author: Murdock :

text:
    American Chemical Paint Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43124.
    Promulgated April 21, 1932

      Percy W. Phillips, Esq., and D. V. Johnston, G. P. A., for the petitioner.

      Arthwr Carnduff, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $3,449.94 in the petitioner’s tax liability for the year 192T. His only adjustment was to disallow depreciation on patents in the amount of $25,555.12 because the patents on which depreciation was claimed were paid for in stock, and the value of the stock was not shown. The only error assigned is the action of the Commissioner in disallowing depreciation on patents.

The petitioner was incorporated under the laws of Delaware, on February 21, 1914. Its principal place of business is at Ambler, Pennsylvania, and it filed its income-tax return for 1927 with the collector of internal revenue at Philadelphia, Pennsylvania. It was incorporated for the purpose of exploiting an invention of a method of preparing steel automobile bodies and other metal surfaces for painting by first treating the metal with a certain solution. The inventor was George D. Feidt. The organizer, and later the president of the petitioner, was J. H. Gravell. In 1913 Gravell was assistant to the superintendent of painting in the paint shop of a firm located near Philadelphia which was engaged at that time in the manufacture of steel bodies for the Hupp Motor Company. Steel bodies for motor cars came into use in about the year 1912. The manufacturers of these bodies encountered serious difficulties in preparing the metal for painting. Various methods of cleaning and preparing the metal surface were tried, but despite all that was done the paint very soon came loose in places, due to the fact that the metal rusted under the paint. In 1912 and 1913 many steel bodies were returned to the manufacturer on account of this defect.

Feidt was a wholesale druggist in Philadelphia. He had furnished some material to the firm by which Gravell was employed. As a result of this connection he learned of the difficulty which his customer was having. In the fall of 1913 he invented the method of preparing steel for painting on which letters patent were subsequently issued. On February 4, 1914, he filed in the United States Patent Office application for letters patent on his method. This application was given Serial No. 816,537. On February 6, 1914, -he assigned his whole right, title and interest in and to his application for patent No. 816,537 and to any patent that might issue thereon, to Percy C. Feger of Philadelphia. The assignment recited a consideration of $1 and other good and valuable considerations. On March 18, 1914, Feger made a similar assignment of the application to the petitioner. The stated consideration for this assignment was 9,000 shares of the common stock and 150 shares of the preferred stock of the petitioner, and other good and valuable considerations. On September 8, 1914, Patent No. 1,109,670 was granted as a result of this application.

On September 14, 1914, six days after the issuance of the above mentioned patent, Feidt filed an application for a patent on a cleaning compound for metals. It was assigned Serial No. 861,550. On September 17,1914, Feidt assigned his whole right, title and interest in this application, and any patent that might issue thereon, to the petitioner for a recited. consideration of $1 and other good and valuable considerations. On December 1, 1914, Patent No. 1,119,781 was issued as a result of this application. The patented compound for cleaning metals, Patent No. 1,119,781, was somewhat similar to the solution described in the patented method of preparing steel for painting, Patent No. 1,109,670.

The authorized capitalization of the petitioner was $500,000, consisting of 9,000 shares of common stock of the par value of $50 a share, and 1,000 shares of preferred stock of the same par value; $42,500 par value of preferred stock was retained in the treasury: $2,500 par value of preferred stock was sold for cash; and all of the rest of the stock, consisting of $5,000 par value of the preferred stock and all of the common stock in the amount of $450,000 par value, was issued at or shortly after the time of the incorporation of the petitioner for an invention covered by an application for patent.

The parties agree that since the property thus acquired was the only asset of the corporation, the value of the stock issued for it representing the cost of the property to the corporation is measured by the fair market value of the property on or about February 25, 1914. Cf. Hershey Manufacturing Co., 14 B. T. A. 867; affd., 43 Fed. (2d) 298. The petitioner therefore attempted to prove this value by calling one witness, Feger, and having him state that in his opinion the property was then worth at least $450,000. The petitioner relied upon certain decisions of the Court of Appeals of the Third Circuit in which the Board was reversed for failing to follow the opinions of witnesses where the record contained no contrary opinions, e. g., Boggs & Buhl, Inc., v. Commissioner, 34 Fed. (2d) 859. This case may go on appeal to that court. The decision of the case rests entirely upon whether or not we are absolutely bound by the opinion of this one witness. The petitioner concedes this and makes no contention that there is any other method of valuation upon which it relies. This corporation of course had no past history which would indicate a value based on earnings. We have not been told when the $2,500 par value of preferred stock was sold nor how much was received for it. But even if we knew these facts we could not determine from them the value of the common stock which the petitioner claims formed the larger part of the consideration. We know that the stock was to be issued to Feger or his nominees, but we do not know who received it, except that Feger, at the time of the hearing, held only three shares of common and none of the preferred. It might be very helpful to know who received the stock and the circumstances under which it was received. We do not know that Feidt ever became a stockholder. A statement of profit and loss introduced by the petitioner shows royalties. These were not explained. Perhaps Feidt disposed of his rights on a royalty basis. It might be helpful to know about that.

The witness, Percy C. Feger, had been engaged in the general practice of law in Philadelphia since 1905. He first learned of the invention from Gravell, who consulted him as to how to market it and for whom he made an investigation of the matter. He had had little previous experience with inventions. His investigation included an afternoon visit to the shop where Gravell was employed. There he saw some steel automobile bodies being treated by the method invented by Feidt, and tried his hand at swabbing and drying some of the bodies. He also experimented with some small sheets of steel at his home. He had some correspondence with manufacturers of automobiles and obtained some information on the number of steel bodies manufactured up to February, 1914. He knew that at least several hundred of these bodies had been treated by the petitioner’s process with satisfactory results. If he knew any other fact of importance at that time, we have not heard of it. He organized the petitioner for his client and has ever since been associated with it as director, secretary-treasurer, and general counsel. We do not know who the other original directors were. A large part of his time has been devoted to the affairs of the corporation. He has handled most of its business dealings with customers. He anticipated in February, 1914, that the corporation would have some hard years at the beginning and would have trouble from infringements, due to the simplicity of its process and the difficulty of detecting infringements in paint shops all over the country. The company found many cases of infringement and its total profits for the first eight years of its existence, without deduction for exhaustion of patents, amounted to less than $150,000. If deductions had been taken at the rate now contended for, the corporation would have suffered a loss of over $50,000 for this period. The profits have been very substantial since 1922, but prior to that time the corporation had acquired other value patents and new markets not anticipated in 1914. The original process, which was a very simple and inexpensive one to use, was still in use in the taxable year 1927, at which time practically every automobile manufactured in the United States was being subjected to this process.

Feger’s opinion was not predicated upon any sale or offer to sell, and he was so inadequately examined as to the facts upon which he relied and the reasoning which he employed in arriving at his conclusion as to value that we are unable to see exactly what his method was. His only explanation was as follows:

WeU, I considered the number of steel bodies that were manufactured from the beginning in 1912 and the enormous increase of the number of those bodies over the years. I did not foresee the enormous increase in automotive transportation that we have witnessed. I tools the profit that we could make at $2.50 a gallon, a net profit of 20 cents a body, and I figured that we would do at least 300,000 bodies a year, because that was the production of steel bodies in 1912, and it increased 100,000 in 1913, and I thought there would be, certainly, that normal rate of increase, of say one-third, or if not one-third at least 100,000. On the basis of that, that gave me $60,000 a year; and in seventeen years, a man would certainly contemplate, in buying the patent, he was going to make a profit, and he would take in over a million dollars. So I think I was very conservative when I put in a value which, since that time, we have earned in one year.

