgment will he entered accordingly.


author: Green : Smith,

text:
    Lewis D. Newman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 19138.
    Promulgated November 18, 1927.

      Francis B. Butler, Esq., and Pierce Butler, Jr., Esq., for the petitioner.

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

Green :

The question involved is whether in determining the gain or loss from the sale of the trust certificates in 1924 the basis provided in section 204(a) of the Eevenue Act of 1924 should be reduced by that portion of the tax-free distributions received in 1923 which was made from an increase in value of property accrued prior to March 1, 1913. In other words, did the respondent err in reducing the basis of $32,143.50 by the amount of $884.61 in addition to the amounts of $1,884.13 and $798.56 ? The petitioner concedes that the basis should be reduced by the amounts of $1,884.13 and $798.56 but not by the amount of $884.61.

It is alleged in the petition and admitted in the answer that “ it is not controverted here that shares of beneficial interest in the trust known as Great Northern Iron Ore Properties are to be treated as shares of capital stock in a corporation and that distributions by the trustees are to be treated as distributions by a domestic corporation.”

At the time the distribution that is in controversy was made, namely, the amount of $884.61 distributed in 1923 from an increase in value of property accrued prior to March 1,1913, the Revenue Act of 1921 was in force. Section 201(b) of that act provided as follows:

For tlie purposes of this Act every distribution is made out of earnings or profits, and from the most recently accumulated earnings or profits, to the extent of such earnings or profits accumulated since February 28, 1913; but any earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, may be distributed exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed. If any such tax-free distribution has been made the distributee shall not be allowed as a deduction from gross income any loss sustained from the sale or other disposition of his stock or shares unless, and then only to the extent that, the basis provided in section 202 exceeds the sum of (1) the amount realized from the sale or other disposition of such stock or shares, and (2) the aggregate amount of such distributions received by him thereon.

At the time the petitioner sold the certificates in 1924, the Revenue Act of 1924 governed. The pertinent sections of this Act are as follows:

Seo. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized.
Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that * * *
Sec. 201. (b) For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stoelc provided, in section %01h (Italics ours.)

The petitioner contends that the word “such” contained in the clause set out in italics above, restricted that clause to tax-free distributions made in 1924 or subsequent thereto on the ground that the word “ such ” could only refer to those distributions mentioned immediately before the clause in italics and that such distributions were by the very context and effective date of the 1924 Act restricted to distributions made in 1924 or subsequent thereto and does not cover those made in 1923.

The respondent on the other hand contends that section 201(b) of the 1924 Act did not specifically provide that only tax-free distributions made subsequent to December 31, 1923, were to be applied against and reduce the basis and that, therefore, such basis should be reduced by all tax-free distributions regardless of when made.

Gain is realized and taxable under the Revenue Act of 1924 only to the extent that it is expressly stated therein. That extent and occasions upon which gain is realized are covered by sections 202, 203 and 204, and particularly section 202(a), which provides that the gain is the difference between the price obtained and the basis provided in section 204. The distribution of dividends, tax-free or otherwise, has no effect upon gain except in so far as expressly covered by section 201. See section 201 (b), swpra.

Title II of the Eevenue Act of 1921 under which section 201(b) fell, was repealed by section 1100 of the Eevenue Act of 1924, to take effect as of January 1, 1924. Title II of the Eevenue Act of 1924, pertaining to the income tax, took effect as of January 1, 1924. See section 283. ■ In our opinion the term “ every distribution ” in section 201(b) of the 1924 Act is, therefore, restricted to distributions made subsequent to December 31, 1923. The second sentence of section 201(b) of the 1924 Act allowing tax-free distributions which would for the same reason, namely, the effective date of the Act, be restricted to. distributions made subsequent to December 31, 1923, is in our opinion so phrased by the words “ may be distributed ” to cover future distributions only. These in our opinion are the only distributions to which the word “ such ” in section 201(b), 1924 Act, can refer and there is no authority in this section for the reduction of the basis as provided in section 204 by the amount of $884.61, distributed in 1923 from an increase in value of property accrued prior to March 1, 1913. Were it intended not to limit the distributions to those in 1924 or subsequent thereto, the word “ such ” is meaningless.

The respondent was in error in reducing the basis by the amount of $884.61, distributions made in 1923 from an increase in value of property accrued prior to March 1,1913. The parties have stipulated that if the Board finds for the petitioner the deficiency for 1924 would be $121.29.

Eeviewed by the Board.

Judgment will be entered on 16 days' notice, under Bule 60.

Smith,

dissenting: The Eevenue Act of 1924 imposes a tax upon the “ net income ” of individuals (section 210). The net income is to be determined by deducting from gross income specified items. Gross income is defined in section 213(a) as including:

* * * gains, profits, and income derived from * * * sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; * * * or gains or profits and income derived from any source whatever.

There is no question that the petitioner derived a gain from the sale of his Great Northern Iron Ore Certificates in 1924 and that the prevailing opinion exempts from tax $884.61 of that gain. This statement is, of course, predicated upon the proposition that in determining the gain the basis is to be reduced by capital distributions made upon such certificates prior to the date of sale. Likewise, there is no question that the distribution of $1,683.17 received' in 1923 was tax exempt in 1923 under the provisions of the Revenue Act of 1921. Although in his computation the taxpayer has conceded that $798.56 of the tax-free distribution in 1923 should be used in the reduction of the cost, the logic of the opinion is that no part of the tax-exempt distribution in 1923 need be used to reduce the cost for the reason that section 201 of the Revenue Act of 1921 was repealed by section 1100 of the Revenue Act of 1924, to take effect as of January 1, 1924.

There can be no question that provisions tending to exempt a person from tax upon income should be strictly construed in favor of the Government. Has such a rule of construction been invoked in the majority opinion?

Section 201(b) of the Revenue Act of 1924 reads precisely as it was printed on December 17, 1923, in the first Committee report of the Revenue Act of 1924, the subject of which is: The Revenue Act of 1924, containing proposed amendments to the existing law suggested by the Secretary of the Treasury.” The House of Representatives adopted the language recommended by the Secretary of the Treasury and the Senate adopted it with one slight change which was later stricken out. The report of the Ways and Means Committee, accompanying the submission of the bill to the House, states with reference to section 201(b) of the bill as follows:

In subdivision (b) of the existing law it is provided that tax-free distributions out of earnings and profits accumulated prior to March 1, 1913, shall be applied against and reduce the basis of the stock only for the purpose of determining a loss from the subsequent sale of the stock; such a distribution is not applied against the basis of the stock for determining the gain from its sale. The proposed bill in section 201(b) provides that a distribution out of earnings and profits accumulated prior to March 1, 1913, shall be applied against the basis of the stock for the purposes of determining both gain and loss from its subsequent sale.
The theory which causes the allowance of the receipt of the dividend free of tax is that this distribution, being out of earnings accumulated prior to March 1, 1913, constitutes a return of capital to the stockholder. If it is treated as a return of capital for purposes of taxation, it should manifestly be considered a return of capital for purposes of determining his capital investment in the stock, and the resulting gain or loss from its subsequent sale (p. 11).