He assumed that the corporation would make a profit of 60 cents on each gallon of material, and that only three automobile bodies would be processed from each gallon. Yet he testified that a gallon of material would always be sufficient to process three bodies and, depending upon the degree of care used, might be sufficient to process any number up to six. There is no testimony to indicate that in February, 1914, anyone could reasonably have anticipated that the material would be sold for $2.50 a gallon or that the corporation would derive therefrom a profit of 60 cents a gallon. The witness further assumed, without stating any particular reason, that 300,000 bodies would be processed each year with the new material. Our own experience and general knowledge of the subject tells us that a prospective purchaser would not have made many of the assumptions which the witness makes. We do not believe, for example, that he would have invested any substantial amount in the application for a patent without first assuring himself that the alleged invention was patentable, did not interfere with any previous patent, and that a patent would probably issue. See Robbs Patent Essentials, 1922, p. 258. There is no testimony to show what he could have learned in this connection in February, 1914. The witness was not shown to be qualified to judge the probabilities of patentability. Cf. Globe Construction Co., 25 B. T. A. 146; Joseph H. Adams, 23 B. T. A. 71; Hershey Manufacturing Co., supra. He assumed that a buyer or seller would have known in February, 1914, that a patent would certainly be granted because up to that time no interferences had been cited. He seemed to think that the application had been on file since the previous fall, but as a matter of fact it had been on file not more than three weeks when the application was turned in for stock. It was not until more than six months later that the first patent was issued. The witness, in some unexplained way, arrived at a present value for the application for patents in February, 1914, from aggregate profits of $1,020,000 ($60,000 x 17) which he estimated would be earned in the seventeen years. We have general knowledge that at least a portion of profits is frequently attributable to good management and that ordinarily a part-of profits must be considered as a normal return on the capital and other assets used in a business before arriving at a value for patents. We do not know what allowance, if any, the witness made on account of these things or on account of the various uncertainties of the future, such as changes or improvements of one kind and .another which any reasonable person would consider before investing in an application for a patent such as this one. Cf. National Water Main Cleaning Co., 16 B. T. A. 223, 238.

Some value was inherent in this invention, but certain serious difficulties which would have to be surmounted by anyone who might attempt to exploit it were also inherent in the invention and apparent from the very beginning. Feger and his associates, whoever they y^erej were perhaps justified in their hope that Feidt’s invention would ultimately prove successful and result in large earnings, that it had a potential value; but we are concerned only with market value in February, 1914. We may not be unduly influenced by the subsequent grant of the patent or by the success which the company ultimately achieved. Cf. Commissioner v. Stephens-Adamson Manufacturing Co., 51 Fed. (2d) 681. We have no special knowledge of this patent application in 1914 aside from what we have learned from the record, nor private knowledge of any particular facts material to the decision of the case. If we had, we would have to put that special knowledge aside in the decision of this case, for we are governed by the evidence adduced. Obviously the well recognized presumption in favor of the correctness of the determination of the Commissioner is vain and futile if it may be overcome by the unsupported opinion of a single witness as the petitioner contends. If we are to act intelligently, we must judge of the weight and of the force of the opinion by our own general experience and general knowledge of the subject of inquiry. Head v. Hargrave, 105 U. S. 45; The Conqueror, 166 U. S. 110; Uncasville Manufacturing Co. v. Commissioner, 55 Fed. (2d) 893; Bogle & Co. v. Commissioner, 26 Fed. (2d) 771; Balaban & Katz Corporation v. Commissioner, 30 Fed. (2d) 807; Am-Plus Storage Battery Co. v. Commissioner, 35 Fed. (2d) 167; Anchor Co. v. Commissioner, 42 Fed. (2d) 99; Patterson v. Commissioner, 42 Fed. (2d) 148; Tracy v. Commissioner, 53 Fed. (2d) 575. We are not obliged to accept the opinion of this witness as absolute, yet we do not disregard his testimony, nor do we refuse to follow his opinion for no reason at all. Our reason is that in the light of the facts proven and of our own experience and general knowledge of the subject of inquiry, his opinion does not appear to be even reasonably reliable. We must assume that the petitioner produced all of the evidence which was available or at least all that it cared to present. Since the evidence produced is not reasonably convincing of the value contended for, the loss must fall upon the petitioner. Cf. Burnet v. Houston, 283 U. S. 223; Jankowsky v. Commissioner, 56 Fed. (2d) 1006.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Black :

license: Public Domain

text:
    Guitar Trust Estate, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 35102.
    Promulgated April 21, 1932.

      J. S. T. Ivins, Esq., Eustis Myers, Esq., and R. G. Winters, O. P. A., for the petitioner.

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

Black :

The principal issue involved in this proceeding is whether petitioner is a trust taxable, if at all, under the provision of section 219 of the applicable revenue acts, or whether it is an association taxable as a corporation.

Section 2 (a) (2) of the applicable revenue acts says: “ The term ‘ corporation ’ includes associations, joint stock companies and insurance companies.” Clearly, petitioner is not a joint stock company such as the Supreme Court held taxable as a corporation in Burk-Waggoner Oil Association v. Hopkins, 269 U. S. 110. In that case, R. M. Waggoner and associates entered into a written agreement which provided for the formation of an “ unincorporated joint-stock association to be known as Burk-Waggoner Oil Association ” and the agreement entered into carried out the purposes of the parties. The Supreme Court, in discussing the nature of joint stock companies, said:

Unincorporated joint stock associations, although technically partnerships under the law of many states, are not in common parlance referred to as such. They have usually a fixed capital stock divided into shares represented by certificates transferable only upon the books of the company, manage their affairs by a board of directors and executive officers and conduct their business in the general form and mode of procedure of a corporation. Because of this resemblance in form and effectiveness, these business organizations are subjected by the act to these taxes as corporations.

We think it requires no argument to hold that under the above quoted definition of joint-stock companies, petitioner does not fit into the classification. It had no fixed capital stock; it issued no shares represented by certificates transferable only upon the books of the company; it had no board of directors and executive officers, unless the three trustees might be classified as such; and it did not conduct its business in the general form and mode of procedure of a corporation.

In Hecht v. Malley, 265 U. S. 144, the Supreme Court, in discussing the meaning of the word “ association ” as used in the applicable revenue act, said:

The word “ association ” appears to be used in the Act in its ordinary meaning. It has been defined as a term “ used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise.”

In applying the above definition to one of the trusts which it had before it, the court held that the Hecht Real Estate Trust, which had been established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common, was an association taxable as a corporation. On that point the court said:

The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and "business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, remove a trustee, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder.

In the instant case no certificates of beneficial interest were issued and the beneficiaries had no power to sell or dispose of their interest in the trust corpus. The trust instrument specifically provided:

The beneficiaries hereunder will have no voice in the control and management of said estate and they shall not mortgage or encumber their beneficial interest, or in any wise dispose of said interest, until they have received same from the trustees.

Also, the instant case does not present a situation where parties owning property as tenants in common (as in the Hecht Real Estate Trust) voluntarily associate themselves together under the trust agreement to operate the property for business purposes. The eight children of the settlors of the trust in the instant case owned no interest whatever in the property at the time the trust deed was executed. They knew nothing about the plans for its execution until after its actual execution. It is clear that the purpose to be accomplished by the execution of the trust deed was to make a donation by the settlors of the trust to their children of an equal interest in their property, after they had reserved a share each to themselves, and to accomplish this without dividing the property. This purpose was explained by John Guitar, Sr., one of the settlors of the trust, in his testimony at the hearing as follows:

Q. Mr. Guitar, will you explain to the Board what the reason was for the creation of this trust?
A. Well, my wife and I had accumulated a right smart property, and had a large family of children, and they were all getting grown, and it kind of puzzled us how to best handle the property for the children. We first thought we would divide it up by deeding a special piece to each child, but saw we couldn’t make a proper division that way by doing that; and we finally decided the best thing to do was to deed it to a trustee to carry it on the same way, each child having an interest in the property. We wanted each child to have the same interest exactly that the other one had.

This sort of an arrangement is, we think, very different from that which was made by members of the Hecht family when, as owners and tenants in common of real estate in Boston, used for offices and business purposes, they voluntarily associated themselves together in the Hecht Real Estate Trust to hold and operate the property for business purposes. We think the distinction between that situation and the one we have before us in the instant case, was well stated by the court in Blair v. Wilson Syndicate Trust, 39 Fed. (2d) 43, wherein the court said:

* * * A distinction is to be made between an agreement between individuals in the form of a trust and an express trust created by an ancestor, although they may have some features in common. The controlling distinction is that one is a voluntary association of individuals for convenience and profit, the other a method of equitably distributing a legacy or donation. Congress has recognized this distinction, classing the former as associations, to be taxed as corporations, and at the same time providing for a separate and distinct method of taxing the income of estates and trusts created by will or deed, classing them together for that purpose. Section 219, Revenue Act of 1921 (42 Stat. 246).

We followed Blair v. Wilson Syndicate Trust, supra, in Wilson Trust, 20 B. T. A. 549.

In our judgment the evidence shows that the chief purpose of the trust deed which we have before us for construction was the equitable distribution of donations which the settlors desired to make to their children without the necessity of immediate partition. We think petitioner was the sort of an entity which Congress intended to tax as a trust under the provisions of section 219 of the applicable revenue acts. We, therefore, sustain petitioner’s assignment of error (a) and hold that respondent erred in seeking to tax petitioner as an association taxable as a-corporation.

The next issue for our determination is whether or not the income of the trust or any part of it in each of the taxable years is, under section 219 of the applicable revenue acts, taxable to the petitioner as a fiduciary or whether the income was taxable to the several beneficiaries in proportion to their respective shares. Petitioner in its petition alleges that it filed information returns on Form 1041, giving information as to the correct amount of the income of the trust for each of the taxable years and showing the beneficiaries among whom it was apportioned and that each of these beneficiaries in turn reported the amount which was apportioned to him and that this was the correct method of handling the matter under section 219 of the applicable revenue acts.

Plainly, under the provisions of section 219 of the applicable revenue acts, the income of a fiduciary may fall into several classifications :

(1) Income which the fiduciary is under a mandatory duty to accumulate and hold for future distribution under the terms of the will or trust. This kind of income is taxable to the fiduciary and not to the beneficiaries.

(2) Income which the fiduciary is under a mandatory duty to distribute “ periodically, whether or not at regular intervals ” says the 1921 Act. “ Currently ” say the 1924 and 1926 Acts. So much of the income as falls within this classification is taxable to the beneficiaries and not to the fiduciary. And this is true, whether the income is actually distributed or not. Estate of Henry Mayer, 16 B. T. A. 1164.

(3) Income which in the discretion of the fiduciary may be either distributed or accumulated.

The 1921 Act does not by express language contain this latter classification (3), but this Board has construed it to have that meaning. William E. Scripps et al., Trustees, 1 B. T. A. 491; Mary L. Barton, 5 B. T. A. 1008; Brown & Ives, Trustees, 2 B. T. A. 936. This classification is expressly made in section 219 of the 1924 and 1926 Acts. Where this kind of income comes into the hands of the fiduciary and he exercises the discretion vested in him to accumulate, the income is taxable to the fiduciary and not to the beneficiaries. John D. Rogers, 16 B. T. A. 368. But in cases where the fiduciary exercises his discretion to distribute, then all such income as is paid or properly credited during the taxable year to the beneficiary is taxable to the beneficiary and not to the fiduciary. William E. Scripps et al., Trustees, supra.

Into which one or more of the above classifications does petitioner’s income fall ? To answer this question will require an examination of the original trust deed dated December 30, 1921, and the purported supplement to the trust deed bearing the alleged date of January 10, 1922.

The original trust deed contains the following paragraph with reference to income:

The said trustees shall make an accounting with the beneficiaries herein once each year during the terms of this trust and the trustees shall, at their option, declare a dividend out of any profits that may have accrued to said estate, which may be paid to each of the beneficiaries herein named, or retained in the business as the trustees may determine. [Italics supplied.]

Under the above quoted provision it is plain that the trustees are not under any mandatory duty to distribute the income of the trust, but are given the option to either accumulate income or to declare dividends and pay them. If this is the clause which was operative during the taxable years, it would bring the income of the fiduciary within classification (3) which we have enumerated, and the question as to whether the income is taxable to the fiduciary or is taxable to the beneficiaries depends upon how the trustees exercised their discretion — upon what they actually did. Petitioner contends however that the supplement was operative during each of the taxable years and not the above quoted clause of the original deed, and that the trustees were required under the supplement to distribute the income and therefore the income was taxable to the beneficiaries and not to the fiduciary. Respondent disputes the effectiveness of the alleged supplement at any time, and contends that it was a mere nullity, and that, acting under the authority of the original trust deed, the trustees exercised their option to accumulate income rather than to declare dividends, and therefore all the income for each of the taxable years is taxable to the fiduciary except comparatively small amounts which were actually distributed to the beneficiaries in the respective taxable years and which are not in dispute. In the alternative, petitioner contends that even if the supplement were not effective, the action of the trustees in dividing the net income in each of the taxable years into ten equal' parts and crediting same to the invested capital account of each of the beneficiaries, was, under the above quoted paragraph of the original deed, an exercise of the discretion to declare and pay dividends and was equivalent to an actual distribution and made the income taxable to the beneficiaries in proportion to their respective shares and not to the fiduciary.

Before passing upon these respective contentions of respondent and petitioner, we shall decide whether or not the alleged supplement to the original trust agreement was effective and, if so, when it became effective. If it was effective in all the taxable years, then we think it placed a mandatory duty upon the trustees to distribute currently the income of the trust to the beneficiaries and that such income would be taxable to the beneficiaries and not to the fiduciary, and this would be true whether such income was actually distributed or not. Estate of Henry Mayer, supra.

Said supplement purported to substitute for tbe already quoted paragraph of the original trust deed a paragraph reading as follows:

The said trustees shall make an accounting with the beneficiaries herein once each year during the term of this trust, and each of the ten beneficiaries is to be credited with one-tenth of the annual income of this trust estate or charged with one-tenth of the loss whichever the case may be, this income may be drawn out at any time by the beneficiaries, the beneficial interest, however, must remain intact until the final termination of the trust and is subject to all the conditions named in the original deed of trust. [Italics supplied.]

This supplement purports to have been executed and delivered only 11 days after the original trust deed and practically contemporaneously therewith, but evidently this is not true.

This purported supplement mentions as a part of its heading the recording of the original trust deed and gives the date of one of its recordings, to wit, December 23, 1922, which was nearly one year after the date of the execution of the original trust deed, to wit, December 30, 1921. Manifestly, if the purported supplement was in fact executed on the date which it purports, to wit, January 10, 1922, it could not have made mention of the recording of the original trust deed, which took place in one of the counties on December 23, 1922. The supplement can not be treated as having been contemporaneously executed with the original trust deed.

The certificate of recording attached to this supplement shows that it was first filed for record in Taylor County, Texas, on March 12, 1924, and was duly recorded the next day, March 13, 1924. The date which this supplement bears manifestly not being the correct date of its execution, and no evidence having been offered showing the true date on which it was executed and having no information on that point, we think that the earliest date that it should be held to be effective is the date when it is shown to have been filed for record, to wit, March 12, 1924. We hold, therefore, that the taxable years 1922 and 1923 are unaffected by it, and that as to those taxable years the rights and obligations of the parties must be determined by the original trust deed. This, as we have already stated, created a trust wherein was vested in the trustees the option to distribute or not as they saw fit. Was the manner of crediting on the books of petitioner to the “ invested capital ” accounts of the several beneficiaries within the taxable years 1922 and 1923 such a “ proper paying or crediting ” to the beneficiaries, within the meaning of the law, as makes the income taxable to the beneficiaries and not to the fiduciary ?

Respondent contends that the alleged credits to the beneficiaries were not of such a nature as to finally and irrevocably place the amounts at the disposal of the individual beneficiaries. “ The fact that they made no attempt to withdraw the amounts except in relatively small amounts, coupled with the fact that the credits were not made to individual accounts payable but to the same ‘ invested capital accounts to which the corpus of the trust had theretofore been credited,” says respondent, indicates unmistakably the intention to retain the amounts in the business rather than to subject the amounts to the free disposition of the individual beneficiaries:”

We think respondent must be sustained in these contentions. Petitioner relies on William E. Scripps et al., Trustees, supra. An examination of the facts in that case will show that the settlor of the trust made it mandatory on the trustees to distribute 50 per cent of the dividends from certain stocks to his children and left it in their discretion as to whether they would distribute the remaining 50 per cent of the dividends to said children or use it in the improvement of the property from which the dividends were derived. In all the taxable years involved in that proceeding and in years prior thereto the trustees had not only distributed the 50 per cent of the dividends which had been made mandatory upon them, but also had distributed in each year the remaining 50 per cent of the dividends as to which they had a certain amount of discretion. On these facts we held that the entire income of the trust was income to be “ periodically ” distributed to the beneficiaries within the meaning of the Revenue Acts of 1918 and 1921 and was taxable to the beneficiaries and not to the fiduciary. Only by holding in the instant case that the credits made in 1922 and 1923 to the “ invested capital ” accounts of the several beneficiaries were in the same category as the actual distributions of income which the trustees made in the Soripps case, would we be justified in holding that the same rule applied to both cases. Such a holding we do not think would be justified.