The report of the Finance Committee accompanying the submission of the bill to the Senate reads, with reference to this same provision of the bill as follows:

In subdivision (b) of the existing law, it is provided that tax-free distributions out of earniKgs and profits accumulated prior to March 1, 1913, shall be applied against and reduce the basis of the stock only for the purpose of determining a loss from the subsequent sale of the stock; such a distribution is not applied against the basis of the stock for determining the gain from its sale. The bill in section 201 (b) provides that a distribution out of earnings and profits accumulated prior to March 1, 1913, shall be applied against the basis of the stock for the purposes of determining both gain and loss from its subsequent sale.
Example: Corporation A has on hand at the present time $100,000 of capital and $50,000 earnings and profits accumulated prior to March 1, 1913. Stockholder X purchased the stock subsequent to March 1, 1913, for $150,000, or owned it prior to March 1, 1913, and its fair market value on that date was $150,000. Corporation A distributes to stockholder X $50,000 of earnings and profits accumulated prior to March 1, 1913. This distribution is not subject to tax. Later the corporation accumulates $75,000 of surplus, and stockholder X sells his stock for $175,000. Under the existing law- X pays a tax on a gain of $25,000 from the sale. Under the bill he would pay a tax on $75,000 from the sale.
The theory which causes the allowance of the receipt of the $50,000 dividend free of tax is that this distribution, being out of the earnings accumulated prior to March 1, 1913, constitutes a return of capital to the stockholder. If it is treated as a return of capital for purposes of taxation, it should manifestly be considered a return of capital for purposes of determining his capital investment in the stock, and the resulting gain or loss from its subsequent sale. If he has had part of his capital returned to him, obviously he can not have that part so returned still invested in the stock. Unless the tax-free distribution is applied in reduction of the basis, the result is that the taxpayer is allowed a return of capital twice because of the same item of capital. In the example given, $75,000 of the sale price of the stock was attributable to an increase in value of the stock resulting from earnings and profits of the corporation accumulated since March 1, 1913. Unless the gain from the sale is considered to be $75,000, it will result in the exemption from tax, not of earnings and profits accumulated prior to March 1, 1913, which have already been distributed tax free, but of increase in value of the stock which is attributable to earnings and profits accumulated after that date (p. 2).

The above history of the bill shows what Congress meant by the provision. There can be no question that legislative intent in the construction of a taxing statute is a prime consideration. It is furthermore to be noted that in prescribing regulations, the Commissioner of Internal Revenue, with the approval of the Secretary, has carried out the legislative intent. In article 1543 of Regulations 65, the Commissioner has provided:

A tax-free distribution made by a corporation out of earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, shall be applied against the basis of the stock for the purpose of determining gain or loss from its subsequent sale. The fact that such distribution is in excess of the cost or other basis (provided in articles 1591-1603) of the stock on which declared does not render it subject to tax.

In this and other regulations the Commissioner has not made any differentiation between a tax-free distribution made in 1924 and in preceding years.

It may also be noted that the interpretation placed by the Commissioner upon the taxing statute is sanctioned by writers upon income tax. Referring to the anomalous provision of section 201 (b) of the Revenue Act of 1921, George E. Holmes, in his work on “Holmes Federal Taxes, Sixth Edition, 1925,” states at page 809:

The 1924 law corrects this anomaly by providing that any tax-free distributions of earnings or profits accumulated or increases in value accrued before March 1, 1913, shall reduce the basis for the purpose of determining gain or loss from a subsequent sale. This provision has two results: (1) it gives the taxpayer one exemption only in respect to the excess of value as of March 1, 1913, over cost; (2) it prevents the taxpayer from receiving tax-free (in the event of subsequent sale) distributions which, although earnings or profits or increases in value to the corporation, are in reality a part of the stockholder’s capital investment.

Robert H. Montgomery, in his work on “ Income Tax Procedure, 1925,” states at page 662:

If distributions have been received from earnings accumulated prior to March 1, 1913, or from appreciation at that date, the basis prescribed by section 204, as set forth in this chapter, must be reduced by such “ tax-free ” distribution.

That section 201(b) of the Revenue Act of 1924 is susceptible of a different interpretation from that put upon it in the prevailing opinion and more in harmony with the other provisions of the taxing act is clearly proven by the history of the provision, the action of the Commissioner in prescribing regulations to put in force the provisions of the act, and by eminent writers on the income tax. All that Congress meant by the last sentence of section 201(b) of the taxing act — reading:

* * * Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913,-have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 204—

is that certain distributions might be made exempt from tax but that “ such ” tax-free distribution shall be applied against and reduce the basis of the stock provided in section 204. The term “ such ” has reference to the tax-free distribution, not necessarily of the tax-free distribution made in 1924, but that made at any time out of the earnings or profits accumulated or increase in value of property accrued before March 1, 1913. Even if there had been no second sentence in section 201(b), it would have been incumbent upon the taxpayer to take into account these free distributions in computing his gain upon the sale of the certificates under the provisions of section 202(b) of the Act, which provides that:

In computing the amount of gain or loss under subdivision (a) proper adjustment shall be made for (1) any expenditure properly chargeable to capital account, and (2) any item of loss, exhaustion, wear and tear, obsolescence, amortization, or depletion, previously allowed with respect to such property.

The tax-free distribution received by the petitioner in 1923 was an item of exhaustion or depletion. The petitioner was a part owner of the trust res. The tax-free distributions were on account of the depletion of the value of the res. That is the reason why he was permitted to receive it tax-free in the year of receipt.

In my opinion a sound construction of the taxing statute is that these tax-free distributions should be taken into account in determining the true gain upon the sale. The same principle of construction of the statute should be invoked as was invoked by the Supreme Court in United States v. Ludey, 274 U. S. 295, where it was held that a taxpayer selling oil-mining properties in 1917, which he had purchased prior to March 1,1913, was required in computing income and excess-profits taxes under the Revenue Act of 1916, as amended by the Revenue Act of 1917, to deduct from the original cost the aggregate of depreciation and depletion items, deduction of which from annual income-tax returns was authorized. In that case there were no provisions of the taxing statutes in question that such depreciation and depletion items should be taken into account in determining the gain or loss and the United States Court of Claims held by virtue thereof that the amounts should not be taken into account. The Supreme Court, held, however, that such a construction was contrary to the scheme of the statute.

Invoking the same rule of construction in the case at bar the same conclusion must be reached. It is inconceivable that Congress intended that in such a case as this all tax-free distributions which had been received by an owner of property who sold such property in 1924 should not be taken account of in determining the gain upon the sale. The scheme of the statute never contemplated such a result and the language of the statute does not fairly warrant it.

Love concurs.


author: Love :

text:
    Carpinter & Baker, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7295.
    Promulgated November 18, 1927.

      Benjamin Mahler, Esq., for the petitioner.
    ■/. E. Marshall, Esq., for the respondent.
   OPINION.

Love :

The petitioner contends that since the payments in question were made on the basis of a binding contract entered into prior to the incidence of the income-tax laws, and since the person who negotiated the agreement in her behalf had procured and left with the petitioner clients who were sources of income to the petitioner in the years 1920 and 1921, the payments were proper deductions by petitioner from its gross income as ordinary and necessary expenses.

The facts are not clear as to what John T. Baker paid in to the petitioner at its formation; that is, the evidence does not show whether the bringing of certain clients to the petitioner which John T. Baker had previously procured and which became income-producing factors to the petitioner was the consideration for the issuance of stock to John T. Baker. It appears John T. Baker was a member of a partnership prior to 1903; that in 1903 the petitioner was formed to succeed this partnership; that in 1907 a large number of clients, who were a source of income to the petitioner, were clients whom John T. Baker had personally secured, and that in the years involved these clients, or at least many of them, were productive of substantial commissions to the petitioner. The principal witness for the petitioner stated as a conclusion that these clients could have been taken away from the petitioner in 1907 by John T. Baker, which is inconsistent with the proposition that they were ever paid in to the petitioner. The same witness testified that the payments to Mrs. Baker were for services performed by John T. Baker. On cross-examination the following statements were made by the aforementioned witness:

Q. Now, wiiat was said in the agreement with reference to designating that as a pension?
A. I do not know whether the word “ pension ” was used; it was done as a pension, however, that is what we considered it.
Q. The reason I asked you that question, Mr. Baker is the fact that in the return of your mother for these two years, signed by you, you designated the payment as a pension from the corporation.
A. Yes, that is the way we considered it.
Q. Now, when your agreement was made, did you discuss these payments as being a pension?
A. For services performed, yes, sir.
Q. But your mother never performed any services?
A. Oh, no, mother never performed any services.

The facts are not clear as to the exact nature of the agreement between Baker and petitioner, but whatever the facts may be with respect to these clients of John T. Baker, the evidence does not show that the agreement made in 1907 on behalf of Mrs. Baker gave to the petitioner any rights which it did not previously have, or furnish any new security for the retention of these accounts. The most that can be said is that in 1907 the petitioner, through its officers, who were members of the same family as John T. Baker, its president and principal stockholder, agreed to make certain payments to the widow of the principal stockholder, beginning after the death of John T. Baker and continuing throughout the life of Mrs. Baker, in consideration of the insurance business which Baker turned over to petitioner. It would seem that petitioner agreed to make the payments to Mrs. Baker in consideration of the insurance business which Baker had personally secured, the commissions from which, or at least a percentage thereof, belonged to him. We fail to see where it has been shown that the payments in question can be said to come within the category of ordinary and necessary expenses. To say the least, they are extraordinary in their nature and would not seem likely to occur other than in a family concern, such as the petitioner or in the acquisition of an income-producing asset. It seems to us that the latter was the basis of the payments. There is not present the condition which exists in many corporations where pensions are paid to employees after they have reached a certain age and have performed certain services. Such consideration as ordinarily attaches to the payment of pensions to former employees for faithful services in the past could hardly attach to the payments here in question. Mrs. Baker rendered no services to the petitioner at any time and, therefore, what was paid to her could not be said to have been on this account; and, consequently, it could not be said that its payment would result in more satisfactory services on the part of present employees of petitioner.

The petitioner’s answer to the foregoing is that the payments are not, in fact, in the nature of a pension, but rather represent payments made on account of clients which John T. Baker left with the petitioner. Even if we concede that such was the consideration for the payments, this would not make them allowable deductions as business expenses, as under such a theory they would be in the nature of capital expenditures which are being made for the acquisition of income-producing assets, and in our opinion under the facts these payments were made by petitioner in consideration of the insurance business turned over to it by Baker. The mere fact that payments are made under a contract does not make such payments allowable deductions from gross income as ordinary and necessary expenses. Cf. Steinbach, Co., 3 B. T. A. 348; John C. Moore Corporation,, 3 B. T. A. 430. Whether a given expenditure is to be treated as capital or expense is a question of fact to be determined in each instance. Gilliam Manufacturing Co., 1 B. T. A. 967. Where the expenditure is for the acquisition of an asset the useful life of which extends beyond the year for which the expenditure is being made, such expenditure is usually to be considered of a capital nature and, therefore, not deductible in its entirety in the year when made. Section 215, Revenue Act of 1918, and Winifrede Coal Co., 1 B. T. A. 566.

The Board is of the opinion that whatever view is taken of the expenditures, the evidence fails to establish that they are ordinary and necessary expenses, and, consequently, the action of the Commissioner in disallowing them as a deduction is sustained.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: Siefkin :

text:
    Olinger Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 25469.
    Promulgated November 18, 1927.

      Geo. A. Crowder, Esq., for the petitioner.

      Granville 3. Borden, Esq., for the respondent.
   OPINION.

Siefkin :

Petitioner urges that it is entitled to deduct the entire amount of a commission note given to obtain a loan in the year in which the note is given, since it kept its books and made its tax return on the accrual basis. Respondent, on the other hand, maintains that the commission be spread ratably over the two-year period of the loan, with the result that only $237.54 of a total commission of $12,500 is allowed by him as a deduction in the year in question.

In American National Co. v. United States, 274 U. S. 99, a similar question was presented. In that case the company sold loan notes to investors and at the same time contracted to pay a bonus of one per cent over the life of the loan. The company charged on its books, whenever a loan note was sold, the aggregate amount of the payments called for in the bonus contract, computed at one per cent per annum to the maturity of the note. When it made its tax return the entire amount was claimed as an expense. The Commissioner allowed the deduction only to the extent of the installments called for by the contracts which matured in the year in question.

The Supreme Court, after citing United States v. Anderson, 269, U.S. 422, 437, said:

So, in the present ease, we think that the amount of the bonus contracts was “ an 'expense incurred and properly attributable ” to the Company’s process of earning income during the year 1917. These contracts were not analogous to obligations to pay interest on money borrowed, but were expenses incurred in selling tlie loan notes in as real a sense as if under its original system of doing business the Company had paid these amounts to brokers as fees for selling the loans or given them notes for such fees. The Company’s net income for the year could not have been rightly determined without deducting from the gross income represented by the commission notes, the obligations which it incurred under the bonus contracts, and would not have been accurately shown by keeping its books or making its return on the basis of actual receipts and disbursements. The method which it adopted clearly reflected the true income. And, just as the aggregate amount of the commission notes was properly included in its gross income for the year — although not due and payable until the expiration of two years — so, under the doctrine of the Anderson case, the total amount of the bonus contracts was deductible as an expense incurred within the year, although it did not “ accrue ” in that year, in the sense of becoming then due and payable.

We believe this decision of the Supreme Court controls the instant case, and that the respondent was in error in not permitting the deduction of the entire amount of the commission in 1922.

Reviewed by the Board.

Judgment will be entered after 15 days’ notice, under Rule 50.


author: SiepKIN :

text:
    George De Forest Brush, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6568.
    Promulgated November 18, 1927.

      F. Morse Hubbard, Esq., for the petitioner.

      W. F. Gibbs, Esq., for the respondent.
   OPINION.

SiepKIN :

Petitioner is an artist who has ranked as one of the foremost American painters since 1895 and enjoyed that rank in 1913. The objects giving rise to the deficiencies here involved are various paintings and a statue which are the work of his hands. Two art dealers, qualifying as experts, testified to the market value of his work and gave their opinion as to the value on March 1, 1913, of the paintings. We have adopted these values, since, so far as the record shows, there is nothing detracting in any way from their testimony, and we do not feel justified in substituting a different value than that shown by this evidence. The finding of these values then leaves as the only question, whether petitioner realized a gain taxable as income on the sale of these paintings in the years in question. The respondent treats the question in his brief as though petitioner were seeking to deduct a loss. Petitioner, however, in his brief merely contends that no taxable gain resulted with respect to any of the paintings, except “By the Fountain.” As to that painting, the net amount received by petitioner being $15,255, and the March 1, 1918, value being $12,000, the taxable gain is fixed at $3,255.