The situation which we have in the instant case is also different from that which existed in Willcuts v. Ordway, 19 Fed. (2d) 917, wherein the court held that the action of the trustees in dealing with the income of certain minor beneficiaries was equivalent to a distribution to them within the taxable years and that the income was therefore taxable to the beneficiaries and not to the fiduciaries. In that case the facts showed that the trustees purchased, with the surplus income of the minor beneficiaries within the years it was available to them, separate securities and within the same years segregated these securities from the corpus of the estate and kept them separate as the property of these minor children. The court held that this action was a “ distribution ” within the taxable year within the meaning of section 219 of the revenue act.

In the instant case we have no such facts before us. There was no investing of the income of each beneficiary in separate securities and segregating these securities from the rest of the corpus of the estate. As respondent points out, there was not even a crediting to the personal account of each beneficiary, but only a crediting to the “ invested capital ” account of each beneficiary, thus evidencing an intention to keep these profits in the business rather than to distribute them.

Under the circumstances which we have narrated, we think the trust income credited to the invested capital accounts of the beneficiaries in 1922 and 1923 was not a proper paying or crediting within the meaning of the law and is taxable to the fiduciary and not to the beneficiaries. Cf. Brown & Ives, Trustees, 2 B. T. A. 936.

As to the taxable years 1924,1925 and 1926, we hold that the supplement to the original trust deed which was executed by the set-tlors of the trust, and appears to have been acquiesced in and acted upon by all the parties, was effective from the date it was filed for record and governs the taxable years 1924, 1925 and 1926. For reasons which we have already stated, we can not hold it effective for any time earlier than the date of its recording because plainly it was not executed on the date which it purports to bear. Under the paragraph of the supplement relating to disposition of income, and which was to take the place of the paragraph in the original trust deed relating to the same subject matter (both of which we have already quoted), we hold that it was mandatory upon petitioner to make annual distribution of its income to the beneficiaries and that petitioner is entitled to take as deductions under section 219(b) (2) of the Revenue Acts of 1924 and 1926, the amount of the net income shown by its books at the end of each of the taxable years 1924, 1925 and 1926. This is true, even though the crediting of the income to the “ invested capital ” account of the respective beneficiaries on petitioner’s books did not, as we have already held, amount to an actual distribution of such income to the beneficiaries. For, where the trust instrument makes it mandatory on the trustees to distribute the income “ currently ” to the beneficiaries, it is taxable to them and not to the fiduciary, whether it is actually distributed or not. Estate of Henry Mayer, supra, and other cases there cited.

The next issue relates to penalties asserted by respondent for all the taxable years, except 1926, as to which respondent has conceded error in assessing the penalty.

Our holding that petitioner’s income for 1924 and 1925 is taxable to the beneficiaries and not to the fiduciary does away with the issue of penalties for those two years, for as the penalties asserted are ad valorem penalties, there can be no penalties if there is no tax.

This leaves us only to decide whether the Commissioner’s assessment of penalties for 1922 and 1923 should be approved. In deter* mining the validity of the respondent’s action in assessing these penalties, it must be remembered that the fiduciary reported income on a calendar year basis and must, therefore, under the provisions of section 227 (a) of the Revenue Act of 1921, make its return “ on-or before the 15th day of March.” This section allows the Commissioner to grant extensions of time for filing returns, the provisions of the 1921 Act with respect thereto reading as follows:

The Commissioner may grant a reasonable extension of time for filing returns whenever in his judgment good cause exists and shall keep a record of every such extension and the reason therefor.

The return required by the statute is one which will show specifically the items of gross income and the deductions and credits allowed by the revenue acts. The law makes no provision for so-called “ tentative ” returns, which have become more or less familiar by virtue of the fact that the respondent is authorized to grant an extension of time for filing a return. This authority in the respondent to grant extensions is, no doubt, the basis for his regulations that a taxpayer may be required to file a tentative return on or before the due date in procuring an extension of time. Article 443, Regulations 62 and 65.

In this proceeding the trustees, for each of the taxable years 1922 and 1923, filed on or prior to the due date the so-called “ tentative ” returns. We find from a consideration of all the evidence that, for each of the years 1922 and 1923, prior to filing the tentative returns petitioner had secured permission from the Commissioner to file completed returns at a later date and that such completed returns were filed within the time as extended by the Commissioner. Under these circumstances no penalties should be imposed and we sustain petitioner’s assignment of error (c).

It is unnecessary for us to rule upon petitioner’s assignments of error (e), (f), (g) and (h), because they relate to deductions claimed by petitioner in years in which we have held the fiduciary is not taxable on the income involved. Even if we decided these issues in favor of respondent, it would only serve to increase the taxable income of the several beneficiaries, because we have already held that under the supplement effective for 1924, 1925 and 1926 all the net income of the estate was distributable to the several beneficiaries and was therefore taxable to them and not to the fiduciary. We do not have the beneficiaries before us and hence it would be irrelevant to decide the above issues.

Respondent’s alternative contention to the effect that if the Board finds and determines that the petitioner is taxable as a fiduciary, the petitioner’s taxable net income for each of the years 1922 to 1926, inclusive, has’been understated by the Commissioner through failure to include in net income the dividends from domestic corporations which were reported by the petitioner in its information returns, is sustained as to the years 1922 and 1923. In a recomputation of the deficiencies for those years, such dividends should be included in petitioner’s net income and the deficiencies increased accordingly, if it has that effect.

Eeviewed by the Board.

Decision will he entered under Rule 50.

Marquette and Seawell dissent.


author: Tkammell :

text:
    Philadelphia Paper Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 44110.
    Promulgated April 22, 1932.

      Theodore B. Benson, Esq., for the petitioner.

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

Tkammell :

Although the petitioner took a deduction of $105,464.11 in its return and asked in its petition that that amount be allowed, it now concedes that the amount deducted was erroneous and asks that there be allowed the amount of $85,535.33, which is computed in the following manner:

Capital stock of Fibopak Sales Company held by Fibre Container Company on June 1, 1923, and taken over by petitioner on July 1, 1923_$46,000. 00
Indebtedness on open account owing by Fibopak Sales Company to Fibre Container Company on June 1, 1923, and taken over by tbe petitioner on July 1, 1923_ 31, 080.17
Indebtedness of Fibopak Sales Company to Fibre Container Company on notes on June 1, 1923, and acquired by tbe petitioner on July 1, 1923_ 67, 000.00
Indebtedness of Fibopak Sales Company to the Philadelphia Paper Manufacturing Company (old company) on notes on June 1, 1923, and acquired by petitioner on July 1, 1923- 1, 000. 00
Total- 145, 080.17
Less indebtedness of Fibopak Sales Company charged off by Fibre Container Company in 1923_ 34, 575.88
110,504.29
Advances to Fibopak Sales Company by petitioner from July 1,1923, to September 30, 1925_$24, 985. 82
135, 490.11
Less assets received by petitioner in liquidation of Fibopak Sales Company_ 49, 954. 78
Balance_ 85, 535.33

The petitioner contends that as a result of taking over the assets of the Fibopak Sales Company in liquidation of that company it sustained a deductible loss of $85,535.38. The respondent denies that the petitioner sustained any deductible loss.

Of the deduction now claimed by the petitioner $24,985.82 represents advances made by it to the Fibopak Sales Company during the period of affiliation between July 1,1923, and the date of the liquidation of the latter company in September, 1925, and owing to the petitioner on the latter date. In liquidation the petitioner received $49,954.78, which is in excess of the amount of the advances owing to it at that time. The evidence does not establish a loss either as a bad debt or otherwise, even if such intercompany transactions might give rise to a bad debt deduction. These advances could not have been considered a part of the cost of the stock acquired because they were in the first place mere loans and not made until after the acquisition of the stock upon liquidation of the Fibre Container Company.

With respect to the remainder of the deduction contended for, $1,000 represents the indebtedness of the Fibopak Sales Company to the old company on notes which were outstanding prior to affiliation and which apparently were acquired by the petitioner on July 1, 1923, when it acquired the assets of the old company. The record does not show what the cost of such notes to the petitioner was, nor does it disclose what the value was at the time of acquisition by the petitioner. Without such information we are not in a position to determine at what amount, if any, they are to be considered in determining the loss contended for, if any amount is allowable as a matter of law. At any rate if they are given a value of $1,000, that amount plus advances made subsequent to affiliation is still less than the amount received in liquidation. Therefore, the amount of $1,000 can not be considered as a loss arising either from an indebtedness owing the petitioner or otherwise.