Considering the question to be merely one as to whether a taxable gain resulted, taken in connection with the uncontradicted fact that the paintings were the work of the petitioner, we may safely assume that the cost was less than the March 1, 1913, values as herein found. We are unable to see any reason why petitioner is not entitled to a valuation as of March 1,1913, the same as any taxpayer who disposes of more prosaic objects.

With respect to the gain derived upon the sale of the statue in the amount of $960, there was no evidence introduced as to March 1, 19Í3, value, and in that respect, we approve the respondent’s determination of the entire amount as income. In other respects, the respondent was in error.

Eeviewed by the Board.

Judgment will he entered on 15 days’ notice, under Rule 50.


author: Green:

text:
    Appeal of Calumet Steel Co.
    Docket No. 6673.
    Promulgated November 18, 1927.

      Albert W. Torhet, <7. P. A., for the petitioner.

      Ward Loveless, Esq., for the Commissioner.
   OPINION.

Green:

The petitioner bases its claim to the right to deduct the amount of the Carbo Company account upon the provisions of section 5 of the Eevenue Act of 1917.

A. S. Hook, who signed all the returns referred to in the findings of fact, was the only witness for the taxpayer. He testified that the policy of the company in charging off accounts as worthless was ultra conservative and that at the time he directed the auditors to charge off the account of the Carbo Company he knew that that account was not worthless and that he expected to be able to collect a. part of the amount due. He stated that at the time the deduction was claimed by the petitioner on its return for 1916, he knew the account was not worthless. On the witness stand he testified that petition in bankruptcy of the Carbo Company was filed in February, 1917. This statement is not in accord with his sworn statement made in the return. He likewise stated on the stand that no effort was made through attorneys to collect this account prior to the time it was charged off in 1916. This statement is not in accord with the return. He likewise stated that the petitioner had never acquiesced in the Commissioner’s disallowance of the deduction here claimed. The petitioner’s letter of acquiescence executed by him, was offered and received in evidence.

We have repeatedly held that the burden is upon the petitioner to produce evidence before us sufficient to overcome the presumption that the Commissioner’s determination is correct. If any weight is to be given to this presumption, it is obvious that the testimony of the witness Hook is not sufficient to overcome it. His statements on the witness stand when this petitioner is seeking to deduct this account as a loss in 1917, do not at all coincide with the answers made in the return executed by him for the year 1916. The witness offered several explanations as to the reason for the conflict. One was that at the time the deduction was taken in 1916 he knew that the account was not worthless and that at that time he expected that the corporation would recover a part of the amount. This statement did not tend to increase our confidence in him. The respondent’s action in reducing invested capital by the amount of the bad debt is approved.

Reviewed by the Board.

Judgment will be entered for the Commissioner.


author: SiefKin :

text:
    John P. Dillon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10985.
    Promulgated November 18, 1927.

      Patrick H. Laughran, Esq., for the petitioner.

      P. J. Bose, Esq., for the respondent.
   OPINION.

SiefKin :

The sole issue in controversy is whether the $28,000 payment by petitioner to the bank represents a deductible loss. The rights and liabilities of the respective parties under the guaranty contracts are not determinative of the question presented, as petitioner was released from those contracts by the agreement under which payment was made. This latter agreement provided for the payment to the bank, the placing of the questionable paper in trust for the bank, and the release of the guarantors from liability under the written guaranty contracts, set out in full in the findings of fact.

Kespondent urges that the payment in question might have saved petitioner’s investment in the bank’s stock and was, therefore, a eapi-tal investment. We grant the possibility, but the conclusion that other considerations prompted the payment in question is inescapable. When the $100,000 was ordered withdrawn from the bank’s assets, the stockholders protected by the guaranty contract were unwilling to stand a stock assessment and were likewise unwilling to see the bank closed. Instead, they agreed to release the guarantors from further liability on the guaranty contract in return for the guarantors’ payment of $100,000 to the bank. .We are of the opinion that the principal consideration moving the guarantors to make the payment in question was the offer to release them from liability under the guaranty contracts.

The cases cited by the respondent are not in point as they involve questions of advances of stockholders to corporations, or with guarantors of stock values. Under such facts, losses are not realized until the corporation becomes insolvent or the stock worthless. The question at bar is essentially different. Though the bank was solvent and continued to function throughout the year, petitioner contracted to stand an immediate loss of $28,000 in consideration of a release from a probable future loss of an uncertain amount. Nor is the question in any wise affected by the value of the paper placed in trust as the bank, and not the guarantors, was the beneficiary under the trust. Accordingly, petitioner was not entitled to any portion of the amounts collected by the trustee. In this respect petitioner’s posi-ii tion differs from that of a guarantor who, upon having to make good | his guaranty, is subrogated to the rights of the bank as was the case in Morris Sass, 7 B. T. A. 557. A guarantor’s loss depends upon whether the obligations guaranteed proved to be worthless in whole or in part. No such contingency exists in the case at bar.

Beviewed by the Board.

Judgment will be entered for the petitioner.


author: Smith :

text:
    Huron Portland Cement Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3334, 4973.
    Promulgated November 21, 1927.

      Hal H. Smith, Esq., for the petitioner.

      M. N. Fisher, Esq., for the respondent.
   OPINION.

Smith :

The question at issue in this case is the actual cash value, for the purpose of computing invested capital, of the limestone and shale deposits paid in to the petitioner corporation in exchange for $1,200,000 par value of its common capital stock. It is the contention of the petitioner that such actual cash value was $1,200,000. The respondent has allowed an actual cash value for the property of only $25,000.

The limestone and shale deposits paid in to the corporation were acquired by H. J. Paxton at a cost of $25,000 plus a certain amount not shown by the record for expenses paid in determining the value of the deposits. He entered into an agreement with J. B. Ford and associates that if they would repay him nine-tenths of the cost of the property and build a cement mill, for which they should receive preferred stock and bonds of the corporation, and give him one-tenth of the common capital stock of such corporation, he would turn the lands over to the corporation. This agreement was acceptable to Ford and his associates. Paxton believed that the limestone deposit would last for a period of at least 50 or 60 years for the operation of a large mill and Ford testified that with the mill that was built in 1907 the deposit would probably last 100 years. Paxton estimated that the deposit contained 50,000,000 tons of limestone. Ford was a little more conservative and estimated that the quarry-able content of the limestone deposit was approximately 40,000,000 tons. For purposes of the organization of the corporation he estimated the value of the deposits at $1,200,000. When asked as to the basis of his estimate he replied:

A. We arrived at that figure in tills way: That Mr. Paxton at 1hat time was very anxious to erect a cement plant and it was largely through his solid-tation to Mr. Berry that the matter came to me that Mr. Paxton wanted to build a cement plant, and he wanted the few of us at that time to go in with Mr. Paxton. Mr. Paxton had seen a few other people at that time about the proposition, and probably would have put the proposition over, as he was pretty anxious to build the mill.
However, after looking into the matter for some time, and knowing at that time that the value of that proposition lay in the amount of limestone, which I knew was there, and knowing about the harbor that we had there, and knowing the low cost of fixing up that harbor, which had been used previously and would only require some dredging, and the market condition I thought the best way to do to get at the value of the property would be to value it on what might be called a royalty basis. I have seen that basis used in a number [of] plant [s] where they had had anywhere from five feet to twenty-two feet, and found that the geologists give an average depth of the limestone in the United States, now in use for cement purposes at something like 22 feet, and they usually establish the value of the stone on a royalty basis. These royalties ran from two cents to five cents a ton, and I have been offered, in some places a price on that basis, and it was on the royalty basis that I fixed the value on that limestone at $1,200,000; that is as the value of the property.
Q. You had before you the suggestion of Mr. Brown ?
A. I had before me the suggestion of Mr. Brown, making it 5 cents a ton, which made something like $15,000 an acre on a certain depth which he took.
Q. Yes.
A. And I made my computation on the basis of three cents which was the average of the rates that I had [paid] for the price of limestone lands.
Q. And you arrived at the value by using the index for limestone properties?
A. X did.
Q. Did you have anything in mind as to a possible profit that you would have to make on the cement manufactured out of that limestone?
A. Yes, sir.
Q. What was that?
A. We felt that we would have to make ten cents a barrel on the cement to come out.

Upon the basis of operating results the petitioner has had a certified public accountant prepare elaborate tables as to the value of the deposit upon the basis of Hoskold’s tables. The computations are made upon the basis that in 1907 there were 42,417,600 tons of quarryable limestone in the deposit and that the deposit would last for a period of 40, 50, 60, or 70 years. It is also assumed that 8 per cent is the fair rate for remuneration of capital invested and that 4 per cent is the proper discount figure to be used. It is also figured that inasmuch as Ford estimated that the company could calculate on a profit of 10 cents per barrel of manufactured cement, and that 1 ton of limestone would produce approximately 3 barrels of cement, the company should compute a profit of 30 cents per ton upon the manufacture of the limestone into cement.

We are of the opinion that the basis for a value of 30 cents per ton for the limestone deposit in 1907 is not warranted by any evidence given by Ford. Ford testified that in purchasing limestone upon the royalty basis a fair royalty was from 2 to 5 cents a ton and that be had figured that 3 cents was the average of the rates that he had paid for limestone lands. He also figured that they would have to calculate on a profit of 10 cents per barrel to come out whole. It seems to us that this is far from saying that the -actual cash value of the limestone in place in 1907 is to be computed upon the basis advanced by the petitioner. We can not determine how much of the manufacturing profit is to be attributed to skill in management and how much to the raw materials.

We think that the actual cash value of the limestone and shale deposits in 1907 is best determined from the following factors: That there were approximately 40,000,000 tons of limestone in place; that if the company were acquiring the deposit upon a royalty basis 3 cents per ton payable annually upon the tonnage mined during the year was a fair royalty price; that the deposit would last 60 years. In our opinion the evidence does not warrant a finding that the actual cash value of the deposits which Paxton transferred to the corporation for $120,000 par value of common stock plus $22,500 cash was in excess of $237,600, and we think that this amount should be used as the value of the deposits in the computation of invested capital.

Reviewed by the Board.

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

Lansdon and Teussbll dissent.


text:
    Peninsula Shipbuilding Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5741.
    Promulgated November 21, 1927.

      G. E. McQulloch, Esq., and Stiles W. Butt, Esq., for the petitioner.

      AVoa 0. Baird, Esq., for the respondent.
   OPINION.

Smith :

In the letter addressed to the petitioner under date of May 26, 1925, the respondent determined deficiencies in tax against the petitioner for the years 1918, 1919, and 1920 in the aggregate amount of $117,706.70. In his letter he stated:

It is further held * * * that you are entitled to deductions from income on account of obsolescence actually sustained, since there was a definite determination on your part on or about November 16, 1918, that at a future time reasonably susceptible of definite determination, your plant would have no useful value, and would therefore be abandoned. The latter date in your case was June 3, 1920. This is in accordance with the contention of your representative as stated at the oral hearing on your case.
In view of the foregoing the following adjustments have been made:
(1) Depreciation at 10% on cost of plant and equipment has been allowed for the period January 1, 1918 to November 16, 1918.
(2) The depreciated cost of all plant and equipment on hand as at November 16, 1918, less adjustment for salvage, has been spread ratably over the period November 15, 1918 to June 3, 1920 and allowed as obsolescence.
(3) The cost of plant and equipment acquired subsequent to November 16, 1918, in order to carry out your contracts with the U. S. Shipping Board, less adjustment for salvage, has been spread ratably over the period from date of acquirement to June 3, 1920, and allowed as obsolescence.
(4) The amount of §200,000.00 allowed by the United States Shipping Board, on account of depreciation of plant, has been included in income for the years 1918, 1919, and 1920, apportioned to each year on the basis of the amount of depreciation chargeable to the boats completed within the year, at the rates of 30% for the first two contracts and 20% for the third contract.

In its petition to this Board the petitioner alleges as error on the part of the respondent as follows:

(a) The Commissioner of Internal Revenue erred in including in income for the years 1918, 1919 and 1920, the sum of $149,763.01 received by the taxpayer in 1923 from the United States Shipping Board Emergency Fleet Corporation in compromise settlement of a larger amount claimed by the taxpayer to be due, which claim of the taxpayer was disputed and denied in toto by the United States Shipping Board Emergency Fleet Corporation during all of the years 1918, 1919 and 1920, and was not determined or liquidated until 1923, in winch year it was paid to the taxpayer.
(See paragraph (4) on page one of the Statement attached to the deficiency letter of May 26, 1925, where it is said:
“ (4) The amount of $200,000 allowed hy the United States Shipping Board, on account of depreciation of plant, has been included in income for the years 1918, 1919, and 1920, apportioned to each year * * *.) ”
(b) The Commissioner of Internal Revenue erred in determining that there is now due from the taxpayer for the years 1918, 1919 and 1920 income and profits taxes in the sum of $117,706.70 or any sum whatsoever in excess of approximately $12,000.

In bis answer to the petition tbe respondent denied that the Commissioner erred in determining the taxpayer’s tax liability for the years 1918, 1919, and 1920.

At the hearing of this appeal counsel for the respondent stated as follows:

Mr. Loveless : May it please the Board, the question involved in this case is one of the utmost importance. The taxpayer had three contracts with the Government for the erection of ships. These contracts, or copies of them, have been stipulated and will be offered in evidence. Under these contracts it was explicitly provided that the depreciation should constitute a part of the cost of the ships to be borne by the United States Government.
The taxpayer over the years 1918, 1919 and 1920 was allowed by the representatives of the Government in its plant the amount of $50,236.99 as depreciation on the plant. The taxpayer was not satisfied with that allowance and the deposition shows and so will the contract that that allowance was not final.
The taxpayer filed with the Shipping Board the claim for depreciation, totaling some $249,000. In 1923 that claim for two hundred and forty-nine odd thousand dollars was allowed by the Government for $200,000; that included the $50,236.99 that was previously allowed, leaving a difference of $149,763.01. Now the taxpayer’s attorney in his opening statement raised the question of whether or not that constituted income in the years 1918, 1919 and 1920 or 1923 when it was paid.
Mr. Smith: Just one point. What constituted income, the $149,000?
Mr. Loveless : Tes. Now get this straight. The $149,763.01, not the $200,000, which represents the total, never constituted income at any time. It was simply a repayment by the United States Government of cost which it was obligated under the contract to bear, which had previously been borne by this taxpayer in the years 1918, 1919 and 1920.
The Commissioner is merely throwing back into the cost of the years 1918, 1919 and 1920 these amounts, because the Commissioner said that they were the years in which the costs were incurred in the construction of the ships, and therefore those were the years in which it should be reflected in the accounts of the taxpayer.
To put this in the year 1923 would be to say that this constituted income in the year 1923. It never constituted income.