The remaining portion of the deduction contended for relates to the capital stock of the Fibopak Sales Company formerly held by the Fibre Container Company and certain indebtedness owing by the former to the latter on open account and on notes. This stock and the right to receive payment of the indebtedness were acquired by the petitioner upon the liquidation of the Fibre Container Company on July 1, 1923, the stock of that company having been acquired previously by the petitioner in exchange for its own stock. Regardless of any other legal question presented, it does not appear from the record what the stock of the Fibopak Sales Company and the right to receive payment of the indebtedness cost the petitioner. The evidence does not disclose what the stock of the Fibre Container Company cost the petitioner. The fact that the petitioner exchanged shares of its capital stock having a certain par value for stock of the Fibre Container Company having a certain other par value is not sufficient to warrant us in making any finding as to either the cost or value of such stock at the time of acquisition. We are not informed as to the value of the stock of the Fibopak Sales Company and the indebtedness at the time of their acquisition by the petitioner on July 1,1923, nor do we know the value of that company’s assets at that time. We therefore do not feel called upon to pass upon the questions of law which have been argued by counsel as to the effect of operating losses of the subsidiary during the period of affiliation or to determine whether any losses constitute intercompany transactions. In the absence of basic facts upon which to determine whether the petitioner has sustained a loss, such would be merely moot questions.

Judgment will be entered for the respondent.


author: Trammell :

text:
    M. Morgenthau-Seixas Company, Inc., of New York, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42946.
    Promulgated April 22, 1932.

      Jesse L. Stem, Esq., for the petitioner.

      Hartford Allen, Esq., for the respondent.
   OPINION.

Trammell :

The issue presented for our determination is whether the petitioner is entitled to a deduction from gross income in 1925 of $4,000 as a reasonable addition to a reserve for bad debts.

The petitioner contends that in its return for 1921 it elected to use the reserve for bad debts method in making deductions for bad debts and as it has never changed its method in that respect it is entitled to use the same method for the taxable year. With respect to its failure to make an addition to its reserve for bad debts in 1921, the petitioner urges that it had no bad debts in that year and there was no occasion to create a larger reserve. The respondent contends that the 1921 return shows an intention on the part of the petitioner to write off specific bad debts. He further contends that, if it be held that the petitioner made no election for 1921 as to the method it would follow with respect to bad debts, it made an election to charge off specific bad debts for 1922, and that, having made this election, it may not change to the reserve basis without permission, which the evidence does not show was obtained.

The evidence does not disclose what a reasonable addition to the reserve for bad debts for the taxable year would be. This being true, we could not find that the petitioner is entitled to the deduction claimed, even if it were entitled to use the reserve method in 1925 in charging off bad debts.

The basis elected for 1921, that is, either the specific charge-off method or the reserve method, must be followed in subsequent years unless the respondent’s permission to change is first obtained. Kay Manufacturing Co., 18 B. T. A. 753. But if the petitioner made no election in 1921 because it had no occasion to take a deduction upon either method, it might adopt one method or another in 1922.

We think, however, that for both 1921 and 1922 the petitioner in its returns has indicated an intention to use the specific bad debt charge-off method of deductions. While a certain amount of reserve was carried on the books for bad debts in 1921, and there appeared on the books at the beginning of 1922 such a reserve, there was no reserve at the end of that year, but a specific charge-off of debts ascertained to be worthless. In so far as the deduction claimed is concerned, however, no use was made of any reserve. For 1921 a charge-off was made for a specific bad debt in its return, although it was found that the debt was not bad. In 1922 another charge-off was made for a bad debt and the reserve method was not used in the return. No addition to reserve for bad debts was claimed as a deduction in either of these years. We are of the opinion, therefore, that the action of the respondent in disallowing as a deduction in the taxable year an amount set up as a reserve for bad debts is correct.

At the hearing the petitioner moved to amend its petition so as to set up a claim for the elimination of certain items from income. The presiding member ruled that the motion would be granted upon the petitioner complying with certain specified requirements as to the form in which the motion and the amendments should be made and the time within which they should be presented. As the petitioner did not comply with such requirements, the amendment is not properly before us; but, if it were, the issue presented thereby would have to be denied, since the petitioner offered no admissible evidence in support thereof.

Judgment will be entered for the respondent.


author: Arundell :

text:
    Phoenix Oil Production Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43436.
    Promulgated April 22, 1932.

      Charles W. Friend for the petitioner.

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

Arundell :

The respondent determined deficiencies in income tax for the years 1925 and 1926 in the respective amounts of $200.23 and $172.52. These deficiencies result from the disallowance of a portion of the depletion deductions computed by petitioner on a discovery valuation and claimed in its returns. The question for decision is whether the respondent erred in rejecting the discovery valuation as a basis of computation.

The facts were stipulated, and we incorporate herein, by reference, the stipulation filed as our findings of fact. A brief summary of the facts will suffice for the purposes of this opinion.

Since its incorporation in 1918 petitioner has been the owner of fractional interests in oil-producing properties and its principal income has consisted of royalties from the operation of those properties.

In determining petitioner’s net income for the years prior to 1925 respondent allowed depletion deductions based on discovery values. The information upon which the allowances were made was obtained from a Form O ” filed by petitioner and accepted by respondent.

In determining the depletion allowable for the years 1925 and 1926 the respondent gave no effect to the discovery values on which allowances for prior years were predicated, but allowed depletion deductions representing 27% per cent of the gross income from the properties where such amounts were not in excess of 50 per cent of the net income (computed without allowances for depletion) from the properties, under section 204(c) (2) of the Revenue Act of 1926. The deductions allowed by respondent were $2,967.32 for 1925 and $2,549.43 for 1926.

On these facts petitioner claims that respondent erred in refusing to compute depletion on the discovery basis. The statute involved is the Eevenue Act of 1926 and particularly certain sections of Title II thereof, which title, excepting certain immaterial sections, is made effective as of January 1, 1925, by section 286. Section 204(a) lays down the primary basis for determining gain or loss in providing that with respect to property acquired after February 28, 1913, the basis shall be cost. Section 204 (c) provides that the basis for depletion shall be the same as for gain or loss, i. e., cost, except that:

(2) In tlie case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no ease shall the depletion allowance be less than it would be if computed without reference to this paragraph.

Following the enactment of the Eevenue Act of 1926 the respondent promulgated ruling I. T. 2278, C. B. V-l, p. 65, holding in part that: “ Discovery is not considered in computing depletion of oil and gas wells under the Eevenue Act of 1926.”

Petitioner attacks this ruling as being legislative in nature and an attempted exercise by the respondent of powers vested solely in Congress. It seems to us clear from a reading of section 204(c) (2) of the 1926 Act that the respondent’s ruling does not go beyond the scope of its terms. A brief study of the prior revenue acts and the legislative history of the Act of 1926 shows beyond doubt that Congress intended that discovery basis should not be used in allowing depletion deductions under the 1926 Act. In each of the Eevenue Acts of 1918, 1921 and 1924, specific provision was made for depletion allowances in the case of oil and gas wells based on discovery value. In the Eevenue Act of 1926 discovery valuation as a depletion basis was retained with respect to mines, but as to oil and gas wells a separate provision (sec. 204(c) (2), supra) was enacted. In the consideration of the Eevenue Bill of 1926 it was pointed out by the Senate Committee on Finance (Eept. No. 52, 69th Cong., 1st sess., pp. 17, 18) that:

The administration of the discovery provision of existing law in the case of oil and gas wells has been very difficult because of the discovery valuation that had to be made in the case of each discovered well. In the interest of simplicity and certainty in administration your committee recommends that in the case of oil and gas wells the allowance for depletion shall be 25 per cent of the gross income from the property during the taxable year. The provision of existing law limiting this amount to an amount not in excess of 50 per cent of the net income of the taxpayer from the property is retained.

In conference between the House and Senate Committees the 25 per cent rate referred to above was changed to 27% per cent. In the case of Darby-Lynde Co. v. Alexander, 51 Fed. (2d) 56, the court, after referring to the depletion provisions of the Revenue Acts of 1921 and 1924, said that:

When Congress wrote the provision for depletion allowance in the case of oil and gas wells in the Revenue Act of 1926, it departed from the discovery value basis because of the difficulty of administration.