At the time that the petitioner entered into its first contract with the United States Shipping Board Emergency Fleet Corporation on May 15,1917, it had a shipbuilding plant which represented a capital expenditure of $110,116.04. To carry out its contract with the Emergency Fleet Corporation it was necessary for it to enlarge its plant. The total additions made to its plant from April 6, 1917, to June 3, 1920, at which time it completed its contracts with the Government and finished active operations, cost $193,339.21. At the time the contracts were entered into it was the expectation of the petitioner that the Government would bear the cost of necessary additions. This was in accordance with its understanding of the terms of the contract. The auditors of the Emergency Fleet Corporation refused, however, to sanction the extensions deemed to be necessary by the petitioner with the result that the petitioner made such extensions at its own expense. Only a small part of the extensions made by the petitioner was authorized by the Emergency Fleet Corporation in advance of the making of such extensions and was paid for during the years 1918, 1919, and 1920. It was contemplated by all parties concerned that any depreciation allowable with respect to the plant should be spread over the period of operations of the petitioner on the war contracts. It was fully appreciated by all that the plant would have only a salvage value upon the completion of such contracts.

The petitioner made claim for greater amounts for depreciation than were allowed by the Emergency Fleet Corporation. This depreciation related not only to the war plant investment items but also to prewar plant investment items. There was also in dispute in certain instances the correct rate to apply to certain items which were added by the Emergency Fleet Corporation. These items were in dispute during the taxable years and were not settled until 1923.

In the determination of the deficiencies herein involved the respondent spread the cost of the prewar plant and of the war plant over the tax years herein involved in a manner satisfactory to the petitioner. He added to the gross income of each of the years, however, prorated portions of the additional allowance made by the Emergency Fleet Corporation to the petitioner in 1923 in the amount of $149,763.01, adding to the gross income of 1918, $8,948.34; of 1919, $83,467.42; and of 1920, $57,347.25. These additions to gross income had the effect of increasing the net income in like amounts. The petitioner objects to such additions to gross and net income for the tax years in question and insists that the amount of $149,763.01 in question was income of the year 1923; that the respondent was in error in adding to the gross income of the tax years in question the amounts above stated and that the deductions from gross income allowed for those years by the respondent in his deficiency letter for depreciation and obsolescence were correct.

The applicable provisions of the taxing statutes are as follows :

That in the case of a corporation subject to the tax imposed by section 230 the term “net income” means the gross income as defined in section 233 less the deductions allowed by section 234, and the net income shall be computed on the same basis as is provided in subdivision (b) of section 212 or in section 226. (Section 232, Revenue Act of 1918.)
(b) The net income shall be computed upon the basis of the taxpayer’s, annual accounting period * * *' in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * * (Section 212, Revenue Act of 1918.)
(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* ******
(7) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence;
(8) In the case of buildings, machinery, equipment, or other facilities, constructed, erected, installed, or acquired, on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war, and in the case of vessels constructed or acquired on or after such date for the transportation of articles or men contributing to the prosecution of the present war, there shall be allowed a reasonable deduction for the amortization of such part of the cost of such facilities or vessels as has been borne by the taxpayer, but not again including any amount otherwise allowed under 'this title or previous Acts of Congress as a deduction in computing net income. * * * (Section 234, Revenue Act of 1918.)

We will consider first the question whether claims made by the petitioner against the Emergency Fleet Corporation for depreciation as an element in determining the cost of the vessels built during the taxable year were accruable items. In numerous appeals the Board has held that disputed and contested claims not set up on the books of account of taxpayers are not accruable items of income or deductions therefrom until the year of actual settlement. In Appeal of Brighton Mills, 1 B. T. A. 392, we said:

An alleged liability of the taxpayer in 1920 for a failure to fulfill a condition precedent to the other party’s performance of a contract must be clearly established and must be then recognized by the parties in order to result in an accrued deductible loss in the year of such alleged breach. The bringing of suit in 1922 and payment in settlement in 1923 do not under the circumstances of the record entitle the taxpayer to deduction of loss in 1920.

To the same effect see Citizens Trust Co. of Utica, 2 B. T. A. 1239; Coghlin Electric Co., 3 B. T. A. 1071; Russel Wheel & Foundry Co., 3 B. T. A. 1168; New Process Cork Co., 3 B. T. A. 1339; Bump Confectionery Co., 4 B. T. A. 50; Lane Construction Corporation, 4 B. T. A. 1133; Empire Printing & Box Co., 5 B. T. A. 203; Gopher Granite Co., 5 B. T. A. 1216; Frank J. Jewell, 6 B. T. A. 1040; Great Northern Ry. Co., 8 B. T. A. 225.

From the evidence of record petitioner had no certainty of ever receiving from the Emergency Fleet Corporation any part of the claims which it was making against it for depreciation. The auditors working on the case steadfastly refused to grant the claims of the petitioner and the denial of such claims was confirmed by superior officers. We are of the opinion that no portion of the amount of $149,763.01 was income of the taxable years involved in this proceeding.

The question next arises as to whether the Boai'd was in error in its former opinion in holding that these were claims for amortization under subdivision (8) of section 234(a) of the Eevenue Act of 1918 and as such, subject to adjustment in the light of the settlement of the claims in 1923. (See section 234(a) of the Eevenue Act of 1924.) The contracts between the petitioner and the Emergency Fleet Corporation did not provide for any deduction for amortization of war facilities. They simply provided for depreciation. The respondent has not found that the deductions were for amortization. The amounts allowed as deductions for the taxable years were allowed as depreciation and obsolescence and were allowed under subdivision (7) of section 234(a) of the Eevenue Act of 1918. The allowances would have been made if there had been no provision in the statute for an allowance for amortization. This is upon the understanding reached by the petitioner and the Emergency Fleet Corporation that the plant would have only a salvage value upon the termination of the war and completion of the contracts.

The allowance for amortization contained in subdivision (8) of section 234(a) of the Eevenue Act of 1918 is a special provision giving relief in a particular class of cases. The claims made by the petitioner against the Emergency Fleet Corporation were, as stated above, not only for depreciation on the war plant but also upon the prewar plant. The allowance finally made by the Emergency Fleet Corporation was not specifically for depreciation upon the war plant but was in settlement of all claims made by the petitioner for depreciation on both the war plant and the prewar plant. We are therefore of the opinion that the settlement of this case in no wise involves section 234(a) (8) of the Eevenue Act of 1918.