From this brief review it is obvious that the respondent’s ruling above quoted does not go beyond the intent of Congress as expressed in the Revenue Act of 1926.

Petitioner contends that it filed its “Form O” with the express understanding that the schedules of depletion contained therein would be used for computing depletion during the entire life of petitioner’s leases. A brief answer will do for this, namely, that there is no evidence of any agreement as to what extent “Form O ” was to be used in computing depletion. Moreover, as contended by petitioner under the first point of its argument, the allowance of depletion is a legislative function, and it was beyond the power of the respondent to prescribe what depletion would be allowed in future years. Deductions for depletion may not be taken as a matter of right, but are allowable only by grant of Congress (Von Baumbach v. Sargent Land Co., 242 U. S. 503; Burnet v. Thompson Oil & Gas Co., 283 U. S. 301) and we are not aware of anything that would prevent Congress from changing the amount or the basis from year to year.

Petitioner’s argument that the change of basis is invalid because retroactive is without merit. The change of method in computing depletion destroyed no vested rights of petitioner and the revenue act can not be said to be invalid on that ground. Cf. Graham v. Goodcell, 282 U. S. 409. Statutes effecting retroactive increases in rates of tax are not for that reason invalid (Milliken v. United States, 283 U. S. 15), and certainly a mere change in the method of computing a deduction allowable only as a special grant is not so arbitrary as to place the statute outside the constitutional powers of Congress in levying taxes.

It is also claimed by petitioner that the last sentence of section 204 (c) (2) of the 1926 Act makes it mandatory for respondent to compute depletion on the discovery basis. The sentence referred to reads: “ Except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.” Petitioner argues that when a taxpayer comes within this exception— that is, when depletion under the percentage of income basis is less than under the discovery basis — section 204 (c) (2) vanishes and the taxpayer stands in the same position as though that section had never been enacted. We do not construe the quoted provision in that way. We take it to mean simply that the depletion allowance computed on the percentage of income basis shall not be less than the allowance computed on the basis of cost, which, as stated above, is the primary basis. If petitioner’s contentions were sound it would be left without any basis at all inasmuch as the provision allowing discovery basis in the Revenue Act of 1924 was repealed as of January 1, 1925, upon the enactment of the Revenue Act of 1926. See section 1200 (a), Revenue Act of 1926.

Decision will be entered for the respondent.


author: Mtjiídock :

text:
    Estate of Rudolph F. Rabe, Sr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39474.
    Promulgated April 22, 1932.

      B. M. 0,Hara, Esq., and J. A. Davis, Esq., for the petitioner.

      D. P. Kimball, Esq., and E. G. Adams, Esq., for the respondent.
   OPINION.

Mtjiídock :

The contention of the petitioner is that the distributions made to Rudolph F. Rabe, Sr., on July 3,1925, and February 3,1926, respectively, were amounts distributed in partial liquidation of the corporation, received by him in part payment for his stock, and therefore not taxable to him as ordinary dividends. The Commissioner has taxed the amounts as ordinary dividends. Has the petitioner proven error? No one contends that the other dividends were in liquidation. However, if the two distributions were in liquidation, why were not the others? On this theory the petitioner might owe more tax than the Commissioner has determined, depending upon what other distributions were made in 1926 prior to Rabe’s death.

The provisions of the Revenue Act of 1926 upon which the petitioner relies are as follows:

Seo. 201. (c) Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 202, but shall be recognized only to tbe extent provided in section 203. In tbe case of amounts distributed in partial liquidation (other than a distribution within the provisions of subdivision (g) of section 203 of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subdivision (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.
****** *
(h) As used in this section the term “ amounts distributed in partial liquidation” means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.

The act of the directors in characterizing the distributions “ liquidating dividends ” did not make them such within the meaning of the term as used in the revenue act. In determining the nature of a distribution, the facts of the case control. If acts are inconsistent with the declared purpose of the directors or stockholders, the declarations need not control. Weiss v. Stern, 265 U. S. 242; W. E. Guild et al., 19 B. T. A. 1186; James P. Gossett et al., 22 B. T. A. 1279; E. G. Perry, 9 B. T. A. 796. A liquidation usually begins with an agreement of the stockholders to liquidate and dissolve. No steps t were taken by the stockholders or others toward dissolution. No effort was made to distribute the assets except as they were realized " in cash. These distributions were not in sufficient amount to impair", the capital. Beyer, the only witness, stated that the corporation was formed to accommodate Babe’s real estate transactions and these ended when Babe became physically incapacitated in May, 1924. But he was unable to tell in particular how the activities of the corporation changed after that time from what they had been previously. Apparently it continued to operate normally, doing those things for which it was created, deriving a profit and distributing only its current and accumulated profits. It did not acquire much additional real estate thereafter, but this was not a change for it had acquired little since 1917. It went on unhurried in selling its lots at a profit. Its principal business seems to have been to hold and collect on mortgages. This continued and served a purpose of the stockholders. So far as the record discloses, its activities were always decreasing after 1917 due to the disposition of the real estate and the discharge of the mortgages as they became due. The record does not support the petitioner’s contention and, therefore, we sustain the action of the Commissioner in taxing these as ordinary dividends.

Judgment will be entered for the respondent.


author: Love :

text:
    Estate of David Afremow, by Sarah Afremow, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39593.
    Promulgated April 22, 1932.

      Douglas D. Felix, Esq., for the petitioner.

      George D. Brdbson, Esq., for the respondent.
   OPINION.

Love :

This proceeding is for a redetermination of a deficiency in income taxes for the year 1925, in the amount of $18,735.64. The decedent, David Afremow, was a resident of Miami, Florida, and died on February 6, 1928. This proceeding was brought by Sarah Afremow, the duly appointed executrix of the estate of David Afremow.

The issues are:

(1) Whether the profit of $3,313.98 from the sale of Lot 15 Block 46 belonged to decedent as determined by -the respondent or to decedent’s wife as originally reported;

(2) Whether the profit of $17,935.85 from the sale of Lots 9, 10 and 11 of Block 96 belonged to decedent as determined by the respondent or to decedent’s wife as originally reported;

(3) Whether the profit of $1,875 from the sale of a one-half interest in an option on Lot 7 of Block B and Lots 6, 7 and 8 of Block 56 belonged to decedent as determined by the respondent or to decedent’s wife as originally reported;

(4) Whether the profit of $1,500 from the sale of a one-half interest in an option on Lots 11 and 12 of Block 51 belonged to decedent as determined by the respondent or to decedent’s wife as originally reported;

(5) Whether the rent of $1,606.81 from Lot 4 of Block 87 (Jefferson Avenue Property) belonged to decedent as determined by the respondent or to decedent’s wife as originally reported;

(6) Whether the profit of $25,555.44 from the sale of Lots A, 11, 12, 13 and 14, Mirado Court, belonged to decedent as determined by respondent; and, if so, whether such profit should be reduced due to an excessive valuation by respondent of three purchase money mortgages, totaling $30,000, which were received by decedent as part of the selling price;

(7) Whether the respondent erred in including in decedent’s income an item of $25,000 received by decedent in connection with a 99-year lease;

(8) Whether the respondent erred in valuing decedent’s one-half interest in a second mortgage of $50,000 received from the sale of Lots 1,2 and 3 of Block 10;

(9) Whether the respondent erred in valuing decedent’s one-half interest in a second mortgage of $14,000 received from the sale of Lot 8 of Block 10;

(10) Whether the respondent erred in valuing a second mortgage of $135,000 received by decedent from the sale of Lots 13, 14, 15 and 16 of Block 104; and

(11) Whether the respondent erred in disallowing an amount of $8,400 claimed by decedent as a loss in a transaction with one B. F. Schoenberg.

We will discuss the issues in the order set forth above.

1.. and 2. The first two issues will be considered .together. The profit of $21,249.83 in question in these two issues was reported by Sarah Afremow (wife of decedent) in her individual income-tax return for the calendar year 1925. The respondent determined that such profit belonged to decedent and included it in his taxable net income.

Petitioner offered in evidence copies of three deeds which disclosed that the legal title to all of the property involved in these two issues was in the name of Sarah Afremow before its sale in 1925. In addition to this evidence decedent’s wife testified that when she came to this country from Bussia she had about $10,000 of her own; that on the day of decedent’s death they had been married about thirty-five years; that the property here in question was her separate property; that her husband was her agent in buying and selling property for her; that he looked after all of her business; that he would take her out to see certain property and if she liked it he would buy it, “ if he thought he could make me some money ”; and that she always trusted him. When asked if anyone else had an interest in the property in question before it was sold in 1925, decedent’s wife answered “No sir, it was my money that was used to buy it. It was my own property.”