We now come to the question as to whether in the determination of a reasonable amount for the allowance of depreciation and obsolescence of plant the amounts determined by the respondent in his deficiency letter to this petitioner should in any wise be reduced by reason of the fact that in 1923 the Emergency Fleet Corporation allowed a larger amount for depreciation than it had been willing to allow during the taxable years. It has been argued by the respondent that the allowance for depreciation and obsolescence should be based upon the cost of the plant to the petitioner and that the cost of the plant should be reduced by the reimbursement made to the petitioner in 1923. We are of the opinion, that the allowable deductions for depreciation and obsolescence should not be made to depend upon the settlement made with the petitioner by the Emergency Fleet Corporation ,in 1928. The cost of both the prewar plant and the war plant was borne by the petitioner in the first instance. Title to the plant always remained in the petitioner. This is evidenced by the fact that it was the petitioner which sold the plant in 1921, and that ,it did not account to the Emergency Fleet Corporation for any jiart of the proceeds of the sale. We therefore think that the reasonable allowance for depreciation and obsolescence for the tax years involved should not be reduced by the amount paid to it by the Emergency Fleet Corporation in 1923.

The amount of $149,763.01 received by the petitioner from the Emergency Fleet Corporation in 1923 was income of 1923, and did not affect its taxable income for prior years.

The opinion in this case, 5 B. T. A. 739, is revised accordingly.

Reviewed by the Board.

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

Van FossaN and Milliicen did not participate.

SteRNíiagen and Murdock concur in the result only.

Phillips dissents.


author: Trammell:

text:
    Morris & Bailey Steel Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9492.
    Promulgated November 21, 1927.

      Henry 0. Evans, Esq., for the petitioner.

      Wm. H. Lawder, Esq., for the respondent.
   OPINION.

Trammell:

The first question is whether the expenditure of $1,300 for a new screw down is deductible as an ordinary and necessary expense, or whether it is a capital expenditure to be depreciated over a physical life of more than one year. From the evidence we are convinced that the expenditure was for a replacement, that the asset acquired had a life of more than a year and that the expenditure constitutes a capital outlay and is not deductible in computing net taxable income for 1919. The screw down in question was still in use at the date of the hearing of this proceeding.

The matter of a deduction on account of the old screw down which was replaced by the new one is not involved in this proceeding.

On the question of the purchase of the new 16-inch guides to replace guides which at the time were in use, it appears that the new guides were in use at the date of the hearing of this proceeding and that they had been used since 1919. There is no evidence that they were not in good condition and will probably last many years longer. It is clear, therefore, that the acquisition of the said guides represents a capital expenditure which is not allowable as a deduction in determining taxable income.

There is no question presented here as to any deduction with respect to the guides which were replaced.

On the question of the inventory of used rolls, it appears that the petitioner included the same in its inventory on the basis of cost or market, whichever was lower, and that it reduced its inventory by 35 per cent in 1920 on account of depreciation sustained in that year as well as in previous years, no deduction ón account of the exhaustion for previous years having been taken or written off until the rolls were worn out or broken. On the rolls which were not used in 1920 no deduction had been taken.

While it may be that the actual measuring of the diameter of the rolls would be a fair and reasonable method of determining the actual exhaustion sustained, the deduction on account of exhaustion of assets can not be accumulated and taken in one year with respect to exhaustion which occurred in prior years. The amount allowable for exhaustion, wear and tear is an annual deduction and is based upon the exhaustion sustained during the taxable year. We do not agree with the petitioner that the rolls should be included in inventory on the basis of cost or market, whichever is lower. Inventories, referred to in the statute, relate to stock in trade or materials or supplies which are used in the manufacturing process and which become a part or ingredient of the manufactured article and do not refer to capital assets such as machinery which is used in manufacturing the article.

The 35 per cent reduction of the inventory price of the rolls represents an average wear or exhaustion on all the rolls whether acquired in 1920 or in prior years. There is insufficient evidence in the record to enable the Board to determine the amount of exhaustion suffered during the taxable year 1920 with respect to the rolls in use during that year. We must, therefore, affirm the determination of the Commissioner on this question.

With respect to the annealing plates, we think a preponderance of the evidence supports the position of the petitioner that these plates were actually and permanently abandoned and scrapped during the taxable year 1920. Their depreciated cost was therefore a proper deduction for that year.

Judgment will ~be entered on 15 days' notice, imder Rule 50.

Considered by MoRRis, Muedook, and Siefiun.


text:
    Oakland California Towel Co., Petitioner, v. Commissioner of Internal Revenue, Respondent
    Docket No. 10432.
    Promulgated November 21, 1927.

      B. E. Brotherton, Esq., for the petitioner.

      J. W. Fisher, Esq., for the respondent.
   OPINION.

Trammell:

From the evidence presented there appears to have been no obligation during 1921 to pay the additional compensation which was decided upon and paid in 1922. Mrs. Hall was asked the question: “ You did not know that you were going to get anything after the first of the year until in March; you did not know you were going to get anything extra? A. No. Q. And of course you did not know how much you were going to get? A. No.” Mrs. Hall also testified that she had no other conversation with Borroughs about Compensation after the latter part of 1921 because she “ thought when the time came he would give me what he felt we could afford to pay — that he could afford to give me.”

There having been no obligation created during the year 1921 to pay the additional compensation which is involved herein, in our opinion, the respondent properly disallowed the deduction claimed with respect thereto for that year.

Judgment will he entered for the respondent on 15 days’ notice, under Rule 50.

Considered by Morris, Murdock, and Siepkin.


author: Trammell :

text:
    Milton D. Eisner, Executor, Estate of Milton S. Eisner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8548.
    Promulgated November 21, 1927.

      Fred D. Bullock, G. P. A., for the petitioner.

      A. H. Mum-ay, Esq., for the respondent.
   OPINION.

Trammell :

The question to be determined on the basis of the facts stipulated is whether tbe said Milton D. Eisner, executor of the estate of decedent, is entitled to prorate the said sum of $2,634.71 over the period commencing July 1, 1921, and ended December 31, 1921. That is to say, whether he is entitled to take as a deduction in the period ended October 8, 1921, the sum of $1,431.90, which sum bears the same ratio to the said sum of $2,634.71 as the period commencing July 1, 1921, and ended October 8, 1921, bears to the entire period commencing July 1, 1921, and ended December 31, 1921, or whether, the same having been actually paid after decedent’s death as aforesaid, it must be taken as a deduction entirely in the period commencing October 9,1921, and ended December 31,1921.

Since the decedent kept his books and records upon the basis of cash receipts and disbursements, only the amounts actually expended during the taxable period involved in the payment of taxes are allowable as deductions in determining his net income. Taxes are allowed as deductions by the statute when paid or accrued according to whether a taxpayer keeps his books and records on the cash basis or accrual basis but it is only when he keeps his books and records on the accrual basis that he is entitled to take as deductions taxes accrued but not paid.

Judgment wiU be entered for the respondent.

Considered by Morris, Muedook, and Siefkin.


text:
    Sherman & Bryan, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9085.
    Promulgated November 21, 1927.

      R. 8. Doyle, Esq., for the petitioner.

      O. G. Holmes, Esq., for the respondent.
   OPINION.

Trammell :

In view of the fact that all other errors assigned in the petition were waived, the determination of the respondent with respect thereto is approved.

With respect to the debt of the Fulton Motor Truck Co. it is necessary that two facts be shown. First, that the indebtedness was ascertained to be worthless during the taxable year, and, second, that it was charged off.

It is clearly shown by the evidence that the debt was actually charged off during the taxable year. This leaves only the question as to whether it was ascertained to be worthless during that year. Under the Revenue Act of 1918 the entire debt must be ascertained to be wholly worthless in order that an allowance may be made with respect thereto. An ascertainment that a debt is worthless only in part does not meet the requirements of the statute.

It is undisputed that the purchaser of the assets of the Fulton Motor Truck Co. owed $142,572.77 to the receiver. While there is evidence that he did not meet his payments promptly and was in arrears at the end of the petitioner’s fiscal year, there is no evidence to indicate that Hackett, the purchaser, was not financially responsible and that a judgment against him for the amount of his notes with interest thereon was not collectible. In addition to this fact, Hackett had already paid more than $142,000 in cash and the assets were security for the balance of their purchase price. If Hackett had not made the payments as agreed, the amount already paid would have become forfeited and the assets could have been sold by the receiver the second time if the receiver was not able to recover from Hackett.

In our opinion, the fact that no dividends were paid by the receiver before the close of the petitioner’s taxable year ended in 1920, is not conclusive. The real question is whether the petitioner ascertained before the close of its taxable year the facts as to whether the debt could be collected or could not be collected. The evidence clearly shows that it was ascertained that the debt could not be collected in full, but there is not a preponderance of evidence that the debt was ascertained to be wholly worthless in 1920. On the other hand, from the facts in the record, it appears that it was ascertained that only a portion oí the debt could not be collected. The total assets were $205,940.88 which, when reduced by the receiver’s, special master’s and attorneys’ fees in the total amount of $22,000, leaves $183,940.88 to be divided among the general creditors, including the petitioner, whose claims totaled $473,525.37.

There was some testimony to the effect that the actual amount of the assets was not known at the end of the petitioner’s taxable year, that certain assets were not considered of value, but this fact is immaterial since all the assets had been sold to Hackett and the receiver had received the cash and notes representing the purchase price.

In view of the foregoing, it is our opinion that the indebtedness was ascertained to be worthless only in part and that this does not meet the test of the statute to entitle the petitioner to the deduction claimed.

Judgment will be entered for the respondent on 15 days' notice, und&)' Rule 50.

Considered by MoRRis, Murdock, and Siefkin.


text:
    Belmont Iron Works, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11552.
    Promulgated November 21, 1927.

      John A. JSelby, Esq., for the petitioner.

      L. G. Mitchell, Esq., for the respondent.
   OPINION.

Trammell:

With respect to the reduction of invested capital on account of taxes for prior years, it appears that the action of the respondent is in accordance with section 1207 of the Revenue Act of 1926. His action in that regard is, therefore, approved.

The question of the computation of a tentative tax upon the income for the year in the determination of the amount of current earnings available for dividends hasigretofore been determined adversely to the respondent. L. S. Ayeres & Co., 1 B. T. A. 1135.

It was contended by the respondent that under section 201 of the Revenue Act of 1918 any distribution by a corporation to its stockholders made during the first 60 days of any taxable year is deemed to have been made from earnings from profits accumulated during prior taxable years and that the surplus must be decreased by the amount of such distributions as from the respective dates of such distributions. We agree with the respondent’s contention.

In W. E. Caldwell Co. v. Commissioner, 6 B. T. A. 47, we said that a “cash dividend declared on February 1, 1918, payable on April 1, 1918, creates a debt due from the corporation to the stockholders immediately from the date of declaration, and under section 201(e) of the Revenue Act of 1918, the distribution must be deemed to have come out of prior years’ earnings. * * * Invested capital should be reduced by the amount of the dividend as of the date of declaration, in accordance with section 326(d) of the same Act, without being affected by any earnings of the taxable year available for dividend purposes.”

In determining invested capital for the years involved consideration should be given to the amount of tax due for the previous year as determined by the Board in the case of Belmont Iron Works, 6 B. T. A. 722.

Judgment will be entered on 15 days' notice, under Rule 50.

Considered by Moeris, Murdock, and Siefkin.


author: Aeundell :

text:
    F. A. Douty, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 13329.
    Promulgated November 21, 1927.

      John A. Collier, Esq., for the petitioner.

      George G. Witter, Esq., for the respondent.
   OPINION.

Aeundell :

Petitioner has established that for the year 1924 he is entitled to credits aggregating $1,200 for his two minor daughters and his mother, who were dependent on him for support. Section 216 (d) Revenue Act of 1924.

As to the loss claimed to have resulted in 1924 from the sale of horses, the record is entirely devoid of evidence upon which a loss in any amount could be allowed. We do not know the amount of petitioner’s investment, whether the losses were capital or operating losses, whether the venture was terminated in 1923 or 1924, the value of the horses taken over by petitioner or the price at which he sold them.

It was also contended by respondent that the loss in question was sustained in a transaction entered into for pleasure and not for profit. Evidence was offered on this point, but in view of petitioner’s failure to establish the amount of the claimed loss, it need not be decided.

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

Considered by SteRNhagen and Green.


author: Sternhagen :

text:
    Virginia H. Holden, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5885.
    Promulgated November 21, 1927.

      Ralph /S'. Rounds, Esq., and Francis E. Neagle, Esq.., for the petitioner.

      Philip M. Glarh, Esq., for the respondent.
   OPINION.

Sternhagen :

Whatever may have been the personal belief of petitioner in 1917 as to the history of the $30,000 whicli she then received or the legal nature of the transaction by which she received it, the record evidence of the transaction as a loan is so unequivocal that it can not be overthrown in order to construe it to be a dividend. The corporate resolution authorizing a loan to McConkie; McConkie’s note; the note of Goff as trustee; Goff’s contemporaneous memorandum, he being the dominating director of the corporation; the note of petitioner herself, an educated and experienced woman in financial matters, well aware of the function of a promissory note and the significance of her signature; the possible motive of the corporation to save Canadian taxes by making a loan instead of declaring a dividend; and the failure of petitioner to treat the amount as a dividend when making her 1917 tax return and thus her saving of taxes which if accrued would now be outlawed, all establish the transaction as a loan, deliberately and purposely made, and that the idea of a dividend, whether ordinary or in liquidation, was considered and rejected. By way of corroboration, all of the subsequent acts carry out the idea of a loan and are inconsistent with that of a dividend — the preservation of the notes; the 1921 dividend resolution and its recognition of the bills receivable; the accounting entries; the cancelation of the notes. Against this the petitioner places her informal conversation with Goff and her testimony that she thought she was getting a dividend. This is, in our opinion, not effective to overcome the official and unrenounced corporate action. If the informal understanding of this stockholder were sufficient to fix the nature of the corporate action as that of a dividend, what becomes of the understanding of Goff as the majority stockholder, who manifestly intended it to be a loan and made it such ?

The petitioner urges that a closely owned corporation may act informally, and so it may. Here the corporation chose to act formally. The petitioner insists that substance is controlling over form; we think both form and substance here converge in a loan in 1917 and a dividend in 1921. In this the case is different from those cited by petitioner.. Both the corporation and the petitioner treated the transaction as a loan in 1917 and were substantially benefited thereby. This was correct. When, however, the dividend came in 1921, she was released from her note, received income, and must bear the burden of its tax.

Judgment will be entered for the respondent.

Considered by Green and Arundell.