Article 11, section 1, of the Constitution of the State of Florida, provides as follows:

All property, real and personal, of a wife owned by her before marriage, or lawfully acquired afterward by gift, devise, bequest, descent, or purchase, shall be her separate property, and the same shall not be liable for the debts of her husband without her consent given by some instrument in writing executed according to the law respecting conveyances by married women.

The respondent concedes that under the laws of the State of Florida a married woman can acquire and possess property, the income from which is recognized as her property, but contends that the record in the instant proceedings does not support a finding that the wife had a separate estate in the property sold. We are not in accord with this contention. In our opinion the record clearly shows that the decedent’s wife owned the property that was soil and that the decedent sold such property for his wife as her agent. We, therefore, find as a fact that, the income in question of $21,249.83 belonged to decedent’s wife and that the respondent erred in determining it to be the income of the decedent.

3. and 4. The third and fourth issues will be considered together. The profit of $3,375 in question was reported by decedent’s wife in her individual income-tax return for the year 1925. The respondent determined that such profit belonged to decedent and included it in his taxable net income.

The evidence offered by petitioner with respect to these two issues is too meager to warrant us in disturbing the respondent’s determination relative thereto. Regarding the third issue, this evidence consisted of a ledger sheet taken from the books of decedent. It was captioned “ Mrs. Sarah Afremow, Mr. Morris Tipp — Statement of Settlement of Lot 7 — Block B, Lots 6-7-8 Block 56.” The debit side of the account was as follows:

Aug. 27, 1925 Binder- $425.00
“ - 840.00
$1, 265. 00
Profit_ 3, 750.00
$5,015. 00
Mrs. Afremow profit-$1, 875. 00

The credit side of the account showed a check of $3,015 and notes of $2,000 (or a total of $5,015) as received in August, 1925. No evidence was offered as to who furnished the option money. The accountant who prepared the returns for decedent and his wife testified that he wrote to Morris Tipp in Chicago, but received no reply; that he searched through decedent’s papers, but could find nothing on this transaction; and that he was advised by the clerk of the Broward County Court that he had no record of such an option. Mrs. Afremow testified regarding the fourth issue as follows:

Q. 10. Do you remember whether or not in 1925 you had any transaction with Mr. Tipp with regard to lots 11 and 12, Block 51 Hollywood property where you had an option on it?
A. I do not remember. I remember Mr. Tipp. My husband used to tails: to Mm. I do not know what. I do not know what was going on.
Q. 11. Do you remember owning an option on lots 11 and 12, Block 51 in Hollywood with Mr. Tipp?
A. I remember this Mr. Tipp but I do not remember what it was.
The respondent’s determination as to issues 3 and 4 is sustained.

5. The evidence offered in connection with the fifth issue is substantially the same as was offered in connection with the first two issues. On May 19, 1925, Carl E. Schirmacher deeded the property in question to Sarah Afremow. It was part of her own separate estate and the income of $1,606.81 belonged to her and not to the decedent. The respondent erred in including such income in the taxable net income of the decedent.

6. Regarding the sixth issue petitioner now concedes that any profit from the sale of the lots in question belonged to decedent, but contends that three purchase money mortgages received in the transaction were overvalued by the respondent. The respondent contends that the pleadings do not put in issue the valuation of the mortgages, and, if they do, the fair market value of such mortgages was equal to their face value.

Assignment of error 4 B (second paragraph) is as follows:

Tbe Commissioner, in fact, included as income to tbe above named taxpayer all of the income of Mrs. Sarah Afremow aggregating $44,056.30, according to tbe agent’s report, although the property from which this income was derived belonged to Mrs. Sarah Afremow.

The amount of $25,555.44 involved in this issue constitutes a part of the $44,056.30 mentioned in the assignments of error. The petition might be more specific than it is, but in substance it alleges that the respondent erred in including any part of the $25,555.44 in the decedent’s income. Petitioner now concedes that a part of the $25,555.44 was correctly included and contests the balance, but for a different reason. Counsel for the respondent did not object when the evidence as to the value of the mortgages was offered. In fact he cross-examined petitioner’s witnesses as to such value. Under the circumstances we will consider the pleadings as placing in issue the fair market value of the three purchase money mortgages, to wit:

Face value of Property sold mortgage received
Lot A_$20, 000
Lots 11 and 12_ 5,000
Lots 13 and 14_ 5, 000

The provisions of the statute involved in this and the remaining issues where the “ fair market value ” of mortgages is considered are subdivisions (a) and (c) of section 202 of the Revenue Act of 1926, which are as follows:

(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 realtáed 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 mnount realised. [Italics supplied.]
(c) The amount realised from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. [Italics supplied.]

The property in the instant issue was sold for a consideration of cash and the three purchase money mortgages. The respondent determined that the fair market value of such mortgages was equal to the face value thereof, namely, $30,000. The petitioner contends that the fair market value of such mortgages was only a total of $15,000. The burden of proving a lesser value than determined by the z-espondent rests upon petitioner. Burnet v. Houston, 283 U. S. 223; Botany Worsted Mills v. United States, 278 U. S. 282; Reinecke v. Spalding, 280 U. S. 227; and Niles Bement Pond Co. v. United States, 281 U. S. 357.

The evidence offered by petitioner on this and the remaining issues wherein the fair market value of mortgages is concerned, consists of‘the testimony of Stephen It. Crawford and C. A. Avant, two financiers of Miami, who were acquainted with all of the property covered by all of the mortgages as to which they testified. Crawford was president of the Mortgage and Management Corporation and in 1925 he was managing vice president of the Miami Mortgage and Guaranty Company and had supervision of all of the company’s affairs. He did practically all of the appraising of property for loans. He was connected with this company from 1920 to 1930, during which period the company loaned between six and seven million dollars in Miami. Avant is in the loan and insurance business. He is vice president of the Seminole Bond and Mortgage Company, a Miami concern that was incorporated in 1921. Avant went to Miami in 1914 and was familiar with the mortgage market in Miami in 1925. His present duties are buying and selling mortgages and real estate, and writing various kinds of insurance. As will later appear from our ultimate findings of value in each of the issues where the fair market value of mortgages is involved, we have given full credence to the testimony of petitioner’s two witnesses, but have also considered such other evidence in the case as the selling price of the property in question, the amount of cash and first mortgages received, and the original cost to petitioner’s husband where such was disclosed.

Regarding the $20,000 mortgage taken in connection with the sale of Lot A, Crawford testified that it probably could have been sold for around 75 cents on the dollar, but certainly not to exceed 80 cents on the dollar; that on a speculative market it might have been sold at somewhere between 90 and 95 cents on the dollar; and that a more definite market was around 75 cents on the dollar. Avant testified that it was his opinion “ that this mortgage could have been sold at approximately 50% of the face value.” The respondent offered no evidence as to the value of the mortgages involved in this or the remaining issues. We find as a fact that the fair market value of the $20,000 purchase money mortgage received by decedent in 1925 as part consideration for the sale of Lot A, Mirado Court was $15,000.

Eegarding the $5,000 mortgage taken in connection with the sale of Lots 11 and 12, Crawford testified that these lots were about 40 by 55 feet each; that they were vacant and unimproved; and that on a speculative sale one could not have realized any more than 40 cents on the dollar for that mortgage. Avant testified that “ There was practically no demand for the sale of mortgages on vacant property at that time, but the mortgage could possibly have been sold for 25% of its face value in July, 1925.” We find as a fact that the fair market value of the $5,000 purchase money mortgage received by decedent in 1925 as part consideration for the sale of Lots 11 and 12, Mirado Court, was $2,500.

Eegarding the $5,000 mortgage taken in connection with the sale of Lots 13 and 14, Crawford testified that these lots were a little larger (about 55 by 60 feet); that there was a cheap garage apartment on Lot 13; and that you could probably get a little more for that mortgage, perhaps as much as 50% as a speculative purchase.” Avant believed “ The mortgage could possibly have been sold at from $2,500.00 to $3,000.00.” We find as a fact that the fair market value of the $5,000 purchase money mortgage received by decedent in 1925 as part consideration for the sale of Lots 13 and 14, Mirado Court, was $3,000.

7. Petitioner in her brief concedes that the respondent’s determination as to the seventh issue was correct.

8. On April 1, 1925, decedent and one Fabian Eandel sold Lots 1, 2 and 3 of Block 10 to one Joseph Yarbalow for a total consideration of $125,000, itemized as follows:

Cash- $35,000
First mortgage assumed_ 40, 000
Second mortgage notes received- 50,000
Total- 125,000

Decedent owned a one-half undivided interest in the transaction. The respondent determined that the fair market value of decedent’s one-half interest in the second mortgage notes was equal to their face value, and further determined that decedent realized a taxable profit on the transaction of $25,160.48, as follows:

Amount realized:
Cash_$17, 500.00
First mortgage assumed- 20, 000. 00
Second mortgage notes_ 25, 000.00
Total_ 62, 500. 00
Deduct basis:
Cost and improvements less depreciation_ 37,339.52
Taxable profit_ 25,160.48

Decedent on his return reported a taxable profit of $160.48, and in so doing he treated the second mortgage notes as having no fair market value. Petitioner contends that decedent’s treatment of the transaction on his return was correct.

Upon the entire record we find as a fact that the fair market value of decedent’s one-half interest in the second mortgage of $50,000 received as part consideration for the sale of Lots 1, 2 and 8, Block 10, was $5,000.

9. During the year 1925 decedent and one F. Handel sold Lot 8 of Block 10 for a total consideration of $30,000, itemized as follows:

Cash_$10,000
First mortgage assumed- 6, 000
Second mortgage notes received- 14, 000
Total consideration- 30,000

Decedent owned a one-half undivided interest in the transaction. The respondent determined that the fair market value of decedent’s one-half interest in the second mortgage notes was $2,833.33 and further determined that decedent realized a profit on the transaction of $5,333.33, as follows:

Amount realized:
Cash_$5,000.00
First mortgage assumed- 3, 000. 00
Second mortgage notes- 2, 333.33
10, 333.33
Deduct basis:
Cost in 1921. 5,000. OO
Taxable profit_ 5, 333. 33

Decedent on his return reported a taxable profit of $3,000 and in so doing he treated the second mortgage notes as having no fair market value. Petitioner contends that decedent’s treatment of the transaction on his return was correct.

Upon the entire record we find as a fact that the fair market value of decedent’s one-half interest in the second mortgage of $14,000 received as part consideration for the sale of Lot 8 of Block 10 was $1,000.

10. During the year 1925 decedent sold Lots 13, 14, 15 and 16 of Block 104 for a total consideration of $215,000, itemized as follows:

Cash_$65, 000
First mortgage assumed_ 75, 000
Second mortgage notes received- 135, 000
Total consideration_ 275,000

The respondent determined that the fair market value of the second mortgage notes was $33,250, and further determined that decedent realized a profit on the transaction of $38,180.35, as follows:

Amount realized;
Cash_$65,000.00
First mortgage assumed_ 75, 000. 00
Second mortgage notes- 33, 250.00
Total_ 173,250.00
Deduct tasis ;
Cost in 1925 and expenses_ 135, 069. 65
Taxable profit_ 38,180. 35

Petitioner contends that the second mortgage notes received by the decedent in the transaction had no fair market value. The decedent so treated the notes in his income-tax return.

Upon the entire record we find as a fact that the fair market value of the second mortgage of $135,000 received by decedent in 1925 as part consideration for the sale of Lots 13, 14, 15 and 16 of Block 104 was $25,000.

11. In connection with the eleventh and last issue, petitioner in her brief states that she concedes the item not because the respondent was correct, but because, due to decedent’s death and the inadequacy of his books, she is unable to offer the required proof.

The deficiency should be redetermined in accordance with this opinion.

Judgment will be entered under Bule 60.


author: Lansdon:

text:
    West Texas Refining & Development Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Col-Tex Refining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 43547, 45653, 46633.
    Promulgated April 25, 1932.

      Charles H. Garnett, Esq., and Walter G. KirTcbride, Esq., for the petitioners.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent has determined that the transfer of assets by the West Texas Company to the Col-Tex Company was a sale from which the West Texas Company realized a gain of $58,-830.61. The petitioners contend that such transfer was pursuant to a plan of reorganization and that no gain should be recognized under the provisions of section 203 of the Eevenue Act of 1926.

The petitioners argue that immediately after the transfer of assets by the West Texas Company to the Col-Tex Company, the former owned all of the outstanding capital stock of the latter; and that the Standard Oil Company became a stockholder thereafter when stock was delivered to it. We think the record fails to support such a contention. All of the transactions set forth in our findings were pursuant to a plan of organization conceived by the parties prior to the contract of June 2, 1925, and set forth in detail at the stockholders’ meeting of the West Texas Company on September 3, 1925. Such plan of organization was completed by delivery of stock to the Standard Oil Company for $184,771.34 in cash, which was then paid to the West Texas Company in accordance with the agreement between that company and the Col-Tex Company. We think the provisions of section 203 are applicable as of the date the plan was completed. Where there are several steps to be taken in effecting the organization of a new corporate enterprise, it is impossible to have them all occur at the same instant. One step must precede another and we do not think the language of section 203, “ immediately after the transfer,” intended that questions of tax liability should be determined by the fact that a transfer of property occurred a few days before cash was paid in, when both are essential steps in the plan of organization. Cf. George G. Moore, 19 B. T. A. 364.

We conclude that, at the determinative date, stock of the Col-Tex Company was owned 50 per cent by the West Texas Company and 50 per cent by the Standard Oil Company. There was no reorganization within the meaning of section 203 of the 1926 Act. Cf. Erle P. Halliburton et al., 25 B. T. A. 1045.

It remains for us to determine whether the Col-Tex Company is liable under section 280 of the Revenue Act of 1926 as a transferee of assets of the taxpayer. The petitioner contends that it was a purchaser for value and that no liability at law or in equity attaches to such a transaction. The respondent contends that the Col-Tex Com® pany acquired assets having a value of $314,969.80 in exchange for $184,771.34, in cash and its own capital stock; and that it was not a purchaser for value, since it acquired the property for less than a fair consideration.

We have heretofore held that where a new corporation acquires all the assets of a taxpayer in exchange for common stock which is delivered to the taxpayer the new corporation is liable as transferee to the extent of the value of the assets received. Signal Gasoline Corporation, 25 B. T. A. 861, and Waterproofed Products Co., 25 B. T. A. 648. In those cases the assets were acquired subject to the liabilities. Here the taxpayer transferred its assets in exchange for stock and an amount of cash which was insufficient to satisfy its liabilities. Unless certain of the creditors are allowed to follow the assets into the transferees’ hands they will be forced to substitute as security for their debts corporate stock of a speculative value. The courts have repeatedly held that a creditor may not be forced to give up tangible assets as security for his debt and thereafter look for payment to shares of corporate stock. Jennings Neff & Co. v. Crystal Ice Co., 128 Tenn. 231; 159 S. W. 1088; Altoona v. Richardson, 81 Kans. 717; 106 Pac. 1026; Hibernia Insurance Co. v. St. Louis & New Orleans Transportation Co., 13 Fed. 516; American Railway Express Co. v. Commonwealth, 190 Ky. 636; 228 S. W. 433; Grenell v. Detroit Gas Co., 112 Mich. 70; 70 N. W. 413; Chicago I. & S. R. Co. v. Taylor, 183 Ind. 240; 108 N. E. 1.

The depreciated cost to the taxpayer of the assets transferred was $314,969.80 and we have found that on the date of the transfer the assets had a value equal to the depreciated cost. The cash consideration paid of $184,771.34 can not be held to be a fair and adequate payment for assets having a value of $314,969.80. We think the Col-Tex Company is liable as a transferee for taxes due from the West Texas Company for 1925.

Decision will be entered for the respondent.

       Sec. 203. (a) upon the sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
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      (b) (3) No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan’ of reorganization, solely for stock or securities in another corporation a party to the reorganization.

        *******

      (e) If an exchange would be within the provisions of paragraph (3) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then—
      (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, but
      (2) If the corporation receiving such other property or money does not distribute it in pursuance of the plan of reorganization, the gain, if any, to -the corporation shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not so distributed.

        (h) As used in this section and sections 201 and 204—
      (1) The term “ reorganization ” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor or its stockholders, or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
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      (i) As used in this section the term “ control ” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.